Islamic Banking Terms: The Complete Glossary

Islamic Banking Terms: The Complete Glossary

The first step to understanding any field is learning its terms. In Islamic banking, this is even harder, because centuries old Arabic terms from Islamic law are used side by side with modern English banking language. A bank officer says: “Your financing is on murabaha, the security will be a rahn, and you need to sign an undertaking.” Most customers simply sign without understanding a word.

This glossary solves that problem. It explains more than fifty Islamic banking terms, arranged into eight families. Each definition is designed to be complete, covering everything the term includes, and precise, excluding what it does not. Every term comes with its Arabic name, its Shariah basis and a practical example.

How to Read These Terms

Almost every Islamic banking product is built from a handful of basic contracts, called “uqud” in Islamic law. A contract (aqd) is an agreement between two parties that creates legal rights and duties. Just as a few letters make thousands of words, Islamic banks combine these few contracts to create all their products. So it helps to read this glossary family by family.

Family One: Core Shariah Principles

These are the principles against which every Islamic financial transaction is measured.

1. Riba (Interest):

A stipulated increase in a loan or deferred transaction with no countervalue. It has two types:

• Riba al Nasi’ah: a fixed increase on a loan in return for time; bank interest falls under this type.
• Riba al Fadl: an unequal exchange of gold, silver, currency or the same kind of staple food (Sahih Muslim, Hadith 1587).

2. Gharar (Excessive Uncertainty):

A transaction whose key elements, such as the item, price, quantity or time, are so unclear that one party is likely to be deceived. The Prophet Muhammad صَلَّى اللهُ عَلَيْهِ وَعَلَى آلِهِ وَسَلَّمَ forbade sales involving gharar (Sahih Muslim, Hadith 1513). Minor uncertainty, present in every deal, is tolerated; only major uncertainty is forbidden.

3. Maysir or Qimar (Gambling):

A transaction where one party’s gain is necessarily another’s loss, and the outcome depends on pure chance rather than effort or production (Surah Al Maidah 5:90).

4. Al Kharaj bil Daman (Profit Follows Liability):

Profit belongs to the one who bears the liability for loss (Sunan Abi Dawud, Hadith 3508). This is the central principle of Islamic banking: a bank may earn profit only when it also bears a real risk.

5. Al Ghunm bil Ghurm (Gain With Risk):

A legal maxim meaning that gain is tied to bearing loss; it extends the principle above.

6. Daman (Liability):

Responsibility for loss if something is destroyed or lost. Profit on an item is lawful only for the one who bears its liability.

7. Qabd (Possession):

Taking possession of an item. It has two forms:

• Physical possession: the item actually comes into your hands.
• Constructive possession: the item is not in your hands, but its risk and control have passed to you, for example when a warehouse receipt is issued in your name.

Possession is required before resale, because the Prophet صَلَّى اللهُ عَلَيْهِ وَعَلَى آلِهِ وَسَلَّمَ forbade profit on something whose risk one has not borne (Jami at Tirmidhi, Hadith 1234). AAOIFI has issued a separate Shariah standard on possession, Standard No. 18.

Family Two: Sale Contracts

8. Bai (Sale):

Transferring ownership of an item in exchange for a price. This is the foundation of Islamic banking: "وَأَحَلَّ اللَّهُ الْبَيْعَ وَحَرَّمَ الرِّبَا", Allah has made trade lawful and interest unlawful (Surah Al Baqarah 2:275).

9. Murabaha (Cost Plus Sale):

A sale in which the seller discloses his cost and sells at an agreed profit on top. This is the most common form of financing in Islamic banks. See our detailed murabaha guide.

10. Murabaha to the Purchase Orderer:

The form of murabaha used in banks: the customer first asks the bank to buy an item and promises to purchase it; the bank buys it and sells it to the customer at a profit. AAOIFI Shariah Standard No. 8 covers this contract.

11. Musawamah (Negotiated Sale):

A sale where the seller does not disclose his cost, and the price is agreed through negotiation. Ordinary market trade works this way. Difference from murabaha: murabaha requires disclosing the cost; musawamah does not.

12. Bai Muajjal (Deferred Payment Sale):

A sale where the item is delivered now and the price is paid later, in one sum or in instalments. Charging more than the cash price because of deferment is permissible, as long as the price is fixed once at the time of sale and never increased for late payment.

13. Salam (Advance Payment Sale):

A sale where the full price is paid in advance and the item is delivered on a fixed future date. The Prophet صَلَّى اللهُ عَلَيْهِ وَعَلَى آلِهِ وَسَلَّمَ said that whoever enters into salam should do so for a known measure, a known weight and a known period (Sahih al Bukhari, Hadith 2240). It is an excellent way to finance farmers. AAOIFI Standard No. 10.

14. Istisna (Manufacturing Contract):

A contract to have something manufactured or built, with the price paid in advance, in instalments or later. Difference from salam: istisna only applies to items that are manufactured, and full advance payment is not required. AAOIFI Standard No. 11.

15. Parallel Salam and Parallel Istisna:

The bank enters into a salam or istisna with one party, and a separate, independent contract of the same kind with another party. The condition is that neither contract depends on the other.

16. Sarf (Currency Exchange):

Exchanging gold, silver or currency for one another. Both sides must take immediate possession, and if the items are of the same kind, the amounts must be equal. The rules of foreign exchange come from this contract.

17. Bai al Inah (Sale and Buy Back):

Selling an item on credit at a higher price and immediately buying it back from the same person in cash at a lower price. The result is giving less cash and receiving more later, so it is a trick to disguise interest, and is impermissible according to the majority of scholars.

18. Tawarruq (Monetisation):

Buying an item on credit to obtain cash, then selling it to a third party for cash.

• Simple tawarruq: the customer sells the item in the market himself; some scholars allow it.
• Organised tawarruq: the bank arranges the whole process itself; the International Islamic Fiqh Academy declared this impermissible, and Mufti Taqi Usmani restricts it to cases of severe necessity.

19. Commodity Murabaha:

Raising funds by buying and selling metals or commodities in international markets; usually a form of tawarruq, so it carries the same concerns. AAOIFI Standard No. 20 covers the sale of commodities in organised markets.

20. Bai al Dayn (Sale of Debt):

Selling a debt or receivable to someone else. If this is done at more or less than its face value, it is interest. That is why Islamic banks cannot sell their receivables at a discount.

Family Three: Ijarah (Leasing)

21. Ijarah (Lease):

Transferring the use of an item for a fixed period in return for agreed rent, while ownership stays with the owner. As owner, the bank bears major loss of the asset. AAOIFI Standard No. 9.

22. Ijarah Muntahia Bittamleek (Lease Ending in Ownership):

A lease that ends with transfer of ownership: when the term ends, the item passes to the lessee through a separate sale or gift. Islamic car financing is based on this.

23. Ijarah Mawsufah fi al Dhimmah (Forward Lease):

A lease of an item that does not yet exist but whose specifications are defined, to be delivered in the future, such as a house under construction. Rent becomes due only after delivery.

24. Sale and Lease Back:

Selling your own asset to the bank and leasing it back. It is permissible under conditions, as long as it does not become a route to bai al inah; Shariah boards watch it closely.

25. Security Deposit:

A guarantee amount paid by the lessee in an ijarah. It is not a share of ownership, but security for the lessee’s obligations.

Family Four: Partnership Contracts

26. Shirkah (Partnership):

Two or more people sharing in property or a business. It has two main types:

• Shirkat al Milk: joint ownership of an asset, such as a house inherited by two brothers.
• Shirkat al Aqd: a business partnership created by contract. AAOIFI Standard No. 12.

27. Musharakah:

Two or more people pooling capital in a joint business.

• Profit: shared in a ratio agreed by mutual consent.
• Loss: always shared in proportion to capital.
• Fixing a set amount of profit for any partner is not permissible.

28. Diminishing Musharakah:

A partnership in which one partner’s share gradually decreases as the other buys it, until the second partner owns the whole asset. Islamic home financing is based on this.

29. Running Musharakah:

A partnership for a business’s working capital, in which the bank provides funds up to a limit and shares in actual profit according to how much money the business used and for how long.

30. Mudarabah:

A partnership in which one party provides capital and the other provides work and expertise.

• Rabb al Mal: the capital provider.
• Mudarib: the working partner.
• Profit: shared in an agreed ratio.
• Financial loss: borne by the capital provider, unless the mudarib’s negligence or misconduct is proven.

AAOIFI Standard No. 13.

31. Unrestricted and Restricted Mudarabah:

• Unrestricted: the mudarib may invest in any halal business.
• Restricted: the capital provider limits the type of business, place or period.

32. Profit Sharing Ratio (PSR):

The agreed ratio in which profit is shared, for example 60:40. The ratio is fixed, not the amount.

Family Five: Deposits and Pool Management

33. Qard (Loan):

Giving money on the condition that the same amount is returned. Any stipulated increase on it is interest. A current account in an Islamic bank is legally a loan to the bank. AAOIFI Standard No. 19.

34. Qard Hasan (Benevolent Loan):

A loan given purely for goodness, with no increase.

35. Pool:

The combined fund of depositors’ money that the bank invests in halal ventures on the basis of mudarabah or wakalah.

36. Weightage:

The weight given to each account in sharing the pool’s profit, based on its amount, term and type; longer term deposits receive more weight. These weights must be disclosed in advance.

37. Hiba (Gift):

A gift from the bank given without any prior condition. If it is fixed or promised in advance, it is no longer a gift but a stipulated increase.

38. Profit Equalisation Reserve (PER):

Setting aside part of the profit in good times so that depositors’ profit does not fall too sharply in bad times. It should be done with depositors’ consent and transparently.

39. Investment Risk Reserve (IRR):

An amount set aside from the depositors’ share of profit to protect against possible losses.

Family Six: Supporting Contracts and Promises

40. Wakalah (Agency):

Appointing someone to act on your behalf, with or without a fee. AAOIFI Standard No. 23.

41. Wakalah bil Istithmar (Investment Agency):

An agency for investment, in which the bank charges a fixed fee to invest your money, and the profit belongs to you.

42. Kafalah (Guarantee):

Guaranteeing another person’s obligation, such as a bank guarantee. AAOIFI Standard No. 5.

43. Rahn (Pledge or Mortgage):

Pledging a valuable item as security for payment. The person holding the pledge may not benefit from it. AAOIFI Standard No. 39.

44. Hawalah (Transfer of Debt):

Transferring your debt to another person who accepts responsibility for paying it. AAOIFI Standard No. 7.

45. Wa’d (Unilateral Promise):

A one sided promise, such as the customer’s promise in murabaha to buy an item from the bank. A promise is not itself a contract, but in some cases keeping it is made binding.

46. Muwa’adah (Bilateral Promise):

Mutual promises between two parties. If both promises are binding, it becomes like a contract, so it is prohibited in some cases. AAOIFI Standard No. 49 covers unilateral and bilateral promises.

47. Arbun (Earnest Money):

An advance paid to secure a deal; if the buyer completes the purchase, it becomes part of the price, and if he withdraws, the seller keeps it. Imam Ahmad permits it, while other Imams have reservations.

48. Ju’alah (Reward Contract):

A promise of a set reward for completing a specific task, such as “whoever finds my lost item will receive this amount”. AAOIFI Standard No. 15.

Family Seven: Capital Markets and Investment

49. Sukuk:

Investment certificates representing ownership shares in a real asset, project or business.

Difference from bonds: a bond is a receipt for a loan, while a sukuk certificate represents ownership. AAOIFI Standard No. 17.

50. Shariah Screening:

The method of testing a company’s shares against Shariah criteria: its core business must be halal, and its interest bearing debt and interest income must be below set limits.

51. Purification:

Calculating the proportion of unintended non compliant income in an investment and giving it to charity.

52. Shariah Compliant Fund:

A mutual fund that invests only in Shariah compliant shares, sukuk or other halal instruments.

Family Eight: Takaful

53. Takaful:

A system of mutual cooperation in which participants contribute donations to a shared fund, which is used to help participants who suffer a loss.

54. Participants’ Takaful Fund (PTF):

The fund in which participants’ contributions are pooled and from which claims are paid.

55. Waqf Model:

A takaful model in which participants’ contributions go into a waqf (endowment) fund; this is the model used in Pakistan.

56. Wakalah Fee:

The fee a takaful company charges for managing the fund; the company is the fund’s manager, not its owner.

The Legal Status of These Terms in Pakistan

In Pakistan, these terms are not only academic; they are part of binding regulatory standards. In a circular dated 12 January 2010, the State Bank of Pakistan decided to adopt AAOIFI Shariah Standards gradually, after detailed review in light of the local environment and the needs of the industry. In the first phase, Standards No. 3 (Default in Payment by a Debtor), No. 8 (Murabaha to the Purchase Orderer), No. 9 (Ijarah and Ijarah Muntahia Bittamleek) and No. 13 (Mudarabah) were adopted. More standards followed, and the State Bank has issued a compendium of all the Shariah standards it has adopted, updated until 31 July 2025. sbpsbp

(State Bank of Pakistan Compendium of Shariah Standards: https://www.sbp.org.pk/ifpd/compendium/Compendium.pdf)

A Final Word

This glossary is a map for your Islamic banking journey. Once you understand these terms, every bank document becomes an open book, and you can judge whether your transaction truly follows Shariah principles. The next guides in this series explain each major product in detail: murabaha, ijarah, diminishing musharakah, Islamic accounts, sukuk, takaful, salam and istisna.