Islamic Banking Glossary

Islamic Banking Glossary kbaadmin May 11, 2022

Increasingly, banks are offering niche services and products to meet the needs of a diverse customer base. Shari’ah-compliant or Islamic banking is an example.

Islamic banking is a system of conducting trade and banking activities in line with the principles of Islamic Shari’ah while avoiding all the prohibited activities such as interest or Riba, Gharar, financing of haram trade and businesses.

It is not banking which is based on pricing money and earning interest as conventional interest-based banks do but it is a system of trade where goods and services are sold and capital is invested by taking risk to earn halal profits. Interest free banking is a subset of Islamic banking concept.

The following is a glossary of some common Islamic Banking Terms:

Letting on lease. Technically, sale of a definite usufruct in exchange for a definite reward. It also refers to a contract of land lease at a fixed rent payable in cash. It is contrary to “Muzarah” when rent is fixed as a certain percentage of the produce of land. It also refers to a mode of financing adopted by Islamic banks. It is an arrangement under which an Islamic bank leases equipment, a building or other facility to a client against an agreed rental. The rent is so fixed that the bank gets back its original investment plus a profit on it.

This term refers to a mode of financing adopted by Islamic banks. It is a contract under which the Islamic bank finances equipment, building or other facility for the client against an agreed rental together with an undertaking from the client to purchase the equipment or the facility. The rental as well as the purchase price is fixed in such a manner that the bank gets back its principal sum along with some profit which is usually determined in advance.

The term refers to a form of business contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual agreement. But the loss, of any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labor. The financier is known ad “rab-al-maal” and the entrepreneur as ‘Mudarib’. As a financing technique adopted by Islamic banks, it is a contract in which all the capital is provided by the Islamic bank while the business is managed by the other party. The profit is shared in pre-agreed ratios, and loss, if any, unless caused by negligence or violation of terms of the contract by the “mudarib” is borne by the Islamic bank.

In a mudarabah contract, the person or party who acts as entrepreneur.

Sale on profit. Technically a contract of sale in which the seller declares his /her cost and profit. This has been adopted as a mode of financing by a number of Islamic banks. As a financing technique, it involves a request by the client to the bank to purchase a certain item for him /her. The bank does that for a definite profit over the cost which is settled in advance. Some people have questioned the legality of this financing technique because of its similarity to riba or interest.

The term refers to financing technique by Islamic banks. It is an agreement under which the Islamic bank provides funds which mingled with the funds of the business enterprise and others. All providers of capital are entitled to participate in the management but not necessarily required to do so. The profit is distributed among the partners in pre-determined ratios, while the loss is borne by each partner in proportion to his contribution.

Gambling. Technically an agreement in which possession of a property is contingent upon the occurrence of an uncertain event. By implication it applies to those agreements in which there is a definite loss for one party and definite gain for the other without specifying which party will gain and which party will lose.

In a Mudarabah contract the person who invests the capital.

pledge, collateral.

An Islamic Banking term to define Interest. Riba is an excuse or increase. Technically an increase, which in a loan transaction or in exchange of a commodity accrues to the owner(lender) without giving an equivalent counter value or recompense in return to the other party. It covers interest both on commercial and consumer loans.

A sale transaction in which a commodity is exchanged for the same commodity but unequal in amount and the delivery of at least one commodity is postponed. To avoid riba-al-buyu, the exchange of commodities from both sides should be equal and instant. Riba-al-buyu was prohibited by the prophet Muhammad (pbuh) to forestall riba (interest) from creeping into the economy from back door.

Usury of trade, It is an alternative term for riba al-buyu.

Increment on the principal of a loan payable by the borrower. It refers to the practice of lending money for any length of time on the understanding that the borrower would return to the lender the amount originally lent together with an increment in consideration of the lender having granted him time to pay. The increment was known as riba al-nasia. It was in vague in Arabia in the days of the prophet Muhammad (pbuh).

Similar characteristic to that of a conventional bond with the key difference being that they are assets backed, and non-interest bearing. A sukuk represents proportionate beneficial ownership in the underlying asset. The assets will be leased to the client to yield the return on the sukuk.

Mutual support which is the basis of the concept of insurance or solidarity. Takaful is an Arabic word that means “guaranteeing each other”. It is a system of Islamic Insurance based on the principle of Ta’awuni (mutual assistance) and tabarru (donation) where the risk is shared collectively by a group.

Reverse murabaha. As used in personal financing, a customer with a genuine need buys something on credit from the bank on a deferred payment basis and then immediately resells it for cash to a third party.

The safekeeping of goods with a discount on the original stated cost; resale of goods with a discount on the original stated cost; the acceptance of sums of money for safe-keeping a sharia’h-compliant frame work, under which it will be repaid, either on demand or in circumstances agreed by the parties involved, and which is not referable to the giving of security. Also see Al-wadia.

Agency Contract, a sharia’h contract where a representative is appointed to undertake transactions on another person’s behalf.

An obligation on Muslims to pay a prescribed percentage of their wealth to specified categories in the society, when their wealth exceeds a certain limit. Zakat purifies wealth. The objective is to take away a part of the wealth of the well-to-do and to distribute it among the poor and the needy.