Shariah and Law in Relation to Islamic Banking and Finance

Shariah and Law in Relation to IslamicBanking and Finance

Sherin Kunhibava* & Shanthy Rachagan**

Islam has a unitary approach to life. It does not put the various aspects ofhuman behaviour into water-tight compartments. It considers man as anintegral whole. In other words, the numerous functions that he or sheperforms, e.g., economic, political, social and religious, are not independentof each other. In the economic field, activities are conditioned by socialmilieu, moral values, cultural heritage, and above all by religious beliefs. Itis therefore said that the word religion being just one aspect of life amongmany others is an insufficient translation for the Arabic term deen, which isoften used to characterise Islam.

— “Islamic Banking in Europe — the Reintegration of Faith andEconomy” Rashid Mengers, the Assistant Director of the Institute of IslamicBanking and Insurance in London, 5th SLIM Annual Lecture, Wednesday,May 15, 2002, Southwark Cathedral.

This article is devoted to exploring the two sources of laws that governs Is-lamic banking and finance. It starts off by explaining the sources of Shariah andthe sources of conventional laws, and comparing the two. Thereafter the funde-mental principles of Shariah that governs Islamic banking and finance are high-lighted. Lastly, a country case study will be done to show how the country hasaccomodated their laws to incorporate Shariah to govern Islamic banking and fi-nance. The country chosen is Malaysia.

Malaysia is chosen because of its advanced position in Islamic banking andfinance and because of its comprehensive legal and regulatory dual system, that iswhere conventional banking and finance functions parallel to Islamic banking andfinance.

Cet article est consacre a l’examen des deux sources de lois qui regissent lesdomaines bancaire et financier du monde islamique. L’auteur decrit d’abord lesorigines de la charia et les origines des lois conventionnelles, puis compare lesdeux. Les principes fondamentaux de la charia relatifs aux domaines bancaire etfinancier du monde islamique sont ensuite mis en evidence. Une etude de casdemontre comment le pays vise par l’etude, soit la Malaisie, a compose avec seslois afin d’integrer la charia en vue de regir les domaines bancaire et financier.

La Malaisie a ete retenue pour cette etude a raison de sa position avancee

* Sherin Kunhibava PhD is a Senior Lecturer at University of Malaya.** Shanthy Rachagan PhD is an Associate Professor at Monash University.

544 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

dans le monde islamique, relativement aux activites bancaires et financieres; lecaractere complet de son double systeme legislatif et reglementaire y permet ausysteme traditionnel des mondes bancaire et financier de fonctionner en paralleleavec les systemes bancaire et financier du monde islamique.

1. INTRODUCTIONConventional banking and finance as we know it today, is governed by the

laws of a nation, that is legislation passed by the State and common law decisionsmade by judges when there is a lacuna in the law (collectively named as conven-tional laws in this article). Islamic banking and finance on the other hand, is gov-erned by two sets of law, one divine Islamic law (Shariah) the other man made(conventional laws). This article is devoted to exploring these two sources of lawsthat governs Islamic banking and finance. It starts off by explaining the sources ofShariah and the sources of conventional laws, and comparing the two. Thereafterthe fundemental principles of Shariah that governs Islamic banking and finance arehighlighted. Lastly, a country case study will be done to show how the country hasaccomodated their laws to incorporate Shariah to govern Islamic banking and fi-nance. The country chosen is Malaysia. Malaysia is chosen because of its advancedposition in Islamic banking and finance and because of its comprehensive legal andregulatory dual system, that is where conventional banking and finance functionsparallel to Islamic banking and finance.

2. SHARIAH AND CONVENTIONAL LAWShariah literally means “the way to a watering place”.1 It is the path that must

be followed by Muslims, and governs man in conducting his life in order to realizethe Divine Will. It includes all forms of behaviour — spiritual, mental andphysical.2

There are four fundamental sources of Shariah law: the Holy Book — Al-Quran, the hadith, ijma and qiyas.3

The first source is the Islamic Holy Book called Al-Quran. The Holy Quran isthe original and eternal source of Shariah law. It constitutes messages that Allah(swt) inspired the Prophet (pbuh) to relay for the guidance of mankind. Thesemessages are universal, eternal, and fundamental.4

The hadith, the second foundation of Shariah, is next in importance to the Al-Quran. It is a piece of information, such as an account, narrative or story and con-stitutes a record of the Sunnah of the Prophet (pbuh), handed down from generationto generation and which has become the rules of faith and practice of Muslims. TheSunnah (pl. sunan) signifies the custom, habit, or usage of the Prophet (pbuh). Itdesignates his behaviour, mode of action, his sayings and declarations under a vari-ety of circumstances in life.5

1 Abdur Rahman I. Doi, Shariah the Islamic Law (A.S Noordeen, 1984) at 2.2 M.A Laldin, Introduction to Shariah and Islamic Jurisprudence (Cert Publications,

2006) at 3.3 Doi, supra, n. 1 at 7.4 Laldin, supra, n. 2 at 56.5 Ibid., at 75.

SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 545

The third source of Shariah law is the ijma. Ijma means a consensus of opin-ion of the mujtahids (the learned scholars of Islam), or an agreement of the Muslimjurists of a particular era on a question of law.6

Qiyas is the process of reasoning by analogy of the mujtahids with regard tocertain difficult and doubtful questions of doctrine or practice, by comparing themwith similar cases already settled by the authority of the Al-Quran and Sunnah andthus arriving at the solution of undecided questions.7

As for conventional law, there are two defined sources of legal jurisdictions,known as the Common law legal system and the Civil law legal system. Whether ajurisdiction follows a Common law legal system as opposed to a Civil law legalsystem typically depends on the historical background of a nation. Common lawsystems usually descend from the English legal system, and therefore all Common-wealth countries have Common law systems.8 Common law systems place empha-sis on judicial decisions, which are considered “law” just as are statutes.9

Civil law jurisdictions, on the other hand, descend from Roman law througheither the Napoleonic Code or the German Civil Code and also from Canon law.Roman law itself evolved in Rome before the Christian era. Canon law, on theother hand, is the body of laws and regulations made by or adopted by ecclesiasti-cal authority, for the government of the Christian organization and its members.10

Under Civil law jurisdictions case law was traditionally given less weight.However, it would seem that the distinction between the two systems is becomingblurred as the importance of judicial decisions in civil jurisdictions are increasinglybeing given more weight and with the growing importance of statute law and codesin Common law countries.11

While the Civil law system descended from Roman law and Canon law, Com-mon law is vaguely described as having been developed and institutionalized fromthe 11th to 12th centuries at the time of King Henry I and II.12 However Makdisi,13

believes that the origins of Common law are actually from Islamic law, due to theuniqueness of Common law which is separate from any other European legal sys-tem, including Roman law and Canon law, but has similarities with Islamic law.Nevertheless, it is safe to say that Common law and Civil law share common char-acteristics. They both deal with the interpretation of man-made laws whether it is

6 Ibid., at 91.7 Ibid., at 97.8 R. W. Lee, “The Civil Law and the Common Law: A World Survey” (1915) 14 Michi-

gan Law Review. “On the American Continent the Civil Law and the Common Lawexist side by side. The former prevails in the south, the latter in the north” at 93.

9 Roderick T. Long, “The Nature of Law, Part III: Law vs. Legislation” online:<http://libertariannation.org/a/f21l3.html>.

10 A. Boudinhon, “Canon Law” Robert Appleton Company (1910), online:<http://www.newadvent.org/cathen/09056a.htm>.

11 Lee, supra, n. 8 at 90.12 George Burton Adams, “The Origin of the Common Law” (1924) 34 The Yale Law

Journal 116-117.13 John A. Makdisi, “The Islamic Origins of the Common Law” (1999) 77 North Carolina

Law Review 1638.


case law or statute.On the other hand, Shariah deals in religious matters and God-made laws, and

therefore differs from Common law and Civil law in that respect. However, it is nota religious law the way Canon law is. Shariah deals not only with purely religiousmatters but also with all those subjects which comprise the content of Common lawand Civil law systems. Shariah comprises of three basic elements, namely, aqidah,fiqh and akhlaq.14 Aqidah concerns all forms of faith and belief in God Allah (swt)and His will, held by a Muslim. Fiqh is concerned with governing the relationshipbetween man and his Creator and between man and man (fiqh will be further de-fined below). Finally, akhlaq covers all aspects of a Muslim’s behaviour, attitudesand work ethic with which he performs his practical actions.15 It is with theShariah branch of fiqh that Islamic finance is governed. Fiqh can be further dividedinto two areas called ibadat and muamalat. Ibadat is concerned with the practicali-ties of a Muslim’s worship of Allah, whereas muamalat is concerned with man-to-man relationships. Nevertheless, aspects such as political activities, economic ac-tivities and social activities fall within the ambit of muamalat.16 Islamic finance,being part of economic activities, is thus linked with Shariah principles throughmuamalat.

Injunctions relating to aqidah, ibadah and akhlaq are fixed and unchangeableas they are considered to be suitable to be implemented at all times and places.However, injunctions of Shariah which regulate the relationship between man andman and other creatures may change with the changes in circumstance, custom,time and place.17 This includes rulings relating to muamalat such as contractuallaw transactions, criminal law, the judiciary and Islamic finance. It is this feature ofShariah that makes it suitable to be implemented at all times as it can accommodatethe needs of people in different times and situations.18

The rulings in relation to muamalat are derived from the sources of Shariah.However, due to the changing circumstances of the world and the needs and inter-ests of the people (maslahah) many of the legal injunctions had to be formulatedfrom the sources of Shariah through reason by rightly qualified Muslim Jurists.This is known as ijtihad, that is, “exerting one’s reasoning faculty to determine apoint of law.”19 During the time of the Prophet Mohammad (pbuh), the Qur’an wasclarified and exampled by the Prophet. After the Prophet’s death and the death ofthe Sahaba (Companions), Muslims confronted a number of difficult questionswith the spread of Islam into new cultures and lands.20 There was a need for properguidelines on how to derive law from Islamic sources. Thus, law schools arose (ormadhab) which developed a comprehensive set of methodologies on how to inter-

14 Laldin, supra, n. 2 at 4.15 S. Haron, Islamic Banking, Rules and Regulations (Pelanduk Publications, 1997) at 18.16 Ibid., at 18-19.17 Laldin, supra, n. 2 at 8, see explanation on fiqh.18 Ibid., at 11.19 Irshad Abdal-Haqq, “Islamic Law: An Overview of its Origin and Elements” (1996) 1

Journal of Islamic Law 9.20 Ibid., at 44.


pret Shariah.21 The process of applying and deducing laws from Shariah and thelaws thereby deduced is collectively known as fiqh.

There are four madhab or schools of law for Sunni Muslims.22 The teachingsof each school depends largely on the geographical area, although there is a scatter-ing of the followers of all four schools in most of the Muslim world.The fourmadhabs23 are the Hanafi, Maliki, Shafi’i and Hanbali.

Since the 10th century the main law-making activity had ceased, and activityof the jurists remained limited to interpretation and explanation of the existing doc-trines, bringing it up to date with life as conditions changed, because it was be-lieved that any principle that could be deduced by ijtihad had already been deducedor extracted.24 After this time any new decision or fatwa (legal opinion) was basedon previously recorded determinations made by a particular madhab. This conceptis known as taqlid or conformity and is sometimes compared to the concept ofstare decisis or judicial precedent in Common law.25 However many well known

21 Ibid., at 45.22 Approximately 90 percent of the Muslims in the world are Sunni while the remaining

are Shia. The differences between the two are basically that the Shia principally in Iraq,Iran, Lebanon and Syria, believe that the leadership of the Muslim community the Ca-liph must be from the Prophets lineage, they await the emergence of a Muslim leaderfrom the line of the Prophet who will embody wisdom and spiritual power of thetwelfth Imam. Until that time his representatives, the ayatollahs provide interim leader-ship. As for the Sunni they do not believe that physical lineage is necessary to be aCaliph. The second difference is that the Shia continue to believe ijtihad (personal rea-soning) as a legitimate source of Islamic law, whereas Sunni Muslim prohibit the cur-rent use of ijtihad. Abdal-Haqq, supra, n. 19 at 51-52. This article will focus on thelegal opinions from the Sunni school of law.

23 The Hanafi school was formed in Kufa, Iraq, under Abu Hanafi who lived from 702 to767. It preserves many of the older Mesopotamian traditions. It based its rulings largelyon ra’y — results of logic deduction of its scholars. Suzy Ashraf, On the IslamicSchools of Law. (n.d.), online: <http://members.tripod.com/~SuzyAshraf/index.html>essays.

The Maliki school comes from Medina, under Malik ibn Anas ibn Amir who livedfrom 717 to 801. This school ruled heavily in favour of the practice (sunnah) of thelocal community of Medina, because at the time it was formed, the word sunnah didnot yet mean “practice of the Prophet” Ashraf. Muhammad Idris ash-Shafi’i (760 to820 in Egypt) was the first one to systematize Islamic Law. Originally, he studied inMadina under Malik ibn Anas ibn Amir founder of the Maliki school. In his book, theRisala (the Message), balancing the two trends, he laid down the sources of Law, Fiqh.He fixed them (in order of priority) to be: Quran Sunnah of the Prophet, based on:Hadith from the Prophet Hadith from the Companions of the Prophet Ijma and QiyasAbdal-Haqq, supra, n. 19 at 49. Ahmad Ibn Hanbal from 778 to 855 founder of theHanbali school, the latest of the four madhabs had followed Shafi’i method with evergreater emphasis on the ahadith, avoiding reasoning as far as possible, but not com-pletely denying it. Thus, the difference between the schools is primarily in the variousweight given to those four components, and in some original decisions remaining fromthe very beginnings of these schools, and belonging to its first masters Ashraf.

24 Abdal-Haqq, supra, n. 19 at 26.25 Ibid., at 37.


scholars have argued the relevance and importance of ijtihad in modern times (seeDoi26 and Kamali27).

Therefore, finding the injunctions of Islamic law requires reference to not onlythe sources of Shariah but also the books of fiqh. Legal opinion of scholars inIslamic finance often refers back to these sources of law when formulating an opin-ion on the permissibility of a contract or instrument in Islamic finance.

Another significant feature of Islamic law which differentiates it from conven-tional law is the fact that not all acts done under Shariah are characterized as legalor illegal. There are intermediate values as to a person’s action.28 There are gener-ally five categories of assessment. These are acts that are:29

i) obligatory, where performance will amount to a reward and omissionwill amount to a punishment from God;

ii) recommended, performance of act is rewarded but neglect is notpunished;

iii) permitted, acts which neither get reward nor punishment;

iv) discouraged, acts where there is a reward for avoidance but no punish-ment for performance; and,

v) forbidden, where there is reward for avoidance and punishment fornon avoidance.

While in other legal systems an act might be allowed, prohibited or indiffer-ently treated, in Shariah an individual is not only guided as to what he is “entitledor bound to do in law, but also what he or she ought, in conscience, to do or refrainfrom doing”.30 In other words Shariah encompasses legal injunctions and moral orethical injunctions whereas conventional law is concerned with legal issues alone.

Thus Shariah encompasses religious laws and laws other than those based onreligion. It is derived from the Quran, Hadis, Ijma and Qiyas. The process of ap-plying and deducing laws from Shariah and the laws thereby deduced is collec-tively known as fiqh. Shariah is unwritten law like Common law. Common lawsystems and Civil law systems, on the other hand, both involve the interpretation ofstatutes and case law; they vary only in the degree of the weight given to eitherstatute law or case law.

Next this article discusses the main fundamental injunctions in Shariah whichgovern Islamic banking and finance.

3. FUNDAMENTAL INJUNCTIONS IN SHARIAHIslam permits and encourages its followers to become involved in trade activi-

ties. As stated in the Quran in verse 275 of Surah 2: “‘Trade is but like usury’, but

26 Doi, supra, n. 2 at 80-81.27 M.H Kamali “Prospects for an Islamic Derivative Market in Malaysia” (1999) 4 Thun-

derbird International Business Review 539.28 Abdal-Haqq, supra, n. 19 at 42.29 Ibid., at 42-43.30 Gamal Moursi Badr “Islamic Law: Its Relation to Other Legal Systems” (1978) 26 The

American Journal of Comparative Law 189.


God hath permitted trade and forbidden usury.”31

The Prophet (pbuh) in his early life used to be a trader, and, similar to many ofhis eminent companions, a businessman. The Prophet (pbuh) was once conferredthe title of “amin” or “trusted one” because of his honesty in all dealings.32 Like-wise the principles of Islamic business include honesty and the belief that trade isto be conducted in a faithful and beneficial manner. Trade manipulations and mal-practices aimed at earning undue profit through operations like hoarding, black-marketing, profiteering, short-weighting, hiding the defective quality of merchan-dise, and adulteration cannot be regarded as honest trade.33 To ensure honesty,transparency and ethical dealings in trade, fundamental injunctions were estab-lished in Shariah, such as the prohibition of riba, gharar, maisir, qimar and jahala.These injunctions are the fundamental principles governing Islamic banking andfinance today. These are described in greater detail below.

(a) Riba, Usury and InterestThe giving and receiving of riba is strictly prohibited in Islam. Literally, riba

means increase, addition, expansion or growth.34 However, not every increase orgrowth is prohibited in Islam; the prohibition is related to the manner throughwhich an addition is gained.35 Riba, with regards to Islamic finance is taken tomean interest paid to depositors and interest charged upon fund users, and is strictlyprohibited in Islam.36 Interest itself is defined as “an amount, or fee, payable forloaning money to the borrower; interest is usually expressed in a percentage.”37

The prohibition of riba is not a new phenomenon. Until a few hundred yearsago any extra amount demanded by the lender in addition to his capital was calledusury. Early European philosophers such as Plato (350 BC)38 and Aristotle (350BC)39 condemned the practice of taking usury. Further, the issue of riba is an old

31 Translated by, Abdullah Yusuf Ali, The Holy Quran Original Arabic Text with EnglishTranslation and Selected Commentaries (Saba Islamic Media, 1999).

32 Haron, supra, n. 15 at 13.33 Ibid., at 13.34 Mohd Daud Bakar, Riba and Islamic Banking, 1–21, online:

<http://www.cert.com.my/> at 5.35 Ibid., at 6.36 Muhammad Taqi Usmani, “The Text of the Historic Judgment on Interest [14 Rama-

dan, 1420]”, Supreme Court of Pakistan (1999), online:<http://tyo.ca/islambank.community/index.php?name=EZCMS&menu=2&page_id=2&POSTNUKESID=b193a0056c664d16cc69a0d71dc6c23a#Over

37 Pelanduk, Dictionary of Financial and Business Terms (Pelanduk, 2000) at 267-268.38 Plato (427–347 BC), Laws, Book V: “In marrying and giving in marriage, no one shall

give or receive any dowry at all; and no one shall deposit money with another whom hedoes not trust as a friend, nor shall he lend money upon interest; and the borrowershould be under no obligation to repay either capital or interest” Plato, Laws. (360B.C.), online: <http://classics.mit.edu/Plato/laws.html>.

39 Aristotle (384-322 BC), Politics, Book I, Part 10: “There are two sorts of wealth-get-ting, as I have said; one is a part of household management, the other is retail trade: theformer necessary and honorable, while that which consists in exchange is justly cen-sured; for it is unnatural, and a mode by which men gain from one another. The most


religious issue, not only in Islam but also in Judaism, Christianity,40 Hinduism andBuddhism.41

Ancient records from Vedic texts in India (2,000-1, 400 BC) and later in theSutra texts (700-100 BC) and in Buddhist Jatakas (600-400 BC) show a contemptfor usury.42

However, by the 2nd century AD and afterwards, the concept of usury wasless stringent where a differentiation was made between prevailing socially ac-cepted range of interest and the amount charged above interest was termed asusury, the latter being condemned.43

In Judaism, in the Old Testament (Torah) it is stated, “If you lend money toany of my people with you who are poor, you shall not be to him as a creditor;neither shall you require usury from him.” (Ex. 22:25). This statement, though, wasinterpreted to mean that lending through usury was not allowed between Jews butallowed to a non-Jew.44

The Christian Church also prohibited all usurious transactions,45 the Gospelaccording to Luke reads, “And if ye do Good to them which do good to you, whatthanks have ye? For sinners also do the same. And if you lend to them of whom yereceive. What thanks have ye? For sinners also lend to sinners to receive as muchagain. But love ye your enemies, and do good, and lend hoping for nothing again;and your reward shall be great and ye shall be the children of the highest for he iskind unto the unthankful and to the evil.” (Luke 6:34-35).46

However this prohibition against usury changed, “by the end of the thirteenthcentury, several factors appeared which considerably undermined the influence ofthe Orthodox Church. Eventually, the reformist group, led by Luther (1483–1546)and Zwingli (1484–1531), agreed to the charging of interest on the plea of humanweakness.”47 In the year 1545 the Act of “In restraint of usury” of Henry VIII inEngland legalized the imposition of interest. This Act fixed a legal maximum inter-est; any amount in excess of the maximum was usury. The practice of setting a

hated sort, and with the greatest reason, is usury, which makes a gain out of moneyitself, and not from the natural object of it. For money was intended to be used inexchange, but not to increase at interest. And this term interest, which means the birthof money from money, is applied to the breeding of money because the offspring re-sembles the parent. Wherefore of any modes of getting wealth this is the most unnatu-ral” Aristotle, Politics. (350 B.C.), online:<http://classics.mit.edu/Aristotle/politics.1.one.html>.

40 Ala Eddin Kharofa, Usury “Interest” or Riba (A.S. Noordeen, 1993) at 16.41 Wayne, et al., “A Short Review of the Historical Critique of Usury” (1998) 8 Account-

ing, Business & Financial History 177.42 Ibid., at 178.43 Ibid., at 179.44 Kharofa, supra, n. 40 at 15.45 Abdul Gafoor, “Interest, Usury, Riba, and the Operational Costs of a Bank” Appropri-

ate Technology Foundation Groningen (2002–2004), online:<http://users.bart.nl/~abdul/article4.html>.

46 Kharofa, supra, n. 40 at 16.47 Gafoor, supra, n. 45.


legal maximum on interest rates was later followed by most states of the UnitedStates and most other Western nations.48 Hence interest was legalized and usury,which was differentiated from interest only in the amount of interest charged, wasnot legal. Usury today is referred to as “a very high rate of interest”.49

In Islam, riba is categorically prohibited through both the Qur’an50 and theSunnah51 of the Prophet leaving no room for any contrary or reverse opinion.52

However, the division of interest and usury has been claimed by a few scholars inIslam;53 they believe that the Qur’an prohibited only usury and not interest.

This view is the minority. The majority and overwhelming view, which is theview taken in Islamic finance, is that interest as well as usury is prohibited in Islam.This was decided in the Council of the Islamic Fiqh Academy, during its secondsession, held in Jeddah 22–28 December 1985, resolution 10/2:54

Any increase or interest on a debt which has matured, in return for an exten-sion of the maturity date, in case the borrower is unable to pay and increase(on interest) on the loan at the inception of its agreement, are both forms ofusury which is prohibited under Shari’a.

The taking or the giving of interest and usury is therefore prohibited in Islam.

(b) Maisir, Qimar, Jahala and GhararQimar or gambling is strictly prohibited in Islam. As stated in verse 219 of

Surah 2 of the Qur’an: “They ask thee concerning wine and gambling. Say: In themis great sin, and some profit, for men; but the sin is greater than the profit.”55

48 Ibid.49 Pelanduk, supra, n. 37 at 466.50 Surah 30, Surah al-Rum, verse 39, Surah 4, Surah al-Nisa, verse 161, Surah 3, Surah

Al-Imran, verse 130-2, and Surah 2, Surah al-Baqarah, verses 275–281.51 There are many narrations of the prohibition of riba through the Sunnah of the Prophet

(pbuh), an often quoted and well known narration is from Ubada ibn al-Samit: TheProphet, peace be on him, said: “Gold for gold, silver for silver, wheat for wheat, bar-ley for barley, dates for dates, and salt for salt — like for like, equal for equal, andhand-to-hand; if the commodities differ, then you may sell as you wish, provided thatthe exchange is hand-to-hand” (Muslim, Kitab al-Musaqat, Bab al-sarf wa bay al-dhahab bi al-waraq naqdan; also in Tirmidhi quoted from M. Umer Chapra, The Na-ture of Riba in Islam. online:<www.iriti.org/downloads/Distance_Learning_Files/The_Nature_of_Riba_in_Islam_Umer_Chapra.doc>.

52 Usmani, supra, n. 36.53 See Fazlur Rahman “Riba and Interest” (1964) 3 Islamic Studies (Karachi); Ahmad

Shafaat, What is Riba? Islamic Perspectives, online:<http://www.islamicperspectives.com/RibaIntro.htm>; M.O Farooq, Riba, Interest andSix Hadiths, online:<http://aa.f370.mail.yahoo.com/ym/ShowLetter?MsgId=8544_127222_85822_3604_62814_0_680_160441_1850555313&Idx=202&YY=74125&inc=

54 OIC Fiqh Academy, Resolution and Recommendations of the Council of the IslamicFiqh Academy (1985–2000). (2000), online:<http://www.islamibankbd.com/page/oicres.htm#10(10/2)>.

55 Translation by Ali, Another injunction on the prohibition of gambling in the Qur’ancan be found in verse 90 Surah 5 of the Qur’an.


Qimar is often described as maisir which means something attained through noeffort.56 This is one of the main reasons that gambling is prohibited in Islam. Otherreasons include: gambling results in the taking away of one’s property without law-ful or proper exchange; gambling causes anger and frustration caused by losing;gambling can be addictive and compulsive which may lead to bankruptcy; and fur-ther, gambling may cause a person to forget his duty as a Muslim.57

Jahala on the other hand means ignorance, and when applied to a sale, willcause the sale to be defective. For example if the object of sale or price was un-known to the buyer due to a buyer’s ignorance, it would be impossible to deliver orreceive the price or object of the sale. This sale would thus be invalid due tojahala.58 Jahala sales are invalid because of information asymmetry, either party isnot privy to all the information, there is an unfair advantage or injustice.

Gharar, also prohibited in Islam, is more difficult to define,59 as it is moregeneral and encompasses a number of other elements such as maisir and jahala.Gharar has been defined as “danger”,60 “risk”,61 and also a transaction equivalentto “a zero-sum game with uncertain payoffs.”62 Al-Zarqa’s63 has defined a ghararsale as the sale of probable items whose existence or characteristics are not certain,and due to the risky nature, makes it akin to gambling.

Gharar sales are invalid precisely because of the excessive uncertainty andrisk involved. For example, the sale of the birds in the sky or the sale of the fish inthe sea. The sale of such items where the number of fish or birds is excessivelyuncertain is invalid. Another example of such a sale can be found from the Hadithnarrated by Abu Huraira:

The Prophet forbade two kinds of sales, that is, Al-Limais and An-Nibadh(the former is a kind of sale in which the deal is completed if the buyertouches a thing, without seeing or checking it properly and the latter is akind of a sale in which the deal is completed when the seller throws a thingtowards the buyer giving him no opportunity to see, touch or check it) and(the Prophet forbade) also Ishtimal-As-Samma’ and Al-Ihtiba’ in a singlegarment.64

56 Abu Khadijah Damansari, The Sin Of Gambling Explained (2007), online:<http://revivalry.blogspot.com/search/label/Mu’amalat%20-%20Rulings>.

57 Yusuf Al-Qaradawi, “The Lawful and the Prohibited in Islam” trans. by Kamal El-Helbawy & M. Moiniddin Siddiqui (Islamic Book Trust, 1994) at 304-305.

58 Wahbah Al-Zuhayli, Financial Transactions in Islamic Jurisprudence §1 (El-GamalM.A trans., Dar al-Fikr, 2003) at 104.

59 Sami Al-Suwailem, “Towards an Objective Measure of Gharar in Exchange” (1999 &2000) 7 Islamic Economic Studies at 61.

60 Al-Zuhayli, supra, n. 58 at 82.61 Mahmoud A. El-Gamal, “An Economic Explication of the Prohibition of Gharar in

Classical Islamic Jurisprudence” (Paper presented at the 4th International Conferenceon Islamic Economics, Liecester U.K., 2001) at 2.

62 Al-Suwailem, supra, n. 59 at 1.63 (1964) in Al-Zuhayli, supra, n. 58 at 83.64 Bukhari, Complete Sahih Bukhari, online:

<http://www.usc.edu/dept/MSA/fundamentals/hadithsunnah/bukhari/008.sbt.html#001.008.364>.


Maisir or gambling due to its high risk and uncertain outcome, and jahalasales in which ignorance can lead to uncertainty, are gharar and invalid. It followsthat maisir, qimar and jahala can be described as the subset of gharar. This isbecause all jahala transactions would amount to gharar because of the excessiveuncertainty involved, but not all gharar sales are jahala. An example of the latterwould be “in the case of buying a runaway slave with known characteristics.”65

Likewise with maisir or qimar, all maisir or qimar transactions are gharar becauseof the high risk involved and uncertain outcome, but not all gharar transactions aremaisir or qimar. This is because the term gharar does not always result in a zero-sum66 outcome; for example the sale of milk in an udder, whereas gambling alwaysresults in a zero-sum game.67 Between jahala and maisir or qimar there would beno relationship unless in cases of extreme ignorance a person goes ahead with thetransaction; then this could amount to a gamble or where a person is gambling andhe is ignorant of the consequences or other facts of the game.

(c) Halal and HaramHalal is that which is permitted, with respect to which no restriction exists,

and the doing of which Allah (swt) has allowed. Haram on the other hand is thatwhich Allah (swt) has absolutely prohibited. The principle is that all is permissibleunless it has been explicitly prohibited, that is, the general rule is permissibility andthe exception is those items which are haram.68

The reasons why items are declared to be haram are due to their impurity andharmfulness. The impurity or harmfulness may be hidden or may not be discoveredduring one’s lifetime. Examples of things which are haram include gambling, alco-hol, prostitution and pork consumption.69

Having explained the fundamental injunctions in Shariah, next this articleturns to a case study, where it will be explained how Malaysia has combinedShariah and conventional laws to govern its Islamic banking and finance industry.

4. CASE STUDY: MALAYSIAN LEGAL AND SHARIAHINFRASTRUCTUREMalaysia has become one of the leading countries in the world in the Islamic

banking sector.70

The era of Islamic banking can be traced back to 1963 when the PerbadananWang Simpanan Bakal-bakal Haji (PWSBH, currently known as Lembaga Urusandan Tabung Haji) was established.

However, a new beginning to Islamic banking activities commenced from the

65 Al-Zuhayli, supra, n. 58 at 109.66 This is a game in which whatever one party gains is what the other loses. Al-Suwailem,

supra, n. 59 at 62.67 Ibid., at 69.68 Al-Qaradawi, supra, n. 57 at 14.69 Ibid., at 44.70 Sherin Kunhibava, “Championing Islamic Banking and Finance in Malaysia” Islamic

Finance News 2010 at 15.


early 1980’s when Malaysia began developing its banking and financial infrastruc-ture to accommodate a dual system. Malaysia officially introduced Islamic bankingand finance to its shores with the passing of the Islamic Banking Act 1983. Its mainpurpose is to govern the operations of Islamic banks, such as stating requirementsfor a bank to be licensed as an Islamic bank. The Islamic Banking Act 1983 definesan Islamic bank as any company which carries on Islamic banking business andholds a valid license. It defines “Islamic banking business” as any banking businesswhose aims and operations do not involve any element which is not approved bythe religion of Islam. The religion of Islam is where Shariah comes in, and this isnot defined by the Islamic Banking Act 1983. Instead the Islamic Banking Act 1983leaves Shariah interpretation and incorporation into Islamic banks through its s. 3.According to s. 3 of the Islamic Banking Act 1983, every bank that wants to prac-tice Islamic banking must establish a Shariah advisory body to advise the bank onthe operations of its banking business to ensure that the bank complies with the“religion of Islam”. Thus, the Shariah Advisory body ensures that Shariah is com-plied with by the Islamic bank.

To ensure uniformity and standardization in the decisions by the Shariah advi-sory bodies of the various Islamic banks, there exists a National Shariah AdvisoryCouncil which advises the Central Bank in Malaysia. The National Shariah Advi-sory Council is the ultimate authority on Islam in Islamic banking and finance inMalaysia. It was established in 1997 by the Central Bank and its primary objectivesare: to act as the sole authoritative body to advise the Central Bank of Malaysia onIslamic banking and takaful operations; to co-ordinate Shariah issues with respectto Islamic banking and finance (including takaful); and to analyze and evaluateShariah aspects of new products/schemes submitted by the banking institutions andtakaful companies.71 Generally, its role is to ensure overall coherence to principalsof Islam and also that all banks offering Islamic services conform to the sameprinciples.

Further, the recent passing of the Central Bank of Malaysia Act 2009 givesgreater clarity to the role of the National Shariah Advisory Council as the ultimateauthority and centre for any issues and questions on Shariah by financial institu-tions and also the courts of law. Under the Central Bank of Malaysia Act 2009 anyruling made by the National Shariah Advisory Council shall be binding on Islamicfinancial institutions, the court and arbitrator.

The Islamic Banking Act 1983 also provides that an Islamic bank may seek theadvice of the National Shariah Advisory Council on Shariah matters relating to itsbanking business, and the Islamic bank shall comply with the advice of the Na-tional Shariah Advisory Council.

In Malaysia conventional banks licensed under the Banking and Financial In-stitutions Act 1989 are also allowed to carry out Islamic banking and finance busi-ness in addition to their conventional banking business, after consulting the Centralbank of Malaysia. Under the Banking and Financial Institutions Act 1989, Islamicbanking business has the same meaning as in Islamic Banking Act 1983, whilstIslamic financial business is defined as any financial business the aims and opera-

71 See online:<http://pkukmweb.ukm.my/~hairum/Ex3613/overview%20of%20Islamic%20Banking%20in%20Malaysia.pdf/assessed>.


tions of which do not involve any element which is not approved by the Religion ofIslam. Further like the Islamic Banking Act 1983, the Banking and Financial Insti-tutions Act 1989 provides that any licensed institution carrying on Islamic bankingbusiness and Islamic financial business may refer a question to the NationalShariah Advisory Council and shall comply with directions on Islamic bankingbusiness and Islamic financial business issued by Bank Negara in consultation withthe National Shariah Advisory Council.

In addition to the National Shariah Advisory Council of the Central Bank,there also exists a Shariah Advisory Council for the Securities Commission, whoserole is to advise the Securities Commission on Shariah related matters and to pro-vide Shariah guidance on Islamic Capital Market transactions and activities.


Thus, in Malaysia conventional law i.e., the Islamic Banking Act 1983, theBanking and Financial Institutions Act 1989 and the Central Bank of Malaysia Act2009 govern the operations of the Islamic banking and financial business, butShariah is left to the Shariah Advisory boards of each bank and the NationalShariah Advisory Councils of the Central Bank and the Securities Commission. Inthis way both conventional laws and Shariah complement each other to ensureproper governance and proper adherence to Shariah by Islamic banking and finan-cial institutions in Malaysia.

One of the main lessons that can be learnt from Malaysia’s comprehensive


regulatory framework with regards to Islamic banking and finance, is on the issueof Shariah governance. In Malaysia, uniformity is maintained in decisions onShariah matters. It is important to ensure uniformity in the decisions of Shariahissues to create certainty for investors and other stakeholders. Investors and otherstakeholders are certain of the outcome of Shariah matters. Uniformity and cer-tainty in Shariah governance is maintained in Malaysia through the one NationalShariah Advisory Council that deals with all the Islamic banking and takaful mat-ters in Malaysia. Even though each Islamic bank has its own Shariah advisoryboard, each Shariah Advisory Board must comply with the directives of the Na-tional Shariah Advisory Council. The National Shariah Advisory Council is theultimate authority in matters of Banking and takaful. With regards to the Islamiccapital market the sole Shariah authority is the Shariah Advisory Council of theSecurities Commission.

Another lesson that can be learnt from the Malaysian regulatory framework isthe transparency of the structure and the distinct roles of every organ in the Islamicfinancial system. Each Islamic bank is governed by the Islamic Banking Act 1983,and conventional banks are governed by the Banking and Financial Institutions Act1989. These acts govern the operational aspect of the banks. On matters of sub-stance that govern the Shariah compliance of the banks’ products and servicesthese are left to the Shariah Advisory Board, and National Shariah Advisory Coun-cil. Each organ in the Islamic financial system has distinct clear roles for whichthey are qualified for.

5. CONCLUSIONThis article explained the sources of law of Islamic banking and finance as

Shariah and conventional law and compared them with each other. Shariah encom-passes more than just law, it includes religious, moral and ethical injunctions. Thisarticle also explained the Shariah injunctions of riba, maisir, qimar, jahala,gharar, halal and haram that apply to Islamic banking and finance. An explanationof how conventional laws and Shariah work in conjunction to govern Islamic bank-ing and finance in Malaysia was made. While the laws of the country may take careof the operation of Islamic banks and conventional banks offering Islamic products,it is Shariah that governs the financial institutions’ business principles.

Date post:	12-Nov-2023
Category:	Documents
Upload:	malaya
View:	0 times
Download:	0 times

Shariah and Law in Relation to Islamic Banking and Finance

Documents