Self-Instruct
The corrected Islāmic return or Isc percentage represents the exact amount of profit generated by an investment or loan. It is an essential concept in Islāmic finance, and it is used to determine the amount of profit that borrowers and investors owe to the financial institution under Islāmic principles.
Sharia law requires that profit earned through any financial transaction must be shared fairly by all parties involved. It prohibits the payment of interest or any other form of usury to ensure that wealth is distributed in an equitable manner among all participants.
This is where the concept of the Isc percentage comes in. It is the agreed-upon profit rate that is shared between the borrower and the financial institution. This ensures a fair distribution of profit and loss sharing between the two parties.
Understanding How Isc Percentage is Calculated
The first step in calculating the Isc percentage is to determine the principal amount being invested or borrowed. This is the initial amount of money that is being lent out or borrowed.
Next, one must determine the length of the investment or loan in terms of days, months, or years. This time period is critical as it determines the duration of the investment or loan and the profit that can be earned or paid.
After determining the duration of the investment or loan, the next step is to determine the net profit earned by the financial institution through the transaction. This is done by subtracting the bank's expenses from the sum of all incoming payments.
Finally, the Isc percentage is calculated by dividing the net profit earned by the financial institution by the total amount of the investment or loan, which results in a percentage value.
For example, if a financial institution has lent out $10,000 to a borrower for a period of one year and the net profit earned by the institution is $1,000, then the Isc percentage would be ten percent.
Calculating the Isc Percentage in Practice
Let us look at how to calculate the Isc percentage for an automobile loan to process how the calculation of Isc is put into action.
Step 1: Determine the Principal Amount
Assume you are purchasing a new car that costs $20,000, and you need to secure financing from an Islāmic bank. This $20,000 amount represents your principal investment or loan amount.
Step 2: Determine the Duration of the Loan
Next, you should determine the time frame for your loan repayment. For this example, we will say that you have a 60-month repayment plan.
Step 3: Determine the Net Profit for the Bank
The next step requires us to determine the bank's net profit earned for this transaction. To do this, we must subtract all of the bank's expenses associated with the loan (such as administrative fees, processing fees, and closing costs) from the total amount of payments made over the 60-month period.
Assume that the administrative cost of processing your application is one percent of the loan amount, or $200 – this is deducted from the $20,000 principal amount, leaving you with $19,800. We'll also assume an annual fee of $50.
Therefore, the total revenue earned by the bank = Total loan payments – administrative costs - annual fees = $24,000 - $200 -($50*5) = $23,750.
The total profit earned by the bank = Total revenue - the principal loan amount = $23,750 - $19,800 = $3,950.
Step 4: Calculate the Isc Percentage
The final step is to determine the Isc percentage by dividing the net profit earned ($3,950) by the total amount of the investment or loan ($20,000) and multiplying it by 100 to convert the decimal to a percentage.
Isc percentage = (Net Profit/Principal Amount) x 100 = ($3,950/$20,000) x 100 = 19.75%
Therefore, based on this calculation, the correct Isc percentage for a 60-month automobile loan of $20,000 from an Islāmic financial institution is 19.75%.
Conclusion
Calculating the Isc percentage is an essential concept in Islāmic finance, and it ensures that profits and losses are shared fairly between the financial institution and the investor or borrower. The calculation is dependent on the principal amount, duration of the investment or loan, the net profit earned by the financial institution, and it is expressed as a percentage of the investment or loan amount. A thorough understanding of this calculation can help investors or borrowers evaluate and compare different types of financing options, thereby making informed financial decisions in the dynamic world of Islāmic finance.