What is Islamic Finance and how is it different from conventional finance?

by Eduyush Team

What Is Islamic Finance?

Islamic finance is a form of finance based on Shariah or the body of Islamic law. Shariah, which means "the path to the water source", is filled with moral purpose and lessons on the truth and is more than just a set of legal rules. At its core, Shariah represents the idea that all human beings and governments are subject to justice under the law. It is a term that summarises a way of life prescribed by Allah for His servants, and it extends to everything from business contracts and marriage to punishment and worshipping. It is common to use "Shariah-compliant" to describe anything permissible under Islamic law.

How is Islamic finance different from conventional finance?

Unlike conventional finance, which most of us know, Islamic finance has one overarching requirement—every financial transaction must be Shariah-compliant. In ensuring Shariah compliance, five fundamental principles are strictly followed

  1. Belief in divine guidance. The universe was created by Allah (SWT), and He created man on earth to fulfil particular objectives through obeying His commands. These commands are not restricted to worship and religious rituals but cover a substantial area of almost every aspect of life, including economic and financial transactions. Man needs such divine guidance because he does not have the power to reach the truth independently. Not only is man imperfect, but also his 'reasons' are often confused with 'desires.' It is the firm belief of every Muslim that Allah gives the commands, and through His divine revelations to the last Messenger, Muhammad is to be followed in letter and spirit.
    • Religion and government are kept separate and independent in a conventional financial system. This is to uphold religious freedom and secularity in government (such that any particular religion does not overly influence it).
  1. No interest. You cannot earn interest on a loan or be required to pay interest on a loan.
    • Compared with conventional financing, this is like borrowing money from the bank and not having to pay a cent of interest. Islamic banks, of course, do not loan you money for free. If you were to obtain an Islamic loan for a project, you could be paying fees or sharing a portion of your profits from the project with the bank.
  1. No haram investments. Money is to be invested in worthy causes, while companies that manufacture haram products like alcohol, tobacco, arms or pornography are avoided.
    • This is similar to the conventional concept of socially responsible investing (SRI), which seeks to maximize both financial return and social good. SRI favours corporate practices that promote environmental stewardship, consumer protection, human rights and diversity. Some practitioners of SRI abstain from businesses similar to those that Islamic ventures would avoid.
  1. Risk sharing is encouraged. The idea of risk-sharing is conscientiously promoted and regularly practised between business partners, such as between a customer and a financial institution:
    • For an Islamic institution, risk sharing is favoured in business dealings with its customers. This fosters the equitable distribution of risk, profits and losses. It also means that the due diligence an Islamic bank performs covers the customer's fitness and the project's financial viability. All in all, risk-sharing is intended to enhance transparency and, very importantly, to promote mutual trust and fairness in dealings among business partners, institutions and consumers.
  1. Financing is based on tangible assets. Financing extended through Islamic products can only expand in step with the rise of the real economy, thereby helping to curb excessive speculation and credit expansion.
    • By contrast, conventional financing is typically based on the promise to pay where tangible assets are not tied to the transaction. This means that traditional financing activity can grow several steps ahead of the real economy, causing speculation and unjustifiable.

From where can we learn Islamic finance

To help fuel growth in Islamic finance and to help the industry meet its shortage of qualified professionals, CIMA's Islamic finance qualifications are designed to appeal to both those who are entirely new to this area of finance and those who are fully experienced and are keen to develop their expertise to a higher level.

CIMA's Islamic Finance qualifications have won awards to recognize their world-leading status in the industry:

Eduyush is an authorized partner of CIMA, and if anyone is interested, they can avail of the course at attractive discounts. Interested students can browse the course here.