BY: Majid Riaz

majidriaz@ymail.com
0321-4426303
 Sources of the Shariah
Framework of Islamic Finance
Shariah, Fiqh & Muamalat
Necessary Requirements of Islamic
Finance
Riba, Gharar, Maysir & Others
Essential Contracts in Islamic Finance
Products and Instruments

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 Primary Sources
The Holy Quran

Sunnah (the sayings, deeds and

endorsements of Prophet Muhammad
PBUH)

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 Secondary Sources (mostly by the exercise of
Ijtihad (reasoning by the learned))
Ijma (Unanimous decision of the Ulama)
Qiyas (analogy)
Istishan/ Istihab (equity in Islamic law)
Maslahah (necessity of the people)
Uruf (custom)

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 In general, the framework of Islamic finance is the
same framework used by the conventional finance
practices.
These frameworks are, legal and regulatory
framework, taxation framework, accounting and
auditing standards, etc.
Might have different or additional framework, such
as accounting and auditing standard, etc, due to its
customs.
In certain jurisdiction, Islamic banking and finance
might be regulated by different sets of regulations,
either separate or additional

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 However, Islamic Finance, as the name
suggests, has another framework,
which is considered the major element
that differentiates IBF from the
conventional banking and finance.
Any violation of this framework will
definitely effect the validity of Islamic
finance itself.
Shariah Compliance Framework

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 Three main interrelated terminologies:
Shariah, Fiqh & Muamalat
Shariah, when viewed from legal
perspective is the fixed elements of
Islamic law, i.e. what has been clearly
stipulated and mentioned in the text.
E.g. five time prayers, prohibition of
riba, etc.
As such, it is revealed in nature
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 Shariah, in this sense, is wide and encompassing
various branches of Islam
Normally, it comes in its generality and it
emphasizes only on the principles and not the
detailed rules (not all the time)
It is the duty of the judge (qadi), mufti and
jurisconsult (ulama) to exert their intellectual
efforts in deriving and applying these principles
on certain given scenarios.
The result of human reasoning and understanding
to the shariah is known as fiqh

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 However, in its general usage, it is called al-syariat
al-Islamiyyah (Islamic law).
Islamic commercial law is one of the components of
Islamic law
Other components of Islamic law include:
Islamic law of purification and worship
Islamic family law
Islamic criminal law
Islamic law of evidence and procedure
Islamic law of inheritance, etc
The main subjects of Islamic commercial law are
commercial contracts and the rules governing them

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 Conclusion of contract by mutual
consent
The avoidance of riba
The avoidance of gharar (Uncertainty)
The avoidance of transactions involving
maysir (gambling)
The avoidance of transactions involving
prohibited commodities

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WHAT TO BE AVOIDED

Riba prohibited in many Quranic verses and

sayings of the Prophet s.a.w.
Meaning: riba is every excess in return of
which no reward or equivalent counter value
is paid, in short, every unjust enrichment is
riba

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 Literally: excess, expand, increase,
growth
Any unjustified excess above and over
the capital, whether in loans (between
creditor and debtor) or in trade (with
similar commodities)

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CONTD
There are also a number of narrations
from the Sunnah on the prohibition of
riba
Some of the narrations give general
prohibitions of riba, e.g.:
The Prophet of Allah s.a.w. cursed the
receiver and the payer of riba, the one who
records it and the two witnesses to the
transaction and said: they are alike (in
guilt).

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 Under Islamic law, riba can occur in two main
situations, i.e.:
riba al duyun (loan): the riba or excess which
occurs in debt and loan transactions because of
extension/delay in repayment
riba al buyu` (exchange): the riba or excess which
occurs in trading transactions involving the
exchange of riba-bearing commodities without
observing the required rules

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 PROHIBITION OF RIBA (LOAN)
Surah al-Baqarah, ayat 275
But Allah hath permitted trade and forbidden usury

Interpretative
Efforts

What amounts to

Trade Usury

Criteria Criteria
Fair exchange of goods or Oppressive / unfair distribution
value of risk & return
Fair distribution of risk & Unjustified enrichment at
return expense of others
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 PROHIBITION OF RIBA
(EXCHANGE)
Sunnah of the Prophet:
Gold for gold, silver for silver, wheat for wheat, barley for barley,
dates for dates, salt for salt - like for like, equal for equal, and
hand-to-hand (spot); if the commodities differ, then you may sell as
you wish, provided that the exchange is hand-to-hand or spot
transaction.

Interpretative Efforts

Application

Currency Staple Food

Rules Rules
Same denomination Same Type
At Par At Par
Spot Spot
Different denomination Different Type
Spot Spot 16
CONTD
In modern finance, riba can occur in:
All interest-based lending activities (e.g. all
conventional bonds)
Fixed return on deposits in conventional banking
(e.g. designated accounts for receivables of the
bonds)
In the secondary trading of debt securities if the
transaction is not spot & if there is discounting
(according to global Shari`ah standard)
Thus, to be Shari`ah compliant, all contracts in
Islamic finance cannot be involved in any of
the usurious activities mentioned above

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 Literally: excess, expand, increase,
growth
Any unjustified excess above and over
the capital, whether in loans (between
creditor and debtor) or in trade (with
similar commodities)

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Riba al-Duyun Riba al-buyu
(RIba in Loan (Riba in exchange
Contract) contracts )

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 The debtor borrowed money to be paid in certain
time, and the amount is more than the amount
borrowed
A creditor gives a periodic loan and takes
monthly interest. The capital sum lasts until the
expiration of the period. Upon expiry, if the
debtor cannot pay, the period to pay back the
capital will be extended and interest will be
charged
Arising out of exchange contract, a buyer must
pay a consideration. If he failed to settle on time,
the period will be extended by increasing the
amount (principle + interest).

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 (c) Mohd Johan Lee 2012 3/17/2012

Mainly based on the saying of the

Prophet: Gold for gold, silver for silver,
wheat for wheat, barley for barley,
dates for dates, and salt for salt; like
for like, hand to hand, in equal
amounts; and any increase is riba.

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 These commodities can be classified under
two main categories which make the illah
(ratio decidendi) for their prohibition:

- i- medium of exchange (currency):

Gold and Silver
-ii- Staple foods: Wheat, barley, dates
and salt
Any other items, even though not
mentioned in the hadith but serve the
same purpose will be considered as having
the same illah by way of qiyas (analogy)
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 Riba al-duyun in loans and certain
controversial contracts (bay
al-inah, bay al-dayn, etc)

Riba al-buyu mainly in bay al-sarf

(exchange of currencies)

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 Meaning of gharar:
- Literally: risk, uncertainty, hazard
- The sale of probable item whose
existence or characteristics are not
certain, due to the risky nature which
makes the trade similar to gambling

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 Sale of fish in the sea, birds in the sky
Sale of unborn calf in its mothers womb
Sale of runaway animal, slave
Involve item which may or may not exist
However, the Prophet did not lay down the
principles (qawaid) for the prohibition of gharar.
Examples given in the hadith were some of the
manifestations of the doctrine, but not
principles.
This has led to the dispute among jurists on the
area and coverage of gharar.

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GHARAR
Meaning: has a range of negative connotations,
such as, uncertainty, deception, risk, hazard,
ignorance etc.
If there is gharar, the contracting party/ies do
not really understand the attributes /
consequence of the contract
Under Islamic law, gharar is prohibited because
its existence in the contract may deny the
parties of equal bargaining power and they
cannot make informed decisions; or if there is
risks on deliverability of the object of the
contract

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 PROHIBITION OF GHARAR
Surah an- Nisa: ayat 29
spend not your property amongst yourself unjustly
(batil) except it be a trade among you by mutual consent

Interpretative Efforts

What amounts to

Unjust (batil) Trade by Mutual

Consent

Criteria Criteria
All illegal & defective Offer & Acceptance,
elements in contracts indicating consent
including gharar & Elimination of mistake, fraud
uncertainty etc
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PROHIBITION OF GHARAR IN THE
SUNNAH
The sunnah uses the word gharar and its
derivatives much more extensively than the Qur`an
in the sense that several new meanings are added
In relation to commercial transactions, the Prophet
s.a.w. in many of his sayings directly prohibited the
sale involving gharar (uncertainty) and jahalah
(ignorance)
Thus, the prohibition of gharar is made conclusive
by the sunnah / hadith of the Prophet s.a.w.
Examples: the prohibition of gharar sale (i.e., the
sale contract affected by gharar), the prohibition of
the sale of fish in the sea, bird in the air, unborn
animals, lost items, etc.

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CONTD
In Islamic law, gharar can be of two degrees:
Excessive or major (gharar fahish)
Minor and tolerable (gharar yasir)
Only major /excessive gharar will affect the validity of
contracts, where it will render the contract void / voidable,
depending on the degree of uncertainty
Gharar affects trading and exchange contracts (mu`awadat);
not charitable and unilateral contracts
In banking & finance gharar can be triggered e.g. in the
sale contract to create the indebtedness if the asset used is
uncertain / vaguely identified; the trading of a securitised
debt which is unconfirmed / not established, sale of
insurance policy

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 Broadly speaking, gharar will effect the
validity of contract if it occurs in these
areas:
- gharar in kind / type / attribute /
quantity of the object
- gharar due to delivery time
- gharar due to the price/ mode of
payment
- doubt over the ability to deliver

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 Gharar which is excessive (gharar fahish)
occurs in exchange contracts (uqud al-
muawadat)
To prevent gharar, the parties to contract
must have adequate knowledge and
information on the subject matter:
i- Their existence and deliverability
ii- Its quality, quantity and attributes
are known
iii- Time frame for payment and
delivery

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 However, gharar is tolerable if:
- i) it is small (gharar yasir)
- ii) It occurs in other than exchange
contracts, such as in gratuitous contracts.
-iii) It happens to the ancillary object
(appendages) only (not the principal and
main subject matter of contract)
- iv) the economic need for the
contract embodying the risk is substantial

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 OTHER THINGS TO BE AVOIDED

Transactions involving the prohibited

commodities, e.g., pork and liquor
Surah al Maidah (5:3)
Surah al Maidah (5:90)

Transactions involving gambling or

maysir/qimar
Surah al Maidah (5:90)

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 Involves the creation of risk for the sake of risk
A combative relationship between two
contracting parties, each of whom undertakes
the risk of loss and the loss of one means gain
for the other
Apply to all games of pure chance
No economic activities are gained in the
practice. The gambler will simply seek to amass
wealth without efforts.
Gambling is gharar in its worst scenario.
Prohibited by al-Quran in Surah al-Maidah (5:90)

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 It is also not allowed to conclude contract
on illegal commodities such as pork,
liquor etc.
Illegality of certain commodities has been
spelt out clearly in the texts of al-Quran
and Sunnah of the Prophet.
E.g. :
- Surah al-Maidah (5:3)
- Surah al-Maidah (5: 90)
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 Underlying principles utilised in devising
products of IBF is very important as they
separate IBF from conventional products.
Contrary to conventional finance, which is
specification driven product, Islamic finance is
more structure and principle based product
Rules and regulations will differ from one
product to another, depending on the structure
employed
In general, various underlying Shariah principles
have been utilised in devising products of Islamic
Banking and Finance.
They can be summarised as below:
- Sale based products
- Lease based products
- Participatory products
- Fee based products 36
SHARI`AH COMPLIANCE: MAIN
PRINCIPLES
CONTRACTS

Lawful
Lawful
Mutual consent Avoid
Avoid Contractual
Contractual
Objective

Interest Uncertainty Gambling Other prohibitions

(riba) (gharar) (maysir/qimar) e.g. Liquor, pork

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ENCOURAGEMENT OF TRADE BY
MUTUAL CONSENT

The Quran encourages work and trade

The Prophet (s.a.w.) himself was a trader
The encouragement of trade is evidenced
by the many instruments of trade
available during the Prophet's lifetime and
in Islamic history thereafter

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BUSINESS CONTRACTS
RECOGNISED IN ISLAM

Contracts of sale and purchase (bay`),

including all its subdivisions, like:
normal or spot sale
mark-up sale (murabahah)
deferred payment sale (BBA)
sale with advance payment but deferred delivery
(bay` al salam)
sale for future delivery of goods with flexible
payment of the price or manufacturing contracts
(bay` al istisna`)
sale of currency (sarf), etc.
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CONTD

Some controversial sales:

Sell and buy back (bay al `inah)
Sale of Sale of debt (bay` al dayn)
Islam recognises partnership contracts which
are mainly based on profit and loss sharing
(PLS), e.g.:
mudharabah
musharakah
A relatively new invention in this regard is:
Musharakah mutanaqisah

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CONTD

Islam recognises public and private project

financing, e.g.:
Leasing (ijarah) - private;
Endowment (waqf) private/public;
State treasury (bayt al mal) public.
Modern forms of private project financing:
Operational lease
Financial lease AITAB (hybrid contract)

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CONTD
Islam recognises other additional contracts to
provide security to the parties in a contract, i.e.,
the contracts of security (`uqud al tawthiqat), e.g.:
suretyship/guarantee (kafalah): involves three parties
mortgage (rahn): involves two parties
These security contracts are normally combined
with other types of contracts, e.g.:
the contract of BBA may be secured by a contract of
security involving collateral (rahn)
Other contracts recognised in Islamic law:
contracts of trusts (al amanat), e.g.: safe-keeping
(wadi`ah)
contracts to do a specified task, e.g.: commision
(ju`alah); agency (wakalah)

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Gratuitou
Gratuitou Investme Supporti
Supporti
Trading
s nt
nt ng
Contracts
Contracts
Contracts Contracts
Contracts Contracts

Mudaraba
Gift Leasing Sale Kafalah
h
Musharaka
Waqf
h
Operation Bay`
Loan al Lease Bithaman Hiwalah
Ajil (BBA)
Ibra
Financial Murabaha
Lease h
Wakalah
Salam

Istisna
etc.
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Islamic Banking

SOURCES OF APPLICATIONS
FUND OF FUND

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 EQUITY DEBT FINANCING
FINANCING

Mudharabah Sale based financingLease Based Financing

Fee Based Services
Musharakah BBA / Murabahah -Ijarah Wakalah
Inah/Tawaruq/dayn -AITAB Kafalah
Salam
Istisna

Comsumer Corporate
Banking Banking
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 ISLAMIC CAPITAL
MARKET

Equity Bond Derivatives

Market Market Market?

-Future Contract
Musyarakah -Debt Based -Options
Mudarabah -ABS -Swap
-Equity Based

Mutual Fund / Islamic

REITs Islamic
Wakalah / mudarabah Hedge Fund
/ musharakah
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 Besides various frameworks applied to banking
practices (be it Islamic or conventional), Shariah
framework is a framework which is peculiar to
Islamic finance alone
Yet, it forms the very substance of Islamic
finance, without which Islamic finance will loss
its Islamicity
As such, in practicing Islamic finance, the dos
and donts must be clearly observed
Islamic commercial law, from the fact that it
subjects to human interpretation and
understanding admits differences of opinion, as
long as these differences are grounded by valid
evidence, produced by capable personnel, done
according to the right methodology

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