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    © Islamic Development Bank, 2007 Islamic Research & Training Institute First Published 1427H (2007) Islamic Research and Training Institute P.O. Box 9201, Jeddah 21413, Saudi Arabia. e-mail: King Fahad National Library Cataloging-in-Publication Data Ali, Salman Syed, 1961−

    Islamic Banking and Finance: Fundamentals and Contemporary Issues / Salman Syed Ali and Ausaf Ahmad. 306 + (x) p.; 24x17 cm. − Jeddah 19143. Includes references and glossary. ISBN 9960-32-162-2 1. Finance – Islamic. 2. Banking – Islamic. 3. Law – Financial 4. Financial Service Industry – Islamic. I. Ahmad, Ausaf. II. Title III. Conference Proceedings 332.121 – dc20

    The views expressed in this book are not necessarily those of the Islamic Research and Training Institute of the Islamic Development Bank or the Universiti Brunei Darussalam. References and citations are allowed but must be properly acknowledged.

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    Foreword vii Acknowledgements ix An Overview Salman Syed Ali and Ausaf Ahmad


    Fundamentals 1 Islamic Banking and Finance: Philosophical Underpinnings

    Mabid Ali Al-Jarhi 13

    2 The Case Against Riba: Is It Compelling?

    Umer Chapra 25

    3 Option Contracts and The Principles of Sale of Rights in Shari[ah

    Mohammed Burhan Arbouna 51

    4 Unresolved issues in Islamic Banking and Finance: Deposit

    Mobilization Sayyid Tahir


    5 Financial Distress and Bank Failure: Relevance for Islamic Banks

    Salman Syed Ali 99

    Contemporary Issues 6 Factors of Success of Islamic Banks: An Empirical Study

    Monzer Kahaf 121


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    7 The Attitude of Bank Customers and Professional Bankers Towards Islamic and Conventional Banks in Bangladesh Mahmood Ahmad


    8 Equity Fund’s Islamic Screening: Effects on its Financial

    Performance Abul Hassan and Antonios Antoniou


    Legal Issues 9 Legal Aspects of Islamic Banking—Malaysian Experience

    Norhasima Yassin 215

    10 Legal Aspects of Islamic Project Finance and Asset Securitization

    in Indonesia: A Vehicle for the Development of Islamic Banking Reza Adirahman Djojosugito


    11 Islamic Bonds; Indonesian Experience

    Cecep Maskanul Hakim 261

    History and Training Issues 12 Islamic Banking in Brunei and The Future Role of Centre for

    Islamic Banking Finance and Management (CIBFM) Hjh Salma Hj Abdul Latiff


    Glossary 301

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    Islamic finance is growing in various parts of the world. It has moved

    from a mere theoretical concept to a practical reality. A natural consequence of this progress is the opening up of new challenges as well as more avenues for its advancement. Islamic finance is therefore confronting some new and some old, but re-formulated, challenges on the intellectual and practical plains. On the intellectual side, refinements in the philosophical underpinnings of the Islamic finance and the financial system are the core issues. While on the practical side, the diversity of regulatory, supervisory and legal environments faced by Islamic financial institutions; the issues of a proper accounting framework; corporate governance; and making available of a complete spectrum of Islamic financial products have evolved as some of the new challenges. These challenges require going back and forth between the drawing board and the reality. Consequently, this approach is reflected in a good number of conferences and research assignments undertaken by IRTI.

    The present volume is a collection of selected papers from a conference jointly organized by IRTI and Universiti Brunei Darussalam in 2004. The conference was unique in its inclusion of some educational lectures on Islamic law (fiqh) of finance for orientation purpose along with sessions devoted to presentation of research papers in Islamic banking and finance. Both categories of presentations were important in their own right. However, the editors felt that the information content of the first category (the orientation lectures) will find its own currency and circulation because lectures by nature are repeated and their information content shared more widely. It is the research papers category that may need support of editing and publishing for broader circulation and knowledge preservation. The editors have therefore put together mostly this second category of papers in this volume. I hope that the readers will find these useful; and that the papers will help in creating further knowledge in the field.

    Bashir Ali Khallat Acting Director Islamic Research and Training Institute

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    We would like to acknowledge the joint efforts of IRTI and Universiti Brunei Darussalam in organizing the conference which generated these papers.

    Particular thanks to Ms. Hjh Salma, Dr. Shamim Siddiqui and other members of the local Organizing Committee from Universiti Brunei Darussalam who were responsible for the local arrangements. We also like to acknowledge with appreciation the Academic Committee of the conference comprising of IRTI and UBD staff who refereed the large number of papers submitted for the conference. Most importantly, thank is due to all the authors who contributed with their papers to the conference.

    We also acknowledge with thanks the tedious work of Mr. Sajjad Qurban, Mr. Amanul Hoque, Mr. Mohammad Asiri and many others at IRTI who helped us at different stages of typesetting and final production of this volume.

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  • Salman Syed Ali ∗ and Ausaf Ahmad **

    Background Islamic jurisprudence (Shari[ah) explicitly prohibits interest (riba) in all its

    manifestations. Islamic Banking and Finance in modern times grew out of the Muslims’ desire to find out the ways and means to fulfil their financial requirements in view of prohibition of interest. Interest based finance had become the dominant system during the colonial period, and continued to be so in many Muslim countries even after their independence. In this backdrop Muslim intellectuals and economists started to write about Islamic economics and financial system, notably in the Indian Subcontinent and Egypt.1 The early writings expounded the philosophy and the concepts of interest-free finance along with its effects on the socio-economic welfare of the society. During that era commercial banks had occupied centre stage of the finance industry in mobilization of savings and providing of loans. Naturally, the first models of Islamic finance purported to explain how a banking system could work without interest.2 These theoretical models perceived two tired mudarabah finance structure, in which the Islamic bank on one hand would receive deposits as agent (mudarib) of its customers; and on the other hand provide finance to enterprise as principal [sleeping partner] (rabb al-mal). In this early period (1930s to 1960s), developments in Islamic finance took place on the intellectual side only. The first practical realization of a bank-like Islamic financial institution, on a small scale, was that of Mit Ghimar in Egypt which started in 1963 and closed down in 1967. Another independent experiment of Islamic finance started in Malaysia in the form of Shari[ah ∗ Islamic Research and Training Institute, Islamic Development Bank. ** Formerly of IRTI, Islamic Development Bank.

    An Overview

  • Salman Syed Ali & Ausaf Ahmad

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    compliant savings and investments scheme for prospective pilgrims (hujjaj) called Tabung Haji. The experiment remained unknown in the academic circles only to be discovered much later and recognized in the 1990s as a successful institution.

    In the 1960s and early 1970s the developments were mostly on the theoretical plane devoid of any practical experimentation. However, the accumulated theoretical knowledge prepared the ground and developed sufficient collective will for the emergence of first Islamic banks one in private sector (Dubai Islamic Bank) and another as a multilateral organization (Islamic Development Bank) both of which came into being in the early 1970s. Many more Islamic banks and financial institutions were created in the following years (for details see Ahmad 2000). A combination of practical realities of the business and constraints of the regulatory environment forced the Islamic banks to rely mostly on murabahah and leasing contracts for the financing activities instead of the originally conceived mudarabah contract in the second tier. So much is the use of murabahah that some authors referred to this practice as murabahah syndrome3.

    Islamic finance has grown beyond banking since 1990s and expanded to the realm of capital markets. Now Islamic financial industry comprises of Islamic banks, investment funds, asset management companies, house financing companies, and insurance companies. The industry is growing in double digits since last decade. This expansion has brought up a number of practical issues and problems that serve as guiding posts for determining the direction of applied research in the field. Such research has become more active. For example, we see that a larger proportion of the fiqh questions a