COLLOQUIUM ON ISLAMIC FINANCE: SHARIAH AND

OPERATIONAL ISSUES IN IMPLEMENTING CONTEMPORARY

PRODUCTS
~ 16-17 DECEMBER 2008 ~ KUALA LUMPUR, MALAYSIA ~

Dr. Asyraf Wajdi Dusuki

Head, Research Affairs
International Shari’ah Research Academy for Islamic Finance
(ISRA)

1
 Outline
• Understanding the
Nature of Banking
Business
• Why Islamic Finance?
• Salient Features of
Colloquiu
m Islamic Finance
On
Islamic • What Does it Mean By
Finance
Shariah Compliant?
• Form vs. Substance

2
 Bank as a Financial Intermediary
Savings &
Investment Financing

Surplus Units Deficit Units

• Individuals Financial • Individuals
Intermediary
• Businesses (e.g. bank) • Businesses
• Government • Government

Return on Return on
investment & financing
savings

Bank’s Liabilities Bank’s Assets

3
 Nature of Banking Business
Assets Liabilities

Long-term contract Short-term Contract

Illiquid Highly Liquid

Withdrawal
Inflexibility
On Demand

Expose to wide array

Risk free
of Risks

4
Why Do We Need To Have
Islamic Finance?

5
To Comply with
Shariah!

6
Conceptual Balance Sheet of an Islamic
Bank
Assets Liabilities

Trade Finance Custodial Services

(Mudarabah/ BBA) (Amanah/Wadiah)

Deposits/Investments
Asset-backed (Mudarabah/ Wakalah)
Securities
(Ijarah/Salam/Istisna) Fund Management/
Private Equity Venture
Fund Management Capital
(Mudarabah/ Special (Special Mudarabah/
Mudarabah/Musyarakah) Musyarakah)

Fee-based Services/
Advisory Capital Owners’ Equity
(Wakalah/Jualah/Kafalah) (Musyarakah)

7
 Wadi’ah Yad Amanah;
Deposit-taking Contracts Wadiah Yad Dhamanah,
Mudarabah; al-Qard
Various forms of
Islamic Contracts BBA – deferred sale;
Sales-based Contracts Murabahah – cost-plus
used in Banking sale; Bai al-Inah, Bai al-
Tawarruq
Ijarah Wa Iqtina; Ijarah
Lease-based Contracts Thumma Al-Bai’, Ijarah
Muntahia Bitamleek

Equity-based Contracts Mudarabah, Musyarakah

Kafalah/Dhaman
Fee-based Contracts (Guarantee); Wakalah
(agency)

Musyarakah Mutanaqisah
Hybrid Contracts (Dimishing Partnership),
Promise/Undertaking AITAB etc.
Wa`ad

8
In a nutshell as a Muslim, a man needs to
abide with Shariah!

Every Transactions
Must Be Shari`ah Compliant!

What Does it Mean By

Shari`ah Compliance?

9
 SHARIAH-COMPLIANT IS NOT
JUST ABOUT:

• Satisfying the mechanics of financial

operation;
• Fulfilling the legal documentation
requirement
• Focusing on the legal form of a
contract

10
VALIDITY vs. PERMISSIBILITY

Validity is based on the FORM of the contract

While Permissibility
A Valid is based
Contract is not necessarily
VALID(SAHIH) PERMISSABLE (HALAL)
on the Halal (Permissable)
contract thatSUBSTANCE
meets its of the contract
contract that isand
used
requirements and conditions to obtain Halal (Permissible) ends.
the INTENTION of the contractors.
11
Financial Contract MUST be BOTH
HALAL (Permissable) & SAHIH (Valid)
 Shariah-Compliant Requires
• Financial Contract to be Shariah compliant
both in terms of FORM and SUBSTANCE
• Operation to be Shariah compliant
• Islamic banking to be more ethical
• Socially Responsible

12
Commodity Murabahah Deposit Placement

US$ 1 Million on spot

Client/Islamic Bank
Broker A US$ 1.1
Where is this Million
proceed deferred
invested?

US$ 1 Million on
spot
Broker B Conventonal Bank
Form and Substance
• Form is the structure of something.
• Substance is the essence or essential nature of
something.
• All schools of Islamic Law base contract permissibility on
substance and intention. As for contract validity, some
schools base it on form, others on substance.
• Misunderstanding some schools’ position.
• Result:
Result In contemporary Islamic banking and finance,
the issue of “legal form vs. economic substance”
becomes the point of contention in determining the
permissibility of certain financial instruments.
• E.g. Buy-back Sale (Bay’ al-inah) and Bay` al-Tawarruq.

14
The Criterion of the Non-Shari’ah Compliant
Transaction
• When a financing mode is structured in such a way that
secures a guaranteed profit to the financier without
taking any risks. Or, when the financier acts in reality as
a creditor who provides money without being involved in
the investment process; i.e. when the substance is
interest-bearing debt.
• This will render the transaction impermissible regardless
of its legal form, e.g. sale, lease… .
• Rationale: Money should not generate money by itself.
Profit should be obtained by virtue of real economic
activities not by lending.

15
 What to compromise the Form or the
Substance?
1. Form and technicalities can be compromised if the
substance is sound.

• The objective of Form is to help ensure the compliance

of the substance with the Shari’ah.

• Classical Jurists have compromised Form in many

examples, which implies that maintaining the form of a
contract is not meant for itself.

• Some of today’s practices in Islamic Finance have just

implied the opposite; maintaining the form at the
expense of the substance.

16
 Form and technicalities can be compromised

• This (compromising the form as long as the substance is

Shari’ah compliant) can be used in validating many
applications.

• One important application is: Validating multiple

contracts in one transaction as long as this transaction
will not lead to Riba or will not be used to circumvent the
Shari’ah.

• E.g. a dealer sells to another dealer a property if the later

agrees to sell him his property.
17
 HOW TO MAKE MONEY IN ISLAM?
‫َ َّمرَحوَعيبلاُللا َّلحاو‬ ‫ُلثِمُعْيَبلا َا َّمنِا اُولاق‬
‫بّرلا‬
ِ ‫ا‬
“Allah permits trading but ‫بّرلا‬
ِ ‫َا‬
“They said that indeed trading
prohibits Riba” (2:275) is just like riba” (2:275)

RIBA PROFITS
What’s WITH
NO
COUNTER-VALUE The COUNTER-VALUE
Difference? (`IWAD)

Effort Risk Liability

(Al-Kasb) (Al-Ghurm) (Al-Dhaman)
18
 Promote Maslahah
Entitlement to
Equal, Adequate,
Freedom from Accurate Info.
Riba

Promote
Freedom from Brotherhood
Gharar

A system grounded
Freedom from on moral and
Dharar ethics
Characteristics of
Shariah-compliant Entitlement to
Freedom to Banking and Financial Transaction at
Contract Fair Price
System
Freedom from
Freedom from
Price control &
Manipulation Qimar & Maysir

19
 ‫وا ا‬
‫و
ًا‬
Dr Asyraf Wajdi Dato' Dusuki
Head of Research Affairs
International Shari'ah Research Academy for Islamic Finance
(ISRA)
2nd Floor, Annexe Block,
Menara Tun Razak,
Jalan Raja Laut,
50350 KL
T: +603 2781 4211
F: +603 2692 4094
M: +6012 6188005
www.isra.my

20