Islamic finance is a type of financing activity that must comply with Sharia. The common practices of Islamic finance and banking came into existence along with the foundation of Islam. Nowadays, the Islamic finance sector grows at 15%-25% per year, while Islamic financial institutions oversee over $2 trillion.
Though only a blooming industry by market terms, representing a 1.5% of the total world’s assets, this system has been present for more than many centuries. It has a 400+ year old banking history, complying with the shariah, and established on moral principles deriving from sources like the Qur’an, Hadith, Ijma or Qayas. The sector is said to increase to $3.5 trillion by 2021.
Gist of Principles of Islamic Finance
- Paying or charging an interest according to Sharia law, interest is usury (riba), which is strictly prohibited.
- Investing in businesses involved in prohibited activities are considered haram or forbidden. Therefore, investing in such activities is likewise forbidden.
- Speculation(maisir)Sharia strictly prohibits any form of speculation or gambling, which is called maisir. Thus, Islamic financial institutions cannot be involved in contracts where the ownership of goods depends on an uncertain event in the future.
- Uncertainty and Risk (gharar) is observed with derivative contracts and short selling, which are forbidden in Islamic finance.
- Material finality of the transaction: Each transaction must be related to a real underlying economic transaction.
- Profit/loss sharing: Parties entering the contracts in Islamic finance share profit/loss and risks associated with the transaction. No one can benefit from the transaction more than the other party.