The Shari’ah Basis
Islamic banking and finance draws its basis from Shari’ah.
Shari’ah is a set of norms, values and laws that governs the Islamic way of life. It governs all aspects of Islam including worship, economic, social and cultural aspects of Islamic society. Generally, Islam means submissions to One God, Allah. This is the essence of all divine revelations since creation of Adam down to all other prophets including Noah, Abraham, Moses, Jesus and finally Prophet Muhammad (peace be upon them).
Fundamental principles of Islamic banking
Islamic banking adherence to fundamental business principles of fair dealing, justice and honesty.
1. Prohibition of riba (interest)
Riba is the stipulated excess without a counter value in both sale and loan. Shari’ah does not recognize money as subject matter of trade, but only as a medium of exchange. “Allah has permitted trade and has forbidden interest.” 2:275. Its prohibition is to ensure justice and equity in commercial transaction.
2. Prohibition of speculative behavior
This includes transactions that has both gharar and maysir elements. Gharar includes excessive uncertainty such as lack of transparency, deception, ignorance, unspecified price and unspecified date of exchange among others. While Maysir means gambling is where the winner takes the entire bet and the loser loses his bet.
3. Prohibition of unlawful activities
These are business activities that violate Shari'ah rules. This includes financing businesses that relates to gambling, alcohol, tobacco, pork production and extending loans purely for profitable purposes.
4. Mutual risk and profit sharing
Islamic banking is based on the principle of mutual risk and profit sharing instead of pure borrowing – lending. For example, financing extended based on Murabaha Sale requires the financier (bank) to purchase commodity and to assume the risk of the commodity before selling it to the customer. Whereas in Mudaraba financing, the capital provider (customer) and the entrepreneur (bank) share business risks in return for share of the profit.