Islamic Banking Terms
Definitions of the most commonly used terms in Islamic banking.
Gharar: Uncertainty. One of three fundamental prohibitions in Islamic finance (the other two being riba and maysir). Gharar is a sophisticated concept that covers certain types of uncertainty or contingency in a contract. The prohibition on gharar is often used as the grounds for criticism of conventional financial practices such as short selling, speculation, futures and derivatives.
Islamic banking: Financial services that meet the requirements of the Sharia or Islamic law. While designed to meet the specific religious requirements of Muslim customers, Islamic banking is not restricted to Muslims: both the financial services provider and the customer can be non-Muslim as well as Muslim. Also called Islamic finance or Islamic financial services.
Ijarah: An Islamic lease agreement. Instead of lending money and earning interest, Ijarah allows the bank to earn profits by charging rentals on the asset leased to the customer. Ijarah wa iqtinah extends the concept of Ijarah to a hire and purchase agreement.
Ijarah-wa-iktana is similar to Ijarah, except that included in the contract is a promise from the customer to buy the equipment at the end of the lease period, at a pre-agreed price. Rentals paid during the period of the lease constitute part of the purchase price. Often, as a result, the final sale will be for a token sum.
Maysir: Gambling. One of three fundamental prohibitions in Islamic finance (the other two being riba and gharar). The prohibition on maysir is often used as the grounds for criticism of conventional financial practices such as speculation, conventional insurance and derivatives.
Mudaraba: A Mudaraba is an Investment partnership, whereby the investor (the Rab ul Mal) provides capital to another party/entrepreneur (the Mudarib) in order to undertake a business/investment activity. While profits are shared on a pre-agreed ratio, loss of investment is born by the investor only. The mudarib loses its share of the expected income.
Mudarib: The Mudarib is the entrepreneur or investment manager in a mudaraba who invests the investor's funds in a project or portfolio in exchange for a share of the profits. For example, a mudaraba is essentially similar to a diversified pool of assets held in a Discretionary Asset Management Portfolio.
Murabaha: Purchase and resale. Instead of lending out money, the capital provider purchases the desired commodity (for which the loan would have been taken out) from a third party and resells it at a predetermined higher price to the capital user. By paying this higher price over installments, the capital user has effectively obtained credit without paying interest.
Musharaka: Profit and loss sharing. It is a partnership where profits are shared as per an agreed ratio whereas the losses are shared in proportion to the capital/investment of each partner. In a Musharakah, all partners to a business undertaking contribute funds and have the right, but not the obligation, to exercise executive powers in that project, which is similar to a conventional partnership structure and the holding of voting stock in a limited company. This equity financing arrangement is widely regarded as the purest form of Islamic financing.
Riba: Interest. The legal notion extends beyond just interest, but in simple terms riba covers any return of money on money - whether the interest is fixed or floating, simple or compounded, and at whatever the rate. Riba is strictly prohibited in the Islamic tradition.
Sharia: Islamic law as revealed in the Quran and through the example of Prophet Muhammad (PBUH). A Sharia compliant product meets the requirements of Islamic law. A Sharia board is the committee of Islamic scholars available to an Islamic financial institution for guidance and supervision in the development of Sharia compliant products.
Sharia Advisor: An independent professional, usually a classically trained Islamic legal scholar that advises an Islamic bank on the compliance of its products and services with the Sharia, or Islamic law. While some Islamic banks consult individual Sharia advisors, most establish a committee of Sharia advisors (often know as a Sharia board or Sharia committee).
Sharia compliant: An act or activity that complies with the requirements of the Sharia, or Islamic law. The term is often used in the Islamic banking industry as a synonym for "Islamic"—for example, Sharia compliant financing or Sharia compliant investment.
Sukuk: Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed income, interest bearing bonds are not permissible in Islam, hence Sukuk are securities that comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest. Sukuk is a certificate of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or investment activity.
Takaful: Islamic insurance. Structured as charitable collective pool of funds based on the idea of mutual assistance, takaful schemes are designed to avoid the elements of conventional insurance (i.e., interest and gambling) that are problematic for Muslims.
Tawarruq: Reverse murabaha. As used in personal financing, a customer with a genuine need buys something on credit from the bank on a deferred payment basis and then immediately resells it for cash to a third party. In this way, the customer can obtain cash without taking an interest-based loan.
Istisna'a (Contracting): Istisna’a is a sales contract of specified items to be manufactured or constructed with an obligation on the part of the manufacturer or builder (contractor) to deliver them to the customer upon completion.
Qard: A Qard is a loan, free of profit. We use this arrangement for our Current Accounts. In essence, it means that your Current Account is a loan to the bank, which is used by the bank for investment and other purposes. Obviously it has to be paid back to you, in full, on demand.
Wakalah: Wakalah is an agency contract, which usually includes in its terms a fee for the expertise of the agent. We may use it for our large Deposit accounts: you own the capital invested, you appoint us as your agent and pay a fee for our expertise.
Bai Salam: Salam means a contract in which advance payment is made for goods to be delivered later on.The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. According to normal rules of the Sharia, no sale can be effected unless the goods are in existence at the time of the bargain, but Salam sale forms an exception given by the Holy Prophet (SAW) himself to the general rule provided the goods are defined and the date of delivery is fixed. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute.
Fiqh: Islamic law. The science of the Sharia. It is an important source of Islamic economics.
Muamalat: Man-to-Man transaction.