2011 IEEE Symposium on Business, Engineering and Industrial Applications (ISBEIA), Langkawi, Malaysia
Foreign Exchange Trading Framework Based On Mudharabah Principle Maheran Mohd Jaffar Ilham Abadi Bin Idris Faculty of Computer and Mathematical Sciences Unversiti Teknologi MARA, 40450 Shah Alam, Selangor, Malaysia
[email protected] [email protected] they will abide therein (forever)”. Further prohibitions are mentioned in several Quranic verses and hadiths.
Abstract— Foreign exchange market is the most liquid and high volatility market. Many researches have been done to improve trading however the trading is mostly done conventionally. Research on foreign exchange trading is very active. Various techniques of forecasting were created. However the most important part is left unwritten: the framework of the trading. Therefore, this paper try to show the proposed foreign exchange framework based on mudharabah principle.
In the modern financial world, the element of usury is normal and taken as a common business practice. According to the Bank Negara Malaysia (BNM), Malaysia is the first country to implement a dual banking system simultaneously where Islamic banking and conventional banking system operates on a parallel basis [4]. BNM took the first step by establishing the basis of two financial systems namely, the system of Islamic finance and the conventional finance system. The first initiative taken by Malaysia in the endeavour of launching Islamic financial system was the establishment of the Perbadanan Wang Simpanan Bakal-Bakal Haji (PWSBH) in 1963. The main purpose for the establishment of this institution was to place savings of muslims who wish to save for their Hajj expenses. When the transaction became bigger which ultimately required better organization, PWSBH and Pejabat Urusan Haji merged in 1969 to form Lembaga Tabung Haji. It was the kick-start for Islamic banking system in Malaysia. According to Association of Islamic Banking Institutions Malaysia (AIBIM) the first Islamic bank in Malaysia was established under the name of Bank Islam Malaysia Berhad (BIMB) in 1983 [5]. Improvement of the systems and various researches has been carried out to ensure the success of the dual banking system policies. Shariah Advisory Council of Bank Negara Malaysia (SAC) was established on 1 May 1997 [6] with the purpose of ensuring that financial companies comply with the Islamic system. To this end Malaysia prides itself by becoming the leader in Islamic financial in this region.
Keywords-component; foreign exchange framework; Islamic foreign exchange, mudharabah, finance
I.
INTRODUCTION
Islam is the religion that was revealed to the Prophet Muhammad p.b.u.h. (peace be upon him), not only specific to the worship part, but includes all aspects of life including morality, faith and syariah. Islam is a way of life (addin) that reveals and is guidance for mankind. The goal is to attain Allah's pleasure. Islam aims at establishing a social order where all individuals are united by bonds of brotherhood and affection like members of one single family. The concept of brotherhood and equal treatment of all individuals in society is meaningless unless accompanied by economic justice such that everyone gets his due for his contribution to society or to the social product and that there is no exploitation of one individual by another. Jabir ibn 'Abdullah reported that Prophet p.b.u.h. said, "Fear injustice. Injustice will appear as darkness on the Day of Rising. Fear avarice. Avarice destroyed people before you and led them to shed one another's blood and to make lawful what was unlawful for them." [1]. One of the ultimate goals of Islam is to protect the rights of all individuals in a society [2]. This was the idea of joint ventures in Islam.
On the other hand, investing in money market such as foreign exchange trading has always been permitted as long as Muslims follow the rules that has been created in order to avoid usury and at the same time gain profit. Many investors see foreign exchange trading as high risk investment. However, albeit its high risk nature, its gain in profit is most of the time is equally high. Islam allows trading and investment but is bounded to certain rules. Any trading carried out must be in accordance with the rules of syariah, known as fiqh muamalat. Islam does not permit the paying and receiving of riba and promotes fairness and equity in trading.
The most basic idea of Islamic trading is to promote equality and fairness. In pre-Islamic era the element of usury or riba present in every transaction. Despite allowing business, Allah strictly prohibits usury. Quoted in the Al-Quran 2:275 [3] which means “Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say: "Trade is like usury," but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are Companions of the Fire;
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Money is a medium of exchange. Long time before money was used, people exchange things using barter system. Barter system is a system which people exchange things with other things which have an equivalent value. Primarily, the values of
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item. In reality, traders rarely trade currency on the spot. The money invested are kept in the market for a few days until the value reaches the amount speculated. This trading is considered as forbidden as it is not traded on the spot as required. According to Jabatan Kemajuan Islam Malaysia (JAKIM) foreign exchange trading contains the element of usury as most foreign exchange trading done by conventional banks are doing Forward FX [10].
things are expressed in term of other things. The benefit of this system is that they can have things that they want in exchange for things they want to part. However, the system depends solely on coincident. The one that they want coincidently is the one that the other party wanted to exchange. Barter system, in most cases, poses more disadvantages than its benefit. When the subject matter for exchange is bulky the exchange is difficult to execute. The exchange of thing using barter system is sometimes unfair as we exchange for things of lower quality than the one we have. The solution of this problem is through the use of a third-party medium of trading using commodities such as gold, silver, etc.
II.
CONVENTIONAL FOREIGN EXCHANGE FRAMEWORK
Framework can be defined as a real or conceptual structure intended to serve as a support or guide in the process of building something useful [11]. In Malaysia, the structure of all banks activities is provided by the central bank [12] in order to promote stability. Basically the structure of foreign exchange trading is shown on figure 1.
Money was the better medium of exchange. The value of money however changes with time. A dollar today may worth more in a year time. This is what we called time value of money. The up and down of currency values are caused by the demand and supply of the currency. This generally is affected by a country's trade and its macro economy policies. The fluctuation of currency encourages more people to invest their money rather than keeping it in the banks. There are many type of investment available, such as bonds, stocks, mutual shares, etc. There are increasing in popularity in money market, especially foreign exchange trading. Bank for International Settlements (BIS) reported that in average, the daily turnover of global foreign exchange markets was estimated around $3.98 trillion [7]. This increases the popularity of foreign exchange trading around the world even in Malaysia. Foreign exchange trading can also be traded 24 hours a day, 5 days a week [8]. This is possible as at any time there will be banks trading currency all over the world.
Foreign Exchange Broker
Local Bank
OTC Inter-bank Market
Local Bank
Client B
Client A
Figure 1. The foreign exchange trading structure Based on the example in Figure 1, the process of foreign exchange started when Client A convert a foreign currency into the domestic currency. In the case of a company sells goods or services to a foreign customer and receives foreign currency, there is a need to convert foreign currency into domestic one. The conversion takes place between the company and its bank. Most of these transactions take place in the over-the-counter (OTC) market which is the inter-bank market.
This market however depends greatly on speculation, as well as other factors. It is a trading which one must trade in pair, the base and the counter currency, where one buy a currency of a country and speculates that the counter currency will be weaken after time. Foreign exchange can be traded in one day and it can also be carried forward. Islamic financial system is dynamic. It changes from time to time without ever changing the fundamental of Islamic teaching. Further researches on Islamic financial system are crucial for the system to survive in these conventional eras. However, nowadays the Islamic system is very well received because it is more favourable compared to the conventional system. In this research, we are going to improve the current framework of Islamic foreign exchange. Such investment is based on Islamic concept of mudharabah which is the focus of this research. Furthermore we are going to forecast the currency prices using stochastic calculus as the nature of the market are undeterministic.
Foreign exchange activity usually traded in derivatives market [13] such as forward, option barrier, and swaps from commercial banks and investment banks or other financial institutions that trade these instruments. However, companies could also deal with an exchange to buy or sell an option contract and to deal in foreign-currency futures. Client
Bank
Mudharabah is a two-party business. The first party act as the capital provider and the other party act as the entrepreneur. The word “mudharabah” means to travel the earth for trade or business. Mudharabah is derived from the word “dharba” which means to travel for trade or business [9]
Voice Broker
Automated Broker
Reuters
Currency in Islam falls in the category of ribawi item. Ribawi item includes grain, rice, gold and silver. To trade ribawi item, there are certain rules to be followed, such as the trading must be carried out on the spot, and should be of the same quantity and this rule only applies to those of the same
Internet
EBS
OTC Interbank Market
Figure 2. Foreign exchange transaction
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In trading foreign exchange banks needs to contact other banks to offer quotes or to gives the best bid. In order to do that, a foreign-exchange broker is needed as an intermediary.
foreign exchange framework based on mudharabah principle is nonetheless to avoid any injustice in trading foreign exchange. This paper also compares the usual framework used by conventional bank in order to show the Islamic part of the framework. Some advantages as well as disadvantages have been found in the framework. Therefore, the proposed foreign exchange framework will be improved in order to cater for the disadvantages.
There are many types of broker; voice brokers, automated broker and internet broker. Previously, most trades took place by telephone where dealer in one bank would call a dealer in another bank and execute a trade. If they did not have access to enough banks to get the currency needed, they would use a voice broker. Reuters initiated the move from voice brokerage to automated brokerage system [14].
This research is funded by the Fundamental Research Grant Scheme (FRGS) Ministry of Higher Education Malaysia, that is managed by the Research Management Institute, Universiti Teknologi MARA 600-RMI/FRGS5/31/FST(26/2008)
Figure 2 illustrates how foreign-exchange dealers at the banks trade foreign exchange. Bank deals with another bank through voice broker or an automated broker such as electronic brokerage system (EBS).
III.
ACKNOWLEDGMENT
REFERENCES
THE PROPOSED ISLAMIC FOREIGN EXCHANGE FRAMEWORK
[1]
As stated before, the buying and selling of currency must be done in spots trading. Thus in the proposed framework, the trading is in spots trading. Next, the sharing of profit between the client and the bank will follow mudharabah principle where the client acts as capital provider and the bank as entrepreneur [15]. The mudharabah concept is used in this case as the whole capital is provided by the client. However if both, the client and the bank, are sharing capital, then musyarakah principle will be used [15]. Figure 3 shows the proposed Islamic foreign exchange framework.
[2] [3] [4] [5] [6] [7] [8]
Client
[9] Mudharabah
[10]
Bank
[11]
Foreign Exchange Broker
[12] [13] OTC Interbank Market
Figure 3.
[14]
[15]
The proposed foreign exchange trading structure
The client gets the profit based on the difference of currency price and the bank gets the profit from interest rate differences thus the division of profit is not fair. Islam proposed a better solution by introducing mudharabah principle. Since the ratio of profit sharing in the mudharabah principle were based on agreed ratio, thus the element of unfairness are eliminated. IV.
CONCLUSION
This paper has proposed a new foreign exchange framework based on Islamic principle. Islam promotes fairness in every aspect of life. Thus, the purpose of proposing the
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Imam Bukhari, Al-Adab Al Mufrad, A Code For Everyday Living: The Example of The Early Muslims. London: UK Uslamic Academy, 2005. Al-Harran, Saad (2003). Musharakah Financing Model [Online]. Available: http://islamic-world.net/economics/musharakah.htm Al-Quran BNM (1993). Bank Negara Malaysia Annual Report 1993 [Online]. Available: http://www.bnm.gov.my/ AIBIM (2010). Islamic Finance [Online]. Available: http://aibim.com/content/view/17/34 BNM (2010a). Shariah Advisory Council of the Bank Negara Malaysia [Online]. Available: http://www.bnm.gov.my/index.php?ch=7&pg=715&ac=802 BIS (2007). Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007 - Final Results [Online]. Available: http://www.bis.org/publ/rpfxf07t.pdf Hee, Y. K., Secrets of FOREX Millionaires. Singapore: Adam Khoo Learning Technologies Group Pte. Ltd., 2008 Al-Jummuah (2010.). Rulings On Partnership Of Mudhaarabah. Retrieved from http://www.alinaam.com/library/business/Mudharabah.htm JAKIM (2010). Ruangan soal jawab Kemusykilan agama [Online]. Available: http://baheis.islam.gov.my/web/musykil_new.nsf TechTarget (2008). Framework [Online]. Available: http://whatis.techtarget.com/definition/0,,sid9_gci1103696,00.html BNM (2010b). Foreign Exchange Administration Website [Online]. Available: http://www.bnm.gov.my/microsites/fxadmin/index.htm Levinson, M., Guide to Financial Market: Fourth Edition. London: Profile Books Ltd., 2005 Reuters (2010). Interactive Brokers Group, Inc. (IBKR.O) [Online]. Available: http://www.reuters.com/finance/stocks/companyProfile?symbol=IBKR. O Maheran (2010), New Musharakah Model In Managing Islamic Investment, ISRA International Journal of Islamic Finance, 2 (2), pp. 25-36. [Online]. Available: http://www.isra.my/publications/journal.html.
