Applying Shariah Principles to Modern Finance

CANONICAL SHARIAH CONTRACTS
APPLIED TO MODERN FINANCE
07/20/20 Dr. Muhammad Imran Usmani- Pakistan 1

CANONICAL SHARIAH CONTRACTS
APPLIED TO MODERN FINANCE
Dr. Muhammad Imran Usmani

Shariah Advisor
Guidance Financial Group
Washington DC
Prohibition of Riba
Those who take riba (usury or interest) will not stand but as stands the one whom the
demon has driven crazy by his touch. That is because they have said: Trading is but
like riba. So, whoever receives an advice from his Lord and stops, he is allowed what
has passed, and his matter is upto Allah. And the ones who revert back, those are the
people of Fire. There they remain forever.
Allah destroys riba and nourishes charities. And Allah does not like any sinful
disbeliever.

Definition of Riba
Sale (Bai):
To sell the commodities with specified
consideration
Lease (Ijarah):
To sell a particular usage with specified
compensation

Permissibility and Reward of Trade and
Joint Business Activities
 Islam encourages trade and business activities
 Allah (SWT) has ordained in Holy Quran
“Allah has permitted trade and prohibited Riba”
 AHADITH
“If you leave behind wealthy heirs, it’s better than that of
leaving them needy and dependent on others and under
their control”

 Prophet (SAW) once said
“Listen! Whoever becomes a guardian of an orphan who owns
some wealth, he should use it in trade and not leave it unutilized
in order to be consumed by sadaqah.
at another occasion he said
“An honest and trustworthy trader on the day of judgment will
be among Siddiqueen”
 Prophet (SAW) also encouraged Shirkah in various
maxims and sayings
Prophet (SAW) once said that Allah (SWT) has stated: “He will
become a partners in a business between two Mushariks until
they indulge in cheating or breach of trust (Khayanat)

Importance of Purifying the
Source of Income in Islam
 The body which is nourished by non-pure sources
is bound to hellfire.
 On the day of Judgment, a person will not be
moved from the place which he stands until he is
asked about the sources of his income, and the
ways he spent it.
 Purifying the source of ones’ nourishment is one
of the important reasons for the acceptance of
supplications by Allah.

SHARI’AH
1. Lexical meaning: Plain Way
(Siratul Mustaqim)
2. Technical meaning: The Divine
Law
 Then We have put you (O prophet) on a plain way
of (our) commandment. So follow it and do not
follow the desires of those who do not know.
(45:18)

SOURCES OF SHARIAH
1. The Holy Qur’an
2. The Sunnah of the Holy Prophet (SAW)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)

RULES OF SHARIAH
1. Three Prohibited Transaction
2. 1. Riba
• Riba Al Nase’ah
• Riba Al Fadhl
1. 2. Maysir
2. 3. Gharar :
3. Al Jahalah, Bai Qablal Qubz etc.

First Revelation about Riba
– “That which you give as interest to increase the

peoples' wealth increases not with God; but that which
you give in charity, seeking the goodwill of God,
multiplies manifold.” (Surah Rome, Verse 39)

Second Revelation
– “And for their taking interest even though it was forbidden

for them, and their wrongful appropriation of other peoples'
property. We have prepared for those among them who reject
faith a grievous punishment ” (Surah al-Nisa', verse 161)

Third Revelation
– “Believers! Do not swallow riba, doubled and

redoubled, and be mindful of Allah so that you
may attain true success” ( Al Imran, Ayat 130)

Fourth Revelation
Surah Al
Baqarah
Verses 274-281

Those who spend their wealth night and day, secretly and openly, they have their
reward with their Lord, and there is no fear for them, nor shall they grieve.
Those who take riba (usury or interest) will not stand but as stands the one whom
the demon has driven crazy by his touch. That is because they have said: Trading
is but like riba. So, whoever receives an advice from his Lord and stops, he is
allowed what has passed, and his matter is upto Allah. And the ones who revert
back, those are the people of Fire. There they remain forever.
Allah destroys riba and nourishes charities. And Allah does not like any sinful
disbeliever. Surely, those who believe and do good deeds, establish Salah and
Zakah have their reward with their Lord, and there is no fear for them,nor shall
they grieve.
O those who believe, fear Allah and give up what still remains of the riba if you
are believers. But if you don not, then listen to the declaration of war from Allah
and His Messenger. And if you repent, yours is your principal. Neither you
wrong, nor be wronged.
And if there be one in misery, then deferment till ease. And that you leave it as
alms is far better for you, if you really know. And be fearful of a day when you
shall be returned to Allah, then everybody shall be paid, in full, what he has
earned. And they shall not be wronged. (Verses of Surah Al Baqarah: 274-281)
Prohibition of Riba in Hadith

The prohibition of Interest is not limited to Islam, but
it is shared by Judaism and Christianity.
Some of the old testaments have rendered riba as haram (See Exodus 22:25,
Leviticus 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8,
Nehemiah 5:7 and Ezakhiel 18:8,13,17 & 22:12).
Agibi Bank was established circa 700 B.C. in Babylonian

and functioned exclusively on equity basis.

ISLAMIC BANKING
 CLASSIFICATION OF RIBA
– Riba-un-Nasiyah or Riba-al-Jahiliya
– Riba-al-Fadl or Riba-al-Bai

ISLAMIC BANKING
 “that kind of loan where specified repayment period
and an amount in excess of capital is
predetermined”( Imam Abu Bakr Jassas Razi)

ISLAMIC BANKING
 “all loans that draw interest is riba”(Hadith quoted
by Ali ibn Talib)
 “the loan that draws profit is one of the forms of
riba”(definition from Sahabi Fazala Bin Obaid)

ISLAMIC BANKING
 real and primary form of riba
 premium paid to the lender in return for his waiting
 giving or taking of every excess amount in exchange
of a loan at an agreed rate irrespective of whether it
is low or high

ISLAMIC BANKING
– Riba-al-Fadl
 Definition: Any excess that is without due consideration
For example: excess taken in exchange of specific commodities
(Al amwal Ur Ribawiyyah) which are homogeneous

ISLAMIC BANKING
– Hadith prohibiting Riba-al-Fadl
 ‘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

ISLAMIC BANKING
– Hadith prohibiting Riba-al-Fadl
 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(spot sales) and sell barley for date anyway you
please on the condition it is hand-to-hand(spot sales)

ISLAMIC BANKING
– Imam Abu Hanifa on Riba-al-Fadl
 commodities must have two common characteristics
– Weight
– Volume
 includes all commodities having weight or volume
and are being exchanged

ISLAMIC BANKING
– Imam Shafi on Riba-al-Fadl
– be a medium of exchange
– be edible
 includes all commodities that are edible or can be
used as a medium of exchange(currency)

ISLAMIC BANKING
– Imam Maalik on Riba-al-Fadl
– can be preserved
– be edible
 includes all commodities that are edible and can be
preserved

ISLAMIC BANKING
– Imam Ahmad Bin Hanbal on Riba-al-Fadl
 first citation conforms to the opinion of Imam Abu
Hanifa
 second citation conforms to the opinion of Imam
Shafi
 third citation includes three characteristics at the
same time i.e. edible, weight and volume

RIBA IN BANKING
 On the both sides of the conventional banks
Riba exists:
 On the Liabilities Side, through borrowing
from depositors on fixed and guaranteed
return
 On the Assets side, through lending on
Interest basis.

Basic Difference between Islamic and
Conventional Modes of Finance
Conventional
money
Bank Client
money + money (interest)

Basic Difference between Islamic and
Conventional Modes of Finance
Islamic
Bank Goods & Client

Services
money

Theoretical Comparison
CONVENTIONAL ISLAMIC
BANKING BANKING
--------------------------- ---------------------------
Is based on interest.
 Is based on profit or rent
Deals in money or papers.  Deals in assets.
 Is based on profit sharing on

Isbased on fixed return on both deposits side, and on profit
Sides of the balance sheet. on assets side.
 Actively participates in
Does not involve itself in trade trade, production and valid
and business
services through valid
contracts.

CONTRACT IN ISLAM
CONTRACT
SUBJECT CONTRACTORS WORDING OF

MATTER CONTRACT
•Non-restricted •Present/immediate
•Specified •Unconditional
•Sane
•Quantified •Non-contingent
•Mature

CONTRACT IN ISLAM
CONDITIONAL CONTRACTS:
1. A condition, which is not against the contract, is a valid
condition.
For example a condition of free delivery to buyer’s
premises.
2. A condition, which seems to be against the contract, but it

is in the market practice, is not void, if its voidness is not
proved with the clear injunctions of the Holy Quran and
Sunnah.
For example a condition that the seller will provide five-
year guarantee and one year free service.

CONTRACT IN ISLAM
3. A condition that is against the contract and not in market
practice but is in favor of one of the contractors or subject
matter, the condition is void.
For example if ‘A’ sells a car with a condition that will
use it on a fixed date every month, this contract will be
void he.
4. A condition, which is against the contract, not in the

market practice and not in favor of any contractor, that is
not a void condition.
For example if both A and B decide to give to charity, a
certain percentage of both subject matter and
cosideration, upon completion of sale.

CONTRACT IN ISLAM
VOID CONDITIONS AND VOID CONTRACTS:
 The contracts of compensation (Uqood Muawadha) like
sale, purchase, lease agreements become void by putting
void condition.
 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.

ISLAMIC SALE CONTRACT
 DEFINITION OF SALE(BAI)
– exchange of a thing of value with another thing
of value with mutual consent.
– the sale of a commodity in exchange of cash.

TYPES OF SALE
1. Valid sale ( Bai Sahih)
2. Void/Non existing Sale ( Bai Baatil )
3. Existing sale but void due to defect ( Bai Fasid )
4. Valid but disliked sale ( Bai Makrooh )

VALID SALE ( Bai Sahih)
– a sale is valid if all elements together with their

conditions are present
– elements of valid sale are

 Contract ( Aqd )
 Subject matter ( Mabe’e)
 Price ( Thaman )
 Possession or delivery ( Qabza )

V a lid S a le
(B a i S a h i h )
C o n tra c t o r tra n s a c ti o n S o ld g o o d s o r P ri c e D e l i v e ry o r p o s s e s s i o n
(A q d ) s u b j e c t m a tte r (T h a m a n ) (Q a b z a )
(M u ta ' a q u a d e e n ) o n l y i n re s p e c t o f m o v a b l e
1 2 3 g o o d s , n o t im m o v a b le 4

ISLAMIC BANKING
 ELEMENTS OF A VALID Contract
– Wording of the CONTRACT ( Aqd )
 Offer & Acceptance ( Ijab-o-Qobool)
– Oral ( Qauli )
– Implied ( Hukmi)
• Credit sales (e.g. Istijrar )
• Hand to Hand ( e.g. Taati )
 The contractors ( Muta’aquadeen ) must be
– Sane
– Mature

ISLAMIC BANKING
– Wording of the Contract( Aqd )
– Contract must be immediate
– Contract must be non-contingent
• unconditional contract
• under reasonable conditions
• under unreasonable conditions but at market practice
and not against the clear injunctions of Islam

ISLAMIC BANKING
C o n tra c t o r T ra n s a c tio n
(A q d )
O ffe r & A c c e p ta n c e B u y e r & S e lle r C o n d itio n s o f C o n tra c t

(Ija b -o -Q o b o o l) (M u ta ' a q u a d e e n ) (S h a ra e t-e -A q d )
1 .1 1 .2 1 .3
O ra l Im p lie d S ane M a tu re S a le m u s t b e S a le m u s t b e im m e d ia te
(Q a u li) (Is h a ra a ) (If m in o r, m u s t u n d e rs ta n d n o n -c o n tin g e n t N o t d e fe rre d to fu tu r e
(In p a s t te n s e ) (In p a s t te n s e ) n a tu re o f tra n s a c tio n ) (e g p ro p e rty m u s t p a s s 1 .3 .2 .
1 .1 .1 1 .1 .2 1 .2 .1 . 1 .2 .2 1 .3 .1 o n s a le d a te n o t o n fu tu re d a te
C re d it S a le C a s h S a le U n c o n d itio n a l c o n tra c t U n d e r re a s o n a b le c o n d itiio n s U n d e r u n re a s o n a b le c o n d itio n

(Is tijra r) (T a a ti) b u t in m a rk e t p ra c tic e
(e g s e ttle m e n t a t th e e n d (e g a s in s u p e rm a rk e ts ) (e g . w a rra n ty o f 1 y e a r
o f th e m o n th ) 1 .1 .2 (a ) 1 .1 .2 (b ) 1 .3 .1 (a ) 1 .3 .1 (b ) o n s a le o f frid g e 1 .3 .1 .(c )

ISLAMIC BANKING
 ELEMENTS OF A VALID SALE ( Bai Sahih)
– SOLD GOOD OR SUBJECT MATTER
( Mube’e )
 Existing
 Valuable
 Usable
 Capable of ownership/title
 Capable of delivery/possession
 Specific & Quantified
 Seller must have title & risk

ISLAMIC BANKING
 ELEMENTS OF A VALID SALE ( Bai

Sahih)
– PRICE ( Saman )
 Quantified ( Maloom )
 Specified & certain ( Muta’aiyan )

ISLAMIC BANKING
 ELEMENTS OF A VALID SALE ( Bai Sahih)
– DELIVERY OR POSSESSION (QABZA)

 Physical ( Haqiqi )
 Constructive ( Hukmi )

Major Contracts Used in
Islamic Banking
 Buying & Selling (Murabaha, Musawama,
Tawarruq)
 Mudaraba/Qiradh: Investment management
 Musharaka: Partnership
 Ijarah: Leasing
 Wakalatul Istismar/Ijaratu Alashkas: Agency
 Istisna’/ Muqawala: Contract of works
 Salam: Forward sale contract

Inception of Islamic Banking
 Dubai Islamic Bank - 1975
- modest beginnings
- Initiated by businessmen who did not
want to deal with interest based system
- Hostile environment
- Challenged by conventional banking
system
- Lack of public awareness

Success Story
 200 + Islamic financial institutions
 $ 100 - 200 billions in funds
 Issuance of Islamic Bonds (Sukuk)
 Post graduate degrees offered in Islamic
banking by major academic institutions
 Important database system (HIFIP)
 Standards for the Industry (AAOIFI)
 Recognition by IMF, World Bank and Basel
Committee

TYPES OF ISLAMIC
INSTITUTIONS
• Islamic Commercial Banks
• DMI, Al Barakah, Al Rajihi)
• Islamic Investment Banks
• First Islamic Investment Bank, Amana Investment
(HSBC), Noriba (UBS), CitiIslamic Inv. Bank.
• Islamic Units of conventional banks
• UBS, Deuche Bank, Credit Swiss, Standard Chart.
Dresdner Bank.

TYPES OF ISLAMIC
INSTITUTIONS
•Islamic Funds:
•Property fund, Equity fund, Islamic Hedge Fund, Murabaha fund,
Capital Protected fund, investment fund, trade fund etc.
•Islamic House Financing Schemes
UBK, Al Manzil, Guidance group US, Lariba, Al
Maskan LLC
•International Financial Market (e.g.
AAOIFI, ICD etc.)
•International Institutions of Islamic Banking
•Islamic Market Index (DJIM, TII)

Uniqueness of Islamic Banking
 Commingling between Finance & Religion and
ethics
 Sharia Supervisory Boards (SSB)
– Studies Articles of associations and bylaws
– Approval of all contracts
– Contribute in designing new products
– Audit the actual implementations
– Issuance of Fatwas (Responsas)
– Conferences - Research - Training

Principles of Islamic Business
1. The Objectives and philosophies of Islamic
banks must thus be in line with the teachings of
Quran and Sunnah of the Prophet (PBUH)
2. Eliminating riba is an important task, but Islamic
banks, by default, must conform to all other
Islamic business principles
3. All teachings imposed on Muslim individuals are
also applicable to Islamic banks

Important Achievements
 Encouraging and attracting depositors for Halal
investments
 Channeling depositors’ funds into productive and
commercially beneficial activities
 Relieving Muslims from trading in prohibited
sectors or activities (e.g. opening an LC for
alcoholic beverages
 Encouraging Zakat and charity
 Disseminating knowledge in the field of Islamic
transaction law (Fiqh al-Mu’amalat)

 Educating Muslim scholars in modern
banking
 Encouraging Takaful (Islamic Insurance)
 Gaining wide acceptance in the
international financial community

The Way Ahead
 Islamic banks must develop the concept of Musharakah
(participating in profit & loss) and Mudaraba, and use it
more aggressively
 Adopt new financing policies to encourage development
and support for the small scale traders
 Develop the Islamic liquidity management and Islamic
money market
 Must improve its services to be competitive with the best
in the market
 Must arrange the Train The Trainers programs for
scholars, bankers, businessmen and professionals

Thank You

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CANONICAL SHARIAH CONTRACTS

APPLIED TO MODERN FINANCE

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 1

Dr. Muhammad Imran Usmani

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– “That which you give as interest to increase the

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– “And for their taking interest even though it was forbidden

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– “Believers! Do not swallow riba, doubled and

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07/20/20 Dr. Muhammad Imran Usmani- Pakistan 16

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Agibi Bank was established circa 700 B.C. in Babylonian

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 20

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 21

 “that kind of loan where specified repayment period

and an amount in excess of capital is

predetermined”( Imam Abu Bakr Jassas Razi)

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 22

 “the loan that draws profit is one of the forms of

riba”(definition from Sahabi Fazala Bin Obaid)

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 23

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 24

For example: excess taken in exchange of specific commodities

(Al amwal Ur Ribawiyyah) which are homogeneous

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 25

 sell dates in exchange of equivalent dates

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 26

 sell barley in exchange of equivalent barley but if a person

transacts in excess, it will be riba.

it is hand-to-hand(spot sales) and sell barley for date anyway you

please on the condition it is hand-to-hand(spot sales)

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 27

 includes all commodities having weight or volume

and are being exchanged

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 28

 includes all commodities that are edible or can be

used as a medium of exchange(currency)

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 29

 includes all commodities that are edible and can be

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 30

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 31

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money + money (interest)

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Bank Goods & Client

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Deals in money or papers.  Deals in assets.

 Is based on profit sharing on

07/20/20 Dr. Muhammad Imran Usmani- Pakistan 35

SUBJECT CONTRACTORS WORDING OF

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2. A condition, which seems to be against the contract, but it

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4. A condition, which is against the contract, not in the