Appendix

Glossary

Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI): An independent, not-for-profit organization supported by governments, central banks, and financial institutions that ensures that all the participants in the Islamic finance industry conform to certain sets of rules and regulations.

agency functions: Commercial bank activities in which a bank acts as an agent for a customer. These tasks include collecting and paying checks, buying stocks and bonds, and corresponding on behalf of the customer.

Allah: Preferred reference among Muslims for the one true God. The word doesn’t have a gender or a plural form, making it the preferred term for even non-Arabic-speaking Muslims.

amana: A trust deposit. The amana contract is similar to the wadia contract except that the amana trustee isn’t allowed to use the asset given for safekeeping. The trustee is held liable if he is found to be negligent with the asset’s safekeeping. See also wadia

’aqd: Arabic term for contract, which is a transaction between two or more parties regarding a particular matter. Per Islamic commercial law, a valid contract must include six specific elements to take place: offerer, offeree, offer, acceptance, subject matter, and consideration.

audit committee: Members of a bank’s (or any other corporation’s) board of directors who supply information to the board regarding the bank’s financial reporting, disclosures, and risks.

Bank of International Settlements (BIS): An association of government central banks, which interacts with the Islamic Financial Services Board (IFSB).

batil: Arabic term for invalid or void contract.

bay’ al dayn: The sale of debt. One of the most controversial Islamic financial products, bay’ al dayn allows a creditor to sell a debt to a third party, and it’s practiced in the secondary market for sukuk. Some sharia boards allow for this product, and some don’t.

bay’ al-muajil: A deferred payment sale in which a bank buys something on a customer’s behalf and then sells it to the customer, who makes installment payments. The bank makes a predetermined profit agreed upon by both parties.

bay bithaman ajil: A deferred payment sale in which the parties agree upon a price that includes a profit for the seller.

bilateral commercial contract: A commercial contract between two commercial banks in which each party promises to perform an action in exchange for the other party’s action.

branch Islamic bank: A dedicated channel for sharia-compliant products offered through a conventional financial institution.

captive market: For Islamic finance, the people who seek out sharia-compliant products because of their religion and culture.

central bank: A government-established entity that regulates a nation’s money supply, interest rates, and private and government banks. It sets monetary policy for the country and serves as a lender of last resort to banks that have liquidity problems.

compliance: In commercial banks, the pursuit of proper conduct so bank operations and customer service can continue without interruption. Islamic banks add an organizational layer to ensure compliance with sharia as well as all other industry regulations and internal controls.

consecutive musharaka: A standard musharaka contract, in which each partner can keep its share in the partnership consecutively until the very end of the joint venture, project, or business. See also musharaka or musharakah

credit risk: Negative results in a bank’s or other lender’s financial standing because a debtor or obligator defaults.

current account: A checking account. In Islamic banks, money given by a depositor to a current account is considered a loan without expectation of any profit return. The depositor loans the bank money solely for the purpose of safeguarding, usually as part of a wadia or qard hasan contract.

declining balance musharaka: A musharaka contract in which one partner is allowed to buy the other partner’s share of equity step by step until it buys the whole equity of the other partner. See also musharaka or musharakah

demand account: A checking account.

dual banking system: A financial system in which both conventional and Islamic banks are operating, such as in Bahrain, Malaysia, and United Arab Emirates.

family takaful: The Islamic alternative to conventional life and disability insurance. These plans are savings or investment products that have maturity dates and are designed to fulfill the future needs of the policyholders. See also takaful

fasid: Voidable contract.

financial screening: The process of determining whether an equity asset is sharia-compliant by considering a company’s financials (including how much debt the company carries). If a company fails the financial screening, it can’t be included in an Islamic investment fund or other investment product.

fiqh-ul-muamalat: Islamic business law.

five pillars of Islam: The foundational beliefs and obligatory acts of Muslims. The first pillar is the belief that there is one God (Allah), and Allah’s final prophet was Muhammad (pbuh). The second pillar is the action of five daily prayers. The third pillar is zakat: giving to and caring for the needy. The fourth pillar is self-purification through fasting (such as during the holy month of Ramadan.) The fifth pillar is Hajj, which is pilgrimage to the holy city of Mecca (in Saudi Arabia); an able-bodied Muslim must make this pilgrimage at least once in his or her lifetime.

forward contract: A contract based on the execution of a sale on a future date at the current market price.

fully-fledged Islamic bank: A bank that operates as an independent organization whose sole purpose is to provide sharia-compliant products.

general takaful: Takaful products that bear the loss of, or damage to, the policyholder’s assets. See also takaful

gharar: Speculative transactions, which are generally prohibited under sharia. Islamic financial institutions are prohibited from taking part in sales, investments, or other transactions that involve excessive risk or uncertainties (though the definition of excessive is a topic of much debate among sharia boards). See also maysir

Gulf Cooperation Council (GCC): A political and economic union of Arab states bordering the Persian Gulf: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.

hadith: The commands, actions, and speech ascribed to the Prophet Muhammad (pbuh), which have been written down and collected through the centuries and are a source of study for sharia scholars who are charged with interpreting Islamic law.

hiba: A gift. A customer with a qard hasan loan may choose to offer the bank a gift upon repayment of the loan. Likewise, a bank may at its own discretion offer a customer whose money is only being safeguarded by the bank a gift based on the profitability of that customer’s deposited amount.

hiwala: A type of bilateral Islamic contract in which debt is transferred from one debtor to another. After the debt is transferred to the second debtor, the first debtor is free from her obligation.

house owner or householder takaful: An Islamic insurance product that provides coverage for residential buildings and household contents (such as furniture, clothing, home computers, and so on). This product is the Islamic alternative to conventional homeowners and renters insurance. See also takaful

ijab: Arabic term for offer, which (along with acceptance) is a mandatory element of an Islamic contract. See also qabul

ijara or ijarah: A lease or rental contract in which one party pays a fixed price for the use of an item over a fixed period of time while the ownership rights and all the liabilities remain with the owner. These contracts are often used to allow someone to lease a car, home, or office building. (Specific ijara contracts may ensure that the lessee assumes ownership of the item in question at the end of a lease period.)

ijma: Consensus of jurists regarding an issue according to sharia.

ijtihad: The interpretation of Islamic law. Sharia scholars practice ijtihad (the root of which, jihad, literally means struggle) through vigorous efforts to study and understand the Quran and sunnah.

index: Generally, a group of companies that serves as a benchmark against which to judge the performance of the rest of the equity market in a country or a region of the world.

individual takaful: Islamic insurance products that bear costs related to the repair or replacement of an individual’s assets in a sharia-compliant manner. See also takaful

industry screening: The process of determining whether an equity asset is sharia-compliant by considering the type of business conducted. Companies that create any product prohibited by sharia (such as pork or pornography) or conduct any prohibited transactions (such as those involving speculation) are screened out. If a company fails the industry screening, it can’t be included in an Islamic investment fund or other investment product.

internal controls: Policies and procedures adopted within an organization to protect its property and assets.

International Accounting Standards Board (IASB): One of the most recognized international accounting standards organizations, which interacts with the Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI).

Islam: The religion of Muslims, who follow both the word of Allah as presented in the Quran and the example set by the Prophet Muhammad (pbuh), who lived from 570–632. The law of Islam, which governs Muslim conduct in all aspects of life, is called sharia.

Islamic Development Bank (IDB): An international Islamic bank that opened in Saudi Arabia in 1975. The establishment of IDB gave the Islamic finance industry its first international presence and paved the way for the opening of similar banks in other nations.

Islamic finance: A financial system that operates according to Islamic law.

Islamic Financial Services Board (IFSB): An international organization that aims to develop a transparent and regulated Islamic finance services industry by introducing new, sharia-compliant prudential standards. It issues principles and standards in corporate governance, risk management, and capital adequacy.

istihsan: Arabic term for juristic preference, which is considered by Muslims to be a minor source of Islamic law.

istisab: Arabic term for presumption of continuity, which is considered by Muslims to be a minor source of Islamic law.

istisna: A deferred delivery contract that comes into play in financing construction projects. The buyer can pay for the item (all at once or in installments) in advance of receiving it. After the manufacturer begins the item’s production, the contract can’t be canceled. Both parties know exactly what the item will be; no uncertainty can exist.

kafala or kafalah: A guaranteed contract in which a third party accepts an existing obligation and becomes responsible for fulfilling someone’s liability. Islamic banks use kafala contracts to issue guarantees for their business customers.

letter of credit: A document that provides a financial guarantee. When a bank issues a letter of credit (most often to facilitate international trade activities), it provides a written promise to the exporter/seller that the importer/buyer has sufficient funds to make the purchase.

liquidity risk: Negative effects caused by a bank’s inability to meet its obligations.

maqasid al-sharia: Objectives of Islamic law. Maqasid theory explains the different paradigms for Islamic law objectives and describes the evolution of Islamic law, thoughts of various scholars, and more.

market capitalization: The total value of all stocks of a corporation.

market risk: The very real possibility that the value of a security or group of securities can drop on any given day. For banks, market risk represents the negative results that can occur because of foreign exchange and interest rate changes, among other factors.

mawqoof: The Arabic word for suspended (as in a suspended contract).

maysir: Gambling, or betting on uncertainties, with the intention of making a profit. Maysir is closely related to gharar, and both are prohibited by Islamic law. See also gharar

mudaraba or mudarabah: A contract based on a financial partnership in which one party (an investor) gives money to another (a fund manager) for the purpose of investing it in a business or economic activity. The investor puts up all the capital, and the fund manager provides expertise and knowledge to help the activity be successful. Both parties share the profits based on an agreed-upon ratio, but only the investor can lose the initial capital if the activity isn’t successful.

mudaraba muqayyadah: Restricted mudaraba. A type of mudaraba contract in which the investor specifies a particular business or project where the investment funds are to be used; the working partner shouldn’t use the funds for any other business or project. See also mudaraba or mudarabah

mudarib: A fund manager. This party brings expertise and knowledge to the table in a mudaraba contract. See also mudaraba or mudarabah

murabaha or murabahah: A cost plus contract used to finance working capital and assets and to secure letters of credit. Both parties in the contract agree to a sales price that includes a profit for the seller or financer; the profit must be clearly indicated when the agreement is formed. Until the money is paid back (in a one-time payment or over time in deferred installments), the bank owns whatever item is being financed.

musharaka or musharakah: A joint venture contract. All parties invest capital upfront, and all share profit and loss based on an agreed-upon ratio. One party (such as a bank) may be a nonworking investor, meaning that another party (the working partner) would be compensated in the profit ratio for time and expertise contributed to the venture.

muwaada: A bilateral promise that occurs when two parties perform two separate unilateral promises on the same subject or service. See also wa’d

nafiz: The Arabic word for enforceable (as in an enforceable contract).

negotiable Islamic debt certificate (NIDC): An Islamic debt instrument based on the Islamic contract of deferred payment sales. An Islamic bank issues this certificate to a customer as evidence of the debt that the bank owes to the customer.

obligator: For sukuk, the government or corporation that is going to benefit from the bond issuance.

operational risk: Negative results to a bank’s performance because of employee or management negligence.

pbuh: Acronym for peace be upon him. Islamic tradition calls for this phrase to follow each reference to the name of a prophet, such as the Prophet Muhammad (pbuh).

primary markets: Financial markets that deal with new issues of financial instruments such as stocks, bonds, and options.

qabul: Arabic term for acceptance, which (along with offer) is a mandatory element of an Islamic contract. See also ijab

qard hasan or qard al hasan: Interest-free loans; the only type of loans that Islamic banks offer. These loans are given to people in need with an expectation that only the principal will be repaid. Islamic banks offer qard hasan loans to fulfill part of their social responsibility. Current account depositors may also place funds into an Islamic bank based on a qard hasan contract (so the depositor is the lender and the bank is the loan recipient).

qimar: Arabic term for any game of chance in modern gambling.

qiyas: An analogical approach used by Islamic scholars to determine sharia compliance on emerging issues.

Quran or Koran: The religious text that is the basis of Islam; considered by Muslims to be the word of Allah.

rab al mal: An investor. This person brings capital to the table in a mudaraba contract. See also mudaraba or mudarabah

rahn: A collateral or pledge contract in which a property is pledged against an obligation.

retakaful: The Islamic alternative to the reinsurance industry. In retakaful, a takaful company pays another insurer to take on some or all of its liabilities for claims that emerge from its contracts. This way, if a significant number of claims are made in a short period of time, the takaful operator reduces its risk of becoming insolvent. See also takaful

reverse murabaha: See tawarruq or tawruq

riba: The Arabic word for interest or usury. Riba is prohibited under Islamic law.

riba al-fadl: The excess money that arises during an exchange of homogenous commodities in unequal quantities or qualities. Islamic law prohibits this exchange and orders that traders must exchange like for like.

riba al-nasibah: Riba based on money lending; the lender and borrower agree upfront on a fixed amount of money to be paid as a reward for the money lent. Islamic law prohibits such transactions.

salam: An Islamic investment contract in which payment is made in full, upfront, for an asset to be delivered on a specific date in the future. This contract can be used to finance any type of sharia-compliant asset. The buyer must know exactly what he is getting (no uncertainty can exist).

savings takaful plans: Islamic insurance products that are custom designed to meet the specific financial goals of the customer while offering protection against misfortunes. See also takaful

secondary markets: Aftermarkets where previously issued financial instruments (such as stocks, bonds, and options) are traded.

shaih: Valid contract.

sharia or shariah: The Arabic word for path or way; used to refer to Islamic law. Sharia is considered Allah’s law, though interpretations of its primary sources — the Quran and the actions of the Prophet Muhammad (pbuh) — may differ. Sharia governs all aspects of a Muslim’s life — from business and justice to prayer, pilgrimages, and lifestyle decisions.

sharia boards: Religious boards, steeped in knowledge of Islam, that use such knowledge to determine whether products offered by financial institutions comply with Islamic principles. (If the products don’t comply, they aren’t offered.) These boards also supervise day-to-day operations of Islamic institutions to ensure compliance with Islamic principles.

sharia governance: A critical element of corporate governance for Islamic institutions that refers to any organizational arrangements and policies through which the firm ensures that it’s sharia-compliant.

socially responsible investing (SRI): A term that refers to making investment choices in support of companies whose activities mesh with a certain set of values and avoiding those that don’t.

Special Purpose Vehicle (SPV): For sukuk, the middleman between the obligator and the investors. The SPV is a separate legal entity created to transfer ownership of the asset, project, or business on which the sukuk are based (because transferring the ownership directly to the individual sukuk holders is impossible). An SPV takes legal ownership of the assets and manages them. See also sukuk; obligator

subsidiary Islamic bank: An Islamic bank formed by an existing conventional financial institution as a separate legal entity. It’s managed independently from the parent company but adheres to the parent company’s strategies.

sukuk: The Islamic alternative to bonds, which are used to transfer money between an investor and a government or company that needs money for projects and asset acquisitions. A sukuk certificate describes ownership or interest in an asset or pool of assets. The sukuk gives the holder the proportionate beneficial ownership of that asset along with the associated risk and potential return of cash flow.

sunnah: The Arabic word for habit. In Islam, this term refers to the overall tradition of the Prophet Muhammad (pbuh) — his every teaching, including his lifestyle and mannerisms. Muslims revere the Prophet as the best example of sharia in action.

takaful: This Arabic word translates to guaranteeing each other. Takaful is the Islamic alternative to conventional insurance. Takaful products involve a mutual risk-sharing arrangement among multiple parties based on the principles of cooperation, social solidarity, and mutual indemnification of members.

takaful operator: A limited liability company (funded by shareholders) that manages a takaful fund. See also takaful

tawarruq or tawruq: A (somewhat controversial) reverse murabaha contract that allows a buyer to purchase an item with deferred payments. The buyer immediately sells the item in order to get money to pay for it. See also murabaha or murabahah

time deposit: A certificate of deposit or savings account with a fixed term.

underwriter: For sukuk, a large financial institution (a bank, insurer, or investment house) that conducts the bond issuance. The underwriter offers insurance to the sukuk issuer that it will purchase any bonds that investors don’t buy. See also sukuk

unilateral commercial contract: A commercial banking contract in which one bank promises to pay another bank for a transaction.

urf: This Arabic word means to know and refers to making decisions based on a society’s customs and practices (as long as those customs and practices don’t go against anything explicit in the Quran and sunnah). Muslims consider urf to be among the minor sources of Islamic law.

wa’d: A unilateral promise, meaning that one party binds itself to perform (or not perform) a function in the future.

wadia or wadiah: A contract between a bank and a customer for purposes of keeping the customer’s money safe. In practice, it’s the Islamic version of a checking account that pays no interest. The account holder’s deposit is guaranteed, and he’s allowed to withdraw the money without any limitations.

wakala or wakalah: A contract in which one entity works as an agent for another. In the effort to manage its liquidity, for example, one bank deposits funds in another bank, and the second bank invests them in a sharia-compliant manner.

wakil: An agent who acts on someone else’s behalf in a wakala contract. See also wakala or wakalah

window Islamic bank model: A setup in which a conventional financial institution carries out Islamic financial activities by assuring its clients that Islamic operations are segregated from the conventional services. This model is used by conventional banks that haven’t converted solely to Islamic financial services.

zakat: A religious obligation or tax (one of the five pillars of Islam) that requires wealthy Muslims to give a share of their riches to the needy.

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