Characteristic of Islamic Finance

Characteristic of Islamic Finance

 What is the relevant characteristic of Islamic Finance?

The most relevant characteristic of Islamic finance can be optimized in the following four basic principles:

  1. To avoid sinful activities
  2. To share the risk
  3. No exploitation
  4. Productive and Materiality purpose

 To avoid sinful activities

Islamic finance is about prohibition of receiving funds and/or channeling these funds in a sinful way as clearly outlined by the Shari’ah law. Hence, transactions that pay interest to depositors or investments in interest bearing stocks are prohibited as this incur riba, which is a fundamental prohibition in Islamic law. Other prohibitions include dubious and uncertain transaction and the production and consumption of liquor and pork.


To share the risk

Islamic finance requires each party to a transaction to share the risks and rewards in a equitable manner. In fact, the rules and conditions of contracts deemed complaint to Shari’ah have in built mechanisms to upload this principles.

No exploitation

Islamic finance promote fairness in dealings by requiring the parties to the contract to explicitly spell out key aspects regarding rights, liabilities and obligations of the transaction leaving no room for ambiguities. The contract shall also be entered into with mutual and voluntary consent of both parties.

Productive and Materiality purpose

Islamic finance requires transactions entered into by the IFI to have real economic purpose and to finance socially productive sectors of the economy. In no eventuality, can therefore an IFI engage in financing alcoholic beverage trade or swine meat industry or other sectors of the economy which would have socially repressive outcomes. The importance of materiality is also upheld in requiring the issuance of sukuk to have an underlying physical asset, instead of mere monetary receivables.

In the Islamic law, the starting point in contractual formulation is permissibility, as propagated by Ibn Taymiyyah, the fourteen century Hanbali scholar with modern views regarding Shari’ah law.

Ibn Taymiyyah says: “ The underlying principle in contracts and stipulations is permissibility(Ibahah) and validity. Any contract and stipulation is prohibited and void only if there is an explicit text( from the Holy Qur’an, the Sunnah or consensus) or a qiyas (analogy) proving its prohibition and voiding.

These clearly stated prohibitions are among others, the prohibitions on riba ( usurious practices), prohibitions on maysir(gamling) and prohibitions on dealing with products deem sinful such as alchoholic beverages and swine meat.

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