Step one: finding your way around Shariah principles

June 15, 2012 8:53 am

By Kaushiq Kodithodika, Advent

The main principles of Islamic finance include:

– The prohibition of taking or receiving interest (riba);

– Capital must have a social and ethical purpose beyond pure, unfettered return;

– Investments in businesses dealing with alcohol, gambling, drugs or anything else that Shariah considers unlawful are prohibited;

– A prohibition on transactions involving maysir (speculation or gambling); and

– A prohibition on gharar, or uncertainty about the subject-matter and terms of contracts-this includes a prohibition on selling something that one does not own.

Because of the restriction on interest-earning investments, Islamic banks seek to obtain their earnings through profit-sharing investments or fee-based returns. When financing is provided for business purposes, the financier, if he wants to make a legitimate gain under the Shariah, should take part in the risk. If a financier does not take part in the risk, his receipt of any gain over the amount provided is classed as interest.

Although Islamic banking and finance authorities are attempting to provide a uniform code of standards and practices, the specifics relating
to Shariah-compliance can vary between regions and Islamic schools of thought.

To ensure local adherence, each financial institution must therefore be guided by its own internal board of Islamic scholars (often assisted by national boards) that advise on the way in which all transactions are to be processed. Moreover, a number of bodies aim to provide standards and references.

Accounting and audit organisation for Islamic
financial institutions (AAOIFI)

The Accounting and Audit Organisation for Islamic Financial Institutions (AAOIFI), established in 1990 in Bahrain, is an autonomous nonfor-
profit body that prepares accounting, auditing, governance, ethics and Shariah standards for Islamic financial institutions, with a view to having them globally adopted as international benchmarks for the industry. They are intended to complement existing international accounting standards (lAS), where there are no specific standards to deal with Islamic banking transactions.

Bahrain and Sudan now require Islamic banks to comply with AAOIFI’s standards, and in the Kingdom of Saudi Arabia and other Muslim majority
countries, AAOIFI’s standards are being specified as guidelines.

Islamic Financial Services Board (IFSB)

The IFSB, based in Kuala Lumpur (Malaysia), is an organisation intended to develop international regulatory standards to promote the soundness
and stability of the Islamic financial services industry. Its main objectives are to promote the development of prudent and transparent Islamic financial services and provide guidance on the effective supervision and regulation of institutions offering Islamic financial products.

In December 2005, the IFSB adopted two standards – the Guiding Principles of Risk Management and the Capital Adequacy Standard which were intended to complement the Basel II accord with provisions specifically designed for Islamic banks.