Islamic finance products, services and contracts are financial products and services and related contracts that conform with Sharia (Islamic law). Islamic banking and finance has its own products and services that differ from conventional banking.Khan, Ajaz A., Sharia Compliant Finance | halalmonk.com These include Mudharabah (profit sharing), Wadiah (safekeeping), Musharakah (joint venture), Murabahah (cost plus finance), Ijar (leasing), Hawala (an international fund transfer system), Takaful (Islamic insurance), and Sukuk (Islamic bonds).
Sharia prohibits riba, or usury, defined as interest paid on all loans of money (although some Muslims dispute whether there is a consensus that interest is equivalent to riba).Farooq, Riba-Interest Equation and Islam, 2005: pp. 3–6Khan, What Is Wrong with Islamic Economics?, 2013: pp. 216–226 Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also haraam ("sinful and prohibited").
, around $2 trillion in financial assets, or 1 percent of total world assets, was Sharia-compliant, concentrated in the Gulf Cooperation Council (GCC) countries, Iran, and Malaysia.
Principles To be consistent with the principles of Islamic law (Shariah) and guided by Islamic economics, the contemporary movement of Islamic banking and finance prohibits a variety of activities: Paying or charging interest. "All forms of interest are riba and hence prohibited".Khan, What Is Wrong with Islamic Economics?, 2013: pp. xv–xvi Islamic rules on transactions (known as Fiqh al-Muamalat) have been created to prevent use of interest. Investing in businesses involved in activities that are forbidden (haraam). These include things such as selling alcohol or pork, or producing media such as gossip columns or pornography.The Islamic Banking and Finance Database provides more information on the subject. Charging extra for late payment. This applies to murâbaḥah or other fixed payment financing transactions, although some authors believe late fees may be charged if they are donated to charity, or if the buyer has "deliberately refused" to make a payment. Maisir. This is usually translated as "gambling" but used to mean "speculation" in Islamic finance. Involvement in contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future is maisir and forbidden in Islamic finance. Gharar. Gharar is usually translated as "uncertainty" or "ambiguity". Bans on both maisir and gharar tend to rule out derivatives, options and futures. Islamic finance supporters (such as Mervyn K. Lewis and Latifa M. Algaoud) believe these involve excessive risk and may foster uncertainty and fraudulent behaviour such as are found in derivative instruments used by conventional banking.Mervyn K. Lewis, Latifa M. Algaoud: Islamic Banking, Cheltenham, 2001 Engaging in transactions lacking "'material finality'. All transactions must be "directly linked to a real underlying economic transaction", which generally excludes "options and most other derivatives". Money earned from the most common type of Islamic financing—debt-based contracts—"must" come "from a tangible asset that one owns and thus has the right to sell—and in financial transactions it demands that risk be shared." Money cannot be made from money, as "it is only a medium of exchange."Usmani, Introduction to Islamic Finance, 1998: p. 12Khan, What Is Wrong with Islamic Economics?, 2013: p. 275 Risk and return on distribution to participants should be symmetrical so that no one benefits disproportionately from the transaction.Khan, Islamic Banking in Pakistan, 2015: p. 89Khan, Islamic Banking in Pakistan, 2015: p. 86 Other restrictions include
A board of shariah experts is to supervise and advise each Islamic bank on the propriety of transactions to "ensure that all activities are in line with Islamic principles".Lewis, M. K. and Algaoud, L. M. (2001) Islamic banking. Cheltenham: Edward Elgar.Nathan, S. and Ribiere, V. (2007) From knowledge to wisdom: The case of corporate governance in Islamic banking. The Journal of Information and Knowledge Management Systems, 37 (4), pp. 471–483. (Interpretations of Shariah may vary by country,Dar, Humayon A. 2010. Islamic banking in Iran and Sudan. Business Asia, 27 June 2010 with it being most strict in SudanEl-Gamal, Islamic Finance, 2006: p. 21 somewhat less in Turkey or Arab countries, less still in Malaysia, whose interpretation is in turn more strict than the Islamic Republic of Iran. Mahmud el-Gamal found interpretations most strict in Sudan and least in Malaysia.)
Islamic banking and finance has been described as having the "same purpose" (Institute of Islamic Banking and Insurance), or having the same "basic objective" (Mohamed Warsame), as conventional banking but operating in accordance with the rules of shariah law.
Benefits that will follow from banning interest and obeying "divine injunctions"Usmani, Introduction to Islamic Finance, 1998: p. 11 include an Islamic economy free of "imbalances" (Taqi Usmani)—concentration of "wealth in the hands of the few", or monopolies which paralyze or hinder market forces, etc.—a "move towards economic development, creation of the value added factor, increased exports, less imports, job creation, rehabilitation of the incapacitated and training of capable elements" (Saleh Abdullah Kamel).
Other describe these benefits (or similar ones) as "principals" or "objectives" of Islamic finance. Nizam Yaquby, for example declares that the "guiding principles" for Islamic finance include: "fairness, justice, equality, transparency, and the pursuit of social harmony".Irfan, Heaven's Bankers, 2015: p. 53 Some distinguish between sharia-compliant finance and a more holistic, pure and exacting sharia-based finance.Irfan, Heaven's Bankers, 2015: p. 236 "Ethical finance" has been called necessary, or at least desirable,Irfan, Heaven's Bankers, 2015: p. 198 for Islamic finance, as has a "gold-based currency".Irfan, Heaven's Bankers, 2015: p. 192 Zubair Hasan argues that the objectives of Islamic finance as envisaged by its pioneers were "promotion of growth with equity ... the alleviation of poverty ... [and] a long run vision to improve the condition of the Muslim communities across the world."
Criticism Modernist/Minimalist critic Feisal Khan argues that in many ways Islamic finance has not lived up to its defining characteristics. Risk-sharing is lacking because profit and loss sharing modes are so infrequently used. Underlying material transactions are also missing in such transactions as "tawarruq, commodity murabahas, Malaysian Islamic private debt securities, and Islamic short-sales". Exploitation is involved when high fees are charged for "doing nothing more substantial than mimicking conventional banking /finance products". Haram activities are not avoided when banks (following the customary practice) simply take the word of clients/financees/borrowers that they will not use funds for unIslamic activities.Khan, Islamic Banking in Pakistan, 2015: p. 112
Others (such as convert Umar Ibrahim Vadillo) agree that the Islamic banking movement has failed to follow the principles of shariah law, but call for greater strictness and greater separation from the non-Muslim world.
Overview of products, contracts, etc.
Banking makes up most of the Islamic finance industry. Banking products are often classified in one of three broad categories,Hussain, M., A. Shahmoradi, and R. Turk. 2014. "Overview of Islamic Finance," IMF Working Paper (forthcoming), International Monetary Fund, Washington, DC. two of which are "investment accounts":Khan, What Is Wrong with Islamic Economics?, 2013: pp. 329–330 Profit and loss sharing modes—musharakah and mudarabah—where financier and the user of finance share profits and losses, are based on "contracts of partnership".Jamaldeen, Islamic Finance For Dummies, 2012: p. 96 "Asset-backed financing", (also known as trade-based financing" or "non-PLS financing"),Khan, Islamic Banking in Pakistan, 2015: p. 90 "debt-like instruments" which are based on "debt-based contracts" or "contracts of exchange". They are structured as sales and allow for "the transfer of a commodity for another commodity, the transfer of a commodity for money, or the transfer of money for money". They involve the financing "purchase and hire of goods or assets and services", and like conventional loans repayment is deferred, increased, and made on a "fixed-return basis". Unlike conventional loans, the fixed return is called "profit" or "markup", not "interest".Khan, Islamic Banking in Pakistan, 2015: p. 87 According to Feisal Khan, "virtually every" Islamic banking advocate argues that these "non-non-participatory" forms of finance are acceptable only as "an interim measure" as Islamic banking develops, or for situations such as small and personal loans where participatory financing is not practical. Faleel Jamaldeen states that debt-based contracts are often used to finance not-so-minor purchases (homes, cars, etc.) for bank customers.Jamaldeen, Islamic Finance For Dummies, 2012: p. 153 These instruments include mark-up (murabaha), leasing (ijara), cash advances for the purchase of agricultural produce (salam), and cash advances for the manufacture of assets (istisna'''). the third category consists of Modes based on contracts of safety and security, include safe-keeping contracts (wadi’ah) for current deposits (called checking accounts in the US), and agency contracts (wakalah). Current account deposits are regarded as trusts or safe-keeping and offer the depositors safety of their money against the bank's guarantee to return their funds on demand. (A current account the customer earns no return, but sources do not agree over whether the bank is allowed to invest the account funds.Khan, What Is Wrong with Islamic Economics?, 2013: p. 330 According to one report, in practice no examples of 100 percent reserve banking are known to exist.)
Non-banking finance Islamic non-banking finance has grown to encompass a wide range of services, but as of 2013, banking still dominates and represented about four-fifths of total assets in Islamic finance.Islamic Financial Services Board (IFSB). 2014. Islamic Financial Services Industry Stability Report. Kuala Lumpur: IFSB. The sukuk market is also a fast-growing segment with assets equivalent to about 15 percent of the industry. Other services include leasing, equity markets, investment funds, insurance (takaful), and microfinance.
These products—and Islamic finance in general—are based on Islamic commercial contracts (aqad i.e. a commitment between two parties) and contract law,Jamaldeen, Islamic Finance For Dummies, 2012: p. 89 with products generally named after contracts (e.g. mudaraba) though they may be combinations of more than one type of contract.
Profit and loss sharing
While the original Islamic banking proponents hoped profit-loss sharing (PLS) would be the primary mode of finance replacing interest-based loans, long-term financing with profit-and-loss-sharing mechanisms is "far riskier and costlier" than the long term or medium-term lending of the conventional banks, according to critics such as economist Tarik M. Yousef.