In this article, we will introduce the most common Islamic Finance terminologies and their definitions for your reference. Considering the rapid growth of Islamic Finance and the Islamic Banking Industry, the need for understanding the Islamic Finance terminologies will become important in the upcoming years. Islamic finance is a financial system that applies a number of distinctive values and unique characteristics based on Shariah principles. Most of the Islamic Finance terminologies come from the Arabic language. Here we list the most commonly used terminologies for your knowledge:
Gharar means uncertainty, risk, hazard, and deceit. Technically, it is something for which the probability of getting it and not getting it are about the same, some would say: something whose acquisition is uncertain and its true nature and quantity is unknown.
Riba is an Arabic word, meaning in English usury or interest. It is a term used in Islamic finance to describe the amount of interest. Usury, or the charging of unnecessarily high-interest rates, is another term for it. According to Islamic Jurists, Riba also refers to the exchange of goods with unequal quantities or qualities.
Purification refers to the act of disposing of unacceptable profits by donating them to charity. Of course, Shariah does not allow Muslims to profit from unacceptable practices and impermissible sources. So, Muslim investors must get rid of any income that derives from riba or other haram sources. In the other words, purification simply means deducting from one’s investment any earnings that come from non-permissible activities under Shari’ah law.
The word Ijarah derives from Arabic, meaning “to give something on rent.” It is a type of contract in Islamic Finance that requires the bank (for example) to buy an item for a customer and then lease it back. Being very similar to the leasing contract, as a customer, you can use an asset or equipment, which an Islamic bank owns for a fixed amount of time against a fixed price. The assets in your Ijarah contract can be a car, a house, a laptop, etc.
A Sukuk is an Islamic financial certificate that complies with Islamic religious law. A Sukuk is shariah-compliant bond-like security that is permissible in Islamic Finance. Since bonds are based on interest, they have traditionally been impermissible for Muslim investors. However, Islamic scholars and financial institutions have developed Sukuk which is not debt and has no interest instrument. It provides a relatively fixed stream of investment income. Being different from traditional bonds, most Sukuk is asset-backed securities. That is the income that Sukuk investors receive is a pass-through of income generated by the underlying assets.
Takaful is also known as Islamic insurance. It is a major Islamic insurance type where participants put their money into a pool system to mutually help each other in the period of any loss or disaster. every participant in the Takaful scheme has agreed to contribute a special amount to the special fund known as tabarru’. In essence, every participant of the fund is cooperating and protecting each other through their contributions. Takaful fixes the issues related to conventional insurance by creating a risk shared fund that invests in only Shariah-compliant investments.
In conventional insurance, members do not share risk accordingly and they invest premiums put in the insurance into impure investments. Different from conventional insurance, takaful policies do not deal with sale or exchange that includes the objectionable aspects of gharar (uncertainty), maysir (gambling), and riba (interest).
It is a partnership agreement in Islamic finance in which partners share in the profits and losses of a business. Musharakah is a type of Shirkah al-Amwal (or partnership), which in Arabic means “sharing.” Since Shariah prohibits interest in lending, Mushakarah allows that partners can share profit on pre-agreed ratios. Thus, each partner also shares the losses in proportion to their contribution.
It is a partnership contract. A Mudarabah contract is a profit-sharing contract. Under a Mudarabah contract, the capital provider agrees to share the profits between themselves and the entrepreneur at an agreed ratio or percentage. While the losses are born solely by the capital provider, provided that such loss is not due to the entrepreneur’s negligence or violation of a specific condition.
Istisna is a sale contract between the seller (bank) and the buyer to manufacture or build an asset at a pre-determined future time.
In the case of istisna, the bank sells an asset even before its existence or completion. The buyer can pay the seller (bank) either in different installments, at the delivery of the asset, or after completion. In Islamic Finance, you can use istisna to finance the construction of the following: houses, roads, projects, plants, and types of machinery.
Wakala is a contract in which a principal (or muwakkil) authorizes or appoints an agent (or wakeel) to carry out a certain legal action on their behalf. in other words, it is an “agency contract”. This contract enables the agent to render services and be paid an agency fee (Ujrah).
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