Screening of Securities and Purification

Islamic equity investments are very similar to socially responsible investments where a set of guidelines determines which companies meet the criteria for investment. In case of Islamic investments, the criteria comes from Shari’ah advisory boards and financial experts. They screen out the companies that are involved in unacceptable businesses such as alcoholic beverages and tobacco, banking and insurance, gambling houses, pork products, and non-defensive arms manufacturing. The screens also exclude debt based bonds and companies which deal in excessive amounts of interest. There are two major indices that provide such screening, UK based FTSE Shari’ah Global Equity Indexes and the US based Dow Jones Islamic Market (DJIM) Indexes. Some investors may even avoid Halal businesses like airlines, hotels, and supermarkets because they serve and sell alcohol and pork, but that would make the market too restrictive for investors.

It is an established fact that most modern companies will have some element of debt and have some dealing in interest. This is unavoidable in the modern economy. Due to this reason, a certain amount of debt and interest income has been allowed by Shari’ah advisory boards as long as final profits are purified through donations to charity. The exact percentage of interest income allowed and acceptable debt to capital ratios varies as there is no clear definition in Shari’ah for this. Some investors might want to avoid companies that deal with riba based banks but that would virtually exclude all companies.

Current screening practices include certain criteria for debt and interest which is considered minimally necessary for a company to function in the economy. As long as the company is not using riba as its primary source of income and not using debt as the primary source of capital, they pass the screens. Typically 5 to 15 percent of income from interest and less than a third of capital from debt has been set as acceptable limits. FTSE Islamic index uses only one screen of no more than one-third debt leverage for total capital. Dow Jones Islamic Index uses 12-month average of debt, cash and interest earning securities, and receivables as a ratio of market cap. As long as all three parameters remain within one-third of market cap, those companies pass the screen.

The low amount of interest has been accepted since the company is not deriving its main income from riba activities. The interest income is incidental which accumulates in banks accounts as idle cash. This interest income can be determined and an equivalent proportion of profits must be given out as charity to purify the earnings.

These screens are not perfect but accepted for the time being, as necessary for a company operate in the modern economy. If a time arrives where interest free economies are thriving and most companies are operating free of riba, these screens could be revised to further minimize or eliminate questionable criteria. The scholars have allowed these criteria based on the Ijtihad since no examples of this situation is available in the previous Islamic texts.