Islamic Banking Terminology
Islamic Banking is a banking practice that is adherent to Sharia laws. To understand the different types of Islamic banking practices you must understand the terminology used in this particular industry.
Common Terms Used in Arab Banking
1. Sharia (path or way). Muslims believe that the Sharia is the sacred laws of Allah. These laws must be abided to above all others. While the different religious sects often have separate interpretations of these laws, they remain the guiding force of the religion.
2. Fiqh al Muamalat (Rules of Transaction). These are the Sharia laws that govern all financial transactions. It is under these guidelines that all Islamic Banking regulations are created.
3. Riba (Interest or Usury). Riba is strictly forbidden in monetary transactions. Muslims believe it is against Allah to collect interest on money borrowed. Therefore all financial transactions must be performed in a very specific way so that banks can render a profit without breaking Riba laws. Late fees are also considered a form of Riba and must not be charged by the banks.
4. Rabal-maal (lender). The bank is considered the rabal-maal in financial transactions. This is generally only used in financial transactions concerning business ventures.
5. Mudarib (borrower). The entrepreneur in a business venture is refered to as the Mudarib.
6. Mudharabah (profit sharing). When an entrepreneur approaches a bank to borrow money for a business venture they will most often enter into a Mudharabah agreement. This agreement provides the business owner all the money necessary to start the business and the new owner manages and runs that business. Profits are split between the parties until all the original funds are repaid. The bank is also paid an additional amount of the profits for a specific period agreed on to compensate for risk. If the business fails, the bank takes on full responsibility of that debt.
7. Musharakah (joint venture). This type of agreement is exactly like the Mudharabah except there is more than one business owner involved so the profits are divided differently.
8. Wadiah (safe keeping). The bank, as part of a lending program, may require a large form of collateral in the form of a bank deposit. This deposit is used for “safe keeping”. During the period that the loan is out the bank is allowed to use that account to invest in other opportunities to generate wealth for the bank. However, the bank must have the ability to repay the customer immediately if the loan is paid. Wadiah must be returned immediately upon payment of the debt. Banks may also offer the client Hibah as a reward.
9. Hibah (monetary gift). When another person’s money is used to generate income for the bank the bank may offer the customer Hiba as a form of thanks. Not to be confused with interest, Hiba is 100% at the option of the bank.
10. Bai al inah or Murabahah (sell and buy or cost plus). Both of these terms are interchangeable in the Islamic banking field. The basis of this practice is to allow for the purchasing of property without the charging of interest. It is the Islamic form of mortgages. When a piece of property is to be purchased the borrower must approach the bank with details of the sale. The bank will purchase the home for a set price from the seller. It will then resell the property to the buyer at a higher price. This will be the final price and no interest is attached.
11. Ijarah (leasing). The banks will lease equipment or services to a business for a set price.
12. Bai salam (advance payment contract). These ventures are very tricky in Islamic banking because they possibly involve “futures” a practice strictly forbidden in Sharia investment rules. Bai salam can only be performed on goods that can be described specifically for quality and quantity. A product that has any room for variance cannot be used in these contracts.