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Islamic Finance – a glossary of terms

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Bai Bithaman Ajil

A contract for deferred payment on the sale of goods. A bank buys goods requested by the client. The bank sells the goods to the client at cost plus profit. They client settles payment in instalments within a predetermined period or in lump sum.

Gharar Lit

The sale of something with unknown consequences, which opens the transacting parties to risk or uncertainty. Examples include selling goods the seller cannot deliver; selling known or unknown goods at an unknown price; or making a contract conditional on an unknown event. Risk and uncertainty are forbidden in sharia.

Ijara

This is a leasing contract, which is a permissible way to earn income under Islamic principles. A financier buys and leases assets to a business owner for a fee. The duration of the lease and the fee are predetermined. The financier remains the owner of the assets.

Murabaha

An estimated 80% to 90% of financial transactions of some Islamic banks belong in this category. It is often used as a treasury or liquidity avenue.

To be sharia-compliant, the transaction must be completed in two stages and as two separate contracts.

In the first stage, the client requests the bank to assume a murabaha transaction and promises to buy the specified commodity. The bank sets a price of cost plus profit, agreed in advance. In the second stage, the client purchases the goods acquired by the bank on a deferred payments basis and agrees to a payment schedule.

Sharia

Islamic canon law derived from three primary sources: the Quran; the Hadith, which are sayings of the Prophet Muhammad; and the Sunnah, which are practices and traditions of the Prophet Muhammad.

Sukuk

A tradable certificate backed by assets. The certificate entitles the holder to the assets’ income stream. Sukuk is often referred to as Islamic fixed income or bond. Sukuk can have numerous structures, some of which can be contentious. Refer to guidelines from the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).

Takaful

Mutual insurance: The members are the insured as well as the insurers. Takaful offers joint risk sharing when one of the members experiences loss of assets.

This abridged glossary is based on a version by Yasaar, a provider of sharia compliance services to the global financial services industry.

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