Islamic Banking Terms and Concepts

Some of us are not familiar with most of the terms used in Islamic finance. It may be that we are not Arabic speakers so we find it hard to understand because all of these concepts are in Arabic or that we are simply not familiar with them. Here is a brief explanation of these terms and concepts.

Islamic bankingWadiahYadDhamanah (savings with guarantee)

This refers to the process of depositing goods or items to someone else for safekeeping. The one who receives the deposits for safekeeping acts as a guarantor and guarantees to pay back the amount deposited, be it in full or in parts upon request. The Wadiah is like a trust and the depository must fulfill his end of the bargain. The depositor has no share of the profits but the depository may give some returns to the depositor if he wishes as a sign of appreciation.

Mudharabah (profit-sharing)

This is an agreement between one party, who is the capital provider and another, who acts as the entrepreneur in a business venture. The entrepreneur takes charge of the day to day activities of the business and the management of funds. In the case of profits being made, it is shared based on the predetermined profit sharing ratio. On the other hand if losses are made, only the capital provider bears the brunt.

Musyarakah (joint venture)

This is a shared venture or partnership in which both parties provide funds to start a business venture. Profits are allocated according to a predetermined profit sharing ratio. In the case of losses, it also shared based on equity or capital contributions.

Murabahah (cost plus)

This refers to the case which two parties agree to sell a good or commodity at a certain price plus a profit margin. The sale is only valid however when both parties agree on the selling price, profit margin and extra costs to be incurred before the sale agreement.

Bai’ BithamanAjil (deferred payment sale)

This refers to the sale of a good on a deferred payment basis (temporary postponement of the payment of an outstanding bill or debt, usually involving repayment by instalments) at a certain price including a profit margin which both parties agree on.

Bai’ al-Inah (sell and buy back)

This transaction involves a sell and buy transaction of an asset between a seller and a customer. The seller will sell the asset on a cash basis to the customer but when the seller wants to buy back the asset he/she can do so with deferred payment but at a higher price than the initial price. This can be seen as loan in the form of sale.

IjarahThumma al-Bai’ (leasing and subsequently purchase)

This type of contract has two phases, the first phase is the Ijarah (leasing/renting) phase followed by the Bai (purchase) phase. In the first contract the hirer leases the product or item for a certain price at a specific period of time. Then at the expiry of the lease period, the hirer enters into another contract with the owner to purchase the product at a certain price.

Ijarah (leasing)

This refers to the contract in which the owner of a product leases or rents out his property to an interested party at an agreed price for a specific period of time.

Qard (interest-free loan)

This is a loan on a goodwill basis in which the borrower has to only payback the principal amount at the expiration of the loan. The borrower may however give the lender gifts in cash or kind voluntarily as a token of appreciation but it must not be predetermined.

Bai’ Salam (future delivery)

This is a contract agreement in which payment for a specific item is made in advance and the item is delivered on a future date.

Bai’ Istijrar (supply contract)

This is an agreement between a supplier and a customer in which the supplier agrees to supply a certain product at an ongoing basis for a specific period. Both parties have to agree on the price and the mode of payment.

Kafalah (guarantee)

This involves a contract in which a third party or contracting party guarantees to make sure that the two parties in a contract fulfill their contractual obligations.

Rahnu (collateralised borrowing)

This refers to the case in which a borrower provides a valuable assest to the lender as a guarantee or as an assurance of paying back the loan. In the event that the borrower defaults on the loan, the asset can be disposed of by the lender to recuperate the amount loaned out.

Wakalah (nominating another person to act)

This is a situation a person elects another person to act on his behalf.

Hiwalah (remittance)

This involves the transfer of funds from the depositor’s/debtor’s account to the receiver’s/creditor’s account at a certain fee as commission for the service.

Sarf (foreign exchange)

Involves the buying and selling of foreign currencies.

 Ujr (fee)

This refers to the fees and commissions charged for services.

Hibah (gift)

This refers to gifts or rewards given voluntarily at the end of a contract or business deal as a token of appreciation.

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