Sukuk is a Sharia-compliant (Islamic religious law) investment option that provides halal (permissible) income for Muslims, as it avoids interest which is considered haram (non-permissible) in Islam, making it an alternative to traditional Western investing.
Western bonds are considered haram in Islam due to the prohibition of exploitative actions and the emphasis on ethics. Interest payments on bonds are considered riba, and making profits by lending money is considered unethical. Interest payments only benefit the recipient of the capital, leading to a cycle of debt for the poor and increased wealth for the rich. Hence, sukuk provides a Sharia-compliant alternative for Muslims to borrow money for personal or business reasons without incurring sin.
So, what are the two main differences between Sukuk and Western bonds?
Well firstly, Sukuk ensures the lender bears some risk, unlike regular bonds where the borrower’s creditworthiness determines the risk. The Sukuk lender cannot guarantee the security’s full investment return or establish a predetermined price, while conventional bondholders receive regular repayments based on a fixed interest rate.
Secondly, Sukuk repayment is linked to the profitability of underlying assets – the lender receives a profit based on asset performance and shares in any potential loss. In contrast, conventional bonds have regular repayments over their lifetimes independent of the borrower’s profit or loss.
After all this, you must be thinking, what makes sukuk a good investment?
Firstly, they can be an excellent way to diversify your portfolio – their stable returns can reduce overall risk and volatility in your portfolio. Secondly, sukuk is tradeable, allowing investors to liquidate their investments quickly and easily. Thirdly, sukuk promotes economic development and monetary stability by ensuring that every financial activity is backed by real economic activity.
You must also be wondering if Sukuk affects global markets and if yes, how?
Sukuk is certainly connected with global markets – when issued, it can increase market liquidity as it attracts investors who otherwise may not have invested in conventional bonds, thus increasing demand and liquidity. Speaking of investors, Sukuk attracts a more diverse group of investors, mainly those from the Middle East and Southeast Asia where Islam is most prominent. As more than one demographic of investors is relied upon, this creates a stable market.
Despite its advantages, sukuk has some common concerns. It is subject to financial risks just like conventional bonds, including credit, rate of return and foreign exchange risk. Additionally, it is taxed differently from conventional bonds in certain regions, impacting tax payments.
Furthermore, only halal transactions qualify for sukuk investment – non-compliance can limit the borrower’s ability to deal with or sell the asset.
I’m not a Muslim, is Sukuk even relevant to me?
Definitely! Sukuk provides ethical investment opportunities to everyday people like you and me, whilst allowing us to diversify our investment portfolios. Sukuk also helps promote financial inclusion by providing access to investing to individuals who may not have had the opportunity to do so. Furthermore, anyone doing an economics/finance degree should also be aware of how Sukuk has a significant impact not just on global markets but on emerging economies too. It increases capital inflows from investors who are interested in investing in emerging markets but are hesitant to use traditional methods to do so. Greater capital inflows mean more capital for infrastructure projects which can spur economic growth. Moreover, Sukuk minimises risk in emerging markets by converting assets into securities, reducing exposure to market risk and potentially improving the credit rating of governments and corporations.
In essence, sukuk provides halal investment options to Western bonds with similar returns. However, it is important to conduct personal research before investing in sukuk, as there are various disadvantages that must be considered.
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