A share of shariah, a handful of takaful
Most commonly referred to as Islamic law, it covers all areas of spiritual and moral obligations, as well as duties in Islam. Islamic finance is solely based on shari’ah – also known as sharia or shariah – and the form of finance is as old as the religion itself. The laws and rules are derived from the religious text of Islam, the Quran, the Sunna (the path of the prophet) and other Islamic scriptures. As shariah law governs all aspects of Muslim life, it places certain restrictions on the kinds of finance and investment options that are commonly available in conventional banking, leaving very few permissible – or halal – investment options for Muslims. The two most significant effects of shariah are the restrictions on riba and haraam. For this reason, it is often seen as a more ethical form of financing.
This is the Arabic term for financial certificates, which are basically interest-bearing bonds that provide a fixed income. This is an area of Islamic finance that is a topic of hot debate as it is technically not allowed under shariah law, which prohibits the charging or paying of interest. As such, sukuk are structured so that they comply with Islamic law using different techniques. Instead of a promise to repay a loan, sukuk constitute a partial ownership in a debt, asset, project, business or investment.
According to shariah law, interest payments as understood in Western banking is considered usury and unjust, so is not allowed in Islamic finance. Instead of paying interest, Islamic finance is based on the joint ownership of assets and the sharing of profits and risk (musharakah). As such, when a bank provides funding to a business, there is an agreement to share in the profit and loss generated from the money provided, negating the need for interest payments, while the investment risk is also shared.
Investments that are not allowed under Islamic law because they are considered sinful are called haraam. These include such businesses that are linked to pork, alcohol, tobacco, pornography, prostitution, gambling, weaponry, as well as many forms of Western entertainment, or advertising contrary to Muslim values. Shariah law also disallows investments into businesses that are operated on interest payments such as Western banks and mortgage providers, or Western insurers. Since the law also disallows gambling, shorting and derivative products are also prohibited.
A kind of insurance concept based on Islamic banking, where money is pooled into a system in order to guarantee each other against any loss or damage. Only takaful companies can operate this service. Takaful products are based on two business models – the mudharabah and the wakala. In the former, the takaful operator manages the operation in return for a share of the surplus on underwriting and a share of the investment profit. The wakala is a contract where the takaful operator acts as an agent and manages the takaful fund in return for an agency fee.