ESSENTIAL READINGS IN

IS ICFIN CE

Edited byDr Mohd Daud Bakar

Dr Engku Rabiah Adawiah Engku Ali

.r1VUrF'-.J~ ...Centre For Research And Training

Perpustakaan Negara Malaysia Cataloguing-in-Publication Data

ESSENTIAL READINGS IN ISLAMIC FINANCEedited by Mohd Daud Bakar, Engku Rabiah Adawiah Engku Ali.

ISBN 978-983-43710-0-51. Finance - Religious aspects - Islam. 2. Islam - Economic aspects.

I. Mohd Daud Bakar. II. Engku Rabiah Adawiah Engku Ali.332.1091761

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918-983-43710-0-5

~ICATIONTEAM

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CoordinatorAhmad Sodikin Kasimin

Copy EditorSiti Mazlita Yamaludin

Norhalizan HarunDesign & Layout

Mohd Khairul Hakimin Mat Hassan

Printed in Malaysia byMASHI PUBLICATION SDN. BHD.

CONTENTS

Foreword

Preface

Acknowledgment

Authors' Profile

SHARI'AH FRAMEWORK

1 RIBA AND ISLAMIC BANKING AND FINANCEDr Mohd Daud Bakar

IntroductionDefinition of RibaTypes and Classifications of RibaRationale and Raison D'etre of the Prohibition of RibaInterest-Based Practices in Conventional BankingSolutions to Interest-Based TransactionsThe Way Forward

v

Vll

Vlll

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37

1113212223

2 DEVELOPING MODERN ISLAMIC FINANCIAL SYSTEMVIA IJTIHAD: AN OVERVIEWDr Mohd Daud Bakar

Introduction 27The Legacy of Islamic Fiqh and Various Guilds of Islamic Law(Madhhab) 29Sources and Principles of Law as Documented in Islamic Legal Theory 33Ijtihad as a Tool in Developing Islamic Financial System 38Conclusion 42Bibliography 43

xiii

3 CONTRACTS IN ISLAMIC COMMERCIAL LAW AND THEIRAPPLICATION IN MODERN ISLAMIC FINANCIAL SYSTEMDr Mohd Daud Bakar

Introduction 47Historical Evolution of Contract in Islamic Law 48Essential Elements of a Valid Contract 49Classification of Contracts 53Reflections and Overview on the Classifications of Contracts 54Contracts of Exchange (Mu 'awadat) 55Contracts of Utilization of Usufruct ('Uqud al-Manfa'at) 63

Contract of Ijarah (Transfer of Usufruct for a Consideration) 63'Ariyah (Lending for Gratuitous Use) 64

Contracts of Security 64Hiwalah (Transfer of Debt) 64Rahn (Pledges) 65Kafalah (Suretyship) 66

Introduction to Conventional and Islamic Banking 66Islamic Financial System in Malaysia: An Overview 69Sources of Fund in Islamic Financial System 70Application of Fund in Islamic Financial System 72New Direction for Islamic Financial System 76Conclusion 84

ISLAMIC BANKING DEVELOPMENT

4 ISLAMIC BANKING: TREND, DEVELOPMENT AND CHALLENGESSyed Alwi Mohd Sultan

Where We Are: The Four Decade Evolution 89Significance of Shari'ah in Islamic Banking 92

Shari'ah Compliance: Briefly 92How Shari'ah Compliance Impacts Operational Aspects 94

Islamic Banking Industry: Key Drivers of Growth and Sustenance 96Challenges at this Juncture 99

Shari 'ah Harmonization 99Product Development and Innovation 100Building Credibility and Confidence 100Competition and Cost Efficiency 101Human Resource - Skills and Expertise 102Marketing 102Corporate Governance Issues 103Risk Management and Regulatory Issues 104

Possible Solutions to Risk Management and Corporate GovernanceIssues in Islamic Banking 106

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The Way Forward 108

5 SHARrAH APPROACHES TO PRODUCT DEVELOPMENT ANDPRODUCT ENHANCEMENT IN ISLAMIC BANKING AND FINANCE:AN APPRAISALDr Mohd Daud Bakar

Nomenclature ofIslamic Banking and Finance 113Islamic Banking and Financial Products: An Overview 115Islamic Perspective and Methodologies to Product Development andProduct Enhancement 117Practical Issues in Product Development and Product Enhancement 123Conclusion 130

6 BAY AL-'/NAH AND TAWARRUQ: MECHANISMS AND SOLUTIONSDr Engku Rabiah Adawiah Engku Ali

Background and Introduction 133Bay' At- 'Inah and Tawarruq: Basic Issues and Problems 135Analysis ofthe Problem: Need of People vis-a-vis Legal Tricks (Hiyal) 143Contemporary Practice of Bay' At- 'Inah and Tawarruq: Suggestionsand Solutions? 151

Islamic Financing Products 151Islamic Investment and Deposit Services Products 159Islamic Hedging Products 162

Conclusion and Way Forward 165

7 COMMODITY MURABAHAH PROGRAMME (CMP):AN INNOVATIVE APPROACH TO LIQUIDITY MANAGEMENTDr Asyraf Wajdi Dusuki

Introduction 171Concept Of Liquidity Management 173Islamic Approach To Liquidity Management 176Commodity Murabahah Programme (CMP) 181The Polemics of Tawarruq-Based Transactions 184Conclusion 187Bibliography 190

TAKAFUL (ISLAMIC INSURANCE)

8 MAKING TAKAFUL MANDATORY-JUSTIFICATION FROM OBJECTIVESOF SHARrAH (MAQAS/D AL-SHARrAH) PERSPECTIVESDr Mohd Daud Bakar

Introduction: Statement of Hypothesis 195

xv

Maqasid al-Shari'ah (Objectives of Shari'ah): An Overview 197Takaful and Maqasid al-Shari'ah Perspective 200Making Takaful Mandatory: Justifications from Maqasid al-Shari'ahPerspective 204Conclusion 209

9 REGULATION OF TAKAFUL BUSINESS: A SHARfAH OVERVIEW OFCONTRACTUAL ASPECTS OF TAKAFUL MODELSDr Mohammed Burhan Arbouna

Introduction 213Takaful Operation Falls under General Rules of Contracts 214The Doctrine of Takaful Evolution 217Features of Islamic Insurance 219Definition and Ruling of Takaful Contribution 221The Relationship of the Participants Themselves 221

Relationship for Premium Mobilization 221Indemnity Relationship 226Partnership Relationship 227The Takharuj and Mubara'ah Relationship 227

The Relationship of the Participants and the Operator 228Agency-Agency Relationship 229The Agency-Mudarabah Relationship 230Participants' Musharakah Relationship with the Operator 233

Issues and Ruling of Surplus 234Surplus versus Profit 234Ruling of Surplus 234Takafal Surplus Distribution Methods 235Application of Surplus and Reserves for Innovation 235Sharing Surplus as Incentive Gift for Good Performance 236

The Reinsurance Arrangement and Investment 237Arranging Loan Facility for Covering Insurance Deficit 238Some Regulatory and Supervisory Considerations 239

Mechanism of Monitoring Segregated Funds 239Risk of Misleading the Public by Takaful Operators 240Capital Adequacy Requirements for Takaful Companies 240Some Risks of Takaful Models 241Application of Conventional Methods of Regulation andSupervision 242

Conclusion 242

10 SOME ISSUES OF GHARAR (UNCERTAINTY) IN INSURANCEWan Marhaini Wan Ahmad

IntroductionLiterature ReviewGharar

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247249251

Types of GhararThe Effects of Gharar on Sales ContractInsurance and Its NatureIssues of Gharar in InsuranceConclusion

LEGAL, ACCOUNTING AND GOVERNANCE INISLAMIC FINANCE

253255257260268

11 THE REGULATORY FRAMEWORK AND LEGAL ASPECTS OFISLAMIC BANKING AND FINANCE IN MALAYSIAMohamad IIliayas Seyed Ibrahim

Introduction 271Which is the Legislating Body for Mu 'amalat? 272

Enumerated Powers 272Respective Power to Enact on the Shari'ah 274Respective Power to Enact on Banking 275Respective Power to Enact on Takaful 275Dominant Subject Matter 276

Which Courts Have Jurisdiction? 277Are Civil and Shari'ah Judges Competent for Mu'amalat? 280Is Litigation the Appropriate Mode of Dispute Resolution forMu'amalat? 285Inadequacies in the Statutes 286

Amendments to the IBA and the Takaful Act 286Statutory Definitions 287

Conclusion 290

12 THE DEVELOPMENT OF ISLAMIC BANKING LAW IN MALAYSIAMohamed Ismail Shariff

Introduction 295The Effect of the Islamic Banking Act and the Establishment ofBank Islam on the Legal System of the Country 296The Scope of Islamic Law to be Applied Under the IslamicBanking Act 297The Application of Islamic Law Within a Common Law System 299Conventional Banks and Interest-Free Banking 302Islamic Banking Documents 305Implementation of Islamic Banking Transactions Within the ExistingCommon Law Legal System 305Some Proposals for a Systematic Development of and an EffectiveImplementation of Islamic Law in the Civil Courts 309Conclusion 313

xvii

13 ACCOUNTING POLICY CHOICE WITHIN THE SHARrAH/SLAM/YYAH FRAMEWORKDr Roszaini Haniffa / Dr Mohammad Hudaib / Dr Malik Mirza

IntroductionTheories of Accounting Policy ChoiceThe Concept of 'Uqud (Contracts)Shari 'ah Islamiyyah and Accounting Policy Choice

Islamic Modes of FinancingValuation of AssetsBusiness DealingsDisclosure Policy

ConclusionReferences

317319321326329330332335337340

14 ACCOUNTING REGULATORY ISSUES ON INVESTMENTSIN ISLAMIC FINANCEDr Abdul Rahim Abdul Rahman

Introduction 347Islam and Accounting 349An Islamic Perspective of Accounting Objectives and Concepts 351Islamic Accounting Concepts on Recognition, Measurement andDisclosure 353AAOIFI Fas 17 and Accounting Issues on Investments in IslamicSecurities 355Concluding Remarks 360References 362

15 RISK MANAGEMENT IN ISLAMIC FINANCE ISSUES,CHALLENGES AND STRATEGIES TO MITIGATE THE RISKDr Dadang Muljawan

Introduction 365The Islamic Economics as a School Thought 367

Islam as the Way of Life for Muslim 367Islamic Economics and the Mainstream Economic Schoolof Thought 370

Contemporary Islamic Banking and Finance 372An Islamic Financial System in a Concurrence to Idea ofIslamic Economics 372Risk Exposure of an Islamic Bank 374Current Development in the Islamic Banking andFinance Industry 382The Use of Non-Directly Associated Asset to Cater theLegitimate Transactions 384

Challenges Ahead and Strategies to Mitigate 385Concluding Remarks 387

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16 CORPORATE GOVERNANCE AND STAKEHOLDERMANAGEMENT: AN ISLAMIC APPROACHDr Asyraf Wajdi Dusuki

Introduction 391A Shift From Shareholders' to Stakeholders' Value Based CorporateGovernance 393Stakeholder Theory 395Islamic Perspectives on the Stakeholder Theory 398Managing Conflict Among Stakeholders 402Pyramid of Maslahah 403Conclusion 409References 410

ISLAMIC CAPITAL MARKET

17 AL·SUYULAH: THE ISLAMIC CONCEPT OF LIQUIDITYDr Mohd Daud Bakar

Concept of Liquidity in Conventional Perspective 417Historical Perspective oflslamic Liquidity 419Principles of Fiqh Governing Islamic Liquidity 428Concept and Modus Operandi of Modern Islamic Liquidity 430Conclusion 439

18 ISSUES IN ISLAMIC DEBT SECURITIZATIONDr Engku Rabiah Adawiah Engku Ali

Introduction 443Securitization: Meaning and Concept 445Islamic Securitization: A Historical Perspective 447Islamic Securitization: Recent Experiences and Practices 449Islamic Debt Securitization (Section 1: Debt Creation) 452

Debt Creation Via Loan Contract: Qard Hasan 452Debt Creation Via Sale Contracts: The Issue of Bay' Al- 'Inah 454Debt Creation Via Sale Contracts: The Issue of Asset 460

Islamic Debt Securitization (Section 2: Debt Securitization) 478Debt Securitization: The Issue of Bay' Al-Dayn 478Debt Securitization: Possible Solutions? 484

Other Possible Forms of Islamic Securitization 486Other Forms of Islamic Securitization 490Conclusion and the Way Forward 491

xix

19 THE ISLAMIC BONDS MARKET: POSSIBILITIES AND CHALLENGESDr Muhammad AI Bashir Muhammad AI-Amine

Introduction 497Salam Bonds 498Ijarah Bonds 505Characteristics of Ijarah Bonds 507Istisna' Bonds 508Muqaradah or Mudarabah Bonds 510Features of Muqaradah Bonds 512Sale and Disposal of Muqaradah Bonds 513Distribution of Profits 513Guarantee of Muqaradah Bonds 514Muqaradah Bonds: An Illustration 522Musharakah Bonds 523Malaysian Government Certificates 525Conclusion 526

20 ISLAMIC LAW ISSUES IN SALE·BASED FINANCINGSTRUCTURES AS PRACTISED IN MALAYSIADr Engku Rabiah Adawiah Engku Ali

Introduction 531Sale and Trade: The Basis and Rules Under Islamic Law 533Sale-Based Financing in Practice 535

BBA and Murabahah Structures 536Istisna'Structure 540

Islamic Law Compliance Issues in Sale-Based Financing: BBA,Murabahah and Istisna' 545

Issue of Bay' al- 'Inah 545Issue of Asset Suitability (Mal) 547Issue of Bay' al-Dayn 557

Conclusion 557

21 FLEXIBILITY VERSUS FAIRNESS CONVENTIONAL DERIVATIVESAND ISLAMIC DERIVATIVESSherin Kunhibava

Background 561Conventional Derivatives 563Islamic Derivatives 565Comparing Conventional and Islamic Derivatives 567Conclusion 573References 574

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22 DERIVATIVES INSTRUMENTS AND ISLAMIC FINANCESOME THOUGHTS FOR A RECONSIDERATIONDr Obiyathulla Ismath Bacha

The Evolution of Derivative Instruments 580Forward Contracts 581The Need for Futures Contracts 582The Need for Options 584The Main Players in Derivative Markets 587

Literature Review: The Islamic View of Current Day DerivativeInstruments 589

The View on Options 590The View on Futures 592Necessary Features for Islamic Financial Instruments 593

Islamic Financial Instruments with Features of Derivatives 595Bay' al-Salam 595The Istijrar Contract 597

An Assessment of the Arguments Against Derivatives 600Trading Volume 600The Issue of Non Delivery 601Cash Settlement 602

Co'lclusion 603References 605Appendix 606

Index 609

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