Preface

First and foremost, I would like to forward my humble gratitude to Allah SWT for
the blessing and strength to complete this individual assignment. Peace and
prayers be upon His Final Prophet and messenger Muhammad, the ideal role
model for human beings.

I would like to take this opportunity to thank you to our lecturer of Fundamentals
of Islamic Banking (CTU351), Ustazah Syafikah Binti Kamal for her support and
advice in complete this individual assignment. I very appreciate what have she
done to explain about this assignment. May Allah reward she what her for all her
efforts.

I would like to extend my deepest gratitude and special thanks to all who have
directly and directly guided me to in the writing this assignment. I express my
deepest appreciation to my beloved parents, family, friends, and colleagues for
their continuous encouragement are greatly appreciated.

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Introduction

Islamic banking based on Islamic law (Shariah). It follows the Shariah, called fiqh
muamalat (Islamic rules on transactions). The rules and practices of fiqh
muamalat came from the Quran and the Sunnah, and other secondary sources of
Islamic law such as opinions collectively agreed among Shariah scholars (ijma),
analogy (qiyas) and personal reasoning (ijtihad).
Modern banking system was introduced into the Muslim countries at a time when
they were politically and economically at a low ebb, in the late 19th century. The
main banks in the home countries of the imperial powers established local
branches in the capitals of the subject countries and they catered mainly to the
import export requirements of the foreign businesses. The banks were generally
confined to the capital cities and the local population remained largely
untouched by the banking system. The local trading community avoided the
foreign banks both for nationalistic as well as religious reasons. However, as
time went on it became difficult to engage in trade and other activities without
making use of commercial banks. Even then many confined their involvement to
transaction activities such as current accounts and money transfers. Borrowing
from the banks and depositing their savings with the bank were strictly avoided
in order to keep away from dealing in interest which is prohibited by religion.
With the passage of time, however, and other socio-economic forces demanding
more involvement in national economic and financial activities, avoiding the
interaction with the banks became impossible. Local banks were established on
the same lines as the interest-based foreign banks for want of another system
and they began to expand within the country bringing the banking system to
more local people. As countries became independent the need to engage in
banking activities became unavoidable and urgent. Governments, businesses
and individuals began to transact business with the banks, with or without liking
it. This state of affairs drew the attention and concern of Muslim intellectuals.
The story of interest-free or Islamic banking begins here. In the following

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paragraphs we will trace this story to date and examine how far and how
successfully their concerns have been addressed.

1. Explain Historical Development of Islamic Banking in the world

Historical Development of Islamic Banking in the world by A.L.M. Abdul Gafoor is

that seems that the history of interest-free banking could be divided into two
parts. First, when it still remained an idea; second, when it became a reality -- by
private initiative in some countries and by law in others. We will discuss the two
periods separately. The last decade has seen a marked decline in the
establishment of new Islamic banks and the established banks seem to have
failed to live up to the expectations. The literature of the period begins with
evaluations and ends with attempts at finding ways and means of correcting and
overcoming the problems encountered by the existing banks.
Interest-free banking seems to be of very recent origin. The earliest references to
the reorganisation of banking on the basis of profit sharing rather than interest
are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad
(1952) in the late forties, followed by a more elaborate exposition by Mawdudi in
1950 (1961).2 Muhammad Hamidullahs 1944, 1955, 1957 and 1962 writings too
should be included in this category. They have all recognised the need for
commercial banks and the evil of interest in that enterprise, and have proposed
a banking system based on the concept of Mudarabha - profit and loss sharing.
In the next two decades interest-free banking attracted more attention, partly
because of the political interest it created in Pakistan and partly because of the
emergence of young Muslim economists. Works specifically devoted to this
subject began to appear in this period. The first such work is that of Muhammad
Uzair (1955). Another set of works emerged in the late sixties and early

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seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar

(1971) and Baqir al-Sadr (1961, 1974) were the main contributors.
Early seventies saw the institutional involvement. Conference of the Finance
Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in
1972, First International Conference on Islamic Economics in Mecca in 1976,
International Economic Conference in London in 1977 were the result of such
involvement. The involvement of institutions and governments led to the
application of theory to practice and resulted in the establishment of the first
interest-free banks. The Islamic Development Bank, an inter-governmental bank
established in 1975, was born of this process.
The first private interest-free bank, the Dubai Islamic Bank, was also set up in
1975 by a group of Muslim businessmen from several countries. Two more
private banks were founded in 1977 under the name of Faisal Islamic Bank in
Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait
Finance House.
However, small scale limited scope interest-free banks have been tried before.
One in Malaysia in the mid-forties and another in Pakistan in the late-fifties.
Neither survived. In 1962 the Malaysian government set up the Pilgrims
Management Fund to help prospective pilgrims to save and profit.6 The savings
bank established in 1963 at Mit-Ghamr in Egypt was very popular and prospered
initially and then closed down for various reasons.7 However this experiment led
to the creation of the Nasser Social Bank in 1972. Though the bank is still active,
its objectives are more social than commercial.
In the ten years since the establishment of the first private commercial bank in
Dubai, more than 50 interest-free banks have come into being. Though nearly all
of them are in Muslim countries, there are some in Western Europe as well: in
Denmark, Luxembourg, Switzerland and the UK. Many banks were established in
1983 (11) and 1984 (13). The numbers have declined considerably in the
following years.
In most countries the establishment of interest-free banking had been by private
initiative and were confined to that bank. In Iran and Pakistan, however, it was by
government initiative and covered all banks in the country. The governments in
both these countries took steps in 1981 to introduce interest-free banking. In
Pakistan, effective 1 January 1981 all domestic commercial banks were permitted
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to accept deposits on the basis of profit-and-loss sharing (PLS). New steps were
introduced on 1 January 1985 to formally transform the banking system over the
next six months to one based on no interest. From 1 July 1985 no banks could
accept any interest bearing deposits, and all existing deposits became subject to
PLS rules. Yet some operations were still allowed to continue on the old basis. In
Iran, certain administrative steps were taken in February 1981 to eliminate
interest from banking operations. Interest on all assets was replaced by a 4
percent maximum service charge and by a 4 to 8 percent profit rate depending
on the type of economic activity. Interest on deposits was also converted into a
guaranteed minimum profit. In August 1983 the Usury-free Banking Law was
introduced and a fourteen-month change over period began in January 1984. The
whole system was converted to an interest-free one in March 1985.

For second option by Mohammad Salleh Bin Abdul Saha, that Historical
Development of Islamic Banking in the world has two types of stage which is 1 st
stage: when it still remained an idea and 2 nd stage: it already became reality.
Firstly, 1st stage: Interest-free banking as an idea which earliest references to the
reorganisation of banking on the basis of profit sharing rather than interest are
found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952)
in the late forties, followed by a more elaborate exposition by Mawdudi in 1950,
including all the writings of Muhammad Hamidullah (1944, 1957 and 1962). They
have all recognised the need for commercial banks and the interest in that
enterprise, and have proposed a banking system based on the basis of profit and
loss sharing (Mudharabah) rather than interest.
In the next two decades interest-free banking which is 2 nd stage: Interest-free
banks became reality that attracted more attention, partly because of the
political interest it created in Pakistan and partly because of the emergence of
young Muslim economists. In 1963, as a result from the pioneering efforts of
Ahmad El-Najjar, the first Islamic Banking was established in Egypt named Mit
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Ghamr Local Savings Bank. The first commercial bank (without using Syariah) in
Egypt, named Nasser Social Banks was established and its objectives are more to
social than commercial. In 1974, the first bank explicitly based on Syariah
principles was established by the Organization of Islamic countries (OIC), named
Islamic Development Bank (IDB) with the mission to provide funding to projects
in the member countries. In 1975-1979, several Islamic banks came into
existence including; in 1975, establishment of first Islamic private commercial
bank named Dubai Islamic Bank. While in 1977, Faisal Islamic Bank of Sudan,
Faisal Islamic Bank in Egypt and Kuwait Finance House and in 1979, Bahrain
Islamic Bank. In 1983-1984, Iran and Sudan introduced 100% Islamic Banking
system.

2. List and elaborate 3 (THREE) principles of Islamic Banking below:

a. Investment and financing (permissible) activities

Firstly, there no element of Gharar.

Gharar literally deceit, risk, fraud,

uncertainty or hazard that may be lead to destruction loss. Technically when a

matter that is concealed by one party. Occurs when a party undertake venture
blindly without sufficient knowledge. Minor uncertainties can be permitted when
there is a necessary. Both of contracting parties must have a perfect knowledge
regarding to transaction. Gharar (uncertainty) can be related to risks arising from
lack of knowledge about the contract (object, price, time of delivery), uncertainty
about the existence and delivery of the object or uncertainty of the outcome.
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Examples transaction include Gharar is sell good that seller is not in position to
deliver, gambling, sell unknown pages or known goods against unknown price,
make a contract conditional on unknown event, sell good on basis of false
description and sell good without proper examination. The word Gharar refer to
the need of believers to be aware of the deceptive character of the worldly
pleasures and not to be deceived by such temptations. Examples in Surah alNisa (4:29):
O you who believe! Eat not up your property among yourselves in vanities: But
let there be amongst you traffic and trade by mutual good-will: Nor kill (or
destroy) yourselves: for verily Allah hath been to you Most Merciful!
In the Sunnah; in commercial transactions, the Prophet SAW in many of his
sayings prohibited the sale involving gharar. Examples is the prohibition of sale
of fish in the sea, bird in the air, unborn animals, etc. Gharar is prohibited by
consensus of the jurists (ijma) since the time of the companions, their followers
(tabiin) and subsequently until now.
The reasons for prohibition of gharar is to ensure full consent and satisfaction of
all parties in a contract. Without full consent and satisfaction the contract is null
and void. Full consent can only be achieved through certainty, full knowledge,
full disclosure and transparency, and zero deceit or fraud. Gharar also results in
the risk being built into the contract at its inception which may result in a profit
for one party and corresponding loss to other party (zero-sum game or
gambling).
Secondly, there is no element of Riba. Literally Riba is define as increase,
addition, excess, expansion or growth. In the other words, it is refer to surplus of
income which lender receives from the borrower, over and above he principal
amount, as a reward for waiting or parting with the liquid part of his capital for a
specific period time. Definitions of riba by Ibn al-Arabi, every excess in return of
which no reward is paid. While Mawdudi is predetermined excess or surplus over
and above the loan received by the creditor conditionally on relation to a
specified period. Any transactions must not have the element of riba. Riba is a
form of return or contractual profit derived from lending and borrowing.
Since it is free from risk and value addition, Islam does not recognize wealth
creation through riba as a legitimate way of making a living. In Surah alBaqarah: 275-281, conclusively prohibiting all forms of riba. Any excess over the
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capital is disallowed they say: trade is like riba, but Allah has permitted
trading and forbidden (haram) riba (usury). Example in the Sunnah, from Jabir
the Prophet SAW cursed the receiver and the payer of riba, the one who records
it and the two witnesses to the transaction: they are alike in guilt. Reasons for
prohibition of Riba is to prevent injustice between contracting parties, exploit the
poor/creditors, an exploitation of people needs. Thus, they have no choice but to
be a involved in Riba. An exploitation of people ignorance over the types of
commodities involved in transaction.
Thirdly, invest to a company or activity that is permissible (halal). A Muslim must
be sure to deal only with companies that produce permissible or halal goods and
services. It is prohibited to invest in interest-bearing financial contracts or
instruments, in gambling or in items like wine and pork. In mean times,
manufacture or sale of impermissible (non-halal) products also prohibited.
Shariah prohibits using or dealing in certain commodities or activities. Islamic
Banking system must encourage and develop the application of Islamic
principles and Shariah law to transactions of finance, banking and business
affairs. It controls the engagement of investment companies in activities that are
tolerable and consistent with the Shariah law thus prevent the occurrence of
activities forbidden by Islam. Only halal activities or manufacture or sale are
allowed. Islamic financing will be inappropriate in financing any enterprise
involved in any type of activities that is unlawful is Islam or harmful to mankind.
The Islamic Bank, for example, does not finance liquor manufacturing,
transportation, storage or distribution companies.

b. Profit and loss sharing compare to interest based investment/loan

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Profit and loss sharing that do not involve charging or paying interest, the Islamic
financial systems promotes the concept of participation in a transaction backed
by real assets, utilising the funds at risk on a profit and loss sharing basis. This
used by Islamic banks are known as Mudharabah and Musharakah. It is between
bank and depositor, the depositor are considered to be provider of capital (Rabb
al mar). The bank functions as a working partner or manager of funds (mudarib
or amil).
Al-Mudharabah it can be define as a joint venture profit sharing contract. The
contract are between capital provider and the entrepreneur. Mudharabah term is
the expression making or performing a journey (Ad-Darb fil Ard). Agent
(entrepreneur) gets profit by performing his hard work and efforts in the long
journeys. The pillars of Mudharabah; Sahibul Mal is the owner of capital, fund
provider. Mudharib is the entrepreneur, Rasul Mal is capital, Al-Ama or Mashru is
business venture or project, Ribh is predetermined share of profit and lastly
Sighah is offer and acceptance.
Al-Musharakah as profit and loss sharing, the word is derived from sharaka or to
share. Al-Shirkah cover in its meaning: shirkah al-mulk (joint ownership of
common property) and shirkah al-aqad (contractual partnership in a business in
a business according to a mutual consent). The concept of profit and loss sharing
in an enterprise, as basis of financial transactions in a progressive one as it
distinguishes good performance from the bad and the mediocre.
Interest-based investment/loan under legal nature of promise is that the
customer is required to make a unilateral promise to buy the commodity from
the bank, before the bank makes the purchase. For the profit rate is that profit
comes from the interest rates while fixed and floating rate that many
conventional banking products are floating-rate products. The rates on such
loans are automatically adjusted upwards or downwards in line with charges in
interest rates. For the rescheduling of payment that the loan rescheduling is
companied by additional interest charge for the timing differences. And for the
rebate on early payment that the conventional financial system grants the
borrower a discount or rebate if the customer decides to pay earlier than the
scheduled time.

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3. Explain salient features of contract:

a. Jualah
Jualah comes from the root word Jaala (held), jaala, yajalu-jalan. Literally
jaala means to be held or to make, while for jualah means fee, price or salary
(al-Mujam al-wa Jiz). Jualah carries two meanings which is to determine the party
who wants to offer jualah will determine the rate of reward and to make an
obligation it is an obligation to reward the person who has completed a task
successfully. Definition of jualah: declaration (akad) for a commitment or a
promise for a person to pay some fee to another person for the task that have
been done. In jualah, there are two parties that would be the subject inthis
promise which is Jail (a person that promise to give the commission for the
achievement of the task) and Majullah (a person that perform the task). The
commission for jualah must be given only after the task have been done.
According to Maliki, Imam Shafie, and Imam Hambali, Jaala is a permissible
contract to be adapted in transactions. On the other hand, Imam Hanafi take an
opposite view that Jaala contract is not compatible with Islamic Shariah due to
the existing of Gharar in order for the task to be done. In Surah Yusuf: 72, they
said: We are missing the measue of the king. And for he produces it is (the
reward of) a load camel and I am responsible for it. Example in the Sunnah, the
Prophet SAW had acknowledge the actin of sahabah (companion) who recited
Surah al-Fatihah of the Quran on patient for a sheep as his fee if the person is
cured.
The nature of Jualah is jualah (service charge) a party pays another a specified
amount of money as a fee for rending a specific service in accordance with the
terms of the contract stipulated between the two parties. Jualah allows
contracting on an object not certain to exist or come under a partys control. It
can be utilized to introduce innovative financing structures. This mode usually
applies to transactions such as consultations and professional services, fund
placements and trust services.

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b. Contract of al-Murabahah
Al-Murabahah refers to the sales of goods at a price which includes cost plus
profit as agreed by both seller and the buyer. In Murabahah, a seller has to reveal
his cost and the contract takes place at an agreed margin profit. This allow
customer to take delivery of the goods immediately and also settle deferred
payment agreement with bank. A renowned Hanafi jurist al-Marghinani has
defined Murabahah as the sale of anything for the price at which it was
purchased by the seller and an addition of a fixed sum by way of profit. Ibn
Qudama, a Hanbali jurist, has defined it as the sale at capital cost as known
profit; the knowledge of capital cost is a precondition in it.
The evidence in hadith; some scholars made Murabahah analogous to a form of
sale called Tawliyyah (sale at purchase price without making profit). It was
reported that when Prophet SAW was preparing for hijrah to Madinah, Abu Bakar
bought 2 camels for the journey. The Prophet SAW said Abu Bakar Sell to me (at
cost without profit) one at them. Abu Bakar said It is yours for nothing. The
Prophet SAW said I would not take it for nothing. Majority of fuqaha comprising
the sahabah (companion of the Prophet), the tabien (followers the sahabah) an
iman of the Mazhab considered Al-Murabahah as a permissible contract based on
rukhsah principle.
The uses of Murabahah is to provide financing for his working capital
requirement to purchase stock & inventories, spare & replacement/semi-finished
goods and raw materials. Bank purchases or appoints the customer as its agent
to purchase the goods on its behalf. Upon delivery, bank pays the supplier at
sight or upon maturity of credit term based on the invoice value. The goods will
be acquired in the banks name and the banks finance. Bank subsequently sells
the goods to the customer on deferred payment terms at a price inclusive of the
Banks profit (Murabahah principles). Customer will undertake to settle the
selling price on the maturity date (30, 60, 90 days or others).

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While for the benefits its enable customer to settle payment obligation to the
seller. Facilitates convenient cash flow management of a business by having a
fixed rate financing nature. As for the conditions, the price of sale must be fixed
at the time of contract. This is important to avoid gharar (uncertainty) in the
transaction. Al-Murabahah must not involve sale of forbidden commodities such
as liquor, pork and the like.

Conclusion
Islamic banking has a young concept. It has implemented Muslim countries and
non-Muslim countries in this Islamic bank system. The first is to work for a better
understanding of the concepts upon which their operations are based. This has
been a success to the extent that now traditional bankers are mostly cooperative
and accommodating. Central bankers have also come forward with new ideas of
better methods for supervision and control, to suit the operations of Islamic
banks. Another means is to train their staff in this new form of banking and to
press for more banking and financial innovations which are necessary for the
new modes of finance. Many challenges still remain, not the least to the
predominance of Murabahah (sale mode) in the operations of some Islamic
banks, as well as the relative scarcity of short-term Islamic financial instruments.
I believe that competition, if allowed and maintained, not only within Islamic
banks, but also between all banks whether Islamic or traditional, would insure a
promising future for the banking industry as a whole.

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References

Ahmed Z. The Theory of Riba, An Introduction to Islamic Finance. Sheikh

Ghazali, Syed Omar, Adit Ghazali (eds). Quill Publishers, Kuala Lumpur,
Malaysia. (1992)

Al-Harran. Islamic Finance: Partnership Finance. Pelanduk Publications,

Kuala Lumpur, Malaysia. (1993)

Mohammad Salleh Bin Abdul Saha. Centre for Islamic Thought and
Understanding (ISB300). University Teknologi MARA Terengganu

Muhammad Ayub. Understanding Islamic Finance: Volume 462 of The

Wiley Finance Series. John Wiley & Sons (2009)

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