Sharia Law basic concept
Muslims follow the principles of Islamic Shariah law, which is derived from the central religious text of Islame, the holy Qùran, the Sunna (the path of the prophet) and other Islamic scriptures. Shariah law governs nearly all aspects of Muslim life, and hence Shariah law imposes certain restrictions on finance and investments within the Muslim community.
The 2 most significant effects of Shariah law on Islamic finance are the restrictions on:
These additional set of rules on top of conventional common laws, leaves little permissible (Halal) investment options for Muslims to pursue, especially in the Western world.
Usury (Riba)
The notion of interest payments in conventional banking is impermissible in Shariah law, because it is considered usury and is therefore unjust.
In place of interest, Islamic finance is based on ownership of assets and the sharing of risk, these two concepts, Musharakah and Mudarabah, distinguish Islamic finance from Western finance which is largely based on principles of interest, debt and risk transfers
In Western finance a bank will receive interest for the risk it takes by loaning money to a business, whilst in Islamic finance a bank that provides funding to a business will have an agreed share in the profit/loss generated from the money it provides. Thus negating the need for interest payments and the investment risk is shared between the bank and the business.
Impermissible Investments (Haraam)
Muslims cannot invest in anything that is considered unlawful or impermissible under conventional Islamic law, for instance any business that has links to pork, alcohol, tobacco, pornography, prostitution, gambling, weaponry and many forms of Western entertainment/advertising that are contrary to Muslim values. Moreover, because of the prohibition of Riba, Muslims cannot invest in most businesses that operate on interest payments like major Western banks and mortgage providers.
Furthermore, because of the concept of Musharakah, they cannot invest in businesses that transfer risk and are deemed unjust, like major Western insurers.
In addition, because Muslims cannot invest in gambling related businesses, most types of trading like shorting and derivatives are also prohibited.
There are also a number of specific accountancy restrictions like limits on the debt to equity ratio or accounts receivable that a company needs to have in order to qualify as being Halal.