What is Participation Finance?
The ban on interest constitutes one of the main pillars of Islam concerning economic and financial activities. For this reason, participation finance was named interest-free finance in Türkiye. On the other hand, the injunctions and prohibitions of Islam regarding economic and financial transactions include other distinct pillars such as the prohibition of gharar, the prohibition of ethically dubious financial activities and the prohibition of selling what is not owned. Avoidance of interest is a necessary but not a sufficient condition. There are still products, services and transactions that are interest-free but not considered within the scope of participation finance. In this regard, the phrase “interest-free finance” is a restrictive term.
Furthermore, it is a common perception in the society that the notion of interest-free finance results in a financial structure that does not provide any returns. Providing that participation finance system focuses on real sector and is based on risk-sharing, it has the potential to offer returns higher than the interest rates offered by the conventional financial system. Reshuffling from the current nomenclature of interest-free finance to that of participation finance can contribute to the formation of a more positive perception and expansion of the customer base.
Participation finance refers to an umbrella term covering all sectors that operate in compliance with the tenets of participation finance, including the interest-free principle, as well as the products, services and transactions offered by these sectors. It is a financial system that works in compliance with tenets of participation finance within the framework of participation finance tenets and purpose-oriented principles and includes products, services, activities and institutions that prioritize purpose-oriented principles.
The Tenets of Participation Finance
The tenets of participation finance are the basic pillars, which can also be considered as the constitution of the participation financial system. They determine whether an institution, an organization, a product or service and a transaction will be included within the scope of participation finance. The tenets of participation finance are based on Islamic law. Unlike other areas such as ibadah (worship), the basic rule in Islamic law with respect to economic and financial matters is to determine the prohibitions and restrictions, and grant freedom for the rest to the parties. The tenets of participation finance basically aim to outline the boundaries of the participation financial system by demonstrating the prohibitions and restrictions.
The tenets of participation finance include ijtihadi (jurisprudential) and non-ijtihadi rules and principles. For instance, the ban on interest is a non-ijtihadi topic whereas the existence and the nature of interest in a financial contact is an ijtihadi topic. Furthermore, defining the prohibitions and restrictions as well as the conceptional features of these prohibitions and restrictions may differ among fiqhi schools. Therefore, the conceptualization and details of the tenets in question should be determined by experts or institutions specialized in this area, such as a centralized national Shariah board.
The tenets of participation finance that are commonly accepted in the world are given below for informational purpose:
- Prohibition of interest
- Absence of gharar and jahalah
- Absence of gambling
- Earning based on risk and responsibility
- Prohibited activities
The Purpose-Oriented Principles
The tenets of participation finance basically draw the legal boundaries of the participation financial system. In the Participation Finance Strategy Document, a general framework called “purpose-oriented principles" is also proposed, which complements and supports the tenets of participation finance.
Whereas the tenets of participation finance focus on the legal aspect of the participation financial system, the purpose-oriented principles focus on its impact and outcomes. The rationale behind the formulation of such an approach is to support the effective implementation of the tenets of participation finance and enable individuals and society to reach various economic, social and humanitarian ideals. For instance, the concept of risk-sharing is not among the tenets of participation finance while it is considered as among the purpose-oriented principles. The main reason for this is that a risk-sharing financial system contribute more to achieving a just, sustainable, and strong economic growth.
Purpose-oriented principles are intended to include, but are not restricted to, the following dimensions regarding participation finance practices:
- The reduction of the permitted practices based on fiqhi necessity as much as possible and developing alternatives instead of these practices.
- Taking prospective implications and consequences of introducing and approving of a new product on the society, economy and environment into account.
- Execution of participation finance practices in a way that directly supports the real economy and creates a positive social impact.
- Reducing or preventing use of products, services and activities that are fictitious in nature.
- Focusing on products, services and activities that support value creation.
- Aligning the economic substance and the legal form in participation finance practices.
The tenets of participation finance determine the legal boundaries of the participation financial system. On the other hand, the purpose-oriented principles aim at increasing the positive social and economic effects of the products, services and practices that are in compliant with the tenets of participation finance. In this regard, it is important to consider purpose-oriented principles in the formulation of strategies, practices and fiqhi decisions regarding participation finance.
Scope of the Participation Finance
The participation financial system is composed of four main sectors (participation financing institutions, participation capital markets, participation insurance, participation social finance) and sub-sectors, markets or institutions which underlie each sector.
Participation Financial Sectors
* Operating in accordance with the tenets of participation finance
** In the Participation Finance Strategy Document, it is proposed that the nomenclature "participation bank" to be changed to "participation finance house".
The sectors that constitute the participation financial system and their components are summarized as follows:
Participation Financing Institutions (PFI):
- Participation finance houses,
- Participation-based development and investment banks,
- Participation-based saving finance companies.
Participation Capital Markets (PCM):
- Sukuk market,
- Participation-based money and foreign exchange markets,
- Participation-based stock exchange market,
- Participation-based investment funds,
- Participation-based angel investing,
- Participation-based venture capital,
- Participation-based crowdfunding, etc.
Participation Insurance (PI):
- Participation insurance companies,
- Participation reinsurance companies,
- Participation-based private pension system,
- Participation-based auto enrollment system.
Participation Social Finance (PSF):
- Waqf (participation-based operating),
- Qard al-hasan,
- Participation-based microfinance