CHAPTER 4PRINCIPLES OF ISLAMIC BANKING

Mohammad Salleh Abd SahaRazizi bin Tarmuji

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CONTENTS

• 4.1 Investment and financing of HALAL activities.

• 4.2 Profit and loss sharing VS Lender-borrower relationship.

• 4.3 Trade-based financing VS Interest-based investment/loan.

• 4.4 Prohibition of Riba, Gharar and Maysir.• 4.5 Payment of zakat.

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4.1 Investment and financing of HALAL activities.

Financial serviced based on Riba.

Gambling and gaming.

Manufacture or sale of non-halal products.

Impermissible to invest and give

financing to company

Manufacture or sale of tobacco-based or related

product.

Stockbroking or share trading in Shariah non-compliant securities.

Other activities that conflicts with Shariah.

Entertainment activities that conflicts with Shariah.

Conventional insurance that containing of gharar.

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4.2 Profit and loss sharing VS Lender-borrower relationship.

-Between bank and depositor.

-The depositor are considered to be provider of the capital (Rabb al mar)

-The bank functions as a working partner or manager of funds (mudarib or amil)

FIRST TIER -Between bank

and entrepreneur.

-The entrepreneur is the manager of fund.

-The bank functions as provider of capital.

SECOND TIER

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Al-Mudharabah (Profit Sharing)

• It can be define as a joint venture profit sharing contract.

• The contract are between capital provider and the entrepreneur

• Mudharabah term: 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.

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Mudarabah Contract

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Pillars of Mudharabah

• Sahibul Mal : owner of capital, fund provider• Mudharib : Entrepreneur• Ra’sul Mal : Capital• Al-Amal or Mashru’ : Business ventures or

project• Ribh : Predetermined share of profit• Sighah : Offer and acceptance

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Al-Musharakah (Profit-Loss Sharing)

The word is derived from sharaka or to shareAl Shirkah cover in its meaning: a. shirkah al-mulk (joint ownership of common property)b. Shirkah al-aqad (contractual partnership in a business in

a business according to a mutual consent).• a partnership or joint venture for an economic activity

between the bank and one or more clients. In this joint venture, all parties may contribute some (not necessarily equal) percentage of all three factors of economic production (capital, labor, and entrepreneurship).

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The Musharakah Contract

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4.3 Trade-based financing VS Interest-based investment/loan.

Trade-based FinancingMurabaha is a contract of sale where the seller discloses to the buyer the actual

cost of the item to be sold in addition to the profit margin (mark up) added, to be mutually agreed upon with the buyer.

Murabaha financing is a widely used contract in contemporary Islamic banking and finance; and it is limited to cases where the customer actually needs to purchase some commodity.

Murabaha is an agreement wherein the bank purchases, at the request of a customer, a specified item, and then sells it to him at a mutually agreed marked-up price.

Payment for goods under murabaha may be made either on cash basis or under deferred payment terms. Although common usage of murabaha in trade financing is typically done by way of deferred payment, by definition, murabaha is not exclusively a deferred payment sales.

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Murabahah in Islamic Banking

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Subject of Murabaha (Item for Sale)

Subject of sale must be specifically known and identified. �Subject of sale must be in existence at the time of sale, and must be �

owned by the seller at time of sale. Subject of sale cannot be for haram use or forbidden commodities �Subject of sale must be something of value and classified as �

property in fiqh. This may raise several important fiqh issues, such as, whether “rights” qualify as property or not.

Sale must be instant and must not be attributed to a future date.�Terms of delivery must be specified and certain. �Sale must be unconditional and must not be contingent on a future �

event or fulfillment of a condition that is external to the transaction.

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Difference Trade-based Financing and Interest-based Investment/loan

Trade-based Financing Interest-based investment/loan

Legal Nature of promiseThe bank has to purchase the requested commodity before selling it to the customer.

The customer is required to make a unilateral promise to buy the commodity from the bank, before the bank makes the purchase.

Profit RatePrice includes a known profit or mark-up. The mark-up in murabaha is part of the sale price, it is set only once and then it does not change overtime.

Profit comes from the interest rates.

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Fixed and Floating rateMurabaha 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.

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.

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

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

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

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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4.4 Prohibition of Riba , Gharar and Maysir

Riba literally is as means to increase, to grow, to exceed, to be more than.In the other words, it is refer to surplus of income which lender receives from the borrower, over and above the principal amount, as a reward for waiting or parting with the liquid part of his capital for a specific period of time.

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Evidence from al-Quran

• Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, "Trade is [just] like interest." But Allah has permitted trade and has forbidden interest. ( al-Baqarah:275)

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O you who have believed, fear Allah and give up what remains [due to you] of interest, if you should be believers. Al-Baqarah:278

And if you do not, then be informed of a war [against you] from Allah and His Messenger. But if you repent, you may have your principal – [thus] you do no wrong, nor are you wronged (279) al-Baqarah

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Evidence from Prophet Tradition (al-Sunnah)The Prophet said, "Avoid the seven great destructive sins." The people enquire, "O Allah's Apostle! What are they? "He said, "To join others in worship along with Allah, to practice sorcery, to kill the life which Allah has forbidden except for a just cause, (according to Islamic law), to eat up Riba (usury), to eat up an orphan's wealth, to give back to the enemy and fleeing from the battlefield at the time of fighting, and to accuse, chaste women, who never even think of anything touching chastity and are good believers. [Sahih al-Bukhari, Sahih al-Muslim]

From Ibn Masood (ra): The Prophet (pbuh) said: "Riba has seventy three segments, the least serious being equivalent to a man committing adultery with his own mother." [Ibn Majah, Hakim].

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Three elements of Riba

Excess or surplus over and above the

loan capital

Bargain to be conditional on the

payment of a predetermined

surplus

Determination of this surplus in

relation to time

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Reasons for

Prohibition of Riba

To prevent injustice between contracting parties

Exploit the poor/creditors

An exploitations of people ignorance over the types of

commodities involved in transaction

An exploitation of people needs. Thus, they have no choice but to be involved in

Riba.

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Types of Riba

Riba al-fadl

Riba al-nasiah

Riba al-qard

Riba al-Jahiliyah

Riba al-Buyu`(arising from sales)

Riba al-Dayn(arising from debt)

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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-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

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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-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 .

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عن��ه • الل��ه رض��ي الص��امت ب��ن عبادة قال ع��نم : وسل عليه الله صلى الله رسول

بال��بر، وال��بر بالفض��ة، والفض��ة بالذه��ب، الذه��ببالمل�ح، والمل�ح بالتم�ر، والتم�ر بالشعي�ر، والشعي�راختلف�ت فإذا بي�د، يدا بس�واء، س�واء بمث�ل، مثالبيد يدا كان إذا شئتم؛ كيف فبيعوا األصناف هذه

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• Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt - like for like, equal for equal, payment being made on the spot. If the species differ, sell as you wish provided that payment is made on the spot'.

Hadith: Muslim

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RIBAWI ITEM

gold

Salt

Silver

Wheat Barley/oat

Dates

salt

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Prohibition of 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

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Examples Transaction include Gharar

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.

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Types of Gharar

•this type of gharar is not tolerate and may result in contract voidabilityGharar

Fahish

•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

tabarru’at) such as gift or bequest•There is a public need for the transaction or

contract (consideration of maslahah)

Gharar Yasir

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Maysir

Refers to the easy acquisition of wealth by chance,whether or not it

deprives the other’s right.

Qimar means the game of chance in which one gains at the cost of others.

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Issues that related to gambling

Contest using sms

The prize winning tickets

Horse racing

Lottery Crossworld puzzles

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Objectives restriction of gambling

It teach us to work for earning a living and not depend on chance and luck.

Individual property is sacred, it may not be taken unless given willingly or by lawful exchange.

Gamblers develop hater and enmity toward one another.

Gambling make a person more greedy. It takes away from the remembrance of Allah.To avoid wasting.

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Payment of Zakat

MEANING OF ZAKAH

To grow

To purify

To improve

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Purpose and Benefit of Zakat

• The foremost and primary is to distribute the wealth of the community among the poor

• Removing the love of wealth from one’s heart, a spiritual disease that could be detrimental to one’s Iman. Thus, it is a form of Tazkiya (self-purification).

• 3) Giving in the path of Allah acknowledging that whatever wealth one possesses is in reality the Almighty’s, and giving a monetary sacrifice for one’s lord.

• 4) Prevention of monopolies in society.razizi.uitm.edu.my

1 Enhances Volume of Productionwhen 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.

2 Discourages HoardingZakat discourages hoarding because it is levied on hoarded wealth.

3 raises SavingsZakat 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.

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

5 Raises investmentZakat Raises investment due to increase in consumption and production of goods.

6 reduces chances of recessionZakat increases circulation of wealth which reduces chances of recession.

7 Reduces inequality of WealthZakat is distributed among the poors from rich people so it reduces inequality of wealth.

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• 8 Raises Income levelDistribution of Zakat acts as an unemployment tool. Zakat is given to poor it increases his income level.

9 Raises Demand for necessitiesZakat Raises demand for necessities because poor buys things with Zakat of his needs.

10 Raises Standard of LivingZakat Raises standard of living of a poor person.

11 Reduces unemploymentZakat reduces unemployment and helps poors to do business with amount of Zakat.

12 End PovertyZakat ends poverty as Zakat is given to poors.

13 Redistribution of National Income.

14 Reduces Crimes.

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Condition of Zakah• Every Muslim who is of a certain age and owns

enough assets is required to pay zakat.Zakah

Performer Muslim

• Full ownership. A muslim only required to pay zakat if he or she has full and legal ownership of an asset.

• It’s 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.

Zakah Assets

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Completion of Haul

• Haul is defined as the completion period for zakah asset.

• The length of time:one islamic Hijri year (1 year Hijri=354.5 days, 1 year Solar= 365.25 days)

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

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Types of ZakatZakah Fitr• Zakah 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 Ramadhan and the first day of Shawal.

• All Muslims are obliged to pay this, regardless of their age, status or wealth.

• The amount of zakah 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.

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• Zakah Al-Mal (on wealth)• Zakah 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 zakah.

• Zakah al-Mal can be subdivided into zakah on:Business, Rental Income,Personal Income, Savings, Gold and Silver, Shares,Livestock, Crop

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Beneficiaries of zakah

Zakah expenditures are only for the poor and for the needy and for those employed to collect [zakah] and for bringing hearts together [for Islam] and for freeing captives [or slaves] and for those in debt and for the cause of Allah and for the [stranded] traveler - an obligation [imposed] by Allah . And Allah is Knowing and Wise.

Surah At-Taubah

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Beneficiaries of zakah

•Those without any means of livelihood and material possessions.The poor (faqir/Fuqara)

•Those without sufficient means of livelihood to meet their necessities.The needy

(Miskeen)

•Those appointed to manage and administer zakah.The

administrators of zakah (Amil)

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•Those who are inclined to enter or have already converted to islam.The sympathiser

(Muallaf)

•Zakah can be used to free slaves or captives.To free slaves (Riqab)

•Zakah can be used to pay off the debts of a person who has borrowed to pay for basic necessities so that he/she can lead a normal life.

•Zakat can also be distributed to those on financial problem.

•e.g: bankrupcy due to the loss of employment and heavy debt.

Those who are in debt (Gharimin)

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•Zakah can be use to finance any form of struggle or work for the love of Allah.

•e.g: Da’wah, building & developing society’s infrastucture and sponsoring a student’s educational expenses.

For the causes of Allah (Fisabilillah)

•Zakah cn be used to help a traveller facing diffilcuties in continuing his journey.

•e.g: loss of money or breake down of vehicles, the repair which he cannot afford.Those who are stranded during a

journey (Ibnus Sabil)

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Islamic Legal Maximالفقهية ) (القواعد

“General rules which apply to all of their related particulars”

Legal maxim is closely relate to the maqasid and provide useful

insights into the goals and purpose of shari’a.

It’s like legal theory, are designed primarily for better understanding

of their subject matter, rather than for enforcement.

Represent an important area of fiqh literature, as their study

imparts strategic knowledge of their subject matter and helps the

reader gain insight into the general character and attributes

of the shari’a

Particularly and inspiring in the vision they impart for the search

particularly of new solutions through ijtihad.

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5 major maxim

Matter are determined according to

intention

Hardship begets facility

What is certain

cannot be removed by

doubt

Custom is arbitrary

Harm shall not be

inflicted nor reciprocated

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Matter are determined according to Intention( بمقاصدها (األمور

• 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.

• Eg: 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 rationalise it in Islamic terms such as mudharabah etc.

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Hardship begets facility( المحظورات تبيح (الضرورات

• 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.

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• Eg: 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.

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What is certain cannot be removed by doubtبالشك ) يزول ال (اليقين

• 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.

• Eg: 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.

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Custom is arbitraryمحكمة ) (العادة

• 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.

• Eg: a person authories 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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Harm shall not be inflicted nor reciprocatedضرار ) وال ضرر (ال

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.

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• Eg: the 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.

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No Reward without risk( بالغنم (الغرم

• Anyone cannot expect to make profit without associating it with risk in his undertakings.

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PAST YEAR QUESTION

APRIL 2011QUESTION 3a) Discuss FOUR(4) differences between al-

Mudharabah and al-Musharakah. (8 marks)b) Demonstrate the mode of operation of al-

Mudharabah and al-Musharakah equity financing. (10 marks)

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APRIL 20L0QUESTION 5

a) Define these terms :i) Ghararii) Maysiriii) Zakativ) Mudharabahv) Musyarakah

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OCTOBER 2010QUESTION 4

a) Define the literal and technical meaning of Mudharabah and Musyarakah.QUESTION 6

b) Explain riba in Islam and classification.c) Discuss THREE(3) differences between riba’

profit.d) Elaborate FOUR(4) rationale behind the

prohibition of Riba’.

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QUESTION 5The prohibition of riba originated fromdebt(duyun) and sale(buyu’).Based of the above statement:a) Define Riba al-Duyu(debt) and Riba al-

sale(buyu’). (4 marks)b) State the conditions of increase and delay in

Riba al-Fadl. (9 marks)c) Explain the chronologies of prohibition of

Riba in the Qur’an. (12 marks)

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0CTOBER 2OO9QUESTION 4b) Explain classification of Riba. (8 marks)c) Explain THREE (3) differences trade and riba.(9

marks)

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