ISLAMIC FINANCE GLOSSARY
By
Abdulazeem Abozaid
Shariah
Shariah means teachings of Islam. This covers belief, ethics and law. Shariah, as a
term, is widely used to indicate Islamic Law and its sources and principles. Shariah,
embodied in Islamic Law, is the core of Islamic Economic Thought and Applications.
Fiqh means ‘Islamic Law’ thus, it is part of Shari'ah.
Fatwa
Fatwa is the legal opinion given by a Shariah scholar based on his understanding of the
Shariah texts and principles. Not all Shariah texts are definitive in authenticity of
meaning; therefore, there is an avenue for the Shariah scholar to use his reasoning in
understanding the speculative text or its applications.
Iqalah/ Cancellation of the Contract
Iqalah or cancellation of a contract is a bilateral agreement of the contracting parties to
revoke or remove the legal effect of a contract. According to some jurist, Iqalah of a
sale contract is considered as a new sale contract.
Urbun
Urbun is a sale contract whereby the buyer pays a sum of money (the urbun) to the
seller with the understanding that if the buyer comes back before the given deadline
and accomplishes the transaction, the urbun would be counted as part of the price of
the sold asset. If, on the other hand, the intended buyer chooses not to conclude the
transaction, the urbun would then be forfeited. It has been controversially suggested
that the modern day options contracts can be lawfully covered by Urbun.
Salam/ Future delivery sale
Salam is sale in which an advanced payment is made for goods which are to be
delivered in the future. According to normal rules, no sale can be affected unless the
goods are in existence at the time of the bargain, but this sort of sale forms an
exception to the general rule provided the goods are defined and the date of delivery is
fixed. In Islamic law, Salam is usually applied in the agricultural sector but it can be
applied to all fungible goods. It is also applied to a mode of financing adopted by
Islamic banks (parallel Salam).
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Parallel Salam
In an arrangement of parallel Salam, the bank enters into two different contracts. In
one of them, the bank is the buyer and in the second the bank is the seller. For
example, if A has purchased from B 1000 bags of wheat by way of Salam to be
delivered on 31 December, A can contract a parallel Salam with C to deliver to him
1000 bags of wheat on 31 December. But while contracting Parallel Salam with C, the
delivery of wheat to C cannot be conditioned with taking delivery from B.
Istisna’
Istisna‘ is a contract to sell a manufacturable thing with an undertaking by the seller to
present it manufactured from his own materials, according to specified description and
at a determined price. The suitability of Istisna‘ for financial intermediation is based on
the permissibility for the contractor in Istisna‘ to enter into a parallel Istisna‘ contract
with a subcontractor. Thus, a financial institution may undertake the construction of a
facility for a deferred price, and subcontract the actual construction to a specialized
firm.
Parallel Istisna’
In an arrangement of parallel Istisna’, the bank that has already sold its client a
manufacturable thing contracts also on Istisna’ basis a real manufacturer to
manufacture something of the same specifications and delivery date as in the first
contract. When the thing is delivered to the bank, the bank delivers the same to its
client. The bank profits from the difference in prices in the two Istisna’ contracts.
Murabaha
Murabaha literally means sale on profit. Tech means a contract of sale in which the
seller declares his cost and profit. This has been adopted (with certain modifications) 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. The bank buys
the desired item for itself first then sells it to its client on credit to the client with a mark
up.
Sarf
Sarf is a contract in which both items that are exchanged are gold, silver or any
monetary units. Sarf is subject to some conditions which are meant to avoid the
occurrence of Riba in sales. The conditions are and spot payment of the two counter
values, and the equality in amount if the two exchanged value are of the same kind
(gold for gold, euro for euro).
Ijarah
Ijarah is lease. The lessor is called Mu’ajjer, the lessee Musta’jer and the rent Ujrah.
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Ijarah Mutahia Bittamlik/ Leasing ending with sale
It refers to a mode of financing adopted by Islamic banks where the Islamic bank
finances equipment, building or other facility for the client against an agreed rental
together with an understanding that the bank will sell the leased asset after the lease
has expired at a nominal price, or will present it to the client as a gift. The terms alIjarah Wal Iqtina, al-Ijarah al-Muntahia Bitamlik and al-Ijarah Thumma al-Bay’, al-Ijarah
Bi Shart al-Tamlik have been used interchangeably.
Inah
Inah refers to a contract of sale where a person sells an article on credit and then buys
it back at a lesser price for cash. Example: A asks a loan of $10 from B. B, instead of
asking for interest on this loan applies a contrivance. He sells an article to A for $12 on
credit and then buys back from him the same article for cash at $10. Inah is considered
a usurious transaction in the disguise of two sales – a trick, and therefore it is
impermissible. However, it is argued that some Islamic banks have used some twisted
interpretation of some juristic statement to claim permissibility of Inah, though it was
clearly prohibited by Fiqh Academy.
Riba
Riba literally means an excess or increase. Technically it denotes any increase which in
a loan transaction (Riba al-Dayn) or in exchange of a commodity (Riba al-Buyu’)
accrues to one contracting party without giving an equivalent counter-value in return to
the other party. Riba could be resulted also from the delay in delivering certain
commodities. Any risk-free or "guaranteed" rate of return on a loan or investment is
riba. Riba, in all forms, is prohibited in Islam. In conventional terms, riba and "interest"
can be used interchangeably.
Zakah (Zakat)
Zakah is the third pillar of Islam. The objective of Zakah is to take away a part of the
wealth of the well-to-do and to distribute it to the poor and the needy. It is levied on
cash, cattle, agricultural produce, minerals, capital invested in industry and business,
etc. The distribution of Zakht fund has been laid down in the Quran (9:60) and is for
the poor, the needy, Zakat-collectors, new Muslims, travelers when in difficulty, the way
of God, captives and debtors.
Musharaka
Musharaka means partnership. It is divided into two main types; the contractual
partnership (sharikat ul-’aqd) which is a partnership or joint venture formed by
contract, and the co-ownership of an asset (sharikat ul-milk). However, Musharaka
typically refers to sharikat ul-‘aqd where partners start a venture for the sake of profit
making. Herein the partners may have equal equity but unequal rights to profit,
unequal equity with equal rights to profit or with unequal equity and unequal rights to
profit, but liability to loss must be in accordance with equity. It is the most common
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type of partnerships and on the basis of which the partnership in Islamic banks has
been modeled.
Mudarab
Mudaraba is a contract in which one party brings capital and the other personal effort.
The proportionate share in profit is determined by mutual consent, while the loss is
borne only by the owner of the capital, in which case the entrepreneur gets nothing for
his labor. The financier is known as Rabb ul -mal and the worker or entrepreneur as
Mudarib. As a financing technique adopted by Islamic banks, Mudaraba 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 the negligence or violation of the terms of the contract by the Mudarib, is borne by
the Islamic bank. The bank passes on this loss to the depositors. Mudaraba is also the
basis on which Islamic banking deposits are structured; depositors place their money as
a capital in Mudaraba and the bank, as Mudarib, invests it for them against a share in
the profit.
Sukuk
Sukuk is an arrangement that has been devised recently as a way for Islamic
organizations to issue an instrument similar to a tradable Western bond, while still
being Shariah compliant.
Investment Sukuk
Investment Sukuk are certificates of equal value representing undivided shares in
ownership of tangible assets, usufruct and services or (in the ownership of) the assets
of particular projects or special investment activity.
Sukuk Al-Ijara/ Ijara Sukuk
It is the most common type of Sukuk. The owner of an existing tangible leased asset, or
asset to be leased, may sell this asset through Sukuk. The issuer of these certificates is
seller of a leased asset and the subscribers are the buyers of the asset, while the funds
mobilized through the subscription are the purchase price of the asset. The certificate
holders jointly own the asset through an undivided ownership, sharing the profits
(rentals and capital appreciation of leased asset) and losses on the basis of the
partnership that exists between them.
Diminishing Musharaka (Musharaka Mutanaqisa)
Diminishing Musharaka is an arrangement whereby a financier (bank) and a customer
participate in joint ownership of property or commercial enterprise. The Share in
ownership of the financier is divided into units with the understanding that the
customer will gradually purchase those units via periodic payments. The objective is for
the customer to become the sole owner of the property or enterprise eventually.
Diminishing Musharaka agreement normally involves also a lease contract whereby the
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financier leases its share to its client against a rent that will be adjusted with every
purchase of the financier’s share units.
Takaful / Islamic Insurance
Islamic insurance (Takaful) is perceived as cooperative insurance, where members
contribute a certain sum of money to a common pool. The purpose of this system is not
profits but to uphold the principle of “bear one another’s burden”. The fund pooled is
normally invested in Shari’ah compliant investment modes for the benefit of all
participants. The takaful company does not own the premiums; rather it is entrusted
with the management of the takaful operations and the administration the takaful fund
against a determined fee, plus a possible incentive form the surplus.
Bay’
Bay’ means sale; an agreement between two parties in which ownership of an item is
transferred from seller to buyer for a price.
Gharar
Gharar means uncertainty. Technically it refers to contractual ambiguity due to
ignorance of an aspect of the contract. Gharar invalidates contracts, but if it is minor
and is normally not conducive to a dispute between the contracting parties, then it can
be tolerated by the Shariah. Gambling and financial derivatives are mostly forbidden
due the gharar (speculation) involved therein.
Qard/ Qard Hasan
Qard means interest free loans, and Hasan (benevolent) is just an affirmation of the
benevolent nature of the loan. A loan according to Islam must be free of interest since
lending is viewed as a benevolent action. Charging interest on loan renders money a
commodity which is not the way Islam view money. However, the lender can take a
pledge, collateral to secure the return of debt but cannot stipulate an increase over the
value of debt in case of default.
Hadith/Sunnah
This term refers to the report of the sayings or actions of the Prophet Mohammed
(Peace be upon him).
Halal
Halal means lawful, permissible. In Islam all things are deemed halal unless otherwise is
established.
Haram
Haram means unlawful, impermissible.
Hukum
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Hukum means ruling. Hukum Taklifi (defining law) is of five categories: obligatory
(wajib/fard), recommended (mustahabb), neutral/permissible
(mubah/halal), reprehensible (makruh), or forbidden (haram).
Ijtihad
Ijtihad refers to decision-making in Islamic law by personal effort. To be valid it has to
be performed by a qualified scholar (mujtahid) and it must not be in conflict with any
Shariah text or principle, and there must be no established doctrine ruling the case.
Istijrar
Istijrar refers to an agreement over a continuous purchase or supply; the supplier
undertakes to provide a particular product on an ongoing basis at an agreed price with
payment made in an agreed manner.
Kafala
Guarantee; a standard Islamic transaction in which a guarantor (kafil) agrees to assume
responsibility for the debts of a creditor (makful 'anhu).
Khiyar
Option; power to cancel a contract. Schools of Islamic law in general recognize different
types of options, some of which are inherent in the sale contract like khiyar al'ayb
(option to cancel if the asset sold found to be defective), and some need to be
stipulated like khiyar al shart (option to rescind sale by the seller or the buyer during a
specified period), or khiyar al naqad (option to cancel on non-payment). All options
must come free of charge and cannot be sold by contractors.
Maqasid al Sharia
Maqasid al Shariah are the higher purposes of Shariah law, which are believed to be
built on five objectives; the protection of religion, life, lineage, intellect and property.
Mayser
Mayser means gambling, and it is impermissible.
Waqf
Waqf refers to charitable trust, an endowment set up for Islamic purposes (usually for
education, mosque building or the poor). It involves tying up a property in perpetuity so
that it cannot be sold, inherited or donated to anyone.
Tawarruq
Tawarruq means monetization, to convert something to cash. One party purchases an
asset on credit from a second party on a deferred payment basis, and then sells it on to
a third party, receiving instant cash. It has been used by some Islamic banks to provide
cash financing to customers (also known as "commodity Murabaha"). It is a highly
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controversial practice and it was ruled by Fiqh Academy (the largest contemporary
representative of Muslim Scholars) as unlawful.
Wa'd
Wa’d means promise. Typically it is unilateral and the primary difference between it and
a contract is that the promise may bind only its maker, whereas a contract binds both
parties. Wa’d has many applications in Islamic finance as it is used to obtain the
commitment of a contractor where engaging in a contract at a particular stage is not
allowed.
Jahala
Jahala means lack of knowledge. It denotes a lack of knowledge or ignorance about
essential contractual terms which in turn leads to gharar.
Ijma’
Ijma’ means consensus of scholars in relation to issues relating to the Shariah.
Daman
Daman refers to the taking on of a liability or responsibility (such as the liability arising
out of a guarantee). It is also used to refer to the guarantee itself.
Rahn / Pledge or pawn
It is an arrangement where a valuable asset is placed as collateral for a debt. The
collateral is disposable in the event of a default but the creditor can keep only the
amount corresponding to his debt and the balance, if any, must be repaid to the debtor.
Kafala / Surety, Guarantee
It refers to a contract of surety in which a person adds to his own liability the liability of
another person in respect of a demand for something.
Wakala/ agency
A contract in which a person delegates his power or business to another and substitutes
him in his own place. The latter is called the wakil, or agent, and the former is called
Muwakkil, or principal. Wakala could be free of charge or with charge. In the later case
it is a commutative contract and it is similar to Ijarah in labor.
Wakala bil istithmar
It means investment agency. The investment agent will be paid a pre-agreed service
fee or commission with the investor being entitled to all of the profit. Some of the
investment deposits in Islamic banks have been structured on this basis.
Hawala
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Hawala covers bill of exchange and promissory note. Through hawala the debtor can
pass on the responsibility of payment of his debt to a third party who possibly owes the
former a debt. Thus the responsibility of payment is ultimately shifted to a third party.
Wadi’a
Wadi’a refers to a contract whereby a person leaves valuables as a trust for safekeeping. Wadi’a in Islamic banking terms refer to ‘deposit’ or bank account.
Qimar
Qimar means gambling. Technically, qimar applies to any 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.
Rabb-ul-mal
Rabb-ul-mal in a mudaraba contract is the contractor who provides the capital.
Mudarib
Mudarib in a Mudaraba contract is the contractor who acts as entrepreneur.
Ajr
Ajr, or Ujra, is a commission, fees or wages levied for services.
Amana
Amana refers to deposits in trust. A person may hold property in trust for another,
sometimes by implication of a contract.
Bay’ Bithaman Ajil, BBA
BBA literary means deferred payment sale. In Islamic finance terminology it refers to
buying of assets on cash by bank then selling them on credit to clients. It differs from
Murabaha as the bank in BBA buys the assets before it receives a request from clients.
Some Islamic banks that practice the highly controversial Inah use this term (BBA)
instead of Inah to avoid the negative connotation of the term ‘Inah’, since its
mechanism involves a differed payment sale.
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