Doubts of Riba being in some Islamic BanksOperations

By: Elhadi Habbani

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Doha May 2013

ContentsSubject PageResearch Method 3Abstract 3Introduction 3Section 2: Literature Review 5Section 3: What is meant by Riba 9- Riba in Fiqh 10- Riba Al-Nasi'ah 10- Riba Al-Fadl 11- The Prohibition of Riba 12- The Prohibition of Riba in Quran 12- The prohibition of Riba in Sunnah 13- Riba and Interest 14- What is wrong with debt 16- What is wrong with interest 17Section 4: The Objectives of the Prohibition of Riba

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- Identifying the objectives of the prohibition of Riba

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- Observing the objectives of the prohibition of Riba

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- Theories in the prohibition of Riba 21

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Section 5: Violation of the Prohibition of Riba in Islamic Banks

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- Profit calculation in Islamic banks 23- Mudarabah and Musharakah profit calculation

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- Using conventional interest rate as benchmark in Islamic banks

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- Tawaroq operations in Islamic banks 29Section 6: Conclusion 34References 36

Research Method:

Based on the objectives of the research which is brieflyclarified in the abstract, and in order to provideevidences to support its main idea, the author useddifferent research methods that can be classified asfollows:1- Theoretical research on some parts of its chaptersmainly when explaining the concept of Riba and identifythe objectives of its prohibition in Islam;

2- Empirical research aiming to help Islamic bankingindustry to mitigate reputation, yield, and interestrate risks by raising the importance of creating uniqueIslamic bench mark as well as profit rate calculationmodels unlike the ones used in conventional banks;

3- Descriptive research when trying to illustrate theway Islamic banks use the same conventional bench marksand calculation methods in calculating profits in bothsides of their balance sheets;

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4- Analytical research when trying to link between theabove mentioned methods and the objectives of theprohibition of Riba in Islam;

Finally on the bases of the research level the researchconcerns with micro level of Islamic banking industry asan economic aspects;

Abstract

The main purpose of this paper is to see whether IslamicBanks are Riba free or they use the same benchmarks andcalculation methods used in conventional banks whencalculating financing profit rates in both sides of thebalance sheet, and to pinpoint some of the Islamicstructured financing products and instruments thatcontains Riba.The paper found that Islamic banks focus on thepermissibility of the contract structures and formsrather than the objectives of the prohibition of Riba inthe way they calculate profit rates, and in all kinds oforganized Tawaroq operations widely used in Islamicbanks, by which, they intentionally providecounterparties by cash as main target rather than realassets. As a result of using the same conventional banksbench marks, our study shows how Islamic banks are beingexposed to reputation, yield, and interest rate mismatchrisks.The paper finally suggests that in order to develop aunique and reputable Islamic banking brand name seriousefforts has to be exerted to, firstly; instruct a uniqueIslamic benchmark and profit calculation method in assetside and liability side. Secondly; to hold back all kindof organized Tawaroq structured transactions extensivelypracticed by most Islamic banks. And lastly, all Islamicbanks and financial institutions should work under oneShariah regularity body with a continuous set ofmandatory regulations and standards to be followed by allIslamic Finance Institutions.

Introduction:

Despite the fact that Islamic financing and bankingindustry has grown-up hurriedly during the last four

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decades and turned out to be a worldwide observableoccurrence as part of the global noticeable growth in thewhole banking industry, which is expanding rapidly interms of modernization of new products, financingstructured operations, contracts, complicated hedginginstruments, and new services situating seriouschallenges before Islamic financing and banking industryto put forth more attempts at all levels to form acompetitive unique alternative Shariah tolerable hedgingtools and financing mechanisms to meet the swiftlyescalating customers' needs, most of studies andresearches concerning Riba continues to be rather rigidand irrelevant to these serious changes focusing, in onehand, in the wordings and the texts rather than theobjectives of Shariah principles, and on how to imitateand replicate conventional banking to legalize cashtransactions, regardless of the spirit of Shariah whichis always stand on a real assets transfer throughpermissible real trade transactions in the other hand,not including very few papers of many supporters of theimportance of stressing on the objectives rather than onforms of the contracts, which are considered as seriousrespectful attempts tried to identify and discover themain essential objectives of the prohibition of riba inIslam with a real unbiased behavior towards the complexfast moving banking industry mainly Islamic banking,clarifying some common misinterpretations to theperception of Riba and interest which can help indeveloping new potential Shariah permissible structuredfinancing instruments.This situation leave the door open for a lot of gaps haveto be visited, studied, and argued on the light of a realpractical experience of Islamic institutions in order todevelop a pure Riba-free Islamic banking system. Our study expected to fill some of the gaps laying in theareas of how Islamic banks applying the concept of timevalue of money, and to prove that how Islamic banksviolating some of the major principles of the prohibitionof Riba, first; in using conventional banking interestrates as benchmark for determining the profit rates inboth sides of the balance sheet, as well as in themethods based in which they calculates the cost of funds

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and profit rates in both debt creating Islamicinstruments like Murabahah and Musawamah, and profitsharing contracts like Mudarabah. And also how do Islamicbanks violate the objectives of the prohibition of Ribain processing Tawaroq transactions aggressively used incontemporary Islamic banks operations. And finally comewith conclusions and suggestions that can motivate morepositive arguments to fill other gaps in the same areas. In this paper which consists, in addition to theintroduction, four sections and conclusion, including theresults of the research, and author suggestions andrecommendations. In Section 2 the paper will review some of the mostimportant literature and contributions walked around thesame border line of the paper subject.In section 3 the paper will explain the meaning of Ribain language and in Fiqh, Riba in Quran and Sunnah, whatis wrong with Reba, interest and debt, and finallydistinguishing between Riba and trade. Section 4 will be reserved for the objectives of theprohibition of Riba, and also presenting briefly sometheories that tried to legalize and justify Riba incertain cases.Section 5 will be reserved to show how Islamic banksusing conventional interest rates as bench marks andtheir consequences, calculation methods within whichIslamic banks in calculating cost of funds and profitrates in both sides of the balance sheet, and how Islamicbanks violating the objectives of the prohibition of Ribain Islam through Tawaroq transactions.Finally section 6 will be booked for conclusion, results,and the author recommendations.

Section 2Literature Review:

While some modern inquiries on investment behavior inIslamic outlook presumes zero rate of time preference in

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Islamic finance, Fahim Khan (1991) argues that, while inone hand, the prohibition of interest in Islamicframework, which can be considered as a refutation oftime value of money, rent, wages, Bay' Mu'ajjal and Salaminstruments include a fixed predetermined part ascompensation for time which, in the other hand, can beconsidered as a recognition of time value of money inIslam. Based on this argument, he concluded that timevalue of money is quite considerable in Islamic bankingand financing basis, as far as it is not claimed as apredetermined value. His argument is widely supported bya well known scholars, that “time has a share in price” MohamadAl-Gammal (2009). He also argued that compensation andprofit earning on Islamic financing cannot be justifiedonly by the pure time factor involved, but rather by thechanging forces of supply and demand and the uncertaintyrisk-bearing involved. Lastly he suggested that, the rateof return paid by IBs on deposits can be used as a proxyfor discount rates for capital budgeting, projectsevaluation, and feasibility studies.Even though, his paper considered as one of the veryimportant contribution on the concept of time value ofmoney that tried to formulate a rationale justificationsfor time value of money beside exerting a respectfuleffort to suggest an Islamic bench mark for measuring andevaluating future cash follows, but the paper did notmention either any thing about how time value of moneyactually applied or on which basis profit rate beingcalculated in Islamic banks. Although, Monzer Kahf (1994) has totally agreed with Khanon the tolerability of time value of money in Islamicframework, he disagreed with him on the basis of timevalue of Islamic banking claiming that human beings, bynature, prefer more consumption over less consumption.This means that an investor will not give up part of hisincome today without having prospective hopes of gettinghigher return in future. This anticipated return is themain motivation that makes the investor sacrifice some ofhis consumption today which represents, according toKahf, his major base of time preference and time value ofmoney. He concluded that time preference considered asinvestment fact rather than merely a consumption fact. So

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he disagreed with Khan that risk bearing is the mainvalidation for profit earning because, based on his viewpoint, risk bearing is not considered as a factor ofproduction because it does not create a value added. Even though Kahf has really added a valuable theoreticalcomments on several points in Khan article that call fordiscussion, but also has been far from discussing theseissues on the light of the real practices of Islamicbanks in terms of methods used in applying the tolerableconcept of time value of money in both profit calculationand some of the Islamic operation implementations.Shamim Ahmad Siddiqui (2006) also reviewed the concept oftime value of money in a broad-spectrum and itssignificance to Islamic economics and finance. Heexamined the fundamental actuality of time value of moneyand put forward that people do not prefer currentconsumption over future consumption. Instead, othervariables affect their choice to get current income (notcurrent consumption) rather than future expected income.Based on this hypothesis he claimed that, from an Islamicstandpoint, either positive time preference or preferencefor attaining an immediate income rather than expectedfuture income are validate compensation for consumptionloans. He concluded that, despite the fact that consumerdurables goods are different from necessities, it wouldbe a unique input of Islamic finance if an instrument ofinterest free loans for such necessities could be workedout. he finally argued that, unlike the argument ofMonzer Kahf on bay muajjal, that bay muajjal is notcomparable to Mudarabah or Musharakah as well as itstolerability cannot be associated to bay Al-Salam. even if the paper calls for the importance of riba freeinstrument in Islamic banks, but did not argue on whetherthe current Islamic financing instruments being practicedin Islamic banks are riba free or not, or on whether themethods of profit calculation applied by Islamic banksare relevant to Islamic Sharia or not. Rininta Nurrachmi, Mia Fathia, Ashanee Mad-ahdin.Ninasrin Radenarmad, Rulia Akhtar (2012) while theyargued that time value of money is a basic financialconcept and an essential factor in the financial organismthat serves for all other perception in finance, they

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distinguished between time value of money in Islamic andconventional banking in the context that, while timevalue of money in Islamic banking tends to be quiteconnected to the real economic and stands on a solid baseof real assets through trade related activities and, sodo contribute in the economic development and growth,conventional banking use money as a commodity in its own,which, according to their viewpoint, leads to inflation.They also highlighted, to some extent, some functionalissues and challenges confronting Islamic banks inapplying the concept of time value of money in somespecific financial products namely Murabahah, Istisna andSalam. Even though, they did not test the base on which Islamicbanks calculate time value of money, their valid argumentthat Islamic products should always be linked to realassets through real trade activities is considered as acloser approach to the importance of avoiding riba inIslamic banks operations.Ali Mohiuaddin Al-Qaradaghi (2007) came a little closerto some of the operations within which Islamic banksviolate the prohibition of riba when he claimed that,there is a similarity between profit mark-up in Islamicbanks and interest rate in conventional banks sinceIslamic banks are using interest rate indicators, such as(LIBOR), as a bench mark and also the profit mark-up inMurabaha, Istisna and even Ijarah Muntahia Bitamleekconverge with interest rate which put more doubts andsuspicions in Islamic banks. He also asserted that thisconnection between profit mark-up and interest might leadto find tricks (Hiyal) that might not be acceptable suchas preferring Ijarah Muntahia Bitamleek, instead ofMurabahah, as a reason for applying floating profit rate.And finally he called for the importance of innovation ofa unique Islamic bench mark and calculation methods. Monzer Kahf (2006) who considered as the first one whoidentified eight essential objectives of prohibition ofriba with a real open minded towards the complicated fastmoving banking industry which can help in creating newprospective Shariah permissible structured financinginstruments. In his paper, he called for paying more

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tension to the objectives of the prohibition of riba dueto the wide momentum raised by the new debt creatingproducts of Islamic banking like Murabaha, Istisna backedby parallel Istisna and Ijarah, and also the new streamof Fatawa came about Tawarruq, Sukuk, and paid-forguarantee (Al-Kafalah Bi Ajr) which has brought in a newdimensions that comprise provision of cash/personalfinancing to individuals as well as corporations andhedging in future commodities and currencies. He finallyargued that these new Fatawa confirmed that a respectfulattempts to mitigate risks of Islamic financing throughmatching the interest-based finance is going on. Ausaf Ahmed, Munawar Iqbal, Tariqullah Khan, (1998) haveidentified 7 challenges facing Islamic banking at theinstitutional and operational aspects. Even though theycalled, in their paper, for the importance of financialengineering and the talent to design Islamic financialproducts in regard to risk, maturity and yield in orderto be able to compete in the fast moving marketenvironment and facing increasing competition andinnovation based on the principles of (Maslaha andIstihsan), but they did not discuss the current practicesof Islamic banks in terms of financial engineering andthe innovated instruments practiced currently in Islamicbanks mainly to legalize cash personal financing toindividuals such as organized Tawarruq operations widelyused by Islamic banks. However they argued, when talkabout Sharia issues as one of the operational aspect'schallenges, that no new product to be implemented untilit is reviewed and approved by Sharia scholars.Hussain Hassan Shahata (2002) came a little bit closer tothe basis of profit rate calculation in Islamic bankswhen argued that, Islamic financial institutions thatdeal with international conventional financialinstitutions encountered many problems due to usinginterest rate as bench mark and called for the need toinnovate an Islamic index consistent with Sharia

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standards, explaining how certain two opinions has beenaroused on the issue, some of which believe that there isno problem to deploy interest rate as a bench mark tocalculate profit rate in Islamic institutions, and theother reject it and emphasizes the need for an Islamicindex. Depending on Quran, Sunnah and Fiqh he attemptedto put general Islamic standards and guidelines based onwhich an Islamic benchmark to be structured. His attemptswas focusing on the evaluation of interest rate as abenchmark for measuring profit rate on deferred paymentfinancial transactions from an Islamic perspective,defining the relevant Islamic instruments within whichthe benchmark can be applied, and finally he confirmedthe importance of developing a unique permissible,objectively, rationale and achievable framework forIslamic debt-creating instruments.Ahmad bin Abdul Aziz Alhadad (2003) argued that Prophet(pbuh) directed people to every moral behavior and awarethem from immoral one, so in actuality, Tawarruq is oneof those confused issues, due to the element ofimmorality in it. This immorality detaches Tawarruq fromthe Islamic finance original rule, which is based onpermissible trade, and transmit it into tricks (Hiyal),which are condemned by Allah and, in turn, these trickslead to riba, which is prohibited by Shari’ah. OIC Fiqh Academy (2009) in its Fatwa on Tawaruq, hasdistinguished between three types of Tawaruq; classicalTawaruq which is permissible, Organized Tawaruq andReverse Tawaruq which are both prohibited in Islam.Malaysia, with an equity market of 86% Shariah-compliant,world’s largest issuer of Islamic Sukuk and 134 Islamictrust funds entity who was aiming to turn out to be the international Islamic financial center by year 2010 andtake the lead in structuring an Islamic pricing benchmarkmodel for the Islamic finance industry in Malaysia aswell as all over the world. To do that, the InternationalShariah Research Academy for Islamic Finance (ISRA) hasappointed a group of experts in Islamic finance andbanking from the Institute of Islamic Banking and Finance

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(IIBF), International Islamic University of Malaysia tocarry out this undertaking. Mohd Azmi Omar, Azman Md Noor, Ahamed Kameel Mydin Meera,Turkhan Ali Abdul Manap, M. Shabri Abdul Majid, SharifahRaihan Syed Zain, Tuan Hj. Md. Ali Sari (2010) who havebeen assigned to undertake the project of formulating anIslamic pricing benchmark, started their mission byasserting that, however, Islamic banks currently usingconventional banks pricing benchmarks because they arepart of an existing conventional finance serving as afinancial intermediary for channeling funds from surplusto deficit units, they have gone further than acting as afinancial intermediary by serving as a wakeel, custodian,partner, entrepreneur, and guarantor. So there is acrucial need for an alternative Islamic pricing benchmark(IPB). The methodology they used started by reviewing theexisting pricing literature from Shariah perspective, theexisting literature on conventional benchmark pricingsuch as KLIBOR, and LIBOR, the existing literature oncost of funds in Islamic banking in Malaysia andworldwide, revisiting the current practices offormulating cost of funds in all Malaysian banks,surveying the existing practices of banks in integratingdifferent risk premiums in pricing, and finally do themodeling and simulation by collecting and testingMalaysian bank's historical data. They held a seriousopen discussions with different treasury and riskdepartments in all Malaysian banks to understand how theyformulate their cost of funds. Their study came out withthirteen proposed Shariah restrictions for an IPB, andconcluded that Islamic finance pricing benchmark shouldbe based on the risk profiles of the real economicbusinesses and quite linked to the real economy,efficiency, and profitability of assets based on the factthat different sectors face different risk profiles. Andfor that major fact they suggested four macroeconomicvariables as a viable IPB these are: Industry productiongrowth to confine the overall economic growth, the moneysupply changes (M2) to confine monetary liquidity, theRinggit exchange rate to mirror the relative globalcompetitiveness, and the Kuala Lumpur Composite Index(KLCI) returns to reflect the overall market trend.

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therefore, the study advised that IBs starts bycollecting the forecasted values of the above fourmacroeconomic variables and computes the expected returnusing the Arbitrage Pricing Theory (APT) model with foreach sector concerned to come out by a benchmark pricingrate for each particular sector, and then estimate theprobability of default for each firm using the firm-specific variables which incorporates the additional raterequired for accepting the firm-specific risks. They alsoconcluded that such proposed pricing benchmark model canbe used by other Islamic financial institutionsworldwide.Although their contribution, based on the author of thispaper point of view, is considered as one of thecomprehensive and serious attempt to construct an Islamicbenchmark, but applying Arbitrage Pricing Model to dothat is widely questionable because Arbitrage isconsidered as part of conventional derivatives which arequite prohibited in Islamic finance, and encountered astream of criticism by a lot of Islamic scholars andeconomists. Mahmoud El-Gamal (2004) has argued on arbitrage thatIslamic Finance attempts to supply Muslims withpermissible replicated conventional financial instrumentsthat are, in fact, totally impermissible in IslamicShariah through what is called Shari`a-arbitrage andTawaroq approved by Shari`a-boards against premiums fortheir services. This makes Islamic financial institutionsto remain profitable, despite intrinsic inadequacy doexists in some of its products and services. He claimsthat Islamic financial institutions are enforced to findnew profitable markets as long as competition forcesprofit-margins downward, as well as tending to cut costsby any means, by focusing on the structures of financialinstruments regardless of their basis, objectives, andthe spirit of Islamic Shariah. Furthermore he assertedthat some natures of asset-based Islamic financialoperations can make the whole industry exposed toexploitation by money launderers and criminal andterrorism financiers, who use comparable ways to hideboth the sources and destinations of money. Hence, heconcluded that Tawaroq and Shari`a arbitrage-based

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Islamic finance leads to violation of Islamic Shariah, aswell as exposing the whole industry to scandals andreputation risk. on the contrary, concentrating on thespirit and the objectives of Islamic Shariah will helpIslamic finance to grow steadily and objectively andsucceed in building a characterize unique Islamic brand-name. Although he came very closer to one of the mainsubjects of this paper, but, still he could not, on onehand, to pinpoint clearly the existent of riba in ShariahArbitrage, he did not argue on how Islamic financialinstitutions apply time value of money on the other hand.Regardless of the impermissibility of Arbitrage PricingModel, it is also might not be relevant to some Islamiccapital markets, Pooya Sabetfar, Cheng Fan Fah, ShamsherMohamad, Bany Ariffin Amin Noordin (2010) have proventhat application of Arbitrage Pricing Theory (APT) on theIranian Stock Market is not applicable due Islamic basedclose economy, sanction, war, and market inefficiency. Toprove that they conducted a test using the principalcomponent analysis and canonical correlation model. Thetest found that one or three variables that can explainthe range of expected returns in this market. Negativestock market returns can be possibly justified by thefinancial and economical sanctions. In general, thefindings put forward that four groups of macroeconomicvariables used in the test that has affected the stockreturns during the period 1991 – 2008. They finallyconcluded that APT is not applicable in the Iranian StockMarket. Although there are many differences in Islamiccapital markets but the inefficiency of them as well asAPT has proven to be failed in Iran as one of the Islamiccapital market in the area, there are great possibilitiesto fail in other Islamic markets.A lot of papers supported the permissibility of timevalue of money and prohibition of riba and interest havebeen issued by different authors, some have differentviewpoints on the permissibility of Tawaruq, and usinginterest rate as a benchmark for profit calculation inIslamic institutions, but very few attempts have beenexerted on examining the actual current practices ofIslamic banks operations to see whether they are ribafree or not. So based on the above literature review

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still there are many gaps has to be filled and someissues have to be settled.

Section 3What is meant by Riba:

Riba in language; the meaning of the word Riba:

Riba is "an Arabic word, derived from the verb Raba that literally means ‘togrow’ or ‘expand’ or ‘increase’ or ‘inflate’ or ‘excess" (Abu Umar: M. KabirHassan 2009, page 2). It also means "An elevated place or hill is calledbecause of its superiority or (increase) in height in comparison with the adjacentplaces… and based to Alqurtubi in his book (Aljami Li Ahkam Al-Quran) It also means"excess" Engku Rabiah(accessed March 14/2014, page 21). Somost of scholars agree that the precise meaning of Ribain Arabic language is an access, increase, grow, inflate,multiply …etc, like to say Raba Al-Mal or else increased.Or to say the thing Raba or else rose and towered, or to say thehorse bulged from a run or panic. Based on ejabat google (Raba in Arabic also come from the word hill whichmeans reputation, height, and pride. Ibn Manzoor said: The thing Raba from Yarbu,

Rabwan, وًا" ب������ و، ر ب������ ا، ي �ر ,and Raba "رب������ increased and grew, so everything grows and

increases the so-called Riba, and from it, extracted the word Riba or "Usury". IbnManzoor said in Rabwah (eminence, elevation, or hill) elevation: "All what rose fromthe ground and mounted" Ejabat google(Accessed March 07/2014). Riba also means Al-Fadl and Alziyadah Qamus Al-Maani (accessedMarch 07/2014), which means that the Arabs in theirlanguage even before Islam used the word Riba to refer toboth Riba of exchanging commodities with increment orexchanging cash or debt.The above meaning of Riba was also supported by MonzerKahf (2006, page 5) who said (Riba is an Arabic word that meansincrement/increase).

Riba in Fiqh:

Even though most of scholars have agreed that Riba inArabic means "increase, or growth as explained before,and the same meaning has been mentioned in Quran as and

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Sunnah. Not all increase meant to be considered asprohibited Riba in Islam. The Qur’an did not mean any increment as itrefers to an increment in a specific transaction, “the” Riba that was common andknown among the Arabs and other nations at the time of revelation (MonzerKahf 2006, 5). while it has been commonly understood inEnglish language as “usury” and interest, but it has muchdeeper, unique, and wide-ranging meaning extorted outfrom the very old trading practices of Arabs beforeIslam, which were quite related to their life norms atthat time, for, In the pre-Islamic and even early Islamicera, Riba implied the increase of money for an additionaltime span of a loan maturity. The pre-Islamic and earlyIslamic Arabs, in their trade practices used to lendmoney, leave its principal unmoved with borrowers, andreceive a continuous interest over principal as a chargefor delaying full settlement of the principal plus itspre-determined interest, and so on, they continueclaiming the principal plus the interest at the due datefrom the debtor, and if he/she was not ready to pay off,they would put additional charge and extend the maturityagain and again. Which means that one of the mostessential aspects of the trading norm of the pre-Islamicand early Islamic Arabs was the dominance of financialtransactions with pre-fixed successive maturities withrevolving interest? While generally in Shari'ah, Riba refers to the incrementpercentage that borrower must pay to the lender above theprincipal amount as a quite linked provision for theloan, or as a compensation to the same lender for anyadditional extension beyond the maturity of the sameloan, the most broader and unique meaning of Riba withinfiqh terminologies that reflected the prehistoric tradinglife of Arabs refer to two kinds of derivative Riba. Riba

al-nasi’ah and Riba al-fadl.

Riba al-nasi'ah:

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Based on the definition of the Portal of GeneralPresidency of Scholarly Research and Ifta of the Kingdomof Saudi Arabia "Riba al-nasi'ah is derived from the Arabic root "nasa'a whichmeans "delay or "defer". This type of Riba falls into two categories: the first one:Charging interest on the loan lent to an insolvent debtor. This category wascommonly practice in the pre-Islamic era. A person, for example, may lend anotherperson a sum of money to be paid back on a specified date. When the date agreedupon is due, the creditor gives the debtor the choice either to repay the debt or deferrepayment in return for charging additional interest on the principal. The Secondone: Exchanging two items of the same type which bear the common cause of RibaAl-Fadl while stipulating deferment of delivery of one or both of the exchanged items.An example of this includes exchanging gold for gold or silver or exchanging silverfor gold while stipulating deferment of delivery" (PCSRI 1999, page 329).The term nasi'ah means to delay or to wait for agreeabletime period consented to the borrower to pay theprincipal with its interest or to suspend the payment foranother period against additional excess or interest. It is quite obvious that the prohibition of Riba alnasi’ah in essence come mainly from the concept of fixinga positive return on an asset that, by nature, can'tcreate value or increment as a compensation just forwaiting some time which is not permitted by Shari’ah.

Riba al-fadl:

Based on the definition of the PGPOSAI also "Riba Al-Fadl isderived from the Arabic root "fadl" which means "increase' or "growth". This type ofRiba involves increase in either of two articles subject to exchange. According toHadith of the Prophet, six things are susceptible to Riba Al-Fadl: gold, silver, wheat,barley, dates, and salt. It is prohibited to charge interest on such transactions whereany of the above things are exchanged for articles of the same type. The same holdstrue with regard to exchanging two articles which bear the same common cause ofprohibition. It is, for complete, prohibited to exchange kilo of gold of gold of inferiorquality for half of a kilo of superior quality. The same is applicable in the case ofexchanging a good type of silver, wheat, barley, dates, or salt for a poor type. It isonly permissible to exchange articles of the above mentioned things provided thatthey are equal in weight and the exchange has to be made in a hand-to-handtransaction. However, it is permissible to exchange a kilo of gold for two kilos ofsilver provided that it is a hand to hand-to-hand transaction. This is because goldand silver are different types. The prophet (peace be upon him) said, (Gold is to be

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exchanged for gold, silver for silver, wheat for wheat, barley for barley, dates fordates, and salt for salt, like for like and equal for equal, payment being made handto hand. If these classes differ, then sell as you wish if payment is made hand tohand. Narrated by Muslim from the Hadith narrated on authority of Ubadah ibn Al-Samit (may Allah be pleased with him) (PCSRI 1999, page 331).It is quite understandable that Islam meant not only toget rid of the exploitation that built in the foundationof interest, but also all manners of unfair exchange inbusiness transactions. This means that although sale ispermitted in Islam, in general, it does not mean that allkind of sale or the whole thing in sale is agreed to inIslam. Since, Riba al-nasi'ah was involved in the verse “Allah hasallowed sale and prohibited riba” (2:275), it is used to becalled "Riba Al-Quran", while Riba Al-fadl used to bereferred to as Riba Al-Hadith because it was not clearlyunderstood from the Holy Quran and has been undoubtedlyaddressed in Prophet Hadith; (Gold is to be exchanged for gold, silverfor silver, wheat for wheat, barley for barley, dates for dates, and salt for salt, like forlike and equal for equal, payment being made hand to hand. If these classes differ,then sell as you wish if payment is made hand to hand. Narrated by Muslim from theHadith narrated on authority of Ubadah ibn Al-Samit (may Allah be pleased withhim.). Some people also classified Riba to Riba Al-Duyun whichincludes: Riba Al-Qard referring to the situation inwhich the Riba or interest imposed at the beginning ofthe loan, and Riba Aljahiliyah referring to the Riba orinterest imposed after delinquency; And Riba Al-Buyu'uwhich refers to the kind of Riba that occur due to theexchange of two similar Ribawi items with deferment ofdelivery. Despite that the classification of Riba in Fiqhto Riba Al-nasi'ah and Riba Al-fadl remains the broadermain types implicitly includes all the other somewhatcomplicated classifications which refer to the samemeaning; both of Riba Aljahiliyah and riba Al-Qard givethe same meaning of Riba Al-nasi'ah which is normallyoccur when a loan contract created or when an existing

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debt is extended so it is meaningless and morecomplicated to divide this obvious and very simpledefinition into two terms.

The prohibition of Riba in Quran:

As explained before that most of scholars and "Fuqaha" whointerpreted Quran claimed that the type of Riba meant inQuran verses refer to Riba Al-nasi'ah or Riba Al-Jahiliyah which was dominant practice within the tradinglife of the ancient Arabs in the Arab Peninsula duringthe pre-Islamic period. So most of them agree on the factthat Riba has been managed and prohibited in Quran stepby step not in a radical way such like the prohibition ofLiquor and some others major sins mentioned in Quran inorder to lead-up them gradually, as a wonderful method ofmanaging change, to know its injustice and the damage itcan cause to the whole society and reach with them to thefinal clear cut stage of definite prohibition. Accordingto M. Umer Chapra (2006, page 1) that "The prohibition of riba inQuran developed gradually and appeared in four revelations. The first revelation wasrevealed in Makkah before the prohibition of riba for which the verse paved the way.It says: “And whatever you lay out with the people in order to obtain an increasedreturn, this increases you nothing with Allah, but whatever you give in alms, seekingAllah’s pleasure, it is those who receive multiplied recompense”, [Chapter al-Rum (TheRomans) 39]. It is quite obvious that Quran in this versecomparing Riba and the fate of their takers with alms,charity or zakat and their payers. As if, at this firststage, it was trying to encourage, give confidence, andpersuade people to avoid Riba. In the second stage in(Surat al-Nisa: Verses 160-161) Quran addressed theexperience of riba in Jews trading society as an exampleof extreme injustice and inequity saying "For wrongdoing on thepart of the Jews, We made unlawful for them [certain] good foods which had beenlawful to them, and for their averting from the way of Allah many [people]" "And [for]their taking of usury while they had been forbidden from it, and their consuming ofthe people's wealth unjustly. And we have prepared for the disbelievers among thema painful punishment" (Quran, Surat al-Nisa, Verses 160-161).

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Although this revelation made some confusion amongst manyscholars about who meant here by the prohibition, Muslimsor Jews, it is quite understandable that the verse washeading for Muslims because "the discontentment with riba first occurredwhile Prophet Muhammad (pbuh) was still in Makkah and there were very few Jewsin Madinah at that time. Besides, the Jews in Madinah were mostly involved in theagricultural sector and not in the commercial sector" M. Umer Chapra (2006,page 1). The third stage of prohibiting Riba in Quran revealedduring the second or third year after Al-Hijrah of theprophet Muhammad, "enjoying Muslims to keep away from Riba if they desiredtheir own welfare. It may be noted that there is a graduation in the strength of theword used i.e. "devour' any person who apprehends the impression created by thisword on the Arabs, who were disgusted if one was described us a glutton, willcomprehend fully strength of the ban intended in the message" Engku Rabiah(accessed March 2014, page 22). So from Quran – Surat Al-Imran – verse 130 "O you who believe! Do not devour riba, doubled andmultiplied; but fear Allah; that you may (really) prosper" It is also quiteclear that this stage was prohibiting the act of chargingmultiple riba using a stronger terms and wording as Islamafter Al-Hijrah become stronger and started to establishthe well organized and modern Muslim regime and thelegislation verses of Quran started to be revealedgradually.The final stage on the prohibition of riba was revealedin Al-Madinah near the completion of Prophet Mission in(Surat Al-Baqarah: Verse 275)“Those who eat riba will not stand (on theDay of judgment) except like the standing of Shaitan leading him to insanity. That isbecause they say: “Trading is only like riba,” whereas Allah has permitted tradingand forbidden riba. So whosoever receives an admonition from his God and stopseating riba shall not be punished for the past; his case is for Allah (to judge). Butwhoever returns (to riba); such are the dweller of the Fire – they will abide therein”.It was the final revelation on prohibition that has putthe definite prohibition of all kind of Riba. if we lookto the verse we can clearly understand the following:1- It strictly disapproved Riba by saying "whereas Allah has

permitted sale and forbidden Riba".

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2- It clearly distinguished between sale and Riba bysaying "that because they say: "sale is just like Riba but Allah has permittedsale and forbidden Riba".

3- It also confirm the prohibition of Riba that hasalready been imposed in the preceding revelation inSurat Al-Imran and fixed the terrible fate that will bemet up in this world and the next as a punishment fordisobedience of departing Riba.

4- It defined clearly the prohibited Riba as anyincrement above principal by saying "But whoever returns (toriba); such are the dweller of the Fire – they will abide therein. It is alsodefined in Surat Al-Baqarah, verse 279 "… But if you repent,you may have your principal…"

The Prohibition of Riba in Sunnah:

Quran, as explained in the four pre-mentioned revelations,has clearly prohibited Riba particularly the finalrevelation in Surat Al-Baqarah: verse 275 which has beenconsidered among most scholars not only laid down thefinal definite prohibition of Riba, but also hasdifferentiated between trade and Riba as well as definedit as an increment over the principal amount. And forthat reason the Riba mentioned in Quran, commonly knownas Riba Al-Quran, is considered among most of scholars asRiba Al-Jahiliyah or Riba Al-nasi'ah as explained before.In Al-Hadith or Sunnah, there are numerous narrations onthe prohibition of Riba, but due to the fact that thedifferences between Hadith and another and from narratorto another the paper will present only the most popularnarrations. While Quran prohibited Riba gradually as said before, Al-Hadith followed different method within which somenarrations prohibited Riba in general, and some othersprohibited a specific types of Riba such as Riba Al-nasi'ah and Riba Al-fadl. However Riba Al-fadl was onlymentioned in Al-Hadith and this why it is commonlycalled, by some scholars, as "Riba Al-Hadith".

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Following are some of the most popular narrationsclassified to some narrations that prohibited Riba ingeneral and some others prohibited other type of Ribamainly Riba Al-fadl:

Riba and interest;

As the paper explained before, that the Riba mentioned inQuran was referred to the Riba which was dominant amongArabs trading life before Islam. Based on that, as alsoexplained before, Riba in Quran refer to Riba Aljahiliyahor Riba Al-nasi'ah which means the extension of thematurity of an existing debt against additional charge tothe outstanding balance of the debt, or granting a newloan with an increment to be paid after deferred periodof time either on an installments structure or pulletpayment. The Qur’an itself implies this definition as it states: “But if ye repent yeshall have your principal, doing no injustice (against others) and no injustice is doneagainst you” (2: 279). This part of Verse 2: 279 has two important indications: 1) itdefines Riba as any increment above the principal of a debt or a loan; and 2) itdescribes such an increment as unjust. The exclusion of profit, being an increment insale, is given by Verse 2:275 “But God made sale permissible” Monzer Kahf(2006, page 5). So the increment either on the issued loanor on the existing debt is done based on the time thatthe creditor has to wait until full payment which meansthat, like the dominant concept of Interest in thecontemporary financial industry within which timerepresents the corner stone based in which interest rate,in any financial market, is defined and fixed becausetime, by nature not as an abstract meaning, impliesuncertainty or risk. Nobody exactly knows what is goingto happen tomorrow or even after one second, but futurecan be predicted using different methods of financialanalysis and risk assessment and then decide how toevade, get around, and mitigate the future uncertainty.So, interest rate in contemporary financial era, likeRiba, defined as an increment on a loan or extending thematurity of existing loan and some time as the return

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that entrepreneur need on his/her capital or investmentwhich is also can be applied in the concept of Riba,interest rate is also defined as a product of acompounding of risks premiums, such as, inflation riskpremium, default risk premium, maturity risk premium, andliquidity risk premium which also can be applied to Ribasince time element is there. But a lot of paperscriticized this point of view based on the following:

1- They assert that interest doesn't refer to Ribabecause interest, as used in the present day ofeconomical and financial terminologies, extends furtherthan fixed rates of return on loans in-kind, and moregeneral and broad-spectrum claiming that Islamicfinance doesn't accept the concept of "time value ofmoney". This is not correct because in Islamic Shariah,based on most of scholars, "time has a share in the price" MohamadAl-Gammal (2009, pages 59, 76, 78, 77,). certainly,this justify that all of Islamic financial institutionsworking with different kinds of deferred salesinstruments with (cost + profit) such as Murabahah,Musawamah, Ijarah which are represents 72% forMurabahah and Musawamah in 2008/2009 and 13% for Ijarahin the same period as shown in the following chart.

1994-1996 2008-20090%20%40%60%80%100%

Financing operations of Islamic banks 1994-96 and 2008-2009 percentages of sample

Murabahah/Musawama Istisna'Ijara MudharabahMusharakah WakalahOthers

Source: Dr. Tariqullah Khan - Islamic Banking and Finance in Theory and Practice -Lectures 3& 4 Theme-2 - QFIS QF Fall 2012.

The additional excess over cost in Islamic institutionsis totally acceptable as compensation to creditor forthe deferment because deferment has a share in the

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price. So, given the Islamic institution complied withsome certain Islamic Shariah conditions explained inthe Ribawi items of Abu Said Al Khudri, selling oneitem for one price on cash basis, and the same item fora higher price on a deferred basis, is quitepermissible in Islamic finance. So, it is quite obviousthat Riba, as mentioned in Quran, and Interest have gotthe same meaning. But it is very important to distinguish between theconcept of the term "time value of money" inconventional banking and Islamic banking. While theformer completely linked time to no asset rather themoney or the cash that has been loaned to the customerwhich is not able to create value or add an incrementin itself by nature because money in the form ofcurrency from an economic point of view considered as astore of value and so its purchasing power alwaysdependent on the real values of products and servicesthat can exchange, and the impact of inflation on thevalue of them. The later, or the concept of time valuein Islamic Finance, is quite linked to a real asset notmoney because it is based on a real sales contractwithin which money is only way or tool of exchange andthe impact of inflation and the other economic forceswill affect directly on the value of the real assetbeing the subject of the sale contract not on the moneyor the cash.

2- They also claim that since Riba Al-fadl was notmentioned in Quran and isn't like Riba Al-nasi'ah whichis similar to the concept of interest, that Ribadoesn't mean Riba and so, interest is more general andbroader than Riba. But this argument also is not valid.Despite that Riba Al-fadl has not been clearlymentioned in Quran. Although Riba mentioned in Quranrefers clearly to Riba Al-nasi'ah which is theextension of the maturity of a debt against additionalcharge, or granting new loan with an increment, I can

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see no different, in the general concept, between thetwo types of Riba for the following justifications:

Loan in Shariah is not a sale contract, it is acontributory and not for profit contract. Although ittransfers ownership and create debt, but doesn'tcreate any value and the debt has no specific maturityand cannot be charged.

Since the for profit contracts that create debt arebased on either exchange contracts, or sharingcontracts, it is not permissible to impose anyadditional charge on the outstanding of the debtcreated through these Islamic contracts.

So since finance, in general, refers to the means toacquire assets by creating deferred obligations or debts,and interest-free lending (or contributory contracts) anddeferred sale of goods and services contracts constitutethe main sources of creating deferred obligations or debtthe difference between Riba Al-nasi'ah and Riba Al-fadlis not important as far as there is a deferredobligations or debt in the two cases.

What is wrong with Debt:

The main general problem with interest that make itinjustice coming from its association with Debt whetherit is new issued or existing one and its invalidassumption that debt can create value while debt is not areal asset. The following are some characteristics of debt that makeit invalid for commercial and for profit activities:

1. Debt in nature is a benevolent and represents aninter-personal transaction between the giver and takerof the debt (loan). So it is illogically to handover acharity to someone with charge above the requiredamount of the loan.

2. Debt also, by nature, is an abstract asset. Oncehanded over to the taker It become an obligation or

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liability on him and, in the same time, become anabstract asset to the giver with no real tangible ortouchable existence although it will be counted as partof the wealth of the giver.

3. Debt has no intrinsic utility or built-in benefit. 4. It is unable to increase or decrease, or to produceincrements or add value because it is abstract assetthat has no inherent usefulness. So it deserves nocompensation or any additional charge. It can't grow ordecline except in our imagination or in the debt marketwhich is subjective, elusive, unreal, tend to take fromthe whole economy without any capability to add valuejust like any parasite creature who live dependent onthe production of other creature devoid of any kind ofgive-and-take sense. Said Monzer Kahf (2006, page 5) "Byits nature and in real life a debt is not liable to increase or decrease; it is not ableto produce increments because it has no intrinsic utility other than being aningredient of wealth. In other words, debt can’t have different values at differenttimes and places unless we create additions in the form of assumptions; that is bycreating a debt market and valuating or assessing debts in relation to time.Additionally the amount of an increment in a debt is also assumptive; it dependson the conditions and externalities in the imaginary market that we create fordebts".

5. It constitute a sacrifice from giver to the sake oftaker deserves no compensation. Any compensation to thegiver as a price for his sacrifice will violateownership principal because loan, by nature, transferownership although it doesn’t add any value. When theloan handed over to the taker he immediately become theowner of the property or the money loaned, andtherefore he has an exclusive authority on his propertyenjoying its benefit and bearing its risk. The giverwho become an owner of abstract debt once he handed theloan to the taker, has no right to claim any incrementcharge otherwise it will be authorized infringement tothe private ownership of someone else which is notpermissible in Islamic Shariah. The personal loan, as

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said Monzer Kahf (2006, page 6) "must remain personal anddeserves thanks, gratitude and appreciation from the borrower and may be areward from God too but it is not a contributor to value creation".

What is wrong with interest:

Based on the imperfections of debt we can easily reachthe wrong with interest that made it equal to theprohibited Riba in Islam. The following are some of themain imperfections of interest (Tariqullah Khan 2012,pages 35-36):

1. It is based on invalid postulate: that debt creates value 2. Violation of property rights & the entitlement to return & responsibility of

loss principle 3. Deviation from reality in existence of increment and in its amount4. It allows rescheduling with increment and inter-bank debts transactions;

both do not create value. . .5. It does not preclude financing non-productive and non-desirable activities,

does not enable moral screening 6. It expands the financing market beyond the needs and size of real market7. Because it is only credit-worthiness-based, interest-based lending favors

the rich at the expense of the productive use of funds

Section 4The Objectives of the Prohibition of Riba

1- Identifying the objectives of the Prohibition of Riba:

It is very difficult, as mentioned in the introduction ofthis paper, to find comprehensive researches extractingthe objectives of the prohibition of Riba and identifythem clearly, because firstly, the notion of Objectivesof Shariah in general is somewhat new science, andsecondly extracting these objectives from Quran, Sunnah,and Fiqh is very difficult job need time, efforts, andcooperation.Out of many papers the author has gone through, he foundthat the paper "Maqasid al Shari’ah in the Prohibition of Riba and their

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Implications for Modern Islamic Finance by Dr. Monzer Kahf prepared for the IIUMInternational Conference on Maqasid al Shari’ah, August 8-10, 2006" is thefirst unique paper that has identified eight essentialobjectives of prohibition of riba that really helps increating new prospective Shariah permissible structuredfinancing instruments. So these eight objectives will bethe base of this section with some additional from someother references that supports the same opinions.

Upholding Realism;

Realism is considered as one of the most crucial terms ofIslamic finance contract that has been obtained fromIslamic Fiqh. It represents one of the sole principlesthat makes a distinct Islamic finance from conventionalfinance. Prohibition of Riba came to affirm thisprinciple because, there is no reality in any transactionthat includes Riba as clarified earlier. The consequencesof unreality in Riba, which are very dangerous havingnegative impact on the whole economy, can be explained inthe following two major points:1- The purpose of the finance application, whichrepresents the first important question that the bankasks at the initial interview with the customer, inconventional banking is not only missing, but alsohaving a no consideration from conventional bankbecause it is going to lend customer liquid money,which normally short term finance, in a form of loan oroverdraft … etc. no matter in which purpose thecustomer will spend that money. Beside the absence ofreality and moral screening to the contract object inthis case, the customer might use the short term loanor over draft to finance long term asset which, inturn, lead to a definite delinquency and this actuallywhat is widely and deliberately happening in

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conventional bank because, by nature, they benefit fromcustomers delinquency to add more interest or Riba.

2- Since debt, as explained before, doesn't createincrement or value, so lender doesn't deserve anyreturn. Thus, one of the objectives of prohibition ofRiba is to prevent and confirm the rule of return thatit should be coming only from the a real asset, havingreal utility, and able, by nature, to create increment.

Upholding the Sanctity of ownership;

As we explained in section three that claiming incrementor charge (interest) on loan after the ownershiptransferred to the borrower is considered as anunauthorized in infringement to the property of someoneelse, because loan transfer ownership and as result, theborrower becomes the owner of the money or, in otherword, the "property", and therefore, he/she, as owner, hehas exclusive authority on his property has full freedomto do what so ever he want by his/her property withoutany degree of infringement from anyone else. So one ofthe main objectives of prohibition of Riba is to protectand sustain this rule.

Prohibiting debt trade and exchange;

Since debt is an abstract and static assets that doesnot, by nature, has the capability to create increment orvalue, and has no real utility in real daily life ofhumankind, so it is not tradable. Trade, based onShariah, must be only on real assets that have utilityand real existence. So prohibition of Riba in relation todebt trade is to prevent the whole economy from the badimpact of unreal trade like debt trade and exchange.

Transmitting all resources from unproductive toproductive activities:

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By disallowing debts trade and exchange and affirmingrealism through the prohibition of Riba we can re-channelthe totally huge economical resources misspend in unrealactivities to a real production and encourage exchangingproducts and services which, in turn, foster trade andexchange among society and revive the circular flow ofincome in the whole economy.

Inhibiting debt discounting or rescheduling for profit:

Although in Islamic finance discounting for earlysettlement of debts is allowed provided that it is notpart of the contract and be only as incentive fromcreditor to debtor to take place only after full earlysettlement, the prohibition of Riba in Islam is aiming toprotect the society from the bad consequences of tradingand rescheduling debts for profit. Because these are non-productive activities as they only transfer wealth fromone person to another.

Preventing the use of business finances for UselessnessPurposes:

As said before in the first objective (Upholdingrealism), ignoring the purpose of finance applicationlead to finance unproductive useless purposes andactivities that might not belong to business or what wecan call it "futility" or "uselessness". Futility" andwhich might lead to definite delinquency because thepurpose of finance will not be used into the mainbusiness of the firm and will add nothing to its asset,instead of that, it will create additional liability tothe company.

Sending personal finance to where it belongs as apersonal service:

Since, loan considered in Shariah as a personal financeor inter-relation between the giver a taker based on theact of charity and benevolence, it should remain a

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personal free of charge service not a business regardlessthe usefulness that the taker can gain from taking theloan. This concept can only be protected by theprohibition of Riba.

Re-channeling Business Financing to Production and Trade:

Since, business financing can only be done, in Islamicfinance, through exchange and sharing Islamic contractswithin which realism is occurred and value creation istargeted, the prohibition of Riba, in forms of unrealfinancing like loan, overdraft, and discount bills, willprotect the whole economy from the inflation of thequantity and size of financing in a society above theactual needs of the real market of production andexchange.

2- Observing the objectives of the prohibition of Riba:2-1The contemporary Islamic structural contracts;

Since, Islamic financial institution is defined as "Adepository/monetary institution of financial intermediation specialized inproviding Finance in accordance with the tenets of Shari’ah especially realism.Morality and prohibition of Riba (interest)" (Monzer Kahf 2013, page3). There is no difference, in the concept ofintermediation, between Islamic and conventionalintermediaries, both of them involve, mobilizing fundsfrom surplus units, packaging size and maturity, andchannel the mobilized funds to deficit units. The maindifferences only in the methodologies, principals,products, and financial structure. Therefore, Islamicintermediaries facing a very crucial challenges and toughcompetition in terms of efficiency, flexibility,innovation, compliance, and governance, which arerequired a unique and carful balancing between the needto comply with Shariah principals and to compete andprove quality and growth in a complicated and fast movingindustry.Although, the Islamic hybrid (structured) contracts haveproven success and a respectful worldwide movement,whether they are traditional hybrid contracts such as

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Murabaha, BBA, Investment Deposit, Parallel Salam.Parallel Istisna, or contemporary hybrid contracts like,Lease Purchase, BOT, Revenue Sharing, Reversed Murabahah,Murabahah Line of Credit, Musharakah Overdraft, stillneed to exert more effort to at the first stage toenhance the existing hybrid contracts and the same timecreate new contracts and in the same time to avoid anykind of replication to conventional banks products.The process, being difficult, it should keep close eye onthe objectives of Shariah in general, and the objectivesof the prohibition of Riba with dynamic open mindavoiding rigidness, inflexibility, and blind taking holdof the texts and false statements.

2-2Contemporary risk mitigation tools;

As supported by many scholars and Islamic bankingpractitioners, it is generally agreeable that Islamicinstitutions are bearing the same credit, market,operation, liquidity, and compliance risks thatconventional financial institution bear beside additionalspecial risks quite related to the nature of Islamicinstitutions in terms of:Products structure risk within which Islamicinstitutions face additional risks in forms of objectrisk, promise fulfillment risk, delivery risk, pricerisk including high cost of fund as well asimpermissibility to charge more in case of delinquencywhich can be addressed also as opportunity cost risk …etc., and also operational risks in a forms of productsprocess risk, additional legal risks, Shariahcompliance risk … etc, and also new market andliquidity risks.

Structure of asset and liabilities risks.Capital requirement risk within which the minimumcapital Islamic institutions have to keep is biggerthan conventional banks.

Shariah screening risk which is indeed very special.

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So Islamic banks, while facing such a higher risks, needdifferent comprehensive risk framework, as well as moreinvestment in research, information technology, andinnovation in this field aiming to enhance the currentrisk management techniques and emerge new risk managementtools and application.Although, the risk managements techniques used inconventional banking are agreed upon to be Shariahimpermissible, but the experience of Islamic banking increating the current risk management tools reveal thecapability to extract, from the conventional bankspractices and Fiqh a customized and structured Shariahpermissible new techniques.The following are some of the major risk management toolsused in Islamic banking industry:1-Revenue sharing and Revenue Sharing Sukuk2-Service and usufruct-based finance3- Third party guarantee: deposit guarantee4- Reverse Murabahah and Murabahah line of credit5- Bundles/packages financing: applying the majorityrule

6- Hedging through options (not trading options)The following also are some risk management toolssuggested by Mohammed Burhan Arbouna and Hurriyah ElIslamy (2012). Some of these tools, namely (Swapping ofusufruct, variation of future profit rates, combinationof securitization) have faced strong disputes andarguments from some scholars and Islamic bankingpractitioners who claimed that such a tools areconsidered as an obvious example of replication andimitation of conventional banks and cannot be legalized:1- Swapping of usufructs;2- Variation of future profit ratios;3- Receivables trading against assets;4- Combination of securitization, (Hawalah andTawaruq);

5- Converting diminishing Musharakah into shares;

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6- Return protection (Waqf Fund);7-Waiver of right to profit;

3- Theories in Prohibition of Riba;

There are some theories and arguments propounded by somewriters trying to legalize Riba in some types of loans bysectors or segments of the economy or specific type ofinterest; such like consumer loans versus investmentloans, Individuals Versus Institutions, compoundingversus simple interest, and nominal versus real rate ofinterest or return. The paper will briefly discuss thesetheories as follows:

3-1 Consumption Loans Versus Investment Loans (Al-Darurah):

The supporters of this argument distinguish betweenconsumer loans refereeing to the financing individualconsumption needs like homes, furniture, electronics andelectrical equipments, and investment loans referring tocorporate or commercial loans or any financing to thebusiness sectors. They ban Riba or interest onindividuals consumer loans and legalize it on corporateor businesses financing. They argue that the main reason of prohibiting Riba inQuran is to dampen unnecessary consumption and encourageproduction which will create new job opportunities andminimize the unemployment percentage to the minimumacceptable levels, foil any kind of economical misuse ofpoor people, support development, economize the minimumacceptable standard of living, and economic stability forthe whole society. They support their argument byclaiming in the pre-Islamic period and even in the earlyyears of Islam borrowing for commercial purposes was notcarried out, and consumer loans were the only dominantkinds of financing therefore, Riba or interest oncommercial loans is not prohibited.

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The opposite criticism of this theory by differenttraditional and even modernists writers claim that evenif Riba on commercial loans were not practiced at thattime when the prohibition of Riba was not made, Riba incommercial loans is still prohibited. They support theirstandpoint by saying that most kinds of alcoholicbeverages available today did not exist in the timeliquor prohibited. Yet all kinds of liquor stillprohibited and will remain prohibited in future. Besidethere are many evidences that commercial loans werewidely dominant during that time. The circumstances, thelocation of Makkah as a focal point of trading at thattime, and the trade of Quraish, Riba Al-Abas MohammadNejatullah Siddiqi (2004, pages 38-41) within which hegranted loans to farmers and merchants not at all toindividuals, all tend to support to the argument that

loans were also practiced in businesses at that time.

So, the conclusion of this debate is that the prohibitionof Riba in Islam is for both individual consumer loansand corporate loans.This theory is also called, by other modernists thetheory of Al-Darurah, said Dr. Engku (accessed March2014, pages 20-21) "The third theory is the theory of Al-Darurah (necessity)and changing circumstances, in which, its propounders claimed that Riba is onlyprohibited on consumption loans not production loans. Thus, because of necessityand changing circumstances, interest rate becomes permissible. This has also beenproven to be faulty because historically, the practice of giving loans for productionwas common since Al-Jahiliyah and thus, is included in the prohibited Riba Al-Jahiliyah. Also, the idea of necessity which the propounders of this theory tried tobuild is inconceivable since necessity cannot be imagined to dominate the wholesystem, as Abu Zahrah said "necessity is only found in individuals, because if not,then it means that the whole society needs al riba like need of starving person to eatthe dead…".

3-2 Nominal Versus Real Rate of Interest:

Another debate between different views and theories onriba that the supporters of this theory argue that there

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is no hadith on Riba regarding the effects of inflationand deflation on the loan. Since, Inflation diminishesthe purchasing power of currency, and deflation increasesit, the giver of loan is subject to the inflation riskwhich therefore it is quite justifiable to compensate himby additional risk premium or interest rate ininflationary economies. The supporters of this theoryclaims that allowing interest on inflationary economicsonly there is no real pre-intention to support thebenefit of the giver of loan rather than help him/her topreserve the real value of his/her benevolent loan at theoccurred at first place because the declining of giversmoney due to inflation is not their fault since inflationis considered as a systematic risk which can't be

avoided by anyone in the society. The adversaries of this theory claiming that any increaseon loans regardless of inflation or deflation would be aclear violation to Quranic and Sunnah in prohibitingRiba. It is argued, since Riba is considered in Islam asa one of the most bigger sins, it is not acceptable to

legalize a bigger sin to fight another sin.

More over from the point of view of the author of thispaper debt is an abstract and stagnant asset that doesn'tmake increment or value so inflation or deflation do nothave any positive or negative impact on it, real assetonly, whether it is products or services that subject tobe impacted positively or negatively by inflation ordeflation which is supporting the prohibition of Riba,and encouraging exchange of products and services whichis, in turn, quite permissible in Islamic Shariah. So, the argument of nominate and real rate of interest orinflation versus deflation is not applicable here.

3-3 Individuals Versus Institutions:

Some writers also assert that the contemporary banks andother intermediary institutions, which are large in their

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scale, did not exist at the pre-Islamic period and thetime of the Prophet, so the interest imposed by thecurrent intermediaries doesn't mean the prohibited Ribain Islam. And they think that the prohibited Ribainvolves individuals only. So in their view payinginterest by individuals for these intermediaries shouldnot be prohibited because it is most likely difficult for

individual to exploit such larger institutions.

The opponents of this theory claim that the prohibitionof Riba in Quran is inclusive all-around the glob anddoesn't differentiate between institutions andindividuals. They also claim that since, borrowing andlending is one of the major functions of intermediariesthey definitely involves exchanging Riba. So, paying orreceiving interest fall under the prohibition of Riba inIslam, no matter, it has been practiced by individuals orinstitutions.

3-4 Compounding Versus Simple Rate:

This theory claims that the prohibited Riba is Riba Al-Jahiliyah which they think it is similar to thecompounding interest rate. Alternatively they argue thatthe simple interest rate calculated and imposed at thetime of contract doesn't constitute the prohibited Riba.But this theory has been widely criticized by manyscholars and found to be unlawful.

3-5 The Theory of Comprehensive Public Need (Al-Hajah):

The propounders of this theory claim that, thecomprehensive public need or "Al-Hajah" is acceptablejustification to legalize interest or Riba because allthe society will benefit. This theory had also beencondemned on the ground that its supporters could notspecify clearly the Riba which is deliberately prohibitedand the Riba which is preventively prohibited.

Section 5

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Violation of the Prohibition of Riba in IBs

1- Profit Calculation in IBs:

OIC Fiqh Academy (1993) implicitly, when discussing thecurrency issues, allows IBs to use price index as well asto use any method of calculation to determine the profitcharge in all deferred payment Islamic FinancingInstruments like (Murabaha, Musawama, Ijara, Istisna,etc) provided that the calculation take place in thefirst place before signing the contract; and also inprofit sharing instrument like (Mudarabah andMusharakah). Based on this Fatwa, IBs normally use compounding methodsin determining its profit in each transaction.The author of this paper disagrees with this concept andargues that; compounding Method is not consistent withthe objectives of the prohibition of Riba because it: 1-Accumulates the daily/monthly profits to the principal

(purchase) amount. This means that the principalamount will regularly increase during the creditfinance life. Richard A. DeFusco, Dennis W. Mcleavey(2007) asserted that using an example of investing$100 now (PV = $100) in an interest-bearing bankinvestment account for 5% annually. At the end of thefirst year the investor will receive $5 as a productof (0.05 X $100) which will result in $105 as futurevalue (FV). So if we suppose N is the period and r isthe interest rate the calculation formula will be asfollows: FV1 = PV (1+r) which is known as the simple interestrate.Now suppose the $100 will be invested for two yearswith 5% interest rate to be credited to the investmentaccount annually (annual compounding). Given $105earned in the first year, the beginning of theinvestment or the present value of the investment inthe next year will be $105. So the amount at the endof the next year will be $105(1.05) = $110.25 bearing

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in mind that the extra $5.25 in the second yearincludes $0.25 is an interest earned on the $5interest earned in the first year. The following tableillustrates that clearly:

  $ % $Original investment     100Interest for the first year

100 5% 5

Interest for the second year

100 5% 5

Interest on first year interest

5 5% 0.25

Total     110.25

As can be seen from the table the simple interest inthe first year is $5 and the same in the next year.The other $0.25 is additional interest made out of the$5 earned in the first year compounding. So instead ofearning total of $110 based on the simple interestmethod the investor earned $110.25 based on thecompounding method which can be illustrated by thefollowing formula:

FV = PV (1+r)N

This, according to the author, is not consistent withthe spirit of Islam because there is no justificationto charge the counterparty for a profit that hasalready being accrued and fiscally hit the investoraccount and received. If there is a need for theinvestor to earn additional profit on the profit hegained through ongoing financing contract it should bedone through a new venture with new segregatedcontract. Given the fact that the Islamic bank whensign a Murabaha contract for 48 month (for example)with the customer the customer will be the owner ofthe asset and the bank will be the owner of anabstract asset that is debt (receivable). So if the

SimpleCompounding

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bank adds the profit accrued and received in the firstpayment (profit of the monthly installment) to theremaining outstanding it will be definitely as if headds charge on a debt which is prohibited in Islam andconsidered as Riba Al-Nasiah itself.

2-The second argument as asserted also by Richard A.DeFusco, Dennis W. Mcleavey (2007), interest rate froman economics point of view, unlike Islamic view, isdetermined in the marketplace by the forces of supplyand demand as well as determined by a compounding ofrisk premiums quite related to supply and demandforces. So if we suppose that interest rate is rinterest rate can be explained by the followingequation:r = Risk free rate + inflation premium + default risk

premium + liquidity premium + maturity premium.But as we explained area that finance in Islam basedon trade and trade based on the principle of "Algunmbi Algurm" which mean that risk is quite connected tothe ownership in Islamic finance which means as soonas the ownership of the asset being transferred to thecustomer the risk automatically transferred with it.Beside that supply and demand forces as well asinflation are still considered as areas of disputes aswe explain in the literature review.

3-So, once the profit in any Islamic financingtransaction being calculated based on the compoundingmethod Riba has occurred no matter this calculationdone today or tomorrow as long as the customer isgoing to pay it. Beside that the IB is doing itintentionally to make more profit. Additionally indebt creating IB instrument always profit ratedetermined at the first place same like loans inconventional banks. So the condition of thecalculation to take place before signing the contractin the OIC Fatwa becomes meaningless.

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The following table represent a an excel screenshot ofthe compounding amortization schedule based on which mostof Islamic financing institutions in Qatar calculatesprofit rate on financing and profit sharing contracts:

Amortization ScheduleInputs Data P Date Loan Payment Intere

stPrincip

alBalance

Annual Percentage rate

6% 1 2/1/2011

100,000.00

0 0 500.00- 100,500.00

Number of payments

69 2 3/1/2011

100,500.00

0 502.50 502.50- 101,002.50

No. of Payments per year

12 3 4/1/2011

101,002.50

0 505.01 505.01- 101,507.51

Finance Amount 100,000 4 5/1/2011

101,507.51

1,743.09

507.54 1,235.56

100,271.96

Monthly rate 0.005 5 6/1/2011

100,271.96

1,743.09

501.36 1,241.73

99,030.22

Posting Date 01/01/2011

6 7/1/2011

99,030.22

1,743.09

495.15 1,247.94

97,782.28

First InstallmentDate

01/05/2011

7 8/1/2011

7,782.28 1,743.09

488.91 1,254.18

96,528.10

Outputs Data 8 9/1/2011

96,528.10

1,743.09

482.64 1,260.45

95,267.64

New financed amount

101,508 9 10/1/2011

95,267.64

1,743.09

476.34 1,266.76

94,000.89

Monthly Installment

1,743 10 11/1/2011

94,000.89

1,743.09

470.00 1,273.09

92,727.80

Total Profit 20,273 11 12/1/2011

92,727.80

1,743.09

463.64 1,279.45

91,448.35

Total Payment 120,273 12 1/1/2012

91,448.35

1,743.09

457.24 1,285.85

90,162.49

As can be seen from the table the formula based on withthe monthly payment is determined is a compoundingformula.

2- Mudarabah & Musharakah Profit Calculation;

The expected profit of any Mudarabah contract is theTotal Earning of the project – Mudarabah Capital);Although the percentage of profit sharing is fixed at thefirst place between Rub-Al-mal (PSIAs holders) & Mudharib(IB) as, for example, 40%/60% or 50%/50% ..etc, share of

FV = (PV * r) / (1-1/(1+r)N

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IB in profit is calculated based on the profit rateapproved by IB (7%, 8%, 9% …etc) or the IB actual cost offund. So If the decided profit rate is 8% IB calculatesprofit based on this rate and the cash flow of theproject provided by the applicant, using the samecompounding formula used in deferred payment as explainedbefore; then divides the result by the expected totalprofit of the project multiply by 100%; the result is theminimum share that IB will accept as Rub-Al-mal.For example if the profit calculated based on 8% isQr.50,000 and the expected profit of the project isQr.200,000 the minimum acceptable share of IB as Rub-Al-mal will be calculated as follows;

50,000/200,000 X 100% = 25%So the profit shares of the two parties of Mudarabah willbe ≥25% to Rub-Al-mal and ≤75% for Mudharib depending onthe negotiation and bargaining. But in any cases the bankwill never accept less than 25% otherwise will losebecause it will be below its actual cost of fund whichhas already calculated based on compounding formula.Furthermore, the distribution of the profit at the end ofthe contract between the two parties normally calculatedin Islamic banks either on the asset side where Islamicbank is Rab-Almal and the customer is the Mudarib, or onthe liability side where the PSIAs holders are Rab-Almaland the bank is the Mudarib, based on the Points Methodsas well which is also a compounding method.Points Model normally used for the following purposes:1- Calculating the shares of the two parties inMudarabah & Musharakah transactions;

2- Reconciliation and settling the Mudarabah andMusharaka shares between the two parties at the end ofthe contract;

3- It is also used by IBs in calculating profitdistribution of investment deposits;

If finance period decided by month or days Points Systemnormally works as follows:

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1- Points: refer to the product of multiplying thefinance amount by the finance period;

2- Denominators: refers to the product of dividing thedays/month of the year by profit rate as follows if thecost of funds is 8%:360/8% days or;12/8%month;

3- The profit is the product of dividing the points bythe denominator;

To explain how it is compounding method let us have thefollowing example: Suppose that a customer (Mudarib) has been granted afinance of Qr.10,000 from IB to be paid to him as per thefollowing schedule:Qr.2,000 in 04/06/2014;Qr.3,000 in 04/07/2014;Qr.5,000 in 04/08/2014;If we know that profit rate is 8% calculate the profitrate and the total amount due from this customer on31/12/2014 using the points method;the answer will be as follows:Points = Amount x Period

Month First FinancePeriod

Second financeperiod

Third financeperiod

June 30 - 04 = 26 - -July 31 31 - 04= 27 -August 31 31 31 - 04= 27September

30 30 30

October 31 31 31November

30 30 30

December

31 31 31

Total 210 180 149

Finance Amount x Period = Totalpoints

First 2,000 210 420,000Second 3,000 180 540,000

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Third 5,000 149 245,000TotalPoints

10,000 1,205,000

Denominator = 360/r = 360/0.08 = 4,500Profits = T. Points/Denominator

= 1,205,000/4,500 = 268Outstanding = Principal + Profit

= 10,000 + 268 = 10,268We will reach the same answer if you we use (T. Value) orany other compounding method.Albaraka Bank Group (2012) has explained how profitcalculated and distributed to PSIAs holders based onresolution 13/5 OIC Fiqh Academy (2001) explaining thatthe Islamic bank calculates profit to be distributed todepositors on a weekly basis based on the profitavailable for distribution at the end of each week. Theweekly profit available for distribution is calculated byadding together both income from the bank's financingactivities as well as investment in equity deals minusany nun-performing accounts provisions for the week. Thenet profit for distribution against deposit band isobtained after withholding the Bank's share as a partnerwith its Shareholder's equity and deducting the Bank'sshare as a Mudharib or as investor of the Capital paid bydepositors. This means that the Bank contributes inprofit sharing on two stages: 1- As a partner in the capital: or due to its share inthe deposit pool in the form of Shareholders' equity.The percentage the Bank is entitled to at this level iscalculated by subtraction of the of Shareholders' fundsby the total deposit pool funds. For example assumethat the Bank gained a profit of Qr.100 000 on thefinancing assets during a one week. If the currentCapital Structure of the Bank is as follows:

Item Qr.Depositors funds 90,000,000Shareholder Equity 10,000,000Total capitalinvested

100,000,000

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The available profit as we explained before will bedistributed as follows:

The bank share = 10,000,000 / 100,000,000 * 100%= 10%

= 10 % * 100 000 = 10 000The remaining profit available for Mudharabah contractwhich has to be distributed between ban as Mudarib andPSICs holders is calculated as follows:

 

100 000 – 10 000 = 90 0002- As a Mudarib: the remaining profit available forMudarabah distribution which is Qr. 90,000 will bedistributed based on a pre-determined profit sharingratio which we have explained before calculated by thebank due to its cost of fund using a compoundingmethod. Let us suppose that the profit sharing ratio is40% to the bank and 60% to the PSIAs holders so the Qr.90,000 distributed between the two parties as follows:

40% to the Bank (Mudharib) = 0.40 * 90,000 =36 000

60% to the Depositors = 0.60 * 90,000 =54 000

So the total profit of the bank will be 36,000 + 10,000= 46,000

The Qr. 54 000 will be distributed between alldepositors using the points system which takes intoaccount the amount of the investment and its duration.The profit ratios defined based on the weight of eachdeposit pool. For example, if Ali has depositedQr.1000 in an investment pool weighting 65%, andAhmed has also deposited Qr.1000 but in a anotherinvestment pool which is weighting 80% then eventhough the amounts are the same, Ahmed will receivemore profits because of the higher weight of the poolhis deposit lies in. normally most Islamic banks putthe weights in an structure to allow long-termdeposits to have a higher weight and profit.

3- Using conventional interest rate as benchmark;

Although, OIC Fiqh Academy, as we said before, permitsthe usage of international conventional interest indexesas a bench mark to determine profit margin in Islamicfinancial institutions, using conventional interest rates

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as a benchmark will expose Islamic bank to three types ofrisks; yield mismatch risk, interest rate mismatch, andreputation risk, Mabid Al-Jarhi (2014). The three typesof risk can be briefly explained as follows: Yield mismatch: refers to the adverse difference the Islamic bank faces between incoming profits from its financing and investment operations and the outgoing profit the bank has to pay to PSIAs holders. In other words it is a pure yield mismatch risk between assets and liabilities.

Interest rate mismatch: refers to the situation pertaining to asset and liability management that occurs when assets that earn interest do not balance with liabilities upon which interest must be paid. For example, an asset that is funded by a liability with a different maturity creates a mismatch.

Reputation risk: refers to the risk of being incompliant with Shariah principles which, in turns, cause a bad reputation to the Islamic bank. For instance using Libor as benchmark in most Islamic banksattracted many criticisms to Islamic banks Ali Mohiuaddin Al-Qaradaghi (2007).

Islamic bank are able to mitigate or rather eliminate these kinds of risks, if they succeeded to generate theirwon pure Islamic benchmark, through different Shariah permissible tool and products such as, but not limited to: Restricted Modarabah with long-term maturity and higherprofit rates;

Restricted Wakala also with long-term maturity and higher profit rates;

Issue Sukuk; Make reserves such as Profit Equalization Reserves (PER) Investment Risk Reserves (IRR).

4- Tawaroq Operations in Islamic Banks:

Tawaroq operations widely practiced by Islamic banks andinstitutions are also potential areas of violating theobjectives of the prohibition of Riba through: Violating the principle of realism which is considered as one of the main general standards of Islamic contracts, and also one of the main objectives of the

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prohibition of Riba. Because in any kind of Tawaroq whether it is organized or unorganized the asset is notthe main target of the sale transaction, instead the cash is the main reason for the whole transaction. Although, the demarcation line between trade an Riba isvery thin but Quran has been very clear on prohibiting Riba by saying (Those who eat Riba will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say: "Trading is only like Riba (usury)," whereas Allah has permitted trading and forbidden Riba (usury). So whosoever receives an admonition from his Lord and stops eating Riba (usury) shall not be punished for the past; his case is for Allah (to judge); but whoever returns [to Riba (usury)], such are the dwellers of the Fire - they will abide therein), Al-Baqarah chapter, verse number 275). Besides violating Shariah principles, it also violates the concept of trade within which a real asset has to be transferred from the seller to the buyer.

Violating the prohibition of Riba also by trading in cash.

IBs are focusing only on the form of the contract rather than its objective which violates the Fiqh base (The lesson in contracts, for the purposes and meanings

not for words and buildings) ( اظ� و ل ف� �ي� لأ ل لأ� ن� اص د و ال معا ود ل لمف% ي� ال عق% رة% ف� ال عب��ي� ن� ا .which makes the contract null and invalid (ال مب�

Violating one of the main building blocks of credit finance that is the bank in order to issue safe financeand avoid credit risk, has to know the main purpose of the finance application and to make sure that, if grantthe finance to the customer, the finance has been used in the same purpose. Without this important knowledge of the final destination of the finance the bank will be exposed to high level of credit risk, and the customer probability of default will increase and the whole economy will be threatened by illegal destinationof the cash being channeled to the customer through Tawaroq transaction. (Some peculiarities of asset-based Islamic financial products can make the industry vulnerable to abuse by money launderers and criminal financiers, who use similar methods to separate sources of money from its destinations) said Mahmoud El-Gamal (2004). Also the customer might use the money in

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gambling, trading in impermissible trade, or any other unauthorized transactions.

Here are some of Tawaroq transaction widely used inIslamic banks in Qatar and of course in most of Islamicbanks all over the world. After checking the proceduresand the paper documents of Tawaroq transaction all foundto be not Riba free:

4-1 Tawaroq Through Car Finance in IBs:

-Although the contract is Shariah compliant yet, thecollusion between all transaction parties not onlyprove Riba, but also make the contract delusive;

-This kind of transaction includes collusion because;The IB know that the customer needs cash;The IB send the customer to one of specific CSRsspecialized in Tawaroq and fully well-known to thebank namely;

The IB know that the CSR charge commission to thecustomer;

Although CSR show the IB the ownership of the car inthe name of the customer but, in fact, there is noreal transfer to the car to the customer and in allcases the customer never see the car and doesn’t knoweven its brand or model;

In some cases when the IB ask the customer to payadvance payment the CSR pay on his behalf and deductthe amount from customer when receive the purchaseorder and delivery note from the IB;

The process of the whole transaction as per thefollowing diagram:

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4-2 Tawaroq Through Jewelry & Precious Stones

-It is the same like Tawaroq through car finance exceptin the following:

Precious Stones Tawaroq done through Musawamah contractsame like car Tawaroq while;

Jewelry (gold or silver) done through Ijarah contractwhere IB lease the usufruct of gold to the customer;

Both contracts includes very clear collusion for thesame justifications mentioned in Tawaroq through carfinance;

9

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In Jewelry Tawaroq when customer resell the jewelry tothe JS or receive cash instead of Jewelry, he violatesthe contracts between him and IB because it is Ijarahcontract where a person cannot sell what he doesn'town, but customers do and IB never claim for that;

The process of the whole Jewelry transaction as per thefollowing diagram;

4-3 Tawaroq Through Metal & Commodities Murabaha

9

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-It is normally different from the other mentionedTawaroq transactions because the purchase takes placeabroad in the open Market through brokers;

-This kind of transaction also includes collusionbecause:

The IB know that the customer needs cash;The IB advise the customer to do this kind of Murabahaas an easiest way to get cash;

IB enforces customer to sign promise to purchase andsell agreement which is considered as a enforcedcontract;

IB also enforces customer to authorize IB to sell theasset on his behalf otherwise his application will notbe processed;

The IB know that the customer is going to receive theprincipal amount minus fees & commissions of the bank& broker;

There is no real asset to be transfer to the customerand normally the customer never see or know even whatcommodity he bought;

The process of the whole transaction as per thefollowing diagram:

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4-4 Tawaroq through Precious Stones Finance:

-It is the same like Tawaroq through car finance exceptin the following;

-Precious Stones Tawaroq done through Musawamah contractsame like car Tawaroq while;

-Jewelry (gold or silver) done through Ijarah contractwhere IB lease the usufruct of gold to the customer;

-Both contracts includes very clear collusion for thesame justifications mentioned in Tawaroq through carfinance;

7

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-In Jewelry Tawaroq when customer resell the jewelry tothe JS or receive cash instead of Jewelry, he violatesthe contracts between him and IB because it is Ijarahcontract where a person cannot sell what he doesn'town, but customers do and IB never claim for that;

-The process of the whole Jewelry transaction as per thefollowing diagram;

4-5 Tawaroq through Stock Purchase Finance

9

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-It is different from metal and commodities Tawaroqbecause the purchase takes place locally from DEthrough Local Broker.;

-This kind of transaction also includes collusionbecause:

The IB know that the customer needs cash;The IB advise the customer to do this kind of Murabahaas one of the easiest ways to get cash;

IB authorizes customer to sell the purchased stocks on hisbehalf and not to sell them before he sign the salescontract with the IB;

The IB know that the customer is going to receive theprincipal amount minus commissions of the Broker;

Normally the customer orders Broker to sell the stocksimmediately after he signed the sale contract with IB;

The process of the whole transaction as per thefollowing diagram;

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Section 6:

Conclusion and recommendations:

Finally, the paper presents many disputes on time valueof money and using conventional interest rates asbenchmark for computing cost of fund and profit rates inboth sides of balance sheet, and discuss some attemptsand trials to innovate and Islamic pricing benchmark andpinpoint the gaps still existing calling for moreresearches and efforts.

10

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In order to link between the concept of Riba and the realactual practices of Islamic banks, the paper has definedthe meaning of Riba in Language and in Fiqh and itsprohibition in both Quran and Sunnah concluded to thefact that Riba and Interest are both refer to one conceptand one meaning. The paper also defined the nature andthe characteristics of debt, and discussed some disputeson the prohibition of Riba between some modernists andsome orthodox writers. And also defined the mainobjectives of the prohibition of Riba.Although, as mentioned in the paper, that Islamicfinance, by nature, facing and bearing risks more thanconventional banking quite linked to its morality andShariah permissibility. It is quite obvious, as a resultof this paper, that Islamic finance as a real asset basedfinance has a unique and logical characteristics andnature that, to large extent, helps in improving Islamicbanking industry which is become a worldwide phenomenon.The paper also, visited the actual practices of Islamicbanks in applying time value of money and find that theyare not Riba-free in terms of applying conventionalpricing indexes as a bench mark which makes them exposedto reputation, yield mismatch, and interest rate mismatchrisks, as well as in the methods on which they calculateprofit margins in both debt-creating as well as in profitsharing Islamic instruments, beside in five kinds ofTawaroq transactions where there is a collusion betweenall parties of the contract and debt trading by chargingagainst real cash transactions as there is no real saleand real transferring of ownership and risk. Despite that still Islamic industry needs more efforts inthe area of researches, innovations, and flexibility toenhance current hybrid instruments and develop newproducts and a unique Islamic pricing benchmark andcalculation methods without violating Shariah principles.

Results:

-The paper concluded to the following results: Time value in Islamic finance is considerable despitethe debates on its bases;

Islamic Banks are not completely Riba free because ofusing the same bench marks and calculation methods used

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in conventional banks when calculating profit rates ondebt creating Islamic financing instruments as well asprofit and loss contracts;

All types of Tawaroq in IBs are not Riba free becauseit contains collisions, beside the asset is not themain target of the sale so;

The main purpose of finance, as one of the mainbuilding blocks of making safe finance, is not knownwhich might lead to gambling, money Landry, terrorism,or any other impermissible activities, and in the sametime enlarge the probability of default.

Islamic banks focusing only on the structure of thecontract rather than on its objectives which violatesthe Fiqh base (The lesson in contracts, for the

purposes and meanings not for words and buildings) ( رة% ال عب��ي� ن� ا اظ� و ال مب� ل ف� �ي� لأ ل لأ� ن� اص د و ال معا ود ل لمف% ي� ال عق% (ف�

As a result of using the same conventional banks benchmarks, IBs are exposed to yield, profit rate mismatch,and reputation risks;

Recommendations:

A serious efforts should be done to innovate a uniquequite different Islamic formula to calculate profitrates in both sides of balance sheet;

An Islamic bench mark based on a perpetuity fixedincome Sukuk to be traded in any Islamic capital marketcan be base for creating Islamic bench mark for profitcalculations;

Meanwhile the author suggests that IBs instead ofcompounding method have to use simple interest ratemethod as best alternative in calculating profitmargins until pure Islamic one emerges;

All kinds of Tawaroq in IBs have to be stopped and aserious efforts to be exerted to innovate a continuousmass of Islamic products that can meet all customersneeds to avoid cash transactions;

All IBs and institution should work under one Shariahregularity body with a continuous set of mandatoryregulations to be followed by all Islamic FinanceInstitutions;

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References:

1- 2- Albaraka Bank Group - Profit Calculation AndDistribution -

2- http://www.albaraka.co.za/home.aspx 2012. 3- Ahmad bin Abdul Aziz Alhadad - TAWARRUQ, ITSESSENCE AND ITS TYPES: MAINSTREAM TAWARRUQ ANDORGANIZED TAWARRUQ - 2003.

4- Ausaf Ahmad, Tariqullah Khan, Munawar Iqbal -Challenges Facing Islamic Banking – IDB, IRTI - 1419H(1998).

5- Abu Umar Faruq Ahmad, University of Western Sydney- M. Kabir Hassan1, University of New Orleans - RIBAAND ISLAMIC BANKING - Journal of Islamic Economics,Banking and Finance; Publishedby: Ibnrafique http://www.scribd.com on Aug 12, 2009 –accessed March 14 2014.

6-Ejabat google – www.ejabat.google.com 7- Engku Rabiah Adawiah Engku Ali – Riba and itsProhibition in Islam – International Islamic University– Malaysia; available athttp://www.cert.com.my/cert/pdf/RIBA_AN2.PDF accessedMarch 14 2014.

8- M. Fahim Khan - TIME VALUE OF MONEY AND DISCOUNTINGIN ISLAMIC PERSPECTIVE - Review of Islamic Economics,Vol. 1, No. 2 (1991). pp. 35-45 – 1991.

9- Monzer Kahf - TIME VALUE OF MONEY AND DISCOUNTING INISLAMIC PERSPECTIVE: RE-VISITED - Review of IslamicEconomics, Vo1.3, No.2, (1994), pp. 31-38 – 1994.

10- Mahmoud A. El-Gamal - Limits and Dangers of Shari`aArbitrage – 2004.

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11- Monzer Kahf – Islamic Finance Contract – HybridContracts – Section 8 – QFIS 2013.

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13- Mohammad Nejatullah Siddiqi - RIBA, BANK INTERESTAND THE RATIONALE OF ITS PROHIBITION - ISLAMIC RESEARCHAND TRAINING INSTITUTE ISLAMIC DEVELOPMENT BANK;Visiting Scholor's Research Series No 2 – 1425 2004.

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18- OIC Academy – resolution number 179 (19/5) 2009.19- OIC Fiqh Academy - resolution number123 (13/5) 2001.20- OIC Fiqh Academy – resolution number 75 (6/8) –1993.

21- Pooya Sabetfar, Cheng Fan Fah, Shamsher Mohamad,Bany Ariffin Amin Noordin - Test of Arbitrage PricingTheory on the Tehran Stock Exchange: The Case of AShariah-Compliant Close Economy – 2010.

22- Quran - Al-Baqarah Chapter – Verse number 275.23- Qamos Al-Maani - www.almaany.com

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24- Richard A. DeFusco, Denis W. McLeavey, Jerald E.Pinto, and David E. Runkle – Time Value of Money –Ethical and Professional Standards and QuantitativeMethods – CFA Institute – Level 1 – Person CustomPublishing, 75 Arlington Street, Suite 300, Boston, MA02116 - 2007.

25- Rininta Nurrachmi, Mia Fathia, Ashanee Mad-ahdin.Ninasrin Radenarmad, Rulia Akhtar - Time Value of Moneyin Islamic Perspective and the Practice in IslamicBanking Implications – 2012.

26- Shamim Ahmad Siddiqui - The Controversy over TimeValue of Money among Contemporary Muslim Economists -Journal of Management and Social Sciences Vol. 2, No.2, (Fall 2006) 144-153.

27- Tariqullah Khan - Islamic Banking and Finance inTheory and Practice - Lectures 3& 4 Theme-2 - QFIS QFFall 2012.

28- Permanent Committee for Scholarly Research and Ifta- Portal of the General Presidency of ScholarlyResearch and Ifta – Kingdom of Saudi Arabia – Part No:13, Page No: 329.

29- Tariqullah Khan - Islamic Banking and Finance inTheory and Practice - Lectures 1& 2 - QFIS QF Fall2012.

30- ارة% ة% – ور� � ارن��� ة% ال معاص���رة% – دراس���ة% م ف% ي� ال مع���ام لأت% ال مال ي���� م ن< ف� ة% ل ل���ر� � ص���ادن Cت % ق Fم���ة% الأ ي� ال – ال ق% مَّ��� م جم���د م جم���ود ال ج�اف� و % وق���� ون<الأ� ئ� Tش���� ولي� – ال ع����ة% الأ� ط����ر – ال طب� % دول����ة% ق � ة% ب لأم ي� س���� Fق% 1430 الأ حات% 2009ة ال مواف����� ف� ،59م – ص����

76،77،7831- ة% – ي��� ن�� ا Tب ع�ة% ال ر – ال طب� Tش� ر ل لن� � اي Tش� ( – دار ال ن� ة% لأم ي� س�� Fالأ v وك ئ��� ة ال ب� ق�% � ي ف ح��وتT ف� � ي� - ب � رداغ ن< ال ق�% ي�� د ع لي� م حي� ال��

م200732- ة% لأم ي� س�� Fمص�ارف� الأ ق% ع لي ال ئ� ط��ب� ع ال ت% ل�ة% م�� � ج ة% الأ� لأمي ل لمع�ام لأت% ال مال ي��� س� Fر ا Tش حو م ؤ� � ة% - ب حان�% T ن< ش ن< ح شي� ح شي�

اه رة% 2002– ال ف%

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