Principles and Practices
Islamic Banking and Finance (MFS 608)

Assoc. Prof. Dr. Mohd Fuad Mohd Salleh Dr. 11th. November 2012


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Shari`ah Principles in Islamic Financing
General Principles in Islamic Mu`amalah
All exchange should be with consent of the parties concerned Full ownership and eligibility of the contractual parties – voluntary, no misstatements and no mistakes The contract object must be clearly mentioned: the types, the amount, can be surrended, useful and clean (pure) according to Islamic Shari`ah Free from riba’, game of chance (al-maisir), preventable ambiguity or uncertainty (al-gharar) and other prohibited action Free from oppression: excessive profit (Ghabn al-Fahsy), hoard (Ihtikar), blockade from the market (Talaqqi al-Rukban).

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The Four Basic Foundations of Islamic Economy:
Economic peace in the Islamic norms framework Brotherhood and just The fare distribution of wealth Individual freedom to gain social welfare

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The Uniqueness of IFS
Faith based (believe in Allah) No interest (Riba’) – credit is basic human right cooperation between capital owner and entrepreneurs in the production process Investment based on actual market price (tangible assets) Socially responsible Environmentally compliant Ethical (share risk, share profits and losses) Helping people free themselves from debt
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Prohibited Elements
1. Interest (Riba’) What is interest?
In the Islamic terminology interest means effortless profit or that profit which comes free from compensation or that extra earning obtained that is free of exchange.

What is Riba’?
Riba` is a loan with the condition that the borrower will return to the lender more than and better than the quantity borrowed

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Why Riba’ is Prohibited

1. It is Allah’s commandment Surah Al-baqarah verse no.275 "Those who devour usury will not stand except as stands one whom the Satan by his touch has driven to madness. That is because they say, "trade is like usury", but Allah has permitted trade and has forbidden usury", verse 276 in the same place he says, "Allah will deprive usury of all blessing, and will give increase for deeds of charity, for he does not love any ungrateful sinner."
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Al-Baqarah, verse 278 - 279, Surah Aal-Imran, verse 130 Surah Al-Nisaa’, verse 161, Surah Al-Ruum, verse 39 From Al-Hadith (the saying of Prophet)
Hazrat Abu Hurairah Radiyallahu anhu reported that the Holy Prophet Sallallahu Alaihi Wasallam said: A time will certainly come over the people when none will remain who will not devour usury. If he does not devour it, its vapour will overtake him. (Ahmed, Abu Dawood, Nisai, Ibn Majah.)

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Why Riba’ is Prohibited
2. Unfair distribution of wealth Only Banks make money 3. Deterrence of economic development Promote laziness Less utilization of assets 4. An operession Illegal – unwillingness to transfer assets by owner 4. Possibilities of borrower to become poorer

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Equity Financing (Sharing of capital) Al-Sharikah Al-Mudharabah Debt Financing (Loan) Al-Murabahah Al-Qard al-Hassan

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Al-Sharikah (Partnership Contract)

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Definition: A contract between two or more parties, entrepreneur and investor, who share their capital, reputation, or expertise to share profit and loss. Two Catagories: i. ii. Sharikah al-`Aqd or al-`Uqud – contract between two parties to share capital or assets Sharikah al-Milk or al-Amlak – ownership on an assets by two parties without using as-Sharikah contract.

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Three Types of Sharikah al-Aqd :

Assets Partnership (Sharikah al-Amwal) capital sharing in terms of assets. ii. Labor Partnership (Sharikah al-Amal or alAbdan) capital sharing in terms of expertise or skills. iii. Reputation Partnership (Sharikah al-Wujuh) capital sharing in terms of reputation or goodwill.

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Methods of Al-Sharikah : Hanafi Sharikah al-Mufawadah Equal share or contribution, profit sharing and management. Each shareholder become a gurantor to each other. Maliki Sharikah al-Inan Sharing of assets or capital to run a business and profit will be shared amongst themselves.

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AL-MUDHARABAH (Profit Sharing Contract)

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- An equity based - A contract between two person for trade purposes. Capital owner (Rabb al-Mal) give the capital to another party (Mudaarib) for involvement in trade, on agreement that profit is to be shared between them. - Eg. Prophet Muhammad (PBUH) befoe he became a prophet was entrusted a capital by Khadijah to do business in Shams (Syria). He used Mudharabah method.

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Two Types of Mudharabah
1) Total/Complete (al-Mutlaqah) where the assets or capital are given to be used in business without any restriction or condition. 2) Conditional/restricted (al-Muqayyadah) the assets or capital are given with some restrictions or conditions.





Bay’ al-Murabahah (cost plus) . alBay’ alBay’ al-Salam (future contract or deferreddeferreddelivery sale) Bay’ al-Istisna’ Bay’ al-Istisna’ (contract to build or make) al-Ijarah (Leasing) alBay’ bi-Thaman ‘Ajil or Bay’ al-Mu’ajjal bialor Bay’ al-Taqsit (Deferred / installment payment) alQard al-Hassan al-

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Borrower need only to repay the total loan (principle) without any additional amount. No profit The only loan type permitted by Shari`ah. The purpose is for economic and social justice. Loan is only to help the people who are in need.. Islam encourage the borrower to pay more as a gift and not determined by the money-lender.

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Flexibility of Islamic finance
• It is not dogmatic rule-making. • Attitude is: “how can we make this happen?”, “Lets do business.” • Exceptions are permitted (but not encouraged) when no alternatives exist.
– Example: Investing in the common stock of leveraged firms is permitted, but the amount of leverage permitted is limited and that portion of investor return must be “purified.”


The Islamic Market
• 20% of the world population. • Not just “furriners” – domestically, between 6 million and 8 million people. • 2.3 million households. • Rapid growth – 6% annual. • Young, highly educated, professional. • Affluent - above average income.


Equity Investing
• Acceptable if the firm does not engage in prohibited practices mentioned above. • Some leeway is possible – previous mention of riba. • Dow Jones Islamic Indexes. • Listing of firms providing Islamic investments in bibliography.


Sukuk – Islamic “Bonds”
• Conventional bonds are riba, and are forbidden. • But, again, a transacation structured on an asset base is permitted. • A series of payments arising from an asset-based transaction may be traded at a market price! • This type of arrangement is referred to as Sukuk, sometimes called “Islamic bonds.”


Takaful - Islamic Insurance
Principle of gharar, or avoidance of risk / uncertainty / gambling. Gharar does not apply to reasonable, unavoidable business risk. Also, standard Insurance contracts often have interest component. It is quite acceptable, however, to form a mutual group for self-help and risk avoidance.


Takaful - Islamic Insurance
Resolution of the problem is that the mutual form of insurance can be made Islamically acceptable. Stock Insurance companies are not acceptable.


Islamic finance is not just for Muslims! Already a sizeable but underserved market, both domestic and international. Rapidly growing and developing. Opportunity to do well while doing good!


“The best of people are those who benefit others the most” (Hadeeth)

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That’s it for today…

Thank You… Wassalam
Mohd Fuad May 2010

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