What is Sharia

Sharia (also known as "Shariah" or "Shari'a") is an Islamic religious law that governs not only religious rituals but also aspects of day-to-day life in Islam. Sharia, literally translated, means "the way."

There is extreme variation in how Sharia is interpreted and implemented among and within Muslim societies today. This is especially prevalent for its financial laws.

BREAKING DOWN Sharia

Sharia-compliant finance is an area of modern finance that is growing among many banks and investment houses. This is due in part to investors eager to work with the Middle East as oil prices continue to increase. Western financial services firms are beginning to offer Sharia-compliant investment vehicles that neither pay interest, nor benefit from gambling.

Ways Sharia Establishes Guidelines for Making Investments

Sharia prohibits the collection of interest paid by a borrower to a lender. Neither party can engage in this practice, which is a staple of many types of financial arrangements and transactions. This naturally can include loans and mortgages, as well as financial vehicles that build interest in order to generate a return. Investing in conventional banking and insurance firms therefore can be prohibited under Sharia.

The activities of business that are invested in under Sharia are also relevant. Companies that may not be invested in include brewers and other producers of alcoholic beverages. Producers and distributors of pornography are likewise banned. Companies that create products such as ham, bacon are disallowed from investments. The producers of weapons and related armaments are not to be invested in. Makers of tobacco and tobacco-related products are also may not be invested in. Businesses that are also deemed by the Sharia Board as prejudicial against the principals of the faith are disqualified from being invested in.

Businesses that are not directly engaged in but derive more than 5% of their revenue from proscribed activities are also prohibited.

The various tenants of Sharia law mean that investment strategies must be developed that can accommodate these restrictions. This does mean that followers of the faith who abide by Sharia cannot engage in sizable portions of the market. There are Sharia-compliant funds that exist to adhere to the restrictions of the faith.

In late 2007, a Sharia index was launched on the Tokyo Stock Exchange. This index includes companies that comply with Sharia law. The companies included in this index are screened on a daily basis and exclude non-Sharia-compliant companies such as casinos and alcohol and tobacco companies.

In the West, Sharia-compliant investments are similar to socially responsible investments.