Shari`ah Principles

in Islamic Financing

Dr. Mohd Fuad Mohd Salleh

2010
 General Principles in Islamic Mu`amalah
• All exchange should be with consent of the parties concerned
• Full ownership and eligibility of the contractual parties –
voluntary, no misstatements and no mistakes
• The contract object must be clearly mentioned: the types, the
amount, can be surrended, useful and clean (pure) according
to Islamic syari`ah
• Free from riba’, gambling (al-maisir), preventable ambiguity or
uncertainty (al-gharar) and other prohibited action
• Free from oppression: excessive profit (Ghabn al-Fahsy), hoard
(Ihtikar), blockade from the market (Talaqqi al-Rukban).

Mohd Fuad May 2010

 Why Islamic Finance
• The Islamic Ruling (Syari`ah) specifies
rules that relate to:

the allocation of resources

property rights

production and consumption

the workings of markets

the distribution of income and wealth

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 The Rules Relate to:

The allocation of resources

Islam looks at wealth as life sustaining, to be used efficiently
“Give not unto the foolish your wealth which Allah has made
a means of support for you”. (Quran, 4:4).

Property rights

Private ownership is affirmed but viewed as a trust
“Believe in Allah and His messenger, and spend of that
whereof He hath made you trustees.” (Quran, 57:7).

Muslims are obligated to fulfill contracts and keep their
promises:
“O you who believe fulfill your undertakings”. (Quran, 5:1)

Mohd Fuad May 2010

The Rules Relate to:
• Production and consumption

Use of wealth and exercise of freedom of enterprise is
constrained by the obligation not to harm others. The Prophet
ruled:
“No injury, and no inflicting of injury”. (Ibn Maja, Sunan: chapter
on Ahkam)

Mohd Fuad May 2010

The Rules Relate to:
• The workings of markets

Islam encourages enterprise, efforts to create wealth, which
has been characterized as God’s bounty:
“And when prayer is ended, then disperse in the land and seek
Allah’s Bounty”. (Quran, 62:10)

All exchange should be with willing consent of the parties
concerned:
“O you who believe squander not your wealth among yourself
in vanity except it be a trade by mutual consent”. (Quran, 4:29)

Mohd Fuad May 2010

The Rules Relate to:
• The distribution of income and wealth

Obligation to care for others and share with them
“O you who believe squander not your wealth among yourself in
vanity except it be a trade by mutual consent”. (Quran, 4:29)

This is symbolized by the well-known duty of paying Zakat or
poor tax

This is a spirit of a cooperative and helpful behavior .

“Who hath created life and death that He may try you, which of
you is best in conduct”. (Quran, 67:2).

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 TWO TYPES OF FINANCING
Equity Financing (Sharing of capital)
Al-Sharikah
Al-Mudharabah

Debt Financing (Loan)

Al-Murabahah
Al-Qard al-Hassan

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 EQUITY FINANCING
Al-Sharikah
(Partnership Contract)

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Definition:
A contract between two or more parties,
entrepreneur and investor, who share their
capital, reputation, or expertise to share profit
and loss.

Two Catagories:
i. Sharikah al-Aqd or al-`Uqud
– contract between two parties to share
capital or assets
ii. Sharikah al-Milk or al-Amlak
– ownership on an assets by two parties
without using as-Sharikah contract.

Mohd Fuad May 2010

 Three Types of Sharikah al-Aqd :
i. Assets Partnership (Sharikah al-Amwal)
capital sharing in terms of assets.
ii. Labor Partnership (Sharikah al-Amal or al-
Abdan) capital sharing in terms of expertise
or skills.
iii. Reputation Partnership (Sharikah al-Wujuh)
capital sharing in terms of reputation or
goodwill.

Mohd Fuad May 2010

Methods of Al-Sharikah :

Hanafi
Sharikah al-Mufawadah
Equal share or contribution, profit sharing and
management. Each shareholder become a
gurantor to each other.

Maliki
Sharikah al-Inan
Sharing of assets or capital to run a business and
profit will be shared amongst themselves.

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 AL-MUDHARABAH
(Profit Sharing Contract)

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DEFINITION :

• A contract of profit sharing between the

capital owner or the investor (Ra’s al-mal) to
give the assets to the entrepreneur (al-
‘Mudharrib) to be used in business with the
condition that profit will be shared justfully.

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Two Types of Mudharabah
1) Complete (al-Mutlaqah)
where the assets or capital are given to
be used in business without any
restriction or condition.

2) Conditional (al-Muqayyadah)
the assets or capital are given with some
restrictions or conditions.

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 DEBT FINANCING

Mohd Fuad May 2010

 DEBT FINANCING

Bay’ al-
al-Murabahah (cost plus) .
Bay’ al-
al-Salam (future contract or deferred-
deferred-
delivery sale)
Bay’ al-
al-Istisna’ (contract to build or make)
al-
al-Ijarah (Leasing)
Bay’ bi-
bi-Thaman ‘Ajil or Bay’ alal--Mu’ajjal
or Bay’ al-
al-Taqsit (Deferred / installment payment)
Qard al-
al-Hassan

Mohd Fuad May 2010

 QARD AL-HASAN
Borrower need only to repay the total loan
(principle) without any additional amount.
No profit
The only loan type permitted by syari`ah.
The purpose is for economic and social justice.
Loan is only to help the people who are in need..
Islam encourage the borrower to pay more as a
gift and not determined by the money-lender.

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 Forbidden Activities
• Activities that are considered harmful to society:
– Alcohol.
– Pork production.
– Illegal / intoxicating drugs.
– Gambling.
– Pornography.
– Arms production.

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 Flexibility of Islamic finance
• It is not dogmatic rule-making.
• Attitude is: “how can we make this happen?”,
“Lets do business.”
• Exceptions are permitted (but not encouraged)
when no alternatives exist.
– Example: Investing in the common stock of leveraged
firms is permitted, but the amount of leverage
permitted is limited and that portion of investor return
must be “purified.”

Mohd Fuad May 2010

 The Islamic Market
• 20% of the world population.
• Not just “furriners” – domestically, between 6
million and 8 million people.
• 2.3 million households.
• Rapid growth – 6% annual.
• Young, highly educated, professional.
• Affluent - above average income.

Mohd Fuad May 2010

 Google search on
‘Islamic Banking’
yields this on the first
page.

Mohd Fuad May 2010

Mohd Fuad May 2010
 Equity Investment
• Acceptable if the firm does not engage in
prohibited practices mentioned above.
• Some leeway is possible – previous mention of
riba.
• Dow Jones Islamic Indexes.
• Listing of firms providing Islamic investments in
bibliography.

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http://www.ftse.com/indices_marketdata/global_islamic/index_home.jsp

http://www.djindexes.com/mdsidx/index.cfm?event=showIslamic

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 Sukuk – Islamic “Bonds”
• Conventional bonds are riba, and are forbidden.
• But, again, a transacation structured on an asset
base is permitted.
• A series of payments arising from an asset-based
transaction may be traded at a market price!
• This type of arrangement is referred to as Sukuk,
sometimes called “Islamic bonds.”

Mohd Fuad May 2010

 http://www.noriba.com/sukuk.htm

QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.

http://www.euromoneybooks.com/default.asp?page=4&productID=3099

Mohd Fuad May 2010

 Takaful - Islamic Insurance

Principle of gharar, or avoidance of risk / uncertainty /
gambling.

Gharar does not apply to reasonable, unavoidable
business risk.

Also, standard Insurance contracts often have interest
component.

It is quite acceptable, however, to form a mutual group
for self-help and risk avoidance.

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 Takaful - Islamic Insurance

Resolution of the problem is that the mutual form of
insurance can be made Islamically acceptable.

Stock Insurance companies are not acceptable.

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 http://www.takaful-malaysia.com/ (Malaysia)

http://www.imanlinc.com/ (U.S.A)

http://www.takaful.com/ (Indonesia)

Mohd Fuad May 2010

 Conclusion

Islamic finance is not just for Muslims!

Already a sizeable but underserved market, both
domestic and international.

Rapidly growing and developing.

Opportunity to do well while doing good!

Mohd Fuad May 2010

 That’s it for
today…
Wassalam
Mohd Fuad May 2010