Islamic finance is a type of financing activity that must comply with Islamic law (Sharia). You’d be surprised to learn that the Islamic finance sector grows at 15%-25% per while, while Islamic financial institutions oversee over $2 trillion.
Considering Islamic finance is based on several restrictions and principles that don’t exist in conventional banking, special types of financing arrangements were developed to comply with the following principles:
Profit-and-Loss Sharing Partnership (Mudarabah)
Mudarabah is a profit-and-loss sharing partnership agreement where one partner provides the capital to another partner who is responsible for the management and investment of the capital. The profits are shared between the parties involved as per the pre-agreed ratio.
Profit-and-Loss Sharing Joint Venture (Musharakah)
Musharakah is merely a form of joint venture where all partners contribute capital and share the profit and loss on a pro-rate basis. The major types of these ventures include diminishing partnership and permanent musharakah. Understanding what they entail will certainly help ensure you implement them perfectly.
Diminishing partnership is mostly used to acquire properties. The bank and investor jointly purchase a property. Subsequently, the bank gradually transfers its portion of equity in the property to the investor in exchange for payments.
Things tend to be different with permanent musharakah since it doesn’t have a specific end date and continues operating as long as the participating parties agree to continue operations. Generally, it is used to finance long-term projects.
Leasing (Ijarah)
In this type of financing agreement, the lessor (who must own the property) leases the property to the lease in exchange for a stream of rental and purchase payments, ending with the transfer of property ownership to the lessee.
Going with the number of prohibitions set by Sharia law, many conventional investment vehicles such as bonds, options, and derivatives are forbidden in Islamic finance. The two major investment vehicles in Islamic finance are equities and fixed-income instruments.
Of course, there is a lot more you need to know than what is merely include in this Islamic finance. Be sure to keep learning and advancing your career.