Islamic Finance
Islamic finance is a system of financial activities and transactions that adhere to the principles of Sharia, or Islamic law. It encompasses various financial instruments and services designed to meet the economic needs of individuals and businesses while complying with Islamic ethical and legal guidelines. Key principles of Islamic finance include the prohibition of interest (usury or riba), adherence to risk-sharing, and ensuring that investments align with Islamic values. The aim is to create an ethical and socially responsible financial system that promotes economic justice and avoids exploitative practices. Islamic finance includes diverse instruments such as Islamic banking, Islamic bonds (sukuk), and Islamic investment funds, providing alternative solutions for those seeking financial services in accordance with Islamic principles.
Basic Financial Arrangements in Islamic Finance
Profit and Loss Sharing Contracts (Mudarabah)
Islamic banks pool investors' funds and agree on profit and loss sharing with depositors. The bank invests in mutual funds screened for Sharia compliance, excluding companies with prohibited income sources.
​
Declining Balance Shared Equity
This model involves joint home ownership between the bank and the investor, commonly used for home financing. The bank gradually transfers its equity to the homeowner through their payments.
​
Lease to Own
Similar to declining balance, the financial institution finances most or all of the house, agreeing to sell it to the homeowner after a fixed term. Payments cover both the lease and the home's purchase price.
​
Installment Sale (Murabaha)
An intermediary with clear title purchases the home and sells it to the buyer at an agreed-upon price, including profit. The purchase can be a lump sum or through deferred payments, representing an acceptable form of finance without interest.
​
Leasing (Ijarah)
Ijarah involves selling the right to use an object for a specific time, with the lessor owning the object during the lease. 'Ijarah wa 'iqtina' allows the object's sale at a predetermined residual value at the lease's end, binding only the lessor.
​
Islamic Forwards (Salam and Istisna)
Rare forms of financing for specific business types, exempt from gharar (excessive uncertainty). The item's price is prepaid, and delivery occurs at a predetermined future point, typically requiring the expertise of an Islamic legal advisor due to specific contract conditions.