Islamic finance simply refers to how individuals and businesses strive to raise capital in line with Sharia, or Islamic law. You can also regard it to be the different types of investments that are permissible under this form or law. In short, Islamic finance is banking, lending, and saving practices that comply with Islamic law.

As per Sharia law, investors must steer clear from investing in companies that engage in forbidden activities, limiting the scope of public equities and Islamic investor can hold. Below is a brief overview of permissible financing arrangements often encountered in Islamic finance?

Profit and Loss Sharing Contracts

Profit and Loss Sharing contracts pool investors’ money and take a share of the profits and losses. This process is agreed upon with the depositors. But what does the bank invest in? Well, a group of mutual funds screened for Sharia compliance has come to be. The filter parses company balance sheets to determine whether any sources of income to the company are prohibited.

Any companies that hold too much debt or engaged in forbidden lines of business are excluded. Aside from actively managed mutual funds, passive funds are in existence as well. They’re based on such indexes as the Dow Jones Islamic Market Index.

Installment Sale

An installment sale commences with an intermediary buying the home with a free and clear title to it. The intermediary investor then agrees on a sale price with the prospective buyer. Keep in mind this price also includes some profit.

With installment sale, you can decide to make the purchase outright or through a series of deferred payments. This credit sale is an acceptable form of finance and should be confused with an interest-bearing loan.

Islamic Forwards

Islamic Forwards are quite rare, and are used for certain types of business. These are an exception to gharar. The price for the item is prepaid, and the item is delivered at a definite point in the future. Since there’s a host of conditions to be met to render such contracts valid, it would always work to your advantage when enlist help from Islamic legal advisor.