An increasing number of individuals and banks have become curious about Islamic finance and how it is conducted in America. The author provides helpful background and tells where services can be found in New England.Finance (Islamic law)

Murtha Cullina

Umar F. Moghul

English

Research Papers in Economics

Summer  2006 10
ontemporary Islamic
finance is a burgeon-
ing subsector of inter-
national finance markets. To properly
understand it, one must first under-
stand that the rules of trade and
finance are part and parcel of the reli-
gion by which Muslims conduct their
lives and order their finances and
businesses. Although no conclusive
data are yet available—a fact reflective
of the industry’s youth—many
observers estimate the global industry
has up to $500 billion in managed
assets and a growth rate of 15 percent
to 20 percent per annum. Some also
contend that between 200 and 300
institutions currently contribute to
the industry worldwide. 
Principled Investing 
Islamic finance is in many respects
akin to socially conscious investing. It
involves what may be called substan-
tive principles that speak to the sub-
stance of the investment—in other
words, the purpose for which the
money will be utilized. In practice,
substantive principles are applied to
the target company’s line of business
and to the specific activities that the
money will advance. Industries such
as gambling, pornography, alcohol,
tobacco, defense, banking, and insur-
ance are typically prohibited because
they involve activities that Islamic law
prohibits. 
Perhaps the most conspicuous fea-
ture of Islamic finance is that the
mechanism of financing must also
comply with what may be termed
procedural principles.
C
The rules of trade and finance are part and parcel of
the religion by which Muslims conduct their lives.
Photography Gettyimages& Banking Communities 11
by Umar F. Moghul, Esq.
Murtha Cullina LLP
Islamic 
Introduction to
FinanceSummer  2006 12
These are the prohibitions against riba
(commonly but incompletely translat-
ed as “interest”) and gharar (inappro-
priate uncertainty). The regulations
derived from riba and gharar control
the manner in which financing takes
place. Here Islamic law is less con-
cerned with the purposes for which
money will be used than with how
money is placed in the hands of those
who will use it. Procedural principles
overlap somewhat with substantive
principles in governing how income is
generated and how profit and loss must
be shared. Additionally, they are con-
cerned with the distribution of wealth
throughout society. 
In its modern and perhaps most
relevant form, the prohibition against
riba disallows the earning or paying of
any benefit, monetary or otherwise, on
a loan of money. In Islam, loans are
characterized as charitable activities
and not profit-making ventures. The
prohibition of riba also applies to trad-
ing that involves certain other com-
modities, such as gold and silver and
particular foods. When these com-
modities are traded one for another, the
trades must be made in equal measure
and without deferral. The prohibition
of riba has been extended by the vast
majority of Muslim jurists to include
Definitions and Interpretation
by Samira Saya
Definitions
Islamic banking is a banking system consistent with Islamic law (Shari’ah) principles and guided by Islamic economics.
In particular, Islamic law prohibits the collection and payment of interest. Generally, it also prohibits trading in financial risk
(seen as a form of gambling). It also prohibits investing in businesses considered haram (prohibited, forbidden), such as
those selling alcohol or pork.
Shari’ah 
An Arabic word for Islamic law, or the Law of Allah, Shari’ah governs both secular and religious life of devout Muslims.
It covers religious rituals and many aspects of day-to-day living, politics, economics, banking, and law.
Riba
The meaning of this Arabic word is close to the charging of interest, which is forbidden by the Quran. Riba also con-
notes a loan in which the borrower makes a return to the lender that is more or better than what was borrowed.
Murabahah (Cost Plus)
Murabahah refers to the sale of goods at a price and includes a mutually acceptable profit margin.The price, other
costs, and the profit margin must be clearly stated upfront.As applied to lending, murabahah is a fixed-income loan for the
purchase of a real asset (such as real estate or a car), with a profit margin instead of a fixed rate of interest.The bank is
not compensated for the time value of money outside of the contracted term (and thus cannot charge additional interest
on late payments), however the asset belongs to the bank until the loan is paid in full.The transaction is similar to “rent-to-
own” arrangements for furniture or appliances.
Mudharabah (Profit and Loss Sharing)
Mudharabah is an arrangement between a capital provider and an entrepreneur. Profits are shared according to an
agreed-upon ratio, but if there are losses, the capital provider must bear them all.The bank is compensated for the time
value of its money in the form of a floating rate pegged to the debtor’s profits.
Gharar
The underlying principle for the prohibition of gharar, which involves the trading of risk or the sale of something that
has not yet been obtained, is that one should not profit from another person’s uncertainty.
Interpretive Letters
Letter No. 806 
In this interpretive letter, the Office of the Comptroller of the Currency approved an arangement proposed by a bank
helping Islamic customers purchase residential real estate in conformity with Islamic principles of banking. Leases that were
functionally interchangeable with loans were considered to be within the “business of banking.” See
http://www.occ.gov/interp/dec97/intdec97.htm.
Letter No. 867 
In this letter, the OCC concluded that financing products through which the bank acquired property on behalf of a
customer and then resold the property to the customer at a mark-up on an installment basis were permissible. See
http://www.occ.gov/interp/nov99/intnov99.htm.
Samira Saya is a legal intern with the Federal Reserve Bank of Boston.& Banking Communities 13
This Communities & Banking article is copyrighted by the Federal Reserve Bank of Boston.The views expressed are not necessarily those of the Bank  or the Federal Reserve System.
Copies of articles may be downloaded without cost at www.bos.frb.org/commdev/c&b/index.htm.
modern commercial bank interest. 
Asset sales and leases substitute for
interest-bearing loans. Because earning
a profit while assuming only credit risk
is unlawful, equity arrangements lend
themselves more readily to Islamic
finance. (See the sidebar “Definitions
and Interpretation.”) Islamic law
demands that the return on capital be
tied to the success of the venture, as in
traditional venture-capital and partner-
ship-based transactions. But there are
important distinctions between conven-
tional equity transactions and Islamic
principles. Rules relating to riba affect
distribution methods and the sharing of
profit and loss, so conventional liquida-
tion-preference provisions, for example,
are typically prohibited. In Islamic pri-
vate-equity transactions, simply speak-
ing, equity holders are supposed to bear
losses on a pro rata basis, but they may
share  profits on a non-pro-rata basis.
This places equity holders on a more
equal footing. 
As for gharar, Muslim jurists gener-
ally hold that Islamic law prohibits
transactions involving excessive uncer-
tainty. Gambling is the most obvious
example of an activity prohibited (at
least in part) by gharar. A less obvious
but arguably more important example
relates to conventional insurance. In
some policies, there is uncertainty about
both the amount of premium the pur-
chaser will ultimately pay and the
amount that will be paid out upon real-
ization of the insured risk. Thus some
insurance policies are prohibited.
The two prohibitions of riba and
gharar drive the structuring of transac-
tions away from conventional arrange-
ments such as interest-bearing debt and
call for creativity. Of course, transac-
tions must comply with local laws and
regulations, but contrary to common
notions, U.S. laws and financial regula-
tions are not wholly inconsistent with
Islamic laws. 
U.S. regulatory bodies at the state
and federal levels have reached out to
Islamic bankers to educate and be edu-
cated. In addition, state tax authorities
and bank regulators—such as the Office
of the Comptroller of the Currency
(OCC) and the Illinois Office of Banks
and Real Estate—have provided written
guidance and comfort, affirming the use
of nontraditional structures that other-
wise might be technically prohibited. 
How It Works Here
The history of contemporary
Islamic finance is brief, and its U.S. his-
tory is even briefer. U.S. efforts regard-
ing Islamic finance began during the
1980s, at least at an institutional level,
and came largely from within the
Muslim population. Such efforts, which
have increased and gained in momen-
tum and sophistication, have focused
mainly on creating retail products. 
Some U.S. banks, such as
Michigan-based University Bank and
HSBC Bank USA, have offered savings
accounts, checking accounts, and credit
cards that comply with Islamic law.
Islamic insurance appeared in the
United States during the 1990s but, to
our knowledge, is currently unavailable.
Some institutions have offered, with
varying degrees of success, mutual funds
and financing for automobiles and
homes. In New England, Chicago-
based Devon Bank and American
Finance House LaRiba offer Islamic
home-financing solutions. Devon Bank
also offers commercial real property
financing on an Islamic basis. 
Local institutions are beginning to
notice the demand for small- and mid-
size-business financing, commercial real
estate financing, and standardized con-
struction-financing products that fol-
low Islamic principles. Efforts toward
establishing an Islamic bank or credit
union are underway, and some have
gained state and federal regulatory
approval. University Bank lays claim to
being the first bank devoted solely to
Islamic finance. Years earlier,
Philadelphia-based Muslim Community
Credit Union gained certain approvals
but was never, to our knowledge, fully
operational. 
Although most Islamic transactions
occur in the Arabian Gulf, there are
Islamic finance windows, or branches, at
international financial institutions.
There also are subsidiaries of Islamic
investment banks conducting business
in America along Islamic lines. In fact,
the bulk of Islamic financial activity
here comes from major international or
foreign institutions transacting for
themselves and their non-U.S.
investors. Many major Western invest-
ment institutions, and recognized
European and U.S. broker dealers and
investment fund managers have offices
both in the Muslim world and here.
In the United States, these institu-
tions structure Islamic investment
opportunities in residential and com-
mercial real estate projects and equip-
ment—sometimes as one-off transac-
tions and often as full-fledged invest-
ment funds. Profits may result from
operating income and sales of the
investment assets. The institutions also
acquire—and make significant invest-
ments in—U.S. companies in the retail,
health-care, consumer goods, and tech-
nology industries through private equi-
ty and, more recently, venture capital
arrangements.
Umar F. Moghul, Esq., is an attorney
in the Islamic finance, private equity,
and structured finance practice groups at
Murtha Cullina LLP.
U.S. regulatory bodies at the state and
federal levels have reached out to Islamic
bankers to educate and be educated.

Introduction to Islamic finance

http://www.bostonfed.org/commdev/c&b/2006/summer/islamicfinance.pdf

Introduction to Islamic finance

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