Shariah

Shariah: The basic principle of the Shariah which serves as guide line in this respects is that if there is more than one provider of capital to a business undertaking, profits can be distributed among them in proportions mutually agreed upon, but losses, if any have to be borne by them strictly in proportion to the capital provided by each party. In most of the earliest theoretical models of Islamic banking, shareholders’ equity and investment deposits were deemed to be the only two remunerable liabilities of an Islamic bank, and holders of investment deposits were treated as one homogenous group.The profit-sharing arrangements between these two groups of providers of capital were envisaged along the following lines:

The aggregate profit earned by the bank on the total capital will be divided over it. After such division, the bank will keep an agreed proportion of the profit and the rest will be given to the holders of investment deposits. The proportion of the profit division will determined with the mutual consent of the two parties concerned.
If the bank suffers a loss, the loss will be shared between the two parties in strict proportion to the capital supplied by each party.
The maximum incidence of loss to an investment account holder in a loss situation will be limited to the amount of his deposit.

In later contributions to the literature on Islamic banking, it was recognized that profit-sharing arrangements among the remunerable liabilities of an Islamic bank could take more complex forms, while still remaining within Shariah Parameters.

The six types of investment operations approved by the Shari’ah are given below:

Murabaha(Cost-plus sale)
Musharaka(Joint venture)
Mudaraba
Ijara(Lease)
Ijara-wa-iktina(Lease- Purchase)
Qard Hasan(Interest free Loan)

1) Murabaha(Cost-plus sale): A contract in which a client wishing to purchase equipment or goods requests the Islamic Institution to purchase these items at cost and charge the clients cost plus a reasonable profit. These funds are repayable on terms agreed between the parties.
2} Musharaka: ‘Musharaka’ refers to a financing technique adopted by Islamic banks. It is an agreement under which the Islamic bank provides fund, which is mingled with the funds of the business enterprises and others. All providers of the capital are entitled to participate in the management but not necessary required to do so. The profit is distributed among the partners in predetermined ratios, while the loss is borne by each partner in proportion to his contribution.
3} Mudaraba: The term “Mudaraba’’ refers to form of business in which one party brings capital and the other personal effort. The proportionate rate shares in profit determined by mutual agreement. But loss, of any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labor. The financier is known as “rab-al maal” or “Shaeeb –al-maal” and the entrepreneur as “mudarib”.As a financial technique adopted by Islamic banks,it is a contract in which all the capital is provided by the Islamic bank while the business is managed by the other party. The profit shared in pre-agreed ratios, and loss, if any unless caused by negligence or violation of terms of the contract by the “mudarib” is borne by the Islamic bank. The bank passes on this loss to the depositor.
4) Ijara(Lease): Ijara is a contract whereby the investment company purchases an asset and leases it to customer.The lease contract specifies the leasing period, the amount and timing of the lease payments and the responsibilities of the both parties during the life of the lease. Leases may be simple rentals or more elaborate contractual agreements committing the parties to the future actions.
5) Ijara-wa-iktina(Lease- Purchase): The investment company finances equipment, building or an entire project for the client.The customer contractually obliged to purchase such equipment or project, which is made available to him against an agreed rental, together with an undertaking to make payments into an Islamic investment account,which will eventually permit purchase by him of the item financed. The profits accumulating in the investment account are for the benefit of the customer.
6) Qard Hasan(Interest free Loan): Funds advanced for humanitarian and welfare purpose. Repayments are made over a period agreed by both parties with no profit accruing to the financing institution. Qard Hasan at present is limited to private Islamic institutions. However, once the Islamic investment companies have sufficient funds, a small part of their financing can be provided on the basis of Qard Hasan to small entrepreneurs and this will speed up the socio economic development of the country.

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