Sharia is a set of Islamic religious laws that govern daily life and religious rituals for Muslims. It also offers principles and guidelines for making important decisions, like finances and investments. Islamic banking and finance follow Sharia rules, but there can be differences in interpretation and implementation, especially in the financial sector.
Learn more about Sharia
It means “the way” and can also be spelled as Shariah or Shari’a. It guides Muslims on how to behave in different areas of life like personal, social, religious, and financial matters.
Interest is important in finance, but it’s not allowed in Sharia law. This means borrowers and lenders can’t pay or receive interest. This includes loans, mortgages, and financial products that earn interest. So, investing in traditional banks and insurance companies might not be allowed under Sharia.
Business activities are important. Investors following Sharia law cannot invest in or work with companies involved in certain activities.
- Making alcohol
- Makers and sellers of adult content
- Makers of pork items like ham and bacon
- Companies that make weapons
- Makers of tobacco products
- Casinos and other gambling businesses
Sharia law influences how investments are made, limiting opportunities for followers of the faith in certain market sectors. In the Western world, Sharia-compliant investments are comparable to socially responsible investments.
Western financial institutions have introduced Sharia-compliant investment options that do not involve interest or gambling. This is because investors are interested in tapping into the growing oil economies of the Middle East, which follow Islamic principles.
Conclusion
Sharia-compliant financial products differ just like traditional financial products. For example, Mudarabah involves a profit-sharing partnership, while Musharakah involves a profit-sharing joint venture.
Sharia-compliant funds must follow the rules of the faith. An Islamic board of scholars needs to be set up to ensure Sharia principles are followed. The board members assess the fund’s investments, including the companies they invest in.
Sukuk are financial certificates known in Arabic. They are Sharia-compliant bonds. The investor base for these bonds is spread across three different regions.
- Countries in the Gulf Cooperation Council and Malaysia
- Countries with a sizable Muslim population, such as India and Pakistan
- The U.S. and Europe, where the Muslim population
Sukuk can be either asset-based or asset-backed. Islamic bonds fall under the category of asset-based, while securitized assets fall under the category of asset-backed. A special purpose vehicle (SPV) is established to issue certificates in capital markets. The funds raised are then used to acquire an asset following the principles of Ijarah.
A middleman purchases the asset and rents it out to the SPV. The SPV can choose to buy the leased asset back before the lease ends. The money from the initial sale can also be invested following rules of a Wakala transaction. This investment is temporary and managed by a special agent called Wakeel.