By Maria Zehra, Ph.D. candidate. at Jamia Millia Islamia – Share investment is permissible under Islamic principles but with certain restrictions. When an individual makes an equity investment, that individual automatically obtains a proportionate ownership stake in the company. The process of determining whether or not a company’s equity is suitable for investment by comparing it to shariah criteria developed by experts in the field of shariah is known as shariah screening.
The shariah screening process classifies into two broad steps:
1. Business screening/Industry-based screening
The screening is qualitative. At this stage, we analyse the company’s active industry. We will only move on to the following screening stage if the company’s industry complies with Shariah law. Companies that, among other things, deal in selling pork, alcohol, gambling, betting, tobacco, adult entertainment, cloning, conventional banking, and advertising and media that do not comply with shariah law are included in this category. These spheres of the economy are generally acknowledged to lack compliance standards.
2. Financial screening/Accounting based screening
This screening is quantitative. At this stage, we analyse the company’s financial accounts to determine whether or not they comply with the accounting rules and methods based on shariah. This includes the items listed below:
1. Shariah abhorrent debt to total assets
2. Shariah Abhorrent income(including questionable income) to total revenue
3. Extent of cash and cash receivables
Although countries and Islamic financial institutions use the same financial screening criteria for the shariah screening of stocks, different indices and countries have adopted different shariah screening norms regarding specifications tailored to their country’s nature and circumstances. This is despite countries and Islamic financial institutions using the same fundamental financial screening criteria.
Similarly, several nations and organisations have distinct ways of dealing with the limitations placed on the amount of money created through activities that do not comply with regulations.
Governments or Islamic financial institutions where the activity took place are responsible for establishing a ceiling for the income generated from business activities that are not per Islamic law.
There are generally two perspectives on this:
- According to some analysts, the restriction is unnecessary when the number of non-Islamic business activities is negligible, and the company engages in them indirectly. If the constraint can’t be avoided, only the firm’s most significant transactions must be monitored to determine if it is prohibited or permitted.
- According to another viewpoint, this shariah limit is necessary to protect Muslims from participating in forbidden actions such as interest or debt.
Related: Towards a Higher Shari’ah Compliance
A summary of the criteria for shariah screening used by different countries and Islamic financial institutions on the subject of the cap on income from non-compliant business activities has been included below:
- S & P Shariah Screening Norm
They have adopted a 5% cap while screening income from non-compliant activities, excluding the interest. Interest is not included because they have another screening of cash plus interest-bearing securities to be less than 33% of average market value over thirty-six months.
AAOIFI also uses a 5% cap. Total income from prohibited elements should not exceed 5% of the company’s total income.
- FTSE Shariah Screening Norm
In its financial screening, FTSE uses 5% cap criteria to exclude income from non-Islamic activities. Income from non-Islamic activities should not be more than 5% of total revenue.
- National Commercial Bank, Saudi Arabia
The Kingdom of Saudi Arabia also uses the same 5% cap on income from non-Islamic activities. Income from non-Islamic activities should not be more than 5% of total income.
- Dubai Financial Market, UAE
DFM uses a 10% cap when screening ‘impure income.’ Impure income should not exceed 10% of the company’s total income.
- Karachi Stock Exchange Meezan Islamic Index
While screening non-compliant income, KMI also uses the 5% cap. Per their criteria, income from non-Islamic activities should not be more than 5% of gross revenue.
- National Stock Exchange(NSE) Shariah Index, India
The NSE imposes a lower cap on income from non-Islamic activities. This cap was issued and recommended by the Mumbai-based Islamic finance institution, ‘Tasis.’ According to this, interest income plus returns on all non-compliant investments should be less than or equal to 3% of total income. They backed up their advice with research showing that even with a 3% cap, various enterprises are accessible that fall under the Shari’ah compliance list.
The SEC employs a somewhat different screening structure. It excludes from its business shariah screening stage those businesses that earn more than 5% of their revenue from plainly banned activities. They allow a 5% tolerance for income from conventional banks, conventional insurance, non-compliant entertainment, alcohol, pork (and pork-related activities), gambling, non-halal food, non-halal beverages, tobacco (and tobacco-related activities), and other income deemed to be shariah non-compliant. Additionally, they allow for a 20% tolerance for other dubious non-Islamic revenue, such as income from resorts, hotels, stockbroking, share trading, rentals from non-compliant activities, and other activities deemed non-compliant by Shari’ah norms.