A beginner’s guide to the concept and principles of Islamic finance
Malaysia has been at the forefront of Islamic finance for over a decade, topping the Islamic Finance Development Indicator (IFDI) once again in 2024, making it a remarkable 12 times in a row. Islamic finance is more than just a financial system – it is a way of conducting transactions that is both ethical and transparent, and in compliance with Islamic principles.
At its core, Islamic finance is built on fairness, shared risk, and the avoidance of exploitative practices. It is a system not just for Muslims but for anyone who values ethical financial practices.
In this entry, we’ll break down the basics of Islamic finance, its key principles, and financial tools, with a special focus on Takaful, the Islamic alternative to conventional insurance.
Key Principles of Islamic Finance
At its heart, Islamic finance is guided by a few key principles that set it apart from conventional finance. Here are the main principles:
1. Prohibition of Riba (interest): Contracts must be clear, with no hidden risks or uncertainty. This means no speculative gambling on markets or investments with unclear outcomes.
2. Fair and transparent transactions: Contracts must be clear, with no hidden risks or ambiguity. This means no speculative gambling on markets or investments with unclear outcomes.
3. Emphasis on risk-sharing: Unlike conventional finance, Islamic finance promotes partnerships where profits and losses are shared fairly, thus creating a more balanced and just financial ecosystem.
4. Avoid the sin industry: Involvement in haram industries such as alcohol, gambling, or tobacco is prohibited. Instead, investments should have social benefits in ethical and meaningful ways.
Common Islamic Finance Tools
To comply with Shariah, Islamic finance has developed unique alternatives to conventional banking products:
Murabaha: A cost-plus financing structure where the seller transparently discloses both the original cost of an asset and a predetermined profit margin. The markup is transparent, avoiding uncertainty and exploitation of interest-based loans.
Mudarabah: A profit-sharing partnership where one party provides capital and the other provides expertise. Profits are split according to the pre-agreed ratio, while losses are typically borne by the investor. This model is often used in Islamic banking and investment funds.
Sukuk: Sukuk refers to Shariah-compliant certificates that represent (partial) ownership of an asset, project, or business. Unlike conventional bonds that pay interest (riba), sukuk generates returns through profit-sharing (Mudarabah), rental income (ijarah), or other approved Shariah contractual agreements.
Ijarah: A leasing or rental contract where one party leases a tangible asset to another party for an agreed period of time and at an agreed rental price. Ownership may transfer at the end of the lease term.
Takaful: Shariah-compliant alternative to conventional insurance.
What is takaful?
Takaful is an ethical, community-based protection that operates as a cooperative system. There are two main types of takaful:
- Family takaful: Covers life, health, and education
- General takaful: Covers property, motor, and business risks
Takaful participants contribute to a shared pool of funds, which is then used to support any member of the group who faces a loss or hardship. Any surplus after claims and expenses is either returned to participants or donated to charity.
A takaful operator such as Ouch! manages the funds in Shariah-compliant ways, ensuring not just financial protection but also contributing to a system that benefits everyone involved. There are also no hidden profits or exploitative practices. Takaful is a way to protect yourself and your family while staying true to ethical financial principles.
Final Thoughts
Islamic finance is not just a niche concept—it is a rapidly growing USD5 trillion global industry with financial solutions that appeal to anyone seeking ethical financial options. And with tools like Takaful, you no longer have to compromise your values for financial security.
Find out more about Pusara Pro by clicking here or download the Ouch! Takaful mobile app from the Google Play Store or Apple App Store today.
Disclaimer: The information in our blog articles and provided by our brand ambassadors/KOLs is for general insights only and not legally binding. We strive for accuracy but cannot guarantee the information’s completeness or reliability. For legal matters, consult official documents or contact an authorised Ouch! representative.