Principles of Islamic Finance

Principles of Islamic Finance:

Islamic finance is controlled by Sharia, the legal framework of Islam and its Quranic interpretation, along with the teachings of Sunna. This framework provides guidelines for people to follow the principles of the Holy Quran and the Sunna in their decision-making in all aspects of life. Financial transactions are one of the more important dealings controlled by Sharia, ostensibly to ensure the more equitable distribution of income and wealth among Muslims in Islamic economies.

Islamic banking has the same purpose as conventional banking: to make money for the banking institute by lending out capital. But that is not the sole purpose either. Adherence to Islamic law and ensuring fair play is also at the core of Islamic banking. Because Islam forbids simply lending out money at interest.  Islamic rules on transactions (known as Fiqh al-Muamalat) have been created to prevent this perceived evil. The basic principle of Islamic banking is based on risk-sharing which is a component of trade rather than risk-transfer which we see in conventional banking. Islamic banking introduces concepts such as profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijar).

The general principles are as follows:

  • The prohibition of Riba (usury or excessive interest) and the removal of debt-based financing from the economy
  • The prohibition of Gharar, encompassing the full disclosure of information and removal of any asymmetrical information in a contract
  • The exclusion of financing and dealing in sinful and socially irresponsible activities and commodities such as gambling and the production of alcohol
  • Risk-sharing, the provider of financial funds and the entrepreneur share business risk in return for shares of profits and losses
  • Materiality, a financial transaction needs to have a ‘material finality’, that is a direct or indirect link to a real economic transaction
  • Justice, a financial transaction should not lead to the exploitation of any party to the transaction.
  • governing principles in Islamic Finance 1

    governing principles in Islamic Finance 1

    governing principles in Islamic Finance 2

    governing principles in Islamic Finance 2

     

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