Islamic Finance Glossary

ISLAMIC FINANCE GLOSSARY

By

Abdulazeem Abozaid

Shariah

Shariah means teachings of Islam. This covers belief, ethics and law. Shariah, as a term, is widely used to indicate Islamic Law and its sources and principles. Shariah, embodied in Islamic Law, is the core of Islamic Economic Thought and Applications. Fiqh means ‘Islamic Law’ thus, it is part of Shari'ah.

Fatwa

Fatwa is the legal opinion given by a Shariah scholar based on his understanding of the Shariah texts and principles. Not all Shariah texts are definitive in authenticity of meaning; therefore, there is an avenue for the Shariah scholar to use his reasoning in understanding the speculative text or its applications.

Iqalah/ Cancellation of the Contract

Iqalah or cancellation of a contract is a bilateral agreement of the contracting parties to revoke or remove the legal effect of a contract. According to some jurist, Iqalah of a sale contract is considered as a new sale contract.

Urbun

Urbun is a sale contract whereby the buyer pays a sum of money (the urbun) to the seller with the understanding that if the buyer comes back before the given deadline and accomplishes the transaction, the urbun would be counted as part of the price of the sold asset. If, on the other hand, the intended buyer chooses not to conclude the transaction, the urbun would then be forfeited. It has been controversially suggested that the modern day options contracts can be lawfully covered by Urbun.

Salam/ Future delivery sale

Salam is sale in which an advanced payment is made for goods which are to be delivered in the future. According to normal rules, no sale can be affected unless the goods are in existence at the time of the bargain, but this sort of sale forms an exception to the general rule provided the goods are defined and the date of delivery is fixed. In Islamic law, Salam is usually applied in the agricultural sector but it can be applied to all fungible goods. It is also applied to a mode of financing adopted by Islamic banks (parallel Salam).

Parallel Salam

In an arrangement of parallel Salam, the bank enters into two different contracts. In one of them, the bank is the buyer and in the second the bank is the seller. For example, if A has purchased from B 1000 bags of wheat by way of Salam to be delivered on 31 December, A can contract a parallel Salam with C to deliver to him 1000 bags of wheat on 31 December. But while contracting Parallel Salam with C, the delivery of wheat to C cannot be conditioned with taking delivery from B.

Istisna’

Istisna‘ is a contract to sell a manufacturable thing with an undertaking by the seller to present it manufactured from his own materials, according to specified description and at a determined price. The suitability of Istisna‘ for financial intermediation is based on the permissibility for the contractor in Istisna‘ to enter into a parallel Istisna‘ contract with a subcontractor. Thus, a financial institution may undertake the construction of a facility for a deferred price, and subcontract the actual construction to a specialized firm.

Parallel Istisna’

In an arrangement of parallel Istisna’, the bank that has already sold its client a manufacturable thing contracts also on Istisna’ basis a real manufacturer to manufacture something of the same specifications and delivery date as in the first contract. When the thing is delivered to the bank, the bank delivers the same to its client. The bank profits from the difference in prices in the two Istisna’ contracts.

Murabaha

Murabaha literally means sale on profit. Tech means a contract of sale in which the seller declares his cost and profit. This has been adopted (with certain modifications) as a mode of financing by a number of Islamic banks. As a financing technique, it involves a request by the client to the bank to purchase a certain item for him. The bank buys the desired item for itself first then sells it to its client on credit to the client with a mark up.

Sarf

Sarf is a contract in which both items that are exchanged are gold, silver or any monetary units. Sarf is subject to some conditions which are meant to avoid the occurrence of Riba in sales. The conditions are and spot payment of the two counter values, and the equality in amount if the two exchanged value are of the same kind (gold for gold, euro for euro).

Ijarah

Ijarah is lease. The lessor is called Mu’ajjer, the lessee Musta’jer and the rent Ujrah.

Ijarah Mutahia Bittamlik/ Leasing ending with sale

It refers to a mode of financing adopted by Islamic banks where the Islamic bank finances equipment, building or other facility for the client against an agreed rental together with an understanding that the bank will sell the leased asset after the lease has expired at a nominal price, or will present it to the client as a gift. The terms al-Ijarah Wal Iqtina, al-Ijarah al-Muntahia Bitamlik and al-Ijarah Thumma al-Bay’, al-Ijarah Bi Shart al-Tamlik have been used interchangeably.

Inah

Inah refers to a contract of sale where a person sells an article on credit and then buys it back at a lesser price for cash. Example: A asks a loan of $10 from B. B, instead of asking for interest on this loan applies a contrivance. He sells an article to A for $12 on credit and then buys back from him the same article for cash at $10. Inah is considered a usurious transaction in the disguise of two sales – a trick, and therefore it is impermissible. However, it is argued that some Islamic banks have used some twisted interpretation of some juristic statement to claim permissibility of Inah, though it was clearly prohibited by Fiqh Academy.

Riba

Riba literally means an excess or increase. Technically it denotes any increase which in a loan transaction (Riba al-Dayn) or in exchange of a commodity (Riba al-Buyu’) accrues to one contracting party without giving an equivalent counter-value in return to the other party. Riba could be resulted also from the delay in delivering certain commodities. Any risk-free or "guaranteed" rate of return on a loan or investment is riba. Riba, in all forms, is prohibited in Islam. In conventional terms, riba and "interest" can be used interchangeably.

Zakah (Zakat)

Zakah is the third pillar of Islam. The objective of Zakah is to take away a part of the wealth of the well-to-do and to distribute it to the poor and the needy. It is levied on cash, cattle, agricultural produce, minerals, capital invested in industry and business, etc. The distribution of Zakht fund has been laid down in the Quran (9:60) and is for the poor, the needy, Zakat-collectors, new Muslims, travelers when in difficulty, the way of God, captives and debtors.

Musharaka

Musharaka means partnership. It is divided into two main types; the contractual partnership (sharikat ul-’aqd) which is a partnership or joint venture formed by contract, and the co-ownership of an asset (sharikat ul-milk). However, Musharaka typically refers to sharikat ul-‘aqd where partners start a venture for the sake of profit making. Herein the partners may have equal equity but unequal rights to profit, unequal equity with equal rights to profit or with unequal equity and unequal rights to profit, but liability to loss must be in accordance with equity. It is the most common type of partnerships and on the basis of which the partnership in Islamic banks has been modeled.

Mudarab

Mudaraba is a contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual consent, while the loss is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labor. The financier is known as Rabb ul -mal and the worker or entrepreneur as Mudarib. As a financing technique adopted by Islamic banks, Mudaraba 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 is shared in pre-agreed ratios, and loss, if any, unless caused by the negligence or violation of the terms of the contract by the Mudarib, is borne by the Islamic bank. The bank passes on this loss to the depositors. Mudaraba is also the basis on which Islamic banking deposits are structured; depositors place their money as a capital in Mudaraba and the bank, as Mudarib, invests it for them against a share in the profit.

Sukuk

Sukuk is an arrangement that has been devised recently as a way for Islamic organizations to issue an instrument similar to a tradable Western bond, while still being Shariah compliant.

Investment Sukuk

Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity.

Sukuk Al-Ijara/ Ijara Sukuk

It is the most common type of Sukuk. The owner of an existing tangible leased asset, or asset to be leased, may sell this asset through Sukuk. The issuer of these certificates is seller of a leased asset and the subscribers are the buyers of the asset, while the funds mobilized through the subscription are the purchase price of the asset. The certificate holders jointly own the asset through an undivided ownership, sharing the profits (rentals and capital appreciation of leased asset) and losses on the basis of the partnership that exists between them.

Diminishing Musharaka (Musharaka Mutanaqisa)

Diminishing Musharaka is an arrangement whereby a financier (bank) and a customer participate in joint ownership of property or commercial enterprise. The Share in ownership of the financier is divided into units with the understanding that the customer will gradually purchase those units via periodic payments. The objective is for the customer to become the sole owner of the property or enterprise eventually. Diminishing Musharaka agreement normally involves also a lease contract whereby the financier leases its share to its client against a rent that will be adjusted with every purchase of the financier’s share units.

Takaful / Islamic Insurance

Islamic insurance (Takaful) is perceived as cooperative insurance, where members contribute a certain sum of money to a common pool. The purpose of this system is not profits but to uphold the principle of “bear one another’s burden”. The fund pooled is normally invested in Shari’ah compliant investment modes for the benefit of all participants. The takaful company does not own the premiums; rather it is entrusted with the management of the takaful operations and the administration the takaful fund against a determined fee, plus a possible incentive form the surplus.

Bay’

Bay’ means sale; an agreement between two parties in which ownership of an item is transferred from seller to buyer for a price.

Gharar

Gharar means uncertainty. Technically it refers to contractual ambiguity due to ignorance of an aspect of the contract. Gharar invalidates contracts, but if it is minor and is normally not conducive to a dispute between the contracting parties, then it can be tolerated by the Shariah. Gambling and financial derivatives are mostly forbidden due the gharar (speculation) involved therein.

Qard/ Qard Hasan

Qard means interest free loans, and Hasan (benevolent) is just an affirmation of the benevolent nature of the loan. A loan according to Islam must be free of interest since lending is viewed as a benevolent action. Charging interest on loan renders money a commodity which is not the way Islam view money. However, the lender can take a pledge, collateral to secure the return of debt but cannot stipulate an increase over the value of debt in case of default.

Hadith/Sunnah

This term refers to the report of the sayings or actions of the Prophet Mohammed (Peace be upon him).

Halal

Halal means lawful, permissible. In Islam all things are deemed halal unless otherwise is established.

Haram

Haram means unlawful, impermissible.

Hukum

Hukum means ruling. Hukum Taklifi (defining law) is of five categories: obligatory (wajib/fard), recommended (mustahabb), neutral/permissible

(mubah/halal), reprehensible (makruh), or forbidden (haram).

Ijtihad

Ijtihad refers to decision-making in Islamic law by personal effort. To be valid it has to be performed by a qualified scholar (mujtahid) and it must not be in conflict with any Shariah text or principle, and there must be no established doctrine ruling the case.

Istijrar

Istijrar refers to an agreement over a continuous purchase or supply; the supplier undertakes to provide a particular product on an ongoing basis at an agreed price with payment made in an agreed manner.

Kafala

Guarantee; a standard Islamic transaction in which a guarantor (kafil) agrees to assume responsibility for the debts of a creditor (makful 'anhu).

Khiyar

Option; power to cancel a contract. Schools of Islamic law in general recognize different types of options, some of which are inherent in the sale contract like khiyar al'ayb (option to cancel if the asset sold found to be defective), and some need to be stipulated like khiyar al shart (option to rescind sale by the seller or the buyer during a specified period), or khiyar al naqad (option to cancel on non-payment). All options must come free of charge and cannot be sold by contractors.

Maqasid al Sharia

Maqasid al Shariah are the higher purposes of Shariah law, which are believed to be built on five objectives; the protection of religion, life, lineage, intellect and property.