Introduction to Shariah and Financial Transaction

7/28/2019 Introduction to Shariah and Financial Transaction

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Islamic concept of brotherhood and equaltreatment of all individuals in society is notmeaningful unless accompanied byeconomic justice, which means everyone gets

his due for his contribution to society or to thesocial product and there is no exploitation ofone another.

Allah SWT says: Surely Allah SWT enjoins thedoing of justice and the doing of good (to

others) and the giving to the kindred, and Heforbids indecency and evil and rebellion; Headmonishes you that you may be mindful...

(Surah An-Nahl: 90).


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Shariah ( ) comes from the word ( ) whichliterally means to prescribe or ordain, law, and astraight road or path.

Literal

The road to watering place; the straight path to befollowed

Technical Rules which are ordained by Allah for His servants by

sending His Messenger

Refers to Islamic laws which were revealed to theProphet Muhammad (saw) and which are recordedin the Quran and Sunnah.


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PRIMARY SOURCES

Al-Quran

Sunnah

Ijma (Consensus ofMuslim Jurist)

Qiyas (AnalogialReasoning)

SECONDARY

SOURCES

Istihsan (Juristicpreference of thestronger principles)

Istishab (Presumption of

continuity)Maslahah Mursalah

(Extended analogy/consideration of publicinterest)

Sadd al-Zarai (Blocking

unlawful means to anunlawful end)

Uruf (Custom)


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Wajib Obligatory

Mandub Voluntary

Mubah Permissible

Makruh Dislike

Haram Forbidden


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Shariah is divine guidance from Allah SWT and ProphetMuhammad SAW. It is comprehensive, immutable andeternal. It covers all aspects of human life, on theindividual as well as collective levels in matters of faith,worship and human relation in personal and public rights

Fiqh Muamalah is Islamic rules concerning wealth andtrading practices. It is also known as Islamic commerciallaws.

Islamic finance and the Shariah-Compliant contracts areamong the areas of knowledge under Fiqh Muamalah.

The implementation of the Islamic rules related to theeconomy necessitates the implementation of the rules ofZakah, Nafaqah, and Jizyah, which in turn means theimplementation of the economic system. The execution ofthe economic system requires the implementation of theIbadah, social system, Islamic foreign policy, and rules

related to the leader all together.


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Financial transactions, in order to be permissible and for thepurpose of earning profit, should be associated with tangible

real assets. In the Islamic framework, money itself is notrecognized as capital, and as such it cannot earn a profit initself.

To ascertain the Shariah position of any types of transaction,we will have to look at their nature. If it is a loan or a credit

transaction culminating in a debt, such loans/debts cannotfetch any increase whatsoever. In the sale of goods or theirusufructs, however, one can make a profit as per the rules ofthe Shariah relating to the respective transactions.

The profit arises out of business is halal, it is not riba. Hence,

Muslim scholars have invented some Islamic transactionswhich do not involve interest and Islamic banks are adoptingthese Islamic transactions.

Muslim scholars in the world were thinking for a long time howto develop a banking system which will be operated based

on shariah principles and will not take any interest on loangiven to people.


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Muhammad Ayub (2007 ) mentioned:

The Quran enjoins us to write down and takewitnesses in all transactions that involve credit oneway or the other.

Similarly, Prophet Muhammad SAW himselfencouraged disclosure of all features of goods beingtraded and the competitive environment in whichpeople get sufficient information about goods andtheir prices in the market.

The Islamic banks disclosure standards are stringentbecause their role is not limited to a passive financierconcerned only with interest payments and loanrecovery. Islamic financing modes are used tofinance specific physical assets like machinery,inventory and equipment.


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Siddiqi (2001) highlighted:

The main aim of Islamic banking and finance to provide aShariah compliant solutions to the conventional systemthat is based on riba.

As an alternative to riba, the profit and loss sharingarrangement are held as an ideal model of financing inIslamic finance.

It is expected that profit and loss sharing mechanism inIslamic finance will significantly remove the inequitable

distribution of income and wealth and may lead to amore efficient and optimal allocation of resources ascompared to the interest-based system and it will ensure

justice between the parties involved as the return to thebank on finance is dependent on the operational results ofthe entrepreneur.


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Prohibit Elements In Islamic Transactions

RIBA GHARAR MAYSIR(GAMBLING)

Allah says Theywill ask thee about

intoxicants andgames of chance; inboth there is greatevil as well as somebenefit for man; but

the evil which theycause is greater thanthe benefit which

they bring

(Al-Baqarah: 219).

(INTEREST/USURY)

Allah says Thosewho devour usury will

not stand except asstand one whom theEvil one by his touch

Hath driven tomadness. That isbecause they say:

"Trade is like usury,"but Allah hath

permitted trade andforbidden usury.(AlBaqarah: 275)

(UNCERTAINTY)

Allah says O you who

believe, Eat not

property amongyourselves unjustly by

falsehood anddeception,except it beatrade amongst you,by

mutual consent

(Al-Nisa: 29).


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Islam recommends avoiding reprehensible transactions andencourages meritorious acts; indifferent acts are Shariahneutral. Prohibited activities have to be avoided in everyrespect, and obligatory acts must be carried upon and never

to be ignored.

The underlying principle in Islamic contracts is permissibilityand validity. And since most of the new banking andfinancial transactions did not even exist as such whenclassical law held sway, any of these transactions would be

considered as valid unless there is an explicit text or religiousrule proving its prohibition and voiding.

Therefore, Islamic banks enter into different concepts whiledoing the business, namely promises or contracts.


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Contracts in Islamic banking are used for trade, lease,

partnership, agency, loans, guarantee, etc. exchange

of ownership in the form of trade involves mutual

exchange of property rights along with usufruct, the

asset and its usufruct are both transferred to the buyer

following the sale agreement irrespective of cashpayment having been made immediately or in the

future.

In addition, the ownership of the asset and its transfer

from the seller to the buyer is an important aspect for

Islamic banking transactions since risk remains with theparty who owns the asset at a point of time following

the transaction.

Islamic banks and financial institutions are required to

adopt transparency, disclosure and documentation to

a greater extent than the conventional banks.


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Form

sofIslamic

C

ontra

cts

DeposittakingContract

Sales basedcontract

Lease-based

contractEquity-based

contract

Fee-based contract

Hybrid Contract


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Islamic transaction is an activity that is consistent with

the principles of Islamic law and its practical applicationthrough the development of Islamic economics.

Investing in businesses that provide goods or services

considered contrary to Islamic principles is also

forbidden.

Because Islam forbids simply lending out money at

interest, Islamic rules on transactions (known as Fiqh al-

Muamalat) have been created to avoid this problem.

The basic technique to avoid the prohibition is the

sharing of profit and loss, via terms such as profit sharing(Mudarabah), safekeeping (Wadiah), joint venture

(Musharakah), cost plus (Murabahah) and leasing

(Ijarah).


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In Islamic financial contract dealings it is commonly acceptedthat commercial dealings must be compliant with certainacceptable practices. These practices can be summarized as

follows:

The contract price of the item financed must be at aprice that is mutually agreeable to all the parties to thecontract.

The agreement to the price must not be made underduress.

The contract must be between parties that are mentallyhealthy and able to make rational decisions.

The parties to the agreement must be old enough tounderstand the implications and consequences ofentering into the said contract or agreement.


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The presentation of the fact relevant to the contacted

items should be without ambiguity or deception. No contract under Islamic Finance may be

contradicting or opposing a value that is prohibited

under Islamic law.

Prohibited activities have to be avoided in everyrespect, and obligatory acts must be carried uponand never to be ignored. The underlying principle inIslamic contracts is permissibility and validity.

Since most of the new banking and financial

transactions did not even exist as such when classicallaw held sway, any of these transactions would beconsidered as valid unless there is an explicit text orreligious rule proving its prohibition and voiding.


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Risk sharing; profit and loss sharing

Limited partnership: one partner provides

capital; other partner providesexpertise/effort and makes businessdecisions

Restricted or unrestricted Examples:

funded participation arrangement

establishment of investment fund


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Risk sharing; profit and loss sharing insame proportions

General partnership / joint venturearrangement between financier andinvestor

Provides equity funding to a venture;greater risk-reward factors and greaterinvestor say in project management


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Asset based

Trade finance / Acquisition finance

Unconditional contract of sale; goods, cost price, mark-

up and payment date = defined and agreed Profit from marked-up sale price (not interest) paid in

instalments

Examples:

import-export finance infrastructure project financing

leveraged acquisition


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Deposit cash or other assets.

A bank is deemed as a keeper and trustee offunds.

The bank guarantees refund of the entireamount of the deposit, or any part of theoutstanding amount, when the depositordemands it.

The depositor, at the bank's discretion, may be

rewarded with Hibah as a form of appreciationfor the use of funds by the bank.

Two types of Wadiah i.e. Yad Amanah & YadDhamanah


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Asset based

Hybrid between conventional

operational and finance leases; abusiness process

Analogous to secured loan

Examples: aircraft finance

ship finance

project finance

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Introduction to Shariah and Financial Transaction

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