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Financial Engineering: An Islamic Perspective

Financial Engineering: An Islamic Perspective. Sami Al-Suwailem IRTI, IDB Rabie I, 1427 -- April, 2006. Concept. Finnerty (1988): Design, development and implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance.

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Financial Engineering: An Islamic Perspective

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  1. Financial Engineering:An Islamic Perspective Sami Al-Suwailem IRTI, IDB Rabie I, 1427 -- April, 2006 Financial Engineering

  2. Concept Finnerty (1988): • Design, development and implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance Financial Engineering

  3. Definition • Principles and strategies for developing innovative financial solutions Financial Engineering

  4. Characteristics • Principles: Goals and rules for economic transactions • Strategies: methods and techniques • Innovative: New and novel • Solutions: Satisfy real needs and create added value Financial Engineering

  5. State of F.E. • Miller: Regulatory arbitrage • Drucker: Products became commodities Financial Engineering

  6. Creativity • Value of innovation • Lateral thinking • Value of constraints • Shariah and creativity Financial Engineering

  7. Principles • Objectives • Balance • Integration • Methodology: • Acceptability • Consistency Financial Engineering

  8. Principle of Balance • Balance for-profit and non-profit activities • Capitalism: market-based solutions • Communism: voluntary-based solutions • Islamic Economics: balanced solutions • Forbearance for unable debtors • Mutual insurance Financial Engineering

  9. Principle of Integration • Integration of financial for-profit activities with real business • Riba: Separates finance from business • Gharar: Separates risk from business • Murabaha: Could be applied to both Financial Engineering

  10. Principle of Acceptability • All economic transactions are acceptable unless otherwise stated • Roots of prohibited dealings: Riba and gharar. • Acceptability and creativity Financial Engineering

  11. Principle of Consistency • Form and substance of Islamic products must be consistent • Evaluation of products: • Evaluate substance • Evaluate form Financial Engineering

  12. Product design Evaluation no Substance acceptable? revise yes no Form acceptable? yes Product acceptable Financial Engineering

  13. Examples • Murabaha: objective is a sale • Tawarruq: objective is a loan Financial Engineering

  14. Strategies • Where to start? • From conventional products: Imitation • From Islamic products: Mutation • From real needs: Satisfaction Financial Engineering

  15. Imitation • Replicate conventional products • Give form priority over substance • Islamic industry becomes a follower • Invite alien problems • Produce inefficient results Financial Engineering

  16. Mutation • Start from Islamic products • Genetic Algorithms • Istisna • Lease-to-own • Value-based Salam Financial Engineering

  17. Satisfaction • Start from real needs • What does the borrower need? • Cash is 10% of money • Most transactions are electronic • Money is a means • Efficiency of Islamic finance Financial Engineering

  18. Conclusion • Thinking out of the box • Preserve the spirit of Islamic finance • Provide solutions to world economy Financial Engineering

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