Fiqh-ul-Mauamlat 12th Week

Islamic Banking and Finance

Islamic bankingis the banking that is consistent with the principles of shariah (Islamic law) and its
practical application through the development ofIslamic economics. A more correct term for Islamic
banking is shariah-compliant finance. Shariah prohibits acceptance of specific interest or fees for loans of
money (known as riba, or usury), whether the payment is fixed or floating. Although these prohibitions
have been applied historically in varying degrees in Muslim countries/communities to prevent un-Islamic
practices, only in the late 20th century were a number of Islamic banks formed to apply these principles
to privateor semi-private commercial institutions within the Muslim community. As of 2014, shariah-
compliant financial institutions represented approximately 1% of total world assets. By 2009, there were
over 300 banks and 250mutual fundsaround the world complying with Islamic principles and as of 2014
total assets of around $2 trillion were shariah-compliant. Although Islamic banking still makes up only a
fraction of the banking assets of Muslims, it has been growing faster than banking assets as a whole,
growing at an annual rate of 17.6% between 2009 and 2013, and is projected to grow by an average of
19.7% a year to 2018. The contemporary movement of Islamic finance is based on the belief that "all
forms of interest are riba and hence prohibited". In addition, Islamic law prohibits investing in businesses
that are considered unlawful, or haraam (such as businesses that sell alcohol or pork, or businesses that
produce media such as gossip columns or pornography, which are contrary to Islamic values).
Furthermore, the Shariah prohibits what is called "Maysir" and "Gharar". Maysir is involved in contracts
where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the
future whereas Gharar describes speculative transactions. Both concepts involve excessive risk and are
supposed to foster uncertainty and fraudulent behaviour. Therefore, the use of all conventional derivative
instruments is impossible in Islamic banking. In the late 20th century, a number of Islamic banks were
created to cater to this particular banking market. Islamic banking has the same purpose as conventional
banking: to make money for the banking institute by lending out capital while adhering to Islamic law.
Because Islam forbids simply lending out money at interest, Islamic rules on transactions have been
created to prevent it. The basic principle of Islamic banking is based on risk-sharing which is a
component of trade rather than risk-transfer which is seen in conventional banking. Islamic banking
introduces concepts such asprofit sharing(Mudharabah), safekeeping (Wadiah),joint
venture(Musharakah), cost plus (Murabahah), and leasing(Ijar).
Usury in Islam:

The word "riba" literally means “excess" or "addition”, and has been translated as interest, usury, excess,
increase or addition. According to Shariah terminology, it implies any excess compensation without due
consideration (consideration does not include time value of money). In Surah al-Baqarah, verse 275,
Allah said:
“Allah has permitted trading and forbidden usury”.
Also in the same surah, verse 278:

“O you who have believed, fear Allah and give up what remains [due to you] of interest, if you should
be believers.”

In Sahih Muslim, chapter Al Riba, there is a Hadith:

 “Allah has imprecated Usurer, the one who writes Usury Contract documents, and its witnesses and
said all of equal in Allah‘s imprecation”.
By the time of Caliph Umar (may Allah be pleased with him), the prohibition of interest was a well-
established working principle integrated into the Islamic economic system. This interpretation of usury
has not been universally accepted or even not applied in the Islamic world.

Business Laws and Financial Transactions in Islam

1. Aqad (contract):

As a general term, it means a commitment between two parties. It is forbidden in Islam for a single
contract to cover more than one agreement asthis defeats many attempts to make Western financial deals
Sharia compliant.
2. Bay al ‘inah (sale and buy-back agreement):
Literally, it means "A loan in the form of a sale". Bay al inah is a financing arrangement where the
financier buys an asset from the customer on spot basis, with the price paid by the financier constituting
the "loan". Subsequently, the asset is sold back to the customer with deferred payment made in
installments, constituting paying back the loan.
3. Bay’ bithaman ajil (deferred payment sale):
This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit
margin agreed to by both parties. Like Bay’ al 'inah, this concept is also used under an Islamic financing
facility. Interest payment can be avoided as the customer is paying the sale price which is not the same as
interest charged on a loan. The problem here is that this includes linking two transactions in one which is
forbidden in Islam. The common perception is that this is simply straightforward charging of interest
disguised as a sale.
4. Bay’ muajjal (credit sale):
Literally bay’ muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic
banks that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin
on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump
sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is
mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot
price or higher or lower than the spot price. Bay’ muajjal is also called a deferred-payment sale. This is
the case where a bank acts as a retailer as the bank earns a profit for a margin on the purchase price of the
commodity and resells it to the borrower at a higher price, and the customer is invoiced to pay this at a
later date.
5. Mudarabah:
"Mudaraba" or Profit-and-loss sharing contract is a kind of partnership where one partner gives money to
another for investing it in a commercial enterprise. The capital investment should normally come from
both partners. The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the
capital and the other party providing its specialized knowledge to invest the capital and manage the
investment project. Profits generated are shared between the parties according to a pre-agreed ratio. If
there is a loss, the first partner "rabb-ul-mal" will lose his capital, and the other party "mudarib" will lose
the time and effort invested in the project. The profit is usually shared 50%-50% or 60%-40% for rabb-ul-
mal.
 6. Murabahah:
This concept refers to the sale of good(s) (such as real estate, commodities, or a vehicle) where the
purchase and selling price, other costs, and the profit margin are clearly stated at the time of the sale
agreement. With the rise of Islamic banking since 1975, Murabahah has become "the most prevalent"
Islamic financing mechanism.Murabahah works as finance when the lender/buyer pays the bank/seller for
the good(s) over a period of time, compensating the bank/seller for the time value of its money in the
form of "profit" not interest.[93] With a fixed rate of profit determined by the profit margin for the purchase
of a real asset, this is a fixed-income loan. The bank is not compensated for the time value of money
outside of the contracted term (i.e., the bank cannot charge additional profit on late payments); however,
the asset remains as a mortgage with the bank until the default is settled.
7. Musawamah:
If the exact cost of the item(s) sold to the lender/buyer cannot be or are not ascertained, a financial
transaction cannot be done on the basis of Murabahah, it is calledmusawamah(bargaining). Musawamahis
the negotiation of a selling price between two parties without reference by the seller to either costs or
asking price. While the seller may or may not have full knowledge of the cost of the item being
negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This
difference in obligation by the seller is the key distinction between Murabahah and Musawamah with all
other rules as described in Murabahah remaining the same. Musawamah is the most common type of
trading negotiation seen in Islamic commerce.
8. Bai Salam:
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The
seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance
price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be
purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods
and cannot be gold, silver, or currencies based on these metals. Barring this, Bai Salam covers almost
everything that is capable of being definitely described as to quantity, quality, and workmanship.
9. Hibah (gift):
This is a token given voluntarily by a debtor in return for a loan. Hibah usually arises when Islamic banks
pay their customers a 'gift' on savings account balances, representing a portion of the profit made lending
funds from savings account balances. Unlike interest and like dividends on shares of stock, Hibah cannot
be guaranteed. Additionally, it is not time bound.
10. Istisna:
Istisna (Manufacturing Finance) is a process where payments are made in stages to facilitate the work of
manufacturing / processing / construction. An installment of Istisna, for example, may enable a
construction company to finance construction of sections of a building or help manufacturers pay for an
order of raw materials. Istisna helps use of limited funds to develop higher value goods/assets in different
stages / contracts.
11. Ijarah:
Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or
service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of
service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.
12. Musharakah (joint venture):
Musharakah is a relationship between two parties or more that contribute capital to a business and divide
the net profit and loss pro rata. This is often used in investment projects, letters of credit, and the purchase
or real estate or property. In the case of real estate or property, the bank assess an  imputed rent and will
share it as agreed in advance. All providers of capital are entitled to participate in management, but not
necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the
loss is borne by each partner strictly in proportion to respective capital contributions. This concept is
distinct from fixed-income investing (i.e. issuance of loans).
13. Qard hassan (good loan):
Qard hassan is a loan extended on a goodwill basis, with the debtor only required to repay the amount
borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal
amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the
debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some
Muslims consider this to be the only type of loan that does not violate the prohibition on riba, for it alone
is a loan that truly does not compensate the creditor for the time value of money.
14. Sukuk (Islamic bonds):
Sukuk, plural of Sakk, is the Arabic name for financial certificates that share some similarities with
conventional bonds hence are also commonly referred to as Islamic Bonds. A major difference between
conventional bonds and sukuk is the structure of sukuk removes interest based elements which is replaced
by an asset based income structure using most typically Ijara or Wakala contracts.
15. Tawarruq:
(Literally "turns into silver") A product where a client customer buys an asset at a marked up price that is
easily saleable and quickly sell the asset to raise cash. For example, a client might buy $1,000 worth of a
commodity like iron from a bank, on condition he/she does not have to pay for it until 12 months later and
then immediately sell the metal back to the bank for $900 to be paid immediately. (This would be the
equivalent of borrowing $900 for a year at an interest rate of 11 per cent.) The product allows clients to
raise money quickly and easily, in theory without breaking Muslim bans on interest.
16. Takaful (Islamic insurance):
Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to
misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to
be uncertain with respect to a very large number of similar individuals. Insurance by combining the risks
of many people enables each individual to enjoy the advantage provided by the law of large numbers.
17. Wadiah (safekeeping):
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the
bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when
the depositor demands it. The depositor, at the bank's discretion, may be rewarded with Hibah(see above)
as a form of appreciation for the use of funds by the bank.
18. Wakalah (power of attorney):
This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar to
a power of attorney.