Question Luke Finance & Economics

Islamic finance

What is Islamic finance?

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Answer Internal Staff

Islamic banking was mainly practised in Muslim countries, however, over time many European countries have begun adopting Islamic banking.

Islamic finance can be summarised as a financial system that operates under the shariah law. Islamic banking is different to the conventional financial system, as features such as banks and investment institutions are operated under Islamic finance. The main concept of Islamic finance is the prohibition of Ribah (interest). Islamic banking also adheres to prohibiting all that goes in contradiction of the Shariah law, for example avoiding any form of transaction with alcohol and gambling.

Fundamental concepts of Islamic banking also include the significance of risk sharing while trying to raise capital. Equally, Gharar (risk or doubt) is another important concept in which any form of trading that shows signs of uncertainty is prohibited.

An example of a permissible financing method is the Mudarabah (profit-and-loss sharing), in which Islamic banks typically group investors’ capital, which is then invested in Sharia compliant investments/funds. It must be noted that both parties agree to a profit and loss sharing ratio prior to the investment taking place.