CHAPTER 1

INTRODUCTION TO ISLAMIC
FINANCE
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 Chapter Outline
1. Philosophy of Islamic Finance
2. Philosophy of Islamic Economics
3. Principles of Islamic Finance
4. Shariah Framework for Islamic Finance
5. Fundamentals Prohibited Elements in Islamic Finance
6. Differences between Islamic Finance and Conventional Finance
7. Development of Islamic Finance in Malaysia
8. Islamic Finance Today: Opportunities, Issues & Challenges to
Sustain Development in Global Financial System

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 1.Philosophy of
Islamic Finance

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What is Islamic Finance?
Definitions:

-built upon some distinctive and unique

characteristics which are based upon certain
principles underlined by Shari’ah. (page 5)
-Provision of financial services on a basis that
is compliant with the principles and rules of
Islamic commercial jurisprudence.

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 Sources of Islamic finance
▪The laws that governing the human deeds are called ‘Fiqh’.
▪‘Fiqh’- understanding the laws relating to human deeds derived
from their respective particular evidences from Qur’an and
hadiths.
▪Fiqh as shariah which referred to :
▪Ibadat (rituals)
▪Munakahat (marriage/family laws)
▪Muamalat (commercial transactions)
▪Jinayat (offences, crimes and punishments)

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Objectives of Islamic Finance
1. To meet the objective of the shariah that is
realizing public welfare Allah SWT. Gives Islam as
rohmah (mercy/compassion). Rohmah is
manifested in 3 aspects:

- Educating the individual

- Establishing justice
- Realizing public welfare

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2. To meet as well the following objectives:
-Socio economic justice and equitable distribution of
income and wealth
-Broad based economic well being with full employment
and optimum rate of economic growth.
-Stability in the value of money to enable the medium of
exchange to be a reliable unit of account.

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 2.Philosophy of
Islamic
Economics

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Principles of Islamic
economics
1. Natural sense of justice (fitrah)
2. Satisfaction of human wants
- The primary propeller of economic development
is the people’s pursuit of well being in the sense
of satisfying ever changing human wants.
* tawhid – not only belief in God’s existence but also
believing in God’s contact with human through
the sending of Prophets. (page 36)

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3. Principles of Islamic
Finance

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The Principles of Islamic Finance that
underlie the methodology of Islamic finance:

1. Prohibition of Riba
2. Prohibition of Gharar

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The Principles of Islamic
Finance (cont)
• Wealth must be generated from legitimate trade and
asset-based investment. (the use of money for the
purposes of making money is expressly forbidden)
• Investment should also have a social and an ethical
benefit to wider society beyond pure return.
• Risk should be shared.
• All harmful activities (haram) should be avoided.

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4.Shariah Framework
for Islamic Finance

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 Shariah
What is shariah? (page 148-149)

Definition:
-the sum of Islamic teachings and system, which
was revealed to Prophet Muhammad SAW
recorded in Quran and deduced from the sunnah

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Sources of Islamic law
Primary sources
-Qur’an – the words of Allah revealed to the prophet
Muhammad SAW consists 0f 114 chapters.
-Sunnah (textual sources) – saying deeds and approvals
of prophet Muhammad SAW.
Secondary sources
-Qiyas (analogical deductions)
-Ijma’a (consensus of opinion)

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Objectives of Islamic law
1. Faith
2. Life
3. Intellect
4. Posterity
5. Property
These objective are of three levels:
i. Dharuriyat (life and death)
ii. Hajiyyat (removing hardship)
iii.Tahsiniyat (beutifying)

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5. Fundamentals
Prohibited Elements in
Islamic Finance

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 Prohibitions in Muamalat
The fundamental difference between Islamic Finance
and conventional finance (Riba, Gambling, Gharar)
-Trade and commerce in Islam must comply with
requirements of the Shariah which refers to:
a) Abstinence from prohibitions (haram matters)
b) Every contract possesses all its essential elements
and each essential element meets the necessary
conditions.

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 There are many prohibitions but the following factors
will make aqads or contracts null and void:
i. Producing and selling impure goods
ii. Producing and selling goods that are of no use, no
value.
iii. Riba
iv. Gharar
v. Maysir (Gambling)

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 Riba
What is riba? (page 177)
▪Riba (usury or interest)
▪Means extra or excess
▪Unlawful gain derived from the quantitative
inequality of the counter values in any
transaction.

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▪Riba is understandable given that the payment and receipt
of interest are central to all conventional banking.
▪Riba literally means increase,addition,expansion or growth.
It is a typical increase or growth , which has been prohibited
by Islam.
▪Riba technically refers to the premium that must be paid by
the borrower to the lender along with the principle amount
as a condition for the loan or for an extension in its
maturity, in this case Riba obviously means interest.
▪Islam made a clear distinction between trade and Riba.
Trading is encouraged but Riba is prohibited.

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 Riba
What is riba? (page 177)
▪Riba (usury or interest)
▪Means extra or excess
▪Unlawful gain derived from the quantitative inequality of the
counter values in any transaction.
▪Types of riba:
1. Riba al-buyu’u (Riba in exchange contract/trading)
2. Riba al-duyun (loan contract/lending or borrowing)

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 1. Riba Buyu’u (exchange
contract/trading transaction)
Occur out of an exchange between two (2) ribawi materials in the
same kind where the necessary rules are observed.
Two (2) of subdivisions:
i. Riba Fadhl
ii. Riba Nasiah/yad

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 i. Riba Fadhl (Ribawi
Materials)
▪Pertaining to trade contracts. It refers to the exchange of different
quantities or qualities of the same commodity
▪(Ribawi materials exchanged are of different weights or measurement)
▪Basis:
▪Media of exchange- Gold, RM, Spore Dollar
▪Foodstuffs- Grains, Meats, Vegetables, Fruit
• Example:- a kilo of wheat being exchanged for 1.5 kilos of wheat.
Rules of exchange:
1) Same kind of the same basis
2) Different kinds of the same basis
3) Different kinds of different basis

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 i. Riba Nasiah/yad (loan
contract)
▪(payment of the price and delivery of the goods are made
at two different times /not immediate)
▪Pertaining to loan contracts. The term nasi’ah means to
postpone, defer or wait and refers to the time that is
allowed for the borrower to repay the loan in return for the
addition or the premium.
▪Example:- selling and buying properties - personal loans

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 2. Riba Duyun (loan
contract/lending and borrowing)
▪The extra amount of money; imposed by the
lender on the borrower in the contract or promised
by the borrower in the contract.
Can be divided into two (2) subdivisions :
i. Riba Qardh (imposed from the beginning)
ii. Riba Jahiliyah (imposed after default)

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Gharar (uncertainty)
▪Ignorance of the goods or price, - or false
description of the goods. - selling of goods that the
seller is not in a position to deliver.
▪Gharar is a type of exchange in which one or both
parties stand to be deceived through ignorance of
an essential element of the exchange
▪The element of speculation inherent in derivatives
trading means that such transactions fall into the
category of Gharar and are therefore prohibited.

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 Gharar (uncertainty) (cont)
▪Literally, it means deception, danger, risk, and uncertainty.
▪Technically, it means exposing oneself to excessive risk and danger in a business
transaction as a result of uncertainty about the price, the quality and the
quantity of the counter value, the date of delivery, the ability of either the
buyer or the seller to fulfill their commitment, or ambiguity in the terms of the
deal.
▪Ibn al-Qayyim described gharar as a sale in which the vendor is not in a
position to hand over the subject matter to the buyer, whether the subject
matter is in existence or not.
▪Imam al-Sarakhsi defined gharar as any bargain in which the result of it is
hidden.
▪Sheikh Wahbah al-Zuhaily defined gharar as a contract which contains a risk to
any one of the parties which could lead to his loss of properties.

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Gharar (uncertainty)
Can be divided into three (3) types:

i) Gharar yasir (minor)

ii) Gharar fahish (major)
iii) Excessive gharar that cannot be avoided

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i) Gharar yasir (Minor/slight)
▪Forgiven
▪Contracts involving minor gharar are
permissible and valid
▪Taken into consideration in arriving at the
price
▪Tolerated and will not invalidate a contract.

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ii) Gharar fahish
(Major/excessive)
▪Unacceptable
▪There is no means of quantifying it
▪Factors: relating to the buyer or seller , asset, price and
contract
▪Not tolerated and may result in voidability of a contract.
▪Examples:- - the sale of fish in the sea - the sale of bird in
the air - the sale of unborn animals - lost items 

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 Maysir (gambling)
▪Definition: Also known as qimar.
▪Refers to easily available wealth or acquisition of wealth by chance,
whether or not it deprives the other’s right
▪Betting or charging something
▪will be forfeited if one fails to obtain the greater gain that one
hopes for.
▪Speculation is not gambling
▪Contracts involving speculation are still valid.
▪Qimar means the games of chance – one gains at the cost of other.
▪Example:- lotteries, illegal racing,
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Ghorm
▪Known as risk and uncertainty in business outcome.
▪Cannot be eliminated because it is a law in nature (hukum
tabi’).
▪No one is free from the vagaries (unexpected) of price
volatilities arising from market movement.
▪E.g: highway robbery, devastating storm, diseases and
uncertain markets.

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6.Differences between
Islamic Finance and
Conventional Finance

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7. Development of Islamic
Finance in Malaysia

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8.Islamic Finance Today:
Opportunities, Issues &
Challenges to Sustain
Development in Global
Financial System

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Individual Assignment
The evolutions of Islamic Finance:
1. Historical background,milestone & development of Islamic finance
in Malaysia
2. Similarities and differences with conventional finance
3. Islamic Finance/banking product offered
4. Riba versus interest and profit
5. Marqasid Shari’ah (page 166)

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Pages – 10- 20 pages excluding references
References – minimum 5 references from various sources

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