Islamic Finance - A brief Overview - click for a definition of Islamic finance
Some common forms of Islamic finance:
Ijara
- An arrangement under which an Islamic bank leases equipment, a building or other facility to a client against an agreed rental. The rent is so fixed that the bank gets back its original investment plus a profit on it. Ijara wa iqtina allows the same arrangement but with the agreement of purchase. Ijara is one of the more popular modes of financing in Islamic Banking.
Murabaha
- Sale at stated cost price and mark-up. This refers to an agreement, where the seller purchases a good/commodity that has been requested by the buyer, and sells it at a mark-up price. The payment can be paid in agreed installments, lump sum or a combination of the two. Murabaha contracts are used to purchase cars, homes but most commonly to issue letters of credit and to provide financing to import trade.
Mudarabah
- The term refers to a form of business partnership between a capital provider ("rab-al-maal") and the entrepreneur ("mudarib"). Whilst any proportionate share in profit is determined by mutual agreement, losses, if any, is borne only by the owner of the capital, in which case the entrepreneur gets no return for their effort.
Musharaka
- This is the classical partnership agreement. All parties involved contribute towards the capital financing of a venture. The parties share profits on a pre-agreed ratio while any losses are shared according to each party's equity holdings.
Diminishing Musharaka
- Diminishing Musharaka allows participation and sharing of profit on a pro rata basis but also provides a method through which the bank's ownership of the project decreases with each payment and ultimately transfers the asset onto the participant.
Takaful
- This is a form of Islamic insurance based on the Quranic principle of Ta'awon or mutual assistance. It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members. Takaful is similar to mutual insurance in that members are the insurers as well as the insured.
Other terminology associated with Islamic finance:
Gharar
- Uncertainty, hazard, chance or risk, ambiguity and uncertainty in transactions. Technically, the sale of something that is not present at hand; or the sale of something where the consequences or outcome is not known. An example would be gambling where the outcome of the transaction is not known. Prohibited in Islam.
Riba
- Riba means a return on money for lending money where the borrower bears all the risk. Any risk-free or "guaranteed" rate of return on a loan or investment is Riba. Riba, in all forms, is strictly prohibited in Islam.
Maysir
- Gambling. The prohibition on maysir is often used as the grounds for criticism of conventional financial practices such as speculation, conventional insurance and derivatives. Prohibited in Islam
Shariah
- Islamic law derived from three sources: the Quran; the Hadith (sayings of the Prophet Muhammad (S.A.W.); and the Sunnah (practice and traditions of the Prophet Muhammad (S.A.W.).
Halal
- That which is permissible. The concept of halal has spiritual overtones. In Islam there are activities, professions, contracts and transactions, which are explicitly prohibited by the Qur'an or the Sunnah. Barring them, all other activities, professions, contracts, and transactions etc. are halal.
Haram
- Unlawful; Transactions which are not permissible under Islamic law.
Zakah/Zakat
- A tax prescribed by Islam for Muslims, who have wealth above an exemption limit at a rate fixed by the Shariah. (normally 2.5%)
Fatwah
- A religious decree
Wadiah
- A safe custody contract between the depositor (customer) and the custodian (bank).
