Islamic Finance 101

Sources of ShariahAre divided into two major sources.• The primary sources: The primary source of shariah is Al

Quran. The second primary source is sunnah. At all time, priority is to be given to Quran over the sunnah.

• The secondary sources : The first secondary source of the shariah is ijma (consensus) among the companions of the Prophet (Sahaba). The second secondary sources is Qiyas (analogical reasoning)

• Other sources: » Ijtihad: the process of deriving the laws of the shari'ah from its

sources» Istihsan : Juristic Preference» Al Masalih al mursala: Consideration of Public Interest » ‘urf : Customary Practices

Proofs for the permissibility of Trade

… And Allah has permitted trade but forbidden riba[AlBaqarah : 275]O you who have believed, do not consume one another's wealth unjustly but only [in lawful] business by mutual consent. [An Nisaa: 29]O you who have believed, when [the adhan] is called for the prayer on the day of Jumu'ah [Friday], then proceed to the remembrance of Allah and leave trade. [Al Jum'ah: 9]There is no blame upon you for seeking bounty from your Lord [AlBaqarah :198].

Pillar of Islamic Business

3 Main Pillars:1. The buyer and the Seller2. The Commodity of subject

matter of the contract3. The Seegha : Offer and

Acceptance

Conditions of Business TransactionsCondition 1:

Mutual ConsentCondition 2:

The buyer and seller must be competent to buy and sellCondition 3:

The commodity must be permissible to use in other times of necessitiesCondition 4:

The Commodity must be sold by the owner or he who is in the position of the ownerCondition 5:

The owner must be able to handover the commodity to the buyerCondition 6:

The commodity must be well determined by sight or by description

Conditions of Business Transactions

O You who believed! Honor your contracts [AlMa’idah: 1]

O you who have believed, do not consume one another's wealth unjustly but only [in lawful]

business by mutual consent.[AnNisaa:29]

The Muslims are upon their conditions, except a condition that makes a prohibited permissible or a

permissible prohibited[Abu Dawud]

Choice or Options in Contracts• Option of cancellation within the trading session• Option of cancellation within a defined period of

timeRef:The buyer and seller have the choice to conclude or repeal the transactions as long as they have not separated [ Agreed Upon]

Forbidden Transactions by ConsensusThere are number of transactions that are forbidden by the agreement of the scholars. Amongst them, Here few common types of transactions:

• Selling a debt for debt • Two Contracts or sales in one• Selling Upon the sale of your brother• The resident selling on behalf of the visitor• Selling impure and forbidden products• Selling during and after the time of second Adhan of Ju’mah• Riba• Sales of excessive Gharar• Gambling

Why are these transaction prohibited?

In General, the following are the reason why the transactions noted are forbidden:

• The contract is upon a commodity or to a person or in a time that is forbidden

• The contract contains riba• The contract contains extreme uncertainty• The contract goes against one or more of the

goals and purpose of the Shariah in business

RibaCase Study : Surah Baqarah 275-280

Major Sins : RibaHadith of Prophet(saw): " Avoid the seven heinous sins "- and after having said this, the propeht (SAW) mentioned them: "associating anything with Allah; magic; killing one whom Allah has declared inviolate without a just case, consuming the property of an orphan, devouring usury, fleeing from the battlefield, and slandering chaste women who are believers but indiscreet." (Bukhari and Muslim)

Quran on RibaThere are 12 verses in quran dealing with Riba. The word riba itself occurs eight times, there times in 2:275 and one time each in 2:276; 2:278; 3:130; 4:161 and 30:394

• 1st Verse: In Makkan Period: Allah says: And that which you give in Riba in order that it may increase from other people's property, has no increase with Allah; but that which you give in Zakah seeking Allah's Face, then those they shall have manifold increase.[Surah Rum: 39]. – In One Opinion, Allah meant Interest but Majority of the scholar in Opinion This means, that which is

given as a gift to others in the hope that they will give back more than they were given(Wrong Intention). There is no reward for this with Allah.

• Prophet (saw) said: No person gives in charity the equivalent of a date which was earned in a lawful manner, but the Most Merciful takes it in His Right Hand and takes care of it for its owner, just as any one of you takes care of his foal or young camel, until the date becomes the size of Mount Uhud

• 2nd Verse: And their taking of Riba though they were forbidden from taking it, and their devouring men's substance wrongfully. And We have prepared for the disbelievers among them a painful torment.[An Nisa:161] – Revealed 1st Year in Madina. This Ayah regarding Jews, Allah prohibited them from taking Riba', yet they

did so using various kinds of tricks, ploys and cons, thus devouring people's property unjustly– The message in this verse that Allah is not pleased with them to deal with Riba/Interest and Yet they are

dealing with Riba. This verse is not directed to Muslim rather it was hint and preparation for later rulings.

Quran on Riba3rd Verse: As per the Ulama It was revealed 3rd Year of hijra before battle of Uhud.

Allah says: O you who believe! Do not consume Riba doubled and multiplied, but fear Allah that you may be successful. [Surah Al-Imran: 130] And: Allah says: And fear the Fire, which is prepared for the disbelievers. And obey Allah and the Messenger that you may obtain mercy [Al Imran: 131-132] Prevented Muslims from usurious loans to equip their armies in response to the action of the pagans, Explicit prohibition of compound interest 4th Verse: Those who eat Riba will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaytan leading him to insanity. That is because they say: "Trading is only like Riba,'' whereas Allah has permitted trading and forbidden Riba. So whosoever receives an admonition from his Lord and stops eating Riba, shall not be punished for the past; his case is for Allah (to judge); but whoever returns (to Riba), such are the dwellers of the Fire, they will Abide therein Allah will destroy Riba and will give increase for Sadaqat. And Allah likes not the disbelievers, sinners.Truly, those who believe, and do deeds of righteousness, and perform the Salah and give Zakah, they will have their reward with their Lord. On them shall be no fear, nor shall they grieve, O you who believe! Have Taqwa of Allah and give up what remains from Riba, if you are (really) believers.And if you do not do it, then take a notice of war from Allah and His Messenger but if you repent, you shall have your capital sums. Deal not unjustly, and you shall not be dealt with unjustly.And if the debtor is having a hard time, then grant him time till it is easy for him to repay; but if you remit it by way of charity, that is better for you if you did but know.And have Taqwa the Day when you shall be brought back to Allah. Then every person shall be paid what he earned, and they shall not be dealt with unjustly. [Surah Bakarah: 275-281]

Quran on RibaIn the above verses Allah says about the 5 Punishment:

Person will stand up in day of judgment very shaky Punishment in hellfire forever Allah will destroy the money Allah does not love Notice of War with Allah

Hadith on RibaAllah has cursed the one who

consumes Riba, The one who gives it, the two witnesses and the one

who writes down the transactions[Muslim]

Hadith on RibaInterest condemns a person to severe punishment:

The Prophe(saw) said: “Last night I saw two men who came to me and took me out to a holy land. We set out until we came to a river of blood in which a man was standing, and on the bank of the river there was a man with stones in front of him. The man who was in the river came and wanted to get out, but the other man threw a stone in his mouth and he went back to where he had been. Every time he wanted to get out, he threw a stone in his mouth and he went back to where he had been. I said, ‘What is this?’ He said: ‘The one whom you saw in the river is the one who consumed ribaa.'” (Bukhaari)

Interest dooms a person to HELL:

The Prophet(saw) said: ‘Avoid the seven sins that doom a person to Hell.’ They said: O Messenger of Allaah, what are they?’ He said: ‘Shirk, magic, killing a soul whom Allaah has forbidden us to kill,consuming ribaa (interest), consuming orphans’ wealth, running away from the battle field, and slandering chaste, innocent believing women.’ ” (Bukhaari, Muslim)

Hadith on RibaALL (direct or indirect) dealings of Interest are Haraam: The Messenger of Allah(saw) cursed ten people: the one who consumes ribaa, the one who pays ribaa, the one who writes it down, the two who witness it, the one who makes it lawful, the one for whom it is made lawful, the one who withholds charity, the one who does tattoos and the one for whom tattooing is done.” (Muslim)

Interest is WORSE than ZINAA: The Prophet said: ” A dirham which a man consumes as ribaa knowingly is worse before Allaah than THIRTY-SIX ACTS OF ZINAA.” (Ahmad, Tabaraanee- saheeh by al-Albaani in Saheeh al-Jaami’).

Interest is like COMMITTING ZINAA with one’s own MOTHER!!!: The Prophet(saw) said: ” There are seventy-two types of ribaa, the least of which is like a man committing incest with his own mother.” (Tabaraanee– saheeh by al-Albaani in Saheeh al-Jaami’).

REASONS FOR PROHIBITION OF RIBA

To prevent injustice between

contracting parties

Exploit the poor/

creditors

An exploitations of people

ignorance over the types of

commodities involved in transaction

An exploitation of people

needs. Thus, they have no

choice but to be involved in Riba

CATEGORIES OF RIBA

CATEGORIES OF RIBA

Riba: Dua Refused• Hadith of prophet(saw): A man who,

having journeyed far, is disheveled and dusty and who spreads out his hands to the sky (saying), 'O Lord! O Lord!' while his food is unlawful, his drink unlawful, his clothing unlawful, and he is nourished unlawfully, how can he be answered?

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PROHIBITION OF GHARAR

Literally: Deceit, risk, fraud, uncertainty or hazard that may be

lead to destruction loss. Technically:

When a matter that is concealed by one party. Occurs when a party undertake venture blindly without

sufficient knowledge Minor uncertainties can be permitted when there is a

necessary Both of contracting parties must have a perfect

knowledge regarding to transaction

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PROHIBITION OF GHARAR

• Sell good that seller is not in position to deliver.• Sell unknown pages or known goods against

unknown price.• Make a contract conditional on a unknown event.• Sell good on basis of false description.• Sell good without proper examination.

Examples of Gharar related transaction:

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PROHIBITION OF MAYSIR

• Refers to the easy acquisition of wealth by chance, whether or not it deprives the other’s right.

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

• Issues that related to gambling:– Contest using SMS– The prize winning tickets– Horse racing– Lottery– Crossword puzzles

Employment in Financial Institutions or LCBO

And cooperate in righteousness and piety, but do not cooperate in sin and aggression. [AlMaidah: 2]Jaabir said: The Messenger of Allah (blessings and peace of Allah be upon him) cursed the one who consumes riba and the one who pays it, the one who writes it down and the two who witness it, and he said: they are all the same. [muslim]Ali and Ibn Mas`ud narrated that the Messenger of Allah said: May Allah curse whoever consumes Riba, whoever pays Riba, the two who are witnesses to it, and the scribe who records it(tafsir ibn kathir)

Modern Transaction – Credit Card

The Main problem with the Credit is the agreement to pay extra money upon any delay in the payment. This is usurious condition

• Buying gold and silver with credit card : Not Permissible• Taking Out cash: Riba charge

immediately

Modern Transaction – Insurance

Forbidden Insurance: House and property insurance Life Insurance Income protection Insurance Funeral insurance etc.

Reason for its prohibition: Contains Riba It embodies eating people’s wealth without right It entrails uncertainty (gharar) in the contract It entails oppression on both parties

Modern Transaction – Banking

• Bank account are regarded as loan facilities. The Shariah considers the account holders to have given loans to the bank

• The interest paid by banks is forbidden by the complete consensus of Ummah.

• Bank Loans for purchasing houses are not permitted in our times as the degree of the necessity has not yet reached unbearable levels.

• Impermissible Transactions: • Penalties for late payment• Fees for credit transactions • Letter of Credit• Credit lines• Overdraft facilities• Charging interest on loans

Modern Transaction – Islamic Banking

Bank Client

money

money + money (interest)

Conventional

Banking System

Modern Transaction – Islamic Banking

Bank ClientGoods & Services

money

Islamic Banking System

Six Key Islamic Banking Principles1. Prohibition of predetermined loan repayments as

interest (riba) 2. Profit and loss sharing is at the heart of the

Islamic system(Risk Sharing)3. Making money out of money is unacceptable. All

financial transactions must be asset-backed4. Prohibition of speculative behavior5. Only Shariah approved contracts are acceptable6. The sanctity of contracts(Purity of Contracts)

Modern Transaction – Islamic Banking

Islamic Finance Terminologies: Murabaha: Musharaka

Murabaha: It is a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest. Bank purchases the goods on behalf of the customer, and re-sells them to the customer on an agreed profit margin and the customer pays the sale price for the goods over installments.

Musharaka : It means partnership. It involves you placing your capital with another person and both sharing the risk and reward with profit sharing ratio, but losses must be proportionate to the amount invested.

Islamic Finance Terminologies: MudarabaIt refers to an investment on your behalf by a more skilled person. It takes the form of a contract between two parties, one who provides the funds and the other who provides the expertise and who agree to the division of any profits made in advance. The Bank would make Sharia’a compliant investments and share the profits with the customer, in effect charging for the time and effort. If no profit is made, the loss is borne by the customer and Islamic Bank of Britain takes no fee.

Islamic Finance Terminologies: Ijarah

Ijara is a form of leasing. It involves a contract where the bank buys and then leases an item. For example auto ijarah is simply an agreement under which the vehicle shall be given to you on rent for a period, agreed at the time of the contract. Bank purchase the vehicle and it out to the consumer for a period upon completion of the ijarah period the consumer get owner ship of the vehicle through a separate sale agreement.

Modes of Islamic Finance and Islamic Finance Terminologies:

1. Murabaha: Literally it means a sale on mutually agreed profit. In Murabahah, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement.

2. Ijarah: Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended.

3. Ijarah-Wal-Iqtin: A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental, together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee.

4. Musharakah: Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business.

5. Musawamah: Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former.

6. Istisna’a: It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery.

Modes of Islamic Finance and Islamic Finance Terminologies :

7. Bai Muajjal: Literally it means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal. •Mudarabah: A form of partnership where one party provides the funds while the other provides expertise and management.

8. Bai Salam: Salam means a contract in which advance payment is made for goods to be delivered later on. Hibah (Gift): This refers to a payment made willingly in return for a benefit received.

9. Qard hassan/Qardul hassan (good loan/benevolent loan). This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor.

10. Sukuk (Islamic bonds): financial certificates that are the Islamic equivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam.

11. Wadiah (safekeeping): In Wadiah, a bank is deemed as a keeper and trustee of funds.

Summary

Can we avoid the Riba from our daily life ? Abu Huraira reported: The Messenger of Allah, peace and blessings be upon him, said, “A time will come upon people when they will consume usury.” They said to him, “Is that all of the people?” The Prophet said, “Whoever does not take from it will be afflicted by its dust.”[Musnad Ahmad 10191]

Prophet(saw)said: Both lawful and unlawful things are evident, but in between them there are matters that are not clear. So whoever saves himself from these unclear matters, he saves his religion and his honor. And whoever indulges in these unclear matters, he will have fallen into the prohibitions, just like a shepherd who grazes (his animals) near a private pasture, at any moment he is liable to enter it.

Another famous hadith narrated by Al-Hasan bin `Ali said that he heard the Messenger of Allah say : Leave that which makes you doubt for that which does not make you doubt

Allaah says: “Have you seen he who took his desire for a god? With knowledge, Allah has led him astray, setting a seal upon his hearing and heart, and has made a veil over his eyes, who then shall guide him after Allah? Will you not then remember!” (al-Jaathia:23)