The underlying financial principles in Islamic finance have remained unchanged historically since their development over 1,400 years ago. Financial products must be certified as Sharia-compliant by an expert in Islamic law. Certification requires that transactions adhere to a number of key principles that include:
- Backing by a tangible asset, usufruct or services.
- Must avoid ‘speculation’ (gharar).
- Prohibition of interest payments (riba).
- Risk & return to be shared among participants.
- Prohibition of finance for activities deemed incompatible (haram), e.g. the sale of alcohol, conventional financing, gambling & tobacco.
In a Murabaha contract of sale, a client petitions a financer to purchase a car on their behalf. Complying with the client’s request, the financer establishes an agreement setting the cost and profit for the car after establishing the selling price of the item and its suitability to the contract at hand.
Upon agreement, the financer proceeds to take legal and beneficial ownership of the intended car, and then proceeds to sell it to the client in a deferred sale which covers the cost of the car and its mark up, with the repayment typically being in instalments.
The Arabic term “Ijara” simply refers to the provision of a service or utility for a stipulated amount in return in the form of a lease, whereby a person or party is given the right to use an object (the usufruct) for a period of time; whilst the owner retains the ownership of the assets.
Lease-ending ownership/lease with ownership is an advancement of the idea of a lease and entails the lessee taking ownership of the leased asset at the end of the lease period. This lease contract doesn’t contain any binding promise to buy or sell the assets, but the owner of the asset being leased may provide a unilateral promise of transfer of ownership of the asset as a gift, or offer a purchase schedule for the asset, if the lease contract runs for a particular period of time. In this instance, the contract of a gift, or a sale, must be independent of the initial lease contract. The purchase price is ultimately decided by the market value of the asset or a negotiated price.