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Fundamentals of Islamic Finance

What is Islamic Finance?

Islamic finance in its modern form is barely 30 years old yet it is a rapidly growing part of the financial sector and has survived the recent global banking crisis almost untouched. The size of the market is huge and demand for Islamic services exists wherever there is a significant Muslim community.

It is reckoned that nearly 500 financial institutions in more than 50 countries practice some kind of Islamic finance and the market has been growing at more around 10-15% per annum. Latest estimates place total assets at around US$1 trillion.

Main Attraction of Islamic Finance:

The main attraction of Islamic finance is that it offers Shariah compliant banking to its clients and is the closest yet that any banking institution has managed to get to genuinely ethical and moral banking. It is underpinned by pure principles, with integrity at the forefront and a genuine sharing of profit and losses as its credo. This has all been achieved with remarkable speed and the sector’s popularity continues unabated.

The diploma Islamic banking course explains in clear terms the basic principles of this increasingly important sector and shows how these and its products differ from the conventional banking models. It is designed to teach delegates the principles of Islamic Banking and to highlight the differences between Islamic and conventional banking.

It explores the different products and services commonly found in both the GCC and the Islamic market globally and it assesses the relative advantages and disadvantages of each. By the end of the course delegates will have a full understanding of the products and principles involved in Islamic Banking and how they differ from Western banking models.

Introduction to Islamic Finance:

Over the last few decades, the Muslims have been trying to restructure their lives on the basis of Islamic principles. They strongly feel that the political and economic dominance of the West, during past centuries, has deprived them of the divine guidance, especially in the socio-economic fields. Therefore, after acquiring political freedom, the masses are striving for the revival of their Islamic identity to organize their collective life in accordance with the Islamic teachings.

In the economic field, it was the biggest challenge for such Muslims to reform their financial institutions to bring them in harmony with the dictates of Shariah. In an environment where the entire financial system was based on interest, it was a formidable task to structure the financial institutions on an interest free basis.

The people not conversant with the principles of Shariah and its economic philosophy sometimes believe that abolishing interest from the banks and financial institutions would make them charitable, rather than commercial, concerns which offer financial services without a return.

Interest Free Loans:

Obviously, this is totally a wrong assumption. According to Shariah, interest free loans are meant for cooperative and charitable activities, and not normally for commercial transactions, except in a very limited range. So far as commercial financing is concerned, the Islamic Shariah has a different set-up for that purpose. The principle is that the person extending money to another person must decide whether he wishes to help the opposite party or he wants to share his profits. If he wants to help the borrower, he must rescind from any claim to any additional amount. His principal will be secured and guaranteed, but no return over and above the principal amount is legitimate.

But if he is advancing money to share the profits earned by the other party, he can claim a stipulated proportion of profit actually earned by him, and must share his loss also, if he suffers a loss.

Exclusion of Interest or Riba:

It is thus obvious that exclusion of interest from financial activities does not necessarily mean that the financier cannot earn a profit. If financing is meant for a commercial purpose, it can be based on the concept of profit and loss sharing, for which Musharakah and Mudarabah have been designed since the very inception of the Islamic commercial law, as explained in masters in Islamic banking and finance.

There are, however, some sectors where financing on the basis of musharakah or mudarabah is not workable or feasible for one reason or another. For such sectors the contemporary scholars have suggested some other instruments which can be used for the purpose of financing, like murabahah, ijarah, Salam or istisna.

Since last two decades, these modes of financing are being used by the Islamic banks and financial institutions. But all these instruments are not the substitutes of interest in the strict sense, and it will be wrong to presume that they may be used exactly in the same fashion as interest is used. They have their own set of principles, philosophy and conditions without which it is not allowed in Shari’ah to use them as modes of financing. Therefore the ignorance of their basic concept and relevant details may lead to confusing the Islamic financing with the conventional system based on interest.

The present book is a revised collection of different articles that aimed at providing basic information about the principles and precepts of Islamic finance, with special reference to the modes of financing used by the Islamic banks and non-banking financial institutions. It has been tried to explain the basic concept underlying these instruments, the necessary requirements for their acceptability from the Shari’ah standpoint, and the correct method of their application. It has been also dealt with the practical issues involved in the application of these instruments and their possible solutions in the light of Shariah.

Shariah Advisory Board:

According to a capacity of a chairman / member of the Shariah Supervisory Boards of a number of Islamic banks in different parts of the world, It had been come across the points of weakness in their operations caused mainly by the lack of clear perception of the relevant rules and principles of Shariah. This experience emphasized the need for the present book in which it has been tried to discuss the relevant subject in a simple way which may be easily understood by a common reader who had no opportunities to study the Islamic financial principles in depth.

This humble effort, it is hoped, will facilitate to understand the basic principles of Islamic finance and the main points of difference between conventional and Islamic banking. May Allah Ta’ala accept this humble effort, honor it with His pleasure and make it beneficial for the readers.

Background of Islamic Finance:

Islamic finance is based on shariah, an Arabic term that is often translated into “Islamic law.” Shariah provides guidelines for aspects of Muslim life, including religion, politics, economics, banking, business, and law. Shariah compliant financing (SCF) constitutes financial practices that conform to Islamic law.

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