Essential Guide to Islamic Finance In Simple English (2019)

Islam is one of the most followed religion in the world. As a comprehensive religion, Islamic finance is part of the system.

With its strong religious and spiritual principles, the religion, Islam guides the followers, or the muslims to live a life according to Allah, their one and only God.

There are five basic pillars Islam which a muslim has to follow at any cost.

Some of the pilgrims are not obligatory as all the muslims are not that financially stable. 

Islam teaches its followers to offer the obligatory prayers everyday, to give charity in the name of Allah and to remain steadfast and patient in life problems.

The holy Quran, the most noble book for muslims, bestowed by Allah and to the last prophet (PBUH) Muhammad is a complete guide for a muslim to live a content and a happy life according to the principles of Islam.

In that book, there is a solution to every problem, whether big or small and it also guides on life matters, such as business, banking, charity, neighboring and etc.

In the similar manner, Islamic finance’s root is the principles mentioned in the Holy book of Quran.

But, what actually is Islamic finance and how does it differ from the modern finance and banking?

What is Islamic Finance?

Islamic finance is also known as the shariah compliant finance.

The application is applied physically in finance and banking by using the shariah laws and the finance principles according to the shariah law. 

Just like the conventional or the modern finance systems, Islamic finance also has fund managers, banks, capital, investment firms, markets and insurance companies.

However, the islamic finance industry revolves around the Islamic banking laws and the conventional banking laws. 

Muslim women discussing Islamic finance

There are many modes of Islamic finance and banking.

Some of them are Mudarabah, wadiah, Musharaka and Murabaha.

These terms are similar to profit sharing, loss bearing, safe keeping and joint venture and cost plus respectively. 

There is also another mode, known as the ijara, which also means leasing in conventional banking. 

Islamic finance and banking prohibits usury or riba strictly.

It means that some islamic scholars restrict all types of interest on the loans of cash.

Moreover profit gained from business of alcohol and drug smuggling is also prohibited or restricted in Islam. 

Basic Concept of Islamic Finance & Banking

Balancing spiritual needs & material pursuits

There is a strong belief in muslims that they will be awarded in the hereafter for performing the shariah compliant banking.

The islamic economic principles are to balance the materialistic needs and spiritual needs.

By following the shariah compliant banking, a muslim keeps a balance between his material pursuits and his worshipping acts.

However, a person should not neglect worshipping Allah for establishing a stable shariah compliant business or economy. 

Balancing individual & social needs

The main concept of Islamic finance is to care about the rest of the world too.

It is about balancing your needs and the social needs by the money granted to you by Allah.

A muslim should follow the islamic finance principles just to make sure that he is using the granted resources wisely. 

Basic Principles of Islamic Finance & Banking

Prohibiting interest or riba’

Riba or interest in all kinds of loans or borrowed money is haram or prohibited in Islamic finance.

Implying interest and giving interest both are sins according to the islamic scholars.

In islamic finance and banking, it is a concept that people take interest for making profit and wealth, which is very unjust to the society.

Hence, riba is strictly prohibited.  It also means that the muslims should not apply for loans in conventional banks or should not promote riba-based products. 

Avoiding gharar or uncertainty transactions

Gharar is the term used in islamic finance for ambiguous based transactions.

Islam guides its followers to stay away from the transactions in which you are not sure what to expect.

Gharar can exist in the following conditions:

  • When two business parties sign a business treaty or a contract but does not reveal full information.
  • When both the business parties do not reveal complete information with each other.

Avoiding gambling

In shariah compliant banking, gambling or wealth gained without effort is strictly prohibited. Islam strictly considers effortless money as haraam.

If a muslim invests a small amount and receives a large handsome amount in return, this is unjust wealth and is strictly prohibited by shariah. One such example is investing in interest-based transactions or products.

Avoiding investment in prohibited industries

Islamic finance does not allow investing in industries which can cause social harm to society, such as investing in an alcohol industry. All the revenue or profit gained from such acts is haram. 

Islamic Products

The two important products of islamic finance are musharakah and mudarabah.

These terms are also known as profit sharing and loss bearing in conventional banking and finance.

It means that the financier has to share the profit as well as the loss with the finance partner or the bank according to the contracts of the business partnership. 

There are other products of islamice finance as well, such as the takaful, ijarah, sukuk, hawala, murabahah, musharakah and wadiah. 

What about Islamic Banking?

Islamic banking is also known as shariah compliant banking or non-interest banking.

The principles of islamic banking are completely based on profit sharing and loss bearing.

Moreover, it also includes the restriction of taking riba or interest on loans.

The investments of islamic banking is completely different from that of conventional banking.

Islamic banking does not allow investing in industries, which are harmful to the society.

Moreover, islamic banking emphasizes on sharing the profit rather than taking the interest. 

Islamic Investment

Islamic investment is also known as shariah compliant investment and revolves around the principles of islamice finance and banking.

Islamic investments are those which can be done with shariah permissibility. The first important thing is the absence of riba or interest in the investment.

The second factor is the absence of unethical concerns in the investments.

It means that in islamic investment, you have to follow the profit sharing and loss bearing strategy rather than taking interest.

Moreover, you should not invest in industries that may pose a threat to the society, such as the alcohol industry or the pork meat industry.

Conclusion

It is important for the muslims to follow islamic finance and banking, which are totally in accordance to the islamic shariah and laws.

However, if a muslim is involved in islamic finance and banking, he should not invest in riba-based transaction through conventional banking.

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