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In order to build a structure, the edifice is built upon a foundation, and the foundation of Islamic Finance is based on the Sharia Law. Like conventional law, Sharia (or divine law) also has its do’s and don’ts. In our previous post, we explained that Sharia is derived directly from the Quran, the holy book and the Sunna, the teachings and practices of the holy prophet, Mohammad, (peace and blessings upon him) and that together these two cover all aspects of human life. The study of Sharia law is called Fiqh (or Islamic jurisprudence). In other words, Fiqh can be described as the human understanding of Sharia.

Conventionally, Fiqh has been categorized into two groups. The personal aspects of the law are covered under fiqh-ul-Ibadaat while the social aspects are covered under fiqh-ul-muamulaat. Fiqh relating to muamulaat (dealings or transactions) covers the study of interactions between human beings. Conventional classifications of law like family law, contract law, property law, civil law, trust law, international law etc. all fall under this branch of Fiqh. Islamic finance is also considered a part of muamulaat (or dealings).

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Just as conventional law encompasses and binds human actions, so does the Sharia law. At this point, it is beneficial to understand how Sharia categorizes human actions. The ‘amaal (or actions) of human beings can either be Halal (permissible) or Haram (prohibited). On a descending scale, these are very clearly categorized as

  1. Fard/Wajib (obligatory)
  2. Mandub (recommended)
  3. Mubah (permissible)
  4. Makruh (reprehensible)
  5. Haram (forbidden)

The Fiqh not only looks at human actions but also studies the circumstances (wadia’) surrounding those actions. Rules in relation to circumstances comprise of

  1. Shart (condition)
  2. Sabab (cause)
  3. Mani (prevention)
  4. Rukhsah, Azeemah (permission, enforcement)
  5. Sahih, Faasid, Batil (validity, corruption, invalidity)
  6. Adaa, Qadaa, I’ada (in time, deferment, repetition)

In future posts when we start our analysis of a simple exchange transaction, we will return to these definitions as we attempt to explain the functionality of Islamic finance.

As per Sharia, God has permitted Bay’ (exchange or trade) and forbidden Riba (interest). Aside from Riba (or interest), other prohibitions include Gharar (uncertainty and/or deceit), Al-Qimar (gambling) and Al-Maysir (unearned income). These rulings are unequivocal and understood by all sects of Muslims as irrefutable.  As a result, the point of departure between Islamic and contemporary financial transactions becomes one of permission vs prohibition. Usually, Islamic financial transactions are trade-based while contemporary financial transactions are interest-based. By extension, the same argument is applicable to Islamic banking versus contemporary banking.

In a conventional bank setting, the bank is basically a money lender, the fundamental component of a transaction is interest, and the bank and the corresponding transacting parties are in a debtor/creditor (or vice versa) relationship. Comparatively, in an Islamic bank, the transactions are trade-based or equity-based and are conducted within the framework of Sharia law. The bank can play many roles such as an agent, a partner, a guarantor, a buyer, a seller, a lessee or a lessor. Because of the prohibition of Riba (interest), Islamic finance proponents have engineered many interesting financial products to make the transactions Halal (or permissible).

Before we start our analysis of a simple Bay’ (exchange or trade) transaction, we need to elaborate more about Riba (interest) and what constitutes Riba under Sharia. In the next few posts, we will expand on the prohibitions concerning financial matters, especially matters relating to Riba before tackling the permissible under Sharia.

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