Islamic Banking

CHAPTER I: INTRODUCTION.
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A. A. BACKGROUND OF THE STUDY:
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Islam is the world’s second largest religion having an estimated 1.8 billion believers around the Numbering Style: A, B, C, … + Start at: 1 + Alignment:
world. This amounts to 24% of the world’s population. Of all major religions, the faith continues to Left + Aligned at: 0.25" + Indent at: 0.5"
grow in number of believers. It is projected that by the end of 2060, it will increase about 70% Formatted: Font color: Auto
more of its current number (Lipka & Hackett, 2017).Since the Muslim population across the world
has increased and still continues to increase, Muslims are inevitably participating and contributing
towards the economy.
Muslims are governed by Islam in their day to day activities. Islam, Unlike any other religions of
the world, governs not only the spiritual life of its followers but also their social, political, cultural
and economic life. Under Islam, there is no separation between business and religion. Therefore,
to participate in the economy, Muslims must follow economic laws and rules that their faith
mandates. However, doing so creates a conflict between the current existing economic systems
in place. More often than not, these conventional systems deal with products which are not
allowed by the Islamic holy text the Qur’an, or have aspects to them which are at odds with the
tenets of the faith. Naturally, Muslims seek an alternate system of finance; a financial system that
will make it viable for them to actively participate and contribute towards the economy and also
promote the tenets of the religion. Thus the system of Islamic Finance came into being.
Islamic finance is an economic system that tries to merge both the economic policies of today Formatted: Normal, Space Before: 0 pt, After: 0 pt
with the moral and ethical considerations of the Islamic faith. Islamic Finance has been quite
successful in various countries around the world. In this vein, Islamic banking continues to develop
and expand. Currently Islamic banking is a fast-growing financial industry. Because of its economic Formatted: Font: (Default) Times New Roman, Font
advantages, many countries have begun to integrate it into their banking system. It’s interest-free character color: Auto
is the magnetic force that attracts investors and customers to patronize Islamic products and services. While
an old system of finance, Islamic banking as we know it today is new. It has similarities with conventional
banking but it is still a different kind of animal from banking as we know it. Formatted: Font color: Auto
Islamic banking is regarded as a good alternative to conventional banking. Its structure is efficient,
effective and resilient to the crises that conventional banking encounter. Islamic banking functions on a
risk-sharing basis (Khan & Bhatti, 2008). In contrast to conventional banking, Islamic banking is interest-
free. Under this type of banking system, there is no riba or interest because the teachings of the Quran
regard riba as sinful. According to Khan & Bhatti (2008), “this allows market forces to determine the
productivities of capital”. Focusing on the productivities of capital and investing more on real assets rather
than on financial assets, it is more economically stable than conventional banking. Furthermore, putting
an interest rate sabotages the free market mechanism and encourages speculative use and hoarding of
capital. Being a value-based system, Islamic banking ensures economic growth and envisions socio-
economic justice in all of its transactions. Its goal is not to maximize capital but to maximize human
welfare.
Because of the advantages of the Islamic banking system, there is an effort to explore it in Canada. Canada’s Formatted: Font color: Auto
banking system is the most effective and safest banking system in the world. Because of this trend, as well
as the growing population and prominence of the Muslim community in Canada, Canada is eyed as the next
western Islamic banking hub. In connection with this, it is important to note that successful integration of
Islamic banking in the United Kingdom serves as a benchmark and guide for other western countries that
seek in offering Islamic finance.
The United Kingdom has a reputation of being one of the worlds financial centers. Its integration if Islamic
finance into its banking system has reinforced this position in global finance. Outside of the Muslim world,
it is the leading center of Islamic banking with more than $5bn UK based institutions offering Islamic
finance services. For Islamic banking to be successful in Canada, it must follow the example of the United
Kingdom. As of now, Islamic finance education and integration of shariah compliant financial products
are a few developments of Islamic banking in Canada. However, despite these developments, Islamic
banking in Canada is still remote and limited. Without existing laws and regulations to govern the system,
it is difficult to adopt in a country that is well-known for its rigid banking rules. Despite the fact that Islamic
mortgages have existed in Canada, the system has not developed to an extent that is similar to the UK.
Banking laws and taxation regulations in Canada might be an obstacle. These statutes and rules are based
on secular principles and not based on scripture. Shariah compliant principles are outside of the province
of these laws. Made by people who have no knowledge in Islamic banking, this will surely conflict with
some of the policies inherent in Islamic banking.
Looking into bank regulations and related laws is important in determining possible structural developments
the banking sector in Canada has to integrate to accommodate the Islamic banking Industry. According to
various feasibility studies conducted by various researchers, looking into the existing rules and identifying
the issues that might be encountered will help in opening the door to Islamic banking.
Banks play a major role in a country’s economy. It is the agent that ensures the efficiency, effectiveness
and health of the financial sector. These laws and regulations exist to protect the shareholders, stakeholders,
and investors. Banking regulation and supervision are important in the growth of Islamic banking. Most
feasibility studies explored legal issues that may prevent the integration of Islamic banking in the country.
By pinpointing such laws, they identified the appropriate amendments for these laws to establish and
regulate the Islamic banking alongside conventional banking. Lujja, Mohammad, Haddan and Oseni (2016)
found that for this to be possible, the laws that prohibit commercial banks from engaging in trade,
commerce, industry, and agriculture must be amended. These are the core activities of Islamic banking,
only if such laws are amended can Islamic banking be allowed to grow in the country. Furthermore, most
of the shariah compliant contracts require Islamic banks to own assets before transferring them to the
customers. This is one of the legal concerns for adopting Islamic banking pinpointed by Graham (2014).
Under the Canadian banking law, there are not allowed to own real properties. Since almost all transactions
involving money are taxed. Moreover, tax regulations should also be modified to accommodate shariah
compliant contracts.
There are a lot of factors that contribute to the success of integration. One of these factors is the political Formatted: Font: 11 pt, Font color: Auto
nature of the country and the flexibility of its legal system (Farah, 2019). One of the most important factors
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to make integration possible is the enactment of laws that address Islamic banking. IN the case of the UK,
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it was easy to adopt the financial regulatory framework on trust law and the application of equity principles
(Farah, 2019. This was mainly due to the fact that British laws are not a rigid set of rules. Rather, these are
laws and regulations that have been created in relation to their experiences as a nation that is why it is
flexible. In the case of Malaysia on the other hand, to cater to the needs of the community, it created laws
and rules to accommodate both conventional banking and Islamic banking. But the enactment of laws does
not in of itself resolve the problem of integration. Formatted: Font color: Auto
Many countries have population composed of believers of multiple religions, therefore

universalizing tax policies to include transactions of both conventional and alternative
systems of finance which are based on a religion is quite difficult. Adding to that is the
problem arising from the interpretation of the Sharia’h law. Interpretation of the nuances
of the Islamic law is already quite complex and varies from scholar to scholar across the
world. Other challenges include insufficient knowledge of the specific features of Islamic
financial products, lack of necessary resources to accommodate Islamic financial
products into the economy, and possible delays in the rulings on tax issues due to
technical, interpretive, and policy concerns that need to be addressed.
One of the reasons why Islamic banking has been successful in the United Kingdom is the spread Formatted: Normal (Web), Space Before: 12 pt, After:
of awareness to Islamic banking. This is possible through the help of the Muslim community. 12 pt
According to the CIA factbook, 4.4% of the population in the United Kingdom are Muslims. This
is more than the 3.2% Muslim population in Canadam, but the number is not far behind.
Out of the potential Western countries that can become global leaders in the promotion and
practice of Islamic Finance, Canada arguably shows the best promise. The North American
country is one of the most culturally diverse and economically robust states in the world. Canada’s
strategic location makes it a connecting link between the economies of the US, Asia, Africa,
Europe and the Middle East, and a wealth of natural resources and open, ambitious and
competitive fiscal policies make this country one of the richest in providing opportunities for
investments in Sharia’h compliant financial products.
The Muslim community in Canada is increasing prominents. Because of its expanding Muslim Formatted: Font color: Auto
population there is an increasing requirement of Sharia’h compliant financial products as well as
the need for institutions that would provide Islamic Financial transactions and deal with manage
such assets locally and globally. (Thiagaraja, Morgan, Tebbutt, & Chan, 2014).
According to the World Economic Forum, Canada is home to one of the world’s most effective Formatted: Font color: Auto
and safest banking systems, home to six of the world’s top ten safest banks. The country also
ranks in the world’s top ten countries for investor protection, according to the World Bank
statistics. (Strength of Investor protection, 2017). The country has a national banking system with
more than 8000 branches, a very strong and stable domestic economy, and is one of the only 2
countries in the G-7 to enjoy an AAA credit rating by the big three credit agencies (Standards &
Poors, Fitch, and Moody’s). Toronto, the country’s financial hub, is projected to be the leader in
North American and global efforts to integrate Islamic Finance into the current economy.
(Graham, 2015).
The country’s financial sector practices a socially responsible policy, not unlike that of the Islamic Formatted: Font color: Auto
Financial System. In this regard, the Canadian financial asset managers have a huge wealth of
experience, including working in some of the largest responsible investments under Islamic
finance in the world. (Canada Islamic Finance Outlook 2016, 2016). The country is home to
Manulife and Sun Life, two of the world’s top ten largest life insurers, which have a significant
presence in Asian markets and have experience in Sharia’h compliant transactions and Islamic
financial models. Canada also has significant financial relationships and trade links with Muslim-
majority countries of the world, primarily through its export of food items. This international
connection also makes the country a land of opportunity for investors in Islamic financial products,
as most of the markets that Canada exports commodities to, are where Islamic system of finance
has a strong presence.
However, the integration of Islamic products into mainstream financial policies in Canada still Formatted: Font color: Auto
remains a challenge. Canadian financial sector policies are the best regulated in the world. This,
though provides a strong and fair market for Islamic Finance to flourish in, also makes it harder
for the adaptation of Islamic finance. These strongly controlled and regulated financial policies
may also impact the requirements of alternative financial products to be viable in the economy
that may result in an uneven playing field where to compete with their financial counterparts.
(KMPG, 2012). Another potential challenge is that of the varying levels of commitment shown by
the investors in understanding the nuances and adhering to the principles of Islamic Finance while
investing in Sharia’h compliant financial products in the country.
While the government of Canada has taken several steps towards facilitating the introduction, Formatted: Font color: Auto
promotion and sustenance of this alternative financial system in the economy, significant changes
are still needed to make this a success story, especially in the area of fiscal policy. In this regard,
lessons from current leaders in the field, such as the United Kingdom and Hong Kong in their
experiences with implementing Islamic financial system and integrating it with their established
fiscal policies will go a long way in realizing the opportunities that are promised by the Islamic
System of Finance.
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Islam is the world’s second largest religion having an With an estimated 1.8 billion believers
around the world. This a, or around 24% mounts to 24% of the world’s population. Of all major Formatted: Font color: Auto
religions, the faith continues to grow in number of believers. It is projected that by the end of 2060,
it will increase about 70% more of its current number , Islam is the world’s second largest religion.
Not only that, the faith is the fastest growing of all the major religions too, with the number of
believers estimated to grow by about 70% of the current number by the end of 2060. (Lipka &
Hackett, 2017).Since the Muslim population across the world has increased and still continues to
increase, Muslims are inevitably participating and contributing towards the economy.
Muslims are governed by Islam in their day to day activities. Islam, Formatted: Font: (Default) Arial, 11 pt
As the Muslim population across the world rises rapidly, so does rise their interest in participating Formatted: Font color: Auto
and contributing towards the economy, both of their country of residence as well as the world
economy as whole. However, Islam, unlikeUnlike all any other religions of the world, governs not
only the spiritual life of its followers but also their social, political, cultural and economic life. Under
Islam, there is no separation between business and religion. is a set of tenets that governs not
only the spiritual life of its followers but also their social, political, cultural and economic life as
well. One cannot look at a particular aspect of a Muslim’s life without considering the impact
his/her faith has on it. Therefore, to participate in the economy, Muslims must follow economic
laws and rules that their faith mandates. This creates conflicts between the current existing
economic systems in place because more often than not, these conventional systems deal with
products which are not allowed by the Islamic holy text the Qur’an, or have aspects to them which
are at odds with the tenets of the faith.
Naturally Formatted: Font: (Default) Arial, 11 pt
Therefore, naturally, Muslims seek an alternate system of finance; a. A financial system that will Formatted: Font color: Auto
not only adhere to the teachings of Islam, makeing it viable for them to actively participate and
contribute towards the economy, but and also promote the tenets of the religion. To fulfill these
requirements,Thus the system of Islamic Finance has come into being.
Islamic finance is essentially an economic system that tries to merge both the economic policies
in vogueof today with the moral and ethical considerations of the Islamic faith. Islamic Finance ,
and has been quite successful in doing so in various countries around the world.
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The core concept of Islamic Finance or Sharia’h Compliant Finance is quite simple. Finance is Formatted: Font color: Auto
described as being ‘Islamic’ when it complies with the Islamic law or Sharia’h, which is a set of
moral codes laid out in the Qur’an and the writings about of the prophet Mohammed.
Muslims believe that their religion’s major aim is to direct and guide humanity to the realization of Formatted: Font color: Auto
its moral potential. For that reason, the first scholars of Islam undertook the creation of Sharia’h.
Sharia’h refers to the commands, prohibitions, guidance and principles under Islam that a believer
must follow in order to obtain spiritual enlightenment in this world, and peace in the afterlife. In
Islam, and to its believers the Muslims, the Sharia’h provides guidance in terms of moral conduct
and practical rulings or laws. Not only that, it through injectings its principles of good social
conduct into its legal prescriptions. This leads to these moral values finding their way to being
incorporated as legal requirements in some specific financial conducts and contracts such as, for
example, Amanah (honesty) in Murabahah financing. Other important principles of moral values Formatted: Font: Italic, Font color: Auto
pertaining to commercial transactions under the Islamic law include:
• The maintaining of timeliness in the payment of debt or delivery of an asset; failure of which may Formatted: Font: Italic, Font color: Auto
involve legal consequences. Formatted: Font color: Auto
• Tolerance in terms of bargaining where the participating parties should be considerate of each
other’s financial requirements and circumstances to reach to a mutually beneficial agreement
regarding the transaction. Formatted: Font color: Auto
• Mutual revocation of a contract on request by one party if they find themselves uncomfortable Formatted: Font color: Auto
with the outcome of a particular transaction.
• Honesty or Amanah in all statements, warranties and representations. Formatted: Font color: Auto
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Therefore, Islamic system of finance is an economic system which makes financial transactions
possible for Muslims while adhering to, following and promoting the Sharia’h law and the Islamic Formatted: Font color: Auto
faith as a whole. Just like conventional financial systems we have in place today, Islamic finance Formatted: Font color: Auto
also features banks, investment firms and insurance companies. However, unlike the former,
Islamic financial systems are not only not only do each of these are governed by the rules and
regulations of the financial industry and judicial systems of the country like their conventional
counterparts, but also by the rules and mandates laid down by the Islamic law. For example,
according to the Sharia’h, ‘making money from money’ is forbidden, as is , same as when dealing
in products which are considered haram to the followers of the faith. Therefore,In this connection, Formatted: Font: Italic, Font color: Auto
in Islamic Finance, banks can’t charge their clients interest on their products, as under the Islamic
law, interest is seen as a means of exploitation of the client. Neither can a transaction based on
speculation be enacted. These unique aspects of the financial system makes it fundamentally the
same, but essentially different from conventional systems of finance.
Naturally, the question arises as to how an entity like Islamic Finance can be feasible in the
tumultuous scenario of modern global economy if the banks can’t charge interest or speculate?
Here, an interesting aspect of Islamic Finance comes to play. The Islamic system of finance has
a unique characteristic in that it is based on risk-sharing. What it means is that the financial risk
of a transaction isn’t borne solely by the client, rather, it is shared almost equally between the
financial institution and the people they serve. This system promotes a long term relationship as
well as prevents cut and run deals between the bank and the client.
For example, in an Islamic mortgage, the bank, instead of lending the money to the client for Formatted: Font color: Auto
buying the property, buys the property itself. The client then buys the property from the bank at a
higher price (Murabahah). Alternatively, the client can also pay the bank a monthly fee, comprising
both of the repayment fee as well as the rent that the bank charges, until the payable amount is
fulfilled and the client owns the property himself (Ijarah). This makes Islamic Finance not only
viable, but also a feasible alternative to the conventional systems of finance, while at the same
time promoting a healthy and interconnected work relationship between the Islamic financial
institution and its clients.
Although the Islamic faith since its inception in the early seventh century introduced the concept Formatted: Font color: Auto
of Islamic financial system and mandated that it be followed by its believers, for the most part this
alternative system of finance has stayed on the sidelines of global economy during its evolution
through the years. Serious efforts of introducing the system of Sharia’h compliant transactions in
the modern times only began at around the late 1960s. This can be attributed to the humongous
rise of the oil industry, particularly in the Middle Eastern countries. This rise of the oil industry and
the immense economic prosperity that followed was the most important factor that created a
renewed interest in Sharia’h compliant transactions as well as the demand for Islamic products
and services worldwide. (Edwards, 2011). This growth in the interest and the worldwide value of
Sharia’h compliant finance was only reinforced as the world was devastated by the catastrophe
that was the financial crisis of 2007-2008. The reason for that are the arguments put forward by
eminent economic scholars across the globe, which stated that Islamic Finance, by virtue of its
non-adherence to speculative transactions, was quite resilient to financial crises that affected
conventional systems of finance quite adversely, such as what happened in 2007. (Dridi & Hasan,
2010).
Islamic Finance is projected to continue growing at a steady rate in response to the economic
growth in countries with large and as of yet relatively unbanked Muslim populations like those in
the Western World like Canada, USA and countries in the European Union. As this Muslim
population increases, so does the interest in Sharia’h compliant products, therefore promoting
and propelling the Islamic System of Finance to the global stage. This is also fueled by the large
financial savings accumulated by some of the major oil-exporting countries (many of which have
Islam as their state religion), that now seek to invest in Sharia’h-compliant financial products
across the world. (Kammer, et al., 2015).
Islamic finance has a greater role to play in the global stage than just being an alternative to the
conventional system of finance, and that is boosting the economic potential in both local as well
as global scenarios. According to an IMF report, the growth of Sharia’h compliant Financing
system has the potential to contribute to the economy in at least three ways. These are:
• Firstly, it can be a vessel for greater financial inclusion, especially of the large underserved Formatted: Font: (Default) Arial
Muslim populations in many countries round the world.
• Secondly, the features of Islamic Finance themselves can provide support for small and medium Formatted: Font: (Default) Times New Roman, 12 pt,
sized enterprises as well as investment in public infrastructure. Font color: Auto
• Finally, Islamic Finance, due to its unique risk sharing features may, in principle, pose less of a Formatted: Font: (Default) Arial
systemic risk than conventional financial systems. (Kammer, et al., 2015).
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Despite all these factors and showing explosive growth, as of now, Islamic Finance is still in its
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infancy. It is still a very niche system, catering to a very particular group of people. However, it is,
by no means, a solely religious product, and for that matter, shows immense promise in the Formatted: Font: (Default) Arial
current economic scenario. Realizing these as of yet untapped potentials, thus, requires proper Formatted: Font:
nourishing of this alternative financial system. To that effect, certain challenges require to be
addressed worldwide, especially in multicultural countries having strong conventional systems of
finance already in place. Only then, can the economic potential of the Muslim community can be
utilized fully, fueling the growth and development of both the local as well as the global economies.
B. DIFFERENCES BETWEEN THE CONVENTIONAL SYSTEMS OF FINANCE AND ISLAMIC
FINANCE: Formatted: Font color: Auto
To understand why and how Islamic System of Finance can prove itself to be a viable alternative
to the conventional system of financial transactions in place today, a basic knowledge about the Formatted: Font color: Auto
major differences between the two of them is vital. The two systems, although have a lot of things
in common like banks, loans etc. also differ from each other in quite a few ways. These differences
stem partly from their respective origins and the principles they follow in conducting financial
transactions, and partly from the rules that each of them adhere to while dealing with a client.
For example, though both conventional systems of finance and Islamic system of Finance offer
their clients mortgages, the way they deal with a mortgage is very different. Under a conventional
mortgage, the client borrows money from the bank to buy his property and repays it with an
additional amount of funds over a period of time. This additional amount is the interest charged
by the bank which is the lender of the money. Also, under the conventional system, the client has
to begin the repayment of the loaned money from the date the bank lends him the money in order
to purchase the property.
Under Islamic mortgage facility however, the bank shares with the customer in the purchase of
his desired property. Thus, the customer and the bank become the joint owner of the property in
proportion of their share in purchasing of the property. In order to own, use, and enjoy the current
property in its entirety, the customer then has to purchase the bank’s share of the property over
a period of time. He also pays a ‘rent’ to the bank. This rent is for using the bank’s share of the
property. These payments go on until the customer manages to purchase the bank’s entire share
of the property and therefore becomes the sole owner of the property. Furthermore, under the
Islamic system finance, the customer has to pay the rent only when he has taken delivery of the
property and confirmed it to be in usable condition. Rent cannot be charged from the day the price
was paid to acquire the property/asset. That means if the supplier has delayed the delivery of the
asset after receiving the full price, the client will not be liable for the rent for the period of delay,
which is a way to prevent any sort of fraud or foul play that puts the client at risk of being taken
undue advantage of in any way during the transaction.
Some of the other major differences between a transaction through a Sharia’h compliant
institution and one through its conventional counterpart are mentioned as follows:
❖ The primary, and arguably the most important of them would be that Islamic Finance is based Formatted: Font color: Auto
on Sharia’h principles. Thus all dealings, business, products, investments etc. are derived from
and follow the rulings prescribed in the Sharia’h law. On the other hand, conventional systems of
finance is essentially secular in its core and is neither bound nor answerable to any religious code
like that of its counterpart.
❖ Since the Sharia’h is the source of Islamic Financial system’s guiding principles, it prescribes
certain tenets for the system to follow; some of which are as follows: Formatted: Font color: Auto
➢ The absence of any and all interest (Riba) in any form of financial transaction. Formatted: Font color: Auto
➢ Any oppressive activity (Zulm) regarding a financial transaction is prohibited. Formatted: Font color: Auto
➢ The prohibition of economic activities that involve and deal with speculation (Gharar). Formatted: Font color: Auto
➢ Any and all transactions that deal with prohibited products (haram) are not allowed. Formatted: Font color: Auto
➢ The payment of an Islamic tax, or the zakat.
❖ Islamic Finance, by virtue of it following the principles of Sharia’h, prohibits any and all cases Formatted: Justified
where the creditor could potentially take advantage of the borrower. Under the eyes of Islam, Formatted: Font color: Auto
whenever interest is charged on a transaction, more often than not it leads to some kind of
injustice. Thus any interest based financial dealing is prohibited. On the opposite end of this
spectrum, the conventional systems of finance is based on the debtor-creditor correspondence.
Conventional financial systems have a twofold relationship. On one hand there is the relationship
between the depositor and the bank, and on the other is that between the bank and the borrowers.
Here interest is considered the price of credit, and thus is promoted, not prohibited.
❖ Another principle that pertains to financial transactions under the Islamic law is that there should
not be any reward without taking a risk. This principle applies to both labor and capital. Thus under Formatted: Font color: Auto
Islamic finance, banks and their clients are considered investors sharing the same business risks,
rather than creditors.
❖ Conventional systems of finance, since they are not beholden to any religious laws, do not deal Formatted: Font color: Auto
with the zakat, a tradition of alms giving that is treated as an obligation of every Muslim and a tax
under the Islamic financial law. On the other hand, in the modern Islamic Banking system, it has
become one of the functions of an Islamic Bank to be a Zakat collection center and the banks
also pay out their zakat, thus committing themselves to the code of social justice and equitable
sharing of wealth as promoted by the religion.
❖ Conventional institutions of finance like banks can, under the financial law charge money
(penalty and compound interest) in case of defaulting on the part of their clients in the payment Formatted: Font color: Auto
of the debt. On the other hand, Islamic banks have no such provision. Under the Sharia’h they
cannot charge any extra money from the defaulters. Only a small amount of compensation can
be accrued and this should be given away to charity as per the Islamic law.
❖ For a conventional interest-based commercial bank, borrowing money from the market is Formatted: Font color: Auto
relatively easier than that of an Islamic Financial Institution, which has to base its borrowing on a
Sharia’h approved underlying transaction. For an Islamic Bank, every transaction it makes has to
go through the scrutiny of the laws and rules put forward by a committee called the ‘Sharia’h
Board’, that determines whether the transaction is ‘Sharia’h compliant’ or not. Since the Sharia’h
boards of different countries have different opinions on the interpretation of the Islamic laws, this
makes a financial deal through an Islamic financial institution more cumbersome than its
conventional counterpart.
❖ Since the income from the advances is fixed, conventional financial institutions give little
importance to developing expertise in project appraisal and evaluations and more on the ‘credit- Formatted: Font color: Auto
worthiness’ of the client, which makes their transactions ‘client-centric’. Conversely, under the
Islamic system of Finance, since risk is shared between the bank and the client, the banks pay
more attention to the ‘viability’ of a project. They provide greater attention to the project appraisal
and evaluation, because in case of a failed transaction, both the clients and the institution stand
to lose. This not only makes the system more ‘project centric’, but also cements the relationship
between the Islamic bank and the client as that of partners, rather than creditors and debtors.
❖ As Islamic Finance is based on the teachings of the Qur’an, the concept of Islamic financial Formatted: Font color: Auto
activity complements the pursuit of social and economic justice ― it targets the promotion of
equitable development opportunities for all. (Edwards, 2011).
C. REQUIRED POLICY CHANGES TO ADOPT ISLAMIC FINANCE AS AN ALTERNATIVE TO
THE CONVENTIONAL FINANCIAL SYSTEM: Formatted: Font color: Auto
Developing and nourishing Islamic Finance is quite easy in countries with a majority Muslim
population, as the interest and requirement for Sharia’h compliant Islamic products are high in Formatted: Font color: Auto
these countries. However, in a multicultural country with a robust economy and a strong
conventional financial system already in place, the story is entirely different. This is because since
Islamic Financial system, even though can be applied to and utilized by people of all faith and
practices, primarily caters to financial needs and requirements of the believers of the religion of
Islam. Thus, it is often sidelined in favor of a more ‘secular’ system like that of the conventional
system of financing in regions where the majority of the population do not adhere to the Islamic
faith. The primary hurdle that this system faces, therefore, is to convince the population and
therefore the country that though it has roots in the tenets of a particular world religion, it is, by no
means a solely ‘religious product’, and as a financial system it is almost as secular as its
conventional counterpart; with Islamic financial products and transactions applicable to, and
enjoyable by everyone, Muslim or not.
Another major hurdle that prevents the successful integration of Islamic finance into a country’s
economic system is that of the existing tax policies in that particular country. Equity is of utmost
importance in designing the instruments of fiscal policy in the Islamic economy. This is essential
to promote a relatively stable fiscal revenue generated through this system. This revenue, in turn,
will fuel and ensure the sustained growth of the Islamic financial system and the economy as a
whole. However, more often than not the already existing fiscal policies of the country prevent
this goal from being reached. Since Islamic finance follows different rules and defines fiscal terms
differently than its conventional counterpart, the structural framework of the tax systems that are
put in place in the countries, which were created keeping the promotion and practice of the
conventional system of finance in mind, often contribute towards a fiscal deficit and insufficient
policy perceptions that hinder sustainable financial growth. These tax laws may also precipitate
gross and fundamental financial breakdowns, thus not only crippling the emerging financial
system, but also grossly disadvantaging it in the current financial scenario.
To prevent and avoid such challenges, the financial industry should introduce and/or amend Formatted: Font color: Auto
policies and legislations currently in place that cover the Islamic Financial system’s operation and
contribution to the society in which it serves. This is particularly important in the sector of re-
defining the terms that are currently in use, which deal with a particular transaction’s compliance
with the Sharia’h law. This will go a long way in levelling the playing field for a system like Sharia’h
compliant finance to find its footing as an alternative system of finance which can provide a viable
replacement for the conventional financial system. The financial industry and the country as a
whole should also give consideration to introducing and promoting models that incorporate ideas
like ‘away-from-interest’ transaction system and ‘risk sharing’ within their fiscal framework. This
would make Islamic finance a growth-supportive and sustainable fiscal policy in the long run.
(Iqbal & Mirakhor, 2013).
A number of these changes are necessary for the Islamic financial products to gain the confidence
and stakeholder support they need to ensure their entry to an otherwise competitive market that
is in place in the global economic stage right now. (Hasan & Sabirzyanov, 2015). Fortunately,
such changes are already afoot. Countries like Malaysia, Indonesia, the United Kingdom, France,
Ireland, Spain, Luxembourg and many countries of the Middle East have already introduced
and/or modified legislations, which have allowed the accommodation of Islamic Finance into their
existing fiscal framework and therefore bolster their local economies. The modern Sharia’h
compliant financial system is a relatively new player in the global field, and is still a developing
financial system. Improvements in the countries’ taxation policies are, therefore, very important in
contributing to its integration to the local economies and therefore boosting both the country and
the world economy as a whole.
D. THE FLOURISH OF ISLAMIC FINANCE IN OTHER COUNTRIES:
Fortunately, the potential of Islamic Finance is being understood by economic scientists and
country leaders all around the world. Across the world, major countries have already taken steps
to integrate Islamic Finance in industry policies. However, not all countries can assert such Formatted: Font color: Auto
political will to accommodate an entirely new financial system into the economic sector. Many
countries have population composed of believers of multiple religions, therefore universalizing tax
policies to include transactions of both conventional and alternative systems of finance which are
based on a religion is quite difficult. Adding to that is the problem arising from the interpretation
of the Sharia’h law. Interpretation of the nuances of the Islamic law is already quite complex and
varies from scholar to scholar across the world. An example of this is the case of the International
Banking giant Goldman Sachs, whose foray into the Islamic Finance industry in 2011 failed due
to the claims by certain scholars of Islam that the services it provided to its clients did not comply
with the Sharia’h law. (Islamic finance Big interest, No interest, 2014). The development of
appropriate methods for the integration of Islamic Finance into the existing financial industry is
even more difficult, as no consensus on developing a fiscal policy framework to accomplish that
goal exists as of now. Other challenges include insufficient knowledge of the specific features of
Islamic financial products, lack of necessary resources to accommodate Islamic financial products
into the economy, and possible delays in the rulings on tax issues due to technical, interpretive,
and policy concerns that need to be addressed. However, the success stories round the world in
this regard are quite encouraging.
One of the major examples of a successful integration of the Islamic System of Finance into the
local economy is the south Asian country of Malaysia. Malaysia was one of the first countries to
introduce legislations to level the playing field for the Islamic financial system and its conventional
counterpart. In the country initially an Islamic banking Act was enacted in 1983 to cater to
transactions which were Sharia’h compliant. This system gradually developed further, and newer
fiscal components within it were introduced. These led to the further introduction of legal rules
such as the Takaful Acts of 1984 and rules governing the Islamic Interbank Money Market. The
central Bank of Malaysia (Bank Negara Malaysia – BNM) later allowed conventional banking
institutions under its purview to provide services which were Islamic law compliant, thus playing
a major role in paving the way for the flourish of this system of finance in the country. These
legislations were further polished by the introduction of the Skim Perbankan Islam or SPI, the
Islamic Banking Scheme and the setting up of Malaysia’s National Sharia’h Advisory Council to
govern transactions compliant with Sharia’h and issues pertaining to them in 1997 and most
recently, the Islamic Financial Services Act in 2013. (ISLAMIC BANKING & TAKAFUL, 2017).
These legislative reforms have made Malaysia one of the global leaders in Islamic Finance.
Malaysia as of 2014 had a total Islamic Bank asset of USD$ 135 million, accounting for 21% of
the country’s total banking assets. It also boasts more than 60% of the global Sukuk (Islamic
bond) market, amounting to US$ 164 billion worth of outstanding Sukuk. It also leads countries
globally with 20 fully fledged Islamic banks in the country and its Sukuk market hosting foreign
investors like Hong Kong, the U.K and South Africa.
Among the notable western countries with a widely multicultural and multi-religious society that
have established or introduced taxation policies to accommodate Islamic Finance is the United
Kingdom. Noting the potential benefits that Islamic Finance and its products can have on the
economy, in 2003 the UK introduced new tax legislation. These ensured that Sharia’h compliant
transactions and financial products were treated equally along with the Conventional Financial
products. (Ainley, Mashayekhi, Hicks, Rahman, & & Ravalia, 2007).
While the worldwide expansion of Islamic Finance has been primarily attributed to the explosive
growth of the economies of the Middle Eastern countries, particularly in the oil industries, Islamic
Finance has found its foothold and flourished in the UK due to primarily two reasons. Firstly, the
flexibility and innovative mindset of the country, that recognizes the benefits such a system can
provide in boosting the country’s economy as a whole. Secondly, the openness to change, which
manifests itself as the country’s willingness to draft and introduce legislations that would pave the
way for the successful integration of an alternative financing module into the current economic
system. These factors have made the UK’s financial and legal environment very interesting and
open for alternative financial products like that of Islamic Finance. They have also played an
important role in the development of knowledge on managing Islamic Financial products by virtue
of the introduction of methods practiced in the already established Financial Institutions of the
Middle East and elsewhere, allowing the development of viable policies regarding the governance
of Islamic products.
The events that led to the growth of the UK Islamic financial sector demonstrates this very well. Formatted: Font color: Auto
The financial industry of the UK has engaged in various forms of Islamic Financial transactions
since the 1980’s. The Sharia’h compliant transactions and financial products first entered the
London financial market in the form of commodity (Murabahah) transactions. In these
transactions, the financial institutions purchased the goods and commodities in question and then
sold them to the client at a price that equaled the original cost of the product plus a reasonable
profit for the bank. This system provided a much needed liquidity to various Middle Eastern
companies and investors, making them interested in pursuing Islamic financial transactions in the
country. However, there were no protections available for such products at that time. (Ainley,
Mashayekhi, Hicks, Rahman, & & Ravalia, 2007).
In the mid 90’s, however, the government of the UK took steps to ensure the coverage of the Formatted: Font color: Auto
Islamic Financial products under its regulatory system. This cumulated in the establishment of a
high-level technical working group spearheaded by Lord George, the major function of which was
to determine how an alternative system of finance such as Islamic Finance could enter the United
Kingdom’s financial market. The reports of this technical committee led to the introduction and
enactment of the Finance Act of 2003 by the parliament of the country in 2003. This act, coupled
with the presence of a single regulatory body for financial transactions that was the Financial
Services Authority established in 1997, eliminated the complications in the regulatory environment
and removed a lot of obstacles in the development of the Islamic Finance in the country. The
provisions of the act also made the accessibility to Islamic financial products at par with their
conventional counterparts. (Ainley, Mashayekhi, Hicks, Rahman, & & Ravalia, 2007). The UK
government further enacted various policies that facilitated the determination of fiscal policies that
would be applicable to Islamic Financial products and their transactions, thus making UK a global
hub in Islamic Finance. (Evans, 2015). These efforts have made UK the first non-Muslim country
to issue a Sukuk or Islamic bond worth £200m in 2014, enlisting the participation of some of the
largest Islamic Banks in the world like Abu Dhabi Islamic Bank, the National Bank of Abu Dhabi,
Dubai’s Emirates NBD Capital and the investment banking arm of Saudi Arabia’s National
Commercial Bank. The United Kingdom also leads the way globally in the Islamic Finance
education sector, with more than 60 UK institutions offering Islamic finance courses and 22 of the
country’s universities offering degree programs specializing in Islamic finance and its applications
in the economic scenario. (Alam & Ennew, 2014).
Another notable example is that of Australia. The scope of Islamic financial transactions in
Australia, till now, was quite limited. This was because of the tax rules in place that applied only
to conventional financial products and disfavored alternate financial systems like Islamic Finance.
For example, many Islamic financial transactions were not treated as a loan for tax purposes but
were instead subjected to taxes under the Capital Gains Tax (CGT) or Goods Service Tax (GST)
or stamp duty. Thus transactions following Sharia’h principles in Australia had required complex
structuring involving combination of Islamic and conventional financing to be viable. To combat
such discrepancies, the Australian government in 2016, as a part of its federal budget plan
proposed the removal of legislative clauses that could prove as a tax barrier to asset-backed
financing arrangements. These proposals, enacted five years after the Australian Tax Office first
presented a paper on Islamic Finance to the government for review aim to facilitate interest free
transactions used in Islamic Financing, which, in recent years seems to be catching on in the
financial sector of the country. The country has also taken steps to facilitate and promote Islamic
Financial products like Murabahah, Ijarah and Sukuk, among others, thus paving the way for the
integration of Sharia’h compliant products and transactions into its stable and highly advanced
financial sector, largely dominated by conventional financial system.
Some of the notable points put forward in the proposal by the Australian government regarding
the promotion and facilitation of Islamic Finance in the country are as follows:
• To amend the income tax laws so that with respect to arrangements that raise the debt finance, Formatted: Font color: Auto
such as deferred payment arrangements, the gain or loss is treated equally as an interest on a
conventional borrowing of funds.
• To develop guiding principles on whether the returns on a deferred payment arrangement or Formatted: Font color: Auto
and asset-based security like a Murabahah or Sukuk transaction should come within the definition
of interest for Interest withholding tax (IWT) purposes. This IWT is payable by a non-resident on
Australian source interest unless there is an exemption.
• To amend the existing tax laws so that IWT exemptions can be made available for Islamic Formatted: Font color: Auto
Financial products with equivalent economic characteristic to debentures and are therefore
eligible for exemptions. This would pave the way for increased foreign investments in Islamic
financial products.
• To develop guidance to determine whether certain Islamic products would come within the Formatted: Font color: Auto
definition of ‘offshore banking activity’ and be considered economically equivalent to offshore
banking activities currently mandated under the Australian fiscal policy. If they are, then these
products and transactions would be entitled to concessional tax treatments like their conventional
counterparts under the law.
• To develop guidance on the characterization of the ‘profit’ element of Islamic Financing Formatted: Font color: Auto
arrangements and its treatment. Particularly, the guidance would clarify whether the ‘profit’
component will be considered as (I) a debt, credit, or a right to credit; or (II) a charge or mortgage
over real property in case of a property transaction.
These recommendations seek not only to promote the various Islamic Financial products like Formatted: Font color: Auto
Murabahah, Ijarah, Tawarruq and Sukuk, but also to ensure a level playing field for these products
to compete with their conventional counterparts. The fiscal policy proposals also benefit and
encourage the financial institutions of the country looking to venture into Islamic Financial
products, such as one of the largest banks of Australia, the National Australia Bank, which
confirmed its maiden Islamic Financial deal in 2015, with a US$ 114 million financial deal in
purchasing of properties in Brisbane. (Vizcaino, 2016).
Other non-Muslim countries that have shown interest in increasing their Islamic Finance footprint
in the global economic stage are Luxembourg, France, Russia, Switzerland and South Korea, to
name a few. Hong Kong and South Africa also have entered the venture, both showing interest
in introducing Sukuk in their respective countries, thus showcasing the growing international
interest in the Sharia’h compliant system of finance.
E. ISLAMIC FINANCE IN CANADA: POTENTIAL PROSPECTS: Formatted: Justified

Out of the potential Western countries that can become global leaders in the promotion and
practice of Islamic Finance, Canada arguably shows the best promise. The North American Formatted: Justified
country is one of the most culturally diverse and economically robust states in the world. Canada’s Formatted: Font color: Auto
strategic location makes it a connecting link between the economies of the US, Asia, Africa,
Europe and the Middle East, and a wealth of natural resources and open, ambitious and
competitive fiscal policies make this country one of the richest in providing opportunities for
investments in Sharia’h compliant financial products.
According to the 2011 National Household Survey done by the Canadian Government, Canada Formatted: Font color: Auto
has a fairly large Muslim population, with 2.8 % (1.3 million) of the country adhering to this religion.
The ratio is set to grow to about 6.6% in 2030, based on the recent demographic trends. (Canada
Islamic Finance Outlook 2016, 2016). These numbers make Muslims the second largest religious
group in the country, as well as the fastest growing. Such an expanding Muslim population in the
country, therefore, means that there is an increasing requirement of Sharia’h compliant financial
products in the country, as well as the need for institutions that would provide Islamic Financial
transactions and deal with manage such assets locally and globally. (Thiagaraja, Morgan,
Tebbutt, & Chan, 2014).
According to the World Economic Forum, Canada is home to one of the world’s most effective
and safest banking systems, home to six of the world’s top ten safest banks. The country also
ranks in the world’s top ten countries for investor protection, according to the World Bank
statistics. (Strength of Investor protection, 2017). The country has a national banking system with
more than 8000 branches, a very strong and stable domestic economy, and is one of the only 2
countries in the G-7 to enjoy an AAA credit rating by the big three credit agencies (Standards &
Poors, Fitch, and Moody’s). Toronto, the country’s financial hub, is projected to be the leader in
North American and global efforts to integrate Islamic Finance into the current economy.
(Graham, 2015).
The country’s financial sector practices a socially responsible policy, not unlike that of the Islamic
Financial System. In this regard, the Canadian financial asset managers have a huge wealth of
experience, including working in some of the largest responsible investments under Islamic
finance in the world. (Canada Islamic Finance Outlook 2016, 2016). The country is home to
Manulife and Sun Life, two of the world’s top ten largest life insurers, which have a significant
presence in Asian markets and have experience in Sharia’h compliant transactions and Islamic
financial models. Canada also has significant financial relationships and trade links with Muslim-
majority countries of the world, primarily through its export of food items. This international
connection also makes the country a land of opportunity for investors in Islamic financial products,
as most of the markets that Canada exports commodities to, are where Islamic system of finance
has a strong presence.
However, the integration of Islamic products into mainstream financial policies in Canada still Formatted: Font color: Auto
remains a challenge. Canadian financial sector policies are the best regulated in the world. This,
though provides a strong and fair market for Islamic Finance to flourish in, also makes it harder
for the adaptation of Islamic finance. These strongly controlled and regulated financial policies
may also impact the requirements of alternative financial products to be viable in the economy
that may result in an uneven playing field where to compete with their financial counterparts.
(KMPG, 2012). Another potential challenge is that of the varying levels of commitment shown by
the investors in understanding the nuances and adhering to the principles of Islamic Finance while
investing in Sharia’h compliant financial products in the country.
While the government of Canada has taken several steps towards facilitating the introduction, Formatted: Font color: Auto
promotion and sustenance of this alternative financial system in the economy, significant changes
are still needed to make this a success story, especially in the area of fiscal policy. In this regard,
lessons from current leaders in the field, such as the United Kingdom and Hong Kong in their
experiences with implementing Islamic financial system and integrating it with their established
fiscal policies will go a long way in realizing the opportunities that are promised by the Islamic
System of Finance.
F. RESEARCH PROBLEM: Formatted: Font color: Auto

In the light of increasing interest and demand of Islamic financial products in Canada, and the Formatted: Font color: Auto
flourish of Sharia’h compliant financial markets in other notable Western countries like the United
Kingdom, this paper intends to determine a viable fiscal policy framework to be implemented in
the Canadian Financial sector. This proposed policy framework will be aiming to amend and
modify existing fiscal policies that may hinder the interest in Sharia’h compliant investing in the
country and also propose addition of certain policies that would help level the playing field
between the Islamic and conventional financial systems and help it flourish in the financial sector,
thus boosting both local and global economies.
The paper will also consider whether the UK experience in the integration of Islamic finance into Formatted: Font color: Auto
a multicultural conventional finance worked as intended and therefore, can provide a template
upon which the needed fiscal policy framework for Canada can be based.
This paper shall also attempt to map out the best practices in Islamic finance taxation policies Formatted: Font color: Auto
from the United Kingdom experience, which can be applied in an economic setting that is of
Canada. It aims to determine if the latter can develop a viable policy regarding the regulations on
Islamic finance tax treatment that will provide a similar market opportunity and enthusiasm for the
finance industry and Sharia’h compliant investors from all over the world in Canada as it now
exists in the UK. The paper will also consider whether the UK experience would be worth learning
from and emulating by other countries in the world with similar socio-political and economic
profiles.
G. STATEMENT OF THE PROBLEM: Formatted: Font color: Auto

This research will look at the United Kingdom’s currently flourishing Islamic market and the current Formatted: Font color: Auto
situation in the Islamic finance sector in the Canadian economy. The paper will analyze the UK’s
fiscal policy framework that has made it the western leader in this field to determine which financial
regulation and policy amendments and additions are to be made to help an alternative financial
system like the Islamic Financial system successfully penetrate and flourish in the Canadian
finance market, which is dominated mainly by a robust and well-regulated conventional financial
system. The question that this study primarily seeks to answer is: What is the most viable policy
framework for Islamic finance in Canada, and how can the United Kingdom’s experience in its
effort to do the same help in developing the aforementioned framework?
H. RESEARCH QUESTIONS: Formatted: Font color: Auto

At the end of this research, we will be aiming to answer the following questions: Formatted: Font color: Auto
a. How can Islamic financial transactions and Sharia’h compliant products better penetrate the Formatted: Font color: Auto
finance market of Canada, which is dominated by a strong and well-regulated conventional
financial system?
b. What are the tax policies in Canada that have a significant impact on the introduction and Formatted: Font color: Auto
promotion of Islamic finance in the country, and how do these hinder the integration of Islamic
Finance into the financial industry of the country?
c. How can the existing fiscal policies be amended, and new policies be added so as to make it Formatted: Font color: Auto
so that a successful integration of Sharia’h compliant finance within the local economy is
possible?
d. How can the United Kingdom’s taxation policy that has made it one of the leaders in this field Formatted: Font color: Auto
in current years, help develop and improve upon a taxation policy framework dealing with Islamic
finance for the country of Canada?

I. OBJECTIVES:
The objectives of this research paper are enumerated as follows: Formatted: Font color: Auto
General: To present suggestions/recommendations on the revision of Canadian tax laws, Formatted: Font color: Auto
regulations and policies for the integration of Islamic Finance in the financial ecosystem of the
country.
Specific: Formatted: Font color: Auto
A. To identify areas in the Canadian tax laws, regulations and policies that need attention to better Formatted: Font color: Auto
address Islamic finance products and help in the promotion and integration of Islamic financial
system in the Canadian economy.
B. To identify the strengths and weaknesses of the United Kingdom’s financial model to integrate Formatted: Font color: Auto
Islamic finance and its impacts in the local and global economic scenario.
C. To determine whether the UK tax policy framework is a potentially good model for Canada, Formatted: Font color: Auto
and to identify the areas of the UK financial model that need modification to be applicable in the
Canadian financial ecosystem.

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CHAPTER I: INTRODUCTION.

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Many countries have population composed of believers of multiple religions, therefore

E. ISLAMIC FINANCE IN CANADA: POTENTIAL PROSPECTS: Formatted: Justified

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H. RESEARCH QUESTIONS: Formatted: Font color: Auto

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