If reading this, you’ve probably heard about Islamic finance at some point in life. Maybe you want to take advantage of what it offers the financial market. Either way, it is essential to have an insight into what you’re dealing with before deciding on the next step of action. And that’s what this quick guide will help you unearth today.
In a nutshell, Islamic finance is a type of financing activity that needs to comply with Sharia (Islamic Law). The concept can also be used in reference to the investments that are permissible under Sharia. Actually, the common practices of Islamic finance and banking came into existence together with the foundation of Islam.
As mentioned earlier, Islamic finance strictly adheres to Sharia law. Contemporary Islamic finance is based on a number of prohibitions that are not always illegal in the countries when Islamic financial institutions operate.
For starters, Islam regards lending with interest payments as an exploitative practice that favors the lender at the expense of the borrower. As per Sharia law, interest is usury (riba), which is strictly prohibited.
Another key principle of Islamic finance covers investing in businesses involved in prohibited activities. Sine activities, such as producing and selling alcohol or pork, are prohibited in Islam. These activities are considered haram or forbidden. For this reason, investing in such activities is also forbidden under Islamic finance.
It is worth mentioning that Sharia prohibits any form of speculation or gambling, which is called maisir. In this regard, financial institutions can’t be involved in contracts where the ownership of goods depends on an uncertain event in the future.
We can never conclude without mentioning the sheer fact that the rule of Islamic finance ban participation in contracts with excessive risk and/or uncertainty. The term gharar measures the legitimacy of risk or uncertainty in investments. Gharar is observed with derivative contracts and short-selling, which are totally forbidden in Islamic finance.
We hope this simple guide will help you get an insight into what Islamic finance offers the market before you finally use it to your advantage.