Running head: ISLAMIC BANKING AND FINANCE 1 ISLAMIC BANKING AND FINANCE 22 Islamic Banking and Finance Tuleen Basrawi 1310186 BNFN 4302 Instructor: Mr. Masood Aijazi Thursday, December 6, 2018 Abstract Everybody values own properties and life. This value inspires protection from loss and to avoid risks by all ways and measures. The examples of events which people are vulnerable to are theft, accidents, deaths, hurricanes, and fire. Insurance was therefore, invented to indemnify a member from a loss. Insurance is a not a new concept per se. The ancient Arabic trade caravans would contribute funds to help a member from loss due to robberies or any disaster on their way to Asia. The Chinese are also great insurance icons. 5000 years ago, Chinese families tied together houses to prevent drowning and to share risks as their houses were on floating water. In ancient Rome, the survivors of a military member who died were compensated by being offered some money as assistance. The other pioneers of insurance are Rhodes who formed the first law on loss in relation to cargo transportation via sea, the Phoenicians, and Lombardians. Insurance is therefore, a tool that helps to control such risks. Modern insurance is traced to 1977 when academicians from Saudi Arabia tried to resolve takaful as cooperative insurance, leading to the formation of the first insurance company in 1979. Generally, Islam allows risk management concept. However, it enhances risk management under certain conditions such as not making profit at others expenses. The initiatives to solve risk problem in ways that comply with sharia have led to Takaful emergence. In this perceptive, the purpose of this research paper is to tackle the concept of Takaful insurance. It is an interesting topic worth studying in that its formation reflects Islam religion. Islamic banking and finance will first be looked into before narrowing down to takaful insurance. Islamic banking sets the foundation for Takaful insurance. Table of Contents Abstract 2 Introduction 4 Islamic banking and finance overview 4 Takaful definition 5 Takaful principles 7 Takaful insurance model 8 Takaful features 9 Takaful and conventional insurance 9 Variations between Takaful and conventional insurance 10 Takaful development 11 Takaful milestones 12 Takaful models 12 Mudarabah model 12 Wakalah model 13 Wakalah / Mudarabah hybrid 15 wakalah with Waqf 17 Takaful products 18 Family Takaful 18 Family takaful types 19 General Takaful 19 Retakaful and reinsurance 20 Conclusion and recommendations 21 References 23 Introduction It is obvious that human activities are prone to loss risk from unexpected circumstances. Insurance has been there for several years back to indemnify the individuals from losses. Insurance concept has been exercised in different places for several years. During those days, trade caravans who encountered risks were the same as those faced presently in trading activities were there. T.

1. Running head: ISLAMIC BANKING AND FINANCE 1
ISLAMIC BANKING AND FINANCE 22
Islamic Banking and Finance
Tuleen Basrawi
1310186
BNFN 4302
Instructor: Mr. Masood Aijazi
Thursday, December 6, 2018
Abstract
Everybody values own properties and life. This value inspires
protection from loss and to avoid risks by all ways and
measures. The examples of events which people are vulnerable
to are theft, accidents, deaths, hurricanes, and fire. Insurance
was therefore, invented to indemnify a member from a loss.
Insurance is a not a new concept per se. The ancient Arabic
trade caravans would contribute funds to help a member from
loss due to robberies or any disaster on their way to Asia. The
Chinese are also great insurance icons. 5000 years ago, Chinese
families tied together houses to prevent drowning and to share
risks as their houses were on floating water. In ancient Rome,
the survivors of a military member who died were compensated

2. by being offered some money as assistance. The other pioneers
of insurance are Rhodes who formed the first law on loss in
relation to cargo transportation via sea, the Phoenicians, and
Lombardians. Insurance is therefore, a tool that helps to control
such risks. Modern insurance is traced to 1977 when
academicians from Saudi Arabia tried to resolve takaful as
cooperative insurance, leading to the formation of the first
insurance company in 1979. Generally, Islam allows risk
management concept. However, it enhances risk management
under certain conditions such as not making profit at others
expenses. The initiatives to solve risk problem in ways that
comply with sharia have led to Takaful emergence. In this
perceptive, the purpose of this research paper is to tackle the
concept of Takaful insurance. It is an interesting topic worth
studying in that its formation reflects Islam religion. Islamic
banking and finance will first be looked into before narrowing
down to takaful insurance. Islamic banking sets the foundation
for Takaful insurance.
Table of Contents
Abstract 2
Introduction 4
Islamic banking and finance overview 4
Takaful definition 5
Takaful principles 7
Takaful insurance model 8
Takaful features 9
Takaful and conventional insurance 9
Variations between Takaful and conventional insurance 10
Takaful development 11
Takaful milestones 12
Takaful models12
Mudarabah model 12
Wakalah model13

3. Wakalah / Mudarabah hybrid 15
wakalah with Waqf 17
Takaful products 18
Family Takaful 18
Family takaful types19
General Takaful 19
Retakaful and reinsurance 20
Conclusion and recommendations 21
References 23
Introduction
It is obvious that human activities are prone to loss risk from
unexpected circumstances. Insurance has been there for several
years back to indemnify the individuals from losses. Insurance
concept has been exercised in different places for several years.
During those days, trade caravans who encountered risks were
the same as those faced presently in trading activities were
there. The Muslim academicians recognize that shared
reasonability basis in Al aagilah system as exercised between
Madinah and Makkah Muslims laid mutual insurance
foundation. It encompassed contributions from the members to
share responsibility to indemnify victims against finance
liability from events. Prophet Muhammad accepted that system
under mutual protection principle and cooperation in good deeds
and virtue. Shared responsibility in “Aquila” system as
exercised between the Muslims of Medina and Mecca therefore,
laid mutual insurance foundation. Islamic insurance was formed
in the early Islamic century second era when the Muslim Arab
traders who expanded into Asia agreed to make contributions to
a fund to cover any colleague who was robbed along the way or
was befell by a disaster referred to as marine insurance. In this
perspective, this research paper aims to analyze takaful
insurance in-depth (Cheikh, 2013). The first section will define

4. takaful insurance, origin of the concept, takaful principles,
features, models, takaful development, difference between
takaful and conventional insurance, takaful products, Retakaful
and reinsurance, and lastly conclusion and
recommendations.Islamic banking and finance overview
Islamic banking has been making stellar improvements to
become a competitive and feasible option to conventional
systems globally. Islamic banking inclusive of finance
institutions have garnered footholds in south East Asia and
Middle East. These hubs have been playing a great role about
raising the awareness of Islamic banking in Western finance
markets and businesses. The elements which have contributed to
Islamic banking and finance success are spiraling oil prices
globally, long boom in middle east economics, innovation of
products and complexity, receptive convention regulators
attitude and advancements in information technology which
have been pushing Islamic finance and banking to expand
globally (Khan & Bhatti, 2008). Provided the growth trends,
there is high probability of Islamic banking winning over a
large percentage of customers from Muslim nations in the
future. The growth in Islamic banking as well as finance is
attributed to “Islamic revival”.
While “mainstream economics” is still dominating the world,
there has been “Islamic revival” in several Islamic nations since
1970s resulting in “Islamic economics” appearance.
Implementation of Islamic economics was viewed as a shift
from colonial rule toward Islam and has established key
transformations in various economic sectors. In the nations
where, Islamic economics ideologies have become famous,
finance services have been offered to comply with Islamic
principles. As a result, new banks have been formed according
to Sharia requirements and there has been a remarked Islamic
banking and finance growth. Islamic banking generally refers to
a banking system which is based on Islamic principles or sharia
and depends on Islamic economics for guidance (Egresi &
Belge, 2017). The key Islamic banking principles are profit and

5. loss sharing and not collecting and paying interest by investors
and lenders. Islamic banks must shun away from transactions
which attract excess risks for example, gambling or transacting
products and services which Islam prohibits. Takaful insurance
also shares ideas with Islamic banking as its foundation is based
on Sharia principles.Takaful definition
Takaful is Arabic terminology which stems from “Kafalah”
meaning guaranteeing one another. Takaful generally implies
mutual assistance. It is focused on ta’awun (mutual assistance
and tabarru’ (donate) whereby the associated is shred among
people in a voluntary manner. Takaful legitimacy is gotten from
the Sunnah and Quran (Maarifa Academy, 2014). This
terminology shares similarity with compensation principles and
shared responsibilities. Takaful or Islamic insuranceimplies an
agreement process among a group of people to deal with injuries
which emanate from certain risks to everybody is vulnerable. A
process is introduced which involves contributions payment as
donations, and resulting in an insurance fund formation which
enjoys legal entity status and has independent finance liability.
This funds resources are meant to indemnify a participant who
is struck by a disaster (Cheikh, 2013). The management of the
funds is by a chosen policy holders or joint stock company
which manages insurance functions and invests fund assets,
against a certain fee.
Takaful is traceable to ancient Arabs as a unified liability which
made offenders to compensate the victim. It later expanded to
varied dimensions inclusive of sea trade to cover any colleague
who was robbed along the way or was befell by a disaster
referred to as marine insurance (Cheikh, 2013). Other traditions
also form takaful origins examples being Kafalah, Diya,
mulawat, Al-Tariq, Hilf, and Ju’hala. Tabarru’ (donation or
contribution) is core of Takaful freeing it from gambling and
uncertainty.
Takaful industry is experiencing quick growth. Takaful
contributions increased by nineteen percent (19%) in 2010 and
were expected to reach twenty-three percent (23%) by 2012.

6. Takaful is not restricted to the Muslim fraternity only. Its
values are one and accepted by all religions (Cheikh, 2013). In
addition, it has in it a profit sharing element which may be good
to growing an investment segment that is ethical. Takaful goal
is to pay a loss that is defined from a fund that is defined.
Takaful refers to the way of bringing economic and social
benefits of contemporary insurance coverage, in a manner
consistent with their religious beliefs, to Muslims, and to
merging economics of several Muslims nations. Therefore,
Takaful development is important, both to social inclusion in
non-Muslim nations, and to economic development in various
nations with emerging economies. Surprisingly, Takaful
industry is experiencing quick growth (Cheikh, 2013). However,
Takaful development encounters barriers because of difficult
structure of understanding Takaful and pending problems
related with it. These problems add to making a proper
regulatory and legal infrastructure development besides finance
reporting, rating, corporate governance among others. Takaful
principles
Takaful concept is based on cooperative principle and on
separation principle between shareholders’ funds and operations
therefore passing Takaful fund ownership and operations to
policy holders. The investment poll’s profits and losses are
shared by policy holders. The policy holders are joint investors
with insurance vendor who acts as the manager (Cheikh, 2013).
Health and family plans now exist for Muslim communities.
Islamic insurance necessitates each participant to make
contribution into a fund which is used for supporting each other
with a participant contributing adequate amounts to cover
anticipated claims.
The basic Takaful principles are mutual indemnity and mutual
contribution and has been exercised for centuries. Takaful has
greatly helped in risk management and risk mitigation basing on
shariah rules. Takaful ideology is to distribute loss among
policy holders or participants instead of transferring to an
insurance company as is exercised in conventional insurance

7. (Cheikh, 2013). The key principles of Takaful are Ta’awun,
Tabarru’, and riba, maysir, or gharar prohibition.
Takaful principles as explained by(Cheikh, 2013) are one must
have a legitimate finance interest in subject matter to take part
in takaful plan, takaful contract is focused on trust principle
whereby all the required material information must be
disclosed, finance loss can only be recovered and not gain in
profit due to quantifiable loss, there is cooperation among
policyholders for common good, takaful operator will find out
the real significant cause which led to the loss in establishing
compensation, each policyholder pays own subscription to assist
those who require help, after compensation for loss the operator
has right to claim from third party who caused the loss, losses
are sub-divided and the liabilities spread as per pooling system,
uncertainty is eradicated with regard to compensation and
subscription, and does not obtain merit at others cost. Takaful
insurance model
Takaful insurance model features mutual concepts of mutual
protection, mutual help, and mutual responsibility as shown by
the below diagram.
Takaful features
Takaful exhibits cooperative risk sharing, sharia compliant
strategies and policies, and clear finance segregation.
Cooperative risk sharing via donation use was meant to cancel
gharar and riba elements in takaful and solve social
responsibility issues, solidarity and need to care for others
(Maarifa Academy, 2014). The premiums paid by the policy
holders are seen as donations to help the members who suffer
loss.
Under strategies and policies, insurance funds investment must
be made on ethical businesses without harming the environment
or people. Ethic considerations cover investments in products or
businesses which do not contradict sharia (Maarifa Academy,
2014). Both end product and process must comply with sharia.
The operators must have a standardized sharia governance
system to see to it compliance with sharia.

8. Under finance segregation, there must be clear segregation
between operators and participants in Islamic law. In addition,
the insurance company role is limited to an operator managing
portfolio and investing the contribution on policyholders’
behalf. In conventional insurance, the insurance companies’
objective is to make profit and agree to bear policy holders
finance burden and losses (Maarifa Academy, 2014). The
shareholders are eligible for profit and bear any deficit burden
at finance year close. Takaful and conventional insurance
Takaful is an Islamic option to conventional insurance where
the funds are contributed by members into a pool based on
ta’awun or mutual help and tabarru’ or donation to share mutual
risks. Conventional insurance approach is based on uncertainty
or gharar, indemnity contract, gambling or maysir, and interest-
based investments involvement or riba (Maarifa Academy,
2014).
Conventional insurance is traced to tenth century10th before
Christ when the first law in relation to public loss was issued in
Rhodes, especially losses from cargo transportation via sea.
Same types of cooperative insurance were evident in china
around 5,000 years back when some families dwelled in houses
that were floating on water. To save a house from drowning, the
families decided to tie together the houses to share risk. Some
communities assisted military members’ family when one of
them died in ancient Rome (Maarifa Academy, 2014). The
community offered vital salaries and money to survivors in
exchange of subscription that each member paid. Insurance
concept spread to Phoenicians then, Lombardians. The pools
were formed and funded by merchants who possessed goods to
minimize losses prone to any merchant. Variations between
Takaful and conventional insurance
The variation between the two insurance are parties to contract,
premiums payments, and insurance funds investment. Takaful
insurance combines tabarru’ contract as well as profit or profit
sharing contract (Maarifa Academy, 2014). Conventional
insurance is exchange contract between insured and insurer.

9. In Takaful, the participant is obliged to contribute to the scheme
and must mutually share the surplus. In conventional insurance,
the participant is obliged to pay premium to insurer (Maarifa
Academy, 2014).
The Takaful operator receives a fee for managing the fund and
from profit-sharing scheme. In conventional, the company
makes profit when there is underwriting surplus. On the other
hand, the counter value is effort and or risk undertaking while
in conventional insurance, there no clear valid counter value
(Maarifa Academy, 2014). Profit source is hoping that uncertain
future will be in insurer’s favor.
Takaful operator poses as fund administrator and attracts
benefits. If fund is inadequate, operator must offer a loan that is
interest free to correct the deficiency (Maarifa Academy, 2014).
Insurer is liable to pay benefits as promised from insurance
funds or shareholders’ funds in conventional insurance.
Indemnification part is focused on mutual contribution while
the indemnification in conventional insurance is a commercial
relation between insured and insurance company (Maarifa
Academy, 2014).
The insured-insurer relationship between participants and
takaful operator is not there in takaful. The participants pose as
insurer and insured at the same time (Maarifa Academy, 2014).
In conventional, there is a clear insured-insurer relationship.
The Takaful funds must be invested in sharia compliant
instruments while there is no restriction in funds investment in
conventional insurance (Maarifa Academy, 2014).Takaful
development
Takaful development in contemporary times was introduced by
Abidin Ibn, an Islamic judge and lawyer who attracted by
insurance concept, with an emphasis on marine insurance as it
common during that period (Maarifa Academy, 2014). In a
similar vein, Muhammed Abduh another great jurist viewed
insurance transaction as same as Mudaraba financing and that
transaction which is same as life insurance or endowment is
legal.

10. The efforts towards the institutionalization of takaful were set
by Sudan in the year 1979 and Malaysia in the year 1984
(Maarifa Academy, 2014). The key role in Takaful development
was by Islamic scholar council declaration in Saudi Arabia and
Majma in 1985 when conventional insurance was declared
forbidden and only the insurance based on sharia was
permissible.Takaful milestones
Takaful development is in a span of six years.
· The resolution on takaful as cooperative insurance by Saudi
scholars took place in 1977.
· A breakthrough was in 1979 when an Islamic insurance
company in Sudan.
· In 1980, an Islamic Arab company was formed in the United
Arab Emirates and in Saudi Arabia.
· The fist law in takaful was formed in 1984 in Malaysia.
· OIC academy approved takaful system in 1985 but left the
work to the scholars (Maarifa Academy, 2014).
The contributions in the takaful industry were expected to hit
twenty-five billion dollars in 2015. The growth is approximately
ten to twenty percent annually (Maarifa Academy, 2014). The
takaful market attained nineteen billion dollars in 2017 and the
market is forecasted to exceed forty billion dollars by 2023.
Takaful models
The key parties of takaful system are takaful operator and
participants. The models examples consist of Mudarabah,
Wakalah, Wakalah / Mudarabah hybrid, and wakalah with Waqf.
Mudarabah model
This model is based on the trust partnership between takaful
operator appointed by participants to manage takaful business.
The funds contributed are participants risk fund and
participants’ investment fund. The participants provide capital
and own takaful undertaking. The operator is regarded
participants’ business partner in investor to entrepreneur
relationship under mudarabah contract (Maarifa Academy,
2014). The profit distributing ratios are predetermined. The

11. participants bear finance loss while operator may lose
managerial efforts.
Wakalah model
Wakalah model is based on agency contract between takaful
participants and operators where the participants own the fund
while the operators pose as agent. The operator qualifies for
agency fee for rendering the services. The fee must be clearly
stated and specified in the contract. Agency fee must cover
management expenses, distribution costs inclusive of
intermediaries’ remuneration. Any surplus from investing the
funds is diverted to participants (Maarifa Academy, 2014).
Operator only receives agency fee focused on takaful model
nature. The operator does not share risk in fund investment or
management.
Wakalah / Mudarabah hybrid
The model is a mixture of wakalah and mudarabah. The wakalah
is used for underwriting while mudarabah is used for
investments. The multi-tasking of the operator makes this model
distinct. Takaful operator qualifies for agency fee for agent
role. Moreover, the operator is qualified to a share in profits
realized for the management of investment activities as
entrepreneur (Maarifa Academy, 2014). The income sources of
the operator are agency fee, profit share from funds investment,
and incentive fee. A significant element of this model is clear
segregation between participants’ funds and shareholders’
funds.
wakalah with Waqf
In this model, the shareholder donates to common pool, forming

12. waqf fund. The company becomes shareholders’ agent and is
responsible for waqf funds management, paying mandatory
claims. The company receives an agreed fee for posing as
shareholders’ agents (Maarifa Academy, 2014). The company
further manages such waqf funds’ investments as an
entrepreneur, thus eligible to share in profit investment.
Takaful products
The two common Takaful businesses are general and family
Takaful.Family Takaful
A family Takaful refers to savings and investment program
which are long-term and have a fixed period of maturity. The
plan enjoys investment profit and offers mutual finance help
among participants. This Takaful is a finance program which
unites efforts to assist one in times of need because of sudden
death among other events which lead to disablement or injury
(Cheikh, 2013). Takaful plans would allow participation in a
Takaful scheme with the objectives of saving regular, invest
with a desire of making profit, and avail cover in terms of
benefits to the successors in case a participant pass on before
maturity.
The examples of Takaful plans which can be invested in are
family Takaful mortgage plan, family Takaful plan for
education, group hospitalization and medical benefit, and group
family Takaful plan. family takaful is the same as life insurance
(Cheikh, 2013). Other examples are accidental death, retirement
plans, savings and education plans, Waaqf plans, and disability
(Maarifa Academy, 2014).
Family takaful types
Family takaful consists of ordinary collaboration, collaboration
focused on certain groups, and collaboration with savings. In
ordinary collaboration, the participants agree to contribute
funds via donations. The premiums are used for the
underwriting activities in case of a disaster for a member
(Maarifa Academy, 2014). The payment is made directly to

13. participant or beneficiaries according to takaful contract.
Collaboration focused on certain groups reflects ethnic,
organization, or community needs. The participants from similar
community assemble to form a common funds pool for a certain
objective. The membership is restricted to who stem from
similar group (Maarifa Academy, 2014). Contributions may be
made jointly by participants and the organization. The benefits
can be enjoyed by beneficiaries or participants. General Takaful
General Takaful schemes refer to joint guarantee contracts on
short-term among participants to offer mutual compensation in
case of loss (Cheikh, 2013). The schemes are meant to fulfill
needs for individuals and organizations protection with respect
to material loss or damage as a result of a catastrophe. This
scheme is renewable annually.
General Takaful means Islamic concept where the participant
contributes money to a fund in terms of participative
contribution. The person enters into contract to become among
the participants by agreeing to mutually assist one another in
case a participant suffers a misfortune due to death, loss,
damage, or permanent disability (Maarifa Academy, 2014).
This product is the same as general insurance.
Contributions gathered from policyholders are seen as donations
and form Takaful fund from which all the claims are reimbursed
(Cheikh, 2013). At year close, after deducting the expenses, any
cash surplus that remains will not be retained but will be
released to policy holders under cash dividends.
Examples of disasters covered by general takaful are motor,
fire, employer liability, fire consequential loss, theft, workmen
compensation, machinery breakdown, and health (Maarifa
Academy, 2014). Retakaful and reinsurance
Retakaful is an option to reinsurance. It refers to takaful
business reinsurance on Islamic rules. It is an insurance where
an insurance company has the ability to transfer to another
insurer part or all of its liabilities against agreed portion from
insurance contribution, this allows insurance company to
safeguard itself against insolvency risk. Retakaful bases on

14. direct insurance companies’ inability to insure the properties
whose finance value is high for example, large factories’ and
big stores (Maarifa Academy, 2014). Second, to increase direct
insurance companies’ capacity in the section of accepting risk
to improve their gains.
In conventional insurance, the insurance operators share risks
collectively. The large insurance companies underwrite small
insurance companies’ risks. Reinsurance is a way of mitigating
such high risks by transferring risks to a reinsurer. Retakaful is
based on Sharia. Risk aversion is structured in a manner where
the takaful operators are participants in undertaking with a large
company. An amount that is agreed is paid periodically from
operators’ fund as premiums to Retakaful company (Maarifa
Academy, 2014). All underwriting risks of takaful operators are
insured by Retakaful company.
Conclusion and recommendations
Takaful generally implies mutual assistance. It is based on
mutual responsibility, mutual help, and mutual protection. The
concept encourages participants to contribute funds to a takaful
system the funds, which are then, used to help a member in case
of a loss. The participant choose a takaful operator to oversee
the funds. The operator is paid an agency fee for the service
rendered. Takaful concept originated from Kafalah among other

15. traditions such as Diya, mulawat, Al-Tariq, Hilf, and Ju’hala.
Takaful legitimacy is gotten from the Sunnah and Quran.
Takaful exhibits cooperative risk sharing, sharia compliant
strategies and policies, and clear finance segregation. From the
discussion, it is evident that takaful is different from
conventional insurance. Conventional insurance is based on
uncertainty or gharar, indemnity contract, gambling or maysir,
and interest-based investments involvement or riba which are
not accepted by Takaful. The model’s examples consist of
Mudarabah, Wakalah, Wakalah / Mudarabah hybrid, and
wakalah with Waqf. The types of takaful insurance that a person
can join are geeral and family takaful. The recommendations are
to choose Takaful over conventional insurance. Takaful is based
on Sharia with regards to Sunnah and Quran and prohibits
gharar, indemnity contract, maysir, and riba. Moreover, Takaful
industry is experiencing quick growth. The takaful market
attained nineteen billion dollars in 2017 and the market is
forecasted to exceed forty billion dollars by 2023. Takaful is
also not restricted to the Muslim fraternity only. Its values are
one and accepted by all religions. In addition, it has in it a
profit sharing element which may be good to growing an
investment segment that is ethical.
References
Cheikh, B. (2013). Abstract to Islamic insurance (Takaful).
Insurance and Risk management, 81(3-4), 291-304.
Egresi, I., & Belge, R. (2017). Islamic banking in Turkey:
Population perception and development challenges. GeoJournal
of Tourism & Geosites, 19(1), 30-55.
Khan, M., & Bhatti, I. (2008). Islamic banking and finance: On
its way to globalization. Managerial Finance, 34(10), 708-725.
Maarifa Academy. (2014). Islamic banking & finance:
Principles and practices. Retrieved from
https://islamicbankers.files.wordpress.com/.../marifas-practical-
guide-to-islamic-banki...

16. Crane/ENGWR 302
The Mander Paper
It’s now time to focus on your second research paper, aka the
Mander Paper. This paper will examine in detail one of the four
arguments in Mander.
Choose your argument. Each of Mander’s four arguments is
quite different. Choose an argument based on your interests and
strengths. Below is a capsulization of each argument and some
of its 21st century implications or connections.
Argument One: Reality reexamined. This delves into
psychological realms, primarily. Consider the extent to which
we struggle with reality in today’s society. Consider photo-
shop, reality television, fake news, etc.
Argument Two: Corporations, advertising, television, and our
experience. This delves into political science, economics, and to
a lesser extent, psychology. How does corporate control present
itself in cyberspace? In mainstream contemporary society?
Argument Three: The physical ramifications of watching
television. This delves into biology, physiology, physics, and
other sciences. How do contemporary devices such as phones
and computers impact our bodies and our health?
Argument Four: The biases in media. This delves into
economics, political science, and psychology. How are biases
reflected in today’s media? What is the importance of “net
neutrality”?
Your paper will include a detailed look at your argument of
choice. This look should include definitions of all key terms, an
effective summary of the argument, and both an Aristotilian and

17. Toulminian analysis of the argument.
Your paper will also include a detailed look at an aspect of 21st
century technology or lifestyle—something that did not exist
when Mander wrote Four Arguments. You will apply Mander’s
argument and logic to this 21st century aspect of reality. Does
Mander’s argument still apply? Why or why not? Would Mander
be concerned with humankind’s interaction with this 21st
century aspect of reality? Why or why not?
Your paper should be between 5-8 pages long. Include at least 6
sources (Mander counts), at least 2 peer reviewed. Your paper
should be impeccably formatted to 8th edition MLA standards.
Major errors in MLA format will result in a 10% reduction of
your grade. There is a detailed rubric for this assignment
attached to the assignment link in our classroom.
Running head: ISLAMIC BANKING AND FINANCE 1
ISLAMIC BANKING AND FINANCE 22
Islamic Banking and Finance
Tuleen Basrawi
1310186
BNFN 4302

18. Instructor: Mr. Masood Aijazi
Thursday, December 6, 2018
Abstract
Everybody values own properties and life. This value inspires
protection from loss and to avoid risks by all ways and
measures. The examples of events which people are vulnerable
to are theft, accidents, deaths, hurricanes, and fire. Insurance
was therefore, invented to indemnify a member from a loss.
Insurance is a not a new concept per se. The ancient Arabic
trade caravans would contribute funds to help a member from
loss due to robberies or any disaster on their way to Asia. The
Chinese are also great insurance icons. 5000 years ago, Chinese
families tied together houses to prevent drowning and to share
risks as their houses were on floating water. In ancient Rome,
the survivors of a military member who died were compensated
by being offered some money as assistance. The other pioneers
of insurance are Rhodes who formed the first law on loss in
relation to cargo transportation via sea, the Phoenicians, and
Lombardians. Insurance is therefore, a tool that helps to control
such risks. Modern insurance is traced to 1977 when
academicians from Saudi Arabia tried to resolve takaful as
cooperative insurance, leading to the formation of the first
insurance company in 1979. Generally, Islam allows risk
management concept. However, it enhances risk management
under certain conditions such as not making profit at others
expenses. The initiatives to solve risk problem in ways that
comply with sharia have led to Takaful emergence. In this
perceptive, the purpose of this research paper is to tackle the
concept of Takaful insurance. It is an interesting topic worth
studying in that its formation reflects Islam religion. Islamic
banking and finance will first be looked into before narrowing
down to takaful insurance. Islamic banking sets the foundation
for Takaful insurance.

19. Table of Contents
Abstract 2
Introduction 4
Islamic banking and finance overview 4
Takaful definition 5
Takaful principles 7
Takaful insurance model 8
Takaful features 9
Takaful and conventional insurance 9
Variations between Takaful and conventional insurance 10
Takaful development 11
Takaful milestones 12
Takaful models12
Mudarabah model 12
Wakalah model13
Wakalah / Mudarabah hybrid 15
wakalah with Waqf 17
Takaful products 18
Family Takaful 18
Family takaful types19
General Takaful 19
Retakaful and reinsurance 20
Conclusion and recommendations 21
References 23
Introduction
It is obvious that human activities are prone to loss risk from
unexpected circumstances. Insurance has been there for several
years back to indemnify the individuals from losses. Insurance
concept has been exercised in different places for several years.

20. During those days, trade caravans who encountered risks were
the same as those faced presently in trading activities were
there. The Muslim academicians recognize that shared
reasonability basis in Al aagilah system as exercised between
Madinah and Makkah Muslims laid mutual insurance
foundation. It encompassed contributions from the members to
share responsibility to indemnify victims against finance
liability from events. Prophet Muhammad accepted that system
under mutual protection principle and cooperation in good deeds
and virtue. Shared responsibility in “Aquila” system as
exercised between the Muslims of Medina and Mecca therefore,
laid mutual insurance foundation. Islamic insurance was formed
in the early Islamic century second era when the Muslim Arab
traders who expanded into Asia agreed to make contributions to
a fund to cover any colleague who was robbed along the way or
was befell by a disaster referred to as marine insurance. In this
perspective, this research paper aims to analyze takaful
insurance in-depth (Cheikh, 2013). The first section will define
takaful insurance, origin of the concept, takaful principles,
features, models, takaful development, difference between
takaful and conventional insurance, takaful products, Retakaful
and reinsurance, and lastly conclusion and
recommendations.Islamic banking and finance overview
Islamic banking has been making stellar improvements to
become a competitive and feasible option to conventional
systems globally. Islamic banking inclusive of finance
institutions have garnered footholds in south East Asia and
Middle East. These hubs have been playing a great role about
raising the awareness of Islamic banking in Western finance
markets and businesses. The elements which have contributed to
Islamic banking and finance success are spiraling oil prices
globally, long boom in middle east economics, innovation of
products and complexity, receptive convention regulators
attitude and advancements in information technology which
have been pushing Islamic finance and banking to expand
globally (Khan & Bhatti, 2008). Provided the growth trends,

21. there is high probability of Islamic banking winning over a
large percentage of customers from Muslim nations in the
future. The growth in Islamic banking as well as finance is
attributed to “Islamic revival”.
While “mainstream economics” is still dominating the world,
there has been “Islamic revival” in several Islamic nations since
1970s resulting in “Islamic economics” appearance.
Implementation of Islamic economics was viewed as a shift
from colonial rule toward Islam and has established key
transformations in various economic sectors. In the nations
where, Islamic economics ideologies have become famous,
finance services have been offered to comply with Islamic
principles. As a result, new banks have been formed according
to Sharia requirements and there has been a remarked Islamic
banking and finance growth. Islamic banking generally refers to
a banking system which is based on Islamic principles or sharia
and depends on Islamic economics for guidance (Egresi &
Belge, 2017). The key Islamic banking principles are profit and
loss sharing and not collecting and paying interest by investors
and lenders. Islamic banks must shun away from transactions
which attract excess risks for example, gambling or transacting
products and services which Islam prohibits. Takaful insurance
also shares ideas with Islamic banking as its foundation is based
on Sharia principles.Takaful definition
Takaful is Arabic terminology which stems from “Kafalah”
meaning guaranteeing one another. Takaful generally implies
mutual assistance. It is focused on ta’awun (mutual assistance
and tabarru’ (donate) whereby the associated is shred among
people in a voluntary manner. Takaful legitimacy is gotten from
the Sunnah and Quran (Maarifa Academy, 2014). This
terminology shares similarity with compensation principles and
shared responsibilities. Takaful or Islamic insuranceimplies an
agreement process among a group of people to deal with injuries
which emanate from certain risks to everybody is vulnerable. A
process is introduced which involves contributions payment as
donations, and resulting in an insurance fund formation which

22. enjoys legal entity status and has independent finance liability.
This funds resources are meant to indemnify a participant who
is struck by a disaster (Cheikh, 2013). The management of the
funds is by a chosen policy holders or joint stock company
which manages insurance functions and invests fund assets,
against a certain fee.
Takaful is traceable to ancient Arabs as a unified liability which
made offenders to compensate the victim. It later expanded to
varied dimensions inclusive of sea trade to cover any colleague
who was robbed along the way or was befell by a disaster
referred to as marine insurance (Cheikh, 2013). Other traditions
also form takaful origins examples being Kafalah, Diya,
mulawat, Al-Tariq, Hilf, and Ju’hala. Tabarru’ (donation or
contribution) is core of Takaful freeing it from gambling and
uncertainty.
Takaful industry is experiencing quick growth. Takaful
contributions increased by nineteen percent (19%) in 2010 and
were expected to reach twenty-three percent (23%) by 2012.
Takaful is not restricted to the Muslim fraternity only. Its
values are one and accepted by all religions (Cheikh, 2013). In
addition, it has in it a profit sharing element which may be good
to growing an investment segment that is ethical. Takaful goal
is to pay a loss that is defined from a fund that is defined.
Takaful refers to the way of bringing economic and social
benefits of contemporary insurance coverage, in a manner
consistent with their religious beliefs, to Muslims, and to
merging economics of several Muslims nations. Therefore,
Takaful development is important, both to social inclusion in
non-Muslim nations, and to economic development in various
nations with emerging economies. Surprisingly, Takaful
industry is experiencing quick growth (Cheikh, 2013). However,
Takaful development encounters barriers because of difficult
structure of understanding Takaful and pending problems
related with it. These problems add to making a proper
regulatory and legal infrastructure development besides finance
reporting, rating, corporate governance among others. Takaful

23. principles
Takaful concept is based on cooperative principle and on
separation principle between shareholders’ funds and operations
therefore passing Takaful fund ownership and operations to
policy holders. The investment poll’s profits and losses are
shared by policy holders. The policy holders are joint investors
with insurance vendor who acts as the manager (Cheikh, 2013).
Health and family plans now exist for Muslim communities.
Islamic insurance necessitates each participant to make
contribution into a fund which is used for supporting each other
with a participant contributing adequate amounts to cover
anticipated claims.
The basic Takaful principles are mutual indemnity and mutual
contribution and has been exercised for centuries. Takaful has
greatly helped in risk management and risk mitigation basing on
shariah rules. Takaful ideology is to distribute loss among
policy holders or participants instead of transferring to an
insurance company as is exercised in conventional insurance
(Cheikh, 2013). The key principles of Takaful are Ta’awun,
Tabarru’, and riba, maysir, or gharar prohibition.
Takaful principles as explained by(Cheikh, 2013) are one must
have a legitimate finance interest in subject matter to take part
in takaful plan, takaful contract is focused on trust principle
whereby all the required material information must be
disclosed, finance loss can only be recovered and not gain in
profit due to quantifiable loss, there is cooperation among
policyholders for common good, takaful operator will find out
the real significant cause which led to the loss in establishing
compensation, each policyholder pays own subscription to assist
those who require help, after compensation for loss the operator
has right to claim from third party who caused the loss, losses
are sub-divided and the liabilities spread as per pooling system,
uncertainty is eradicated with regard to compensation and
subscription, and does not obtain merit at others cost. Takaful
insurance model
Takaful insurance model features mutual concepts of mutual

24. protection, mutual help, and mutual responsibility as shown by
the below diagram.
Takaful features
Takaful exhibits cooperative risk sharing, sharia compliant
strategies and policies, and clear finance segregation.
Cooperative risk sharing via donation use was meant to cancel
gharar and riba elements in takaful and solve social
responsibility issues, solidarity and need to care for others
(Maarifa Academy, 2014). The premiums paid by the policy
holders are seen as donations to help the members who suffer
loss.
Under strategies and policies, insurance funds investment must
be made on ethical businesses without harming the environment
or people. Ethic considerations cover investments in products or
businesses which do not contradict sharia (Maarifa Academy,
2014). Both end product and process must comply with sharia.
The operators must have a standardized sharia governance
system to see to it compliance with sharia.
Under finance segregation, there must be clear segregation
between operators and participants in Islamic law. In addition,
the insurance company role is limited to an operator managing
portfolio and investing the contribution on policyholders’
behalf. In conventional insurance, the insurance companies’
objective is to make profit and agree to bear policy holders
finance burden and losses (Maarifa Academy, 2014). The
shareholders are eligible for profit and bear any deficit burden
at finance year close. Takaful and conventional insurance
Takaful is an Islamic option to conventional insurance where
the funds are contributed by members into a pool based on
ta’awun or mutual help and tabarru’ or donation to share mutual
risks. Conventional insurance approach is based on uncertainty
or gharar, indemnity contract, gambling or maysir, and interest-
based investments involvement or riba (Maarifa Academy,
2014).
Conventional insurance is traced to tenth century10th before
Christ when the first law in relation to public loss was issued in

25. Rhodes, especially losses from cargo transportation via sea.
Same types of cooperative insurance were evident in china
around 5,000 years back when some families dwelled in houses
that were floating on water. To save a house from drowning, the
families decided to tie together the houses to share risk. Some
communities assisted military members’ family when one of
them died in ancient Rome (Maarifa Academy, 2014). The
community offered vital salaries and money to survivors in
exchange of subscription that each member paid. Insurance
concept spread to Phoenicians then, Lombardians. The pools
were formed and funded by merchants who possessed goods to
minimize losses prone to any merchant. Variations between
Takaful and conventional insurance
The variation between the two insurance are parties to contract,
premiums payments, and insurance funds investment. Takaful
insurance combines tabarru’ contract as well as profit or profit
sharing contract (Maarifa Academy, 2014). Conventional
insurance is exchange contract between insured and insurer.
In Takaful, the participant is obliged to contribute to the scheme
and must mutually share the surplus. In conventional insurance,
the participant is obliged to pay premium to insurer (Maarifa
Academy, 2014).
The Takaful operator receives a fee for managing the fund and
from profit-sharing scheme. In conventional, the company
makes profit when there is underwriting surplus. On the other
hand, the counter value is effort and or risk undertaking while
in conventional insurance, there no clear valid counter value
(Maarifa Academy, 2014). Profit source is hoping that uncertain
future will be in insurer’s favor.
Takaful operator poses as fund administrator and attracts
benefits. If fund is inadequate, operator must offer a loan that is
interest free to correct the deficiency (Maarifa Academy, 2014).
Insurer is liable to pay benefits as promised from insurance
funds or shareholders’ funds in conventional insurance.
Indemnification part is focused on mutual contribution while
the indemnification in conventional insurance is a commercial

26. relation between insured and insurance company (Maarifa
Academy, 2014).
The insured-insurer relationship between participants and
takaful operator is not there in takaful. The participants pose as
insurer and insured at the same time (Maarifa Academy, 2014).
In conventional, there is a clear insured-insurer relationship.
The Takaful funds must be invested in sharia compliant
instruments while there is no restriction in funds investment in
conventional insurance (Maarifa Academy, 2014).Takaful
development
Takaful development in contemporary times was introduced by
Abidin Ibn, an Islamic judge and lawyer who attracted by
insurance concept, with an emphasis on marine insurance as it
common during that period (Maarifa Academy, 2014). In a
similar vein, Muhammed Abduh another great jurist viewed
insurance transaction as same as Mudaraba financing and that
transaction which is same as life insurance or endowment is
legal.
The efforts towards the institutionalization of takaful were set
by Sudan in the year 1979 and Malaysia in the year 1984
(Maarifa Academy, 2014). The key role in Takaful development
was by Islamic scholar council declaration in Saudi Arabia and
Majma in 1985 when conventional insurance was declared
forbidden and only the insurance based on sharia was
permissible.Takaful milestones
Takaful development is in a span of six years.
· The resolution on takaful as cooperative insurance by Saudi
scholars took place in 1977.
· A breakthrough was in 1979 when an Islamic insurance
company in Sudan.
· In 1980, an Islamic Arab company was formed in the United
Arab Emirates and in Saudi Arabia.
· The fist law in takaful was formed in 1984 in Malaysia.
· OIC academy approved takaful system in 1985 but left the
work to the scholars (Maarifa Academy, 2014).
The contributions in the takaful industry were expected to hit

27. twenty-five billion dollars in 2015. The growth is approximately
ten to twenty percent annually (Maarifa Academy, 2014). The
takaful market attained nineteen billion dollars in 2017 and the
market is forecasted to exceed forty billion dollars by 2023.
Takaful models
The key parties of takaful system are takaful operator and
participants. The models examples consist of Mudarabah,
Wakalah, Wakalah / Mudarabah hybrid, and wakalah with Waqf.
Mudarabah model
This model is based on the trust partnership between takaful
operator appointed by participants to manage takaful business.
The funds contributed are participants risk fund and
participants’ investment fund. The participants provide capital
and own takaful undertaking. The operator is regarded
participants’ business partner in investor to entrepreneur
relationship under mudarabah contract (Maarifa Academy,
2014). The profit distributing ratios are predetermined. The
participants bear finance loss while operator may lose
managerial efforts.
Wakalah model
Wakalah model is based on agency contract between takaful
participants and operators where the participants own the fund
while the operators pose as agent. The operator qualifies for
agency fee for rendering the services. The fee must be clearly
stated and specified in the contract. Agency fee must cover
management expenses, distribution costs inclusive of
intermediaries’ remuneration. Any surplus from investing the
funds is diverted to participants (Maarifa Academy, 2014).
Operator only receives agency fee focused on takaful model
nature. The operator does not share risk in fund investment or
management.

28. Wakalah / Mudarabah hybrid
The model is a mixture of wakalah and mudarabah. The wakalah
is used for underwriting while mudarabah is used for
investments. The multi-tasking of the operator makes this model
distinct. Takaful operator qualifies for agency fee for agent
role. Moreover, the operator is qualified to a share in profits
realized for the management of investment activities as
entrepreneur (Maarifa Academy, 2014). The income sources of
the operator are agency fee, profit share from funds investment,
and incentive fee. A significant element of this model is clear
segregation between participants’ funds and shareholders’
funds.
wakalah with Waqf
In this model, the shareholder donates to common pool, forming
waqf fund. The company becomes shareholders’ agent and is
responsible for waqf funds management, paying mandatory
claims. The company receives an agreed fee for posing as
shareholders’ agents (Maarifa Academy, 2014). The company
further manages such waqf funds’ investments as an
entrepreneur, thus eligible to share in profit investment.
Takaful products
The two common Takaful businesses are general and family
Takaful.Family Takaful
A family Takaful refers to savings and investment program
which are long-term and have a fixed period of maturity. The
plan enjoys investment profit and offers mutual finance help
among participants. This Takaful is a finance program which
unites efforts to assist one in times of need because of sudden
death among other events which lead to disablement or injury
(Cheikh, 2013). Takaful plans would allow participation in a
Takaful scheme with the objectives of saving regular, invest
with a desire of making profit, and avail cover in terms of

29. benefits to the successors in case a participant pass on before
maturity.
The examples of Takaful plans which can be invested in are
family Takaful mortgage plan, family Takaful plan for
education, group hospitalization and medical benefit, and group
family Takaful plan. family takaful is the same as life insurance
(Cheikh, 2013). Other examples are accidental death, retirement
plans, savings and education plans, Waaqf plans, and disability
(Maarifa Academy, 2014).
Family takaful types
Family takaful consists of ordinary collaboration, collaboration
focused on certain groups, and collaboration with savings. In
ordinary collaboration, the participants agree to contribute
funds via donations. The premiums are used for the
underwriting activities in case of a disaster for a member
(Maarifa Academy, 2014). The payment is made directly to
participant or beneficiaries according to takaful contract.
Collaboration focused on certain groups reflects ethnic,
organization, or community needs. The participants from similar
community assemble to form a common funds pool for a certain
objective. The membership is restricted to who stem from
similar group (Maarifa Academy, 2014). Contributions may be
made jointly by participants and the organization. The benefits
can be enjoyed by beneficiaries or participants. General Takaful
General Takaful schemes refer to joint guarantee contracts on
short-term among participants to offer mutual compensation in
case of loss (Cheikh, 2013). The schemes are meant to fulfill
needs for individuals and organizations protection with respect
to material loss or damage as a result of a catastrophe. This
scheme is renewable annually.
General Takaful means Islamic concept where the participant
contributes money to a fund in terms of participative
contribution. The person enters into contract to become among
the participants by agreeing to mutually assist one another in

30. case a participant suffers a misfortune due to death, loss,
damage, or permanent disability (Maarifa Academy, 2014).
This product is the same as general insurance.
Contributions gathered from policyholders are seen as donations
and form Takaful fund from which all the claims are reimbursed
(Cheikh, 2013). At year close, after deducting the expenses, any
cash surplus that remains will not be retained but will be
released to policy holders under cash dividends.
Examples of disasters covered by general takaful are motor,
fire, employer liability, fire consequential loss, theft, workmen
compensation, machinery breakdown, and health (Maarifa
Academy, 2014). Retakaful and reinsurance
Retakaful is an option to reinsurance. It refers to takaful
business reinsurance on Islamic rules. It is an insurance where
an insurance company has the ability to transfer to another
insurer part or all of its liabilities against agreed portion from
insurance contribution, this allows insurance company to
safeguard itself against insolvency risk. Retakaful bases on
direct insurance companies’ inability to insure the properties
whose finance value is high for example, large factories’ and
big stores (Maarifa Academy, 2014). Second, to increase direct
insurance companies’ capacity in the section of accepting risk
to improve their gains.
In conventional insurance, the insurance operators share risks
collectively. The large insurance companies underwrite small
insurance companies’ risks. Reinsurance is a way of mitigating
such high risks by transferring risks to a reinsurer. Retakaful is
based on Sharia. Risk aversion is structured in a manner where
the takaful operators are participants in undertaking with a large
company. An amount that is agreed is paid periodically from
operators’ fund as premiums to Retakaful company (Maarifa
Academy, 2014). All underwriting risks of takaful operators are
insured by Retakaful company.

31. Conclusion and recommendations
Takaful generally implies mutual assistance. It is based on
mutual responsibility, mutual help, and mutual protection. The
concept encourages participants to contribute funds to a takaful
system the funds, which are then, used to help a member in case
of a loss. The participant choose a takaful operator to oversee
the funds. The operator is paid an agency fee for the service
rendered. Takaful concept originated from Kafalah among other
traditions such as Diya, mulawat, Al-Tariq, Hilf, and Ju’hala.
Takaful legitimacy is gotten from the Sunnah and Quran.
Takaful exhibits cooperative risk sharing, sharia compliant
strategies and policies, and clear finance segregation. From the
discussion, it is evident that takaful is different from
conventional insurance. Conventional insurance is based on
uncertainty or gharar, indemnity contract, gambling or maysir,
and interest-based investments involvement or riba which are
not accepted by Takaful. The model’s examples consist of
Mudarabah, Wakalah, Wakalah / Mudarabah hybrid, and
wakalah with Waqf. The types of takaful insurance that a person
can join are geeral and family takaful. The recommendations are
to choose Takaful over conventional insurance. Takaful is based
on Sharia with regards to Sunnah and Quran and prohibits
gharar, indemnity contract, maysir, and riba. Moreover, Takaful
industry is experiencing quick growth. The takaful market
attained nineteen billion dollars in 2017 and the market is
forecasted to exceed forty billion dollars by 2023. Takaful is

32. also not restricted to the Muslim fraternity only. Its values are
one and accepted by all religions. In addition, it has in it a
profit sharing element which may be good to growing an
investment segment that is ethical.
References
Cheikh, B. (2013). Abstract to Islamic insurance (Takaful).
Insurance and Risk management, 81(3-4), 291-304.
Egresi, I., & Belge, R. (2017). Islamic banking in Turkey:
Population perception and development challenges. GeoJournal
of Tourism & Geosites, 19(1), 30-55.
Khan, M., & Bhatti, I. (2008). Islamic banking and finance: On
its way to globalization. Managerial Finance, 34(10), 708-725.
Maarifa Academy. (2014). Islamic banking & finance:
Principles and practices. Retrieved from
https://islamicbankers.files.wordpress.com/.../marifas-practical-
guide-to-islamic-banki...
Running Head: Risk Management In Islamic Banking and
Finance
Risk Management In Islamic Banking and Finance
2
RISK MANAGEMENT IN ISLAMIC BANKING AND
FINANCE

33. Islamic Banking and Finance
BNFN 4302
Instructor: Mr. Masood Aijazi
29th April, 2018
Halah Bahanshal-1510635
Yusra Bashanfar-1410057
Abstract
Islamic Financial industry has shown tremendous growth over
the past decade but the management of risk is still an
unresolved issue amongst practitioners in this industry.
Therefore, professional risk management has increasingly
gained importance in the context of Islamic financial
institutions, in their attempts to adapt to the challenges and
issues brought about by globalization. The research is an
attempt to examine an overview of Risk: What is Risk? It’s
meaning in Islam and the different categories of risks. It also
attempted to determine specific and general risks faced by
financial institutions including Equity Investment Risk, Market
Risk, Liquidity Risk, Leased Asset Value Risk, Fiduciary risk
and displaced commercial risk. Further, a proposed risk
management process is reviewed in this paper to assist Islamic
financial institutions in the avoidance and eliminations of risks.
The paper attempts at having a continuous elaboration on the
risk management and mitigation techniques that are available in
Islamic finance currently with reference to many previous
researches conducted in this area.

34. Contents
Abstract 1
Introduction 2
The Meaning of Risk 3
Types of Risks 4
Equity Investment Risk 4
Market Risk 4
Mark-up Risk 4
Price Risk 5
Liquidity Risk 5
Credit Risk 5
Operational Risk 6
Legal risk 6
Leased Asset Value Risk 6
Fiduciary risk 7
Displaced commercial risk 7
Risk Management and Mitigation Techniques 10
Collateral 10
Guarantees 10
Loan Loss Reserve 11
Risk adjusted rate of return (RAROC) 12
Value at Risk (VaR) 12
Derivatives 13
Forwards 13
Islamic Swaps 15
Options 17
Conclusion and Recommendation 18
References 20

35. Introduction
Islamic banks were established under diverse social and
economic environments. It first started in Egypt as a small trial
rural banking, and now it reached to a level spreading both
locally and internationally that is committed to offering a wide
range of Islamic banking practices and services. Because of the
their operational success and its appeal to many Muslims as an
alternative to conventional practices as well; Islamic banking
showed a trend of spreading from east to west, from Indonesia
and Malaysia towards Europe and America; However, according
to Swartz (2013) “Islamic financial markets are, however, still
in the infant stage of development. More work is needed in
order to better account, for example, for liquidity risk exposure,
and Islamic banks still have to face other challenges”.
Islamic Banking industry is somewhat new, the integrated risks
Islamic banks face are of two types. First, the risks that are
similar to those faced by conventional counterparties. Second,
risks that are unique to Islamic banks which require their
compliance with Shariah. Thus, Risk management in Islamic
banks shows a difference from their conventional counterparties
because some of the mitigation techniques are unlawful
according to Shariah (Khan & Ahmed, n,d). In this paper, the
meaning of risk is first discussed, followed by a brief
explanation for the types of risks faced by Islamic financial
institutions. Secondly, Risk Management process is discussed
and elaborated more. The third section talks about the risk
management and mitigation techniques: including Risk Adjusted
Rate of Return, Value at Risk, and the use of derivatives.
Towards the end, the authors summed up the paper and gave the
recommendation needed. The Meaning of Risk
When it comes to discussing Risk, it is worthwhile to clear up
the meaning of the two terms: risk and gharar (uncertainty). As
visible to many, no clear differences exist between the two
terms, and some express gharar as risk. However, the best term
in Arabic that describes Risk is khatar. According to Swartz

36. (2013), “Risk refers to the events that can be associated with
given probability while uncertainty refers to the events for
which probability assessment is not possible” p. 3800. By
considering the technical meaning of gharar, we can recognize
that there is a slight difference between these two: risk and
gharar. Ibn Taymiyyah (728H-1328G) defined risk (khatar) as
follows: “Risk falls into two categories: commercial risk, where
one would buy a commodity in order to sell it for profit, and
rely on Allah for that. This risk is necessary for merchants …
and although one might lose sometimes this is the nature of
trade. The other type of risk is that of gambling, which implies
eating people’s wealth for nothing. This is the type that Allah
and His Messenger (PBUH) have prohibited.” The exact
meaning of gharar is danger, deception, illusion, and conceit
that is derived from the Arabic verb gharra, which means to
deceive, to delude, and to mislead. Gharar is the thing that is
prohibited in Islam but however Risk is not; because if so every
commercial transaction will be unlawful in the eyes of Islam.
Thus, Risk is different from gharar.
There are many reasons behind why Risk exists in any
transaction. Reasons vary from being natural such as volcanoes,
earthquakes to being a man-made such as market factors, theft
among others. Thus, the contract is not considered invalid if
risk exists alone, because the existence of all of these risks is
unavoidable in everyday transactions. However, if an element of
gharar exists in any transaction the contract is deemed invalid.
At the end, Risk is an element that is difficult to be controlled
or avoided while gharar is within peoples control and it can be
avoided (Swartz, 2012).Types of Risks
Islamic banking and finance needs to create value for their
participants and clients, and to create this value senior
management must consider the risks that they usually face.
After that they need to maintain, control, and manage these
risks to reduce it and reach at the lowest possible risk.Equity
Investment Risk
Equity Investment is the investment of participants’ surplus

37. funds through buying and holding shares in either a listed
company in the stock exchange or unlisted company (Joint
venture or start up). These instruments usually use mudarabah
and musharakah contracts, as they are the most used in Islamic
finance as an equity- based contracts. These financial
instruments are joint venture in case of mudarabah contract
which includes a capital provider (rab al-mal) and entrepreneur
(mudarib), and joint venture in both capital and management in
the murabaha contract. The participants buy shares from a firm
in expectation of return in the form of income as dividend and/
or capital gain. Clients usually prefer shares with higher value
to get higher income however the risk is that if the share value
decreases which result to investment risk (losses) for these
investors. Unlisted companies have a higher risk than listed
companies as these companies are start-up companies and the
defaulting percentage is high. To conclude, equity risk arises
from the partnership contract or businesses (Jamaldeen,
n.d).Market Risk
Market risk is known as systematic risk or market systematic
risk that is generated from the fluctuation of market prices. The
market risk arises from the possible loss that could be
experienced by investors due to fluctuations in prices. The
volatility of asset market value results in market risk, especially
for transaction that includes either future delivery or deferred
payment such as salam or murabahah contract. In addition to
that, foreign exchange transactions as it is not fixed meaning
that the prices fluctuate resulting in income fluctuation.
Consequently, market risk is the movements or changes in
prices of many things such as commodity (Helmy, 2012).
Mark-up Risk
The Islamic banks give a mark-up rate in murabaha contracts for
a fixed period, while the benchmark rate may vary; meaning
that the predominant mark-up rate may increase behind the rate
the bank has locked into a contract, resulting that the bank is
incapable to benefit from the higher rate in the market. Because

38. of the non-availability of an Islamic index of rate of return, the
Islamic bank usually use the London Interbank Offered Rate
(LIBOR) as a benchmark meaning that they align their market
risk with the movement in LIBOR rates (Helmy, 2012).
Price Risk
The Islamic banks face price risk in the case of forward sale
(bay’ al-salam), that is during the commodities delivering
period and its sale at the current market price as well. This risk
is like the market risk of a forward contract in conventional
banks in the case that it is not hedged properly (Helmy, 2012).
Liquidity Risk
Hassan, kayed & Oseni (2013) reported that liquidity risk is the
possible expected loss by Islamic finance institution which
arises due to the insufficient liquidity to meet normal operating
obligations and operating needs. The liquidity risk is the
difficulty that Islamic finance face to meet its liability through
selling assets where its market value had fallen. It is a type of
systematic risk where the Islamic bank be in a case of not being
able to meet expected and unexpected cash flow needs. Cash
flow includes the portfolio asset of financial institution where
they are enabling to liquidate these assets at appropriate
maturity and rates causing liquidity risk. The liquidity risk can
be caused by incorrect judgment and complacency,
unanticipated change in cost capital, abnormal behaviour of
financial markets, range of assumptions used, risk activation by
secondary sources, breakdown of payment systems,
macroeconomic imbalances, financial infrastructure deficiency,
and contractual forms.Credit Risk
Credit risk associated with the loss of income when the
counterparty delay the payment that agreed on the contract. The
probability of credit risk underlies all Islamic modes of finance.
To demonstrate, murabaha contracts credit risk increases when
the counterparty default in paying the full debt on time. Un-
payment of debt can be due to either external systematic sources
or to internal financial causes, or an outcome of moral hazard

39. (wilful default). Moral hazard should be distinguished purely as
Islam does not allow restructuring debt through compensation
unless it is a situation of wilful default. For the profit-sharing
modes like mudarabah and musharakah contracts, the credit risk
situation occurs when the entrepreneur does not pay off the
share of the bank when it is due. This problem might increase
due to the asymmetric information problem, as the banks do not
have adequate information on the actual profit of the firm
(Ahmed & Khan, n.d).
Operational Risk
It is the risk associated with the execution of the business. This
risk arises from the direct or indirect loss resulting from
inadequate or failed internal processes, people, and technology
or from external events. This risk includes the legal risk
however it is exclude the reputation risk or risk associated from
strategic decision. Operational risk may result from unqualified
professionals who manage Islamic bank operations. Also it can
be due to non-compliance with Shariah requirement. Moreover,
one example of operational risk is the computer software that is
available in the market for conventional banks may not be
suitable for Islamic banks due to the distinct of the Islamic
business nature, so it increases the system risk of improving and
using informational technologies in Islamic banks (Ahmed &
Khan, n.d).
Legal risk
According to Ahmed & Khan (n.d), there are many reasons for
legal Islamic bank risk. First, the common law or civil law
framework adopted by most countries does not include laws
which assist the feature of Islamic banks products. For instance,
Islamic bank main activities is trading and investing in equities
like murabaha and mudarabah respectively, however these
activities are forbidden for commercial banks according to
banking law and regulation. Second, as contracts are not
standardize, the procedure of negotiation of various aspects of a
transaction are more complex and costly. Additionally, financial
institutions are not protected against risks that they cannot

40. anticipate or that may not be enforceable. Use of standardized
contracts can also make transactions easier to administer and
monitor after the contract is signed. Lastly, shortage of Islamic
courts which can enforce Islamic contracts raises the legal risks
of utilizing these contracts.Leased Asset Value Risk
In the case of ijarah, the bank face a market risk in case of
falling in the residual value of the leased asset at the expiry
date of the lease contract, or due to termination of the contract
in case of default (Helmy, 2012).Fiduciary risk
Ahmed & Khan (n.d) reported that breaking contracts by the
Islamic bank itself can result in fiduciary risk. For example, the
bank may not be able to comply totally with the Shariah
requests of different contracts knowingly or unknowingly. The
inability to comply with the Shariah results in loss of
depositors’ trust, which in turn causes deposits withdrawals.
The fiduciary risk can be also be introduced by the lower rate of
return than the market, when depositors/investors interpret a
low rate of return as breaching an investment contract or
mismanagement of funds by the bank (AAOIFI, 1999).
Displaced commercial risk
This is the transformation of the risk associated with deposits
to equity holders. Displaced commercial risk implies that the
bank may operate in full compliance with the Shariah
requirements; however, it may not be able to pay competitive
rates of return as compared to its peer group of Islamic banks
and the other conventional competitors. Therefore, depositors
seek to withdraw their money and deposit it in other banks that
provide higher return. In fact, this risk arises from other
competitors’ pressure, where Islamic banks are forced to give
share of its profit to pay depositors and prevent withdrawals due
to lower return. Conventional banks usually try to minimize or
transfer the loss to save their financial statement, whereas
Islamic banks try to eliminate loss as investors and depositors
will bear the loss. In addition to that Islamic banks do not
invest depositors funds in risky projects as the loss opportunity
is high although the riskier investments may have higher

41. returns, hence Islamic banks invest in less risky investment
because of the shortage of deposit insurance and guaranteed
return. Some central banks authorize Islamic banks to hold a
legal reserve to cover any depositor’s capital loss. Low risk
profile does not protect the bank from any losses or lower
return; hence the Islamic bank needs to employ alternatives to
keep depositors interested, to compensate depositors and to
keep competitive with conventional banks. Islamic bank should
create special pools for reserve money like a Profit Equalization
Reserve (PER) and an Investment Risk Reserve (IRR) which
help them to reduce the risk of low return or losses. Those funds
are reserved to regulate returns in a situation of less than
anticipated results (Fleifel, 2009)
Categories of Risk
Risk can be classified into different categories. The most
important ones are the following (Introduction to Islamic
Muamalat Learning Outcomes, n.d):
1. Pure Risk versus Speculative Risk
Description
Example
Pure Risk
The possibilities that can result in only a loss (e.g. house
destroyed due to fire) or no loss (e.g. no house destroyed in a
fire occurred in that year). Pure risks can generally be covered.
Fire, lightning, flood, storm, premature death, accident, theft,
etc.
Speculative Risk
The possibilities that can result in loss, no loss or profit (gain).
Speculative risks generally cannot be covered.
Investments in the stock market, foreign currency fluctuations,
venturing into a new business.
2. Fundamental Risk versus Particular Risk

42. Risk
Description
Example
Fundamental
Risk that will affect the whole society or a large number of
people within the community. It is not within the control of
individuals. Fundamental risks generally cannot be covered.
Damage to property due to earthquake, war, etc.
Particular
Risk that will affect only individuals and is within the control
of individuals. Particular risks can generally be covered.
Damage to property from accidents, thefts, robbery.
Risk identification
Risk identification denotes the process of classifying,
evaluating, reviewing and forecasting possible risks. The main
purpose behind risk identification is to identify risks one
company is exposed to and then risks are classified and
documented. At the end of this process, a list of categorized
risk is provided.
Risk Evaluation
Risk evaluation is the process of studying the impact and results
of each risk and assessing the possible expected resulting losses
as well. Thus, resources will be utilized in order to take the
needed actions and practices. To evaluate or assess the impact
of the risk, the firm must consider these two factors according
to the Introduction to Islamic Muamalat Learning Outcomes,
(n.d), p. 21:
a. Risk Frequency:
“Refers to the number of times a loss producing event will
occur during a given time period (probability of its
occurrence)”.
b. Risk Severity
“Refers to the cost or amount of loss, in money terms, arising

43. from a loss producing event”.
Develop Risk Management Plan
As soon as risks have been identified and evaluated
entirely, here comes the need to develop a risk management
plan using the most suitable and applicable risk handling
method. The firm should bear in mind the cost and the
effectiveness of each method before final decision is made. Risk
handling methods includes Risk Avoidance, Risk Control, and
Risk Retention among others.
Implementation of Risk Management Plan
Based on the firm decision on which handling method/methods
to be used, the plan should be implemented. When this step is
performed, risk should be ranked and matched with the actions
to be taken.
Reviewing and Monitoring of Risk Management Plan
This step comprises periodical reviews, supervising the
implementation process and revising the plan in response to any
changes in the business and economic environment as well.
Periodical reviews assist in identifying any deficiencies or
adjustments and also ensure attaining the objectives of the plan.
Reviews should be done at least once a year to ensure
successfulness of the program. Risk Management and
Mitigation Techniques
Many risk measurement and mitigation techniques have evolved
recently. Some of these techniques are used to mitigate specific
risks while others are meant to deal with overall risk of a firm.
In this section we outline some contemporary techniques used
by well-established financial institutions in the process of risk
management and mitigation. Collateral
Collateral is an important security against credit loss. It is used
by Islamic banks to secure finance as al-Rahn, an asset as a
security in a deferred obligation, is allowed in shariah.
According to Islamic finance principles, there are many things
are not eligible to use as a collateral such as debt due from a
third party, perishable commodities and something which is not
prevented by the Islamic law as an asset, such as an interest-

44. based financial instrument. However, on the other hand, there
are many eligible assets that can be used as collateral such as
cash, tangible assets, gold, silver and other precious
commodities, shares in equities and debt due from the finance
provider to the finance user. Hence, the industry-wide general
quality of collateral on two things: number of institutional
characteristics of the environment and the products offered by
the industry. In fact, improving both the infrastructure of the
institution and the Islamic banking product can be instrumental
in boosting collateral quality and decreasing credit risks
(Ahmed & Khan, n.d).Guarantees
Guarantees is a complementary method to collateral in
improving the credit quality. Conventional Guarantees are
highly important materials to monitor credit risk in
conventional banks and in fact some Islamic banks do use
commercial guarantees despite the fact that it is against general
fiqh understanding. According to fiqh, a third party can provide
guarantees as a benevolent act and on the basis of a service
charge for actual expenses. Due to the shortage of consensus,
thus, the tool is not actively used in the Islamic banking
industry (Ahmed & Khan, n.d).Loan Loss Reserve
According to Ahmed & Khan (n.d), sufficient loan loss reserves
display safeguard against estimated credit losses. The
effectiveness of these reserves relies on the credibility of the
systems in place for calculating the expected losses. Recent
developments in credit risk management techniques have
enabled large traditional banks to recognize their estimated
losses correctly. The Islamic banks are also requested to
maintain the mandatory loan loss reserves subject to the
regulatory requirements in different jurisdictions. However, the
Islamic finance modes are varied and heterogeneous as
compared to the interest-based credit, thus requiring more
rigorous and credible systems for estimated loss calculation.
Moreover, to compare the risks of different institutions, there is
also a need for regular standards for loss recognition across
modes of finance, financial institutions and regulatory

45. jurisdictions. The AAOIFI Standards No. 1 provides the
foundation of income and loss recognition for the Islamic
finance modes. However, banks and regulatory organizations do
not apply these standards except for a few institutions. In
addition to the mandatory reserves, some Islamic banks have
also established investment protection reserves. For example,
the Jordan Islamic Bank has pioneered the establishment of
these reserves, which are established with the contributions of
investment depositors and bank owners. The reserves are aimed
at providing protection to capital as well as investment deposits
against any risk of loss including default, thereby minimizing
withdrawal risk (Ahmed & Khan, n.d).
GAP Analysis
GAP analysis is an on balance sheet interest rate risk
management tool. GAP analysis addresses the expected interest
rate fluctuations over a specific period. According to Khan &
Ahmed (2001), p.41 “In this method a maturity/ repricing
schedule that distributes interest-sensitive assets, liabilities, and
off-balance sheet positions into time bands according to their
maturity (if fixed rate) or time remaining to their next repricing
(if floating rate) is prepared.” Indicators and factors that cause
the interest rate sensitivity are identified by using these
schedules.
GAP models focuses on managing and handling net interest
income over different time intervals. After the time interval has
been selected, assets and liabilities are gathered and grouped
into these time buckets according to maturity (for fixed rates) or
first possible repricing time (for flexible rates). Rate sensitive
assets (RSAs) are assets that can be repriced and rate sensitive
liabilities (RSLs) are liabilities that can be repriced as well.
Therefore, GAP for a specific time interval is calculated as the
difference between rate sensitive assets (RSAs) and rate
sensitive liabilities (RSLs):
GAP = RSAs – RSLs
GAP provides the firm with information about the effect of
changes in interest rate on the net interest income. For instance,

46. when the rate sensitive assets exceed liabilities, GAP will be
positive. Hence, when future market interest rate increases, net
interest income will increase as well because the change in
interest income is greater than the change in interest expenses.
The same will happen if future market interest rates decline and
GAP is positive, resulting in reducing the net interest income
(Khan & Ahmed, 2001).Risk adjusted rate of return (RAROC)
According to Khan and Ahmed (2001), Risk adjusted rate of
return (RAROC) was developed by Bankers Trust in the late
1970s. In RAROC, Risk resulted from the trade-off between risk
and reward of different assets and activities is quantified.
RAROC was considered a prominent methodology used to
measure performance by the end of the 1990s. It allowed firms
to measure all related risks and provided manager with a tool to
measure risk/return trade-off in different assets and thus making
better decisions. The companies’ economic capital protects
financial institutions against any unexpected losses, thus, it is
important that capital is efficiently allocated for the several
risks that these institutions may face. In fact, RAROC analysis
determines the amount of economic capital needed by different
products and it as well determines the total return on capital of
a firm. RAROC is used by Islamic banks to assign capital to the
different modes of Islamic financing as Islamic financial
instruments have various risk profiles, such as murabahah is
considered less risky mode as compared to mudarabah and
musharakah (Abdul Rehman, 2016). Although RAROC is used
to estimate the capital requirements for market, credit and
operational risks; it is also used as an integrated risk
management tool. RAROC is determined as,
RAROC = Risk-adjusted Return / Risk Capital; where
· risk-adjusted return equals total revenues less expenses and
expected losses (EL)
· risk capital is that reserved to cover the unexpected loss given
the confidence level.Value at Risk (VaR)
Value at Risk (VaR) is one of the newly developed risk
management tools. VaR is a very popular method because it is

47. easy to be implemented and majorly accepted by top
management. VaR according to Khan & Ahmed (2001) “a
quantile measure to quantify the risk for financial institution” p.
42. Under normal market conditions, VaR indicate the worst
expected loss a firm can incur at specific time horizon and at a
given level of confidence. VaR designate financial risk in a
portfolio into a simple number. VaR includes many other risks
like foreign currency risk, commodities, and equities; although
it is used mainly to measure market risk. VaR has many
variations and can be estimated in different ways, below one of
them is explained.
Assume that an amount A0 is invested at a rate of return of r, so
that after a year the value of portfolio is A= A0 (1+r). The
expected rate of return from the portfolio is µ with standard
deviation σ. VAR answers the question of how much can the
portfolio lose in a certain time period t (e.g., month). To
compute this, we construct the probability distribution of the
returns r. We then choose a confidence level c (say 95) percent.
VaR tells us what is the loss (A*) that will not be exceeded c
percent of the cases in the given period t. In other words, we
want to find the loss that has a probability of 1-c percent of
occurrence in the time period t. Note that there is a rate of
return r* corresponding to A*. Depending on the basis of
comparison, VaR can be estimated in the absolute and relative
sense. Absolute VaR is the loss relative to zero and relative
VaR is the loss compared to the mean µ (Khan & Ahmed, 2001,
P.43).Derivatives
Over the past centuries, Derivative are commonly used as a
measure of protection, and as a minimizer for risk exposure. As
we know, today financial institutions are more vulnerable to
risk exposure, thus, financial institutions do their best to
mitigate those risks and operate efficiently. With financial
innovation, newer and more updated products are developed to
achieve stability and sustainability. In the past years,
Derivatives were and are still commonly used as a measure of
protection, and as a minimizer for risk exposure. However,

48. those instruments are not compliant with shariah principles and
thus can be not be utilized by Islamic institutions because in
shariah law, all contracts must be free from riba (interest),
rishwah (corruption), maisir (gambling), gharar (unnecessary
risk) any corruptive measure. Therefore, there was a need for
conventional like derivative but that are compliant with shariah
where some are explained below.
Forwards
Islamic Foreign Exchange Forward
FX Swap is a derivative instrument that has a precise objective
of hedging against risk of fluctuation in currency exchange rate.
Islamic Foreign Exchange forward is the Islamic substitute to
the conventional FX forward. In this context, Islamic Foreign
Exchange forwards is based on wa’ad (Undertaking) and
tawarruq Islamic principles so as to imitate conventional FX
forward but in a way that is complying to Shariah. The IIFM
IFX Forward templates are based on the wa‘ad structure (Zahan
& knett, 2011). A wa'ad in this case is a promise made by one
party (the Buyer) to the other party (the Seller) that, if the
Seller decided to exercise the Wa'ad or what’s called
undertaking the wa'ad, the Buyer will fulfil the promise, that is
in this case: entering into the transaction under which he will
buy from the Seller one currency in exchange for another
currency on the relevant settlement date. The concept of wa’ad
arises at dealing date when the client promises or commits
himself for an exchange of a specified amount of money on a
specified date. The wa‘ad need to exist in each IFX Forward
transaction. If and the Seller decided to exercise the relevant
wa‘ad on the relevant Exercise Date (by the Seller sending an
Exercise Notice), the Buyer is then required to purchase a
specified amount of one currency in exchange for a specified
amount of another currency. The terms of the contract are the
Offer and Acceptance of the Buyer and Seller.
There are two common IFX structures developed by IIFM which
are commonly used as a Shari‘ah compliant hedging tool:

49. 1- Two unilateral and Independent Wa‘ad based structure.
2- Single Binding Wa‘ad based structure.
For the two unilateral and independent Wa‘ad structure, each
party needs to execute a Wa‘ad while for the single binding
Wa‘ad Structure, only one party needs to execute a Wa‘ad.
Below given an illustrative example as per (IIFM/ISDA Islamic
Foreign Exchange Forward (IFX) Standard Templates Wa‘ad
based Structures, n.d)
Two unilateral Wa‘ad structure.
Scenario 1: on the Exercise Date if USD/GBP Spot Rate is <
1.51, the Customer exercises its rights under Wa’ad 1, so that
on the Settlement Date, the Bank buys GBP 1 million in
exchange for USD 1.51 million.
Scenario 2: on the Exercise Date, if USD/GBP Spot Rate is >
1.51 (i.e. Forward Rate of 0.66 > GBP/USD Spot Rate), the
Bank exercises its rights under Wa’ad 2, so that on the
Settlement Date, the Customer buys USD 1.51 million for GBP
1 million.
Single Wa‘ad structure
On the Exercise Date, the Bank exercises its rights under the
Wa’ad, so that the Customer buys GBP 1 million in exchange
for USD 1.51 million. Although for Shari’ah related reasons the
Bank is not strictly under an obligation to exercise its rights
under the Wa’ad, given that this is an IFX Forward product the
expectation is that it would do so.
Islamic Swaps
Islamic finance as conventional finance is exposed to the risks
of market volatility and fluctuation either in currency rate
market or interest rate market. Accordingly, Islamic swaps are
organized in a way to successfully operate as a hedging
mechanism in Islamic finance. Islamic swaps are hybrid
contract that are practised in a similar way to conventional
swap, thus attaining the same objectives as conventional swap
contracts. What is more important is that swaps are structured to

50. be compliant with the Islamic commercial jurisprudence
principles: Shariah requirements. This denotes the importance
of ensuring that contracts are free from riba (usury), gharar
(excessive ambiguity) and any element of gambling in the
transactions. There are several types of financial swaps that are
commonly used in the conventional financial system. In fact,
there are three main instruments of Islamic swaps developed in
a compliant way with Shariah laws and principles; those are FX
Swap, Cross Currency Swap, and Profit Rate Swap.
Islamic profit rate swap
A profit rate swap is the best alternative to conventional interest
rate swap “under which the parties agree to exchange periodic
fixed and floating payments by reference to a pre-agreed
notional amount” (Islamic Derivatives: Theory and Practice,
n.d, p.137). Like many conventional derivative products, the
conventional interest rate swap is not allowed in the shariah
rules as it contradicts the shariah principles prohibiting riba,
maisir and gharar. Here comes the role of profit rate swap
which is similar to conventional interest rate swap but in a
shariah compliant way. A profit rate swap uses both the
primary (Term) Murabaha and reciprocal murabaha transactions.
A term murabaha is used to generate fixed payments comprising
both a cost price and a fixed profit element. The series of
corresponding reverse murabaha contracts are used to generate
the floating leg payments (the cost price element under each of
these reverse murabaha contracts is fixed but the profit element
is floating).
(i) The Primary (Term) Murabaha
The floating rate payer will start the process by purchasing
goods from a commodity broker and then those goods will be
sold to the swap counterparty (the Fixed Rate Payer). The value/
price of the good purchased and sold is pre-agreed between
parties and commodities are delivered on the same date as the
transaction date. Once the Fixed Rate Payer receives the
commodity, he will on-sell this commodity to a different broker
and gets cash on sale. Then the Fixed Rate Payer will pay in

51. instalments for the goods he purchased from the floating rate
payer based on a term Murabaha. Instalments are made on a
series of pre-agreed payment dates, where each instalment
includes cost price element and a fixed profit portion.
(ii) The series of sequential Secondary Reverse Murabaha
Contracts (SRMCs)
In conventional context, a contract exists between the Floating
and fixed Rate Payer, where the Floating Rate Payer approves to
pay a variable amount (linked, for example, to LIBOR) to the
Fixed Rate Payer on certain pre-specified dates is considered
unlawful in the eyes of Shariah. Thus, SRMCs arise to solve
this problem in which floating rate payment is linked to an
underlying purchase and sale of commodities (Islamic
Derivatives: Theory and Practice, n.d).
Options
Options are one most powerful instrument that is used as risk
management tool. Yet, trading in options is prohibited based on
the resolution of the Islamic Fiqh Academy. For that reason, the
usage of options by the Islamic banks as risk management tools
is restricted and narrow to some degree. However, below
explained some forms of options that are mostly used.
Bai’ al-tawrid with khiyar al-shart
In bai’ al-tawrid contracts both parties are exposed to price risk.
That is immediately after the parties had signed the contract of
fixed price and quantity, a change in the market price of that
commodity may be faced. The buyer will be at a loss if he
continues with the contract given the market price declines. For
the seller, if market price rises, the seller will lose by
continuing with the contract. Thus, in such contracts of
continuous-supply purchase, a khiyar al-shart (option of
condition) for cancelling or revoking the contract will enhance
justcity and will reduce the risk for both parties as well (Ahmed
& Khan, n.d). Khiyar al-shart according to Obaidullah (1998),
“is an option that is in the nature of a condition stipulated in the
contract. It provides a right to either of the parties, or both, or

52. even to a third party to confirm or to cancel the contract within
a stipulated time period” p.77. In this context, the involved
party gets some time period for re-evaluation of the benefits and
costs involved, before giving final confirmation or assertion to
the contract. In fact, there is a consensus among jurists from all
the major school regarding the permissibility of khiyar al-shart.
The permissibility of such options is inferred directly from the
following hadith of the holy prophet (PBUH) reported by al-
Bukhari and Muslim. When Habban Ibn Munqidh complained to
the holy prophet (peace be upon him) that he was the victim of
frequent fraud in some earlier transactions, the holy prophet
(PBUH) is reported to have said “When you conclude a sale you
may say that there must be no fraud and you reserve for
yourself an option lasting three days.” (Obaidullah, 1998)
Bay al-arbun
Bay al-arbunindicates a sale contract between a buyer and a
seller in which an amount of money is deposited faithfully by
the buyer and this amount represents part of the total amount to
be paid and if, however, the buyer fails to ratify the contract he
will lose the amount deposited which the seller can retain. Bay
al-arbun is similar to call option in which deposit or premiums
are not returned to the buyer by the seller in the case the former
does not exercise the option or confirm the contract.
Nevertheless, for the call option, even if the buyer does exercise
the option and the contract is confirmed, premiums will be lost.
While for bay al-arbun the initial deposit (premium) paid is
considered as a part of the sale price when the contract is
confirmed. Arbun is mostly used by Islamic funds as a way to
reduce portfolio risks, known nowadays in the Islamic financial
markets as the principal protected funds (PPFs). The PPF
roughly works like that: the total fund raised is divided where
97 percent of it is invested in low-risk but liquid murabaha, and
it gives lower return. The left over 3 percent of the fund is
invested in arbun contract, where down payment is made for the
purpose of purchasing common stocks in a future date. The fund
managers go for this transaction when he expects that prices

53. will be in the rise. If the future price of the stock increases as
expected by the fund manager, the arbun is utilized by
liquidating the murabaha transactions. Otherwise, the arbun
lapses, incurring a 3 per cent cost on the funds. However, fund
manager compensate for this cost by the returns generated from
murabaha transactions. In this context, arbun can be used
efficiently to protect investors from unfavourable market
conditions (Risk) and as well gain when market condition is
favourable (Ahmed & Khan, n.d).Conclusion and
Recommendation
Risk - return trade off theory is a fact that Islamic financial
institutions face like their conventional counterparties. In fact,
Islamic financial institutions face more risks than conventional
banks because of the requirements of the Shariah principles.
Thus, Islamic Financial institutions are in greater pressure to
control and mitigate risks to gain an acceptable return. Risk
mitigation techniques that are commonly used by conventional
banks are not Shariah compliant; however, despite of that
scholars and knowledgeable people in both Shariah and finance
worked on the development of new Shariah- compliant products.
In addition, with financial innovation and development, Islamic
financial institutions now have a broad range of products as
well as techniques that are Shariah compliant to avoid, transfer
and mitigate risks.
In conclusion, we recommend Islamic financial institutions to
understand the expected risks they will face thoroughly, and
then use one of the above risk mitigation or a combination of
them to ensure that risk is avoided, reduced and even mitigated.
Thus, if those proved to be efficient, higher return can be
realized because of the risk and return trade-off. Moreover,
Islamic financial institutions should ensure their compliance
with Shariah laws and principles so not to upset customers who
are now more aware of the Islamic financial system. One more
point to bear in mind is that despite of the more types of risks
that Islamic banks face than their counterparties, Islamic
banking and finance is now more and more developing as well

54. as growing and more innovation is coming into this field which
will further enhance the industry.
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ese.unile.it/index.php/ejasa_dss/article/viewFile/11306/11158

56. Research Project
Islamic Banking and Finance
Fall 2018
*
The Project GuidelinesCover page must state clearly the title of
the research paper, course title and code, academic semester,
name of instructor and date.You should provide a table of
contents in your research paper.In your references list, use a
wide range of academic information sources such as books,
journals, reliable internet websites, newspapers, etc.) and write
them in APA style.The paper should contain no spelling
mistakes, is properly structured with appropriate headings and
titles, numbered and properly stapledThe paper should be 12 -14
pages [Abstract or Executive Summary 1 page introduction: 1
page; main body: 8-11 pages; conclusion: 1 page). You may
attached appendices if so desired. Submission Deadline will be
on 5 December (for Prelim Draft) and Submission has to be in
soft copy in the safe-assignment link that will be available on
the Blackboard on due date.
Requirements: I need a research paper of 13 pages about Islamic
insurance (Takaful) read the rubric and follow it i will post
some 2 DOCUMENTS ONE IS THE BOOK AND THE OTHER