Principles of Islamic Finance

In a constantly changing financial world, where successive economic crises have called into question traditional models, Islamic finance is emerging as a credible and ethical alternativeFar from being reserved solely for Muslim countries, it is now attracting a growing number of investors and financial institutions across the world, of all faiths.

Beyond preconceived ideas and prejudices, this age-old financial system, based on the principles of Sharia, offers a unique approach where ethics and morality occupy a central place. Exit interests and excessive speculation: Islamic finance favors risk sharing and investment in the real economy.

In this article, we dive into the heart of this alternative financial system to understand its fundamental principles, explore its mechanisms, and discover why it is attracting more and more attention from global economic players.

What is Islamic finance?

Islamic Finance is an alternative financial system that operates according to the principles of Islamic law, also known as Sharia. This system is fundamentally different from conventional finance by its ethical approach and strict rules regarding financial transactions.

At the heart of Islamic finance is the absolute prohibition of interest (riba). This prohibition is based on the principle that money should not generate money by itself, but rather serve as a medium of exchange and a measure of value. Profits in this system must come from legitimate and productive business activities, thus contributing to the development of the real economy.

Another fundamental pillar is the principle of risk sharing among stakeholders. In any Islamic financial transaction, profits and losses must be shared equally among the participants. This approach encourages greater responsibility and better risk assessment in investment decisions.

Islamic finance also requires that all transactions be backed by tangible assets. This means that every financial transaction must be linked to a real economic activity or physical asset. This rule naturally limits excessive speculation and promotes greater financial stability.

Article to read: 14 Islamic financial instruments

The sources of Islamic law

To answer the question what are the fundamental principles of Islamic Finance is to seek to understand sources of Islamic law. The Islamic economy as a whole is based on the Koran, thehe holiest text in Islam. It is the word of God which was dictated to the prophet Muhammad by the angel Gabriel. According to this book, the Prophet is the intermediary responsible for transmitting the word of God to Man. The Quran is therefore the main source of Islamic law and takes precedence over all others. sources of Sharia'a. After this first source which is the Koran, the Sunnah (Hadith) is the second primary source of Islamic law.

Throughout the life of the Prophet, Muslims asked him to clarify certain passages from the Quran in order to be able to continue to live in accordance with the model that God had taught them. To do this, the Sunna of the Prophet were written. It is a set of words, deeds and approvals of the Prophet on the basis of which Muslims can draw inspiration to define their moral orientation and behavior.

As a secondary source of Muslim law, we retain consensus (Ijma), reasoning by analogy (Qiyas) and interpretation (Ijtihad). The word Ijma means “ agreement on a question » and corresponds in the present case to an agreement reached by Muslim jurists on certain questions of law or on a particular situation. Qiya is a rule of law that is created based on the interpretation of a new situation using rules already existing within the Quran or Sunnah.

The prohibitions of Islamic finance

What is the riba ?

Le riba refers to any illicit enrichment. To any surplus income obtained without providing significant efforts such as interest. The ulama have distinguished at least three types of riba. Thus, Muslim investors face several challenges and opportunities.

✔️ First form of riba : interest

Interest is the surplus paid or claimed over an initial sum of money when repaid. It is the remuneration for a loan, generally in the form of a periodic payment from the borrower to the lender. At the time of Muhammad, the development of riba created situations of quasi-slavery for borrowers who were unable to repay. It was this unique form of interest that the prophet aimed first and foremost to prohibit.

The Islamic conception of interest joins several other religions and schools of thought. Indeed, the origin of riba is found in the continuity of Judaism, Christianity and Islam. Already in the Ancient Greece, Aristotle (384 BC) called the practice of interest detestable, because money was created for exchange and not to serve itself.

Jewish tradition very clearly condemns the practice of lending at interest and it was not until the return of the capacity of Babylon that it was authorized, but for non-Jews only. The Catholic Church, for its part, was initially very explicit on this subject. Under the leadership of a certain Calvin in the XVI^rd century, the authorization was given to the Protestants and thereafter the practice spread to the whole of the Christian community.

For Muslim law, the prohibition of interest is formal since it draws its foundation from a clear principle of the Koran. Sura "The Exodus", verse 6, says that we must prevent goods from circulating exclusively in the hands of the rich. Consequently, loans of metals (gold, diamonds, silver) and food products are prohibited. This type of riba, which is the most widespread in the world nowadays.

✔️ Second courtme of riba : the surplus collected on certain goods

The concrete surplus perceived during a direct exchange between certain types of goods of the same nature (gold, silver, currency, etc.) is also riba. This type of riba is known as ribâ al fadhl ou ribâ al bouyou.

✔️ Third form of riba : a particular advantage

Another form of riba was condemned by the Mohamet Companions in these terms: "Any loan which yields an advantage (conditioned on the lender in relation to what he initially advanced) constitutes riba ". In terms of debts, most Islamic economic institutions advise participation arrangements between capital and labor.

This latter rule takes up the Islamic principle that the borrower should not bear the entire cost in the event of bankruptcy, because " It is Allah who decides this failure, and wants it to fall on all those affected." This is why conventional debts are unacceptable. But conventional risk investment structures are put into practice even on very small scales.

However, not all debt can be considered risky investment structures. For example, when a family buys a house, it is not investing in a risky business. Similarly, buying other goods for personal use, such as cars, furniture, etc. cannot seriously be considered a risky investment in which the Islamic bank would share the risks and profits.

???? The prohibition of uncertainty (Gharar)

Le Gharar constitutes the second major prohibition in Islamic finance. It is defined as the random nature of probable elements whose uncertain and risky nature resembles games of chance. It brings together situations where the information is incomplete and the subject of the contract presents intrinsically risky and uncertain characteristics.

In the Quran, the Gharar is explicitly cited. The following expressions can be found in Surah 5, verses 90 and 91: “ O you who have believed! Wine, divination by the entrails of the victims as well as the drawing of lots (game of chance: Maysir) are just an unclean act of what Satan does. Avoid it! …The devil only seeks to introduce among you the seeds of discord through animosity and hatred through wine and gambling, and to turn you away from the invocation of God and prayer . So are you going to put an end to it? ».

However, certain conditions must be met. The uncertainty inherent in a contract must first be significant and based on the object to invalidate the contract. Then, the contract must necessarily be a bilateral contract and not unilateral as is the case in a donation or a free service. Finally, the Gharar is accepted in cases where the very objective of the contract cannot be achieved without this uncertainty.

???? The prohibition of chance (Qimar) and speculation (Maysir)

In FI, it is forbidden to " earn money only by lending it to others. You have to really take part in the project. If the success of a project depends purely on chance, then there is Maysir. It is this principle which is, among other things, retained to indicate that speculation is prohibited in Islamic finance. Indeed, speculation often turns out much too risky. The objective is not to participate in a real economy, but to earn money randomly, without being interested in the project itself and its real performance.

The third major prohibition in Islamic finance is therefore the Qimar (chance) and Maysir (speculation). These two notions are closely linked to the previous great prohibition, the gharar. They are even sometimes confused within the literature. In fact, the Qimar is often defined as being Maysir. However, the difference is that the Maysir goes well beyond games of chance since it corresponds to any unjustified enrichment.

Broadly, they are inherent in the form of contract in which the rights of the parties to the contract depend on a random event.

???? The prohibition of illicit investments

The last major ban is based on illicit investments. Islamic finance must be socially responsible. All the activities that Allah has created and all the benefits that flow from them are defined as " halal ». This rule leads to the prohibition of a large number of sectors of activity in which Muslims must not invest.

From a financial point of view, the underlyings of any type of contracts must also be Shariah-compliant. Quranic prohibitions moralists concern, by extension, commercial matters.

The requirements of Islamic finance

???? The profit and loss sharing principle (3P)

The first and foremost requirement in Islamic finance is profit and loss sharing. In fact, the principle of equity is the basis of the economic conception of Muslim law. This requirement of Islamic finance is presented as a alternative to the practice of self-interest which is haram. In reality, one of the prohibitions of the FI is the prohibition of interest in all economic and financial operations. Stakeholders in banking activity are obliged to share the risks and therefore the profits or losses in order to legitimize the remuneration resulting from the investment project.

In reference to this principle, the FI is called " crowdfunding ". This principle also means that the terms of a contract must benefit all parties equitably. This is why in Islamic banks (IB) there are participatory contracts signed between the bank and its clients. These contracts allow BIs to finance entirely or in part, depending on the type of contract, an investment project carried out by the client and to participate with them in the profits and losses.

When signing these contracts, the proportions of intervention in the future profits and possible losses of each party must be clearly defined. In such contracts, the client is more generally the project manager and the parties share without exception the losses and profits in accordance with the contractual clauses, except in the event of negligence or Proven gross negligence on the part of the client. The 3P principle establishes a new relationship between the investor (the bank) and the entrepreneur (the client).

???? Invest in tangible assets

The second main requirement of the IF is the backing of the investment to a tangible asset or Asset Backing. According to this requirement, all financial transactions must involve real assets to be valid under Sharia law. This principle of Asset Backing makes it possible to strengthen the potential in terms of stability and risk control and to ensure the connection of the financial sphere to the real sphere. Through this requirement, the Fi participates in the development of the real economy by creating non-risky economic activity.

???? Ownership requirements

Taking into account the particularity of the notion of property is a strong requirement in Islamic law. In fact, Islamic doctrine does not agree with capitalism in his assertion that private property is the principle, nor with socialism when he considers socialist property as a general principle.

At the same time, it admits the different forms of ownership when it adopts the principle of dual ownership (property in various forms) instead of that of the single form of property that capitalism and socialism make. The desire to earn a living, to live comfortably, even to have ornaments or decorations and to protect oneself from a uncertain future is never considered as an evil. Rather, he says that his precepts are the means to succeed in this field without trading it for failure in the hereafter. The Quran says that Allah is the sole owner of all that is in heaven and on earth.

L'Homme However, is only the steward of Allah on earth. He is responsible to He, of what is entrusted to him. Unlike the capitalist world, the notion of property according to Muslim law is divided into three categories. These are public property, state property and private property.

✔️ Public ownership

In Islam, public property refers to natural resources over which all people have equal rights. These resources are considered common property. This property is placed under the guardianship and control of the state, and any citizen can enjoy it, as long as it does not harm the rights of other citizens over this property. In terms of privatization of public property, certain properties such as water, fire, pasture cannot be privatized.

The sentence of Mohammed according to which men are associated in these three areas, has led scholars to consider that the privatization of water, energy and agricultural land could not be authorized. As a general rule, the privatization and/or nationalization of public property is the subject of debate within the doctrine.

✔️State property

This property includes certain natural resources as well as other properties that are not can be immediately privatizeds. Property in an Islamic state can be movable or immobile. It can be acquired by conquest or by peaceful means. Unclaimed properties, unoccupied or without heirs, uncultivated land (mawaf) can be considered state property. During Muhammad's lifetime, one-fifth of the equipment captured from the enemy on the battlefield was considered state property.

However, Muhammad said: "The old lands and the fallow lands are for Allah and His Messenger, then they are for you." The jurists conclude from this that in the end, private property takes precedence over state property.

✔️ private property

There is a consensus among Islamic jurists and sociologists that Islam recognizes and encourages the individual right to private property. The Quran regularly addresses the issues of taxation, inheritance, the prohibition of theft, and the legality of property. Islam guarantees the protection of private property through severe punishments against thieves. Muhammad says that he who dies defending his property is like a martyr.

Islamic economists have classified the acquisition of private property into three categories: involuntary, contractual or non-contractual. When it is involuntary, it means that the individual has benefited from an inheritance, a bequest or a gift. A non-contractual acquisition is an acquisition such as the collection or exploitation of natural resources that have not previously been privately owned. However, contractual acquisition includes activities such as trading, purchasing, renting, hiring, …

However, Maliki and Hanbali jurists argue that if private property endangers the public interest, the state can limit the amount of private property of an individual. However, this view is not shared, it is debated in other schools of thought of Islamic law.

Article to read: The 14 Islamic Financial Instruments

???? Equality requirements

The ban on usury considered riba between the contractors, aims to establish religious, social and economic equality.

✔️Equality from the point of view of Islam

Islam is above all, justice, equality and honesty. Under Sharia, therefore, all believers are equal. Muhammad says that no one can claim to be believing if he does not love for his brother what he loves for himself. This is why Islam considers usury as a tool promoting selfishness. This is why the verses relating to its prohibition in the Koran are preceded by several verses which encourage individuals to mutual cooperation, solidarity and charity. In our opinion, the degradation of values ​​has favored the appearance of individual miseries, even within the developed countries.

This progress which our countries bear witness to, leaves man indifferent to man at the level of interpersonal relations. If Islam, in its industrialization, were to keep the substance of the Koranic principles, it would give the world a resounding lesson.

✔️ Social equality

The prohibition of interest is also intended to establish equality within a society between those who hold capital and he who fructifies it. Recognizing a surplus to the holder of capital, without it also being recognized to the user of this capital, constitutes a privilege recognized to capital in relation to labor. The practice of interest places capital at the center of social inequalities. However, in Muslim law, wealth must not be a source of social inequality.

✔️ Economic equality

Islam seeks, if only on a theoretical level, to create a counterweight to the domination of the rich. From the Islamic point of view, wealth belongs to God, and that individuals are only the holders.

Wealth should not, therefore, be a source of economic power. It must flow continuously within the framework of what is permitted by Sharia and must be spent to help the poor and also enable them to earn.

🌽 The principle of justice

Justice is the moral principle that requires respect for law and equity. Social justice requires fair living conditions for everyone. If you repent, your capital will belong to you, do not harm anyone (taking more than is rightful), and you will not be harmed (by receiving less than what you lent). For Muslims, the prohibition of interest also aims at the principle of justice. This notion of justice can be examined from three angles: the religious, social and economic angle

✔️ Justice from the perspective of Islam

If a Muslim seeks to gain at the expense of his brother by taking advantage of his need to subject him to abuse, he is committing an act of injustice. “No one can claim to be a believer if he does not love for his brother what he loves for himself.” The Quran seeks to develop among Muslims the feeling that they all belong to the same community charged with a mission. However, usury is perceived as a means based on injustice, fostering disunity and the spirit of hatred.

This is why one of the priorities of the prophet was to condemn any benefit drawn directly or indirectly from this kind of practice.

✔️ Social justice

La social justice is also at the center of Islamic concerns. The prohibition of interest therefore goes in this direction. In other words, it seeks to establish justice between the holders of funds and those who intervene through their work. The disadvantage of recognizing a surplus in capital compared to work is not only of a moral nature. Indeed, this kind of consideration leads us to lower the values ​​of Man and to raise the value of matter. Beyond this observation, there are direct repercussions on the very structure of society.

Interest promotes social disparities by channeling wealth without risk or pain into the hands of a minority. This observation is in direct opposition to what the Koran proclaims, which prohibits monopolies.

✔️ Economic justice

In the traditional banking system, the creditor benefits from a pre-established amount represented by interest. In this case, by the loan contract, the capital and labor only belong to one person who is the taker who handles them at his own risk. We can therefore wonder whether there is really justice from an economic point of view in this type of process. Because, if the capital deteriorates, it is the lessee who will assume full responsibility.

Islam says that if one wants to make the lender participate in the profit realized, it is necessary at the same time to make him participate in the loss one may incur. This is why putting the balance on the lender's side constitutes an injustice. However, from the moment when the owner of the capital participates in the profits and losses, it is no longer a question of a loan but of a real joint cooperation that islam calls Mudaraba.

In Muslim law, wealth is not intended to constitute a source of economic power, nor to be immobilized. Wealth should be used to help others and also enable them to earn. This denunciation of Islam leads us to understand that through the most direct form of aid which is zakat, those who receive (the poor, the weak, the orphanss) have a marginal tendency to consume. This transfer of wealth would therefore increase demand and generate economic development to a certain extent.

???? Payment of Zakat

Zakat, the third pillar of Islam, is both a financial obligation, act of worship and right of God. It provides a central function in putting into action the principle of equity, through the redistribution of wealth, from the richest to the needy. Concretely, any Muslim detaining for the duration of the lunar year (hawl) wealth above a tax threshold (nissab) 85 grams of gold. That's about 1500 euros today, is required to donate 2,5% to orphans, the poor, war refugees, etc.

Zakat must therefore be analyzed as a measure encouraging Muslims to invest, pushing them to make their money grow. This analysis is also confirmed by the treatment inflicted in Islam on hoarding, seen as an absolute lack of faith to the extent that it is a sign of a lack of confidence in the future. THE Quran states than : " those who hoard gold and silver, far from spending it on the path of God, announce to them a painful punishment ».

Thus, based on these ethical principles of Muslim law, the promoters of the Islamic financial system intend to establish a new model, carrying positive values ​​and offering Muslims and non-Muslims the legitimate possibilities of benefiting from modern banking services by following the " way of God ". However, I cannot leave you without offering you this guide to increase the SEO of your website.

It's your turn