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Business News/ Money / Calculators/  De-jargoned: Islamic finance
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De-jargoned: Islamic finance

Islamic finance adheres to Sharia laws on investments and interest

Hemant Mishra/MintPremium
Hemant Mishra/Mint

The Reserve Bank of India recently gave permission to the Kerala government to launch a financial institution that would be compliant with the rules of Islamic finance. Islamic finance adheres to Sharia laws on investments and interest.

What is it?

The fundamental principles of Islamic finance say that any financing should not involve riba (there should be no giving or receiving of interest), gharar (there should be no speculation involved in the financed projects) and haram (investment in certain products such as alcohol, gambling and pork which are prohibited by Islamic law). So Islamic finance prohibits interest-based and speculative transactions, among other things. However, both risk and reward may be shared by all stakeholders, including customers, at a pre-determined rate. The products offered by these institutions are Sharia-compliant.

Other features

Islamic banks are allowed to make equity financing or venture capital. The rules say that gains are shared at the pre-agreed rate and losses are shared in the ratio of the equity participation. While gains can’t be in the form of interest, you can take back profits made by the business financed by the institution. So here a credit seeker is made a partner and this increases responsibility for the customer as well. Also, these institutions provide financing only to ventures having fair chances of returning profits and which are socially beneficial. Creditworthiness of the borrower may not be enough for a venture to get financed. One of the objectives of such institutions is to provide finance to people with limited access to capital. This is done to promote equality.

Institutions following Islamic law collect and distribute zakat (religious tax). This tax is collected and a fund is created which is then used for social development of the poor either through the institution directly or through other religious organizations.

However, all such institutions mandatorily need to be compliant with the central bank of the country in which it is operating. Such institutions have a supervisory board which ensures that all business activities are done in accordance with strict guidelines.

State of islamic finance

Globally, many international institutions have entered this space, though in India it is still to gain traction. However, many educational institutions in India have started offering specialized courses on Islamic finance as it is believed that with the space opening up, there will be demand for Islamic finance specialists.

Over the years, Islamic finance has evolved and the system has certain provisions that help it adapt to the changing socioeconomic situations. Such adaptability shows the progressive character of the system.

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Published: 21 Aug 2013, 06:49 PM IST
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