Modes of Finance

Islamic scholars agree there are several modes of finance that are deemed to be in accordance with Shariah Law. Two of the most common are:

Ijara: This form of financing is basically a lease. It involves a financier or financial institution purchasing an item the client is interested in and then leasing it to them over a fixed period of time at a previously agreed price. Throughout the period of the lease the financier or financial institution retain ownership of the item.

Ijara wa Iqtina are leasing contracts used for a longer period of lease, and contain an option for the client to purchase the item at the end of the period.

Ijara forms of financing can be used for goods such as cars etc. In the case of mortgages, the bank purchases the property a client is interested in and then leases it to the client. The client makes regular payments to the bank towards the original cost of the property, as well as regular rental payments for living in the property. This rent is in no way seen as riba but as an acceptable payment for use of the property. The house remains the property of the bank until the final instalment is paid when ownership is transferred to the client.

Musharaka: This is based on a "shared ownership" principle. In this instance both parties are supposed to supply working capital. In the case of mortgages, the bank buys the property a client is interested in and leases it to the client similar to an Ijara contract. The difference is in the "shared ownership" concept. The first instalment paid by the client is taken to be an initial share of the property.

Under 'diminishing' Musharaka agreements, every instalment paid by the client is deemed to increase their share of the asset until they own 100 per cent.