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It is a unique form of socially responsible investment. Islam makes no division between the spiritual and the secular, hence its reach into the domain of financial matters.
Although they have been mandated since the beginnings of Islam in the seventh century, Islamic banking and finance have been formalised gradually since the late 1960s, coincident with and in response to tremendous oil wealth that fuelled renewed interest in and demand for Shariah-compliant products and practice.
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Central to Islamic banking and finance is an understanding of the importance of risk sharing as part of raising capital and the avoidance of riba (usury) and gharar (risk or uncertainty).
Islamic law views lending with interest payments as a relationship that favours the lender, who charges interest at the expense of the borrower. Because Islamic law views money as a measuring tool for value and not an "asset" in itself, it requires that one should not be able to receive income from money (for example, interest or anything that has the genus of money) alone.
Deemed riba (literally an increase or growth), such practice is proscribed under Islamic law (haram, which means prohibited), as it is considered usurious and exploitative. By contrast, Islamic banking exists to further the socio-economic goals of Islam.
Sharing profit and loss
Accordingly, Shariah-compliant finance (halal, which means permitted) consists of profit banking in which the financial institution shares in the profit and loss of the enterprise that it underwrites. Of equal importance is the concept of gharar. Defined as risk or uncertainty, in a financial context it refers to the sale of items whose existence is not certain.
Examples of gharar would be forms of insurance, such as the purchase of premiums to insure against something that may or may not occur, or derivatives used to hedge against possible outcomes.
The equity financing of companies is permissible, as long as those companies are not engaged in restricted types of business - such as the production of alcohol, pornography or weaponry - and only certain financial ratios meet specified guidelines.
Below is a brief overview of permissible Islamic financing arrangements:
Profit-and-loss sharing contracts (mudarabah): The Islamic bank pools investors' money and assumes a share of the profits and losses. This is agreed upon with the depositors.
Staff Reporter
