Mahyuddin Khalid emkay@salam.uitm.edu.

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ISLAMIC BANKING AND FINANCE PRINCIPLES OF ISLAMIC BANKING

CONTENTS
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INVESTMENT AND FINANCING OF HALAL ACTIVITIES PROFIT AND LOSS SHARING VS LENDERBORROWER RELATIONSHIP TRADE-BASED FINANCING VS INTERESTBASED INVESTMENT/LOAN PROHIBITION OF RIBA, GHARAR AND MAYSIR PAYMENT OF ZAKAT

INVESTMENT AND FINANCING OF HALAL ACTIVITIES

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Financial serviced based on Riba Gambling and gaming Manufacture or sale of non-halal products Manufacture or sale of tobacco-based or related product Stockbroking or share trading in Shariah noncompliant securities Other activities that conflicts with Shariah

Impermissible to invest and give financing to related activities

Entertainment activities that conflicts with Shariah

Conventional insurance that containing of gharar

PROFIT AND LOSS SHARING VS LENDER-BORROWER RELATIONSHIP

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PROFIT LOSS SHARING

First Tier Between bank and depositor The depositor are considered to be provider of the capital (Rabb al mal) The bank functions as a working partner or manager of funds (mudarib or amil) Second Tier Between bank and entrepreneur The entrepreneur is the manager of fund The bank functions as provider of capital

LENDER-BORROWER RELATIONSHIP
The relationship between a lender and a borrower is governed by a loan contract between them. Such a contract would specify all the obligations of the two parties in every possible future contingency. With respect to: The amount of repayment The interest rate on the remaining debt. A possible adjustment in the collateral required by the lender. The actions (in particular investment decisions) to be undertaken by the borrower.

TRADE-BASED FINANCING VS INTEREST-BASED INVESTMENT/LOAN

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TRADE-BASED FINANCING The bank has to purchase the requested commodity before selling it to the customer.

CHARACTERISTICS Legal Nature of promise

INTEREST-BASED LOAN The customer is required to make a unilateral promise to buy the commodity from the bank, before the bank makes the purchase. Profit comes from the interest rates.

Price includes a known profit or mark-up. The mark-up in murabahah is part of the sale price, it is set only once and then it does not change overtime. Murabaha financing products are fixed-rate products. The rate, once determined for a given contract, is not allowed to float with changes in the interest rates or any other rate.

Profit Rate

Fixed and Floating rate

Many conventional banking products are floating-rate products. The rates on such loans are automatically adjusted upwards or downwards in line with changes in interest rates.

TRADE-BASED FINANCING VS INTEREST-BASED INVESTMENT/LOAN

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TRADE-BASED FINANCING

CHARACTERISTICS

INTEREST-BASED LOAN

Murabaha does not allow such rescheduling as no additional amount can be charged for the same. The amount of the murabahah price remains unchanged.

Rescheduling of payment

Loan rescheduling is accompanied by additional interest charge for the timing differences.

If it is given voluntarily, it is allowed. The rate of discount must not be pre-specified in the murabahah contract as a condition. It is not a right that the debtor can claim.

Rebate on early payment

Conventional financial system grants the borrower a discount or rebate if the customer decides to pay earlier than the scheduled time.

PROHIBITION OF RIBA
Definition of Riba on Trade transaction

Unlawful gain derived from the quantitative inequality of the counter-values in any transaction purporting to effect the exchange of 2 or more species which belong to the same genus(category) and are governed by the same efficient cause(illah) Definition of Riba on Loan transaction A predetermined excess or surplus over and above the loan received by the creditor conditionally in relation to a specified period
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EVIDENCE

Al-Quran
Al-Baqarah:

275

EVIDENCE

Hadith:
From

Jabir: The Prophet saw cursed the receiver and the payer of usury, the one who records it and the two witnesses to the transaction and said: They are all alike (in guilt and sin). From Abi Said al-Khudri: The Prophet saw said: gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, and hand to hand. Whoever pays more or takes more has indulged in riba. Take taker and the giver are alike (in guilt).
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ELEMENTS OF RIBA
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Determination of this surplus in relation to time

Bargain to be conditional on the payment of a predetermined surplus

Excess or surplus over and above the loan capital

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REASONS FOR PROHIBITION OF RIBA

To prevent injustice between contracting parties An exploitation of people needs. Thus, they have no choice but to be involved in Riba

Exploit the poor/ creditors

An exploitations of people ignorance over the types of commodities involved in transaction

CATEGORIES OF RIBA
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Categories of Riba

Riba al-Buyu` (Trade Transaction)

Riba al-Dayn (Loan Transaction)

Riba al-Fadl

Riba al-Qard

Riba al-Nasiah

Riba alJahiliyah

CATEGORIES OF RIBA
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RIBA AL-BUYU`
Riba al-Fadl
Also known as Riba al-buyu that is riba by excess. It applies to six items : gold, silver, date, raisin, wheat and barley and the like of them.

RIBA AL-DAYN
Riba al-Qard
It is riba in debt or out of lending and borrowing. It was originated from the transaction of a loan , and it is interest or payment charged due to the loan given. On the other words, it is the extra amount over the above principal of the loan.

Riba al-Nasiah
Its occurs whenever the creditor advanced loan on some monthly interest in addition to the principal sums. Increase due time On other words, this stipulated interest which the lender takes from the borrower to pay back the capital. Second opinion- Any delay in the exchange of the ribawi items from the same type and category

Riba al-Jahiliyah
It is Riba in loan. It is when a loan contract is made or at rescheduling a previous debt. It is take place only in debts created via lending or extended to a new maturity via rescheduling.

RIBAWI ITEM
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Gold

Salt

Salt

Dates

Ribawi Item
Barley/Oat Wheat

Silver

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ISLAMIC RULINGS ON RIBA IN TRADE

Category 1 Same category Type Same type Exchange Spot exchange Quantity Equal in quantity Regardless of quality Items Gold with Gold, Wheat with Wheat

2 Same category

Different type

Spot exchange

Inequality is permitted

Equality is not a God with Silver condition Wheat with Rice Salt with Dates

3 Different category

Different type

Delayed is permitted

Inequality is permitted

Time and Gold with Wheat Quantity Factor RM with Dates is not a condition

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ISLAMIC RULINGS ON RIBA IN TRADE

Category Type Exchange Quantity Items

4 Ribawi Items and Non- Delayed is Inequality is Ribawi Items permitted permitted

Time and Quantity Factor is not a condition

RM with vehicles UD with furniture

5 Between 2 NonRibawi Items

Delayed is Inequality is permitted permitted

Time and Quantity Factor is not a condition

Bricks with Sands Cloth with Patrols

PROHIBITION OF GHARAR
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Literally:
Deceit,

risk, fraud, uncertainty or hazard that may be lead to destruction loss. a matter that is concealed by one party.

Technically:
When

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

PROHIBITION OF GHARAR
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Examples of Gharar related transaction: Sell good that seller is not in position to deliver. Sell unknown pages or known goods against unknown price. Make a contract conditional on a unknown event. Sell good on basis of false description. Sell good without proper examination. Gambling.

TYPES OF GHARAR
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Gharar Yasir
This type of gharar is tolerate and will not invalidate a contract. Gharar yasir may include the following cases: The uncertainty is slight or trival Contract is unilateral or charitable (al tabarruat) such as gift or bequest There is a public need for the transaction or contract (consideration of maslahah)

Gharar Fahish
This type of gharar is not tolerate and may result in contract voidability

PROHIBITION OF MAYSIR
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Refers to the easy acquisition of wealth by chance, whether or not it deprives the others right. Qimar means the game of chance in which one gains at the cost of others. Issues that related to gambling:
Contest

using SMS The prize winning tickets Horse racing Lottery Crossword puzzles

PAYMENT OF ZAKAT
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Meaning of zakat

To grow To purify To improve The foremost and primary is to distribute the wealth of the community among the poor Removing the love of wealth from ones heart, a spiritual disease that could be detrimental to ones Iman. Thus, it is a form of Tazkiya (self-purification). Giving in the path of Allah acknowledging that whatever wealth one possesses is in reality the Almightys, and giving a monetary sacrifice for ones lord. Prevention of monopolies in society.

Purpose of Zakat

BENEFIT OF ZAKAT
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Enhances Volume of Production

When Zakat is collected and distributed among the poor they spend it on various consumer goods which increase the demand of various products of industries which increases production of goods.

Discourages Hoarding

Zakat discourages hoarding because it is levied on hoarded wealth.

Zakat is paid out of the accumulated wealth. the wealth owner must in saving ratio, in order to prevent the level of his wealth from decreasing.

Raises Savings

Zakat increase level of income

Zakat increase level of income due to circulation of wealth in the economy.

Zakat is distributed among the poor from rich people so it reduces inequality of wealth. Zakat ends poverty as Zakat is given to poor.

Reduces inequality of Wealth

Redistribution of National Income.

CONDITION OF ZAKAT
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Zakat Performer Muslim

Every Muslim who is of a certain age and owns enough assets is required to pay zakat. Full ownership. A Muslim only required to pay zakat if he or she has full and legal ownership of an asset. Its payable only on those assets acquired for the purpose of creating or generate wealth. Zakat need only be paid on those assets that exceed a minimum value. Minimum value is termed Nisab. Haul is defined as the completion period for zakat asset. The length of time:

Zakat Assets

Completion of Haul

One Islamic Hijri year (1 year Hijri=354.5 days, 1 year Solar= 365.25 days)

Zakat only payable on asset that have been held for at least this period.

TYPES OF ZAKAT
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Zakat Fitr Zakat Fitr is a one off payment that is made once in every Muslim Hijri calendar year at any time between the first day of the month of Ramadan and the first day of Shawal. All Muslims are obliged to pay this, regardless of their age, status or wealth. The amount of zakat payable is approximately 3kg of staple food in the relevant country or an amount of money that is equivalent to the price of the food.

Zakat Al-Mal (on wealth) Zakat al-Mal is an annual payment based on the amount of wealth owned by a Muslim individual or organization. This payment is obligatory upon any Muslim individual or organization that has completed the requirement of Nisab (minimum taxable amount) and Haul (one Muslim Hijri calendar year). The payment is 2.5% out of the total wealth deemed for zakat. Zakat al-Mal can be subdivided into zakat on: Business, Rental Income, Personal Income, Savings, Gold and Silver, Shares, Livestock, Crop

BENEFICIARIES OF ZAKAT
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1. 2. 3. 4.

5. 6.

The poor (Faqir/Fuqara) The needy (Miskeen) The administrators of zakat (Amil) The sympathizer (Muallaf) - Those who are inclined to enter or have already converted to Islam. To free slaves (Riqab) Those who are in debt (Gharimin)

Zakat can be used to pay off the debts of a person who has borrowed to pay for basic necessities or those on financial problem. Zakat can be use to finance any form of struggle or work for the love of Allah. Zakat can be used to help a traveller facing difficulties in continuing his journey.

7.

For the causes of Allah (Fisabilillah)

8.

Those who are stranded during a journey (Ibnus Sabil)

ISLAMIC LEGAL MAXIM ( )

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Qawaid fiqhiyyah or Legal maxims are general rules which can be applied in various cases that come under common rulings. Plays great role in the formation of Islamic law because they are uses as principles to deduce rules of fiqh. Legal maxims are indeed general rules of fiqh, which can be applied in various cases that come under the common rulings e.g.. transactions, munakahat, evidence etc. Have a great role in the formation of Islamic law because they are used as guidelines in finding the rules of fiqh but cannot be accepted as sources of shariah. These maxims have solved most of the minor rules of fiqh and without them these minor rules will have no standing ground which will make it hard to solve

FIVE MAJOR MAXIMS

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Acts Are Judged By The Intention Behind Them

Certainty Is Not Dispelled By Doubt Hardship Begets Facility

Harm Must Be Removed

Custom Is The Basis Of Judgement

ACTS ARE JUDGED BY THE INTENTION BEHIND THEM

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()

An act of any human being is judged in the light of intention or the purpose it seeks to have effects. This means that the effect to be given to any particular action or transaction must be in accordance with the intent underlying such action or transaction. E.g.:
Banks

declare their policy of financing customers on non-interest bases it would be necessary to do so and not merely continue the same practice and seeking to rationalize it in Islamic terms such as mudharabah etc.

CERTAINTY IS NOT DISPELLED BY DOUBT

( )
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It is discusses about the principle that should be followed if there is doubt in any matter particularly in matters pertaining to Islamic law. This means that a fact established by law or proven with evidence will remain so, until there is another certainty that removes it. E.g.:
A

partner has no right to assume a minimum rate of profit earned by his business partner and claim his share in that profit as different from amount stated to have been actually earned by the partner.

HARDSHIP BEGETS FACILITY ()

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The maxim indicates that any ruling which implementation causes hardship to a person or the action is unable to be performed by a particular person for a specific acceptable reason, then there are alternative and ways out that can be resorted to in order to overcome the difficulties and hardship. Hardship- refer to surpass the normal limit and ability of a person such as travel/sickness/ dharurah etc. E.g.:

If the court orders the sale of assets of a negligent debtor to pay his creditors, it must begin with the sale of his movable goods if this would suffice to clear his debt, before selling his real property.

HARM MUST BE REMOVED ()

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The scholars have classified harm into two categories :

Harm which is inflicted intentionally in order to cause damage. This kind of harm is forbidden and the perpetrator shall bear the consequences of his action. Harm which is cause unintentionally without any intention to cause harm or damages to others.

E.g.:

A buyer of perishable goods absents himself without taking possession of the purchased goods. The seller , in order to protect himself and the buyer from loss, has a right to unilaterally revoke the contract of sale and sell the goods to some other party.

CUSTOM IS THE BASIS OF JUDGEMENT

( )
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This maxim means the practices of the people whether in their actions or sayings, regardless of whether they are general practices of the people or the practices of certain groups of people. E.g.:
A

person authorizes another to sell something on his behalf without laying down conditions as to sale price and unit of currency, the agent will be treated to be bound by conventional rules of charging a reasonable price and prevalent currency.

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END OF CHAPTER