managing finances a shariah compliant way.pdf

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MMMAAANNAAAGGGIIINNNGGGFFFIIINNNAAANNNCCCEEESSSN

AAA SSSHHHAAARRRIIIAAAHHHCCCOOOMMMPPPLLLIIIAAANNNTTTWWWAAAYYY

Omar Mustafa Ansari


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Book Managing Finances A Shariah Compliant Way

Author Omar Mustafa Ansari

Copyright All rights reserved by the publisher

Title design Oramatic Web & Graphic DesignersPhone: 0092 322 8270535

Publisher Time Management ClubP.O. Box 12356, DHA, Karachi 75530

Fazlee Book Super StoreUrdu Bazar, Near Radio Pakistan, KarachiPhone: 0092 21 2212991Email: [email protected]

Kitab Serai

Al Hamd Market, Gizni Street, Urdu Bazar,LahorePhone: 0092 42 7320318Email: [email protected]

Available at

Islamic Research AcademyD-35, Block 5, Federal B Area, Karachi. 75950Phone: 0092 21 6349840 & 6809201Fax: 0092 21 6361040

Contact withAuthor

Email: [email protected]

Price For Pakistan Rs. 200/-Not for sale outside Pakistan


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In the name of ALLAH, the most Beneficent, the most Merciful

Dedicated to

All who helped me out in this humble effort and those who guided me forpreparation for the life hereafter, particularly my father Shamsuddin Khalid

Ahmed Ansari, my mother Aasia Khalid, my grandmother Umme Zubairand my teacher and mentor M. Basheer Juma.


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THE BOOK

The staggering development of Islamic banking at global levelhas necessitated education and training for the bankers, business and

industrial communities and savers / investors who are lookingincreasingly for financial products which are in harmony with thetenets of the Shariah. The major challenge in Pakistan, where efforts topromote Islamic banking were started afresh after the historicjudgment of the Supreme Court of Pakistan in 1999, is creatingawareness among all stakeholders about the theory and practice ofIslamic banking and finance.

The book Managing Finances A Shariah Compliant Way byOmar Mustafa Ansari is a useful addition to the available material inthis regard and a valuable guide for all those who want to manage theirpersonal or Companies funds in lines with the tenets of the Shariah.Being an Accountant and Auditor by profession and by dint of hisinvolvement in Shariah related audit of Islamic banking institutionsover last few years, the author sufficiently understands the mostproper way of banking operations and managing investments

according to the principles of the Shariah. The book has been writtenwith special reference to Pakistans financial market. I would say that itis a must reading for the Companies CFOs and the general investors.

(Muhammad Ayub)Director Training, Development and Shariah Matters

Institute of Islamic Banking and Insurance, LondonJune 19, 2007


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THE AUTHOR

Omar is a Chartered Accountant by profession. Presently he isassociated with Ford Rhodes Sidat Hyder & Co. CharteredAccountants (a member firm of Ernst & Young Global) as a Partner.

Omar has gained substantial experience in the audit andrelated services to local and multinational companies operating indiversified sectors. His area of specialization is providing audit andother services for Islamic finance industry. His portfolio of clients inIslamic finance industry, over past few years, includes Islamiccommercial banks, Takaful companies, Islamic Mutual Funds andModarabas.

Besides audits and related services, Omar has acquireddiversified experience in respect the fields of Islamic finance andbanking including Shariah compliance inspection, Shariah audits,internal Shariah review, development of Shariah compliance inspectionmanual and operating manual for Islamic commercial banking andfinancial institutions.

Omar has been one of the key speakers and trainers fortraining courses for Islamic bankers, arranged by the National Instituteof Banking And Finance (NIBAF) an institute run by the State Bankof Pakistan. These courses are carried out by NIBAF in its campusesin Karachi and Islamabad. His main topics include the accounting forIslamic financial products, auditing the Islamic financial institutions,governance and risk management for Islamic financial institutions,besides a few basic Islamic financial products. He is also serving as analternate member on the committee for review of Takaful rules,constituted by the Securities and Exchange Commission of Pakistan.

Omar has been speaker and anchor man for various seminarsand workshops on Islamic finance and related topics on variousforums, particularly various accounting and auditing professionalbodies. Topics for these Seminars include accounting issues forIslamic banking, tax issues for Islamic banking, Takaful, Shariahcompliance and audit for Islamic finance and Sukuks.


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(i)

TABLE OF CONTENTS

PREFACE.............................................................................................................1

INTRODUCTION TO ISLAMIC FINANCE................................................... 3

BASIC DIFFERENCE BETWEEN THE ISLAMIC AND SECULAR ECONOMICSYSTEMS...............................................................................................................................4

PILLARS OF ISLAMIC ECONOMIC SYSTEM .................................................................... 5ZAKAT AND USHR.............................................................................................................. 6SADAQAT AND KHAIRAT................................................................................................... 6PROHIBITION OF RIBA..................................................................................................... 6

WHY INTEREST IS HARMFUL FOR THE SOCIETY?...................................................... 7EMPHASIS ON PROHIBITION OF RIBA........................................................................... 9

WHAT QURAN SAYS REGARDING RIBA? ........................................................................ 9AHADITH AGAINST RIBA................................................................................................ 10IS MODERN DAYSINTEREST ALSO ATYPE OF RIBA? ............................................. 11LAW OF INHERITANCE ................................................................................................... 11

ENCOURAGEMENT OFTRADE AND COMMERCE ......................................................13RESTRICTIONS ON UNFAIR TRADE PRACTICES.......................................................... 13KHUMS ...............................................................................................................................14OTHERTAXES.................................................................................................................. 14IS MERELY IMPLEMENTATION OF ISLAMIC ECONOMIC SYSTEM SUFFICIENT? 15IS ISLAMIC BANKINGTRULY ISLAMIC? ....................................................................... 16INTEREST-FREE BANKING INTRODUCED IN 1980S.................................................. 16ISLAMIC BANKINGAS INTRODUCED NOW ............................................................. 19OPERATIONS OF ISLAMIC BANKS .................................................................................20SOCIO-ECONOMIC EFFECTS OF ISLAMIC BANKING ................................................. 20

WHY ISLAMIC BANKING? ...............................................................................................21

SHARIAH COMPLIANT BUSINESS A FEW CHARACTERSTICS ......... 23

COREACTIVITIES OF BUSINESS ................................................................................... 24UNLAWFUL BUSINESSES ................................................................................................ 24CAPITAL STRUCTURE OF BUSINESS AND SOURCES OF FINANCING...................... 25PROFIT AND LOSS SHARINGAMONGST PARTNERS ................................................. 26

ARRANGEMENTS FOR FINANCING............................................................................... 26BASICTOOLS OF INTEREST-FREE FINANCING ........................................................ 27

DEALINGS WITHTHIRD PARTIES ................................................................................28DEALINGS WITH EMPLOYEES ....................................................................................... 28

PROFIT AND LOSS SHARING BASED FINANCING .................................31


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LOANS ................................................................................................................................ 31MUSHARAKA AND MODARABA...................................................................................... 32MODARABA ANDTYPES OF MODARABA..................................................................... 33

WHY MODARABA? ........................................................................................................... 34CERTAIN CONTROVERSIES REGARDING MODARABA............................................. 36SHARIAH PROVISIONSAPPLICABLE TO MODARABA................................................ 36MUSHARAKA..................................................................................................................... 39BASICTYPES OF SHIRKAH .............................................................................................40

TYPES OF MUSHARAKA................................................................................................... 40PRACTICALAPPLICATION OF MUSHARAKA BASEDTRANSACTIONS..................... 42PARTNERSHIPS.................................................................................................................42PROVISIONS OF PARTNERSHIP LAW NOT IN COMPLIANCE WITH SHARIAH ......43LIMITED LIABILITY COMPANIES.................................................................................. 44

LIMITED LIABILITY CONCEPT ..................................................................................... 44ARTIFICIALJURISTIC PERSONALITY CONCEPT ........................................................ 45ARE LIMITED LIABILITY COMPANIES BASED ON MODARABA RULES? ............... 46BASIC NON-COMPLIANCES OF SHARIAH IN COMPANY LAW.................................. 46DOS AND DONTS FOR MUSHARAKAARRANGEMENTS ........................................... 47DIMINISHING MUSHARAKA........................................................................................... 50DOS AND DONTS FOR DIMINISHING MUSHARAKAARRANGEMENTS.................. 51HOW TO DIFFERENTIATE A MUSHARAKA FROM MODARABA?.............................. 53

TRADE-BASED ALTERNATES TO FINANCING ...................................... 55

BAY.................................................................................................................................... 56BASIC PRINCIPLES OFTRADE ....................................................................................... 56BAY MURABAHA.............................................................................................................. 59FACTORS DETERMINING SELLING PRICES................................................................ 59

TYPICAL MURABAHA SALE ............................................................................................ 61MODERN-DAY MURABAHA........................................................................................... 61MURABAHA SALEAS A FINANCINGTRANSACTION .............................................. 62PROVISIONS INAPPLICABILITY OF MURABAHA........................................................ 64ISTIJRAR.............................................................................................................................67

TAWARRUQ........................................................................................................................ 68BAY SALAM....................................................................................................................... 70

APPLICABILITY OF SALAM SALE.................................................................................... 70SHARIAH PROVISIONS IN SALAM .................................................................................. 73PARALLEL SALAM............................................................................................................. 75SHARIAH PROVISIONS IN PARALLEL SALAM .............................................................. 76BAY ISTISNA..................................................................................................................... 77PRACTICALAPPLICABILITY OF ISTISNA...................................................................... 77SHARIAH PROVISIONS FOR ISTISNA............................................................................. 80PARALLEL ISTISNA.......................................................................................................... 82

LEASE-BASED ALTERNATES TO FINANCING........................................ 85

IJARA................................................................................................................................... 85


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PRACTICALAPPLICABILITY OF IJARA.......................................................................... 85IJARA MUNTAHIA BITTAMLEEK /IJARAWA IQTINA............................................... 87SALE AND LEASEBACK..................................................................................................... 89

DOS AND DONTS FOR IJARA........................................................................................ 89DOS AND DONTS FOR IJARA MUNTAHIA BITTAMLEEK........................................ 93

AGRICULTURAL FINANCING ..................................................................... 95

SALAM................................................................................................................................. 95MUZARAA......................................................................................................................... 96DOS AND DONTS FOR MUZARAA.............................................................................. 98MUSAQA..........................................................................................................................101DIFFERENCE BETWEEN MUZARAA AND MUSAQA...............................................101DOS AND DONTS FOR MUSAQA...............................................................................102MUGHARASA................................................................................................................... 102NORMAL MODES OF ISLAMIC FINANCINGAPPLICABLE TOAGRICULTURESECTOR............................................................................................................................103

CONSUMER FINANCING A CONSUMERS PERSPECTIVE ............... 105

HOUSING FINANCEARRANGEMENTS (MORTGAGES)........................................... 107MURABAHA BASED HOUSING FINANCE MODEL ...................................................108IJARA MUNTAHIA BITTAMLEEK BASED HOUSING FINANCE MODEL ............... 109ISTISNA BASED HOUSING FINANCE MODEL .......................................................... 110

DIMINISHING MUSHARAKA BASED HOUSING FINANCE MODEL.......................111CAR FINANCING AND LEASING ..................................................................................116CREDIT CARDS ............................................................................................................... 117DEBIT CARDS,ATMCARDS AND CHARGE CARDS.................................................119PERSONAL LOANS .........................................................................................................120

INTEREST-FREE FINANCIAL MANAGEMENT...................................... 123

TIMEVALUE OF MONEY..............................................................................................123TIMEVALUE OFASSETS ...............................................................................................125TIMEVALUE OF MONEY AS A PERFORMANCE MEASUREMENTTOOL ............. 126

MANAGING FINANCESWHY AND HOW? ..............................................................128WORKING CAPITAL MANAGEMENT...........................................................................129DEBTORSMANAGEMENT...........................................................................................130BILLS DISCOUNTING OR FACTORING ....................................................................... 132EXPORT BILLS DISCOUNTING.................................................................................... 133GENERAL BILLS DISCOUNTING .................................................................................134

JUALA................................................................................................................................ 135SECURITIZATION OF RECEIVABLES...........................................................................136SECURITIZATION OF FUTURE RECEIVABLES .......................................................... 137

INVENTORY

MANAGEMENT

STOCK

LEVEL

CONTROL

......................................138CREDITORS MANAGEMENT ........................................................................................140EQUITY FINANCING ..................................................................................................... 142


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EQUITY FINANCING ON MUSHARAKA BASIS ........................................................... 142EQUITY FINANCING ON MODARABA BASIS .............................................................143PERMISSIBILITY OF PREFERENCE SHARES ..............................................................144

MODARABA PREFERENCE SHARESAPROPOSED MODEL .................................145LONG-TERM FINANCING ............................................................................................146SHORT-TERM FINANCING ..........................................................................................147SOURCES OF INTEREST-FREE FINANCING................................................................148FAMILY AND FRIENDS................................................................................................... 148GENERAL PUBLIC ..........................................................................................................149ISLAMIC FINANCIAL INSTITUTIONS ...........................................................................149CONVENTIONAL FINANCIAL INSTITUTIONS............................................................150INVESTMENT OF EXCESS FUNDS ...............................................................................151STOCK MARKET OPERATIONS .................................................................................... 152

MARGINALTRADING AND BADLA.............................................................................153SHORT-SELLING,FORWARD SELLING AND FORWARD PURCHASES......................154SELLING BEFORE POSSESSION .................................................................................... 155EQUITY INVESTMENT INJOINT STOCK COMPANIES ............................................ 156PURIFICATION................................................................................................................ 158PURIFICATION OF INDIRECT INCOME AND CAPITAL GAINS ...............................158INVESTMENT IN REDEEMABLE CAPITAL.................................................................159PREFERENCE SHARES .................................................................................................. 160INVESTMENTS IN MUTUAL FUNDS............................................................................161INVESTMENT IN MODARABAS .................................................................................... 161INVESTMENTS IN GOVERNMENT SECURITIES........................................................ 162PERSONAL LEVELMUSHARAKA AND MODARABA...............................................163FOREIGN EXCHANGE ................................................................................................... 163INVESTMENTS IN REAL ESTATE ................................................................................164

ACCOUNTING ANDTAXATION ISSUES FOR INVESTMENT IN REAL ESTATE ....165SHARIAH COMPLIANT SOLUTIONS FOR RAISING FINANCES ...............................166SPECIFIC SOLUTIONS FOR RAISING FINANCES ......................................................... 167REDEEMABLE CAPITAL................................................................................................. 167SPECIAL PURPOSE VEHICLES .......................................................................................169

SPECIAL PURPOSE MODARABA.................................................................................... 169GENERAL BUSINESS MATTERS ................................................................ 171

EMPLOYEESRELATIONS.............................................................................................171RETIREMENT BENEFITS ..............................................................................................172DEFINED CONTRIBUTION PLANS...............................................................................172DEFINED BENEFIT PLANS ...........................................................................................174INSURANCE .....................................................................................................................175BANK GUARANTEES...................................................................................................... 175LETTERS OF CREDIT..................................................................................................... 177

TAXATION .......................................................................................................................178DEALINGS IN FOREIGN CURRENCY..........................................................................180FORWARD CONTRACTS................................................................................................. 182


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MARKETING....................................................................................................................183ADHERENCE TO THE LAW OF THE LAND .................................................................183

INSURANCE AND TAKAFUL.......................................................................185WHY INSURANCE IS CONSIDERED HARAM..............................................................186GHARARUNCERTAINTY...........................................................................................186MAISARGAMBLING .................................................................................................... 187RIBAINTEREST...........................................................................................................187LACK OF RELIANCE ONTAQDEER.............................................................................188

ALTERNATE OF CONVENTIONAL INSURANCE SYSTEMTAKAFUL...................189HOWTAKAFUL WORKS?................................................................................................ 189RATIONALE FOR PERMISSIBILITY OFTAKAFUL ...................................................... 192

TAKAFUL BUSINESS IN PAKISTAN...............................................................................193OTHERALTERNATES TO INSURANCE ...................................................................... 194

FINANCIAL REPORTING PRINCIPLES....................................................195

HONESTY ANDTRUTHFUL PRESENTATION ........................................................... 195UNIFORMITY OF FORM AND SUBSTANCE.................................................................197

AUDIT ...............................................................................................................................199SELECTION OF AUDITOR..............................................................................................200INTERNALAUDIT ..........................................................................................................202CODES OF ETHICS ISSUED BYAAOIFI..................................................................... 202

PROBLEMS OF A MUSLIM EMPLOYEE....................................................203

SEEKING THE RIGHT JOB .............................................................................................203TIME AND DUTY............................................................................................................. 204RETIREMENT BENEFITS ..............................................................................................205PROVIDENT FUND ........................................................................................................206PENSION AND GRATUITY.............................................................................................207OTHER RETIREMENT BENEFITS ................................................................................209LOANS AND ADVANCES ................................................................................................. 209

ALTERNATES FOR EMPLOYEE LOANS ...................................................................... 212

TRANSPORT FACILITIES...............................................................................................212MEDICAL FACILITY........................................................................................................215

ZAKAT..............................................................................................................217

SAHIB-E-NISAB .............................................................................................................. 217NISAB ...............................................................................................................................217BASIC EXEMPTIONS ...................................................................................................... 218RATE OF ZAKAT ............................................................................................................. 218ZAKATYEAR................................................................................................................... 219

RATIONALE FOR SELECTING 1ST

OF RAMADAN ....................................................... 219TOWHOM ZAKAT MAY BE PAID ................................................................................220ZAKAT ON GOLD............................................................................................................220


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ZAKAT ON SILVER..........................................................................................................221ZAKAT ON PRECIOUS STONES .................................................................................... 221ZAKAT ON CASH AND RECEIVABLES ......................................................................... 221

ZAKAT ON PROVIDENT FUND BALANCES................................................................223ZAKAT ON REAL ESTATE .............................................................................................224ZAKAT ON BUSINESS..................................................................................................... 224ZAKAT ON PARTNERSHIPS...........................................................................................224ZAKAT ON SHARES IN LIMITED COMPANIES........................................................... 225ZAKAT /USHR ONAGRICULTURAL PRODUCTS ...................................................... 226ZAKAT ON LIVESTOCK.................................................................................................. 227ZAKAT ON HOUSE,HOUSEHOLD ITEMS,VEHICLES AND NECESSITIES...........227LIABILITIES DEDUCTIONS...........................................................................................228ZAKAT PAID TO GOVERNMENT ..................................................................................229

ADJUSTMENT OF ZAKAT WITH INTEREST................................................................230IS ZAKAT DUE ON INTEREST-BEARING INSTRUMENTS? .....................................230ZAKAT AND USHR SELFASSESSMENT FORM........................................................... 231

LEGAL AND TAXATION ISSUES IN PAKISTAN ......................................239

TAXES ON MURABAHA AND OTHER ISLAMIC FINANCE TRANSACTIONS............ 240WORKERSPROFITS PARTICIPATION FUND (WPPF)............................................ 242ADDITIONALTAX UNDER INCOMETAX AND SALESTAX LAW ........................... 244INTEREST ON LEGAL CLAIMS ..................................................................................... 245

FUNDED RETIREMENT BENEFITS ............................................................................246INTEREST AS A PROFITTRANSFERTOOL ................................................................248TAX BENEFITS ON INTEREST..................................................................................... 249

GLOSSARY OF TERMS ..................................................................................251

BIBLIOGRAPHY.............................................................................................267


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Preface

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PREFACE

Islam by its real meaning denotes the phenomenon ofcompletely following somebodys commands or surrendering against

someones will. In general understanding, it is the state in whichsomebody follows the instructions of Allah Almighty. By nature, it isnot a religion as is understood in general and instead, it is a Deen

)( which stands for a complete way of life. Allah Almighty declaresin His Book, at not less than three places in the same wordings, thatHe is the ONE who has sent HIS Messenger (SAAWS) with divineguidance and the true way of life to overpower all other ways of life,

irrespective of the opposition of the pagans or polytheists ) ( .

And if understood in the same manner, our Deen provides uswith a complete set of instructions to be followed in our whole life.The matter of being a Muslim duly includes the state of adherence tothe complete set of instructions made available to us through the HolyQuran and Sunnah. Alhamdolillah, there is, and always remains, agroup of Ahl-e-Iman, who have the desire to perform all of theiractivities in accordance with the rules set by Allah Almighty.

Besides all other areas of life, our Deen also provides guidanceon the business, trade and financing matters. This study is a humbleeffort to overcome the need of entrepreneurs and businessmen inPakistan, as well as, students of accounting, finance and business,having a keen desire for running their businesses in accordance withthe basic principles of Islam in order to please Allah Almighty forassurance of betterment of the life hereafter. In the newer terminologyand theories, employment is also a type of entrepreneurship in whichthe employee renders his services against a specific return, andaccordingly, certain matters particularly relating to the employees havealso been included in this study.


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Preface

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Any guidance generally provided by the religious scholars is ofprinciple nature which needs practical expertise and knowledge for itsimplementation in complex business transactions nowadays. On theother hand, it has also been observed that people have obtainedFatawa in favour of certain transactions by presenting scenarios tovarious scholars that were not in the true substance and spirit of thetransaction. The prime objective of this study is to make available aguide to general public (particularly businessmen) for making

awareness of basic Islamic concepts for managing a businesss finances.It is rather a business guide, instead of some sort of research materialon Islamic banking and finance, and should be construed as just aguide for a businessman and finance professionals.

It should clearly be kept in mind that the person behind thisstudy is not a religious Scholar at all nor he claims to be one. He is anaccountant by profession and accordingly the matters purely relating to

Fiqh have not been discussed in detail and author has not given hisopinion in any such matter and instead, has just identified or ratherreproduced the opinions and views of various scholars. It is alsopertinent to note that there are certain differences of opinion betweenscholars regarding the permissibility or otherwise of a few of thetransactions, for example Tawarruq. In such cases, it has been avoidedto comment on the permissibility of the same, although the dissentingopinions have been disclosed just for the knowledge of the reader.

The author has diligently made efforts to the best of hisabilities to compile this study but he realizes his shortcomings andweaknesses. Accordingly, the readers are strongly recommended tofollow their respective Fiqh and to obtain Fatwa from any respectablescholar before taking any action. This study should not be consideredat all as a substitute to obtaining a Fatwa according to your respectiveFiqh and the author can not accept any responsibility in this respect.


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Chapter One

Introduction to Islamic Finance

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INTRODUCTION TO ISLAMIC

FINANCE

Islam by its real meaning denotes the phenomenon of

completely following the command of somebody. In generalunderstanding it is the state in which some body follows theinstructions of Allah Almighty. Islam, by its very nature, is not a

religion like any other religion. It is a Deen )( which denotes acomplete way of living and provides us with a complete set ofinstructions to be followed in the whole life of a Muslim. These

include the Ibadaat )( and Muamlaat )( i.e. the modesof worship in different styles and the matters of dealings with others.We know that being a Muslim demands the state of adherence to thecomplete set of instructions made available to us through the HolyQuran and Sunnah, irrespective of such instructions being included inthe Ibadaat or Muamlaat.

The set of instructions received, which we generally call ourDeen, in addition to other matters, provide us full guidance in thematters relating to business. In this study, we will try to understandand apply such principles in the affairs of managing the finances of abusiness in Pakistan, within the framework provided by AllahAlmighty through its Messenger SAAWS.

Since, the most crucial issue for doing business in this era isthe matter of avoiding interest-bearing and similar transactions, amajor area of this study is devoted on interest-free financing alternatesand interest-free financial management. In this study, we haveconsidered most of the options available for an interest-free system. Inthis respect, it is worthwhile to note that certain schools of thoughthave objections of certain tools of Islamic finance on various grounds.Similarly, it has also been established by almost all schools of thought


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that a few of these tools are doubtful in a few aspects, hence, althoughbeing permissible or Mubah )( , it is advisable to avoid them.Without going into the details for rationale of such comments, wewould just identify the situation in case of each of the tools and wouldleave the matter on the judgment of the reader or recommend him toconsult his respective Shariah scholar to avoid any ambiguity.

Basic Difference between the Islamic

and Secular Economic Systems

The basic difference between the Islamic and Seculareconomic systems is that Islam does not bind anybody to earn, saveand invest money except in such businesses which are declaredimpermissible (Haram) on account of their very nature. On thecontrary, Islam does not allow concentration of wealth in a mannerthat even a single person lives below the poverty line. In an Islamic

system, the poverty line does not reflect just a benchmark in form ofnumber of calories available to a human being, and instead, it reflectsthe basic necessities of life in all respects. Zakat and Sadaqat are themain tools used for the purpose in addition to the restrictions onunreasonable trade practices, providing basic necessities to everybodyon controlled prices and prohibitions on earning profits over areasonable limit.

This study does not purport to cater the macro economicsissues, which we understand, have already been catered by works ofmany of the respectable economists and scholars. Any of the readershaving interest in the subject, may consult such commendable studies.Particularly, a few works by Maulana Syed Abul Aala Maududi,Maulana Justice (Retired) M. Taqi Usmani, Dr. M. Nijatullah Siddiquiand Dr. M. Umar Chapra should be consulted by every readerinterested in the concepts and details of an Islamic economic and

monetary system. Nevertheless, in order to bring the reader in thesame wavelength, we consider it necessary to discuss a few basicconcepts of Islamic economics.


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If we consider the Islamic economic theories in brief, we willcome across two basic concepts. The first one the avoidance ofconcentration of wealth whereas the second one is discouragement ofsavings over and above the human needs and encouragement ofspending culture within certain limits. While practically applying boththese theories, economy that emerges which may rightly be termed asan Islamic economy providing livelihood to each and every individualof the Society with the lowest possible number of have-nots (ideally

zero, which has been evidenced during the regime of Khilafat-e-Rashida) and a minimum difference between the people having thelowest earning and the class of people with the highest level ofearnings.

It is worth noting that Islam strongly encourages the socialequality amongst all the members of society through various culturaleffects particularly including Prayers in Mosque and Hajj. On the

contrary, it does not support the concepts of economic equality asproposed by the Socialism and Communism. In this respect, variousrespectable works are already available and the same is not a subject ofthis study. All the interested readers are encouraged to consult tovarious studies on this subject by a number of respectable scholars.

Pillars of Islamic Economic System

Now coming back to our topic, we may note that the Islamiceconomic system uses the following basic instruments as its pillars toachieve the above objectives:

Zakat and Ushr; Sadaqat and Khairat; Prohibition of Riba; Law of inheritance;

Encouragement of trade and commerce; Restrictions on unfair trade practices; Khums; and Other taxes.


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Zakat and Ushr

The first and the most important instrument in this respect isZakat, which results in flow of economic resources from the Havesto the Have-nots, as well as, discourages the savings andconcentration of wealth in a few hands. Similar and identicalinstrument in most of the respects is Ushr except for the differencethat it is levied on the produce and not on the wealth (in form of land

and agricultural resources). Like Zakat, it also results in flow ofeconomic resources from well-off to the needy. Particularly inagriculture based economy like Pakistan whereby the agriculturalproduce is a significant portion of the countrys GDP, Ushr, ifeffectively utilized, might prove to be a very effective tool in thisrespect.

Sadaqat and Khairat

Second instrument in this respect is encouragement ofSadaqat and Khairat of all sorts. All the Muslims have been advised tospend maximum of their savings in the way of Allah, either throughhelping people or through investing in the causes that are beneficial tothe society, as a whole. Although these are not mandatory, and theirquantum has been left by Allah Almighty on the individuals own willand choice, but in an Islamic society people generally have a practice

of making Sadaqat and Khairat to get reward in the life hereafter.Resultantly, these also play a vital role in de-concentration of wealth inan economy.

Prohibition of Riba

The third instrument is prohibition of Riba (interest andusury). Interest is one of the few prohibitions that are common in the

divine guidance of most of the known religions. Being a Muslim, ourbasic object for this study is to ensure abidance of the rules set out byAllah Almighty, irrespective of any enquiry as to the reason orrationale for the same. However, our faith includes the basic principle


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that anything declared Haram by Allah, must be dangerous andharmful for us and if it does not appear as such to somebody at themoment, it must be causing some problem with the society whichmight be beyond our limited intellect.

Why Interest is Harmful for theSociety?

We will try to briefly discuss only two aspects of interest thatare harmful for the society in general and economy in particular. Thefirst aspect which is a social factor is that earning interest and facilitiesto earn interest encourages people to get the benefit of someone elsesneeds which is, and shall not be, something pleasant for the society ifsuch culture is cultivated in the society in general. Such practice alsoresults, in the long run, in the greedy approach of people which alsonullifies the basic instruments of Islamic economic system including

Zakat, Ushr and Sadaqat.

The second aspect, which is more directly relevant to ourstudy, is its economic aspect. If we try to define interest in pureeconomic terms, it is generation of wealth without any productive ortrading activity. In other words, as also concluded by a number ofrespectable economists, it is the prime cause for inflation in aneconomy. Accordingly, we will briefly discuss this issue.

Assume that there is a closed economic model in which thenumber of resources and productive assets remain constant for somegiven period of time. Now, in each economy there is a movementideally through the productive activities, services, trading and use ofassets. All these movements result in profit taking by one party, butprovide a real benefit to the other party against such loss or expense.Accordingly, in ideal circumstances, the total amount of money

remains the same in such economy and if the amount of moneyincreases, it is directly proportionate to the amount of production ofresources and services in the economy. Only in case of interest, thesituation is not the same. In case of interest, which is charged on the


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money lent to another party, it is not certain whether any real benefitto the second party is achieved or not. On the other hand, the amountof interest charged increases the amount of total circulation of moneyin the economy. This amount of increase is generally not linked to theproductive activities, trading and services generated in the economy.As a consequence of the same, the proportion between the amount ofmoney in circulation and the collective value of resources and assetsavailable in the economy is adversely disturbed resulting in inflation in

economy. This is a very simple example for understanding of theconcept for a general reader and is not intended to open door fordebates on the issue.

The governments, banks and other financial institutions havenow generated a huge volume of money in circulation, in excess of theamounts of currency in circulation. This is generally created as aconsequence of interest-bearing loans in addition to the equity limits

and other techniques of creation of money used by the monetaryagencies / reserve banks, financial institutions and commercial banks.Although as a part of risk management practices and through thereserve banks monetary policies these practices are now controlled tocertain extent, even then, this ratio is not adequate in most of theworlds economies. In view of the same, now our worlds wholeeconomic system has no foundations except for the public reliance onthe solvency of the financial institutions and rather on the respective

governments. Just imagine what will happen if American people loosetheir reliance on the T-Bills. In past, we have evidenced a number ofbank failures which had an adverse impact on the whole economies.

Such weak foundations of the present economic system mayalso be termed as the spiders web which, besides how large networkit has, is the weakest home as these systems do not take patronagefrom Allah Almighty as proclaimed in the Holy Quran in the Surah

Ankabut Verse 41.

Because of the generation of wealth without correspondingtrading or productive activity or benefit in form of services, the whole


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economic system looses the equilibrium which is generally observed inform of extra-ordinary increased or decreased market interest rates. Avery relevant example of such weaknesses in the system has beenobserved in the recent past, by a decline in the market interest ratethroughout the world whereby the London Inter-Bank Operating Rate(LIBOR) was ranging somewhere near to 1 percent per annum. Evenin the recent past, overnight inter-bank rates had once turned out to benegative in Japanese inter-bank market.

Emphasis on Prohibition of Riba

It is also worthwhile discussing the emphasis that has beendrawn by Allah Almighty and the Holy Prophet SAAWS on theprohibition of Riba. A few scholars are of the view that the accent ofIslamic Shariah is the hardest in case of Riba as compared to most ofother prohibitions, particularly, where it has been declared as a War

against Allah Almighty and the Holy Prophet SAAWS. In severalAhadith, it has been termed as one of the worst sins, a human cancommit.

We should first have a look on certain Verses and Ahadithagainst Riba, in order to just have an understanding of the stance ofAllah Almighty and His prophet SAAWS in this respect.

What Quran says regarding Riba?

In Verse 161 of Surah Al Nisa', Allah SWT declares that:

And for their taking interest even though it was forbiddenfor them, and their wrongful appropriation of other peoples'property, we have prepared for those among them who rejectfaith a grievous punishment.

Verse 130 of Surah Ale Imran states that:


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Believers! Do not swallow Riba, doubled and redoubled, andbe mindful of Allah so that you may attain true success.

In addition to all above, in Surah Al Baqarah, Verses 274 to281 Allah Almighty proclaims that:

Those who take Riba will not stand but as stands the onewhom the demon has driven crazy by his touch. That is

because they have said: Trading is but like Riba. So, whoeverreceives an advice from his Lord and stops, he is allowed whathas passed, and his matter is upto Allah. And the ones whorevert back, those are the people of Fire. There they remainforever. Allah destroys Riba and nourishes charities. AndAllah does not like any sinful disbeliever. Surely, those whobelieve and do good deeds, establish Salah and Zakat havetheir reward with their Lord, and there is no fear for them,

nor shall they grieve. O those who believe; fear Allah and giveup what still remains of the Riba if you are believers. But ifyou don not, then listen to the declaration of war from Allahand His Messenger. And if you repent, yours is your principal.Neither you wrong, nor be wronged. And if there be one inmisery, then defer till ease. And that you leave it as alms is farbetter for you, if you really know. And be fearful of a daywhen you shall be returned to Allah, then everybody shall be

paid, in full, what he has earned. And they shall not bewronged.

Ahadith against Riba

Besides this, there are a number of Ahadith that declare thissin to be one of the worst sins a human can commit. Just for example,following is the translation of a few Ahadith, taken from Mishkwat-ul-

Masabeeh )

( Chapter of Riba:

The sin of taking Riba has 70 parts and the smallest part ofthe same is equivalent to marrying ones mother.


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One Dirham (penny) of Riba that somebody knowingly eats(or consumes) is worse than thirty-six times doing Rape.

The Hell has the first right on the person whose meat isdeveloped by eating Haram.

Is Modern Days Interest also a Typeof Riba?

Another issue or rather non-issue that has continuously beenraised by various circles during the last few decades is regarding thedefinition of Riba which, according to the perspective of these socalled scholars and intellectuals, does not include the commercialinterest which is in practice in the recent days. Here we wish to avoidany discussion on this topic, as it is not the subject of our study rightnow and more importantly because we do not consider it necessary to

discuss on a topic that has already been well discussed andexhaustively resolved by a number of respectable scholars in detailwith direct references from the holy Quran and Sunnah.

Since this is a very crucial issue hence we recommend the

readers to consult two books namely Sood )( and Muashiat-e-

Islam )( by Maulana Syed Abul Aala Maududi and thehistorical judgments on Riba by the Honourable Federal Shariat Court

and the Shariat Appellate Bench of the Honourable Supreme Court ofPakistan (Decisions written by Justice (R) Dr. Tanzeel-ur- Rehman andJustice (R) Maulana Muhammad Taqi Usmani)

Law of Inheritance

The fourth instrument used for the purpose of developmentof a just and equitable economic system, is the law of inheritance in

Islam. When considering as a layman nobody can identify the benefitsof this law towards the betterment of society. However, if we considerits long-term impacts on the society, we can observe that it serves twobasic objectives.


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The first one which is the general understanding of a laymanis that since this rule has been specifically mentioned in Shariah, so ithelps in avoiding the disputes amongst the family members which mayarise if such distribution would not have been specifically mentionedin the Holy Quran and Sunnah. This is the social aspect of the law ofinheritance whereas its economic impact is much pervasive in thelong-term. From economic perspective, one can observe that it alsoresults in avoidance of concentration of wealth and if applied in its

true spirit, it has always proved to be a very effective tool for de-concentration of wealth in the economy.

The division of inheritance according to Shariah is amandatory requirement and even a will made by a person can notchange such proportions. According to Shariah a will can only bemade upto the extent of one-third of somebodys wealth and the samecannot be made in the favour of any of those who are entitled to

inheritance according to Holy Quran. Allah Almighty has declared inSurah An Nisa that these laws of inheritance are the boundaries set byAllah Almighty and those who do not obey Allah and His Messengerwill be entered into fire and will remain there forever. There are just afew categories of sins in which Allah Almighty has declared that thosecommitting such sins will remain in Hell forever and there will not beany forgiveness afterwards and disobeying Allah in the matter ofinheritance is amongst such worst sins. In addition, it should also be

noted that by disobeying these laws we also take someone elses rightin this worldly life, which we will have to pay for on the day ofjudgment, whereby such aggrieved person will have a right to get the

Sawab )( of our right-doings or to transfer his or her sins to us inproportion to the right for which he or she was deprived.

In light of the above, we all Muslims, should reconsider ourattitude and make sure that we are not heading towards the Hell

forever. May Allah bless us all and forgive us by maximum of Hiskindness and mercy.


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Encouragement of Trade andCommerce

Fifth tool for the purpose is encouragement of trade andcommerce. Such encouragement affects the society from two sides.First, the people invest directly in trade and commerce instead ofsavings and investing in non-productive matters and take risk of lossalso, which results in overall resource mobilization and eventually in

the movement in the economy.

On the other hand it also involves people in trade andcommerce and instead of wasting money in futile avenues or earninginterest without any productive activity; such people become a betterand useful part of the society. Additionally, it also increases the overallemployment ratio, in form of either increased employments or moreadequately, in form of self-employments. It is also interesting to note

that in case of trade, a few transactions that apparently appear to bevery much similar to interest-bearing transactions, have also beenallowed by the jurists under the Shariah principles.

When considering the rationale for the same, we come acrossa very interesting fact that trade results in movements in economywhereas interest do not result any movement in the economy nordirectly results in or any other productive activity and accordingly

results in stagnancy of economy (if seen solitarily because it is notdependent of any activity). If analyzed in detail, this also appears to bea gift of divine guidance on the mankind for its own betterment.

Restrictions on Unfair Trade Practices

Sixth pillar for the purpose is restriction on unfair tradepractices. Such restrictions include, but are not limited to, prohibition

of black marketing, taking benefit from the ignorance of the supplierand the customer, gambling and speculation businesses, contractswithout clarity on each aspect and avoiding Gharar i.e. uncertainty,trade of Haram and impermissible commodities, and so on.


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Under these broad principles, the Islamic government hasbeen empowered to devise rules and regulations to ensure a fair tradeand commerce system in the economy. Under these principles, thegovernment has also been allowed to further make any othertemporary restrictions and prohibitions that might be considerednecessary to ensure stability of economy and benefit of the public atlarge. These rules and regulations may include levy of taxes and dutieson certain items and providing subsidies on others. These may also

include the control over the prices of public necessities. Similarly,these may include nationalization of certain commercial and industrialactivities if these are considered to be in the benefit of the generalpublic at large, although the same may not be considered as apermanent solution of the situation.

Khums

Seventh tool in this respect is Khums which literally meansone fifth or 20 percent. Khums is the amount of governments sharein any Maal-e-Ghanimat (assets left by the defeated army), any buriedtreasure and, according to a number of jurists, all minerals which arefound under the ground including, petroleum, gases, ores etc.. In thedays of Khilafat-e-Rashida and even afterwards, Khums arising onMaal-e-Ghanimat were a major source of income for the governmentwhich was then eventually distributed amongst the needy, as well as,

were used to pay for the governments needs. In these day, Khums onminerals can be an excellent tool contributing for the benefit of thepoor and needy people because Khums shall also be distributed in themanner like Zakat and Ushr, and even in a few books of Islamicjurisprudence, it has been termed as Zakat on minerals etc..

Other Taxes

Eighth tool in this respect is levy of other taxes in accordancewith the Shariah requirements. Theses taxes may be divided indifferent categories. The first category is the taxes applicable on Non-Muslims including Jizya, Khiraj and Fay. Jizya is a tax levied by Islamic


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government on every individual Non-Muslim against the governmentsduties for his safety and the social benefits to be provided to him.Khiraj is the levy of tax on semi independent states, as well as, onNon-Muslim land owners whose lands are not acquired by force bythe government, once a land is conquered by Muslim forces. Fay is atax on the landowners, generally the old landowners, with whom theirlands are left by the government for cultivation.

In addition to these taxes applicable on Non-Muslims, thereare a few taxes applicable on traders. These taxes are levied on Muslim,Non-Muslim, citizens of the country and foreign traders (expatriates)on different activities and commodities at different rates, as thegovernment may deem fit.

The prime objective of levying these taxes is to make availableenough funds for the collective social objectives, including but not

limited to, security of peoples life, assets and dignity, defense of thecountry, provision of basic necessities to the have-nots, provision ofgeneral public facilities like health, education and means oftransportation and so on. In any case, the moneys so collected are notconsidered to be the personal property of any individual including theCaliph or other officials of the government.

Is Merely Implementation of Islamic

Economic System Sufficient?

Islamic economic system is not something that can work inisolation of the geo-political and legislative system, as well as, andmore importantly the societys behavior towards the injunctions ofIslamic Shariah in personal and collective matters. Accordingly, in aneconomy whereby most of the businessmen are not honest in fairlypresenting the financial statements of their businesses, how difficult it

could prove to introduce a profit and loss sharing based financialsolution?


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Similarly, in most of the cases payment of Zakat and Sadaqatdepends on the individual and particularly, in view of the giganticvolume of the black economy in the country (which according tocertain estimates is larger than the white economy in Pakistan) whatcan be expected even if a good system for Zakat and Ushr isintroduced? Accordingly, the complete transition of economy to anIslamic economic system can be performed when and only when theoverall consensus of the society is developed towards practical

application of Shariah in all the facets of human life, particularlyincluding the governmental, political and legislative structures.

Besides such an unsatisfactory and rather discouraging attitudeof the society towards application of Islamic Shariah, it should benoted that such a situation does not relieve a Muslim from theapplicability of Shariah principles, but rather increases hisresponsibilities in the way that it becomes his duty not only to try to

abide by all applicable Shariah requirements but also to put hisendeavors towards improvement in such system.

Is Islamic Banking Truly Islamic?

The question, as to whether Islamic banking is truly Islamic,has two different facets. The first one is that whatever is beingperformed in the name of Islamic banking is apparently quite similar

to the operations of a conventional financial institution hence createsdoubts in peoples mind. The second facet of this question is moreimportant and deals with the socio-economic factors associated withthe overall Islamic financial system.

Interest-free Banking Introduced in1980s

As far as the first question is concerned, we may conclude thatIslamic banking in Pakistan may be divided in two different regimes.The first one that is generally called interest-free banking wasintroduced in the regime of General Mohammad Zia-ul-Haq, and


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which is still in operation in Pakistan with the conventionalcommercial banks and other financial institutions. Without any doubton the intentions of the people who initiated the same and whoendeavored to convert the whole system on an Islamic basis, it may beconcluded that in the softest terms, we may call such experiment atragedy for Islamic banking which was not only a failed experiment ofits own but also resulted in practical impediments in the operation ofreal Islamic banking in Pakistan.

The overall scheme implemented by General Zias team wasconsisting of the following steps:

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

Amendments in company law and certain other lawsto introduce certain Shariah compliant financial

solutions including interest-free redeemable capitaland certain restrictions on purely interest-basedinstruments including debentures and preferenceshares; and

Introduction of Modarabas as interest-free limitedfinancial service providers and special purposevehicles for raising interest-free finances.

Although we feel that the intentions of the initiators werequite positive, but the system could not survive because of a few basicfactors, as follows:

The implementers (government officials, State Bank,bankers and public at large) were generally notconvinced with the prohibition of Riba (particularlythe commercial interest) or were not aware of

practical alternatives of interest-based financialsolutions. Generally they were of the opinion that thissystem cannot survive, or more appropriately we can


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say, that they were not willing to change it due toreasons of their own; People amongst the general public who were well

aware of prohibition of interest in Islam werepractically away from the banking and financialmarkets and no sincere efforts were made to bringthem in, and accordingly they are still away from thatsystem. In other words we may say that banking

system, Islamic or conventional, has no impact onthem as they are already away from the same leavingmajority of such people in effective position (bothfrom the bankers and public including industrialistsand traders) who are practically unaware of theirresponsibilities as a Muslim in this respect;

No adequate training of Islamic banking was carriedout for the bankers nor for the public at large;

The scheme of interest-free banking introducedthrough the State Banks circulars, by itself contained

a few questionable options from Shariah perspective;and

There was no monitoring structure for the same fromShariah perspective by the regulators that caused asituation that every banker got a few Shariahcompliant agreements prepared and then started

interpreting Islam of his own resulting in a purelyinterest-based financing system with the title of mark-up and profit instead of interest.

The above mentioned factors should not be considered as allinclusive, however, these may cause us to believe that the interest-freebanking system as in vogue in Pakistan is absolutely not Islamic. Thisconclusion has already been reached by the Federal Shariat Court and

the Shariat Appellate Bench of the Supreme Court of Pakistan.


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Islamic Banking As Introduced Now

After the historical judgments on Riba, first by theHonourable Federal Shariat Court and then by the Honourable ShariatAppellate Bench Supreme Court of Pakistan on an appeal thereagainst, it has been established that the banking system in vogue in thecountry is not Shariah-compliant at all and according to theConstitution of the country any law repugnant to the principles of

Islamic Shariah shall be considered invalid and accordingly, both theHonourable courts allowed the federal government with some time toensure transition of conventional banking and economic system into aShariah compliant economic system duly including the financial systemin practice.

Although with a subsequent judgment of the HonourableSupreme Court of Pakistan, the said judgment has been set aside and

apparently the government quarters, as in the past, are not appearingto do the needful. However, in order to lower the day by day raisingvoice in demand of Islamic banking in the country, and to some extentby the endeavors of the some sincere officials including the thenGovernor State Bank, the State Bank decided to implement a parallelIslamic Banking system in the country and is now allowing opening ofIslamic commercial banks and Islamic banking subsidiaries andbranches of conventional banks who operate under strict Shariah

compliance under monitoring by their respective Shariah advisors andto some extent by the regulators also.

In this respect it should be appreciated that the State Bank hasoffered its maximum support to these Islamic banks in form ofvarious Shariah compliant schemes for them particularly including anIslamic Export Refinance Scheme which was a prominent demand ofthe Islamic banking sector. Similarly, other support services and

guidance are also being provided.


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Operations of Islamic Banks

Now the Islamic banks in the country having been licensed asIslamic commercial banks are operating under the requirements ofIslamic Shariah. These banks have their own Shariah boards generallycomprising renowned Shariah scholars and it may be concluded thatthese banks do not do anything Haram by will except under

compulsion )( for which they obtain approval from their

Shariah boards. If, for any reason, they earn some earning which is notHalal, the same is contributed to charity under approval of theirShariah boards.

However, when considering their operations it may beobserved that although their liability side is purely based on Musharakaand Modaraba, their asset side generally comprise of Murabaha,Diminishing Musharaka (Ijara Based) and Ijara Muntahia Bittamleek

which are although permissible but are considered less desired orborder-line transactions. In this respect, their perspective is alsoimportant to be heard, according to which, unless an adequatedocumentation and fair financial reporting culture is implemented inthe country, with due will of the business community, real profit andloss sharing based financial products (Musharaka and Modaraba) maynot be offered at large.

Socio-economic Effects of IslamicBanking

In this respect a few people, generally practicing Muslims, areof the view that since the Islamic banking is also based on profitmotive and in present form it generally works on fixed return basisalthough the risks it take are higher than the traditional banking, hencethe same cannot be a positive factor towards the socio-economic

changes Islam desires. This question is very important and the authorpersonally concurs with the concerns of those who raise the same, atleast to some extent.


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In this respect it can easily be concluded that the fixed returnbased banking, although being Shariah compliant, is not what has beendesired by Islam as a complete way of living. On the contrary, besidesconsidering the fact that the Islamic banking industry in the country isin its infancy stages, we should also bear in mind that only the changein banking system is not a solution to the overall revolution ofeconomic system unless other facets of Islamic economic system arenot implemented simultaneously. Consequently, if the Islamic banking

is not contributing enough towards betterment of society, we cannotblame the same alone.

Why Islamic Banking?

In some areas Haram and Halal have a very small difference.For an example, only saying the name of Allah Almighty on an animalat the time of slaughter makes it Halal and permissible while by not

saying that name it becomes Haram. Similarly, by just a few words ofacceptance in Nikah, in presence of a few persons, a man and womanbecome Halal for each other. In a similar fashion, if a transaction canbe engineered in a way that the same becomes Shariah compliant, thenwe should not conclude that the same is Haram only due to itsresemblance with the interest-based financing.

It is pertinent to note that since the Islamic financial services

sector is in its initial stages as compared to the conventional banking, ithas to follow the conventional system in the pattern of financialproducts and is still not in a position to invent absolutely new financialservices. For example, if they have running finance and overdraft as afinancing tool, we have structured an alternate to the same in form ofIstijrar with Murabaha. Similarly, if they use finance leases as afinancing tool, we have converted the same in a Shariah compliantform in form of Ijara Muntahia Bittamleek or in form of Diminishing

Musharaka. These are only two examples, but the tally is practicallyvery high and for each interest-based financial product except forthose explicitly Haram, more than one alternates have been engineered.


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

As a conclusion to this question, we may say that we arerequired by our religion to implement a complete Islamic way of living

in our individual and collective lives and the society and thegovernment as well. The Islamic banking system is a part of suchsystem and is not construed to be applicable in isolation while otherlaws and customs repugnant to the Shariah requirements are still inforce. However, for the sake of our own benefits, in order to avoidinterest by ourselves and providing interest-free opportunities to ourall Muslims, we should promote and support the Islamic banking inthe country with all our possible efforts and endeavors. Such Islamic

banking can provide us with a shelter from interest-based transactionsfor the time being and might support us in augmenting a truly Islamicfinancial system, and more appropriately said, will serve as anexperiment for the time when we will really be in a position to theimplement the complete Islamic way of living in our beloved country.


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Dealings with third parties, including but not limitedto, employees, customers and suppliers are according

to the principles defined for the purpose by Shariah.

Core Activities of Business

This principle entails that the core activities of business areHalal. In this context the first matter that needs to be decided is the

definition of core activities. According to a school of thought thismatter relates to the major part of business from where the majorportion of revenues and profits are derived. However, another schoolis of the view that involvement of a minor part of Haram revenuesmakes the whole bucket rotten. Being not capable of that, we do notcomment on the same and the readers are advised to follow their Fiqhafter obtaining advice from respective scholars. However, as a matterof principle the core activities of the business should not be Haram in

Shariah.

We would like to list down a few of the activities in which aMuslim Businessman should not indulge:

Manufacture, sale, marketing etc. of Haram Goodse.g. Wines, Pork, etc.;

Financial services with involvement of interest and

other prohibited transactions; Services which are principally not allowed by Shariah

e.g. Advertising services if the basic principles ofShariah are not adhered to; and

Sales and services with regard to television, film,music etc. save the productions whereby the Shariahprinciples have been adhered to.

Unlawful Businesses

Another factor important in the decision is whether theseactivities are lawful in the eyes of the present government. In order to


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make simple the decision we can take an example. All of us know thatsmuggling of any sort is not a lawful activity. However, in Shariahprinciples the business of purchasing some commodities e.g. wheatfrom a country and selling it to another country is a Halal activity. Insuch a situation it is difficult to decide whether smuggling of wheat is areally Halal business.

In these circumstances, dissenting opinions of various

scholars are available. While it is considered advisable to obtain fatwain this respect, a general rule that may be derived is that the laws of theland should be followed because these are generally developed in thegreater benefit of the society and the nation, unless these are againstthe basic principles of Islam or unless the said nation is at war with

Muslims i.e. a Dar-ul-Hurb ( ) and Jihad has been declaredthere against. Accordingly, in general, involvement in unlawfulbusinesses should be avoided although these appear to be Halal in

their substance.

Capital Structure of Business andSources of Financing

For a Shariah compliant business, the second condition is thatthe capital structure of the business should be in accordance with theinjunctions of Islamic Shariah. Ideally the capital of the business

should be brought from Halal sources and should not contain anyinterest-based or any other prohibited financing. In case of extremepressures; that may be termed as Iztirar, if such financing exists,maintaining of an adequate debt equity ratio is a must for whichdifferent benchmarks have been set by various scholars. Nevertheless,the majority of scholars consents that such debts should, in any case(even in Iztirar), not be higher than 1/3rdof the total capital.

Such impermissible debts include the interest-based loans,debentures, lease financing under conventional finance lease,redeemable capital and preference shares. Other financing andfinancial services options including L/Cs particularly Usance L/Cs,


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suppliers credits, bank overdrafts and running finances should alsonot be based on options prohibited by Shariah.

Profit and Loss Sharing AmongstPartners

Profit and loss sharing arrangement amongst the partners, oramongst the members, in case of a joint stock company, is also an

important aspect to be coped with. These arrangements should,irrespective of the legal framework applicable thereto, be incompliance with the basic principles of Musharaka or Modaraba as arebeing discussed in detail in the ensuing pages.

Arrangements for Financing

We are living in an era whereby the prediction of a well

known Hadith has come true. According to the said Hadith, a time willcome when everybody will be involved in Riba and even if he is notindulged in Riba, he will inhale its vapors. Now we can observe thatour overall economic and monetary systems are based on theprinciples of interest and it has become a very difficult task for anyperson to live in such systems, enter into business transactions and stilltry to avoid interest and allied transactions.

The matter of obtaining interest-free financing is a hurdle formost of the businessmen in Pakistan in expanding their businesses,and when viewed in macro perspective, the same negatively impactsthe growth of the economy. In absence of such arrangements generallythe businessmen opt for making small financing arrangements throughprivate borrowings on Modaraba or Musharaka basis, or just leaveaside the options of any such borrowings. Similarly, smallentrepreneurs have no options available for obtaining interest-free

finances. In addition, keeping in view the fact that the efforts made inthe decade of 1980s to Islamize the economy had turned out to beunsuccessful and eventually declared as repugnant to Shariah, our


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reliance on the proclamations and claims of promoting Islamicbanking is no more than zero.

Another important hurdle has been created by the so-calledIslamic banks and other financial institutions (particularly Modarabas),constituted in Pakistan with a prime objective of getting benefit ofsomebodys religious belief. As a consequence, it has been madeliterally impossible to identify any purely Islamic financial institution.

In addition, a few of so-called Islamic banks have played a significantrole in establishing this reputation that no one can now rely on Islamicbanking and Islamic financial institutions.

In the ensuing pages, we will first discuss the options forinterest-free financing available in Pakistan. In this connection a fewsuggestions would also be preferred in order to make a few optionsavailable for the general public.

Basic Tools of Interest-FreeFinancing

The basic tools of interest-free financing or in certain cases,alternates to financing are based on any of the three options i.e.:

Profit and loss sharing based modes;

Trade-based modes; and Lease based modes.

These are the general tools available according to the languagegenerally used by the scholars. While discussing on each option indetail, we will try to clarify their meanings and the available alternatesfor the same in the current business environment. In the ensuing pages,we will endeavor to understand the basic themes and applicability of

the above discussed tools.


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Dealings with Third Parties

Similarly, for a Shariah compliant business, the code of ethicshas been defined in the divine guidance. Such code basically consistsof the principles of truth, fairness, honesty, integrity and avoidance ofexorbitant profits e.g. by way of black marketing or taking benefit ofignorance of the third party. All these principles, along with otherprinciples of life have been detailed in the holy Quran and Sunnah and

have duly been summarized by a number of jurists in the field of Fiqh-ul-Muamlat.

Third parties generally include suppliers and customersbesides other stakeholders. In the modern days management theories,the suppliers, customers and other stakeholders are considered to be apart of the business cycle and are considered business partners for allpractical purposes. Applying the principles defined by Shariah can not

only provide us with the benefits in the life hereafter, but can alsocontribute a lot toward business success in this worldly life.

Dealings with Employees

In addition to the general principles applicable to all thirdparties, there are a few principles applicable to employees. Theseprinciples are derived from various Ahadith and holy verses. In short,

these principles include payment of wages on time, social equalitybetween the employer and the employee, and avoidance ofexploitation in any form and in any manner.

Particularly, according to Shariah principles, it is a must thatall the dues of the employees and the service providers should be paidimmediately, when these become due. This principle is derived from avery common Hadith whereby it is ordered that the wages to the

labour should be paid before his sweat gets dried. In case of anyexpected delay in payment, it should be pre-agreed with the employeesor the service providers.


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Besides these factors, the most significant factor for thesuccess of a business is the satisfaction and devotion of the workforce,which can be easily achieved, if all the basic principles of Shariahapplicable to dealing with employees are complied with, particularlythe social equality and the avoidance of exploitation.


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PROFIT AND LOSS SHARING

BASED FINANCING

Profit and loss based modes of financing are the only

modes of financing available under the provisions of the IslamicShariah. It means that the trade-based and lease based modes areactually not the modes of financing but rather these are actuallyalternates to financing. These are considered financing activities justfor ease of reference. Otherwise, only Musharaka and Modaraba arethe modes of financing allowable in Islam, besides providing interest-free loan i.e. Qard or Qard-e-Hasana on which no return is allowed.

Another reason for their preference is that all the other tools,particularly Bay Murabaha, and Ijara Muntahia Bittamleek, have someresemblance to the interest-based financing and even have certaincontroversial issues or gray areas, hence, are not preferred by anumber of scholars if Musharaka and Modaraba based options forfinancing are available and even a few of scholars have not permitted afew of such controversial options, at all.

Loans

In Islamic Shariah, loans called Qard )( have only oneconcept i.e. these are interest-free. These are repayable in exactly equalamounts in which these are paid. From characteristics, these may bedivided in two types. The first type may be called Qard and the secondmay be called Qard-e-Hasana. These may be distinguished only in onemanner i.e. in Qard-e-Hasana; the lender gives the debtor an option of

not making the repayment in case he is unable to do that, and has nooption to sue for recoveries.


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FLOW OF TRANSACTION IN LOAN(QARD-E-HASANA)

Rs. 1,000 (No impact of TimeInvolved)

Rs. 1,000

BORROWER

LENDER

In Islamic society, all Muslims are not only encouraged but areactually required to give loans to all those in need without anyhesitation. They are further required to waive such loan, if the debtoris not in a position of making repayment. In other words for thosewho believe in the life hereafter, the Qard-e-Hasana is the best option

in order to please Allah Almighty. However, it is not mandatory and inIslamic society, no one can be forced to make loans on this principle.

Musharaka and Modaraba

Musharaka )( or Shirkah )( may be termed as apartnership. It generally denotes a business run in partnership withefforts and capital investment from all the partners. Modaraba

)

( is another form of partnership in which any or a few of thepartners do not actively take part in the activities of the businesswhichmay be termed as a dormant partnership in the modern terminology.


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Although the rules used in for managing Musharaka andModaraba are a bit different, basic theme thereof remains the samehence we would prefer to discuss both of these tools simultaneously,which would also assist us in understanding the difference between thetwo.

Needless to mention, the pure Islamic financing concepts aremounted on these two tools. Particularly, the trade-based and lease

based modes of Islamic finance are not very much desirable in theIslamic economic system because of being fixed return based,although the financier takes the risk of loss on assets. Nevertheless, aswe will, later in this study, discuss in detail that these two options arevery much open and provide a wide range of Islamic financialproducts to cater the basic needs of a business.

Modaraba and Types of Modaraba

Modaraba )( which is also sometimes termed as

Muqarida )( in Shariah terms; is a type of profit sharing againstloans which is one of the most practically applied forms of interest-free financing in Islamic society for centuries.

By definition, it is a partnership in profit between capital andefforts (including entrepreneurship and labour). In Modaraba, one

party called Rab-ul-Mal )

( brings capital and the other partycalled Modarib )( contributes his personal efforts. Theproportionate share in profit is determined in any ratio by mutualagreement, but the

managing finances a shariah compliant way.pdf

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