Fundamental of Islamic Banking - Principles of Islamic Banking

1. ISLAMIC
BANKING AND
FINANCE
Mahyuddin Khalid
emkay@salam.uitm.edu.my
PRINCIPLES OF ISLAMIC BANKING

2. CONTENTS
 INVESTMENT AND FINANCING OF HALAL
ACTIVITIES
 PROFIT AND LOSS SHARING VS LENDER-
BORROWER RELATIONSHIP
 TRADE-BASED FINANCING VS INTEREST-
BASED INVESTMENT/LOAN
 PROHIBITION OF RIBA, GHARAR AND
MAYSIR
 PAYMENT OF ZAKAT
2

3. INVESTMENT AND FINANCING OF HALAL
ACTIVITIES
Impermissible to invest and
give financing to related
activities
Financial serviced based on Riba
Gambling and gaming
Manufacture or sale of non-halal products
Manufacture or sale of tobacco-based or
related product
Stockbroking or share trading in Shariah non-
compliant securities
Other activities that conflicts with Shariah
Entertainment activities that conflicts with
Shariah
Conventional insurance that containing of
gharar
3

4. PROFIT AND LOSS SHARING VS LENDER-BORROWER
RELATIONSHIP
PROFIT LOSS SHARING
• First Tier
• Between bank and depositor
• The depositor are considered to be
provider of the capital (Rabb al mal)
• The bank functions as a working partner or
manager of funds (mudarib or amil)
• Second Tier
• Between bank and entrepreneur
• The entrepreneur is the manager of fund
• The bank functions as provider of capital
LENDER-BORROWER
RELATIONSHIP
• The relationship between a lender and a
borrower is governed by a loan contract
between them.
• Such a contract would specify all the
obligations of the two parties in every
possible future contingency.
• With respect to:
• The amount of repayment
• The interest rate on the remaining debt.
• A possible adjustment in the collateral
required by the lender.
• The actions (in particular investment
decisions) to be undertaken by the
borrower.
4

5. TRADE-BASED FINANCING VS INTEREST-BASED
INVESTMENT/LOAN
TRADE-BASED FINANCING CHARACTERISTICS INTEREST-BASED LOAN
The bank has to purchase the
requested commodity before
selling it to the customer.
Legal Nature of
promise
The customer is required to
make a unilateral promise to
buy the commodity from the
bank, before the bank makes
the purchase.
Price includes a known profit
or mark-up.
The mark-up in murabahah is
part of the sale price, it is set
only once and then it does not
change overtime.
Profit Rate Profit comes from the interest
rates.
Murabaha financing products
are fixed-rate products.
The rate, once determined for
a given contract, is not
allowed to float with changes
in the interest rates or any
other rate.
Fixed and Floating
rate
Many conventional banking
products are floating-rate
products.
The rates on such loans are
automatically adjusted
upwards or downwards in line
with changes in interest rates.
5

6. TRADE-BASED FINANCING VS INTEREST-BASED
INVESTMENT/LOAN
TRADE-BASED FINANCING CHARACTERISTICS INTEREST-BASED LOAN
Murabaha does not allow
such rescheduling as no
additional amount can be
charged for the same.
The amount of the
murabahah price remains
unchanged.
Rescheduling of
payment
Loan rescheduling is
accompanied by
additional interest charge
for the timing differences.
If it is given voluntarily, it is
allowed.
The rate of discount must
not be pre-specified in the
murabahah contract as a
condition.
It is not a right that the
debtor can claim.
Rebate on early
payment
Conventional financial
system grants the
borrower a discount or
rebate if the customer
decides to pay earlier than
the scheduled time.
6

7. • Unlawful gain derived from the quantitative
inequality of the counter-values in any transaction
purporting to effect the exchange of 2 or more
species which belong to the same
genus(category) and are governed by the same
efficient cause(illah)
Definition of Riba on Trade transaction
• A predetermined excess or surplus over and
above the loan received by the creditor
conditionally in relation to a specified period
Definition of Riba on Loan transaction
PROHIBITION OF RIBA
7

8.  Al-Quran
 Al-Baqarah: 275
EVIDENCE
8

9.  Hadith:
 From Jabir: The Prophet saw cursed the receiver
and the payer of usury, the one who records it
and the two witnesses to the transaction and
said: “They are all alike (in guilt and sin).
 From Abi Said al-Khudri: The Prophet saw said:
gold for gold, silver for silver, wheat for wheat,
barley for barley, dates for dates, salt for salt,
like for like, and hand to hand. Whoever pays
more or takes more has indulged in riba. Take
taker and the giver are alike (in guilt).
EVIDENCE
9

10. ELEMENTS OF RIBA
Excess or surplus over
and above the loan
capital
Bargain to be
conditional on
the payment of
a
predetermined
surplus
Determination of
this surplus in
relation to time
10

11. REASONS FOR PROHIBITION OF
RIBA
To prevent
injustice
between
contracting
parties
Exploit the
poor/
creditors
An exploitations
of people
ignorance over
the types of
commodities
involved in
transaction
An exploitation
of people
needs. Thus,
they have no
choice but to be
involved in Riba
11

12. CATEGORIES OF RIBA
Categories of
Riba
Riba al-Buyu`
(Trade Transaction)
Riba al-Fadl
Riba al-Nasiah
Riba al-Dayn
(Loan Transaction)
Riba al-Qard
Riba al-
Jahiliyah
12

13. CATEGORIES OF RIBA
RIBA AL-BUYU`
Riba al-Fadl
•Also known as Riba al-buyu’ that is riba by excess.
•It applies to six items : gold, silver, date, raisin, wheat
and barley and the like of them.
Riba al-Nasiah
•Its occurs whenever the creditor advanced loan on
some monthly interest in addition to the principal sums.
•Increase due time
•On other words, this stipulated interest which the
lender takes from the borrower to pay back the capital.
•Second opinion- Any delay in the exchange of the
ribawi items from the same type and category
RIBA AL-DAYN
Riba al-Qard
•It is riba in debt or out of lending and borrowing.
•It was originated from the transaction of a loan , and it
is interest or payment charged due to the loan given.
•On the other words, it is the extra amount over the
above principal of the loan.
Riba al-Jahiliyah
•It is Riba in loan.
•It is when a loan contract is made or at rescheduling a
previous debt.
•It is take place only in debts created via lending or
extended to a new maturity via rescheduling.
13

14. RIBAWI ITEM
Ribawi
Item
Gold
Salt
Silver
WheatBarley/Oat
Dates
Salt
14

15. 15
ISLAMIC RULINGS ON RIBA IN
TRADE
Category Type Exchange Quantity Items
1 Same
category
Same
type
Spot
exchange
Equal in
quantity
Regardless of
quality
Gold with Gold,
Wheat with Wheat
2 Same
category
Different
type
Spot
exchange
Inequality
is
permitted
Equality is not a
condition
God with Silver
Wheat with Rice
Salt with Dates
3 Different
category
Different
type
Delayed is
permitted
Inequality
is
permitted
Time and
Quantity Factor
is not a
condition
Gold with Wheat
RM with Dates

16. 16
ISLAMIC RULINGS ON RIBA IN
TRADE
Category Type Exchange Quantity Items
4 Ribawi Items and Non-
Ribawi Items
Delayed is
permitted
Inequality is
permitted
Time and
Quantity
Factor is not a
condition
RM with vehicles
UD with furniture
5 Between 2 Non-
Ribawi Items
Delayed is
permitted
Inequality is
permitted
Time and
Quantity
Factor is not a
condition
Bricks with Sands
Cloth with Patrols’

17. PROHIBITION OF GHARAR
 Literally:
 Deceit, risk, fraud, uncertainty or hazard that
may be lead to destruction loss.
 Technically:
 When a matter that is concealed by one party.
 Occurs when a party undertake venture
blindly without sufficient knowledge
 Minor uncertainties can be permitted when
there is a necessary
 Both of contracting parties must have a
perfect knowledge regarding to transaction
17

18. PROHIBITION OF GHARAR
• Sell good that seller is not in position to
deliver.
• Sell unknown pages or known goods
against unknown price.
• Make a contract conditional on a
unknown event.
• Sell good on basis of false description.
• Sell good without proper examination.
• Gambling.
Examples of Gharar related
transaction:
18

19. TYPES OF GHARAR
Gharar Yasir
• This type of gharar is tolerate and
will not invalidate a contract.
• Gharar yasir may include the
following cases:
• The uncertainty is slight or trival
• Contract is unilateral or charitable
(al tabarru’at) such as gift or
bequest
• There is a public need for the
transaction or contract
(consideration of maslahah)
Gharar Fahish
• This type of gharar is not tolerate
and may result in contract
voidability
19

20. PROHIBITION OF MAYSIR
 Refers to the easy acquisition of wealth by
chance, whether or not it deprives the other’s
right.
 Qimar means the game of chance in which
one gains at the cost of others.
 Issues that related to gambling:
 Contest using SMS
 The prize winning tickets
 Horse racing
 Lottery
 Crossword puzzles
20

21. PAYMENT OF ZAKAT
 Meaning of zakat
 To grow
 To purify
 To improve
 Purpose of Zakat
 The foremost and primary is to distribute the wealth of the
community among the poor
 Removing the love of wealth from one’s heart, a spiritual
disease that could be detrimental to one’s Iman. Thus, it
is a form of Tazkiya (self-purification).
 Giving in the path of Allah acknowledging that whatever
wealth one possesses is in reality the Almighty’s, and
giving a monetary sacrifice for one’s lord.
 Prevention of monopolies in society.
21

22. BENEFIT OF ZAKAT
 Enhances Volume of Production
 When Zakat is collected and distributed among the poor they spend it
on various consumer goods which increase the demand of various
products of industries which increases production of goods.
 Discourages Hoarding
 Zakat discourages hoarding because it is levied on hoarded wealth.
 Raises Savings
 Zakat is paid out of the accumulated wealth. the wealth owner must in
saving ratio, in order to prevent the level of his wealth from decreasing.
 Zakat increase level of income
 Zakat increase level of income due to circulation of wealth in the
economy.
 Reduces inequality of Wealth
 Zakat is distributed among the poor from rich people so it reduces
inequality of wealth.
 Zakat ends poverty as Zakat is given to poor.
 Redistribution of National Income.
22

23. CONDITION OF ZAKAT
 Zakat Performer Muslim
 Every Muslim who is of a certain age and owns enough assets is
required to pay zakat.
 Zakat Assets
 Full ownership. A Muslim only required to pay zakat if he or she has
full and legal ownership of an asset.
 It’s payable only on those assets acquired for the purpose of creating
or generate wealth.
 Zakat need only be paid on those assets that exceed a minimum
value.
 Minimum value is termed Nisab.
 Completion of Haul
 Haul is defined as the completion period for zakat asset.
 The length of time:
 One Islamic Hijri year (1 year Hijri=354.5 days, 1 year Solar= 365.25 days)
 Zakat only payable on asset that have been held for at least this
period.
23

24. TYPES OF ZAKAT
Zakat Fitr
• Zakat Fitr is a one off payment that is
made once in every Muslim Hijri
calendar year at any time between
the first day of the month of
Ramadan and the first day of
Shawal.
• All Muslims are obliged to pay this,
regardless of their age, status or
wealth.
• The amount of zakat payable is
approximately 3kg of staple food in
the relevant country or an amount of
money that is equivalent to the price
of the food.
Zakat Al-Mal (on wealth)
• Zakat al-Mal is an annual payment
based on the amount of wealth
owned by a Muslim individual or
organization.
• This payment is obligatory upon any
Muslim individual or organization that
has completed the requirement of
Nisab (minimum taxable amount)
and Haul (one Muslim Hijri calendar
year).
• The payment is 2.5% out of the total
wealth deemed for zakat.
• Zakat al-Mal can be subdivided into
zakat on:
• Business, Rental Income, Personal
Income, Savings, Gold and
Silver, Shares, Livestock, Crop
24

25. BENEFICIARIES OF ZAKAT
1. The poor (Faqir/Fuqara)
2. The needy (Miskeen)
3. The administrators of zakat (Amil)
4. The sympathizer (Muallaf) - Those who are inclined to enter
or have already converted to Islam.
5. To free slaves (Riqab)
6. Those who are in debt (Gharimin)
 Zakat can be used to pay off the debts of a person who has
borrowed to pay for basic necessities or those on financial
problem.
7. For the causes of Allah (Fisabilillah)
 Zakat can be use to finance any form of struggle or work for
the love of Allah.
8. Those who are stranded during a journey (Ibnus Sabil)
 Zakat can be used to help a traveller facing difficulties in
continuing his journey.
25

26. ISLAMIC LEGAL MAXIM ( )
 Qawaid fiqhiyyah or Legal maxims are general rules
which can be applied in various cases that come
under common rulings.
 Plays great role in the formation of Islamic law
because they are uses as principles to deduce rules
of fiqh.
 Legal maxims are indeed general rules of fiqh, which
can be applied in various cases that come under the
common rulings e.g.. transactions, munakahat,
evidence etc.
 Have a great role in the formation of Islamic law
because they are used as guidelines in finding the
rules of fiqh but cannot be accepted as sources of
shariah.
 These maxims have solved most of the minor rules
of fiqh and without them these minor rules will have
no standing ground which will make it hard to solve
26

27. 27
FIVE MAJOR MAXIMS
Acts Are Judged By The Intention
Behind Them
Certainty Is Not Dispelled By
Doubt
Hardship Begets Facility
Harm Must Be Removed
Custom Is The Basis Of
Judgement

28. ACTS ARE JUDGED BY THE INTENTION BEHIND
THEM
( )
 An act of any human being is judged in the
light of intention or the purpose it seeks to
have effects.
 This means that the effect to be given to any
particular action or transaction must be in
accordance with the intent underlying such
action or transaction.
 E.g.:
 Banks declare their policy of financing customers
on non-interest bases it would be necessary to
do so and not merely continue the same practice
and seeking to rationalize it in Islamic terms
such as mudharabah etc.
28

29. CERTAINTY IS NOT DISPELLED BY DOUBT
( )
 It is discusses about the principle that should
be followed if there is doubt in any matter
particularly in matters pertaining to Islamic
law.
 This means that a fact established by law or
proven with evidence will remain so, until
there is another certainty that removes it.
 E.g.:
 A partner has no right to assume a minimum rate
of profit earned by his business partner and
claim his share in that profit as different from
amount stated to have been actually earned by
the partner.
29

30. HARDSHIP BEGETS FACILITY
( )
 The maxim indicates that any ruling which
implementation causes hardship to a person or
the action is unable to be performed by a
particular person for a specific acceptable
reason, then there are alternative and ways out
that can be resorted to in order to overcome the
difficulties and hardship.
 Hardship- refer to surpass the normal limit and
ability of a person such as travel/sickness/
dharurah etc.
 E.g.:
 If the court orders the sale of assets of a negligent
debtor to pay his creditors, it must begin with the
sale of his movable goods if this would suffice to
clear his debt, before selling his real property.
30

31. HARM MUST BE REMOVED
( )
 The scholars have classified harm into two
categories :
 Harm which is inflicted intentionally in order to cause
damage. This kind of harm is forbidden and the
perpetrator shall bear the consequences of his
action.
 Harm which is cause unintentionally without any
intention to cause harm or damages to others.
 E.g.:
 A buyer of perishable goods absents himself without
taking possession of the purchased goods. The
seller , in order to protect himself and the buyer from
loss, has a right to unilaterally revoke the contract of
sale and sell the goods to some other party.
31

32. CUSTOM IS THE BASIS OF JUDGEMENT
( )
 This maxim means the practices of the
people whether in their actions or sayings,
regardless of whether they are general
practices of the people or the practices of
certain groups of people.
 E.g.:
 A person authorizes another to sell something
on his behalf without laying down conditions as
to sale price and unit of currency, the agent will
be treated to be bound by conventional rules of
charging a reasonable price and prevalent
currency.
32

33. END OF CHAPTER33