This checklist describes Islamic profit sharing, leasing, equity sharing, and asset trading alternatives to riba (interest) including musharakah, mudarabah, murabahah, salam, and ijarah.
Riba (financial interest obtained by charging money from the lending of money) is prohibited by Islamic law. Under shariah principles, money is regarded purely as a means of exchanging goods or services, without value itself. Islamic law acknowledges and values human effort, initiative, and cooperation in a business above the financial value of the money used to finance it.
To comply with this fundamental principle, Islamic finance has developed practices based on custom and fairness that do not involve the paying and charging of interest. Initially these were restricted to profit sharing arrangements, also known as musharakah and mudarabah.
However, these have now diversified and include leasing, equity sharing, and asset trading techniques such as murabahah, salam, and ijarah-based finance.
Musharakah and murabahah can be used for the purposes of overseas trade financing or single transaction financing. More specifically, murabahah in mainly used in import/export finance, whereas musharakah is most widely used for joint venture finance and syndications. Salam is widely used in the farming sector for the finance of agricultural products and farmers.
Ijarah, another permitted form of finance, is an Islamic form of leasing. The banks first buy and maintain the assets, and then they dispose of them in accordance with the Islamic law. Ijarah wa iqtinah is an extension of ijarah to cover hire and purchase agreements.
A combination of ijarah and diminishing musharakah can present a shariah-compliant alternative to conventional mortgages. Under the musharakah partnership principle, the financial institution acquires the property. Although ownership remains in the hands of the institution, the client can occupy the property throughout the pre-arranged period of the agreement, typically 20–30 years, in return for a monthly payment. These arrangements have similarities to variable shared equity plans, with the client’s ownership share steadily increasing with each monthly payment, while the institution’s progressively falls. The client only gains full ownership when the final payment has been made.
Musharakah and mudarabah are the most approved contracts under shariah law and their application is encouraged by shariah scholars.
Salam-type arrangements enhance production by encouraging the seller to produce enough to at least settle the loan, and also help to stabilize pricing in commodities markets.
In Islamic finance, buybacks and rollover are not allowed, being viewed as a backdoor means of charging interest and providing less flexibility of investment.
Assess carefully the contracts and products offered and whether they are too expensive to operate. Often smaller scale transactions cost more to operate, process, and regulate than larger ones.
Investigate and understand local customs and financial practices, as these can vary widely between countries and even regions.
Muslims living in Western countries—where conventional banking practices are the norm—need to be extra vigilant over the risk that interest is being levied on them without their knowledge, for example by utility companies or local authorities for any inadvertent late payments.
Dos and Don’ts
Encourage communication and dialogue between shariah experts and the financiers in order to ensure that the products offered are compliant with shariah law.
Providers should consider establishing formal panels of Islamic scholars who have the expertise to oversee and audit the products to ensure shariah compliance.
Expect variations between schemes available in different countries according to local attitudes and conventions.
Don’t underestimate the help that local religious leaders can provide in explaining to potential users how the financial products offered are shariah compliant. Their help can provide valuable reassurance to potential users of the products.
Don’t succumb to competitive pressures by introducing new products that have been successful in other regions until you are confident of their acceptability to local Islamic scholars.