Sharia law is a religious law that lays down governing principles for spiritual, mental, and physical behavior that must be followed by Muslims. Regarded as God’s command for Muslims, Sharia law is essentially Islam’s legal system.
The four primary sources of Sharia Law are:
The Quran – The Holy Book conveys Allah’s messages relayed by the Prophet, which are universal and eternal in nature.
The Hadith – The Hadith or narrative of the Sunnah of the Prophet constitutes the rules of faith of the Muslim community.
Ijma – Ijma contains the opinions of Islam’s learned scholars on matters of law.
Qiyas – Qiyas is the process of comparing difficult questions of doctrine with similar cases settled by the authority of the Holy Book and Sunnah.
Sharia law is a religious law that lays down governing principles for spiritual, mental, and physical behavior that must be followed by Muslims.
It categorizes all man’s acts into five distinct categories: obligatory, recommended, permitted, discouraged, and forbidden. The giving and receiving of interest (riba), extremely risky investments, gambling, prostitution, and alcohol consumption are prohibited.
The belief that trade is to be conducted in a faithful and beneficial manner and the principle of risk-sharing form the basis of Islamic business.
Intricacies of Sharia Law
Sharia law encompasses legal as well as moral and ethical directives. It characterizes all man’s acts into the following five categories:
Sharia comprises three basic elements:
Aqidah concerns all forms of faith and belief in Allah, held by a Muslim.
Fiqh governs the relationship between man and his Creator (ibadat) and between man and man (muamalat). Political, economic, and social activities fall within the ambit of muamalat. Islamic finance, covered in economic activities, is thus linked with Sharia principles through muamalat.
Akhlaq covers all aspects of a Muslim’s behavior, attitude, and work ethic.
While directives relating to aqidah, ibadah, and akhlaq are fixed and unchangeable, directives of muamalat (including rulings such as contractual law transactions, criminal law, the judiciary, and Islamic finance) which govern the relationship between man and man, may change with the changes in circumstance, custom, time and place.
Fundamental Principles Governing Islamic Banking and Finance
Sharia law encourages Muslims to involve themselves in trade activities. The belief that trade is to be conducted in a faithful and beneficial manner forms the basis of Islamic business.
Trade manipulations and malpractices such as hoarding, black marketing, profiteering, adulteration, etc., are regarded as dishonest trade.
Islamic finance is a method of regulating a financial system that abides by Sharia law. The fundamental principles governing Islamic banking and finance today are as follows:
The giving and receiving of riba (interest or usury paid to depositors and interest charged from fund users) are strictly prohibited in Islam.
Qimar or gambling is strictly prohibited as well as it signifies value attained through no effort, can be addictive and compulsive which may lead to bankruptcy and causes anger and frustration upon losing.
Jahala means ignorance, and Jahala sales are invalid because of information asymmetry affording an unfair advantage to one of the parties involved.
Gharar is defined in Sharia law as risk, or as a transaction equivalent to “a zero-sum game with uncertain payoffs.” Gharar sales are invalid because of the excessive uncertainty and risk involved, which make them similar to gambling.
Halal refers to those acts that are permitted by Allah, for which no restrictions exist. On the other hand, acts that are absolutely prohibited constitute haram. For example, prostitution, gambling, and consumption of alcohol or pork are considered harmful and impure and are declared to be haram.
Main Categories within Islamic Finance
Risk-sharing forms the underlying principle of Islamic banking. The bank shares the risk of an investment with its customers, and the profit is divided among them according to pre-decided terms. The main financial products within Islamic finance are:
Ijara – A leasing agreement where the bank leases an item to a customer for a specific period.
Ijara-wa-Iqtina – Similar to Ijara, except that the customer is able to purchase the leased item at the end of the period.
Mudaraba – Investment products offered by financial experts in which the bank and the customer share all profits.
Murabaha – A form of credit devoid of interest, which allows the customer to make a purchase.
Musharaka – An investment partnership between the bank and the customer with profit-sharing according to a pre-decided contract.
Thank you for reading CFI’s guide to Sharia Law. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: