Introduction to Islamic Finance Contracts

1. INTRODUCTION TO ISLAMIC
FINANCE

2. Outlines
• Definition of Non Interest Banking
• Sources Of Sharia
• Shariah, Fiqh & Mu’amalat
• Necessary Requirements of Islamic Finance
• Riba, Gharar, Maysir & Others
• Essential Contracts in Islamic Finance
• Products and Instruments
2

3. What is Non Interest Banking (Islamic Finance)
• Islamic finance is a type of financing that complies with the
tenets of the religion of Islam
• It is often called “business with ethics,”* similar to the
principles behind Lutheran funds, Roman Catholic funds,
“green” funds and other impact investing
• Think of the “consumer protection code” being incorporated into the
substantive legal principles from the outset

4. What is Non Interest Banking (Islamic Finance)
• The principles of Islamic finance began with the advent of Islam and the Islamic
legal system in the 7th century, C.E.
o While the main tenets of Islam are its five pillars (testimony of faith, 5 daily
prayers, charity of at least 2.5%, fasting in the month of Ramadhan and holy
pilgrimage to Mecca), as a 1,400 year old legal system, Islam addresses
every one of the same topics that is addressed by any other legal system,
including prescriptions on financing transactions
• In medieval times until the prominence of Florentine banking and interest-based
lending, the general financial principles under Islamic law were shared amongst
Muslims and Europeans
• As the differences increased and as financial transactions became more
complicated in the modern era, the modern Islamic finance industry emerged in
Egypt in 1963 with the Mit Ghamr Savings Bank
• Since then, modern Islamic finance has grown tremendously
o The $2.2 trillion global Islamic finance industry is expected to grow 10%-
12% over 2021-2022 due to increased Islamic bond issuance and a modest
economic recovery in the main Islamic finance markets

5. Principles of Non- Interest Banking (Islamic
Finance)
• The principles of Islamic finance that are different from those underlying conventional
interest-based finance include:
o Prohibition on the payment or receipt of interest / usury (riba in Arabic)
• One cannot get something for nothing, therefore unearned profit (i.e., profit without expected,
normal business risk) is forbidden
• Income must be proportional to actual profits (not fixed), and losses must fall on partners in
proportion to their capital contributions, without regard to profit shares
o Prohibition on contractual uncertainty (gharar in Arabic)
• Jurists agree that excessive gharar (or contractual uncertainty) is not permitted (i.e., certain
derivative transactions, short selling and speculation), but minimal gharar is allowed
o Requirement of a tangible asset in transactions
• In order for something to be properly the subject of a contract, it must be considered property
(i.e., either tangible or a usufruct, the legal right of using and enjoying the fruits or profits of
something belonging to another)
o Thus, for example, one cannot transact in (i) what one does not own, (ii) derivatives (with
limited exceptions) or (iii) purchases and sales of debt above or below par
o Prohibition on deriving profit from prohibited (haram in Arabic) businesses like drugs,
alcohol or tobacco for human consumption, pornography, weapons, gambling, prostitution,
pork for human consumption and interest-based financing.

6. Sources of the Shariah
• Primary Sources
• The Holy Quran
• Sunnah (the sayings, deeds and endorsements of Prophet Muhammad
PBUH)
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7. Sources of the Shariah
• 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)
Surdul Dara’ih (Blocking the means)
U’ruf (custom)
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8. The Shari’ah Framework of Islamic Banking
and Finance
• 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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9. Shariah & Fiqh
• 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
• Fixed v. Flexible
• Agreements v. Differences
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10. Fiqh Mu’amalat (Islamic Commercial Law)
• However, in its general usage, it is called al-shariat 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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11. Islamic Finance Paradigm
• Original rule of permissibility:
- Initial legal ruling in commercial contract is permissibility
- Contrary to acts of devotion (Ibadat)
- No legal injunction is needed in sanctioning new contract
- Every contract is considered lawful and acceptable if no principle of
shari’ah is violated
- Open a very wide door for further innovations
• Real Economic Activities
• Transactions-oriented not loan-based.
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12. WHAT AMOUNTS TO SHARIAH COMPLIANCE?
• In Islamic jurisprudence, the main source of law is the Shari`ah or
Islamic law as contained in the Quran and Sunnah
• Underlying rule: all contracts are deemed permissible except when
there is contravention of any established principles of Islamic law /
Shari`ah
• Legal maxim (qa`idah fiqhiyyah):
“Al Asl fi al `Uqud al Ibahah”
-“the original rule in contracts is permissibility”
• The parameter: Avoidance of any contravention of the established
principles and prohibitions in Islamic law
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13. What to do and what to avoid
• Conclusion of contract by mutual consent
• The avoidance of riba (interest)
• The avoidance of gharar (speculation)
• The avoidance of transactions involving maysir (gambling)
• The avoidance of transactions involving prohibited
commodities
13

14. 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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15. The avoidance of riba
• 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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16. Prohibition
In Islamic
financial
system
Riba
(Usury) Short
Sale
(Future or
goods you
do not own)
Monopoly
Unfair &
Unjust
Contracts
Unlawful &
unethical
trade
Money
Trading
(money is
payment
mechanism)
Gambling
Gharar
(Deception,
Speculation)
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05/11/2013

17. 17
• 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

18. 18
“Those who (in charity) spend of their goods by night and by day, in secret and in public, have their reward
with their Lord: on them shall be no fear, nor shall they grieve. Those who devour usury will not stand except
as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: “Trade is like
usury,‟ but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their
Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the
offense) are companions of the Fire: They will abide therein (forever). Allah will deprive usury of all blessing,
but will give increase for deeds of charity: For He loveth not creatures ungrateful and wicked. Those who
believe, and do deeds of righteousness, and establish regular prayers and regular charity, will have their
reward with their Lord: on them shall be no fear, nor shall they grieve. O ye who believe! Fear Allah, and give
up what remains of your demand for usury, if ye are indeed believers. If ye do it not, Take notice of war from
Allah and His Messenger: But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall
not be dealt with unjustly. If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if ye
remit it by way of charity, that is best for you if ye only knew. And fear the Day when ye shall be brought back
to Allah. Then shall every soul be paid what it earned, and none shall be dealt with unjustly.”
The Holy Quran, 2:274-281 (Abdullah Yusuf Ali trans., 3rd ed. 1946)
Quran on Usury

19. 19
• 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

20. 20
Old Testament
“Thou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything
that is lent upon usury. Unto a stranger thou mayest lend upon usury; but unto thy brother thou
shalt not lend upon usury: that the LORD thy God may bless thee in all that thou settest thine hand
to in the land whither thou goest to possess it.”
Deuteronomy 23:19-20 (King James)
Further texts demand a resettling of land, debts and property every 7 years, and total
resettlement every 49 years

21. 21
New Testament
“And if ye lend to them of whom ye hope to receive, what thank have ye? For sinners also lend to
sinners, to receive as much again. 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 is
kind unto the unthankful and to the evil.”
Luke 6:34-35 (King James)
St. Thomas Aquinas abhorred the vice of usury

22. 22
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

23. 23
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

24. 24
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

25. 25
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.

26. 26
RIBAWI ITEM
Ribawi
Item
Gold
Salt
Silver
Wheat
Barley/Oat
Dates
Salt

27. 27
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
NGN with Dates

28. 28
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
NGN with vehicles
USD 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 Petrol’

29. 29
PROHIBITION OF GHARAR
• Literally:
• Deceit, risk, fraud, uncertainty or hazard that may 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

30. 30
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:

31. 31
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

32. 32
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
• Football betting

33. 33
NON HALAL (NON PERMISIBLE) 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

34. Conclusion
• Different frameworks can be applied in Islamic Finance provided such
frameworks align with shariah framework
• Shariah framework forms the very substance of Islamic finance, without
which Islamic finance will loss its status as Halal product/service
• As such, in practicing Islamic finance, the do’s and don’ts 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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35. ISLAMIC FINANCE
CONTRACTS
35

36. Introduction
3
6
• Financial Contracts are the basis for the development of Banking products.
The contracts guide the parties on having a successful relationship that will
be mutually beneficial to both and in case of any disagreement, it guides on
how amicable resolution can be reached by protecting the rights of the
parties.
• Sales contracts are the most commonly used by Islamic Banks in their
transactions because it is a straightforward contract and considered to be
less riskier than other contracts such as Mudarabah.

37. Objectives
• The objective of the training is to understand Islamic Finance
Contract.
• Understand the basis of risk/rewards and how they are handled in
Islamic Finance contracts.
• Understand the difference between classical and modern Islamic
Finance contracts.
• Understand the key features that differentiate Islamic finance
contracts in Non Interest Islamic banks and conventional Banks.
3
7

38. Islamic Finance Contracts
3
8
• Contract or Aqd in Arabic language means tying tightly
, as in tying a rope.
Arabs use the word to refer to ‘firm belief ’or determination. It also means
‘make a covenant’ the word ‘aqd also carries the meaning of “obligation’, as
used in the first verse of Surah al-Maida. “O ye who believe! Fulfil your
obligations”.
• In Islamic jurisprudence, the word contract is used to mean an engagement
and agreement between parties that is legally accepted, Impactful and
binding.
• Some scholars have differentiated Aqd from Wa’ad. They believe that while
the former is a contract, the latter is a promise but could become a contract
ifit is bilateral.

39. 8
Profit and Loss in Islam
 In Islam, no party is entitled to a profit without taking a risk. This is the basis for the prohibition of
Riba, gambling and all other business activities that lead to the exploitation of one party by the other
.
Islam encourages fairness and transparency in allbusiness dealings.
 Scholars have developed principles surrounding profit such as al-ghounm bi al-ghourm “reward begets
risk”, which is a key principle guiding Profits and Losses Sharing (PLS). It means the parties in a
financial contract agrees on profit & loss. Another rule is "benefit begets liability" (al-kharaj bi al-
daman).
 Based on the above, it is believed that there must always be an equal counter value on parties in a
financial transaction because an increase which is without an equal counter-value ('iwad) is riba. The
necessary components of 'iwad must be present for profit (ribh) to be lawful (halal), and if any of the
components is absent, the income made in the transaction is considered to be unlawful (haram).
These components are:
 Risk (Ghunm)– Any risk associated with the businessdealing.
 Liability (Daman) – This includes ownership (milkiyyah).
 Earnings (Kasb) – This implies to strive to earn or gainwealth meaning work and effort(amal).

40. BasicPrinciples of Islamic Finance Contracts
40
Structuring financial contracts in Islamic Finance is guided by some principles
such as:
1. Permissibility of allthings, transactions and contracts.
2. Asset based.
3. Prohibited contracts and elements, specifically Riba,excessive Gharar etc.
4. Ownership of assets (milkiyya).
5. Compliance with Shari’ah.

41. Elements of Islamic FinanceContracts
41

42. Typesof Islamic Financial Contracts in IslamicBanks
42
Contract
s
Equity
Based
Musharaka
h
Mudaraba
h
Sales
Based
Murabah
a
Musawama
h Bai
Muajjal
Salam
Istisnah
Leas
e
Ijara
Ijara wa
iqtina
Ijara thumma al bai
Ijara mausufa
fizzimma
Qard
Other
s
Wakal
a
Kafala
Hawal
a
Ju’ala

43. Making Contracts Shari’ah Compliant
43
Conventional
contracts
Shari'ah
screening
Shari'ah
compliant
contracts/product
s

44. Shari'ah Compliance
44
• The responsibility of the management is to ensure Shari'ah compliance
in all activities.
• The Shari'ah Audit Unit reviews and reports if Shari'ah guideline are being
followed.
• Advisory Committee of Experts – Reviews and report whether Shari'ah
principles are adhered to. They endorse the activities of the bank in their
report. Matters of Shari'ah are referred to them.
• Other Departments: Product development, IT
, strategy, RMD, FINCON,
treasury etc, allplay their roles in ensuring compliance.
• Supervisors and Reports: The supervisors ensure compliance with Shari'ah in
their departments while their reports ensure they follow the basic guidelines
etc.