What is Islamic Finance?

PropertyGuru Editorial Team
What is Islamic Finance?
Islamic finance refers to the system of finance by which corporations, including banks and other lending companies, raise capital in accordance with Islamic Law or Shariah.
Governed by the underlying principles of the assurance of fairness for all, mutual risk and profit sharing among parties, transactions under Islamic finance are based on a business activity or asset.
And since it exist to further Islam’s socio-economic goals, activities that involve gambling (maisir), interest (riba) and speculative trading (gharar) are proscribed.
As such, Shariah contracts include:

1) Ijarah

Ijarah is a contract of lease or commission involving an exchange of benefits or usufruct of an asset or a service for rent or commission for a certain period of time. The concept is normally applied in financing contracts like real property financing, project financing, personal financing and vehicle financing.

2) Istisna`

Istisna` refers to a sale and purchase contract that involves producing, constructing or manufacturing a certain asset according to the agreed terms and specifications by the seller, developer/manufacturer and the customer.

3) Mudarabah

Mudarabah refers to a contract to conduct a joint venture and involves a rabbul mal (the investor who provides the capital) and a mudarib (the entrepreneur). Under this contract, any profit generated from the capital is shared while losses are borne solely by the rabbul mal.

4) Musyarakah

Musyarakah is a partnership contract between two or more parties, whereby all parties contribute to the capital and share in any profit or loss incurred from the partnership.

5) Qard

Qard is the giving of a property to a party who is expected to benefit from it and subsequently return an equivalent replacement for it.

6) Rahn

Under this concept, an asset is made as a security for a loan/financing so that the debtor can recover the loan/financing in the event of default by selling the asset. Notably, assets such as real estate, investment and share certificates are types of securities usually accepted by Islamic financial institution throughout a particular loan or financing tenure.

7) Takaful

Takaful refers to the cooperation among a certain group of persons to mutually aid and guarantee each other to meet a particular need, like providing compensation for a certain loss or other kind of financial needs. The participants, under this concept, voluntary contribute money to establish a specific fund to pay for any loss suffered by one of its participants.

8) Tawarruq

Tawarruq refers to the act of purchasing an asset on credit and subsequently selling it on a cash basis to a third party. Also known as commodity murabahah, tawarruq is commonly used in deposit products, asset and liability management, financing and risk management.

9) Wadi’ah

Wadi’ah refers to the contract by which the Islamic bank serves as the trustee and keeper of the depositors’ funds and guarantees to return part or the entire deposit, on demand by the depositor.

10) Wakalah

Wakalah is a contract by which a person appoints another party to serve as his agent and perform a certain task for a fee.

11) Bai’ Dayn

Bai’ Dayn is a method of sale of debt that was created under exchange contracts like bai` bithaman ajil, murabahah, istisna`, ijarah and other Shariah compliant business activities.

12) Bai` `Inah

Bai` `inah is a contract by which a seller disposes of an asset on a cash basis and then acquires it back at deferred price, normally higher than the cash sale price. Under this form of contract, a seller may also dispose of an asset at a deferred price and acquire it back on a cash basis, but at a lower price.
Global finance intelligence group, The Banker, revealed that there are 614 Islamic financial institutions across the world.
In Malaysia, the country’s first Islamic Bank was established with the enactment of the Islamic Banking Act 1983. Thereafter, more Islamic financial institutions have been set up within the country following the liberalisation of the Islamic financial system.
With 16 Islamic banks listed on Bank Negara Malaysia, Islamic banking assets in Malaysia amounted to RM434 billion as at end-May 2014, or 21 percent of the country’s total banking-system assets, said The Star citing a Moody’s report.
Given the country’s vibrant market in sukuk issuance and good reputation for Islamic finance regulation, it comes as no surprise that other foreign banks are coming here to do business.
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