What are the basic principles or laws of Islamic banking?

There are at least six fundamental principles which are taken into consideration while executing every Islamic banking transaction. These principles distinguish a financial transaction from a Riba/interest based transaction to an Islamic banking transaction.

1.     1. Sanctity of contract:

Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the views of Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or voidable. An invalid contract is a contract, which by virtue of its nature is invalid according to Shariah rulings. Whereas, a voidable contract is a contract, which by nature is valid, but some invalid components are added in the valid contract. Unless these invalid components are eliminated from the valid contract, the contract will remain voidable.

2.      2. Risk sharing:

Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkhiraj Biddamaan 21 ” and “Alghunun Bilghurum22”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit. Thus in every Islamic banking transaction, the Islamic financial institution and/or its deposit holder take(s) the risk of ownership of the tangible asset, real services or capital before earning any profit there from.

3.     3.  No Riba/interest:

Islamic banks cannot involve in riba/interest related transactions. They cannot lend money to earn additional amount on it. However as stated in point No. 2 above, it earns profit by taking risk of tangible assets, real services or capital and passes on this profit/loss to its deposit holders who also take the risk of their capital.

4.     4.  Economic purpose/activity:

Every Islamic banking transaction has certain economic purpose/activity. Further, Islamic banking transactions are backed by tangible asset or real service.

5.    5. Fairness:

Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.

6.    6.   No invalid subject matter:

While executing an Islamic banking transaction, it is ensured that no invalid subject matter or activity is financed by the Islamic financial transaction. Some subject matter or activities may be allowed by the law of the land but if the same are not allowed by Shariah, these can not be financed by an Islamic bank.