Download - Work Book for Islamic Finance & Economics IQRA University

Yousuf Ibnul Hasan [email protected]

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Chapter 1 Economics System in Islam

What is Islamic Economics? What are the principles upon which Islamic Economy, its monetary and financial systems function? Islamic Economics is a system that defines the available resources blessed by Almighty Allah to the mankind. How these resources are utilized and distributed by man keeping in it the social justice and seeking best of these in participation and cooperation by applying the knowledge, experience, ability and efforts through the power of pen and book granted by Almighty Allah to men in confirmation of “Unique among Creations” and “Custodian” to all the resources that Almighty Allah owns it alone and absolute.

Islamic economics is as old as Islam itself”. Islam is not a religion. It is a complete political, social, financial & economic system for Islamic & non Islamic communities.

Islam is “Deen”. It totally differs to the religions because of the definition, depth and details and interpreted as a “Lifestyle”. Its principles are comprehensively guided in

Holy Quran, explained in Hadiath and practice by Holy Prophet Muhammad May

Peace Be upon Him as Sharia‟h”

Almighty Allah identified Aims, Objectives, Purpose, Way and Means of Islamic Economics through the first guidance in Holy Quran that opens the chapters of economics system in Islam which is the life of individual Muslim.

“READ (IQRA) in the name of your Lord, who has created you with the clot of frozen blood and taught you with the power of pen …………….

The word READ opens the chapter of an Islamic Economics; in RATIONAL, through EFFORTS, by APPLICATION with DISCRIPTIVENESS.

20th Century Economists define Islamic Economics Hasan-uz-Zaman Islamic economics is the knowledge and application of injunctions and rules of the Sharia‟h that prevent injustice in the acquisition and disposal of material resources in order to provide satisfaction to human beings and enable them to perform their obligations to Allah and the society.


M. Akram Khan Islamic economics aims at the study of human recovery achieved by organizing the resources of earth on the basis of cooperation and participation.

Dr. Nejatullah Siddiqi Role of Shariah define belief in justice and freedom, cooperation and sharing which are the fundamentals to Islamic economic philosophy within the total Islamic system. Key to Islamic economics philosophy lies in man's relationship with Allah, his universe and his people. The other human beings are the nature and purpose of man's life on earth.

The concept of economics It was established on the day Adam who was senseless to his needs and desires at the time he was created, disobeyed Allah Almighty on temptation of Iblees. AAddaamm‟‟ss aacctt ooff ddiissoobbeeddiieennccee ccrreeaatteedd tthhee pprriinncciipplleess ooff eeccoonnoommiiccss tthhaatt rreevvoollvvee aarroouunndd Theory of Need, Want and Desire that lead to Act, Acquire and Accept. PPrroopphheett AAddaamm wwaass sseenntt ttoo eeaarrtthh ttoo ddeevveelloopp mmaannkkiinndd wwiitthh aa ssyysstteemm ooff lliiffee tthhaatt ppllaacceedd tthhee NNaattuurraall EEccoonnoommiiccss aass.. “Any activity that has a commercial, economical and financial purpose with the priority of social benefit to mankind is classified as Islamic Economics and the system that has basis on this classification leads to socio- economic development and not just the economic development.”

The bases of Islamic economic are well define as:

Resources are unlimited and efforts are limited.

Needs and wants does not effect on the supply or resources.

Availability of resources is dependent on efforts that develop the affordability in satisfying the needs.

Nations were putting their efforts in achieving knowledge and seeking their rights in economic system are the leaders of economic growth.

Nation that merges the economics growth with socio development develops the Communities “For the people, By the people and Of the people”.

Socio Economics Development converts Peoples into Nation.

The Nations are in One Identity and recognizes through achievement of its knowledge and distribution of resources achieve through social justice, participation and cooperation with trust in the leadership and confidence in the nation having unity, discipline and faith that work on a system believing “The voice of the nation is the voice of the God”.


Islamic Economic regards three factors of productions.

Man, Money and Commodity

These three basic factors bring other factors of productions keeping themselves as guide to socio economic system. Economic activity travels in triangle and in clock wise, the point of origin is the point of destination. Man is the source behind all activities that leads towards Islamic Economics System and its abilities, capabilities and control over is the key of efficiency and success that develop healthy communities.

Role of Man & Money in Islamic Economics 1. The financial matters in the human life play a vital role 2. These identify principles of finance including earnings, income, and distribution of

wealth & utilization of the same. 3. Matters pertaining to money must be fair and transparent and useful for

developing socio-economic life of the community. 4. Monopoly of a group or an individual who keeps a control on world monetary

policies and gets most out of these resources by blocking wealth, crossing their jurisdictions to be eliminated.

5. It does not impose limits on amount of wealth that an individual can acquire. 6. It guides in maintaining of wealth in a proper form of distribution and incentives

for work and efforts. 7. It shows opposition & defends against misuse of exploitation in getting hold of

wealth through unfair means. 8. It clearly denies "free" market of Capitalism, which has led to the situation of

survival of a part of the society. 9. It emphasizes public revenue from natural resources is used to secure the needs of

community and not to fill pockets of casino owners. 10. It encourages state to provide public, essential resources to cover needs of every

individual and family. 11. It outlaw hoarding of wealth and eliminate copyright or patent laws that would

open an avenue for potential monopoly to develop. 12. It protects the ownership of businesses and companies by restricting it only to

those who contributes both capital or effort 13. It effectively puts a seal on such concepts as "corporate takeover" from ever

becoming a reality. 14. It classifies wealth in a systematic way to protect rights of individuals to access

wealth. 15. It protects the society and secures the needs of the people.

MAN

MONEY COMMODITTY


16. It mandates vital and natural resources as public property while allowing for unlimited access to luxury items.

17. It protects society by defining certain needs as a “prohibited needs”. 18. It disregards corrupt man-made systems and protects honour, rights of woman,

minor and orphans. 19. It bans all forms of prostitution, pornography or any activities that exploit charms

and physical attractiveness of women. 20. It prohibits alcohol, gambling, spiral of corruption, social turmoil and moral

destruction

Relationship of Allah and Man Tawhid (Oneness of Allah) the total commitment to the will of Allah by submission & the mission to mould human life in accordance with Allah‟s will”.

44 GGrreeaatt wwaayyss ooff aacccceeppttiinngg TTaawwhhiidd

1st Look back and thank Allah.

2nd Look forward and trust Allah

3rd Look Around and believe in Allah

4th Look within yourself and find Allah

Life on earth It is a test and its purpose is to prove successfully by doing Allah‟s willed. For man entire universe with all the natural resources and powers is opens to exploitation, which Allah owns it alone. Provisions are available to man being the nature of trust on men.

Islam & Faith 1. Almighty Allah is absolute 2. Prophet Mohammad Peace be upon Him, was an executive judge 3. Holy Quran is the code of conduct.

Islam organizes that Man‟s life in its aspect of political, social, commercial, financial,

legal, commercial, monetary or economy.

Islamic Economics is an Application of Deen (Principles of Lifestyle). Through the Theory “The Holy Quran”, By the explanation of theory “Hadiath” and Practice and Implementation “Sharia‟h”

Islamic economics is an independent system,

1. It enjoys a separate identity.

2. It is a self-contained system with its own economic policy,

3. It covers interests at Private and Public as well as Material or Spiritual.

4. It has given a complete system of lifestyle, Earning, Expenditure, Businesses, and Relationship with Legal Framework.

5. It emphasizes for all bases on Social Justice, Equality, Unity, love, Cooperation, Sharing, Transparencies in all affairs and respect.


Islamic Economics System guards

1. Rights of minorities and non-Muslims in the Islamic state.

2. Rights of Women and Orphan‟s

3. Rights of employees

4. Rights of Financier and user.

5. Individual property rights

6. Rights of everyone without race, religion, language, color or sect.

Islamic Economics system is based on four principles

1. All wealth belongs to Almighty Allah

2. Man is the trustee of the wealth

3. Hoarding of wealth is prohibited

4. Wealth must be in circulation at all time

Three parameters for day-to-day affairs and problems. IJMA (Gathering), QIYAS (Discussion) AMAL (Act)

What Islamic Economic accept as true 1. Specifically considering distribution of resources as an economic problem. 2. It differ application to capitalist & communist systems for production. 3. It differentiates between basic needs and luxuries. 4. It does not accept the concept of effective scarcity of resources. 5. It does not accept concept of inflation The Holy Quran identifies the resources are sufficient, unlimited and a number of qualities to fulfill the basic needs like food, clothing and shelter for over fifty billion human beings at all time and conventional economics misguides this reality with starvation, poverty, & economic backwardness because of misdistribution originated from man-made laws and systems.

Basic Principles of Islamic Economics

1. The principle of flexible ownership

2. The principle of economic freedom within a “defined limit”

3. The principle of social justice.

Islamic law permit three types of ownership,

1. The individual ownership.

2. The state ownership.

3. The public ownership.


Economic Freedom within a Defined Limit

1. Islamic law prohibits all such social and economic activities that differ to the teachings of Islam and principles and values approved by Islam. Such social and economical activities fall under the category of Riba

2. It defines the principles on which ruler sworn in for supervision of general activities intervenes in any anti Islamic economic activities.

3. It guides State to protect and safeguard public interest through the control on individual freedom in the illegal and non-permitted actions they involve due to which the economic activity of the community and society suffer.

4. Men have no right to possess unlimited wealth and desire to obtain wealth by any means and way he may choose.

5. Right is given to every member of the society by appointing each one as a guardian of the public trust and the ownership is limited for the public welfare and for the betterment of mankind.

Social Justice in Islamic Economics 1. To give-and-take responsibility

2. To keep social balance

3. Prohibits growth in differences that few live in extra luxury and rest were deprived of basic necessities of life and forced to live a life of misery, hunger, without shelter, illness and as neglected class of the society.

Tawhid (monotheism)

TTeerrmmss uussee iinn IIssllaammiicc FFiinnaanncciiaall SSyysstteemmss Ijtehad:

1. Emphasize on independent legal judgment, effort and ability to figure out rules from sources that carry out social justice in accordance with Islamic Economics.

2. Economical and social problems can be solved only through Ijtehad, particularly issues in regard to which, no definite injunction is available in the Quran, or Sunnah.

Ethics

1. It is third element for the enforcement of social justice.

2. Islamic economics considers ethics in relation to human lifestyle or religion.

3. Islamic Sharia‟h defines social justice in Islamic Economic as the pillar of the concept that functions with a valid reason.

4. The concept of Zakat and prohibition of Riba practices in daily life of Islamic society bring the stability, peace, harmony and social development.

5. It gives the real value of Money

6. It defines the state responsibilities for income distribution as the basic principles of social justice


Muslim contribute for Economics

Ibn Khaldun, Muslim Philosopher, Scholar & Economist and respected as father of Economic System of all times, Adam Smith accepted him as the "father," of economics. Authenticated name in Islam for defining different fields of knowledge, specially science of civilization. He contributed theories and concept in economics that placed him above-board in the history of economics thought as a major predecessor.

Planted seeds of classical economics in production, supply and cost

Pioneered in consumption, demand, and utility, the bases of modern economic theory

Believes in free market economy.

Introduced labor theory of value.

Free economy & for freedom of choice.

Analyzed relationship of economic study, which are demand, supply, prices and profits

First to put seed of modern demand theory which was further developed by Thomas Robert Malthusian, Alfred Marshall

Logically role of cost of production on supply and prices

Theory of profit as a reward for undertaking risk in a future of uncertainties

Concept for traders maximize profits, "Buy cheap and sell valued,"

Concept of macroeconomics

“Theory of Growth” based on capital accumulation through man's efforts

Economic Development through Migration

Tax Theory in history

Theory for the best Rate of Taxation

Explain advantages of trade among nations through foreign trade with people's satisfaction, merchants' profits, and country‟s wealth and how all increased.


Chapter 2

Islamic Financial System Introduction & Background

MAN, MONEY & COMMODITY The three factors of production give birth to an exchange system and its practice in the fulfillment of human needs. The concept of money and function, value and importance are clearly defined in Islamic Economic which are using the money by men for a specific purpose to fulfill its need in which the money act into servicing against commodity or services. It is and prohibit of buying and selling money into similar quality by putting the price at a certain fixed rates over and above of the principle amount which is ultimately become the price of the money and money become commodity. Where as money is medium of exchange its value does not change against commodity or services whereas the volume change with the change in the value of commodity or services. When money use for specific purpose, that is either to buy commodity or to pay for the services it exchange the two hands that belong to owner of the money who pay to the owner of the commodity or person whose services are taken by money owner. In this activity if it is commercial activity the outcome of the use of money is that is increase in the principle amount is define as profit which is distributed between money owner the financier and money user known as trader or entrepreneur who uses the money at pre determine ratio on Net Profitability of the transaction. The two exchange system are classified as

1. Lending and Borrowing which is the trading at a price of money. Lending is base on principle amount in transaction by pricing it with the time value without the concept of utilization of money and its impact on economic activity. Lending is normally put into activity money for unstated purpose against the security without going through pros & cones of activity i.e. loan, speculation, betting, gambling ect for which money is spent on. This act gives fixed return either in cash or in the term mortgaged movable or non movable property/properties.

2. Financing and Participation by man with money for commodity or services on a pre agreed share at ratio on profitability. Financing is made available on the basis of Man‟s ability to use the money and to multiply, divide, subtract and add the amount realize through the exercise of money. Financing is joining in the profitable operation (like Commercial vehicle purchase, acquiring business operation etc) for the acquirer with proper verification / validation of data submitted by seeker. In short the financier becomes the indirect partner in that venture with pre-agreed ration and unguaranteed returns.

Historical Background Financial matters in Post Islamic era were commonly practiced on the basis of social priorities and Prophet (PBUH) too was involved in commercial and financial activities considering social obligations in financial matters


It is authenticated by archives of the Islamic world that with the introduction of financing and discarding lending formed the most powerful community development on the basis of social development in first Islamic state under the guidance of Prophet Muhammad (May Peace Be upon Him) in the rule of four Caliphs. Financing system was introduce in the period of Prophet May peace be upon Him with the introduction of the concept of Money in shape of Dharam and Dinnars as the medium of exchange in all commercial activities. The transactions under guaranteed result were converted into appraisal method as pre-commercial method of estimation of result. Rehen (Collateralization) against the use of money was prohibited and Arboon (Equity participation by user of money) was introduce that give the right of money owner to be the partner in the transaction with all the rights and permission to share and act in the transaction was introduce and all the financial products were practiced with collateral within the structuring of the transaction. Interest based system that was dominating 98% of monetary markets till 1980‟s and was controlling the money market with its powerful grip which is titled as the Conventional Monetary System now reduce to almost 55% and it is rapidly reducing and replacing by financing products which is gaining the momentum on daily basis. Financial system derived from Quran, Sunnah and Hadiath has a well defined title that signifies motive and concept of the system as Socio-Financial System.

1. Islamic Finance was practice for the most part in the Muslim world throughout the middle ages.

2. In Spain, the Mediterranean and Baltic states, Islamic merchants became vital intermediaries for trading activities.

3. European financiers and businesspersons later adopted many concepts, techniques, and instruments of Islamic finance.

4. Term "Islamic finance” is relatively new for commercial money market in a sense as it appearing only in the early 1960‟s through a movement that started from Egypt when the first Social Bank was establish to bring the change in the money activities and unite money with ability with propose and period.

5. Commercial or business activities confirming to Islamic principles are made under the umbrella of either "interest-free" or "Islamic Banking which Islamic financial system simply as "interest-free" does not provide a true picture of the system as a whole. Prohibition of receiving and paying interest may be the base of this system, not all.

6. It works on Islamic set guidelines consisting of Risk Sharing, Individual Rights & Duties, Property Rights, Purity of Contracts, Commitments, Transparencies, Fair Deals and Employment Growth.

7. Not limited to banking only but covers capital formation, capital markets, and all types of financial settlement.

8. The philosophical roots of an Islamic financial system originate from the relations of factors of production and economic activities.


9. Conventional financial system deals primarily with the economic lending and borrowing aspects of transactions.

10. Financial system equally emphasizes on the ethical, moral, social & religious proportions for enhancing equality and fairness for an ideal society.

11. It fully appreciates context of Islamic teachings on the work ethic, wealth distribution, social and economic justice as well as role of the state and responsibilities and duties of the citizen. .

12. It is established on absolute prohibition of payment or receipt of predetermined and guaranteed return rate.

13. Pre-agreed/ estimated share of profit or growth had been noticed in the archives, way back to post Islamic era and was practiced by Muhammad (May Peace Be Upon Him), the Caliphs and the Asahab (close associates of Prophet May Peace Be upon Him).

14. This ended the concept of interest and ruled out use of debt-based instruments.

15. The system encourages risk sharing, promotes entrepreneurship, discourages speculative behavior, and emphasizes the sanctity of contracts

16. Basic framework for Islamic financial system is enforcement of the rules for handling of economic, social, political, and cultural characteristic of Islamic societies.

17. The financial contract was introduce instead of agreement and all unwritten terms and condition were disregarded and does not have any legal authentication instead of which terms of conditions have to be pre-agreed, pre-define, clearly understood and undertaking is endorse in presence of two witness. The memorandum is written by third party and it is read in front of two witnesses before it is signed by the partners of the transaction.

DDeeffiinniittiioonn ooff FFiinnaannccee aanndd FFiinnaanncciinngg

1. Finance is an intermediary source having a value to act in production, trading and exchange of commodities, services and assets.

2. Financing is the source that makes the money service for specific purpose within specific period, in between person to person, person to institution or institution to institution with an understanding to share the result in profit and loss.

3. Financing is the source that develops ownership, support entrepreneurship and line-up procurement, production, distribution, utilization through participation and cooperation between skill and capital on the basis of profit and loss acceptability upon the maturity.

4. Financing is the use of money by one who owns it and the other who has the ability to use it for a common purpose to make profit by participation and cooperation.

5. Financing is the act of money without the concept of liability, collateral or the guarantee. Its origin is investment and its end is ownership.

6. Financing is an act of money which is classified as the opposite to lending.


Difference of Financing & Lending

1. Financing is Equity and not Liability

2. Lending is liability and not participation.

3. Financing is made and Loan is given

4. Loan is secure financing is support.

5. Financing is an investment and loan is facility.

6. Loan cannot be financing until it is agreed on Profit and loss sharing

7. Financing cannot be a loan till return is guaranteed.

8. Loan is given at a price of money with the application of Rate

9. Financing ultimate outcome is profit that is being shared in an agreed Ratio.

10. Loan has to be secure by external factor of collateral

11. Financing is collateralize within its own system

12. Financing cannot be made until the user is able to use it

13. Lending is given against the confirmation of guarantee.

14. Lending leads to inflation and liquidation

15. Financing ends at ownership

16. Financing increase the capital base and net worth

17. Lending increase the liability, cost and decrease the net worth.

18. Financing is adjusted through diminishing method through the profit earning.

19. Lending is return back by decreasing the capital of the transaction.

20. Financing is the part of the capital which is protected by making the provision of reserve through the profitability.

21. Lending is cover by using security method, like mortgage on property, lien on paper instruments, charge on commercial assets and pledge on commercial goods in trade.

The world of Money First is Monitory Market where money is bought and sold. In this system money is treated as commodity instead medium of exchange. System which is based on Interest, according to Islamic financial system it is commonly known as a one category of Riba. Second is the Financial Market that emerged on factual and authentic principles of Islam on the guidance of Holy Quran, explained in Hadiath. In this market the money is been served on the basis of capital or by skill with clear understanding of participation in responsibilities, duties, obligations, earning, income, risk and profit sharing.


Basic principles of Islamic financial Prohibition of Riba Any unjustifiable increase of capital through the use of the capital whether in financing, lending or sales is central belief of the system. Any positive, fixed, predetermined rate tied to maturity and amount of principal etc. i.e. guaranteed regardless of performance of the investment is prohibited Risk sharing Interest is prohibited and owner of funds become investors instead of creditors. The provider of capital and entrepreneur shares business risks and shares profits and loss according to the ratio of investment and participation by way of their Capital or Skill. Money as "potential" capital 1. Money is treated as "potential" capital

2. It becomes actual capital only when it joins hands with other resources to undertake a productive activity.

3. Islam recognizes the time value of money, only when it acts as capital, not when it is "potential" capital

4. Money cannot be treated as Capital if it is not in circulation.

Prohibition of speculative behavior An Islamic financial system discourages exhibition of wealth and prohibits transactions featuring extreme uncertainties, gambling, and risks

Transparency of contracts Islam upholds contractual obligations and disclosure of information as a sacred duty. This feature is intended to reduce risk of information and moral hazards.

Shariah Approved Activities Only those business activities that do not violate the rules of Sharia’h qualify for investment. For example, any investment in businesses dealing with alcohol, gambling, and casinos would be prohibited Concept of Finance defines “Interest” as price of money where lender charges borrower pays. Islam accepts that agreement between financier and user to be pre agreed on terms of transaction and fulfills obligations in rightful manner. Transactions encounter difference of opinion, when it starts entering into non transparent acts. Thus it affects relationship and harmony of two parties. In this condition monetary and financial affairs are forbidden.

Salient features of this order

1. Islam clearly characterizes difference between lawful and forbidden economic activities and permits the Muslims to make all efforts for their right in seeking their economic benefits.


2. Islam prohibits financial, economical, social and legal actions, which are morally, financially and socially damaging to the community life.

3. The Islamic financial system employs concept of participation in enterprise, utilizing funds at risk on a profit-and- loss-sharing basis.

4. It implies Careful investment policy, diversification of risk and careful management by Islamic financial institutions.

5. Potential profit in proportion to the risk assumed and to satisfy conflicting demands of participants in the current environment and within the guidelines of the Shariah.

How Finance is Appraise Financing appraisal is base on straight line method. It does not work on simple paper presentation but on factual findings with clear declaration of facts and modes operandi of the transaction for which a 12-P Formula is recommended as perimeters of financial appraisals

12-P Formula is pre-financing activities

1. Person who is financing to whom?

2. Purpose for which financing is work out?

3. Project for which financing is required?

4. Period for which finances to stay as financing?

5. Product that develop through financing?

6. Process to be use for financing?

7. Price is the volume of finance require?

8. Place locations where finance shall be utilize?

9. Participation, relationship and responsibilities of financier and user?

10. Pact terms and condition of financing between parties of financing?

11. Professionalism ability, experience, knowledge and expertise in purpose?

12. Perfectness in Performances?

13. Profitability by the application of twelve “P” formulas which is the RISK base

perimeters


Chapter 3 Riba- Profit & Interest

Introduction & Difference Almighty Allah clearly defines principles and means of goods and services, weight and measurement, time and period, increase and decrease, profit and loss, buying and selling, giving and taking, efforts and lethargy, success and failure, defeat and winner, richness and poverty, knowledge and ignorant, civilized and orthodox, traditions and customs, morals and ethics, transparencies and ambiguity, keenness and malice, honesty and fraud, crime and punishment, reward and penalty. Performance in the man‟s daily life is define only and only in the will of Almighty Allah for which the holy books are given to mankind and the messengers is sent to explain the evil and sins, the losses and distraction and the health wealth and happiness of mankind. For the betterment of humanity Allah have define the limits of everything that the men have in this daily life. Men have given unlimited power through achieving knowledge and store in human mind and act according to an organize system that is clearly explain in Holy Quran, Hadiath and Sharia‟h. Almighty Allah prohibited any object or any act that is harmful to humankind that creates instability, bring injustice, become injurious to human life and considered as unconstructive to Socio Economic System. Riba is an Arabic word drive from word RIBH which means Profit. It means excess, increase or addition in accordance to the Islamic guidance for commercial and business practices and correctly interpreted according to Shariah terminology as Profit. Riba is any earning, income, profit or benefits being earned, taken or received through wrong means, bad intentions, shady practices or wicked participation. Such earning, income, profit or benefits are classified as RIBA. Such earning, income, profit or benefits are not only treated as immoral, unjust and filthy but furthermore threat to socio economic life of society. Such earning, income, profit or benefits leads to crimes of various nature, cruelty, exploitation & self-importance.

Riba is as a combination of evil and sins. Riba is bad practice to earn & gain. Riba is the cause of social, cultural, traditional, financial and legal and commercial turmoil‟s

Holy Quran Al-Baqarah 2:275-6 People who indulge in Riba shall be raised like those who have been

Driven to madness by the touch of Devil. That is because they say that Riba-based transaction is just like trading, while Allah has permitted trade and prohibited Riba. Hence those who have received the warning from Allah and have stop accordingly, may have what has already passed, their case being entrust to Allah but those who

revert to Riba-based dealings, shall be the inhabitants of the hell-fire and abide therein for ever.

(You must know that) Allah deprives Riba from all blessings and blesses charity; He loves not any ungrateful sinners.


Al-Baqarah 2:278-79 O you believers!

Fear Allah and give up Riba that remains outstanding if you are true believers. Watch out! If you do not obey this directive, then Allah declares war against you from Himself and from His Prophet. But, if you give up your outstanding Riba, then you can claim your principals. Neither should you inflict harm with Riba to others, nor should

others harm you. Hadiath reinforce concept of Riba in Holy Quran, The Prophet Muhammad (May Peace Be upon Him) Said: "There is no Riba except in loaning." (Nasaee 4504)

"Verily Riba is in loaning." (Muslim 2991)

"There is no Riba in hand to hand (spot) transactions." (Muslim)

At the last Pilgrimage, "All of the Riba of Jahilliya is null and void. In this respect, the first Riba I (May Peace Be Upon Him) withdraw is the Riba that the borrowers owe to my uncle Abbas; it is cancelled completely. (Muslim) 3 See Shafi (1996). The Prophet (May Peace Be upon Him) cursed all those who take Riba, who give Riba, who write a Riba contract and the two witnesses to a Riba contract. He (May Peace Be upon Him) further said: "They are all alike (in fault)." (Muslim 2995)

Riba in Financial Affairs

1. Riba must be eliminated from the financial transactions.

2. No thing is more horrific as compared to Riba that Islam has prohibited.

3. Nothing is more dreadful than Riba, is remains in widespread threatening socio economic activities in both theory and practice.

4. Riba convert financing system into lending system that make the money as a commodity and owner of the wealth, a seller and user of the same as buyer.

5. Riba does not justify money to be a medium of exchange and brings the love of money instead of respect for the money.

Interest When money become a commodity and bought and sold with guaranteed results of profitability or increase in volume of money being used for the transaction, such increase is the price of the money and this price of the money is classified as Interest which is the part of Riba. There is confusion in understanding for the terms Interest & Riba (Usury). The question arise “Interest is Riba or Riba is Interest”? To make a distinction of terms with rational reasoning, Islam through definitions and


interpretations, provides in Holy Quran and Hadiath, Riba is clearly explained where Interest is define by the scholars. Abul Ala Maududi,

Interest is an earning through lending on money by lender from borrower on condition that lender shall charge a fixed amount of money in addition to the principal.

Interest is prohibited in Islam and people are not allowed to make money by lending their capital on interest. Capital is to be invested in productive manner that increases

the profits. Keynes western economist defines

"Interest has nothing to do with influencing volume of savings. Practically it is rate of return on investment that determines rate of saving”

“Aristotle” Greek researcher & philosopher define Interest in his book

“Money & Politics”. “Interest is an artificial profit, which does not enter in legal trading. Using money as a

commodity is selling, just a forged artificial transaction. Money has to be used as a means of sale and purchase and a measurement of a commodity to be sold or

purchased. Money is just a means to ascertain value of commodity and it cannot be sold or purchased within similar quantities”.

Definition of Interest Any amount, earning or income that is taken over and above to principal amount, without any risk, efforts, activity, without loss sharing and the return is guaranteed within a specific time is called interest. The compulsory return, income, earning on a fixed term & fixed percentage, upon principal amount, is an Interest. Interest is the price of money whereas money is just an intermediary between exchanges of transaction. There are many categories of Riba. Interest is one of the categories of Riba. Prophet Moses (May Peace be upon him) TToorraahh 2222nndd vveerrssuuss ooff tthhee ““EExxoodduuss”” If you lend money to any of my people with you who are poor, you shall not be to him

as an exact Riba from him.” Deuteronomy verse 23rd

“You shall not lend upon Riba to your brother, Riba on money, Riba on virtual, Riba on anything that is lent for Riba.”

Leviticus 25:35 "'If one of your countrymen becomes poor and is unable to support himself among you,

help him as you would an alien or a temporary resident, so he can continue to live among you.

Judaism

Inn several Biblical passages in which the taking of interest is either forbidden discouraged or disliked.

http://bible.cc/leviticus/25-35.htm


Roman Catholic Church In fourth century AD prohibited taking of interest by Church Scholars. In the eighth century under Charlemagne it was declared usury to be a general criminal offence. Anti-usury movements gained momentum during early middle ages and reached its peak in 1311 when Pope Clement V forbade on usury absolutely and declared all secular legislation in its favor, null and void ((TTiimmootthhyy 66::1100)) ""TThhee lloovvee ooff mmoonneeyy iiss tthhee rroooott ooff aallll eevviill.."" Ancient Hindu Religion Vasishtha, a well known Hindu law-maker made a special law which forbade higher castes of Brahmans (priests) and Kshatriyas (warriors) from being usurers or lending at interest. Vedic texts of Ancient India (2000-1400BC) Jatakas, (600-400 BC). Usury is referred in a humiliating manner: “Two-Faced elites accused of practicing Usury”.

Islam for Money Matter

1. Riba does not justify money to be a medium of exchange and develop the love of money in several ways that disrupt the entire system of mankind.

2. Islam stresses a respect of money by disregard lending and borrowing and guide to financing on participation by uniting money and skill as equal in effort and utilization and value.

3. Islam guides the point of origin and limit of destination of monetary transaction.

4. Islam defines duties and responsibilities between money owner and money user.

55.. The combination and participation of money and effort brings the result which is share according to the pre-agreed terms of understanding is the creation of Profit

DDeeffiinniittiioonn ooff PPrrooffiitt Income on financing is determined not on financing amount, but takes principal amount, cost of transaction and applicable fee & charges as a part. Profit is the aim of financing and loss is “acceptance”. Appraisal, Precaution, Trust, Confidence, Experience, Knowledge, Purpose, Will and Sprit are business ethics that result in realizing profit on the transaction. Profit is an amount appreciates over and above to the principle amount of investment on the basis of profit and lost sharing between the two participants of the transaction upon the maturity as gross return. This gross return over to the principal amount of investment then be deducted with applicable and agreed fee, expenses and charges which is classified as the cost of the transaction brings out Net Income on the transaction.


The Net Income which is to be shared in an agreed ratio instead of confirms and guaranteed rate is the Profit. Profit is share in ratio and not divided in rates applied on principle. Now the question? If Interest is eliminated from monetary system, would it be possible that system & transactions would become transparent and clear? Answer is simple and straight: “Filth remains in its hard and powerful grip irrespective of other factors”. Interest alone cannot be eliminated without eliminating categories that fall under term called Riba.

Acts of Riba to earn, gain or benefit Some of the categories are mentioned and clearly defined in Islamic Economics. Islam strictly prohibits these as well as society disregards them due to their dreadful effect on social, moral, cultural, economical, financial and legal life styles of the society. The main classes of RIBA that develop earning in wrong means and disturb the natural system of economic activities as well as eliminate the social justice in gaining and distribution of the unlimited resources that ultimate give the birth of an economic concept of Resources are limited and wants and needs are unlimited. These acts that make money into Riba earning are as follows:-

1. Exploitation by taking advantage of status and position,

2. Irregular weight & measures for profitability,

3. Wrong declaration for higher return,

4. Transaction under misconduct (misbehavior),

5. Crime & Law breaking,

6. Mistrust and commit a breach or false commitment,

7. Manipulation of affairs for benefits at a cost and efforts of other,

8. Gambling in all form,

9. Promising to secure the benefit by covering honorable, nearest, dearest

10. Falsehood and Lies

11. Betting and gambling

12. Speculation, assumption, baseless information,

13. Trading in commodities prohibited by Islam and law of the land,

14. Income from the practices or activities that are prohibited by Islam,

15. Breaking and abuse of state law for self benefit or for any purpose that is declared as punishable act.

16. Disobedience to the state law by declaration and submission of wrong information for self-benefits.


17. Disturbing the peace of community by using force, like strikes, processions, lock-up and wheel jamming act for any purpose for seeking rights, benefits, political and religious mileage that stop the economics activities and deprive earning opportunities of individuals.

18. Committing and involving in the illegal acts.

19. Interest that is the price of money taken in cruelty, exploitation, wrong means, false declaration, and advantage based on weak or wrong calculation,

20. Taking and giving return on loans or fixing amount without appraising the use of funds that are given to user. E.g. treating money as the commodity and fixing a price through application of rates on principle amount in use.

21. Keeping deposit with person or institution having involved in Riba practices,

22. Using deposits as investments and declaring non-transparent results that lead to discrimination of sharing in accordance with investment percentage,

23. Holding and storing of currency that affects economic activities negatively.

24. Holding commodities that lead towards scarcity in the supplies against market demand.

25. Monopoly and monopolization of activity, transaction and business to taking sole benefit, stopping the growth of employment and earnings

26. Grabbing the wealth through unfair mean and applying brutal methods.

27. Illegal encroachment on the property that is not owned by encroacher. For example, construction of Masjid on the property that was not purchased, gifted or legally transferred to title made,

28. Using public money for luxuries and self-usage,

29. Misusage of rights belonging to minors, orphans, widows and women,

30. Misappropriations among share division on inherited wealth,

31. Miscalculation of share for inherited wealth under law of inheritance.

32. Any activity of acts that damage the physical and natural charm of women and make women a tool for commercial viability.

33. Income by power and cruelty,

34. Misuse of power and status,

35. Theft & Robbery,

36. Smuggling,

37. Adultery (disloyalty),

38. Human trading,

39. Pressurizing and influencing of earning situation and taking benefits.

40. Misuse of public representation and obtaining self benefit through this status and using the representation in wrong means.


41. Misuse of ownership right on the commodity by charging over and above the prevailing price, furthermore, avoiding payment to state, that is its right toward revenue, by hiding the earning to such transaction.

42. Premium on commodity for extra benefit by not declaring the transaction as legal earning or fair means like.

43. Abuse of labor by employer and wickedness of labor in fulfillment of assignment for which fee, wages and commission is agreed and paid.

44. Abuse of right assigned for child and women.

45. Earning through selling, trading or dealing in commodities and act that are harmful for human life and community.

Above classes differentiate between status of Interest vis-à-vis Riba

Fundamental Facts on Riba Basis of Islamic thoughts conflict directly with the Riba based system. As “No Islam exists in a place where there is Riba based system”.

1. Riba based system is a misery not only on humanity, faith, morals or imagination of life, but also in every core of economic and practical life.

2. It is the most hateful system, which eradicates human satisfaction and frustrates its civilized and neutral developments.

3. Islam has complete ethical system supported by realistic system as interlink.

4. Ethics & reality cannot be separated in Islam & cannot be practiced alone.

5. Islam has clearly stated benefits of following of ethics and reality that followers follow in daily life.

6. Successful Islamic economics does not rise without Ethics which cannot be separated to reality of life and its rational approach.

7. Practical life of people cannot prosper without proper ethics.

8. Riba practices corrupt the individual‟s ethics, behavior, and feelings towards community and the society.

9. It also corrupts the human life, culture and the relationship by spreading the spirit of greed, selfishness, sneakiness and gambling in general.

10. Today investing capital on minimum risk basis over guaranteed return is commonly practiced including funds as deposit, invested on no risk with guaranteed return.

11. Interest is paid at lower to the depositor‟s investment and higher to investment managers and shareholders.

12. Money lent to somebody on higher return or interest does not grow useful projects but seeks the most lucrative opportunity even if profit comes from the lowest nature and the meanest tendency.


13. Islam is a connected system; it prohibits the dealing with Riba.

14. It also defines all its systems based on providing the need to it.

15. It organizes the aspects of social life on giving out means of dealing without touching growth of human, social & economic development.

16. A true Muslim should have a firm belief that whatever Almighty Allah has prohibited, can develop human life in better and fair way.

17. It must be kept as a firm belief to restrain from false and evil acts for the betterment of life with its development and growth in harmony.

18. Almighty Allah is the Creator of this life and makes man, custodian to all the blessings for humanity.

19. Mans determination towards the Almighty Allah overcomes all and guides the man to the right path.

20. It is also impossible for the Muslims to raise the community in prosperity or the perception that wickedness can show the way to advancement, going against the prohibitions of Almighty Allah.

Riba Al Nassiah

Riba al Nassieah practiced before Islam as man paying his money to another for a pre agreed period.

In return, he took from him a certain amount every month without taking the principal amount.

When date of payment came, he asked him for his capital and if he was unable to repay would increase in his fund and the term of repayment.

Riba Al Fadal

1. A man sells an article in exchange of another article having same quality and nature with an increase or decrease like gold sold for gold, rupee for a rupee, corn for corn and barley for barley.

2. This kind is considered as Riba, as commodities are similar to each with different values not ascertain.

3. Such transaction has the involvement of exploitation and injustice on any one‟s part of the two.

4. Riba system emerges initially on a rule that there is no relationship between the determination of Allah and the life of man.

5. Riba creates the false feeling in the mind of men that wealth ownership would bring the power to become the master of this earth. It instructs the men to not to get bound by a pledge himself from Allah and to ignore the importance of following the commandments of Allah.

6. Riba establishes a feeling of liberty among humans for ways and means of obtaining wealth, encouraging to adopt more unfair means to multiply it.


7. Riba provides an individual a feeling that he is free to enjoy his wealth without abiding the contract of faith and trust in Almighty Allah or obeying any condition as holder of wealth, for which he is not bound to keep the interest of others.

Gharar is uncertainty, hazard, chance or risk and technically it is sale of a thing which is not present at hand or the sale of a thing whose consequence or outcome is not known or a sale involving risk or hazard in which one does not know whether it will come to be or not. Such as fish in water or a bird in the air which are dishonesty through ignorance by one or more parties to a contract. There are several types of Gharar, all of which are Haram. The following are some examples:

1. Selling goods that the seller is unable to deliver

2. Selling known or unknown goods against an unknown price

3. Selling goods without proper description

4. Selling goods without specifying the price

5. Making a contract conditional on an unknown event

6. Selling goods on the basis of false description

7. Selling goods without allowing buyer to properly examine the goods

8. Gambling is a form of Gharar because the gambler is ignorant of the result of his gamble


Chapter 4 SAVING AND SAVING CONDUCT

Saving leads to investment through participation and goals in the Islamic financial System in spreading the saving awareness and developing it Saving, investment and participation is an individual decision which change into profit and loss sharing in economic activity that leads toward socio-economic development.

1. Saving deposit is a decision that is taken by an individual.

2. Saving is a part of income that is kept aside for spending to a later time.

3. Islamic Finance gives particular importance and care to saving deposits. .

4. Reasons that encourage taking decision for avoiding un-necessary spending of income and use saving for better purpose.

5. Saving distinguish a commitment that define individual of realizing his own interest and the betterment of economic activities.

6. Islamic Financial System defines a way to saving funds.

7. Saving is employed according to the requirements and means of incentives that give individual to practice saving application.

8. It do not neglect individual and guided to lead his saving motives as a caution to ensure safety for him for future.

9. It rises to the individual standard of living.

10. They caution towards wastage and guide to make profit.

The cross road Saving is one of the qualities of the member of healthy and welfare community. Saver do not spend wastefully in regards to what he receive funds in his hand. Saving Conduct is the saving for future of community for common goals. To apply the directives Islam called for in Holy Quran IX, 34 Chapter the Regret means:

And as for those who store up gold and silver and do not spend those in Allah’s cause

announce to them a painful destiny.

1. Islamic Financial System do not neglect saving motives of saving.

2. It does not stick on to Islam and nature of human beings and their character.

3. It makes clear to individual step by step as when he makes his saving interest.

4. It exercises a practical devotion of worshipping.


Savings operations in Islamic Finance 1. Do not differ with conventional that system that focus all efforts on class of savings.

2. It does not care about size of savings that is conventional system practice of discourage savings which are below a minimum limit.

3. It stresses on the continuous and timely investment savings that are collected in any size of amount.

4. Islamic System emphasis on benefit for the community and does not remain to make profit at all ways through funds colleted.

5. It cares saving conduct and not the individual interest by guiding the ways and benefits of saving.

6. Saving and Spending is the social conduct and un-necessary saving is discouraged and moderate spending is encouraged.

7. Saving is a part of broad Islamic Financial System and provide individual to take part in shaping its individual character to adapt himself for welfare of Community as a whole.

8. More saving activity becomes a habit; it expands large number of community balance to community requirements and increases community in becoming strong and number of needy persons decreases.

Is Conventional system of saving is better then Islamic System for Savings?

1. In their ability to attract savings by offering interest on savings rather Islamic system does not offer any interest

2. Risk free investment

3. It is easy to investment in any form of currency and in any product or services.

4. Verity of saving products that gives a choice to saver to save.

5. Inter-lending support in investment of savings

6. Multi currency conversion of saving funds.

7. Saving on the basis of earning on compound interest return increases the volume of saving returns and it is the attraction and temptation.

8. Saving in conventional system do not need obligation on declaration of details of saving results by saving managers

Islamic Financial System 1. Restrict saving to be invested in illegal form.

2. Compounding of saving return is prohibited.

3. Savings are invested on Profit & Loss Basis.

4. Restricted saving products are available to the saver.

5. Limited numbers of financial institutions operating on Riba free.

6. Saving cannot be invested in prohibited products and practices.


7. Savings results are transparent, short tenure and with clear understanding of Profit & Loss.

8. Human ego avoid pain whenever it finds the way to that.

9. Conventionally it is found that savers have higher participation in investment and lesser in receiving in return.

10. Savers are less important in saving operation whereas the savings are the real players that generate the interest.

11. Conventional system restrict higher ratio of saver on the saving return and allow higher return to the saving fund operators.

12. Besides social and educational effects for spreading saving conduct, are there are economic reasons in which Islamic Financial play great notice to spread the saving conduct.

13. Voluntarily an individual savings is a part of individual‟s income for which he temporarily postpones his spending.

14. The saving he made help in financing the economic activities for socio economic development.

INVESTMENT There are common apprehension & economic principles which can be taken as guiding rules of the Islamic Financial System for investment. Saving leads to Investment

1. Rule of Profit & Loss sharing is Participation.

2. Loan leads to seeking price of money that increase in capital.

3. Financing is made on principle of safety for capital and obtaining profit.

4. Expenditure is deducted from profit and not from capital.

5. Profit which can be distributed is net profit and not gross profit.

6. Islamic Financial System allow participation in Joint Stock Companies or Limited Liability Companies from its accounts or can participate in a part of the capital of existing companies

7. It implies financing the working capital in the projects for short term financing on the basis of participation which is not the lending on interest, but made on profit and loss sharing on Net Earning on investment.

8. Legitimate participation is a way of seeking profit through money from the money owner and work close of participator at a common purpose among each participant for earning profit.

9. Riba Free Financial House can may be the money owner and saver the participator or vice versa.

10. The Riba Free Financial Houses are permitted to be a participator from employer to re-participate with the previous participated funds on a Profit & Loss basis.


11. The Riba Free Financial Houses can be the second participator if it receives participation from the first participator.

12. The Riba Free Bank may be the second participator if it receives participation from the first participator.

13. The Riba Free Finance House as money owner bears loss alone as long as the participator does not exceed his role.

14. If the Riba Free Finance House works as a participator it does not bear loss as is sufficient that the Riba Free Finance House‟s effort and work are of no return.

15. It is allowed that the profit between money owner and participator is pre agreed. But if it is determined sum of principal amount of money with the condition of no loss then participation becomes null and void.

16. Riba Free Finance House can trade its funding precious stone and in foreign currencies on its conditions written down in the exchange contract.

17. Investment in financial securities is only valid in shares and not in debentures.

In Conventional System traditions do not approve the Finance Houses or the lenders to perform investments by it whereas Riba Free Finance House

breaks the tradition in three stages. Firstly Rule to be known that every person is taken by his words. Allah‟s word revealed in written form and by traditions of Prophet (May Peace be upon him) as considering Riba Free Finance Houses and their systems are the blessings and in purity which cannot be break, provided these are followed in according to its pure soul and every person that need or participate with such houses and institutions have qualities that benefit both in unlimited ways through ability and capabilities that combine with the money. Secondly With no doubt Finance Houses with their present forms and existing functions rose up in response to different environments and non Islamic philosophies in their present form and they serve these environments which are not necessarily convenient for serving Islamic communities in achieving the Rules approved by Almighty Allah Thirdly 1. Riba Free Financial System guide to perform direct investments or financing by

participation and stop all practices of other nature that deviate to its system.

2. In case if continues its operations in style of usurious banks and follow the lending of saving funds by covering its administrative expenses from these funds, this damage the investment and create a difference between the two system.

3. Financing by participation means sharing Investor (bank‟s) capital of productive project becomes a partner in the ownership project, partner in management, running and supervision and partner in all what it yields from profit or loss according to proportions agreed upon.


4. The Investor (bank) can sell its share to a limit restore only the price agreed upon in the selling contract either it is less or more than its capital.

5. Justice must be secured and there should not be exploitation as in the case of loan at interest where the lender obtains all its capital completely with an increase in its capital equal to the mount of interest either the project which borrowed makes a loss or profit.

6. Participation should exist on joint liability between the financier and the financing in case of loss and in case of profit.

7. Financier or Islamic Bank is a partner in the financing on the condition to accept loss or profit as the condition of participation.

8. From here comes the glorious reference and great wisdom, thus this participation in the two cases (loss and profit) obliges the two partners (every of them) to make the project prosper, and to do every effort to supervise it to participate in its success and therefore the efforts of the two partners should be faithfully directed to its development

PARTICIPATION Participation operations lead at the end to an ownership that is applied in projects or transactions. Islamic Financial System through its Banking System contributes in solving the problems. 1. Diminishing participation that ends at ownership of any one partner of the

partnership in the transaction. 2. In participation were the financer or bank gives the partner the right to replace it by

ownership. 3. It is either at once or in parts according to pre-agreed conditions on a basis of

organized arrangement by keeping a part of income as an installment to repay financing.

Method of diminishing participation

1. Entrepreneur presents the project to Financier.

2. Financier sees its viability of the project.

3. Financier finances as the partner of the project.

4. Entrepreneur pay through earning of profit in parts.

5. If entrepreneur owner keeps it ownership to him, the profit is distributed between financier and entrepreneur according to the proportions agreed upon.

6. In case entrepreneur pay the financing either at once or in installments financier has no right to obtain any privilege because of the increase in prices.

7. The financier or bank invest in project with the capital and therefore it is treated as a partner in the transaction either equally or in part and any change in value of the transaction the working partner has always choice either to sell and earn profit or buy himself according to market price.


8. In hire selling method the financer has to participate in construction on the land then rents the housing units.

9. The land owner pays the ownership and rent and finally become an ownership to its hirer after a period of time.

10. Rent installment includes a calculated part of costing.

Rules for the participation which financier follows with partner in project or in transactions.

1. Each participation transaction is under a contract and conditions that specify investment and profit in proportion of each partner and instruct two matters:

2. First: The participator should keep accounts for the business operation.

3. Second: The accounts of the participation transaction should be checked by the expert accountant to approve their results.

4. Islamic Finance has a social target.

5. Participation in the course of financing for the purpose is to enlarge economic base and to open doors for all who wish for work in production, distribution and services.

6. For small worker who needs a small financing forcing him to keep accounting books is asking him impossible act which could makes him reject financing.

7. Keeping accounting books and auditing exceed the value of the financing.

8. The expense of this checks are treated as the cost of the transaction.

How financier determine profits on investment First stage: Every participation understanding determines the share according to the rules of participation contract. Second Stage: By preparing Profit & Loss account of investment operations and determining the portion resulting from participation transactions and from the results of investment projects which the financier operates alone. Third Stage: The distribution of net profit and loss of investments among the group of investors and the financier or bank and everyone according to his share in investment, as the shares with a sum of its funds in transactions. After that it is distributed among every one of investors.

Profit portion of every investor from the profit determined

1. Every investor obtains his portion of profit according to pre-agreed terms as regards to investing operations.

2. By mixing of total fund participated or deposited by the investor in the bank to the time of investment:

3. The profit is only shared for the period in which the funds are being invested.

4. Mixing of fund that forms the capital of the transaction leads to a fair distribution as


regards the share of investors from profits distributor.

Is it possible that the result of investment is a loss There are chances that the fund managers (Islamic Bank) for the sake of eliminating the possibility of loss from investment operations. Keeping such possibility there are ways to keep investors secure and in banking provisions are made for the purpose of safeguarding such possibilities by way of.

1. Technical pre- study of the investment projects before their execution.

2. The qualitative and geographical distribution of investments is kept as important to the pre-study.

3. The refusal of conditional investment in a certain project that has whole operations of is a distribution of risk.

4. Formation of appropriate provisions and reserves

Forming appropriated provisions & reserves.

1. Provision or reserve is a part of profit that is put aside to encounter probable loss or to strengthen the financial standing.

2. The reserve is of the right of the profit owner from which the reserve is deducted.

3. Reserve or provision made to encounter losses and are deducted from investment profits before distribution.

4. Reserves are the right of investors and the bank (participators) together.

5. Investor is not a permanent and may finish his participation is a natural matter.

6. Casual problem is seen on withdrawal but it could be overcome with in-build system of diminishing ownership.

7. In order to investment operations without disputes, the bank make a reserve or an investment provision from the proportion the bank charges in return for its efforts and for managing investments.

8. Therefore this reserve is employed to encounter any emergency and the balance is still be owned by the bank.


Chapter 5 Riba Free Mode of Financing

MODARABA

Modaraba –Commenda- Qarad the three distinct concepts appropriate for Riba Free Economic Activities. Three names with an ancient background of transactions used for economic activities classified as business activities under a contract of “Money and Ability”

The owner of money is the financier and called as Rab-Al-Maal and the worker is called Modarib (entrepreneur)

Commenda is a pre-Islamic word from Italy

Qarad It is a Hegari word generally found in Imam Malik‟s and Imam Shafei‟s schools of thought.

Modaraba It is of Iraqi origin and found mostly in Imam Abu Hanifa‟s and Imam Ibn Hambal‟s schools of thought.

According to Fuqaha Modaraba is a partnership contract between two parties, persons or organizations in which one brings the capital and the other shares his time, efforts, expertise, capabilities, experience, knowledge and skills for a specified project or transaction. Upon the maturity, profit is shared according to the pre-agreed terms, which will in ratio at equal or according to participation in transaction. The capital of the transaction is the financier contribution in shape of money which is capital in material and it then associates with human efforts which is capital in virtual. Profit is share from the Net Profitability and Management Fee is the right of Modaraba which is taken out from Gross Profit and treated as cost of Modaraba transaction. In case of loss the Rab-Al-Maal (financier) looses the capital investment and Modarib (skill) loses its time, efforts and reputation. There is no management fee for Modarib and all the capital assets of the transaction become the right of the Rab-Al-Maal (financier).

In Islamic jurisprudence Modaraba is a contract between persons, between persons and institutions, and between institutions, through which finances are given for trading or manufacturing purpose. Profit sharing is agreed upon beforehand at a predetermined ratio and not the rate. In case of loss, the financier loses the money used to finance and the worker loses his time, efforts and talent. Islamic jurisprudence show the legal demonstration in accordance with the Quran, Hadiath, Sharia’h of the Prophet (May Peace Be Upon Him) and the practice of Ashab (companions of Prophet May Peace Be upon Him).

According to Modaraba practice in post Islam era the concept of financing was develop and lending was considered as buying and selling of money under guarantees and promises which put the transaction into a kind of exploitation on the basis of wealth.


The collateral is the human capabilities which are above to the value of money as loss of money is recoverable, where loss of time efforts and reputation that Modarib suffers in case of loss which cannot be recovered.

The Four School of Thoughts IMAM ABU HANIFA He was flexible on the conditions of Modaraba and consider as the authentic among other three schools. He was a trader and made several transoceanic voyages in connection with trading & preaching. He faced countless problems of hardship of traveling; Imam Abu Hanifa‟s justified the flexibility in certain conditions. His teaching on the legal framework of Modaraba is treated as the most rational approach. Imam Humble School has the identical conditions with Imam Abu Hanifa‟s school. IMAM MALIK and IMAM SHAFEI The two were more rigid in terms of the limitations of economic activities. They had adhered to the Sharia’h rules theoretically. The Four Imams agreed on certain conditions and differed on some. But all have guided Modaraba as the Financing on the basis of Human skill‟s as the base of the transaction and confirm Men as the human capital in the transaction and the prime assets that ranks above to all fixed or current assets of the transaction,

As the Modaraba mode penetrated in the economic activities and Sharia’h accepted the mode, scholars laid down Modaraba conditions & rules. Though rules and conditions of Modaraba are in accordance with the teachings of the Holy Quran and Sunnah, different scholars have interpreted them differently.

The History of Modaraba reveals that the business under the concept of Modaraba was in practice before the rise of Islam, emerging from Italian city of Rome, which was the center for trade and culture in the Christian world. When Christian traders entered the Arab world, they chose Baghdad as the place for business. As a capital of Iraq, Baghdad was the center of trade, education and culture. Business communities of Iraq acknowledged the Commenda mode of business and started practicing it. Iraq developed the system and named it Quard, which spread in the Arab and Persian world, and eventually penetrated to all places where the religion of Islam reached, either through traders or by the Muslim conquerors. Credit goes to Islam in the developing a proper shape for the concept of Modaraba by prohibiting Riba in financial dealings. The Holy Quran says: “Whereas Allah permitted trading forbid Riba”. The Prophet Mohammad (Peace Be upon Him) left on a trading trip to Syria and used Modaraba method by making a contract with Hazrat Khadija Al Kubra, who financed the transactions before the Prophet Mohammad (Peace Be upon Him) married her. Therefore, Modaraba is treated as Sunnah Al Ijma.


The Great Fuqaha (Religious Scholars) explained:

Modaraba on Quays which is fixed return or wages is not allowed. The reason for this is the unknown salary for an unknown activity.

Al KASSANI says Modaraba becomes invalid if it is on the basis of Qiyas as it involves an unknown salary for an unknown amount of work. Qiyas is only allowed in accordance with the teachings of the Holy Quran, Sunnah and Ijma. IBNE TAYMIYA Modaraba is valid on the basis of Qiyas. Fuqaha had invalidated Modaraba on the basis of Qiyas (wages). IBNE GHAZI says Modaraba is permissible as an exception to Gharar (fraud) and unknown remuneration

Modaraba falls in the partnership type of contract, which has a vague similarity to Mufawadah. It differs because money is the main objective in Modaraba and work in the second. Rab-Al-Maal (the financier) does not have to take an active part in the daily operations as in the case of employment. There will be no return for Modarib if a profit does not result in the transaction. In case of loss Rab-Al-Maal has the right to investigate the cause of loss, whereas, in case of any negligence or misappropriation or a purposeful mistake by the Modarib, financier can claim the financing. Al-Baghi‟s definition “Money that can be fructifying through work should not be lent for higher return, but can be traded for generating a profit”.

Reason for prohibition of Modaraba by way of Quays is invalid with genuine reasons as in participation type of transactions the parties of the transaction are the partners and any salary or on the wages does not justify as such transaction are base on equity participation, profit and loss understanding and share of profitability according to ratio of involvement through money or ability and the terms of transactional return are pre-agreed and pre- define in the memorandum of understanding of the deal.

Modaraba Formation with Restrictions & Permissions

1. Only money in shape of Dirham, Dinars, Rupees, Dollars or any other currency is used as a medium of exchange in the Modaraba mode.

2. Commodity in exchange of another commodity (i.e. barter trade) is not permissible. On the other hand, Modaraba contract cannot be established with just anybody.

3. Experience, knowledge and skill of related business processes are an essential condition of the contract.

4. Return on financing with a condition of profit & loss sharing is the legitimate and allowed by Shariah.


5. There is no harm in investigating the cause of loss in Modaraba.

6. Modarib bound to provide justification to the satisfaction of Rab-Al-Maal on loss.

7. In case of any dispute over the causes of a loss, the jurists permit the arbitration clause in the agreement.

8. Capital is the soul of Modaraba and it should be in the form of currency instead of a commodity.

9. Currency is the origin of price and value of goods. The Market value of currency does not change that is why almost all Fuqaha had invalidated Modaraba with commodities. The currency should be the currency of location of Modaraba of transaction.

SAMARKANDI has given his views that capital should consist of consummate value. Here is the reason: “Modaraba transaction with paper currency is permissible. Even gold, silver and precious metals are not permitted for the capital of Modaraba” This condition is explained an example as Superior quality dates presented to Prophet (Peace Be Upon Him). These dates obtained in exchange with inferior quality dates. Prophet (Peace Be upon Him) refused to accept the gift and asked to return the superior dates to its original owner. Prophet (Peace Be upon Him) stressed on sale of inferior dates, first. Then, with the amount received from the sale of the inferior dates, superior dates were to be purchased. When transaction was completed, quantity was lesser then it was before.

10. Accordance to Prophet‟s (Peace Be upon Him) a commodity cannot be the capital of a Modaraba contract.

11. As far as coins are concerned, their restrictions are due to involvement of metal, which is also a commodity.

12. Any commodity should be exchanged with another of the same quality and the same quantity, or it has to be bought through a currency that acts as a medium of exchange in the economic affairs of Islam.

13. Islamic economics does not treat money as a commodity. All the Four Imams have forbidden Modaraba between coins and commodities

14. Metal Coins too cannot be the capital of Modaraba as coins are restricted due to involvement of metal, which is also a commodity.

15. Commodity must be exchanged by another of same quality & quantity.

16. It has to be bought through a currency that acts as a medium of exchange in the economic affairs of Islam.

All Four Imams forbidden Modaraba between coins and commodities and with this clarification, it is set that the capital of the Modaraba must be in currency and not in coin form and the most preferred form of currency should be paper because it establishes value that is easily traded and the market value is infrequently changed. 17. Liabilities cannot be the capital.

18. Return on capital is not guaranteed.

19. The capital of Modaraba should be deposited in cash with the Modarib in full trust


and confidence

20. Modaraba becomes invalid if the return of finance is guaranteed.

21. It should be of known in quality and quantity.

22. Ignorance leads to differences and disputes.

23. Profit Sharing should be at maturity of transaction.

24. It should not be paid in parts before the maturity of the transaction because payment might exceed the share and any one of the two partners might devour all the profit.

25. Modaraba is only achieved through participation because of profit & loss sharing contract, based on justice and trust among the partners.

26. It is not justice that all profit goes to one and other suffers.

27. Modaraba transaction cannot be roll-over, extended or re-validated under same contract. Any changes in the contract condition nullify the Modaraba contract.

28. Modaraba nullify immediately upon the creation of any doubt from any of the party of Modaraba.

29. In case of pre-mature close of Modaraba by Rab-Al-Maal all loses have to be accepted by Rab-Al-Maal. But in case the closure is due to the Modarib demand then Modarib has to forgo his total rights and Rab-Al-Maal is allowed to declare the consequences of closure.

Imam Malik

30. Refund of liabilities that could be delayed purposely for making more money is prohibited.

31. Modarib has to return the capital and Rab-Al-Maal has a choice to invest money that is returned on maturity of Modaraba.

32. Capital cannot be Roll-over under same agreement.

33. Modarib in a monetary constraint and wish to keep money for longer has to first end the agreement and enter into fresh agreement either with same terms or additional mutually agreed upon.

AL BASHI says that it might be Modarib intention for benefit in order to prolong payment of his liabilities which cannot be permitted. Almost all scholars have forbidden the usage of debts as Modaraba capital. IBN KADAMA There is no wrongdoing if the Liabilities taken as Modaraba Capital with the permission of Rab-Al-Maal who has settled the price with a clear conscience”.

34. In another way, it is like a commodity given to Modarib which can be used as a capital of the transaction.

35. All Fuqaha agreed that only capital be in the form of cash as it is the Participation of Rab-Al-Maal. The debts remain in the possession of debtor. Participation with Cash is different from debts, as it remains the property of Rab-Al-Maal even when


it is with Modarib.

36. Cash Participation is the capital of Modaraba and remains with Modarib in trust.

37. All activities pertain to Modaraba should be agreed in witting including functions and operation in proper record, supported with documentary proof.

38. Modarib can invest the Capital by self or by making similar contract with other person, institute or organization without the permission of Rab-Al-Maal but keeping him in confidence.

39. Modarib status could be change to Rab-Al-Maal and Rab-Al-Maal could be Modarib too with the condition of contract and agreement in transaction.

Essential conditions of Modaraba financing

1. For differentiating Modaraba mode of financing and interest mode of loans, principals should be kept in mind before establishing financial transaction that in normal banking and lending practice, money is made available to borrower against guaranteed return of principle with profit.

2. In such practice collateral is the cover against the lending that ultimately liquidated in case of loss by lender.

3. In Modaraba, profit and loss is the end of the contract and profit and loss sharing is the key. In case of a loss, the Rab-Al-Maal suffers the financial loss and Modarib faces loss in time, effort and his name.

4. Capital has to be surrendered to Modarib who is free to utilize it in business mutually agreed between Modarib and Rab-Al-Maal. According to Imam Ibn Hambal, this condition satisfies Modarib for his free actions to Capital utilization and can take better way to earn best.

5. Rab-Al-Maal interference in the working disrupts the connection between Capital and Modarib. But the cooperation of Rab-Al-Maal is accepted.

6. Relationship as an employee and an employer between the two parties which are Rab-Al-Maal and Modarib invalidate Modaraba transaction.

7. Share of profit has to be pre-agreed at the pre-agreed ration and not the rate applied on the principle amount but on Net Profit.

8. Modarib is entitling for Modaraba management fee out of Gross profit and not from the capital of Modaraba.

9. Modarib fee must be pre- agreed and terms have to in the agreement.

10. Rab-Al-Maal cannot impose the amount of percentage.

11. The ignorance and discriminative distribution share of profit invalidates the Modaraba. Profit is the essence of contract and its ignorance invalidate the terms of the contract.

12. Profit has to be divided by half or by third after deduction of pre-agreed Cost and Expenses including Modarib fee.

13. Rab-Al-Maal gets share of his Capital investment and Modarib gets share for his


efforts.

14. In loss, Modarib has no share nor can‟t Rab-Al-Maal claim his capital.

15. Assets shall be the right of Rab-Al-Maal.

Classification of Modaraba

1. Modaraba can be classified as, General purpose and Specific Modaraba.

2. In General purpose Modaraba, the operation is not restricted to activity, partner and place.

3. General purpose Modaraba is mostly used between Modarib and Rab-Al-Maal in which Rab-Al-Maal empowers, Modarib to act, invest or activate capital for earning profit.

4. Specific Modaraba is limited by one or several aforementioned restrictions. Modaraba can be restricted to certain conditions and has to commit for the non-compliance.

Multiple Modaraba 1. One Rab-Al-Maal finances several Modarib at one time with different terms and

conditions of contract.

2. Several Rab-Al-Maal finance to one Modarib as an individual worker or as in group by pool of capital under single agreement between Modarib and Rab-al-Mall either in group or by proxy to single person in representation.

3. One Rab-al-Maal finance to several Modarib and each Modarib using the financing amount investing in several transaction for specified period under single agreement.

HAKIM IBN HAZAM Close Companion of Prophet (May Peace be upon him) Says and it has to be taken as the authentic condition in the present practices

“I lay down conditions in Modaraba that if my money is left in a humid place or taken across the sea or washed between fast-moving water, Modarib will be responsible for

the non-compliance of the conditions.”

Banking & Financial Institutes 1. Banks can finance their funds or from their deposits for financing someone to carry

out Modaraba.

2. Banks can be Modarib for their Depositors and Rab-al-Maal for Modarib seeking financing.

3. The contract shall be two separate.

4. The first contract with the Depositor as Modarib and second contract with Modarib whom financed.

5. The contracts can have different terms and different profit sharing.

6. Both the contract should be matured on the pre agreed date and bank cannot pay-off without realizing the profit of its financing or from own source.


7. Banks can specify the purpose of Modaraba to safeguard depositor‟s capital.

8. Bank can enter into a General Purpose Modaraba. But in case of being a Rab-al-Maal it only enters into Specific Modaraba Contract.

9. Banks are not permitted to ask for guarantee against the loss of capital, but participate in the transaction as partner by holding the assets of transaction excluding Capital.

10. Modaraba can be in consolidation with other mode of financing permitted like Musharaka, Morabaha, Ijarah, Havana, Musaqa or Mussaja.

Al Mighty Allah instruct Oh you misuse your wealth in self-importance among them. This wealth should be used for trade on mutual consent”. Those who believe in Allah should observe their duty to Allah and give up what remains from Riba, if they are true believers. If they do not, then they are warned for a war with Allah and his Prophet (Peace be upon him) and if you ask forgiveness, then you have your principal without interest. Wrong not and you shall not be wronged.”

Summary A profit-sharing agreement between two parties, in which one provides the finance,

and the other provides entrepreneurial and management skills.

Profits are divided on a pre-determined ratio.

Losses are borne by the provider of capital and Modarib loose its reputation, time and efforts.

Financing is made in the absolute trust on the skills, experience, reputation, capability and feasibility of Modaraba transaction or project.

Modaraba agreement is made only to the transaction purely based free from all the classifications and categories of the Riba.


Chapter 6

Morabaha Financing “Trade Financing”

The word Morabaha is taken from the Arabic word Ribh which means Profit. Originally, Morabaha is a contract of sale in which a commodity is sold on profit. The seller tells the buyer his cost price as well as his profit he is adding to the cost. Modern form of Morabaha has become the single most popular technique of financing all over the world.

Morabaha is a financing mode for trading activities on basis of sale on profit.

Technically, it is a contract of sale in which seller declares his cost and profit.

It is an ancient practice which was seen in archives prior to horizon of Islam.

Morabaha practice developed in Islamic financial system with guidance of Islamic Shariah.

Morabaha is a financing technique that involves a request by the Morahib (Worker) to the financier (Rab-al-Maal) for the purchase of a certain goods or equipment for him.

The financier after the appraisal of the price and cost estimates its profit over the cost which is settled as purchase price in advance.

The financier pay on behalf of the Morahib and deliver the goods after taking acceptance of receiving the goods as per request

There is a question on the legality on Morabaha financing technique due to its similarity with Interest of Riba.

In reality it is wise to settle all the terms in pre-agreed as saying of Prophet Muhammad, May Peace Be Upon Him.

“You must settle your terms in writing and in agreeing prior to your trading and in

trust and for better profitability.”

Confirmation Conference on Islamic Banking held at Dubai in 1979 endorsed the terms & condition of contract between two parties of Morabaha as: “This conference concluded that the Morabaha transaction comprises a promise to purchase on behalf of the Morahib according to condition agreed upon and promise by the financier to conclude the sales after purchasing the commodity based on the decided condition”. Morabaha Key Notes

Financier is Rab-al-Maal & financing is made for the procurement of goods and commodities.

Morahib is the party of contract to sell the goods that Rab-al-Maal financed under the contract.

It is not capital base contract and funds are use as financing for purchases of goods.

Morahib has to prove and satisfy the Rab-al-Maal of capabilities know-how of goods requested and marketing and selling plans of the goods that are financed.


How Morabaha mode of finance operates? Morahib needs goods and approaches financier to get the required goods or

commodities through financing

In interest-based system, money is landed on interest to the borrower who would go and buy the required commodity from the market.

This option is not available in Morabaha.

Money cannot be lent directly to Morahib.

Financing against the procurement of goods or commodity requested, directly paid to supplier in accordance to request of Morahib.

Morahib approach Rab-al-Maal with his request to acquire goods for trading purpose.

The request must be in writing with clear specification of goods required along with the supplier identification and prices declare by the supplier.

Rab-al-Maal by self or through agent enters into purchase deal with the supplier of Morahib and negotiates the price to a minimum possible level.

Supplier final price and Morahib declare price if differ this difference is part of earning for Rab-al-Maal as efforts involve to be compensated

Morahib cannot claim a part of this earning, however Rab-al-Maal as good gesture can reduce the profit on the commodity that he add on procured price declare by Morahib.

Morahib upon receiving the goods from supplier issue an acceptance confirming the quality and quantity of goods received from the supplier as well as issue detail of stock kept at place.

Rab-al-Maal can also appoint its Moqqadum (agent) who is allowed to receive the delivery of goods and commodities on behalf of Rab-al-Maal.

Moqqadum (agent) may keep the goods and commodities under his control and release upon the delivery order issued by Rab-al-Maal to the Morahib either upon the payment or under differ payment terms.

It is compulsory that goods transfer from Rab-al-Maal to Morahib should be on the pre-agreed price which was incorporated in the Morabaha Financing Contract supported by Local or Foreign Purchase Order duly signed by Morahib..

Morabaha transaction completed in two stages!

Firstly, the Morahib requests the Rab-al-Maal to undertake a Morabaha transaction and promises to buy the commodity specified by him.

The promise is not a legal binding and Morahib may go back on his promise and the Rab-al-Maal takes the risks of the amount financed.

In this situation the Arboon amount is kept as the stake of Morahib, subsequently is used to cover the price margin where Rab-al-Maal can sell the goods by reducing the price to attract the buyer.

Secondly, Morahib purchases good acquired by Rab-Al-Maal on a deferred payments basis and agrees to a payment schedule on various dates.

On such arrangements the profitability of Rab-Al-Maal shall not be change and pre-agreed price of resale of goods between the two parties of Morabaha contract shall remain constant.


Morabaha sale contracts allow the commodity sold it to the Morahib or in case if these are refuses to purchase by Morahib then Rab-Al-Maal can sell buy at best suitable price taking the advantage of Arboon.

This prime clause of the contracts and it should be accepted by Morahib.

Morabaha mode of financing is widely used by Islamic banks for various financing requirements.

To provide finance in various and diverse sectors

To consumer finance for purchase of consumer durable such as cars and household appliances

To real estate to provide housing finance

To the manufacturing sector for the purchase of machinery, equipment and raw material etc.

To finance short-term trade for which it is eminently suitable.

To issue letters of credit for local and international procurements on behalf of Morahib.

To finance import trade in today form of FIM (Finance Imported merchandise)

Fuqaha (Islamic Scholars) on Morabaha Imam Malik Both parties in Morabaha Contract are legally bound to fulfill the terms of contract. Any mis-declaration or mis-commitment from any party towards the contract, offender would be liable to legal proceedings. Other schools took it as religious obligation and legal binding if it is to the interest of the public. Contract of such nature needs great technical accuracy and a sound knowledge of Shariah. The binding nature of the Morabaha contract might require the endorsement of the legislations in some Islamic countries where such transactions are in practice. Imam Baghi Contract concluded toward who purchases the camel because of need of others and then sell at a higher price. Such contracts end in two sales,

Firstly, they are purchased in cash.

Secondly, they are sold on credit.

Financier pays cash for commodity at the request of Morahib then sells same to Morahib on credit after adding its profit. In other words, financier by adding its profit loan excess to original purchase price as interest which Morahib will have to pay even if price of commodity falls. Such transactions fall under classification of Riba as interest.

Imam Al Shafai

If a man sees a commodity in the possession of another and agrees to purchase the commodity with the profit set by seller; such transaction is valid, as it is not binding to any of the party of the contract till the close of the transaction.

If a man purchases the commodity and agree to pay the profit, then sale is valid as the purchaser himself agrees to offer the profit.


If Morahib requests Rab-al-Maal to purchased separately the goods on cash and then he shall buy in installments at later stage. The cash based sales accepted.

Under second installation scenario sales would become valid provided Morahib purchase on installment or at cash at an agreed price of contract

Imam Ibn Rashid

Morabaha sales are approved sales, but sales by mutual consent are preferable. “Sales by mutual consent are permitted because Morabaha sales according to Imam Ahmed require honesty and integrity on the part of the seller”.

Temptations have the possibility of being led into inaccuracy in one‟s favor of sales which is agreed by mutual consent.

In case seller cheats with price or capital, sale remains valid, but buyer get entitlement to claim the difference from the seller or drop the sale.

Some Fuqaha say that the buyer has no choice but is entitled to deduct the difference.

Morabaha sales are governed by the same conditions applied to sales in general with most important aspect that both buyers and sellers should know the amount of the financing and the yield.

The seller must declare,

I bought for 100 and claim it for with a profit of ten which then is 110.

Selling in Installments of Differed Sales Time has to be agreeing on the price based on the period of credit term.

Morahib must agree to pay on maturity.

If unable to fulfill financier has the right to claim the goods by confiscating his Arboon which ultimately covers the price including the compensation for the loss of time.

Morahib have to reveal quantity of stock in hand to financier.

Any discrepancy to original delivered quantity would be paid by Morahib.

In case of failure to pay, Morahib can be legally punished for misappropriation and theft.

Some Fuqaha forbid such types of sale, considering the increase in price as Interest, a category of Riba. While some of the Fuqaha permit such sales as it is based on mutual agreement, and agree with Allah as said in Holy Quran: Whereas Allah permitted trading and forbidden usury and O’ ye who believe! Misuse not yours wealth among your selves in pride, except it be a trade by mutual consent”. Financial institutions use Morabaha financing in both ways,

Differed sales of cost price for those who need the commodity for their personal use and not for trade as seen in Consumer Financing.

On short term basis with limited installments provided to those who cannot afford to pay in one go but with an ability to pay in installments.


Morabaha Cost-plus Financing

This is a contract of sale between Financier and Morahib at a price which includes a profit margin agreed by both parties.

As a financing technique, it involves the purchase of goods by financier on requested by Morahib.

Goods then sold to Morahib with a built-in profit.

Repayments in installments are specified in the contract as Morabaha Cost-Plus Financing.

Selling in Installments of Differed Sales

Differed sales or sales by installment could be carried out on the basis of the cost price of commodity.

No disagreement on such type of sale carried out and allowed.

Differed sale could be at a higher price than actual one of the commodity.

Some Fuqaha disagree on that type of sale. But most agree to such sales as seller informs the buyer of cash price and price on deferred payment terms as clear terms for two types of sales transaction.

Islamic jurists proposed forms of partnership to provide credit & finance for Agricultural, Manufacturing and for trading purposes. These are:

Consecutive Partnership

This instrument of financing is a real innovation on part of Islamic banks.

Islamic banks take depositors for one financial year as partners in the proceeds of that financial year without matching with the periods of projects in which depositors funds are invested.

Pending proceeds from previous years, for which accruals or provisions were made, are included in the proceeds of the year in question.

Yields corresponding to the same financial year are excluded if they are not yet due and left to a future year.

This accounting system is necessary to reconcile the depositors' withdraw regardless liquidation of investment in which their funds are used.

Continuity of the bank's investments which constantly flow in a mixed basket to make regular accounts every financial year, as an accounting unit for this basket

Agricultural Partnerships Privately owned agricultural land could be utilized one of the three ways:

Directly by the owner,

Indirectly by renting it (Ijarah)

Through agricultural partnership. The two main frameworks in traditional Islamic law for agricultural enterprise and both these techniques typically afford a partnership between capital and labor. These techniques are


Muzara’ a (share cropping) Musaqa (water partnership or tree-sharing).

Sharecropping Muzara' a (sharecropping or crop partnership) is a contract whereby landlord puts his agricultural land at farmer's disposal to farm. Farmer undertakes to give owner an amount of agricultural products. This framework is based on a partnership between capital and labor. Tree-sharing Musaqa (water partnership or tree-sharing) is a contract whereby one person trim and water fruit trees own by other person or are at his disposal, in exchange for an amount of realize through the sale of the fruits on pre-agreed upon. If a contract of Musaqa or tree sharing is related to fruitless trees, like willows and sycophants, it is not valid. However, it would be valid in such trees as henna whose leaves are used or trees whose flowers are used.


Chapter 7

Musharka financing (Equity Participation or Venture Financing

Introduction

Musharka or Shirkah can be defined as a form of partnership where two or more persons combine either their capital or labor together to share the profits & enjoying similar rights and liabilities. It is a contract between two or more persons who launch a business or financial enterprise to make profit.

Introduction & Back ground

1. Dilemma in this modern world for entrepreneur is his capability to initiate his idea for a new business.

2. He look to raise equity, capital or financing to enter business venture.

3. Firstly loan need collaterals arrangements, keeping in mind the impossibility.

4. Secondly borrowing that is made for the purpose is subject to the cost to be paid in shape of interest ranges to 6% to 20% or more.

5. Thirdly cost to be paid on loan has to be determining on the volume of risk and success.

6. If interest rate is 6% but the venture has a 10% chance of failing within a year, the lender will probably charge interest at a rate of 16%.

7. High interest on compounding imposes heavy costs on the venture from the start.

8. It increases the danger of failure and rise interest rate. If venture's prospects can not be predicted with confidence, it is difficult to calculate an appropriate interest rate.

9. Alternative for entrepreneur is admitting a partner to the business that is entitled to receive a portion of profits from the venture in exchange for contributing capital.

10. The partner's contribution and participation is pre determined.

11. There is no need to compute an interest rate and there are no fixed costs of debt.

12. The partner will receive profits only if earned

Condition of Musharka

1. Musharka is a technique of financing used as a partnership.

2. Two or more parties provide finance for a project.

3. All partners are entitled to a share in the profits resulting from the project in a ratio which is mutually agreed upon.

4. In case of loss it is shared exactly in the proportion of capital.

5. All partners have a right to participate in managing the project.

6. Any one can waive the right of participation in favor of partner or partners.


Historical Background Musharka

1. From the beginning of human society methods to meet day to day needs have been changing with the change of social, economic, scientific, cultural and political circumstances.

2. Especially habits, fashions and the standard of living.

3. These methods regulate the commercial activities and vary from place to place and time to time.

4. The Arab society at the time of the rise of Islam had very simple financing methods and forms of business peculiar to that society

5. Birth of Islam saw Musharka practice in Arabia in commercial activities.

6. Islam endorse and Prophet May Peace be upon Him perform business on the basis of Musharka.

7. After Hijra Muhajireen and Ansar were declared by Prophet May Peace be upon Him to be brothers.

8. Subsequently they joined as partners on Musharka, Muzara and Mussaqa form trade and commerce.

9. Nature of transactions in the different forms was identical. These forms were so developed that they became independent institutions.

10. Jurists formed detailed rules about the form.

11. There is a consensus of opinion among the jurists of all schools- of thought that Musharka is a valid and legitimate contract in Islam.

12. The jurists, however differ over its form conditions and other details

Islamic Perspective

1. Islam stress on the socio economic development that tie individuals with brotherhood and care like members of one single family.

2. This brotherhood is universal and not narrow-minded.

3. It is not tie by any geographical boundaries and take whole of mankind group, tribe or race into one relation and that is universal partners for better earth.

4. The concept of brotherhood and equal treatment in society and before the law is not meaningful unless accompanied by economic justice.

5. Receiving dues for individual who contribute to economic activity in society or to the social product without any kind of exploitation of one by another.

The Prophet May Peace Be Upon Him warned:

"Beware of injustice for injustice will be equivalent to darkness on the Day of judgment".

1. This warning is against injustice and exploitation and to protect the rights of all


individuals whether consumers, producers, distributors, employers or employees with aim to promote welfare and ultimate goal of Islam.

2. Special significance is given to the relationship between the employer and the employee which Islam places in a proper setting and specifies norms for the mutual treatment of both so as to establish justice between them.

3. An employee is entitled to a "just" wage for his contribution to output and it is unlawful for the employer to exploit his employee.

4. In case is with trader and consumer the dealing fair and transparent.

Two main forms of Musharka Permanent Musharka

1. In this form the parties of Musharka participates in the equity of a project or transaction and receives a share of profit on a pro rata basis.

2. The period of contract is not specified.

3. It can continue so long as the will of the parties.

4. This technique suits for long terms projects as funds and development are committed and protracted.

Diminishing Musharka –

1. It allows equity participation on a pro-rate basis

2. System by which equity of parties keeps on reducing ultimately the ownership of the asset on any one or more participants is transfers.

3. Partners gets dividend on their equity and if any of the partner sell or buy other partner some of its equity, it is allowed to do so.

4. Equity held by partner progressively reduced and at a certain time equity held by any partner reach to ZERO.

5. Disposal of total equity an end of Musharka

6. Musharka form of financing is being used by Islamic banks to finance Project Financing and Working Capital.

Types of Musharka Shirkah -Al-Milk (non-contractual) It involves co-ownership and form when two or more persons get joint-ownership of some asset without a formal partnership agreement. It is a proper partnership as the parties concerned willingly entered into a contractual agreement for joint investment and the sharing of profits and risks. Example

1. Two persons receiving an inheritance or a gift of property which mayor may not be divisible?

2. Partners have to share property or its income in accordance with their share until they decide to divide.


3. If the property is divisible and partners still decide to stick together, It is Shirkah al-Milk Ikhtiyariyyah (voluntary).

4. If it is indivisible and they are forced to stay together it is characterized as Jabriyyah (involuntary).

Shirkah al-Uqood (contractual partnership)

1. The agreement need not necessarily be formal and written, it could be informal and oral.

2. Just as in Modaraba, the profits can be shared in any equitably agreed proportion.

3. Losses must, however, be shared in proportion to the capital contribution.

Type of Al-Uqood: In Fiqh Shirkah al-Uqood divided into four kinds:

Al-Mufawada (full authority & obligation)

1. In Mufawada partners are adults,

2. Equal in their capital contribution,

3. Their ability to undertake responsibility along with their share of profits and losses on the transactions.

4. They have full authority to act on behalf of the others

5. Jointly and severally responsible for the liabilities of their partnership business, provided that such liabilities have been incurred in the ordinary course of business.

6. Each partner can act as an agent (Wakil) for the partnership business and stand as surety or guarantor (Kafil) for the other partners

Al-Inan (restricted authority & obligation)

1. Inan involve all partners need not be adults or have an equal share in the capital.

2. They are not equally responsible for the management of the business.

3. Their share in profits may be unequal, but this must be clearly specified in the partnership contract.

4. Their share in losses would be in accordance with their capital contributions.

5. Shirkah Al-Inan the partners act as agents but not as sureties for their colleagues.

Al-Abdan (labor, skill and management)

1. Shirkah al-Abdan is where the partners contribute their skills and efforts to the management of the business without contributing to the capital.

2. They use their expertise, experience and goodwill that give confidence and strength to the venture either on profit or wages.

Al-Wujuh (goodwill, credit-worthiness)


1. Partners use their goodwill, their credit-worthiness and their contacts for promoting their business without contributing to the capital.

2. Both these forms for partnership, where the partners do not contribute any capital, would remain confined essentially to small-scale businesses only.

These are of course models. In practice, however, the partners may contribute not only finance but also labor, management and skills, and credit and goodwill, although not necessarily equally Modern Musharka and its Conditions

1. The modern business concerns being run on the basis of Musharka

2. Partnership: It is regulated by Partnership: It is regulated by-

3. Partnership rules framed by the government,

4. Business practices prevailing in the business community.

Limited Company

5. This type of Musharka is strictly controlled by the statutory rules framed by the government Its commercial activities are, however, influenced by the business practices.

Co-operative societies

6. This Musharka is also governed by statutory rules.

7. Its commercial activities are influenced by the practices prevailing in the business community.

8. The modern Musharka principally resembles Shirkah al-Inan. The details are, however, considerably different due to change of Urf and other factors including modem commercial techniques, economic conditions and legal requirements.

9. Let us discuss briefly the conditions of Musharka, which are those of Shirkah al-Inan. Other types of Musharka mentioned by jurists are nearly obsolete nowadays.

10. Capital invested by partners may be unequal.

11. Majority of jurists, capital should be in shape of currency and not the goods.

12. Condition for capital in form of currency was imposed when it was difficult to refer goods in terms of currency.

13. In barter systems jurists framed the rules, now goods are generally referred or accounted for in terms of currency.

14. This condition is waived in limited companies and co-operative societies as the capital is invested in the form of equal units of currency called shares and the intended partners buy as many shares as they wish.

15. This practice has universally been accepted as urf and is therefore according to Islamic principles.


Chapter 8

Ijarah Financing

(Asset Financing) Definition Leasing is a contract in which asset is transfers to user for an agreed period on an agreed consideration “Ijarah is a lease contract as well as a hire contract”. Both the contract are similar to each In Islamic Finance Ijarah is a lease contract under which financial institution leases equipment or a building to one of its clients against agreed rentals or installments equal to the value of the assets. The financier is known as Rab-al-Maal who financer equipment to Sarif (User or Tenant) or the equipment provider through financing is LESSOR and The equipment user is LESSEE

Ijarah Ijarah basically facilitate the cost to be spread for large purchases into affordably installments for payment. In Ijarah either the end of the transaction is the ownership of assets that acquired through lease financing or in another case the equipment is returned to financier. Ijarah Financing is a contract in which a lessee request for an equipment or a property and lesser provide through its financing the specified and requested equipment or property. The Lessee agree to pays a monthly, quarterly, semi-annual or annual rent to lesser for the right to use equipment a specific amount within agreed time of time i.e. 12, 24, 36, 48, or 60 months OR what ever time agreed.

Historical Perspective

Though leasing began in 2010 BC but modern leasing began in early fifties.

Creation of the Investment Tax Credit in 1962 encourages growth through "tax-oriented" leasing and new products were quickly developed to meet the growing demand.

Over the last 50 years, many leasing companies developed non-tax oriented products such as income funds, operating leases, limited partnerships, vendor programs, and end sharing in order to remain competitive.

Equipment leasing blossomed over the last 20 years

Banking industry started leasing by giving credibility to a market place which had been previously regarded as a last-resort financing alternative.

Accounting profession produced a document to help standardize lease reporting


in financial statements.

Internal Revenue Service issued guidelines to aid lesser and lessees in structuring leasing transactions.

Why do Lease Business?

Cash flow - Monthly payments are generally smaller for leases than for loans and they usually require a smaller or no down payment.

Use vs. ownership - Many businesses have discovered they don't need to own the equipment they use.

In past renting and leasing were limited, today's psychology it more to economics rather than moralities of ownership The Modern Concept of Ijarah

Ijarah is an ancient technique which can be seen as leasing which is the modem technique which can be compared with Islamic technique of Ijarah.

Leasing is based on fundamental concept of Ijarah, according to which one does not have to own an asset in order to enjoy benefits of it.

There are business examples which benefited from their investment in fixed assets and made substantial capital profits from the sale of assets or been able to improve their balance sheets by the revaluation of assets.

Primarily profitability of a business lies in the effective utilization of its resources. Therefore USE is important rather OWNERSHIP.

For example

Investment appraisal made on some new venture. The choice of purchasing or leasing is partially a matter of arithmetic and partially a question of the availability of the capital.

Ijarah provide usage by paying a rent with understanding to acquire the ownership right on the equipment under Ijarah mode of financing.

Cross Road of Ijarah

1. Ijarah is a financing facility in which the Rab-al- Maal on the request of user agree to finance the asset of any nature.

2. Ijarah is financing mode in which finance cannot be disburse directly to the user of the finance.

3. An asset is arranged and handed over on the condition that user will pay the rentals for its usage to a certain period and then return the assets upon maturity back to the financer.

4. Ijarah can also be financed in which the price of the assets are taken in installment over a certain period and assets is been given to the user to use it and pay the rentals of the usage.


5. The rental is the earning of the user and payment of installments leads towards ownership of the assets of user.

6. The early user pays the price of the assets the lesser number of rentals he pay and less is the expense on him.

7. The financing amount is determined in accordance to the portion of gross income of the user which he can afford to pay as rental and installment.

8. The gross income is declared by user and has to prove the authentic proof of the income.

9. The financing amount base on the affordable level determines on the gross monthly income of the user then divided into financing and equity.

10. The equity of the user is called as ARBOON (up-front or advance) and the financing is added to the ARBOON that make the total financing amount.

11. The financing amount is inclusive of the direct and indirect cost on the purchase of the assets and the installment is workout on the amount of total cost and price less Arboon in number of equal installment which are spread over the financing period.

12. The user repay in two parts which are Installment that give right of ownership on the asset which are also consider user‟s saving

13. Rentals that are user expenses that he or she bears of using the asset.

14. the two agreements signed between user and financer have amounts of financing, installments, rentals and cost.

15. Ijarah financing due to its special features supplement existing conventional forms of lending and further increase speed investment in the private sector.

16. Ijarah financing improve the capacity utilization, quality, production cost, profitability, internal generation of cash for future investment, improve saving conduct and international competitive capability to increase construction industry.

17. Ijarah financing also suited to the programs of balancing, modernization and replacement of common man need.

18. It involves a small dosage of investment which would carry relatively smaller investment risks but would result in a quick value added.

19. It increase capacity utilization and thus contributes to the growth of the economy and develops saving conduct by converting expenses into compulsory saving.

20. It is asset transfer to another for use on an agreed period with financial consideration according to the affordability level of the user.

21. Ijarah financing must have a useable asset.

22. It is necessary for a Ijarah contracts that body of property remains in the ownership of the seller and only its usage is transferred to the user and then over an agreed period he buys out the ownership of using property.


23. Ijarah Financing cannot be affected in respect of disbursement of money, to user to acquire himself due to consuming nature of money. If anything of this nature is acquired by the user, it would be consider as a loan with all rules concerning the transaction of loan that would accordingly be applied.

24. Any increase or decrease in the rental or financing on valid contract would be treated as interest that is usually charged on a loan. The figure of installment never changes however the number of rentals is increase or decrease according to repayment practice.

25. All the liabilities emerging from the ownership shall be borne by the financier, but the liabilities referable to the use of the property shall be borne by the user.

Example of the contract in Property Ijarah Ahmed graduated and joins the professional life at the age of 22 years. His monthly income is estimated to Rs.20,000 in which he get 40% home allowance that is Rs.8,000. After three years he decided to buy a property and applied for LA Riba Home Financing under Riba free financing mode. He approach the Home Financing Company who explain his that he can afford 40% of his income for acquiring his home. Ahmed need a property at a value of Rs.1,000,000 with total cost and expenses added to Rs.50,000. Thus the price of the property reaches to 1,050,000. Home Financing Company and Ahmed reach to an agreement that Ahmed will contribute the 30% and Financing Company shall invest 70%. Contract: Property value: Rs.1,000,000 Tax 2%: Rs. 20,000 Documentation: Rs. 10,000 Fee, Commission: Rs. 30,000 Total Price Rs.1,050,000 Equity 30%: Rs. 315,000 Financing: Rs. 735,000 Monthly Income: Rs. 20,000 House Allowance : Rs. 8,000 Installment 70%: Rs. 5,600 Rental 30%: Rs. 2,400 Period: 131.25 Installments = 10 years 11 months

After 10 years Ahmed paid Rs.735,000 + Rs.314,400 = Rs.1,049,400

This is approximately 42.775% excess to financing facility.

As he takes over the ownership of his home he make a valuation of his home and found that the value has increase by 30% and his home is now valued to Rs.1,300,000.


His expenses to own the home decrease and he turn into premium from expenses of 42.775% to premium at 23.880%

Home that he bought through LA RIBA Home Financing at a total cost of Rs.1,313,920 which deducted from the present value of the property Rs.1,300,000 shall only burden him Rs.13,920 in 10 years 11 month.

If the value decrease then he still hold a property that allow him to live in it and the House Allowance convert into his monthly income instead of rental expenses. He will still be beneficial.

In developing countries, house allowances are non-taxable and this give the Ahmed a benefit of Rs.800 per month as tax rebate on Rs.8,000. Rs.800 in 10 years 11 month benefits him to user minimum of Rs. 104,800 additionally.

On the other side if he pay early in 10 years instead of 10 years 11 month he save 11 rental amount which equal to Rs. 24,400.

Summery The product base on the affordability + Gross Income + Payment Schedule application which means pay early is the profit to the user and loss to the financier in profitability and pay late is income to financier and loss to user.

Comparison

1. A comparison between leasing and other similar forms of transactions, such as rental, will give a clearer picture.

2. "Rent a Car business is a contract according to which the objects are leased to individuals or a number of users for a much shorter period than their actual useful life.

3. In contract law, the "rental contract" specifies the lease and the usage for an indefinite period.

4. Like IBM's computer sales system which has an overwhelming world market share.

5. To promote sales in an attempt to outstrip its competitors, with the belief that it could control the progress of technological innovation of computers.

6. Users of equipment leased on a rental system are major enterprises with continuous usage of rented equipment in a short-lived, but the lesser is charged with the responsibility for maintenance.

7. In the case of "rental" the lesser is moreover charged with the responsibility for coping with the products obsolescence, so that it may be termed as a service-oriented business.

Economic Role of Ijarah

1. Lease financing due to its special features supplement existing conventional forms of financing and further increase speed investment in the private sector.

2. There is a large requirement of balancing and modernizing for existing


industry.

3. Lease financing through balancing and modernization of existing industry improve the capacity utilization, quality, production cost, profitability, internal generation of cash for future investment and international competitive capability to increase exports.

4. Lease financing is most suited to the programs of balancing, modernization and replacement. It would involve a small dosage of investment which would carry relatively smaller investment risks but would result in a quick value added production. It would increase capacity utilization and thus contribute to the growth of the economy.

5. Leasing is the contract

6. Asset transfer to another person for use on an agreed period with financial consideration.

7. The subject of lease must have a valuable use.

8. It is necessary for a lease contract that body of leased property remains in the ownership of the seller and only its usage is transferred to the lessee.

9. Any thing that cannot be used cannot be leased.

10. Lease cannot be affected in respect of money, edibles, fuel and ammunition etc. due to consuming nature of products.

11. If anything of this nature is leased out, it would be consider as a loan with all rules concerning the transaction of loan that would accordingly be applied.

12. Any rent charges on this invalid lease would be treated as interest that is usually charged on a loan.

13. All the liabilities emerging from the ownership shall be borne by the lesser, but the liabilities referable to the use of the property shall be borne by the lessee.

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Example “A said to B “I lease you out my cars”.

Lease is void unless leased car is clearly identified.

Rental must be determined for whole period of lease at the time of contracting a lease.

It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of lease agreement.

If the rent for a prior phase of the lease period has not been determined or left at


the option for the lesser, the lease will not be valid.

Example Mr. A leases his house to Mr. B for a period of 5 years. The rent for the first period is fix at an amount on monthly basis and it is also agreed that the rent of every subsequent year shall be 10% more than the previous one. The leases remains valid

In this example Mr. A laid down a condition in the agreement that rent of an amount per month is fixed for the first year only.

Rent for subsequent year shall be fixed each year at the option of the lesser.

The lease is void, because the rent would be uncertain.

Mostly in the long-term lease agreement it is not in the benefit of the lesser to fix one amount of rent for the whole period due to the fact the market conditions differ from time to time.

In this case, the lesser has two options, either

(a) He can contract a lease with a condition that the rent shall be increased at a specified proportion after a specified period. Like six months or one year.

Or

(b) He can contract the lease for a shorter period after which the parties of lease in fresh terms and conditions, but the renewal shall be affected by mutual consent with full liberty to each one of them to refuse the renewal.

In such case the lessee is bound to vacate the leased assets and return it back to the lesser.

Lesser cannot raise rent unilaterally for that reason any agreement to the contrary is null and void.

Rent or part thereof may be payable in advance before delivery of asset, but the amount collected by lesser shall remain with him as account payment and shall be adjusted to the rent after it is due.

Lease period shall commence from the date on which leased asset has been delivered to lessee, no matter whether the lessee has started using it or not.

If leased asset has totally lost the function for which it was leased for and no repair is possible then lease shall terminate on the day on which such loss has been caused. However, if the loss caused by the misuse or by the negligence of the lessee he will be liable to compensate the lesser with the depreciated value of the asset as it was immediately before the loss.

1. Like other modes of financing, lease is not originally treated as one.

2. It is simply a transaction meant to transfer the use of an asset from one


person to another for an agreed consideration.

3. Certain financial institutions have adopted leasing as a mode of finance used in place of interest.

4. This kind of lease, generally known as the financial lease notable from the operating lease that has many basic features of actual leasing transactions with which it is distributed with.

5. When the financial institutions on interest free modes established in the recent past they found that leasing was a recognized mode of finance throughout the world.

6. On the other hand, they realized that leasing was a lawful transaction according to Shariah and it could be used as an interest free mode of finance.

7. Leasing has been adopted by the Islamic Financial Institutions, yet very few of them paid attention to the fact that the financial lease has a number of characteristics more similar to interest as the actual lease transaction.

8. They started using same model agreements for leasing as were in vogue among the traditional financial institutions without any modification, while a number of their provision was not in conformity with the Shariah.

9. The primary advantage of Ijarah over the conventional forms of borrowing to finance equipment is that the ownership of the asset remains with the lesser.

10. The financing is largely unrelated to the size of assets and the capital base of the lessee, depending principally on the ability of cash flow to service payments of lease rentals.

11. Ijarah is probably the most suitable mean to raise investment funds especially for industries where rapid technological innovation is either underway or desired, top class firms which are quickly expanding their business or small & medium enterprises and firms which have normally insufficient assets and capital base to meet normal collateral requirements of most other forms of long term financing. The basic security under the Ijarah arrangement is the "ownership of the equipment". The title of ownership to the equipment remains with the leasing company but in case of serious default, the equipment is repossessed


Chapter 9 Sukuk

Financial Instrument

Sukuk is an Arabic word and plural of a word Sakk. It signifies legal instrument, deed or Cheque. It is an Arabic name for a financial certificate which can be taken similar to Bond. Islamic Jurisprudence Sukuk A financial product that develops input methods for capital resources. It structure and engineered. It is an Islamic financial products bases of output Fixed and guaranteed Income or interest bearing bonds are not permissible in Islam. Sukuk is profit base instrument that declare its outcome on the utilization of the money collected on maturity of the term of investment. Profitability: It profit is not pre-agreed, pre-determines or fixed. The total investment is deducted from the cost to determine the Net Profit of the transaction for which the Sukuk been issued. Upon realization of the Net profit the total amount is distributed according the ratio of the investment in the capital of the invested amount Sukuk are securities Meeting terms of Islamic Financial law and investment principles which prohibits charging, paying interest & involvement of Riba. Sukuk is a Financial Assets Act in accordance with Islamic law and classified in accordance with their tradability and non-tradability in the secondary markets Islamic Investment Principles IIP: IIP is the part of „Shariah‟, indirectly to be an „Islamic Law‟. Actually it is extensive to law as it cover general body of spiritual and moral obligations and duties in Islam A time-honored instrument for a contemporary use in post Islamic era Sakk which are now called Sukuk were similar with Conventional Cheque. It is a document representing a contract, Conveyance of rights, obligations or financial transaction in conformity with the Shariah. Practical evidence in archives indicates Sukuk as a product extensively used during medieval Islam for transferring financial obligations originating from trade and other commercial activities. Fundamental nature of Sukuk in modern Islamic perspective lies in concept of asset monetization and Securitization that is achieved through the process of issuance of Sukuk (Taskeek). Its great potential is in transforming an asset‟s future Cash Flow into present cash flow.


Sukuk may be issued on existing as well as specific assets that may become available at a future date. Sukuk is the key to structure capital as well cover the liquidity requirement for permanent or temporary requirement The need for tangible assets Shariah Rule

Financing should only be raised for specific purpose and identifiable which must have the Economical and social viability.

Transactions under indebtedness are prohibited as a result conventional bonds or debenture are not permitted.

Sukuk returns and cash flows are linked to transaction workout Net Profit of transaction without any guarantee of return.

User of funds needs to utilize financing along with contributing its equity in transaction.

Contribution of Equity is the share of risk that user confirm in the transaction.

Sukuk funds are Equity of Sukuk owners that form into finance or funds for venture

Shariah accept with risk and return guideline of Islam.

Problem with interest or „Riba‟ Bad Earning Shariah Rule

Money is considers as measuring tool for value.

Money is not a commodity.

Money cannot be bought and sold in similar quality.

Money to remain in circulation and cannot to be stagnant or in holding

Money must have support of equal value with authentication.

Money issuance on goodwill is an artificial value and such issuance is just a paper printing.

Money requires to be utilized to receive income or anything that has the type of money alone.

Money in exchange of money in similar quality is Interest a price of Money which is „Riba‟.

Implication for Islamic financial institution is trading and financing, receivables for anything other than equality.

Conventional loan, lending, borrowing or debt base plastic currencies are not permissible.

Problem of uncertainty „Gharar‟

Ambiguity in contractual terms or uncertainty in existence of an original asset


consider as unoriginal.

Shariah add in the concept of „Public benefit‟, that, overwhelmingly in the public good may yet be transacted

Hedging or mitigation of avoidable business risks may fall into this category of Gharar but there is still much discussion yet to come.

Formula P-

Financing only made available with clear understanding of

Person, Purpose, Product, Project, Price, Period, Performance, Process= Profitability

Profit and acceptance of Loss

Declaration of Results

Financing is made available on 8 P formula

Financing to be in clear confirmation:

Term and condition to pre-agreed

Duties and Responsibilities to define

Decision to be witness by active witnesses

Arbitration to be integral part of agreement

Agreement to be made by third person.

Monitor to be external body.

All matters to be in writing

Sukuk for Financing

Sukuk is the source of financing

Sukuk is the source for structuring Capital

Sukuk is encouragement of saving conduct

Sukuk is a trading instrument without excess to the face value

Sukuk is specific and in general.

Sukuk must be in clear period and validity.

Sukuk return are declared on maturity.

Controversy

Sukuk are widely regarded as controversial due to their visible purpose of evading limits on Riba

Traditional scholars do not believe that this is effective, referring to the fact that Sukuk requires payment for Time Value of Money

This consider as the basic application of Interest


Present Sukuk offer fixed and guaranteed rate of return on investments, similar to interest and it is risks free of particular venture for which Sukuk were issued.

In reality banks invest in assets and return from investment is spread over the period. This flow of income is "fixed" and Rate is pre declare without utilization of investment amount which given to investors.

There is an asset in the background.

There is more security for the investor.

This security makes Sukuk increasingly appealing to global investors including Muslims and non-Muslims.

The soul of the Sukuk is not what is been practice and the return is simply an Interest which deviate the principal of participation.


Chapter 10 Important Terms use in Islamic Finance & Banking

Al Ajr: A commission, fees or wages levied for services.

Arboon: Margin, Advance or up-front

Amanah: Reliability or trustworthiness. Important value of Islamic society in mutual dealings. It also refers to deposits in trust. A person may hold property in trust for another, sometimes by implication of a contract.

Al Wadiah: Resale of goods at a discount to the original cost, Safe keeping.

Al Wakala: Absolute power of attorney.

Al Rahn Al: Arrangement where a valuable asset placed as collateral for a debt. collateral is disposable in the event of a default. Pawn Broking.

Awkaf: A religious foundation set up to assist the poor and needy.

Bai Muajjal (Deferred Payment Contract) A contract involving the sale of goods on a deferred payment basis.

Bai al Salam Advance payment for goods which are to be delivered later.

Baitul Mal: Treasury.

Fatwah: A religious decree.

Fiqh: Islamic jurisprudence. The science of the Shariah. It is an important source of Islamic economics.

Farman: Order or directives

Gharar: Uncertainty, hazard, chance or risk. Technically, sale of a thing which is not present at hand; or the sale of a thing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does not know whether it will come to be or not, such as fish in water or a bird in the air. There are several types of Gharar, all are Haram

.Halal: That which is permissible. In Islam there are activities, professions, contracts and transactions which are explicitly prohibited (Haram) by the Qur'an or the Sunnah. Barring them, all other activities, professions, contracts, and transactions etc. are Halal. An activity may be economically sound but may not be allowed in the Islamic society if it is not permitted by the Shari'ah.

Hawala: Money transfer by way of using financial instrument or means commonly known as Telegraphic Transfer, by using SWIFT System or. Technically, a debtor passes on the responsibility of payment of his debt to a third party who owes the former as debt. Thus the responsibility of payment is ultimately shifted to a third party. Hawala is a mechanism for settling international accounts, by book transfers.

Haram Unlawful.

Ijarah (Leasing) A contract where the bank or financier buys an Ijarah equipment or other assets to the business owner for a fee.


Ijarah Wa Iqtina (Lease to Purchase) This term refers to a mode of financing adopted by Islamic banks. It is a contract under which the Islamic bank finances equipment, a building or other facility for the client against an agreed rental together with an undertaking from the client to purchase the equipment or the facility. The rental as well as the purchase price is fixed in such a manner that the bank gets back its principal sum along with some profit which is usually determined in advance.

Ijtehad: effort, exertion, industry, diligence. Technically try of a jurist to derive or formulate a rule of law on the basis of evidence found in the sources.

Istisnaa (Progressive Financing) A contract of acquisition of goods by specification or order where the price is paid progressively in accordance with the progress of a job. An example would be for the purchase of a house to be constructed, payments are made to the developer or builder according to the stage of work completed. This type of financing along with Bai salaam are used as purchasing mechanisms, and Morabaha and Bai Muajjal are for financing sales.

Modaraba (Trust Financing to skill)

Modarib: Entrepreneur, a person having skills

Muamalat: Economic transaction or commercial activity.

Morabaha (Cost-plus Financing in Trading)

Morahib: Trader

Musharaka: Venture or Equity financing that becomes part of the Capital.

Mushariks: Business Partner

Musaqa: A contract in which the owner of the garden shares its produce with another person in return for his services in irrigating the garden.

Muzara: A contract in which one person agrees to take the land of the other person in return for a part of the produce of the land.

Qard Hasan: Financial assistance without profit on the condition that the amount shall be paid back or the services shall be given against the financial assistance.

Qimer: gambling. An agreement in which possession of a property is conditional upon the happening of an uncertain event. By implication it applies to those agreements in which there is a definite loss for one party and definite gain for the other without specifying which party will gain and which party will lose.

Rab-al-Maal: Owner of money or financer to the transaction

Riba: This term literally means an increase or addition. Technically it denotes any increase or advantage obtained by the lender as a condition of the loan. Any risk-free or "guaranteed" rate of return on a loan or investment is Riba. Riba, in all forms, is prohibited in Islam. In conventional terms, Riba and "interest" are used interchangeably.


Ruqa: Cheque or pay-order

Sadaqah: Charitable giving.

Shariah: Islamic law derived from 3 Primary sources: the Quran; the Hadith (sayings of the Prophet Muhammad); and the Sunnah (practice and traditions of the Prophet Muhammad) and three Secondary sources Qiyas (Analogical deductions and reasoning), Ijma (consent of Islamic Scholars) and Ijtehad (Legal reasoning).

Shirkah A contract between two or more persons who launch a business or financial enterprise to make profit. Shirkah = Musharaka.

Suftajal: Bill of exchange or a banking instrument used for payable at a future fixed date and in other cases they were payable on sight. Suftajah is distinct from the modem bill of exchange in some respects. Firstly, a sum of money transferred by Suftajah had to keep its identity and payment had to be made in the same currency. Exchange of currencies could not take place in this case. Secondly, Suftajah usually involved three persons. 'A' pays a certain sum of money to 'B' for agreeing to give an order to 'C' to pay back to 'A'. Third, a Suftajah could be endorsed.

Sukuk is an investment certificate with specific purpose for a specific period in which the owner title is endorse on the face and it is non-negotiable, not to be use for collateral, not use as cash and non transferable. It is a certificate entitling the holder to the benefits of the income stream of the assets backing the certificate. Equivalent to a fixed income bond.

Takaful: This is a form of Islamic insurance based on the Quranic principle of Ta'awon or mutual assistance. It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members. Takaful is similar to mutual insurance in that members are the insurers as well as the insured.

Waqf: Detention appropriation or tying-up of a property in time without end so that no propriety rights can be exercised over the usufruct. The Waqf property can neither be sold nor inherited or donated to anyone. Awqaf consists of religious foundations set up for the benefit of the poor.

Zakat: contribution which is prescribed by Islam on all persons having wealth above an exemption limit at a rate fixed by the Shariah.


Numerical (Application of Islamic Financial Products)

Modaraba Rab-al-Maal invested 500,000 with Modarib on the condition that he will take 10% on Gross profit which he workout on the estimated sale of Rs.620,000. In addition he will share the profit 40% on the net profit and 60% will be the share of Rab-al- Maal.

Simple Modaraba % Amounts

Principal investment 500,000.0 Sales & Services

620,000.0

Gross Profit

120,000.0 Management Fee 10 12,000.0 Return on Investment 108,000.0

Modarib 40 43,200 Gross Profit

Rab-al- Maal 60 64,800 54.0

Modarib Earning

43,200 36.0

Modarib Management Fee

12,000 10.0

Modarib Income

55,200 46.0 On the investment of 500,000 the sale realized 620,000 that declared Gross Profit of 120,000. Modarib deducted 10% Management Fee which give Net Profit 105,000. Net profit distributed according to pre-agreed Ratio 40% Modarib and 60% Rab-Al-Maal. Rab-Al-Maal earned 13% on investment of 500,000. Modarib made 46% over to Gross profit.


Multiple Modaraba United Travel invested funds Rs.1,000,000 with Muslim Bank on the pre-agreed condition of 10% Management Fee for Bank Muslim on Gross Profit and Pre-agreed share of profit on Net Profit at a Ratio of 45% and 55%. Bank Muslim further investment Rs 500,000 with Dawn Group at 10% Management Fee on Gross Profit and Profit Sharing Ratio 45:55 on Net Profit on an estimated sale of Rs.650,000. Bank Muslim further investment Rs 500,000 with Sun Group at 10% Management Fee on Gross Profit and Profit Sharing Ratio 40:60 on Net Profit on an estimated sale of Rs.700,000.

MULTIPLE MODARABA DISCRIPTION AMOUNT

United Travel Invested with Muslim Bank 1,000,000

Proceed at Maturity Dawn Group 581,000

Proceeds at Maturity Sun Group 608,000

GROSS PROFIT 18.9 189,000

Muslim Bank Management Fee 10.00 18,900

Net Earned Profit 17.01 170,100

Bank Muslim Share of Profit 45.00 76,545

United Travel Share of Profit 55.00 93,555

Bank Muslim Income Amount & % on Gross Profit 50.50 95,445

United Travel Profit Amount & % on Investment 9.36 93,555

1st Financing AMOUNT

Muslim Bank with Dawn Group

500,000

Sales Proceeds At Maturity

650,000

Gross Profit

150,000

Dawn Group Management Fee 10.00 15,000

Net Earned Profit Amount and % on Investment

135,000

Dawn Group Share of Profit 40.00 54,000


Down Group Income amount and % on Gross Profit 46.00 69,000 Bank Muslim Share of Profit Amount & % on Investment 54.00 81,000

2nd Financing AMOUNT

Muslim Bank with Sun Group

500,000

Sales Proceeds At Maturity

700,000

Gross Profit

200,000

Sun Group Management Fee 10.00 20,000

Net Earned Profit Amount and % on Investment

180,000

Sun Group Share of Profit 40.00 72,000


Sun Group Income amount and % on Gross Profit 46.00 92,000 Bank Muslim Share of Profit Amount & % on Investment 54.00 108,000


Collective Modaraba

Ratio Amounts Profit Return

Amount of Investment

10,000,000 Earned %

Brooks Group 12% 1,200,000 162,000 13.50

Allied Group 15% 1,500,000 202,500 13.50

Untied Group 10% 1,000,000 135,000 13.50

Scan Croup 11% 1,100,000 148,500 13.50

Services & Sale Group 12% 1,200,000 162,000 13.50

Sitara Group 10% 1,000,000 135,000 13.50

Faisal Group 10% 1,000,000 135,000 13.50

Reserve 20% 2,000,000 270,000 13.50

Total 100% 10,000,000 1,350,000

Working

Principal investment

10,000,000

Sales & Services

12,500,000

Gross Profit

2,500,000

Management Fee 10 250,000 2,250,000

Modarib Profit 40

900,000 Return

Return on Investment

1,350,000.0

13.50%


MUSHARKA MODE OF FINANCING Globe Inc declared Net Worth is 6 Million divided into 60,ooo shares of Rs.100 each. The company received the finance Rs.2 million from Bank against the sale of 20,000 shares. During the five years the company declared 1st years Loss (100,000) 2nd year loss (200,000) 3rd year Profit 50,000, 4th year profit 190,000 and 5th year 280,000. In the last year the Globe Inc buy out the total shares from Bank at last prevailing price.

S.N DISCRIPTION AMOUNT PRICE SHARES PROFIT

IN WORTH OF SHARE HELD & LOSS

1 Sponsors 6,000,000 100.00 60,000 1 Bank Financing 2,000,000 100.00 20,000 2 Sponsors 4,000,000 100.00 40,000

PRICE PROFT/LOSS

YEAR 1 PROFIT /LOSS (100,000) 100.00 98.33 Bank Financing 20,000 (1.67) 1,966,667 (33,333.33)

Sponsors 40,000 (1.67) 3,933,333 (66,666.67)

YEAR 2 PROFIT /LOSS (200,000) 98.33 95.00 Bank Financing 20,000 (3.33) 1,900,000 (100,000.00)

Sponsors 40,000 (3.33) 3,800,000 (200,000.00)

YEAR 3 PROFIT /LOSS 50,000 95.00 95.83 Bank Financing 20,000 0.83 1,916,667 (83,333.33)

Sponsors 40,000 0.83 3,833,333 (166,666.67)

YEAR 4 PROFIT /LOSS 190,000 95.83 99.00 Bank Financing 20,000 3.17 1,980,000 (20,000.00)

Sponsors 40,000 3.17 3,960,000 (40,000.00)

YEAR 5 PROFIT /LOSS 280,000 99.00 103.67 Bank Financing 20,000 4.67 2,073,333 73,333.33

Sponsors 40,000 4.67 4,146,667 146,666.67

Explanation to the transaction Globe sold 20,000 shares at Rs.100 each and Bank finance Rs.2 Million. The company declared the loss which was divided by Total shares giving per share loss which decrease the price of the share and capital valued decrease according to share in the loss. 2nd year again loss declared that further decrease the share price and capital. 3rd year was the profit which was added to the loss of the share which increases the share price. 4th year profit declared which further cover the loss per share and 5th year the profit make a break even on the share price and the balance per share profit is multiplied by share holding of each party giving the share of profit to each partner. On 5th year the Globe buy out the share and the price used was the last declared profit price giving premium to the Bank. In case loss the share price decrease and profit cover the loss till it reach to breakeven level and over to breakeven is the profit which is shared. Globe Inc declared Net Worth is 1 Million divided into 1,000,000 shares of Rs.100 each. The company received the finance Rs.5 million from Bank against the sale of shares at base price. During the five years the company declared 1st years Loss (100,000) 2nd year loss (200,000) 3rd year Profit 50,000, 4th year profit 190,000 and 5th year 280,000. In the last year the Globe Inc buy out the total shares from Bank at last prevailing price.


IJARA MODE OF FINANCING Mr. A request Ijarah Finance Company to finance a motor car having a market price 5,400,000 and declared his Gross Monthly Income (GMI) 600,000 and agree to contribute his Arboon 20% of the market price. The company appraises the financing to be repaid within 36 month in 36 equal repayments that include Principle + Rental+ Fixed Cost Income Tax 6% and Insurance 5% for the total period. The repayment amount workout on the GMI. Workout The price of the equipment is 5.5 million. Insurance and Tax is added to the price determine the Cost Price of the equipment which was deducted by Al-Arboon from the market price determining the participation of Ijarah Company and Sarif in the Cost Price. The Ijarah Company financing amount then divided into 36 installments which determine the monthly installment which was subtracted from 30% GMI realizing the Monthly Rental which should not be more than 50% of the Installment amount. The Monthly installment amount is the Monthly Saving which the Sarif pays to make its ownership in the assets and Rental are the expenses which he pays to use the equipment during the financing period. The installment amount and the rental amount workout from the GMI determine the saving and Expense percentage of the Sarif. On the maturity of the transaction the Financing Amount+ Al-Arboon + Total Rentals determine the total value of the assets at the maturity which the Sarif owns it.

Total Installment 36 Market Price

5,400,000

Yearly Insurance (In %) 5.0 270,000

Income Tax.(% ) 6.0 324,000

Cost of Vehicle

5,994,000

Equity (In %) 20.0 1,080,000

Ijarah Financing Amount

4,914,000

Installment for Ownership 36.0 136,500

Rentals in % of Installment 31.9 43,500

Total Monthly Payment 3.7 180,000

Gross Monthly Income

600,000

Monthly Affordability Amount 30.0 180,000

Monthly Saving in % 22.8 136,500

Monthly Expenses in % 7.3 43,500

Ijarah Financing Amount

4,914,000

Total Rents

1,566,000

Arboon

1,080,000

Total Price of Assets

7,560,000

Less Cost 12.1 594,000

Ijarah Net Profit 59.34 972,000

Monthly Net Profit in % 1.648 16,022

Annual Profit in % 19.78 192,264


Morabaha Morabaha

First Form

Quantity Price Total Price LPO Amount 20.00 25,000.00 500,000.00 Bank Purchase 20.00 24,000.00 480,000.00 Margin 20.00 5,000.00 100,000.00

Bank Financing 20.00 19,000.00 380,000.00 Bank Sale 20.00 25,800.00 516,000.00

Arboon 20.00 5,000.00 100,000.00 Bank Profit 20.00 1,800.0 36,000.00

Sukuk into Morabaha Capital 50,000,000.00

Sukuk value 1,000.00 Total Sukuk 50,000.00 Per Sukuk Profit (362.00) DISCRIPTION AMOUNT TOTAL SUKUK PROIT EARN

SCAN GROUP 3,000,000.00 3,000.00 (1,086,000.00)

DELEX GROUP 4,000,000.00 4,000.00 (1,448,000.00)

FEDERAL INC 5,000,000.00 5,000.00 (1,810,000.00)

PAKISTAN HOUSE 6,000,000.00 6,000.00 (2,172,000.00)

KARACHI COMPANY 7,000,000.00 7,000.00 (2,534,000.00)

BMW 8,000,000.00 8,000.00 (2,896,000.00)

FORD GROUP 12,000,000.00 12,000.00 (4,344,000.00)

SPONSORS 5,000,000.00 5,000.00 (1,810,000.00)

TOTAL CAPITAL 50,000,000.00 50,000.00 (18,100,000.00)

MORABAHA

DISCRIPTION QUANTITY PRICE AMOUNT

LPO Amount 2,000.00 24,500.00 49,000,000.00

Transport 2,000.00 50.00 100,000.00

Income Tax 2,000.00 200.00 400,000.00

Selling Expenses 2,000.00 100.00 200,000.00

Clearing Expense 2,000.00 30.00 60,000.00

Warehousing 2,000.00 80.00 160,000.00

Packing 2,000.00 40.00 80,000.00

Total 2,000.00 25,000.00 50,000,000.00

Sales 1 1,000.00 16,000.00 16,000,000.00

Sales 2 1,000.00 15,900.00 15,900,000.00

Total Sales 2,000.00 15,950.00 31,900,000.00

Net Loss 1,000.00 (18,100.00) (18,100,000.00)


Sukuk into Ijarah FINANCIING AMOUNT RS.4,914,000 DIVIDED INTO SUKUK @ RS 100 EACH PURCHASE BY SUKUK HOLDERS 5%, 10%, 15%, 25%, 7%, 20%, 18%. FOR IJARAH FINANCING OF EQUIPMENT HAVING MARKET PRICE RS.5,400,000 WITH 5% INSURANCE, 6% TAX. THE SARIF AGREE ON 20% ARBOON AND GMI 30% ON rS.600,000 AND RESTRICTED THE RENTAL OVER INSTALLMENT TO MAXIMUM 35%. WORK OUT THE IJARAH SUKUK SHEET Capital

4,914,000

Sukuk Value

100.00 Number of Sukuk issued

49,140

Per Sukuk Profit

19.78 Sukuk Holders Ratio No of Sukuk Investment Profit

Mr. Hasan 5 2,457 245,700 48,600 Mr. Ahmed 10 4,914 491,400 97,200 Mr.Muhamad 15 7,371 737,100 145,800 Mr. Siddiqui 25 12,285 1,228,500 243,000 Mr. Kashif 7 3,440 343,980 68,040 Bank Islami 20 9,828 982,800 194,400 Financial Group 18 8,845 884,520 174,960 Total 100 49,140 4,914,000 972,000 IJARA Financing

Total Installment 36 Market Price

5,400,000

Yearly Insurance (In %) 5.0 270,000 Income Tax.(% ) 6.0 324,000 Cost of Vehicle

5,994,000

Equity (In %) 20.0 1,080,000 Ijarah Financing Amount

4,914,000

Installment for Ownership 36.0 136,500 Rentals in % of Installment 31.9 43,500 Total Monthly Payment 3.7 180,000 Gross Monthly Income

600,000

Monthly Affordability Amount 30.0 180,000 Monthly Saving in % 22.8 136,500 Monthly Expenses in % 7.3 43,500 Ijarah Financing Amount

4,914,000

Total Rents

1,566,000 Arboon

1,080,000

Total Price of Assets

7,560,000 Less Cost 12.1 594,000 Ijarah Net Profit 59.34 972,000 Monthly Net Profit in % 1.648 16,022 Annual Profit in % 19.78 192,264