Principles and Prohibitions of Sharia in Finance

Islamic finance is a system of financial services based on the principles of Sharia (Islamic law). The Islamic finance market reached $4.5 trillion in assets by 2023 and continues to grow at a rate of 10–15% per year. For CIOs in GCC countries and global institutions working with Islamic investors, understanding this system is essential.

Key Sharia Prohibitions

Riba — Usury/Interest

Riba is the prohibition of receiving or paying a fixed interest rate. This is the central prohibition of Islamic finance.

Basis: The Quran (2:275) directly prohibits riba. Any predetermined, fixed profit from lending money is forbidden.

Implication: Islamic financial instruments cannot use standard interest-based lending. Instead, profit-sharing structures or financing through real assets are used.

Gharar — Excessive Uncertainty

Gharar is the prohibition of excessive uncertainty or speculation in contracts.

What is prohibited:

• Sale of an asset not yet owned by the seller (pure short selling)
• Contracts with an indeterminate subject or price
• A range of derivative structures (options, futures on financial assets — subject to disagreement)

Exceptions: Moderate uncertainty is allowed (all deals have an element of uncertainty). Only excessive uncertainty is prohibited.

Maysir — Gambling

Prohibition of gambling and speculation, where profit results from pure chance rather than real activity.

Implication: Prohibition on participating in casino companies, lotteries. A range of derivative transactions are classified as maysir.

Key Principles of Islamic Finance

1. Profit & Loss Sharing

Instead of a fixed interest rate, the parties share profit (and risk) in proportion to their contribution or by agreement.

Mudarabah: One party provides capital (Rabb al-Maal), the other — labor and management (Mudarib). Profits are divided according to an agreed ratio. Losses are borne only by the capital owner (unless there is negligence by the manager).

Musharakah: All partners contribute capital (and/or labor), share both profits and losses proportionally to their stake.

2. Asset-backing

Every financial transaction must be linked to a real asset or service. Money itself cannot be a commodity.

3. Haram Screening

It is forbidden to finance: alcohol, tobacco, pork, pornography, weapons of mass destruction, gambling, conventional (riba-based) banks.

Thresholds for screening (popular standards — AAOIFI, Dow Jones Islamic):

• Prohibited income < 5% of total revenue
• Interest-bearing debt < 33% of market capitalization

4. Justice and Shared Risk

Islamic finance emphasizes that whoever receives income must also bear risk. "No risk, no return."

Regulatory Framework

Leading Standard-Setting Bodies:

• AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) — Bahrain. Develops Sharia, accounting, and auditing standards.
• IFSB (Islamic Financial Services Board) — Kuala Lumpur. Prudential standards for Islamic banks/insurers/markets.
• OIC Fiqh Academy — Religious body determining the permissibility of instruments.

Sharia Supervisory Boards: Each Islamic financial institution establishes a Sharia Board composed of recognized scholars. They issue fatawa (religious rulings) on the permissibility of products. The composition and independence of these boards critically affect trust in the product.