Shariah Compliance – Understanding Islamic Finance
With the kind of financial developments and strategies that the Kingdom of Saudi Arabia has so far developed, the day is not far away when Saudi will become the global leader in Islamic Finance.
Since Islamic Financing forms the very basis of Saudi’s business arena, Lamaa wants to go back to the basics and deep dive into Islamic Finance and what it really means.
Islamic Finance – A Quick Background
The basic practices of Islamic Finance date back to the foundation of Islam. The formal establishment of Islamic Finance however, happened in the 1960s.
Over the last two decades, Islamic Finance has seen immense growth. Interestingly, Islamic Finance has not just grown in Muslim Countries and population, but even the secular financial centres of the West have demonstrated a steady incline. Due to this, the commercial wisdom over Islamic Finance and its principles has caught speed. Globally the Islamic Finance sector sees a year-on-year increase of 15-25% while earning more and more relevance every day.
With Islamic Finance gaining global momentum and Saudi Arabia crossing an extraordinary SAR 3000 billion worth of assets by 2019, let us deep dive into some basics of Islamic Finance.
What is Islamic Finance?
In the most basic words, Islamic Finance is a type of financial activity that complies with the Islamic Law, also called “Shariah
”. It encompasses the types of investments that are allowed under Shariah
. Islamic Finance enforces guidance on saving, investing, and lending based on the moral practices of Islam.
Principles of Islamic Finance
- Charging Interest
According to Islam, lending money with interest is an exploitative practice that favours the lender at the expense of the borrower. Hence, Shariah
law strictly prohibits charging interest, or riba
, in any condition.
- Investing in Prohibited Activities
Certain activities, such as producing/selling alcohol or pork are not allowed by Islam. Being in the forbidden or haram
category, investing in businesses involved in these activities is not allowed under Islamic Law.
- Extreme Risk
Sharia forbids involvement in businesses with excessive risk or uncertainty. Excess Risk or gharar
is seen as quick money-making scheme which is not allowed by Islam.
Gambling, also referred to as maisir
, is seen as a highly uncertain and prohibited activity. Islamic Financing Institutions thus are not allowed to be involved with contracts where the possession of goods depends on an uncertain event in the future.
- Revenue Sharing
As per Islam, two parties entering into an agreement or contract must share profits and losses along with risks related to the transaction. Only person that benefits through that transaction can be the other party.
Permitted Financing Arrangements by Shariah
There are only certain types of financial arrangements that are allowed as per the Islamic Law of Financing.
An arrangement where one party provides capital to another party responsible for investment of that capital whereas profits and losses are shared between the two as per an agreed ratio.
An arrangement where all parties contribute capital and share profits and losses at pro-rata.
An arrangement where an owner of a property leases it to another party. In return, the party pays rentals and purchase payments until the property ownership is acquired.
Investing Options under Islamic Finance
Investment options under Shariah
are also quite stringent. Hence, only two types of investment options are allowed. One can purchase company shares or private equity from a Shariah
-Compliant Company or Institution. Since conventional bonds are not permissible under Islamic Financing, the other option is investing in Shariah
-Compliant Bonds. These bonds reflect partial ownership in an asset and not debt obligation.
Word from Lamaa
Lamaa is Riyadh’s first Shariah
Compliant Fintech. This means that Lamaa’s ways of working adhere to the Shariah
law and Islamic Finance. Lamaa is a Fintech, which means Lamaa adds the latest technology to Islamic Finance making it a faster tool to help Saudi-made small, medium and large enterprises flourish and prosper in KSA and globally.