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Islamic Finance bASIC.pptx
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- 2. Outlines • Definition ofNon 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 NonInterest 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 NonInterest 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 theShariah • Primary Sources • The Holy Quran • Sunnah (the sayings, deeds and endorsements of Prophet Muhammad PBUH) 6
- 7. Sources of theShariah • 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) 7
- 8. The Shari’ah Frameworkof 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 8
- 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 9
- 10. Fiqh Mu’amalat (IslamicCommercial 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 10
- 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. 11
- 12. WHAT AMOUNTS TOSHARIAH 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 12
- 13. What to doand 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 BEAVOIDED • 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 14
- 15. The avoidance ofriba • 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) 15
- 16. Prohibition In Islamic financial system Riba (Usury) Short Sale (Futureor goods you do not own) Monopoly Unfair & Unjust Contracts Unlawful & unethical trade Money Trading (money is payment mechanism) Gambling Gharar (Deception, Speculation) 16 05/11/2013
- 17. 17 • Unlawful gainderived 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 (incharity) 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: • FromJabir: 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 shaltnot 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 ifye 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 Excessor 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 PROHIBITIONOF 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 Categoriesof 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 RIBAAL-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.
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- 27. 27 ISLAMIC RULINGS ONRIBA 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 ONRIBA 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 GhararYasir •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 (NONPERMISIBLE) 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 frameworkscan 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 34
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- 36. Introduction 3 6 • Financial Contractsare 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 objectiveof 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 Lossin 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 IslamicFinance 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 IslamicFinanceContracts 41
- 42. Typesof Islamic FinancialContracts 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’ahCompliant 43 Conventional contracts Shari'ah screening Shari'ah compliant contracts/product s
- 44. Shari'ah Compliance 44 • Theresponsibility 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.