Islamic finance

Islamic banking, Islamic finance ( ar, مصرفية إسلامية), or Sharia-compliant finance is banking or financing activity that complies with Sharia (Islamic law) and its practical application through the development of Islamic economics. Some of the modes of Islamic banking/finance include '' Mudarabah'' (profit-sharing and loss-bearing), ''Wadiah'' (safekeeping), '' Musharaka'' (joint venture), ''Murabahah'' (cost-plus), and ''Ijara'' ( leasing).

Sharia prohibits '' riba'', or usury, defined as interest paid on all loans of money (although some Muslims dispute whether there is a consensus that interest is equivalent to ''riba''). Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also ''haram'' ("sinful and prohibited").

These prohibitions have been applied historically in varying degrees in Muslim countries/communities to prevent un-Islamic practices. In the late 20th century, as part of the revival of Islamic identity, Usmani, ''Introduction to Islamic Finance'', 1998: p. 6 A number of Islamic banks formed to apply these principles to private or semi-private commercial institutions within the Muslim community. Their number and size has grown, so that by 2009, there were over 300 banks and 250 mutual funds around the world complying with Islamic principles, and around $2 trillion was Sharia-compliant by 2014. Sharia-compliant financial institutions represented approximately 1% of total world assets, concentrated in the Gulf Cooperation Council (GCC) countries, Pakistan, Iran, and Malaysia. Although Islamic banking still makes up only a fraction of the banking assets of Muslims, since its inception it has been growing faster than banking assets as a whole, and is projected to continue to do so. Warde, ''Islamic finance in the global economy'', 2000: p. 21

The industry has been lauded for returning to the path of "divine guidance" in rejecting the "political and economic dominance" of the West, and noted as the "most visible mark" of Islamic revivalism, its most enthusiastic advocates promise "no inflation, no unemployment, no exploitation and no poverty" once it is fully implemented. However, it has also been criticized for failing to develop profit and loss sharing or more ethical modes of investment promised by early promoters, and instead selling banking productsQureshi, D.M. 2005. Vision table: Questions and answers session. In ''Proceedings of the First Pakistan Islamic Banking and Money Market Conference'', 14–15 September, Karachi that "comply with the formal requirements of Islamic law",Fadel, Mohammad. 2008
''Riba'', efficiency, and prudential regulation: Preliminary thought.
''Wisconsin International Law Journal'' 25 (4) (April) 656 but use "ruses and subterfuges to conceal interest", and entail "higher costs, bigger risks" than conventional (''ribawi'') banks.

History

Usury in Islam

Although Islamic finance contains many prohibitions—such as on consumption of alcohol, gambling, uncertainty, etc. – the belief that "all forms of interest are '' riba'' and hence prohibited" is the idea upon which it is based.
The word "''riba''" literally means "excess or addition", and has been translated as "interest", "usury", "excess", "increase" or "addition".

According to Islamic economists Choudhury and Malik, the elimination of interest followed a "gradual process" in early Islam, "culminating" with a "fully fledged Islamic economic system" under Caliph Umar (634–644 CE).

Other sources (''Encyclopedia of Islam and the Muslim World'', Timur Kuran), do not agree, and state that the giving and taking of interest continued in Muslim society "at times through the use of legal ruses ('' ḥiyal''), often more or less openly,"''Encyclopedia of Islam and the Muslim World'', p. 596 including during the Ottoman Empire.Kuran, ''The Long Divergence'', 2011: p. 148Kuran, ''The Long Divergence'', 2011: p. 152
Still another source (International Business Publications) states that during the "Islamic Golden Age" the "common view of ''riba'' among classical jurists" of Islamic law and economics was that it was unlawful to apply interest to gold and silver currencies, "but that it is not ''riba'' and is therefore acceptable to apply interest to fiat money – currencies made up of other materials such as paper or base metals – to an extent."

In the late 19th century Islamic Modernists reacted to the rise of European power and influence and its colonization of Muslim countries by reconsidering the prohibition on interest and whether interest rates and insurance were not among the "preconditions for productive investment" in a functioning modern economy. Syed Ahmad Khan, argued for a differentiation between sinful ''riba'' "usury", which they saw as restricted to charges on lending for consumption, and legitimate non-''riba'' "interest", for lending for commercial investment.

However, in the 20th century, Islamic revivalists/Islamists/activists worked to define all interest as ''riba'', to enjoin Muslims to lend and borrow at "Islamic Banks" that avoided fixed rates. By the 21st century this Islamic Banking movement had created "institutions of interest-free financial enterprises across the world". Loans are permitted in Islam if the interest that is paid is linked to the profit or loss obtained by the investment. The concept of profit acts as a symbol in Islam as equal sharing of profits, losses, and risks.

The movement started with activists and scholars such as Anwar Qureshi, Naeem Siddiqui, Abul A'la Maududi, Muhammad Hamidullah, in the late 1940 and early 1950s.
They believed commercial banks were a "necessary evil," and proposed a banking system based on the concept of '' Mudarabah'', where shared profit on investment would replace interest. Further works specifically devoted to the subject of interest-free banking were authored by Muhammad Uzair (1955), Abdullah al-Araby (1967), Mohammad Najatuallah Siddiqui, al-Najjar (1971) and Muhammad Baqir al-Sadr.

Since 1970

The involvement of institutions, governments, and various conferences and studies on Islamic banking (Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, The First International Conference on Islamic Economics in Mecca in 1976, and the International Economic Conference in London in 1977) were instrumental in applying the application of theory to practice for the first interest-free banks. At the First International Conference on Islamic Economics, "several hundred Muslim intellectuals, Sharia scholars and economists unequivocally declared ... that all forms of interest" were ''riba''.

By 2004, the strength of this belief (which is the basis of Islamic finance) was demonstrated in the world's second largest Muslim country—Pakistan—when a minority (non-Muslim) member of the Pakistani parliament questioned it, pointing out that a scholar from Al-Azhar University, (one of the oldest Islamic Universities in the world), had issued a decree that bank interest was not un- Islamic. His statement resulted in "pandemonium" in the parliament, a demand by members of leading Islamist political party to immediately respond to these allegedly derogatory remarks, followed by a walkout when they were denied it. When the upset members of parliament returned, their leader (Sahibzada Fazal Karim), stated that since the Pakistan Council of Islamic ideology had decreed that interest in all its forms was ''haram'' (forbidden) in an Islamic society, no member of parliament had the right to "negate this settled issue".Govt accused of fudging figures: Poverty reduction
dawn.com , 17 June 2004

The council's decree notwithstanding, over the years a minority of Islamic scholars (Muhammad Abduh, Rashid Rida, Mahmud Shaltut, Syed Ahmad Khan, Fazl al-Rahman, Muhammad Sayyid Tantawy and Yusuf al-Qaradawi) have questioned whether ''riba'' includes all interest payments.Siddiqi, ''Riba, Bank Interest'', 2004: p. 55–56 Others (Muhammad Akran Khan) have questioned whether ''riba'' is a crime like murder and theft, forbidden by Sharia (Islamic law) and subject to punishment by human beings, or simply a sin to be inveighed against, with the reprimand left to God, since "neither the Prophet nor the first four caliphs nor any subsequent Islamic government ever enacted any law against ''riba''."

With an increase in the Muslim population in Europe and the current lack of supply, opportunities will arise for the important role which Islamic finance plays in Europe's economy. In particular, Luxembourg is emerging as a leader and hub for Islamic funds.

Banking

While revivalists like Mohammed Naveed insist Islamic Banking is "as old as the religion itself with its principles primarily derived from the Quran", secular historians and Islamic modernists see it as a modern phenomenon or " invented tradition".

It is argued that the fundraising business of Zubayr ibn al-Awwam were practically a Banking with zero interests. Zubayr pioneering this practice by technically modified the money keeping service to be a loan which Zubayr obligated to pay off, while Zubayr also got privilege to manage the money he kept to do his business. The practice of Zubayr to accept deposits from peoples while not charging any interest to his clients were causing Zubayr to suffered an inflated debt of 2,000,000 Dinar during his death. However, al-Zubayr invested the deposit moneys of the clients for his own lucrative businesses, so his inheritors managed to settle his debts, while still leaving many heritage for his family. After his death, his son Abdullah ibn Zubayr sold the property for 1.600.000 dinar, This practice was allowed according to classical scholar consensus, such as Ibn Taymiyyah in his Majmu Fatawa.

Early banking

According to Timur Kuran, by "the tenth century, Islamic law supported credit and investment instruments" that were "as advanced" as anything in the non-Islamic world, but prior to the 19th century there were no "durable" financial institutions "recognizable as banks" in the Muslim world. The first Muslim majority-owned banks did not emerge until the 1920s.Kuran, Timur. 2004. ''Islam and Mammon: The economic predicaments of Islamism''. Princeton, NJ; Princeton University Press, pp. x–xi

An early market economy and an early form of mercantilism, sometimes called ''Islamic capitalism'', was developed between the eighth and twelfth centuries. The monetary economy of the period was based on the widely circulated currency the gold dinar, and it tied together regions that were previously economically independent.

A number of economic concepts and techniques were applied in early Islamic banking, including bills of exchange, partnership (''mufawada'', including limited partnerships, or ''mudaraba''), and forms of capital (''al-mal''), capital accumulation (''nama al-mal''), cheques, promissory notes, trusts (see ''Waqf''), transactional accounts, loaning, ledgers and assignments.Subhi Y. Labib (1969), "Capitalism in Medieval Islam", ''The Journal of Economic History'' 29 (1), pp. 79–96 2–3 Muslim traders are known to have used the cheque or ''ṣakk'' system since the time of Harun al-Rashid (9th century) of the Abbasid Caliphate. Organizational enterprises independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced during that time. Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.Jairus Banaji (2007), "Islam, the Mediterranean and the rise of capitalism", ''Historical Materialism'' 15 (1), pp. 47–74, Brill Publishers.

20th century

In the middle of the 20th century, some organizational entities were found to offer financial services complying with Islamic laws. The first, experimental, local Islamic bank was established in the late 1950s in a rural area of Pakistan which charged no interest on its lending.

In 1963, the first modern Islamic bank on record was established in rural Egypt by economist Ahmad Elnaggar to appeal to people who lacked confidence in state-run banks. The profit-sharing experiment, in the Nile Delta town of Mit Ghamr, did not specifically advertise its Islamic nature for fear of being seen as a manifestation of Islamic fundamentalism that was anathema to the Gamal Nasser regime. Also in that year the Pilgrims Saving Corporation was founded in Malaysia (although not a bank, it incorporated basic Islamic banking concepts).

The Mit Ghamr experiment was shut down by the Egyptian government in 1968. Nonetheless, it was considered a success by many, as by that time there were nine similar banks in the country. In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank, which as of 2016 was still in business in Egypt.

Since 1970

The influx of "petro-dollars" and a "general re-Islamisation" following the Yom Kippur War and 1973 oil crisis encouraged the development of the Islamic banking sector, and since 1975 it has spread globally.

In 1975, the Islamic Development Bank was set up with the mission to provide funding to projects in the member countries. Warde, ''Islamic finance in the global economy'', 2000: p.? The first modern commercial Islamic bank, Dubai Islamic Bank, was established in 1979. The first Islamic insurance (or ''takaful'') company – the Islamic Insurance Company of Sudan – was established in 1979. The Amana Income Fund, the world's first Islamic mutual fund (which invests only in Sharia-compliant equities), was created in 1986 in Indiana.

From 1980 to 1985, Islamic investments underwent a "spectacular expansion" throughout the Muslim world, attracting deposits with the promise of "great gains" and "religious guarantees" supplied by Islamic jurists who were "recruited to issue fatwas denouncing conventional banks and recommending their Islamic rivals." Kepel, ''Jihad'', (2002): p. 280 This growth was temporarily reversed in 1988 in the largest Arab Muslim country, Egypt, when the Egyptian state – worried that Islamist movements were building up a "war chest" and being given financial independence – reversed its tacit support for the industry, and launched a media campaign against Islamic banks. The ensuing financial panic led to the bankruptcy of some companies. Kepel, ''Jihad'', (2002): p.280–1

In 1990 an accounting organization for Islamic financial institutions ( Accounting and Auditing Organization for Islamic Financial Institutions, AAOIFI), was established in Algiers by a group of Islamic financial institutions.
Also in that year the Islamic bond market emerged when the first tradable ''sukuk'' – the Islamic alternative to conventional bonds – were issued by Shell MDS in Malaysia. In 2002, the Malaysia-based Islamic Financial Services Board (IFSB) was established as an international standard-setting body for Islamic financial institutions.

By 1995, 144 Islamic financial institutions had been established worldwide, including 33 government-run banks, 40 private banks, and 71 investment companies.
The large US-based Citibank began to offer Islamic banking services in 1996 when it established the Citi Islamic Investment Bank in Bahrain. The first successful benchmark for the performance of Islamic investment funds was established in 1999, with the Dow Jones Islamic Market Index (DJIMI).

Also in the 1990s, a false start was made in Islamic banking in the UK, where bankers declared returns "interest" for tax purposes, while insisting to depositors they were actually "profit" and so not ''riba''. Islamic scholars issued a fatwa stating they had "no objection to the use of the term 'interest'" in loan contracts for purposes of tax avoidance provided the transaction did not actually involve ''riba'', and the Islamic bankers used the term for fear that lack of tax deductions available for interest (but not profit) would put them at a competitive disadvantage to conventional banks. Muslim customers were not persuaded, and a "bad taste" was left "in the mouth" of the market for Islamic financial products. The Islamic Bank of Britain, the first Islamic commercial bank established outside the Muslim world, was not established until 2004.

By 2008 Islamic banking was growing at a rate of 10–15% per year and continued growth was forecast. There were over 300 Islamic financial institutions spread over 51 countries, as well as an additional 250 mutual funds complying with Islamic principles. Worldwide, approximately 0.5% of financial assets were estimated to be under Sharia-compliant management according to '' The Economist'' magazine.

But as the industry grew it also drew criticism (from M.T. Usmani among others) for not progressing from "debt-based contracts", such as ''murabaha'', to the more "genuine" profit and loss sharing mode, but instead moving in the opposite direction, "competing to present themselves with all of the same characteristics of the conventional, interest-based marketplace".

During the global financial crisis of 2008, Islamic banks were not initially impacted by the 'toxic assets' built up on the balance sheets of US banks as these were not Sharia-compliant and not owned by Islamic banks. In 2009, the official newspaper of the Vatican (''L'Osservatore Romano'') put forward the idea that "the ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service". (The Catholic Church forbids usury but began to relax its ban on all interest in the 16th century.)
However, the drop in valuation of real estate and private equity – two segments heavily invested by Islamic firms – following the collapse of Lehman Brothers Islamic did hurt Islamic financial institutions.

As of 2015, $2.004 trillion in assets were being managed in a Sharia-compliant manner according to the State of the Global Islamic Economy Report. Of these $342 billion were ''sukuk''. The market for Islamic ''Sukuk'' bonds in that year was made up of 2,354 sukuk issues, and had become strong enough that several non-Muslim majority states – UK, Hong Kong, and Luxemburg – issued ''sukuk.''

There are multiple Shari'ah-compliant indexes, created by Shari'ah screening of companies. Such indexes include DJIM, S&PSI, MSCI and country-based indexes like KMI-Pakistan and SCM-Malaysia.

Principles

To be consistent with the principles of Islamic law ( Sharia) – or at least an orthodox interpretation of the law—and guided by Islamic economics, the contemporary movement of Islamic banking and finance prohibits a variety of activities, some not illegal in secular states:
*Paying or charging interest. "All forms of interest are '' riba'' and hence prohibited". Islamic rules on transactions (known as ''Fiqh al-Muamalat'') have been created to prevent use of interest.
*Investing in businesses involved in activities that are forbidden ('' haraam''). These include things such as selling alcohol or pork, or producing media such as gossip columns or pornography.
*Charging extra for late payment. This applies to '' murâbaḥah'' or other fixed payment financing transactions, although some authors believe late fees may be charged if they are donated to charity,: "The prevalent position, however, seems to be that creditors may impose penalties for late payments, which have to be donated, whether by the creditor or directly by the client, to a charity, but a flat fee to be paid to the creditor as a recompense for the cost of collection is also acceptable to many fuqaha." or if the buyer has "deliberately refused" to make a payment.
*''Maisir.'' This is usually translated as "gambling" but used to mean "speculation" in Islamic finance. Involvement in contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future is ''maisir'' and forbidden in Islamic finance.
*''Gharar''. ''Gharar'' is usually translated as "uncertainty" or "ambiguity". Bans on both ''maisir'' and ''gharar'' tend to rule out derivatives, options and futures. Islamic finance supporters (such as Mervyn K. Lewis and Latifa M. Algaoud) believe these involve excessive risk and may foster uncertainty and fraudulent behaviour such as are found in derivative instruments used by conventional banking.
*Engaging in transactions lacking "'material finality'. All transactions must be "directly linked to a real underlying economic transaction", which excludes "options and most other derivatives".

Money on the most common type of Islamic financing – debt-based contracts – "must be made from a tangible asset that one owns and thus has the right to sell – and in financial transactions it demands that risk be shared." Money cannot be made from money. Another statement of the Islamic banking theory of finance is: "Money has no intrinsic utility; it is only a medium of exchange." Usmani, ''Introduction to Islamic Finance'', 1998: p.12
Other restrictions include
*Islamic banks are to collect ''zakat'' (obligatory religious alms giving) from customers' accounts – at least according to some sources.Nathan, S. and Ribiere, V. (2007) From knowledge to wisdom: The case of corporate governance in Islamic banking. The Journal of Information and Knowledge Management Systems, 37 (4), pp. 471–483.
*A board of Sharia experts is to supervise and advise each Islamic bank on the propriety of transactions to "ensure that all activities are in line with Islamic principles". (Interpretations of Sharia may vary by country. According to Humayon Dar,Dar, Humayon A. 2010. Islamic banking in Iran and Sudan. ''Business Asia'', 27 Jun

interpretation of the Sharia is more strict in Turkey or Arab countries than in Malaysia, whose interpretation is in turn more strict than the Islamic Republic of Iran. Mohammed Ariff also found less exacting Sharia-compliance in Iran where the Islamic government had decreed "that government borrowing on the basis of a fixed rate of return from the nationalized banking system would not amount to interest" and consequently would be permissible." Mahmud el-Gamal found interpretations most strict in Sudan and least in Malaysia.) #MeGIFLEP2006, El-Gamal, ''Islamic Finance'', 2006: p.21
*Risk sharing. symmetrical risk and return on distribution to participants so that no one benefits disproportionately from the transaction.

In general, Islamic banking and finance has been described as having the "same purpose" as conventional banking but operating in accordance with the rules of Sharia law (Institute of Islamic Banking and Insurance), or having the same "basic objective" as other private entities, i.e. "maximization of shareholder wealth" (Mohamed Warsame). In a similar vein, Mahmoud El-Gamal states that Islamic finance "is not constructively built from classical jurisprudence". It follows conventional banking and deviates from it "only insofar as some conventional practices are deemed forbidden under Sharia."

A broader description of its principles is given by the Islamic Research and Training Institute of the Islamic Development bank,

"The most important feature of Islamic banking is that it promotes risk sharing between the provider of funds (investor) on the one hand and both the financial intermediary (the bank) and the user of funds (the entrepreneur) on the other hand ... In conventional banking, all this risk is borne in principle by the entrepreneur."

Some proponents (Nizam Yaquby) believe Islamic banking has more far reaching purposes than conventional banking, and declare that the "guiding principles" for Islamic finance include: "fairness, justice, equality, transparency, and the pursuit of social harmony", Irfan, ''Heaven's Bankers'', 2015: p.53 although others describe these virtues as the natural benefits of following Sharia. (Taqi Usmani describes the virtues as guiding principles in one section of his book on Islamic Banking, and benefits in another.) Usmani, ''Introduction to Islamic Finance'', 1998: p.11, 167–8

Nizam Yaquby, for example declares that the "guiding principles" for Islamic finance include: "fairness, justice, equality, transparency, and the pursuit of social harmony". Some distinguish between Sharia-''compliant'' finance and a more holistic, pure and exacting Sharia-''based'' finance. Irfan, ''Heaven's Bankers'', 2015: p.236 "Ethical finance" has been called necessary, or at least desirable, Irfan, ''Heaven's Bankers'', 2015: p.198 for Islamic finance, as has a " gold-based currency". Irfan, ''Heaven's Bankers'', 2015: p.192 Taqi Usmani declares that Islamic banking would mean less lending because it paid no interest on loans. This should not be thought of as presenting a problem for borrowers finding funds, because – according to Usmani – it is in part to discourage excessive finance that Islam forbids interest. Usmani, ''Historic Judgment on Interest'', 1999: para 159 Zubair Hasan argues that the objectives of Islamic finance as envisaged by its pioneers were "promotion of growth with equity ... the alleviation of poverty ... nda long run vision to improve the condition of the Muslim communities across the world."
Some (such as convert Umar Ibrahim Vadillo) believe the Islamic banking movement has so far failed to follow the principles of Sharia law, or at least failed to follow them sufficiently strictly.

On the other hand, Usmani preached that an Islamic economy free of the "imbalances" in society – such as concentration of "wealth in the hands of the few", or monopolies which paralyze or hinder market forces – would ''follow'' from obeying "divine injunctions" by banning interest (along with other Islamic efforts). Usmani, ''Introduction to Islamic Finance'', 1998: p.11 (Later in his book ''Introduction to Islamic Finance'', he argues that Islamic principles should include "the fulfillment of the needs of the society" giving "preference to the products which may help the common people to raise their standard of living", but that few Islamic banks have followed this path.) Usmani, ''Introduction to Islamic Finance'', 1998: p.167-8 Another source (Saleh Abdullah Kamel), described the changes anticipated for the Muslim community by following Islamic approach to economics, banking, finance, etc., as a "move towards economic development, creation of the value added factor, increased exports, less imports, job creation, rehabilitation of the incapacitated and training of capable elements".

Scriptural basis

The Sharia law that forms the basis of Islamic banking is itself based on the Quran (revealed to the Islamic prophet Muhammad) and ''a hadith'' (the body of reports of the teachings, deeds and sayings of the Islamic prophet Muhammad that often explain verses in the Quran).
Prohibition of ''gharar'' is based on ''ahadith'' declaring as forbidden ''gharar'' the sale of things like "the birds in the sky or the fish in the water". ''Maisir'' is thought to be banned by verses 2:219, 5:90, and 91 in the Quran.

However, "the Islamic evaluation" of modern banking centers around the definition of interest on loans as ''riba.'' Twelve verses in the Qur'an deal with ''riba'', the word appearing eight times in total, three times in verses 2:275, and once in 2:276, 2:278, 3:130, 4:161 and 30:39.Siddiqi, ''Riba, Bank Interest'', 2004: p.35 ''Riba'' is mentioned numerous times in ''a hadith'', including Muhammad's Farewell Sermon.

A number of orthodox scholars point to Quranic verses (2:275–2:280) as declaring ''riba'' "categorically prohibited" and "unjust" (''zulm''), and defining it to mean any payment "over and above the principal" of a loan.Siddiqi, ''Riba, Bank Interest'', 2004: p.36 (Although at least one source states "it is commonly argued" that ''riba'' is "defined by hadith".)Farooq, ''Riba, Interest and Six Hadiths'', 2009: p.105

''Those who devour usury shall not rise again except as he rises, whom Satan of the touch prostrates; that is because they say, 'Trafficking (trade) is like usury.' God has permitted trafficking, and forbidden usury. Whosoever receives an admonition from his Lord and gives over, he shall have his past gains, and his affair is committed to God; but whosoever reverts – those are the inhabitants of the Fire, therein dwelling forever.
God blots out usury, but freewill offerings He augments with interest. God loves not any guilty ingrate.
Those who believe and do deeds of righteousness, and perform the prayer, and pay the alms – their wage awaits them with their Lord, and no fear shall be on them, neither shall they sorrow.
O believers, fear you God; and give up the usury that is outstanding, if you are believers.
But if you do not, then take notice that God shall war with you, and His Messenger; yet if you repent, you shall have your principal, unwronging and unwronged.
And if any man should be in difficulties, let him have respite till things are easier; but that you should give freewill offerings is better for you, did you but know. '' ()

According to the orthodox, an "increase over the principal sum" in ''loans of cash'' are riba. An increase over the principal sum in ''financing a purchase'' of some product or commodity is another matter. These are ''not'' riba – according to the orthodox interpretation – at least in some circumstances. (These are sometimes known as "credit sales".) According to noted Islamic scholar Taqi Usmani, this is because in Quran aya 2:275 (''"they say, 'Trafficking (trade) is like usury,' utGod has permitted trafficking, and forbidden usury"'') "trafficking (trade)" refers to credit sales such as ''murabaha'', the "forbidden usury" refers to charging extra for late payment ( late fees), and the "they" refers to non-Muslims who did not understand why if the first was allowed both were not. Usmani, ''Historic Judgment on Interest'', 1999: paras 50, 51, 219 For this reason (according to Usmani) it is ''not'' true that "whenever price is increased taking the time of payment into consideration, the transaction comes within the ambit of interest". Instead of "principal" and "interest rate", the credit taker is paying "cost" and "profit rate". (Another difference with conventional finance is that there is no penalty for late payment.)

Interest and credit sales

While Usmani and other Islamic Banking pioneers envisioned credit sales like ''murâbaḥah'' being a limited part of the Islamic Banking industry and subordinate to profit and loss sharing, it has become the "most common" mode of Islamic financing.

The distinction between credit sales and interest has also come under attack from critics such as Khalid Zaheer and Muhammad Akram Khan – criticizing it from opposite points of view. Zaheer considers profit from credit sales to be ''riba'', the same as interest, and notes the lack of enthusiasm of orthodox scholars – such as the Council of Islamic Ideology – for credit sales-based Islamic Banking, which they (the council) call "no more than a second best solution from the viewpoint of an ideal Islamic system".
Khan calls the distinction "frivolous and laboured", a way of charging interest using another name, necessary because businesses "cannot survive where cash and credit prices are equal".
Others note that in terms of standard accounting practice and truth-in-lending regulations getting 90 days credit on a Rs 10000 product and paying an extra Rs 500, cost very nearly the same and is considered very nearly the same as paying in cash, using a three-month loan at 20% per annum.

Taqi Usmani, however, explains that this is a "misconception".
Paying more for credit when buying a product ("an exchange of commodities for money") does not violate Sharia law, but exchange of "one unit of money for another of the same denomination" ("an exchange of money for money") and charging for credit ''is'' a violation of Sharia. The cash loan is different because "money has no intrinsic utility".

Other orthodox supporters (such as Kahf) have defended the Sharia-compliance of the practice saying that among other things, attaching commodities to money in finance prevents money from being used for speculative purposes. Critics report widespread abuses of "synthetic" ''murabaha'', which are loans with interest in all but name.Frank VOGEL and Samuel Hayes, III. Islamic Law and Finance: Religion, Risk and Return he Hague: Kluwer Law International, 1998 pp.8–9 Farooq, ''Riba-Interest Equation and Islam'', 2005: p.19

Types of Islamic lending

One of the pioneers of Islamic banking, Mohammad Najatuallah Siddiqui, suggested a two-tier ''mudarabah'' model as the basis of a ''riba''-free banking. The bank would act as the capital partner in ''mudarabah'' accounts with the depositor on one side and the entrepreneur on the other side. (Another pioneer Taqi Uthmani called ''mudarabah'' and another profit-sharing form of finance ''musharakah'', the "real and ideal instruments of financing in Shari‘ah".) This model would be supplemented by a number of fixed-return models—mark-up (''murabaha''), leasing (''ijara''), cash advances for the purchase of agricultural produce (''salam'') and cash advances for the manufacture of assets (''istisna), etc. In practice, the fixed-return models, in particular ''murabaha'' model, became the industry staples, not supplements, as they bear results most similar to the interest-based finance models. Assets managed under these products far exceed those in " profit-loss-sharing modes" such as ''mudarabah'' and ''musharakah''.

Time value of money

The time value of money – the idea that there is greater benefit in receiving money now rather than later, so that savers/investors/lenders should be compensated for delayed gratification – has been called one of the "most significant" arguments in favor of charging interest on loans. As such, some Islamic finance supporters have opposed the concept, arguing that some consumption – such as eating – can only be done over time, and discounting for time encourages negative outcomes such as unsustainable production like desertification, since the desertification comes in the discounted future.
However, since Islamic banking also calls for rewarding delayed gratification in the form of "return on investment" on both profit-sharing and credit sales, Islamic scholars and economists have tended to insist that time value of money is a valid concept "provided the rate of discount is the 'rate of return' on capital rather than the rate of interest," a position critics find specious.

Early payment of debt

The opposite of credit sales (i.e. the opposite of charging more in exchange for giving the buyer time to pay) is reduced charges for early payment. This is considered ''haram'' by the four Sunni schools of jurisprudence ('' Hanafi'', '' Maliki'', '' Shafi'i'', '' Hanbali''), but not by all jurists according to Ridha Saadullah. He notes that such reductions have been permitted by some companions of the Prophet and some of their followers. This position has been advanced by Ibn Taymiyya and Ibn al-Qayyim, and it has, more recently, been adopted by the Islamic '' Fiqh'' Academy of the OIC. The Academy decided that "reduction of a deferred debt in order to accelerate its repayment, whether at the request of the debtor or the creditor is permissible under ''Shariah''. It does not constitute forbidden ''riba'' if it is not agreed upon in advance and as long as the creditor-debtor relationship remains bilateral. ..."

Islamic laws on trading

As noted above, the primary focus of Islamic banking is on financing without interest to avoid ''riba'', while trade is not an issue (per the Quranic statement that ''"God has permitted trade and forbidden riba sury''. However trade transactions that involve gambling (''maisir''), or excessive risk (''bayu al-gharar'') are ''not'' permitted. Among the financial instruments and activities common in conventional finance that are considered forbidden (or at least Islamically problematic) by many Islamic scholars and Muslims are:
* margin trading: This uses borrowed money to buy shares of stock or other financial instruments. It both involves forbidden interest on the borrowed money, and much greater risk than non-margin investing because losses can be greater than the amount borrowed;
* short selling: borrowing/renting shares of stock or some other instruments and selling it, sometimes without possessing it, on the hope that it can be later repurchased at a lower price for a profit. It is traditionally thought to violate the hadith stating "Do not sell which you do not possess," and has been declared impermissible by numerous sources (Raj Bhala, Taqi Usmani, Humayon Dar.
*day trading: very short term buying and selling of financial instruments) has been called un-Islamic because the short period of "ownership" means day traders do not truly own what they trade, and furthermore pay interest. Among the sources calling it un-Islamic include Yusuf Talal DeLorenzo, and Focus Business Services of the UAE.
* derivatives: contracts that derive their value from the performance of an underlying asset; (The "notional value" of the world's over-the-counter derivatives at the end of 2007 was $596 trillion and the gross market value of all outstanding derivatives was $14.5 trillion.) Options, futures and "other derivatives" are "generally" not used in Islamic finance "because of the prohibition against maisir", Sources stating that most derivative or some kinds of derivative are banned by Islamic scholars include Juan Sole and Andreas Jobst,Solé, Juan A. and Jobst, Andreas (Andy), Operative Principles of Islamic Derivatives – Towards a Coherent Theory (March 2012). IMF Working Paper No. NO.12/63. Available at SSRN: https://ssrn.com/abstract=2028239 P. S. Mills and J. R. Presley, Taqi Usmani, Investopedia. The most commonly used derivative are:
** forwards: customized contracts to buy or sell an asset at a specified price on a future date. unlike futures contracts forward contracts are not traded on any exchanges;
**futures: a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price at a specified time in the future;
**options: contracts offering the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date);
** swaps: contracts through which two parties exchange financial instruments to transfer risk.

On the other hand, at least one Islamic scholar (Mohammed Hashim Kamali) finds "nothing inherently objectionable" in selling and using options, which like other kinds of trade is ''mubah'' (permissible) in fiqh, and "simply an extension of the basic liberty that the Quran has granted". And both Islamic finance practitioners and critics find benefit in at least some uses of derivatives and short selling – managing risk in times of financial trouble, improving market efficiency and employee productivity.

At least some in the Islamic finance industry use derivatives and make short sales, and permissibility of this is a subject of "heated debate".
Global standards for trading Islamic profit-rate and currency swap derivatives were set in 2010 with the "Hedging Master Agreement"iran-daily.com
(click on "Islamic Derivatives Standards Set"), 2 March 2010 (see below).
A "Shariah-certified" short-sale had been created by some Shariah-compliant hedge funds. However both have been criticized as un-Islamic.

Justification for Islamic banking

It has been praised – or at least described positively – for
*turning a "theory" into a trillion dollar Usmani, ''Introduction to Islamic Finance'', 1998: p.162-3 "reality", asserted Islam into international financial markets (according to Taqi Usmani);
*enriched the Islamic legal system by providing it with real world business questions to find shariah-compliant solutions for (Usmani);
*creating an "ethical, sustainable, environmentally- and socially-responsible" system (according to Abayomi A. Alawode);
*drawing conventional banks into the industry in search of Muslim customers (Munawar Iqbal and Philip Molyneux);
*drawing new customers and money into banking, rather than taking existing customers and their money away from conventional banking, (Laurent Gheeraert).
*Creating a less risky form of finance (according to Zeti Akhtar Aziz and others),
**by forbidding speculation, so that, for example, the excesses that led to the global financial crisis of 2007–2008 are avoided (according to Ibrahim Warde);
**and by use of two kinds of accounts:
***"current accounts" – where funds earn no return and (in theory) are held, not invested by the bank, so not subject to risk;
***and ''mudarabah'' accounts – where the depositors share in any losses with the bank, so diminishing the bank's risk.
*While the industry has problems and challenges, these can be explained by
**its relative youth and low position on the " learning curve" that will solved these difficulties over time; Usmani, ''Introduction to Islamic Finance'', 1998: p.xviii and by
**non-Islamic influences which can only be eliminated when the industry operates in a truly Islamic society and environment.

Industry framework

Islamic financial institutions take different forms. They may be
#Full-fledged Islamic financial institutions (for example Islami Bank Bangladesh Ltd, Meezan Bank in Pakistan);
#Islamic "windows" – i.e. separate, sharia-compliant units Jamaldeen, ''Islamic Finance For Dummies'', 2012:53 – in conventional financial institutions (for example: HSBC – HSBC Amanah, American Express Bank, ANZ Grindlays, BNP-Paribas, Chase Manhattan, UBS, Kleinwort Benson, Commercial Bank of Saudi Arabia, Ahli United Bank Kuwait, Riyad Bank); (Scholars debate compliance of this form, according to Faleel Jamaldeen, "primarily" because of "where" the funds for these windows come from.) Jamaldeen, ''Islamic Finance For Dummies'', 2012:121
#Islamic subsidiaries of conventional financial institutions (for example: Citibank subsidiary Citi Islamic Investment Bank (Bahrain), Union Bank of Switzerland subsidiary Noriba Bank).
#Islamic NBFCs or Non Banking Financial Institutions (Like small NBFCs that are operational in India)

Size and locations

Sharia-compliant banking grew at an annual rate of 17.6% between 2009 and 2013, faster than conventional banking, and is estimated to be $2 trillion in size,
but at 1% of total world,see also: Hasan, Maher and Jemma Dridi (2010). ''The effects of the global crisis on Islamic and conventional banks: A comparative study. IMF working paper WP 10/201, September . Washington, DC: International Monetary Fund. p.3-4'' still much smaller than the conventional sector.

As of 2010, Islamic financial institutions operate in 105 countries. Statistics differ on which country has the largest Islamic banking sector. According to the 2016 World Islamic Banking Competitiveness Report (see table), Saudi Arabia, Malaysia, United Arab Emirates, Kuwait, Qatar, and Turkey represented over 87% of the international Islamic banking assets. A 2006 report by ISI Analytics also lists Saudi Arabia at the top and Iran as insignificant.Askari, Hossein, Zamir Iqbal and Abbas Mirakhor. 2010. ''Globalization and Islamic finance: Convergence, prospects and challenges.'' Singapore: John Wiley & Sons (Asia). cited in ... In Qatar, Islamic banking assets were valued at $97 billion at the end of 2017, accounting for nearly 81% of total Islamic finance assets, according to QFC Authority chief executive officer Yousuf Mohamed al-Jaida. The country also announced the launch of an energy-focused Islamic bank with $10 billion capital in 2019, which would make it the biggest Islamic lender for energy projects in the world.

However, according to Ibrahim Warde, Shia-majority Iran dominates Islamic banking with $345 billion in Islamic assets, Saudi Arabia with $258 billion, Malaysia $142 billion, Kuwait with $118 billion and UAE with $112 billion. Islamic banks in UAE also provides Islamic investment programs which are Shariah compliant. Warde, ''Islamic finance in the global economy'', 2000: p.1 And according to Reuters, Iranian banks accounted for "over a third" of the estimated worldwide total of Islamic banking assets, (although sanctions have hurt Iran's banking industry and "its Islamic financial system has evolved in ways that will complicate ties with foreign banks"). According to the latest central bank data, Iran's banking assets as of March 2014 totalled 17,344 trillion riyals or $523 billion at the free market exchange rate.
According to The Banker, as of November 2015, three out of ten top Islamic banks in the world based on return on assets were Iranian.

Sharia advisory councils and consultants

Because compliance with shariah law is the '' raison d'être'' of Islamic finance, Islamic banks and banking institutions that offer Islamic banking products and services should establish a Shariah Supervisory Board (SSB) – to advise them on whether or not some proposed transactions or products follows the Sharia, and to ensure that the operations and activities of the banking institutions comply with Shariah principles.

According to various Islamic banking organizations some requirements for SSBs include:
*that they be composed of jurists specializing in ''fiqh al-muamalat'' i.e. Islamic commercial jurisprudence, ( Accounting and Auditing Organization for Islamic Financial Institutions, AAOIFI);AAOIFI 2005. ''Accounting, auditing and governance standards for Islamic financial institutions.'' Manana, Bahrain: Accounting and Auditing Organization for Islamic Financial Institutions
*their fatwas (legal opinions) and ruling be binding, (AAOIFI);
*that they have at least three members, (Institute of Islamic Banking and Insurance);
*that their members not be employees of the financial institution they supervise;
*and be appointed and have their remuneration set by a "general assembly" rather than the institution's board of directors, ( International Association of Islamic Banks).Warde Ibrahim, 2000: Islamic finance in the global economy, Edinburg, Edinburg university press. p.226-27
In addition, their duties should include:Grais, Wafik and Matteo Pellegrini. 2006. ''Corporate governance and Shari'ah compliance in institutions offering Islamic financial services.'' Policy research working paper 4054, November. Washington, DC: World Bank., p.7
*calculating zakat payable by Islamic financial institutions, (AAOIFI);
*disposing of non-shariah-compliant income, (AAOIFI);
*advising on the distribution of income among investors and shareholders, (AAOIFI).

Since the beginning of modern Islamic finance, the work of the Shariah boards has become more standardized.
Among the organizations that have issued guidelines and standards for Shariah compliance are the AAOIFI,AAOIFI. 2008. ''Governance standards. Shari'a supervisory board: Appointment, composition and report.'' Manana, Bahrain: Accounting and Auditing Organization for Islamic Financial Institutions. Fiqh Academy of the OIC, Islamic Financial Services Board (IFSB) (2009). The guidelines and standards are not regulations though, and each Islamic financial institution has its own SSB, which are not generally obliged to follow them.

However, their home country many have a regulatory organization that they are required to follow.
As of 2013, regulators in Bahrain, Indonesia, Jordan, Kuwait, Lebanon, Malaysia and Pakistan have developed guidelines for SSBs in their respective jurisdictions. Some countries, like Indonesia, Kuwait, Malaysia, Pakistan, Sudan, and the UAE have centralized SSBsAskari, Hossein, Zamir Iqbal Mirakhor. 2010. ''Globalization and Islamic finance: Convergence, prospects and challenges.'' Singapore: John Wiley & Sons (Asia), 21 (In Malaysia that SSB is called the Shariah Advisory Council, and was set up at Bank Negara Malaysia (BNM).) A number of Shariah advisory firms have now emerged to offer Shariah advisory services to the institutions offering Islamic financial services.

Financial accounting standards

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), has been publishing standards and norms for Islamic financial institutions since 1993. By 2010, it had issued "25 accounting standards, seven auditing standards, six governance standards, 41 ''shari'ah'' standards and two codes of ethics." (By 2017 it had issued 94 standards in the "areas of Shari’ah, accounting, auditing, ethics and governance".) Although it is an independent body, its "pronouncements on the acceptability or otherwise of contractual structures in relation to Islamic financial instruments are to be viewed in the same vein as regulatory edicts." Irfan, ''Heaven's Bankers'', 2015: p.33 Its standards are mandatory for Islamic financial institutions in Bahrain, Sudan, Jordan and Saudi Arabia, and recommended for other Muslim countries and Islamic financial institutions according to Muhammad Akram Khan.
Established in Algiers in 1990, its original name was Financial Accounting Organization for Islamic Banks and Financial Institutions. It later moved its headquarters to Bahrain.

The International Islamic Financial Market – a standardization body of the Islamic Financial Services Board for Islamic capital market products and operations – was founded in November 2001 through the cooperation of the governments and central banks of Brunei, Indonesia and Sudan. Its secretariat is located in Manama Bahrain. It is not a regulatory body and its recommendations are "not implemented by most Islamic banks". Faleel Jamaldeen differentiates its controlling body (Islamic Financial Services Board) from the other Islamic Financial standards organ, the AAOIFI, saying,

the AAOIFI sets best practices for handling the financial reporting requirements of Islamic financial institutions, IFSB standards are mainly concerned with the identification, management, and disclosure of risk related to Islamic financial products. Jamaldeen, ''Islamic Finance For Dummies'', 2012:54

Individual countries also have accounting standards. The Institute of Chartered Accountants of Pakistan issues Islamic Financial Accounting Standards (IFAS).

Supporting institutions

The Islamic Interbank Money Market was established by Bank Negara Malaysia on 3 January 1994, and has developed instruments to manage the liquidity needs of the Islamic financial institutions – "funding and adjusting portfolios over the short term".

The Islamic Financial Services Board was founded on 3 November 2002 at Kuala Lumpur by central banks of Bahrain, Iran, Kuwait, Malaysia, Pakistan, Saudi Arabia, Sudan along with the Islamic Development Bank, AAOIFI, and IMF.
As of April 2015, the 188 members of the IFSB comprise 61 regulatory and supervisory authorities, eight international inter-governmental organisations, and 119 market players (financial institutions, professional firms and industry associations) operating in 45 jurisdictions. From 2002 to 2012 it issued 17 standards, guiding principles and notes. Jamaldeen, ''Islamic Finance For Dummies'', 2012: p.260
Its objective is to standardize and harmonize the operation and supervision of Islamic financial institutions, standards and capital adequacy, risk management and corporate governance in consultation with a wide array of stakeholders and after following a lengthy process. It complements the task of the Basel Committee on Banking Supervision. As of 2015 it had published 17 standards and six guidance notes.

Islamic International Rating Agency started operations in July 2005 in Bahrain. It is sponsored by 17 multilateral development institutions, banks and other rating agencies.

The Dow Jones Islamic Market Index (DJIMI) was established in 1996. The Index has been approved by Fiqh Academy of the OIC.McMillen, Michael J.T. 2008. "Asset securitization sukuk and Islamic capital markets: Structural issues in these formative years." ''Wisconsin International Law Journal'' 25 (4) (Winter), p.730 It uses three levels of screening—eliminating businesses involved in activities not allowed by Islamic law (alcohol, pork, gambling, prostitution, pornography, etc.); eliminating companies whose total debts divided by their 12-month average market capitalization are 33% or more of their total sources of funds; eliminating companies that have 'impure income or expenditure' (including, of course, interest) of more than 5–10 per cent of their income or expenditure (eliminating businesses with ''any'' 'impure income' being considered impractical).

In 2006, Citigroup launched the Dow Jones Citigroup Sukuk Index. The sukuk making up the Index must be at least $250 million in size, have a maturity of at least one year and a minimum rating of BBB-/Baaa3. In 1998, the FTSE Global Islamic Index was launched. It has 15 Islamic indices for various regions.
In 2007, the MSCI Islamic Index series was launched, one of the "MSCI 'Faith-Based' Indexes". It is constructed from the conventional MSCI country indices and covers 69 developed, emerging and frontier markets, including regions such as the Gulf Cooperation Council and Arabian markets.

Central banking

Although no Muslim country has yet banned interest on loans completely, suggestions have been made as to how to deal with monetary policy when central banks operate in an interest-free environment and there are no longer any interest rates to lower or raise. Economist Mohammad N. Siddiqi has proposed that central banks offer "refinance facilities" to expand or contract credit as needed to deal with inflation or deflation.Siddiqi, Muhammad Nejatullah. ''Some aspects of the Islamic Economy.'' Lahore, Islamic Publications, 1970; New Delhi, Markazi Matabah Islami, 1972, 105

He also proposes that short term credit for the production sector of the economy, be estimated by the central banks and the provided by them by manipulating the "refinance ratio" and the "lending ratio".

According to economist and Islamic finance critic Feisal Khan, a "true" or strict Islamic banking and finance system of profit and loss sharing (the type supported by Taqi Usmani and the Shariah Appellate Bench of the Supreme Court of Pakistan) would severely cripple central banks' ability to fight a credit crunch or liquidity crisis that leads to a severe recession (such as happened in 2007–8). This is because if credit was provided by taking "a direct equity stake in every enterprise" (the PLS approach) it would contract in a credit crunch. But situations like this – when financiers are "less and less sure of the creditworthiness of their financial sector counterparties" and essentially stop lending to even the biggest and most stable borrowers or even other banks – is exactly the time when credit expansion and "flooding" the economy with liquidity is needed to prevent widespread business bankruptcy and unemployment.

Products, services and contracts

Banking makes up most of the Islamic finance industry. Banking products are often classified in one of three broad categories, two of which are "investment accounts":
* Profit and loss sharing modes – ''musharakah'' and ''mudarabah'' – where financier and the user of finance share profits and losses, are based on "contracts of partnership". Jamaldeen, ''Islamic Finance For Dummies'', 2012:96 These have been called the "real and ideal" modes of Islamic finance as Islam calls for sharing of rewards and losses by all who contribute capital to a commercial enterprise (according to Taqi Usmani Usmani, ''Introduction to Islamic Finance'', 1998: p.14 and other theoreticians of Islamic finance).
*"Asset-backed financing", "debt-like instruments" such as mark-up (''murabaha''), leasing (''ijara''), cash advances for the purchase of agricultural produce (''salam''), and cash advances for the manufacture of assets (''istisna). These are based on "contracts of exchange", and involve the "purchase and hire of goods or assets and services on a fixed-return basis". The fixed return resembles the interest of conventional banking rather than variable profits and losses, but is called "profit" or "markup", not "interest". Originally these modes were intended by Islamic banking advocates to be "interim" measures, or to be used for situations where participatory financing was not practical, but now account for the great bulk of investments in many Islamic banks.
the third category consists of
*Modes based on contracts of safety and security, include safe-keeping contracts (''wadi’ah'') for current deposits (called checking accounts in the US), and agency contracts (''wakalah'').

Most Islamic finance is in banking, but non-banking finance such as ''sukuk'', equity markets, investment funds, insurance (''takaful''), and microfinance,
is also fast-growing, and as of 2013 represented about one-fifth of total assets in Islamic finance.Islamic Financial Services Board (IFSB). 2014
Islamic Financial Services Industry Stability Report
. Kuala Lumpur: IFSB.

These products – and Islamic finance in general – are based on Islamic commercial contracts and contract law, Jamaldeen, ''Islamic Finance For Dummies'', 2012:89 with many products named after a particular contracts (e.g. ''mudaraba'') although they are combinations of more than one contract.

Profit and loss sharing

While the original Islamic banking proponents hoped profit-loss sharing (PLS) would be the primary mode of finance replacing interest-based loans,
long-term financing with profit-and-loss-sharing mechanisms is "far riskier and costlier" than the long term or medium-term lending of the conventional banks – according to critics such as economist Tarik M. Yousef – and has "declined to almost negligible proportions".Iqbal, Munawar, and Philip Molyneux. 2005. ''Thirty years of Islamic banking: History, performance and prospects.'' New York: Palgrave Macmillan.Kuran, Timur. 2004. ''Islam and Mammon: The economic predicaments of Islamism''. Princeton, NJ; Princeton University PressYousef, T.M. 2004. The murabaha syndrome in Islamic finance: Laws, institutions and policies. In ''Politics of Islamic finance,'' ed. C.M. Henry and Rodney Wilson. Edinburgh: Edinburgh University Press Loans are permitted in Islam if the interest that is paid is linked to the profit or loss obtained by the investment. The concept of profit acts as a symbol in Islam as equal sharing of profits, losses, and risks.

Mudarabah

A ''mudarabah'' or ''mudharabah'' contract is a profit sharing partnership in a commercial enterprise. One partner, ''rabb-ul-mal'', is a silent or sleeping partner who provides money. The other partner, ''mudarib'', provides expertise and management. The arrangement is similar to venture capital in conventional finance, in which a venture capitalist finances an entrepreneur, who provides management and labor.

Profits are shared between the parties according to a pre-agreed ratio, usually either 50%–50%, or 60% for the ''mudarib'' and 40% for ''rabb-ul-mal''. If there is a loss, the ''rabb-ul-mal'' loses the invested capital, and the ''mudarib'' loses the invested time and effort. The sharing of risk reflects the view of Islamic banking proponents that under Islam, the user of capital – labor and management – should not bear all the risk of failure. Sharing of risk, according to proponents, results in a balanced distribution of income, and prevents financiers from dominating the economy. Usmani, ''Introduction to Islamic Finance'', 1998: p.17-36

Musharakah (joint venture)

Like ''mudaraba'', ''musharakah'' is also a profit and loss sharing partnership, but one where investment comes from all the partners, all partners are given the option of participating in the management of the business, and all partners share in losses according to the ratio (''pro rata'') of their investment.

''Musharakah'' may be "permanent" or "diminishing". It is often used in investment projects, letters of credit, and the purchase or real estate or property. Use of ''musharaka'' is not great. In Malaysia, for example, the share of ''musharaka'' (or at least permanent ''musharaka'') financing declined from 1.4 percent in 2000 to 0.2 per cent in 2006

Diminishing Musharaka

''Musharaka al-Mutanaqisa'', (literally "diminishing partnership"), is a popular type of financing for major purchases such as housing. In it, the bank and purchaser (customer) have joint ownership of a purchased asset with the customer also leasing the asset. As the customer gradually paying off the cost the bank's equity share diminishes from all but the customer percentage of downpayment to nothing.
If the customer defaults and the asset is sold, the bank and the customer split the proceeds according to each party's current equity.

It would assist at this point to highlight how ''Musharaka al-Mutanaqisa'' is different than conventional banking mortgages, so that the salient difference, both in terms of law and practice is understood. To assist in this understanding, let's first see how regular mortgages work in the United States:

Once a buyer wishes to purchase a home, she approaches the lender and requests a loan. The lender in turn, if buyer qualifies, will lend money to buy the house, and the bank will usually set a fixed percentage of interest to be paid to the lender. Each payment to lender will then include a return of the portion of principal and the interest accrued on the remaining balance for that period. Over time, the entire principal is paid back to the lender, together with all the interest that is due. In terms of the ownership of the house, the buyer/borrower/debtor will have legal title to the house during the term of repayment and thereafter too. In the county title records office, the borrower will have a title deed showing the buyer as the title holder, and not the bank. Any diminishing value of the house is the risk of the borrower and not the bank. On the other hand, any appreciation is also of the borrower and the bank cannot ask for more principal due to the appreciation. Hence, the bank and the borrower know at the outset the exact obligations to each other. The bank, in an effort to secure its loan, will place a lien (a charge) on the property, so that if the borrower does not repay the loan, the bank gets the right to foreclose on the borrower's right to hold title and have the title be transferred to the bank (or the house be auctioned and the proceeds received by bank). In the U.S., most states have a judicial foreclosure process where the bank asks the court to sell the property to recover the balance of its loan and accrued interest, plus any other costs of the suit.

How is then ''Musharaka al-Mutanaqisa'' going to address the interest portion of the payment from borrower to the bank. The concept of title here then becomes critical, because the Islamic bank will still come up with the money to buy the house, but the bank will buy the house in partnership with the homeowner. Together the bank and the borrower will become "tenants in common" and the local recorder office will show both the bank and the buyer as joint owners. The percentage of ownership of the house at this point will be based on money ratio between bank and buyer. Let's assume buyer paid 10% and the bank paid 90% of the price. However, since the bank will not be living in the house, the buyer will agree to a rental payment for the use of the 90% of the portion of the property. In addition, buyer will also agree to buy a certain percent of the bank's portion on a monthly basis. Hence, buyer pays rent for usage, and also an amount to buy out the bank's portion. Since there is no interest being paid, this form of ownership (in partnership) is acceptable under shariah. At the end of the agreed rental term, the buyer will have bought out all of the 90% portion of the partnership, and buyer can then ask the bank to dissolve the partnership. The recorder's office will have a new title deed recorded, whereby the bank ceases to be a tenant-in-common with the buyer, and the buyer becomes the entire title holder (whether alone or with spouse, or any other entity as chosen by buyer).

The essence of both transactions is different, and that is based on the outset as to who exactly legally has title to the house at the outset. The other difference is that the monthly payments by buyer in Islamic banking are rent and partnership buyout payments, and not return of principal and interest as they are in conventional banking. Economically then, the Islamic bank also shares in the risk of house value dropping, where in the conventional banking model the bank has not taken any risk of depressed values. The opposite is true also, where both the Islamic bank and the buyer gain if house is sold for more than the book value of the partnership. In conventional banking, the bank does not benefit from rising prices.

Skeptics of the Islamic banking argue that the result is the same: the buyer makes monthly payments to own the house, much like a conventional mortgage. But has the risk of home ownership not been shared in Islamic banking? If it has legally, then it is not the same as the conventional mortgage transaction.

Asset-backed financing

Asset-backed or debt-type instruments (also called contracts of exchange) are sales contracts that allow for the transfer of one commodity for another commodity, the transfer of a commodity for money, or the transfer of money for money. They include ''Murabaha'', ''Musawamah'', ''Salam'', ''Istisna’a'', and ''Tawarruq''.

Murâbaḥah

''Murabahah'' (or ''murabaha'') is an Islamic contract for a sale where the buyer and seller agree on the markup (profit) or "cost-plus

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