Chapter - 4-islamic fiance for all t.ppt

islamic finance for allslamic banking, also referred to as Islamic finance or Shariah-compliant finance, refers to financial activities that adhere to Shariah (Islamic law). Two fundamental principles of Islamic banking are the sharing of profit and loss and the prohibition of the collection and payment of interest by lenders and investors.

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Islamic Finance and Banking
Prepared By:
Dr. H. M. Mosarof Hossain
Professor
Department of Finance
University of Dhaka
[email protected]

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Chapter 4: Shari’ah Framework and
Principles for the Islamic Financial System
Sharia or sharia law (ةعيرش) is the Islamic legal system
derived from the religious precepts of Islam, particularly the
Quran and the Hadith. The term sharia comes from the
Arabic language term sharīah, which means a body of
moral and religious law derived from religious prophecy, as
opposed to human legislation. It deals with many topics,
including crime, politics, and economics, as well as personal
matters such as hygiene, diet, prayer, everyday etiquette
and fasting. Adherence to sharia has served as one of the
distinguishing characteristics of the Muslim faith historically.

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Shari’ah Framework and Principles for the
Islamic Financial System
In its strictest and most historically coherent
definition, sharia is considered in Islam as the
infallible law of God. Literally it means “the road to
the watering place”. According to Qur’an; “Then We have
put you on a plain way (ةعيرش) of commandment. So
follow you that ( Islamic monotheism and its laws),
and follow not the desires of those who know not.”
(Al-Qur’an, 45:18). It is the sum of the islamic
teachings and system, which was revealed to
prophet Muhammad (Pbuh), recorded in the Qur’an
as well as deducible from the prophet’s divinely-
guided lifestyle called the sunnah.

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Components of Shari’ah
The Shari’ah, which contains all different commandments of
Allah (swt) to mankind, can be divided into three fields such
as:
i. Al-ahkam al-taqdiyyah i.e. the sanctions relating to
beliefs such as the belief in Allah (swt) and the day
of judgement,
ii. Al-ahkam al-akhlaqiyyah i.e. the sanctions relating
to morals and ethics such as the injunction to the
truth, be sincere, be honest etc.
iii. Al-ahkam al-amaliyyah i.e. sanctions relating to the
sayings and doings of the individual and his
relations is called fiqh.

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Sources of Islamic Law (Shari’ah)
A: Primary sources – Qur’an, Sunnah, Ijma and Qiyas.
B: Secondary sources – juristic preference (istihsan),
presumption of continuity (istishab), custom (urf),
consideration of public interest (maslahah al-mursalah),
blocking of means (sadd al-dhara’i), and the practice of the
people of Madinah (amal ahl al-Madinah).

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Maqasid Al-shari’ah vis-à-vis Islamic
finance
Maqasid Al-shari’ah is defined as “the deeper
meanings and inner aspects of wisdom (hikam)
considered by the lawgiver in all or most of the
areas and circumstances of legislation”. It also
explained the importance of the knowledge of
maqasid al-shari’ah for mujtahids not only in
understanding and interpreting the text of shari’ah,
but also to find solutions to the new problems
facing muslims and about which those text are
silent.

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Maqasid Al-shari’ah vis-à-vis Islamic
finance
In islamic finance and banking, equity-based
financing like musharakah and mudarabah are
closer to the realisation of maqasid al-shari’ah. On
the other hand, debt-based personal financing like
ijara transactions, sale transactions and bay’ al-
inah are not fully in line with maqasid al-shariah. In
most situations, the customers are in real need of
cash for some legitimate purposes for inah and
tawarruq are shari’ah compliant.

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Legal maxims pertinent to Islamic finance
Legal maxims are defined as the general fiqh
principles which are presented in a simple format
consisting of the general rules of shari’ah in a
particular field related to it. The function of legal
maxims is to facilitate the understanding of how
problems and principles could be used to deduce
the many rules of fiqh. These are formulated based
on certain evidences from the Qur’an or Sunnah.
For example, “The burden of proof is on him who
claims, and the oath is on him who denies.” These
are also constructed upon principles of pure justice,
interest of human beings and principles are
generally confirmed by the shari’ah.

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Legal maxims pertinent to Islamic finance
Modern issues in islamic finance which have no
precedent from the classical texts arise from time to
time and these issues need to be addressed
according to islamic rulings. Thus the solution is
founded in the application of legal maxims to develop
the parameters of islamic banking and finance and its
general principles. Generally following five legal
maxims are considered as unanimously accepted for
covering the most issues of fiqh:
1. Matters are determined according to intentions (Al-
umur bi maqasidiha): This is originated from “Deeds
are judged by intentions and every person is judged
according his intention” (Al Bukhari).

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Legal maxims pertinent to Islamic finance
All human acts, once done, must be valued in
accordance with intention. The intention of the parties
in a transaction is relevant in determining its legal
effect. An example of this in modern banking is the
imposition of ta’widh that is the compensation paid by
the intentionally defaulting parties that is allowed on
the basis of preventing intentional defaults by
customers.
2. Hardship begets facility (Al-mashaqqatu tujlab at-
taysir): Difficulty is to be accompanied by easiness.
Necessity renders prohibited things permissible.
According to this, exceptions must be granted in order
to avoid the injustice.

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Legal maxims pertinent to Islamic finance
“Allah has not laid down upon you in religion any hardship”
(Surah Al-Hajj, 78). Also “He intends every facility for
you, and he does not want to put you in hardship”,
(Surah Al-Baqara, 286).This is found to be of important
relevance in modern islamic finance, for example, the
permission to deal with conventional banking for the
muslim minority living in non-muslim countries to some
extent.
3. Harm should not be inflicted nor reciprocated (La darara
wa la dirar): It means injurious or harmful acts must be
avoided and prevented in all cases. Based on this
principle, the debtor’s act of delaying payment which
could harm the creditor must be avoided by having a
compensation/penalty clause.

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Legal maxims pertinent to Islamic finance
4. What is certain cannot be removed by doubt (Al-yaginu la
yuzala bi ash-shakk): This is pertinent in solving the cases of
doubt. The origin of all things is permissibility. It means all
things or creatures in this world are permissible for
consumption or use by humans, unless Allah says otherwise.
The Qur’an states in Surah Al Baqarah, verse 29: “And he
has created for you every creation on earth.” In sunnah, The
Prophet (pbuh) said, “What is permitted by Allah in the Qur’an
is halal and what is prohibited is haram, what is left
unmentioned is permitted so accept the leave given by Allah,
verily Allah does not forget anything.” This rule widens and
paves the way for the innovation of different tools and
instruments for financial transactions without necessarily
finding the authority for their permissibility.

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Legal maxims pertinent to Islamic finance
5. Customary practices as a basis of judgements (Al-adatu
muhakkamatun): Customary practices of society in terms
of their words and actions are acknowledged and
recognised by the shari’ah in the absence of textual
injunction, provided they have fulfilled the following
requirements:
a)The custom must not violate a divine text of the Qur’an
and Sunnah or any shari’ah principles.
b) The custom must be consistently applied and prevailing in
the society.
c) The custom must have been in effect at the time the
activity or transaction was carried out.

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Legal maxims pertinent to Islamic finance
d) The two contracting parties must not have agreed to a
condition contrary to the customary practice. If they have
agreed to the contrary, then the customary practice is not
recognised.

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Differences of opinion among scholars
The differences of opinion among the jurists take place in all
stages of the development of islamic jurisprudence. The
nature of textual evidences either from the Qur’an or
Sunnah allows room for differences of opinion. It is natural
that muslims across the eras and jurisdictions have
differences of opinion in economic transactions law, even
from the early stage of islamic laws development in the
hands of the early jurists. With regard to modern islamic
finance and banking, the difference across jurisdictions as
well as among individual jurists is an acceptable fact. This
is due to the fact that modern islamic finance emerged
amidst the complicated conventional system, striving to
provide alternatives to muslims. Basically, there are four
main reasons for conflicting rulings among the jurists:

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Differences of opinion among scholars
a) Variation in understanding the meaning of a word
in the texts
b) Differences over the narrations of the Sunnah
c) Conflict in the application of principles
d) Divergence in the method of Qiyas

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Role of ijtihad and mujtahid in Islamic
banking and finance
It is an effort made by the mujtahid in seeking
knowledge of the legal rules of shari’ah through
interpretation. Thus, ijtihad entails the effort made by
the qualified scholars in order to derive rulings, by
using the principles of interpretation of law known as
usul al-fiqh. Ijtihad might need to be performed
collectively. Modern issues like islamic finance might
need collective rather than individual ijtihad. This is
classified as:
a) Ijtihad to discover the laws directly from the text
whether it is explicitly or impliedly mentioned by the
text. This involves direct interpretations by the
mujtahid on the specific meaning of the available text.

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Role of ijtihad and mujtahid in Islamic banking
and finance
b) Ijtihad to extend the law to new cases that might be
mentioned in the text requires to apply qiyas by
looking at the illah or underlying rationale.
c) Ijtihad to extend the law to new cases that are not
covered by the previous two methods by extending
the general principles of law or maqasid al-shari’ah as
laid down by the text. Many issues of modern islamic
finance fall within this type of issue, and hence
necessitate the exercise of collective ijtihad.

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Fundamental prohibited elements in islamic
finance
i.Prohibition of riba- Riba literally means excess,
expansion, increase, addition or growth. It could be
defined as unlawful gain derived from the quantitative
inequality of the counter values in any transaction
purporting to affect the exchange of two or more
species which belong to the same genus and
governed by the same efficient cause. Riba may be
the following two types:
(a)Riba al –duyun or riba al-nasi’ah (Lending-borrowing)
(b) Riba al-buyu’ or riba al-fadl ( Trading or exchanging)

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Fundamental prohibited elements in islamic
finance
ii. Prohibition of gharar- literally it means risk, uncertainty
and hazard. A contract which contains a risk to any one
of the parties which could lead to his loss of property is
known as gharar. “ O you who believe! Eat not your
property among yourselves unjustly by falsehood and
deception, except it be a trade amongst you, by mutual
consent” (Surah Al-Nisa, 29).
iii. Prohibition of maysir- it means games of pure chance
where any party might gain at the expense of the loss of
the other party. “ O believers, wine and gambling, idols
and divination by arrows are but abominations devised
by satan; avoid them so that you may prosper.

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Indeed satan seeks to stir up enmity and hatred among
you by means of wine and gambling and to keep you
away from remembrance of Allah (S.w.t.) and from
your prayers” (Surah al-Ma’idah, 90-91).
Mutuality of risk sharing:
The Qur’an had permitted sale due to fairness in risk and
return that assumes risk-taking where the seller
deserves the profit from the sale. Risk can be divided
into the following three types:
i. Entrepreneurial risk that might occur as part of the
normal course of business in every economic activity.

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ii. Natural risk that might occur from natural disasters and
calamities that can be minimized through cooperative
insurance.
iii. Unnecessary risk which are not part of everyday life but
arise from games of chance created by people.
Governance and transparency:
The significance of shari’ah governance transpires via
its role of ensuring the confidence of the islamic finance
industry in the eyes of the public. More importantly,
shari’ah governance ensures that the industry is at all
times in accordance with the wishes and laws of the
Almighty by ensuring the legitimacy of the products
offered.

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Effective shari’ah governance requires the setting up of a
clear and comprehensive framework to regulate the
islamic finance industry and guide its development by
forming shari’ah advisors. IFIs must abide and
adhere to the same regulatory requirements when it
comes to the issue of disclosures that will ensure the
smooth management.

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Issues and challenges
1.Ensuring the maximum utilization of the shari’ah
principles in developing islamic financial products.
2. Addressing the need for harmonisation of the
interpretation of shari’ah across jurisdictions.
3. Ensuring a high quality and standard of shari’ah
services.
4. Realising maqasid al-shari’ah at the level of general
framework of islamic finance or product development.