Financing is an indispensable tool of modern life both in personal and business context. As many bigger purchases of modern life require financing for practical reasons, people depend on availability of affordable financing products. Observant Muslims have been constrained in utilizing conventional financing, because Islam prohibits riba, and therefore, on the basis of presumed riba-interest equivalence, usury as well as interest is considered prohibited. 

In a modern economy banking plays the pivotal role for most financing needs of individuals, families and even businesses. Thus it is understandable that as the field of Islamic finance developed, Islamic banking occupied the eminent position among the broad category of Islamic financial institutions.

Understanding Islamic banking and financing must begin with the recognition that Islam considers the entire life of its adherents, including trade and finance, as part and parcel of the religion. Similar to socially conscious investing, Islamic finance is governed by a number of substantive principles based on a number of positive commands (injunctions) and negative commands (prohibitions).

First, according to Islamic law, many sectors or products are specifically prohibited (e.g., gambling, pornography, alcohol, conventional banking/insurance) and therefore no trade or financing can be applied to transactions related to such products.

Secondly, riba is forbidden in Islam. Based on the presumed riba-interest equivalence, interest is also thus regarded as prohibited and all interest-based investments are unlawful according to traditional Islamic law. On the basis of this particular prohibition, all conventional banking and financing based on interest is Islamically regarded as unacceptable.

Thirdly, debt (dayn) or loan is not recognized in Islamic law as a valid form of financing. Since debt/loan is an interest-based instrument, except qard al-hasana (charitable or interest-free loan), Muslims cannot lawfully earn any return or yield from any debt-based instruments. This has generally caused shunning all fixed-return based transactions or depository accounts.

Fourthly, Islamic law subjects all contracts to a set of procedural principles and thus not all types of financing contracts are permissible. Thus, for example, Islamic law does not allow any contractual agreement involving a product which is not in the constructive possession of the seller at the time of the transaction. Also, any contract vulnerable to gharar (excessive uncertainty) or speculation is not permissible either. Furthermore, subject to prohibition of riba, certain commodities such as gold, silver and a number of food staples cannot be traded except in equal measure and on the spot (no deferral).

Fifthly, Islamic law requires that any investment type transaction, including savings accounts, must be also within a framework of equitable loss and risk sharing. Thus, the valid avenues for Muslims to invest are generally equity-based. Apart from these broad and other specific parameters, all trades (buy/sell) transactions are generally permissible.

Based on growth in Islamic finance in the last century, a wide range of financing products and services are available in various parts of the world. Asset sales and leases now serve as substitutes for interest-based financing. A number of commonly used methods include: profit-loss-sharing modes (mudaraba - silent partnership, musharaka - partnerships in general), cost-plus or mark up (murabaha -w a particular type of sale, where the seller expressly specifies the cost on the commodities to be sold and sells it to another party by adding some profit or mark-up thereon which is disclosed to the buyer), lease (ijara), sukuk (bond-equivalent financial certificate or securitized assets that convert future cash flows in present cash flows and thus offering more flexibility in Islamic finance), and so on. The rules and procedures governing such methods are generally agreed upon by the various bodies of Islamic experts, such as OIC Islamic Fiqh Academy. Individual transactions are generally reviewed by or in compliance with the guidance of the Shariah supervisory board of individual Islamic finance institutions.

Islamic financing products are filling an important void in the services desired by Muslims and are gaining popularity as they are trying to offer competitive returns, while being Shariah-compliant.

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Comments (1)

• 2011-07-21 17:07:10 | Maximilian  - ......

  @Niomi - You refer to an interesting position there. Not everyone has the aptitude to make sure these effects are undertaken in the proper approach and constructive tips such as those you have provided will help endorse the problems to a much larger point than it is at present. =-=

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