Understanding corporate finance: raising finance: alternative finance
Islamic finance is a way of purchasing assets, raising capital, making a deposit or investing without taking out a conventional loan involving interest. It is based on Shari’a law and in particular the law that the payment and receipt of interest is forbidden. The prohibition on interest is partly based on the idea that money on its own must not generate a profit. To earn a return from their money the capital owner must undertake some of the risk in the enterprise that is using the money. The payment of interest would not encourage the capital owner to undertake such a risk.
Certain Islamic contracts equate economically to conventional finance. This was recognised in FA2005 which provided that certain of the more common Islamic finance contracts that equate to loans and savings accounts, when provided by financial institutions are treated in the same way for both customers and the financial institution as conventional finance. The contracts do not need to be Islamic: as long as they meet the requirements of the rules in FA2005 they will be brought into the loan relationship legislation. The legislation refers to these as ‘alternative finance arrangements’. See CFM44000 for more details.
CFM11130 provides an overview of the types of Islamic finance contract that come within the loan relationships legislation.