INCEIF CLASS

FN 6013 ISLAMIC FINANCE

TOPIC 1

Assoc. Prof. Dr. Asyraf Wajdi Dusuki

Head, Research Affairs
International Shariah Research Academy for Islamic Finance (ISRA)

General Framework of Islamic

Finance

Workshop
on Islamic
Banking
Operation

Islamic Banking as Financial Intermediary

Fundamentals of Contracts and

Sources of Prohibitions

Salient Features of Islamic Finance

Introduction to Shariah

Understanding the Objectives of

Shariah

The Dynamism of Shariah and Fiqh

Characteristics of Shariah Contracts

General Overview of Islamic Finance

3
Source: KFHR and Bank Negara Malaysia

Emerging interest on Islamic finance as viable alternative to the global

financial system
Starting in 1971 with the first Islamic bank in Egypt,
there are now more than 600 Islamic financial
institutions in 75 countries
UK
Govt sets an objective to entrench
London as a global gateway for Islamic
finance

Germany
Saxony-Anhalt state issued
government sukuk
First Islamic bank to operate
in 2010

Turkey
Announced IFC Istanbul in Sep 09
with focus includes interest-free
Plans to issue sovereign sukuk, amend
financial business
tax law on IF
Iran Bahrain
Qatar
Pakistan
France
Malta
Saudi Arabia
UAE
Kuwait Thailand
Passed rules/regulations to
Plans to position
Malaysia
support Islamic finance
as Islamic finance
Sudan
activities
hub for the
Mediterranean
In process of licensing
Indonesia
Islamic banks
Jordan
Made fiscal & legal
adjustment for IF
Plans to tap sukuk market to
transaction i.e. taxation
finance its deficit
Singapore
guidelines on sukuk &
Established first Islamic bank
murabaha
Introduced tax neutrality for Islamic finance

South Korea
Parliament expected to
pass the law related to
offering of tax waiver on
foreign investors interest
income from sukuk issued

5 FSA-approved Islamic banks and

Takaful operators

Aspiring to be centre for Islamic finance

Launched Islamic ETF

Japan
Law passed allowing
banks to do Islamic
finance
Hong Kong

Aims to become Islamic

finance gateway to China
Plans to issue sovereign sukuk
Hang Seng Islamic China Index
Fund in 2007
Brunei
Aim to become
Islamic financial
services hub for
Asia

Muslim-majority countries offering Islamic finance (IF)

Non-muslim countries starting to offer IF

Courtesy of Bank Negara Malaysia

Global developments Islamic banking

Islamic banking presence across the world

Starting in 1971 with the first Islamic bank in Egypt,

there are now more than 600 Islamic financial institutions in 75
countries

Stages of evolution: Islamic institutions, products and geographical

reach

Source: Bank Negara Malaysia &

Maybank Investment

Why Do
We Need
Islamic Finance?

To Comply with Shari`ah!

Halal Earnings

Halal Spending

Distribution of Wealth

Allah Strongly Condemns

and Prohibits Riba

O you who believe! Observe your duty to Allah, and give up what remaineth
(due to you) from usury, if you are (in truth) believers. And if you do not,
then be warned of war (against you) from Allah and His messenger. And if
you repent, then you may have your principal (without interest). Wrong not,
and ye shall not be wronged. (Al-Baqarah: 278-279)

Prophet s.a.w. also condemns Riba

"Avoid the seven grave sins". The companions asked: "And what are they, O Messenger of Allah?
He said: "They are: associating others with Allah, engaging in magic, killing a forbidden
human soul without a legal right, devouring riba, devouring the wealth of an orphan,
escaping on a day of religious battle, and defamation of unsuspecting believing married
women.

The Prophet s.a.w. condemns those who take riba, give riba, witness to riba (transaction) and the
writer of the riba transaction.

"There are seventy three different types of riba, the least of which is equivalent to bedding one's
mother, and the worst of which is equivalent to destroying the honor of a Muslim". (Narrated
by Ibn Majah and Al-Hakim).

Is Islamic Finance Only to Satisfy

the need for Muslims to Comply
with Shariah?

Islamic Finance is also expected

to address the interest of different
clientele!

$$

ENDS /

The
Framework
of Islamic
Finance

Maqasid al-Shariah
(The Objectives of Shariah)

1st Level of
Compliant

Riba

Al-Zulm
(Qimar)

Gharar

MEANS/

Uqud Musamma
(Nominate Contracts)

Islamic Contract

Uqud Ghair Musamma

(Non-Nominate Contracts

Investment Activities
Rectifying & Purifying
2nd Level
of
Compliant

Shariah-Compliant
Operation

Conversion Process
Hedging Instruments

Monitoring & Supervision

Social Responsibility

FUNDAMENTALS OF ISLAMIC
FINANCIAL TRANSACTIONS

14

Any transfer of wealth or property

has to be made through a valid
contract or `aqad
Theory of Contract in
Islam

Divine Sources
(Quran & Sunnah)

Mutual Consent
(Redho)
15

Riba

Shariah Parameter
in the Theory of
Contract
( )

Al-Zulm
(Qimar)

Gharar

Islamic Contract

SHARIAH-COMPLIANCE
PARAMETERS
IBF
Contracts

Lawful Objective/Purpose
mutual consent
No coercion, fraud,
misrepresentation,
influence, mistake etc.

No Prohibited elements
Nonhalal

Riba
Gharar

Maysir

Riba
Literally means excess, increase, expansion, growth.
In Shariah:
Hanafis School (Imam Sarakhsi, Al-Mabsut):

A surplus or an excess in return without counter value stipulated as
condition in a contract

Riba was made forbidden in the 8th or 9th year after the
Hijrah (flight from Makkah)
12 Quranic verses dealing with Riba
The word riba occurs 8 times, 3 times in 2:275 and one time
each in 2:276, 2:278, 3:130, 4:161 and 30:39

18

Categories of Riba
1. Riba al-Qard @ Riba
al-Duyun

Applies to loan (qard) or to any

debt (dayn) regardless of the
cause of that debt be it because
of a loan contract or because of
any transaction like a deferred
price sales or deferred rental in
lease contract.
It triggers Riba al-nasiah when
additional charge is imposed on
late payment.
Also known as Riba Jahiliyyah or
Riba al-Quran

2. Riba al-Buyu
( Exchange)

1.

2.

Applies to sale transactions in

certain commodities
It has two types:
Riba al nasa (delay in paying or
delivery of one or the two sold
items); and
Riba al fadl (exchanging one ribawi
commodity for the same
commodity but unequal in amount.
Also known as Riba as-Sunnah

19

Prohibition of Riba (in Exchange)

Sunnah of the Prophet s.a.w.:

Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates,
salt for salt - like for like, equal for equal, and hand-to-hand (spot); if the
commodities differ, then you may sell as you wish, provided that the exchange is
hand to hand or spot transaction

Interpretative Efforts

Application
Currency
Same denomination :
At par
Spot
Different denomination:
Spot

Riba (Usury)

Same type:
At par
spot
Different type:
spot

Examples
In loan transactions, riba
will occur in the following:
There is excess or surplus
over and above the loan
capital
Determination of surplus in
relation to time
Stipulation of surplus in loan
agreement

In debt securities/bonds
issuance, riba can occur in :
All interest based lending
activities (conventional bonds)
Fixed return on deposits in
conventional banking
(designated account for
receivable of the bonds)
In the secondary trading of
debt securities (if the
transaction is not spot & if
there is discounting) according to global standard

Gharar
Literally: Deceit, fraud, uncertainty, danger, peril, or hazard that
might lead to destruction or loss
Technically: uncertainty and/or ignorance of one/both parties in a
contract over the substance or attributes of the object of sale, or
doubt over its existence and availability at the time of contract
Rationale for prohibition:
To ensure full consent and satisfaction of the parties in a contract
Gharar in commercial contracts may lead to injustice, exploitation
and/or enmity among contracting parties

22

Types of
Gharar
1

Gharar yasir
(minor or
slight)
Tolerated and will
not invalidate a
contract
e.g. Bay salam
(forward sale)

Gharar Fahish
(major or excessive)
Not tolerated and may
result in contract
voidability
e.g. Bay madum (sale
of inexistence object)
23

Gharar in a contract

Exchange Contract
(e.g. Sales, Leasing)
1.
2.
3.
4.

Non Posession/existence of object

Conditional Sales
2 in 1 contract
Selling with unknown price

24

Gharar Is Tolerable
Exceptional Contract
(e.g. salam, istisna)

Gharar is tolerable!

Why?
1. Public needs (hajiyat
and maslahah)
2. Gharar is trivial with
stipulated conditions

Charitable Contract
(e.g. hibah, takaful)
No Issue of Gharar!

Why?
It is a unilateral contract
and hence does not
lead to dispute
25

Whats The Difference Between Riba & Ribh

Allah permits trading but
prohibits Riba (2:275)

They said that indeed trading

is just like riba (2:275)

RIBA
NO
COUNTER-VALUE

PROFITS
Whats
The
Difference?

Qaidah Fiqhiyyah:

Justification of Profit is due to
property, effort and liability assumed
(Jamharatul al-Qawaid al-Fiqhiyyah
Vol.1 P.332)

WITH
COUNTER-VALUE
(`IWAD)

26
Effort
(Al-Kasb)

Risk
(Al-Ghurm)

Liability
(Al-Dhaman)

General Classification of Contract in Islam

Profit-making Contracts

Charitable Contracts
()

Exchange Contracts
()
Cooperation Contracts
()

27

TYPES OF CONTRACTS

Contracts of
Guarentee
/Supporting
Contract
Tawthiqat)

-Guarantee Kafalah
-Transfer of Debt/
liability Hawalah
-Collateral/Pledge
Rahn

Unilateral
Contracts
/Charitable
(Uqud
Tabrruat)

-Hibah Gift
-Iarah Simple loan
-Qard Loan
-Endowment Waqf
-Wasiyah
-Takaful

Contracts
of
Partnership
(Uqud
Ishtirak)

-Musharakah
-Mudarabah

-Muzaraah
(Share-Cropping
Agreements)
-Musaqat
(Watering)

Con tract of
Exchange
(Uqud
Muawadat)

-Murabahah (Mark-up sale)

-Istisna (Manufacture Sale)
-Baimuajjal (Differed sale)
-Bai Asalam/(Forward Sale)
-Sarf (Exchange)
-Ijarah
-Jualah commission

Deposit-taking Contracts

Various forms of
Islamic Contracts
used in Banking

Sales-based Contracts

BBA deferred sale;

Murabahah cost-plus sale;
Bai al-Inah, Bai al-Tawarruq

Lease-based Contracts

Ijarah Wa Iqtina; Ijarah

Thumma Al-Bai, Ijarah
Muntahia Bitamleek

Equity-based Contracts

Mudarabah, Musyarakah

Fee-based Contracts

Promise/Undertaking
Wa`ad

Wadiah Yad Amanah; Wadiah

Yad Dhamanah, Mudarabah;
al-Qard

Hybrid Contracts

Kafalah/Dhaman (Guarantee);
Wakalah (agency)

Musyarakah Mutanaqisah
(Dimishing Partnership),
AITAB etc.

29

Promote Public
Interest
(Maslahah)
Freedom from
Riba

Entitlement to
Equal, Adequate,
Accurate Info.

Promote
Brotherhood

Freedom from
Gharar (Ambiquity)

A system grounded
on moral and
ethics

Freedom from
Dharar (Detrimental)

Freedom to
Contract

Characteristics of Shariahcompliant Banking and

Financial System
Freedom from
Price control &
Manipulation

Freedom from
Qimar & Maysir
(Gambling)

Entitlement to
Transaction at
Fair Price

Consumer Demand

Shariah Compliant

Viability?
Risk?
Legal Structure

We need to
finance our
car, house,
business

How to
structure
financial
products that
comply with
Shariah?

ISLAM
& Components of Shariah
I`tiqadiyah
(Belief)

Economics

`Amaliyah
(Dealings)

Akhlaqiah
(Morality)

Ibadah

Muamalah

(Human with Creator)

(Human with human)

Family Law

Criminal Law

Issues in Islamic banking and finance

Politics

Approach in Deriving Hukm Syari (Islamic

Legal Ruling)
Ibadah

Fixed
Determined by God
Based on premise:


Original ruling in Ibadah is invalid
unless there is a valid
justification for its
commandment
Otherwise, it is considered
bidaah (innovation)

Muamalah
Combination of fixed and
flexibility
Based on premise:

The original ruling is

permissible unless there is a
clear and valid justification
that suggest otherwise
Understanding the illat
(rationale) and maslahah

WHAT IS SHARIAH?

INTRODUCTION TO SHARIAH

Technical
meaning:
SHARIAH

-Shariah refers to the

laws and
commandments and
way of life prescribed by
Allah to mankind

-Shariah refers to

commands, prohibitions,
guidance, and principles
that God has addressed
to mankind. Pertaining
to their conducts in this
world and salvation in
the next.
FEATURES OF SHARIAH
:
1) Rabbaniyyah (Divine
Origin). Reward in the
world and hereafter.
2)Alamiyyah and
umumiyyah (universal)
Permanent.
3)Syumul
(comprehensiveness)

FIQH

Literal meaning:
- The term of fiqh is
used in the literal
sense to mean
knowledge and
understanding al-

fahm.

Technical meaning:
- The knowledge of
the legal rules (Al

Ahkam Al Shariyyah),
pertaining to conduct
that have been
derived from their
specific evidences.

Cont

BENEFITS OF
USUL FIQH

USUL FIQH

SHARIAH FRAMEWORK OF ISLAMIC FINANCE

Sources of
Shariah
Maqasid
Al-Shariah

Legal
maxims

SOURCES OF SHARIAH LAW

PRIMARY SOURCES
Ijtihad

Al - Quran

Sunnah

Consensus

Analogy

SECONDARY SOURCES

public
interest
(al-istislah),
Maslahah

Juristic
preference
(al-istihsan)

Practices of
Peoples
of Medina
(amal ahl
al-madinah)

General
customary
practices
(al-adah)

Presumption
Of continuity
(al-istishab)

Saad
Al-dariah

Companions
opinion
(qawl
al-sahabi).

Shar Man
Qablana
(earlier
scriptures).

MAQASID AL-SHARIAH
AL-GHAZALI:
- The very objective of the Sharah is to promote the well-being of the people, which lies in
safeguarding their faith (dn), their lives (nafs), their intellect (aql), their posterity (nasl), and
their wealth (ml).
-Whatever ensures the safeguarding of these five serves public interest and is desirable, and
whatever hurts them is against public interest and its removal is desirable
IBN ASHUR:
- defined Maqasid al-Shariah based on two aspects:
1: The general aspect which is the purpose and wisdom behind the enactment of
all or most of the shariah ruling. This definition is more related to the general objective of

Shariah.

2: The second definition of Maqasid al-Shariah is very specific. It is related to specific

objective to those objectives that are designed to achieve specific benefits to people in
their daily activities, such as Islamic finance.

ALAL AL-FASI:
- defined Maqasid Shariah as the end sought behind the enactment of each of the ruling of
Shariah and the secret involved.
-This definition covers the public Maqasid (ama) and the specific/private Maqasid (khasa).

Cont

IMPORTANCE OF MAQASID AL-

SHARIAH IN ISLAMIC FINANCE

CLASSIFICATION OF

MAQASID AL-SHARIAH:
3 major categories:

Maqasid Shariah is crucial to Islamic jurisprudence.

Maqasid helps to validate the different resolutions and

ruling derived from the text.

The necessities or
essentials (daruriyyat).

The requirements/needs
(hajiyyat).

Muslim jurists depend on Maqasidi approach in all types

of ijthad including Ijtihad in Islamic finance.
The complementary/
embellishments(tahsiniy
Maqasid is important to comprehend Shariah from a
broader approach.

yat).

Essential reference for Shariah Advisory in issuing fatwa

and resolution.

All Islamic legal ruling

aims at realizing one of
the above categories.

Essential reference for regulators such as Bank Negara &

Securities commission.
Essential reference for setting bodies such as AAOIFI &
IFSB.
Essential reference for financial planning sectors.

MAQASID AL-SHARIAH

3. THE COMPLEMENTARY
2. THE NEEDS
1. THE NECESSITIES

(AL-TAHSINIYYAT)

(AL-HAJIYYAT)

(AL-DARURIYYAT )

Protection of Faith (Din)

Protection of Life (Nafs)
Protection of Posterity (Nasl)
Protection of Property (Maal)
Protection of Reason ('Aql)

* They are essential and basic for the establishment

of welfare in this world and the world hereafter, in
the sense that if they are ignored then coherence
and order cannot be established and fasad
(chaos and disorder) will prevail in this world, and
there will be obvious loss in the world hereafter.

* They consist of five things:

Some scholars argued that though the five daruriyyat are essential for human welfare,
necessities are not confined to these five maqasid, hence; they proposed additional
daruriyyat such as equality, freedom and the protection of the environment.

THE FIVE FUNDAMENTAL OF NECESSITIES

Preservation
of al-Din

Preservation
of Life (Al-Nafs)
Preservation Of (Nasl)
human being
(Al-Ird) Family
Preservation of Wealth through
Acquisition and Development
Preservation of Wealth from Damage
Preservation of Wealth through the
Protection of Ownership
Preservation of Wealth through its
Value Protection
Preservation of Wealth through its
Circulation

Preservation of
Intellect or Mind
(Al-Aql)

Preservation
of Property
(Al-Mal)

cont..
2. THE NEEDS/REQUIREMENTS
(AL-HAJIYYAT)

They are provisions that aim at

removing hardships and/or
facilitating life.
Removing hardship is said to
fulfill the hajiyyah (requirements).
Examples of hajiyyah are:
1) The permission for qirad
(profit-sharing through
borrowing)
2) Musaqat (profit sharing)
3) Bai salam (forward buying of
a commodity which does not
yet exist)

3. THE COMPLEMENTARY/
EMBELLISHMENTS(AL-TAHSINIYYAT)

They are things that beautify

life and puts comforts into it.
Examples of tahsiniyyat are:

Permission to use beautiful,

comfortable things; to eat
delicious food; to wear fine
clothing and so on.

Preservation of Wealth

Eliminate Prejudice

Alleviate Hardship
Justice

Maqasid as-Shariah in Islamic Finance

Macro
Maqasid

Micro
Maqasid

Assessment on the overall

impact and contribution

Assessment on the transactional

instrument and mechanism

Ar-Rawaj (Distribution of Wealth)

Approach in Realization of the
Objectives of Shariah

HIGHER OBJECTIVES OF ISLAMIC FINANCE

Compliance with Shariah commands and prohibitions.

Achievement of a comprehensive economic development

Achievement of capital growth

Achievement of a balance distribution and a smooth

circulation of wealth.
Avoidance of the fundamental prohibitions: Usury (riba),
Excessive Risk (gharar), Unknown (jahalah)and
Gambling(maysar).
Achievement of the principle of risk sharing

LEGAL MAXIMS

INTRODUCTION

THE FIVE FUNDAMENTAL LEGAL

MAXIMS
The most comprehensive and broadly based of all maxims are
known as al-qawaid al-fiqhiyyah al-asliyyah,
or the normative legal maxims, and they apply to the entire
range of fiqh without any Specification are:

1. Acts are judged by on the intention behind

them. (Al umuru bimaqasidiha)

2. Certainty is not to be overruled by doubt. (Al

yaqinu la yazulu bish -shakk)

3. Harm must be eliminated (Al-darar yuzal)

4. Hardship begets facility. (Al mashaqqatu

tajlibu At-taysir)

5. Custom is the basis of judgments. (Al-adatu

muhakkamatun)

1- The maxims are based on

the fiqh itself. Usul al-fiqh is

2- Legal maxims are designed to

facilitate a better understanding of
the Shariah and the judge may not
base his judgement on them unless the
maxim in question is derived from the
Quran or hadith or supported by
other evidence whereas Usul Al-Fiqh is
derives from Quran and Sunnah and
its rules are in binding

concerned with the

methodology of legal
reasoning and the rules of

interpretation, the meaning

and implication of commands
and prohibitions, and so forth.

DIFFERENCES
BETWEEN USUL
AL-FIQH AND
AL-QAWAID
FIQHIYYAH

AN OVERVIEW ON THE THEORY OF CONTRACT

LITERAL MEANING:

TECHNICAL MEANING:

The Arabic equivalent of the

word contracts is uqud,
plural of aqd.
The literal meanings of this
word are to tie, to join, to
lock, to hold, to contract,.
Among these meanings, the
last one is closely related to its
technical meaning.

Contract is:
Conjunction of an offer or ijab
and an acceptance or qabul.
Or
Conjunction of the elements
of disposition, namely, offer
(ijab ) and acceptance
(qabul).
It is a connection between offer
and acceptance

CONTRACT

PILLARS & CONDITIONS OF SHARIAH CONTRACTS

Majority: contract consists of:

Statement, two contracting
parties, and the subject matter.

Subject
Matter
of contract
(Mawdu
Al Aqd)

Be legal

Hanafi: Statement is the only pillar of the

contract

THE PILLARS
OF CONTRACT

All aspects will automatically follow the

statement

The two
Contracting
Parties
(Al-Aqidan)

Puberty
Capability of
Male:
ejaculate
Known
a Sub
Sperms
in his
To both
Matter to be Must be in
night
dreams
Parties
handed
existence
Female: onset
specification Over/delivery
Of
menstruation

Sanity
(Akil)

Statement
Of Contract
(Sighah)

Maturity
(Rushd)(

Use Past
Tense

Conformation
of offer
and
acceptance

Clarity of
offer
and
acceptance

Connection
of
acceptance
With offer

PILLARS & CONDITIONS OF SHARIAH CONTRACTS

SUBJECT MATTER
OF CONTRACT
(MAWDU AL-AQD)

Be legal
Suitability of the
Subject matter

Known
To both
Parties

Capability of
a Subject
Matter to be
handed over

Must be present
in existence

Exception for donation/

charity

1: considered
property of value
2: Not forbidden
by the Shariah

1: viewing a
similar object
2: identified
by the description

Exception for Salam

1: owned by
any of the parties
2. Delivery
Stray animal (Sharid)
Prey animal cannot
Be sold (farisa)

selling grains
or fruits before
their perfect
appearance
is not allowed

Pillars & Conditions of Shariah contracts

THE TWO
CONTRACTING
PARTIES
(AL-AQIDAN)

Puberty
both contracting
parties must
attain puberty

A person is not allowed to deal with his

wealth independently without attaining
maturity

Sanity (Akil)
both must be sane
If both or one of them is
insane no contract is
to be made

Male: when he starts

Ejaculate Sperms
in his night dreams
Female: at the onset of
menstruation

Maturity
(Rushd)

Good and proper dealings

with wealth from a worldly
viewpoint

Request consent of his

guardian
IF NOT

signs do not appear

Abu Hanifah:M18,F17
Malik 17 for both
Al Sahiban: 15 both

If a person possesses all these three qualities,

puberty, sanity and maturity, he is considered
to be fully capable of negotiating and
concluding different types of contracts
independently

(SIGHAH)
OFFER & ACCEPTANCE
According to
Hanafi School
of Law

According to
the majority of
scholars

Hanafi: statement is
considered to be the only
pillar of a contract

Use Past
Tense in forming
the contract
(Recommended)

STATEMENT
OF CONTRACT
(SIGHAH)
OFFER,
ACCEPTANCE

Confirmation
of offer
and acceptance

Majority: Statement, contracting

parties and the subject matter
form the pillars
Session Of Contract

Clarity of offer
and acceptance

Connection
of acceptance
with offer
Is the contract

Verbal expression for

forming an offer and
an acceptance

Explicit or implicit

Clear and
void of ambiguity

Binding immediately
following an offer and
acceptance, or can be
delay for further thinking
until the end of the session,
(khiyar al-majlis).

1: Hanafi and Maliki contract is binding immediately.

Writing, fax, phone

new modern tools

Present, future,
or the command could
be utilised depending
on the intention
54

2: other jurists maintain that both parties are allowed to rethink and
delay until the end of the session.
Jurists have disputed whether an offer and acceptance are allowed to be formed
through silent consent by means of giving a price and handing over the sold
good (Mua'atat). Shafii: Not valid. Majority: Valid.

Assoc. Prof. Dr Asyraf Wajdi Dusuki

Head, Research Affairs
ISRA @ INCEIF
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Menara Tun Razak
Jalan Raja Laut
50350 Kuala Lumpur
MALAYSIA
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Fax : +603-2691 1940
Email
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