Glossary of terms used in Islamic finance

24 May 2004

Ijara An arrangement under which an Islamic bank leases equipment, a building or other facility to a client against an agreed rental. The rent is fixed so the bank gets back its original investment plus a profit. Ijara wa iqtina allows the same arrangement but with the agreement of purchase. Ijara is one of the more popular modes of financing in Islamic banking.

Murabaha Sale at stated cost price and mark-up. This refers to an agreement whereby the seller purchases a good/commodity that has been requested by the buyer and sells it at a marked up price. The payment can be made in agreed installments, lump sum or a combination of the two. Murabaha contracts are used to purchase cars and homes but most commonly to issue letters of credit and to provide financing to the import trade.

Mudarabah This term refers to a form of business partnership between a capital provider ("rab-al-maal") and the entrepreneur ("mudarib"). Whilst any proportionate share in profit is determined by mutual agreement, losses, if any, are borne only by the owner of the capital, in which case the entrepreneur gets no return for their effort.

Musharaka This is the classical partnership agreement. All parties involved contribute towards the capital financing of a venture. The parties share profits on a pre-agreed ratio while any losses are shared according to each party's equity holdings.

Diminishing Musharaka allows equity participation and sharing of profit on a pro rata basis but also provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers the ownership of the asset to the participants.

Gharar means uncertainty, hazard, chance or risk, ambiguity and uncertainty in transactions. Technically, the sale of something that is not present at hand; or the sale of something where the consequences or outcome is not known. An example would be gambling where the outcome of the transaction is not known. Prohibited in Islam.

Riba means a return on money for lending money whereby the borrower bears all the risk. Any risk-free or "guaranteed" rate of return on a loan or investment is Riba. Riba, in all forms, is strictly prohibited in Islam.

Maysir Gambling. The prohibition on maysir is often used as the grounds for criticism of conventional financial practices such as speculation, conventional insurance and derivatives. Prohibited in Islam Sharia

Sharia Islamic law derived from three sources: the Quran; the Hadith (sayings of the Prophet Muhammad); and the Sunnah (practice and traditions of the Prophet Muhammad).

Takaful This is a form of Islamic insurance based on the Quranic principle of Ta'awon or mutual assistance. It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members. Takaful is similar to mutual insurance in that members are the insurers as well as the insured.

Halal That which is permissible. The concept of halal has spiritual overtones. In Islam there are activities, professions, contracts and transactions, which are explicitly prohibited by the Quran or the Sunnah. Barring them, all other activities, professions, contracts, and transactions etc are halal.

Haram Unlawful - transactions which are not permissible under Islamic law.

Zakah/Zakat A tax which is prescribed by Islam on all persons having wealth above an exemption limit at a rate fixed by the Sharia.

Fatwah A religious decree

Wadiah A safe custody contract between the depositor (customer) and the custodian (bank).