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A Historical Perspective on Islamic Finance
Islamic finance is a modern financial system grounded in Shari'ah law, derived from the Qur'an and Sunna. It prohibits riba (interest), gharar (uncertainty or speculation), and investment in industries considered unethical, such as alcohol, pork, gambling, and conventional financial services. Islamic finance offers an ethical alternative, emphasizing transparency, risk-sharing, and social justice.
The concept began in the 1950s, driven by Muslim scholars seeking a "third way" economic model, distinct from capitalism and socialism, focusing on moral responsibility in economic activity. This vision led to the idea of homo Islamicus, someone guided by faith in their financial decisions, as opposed to the self-interested homo economicus of conventional economics.
Islamic finance took shape in the 1970s in the Gulf and Malaysia, following the oil boom. Investors sought ways to handle wealth in line with their faith, which gave rise to institutions offering Shari'ah-compliant products. Compliance is assured by Shari'ah boards composed of scholars who review and approve financial products, often issuing a fatwa certifying their permissibility.
The industry follows financial filters like the Dow Jones Islamic Market Index, which screens companies based on debt levels, cash ratios, and income sources. These screens ensure businesses are not involved in forbidden (haram) activities and meet ethical standards.
Islamic finance uses distinct contracts to replace conventional loans. Common ones include:
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Mudaraba: profit-sharing where one party provides capital, the other expertise
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Musharaka: joint investment with shared profit and loss
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Murabaha: cost-plus sale used for purchasing goods
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Salam: advance payment for future goods
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Istisna': financing for manufacturing or construction
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Ijara: leasing contracts for fixed assets
While these contracts are based on historical Islamic practices, some, especially murabaha, have drawn criticism for resembling interest-based lending. In the U.S., regulators like the OCC have allowed murabaha home financing, but scholars like Mahmoud El-Gamal warn that focusing on legal form over ethical substance may undermine the purpose of Islamic finance.
To move beyond compliance formalities, the industry is exploring models that prioritize ethics and inclusion, such as Islamic microfinance, takaful (mutual insurance), and cooperative Islamic banking. These approaches aim to serve both Muslims and non-Muslims seeking ethical, transparent alternatives to conventional finance.