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What is Islamic Banking and Finance Brief Introduction

A high caliber Investment Professional with an experience amounting over 30 years, majorly across various facets of Investment.

Objective of Sharia


Short Selling is Not Halal

What is Islamic Banking

What is Islamic Banking and Finance

Frequently Asked Question

This blog is about basic understanding of Islamic Banking and Finance. I am trying to clear some misconception.

  • What is Islamic Banking and Finance

Islamic Banking and Finance is the company which work and guided and governed by principle of Shariah, these institutions do not charge any interest or do not pay interest, basic principle is Profit Sharing and Risk Sharing.

  • What does it mean by Interest Free Banking?

Interest free banking means, they do not charge you interest when they finance you or invest with you. The basic principle is no interest, or compound interest will be charged. The system should be transparent and ethical.

  • Interest Free Loan

Interest free loan, are given against mortgage or guarantee. They are personal loan given for specific time, same amount will be returned and no interest will be charged. Individuals or Charitable Organization usually offer this option. We should have such institutions so that poor can get timely help.

One of reason of poverty is Interest Paid on Loan taken for Medical Treatment, Marriage, and Education.

There is need to develop such institutions.

  • Islamic Banking and Finance

They are for profit companies. They make money and share the profit with investors. They make money by Trade Financing and Investing on Shariah Principles. (Profit Sharing, Cost Plus Financing, Rent etc.)

  • What are different financing types

Murabah Financing – Cost plus Financing, it is Trade Financing

Musharakah Financing – Joint Venture, profit sharing contract

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Mudarbah Financing – Profit Sharing Investment

Ijara Financing – It is Lease Finance, the Rental is Fixed and is duration also fixed.

Wakalah – It is system where investor give right to third party to invest and manage his portfolio according to Islamic Principles.

Istisna – is contract for Construction Project where owner gives the asset to be built by investor and then the completed project is handed over to the owner, we can talk of hybrid mechanism of Diminishing Musharkah or Ijar for long term financing structure for such mega projects.

Diminishing Musharkah – This partnership, where ownership of investors is reduced gradually and accordingly profit share, this is very good for Housing, Project Finance and Car Finance.

Hybrid Contracts – When more than one contract is used for financing, it is called Hybrid Contracts.

Istisna + Ijar

Istisna + Diminishing Musharkah

There many options available for creating a solution as per needs.

Project Finance – There are number of Hybrid Financing Option for Mega Projects or PPP Projects. Investors, Contractors, Project Advisors and Government can work together on Project Financing where guarantees are given by government, or Project Owners.

Salam – This Forward Contract, where Financing is given to Produce Product in advance with guarantee. This is used for Crop Financing.

Tawarruk – is a person buys commodity or product on deferred payment, with right to resale.

Sukuk - It is debt instrument, where fixed return is promised and risk sharing. Ownership of asset is transferred to Investor and they have full right on asset, in the event of default.

Islamic Finance

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Investment Share Market

How Islamic Banks Make Money

  • How investors make money

Investors get profits by Investing in Profit sharing or trading or rental agreement with the Institution.

Deposits are classified according to investment contracts.

Investors share Profit and Loss.

  • How Bank, Islamic Finance Company make money

They share profit, rental with investors.

They get management fees on wakala contracts (Trustee)

  • What is key difference between Conventional and Islamic Bank

Convention Baking is bank based on Fixed Interest(Riba) and on default Compound interest is charged. Depositor gets fixed interest, whatever money banks make. Even though it is said, deposits are safe, but they are not, depositors can lose everything if bank collapse.

The Profit is shared based on agreed contract, so is loss. The loss is only related to the contract they entered and has nothing to do with status of whole bank.

Apart Financial Audits, Islamic Bank must have independent Sharia Auditors, who advise and see if business is carried out according to Islamic Principles.

  • Role of Shariah Auditors

Shariah Auditors are key stake holders; they are independent auditors who keep watch on every activity, they keep watch that every activity will be get pre-approval from them.

Every activity, must comply with Shariah Principle.

This whole Value chain of the system must be shariah compliant. If this chain is broken anywhere, then we cannot say, they are Shariah Compliant.

Shariah Compliance is single biggest challenge of Islamic Finance.

  • Investing in Share Market

Investing in Share Market is allowed with following Terms and Condition

  • The Company Must be shariah complaint
  • There is Rules for Share Market Investment must be followed
  • Short Selling
  • Forex and interest based debt are not allowed.
  • Exchange Traded Funds

Shariah Compliant Exchange Traded Funds are allowed, they must follow the regulation set by Shariah Committee.

  • Takaful – Islamic Insurance

Takaful is Shariah Compliant Insurance. There are different methods for sharing risk. It is all about how Risk is distributed and managed. We have Takaful and Re-Takaful companies.

There are number of different Takaful Model for Structuring and sharing of Risk.

  • What is key Difference

The key difference between conventional Insurance and Takaful, takaful has different structures and methods and contracts, depending nature of business and needs and worked according to principles of Shariah.

In conventional methods, Risk is Transferred to other Party, but in Takaful Risk is Shared and Managed.

  • Crypto Currency

All types of Crypto Currency are not Shariah Compliant. They are not halal; no one should invest in it.

  • Day Trading

Day Trading is not Shariah Complaint and should not practice.

  • Online Trading

Online Trading Platforms which are not monitored or without shariah auditors, whose activities are not certified are not Halal.

  • Forex Trading

Forex Trading, money for money in currency trading is not Shariah Compliant. Only Spot Exchange of Money is allowed.

  • Haram Activities

Any activity which is considered as haram, investment in them Haram

  • Gambling
  • Casino’s
  • Alcohol
  • Pork
  • Arm
  • Interest Banking/Conventional Banking
  • Movies/Music/anything which promotes adultery

Islamic Structures and Shariah Compliance

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Who Set Shariah Standards

Who Define Shariah Standards

The Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) is an Islamic international autonomous non-for-profit corporate body, they define Shariah Standards and oversee the implementation. (AAOIFI)

Development of Shariah Standards is there prime Responsibility.

They have Accredited Courses for Shariah Auditors and Shariah Accountant.

  • “CIPA” stands for Certified Islamic Professional Accountant
  • Certified Shari’ah Advisor (CSAD);
  • Certified Shari’ah Auditor (CSAU)

Islamic Financial Service Board (IFSB)

This is body representing Islamic Financial Institution.

The Islamic Financial Services Board (IFSB) is an international standard-setting organization that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors. The IFSB also conducts research and coordinates initiatives on industry related issues, as well as organizes roundtables, seminars and conferences for regulators and industry stakeholders.

CIIFP – Chartered Institute of Islamic Finance Professional

The Chartered Institute of Islamic Finance Professionals (CIIF) was established in 2015 as a professional body for Islamic finance practitioners to support the capacity building agenda of the industry by setting professional standards to drive the next phase of Islamic finance human capital development.

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Investing in Share Market

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