Principles of Islamic Banking & Finance

Islamic banking typically referred to as Islamic finance or shariah-compliant finance which is a kind of finance or banking practice that sticks to shariah rules (Islamic law). Two key elements of Islamic banking are the sharing of profit and loss, and the disallowance of the kinds and payment of interest by banks, financial institutions, and speculators/investors.

The practices of Islamic banking and finance came into existence during the times of the Holy Prophet (SAWW) but the proper formal establishment of current Islamic finance and banking started in the late 20th century. Today, there are more than 500 banks and over 400 mutual funds around the globe that follow Islamic standards. Somewhere in the years between 2000 and 2016, the Islamic bank’s capital inflated from $200 billion to nearly $3.5 trillion last year. This development is to a great extent because of the rising economies of Muslim nations, particularly those that have profited by the rising cost of oil i.e. Gulf region.

Principles of Islamic Finance

Islamic finance firmly adheres to Sharia laws. Modern-day finance depends on various elements that are prohibited in Islam. Islamic finance doesn’t operate on four principles which are acceptable and a major part of conventional financial operations. These four principles are:

1. Paying or charging an interest (Riba)

Islam considers providing loans with interest payments as an exploitative practice that favors the moneylender at the cost of the borrower. As indicated by Sharia law, interest is usury (riba) has been straightforwardly declared haram by Islam.

Prohibition of interest in hadith, “the prophet (PBUH) cursed the receiver, the payer of the interest, the one who records it and the two witnesses of the transaction and said they are all alike (in guilt).” – Sahih Muslim

2. Putting resources into businesses engaged with Haram activities

A few activities, for example, creating and selling liquor or pork, are denied in Islam. These exercises are considered haram or prohibited. In this manner, putting resources into such dealings or activities is similarly illegal.

3. Speculation (Maysir)

Sharia carefully restricts any type of speculation or betting, which is called maysir. Accordingly, Islamic financial institutions can’t be associated with contracts where the goods are owned by uncertainty or ownership relies upon the uncertainty of future events.

4. Risk and uncertainty (Gharar)

The laws of Islamic finance prohibit participating in contracts with inordinate danger as well as uncertainty. The term gharar measures the authenticity of danger or vulnerability in speculations. Gharar is seen with subsidiary agreements and short-selling, which are prohibited in Islamic finance.

Along with the above-mentioned prohibitions, Islamic finance depends on two other significant elements:

  • Material conclusiveness of the transaction:

Every transaction must be identified with a genuine fundamental financial transaction.

  • Profit/loss sharing:

Parties going into the agreements in Islamic finance share profit/loss and dangers related to the transaction. Nobody can profit from the exchange more than the other party.

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