What are the principles of Islamic finance?

As per the recent research, the Islamic finance sector is worth more than $2.4 trillion USD. It serves nearly around 2 billion Muslims all across the globe and is built on the foundation of Sharia or Islamic law. Though, the common practices of Islamic Finance came into existence with the foundation of Islam but the formal Islamic finance was started only about a century ago.

Basically, the difference between conventional Western Finance and Islamic Finance is that some practices and principles used in conventional finance are prohibited under the Islamic laws. Take note, Islam takes financing with interest payments as an exploitive practice which favors financer at the expense of the borrower. Hence, collecting and paying with interest is highly prohibited.

Until now, rules of Islamic finance have also been participating in contracts with high risk and uncertainties. As far as Islamic finance is concerned, the material finality of transaction is necessary. Specifically, each translation must be related to real underlying economic transaction. In fact, parties entering into contracts during Islamic finance share profit or loss and risks associated with the transaction. It signifies that no party can benefit from the transaction more than the other party.

All because of the principles of Islamic finance, different arrangements were developed to comply with Shari’ah:

  • Mudaraba

It’s a common partnership where one partner (rab-ul-amal) acts like an investor and provide capital to another partner (mudarib), responsible for managing the capital. Both partners can share the profits as per pre-agreed rate.

  • Musharaka

It’s quite similar to mudaraba except that all parties involved in the partnership contribute to the capital and share profit and loss on a pre-agreed ratio. This involves two types of partnerships such as:

Permanent:In this type of partnership, project does not have a deadline and continues to work till the involved parties agree to continue operations.

Diminishing: During this type of partnership, the bank and investor jointly purchase a property. And the bank gradually transfers its portion of equity in the property to the investor in exchange for cash. It is often utilized while acquiring properties.

  • Murabaha

It is a term that describes a contract where the buyer and seller agree on a mark-up or “cost-plus” price for a good being sold. In this contract, the price is marked-up because the buyer is allowed to pay over time like with monthly payments. In fact, a certain amount of fee is charged rather than riba (interest). It is to note that this type of loan is acceptable or considered legal in Islamic countries.

At times, it becomes a matter of argument that this is just the other method of charging interest. But there is a difference in the structure of the contract. The bank sells an asset and charges profit which as per Sharia is permitted.

All the above discussed instruments are used in financing WAQF projects along with blockchain technology.

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