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Introduction to Philosophy Islamic Finance and Banking

Islamic Shariah prohibits interest but it does not prohibit all gains on capital. It is only the increase stipulated or sought over the principal of a loan or debt that is prohibited. Islamic principles simply require that performance of capital should also be considered while rewarding the capital. The prohibition of a risk free return and permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities in an Islamic set-up real asset-backed with ability to cause value addition.

Islamic banking system is based on risk-sharing, owning and handling of physical goods, involvement in the process of trading, leasing and construction contracts using various Islamic modes of finance. As such, Islamic banks deal with asset management for the purpose of income generation. They will have to prudently handle the unique risks involved in management of assets by adherence to best practices of corporate governance. Once the banks have stable stream of Halal income, depositors will also receive stable and Halal income.

The forms of businesses allowed by Islam at the time the Holy Quran was revealed included joint ventures based on sharing of risks & profits and provision of services through trading, both cash and credit, and leasing activities. In the Verse II:275, Allah the Almighty did not deny the apparent similarity between trade profit in credit sale and Riba in loaning, but resolutely informed that Allah has permitted trade and prohibited Riba. Profit has been recognized as reward for (use of) capital and Islam permits gainful deployment of surplus resources for enhancement of their value. However, alongwith the entitlement of profit, the liability of risk of loss on capital rests with the capital itself; no other factor can be made to bear the burden of the risk of loss. Financial transactions, in order to be permissible, should be associated with goods, services or benefits. At macro level, this feature of Islamic finance can be helpful in creating better discipline in conduct of fiscal and monetary policies.
Besides trading, Islam allows leasing of assets and getting rentals against the usufruct taken by the lessee. All such things/assets corpus of which is not consumed with their use can be leased out against fixed rentals. The ownership in leased assets remains with the lessor who assumes risks and gets rewards of his ownership.


Shariah is the moral code and religious law of Islam. Sharia deals with many topics addressed by secular law, including crime, politics and economics as well as personal matters such as sexual intercourse, hygiene, diet, prayer, and fasting. Though interpretations of shariah vary between cultures, in its strictest definition it is considered the infallible law of Godas opposed to the human interpretation of the laws (fiqh).

From Allah - The first and the most important attribute of Islamic Shari`ah is that it is from Allah.
Comprehensive, encompassing, and complete - Shari`ah is a comprehensive guidance that takes into consideration all aspects of the human life. Balanced and moderate - It balances between the body and the soul, between the intellect and the emotions, between this life and the eternal one. It balances between theory and reality, between thinking and acting, between the unseen and the apparent. Release from burdens - One important attribute of Shari`ah is that it came to make things easy and remove burdens.

Practical - It acknowledges their needs and desires. Allah knows the humans He created and knows that they need to eat, drink, and get married. They have materialistic necessities and needs the same way they have their spiritual and emotional needs. Preserved - One important attribute of Shari`ah is that it is the last Shari`ah to humanity. It will continue to remain and reach generation after generation. For that, Allah preserved and protected its sources. Synergetic - They create synergy between people, where they help one another to promote the good and remove the evil. Shari`ah also establishes synergy between people and their leadership at all levels.


These are various practices which have been declared forbidden by the Quran and the Sunnah. These include: i. ii. Hoarding Debasement of money

i. Hoarding of Money - Islam discourages hoarding of money (iktlnaz) which is destructive to society and also harms individuals. The invention of money meant that a buyer might pay the seller the price of his commodity, and the seller may buy some other things from a third person and pay that sum of money to him. The money one gets but does not spend, keeping it to oneself, is depriving the money of its natural function as a medium of exchange and utilizing it for an unreal purpose. Hoarded money cannot be equal to money in circulation. It should be allowed to circulate in society as widely. ii. Debasement of Money - During the prophets time, debasement of currency in all forms was strictly forbidden. Trading in money encourages counterfeiting and so confidence in the currency can be lost, resulting in inflation. Sale and purchase of money as merchandise is a major cause of monetary instability. Even western economist are of the view that it should not be allowed.

Impediments transaction in islam




A transaction which involves fraud or adulteration, like, when one commodity is mixed with another, and it is not possible to detect the adulteration, nor does the seller inform the buyer about it, like, to sell ghee mixed with fat. This act is called cheating (ghish) or adulteration. The holy Prophet of Islam (s.a.w.a) said: "If a person makes a deceitful transaction with the Muslims, or puts them to a loss, or cheats them, he is not one of my followers. And when a person cheats his fellow Muslim (i.e. sells him an adulterated commodity), Allah deprives him of Blessings in his livelihood, closes the means of his earnings, and leaves him to himself."

Such transactions were to be arranged and executed under duress (with Ikrah), they have no validity in the sight of the Shari'ah of Islam. In normal practice, once the person concerned comes out of the state of Ikrah (compulsion, duress), he will have the option to reassess the sale or gift done under duress and exercise his free will to retain or cancel it. And then it appears in Hadith:

The wealth and property of a Muslim does not become lawful unless it be with a whole-hearted pleasure from the person.

Islamic law conceives of mistake as a substantive or intrinsic element which capable of occurring only during the formation of contractual agreement. Mistake could arise from an assumption as to the existence, quality or quantity of

the contractual object or to the nature or existence of the contract itself.

The provisions concerning mistake are scattered and usually are to be found in the books of fiqh among the discussion in option of description, defect or sight. The Islamic concept of mistake is inextricably bound to the notion of consent in contract. The law lacks in formulated theory because the provision of mistake are in actuality, mostly preclusions or safeguards designed to prevent its very incidence.

We have discussed the central ingredients of Islamic finance and some relevant aspects that could be helpful in achieving Shariah compliance for Islamic banks transactions. The term Islamic finance or Islamic banking simply refers to a state of affairs wherein the financial institutions and the clients have to fulfil the relevant principles of Islamic jurisprudence. Some conditions have been put in place to ensure that contracts do not contain the elements of Riba, Gharar and Maisir the main prohibitions as discussed in Islamic law. The Islamic banking system is based on risk-sharing, owning and handling of physical goods, involvement in the process of trading and leasing and construction contracts using various Islamic modes of business and finance.