Islamic finance & transacitons

Islamic finance is a type of financing activity that must comply with the Sharia. The concept can also refer to the investments that are permissible under Sharia. The common practices of Islamic finance and banking came into existence along with the foundation of Islam. What separates conventional finance and Islamic finance is that some of the practices and principles that are used in conventional finance are unacceptable in Islamic Finance. The major principles of Islamic Finance are:

Paying or charging an interest

The Sharia is very clear and bold in the prohibition of lending money with interest payments. This is considered a major sin, and an exploitive practise that favours the lender at the expense of the borrower.

Investing in businesses involved in prohibited activities

Certain industries are considered unethical, and it is impermissible to invest in such activities such as producers of alcohol, gambling, pork and pornography.

Speculation (maisir)

Sharia strictly prohibits any form of speculation or gambling, this is called maisir. This translates in the finance world as the prohibition of contracts where the ownership of goods depends on an uncertain event in the future.

Uncertainty and risk (gharar)

One major factor that renders a contract impermissible is excessive risk and/or uncertainty. The word used to describe this process is gharar , it measures the legitimacy of risk or uncertainty in investments. Gharar is observed with derivative contracts and short selling, which are forbidden in Islamic finance.

Additional prohibitions

Material finality of the transaction. That each transaction must be related to a real underlying economic transaction.

Profit/loss sharing. Parties entering into the contracts in Islamic Finance share profit/loss and risks associated with the transaction. No one can benefit from the transaction more than the other party.