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Islamic Finance: Principles and Basics

By Zimaam Zayn

Introduction:

Over the past few decades, Muslims have sought to align finance with Islamic principles. Some believe removing interest makes finance charitable, but profit can still be earned within an Islamic framework.

Profit Without Interest

Excluding interest does not prevent financiers from earning profit. Islamic finance provides ethical alternatives that ensure commercial viability.

Islamic Finance vs. Capitalism

Islam acknowledges market economies but imposes ethical guidelines. In capitalism, unchecked profit motives allow interest, gambling, and speculative transactions, concentrating wealth among a few and distorting market forces.

Asset-Backed Finance

Islamic finance is always tied to real assets, unlike conventional finance, which deals mainly in money. Money itself has no intrinsic value and is merely a medium of exchange. Profit arises from transactions involving real goods or services.

Islamic Finance Methods

Risk Sharing in Islamic Finance

Unlike interest-based loans, where the lender has no concern for how funds are used, Islamic finance involves risk-sharing, in Musharakah and Mudarabah - Funds and Labour are at risk and in Murabahah and Ijarah:

Capital & Entrepreneurship

Capitalism separates capital providers and entrepreneurs—one earns interest, while the other takes risks. Islam integrates them: anyone investing funds becomes a participant in the business and shares in its profits.

Challenges in Islamic Finance

Critics argue that Islamic finance has not brought major change. However:

Despite these challenges, Islamic finance continues to grow as more people recognize its ethical and economic benefits.

Musharakah

Musharakah, meaning "sharing" in Arabic, refers to a joint enterprise where partners share profits and losses. Unlike interest-based financing, where a fixed return is predetermined, musharakah distributes profits based on actual earnings.

Conventional vs. Islamic Financing

In conventional systems, industrialists may contribute only 10% of a project’s capital, while depositors provide 90%. Despite this, the industrialist reaps most of the profits, leaving depositors with a small return. Islamic finance requires financiers to either provide loans as humanitarian aid or share in both profits and losses.

Types of Musharakah (Shirkah)

Musharakah typically refers to Shirkat-ul-Amwal, where two or more parties invest capital in a joint commercial venture.

Basic Rules of Musharakah

Profit and Loss Sharing

Nature of Capital

Management of Musharakah

By default, all partners have the right to manage. Partners may agree that only one manages, making others sleeping partners, who are entitled to profit only in proportion to their investment.

Termination of Musharakah:

Termination Of Musharakah Without Closing Business:

If one of the partners wants to terminate the musharakah while others wish to continue, they may purchase the leaving partner’s share by mutual agreement. The share’s price must be determined by consent. If there is a dispute, the leaving partner may compel liquidation or distribution.

A condition can be agreed upon at the beginning of the musharakah that liquidation or separation will not occur unless all or a majority of partners agree. A single partner wishing to exit must sell their share to other partners and cannot force liquidation. Hanbali jurists permit this. (See Al-Insaf - Al-Mardavi)

MUDARABAH:

Mudarabah is a special partnership where one partner (rabb-ul-mal) provides capital, and the other (mudarib) manages the business.

A rabb-ul-mal can contract mudarabah with multiple mudaribs through a single transaction, and they will jointly use the capital. The mudarib’s share is divided among them as agreed. (Al-Mughni 5:145)

Differences Between Musharakah and Mudarabah:

Distribution of Profit:

The profit-sharing ratio must be agreed upon at the start, with no fixed proportion required by Shari‘ah. Different ratios may be set for different situations. Apart from profit-sharing, the mudarib cannot claim a salary or fee. All Islamic Fiqh schools agree on this, though Imam Ahmad allows the mudarib to cover daily food expenses from the mudarabah account. (Al-Mughni, 5:186)

If the business incurs a loss but gains profit in another transaction, the profit first covers the loss, and any remaining amount is shared between the parties. (Al-Mughni, 5:168)

Termination Of Mudarabah:

Either party can terminate the mudarabah at any time by giving notice. If assets are in cash and profit is earned, it is distributed. If assets are not in cash, the mudarib is given time to sell and liquidate them.

Hanafi and Hanbali schools allow setting a fixed term (e.g., six months or one year) for mudarabah, after which it ends automatically. However, this is optional and not mandatory.

Either party can end the contract at any time, but early termination by the rabb-ul-mal may harm the project, especially in its initial stages.

Partners can agree not to terminate mudarabah for a specific period unless certain conditions arise. This does not contradict Shari‘ah principles.

MUSHARAKAH & MUDARABAH AS MODES OF FINANCE:

Musharakah and mudarabah are traditionally used for joint ventures where all partners participate from inception until closure. However, they can also finance running businesses if applied correctly.

Key principles:

Project Financing:

Musharakah and mudarabah can be used for project financing. If the financier funds the entire project, mudarabah applies. If both parties invest, musharakah is used, with one party managing the business.

If the financier wishes to exit, the other party can buy out their share at an agreed price or bring in a new investor.

SECURITIZATION OF MUSHARAKAH:

Musharakah is useful for large projects needing substantial funds. Investors receive musharakah certificates representing their ownership share in the assets. Once the project acquires significant non-liquid assets, these certificates can be traded in the secondary market. However, trading is not permitted when all assets remain liquid.

Musharakah certificates represent direct pro rata ownership in project assets. When funds are used to acquire non-liquid assets like land, buildings, or machinery, certificate holders proportionately own these assets. If assets are a mix of liquid and non-liquid, Shafi’i scholars restrict trading, whereas Hanafi scholars allow trading if the liquid portion is minor.

Financing on Single Transaction:

Musharakah and mudarabah can also be applied to individual transactions. For instance, an importer may seek financing for a single trade, where ownership of goods is shared based on investment ratio. Similarly, in export financing, where the sale price is predetermined, expected profits can be estimated. The financier may require the exporter to handle logistics, absolving them from potential loss.

Financing on Working Capital:

Business capital can be evaluated with mutual consent, treating the financier’s investment as a proportionate ownership share. At the end of the term, a reassessment of all liquid and non-liquid assets determines profit distribution. Though traditional principles require liquidation to determine profit, mutual consent allows asset valuation as a “constructive liquidation.”

Sharing in the Gross Profit Only:

Industries with large fixed assets face difficulties in profit calculation due to indirect expenses like depreciation and salaries. Instead of net profit, gross profit can be distributed, with adjustments in the financier’s profit share to compensate for the use of machinery, buildings, and staff.

The client may also charge an agreed rent for using their assets, independent of profit or loss. Alternatively, the financier’s profit ratio may be increased instead of paying rent, an approach justified by Imam Ahmad ibn Hanbal’s analogy.

Running Musharakah Account on the Basis of Daily Products:

Many financial institutions finance working capital by maintaining a running account. Debits and credits continue up to the maturity date. A suggested approach for musharakah or mudarabah financing includes:

Diminishing Musharakah:

Diminishing musharakah involves a financier’s share being divided into units, which the client purchases periodically until full ownership is transferred.

Steps for House Financing Based on Diminishing Musharakah:

  1. Creating joint ownership (Shirkat-al-Milk).
  2. Renting the financier’s share to the client.
  3. The client promises to purchase the financier’s share units over time.
  4. The client gradually purchases the units.
  5. Rental adjustments based on the financier’s remaining share.

Diminishing Musharakah for Service Businesses:

For example, purchasing a taxi for hire under diminishing musharakah follows the same steps. However, depreciation must be considered when determining unit prices.

Diminishing Musharakah in Trade

Diminishing Musharakah is a partnership where two partners invest different amounts in a business. Over time, the client buys the financier's share in the partnership. However, the price of these shares cannot be fixed in advance, as that would guarantee the financier’s capital, which is not allowed in Musharakah.

The financier has two ways to price the units:

Although both methods are allowed under Shari'ah, the second option is impractical. If the client sells shares to someone else, it could bring in new partners, making it harder for the financier to get back their investment. For this reason, the first option is the preferred choice in Diminishing Musharakah.

Murabahah (Cost-Plus Sale)

Murabahah is a common Islamic financing method where the seller discloses the cost of a product and adds a fixed profit margin. The key difference from other sales is transparency—both the cost and profit are clearly stated.

If the seller does not disclose the cost and only sets a final price, the sale is called Musawamah (negotiation or bargaining), not Murabahah.

Basic Rules of Sale

Bai Mu'ajjal (Deferred Payment Sale)

Bai Mu'ajjal is a sale where payment is delayed.

Murabahah as a Financing Method

Murabahah was originally not meant as a financing tool but is now used to replace interest-based loans in an Islamic way.

Conditions for Murabahah Financing:

A financial institution can use Murabahah for financing by following these steps:

  1. Agreement – The institution and client sign a general agreement where the institution agrees to sell and the client agrees to buy commodities with an agreed profit margin.
  2. Agency Appointment – When the client needs a specific commodity, the institution appoints the client as its agent to purchase it.
  3. Purchase on Behalf of Institution – The client buys the commodity on behalf of the institution and takes possession as its agent.
  4. Offer to Purchase – The client informs the institution and offers to buy the commodity from the institution.
  5. Sale Conclusion – The institution accepts the offer, and the sale is finalized.

Important Condition: The commodity must be bought from a third party. A 'buy-back' agreement, where the institution purchases the commodity from the client, is not allowed under Shari’ah, as it resembles an interest-based transaction.

Issues in Murabahah

Different Pricing for Cash and Credit Sales

The financier buys the commodity with cash and sells it on credit, adjusting the price based on the payment period.

Longer payment terms result in a higher price, making Murabahah-based sales more expensive than cash market prices.

Since Islam treats money and commodities differently, this markup is not considered interest.

Using Interest-Rate as Benchmark

Many financial institutions determine Murabahah profit using interest-rate benchmarks like LIBOR.

While not ideal, this practice is still used due to market conditions.

Islamic finance institutions should move away from this model to develop interest-free financial mechanisms.

Promise to Purchase

If the client is not obligated to buy the commodity after the financier has purchased it, the financier risks losses.

To mitigate this risk, Murabahah contracts often include a binding promise from the client to buy the commodity after the financier acquires it.

The Legal Status of a Promise in Murabahah

The fuqaha’ (Muslim jurists) have different views on the subject:

The Qur’an emphasizes fulfilling promises: "And fulfill the covenant. Surely, the covenant will be asked about (in the Hereafter)." (Bani Isra’il: 34)

Imam Abu Bakr al-Jassas states that this verse implies that if one undertakes a commitment, it becomes obligatory. (Ahkam al-Qur’an, 3:420)

The Islamic Fiqh Academy (Jeddah) ruled that commercial promises are binding if:

If the promisor backs out, the court can force them to purchase the commodity or pay actual damages, but not opportunity costs. (Resolution no. 2 and 3, Fifth Conference, Kuwait, 1409 AH)

Securities Against Murabahah Price

Since Murabahah is a deferred payment sale, financiers require security to ensure payment. The security can be:

According to the Hanafi School, security must be explicitly agreed upon. The Shafi’i and Hanbali jurists rule that if a pledged asset is damaged due to negligence, the mortgagee bears the loss. Otherwise, the purchaser is responsible and must pay the full price. (Al-Mughni, 4:442)

Guaranteeing the Murabahah

In murabahah financing, the seller can require the purchaser to provide a third-party guarantee. If the purchaser defaults, the guarantor becomes liable for the payment. However, in modern commercial settings, guarantors often charge a fee, whereas classical fiqh unanimously considers guarantees a voluntary service that cannot be monetized. Finding free guarantors is challenging, so some contemporary scholars argue that this prohibition is not directly from the Qur’an or Sunnah but rather derived from the prohibition of riba.

Penalty for Default

If a client fails to pay on time, the price cannot be increased. Once fixed, the murabahah price remains unchanged. Some clients exploit this rule by intentionally delaying payments. To address this, scholars suggest a compensation method tied to the bank’s profit distribution:

The Prophet ﷺ condemned unjustified delays in payment, stating: “The well-off person who delays payment subjects himself to punishment and disgrace.” (Sahih al-Bukhari, hadith no. 2400). However, Imam al-Shafi’i held that while rent for usurped land must be paid, money usurped is returned as is, indicating that opportunity cost is not recognized in Islamic law.

Alternative Approach

Instead of charging a penalty as income, the client can pledge to donate a specified amount to a charitable fund if they default. This fund, maintained by the bank, is used solely for charitable purposes. Since this is a self-imposed commitment rather than a financier-imposed penalty, it is legally enforceable. The penalty clause should follow this format:

"The client hereby undertakes that if he defaults in payment of any of his dues under this agreement, he shall pay to the charitable account/fund maintained by the Bank/Financier a sum calculated at ...% per annum for each day of default, unless he provides satisfactory evidence that non-payment was due to poverty or factors beyond his control." (From Taqi Usmani Ustad's Book)

No Roll Over in Murabahah

In conventional finance, if a client cannot pay on time, the bank may extend the facility under new terms. However, murabahah is a sale, not a loan, so the seller can only claim the agreed price. The same commodity cannot be resold between the same parties.

Rebate on Early Payment

If a debtor wishes to repay early, they may seek a discount. Most jurists, including the four major schools, prohibit making this a contractual condition (Al-Mughni, 4:174–75).

Some scholars permit it, citing a hadith where the Prophet ﷺ said: “Give a discount and receive (your debts) soon.” (Al-Sunan al-Kubra, 6:28). However, the majority reject this hadith as weak, with even Imam al-Baihaqi acknowledging its unreliability. The Islamic Fiqh Academy also prohibits this (Resolution no. 66, VIth Session, Jeddah).

Thus, in murabahah financing, rebates cannot be contractually stipulated, but if the bank voluntarily grants a rebate—especially for needy clients—it is permissible.

Rescheduling Payments in Murabahah

If a client cannot pay on time, they may request rescheduling. Unlike conventional banks, which charge additional interest, Islamic banks cannot increase the amount. The murabahah price remains the same in the original currency.

Some clients misuse murabahah agreements to obtain funds without genuine purchases. To ensure the legitimacy of transactions:

Ijarah (Islamic Leasing)

Definition:

"Ijarah" is an Islamic fiqh term that lexically means "to give something on rent." In jurisprudence, it applies to two situations:

For Islamic banking, the second type—leasing of assets—is more relevant as both an investment and financing tool. Leasing is similar to a sale, except that ownership of the leased asset remains with the lessor, while only its usufruct is transferred to the lessee.

Basic Rules of Leasing (Ijarah)

Lease as a Mode of Financing

Like Murabahah, leasing (Ijarah) is not originally intended as a mode of financing. It is primarily a transaction for transferring the usufruct of an asset from one party to another for an agreed period in exchange for rent. However, in modern Islamic finance, leasing has been adapted as a structured financial tool while adhering to Shari‘ah principles.

Key Aspects of Ijarah in Financing

  • Commencement of Lease:
    • Unlike a sale contract, an Ijarah agreement can be made for a future date.
    • While forward sales are prohibited in Shari‘ah, a lease agreement for a future date is allowed, provided that rent is payable only after the lessee has received the asset.
  • Different Relationship at Different Stages:
    • Before delivery, the relationship between the parties is that of a principal (lessor) and agent (lessee).
    • Once the lessee takes delivery, the lease contract becomes effective, and the relationship shifts to that of a lessor and lessee.
    • These two stages must not be confused or mixed.
  • Ownership-Related Expenses:
    • Since the lessor owns the asset, they are responsible for all costs incurred during its purchase and transportation, such as freight and customs duties.
  • Liability of the Parties:
    • The lessee is liable for damages resulting from misuse or negligence.
    • The lessee is also responsible for normal wear and tear during usage.
    • However, losses caused by factors beyond the lessee’s control must be borne by the lessor.
  • Variable Rentals in Long-Term Leases:
    • Fixing a single rental amount for long-term leases may not be beneficial due to changing market conditions.
    • Then lessor has two options:
      • (a) Set a predetermined rental increase (e.g., 5%) at specified intervals (e.g., annually).
      • (b) Enter into a short-term lease with the possibility of renewal at new terms.
  • Penalty for Late Payment of Rent:
    • In conventional financial leases, penalties for late payments often increase the lessor’s income, which is not permissible in Shari‘ah.
    • Instead, the lessee may undertake to pay a penalty that will be donated to charity if they delay payment.
  • Termination of Lease:
    • If the lessee violates any lease terms, the lessor has the unilateral right to terminate the contract.
    • If no violation occurs, the lease can only be terminated with mutual consent.
  • Insurance of Assets:
    • If the leased asset is insured under Takaful (Islamic insurance), the cost must be borne by the lessor.
  • Post-Lease Asset Ownership:
    • The asset remains the property of the lessor after the lease ends. If the lessee wishes to retain control of the asset, they cannot demand compensation for giving it up. Shari‘ah prohibits linking two separate transactions as a pre-condition (e.g., making lease termination conditional upon payment). The lessor may either reclaim the asset or renew the lease at the end of the contract.
  • Sub-Leasing:
    • If an asset is suitable for multiple types of usage, the lessee cannot sub-lease it to another party without explicit permission from the lessor.
  • Assigning the Lease:
    • The lessor has the right to sell the leased asset to a third party. Upon sale, the new owner steps into the role of the lessor, and the relationship of lessor-lessee transfers accordingly.

    • Head-Lease:

    In modern leasing, head-leasing is a concept where a lessee sub-leases the property to multiple sub-lessees. The lessee then invites others to invest in these sub-leases, charging a fee for participation in rental income. This arrangement is not compliant with Shari‘ah because the lessee does not own the asset or its usufruct after sub-leasing it.

    Salam and Istisna’ as Modes of Sale and Financing

    General Rule for Sales in Shari‘ah:

    For a sale to be valid in Shari‘ah, three key conditions must be met:

    However, Shari‘ah allows two exceptions: Salam and Istisna’.

    1) Salam (Forward Sale with Advance Payment)

    Salam is a sale where the seller commits to delivering a specific commodity at a future date, while the buyer pays the full price upfront. This was permitted by the Prophet ﷺ to assist farmers and traders needing capital but unable to take interest-based loans.

    Conditions for Salam:

    Salam as a Mode of Financing:

    Salam serves as a financing tool for small farmers and traders. The price in Salam contracts is usually lower than the spot market price, allowing financial institutions to earn a profit. The seller may be required to provide a security or guarantee to ensure timely delivery.

    Ways Financial Institutions Benefit from Salam:

    Rules of Parallel Salam:

    2) Istisna’ (Manufacturing Contract)

    Istisna’ refers to a contract where a purchaser orders the manufacturing of a specified item at an agreed price. The manufacturer is under a moral obligation to produce the item, but the contract remains cancellable until manufacturing begins but a prior notice is given. (Radd al-Muhtar, 5:223)

    Differences Between Istisna’ and Salam:

    Right to Reject Goods in Istisna’

    According to Imam Abu Hanifah, the buyer retains the option of seeing (khiyar-ur-ru’yah), meaning they can reject the goods upon inspection. Imam Abu Yusuf disagrees, ruling that if the manufactured goods meet the agreed specifications, the buyer is obligated to accept them.

    Delivery Timing in Istisna’

    While setting a delivery time is not mandatory, the buyer may impose a maximum delivery period. If the manufacturer exceeds this period, the buyer is not obligated to accept the goods.

    Istisna’ as a Mode of Financing

    One of the most significant applications of Istisna’ is in the housing finance sector. If a client already owns land and requires financing for the construction of a house, the financier may agree to construct the house on that land under an Istisna’ contract. If the client does not own land and wishes to acquire both land and a house, the financier may undertake to provide a fully constructed house on a specified piece of land.

    Since Istisna’ does not require the price to be paid in advance or at the time of delivery (Sharh al-Majallah, 2:40), the payment schedule can be structured flexibly. It can be agreed upon in lump sum or installments. Additionally, the financier is not required to construct the house personally. Instead, they can enter into a parallel Istisna’ contract with a third-party contractor to fulfill the construction obligation.

    Islamic Investment Funds

    An Islamic Investment Fund is a collective investment pool where investors contribute surplus capital for Shari‘ah-compliant investments with the goal of earning halal profits.

    The key distinguishing features of Islamic investment funds are:

    Equity Funds in Islamic Finance

    Equity funds invest in the shares of joint stock companies, generating profits through capital gains and dividends.

    Shari‘ah Compliance in Stock Investments

    Islamic scholars generally agree that a company’s shares can be traded if:

    However, some companies mix halal and haram elements, such as keeping surplus funds in interest-bearing accounts or investing in interest-based securities.

    Scholarly Debate on Mixed-Income Companies

    Conditions for Investment in Shares

    Islamic Equity Funds

    Based on these conditions, Shari‘ah-compliant share trading is permissible, allowing for the establishment of Islamic Equity Funds. Subscribers to such funds are treated as partners, and their pooled capital is invested in compliant stocks. Profits are generated either through:

    Purification Process

    Any earnings from non-permissible sources (e.g., bank interest) must be removed through purification. Scholars differ on whether capital gains from stock trading require purification:

    Fund Management Structures

    Other Types of Islamic Investment Funds

    1. Ijarah Fund (Leasing Fund)

    Uses pooled investments to acquire assets like real estate, vehicles, or machinery for leasing. Fund subscribers receive sukuk (certificates) representing proportional ownership in leased assets. Rental income is distributed among investors.

    Key Shari‘ah Rules for Ijarah Funds:

    2. Commodity Fund

    Investments are used to purchase and resell commodities for profit. Income is distributed proportionally among investors.

    Shari‘ah Compliance Requirements:

    Futures trading in conventional commodity markets does not comply with these conditions, making it impermissible for an Islamic Commodity Fund.

    3. Murabahah Fund

    Uses cost-plus financing (Murabahah) to buy goods and sell them at a markup. Customers purchase goods from the fund on a deferred payment basis. This model is widely used by Islamic banks. Murabahah Fund Must Be a Closed-End Fund so its units cannot be traded in secondary markets.

    4. Bai‘ al-Dayn (Debt Trading) – Prohibited

    Bai‘ al-dayn (sale of debt at a discount) is strictly prohibited in Shari‘ah. If someone has a receivable debt and sells it at a discount (e.g., bill of exchange trading), it falls under riba (interest).

    Rationale for Prohibition:

    A debt is equivalent to money in Shari‘ah. Selling money for a different amount (e.g., $100 for $90) is riba and is not allowed.

    5. Mixed Fund

    Diversified investments: Includes equities, leasing, commodities, etc. If liquid assets (cash, receivables, etc.) exceed 50%, its units cannot be traded per the majority of contemporary scholars. In such a case, the fund must be closed-end.

    The Principles of Limited Liability

    The concept of limited liability has become an essential element of large-scale trade and industry. In modern economic and legal terminology, limited liability refers to a condition where a partner or shareholder of a business is protected from bearing losses beyond the amount they have invested in a company or partnership with limited liability. If the business incurs losses, a shareholder's maximum loss is restricted to their original investment, and their personal assets remain unaffected.

    The primary objective of introducing this principle was to encourage investment by assuring investors that their personal wealth would not be at risk. If a limited company’s liabilities exceed its assets, leading to insolvency and liquidation, creditors may lose part of their claims since they can only recover from the liquidated assets and have no recourse to shareholders for the remaining claims.

    Limited Liability and the Concept of Juridical Personality

    The concept of limited liability is closely linked to the juridical personality of modern corporate entities. According to this concept, a joint-stock company is recognized as a separate legal entity, distinct from its individual shareholders. This fictive entity has legal rights and obligations similar to a natural person.

    A fundamental question arises: is the concept of a juridical person acceptable in Shari‘ah? If a company, as a juridical person, possesses rights and obligations akin to a natural person, then the same principle applies upon its insolvency. The liquidation of a company is analogous to the death of an individual. Just as a deceased insolvent person’s creditors may suffer losses, the creditors of an insolvent company may also experience losses upon its liquidation.

    Although classical Islamic Fiqh does not explicitly discuss the modern concept of juridical personality, there are precedents from which it may be inferred:

    1. Waqf

    A Waqf is a legal and religious institution where an individual dedicates property for a religious or charitable purpose. Once declared as Waqf, the property no longer belongs to the donor, nor do the beneficiaries own it; rather, its ownership vests in Allah.

    Key legal principles from Waqf include:

    2. Baitul-Mal

    The Baitul-Mal (Islamic state treasury) is another example of a juridical person. Although all citizens have beneficial rights over it, no individual owns it. Nevertheless, Baitul-Mal has independent rights and obligations. Imam Al-Sarakhsi states in Al-Mabsut (14:33) that Baitul-Mal possesses both rights and obligations.

    3. Joint Stock in Islamic Jurisprudence

    Imam Shafi‘i's Fiqh provides an example akin to a juridical person in joint-stock companies. In a partnership where assets are combined, zakah is levied on the entire joint-stock rather than individual partners. This principle (Khultah-al-Shuyu’) also applies to zakah on livestock and is partially accepted by the Maliki and Hanbali schools.

    4. Inheritance Under Debt

    If a deceased person’s liabilities exceed their estate, the estate is treated as an independent entity until debts are settled. Jurists confirm that such an estate neither belongs to the deceased, their heirs, nor the creditors. This treatment mirrors the concept of a juridical person since the estate holds legal standing until debts are cleared.

    5. Limited Liability in the Case of Slaves

    The closest analogy to modern limited liability is found in the historical institution of slavery. A slave permitted to trade (mudabbar) operated with capital provided by their master. The master owned all profits and capital, yet if the slave incurred debts, creditors could only claim from the slave’s stock and cash or, ultimately, by selling the slave. If debts remained unpaid even after the slave’s death, creditors had no claim on the master’s personal assets.

    This principle closely resembles limited liability in joint-stock companies, where an investor’s liability is restricted to their investment, and creditors cannot claim beyond the corporate assets.

    Limitations on the Application of Limited Liability in Islam

    While limited liability is supported by Islamic precedents, it must not be used to deceive creditors or evade legitimate financial responsibilities. Therefore, its application should be restricted:

    By maintaining these restrictions, Shari‘ah ensures that the concept of limited liability does not become a tool for unethical financial practices while still enabling business growth and investment.

    Conclusion:

    Islamic Financing is a very vast topic we tried to present to you a very brief understanding. Most of the work was derived from Ustad Taqi Usmani's book Introduction To Islamic Finance: Read the Highlighted Book Here

    Stay Safe. Allahhafiz!

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