LECTURE 1

INTRODUCTION

 WHAT IS ISLAMIC BANKING?

Banking system or practices that adhere to ISLAMIC law (shariah) and principles based on the
Quran and Sunnah.

 WHY DO WE NEED ISLAMIC FINANCIAL SYSTEM?

To comply with Shariah.

 WHY DO WE NEED TO COMPLY WITH SHARIAH?

It is a command from God - Allah and teachings of the Prophets Muhammad (PBUH) for ALL
MUSLIMS.

 Islamic banking is a faith-based system.

 The disobedient will be sinful and not blessed by Allah s.w.t.

 These are the reason that are strong enough to lead to the establishment of Islamic
banking system in Malaysia and around the world.

 It is clear that Islamic banking is established to due to the reason that interest is prohibited
in Islam. Islamic banking practice that still have the elements of riba (interest) will
jeopardize the main reason of its establishment.

 Islamic banking is to facilitate the need of Muslims and alternative needs of non-Muslims,
in fulfilling their banking needs.

 Islamic banking practice is guided by Al-Quran and Hadith as the major reference in Islam
and guided by Shariah.

 There are many challenges need to be confronted in adopting and practicing fully shariah
compliant Islamic banking system.

FACTORS CONTRIBUTE TO GROWTH OF ISLAMIC BANKING AND FINANCE

 Among the factors that have contributed to the rapid progress of Islamic banking &
finance are:

 There are 1.9 billion Muslims in the world which constitute 25% of the global population
and the numbers are growing much faster than any other religious group.

 The demand for Islamic finance is expected to rise exponentially as Islamic finance is
consider as safe heaven since it is crisis proof. It becomes important part of portfolios to
buffer the risk.

 More factors?

ISLAMIC BANKS AS FINANCIAL INTERMEDIARIES

The Banking Business: Banks as Financial Intermediaries

Holds Capital Takes Deposits Makes Loans

ISLAMIC BANKING IN MALAYSIA

 In Malaysia, Islamic banking is part and parcel of Malaysian Financial System. It is one of
the important components of Malaysian Financial System.

 Islamic banking practice in Malaysia is being monitored and supervised closely by National
Shariah Advisory Council (SAC of BNM).

 In the early stage of the establishment of Islamic banks, the National Steering Committee
has proposed that the Islamic Banks should be given a period of 10 years to operate
without facing any unhealthy competition. This is to make sure Islamic banking can
innovate, create and improve its products.

 After 3 decades, Islamic banking has flourished and being one of the vital components in
the competitive and dynamic system of Malaysian Financial System.

 The first Islamic finance institution in the country was Tabung Haji (1966).

 It inspired the establishment of Bank Islam Malaysia in 1983 as the first full-scale Islamic
commercial bank of Malaysia.

 Bank Negara Malaysia has made untiring efforts, under its ex- governor Tan Sri Dr. Zeti, to
promote Islamic finance at home and abroad on various fronts—the development of
products, the design of regulatory standards, juridical research, Islamic finance education
and training—through INCEIF, the Global University of Islamic Finance, which it
established.

 Today, Malaysia leads the world in Islamic banking and finance.

ISLAMIC ECONOMIC SYSTEM

Fundamental principles of an Islamic economic system:

 Prohibition of interest (riba), uncertainty (gharar), gambling (maisir).

 Trading of forbidden objects – prohibition trade of pork, alcohol,

 Prohibition of hoarding and monopoly.

 Spirit of cooperation – help the needy/poor –pay zakat

 The duality of risk – risk and reward

 No gain without effort , risk and liability. iwad

 Encourage investment.

FUNDAMENTAL REFERENCE IN ISLAMIC BANKING.

 AL- QURAN

 HADITH (SUNNAH)

 IJMA

 QIYAS

WHY INTEREST IS BANNED IN ISLAM?

 Muslims require no argument as to why they must shun interest.

 But interest payments cannot meet the norms of social justice at the macro level.

 Interest payments have many disadvantages than advantages that are harmful to individuals
and society as a whole.
ISLAMIC AND CONVENTIONAL BANKING
Money and economies

 Its primary function:

 As a medium of exchange

 Measure of value for comparisons

 A standard for deferred payments

 Storing value (i.e. wealth in liquid form)

 A unit of account, i.e. the currency, in terms of which the values (prices) of
commodities in business transactions would be expressed

IN ISLAM MONEY IS NOT A COMMODITY !!!

Overview: The origin and evolution of Islamic banking and finance

 The origin of the modern Islamic bank can be traced back to the earlier time when the
Prophet himself practised partnerships (mudarabah).

 The first financial institution, known as the Baitulmal or the public treasury, was established
by the Prophet (Peace Be Upon Him) himself.

 Umar Al-Khattab, the second caliph, who gave the institution of Baitulmal a distinct entity (in
644 AD) and identified its sources of revenue, including zakat (a charge on wealth), kharaj
(land revenue), jizia (poll tax), custom duties, tolls and sadaqa’at (or donations).

 While these principles were used as the basis for a flourishing economy in earlier times, it is
only in the late 20th century that a number of Islamic banks were formed to provide an
alternative basis to Muslims although Islamic banking is not restricted to Muslims.

 Islamic banking and finance gained momentum after the 1960s with the rise of Islamic
revivalist movements across the world.
A BRIEF HISTORICAL OVERVIEW

Egypt

 Was one of the first countries to adopt Islamic banking

 The first Islamic bank was launched by Ahmad El Najjar under a secular cover for fear of
being seen as a symbol of the Islamic revivalism that was distasteful to the political
establishment of the country.

 The bank took the form of a savings bank that was based on profit sharing in the Nile Delta
town of Mit Ghamr in l963.

 That particular experiment was short-lived – the bank had to close in 1967 – but soon there
were nine such banks operating in Egypt.

 These banks worked without taking or giving interest.

 Anwar Sadat, the then president of Egypt, established the first public sector bank in 1971.
The Nasir Social Bank operated as an interest-free institution, although it did not declare any
commitment to Islamic law.

 In the 1980s a number of Islamic banks collapsed under trying conditions and the savings of
many Egyptians were completely lost.

Iran

 Banking in Iran was rationalized on the heels of the Islamic revolution in 1979.

 The 35 banking units working in the country were merged into six commercial and three
specialized banks.

 A law for interest-free banking was passed in 1983 and banks were asked to discard interest
payments by 21 March 1984.

 All banking transactions were to follow Islamic law.

 They were allowed to take in two types of deposit.

− First, qard hassan, which covered current and savings accounts. Such
deposits are treated as the bank’s resources and any return on them is
decided by the bank’s management.

− The second are investment deposits, the return on which accrues

according to a profit-sharing contract.

 Banking products are based on Islamic contracts—musharakah, mudarabah, ijarah

instalment transactions, direct investment, forward transactions, etc.
Pakistan

The separation of East Pakistan, now Bangladesh, did not provide much space for the expansion of
Islamic finance until 1977.

 During the term of President Zia-ul-Haq, a comprehensive programme of Islamization in

various sectors—economic, social and political—was launched.

 A process of economic Islamization was simultaneously initiated with a time frame of

three years.

 Consequently, all the commercial banking operations were made ‘interest free’ from 1 July
1985.

 Recently, the State Bank of Pakistan has allowed the formation of fully-fledged Islamic
Banks in the private sector.

 The popularity of Islamic banking is on the rise in Pakistan in recent years, with deposits
going up from about US$3 billion to US$4 billion in 2011.

Middle East and North Africa

 The MENA region has emerged as an important element in the developmental programmes
of the constituent countries.

 They dominate their financial services sector, which also includes investment and mutual
funds, project finance companies and takaful institutions.

 As a result, global players have been attracted to the region despite concerns about the lack
of a focused and cohesive regulatory framework.

 The area is vast, extending from Morocco to Iran and to Yemen in the south, and comprises
numerous countries, big and small, whose interpretations of the religious injunctions vary. In
many countries, with the exception of the United Arab Emirates (UAE) and Bahrain, Islamic
banks are regulated and supervised mostly in the same way as conventional banks.

LEADING ISLAMIC BANKING AND FINANCE CENTRES

 BAHRAIN

 DUBAI

 KUALA LUMPUR

 LONDON

COMING UP:

 HONG KONG

 SINGAPORE

 JAPAN
ISSUES IN IMPLEMENTATION

 Many of Islamic banking basic principles are commonly accepted all over the world, for
centuries. The principles are not new but arguably, their original state has been altered over
the centuries.

 In term of practice, Islamic banking nowadays does not fully implement the Islamic
principles but it resembles the conventional banking practice in many ways.

FUTURE OF ISLAMIC BANKING

 Islamic banking is for real. It is based on solid foundation and at a time when many are
questioning the morality of conventional debt finance, it offers an attractive alternative. It
has been developing for the past four decades and has exciting future.

LECTURE 2

Philosophy of Islamic Banking

❖ Prohibition of Riba (interest)

❖ Prohibition of Gharar (uncertainty)

❖ Prohibition of Maisir (gambling) and Qimar (Game of Chance)

❖ Trading of prohibited goods and services. (wine & swine and illegal activities)

▪ Islam encourages the freedom to engage in business and financial transactions but must
comply with a number of prohibitions, ethics and norms (rule).

▪ Concern for shariah tenets (system of belief) should dominate all other concerns of IB.
(shariah first, profit comes next)

▪ Only through the compliance of Islamic financial operations with the principles of shariah
that the system can develop on a sustainable basis and can ensure fairness for investors, the
business community and institutions.

The basic prohibitions

❖ Islamic law does not recognize transactions that have proven illegitimate factors and/or
objects and must be avoided in commerce or business transactions.

❖ In 1980 “ Interest Free Banking” – a narrow concept was introduced. However, Islamic
banking covers not only interest prohibition but also all others prohibition as stated by the
shariah (law).

❖ The prohibition of riba, gharar, Maisir and trading of prohibited objects can be found clearly
in the two most important sources of shariah which are Al-Quran and Hadith – Sunnah.
Prohibition of Riba in the Quran

The Holy Quran and Sunnah strongly condemn Riba. Quran mentioned about prohibition of riba in
more that 13 verses.

▪ Surah al-Baqarah, verse 275. (2:275)

“Allah has allows (profit from) trade and prohibited riba”

▪ Surah al-Rum, verse 39 (30:39)

“That which you give as Riba to increase the people’s wealth increases not with God; but that
which you give in charity, seeking the goodwill of God, multiplies manifold”

▪ Others Surah in al-Qur’an include:

4:161, 3:130, 2: 275 – 281.

Prohibition of Riba in the Sunnah

▪ From Jabir r.a:

“The Prophet (pbuh) cursed the receiver and the payer of interest and the one who
records it and the witnesses to the transaction and said: ‘They are all alike [in guild]’.”

▪ From Anas ibn Malik r.a:

“The Prophet said: ‘When one of you grants a loan and the borrower offers him a dish, he
should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the
two of them have been previously accustomed to exchanging such favours mutually’.”

▪ The Holy Prophet (Pbuh) said, “gold for gold, silver for silver, wheat for wheat,
barley for barley, dates for dates and salt for salt – like for like, equal for equal, and
hand to hand; if the commodities differ, then you may sell as you wish, provided
that the exchange is hand to hand.”

▪ (HADITH ON EXCHANGE OF RIBAWI ITEM)

Riba in loans / Debts

❖ From the above references to al-Qur’an and Sunnah, we can derive a number of results
regarding the severity of the sin of Riba.

(What the Qur’an have discussed is the Riba on loans and debts. As conventional banks’ financing
falls into the category of loans on which they charge a premium (excess), it falls under the purview of
Riba as being prohibited by the Holy Quran.)

Avoiding Interest

❖ The most important feature is the avoiding of interest.

 ❖ Lender according to Shariah, has to lent money to the borrower for the period of loan
without seeking any worldly compensation – IB will not take or give any loan or enter into
contracts seeking any increase over the principal of loans or debt created as a results of any
credit transaction.

Definition of Riba

Literally means excess, increase, expansion, growth

▪ Some definitions:

▪ Riba is every excess in return of which no rewards or equivalent counter value is

paid.

▪ The premium that must be paid by the borrower to the lender along with the
principal amount, as a condition for the loan or for an extension in its maturity,
which today is commonly referred to as interest.

▪ Riba is a predetermined excess or surplus over and above the loan received by the
creditor conditionally in relation to specified time period.

▪ It contains 3 elements:

▪ Excess or surplus over and above the loan capital

▪ Determination of this surplus in relation to time

▪ Stipulation (mentioning) of this surplus in the loan agreement

❖ Any increase or interest on a debt that has matured, in return for an extension of the
maturity date, in case the borrower is unable to pay the increase (interest) on the loan at
the beginning of its agreement, are both forms of usury.

-IIFA

RIBA vs. PROFIT

Types of Riba

Types of Riba – RIBA AL DUYUN

Scholars have divided riba into two types:

1.    RIBA AL-DUYUN.

This type of riba occurs in lending and borrowing. Any kind of addition or increase above the
amount of principal whether the addition or increase are inflicted by the lenders or willingness of
the borrowers.

Riba al-Duyun is divided in two types:

a. RIBA AL-QARDH
Riba is imposed from the beginning and will be proportionate to the time taken by borrower to
repay the loan. The longer the period of loan, the higher the interest would be.
 b. RIBA AL-JAHILIYYAH

There is no riba at the beginning and the riba is imposed due to late payment. This arises when the
creditor in a deferred contract of exchange, demands from the debtor an additional amount over
and above that which was initially agreed to in the original contract for the granting more time for
borrower to pay. For example: late payment charges on credit card or any loan.

****Riba al Qardh and Riba al Jahiliyyah refer to ‘interest’ because they are associated with the
‘addition or increase’ and the ‘extension’ of time to maturity.

2.  RIBA AL-BUYU’
Riba al-buyu’ occurs in trading transactions. A transaction (trading/sale) in which a commodity is
exchanged for the same commodity but unequal in amount or the same product in equal amounts
but there is a postponement in delivery.

This kind of riba may occur out of an exchange between two ribawi materials of the same kind,
where the necessary rule(s) is/are not observed.

Types of Riba al Buyu’ are:

a.    Riba al Fadhl

b.    Riba al Nasiah

▪ Riba al Fadhl.

The ribawi materials exchanged are of different weights, measurements or numbers and are
exchanged at the same time. (Riba of Excess): Purchased and sales of homogeneous commodity,
where money is exchanged for money but in different quality.

▪ Riba al Nasiah

Riba by virtue of deferment at the time of exchange. The ribawi materials exchanged are of equal
weights, measurement or numbers but payment of the price and delivery of the goods are made at
two different times. This can be termed as a sale transactions, which involves barter exchange of the
homogeneous commodity in equal amounts and postponement of delivery, by either or both
parties.

Ribawi Materials

Ribawi goods are items sold by weight and by measure. The basis for the prohibition of riba in the
exchange of commodities is the famous hadith of the Prophet on six commodities.
As reported by Ubadah Ibn Samit that the Prophet s.a.w said, 

“Exchange of gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates , salt
for salt, like for like, equal for equal, and hand to hand (i.e. on the spot); if the commodities differ,
then you may sell as you wish, provided that the exchange is hand to hand” or a spot transaction.”

❖ It was a common practice of Arabs during Prophet time to exchange a similar item but of
superior quality with greater amount of inferior quality.

❖ For example 1kg of superior quality of dates is exchanged with 2 kg of dates of inferior
quality.

❖ This action is a riba transaction and was prohibited by Prophet Muhammad PBUH.

❖ On top of this, Prophet Muhammad PBUH also prohibits exchange of ready products with
product that are not ready or away.

Rules of Exchange for Ribawi materials

▪ Ribawi materials of the same basis and of the same kind: (exchange gold with gold)

1. Material must be of the same weight, measurement or number of units.

2. Exchange of goods must be done immediately , ie. on the spot

▪ Ribawi material of a different kind and of the same basis: (exchange gold with silver)

1. Different in weight, measurement or number of units allowed.

2. Exchange of goods must be done immediately, ie. on the spot.

▪ Ribawi material of a different kind and a different basis; (exchange gold with wheat)

1. Different in weight, measurement or number or units allowed.

2. No requirement for the exchange of goods must be done immediately, ie. The
exchange can be deferred.

3. In conclusion, no condition applied.

WISDOM BEHIND PROHIBITION OF RIBA

ECONOMIC PERSPECTIVE

▪ The taking of interest implies taking another person’s property without giving him
anything in exchange, because one who lends RM 1 for RM2 gets the extra RM1 for
nothing. Hadith: “A man’s property is as sacred as his blood”. Thus riba can equated
to stealing other people’s property. Permitting the taking of interest discourages
people from doing good for one another, as is required by Islam. It beats the
purpose of debt which is to help one another.
 ▪ Riba makes the lender lazy and prevents them from working (productively) to earn
money since the person with money can earn extra money though interest without
working for it. It will create a non- productive society/ nation.

▪ Riba is depriving the borrower who is in need by forcing him to over- work to pay
the interest portion –which is way too high than the amount borrowed.

▪ The interest-based system discourages innovation, particularly on the part of small

scale enterprises as interest is normally high for small enterprise.

▪ Riba leads to unjust enrichment, which further impoverishes the poor. Wealth
inequality (in terms of purchasing power) is widened. The rich become richer, and
the poor become poorer. The rich might exploit the poor. Rich might benefit from
poor.

▪ Because the primary basis of interest based lending is creditworthiness, there will be
disproportionate supply of credit to the already wealthy segments of population. –
only those with high credit ratings will get attractive loan and those with poor credit
rating have to pay high interest. Thus, domination of large enterprises leads to
demise of smaller economic units - poorer segments of the economy are at an
economic disadvantage when competing for credit to finance economic activities. As
a result, wealth and income disparities worsening.

▪ Inflexibility in a loss situation leads to bankruptcies – loss of productive potential and

unemployment.

▪ Transfer of real assets to the lenders. Most debt financing requires some form of
collateralisation in the form of real assets (real estate, equipment & machinery).
Given that with the current monetary system, bank debt is non-repayable in
aggregate due to high interest, loan defaults are unavoidable. Interest-based lending
will, by design, lead to transfer of real assets from the borrower to the lender, in the
long run.

▪ Funding not channeled to the deserving economic agents. The interest payment
made by the government can be used instead for projects that benefits the public,
poverty alleviation. The interest portion can be used to improve one’s life status and
financial stability.

▪ Riba leads to destruction and are prone to economic crisis.

Instructions to the debtors

❖ Debtors duty is to repay the loan in fulfillment of the promise or contract made with the
creditor. Willful default or procrastination in payment of due debt has been equated by the
holy prophet to injustice.

❖ Allah says in the Quran “ O you who believe! Fulfill your obligations”.

❖ Prophet Muhammad Pbuh said “ The best person among you is the one who does his best in
debt settlement”.
 ❖ The shariah allows punishment of a debtor who does not pay his debt and if he defaults
willfully, he can be arrested, punished and dealt with harshly.

Instructions for the creditors

❖ The Holy Quran encourages creditors to give more time for payment, or even to waive the
loan amount, if the debtors is in dire straits.

❖ Creditors are encourage to be polite to debtors and to waive a part of the loan.

❖ In the case of a debt with a settled due date, the creditors cannot ask for earlier repayment
so long as the debtor does not transgress the terms and conditions.

GHARAR

❖ Gharar is an Arabic word that associates with uncertainty, deception and excessive risk.

❖ Also refers to entering into a contract in absolute risk or uncertainty about the ultimate
results of the contract and the nature and /or quality and specifications of the subject
matter or the rights and obligations of the parties and uncertainty on delivery.

❖ Also when there is a lack of adequate value-relevant information or there is inadequacy and
inaccuracy of any vital information which leads to uncertainty and exploitation of any of the
parties when contracts are not drawn out in clear term.

❖ Business term: to undertake a venture blindly without sufficient knowledge or to undertake

an excessively risky transaction.

MORE ON GHARAR

 Contracting parties should have perfect knowledge of the counter values intended to be
exchanged as a result of their transactions.

 Gharar is the sales of probable items whose existence or characteristics are not certain, due
to the risky nature which makes the trade similar to gambling.

 Also occurred when subject matter, price are not determined and fixed in advance.

 Ambiguous terms in commercial contracts is one example of gharar.

 Solution: contracts need to be drafted. Practise of transparency– to avoid dispute.

Classical examples of Gharar in sales – Analogies

▪ Sale of fish still in the sea

▪ Sale of birds in the sky

▪ Sales of unborn animals

 ▪ Sales of runaway animal

▪ Sales of milk in the udder/gland of an animal without measurement

▪ Prophet Muhammad PBUH said “ Sell not what is not with you”

Avoiding Gharar

❖ The current practices in FI and insurance companies, in the futures and options market
consist elements of Gharar, interest, gambling etc.

❖ IB cannot engage in speculative trade in shares, short-selling, discounting of bills and

securities or trading in unidentified items. Trading in derivatives also involved gharar, is a
grey area for IB.

❖ Gambling presents in almost all conventional financial institution schemes/products.

Prohibition of Gharar

❖ Rationale for the prohibition of gharar

 To ensure full consent and satisfaction of the parties in a contract where without full
consent, a contract may not be valid

(Full consent may only be achieved through certainty, full knowledge, full disclosure and
transparency)

 Gharar in commercial contracts may lead to injustice, exploitation and/or enmity

among contracting parties

 To prevent weak from being exploited

 To have a crystal clear contract.

 Types of gharar
 Gharar Yasir (minor or slight)

• Tolerated and will not invalidate a contract

 Gharar Fahish (major or excessive)

• Not tolerated and may result in contract voidability

Types of Gharar
 Types of Gharar

Gharar Yasir
Gharar Fahish
(Minor
(Major Gharar)
Gharar)
Gharar Fahish (Major Gharar)

 An uncertainty which is so great that it becomes unacceptable; or

 It is so vague that there is no means of quantifying it.

 Gharar arise out of the following:

Assets or merchandise does not exist;

Assets or merchandise cannot be delivered;

Asset or merchandise is not according to the specification; and

Deferred sale in which the deferment period is unknown

Gharar Yasir (Minor Gharar)

 It is found in nearly all contracts

 If the ignorance is over an aspect of sale that is not likely to obstruct completion and
delivery, the basic purpose of the sale is fulfilled and it remains valid.

 Example:

Purchase of fruits without peeling or cutting of the skin to see the inside

Charging a fix amount for a bus fare for a certain distance even though a passenger
does not travel the whole distance.

Charging a fixed rate per night for a hotel room, even though different guest use the
different number and quantities of the services in the room.

Avoiding Gambling and Game of Chance

❖ Maisir refers to the easy acquisition of wealth by chance, whether or not deprives the
others' right.

❖ Also refers to any form of business activities where monetary gains are derived from mere
chance, speculation or conjecture.

❖ All instruments like price bond or lotteries in which coupon or tabs are given and
inducement or incentives are provided by an uncertain and unknown event depending on
 chance, or disproportionate prices are distributed by drawing of lots or where the
participating persons intend to avail themselves of chance at prizes are repugnant to the
injunctions of Islam.

❖ Gambling are present in conventional financial institution schemes/products.

DEBT VERSUS EQUITY

❖ Debt remain a part of Islamic finance but greater emphasis is on equity.

❖ Equity or partnership modes can serve as an alternative to interest in the Islamic

framework.

❖ Debt will continue to exist but must comply with the Shariah principles.

❖ Debt and Equity should be balance to create a healthy balance for the prosperity of the
economy and society.

IB : Business versus Benevolence

❖ Islamic bank are profit oriented and not a charitable organisations.

❖ Islamic bank are doing business with the available funds and passing on a part of the income
to the fund owners –depositors and investors.

❖ Islamic banks sell goods purchase by them at a profit, lease assets against rentals and share
the profit (or bear the loss) accruing from partnership based investments.

❖ They help society to develop by facilitating asset-backed investment and the supply of risk-
based capital.

❖ They can also take part in social and welfare activities.

TIME VALUE OF MONEY

❖ Time Value of Money (TVM) is not allowed in debt/ loan contract

❖ However it is allowed in sales contract

❖ WHY is it so??

Time Value of Money in sales contact

❖ The Islamic Fiqh Academy of the OIC and Shariah boards of all Islamic banks approved the
legality of time value of money in the pricing of goods which involves sales contract.
However, time value of money is not recognised at all in debt contract due to the riba
element involved.
 ❖ In sales contract, Islamic jurists allow the difference between cash and credit prices of a
commodity. It means the same goods can be sold on credit (deferred) basis at different price
(normally higher) than the cash (on the spot) transaction.

❖ What is prohibited is any addition to the price once agreed because of any delay in its
payments. This is because the commodity once sold (on credit), generates debt and belongs
to the purchaser on a permanent basis and the seller has no right to re-price a commodity
that he sold and which does not belong to him.

POINT TO NOTE!!

❖ Time value of money can be used as a guide for pricing of deferred sale, but cannot be used
to calculate late payment charges.

LAST WORDS

❖ Apart from riba, gharar and Maisir (gambling), Islam also forbids transactions involving
unjust enrichment, excessive risk, monopoly, hoarding of commodities ( with the intention
to increase the price in the market), embezzlement, trading in unlawful commodities, and
corrupt tendencies.

❖ Allah the Almighty says in Holy Quran:

“And eat up not one another’s property unjustly (in any illegal way), nor give bribery to rulers that
you may knowingly eat up a part of the property of others sinfully”.

LECTURE 3

Shariah - The concept and meaning of Shariah

❖ As a religion, Islam encompasses the total lifestyle and well being of Muslims; social,
political and economics, which are govern by shariah.

❖ The word Shariah originates from shar, which means “the path or the road leading to the
water”, and the verbs shara’a literally means “to chalk out or mark out a clear road to the
water”

❖ In other words, Shariah is the way which directs man’s life to the right path. From the word
“to the right path” came the meaning of “law”.

Thus Sharī’ah is known as ‘Islamic Law’.

▪ Commands, prohibitions, values prescribed by Allah human being either through Al-
Quran or As-Sunnah (the teachings of the Prophet Muhammad s.a.w.)

❖ The concept of Shariah encompasses not only the conduct of man in his life towards
realising the Divine Will, but also covers all behaviour –spiritual, mental and physical. This
means that the concept of shariah is greater than law, covering all aspects of living including
faith and practices, personal behaviour, legal and social matters. (EVERYTHING)
Shariah - The broader concept and meaning of Shariah

▪ Shariah: is a set of norms, values and laws that makes up the Islamic way of life.

▪ It governs all forms of practical action, comprising ibadat & muamalat

▪ General Muamalat for conduct of the civil arena.

❖ Munakahat: marriage, divorce, inheritance, guardianship and related

matters

❖ Jinayat: offences against the human body

❖ (Muamalat: conduct that cover human activities related to business, trade

and effort in accumulating wealth and means or activities related to
economic development in 3 areas (Political, Economic & Social)

▪ SHARIAH IS A SUBSTANCE, NOT MERELY BASED ON PRODUCT FORM OR NAME.

▪ THE MAIN PURPOSE OF ISLAMIC BANKING IS TO FULFILL SHARIAH REQUIREMENT, NOT

SERVING AS “ANOTHER PLATFORM” TO MAKE PROFIT.

Sources of Shariah

Major sources

❖ Al-Quran: - authentic and eternal source of shariah law. It constitutes messages that
Allah (swt) presented to the Prophet Muhammad for the guidance of mankind.
These messages are universal, eternal and fundamental.

❖ Al-Sunnah: - describes the customs, habits, sayings, deeds and approval of the
Prophet Muhammad. (the implementation and deliberation of the Quran)

❖ Ijma: the consensus of opinion of the qualified legal scholars among Muslims in a
particular time after the death of the Prophet Muhammad.

❖ Qiyas: - the process of reasoning by comparing them with similar cases already
settled by authority of the Qur’an and Sunnah.

Minor sources

❖ Ijtihad (striving or self-exertion): the sources or methodology which gives Islamic

laws its adaptability to new situations and capacity to tackle all new issues and
problems.

❖ Istihsan: method of exercising personal opinion in order to avoid any rigidity and
unfairness that might result from literal application of law.

❖ Maslahat (benefits or interest): unrestricted public interest. Considerations which

secure a benefit or prevent harm.

❖ “Urf”(well-known customary): recurring practices which are acceptable to people of

sound mind
Approach in Deriving Islamic Legal Ruling

❖ Based on premise:

‫األصل في األشياء االباحة‬

“The original ruling is permissible”

❖ Every thing is originally permissible, unless there is a clear and valid justification that suggest
otherwise (not permissible) besides taking into account the maslahah (public benefit).

❖ Thus, any conventional banking product/contract that does not have clear prohibition by
Shariah can be used in Islamic banking system.

❖ Maqasid Shariah (objective of shariah)

❖ One of the methods used to decide the permissibility of Islamic banking and finance product.

❖ Maqasid shariah is to achieve Maslahah Mursalah (public interest).

❖ Any Islamic banking and finance products that are against the public interest (harmful to
society) can be deemed as not permissible.

MAQASID SHARIAH

❖ It outlines the objectives and wisdom (hikmah) as prescribed by Shariah (Allah & His Prophet
PBUH) in all its rulings to protect and preserve the benefits and interests (maslahah) of
society.

❖ 5 elements Maqasid Syariah: protection of these five elements:

1) Nafs (Life)

2) Deen (Religion)

3) Aqal (Intellect)

4) Zuriyat (Progeny)

5) Mal (Wealth)

MASLAHAH MURSALAH (PUBLIC INTEREST)

## Maqasid shariah is to achieve Maslahah Mursalah

Maslahah mursalah is the benefits or interests for public which are deemed necessary from Syariah
perspectives. It is achieved by protecting and preserving the five elements of Maqasid Shariah.

Hadith on prohibition of wine/ alcoholic drinks

 ❖ Anas said that the Prophet Muhammad PBUH cursed ten people in connection with wine:
the wine-presser, the one who has it pressed, the one who drinks it, the one who conveys it,
the one to whom it is conveyed, the one who serves it, the one who sells it, the one who
benefits from the price paid for it, the one who buys it, and the one for whom it is bought.

Hadith on prohibition of zina, stealing and drinking wine

❖ Messenger of Allah as saying, "When one commits zina (fornication) he is not a believer,
when one steals he is not a believer, when one drinks wine he is not a believer ... " [Bukhari
& Muslim

TRADING IN ISLAM

Profit (from trade) versus interest: Permissibility versus Prohibition

❖ Allah has allowed Al-Bai' (trading) but prohibits Riba (Al-Baqarah 275).

❖ Islam signifies that the alternative to riba is trade.

❖ Bai' – exchange of one thing with another; subject matter with price . Or legally stated as
“the exchange of property for property with mutual consent of the parties, which is
completed by declaration and acceptance.”

Bai' = sales / exchange – involve all type of business

❖ For a sale to be valid, it must be free from elements of Riba (riba al-buyu), deception and/or
Gharar.

TRADING

❖ Trade is one of the commendable profession and Islam has put a tremendous emphasis on it
for the acquisition of wealth.

❖ The Prophet said” The best earnings are those of the businessman who does not tell a lie
when he speaks; does not misappropriate the trust; does not break the word if he promises;
does not cavil (find fault unnecessarily or raise unnecessary objections) while making
purchases; does not boast while selling his goods; does not prolong the period of repayment
of loan; and does not cause difficulty to his debtors!”

Types/ categories of Bai' (sales)

For the sales to be valid, it must have underlying contracts. Contract is the most fundamental
aspect in Islamic finance.

Contracts of Muamalat can be classified into:

1. Valid (Sahih).

A contract according to Islamic law .

 2. Voidable/defective (Fasid), and

Due to irregularities such as non existence of the subject matter and riba or gharar contained in the
contract. However if the cause of irregularities is removed, the contract becomes valid.

3. Invalid/void (Batil) contracts.

Contract that do not fulfill the conditions relation to offer and acceptance, subject matter,
consideration and possession or delivery or involve some illegal external attributes.

Requirement of a valid sale contract

Islamic banks have to undertake trade that is governed by Islamic Shariah.

Valid
Bai'
Condition Condition of
Conditi of Subject Delivery
on of Matter
Price
Known Existent / Physical
Vaild for
existable
Ownership /
Certain Constructive
possession
Ownership/
Risk of seller
Valuable
Usable (not
prohibited in
Shariah)

Requirement of a valid sale contract

❖ The requirement must be completely satisfied to ensure the validity of the contracts.

❖ The approved forms of bai' reflect the principles of mutual consents of the parties and
justice, with an emphasis on good manners, leniency and honesty.

❖ Buyer and seller must have an understanding and sufficient discretion, the commodity and
the price should be known to both parties.

❖ The parties must enter into a contract voluntarily with full/ free consent.

❖ Both parties must be fully competent – intellectually sound adults.

 ❖ The subject of the sale must be a property of value acceptable in shariah – it must be pure,
lawful, clean, marketable and having legal and commercial value.

❖ The seller must be the owner of the object being sold.

❖ The seller must be in the position to deliver the goods.

❖ Both parties must take notice of the object of the sale by examining or by adequate
description.

Valid sales contract requirements (cont..)

❖ The price must be precisely determined and known to the parties at finalisation of the
contract.

❖ All permissible goods can be purchased/sold on credit in exchange for cash – the counter
values not being homogenous.

❖ The credit price of a commodity can be more than its cash-n-carry price. But the price must
be precisely determined when the sales contract is completed. In the case of late payment
by the debtor in a credit sale, the seller cannot get any compensation from the buyer.

❖ Money cannot be traded as a commodity and financial transaction must be supported by

genuine trade or business-related activities.

CONTRACTS AND INSTRUMENTS

❖ ‘Contracts’ are agreements between parties based on their free consent, reciprocal
consideration and a lawful object.

❖ ‘Instruments’ are the documental outcome of contracts that are saleable in the market.

❖ Contracts are drawn to ensure the existence of clearly recognised guidelines for all parties
involved. Contracts state the standing of all those involved and the conditions of the
transactions that are to take place

WHAT IS ‘AQAD (CONTRACT)

❖ ‘Aqad can be translated as “contract”.

❖ Barbati defined “aqad” as:

“Legal relationship created by the conjunction of two declarations, from which flow legal
consequences with regard to the subject matter”.

❖ Definition defines the essential elements of an ‘aqad:

1. The contracting parties;

2. The offer (ijab) and acceptance (qabul);

3. The consideration; and

4. The subject matter of ‘aqad.

Essential elements of a valid contract

. ISLAMIC CONTRACT must consist of the following elements

1. Offer and Acceptance:

Necessary conditions:

a. The acceptance must conforms to the offer in all its details

b. Must be executed in the same session

c. The capacity of the person must be mentally competent

d. Offer to remain open until it is accepted, rejected, retracted or has expired.

2. Subject matter of the contract:

Necessary conditions:

a. Legal and not prohibited by Shariah

b. Existence – the object must be legally own by the parties

c. Delivery – objects should be able to be delivered to the buyer at the time of

contract

d. Determination – the object must be known to the parties – its essence,

quantity and value

3. Consideration / Price

Necessary conditions:

a. Must be something which is customary accepted as medium of exchange.

b. Must be a valuable commodity. The most popular: money.

4. Capacities of the parties to contract Necessary conditions:

a. The parties must be competent to make a contract.

b. Physical and intellectual maturity – reached age of puberty (to avoid coercion)

Broad rules for the validity of Muamalat

1. Free Mutual consent.

Consent obtained through oppression, fraud and misperception renders a contract invalid. All parties
must have certain and define knowledge of the subject matter of the contract and the right and
obligation arising from it. Goods should be inspected especially in credit sales. False bidding,
charging exorbitant prices, taking advantages of an ignorant parties and concealing material defect
in the goods are strictly prohibited.

2. Prohibition of Gharar

Must be free from excessive uncertainty (Gharar) about the subject matter or the consideration
(price) given in exchange. Therefore subject matter must exist at the time of sale.

3. Avoiding Riba

Any excess or increase without corresponding consideration in an exchange of an asset for another
asset is consider riba.

3. Avoiding Qimar and Maisir (Games of Chance)

Qimar includes every form of gain or money, the acquisition depends purely on luck and chance.

Maisir means getting something or profit without working for it.

Lotteries and price schemes based on purely on luck are prohibited.

5. Prohibition of two mutually contingent contracts

Sales of two items in such a way that one who intends to purchase an item is obligated to purchase
the other also an any given price. To avoid this prohibition, a contract of sale must relate to only one
transaction and different contract should not be mixed.

6. Conformity of contracts with the Maqasid of Shariah

Any contract should not be against the benefits of the public at large.

7. Profit with liability

A person can only profit when he bears the risk of loss in business. Any excess over and above the
principal sum paid to the creditor by the debtor is prohibited because the creditor does not bear any
business risk with regard to the amount lent.

8. Permissibility as a general rule

Everything that is not prohibited is permissible. All agreements and conditions in a contract are
permissible as long as they do not contradict any explicit text of the Quran and Sunnah.

Mal (Wealth), Usufruct and ownership

❖ Contracts deal with goods/wealth (Mal), usufruct of goods and transfer of ownership of the
goods/usufruct from one to another party.
 ❖ Wealth is anything that is useable and has legal and material value for the people. It means
that anything considered Mal from a juristic point of view should be of value, possess able
and it should have a legitimate use.

❖ Money is also Mal. It serves as a medium of exchange or the standard by which the value of
other goods is measured but in itself is not a subject matter of sale.

❖ Ownership can be acquired through contracts such as:

▪ Ownership of assets (Milk ul’Ain) -

▪ Ownership of a debt (Milk ul Dayn)

▪ Ownership of usufruct (Milk ul Manfa’at)

❖ If a person gets ownership of the asset, he gets ownership of its manfa’at also but not the
other way around – getting usufruct of something does not mean ownership of the asset
itself as in the case of Ijarah where usufruct is transferred to the lessee and the ownership
remains with the lessor.

❖ The concept of transfer of ownership of an asset is very important as it determines the

liability, right, risk and reward for Islamic bank in their asset-based operations

ISLAMIC FINANCIAL SYSTEM ETHICS

Financial system must be fair and ethical to all participants.

❖ Seven classes of fairness relevant to financial system:

1. Freedom from coercion

2. Freedom from Misrepresentation

3. Right to Adequate and Accurate Information

4. Right to Equal Information Processing Power

5. Freedom from Impulse

6. Right to trade at Efficient Prices

7. Right to Equal bargaining Power

1. Freedom from coercion

Contracting parties have the right not to be coerced into a transaction. A transaction is fair if it is
backed by the free will of all the parties to the contract.

2. Freedom from Misrepresentation

Contracting parties have the right to rely on information voluntarily disclosed as truthful. If
deliberate disclosure of wrong information, then a claim can be made against the provider of
information.

3. Right to Adequate and Accurate information

Contracting parties are entitles to equal access to a particular set of information. A party in
possession of a specific set of value relevant information is forced to disclose it to others. Release of
inaccurate information is forbidden. The contract can become void.

4. Right to Equal Information Processing Power

This right entitles contracting parties not only to equal access to a common set of information but
also to disclosure of information in a “processed” form or prohibition of certain transactions where
certain groups of investors may be at an information processing disadvantage.

5. Freedom from Impulse

This right entitles contracting parties to protection from imperfect self-control. Example: forced to
make on the spot decision without freedom to have a deep thought on a certain decision.

6. Right to trade at Efficient Prices

This right entitles contracting parties to trade at prices they perceive as efficient or correct. The
alternative is to let prices adjust by whatever amount necessary to equate supply and demand by
investors, even if this process creates excessive volatility.

7. Right to Equal bargaining Power

This right entitles contracting parties equal power in negotiations leading to a transaction. Unequal
bargaining power can occur when one party to the transaction has deficiencies in information
processing or imperfect self-control.