The Extent of Tawhid and Effect to Islamic Finance Activities

The Relationship of Tawhid and Trade (commerce)

Tawhid is the essence of Islam. It simply means to regard God as one. The extension of
the word Tawhid is that god (Allah), the unique one, encompassing all the attributes of
perfection, is incomparable, unchangeable, and the sole creator of the universe with whom
no partner could be associated. The universe is governed by His will and He is omniscient
and omnipotent. All created beings must worship Him yet this worship offers Him no
assistance.
The entire universe with all the natural resources and powers is made amenable to
exploitation by man, though it is owned by Allah (SWT) alone. But, there is no room for
wrong thoughts and attitude in carry out any activities which runs contradictory to Islam
because of the belief in Allah, Life on earth being a test and all the provisions available to
man being in the nature of trust, man is accountable to Allah (SWT) and his success in the
life hereafter depends on his performance in this life on earth."
As emphasized in the Holy Quran is that Almighty Allah is the Only One Who provides
sustenance to His creatures and provides for their needs.

O men! Call to mind the favor of Allah on you; is there any creator besides Allah who gives
you sustenance from the heaven and the earth? There is no god but He; whence are you then
turned away? (35:3)

Mankinds responsibilities under Tawhid fall into two categories, fardain which is an
individuals obligation to perform his or her religious duties and fard kifayah, which is an
obligation for man to serve the entire community, through services to each other,
necessary for the community to live safely and comfortably. Thus the obligation to improve
the Muslim Ummah (community) falls under fard kifayah. Islam espouses that free trade
is a major factor in the enhancement of living standards of the general community, subject
to some constraints on business in the interests of the wider community.
Consequently, Islam does not prohibit worldly success, in fact Allah (SWT) has provided
opportunities for humankind to obtain success through doing business and it is certainly
the responsibility of the individual to do so. However involvement in business should also
carry with it benevolent intentions for others while seeking success for oneself.
In Rasullullah famous sermon on the occasion of his last hajj, the Prophet declared, among
other things:
your life, your property and your dignityare sacrosanct. (Muslim, kitab al-Haj,
Bab Hajjat al-Nabi).
Allah also mentioned in the Quran:
Believe in Allah and His messenger, and spend of that whereof He has made you
trustees; and such of you as believe and spend (aright), theirs will be a great
reward. (57:7) and bestow upon them of the wealth of Allah which He has
bestowed upon you...(24:33)

Definition of Islamic Finance

Islamic finance is defined as a financial service principally implemented to comply with the
main tenets of Sharia (or Islamic law). In turn, the main sources of Sharia are the Holy
Quran, Hadith, Sunna, Ijma, Qiyas and Ijtihad. The Holy Quran is the book of revelation
given to the Prophet Muhammad and Hadith is the narrative relating the deeds and
utterances of Prophet Muhammad. Sunna refers to the habitual practice and behaviour of
Muhammad during his lifetime. Ijma is the consensus among religion scholars about
specific issues not envisaged in either the Holy Quran or the Sunna. Qiyas is the use of
deduction by analogy to provide an opinion on a case not referred to in the Quran or the
Sunna in comparison with another case referred to in the Quran and the Sunna and Ijtihad
represents a jurists independent reasoning relating to the applicability of certain Sharia
rules on cases not mentioned in ether the Quran or the Sunna.
A large number of Islamic finance definitions are found in the literature, ranging from the
relatively simple definitions for specific aspects (say, Islamic banking) to more complex
definitions covering all financial operations. Warde (2000, p. 5), for example, defines
Islamic finance as follows: Islamic financial institutions are those that are based, in their
objectives and operations, on Qurans principles (principles of the Muslims holy book).
This particular definition suggests that Islamic financial firms are not just banks, but also
other types of financial intermediaries that employ Sharia principles. The other point of
departure is that the Sharia ostensibly requires the adjustment of all aspects of Muslims
lives and the formation of a complete moral system. According to Iqbal (1997), while the
prevailing Western financial system focuses on the capitalistic features of economic and
financial processes, Islamic finance aims to make an actual moral and equitable distribution
in resources and social fairness in all (Muslim) societies.

The Effect of Tawhid on Islamic Finance Activities

Adhering to the principle of Tawhid as building rock in Islamic Finance, human as

vicegerent and khilaf need to use the resource in fairness and as well as enhancing the
standard living of the ummah since the resources belong to Allah as the owner of whole
universe.
Islamic finance is controlled by Sharia, the legal framework of Islam and its Quranic
interpretation, along with the teachings of Sunna. This framework provides guidelines for
people to follow the principles of the Holy Quran and the Sunna in their decision-making in
all aspects of life. Financial transactions are one of the more important dealings controlled
by Sharia, ostensibly to ensure the more equitable distribution of income and wealth
among Muslims in Islamic economies. There are several general principles and measures
that pertaining to sharia rules in shaping and guiding Islamic Finance activities.
The general principles and measures are as follows:
(i)

the prohibition of Riba (usury or excessive interest) and the removal of debtbased financing from the economy;
Riba, which is pre-determined interest, is prohibited, as it is unlawful gain in terms
of not being result of productive economic or financial activity. Islamic economics
proposes profit and loss sharing and risk taking and sharing against predetermined
capital gains to motive individuals to actively engage in the economy. The objective
of the prohibition of riba is not only social justice but also due to achieving
economic optimality alongside social optimality with participatory economic
objectives. In Quran, Allah (SWT) has mentioned his Riba is forbidden in trade.
Allah has permitted trade and has forbidden riba (interest) (Quran 2:275). Islamic

finance encourages entrepreneurship and trade, and prohibits interest in all business
dealings. Islamic banks deal in goods and documents, not in money. Money is used
only as a medium of exchange for purchasing assets and then engaging in sale, lease
or investment. On the other hand, conventional banks deal with money and documents
and not in goods. Money is treated as a commodity which is bought and sold. This is
contrary to the nature of money as being a medium of exchange, unit of account and
store of value.
(ii)

The prohibition of Gharar, encompassing the full disclosure of information and

removal of any asymmetrical information in a contract;
The Arabic word Gharar is a fairly broad concept that literally means deceit, risk,
fraud, uncertainty or hazard that might lead to destruction or loss. Gharar in
Islam refers to any transaction of probable objects whose existence or description
are not certain, due to lack of information and knowledge of the ultimate outcome
of the contract or the nature and quality of the subject matter of it. For
instance, Ahmad and Ibn Majah narrated on the authority of Abu-said Al-khudriy:
Prophet Muhammad has forbidden the purchase of the unborn animal in the
mothers womb, the sale of the milk in the udder without measurement, the
purchase of spoils of war prior to distribution, the purchase of charities prior to
their receipt, and the purchase of the catch of a diver.
Islam has clearly forbidden all business transactions, which leads to exploitation
and injustice in any form to any of the parties of a contract. It seeks protecting
the different parties from deceit and ignorance by forbidding Gharar in any
commercial exchange contracts that are not free from hazard, risk or speculation
about the essential elements in the transaction to either party, or uncertainty of
the ability of one party to honour its rights and obligations. It requires that all
Islamic financial and business transactions must be based on transparency,
accuracy, and disclosure of all necessary information so that no one party has
advantages over the other party.
The rationale behind the prohibition of Gharar is to ensure full consent and
satisfaction of the parties in a contract. Full consent can only be achieved in full

disclosure and transparency and through perfect knowledge from contracting

parties of the counter values intended to be exchanged. The prohibition of Gharar
protects against unexpected losses and the possible disagreements regarding
qualities or incompleteness of information.
(iii)

Maysir, the exclusion of financing and dealing in sinful and socially irresponsible
activities and commodities such as gambling and the production of alcohol;
Islam has also categorically and firmly prohibited all forms of gambling. Maysir and
is forms of gambling transactions that are considered as totally inequitable in
Islam. Maysir refers to the easy acquisition of wealth by chance, whether or not it
deprives the others right.
Even though, gambling consists in a form of speculation and that there should not
be any place for commercial operations in Islam as it is purely speculative. The
prohibited speculation under the Shariah is not that, which relies on the analysis
of a lot of economic and financial data and which involves the investment of assets,
skills and labour. Rather, it is one involving an effortless gain similar to a gambling
scheme or activity. This is because the buyer is engaged in a transaction aimed at
making profit through trading and not through dishonest appropriation of the
property of others.

(iv)

Prohibition of using or dealing in forbidden commodities

Islamic finance encourages people to invest their money, but this general
encouragement is expected to comply with the rules set by Sharia. According to
Islamic doctrine, some commodities, such as alcohol, drugs, and pork, are strictly
forbidden. Thus, people should not use or exchange items banned by the Holy
Quran.

Some scholars have pointed out that neither individuals or institutions can trade or
finance enterprises that deal in forbidden items. This matter can be seen through
investment portfolio made by Islamic Finance intermediaries and banking sector
where they only deal or invest in Sharia compliant company based. The aim of
Sharia in this regard is to promote ethical investments that again do not affect
people and society adversely through the violation of religious prohibitions.
(v)

The sharing of business profits and risks

Islamic finance encourages people to invest their money effectively without any
injustice for those who are either lenders or borrowers. According to this
principle, lenders should share with borrowers the profits or losses from the
funded enterprise. Usually this is taken as they should equally distribute the risk
of their business, consistent with their sharing of the capital contributed to the
enterprise.
Kahf and Khan (1993) explain this in two parts: a profit-sharing principle and a
profit/loss sharing principle. According to the former, both the owner of the
capital and the entrepreneur share in the profits of the enterprise, referred to as
Mudarabah. In this method of finance, the owner of the funds provides capital to
an entrepreneur who provides experience and effort as a working partner.
However, they only share the profits of the business. In the case of a loss, the
owner of the funds bears the risks of loss and the entrepreneur losses their time
and effort. The latter principle is a full partnership in capital and management, as
well as in the profit and loss, of a particular enterprise. For instance, the
Musarakah (full partnership) in Islamic finance allows partners to share specific
percentages of capital in their working partnership and any profit/loss earned
from the enterprise is divided according to the proportion of capital invested.

(vi)

Paying and Collecting zakat ( payment to the poor) and Giving Sadqa (charity or
alms)
Zakah is the cornerstone of the financial structure in an Islamic economy. It is one
of the fundamental tenets of Islam. Literally, Zakah means purification.

Technically it means a contribution of a proportion of wealth for the use of the

poor and needy as sanctification for the remainder of the property. Methods have
been developed to systematically manage the zakah funds to enhance its positive
impact on alleviating poverty. In other words, instead of simply giving funds to
those economically less fortunate for their immediate consumption, corporate
sector also can develop projects for the sustainability, survival and continuity of
the economically less fortunate is the new strategy with zakah funds.
Sadqa aims at providing the immediate needs of an individual. Waqf, or pious
foundation, as part of the voluntary act encouraged in Islamic Finance to corporate
sector,aims to provide the goods and services which either could not be provided
for at all or sufficiently due to the failure of the market mechanism or the
government.
In addition to awqaf aiming at providing health services, education, and food
distribution etc., the use of funds accumulated in waqf in an efficient manner is
being developed through cash-waqf system and human development projects to
enhance their contribution to the economic development of the societies.

(vii)

Implementation of Takaful ( Islamic Insurance )

In conventional insurance body, its commercial insurance contracts have a
substantial Gharar component that affects the outcome of an insurance contract.
In brief, the insurance contract represents a sale contract and the amount of the
insurance which may be collected by the insurer and the insured is potentially
unknown. It is the unknown payoffs implicit in an insurance contract that leads to
Gharar.
So, since Gharar element is prohibited in any transaction, a Takaful or Islamic
insurance which is another important aspect of Islamic financial institutions
introduced, which operate on a non-interest basis. Apart from that, Islamic
insurance is a cooperative insurance scheme that could be established with a pool
of funds by a specific group of people who do not aim to obtain profit from the

pool, but may invest its funds in permissible activities in Islam to increase the
funds wealth. In turn, the Takaful provides members with financial help in the
instance of specific events.