Chapter 3Philosophy of islamic finance

D P D 2 0 2 3 F O U N D A T I O N I N I S L A M I C F I N A N C E

3.1 shariah framework

SHARIAH

MUNAKAHAT JINAYAT

MUAMALAT AMMAHIBADAT

ECONOMIC SOCIALPOLITIC

MUAMALAT

IBADAHThe word ibadah is derived from abd which means ‘servant and slave’. Therefore the meaning of ibadah is servitude and slavery. It is concerned with the practicalities of worship to Allah, in the context of the relationship between man and his Creator.

In terms of Islam, ibadah is the obedience, submission, and devotion to Allah (God) along with the ultimate love for Him.

The rules of ritual purification, prayer, pilgrimage, fasting, war (jihad) and some other form of worship are dealt with under this heading. Most of these rules deal with the rights owed to Allah by the individuals alone or by the community as a whole.

Muslims believe that ibadah is the reason for the existence of all humanity. That is, Muslims believe that all people exist only to submit to Allah.

Present a framework for conduct in the civil arena. It is concerned with the practicalities of a person’s daily life, in the context of relationship between man and man, and other creatures which include animal, plant and non-living things.

a) Muamalatb) Munakahatc) Jinayat

3.1.1 muamalah ammah

Muamalat is plural and the singular is muamalah. Muamalah is from the verb “aamala” literally meaning to interact. Muamalat means interactions or transactions.

Commercial transactions are concluded through contracts which are permitted by the Shariah as evidenced by the Quran, the Sunnah and other sources of Islamic Law.

a) MUAMALAT

Conduct that cover human activities related to business, trade and efforts in accumulating wealth and means or activities related to economic development, in three areas:

a) politicalb) economicc) social

b) MUNAKAHATDescribed as Islamic Family Law or Personal Law or Muslim Law of Personal Status.

Concerns with family matters; 1. Marriage, 2. Divorce,3. Inheritance,4. Maintenance,5. Guardianship, and related matter

c) JINAYATJINAYAT (criminal law)

Conduct related with offences against the human body and tort are called jinayat. The term jinayat also used for torts when the offence falls under ghasb (usurpation, misappropriation) and italf (destruction of property)

Crime: consists in legal prohibitions imposed by Allah, whose infringement entails punishment prescribed by Him.

1. Hudud2. Qisas3. Ta’zir

3.2 philosophy of financePHILOSOPHY

a) Tauhid Uluhiyyahb) Tauhid Rububiyyahc) Purification concept (Tazkiyyah)d) Judgement Daye) Human as a caliph

• Allah is the true existence and everything else, including man exist because of Him.

• Thus, Man’s prayers, other acts of worship, life and death should all be for the sake of Allah.

• All man activities, if done for the sake of Allah, are considered ‘Ibadah. (al-’amal ‘badah)

a) Tauhid Uluhiyyah

Allah is Rab (the Authority to make regulations to protect and sustain the lives of so many creatures).

This concept is explained that Allah swt is the creator and sole owner of the entire source in the universe. So Allah entitled to lay down the law and regulations on human

life to be observed and obeyed.

b) Tauhid Rububiyyah

In an economic context, Rububiyyah the Divine rules for organizing human livelihood and economic activities in peace. Economics must use the divine rule.

This concept is a means of purification and human development agent.

The concept of tazkiyyah forming soul and moral purity in a relationship with God, man and nature.

Purification of property is done through charity and alms.

c) Tazkiyyah

Economic development according to this concept can also be done by avoiding the practice of usury.

As a result of the concept of tazkiyyah, born al-Falah, the success attain in this world and the hereafter.

Judgment Day is the day on which all activities in the world will be judged and rewarded. This makes life including economic activity continues on the right path (according to Shariah).

All actions and human behavior will always be analyzed in terms of its impact on life in the hereafter. Therefore, people will carrying out economic activities that do not conflict with Islamic law.

d) Judgment Day

Khilafah refer to the role, status as well as the man kind’s responsibilities to themselves and to the ummah as a whole.

Khilafah are the relationship between man and god, man and his fellow men, man and other elements and creatures of the universe man and his innermost self.

e) Human as a caliph

Human principally has been assigned to safe guard this world which belongs to Allah (Quran, 2:30).

On the day of judgment every human being will be accountable for his or her conduct in this world which will determine their true end whether to the heaven or to the hell.

3.2.1 Quranic verses relating to wealth /economic/ finance

Surah al-Nisaa’

O you who have believed, do not consume one another's wealth unjustly but only [in lawful] business by mutual consent. And do not kill yourselves [or one another]. Indeed, Allah is to you ever Merciful.

Surah al-Baqarah

And spend in the way of Allah and do not throw [yourselves] with your [own] hands into destruction [by refraining]. And do good; indeed, Allah loves the doers of good.

They ask you, [O Muhammad], what they should spend. Say, "Whatever you spend of good is [to be] for parents and relatives and orphans and the needy and the traveler. And whatever you do of good - indeed, Allah is Knowing of it."

Surah al-Baqarah

Who is it that would loan Allah a goodly loan so He may multiply it for him many times over? And it is Allah who withholds and grants abundance, and to Him you will be returned.

Surah al-Baqarah

3.2.2 islamic views on finance

The example of those who spend their wealth in the way of Allah is like a seed [of grain] which grows seven spikes; in each spike is a hundred grains. And Allah multiplies [His reward] for whom He wills. And Allah is all-Encompassing and Knowing.

Surah al-Baqarah

3.2.3 Difference between islamic finance and conventional finance

CHARACTERISTICS ISLAMIC CONVENTIONAL

Ownership of resources Allah is the sole owner; man acts as a trustee to utilize natural resources

Privately owned by individuals @ the private sector

Decision maker Individuals & producers, based on Islamic principles & commandments

Individual

Price determination Consumers & producers (power of the market) based on Islamic principles & commandments

Price mechanism

CHARACTERISTICS ISLAMIC CONVENTIONAL

Freedom to reap profit Freedom to seek profit, provided that interest is not involved

Freedom to reap profit resulting in high incentives to work

Freedom of choice Individuals & producers have freedom of choice, provided there is no contravention of Islamic principles & commandments

Individuals & producers have freedom of choice

Production objective Priorities the accumulation of π & social welfare based on Islamic principles & commandments

To maximize π by prioritising individual interest

3.3 characteristic of shariah

1. Rabbaniyah (divine)2. Reward in the world and

hereafter3. Alammiyah and Ummumiyyah4. Permanent5. Syumul

3.4 forbidden practice in islamic finance

Trade and commerce in Islam must comply with requirements of the Shariah, which broadly speaking refer to:

- abstinence from prohibitions, (haram matters), and- observing that every contract possesses all its essential elements and that every essential element meet the necessary conditions.

There are many prohibitions, but these five will make aqads or contracts invalid:

(i) Producing and selling impure goods;(ii) Producing and selling goods that are of no use therefore of no value;(iii) Riba;(iv) Gharar, i.e. ambiguity or uncertainty; and(v) Maisir (gambling), i.e. anything that involves

betting.(vi)Zulm

3.4.1 Prohibition in muamalat

a) Producing and selling impure goods

It must not be of any of the following substances:

dogs and pigsevery intoxicating liquidCarcassesblood, pus and vomitdroppings and urinemilk of animals not eaten by men

b) Producing and selling goods that are of no use therefore of no value

• Products that disrupt and endanger the physical and mental health will not be released because it is forbidden.

• Products that can damage moral values and humanity will not be released because of the forbidden.

• Products that can undermine the dignity and well-being will not be released because of the forbidden.

• Products that can lead men to evil (sin) will not be issued.• Only good, quality products that will enhance human values

will be produced as obligatory demands of fardhu kifayah.

c) RibaRiba has been extracted from raba. It means addition, increase.

Riba literally means to increase, to grow, to rise, to add, to swell. It is however, not every increase or growth which has been prohibited by Islam.

Riba technically refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity

Definition

That which you give as riba to increase the peoples' wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold. (30:39).

RIBA IN THE HOLY QUR'AN

Stage of prohibition.

1. First Revelation (Surah al-Rum, verse 39)

And for their taking riba even though it was forbidden for them, and their wrongful appropriation of other peoples' property, We have prepared for those among them who reject faith a grievous punishment. (4:161).

2. Second Revelation (Surah al-Nisa', verse 161)

O believers, take not doubled and redoubled riba, and fear God so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy. (3:130-2).

3. Third Revelation (Surah Al 'Imran, verses 130-2)

RIBA

RIBA DUYUN

RIBA NASI’AH / RIBA YAD

RIBA FADHL

RIBA JAHILIYYAHRIBA QARD

RIBA BUYU’

Riba duyun - Riba out of lending and borrowing. This kind of riba is the extra amount of money over and above the principal of the loan either:Imposed by the lender on the borrower in the contract; or Promised by the borrower in the contract. i. Riba al-Qard - Riba is imposed or promised from

the beginning.ii. Riba al-Jahiliyyah - There is no riba at the

beginning; riba is imposed only after default

b. Riba buyu’ - Riba in trading transactions. This kind of riba may occur out of an exchange between two ribawi materials of the same kind where the necessary rule(s) are not observed. i. Riba al-Fadhl - The ribawi materials (of the same

basis and same kind) exchanged are of different weights, measurements or numbers and they are exchanged at the same time.

ii. Riba an-Nasiah - The ribawi materials exchanged are of equal weights,measurements or numbers but payment of the price and delivery of the goods are made at two different times

Ribawi itemi. Barleyii. Wheatiii. Saltiv. Datesv. Goldvi. Silver

Condition of exchange of ribawi item

vii. Spotviii. Equalix. Alike

TYPE CURRENCY STAPLE FOODGOLD SILVER RM USD WHEAT BARLEY DATE SALT

CURRENCY

GOLD SILVER RM USD

STAPLE FOOD

WHEAT BARLEY DATE SALT

On the spot and same amount, quantity or weight (at par) On the spot basis only Free from the above condition

d) GhararDEFINITION• The Arabic word gharar is a fairly broad concept that

literally means deceit, fraud, uncertainty, danger, peril, delusion, or hazard that might lead to destruction or loss

• Gharar refers to any transaction of probable items whose existence or characteristics are not certain, due to lack of information, ignorance of essential elements in the transaction to either party, or uncertainty of the ability of one party to honor the contract.

• The Prophet (s.a.w) has forbidden the purchase of 1. the unborn animal in the mother’s womb,2. the sale of the milk in the udder without

measurement, 3. the purchase of spoils of war prior to

distribution, 4. the purchase of charities prior to their receipt, 5. and the purchase of the catch of a diver.

• All jurists agree that gharar should be avoided in commercial exchange contracts.

• As Islamic Shari’a forbids riba (interest) because it leads to exploitation and injustice in the society, it also forbids gharar in any transaction to protect the two parties from deceit, ignorance and uncertainty.

• All Islamic financial and business transactions must be based on

1. transparency, 2. accuracy, and 3. disclosure of all necessary information

so that no one party has advantages over the other party.

• Islam has clearly forbidden all business transactions, which cause injustice in any form to any of the parties such as the form of hazard leading to uncertainty in any business, or deceit or fraud or undue advantage.

• The rationale of prohibition of gharar is to ensure full consent and satisfaction of the parties in a contract.

• Without full consent, a contract may not be valid. • Full consent can only be achieved through certainty,

full knowledge, full disclosure and transparency• While the prohibition of riba is absolute, some

degree of gharar or uncertainty is acceptable in the Islamic framework.

1. Major Gharar

In general terms major gharar is: an uncertainty which is so great that it

becomes unacceptable, or it is so vague that there is no means of

quantifying it.

TYPES OF GHARAR

More specifically major gharar arises out of one of the following:

Relating to buyer or seller: Buyer or seller is not capable of taking responsibility not of

majority age, or drunk Buyer or seller is prohibited from disposing of his property:

declared bankrupt, or declared prodigal Buyer or seller is coerced.

Relating to asset: asset or property does not exist asset or property is not free from encumbrances or asset or property is not specific or not according to its

specifications.

Relating to price: Price not mentioned in absolute amount, Two prices in one contract , or Mention of ibraa’ in absolute amount or percentage of

selling price

Relating to contract: Contract is conditioned (in sale) Contract is not expressed in an absolute and decisive

language (with “shall”, “will” or “agree to”)

2. Minor Gharar

Minor gharar or minor uncertainty is forgiven.

Contracts involving minor gharar are permissible and valid.

In contracts involving minor gharar the gharar is taken into consideration in arriving at the price.

Maisir: it refers to gambling or any activity that involves betting, involving money or any items on the outcome of an unpredictable event.

Gambling is betting or charging something that will be forfeited if one fails to obtain the greater gain that one hopes for.

Speculation is not gambling. Some jurists say that speculation is prohibited, but contracts involving speculation are still valid.

e) Maisir

e) Zulm A comprehensive Arabic term used to refer to all forms of inequity, injustice, exploitation, oppression and wrong doing, whereby a person either deprives others of their rights or does not fulfil his obligations towards them.  

Also refers to trading in items the use of which is prohibited in Islamic law (Shari'ah) such as intoxicants (e.g. alcoholic drinks & illegal recreational drugs), pork, etc

3.4.1 impediment transaction in islam

The jurists determined that any consent which is impeded is consent conditional upon the cause of contract.

Considered the consent is impaired and invalid – no an actual agreement.

Eg : victim of mistake, fraud or deceit – the contract become voidable and burden of proof lies in establishing that the consent had been induced by misleading factors.

4 Grounds of the impediments

Mistake Fraud

Duress Effective constraint

Definition Term use - Ghalat, which applies to both to

calculated and material error. In Maliki texts – jahl (ignorance) is found to replace

ghalat. Oxford law dictionary – define mistake as a

misunderstanding or erroneous belief about a matter of fact or a matter of law.

a) Mistake (Ghalat)

Concept of mistake in islamic contract

Islamic law conceives of mistake as a substantive or

intrinsic element which capable of occurring only during

the formation of contractual agreement.

Mistake could arise from an assumption as to the

existence, quality or quantity of the contractual object

or to the nature or existence of the contract itself.

The provisions concerning mistake are scattered and

usually are to be found in the books of fiqh among

the discussion in option of description, defect or sight.

The Islamic concept of mistake is inextricably bound

to the notion of consent in contract.

The law lacks in formulated theory because the

provision of mistake are in actuality, mostly

preclusions or safeguards designed to prevent its very

incidence.

Categories of Mistake

7) Mistake as to law

6) Mistake as to person

5) Mistake as to value

4) Mistake of non-disclosure of the will

3) Mistake with stipulation intention

2) Mistake as to meaning

1) Mistake as to object of the contract

b) Fraud Fraud is a type of criminal activity, defined as:

'abuse of position, or false representation, or prejudicing someone's rights for personal gain'.

Put simply, fraud is an act of deception intended for personal gain or to cause a loss to another party.

The general criminal offence of fraud can include: deception whereby someone knowingly makes false

representation or they fail to disclose information or they abuse a position.

Surah al-Baqarah

And eat up not one another's property unjustly (in any illegal way e.g. stealing, robbing, deceiving, etc.), nor give bribery to the rulers (judges before presenting your cases) that you may knowingly eat up a part of the property of others sinfully.

Transactions must be free of all types of fraud

"Give just measure, and cause no loss (to others by fraud).

Surah ash-Shu’ara

Among the forbidden frauds in Islam are:

i. Al-Tanajushii. Tadlis Al-‘Aib iii. Al-Khilabahiv. Al-Khiyanah

i) Al-Tanajush

Refers to the silent collusion between seller and buyer, whereby the buyer pretends to buy the seller’s goods at a higher price in order to create the illusion of high demand. As a result, other customers are fooled and compete to buy the same goods at a high price.

ii) Tadlis Al-‘Aib

Occurs when the seller purposely hides the flaws or imperfections in his goods.

iii) Al-KhilabahIs a fraud perpetuated through actions or words by one of the parties to an aqad, in order to persuade the other party to enter into the contract.

iv) Al-KhiyanahRefers to fraud or deceit in stating the actual ratio of capital utilised in purchasing goods or in pursuing other activities that result in the same outcome.

c) Duress Literally, ikrah is derived from the root word ka ra ha which is constructed as akrahahu meaning ‘to force someone to do something against his wishes’. The word kurh is also the antonym of hubb (love) such, these two terms are used in an opposite sense, as in for example in the Qur’an (2:216) which reads:

Fighting is prescribed for you, and ye dislike it. But it is possible that ye dislike a thing which is good for you, and that ye love a thing which is bad for you. But Allah knoweth, and ye know not.

Technically, jurists have offered various definitions of duress.

Sarakhsi(1978) for example, defines this as follows: “ by duress one designates the action of one person against another suppressing the consent of this latter person or vitiating his free will”.

Zayla`i (1315 H) on the other hand considers duress as an action directed against a person which suppresses his consent while

Bukhari (1995) defines it as forcing a person to perform an act against his wishes by way of any threat of which the person exerting duress (mukrih) is capable, so that the duressed person (mukrah) is intimidated and deprived of free consent.

A more precise definition is given by Asqalani (1407 H)by stating that duress is to force another person to do what he does not wish while other definitions are found to be almost identical to those previously given.

Contemporary jurists for their part give no differing definition of duress , except by either modifying or accepting those offered by their predecessors. For instance, Abu Zahrah(1977) states that duress is an order from one person to another to commit an act or utter words under