islamic finance

What is Islamic Finance?

Guest post by Dur-e-Sabih

Islam is truly a way of life. It not only provides spiritual guidance and relates our duties towards Allah. It also educates us on how we should live our life in this world.

Everything from how to treat other people and relations to guidance on how to eat and drink. The life of the Holy Prophet Muhammad (SAW) is a shining example of how we should live our lives. 

Islam, being a practical religion, as a result also has clear rules and laws regarding business dealings, trade, and even finance. Islamic finance is a detailed subject. All Muslims must be knowledgeable about Islamic finance to adhere to Islamic laws. 

What Is Islamic Finance?

Simply put, Islamic finance refers to all financial dealings consistent with Shariah. Shariah is Islamic jurisprudence. Islamic finance represents a financial structure compliant with the rules and regulations of Islamic beliefs. 

One key aspect, is the notable exclusion of interest or usury within the financial system. The charging and paying interest in return for money loaned is a fundamental feature of the global financial structure. This is where Islamic finance differs from the financial model followed globally. 

What is Islamic finance?

Here are the characteristics of Islamic finance that set it apart from any other financial model in the world:

Prohibition Of Interest

Usury is the charging of money against borrowed money,which is strictly prohibited in Islam. Interest is condemned by Allah in the Holy Quran harshly. In verse 275 of Surah Al-Bakarah, Allah says:

“Those who consume interest cannot stand [on the Day of Resurrection] except as one stand who is being beaten by Satan into insanity. That is because they say, “Trade is [just] like interest.” But Allah has permitted trade and has forbidden interest. So whoever has received an admonition from his Lord and desist may have what is past, and his affairs rest with Allah. But whoever returns [to dealing interest or usury] – those are the companions of the Fire; they will abide eternally therein.” [2:275]

Investing In Ventures That Benefit The Society

Islam places a lot of stress on duties towards others and the community. Unlike Western traditions and philosophies, where the individual is prioritized, in Islam the needs of others are put before that of the individual. 

This is why a defining characteristic of Islamic finance is that investments be done in legitimate businesses. Those that benefit others through generating jobs or servicing the community are especially encouraged.

 For example, the setting up of an Islamic school. Not only is it a legal business, but it also provides a service to the community by providing education to children. 

Sharing Of Risk

In global finance, there is a common understanding that risk is an integral part of doing business. That is true in all cases. With any business, the chances of profit or loss are always there. 

The typical belief surrounding risk is that the higher the risk, the higher the profit or loss. Furthermore, risk needs to be managed to an acceptable level. 

Islamic finance views risk as unavoidable. However, there is the rule to share risk. Any transaction involves two parties, typically the buyer and the seller. Islamic finance requires that both parties bear the risk, and its resulting outcome, equally. This ensures that no one party is unnecessarily burdened by risk. 

There are numerous traditions narrated by the companions of the Holy Prophet (SAWW) that prohibit certain transactions that appear to increase the risk of one party over the other. 

Hazrat Abdullah bin Umar (RA) narrates the following tradition:

“The Messanger of Allah (SAWW) stood up among us and said: ‘Do not sell fruits until their condition is known.'” [Sunan an-Nasai 4522, Book 44, Hadith 74]

In addition to this, extreme risk and transactions based on speculation are forbidden. These have been compared to gambling, where the probability of winning is very low. 

Investing In Unlawful Businesses

Owning and operating businesses forbidden in Islam goes against the fundamentals of Islamic finance. 

This includes businesses involved in making and selling unlawful substances like alcohol, pork, or drugs. It also includes such activities as gambling and prostitution. Any activity that goes against the ethical and spiritual beliefs of Islam. 

The Implementation Of Contracts

A vow, spoken in or documented, holds great significance in Islam. This is why contracts are so important. Drawing up contracts must be fair; it should not benefit one party unnecessarily. 

Once agreed upon, contracts must be kept. Contracts must involve outside witnesses, so a party can request looking into the agreement. This will also help with the implementation later on.

“And fulfil (every) covenant. Verily! the covenant, will be questioned about” (Al-Isra)

Instruments Of Islamic Finance

It is hard to envision a financial system that does not rely on interest. Despite the obvious absence of interest, Islamic finance has various financial instruments to encourage and abet business and trade. 

Some of these financial tools include:


Ijarah is a lease agreement that is consistent with the fundamentals of Islamic finance. The usual lease agreement requires the lessee to pay the amount of the asset and interest on it in installments over the years. 

In Ijarah, the installments are based on the current market value of the asset, along with a markup decided when the lease agreement is signed. 


Islamic bonds are Sukuk. Bonds are issued against loaned amounts and pay an interest rate at set intervals, and binds can be sold in the market or held off till the bonds mature so the principal amount can be retrieved.

Sukuk agreements give the lender part ownership of assets. The profit these assets provide becomes the revenue for the lender,who can always trade the Sukuk certificate to get the principal amount back. So Sukuk provides a right to ownership of actual assets rather than a piece of paper that provides revenue in the form of interest. 


Financing can be done through Mudarbah, which is equity finance. In a Mudarbah contract, two parties agree to collaborate to start a business. 

One party provides the financing, and the other the skills and expertise to operate the business. The agreement details how profit and loss will be shared. 


Like Mudarbah, in Musharaka, both parties pool financial resources and expertise. The contract further details how profit and loss sharing would take place. 

Choosing Islamic Finance

Islamic finance is a vast subject. The breadth and depth of this field are immense. You can find multiple traditions of the Holy Prophet (SAWW) regarding ways to conduct financial transactions on resources such as Muslim Pro

It isn’t easy to envision an alternative to the current financial system implemented globally. It is so pervasive. However, based entirely on interest which goes against the basic teachings of Islam. 

Islamic finance is a viable option. It has financial tools and instruments to assist trade and business. Islamic finance is integral to uplifting the economy in a manner that is equitable and just.

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