1 | P a g e

SHARIAH ASPECT OF BUISNESS AND FINANCE

INDIVIDUAL ASSIGNMENT

BY

NITHIYARAJAN A/L MASILAMANY 6112040891

GIM 6213

LECTURER

PROF MADYA DR.MOHD FUAD

2 | P a g e

Contents Introduction ................................................................................................................................................... 3

The main rules for Islamic finance ............................................................................................................... 5

How do the banking arrangements work for customers? .............................................................................. 7

Is the arrangements and practice similar to ethical banking, then? ............................................................. 14

What choices do people have? .................................................................................................................... 15

The function of “Fiat Money” in Islamic Banking. .................................................................................... 15

Conclusion .................................................................................................................................................. 16

Reference .................................................................................................................................................... 18

3 | P a g e

Introduction How is Islamic finance different from conventional finance? It looks the same. The result is often the

same. What’s the difference? Well, the best way to find out is with a simple, real-world

comparison. Let’s take $10,000, for instance. And let's compare what a conventional bank can do

with this $10,000 and what an Islamic bank can do. First, the conventional bank.The conventional

bank finds a credit worthy customer and lends at 5% interest. The bank is not particularly

concerned about what happens to this money other than that it gets repaid. The customer, on the

other hand, has already found a borrower willing to pay 7%. This borrower runs a small credit co-op for

students and lends at 10%. One of these students is enterprising enough to lend to his unemployed

brother at 15%. Who has just discovered the power of compounding interest and now lends to street

vendors at 25%. We could go on. But you get the idea. As we speak, there are poor people paying

upwards of 40%...per month! Now obviously we can’t blame conventional banks for everything that

happens after they’ve made the initial loan. But we can blame the power of compounded

interest.”Interest, and the fact that you don’t need actual cash to lend money means that the original

$10,000 could keep passing hands until we pump out over $100,000 of artificial wealth. Artificial is

right.How much actual cash is there? Only $10,000. With interest, we managed to turn $10,000

into much more. Now what happens if the street vendors go out of business? Or the unemployed brother

doesn’t find his job? Or the credit co-op goes bankrupt?That’s right. Loans don’t get repaid. And if

enough people can’t repay their loans, lenders get into all sorts of trouble. This vicious cycle sets off a

domino effect of defaults.And imagine that instead of a $10,000 personal loan, it’s a million dollar

business loan, or a billion dollar World Bank loan. Compounding interest grows so fast that

borrowers are often unable to repay. People, economies, and the environment pay the price as we

grow more desperate to meet rising debts.So are we surprised when billions of dollars vanish into thin

air? Let’s take the example of the Islamic bank. With this $10,000 the Islamic bank only invests in actual

assets and services. It might buy machinery, lease out a car, or invest in a small business. But,

throughout, the transaction is always tied to a real asset or service. And this is the central point: we

4 | P a g e

can’t simply “compound” assets and services like we can compound interest-based loans. An asset

or service can only have one buyer and one seller at any given time. Interest, on the other hand, allows

cash to circulate and grow into enormous sums.That’s the difference between Islamic finance and

conventional finance: the difference between buying and selling something real and borrowing and

lending something fleeting.In recent years we’ve witnessed the most dramatic global financial downturn

seen in decades. What began as a housing bubble soon became a sub-prime credit crisis. And what many

thought would remain a credit crisis soon spread into a global financial meltdown. It devastated every

corner of the world.And while these events affected most of us negatively, there was one silver

lining: people finallygave a serious look at alternative forms of finance. And many people stopped

believing that interest could solve all problems.

5 | P a g e

The main rules for Islamic finance

Figure 1 Source of Shariah

6 | P a g e

The rules governing Islamic Finance are derived from the Shari'ah. The Shari'ah is a framework

of Islamic Jurisprudence derived from the primary sources: The Qur'an and the teachings of the

Prophet Muhammad (pbuh) known as the Sunnah. In addition to which there is a dynamic

secondary source of common law rulings and scholarly interpretations referred to as Fatwa's.

These fatwas are the results of human interpretation of the Shari' ah, of its texts, or its principles,

or a combination of the two; they are not the word of God. Islamic law, it must be remembered,

is more a process than a code, and the results of legal deliberations may differ when different

methods are employed. Several fatwas are indicative of an acceptance on the part of Shari'ah

Supervisory Boards of new realities in the marketplace and of their willingness to understand and

work with these to the extent that Islamic religious and legal principles will allow. Such an

attitude has ever characterized the best in Islamic legal thought.

The originators of modern banking based their system on ‘interest-oriented investments and

earnings which are clearly prohibited in the Shari'ah of Islam. Therefore, modern banking

institutions, which gradually became essential to the commercial activity of the entire world,

were totally antithetical to the guidance revealed to humankind through the Qur'an and the

Sunnah of the Prophet Muhammad (pbuh).Many Muslims, believing in the prohibition of

interest, remained aloof from this modern system of banking, and those who did enter the field

restricted themselves to the routine work necessary for their employment. This was done because

they had reservations about interest-based transactions and also because, owing to their political

decline, they were unable to control the wheel of international commercial transactions.

7 | P a g e

How do the banking arrangements work for customers?

There are several Islamic financial instruments

Ijarah = leasing

Alternative spelling = Ijara

A lease agreement whereby a bank or financier buys an item for a customer and then leases it to

him over a specific period, thus earning profits for the bank by charging rental.

The duration of the lease and the fee are set in advance. During the period of the lease, the asset

remains in the ownership of the lessor (the bank), but the lessee has the right to use it. After the

expiry of the lease agreement, this right reverts back to the lessor.

This is a classic Islamic financial product.

Ijarah Thumma Bai = leasing to purchase

The principle governing an Ijarah contract at the end of the lease period, when the lessee buys

the asset for an agreed price through a purchase contract.

Ijarah wa Iqtina = buy-back leasing

A hire and purchase mode of financing where an Islamic bank finances equipment, a building or

other facility for the client against an agreed rental, together with an undertaking from the client

8 | P a g e

to repurchase the facility at the end of the contract. The rental and the purchase price are fixed so

that the bank gets back its principal sum along with some predetermined profit.

Ijtehad = effort, exertion, industry

A faqhi‘s endeavor to formulate a rule on the basis of evidence found in the Islamic sources.

Inan = financial partnership

Istijrar = recurring sale

Different quantities are bought from a single seller over a period of time. Sometimes it is also

referred to transactions whereby seller delivers different quantities in different installments to

complete the full purchase. Some divergence among the scholars in terms of the timing of

fixation and pricing.

Istisnah = advance purchase of goods or buildings

Alternative spellings = Istisna, Istisna’a, Istisna’ah

A contract of acquisition of goods by specification or order, where the price is paid in advance,

or progressively in accordance with the progress of a job. For example, to purchase a yet to be

constructed house, payments would be made to the builder according to the stage of work

completed.

This type of financing, along with Salam, is used as a purchasing mechanism, and Murabahah

and Bai Bithaman Ajil are for financing sales.

9 | P a g e

Mudarabah = trust financing, profit sharing

Alternative spellings = Mudaraba, Modaraba, Modarabah

An investment partnership, whereby the investor (the rab al maal ) provides capital to the

entrepreneur (the mudarib ) in order to undertake a business or investment activity. While profits

are shared on a pre-agreed ratio, losses are born by the investor alone. The mudarib loses only

his share of the expected income.

The investor has no right to interfere in the management of the business, but he can specify

conditions that would ensure better management of his money. In this way Mudarabah is

sometimes referred to as a sleeping partnership.

A joint Mudarabah can exist between investors and a bank on a continuing basis. The investors

keep their funds in a special fund and share the profits before the liquidation of those financing

operations that have not yet reached the stage of final settlement. Many Islamic investment funds

operate on the basis of joint Mudarabah.

Mudarib = entrepreneur in a Mudarabah contract

The entrepreneur or investment manager in a Mudarabah who puts the investor’s funds in a

project or portfolio in exchange for a share of the profits. A Mudarabah is similar to a diversified

pool of assets held in a discretionary asset management portfolio.

10 | P a g e

Mufawadah = equal, unlimited partnership

Murabahah = cost-plus financing

Alternative spellings = Morabaha, Morabahah, Murabaha

A form of credit that enables customers to make a purchase without having to take out an

interest-bearing loan. The bank buys an item and sells it to the customer on a deferred basis. The

price includes a profit margin agreed by both parties. Repayment, usually in installments, is

specified in the contract.

The legality of this financing technique has been questioned because of its similarity to riba.

However, the modern Murabahah has become the most popular financing technique among

Islamic banks, used widely for consumer finance, real estate, the purchase of machinery and for

financing short-term trade.

.

Musharakah = joint venture, profit and loss sharing

Alternative spelling = Musharaka

An investment partnership in which all partners are entitled to a share in the profits of a project

in a mutually agreed ratio. L osses are shared in proportion to the amount invested. All partners

to a Musharakah contribute funds and have the right to exercise executive powers in that project,

11 | P a g e

similar to a conventional partnership structure and the holding of voting stock in a limited

company.

This equity financing arrangement is widely regarded as the purest form of Islamic financing.

The two main forms of Musharakah are:

Permanent Musharakah: an Islamic bank participates in the equity of a project and receives a

share of the profit on a pro rata basis. The length of contract is unspecified, making it suitable for

financing projects where funds are committed over a long period.

Diminishing Musharakah: this allows equity participation and sharing of profits on a pro rata

basis, and provides a method through which the bank keeps on reducing its equity in the project,

ultimately transferring ownership of the asset to the participants. The contract provides for

payment over and above the bank’s share in the profit for the equity held by the bank.

Simultaneously the entrepreneur purchases some of the bank’s equity, progressively reducing it

until the bank has no equity and thus ceases to be a partner.

Muzara’a = agricultural contract

A contract in which one person works the land of another person in return for a share in the

produce of the land.

Qard = loan

Qard Hasan = benevolent loan

12 | P a g e

Alternative spelling = Qard Hassan

A loan contract between two parties for social welfare or for short-term bridging finance.

Repayment is for the same amount as the amount borrowed. The borrower can pay more than the

amount borrowed so long as it is not stated by contract.

Most Islamic banks provide interest-free loans to customers who are in need. The Islamic view

of loans (qard) is that there is a moral duty to give them to borrowers free of charge, as a person

seeks a loan only if he is in need of it. Some Islamic banks give interest-free loans only to the

holders of investment accounts with them; some extend them to all bank clients; some restrict

them to needy students and other economically weaker sections of society; and some provide

interest-free loans to small producers, farmers and entrepreneurs who cannot get finance from

other sources.

Riba = interest

An increase, addition, unjust return, or advantage obtained by the lender as a condition of a loan.

Any risk-free or “guaranteed” rate of return on a loan or investment is riba. Riba in all its forms

is prohibited in Islam.

In conventional terms, riba and “interest” are used interchangeably, although the legal notion

extends beyond mere interest.

13 | P a g e

Riba al Diyun = usury of debt

Also known as usury of delay (riba al nasia).

The usury of debt was an established practice amongst Arabs during the pre-Islamic period. It

can occur as an excess increment on top of the principal, which is incorporated as an obligatory

condition of the giving of a loan.

Alternatively, an excess amount is imposed on top of the principal if the borrower fails to repay

on the due date. More time is permitted for repayment in return for an additional amount. If the

borrower fails to pay again, a further excess amount is imposed, etc.

Ruq’a = payment order

A payment order to draw money from the bank; used in the early Muslim period.

14 | P a g e

Tabarru’ = Takaful donation

A contract where a participant agrees to donate a pre-determined percentage of his contribution

(to a Takaful fund) to provide assistance to fellow participants. In this way he fills his obligation

of joint guarantee and mutual help should another participant suffer a loss. This concept

eliminates the element of gharar from the Takaful contract.

Takaful = Islamic insurance

Based on the principle of mutual assistance, Takaful provides mutual protection of assets and

property and offers joint risk-sharing in the event of a loss by one of the participants. Takaful is

similar to mutual insurance in that members are the insurers as well as the insured.Conventional

insurance is prohibited in Islam because its dealings contain several haram elements, such as

gharar and riba.

Is the arrangements and practice similar to ethical banking, then?

There is some common ground. Some of the tenets of Islamic banking will appeal to anyone,

Muslim or otherwise, who agrees with the underlying principles of equitable distribution for

everyone, the ideals of fair trading, spending of wealth judiciously, and well-being of the

community as a whole. These principles result in an exacting ethical stance relating to

investment.

15 | P a g e

What choices do people have?

The 1.8 million plus Muslims living in the UK can now manage their money on a day-to-day

basis without compromising their deeply held convictions. Lloyds TSB offers a current account,

as does HSBC through its Amanah Finance division, together with a home-financing scheme.

However, although money is held separately to that managed by the rest of the organisation,

these are large institutions that are not wholly compliant with sharia principles.

The Islamic Bank of Britain, which opened in 2004, operates entirely in accordance with sharia

law. It has branches in London, Leicester, Birmingham and Manchester and offers a range of

savings accounts, a current account and financing deals.Homebuying products, credit or charge

cards and other services will be available later this year. The managing director, Michael Hanlon,

says its products are competitively priced and "equivalent to those available in a conventional

bank".The Ahli United Bank specialises in home-financing schemes. As well as helping Muslims

buy a property to live in, it now offers sharia-compliant funding for buy-to-let property

investments.

The function of “Fiat Money” in Islamic Banking.

In the new modern world, Muslims interact with financial institutions which act as intermediaries

between the capital providers or depositors and the individuals, or businesses which need

the capital to buy premises, automobiles and for business operations. In return, the

16 | P a g e

financial institutions charge interest on the loans given to the individuals and businesses

and pay fixed interest to the depositors. One of the reasons that the financial institution charge

fixed interest is because the fiat money deposited and lent out are subject to inflation. In other

words, RM10,000 today is not the same as RM10,000 five years from now as the value of paper

money is always fluctuating. Dr Umer Chapra mentions in his paper titled "Monetary Policy

in an Islamic Economy" that one of the important goals Islam emphasis in realizing the socio

economic is stability in the value of money (p. 31). Dr Hakimi Ibrahim in his article "The

Meaning of Islamic Currency" mentioned that some people says that there is no riba if we

borrow RM1,000 from a friend and we return the same amount after ten years. We could

say that it has no elements of riba because it is the same in quantity. However 10 years from

today the same amount will not have the same value or purchasing power. Maybe the value is

lesser than the value of RM50 today. If this happens then the instability causes concerns even

though it is not riba (Dr Hakimi,1998).

Conclusion

All banking products can largely be divided into the following 4 categories:

1. Equity

2. Trading

3. Leasing, and

4. Debt

Equity refers to direct ownership, trading refers to buying and selling, leasing refers to giving

an asset or service out on rent, and debt refers to providing an interest-based loan. Simply put,

17 | P a g e

Islamic finance permits equity, trade, and lease-based transactions, but forbids debt. And in

many ways we’re already familiar with these kinds of transactions. Here’s most of Islamic

finance in a nutshell:

• Mudarabah, Musharakah, and Sukuk are all equity based

• Murabaha, Salam, and Istisna are trade based

• And Ijarahs are lease based

Some of the basic principles that guide Islamic banks. These are that transactions must:

1. Be interest free

2. Have risk sharing and asset and service backing

3. Have contractual certainty

4. And that all the elements of the transaction must, in and of themselves, be ethical

18 | P a g e

Reference

Abdul-Rahman, Dr. Y. K. & Tug, S. A. 1999. Towards a LARIBA (Islamic)

Mortgage financing in the United States providing an Alternative to Traditional

mortgages. International Journal of Islamic Financial Services, Vol. 1, No. 2, July-

September 1999

Ahmad, S. 1992 Towards interest-free banking. New Delhi: International Islamic

Publishers.

Bacha, Dr. O. I. 1999. Derivative Instruments and Islamic Finance: Some thoughts

for Reconsideration. International journal of Islamic financial Services, vol.1, No.1,

April-June 1999.

Edward’s, W. CEO, Delphi Risk Management, May 2000 Planned Saving Magazine.

Edward’s, W. Competitive pricing of Islamic Financial products, 1

st

Quarter 99,

Princeton Economics journal, Princeton, USA

El-Gamal, M. Can Islamic banking survive a micro-evolutionary prospective, 21 Feb

1997

Fadal, M. International journal of Islamic financial services, Vol1,No2, July-Sept,

19 | P a g e

1999

Fisher, I. 1930. The Theory of Interest, New York: Macmillan.

Fisher, I. 1935a. The Debt-Deflation Theory of Great Depression’, Econometrica (1)

337-357.

Fisher, I. 1945 100% money. New Haven: City Printing.

Fisher, I 1993b. Booms and Depressions, London: George Allen & Unwin.

Friedman, M. 1969. The monetary theory and policy of henry simons. In Friedman,

M., ed., The Optimum Quantity of Money and Other Essays. Aldine, Chicago.

Abu Bakar Bin Mohd Yusuf, Nuradli Ridzwan Shah Bin Mohd Dali, Norhayati Mat

Husin (2002). Implementation of the Gold Dinar: Is it the End of Speculative Measure? Journal

of Economic Cooperation 23, 3 (2002) 71-84.

Bernanke, Ben & James, Harold (1991), The Gold Standard, Deflation, and Financial Crisis in

the Great Depression : An International Comparison,

http://www.nber.org/chapters/c11482

Camerer, Colin and Dan Lovallo, Overconfidence and Excess Entry: An Experimental

Approach,

American Economic Review vol. 1, no. 1, March 1999, 306-318.

Chapra, Dr M Umar (1983). "Monetary Policy in an Islamic Economy" Money and Banking in

20 | P a g e

Islam. International Centre for Research in Islamic Economics, King Abdul Aziz

University, Jeddah..

Cizakca, Murat (2010), The Case against the Islamic Gold Dinar. INCEIF. MPRA Paper

No.

26645.

Frankel, Jeffrey A., and Andrew K. Rose, Currency Crashes in Emerging Markets: An Empirical

Treatment, Journal of International Economics 41, November 1996, 351 – 368.

Gignoux, Philippe. 2009. Dirham in Pre-Islamic Iran. In http:/www.iranica.com/

newsite/articles.unicode/v7f4/v7f472.html Visited August 3, 2009.

Hail ‘Abd al -Hafid (1999), Taghayyur al-Qimah al- Shira ’iyyah Li al -Nuqud al-Waraqiyyah,

al-

Ma’had al - ‘Alami Li al -Fikr al-Islami, Dirasat Fi al-Iqtisad al-Islami, 35.

Haneef, M. A. and E. R. Barakat (2006), Must Money Be Limited to Only Gold and Silver? A

Survey of Fiqhi Opinions and Some Implications, JKAU: Islamic Econ., Vol. 19, No. 1,

pp: 21-34.

Hassan, Zubair (2008). Ensuring Exchange Rate Stability: Is Return to Gold (Dinar) Possible?

JKAU: Islamic Econ., Vol. 21 No. 1, pp: 3-25.

21 | P a g e

Hommel, Jason (2000), Gold & Hypothetical (constant) Growth

Rates,

www.geocities.com/bibleprophesy/goldrates.htm.

Islahi, Abdul Azim (2006), Monetary Thought of the Sixteenth-century Muslim Scholars, MPRA

Paper 18346. Kahneman, Daniel, Paul Slovic and Amos Tversky, Judgment under Uncertainty:

Heuristics and

Biases, Cambridge University Press, 1982.

Konac, Enver Hakan. The East Asian Crisis: Lessons for OIC Countries. Journal of Economic

Cooperation 21, 2 pg 15 - 24, 2000.

Obstfeld, Maurice, The Logic of Currency Crises, Cahiers Economiques et Monetaires 43:189-

213.

Redish, A. (2000). Bimetallism: An Economic and Historical Analysis. Cambridge: Cambridge

University Press.

Reinhart, Carmen and Rogoff, Kenneth (2011), From Financial Crash to Debt Crises, American

Economic Review 101.

Rose, Peter S. Money and Capital Markets : The Financial System in an Increasingly

Global

Economy, Richard D. Irwin, Inc., 1994

22 | P a g e

Sanusi, M.M. (2002) Gold Dinar, Paper Currency and Monetary Stability: An Islamic

View,

‘‘Proceeding of the 2002 International Conference on Stable and Just Global Monetary

System’’, Kuala Lumpur, 19 -20 August, pp. 73-89.

Siddiqi, Muhammad Nejatullah (1981). Muslim Economic Thinking."A Survey of Contemporary

Literature". Great Britain. Robert MacLehose and Co. Ltd.

Siegfried, N. A. (2001) Concepts of Paper Money in Islamic Legal Thought, Arab Law

Quarterly, University of Hamburg, Kluwer Law International. Printed in the Netherlands.

Triffın, R. (1964). The Evolution of the International Monetary System: Historical Reappraisal

and Future Perspectives. Princeton, N.J: International Finance Section, Dept. of

Economics, Princeton University.

Tunçer, Ali Coşkun (2013), The Black Swan of the Golden Periphery: The Ottoman

Empire

during the Classical Gold Standard Era. London School of Economics CWPESH no. 13.

Vadillo, Umar Ibrahim (2008) White Paper on the Gold Dinar: The Roadmap of

Implementation.