canonical sharia contracts applied to modern finance

04/10/23 Dr. Muhammad Imran Usmani- Pakistan

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CANONICAL SHARIAH CONTRACTS CANONICAL SHARIAH CONTRACTS APPLIED TO MODERN FINANCEAPPLIED TO MODERN FINANCE

CANONICAL SHARIAH CONTRACTS CANONICAL SHARIAH CONTRACTS APPLIED TO MODERN FINANCEAPPLIED TO MODERN FINANCE

Dr. Muhammad Imran UsmaniShariah AdvisorShariah Advisor

Guidance Financial GroupGuidance Financial GroupWashington DCWashington DC


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Prohibition of Riba

Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said: Trading is but

like riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is upto Allah. And the ones who revert back, those are the

people of Fire. There they remain forever.Allah destroys riba and nourishes charities. And Allah does not like any sinful

disbeliever.


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Definition of Riba

Sale (Bai):

To sell the commodities with specified consideration

Lease (Ijarah):

To sell a particular usage with specified compensation


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Permissibility and Reward of Trade and Joint Business Activities

Islam encourages trade and business activities Allah (SWT) has ordained in Holy Quran

“Allah has permitted trade and prohibited Riba” AHADITH

“If you leave behind wealthy heirs, it’s better than that of leaving them needy and dependent on others and under their control”


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Prophet (SAW) once said“Listen! Whoever becomes a guardian of an orphan who owns some wealth, he should use it in trade and not leave it unutilized in order to be consumed by sadaqah.

at another occasion he said

“An honest and trustworthy trader on the day of judgment will be among Siddiqueen”

Prophet (SAW) also encouraged Shirkah in various maxims and sayingsProphet (SAW) once said that Allah (SWT) has stated: “He will become a partners in a business between two Mushariks until they indulge in cheating or breach of trust (Khayanat)


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Importance of Purifying the Source of Income in Islam The body which is nourished by non-pure sources

is bound to hellfire. On the day of Judgment, a person will not be

moved from the place which he stands until he is asked about the sources of his income, and the ways he spent it.

Purifying the source of ones’ nourishment is one of the important reasons for the acceptance of supplications by Allah.

SHARI’AH1. Lexical meaning: Plain Way

(Siratul Mustaqim)

2. Technical meaning: The Divine Law


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Then We have put you (O prophet) on a plain way of (our) commandment. So follow it and do not follow the desires of those who do not know. (45:18)


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SOURCES OF SHARIAH

1. The Holy Qur’an

2. The Sunnah of the Holy Prophet (SAW)

3. Ijma’ (consensus of the Ummah)

4. Qiyas (Anology)


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RULES OF SHARIAH

1. Three Prohibited Transaction

2. 1. Riba• Riba Al Nase’ah• Riba Al Fadhl

1. 2. Maysir

2. 3. Gharar :3. Al Jahalah, Bai Qablal Qubz etc.


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First Revelation about Riba

– “That which you give as interest to increase the peoples' wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold.” (Surah Rome, Verse 39)


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Second Revelation

– “And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other peoples' property. We have prepared for those among them who reject faith a grievous punishment ” (Surah al-Nisa', verse 161)


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Third Revelation

– “Believers! Do not swallow riba, doubled and redoubled, and be mindful of Allah so that you may attain true success” ( Al Imran, Ayat 130)


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Fourth Revelation

Surah Al BaqarahVerses 274-281


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Those who spend their wealth night and day, secretly and openly, they have their reward with their Lord, and there is no fear for them, nor shall they grieve.Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said: Trading is but like riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is upto Allah. And the ones who revert back, those are the people of Fire. There they remain forever.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 Zakah have their reward with their Lord, and there is no fear for them,nor shall they grieve.O those who believe, fear Allah and give up what still remains of the riba if you are believers. But if you don 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. (Verses of Surah Al Baqarah: 274-281)


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Prohibition of Riba in Hadith


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The prohibition of Interest is not limited to Islam, but it is shared by Judaism and Christianity.

Some of the old testaments have rendered riba as haram (See Exodus 22:25, Leviticus 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezakhiel 18:8,13,17 & 22:12).

Agibi Bank was established circa 700 B.C. in Babylonian and functioned exclusively on equity basis.


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ISLAMIC BANKING

CLASSIFICATION OF RIBA

– Riba-un-Nasiyah or Riba-al-Jahiliya

– Riba-al-Fadl or Riba-al-Bai


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ISLAMIC BANKING



“that kind of loan where specified repayment period

and an amount in excess of capital is

predetermined”( Imam Abu Bakr Jassas Razi)


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ISLAMIC BANKING



“all loans that draw interest is riba”(Hadith quoted

by Ali ibn Talib)

“the loan that draws profit is one of the forms of

riba”(definition from Sahabi Fazala Bin Obaid)


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ISLAMIC BANKING



real and primary form of riba

premium paid to the lender in return for his waiting

giving or taking of every excess amount in exchange

of a loan at an agreed rate irrespective of whether it

is low or high


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ISLAMIC BANKING


– Riba-al-Fadl

Definition: Any excess that is without due consideration

For example: excess taken in exchange of specific commodities

(Al amwal Ur Ribawiyyah) which are homogeneous


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ISLAMIC BANKING

CLASSIFICATION OF RIBA– Hadith prohibiting Riba-al-Fadl

‘sell gold in exchange of equivalent gold sell silver in exchange of equivalent silver

sell dates in exchange of equivalent dates sell wheat in exchange of equivalent wheat sell salt in exchange of equivalent salt sell barley in exchange of equivalent barley


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ISLAMIC BANKING

sell barley in exchange of equivalent barley but if a person

transacts in excess, it will be riba.

However sell gold for silver anyway you please on the condition

it is hand-to-hand(spot sales) and sell barley for date anyway

you please on the condition it is hand-to-hand(spot sales)

CLASSIFICATION OF RIBA– Hadith prohibiting Riba-al-Fadl


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ISLAMIC BANKING


– Imam Abu Hanifa on Riba-al-Fadl commodities must have two common characteristics

– Weight

– Volume

includes all commodities having weight or volume

and are being exchanged


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ISLAMIC BANKING


– Imam Shafi on Riba-al-Fadl commodities must have two common characteristics

– be a medium of exchange

– be edible

includes all commodities that are edible or can be

used as a medium of exchange(currency)


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ISLAMIC BANKING


– Imam Maalik on Riba-al-Fadl commodities must have two common characteristics

– can be preserved

– be edible

includes all commodities that are edible and can be

preserved


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ISLAMIC BANKING


– Imam Ahmad Bin Hanbal on Riba-al-Fadl first citation conforms to the opinion of Imam Abu

Hanifa

second citation conforms to the opinion of Imam

Shafi

third citation includes three characteristics at the

same time i.e. edible, weight and volume


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RIBA IN BANKING

On the both sides of the conventional banks Riba exists:

On the Liabilities Side, through borrowing from depositors on fixed and guaranteed return

On the Assets side, through lending on Interest basis.


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Basic Difference between Islamic and Conventional Modes of Finance

Conventional

Bank Client

money

money + money (interest)


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Basic Difference between Islamic and Conventional Modes of Finance

Islamic

Bank ClientGoods & Services

money


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CONVENTIONAL BANKING

--------------------------- Is based on interest.

Deals in money or papers.

Is based on fixed return on both Sides of the balance sheet.

Does not involve itself in trade and business

ISLAMIC ISLAMIC BANKINGBANKING--------------------------- ---------------------------

Is based on profit or rentIs based on profit or rent

Deals in assets.Deals in assets.

Is based on profit sharing on Is based on profit sharing on deposits side, and on profit deposits side, and on profit on assets side.on assets side.

Actively participates in Actively participates in trade, production and valid trade, production and valid services through valid services through valid contracts.contracts.

Theoretical Comparison


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CONTRACT IN ISLAM

CONTRACT

SUBJECT MATTER

CONTRACTORS WORDING OFCONTRACT

•Specified •Quantified

•Non-restricted•Sane•Mature

•Present/immediate•Unconditional•Non-contingent


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CONTRACT IN ISLAMCONDITIONAL CONTRACTS:

1. A condition, which is not against the contract, is a valid condition. For example a condition of free delivery to buyer’s premises.

2. A condition, which seems to be against the contract, but it is in the market practice, is not void, if its voidness is not proved with the clear injunctions of the Holy Quran and Sunnah. For example a condition that the seller will provide five-year guarantee and one year free service.


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CONTRACT IN ISLAM3. A condition that is against the contract and not in

market practice but is in favor of one of the contractors or subject matter, the condition is void. For example if ‘A’ sells a car with a condition that will use it on a fixed date every month, this contract will be void he.

4. A condition, which is against the contract, not in the market practice and not in favor of any contractor, that is not a void condition. For example if both A and B decide to give to charity, a certain percentage of both subject matter and cosideration, upon completion of sale.


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CONTRACT IN ISLAM

VOID CONDITIONS AND VOID CONTRACTS: The contracts of compensation (Uqood Muawadha) like

sale, purchase, lease agreements become void by putting void condition.

Non-compensatory (voluntary) agreements (Uqood Ghair Muawadha) like contract of loan (Qard-e-Hasanah), do not become void because of void condition. The void condition, however, becomes itself ineffective.


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ISLAMIC SALE CONTRACT

DEFINITION OF SALE(BAI)

– exchange of a thing of value with another thing

of value with mutual consent.

– the sale of a commodity in exchange of cash.


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TYPES OF SALE

1. Valid sale ( Bai Sahih)

2. Void/Non existing Sale ( Bai Baatil )

3. Existing sale but void due to defect ( Bai Fasid )

4. Valid but disliked sale ( Bai Makrooh )


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VALID SALE ( Bai Sahih)

– a sale is valid if all elements together with their conditions are present

– elements of valid sale are Contract ( Aqd ) Subject matter ( Mabe’e) Price ( Thaman ) Possession or delivery ( Qabza )


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C on trac t o r tran s ac tion(A q d )

1

S o ld g ood s o rsu b jec t m atte r

(M u ta 'aq u ad een )2

P ric e(T h aman )

3

D elive ry o r p ossess ion(Q a b za )

on ly in resp ec t o f m ovab leg ood s , n o t im m ovab le 4

V a lid S a le(B a i S ah ih )


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ISLAMIC BANKING

ELEMENTS OF A VALID Contract– Wording of the CONTRACT ( Aqd )

Offer & Acceptance ( Ijab-o-Qobool)– Oral ( Qauli )– Implied ( Hukmi)

• Credit sales (e.g. Istijrar )• Hand to Hand ( e.g. Taati )

The contractors ( Muta’aquadeen ) must be– Sane– Mature


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ISLAMIC BANKING

– Wording of the Contract( Aqd )– Contract must be immediate

– Contract must be non-contingent• unconditional contract• under reasonable conditions• under unreasonable conditions but at market practice

and not against the clear injunctions of Islam


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ISLAMIC BANKING

O ra l(Q a u li)

(In p as t ten se)1 .1 .1

C red it S a le(Is tijra r)

(eg se ttlem en t a t th e en d o f th e m on th ) 1 .1 .2 (a)

C ash S a le(T a a ti)

(eg as in su p erm arkets )1 .1 .2 (b )

Im p lied(Ish a ra a )

(In p as t ten se) 1 .1 .2

O ffe r & A ccep tan ce(Ija b -o -Q oboo l)

1 .1

S an e

1 .2 .1 .

M atu re(If m in or, m u s t u n d ers tan d

n atu re o f tran sac tion )1 .2 .2

B u yer & S e lle r(M u ta 'aq u ad een )

1 .2

U n con d it ion a l con trac t

1 .3 .1 (a)

U n d er reason ab le con d it iion s

1 .3 .1 (b )

U n d er u n reason ab le con d it ionb u t in m arke t p rac tice(eg . warran ty o f 1 year

on sa le o f frid g e 1 .3 .1 .(c )

S a le m u s t b en on -con tin g en t

1 .3 .1

S a le m u s t b e im m ed ia teN ot d e fe rred to fu tu re(eg p rop erty m u s t p ass 1 .3 .2 .on sa le d a te n o t on fu tu re d a te

C on d ition s o f C on trac t(S h a ra e t-e -A qd )

1 .3

C on trac t o r Tran sac tion(A q d )

1


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ISLAMIC BANKING

ELEMENTS OF A VALID SALE ( Bai Sahih)– SOLD GOOD OR SUBJECT MATTER

( Mube’e ) Existing Valuable Usable Capable of ownership/title Capable of delivery/possession Specific & Quantified Seller must have title & risk


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ISLAMIC BANKING

ELEMENTS OF A VALID SALE ( Bai

Sahih)

– PRICE ( Saman )

Quantified ( Maloom )

Specified & certain ( Muta’aiyan )


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ISLAMIC BANKING

ELEMENTS OF A VALID SALE ( Bai Sahih)

– DELIVERY OR POSSESSION (QABZA)

Physical ( Haqiqi )

Constructive ( Hukmi )


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Major Contracts Used in Islamic Banking

Buying & Selling (Murabaha, Musawama, Tawarruq)

Mudaraba/Qiradh: Investment management Musharaka: Partnership Ijarah: Leasing Wakalatul Istismar/Ijaratu Alashkas: Agency Istisna’/ Muqawala: Contract of works Salam: Forward sale contract


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Inception of Islamic Banking

Dubai Islamic Bank - 1975- modest beginnings- Initiated by businessmen who did not want to deal with interest based system- Hostile environment- Challenged by conventional banking system- Lack of public awareness


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Success Story

200 + Islamic financial institutions $ 100 - 200 billions in funds Issuance of Islamic Bonds (Sukuk) Post graduate degrees offered in Islamic

banking by major academic institutions Important database system (HIFIP) Standards for the Industry (AAOIFI) Recognition by IMF, World Bank and Basel

Committee


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TYPES OF ISLAMIC INSTITUTIONS• Islamic Commercial Banks• DMI, Al Barakah, Al Rajihi)

• Islamic Investment Banks • First Islamic Investment Bank, Amana Investment

(HSBC), Noriba (UBS), CitiIslamic Inv. Bank.

• Islamic Units of conventional banks• UBS, Deuche Bank, Credit Swiss, Standard Chart.

Dresdner Bank.


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TYPES OF ISLAMIC INSTITUTIONS

•Islamic Funds: •Property fund, Equity fund, Islamic Hedge Fund, Murabaha fund, Capital Protected fund, investment fund, trade fund etc.

•Islamic House Financing SchemesUBK, Al Manzil, Guidance group US, Lariba, Al Maskan LLC•International Financial Market (e.g. AAOIFI, ICD etc.)•International Institutions of Islamic Banking•Islamic Market Index (DJIM, TII)


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Uniqueness of Islamic Banking Commingling between Finance & Religion and

ethics Sharia Supervisory Boards (SSB)

– Studies Articles of associations and bylaws– Approval of all contracts – Contribute in designing new products– Audit the actual implementations– Issuance of Fatwas (Responsas)– Conferences - Research - Training


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Principles of Islamic Business

1. The Objectives and philosophies of Islamic banks must thus be in line with the teachings of Quran and Sunnah of the Prophet (PBUH)

2. Eliminating riba is an important task, but Islamic banks, by default, must conform to all other Islamic business principles

3. All teachings imposed on Muslim individuals are also applicable to Islamic banks


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Important Achievements

Encouraging and attracting depositors for Halal investments

Channeling depositors’ funds into productive and commercially beneficial activities

Relieving Muslims from trading in prohibited sectors or activities (e.g. opening an LC for alcoholic beverages

Encouraging Zakat and charity Disseminating knowledge in the field of Islamic

transaction law (Fiqh al-Mu’amalat)


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Educating Muslim scholars in modern banking

Encouraging Takaful (Islamic Insurance) Gaining wide acceptance in the

international financial community


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The Way Ahead

Islamic banks must develop the concept of Musharakah (participating in profit & loss) and Mudaraba, and use it more aggressively

Adopt new financing policies to encourage development and support for the small scale traders

Develop the Islamic liquidity management and Islamic money market

Must improve its services to be competitive with the best in the market

Must arrange the Train The Trainers programs for scholars, bankers, businessmen and professionals

Thank You

canonical sharia contracts applied to modern finance

Spiritual