Muslims on the stock exchange: what is allowed and what is not?

The demand for Sharia-compliant investments has been growing for years. How can Muslims participate in the stock market in accordance with Islam, what are the limits and which banks support them?

Ownership is allowed, interest is not. In Islam, certain rules apply to trade and business within an economy. What fundamentally differentiates Islamic finance from conventional finance is the prohibition of interest. In addition, Muslims must adhere to certain concepts such as “ethical investing” and “morally sound purchases”. The aim should be to create justice for all involved.

Islamic basics

Islam is a religion that not only focuses on the individual relationship to God, but also serves as a guide for a person’s entire life. The rules and regulations that must be observed and followed are set out in Sharia, Islamic law. It encompasses all aspects of human life, including social, economic and political issues. It is derived from two main sources: The Koran as the direct message of God and the Sunna, the behavior and way of life of the Prophet Mohammed. As a result, Islamic banks must also adhere to the rules and laws of Sharia law. This has meant that Islamic banks have to have a supervisory board, the so-called Sharia board. It includes qualified Islamic scholars who ensure that all guidelines for Islamic financing in accordance with Sharia law are adhered to. For example, illegal enrichment or transactions that involve high risk or speculation or investing in prohibited industries such as the sale of alcohol or pork are prohibited.

From this three important principles have emerged that distinguish the Islamic financial system from conventional financial systems:

Prohibition of Interest

The most important principle of Islamic financing is the prohibition of interest (riba). According to the Sharia, Muslims are neither allowed to collect nor to pay interest. From an Islamic point of view, interest favors a financial activity that accumulates wealth in the hands of a few people and exposes the borrower to the risk of possible loss. In addition, Islam motivates people to earn their profits and wealth through self-employment rather than through financial transactions. The accumulation of interest, on the other hand, is considered selfish. Riba is considered an unlawful accumulation of wealth and is prohibited in all respects – be it for business investments or for personal financial investments. The aim is to create a financial system that is fair and beneficial for all involved.

Profit and loss sharing

Another important principle of Islamic finance: profit and loss sharing. This is a form of partnership in which the parties are viewed as trading partners and are equally involved in the profit and loss of the investment. Islam also prohibits all forms of speculation (Gharrar) and gambling (Maysir). Contractual partners must be informed in detail about the subject matter and consequences of a contract. Also included are transactions that are associated with an incalculable risk and contain an uncertain price. Maysir refers to transactions whose course and outcome cannot always be calculated. What is meant is any involvement in games of chance, but also in business related to it.

Financial methods

Nowadays there are various finance methods offered by Islamic banks. One of them is the Murabaha. Here the financial institution acquires the goods to be financed and then sells them on to the customer. Since the bank assumes a certain risk here as a middleman, it is entitled to a reasonable return according to Sharia law. The customer must pay this by adding a surcharge to the original price.

Another method of Islamic financing is the Mudaraba, which is equivalent to the special assets of the capital investment companies. A trustee takes over the function of the investment company and invests the customers’ assets. For his services, the trustee regularly receives a fixed share of the return on the investments. For smaller investments, the Musharaka, equity financing through participation on a time basis, is suitable. The customer brings assets and the respective financial institution money into the participation. The distribution of the profits takes place according to a certain agreed formula, the losses, however, in each case in the amount of the capital shares.

Similar to operating leasing, a financial institution at Ijara allows its customers to use an asset temporarily for a fee. Similar to Murabaha, the bank purchases the items at its own expense and rents them to the customer. This method is used in particular in cross-border transactions for asset financing, such as the purchase of ships, aircraft or equipment. If you want to finance projects that are not yet finished, the Istisna is the right choice. This takes place when a banking institution commissions the entrepreneur to manufacture the respective goods on behalf of a customer. He finances the completion of the goods and sells them on to the customer, who in turn has to pay the wages plus a profit mark-up.

Muslims and Stock Trading – What Are the Options?

Most Muslims know that interest rate transactions are prohibited from an Islamic point of view, but there is a great deal of uncertainty about trading in stocks.

What is allowed and what is not?

A share is a participation certificate and thus a company participation. Participation in a company is not initially prohibited, but it depends on what kind of company it is. If it does not comply with Islamic principles, a Muslim is not allowed to acquire the relevant share certificate. Whether a company complies with Islamic law or not is checked by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOFI). Among other things, this is responsible for setting standards for Islamic banks and for checking the conformity of companies.

The test procedure can be roughly divided into two parts: the sector and financial analysis. The sector analysis describes the examination of the business model of a company. The aim is to ensure that the company generates its profit from permitted sources. Prohibited sources include, for example, income from trading in alcohol, pork or gambling. The financial analysis, on the other hand, describes the examination of financial ratios, which should be within a certain framework. For example, a company should have no more than 33 percent liabilities.

In addition, there is the option of choosing Islam-compliant stocks from a specialized index, for example the Dow Jones Islamic Index or the Dow Jones Islamic Market Titans 100. The latter achieved an increase of almost 33.5% over the past three years and includes Shares such as Apple, Microsoft or Johnson & Johnson. There are a number of banks that help Muslims participate in the stock market. Islamic banks in particular play a major role here, of which there are now more than 300 in 75 countries. But conventional banks also participate in the market for Islamic investments. Including HSBC, Citibank, Standard Chartered and Deutsche Bank.