islamic_banking_and_finance

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Ahadith Concerning Usury (Interest)

Sahih Al-Bukhari Hadith 7.829 Narrated by Abu Juhaifa The Prophet forbade the use of the priceof blood and the price of a dog, the one who takes (eats) usury the one who gives usury, the

woman who practises tattooing and the woman who gets herself tattooed.

Al-Tirmidhi Hadith 2828 Narrated byAbuHurayrah Allah's Messenger (peace be upon him) said,"On the night when I was taken up to Heaven I came upon people whose bellies were like housesand contained snakes which could be seen from outside their bellies. I asked Gabriel who theywere and he told me that they were people who had practised usury." Ahmad and Ibn Majahtransmitted it.

Al-Tirmidhi Hadith 2826 Narrated byAbuHurayrah Allah's Messenger (peace be upon him) said,"Usury has seventy parts, the least important being that a man should marry his mother." IbnMajah and Bayhaqi, transmitted it in Shu'ab al-Iman.

Al-Tirmidhi Hadith 2825 Narrated byAbdullah ibn Hanzalah ; Abdullah ibn Abbas Allah'sMessenger (peace be upon him) said, "A dirham which a man knowingly receives in usury ismore serious than thirty-six acts of fornication." Ibn Abbas's version adds that he said, "Hell ismore fitting for him whose flesh is nourished by what is unlawful." Ahmad and Daraqutnitransmitted it. Bayhaqi transmitted in Shu'ab al-Iman on the authority of Ibn Abbas.

Al-Muwatta Hadith 31.95 What Is Not Permitted of Free Loans Malik related to me that he hadheard that Abdullah ibn Masud used to say, "If someone makes a loan, they should not stipulatebetter than it. Even if it is a handful of grass, it is usury." Malik said, "The generally agreed onway of doing things among us is that there is no harm in borrowing any animals with a set

description and itemisation, and one must return the like of them. This is not done in the case offemale slaves. It is feared about that that it will lead to making halal what is not halal, so it is notgood. The explanation of what is disapproved of in that, is that a man borrow a slave-girl andhave intercourse with her as seems proper to him. Then he returns her to her owner. That is notgood and it is not halal. The people of knowledge still forbid it and do not give an indulgence toany one in it."

Sahih Al-Bukhari Hadith 7.259 Narrated byAbu Juhaifa The Prophet cursed the lady whopractices tattooing and the one who gets herself tattooed, and one who eats (takes) Riba' (usury)and the one who gives it. And he prohibited taking the price of a dog, and the money earned byprostitution, and cursed the makers of pictures.

Sahih Al-Bukhari Hadith 6.67 Narrated byIbn Abbas The last Verse (in the Qur'an) revealed tothe Prophet was the Verse dealing with usury (i.e. Riba).

Sahih Al-Bukhari Hadith 8.840 Narrated byAbu Huraira The Prophet said, "Avoid the sevengreat destructive sins." They (the people) asked, "O Allah's Apostle! What are they?" He said,"To join partners in worship with Allah; to practice sorcery; to kill the life which Allah hasforbidden except for a just cause (according to Islamic law); to eat up usury (Riba), to eat up the


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property of an orphan; to give one's back to the enemy and fleeing from the battlefield at the timeof fighting and to accuse chaste women who never even think of anything touching chastity andare good believers."

Sunan of Abu-Dawood Hadith 4858 Narrated bySa'id ibn Zayd The Prophet (peace be upon him)

said: The most prevalent kind of usury is going to lengths in talking unjustly against a Muslim'shonour.

Sahih Al-Bukhari Hadith 5.159 Narrated byAbu Burda When I came to Medina, I met Abdullahbin Salam. He said, "Will you come to me so that I may serve you with Sawiq (i.e. powderedbarley) and dates, and let you enter a (blessed) house that in which the Prophet entered?" Thenhe added, "You are in a country where the practice of Riba (i.e. usury) is prevalent; so ifsomebody owes you something and he sends you a present of a load of chopped straw or a loadof barley or a load of provender then do not take it, as it is Riba."

Sunan of Abu-Dawood Hadith 3327 Narrated byAbdullah ibn Mas'ud The Apostle of Allah

(peace be upon him) cursed the one who accepted usury, the one who paid it, the witness to it,and the one who recorded it.

Sunan of Abu-Dawood Hadith 3534 Narrated byAbuUmamah The Prophet (peace be upon him)said: If anyone intercedes for his brother and he presents a gift to him for it and he accepts it, heapproaches a great door of the doors of usury.

Sunan of Abu-Dawood Hadith 3325 Narrated byAbuHurayrah The Prophet (peace be upon him)said: A time is certainly coming to mankind when only the receiver of usury will remain, and ifhe does not receive it, some of its vapour will reach him. Ibn Isa said: Some of its dust will reachhim.

Al-Tirmidhi Hadith 2829 Narrated byAli ibn AbuTalib Ali heard Allah's Messenger (peace beupon him) curse those who took usury, those who paid it, those who recorded it, and those whorefused to give sadaqah. And he used to prohibit wailing. Nasa'i transmitted it.

Prophet Muhammad's Last Sermon This Sermon was delivered on the Ninth Day of Dhul Hijjah10 A.H in the Uranah Valley of mount Arafat. "O People, lend me an attentive ear, for I don'tknow whether, after this year, I shall ever be amongst you again. Therefore listen to what I amsaying to you carefully and take these words to those who could not be present here today. OPeople, just as you regard this month, this day, this city as Sacred, so regard the life and propertyof every Muslim as a sacred trust. Return the goods entrusted to you to their rightful owners.Hurt no one so that no one may hurt you. Remember that you will indeed meet your Lord, andthat He will indeed reckon your deeds. Allah has forbidden you to take usury (Interest), thereforeall interest obligation shall henceforth be waived... Beware of Satan, for your safety of yourreligion. He has lost all hope that he will ever be able to lead you astray in big things, so bewareof following him in small things. O People, it is true that you have certain rights with regard toyour women, but they also have right over you. If they abide by your right then to them belongsthe right to be fed and clothed in kindness. Do treat your women well and be kind to them forthey are your partners and comitted helpers. And it is your right that they do not make friends


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with any one of whom you do not approve, as well as never to commit adultery. O People, listento me in earnest, whorship Allah, say your five daily prayers (Salah), fast during the month ofRamadhan, and give your wealth in Zakat. Perform Hajj if you can afford to. You know thatevery Muslim is the brother of another Muslim. You are all equal. Nobody has superiority overother except by piety and good action. Remember, one day you will appear before Allah and

answer for your deeds. So beware, do not astray from the path of righteousness after I am gone.O People, no prophet or apostle will come after me and no new faith will be born. Reason well,therefore, O People, and understand my words which I convey to you. I leave behind me twothings, the Qur'an and my example, the Sunnah and if you follow these you will never go astray.All those who listen to me shall pass on my words to others and those to others again; and maythe last ones understand my words better than those who listen to me direcly. Be my witness ohAllah that I have conveyed your message to your people."

Al-Muwatta Hadith 31.84 Usury in DebtsMalik related to me that Zayd ibn Aslam said, "Usury in the Jahiliyya (days of ignorance - priorto Islam) was that a man would give a loan to a man for a set term. When the term was due, he

would say, 'Will you pay it off or increase me?' If the man paid, he took it. If not, he increasedhim in his debt and lengthened the term for him ." Malik said, "The disapproved way of doingthings, about which there is no dispute among us, is that a man should give a loan to a man for aterm, and then the demander reduce it and the one from whom it is demanded pay it in advance.To us that is like someone who delays repaying his debt after it is due to his creditor and hiscreditor increases his debt." Malik said, "This is nothing but usury. No doubt about it." Malikspoke about a man who loaned one hundred dinars to a man for two terms. When it was due, theperson who owed the debt said to him, "Sell me some goods, whose price is one hundred dinarsin cash for one hundred and fifty on credit." Malik said, "This transaction is not good, and thepeople of knowledge still forbid it." Malik said, "This is disapproved of because the creditorhimself gives the debtor the price of what the man sells him, and he defers repayment of thehundred of the first transaction for the debtor for the term which is mentioned to him in thesecond transaction, and the debtor increases him with fifty dinars for his deferring him. That isdisapproved of and it is not good. It also resembles the hadith of Zayd ibn Aslam about thetransactions of the people of the Jahiliyya. When their debts were due, they said to the personwith the debt, 'Either you pay in full or you increase it.' If they paid, they took it, and if not theyincreased debtors in their debts, and extended the term for them."

Islamic economic jurisprudence

Islamic economics refers to the body ofIslamic studies literature that "identifies and promotesan economic order that conforms to Islamic scripture and traditions," and in the economic worldan interest-free Islamic banking system, grounded in Sharia's condemnation ofinterest (Riba).The literature originated in "the late 1940s, and especially" after "the mid-1960s."[1] The bankingsystem developed during the 1970s.[2] Islamic economic literatures' central features have been


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called "behavioral norms" derived from the Quran and Sunna, zakat tax as the basis of Islamicfiscal policy andprohibition of interest.[1]

In Shia Islam, some scholars such as Mahmoud Taleghani, and Mohammad Baqir al-Sadr, havedeveloped an "Islamic economics" emphasizing the uplifting of the deprived masses, a major

role for the state in matters such as circulation and equitable distribution of wealth, and ensuringparticipants in the marketplace are rewarded for being exposed to risk and/or liability.

Islamist movements and authors generally describe an Islamic economic system as neitherSocialist norCapitalist, but a "third way" with none of the drawbacks of the other twosystems.[3][4]

History

Main article:Islamic economics in the world

Traditional Islamic concepts having to do with economics included

y zakat- the "taxing of certain goods, such as harvest, with an eye to allocating these taxesto expenditures that are also explicitly defined, such as aid to the needy."

y Gharar- "the interdiction of chance ... that is, of the presence of any element ofuncertainty, in a contract (which excludes not only insurance but also the lending ofmoney without participation in the risks)"

y Riba - "referred to as usury (modern Islamic economist have consensus that it does notrefer to usury only rather Riba is any kind of interest)" [5]

These concepts, like others in Islamic law, came from the "prescriptions, anecdotes, examples,

and words of Muhammad, all gathered together and systematized by commentators according toan inductive, casuistic method." [5] Sometimes other sources such as al-urf, (the custom), al-aql(reason) or al-ijma (consensus of the jurists) were employed.[6]

In addition, Islamic law has developed areas of law that correspond to secular laws ofcontractsand torts.

[edit] Early reforms under Islam

Main article:Early reforms under Islam

Some argue early Islamic theory and practice formed a "coherent" economic system with "ablueprint for a new order in society, in which all participants would be treated more fairly".Michael Bonner, for example, has written that an "economy of poverty" prevailed in Islam until13th and 14th century. Under this system God's guidance made sure the flow of money andgoods was "purified" by being channeled from those who had much of it to those who had littleby encouraging zakat (tax) and discouraging riba (usury/interest) on loans. Bonner maintainsMuhammad also helped poor traders by allowing only tents, not permanent buildings in themarket of Medina, and not charging fees and rents there.[7]


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[edit] Classical Muslim economic thought


To some degree, the early Muslims based theireconomic analyses on the Qur'an (such as

opposition to riba, meaning usury/interest), and from sunnah, the sayings and doings ofMuhammad.

Perhaps the most well known Islamic scholar who wrote about economics was Ibn Khaldun(13321406),[8] who is considered a father of modern economics.[9][10] Ibn Khaldun wrote oneconomic and political theory in the introduction, orMuqaddimah (Prolegomena), of hisHistoryof the World(Kitab al-Ibar). In the book, he discussed what he called asabiyya (social cohesion),which he sourced as the cause of some civilizations becoming great and others not. Ibn Khaldunfelt that many social forces are cyclic, although there can be sudden sharp turns that break thepattern.[11]

His idea about the benefits of the division of laboralso relate to asabiyya, the greater the socialcohesion, the more complex the successful division may be, the greater the economic growth. Henoted that growth and development positively stimulates both supply and demand, and that theforces of supply and demand are what determines the prices of goods.[12] He also notedmacroeconomic forces of population growth, human capital development, and technologicaldevelopments effects on development.[13] In fact, Ibn Khaldun thought that population growthwas directly a function of wealth.[14]

Other important early Muslim scholars who wrote about economics include Abu Hanifah, AbuYusuf(731-798), Ishaq bin Ali al-Rahwi (854931), al-Farabi (873950), Qabus (d. 1012), IbnSina (Avicenna) (9801037), Ibn Miskawayh (b. 1030), al-Ghazali (10581111), al-Mawardi

(10751158),Nasr al-Dn al-Ts(12011274), Ibn Taimiyah (12631328) and al-Maqrizi.

[edit] Economy in the Caliphate

During the Arab Agricultural Revolution, a social transformation took place as a result ofchanging land ownership giving individuals of any gender,[15]ethnic orreligious background theright to buy, sell, mortgage and inherit land. Based on the Quran, signatures were required oncontracts for majorfinancial transactions concerning agriculture, industry, commerce, andemployment. Copies of the contract were usually kept by both parties involved.

There are similarities between Islamic economics and leftist orsocialist economic policies.

Islamic jurists have argued that privatization of the origin of oil, gas, and other fire-producingfuels, agricultural land, and water is forbidden. The principle of public or joint ownership hasbeen drawn by Muslim jurists from the following hadith of the Prophet of Islam:

Ibn Abbas reported that Muhammad said: "AllMuslims are partners in three things- in water,herbage and fire."(Narrated in Abu Daud, & Ibn Majah) [4] Anas added to the above hadith, "Itsprice is Haram (forbidden)"[16] Jurists have argued by qiyas that the above restriction onprivatization can be extended to all essential resources that benefit the community as a whole.[17]


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Aside from similarities to socialism, early forms of proto-capitalism and free markets werepresent in the Caliphate.[18] An early market economy and early form ofmerchant capitalismdeveloped between the 8th and 12th centuries.[19] A vigorous monetary economy developedbased on the wide circulation of a common currency (the dinar) and the integration of previouslyindependent monetary areas. Business techniques and forms ofbusiness organization employed

during this time included early contracts,bills of exchange, long-distance international trade,early forms ofpartnership (mufawada) such as limited partnerships (mudaraba), and early formsof credit, debt, profit, loss, capital (al-mal), capital accumulation (nama al-mal),[20]circulatingcapital, capital expenditure, revenue, cheques,promissory notes,[21]trusts (waqf), savingsaccounts, transactional accounts, pawning, loaning, exchange rates, bankers, money changers,ledgers, deposits, assignments, the double-entry bookkeeping system,[22] and lawsuits.[23]Organizationalenterprises similar to corporations independent from the state also existed in themedieval Islamic world.[24][25] Many of these concepts were adopted and further advanced inmedieval Europe from the 13th century onwards.[20]

The concepts ofwelfare andpension were present in early Islamic law as forms ofZakatone of

the Five Pillars of Islam, since the time of the Rashidun caliphUmarin the 7th century. Thetaxes (includingZakatandJizya) collected in the treasury (Bayt al-mal) of an Islamicgovernment were used to provide income for the needy, including the poor, the elderly, orphans,widows, and the disabled. According to the Islamic jurist Al-Ghazali (Algazel, 10581111), thegovernment was also expected to stockpile food supplies in every region in case a disaster orfamine occurred. The Caliphate was thus one of the earliest welfare states.[26][27]

[edit] Post-colonial era

During the modernpost-colonial era, as Western ideas, including Western economics, began toinfluence the Muslim world, some Muslim writers sought to produce an Islamic discipline of

economics. Because some Islamic scholars consider Islam more than a spiritual formula to acomplete system of life in all its walks, [28] these writers believed that it should logically followthat Islam also had its own economic system unique from and superior to non-Islamic systems.[7]To date, however, there have been no agreement as to the methodological definition and scope ofIslamic Economics.

In the 1960s and 70s Shia Islamic thinkers worked to develop a unique Islamic economicphilosophy with "its own answers to contemporary economic problems." Several works wereparticularly influential,

y Eslam va Malekiyyat(Islam and Property) by Mahmud Taleqani (1951),y N

idham ul-Iqtisad fil Islam (The Economic System of Islam) by Taqiuddin Nabhani(1953),y Iqtisaduna (Our Economics) by Mohammad Baqir al-Sadr(1961) andy Eqtesad-e Towhidi (The Economics of Divine Harmony) by Abolhassan Banisadr(1978)y Some Interpretations of Property Rights, Capital and Labor from Islamic Perspective by

Habibullah Peyman (1979).[29][30]


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Al-Sadr in particular has been described as having "almost single-handedly developed the notionof Islamic economics" [31]

In their writings Sadr and the other authors "sought to depict Islam as a religion committed tosocial justice, the equitable distribution of wealth, and the cause of the deprived classes," with

doctrines "acceptable to Islamic jurists", while refuting existing non-Islamic theories ofcapitalism and Marxism. This version of Islamic economics, which influenced the IranianRevolution, called for public ownership of land and of large "industrial enterprises," whileprivate economic activity continued "within reasonable limits." [32] These ideas helped shape thelarge public sector and public subsidy policies of the Iranian Revolution.

In the 1980s and 1990s, as the Islamic revolution failed to reach the per capita income levelachieved by the regime it overthrew, and Communist states and socialist parties in the non-Muslim world turned away from socialism, Muslim interest shifted away from governmentownership and regulation. In Iran, it is reported that "eqtesad-e Eslami (meaning both Islamiceconomics and economy) ... once a revolutionary shibboleth, is indubitably absent in all official

documents and the media. It disapperared from Iranian political discourse about 15 years ago[1990]." [30]

But in other parts of the Muslim world the term lived on, shifting form to the less ambitious goalof interest-free banking. Some Muslim bankers and religious leaders suggested ways to integrateIslamic law on usage of money with modern concepts ofethical investing. In banking this wasdone through the use of sales transactions (focusing on the fixed rate return modes) to achievesimilar results to interest. This has been heavily criticized by many modern writers as a means ofcovering conventional banking with an Islamic facade.

[edit] Traditional approach

While many Muslims believe Islamic law is perfect by virtue of its being revealed by God,Islamic law on economic issues was/is not "economics" in the sense of a systematic study ofproduction, distribution, and consumption of goods and services. An example of the traditionalistulama approach to economic issues is Imam Khomeini's workTawzih al-masa'ilwhere the term`economy` does not appear and where the chapter on selling and buying (Kharid o forush) comesafter the one on pilgrimage. As Olivier Roy puts it, the work "presents economic questions asindividual acts open to moral analysis: `To lend [without interest, on a note from the lender] isamong the good works that are particularly recommended in the verses of the Quran and the inthe Traditions.`" [33]

[edit] Property

The Qur'an states that God is the sole owner of all matter in the heavens and the earth.[34] Man,however, is God's viceregent on earth and holds God's possessions in trust (amanat). Islamicjurists have divided properties into three categories:[35]

y Public propertyy State property


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y Private property[edit] Public property

Public property in Islam refers to natural resources (forests,pastures, uncultivated land, water,

mines, oceanic resources etc.) over which all humans have equal right. Such resources areconsidered the common property of the community. Such property is placed under theguardianship and control of the Islamic state, and can be utilized by any citizen, as long as it doesnot undermine the right of other citizens over it.[35]

Some types of public property can not be privatized under Islamic law. Muhammad's saying that"people are partners in three things: water, fire and pastures", has led some scholars to believethat the privatization ofwater, energy and agricultural land is not permissible. Other types ofpublic property, such as gold mines, were allowed by Muhammad to be privatized, in return fortaxes to the Islamic state. The owner of the previously public property that was privatized has topay zakat and, according Shiite scholars, khums as well. In general theprivatization and

nationalization of public property is subject to debate amongst Islamic scholars. Public propertythus, eventually, becomes state or private property.[35]

[edit] State property

State property includes certain natural resources, as well as other property that can't immediatelybe privatized. Islamic state property can be movable, or immovable, can be acquired throughconquest, or peaceful means. Unclaimed, unoccupied and heir less properties, includinguncultivated land (mawat), can be considered state property.[35]

During the life of Muhammad, one fifth of military equipment captured from the enemy in the

battlefield was considered state property. During his reign, Umar(on the recommendation ofAli)considered conquered land to be state property, instead of private property (as was usualpractice). The reason for this was that privatizing this property would concentrate resources inthe hands of a few, and prevent this property from being used for the general good of thecommunity. The property remained under the occupation of the cultivators, but the taxescollected on it went to the state treasury.[35]

Muhammad said "Old and fallow lands are for God and His Messenger (i.e. state property), thenthey are for you". Jurists draw from this the conclusion that, ultimately, private ownership takesover state property.[35]

[edit] Private property

There is consensus amongst Islamic jurists and social scientists that Islam recognizes andupholds the individual's right to private ownership. The Qur'an extensively discusses taxation,inheritance, prohibition against stealing, legality of ownership, recommendation to give charityand other topics related to private property. Islam also guarantees the protection of privateproperty by imposing stringent punishments on thieves. Muhammad said that he who diesdefending his property was like a martyr.[36]


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Islamic economists have classified the acquisition of private property into three categories:involuntary, contractual and non-contractual. Involuntary means are inheritance, bequests, andgifts. Non-contractual is acquisition involves the collection and exploitation of natural resourcesthat have not previously been claimed as private property. Contractual acquisition includesactivities such as trading, buying, renting, hiring labor etc.[36]

A tradition attributed to Muhammad, with which both Sunni and Shi'ite jurists agree, in caseswhere the right to private ownership causes harm to others, then Islam is in favor of curtailingthe right in those cases. Maliki and Hanbali jurists argue that if private ownership endangerspublic interest, then the state can limit the amount an individual is allowed to own. This view,however, is debated by others.[36]

[edit] Market

Islam accepts markets as the basic co-ordinating mechanism of the economic system. Islamicteaching holds that the market, through perfect competition, allows consumers to obtain desired

goods, producers to sell their goods, at a mutually acceptable price.[37]

The three necessary conditions for an operational market are said to be upheld in Islamic primarysources:[37]

y Freedom of exchange: the Qur'an calls on believers to engage in trade, and rejects thecontention that trade is forbidden.[38]

y Private ownership (see above).y Security of contract: the Qur'an calls for the fulfillment and observation of contracts.[39]

The longest verse of the Qur'an deals with commercial contracts involving immediate andfuture payments.[40]

[edit] Interference

Islam promotes a market free from interferences such asprice fixing and hoarding. Governmentintervention, however, is tolerated under specific circumstances.[37]

Islam prohibits the fixation of a price by a handful of buyers or sellers who have becomedominant in the market. During the days ofMuhammad, a small group of merchants used tomeet agricultural producers outside the city and bought the entire crop, thereby gainingmonopoly over the market. The produce was later sold at a higher price within the city.Muhammad condemned this practice since it caused injury both to the producers (who in the

absence of numerous customers were forced to sell goods at a lower price) and the inhabitants ofMedina.[37]

The above mentioned reports are also used to justify the argument that the Islamic market ischaracterized by free information. Producers and consumers should not be denied information ondemand and supply conditions. Producers are expected to inform consumers of the quality andquantity of goods they claim to sell. Some scholars hold that if an inexperienced buyer is swayed


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by the seller, the consumer may nullify the transaction upon realizing the seller's unfairtreatment. The Qur'an also forbids discriminatory means of transaction.[37][41]

Government interference in the market is justified in exceptional circumstances, such as theprotection of public interest. Under normal circumstances, government non-interference should

be upheld. When Muhammad was asked to set the price of goods in a market he responded, "Iwill not set such a precedent, let the people carry on on with their activities and benefitmutually."[37]

[edit] Monetary & Fiscal Policy

Monetary and fiscal policy can include developments both for a state in transition to an Islamicmodel as well as when it reaches equilibrium.[42]

[edit] In Equilibrium

Monetary policy emphasizes keeping inflation towards a theoretical zero percent. The value ofthe currency being maintained according to a basket of goods and services that is reflective of theeconomy as well as the value of a basket of currencies that would be represented by their level oftrade with the Islamic state. The proportion of the two being weighted to the proportion offoreign trade to domestic consumption. This parallels classical and neo-classical ideals.

Money Supply expansion is indexed directly to the population rather than through banking, toavoid an unfair benefit to banking at the cost of the populace. Regulatory creep, conflict ofinterest and political interference is avoided by a proposed independence of banking and thestatistical authority.[42]

[edit] In Transition

Gradual transition is preferred over drastic change, calling for a transitional state similar toCommunism's transitional state of Socialism. Impairment of banking, staggered increases inreserve ratios and a gradual approach in the general regulatory framework is consideredpreferable.[42]

A Keynesian fiscal policy is called for to counteract the fall in the money supply caused by thetransitionary policies. Timing and proportion is seen as critical to the success of such atransition.[42]

[edit] Banking

Main article:Islamic banking

[edit] Interest


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The Quran (3: 130) clearly condemns what it calls by the Arabic term "riba," usually translated"interest": "O, you who believe! Devour not riba, doubled and redoubled, and be careful ofAllah; haply so you will prosper."

[edit] Debt arrangements

Most Islamic economic institutions advise participatory arrangements between capital and labor.The latter rule reflects the Islamic norm that the borrower must not bear all the cost of a failure,as "it is God who determines that failure, and intends that it fall on all those involved."

Conventional debt arrangements are thus usually unacceptable - but conventional ventureinvestment structures are applied even on very small scales. However, not every debtarrangement can be seen in terms of venture investment structures. For example, when a familybuys a home it is not investing in a business venture - a person's shelter is not a business venture.Similarly, purchasing other commodities for personal use, such as cars, furniture, and so on,cannot realistically be considered as a venture investment in which the Islamic bank shares risks

and profits for the profits of the venture.

[edit] Savings-Investment

An alternative Islamic savings-investment model can be built around: 1. Venture capital firms; 2.Investment banks; 3. Restructured corporations; and 4. Restructured stock market.[42] This modellooks at removing the interest-based banking and in replacing market inefficiencies such assubsidization of loans over profit-sharing investments due to double taxation and restrictions oninvestment in private equity.

[edit] Money changers

Due to religious sanctions against odious debt, Tamil Muslims have historically been moneychangers (not money lenders) throughout South and South East Asia.[43]

[edit] Natural capital

Perhaps due to resource scarcity in most Islamic nations, this form of economics also emphasizeslimited (and some claim also sustainable) use ofnatural capital, i.e. producing land. These latterrevive traditions ofharam and hima that were prevalent in early Muslim civilization.

[edit] WelfareSocial welfare, unemployment,public debt and globalization have been re-examined from theperspective of Islamic norms and values. Islamic banks have grown recently in the Muslim worldbut are a very small share of the global economy compared to the Western debt bankingparadigm. It remains to be seen[vague] if they will find niches - although hybrid approaches, e.g.Grameen Bankwhich applies classical Islamic values but uses conventional lending practices,are much lauded by some proponents of modern human development theory.


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[edit] Islamic stocks

In June 2005 Dow Jones Indexes,New York, and RHB Securities, Kuala Lumpur, teamed up tolaunch a new "Islamic Malaysia Index" a collection of 45 stocks representing Malaysiancompanies that comply with a variety of Sharia-based criteria. Three variables (the total debt of

an indexed company, its total cash plus interest-bearing securities and its accounts receivables)must each be less than 33% of the trailing 12-month average capitalization, for example.[citationneeded] Islamic bonds, or sukuk, use asset returns to pay investors to comply with the religionsban on interest and are currently traded privately on the over-the-counter market. In lateDecember 2009 Bursa Malaysia announced it was considering enabling individuals to tradeShariah- compliant debt on its exchange as part of a plan to attract new investors to thesecurities.[44]

[edit] Economic Modeling & a New Science of Muslim

Economics

Economic modeling in an Islamic context looks to find alternative variables and parameters. Forinstance, many of the key models in modern economic theory have interest (riba) as a keyelement. According to one author, Tobin's q could be a replacement for interest. Islamiceconomics still needs pioneers to create the building blocks of Islamic econometrics.[42]

[edit] Popularity and availability


Today there are many financial institutions, even in the Western world, offering financialservices and products in accordance with the rules of the Islamic finance. For example, legalchanges introduced by ChancellorGordon Brown in 2003, have enabled British banks andbuilding societies to offer so-called Muslim mortgages for house purchase.

In 2004 the UK's first stand alone Sharia'a compliant bank was launched, the Islamic Bank ofBritain. Several banks offer products and services to its UK customers that utilise the Islamicfinancial principles; such as Mudaraba, Murabaha, Musharaka and Qard.

The Islamic finance sector was worth between 300 and 500 billion dollars (237 and 394 billioneuros) as of September 2006, compared with 200 billion dollars in 2004. The number of Islamic

retail banks and investment funds number in their hundreds and many Western financialinstitutions offer products that comply with Sharia law, including Citigroup, Deutsche Bank,HSBC, Lloyds TSB and UBS. In 2008, at least $500 billion in assets around the world weremanaged in accordance with Sharia, or Islamic law, and the sector was growing at more than10% per year. Islamic finance seeks to promote social justice by banning exploitative practices.In reality, this boils down to a set of prohibitionson paying interest, on gambling withderivatives and options, and on investing in firms that make pornography or pork.[45]


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[edit] Business Method Patents

With the recent ability topatentnew methods of doing business in the United States, a smallnumber ofpatent applications have been filed on methods for providing Sharia compliantfinancial services. These pending patent applications include:

y US US20030233324A1Declining balance co-ownership financing arrangement. Thisdiscloses an allegedly Sharia compliant financing arrangement for home purchases andrefinances that does not involve the payment of interest.

y WO WO06068837A2[dead link]Controlling a Computer System Enabling Sharia-Compliant Financing. This discloses an improved computer system for carrying outSharia compliant financial transactions.

[edit] Views

Sohrab Behada's study argued that the economic system proposed by Islam is essentially acapitalist one.[46]

[edit] Criticism

Its popularity notwithstanding, critics of Islamic economics have not been sparing. It has beenattacked for its alleged "incoherence, incompleteness, impracticality, and irrelevance;" [47] drivenby "cultural identity" rather thanproblem solving.[48] Others have dismissed it as "a hodgepodgeof populist and socialist ideas," in theory and "nothing more than inefficient state control of theeconomy and some almost equally ineffective redistribution policies," in practice.[49]

In a political and regional context where Islamist and ulema claim to have an opinion abouteverything, it is striking how little they have to say about this most central of human activities,beyond repetitious pieties about how their model is neithercapitalist norsocialist.[49]

Interest-bearing (Riba) and speculation-involving (Gharar) trading are clearly prohibited byexplicit canonical texts. Based on this prohibition, presumably financial structures of all theIslamic products should be interest and speculation free. Nevertheless, some new empiricalstudies hypothesize that Islamic finance products structure is based on the Islamic prohibitions;however, these products risk management is still based on revoking the underlyingprohibitions. The most prominent case here is Islamic financial market products such as, interalia, Salam and Istisna these products are used are hedging methods for the Islamic bonds

known as Sukuk. If Sukuks originator or investors wish to hedge against interest rate orexchange rate risks, then they have to use one of the former methods. These methods as theyoriginally mimic the conventional risk management practice, should involve either interest-bearing or speculation-bearing trading or even both. There have been some innovations that tryto avoid falling in interest-based and/or speculation based transactions. Parallel Salam andsynthetics are some of the more recent.[citation needed]


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Islamic banking

Also known as participant banking Islamic banking refers to a system ofbanking or bankingactivity that is consistent with the principles ofIslamic law (Sharia) and its practical applicationthrough the development ofIslamic economics. Sharia prohibits the payment or acceptance ofinterest fees for loans of money (Riba, usury), for specific terms, as well as investing inbusinesses that provide goods or services considered contrary to its principles (Haraam,forbidden). While theseprinciples were used as the basis for a flourishing economy in earliertimes, it is only in the late 20th century that a number of Islamic banks were formed to applythese principles toprivate or semi-private commercial institutions within the Muslimcommunity.[citation needed]

History of Islamic banking

[edit] Introduction

During the Islamic Golden Age, early forms of proto-capitalism and free markets were present inthe Caliphate,[1] where an early market economy and an early form ofmercantilism weredeveloped between the 8th-12th centuries, which some refer to as "Islamic capitalism".[2] Avigorous monetary economy was created on the basis of the expanding levels ofcirculation of astable, high-value currency (the dinar) and the integration ofmonetary areas that were previouslyindependent.

A number of economic concepts and techniques were applied in early Islamic banking, includingbills of exchange, the first forms ofpartnership (mufawada) such as limited partnerships(mudaraba), and the earliest forms ofcapital (al-mal), capital accumulation (nama al-mal),[3]cheques,promissory notes,[4]trusts (see Waqf),[5]transactional accounts, loaning, ledgers andassignments.[6]Organizationalenterprises independent from the state also existed in the medievalIslamic world, while the agency institution was also introduced during that time.[7][8] Many ofthese early capitalist concepts were adopted and further advanced in medieval Europe from the13th century onwards.[3]

[edit] Riba

The word "Riba" means excess, increase or addition, which according to Shariah terminology,implies any excess compensation without due consideration (consideration does not include timevalue of money). The definition ofriba in classical Islamic jurisprudence was "surplus valuewithout counterpart", or "to ensure equivalency in real value", and that "numerical value wasimmaterial." During this period, gold and silvercurrencies were the benchmark metals thatdefined the value of all other materials being traded. Applying interest to the benchmark itself(ex natura sua) made no logical sense as its value remained constant relative to all othermaterials: these metals could be added to but not created (from nothing).


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Applying interest was acceptable under some circumstances. Currencies that were based onguarantees by a government to honor the stated value (i.e. fiat currency) or based on othermaterials such as paper orbase metals were allowed to have interest applied to them.[9] Whenbase metal currencies were first introduced in the Islamic world, the question of "paying a debt ina higher number of units of thisfiatmoney being riba" was not relevant as the jurists only

needed to be concerned with the real value of money (determined by weight only) rather than thenumerical value. For example, it was acceptable for a loan of 1000 gold dinars to be paid back as1050 dinars of equal aggregate weight (i.e., the value in terms of weight had to be same becauseall makes of coins did not carry exactly similar weight)..

[edit] Modern Islamic banking

Interest-free banking seems to be of very recent origin. The earliest references to thereorganisation of banking on the basis of profit sharing rather than interest are found in AnwarQureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followedby a more elaborate exposition by Mawdudi in 1950.[citation needed] The writings of Muhammad

Hamidullah 1944, 1955, 1957 and 1962 should be included in this category.[citation needed]

Theyhave all recognised the need for commercial banks and their perceived "necessary evil," haveproposed a banking system based on the concept of Mudarabha - profit and loss sharing.[citationneeded]

In the next two decades interest-free banking attracted more attention, partly because of thepolitical interest it created in Pakistan and partly because of the emergence of young Muslimeconomists. Works specifically devoted to this subject began to appear in this period. The firstsuch work is that of Muhammad Uzair (1955).[citation needed] Another set of works emerged in thelate sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.[citation needed]

The early 1970s saw institutional involvement. The Conference of the Finance Ministers of theIslamic Countries held in Karachi in 1970, the Egyptian study in 1972, the First InternationalConference on Islamic Economics in Mecca in 1976, and the International Economic Conferencein London in 1977 were the result of such involvement. The involvement of institutions andgovernments led to the application of theory to practice and resulted in the establishment of thefirst interest-free banks. The Islamic Development Bank, an inter-governmental bank establishedin 1975, was born of this process.[10]

The first modern experiment with Islamic banking was undertaken in Egypt under cover withoutprojecting an Islamic imagefor fear of being seen as a manifestation of Islamic

fundamentalism that was anathema to the political regime.

[citation needed]

The pioneering effort, ledby Ahmad Elnaggar, took the form of a savings bank based on profit-sharing in the Egyptiantown ofMit Ghamrin 1963. This experiment lasted until 1967 (Ready 1981), by which timethere were nine such banks in country.[11]

This section requires expansion.


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In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, currently, isstill in business in Egypt. In 1975, the Islamic Development Bankwas set-up with the mission toprovide funding to projects in the member countries. The first modern commercial Islamic bank,Dubai Islamic Bank, opened its doors in 1975. In the early years, the products offered were basicand strongly founded on conventional banking products, but in the last few years the industry is

starting to see strong development in new products and services.

Islamic Banking is growing at a rate of 10-15% per year and with signs of consistent futuregrowth.[12] Islamic banks have more than 300 institutions spread over 51 countries, including theUnited States through companies such as the Michigan-based University Bank, as well as anadditional 250 mutual funds that comply with Islamic principles. It is estimated that overUS$822 billion worldwide sharia-compliant assets are managed according to The Economist.[13]This represents approximately 0.5% of total world estimated assets as of 2005.[14] According toCIMB Group Holdings, Islamic finance is the fastest-growing segment of the global financialsystem and sales of Islamic bonds may rise by 24 percent to $25 billion in 2010.[15]

The Vatican has put forward the idea that "the principles of Islamic finance may represent apossible cure for ailing markets."[16]

[edit] Largest Islamic banks

Shariah-compliant assets reached about $400 billion throughout the world in 2009, according toStandard & Poors Ratings Services, and the potential market is $4 trillion.[17][18]Iran, SaudiArabia and Malaysia have the biggest sharia-compliant assets.[19]

In 2009 Iranian banks accounted for about 40 percent of total assets of the world's top 100Islamic banks. Bank Melli Iran, with assets of $45.5 billion came first, followed by Saudi

Arabia's Al Rajhi Bank, Bank Mellat with $39.7 billion and Bank Saderat Iran with $39.3billion.[20][21] Iran holds the world's largest level of Islamic finance assets valued at $235.3bnwhich is more than double the next country in the ranking with $92bn. Six out of ten top Islamicbanks in the world are Iranian.[22][23][24] In November 2010, The Bankerpublished its latestauthoritative list of the Top 500 Islamic Finance Institutions with Iran topping the list. Seven outof ten top Islamic banks in the world are Iranian according to the list.[25] you can find moreinformation specially in persian in www.islamicfinance.ir

[edit] Principles

Islamic banking has the same purpose as conventional banking except that it operates in

accordance with the rules ofShariah, known as Fiqh al-Muamalat(Islamic rules ontransactions). The basic principle of Islamic banking is the sharing of profit and loss and theprohibition ofriba (usury). Common terms used in Islamic banking includeprofit sharing(Mudharabah), safekeeping (Wadiah),joint venture (Musharakah), cost plus (Murabahah), andleasing (Ijar).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, abank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while


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allowing the buyer to pay the bank in installments. However, the bank's profit cannot be madeexplicit and therefore there are no additional penalties for late payment. In order to protect itselfagainst default, the bank asks for strict collateral. The goods or land is registered to the name ofthe buyer from the start of the transaction. This arrangement is called Murabaha. Anotherapproach isEIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loans

for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor andthen retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower form apartnership entity, both providing capital at an agreed percentage to purchase the property. Thepartnership entity then rents out the property to the borrower and charges rent. The bank and theborrower will then share the proceeds from this rent based on the current equity share of thepartnership. At the same time, the borrower in the partnership entity also buys the bank's share ofthe property at agreed installments until the full equity is transferred to the borrower and thepartnership is ended. If default occurs, both the bank and the borrower receive a proportion of the

proceeds from the sale of the property based on each party's current equity. This method allowsfor floating rates according to the current market rate such as the BLR (base lending rate),especially in a dual-banking system like in Malaysia.

There are several other approaches used in business transactions. Islamic banks lend their moneyto companies by issuing floating rate interest loans. The floating rate of interest is pegged to thecompany's individual rate of return. Thus the bank's profit on the loan is equal to a certainpercentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba isventure capital funding of an entrepreneur who provides labor while financing is provided by thebank so that both profit and risk are shared. Such participatory arrangements between capital andlaborreflect the Islamic view that the borrower must not bear all the risk/cost of a failure,resulting in a balanced distribution of income and not allowing lender to monopolize theeconomy.

Islamic banking is restricted to Islamically acceptable transactions, which exclude thoseinvolving alcohol, pork, gambling, etc. The aim of this is to engage in only ethical investing, andmoral purchasing.

In theory, Islamic banking is an example offull-reserve banking, with banks achieving a 100%reserve ratio.[26] However, in practice, this is not the case, and no examples of 100 per centreserve banking are observed.[27]

Islamic banks have grown recently in the Muslim world but are a very small share of the globalbanking system. Micro-lending institutions founded by Muslims, notably Grameen Bank, useconventional lending practices and are popular in some Muslim nations, especially Bangladesh,but some do not consider them true Islamic banking. However, Muhammad Yunus, the founderof Grameen Bank and microfinance banking, and other supporters of microfinance, argue thatthe lack ofcollateral and lack of excessive interest in micro-lending is consistent with the Islamicprohibition ofusury (riba).[28][29]


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[edit] Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBSbanks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensurethat the operations and activities of the banking institutions comply with Shariah principles. On

the other hand, there are also those who believe that no form of banking that involves interestpayments can ever comply with the Shariah.[30]

In Malaysia, the National Shariah Advisory Council, which has been set up at Bank NegaraMalaysia (BNM), advises BNM on the Shariah aspects of the operations of these institutions andon their products and services. (See: Islamic banking in Malaysia). In Indonesia the UlamaCouncil serves a similar purpose.

A number of Shariah advisory firms have now emerged to offer Shariah advisory services to theinstitutions offering Islamic financial services. Issue of independence, impartiality and conflictsof interest have also been recently voiced. The WDIBFWorld Database for Islamic Banking and

Finance has been developed to provide information about all the websites related to this type ofbanking.[31]

[edit] Fundamentals of Islamic finance

The term Islamic banking refers to a system of banking or banking activity that is consistentwith Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamiclaw prohibits usury, the collection and payment of interest, also commonly called riba in Islamicdiscourse. In addition, Islamic law prohibits investing in businesses that are considered unlawful,or haraam (such as businesses that sell alcohol or pork, or businesses that produce media such as

gossip columns or pornography, which are contrary to Islamic values). In the late 20th century, anumber of Islamic banks were created to cater to this particular banking market.

[edit] Usury in Islam

The criticism of usury in Islam was well established during the Prophet Muhammad (S.A.W) lifeand reinforced by several of verses in the Quran dating back to around 600 AD. The originalword used for usury in this text was Riba, which literally means excess or addition. This wasaccepted to refer directly to interest on loans so that, according to Islamic economists Choudhuryand Malik (1992), by the time of Caliph Umar, the prohibition of interest was a well-establishedworking principle integrated into the Islamic economic system. This interpretation of usury has

not been universally accepted or applied in the Islamic world. A school of Islamic thought whichemerged in the 19th Century, led by Sir Sayyed, argues for an interpretative differentiationbetween usury, or consumptional lending, and interest, or lending for commercial investment(Ahmed, 1958). Nevertheless, Choudhury and Malik provide evidence for a gradual evolutionof the institutions of interest-free financial enterprises across the world (1992: 104). They cite,for instance, the current existence of financial institutions in Iran, Pakistan and Saudi Arabia, theDar-al-Mal-al-Islami in Geneva and Islamic trust companies in North America. This growing


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practice of Islamic banking will be discussed more fully in a later section as a modernapplication of usury prohibition.

[edit] Islamic financial transaction terminology

Bai' al 'inah (sale and buy-back agreement)

Bai' al inah is a financing facility with the underlying buy and sell transactions between thefinancier and the customer. The financier buys an asset from the customer on spot basis. Theprice paid by the financier constitutes the disbursement under the facility. Subsequently the assetis sold to the customer on a deferred-payment basis and the price is payable in installments. Thesecond sale serves to create the obligation on the part of the customer under the facility. Thereare differences of opinion amongst the scholars on the permissibility of Bai' al 'inah, howeverthis is practised in Malaysia (A set of strict conditions must be complied) and the likejurisdictions.[32][33]

[edit] Bai' bithaman ajil (deferred payment sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes aprofit margin agreed to by both parties. Like Bai' al 'inah, this concept is also used under anIslamic financing facility. Interest payment can be avoided as the customer is paying the saleprice which is not the same as interest charged on a loan. The problem here is that this includeslinking two transactions in one which is forbidden in islam. The common perception is that thisis simply straightforward charging of interest disguised as a sale

[edit] Bai' muajjal (credit sale)

Literally bai' muajjalmeans a credit sale. Technically, it is a financing technique adopted byIslamic banks that takes the form ofmurabahah muajjal. It is a contract in which the bank earnsa profit margin on the purchase price and allows the buyer to pay the price of the commodity at afuture date in a lump sum or in installments. It has to expressly mention cost of the commodityand the margin of profit is mutually agreed. The price fixed for the commodity in such atransaction can be the same as the spot price or higher or lower than the spot price. Bai' muajjalis also called a deferred-payment sale. However, one of the essential descriptions of riba is anunjustified delay in payment or either increasing or decreasing the price if the payment isimmediate or delayed.

[edit] Musharakah

Musharakah (joint venture) is an agreement between two or more partners, whereby each partnerprovides funds to be used in a venture. Profits made are shared between the partners according tothe invested capital. In case of loss, each partner loses capital in the same ratio. If the Bankprovides capital, the same conditions apply. It is this financial risk, according to the Shariah, thatjustifies the bank's claim to part of the profit. Each partner may or may not participate in carryingout the business. A working partner gets a greater profit share compared to a sleeping (non-


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working) partner. The difference between Musharaka and Madharaba is that, in Musharaka, eachpartner contributes some capital, whereas in Madharaba, one partner, e.g. A financial institution,provides all the capital and the other partner, the entrepreneur, provides no capital. Note thatMusharaka and Madharaba commonly overlap.[34]

[edit] Mudarabah

"Mudarabah" is a special kind of partnership where one partner gives money to another forinvesting it in a commercial enterprise. The investment comes from the first partner who is called"rabb-ul-mal", while the management and work is an exclusive responsibility of the other, who iscalled "mudarib".

The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capitaland the other party providing its specialist knowledge to invest the capital and manage theinvestment project. Profits generated are shared between the parties according to a pre-agreedratio. Compared to Musharaka, in a Mudaraba only the lender of the money has to take losses.

[edit] Murabahah

Main article: Murabahah

This concept refers to the sale of goods at a price, which includes a profit margin agreed to byboth parties. The purchase and selling price, other costs, and the profit margin must be clearlystated at the time of the sale agreement. The bank is compensated for the time value of its moneyin the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (suchas real estate or a vehicle), with a fixed rate of profit determined by the profit margin. The bankis not compensated for the time value of money outside of the contracted term (i.e., the bank

cannot charge additional profit on late payments); however, the asset remains as a mortgage withthe bank until the default is settled.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances that arecommon inNorth American stores.

[edit] Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by theseller to either costs or asking price. While the seller may or may not have full knowledge of thecost of the item being negotiated, they are under no obligation to reveal these costs as part of the

negotiation process. This difference in obligation by the seller is the key distinction betweenMurabaha and Musawamah with all other rules as described in Murabaha remaining the same.Musawamah is the most common type of trading negotiation seen in Islamic commerce.

[edit] Bai salam

Bai salam means a contract in which advance payment is made for goods to be delivered lateron. The seller undertakes to supply some specific goods to the buyer at a future date in exchange


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of an advance price fully paid at the time of contract. It is necessary that the quality of thecommodity intended to be purchased is fully specified leaving no ambiguity leading to dispute.The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals.Barring this, Bai Salam covers almost everything that is capable of being definitely described asto quantity, quality, and workmanship.

[edit] Basic features and conditions of Salam

1. The transaction is considered Salam if the buyer has paid the purchase price to the sellerin full at the time of sale. This is necessary so that the buyer can show that they are notentering into debt with a second party in order to eliminate the debt with the first party,an act prohibited under Sharia. The idea of Salam is to provide a mechanism that ensuresthat the seller has the liquidity they expected from entering into the transaction in the firstplace. If the price were not paid in full, the basic purpose of the transaction would havebeen defeated. Muslim jurists are unanimous in their opinion that full payment of thepurchase price is key for Salam to exist. Imam Malik is also of the opinion that the seller

may defer accepting the funds from the buyer for two or three days, but this delay shouldnot form part of the agreement.2. Salam can be effected in those commodities only the quality and quantity of which can be

specified exactly. The things whose quality or quantity is not determined by specificationcannot be sold through the contract of salam. For example, precious stones cannot be soldon the basis of salam, because every piece of precious stones is normally different fromthe other either in its quality or in its size or weight and their exact specification is notgenerally possible.

3. Salam cannot be effected on a particular commodity or on a product of a particular fieldor farm. For example, if the seller undertakes to supply the wheat of a particular field, orthe fruit of a particular tree, the salam will not be valid, because there is a possibility thatthe crop of that particular field or the fruit of that tree is destroyed before delivery, and,given such possibility, the delivery remains uncertain. The same rule is applicable toevery commodity the supply of which is not certain.

4. It is necessary that the quality of the commodity (intended to be purchased throughsalam) is fully specified leaving no ambiguity which may lead to a dispute. All thepossible details in this respect must be expressly mentioned.

5. It is also necessary that the quantity of the commodity is agreed upon in unequivocalterms. If the commodity is quantified in weights according to the usage of its traders, itsweight must be determined, and if it is quantified through measures, its exact measureshould be known. What is normally weighed cannot be quantified in measures and viceversa.

6. The exact date and place of delivery must be specified in the contract.7. Salam cannot be effected in respect of things which must be delivered at spot. For

example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah,that the delivery of both be simultaneous. Here, salam cannot work. Similarly, if wheat isbartered for barley, the simultaneous delivery of both is necessary for the validity of sale.Therefore the contract of salam in this case is not allowed.

[edit] Hibah (gift)


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This is a token given voluntarily by a debtor to a debitor in return for a loan. Hibah usually arisesin practice when Islamic banks voluntarily pay their customers a 'gift' on savings accountbalances, representing a portion of the profit made by using those savings account balances inother activities.

It is important to note that while it appears similar to interest, and may, in effect, have the sameoutcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannotbe 'guaranteed.' However, the opportunity of receiving high Hibah will draw in customers'savings, providing the bank with capital necessary to create its profits; if the ventures areprofitable, then some of those profits may be gifted back to its customers as Hibah.[35]

[edit] Ijarah

Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use orservice for a fixed price or wage. Under this concept, the Bank makes available to the customerthe use of service of assets / equipments such as plant, office automation, motor vehicle for a

fixed period and price.

[edit] Advantages of Ijarah

Ijarah provides the following advantages to the Lessee:

Ijarah conserves the Lessee' capital since it allows up to 100% financing.

Ijarah gives the Lessee the right to access the equipment on payment of the first installment. Thisis important as it is the access and use (and not ownership) of equipment that generates income.

Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of flexibleterms

Ijarah is not considered Debt Financing so it does not appear on the Lessee' Balance Sheet as aLiability. This method of "off-balance-sheet" financing means that it is not included in the DebtRatios used by bankers to determine financing limits. This allows the Lessee to enter into otherlease financing arrangements without impacting his overall debt rating.

All payments towards Ijarah contracts are treated as operating expenses and are therefore fullytax-deductible. Leasing thus offers tax-advantages to for-profit operations.

Many types of equipment (i.e computers) become obsolete before the end of their actualeconomic life. Ijarah contracts allow the transfer of risk from the Lesse to the Lessor in exchangefor a higher lease rate. This higher rate can be viewed as insurance against obsolescence.

If the equipment is used for a relatively short period of time, it may be more profitable to leasethan to buy.


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This is a loan extended on a goodwill basis, and the debtor is only required to repay the amountborrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond theprincipal amount of the loan (without promising it) as a token of appreciation to the creditor. Inthe case that the debtor does not pay an extra amount to the creditor, this transaction is a trueinterest-free loan. Some Muslims consider this to be the only type of loan that does not violate

the prohibition on riba, since it is the one type of loan that truly does not compensate the creditorfor the time value of money.[36]

[edit] Sukuk (Islamic bonds)

Main article: Sukuk

Sukuk, plural of Sakk, is the Arabic name for financial certificates that are the Islamicequivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam.Hence, Sukuk are securities that comply with the Islamic law (Shariah) and its investmentprinciples, which prohibit the charging or paying of interest. Financial assets that comply with

the Islamic law can be classified in accordance with their tradability and non-tradability in thesecondary markets.

[edit] Takaful (Islamic insurance)

Main article: Takaful

Takafulis an alternative form of cover that a Muslim can avail himself against the risk of lossdue to misfortunes. Takaful is based on the idea that what is uncertain with respect to anindividual may cease to be uncertain with respect to a very large number of similar individuals.Insurance by combining the risks of many people enables each individual to enjoy the advantage

provided by the law of large numbers. See Takaful for details.

[edit] Wadiah (safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in thebank and the bank guarantees refund of the entire amount of the deposit, or any part of theoutstanding amount, when the depositor demands it. The depositor, at the bank's discretion, maybe rewarded withHibah (see above) as a form of appreciation for the use of funds by the bank.

[edit] Wakalah (power of attorney)

This occurs when a person appoints a representative to undertake transactions on his/her behalf,similar to apower of attorney.

[edit] Islamic equity funds

Main article: Sharia investments


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Islamic investment equity funds market is one of the fastest-growing sectors within the Islamicfinancial system. Currently, there are approximately 100 Islamic equity funds worldwide. Thetotal assets managed through these funds currently exceed US$5 billion and is growing by 1215% per annum. With the continuous interest in the Islamic financial system, there are positivesigns that more funds will be launched. Some Western majors have just joined the fray or are

thinking of launching similar Islamic equity products.

Despite these successes, this market has seen a record of poor marketing as emphasis is onproducts and not on addressing the needs of investors. Over the last few years, quite a number offunds have closed down. Most of the funds tend to target high net worth individuals andcorporate institutions, with minimum investments ranging from US$50,000 to as high as US$1million. Target markets for Islamic funds vary, some cater for their local markets, e.g., Malaysiaand Gulf-based investment funds. Others clearly target the Middle East and Gulf regions,neglecting local markets and have been accused of failing to serve Muslim communities.

Since the launch of Islamic equity funds in the early 1990s, there has been the establishment of

credible equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneeredIslamic investment indexing in 1999) and the FTSE Global Islamic Index Series. The Web sitefailaka.com monitors the performance of Islamic equity funds and provide a comprehensive listof the Islamic funds worldwide.

[edit] Islamic derivatives

See also: Financial derivatives

With help of Bahrain-based International Islamic Financial Market and New York-basedInternational Swaps and Derivatives Association, global standards for Islamic derivatives were

set in 2010. The Hedging Master Agreement provides a structure under which institutions cantrade derivatives such as profit-rate and currency swaps.[15]

[edit] Islamic laws on trading

The Qur'an prohibits gambling (games of chance involving money) and insuring ones' health orproperty (also considered a game of chance). The hadith, in addition to prohibiting gambling(games of chance), also prohibits bayu al-gharar(trading in risk, where the Arabic wordghararis taken to mean "risk" or excessive uncertainty).

TheHanafimadhab (legal school) in Islam definesghararas "that whose consequences arehidden." The Shafi legal school definedghararas "that whose nature and consequences arehidden" or "that which admits two possibilities, with the less desirable one being more likely."The Hanbali school defined it as "that whose consequences are unknown" or "that which isundeliverable, whether it exists or not." Ibn Hazm of the Zahiri school wrote "Ghararis wherethe buyer does not know what he bought, or the seller does not know what he sold." The modernscholar of Islam, Professor Mustafa Al-Zarqa, wrote that "Gharar is the sale of probable itemswhose existence or characteristics are not certain, due to the risky nature that makes the trade


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similar to gambling." Other modern scholars, such as Dr. Sami al-Suwailem, have used GameTheory to try and reach a more measured definition of Gharar, defining it as "a zero-sum gamewith unequal payoffs".[37]

There are a number ofhadith that forbid trading ingharar, often giving specific examples of

gharhartransactions (e.g., selling the birds in the sky or the fish in the water, the catch of thediver, an unborn calf in its mother's womb etc.). Jurists have sought many complete definitionsof the term. They also came up with the concept ofyasir(minor risk); a financial transactionwith a minor risk is deemed to be halal(permissible) while trading in non-minor risk (bayu al-ghasar) is deemed to be haram.[38]

Whatghararis, exactly, was never fully decided upon by the Muslim jurists. This was mainlydue to the complication of having to decide what is and is not a minor risk. Derivativesinstruments (such as stock options) have only become common relatively recently. Some Islamicbanks do providebrokerage services for stock trading.

[edit] Microfinance

Microfinance is a key concern for Muslims states and recently Islamic banks also. Microfinanceis ideologically compatible with Islamic finance, capable of Shariah-compliancy, and possesses asizeable potential market. Islamic microfinance tools can enhance security of tenure andcontribute to transformation of lives of the poor.[39] The use of interest found in conventionalmicrofinance products and services can easily be avoided by creating microfinance hybridsdelivered on the basis of the Islamic contracts of mudaraba, musharaka, and murabaha. Already,several microfinance institutions (MFIs) such as FINCA Afghanistan have introduced Islamic-compliant financial instruments that accommodate sharia criteria.

[edit] Controversy

In Islamabad, Pakistan, on June 16, 2004: Members of leading Islamist political party inPakistan, the Muttahida Majlis-e-Amal (MMA) party, staged a protest walkout from theNationalAssembly of Pakistan against what they termed derogatory remarks by a minority member oninterest banking:

Taking part in the budget debate, M.P. Bhindara, a minority MNA [Member of the NationalAssembly]...referred to a decree by an Al-Azhar University's scholar that bank interest was notun-Islamic. He said without interest the country could not get foreign loans and could notachieve the desired progress. A pandemonium broke out in the house over his remarks as anumber ofMMA members...rose from their seats in protest and tried to respond to Mr Bhindara'sobservations. However, they were not allowed to speak on a point of order that led to theirwalkout.... Later, the opposition members were persuaded by a team of ministers...to return to thehouse...the government team accepted the right of the MMA to respond to the minority member'sremarks.... Sahibzada Fazal Karim said the Council of Islamic ideology had decreed that interestin all its forms was haram in an Islamic society. Hence, he said, no member had the right tonegate this settled issue.[40]


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Some Islamic banks charge for the time value of money, the common economic definition ofInterest (Riba). These institutions are criticized in some quarters of the Muslim community fortheir lack of strict adherence to Sharia.

The concept of Ijarah is used by some Islamic Banks (the Islami Bank in Bangladesh, for

example) to apply to the use of money instead of the more accepted application of supplyinggoods or services using money as a vehicle. A fixed fee is added to the amount of the loan thatmust be paid to the bank regardless if the loan generates a return on investment or not. Thereasoning is that if the amount owed does not change over time, it is profit and not interest andtherefore acceptable under Sharia.

Islamic banks are also criticized by some for not applying the principle of Mudarabah in anacceptable manner. Where Mudarabah stresses the sharing of risk, critics point out that thesebanks are eager to take part in profit-sharing but they have little tolerance for risk. To some inthe Muslim community, these banks may be conforming to the strict legal interpretations ofSharia but avoid recognizing the intent that made the law necessary in the first place.[citation needed]

The majority of Islamic banking clients are found in the Gulf states and in developed countries.With 60% of Muslims living in poverty, Islamic banking is of little benefit to the generalpopulation. The majority of financial institutions that offer Islamic banking services are majorityowned by Non-Muslims. With Muslims working within these organizations being employed inthe marketing of these services and having little input into the actual day to day management, theveracity of these institutions and their services are viewed with suspicion. One Malaysian Bankoffering Islamic based investment funds was found to have the majority of these funds investedin the gaming industry; the managers administering these funds were non Muslim.[40] Thesetypes of stories contribute to the general impression within the Muslim populace that Islamicbanking is simply another means for banks to increase profits through growth of deposits and

that only the rich derive benefits from implementation of Islamic Banking principles.

Hence, the controversy that surrounds Islamic Banking continues. Is Islamic Banking reallyIslamic? This is a question that still is a matter of debate among the Muslim academia.

In Korea a proposal to open the country to Islamic Banking has been controversial

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Islamic Banks & FinancialInstitutionsInformation System

1. Musharakah (Partnership)2. Mudarabah (Passive Partnership)


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3. Diminishing Partnership4. Bay al-murabahah (Sales Contract at a Profit Mark-up)5. Ijarah (Leasing)6. A Lease Ending in the Purchase of the Leased Asset7. Salam8. Al-istisna (Contract of Manufacture) and Al- istisna Al-Tamwili (Financing by Wayof istisna)9. Jualah10. Wakalah11. Takaful12. Sukuk

1. Musharakah (Partnership)

Musharakah literally means sharing. In the Islamic finance literature it refers to ajoint enterprise in which all the partners share the profit or loss of the joint venture.

The financial term is derived from the Islamic legal term shirkah with the sameliteral meaning but having a broader application. In the Islamic fiqh literatureshirkah is of two kinds: The first is shirkat-ul-milk which means joint ownership oftwo or more persons of a particular property which may come into existence eitherthrough inheritance or joint purchase. The second kind of shrikah is shirkat-ul-aqd,which means a partnership established through a contract. Such contractualpartnerships are usually established for commercial purposes and take severalforms such as partnership in the capital of the enterprise, partnership in labour andmanagement, common goodwill or a combination of these elements.Musharakah as a financial contract refers to an arrangement where two or more

parties establish a joint commercial enterprise and all contribute capital as well aslabour and management as a general rule. The profit of the enterprise is sharedamong the partners in agreed proportions while the loss will have to be shared instrict proportion of capital contributions. The basic rules governing the musharakahcontract include:

i) Profit of the enterprise can be distributed in any proportion by mutual consent.

However, it is not permissible to fix a lump sum profit for anyone.

ii) In case of loss, it has to be shared strictly in proportion to the capitalcontributions.iii) As a general rule all partners contribute both capital and management.However, it is possible for any partner to be exempted from contributinglabour/management. In that case, the share of profit of the sleeping partner has tobe in strict proportion of his capital contribution.iv) The liability of all the partners is unlimited.


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As a mode of finance, an Islamic bank can advance money to a client using thecontract of musharakah. Normally the bank will use the option of being a sleepingpartner. The contract can be more widely used by Islamic funds whereby the unitholders can assume the role of sleeping partners. The contact can also be used insecuritized assets.

TOP2. Mudarabah (Passive Partnership)Mudarabah is a special type of partnership. This is a contract between two parties :a capital owner (called rabb al-mal) and an investment manager (called mudarib).Profit is distributed between the two parties in accordance with the ratio that theyagree upon at the time of the contract. Financial loss is borne by the capital owner;the loss to the manager being the opportunity cost of his own labour, which failedto generate any income. Except in the case of a violation of the agreement ordefault, the investment manager does not guarantee either the capital extended tohim or any profit generation. Some other important features of the mudarabahcontract include:i) While the provider of capital can impose certain mutually agreed conditions onthe manager, he has no right to interfere in the day-to-day work of the manager.

ii) mudarabah is one of the fiduciary contracts (uqud al-amanah). Mudarib isexpected to act with utmost honesty, otherwise he is considered to have committed

a grave sin (in addition to worldly penalties). This has important implications for themoral hazard problem.iii) The liability of the rabb al-mal is limited to the extent of his contribution to thecapital.

iv) The mudarib is not allowed to commit the mudarabah business for any sumgreater than the capital contributed by the rabb al-mal.v) All normal expenses related to mudarabah business, but not the personalexpenses of the mudarib, can be charged to the mudarabah account .vi) The contract of mudarabah can be terminated at any time by either of the twoparties on giving a reasonable notice. (This condition may create serious problemsin the context of modern commercial enterprises. However, using the GoldenPrinciple of Free Choice the parties can agree on any conditions in the contract thatwill regulate the termination so as not to cause any damage to the enterprise). vii) No profit distribution can take place (except as an ad hoc arrangement, andsubject to final settlement), unless all liabilities have been settled and the equity ofthe rabb al-mal restored.As a mode of finance applied by Islamic banks, on the liabilities side, the depositorsserve as rabb-al-mal and the bank as the mudarib. Mudarabah deposits can beeither general, which enter into a common pool, or restricted to a certain project or


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line of business. On the assets side, the bank serves as the rabb-al-mal and thebusinessman as the mudarib (manager). However the manager is often allowed tomix the mudarabah capital with his own funds. In this case profit may bedistributed in accordance with any ratio agreed upon between the two parties, butthe loss must be borne in proportion to the capital provided by each of them.

TOP3. Diminishing PartnershipThis is a contract between a financier (the bank) and a beneficiary in which the twoagree to enter into a partnership to own an asset, as described above, but on thecondition that the financier will gradually sell his share to the beneficiary at anagreed price and in accordance with an agreed schedule.

TOP4. Bay al-murabahah (Sales Contractata Profit Mark-up)In the classical fiqh literature, there is a sales contract called bay muajjal whichrefers to sale of goods or property against deferred payment (either in lump sum or

instalments). Bay muajjal need not have any reference to the profit margin thatthe supplier may earn. Its essential element that distinguishes it from cash sales isthat the payment is deferred. Strictly speaking, the deferred payment can be higherthan, equal to or lower than the cash price.There is another sale contract known as bay al-murabahah, which refers to a sale inwhich the seller declares his actual cost and the parties agree on adding a specificprofit margin. Basically, this is a two party buying and selling contract. No financialintermediation is involved. The Islamic banks have created a mode of finance bycombining the concepts of bay muajjal and bay al-murabahah. They use thiscontract as a mode of finance in the following manner.

The client orders an Islamic bank to purchase for him a certain commodity at aspecific cash price, promising to purchase such commodity from the bank once ithas been bought, but at a deferred price, which includes an agreed upon profitmargin called mark-up in favour of the bank. Thus, the transaction involves anorder accompanied by a promise to purchase and two sales contracts. The firstcontract is concluded between the Islamic bank and the supplier of the commodity.The second is concluded between the bank and the client who placed the order,after the bank has possessed the commodity, but at a deferred price, that includesa mark-up. The deferred price may be paid as a lump sum or in instalments. In thecontract between the Islamic bank and the supplier, the bank often appoints theperson placing the order (the ultimate purchaser) as its agent to receive the goods

purchased by the bank. The basic rules governing the murabahah contract include:

i) The subject of sale must exist at the time of sale.

ii) The subject of sale must be in the ownership of the seller at the time of sale. iii) The subject of sale must be in the physical or constructive possession of theseller.


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iv) The delivery of the sold commodity to the buyer must be certain and should notdepend on a contingency or chance.v) As in any sales contract the price must be specified and once specified it cannotbe increased in case of default.vi) The time of delivery must be specified.vii) The payments schedule must be specified.

TOP5.Ijarah (Leasing)In the simple lease contract the usufruct generated over time by an asset, such asmachinery, airplanes, ships or trains is sold to the lessee at a predetermined price.This is called an operating lease, as opposed to a financial lease. The operatinglease has a number of features that distinguish it from other forms of leasing.Firstly, the lessor is himself the real owner of the leased asset and, therefore, bears

all the risks and responsibilities of ownership. All defects, which prevent the use ofthe equipment by the lessee, are his responsibility, even though it is possible tomake the lessee responsible for the day-to-day maintenance and normal repairs ofthe leased asset. Secondly, the lease is not for the entire useful life of the leased

asset but rather for a specified short-term period (for a month, a quarter, or ayear) unless renewed by mutual consent of both the parties.

TOP6. A Lease Endinginthe Purchaseofthe Leased AssetSince the entire risk is borne by the lessor in the operating lease, there is a dangerof misuse of the leased asset by the lessee. The financial lease helps take care of

this problem by making the lease period long enough (usually the entire useful lifeof the leased asset), to enable the lessor to amortize the cost of the asset withprofit. At the end of the lease period the lessee has the option to purchase theasset from the lessor at its market value at that time. The lease is not cancellablebefore the expiry of the lease period without the consent of both the parties. Thereis, therefore, little danger of misuse of the asset.A financial lease has other advantages too. The leased asset serves as security and,in case of default on the part of the lessee, the lessor can take possession of theequipment without court order. It also helps reduce the lessors tax liability due tothe high depreciation allowances generally allowed by tax laws in many countries.The lessor can also sell the equipment during the lease period such that the lease

payments accrue to the new buyer . This enables the lessor to get cash when heneeds liquidity. This is not possible in the case of a debt because, while the Shariahallows the sale of physical assets, it does not allow the sale of monetary debtsexcept at their nominal value.Some of the jurists have expressed doubts about the permissibility of financialleases. The rationale they give is that the long-term and non-cancellable nature ofthe lease contract shifts the entire risk to the lessee, particularly if the residual


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value of the asset is also fixed in advance. The end result for the lessee may turnout to be wor

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