Section Week 4

Regulatory structure of Islamic financial institutions

This Chapter is conceptual rather than historical.

Shariah Law: it is the code of conduct of Muslims. The Arabic word ‘Shariah’ means
path to the watering place. It is also called the Islamic law.

Shariah Ruling

Obligatory (5 types) Declaratory

1. Wajib (which need to be followed like mutual consent in a contract)

2. Mustahabb (which are recommended, like ensuring the contract is written)

3. Mubah (which are permissible and neither rewarded nor punished, like having two
parties to a contract or having more than two)

4. Makruh (which are discouraged, for example a poor person donating whatever they
own rather than leaving it for their poor heir)

5. Haram (which are forbidden, like taking interest on a loan contract).

Declaratory: provides clarification for obligatory ruling, helps application and

implementing of obligatory ruling by describing causes, “What IF” conditions and
obstacles related to the obligatory rulings.

Maslahah: (the best interest of the general public).

1
 Maslahah

Daruriyyat Hajiyyat Tahsiniyyat

The first is Daruriyyat, the essential elements for a person, like their faith, their life,
their intellect, wealth and the continuity of their family.

The second category is Hajiyyat, the complementary elements, the lack of which will
cause hardship but not disrupt life totally, like the availability of transportation or being
involved in an economic activity.

The third category is Tahsiniyyat, additional elements that make life nicer, customs and
ways of behavior, like being polite and pleasant in dealings with people.

Sources of Shariah (Main)

 Quran – holy book of Islam

 Sunnah – sayings, practices and conducts of the Prophet Mohammad

 Ijma – consensus of jurists (What scholars agreed on)

 Qiyas – analogical deductions (original ruling is applied to a new matter with

similar characteristics) (In the case of no clear guidance about a new matter,
original ruling is applied)

Ways of Shariah law elaboration (added to suite individuals)

 Ijtihad (which meant independent interpretation by a scholar) “Shariah + studied

finance”

 Ikhtiyar (choosing from past views)

 Dururah (some relaxation in rules may be considered if it is a necessity)

2
  Istihsan (which is the preference of a jurist)

 Istishab (which is the presumption that a situation existing previously continues

to exist unless proven otherwise) (Situation not going to change)

Schools of Islamic Jurisprudence

 Sunni Schools – Maliki, Hambali, Shafi and Hanafi

 Shiite School – Jaafari

Ethics in Shariah compliant business and finance

1. Honesty. All parties should be truthful, fair and just to each other and fulfil their
obligations.

2. Transparency. All contracts should clearly specify the quality, quantity and price
of the goods or services being transacted; they should also specify delivery
details, and the rights and obligations of all parties.

3. Mutual consent. All parties in the contract should have entered into it with
mutual consent, without any exploitation.

4. Property. No property can be appropriated wrongfully or unjustly. (accurate

valuation)

5. Employees. All employees of the business should be treated fairly.

6. Price stability. Shariah prohibits hoarding or cheating, which achieves price

instability.

7. Generosity and leniency. Shariah encourages parties in the business transaction

to be considerate of all other parties, and be generous whenever possible, sell or
buy at a fair price and allow additional time to borrowers if they really need it.

8. Halal versus Haram. Only Halal businesses, products and transactions should be
dealt with and all Haram or prohibited items should be avoided.
3
Prohibition of interest or Riba

 Riba is earning money from money

 Riba is fixed and positive, depending on the amount and time of the loan

 Originally prohibited in all 3 Abrahamic religions

Riba

Riba El Nasiah Riba El Fadl

Riba al Nasiah – main type, interest paid on loans

Riba al Fadl – exchanging same type of goods, smaller amounts of superior quality
with larger amount of inferior quality, money exchanged with money in different
amounts, or exchange of money like commodities like gold, silver, dates, wheat etc.
In contemporary Islamic finance, foreign currency transactions are acceptable as
long as they are concluded on the spot, hand to hand.

Prohibition of Gharar or uncertain dealings

Involves taking excessive risks or unnecessary uncertainty

Gharar

Fahish Yasir

Gharar Fahish - substantial amount and not allowed; Gharar Yasir - trivial amount
and is tolerated.

Prohibition of Maysir

4
 Involves all kinds of games chance or dealings where one can gain significantly or
lose all depending on the way the deal moves.

Maysir is prohibited in Islam because it leads to winning at the expense of others

losing, so it is socially unacceptable. Maysir is different from risk in everyday life or in
business, which is acceptable. It is risk taken to win without any productive activity
involved and has the possibility of losing everything.

Other Principles of Shariah Law

 Encouragement to Use Profit & Loss

 Requirement for Sharia Compliant Contracts

 Avoid Hoarding (store up)

 Avoid Taking Advantage of the Seller

 Freedom of Contract (Mutual consent of all parties)

 Original Permissibility ( All parties agree)

 Interest of Society (social welfare into consideration)

 Relieving of Hardship versus Providing of Benefits (Both are important, but if

one has to be chosen over the other then relieving of hardship would be
given more importance) (prevent something bad comes before providing
benefit)

 Remove Extreme Hardship (When no other choice exists to remove extreme

hardship even an unlawful thing is accepted, like eating pork when no other
food is available and one could starve)

Environment of Islamic financial institutions:

5
Islamic banks are set up in three different environments.

Firstly, they could be established in a Muslim country where by State law all financial
institutions are required to be Shariah-compliant. (Iran, Sudan and Pakistan)

Secondly, they could be established in a Muslim or non-Muslim country where central

bank and State regulations allow both conventional and Islamic banks to operate and
often have some differences in the rulings for Islamic financial institutions (IFIs) in
accordance with their different operational framework. This is called the dual banking
environment. (GCC countries, South Asia and South-East Asia and the Middle East and
North African Muslim-majority countries.)

Thirdly, they could be set up in a non-Muslim country where central bank regulations do
not provide any separate rulings or facilities for IFIs to operate. (like the UK, other
European countries, the USA, Canada, Australia).

Shariah Supervisory Board or SSB

The first and second categories, the setting up of a Shariah Supervisory Board is
mandatory, while in the third category it is optional for the IFI.

Most IFIs that operate within the third category voluntarily set up an SSB to give
confidence to their stakeholders rather than to satisfy the regulatory authorities of the
jurisdiction they operate in.

The SSB is a body set up with a group of Islamic Shariah scholars or jurists to assist the
IFI to operate in accordance with Islamic Shariah law. The SSB is also sometimes called
the Shariah Board, Shariah Committee, Shariah Advisory Committee, Shariah Council,
Shariah Control Committee or simply the Religious Board.

QUESTIONS:
6
MCQs:

1. The three methods of elaborating the Shariah law are:

a. Quran, Sunnah & Ijtihad

b. Ijtihad, Ikhtiyar and Dururah
c. Ikhtiyar, Ijtihad & Qiyas
d. Ijma, Qiyas & Dururah

2. The sources of the Shariah are in the below order:

a. Quran, Sunnah, Qiyas, Qanoon

b. Quran, Sunnah, Ijma, Qiyas
c. Quran, Sunnah, Ijma, Ikhtiyar
d. Quran, Sunnah, Qanoon, Ikhtiyar

3. Which principles listed below is one of the key principles related to Islamic
finance and banking?

a. Prohibition of profit
b. Prohibition of Gharar
c. Prohibition of Shariah Supervisory Board
d. Prohibition of public good

4. One of the key principles related to Islamic finance is

a. To encourage the use of Riba and Gharar

b. To Earn money from money
c. To avoid hoarding
d. Hoarding

True/False:

5. Riba is the increase, addition, expansion or growth of the loan amount.

6. Gharar is uncertainty or ambiguity.
7. Maysir is All kinds of gambling or game of chance.
8. Shariah Supervisory Boards makes sure the bank chooses the most profitable
investments.
Essay:
9. Define Shariah.
10. How important is ethics in Shariah compliant business and finance? Discuss.

Answers:

7
1. b
2. b
3. b
4. c
5. T
6. T
7. T
8. F
9. The Arabic word “Shariah” means path to the watering place. It is also called the
Islamic Law. Islam influences all aspects of a Muslim’s life – as individuals, within the
family, society, and in the relationships with the state and the community and in the
manner business or commercial activities are conducted. Shariah law is a comprehensive
code of conduct for the Muslim’s life, given by the Creator – Allah. The Muslim
population can derive rules from the Shariah law but cannot create the law. The same
Shariah law applies in all Muslim countries.

10. Ethics involves moral behavior of a person and it is equally important in today’s
business and finance. Ethics in business includes social and environmental
responsibilities and leads to sustainable business. Islamic Shariah compliant commerce
and finance is based on religious doctrines and thus are inherently ethical. Specific ethical
rules in Islamic business, many of which are common to business ethics anywhere in the
world are:
Honesty: All parties should be truthful, fair and just to each other and fulfill their
obligations
Transparency: All contracts should clearly specify the quality, quantity and price of the
goods or services being transacted, specify delivery details, and the rights and obligations
of all parties.
Mutual consent: All parties in the contract should have entered into it with mutual
consent, without any coercion or exploitation.
Property: No property can be appropriated wrongfully or unjustly.
Employees: All employees of the business should be treated fairly
Price stability: Shariah prohibits hoarding or cheating, which achieves price stability
Generosity and leniency: Shariah encourages parties in the business transaction to be
considerate of all other parties, be generous when possible, sell or buy at a fair price and
allow additional time to borrowers if they really need it.
Halal versus Haram: Only Halal businesses, products and transactions should be dealt
with and all Haram or prohibited items should be avoided.