Islamic Banking Terms - What They Mean

THE Al Quran clearly states that Muslims cannot make money on money. Chapter 2, Verses 278 and 279 of the Al Quran are specific:

"O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers. If ye do it not, Take notice of war from Allah and His Messenger: But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly."

But this does not mean that Islam forbids business activities or making profits. The Prophet Mohammed SAW himself was a trader early in his life.

Islamic law allows business activities for as long as they do not involve interest, also commonly called 'riba', in any form.

To fulfill this purpose, Islamic financial institutions have introduced financial instruments that satisfy these requirements.


The common Islamic concepts used in Islamic banking are Mudharabah (trust financing), Wadiah (safekeeping), Musharakah (partnership financing), Murabahah (cost-plus financing) and Ijarah (leasing).


Mudharabah is an arrangement, or agreement between a capital provider and an entrepreneur (mudarib), whereby the entrepreneur could mobilise funds for his business activities. Any profit made will be shared between the two according to an agreed ratio while losses are solely borne by the capital provider.


In Wadiah, a bank is deemed a keeper and trustee of funds. The bank guarantees the refund of the whole amount or any part thereof of a depositor's funds when the depositor demands it.


The bank may at its discretion reward the depositor with hibah (gift) as a form of appreciation for the use of funds.


The concept of Musharakah is normally applied for business partnerships or joint ventures. The management of the project can be pre-agreed by all parties. Profits are shared on a pre-agreed ratio but losses are divided based on equity participation.


Murabahah involves the purchase of goods by the bank at the request of the customer.


The goods are then sold to the customer at a price, which includes a profit margin agreed by both parties. The customer usually makes repayments in instalments.


The Ijarah contract is undertaken under a leasing arrangement, for example in an equipment financing facility. The bank will buy and lease out the equipment at an agreed rental over a specified period.


Ijarah Wa-Iqtina or lease/hire purchase involves the commitment of the customer to purchase the equipment at the end of the leasing period at an agreed price. The rental paid during the leasing period will constitute part of the price.


Securities in the form of certificates of debt entered under contract of exchanges such as trade financing can be traded in the secondary market under the Bai al-dayn concept.


Bai Al Salam is when the purchase price of goods is paid in advance and the delivery will take place in the future.


Bai Bithaman Ajil is similar to the Murabaha concept wherein it involves a credit sale, and repayments are made on an instalment basis within a pre-agreed period, or in a lump sum.


The bank will buy the goods and subsequently sell them to the customer at an agreed price, which includes a profit margin.


Gharar is simply interpreted as deception. Hence, Bay Al-Gharar is when one or both parties have entered into an exchange where deception is involved. An obvious illustration of a Bay Al-Gharar exchange is the selling of a sick animal, or selling goods, with false descriptions.


The Istisna concept is applicable when goods are acquired and payment is made progressively in accordance with the progress schedule, for instance the purchase of a house under construction where payments to the developer/contractor are made according to the stage of completion.


A loan extended on a goodwill basis or interest-free is known as Qard Ul Hasan. The borrower is only required to repay the amount borrowed.


However, the borrower may, without promising it, pay extra as a token of appreciation.


As in conventional banking, an asset can be placed as collateral for a debt and the asset may be disposed of when a default occurs. This arrangement is termed Al-Rahn.


Muslims who are able to pay are required to pay zakat or religious tax. The first type of zakat is Zakat al-fitr, which is a kind of charity to be paid at the end of the fasting month of Ramadhan.


The other type of zakat is Zakat al maal, which is an annual tax on the wealth of a Muslim above a certain level. The rate depends on the type of assets owned.

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