What Is the AAOIFI?
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is a Bahrain-based international body established in 1991. It sets Shariah standards for Islamic financial institutions worldwide, covering banking, insurance, and capital markets.
With over 45 Shariah standards adopted by central banks and regulatory authorities across the globe, AAOIFI provides the most widely recognized framework for Islamic finance compliance. Its standards ensure that financial products and investment activities align with the principles of Shariah law.
The Two-Tier Screening Process
AAOIFI's Shariah Standard No. 21 governs investment in shares. It defines a two-tier screening process that every stock must pass to be considered Shariah-compliant.
Tier 1: Business Activity Screen
The first screen examines what a company does. Companies whose core business involves impermissible activities are excluded entirely. Impermissible activities include:
- Alcohol production or distribution
- Gambling and gaming operations
- Conventional finance and interest-based lending
- Pork and pork-related products
- Tobacco manufacturing
- Weapons and defense manufacturing
- Adult entertainment
If more than 5%of a company's revenue comes from impermissible sources, the stock is classified as non-compliant.
Tier 2: Financial Ratio Screen
Even if a company's core business is permissible, it must also meet strict financial thresholds to ensure its balance sheet does not rely excessively on interest-based instruments:
- Interest-bearing debt must be below 30% of market capitalization
- Interest-earning assets (deposits, bonds) must be below 30% of market capitalization
- Impure income (from non-compliant activities) must be below 5% of total revenue
Understanding Compliance Statuses
After running both screens, each stock receives one of three compliance statuses:
- Compliant: Passes both screens. Impure income is below 5% of total revenue. The stock is suitable for Shariah-conscious investors.
- Questionable (Audit Required): Passes the business activity screen, but impure income falls between 5% and 33%. Requires detailed analysis before an investment decision.
- Non-Compliant: Fails one or both screens. The stock should be avoided by Shariah-conscious investors.
Dividend Purification
Even compliant stocks may generate a small percentage of impure income, typically between 0.5% and 4% of total revenue. This happens because most large companies earn minor amounts from interest on cash deposits or other non-compliant sources.
The purification formula is straightforward:
Impure Revenue Percentage x Dividends Received = Amount to Donate
This donation amount is tax-deductible in the United States and Canada, meaning purification is not just a spiritual obligation but also a financially sound practice. Purification restores the spiritual integrity of your investment returns and channels funds back into communities through charitable giving.
Why PureInvest Uses AAOIFI
We chose the AAOIFI methodology because it is the most widely adopted Shariah screening standard globally. Here is why it matters:
- Global adoption: Recognized by Islamic financial institutions across 45+ countries
- Quantitative thresholds: Clear, numerical benchmarks (30% debt, 5% impure income) eliminate subjectivity
- Consistency: The same stock receives the same compliance verdict regardless of who performs the screening
- Institutional trust: Central banks and regulatory authorities reference AAOIFI standards in their frameworks
Disclaimer: PureInvest provides screening and informational tools based on established Shariah standards. It is not a financial advisor. All investment decisions should be made with the consultation of a qualified professional.