Fundamentals of Islamic Finance

The term “Islamic banking ” refers to a system of banking or banking activity that is consistent with Islamic law (Shariah ) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection and payment of interest, also commonly called riba in Islamic discourse. In addition, Islamic law prohibits investing in businesses that are considered unlawful, or haraam (such as businesses that sell alcohol or pork, or businesses that produce media such as gossip columns or pornography, which are contrary to Islamic values). Furthermore the Shariah prohibits what is called “Maysir ” and “Gharar ”. Maysir is involved in contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future whereas Gharar describes speculative transactions. Both concepts involve excessive risk and are supposed to foster uncertainty and fraudlent behaviour. Therefore the use of all conventional derivate instruments is impossible in Islamic banking. In the late 20th century, a number of Islamic banks were created to cater to this particular banking market.