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Islamic banking, also referred to as Islamic finance or shariah-compliant finance, refers to financial activities that adhere to shariah (Islamic law). Two fundamental principles of Islamic banking are the sharing of profit and loss, and the prohibition of the collection and payment of interest by lenders and investors.
Islamic banking is grounded in the tenets of the Islamic faith as they relate to commercial transactions. The principles of Islamic banking are derived from the Qur'an–the central religious text of Islam. In Islamic banking, all transactions must be compliant with shariah, the legal code of Islam (based on the teachings of the Qur'an). The rules that govern commercial transactions in Islamic banking are referred to as fiqh al-muamalat.
This is a very common strategy in the trading world, but it’s mostly been a tool of large financial institutions. With the democratization of financial markets thanks to cryptocurrencies, there might be an opportunity for cryptocurrency traders to take advantage of it, too.
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The foundation of the Islamic Banking model is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. This system of financial intermediation contributes to a more equitable distribution of income and wealth.
Although based on Shari'a principles, Islamic Banking is not restricted to Muslims only and is available to non-Muslims as well.
Islamic Banking is about conducting business in a fair and transparent manner. Guiding you through to ensure full understanding of risks and costs associated with the products and services is the utmost prerogative.
Benefits and Risks of Halal Investing
Investing according to Islamic principles can offer many benefits to Muslims and non-Muslims alike. Halal investing encourages a disciplined investment process that promotes in-depth security research and monitoring. Generally, the low debt requirements of Islamic screens facilitate a conservative approach that appeals to risk-averse investors.
Halal investing discourages short-term speculation, and some Islamic scholars interpret high portfolio turnover rates (frequent trading) as a type of gambling. Low turnover minimizes portfolio trading expenses, such as broker commissions, while increasing tax efficiency by avoiding rapid buying and selling of securities that can generate taxable capital gains.
The limitations imposed on investment opportunities by Islamic principles potentially creates risk. For example, among the securities researched monthly by Universal Banks for the Amana Funds, less than half pass the initial screens necessary to be considered halal. Restricting investment choices to a smaller universe means that a halal portfolio may not be as diversified as other portfolios, which may increase the risk of loss. The returns from various market sectors rise and fall at different times. Islamic principles may limit opportunities to gain when prohibited market sectors, such as financial services, rally.
Because Islamic principles preclude the use of interest-paying investments, halal cash reserves cannot be invested in traditional money market funds or deposited in an interest-earning bank account and therefore do not earn income.
Halal Investment Guidelines
Halal investing requires investment decisions to be made in accordance with Islamic principles. As a faith-based approach to investment management, investors often consider halal investing to be a category of ethical or socially responsible investing.
Islamic principles require that investors share in profit and loss, that they receive no interest (riba), and that they do not invest in a business that is prohibited by Islamic law, or sharia. Before investing in a company, it is necessary to evaluate its business activities and financial statements to determine where its primary revenues come from and how its balance sheet is managed. A company that meets certain criteria (mentioned below) would be halal, or permissible. If it does not meet the criteria, it would be haram, or not permitted.
Interpretation of Islamic law as applied to business activities is nuanced, and halal investment guidelines can vary. Many different standards exist, and therefore Muslim investors often rely on guidance from Islamic scholars to help determine whether an investment is halal.
Investments that sharia scholars universally consider unacceptable are companies whose primary business activities violate the core tenets of Islam, including the manufacture or marketing of alcohol; gambling or gaming activities; conventional interest-based financial services; pork and pork products; and pornography. In addition, most sharia scholars advise against investing in tobacco companies.
Islamic scholars have established financial guidelines to determine when a business activity is a core source of revenue and when it is not. For example, the "five percent rule" says that a core business activity is one that accounts for more than five percent of a company's revenue. This reasoning applies to the Islamic prohibition on riba, or interest, as well. If a company's interest-based income or holdings exceed certain limits, then investing in the company is forbidden.
Often, it is not possible to avoid haram business activities. This is acceptable as long as the investment meets the criteria outlined in the Halal Investment Screening section below. However, Islamic scholars agree that Muslim investors must account for any income derived from riba or other haram sources and then give it away to a charity or someone in need. This process is known as "purification" or "cleansing" of tainted investment income. Scholars also agree that purification of tainted investment earnings should be done anonymously so that the donor receives no residual benefit, such as personal recognition or a tax deduction.