BFI - YIBS 2022/202

CHAPTER ONE: ISLAMIC BANKING – INTRODCTION,

BACKGROUND AND GLOBAL SCENARIO

a) Concept Of Islamic Shariah

The meaning of the word “Shariah” is “the way”. Shariah refers to the “Law of
Islam”, and the 4 main sources of Muslim law (or Islamic law) are Quran,
Sunnah, Ijma, and Qiyas. Shariah provides a guide to all the matters that Allah
has legislated for humans. Allah sent messengers to people, who guide them to
the Right Path, that leads them to happiness in this world and hereafter. All
messengers taught the same message “Worship Only One God”. However, the
specific prescriptions of these divine laws varied according to the needs of
“People” and “Time”.

b) Importance of Shariah In Islamic Banking

The importance of Muslim law, or Shariah, can be difficult for non-Muslims to

understand. For example, it may seem strange when someone says a judge
should follow the legal code outlined in the Quran. But Shariah is actually far
more than just a set of rules. It’s a way of life. It encompasses everything from
what foods to eat to how you should dress. And it has been used for centuries as
a way of organizing society and guiding individuals. More importantly, it
provides Muslims with answers to many everyday problems, such as is
investing in cryptocurrency is Halal, or Haram? or whether can Muslims invest
their money to earn Interest (or Riba), which is Haram (or Illegal in Islam).

In other words, Shariah helps make sense of life by providing guidance and
structure. Shariah offers valuable guidance that can help people live happier

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and more fulfilling lives. Shariah plays an important role in the lives of Muslims
around the world and deserves to be taken seriously and respected.

Shariah in the Light of Quran: The Holy Prophet Muhammad (Peace be

upon him) was His last messenger, and his Shariah represents the ultimate
manifestation of divine mercy. In the Holy Quran, Allah says:

“Today, I have perfected your way of life for you, and completed My favour
upon you, and have chosen Islam as your way of life.”.

Shariah and the Domain of Muslims:

The word “Muslim” means “One who submits to Allah”. Islam expects a
Muslim to follow its laws, in every aspect of life. The Muslim Law is not
limited, and no aspect of human life is outside its domain. Whether it is:
Personal and familial, Religious and social, moral and political, or even it is
related to business and economics.

“It is not fitting for a Believer, man or woman, when a matter has been decided
by Allah and His Messenger, to have any option about their decision. If anyone
disobeys Allah and His Messenger, he is indeed on a clearly wrong Path”.

c) Sources of Muslim Law (Shariah):

Shariah laws are abstracted from the following four resources:

1. QURAN: a book of Allah;

2. SUNNAH: the practices of the Holy Prophet Muhammad (Peace be upon
him);
3. IJMA: the approval and agreed opinion of the Muslim jurists; and;

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4. QIYAS: the analogy from the Quran, Sunnah, and Ijma.

We will take a look at each of these sources of Islamic law.

1. QURAN:

Quran is the sacred book of Muslims and is the primary source of Muslim laws.
Allah dictated Quran through Angle Jibrael, the Angel, to Prophet Muhammad
(Peace be upon him). Quran is a complete code of conduct itself. It tells us what
Allah wants us to do, from birth to death.

Quran is the Primary Source of Sharia because it has direct words of Allah.
However, when it does not speak directly on a certain subject, Muslims only
then turn to alternative sources.

2. SUNNAH:

The word Sunnah means “a system”, “a path”, or “an example”. In Islam, it

refers to the practices of the Prophet Muhammad (Peace be upon him), and his
life examples.
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 Sunnah is the things that Prophet Muhammad (Peace be upon him) said, did,
or agreed to.
 Sunnah clarifies details of what is stated generally in the Quran.

All his life, the Prophet acted on what Allah told him to do. So, it is part of
every Muslim’s faith that Sunnah is complete obedience to Allah, and so it must
be followed.

WHO WERE SAHABA’s?

They were Prophet’s family members and companions, who observed him
during his lifetime, and shared with others exactly what they had seen in his
words, and behaviors.

WHAT IS AHADITH?

These are the “Sayings, actions, and the actions done with the approval of
Prophet Muhammad (Peace Be Upon Him)”. They include issues concerning
personal conduct, community, family relations, and political matters. Ahadith
were collected and compiled very carefully, and they all are reported by Sahaba.

3. IJMA:

It may be defined as: “Consensus of opinion of the companions of the Holy

Prophet Muhammad (Peace be upon him) or Muslim jurists of the first three
centuries of the Hijra”. Ijma is simply an agreed-upon decision. It is used in an
Islamic society to overcome a problem, which could not be found in Quran, or
in Sunnah.

Ijma may be understood from the following Hadith of Prophet Muhammad

(Peace Be Upon Him), who said:

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“If anything comes to you for decision, according to the book of Allah, if
anything comes to you, which is not in the book of Allah, then look to the
Sunnah of the Prophet (Peace be upon him). If anything comes to you, which is
not in the Sunnah of Prophet Muhammad (Peace be upon him), then look to
what people unanimously agrees upon”.
Hadith

4. QIYAS:

Qiyas means, “Judging by comparing with something”. It may be defined as

“The analogy from the Quran, the Sunnah, and Ijma”. Qiyas can be carried out
only in a Sharia-governed state, when a solution to a problem cannot be found
in Quran, Sunnah, and Ijma. When something needs a legal ruling but has not
been clearly addressed in the other sources, Islamic jurists may use an analogy,
reasoning, and legal precedent to decide on new case law.

Qiyas may be understood from the following Hadith of Prophet Muhammad

(Peace Be Upon Him), who said:

“Judge upon the book of Allah, upon the Sunnah of the Prophet, and if you do
not find it in that, then use your personal opinion”.
Hadith

d) Concept of Halal (Lawful) and Haram (Unlawful)

Islam has introduced concept of Halal (lawful) and Haram (unlawful) in its
economic system. In fact the foundations of the Islamic economy have been laid
on this concept. This concept reigns supreme in the realm of production as well
as consumption. Certain means of earning livelihood and wealth have been
declared unlawful such as interest, bribery, gambling and games of chance,

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speculation, short weighing and short measuring, business malpractices, etc.

Unlawful means of earning are strictly forbidden and a follower of Islam is
permitted to earn through lawful and fair means. Similarly in the field of
consumption certain items of food are unlawful such as dead animals, blood,
swine flesh and animals slaughtered in the name other than that of Allah. Even
expenses on certain items such as drinks, narcotics, debauchery, prostitution,
pornography, things that promote obscenity and vulgarity, lotteries and
gambling are strictly inadmissible.

Now let us glance through relevant verses of the Quran and Ahadith of
Muhammad (PBUH), the Prophet of Islam, to highlight in brief the concept of
halal and haram.

Verses from Quran:

“O mankind! Eat of that which is lawful and wholesome in the earth, and follow
not the footsteps of the devil. Lo! he is an open enemy for you”.
Al-Quran Chapter-2, Verse-168
“And eat not up your property among yourselves in vanity, nor seek by it to
gain the hearing of the judges that ye may knowingly devour a portion of the
property of others wrongfully”.
Al-Quran Chapter-2, Verse-188
“O ye who believe! Eat of the good things wherewith We have provided you,
and render thanks to Allah if it is (indeed) He Whom ye worship. He hath
forbidden you only carrion, and blood, and swine flesh, and that which hath
been immolated to (the name of) any other than Allah. But he who is driven by
necessity, neither craving nor transgressing, it is no sin for him. Lo! Allah is
Forgiving, Merciful.”
Al-Quran Chapter-2, Verse 172 & 173

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Ahadith of Prophet Mohammed (PBUH):

“The messenger of Allah said: Verily Allah is pure. He does not accept but what
is pure …..Then he mentioned about a man disheveled in hair and laden with
dust, making his journey long and extending his hands towards heaven: O Lord!
O Lord! while his food was unlawful, his drink unlawful, his dress unlawful and
he was nourished with unlawful things. How he can be responded for that?”.
Hazrat Abu Huraira (RA) Sahi Muslim
“The messenger of Allah cursed the bribe taker and the bribe giver”.
Hazrat Abdullah bin Umer (RA) Abu Daud
“The messenger of Allah forbade the price of dogs, earnings of prostitute and
foretelling of a soothsayer”.
Hazrat Abu Masud Al Ansari (RA) Sahi Bukhari & Sahi Muslim
“the messenger of Allah…..forbade the sale of wine, dead animals, pigs and
idols…….”.
Hazrat Abu Jabir (RA) Sahi Bukhari & Sahi Muslim
“The messenger of Allah cursed the devourer of usury, its payer, its scribe, and
its two witnesses. And he said that they are equal (in sins)”.
Hazrat Jabir (RA) Sahi Muslim
“The messenger of Allah prohibited intoxicants, games of chance, card-playing
and Gobairah and he said: Every intoxicant is unlawful.”.
Hazrat Abdullah Bin Umer (RA) Abu Daud.

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e) WHAT IS ISLAMIC BANKING?

Islamic Banking Definition:

Banking is a concept that has been used in our society in different form and
shapes. The history of banking is as old as 2000 BC when there were trading
system and the gold coins. There are different banking systems in the world but
the most famous ones are Islamic and conventional banking. The main function
of conventional bank can be summed up in one sentence: The banks borrow to
lend. They borrow in the form of deposits and lend this money to earn interest.
In contrary, Islamic banking system is based on the principle of partnership.
Here is the Islamic banking definition: “The shareholders, the depositors and the
borrowers-all would participate in an asset or business, on profit-loss sharing
basis”. Here you will get complete information about what is Shariah banking?

Islamic Banking System:

It is a finance management system that is based on the Islamic rules of Sharia.

The main concept is the prohibition on collection of interest and its utilization
for the business purposes. Muslim banking is a saving money framework that
depends on the standards of Islamic law, additionally known as Shariah law,
and guided by Islamic financial matters. Two fundamental standards behind the
concept are the sharing of benefit and misfortune. Gathering interest or Riba
isn’t allowed under Islamic law.

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It’s concepts have an indistinguishable reason from traditionally managing an

account aside from that it works as per the guidelines of Shariah, known as
Fiqh al-Muamalat (Islamic rules on financial business and economic
activities). Muslim banking as an account exercises must be polished reliable
with the Shari’ah and its pragmatic application through the improvement of
Islamic financial aspects. A significant number of these standards whereupon it
is based, are regularly acknowledged everywhere throughout the world, for
quite a long time as opposed to decades. These standards are not new but rather
their unique state has been changed throughout the hundreds of years.

Shariah Banking in Early Ages of Islam:

The history of Islamic banking goes back to the earliest reference point of Islam

in the 7th century. The first spouse of prophet Muhammad’s (PBUH), Khadija,
was a businesswomen, and the Prophet Mohammad (PBUH) went about as a
specialist for her business, utilizing a significant number of similar standards
utilized as a part of contemporary concepts.

In the Middle Ages, exchange and business activity in the Muslim world
depended on Islamic rules as account standards, and these thoughts spread all
through Spain, Baltic States, and Mediterranean, giving a portion of the premise
to western standards. From the 1960s to 1970s, the modern world accepted the
system.

How Does Islamic Banking Work?

It is important that you understand the rules to know how it works. There is
consensus among the Shariah scholars that credit price of a commodity can
genuinely be more than its cash price. The Islamic Fiqh Academy of OIC
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(organization of Islamic cooperation) and Sharia Boards of all Islamic banks,

approve the legality of this difference. However, no addition to price once
mutually agreed.

Keeping in mind the end goal to procure cash without charging premium,
Islamic banks utilize value support frameworks. This implies if a bank credits
cash to a business, the business pays back the advance without premium, yet it
gives the bank an offer in its benefits. In the event that the business defaults on
the advance or do not win any benefits, the bank does not get any benefit either.

Is Islamic Banking System Really Islamic?

Yes it is, if it is being practiced on the basis of rules and regulations defined by
Islamic laws. In case any organization is not following the rules defined in
Quran, Hadith, Ijma or Qayas, they are not allowed to claim themselves an
Islamic bank.

f) ISLAMIC ECONOMIC SYSTEM

Islamic Economics:

The fundamentals of the Islamic economic system start with the differences it
has with the capitalistic, communistic, socialistic, and other mixed types of
economic engines that have existed over the past centuries. There are seven
major principles and characteristics of Islamic economic system, that in some
ways mirror their capitalistic and socialistic counterparts, but are still unique
and vibrant only to the Islamic economics.

Principles and Characteristics of Islamic Economic System:

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Islamic economics consists of organizations, institutions, and social values that

exemplify the production, exchange, and consumption of goods and services.
Those who follow Islam are encouraged to lead a life of material gain in a way
that it shows respect for others, makes their place secure in the world, and
provides a source of happiness for their families.

1. Consumption:

Basic consumption is a fundamental part of all economies, including the Islamic

economic system. People have needs and businesses exist to fulfill them either
through goods or services.

2. Government Services:

The government serves to keep down activities that are considered non-Islamic
in nature such as the black market, gambling, smuggling, and similar activities.
In addition, the poor have their basic needs fulfilled in terms of basic life
necessities such as food, health, and clothing. Also, there is a requirement for
equal opportunity employment and security so that everyone has a chance to
work and prosper.

3. No Riba:

According to the Islamic economic system, the Islamic state should run without
interest, which means that the financial system does not use interest as part of
the lending procedures when running their banks and financial institutions. It is
one of the key characteristics of Islamic economic system, and also a
fundamental element of an Islamic banking system.

4. Private Property:

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This is encouraged, although the property itself cannot be used against the
interest of the public. The payment of Zakat for the ownership of the property is
mandatory.

5. Production:

As with capitalistic systems, production is an essential element as it not only

addresses the needs of consumers, but also provides employment and
opportunity. Under the principles of Islamic economic system, production is
part of the social fabric which makes it vital to society and includes a price
system.

6. Wealth:

The acquisition of wealth is not discouraged, although it does include a payment

of Zakat. It should be noted that the purchase of luxuries is not encouraged
either, so the focus of the wealth is more along the lines of the greater good for
the family and community.

7. Zakath:

Payment of Zakath is one of the major characteristics of Islamic economic

system, as well as a major resource for the stability of poor in the Islamic
society. It regards as a type of worship, in which a proportion of wealth
collected from the rich and given to the poor on an annual basis. This also
provides support to the state by reducing number of needy people.

Objectives of Islamic Economics and finance

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1. Taking the permanent tax (Zakat) which ranges between 2.5-10% of the
stored possession (which is not essential for one's living), in every year.
2. To prevent capital interest or usury.
3. Seizing lands and national resources which are not under exploitation by their
owners. There is a well-known Islamic rule in this respect: "Land is for whoever
cultivates it.
4. Preventing accumulation and storage of money which is not utilised in the
national production.
5. Protecting the hereditary laws which help in distributing the person's wealth
among his relatives, which is a big action against capital inflation.
6. Preventing wastage of national wealth by luxuries.
7. Administering and utilising the national production by using the collective
possession field.
8. To prevent gambling, cheating, monopoly, etc.

Difference between Islamic, Capitalism and Socialism economic systems

capitalism socialism Islamic

There is absolute and Denies rights to property Admits rights to property but does
unconditional rights not consider it to be absolute or
to private property unconditional right that is bound
to cause disorder

CONCLUSION:

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The Islamic Economic System is markedly different to capitalistic, socialistic,

communistic, and mixed economic systems. Basic principles of capitalism must
be changed considerably to fit Islamic economics, but it must be said that some
of the foundations are similar in terms of acquisition of wealth. However, it is
the application of the wealth and how it ties into production that makes the
economic system of Islam unique in the world. Professionals willing to join
Islamic banking industry and fully understand what is Islamic banking? should
join a globally recognized CIFE (best Islamic finance certification), which is a
part of diploma in Islamic banking and finance program.

g) ARCHITECHTURE OF ISLAMIC FINANCIAL SYSTEM

Financial architecture comprises of those best practices, principles, guidelines

and standards needed to enhance the financial sector. The purpose of
architecture of Islamic finance is to enhance the Islamic financial sector
development and performance and strengthening macroeconomic growth and
stability.

Certain unique financial architectural features are needed for Islamic finance

1) Legal infrastructure
 Financial laws – containing legal basis for Islamic finance i.e banking,
takaful (insurance) and capital markets.
 Tax laws – adjustment of tax laws relating to income on profits, transactions
(capital gains and stamp duties), goods and services (value added tax).
 Dispute settlement framework – containing the accommodation of disputes
relating to Islamic finance.

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 Bankruptcy and resolution of Islamic banks.

2) Regulations and Supervision framework
 Shariah (compliance changes with the nature of transactions and risks in
financial transactions.
 Need for regulatory/supervisory framework to deal with different types of
risks in Islamic finance.
 Regulatory standards – IFS (Islamic finance service board) is responsible for
developing regulatory guidelines for Islamic banks, takaful and capital
markets.
 Implementation – departments/units in regulatory bodies being put in place
to deal with Islamic finance.

3) Shariah Governance framework

 Shariah compliance is key to Islamic finance as customers deal with Islamic
finance due to religious convictions
 Shariah governance guidelines provides a framework
4) Liquidity infrastructure
 Contains Shariah compliant liquidity instruments (Liquidity refers to the
ease with which an asset, or security, can be converted into ready cash
without affecting its market price)
 Islamic money markets ( Islamic money market can be defined as
a financial market in which wholesale short term instruments are being
transacted in accordance with rules and guidelines stipulated by Sharia)
 Shariah compliant lender of the last resort facilities(A lender of last
resort is the provider of liquidity to financial institutions that are
experiencing financial difficulties)
5) Information infrastructure and transparency
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 This feature is key for effective market discipline

- Provides information on financial institutions to stakeholders (investors,
depositors)
- Information on credit worthiness of clients.
 Accounting and auditing framework – AAOIF (Accounting and auditing
organization for Islamic financial institutions)
 Credit reporting systems and rating agencies – IIRA (Industrial internet
reference architecture) conducts Shariah rating of Islamic financial
institutions.
6) Consumer Protection Architecture
 Consumer protection – fair treatment of customers.
 Financial literacy – consumer empowerment on demand side. Islamic
financial transactions are new and complex which requires the need for
financial education and awareness schemes.
 Deposit insurance – protects depositors in case of bank closures following
the shariah compliant deposit insurance schemes.
7) Human capital and knowledge development
 Good quality of human capital with knowledge and skills to develop Islamic
financial sector.
 Need for
- Provision of education and training in Islamic finance
- Research and development to create new knowledge needed for
development of Shariah based Islamic finance.
- Knowledge and skills of financial architecture at different levels

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h) THE CONCEPT OF WEALTH IN ISLAM

Economic Philosophy of Islam

They practice the No Riba concept because it encourages

- Concentration of wealth in few hands

- Creation of monopolies
- Greed and selfishness leading to injustice and oppression

Islamic Model of Distribution Of Wealth

It is based on two underlying principles

- Importance of economic growth

- Real nature of wealth and property
1) Importance of Economic Goals
- According to materialistic economics (livelihood is the fundamental
problem of man and economic development is the ultimate goal of human
life.
- According to Islamic economics (livelihood may be necessary and
indispensable but cannot be the true purpose of human life, Economic
activities of man are lawful, meritorious and at times obligatory and
necessary)
2) Real Nature Of Wealth And Its Property
- Wealth in all its possible forms is created by Allah
- Therefore wealth is the property of Allah
- The right of property which accrues to man is delegated to him by Allah
- Allah may command man to give a specified part of his wealth to another
man.
- Allah may forbid use of wealth in a particular way

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Therefore Allah has the right to demand that man subordinates his use of wealth
to the commandments of Allah.

i) Objectives Of Distribution Of Wealth in Islam

1) Establishment of a practical economic system

Islam accepts the following things within a certain limits

- Laws of demand and supply

- Motive of personal profit
- Market forces
- Natural relation of employer and employee

The first object of the distribution of wealth is that it would be the means of
establishing in the world a system of economy which is natural and
practicable, and which, without using any compulsion of force, allows every
individual to function in a normal way according to his ability, his aptitude, his
own choice, and liking, so that his activities may be more fruitful, healthy and
useful. And this cannot be secured without a healthy relationship between the
employer and the employee, and without the proper utilization of the natural
force of supply and demand. That is why Islam does admit these factors.

2) Enabling everyone to get what is rightfully due to him

- Elementary level of deserving wealth: factors of production
- Secondary level of deserving wealth: Poor

Only those factors that have taken a direct part in producing wealth are entitled
to share in “wealth”, and no one else. On the contrary, the basic principle of
Islam in this respect is that “wealth” is the property of Allah Himself and He
alone can lay down the rules as to how it is to be used. So according to the

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Islamic point of view, not only those who have directly participated in the
production wealth but those to whom Allah has made it obligatory upon others
to help, are legitimate sharers in wealth.

Hence, the poor, the helpless, the needy, the paupers and the destitute – they too
have a right to wealth, for Allah has made it obligatory on all those producers of
wealth among whom wealth is in the first place distributed that they should pass
on to them some part of their wealth.

3) Eradicating the concentration of wealth through

- Prohibition of hoarding, interest, gambling, speculation, Uqood Fasidah
(void contracts) and Gharar(risk or uncertainty)

Islam in this respect is that it has not permitted any individual or group to have a
monopoly over the primary sources of wealth but has given every member of
the society an equal right to derive benefit for them.

Mines, forests, un-owned barren lands, hunting and fishing, wild, grass, rivers,
seas, spoils of war, etc., all these are primary sources of wealth. With respect to
them, every individual is entitled to make use of them according to his abilities
and his labor without anyone being allowed to have any kind of monopoly over
them.

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j) THE FACTORS OF PRODUCTION IN ISLAM AND THEIR

COMPENSATIONS

The Factors Of Production In Conventional System

Capitalism has four factors of production

1) Capital- the produced means of production

Compensation: interest
2) Land- natural resources (that is to say, those things which are being used as
means of production without having previously undergone any process of
human production). Compensation: Rentals
3) Labour- that is to say, any exertion on the part of man.
Compensation: Wages
4) Entrepreneur or Organization- the fourth factor which brings together the
other three factors exploits them and bears the risk of profit and loss in
production. Compensation: Profit

The Factors Of Production In Islam

1) Capital- That is, those means of production which cannot be used in the
process of production until and unless during this process they are either
wholly consumed or completely altered in form, and which, therefore,
cannot be let or leased (for example, liquid money or food stuffs etc)
Compensation: Profit
2) Land- that is, those means of production which are used in the process of
production that their original and external form remains unaltered, and which
can hence be let or leased (for example, lands, houses, machines etc)
Compensation: Rentals

3) Labour- this is human exertion, whether of the bodily organs or of the mind
or of the heart. This exertion thus includes organization and planning.

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Compensation: Wages
k) CONCEPT OF FREE AND FAIR MARKET SYSTEM IN ISLAM

Islam promotes free market institutions. Theoretically Islam and free market are
compatible. It is noteworthy that Islam does not ban or reject any of the 5 pillars
of free market economy discussed in the second section. There is no Qur’anic
verse or sound hadith (prophetic tradition) which explicitly ban or outlaw
private property, freedom of choice, entrepreneurship, competition, limited
government and free trade.

 Private Property:

Islam recognizes and protects private property. The existence of “law of

inheritance” by itself is a proof that Islam recognizes private property. In many
verses Qur’an talks about “their property, sons, animals,..” and warn the
believers not to get, obtain, or eat them in illegal and unjust ways. “Do not eat
your property among yourself unlawfully; do not give them to judges (as
bribe)to knowingly committing sin and eat some of the property of people”
(Qur’an, al-Bakarah, 2/188).

 Freedom of choice and entrepreneurship

On one side, consumers have the right to use their money freely on those goods
and services they need. Nobody can force them to spend money on anything
they do not wish to do so.

On the other side, entrepreneurs have the right to invest their resources,
financial or otherwise, in those sectors they would like to invest. Nobody can
force them to produce a commodity they do not wish, or invest in an industry in
which they do not plan to do so.

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They however are compelled to do so following the laws of production and

consumption.

 Competition (free entry and exit)

In its simplest meaning, competition can be defined as the “race for better
quality and cheaper price.” At the market level, this implies the right to enter
and exit. In other words, every firm, company or entrepreneur should have the
right to enter into a market, sector or industry they wish to enter, or exit from a
market whenever they wish, for any reason. This is an extremely important
institution to promote better product quality, higher product variety, lower costs
and hence cheaper prices.

 Free trade

Many arguments can be put forward on how Islam promotes free trade, as
partially mentioned above. It is important to remember that the Islam’s Prophet
(pbuh) himself was a trader. He travelled to Damascus (Syria) a few times with
the trading caravans. Trade has been considered to be the main source of
making a living, hence free trade is encouraged in many ways. For instance, the
Prophet (pbuh) did not permit merchants to hide the goods to sell later at a
higher price. This means no hoarding is allowed. He did not allow purchasing
the goods on the halfway at a cheaper price and sell them in the market place at
a higher price, i.e. no price speculation. Similarly, the Prophet rejected to fix the
prices or set up a price ceiling.

 Limited government

As regards to the limited government, Islam asks people to obey the rulers from
among themselves. At the same time, Islam asks the political authorities to be
just, observe the rights of the subjects. Oppression and torture are outlawed. The

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second Caliph Omar bin al-Hattab showed the ideal example of being just and
making government a servant to the people.

In short, in Islam, private property is recognized and promoted; people are

asked to work and obtain wealth; price-fixing is rejected; the market place is
open to everyone, no monopoly and asymmetric information; political authority
is asked to treat the subjects justly… We conclude that free market economy
and Islam are not foes, but friends. There are not inherent contradictions
between Islam and market economy.

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CHAPTER TWO: CONCEPT OF RIBA, GHARAR, QIMAR AND

OTHER PROHIBITED ACTIVITIES

a) WHAT IS RIBA?

Riba is an Arabic word, and it means: “Excess, Increase or Addition”. In Quran

and Hadith, it is used for ‘interest’. Types of Riba in Islam are Riba An Nasiyah
and Riba An Fadl. Let us understand riba with the help of an example: Suppose
a person lent a sum of money to another person and asked the debtor to pay it
back together with an agreed additional sum of money within a fixed period. Or
a rate of interest was fixed for a specific period, and if the principal along with
the interest was not paid within that period, the rate of interest was enhanced for
the extended period, and so on. This enhanced or additional amount is “Riba”.

Prohibition of Riba in Islam:

Islam prohibits Riba because it inculcates miserliness, selfishness, callousness,

indifference, inhumanity, greed, and worship of wealth. It also destroys the
spirit of sympathy, mutual help, and cooperation, and thus affects the feelings of
brotherhood and unity among the community.

It is prohibited because it causes many economic evils, for example, It leads to

hoarding of money, adversely affecting its circulation among larger sections of
society. It also causes the establishment of monopolies, cartels, and
concentration of wealth in a few hands. And so, the gulf between the rich and
the poor widens.

Riba in Quran and Hadith:

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It is prohibited in many places in the Quran and Hadith. Here are some
references:

RIBA IN QURAN:

“And whatever you give for interest to increase within the wealth of people will
not increase with Allah. But what you give in Zakath, desiring the countenance
of Allah – those are the multipliers.”.
Surah Ar-Rome, Verse-39!

“And [for] their taking of usury while they had been forbidden from it, and their
consuming of the people’s wealth unjustly. And we have prepared for the
disbelievers among them a painful punishment”.
Surah Al-Nisa, Verse-161!

“O you who have believed, do not consume usury, doubled and multiplied, but
fear Allah that you may be successful”.
Surah Aal-e-Imran, Verse-130!

“Those who consume interest cannot stand [on the Day of Resurrection] except
as one stands who is being beaten by Satan into insanity. That is because they
say, “Trade is [just] like interest.” But Allah has permitted trade and has
forbidden interest. So whoever has received an admonition from his Lord and
desists may have what is past, and his affair rests with Allah . But whoever
returns to [dealing in interest or usury] – those are the companions of the Fire;
they will abide eternally therein”..
Surah Al-Baqarah, Verse-257!

RIBA IN HADITH:

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“All of the Riba of Jahiliya is annulled. The first Riba that I annul is our Riba,
that accruing to Abbas Bin Abdul Mutallib, it is being cancelled completely.”
Reported by, Hazrat Jabir RadiAllah

TYPES OF RIBA?

There are two types of Riba in Islamic banking. We will discuss each of them in
detail:

Riba An Nasiyah:

It is also called Riba Al Jahiliya, and it refers to the addition of the premium,
which is paid to the lender, in return for his waiting as a condition for the loan.
It is technically the same as interest, and this is the real and primary form.

“Every loan that draws excess is Riba.”

Hadith

Riba Al Fadl:

It is also called known as Riba Al Bai. It is defined as excess compensation,

without any consideration, resulting from a sale of goods.
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“Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent

silver, sell dates in exchange of equivalent dates, sell wheat in exchange of
equivalent wheat, sell salt in exchange of equivalent salt, sell barley in
exchange of equivalent barley, but if a person transacts in excess, it will be
Riba. However, sell gold for silver anyway, you please on the condition, it is
hand-to-hand and sell barley for date anyway, you please on the condition, it is
hand-to-hand.”
Hadith

LAWS REGARDING RIBA AL FADL:

Any difference in value or quality should be ignored and the commodities

should be exchanged in equal weight and volume. Instead of a direct exchange
of commodities of the same kind, a person should sell his commodity against
cash at the market value, and buy someone else’s commodity in exchange for
cash at the market value.

Difference between Trade and Interest:

In trade, one earns profit as a result of the initiative, enterprise, efficiency, and
hard work, profit fluctuates, and there is a risk of loss as well. On the other
hand, the interest is not earned through hard work or any value-creating process.
It is not the reward of labor but is in fact an unearned income. The lender gets
his fixed amount, irrespective of the fact, whether the debtor earns any profit or
sustains a loss.

Shariah Rules Regarding Riba-Free Loans

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The loan may be in any form that is in cash or in commodity, it may be big or
small, it may be for the personal needs of the debtor or for purpose of business,
the loan shall be given without interest. Since the verbal agreements regarding
loans lead to disputes, Quran has made it obligatory for both creditor and debtor
to bring the contract of debt into writing in the presence of two witnesses and
settle terms and conditions regarding its repayment.

According to a Hadith: “Whoever takes a loan, with an intention of not

returning it, is a thief”.

A debtor is eligible for Zakath, for discharging the burden of his debt. Here are
some of the duties of Debtor and Creditor in Islam:

Duties of Debtor in Islam:

 Debt should be incurred only when it is unavoidable. It may be incurred

to satisfy basic needs or to discharge an essential responsibility.
 In no case, debts should be contracted for unlawful purposes, or for
luxurious living.
 The contract of loan should be reduced in writing, in the presence of two
witnesses. The debtor has the right to give dictation to the scribe when the
contract of loan is being written.
 Debt should be taken with a clear intention to pay it back.
 If a creditor demands some security in the shape of property or asset, the
debtor is bound to provide the same.
 The debtor should pay back the debt promptly, on the promised date or
earlier.
 The debtor is duty-bound to clear his debts, before his death. Otherwise,
his legal heirs should clear the debts.

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Duties of the Creditors in Islam:

 The loan should be advanced to a genuinely needy person, who requires

the loan for genuine needs.
 When a creditor lends money to someone, he should make a contract in
writing with the debtor, settling the terms and conditions of the loan, and
the time for its return.
 If the debtor has become insolvent and is not in a position to pay back the
loan, the creditor is enjoined to remit the debt. It is an act of great virtue
and it carries many rewards.
 If the debtor is not able to make full payment, the creditor shall accept
payment in installments.
 The creditor is allowed to use harsh words in case of a solvent debtor,
who does not repay the loan despite persistent demand. But still, he is
instructed not to lose his cool. He should kindly treat his debtor and
should not injure the dignity of the debtor.

Role of Bait-ul-Maal:

The state-managed Public Treasury is called Bait-ul-Maal and it provides loans

to needy people in the society.

FOR EXAMPLE:

The people would do their business with whatever capital and economic sources
they have, and they would not be generally too ambitious to expand it with
borrowed capital.

“The state would need hardly any loans, but, if the state fails to raise funds and
the need is dire, it can resort to borrowing. However, the borrowing should be

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restricted to need only, and loans should be raised preferably from brother
Muslim countries, free of interest”.

b) WHAT IS GHARAR?

Gharar is an Arabic word which means a high level of uncertainty and risk in
monetary transactions. An unambiguous sale, a transaction where the outcome
is unknown. Gharar transactions are high risk and hazardous transactions such
as insurance.
Gharar means uncertainty. In Islamic finance gharar is seen as a deceptive
practice. Where someone is either buying or selling something that is unknown.
Any transaction where the price and/or receivables of the item/service is not
known in full at the point of sale is gharar (uncertain/unknown).

By the unanimous consensus of all the scholars of Islam. From all the four main
schools of thought; Hanafi, Shafi’i, Maliki and Hanbali. All contracts of gharar
are forbidden (haram) in Islam and considered null and void.
Therefore, in Islamic banking Bai’ al-Gharar (sale of uncertainty) is prohibited.
Examples of Gharar include;

1. If someone sells you a can of food that does not have a label and so you
are uncertain what you are buying. This is Gharar (uncertainty).
2. If someone sells you crops that have not yet harvested.
3. If someone tried to sell you fish in the sea that has not been caught or an
animal that has not yet been born.
4. Selling milk that is still in the udders of the animal and not yet extracted
out.
5. Futures and Options Contracts
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In the sharia all such transactions are known as Gharar (uncertain/unknown).

The Prophet (peace be upon him) forbade all transactions that have a high level
of uncertainty (Gharar). He also gave us explicit examples of what constitutes
gharar:

It was narrated that Abu Sa’eed Al-Khudri (may Allah be pleased with him)
said:“The Messenger of Allah (peace be upon) forbade selling what is in the
wombs of cattle until they give birth. And selling what is in their udders unless it
is measured out. And selling a slave who has fled. And selling spoils of war
until it has been distributed. And selling Sadaqah until it has been received. And
what a diver is going to bring up (i.e the catch from the sea).”
[Sunan Ibn Majah • Book 12, Hadith 60 • Graded Reliable (Hasan)]

Examples of Gharar in Daily Transactions

Examples of gharar in daily transactions could include;
1. Conventional Insurance Contracts (e.g. Life insurance, Car Insurance)
2. Derivative transactions (e.g. Forwards, Futures and Options Contracts)
3. Short selling and speculation in the stock market (e.g. where a seller is
trying to sell an asset which they do not own)
4. Forex trading
All of the above cases create unnecessary risk and fall under fraud, deceit,
hazard or uncertainty that may lead to loss or destruction.
This is why in Islamic banking and finance gharar is one of the prohibited
elements.
Evidence of the Prohibition of Gharar in the Quran
There are two verses in the Qur’an where scholars say that Allah has prohibited
the concept of Gharar (uncertainty):

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“Do not consume one another’s wealth unjustly. Nor deliberately bribe
authorities in order to devour a portion of others’ property, knowing that it is a
sin.” – [Quran 2:188]

Islamic jurists explain one of the meanings of the first part of this verse is
referencing gharar. This is because Gharar is an unjust predatory practice of
consuming people’s wealth. And Allah has prohibited such practices of
devouring people’s wealth unjustly and deceptively.
“O you who have believed, do not consume one another’s wealth unjustly but
only (in lawful) business by mutual consent.” – [Qur’an 4:29]
Source: https://quran.com/4/29

In the above verse Allah emphasizes two essential conditions of Islamic finance.
Firstly that the terms must be just and fair to both parties and secondly mutual
consent from both sides. If either of the conditions is missing then the contract
is prohibited (haram).

Gharar by its nature is unjust and deceptive. Therefore even if someone were to

agree to a contract containing Gharar out of compulsion the contract is still
prohibited. This is because it does not fulfil the first condition of justice and
fairness. This is why Islam prohibts Gharar.
The evidence of the prohibition of gharar is mentioned in the hadith of the
Prophet (peace be upon him) mentioned in Sahih Muslim.
Narrated on the authority of Abu Huraira that the Messenger of Allah (peace be
upon him) forbade a transaction determined by throwing stones, and the type
which involves some gharar (uncertainty).
[Sahih Muslim • Book 21, Hadith 8 • Graded Authentic (Sahih)]

Types of Gharar
There are two types of Gharar:
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1. Gharar Yasir (light or minor uncertainty)

2. Gharar Fahish (excessive or major uncertainty).
Both forms of gharar are not haram. Gharar Fahish is the haram kind of Gharar.
Gharar Yasir is under the halal class of Gharar.
1) Gharar Fahish (excessive gharar) is an excessive amount of uncertainty or
ambiguity. The amount of uncertainty is so high that the sharia considers it
unjust and predatory. Gharar Fahish is therefore prohibited (haram) in Islam.

Example of Gharar Fahish (Major or Excessive Gharar)

An example of Gharar Fahish is conventional insurance contracts. Insurance
contracts are highly ambiguous and predatory in nature. You could pay towards
your insurance policy for decades and get nothing. Or you could end up in an
accident tomorrow and get a huge lump sum.
This level of high risk and uncertainty in conventional insurance contracts
Gharar Fahish. And Gharar Fahish is haram in Islam.

2) Gharar Yasir (light or minor gharar) is a trivial amount of uncertainty

that is present in all transactions. The amount of uncertainty is so small that
the sharia considers it negligible. Gharar Yasir is therefore NOT haram. It is
just mild or moderate uncertainty that cannot be avoided.

Example of Gharar Yasir (Minor or Light Gharar)

An example of Gharar Yasir is when you buy a house. Later you discover that
one of the light switches is not working. But you didn’t know about this when
you bought the house. This is Gharar Yasir/Yaseer.
Evidently you bought the house based on the overall general condition of the
house. So one or two light switches not working is negligible and not
considered excessive. So your house purchase is halal.

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Why is Gharar Haram (Prohibited) in Islam?

Gharar is haram (prohibited) in Islam to prevent injustice and deceit. Any
transaction where the outcome is not known can lead to disputes and injustice.
Islamic finance is built on the premise of openness, certainty and justice. Gharar
(uncertainty) defies the very purpose of Islamic finance.
The effects of gharar may not be seen straight away. But they can have a huge
impact on a person’s finances in the future. This is why one of the foundational
premises in Islamic economics is the prohibition of Gharar.
All transactions where the outcome of the deliverable is not known at the point
of sale are not permissible in Islam. Even if both parties agree to the terms it is
still not allowed. This is why many Islamic banks ban contracts of gharar.
Gharar runs counter to the notion of openness and certainty in business
dealings.

Gharar in Insurance
Gharar in insurance is that you do not know for certain what you will get in the
end. As part of your insurance contract you may pay premiums for
months/years but if no misfortune happens you get nothing.
On the other hand, you may pay towards your insurance for a few months and
within that time you have an accident and get a large sum of money.

Conventional insurance contracts also deal with interest (riba) and gambling or
speculation (maysir/qimar).

What is the difference between Riba (Interest) and Gharar (Uncertainty)?

The main difference between Riba and Gharar is that Riba (interest) is an
increase added on the exchange of money for money transactions. While Gharar

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(uncertainty) is where someone is either buying or selling something that is

uncertain/unknown.
Example of Riba: If someone gives you $100 and they ask $110 for lending
you the $100. The $10 increase is Riba (interest/usury).
Example of Gharar: If you give someone $100 but it is uncertain what you
will or will not get in return. This is Gharar (uncertain/ambiguous/unknown).
This is the distinction between riba and gharar. Both these types of transactions
are prohibited (haram) elements in Islamic finance.

MAYSIR (GAMBLING) AND QIMAR

Gambling refers to easily available wealth or acquisition of wealth by chance,

whether or not it deprives the other’s right.

Qimar means a game of chance – one gains at the cost of other

Example: interest, illegal racing

In its literal meaning, qimar refers to betting and wagering. Technically, it

involves taking ownership of some form of wealth (mal) by way of a wager.
Qimar or gambling includes every game in which the winner receives
something (money, goods, etc) from the loser. This zero-sum game constitutes
wagering on very risky outcomes which shariah outspokenly forbids.

On the other hand, maysir is broader in scope than qimar. Maysir includes all
kinds of gambling, that is, it is more than a particular game of chance.

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CHAPTER THREE : COMPARISON OF ISLAMIC AND

CONVENTIONAL BANKING

Islamic Banking VS Conventional Banking:

Let us first understand the major difference between Islamic banking and the
conventional banking system. Islamic banking must comply with Sharia laws,
but conventional banks do not have to comply with them. For example,
conventional banks charge interest (Riba), and they may involve in the trading
of Shariah prohibited elements such as Alcohol, Pork, etc., or elements like
Gharar (Uncertainty) or Maysir (Gambling).

1. Conventional Banking:

Conventional banking is the traditional way of banking that involves taking

deposits from individuals and businesses and making loans to those who need
financing. This type of banking allows individuals to put their money into a
conventional bank, where it can sit and earn interest while they are not using it.
Individuals can also make small loans at this time, such as for a car or home
improvement project.
In conventional banking, there are three main types of products: savings
accounts, checking accounts, and time deposits.

 Saving Accounts: These accounts allow people to store their money and

earn interest (Riba) on it at the same time.
 Saving Account: Savings account allows clients to save their earnings
and use them later when needed.
 Time Deposits: They are similar to checking accounts but with higher
interest rates.

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All these products are also found in Islamic banks, but with the elimination of
Interest (Riba) and other prohibited elements.

2. Islamic Banking:

Islamic banking is a type of finance that involves the use of profit-sharing,

interest-free loans, and other financial services based on the principles of
Islamic Sharia law. Unlike conventional banking, which charges interest on
loans, Islamic banks are structured to encourage financial transactions with
a principal focus on charity and community development.

In many ways, Islamic banking is similar to conventional banking in that it

allows individuals to save their money and receive loans for large purchases
such as homes or vehicles. However, there are also differences in how Islamic
banks operate. It’s often referred to as “ethical” or “people-friendly” banking.
As well as being more ethical, Islamic banking is also more environmentally
friendly than conventional banking because it encourages people to make
smaller loans rather than take out large ones. This means that Islamic banks can
also be more sustainable than conventional ones in the long run.

“Islamic banking is an Ethical Banking System, and its practices are based on
Islamic (Shariah) laws. Interest in completely prohibited in Islamic banking. It
is asset based financing, in which trade of elements prohibited by Islam are not
allowed. For example, you cannot take a loan for a Wine Shop. On the other
hand, Conventional Banking is an Un-Ethical Banking system based on Man-
Made Laws. It is profit-oriented and its purpose is to make money through
interest”..
Key Note!

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Key Differences between Conventional and Islamic Banking:

Now, let us review some major differences between Islamic banking and
conventional banking systems:

Conventional Banking System Islamic Banking System

Money is a product besides a medium Real Asset is a products. Money is

of exchange and a store of value. just a medium of exchange.

Profit on the exchange of goods &

Time value is the basis for charging
services is the basis for earning
interest on capital.
profit.

The expanded money in the money

A balanced budget is the outcome of
market without backing the real assets
no expansion of money.
results in deficit financing.

Interest is charged even in the case,

Loss is shared when the
the organization suffers losses. Thus
organization suffers a loss.
no concept of sharing loss.

While disbursing cash finance, The execution of agreements for the

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running finance, or working capital exchange of goods & services is a

finance, no agreement for the must while disbursing funds under
exchange of goods & services is Murabaha, Salam & Istisna
made. contracts

Due to the nonexistence of goods &

Due to the existence of goods &
services behind the money, while
services, no expansion of money
disbursing funds, the expansion of
takes place and thus no inflation is
money takes place, which creates
created.
inflation.

Due to inflation, the entrepreneur

increases the prices of his goods & Due to control over inflation, no
services, due to incorporating the extra price is charged by the
inflationary effect into the cost of the entrepreneur.
product.

Musharakah & Diminishing

Bridge financing and long-term loan Musharakah agreements are made
lending are not made on the basis of after making sure of the existence of
the existence of capital goods. capital goods before disbursing
funds for a capital project.

The government very easily obtains

Government can not obtain loans
loans from Central Bank through
from the Monetary Agency without
Money Market Operations without
making sure the delivery of goods to
initiating capital development
the National Investment fund.
expenditure.

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The real growth of wealth does not
take place, as the money remains in
few hands.
Due to the failure of the projects the
loan is written off as it becomes a
nonperforming loan.
Debt financing gets the advantage of
leverage for an enterprise, due to
interest expense as a deductible item
from taxable profits. This causes a
huge burden of taxes on salaried
persons. Thus the saving and
disposable income of the people is
affected badly. These results decrease
the real gross domestic product.
Due to a decrease in the real GDP, the
net export amount becomes negative.
This invites further foreign deb.ts and
the local currency becomes weaker.
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Real growth in the wealth of the
people of the society takes place,
due to the multiplier effect and real
wealth goes into the ownership of a
lot of hands.
Due to the failure of the project, the
management of the organization can
be taken over to hand over to better
management.
Sharing profits in the case of
Mudarabah and sharing in the
organization of business venture in
the case of Musharakah, provides
extra tax to Federal Government.
This leads to minimizing the tax
burden on salaried persons. Due to
this savings & disposable income of
the people increased, which results
in an increase in the real gross
domestic product.
Due to an increase in the real GDP,
the net export amount becomes
positive, this reduces the foreign
debt burden and the local currency
becomes stronger.
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CHAPTER FOUR: ISLAMIC LAW OF CONTRACT

A contract is a voluntary, deliberate and legally binding agreement between 2

or more competent parties. Contracts are usually written but may be spoken
or implied and generally have to do with employment, sale or lease or
tenancy.

A contractual relationship is evidenced by

An offer
Acceptance of the offer
A valid (legal or valuable) consideration
Shariah explain certain requirements for a contract to be valid and lawful.
Any contract which fulfils the prescribed requirements of Shariah, is deemed
valid and lawful. Islamic financial contracts have been developed throughout
the Islamic civilization based on the needs and requirements of society.

Definition of contract and its elements

After discussing the historical background of Shariah contracts very briefly,

we move on to explain the elements and prerequisites of a valid contract
in Shariah. Contract is also known as “Aqd”. Literally, this word “contract”
or “Aqd” means to conclude or to tie. As such, any covenant, pact,
agreement and treaty will also be referred to as Aqd since all of them
demonstrate firm resolution for execution. Plural word for Aqd is Uqood.
Technically, it can be defined as combination of offer and acceptance
between contracting parties which constitute legal obligations on them.

There are mainly three elements of a valid contract:

1.     Form of the contract (offer and acceptance).

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2.     Subject matter of the contract.

3.     Contracting parties.

1) Form of the contract

The form refers to the expressions which are made by contracting parties in
order to show their will and intention to enter into a contract. It is also
knowns as offer (Ijab) and acceptance (Qabul). The declaration which is
made first to create an obligation, is termed as offer (Ijab). And the
subsequent declaration to accept the offer, is called acceptance (Qabul).
There are some general requirements of for offer and acceptance.  First, it
should be in clear language and unconditional. Second, there should be
conformity between offer and acceptance. Third, both offer and acceptance
must be concluded in the same session. Generally, offer and acceptance are
exercised in words. However, it is not necessary to express them only in
words. It can be done by other methods such as writing and conduct etc.

2) Subject matter of the contract

Subject matter refers to the object of the contract upon which the legal
obligations are manifested. It can be a good or property of sale contract or
pledged object in a pledge contract and usufruct in a lease contract. The
general requirements for subject matter are summarized in the following.

1.     The Subject matter must not be a prohibited item in Shariah.

2.     It should be in the ownership of the seller.

3.     It should be in existence or available at the time of conclusion of the

contract.

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4.  It must be identified and clearly known to the contracting parties in order
to avoid any dispute later.

5.  The delivery of subject matter must be confirmed and certain at the time
of contract.

3) Contracting parties

There are at least two parties in a contract, the offeror and offeree. The
offeror is the one who makes an offer and offeree is the one who accepts that
offer. The main condition for these parties is that they must have legal
capacity and competency to enter into a contract. In other words, they must
be mature and sane. The maturity means that a person is capable to deal his
wealth properly and know the basics of business and trade. If someone is
immature or not have the legal capacity, then he is not allowed to enter into a
contract independently.

A condition that is against the contract and not in market practice but is in
favour of one of the contractors or subject matter, the condition is void. For
example: If “A” sells a car with a condition that he will use it on a fixed date
every month, this contract will be void.

A condition, which is against the contract, not in the market practice and not in
favour of any contractor, that is not a void condition. For example: if both A
and B decide to give a charity, a certain percentage of both subject matter and
consideration, upon completion of sale.

VOID CONDITIONS AND VOID CONTRACTS

The contracts of compensation (Uqood Muawadha) like sale, purchase,

lease agreements become void by putting void condition.

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Non-compensatory (voluntary) agreements (Uqood Ghair Muawadha) like

contract of loan (Qard-e-Hasanah), do not become void because of void
condition. The void condition, however, becomes itself ineffective.

CHAPTER FIVE: ISLAMIC LAW OF SALE AND PURCHASE

Bai (Sale) • Definition: Exchange of a valuable thing by another valuable thing

with mutual consent. It is also the sale of a commodity in exchange for cash.

Bai’ ‘Inah which means a contract of sale and purchase

Concepts of Islamic sale and purchase

Valid sale (Bai Sahih) :

Bai Sahih is a valid sale where all elements (contract, subject matter, price,
possession) together with their conditions are present.

Aqd (Contract)

• Mabee (Subject Matter)

• Thaman (Price)

• Qabza (Possession or delivery)

Conditions for (Contract) • Offer and Acceptance Must be in Past/Present

tense (Implied form is also applicable) • Sale must be instant and absolute • Sale
should be unconditional • A contract must not be comprise of any other contract
within itself.

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Conditions for Subject matter • Existing (Salam and istisna are exempted) •
Valuable (Some things do have scope of becoming valuable with the change of
time) • Usable (In the light of shariah) • Capable of ownership/title (Things that
could be in private property) • Capable of delivery and possession (a stolen car)
• Seller must have ownership & risk(Other wise it will be dependent on the
permission of its owner) • Specific / Quantified (Transaction will not be
completed until separated in W/H)

Conditions for Price •The price must be quantified •The price must be
specified in terms of currency etc. •The price must be certain at the time of
contract (either this or that will not be accepted)

Conditions for delivery or possession: physical and constructive

Void/ Non existing Sale (Bai Baatil) :

An agreement of sale which is unlawful in respect of its substance and

description. For example, an agreement of sale concluded by a lunatic or a
minor is batil since it does not possess substance of the agreement, which is the
proposal and acceptance by a sane or major person.

Existing sale but void due to defect (Bai Fasid) :

An agreement of sale that is lawful in its substance but unlawful in respect of its
description. The substance of the agreement refers to proposal, acceptance and
the article of sale. The description refers to characteristics other than the
substance, such as price of the article of sale. If an agreement of sale for a
definite article is concluded by proposal and acceptance but the price is not
settled, the agreement would be fasid although it is enforceable (mun‘aqad) so
far as its substance is concerned. In a fasid sale, the buyer should not

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possess the subject matter. If possessed with the consent of the seller, title or
ownership will pass to the buyer but usage of subject matter will be
impermissible. He must return it to the seller.

Valid but disliked sale (Bai Makrooh) :

A sale will be Makrooh when the transaction is complete and one gets
possession of the goods but is disliked eg. sale after Juma Azaan, sale after
hoarding or where a third party intervenes to buy something which was under
negotiation of sale between other parties.

Types of Sales:
Following are the common types of sales

1.Bai Musawamah: It refers to normal sale in which cost price is not known.
2.Bai Murabaha: It refers to a sale in which cost and sale price is known to the
buyer.
3.Bai Muqayada: It refers to barter sale excluding currency sale.
4.Bai Surf: It refers to the sale of gold, silver and currency.
5.Bai Salam: It is a kind of sale in which payment is spot while the delivery of
the good is deferred.
6.Bai Istisna: It refers to such sale in which commodity is transacted before it
comes into existence. It is basically an order to manufacture.
7.Bai Muajjal: It refers to such sale in which payment is delivery is spot while
payment is deferred but cost is not known.

Prohibited transactions in Islam

Islam prohibited unethical business transactions

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1) Dealing of Haram items: unlawful items such as carrion (death meat), pigs,
and idols are prohibited in Islamic transactions.
2) Sale of Al-Gharar: uncertainty, risk or speculation is prohibited in Islamic
transactions.
3) Hoarding of food stuffs: excessive purchase and storage of foodstuffs in
expectations of future rise in price is haram in Islamic transactions.
4) Exploitation of one’s ignorance of market condition (price and quantity of
goods)
5) Al-Najish (Trickery): A situation where a person offers a high price for
something without intending to buy it just to cheat or defraud another person
who really means to buy it.
6) Cheating and fraud in business transactions
7) Swearing : A recourse of swearing that items are in good quality. Swearing
in business for persuasion is forbidden in Islam.
8) Giving short measure: taking full measures of goods from others and
giving short measures in your turn.
9) Dealing in stolen goods.

KHIYARS

The term khiyar refers to the option or right of the buyer & seller to rescind
(cancel officially, revoke) a contract of sale.

Conditions under which Khiyar can be exercised

1. Khiyar-e-Shart (Optional condition): At the time of sale Buyer or Seller

can put a condition that he has an option to rescind the sale within the specific 4
days. This option is called Khiyar-e-Shart. Specification of the days is necessary
for this Khiyar. Within this period, he has the right to rescind/dissolve the sale

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without any reason. If the buyer puts the condition, it is called Khiyar-e-
Mushtari (option of buyer) and when put by the seller, it is called Khiyar-e-Bai
(option of seller). This Khiyar is not transferred to heirs.
2. Khiyar-e-Roiyyat (Option of inspecting goods): Where the goods can be
returned after inspection. This applies automatically to all contracts. Eg. ‘A’
buys machinery from ‘B’ without seeing. However, ‘A’ has the option to return
the machinery after inspection.
3. Khiyar-e-Aib (Option of defect): Where the goods can be returned if found
defective. It is the responsibility of the seller to supply goods free of error/defect
or point out the defect to the buyer. No way is he allowed to cover the defect of
the goods which constitutes as fraud. In one of the hadiths, Prophet has stated
“He is not amongst us who indulges in fraud.” Therefore the buyer has the right
to return the good in case of a defect which is considered a defect in the market
and which depreciates the value of the goods. Eg. ‘A’ buys batteries from ‘B’.
However, ‘A’ has the option to return them to ‘B’ if the batteries are found to be
defective or not in working condition.
4. Khiyar-e-Wasf (Option of quality): Where the goods are sold by
specifying a certain quality by the Seller but which is absent in the goods. Eg.
‘A’ buys a car from ‘B’ who has specified automatic transmission of the car.
However when ‘A’ uses the car, he finds the transmission to be manual.
Therefore he can return the car to ‘B’ in the absence of a specific quality.
5. Khiyar-e-Ghaban (Option of price): Where the seller sells the goods at a
price which is far expensive than the market price, a Buyer has the right to
return it to the seller. Eg. a Parker pen is sold to ‘A’ by ‘B’ at a price of
Rs.500/-. However after the sale, ‘A’ discovers its market price to be Rs.250/-,
he has the option to return the pen to ‘B’.

IQALA (Recession of Contract)

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Where parties freely consent to rescind the contract i.e. each party will give
back the consideration received by it.
Neither the buyer nor the seller has the sole right to rescind the contract after
execution of a contract. Often the buyer wants to rescind the contract after
buying goods. In this case, it is necessary that he gets the seller’s consent.
Therefore this mutual agreement between buyer and seller to rescind the
contract is called Iqala.
In one of the hadiths, Prophet has stated “He who does the Iqala (rescinding of
the contract) with a Muslim who is not happy with his transaction, Allah will
forgive his sins on the Day of Judgment.”
However, it may be noted that the price of the goods being returned under Iqala
will remain unchanged.
Effect on third Parties: Iqala is treated as a new sale as if a new contract is
entered into between the parties rescinding the original contract.

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