What is Islamic Finance and How It is Different from the Traditional Finance

Islamic finance is based on the law of Sharia stipulated by Quran and sayings, and actions of Prophet Muhammad (PBUH). In other words, Islamic finance is linked to the faith and is derived from the Islamic faith. Since Islam is Deen, a way of life, it covers all aspects of our life including finance.

How is Islamic Finance Different from the Traditional Mainstream Finance?

The most obvious difference between traditional finance and Islamic fiancé is that interest or RIBA as described in the Quran, is prohibited in Islamic. Money in Islam is a medium of exchange and a store of value. While on the other hand, money is compounded by interest which is unlawful in Islam. In addition, there is also prohibition of alcohol, gambling and pork etc in Islam and consequently any dealings in prohibited or ‘haram’ is strictly forbidden in Islamic finance.

Uncertainty in contractual dealings is also prohibited in Islam. It is aimed at avoiding disputes between the parties involved in trade and also protecting them from undue risks, these are based on fundamental principles of Islamic law called sharia. Hence the reason, gambling is not allowed in Islamic as it can put people at risk of loosing their possessions. Based on the same rulings of uncertainty and ambiguity avoidance, forex trade is also prohibited in Islam. How are Over 1400 years old Islamic finance rules applied today?

Due to advancement and innovations in technology, modern finance has completely transformed as compared to the finance that existed in the age of Prophet Muhammad (PBUH). Therefore, our main challenge is how to apply those old rules to the modern-day financial markets. The answer to this question lies in the fact that there are qualified scholars who are experts in the ruling of the Quran and sunnah. They apply the same principles of sharia to the modern context. In other words, the principles and rulings of sharia are fixed for ever, but scholars apply those same rules to modern days’ financial challenges and thus guide us how to make financial products sharia compliant. For examples, leasing and mortgages are used in Islamic finance but they are compliant to the sharia law. Islamic mortgages, for instance, are fundamentally different from the traditional mortgages. Sharia compliant mortgages are not based on interest, they are called Home Purchase Plans (HPP). There is the concept of co-ownership between the bank and the customer, so the customer pays instalments and buys more share of the property and eventually he takes full ownership. Who defines Islamic finance?

There are qualified and knowledge scholars of Quran and sharia law who keep themselves abreast of the modern finance as well, so that they can constantly keep the financial products in compliance with the sharia law. Islamic Financial Council (IFC) designs and offers courses for scholars to educate them on modern days’ business and financial system. As a fundamental principle, scholars don’t make financial products, they provide advisory service whether a financial service is sharia compliant and if they are not sharia complaint what changes are needed to ensure these financial products comply with the basic principles of the law of sharia.