Archive for Islamic Finance Stock Screening
According to Amanie, there are two main methods for Islamic stock screening including the Malaysian and the Global approach. In the Malaysian approach, one examines the core-activities and non-halal income while in the Global approach, one examines the core activities, non-halal income as well as the interest expense and the ratio of liquid assets to illiquid assets.
Stock Screening (Level 1) Core-Prohibited Activities
The following activities are generally considered core-prohibited activities:
- Conventional financial institutions based on interest (riba) or contractual uncertainty (gharar) – insurance/reinsurance.
- Alcoholic beverages.
- Gaming/gambling/games of chance.
- Pork production.
- Non-halal food products.
- Entertainment and leisure related to pornography or with an adult content.
- Arms, defence, and military equipment manufacturers. (Hallelujah!)
- Tobacco-related products.
- Other activities deemed to be repugnant to Sharia’h principles.
According to Amanie, all of the core-prohibited activities listed above are clearly prohibited in the sources of Islamic law except the arms and tobacco related products. ‘While arms and weapons could be destructive to the society, the tobacco related products are harmful to one’s life and others.’
Stock Screening (Level 2) Financial Ratios
After passing the first level of stock screening, the screening moves to level two, which is basically financial ratio screening. In order to be approved as Sharia’h compliant stock, the company issuing the stock shall not be in one of the following categories:
- A company whose interest-bearing debt, divided by the immediately preceding 12 month average market capitalization (or total assets) exceeds 33%;
- A company whose cash and interest-bearing securities, divided by the immediately preceding 12 month average market capitalization (or total assets) exceeds 33%;
- A company whose cash and receivables, divided by the immediate preceding 12 month average market capitalization (or total assets) exceeds 33%/49%. *This ratio is relevant in making the share tradable on the secondary market – (to avoid exchanging money for money). The AAOIFI Sharia’h Standard on Shares allows shares to be traded even if the liquid assets are more than 49% provided they do not exceed 70%.
*(Non-halal interest income and interest expense is tolerated up to 33% of the total market capitalization or total assets. The Scholars have relied indirectly on one Tradition of the Prophet (PBUH) in giving a will to an outsider which was limited to one third of one’s property.)
Stock Screening (Level 3) Non-Halal Income
Non-halal income is generally tolerated up to 5%, which is subject to cleansing out of dividends paid by the company. Non-halal income is generated from non-halal activities such as listed in the core-prohibited activities above. (AMANIE)