practic

Nature of Capital in Musharakah

2010-02-17T23:41:00.000-08:00

In previous post we studied about Musharakah in detail. This post is also relates to Musharakah as shown by title. Here we will discuss nature of capital introduced by partners in Musharakah business, its types and nature.

There are different views about nature of capital invested by partners in musharakah business. Most of the Muslim jurists are of the opinion that capital must be in liqid form i.e in cash/money. According to them Musharakah can't be executed or formed on capital contributed in commodities. It is mandatory that whole capital must be in form of money or liquid cash and no part of capital should be in form of commodities.
However, there are different views in this respect discussed below in detail.

In view of Imam Malik, there is no restriction of liquidity of capital in musharakah contract. It is not a condition for a valid contract of musharakah. Partners can invest in form of liquid cash or commodities or both. However if a partner invests in form commodities, his share of capital shall be determined on basis of current market price of commodities. This view is also adopted by some Hanbali jurists.

Imam Abu Hanifah and Imam Ahmad are of the view that no contribution in kind is acceptable in a musharakah. Their standpoint is based on two reasons:

Firstly they are of the opinion that if partners contribute in form of commodities, that are always distinguishable from the commodities contributed by other partner. For example, if a partner contributes a vehicle and the other contributes furniture as a capital in a business. In this case, commodities of each partner is distinguishable from the other and no partnership can take place. On the other hand if both partners invest in form of liquid cash, it can't be distinguished and will goes to a common pool. In this case valid partnership can be established.

Secondly they say that in case of redistribution of share capital in musharakah contract, if a capital is in form of commodities it will create problems and redistribution can't take place because commodities have to be sold at that time.It the capital is repaid on the bases of its market value, it may be increased or decreased and whole benefit or loss due to change in market value may go to one partner.

Imam al-Shafi has come in between the two points of view explained above. He says that the commodities are of two kinds:

(i) Dhawat-ul-amthal the commodities which, if destroyed, can be compensated by the similar commodities in quality and quantity e.g. wheat, rice etc. If 100 kilograms of wheat are destroyed, they can easily be replaced by another 100 kg. of wheat of the same quality.

(ii) Dhawat-ul-qeemah the commodities which cannot be compensated by the similar commodities, like the cattle. Each head of sheep, for example, has its own characteristics which cannot be found in any other head. Therefore, if somebody kills the sheep of a person, he cannot compensate him by giving him similar sheep. Rather, he is required to pay their price.

Imam al-Shafi is of the point of view that if the commodities pertains to first kind i.e Dhawat-ul-amthal, it may be contributed to Musharakah as a share capital while the commodities of second kind i.e Dhawat-ul-qeemah are not allowed to contribute as a capital in Musharakah contract.

By this distinction between Dhawat-ul-amthal and Dhawat-ul-qeemah, Imam al-Shafi has met the second objection on 'participation by commodities' as was raised by Imam Ahmad. For in the case of Dhawat-ul-amthal, redistribution of capital may take place by giving to each partner the similar commodities he had invested. However, the first objection remains still unanswered by Imam al-Shafi.

In order to meet this objection also, Imam Abu Hanifah is on the point of view that if commodities pertains to Dhawat-ul-amthal, it should be mixed in such a way that the commodities of each partner can't be distinguished from other. If commodities are distinguishable from other, musharakah is not valid.

In short, in view of Imam Malik, musharakah can be executed by contributing commodities as capital, without any restriction. Share of capital is determined on bases of current market value of commodities. While Imam Shafi says that commodities can only be contributed as share capital in musharakah it they pertains to Dhawat-ul-amthal. Imam abu Hanifah says that if commodities are in category of Dhawat-ul-amthal, musharakah contract can be executed by mixing of commodities in such a way that can't be distinguished from other partners, and if commodities are of Dhawat-ul-qeemah, that commodities can't be form part of share capital and no musharakah can be executed.

The view of Imam Malik is more simple and reasonable and meets the needs of modern business. It is more likely to act upon on this view. We may conclude that a musharakah business can be formed on both cash and commodities. However in case of commodoties, current market value should be determined on that date and considered as value of capital.

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2010-01-25T03:26:00.001-08:00

Musharakah is word of Arabic origin which literally means sharing. In financial world or banking & finance industry, it means a joint enterprise in which all the partners share the profit of a business or partnership according to predetermined profit sharing ratio while the loss is distributed in the ratio of contribution (capital)

The word Musharakah is derived from 'Shirkah' means sharing, while the term 'Musharakah' is not found in the books of Fiqh. This term has been introduced recently by those who have written on the subject of Islamic Finance and it is normally restricted to a particular type of 'Shirkah', that is, the Shirkat-ul-amwal where two or more persons invest some of their capital in a joint commercial venture. However, sometimes it includes Shirkat-ul-amal also, where partnership takes place in the business of services. (These terms will be discussed later in this article).

Musharakah does not envisage a fixed rate of return to the investors rather the return depends on the actual earnings of business. If a business earns profit, it is distributed among partners according to predetermined profit sharing ratio and in case of loss, each partner will suffer according to ratio of his investment(capital).

This article covers the following aspects of Musharakah

Types of Musharakah

Distribution of Profit

Sharing of Loss

Management of Musharakah

Termination of Musharakah

Termination without Closing the Business

Types of Musharakah

There are two basic types of Musharakah

Shirkat-ul-Milk

It means joint ownership of two or more persons in a particular property. This kind of "Shirkah" may come into existence in two different ways:

By Option of the Parties:
If two or more persons purchase a property, it will be owned jointly by both of them and the relationship between them with regard to that property is called 'Shirkat-ul-milk', here this relationship has come into existence at their own option.

By Enforcement of Law:
After the death of a person, all his heirs inherit his property which comes into their joint ownership as an automatic consequence of the death of that person.

Shirkat-ul-Aqd

Shirkah-ul-Aqd means "a partnership executed by a mutual contract". It may be translated as "joint commercial enterprise.

Shirkat-ul-aqd is further divided into three kinds:

Shirkat-ul-amwal
where all the partners invest some capital into a commercial enterprise.

Shirkat-ul-Amal
where all the partners jointly undertake to render some services for their customers, and the fee charged from them is distributed among them according to an agreed ratio.

Shirkat-ul-wujooh
Here the partners have no investment at all. All they do is that they purchase the commodities on a deferred price and sell them at spot. The profit so earned is distributed between them at an agreed ratio.

Distribution of Profit

The profit sharing ratio must be defined and agreed between the partners at the time of agreement. If no such ratio is determined, the contract is not valid in shariah

The partners are not allowed to fixed rate of return or fixed ratio of profit with respect to their capital. They can only get their share of profit/loss.

Therefore, if A and B enter into a partnership and it is agreed between them that A shall be given Rs 10,000/- per month as his share in the profit, and the rest will go to B, the partnership is invalid. Similarly, if it is agreed between them that A will get 15% of his investment, the contract is not valid. The correct basis for distribution would be an agreed percentage of the actual profit accrued to the business.

If a lump sum amount or a certain percentage of the investment has been agreed for any one of the partners, it must be expressly mentioned in the agreement that it will be subject to the final settlement at the end of the term, meaning thereby that any amount so drawn by any partner shall be treated as 'on account payment' and will be adjusted to the actual profit he may deserve at the end of the term. But if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned.

Is it necessary that the ratio of profit of each partner conforms to the ratio of capital invested by him? There is a difference of opinion among the Muslim jurists about this question.

In the view of Imam Malik and Imam Shafi‘i, it is necessary for the validity of musharakah that each partner gets the profit exactly in the proportion of his investment. Therefore, if A has invested 40% of the total capital, he must get 40% of the profit. Any agreement to the contrary which makes him entitled to get more or less than 40% will render the musharakah invalid in Shari‘ah.

On the contrary, the view of Imam Ahmad is that the ratio of profit may differ from the ratio of investment if it is agreed between the partners with their free consent. Therefore, it is permissible that a partner with 40% of investment gets 60% or 70% of the profit, while the other partner with 60% of investment gets only 40% or 30%.

The third view is presented by Imam Abu Hanifah which can be taken as a via media between the two opinions mentioned above. He says that the ratio of profit may differ from the ratio of investment in normal conditions. However, if a partner has put an express condition in the agreement that he will never work for the musharakah and will remain a sleeping partner throughout the term of musharakah, then his share of profit cannot be more than the ratio of his investment.

Sharing of Loss

In case of loss, all muslim jurists are agreed that loss will be distributed accoriding to their ratio of investment. For example if partner has invested 30% of total capital, he will suffer 30% in case of loss. If there is any condition to the contrary, it will be deemed void.

Management of Musharakah

The management of Musharakah business will be done by all partners, every partner has right to take part in management of Musharakah business. However, partners may agree on a condition that management of Musharakah business will be carried out by one or few of them. In such a condition sleeping partners are allowed to the profit only to the extent of their investment.

However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all the matters of the business and any work done by one of them in the normal course of business shall be deemed to be authorized by all the partners.

Termination of Musharakah

Musharakah is deemed to be terminated in any one of the following events:
1) Every partner has a right to terminate the contract of musharakah at any time after serving a notice to other partners.
2) In case of death of a partner, the contract of musharakah come to an end. His heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of musharakah.
3) If any one of the partner becomes insane or incapable of being a partner, the musharakah agreement stands terminated.

Termination of Musharakah without Closing the Business

If one of the partners wants termination of the Musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. The partners who want to run the business may purchase the share of the partner who wants to terminate his partnership, because the termination of the Musharakah with one partner does not imply its termination between the other partners.

However, in this case, the price of the share of the leaving partner must be determined by mutual consent, and if there is a dispute about the valuation of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or the distribution of the assets themselves.

The question arises whether the partners can agree, while entering into the contract of the Musharakah, on a condition that the liquidation or separation of the business shall not be effected unless all the partners, or the majority of them wants to do so, and that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation. Most of the traditional books of Islamic Fiqh seem to be silent on this question. However, it appears that there is no bar from the Shari’ah point of view if the partners agree to such a condition right at the beginning of the Musharakah. This is expressly permitted by some Hanbali jurists.This condition may be justified, especially in the modern situations, on the ground that the nature of business, in most cases today, requires continuity for it’s success, and the liquidation or separation at the instance of a single partner only may cause irreparable damage to the other partners.

If a particular business has been started with huge amounts of money which has been invested in a long term project, and one of the partners seeks liquidation in the infancy of the project, it may be fatal to the interests of the partners, as well as to the economic growth of the society, to give him such an arbitrary power of liquidation or separation. Therefore such a condition seems to be justified.

2010-01-14T04:08:00.000-08:00

There are different terms that are used for Islamic banking and Finance as Islamic Banking, Islamic Finance, Halal Finance, Halal Investment, Halal Mortgages, Islamic Investment, Islamic Loans, Sharia Banking, Sharia Finance and Sharia Investment etc.

Islamic banking and finance or Islamic Finance refers to a system of banking or banking activity(s) that is consistent with Sharia based principles and rules and guidelines of Islamic finance.

Islamic law prohibits interest (usury) commonly called riba, the collection and payment of interest, trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered unlawful, or haraam.

Islamic finance has been gaining momentum on a global scale for the last few years. Many Islamic Banks have sprung up over the last few years. These changes are occurring both in Muslim and in western countries, and are driven by a global trend amongst Muslims to become more observant of their faith. It might have been the reason why Islamic Banking emerged, however, today Islamic Banking is sought by Muslims and non-Muslims due to the benefits it offers.

MODES OF ISLAMIC FINANCE

There are different modes of Islamic Finance that are used by Islamic Financial Institutions in financial transactions. Here is a brief summary of modes of Islamic Finance. For more details please visit links in mode of finance.

Mudarabah

Musharakah

Diminishing Musharakah

Mudarabah

Mudarabah is a special kind of partnership permitted by Sharia where one partner provide funds to another for investments it in a commercial enterprise (mortgage, insurance, credit, financing and other business). The partner who invests is called "rabb-ul mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib".

Visit this link to read more about Mudarabah

Musharakah

Musharakah means a joint enterprise formed for conducting some business in which all partners contribute to capital and management is done by all and any one acting for all. Profit is shared according to a predetermined specific ratio while the loss is shared according to the ratio of the contribution (capital).

Diminishing Musharakah

Another form of Musharakah, developed in the near past, is 'Diminishing Musharakah'. According to this concept, a financier and his client participate either in the joint ownership of a property or an equipment, or in a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financier are purchased by him so as to make him the sole owner of the property, or the commercial enterprise, as the case may be.

Murabaha

Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance.

Ijarah

Ijarah is a contract of transfer of known and proposed usufruct against a specified and lawful return or consideration of a product or service. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.

Ijarah-Wal-Iqtina

A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

Istisna

It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways.

Salam

Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies. Barring this, Bai Salam covers almost everything, which is capable of being definitely described as to quantity, quality and workmanship.

Istijrar

Istijrar means purchasing goods time to time in different quantities. In Islamic jurisprudence Istijrar is an agreement where a buyer purchases something from time to time; each time there is no offer or acceptance or bargain. There is one master agreement where all terms and conditions are finalized.

practice table

2010-01-12T01:18:00.000-08:00

Mudarabah is a very common mode of finance used by islamic institutions. Mudarabah is mostly used in deposit base products like as saving accounts, term deposits etc.This article is covers the following aspects of Mudarabah.

Definition

Types of Mudarabah

Business of the Mudarabah

Joint Mudarabah

Distribution of the profit

Termination of Mudarabah

Definition

Mudarabah is a special kind of partnership permitted by Shariah where one partner gives money to another for investments it in a commercial enterprise (mortgage, insurance, credit, financing and other business). The investments comes from the first partner who is called "rabb-ul mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib".

Types of Mudarabah

There are two types of Mudarabah

Al-Mudarabah Al-Muqayyadah (restricted mudarabah)

The rabb-ul-mal may specify a particular business for the mudarib i.e. (mortgage, insurance, credit, financing, banking, investment funds, bonds investment and any other business), in which case he shall invest the money in that particular business only. This is called al-Mudarabah al-muqayyadah (restricted mudarabah).

Al-Mudarabah Al-Mutlaqah (unrestricted mudarabah)

But if he has left it open for the mudarib to undertake whatever business he wishes, the mudarib shall be authorized to invest the money in any business he deems fit. This type of mudarabah is called 'al-mudarabah al-mutlaqah" (unrestricted mudarabah)

Business of the Mudarabah

Mudarabah is partnership business and any type of business can be formed under Mudarabah. There is no restriction by rules to do a specific business under Mudarabah agreement. It is mutual agreement of rabb-ul-mal (The Investor) and mudarib (The Manager) to select the type of business i.e. (mortgage, insurance, credit, financing, banking, investment funds, bonds investment and any other business).

Joint Mudarabah

A rabbul-mal can contract mudarabah with more than one person through a single transaction. It means that he can offer his money to A and B both, so that each one of them can act for him as mudarib and the capital of the mudarabah shall be utilized by both of them jointly, and the share of the mudarib shall be distributed between them according to the agreed proportion. In this case both the mudaribs shall run the business as if they were partner’s interest. The mudarib or mudaribs, as the case may be, are authorized to do anything which is normally done in the course of business. However, if they want to do an extraordinary work, which is beyond the normal routine of the traders, they cannot do so without express permission from the rabb-ul-mal.

Distribution of the profit

It is necessary for vaidity of mudarabah that parties should define profit sharing ratio at the beginning of business. There is no particular proportion has been prescribed by the Shariah. It has been left on mutual consent of paraties. They can share the profit in equal proportions, and they can also allocate different proportions for the rabb-ul-mal and the mudarib. However, a lump sum amount of profit cannot be allocated to any party and they cannot fix a specific rate of profit tied up with capital. For example, if the capital is USD 1,000,000/- they cannot agree on a condition that USD 100,000/- out of the profit shall be the share of the mudarib, nor can they say that 20% of the capital shall be given to rabb-ul-mal. However, they can agree on that 40% of the actual profit shall go to the mudarib and 60% to the rabb-ul-mal or vice versa.

However they can fix different ratios of profit for different situations i.e. the rabbul-mal can say to mudarib, "If you trade in cloth, you will get 30% of the profit and if you trade in made-ups, you will have 50% of the profit. In same way he can say "If you do the business in your town, you will be entitled to 30% of the profit, and if you do it in another town, your share will be 50% of the profit. Mudarib cannot claim any salay, remuneration or fee for work done other than his share of profit. All the schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed for the mudarib drawing his daily expenses of food only from the mudarabah account.

The Hanafi jurists restrict this right of the mudarib only to a situation when he is on a business trip outside his own city. In this case he can claim his personal expenses, accommodation, food, etc., but he is not entitled to get anything as daily allowances when he is in his own city. If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, and then the remainder, if any, shall be distributed between the parties according to the agreed ratio.

Termination of Mudarabah

The contract of mudarabah can be terminated at any time by either of the two parties. The only condition is to give a notice to the other party. If all the assets of the mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the agreed ratio. However, if the assets of the mudarabah are not in the cash form, the mudarib shall be given an opportunity to sell and liquidate them, so that the actual profit may be determined.
There is a difference of opinion among the Muslim jurists about the question whether the contract of mudarabah can be affected for a specified period after which it terminates automatically. The Hanafi and Hanbali schools are of the view that the mudarabah can be restricted to a particular term, like one year, six months, etc, after which it will come to an end without a notice. On the contrary, Shafi‘i and Maliki schools are of the opinion that the mudarabah cannot be restricted to a particular time.
However, this difference of opinion relates only to the maximum time-limit of the mudarabah. Can a minimum time-limit also be fixed by the parties before which mudarabah cannot be terminated? No express answer to this question is found in the books of Islamic Fiqh, but it appears from the general principles enumerated therein that no such limit can be fixed, and each party is at liberty to terminate the contract whenever he wishes.
This unlimited power of the parties to terminate the mudarabah at their pleasure may create some difficulties in the context of the present circumstances, because most of the commercial enterprises today need time to bring fruits. They also demand constant and complex efforts. Therefore, it may be disastrous to the project, if the rabb-ul-mal terminates the mudarabah right in the beginning of the enterprise. Specially, it may bring a severe set-back to the mudarib who will earn nothing despite all his efforts. Therefore, if the parties agree, when entering into the mudarabah, that no party shall terminate it during a specified period, except in specified circumstances, it does not seem to violate any principle of Shariah.

2010-01-09T03:49:00.000-08:00

2010-01-08T02:07:00.001-08:00

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FAQs

2009-12-13T22:56:00.000-08:00

FAQs on Islamic Banking covers all possible questions that can be raised in your mind. However any question or matter not covered can be clarified through FEED BACK form.

Q 1) What is Islamic Banking?

Islamic banking is defined as banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and un-social practices.

In practical sense,Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic prosperity.

Q 2). What is the philosophy of Islamic banking?

The philosophy of Islamic banking takes the lead from Islamic Shariah. According to Islamic Shariah, Islamic banking cannot deal in transactions involving interest/riba (an increase stipulated or sought over the principal of a loan or debt). Further, they cannot deal in the transactions having the element of Gharar (Excessive level of uncertainty or ambiguity created due to the lack of information or control in a contract.) or Maiser (Game of Chance). Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of Islam). Islamic banks focus on generating returns through investment tools which are Shariah compliant as well. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of finance.The prohibition of a risk free return and permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities asset-backed in an Islamic set-up with ability to cause ‘value addition’.

Q 3) What is Meant By Riba?

The word "Riba" means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). This definition of Riba is derived from the Quran and is unanimously accepted by all Islamic scholars.

The meaning of Riba has been clarified in the following verses of Quran.

"O those who believe; fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your principal; neither will you do wrong nor will you be wronged.(Surah Al Baqarah 2:278-9)"

Q 4) What is interest? Is there any difference between interest and Riba?

The origination of term interest dates back to 17th century with the emergence of banking system at global level. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning/value as that of Riba as defined in the previous question. Further, it is narrated that “the loan that draws interest is Riba”. There is consensus among the Muslim scholars of all the fiqhs that interest is Riba in all its forms and manifestations.

Q 5) What are the different kinds of Riba?

There are two kinds of Riba:

* Riba-An-Nasiyah/Riba-Al-Quran
* Riba-Al-Fadl/Riba-Al-Hadith

Riba An Nasiyah/Riba Al-Quran:

In the Holy Quran, Allah (SWT) says in Sura Al-Baqarah (2-279):

“ …..And if you repent, yours is your principal”

It is reported by Harith ibe Abi Usamah in his Musnad that Sayyidna Ali Radi-Allahu Anhu reportedly referred that the Holy Prophet said:

"Every loan that derives a benefit (to the lender) is riba".(Al-Syuti, Al-Jame’ al-Saghir V.2, P.94)

Example of Riba-al-Nasiyah/Interest: If Mr. A lends Rs.100 to Mr. B (a borrower) with a condition that Mr. B shall return him Rs.110 after one month. In this case, the extra amount of Rs. 10 is Riba or Interest.

Riba-al-Fadl:

Abu Said al Khudri Radi-Allahu anhu narrated that Holy Prophet (Peace be Upon Him) said:

"Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, like for like, payment made hand by hand. If anyone gives more or asks for more, he has dealt in riba. The receiver and giver are equally guilty".

Based on aforesaid definition, it may be noted that economically speaking it would be irrational to exchange one kilogram of wheat with one and a half kilogram of wheat in a spot exchange. Therefore, some fuqaha have pointed out that Riba-al-Fadl has been prohibited because if it was left un-prohibited it could be used as a subterfuge for getting Riba-al-Nasiyah. Of the six commodities specified in the hadith, two (gold and silver) unmistakably represent commodity money used at that time. One of the basic characteristics of gold and silver is that they are monetary commodities. As a matter of fact, each of the six commodities mentioned in the hadith has been used as a medium of exchange at some time or the other.During the dark ages, only the first form (Riba An Nasiyah) was considered to beRiba. However, the Holy Prophet (Peace be Upon Him) also classified the second form (Riba-al-Fadl) also as Riba.

Q 6) What are the revelations/verses in Holy Quran regarding prohibition of Riba/interest?

There are four sets of revelations about Riba which were revealed on different occasions.

1. First Revelation: In Surah-Ar-Rum, verse 39 , dealing in riba has been discouraged in the following words:

"And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah." [Surah Ar-Rum 30:39]

2. Second Revelation: Muslims have been informed about the practice of taking riba by Jews in Surah An-Nisaa:

"And because of their charging riba while they were prohibited from it." [Surah An-Nisaa 4-161]

3. Third Revelation: Riba/Interest has been abolished in the third verse of Surah Ali-Imran. The prohibition of riba is laid down in the following words:

"O those who believe do not eat up riba doubled and redoubled." [Surah Al-e-Imran 3- 130]

4. Fourth Revelation: In the fourth revelation, Riba has categorically been prohibited in all its forms. The following set of verses is found in the Surah Al-Baqarah, verse 275-281 in the following words:

"Those who take interest will not stand but as stands whom the demon has driven crazy by his touch. That is because they have said: 'Trading is but like riba'. And Allah has permitted trading and prohibited riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to Allah. And the ones who revert back, those are the people of Fire. There they remain for ever. Allah destroys riba and nourishes charities. And Allah does not like any sinful disbeliever. Surely those who believe and do good deeds, establish Salah and pay Zakah, have their reward with their Lord, and there is no fear for them, nor shall they grieve. Othose who believe, fear Allah and give up what still remains of the riba if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be wronged. And if there be one in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. And they shall not be wronged." [Surah Al-Baqarah 2:275-281]

Q 7) What are the sayings/Ahadith9 about Riba/Interest?

According to Islamic jurists and scholars, there are around 40 different Ahadith on the subject of riba and its prohibition from Holy Prophet (peace be upon him). Few of these are as follows:

1. From Hazrat Jabir (May Allah be pleased with him): The Prophet, cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: "They are all alike [in guilt]."

2. Jabir ibn Abdallah (May Allah be pleased with him), giving a report on the Prophets Farewell Pilgrimage, said: The Prophet addressed the people and said "All of the riba of Jahiliyyah is annulled. The first riba that I annul is our riba, that accruing to Abbas ibn Abd al-Muttalib (the Prophet’s uncle); it is being cancelled completely."

3. From Hazrat Abdallah ibn Hanzalah (May Allah be pleased with him): The Prophet, said: "A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times."

4. Bayhaqi has also reported the above hadith in Shuab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful."

5. From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest."

6. From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother."

7. From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "There will certainly come a time for mankind when everyone will take riba and if he does not do so, its dust will reach him."

8. From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "God would be justified in not allowing four persons to enter paradise or to taste its blessings: he who drinks habitually, he who takes riba, he who usurps an orphans property without right, and he who is undutiful to his parents."

Q 8) Are there any injunctions against Riba/usury in religious texts other than Holy Quran?

The following references against the prohibition of Riba/usury are drawn from the old testament of the bible:

Deuteronomy 23:19: "Thou shall not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything that is lent upon usury."

Psalms 15:1, 2, 5: "Lord, who shall abide in thy tabernacle? Who shall dwell in thy holy hill? He that walketh uprightly, and worketh righteousness and speaketh the truth in his heart. He that putteth not out of his money to usury, nor taketh reward against the innocent."

Proverbs 28:8: "He that by usury and unjust gain increaseth his substance, he shall gather it for him that will pity the poor."

Nehemiah 5:7: "Then I consulted with myself, and I rebuked the nobles, and rules and said unto them, Ye exact usury, every one of his brother. And I set a great assembly
against them."

Ezekiel 18:8.9: "He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniguity, hath executed true judgment between man and man, hath walked in my statues, and hath kept my judgments, to deal truly; he is just. He shall surely live, said the Lord God."

Ezekiel 22:12: "In thee have they taken gifts to shed blood; thou hast taken usury and increase, and though hast greedily gained of thy neighbors by extortion, and hast forgotten me, said the Lord God."

In these excerpts of the Bible the word usury is used in the sense of any amount claimed by the creditor over and above the principal advanced by him to the debtor. The word riba used in the Holy Qur'an carries the same meaning because the verse of Surah An-Nisaa (4-161) explicitly mentions that riba was prohibited for the Jews also.

Q 9) Does interest/Riba is related only to consumption loans or it applies to commercial loans also?

The interest is prohibited whether it is consumption loan (loan for meeting day to day human needs) or commercial loan (loan for business purpose). There are quite a number of ahadith which clarify that in the days of Holy prophet, people not only borrowed for consumption purposes but also for productive purposes. A few of the ahadith are given as follows for reference:

(i) Ibn Saad has reported Hazrat Umar ( Radi-Allahu anhu), wanted to send a trade caravan to Syriya. He borrowed four thousand dirhams from Sayyidna Abdurrahman ibn Awaf, Radi-Allahu anhu for this purpose.

(ii) Ibn Jarrir has reported that Hind, daughter of Utbah and wife of Abu Sufyan borrowed four thousand dirhams from Sayyidna Umar, Radi-Allahu anhu, for the purpose of her trade. She invested this money in purchasing goods and selling them in the market of the tribe of Kalb.

Q 10) Does the prohibition of Riba apply equally to the loans obtained from or extended to Muslims as well as non-Muslims?

With respect to the receipt and payment of interest, there is no distinction between Muslims and non-Muslims or between individuals and states because interest is prohibited not only in Islamic scriptures but also in other religious scriptures of the world as given in Question No. 8 above. Therefore, prohibitions of interest apply to Muslims as well as to non-Muslims.

Q 11): What are the basic principles of Islamic banking?

There are at least six basic principles which are taken into consideration while executing any Islamic banking transaction. These principles differentiate a financial transaction from a Riba/interest based transaction to an Islamic banking transaction.

1. Sanctity of contract: Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the eyes of Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or voidable. An invalid contract is a contract, which by virtue of its nature is invalid according to Shariah rulings. Whereas a voidable contract is a contract, which by nature is valid, but some invalid components are inserted in the valid contract. Unless these invalid components are eliminated from the valid contract, the contract will remain voidable.

2. Risk sharing: Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkhiraj Biddamaan 21 ” and “Alghunun Bilghurum22”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit. Thus in every Islamic banking transaction, the Islamic financial institution and/or its deposit holder take(s) the risk of ownership of the tangible asset, real services or capital before earning any profit there from.

3. No Riba/interest: Islamic banks cannot involve in riba/interest related transactions. They cannot lend money to earn additional amount on it. However as stated in point No. 2 above, it earns profit by taking risk of tangible assets, real services or capital and passes on this profit/loss to its deposit holders who also take the risk of their capital.

4. Economic purpose/activity: Every Islamic banking transaction has certain economic purpose/activity. Further, Islamic banking transactions are backed by tangible asset or real service.

5. Fairness: Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.

6. No invalid subject matter: While executing an Islamic banking transaction, it is ensured that no invalid subject matter or activity is financed by the Islamic financial transaction. Some subject matter or activities may be allowed by the law of the land but if the same are not allowed by Shariah, these can not be financed by an Islamic bank.

Q 12) What is meant by Shariah/Islamic Law?

Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the divine law of Islam is derived from the following four sources:

1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)

Q 13): The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar?

The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. If a transaction is done according to the rules of Islamic Shariah it is halal even if the end result of the product may look similar to conventional banking product.

For example a normal McDonalds burger in USA and Pakistan may look similar, smell similar and taste similar but the former is haram and the later is halal due to its compliance of Islamic guidelines of slaughtering animals.

Similarly, if a person is feeling hungry, he may steal a piece of bread and eat or alternatively buy a piece of bread to eat. The apparent end result would be same but one is permissible in Shariah and the other is not allowed.

The same is also true for Islamic and conventional banking. Therefore, it can be concluded that it is the underlying transaction that makes something “Halal” (allowed) or “Haram” (prohibited) and not the result itself. Apparently, Islamic banks may look similar to conventional banks, however the contracts and product structures used by Islamic banks are quite different from that of the conventional bank. In the verse 2:275 of the Holy Quran, Allah the Almighty has responded to the apparent similarity between trade and interest by resolutely informing that he has permitted trade and prohibited Riba (though they may look similar to someone).

Q 14) If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers?

The Islamic bank uses its funds in various trade, investment and service related Shariah compliant activities and earns profit thereupon. The profit earned from such activities is passed on to the depositors according to the agreed terms.

Q 15). Are not Islamic banks just paying interest and dressing it as profit on trade and investments?

No, Islamic banks accept the deposits either on profit and loss sharing basis or on Qard basis. These deposits are deployed in financing, trading or investment activities by using the Shariah compliant modes of finance. The profit so earned by the bank is passed on to the depositors according to the pre-agreed ratio which, therefore, cannot be termed as interest.

Q 16): Islamic banks use interest base system (KIBOR) as a Bench Mark while determining profit; how Islamic banking can be said to be Islamic?

Islamic banks should ideally have their own benchmark system for determination of profit. Since, the industry is in its initial stage of development, it is using the available benchmark for the banking industry. It is expected that once it is grown to a sizable level, it would have its own benchmark. However, using Interest Rate benchmark for determining the profit of any permissible transaction does not render the transaction as invalid or haram. It is the nature/mechanism of the transaction that determines its validity or otherwise.

For example Mr. A and Mr. B are two neighbors. Mr. A sells liquor which is totall prohibited in Islam whereas Mr. B, being a practicing Muslim dislikes the business of Mr. A and starts the business of soft drinks. Mr. A wants his business to earn as much profit as Mr. A earns through trading in liquor. Therefore he decides that he will charge the same rate of profit from his customers as Mr. A charges over the sale of liquor. Thus he has tied up his rate of profit with the rate used by Mr. A in his prohibited business.

One may say that Mr. B uses an undesirable benchmark in determining the rate of profit, but obviously no one can say that the profit charged by him is haram because he has used the rate of profit of the business of liquor only as a benchmark. The same is true for Islamic banks, it is most desirable and preferable that Islamic banks develop their own benchmark however; in the absence of any such alternative, interest rate related benchmark can be used.

Q 17) Is Islamic banking meant only for Muslims?

The teachings of Islam are not confined to Muslims, rather these equally address the non-Muslims due to their universal nature. The basis of Islamic banks is laid down on ethical values and socially responsible system. The values like justice, mutual help, fee consent and honesty on the part of the parties to a contract, avoiding fraud, misrepresentation and misstatement of facts and negation of injustice or exploitation form the basic principles of Islamic banking. Therefore, the principles of Islamic banking lead the economic system to achieve the common good and economic prosperity. On this premise, Islamic banking becomes a viable option for everyone irrespective of their religion.

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2009-12-06T23:14:00.001-08:00

Islamic Banking Explained

2009-05-26T22:29:00.000-07:00

Author: Adam Khan

Ever one is talking about Islamic Banking System even recently world largest bank HSBC has also started to facilitate customer under Islamic Banking System, particularly in housing and mortgage area.

Islamic banks appeared on the world scene as active players over two decades ago. But "many of the principles upon which Islamic banking is based have been commonly accepted all over the world, for centuries rather than decades".

The basic principle of Islamic banking is the prohibition of Riba- (Usury - or interest): "While a basic tenant of Islamic banking - the outlawing of riba, a term that encompasses not only the concept of usury, but also that of interest - has seldom been recognised as applicable beyond the Islamic world, many of its guiding principles have. The majority of these principles are based on simple morality and common sense, which form the bases of many religions, including Islam. "The universal nature of these principles is immediately apparent even at a cursory glance of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other writers, particularly those writing in the 19th century, have attacked the barbarity of the practice. Much of the morality championed by Victorian writers such as Dickens - ranging from the equitable distribution of wealth through to man's fundamental right to work - is clearly present in modern Islamic society. "Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century." (Islamic Finance: A Euromoney Publication, 1997) It is evident that Islamic finance was practiced predominantly in the Muslim world throughout the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen. The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the oil producing countries, received a boost due to rationalization of the oil prices, which had hitherto been under the control of foreign oil Corporations. These events led Muslims' to strive to model their lives in accordance with the ethics and philosophy of Islam. Disenchantment with the value neutral capitalist and socialist financial systems led not only Muslims but also others to look for ethical values in their financial dealings and in the West some financial organisations have opted for ethical operations. Islam not only prohibits dealing in interest but also in liquor, pork, gambling, pornography and anything else, which the Shariah (Islamic Law) deems Haram (unlawful). Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as: While permitting the individual the right to seek his economic well-being, Islam makes a clear distinction between what is Halal (lawful) and what is haram (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious. While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it. While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat. While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance. Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive. The Islamic financial system employs the concept of participation in the enterprise, utilizing the funds at risk on a profit-and- loss-sharing basis. This by no means implies that investments with financial institutions are necessarily speculative. This can be excluded by careful investment policy, diversification of risk and prudent management by Islamic financial institutions. It is possible, that investment in Islamic financial institutions can provide potential profit in proportion to the risk assumed to satisfy the differing demands of participants in the contemporary environment and within the guidelines of the Shariah. The concept of profit-and-loss sharing, as a basis of financial transactions is a progressive one as it distinguishes good performance from the bad and the mediocre. This concept therefore encourages better resource management. Islamic banks are structured to retain a clearly differentiated status between business , shareholders' capital and clients' deposits in order to ensure correct profit-sharing according to Islamic Law.

Article Source: www.articlesbase.com

About the Author:Adam

Building Reliance on Islamic Finance and Banking

2009-05-26T06:20:00.000-07:00

ARTICLE (August 24 2006): Nowadays Islamic finance is a more common term not only in the country, but throughout the world and the Islamic financial institutions are now handling an asset base of around $300 billion. These institutions are spread all over the world, including European countries and the United States.

In particular these have their significant presence in Saudi Arabia, Bahrain, the United Arab Emirates, and other GCC countries, Malaysia, Sudan and Iran. With the grace of Allah Almighty, we are now fortunate enough to have a number of Islamic financial institutions operating in the country.

These Institutions include Islamic commercial banks, Islamic banking branches of various commercial banks, certain Islamic investment finance companies, Islamic mutual funds, Modarabas, Takaful companies (incorporated but not yet commenced operations) and certain other financial institutions that are offering financial products under Islamic modes of finance e.g. House Building Finance Corporation and certain leasing companies.

With such a fortune, the next target which the Islamic banking and finance industry is facing is to build the public reliance on the Islamic finance and banking.

CAN BANKING AND FINANCE EVER BE REALLY ISLAMIC?

At the outset, we feel it pertinent to discuss a very common question that is in the mind of every Muslim, particularly in Pakistan because here we have already faced a complete disaster in the name of interest-free banking and so-called Islamic financial institutions, including Modarabas.

The question, as to whether Islamic banking is really Islamic, has two different facets. The first one is that whatever is being performed in the name of Islamic banking is apparently quite similar to the operations of a conventional financial institution hence creates doubts in the people's mind. The second facet of this question is more important and deals with the socio-economic factors associated with the overall Islamic financial system.

The Islamic economic system is not something that can work in isolation of the geo-political and legislative system, as well as, and more importantly the society's behavior towards the injunctions of Islamic Shariah in personal and collective matters. Accordingly, one can easily imagine that in an economy whereby most of the businessmen are not honest in fairly presenting the financial statements of their businesses, how difficult it is to introduce a profit-and-loss sharing based financial solution.

Similarly, in most of the cases payment of Zakat and Sadqat depends on the individual and particularly, in view of the gigantic volume of the black economy in the country, which according to certain estimates is larger than the white economy in Pakistan, what can be expected even if a good system for Zakat and Ushr is introduced?

Accordingly, the complete transition of economy to an Islamic economic system can be performed when and only when the overall consensus of the society is developed towards practical application of Shariah in all the facets of human life, particularly including the governmental, political and legislative structures.

Despite such an unsatisfactory and rather discouraging attitude of the society towards application of Islamic Shariah, it should be noted that such a situation do not relieve a Muslim from the applicability of Shariah principles, but rather increases his responsibilities in the way that it becomes his duty not only to try to abide by all applicable Shariah requirements in his personal capacity but also to put his endeavors towards improvement in such system.

INTEREST-FREE BANKING INTRODUCED IN 80S:

As far as the first question is concerned, we may conclude that Islamic banking in Pakistan may be divided in two different regimes. The first one that is generally called interest-free banking was introduced in the regime of General Mohammad Zia-ul-Haq, and which is still in operation in Pakistan with the conventional commercial banks and other financial institutions. Without any doubt on the intentions of the people who initiated the same and who endeavored to convert the whole system on an Islamic basis, it may be concluded that in the softest terms we may call such experiment a disaster for Islamic banking which was not only a failed experiment of its own but also resulted in practical impediments in the operation of real Islamic banking in Pakistan.

THE OVERALL SCHEME IMPLEMENTED BY GENERAL ZIA'S TEAM CONSISTED OF FOLLOWING STEPS:

-- Replacement of complete interest-based banking system with non-interest based system;

-- Amendments in company law and certain other laws to introduce certain Shariah compliant financial solutions including interest-free redeemable capital and certain restrictions on purely interest based instruments including debentures and preference shares; and

-- Introduction of Modarabas as interest-free limited financial service providers and special purpose vehicles for raising interest-free finances.

-- Although we feel that the intentions of the initiators were quite positive, the system could not survive because of a few basic factors, as follows:

-- The implementers (bankers and public-at-large) were generally not believing in the prohibition of Riba in Islam or were not aware of applicability of practical alternatives of interest based financial solutions and were of the opinion that this system cannot survive, or more appropriately we can say, that they were not willing to change it due to reasons of their own;

-- People amongst the general public, who were well aware of prohibition of interest in Islam, were practically away from the banking and financial markets and no sincere efforts were made to bring them in, and accordingly they are still away from that system. In other words we may say that banking system, Islamic or conventional, has no impact on them as they are already away from the same leaving majority of such people in effective position (both from the bankers and public including industrialists and traders) who are practically unaware of their responsibilities as a Muslim in this respect;

-- No adequate training of Islamic banking was carried out for the bankers nor for the public at large; and

-- Although the scheme of interest-free banking introduced through the State Bank's circulars, by itself contained a few question marks from Shariah perspective. Moreover, there was no monitoring structure for the same from Shariah perspective by the regulators, resulting in a situation that every banker got a few Shariah compliant agreements prepared and then started interpreting Islam of his own resulting in a purely interest based financing system with the title of mark-up and profit instead of interest.

The above mentioned factors should not be considered as all inclusive, however, these may cause us to believe that the interest-free banking system as in vogue in Pakistan is absolutely not Islamic.

WHAT'S UP NOW?

After the historical judgments on Riba, first by the honorable Federal Shariat Court and then by the honorable Shariat Appellate Bench, Supreme Court of Pakistan on an appeal there against, it has been established that the banking system in vogue in the country is not Shariah-compliant at all and according to the Constitution of the country any law repugnant to the principles of Islamic Shariah shall be considered invalid and accordingly, both the honorable courts allowed the federal government with some time to ensure transition of conventional banking and economic system into a Shariah compliant economic system duly including the financial system in practice.

Although with a more recent judgment of the honorable Supreme Court of Pakistan, the said judgment has been set aside and apparently the government quarters, as in the past, are not appearing to do the needful. However, in order to lower the day by day raising voice in demand of Islamic banking in the country, and to some extent by the endeavors of certain sincere officials, the State Bank has now decided to implement a parallel Islamic Banking system in the country and is now allowing opening of Islamic commercial banks and Islamic banking subsidiaries and branches of conventional banks who will operate under strict Shariah compliance under monitoring by their respective Shariah Boards/Shariah Advisors and to some extent by the regulators also.

Similarly, the Securities and Exchange Commission of Pakistan (SECP) has principally agreed to allow Takaful (Islamic Insurance) companies to operate in Pakistan, although the relevant rules are presently in development stage. A few Modarabas have already been operating in Pakistan under Shariah compliant modes for last two decades whereas as a recent introduction, two Islamic mutual funds have commenced operation in the country within the past two years.

In this respect it should be appreciated that the State Bank has offered its maximum support to these Islamic banks in form of various Shariah compliant schemes for them particularly including and Islamic Export Refinance Scheme which was a prominent demand of the Islamic banking sector. Similarly, an important amendment has been introduced in the Sales Tax law to support Murabaha transactions by Islamic Banks.

OPERATIONS OF ISLAMIC BANKS:

Now the Islamic banks in the country having been licensed as Islamic commercial banks are operating under the requirements of Islamic Shariah. These banks have their own Shariah Supervisory Boards and Shariah Advisors generally comprising renowned Shariah scholars and it may be concluded that these banks do not do anything Haram by will except under compulsion for which they obtain approval from their Shariah Boards and Advisors.

If, for any reason, they earn some earning which is not Halal, the same is contributed to charity under approval of their Shariah Boards and Advisors. These include full-fledged Islamic commercial banks and the Islamic banking branches of conventional banks.

However, when considering their operations it may be observed that although their liability side is purely based on Musharaka and Modaraba, their asset side generally comprise of Murabaha and Ijara Muntahia Bittamleek which are although permissible but are considered less desired or border-line transactions.

In this respect, their perspective is also important to be heard, according to which, unless an adequate documentation and fair financial reporting culture is implemented in the country, with due will of the businessmen fraction, Musharaka and Modaraba based financial services may not be offered at large.

SOCIO-ECONOMIC EFFECTS:

The second facet of our question is about the socio-economic factors of Islamic banking. In this respect a few people, generally practicing Muslims, are of the view that since the Islamic banking is also based on profit motive and in present form it generally works on fixed return basis although the risks it take are higher than the traditional banking, hence the same cannot be a positive factor towards the socio-economic changes Islam desires. This question is very important and the writer personally concurs with the concerns of those who raise the same, at least to certain extent.

In this respect it can easily be concluded that the fixed return based banking, although being Shariah compliant, is not what has been desired by Islam as a complete way of living. On the contrary, besides Islamic banking in the country is in its experimental stages, we should also bear in mind that only the change in banking system is not a solution to the overall revolution of economic system unless other facets of Islamic economic system are not implemented simultaneously. Consequently, in case the Islamic banking, in your opinion, is not contributing enough towards betterment of society, you cannot blame the same alone.

WHY ISLAMIC FINANCE?

Most importantly, it should be kept in mind that in some areas Haram and Halal have a very small difference. For example, only saying the name of Allah Almighty on an animal at the time of slaughter makes it Halal and permissible while by not saying that name we make it Haram or by just a few words of acceptance in Nikah, in presence of a few persons, a man and woman become Halal for each other.

Similarly, if a transaction can be engineered in a way that the same becomes Shariah compliant, then we should not conclude that the same is Haram only due to its resemblance with the interest based financing.

It is also pertinent to note that since the Islamic financial services sector is in its initial stages, as compared to the conventional banking, we unfortunately have to follow the conventional system in the pattern of financial products and are still not in a position to invent absolutely new financial services. For example, if they have running finance and overdraft as a financing tool, we have invented an alternate to the same in form of Istijrar with Murabaha or Musharaka based running finance model.

Similarly, if they use finance leases as a financing tool, we have converted the same in a Shariah compliant form in form of Ijara Muntahia Bittamleek or in form of Diminishing Musharaka. These are only two examples, but the tally is practically very high and for each interest based financial product except for those explicitly Haram, more than one alternates have been engineered.

In this respect, it also needs to be considered that during the last few centuries, the conventional banking system has well read the human needs and psychology and has invented a considerable number of financial products and accordingly, it is not simple to just invent a new financial tool just for the purpose of inventing one.

As a conclusion to this question, we may say that we are required by our religion to implement a complete Islamic way of living in our individual and collective lives and the society and the government as well. The Islamic banking and financial system is a part of such system and is not construed to be applicable in isolation while other laws and customs repugnant to the Shariah requirements are still in force.

However, for the sake of our own benefits, in order to avoid interest by ourselves and providing interest-free opportunities to our brothers and sisters in Islam, we should promote and support the Islamic banking and finance in the country with all our possible efforts and endeavors. Such Islamic banking can provide us with a shelter from interest based transactions for the time being and might support us in augmenting a truly Islamic financial system, and more appropriately said, will serve as an experiment for the time when we will really be in a position to the implement the complete Islamic way of living in our beloved country.

The first argument which is generally heard against Islamic banking is that there is NO difference between the conventional banking and Islamic banking and this is merely a change of name. The second argument is that even in Islamic banking, the most common products being used e.g. Murabaha, Musawwama, Salam, Istisna and Ijara Muntahia Bittamleek are on fixed return basis. Answers to these observations have already been discussed in the preceding paragraphs. However, we should just recall the fact that unless we can distinguish an Islamic bank from a conventional bank, it would be difficult for any of us to rely on the same.

Particularly, it is observed that they try to make sure that their product is similar to the conventional products in all respects, even if for that purpose they have to incorporate a few provisions in these products which are not considered to be good or a few of them are considered Makrooh. In addition, their endeavors are focused towards minimization of their risk through every possible option and accordingly, the essence of Islamic finance which is based on risk taking is killed.

The third question is generally raised on the honesty and integrity of Islamic financial institutions. This question, which is asked the most times, is that these Banks are using the name of Islam to earn a few bucks more as compared to the conventional banks. This question has two sides. The first one is on the financing side, where these Banks charge higher than the charges of a conventional bank.

In other words, internal rate of return on Islamic financial products is higher than the conventional products. A justification of this argument is that since the Islamic financial institutions are subject to the commodity risk and the price risk, in addition to the conventional risks that a bank faces, they are justified in their demand. In addition, particularly in case of Ijara Muntahia Bittamleek, since the risk and reward of the asset rests with them for the whole tenure of lease, which inter-alia includes payment of insurance premiums, they may be justified in charging a higher rental. Nevertheless, financial experts have generally felt that even if these factors are considered, the pricing by these Banks is on the higher side.

On the contrary, it is observed that on the deposit sides they pay less as compared to the conventional banks. In addition, it is generally observed that the expected rates, as well as, the actual rates of return offered by these financial institutions are fairly equivalent to the rates being offered by conventional financial institutions.

In a profit and loss based model, it is agreeable that they assign weightage to different types of deposits in a manner that the total return on investment and financing pools is allocated amongst various depositors and the Bank (working as a partner). Nevertheless, the question that a participant of a lecture asked me was very distressing for me, as well as, most of the supporters of the Islamic finance in general. He asked the reason as to why the return to depositors of these banks averages out to be 2 percent per annum - which is slightly less than or fairly equivalent to the rates being offered by the conventional banks, whereas their return on capital employed, which is attributable to the shareholders is around 20 percent per annum.

The fourth question is the acceptability of insurance under conventional mode. A number of practicing Muslims and jurists are of the view that unless the option of Takaful is available, the Islamic financial institutions should not opt for conventional insurance which is impermissible. Instead, options for internal Takaful fund or any other similar option shall be used. However, we all hope that such question shall stand resolved in near future once the rules for Takaful companies are finalized by the SECP and these are operational in the country.

The fifth argument is about the marketing approach being used by these financial institutions, which adversely effects the public reliance on this mode. People raising such question have two grounds for the same. The first one is the general marketing approach being applied by a few Islamic financial institutions which include advertisement and other publicity materials including involvement of women and employment of women for Islamic banking business without Hijab or even appropriate attire (as defined by Shariah).

Although a few modern and liberal Muslims will not like this objection at all, nevertheless, it should be kept in mind that a common man cannot understand "Islamic" banking while he feels that other factors of business are not really Islamic. Another similar objection is the marketing strategy in which sometimes it is felt that false statements are made for promotional purposes.

An example of the same is the claim by a leading Islamic bank that all its day to day activities are monitored by its Shariah Advisor. Just imagine, if it is humanly possible, that a part time Shariah Advisor can look after all day to day activities of a full-fledged bank with a number of branches even located at other cities. Another example is the claim by an Islamic mutual fund that it is the first one of its kind in the country, whereas another fund was operating in the country for around one year earlier to subscription for such mutual fund.

The sixth argument is of key significance from the perspective of the overall control environment of these banks with regard to the applicability of Shariah principles.

You would note that most of these institutions have hired the conventional bankers and generally no or very little consideration is awarded to ensure that they are well conversant with the Shariah requirements with regard to the modes of finance being used by these Banks. Consequently, a number of non-compliances of such requirements have been discussed on various forums. Since the objective of this article is just to highlight the issues, these are not being discussed in detail. Anyway, I have myself met a few Islamic bankers at various occasions that were not fully conversant with the basic principles of Shariah compliant products that they were marketing.

The seventh question with which I can't personally agree is regarding the appointment of Shariah Boards and Shariah Advisors. People have largely noted and discussed at various forums that the major contribution in this field in Pakistan is limited to a very small group of jurists most of whom relate to a single family and their pupils. Besides this, another question is also being raised that generally the honorariums, consultancy fee and other benefits being offered to such jurists by the Islamic financial institutions in Pakistan, as well as, abroad are quite high and this may jeopardise their independence.

I personally along with most of the people conversant with the business and operations of Islamic finance do not agree with this observation because the contribution of these people to the industry as a whole is remarkable and they deserve even more than that based on their contribution and efforts in the promotion of this industry. The general concept that a Maulvi should be paid the minimum at which he can live, is not something justifiable. If you are getting benefits from their efforts, their knowledge and skills, then they should be justifiably rewarded.

However, we all agree that it is the right time that contributions from jurist from other schools of thought should necessarily be provided opportunities to enter into the field. For this purpose, it would be a good idea that a jurist should not be allowed to hold more than one remunerative position as a Shariah Advisor or member of a Shariah Board. However, honorary/advisory members may hold up to three positions in all. This will ensure that fresh blood gets a route to enter into the field which will eventually improve the overall Shariah compliance in the field, as well as, will help these institutions to innovate fresh products.

STANDARDIZATION OF SHARIAH COMPLIANCE REGULATIONS:

Internationally, there have been a lot of efforts for standardisation of practices being followed by various Islamic financial institutions. These efforts include a lot of research work. Nevertheless, the most admirable job has been performed by the Islamic Fiqh Academy of the Organisation of Islamic Countries and the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI).

This organisation has been established by a number of Islamic financial institutions operating throughout the world and is based at Bahrain. AAOIFI has established an Accounting and Auditing Standards Board, as well as, a Shariah Board. These Boards have, to date, performed a commendable job by issuing accounting, governance, auditing and Shariah standards for Islamic financial institutions.

Since these Boards have been established by choosing the experts of the fields from throughout the Islamic world, their works, are considered to be a consensus of the experts from the field and hence these work may be used for standardisation of practices of Islamic finance and banking throughout the world.

In Pakistan, the Institute of Chartered Accountants of Pakistan has issued draft Islamic accounting standards for Ijara and Murabaha which are under finalisation phases. However, these drafts do not contain enough details regarding standardisation of transactions. On the other hand, the State Bank has issued essentials for Islamic banking and financial products and a bunch of model agreements.

A very useful book has also been published by the State Bank on the topic of Islamic finance. Nevertheless, these are just guidelines and not a mean of standardisation of practices. As a part of its efforts, the State Bank has established a Islamic Banking Department, duly supported by an independent Shariah Advisory Board comprising of Shariah jurist, lawyer and account members.

Nevertheless, without going into further details it is pertinent to mention that as evident from its name, it is just an advisory board and accordingly, advises when and only when such advises are sought.

In contrast, SECP has not yet demonstrated any concrete initiative for promotion of Islamic finance in country. As an example, the matter of establishment of Takaful companies in Pakistan is pending finalisation of rules on the part of SECP. Similarly, there is no monitoring of Islamic financial institutions that come under its umbrella, including, Islamic mutual funds, Modarabas, Housing finance companies etc, as well as, the Islamic financial products issued eg Musharaka TFCs issued by Sitara Energy.

From the above details, it is established that a great deal is outstanding on the part of our regulators, as well as, the lawmakers to ensure that a conducive environment for promotion of Islamic finance is made available in the country, particularly including the standardisation in order to build public reliance on these products and institutions. However, from the old times a Shariah Board for Modarabas was operating or rather not-operating.

In view of the same, it may be recommended that the State Bank and the SECP shall join forces to form an independent authoritative Shariah Monitoring Board for Islamic financial institutions and Islamic financial products. In our humble opinion, such Board shall besides advising on matters, as and when its advises are sought, also establish an independent and effective monitoring framework for Islamic financial institutions.

Besides this, its functions shall include setting standards of operations for these institutions based on Islamic Shariah. For that purpose it is advisable that in addition to the members of the State Bank's Shariah Advisory Board and the members of the Supervisory Board for Modarabas, a few executive, full-time working members of such Board shall be appointed. These members shall also be taken from bankers, accountants, lawyers and most importantly from Shariah jurists.

Islamic banking department of SBP and SECP shall support such Board in development of rules and regulations for Islamic financial institutions, particularly ensuring standardisation and consistency in the practices of Islamic financial institutions and their maximum compliance with the requirements of Islamic Shariah.

However, unless such standards are developed, which shall obviously take some time, the State Bank and the SECP may decide to adopt Shariah Standards issued by AAOIFI as a regulatory framework for Islamic financial institutions. Even after, these standards will provide a solid base for further strengthening the standardisation process.

SHARIAH COMPLIANCE ASSURANCE:

Most importantly, it should be kept in mind that even these rules, regulations and standards might not work unless and until an effective network of check and balance is established to ensure compliance of the same in letter and spirit. My personal experiences have proved, which I am sure that a number of readers will second, that the Shariah compliance cannot be ensured merely on the basis of approval of products by the Shariah Supervisory Boards and the Shariah Advisors.

PRESENTLY THE FRAMEWORK OF SHARIAH COMPLIANCE ASSURANCE IN PAKISTAN MAY BE DIVIDED IN THREE DIFFERENT TYPES OF ASSURANCE AS FOLLOWS:

1. The first option which is being used by a leading Islamic commercial bank is the Shariah compliance review report of the Bank's own Shariah Supervisory Board or the Shariah Advisor. This option is although considered an effort to ensure Shariah compliance; the same cannot be construed to fulfil the need in this respect because of three basic weaknesses being discussed as follows:

-- The first weakness is that the Shariah jurists who are sitting on the Board or are appointed as Shariah Advisors generally have no or a very little knowledge about the principles of finance, accounting and auditing, and more importantly, of the operations of the financial institutions. Consequently, their compliance review generally remains limited to the extent of assurance of the legal form of transactions ie vetting of agreements etc. On the contrary, the operational matters, which include the substance of the transaction might remain unattended because it is not the core competence of these respectable jurists. Besides this, generally the management do not wish to bring each and every matter in the attention of the Board or the Advisor;

-- The second weakness is independence of the person performing the assurance function. Although we don't have any doubt on the personal independence and integrity of these respectable jurists, they would themselves appreciate that the work performed under one's guidance should always be counter checked by an independent person. Particularly, keeping in view the human tendency of errors, it cannot be advised that the person supervising and monitoring the transactions is also entrusted to recheck the same; and

-- The third issue is of time and skilled staff. Generally those on the Shariah Boards and on the seat of Shariah Advisors are busy guys. They are generally serving a number of Boards and educational institutions and are involved in a number of social and religious activities. In addition, they do not have any skilled staff hired for the purpose of assisting them in the assurance work. Consequently, you can easily imagine that it is humanly not possible for a single person to perform a comprehensive Shariah compliance audit of the operations of a full-fledged Islamic financial institution which may even have a number of branches.

2. The second option being used by two Islamic mutual funds in the country is Shariah compliance audit by the external auditors of the Islamic financial institutions. In such option, the external auditor is also assigned with the task of performing Shariah compliance audit with a scope defined in advance. This may be considered to be a viable option for independent assurance of compliance with the Shariah terms.

HOWEVER, SUCH SYSTEM HAS TWO BASIC WEAKNESS BEING DISCUSSED AS FOLLOWS:

-- Since the external auditor is also entrusted with the task of performing the Shariah compliance audit, his expertise in Islamic finance is not ensured. You would appreciate that if the auditor is not equipped with the necessary skills and knowledge, the output of the assignment might not be as good as may be expected from an experience auditor; and

-- Since the scope of the audit is pre-defined and the matter of permissibility of a transaction is generally subject to the opinions and perspectives of the Shariah Supervisory Board or the Shariah Advisor, the independence of the exercise, to some extent, remains in jeopardy.

3. The third option is being exercised by the State Bank in form of Shariah compliance Inspection of Islamic commercial banks. This is a very good option, as it is independent and authoritative in nature. Nevertheless, since the results of such inspections are considered to be confined to the management of the Bank and the State Bank, the benefits of such exercises cannot be forwarded to the general public.

Moreover, such exercise is limited to the Islamic commercial banks and the Islamic banking branches of conventional commercial banks and consequently other financial institutions that are governed by the SECP including Islamic mutual funds, Modarabas, Takaful companies, Housing finance companies, Investment finance companies and leasing companies shall remain out of ambit of such exercise.

In view of the same, it is proposed that a framework for Shariah compliance audits of Islamic financial institutions shall be introduced. In this framework, a common panel shall be approved by the State Bank and the SECP amongst reputable firms of chartered accountants, having experience, knowledge and skills in Islamic banking and finance.

All the Islamic financial institutions operating in the country shall be required to get a Shariah compliance audit performed. In the absence of relevant expertise in the country, in the beginning phase, the existing external auditors may also be allowed to perform such audit, if they are amongst the approved panel of Shariah compliance auditors as approved by the State Bank and the SECP. However, in the later phases these duties may be allocated to different auditors in order to improve the independence in performance of their duties.

It is, anyway, pertinent to note that the scope of such audit needs to be assigned by the regulators ie the State Bank and the SECP. Due consideration shall be given to the nature of each financial institution and accordingly different scope of work may be assigned for Shariah compliance audits of various Islamic financial institutions. However, in the absence of initiative from the regulators, an association of Islamic financial institutions may, with the help of respectable jurists, define such scope.
ARTICLE (August 25 2006): The first argument which is generally heard against Islamic banking is that there is NO difference between the conventional banking and Islamic banking and this is merely a change of name. The second argument is that even in Islamic banking, the most common products being used eg Murabaha, Musawwama, Salam, Istisna and Ijara Muntahia Bittamleek are on fixed return basis.

Answers to these observations have already been discussed in the preceding paragraphs. However, we should just recall the fact that unless we can distinguish an Islamic bank from a conventional bank, it would be difficult for any of us to rely on the same.

Particularly, it is observed that they try to make sure that their product is similar to the conventional products in all respects, even if for that purpose they have to incorporate a few provisions in these products which are not considered to be good or a few of them are considered Makrooh.

In addition, their endeavors are focused towards minimisation of their risk through every possible option and accordingly, the essence of Islamic finance which is based on risk taking is killed.

The third question is generally raised on the honesty and integrity of Islamic financial institutions. This question, which is asked the most times, is that these Banks are using the name of Islam to earn a few bucks more as compared to the conventional banks.

This question has two sides. The first one is on the financing side, where these Banks charge higher than the charges of a conventional bank. In other words, internal rate of return on Islamic financial products is higher than the conventional products.

A justification of this argument is that since the Islamic financial institutions are subject to the commodity risk and the price risk, in addition to the conventional risks that a bank faces, they are justified in their demand.

In addition, particularly in case of Ijara Muntahia Bittamleek, since the risk and reward of the asset rests with them for the whole tenure of lease, which inter-alia includes payment of insurance premiums, they may be justified in charging a higher rental.

Nevertheless, financial experts have generally felt that even if these factors are considered, the pricing by these Banks is on the higher side. On the contrary, it is observed that on the deposit sides they pay less as compared to the conventional banks. In addition, it is generally observed that the expected rates, as well as, the actual rates of return offered by these financial institutions are fairly equivalent to the rates being offered by conventional financial institutions.

In a profit and loss based model, it is agreeable that they assign weightage to different types of deposits in a manner that the total return on investment and financing pools is allocated amongst various depositors and the Bank (working as a partner).

Nevertheless, the question that a participant of a lecture asked me was very distressing for me, as well as, most of the supporters of the Islamic finance in general.

He asked the reason as to why the return to depositors of these banks averages out to be 2 percent per annum - which is slightly less than or fairly equivalent to the rates being offered by the conventional banks, whereas their return on capital employed, which is attributable to the shareholders is around 20 percent per annum.

The fourth question is the acceptability of insurance under conventional mode. A number of practising Muslims and jurists are of the view that unless the option of Takaful is available, the Islamic financial institutions should not opt for conventional insurance which is impermissible. Instead, options for internal Takaful fund or any other similar option shall be used.

However, we all hope that such question shall stand resolved in near future once the rules for Takaful companies are finalised by the SECP and these are operational in the country.

The fifth argument is about the marketing approach being used by these financial institutions, which adversely effects the public reliance on this mode. People raising such question have two grounds for the same. The first one is the general marketing approach being applied by a few Islamic financial institutions which include advertisement and other publicity materials including involvement of women and employment of women for Islamic banking business without Hijab or even appropriate attire (as defined by Shariah).

Although a few modern and liberal Muslims will not like this objection at all, nevertheless, it should be kept in mind that a common man cannot understand "Islamic" banking while he feels that other factors of business are not really Islamic.

Another similar objection is the marketing strategy in which sometimes it is felt that false statements are made for promotional purposes. An example of the same is the claim by a leading Islamic bank that all its day to day activities are monitored by its Shariah Advisor.

Just imagine, if it is humanly possible, that a part time Shariah Advisor can look after all day to day activities of a full-fledged bank with a number of branches even located at other cities. Another example is the claim by an Islamic mutual fund that it is the first one of its kind in the country, whereas another fund was operating in the country for around one year earlier to subscription for such mutual fund.

The sixth argument is of key significance from the perspective of the overall control environment of these banks with regard to the applicability of Shariah principles. You would note that most of these institutions have hired the conventional bankers and generally no or very little consideration is awarded to ensure that they are well conversant with the Shariah requirements with regard to the modes of finance being used by these Banks.

Consequently, a number of non-compliances of such requirements have been discussed on various forums. Since the objective of this article is just to highlight the issues, these are not being discussed in detail. Anyway, I have myself met a few Islamic bankers at various occasions who were not fully conversant with the basic principles of Shariah compliant products that they were marketing.

The seventh question with which I can't personally agree is regarding the appointment of Shariah Boards and Shariah Advisors. People have largely noted and discussed at various forums that the major contribution in this field in Pakistan is limited to a very small group of jurists most of whom relate to a single family and their pupils.

Besides this, another question is also being raised that generally the honorariums, consultancy fee and other benefits being offered to such jurists by the Islamic financial institutions in Pakistan, as well as, abroad are quite high and this may jeopardise their independence.

I personally along with most of the people conversant with the business and operations of Islamic finance do not agree with this observations because the contribution of these people to the industry as a whole is remarkable and they deserve even more than that based on their contribution and efforts in the promotion of this industry.

The general concept that a Maulvi should be paid the minimum at which he can live, is not something justifiable. If you are getting benefits from their efforts, their knowledge and skills, then they should be justifiably rewarded.

However, we all agree that it is the right time that contributions from jurist from other schools of thought should necessarily be provided opportunities to enter into the field. For this purpose, it would be a good idea that a jurist should not be allowed to hold more than one remunerative position as a Shariah Advisor or member of a Shariah Board.

However, honorary/advisory members may hold upto three positions in all. This will ensure that fresh blood gets a route to enter into the field which will eventually improve the overall Shariah compliance in the field, as well as, will help these institutions to innovate fresh products.

STANDARDIZATION OF SHARIAH COMPLIANCE REGULATIONS

Internationally, there have been a lot of efforts for standardisation of practices being followed by various Islamic financial institutions. These efforts include a lot of research work. Nevertheless, the most admirable job has been performed by the Islamic Fiqh Academy of the Organisation of Islamic Countries and the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI).

This organisation has been established by a number of Islamic financial institutions operating throughout the world and is based at Bahrain. AAOIFI has established an Accounting and Auditing Standards Board, as well as, a Shariah Board. These Boards have, to date, performed a commendable job by issuing accounting, governance, auditing and Shariah standards for Islamic financial institutions.

Since these Boards have been established by choosing the experts of the fields from throughout the Islamic world, their works, are considered to be a consensus of the experts from the field and hence these work may be used for standardisation of practices of Islamic finance and banking throughout the world.

In Pakistan, the Institute of Chartered Accountants of Pakistan has issued draft Islamic accounting standards for Ijara and Murabaha which are under finalisation phases. However, these drafts do not contain enough details regarding standardisation of transactions. On the other hand, the State Bank has issued essentials for Islamic banking and financial products and a bunch of model agreements.

A very useful book has also been published by the State Bank on the topic of Islamic finance. Nevertheless, these are just guidelines and not a mean of standardisation of practices. As a part of its efforts, the State Bank has established a Islamic Banking Department, duly supported by an independent Shariah Advisory Board comprising of Shariah jurist, lawyer and account members.

Nevertheless, without going into further details it is pertinent to mention that as evident from its name, it is just an advisory board and accordingly, advises when and only when such advises are sought.

In contrast, SECP has not yet demonstrated any concrete initiative for promotion of Islamic finance in country. As an example, the matter of establishment of Takaful companies in Pakistan is pending finalisation of rules on the part of SECP.

Similarly, there is no monitoring of Islamic financial institutions that come under its umbrella, including, Islamic mutual funds, Modarabas, Housing finance companies etc, as well as, the Islamic financial products issued eg Musharaka TFCs issued by Sitara Energy.

From the above details, it is established that a great deal is outstanding on the part of our regulators, as well as, the lawmakers to ensure that a conducive environment for promotion of Islamic finance is made available in the country, particularly including the standardisation in order to build public reliance on these products and institutions. However, from the old times a Shariah Board for Modarabas was operating or rather not-operating.

In view of the same, it may be recommended that the State Bank and the SECP shall join forces to form an independent authoritative Shariah Monitoring Board for Islamic financial institutions and Islamic financial products.

In our humble opinion, such Board shall besides advising on matters, as and when its advises are sought, also establish an independent and effective monitoring framework for Islamic financial institutions. Besides this, its functions shall include setting standards of operations for these institutions based on Islamic Shariah.

For that purpose it is advisable that in addition to the members of the State Bank's Shariah Advisory Board and the members of the Supervisory Board for Modarabas, a few executive, full-time working members of such Board shall be appointed.

These members shall also be taken from bankers, accountants, lawyers and most importantly from Shariah jurists. Islamic banking department of SBP and SECP shall support such Board in development of rules and regulations for Islamic financial institutions, particularly ensuring standardisation and consistency in the practices of Islamic financial institutions and their maximum compliance with the requirements of Islamic Shariah.

However, unless such standards are developed, which shall obviously take some time, the State Bank and the SECP may decide to adopt Shariah Standards issued by AAOIFI as a regulatory framework for Islamic financial institutions. Even after, these standards will provide a solid base for further strengthening the standardisation process.

SHARIAH COMPLIANCE ASSURANCE

Most importantly, it should be kept in mind that even these rules, regulations and standards might not work unless and until an effective network of check and balance is established to ensure compliance of the same in letter and spirit.

My personal experiences have proved, which I am sure that a number of readers will second, that the Shariah compliance cannot be ensured merely on the basis of approval of products by the Shariah Supervisory Boards and the Shariah Advisors.

Presently the framework of Shariah compliance assurance in Pakistan may be divided in three different types of assurance as follows:

1. The first option which is being used by a leading Islamic commercial bank is the Shariah compliance review report of the Bank's own Shariah Supervisory Board or the Shariah Advisor. This option is although considered an effort to ensure Shariah compliance; the same cannot be construed to fulfil the need in this respect because of three basic weaknesses being discussed as follows:

The first weakness is that the Shariah jurists who are sitting on the Board or are appointed as Shariah Advisors generally have no or a very little knowledge about the principles of finance, accounting and auditing, and more importantly, of the operations of the financial institutions.

Consequently, their compliance review generally remains limited to the extent of assurance of the legal form of transactions ie vetting of agreements etc. On the contrary, the operational matters, which include the substance of the transaction might remain unattended because it is not the core competence of these respectable jurists.

Besides this, generally the management do not wish to bring each and every matter in the attention of the Board or the Advisor; The second weakness is independence of the person performing the assurance function. Although we don't have any doubt on the personal independence and integrity of these respectable jurists, they would themselves appreciate that the work performed under one's guidance should always be counter checked by an independent person.

Particularly, keeping in view the human tendency of errors, it cannot be advised that the person supervising and monitoring the transactions is also entrusted to recheck the same; and

The third issue is of time and skilled staff. Generally those on the Shariah Boards and on the seat of Shariah Advisors are busy guys. They are generally serving a number of Boards and educational institutions and are involved in a number of social and religious activities.

In addition, they do not have any skilled staff hired for the purpose of assisting them in the assurance work. Consequently, you can easily imagine that it is humanly not possible for a single person to perform a comprehensive Shariah compliance audit of the operations of a full-fledged Islamic financial institution which may even have a number of branches.

2. The second option being used by two Islamic mutual funds in the country is Shariah compliance audit by the external auditors of the Islamic financial institutions. In such option, the external auditor is also assigned with the task of performing Shariah compliance audit with a scope defined in advance.

This may be considered to be a viable option for independent assurance of compliance with the Shariah terms. However, such system has two basic weakness being discussed as follows:

-- Since the external auditor is also entrusted with the task of performing the Shariah compliance audit, his expertise in Islamic finance is not ensured. You would appreciate that if the auditor is not equipped with the necessary skills and knowledge, the output of the assignment might not be as good as may be expected from an experience auditor; and

-- Since the scope of the audit is pre-defined and the matter of permissibility of a transaction is generally subject to the opinions and perspectives of the Shariah Supervisory Board or the Shariah Advisor, the independence of the exercise, to some extent, remains in jeopardy.

3. The third option is being exercised by the State Bank in form of Shariah compliance Inspection of Islamic commercial banks. This is a very good option, as it is independent and authoritative in nature. Nevertheless, since the results of such inspections are considered to be confined to the management of the Bank and the State Bank, the benefits of such exercises cannot be forwarded to the general public.

Moreover, such exercise is limited to the Islamic commercial banks and the Islamic banking branches of conventional commercial banks and consequently other financial institutions that are governed by the SECP including Islamic mutual funds, Modarabas, Takaful companies, Housing finance companies, Investment finance companies and leasing companies shall remain out of ambit of such exercise.

In view of the same, it is proposed that a framework for Shariah compliance audits of Islamic financial institutions shall be introduced. In this framework, a common panel shall be approved by the State Bank and the SECP amongst reputable firms of chartered accountants, having experience, knowledge and skills in Islamic banking and finance. All the Islamic financial institutions operating in the country shall be required to get a Shariah compliance audit performed.

In the absence of relevant expertise in the country, in the beginning phase, the existing external auditors may also be allowed to perform such audit, if they are amongst the approved panel of Shariah compliance auditors as approved by the State Bank and the SECP. However, in the later phases these duties may be allocated to different auditors in order to improve the independence in performance of their duties.

It is, anyway, pertinent to note that the scope of such audit needs to be assigned by the regulators ie the State Bank and the SECP. Due consideration shall be given to the nature of each financial institution and accordingly different scope of work may be assigned for Shariah compliance audits of various Islamic financial institutions. However, in the absence of initiative from the regulators, an association of Islamic financial institutions may, with the help of respectable jurists, define such scope.

(Concluded)

this is practice

2009-03-27T07:06:00.000-07:00

Time value of money

The time value of money is the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In other words, the present value of a certain amount a of money is greater than the present value of the right to receive the same amount of money time t in the future. This is because the amount a could be deposited in an interest-bearing bank account (or otherwise invested) from now to time t and yield interest. Consequently, lenders acting at arm's length demand interest payments for use of their capital.

Additional motivations for demanding interest are to compensate for the risk of borrower default and the risk of inflation (as well as some other more technical factors).
All of the standard calculations are based on the most basic formula, the present value of a future sum, "discounted" to a present value. For example, a sum of FV to be received in one year is discounted (at the appropriate rate of R) to give a sum of PV at present.
Some standard calculations based on the time value of money are:
Present Value (PV) of an amount that will be received in the future.
Future Value (FV) of an amount invested (such as in a deposit account) now at a given rate of interest.
Present Value of an Annuity (PVA) is the present value of a stream of (equally-sized) future payments, such as a mortgage.
Future Value of an Annuity (FVA) is the future value of a stream of payments (annuity), assuming the payments are invested at a given rate of interest.
Present Value of a Perpetuity is the value of a regular stream of payments that lasts "forever", or at least indefinitely.
Contents
Calculations
There are several basic equations that represent the equalities listed above. The solutions may be found using (in most cases) a financial calculator or other means.
For any of the equations below, the formulae may also be rearranged to determine one of the other unknowns. In the case of the standard annuity formula, however, there is no closed-form algebraic solution for the interest rate (although financial calculators can readily determine solutions).
These equations are frequently combined for particular uses. For example, bonds can be readily priced using these equations. A typical coupon bond is composed of two types of payments: a stream of coupon payments similar to an annuity, and a lump-sum return of capital at the end of the bond's maturity - that is, a future payment. The two formulas can be combined to provide a present value for the bond.
An important note is that the interest rate r is the interest rate for the relevant period. For an annuity that makes one payment per year, r will be the annual interest rate. For an income or payment stream with a different payment schedule, the interest rate must be converted into the relevant periodic interest rate, for example, a monthly rate for a mortgage with monthly payments (see the example below). See compound interest for details on converting between different periodic interest rates.
The rate of return in the calculations can be either the variable solved for, or a predefined variable that measures a discount rate, interest, inflation, rate of return, cost of equity, cost of debt or any number of other analogous concepts. The choice of the appropriate rate is critical to the exercise, and choice of the wrong discount rate can make the results meaningless. In most cases, however, the mathematics are similar, if not identical.
For calculations of annuities, you must decide whether the payments are made at the beginning of each time period, or (as in the formulas given) at the end. The calculator you use will allow the input somehow.

Formulas
Present value of a future sum
The present value formula is the core formula for the time value of money; each of the other formulae is derived from this formula. For example, the annuity formula is the sum of a series of present value calculations.
• The present value (PV) formula has four variables, each of which can be solved for:
1. PV is the value at time=0
2. FV is the value at time=n
3. r is the rate at which the amount will be compounded each period
4. n is the number of periods

Future value of a present sum
• The future value (FV) formula is similar and uses the same variable.

Present value of an annuity
• The present value of an annuity (PVA) formula has four variables, each of which can be solved for:
1. PVA the value of the annuity at time=0
2. A the value of the individual payments in each compounding period
3. r equals the interest rate that would be compounded for each period of time
4. n is the number of payment periods.

Future value of an annuity
• The future value of an annuity (FVA) formula has four variables, each of which can be solved for:
1. FVA the value of the annuity at time=n
2. A the value of the individual payments in each compounding period
3. r equals the interest rate that would be compounded for each period of time
4. n is the number of payment periods.

Present value of a growing annuity
Similar to the formula for an annuity, the present value of a growing annuity (PVGA) uses the same variables with the addition of G as the rate of growth of the annuity (A is the annuity payment in the first period). This is a calculation that is rarely provided for on financial calculators.

Present value of a perpetuity
The PV of a perpetuity (a perpetual annuity) formula is simple division.

Present value of a growing perpetuity
When the perpetual annuity payment grows at a fixed rate (g) the value is theoretically determined according to the following formula. In practice, there are few securities with precisely these characteristics, and the application of this valuation approach is subject to various qualifications and modifications. Most importantly, it is rare to find a growing perpetual annuity with fixed rates of growth and true perpetual cash flow generation. Despite these qualifications, the general approach may be used in valuations of real estate, equities, and other assets.

Derivations
Annuity derivation
The formula for the future value of a regular stream of future payments (an annuity) is derived from a sum of the formula for future value of a single future payment, as below, where C is the payment amount and n the time period.
A single payment C at future time i has the following future value at future time n:

Summing over all payments from time 1 to time n, then reversing the order of terms and substituting k = n − i:

Note that this is a geometric series, with the initial value being a = C, the multiplicative factor being 1 + r, with n terms. Applying the formula for geometric series, we get

The present value of the annuity (PVA) is obtained by simply dividing by (1 + r)n:

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Another simple and intuitive way to derive the future value of an annuity is to consider an endowment, whose interest is paid as the annuity, and whose principal remains constant. The principal of this hypothetical endowment can be computed as that whose interest equals the annuity payment amount:

Principal = C / r
Note that no money enters or leaves the combined system of endowment principal + accumulated annuity payments, and thus the future value of this system can be computed simply via the future value formula:
FV = PV(1 + r)n
Initially, before any payments, the present value of the system is just the endowment principal (PV = C / r). At the end, the future value is the endowment principal (which is the same) plus the future value of the total annuity payments (FV = C / r + FVA). Plugging this back into the equation:

Perpetuity derivation
Without showing the formal derivation here, the perpetuity formula is derived from the annuity formula. Specifically, the term:

can be seen to approach the value of 1 as n grows larger. At infinity, it is equal to 1, leaving as the only term remaining.
Examples
Example 1: Present value
One hundred euros to be paid 1 year from now, where the expected rate of return is 5% per year, is worth in today's money:

So the present value of €100 one year from now at 5% is €95.23.
Example 2: Present value of an Annuity - solving for the payment amount
Consider a 10 year mortgage where the principal amount P is $200,000 and the annual interest rate is 6%.
The number of monthly payments is

and the monthly interest rate is

The annuity formula for (A/P) calculates the monthly payment:

Example 3: Solving for the period needed to double money
Consider a deposit of $100 placed at 10% (annual). How many years are needed for the value of the deposit to double to $200?
Using the algrebraic identity that if:

then

The present value formula can be rearranged such that:
(years)
This same method can be used to determine the length of time needed to increase a deposit to any particular sum, as long as the interest rate is known. For the period of time needed to double an investment, the Rule of 72 is a useful shortcut that gives a reasonable approximation of the time period needed.
Example 4: What return is needed to double money?
Similarly, the present value formula can be rearranged to determine what rate of return is needed to accumulate a given amount from an investment. For example, $100 is invested today and $200 return is expected in five years; what rate of return (interest rate) does this represent?
The present value formula restated in terms of the interest rate is:

Example 5: Calculate the value of a regular savings deposit in the future.
To calculate the future value of a stream of savings deposit in the future requires two steps, or, alternatively, combining the two steps into one large formula. First, calculate the present value of a stream of deposits of $1,000 every year for 20 years earning 7% interest:

This does not sound like very much, but remember - this is future money discounted back to its value today; it is understandably lower. To calculate the future value (at the end of the twenty-year period):

These steps can be combined into a single formula:

Example 6: Price/earnings (P/E) ratio
It is often mentioned that perpetuities, or securities with an indefinitely long maturity, are rare or unrealistic, and particularly those with a growing payment. In fact, many types of assets have characteristics that are similar to perpetuities. Examples might include income-oriented real estate, preferred shares, and even most forms of publicly-traded stocks. Frequently, the terminology may be slightly different, but are based on the fundamentals of time value of money calculations. The application of this methodology is subject to various qualifications or modifications, such as the Gordon growth model.
For example, stocks are commonly noted as trading at a certain price/earnings ratio. The P/E ratio is easily recognized as a variation on the perpetuity or growing perpetuity formulae - save that the P/E ratio is usually cited as the inverse of the "rate" in the perpetuity formula.
If we substitute for the time being: the price of the stock for the present value; the earnings per share of the stock for the cash annuity; and, the discount rate of the stock for the interest rate, we can see that:

And in fact, the P/E ratio is analogous to the inverse of the interest rate (or discount rate).

Of course, stocks may have increasing earnings. The formulation above does not allow for growth in earnings, but to incorporate growth, the formula can be restated as follows:

If we wish to determine the implied rate of growth (if we are given the discount rate), we may solve for g:

Time value of money formulae with continuous compounding
Rates are sometimes converted into the continous compound interest rate equivalent because the continuous equivalent is more convenient (for example, more easily differentiated). Each of the formulae above may be restated in their continuous equivalents. For example, the present value of a future payment can be restated in the following way, where e is the base of the natural logarithm:

See below for formulaic equivalents of the time value of money formulae with continuous compounding.
Present value of an annuity

Present value of a perpetuity

Present value of a growing annuity

Present value of a growing perpetuity

2008-01-01T02:31:00.000-08:00

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Nature of Capital in Musharakah

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Types of Musharakah

Shirkat-ul-Milk

Shirkat-ul-Aqd

Distribution of Profit

Sharing of Loss

Management of Musharakah

Termination of Musharakah

Termination of Musharakah without Closing the Business

MODES OF ISLAMIC FINANCE

Mudarabah

Musharakah

Diminishing Musharakah

Murabaha

Ijarah

Ijarah-Wal-Iqtina

Istisna

Salam

Istijrar

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Definition

Types of Mudarabah

Al-Mudarabah Al-Muqayyadah (restricted mudarabah)

Al-Mudarabah Al-Mutlaqah (unrestricted mudarabah)

Business of the Mudarabah

Joint Mudarabah

Distribution of the profit

Termination of Mudarabah

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FAQs

Q 1) What is Islamic Banking?

Q 2). What is the philosophy of Islamic banking?

Q 3) What is Meant By Riba?

Q 4) What is interest? Is there any difference between interest and Riba?

Q 5) What are the different kinds of Riba?

Q 6) What are the revelations/verses in Holy Quran regarding prohibition of Riba/interest?

Q 7) What are the sayings/Ahadith9 about Riba/Interest?

Q 8) Are there any injunctions against Riba/usury in religious texts other than Holy Quran?

Q 9) Does interest/Riba is related only to consumption loans or it applies to commercial loans also?

Q 10) Does the prohibition of Riba apply equally to the loans obtained from or extended to Muslims as well as non-Muslims?

Q 11): What are the basic principles of Islamic banking?

Q 12) What is meant by Shariah/Islamic Law?

Q 13): The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar?

Q 14) If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers?

Q 15). Are not Islamic banks just paying interest and dressing it as profit on trade and investments?

Q 16): Islamic banks use interest base system (KIBOR) as a Bench Mark while determining profit; how Islamic banking can be said to be Islamic?

Q 17) Is Islamic banking meant only for Muslims?

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Islamic Banking Explained

Building Reliance on Islamic Finance and Banking

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