Islamic banking (Arabic: مصرفية إسلامية) is banking or banking activity that is consistent with the principles of sharia (Islamic law) and its practical application through the development of Islamic economics. As such, a more correct term for Islamic banking is sharia compliant finance.
Sharia prohibits acceptance of specific interest or fees for loans of money (known as riba, or usury), whether the payment is fixed or floating. Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also haraam ("sinful and prohibited"). Although these prohibitions have been applied historically in varying degrees in Muslim countries/communities to prevent unIslamic practices, only in the late 20th century were a number of Islamic banks formed to apply these principles to private or semi-private commercial institutions within the Muslim community.
Mudaraba (مضاربة) is a contract whereby one side the investor or Rabb ul Mal contributes money and the other side work, being the manager or Mudarib. The Rabb ul Mal bears all losses, and the Mudarib earns a profit share.
Mudaraba is a concept to provide capital to somebody undertaking the work. It could be understood as being similar to the function of an asset manager or employed manager of a company. Legally this concept is established as permissible by the consensus of the scholars and not based on primary sources of the Shariah.
As the profits are shared with the manager (Mudarib) and the capital provider (Rabb ul Mal) but the losses are beared only by the capital provider this mode is also named profit sharing – loss bearing. Before the manager gets his share, the losses, however, if any, needs to be recovered. A wage could be negotiated.
Musharaka is a contract of partnership between two or more parties in which all the partners contribute capital, participate in the management, share the profit in proportion to their capital or as per pre-agreed ration and bear the loss, if any, in proportion to their capital/equity ratio.
In the Islamic Banking context, the Islamic Bank may be a partner with its client for running a business where both of them contribute capital, either both of them or the client alone take part in the management of business as per terms of the contract and share the profit as per agreed ration or bear the loss, if incurred, as per their capital/equity ratio.
Sukuk (Arabic: صكوك, plural of صك Sakk, "legal instrument, deed, check") is the Arabic name for financial certificates, but commonly referred to as "sharia compliant" bonds. Sukuk are defined by the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets.
The Fiqh academy of the OIC legitimized the use of sukuk in February 1988 Since fixed-income, interest-bearing bonds are not permissible in Sharia or Islamic law, Sukuk securities are structured to comply by not paying interest. This is generally done by involving a tangible asset in the investment. For example, by giving partial ownership of a property built by the investment company to the bond owner who collect the profit as rent, which is allowed under Islamic law. Upon expiration of the Sukuk, the rent payments cease.
Wadiah corresponds to safekeeping, custody, deposit and trust. In Islamic finance, wadiah refers to the deposit of funds or assets by a person with an Islamic bank. In this arrangement, the depositor deposits his funds or assets with the bank for safekeeping and in most of the agreements the bank charges a fee for the safe custody of the depositor’s funds.
Cost-plus-profit-sale mode of financing. banks buy goods according to customers demand and then sell it to customers at a profit.
The risk bearing period for the bank is shorter than other financing techniques and the institution also identifies its profit as soon as the sale-purchase transaction is complete.
Bai Muajjal is a form of Murabaha where customer pays in deferred manner.
Musawama is transaction of sale in which neither the cost of acquiring the asset nor the profit to be earned from it are disclosed to the client. The asset is sold in return of a lump sum price.