Johaina Khalid

Lecturer, IMS.
University of Peshawar.
− To impart the students knowledge regarding fundamentals of Islamic
finance and learning of the current products and services operated by
Islamic banks, capital markets, and money market including shariah
legitimacy, structures, process flows, practice and regulation of key
financial products and documentation.
− The students are expected to have understanding about subject related
practices and differentiating features of Islamic finance vs. conventional
finance.
 Conceptual Framework.
• Financial system
• Islamic Financial System
• Principles of Islamic finance
• Islamic Economic system vs Capitalism.
• Islamic Financing; Asset backed Financing
• Islamic Banking vs conventional Banking.
 Islamic law of Business contracts
• Rules of a sale contract
• Kinds of sale contract in Islamic law.
 Islamic Banking
o Trade Based Modes.
▪ Murabaha to the purchase orderer (banking murabahah
sale contract)
▪ Salam (forward sale) and parallel salam (liquidity
management)
▪ Istisna’ (order to manufacture) and parallel Istisna’ (sub-
contracting)
o Participatory Modes.
▪ Principles of Islamic partnerships
▪ Joint stock company and limited liability
▪ Redeemable musharakah/ Diminishing musharakah
(House/business/vehicle finance)
▪ Mudarabah/ redeemable mudarabah - Deposit
management & project finance
 o Rent Based Modes.
▪ Ijara (Lease) as mode of financing
▪ Relevant Products:
▪ Operating Ijara – leasing company perspective
▪ Ijara Muntahiya Bi al Tamleek and ijara Wa Iqtina (transfer of
ownership of asset respectively by way of gift and sale once Ijara
terminates) [car/machinery/house finance]
 Islamic capital market
▪ Bonds (sukuk) market
▪ Concept, shariah legitimacy and differentiating features
▪ Overview of the market
▪ Structures of sukuk issues in Pakistan and case studies of Motorway
and WAPDA sukuk
▪ Equity market
▪ Islamic equities and index
▪ Screening criteria to select Islamic stock
 An Introduction to Islamic Finance by
Muhammad Taqi Usmani.

 Meezan Bank’s guide to Islamic banking by

Muhammad Imran Ashraf Usmani.
The financial system is the system that allows
the transfer of money between savers
and investors. (Lenders and Borrowers)
Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson
Prentice Hall. p. 551. ISBN 0-13-063085-3.
Financial System comprises of "a set of complex
and closely interconnected financial institutions,
markets, instruments, services, practices, and
transactions.“
Gurusamy, S. (2008). Financial Services and Systems 2nd edition, p. 3. Tata McGraw-Hill Education. ISBN 0-07-015335-3
 Khaleequzzaman, M. Principles of Islamic Finance [PPT Document].
Retrieved from Lecture Notes online website: www.alhudacibe.com
 inples of Islamic Finance

Prohibitions & Permissions

1. Prohibition of Riba:
Riba means excess– Predetermined/fixed/time related
Excess of weight or measure in one of the two homogenous articles in a
contract of exchange
 An increment on loan received by the lender (benefit of delay) - Riba
al Nasi’ah (Riba al Jahiliyyah, Quranic Riba)
 Discrepancy appropriated through exchange of goods (arising from
weight or measure subject to conditions) -Riba al Fadl

Resolutions of The Azhar Islamic Research Academy Egypt, The

Council of Islamic Ideology Pakistan, and The Islamic Fiqh Academy
of OIC have concluded that: The bank interest in all its forms is Riba
 Principles of Islamic Finance

Principles of Islamic Finance

A. Qur’an
1. Surah al-Room – [Undesirability of Riba was revealed where
Allah (SWT) conveyed His displeasure on such transactions]
(30:39) “That which you give as riba to increase the people’s
wealth increases not with God: but that which you give in
charity, seeking the goodwill of God multiplies manifolds”
 Principles of Islamic Finance

Principles of Islamic Finance

2. Surah al-Nissa – [In response to provocations of Jews and
recounting their sins, including charging of Riba, Allah (SWT)
tells them about the punishment and rewards for the clear
minded] (4:161-162) “And for their taking riba although
forbidden for them, and their wrongful appropriation of
other people’s property, we have prepared for those a
painful doom for these disobedient persons. However, We
will give a great reward to those among the jews) who are
clear minded about the truth, without a grain of doubt, and
who believe in the Quran and all other revealed books,
establish salah, give zakat, and believe in Allah and the day
of judgment”
 Principles of Islamic Finance

Principles of Islamic Finance

3. Surah Aale-Imran – [Riba was expressly prohibited for
Muslims] (3;130) “O believers, take not doubled and re-
doubled riba, and fear Allah so that you may prosper. Fear
the fire which has been prepared for those who reject faith,
and obey Allah and the prophet so that you get mercy”
 Principles of Islamic Finance

Principles of Islamic Finance

4. Surah al-Baqarah – [In response to adversaries of Islam’s
question of paralleling profit and Riba, Allah (SWT)
permitted sale and prohibited Riba, and that the matter of
already charged Riba was with Allah] 92:275-277) “Those
who take riba shall be raised like those who have been driven
to madness by the touch of the devil; this is because they
say :’trade is just like interest’ while God has permitted trade
and forbidden interest. Hence those who have received the
admonition from their Lord and desist, may keep their
previous gains, their case being entrusted to God, but those
who revert shall be the inhabitants of fire and abide therein
for ever”
 Principles of Islamic Finance

Principles of Islamic Finance

5. Surah al-Baqarah- [Declaration of war from Allah (SWT) and
His Prophet (PBUH) against those who disobey the
prohibition, and all previous Ribavi transactions were
entitled to receive principal only, and that to give the debtor
grace period until he can manage to clear the dues against
him] (2;278-280) “O believers fear Allah, and give up what is
still due to you from riba if you are true believers. If you do
not do so, then there is declaration of war from Allah and His
Messenger. But if repent, you can have your principal.
Neither you should commit injustice nor should you be
subjected to it. And if the debtor is in misery, let him have
respite until it is easier, but if you forego it as charity, it is
better for you if you realize.
 Principles of Islamic Finance

Principles of Islamic Finance

1. Prohibition of Riba: Prohibition in Shariah:
B. Ahadith
Ahadith relate to the following subjects:
1. Prohibition of Riba [various parties to Ribawi
transaction]
2. Consequences of indulging in Riba […Night of
ascendance to Heavens…, violators subject to the
curse]
3. Forms of Riba in loans and other transactions
[…Varily/Indeed Riba was in lending, …exchange of
radi with burney dates…, Riba al Fadl]
 Principles of Islamic Finance

Principles of Islamic Finance

B. Ahadith
Ahadith relate to the following subjects:
4. Creditor and debtor relationship […not to accept any
gift or ride from borrower…, …even minute benefit
transferring from debtor to creditor…]

5. Outstanding debt, the necessity of repaying the debt

[…all sins would be forgiven except o/s debt…,
…dishonor and punishment for willful defaulter…,
…allowance of repayment time for genuine
defaulter…]
 Principles of Islamic Finance

Economic Rational For Prohibition of Riba

1. Interest (Price of Capital)– main factor for unjust distribution
of production results
• Capital receives the whole benefit but does not share losses
• Entrepreneur is discriminated by paying fixed rate of interest even in
case of loss
• Capital is discriminated by receiving small amount of interest when
entrepreneur earns large profits
• Industrial borrower receives large profits and pays small part to
depositors through conventional banking (net resource transfer from
poor to the rich) –Concentration of income and wealth.
Islamic finance prescribes Profit and Loss sharing as no one
can determine the productivity of capital and entrepreneur
before hand.
 Principles of Islamic Finance

Economic Rational For Prohibition of Riba

2. Credit worthiness preferred over productivity and proper
utilization of loan – corporate sector appropriates the funds
while Small businesses are neglected despite their economic
feasibility
Islamic banks downscale their operations as they share in
the results of the business and credit worthiness occupies
secondary position than productivity.
3. The interest system promotes passive behavior and risk
aversion – absence of effort affects production and
productivity
Islamic finance brings active partners together (P&L sharing)
 Principles of Islamic Finance

Economic Rational For Prohibition of Riba

4. The conventional banking exposed to instability
Islamic banking, working through the system of profit and
loss sharing, demonstrates a stable system.
5. Moral hazard and adverse selection-
Equity finance provides access to information [more even
resource distribution]
 Principles of Islamic Finance

Principles of Islamic Finance

2. Profit belongs to one who bears responsibility of loss:
- These two interrelated characteristics are expressed in the
Prophet (PBUH)'s saying "al kharaj bi al daman “ –
entitlement of gain is linked to the responsibility for loss”.
- The principle of liability distinguishes profit from riba more
clearly than prohibition of Riba.
3. Variable return:
Profit Sharing Principle (PSP) or the Profit and Loss Sharing
Principle (PLSP).
 Mudarabah – Profit sharing principle
 Musharakah – Profit and loss sharing principle
 Principles of Islamic Finance

4. Asset backed financing: Money cannot be considered as

capital – real sector activity
MONEY
Conventional
FI Client
FI
Finance
MONEY

MONEY/GOODS
Islamic
FI FI
Client
Finance
MONEY/COUNTER
VALUE
 Principles of Islamic Finance

Principles of Islamic Finance

5. Prohibition of uncertainty: Gharar [minor vs. major]
Uncertainty at very inception of the contract
Sale of probable items whose existence or characteristics are
uncertain. Such risky nature of trade is similar to gambling.

 Bay al Mukhadarah – eg. Selling fruit before they ripen

 Bay al Samak fi’l Ma – eg. Selling fish in the water
 Bay Safqatan fi Saqfah – eg. Two prices in one sale, etc.
 Selling goods without proper description – Pebbling Sale of milk
in the udder of a cow
 Principles of Islamic Finance

Principles of Islamic Finance

5. Prohibition of maysir (gambling)
Refers to acquisition of wealth at others cost
Quran condemns maysir stating it Satan “wants only to sow
enmity and hatred among you, and hinder you from
remembrance of God and from prayer”
6. Prohibition of fraud and deception (Khilabah and Ghishish):
Disclosure of full information/avoiding to deceive others,
avoiding to appropriate property fraudulently
7. Prohibition of conditional sale or combining two
inconsistent contracts;
Islamic Financial System is a financial system
which is governed by Shariah (Islamic Law),
sourced from the Quran and Sunnah.
 Capitalism is a system in which factors of
production are controlled by private owners for
profit motive.
 The desire for profit is the sole consideration of
the property owner.
 Market forces of Demand and Supply play a
strong role in resource allocation.
 There are four factors of production that is Land,
labor, entrepreneur and Capital entitled to Rent,
wages, Profit and Interest.
 Islam does not deny the market forces and
market economy. Even the profit motive is
reasonable to some extent. Private
ownership is not totally negated.
 Yet, the basic difference between capitalist
and Islamic economy is that in capitalism, the
profit motive or private ownership are given
unbridled power to make economic
decisions. Their liberty is not controlled by
any divine injunctions.
 Whereas, In Islamic Economic System, after
recognizing private ownership, profit motive and
market forces, Islam has put certain divine
restrictions on the economic activities.
 These restrictions being imposed by Allah Almighty,
Whose knowledge has no limits, cannot be removed
by any human authority.
 The prohibition of riba (usury or interest), gambling,
hoarding, dealing in unlawful goods or services,
short sales and speculative transactions are some
examples of these divine restrictions.
 All these prohibitions combined together have a
cumulative effect of maintaining balance,
distributive justice and equality of opportunities.
 According to the capitalist theory, capital and entrepreneur are
two separate factors of production. The former gets interest while
the latter is entitled to profit.
 Interest is a fixed return for providing capital, while profit can be
earned only when there is a surplus after distributing the fixed
return to land, labor and capital (in the form of rent, wages and
interest).
 Islam, on the contrary, does not recognize capital and
entrepreneur as two separate factors of production. Every person
who contributes capital (in the form of money) to a commercial
enterprise assumes the risk of loss and therefore is entitled to a
proportionate share in the actual profit.
 In this manner 'capital' has an intrinsic element of
'entrepreneurship', so far as the risk of the business is concerned.
 Therefore, instead of a fixed return as interest, it derives profit.
The more the profit of the business, the higher the return on
capital.
 The conventional / capitalist concept of
financing is that the banks and financial
institutions deal in money and monetary papers
only. In fact, they are forbidden, in most
countries, from trading in goods and making
inventories.
 Money has no intrinsic utility; it is only a medium
of exchange; Each unit of money is 100% equal
to another unit of the same denomination,
therefore, there is no room for making profit
through the exchange of these units inter se.
 The profit earned through dealing in money
(of the same currency) or the papers
representing them is interest, hence
prohibited.
 Therefore, unlike conventional financial
institutions, financing in Islam is always based
on illiquid assets which creates real assets
and inventories.
 Thus, every financing in Islamic system
creates real asset, may it be Musharka,
Mudaraba, Salam, Istisna or even Murabaha.
 Interest Based Financing Does not necessarily
create real assets therefore supply of money
through the loans advanced by the financial
institutions does not normally match with the
goods and services produced in the society.
 This gap between the supply of money and
production of real assets creates or fuels
inflation.
 Since financing in an Islamic system is backed by
assets, it is always matched with corresponding
goods and services.