Cima Cert If 1

Islamic
Commercial Law
Certicate in Islamic Finance

A global product for a diverse world
Islamic Commercial Law

Certicate in Islamic Finance
A global product for a diverse world
Chartered Institute of Management Accountants (CIMA)

26 Chapter Street, London SW1P 4NP, UK
T. +44 (0)20 8849 2287
F. +44 (0)20 8849 2450
E. cima.contact@cimaglobal.com
www.cimaglobal.com
First edition 2008
Published by SPG Media Limited
CIMA Certicate in Islamic Finance, set: ISBN 978-1-85971-585-7

Islamic Commercial Law, Study Guide One: ISBN 978-1-85971-581-9
Copyright 2008 CIMA
All rights reserved. No part of this publication may be reproduced, stored
in a retrieval system or transmitted in any form or by
any means, electronic, photocopying or otherwise, without prior
permission of the copyright owner.
No responsibility is assumed by the copyright holder for any injury
and / or damage to persons or property as a result of products liability,
negligence or otherwise, or from any use or operation of any methods,
products, instructions or ideas contained in the material herein.
Whilst every effort has been made to ensure the accuracy of the
information in this publication, neither CIMA nor SPG Media Limited
accept responsibility for errors or omissions.
Printed by The MANSON Group Ltd
Certicate in Islamic Finance and Banking Book one
Contents
Contents
How to use this guide
What is nance?
Introduction
14
Chapter one
An introduction to Islamic nance
18
Chapter two
Shariah compliance
38
Chapter three
Sources of Islamic commercial law
54
Chapter four
Methodology of interpretation
of Islamic commercial law
Chapter ve
Formation of contracts
Chapter six
Classication of contracts
76
90
104
Chapter seven
Comparison of classications
of contract
124
Chapter eight
Traditional Islamic contracts
and Islamic nance
140
Chapter nine
Overview of Islamic banking,
Takaful and capital market products
152
Chapter ten
Application of Islamic
contracts in Islamic nance
166
Chapter eleven
Implementation of Shariah standards,
policies and rulings in Islamic nance
182
Sample Examination
198
Glossary
204
Index
216
How to use
this guide
Realising your potential with this study guide

as a learning companion
We at CIMA want you to succeed in your studies and to use this success
both to your own advantage and to that of your current or future employers.
Regardless of how interested you are in the subject, distance learning
materials are challenging at the best of times. For many of you the subject
will be new and hence out of your usual comfort zone. The following pages
include useful information and tips that will assist you in using the guide as a
learning companion on the journey to expanding your learning horizon.
We at CIMA, with a group of respected authors and industry experts in
the eld, have pioneered and with substantial effort developed four study
guides that cover the major areas of Islamic nance, which provide a strong
foundation in the eld of Islamic nance. To enable you to have a complete
learning experience we have provided you with all the material you need
to pass the required assessments. You or your employers have invested a
considerable amount of money in purchasing the study materials for the
CIMA Certicate in Islamic Finance (CIMA CIF). We wish you every success
in your learning experience and subsequent career in this exciting and fast
growing eld of the nance industry.
The Certicate in Islamic Finance comprises four study guides:
Study guide one:
Study guide two:
Islamic Banking and Takaful (Products and Services)
Study guide three: Islamic Capital Markets and Instruments

Study guide four:
Accounting and Analysis of Islamic Financial Institutions.
You may choose to study the above modules in any order but we strongly
suggest that you begin with study guide one. Study guide one includes
an introduction to the subject of conventional nance and explains why
Islamic nance has become increasingly important in recent years and why
it continues to grow. Study guide one includes a glossary of the key terms
and contracts used throughout each subsequent guide. For easy reference,
this introduction and glossary can be found on the CIMA website at (www.
cimaglobal.com/islamicnance). It is vital that you read this introduction and
that you refer to it regularly as you work through each of the study guides.
It is also important that you appreciate the relevance of several key aspects of
the study guides. Each of these aspects is explained below and tips are offered,
where appropriate, as to how you can get the most from your studies.
4
Language
All four guides are written in English; however Islamic nance relies to a great extent on a large
number of Arabic terms and phrases as well as a few in Latin. Islamic nance is built on a foundation
of historic contracts, which have been used for centuries in Islamic commerce. These contracts, while
straightforward in terms of content, are known by their Arabic names. These names, many of which are
challenging to pronounce, will probably be new to you. The subtle differences between the meanings
of some of them need to be understood, as that understanding is the key to you pursuing a successful
career in Islamic nance. In addition to the actual contract names there are many other Arabic terms
used in the industry. You will in essence be learning to use words from the Arabic language, which will be
new to most of you. You cannot avoid this and need to be comfortable with these terms and phrases as
they are integral to the construction and delivery of the various contract types that underpin the whole
of Islamic nance. By referring back to the terms and phrases identied in the glossary you will soon be
comfortable with such terms as Qard, Wakalah, Musharakah and Murabahah, to name but a few.
Without any doubt, the most challenging aspect of the study of Islamic nance will be your
understanding of these terms and phrases, but, as with any new language, the sense of achievement
you will feel once you become uent in their use will make it worthwhile. You will also be able to
impress your family, friends and business associates with your new found language skills. After dinner
conversations and presentations during meetings will never be the same again.
Self study - the guides

Working on your own, particularly when the subject matter is new to you, is never an easy task. In writing
these study guides the authors have constantly put themselves in your position and attempted to create
materials that will hold your interest. They have also tried to ensure that they are easy to follow and
act as a complete learning experience. We believe that the guide you are about to read will give you a
thorough underpinning in the subject area. For a foundation course this is all that you need to pass the
nal examination and to follow a successful career in Islamic nance.
The text regularly requires you to stop, attempt exercises or Islamic challenges in order to get you to
interact with what you are reading. It is crucial to your understanding of the subject that you attempt
these exercises or challenges honestly. The answers for the questions and exercises are given at the end of
the respective chapter to conrm your understanding. In addition, at the end of each chapter is a series of
questions with which to test your new-found knowledge. Each set of questions at the end of the chapter
includes a series of multiple choice questions, which are in a similar form to those that comprise the nal
assessments you will be expected to pass before achieving your Certicate in Islamic Finance. Again,
solutions follow the questions at the end of the chapter.
Each guide concludes with a mock examination, which has the same number of questions as the relevant
nal assessment and is a good way of assessing whether you are ready or not to sit the nal assessment.
Learning outcomes
At the start of each chapter we list the learning outcomes that you should have achieved by the time you
have worked through the chapter. These learning outcomes relate to the questions you will be required
to answer in the live electronic assessment, which you must pass to achieve a credit in this subject. It is
therefore vital to your success that you feel condent at the end of each chapter that you have achieved
these outcomes. A useful tip would be to return to the learning outcomes once you have come to the
end of each chapter and make sure that you are familiar with each of them. The questions and answers at
the end of each chapter have been created to test you in your achievement of these learning outcomes.
Getting the right answer to these questions at the rst attempt is a good sign that you are achieving the
learning outcomes, where inability to answer them is a sure sign that you need to return to the detailed
content of the chapter. The nal examination will include questions relating to each chapter and the
respective learning outcomes (see below for more details).
Key points
The authors have highlighted key points, which they feel you should remember. While the rest of
the text is important to your understanding of the subject in question, these key points indicate the
crucial element of the text which you need to remember.
Quotes and examples from real life

Throughout the study guide you will see quotes and examples from real life. The quotes presented refer
to authoritative sources on the topic in question. While the study guide is not a religious text, some of
these quotes come directly from the Quran and the Traditions of the Prophet Muhammad. This is both
deliberate and unavoidable as the very reason that Islamic nance has developed is to offer an alternative
to conventional nance based on compliance with requirements of Shariah principle and rules derived
from the Quran and the Traditions of the Prophet Muhammad. Quotes from these sources, we believe, are
essential to your understanding of the development of the subject matter.
Other quotes come from individuals or organisations at the forefront of the development of best practices
in Islamic nance. These quotes are given in the context of the topic being discussed in order to emphasise
or further explain a point being made.
Exercises with solutions

Included throughout the guide are exercises that require you to respond to the material you have just
been reading. The answer to each exercise is given at the end of the relevant chapter, but to get the
most from your studies you should refrain from simply reading the question and then going to the
answer. You will learn little from this practice and remember even less. Read the question and give an
answer, if you can. If the answer is not on the tip of your tongue, then go back through the preceding
text and see if you can nd it.
Islamic nance challenges

In addition to the exercises mentioned above, each chapter includes a series of Islamic nance challenges.
These have been devised to develop and test your knowledge beyond that which is required for the nal
examination. In most cases these questions require you to apply the knowledge you have attained to
a specic problem or issue. Merely repeating what you have just read will not be sufcient to achieve
the correct answer. You will be required to think about what you have been reading and give a reasoned
answer. By including such challenges we believe that you will be making best use of the guide, not just as
a vehicle for passing the nal examination. These are meant to assist you to apply the knowledge you have
gained in a way that will provide insight on possible situations as well as practical applications of Islamic
nance where relevant to the nancial needs of business or individuals with a higher sense of fullment.
Chapter summaries
At the end of each chapter we have included a summary that lists the important points that you should
have understood from your studies. These summary points help you to trace the important sub topics and
the key points discussed in the guide.
Revision questions with answers

Each chapter ends with a series of questions and answers. The rst revision question will always involve
a series of multiple choice (MCQ) sub-questions. It is very important that you attempt each of these as
they are indicative of the MCQs that will be used in your nal examination. In addition to MCQs, you will
also nd a variety of other question types where relevant. Although these additional question types do not
appear in the nal examination they have been devised to increase your understanding of the subject and,
through better comprehension, will help you answer the MCQs.
Mock examination
For a comprehensive pre-assessment of your learning experience, you will nd a mock examination
at the end of the study guide. In terms of the number and type of questions, this mock examination
exactly replicates the examination you will need to do in your nal live on-line examination. While
the live questions will be different to those tested here, the areas and weightings of topics covered will
be the same. If you can answer these questions correctly you can be fairly condent that that you will
be able to answer the live questions correctly and thus pass the test. You need to score 65% in the
examination to pass.
The questions asked have been created to test each of the learning outcomes, which were listed at the
start of each chapter. The revision questions at the end of each chapter also represent the type of direct or
analytical questions you will be asked in the live examination. You should use both sets of questions to
test your understanding of this challenging subject.
Examples from real life

Islamic nance is an innovative and dynamic subject, which is a thriving nancial activity around the world
today. We have included, where possible, examples of real Islamic nancial products to complement
descriptions in the text. Many such examples are given in the form of extracts from advertising materials
used by real nancial institutions to market their products. It should be emphasised that these real life
examples are given as exemplars only. Islamic nance is a dynamic and fast-changing industry and some
of the products illustrated as examples in the text may already have been superseded by new or altered
versions. To ensure that you have access to up to date versions of each product we recommend that you
search the internet for similar products being offered at the time you are reading the text.
CIMA CIF website

While the four guides that make up the Certicate in Islamic Finance are all you need to successfully
complete your studies, we also know that you will feel more comfortable knowing there is somewhere out
there you can go to for support. CIMA CIF website has been created to provide the assistance you need. It
includes important information about the certicate, keeps track on your progress and is where you can
register for the nal examinations.
The website also has an area where we list frequently asked questions and the answers that were given.
It also includes an area where we will post updates which we feel are relevant to your studies.We would
hope that you will be a regular visitor to the website and thus feel that you are not alone in your studies.
The website can be found at www.cimaglobal.com/islamicnance.
Islamic Finance is constantly changing and CIMA will regularly update the study guides to reect
these changes. As changes to the hard copy guides can only take place during a reprint, we will keep
you up to date by posting details on the website of changes which have occurred between print runs.
Where necessary we will also supply references to additional support material, including suggested
further reading.
Most changes to material which we highlight on the website will be for information purposes only and will
not affect the assessments you sit. Where changes that take place are deemed sufciently important
CIMA may change the assessments to reect this.
Students will be emailed alerts about any new examinable material which appears only on the website.
Where applicable, new material will be assessable three months from the date of the rst alert and
when it appears on the website.
The future
You are embarking on a new journey, which for many of you will be a gateway to new knowledge and
experience. Like all journeys, you need to be properly prepared in order to meet all eventualities. This
guide, as part of the Certicate in Islamic Finance, is, we believe, a vital part of a successful career in this
exciting new development in global nance.
The nal examinations

In order to achieve the CIMA Certicate in Islamic Finance you will need to take a nal examination
comprising of multiple choice questions in each of the four subjects. The cost of each examination is
included in the price of the study guide. The examinations are computer based and you can take these only
at CIMA-accredited examination centres.
You may do the nal examinations in any order but CIMA strongly recommends that you do module one,
Study Guide One: Islamic Commercial Law rst as this provides the vital introduction to and underpinning
for the other modules.
Each examination consists of 40 or 50 multiple choice questions. For each question there are four options,
only one of which is correct. The answers to all the questions in the nal test are contained within the
study guide and reect the learning outcomes shown at the beginning of each chapter. You will have had
the opportunity to do numerous practice examples by the time you come to the end of this study guide.
You have about an hour to complete each examination. In order to pass the examination you need to
achieve a 65% pass mark. If you pass you will get your result immediately afterwards.
Each module is separately certicated. When you have completed all four modules and passed the nal
examinations, you will receive the CIMA Certicate in Islamic Finance.
We wish you every success.
What is nance?
What is nance?
What is nance?
The nance industry has evolved over hundreds of years and covers a wide
range of subjects including banking, credit, investment and insurance. One
of its key functions is the allocation of resources between those who have
a surplus and wish to invest and those who need to borrow in order to
nance a project or purchase transaction. Simply put it is a mechanism
for reallocating funds between those who have and those who have not.
Finance can also be viewed as an opportunity to arbitrage when there is
disparity between price and value arising from a state of disequilibrium
of value expectations. Every level of risk or uncertainty, assumed by the
investor or nancier, is met with an expected or required return. The
nance industry also includes the insurance sector where individuals or
those in business safeguard themselves or their assets against injury or loss
by the transfer and pooling of risks.
Conventional or western nance has become a multi billion dollar industry,
where individuals or businesses can invest or borrow funds through
specialist markets around the world. With the exception of funds generated
for illegal activities, the nance industry does not concern itself with the
use to which funds are put or how the funds arise. There is almost no limit
to the variety of nancial products available for those with a need to invest
or borrow. As an individual, you will no doubt have interacted in some way
with the nance industry; most likely as a depositor, borrower or having
taken out some form of insurance.
Two factors underpin conventional nance: (1) the use of interest as the
form of return or benchmark for those investing funds and a cost to those
borrowing them and (2) almost all areas of nance involve an element of
uncertainty. Conventional nance has evolved into sophisticated products
to meet the nancing requirements of individuals and businesses with
funds to invest, funding requirements to be met and insurance cover to be
provided. Each of these products to some extent will involve an element
of risk or uncertainty and in the banking products will incorporate interest
charged as a form of remuneration or as a cost of borrowing or defaulting
on an agreement. Traditionally in nance interest rates rise in order to
compensate for increasing risk or uncertainty assumed by the lender.
Alternatively, measures to mitigate or reduce the risk or uncertainty can
anticipate a lower rate of interest.
What is nance?
What is Islamic nance?

Islamic nance involves the revival of trade and investment principles and practices established
centuries ago within the context of modern nance and the nancial system. As a relative newcomer
to the nance industry, it has arisen as a result of the fact that conventional nance does not
meet the requirements of Shariah principles and rules and does not conform to the beliefs and
precepts of the religion of Islam. Key to the evolution of Islamic nance is the belief held by
Muslims that absolute ownership belongs to God and man as the servant and vicegerent act in
trust in administering wealth in a just and equitable manner. Oppressive behaviour, such as usury, is
prohibited and the charging and receiving of interest is unacceptable. Hence a moral code and social
order is prescribed based on the Islamic belief system.
The Quran is the absolute source of divine guidance and Shariah law according to Islamic belief. It
prescribes mankind to engage in activities that are lawful and good and prohibit those that cause
harm and dispute in the society. Among its prohibitions are trading in pork or pork products as well
as intoxicants and games of chance. The teachings of Islam based on the Quran and the Traditions
of the Prophet Muhammad state that the entire value chain of activities relating to these prohibited
activities is also equally prohibited. This includes all aspects of the production, storage, transportation,
marketing and advertising of such products and activities.
In prescribing the form of economic activities under Islam, trade is encouraged, usury is prohibited
and the acquisition of wealth should be achieved through lawful means that promote mutual consent
and goodwill. In this respect interest as usury is replaced with prot from trade. Muslims believe that
prot should involve decisions on risk preferences and choices and that nance should be mobilised
for acceptable, personal and business purposes as prescribed by the Shariah principles and rules.
You will now realise that the conventional nance industry, as described at the start of this section,
does not meet the requirements of the Shariah principles and rules as it is practised and motivated
by interest rate, takes risk in favour of lenders and is not generally concerned about the use or
application of funds. In the last 40 years various nancial institutions have attempted to develop
nancial products that are consistent with the Shariah principles and rules. The cash surpluses
generated from the extraction of oil in the Middle East and throughout South East Asia, both of which
areas have substantial Muslim populations, focused attention on the need to develop a nancial
system that met the requirements of Muslims. Similarly, from the perspective of insurance, many
individuals who follow the teachings of Islam also wanted to insure themselves or their property
against loss or injury, through risk sharing and pooling arrangements that promote mutual goodwill
and assistance in case of peril or hazard.
Simple economic theory explains what happened next. With an estimated 1.8 billion Muslims
worldwide, increasing cash balances from oil extraction and the demand for acceptable investment
and insurance products, an industry developed to meet these requirements. 25% of all Muslims
live in countries with a Muslim majority, which means that the demand for acceptable products in
these countries is backed by the political will to underpin the industry with relevant legislation and
legal systems. To date, mainly as a result of substantial oil revenues, development in this sector has
been focused in two key regions of the world, South East Asia and the Middle East. However, an ever
increasing number of Muslims and non-Muslims worldwide are seeking out Islamic nancial products.
As a result of this increasing demand, nancial institutions around the world have taken up the call
for new products and almost all areas of the conventional nancial industry have now been replicated
or adapted in a way that is acceptable to Islamic beliefs and practices.
Shariah compliance
A vital part of Islamic nancial activities is the requirement to achieve Shariah-compliant status
- to ensure that the nancial activities of the institution meet the requirements of the Shariah
principles and rules prescribed in the Quran and the Traditions of the Prophet Muhammad. To
achieve this, there is a need to establish adequate systems and controls in the form of an Internal
Shariah Control System (ISCS). The ISCS provides assurance that all nancial activities are conducted
in accordance with Shariah principles. An internal Shariah review is a prudent, if not a regulatory
requirement to self assess the degree of compliance the nancial institution adheres to in terms of
all Shariah principles prescribed in the form of standards, guidelines and best practices by relevant
governing bodies such as the Accounting and Auditing Organisation for Islamic Financial Institutions
(AAOIFI) and the Islamic Financial Services Board (IFSB).
What is nance?
Shariah compliance is critical to an Islamic Financial Institutions (IFIs) operations and must
permeate throughout the organisation, their products and activities. The implications of Shariah
non-compliance and risks associated with the IFIs duciary responsibilities towards different
fund providers would expose the IFI to fund providers withdrawals, loss of income or the voiding
of contracts. This in turn would lead to a diminished reputation and/or the limitation of business
opportunities.
Shariah advisory boards

Shariah advisory boards are independent advisory panels, comprising scholars and jurists in Islamic
commercial law and Islamic nance. The board explains and interprets the teachings of Islam as well
as formulating policies and expressing opinions to guide Islamic nancial practices based on Shariah
principles and rules. These opinions, policies and guidelines have been developed to provide assurance
and integrity to the systems of nancial institutions by ensuring that the products, processes and
instruments do not run contra to the principles set under the Shariah. They are perceived as the most
essential organ of governance in the structure of Islamic banking and nance. The Shariah board or
Shariah committee of an IFI should be able to express opinions on the nancial institution and should
be able to endorse the products or services of that institution.
Although all Shariah boards share the common goal of ensuring compliance, variations arise in
terms of establishment and conduct of the board such as methods of appointment, composition
of members, internal supervision and so on. International Shariah standard setting bodies such as
AAOIFI have issued several standards on such matters as well as on aspects of governance of Shariah
compliance. The recommended practices of many governing bodies such as AAOIFI and IFSB, as well as
adopted practices by individual IFIs, are based on the decisions of the Shariah board and are binding
on the IFIs and those institutions that adopt Islamic nancing transactions.
The importance of contracts

Fullment of contractual rights and obligations is an integral element of social conduct within an
Islamic society. These contracts should be lawful and proper and adhere to Shariah principles and rules.
A variety of commercial contracts play a vital part in underpinning the products and services offered
by IFIs as well as Islamic nancial instruments. Such contracts ensure that those interacting within the
Islamic nancial system are seen to be beneting from trading and real investment activities and not
simply the transferring and holding of cash balances and receivables in the form of loans and advances.
Those practising the Islamic belief do not accept that prots are earned simply from the use of money
interest earned from loans and advances. Muslims believe that prot should be earned by the
recipient from productive investment or trading activity. As such, surplus funds held by an individual
should only be invested in projects in which the investor has an active role in assuming trade or
investment risk or both, if they are to benet from the investment, for example, if they wish to see the
surplus funds increase. Consequently individuals or businesses can obtain nancing instead of loans by
involving the nancial institution in nancing purchase, trade or investment transactions. The nancial
institution then prots from a true sale, real trade or investment transactions.
Under conventional nance X borrows from Y to obtain funds. Y charges X interest based on the
amount of the loan, the perceived risk and duration of the loan. In the context of Islamic nance X
and Y need to become trading parties or investment partners. The necessity for both the provider
and user of funds to interact in a trading enterprise requires that agreements or contracts play an
important role in the trading or investment process. The nature of these contracts is at the very heart
of every aspect of Islamic nance.
To date the Islamic nance industry has replicated conventional interest-bearing and risk-bearing
products by using a set of key trade and investment contracts types. An understanding of these
contract types is crucial to understanding most of what follows in the area of Islamic nance.
The glossary, which forms part of each guide, explains all of the major contract types. You need to
understand each if you are to be articulate and involved in Islamic nance.
Islamic nancial institutions: products and services

The nature of IFIs, which have evolved since the 1960s, has adapted to meet the various needs of the
Muslim communities, society and the industry. From specialised nancial institutions that promoted
the welfare of Muslims during the earlier phase, these institutions have now become innovative and
enterprising nancial institutions within the global nancial industry. The nancial intermediation of
10
What is nance?
lending-based institutions is replaced with trading and prot-sharing institutions that, are directly
involved in the nancing of transactions as well as engaging in equity partnerships.
Loans and advances are replaced by new nancing vehicles that are based around sales, lease and
equity contracts. The nancing of sales and purchases, as well as leasing, involves trade contracts.
Equity-based nancing involves Mudarabah and Musharakah nancing or investments. These contracts
vary in their application to suit the purpose of nancing, such as term or working capital nancing,
as well as matching customer requirements, such as retail or corporate, as well as the nancial
institutions funding objectives.
Fixed deposits are replaced with investment accounts where xed determinable interest paid to
depositors is replaced with prot sharing dividends. The latter involves a predetermined prot sharing
ratio mutually agreed by both the nancial institution and the investment account holder. For certain
types of investments, the investment account holder can specify the area in which the funds are to be
invested. In this respect the investment account holders share the prots with the nancial institution
for a given level of risk exposure. Other savings and current accounts are based on safe custody
contracts or loan contracts that do not involve interest payments. The nancial institution may
however, at its discretion, declare dividends in the form of a gift (Hiba) to the account holders.
The Islamic Capital Market (ICM)

Capital markets, along with nancial institutions, perform the function of effectively mobilising
funds in society. The capital markets help to mobilise surpluses from economic units with excess
capital and transfer them to agents, who have managerial and entrepreneurial talents and investment
opportunities. This method of fund mobilisation is known as direct nancing because the funds are
transferred from the public to companies directly, without the nancial intermediation of nancial
institutions. The ICM refers to a market where capital market activities are carried out in ways that
comply with relevant Shariah principles and rules. Over the years, the ICM has evolved to provide
a wide array of products and services to meet the needs of both companies and investors who are
seeking products and instruments that are not only commercially feasible and attractive but also,
more importantly, Shariah compliant. Generally speaking, the ICM provides three markets similar
to the conventional capital markets described above: the Islamic equity markets, the Islamic xedincome instruments or Sukuk market and Islamic derivatives or Islamic-structured products market.
The Islamic equity market

The Islamic equity market refers to the market place where Shariah-permissible stocks or shares
are transacted. A share is known in Arabic as Sahm or Asham (in plural). There is no distinction with
regards to the features of a share in Islamic nance vis--vis a conventional share. As described above,
they are capital-raising instruments, a means of sharing risk, a means of securing ownership and are
transferable, negotiable and liquid. The main concern of Islamic equity does not relate to the structure
of an ordinary share, but on the activities of the company that issues the share to the public. In other
words, investors, particularly Muslim investors who are sensitive to Islamic investment guidelines,
must examine whether the company undertakes its activities according to Shariah principles and
rules. As shares represent an ownership right in the company, Muslim shareholders ought not to
invest their capital to support activities that are non compliant. As a result, they should not invest in
companies that offer interest-based nancial products, conventional insurance, gambling activities,
pornography and entertainment activities. It should be noted that the Islamic equity component of
the ICM also includes other sub-divisions such as Islamic unit trusts or mutual funds, Islamic private
equity funds, Islamic real estate investment trusts, Islamic exchange-traded funds and to a lesser
extent specialised funds such as leasing funds and Mudarabah commodity funds. Each of these will be
fully explained in the respective study guide.
The Islamic xed-income instruments or Sukuk market

A Sukuk refers to the process of aggregating tangible assets or usufruct or an interest in a project into
divisible units or securities that reect the proportionate ownership of that asset or usufruct or project,
as the case may be. A Sukuk does not deal with receivables or nancial assets. Sukuk holders each
hold an undivided benecial ownership interest in the underlying assets. Consequently, Sukuk holders
are entitled to share in the revenues generated by the Sukuk assets. In short, Sukuks are monetarydenominated participation certicates of equal unit value issued to investors. These Sukuks represent
their proportionate share in the ownership of the underlying assets and a pro-rated share in the income
generated by those assets. Sukuks do not represent any indebtedness by issuer to the investor.
11
What is nance?
The return to the investors in Sukuks is not xed or guaranteed but is subject to the performance of
these underlying assets. A Sukuk, which is performance based, does not promise any xed income.
The Islamic derivatives or Islamic structured products market

Islamic-structured products or Islamic derivatives are meant to hedge the nancial risk associated
with an underlying asset. This asset could be commodity, share, bond, Sukuk, currency, prot rate and
so on. Several Shariah contracts can be used to achieve the desired objectives of derivatives. Typically
a Salam contract in Islamic commercial law is a hedging investment tool where both the buyer and
seller have locked in the future price to be paid by one to the other. Chronologically speaking, the rst
derivative investment in conventional nance was probably the forward contract. Not surprisingly,
forwards were also the simplest type of derivatives. The next step in the evolutionary chain was
the development of futures contracts, which were designed to manage risk more effectively and
efciently. Another derivative instrument is the option, which is a right (but not the obligation), to
buy or to sell, which is given to an option holder. It provides exibility to execute a purchase or sale
obligation at a predetermined price in the future. A swap is another useful product in this respect. All
these products and instruments have some Shariah justication to make them compliant and able to
manage risk in Islamic nance.
Accounting and analysis of Islamic nancial transactions

Within Islamic nance, the purpose of nancial reporting is re-examined in the light of ensuring
that it addresses user information needs, and ensuring that all nancial activities of IFIs are not only
commercially viable but also Shariah compliant.
The nature of accounting, reporting and analysis of the nancial operations of IFIs signicantly evolved
with the establishment of AAOIFI nancial accounting, reporting, auditing and governance standards.
The contractual rights and obligations of Islamic nancial activities needs to be disclosed as does the
fact that neither unlawful income nor unlawful expenditure has been earned or incurred. In addition, the
prot-sharing mechanism between shareholders and investment account holders needs to demonstrate
equitable distribution policy and practices. Hence the nancial reality, presented in the nancial
statements, reects both nancial and religious accountability in terms of meeting international
nancial reporting standards as well as Shariah principles and rules.
Certicate in Islamic nance - content

Introduction
The growth in the Islamic nance industry has outpaced the development of education in this area.
This study system has been devised to meet the shortage in teaching materials and will introduce you
to key areas of the Islamic nance industry as identied above. Through the four study guides you
will be introduced to Islamic commercial law, banking and insurance (Takaful), Islamic capital markets
and instruments and the accounting and analysis of IFIs. Each of these guides has been developed
to give you an in-depth understanding of the principles that underpin the Islamic nance industry,
the key factors that drive growth in the industry and the challenges that face the industry today. The
guides have been written in such a way as to allow you to understand the practical applications of the
knowledge you are gaining.
Terminology
Many of the technical terms used in Islamic nance are derived from Arabic. You will already have
noticed the use of such words as Takaful, Shariah, Mudarabah, Musharakah, Hiba, Sukuk and Salam,
above, which are all Arabic terms. For those of you with no experience in Arabic, these words and terms
may prove challenging, but it is essential, if you are to succeed in understanding much that underpins
Islamic products and services that you master these concepts and terms. We have created a glossary of
terms for you to refer to and we have included a detailed explanation of the nature of the contracts, the
key to all of the Islamic nancial products and services. It is left to you to make the most of the glossary
and contract explanations to maximise the benet you gain from these guides.
Benets and objectives

The Certicate in Islamic Finance programme is designed to meet the needs of those who work in the
Islamic nancial industry. It provides an important platform for professionals to gain new knowledge,
develop new skills equip them to address emerging issues within the Islamic nancial industry.
12
What is nance?
Certicate in Islamic Finance - overview of study guides

Study guide one: Islamic Commercial Law
This study guide will introduce you to Islamic law and Islamic commercial jurisprudence as it relates to
Islamic nance, including the sources, principles, concepts, methodology, standards and applications of
Islamic law in relation to the nancial system, industry and environment. In addition to the theoretical
aspects this guide will explain the importance of contracts in relation to Islamic nance and will outline
practical applications of Islamic contracts to contemporary Islamic nancial products and services.
Study guide two: Islamic Banking and Takaful (Products and Services)
In this study guide you will be introduced to the nancial systems, products and services offered by
IFIs in the Islamic banking and Takaful industries. The guide also provides an overview of the types of
nancial institutions operating within the system. It explains the various nancial products and services
provided by both banking and Takaful institutions in terms of product features and mechanisms. Finally,
it highlights pertinent risk management issues relevant to the nancial institutions involved in Islamic
nancial activities.
Study guide three: Islamic Capital Markets and Instruments

In this study guide you will be introduced to the nature and development of Islamic capital markets,
relevant international agencies, Islamic bonds and Sukuk, Islamic mutual funds, Islamic stock screening
processes and Islamic structured products. The study guide explains the importance and need for
Islamic capital markets, the distinct features of Islamic capital market system and instruments such
as Islamic bonds, Sukuks and Islamic asset-backed securities and identies the challenges in adopting
relevant contracts and structures in Islamic structured nance.
Study guide four: Accounting and Analysis of Islamic Financial Institutions

In this study guide you will be introduced to the reporting framework and reporting standards of IFIs
as well as analysing and classifying Islamic funding and nancing transactions. The various funding
facilities are analysed in terms of reporting requirements as well implications on the prot sharing
distribution mechanisms. In addition it explains how the nancing transactions adopting different
contracts of nancing are reported in the nancial statements. Reasonable assurance in terms of
nancial accountability and Shariah compliance of the nancial institutions is also covered in this
study guide. It will also assist you in understanding and analysing the nancial information of IFIs.
Study plan for Certicate in Islamic Finance

All candidates are encouraged to be familiar with study guide one prior to reading the other study
guides. Study guide one enables a learner to be familiar with the foundations of Islamic commercial
law, which are constantly referred to in the other study guides.
You may then decide to continue with either study guide two or three depending on your familiarity
with the banking, Takaful and Islamic capital market areas. Study guide four assumes that the learner is
familiar with Islamic commercial law as well as the nancial industry prior to acquiring understanding
of accounting, reporting, auditing and governance requirements of IFIs and transactions.
To facilitate learning, each study guide is designed with expected learning outcomes, exercises, Islamic
challenges, key point notes as well as revision questions to provide feedback and reassurance in relation
to the learning experience. In addition, relevant examples and quotes from nancial industry and the
environment are cited to allow students to be familiar with the context of material discussed in the
Islamic nancial services industry. Islamic challenges are included to stimulate discussion beyond the
scope of each topic discussed in the chapter. This allows the more advanced learner to articulate a
more in-depth and stimulating learning experience.
A mock exam paper is included at the end of each study guide. This should allow you to prepare
yourself for the computer-based assessment examinations that you need to pass to achieve the
Certicate in Islamic Finance.
We wish you every success in your studies.
For further information and advice please visit the website

www.cimaglobal.com/islamicnance.
13
Introduction
The CIMA Certicate in Islamic Finance Introduction

The Islamic Financial Services Industry (IFSI) has emerged as a signicant
sub sector of the global nance industry. While certain areas of the
industry have developed at a faster rate than others there are no areas of
conventional nance that cannot be transformed or replicated in a Shariahcompliant way. The CIMA Certicate in Islamic Finance covers all aspects
of the discipline of Islamic nance as they exist today. Such is the speed of
change in the industry that Islamic nance practices are expected to expand
and develop exponentially over the forthcoming years.
The certicate, through its four study guides, will introduce you to the major
areas of current development. Study Guide One, Islamic Commercial Law,
introduces you to the differences between conventional and Islamic nance,
the terms applied, the contracts used and the legislative underpinnings
that exist worldwide to support the industry. Study Guide Two, Banking
and Takaful, introduces two of the major areas of Islamic nance, banking
and insurance (Takaful). Study Guide Three, Islamic Capital Markets and
Instruments, reviews the current developments in the Islamic Capital
Markets (ICMs) and the products being created to meet demand in this area.
Study Guide Four, Accounting and Analysis of Islamic Financial Institutions,
examines the Framework of Financial Reporting which currently exists for
Islamic Financial Institutions. In addition it introduces the standards set
by such groups as the Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI), the differences in reporting required and
the roles of the external auditors, Shariah boards as well as audit and
governance committees.
This guide introduces you to Islamic commercial law and its application to
transactions within Islamic nance. It highlights the sources of the Islamic
commercial law including the Quran and the Traditions of the Prophet
Muhammad. It explains the methodologies used by modern scholars to solve
modern problems in Islamic nance. It also introduces the historic contracts
involved in Islamic commercial law, explaining how they are classied
and why particular contracts are chosen to meet particular nancial
requirements. An understanding of these contracts and their behaviour
will help you understand the structures and application of Islamic nancial
products. Finally, the guide explains what is meant by Shariah compliance,
its signicance in Islamic nance and how it is applied in modern nancial
activities. Shariah compliance is a key issue in Islamic nance and the guide
briey explains the nature and importance of the Shariah standards that
have been developed in this area.
14
Terms and contracts

A key requirement for the successful completion of all four guides, which comprise the Certicate
in Islamic Finance, is your understanding of the Arabic technical terms and historic contacts used in
creating Shariah-compliant products. Each study guide includes a detailed glossary of these terms
and contracts. You are strongly recommended to refresh your memory in this area. A copy of the
introduction can be found at our website www.cimaglobal.com/islamicnance.
Study Guide One

Contents
Chapter one looks at the roots of Islamic nance. It highlights the unique features in Islamic nance
that were actually established more than 1,400 years ago. This chapter also describes the main
differences between Islamic nance and conventional nance. Finally the chapter will also introduce
you to how useful Shariah-compliant products are created.
Chapter two highlights the key issue in Islamic nance which is Shariah compliance. It denes
Shariah compliance and how it is applied in modern nancial activities. This chapter also introduces
the methods used to ensure compliance, which is essential at both the nancial structuring and
operations stages.
Chapter three explains how Islamic commercial law varies from the conventional modern law, as it is
derived from sources that were revealed by God Almighty. This chapter will introduce the sources from
which Islamic law developed including both the primary and secondary sources of law. It highlights
the practice of reasoning (Ijtihad) and the principles which underlie this process. Ijtihad is one of
the methodologies used by the modern scholars to solve modern issues and problems using their
reasoning and interpretative skills which give great impact to the development of Islamic nance.
Chapter four looks at how Ijtihad can solve practical modern nancial issues from an Islamic
perspective. It introduces the basis and idea of Ijtihad or interpretation as practised within Islamic
commercial law. It covers the many types and variations of Ijtihad that enable jurists to solve modern
and day-to-day problems.
Chapter ve builds on the importance of the contract which is the core foundation of an Islamic
nance product. It explains that the creation of nancial products results from the ability to use one
or more traditional contracts to meet the requirements of the customer. This chapter also looks at
the meaning of contract as used in Islamic commercial law including the explanation of what makes
a valid and enforceable contract. Finally this chapter considers the signicance of understanding the
components needed for a valid contract in Islamic nance.
Chapter six highlights how various contracts in Islamic commercial law are classied. The variety of
contract classications is essential to meet the diversity of relevant commercial purposes. Only with
a full understanding of each classication are Islamic nancial institutions able to structure products
that meet the ultimate aim of clients and customers in a Shariah-compliant way.
Chapter seven explains how to compare and contrast a variety of classications of contract in
Islamic nance. This chapter also highlights the application of a particular contract to meet a specic
nancial purpose.
Chapter eight introduces the process by which Islamic IFIs select the appropriate contracts to meet
the needs of their clients. The chapter will also introduce the process of transforming particular
traditional contracts into nancial products. This process is known as nancial engineering. As a result,
simple contracts have been used to create products that effectively satisfy modern nancial needs.
This chapter attempts to guide you through this interesting and challenging task.
Chapter nine highlights some of the leading Islamic nancial products and services, not only in the
banking industry but also in the Takaful and capital market. It also introduces you to relevant contracts
that form and create these products and, to some extent, to the reason why a particular contract is
able to meet a certain nancial aim and objective. This chapter gives an overview of the products that
are currently available in the market and attempts to link these products with the original contracts
that dictate the behaviour of these nancial products.
Chapter ten introduces the reasons why a particular contract or group of contracts is chosen to meet
a particular nancial need. It explains in practical terms the development of Islamic nancial products,
which are comparable with conventional nancial products. This chapter also reinforces the previous
discussion on contracts, classications of contracts and transformation of contracts into
nancial products.
15
Chapter eleven explains the objective of Shariah standards. It also highlights the attempts being
made by Shariah scholars to ensure harmonisation of standards across the industry and some of the
solutions proposed.
Learning outcomes
On completing this study guide you should be able to achieve the following learning outcomes
according to the following chapters:
Chapter one: An Introduction to Islamic nance
Dene Islamic nance whether in the form of banking, insurance or capital market segments.
Describe the salient features of Islamic nance comprising of interest-free transactions,

uncertainty-free transactions, prot and loss sharing and the economic and monetary functions
of money.
Illustrate how these features require the provision of different nancial products to those
supplied through conventional nance.
Explain how Islamic nance can satisfy nancial needs without violating religious prohibitions.
Chapter two: Shariah compliance
Dene the meaning of Shariah compliance.
Appreciate the importance of Shariah compliance in all nancial activities of an IFI.
Identify the key stakeholder interested in Shariah compliance.
Chapter three: Sources of Islamic commercial law
Dene the meaning of source of law from an Islamic perspective.
State the importance of source of law in Islamic law.
Distinguish between the primary and secondary sources of Islamic law.
Distinguish between Shariah (Divine sources of law) and Fiqh (Islamic substantive law or
positive law).
Identify the most workable technique of law in developing contemporary Islamic commercial law.
Chapter four: Methodology of interpretation of Islamic commercial law
State the basis of interpretation in Islam.
Dene the meaning of Ijtihad or interpretation.
Distinguish various forms of Ijtihad inclusive of both textual-based and human-based

reasoning.
Identify the need of Ijtihad in modern times.
Demonstrate the practicality of Ijtihad in solving modern issues and problems.
Chapter ve: Formation of contracts
Explain the meaning of contract (Aqd) in Islamic commercial law.
Explain the requirements of a valid and enforceable contract.
Chapter six: Classication of contracts
Describe the basis of classications of contracts.
Chapter seven: Comparison of classications of contract
Compare and contrast various classications of contracts.
Apply respective contracts to a specic case for a specic purpose.
Chapter eight: Traditional Islamic contracts and Islamic nance
16
Illustrate the exibility of Islamic commercial law to meet nancial need without resorting to
lending for an interest.
Describe the relationship between traditional contracts and Islamic nance products and
services.
Chapter nine: Overview of Islamic banking, Takaful and capital market products
Understand and explain Islamic banking products.
Understand and explain Takaful products.
Understand and explain Islamic capital market products.
Chapter ten: Application of Islamic contracts in Islamic nance
Explain the reason(s) why some contracts are preferable over other contracts in Islamic nance.
Discuss briey product development in Islamic nancing using the traditional contracts.
Chapter eleven: Implementation of Shariah standards, policies and rulings in

Islamic nance
Describe the objectives of Shariah standards.
Explain how to deal with different rulings arising from different interpretations of the sources
and techniques of law.
Identify solutions to enhance Shariah compliance.
17
Chapter one
An introduction
to Islamic nance
Learning outcomes
On completion of this chapter,
you should be able to:
dene Islamic nance whether in the form of banking,

insurance or capital market segments
describe the salient features of Islamic nance

comprising of interest-free transactions, uncertaintyfree transactions, prot and loss sharing and the
economic and monetary functions of money
illustrate how these features require the provision of

different nancial products to those supplied through
conventional nance
explain how Islamic nance can satisfy nancial needs

without violating religious prohibitions.
Indicative syllabus content

Introduction to Islamic nance.
Salient features of Islamic nance.
Conventional versus Islamic nance.
Compliance with religious beliefs.
1.0 Introduction
Islamic nance has its roots in the past as well as the present. Its links
to the past relate to the fact that it is based on principles and features
that were established more than 1,400 years ago. Its links to the present
relate to the fact that these ancient features are now being presented to
contemporary society in a form that is both modern and innovative. Islamic
nance is distinct from conventional nance in many respects but has a
common goal in achieving the same economic benet as conventional
nance offers to society. In this chapter you will be introduced to the main
differences between conventional and Islamic nance, including the need to
exclude interest and uncertainty. You will also be shown how the features
of nance that are acceptable can be used on their own, or in combination
with Shariah principles to create useful Shariah-compliant products.
Islamic nance is essentially driven by principles and contracts that are
structured in a manner that is not only compliant to Islamic teachings
but is also capable of offering products and services comparable to and
compatible with those of conventional nance.
1.1 Islamic tradition
The essence of Islam is that it derives its principles and values from the Quran and Traditions of
the Prophet Muhammad. The history of Islamic law begins with the revelation of the Quran that
contains legal principles and injunctions dealing with subjects such as ritual, marriage, divorce,
succession, commercial transactions and penal laws. In contrast, the Traditions of the Prophet
Muhammad record the sayings, actions and tacit approvals of the prophet Muhammad. The literature
of the Traditions of the Prophet Muhammad covers a much wider range of topics than the legal
verses in the Quran.
Unlike other legal systems, Muslims believe that Islam starts from a given or self-evident premise,
namely the revelation. It was with the aim of directing and guiding humanity to the realisation of its
moral potential and worldly worth that Islam undertook to create a system known as the Shariah.
Muslims believe that Shariah refers to commands, prohibitions, guidance, and principles under
Islam and is the clear path for the believer to follow in order to obtain guidance in this world and
deliverance in the next.
Key points
The essence of Islam is that it derives its principles and values from the Quran and Traditions
of the Prophet Muhammad.
Muslims believe that Shariah refers to commands, prohibitions, guidance and principles under
Islam and is the clear path for the believer to follow in order to obtain guidance in this world
and deliverance in the next.
19
Shariah provides guidance in terms of belief, moral conduct and practical rulings or laws. The focus
in this study guide will be conned to the practical rulings or substantive law governing Islamic
nance. This does not negate the importance of moral values in Islamic nance. Essentially, a
complete system of life is based on both legal prescriptions and moral and good conduct. Moral
values have been incorporated as legal requirements in some specic contracts such as Amanah
(honesty) in Murabahah (mark-up) nancing. Other principles of moral values pertaining to
commercial transactions include:
(a)
timeliness in the payment of debt or delivery of an asset; the failure to observe this aspect
might involve legal consequences
(b)
tolerance in terms of bargaining, where the parties are encouraged to be considerate of each
others requirements and circumstances
(c)
mutual revocation of a contract on request by one party if he nds himself uncomfortable with
the outcome of the transaction
(d)
honesty or Amanah in all statements, representations and warranties.
These principles are not meant to be exhaustive but rather to highlight areas where morality is
relevant in commercial dealings.
1.2 The meaning of Islamic nance

Islamic nance is a term that reects nancial business that is not contradictory to the principles of
Shariah. Conventional nance, particularly conventional banking business, relies on taking deposits
from, and providing loans to, the public. Therefore, the banker-customer relationship is always
a debtor-creditor relationship. A key aspect of conventional banking is the giving or receiving of
interest, which is specically prohibited by Shariah. For example a conventional banks xed deposit
product is based on a promise by the borrower, that is the bank, to repay the loan plus xed interest
to the lender, that is the depositor. Essentially, money deposited will result in more money, that is
the basic structure of an interest based system.
In other non-banking businesses, conventional products and services such as insurance and capital
markets could be based on elements that are not approved by Shariah principles such as uncertainty
(Gharar) in insurance and interest arising in conventional bonds or securities. In the case of
insurance, the protection provided by the insurer in exchange for a premium is always uncertain as
to its amount as well as its actual time of happening. A conventional bond normally pays the holder
of the bond the principal and interest.
Conventional practices could also involve selling or buying goods and services that are not lawful
from a Shariah perspective. These might be non-Halal foods such as pork, non-slaughtered animals
or animals not slaughtered according to Islamic principles, alcohol or services related to gambling,
pornography and entertainment. In short, conventional business practices could be non-compliant
from a contractual structure perspective (if they are based on interest and uncertainty) and/or from
a transactional perspective when they are involved in producing, selling or distributing goods and
services that are not lawful according to the Shariah.
Key point
Islamic nance is a term that reects all aspects of nancial business that are not
contradictory to the principles of Shariah.
Exercise 1.1
Which of the following best denes Islamic nance?
(A) Financial products and services that are offered to Muslims only.
(B) Financial products and services that are offered by Islamic banks.
(C) Financial products and services that are conducted according to Islamic teachings.
(D) Financial products and services that were offered during the time of Prophet Muhammad.
20
1.2.1 Banking and interest (Riba)

Islamic banking is the branch of Islamic nance that has seen the most growth to date. It is also
the branch of nance that needs to be viewed from a different perspective as it cannot replicate
conventional banking. This is because the most important underlying principle of conventional
banking is that money creates money or that money has a premium, known as interest or usury.
This practice (known in Arabic as Riba) is the antithesis of Islamic nance because Islamic law, from
the beginning, has categorically denounced it. Money has never been perceived as a commodity
for which there is a price for its use. Instead, Islamic law consistently views money as a medium of
exchange, a store of value and a unit of measurement.
As money cannot earn money, a link has to be introduced between money and prot as an
alternative to interest. It is against this backdrop that Islamic banking has been primarily involved in
trading, leasing and fee-based as well as investment activities. Those involved in Islamic banking are
not in a position to either borrow or lend money for interest. Subsequently, the nature of the Islamic
banker-customer relationship varies according to the different contracts that Islamic banks and their
customers enter into.
Key points
Riba is dened as usury or interest.
In interest-based systems, money earns more money through lending.
The application of nancial interest or Riba is prohibited in Islam.
Money in Islam is a medium of exchange, a store of value and a unit of measurement.
1.2.2 Islamic banking the relationship between the user and the supplier of funds
The relationship of the Islamic bank with the suppliers of funds can be of agent and principal,
custodian and depositor, entrepreneur and investor as well as between fellow partners in a joint
investment project. Similarly, the relationship of the bank with the users of funds can comprise of
vendor and purchaser, investor and entrepreneur, principal and agent, lessor and lessee, transferor
and transferee, and between partners in a business venture. This is in sharp contrast to that of
conventional banking, which is simply a lender-borrower relationship.
Conventional banks will accept a deposit from a depositor and promise to repay the money plus
interest which is xed, let us say, at 3%. As a nancial intermediary, the bank will use this money
deposited to lend to customers who need a loan. Here, the bank will charge the customers interest,
let us say, at 4%. The spread or the difference between the interest rate paid and interest rate
charged, namely 1%, is the banks prot. The notion of interest has made this model of nancial
intermediary work well.
Table 1.1 Deposit/liability: contractual relationship conventional banks and Islamic banks
Conventional Banking
Islamic Banking
Lender-borrower relationship
Depositor-custodian relationship
Lender-borrower relationship
(but free from interest)
Investor-entrepreneur relationship
Financing/Asset: Contractual Relationship

Conventional Banking
Islamic Banking
Borrower-lender relationship
Purchaser-seller relationship
Lessee-lessor relationship
Principal-agent relationship
Entrepreneur-investor relationship
21
The above illustrates that Islamic banking has departed from the concept of loans to use other
contracts that are compliant and free from the element of interest in both deposit taking and
nance provision.
1.2.3 Basic principles of Takaful Islamic insurance

Takaful is an Arabic term
derived from the root word
kafala, meaning to guarantee.
To be more precise, it is derived
from the verb Takafala meaning
to mutually guarantee and
protect one another. Therefore,
literally, it means mutual help
and assistance.
With regards to Islamic insurance, better known as Takaful, the insurer, that is the insurance company,
is prohibited from providing indemnity to the insured, that is the policyholders, as this is not
acceptable to Shariah principles. This is because both the premium paid by policyholders and the
indemnity paid by the insurer are uncertain and therefore not permissible as they contain the element
of uncertainty or Gharar. A simple conventional insurance contact is based on buying protection.
David seeks to insure his life for 30 years. Let us say that the premium he has to pay is $100
per month for 30 years for the insured sum of $200,000. If David dies during the policy period,
his nominee or beneciaries will benet from this insured sum irrespective of when David died
during the thirty year period. He might have paid only $2,400. Alternatively, David could survive
until maturity and in this case, he will receive no benet at all. This leads to uncertain results
that are not acceptable under Islamic beliefs.
Conventional life insurance companies are prot seeking entities and need to allow for things like
average life expectancy and high risk customers when setting their premiums in order to ensure that
it prots from offering life insurance to its customers.
Takaful introduces the contract of donation among the participants/policyholders as a substitute
for the contract of sale of indemnity for a premium as practised in conventional insurance. This is to
make uncertainty irrelevant because in Islamic terms uncertainty is only tolerable in gratuity or in
a unilateral contract such as a donation. The presence of the element of uncertainty in a donation
contract, which is unilateral in character, does not render it invalid. A donation contract can accept
and tolerate any uncertainty because the purpose of any unilateral contract is not a commercial gain.
Key points
Takaful is a scheme that provides mutual contribution and mutual assistance to cover both life
and general policies.
Takaful is based on donation contract and not a sale contract. Thus, uncertainty in Takaful is
acceptable because the ultimate aim is merely to help one another and not to achieve any
commercial gain.
1.3 Other differences between conventional and Islamic nance

Islamic capital markets that consist of both equity investments and xed income instruments
must avoid some conventional elements and principles from both contractual and transactional
perspectives. In addition to interest and uncertainty, issues such as gambling, which is a zero-sum
game, investments in unlawful activities and capital guarantee elements in equity-based products
are to be avoided. In short, Islamic nance, unlike conventional nance, must be distinctive in its
contractual and transactional features to render it different from conventional nance, although
ultimately both may achieve the same economic benets.
Exercise 1.2
Briey explain why:
(i) under Islamic commercial law, money cannot generate income by the mere act of lending it
out to a borrower?
(ii) Islamic banking cannot rely on interest earned on a loan?
22
Islamic nance challenge 1.1

Z has a business idea that requires substantial capital funding from third parties. Z has
heard from one of his friends that he could obtain this funding from an Islamic bank.
Confused, Z has asked you to explain why he should approach an Islamic bank for funding
and how borrowing from an Islamic bank would be different from borrowing from a
conventional bank. Draft some notes for Z explaining the relationship between a borrower
and an Islamic bank and explain what difference this will make to his loan.
Points to note:
under Islam, loans offered in return for interest earned are prohibited
prot must be generated from other contracts such as trade, lease or investment by
converting the money into a real asset prior to undertaking other contracts such as sale
or lease
money must be put into real business transactions to generate income; this might include
the purchase of goods at x and the sale of those goods to a customer at x + y on a
deferred payment scheme
the bank would arrange to supply the necessary capital equipment for Z on this basis
suppose Z approaches a conventional bank to borrow a sum of 100,000 to purchase
new equipment for his printing business and for this he is quoted 4% interest per annum
on the proposed loan; in contrast, an Islamic bank can offer him credit sale nancing
whereby the Islamic bank will purchase the equipment from the vendor at 100,000 and
sell it to Z at 100,000 plus a mark-up or prot, let us say of 4% per annum
Z would not incur interest but the bank would earn a prot on the transaction.
1.4 The salient features of Islamic nance

As mentioned above, Islamic nance, especially Islamic banking, enjoys certain features that you
would not nd in conventional banking. These features are as follows:
1.4.1 Interest free

Islamic banking is interest free, meaning that all banking business and activities must prima facie
be free from any element of interest. In Islamic law, interest can arise when there is an exchange
of two similar usurious items or assets such as money for money or main food for main food. In
banking, the leading practice from which interest originates is the exchange of money for money,
that is, money lending. Modern banking is based on the lending of money for a premium - interest.
Islamic banks must eliminate interest in all its forms, be it in cash or kind. A xed deposit account
in a conventional bank is a good example of how the bank pays interest in cash. A good example
of the avoidance of interest in kind is the prohibition of any advertisement of gifts for prospective
saving and current account holders when these accounts are based on a Wadiah (safekeeping) or
Qard / Hassan (loan) contract. This is deemed to be promising a form of interest in kind payable to
savings and current account holders. Although a gift such as a pen or umbrella or savings box is not
in monetary form, it is still deemed as an extra gain for the lender. The Quran states that interest, be
it in cash or in kind, is not permissible.
Those who devour usury will not stand except as stands one whom the satan by his touch hath driven
to madness. That is because they say: Trade is like usury, but God Almighty hath permitted trade
and forbidden usury...
Quran 2:275
23
1.4.2 The need for underlying assets

Islamic nance requires that all banking business based on sale or lease must have an underlying
asset. As the Islamic bank either acts as a seller or a service or usufruct vendor, or lessor, the asset
or service is of paramount importance. The absence of an underlying asset will render the contract
void ab initio. This is in contrast to conventional banking where the asset element is not a necessary
requirement. Its importance lies only in terms of collateral security in the sense that the asset
purchased using the loan money may be charged or assigned as security in favour of the bank. The
asset was never part of the loan transaction.
1.4.3 The avoidance of uncertainty or gambling

All transactions made by Islamic nancial institutions (IFIs) must be free from elements of
uncertainty (Gharar) and gambling (Maisir). This is because Gharar might lead to disputes caused by
an unjustied term in the contract arising from misrepresentation and fraud. Gambling is seen as an
action that always enriches one party at the expense of the other - a zero-sum-game.
A Mudarabah contract is a
prot sharing contract. Under a
Mudarabah contract, the capital
provider agrees to share the
prots between themselves and
the entrepreneur at an agreed
ratio or percentage.
A Musharakah contract is a form
of equity partnership investment.
It is similar to equity investment
in a conventional capital market
but the investments made
must be conned to stocks and
nancial securities or other
assets that are consistent with
the principles of Shariah.
1.4.4 Prot and loss sharing

Prot and loss sharing is possible in some Islamic banking activities. The bank will share the prot
made with its customers either on a proportionate basis or on an agreed prot-sharing ratio. In the
case of a loss, the loss will be borne by the bank under a Mudarabah contract or by both parties
proportionately in the case of a Musharakah contract. This concept is in direct contrast to xed
income-based products. Again, the concept of prot and loss sharing is peculiar to Islamic banking
although, strictly speaking, Islamic banking is not an equity market, which is normally represented by
the stock market.
1.4.5 Rights and liabilities of banks and customers

The rights and liabilities of both banks and their customers are well documented not only in
conventional banking laws but also the legislation of many countries including contracts acts, the
sale of goods acts, consumer protection acts and hire purchase acts. An important and signicant
feature of Islamic banking is the new perspective it gives to this relationship. This has pushed Islamic
banking beyond normal and conventional banking business. An Islamic bank is neither a lender nor
a borrower, but can instead become a bona-de trader licensed under banking law. This aspect of the
transaction has not been given proper attention until now, although certain amendments to various
legal systems have been made.
Amendments to the stamp duty acts and the real property gains tax in jurisdictions such as Malaysia,
the UK and Singapore illustrate this aspect. The buying and selling of property, for example, would
otherwise attract a double stamp duty for the two transactions required to achieve the nancing
features of the product. The changes also preclude a gains tax arising from the sale of the property to
the customer by the bank the second of two sales transactions. The rst transaction occurs when
the nancier purchases the asset from the vendor. The second transaction occurs when the nancier
sells the same asset at a mark-up to their customer. Without these necessary amendments, a gain
would result from both transactions. In practice, this cost or extra tax would have to be borne by the
customer making Islamic products more costly from a customers perspective.
1.4.6 Shariah compliance

The central focus of Islamic nance is Shariah compliance. To ensure compliance a distinctive
feature of Islamic nance is the establishment of a Shariah advisory or supervisory board to advise
IFIs, Islamic insurance companies, Islamic funds and any other providers which offer Islamic nancial
products. The establishment of a board, the opinions of which are binding on all IFIs, is required to
guide the institutions towards Shariah compliance. An institution cannot claim to be doing Islamic
nancial business until and unless it sets up a Shariah board or committee consisting of qualied
scholars who are of high reputation and who possesses the necessary skills.
1.4.7 Unlawful goods or services

Another equally important feature is that Islamic nance must not be involved in any activities
pertaining to unlawful goods and services. These prohibited goods and services include, among
others, non-halal foods such as pork, non-slaughtered animals or animals that were not slaughtered
according to Islamic principles, intoxicating drinks, entertainment and pornography, tobacco-related
24
products and weapons. Non-involvement is not only limited to buying or selling but also includes
all chains of production and distribution, such as the packaging, transportation, warehousing and
marketing of these prohibited goods and services.
1.4.8 Overriding principles of Islamic law

Islamic nance essentially refers to Shariah-compliant nancial activities. In addition to observing
the above-mentioned features, Islamic nancial products and services must not contain any
principles, terms and conditions that are contradictory to established legal maxims or legal
principles. These legal maxims are the overriding principles and essential parameters of Islamic law,
widely accepted by Muslim jurists. An example would be the principle that capital in equity-based
nancing or investment cannot be guaranteed by the manager or other partner. An equity contract
must be free from capital guarantee to reect the very essence of equity investment that is equity
investors must bear the risk of loss of capital.
Exercise 1.3
A bank has been set up to offer Islamic nancial products and services. In order to attract new
customers. This bank advertises in the media that the rst 1,000 customers who open Islamic
saving accounts based on the principle of Qard / Hassan (interest-free loan) will be given a gift
worth $100 each. Does this product offering comply with Shariah principles?
Key points
Islamic banking comprises the following features:
interest free
the need for underlying assets
the avoidance of uncertainty
prot and loss sharing
rights and liabilities of banks and customers arising from commercial contracts other
than a loan contract
Shariah compliance
prohibition of unlawful goods or services
overriding principles of Islamic law.

John and Tom each intend to purchase a house. John intends to use an Islamic house
nancing facility while Tom intends to use a conventional bank loan. Each house is being
sold by the developer at $100,000, but John will have to pay the bank $130,000 when he
buys the house from them. Explain the stamp duty liabilities which will arise in:
(a) a country where stamp duty exists and no amendment has been made to the relevant
act to take account of Islamic house nancing transactions, and
(b) where the relevant stamp duty has been amended to allow for Islamic house nancing
transactions.
Solution
(a) John will be required to pay 2% of $100,000 and 2% of $130,000 that is a total of
$4,600. Tom will only have to pay $2,000 that is 2% of $100,000 loan.
(b) In countries where relevant amendments have been made to the stamp duty act to
facilitate Islamic nancing schemes, John would only have to pay stamp duty on the
rst transaction only, that is 2% of $100,000 which is equivalent to $2,000 only. This
will render stamp duty paid under both Islamic house nancing and a conventional
house loan to be the same amount.
25
1.5 Riba and Gharar

As a key to understanding Islamic nance it is important to further explain the meaning of two
terms or concepts that must be avoided by Islamic nance in all circumstances: Riba and Gharar. The
avoidance of these two elements is a basic requirement of all Islamic nancial activities.
1.5.1 Riba
Riba is simply translated into English as usury or interest. Any premium charged on money borrowed
is tantamount to Riba irrespective of the amount paid. Riba in its simplest term is an advantage
to one party at the expense of another for no appropriate consideration. Islamic commercial law
addresses the issue of this unjustied advantage from two possible transactions, namely in a loan or
currency exchange contract as well as in a barter trading contract.
Muslim jurists have unanimously agreed that two separate classes of assets are susceptible to Riba,
namely currency or money and a few commodities, mainly food items. The requirements of an
exchange involving these two types of assets are the same.
It is explained in the tradition that the Prophet Muhammad was reported to have said: Gold for gold,
silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt, like for like, equal for
equal, hand-to-hand, if the commodities differ, then you may sell as you wish provided the exchange is
hand-to-hand.
These requirements are only applicable when there is an exchange of one currency for another
currency whether it is the same currency or different currencies. The requirements also apply to the
exchange of a food item for another food item, be it of the same food item or of different types
and kinds.
A summary of the above tradition and its inherent requirements is depicted in the following table.
Table 1.2 Requirements for an exchange involving usurious items

Currency for currency
Food item for food item
Subject matter
Shariah requirements
Subject matter
Shariah requirements
Same currency
(GBP for GBP)
Spot transaction
Same food item

(barley for barley)
Spot transaction
Different food items

(barley for wheat)
Spot transaction
Equal amount
Different currencies Spot transaction

(GBP for USD)
Equal amount
The above table clearly illustrates that Riba is conned to these categories of assets, provided they
are exchanged within the same class, that is, currency for currency. An equal amount of the counter
value is required in exchange of assets of the same class. Spot exchange, or the simultaneous
delivery of counter values, is also required when one currency is exchanged for another currency
or when a food item is exchanged for another food item, irrespective of whether these currencies
or food items are the same or different types. Any delay in the delivery will render the exchange
tantamount to Riba, known as Riba al-nasiah, that is, Riba by virtue of deferment in the exchange or
delivery of these two counter values.
26
Table 1.3 Illustration of Riba by deferment (Riba al-nasiah)

Exchange transation
Time of delivery
Remark
1,000 to 100
Spot
No Riba
1,000 to 100
Deferred
Riba
1,000 to $3,000
Spot
No Riba
1,000 to $3,000
Deferred
Riba
100 tons of wheat for 100 tons of wheat
Spot
No Riba
100 tons of wheat for 100 tons of wheat
Deferred
Riba
100 tons of wheat for 100 tons or barley
Spot
No Riba
100 tons of wheat for 100 tons of barley
Deferred
Riba
From another perspective, the exchange of these two assets is also subject to the same amount or
quantity of the two counter values if they are of the same type. The failure to observe this would
lead to the practice of Riba called Riba al-fadl, namely Riba by an excess of one of the counter values.
However, the requirement to have the same quantity is not applicable if they are of different types
such as GBP for USD or wheat for barley.
Table 1.4 Illustration of Riba by excess (Riba al Fadl)

Exchange
Amount
Remark
GBP to GBP
Same/equal
No Riba
GBP to GBP
Not equal
Riba
GBP to USD
Same/equal
No Riba
GBP to USD
Not equal
No Riba
Wheat to wheat
Equal
No Riba
Wheat to wheat
Not equal
Riba
Wheat to barley
Equal
No Riba
Wheat to barley
Not equal
No Riba
This tradition is the foundation of the permissibility of currency exchange, done on the basis of the
prevailing rate of exchange, for example to exchange 1,000 for $3,000, provided this is done on a
spot basis. Any deferment of the exchange or delivery as in the case of a forward currency exchange
is not in line with the requirements of the tradition, and is thus prohibited. The amount of exchange
is not relevant when the exchange involves two different usurious items such as USD for GBP.
The theory of Riba could therefore be summarised as follows:
RIBA(1) = exchange of two similar usurious item for different counter values and for deferred
exchange, for example, 1,000 for 1,200 being exchanged of one another on deferred basis
RIBA(2) = exchange of two dissimilar usurious items for deferred exchange, for example, 1,000
being exchanged for $1,000 on deferred exchange.
From the above, a loan in GBP provided by conventional banks and other institutions that imposes
on the borrower the requirement to repay the principal amount borrowed plus a premium in the
same currency would come under the purview of Riba (interest/usury). This practice of modern Riba
in the banking sector relates to both Riba al-nasiah (Riba by deferment) and Riba al-fadl (Riba by
excess) because the borrower is obligated to pay more than he borrowed and repayment will take
27
place in the future. This is the reason why conventional saving accounts and xed deposit accounts,
as well as all nancing modes based on loan-for-interest are not compliant to Shariah principles. The
theory of Riba also applies to currency exchange, which can only be done on a spot basis. Forward or
future currency transactions are not allowed.
It is important to explain one exception to the above principles of exchange involving either currency
or food items. Islamic commercial law does allow a loan contract, called Qard / Hassan but it must
be free from Riba in the repayment of the loan. However, Islamic commercial law tolerates the
requirement of having to exchange two counter values on a spot basis as this is illogical to the
concept and philosophy of a loan, which is essentially to allow the borrower to repay their loan
obligation in the future. If they have to repay the loan almost immediately after borrowing, then
the loan has no meaning. This exception is granted to allow the practice of lending of either money
or fungible goods for no premium. What is more relevant is the prohibition of any excess in the
repayment of the loan. The deferment in time can be tolerated if the loan is for the purpose of
helping the borrower who seeks nancial help in terms of money.
The theory of Riba could therefore be summarised as follows:
The stipulation of an excess for the lender in loan is prohibited, and it amounts to Riba, whether the
excess is in terms of quality or quantity or whether the excess in a tangible thing or a benet, and
whether the excess is stipulated at the time of contract or while determining the period of delay for
satisfaction or during the period of delay and, further, whether the stipulation is writing or is part of
customary practice.
Quran 2:275. AAOIFI Shariah Standard, No. (19), Qard (loan), 4.4/1
Exercise 1.4
An Islamic bank has provided two loans. The rst loan of $10,000 was made to a customer with
the requirement that $11,000 be repaid after one year. The second loan of $10,000 made to
another customer, had the requirement that $10,000 be repaid after one year.
Is either of these transactions Shariah compliant?
1.5.2 Gharar
Gharar is another element that is to be avoided in any transaction. Gharar simply refers to a lack
of knowledge or uncertainty that could result in an outcome detrimental to one party. This lack
of knowledge, as well as a lack of control of the outcome of any transaction, may stem from
misrepresentation, mistake, fraud, duress, or terms beyond the knowledge and control of one of the
parties to the contract.
There are many examples of Gharar-based transactions that are prohibited including the sale of the
off-spring in the womb of a pregnant animal as the outcome is obviously beyond the control of the
parties involved and therefore uncertain. In addition, the sale of sh in the water, birds in the sky or
a runaway horse are also prohibited. The reason behind this is that the ability of the seller to deliver
these items is uncertain.
Gharar in practice relates potentially to issues such as pricing, delivery, quantity and quality of assets
that are transactional-based and would affect the degree or quality of consent of the parties to a
contract. For example, one cannot buy an option at a certain price to have the right to purchase its
underlying shares, as an option is not ascertainable and is thus uncertain. An option is just a right. It
is not an asset whose specications are clear and attainable. In conventional insurance, the premium
paid by policyholders and the indemnity provided by the insurer upon a claim are equally uncertain,
thus making conventional insurance non-compliant from an Islamic legal perspective.
Unlike Riba, which is determined by a xed formula as previously explained, the determination
of Gharar is based on many aspects. This is because the parameter of knowledge or consent and
the risk tolerance by society is not xed. Above all, Islamic commercial law has accepted the
distinction between major uncertainty (Gharar Fahish), which is to be avoided at all times, and minor
uncertainty (Gharar Yasir), which is tolerated by society. The practice of paying a certain amount
of money for the use of a public toilet in some societies reects the tolerance level in that society.
The society accepts different levels of consumption of facilities that are uncertain for a standard
payment which is xed.
28
Key point
Gharar simply refers to a lack of knowledge or uncertainty that could result in an outcome.
1.6 Prot and loss sharing

In addition to these two prohibited items, Islamic nance is also closely associated with the practice
of prot and loss sharing. This is unique as IFIs will share the prot or loss, as the case may be, with
depositors as well as fund users if the contracts entered into by the two parties are based on either
Mudarabah or Musharakah. In terms of deposit, IFIs act as the manager while the depositors are
the capital providers who deposit their capital on the basis of a Mudarabah contract either through
their savings or investment account. The depositors will share the prot with the bank based on a
particular ratio. The depositor will also bear the loss entirely under the Mudarabah contract while the
banks will lose their time, work, effort and expected prot.
IFIs may nance their customers using either Mudarabah or Musharakah. Here, the IFIs act as the
capital providers and share the prot with their customers upon its realisation in any business
venture. Loss will be borne by the IFI under the Mudarabah contract, but the loss is to be shared
between the IFI and the customer under the Musharakah contract. This makes Islamic nance
distinctive from that of conventional nance.
Exercise 1.5
(i) Is prot and loss sharing distinctive to Islamic banks?
(ii) What type of Riba is involved where there is an increase of one of two counter values in the
exchange of two similar usurious items?
(iii) Is an exchange of 50,000 for $50,000 on a spot basis tantamount to Riba?
1.7 Islamic nance compared with conventional nance

Islamic nance does not, and should not, deal with money directly as money cannot earn more money
by itself. Money must be put into real business activities to earn extra money. This is the whole basis
of trading. In other words, IFIs facilitate the nancing needs of customers by becoming sellers, lessors
or partners as the case may be. The function of money has been transformed from a commodity into
an enabler to facilitate trading, leasing and investment as illustrated in the following diagram.
Figure 1.1 The function of money in Islamic nance

Sell the same asset to
customer at x + y
Shareholders
fund
Purchase of an
asset at x from
the vendor
x money
Islamic Financial
Institution
Lease the same asset

to customer at x+y
Islamic Deposit
Accounts
x money
Capital
investment in
x project
y% prot sharing
x% prot sharing
Customer/partner
The pool of money, collected through various Islamic accounts and or shareholders funds, is
channelled to nance trade, lease or investment activities. From a micro perspective, the money
has been transferred into real economic stock in order to generate more income. Thus, the prot
generated by IFIs is the outcome of dealing with a real asset rather than a monetary asset.
29
A simple illustration of this could be where a bank has allocated 100,000 to nance a customer to
purchase a house from a vendor at the cost of 100,000. This initial 100,000 will be used by the bank
to purchase the identied house from the vendor. By doing so, a monetary asset has been transformed
into a real asset i.e. a house. Subsequently, the bank will sell the same house to the customer. The selling
price, based on a Murabahah contract, is 120,000 which is payable over ten years. The whole process
is a total departure from the conventional practice of lending and borrowing. The bank in Murabahah
nancing has to purchase the house before it can be sold to the customer. There are real sale and
purchase transactions underlying this facility and in some jurisdictions, this would trigger a double
stamp duty on the two sets of documents. In those jurisdictions, relevant amendments have been made
to the relevant stamp duty acts to avoid double stamp duty for these two transactions.
House Financing
Conventional
Islamic
100,000 of loan
120,000 [Loan + Interest]
100,000 of purchase price payable to vendor

by the bank
120,000 of selling price payable to the bank/
seller by the customer
1.8 Shariah compliance and the equity market

The distinction between Islamic nance and conventional nance is more obvious in banking
and insurance products as well as in xed income instruments than it is in the equity market.
Conventional banking and xed income instruments are essentially based on interest, while the
conventional insurance contract is based on the sale of an indemnity for a premium that contains
a considerable degree of uncertainty. The distinction between the Islamic and conventional equity
markets is however less clear because the prohibited elements are contained not in the structure of
the respective contracts but in transaction-based activities.
There is no Shariah issue on the contract of investment in the equity market as it is essentially
based on the principle of prot and loss sharing. In other words, buying a share in any stock
exchange is permissible as this purchase reects a contract of Musharakah among the shareholders.
This contract per se is compliant. However, Shariah objections are mainly concerned with the
activities of the companies in which the capital, through subscription to the shares, is put. These
activities may include the sale or purchase of assets and services that are not approved under
Shariah principles such as the sale or purchase of non-Halal food and drink. Non-approved activities
also include activities related to the balance sheet of the company such as the borrowing or raising
of more capital through interest-based transactions such as overdrafts and conventional bonds.
In the realm of investment where money has to be injected into real economic activities, Islamic
commercial law is also relevant to the transactional activities of the companies. This shows that
compliance at both contractual and transactional levels is important in Islamic nance, making it
distinctive from conventional nance.

Islamic nance does not view money as a commodity. Here, money has no intrinsic value
of its own, but having money allows for the purchase of goods and services. Money can
potentially grow by putting it into real economic activities such as trading and investment
activities. How, on the other hand, does conventional nance perceive money in terms of
both theory and practice?
Points to note
There is more than one answer to this question. Many conventional textbooks on nance,
dene money as a medium of exchange, a unit of measurement and a store of value. In
medieval times, money was viewed by many as a commodity in as far as the owner of money
could claim a premium if the money was loaned to another party. This is the origin and
basis of modern interest. This view tends to be prevalent in the contemporary conventional
nancial market.
30
Exercise 1.6
(i) A bank has extended a Murabahah facility to a customer whereby the bank purchases from
the vendor an asset at x amount i.e. 200,000. The bank subsequently sells the asset to a
customer at x+y amount e.g. 250,000 payable within ve years. Why is this additional
payment permissible in Murabahah but not permissible in a loan contract?
(ii) A new Islamic bank has been established in your area. The bank accepts deposits on Islamic
principles. It has received an application for nancing except from a customer who intends
to purchase a factory that produces alcoholic liquor. This customer has put in an application
for Murabahah nancing, which has been declined. The customer has asked you to explain
why the application has not been accepted. How would you explain this to the customer?
1.9 Conclusion
This chapter introduced you to many of the key components that make up the subject of Islamic
nance. Specically, the chapter outlined the history and development of Islamic nance. It also
introduced the differences between conventional and Islamic nance. Having studied this chapter
you should now appreciate why such key aspects as the avoidance of interest and uncertainty in
Islamic transactions, the need to ensure Shariah compliance and the concept of prot sharing
underpin the need for the development of Islamic nance. The chapter also briey introduced you
to Islamic insurance or Takaful, concluding with an explanation of the critical matters relating to
Shariah compliance and the equity market. All of these components will be discussed again in more
detail throughout this and the other guides which comprise the Certicate in Islamic Finance.
The following chapter will examine the sources of Islamic Commercial law that underpin many of the
Shariah principles governing commercial transactions.
1.10 Summary
Having read this chapter the main points that you should understand are as follows:
1.
the essence of Islam is that it derives its principles and values from the Quran and the Traditions
of the Prophet Muhammad
2.
the principles of Islam as enshrined in both the Quran and the Traditions of the Prophet
Muhammad are known as Shariah
3.
Islamic nance is a term that reects nancial business that is not contradictory to the principles
of Shariah
4.
the giving or receiving of interest (Riba) is specically prohibited by Shariah, as is the existence
of uncertainty (Gharar)
5.
unlike conventional banking, where the relationship is simply lender-borrower, the relationship
in Islamic banking can be of agent and principal, depositor and custodian and investor and
entrepreneur, on the liability side of the bank; as for the asset side, the relationship could be of
seller and purchaser, lessor and lessee, principal and agent, as well as between fellow partners in
a joint investment project
6.
in order to remove the element of uncertainty from Islamic insurance (Takaful), the contract of
donation is introduced among the participants/policyholders in place of the contract of sale of
indemnity for a premium as practiced in conventional insurance
7.
all banking business based on sale or lease must have an underlying asset
8.
prot and loss sharing is possible in some Islamic banking activities
9.
Islamic nance must not be involved in any activities pertaining to unlawful goods and services
10. Islamic nance does not, and should not, deal with money directly; this is because money cannot
earn more money by itself, money must be put into real business activities to earn extra money
11. the distinction between the Islamic and conventional equity markets mainly concerns the
activities of the companies in which the capital through subscription of the shares are put; these
activities may include activities such as the sale or purchase of assets and services which are
disapproved by Shariah principles.
31
Chapter 1 Answers
Exercise 1.1
(C) Any types of nancial products or services, compliant to the requirements of Islam, fall
within the scope of Islamic nance. They can be offered to anyone and by anyone without any
restriction because Islamic nance is inclusive in character. The only restriction is with regard to
the products and services themselves. These must be structured according to the teachings of
Islam. For example, the payment or charging of interest is not allowed in Islam. Thus, products
of Islamic nance must be free of any element of interest.
Exercise 1.2
(i) Under Islamic commercial law, money must be put into a real business transaction to
generate income. This might include the purchase of goods at x and the sale of those
goods to a customer at x + y on a deferred payment scheme or credit sale.
(ii) Under Islam, loans offered in return for interest earned are prohibited. Prot must be
generated from other contracts such as trade, lease or investment by converting the money
into a real asset prior to undertaking other contracts such as sale or lease.
Exercise 1.3
The banks product offering is not compliant because Islamic nance must be free from interest
either in cash or in kind. Giving a gift, which is advertised prior to the opening an account, is
deemed as interest in kind. This is because the bank will borrow the money from the depositor
under this contract and therefore, any extra payment intended to be paid by the borrower to
the depositor/lender in the form of gift is tantamount to Riba.
Exercise 1.4
The rst transaction is not compliant. However, the second is compliant. Although Shariah
principles require the repayment of loans to be on a spot basis i.e. not deferred, Shariah
principles tolerate non spot transactions if the loan is meant to help the borrower and not to
provide any commercial advantage to the bank from its lending activities.
Exercise 1.5
(i) Yes. No such arrangement of prot and loss sharing is being practised in an interest-based
banking system.
(ii) The type of Riba is called Riba al-fadl or Riba by excess because of the premium in one
of the counter values in the exchange involving two similar usurious items, for example,
1,000 for 1,200.
(iii) No. There is no Riba involved as the requirement of equal amounts does not apply to an
exchange involving two dissimilar usurious items, that is, GBP for USD. The rate of exchange
is to be agreed by both parties with spot delivery. In practice, the exchange rate agreed will
be the same as prevailing conventional exchange rate (though in theory they could adopt a
different exchange rate).
Exercise 1.6
(i) Murabahah nancing to purchase an asset is permissible because it does not deal with
money directly. The nancier is selling the asset to a customer at a mark-up. The nancier
did not advance a loan and charge a premium on the loan.
(ii) Financing to purchase a factory that produces alcohol is not acceptable as alcohol is not
compliant. The factory therefore would be used for the production of prohibited goods.
Both the contract and subject matter (or the use to which it might be put) must be
compliant. If the factory was to be used in the production of a Shariah-acceptable product
then the nance could proceed.
32
33
Revision questions
Revision Questions
Question 1 Multiple choice
1.1 As well as being interest free, Islamic nance must also be free from:
(A)
Gharar
(B)
prot
(C)
loss sharing
(D)
equity.
1.2 In Islamic nance, how can prot be realised?

(A)
By lending money out to the borrower.
(B)
By leaving the money idle.
(C)
By trading or leasing.
(D)
By creating a charge on money for a loan.
1.3 Which of the following is a non-lawful asset from a Shariah perspective?

(A)
A car.
(B)
A house.
(C)
Printing equipment.
(D)
Non-slaughtered animals.
1.4 Fixed deposits, as practised by conventional banks, are not permissible because they include:
(A)
Gharar (uncertainty)
(B)
Riba al-fadl (Riba by excess)
(C)
Riba al-nasiah (Riba by deferment)
(D)
both Riba al-fadl and Riba al-nasiah.
1.5 Which of the following is not a correct description of the prot sharing concept in a
Mudarabah investment account?
34
(A)
Investors bear the loss of capital.
(B)
Manager shares the loss of capital with the investors.
(C)
Prot is to be shared between the investors and managers.
(D)
Prot must be shared according to an agreed ratio.
Identify which of the following descriptions reects Riba (Tick ), and which are free from Riba (tick )
1. A $1,000 is being loaned out to a person with a condition the repayment must
be made in the future for $1,000.
Revision questions
Question 2
2. An importer purchases 1,000 tons of wheat from an exporter at 10,000 to be

paid in the future.
3. A and B enter into a forward currency contract to deliver to each other a certain
currency, i.e. USD, for Saudi Riyal at the exchange rate of 1:4. The delivery date
will be six months later.
Question 3
Match the following subject headings to the descriptions.
Subject Matter
Descriptions
1. Islamic nance
Both parties must share the prot and loss.
2. Riba
Lack of knowledge that could render one of the parties in a

disadvantageous position.
3. Shariah board
Financial activities which conform to Shariah principles
4. Gharar
A board consisting of qualied scholars to advise on Shariah

compliance.
5. Musharakah
A premium or deferment in the exchange of two usurious items.
35
Revision questions
Answers
1.1 (A) Gharar, as well as Riba, must be avoided as they may put one or other party in a
1.2 (C) Money can grow if the owner of the money is willing to take risks. Among others risks, he
can use his money to purchase goods at a cost of x and sell them to another party at x+y. In
short, prot gained through a sale transaction is allowed by the Shariah.
1.3 (D) Non-slaughtered animals are deemed to be not pure or clean from a Shariah perspective.
1.4 (D) Both Riba al-fadl and Riba al-nasiah.
1.5 (B) The manager will not share the loss of capital under Mudarabah because he does not
essentially provide any capital. The investors will bear all of the loss of capital.
Question 2
1. A $1,000 is being loaned out to a person with a condition that the
repayment must be made in the future for $1,000.
(The deferment of time of repayment does not lead to Riba provided there is no
extra repayment amount).
2. An importer purchases 1,000 tons of wheat from an exporter at 10,000 to be

paid in the future.
(Any sale contract for a future payment involving money for a commodity is
not Riba because Riba could only occur when there is an exchange of similar
commodities or money for money.
3. A and B enter into a forward currency contract to deliver to each other a
particular currency, i.e. USD, for Saudi Riyal at the exchange rate of 1:4. The
delivery date will be six months later.
(Forward Forex is not compliant as the exchange of the two currencies is not spot.
Currencies must be exchanged on a spot basis).
36
Subject Matter
Descriptions
1. Islamic nance
Financial activities which conform to Shariah principles.
2. Riba
A premium or deferment in the exchange of two usurious items.
3. Shariah board
A board consisting of qualied scholars to advise on Shariah

compliance.
4. Gharar
Lack of knowledge that could render one of the parties in a

5. Musharakah
Both parties must share the prot and loss.
Revision questions
Question 3
37
Chapter two
Shariah compliance
Learning outcomes
dene the meaning of Shariah compliance

appreciate the importance of Shariah compliance
in all nancial activities of an Islamic nancial
institution (IFI)
identify the key stakeholder interested in Shariah

compliance.
Shariah compliance

The meaning of Shariah compliance
Salient features of Shariah compliance
Stakeholders in Shariah compliance
Regulation and Shariah compliance
2.0 Introduction
Shariah compliance is the key issue of Islamic nance. In this chapter
you will be introduced to the term Shariah compliance, the requirement
for Islamic nancial products to comply with Shariah principles and the
stakeholders interested in Shariah compliance. You will also be introduced
to methods used to ensure compliance, which is essential at both the
structuring and operational stages.
2.1 Meaning of Shariah compliance
2.1.1 The general meaning of compliance
The need for compliant behaviour for every society is based on established norms and values
that are adopted as the basis for particular laws, regulations, guidelines or principles. Compliance
or conformance is necessary to ensure the preservation of a social order which will facilitate the
achievement of societal objectives. In this respect compliant behaviour is universal and in Islam it
relates to Shariah principles and rules.
The policies and practices of nancial institutions and behaviour of market participants in the
Islamic nancial services industry are required to comply with Shariah principles and rules
expressed in the form of regulatory requirements, guidelines and standards. The scope for such
compliant behaviour includes all activities where reasonable assurance should be provided to the
investing public and society that such activities do not confound or violate Shariah principles and
rules. Any form of non-compliance will impair such assurance and affect investor condence in the
Islamic nancial system.
Exercise 2.1
Before proceeding, in your own words what do you understand by the term compliance?
Compliance essentially refers to the status of conforming to a certain standard, which subsequently
dictates the status of being compliant or otherwise. Compliance imposes on a person or corporation
the requirement to adhere to all those requirements that are prescribed by a certain point of
reference. This guides the process of compliance and sets a standard which those seeking compliance
are expected to achieve. Compliance with a standard can only be expected if the relevant standard
has been made known to all parties concerned.
Standards are usually set by experts in the eld and are determined after lengthy debate over what
should be included. Most standards are not legally binding but are expected to be followed by virtue
of the fact that they are supported by leading experts. It is normally left to the conscience of the
individual as to whether they adopt a standard. Not following a standard would be going against
that which was generally accepted as best practice and would need to be supported by evidence that
the standard did not apply in the given circumstances.
2.1.2 Compliance with Shariah standards

In the context of Islamic nance, a standard is embodied in Shariah principles and thus, Shariah
compliance means adherence to all Shariah principles. Products and services coming under the
39
Shariah compliance
banner of Islamic nance must adhere strictly to the requirements of the Shariah principles in all
aspects pertaining to a nancial product or service. This means that compliance is not only limited
to the design and structure of the product or service, but also the terms and conditions, the legal
documentation, the accounting treatment, the standard operating procedures, IT aspects, through
to the marketing brochures relating to the product or service. To be Shariah-compliant requires that
each of these must conform to the requirements of Shariah principles.
Products that are in conict with, or depart from, Shariah principles are deemed to be noncompliant. Normally, any areas of non-compliance will be addressed and, if applicable, relevant
action will be taken to bring the products into compliance. In some jurisdictions, such as in Malaysia
as per the Islamic Banking Act 1983 (Section 4), non-compliant activities may lead to the revocation
of a license granted to an IFI. Although this is not specically mentioned in other jurisdictions,
this is a logical consequence for any licensing process because IFIs must adhere to their articles of
association that normally mention their duty to comply with Shariah principles. Mention should
also be made that, with the exception of Malaysia, other jurisdictions have no separate legislation or
act covering Islamic banking.
Compliance is a Shariah requirement of conducting Islamic nance activities. The availability
of Shariah standards is an important aid to facilitate Shariah compliance and to make Shariah
compliance measurable and comparable across jurisdictions.
Key points
Shariah compliance means total adherence to all Shariah principles.
Products and services coming under the banner of Islamic nance must adhere strictly to the
requirements of the Shariah principles.
The availability of Shariah standards is an important aid to facilitate Shariah compliance and
to make Shariah compliance measurable and comparable across jurisdictions.
2.2 Salient features of Shariah compliance

There are three salient features of Shariah compliance:
(a)
the fullment of all mandatory requirements of a particular contract
(b)
the avoidance of any prohibited practices, terms and conditions
(c)
the maintenance of compliance throughout the life of the product.
Figure 2.1 Salient features of Shariah compliance
Fullment of all
the necessary
requirements
Shariah
compliance
Continuous
compliance
Avoidance of all
prohibitions
This diagram shows that full-edged compliance should meet these requirements at all times,
otherwise there will be a breach of Shariah compliance. A possible breach may take place in one
of these areas or, in a worst-case scenario, in all three areas. However, the most likely breach is
40
Shariah compliance
normally a failure to sustain continuous compliance. A product such as house nancing may be
endorsed as compliant because it fulls all conditions and is free from all prohibited terms. However,
if a customer were to default, an IFI may wish to impose on the customer some additional payment
that would not be compliant.
Shariah compliance must be represented in both the process and the outcome. It should start from
the product design and go through to product implementation and, as stated above, relate to all
supporting services such as accounting, IT, marketing and advertisement, legal documentation, risk
management, application forms and all other documentation.
Figure 2.2 Coverage of Shariah compliance
Shariah compliance
Product design and structure
Legal documentation
Accounting treatment
IT solutions
Recovery and restructuring
Risk management
As shown in the above diagram, Shariah compliance transcends the scope of product design and
structure to cover other relevant considerations. For example, a product may be compliant and
lawful in its product offering but it may contain a risk management tool that is not compliant, such
as an interest rate swap to hedge any asset liability mis-match of the bank. In this case, the Shariah
compliance requirements would demand the risk management tool to be equally compliant, such
as having a compliant prot rate swap instead of an interest rate swap. The concept of a prot rate
swap will be discussed in Study Guide Three.

The DEF Company is an airport operator. They have issued a Sukuk Ijarah amounting
to 500 million. The Sukuk is based on the following structure. The DEF Company has
sold the airport to investors through an SPV/Issuer at 500 million and leased back the
airport from the investors at 700 million payable within ve years. The prospectus of the
Sukuk issuance mentioned that the proceeds of the Sukuk will be issued to nance the
construction of a new terminal and an airport hotel.
Sukuk certicates of investment
Given this information, what are the key areas that the Shariah advisors of this Sukuk must
supervise to ensure strict compliance to Shariah principles?
Solution
One of the key areas would be the actual utilisation of the Sukuk proceeds. The proceeds
must be used to nance the projects as mentioned. Special attention must be given to the
development of a hotel as it may involve some services which are not compliant to Shariah
principles.
Exercise 2.2
Explain how information technology might impact on an IFIs ability to achieve Shariah
compliance?
41
Shariah compliance
2.3 Stakeholders in Shariah compliance

Compliance with Shariah principles is key to the operation of Islamic nancial activities. There
are many parties concerned with Shariah compliance including regulators, shareholders, a banks
management, customers and the public at large. These stakeholders have a direct and indirect
interest in the achievement of Shariah compliance in any given IFI.
Figure 2.3 Stakeholders in Shariah compliance
Regulators
Banks
management
Stakeholders
of Shariah
compliance
Banks
shareholders
Customer
and public
2.4 Regulators central government

Regulators are concerned with compliance issues relating to a licensed nancial institution as the
licence will have been granted subject to compliance with Shariah principles. It is common for a
company, which intends to be licensed as an Islamic bank, to incorporate in its memorandum and
articles of association that the primary business of the company is banking under Shariah principles.
Some countries, such as Malaysia, also state in their statutes that the award of an Islamic banking
license depends primarily on the establishment of a Shariah board for the company. The Malaysian
Islamic Banking Act 1983, Section 3(5) (sub-section b) provides that, the central bank shall
recommend the grant of a license and the Minister shall not grant a license, unless the central bank
or the Minister, as the case may be, is satised:
That there is, in the articles of association of the bank concerned provisions for the establishment of
a Shariah advisory body to advise the bank on operations of its banking business in order to ensure
that they do not involve any element which is not approved by the religion of Islam.
Although similar direct provision cannot be found elsewhere, it can be envisaged that the approving
authority may not award a license if certain prerequisites are not met.
2.5 Regulators Shariah advisory and supervisory boards

A prudent regulatory policy to be imposed on an Islamic bank is the requirement to set up its own
Shariah board prior to its licensing. A Shariah board can take the form of either a Shariah advisory
board or a Shariah Supervisory Board (SSB). The two boards differ as follows:
a.
42
A Shariah advisory board is mainly entrusted to issue Fatwas/religious opinions on particular

products or issues, whereas the Shariah supervisory board is expected not only to issue an
endorsement where applicable, but also to supervise the day-to-day activities of the bank.
In other words, the supervisory role is wider than the advisory role and from the perspective
of Shariah compliance, the supervisory function of the Shariah board is more appropriate.
Having said this, what determines the supervisory or advisory role is not the title and the
nomenclature, but the actual terms of reference of the Shariah board. If the terms of reference
in the appointment of a Shariah advisory board include a supervisory and review function, then
Shariah compliance
its position is as good as a supervisory board. Likewise, the title of a Shariah supervisory board
does not necessarily reect the power of supervision and review unless this power is clearly
mandated in the terms of reference of the establishment of the Shariah board.
b.
The Shariah supervisory board is used to reect the comprehensiveness of Shariah advice
and reviews all the activities of an institution, whereas the Shariah advisory board is used in
some contexts and jurisdictions to reect the limited power and coverage that this Shariah
board has. If the institution being supervised is a full-edged IFI, Islamic insurance (Takaful)
or Islamic asset management company, then the term Shariah supervisory board is more
appropriate. The board members, consisting of qualied scholars, must ensure that all activities
of the institution, as explained in section 2.1.2, conform with Shariah principles. In the case of
an Islamic window operating from within a conventional bank, that is a conventional nancial
institution offering selected Islamic nancial products, Islamic insurance or Islamic funds, the
term Shariah advisory board would be deemed to be more appropriate. The function of the
scholars who are on this board is mainly to ensure that a particular product, scheme or fund
being offered by this Islamic window or conventional entity is in line with Shariah principles.
The design, structure and legal documentation of these products must be Shariah compliant.
Other dimensions of a full-edged IFI such as IT solutions, accounting treatment and risk
management methodologies should support Shariah compliant products and systems. The
Shariah board is not entrusted to endorse except on product design, structure and the main
activities, as well as on respective legal documents or prospectus, as the case may be.
Denition of SSB
A Shariah supervisory board is an independent body of specialised jurists in Fiqh al-Muamalah
(Islamic commercial law). However, the Shariah supervisory board may include a member other
than those specialized in Fiqh al-Muamalah, but who should be an expert in the eld of Islamic
nancial institutions and with knowledge of Fiqh al-Muamalah. The Shariah supervisory board is
entrusted with the duty of directing, reviewing and supervising the activities of the Islamic nancial
institution in order to ensure that they are in compliance with Islamic Shariah rules and principles.
The Fatwas, and rulings of the Shariah supervisory board shall be binding on the Islamic nancial
institution.
Governance Standard for Islamic Financial Institutions No.1. Accounting, Auditing and Governance
Standards for Islamic Financial Institutions 2004-2005, Shariah Supervisory Board: Appointment,
Composition and Report p.5
Table 2.1 Advisory versus supervisory boards

Shariah advisory board
Shariah supervisory board
Limited in issuing Fatwa on products.
Entrusted to issue Fatwa and review the

whole activities pursuant to Fatwa.
Appropriate and relevant to Islamic window

or conventional nancial institutions offering
Islamic nancial products.
Appropriate and relevant to fully-edged

Islamic Financial Institutions (IFIs).
The Shariah supervisory services to be provided by a Shariah board are expected to guide the
Islamic bank in carrying out all of its activities according to Shariah principles. From a regulators
perspective this would probably be the best method to achieve compliance as the banks
management may not be able, academically and intellectually, to achieve this statutory requirement
without the assistance of a Shariah board. An Islamic banks licence may be revoked if the bank fails
to establish this Shariah board or fails to observe Shariah principles. Such a provision is included in
the Malaysian Islamic Banking Act 1983 section 4 (3), which states:
where a licence is subject to conditions, the Islamic bank shall comply with those conditions.
43
Shariah compliance
2.5.1 Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFIs) governance
standard on the appointment of the Shariah board is equally important as the standard is directed
to the appointing authorities and that may include the central bank and other agencies. Article 7 of
the standard provides:
The Shariah supervisory board shall consist of at least three members. The Shariah supervisory
board may seek the service of consultants who have expertise in business, economics, law,
accounting and/or others. The Shariah supervisory board should not include directors of signicant
shareholders of the Islamic nancial institution.
This is followed by Article 8, which notes:
The dismissal of a member of the Shariah supervisory board shall require a recommendation by the
board of directors and be subject to the approval of the shareholders in several meetings.
2.5.2 Independence of boards

The establishment of the Shariah board, either as the Shariah advisory board or the Shariah
supervisory board acts as an external organ to the Islamic bank. The Shariah advisers appointed
to the board are neither shareholders nor employed as salaried staff of the bank. Independence
from the bank gives this board the power and authority to guide it towards Shariah compliance.
It is common practice to allow shareholders in their Annual General Meeting (AGM) to appoint
Shariah advisers or endorse a proposed list of these Shariah advisers as suggested by the banks
management. AAOIFIs governance standards, Shariah Supervisory Board: Appointment, Composition
and Report, specically allows for this. Article 3 states that:
Every Islamic nancial institution shall have a Shariah supervisory board to be appointed by the
shareholders in their annual general meeting upon the recommendation of the board directors
taking into consideration the local legislation and regulations.
The requirement of establishing a Shariah board implies that the compliance to Shariah principles
should be maintained by the bank and not by the regulators. The main aim is to have an independent
Shariah board whose role is to guide the Islamic bank and also, possibly more importantly, to
objectively review and audit the Shariah compliance of the bank at both the process and outcome level.
Exercise 2.3
An Islamic nancial institution has established a committee of three scholars to advise on its
operations. The main task is to issue the Fatwa and to review its operations for the purposes
of issuing a Shariah certication of compliance, to be included in the annual nancial report.
Does this reect the work of a Shariah advisory or Shariah supervisory board?

What are the advantages and disadvantages of having a central Shariah Board at the
Central Bank?
Solution
Advantages
44
Disadvantages
armonisation of Fatwas in one given

H
jurisdiction.
Turn around time might be long /not efcient
Imposition of common standards
Could lead to lack of innovation
Shariah compliance
2.6 Regulators central bank Shariah board

The matter of Shariah compliance for the regulators has been made clear by recent developments
that allow central banks or monetary agencies to appoint a Shariah board. The Central Bank Act
of Malaysia 1958 (revised 1994), for example, incorporated this power to the central bank to
establish a Shariah board. In addition, the central bank has issued guidelines for the establishment
of Shariah committees at each individual Islamic bank and Islamic Takaful company in Malaysia. In
other relevant guidelines, such as the Guidelines on the Offering of Islamic Securities, issued by the
Securities Commission of Malaysia (2004), a standard or criteria has been placed on those who are
qualied to act as Shariah advisers to advise on the issuance of Islamic securities, such as Islamic
Sukuk. These criteria are as follows:
An independent Shariah adviser who has been approved by the Securities Commission and who
meets the following criteria:
i.
is not an un-discharged bankrupt
ii.
has not been convicted for any offence arising out of a criminal proceeding
iii.
is of good repute and character
iv.
possesses the necessary qualications and expertise, particularly in Fiqh al-muamalah and Islamic
jurisprudence, and has a minimum of three years experience or exposure in Islamic nance.
Fiqh al-muamalah Islamic

commercial law
These specic requirements are not provided in other jurisdictions. The requirement of good
character of the Shariah advisors is normally documented in the letter of appointment of the
Shariah advisors by the IFIs.
These requirements, both statutory and non-statutory, are necessary to safeguard the very essence
of Islamic nance that is the attainment of Shariah compliance. The power invested in Shariah
boards gives them the authority to enforce compliance be it Shariah or otherwise and ensure the
soundness and stability of the entire nancial and monetary system in a given country.
2.7 Shareholders
Muslim shareholders of IFIs, who contribute their capital to support banking and nancial business
activities, are equally likely to be concerned with the degree of Shariah compliance that their bank
adheres to. They would expect that all the activities of the bank would conform with that stated
in its articles of association, whether it is a private limited company or a public listed company.
However, the expectation may be higher if this bank is a public listed company. The investors buying
into the shares of this company may have made their decision on the basis of statements made in
the company prospectus to only undertake Shariah-compliant business.
As previously mentioned, the role and function of the shareholders, among others, is to endorse the
appointment of the members to the Shariah board of the company. This is seen as an important
role as the selection of qualied and high-calibre Shariah advisers will not only ensure Shariah
compliance but will also work with management to produce new and innovative Shariah-compliant
products, hence adding value to the shareholders.
In addition, AAOIFI governance standards prescribe that the annual Shariah report, which is likely
to include the Shariah review report, should be submitted to the AGM for endorsement. This
provides a platform for all shareholders to assess the performance of their institution as far as
Shariah compliance is concerned. Active participation by shareholders could potentially enhance the
Shariah-compliance process and environment in the institution.
Related to this issue is a new phenomenon where some conventional banks, with the consent and
approval of their shareholders and relevant regulatory authority, have decided to convert their total
operation into an Islamic bank. Here it is essential that shareholders are regularly updated on the
whole process of conversion. In some cases, the consent of the shareholders is required to writeoff some assets in the balance sheet of the (existing) bank where these assets cannot be converted
into Islamic assets for one reason or another. Examples of such assets include, for example, credit
card receivables and housing loan receivables. These are existing receivables that originate from
interest-based contracts, thus not a lawful income to the new entity seeking to comply with the
Shariah principles. The write-off of these receivables may be necessary because they cannot be easily
converted into Islamic assets. The consent to write-off reects the concern of shareholders to be
compliant and their commitment to the future business of the new entity, which should be free from
Riba and Gharar. These assets may be disposed of or sold to a third party prior to the decision of the
45
Shariah compliance
conversion policy. Otherwise after a decision has been made by the shareholders to convert the bank,
any proceeds from the disposal of non-approved assets to a third party must be given to charity.
The management of the bank has to full the mandate, expectations and resolutions passed by
the AGM of the shareholders and, in this context, undertake all nancial activities in tandem with
Shariah principles. Most of the management team of existing IFIs are not well-versed in Shariah
principles. Therefore, it is difcult, if not impossible, for them to ensure strict compliance to Shariah
principles in terms of product design as well as implementation of the products. Hence the need for
a Shariah board or committee. The Shariah board, although not part of the management, is useful
to guide the management to attain Shariah compliance in all aspects of the activities. The presence
of the Shariah board not only meets the expectation of the central bank and the shareholders, but
also assists management in avoiding any non-compliance.
2.8 Shariah compliance ofcers

New and recent developments in Islamic nance have seen the management of many IFIs appointing
dedicated staff with Shariah backgrounds as full-time ofcers entrusted to assist with Shariah
compliance. The duties of these Shariah compliance ofcers are, among others:
(a)
to follow-up on the implementation of Fatwa and resolutions issued by the Shariah board by
the management in all aspects (as the Fatwa and resolutions of the Shariah board are binding
on IFIs)
(b)
to vet all relevant documents pertaining to a product, such as legal contracts and documents,
relevant forms and marketing brochures
(c)
to liaise with the Shariah board on any issues and matters relevant to Shariah compliance
(d)
to assist in carrying out an annual Shariah review under the guidance of the Shariah board
(e)
to inculcate and maintain the environment of Shariah compliance in all aspects of the business
by conducting training for other staff, assisting in replying to staff queries on Islamic nance,
advising the management on the direction of Islamic nance, etc.
Exercise 2.4
A Shariah compliance ofcer functions like a legal compliance ofcer in most nancial
institutions. In what sense, does the role and function of the Shariah compliance ofcer differ
from a Shariah supervisory board.
While the SSB is responsible for forming and expressing an opinion on the extent of an IFIs
compliance with the Shariah, the responsibility for compliance therewith rests with the
management of an IFI. (Consideration should be given to the denition of management
in relevant national legislation and regulation). To enable management to carry out this
responsibility effectively, the SSB of the IFI shall assist by providing guidance, advice and
training relating to compliance with the Shariah. The Shariah review of an IFI does not relieve
management of their responsibility to undertake all transactions in accordance with the Shariah.
It is the managements responsibility to provide to the SSB all information relating to the IFIs
compliance with the Shariah.
Governance Standard for Islamic Financial Institutions No.2. Shariah Review, Accounting, Auditing and
Governance Standards for Islamic Financial Institutions 2004-2005, p5
2.9 Customers and public at large

The customers and public at large are also privy and party to the requirements of Shariah
compliance. Relatively speaking, their interest in Shariah compliance is more sensitive compared
with other stakeholders as the customers are the direct consumers and users of Islamic nancial
products. The reason why they have opted to open an account with an Islamic bank or to obtain an
Islamic house nancing scheme, for example, is because they are reliant on the endorsement by the
respective banks that their nancial products are compliant with Shariah principles. Any element
of non-compliance will be a misrepresentation on the part of the bank, which should uphold the
interests of the customers at all times.
There have been cases where IFIs have decided to write-off an amount owed to them when it
discovered there were some non-compliant issues pertaining to the debts. It could happen that in a
house nancing under Murabahah, the bank, upon the request of the customer who faces nancial
46
Shariah compliance
difculty, agrees to reschedule the tenor of the payment period and, subsequently, the amount of
monthly payment to a lower amount, but the total payable under this rescheduling exercise will be
increased from the original selling price. Although the rescheduling is acceptable, the additional price
due to rescheduling is not compliant as this is deemed to be of Riba transaction. Therefore, any extra
income generated from this rescheduling exercise, if any, has to be written off. This is the highest
manifestation of adherence to Shariah principles as income generated from these non-compliant
activities cannot be recorded as legitimate income.
In some cases, the bank may commit a mistake that triggers the breach of Shariah compliance. In
this scenario, the customer cannot be burdened in their obligation and thus, their obligation will
be distinguished to ensure that they are not oppressed by a mistake committed by the bank. For
example a bank agreed a selling price and calculated the monthly payment incorrectly that is lower
than was agreed. If and when the bank notices this shortfall after a period of time, then it cannot
revoke the contract due to its own mistake. Also, the bank is not entitled to ask the customer to
make good of the past under-payment as this will incur an extra burden to the customer. Obviously,
the bank may charge the correct amount of payment from the date the error was spotted, but
cannot back-date the payment.
From the above it is obvious that Shariah compliance is integral to all stakeholders of Islamic
nance. This is a phenomenon that is totally absent in the conventional banking system. The nonadherence to this requirement will defeat the very meaning of Islamic nance in both its law and the
spirit of the law.
Key point
There are many parties that are concerned with Shariah compliance. These include regulators,
shareholders, a banks management, customers and the public at large.

Shariah compliance is only effective if the Shariah board members are provided with full
information on the operations of the IFIs. They should also be given access to relevant
documents and IT systems. What remedies do the Shariah boards have where these are not
made available?
Solution
There are many remedies available to the Shariah board, including:
(a) report to the Central Bank or relevant authority
(b) make a special report to the annual general meeting of the shareholders
(c) if necessary, undertake public awareness in the society.
2.10 Conclusion
Shariah compliance lies at the heart of all aspects of Islamic nance. This chapter explained why
Islamic nancial products must comply with Shariah principles and outlined the reasons why
stakeholders need to be condent that compliance has been achieved. Systems need to be put in
place to achieve stakeholder condence. This chapter also introduced you to the methods which
have been developed to ensure compliance, both at the structuring and operational stages.
The following chapter will look at the legal sources that underpin the development of Islamic
nance. It will also consider the various schools of thought that exist and explain how Shariah
standards, policies and rulings are implemented in the framework of Islamic nance.
47
Shariah compliance
2.11 Summary
48
1.
compliance essentially means conforming to a certain standard that subsequently dictates the
status of being complaint or otherwise
2.
compliance imposes on a person or corporation the requirement to adhere to all prescribed

requirements
3.
standards are usually set by experts in the eld and are determined after lengthy debate over
what should be included
4.
products that are in conict with, or depart from, Shariah principles are deemed to be
non-compliant
5.
Shariah compliance must be represented in both the process and the outcome.
6.
parties concerned with Shariah compliance include regulators, shareholders, a banks

management, customers and the public at large
7.
regulators are concerned with compliance issues relating to a licensed nancial institution, as
the licence will have been granted subject to compliance with Shariah principles
8.
Muslim shareholders expect all the activities of the company to be Shariah-compliant, as

investors buying into the shares of this company may have made their decision on the basis of
the prospectus of the company to undertake Shariah-compliant business
9.
the interest of customers and the public at large lies with the fact that they are the direct
consumers and users of Islamic nancial products; they probably articulate with the bank
because the bank has stated that its nancial products are compliant with Shariah principles.
Shariah compliance
Chapter 2 Answers
Exercise 2.1
The key aspect to include in your answer is that compliance means doing something that
conforms to an agreed standard, rule or piece of legislation. In not contravening a standard, rule
or piece of legislation, an individual is said to be complying. Compliance normally means acting
in a way that is consistent with both the spirit as well as the letter of the standard, rule or piece
of legislation.
Exercise 2.2
The IT function is to record all transactions using information technology. The method of
recording this data and how that would generate overall data processing might breach some
Shariah principles. Any gap in the IT must be fullled as the IT system reects the actual
recording of transactions. For example, if the IT system does not follow the proper sequence
of a contract, then the recording of the transaction will not be in accordance with Shariah
principles. In the case of a Tawarruq deposit product, the IT system must record that the IFI
purchases an asset from the customer/depositor after the customer/depositor has purchased
that asset from a commodity broker through the IFI. Also, the IT system may be set up to
impose a penalty interest on any overdue payment which is not compliant.
Exercise 2.3
This reects the function of a Shariah supervisory board as it includes the review exercise.
Exercise 2.4
While the Shariah board is external to the nancial institution, the Shariah compliance
ofcer is internal and is employed as a full time member of staff. Thus, he has more time and
resources to check all relevant activities and documents to ensure Shariah compliance and
to report any non-compliance matters to the SSB.
49
Revision questions
Shariah compliance
Revision Questions
1.1 What is Shariah compliance?
(A)
Adherence to the Fatwa of the Shariah board.
(B)
Adherence to regulations issued by regulators.
(C)
Adherence to all Shariah principles required in a given contract.
(D)
Adherence to all Shariah principles governing a contract and all supporting materials
and processes.
1.2 Which of the following is not integral to the Shariah compliance process?
(A)
The avoidance of all prohibitions in a certain nancial product.
(B)
Continuous compliance throughout the life of a product.
(C)
Annual reporting to regulators.
(D)
The fullment of required principles, terms and conditions.
1.3 Which of the following is not a stakeholder of Shariah compliance?

(A)
Regulators.
(B)
The AAOIFI.
(C)
Customers.
(D)
A banks shareholders.
1.4 Who has the authority to dismiss a member of a Shariah board?

(A)
The regulators.
(B)
The shareholders.
(C)
Other members of the Shariah board.
(D)
The board of directors.
1.5 Which of the following best describes a Shariah compliance ofcer?
50
(A)
A Shariah audit ofcer appointed by the regulator to oversee the day-to-day Shariah
compliance requirements.
(B)
A full-time Shariah ofcer appointed by the IFI to ensure the compliance of the IFI to
Shariah principles.
(C)
A representative of the board of directors who is well versed in Shariah principles.
(D)
Member of the audit committee of the bank who holds a Shariah degree.
Shariah compliance
Match the following roles and functions to the appropriate column, depending on whether they are
performed by the Shariah advisory board or the Shariah supervisory board
(A)
Issuance of Fatwa.
(B)
Issuance of Fatwa and its supervision.
(C)
Supervisory role of Shariah board.
(D)
Advisory role of Shariah board.
Revision questions
Question 2
Question 3
Why do IFIs need to write off non-approved assets?
Question 4
According to AAOIFIS Governance Standard on Shariah Supervisory Board (article 3), which party is
normally acknowledged as the best authority to appoint the Shariah board members?
51
Revision questions
Shariah compliance
Answers
1.1 (D) Shariah compliance presupposes adherence to all Shariah principles relevant to a particular
contract. These might include other supporting materials and processes. It is wider than
adherence to the fatwa of the Shariah board and any guidelines issued by respective regulators.
1.2 (C) The duty of annual reporting to respective regulators is not relevant to Shariah compliant
processes though it may be relevant from a regulatory framework perspective.
1.3 (B) The AAOIFI is a standard-setting body that is not linked to the nancial institution and
its products.
1.4 (B) According to the AAOIFI Governance Standard, the dismissal of any member of the Shariah
Board can only be decided by the shareholders. This serves to reinforce the notion that the
Shariah board is an independent body that is separate from the management of the bank.
1.5 (B) A Shariah ofcer is an employee of the nancial institution who is responsible for ensuring
the compliance of all activities of the institution. The Shariah ofcer is also required to report
any non compliant issues to the Shariah board.
Question 2
(A) Issuance of Fatwa.
(B) Issuance of Fatwa and its supervision.
(D) Advisory role of Shariah board.
(C) Supervisory role of Shariah board.
Question 3
These non-approved assets, which may occur accidentally or through negligence, cannot lawfully be
distributed to shareholders or depositors to the IFIs.
Question 4
The best authority to appoint Shariah board members, according to AAOIFIS Governance Standard
on Shariah Supervisory Board (article 3), is the shareholders in their annual general meeting. This
ensures that the board is independent from the management of the IFI. In this way, the Shariah
board is responsible to shareholders instead of the board of directors.
52
Shariah compliance
Revision questions
53
Chapter three
Sources of Islamic
commercial law
Learning outcomes
dene the meaning of source of law from an

Islamic perspective
state the importance of source of law in Islamic law

distinguish between the primary and secondary
sources of Islamic law
distinguish between Shariah (divine sources of law)

and Fiqh (Islamic substantive law or positive law)
identify the most workable technique of law in

developing contemporary Islamic commercial law
describe the early development of Islamic (Sunni)

schools of law.

The meaning and source of Islamic law.
The importance of source.
Primary and secondary sources of law.
Shariah law and Fiqh law.
Schools of law.
3.0 Introduction
Islamic commercial law, as distinct from conventional modern law, is
derived from sources which, according to Muslim belief, were revealed
by God Almighty. According to Islam, the requirements as stated in these
sources must be adhered to when establishing a point of law. Basically,
a source is a place from which something is derived or extracted. In this
chapter you will be introduced to the sources from which Islamic law
developed including both the primary and secondary sources of law. You
will also be introduced to the practice of reasoning (Ijtihad) and to the
principles that underlie this process. Ijtihad allows modern scholars to solve
modern issues and problems using their reasoning and interpretative skills
and this has resulted in the development of several Islamic schools of law.
3.1 The meaning of source of law in Islam
3.1.1 The meaning of Shariah
Literally, Shariah means the path to the watering place. Muslims believe that Shariah is the clear
path for believers to follow in order to obtain guidance in this world and deliverance in the next.
In its common usage, Shariah refers to the commands, prohibitions, guidance and principles that
Muslims believe God Almighty has prescribed to mankind.
3.1.2 The sources of law

The essence of Islam is that it derives its principles and values from a given source. In a legal sense,
the term source has more than one meaning. Source can denote the originating fount of a system.
For Islam and Islamic law this source is the Quran and is held to be divine in character. Source can
also refer to the main body of the law such as in the case of judicial precedent in English common
law. When used in the plural, it generally refers to the totality of rules and authorities arranged in a
structural hierarchy. Essentially, the source of the law is not the law itself. Rather it is the place from
which a law can be derived and extended. To put it simply, the source indicates where a rule or legal
argument is taken from.
However, in some cases, the divine source also contains laws that are substantive in character.
Both of these are known as the sources; one provides the proof and the other the law from which a
principle of law can be extracted. This phenomenon can be compared with the way European civil
law and English common law work. European civil law relies heavily on enacted laws and statutes
while English common law relies on case law. Both statutory and case law are the sources of law for
European civil law and English common law respectively.
55

Using the internet or your local library look up the case of Donoghue v. Stevenson [1932]
All ER Rep 1; [1932] AC 562; House of Lords and explain how case law can be a source of
law in English common law.
Points to note
A case decided by a court must have been based on a reason, known as ratio decidendi, or
simply the legal basis on which a law is established (in Islamic law, this is known as Illah).
In the case of Donoghue v. Stevenson, the primary test or principle used in determining the
existence of a duty of care is known as the neighbour principle. In this case, the defendant,
a ginger beer manufacturer sold ginger beer drinks to a retailer. The ginger beer bottles
were opaque. A bought a bottle and entertained a friend, the plaintiff who drank the ginger
beer. When A relled the glass, the remains of a snail came out of the bottle. The plaintiff
suffered shock and was severely ill as a consequence. The plaintiff sued the manufacturer
and claimed that the manufacturer had a duty in the course of his business, to prevent
snails from entering into his ginger beer bottles and further that he had a duty to ensure
that all empty bottles were carefully inspected before they were lled with ginger beer. The
issue in this case was whether the defendant owed such a duty to the plaintiff. The House
of Lords held that the test to determine the existence or otherwise, of such a duty, was
whether the plaintiff was the neighbour of the defendant. This decision in this case can be
used to decide on future case because the neighbour principle is an objective test in the
sense that the court will ask the hypothetical question: would a reasonable man, who is in
the same circumstances as the defendant, foresee that his conduct will adversely affect the
plaintiff? If the answer is yes, this means that the plaintiff is a neighbour of the defendant
and the latter owes the former a duty of care. The neighbour principle is the basis of law to
which future cases must refer.
3.1.3 Combined sources of law

Islam has combined these two elements in two divine sources of law namely the Quran and the
Traditions of the Prophet Muhammad. The Quran on its own contains principles of law as well as
substantive law. For example, the Quran prescribes that an obligation is to be fullled
(chapter 5: verse 1). This is a leading principle in Islamic commercial contract without which the
sanctity of the contract cannot be upheld. On the other hand, the Quran also prescribes a specic
law for a specic case such as the prohibition of interest (Riba), (chapter 2: verse 275) and the
permissibility of providing a collateral or a pledge to secure a loan or nancing (chapter 2: verse 283).
The source of law in Islam provides the overriding and general principles for general application as
well as detailed specic law for a specic case. The source of law in Islam is seen as divine as it was
revealed by God Almighty to the Prophet Muhammad. It is from this source that the whole Islamic
legal system evolves and develops.
Key points
Islam is a religion based on a system of principles and rules designed to achieve the
betterment of humankind.
According to Islam, Shariah refers to the commands, prohibitions, guidance, and principles
that God Almighty has prescribed to mankind.
Islam has combined these two elements in two divine sources of law namely the Quran and
the Traditions of the Prophet Muhammad.
A source of law may establish a general principle as well as prescribe a specic law for a
specic case.
56
Exercise 3.1
Briey explain:
(i) What is the origin of the sources of law in Islam?
(ii) Why the sources of law are different from substantive law?
(iii) What the sources of law in Islam are?
3.2 The importance of the source of law in Islam

3.2.1 The Quran
The source of law is important in any legal system. The history of Islamic law begins with the
revelation of the Quran, which contains legal principles and injunctions dealing with subjects such as
ritual, marriage, divorce, succession, commercial transactions and penal laws.
3.2.2 The Traditions of the Prophet Muhammad

Another divine source of Islam is the Traditions of the Prophet Muhammad, which is a record of all the
sayings, actions and tacit approvals of the Prophet Muhammad. The literature of the Traditions of the
Prophet Muhammad is extensive and covers a much wider range of topics than the legal verses in the
Quran. This is not a difcult matter to appreciate as the Prophet Muhammad was often approached
by his companions and the community for his decisions on a particular case or problem. The Prophet
Muhammad answered and addressed these cases either through the Quran or through his Traditions,
which is seen as equally divine in character. The Prophetic Traditions, generally speaking, like English
case law, concern a particular fact or situation by recording an answer given to a specic question or
a remedy provided for a specic grievance. Among other examples, he was asked by his community
on the permissibility of Salam sales, that is forward sales or a sale of deferred delivery against a cash
payment in advance. To this he replied that a sale is valid provided the asset to be delivered in the future
is certain in its specications and its weight or its measure. The time of delivery must also be certain.
3.2.3 The importance of the two divine sources

These two divine sources are important as they provide not only the parameters of what is approved
and what is not but also some specic injunctions for specic cases in life. Once these are prescribed,
they become binding on Muslims who are expected to strictly follow these guidelines and injunctions.
Muslim jurists may extend these guidelines and injunctions to other cases where relevant but they are
not authorised to change the fundamental principles and injunctions as contained in the Quran and
the prophetic traditions.
Islamic law developed historically through the divine-text approach in the sense that Muslim jurists
are guided not by intuition but by textual evidence. This textual evidence constitutes the source of
law from which the law is derived, and is later extended by jurists through other legal techniques of
application and extension. For example, the source of law in the prohibition of liquor is the verse that
clearly prohibits the consumption of liquor (chapter 5: verse 60). This verse has been the basis from
which the same prohibition was extended to other items that are intoxicating in nature such as drugs.
The method of extension will be illustrated later under the technique of analogy (section 3.3.6).
Exercise 3.2
According to Islam, the source denotes a place from which one may nd what one is looking
for. Explain the importance of source in the context of Islamic law.
Key points
The Quran contains legal principles and injunctions on dealing with subjects such as ritual,
marriage, divorce, succession, commercial transactions and penal laws.
The Traditions of the Prophet Muhammad are a record of all the sayings, actions and tacit
approvals of the Prophet Muhammad.
These two divine sources are important as they provide not only the parameters of what is
approved and what is not but also provide specic injunctions for specic cases in life.
57

Explain how the case of a Salam sale can be used as a principle of law for future cases?
Solution
Salam sales, although specic, allude to many principles of law that are of general application.
These include, amongst others, the following:
(a) forward sales are only permissible if the payment is made in advance
(b) the underlying asset of a Salam sale is something which is either weighable or measurable
(c) a Salam sale allows both parties to lock in the price at the time of contract against future
uctuation of the price; this is useful for nancial risk management, particularly against
market risk.
3.3 Primary and secondary sources of Islamic law

In Islamic law, sources of law may be classied into two broad categories, namely primary and
secondary depending on their origin. While primary sources are based on revelation, secondary
sources are based on human interpretation and reasoning, which, in practice, are, or should be, traced
back to primary sources. Islamic law has combined both revelation and human reasoning. Although
Islamic law is sacred, it is by no means irrational to the effect that determining the law is a matter of
speculation or ad hoc nding. There is always interplay and synergy between revelation and human
reasoning, or primary and secondary sources, in order to provide legal answers and solutions to a
given case.
Key points
Primary sources of law in Islam are based on revelation.
Secondary sources of law are based on human interpretation and reasoning.
3.3.1 General principles and maxims of the Quran

Although the Quran contains specic rulings on matters such as marriage, divorce, inheritance
and criminal offences and punishments, the larger part of Quranic legislation consists of broad and
general principles and maxims. It has been observed that the Quran provides general principles
through the following two means:
(a) Constitutional principles
The rst is by embodying in a specic verse a principle of law, which is meant for general application
in all places and in all ages. For example, the sanctity of life; the obligation to full an obligation; the
duty towards ones parents; the prohibition of illegal means of enrichment; the provision of nancial
protection for the poor and needy; the duty to obey authority; the equality of man and woman, and
many other principles of law are thus directly or indirectly laid down in the Quran. The ability to
identify all relevant constitutional principles of the Quran depends on ones ability to deal with the
Quran from a methodological perspective to derive as many principles as possible. Many of these
principles are also common in the constitutions of most modern states such as the sanctity of life,
the rule of law, equality of sexes, etc.
(b) Empirical reading of the verses
The second approach is found through an empirical reading of the verses of the Quran. The Quran
is full of verses that have common themes, so much so that a scholar can extract a principle of law
that is common to all of those verses. What is of relevance and importance here is the main message
of the principle of law underlying these verses, irrespective of the form in which these verses are
presented in the Quran. A principle of law could be inspired through a direct legalistic form, a
narration or an implied prescription. Muslim jurists have undertaken such an empirical study of the
Quran and concluded that there are ve objectives that Islam was essentially revealed to protect.
58
These are the protection of:
religion
life
intellect
lineage
property.
This is because the Quran has constantly and empirically endorsed these aspects of protection and
promotion, which makes it clear under Islamic belief that these ve aspects are fundamental to the
survival and very existence of humankind.
The same approach to looking at verses of the Quran could add other objectives to these ve
identied objectives of Islamic law. The Quran also discusses the importance of education, freedom,
justice and fairness as well as other themes that are empirically founded and endorsed. These could
also be promulgated as the Quranic fundamental requirements for the benet of mankind. Being a
source, the Quran should be general enough to transcend the limits of time and place and, therefore,
the effort to understand and interpret the Quran is equally everlasting.
3.3.2 The Traditions of the Prophet Muhammad

The other revealed source of Islam is the Traditions of the Prophet Muhammad. This simply refers
to the sayings, deeds and tacit approvals of the Prophet Muhammad in so far as they relate to legal
rulings. Legal rulings in Islamic law have ve categories, namely:
the obligatory
the recommended
the forbidden
the reprehensible
the permissible.
The Prophetic Traditions are the manifestation of rulings that originated from the Prophet
Muhammad and can best be described as the case law of Islam. Unlike the Quran, the cases that
were referred to the Prophet Muhammad were normally based on particular facts to which the
Prophet Muhammad gave his judgment either in the form of sayings, deeds or tacit approval.
The Traditions of the Prophet Muhammad are full of precedents, which Muslim jurists throughout the
ages have referred to as a guide in arriving at a particular legal ruling by way of analogy and other
techniques of legal interpretation. What is important in the Prophetic Traditions is not the case per
se but the facts of the case and the ratio or legal basis on which the Prophets pronouncement was
made. It is this basis that is relevant and extendable to modern and current application of law. Each
new case requiring a legal solution must share the same legal basis of the precedent or original case
as prescribed in the Quran, Prophetic Traditions or both.
3.3.3 General principles of nancial law as laid out in the Traditions of the
Prophet Muhammad
In terms of general principles, the Traditions of the Prophet Muhammad provide, inter alia, the
maxim that the benet is in proportion to the liability or detriment (Al-kharaj bi al-Daman). This
tradition simply establishes a maxim that in order for someone to earn a benet or prot from their
commercial transaction, they must take a corresponding risk. This tradition precludes activities which
would bring benet without taking any risk such as the enjoyment of interest in a xed-deposit
account, as offered by conventional banks.
Like English common law cases, the Traditions of the Prophet Muhammad deal with particular facts
of various situations by recording an answer given to a specic question or a remedy provided for a
specic grievance. Someone, with a question, problem, grievance or dispute, would have gone to the
Prophet Muhammad who gave an answer or ruling for such a remedy. The Traditions of the Prophet
Muhammad therefore, to some extent, represent the case law of Islam.
One example of such a case involved the Prophet Muhammads two companions who wanted to
mutually exchange palm dates. The exchange would have involved two different quantities and amounts
of dates. The Prophet Muhammad instructed that the transaction be stopped because it would be
59
tantamount to Riba (interest/usury). Instead, the Prophet Muhammad instructed the owner of the
lower-grade dates to sell his dates in the market rst for cash and only after that could he buy the
better dates from another party through the payment of money. Riba was avoided as the dates were
exchanged for money and not for dates of different quality and quantities, as initially proposed.
Exercise 3.3
Explain the ratio or the legal basis for the prohibition of the exchanging of two different
amounts of dates.
The above case indicates that barter trading is discouraged as it may lead to fraud and injustice. In
addition, the case highlights the principle of Riba, particularly Riba al-fadl, that is Riba by an excess that
arises when two similar usurious items, which have different values, are exchanged (refer to section 1.5.1).
The sources of Shariah are of two types: revealed and non-revealed. These are only two revealed
sources- rst the Quran; second, the teachings and exemplary conduct (Sunna) of the Prophet
Muhammad. The authority of the Sunna as a source of Shariah as next to the Quran is indicated in
the Quran itself. The non-revealed sources of Shariah are generally founded in juristic reasoning and
may take a variety of forms, including analogical reasoning (Qiyas), juristic preference (Istihsan),
considerations of public interest (Istislah) and even general consensus (Ijma) of the learned.
Mohd Hashim Kamali, Law and Society - The Interplay of Revelation and Reason in the Shariah, in the
Oxford History of Islam, p.118
For Muslims, the Sunnah is the secondary source of Islamic law after the Quran. Some things not
explained in detail in the Quran are claried in the Sunnah as a result of religious actions instituted
by the Prophet Muhammad.
Exercise 3.4
The Quran provides general principles of law and the Traditions of the Prophet Muhammad, to
a large extent, provide explanations to these principles. Provide one example to illustrate this
relationship.
3.3.4 Ijtihad or legal reasoning

The law-making methodology based on the Quran and the Traditions of the Prophet Muhammad is
generally known as Ijtihad, legal reasoning.
Jurists and scholars use this legal reasoning or Ijtihad to arrive at what is thought, on a best effort
basis, to be the law as intended by the law giver, God Almighty. All subsidiary sources come under
the purview of Ijtihad.
Ijtihad in most cases relies on the faculty of mind, namely Ray (a considered opinion). Ray has
a exible and dynamic nature. It decides the cases in light of the spirit, wisdom and fairness of
Islam. It is the well-considered and balanced opinion of a person who aspires to reach a correct
decision. These subsidiary sources include Qiyas (analogical reasoning), Istihsan (juristic preference),
Maslahah Mursalah or Istislah (unrestricted public interest), Sadd al-Dharai (blocking the means),
Urf (customary practice) and Istishab (presumption of continuity). All these terms are juristic in
character and are cited in Arabic. An English translation and a brief illustration of each of these terms
will be provided in the next section. Students are encouraged to refer to the glossaries to assist in
understanding these terms.
The above subsidiary sources are all discussed in Islamic law as the bases of law nding for cases
not specically covered by the legal texts. Generally, all of these sources are aimed at arriving at a
decision, as a result of thought, contemplation and a genuine search for the truth, in a case where
indications are conicting or lacking. In Islamic law, a considered opinion is binding within the sphere
of law simply because it is arrived at by a competent scholar, as a result of diligent and conscientious
reasoning (Ijtihad). In other words, a tentatively constructed rule has the full force of a bona de
rule of law if the interpretation or reasoning upon which it is based is diligent and conscientious.
Therefore, it can be said that a considered opinion in Islam is binding in matters of law.
60

Explain the need for Ijtihad when two divine sources of law already exist.
Solution
The written texts are limited in number but the incidents of daily life are unlimited and it is
impossible for something innite to be enclosed by something nite. Each case is therefore
looked at on its facts and a decision is made. The sources of law are provided to ensure that
the reasoning and interpretation are not devoid of Divinely guided principles. Therefore
a Muslim jurist cannot decree that interest can be made lawful in certain circumstances
because this reasoning (Ijtihad) would be null and void. Although Ijtihad is useful in solving
modern problems, it cannot in any way contradict the principles of law which are prescribed
by the sources of Islamic law.
3.3.5 Ijma consensus of Muslim jurists

The rst tool or technique of Ijtihad is Ijma. This refers to the consensus of Muslim jurists on a particular
legal issue at a particular point of time after the demise of the Prophet Muhammad. Once a consensus
is achieved, it becomes a binding authority on Muslim communities. It must be upheld unless the basis
of arriving at that consensus has changed due to a new discovery of principles or a new Ijtihad, which
is more appealing. It is to be noted that a technical and valid Ijma or consensus is hard to achieve as it
requires the unanimous consent and agreement of all qualied jurists at a particular time, on a particular
legal issue that requires a common standpoint. In modern times, Ijma will arguably be the least effective
means of Ijtihad, particularly in the area of Islamic commercial law as this aspect of law is very dynamic,
hence consensus is often difcult to attain.
However, the decisions and resolutions on Islamic nance, issued by international Islamic bodies, such
as the International Islamic Academy of Fiqh of the Organisation of Islamic Conference (OIC) and the
Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) could be persuasive if
not binding because these decisions reect the views of the majority of contemporary Muslim jurists on
a particular legal point. The decisions of these two bodies, although not satisfying the strict requirements
of a technical consensus, are well-respected and acknowledged by many regulators and stakeholders in
contemporary Islamic nance.
Exercise 3.5
Explain why the process of Ijma, that is consensus or agreeing differences, is difcult to achieve
in practice?
3.3.6 Qiyas analogical reasoning

Of all the subsidiary sources, Qiyas or analogical reasoning is the most important and workable
instrument. Qiyas, broadly speaking, is the legal method of extending the law beyond what is stated
in the authoritative legal sources. It is an extension of a precedent and not the establishment of a
fresh ruling by itself. To do this, it is necessary to draw a parallel or to nd a similarity between what
is mentioned in the legal texts and a new problem. This is known as Illah or ratio decidendi, loosely
translated as the reason. Once it is known that both the original and the assimilated cases share the
same reason, the judgment (Hukm) of the original case is extended to the assimilated case. As a result,
the new problem carries the same ruling as the original. In the case of wine prohibition, the basis is
intoxication. In the case of strict requirements of exchanging certain food items, the legal basis relates
to the nature of these items, namely main foods instead of specic items as mentioned in the relevant
Tradition of Prophet Muhammad. In the case of Donoghue v. Stevenson, it was held that negligence has
occurred if someone has a duty of care but has breached that duty which as a result has caused harm to
another party.
Although Qiyas is based on reasoning and is speculative in character, it is the most accepted instrument
and legal method. It is more systematic and less arbitrary than other forms of legal reasoning. This is due
to its internal system and processes that free the application of Qiyas from relying merely on discretion
or personal whim. Credit goes to the detailed procedure and methods used to establish the proper Illah
or reason applicable in the proper context.
61
Qiyas assists the jurist not only to nd and discover a correct Illah, ratio decidendi or reason contained
in textual evidence, but also to ensure the application of this ratio to a correct context and situation. This
is to avoid the discovery of an improper reason or the discovery of the proper reason wrongly applied
to an improper case. Clearly the nding of the correct reason does not necessarily guarantee the proper
extension of the legal ruling to a new case. Therefore, the most crucial factor is to determine the element
of similarity that justies the transfer of the rule from one case to another, because it is this element
that determines the validity of the conclusion.
3.3.7 Illah reason

The central theme of Qiyas is the Illah, ratio decidendi or reason. Among other salient features of
the Illah are the following:
(i)
the Illah must be an evident attribute and hidden considerations such as intention, consent,
and goodwill are not to be considered as Illah since they are not ascertainable; in other words,
the Illah must be denite and perceptible; the Illah for a valid contract, for example, is the offer
and acceptance instead of the buyers and sellers actual consent, simply because consent is
imperceptible
(ii)
the Illah must also be a constant and regular attribute that is applicable to all cases without
being affected by differences of persons, times, places and circumstances, etc
(iii) the Illah should also be co-extensive in a way that whenever it exists, the rule of law will
also exist
(iv) the Illah should also be co-exclusive, that is, if the Illah does not exist, the rule of law will
also not exist.
An accurate appreciation of these features would prevent Muslim jurists from making unnecessary and
invalid legal conclusions.
Key points
The law making methodology based on the Quran and the Traditions of the Prophet
Muhammad is generally known as Ijtihad legal reasoning.
Ijtihad, in most cases relies on the faculty of mind, namely Ray - a considered opinion.
3.3.8 Qiyas al-tard case-to-case comparison

The most common logical argument used in Islamic legal theory is analogy or Qiyas al-tard. This is
basically a case-to-case comparison. The basic course of reasoning is the extension of a legal rule from
one case to another due to a similarity, deemed by the jurists to be a material similarity. The form of
this argument is as follows:
A has the property X.
B has the property X.
A has the rule J.
X is a relevant property in inducing J.
Therefore, rule J must also apply to B.
Qiyas al-tard or analogy is relatively similar to a syllogistic argument.
A case in point is the Quranic prohibition of wine drinking. The jurist may argue that the reason for its
prohibition is its intoxicating quality. They may therefore formulate their ndings in the categorical
proposition: All intoxicating substances are forbidden. Once they establish the major premise, they
will be able to set forth a syllogism in which the minor premise is, for example: Vodka is an intoxicating
substance and the conclusion is vodka is forbidden. Since wine drinking is prohibited because of its
intoxicating properties, the prohibition, therefore, would apply to other intoxicating substances.
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3.3.9 Istihsan juristic preference

Another principle or technique of law is known as Istihsan or juristic preference. This principle in Islamic
legal theory is discussed by Muslim jurists in connection with the principle of Qiyas. Literally, Istihsan
comes from the root (in Arabic) Hasuna, meaning beautiful, comely, good, pleasing appealing and
other similar words. Broadly speaking, Istihsan takes place when a jurist makes a decision in a particular
case that is different from a similar case that has already been decided. The case decided based on
Istihsan is a departure from a precedent for a reason, which is stronger than the one found in similar
cases. In other words, Istihsans application is to discard the application of Qiyas by virtue of another
reason that is stronger and more appealing. The features and functions of Istihsan are very similar to
equity in common law. The equity principle was developed to remove the rigidity and, occasionally, the
harshness of the principles of law.
In this context, it is worth mentioning an example of the application of Istihsan in modern cases.
Islamic law lays down rather precise prescriptions regarding the custody and maintenance of children.
The presumption is that the welfare of the child is always in the custody of prescribed relatives. Among
other prescriptions, the law says that a girl should remain with her mother until puberty, at which
time she goes to the custody of her father. However, what if either parent is an unt guardian? The
recognition of a judges right to exercise Istihsan in custody cases requires the departure from this
principle by allowing the welfare of the minor to prevail over the letter of the law. The guardian in this
case could be either the mother or the father or indeed a party other than the parents if both parents
are found to be unt.
Istihsan can be loosely associated with the doctrine of equity in English law. It normally applies where
there is a conict between law and equity where equity should prevail. In the case of Walsh v. Lonsdale
[1882] 21 ChD 9, it was decided that equity should prevail over the established principles of law for the
sake of justice and fairness. In this case a person who was let into possession of land under an invalid
instrument was relieved by treating the instrument as an agreement for a lease.
3.3.10 Maslahah or public interest

The next technique of law is centred on the doctrine of Maslahah or public interest. Briey, Maslahah
in the eyes of jurists is an expression for the search for something useful or the removal of something
harmful. Literally, Maslahah is an Arabic word that means utility, what is good or benecial, an
advantage and something for the public good. In a legal sense, it tends to underline the aims of
legal rulings and the intended utility of the law. These aims are well-manifested in the preservation of
Maqasid (objectives) of the law, which consist of ve safeguards for human beings: faith, life, intellect,
posterity and property. What assures the preservation of these ve principles is Maslahah and whatever
fails to preserve them is Mafsadah (evil and harm). Maslahah, as a principle of legal reasoning, is to
argue that good is lawful and that lawful must be good.
The following example illustrates the legal reasoning based on Maslahah. It relates to the case of
creating a trust for the benet of the investors in Islamic capital market products, for example, Sukuk
al-ijarah. The creation of trust will transfer the legal ownership of the leased asset to the trustee and
away from the issuer/lessee. In the case of the issuer/lessee going into liquidation, the leased asset will
be removed from any bankruptcy action. Hence, the interest of the investors will be protected even
though the issuer/lessee has been served with a liquidation order.
3.3.11 Sadd al-dharai` or blocking the means

Another principle or technique of law, which is largely related to Maslahah, is Sadd al-dharai`, that is,
blocking the means or to consider the ultimate result of any action. By virtue of blocking the means, any
particular action that would bring harm to mankind would be deemed unlawful and illegitimate. Therefore,
blocking the means must imply blocking the means to evil and not something good. A typical case for the
application of this principle will normally arise when lawful means are expected to lead to unlawful results,
or lawful means that normally lead to a lawful result are used to procure an unlawful end.
A good example is a doubtful deposit received without checking the source. This might mean
that monies from illegal activities are being accepted. Thus there is the need to avoid money
laundering activities.
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3.3.12 Urf or customary practice

In addition to other subsidiary sources, Islamic law also gives importance to Urf or customary
practice. Essentially, the prevailing practice or standard reects a kind of public interest that has been
accumulated and accepted in given society. This is valid as long as the practice or standard does not
contradict the established principles of Islamic law, as no legal system would recognise a practice
that runs counter to its fundamental principles. The recognition of custom is expected to initiate
new laws, where other sources of law are silent or are to be applied to the standing law or be used as
circumstantial evidence in cases of dispute. It is on the merit of this argument that many practices have
been accepted in society without any dispute, as if they are an integral part of the law. This includes the
obligation of delivery on the part of the seller in some merchandise contracts and a right of warranty in
some products and goods. Islamic law has afrmed the position of Urf or custom by having many legal
maxims such as custom is binding or authoritative. Urf or custom should conform to the following
conditions in order to be recognised as valid in Islamic law:
(i)
it should be commonly practised by the community or a community, the former being a

phenomenon common to all sections of Muslim society and the latter common to a particular
group or in a particular area
(ii) a practice should be current at the time of the contingency to which it relates and from which it is
to be consulted; a previous Urf is not admissible nor is Urf that post-dates the contingency
(iii) Urf should not contradict an explicit provision of the Quran or the Traditions of the Prophet
Muhammad; consequently, wine drinking, adultery, usury and the like cannot be justied on
grounds of common custom in the society
(iv) in cases of dispute, Urf is to be considered only where there is no explicit stipulation between the
parties concerned; if an explicit stipulation exists, that stipulation should be adopted and custom
discounted.
3.3.13 Istishab or presumption of permissibility

The last technique of law is the principle of presumption of permissibility, that is, Istishab. This is
based on an important maxim in Islamic law that dictates that the original ruling for every matter is
permissible unless proven otherwise. This principle is useful in Islamic commercial law as it announces
from the very beginning that all contracts and terms are deemed to be legitimate and lawful. If
research fails to nd any prohibition to these contracts and terms then they are upheld as compliant to
Islamic law.
A fair value concept is a good example of how Islamic law accepted a new concept of valuation in
addition to book value and market value.

Outline the reasons for the introduction of equity in common law tradition and explain
how this can be seen in Islamic law.
Solution
Equity is based on natural justice, good conscience and fairness. Common law was regarded
as technical and rigid whereas equity was not. In the case of Walsh v. Lonsdale, there was a
conict between law and equity and it was decided that equity should prevail. In this case,
a person who was granted possession of land under an invalid instrument was relieved by
treating the instrument as an agreement for a lease. This is so as not to bring injustice to
that person. The same line of argument took place in Islamic law. A person entered into
an agricultural partnership or Muzaraah contract. The person cultivated the land that was
provided by the other party. However, the cultivator died before the harvest was ready.
According to the established principles of partnership, the partnership terminates with
the death of one of the partners. Were this to be upheld, the deceased partner or his
family would have been treated unfairly. The Istihsan principle comes in to ensure that the
partnership is presumed to continue until the harvesting is gathered. In this way the family
of the deceased cultivator are able to share the crop as agreed.
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3.4 Comparison between Shariah (divine sources of law) and Fiqh

(Islamic substantive law)
3.4.1 Shariah
Muslims believe that God Almighty sees the Shariah as essential to human life. The Shariah, as the
divinely-ordained blueprint for human conduct, is a self-contained system. It encompasses all aspects
of human life, on the individual as well as at collective levels, in matters of faith, moral conduct,
practical rulings and observance in all aspects of life, be it family, worship, nancial transactions or
justice administration. To this effect, the Shariah has been described by leading western scholar Joseph
Schacht as the epitome of Islamic thought, the most typical manifestation of the Islamic way of life,
the core and kernel of Islam itself.1.
3.4.2 Fiqh
Fiqh is an Arabic word that means a deep and thorough understanding and intelligence. Technically
speaking, Fiqh refers to a set of practical rulings and laws that are the outcome of the legal
interpretation (Ijtihad) as interpreted by Muslim jurists. This expression implies that Fiqh is about
practical rulings and laws (excluding matters of faith and morals). It is also a product of human
understanding and interpretation of the sources of law.
3.4.3 Differences between Shariah and Fiqh

The basic differences between Shariah and Fiqh can be summarised as follows:
(i)
While Shariah is divine in character, Fiqh reects the effort of humans, namely Muslim jurists, to
understand the Shariah and to apply its principles and general guidance to specic cases, which
are not provided for in sources of the Shariah or in a case where the texts of the Shariah are less
clear and need some Ijtihad.
(ii)
The methodology of the Shariah is to provide general principles and maxims, such as the
requirement to full an obligation. In addition, Shariah is not typically concerned with detailed
explanations or illustrations. On the other hand, the function of Fiqh is to provide explanations
and detailed prescriptions to meet the complexities of human life. For example, in the case of a
breach of contract, Muslim jurists have to address the issue of compensation in detail, such as the
basis of a valid and enforceable composition, the quantum of compensation and the method of
payment. These detailed prescriptions are only documented in Islamic Fiqh literature and books
and are not available in the texts of the Shariàh. Thus, Fiqh is also known as the substantive or
positive law of Islam.
(iii) The Shariah covers matters of faith, moral conduct and laws. Fiqh relates only to the last aspect
of the Shariah, that is, the practical aspects of the Shariah, known in modern terms as laws
or rules. The practical aspect of observance and compliance includes almost all aspects of
human affairs, such as personal worship, nancial activities, family affairs, dispute resolution and
justice administration and international law. Thus Islamic nance is a subset of Fiqh, an area of
practical rulings known in Arabic as Fiqh al-Muamalah or simply Islamic commercial law. Islamic
commercial law essentially covers a number of issues such as the formation of contracts, the
sale of goods and services, investment activities, security and collateral. The overall relationship
between Islam, Shariah, Fiqh, Islamic commercial law and its various applications is depicted in
the following diagram.
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Figure 3.1 The overall relationship between Islam, Shariah, Fiqh, Islamic commercial law and its various applications
Shariah
Fiqh
Faith
Worship
Family affairs
Financial activities
(Islamic commercial
law/Fiqh al-Muamalah)
Contracts
Morals
(Law and Rules)
Banking
products
Justice
administration
Insurance
products
Penal code
International
law
Capital market
products
Key points
Fiqh refers to a set of practical rulings and laws that are the outcome of the legal
interpretation (Ijtihad) as interpreted by Muslim jurists.
Shariah is divine in character whereas Fiqh reects the effort of humans to understand the
Shariah and to apply its principles and general guidance to specic cases.
Exercise 3.6
A friend of yours is confused about the relationship between Shariah and Fiqh. So has asked
you to explain how they relate to each other.
3.5 Ijtihad the technique of developing contemporary

Islamic commercial law
3.5.1 Islamic legal theory
Islamic law, as seen in previous sections, is a very distinctive law. On one hand it relies heavily
and primarily on divine texts that are represented by the Quran and the Traditions of the Prophet
Muhammad. On the other hand it relies on the jurists to interpret these sources and apply their
interpretations to new cases. Here lies the importance of Ijtihad as the technique in developing
contemporary Islamic commercial law to relate revelation to reason and vice versa. The process and
procedures of Ijtihad are compiled in a discipline called Usul al-Fiqh or Islamic legal theory, which
assists and guides the jurists to interpret and deduce the law from both revelation and reason
systematically. This is because, although legal constructions are humanly conceived, the validity of
arguments in Islamic law, unlike in western and modern law, rest primarily upon the epistemological
value of the revealed premises from which they are constructed. In other words, the legality of
Ijtihad or interpretation in Islamic law is always subject to its connement to a parameter, which is
provided by Shariah principles. Reasoning cannot be void of Shariah guidance. All reasoning efforts
must conform to general principles of the Shariah. Ijtihad, though it is a human reasoning, must be
66
properly governed to ensure it is undertaken and exercised according to particular standards and
principles so as to avoid the whims and fancies of those involved.
It is clear that the search for new laws requires the process of legal reasoning to arrive at what
is most likely to be the ruling of God Almighty in a given situation. Therefore, in Islamic legal
theory, determining the law is not a matter of speculation or intuition. Rulings for individual cases
have to be arrived at through a highly complex methodology known as Ijtihad. Above all, Islamic
jurisprudence is not only concerned with the law proper (Fiqh) but also with questions of linguistics,
logic, methodology, custom, epistemology, fairness and justice. In conclusion, Ijtihad seems to be an
effective means of addressing the challenges facing contemporary issues in Islam particularly with
regard to nancial matters. A more detailed illustration of the function of Ijtihad will be given in the
forthcoming chapters.
3.6 Early development of Islamic schools of law in Sunni Islam

As there are many ways and methods of understanding both the Quran and the Traditions of the
Prophet Muhammad and their interpretations, disagreement is inevitable in Islamic law. These
differences of opinion are well documented in the legacy of Islamic law, particularly in the writings of
all major schools of Islamic law.
3.6.1 Madhhab schools of Islamic legal thought

From the middle of the eighth century (AD), a number of juristic scholars emerged whose
independent interpretations of the general principles and specic cases of both the Quran and the
Traditions of the Prophet Muhammad stimulated the development of separate legal schools in Islam.
Islamic jurisprudence became a highly technical process and disputes about methods and judicial
opinions crystallised into various legal schools designated by the names of their founding scholars.
The differences in legal thought were mostly due to the various ways in which the Quran and the
Traditions of the Prophet Muhammad were interpreted in relation to local customary law and the
quality of reasoning used in extending the principles to unprecedented cases. As a result, several
legal systems or schools called Madhahib (plural of Madhhab) developed corresponding to different
methods of conducting jurisprudence. These Madhahib usually differed with regard to the details of
practical applications, but divergence of opinions with regard to general principles of Shariah has
been negligible.
3.6.2 The Hana school of law

The oldest legal school is the one that followed Iraqi tradition and is called the Hana school of law.
It is named after its founder Abu Hanifah, who died in 767AD. The Hana school of law is known for
its endorsement of reasoning and logic as legitimate sources in the application of practical rules to the
practical questions of life.
Abu Hanifahs unusual ability to broaden juristic practice with the use of analogy and juristic preference
allowed Hana jurists to carry out meticulous investigations of legal sources to formulate their juridical
decisions. The Hana school of law has been the most exible and workable school in the area of
commercial transactions. In terms of the geographical distribution the school came to dominate most
territories of what was the Ottoman Empire, particularly in the eastern Mediterranean, simply because
it was the ofcial school of law of the ruling government. The Hana school of law is also predominant
in the Indian subcontinent and central Asia covering both Russia and China and could therefore be
considered the largest school of law in the Muslim world.
3.6.3 The Maliki school of law

Chronologically, the next school is the Maliki, which originated in Medina and was named after the
prominent legal scholar and traditionalist Malik bin Anas (d.795AD).
Those who adhered to the rulings of Malik bin Anas were known as the Malikis. In his legal formulations
Malik relied heavily upon the well-established practices of the early companions of the Prophet
Muhammad in Medina. Although he was bound by the practice of the Medinese in his legal doctrines,
Malik also used analogical deduction in cases not treated in the Quranic verses or in the Traditions of
the Prophet Muhammad to arrive at a rule. Maliki jurists regard juristic preference and public interest
as valid sources of juridical decisions. The adherents of the Maliki school of law tend to be concentrated
today in North and West Africa, although they are found in other parts of the Arab world, including the
Hejaz in Saudi Arabia, and Kuwait.
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3.6.4 Shai school of law

The third major surviving school is called the Shai school of law. This school was named after
Muhammad bin Idris al-Shai (d.820AD).
The Shai school of law was the result of a synthesis conducted by a single scholar who was
thoroughly familiar and well versed with the doctrines of both the Maliki and Hana schools. From
the Maliki school of law he reafrmed the Traditions of the Prophet Muhammad as a source of law coexisting and co-equal with the Quran. He articulated the view, which subsequently found widespread
acceptance, that the Traditions of the Prophet Muhammad explained the meaning of the Quran. From
the Hana school of law he accepted the role of independent sound judgment and used that as a tool
for analogical inference in his legal theory.
Al-Shais contribution lies in his synthesis of legal theory in Islamic jurisprudence. It can be noted
that the legal theory in Islamic jurisprudence developed by al-Shai deals best with areas of law that
are xed. These include devotional matters and the like because al-Shai and his school of law was
never involved in areas of law that are exible and worldly, as in the case of the Hana school of law.
The distribution of the members of the Shai school of law tends to correspond to the pattern of the
major trade routes, with which Shai communities mostly associated. One nds large numbers of the
Shais in East Africa, Yemen, Malaysia and Indonesia.
3.6.5 The Hanbali school of law

The last of the four schools of law is the Hanbali school of law. It was named after its founder Ahmad
bin Hanbal (d.855AD) who compiled work on the Traditions of the Prophet Muhammad. This became
the source for juridical decisions of the Hanbalis.
Generally speaking, the Hanbali school of law leaned more on tradition than the science of law and
jurisprudence. The Hanbali school of law has dwindled in size so that its adherents are rarely found
outside central Saudi Arabia. However, the widely-appreciated originality and intellectual distinction of
some of its medieval jurists has allowed it to retain an inuence entirely out of proportion to its number.
3.6.6 All schools are equal

Muslims attribute an equal value to all four surviving schools as the differences between them are
in the detail. These differences are in the domain of the application of law (branches of law) and
not in the principles of the law (roots of law). It is important to note that these four schools are in
agreement on all points vital to Islam. They acknowledge the authority of the Quran and the Traditions
of the Prophet Muhammad as the ultimate sources of law in Islam. They have a different emphasis of
adherence to other subsidiary sources. These differences have led to different perspectives on many
legal issues.
Key points
Madhhab is a school of Islamic legal thought.
All schools of law agreed on principles of law though they may differ in specic cases and legal
formulations.
Exercise 3.7
Briey explain:
(i) Why various schools of law developed in Islam?
(ii) Whether these schools of law are contradictory to each other in their nal conclusions and
opinions?
3.7 Conclusion
This chapter introduced you to the sources from which Islamic law developed including both the
primary source (revelation) and secondary source (human interpretation). It also introduced you
to the crucial process of Ijtihad and to the principles which underlie this process. You will have
seen that the use of Ijtihad has resulted in the development of several Islamic schools of law. You
were introduced to the four major Islamic schools of law that are the Malikis, Hanbalis, Shais and
Hanas. As explained, these schools of law have a direct effect on the geographical development of
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Islamic nance. You will see in later chapters of this guide and throughout the other three guides
that this effect on geographical development has led to erce debate throughout the Muslim world
as to what constitutes acceptable practice in Islamic nance.
The next chapter will explain Ijtihad in further detail and show how it can be applied as a solution in
modern nancial issues.
3.8 Summary
1.
Islam is a religion based on a system of principles and rules
2.
the essence of Islam is that it derives its principles and values from a given source; for Islam and
for Islamic law, which is part of Islam, these sources are the Quran and the Traditions of the
Prophet Muhammad
3.
the two sources are important as they provide not only the parameters of what is approved and
what is not permitted but also some specic injunctions for specic cases in life
4.
secondary sources are those based on human interpretation and reasoning which in practice are,
or should be, traced back to the primary sources in one way or another
5.
Ijtihad is the legal reasoning used by jurists and scholars to arrive at what is thought, on a
best-effort basis, to be the law as intended by the Quran and the Traditions of the Prophet
Muhammad
6.
Ijtihad is the most workable technique in developing contemporary Islamic nance. However, the
exercise of Ijtihad must be properly governed to avoid resorting to the whims and fancies of an
individual
7.
Ijma refers to the consensus of Muslim jurists on a particular legal issue at a particular point in
time; this then becomes a binding authority on Muslim communities
8.
Qiyas is a form of analogical reasoning that extends the law beyond what is stated in the
authoritative legal sources; it is an extension of a precedent and not the establishment of a fresh
ruling by itself
9.
Qiyas al-tard is the use of analogy, that is, the extension of a legal rule from one case based on a
similarity, deemed by the jurists to be a material similarity
10. the Illah or reason given in a Qiyas must be an evident attribute, as well as constant and regular;
it should also be co-extensive and co-exclusive
11. Istihsan or juristic preference takes place when a jurist departs from a precedent and takes a
decision in a case by virtue of another reason that is stronger and more appealing
12. Urf is the acceptance of customary practice where the prevailing practice or standard in society
reects a kind of public interest that has been accumulated and accepted; this is valid as long as
the practice or standard does not contradict the established principles of Islamic law
13. Istishab suggests that in Islamic commercial law all contracts and terms are deemed to be
legitimate and lawful until research determines whether there is any prohibition
14. while Shariah is divine and contains general principles, Fiqh is the understanding by Muslim
jurists of the Shariah and also deals with detailed prescriptions of the law
15. there are at least four surviving Islamic schools of law in Sunni-Muslim society; although they
may have many different perspectives on specic laws and legal matters, they have one common
perspective on Shariah and the general principles of Islamic law.
Notes:
1.
Schacht, Joseph, Origins of Muhammadan Jurisprudence, Oxford 1950, 124ff
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Chapter 3 Answers
Exercise 3.1
(i) The origin of the source of law in Islam is revelation as both the Quran and the Traditions
of Prophet Muhammad are regarded as being divinely revealed and inspired.
(ii) The source denotes a place from which a substantive law originates. Substantive law
generally speaking is detailed and specic to a particular case in point.
(iii) The sources of law in Islam are the Quran and the Traditions of the Prophet Muhammad.
Exercise 3.2
The source of law is important in Islam because it denotes a place from which the whole body
of law will later develop. To ensure that Islam is always centred upon revelation, this source
must be equally revealed and divine in character. The main function of the source is to provide
a guideline or parameters for general application on matters such as an obligation to full a
contract. The source also provides general principles to be extended to other similar cases, such
as the extension of the prohibition of liquor to other intoxicating items such as drugs. Islamic
law has developed historically through the divine-text approach because all legal formulations
and conclusions by the jurists had to be based on the divine texts of both the Quran and the
Traditions of the Prophet Muhammad.
In conclusion, the source denotes a place from which a required solution can be arrived at. This
source, as far as Islamic law is concerned, is based on revelation applied and extended through
interpretation and extension. This reects a signicant synergy between the sources of law,
which are divine and the process to benet from these sources, which is human driven.
Exercise 3.3
The legal basis is not related to a specic item such as dates or barley. Although dates are
mentioned in one of the Traditions of the Prophet Muhammad (refer to section 1.5.1) the dates,
as well as other items mentioned in that tradition, are not the real reason for this prohibition.
Some jurists have extracted the basis of this prohibition as the main foods and therefore, any
exchange of two main foods must be subject to the same requirements. Therefore, an exchange
of corn for corn is equally governed by the same ruling and requirement (on the assumption
that corn is a main food in some societies) that are of equal and spot exchange.
Exercise 3.4
The Quran has categorically prohibited interest or Riba. However, the Quran never explained
the forms and classications of prohibited Riba. It is only the Traditions of the Prophet
Muhammad that explain Riba in detail. A good example is the Prophets pronouncement on the
exchange of two different qualities of dates as explained in section 3.3.3.
Exercise 3.5
Ijma requires all living scholars to agree on a particular part on law. Any disagreement will
result in an invalid ijma. Getting all living scholars to agree to any one solution to a difference
of opinion is unlikely to be easy. Indeed it may not be possible.
Exercise 3.6
Shariah is a comprehensive system that governs many other components. One of the
components is known as Fiqh, which relates to practical rulings on human conduct. Thus, Fiqh
is part of the Shariah as the Shariah is wider in scope. Also, while Shariah is Divine, Fiqh is
human in the sense that Fiqh is derived from interpretation by man.
Exercise 3.7
(i) The emergence of various schools of law in Islam was the result of Ijtihad. Ijtihad is bound
to result in more than one opinion, thus the development of many schools of law.
(ii) Many of the legal conclusions and opinions of these schools of law could be contradictory.
Differences of opinion occur, however on the detailed application of the law only and not
on the principles.
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71
Revision questions
Revision Questions
1.1 Which of the following is NOT a valid description of both the Quran and the Traditions of the
Prophet Muhammad?
(A)
Both were revealed through Revelation.
(B)
Both are primary sources of Islamic law.
(C)
Both can be extended to other specic and new cases.
(D)
Both primarily provide detailed rulings of Islam.
1.2 What does Qiyas or analogy refer to?

(A)
Public interest that is good for the society and which does not contradict Shariah
principles.
(B)
The customary practice of the society, which is both benecial and acceptable.
(C)
An extension of a ruling prescribed in the Quran or the Traditions of the Prophet

Muhammad to a new case which shares similar reasoning with the original ruling.
(D)
The consensus of the Muslim jurists and scholars at one point in time, on a specic
legal issue.
1.3 Which of the following denes Ijtihad?

(A)
The consensus opinion of a number of leading Muslim jurists and scholars.
(B)
Customary practice.
(C)
A reliance on the texts of the Quran and the Traditions of the Prophet Muhammad.
(D)
The process of legal reasoning by the jurists to arrive at a legal solution for new cases.
1.4 What is the function of Urf (customary practice)?

(A)
To provide an explanation as circumstantial evidence in cases of dispute.
(B)
To extend the law to new cases.
(C)
To block any means to consequences which are unfair or harmful.
(D)
To presume that everything is permissible unless proven otherwise.
1.5 Which of the following statements is NOT correct with regard to the Islamic schools of law
in Sunni Islam?
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(A)
The schools of law were named after their founders.
(B)
The schools of law were distributed across the globe.
(C)
The schools of law differed from each other in matters of specic rulings.
(D)
Various schools of law developed in order to encourage a variety of opinions.
Revision questions
Question 2
Match the following descriptions to both Shariah and Fiqh respectively.
Descriptions
General principles.
Humanly interpreted.
Governs faith, moral and law.
Detailed rulings.
Revealed by God Almighty.
Relates to law only.
Shariah
Fiqh
Question 3
Fill in the blank(s) to correctly complete the following sentences.
1.
Juristic preference (Istihsan) is to prefer one ruling over another ruling that is already prescribed
as the precedent. This preference is due to a reason which is
and
.
2.
All contracts and terms under the principle of presumption of permissibility are deemed
unless proven otherwise.
3.
Reason (Illah) is the effective cause or reason for a ruling in Islamic. Among the attributes of
valid reason in Islamic law are that it must be evident, constant,
and
.
4.
The distinctive features of Hana school of law are
5.
Differences of opinion among the scholars did not relate to

always related to
.
and
.
but they were
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Revision questions
Answers
1.1 (D) Muslims refer to the Quran and also to the Traditions of the Prophet Muhammad as their
main reference for rulings. However, the Quran provides detailed rulings of Islam only in a few
limited cases.
1.2 (C) Qiyas uses rulings in the Quran and the Traditions of the Prophet Muhammad as the basis
for a decision in a new case. Qiyas is an extension of an original ruling to a new case.
1.3 (D) Ijtihad is a legal reasoning by the jurists to solve a new case that requires a legal solution.
The solution required is either not clearly or directly provided in the text or not provided in the
text at all.
1.4 (A) In most cases Urf or customary practice provides a useful reference to settle disputes in a
society, particularly in matters that are commonly upheld by the society.
1.5 (C) The difference between the schools of law in Sunni Islam is only on the details of practical
applications.
Question 2
Shariah
Fiqh
General principles
Detailed rulings
Revealed by God Almighty
Humanly interpreted
Governs faith, moral and law
Relates to law only
Question 3
1. Stronger and more appealing.
2. Lawful/permissible.
3. Co-extensive and co-exclusive.
4. Reasoning and logic.
5. Principles of law, branches of law.
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Revision questions
75
Chapter four
Methodology
of interpretation of
Islamic commercial law
Learning outcomes
dene various forms of Ijtihad inclusive of both

textual-based and human-based reasoning
identify the need for Ijtihad in modern times

understand the practicality of Ijtihad in solving modern
issues and problems
describe approaches to Ijtihad.
Methodology of interpretation of Islamic commercial law

The basis of interpretation in Islam.
Ijtihad.
4.0 Introduction
In this chapter you will learn more about the basis and idea of Ijtihad or
interpretation as practised within Islamic commercial law. The introduction
will cover the many forms of Ijtihad that enable the jurists to overcome
modern and day-to-day problems. You will also learn how Ijtihad can solve
practical modern nancial issues from an Islamic perspective.
4.1 The basis of interpretation (Ijtihad) in Islam
Although Islamic law starts from given or self-evident premises that constitute the sources of Islamic
law, it also appeals to Ijtihad to enable it to answer all questions arising in a given society at any
point in time. However, it should be made clear that Ijtihad is not applicable to matters of belief and
theology. Theological issues are not subject to Ijtihad as all the principles and foundations of belief
have been revealed without the need for further interpretation and reasoning. Ijtihad, in the context of
religion of Islam, applies exclusively to matters of law.
The basis of interpretation can be traced to the time of the Prophet Muhammad. The most obvious
basis is the record of the prophets conversation with his companion, Muadh bin Jabal, on the eve of the
latters departure to Yemen as a judge and teacher. The Prophet Muhammad asked Muadh bin Jabal
how he would solve a legal issue should a new case arise in Yemen. He replied that he would resort
to the Quran if there was anything he could base his conclusion on, otherwise he would refer to the
Traditions of the Prophet Muhammad to nd an answer. The Prophet Muhammad probed further as to
how he would solve a legal issue in a case where neither the Quran nor the Traditions of the Prophet
Muhammad could help. Muadh bin Jabal replied that he would resort to applying Ijtihad and would not
be negligent in his undertaking. The Prophet Muhammad endorsed this methodology and this tradition
has become the most celebrated basis of Ijtihad.
This and other traditions reafrm the basis of Ijtihad. On the other hand Ijtihad is an inevitable
technique of law for the following reasons:
4.1.1 Life is complex

While the legal texts in the Quran and the Traditions of the Prophet Muhammad are limited, the
potential issues in life are not. Thus, it is impossible for something innite to be enclosed by something
nite. In other words, in cases that require a decision, and authority from either the Quran or the
Traditions of the Prophet Muhammad cannot be found, the accepted methodology is to undertake
legal reasoning and interpretation to nd an answer.
4.1.2 Understanding and application

Even in the case of the availability of a legal text it does not mean that Ijtihad is not needed as Ijtihad
involves the whole process of understanding a text and the application of this understanding to the
correct context and issue.
A case in point is the basis of Riba or interest involving the exchange of four items namely, wheat,
barley, dates and salt. The Prophet Muhammad reportedly said: Gold for gold, silver for silver, wheat for
wheat, barley for barley, dates for dates, and salt for salt, like for like, equal for equal, hand-to-hand. If the
commodities differ, then you may sell as you wish, provided that the basis of exchange is hand-to-hand.
This text has provided a basis as to why an exchange involving these six commodities shall be observed
with extra diligence to ensure its compliance to Shariah requirements.
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Muslim jurists have unanimously agreed that the legal basis (ratio decidendi) of the rst two items,
namely gold and silver, is their function as currency at that point in time. Therefore, using simple
analogy, any form of currency will be equally subject to the same rule; they have to be of spot and
simultaneous transfer (hand to hand) as well as of equal amounts if they are in exchange for the same
currency. If the two currencies are of different denominations, then they can be exchanged for each
other based on a negotiable rate, as long as the transfer of the two currencies is spot and simultaneous
(refer to section 1.5.1).
An Ijtihad is required in determining the legal basis of the last four items as scholars have unanimously
agreed that they were not meant to be specic or exhaustive. These four items need a common basis
to render them extendable to other new items. Guided by the above text, scholars of different schools
of law have attempted to give their respective interpretations. While the Shais upheld the fact of
edibility as the legal basis, the Hanas have contended that the common basis of these four items is
that they are measurable and weighable. The Maliki school of law argued that what these four items
have in common is that they are main foods and can be preserved.
Clearly, there is more than one interpretation of the intended legal basis of these four usurious items
and these could logically lead to various, if not conicting, rules and decisions. Having said this, the fact
remains that Ijtihad is a necessary tool in Islamic legal tradition in the issue of deciding the legal basis
of Riba in these four food items.
Key point
When a decision or authority is not found in the Quran or the Traditions of the Prophet
Muhammad, the accepted methodology is to undertake legal reasoning and interpretation
(Ijtihad) to nd an answer.
4.1.3 Limitation of divine texts

It has also been advocated that Ijtihad is needed because Islamic law in totality was not given ready
made. Many aspects, particularly detailed explanations and illustrations of legal principles, are not
readily and instantly available in the divine texts. As previously mentioned, Islamic revelation was
stopped by the demise of the Prophet Muhammad and Muslims are left with two divine sources or
texts that are not in the form of detailed codes and specic rulings for all specic issues - current
and in the future. This is the nature of Islamic revelation and, subsequently, the law-making process
in Islamic legal tradition.
Guided by these two sources, Muslim jurists and scholars are expected to do their level best to
understand, interpret and apply these texts to all issues and cases. From a legal perspective this
process means that, among other things, Islamic law is open to innovation and legal reasoning.
Ijtihad is to use ones personal reasoning to interpret and reinterpret the texts and principles. The
basis of Ijtihad is to encourage the culture of innovation and creative reasoning in attempting to
solve a problem with a solution that requires comprehension and contemplation.
Exercise 4.1
Indicate which of the following statements is true/false:
(A) Ijtihad is not valid where relevant text exists to provide a solution to an issue
(B) Ijtihad has only been valid since the demise of the Prophet Muhammad.
4.2 Meaning of Ijtihad or interpretation

Ijtihad, which is an Arabic word, is derived from the root word Jahada, meaning to strive to do
something. It applies to any kind of work that requires some effort by the doer. Work that does not
require any effort or any considerable effort cannot be deemed as Ijtihad.
4.2.1 Salient features and requirements of Ijtihad

In 4.1 above, a tradition of the Prophet Muhammad was cited as an example of how the Prophet
Muhammad endorsed the approach to be taken by a would-be judge on the eve of the latters
departure to Yemen. This piece of tradition indicated a few critical salient features and requirements
of Ijtihad. Among other things, the tradition mentions the use of ones personal opinion (Ray).
This opinion should be considered and contemplated because the same tradition maintains that
Ray cannot be exercised without due diligence and care. It is only a considered opinion when it is
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exercised by a qualied jurist. It should be undertaken in good faith and with a high standard of
scholarship.
Ijtihad, from a basic legal denition, is to make use of ones best ability under the guidance of the
broad principles of Shariah in the search for a legal status. From a more technical perspective, Ijtihad
is seen as the total expenditure of effort in the search for an opinion as to any legal rule in such a
manner that the individual sense (within himself) has an inability to expand further effort. It is clear
that Ijtihad requires a high standard from both the Mujtahid, that is, the doer of Ijtihad, as well as
the exercise of Ijtihad itself. This denition emphasises that the search must be total, involving the
jurists utmost energies and skills. If the jurists fail to discover evidence that they were quite capable
of discovering, then their reasoning will be void as they have been negligent in their research and
contemplation.
Ijtihad is a process and means to arrive at a particular objective. It takes place at the beginning
of the process, the outcome of which is called Fiqh (Islamic substantive law). In other words,
Ijtihad interprets the texts and principles of law, as the case may be, and results in a concise legal
formulation or answer for a specic issue.
Key point
Ijtihad requires a high standard both from the Mujtahid, that is, the practitioner of Ijtihad, as
well as the exercise of Ijtihad itself.
4.2.2 The approach to Ijtihad

As mentioned in chapter one, Islamic law is distinct from both common law and civil law
respectively. Law nding in Islamic law is always based on a text-oriented approach. In the history of
Islamic law, the great bulk of positive or substantive law was the outcome of juristic interpretations.
Roman law was also known for its heavy dependence on interpretation as the means to discover the
law and for this reason Roman law is known as the jurists law.
Although jurists in Islamic law, as in the case of Roman law, had the function of discovering the law
for the consumption of interested parties and authorities in the state, Muslim jurists were probably
more restricted than their Roman counterparts. Roman jurists depended largely on their intuition in
arriving at solutions to legal problems. They were guided as much by notions of equity as they were
by substantive legal doctrine. This intuition is likely to have derived from the social and psychological
forces of the age. In Roman eyes, a jurist was a man possessed of legal wisdom; it was his sound
judgment and insight, more than any specic philological or hermeneutical skills that elicited the
respect of his contemporaries and provided the basis for his authority. On the contrary, Muslim
jurists were bound to more formal sources and texts. Their authority depended more upon the
jurists skills than upon any inherent wisdom.
To some extent, this process of interpretation is also true with regard to common law. However,
unlike Roman law and Islamic law, which place a signicant role on the jurists, judges were primarily
responsible for the development of common law. Common law is alternatively known as judgemade-law. It is noteworthy that in the UK, parliament provided judges with the general assistance of
the Interpretation Act 1889, which provides rules for statutory interpretation. Even with the help of
the interpretation act, judges are constantly faced with cases that depend on their interpretation of
a word or phrase in a statute for which no adequate denition is provided by the legislature.
4.2.3 Methodologies of interpretation as developed in common law

The following are some established methodologies of interpretation as developed in common law:
1.
The judge should apply the words according to their ordinary, plain and natural meaning. This
is a known as the literal rule, the application of litera legis. One of the most striking examples
of the use of this rule occurred in Race Relations Board vs Dockers Labour Club and Institute
Ltd. (1976) where the House of Lords considered the phrase to the public or a section of the
public, contained in the Race Relations Act 1968. The lords decided that membership of a
private organisation did not come within the phrase and so racial discrimination in this context
could be practised within the law.
79
2.
The literal application need not be applied if to do so would lead to absurdity or inconsistency
within the statute itself. An outstanding example of this rule occurred in Re Sigsworth
(1935), where a man was found to have murdered his mother. In the statute dealing with
the distribution of the mothers estate it was laid down that the estate was to be distributed
among the issue. The son was her only child. The judge held that the common law rule that a
murderer cannot take any benet from the estate of a person he has murdered prevailed over
the apparently clear words of the statute.
3.
If the literal rule fails to assist a judge, they are entitled to consider the mischief rule. This rule,
which was rst settled in Heydons Case (1584), allows the judge to consider (1) what was the
common law, (2) what was the defect or mischief in the common law, and (3) what remedy
parliament in the legislation has provided for the defect. Here a judge is entitled to examine
existing legislation and case law before coming to their decision, with the intention that their
ruling will suppress the mischief and advance the remedy. In Kruhlak vs Kruhlak (1958) the
court held, in connection with afliation proceedings, that a married woman with no husband
to support her is a single woman for the purposes of the legislation. The mischief that the
statute in that case was aimed at was the situation of an illegitimate child with no means
of support. This rule is sometimes referred to as interpretation ratio legis as distinct from
interpretation litera legis.
4.2.4 Relevance of methodologies of interpretation to Islamic legal interpretation

These methodologies of interpretation, while relevant to the common law system, are also relevant
in Islamic legal interpretation. Interpretation is inevitable in most legal systems as can be seen in
both civil law and common law legal traditions.
The need for interpretation in Islamic law is more obvious, because Islamic law starts from selfgiven texts that are revealed in Arabic, thus interpretation is central and fundamental. This is what
it is meant by the statement that Islamic law always has a text-oriented approach. Put simply,
interpretation in Islamic law, which is always guided by the texts, is inherently of philological or
linguistic implication. A Muslim jurist must determine what meanings the words of the text have
in the classical language and whether they are particular or probable meanings. In particular, he
must be able to identify commandments and prohibitions and determine the precise nature of such
commandments or prohibitions, that is, whether they allow, recommend, require, disapprove or
forbid acts.
4.2.5 Language and interpretation of Islamic law

Familiarity with the Arabic language is a prerequisite to understanding the Quran and the Traditions of
the Prophet Muhammad since both have come to Muslims in the language, grammar and morphology
of Arabic. The following examples illustrate the importance of interpretation in Islamic law.
The Quran states: Prove orphans till they reach the marriageable age and if you then nd sound
judgment in them, release their property to them. (Chapter 4, verse 6)
Although the text may seem easy to understand, the actual meaning of marriageable age and the
attribute of prudence or sound judgment need some considered opinion to make their technical
meaning clear to all interested parties.
In another case in the Quran, it was mentioned that a pledge might be a useful means to secure loan
or nancing for someone who is on a journey and away from his family and relatives.
The Quran reads: If ye are on a journey and cannot nd a scribe, a pledge with possession (may serve
the purpose). (Chapter 2, verse 283)
This verse does not, however, restrict the act of pledge to the circumstances of being on a journey.
In fact, the verse simply conrms the fact that a pledge would be a relatively easier instrument to
convince potential lenders or creditors. A pledge is equally permissible in other circumstances.
Exercise 4.2
Briey explain what is meant by the term Ijtihad.
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4.3 Various forms of Ijtihad ranging from textual-based reasoning to

human-based reasoning based on equity and consideration of custom
Ijtihad is a process of reasoning to nd a solution for a case for which there is no direct textual
solution. Occasionally, it involves some interpretative effort to understand the text. While many
forms of Ijtihad are applicable, these are the two basic grounds that explain why Ijtihad is used.
The rst logical form of Ijtihad is to use ones ability to understand the meaning, in any given
text, be it in the Quran or the Traditions of the Prophet Muhammad. While some of the meanings
are clear and straightforward, some are probable in character as they are open to more than one
interpretation. Where a text is open to interpretation, Muslim jurists, guided by broad principles
of Islamic law, will require many skills of interpretation such as philological principles, contextual
understanding and analogical reasoning to put forward their respective best understanding of the
meaning of a particular text.
The Quran states that there must be a written document for a contract that creates future
obligation.
The Quran reads to the effect: O ye who believe! When ye deal with each other, in transactions
involving future obligations in a xed period of time reduce them to writing, let a scribe write down
faithfully as between the parties; let not the scribe refuse to write: as God Almighty has taught him,
so let him write. (Chapter 2, verse 282)
4.3.1 The need for written contacts

The question arises as to whether this imperative really means an obligation to document all
contracts in writing, particularly those of debt-based contracts. The verse seems to indicate such
an obligation. However, Muslim jurists, after taking into consideration the whole structure and
style of the verse, have concluded that the documentation of contracts is only recommended or
encouraged.
The verse implicitly indicates that the purpose of this documentation is to protect the interests of
contracting parties. Documentation is not an integral element to the contract. Protection of the
interest could be achieved through written documentation, as well as from attestation and pledge
that are also mentioned in the Quran. This is the contextual interpretation of the verse that is
upheld by the majority of scholars. Some scholars who are literalists have, however, upheld the rule
of obligation for a written documentation of a debt-based contract.
4.3.2 The denition of solvency

In one of the Prophetic Traditions, the Prophet Muhammad is reported to have stated:
The procrastination of a solvent debtor is unjust which justies him to be punished and his
reputation to be tarnished.
The literal meaning of this tradition may be open to interpretation. In a legal discourse, standards
must, however, be established for both procrastination and solvency, that is, how is one legally
perceived as delaying a nancial obligation and how is one described as solvent? For example, does
difculty in payment due to some temporary cash ow problem mean a state of insolvency?
The common prevailing meaning in the Islamic nancial market is that a person is deemed to
be nancially solvent if he is not declared bankrupt, even though he may have some nancial
difculties. Therefore, he is still expected to make scheduled payments as agreed and documented in
the agreement between him and the creditor/nancier. The onus of burden of proof of insolvency, or
at least extreme nancial difculty, is upon him to prove, otherwise he is deemed to be nancially
capable of paying whatever he owes to the nancier/creditor. The requirement of presumption of
solvency was brought in to ensure that some equitable consideration is given to the debtor. This is
obviously an Ijtihad based on fairness and the Maslahah principle, which is another form of Ijtihad
other than interpretative form of Ijtihad on the texts.
Maslahah what is good or

benecial
4.3.3 Default of payment

The same tradition also speaks about the punishment for those who default on payment of
their debt while they are solvent. Muslim jurists have suggested that imprisonment, penalty and
compensation, foreclosure of their personal assets and physical punishment could all be considered
81
in such cases, but the prevailing practice in the Islamic nancial industry is to impose a nancial
penalty on the solvent defaulter. The proceeds of this nancial penalty are to compensate only for
the actual loss incurred by the creditor/nancier, which does and should not include the cost of fund
or opportunity loss. Any surplus penalty is to be given out to charitable bodies and organisations.

Within an Islamic context, how would new problems in society be resolved if Ijtihad was
not used?
Solution
If Ijtihad were to be neglected or marginalised, the solutions to new problems would either
have to be determined on an ad hoc basis or it might not be possible to nd a solution.
4.4 Qiyas or analogy

Another form of Ijtihad is to extend the ruling already prescribed in the texts to a new case that
shares the same or similar basis of law, called Qiyas or loosely translated into English as analogy.
This is the most systematic and structured form of Ijtihad that requires rigorous procedures
and processes. In Islamic commercial law, the practice of Qiyas or analogy is always relevant,
as analogy is based on ratiocination, that is, to nd the right basis of the legal ruling for the
purposes of extending it to a new case. In section 1.3.7 of chapter one, an example of analogy
involving intoxicating items was explained to show how a legal basis in wine was extended to other
intoxicating items such as spirits and drugs. This is basically a case-to-case comparison.
Key point
Another form of Ijtihad is to extend the ruling already prescribed in the texts to a new case
that shares the same or similar basis of law, called Qiyas or loosely translated into English
as analogy.
4.4.1 Induction
Another form of analogical argument is induction. Unlike analogy, induction starts from the common
rule for a number of cases, which will be similar or identical in relevant aspects. The form of argument
is: A, B, C, D and so on are cases that have the common characteristic X and the rule J; all cases that
have the characteristic X must have the rule J; S has the characteristic X; therefore S has (and must
have) the rule J. A concrete example of induction from Islamic law is the case of interest (Riba). The
Prophet Muhammad was said to have prohibited the exchange of gold for gold, silver for silver, dates
for dates, wheat for wheat, salt for salt and barley for barley unless they were equal in quantity and
delivered immediately.
The jurists, other than the Zahiris (literalists), have unanimously agreed that the above pronouncement
is not due to their particular species but rather to a specic reason. Nevertheless, jurists are divided
among themselves as to the intended reason for the above prohibition. In short, the Shais maintain
that such a transaction (with reference to dates, barley, wheat and salt) is unlawful in the exchange
because they are edible. The Hanas believe the reason for the prohibition is because of the goods
capacity to be sold by weight or measure. According to the Malikis, the exchange is unlawful because
these articles are food and can be preserved, which is the reason for usury in barter trading.
It is obvious that the reason formulated in the respective schools of law is derived from the tradition
through induction, that is, articles of wheat, salt, dates and barley are cases that have the common
characteristic X (the reason) and therefore, subscribe to the rule J (the prohibition of exchange of two
similar Ribawi items unless hand to hand and of equal amount). Subsequently, by way of extension, all
cases that have the characteristics X must have the rule J.
This premise of argument is agreeable to all the schools of law even though they have considered
different rationales (reason) as the underlying cause of the judgement. In accordance, all goods
possessing this reason must be subject to the above prohibition pronounced by the Prophet
Muhammad. For instance, in the Hana school of law, goods that are saleable by weight and measure,
for example raisins, must be subject to the same requirements of exchange, such as quantity and time
of delivery otherwise Riba is applicable.
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Key points
Induction is another form of analogical argument.
Unlike analogy, induction starts from the common rule for a number of cases, which will be
similar or identical in relevant aspects.
4.5 Ijtihad - applied to new and unprecedented cases

The third and the last form of Ijtihad requires referral to some grounds or techniques of law to arrive
at the required solutions. This is the widest scope of Ijtihad as it could be based, for example, on
customs, public interest, blocking the means to evil and juristic preference. Unlike the rst and second
approaches, this approach is more exible and dynamic. Most of the new and unprecedented cases are
the outcome of this kind of Ijtihad. This approach depends more upon the skills of the jurist to put a
systematic argument to their conclusions in tandem with general objectives of the Shariah.
Many examples can be presented to show this methodology of interpretation. Among other practical
examples is the premature distribution of prot arising under Mudarabah contract as well as the
contribution of assets as the capital in equity-based nancing. These will now be explained.
4.5.1 Mudarabah
Mudarabah is a partnership contract wherein one party provides the capital and the other provides
the work and management. Mudarabah is used as a contract in Islamic investment accounts in most
Islamic Financial Institutions (IFIs). The depositors are the investors and the bank is the manager.
Normally, a particular period of the investment account is agreed upfront between the two parties, for
example, a 12-month period. The net realised prot, if any, will be distributed between the two parties
based on an agreed ratio or percentage at the end of the investment period. However, the practice
allows a premature distribution of prot, for example after six months. This is now easier as many IFIs
have adopted a daily basis of prot calculation. The practice of allowing the premature distribution
of prot is supported by the principle of public interest. Above all, the practice is void of any Shariah
prohibited items and elements as prot can be distributed either at the end or prior to the end of the
investment account period, but later subject to a process of rationalisation.
This reects a sort of Ijtihad because the established principles on Mudarabah have stated that prot
can only be realised and distributed after the expiry of the investment period. This might suit a typical
project using Mudarabah as a source of nancing. However, in the eld of Islamic deposit or account,
such a rule might not attract depositors to invest in IFIs. Therefore, exibility, by allowing a premature
distribution to Islamic depositors, would be in line with the principle of the public interest, thus
representing a kind of Ijtihad.
Key point
Mudarabah is a partnership contract wherein one party provides the capital and the other
provides the work and management.
4.5.2 Capital for equity-based nance

As with the capital in any equity-based nancing and investment, the capital should ideally be in the
form of monetary assets, for example, GBP or Japanese yen. However, there is also a possibility that
assets such as machinery, equipment or land can be accepted as capital in a joint-venture business.
There is no Shariah prohibition in taking these assets as capital because they, like money, help to
generate more business opportunities and, hopefully, prot. Also, the presumption of law is always
that every contract or term or clause is deemed approved unless proven otherwise. In order to avoid
dispute, jurists have imposed that these assets must be subject to valuation rst to translate these
assets into capital that is worth a particular amount of money. This will help in terms of determining
the prot or loss sharing due to the liquidation of the joint venture or company.
Exercise 4.3
The principle of capital introduced as equity-based nancing and investment is that it should
be in the form of cash. Explain why capital introduced in the form of another asset might also
be acceptable as capital?
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4.6 Need of Ijtihad in modern times

Although Islam is based on revelation, this stopped with the demise of the Prophet Muhammad. New
cases are inevitable and require a Shariah solution as and when they occur. Issues such as short sales,
purchasing and trading of options, swap transactions and future commodity markets are contemporary
nancial issues. Also cases can originate from old contracts when they are implemented in a modern
framework. Issues such as the redemption of Musharakah capital or the oating rate of rental payment
based on certain benchmarks such as the London Inter-Bank Offer Rate (LIBOR) are real and bona-de
issues in contemporary Islamic nancial markets.
Obviously, these issues need some Shariah perspective if not a solid solution. It is against this
background that the need for Ijtihad arose. Without resorting to Ijtihad, two possible scenarios are likely
to arise:
Islam will be defective and unable to face the challenges of modernism and post-modernism in all
aspects of life
solutions proposed to solve these new problems may not be grounded on accurate Ijtihad because
they are ad hoc exercises undertaken by non-qualied jurists to satisfy the requirements of society.
Ijtihad, however, offers creative reasoning supported by structured and systematic methodologies, which
provides a sound basis for a new legal solution.
Ijtihad is the vehicle through which best-probable solutions can be provided in a manner that is
systematic and transparent. A fact to be noted is that Ijtihad, unlike texts of the sources of law, will only
produce rulings that are probable in character. The probability of the legal ruling is the parameter of
Ijtihad. Also, for Ijtihad to achieve this status of probability, it must be fullled by qualied jurists and
scholars. Modern Islamic societies have enhanced the function of Ijtihad to meet modern needs more
satisfactorily. Among these measures are:
1.
The scholarship of Mujtahid

The scholarship of the Mujtahid (the one who undertakes Ijtihad) should be well established and
accepted by the community. This could be achieved through proper qualication or practice, or both.
2.
Collective Ijtihad
Instead of relying on personal views and reasoning, a collective Ijtihad is adopted. Therefore,
views, opinions and resolutions issued and pronounced by some international bodies, such as the
International Islamic Academy of Fiqh of the OIC, the AAOIFI Shariah boards and other IFIs that
have issued Fatwas are always worthy of adherence.
3.
The publications of resolutions

The publication of resolutions means that the stakeholders of Islamic nance can have access to
them. Some Ijtihads are well grounded and hence, well accepted across jurisdictions. The acceptance
of these views by the general public across jurisdictions is the key evidence of their soundness and
validity.

Ijtihad is a form of creative thinking used to solve a particular problem. Can anyone exercise
Ijtihad to produce a valid solution to a problem or are specialist skills required?
Solution
Although Ijtihad is a form of creative thinking, it must be performed only by someone who
has the required knowledge and skills. It is only useful and valid if it is performed according
to the correct methodologies and guidelines. A non-expert would therefore not be able to
perform Ijtihad.
4.7 Practicality of Ijtihad in solving modern issues and problems

Ijtihad should have a practical application in solving modern issues and problems not only in Islamic
nance but also in other elds of law. Ijtihad sometimes interprets the meaning of a verse, qualies its
meaning and on other occasions reinterprets the meaning. One tradition accepted by the majority of
the scholars is the prohibition of a person selling something that they do not own or possess. Some
jurists have, however, contended that the meaning of this tradition does not refer to non-physical
84
ownership or possession. It refers to the ability of the vendor to deliver the sold asset as and when
requested by the buyer. In other words, according to this interpretation, a trader may sell something
that he does not own provided he is in the capacity to deliver the said asset upon concluding a contract.
4.7.1 Qualications and contextualisation of interpretations

In giving a proper interpretation a jurist may qualify or exempt some application from the general
principles. This is also part of the interpretative effort. A jurist may also attempt to give a contextual
interpretation of a text. As discussed some jurists have interpreted the pronouncement, Do not sell
what you do not own, to mean that the trader can still sell something he does not own at the time of
contract provided he is in a position to deliver the said asset to the purchaser. This interpretation refers
to a contextual interpretation, that is, the context in which the prohibition was pronounced.
In another similar tradition the pronouncement, Do not sell (something) until you have possessed
(it), has been qualied by a leading scholar as a prohibition relating to food items only. As for other
items and goods, no such requirement is needed. This is also an example of how a qualication or
a contextual interpretation has been attempted. Other scholars would apply the prohibition in this
tradition to all items and goods.
4.7.2 Dealing with new situations

On another dimension, Ijtihad could offer a fresh resolution that is not necessarily backed by previous
views and opinions. Some issues were not deliberated on in the past as they were not relevant given
the time and environment. However, new issues need modern solutions and contemporary scholars
must provide the best probable answer. For example securitisation is a new idea that receives
endorsement by most contemporary scholars. Basically, securitisation refers to a process of converting
something into its cash equivalent in the form of papers that are tradable in the secondary market. It is
through securitisation that an illiquid asset can be transformed into tradable securities.
The product of securitisation is known as Sukuk, that is, certicates of investment. Sukuk al-ijarah, for
example, reects the process of the division of the ownership of tangible assets, for example, the leased
assets, into units that have equal value and the issuance of those units to investors. A Sukuk holder
or investor is essentially a benecial owner of this asset, which is divided proportionately among the
investors. For this reason, Sukuk investors are entitled to receive the rental payments paid by the lessee.
The development of Sukuk al-ijarah, certicate of investment in leased assets, is a new compliant
solution to mirror the xed-income instrument in the conventional bond market.
Exercises 4.4
A company wishes to borrow $100 million to nance an extension project. The company
balance sheet shows that it owns a factory worth in excess of $100 million. Compare and
contrast how the company could raise this nance by issuing either bonds or a Sukuk.

Explain why it is acceptable that Ijtihad, more often than not, tends to have created more
than one opinion instead of achieving one common view.
Solution
Ijtihad requires personal reasoning by jurists. Although jurists are governed by the general
principles of the Shariah, this does not necessarily lead them to one opinion. Differences of
opinion in Ijtihad are not abnormal. On the contrary, it contributes to the development of
Islamic law. For example, the issue of whether someone can sell an asset without owning it is
a subject of Ijtihad. While some scholars have not disapproved such a transaction, some have
found it to be compliant provided the ability to deliver the asset on the part of the seller is
certain. This gives room for product development in some cases where the ownership is not
established at the time of contract.
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4.8 Conclusion
Leading on from the preceding chapter, this chapter explained in more detail the crucial concept of
Ijtihad or interpretation as practised within Islamic commercial law. The primary sources of Islamic
commercial law were written hundreds of years ago. Life in the 21st century is complex and you
were introduced to how Ijtihad may help to resolve current issues in Islamic nance, which were not
relevant at the time the primary sources were written. You should now see that Ijtihad, in its various
forms, is an efcient tool in product development in 21st century Islamic nance.
The following chapter turns to the formation of contracts, an essential topic in the study of Islamic
nance.
4.9 Summary
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1.
the Quran and the Traditions of the Prophet Muhammad require interpretation (Ijtihad) when
applied to much of the modern commercial world
2.
Ijtihad, from a basic legal denition, is to make use of ones best ability under the guidance of
the broad principles of Shariah in the search for a legal status
3.
the rst logical form of Ijtihad is to use ones ability to understand the meaning, of any given
text, be it in the Quran or the Traditions of the Prophet Muhammad
4.
Qiyas is another form of Ijtihad, which that extends a ruling already prescribed in the texts to a
new case that shares the same or similar reason of law, that is, through analogy
5.
the third form of Ijtihad requires referral to some grounds or techniques of law to arrive at the
required solutions, and depends more upon the skills of the jurist to put a systematic argument
to their conclusions, in tandem with the general objectives of the Shariah
6.
Ijtihad has a practical application in solving modern issues and problems not only in Islamic
nance but also in other elds of law.
Chapter 4 Answers
Exercise 4.1
(A) False.
Ijtihad is valid irrespective of the availability of relevant text as long as there is a need for
some form of interpretation. In other words, the text is probable in meaning and therefore
needs or requires an interpretation to identify the most likely intended meaning.
(B) True.
Ijtihad was not needed during the lifetime of the Prophet Muhammad because the ultimate
reference was the revelation.
Exercise 4.2
Ijtihad is the total effort required in terms of reasoning on the part of the Mujtahid/scholar to
nd a solution to an issue.
Exercise 4.3
The whole purpose of having capital in the partnership is to enable the business venture to
commence. Although cash is ideal for this purpose, cranes to be used for construction work or
machines to be used for production work are also useful. Cash invested is often used ultimately
to purchase assets such as cranes or machinery to support the business venture in addition to
meeting the working capital needs.
Exercise 4.4
Issue bonds - if the company decides to issue bonds it will have the bonds created and
exchange these for the nance required. The bonds will acknowledge the borrowed amount and
the obligation to repay this amount along with an agreed element of interest.
Issue a Sukuk - the company could issue a Sukuk that under the terms of which they agree
to sell the factory to investors for the required $100 million. As the owners of the factory,
the Sukuk holders would normally lease the factory back to the company. The relevant rental
payment typically includes the principal amount and an element of prot. In this way the
company gets the cash injection it needs. It also maintains the use of the factory until it
ultimately regains ownership of the factory. The company would never resort to paying interest.
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Revision questions
Revision Questions
1.1 Which of the following is true with regard to the Prophetic statement on Ijtihad?
(A)
The Prophet Muhammad endorsed the practice of Ijtihad for use after scholars have
considered both the Quran and the Traditions of the Prophet Muhammad.
(B)
Ijtihad is an exercise that can be freely undertaken by anyone involved in Islamic nance.
(C)
Ijtihad is valid even without prior reference to the Quran or the Traditions of the Prophet
Muhammad.
(D)
The Prophet Muhammad restricted Ijtihad only to his time.
1.2 Ijtihad practised on the four food items as mentioned in the Prophetic Tradition has resulted
in three different views on the probable reason for this prohibition. Which of the following
is not a probable reason?
(A)
Edibility.
(B)
Medium of exchange.
(C)
Measurability and weightability.
(D)
Main and preservable foods.
1.3 Ijtihad is still relevant and useful in some cases where divine texts are provided because:
(A)
the legal texts in the Quran and the Traditions of the Prophet Muhammad are unlimited
but potential issues in life are limited
(B)
Ijtihad is required in all text interpretations
(C)
the text might be probable and therefore require interpretation
(D)
Islamic law in totality has given detailed explanations and comprehensive illustrations of
legal principles in the divine texts.
1.4 What does the term ratiocination refer to?

(A)
Extending an old law to a new case.
(B)
Interpretation to render texts more clearly understood.
(C)
Establishing new contracts types when they are needed by society.
(D)
Discovering a legal basis for a given original ruling.
1.5 Which of the following is an appropriate measure to enhance Ijtihad?

(i)
A high level of scholarship on the part of Mujtahid (the practitioner of Ijtihad).
(ii)
Ijtihad is open to all to exercise.
(iii)
Collective Ijtihad.
(iv)
Making the bases of Ijtihad known to other scholars.
Mark all that apply:

(A)
i and iv
(B)
ii
(C)
i, iii, iv
(D)
all of the measures.
Question 2
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(A)
Why has Qiyas or analogy been deemed to be part of Ijtihad?
(B)
Explain why capital, in the form of assets that are subject to valuation, can be accepted
as valid capital in equity-based nancing or investment.

1.1 (A) The Quran is the primary source of reference while the Traditions of the Prophet
Mohammad will be referred to if no relevant reference can be found in the Quran. Thus, Ijtihad
must refer to these two primary sources before considering other techniques such as Qiyas,
Istihsan and so on.
Revision questions
Answers
1.2 (B) Various schools of law mentioned edibility, the fact that the food is measurable and
weighable and that the food belongs to the main food category and can be preserved are the
probable reasons why the exchange of these four food items must be of equal amount and/or
spot as the case may be in the exchange. The function of medium of exchange was never
mentioned.
1.3 (C) Scholars rely on Ijtihad even in cases where the texts are provided because these texts
could give more than one meaning and thus require some interpretation to identify the most
likely interpretation or meaning intended by the lawgiver.
1.4 (D) Ratiocination is a process to discover a ratio or the basis of a legal ruling in a given
original case such as the basis of intoxication in the prohibition of wine drinking.
1.5 (C) The quality of the practitioner of Ijtihad coupled with a concerted effort on the part of the
scholars is believed to add value to decisions reached by Ijtihad. Furthermore disclosure of the
basis of these decisions will ensure that Ijtihad-based decisions are accepted and upheld.
Question 2
(A) Qiyas or analogy requires the jurists to understand the basis of law contained in the text and
later to extend this basis to a new case, provided the new case shares the same legal basis. This
requires an effort to be undertaken by the jurists, thus it is an Ijtihad.
(B)
Like cash, assets in the form of land or equipment for example, are useful when undertaking
a new business venture. There is no prohibition on taking these assets as capital in a jointventure business. Some, if not all, of the cash-based capital will be converted into assets to
undertake the business venture.
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Chapter ve
Learning outcomes
explain the meaning of contract (Aqd) in Islamic

commercial law
explain the requirements of a valid and enforceable

contract.
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The meaning of contract.
The requirements of a valid and enforceable contract.
5.0 Introduction
Contracts are the foundation upon which Islamic nancial products rest.
The creation of nancial products results from the ability to use one or
more traditional contracts to meet the requirements of the customer. In
this chapter you will be introduced to the meaning of contract as used in
Islamic commercial law. This will include an explanation of what makes a
valid and enforceable contract. An understanding of what constitutes a valid
contract is essential to the creation of legitimate Islamic nancial products
and services which are based on such contracts.
Majallah al-Ahkam al-Adliyyah [the Islamic Civil Code of the Ottoman Empire promulgated in
1876] or translated into English as the Mejelle states that man is social by nature and that social
life is essential to him. Therefore, in view of the fact that a man is social by nature, he cannot live in
solitude like other animals, but is in need of co-operation with his fellow men in order to promote
an urban society. Every person, however, seeks the things which suit him and is vexed by any
competition. As a result, it has been necessary to establish laws to maintain order and justice.
Majallah al-Ahkam al-Adliyyah [the Islamic Civil Code of the Ottoman Empire promulgated in 1876]
5.1 Meaning of contract (Aqd) in Islamic commercial law

Islamic commercial law, known in Arabic as Fiqh al-Muamalah, constitutes an important branch of
law dealing with issues of contract and the legal effect(s) arising from a contract. The effect of a
contract is as important as the formation of a contract because a contract could be valid, invalid or
voidable. The contract is central and fundamental to many aspects of life.
The whole idea of contract is to facilitate the rightful and legitimate needs of people towards each
other. The contract could be political, social, commercial or even family-based such as those relating
to marriage and divorce. The Mejelle highlighted above has, however, focused mainly on commercial
contract as the Mejelle related to the civil code of the Ottomans.
Exercise 5.1
Using an example from your own everyday life explain why contracts are a fundamental part of life.
5.2 The nature of contract

The contract is known in Arabic as Aqd, which translated means to tie. Put simply, a contract ties
both the offeror and offeree.
Contract plays a signicant role in fullling the human need to deal with each other. A contract is a
complex legal issue both in its jurisprudential foundation and its practical function. Intellectually, it
is perhaps the most rewarding eld of the law in action. Contracts have been an integral element of
human life, in both primitive and modern times. Without contracts, dealings and interactions among
people could not have been possible. Contracts express the intention of the parties and establish
their rights and liabilities.
However, from a wider perspective, contracts can include a broad range of relationships, be it
religious, political, social or economic. In other words, contracts apply to the ruler and the ruled,
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husband and wife, as well as to a nancial contract such as sale, lease or partnership. This section
concerns contracts that are nancial in nature and create nancial rights and liabilities.
5.2 Contracts and the Quran

O ye who believe! Eat not up your property among yourself in vanities; but let there be amongst you
trafc and trade by mutual goodwill.
Quran 4:29
As mentioned in chapter one, Islamic law, unlike other legal systems, starts from given premises in
the form of the Quran and the Traditions of the Prophet Muhammad. The Quran, as the primary
source of law, deals with the principle of contract in one way or another. The Traditions of the Prophet
Muhammad explain and illustrate the meaning and implication of a contract from an Islamic legal
perspective.
The Quran mentions many types of contracts including about 40 verses dealing with a dozen
commercial contracts that are nancial in character.
Central to these Quranic verses is verse 1 of chapter 5 of the Quran that enjoins believers to
full their contracts which is also supported by other verses with the common theme of keeping a
promise and fullling all obligations.
The Quran uses a technical word for a contract which is Aqd in Arabic, meaning to tie or to knot.
The verse above attaches an obligation to full all contracts made. Obviously, obligation has a legal
connotation that imposes some legal injunctions and implications on the parties to a contract.
As in other legal systems the contract in Islamic commercial law reects the consent of both parties to
a contract.
The Quran (chapter 4, verse 29) prescribes on Muslims not to devour your assets among yourselves in
vanity, except in trading by your mutual consent.
The verse explains that the transfer and exchange of properties, assets and services will only be valid if
they are based on the consent of the parties involved. Mutual consent is normally achieved through a
contract that is based on an offer from one party (offeror) and an acceptance by another (offeree).
In addition to verses that establish the principle of the sanctity of a contract and its rationale, there are
others that reveal a relatively advanced stage of commercial contracts, for example, sale, hire, forward
sale, debt-based transactions, charges in Rem or personal guarantee as security and duciary contracts
such as deposit taking. The mention of these contracts in the Quran gives the impression that
contracts in their various manifestations were not uncommon during the time the Quran was revealed.
Key points
Contract is known in Arabic as Aqd.
A contract ties both the offeror and offeree.
5.3 Contracts and the Prophet Muhammad

The Traditions of the Prophet Muhammad not only reafrm the meaning and function of contract but
also provide sufcient illustrations to explain what a valid contract is vis--vis an invalid one.
The Prophet Muhammad has been reported to have pronounced: The property of a Muslim is not lawful
for others to enjoy unless by the owners consent.
This tradition reafrms the need for a contract to transfer property from one to another without which
the consumption of anothers property is unlawful. The Traditions of the Prophet Muhammad, as the
case law of Islam, has illustrated many forms of both lawful and unlawful contracts. For example,
the sale of the foetus of an animal is prohibited as its delivery in the future, cannot be guaranteed,
for example, the foetus could have died while in the womb. This case and many others reafrm the
function of a contract, which is to express the real consent of the parties involved. The presence or
absence of any element that might affect the quality of the consent, as will be discussed later, will
render the contract void or voidable.
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5.4 The technical denition of a contract

Generally speaking, contract has been dened in modern law as an agreement between two or more
persons that creates an obligation to do or not to do a particular thing. Surprisingly under traditional
Islamic commercial law there was no technical or precise denition of a contract. The nature of
contract was essentially dened when considering sales (Al-bay), as a sale is the most common
medium under which a contract can be concluded. Issues such as offer and acceptance and how they
relate to each other and how they lead to particular legal rights and liabilities were discussed with
reference to a sale contract and not in a specic chapter on contract per se. The duty of contemporary
scholars and legal practitioners is to extract from these extensive discussions principles to govern
the general theory of contract in Islamic law. Thus, the discussion of the general theory of contract in
Islamic commercial law is a recent phenomenon.
The Majallah al-Ahkam al-Adliyyah, or Mejelle referred to earlier, was most likely the rst attempt to
give a precise technical denition of a contract or Aqd. It dened a contract or concluding a contract
as the connection of an offer with an acceptance in a lawful manner which marks its effect on the
subject of that connection. As can be seen, this denition is similar to the denition of a contract
in other legal systems. However, the Islamic denition is distinctive as it qualies the manner and
impact of concluding a valid contract with the instruction that it should comply to Shariah principles
as expressed in the statement in a lawful manner. The proper and valid manner of concluding a
contract will make the contract valid and its result enforceable. How to achieve a proper conclusion of
a contract will be elaborated in the next section.
Key point
A contract is dened in modern law as an agreement between two or more persons that
creates an obligation to do or not to do a particular thing.
Exercise 5.2
Would a contract to form a partnership to produce alcohol for export to a non-Islamic export
market be a good and valid contract from an Islamic perspective?

Islamic commercial law did not develop a theory of contract until recently through the
codication of civil code of the Mejelle. Did this mean that Muslims in the past were not
exposed to the importance of contract and its requirements?
Solution
Structured discussions of the denition of contracts, its elements and various possible
practices and implications was not documented in the past. This does not necessarily mean
that the contract was foreign to Islamic civilisations. The Quran itself specically mentioned
contracts and their sanctity. Muslim jurists have focussed discussion pertaining to contract on
the sale contract, where an explanation is given as to the meaning of offer, acceptance, etc.
The same is repeated in other discussions on other contracts such as lease, partnership and
so on. In other words, the discussion was not systematic in one chapter but was made in all
transactions such as sale, lease, partnership etc.
5.5 Requirements of a valid and enforceable contract

For a valid and enforceable contract to take place under Islamic commercial law, certain conditions
must be met. Islamic commercial law, generally speaking, has six elements that are integral to a valid
and enforceable contract. Each of these elements is a requirement on its own merit to the effect that
the non-compliance of each of them will render the contract invalid or voidable though the other
remaining requirements may be in order. The six elements are illustrated in the following diagram:
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Figure 5.1 Six elements integral to a valid and enforceable contract
Consideration
Object
Offeree
Offeror
Acceptance
Offer
Contract
Compliance with Shariah principles
These six elements are logical requirements from a common sense perspective as a contract, in
most forms, is dependent on them to exist. Unlike other legal systems, Islamic commercial law adds
another requirement as the basic foundation; that after satisfying all six elements, the contract must
be compliant to Shariah principles.
The necessary elements of a contract are different in other legal systems. While offer and
acceptance, consideration and an intention to create legal relations are fundamental elements in
common law, the concept of consideration is not central in civil law.
Key points
The requirements for a valid contract in Islam are as follows:
offer
acceptance
offeror
offeree
object
consideration.
In addition, the purpose and the objective of the contract must be compliant with
Shariah principles
5.5.1 An offer
An offer is a statement of intention expressed by one of the parties inviting the other party to
accept their proposal. An offer could technically be initiated by any party to a contract be they a
potential buyer or seller. The one who initiates a proposal is known as an offeror and the one to
whom the proposal is addressed is called the offeree. The Mejelle (the civil code of the Ottoman
caliphate) denes an offer as:
The statement made in the rst place with a view to making a disposition of property and such
disposition is proved thereby.
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An offer should be clear, absolute and communicated to the offeree. This basic requirement is
similar to other legal systems. Some scholars have required that an offer must refer to a denite
and specic party while others do not require such a condition. The view of the latter scholars is
manifested in their writings in the following example.
If someone has presented his goods for sale and offered to sell them at a certain quoted price, the
sale is concluded for the one who has paid such an amount because he has heard the offer or has
been informed about it. The sale is binding on the offeror and he has no right to decline the sale of
these goods, except where the buyer who came forward to purchase has not heard of the offer or has
not been informed about it.
However, this situation must be distinguished from an invitation to treat. Unlike a valid offer, an
invitation to treat is simply an invitation to the public at large to give their offer for particular goods.
Inviting the public through, for example, advertisements or the display of goods with a tagged
price is not essentially an offer from the party who advertises or displays his goods. A member of
public interested in the goods may approach the merchandiser to give his offer to purchase, but
the acceptance should come from the party who advertises and displays the goods. As it is merely
an invitation to treat, the consent of any of the public to purchase shall not be deemed as an
acceptance because this invitation is not an offer from a Shariah perspective.
The same position is upheld under common law in the UK. One of the leading cases to uphold this
position is Pharmaceutical Society of Great Britain vs Boots Cash Chemists [1953] 1 QB 401. The
defendants, Boots Cash Chemists, were charged under the Pharmacy and Poisons Act 1933 (UK),
which provided that it was unlawful to sell certain poisons unless such sale was supervised by a
registered pharmacist. Boots was one of the rst stores during that time operating a new system of
sale. When a customer entered the store he was given a basket and could pick items off the selves as
they wished and place them in the basket. The customer would then take it to the cash desk next to
which a registered pharmacist would sit.
The plaintiff, the Pharmaceutical Society of Great Britain, argued that the display of goods was
an offer to sell that was accepted by the customer upon placing the drugs in the basket, at which
moment the contract of sale was formed. This was deemed to breach the sale of certain drugs
without the supervision of a pharmacist. The court ruled that the display was only an invitation to
treat. A proposal to buy was made when the customer placed the articles in the basket. Hence the
contract of sale would only be made at the cashiers desk. That being the principle, the shop owners
had not made an unlawful sale. Similar decisions were upheld in many other cases relating to an
invitation to treat such as Fisher v Bell (1961), Grainger v Gough (1896) etc.

Having read the details of the Boots Cash Chemist case above, explain what you would
expect the Shariah perspective to be on this point of law.
Solution
Islamic commercial law also recognises the principle of invitation to treat as distinct from
a proper offer. One of the features of this principle is that this invitation is open to all
without specifying a particular offeree. Also, Islamic law holds that the display of goods in a
shop generally does not constitute a proposal to sell. The shop-owner merely holds himself
prepared to consider proposals made to him at the suggested price, normally tagged to the
items. The position is therefore the same for both conventional and Islamic businesses.
Key point
An offer is a statement of intention expressed by one of the parties inviting the other party to
accept the proposal.
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5.5.2 Accepting an offer

An acceptance is an expression of approving the proposal by the offeror with regard to the same
details as expressed in the offer. Any variation in the acceptance with regards to some or all the
details in the offer would turn this acceptance into a counter offer or counter proposal. Therefore, it
is important to ensure that the offeree accepts the offer as it was given without putting or deleting
anything that was not originally included. Otherwise, this kind of acceptance will be deemed a new
offer from the offeree to the offeror, which gives the choice to the original offeror to accept or
otherwise. This logic will continue until both parties have agreed on all the specications and details
mentioned in the offer. Only when this happens can it be said that the contract is legally concluded
because the acceptance conforms to the offer, thus the meeting of two minds or, to put it simply,
mutual consent, has been reached.
If an offer is to be accepted, the unequivocal acceptance of that offer must be communicated to
the person who has made the offer. It is important to note that the expression of both the offer
and acceptance could be made verbally or in writing or even by the conduct of the relevant parties
that indicates a particular proposal and acceptance by the other party. This also includes a written
mode of expression that covers all modern means of communications such as the telephone, fax
or email. The Shariah does not require or insist on any specic technique to reect an offer and an
acceptance. Equally important is that both the offer and acceptance must be communicated to each
other. A mere expression, be it verbally or in writing, that is not communicated to the knowledge of
the other party, be it the offeror or offeree, is not a valid offer or acceptance.
5.5.3 When acceptance takes place

The communication of an offer and its acceptance means that both parties are informed of the
others intention. Communication methods will obviously differ depending on whether it is an inter
praesentes contract or an inter absentes contract. If the two parties are physically present (inter
praesentes), then communication should be direct and instant or simultaneous as they are physically
close to one another. In an inter absentes contract, communication depends on the medium through
which the offer or acceptance, or both, are being communicated to each other.
While it is clear that communication of an acceptance can take many forms, it is less clear when
acceptance takes place. When an acceptance is made over the telephone, the acceptance is deemed
to occur at the time and place that it is heard by the offeror. This rule should also apply to other
instantaneous forms of communication, such as a direct offer and acceptance between two parties
who are physically present in the same place. For non-instantaneous forms of communication, the
acceptance is effective upon the receipt of the acceptance through letter, email, telex or facsimile.
Islamic commercial law, unlike other legal systems, requires that the acceptance to the offer be
immediate so both the offer and acceptance are jointly connected in one single session without any
gap in time. This is the requirement of the essential unity of time, technically known as the session
of the contract, which should be continuous and not disrupted. Therefore, certain interruptions
during the session of contract, such as stopping to eat or the discussion of other subjects or a change
in position or attitudes, or even falling asleep are deemed to terminate the session of the contract,
thus making the offer lapse in terms of time. This requirement is relatively easy within contracts
inter praesentes but it is problematic with regard to contracts inter absentes. Here the Muslim
jurists have to extend the doctrine to the time when the offeree receives a particular offer. As for
the acceptance, the unity of time terminates or lapses if the offeree has failed to respond to the
offer within the timeframe mentioned in the offer or when the offeror revokes his offer, or when the
offeree makes a declaration of acceptance.
Exercise 5.3
Indicate which of the following statements are true/false.
(A) In inter-praesentes contract, both offer and acceptance may not be instantly linked to each
other at the same time.
(B) Other than providing a general principle on the obligation to full a contract, the Quran
does not mention contracts in any other context.
(C) The session of contract refers to the meeting of two minds within the same time period.
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5.5.4 Parties to a contract

With regard to parties to a contract, there must always be two parties: the offeror and the offeree.
The two parties could be individuals, a group of people or even a legal entity such as a company.
For a contract to be concluded there must be more than one party otherwise the offer cannot be
accepted and, therefore, there is no conclusion. However, it is important to note that Islamic law,
unlike English law, considers unilateral contracts such as donations, gifts, wills and endowments as
a normal contract, although the offeree will not have to accept the offer to make the contract valid.
This kind of contract is valid and enforceable even though the offeree has no notice or knowledge of
the proposal made by the offeror. In other words, the contract concludes once the offeror, normally
the donor, declares their intention to write a will to someone irrespective of whether or not the
offeree or recipient is aware of this declaration at the time of contract. This constitutes a one-party
contract to the effect that the consent or acceptance by the offeree or rather the recipient is not
required. The offeree has no obligation to pay any consideration or price for whatever he receives
from the offeror. Under English law this kind of contract is known as a contract under seal that must
be registered at the court to be valid and enforceable.
Under Islamic commercial law some contracts are concluded through three parties, such as the
assignment of debt (Hiwalah), which involves the transferor (principal debtor), the transferee and
the beneciary. Having said this, technically speaking, the consent of two parties, the transferee and
beneciary/claimant, is sufcient to effect a valid assignment or transfer of debt. The consent of the
transferor is not really required as his consent is insignicant. The transferor merely transfers the
right to claim an amount of money owing from him to another person so the beneciary or claimant
may claim that amount of money from another party, namely the transferee. All in all, this contract
too has two dominant parties whereby the third party, although integral to the whole contract, is
supplementary to the process.
Key points
At least two parties must be represented in concluding a contract.
The parties can be individuals, a group of people or even a legal entity such as a company.
The most relevant issue pertaining to parties to a contract is legal capacity or capability covering
their rights and liabilities. Islamic commercial law has placed a signicant focus on the issue of the
capacity to conclude a contract.
Even the Quran has indirectly alluded to this requirement as seen in verse 6 of chapter 4, prove
orphans until they reach marriageable age and if you nd in them sound judgment, deliver to them their
properties.
5.5.6 Physical and intellectual maturity

In Islamic commercial law, no person can validly conclude a legal transaction without rst having
attained physical and intellectual maturity, that being the equivalent of the majority age. To enjoy full
capacity, a person, whether male or female, should attain physical puberty (Bulugh) and enjoy sound
judgment also known as prudence (Rushd) in his or her judgment.
Having said this, most modern civil codes in Muslim countries have adopted a particular age as the
majority age to make the law standard and applicable to all cases. Most countries give 18 as the age of
maturity, thus the age when someone is capable of concluding a contract. This approach, particularly
in modern times, is acceptable to provide certainty in law. If a particular law deems a certain age as
having attained the age of majority, then it will be taken as such without the need to examine the
actual attainment of that with reference to marriageable age and prudence status. The burden of
proof will be shifted to any party who claims something contradictory to the provision of law.
5.5.7 Aspects of religion

Aspects of religion could also be relevant to contracting parties. Generally speaking, in most nancial
contracts and matters, there is no requirement that all the contracting parties should be Muslims.
Thus, a Muslim party can conclude a contract with a Muslim and non-Muslim party alike. This applies
to most Islamic commercial contracts such as sale, lease, partnership, agency, safe keeping or deposit,
charge, assignment of debt, guarantee and bailment.
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Throughout the history of Islamic commercial law many concrete treatises and contracts have
been made for which documents exist to demonstrate that transactions between Muslims and
non-Muslims were not uncommon, including partnerships and joint ventures. The only exception is
limited to contracts that require religion as the basis of performance, such as the appointment of a
manager under hire or agency contract to manage a mosque or any other holy place in Islam.
The same restriction applies to one type of partnership in Islamic commercial law known as Shirkah
al-Mufawadah, which allows the partners to have absolute rights on behalf of the other partners to
transact with any third party. The liability under this form of partnership is, however, not limited to
the respective nancial contribution by the partners but may extend to the personal liability of the
individual partners. Therefore, aspects of religion may be relevant to the entering into contracts that
are non-compliant by a non-Muslim party without any prior approval from his Muslim partners(s).
This will obviously complicate the management and liability of the company.
Key point
A Muslim party can conclude a contract with a Muslim and a non-Muslim party alike
Exercise 5.4
Explain why it is imperative that when entering into a contract, one must have the legal capacity
to do so (this means that, one is not a minor, a drunken person or a person of unsound mind).
5.5.8 Object of the contract

In addition to the contracting parties and offer, as well as acceptance, the object of the contract is
integral to the formation of a valid contract. The object of the contract refers to the subject matter
that relates to the contract. The subject matter could possibly be an asset, service, money, capital,
liability, rights and receivables.
In a sale contract, for example, the subject of sale is a particular asset that the buyer is interested to
purchase from the seller. This could be a house, a car or equipment. In a currency exchange, the asset
is one of the currencies to be exchanged for another. The object in this currency sale is the currency
provided by the seller, whereas the currency provided by the buyer is deemed as consideration.
As for an Ijarah contract, the object of the contract is the services provided either by an asset or
a person. These are some common examples of an object in any contract. Islamic commercial law
has prescribed a few conditions to render this asset compliant to Shariah principles. Among these
requirements are:
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a)
The object must be an approved asset from the Shariah perspective. This condition is
required by the religion perspective that deems some assets as either impure or not approved.
These prohibited assets include pork, liquor etc. For services and activities they include
entertainment, and pornographic and gambling activities. Therefore, an IFI cannot nance a
customer under Murabahah to purchase, for example, equipment that produces only special
bottles for liquor production.
b)
This object must be made known and determined to avoid any element of Gharar
(uncertainty). Gharar would normally lead to a dispute among the parties. An object that
cannot be known and identied such as a foetus in the womb of an animal, protection under
modern insurance schemes or an object to be discovered later is not a valid subject matter.
The exception is given to both Istina and Salam contracts where the subject matter is not yet
available at the time of contract. However, the object under both Salam and Istina must be
able to be identied by certain specications. This is to avoid uncertainty. In this respect, the
doctrine of mistake is established in common law. A mistake is an incorrect understanding by
one or more parties to a contract and may be used as grounds to invalidate the agreement.
Therefore, the requirement to be certain about the object of contract in Islamic law is to avoid
the invalidation of the contract.
c)
The object must be able to be delivered at the contracted time of delivery. The purpose of
entering into a contract is to enjoy the benet of an object of a contract (from the buyers
perspective). Therefore, any object that cannot be delivered because of its unavailability, such
as lost property or due to legal caveat or encumbrance, is not a valid or complete contract. The
sale of an encumbered asset is voidable pending on the consent of the pledge or mortgage.
d)
The nature of the objects must suit the respective contracts. For example, for an Istisna
contract, the subject matter must be an asset to be constructed or manufactured. It cannot
be an asset that is already in existence as Istina requires some transformation of raw material
into a nished product. As for a lease or Ijarah contract, the object must be something where
the substance of the asset will remain intact after usage. Thus, one may lease a vehicle or
house but things like fruits or vegetable or petrol as the substance of these assets once
consumed will not remain intact.
Key points
Object of contract refers to the subject matter that relates to the contract.
The subject matter could possibly be an asset, service, money, rights or receivables.

An entrepreneur intends to operate a business that provides education to students who
have failed to gain admission to universities or colleges. For this purpose, he needs to have
a building that can accommodate the students. As he has no building and insufcient cash,
he plans to engage a contractor to build him the necessary student accommodation. He
will purchase the building from the contractor when it is complete in two years time and
will pay the cost of construction within two years of the date of construction. Would this
transaction contradict Shariah requirements pertaining to the object of sale?
Solution
Essentially, an object of sale must be in existence at the time of contract to avoid Gharar, for
example, uncertainty in terms of asset specications, deliverability, etc. However, Shariah
principles allow some sales such as Istisna and Salam which involve future delivery of assets.
For these contracts to be valid, the detailed specications and the time of delivery of the
assets must be determined and agreed upfront. In the above case, the entrepreneur would
need to enter into an Istisna contract with the builder and the detailed specications and
the time of delivery of the accommodation would need to be agreed when the contract was
entered into.
5.5.9 Consideration
The last requirement for a valid contract is the aspect of payment or consideration. This is a
payment normally paid by the buyer or lessee to the seller or lessor respectively. In the sale
contract, it is known as the price and in the contract of lease it is known as the rental. There is a
possibility that the payment will be in the form of a fee paid for services rendered, particularly
under the Wakalah contract. The following are the relevant principles governing the consideration in
Islamic law of contract.
(a)
Consideration must be Halal in character. This is because consideration in Islamic commercial

law could be in the form of money, an asset or even services. A buyer under the Istisna
contract, for example, could pay the seller either in the form of money or in the form of
asset, such as giving the seller a vehicle, or providing services to the seller, such as providing
accounting services. Asset and services, if used as consideration, must be religiously approved.
(b)
The consideration amount must be made clear and xed to avoid uncertainty. The amount, the
time and place of delivery among others must be clearly agreed in the contract. If a oating
rate of rental is being used, such as in an Ijarah contract, the benchmark against which the
rental is linked must be made known and be agreed to by the two parties.
(c)
Similar to the object of a contract, a consideration must also be capable of being delivered to
the other party. The inability of the consideration to be delivered will render the contract void.
Wakalah is a contract between an

agent and principal. This contract
enables the agent to render
services and be paid a fee (Ujrah).
Exercise 5.5
What is an alternative term for consideration in the context of a contract?
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5.6 Conclusion
Crucial to your study of Islamic nance is an understanding of the key contracts which underpin this
subject. Contracts are the basis for all transactions which are later transformed into Islamic nancial
products. This chapter introduced you to the technical meaning of contract as well as the meaning
and nature of contracts as evidenced in the Quran and in the Traditions of the Prophet Muhammad.
You were also introduced to the requirements of a valid contract and the essential components that
represent a valid and enforceable contract in Islamic commercial law.
In the next chapter you will be introduced to the various contracts classications according to their
behaviour and function.
5.7 Summary
1.
contract is central and fundamental to facilitate the various needs of people in any given
society
2.
contract is deemed to be fundamental because it expresses the intention of the parties and
their consent to the rights and liabilities arising from that contract
3.
fullment of all obligations arising from contracts is the main theme of the Quranic verse that
reads: O ye who believe, fulll all your contracts
4.
obligations arising from a contract are natural consequences; therefore the consent of both
parties to a contract is needed to avoid consuming others properties unlawfully
5.
in addition to some contracts established in the Quran, such as hire, forward sale, guarantee
and deposit taking, the Traditions of the Prophet Muhammad illustrates some aspects of a
contract to make it compliant, such as the prohibition of uncertainty in the subject matter of
sale, for example, the sale of the foetus of an animal
6.
the general theory of contract was not presented in any specic discussion in the classical
writings of Islamic law; principles and fundamentals, and perhaps, the illustrations of contract
are extracted from detailed discussion of sale and its various types
7.
contract or Aqd, literally to tie, is the connection of an offer with an acceptance in a lawful
manner that marks its effect on the subject of that connection; contract in Islamic commercial
law is distinctive because the effect of this contract must be compliant to Shariah principles.
8.
six elements are needed to constitute a valid and enforceable contract, (provided the effect
of this contract is compliant to Shariah principles); these six elements are: offer, acceptance,
offeror, offeree, consideration and subject matter
9.
offer and acceptance must refer to the same terms and conditions and must be communicated
to each other to make them a valid contract - simply the meeting of two minds
10. Islamic commercial law requires the essential unity of time between the offer and acceptance;
this form of unity differs from inter praesentes contract to an inter absentes contract
11. parties to a contract must be of majority age and of sound mind
12. religion is not a requirement in Islamic contracts except in a few limited contracts that
requires the parties to be Muslim, such as in Shirkah al Mufawadah.
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Chapter 5 Answers
Exercise 5.1
You could have given many examples in answering this question. Most people conclude a
contract or series of contracts everyday in different situations. For instance, when you buy
food from a shop or a train ticket, you conclude an effective contract. A contract manifests the
intention of two parties to enter into a particular arrangement or transaction be it marriage, a
sale, partnership and so on. Essentially a contract is an agreement, usually made between two
parties, to sell, lease, form a partnership, guarantee, etc.
Exercise 5.2
Having met all the conditions for a valid contract, a contract from an Islamic perspective must
result in something that does not contravene Shariah principles. It is a requirement that a
contract should be enacted in a lawful manner that relates to the compliance with both the
law of the country as well as Shariah principles. This contract would not be good or valid from
an Islamic perspective as it involves the production and export of a prohibited item under the
Quran, for example alcohol.
Exercise 5.3
(A) False.
Inter-praesentes or a physically present form of contract requires the offer and acceptance
to be communicated to each other almost instantly. This is different from inter-absentes
which allows some deferment in time for the offeree to accept the offer provided it is still
within an agreed time period.
(B) False.
The Quran does mention relatively complex and structured contracts such as sale, lease,
pledge, etc. This is an addition to the principle of sanctity of the contract. This means that a
valid contract must be fullled by both parties.
(C) True.
The session of contract refers to the unity of time of both the offer and acceptance, even
though the offeror and offeree may be in two different places, for example not physically
present in one common place.
Exercise 5.4
This requirement is necessary to protect the interests of the parties to a contract. A minor who
concludes a contract on his own, without the consent of the guardian, may, for example, bring
about loss or harm to his property. The same applies to those who lack sound judgement, for
example, those who are drunk or of unsound mind.
Exercise 5.5
Consideration can be alternately called price, payment, rental, fee and counter value.
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Revision questions
Revision Questions
1.1 Which of the following is not relevant to a contract?
(A)
Consent of parties.
(B)
Rights and obligations arising from a contract.
(C)
Risk of loss.
(D)
Offer and acceptance.
1.2 Which one of the following statements regarding Invitation to treat is true?
(A)
Invitation to treat binds the person who makes the invitation to sell.
(B)
An offer is not needed when there is an invitation to treat.
(C)
Invitation to treat is deemed as a good and valid offer.
(D)
Acceptance by the one who responded positively to the invitation to treat is not
deemed as an acceptance.
1.3 What is meant by essential unity of time of both offer and acceptance in terms of rendering a
contract valid?
(A)
Determent of price is not permissible.
(B)
The order of offer and acceptance in terms of sequence is important.
(C)
The contract cannot be contingent on any future event.
(D)
Both the offer and the acceptance must be linked to each other within the same
time period.
1.4 What are the requirements with regard to legal capacity to enter into an Islamic contract?
(A)
Being Muslim by religion and of good conduct and character.
(B)
Prudence and puberty.
(C)
Prudence and good conduct.
(D)
Male and being of sound mind.
1.5 In which of the following contracts of Islamic commercial law is the religion of the parties a
relevant factor?
(A)
Sale involving asset of future delivery (Salam).
(B)
Partnership based on absolute right to each of the partners (Shirkah al-Mufawadah).
(C)
Lease with an option to purchase (Ijarah muntahia bi tamleek).
(D)
Partnership by capital contribution (Musharakah).
Question 2
Which of the following statements are true/false?
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1.
Communication of acceptance to an offer is not possible through conduct of the offeree.
2.
Aqd means a contract that would bind the parties who have entered into that contract with
full consent.
3.
A contract must always be bilateral, that is, comprising of two parties.
4.
An offer is always an expression from someone to sell something to the other party.
5.
Deliverability of the subject matter is not a requirement to render a contract valid.

1.1 (C) The risk of loss has no bearing on the validity of a contract, the other three factors are crucial.
1.2 (D) An invitation to treat is simply an invitation to the public at large to give their offer to
purchase particular goods. It is up to the one who gives the invitation to accept or otherwise.
Above all, this invitation does not bind the one who makes this invitation.
Revision questions
Answers
1.3 (D) The concept of the session of the contract stipulates that a contract should be entered into
in a continuous and not disrupted session whereby the meeting of two minds must take place
within the same time period.
1.4 (B) Prudence and puberty are required before a person is deemed to have legal capacity to enter
into a contract as prudence represents sound judgment and puberty represents physical and
intellectual maturity.
1.5 (B) As the Shirkah al-Mufawadah contract allows one partner to fully act on behalf of the other
partner, it is a requirement that the partners are Muslims so as to avoid a situation where the
non-Muslim partner may enter into a non-Shariah compliant contract that is not valid from an
Islamic perspective.
Question 2
1.
False.
Communication can be effected through any means as long as it serves the purpose of
communicating the intention of an acceptance by the offeree to the offeror.
2.
True.
3.
False.
A contract in Islamic commercial law could also be a unilateral contract such as a will, a
donation or a waiver. This type of contract is also valid and enforceable.
4.
False.
An offer can come from either the buyer or the seller. The offer is essentially the rst
expression to invite another party to enter into a proposed contract irrespective of who has
expressed this proposal.
5.
False.
The ability to deliver an asset is a requirement to render a contract valid. If this were not the
case the subject matter of the sale could be something that cannot be delivered to the buyer.
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Chapter six
Classication
of contracts
Learning outcomes
describe the basis of classications of contracts.

Basis of classication of contracts.
Time, payment and delivery of contracts.
Transfer of right to use (usufruct).
Contracts of Partnership, security and safe custody.
Wakalah and Jualah
6.0 Introduction
As stated in the previous chapter, contract is the foundation upon which
Islamic nance rests. The creation of nancial products results from the
ability to use one or more traditional contracts to meet the requirements
of the customer. In this chapter you will be introduced to how various
contracts are classied. The variety of contract classications is essential
to meet the diversity of relevant commercial purposes. Without a full
understanding of each classication Islamic Financial Institutions (IFIs)
would be unable to structure products that meet the ultimate aim of clients
and customers in a Shariah-compliant way. For you, the whole process of
product structuring starts from an understanding of Islamic contracts and
their various classications.
6.1 Basis of classication of contracts
A contract may have more than one type and classication to meet the various legitimate needs
of society, from sale to partnership to collateral contracts. The need for these various motives and
intentions is as old as human society itself. It reects the complexity of human desire, which should
be satised as long as it can be accommodated within the broader Shariah parameters.
The discussion of classication of contract is important to underscore the following:
(a)
the behaviour and salient features of each classication
(b)
renement and enhancement of existing contracts for product development in Islamic

nancial markets
(c)
the synergy among these contracts to satisfy a unique and distinctive need of a modern
society, for example, hedging instruments.
The following section will explain and illustrate the behaviour and salient features of each
classication of contract. Subsequent sections will consider the enhancement and synergy of the
various contracts to support the requirements of modern Islamic nancial markets and instruments.
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Figure 6.1 Overview of classication of contract in Islamic commercial law
Contract
Bilateral
Work or
services
Safe
custody
Security
Unilateral
Partnership
Leasing
Commissionbased
contract
Transfer
of debt
Partnership
by
reputation
Financial
lease
Agencybased
contract
Guarantee
Partnership
by work and
services
Operating
lease
Sale
Will
Loan
Subject
matter
Cost or
prot
Donation
Waiver
Gift
Time of
delivery
of object
Time of
payment
Currency
Future
Spot
Rights/
intangible
properties
Pledge
Partnership
by capital
Future
Spot
Receivable
Partnership
by combining
capital and
work
Tangible
asset
Discountedbased sale
Cost-based
sale
Negotiated
sale
Cost plus
prot
6.2 Bilateral and unilateral contracts

From a macro perspective, a contract is essentially divided into two broad clarications, namely,
bilateral and unilateral contracts. The basis of classication is crucial as each have distinctive
behaviours and features. A summary of their respective salient features is illustrated in the
following table.
Issues
Bilateral
Unilateral
Contracting parties
Two parties
One party
Consideration
Requirement
Not a requirement
Acceptance by the offeree
Requirement
Not a requirement
Purpose
Commercial
Gratuity
Element of uncertainty (Gharar) Prohibited
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Tolerated
6.2.1 Bilateral contracts

A bilateral contract is one that takes place between two parties who have full legal capacity. Parties
enter into such contracts to attain some form of commercial gain. It is therefore logical that any
element of uncertainty, either in terms of price, object of exchange, time and manner of payment
and delivery must be specied to avoid any dispute. Disputes tend to arise only when those that
enter into a contract for a commercial purpose fail to realise their desire due to elements that make
the contract unfavourable to them. Under Islamic law all bilateral contracts must be free from
Gharar to render these contracts valid.
6.2.2 Unilateral contracts

A unilateral contract is normally where people wish to give a kind of favour to the other party
(recipient) without expecting any return. The motive could be love and care or gratuity. In doing
so, the acceptance as well as consideration from the recipient (to whom the offer and favour is
dedicated) are no longer required to make the contract valid. In addition, the presence of any
element of uncertainty or Gharar in any terms of the contract is tolerated.
6.2.3 Uncertainty - Gharar

The reason that uncertainty can be tolerated in a unilateral contract is because certainty is only
required in a contract if two parties are to benet. Without it the quality of consent of one of the
contracting parties would be lost. In a unilateral contract, which is mainly gratuitous, the issue of the
quality of consent is not relevant as the recipient does not need to accept or pay any counter value
or consideration. Gratuitous contracts, because they are motivated by acts of love and kindness, do
not require the necessity for certainty.
A sale contract is a typical bilateral contract. It takes place between the buyer and seller to the effect
that both must exchange consideration or price and objects to each other respectively. Any element
of uncertainty in the price or object and other essential terms will render this contract void or
voidable. The sale of an object, whose quantity or quality is not specically known to the buyer, is not
a valid contract. Likewise, the sale of a particular object for an uncertain price will also be deemed
void. Compare this position with a gift or donation or something contained in a will, the contents
of which are not known to the recipient. A donor/offeror may offer to give away a portion of his
assets either through a gift or donation or a will contract without providing any details pertaining
to the asset of the contract. These unilateral contracts are valid even though there is no specic
disclosure of the subjects because fraud or misrepresentation are not relevant in these contracts.
This is acceptable for the reason that the recipient or the counter party in unilateral contracts will
never offer any consideration in exchange of the gift, donation or will. Therefore non-disclosure of
specications of the asset will not lead to any cases of fraud or misrepresentation and the like.
6.2.4 Nature of the objects of the contract
The nature of the objects must suit the respective contracts. This is to make the entire contract
logical and consistent with the objective and salient features of any given contracts. For example, for
an Istina contract, the subject matter must be an asset to be constructed or manufactured. It cannot
be an asset that is already in existence. As for lease or Ijarah contract, an object must be something
where the substance of the asset will remain intact after usage.
6.2.5 Islamic insurance or Takaful and uncertainty

In Islamic nance, the distinction between a bilateral and a unilateral contract has proved useful
in Islamic insurance or Takaful. Conventional insurance works on the premise that the insurer sells
protection for a premium. However, as the sale of protection is uncertain and speculative, it is deemed
invalid and void from a Shariah perspective. The insurance industry works entirely on the principles of
uncertainty of risk. Islamic insurance, like conventional insurance, has no option but to deal with this
fact in providing protection and indemnity. However, given the objection to selling protection due its
uncertainty, Islamic insurance, has developed a model around a donation contract to deal with the
uncertainty of protection and premium in a way that is compliant to Shariah principles.
Under donation (Tabarru) contracts, the policyholders/participants will donate to a Takaful fund from
which protection can be made available to any participant who suffers loss or damage. The amount
to be donated by each participant throughout the period of Takaful and the amount to be received
by a participant in the case of valid claim are not certain. However, this is acceptable as uncertainty
107
in unilateral contracts is tolerable. This is the merit of having a unilateral contract to facilitate the act
of donation in both the contribution (premium) and compensation. Without this donation contract,
Islamic insurance could not have replicated the economic benets of a traditional insurance scheme,
which works primarily on uncertainty of risk premium and compensation.
Key points
A contract may have more than one type and classication in order to meet the various
legitimate needs of society.
From a macro perspective, a contract is essentially divided into two broad classications,
namely bilateral and unilateral contracts.

Explain how a donation or Tabarru contract removes any elements of uncertainty in a
Takaful scheme, thus making Takaful acceptable as an Islamic nance product.
Solution
Takaful schemes like conventional insurance are not free from elements of uncertainty. No
contract can remove this uncertainty as the insurance business, be it Islamic or conventional,
is linked to uncertain elements in many respects. The contract of donation was not meant
to remove this uncertainty as uncertainty is integral to Takaful practice. However, the
donation contract will render all elements of uncertainty (Gharar) acceptable or tolerable
because uncertainty does not invalidate unilateral contracts. The existence of uncertainty in a
unilateral contract such as donation will not make the contract null and void.
Exercise 6.1
Explain why a promise by one party constitutes a contract from an Islamic perspective.
A promise also forms a contract in English law as long as it involves a consideration to be paid by the
promisee. A promise by someone to sell his car to another person is an offer which binds the offeror.
Having said this, a promise in unilateral contracts is not enforceable in English law.
6.3 Common unilateral contracts

Under the unilateral contract family there are a few contracts that are of common application in
practice. These include a will contract, or Wasiyyah in Arabic, where a testator leaves behind a valid
will and testament in favour of some identied beneciary. However, in Islamic law the nominee of a
will must not be one of those who are the recipients or beneciaries of the inheritance.
The list of the beneciaries of an inheritance and their respective shares are clearly detailed out in
the Quran to avoid any dispute with regard to distribution of estate according to Islamic law of
inheritance. A will is valid to a beneciary who is not listed up to one-third of the total estate of the
testator. Again, this is to protect the interest of the inheritance beneciaries against other beneciaries.
In addition to a will, contracts such as waiver (Tanazul) and discount (Ibra) are common. A waiver
reects the consent of the owner of a particular entitlement to waive whatever is due to him from
another party. A waiver could be practised as and when the donor wishes or, alternatively, it could
be put in a contract up front. In asset management or where a specialised fund is managed by a
professional manager, investors may agree up front that if returns were to exceed a particular rate,
that is, the hurdle rate, they will waive the remaining returns to the fund manager as an incentive fee.
As for a discount (Ibra), the creditor may decide to discount or rebate the outstanding amount of
a debt owed to him, normally when the debtor wishes to repay early. In Islamic commercial law,
this rebate must be exercised by the nancier at his sole discretion. A pre-agreed arrangement is
not permissible under Islamic commercial law as this may render the selling price uncertain from
the beginning. This is because the selling price could be a full payment or a full payment less some
rebate, hence it would be uncertain. However, where rebates are given as and when the need arises,
uncertainty in the price is no longer an issue because this is meant to retire the outstanding
debt payment.
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Key points
A unilateral contract normally takes place where people wish to give a kind of favour to the
other party (recipient) without expecting any return.
A bilateral contract is one that takes place between two parties who have full legal capacity.
Exercise 6.2
While explaining to some friends that an element of uncertainty would not make a unilateral
contract null and void, someone reminds you that you have previously said that Gharar is to be
avoided in Islamic contracts. How would you explain this apparent contradiction?
6.4 Bilateral contracts

A bilateral contract, unlike a unilateral contract, requires the consent of both parties as it involves the
payment of the consideration for an exchange. The elements of Gharar and Riba are relevant in this
group of contracts. A loan contract or Qard in Islamic law could affect money as well as fungible items
such as food items. An overriding principle in a loan contract is that the lender should not benet
from his lending, either in cash or in kind.
This is based on a tradition of the Prophet Muhammad, which states that every loan that draws
benet (to the lender) is tantamount to Riba.
Any loan of money where the borrower is obliged to repay the principal plus some premium (interest)
is denitely prohibited.
Although a loan contract in Islamic commercial law is not interest based, it does not necessarily
prevent the borrower from paying more than he borrowed, provided that this is not contractually
agreed in the contract. The extra payment is paid as a gesture of good faith in appreciation of the act
of lending for no interest payment.
In another tradition of the Prophet Muhammad, it has been reported that best among you is the one
when he settles his loan or debt, he will settle in the best manner possible.
An Islamic loan, commonly translated into English as a benevolent loan (Qard / Hassan), is not a
donation contract. It is still a liability contract whereby the borrower has an established liability and
obligation to repay the loan. A charge or any form of security can be imposed on the borrower for this
obligation. If the borrower were to die, the liability shall be transferred to his or her heirs.
An Islamic loan contract would allow the borrower to repay the loan in the future and not on a spot
basis. As mentioned, where there is an exchange of money for money of the same currency (or of
different currency), the exchange must be simultaneous, otherwise it becomes Riba al-nasiah (Riba by
the deferment).
However, in the context of an Islamic loan the requirement of a spot delivery and exchange is
tolerated because the loans purpose is to assist the borrower when he needs some time to repay.
However, any imposition of extra payment, in cash or in kind, is strictly prohibited because Islamic
loans are meant to help the borrower instead of making a prot.
Key points
Qard / Hassan is a loan contract.
Any loan of money where the borrower is obliged to repay the principal plus some premiums is
prohibited in Islam.
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6.5 Sale contracts

The most important group of contracts in Islamic commercial law is the sale contract. Throughout
history sales have been crucial. The Quran has singled out sale (Bay) as the alternative to Riba or
interest-based loan (Quran: chapter 2, verse 275). The term Bay, as it occurs in the Quran, includes
both the sale of ownership and the sale of the usufruct or right to use. The following section relates to
the sale contract that ends up with the transfer of legal ownership of an asset to another person. The
transfer of services or usufruct will be dealt with under a section on lease contracts (section 6.10).
Generally speaking, a sale contract involves an exchange of one commodity for another commodity
(barter trading) or a commodity for money (sale) or of money for money (currency exchange). As
highlighted, Riba may exist in the sale of a commodity for another commodity as well as in the
exchange of money for money if the relevant requirements are not met. However, Riba is detached
from any transaction involving a sale of commodity for money because the two counter values
involved in this transaction are not usurious items when exchanged for each other. The requirement
of a spot transaction of equal amount and quantity of the two counter values is not applicable. It
makes a sale contract (other than barter and currency exchange) distinct and free from an element of
outright interest. However, a sale contract may be susceptible to Gharar, which normally affects the
quality of knowledge about the prescription of goods and consideration or price.
Contracts of sale include a number of contracts categorised into many respective classications.
However, these classications that explain the features and functions of each sale contract may
overlap.
Key points
Bay is a sales contract.
Sales contracts involve an exchange of one commodity for another commodity (barter trading)
or a commodity for money (sale) or of money for money (currency exchange).
6.6 Sale of trust (Amanah)

Islamic commercial law recognises the importance of honesty and full disclosure of the actual cost
price of any commodity for the benet of the buyer. Following this principle, sale contracts are
normally divided into two classications, namely sale of trust (Amanah) and sales that are not based
on trust. The latter type of sale may arise where the price depends on bargaining skills without any
reference to the cost or prot margin. Under the sale-of-trust principle, the seller must disclose the
actual cost price to the prospective buyer. Non-disclosure or dishonest disclosure would render the
sale contract null and void ab initio. In such cases the commodity must be returned to the seller/
owner for the return of the consideration to the buyer.
There are three types of sale contracts that come under the purview of trust sale, namely Bay alMurabahah, Bay al-Tawliyah and Bayal-Wadiah.
6.6.1 Cost-plus or Bay al-Murabahah

Bay al-murabahah literally means increase or prot. In classical literature, it has been dened as
the sale of a commodity at cost price plus a known prot. The prot may be declared in exact value
such as in the statement of the vendor: I purchased this commodity at 10,000 and I am selling it at
the prot of 1,000 so the selling price is 11,000. The prot may also be xed in ratio or percentage
such as 10% of the cost price. As part of a trust sale, the vendor must state either their cost price or
the prot for the knowledge of the buyer.
6.6.2 Not-for-prot or Bay al-tawliyah

Bay al-Tawliyah is also a trust sale even though the vendor will sell their asset at the cost price
without any prot. The trust feature arises from the requirement of the disclosure of the actual cost
price. The buyer relies on this statement before making a decision to purchase or otherwise, and
therefore a strict duty of disclosure is imposed on the vendor.
6.6.2 Discounted price or Bay al-Wadiah

Bay al-Wadiah is a sale below the cost price or at a discounted price. This sale also requires honesty
on the part of the vendor since any reference to the cost price might induce the buyer to purchase
110
believing that the vendor is honest in his disclosure. This kind of sale is deemed as a trust sale because
the buyer will not be in the position to know whether an asset is being sold below the cost price as
claimed by the seller or otherwise. The only statement he can rely on is the statement made by the
seller that the seller has purchased a particular asset at, for example $5,000, and has now sought to
sell the same asset at, for example $4,000. A prospective seller may use this statement to inuence
the buyer to purchase. It is for this reason that a strict and honest disclosure of the cost price is
required. The contract is null and void if the statement made is found to be untrue.
Table 6.2 Various types of trust (Amanah) sale

Trust (Amanah) Sale
Types
Cost*
Selling price
Prot
Loss
Murabahah
1,000
1,100
100/10%
Tawliyah
1,000
1,000
Wadiah
1,000
800
200
* The cost must be disclosed in all contracts because the trust principle requires the seller to disclose
honestly the actual cost incurred by the seller in purchasing these goods from the vendor.
Key point
The three types of sale contracts that come under the purview of trust sale are
Bay al-Murabahah, Bay al-Tawliyah and Bayal-Wadhiah.
6.7 Negotiated sale or Musawamah

Sale contracts that are not based on trust are generally known as Musawamah. This is a normal sale
concluded through negotiations between the seller and buyer where no reference was made to the
original cost price. Any reference to either the cost price or prot will render this contract no longer
Musawamah and it will revert to a trust sale. However, it is not to be inferred that Musawamah
could not bring prot to the seller as the actual prot to be made by the seller is not known to
the purchaser unlike in the case of Murabahah. Some IFIs have used Musawamah in their nancing
schemes in which no reference is made to either the cost price or the prot margin. What appears in
the statement of claim or invoice is one gure that is the selling price payable by the buyer to the
seller without disclosing the cost price or prot.
There is no requirement that payment under these contracts must be either spot or deferred. In other
words, the payment arising from Murabahah, Tawliyah, Wadiah and even Musawamah could be on a
spot basis or on an instalment basis. The feature of spot or deferred payment is not integral to this
classication. However, the delivery of the asset under all these contracts must be on a spot basis to
distinguish them from a forward contract or a deferred delivery sale.
Table 6.3 Summary of contract features

Contracts
Delivery
Payment
Remarks
Musawamah
Spot
Spot/deferred
No disclosure of cost
Price would be at
prot or cost or loss
but not known to the
purchaser
Murabahah
Spot
Spot/deferred
Disclosure of cost
Price at cost plus
mark-up
Tawliyah
Spot
Spot/deferred
Disclosure of cost
Neither prot nor
loss
Wadiah
Spot
Spot/deferred
Disclosure of cost
Sale at loss
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The previous table explains that the basis of classication of these four main types of sale is basically
the disclosure or non-disclosure of the cost price. Also, it explains that in some sale contracts, a prot
or loss can be distinguished clearly in contrast to some contracts, namely Musawamah, wherein the
prot or the loss to the seller cannot be ascertained by the purchaser. However, all four contracts
require that the delivery of underlying goods must be on spot basis, but the payment of the selling
price could either be on spot or on deferred basis as agreed by both parties.
Key points
Sales contracts that are not based on trust are generally known as Musawamah.
This is a normal sale concluded through negotiations between the seller and buyer where no
reference was made to the original cost price.

Murabahah is a trust sale. It is essentially a sale of an asset to a person in which the cost
price of the asset is disclosed and from which the actual prot margin or mark-up can be
ascertained by the buyer. In a typical situation, a seller will inform the buyer that he has
purchased an asset, for example, equipment or furniture at 10,000 and the seller now
intends to sell the same asset to the buyer at 12,000 which is payable for example within
two years. The buyer may agree to purchase this asset at 12,000 although the market
price is only 10,000 if it is paid on spot. Explain why a buyer would agree to enter into
this kind of transaction.
Solution
Probably the most important consideration here is that the buyer is getting a credit sale
facility. This enables him to own an asset now while paying for it later. In addition the buyer
might nd this method more suitable for him because he would know the actual cost that the
nancier has paid, and hence the prot margin being earned by the seller. A judgement can be
made as to whether the buyer nds the selling price acceptable, knowing what the seller paid
for the asset.
6.8 Time of payment

Sales can be classied according to the time of payment of the price or consideration. In some
contracts the payment must be deferred, such as in Bay al Muajjal or a deferred payment sale. In
other contracts, full payment must be paid in advance such as in a Salam contract. A Salam sale is
a forward sale where the purchaser must pay the full payment in advance for a commodity to be
delivered to him in the future. Under this sale, both the buyer and seller have locked the price in
anticipation of future price movements. Also, in currency exchange contracts, both of the counter
values must be exchanged for each other on a spot basis. In this sale transaction involving two
different currencies, one of the currencies is the object, while the other is the price.
There are other contracts wherein the payment can be made on a spot or deferred basis based on
the agreement of the parties. This applies to all other contracts other than Bay al-Muajjal, Salam
sale and currency exchange. Islamic commercial law also recognises down-payment (Urbun) as a
kind of sale that gives the buyer a right (not an obligation) to proceed with the sale contract if he so
wishes. If he proceeds, then the amount paid, that is, earnest money, will be deemed as part of the
selling price. Otherwise, this amount of money will be forfeited in favour of the seller. The summary
of the above sale contracts with regards to the time of payment is illustrated in table 6.4 below.
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Table 6.4 Summary of sales contract time of payment

Type of sale contracts Spot payment
Deferred payment
Remarks
Bay muajjal
Agreed as such by two

parties
Bay al-salam
Deferment of payment
is not permissible
Bay al-urbun

(the remains of the
payment)
Deposit will be
forfeited if the
contract is terminated
(part of the payment)

Bay al-sarf
(currency exchange)
Both counter values

must be exchanged
with each other on
spot basis
Other sale contract
As agreed by the
parties
The above table illustrates that for some sale contracts, the time of payment must be made
according to the requirements of the contract type. Salam and currency exchange require a spot
payment basis to achieve their validity, otherwise they become null and void. As for an Urbun sale,
some payment must be made on spot to entitle the buyer to pay the remaining amount within the
specied period.
Exercise 6.3
Outline the main differences between a Salam and Urbun sale.
6.9 Time of delivery

In some contracts, the delivery of the asset must be on a spot basis because they are sold based on
the identication of their physical nature. These include all spot delivery sales such as Murabahah,
Musawamah, Tawliyah and Wadiah. Any deferred delivery involving a particular ascertained asset
that is already in existence is not permissible. In addition, an object such as currency must also be
delivered on the spot because it is a usurious item.
In other contracts such as Salam and Istisna, the asset must be delivered in the future. While
Salam is a forward sale, Istisna is a construction contract. Under Istisna the purchaser purchases
a completed asset to be constructed by the contractor. The asset will only be delivered to the
purchaser upon its completion. The reason these assets must be delivered in the future is that the
parties have entered into contracts with the purpose of delivering or acquiring an asset that is
identied by description and not by reference to a particular physical nature. Assets identied by
description only could not have been in existence.
Table 6.5 Summary of sales contracts time of delivery

Type of sale contracts
Spot delivery
Deferred delivery
Salam and Istisna
Currency exchange contract
Other than Salam and Istisna

contracts
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The previous table shows that while in Salam and Istisna sales the delivery of the goods must be
deferred to a future date, other sale contracts require the opposite, that is, spot delivery. As for a
currency exchange contract, the reason for spot delivery is to avoid Riba in return for a delay in the
exchange. Other sales contracts require a spot delivery because the underlying asset is ascertained
by its physical identication, therefore its delivery cannot be delayed to the future. The exception of
deferred delivery is only given to the Salam and Istisna sales.
Exercise 6.4
Is a Murabahah transaction valid in the case where the asset is to be delivered in the future?
6.10 Transfer of the right to use (usufruct)

The second major classication of contracts relates to the transfer of usufruct or the right to use.
Unlike a sale contract, this contract will effectively transfer the right to use a particular asset from
the owner to the user. This type of contract is known as Ijarah in Islamic commercial law and consists
of both hire and lease contracts. In a hire contract, a person sells their services to another person
and the consideration is normally a wage or salary. Most of the services contracts belong to this
sub-division of the Ijarah contract. This is known in Arabic as Ijarah ala al-Ashkash (hire of persons).
Another sub-division of the Ijarah contract is known as Ijarah al-Ayan (lease of the asset). The owner
of the asset is called the lessor while the user is called the lessee. The lessee will benet from the
usufruct of the asset and for this he has to pay rental. This type of Ijarah contract would be more
relevant in nancial markets.
The salient features of Ijarah, particularly the lease of usufruct, are inter alia as follows:
(a)
the lessor must be the owner of the leased asset or the agent of the legal owner; the lessee,
with the consent of the lessor, can sub-lease the leased asset to a third party, that is, the
sub-lessee
(b)
the leased asset must be of benet to the lessee and, above all, should be lawful from the
Shariah perspective; for example, the lease of a centre for gambling activities is not permissible
(c)
the rental must be xed and known to both parties; a oating rental rate is also permissible
provided the benchmark or basis on which the rental is periodically revised is xed and
agreeable to both parties upfront, the benchmark could have any reference basis, provided it
is always in existence and can be referred to for the purpose of determining the newly revised
rate of rental payment
(d)
the ownership risk should be borne by the lessor, which includes any cost to maintain the
property, such as major maintenance and the cost of insurance, if required, to insure the asset
from re and natural disaster; the cost arising from the use of the leased property must be
borne by the lessee - examples of this include water bills for leased property and road tax for a
leased vehicle
(e)
the leased asset should be treated in trust (Amanah) in the hands of the lessee; any damage
caused to the leased asset without any negligence or misconduct by the lessee will not be a
liability on the lessee
(f)
total damage to the leased asset will render the lease contract null and void unless the lessor is
able to substitute the damaged asset with another asset of the same features of the usufruct;
partial damage will give an option to the lessee to continue with the contract with or without a
proportionate reduction of the rental payment
(g)
an Ijarah contract is a binding contract to the effect that one party cannot amend the terms of
the contract unilaterally such as to revoke the contract or revise the rental; any amendments
must be jointly agreed on by both parties.
6.11 Operating and nancial leases

An Ijarah involving a usufruct has two main types, namely an operating lease (Ijarah Tashghiliyah)
and a nancial lease (Ijarah muntahia bi tamleek).
6.11.1 Operating leases

An operating lease is a straightforward lease where the owner/bank will purchase the asset from the
vendor and subsequently leases it to the lessee/customer at an agreed rate of rental for a dened
114
period. Upon the expiry of the lease contract, the lessee must return the leased asset to the lessor.
At this point the lessor may continue to lease the asset to the same lessee or decide to lease it to a
third party. The lessee has no right to purchase the leased asset from the lessor.
6.11.2 Financial leases

Another type of lease is Ijarah muntahia bi tamleek, which is loosely translated into English as a
nancial lease or an Islamic hire and purchase contract. It refers to the transfer of the usufruct of a
particular property to another person in exchange for rent. The lease will end with the transfer of the
leased property from the lessor to the lessee. Under this scheme, the lessee has an option to put
to the lessor to sell the leased asset to him according to an agreed manner of transfer of ownership.
In other words, the lessor has given his promise or undertaking (Wad) to sell this leased asset to
the lessee as and when required. The price and manner of payment to transfer the ownership are
normally agreed in advance.
Table 6.6 Summary of operating and nancial leases

Features
Operating lease
Financial lease
Contract
Ijarah
Ijarah coupled with an

undertaking by the lessor to sell
the leased asset to the lessee.
Ownership risk and cost
(on the lessor)
(on the lessor)
Usage risk and cost
(on the lessee)
(on the lessee)
Rental
Fixed or oating
Fixed or oating
Ownership transfer
Asset
No restriction provided it is
benecial and compliant
No restriction provided it is
benecial and compliant
The above table illustrates that the only distinction between these two types of Ijarah is on the
obligation of the lessor under a nancial lease to sell the leased asset to the lessee once the lessee
exercises their option to purchase. Other features are common to both.
Key points
Ijarah contract transfers the right to use a particular asset from the owner to the user.
In an operating lease or Ijarah Tashghiliyah, the lessee has no right to purchase the leased asset
from the lessor.
In a nancial lease or Ijarah muntahia bi tamleek, the lessor gives his promise or undertaking
(Wad) to sell the leased asset to the lessee as and when required.
Exercise 6.5
Which contract is most suitable where the lessee wishes to purchase the leased object either at
the end of the leased period or at any time during the lease period?
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In contracts of sale, the price, irrespective of the various contract classications, must be
certain and hence xed. Can you explain why the rental payment under a lease contract can
be either xed or oating.
Solution
The object of a sale is xed and therefore the selling price must equally be xed. For example
in a Murabahah contract, where 100 computers are valued at 1,000 each, and each is sold
to a customer at a Murabahah price of 1,200 each, payable within ve years, the price of
1,200 for each unit cannot change. It does not matter if the market price rises in the future
because the sale price was agreed on the day of contract and the assets, in this case the
computers, were transferred to the customer immediately after completing the Murabahah
sale contract. Under Ijarah, the object of the lease is not the asset itself but rather its usufruct.
Usufruct or services are not delivered one-off at the time of contract but are to be made
available by the lessor, throughout the lease period. Therefore, the consideration or rental
for this usufruct can be revised periodically subject to the consent of both parties. The
newly revised rental will only apply to a future usufruct or services and cannot be applied in
retrospect. Thus, the rental could either be xed or oating as agreed by two parties.
6.12 Contracts of partnership

Another classication of contract is contract of partnership, which consists of Mudarabah and
Musharakah. Mudarabah is a contract of partnership in prot whereby one party provides capital
and the other provides labour and management. While prot is to be shared between the two based
on an agreed ratio, the loss must be borne by the capital provider alone. The manager only risks the
loss of his time, effort and expected prot. Musharakah, on the other hand, is a partnership contract
in which the two parties must contribute capital to the joint venture. The management can be
undertaken by either or both of them, or it can be outsourced to a third party. The element of work
and management is not integral to Musharakah. As for prot sharing, it may be shared according
to an agreed ratio, but as for the loss it must be distributed according to proportionate capital
contribution.
Key points
Mudarabah and Musharakah are the two main contracts of partnership.
Mudarabah is a contract of partnership for prot, whereby one party provides capital and the
other provides skills and management.
Musharakah is a partnership contract in which the two parties must contribute capital to the
joint venture.
6.13 Contracts of security

Contracts of security are another important type of contract in Islamic commercial law. The purpose
of having this contract is to protect the party in whose interest the contract has been entered. There
are three main contracts of security: Hiwalah (transfer of debt), Rahn (pledge) and Kafalah (guarantee).
6.13.1 Hiwalah
Hiwalah means transferring the right to a claim for a payment of debt to another party (transferee)
who will later claim from the principal debtor. In a case where A owes B a particular amount of money
and, at the same time, B also owes C a particular amount of money, then Hiwalah is possible. Ideally,
in order to settle this respective obligation, A will pay to B and B will have to settle his debt owing
to C. However, under a Hiwalah arrangement, B, who is the creditor to A but the debtor to C, can
simply transfer his claim of debt on to C (transferee). Once the transferee has accepted the transfer
of debt, the transferor (B) would be released from his obligation towards C, who is the principal
creditor/transferee. The transferee can only claim his right from A, who is the principal debtor in this
transaction.
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Figure 6.2 Pre-Hiwalah

Obligation to
Obligation to
A owes B
$1,000
B owes C
$1,000
Figure 6.3 Post-Hiwalah

1. A Pays $1000
B
3. B will not require
A to pay $1,000
C
2. C will not require
B to pay $1,000
6.13.2 Rahn
Rahn or pledge is to use property as a security in respect of a right of claim, the payment of which
may be taken from the value of the property. In a typical case of indebtedness, the debtor will have
to furnish a kind of security or pledge to the creditor/nancier. The debtor is called a pledgor and the
creditor is known as a pledgee. If the pledgor fails to settle the payment as agreed, the pledgee has
a right to dispose of the pledged asset to get back the amount of money owed to him. The pledge
makes a creditor a secured creditor and is normally ranked higher than other creditors who have no
pledge or security.
6.13.3 Kafalah
Kafalah means to add another obligation to an existing obligation in respect of a claim for
something. Kafalah may relate to a person, nancial obligation or particular act of performance.
Kafalah relating to a person involves the production of the person for whom the Kafalah (bail)
has been given. Kafalah relating to nancial obligation implies an obligation on the guarantor to
pay in the event that the principal debtor (guaranteed person) fails to pay the agreed payment to
the creditor. Kafalah, unlike Hiwalah, would not release the principal debtor in whose favour the
contract is concluded because it provides a guarantor to the existing obligation, not a transfer of the
obligation. The creditor may have recourse to either the debtor or the guarantor, although in practice
the creditor will only have recourse to the guarantor once he has exhausted all other means to get
the payment from the debtor.
Exercise 6.6
Which one of the following statements is true?
(A) Both Kafalah and Hiwalah release the obligation of the principal debtor.
(B) Hiwalah releases the obligation of the transferor, who is also a debtor. Kafalah does not
release the obligation of the principal debtor.
117
Key points
Hiwalah, Rahn and Kafalah (guarantee) are three main contracts of security.
Hiwalah means transferring the right to a claim for a payment of debt to another party
(transferee) who will later claim from the principal debtor.
Rahn or pledge is to use property as a security in respect of a right of claim, the payment of
which may be taken from the value of the property in the case of non-payment of the debt or
liquidation.
6.14 Wakalah and Jualah

Islamic law also recognises contracts to do work. This is a contract where a party engages another
party to do work on their behalf. The contract looks similar to a hire contract. This type of contract
consists of two specic contracts: Wakalah (agency) and Jualah (commission-based). As for Wakalah,
the principal will appoint an agent to undertake a particular assignment or work for them. All rights
and liabilities will be assumed by the principal. The agent could be paid for their service as the fee is
not integral to the wakalah contract. If a fee is agreed to in the Wakalah contract, the agent will be
paid for their service regardless of whether they have achieved the intended objective. With regards
to Jualah, the fee will only be paid upon the specic performance by the appointed party. The fee
paid is conventionally known as a commission.
6.15 Contracts of safe custody - Wadiah

The last category or classication of contract is a contract of safe custody. This is typically a contract
between a depositor who deposits their assets and a custodian who receives the deposited asset
and keeps it under their safe custody. The custodian receives this asset on the principle of Amanah
(trusteeship) in the sense that they will not be liable for damage or loss to the deposited item if there
is no negligence or misconduct on their part.
The deposited items could include almost all types of assets that could be delivered physically to the
custodian. A safety deposit box in a bank is a good example of a safe custody contract. This contract also
accepts money as a deposited item. However, when money is being deposited, the nature of the contract
is transformed into a loan contract because it could potentially give extra benet to the depositor, thus
the possibility of Riba. The reason for this transformation is explained in section 9.1.1 of chapter nine.
Exercise 6.7
A company has invented a new product that it intends to market quite aggressively. For this
purpose, it intends to appoint sales people across the country. However, to reduce the cost
of marketing, the company is planning to reward its sales persons by way of commission on
their actual sales of the new product. What would be the most suitable contract between the
company and its sales people?
6.16 Conclusion
This chapter explained how various Islamic contracts are classied according to their behaviour and
function. It also introduced you to how nancial products are created as a result of the ability to use
one or more traditional contracts to meet the requirements of the customer. You should have seen that
the variety of contract classications provides exibility in the products which can be offered within
Islamic nance. You should now have a good appreciation of the various features of each contract.
In the following chapter we will compare and contrast various classications of contract in order for
you to appreciate the different behaviour of distinct contracts. This will also help you understand how
to apply a particular contract to meet a specic purpose.
118
6.17 Summary
1.
the classication of contracts is important in order to appreciate the salient features of each
contract as they subsequently add value to product development in Islamic nance
2.
the two major broad classications of contract are bilateral contracts and unilateral contracts
3.
from a perspective of the duty to disclose the actual cost price, sale contracts are categorised
into sale of trust, which consists of Murabahah, Tawliyah and Wadiah, and negotiated sale
known as Musawamah
4.
sales from time of payment perspective can be divided into three classications: mandatory
spot payment (Salam and currency), spot payment with the rest to be made later within a
specied period (Urbun), sale contracts that are open to either spot or deferred payment as
agreed by the parties
5.
the time of delivery of an asset in a sale contract also forms the basis of particular
classications of sale contracts. Essentially, some sale contracts require spot delivery and some
contracts such as Salam and Istina are used where deferred delivery is required
6.
Ijarah refers to the right to use for rental and could be an operating or nancial lease
7.
a partnership contract could be either Mudarabah or Musharakah; Mudarabah is a partnership

between a capital provider and an entrepreneur, however, Musharakah requires both partners to
contribute capital into the venture
8.
a security contract is aimed at protecting the interest of the main creditor or a person in whose
favour the contract is entered into; it includes contracts of pledge, guarantee and assignment
of debt.
9.
contracts to do work on behalf of or for the benet of someone are also recognised in Islamic
commercial law; the contract can be based on Wakalah or Jualah
10. a safe custody contract or Wadiah is a contract of a depositor depositing their asset with
a custodian.
119
Chapter 6 Answers
Exercise 6.1
In a unilateral contract, although only one party is bound to provide the object of the contract
and although he receives no consideration, this is deemed to be a valid and enforceable
contract because it binds one party and it might create a situation that is detrimental to
another party. For example, Khalid has promised or agreed to donate his car to Ismail. Relying
on that promise, Ismail has sold his car in anticipation of receiving the car from Khalid. This
could put Ismail in a disadvantageous position if the promise by Khalid to donate his car was
not deemed to be an enforceable contract. A promise by one party is a binding unilateral
contract in Islamic law binding only the promisor.
Exercise 6.2
Uncertainty or Gharar only affects bilateral contracts as these contracts are normally based
on the exchange of something for a price. Bilateral contracts also aim to make commercial
gains. Any element of uncertainty will render a bilateral contract void or voidable. These two
considerations are not present in unilateral contracts. This means that unilateral contracts will
remain valid even though they may contain an element of uncertainty. The main purpose of
this contract is not for commercial gain but rather for love, care and as a token of appreciation
to others.
Exercise 6.3
While the full payment of selling price under a Salam sale contract must be paid in advance,
the selling price under Urbun sale contract is partially deferred. A small down payment will
bind the seller under an Urbun sale not to sell the goods reserved for the buyer to another
party within the time frame agreed for the buyer to settle the remainder of the sale price.
Another difference is that the goods under a Salam contract do not necessarily have to be in
existence at the time of contract. Under an Urbun sale contract, the asset must be in existence
at the time of contract. Both contracts share the feature that the goods under negotiation are
to be delivered at some time in the future.
Exercise 6.4
A Murabahah transaction, in the case where the asset is to be delivered in the future, would not
be a valid transaction. Contracts other than Salam and Istisna, such as Murabahah, require the
object of the contract to be delivered on a spot basis. The exception to deferred delivery is only
granted to Salam and Istisna contracts.
Exercise 6.5
An Ijarah muntahia bi tamleek contract is a lease arrangement whereby the lessee has the right
to purchase/own the leased asset. The lessor has given his promise or undertaking to sell the
leased asset to the lessee when requested to by the lessee but subject to certain terms and
conditions.
Exercise 6.6
(B) True.
The immediate effect of Hiwalah is to transfer the liability of the transferor who owes
some payment to the principal creditor. Kafalah makes the guarantor jointly liable together
with the principal debtor.
Exercise 6.7
The Jualah contract (commission-based contract) would be the most effective and useful
contract as the payment to the sales people will be linked to actual sales of the product.
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121
Revision questions
Revision Questions
1.1 What is meant by the term Tanazul?
(A)
To waive the risk of loss.
(B)
To compensate for the lack of prot.
(C)
To give away a proportion of the prot to another party.
(D)
To take a share in the prot.
1.2 What is the basis of sale of trust (Amanah)?

(A)
Deferred payment sale.
(B)
Disclosure of the actual cost price.
(C)
A mark-up on the sale price.
(D)
Disclosure of the quality of the asset.
1.3 Which of the following is the correct description of a Salam sale?

(A)
Spot payment against future delivery.
(B)
Payment based on progress of delivery.
(C)
Spot delivery against spot payment.
(D)
Deferred payment and deferred delivery.
1.4 What is the main distinction between an operating lease and a nancial lease?
(A)
Rental payment must be xed in a nancial lease.
(B)
Ownership risk must not be borne by the lessee in a nancial lease.
(C)
Financial lease is not compliant to Shariah principles.
(D)
A nancial lease gives the lessee the right to purchase the leased asset at the end
of the lease.
1.5 When the transferee accepts the transfer of debt under a Hiwalah contract, what is the
consequence of the contract?
(A)
The transferor and principal debtor jointly owe the debt payment to the transferee.
(B)
The liability of the transferor to pay the debt is extinguished.
(C)
The liability to pay the debt is transferred to the guarantor.
(D)
The transferee has recourse to the transferor in the case of non-payment by the
principal debtor.
Question 2
Match the following descriptions to the corresponding subject matter
Subject Matter
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Descriptions
1. Unilateral contract
A. Deferred delivery sale where the payment could be either on spot

or deferred payment basis.
2. Jualah
B. Down payment sale whereby some payment must be made on

spot and the remaining must be paid within the agreed period. This
payment will be forfeited if the remaining payment is not paid
within the agreed period.
3. Musharakah
C. A contract that tolerates an element of uncertainty in both the

subject matter and price.
4. Istisna
D. A fee is only paid based on certain agreed performance.
5. Urbun
E. Partnership wherein both parties contribute capital to the venture.

1.1 (C) A waiver reects the consent of the owner of a particular entitlement to waive whatever is
due to him from another party.
Revision questions
Answers
1.2 (B) Under the sale-of-trust principle, the seller must disclose the actual cost price to the
prospective buyer simply because the buyer has relied on his statement or disclosure of the
cost price.
1.3 (A) A Salam sale is a forward sale whereby the purchaser must pay the full payment in
advance for a commodity to be delivered to him in the future.
1.4 (D) A nancial lease allows for the lessee to purchase the leased asset at the end of the lease
period. If the lessee decides to purchase the leased asset, the lessor/owner must sell the asset
to the lessee.
1.5 (B) Hiwalah is the transfer of debt obligation. Once a person has transferred a debt to
someone else, for example, the transferee, he or she is no longer obliged to pay that debt.
The principal creditor can only claim the payment of the debt from the transferee, who is the
principal debtor.
Question 2
Subject Matter
Descriptions
1. Unilateral contract
C. A contract that tolerates element of uncertainty in both the

subject matter and price.
2. Jualah
D. A fee is only paid based on certain agreed performance.
3. Musharakah
E. Partnership wherein both parties contribute capital to the venture.
4. Istisna
A. Deferred delivery sale where the payment could be either on spot

or deferred payment basis.
5. Urbun
B. Down payment sale whereby some payment must be made on

spot and the remaining shall be paid within the agreed period. This
payment will be forfeited if the remaining payment is not paid
within the agreed period.
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Chapter seven
Comparison of
classications
of contract
Learning outcomes
compare and contrast various classications of

contracts
apply respective contracts to a specic case for a

specic purpose.
Comparison of classications of contract

Comparing and contrasting classications of contracts.
Understanding the intention of the parties to a contract.
Differences in contract types.
The application of the right contract.
Flexibility of sales contracts.
Transforming classical contracts into products that are commercially viable.
7.0 Introduction
Following on from the previous two chapters, which introduced you to the
nature of contracts and how they are classied, this chapter shows you
how to compare and contrast various classications of contract in order for
you to appreciate the different behaviour of distinct contracts. You will also
be shown how to apply a particular contract to meet a specic purpose.
Understanding the various classications of contract and their distinctions
will allow you to apply what you have learned thus far to specic nancial
products. By the end of this chapter you should be able to assign the correct
contract to a particular nancial product. If by the end of the chapter you
feel unable to do this we would recommend that you refer back to the
previous two chapters as they lay the foundation of both this and the
following three chapters.
7.1 Comparison of various contracts highlighting the similarities and
dissimilarities between them
The previous chapter explained the classication of contracts and their bases. This chapter will
compare and contrast the various contracts with a view to determining whether there is any
common ground between them. Naturally, such comparisons will also lead to the discovery of some
dissimilarity. Knowledge of this is useful in understanding Islamic nancial product design as well as
in contributing to product development and enhancement.
7.2 Intention of the parties to the contract

The rst aspect that is relevant is the intention of the parties when entering into a contract to
purchase a particular asset either at the time of contract or in the future. The parties have entered
into the contract for one common purpose, that is to transfer ownership or acquire ownership.
Ironically, this objective can be achieved through more than one contract, namely the sale contract,
the lease with an option to purchase and the diminishing partnership or Musharakah Mutanaqisah.
All facilitate the purchase of a particular property. While the sale transfers ownership on the spot, the
lease, with an option to purchase, will transfer ownership rights when the lessee exercises his option
to purchase. The same is true with regard to Musharakah Mutanaqisah wherein the ownership of a
jointly-owned property will be transferred to one of the joint owners progressively by virtue of buying
back the shareholding of the other joint owner. Ultimately, under Musharakah Mutanaqisah, one party
(who is normally the asset seeker) would own this asset through the redemption of the other joint
owners shareholding and interest in the said asset. Redemption is as good as a sale contract in the
sense that one partner purchases the share of another partner, but it is done progressively. From this
perspective, all these contracts share the same feature that allows a transfer of ownership.
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Table 7.1 Transfer of ownership

Transfer of ownership mechanisms
Sale contract
Lease with an option to

purchase
Diminishing partnership
Payment as consideration of
purchase price.
Payment of consideration
by the lessee to purchase
or through the gift by the
lessor to the lessee for no
consideration.
Progressive redemption
of shares from one of the
joint owners of the others
shareholdings.
Although these three structures belong to a different classication of contract, they are in the
position to serve a common purpose that is to transfer the ownership to the customer via the
respective mode of nancing. However, each structure has its own distinctive features.
Key point
In Musharakah Mutanaqisah, the ownership of a jointly-owned property will be progressively
transferred to one of the joint owners by virtue of buying back the shareholding of the other
joint owner.
Exercise 7.1
Given the volatility of the cost of funds or the Base Lending Rate (BLR) in your home country,
propose with reasons the most suitable long term Islamic nance contracts for house nancing.
7.3 Partnership contracts

It can be inferred from the previous chapter that some contracts may share some common
ground, but differ from each other in particular features, for example partnership contracts. These
contracts are Mudarabah and Musharakah. Essentially, these are neither sale nor lease contracts.
They allow both parties to jointly contribute capital and work to undertake a common business
venture, whereby income is to be generated and not xed. Both parties will only benet from their
investment if the said business venture has realised a net prot after netting the cost and returning
the capital to the provider(s). However, both Mudarabah and Musharakah have distinctive features.
Table 7.2 Similarities between Mudarabah and Musharakah

Features
Mudarabah
Musharakah
Limited liability
Prot is negotiable
No xed income
Damage in the case of

negligence and misconduct
Third-party guarantee on
capital
Table 7.2 simply illustrates that both Mudarabah and Musharakah share some common features.
These are prescribed by Islamic commercial law through either text provisions or Ijtihad of the
scholars.
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Table 7.3 Differences between Mudarabah and Musharakah

Features
Mudarabah
Musharakah
Capital from one party and

management from another
Capital from both parties
Loss borne by all parties
Management in business
venture
Table 7.3 illustrates that although both Mudarabah and Musharakah may have common aspects, they
also have distinctive features, especially with regard to how they are constructed. Mudarabah, unlike
Musharakah, is a partnership contract whose features are illustrated in table 7.2.
Under both the Mudarabah and Musharakah contracts losses are borne by the capital providers. In the
case of the Mudarabah partnership the entrepreneur does not contribute capital, but is entitled to an
agreed share of prots. Where a loss occurs, the capital provider is left to suffer this alone. In the case
of Musharakah partnerships all partners are capital providers, hence, while prots are shared according
to agreed ratios, losses are also shared in proportion to the capital contributed.
7.3.1 Mudarabah
Mudarabah is based on one party providing the capital to the partnership and the other providing work
and management. There cannot be a situation where both contribute capital or work. To be consistent
with this contract construction, all losses must be borne by the capital provider only. The manager will
only lose his time and effort. Also, the capital provider cannot be in charge of the administration and
management of the venture. These are to be assumed by the manager.
7.3.2 Musharakah
A Musharakah contract imposes on both parties to contribute capital. The loss must be borne by both
parties in proportion to their capital contribution. However, the prot, as in Mudarabah, is negotiable
based on certain ratio or percentage. Also, both parties under Musharakah can participate in the
management of the business venture, although either one of them or both have the right not to be
involved. In the latter case, they may appoint another person or company to manage the business
venture for the partnership. Having said this, the most interesting feature in a Musharakah contract,
unlike Mudarabah, is that it would entitle the partner(s) to be actively involved in the administration
and management of the partnership. This is a feature that would give some value in terms of executive
powers and rights compared with a Mudarabah contract.

An IFI has invested $100 million in a construction contract to build a new power plant.
Neither the manager nor the contractor provided any capital. Instead it was agreed that the
manager would provide expertise and project management. The IFI subsequently discovers
that there has been mismanagement on the part of the entrepreneur/contractor that has
lead to a cost over-run and a potential delay in completion, thus late delivery to the client.
Explain how the IFI could resolve the situation.
Solution
The existing contract is based on a Mudarabah contract. Under this contract, the capital
provider is not authorised to manage or to be involved in the management of the business
venture. One solution might be to convert the Mudharabah contract into a Musharakah
contract. This will require the agreement of the manager to put some capital into the project.
If this suggestion is accepted, the IFI will then have the right to oversee the management of
the project. This is because a Musharakah contract gives executive power to all partners. The
issue here will be in getting the other parties to agree to this change of contract.
127
Key points
In a Mudarabah contract, all losses must be borne by the capital provider. The manager will only
lose his time and effort.
In Musharakah, the loss must be borne by both parties in proportion to their capital contribution.
7.4 Functions of security contracts

In the context of a security contract, there are some distinctive features that differentiate one contract
from another. These features suit different circumstances in real market practice. One feature that is
common to all contracts in this category is that they are not primary contracts with original rights and
liabilities. The need for a security contract arises only to secure the rights and liabilities that originate from
primary contracts, such as sale, lease and, to some extent, investment contracts. In other words, in the
absence of a primary contract, these security contracts are meaningless because they have no interests
to protect. However, in protecting the interests of the principal creditor, they have different features that
should be recognised. These distinctive features can be summarised as follows.
Table 7.4 Features of security contracts

Features
Pledge
Guarantee
Transfer of debt
Parties
2 parties
3 parties
3 parties
Effect
Original debt is not

extinguished
Original debt is not

extinguished
Original debt is
extinguished
Types
1. Possessive pledge
2. Non-possessive
pledge
1. Performance
2. Bailment
1. Restricted
2. Non- restricted
Recourse right
to debtor
Non-applicable(except in the case of

death and insolvency
of the principal debtor)
Additional asset to be
provided by the debtor
Consent of the
principal debtor
Table 7.4 outlines the specic features of each of these security contracts. While the Hiwalah contract
will release the transferor from any liability once the transferee has agreed to the transfer of debt, both
pledge and guarantee will not release the liability of the principal debtor until and unless the payment or
performance has been made to the satisfaction of the principal creditor. In other words, under Hiwalah,
the transferor, who is also the debtor to the principal creditor, will be released from any liability towards
the principal creditor once the transferee, who is also the principal creditor, agrees to accept the payment
by the principal debtor who owes the transferor.
Actual payment of debt by the transferor to the principal creditor is not a requirement to render their
liability extinguished. However, to have the benet of this feature, there must be three parties who
happen to owe to each other. As a consequence, the principal creditor, upon accepting the transfer of
debt, is not entitled to recourse to the transferor (their immediate debtor) unless in the case of death
and insolvency of the principal debtor. Different applications and types of securities can be pledged, for
example, they could be possessive whereby the pledgee would hold the pledged asset preventing the
pledgor using it. The pledge could alternatively be non-possessive, which is more common in practice,
whereby the pledge will only create caveat on the transfer of ownership but the asset will remain in
the possession of the pledgor. The guarantee is, however, meant to ensure performance by the principal
debtor or to produce a person before the court of law (bailment). As for Hiwalah, the transferee may or
may not be related to the transferor. If the transferee, prior to the transfer of debt, was the creditor to the
transferor, then it is called restricted Hiwalah.
Islamic commercial law also allows non-restricted Hiwalah whereby the transferee is a third party who
agrees to collect the payment from the principal debtor but is also willing to advance to the transferor
an amount of money equivalent to the money to be collected. This practice resembles factoring in
many aspects. It is possible for one obligation to be secured by more than one contract. In Islamic house
nancing, based on Murabahah, for example, there is no objection to a creditor requiring that the debtor
128
provide a pledge as well as a guarantor from whom the creditor can claim should the debtor fail to pay
what is due under the Murabahah sale. Obviously, the application of Hiwalah is unique as it requires some
prerequisite in terms of parties to the contract and the nature of nancial obligation.
Key point
The need for a security contract arises only to secure the rights and liabilities that originate
from primary contracts, such as sale, lease and, to some extent, investment contracts.
Exercise 7.2
The ABC bank has extended Murabahah nancing to the XYZ company over ve years. The
XYZ company has invested in some compliant shares and sukuks which are free from any
encumbrances. These assets form part of the assets of the XYZ company.
(a) What would be the best means of security to ABC Bank?
(b) Would your answer be different if XYZ company had no assets which were free from any
encumbrances?
7.5 Flexibility of contracts

Some sales contracts are more exible than others. The following are examples.
Table 7.5 Flexibility of contracts

Forward Sale/Deferred Delivery Sale
Features
Salam
Istisna
Payment
Advance
Flexible payment
Delivery
Future
Future
Subject matter
Agriculture produce
Asset to be constructed or
manufactured
Security
The following table summarise a comparison between the various types of sale contracts.
Table 7.6 Comparison of sales contracts

Sale Contracts
Features
Murabahah
Musawamah
Istisna
Salam
Payment
Spot future
Spot future
Flexible
Advance
Delivery
Spot
Spot
Future
Future
Security
(Future payment) (Future payment)
(Future delivery) (Future delivery)
Prot margin
Asset
Identication by
physical reference
Identication by
physical reference
Identication by
description
Identication by
description
Table 7.5 and table 7.6 show that sale contracts include various features which could offer some
exibility in some specic cases and needs. Although both Salam and Istisna are of deferred delivery
sales, Istisna is more exible in terms of the method of payment. Here, payment for any construction or
manufacturing contract can be made on a spot basis or during its progress. This gives more room for IFIs
product development to suit the need of their customers. However, mention should be made that Salam
and Istisna are applicable to different subject matter. While Salam is normally used for goods that need
no construction, such as agriculture and metal, Istisna is only valid on assets that need some form of
construction or manufacturing, such as a building, power plant or highway.
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The exibility of the sales structure is made clearer in table 7.6. A brief comparison, between
Murabahah, Musawamah, Istisna and Salam has shown that an IFI may use the relevant sales
contract to satisfy the need of its client. Obviously, IFIs can use a Murabahah or Musawamah contract
to nance the purchase of a house or factory that is already constructed. However, if a customer
obtained nancing to own a property still under constructions then Istisna would be more practical.
The above discussion aims to highlight that each contract has its own distinctive characteristics that
need to be appreciated. It will also help you to understand product development and enhancement
in Islamic nance as all Islamic nancial products and services are essentially based on contracts.
The features and characteristics are integral to, and not detachable from, a contract that will
subsequently be transformed into a commercial product. For example, a product of Islamic project
nancing based on Istisna will have to internalise all the features of Istisna as prescribed by Islamic
commercial law, as well as established principles formulated by jurists. Obviously, if the nance was
meant to purchase an asset that can be physically identied by reference to a particular existing
asset, Istina in this case will not be possible. A Murabahah sale would be more appropriate.
Key points
Salam is normally used for goods which do not involve construction.
Istisna is only valid on assets such as a buildings, power plants or highways, which require
some form of construction or manufacturing.
In Istisna, the payment for any construction or manufacturing contract can be on a spot basis,
progress based or any other manner agreed by both parties.
Exercise 7.3
Why is there a distinction between the position of assets in relation to Murabahah or
Musawamah vis--vis Istisna and Salam?
7.6 Contracts to do work

Islamic law also recognises a contract where a party engages another party to do work on its behalf.
The contract looks similar to a hire contract. This type of contract consists of two specic contracts:
Wakalah (agency) and Jualah (commission-based). For Wakalah, the principal will appoint an agent
to undertake a certain assignment or work. All the rights and liabilities will be assumed by the
principal. The agent could be paid for their service as the fee is not integral to the Wakalah contract.
If a fee is agreed, the agent will be paid for their service regardless of whether they have achieved the
intended objective. With regards to Jualah, the fee will only be paid upon the specic performance
by the appointed party. The fee paid is conventionally known as a commission. The basic difference
between these two contracts is depicted in the following table.
Table 7.7 Differences in contracts to do work

Contracts to do work
Features
Wakalah (agency contract)
Jualah (commission-based
contract)
Identied work
Payment/ fee
/
Condition for payment
Work
Performance or achievement of
certain standard
This table attempts to explain that although both Wakalah and Jualah are of the same category,
they differ with regard to the scheme of reward or compensation. A fee paid under Wakalah is due
once the Wakil (agent) has performed his duties, irrespective of the quality or degree of performance.
A fund manager will be paid, for example, 1.5% of the Net Asset Value (NAV) of the fund on a
yearly basis for his management services. The fact that the fund performs to the expectations of the
investors or otherwise is irrelevant. However, under Jualah, the fee is only paid once and the worker,
or perhaps the fund manager, is able to achieve some rate of return, that is, the hurdle rate. This fee
structure is useful to incentivise and reward the fund manager for their performance.
130
Key points
Fees paid under Wakalah are due once the Wakil (agent) has performed his duties, irrespective
of the quality or degree of performance.
In Jualah, the fee is only paid once the worker has achieved the prescribed targets, as agreed in
the contract.
Exercise 7.4
Can you identify which contracts the Urbun principle does and does not apply to and provide
reasons for your answer? You may wish to make reference to table 7.6 above.
7.7 Potential and actual application of these contracts to various Islamic

nancial products and services.
Islamic nancial products and services are structured to meet the legitimate needs of society. Islamic
contracts are resourceful in satisfying the commercial needs of customers, both retail and corporate.
These contracts are important in order to substitute the function of lending for interest the main
contract in all conventional banking products.
The application of these various products adds diversication to Islamic nance in terms of product
offering. It also makes Islamic nance more challenging as practitioners and advisers have to
vet many different and various principles contained in a single product. These principles have a
signicant impact on legal and taxation issues as well as relevant risks such as market risks, rate of
investment return risk and operational risk. These nancial products are obviously more complicated
and diversied compared with simple loan transactions.
7.7.1 Using historic contracts to meet todays requirements

All the contracts explained in the previous chapter existed in the past. However, they did not
constitute banking products as until recently there were no Islamic banks. The challenge is how to
use these contracts to suit the nancial intermediary function of an Islamic bank as well as other
Islamic institutions and markets such as Islamic insurance and an Islamic stock market. This has been
done successfully by using relevant nancial engineering skills, but without diluting the very features
of the contracts concerned.
Istisna, for example, is a contract designed to enable a purchaser to order an item to be constructed
and delivered in the future. The payment could be made in advance or any manner agreeable to both
the purchaser and the seller/contractor. Typically, as in the past, both the purchaser and the seller
are the ultimate purchaser and seller respectively. An advance payment or payments based on the
progress of the construction, if applicable, would help the contractor nance his cost of construction.
7.7.2 Financial engineering

Where the purchaser, of say a house, lacks sufcient capital, then banks accept that a different
product is required. Realising that an Islamic bank is neither an ultimate purchaser nor an ultimate
seller or contractor, jurists have put forward an alternative structure that is based on proper and
approved nancial engineering. This structure, called parallel Istisna (Istisna Muwazi) refers to a
contract of two independent and non-related contracts of Istisna. The rst contract is entered
into between the bank acting as the seller/contractor and the customer as the purchaser. Under
this contract, the customer may pay the Istina purchase price at, for example, 120,000 payable
in ve years. Subsequent to that rst contract, the bank, acting as the purchaser, will enter into
another contract of Istisna with another party, which is the seller/contractor, at for example,
100,000, which is paid according to the progress of the construction. These two contracts must be
independent in the sense that if the contractor in the second contract fails to deliver the required
asset as specied in the contract, this will not exempt the bank in the rst contract, as the seller,
from delivering the asset as requested to the customer.
The liability of both buyer(s) and seller(s) in these two parallel Istisna contracts are not contingent
upon one another. They have to be stand-alone contracts to reect the real Istisna venture entered
into by IFIs. By doing some nancial engineering to the original structure, it is clear how a classical
contract such as an Istisna contract can be used effectively in modern banking environment, not
only for retail but also for corporate customers.
131
7.7.3 Augmenting historic contracts

In other cases, a classical contract is adopted but is subject to additional requirements to make it
viable from a commercial perspective. A contract per se is compliant to Shariah principles but is
defective in meeting rigorous and prudent banking standards. A good example is the Murabahah
contract. Murabahah,as practised in the past, presupposes the seller to already own an asset before
he can sell it to a customer at a marked-up price. This approach, although compliant, poses many
risks, especially to the nancier. Such problems include:
(a)
difculty in identifying the assets that are most likely required by the customers; it would
be almost impossible for the nancier to purchase all consumer goods as these are not only
diverse but also different within the same group of asset in terms of colour, design, etc
(b)
storage costs, where the nancier has to purchase all assets that it intends to sell to customers
at a marked-up price and store them in a warehouse while waiting for customers to approach
the nancier for Murabahah nancing
(c)
non-productive use of capital as the capital has been used to purchase items and assets that
are not necessarily sold within a short period of time; hence, the loss of opportunity to invest
in other investment schemes for the benet of both the depositors and shareholders; the worst
scenario is that these assets could have expired or be obsolete due to some technological or
demand reasons; their value will decrease or the bank could lose the whole value entirely
(d)
there is no guarantee that the customers will approach the nancier to get these assets in a
Murabahah sale; therefore, the nancier has taken an excessive market risk.
7.7.4 Making nancial products commercially viable

In order to overcome the above issues, some additional components have to be added to make the
nancial product commercially viable. These include, among others, the following:
(a)
a promise or an undertaking by the customer to purchase a particular asset from the nancier
upon the purchase of the assets from the vendor by the nancier; this is to avoid the customer
breaching the contract and to protect the nancier
(b)
it is only upon the request and promise by the customer that the nancier would purchase the
requested asset from the vendor.
These two additional components convert the classical Murabahah into a nancial Murabahah, called
Murabahah li al-Amir bi al-Shira or Murabahah to the purchase orderer. Examples of this Murabahah
and parallel Istisna facility illustrate the application of contracts to modern Islamic nancial
products and services.

A company has been given a concession to build and operate a highway. This company
intends to seek Islamic nancing to cover the cost of construction and maintenance of the
highway. Propose as many contracts as possible that could be considered for this purpose.
Solution
More than one contract could facilitate the above nancing. These contracts include:
a. Mudarabah whereby the investors provide the capital and the company provides the work
and management relating to construction and operation of the highway
b. Musharakah whereby the investors and the company jointly contribute the capital to
cover the cost of nancing to build and operate the highway
c. Murabahah nancing to nance the purchase of raw materials, equipments cranes and
other assets needed to build and maintain the highway, however, Murabahah cannot
provide working capital requirements to pay the salaries and other cash-based costs
d. Istisna nancing using a parallel Istisna concept. Here both the nancier and operator
contribute capital toward the cost of building and maintaining the highway.
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Exercise 7.5
Both classical and nancial Murabahah are based on the same principles and are both
Shariah compliant. Can you explain why nancial Murabahah is used in preference to
classical Murabahah?
7.8 Conclusion
This chapter explained how it is possible to meet the needs of different customers by understanding
the features of the various contracts. You were shown how to compare and contrast various
classications of contract in order to appreciate the different behaviour of distinct contracts and to
apply a particular contract in order to meet a specic purpose. This chapter should have reinforced
your understanding of the different classications of contract and their economic functions in real
business transactions.
In the following chapter we turn our focus to how traditional contracts are used in Islamic nance to
arrive at specic Islamic nancial products.
7.9 Summary
1.
although contracts are different from each other in terms of features, they may be used to
nance a common nancial need such as the purchase a house. Contracts such as Murabahah,
Ijarah muntahia bi tamleek and Musharakah Mutanaqisah are relevant to this common purpose
2.
Musharakah is different from Mudarabah, not only with regard to capital structure, but, more
importantly, it provides the opportunity for the IFI to participate in the management of the
business venture
3.
each pledge, guarantee and transfer of debt has different functions and requisites with regard to
providing securities to the creditor; the application of the right contract or contracts of security
to secure either the payment or delivery is important
4.
exibility of some sales contracts can be used to nance different nancing requirements; while
Murabahah or Musawamah can be used to purchase a house that has been completed, Istisna
can be used to pay for a house that is still under construction
5.
payment of a fee based on a performance that is linked to an agreed benchmark, as embodied in

the contract of Jualah, could be more appealing compared with a fee under a Wakalah contract
for the work done by the Wakil/agent; both are, however, useful in their respective context
6.
the manifestation of both parallel Istina and nancial Murabahah is clear evidence of how
classical contracts, such as Istina and Murabahah, can be transformed to products that are
commercially viable.
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Chapter 7 Answers
Exercise 7.1
House nancing could be effected through Murabahah, Ijarah muntahia bi tamleek or
diminishing Musharakah. All three contracts could be used to structure a nancial product
for house nancing. However, given the above scenario, both Ijarah muntahia bi tamleek and
Musharakah Mutanaqisah are likely to be more appropriate because the rental can be revised
according to the prevailing cost of funds. A Murabahah contract would expose the Islamic
Financial Institution (IFI) to increasing interest rate risk or the cost of funds rising particularly
for long term house nancing.
Exercise 7.2
(a) Given the above scenario, the ABC Bank could create a charge on the companys shares and
Sukuk and other unencumbered assets. A charge (Rahn) and guarantee (Kafalah) are both
possible in the case where the customer/company has some assets
(b) Where the customer/company has no assets upon which a charge can be created, the ABC
Bank could require the XYZ company to produce a guarantor to guarantee the payment of
Murabahah nancing. Only a guarantee (Kafalah) is possible in such cases.
Exercise 7.3
Both Murabahah and Musawamah require spot delivery of the asset under consideration.
Therefore the asset must already be in existence. In the case of Salam and Istisna, which are
based on the principle of deferred delivery, at the time of the contract, the asset can only be
identied by a description of what needs to be produced or manufactured.
Exercise 7.4
Urbun, which is a down payment scheme, is applicable in the case of Murabahah, Musawamah
and Istisna as these sale contracts accept deferred payment arrangements. Urbun cannot
apply to Salam as this contract requires the full payment in advance.
Exercise 7.5
Financial Murabahah suits the function of the IFI as an intermediary rather than a trader.
Problems of storage, market risk and meeting the specic needs of customers are effectively
removed simply by having this concept which relies on the fact that demand precedes supply.
There is no need, therefore, for the IFI to purchase the goods prior to the request of the
customer for Murabahah nancing. Classical Murabahah presupposes that the nancier owns
the item before the sale is initiated.
134
135
Revision questions
Revision Questions
1.1 Both Ijarah muntahia bi tamleek and Musharakah Mutanaqisah help IFIs to nance a customer
to purchase a house. What is the basic difference between these two products?
(A)
While Ijarah muntahia bi tamleek is based on sale, Musharakah Mutanaqisah is based on

partnership.
(B)
While transfer of ownership under Ijarah muntahia bi tamleek takes place at the end, it
takes place progressively under Musharakah Mutanaqisah.
(C)
Ijarah muntahia bi tamleek is only suitable for nancing for a completed house whereas
Musharakah Mutanaqisah suits both a completed house and a house under construction.
(D)
Unlike Ijarah muntahia bi tamleek, Musharakah Mutanaqisah is based on rental which

must be xed.
1.2 An investor in a business venture wishes to participate in the management of the business
venture. Which of the following contract(s) are suitable?
(A)
Mudarabah.
(B)
Musharakah and Mudarabah.
(C)
Musharakah.
(D)
Ijarah.
1.3 Which of the following contracts of security is suitable for securing the interest of a nancier
under Murabahah nancing?
(A)
Pledge.
(B)
Guarantee.
(C)
Assignment of debt.
(D)
Pledge and guarantee.
1.4 Which of the following descriptions does not apply to a Wakalah contract?
(A)
The agency contract for no fee consideration.
(B)
The agency contract for a xed fee consideration.
(C)
The agency contract is for a fee consideration but is based on a specied performance or
benchmark.
(D)
An agency contract stipulating that an agent will work on something on behalf of the
principal.
1.5 What is the main reason for adopting nancial Murabahah in preference to classical Murabahah?
136
(A)
It is more compliant to Shariah principles.
(B)
It is more commercially viable to both the bank and the customer.
(C)
It is more economical for the customer.
(D)
It is easier for the IFI to arrange and requires less administrative work to service it.
Pledge or guarantee?
Fill in the blank column with the most suitable contract or product for the description given. You will need
to choose from the following: Financial Murabahah, Musharakah Mutanaqisah, Istisna or parallel Istisna,
Salam and Jualah contracts.
Description
Revision questions
Question 2
Product or contract
Financing house under construction.
The bank desires to avoid storage cost in providing

consumer nancing under a sale contract.
Investors seek to compensate the fund manager only
for his excellent performance based on certain rate of
investment return.
Customers seek to buy the ownership of a house
progressively.
Advance payment to set the delivery in the future to
hedge the risk of market risk.
137
Revision questions
Answers
1.1 (B) The transfer of ownership under Ijarah muntahia bi tamleek takes place at the end of
the lease because it is a lease contract with the option to purchase the asset. In the case of
Musharakah Mutanaqisah, the ownership is transferred progressively through the redemption
of the partnership by the customer.
1.2 (C) Only the Musharakah contract allows the investor to take part in the management of
the business. Under the Mudarabah contract the management of the business is performed
exclusively by the manager.
1.3 (D) There is no objection under Shariah to a creditor requiring the debtor to provide both a
pledge and a guarantor, from whom the creditor can claim should the debtor fail to pay what is
due under Murabahah sale nancing.
1.4 (C) A fee paid under a Wakalah cannot be linked to any performance or benchmark; otherwise
it becomes a Jualah contract.
1.5 (B) Under the classical Murabahah concept, the seller must own the asset prior to receiving a
request for Murabahah nancing from the buyer. This is different from nancial Murabahah,
where the seller/nancier will only purchase the desired asset after receiving a request from
the buyer.
Question 2
Description
138
Product or contract
Financing house under construction.
Istisna or parallel Istisna.
The bank desires to avoid storage cost in providing

consumer nancing under a sale contract.
Financial Murabahah.
Investors seek to compensate the fund manager only

for his excellent performance based on certain rate of
investment return.
Jualah contract of management.
Customers seek to buy the ownership of a house

progressively.
Musharakah Mutanaqisah.
Advance payment to set the delivery in the future to

hedge the risk of market risk.
Salam.
Revision questions
139
Chapter eight
Traditional
Islamic contracts
and Islamic nance
Learning outcomes
illustrate the exibility of Islamic commercial law to

meet nancial needs without resorting to lending for
an interest
describe the relationship between traditional

contracts and Islamic nance products and services.
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Traditional Islamic contracts and Islamic nance

The traditional contracts available.
The selection of proper and relevant contracts.
The incorporation of all the leading principles governing that contract.
The need to enhance a contract to make it commercially viable.
Incorporating new features to render the product viable and feasible.
8.0 Introduction
In this chapter you will be introduced to the process by which Islamic
Financial Institutions (IFIs) select the appropriate contracts to meet the
needs of their clients. The chapter will also introduce you to the process of
transforming particular traditional contracts into nancial products. This
process is known as nancial engineering. It is not an exaggeration that
most if not all contemporary Islamic nancial products are the result of
this nancial engineering. As a result simple contracts have been used to
create products that effectively satisfy modern nancial needs. This chapter
attempts to guide you through this interesting and challenging task.
8.1 Flexibility of Islamic commercial law to meet nancial needs without
resorting to interest-based lending
8.1.1 Contracts
Contracts are the result of the meeting of two minds, the offeror and offeree, on common grounds
or terms. The grounds or terms of the contract are what distinguish one contract from another. For
example, a sale contract is different from a lease contract and the two cannot serve the same purpose
at the same time. While one is dedicated to satisfying the transfer of ownership, the other affects the
transfer of the right of use or usufruct while retaining ownership or title with the owner/lessor.
8.1.2 Contracts - the basis of Islamic nance products

You will have gathered by now that the products and services of Islamic nance are based on a
variety of contracts. The various contract types are explained in the glossary of contract and features.
When a contract type has been chosen, specic features and terms are attached to make them
workable and Shariah compliant. The selection of a particular contract is relatively easy compared
with the incorporation of all the relevant terms and conditions to render a product both Shariahcompliant and commercially viable. Therefore, a viable contract to suit each Islamic nancial product
must take into consideration all relevant Shariah principles pertaining to that contract and product.
It is in this context that the appropriate knowledge and understanding of Shariah principles are
critical, not only to ensure compliance but also to help develop competitive and innovative products
and services.
Exercise 8.1
In previous chapters, you were introduced to many principles of law relating to the various
contracts used in Islamic nance. Without reference to these chapters, can you give examples
of the principles that apply to sale, lease and partnership contracts? You may wish to think
about conditions for sale, lease and partnership.
141

A discussion of a contract in Islamic commercial law cannot be detached from its
underlying principles and features. The principles and features are the effective elements
in making one contract distinct from other contracts. On the same basis, Islamic nance,
which is based on specic contracts, is distinct from conventional nance.
Provide a real example that can illustrate the above statement.
Solution
There could be more than one illustration to describe the above. In accepting a deposit on
the basis of Mudarabah from the depositors, the IFI is willing to share the prot, if any, with
their depositors as Mudarabah, unlike a loan in a xed deposit account, is a prot-sharing
concept. In a restricted Mudarabah investment account the nature and full disclosure of
investment activities must be disclosed to the depositors. These disclosure requirements
make the Mudarabah contract different from both other Islamic contracts and conventional
xed deposit accounts. In conventional insurance protection is sold for a premium. In Islamic
insurance or Takaful, the Takaful company does not sell protection and does not receive any
premium. Premiums are paid as donations by the policyholders to a fund that is managed by
the Takaful operator to compensate or indemnify the participants if the prescribed risk occurs.
The contract of donation and its features are very distinct from other contracts and at the
same time make it different from conventional insurance.
Figure 8.1 Constituents of an Islamic nancial product
Islamic nancial products
Principles of law governing contract
Contract
The above diagram shows that the creation of successful Islamic nancial products is the result of
selecting proper and relevant contracts as well as incorporating all leading principles of that contract
in the product. When a contract has been selected or identied as the basis of a nancial product,
there is no option from a Shariah perspective but to incorporate its salient principles into all aspects
of the product.
Key point
A successful Islamic nancial product is the result of the selection of proper and relevant
contract(s), as well as the incorporation of all the leading principles and features of that
contract(s) in the nancial product.
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8.2 Conventional banking model

Conventional banking works exclusively on the premise of lending by charging interest and
borrowing by paying interest. A savings account reects borrowing by the bank from the depositor(s)
and for this the bank will undertake to pay interest to the depositor(s) for the loan. It is a liability in
the records of the bank. On the other hand, when the bank nances a customer, say, to purchase a
house, the bank simply arranges a loan to the customer to allow the latter to purchase a house. The
bank charges the customer interest on the loan. Normally, the bank charges interest on such loans
at a higher rate from that which it pays to the depositors. The spread between these two rates is the
banks net interest income.
This brief summary of the nature of conventional banking implies that the basis of all banking
activities is an interest mechanism. In other words, the mobilisation of funds from the surplus unit
in the society (depositor) to the decit unit (borrower) is made possible through the intermediation
of interest, which is basically a charge or premium on money when it is loaned out. Money has been
deemed as a commodity and for that reason money has a premium, whereby the lender expects to
be compensated for lending out his money.
8.3 Islamic banking

8.3.1 Meeting the needs of customers
Given that the receiving and paying of interest are specically forbidden under Shariah law, IFIs have
had to develop a banking system without resorting to the interest mechanism. This requirement has
to be seen, however, in light of three key facts:
1.
shareholders in these IFIs expect a Return On Equity (ROE) when they invest their capital in an
Islamic bank
2.
Islamic banks must be effective in mobilising funds to nance both the retail and corporate
sectors of the economy
3.
as with conventional banks most Islamic banks set out to make a prot.
Satisfying these three requirements requires exibility in the application of Islamic commercial law.
The prohibition of lending money in return for interest in Islamic commercial law does not mean
that Islamic commercial law is unable to satisfy a commercial need that is normally satised through
a loan contract. Unlike conventional nance, where the borrower agrees to repay the principal plus
an extra amount of money called interest, in Islamic nance the nancial institution will nance
the customer for the purchase of, say, a car or house or provide a letter of credit by means of sales,
leasing or other types of contract.
8.3.2 Real economic activities

Muslims believe that money cannot earn money by itself, but that it should be put into real
economic activities, such as trading, leasing and investment to earn extra income.
The Quran states that trading or sales are accepted but not Riba or an interest-based transaction.
Chapter 2, verse 275 of the Quran reads: God has made trade lawful and Riba unlawful.
A linkage between money and prot or income is to be established through commodity, services
or investment contracts. The whole idea is to involve money in real economic activities for Islamic
banks to earn a prot.
8.3.3 Finding the right contract

Sales contracts, leasing contracts and partnerships or joint-venture contracts, among others, can
be used to provide the same economic benet that a conventional loan contract offers. A house
seeker in Islamic nance may approach an Islamic bank to obtain appropriate nance because the
ultimate aim is to be able to acquire a house on credit. Instead of lending the required money to this
customer, the Islamic bank, based on the request of this customer, will purchase the selected house
from the vendor at a purchase or cost price. The Islamic bank will then sell the same house to the
customer at the purchase price plus a margin of prot and allow the customer to pay this selling
price on an instalment basis. By so doing, the bank earns extra income, not from lending for interest,
but by trading on a marked-up sale, whereby the differential amount between the purchase price
and the selling price would be seen as prot earned by the bank. This type of transaction is based on
a Murabahah contract.
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Ultimately, the customer is able to acquire their preferred house on credit, without paying any
interest to the bank. However, they have to pay a higher price under a credit sale compared with the
cash sale. The sale contract used is an alternative to a term loan facility to purchase a house under a
conventional banking scheme. The following table outlines the differences between a conventional
house loan and an Islamic house purchasing arrangement.
Table 8.2 Conventional vs. Islamic house nancing

Conventional house loan facility
Islamic house nancing facility
1. Customer approaches the bank for a loan,

for example 100,000 to purchase a
particular house.
1. Customer approaches the bank and seeks

to purchase from the bank a particular
house where the cost price of the house is
100,000.
2. The bank advances a loan of 100,000 to the

customer for a xed-interest rate of 4% per
annum for 10 years.
2. The bank purchases the house from the

vendor at 100,000.
3. The customer purchases the house at

100,000 using the loan facility provided by
the bank.
3. The bank sells the house to the customer

at 100,000 plus 4% prot per annum
(Murabahah).
4. The customer pays back the principal and

interest every month.
4. The customer pays the selling pricing

comprising of the cost and prot every month.
[100,000 x 4/100 x 10 years = principal +

interest]
[100,000 x 4/100 x 10 years = selling price]
Exercise 8.2
Based on the information given in the table above, calculate the nal repayment amount
under a conventional house loan facility and the nal selling price under an Islamic house
nancing facility.

Some critics of Islamic nance have suggested that nancial Murabahah is no different
from a term loan facility to nance the purchase of a house. In both cases the bank,
whether Islamic or conventional, simply acts as an intermediary. What in your view are the
similarities and differences?
Solution
From the point of view of economic benet, both facilities serve the same purpose of allowing
a customer to own a house and to pay later with a margin of prot or interest as the case
may be. The similarity of the ultimate result therefore should not be a contentious point.
The methods of achieving this result are however different. The term loan facility offered by
conventional banks charges interest - premium on money loaned by the bank. Islamic nance
brings the concept of sale instead of loan to nance the customer. The Islamic bank has to
purchase a house from a vendor at x amount and sell it to the customer at x+y amount.
These are two real transactions whereby the Islamic bank actually purchases a house before
it can be sold to the customer. In many jurisdictions, stamp duty regulations have been
amended to avoid the possibility of double taxation on these two transactions (refer to
chapter one, section 1.4.5, which covers stamp duty implications relating to Islamic nance).
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8.4 The relationship between traditional and Islamic nancial products

and services
All products and services offered by IFIs originate from traditional contracts. This section explains
how a classical or traditional contract can be transformed into a viable Islamic banking product. The
exibility and functionality of these contracts are crucial in supporting the Islamic banking business
environment. Islamic commercial law supplies a variety of contracts to facilitate Islamic nancial
business to compete with conventional or interest-based nancial products.
8.4.1 Purpose of the product

In order to select the correct type of contract it is necessary to appreciate the purpose of a product
and its salient features. Once a contract type has been selected checks and assessments must be
carried out to ensure how feasible the contract is in meeting that particular purpose. In section 8.3.3
above, we saw how a Murabahah contract could be selected to facilitate Islamic house nancing and
meet the respective needs and expectations of both the nancier and the customer.
8.4.2 Searching for the correct Islamic contract

Other classical contracts, with different salient features, may have been available to facilitate the
purchase of a house. The selection and deployment of a classical contract to support or facilitate a
modern Islamic nancial product or service are centred on three activities:
(i)
a search for a potential contract, or combination of contracts, which could satisfy the ultimate
purpose of a particular nancial product
(ii)
the selection of a particular contract or combination of contracts to be the main underlying

contract or template for the proposed product
(iii) the transformation of this traditional contract into a commercial product by either enhancing
its features or rening some of its features to suit the market realities.
The relationship between these three activities can best be explained by an example. Vehicle
nancing is conventionally facilitated through a hire purchase contract. A vehicle hire purchase
contract is a lease contract in which an option is given to the lessee to purchase the vehicle by
paying all instalments as prescribed in the schedules. The customer is deemed to purchase the vehicle
after making all the scheduled payments by the end of the hire purchase period. The lease payments
include an element of interest to reect the fact that deferred payment terms have been agreed.
IFIs need to offer a similar product maintaining similar features. The conventional features of this
product are:
(i)
the customer leases a vehicle for a rental payment
(ii)
the customer is given an option (not an obligation) to purchase the vehicle; if this is exercised it
binds the nancier
(iii) full payment of the scheduled rentals means the transfer of the title of the vehicle to the
customer without a need to enter into a sale contract.
The key feature of this product is that it is a lease contract, but with the rights of the lessee to
purchase the leased asset and the obligation of the nancier to sell the vehicle if this option is
exercised by the lessee. This is basically the purpose of this product, known as hire purchase.
Exercise 8.3
Given the features of conventional hire purchase, indicate the features relating to the transfer
of ownership, which might potentially be non Shariah compliant and explain the concern.
Key point
A traditional contract can be transformed into a viable Islamic banking product due to its
exibility and functionality to support the Islamic banking business environment.
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8.5 Choosing the correct Islamic contract

As noted above the rst activity is to look for a contract that is likely to achieve the intended
purpose. Leasing is the key term in this transaction - the lease of or use of a corporeal property or
usufruct. Therefore, a leasing contract, and not a hire contract for a personal service, seems to be
relevant. This is the rst dimension of the relationship of a classical contract with a modern Islamic
nancial product, known as hire purchase.
8.5.1 Ijarah or leasing

The Islamic contract of Ijarah to all intents and purposes meets the requirements of leasing as
it allows for the transfer of the right to use an asset, but does not transfer the ownership of the
leased asset to the user or the lessee. However, another contract is needed to satisfy the purpose
and features of a conventional hire purchase, to allow for the subsequent transfer of ownership
at the end of the lease period. Another search must be done to select a contract or contracts to
complement the Ijarah contract to allow for the effective transfer of the title of the leased asset to
the customer/user of the usufruct.
8.5.2 Ijarah muntahia bi tamleek or transferring the title

Under Islamic commercial law there is more than one contract that could legally and effectively
transfer the ownership from one party to another, including sales, gifts and waivers. Therefore, a
nancier under Islamic hire purchase may transfer the title to the customer/user by arranging to sell
the leased vehicle or by giving it away on a gift basis at the end of the lease period. The Accounting
and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has shown that Ijarah and Ijarah
muntahia bi tamleek can effectively transfer the title of the vehicle under Shariah Standard No 9.
In Ijarah muntahia bi tamleek, the method of transferring the title of the leased asset to the lessee
must be evidenced in a document, using one of the following methods:
1.
by means of a promise to sell for a token or other consideration, or by accelerating the payment
of the remaining amount of rental, or by paying the market value of the leased property
2.
a promise to give it as a gift (for no consideration)
3.
a promise to give it as a gift, contingent upon the payment of the remaining instalments.
These provisions clearly mention the sale mechanism either by (a) paying a token and a nominal
value or (b) by considering the remaining Ijarah rentals as the price for the purchase, or (c) by
paying an amount of money, which is equivalent to the market value of the vehicle intended to
be purchased by the customer. Alternatively, the transfer can be affected by the nancier/owner
including a gift contract. This gift contract could be conditional or non-conditional.
Exercise 8.4
Based on your understanding of the product of Ijarah muntahia bi tamleek, identify relevant
contracts which are used to construct this product.
8.6 Ensuring viability of the chosen Islamic product

In order to transform these two contracts into a viable and compliant product, the transfer of the
title must be executed separately from the Ijarah contract. A mere signing of the Ijarah contract will
not affect the transfer of title, as it will in the case of conventional hire purchase. Another contract
must be executed when the transfer of title is sought. In addition, to make this product viable and
similar to a conventional hire purchase agreement, a sale undertaking or Wad (unilateral promise by
one party to sell) is incorporated. Here the lessor/owner undertakes to sell the leased vehicle to the
lessee upon the exercise of an option by the lessee/user. This is to maintain the function of option
in conventional hire purchase. A sale undertaking by the nancier/owner will be an obligation on
the nancier to sell the leased asset as and when required by the customer/user. In addition, the
customer/user will give his Wad to purchase back the leased asset at an agreed price if he defaults
on the rental payments. This Wad is binding upon him.
The illustration of the Islamic nancial product known as Ijarah muntahia bi tamleek (lease ending
with ownership) or Ijarah Thumma al-Bay (lease followed by a sale), or simply translated as Islamic
hire and purchase, shows how classical contracts can be linked to modern and sophisticated Islamic
nancial products. Contracts like lease, sale and promise are simple contracts. However, when
146
they are combined for a purpose they form a new product that is more relevant to the current
environment to facilitate customers in this case to acquire vehicles following Shariah principles.
Exercise 8.5
An IFI has purchased a vehicle from the supplier at $50,000 at the request of a customer. The
vehicle is then leased out to the customer under Ijarah muntahia bi tamleek. The IFI, failed
to incorporate a clause on wad to commit the lessee to purchase the leased asset should
he default on payments. The customer did default and the Ijarah muntahia bi tamleek is
terminated. What can the IFI do in this situation?
(a) Continue charging the rental payment
(b) Sell the leased asset to the market and bear all the market risk/loss.
(c) Sell the leased asset to the market and require the customer to make good any shortfall
between the cost and market price.
(d) Repossess the leased asset until the customer pays the debt.

From the above it is clear that Wad can enhance certain Islamic contracts. An example of
this is vehicle nancing using the Ijarah principle or contract. What would be the effect on
an IFIs Capital Adequacy Ratio (CAR) if Wad could not be incorporated in such nancing
arrangements?
Solution
Wad is very important to the nancier as it protects him in the case of default. Without
Wad, the nancier incurs market risk when he has to sell the leased asset on the open
market to recover the nancing amount. From a risk management perspective, without this
put option or Wad, the risk weightage of the IFI would be higher, thus affecting their CAR.
Exercise 8.6
What are the two methods AAOIFI Shariah Standard No 9 on Ijarah and Ijarah muntahia bi
tamleek provides for effecting the transfer of ownership of a leased asset?
8.7 Conclusion
In this chapter we explained the process by which IFIs select appropriate contracts to meet the
needs of their clients. We also introduced you to the process of transforming particular traditional
contracts into nancial products. The chapter should have equipped you with the skills to transform
a traditional contract into an acceptable Islamic nancial product.
In the following chapter we will introduce you to the leading Islamic nancial products and services
in the banking, Takaful (insurance) and capital market sectors.
8.8 Summary
1.
the basis to all Islamic nancial products and services are the traditional contracts that are
available in the texts of the literature of Islamic commercial law
2.
when a nancial product is being developed, emphasis should be given to the selection
of proper and relevant contracts, as well as the incorporation of all the leading principles
governing that contract
3.
while the receiving and the payment of interest are categorically forbidden, IFIs must work on
a structure that would benet the shareholders to the IFIs, effectively mobilise funds in the
society and generate prot to IFIs; this could be achieved, for example, through sale or lease,
instead of lending money for interest
4.
money will earn money or extra income when it is put in real economic activity such as sale
transactions and leasing contracts, as well as partnership contracts; having nancing using
Musharakah can replace the conventional house loan
147
148
5.
the selection of a suitable contract for any proposed nancial product must take into
consideration the purpose of that product to match the character of the selected contract; the
resulting contract may need some enhancement to make it commercially viable; for example, a
lease with an option to purchase or a lease with a possible gift by the lessor is a good selection
to nance vehicle nancing
6.
in some cases, a new feature or contract must be incorporated to render the product viable
and feasible; an undertaking by the lessor to sell the leased asset to the lessee under Ijarah
muntahia bi tamleek is a feature to make this product viable.
Chapter 8 Answers
Exercise 8.1
Each contract has its own distinctive principles or features. The following examples are not
meant to be exhaustive, but are illustrative of these distinctions.
Sale
Lease
Partnership (Musharakah)
Transfer of ownership.
Right to use the asset.
Combination of two sources

of capital .
Sale price must be xed.
Rental can be xed or

oating.
Prot sharing ratio can be

negotiated and can be revised.
Exercise 8.2
(a) The repayment amount of the loan consisting of both principal and interest: 140,000
(b) The selling price consisting of both purchase price and prot margin: 140,000.
Exercise 8.3
The key feature of conventional hire purchase is that it assumes that the ownership of the
leased asset is transferred to the lessee/customer once the nal payment has been made.
The conventional hire purchase agreement combines a lease and sale in one contract. Islamic
nance requires a distinction between lease and transfer of ownership whereby one contract
must precede the other and the method of transfer of the asset must be clearly identied.
Exercise 8.4
(a) Ijarah or lease of the asset by the lessor to the lessee.
(b) Wad or promise by the lessor to sell or gift the leased asset.
(c) Wad or promise by the lessee to purchase (in the case of default or early termination of
Ijarah contract) by the lessee.
(d) Actual sale or gift to transfer the ownership of the leased asset to the lessee.
Exercise 8.5
(b) Sell the leased asset to the market and bear all the market risk/loss.
Exercise 8.6
(a) Sale at either token or market price or at price, which is equivalent to the
outstanding rentals.
(b) Conditional or outright gift of the leased asset by the lessor to the lessee.
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Revision questions
Revision Questions
1.1 Which of the following is not the correct description of the contract and its inherent principles
or features?
(A)
Sale contract is based on certainty of asset and price and will result in the transfer of
ownership.
(B)
Pledge or Rahn does not transfer the ownership right to the pledgee though the pledgee
has a right to ask the court to dispose of the pledge to pay the outstanding payment to
the pledgee.
(C)
Ijarah contract can be for xed or oating rental and can transfer the ownership of the
leased asset to the lessee.
(D)
Musharakah contract starts with a joint capital contribution by two parties on condition
that the loss must be borne by both of them proportionately.
1.2 Which of the following statements reect the requirement for Islamic nance to be engaged in
real economic activities as an underlying principle to enjoy prot?
(A)
The bank, upon the request of the customer, advances money to the vendor and later
charges the customer the principal and prot for the facility.
(B)
The bank contributes $100,000 to a customers existing business valued at $50,000 to

enhance working capital for a prot and loss sharing arrangement between the bank and
the customer.
(C)
Upon accepting the customers deposit, the bank uses the deposit for its investment but
promises to pay the depositor his principal and prot.
(D)
Being a partner to a customer, the bank provides an additional loan to the customer if
the business venture were to exceed the original paid-up capital.
1.3 Which of the following describes the order followed by an Ijarah muntahia bi tamleek nancial
contract?
(A)
Lease of the asset and purchase of the asset by the lessee.
(B)
Lease of the asset with a promise by the lessor to sell or gift the asset and the eventual
sale or gift to the lessee.
(C)
Promise to sell or gift by the lessor, lease of the asset and eventual sale or gift to the
lessee.
(D)
Promise to purchase by the lessee, lease of the asset and sale or gift to the lessee.
1.4 Which of the following is not a valid lease structure for Ijarah muntahia bi tamleek ending with
ownership transfer?
(A)
Ownership transfer through a sale at market value.
(B)
Ownership transfer through a conditional gift by the lessor.
(C)
Ownership transfer through a sale at a token price.
(D)
Ownership transfer through the payment of all rental payments.
Question 2
What is the role of Wad in Ijarah muntahia bi tamleek?
Question 3
Having read this chapter, explain what steps need to be taken in order to develop a viable Islamic
nancial product. Your answer should be logically structured to indicate the sequence of the
necessary steps.
150

1.1 (C) Ijarah contract does not transfer the ownership of the leased asset on its own. The transfer
of ownership can only be affected through either sale or gift contract.
Revision questions
Answers
1.2 (B) Providing capital to a business venture and risk taking in the outcome of the venture
reects that capital has been converted into real economic activity. The capital has diluted
its monetary form to become a real asset, and this reects a real economic activity. Other
activities do not reect the transformation of money into real assets.
1.3 (B) The proper sequence under Ijarah muntahia bi tamleek is a lease contract that
incorporates the promise by the lessor to either sell or gift the leased asset to the lessee
based on certain terms and conditions; it eventually results in the transfer of ownership
through either sale or gift.
1.4 (D) Under Ijarah muntahia bi tamleek, the asset will be transferred though the payment of a
purchase consideration on top of the lease payments or through the act of the lessor gifting
the asset to the lessee, upon full payment of all rental obligations.
Question 2
The important feature of Wad is that it imposes on the lessor the duty to sell the leased asset to
the lessee once the lessee exercises his option to purchase. The Wad is an undertaking to sell by the
lessor, which can be invoked as and when required by the lessee. The customer also gives his Wad or
undertaking to purchase the leased asset from the lessor in the case of default.
Question 3
Essentially, developing a new nancial product will start from understanding its ultimate purpose
followed by selecting a relevant contract to achieve that purpose and the incorporation of all of its
principles and features to suit the product behaviour. Let us assume that the ultimate purpose is
to allow the IFI to share in the prot of a business venture as compared to a xed amount of prot
arising from a nancing product. This suggests either the Mudarabah or Musharakah contract rather
than Murabahah or Salam or Istisna or even Ijarah contract. Then, specic features of the intended
product need to be examined. For example, if the IFI seeks to have executive powers, Musharakah
would be more relevant as compared to Mudarabah. The process of identifying the commercial
features of the product will continue until the full version of a new product is completely supported
by relevant Shariah principles.
151
Chapter nine
Overview of
Islamic banking,
Takaful and capital
market products
Learning outcomes
understand and explain Islamic banking products

understand and explain Takaful products
understand and explain Islamic capital market products.
Overview of Islamic banking, Takaful and capital market products

Introduction to Islamic banking products.
Stock screening as an aid to investors.
Introduction to Takaful products.
Introduction to Islamic capital market products.
9.0 Introduction
In this chapter you will be exposed to the leading Islamic nancial products
and services, not only in the banking industry but also in the Takaful and
capital market. You will also be introduced to relevant contracts that form
and create these products and, to some extent, to the reason(s) why a
particular contract is able to meet a particular nancial aim and objective.
This chapter, in addition to giving an overview of the products that are
currently available in the market, will link these products with the original
contracts that dictate their behaviour.
9.1 Directory of Islamic banking products and their underlying contracts
Islamic Financial Institutions (IFIs) offer many products and services to meet their clienteles needs,
both in the deposit and nancing sides of a bank. These products and services are important to make
IFIs competitive with conventional banks in terms of product offering.
In relation to Islamic savings or deposits, there are three main categories of account, namely an
Islamic savings account, an Islamic current account and an Islamic investment account. Some Islamic
banks may have an account for their depositors called an Islamic xed income deposit or account.
The following section will briey outline the product features of these various accounts and their
underlying contracts. Before we proceed to give a detailed illustration of each and every product, a
summary of these deposit products and their underlying contracts, is depicted in the following table.
Table 9.1 Islamic deposit accounts

Product types
Underlying contracts
Islamic savings account
Wadiah yad dhamanah

Qard / Hassan
Mudarabah
Islamic current account
Wadiah yad dhamanah

Qard / Hassan
Hybrid of Wadiah or Qard / Hassan and Mudarabah
Islamic investment account

(both restricted and unrestricted)
Mudarabah
Islamic xed-income deposit
Murabahah tawarruq
9.1.1 Savings accounts

Savings accounts aim to facilitate the keeping of depositors money in an account that is safe whilst
giving the depositors the exibility to withdraw their money and opportunity to benet from some
income from the savings. The contract that could facilitate this purpose could be Wadiah (safe custody),
Qard / Hassan (interest-free loan) and Mudarabah (prot sharing). Although each of these contracts
has their distinctive features, they are able to satisfy the above aim and objective in their own way.
153
9.1.1.1 Qard / Hassan

Qard / Hassan, being an interest-free loan, allows the borrower to borrow the money from the
lender without any obligation to pay interest in addition to the loan repayment. The liability
of the borrower is just limited to the repayment of the principal amount of loan. The borrower
may, however, award some benet to the lender at his sole discretion (Hiba). Such gifts cannot
be contracted in any form to avoid interest in this loan facility. As for an Islamic savings account,
which is based on Qard / Hassan, while the depositor is in the position of the lender, the bank is the
borrower. The money deposited in this account is deemed the banks where the bank has a liability
to repay the principal on demand. The bank may give some return to the depositors, which cannot be
agreed or promised in advance to avoid the equivalent of an interest payment as this is prohibited.
9.1.1.2 Wadiah
A Wadiah contract, on the other hand, simply means a safe custody contract. A depositor by
depositing their money with a bank for safe custody purposes has entered into a Wadiah contract.
On the other hand, the bank will give its undertaking to be liable for any loss to the deposited item,
namely the money deposited in this account. This has changed the contract of Wadiah from being
a mere trusteeship contract to a liability contract on the part of the custodian, that is, the IFI. This
shift in the nature of a Wadiah contract from trusteeship to suretyship is necessary to allow IFIs, as
custodians, to use the monies for their investment and nancing activities.
Muslim scholars view guaranteed safe custody contracts (safe custody plus liability) involving
the lending of money as contracts which cannot promise any extra benet to the depositor. This
is because the deposit of money under the safe custody contract could give the custodian the
opportunity to use the money to pay interest to encourage more deposit. This resembles money
lending for interest under the Qard / Hassan contract, which is prohibited.
9.1.1.3 Mudarabah
A Mudarabah contract has also been used to facilitate this account. Unlike both Qard / Hassan
and Wadiah contracts, depositors under the Mudarabah savings accounts will share prot with the
bank on an agreed prot-sharing ratio. As there is no lender-borrower relationship in a Mudarabah
contract, any promotional gift and extra benet are permissible when opening this account based on
the Mudarabah contract.
9.1.2 Current accounts

The same contracts are used to structure Islamic current accounts. Account holders under both
Qard / Hassan and Wadiah contracts are deemed to be lenders to IFIs and the rules and principles
regarding money lending would be the same as those that relate to Islamic savings accounts.
However, the Mudarabah contract is not used as a primary contract in Islamic current accounts.
Currently, Mudarabah is coupled with either a Qard / Hassan or Wadiah contract to make it more
feasible. This account is simply a hybrid of both a liability contract, represented by either a Qard /
Hassan or Wadiah contract, and an investment contract, represented by a Mudarabah contract. It
is a condition of such accounts that they must maintain a minimum balance to enjoy Mudarabah
features, otherwise they will be treated under a liability contract with no prot-sharing feature.
9.1.3 Investment accounts

An Islamic investment account is typically based on a Mudarabah contract in which depositors
provide the capital and IFIs provide the work and management. The prot, if any, is to be shared
between the depositors whereas any loss will mean that the bank loses time, effort and expected
prot. A Mudarabah investment account could be a restricted as well as an unrestricted investment
account. The detailed features and procedures of these two accounts will be discussed in Study
Guide 2 (section 4.5.1).
9.1.4 Fixed income account

An Islamic deposit account can give a xed income to the depositors. The contract used is Tawarruq,
which is simply a sale transaction involving three independent parties or more. For this account,
the depositor, for example, will appoint IFIs to purchase a particular asset from a prime broker at x
amount on cash basis and will subsequently, thereafter, sell the same asset to this bank at x+y to be
paid, let us say, after one year, which corresponds to the tenure of this deposit account. Under this
contract and structure, the depositor is deemed to deposit the x amount in the bank but will get
x+y as the return in the future. This account is discussed in detail in Study Guide 2 (section 4.6).
154
Key points
There are four main categories of Islamic savings or deposit accounts, namely Islamic savings
account, Islamic current account, Islamic Fixed income account and Islamic investment account.
The common contracts applicable in Islamic savings or deposit accounts are Wadiah,
Qard / Hassan, Mudarabah, Tawarruq and any combination of these contracts.
Exercise 9.1
1. What are the three main objectives of a savings account?
2. Outline the key differences between the principle of Qard / Hassan and the principle of
Wadiah?
3. What is the arrangement between the bank and the depositors in a Mudarabah investment
account?
4. How are Islamic xed income accounts different from conventional xed deposit accounts?
9.2 Financing products

IFIs offer several categories of products and services to their clients who seek nancing. These can
be classied into equity-based nancing and debt-based nancing. The main purpose of providing
this nancing is to facilitate customers to obtain the necessary assistance to either acquire or use a
property, or to meet particular expenses in a project. These products and services will be explained
briey with special reference to their underlying contracts. The detailed features of these products
will be explained in Study Guide 2 (chapters 5 and 6). The following table summarises some leading
nancing products and their respective and underlying contracts.
Table 9.2 Financing products

Equity-based
Debt-based
Product
Contract
Product
Contract
1. Project nancing
Mudarabah
Musharakah
1. House nancing
Murabahah
Ijarah muntahia
bi tamleek
Istisna
2. Trade nancing
Musharakah
(letter of credit)
2. Asset nancing
Murabahah
Ijarah muntahia
bi tamleek
3. Venture capital
nancing
Mudarabah
Musharakah
3. Letter of credit
Murabahah
4. House nancing
Musharakah
Mutanaqisah
4. Overdraft
Inah
Tawarruq
Sale and lease-back
5. Asset nancing
Musharakah
Mutanaqisah
6. Cash nancing
Inah
Tawarruq
7. Personal nancing
(education, travel,
medical, etc.)
Ijarah
Inah
Tawarruq
8. Credit/charge card
Tawarruq
Inah
Kafalah
155

With reference to table 9.2:
(a) Do you think that Islamic nancing products can satisfactorily substitute all
conventional nancing products, both retail and corporate?
(b) In what areas that you think current Islamic nancing products are not able to meet the
nancial needs of the customers in a manner that is Shariah compliant.
Solution
(a) The above list of Islamic nancing products can offer a good alternative to most
conventional nancing products. Conventional banks would normally offer the above
facilities but on the basis of an interest-based lending arrangement. You should compare
these Islamic nancing products with the list of products that are typically available at
any commercial bank in your town.
(b) There are areas where Islamic nancing is lacking, especially in corporate nancing.
These include amongst others, factoring facilities whereby in conventional practice, a
bank will purchase the receivables from a client on a discounted basis and will claim the
full payment from the party who owes the client this amount. In other words, the client
would factor or transfer the full risk of collection, including credit losses, to the bank.
There is no equivalent Islamic factoring in the global market though there is a Malaysian
version of Islamic factoring based on sale of debt which is not acceptable in other
jurisdictions.
9.2.1 Equity-based nancing vs debt-based nancing

Equity-based nancing is different from debt-based nancing. Under equity-based nancing the
customer owes no nancial obligation to the bank as the customer and the bank have agreed
to share the prot, if any, and to bear the loss where relevant. The bank has no recourse to
the customer in the event of non-payment of expected prot unless a case of negligence and
misconduct is found against the customer who is the manager or managing partner in a Mudarabah
and Musharakah contract respectively. On the other hand, debt-based nancing creates an
obligation upon the customer to pay a particular amount of money to the bank in all circumstances
whereby the obligation of payment is not linked to any attainment of prot. Upon entering into
debt-based nancing, a customer is under an obligation to make payment according to agreed
terms and schedules.
Exercise 9.2
What key feature makes debt-based nancing distinct from equity-based nancing?
The two main contracts used in equity-based nancing are Mudarabah and Musharakah.
9.2.1.1 Equity-based nancing - Mudarabah

The rst contract is called Mudarabah, where one party provides the nance and the other provides
the expertise and management. Prots are shared on a pre-agreed basis, but losses are borne only by
the provider of the capital.
It is envisaged that this contract would apply to some products such as project nancing and
venture capital nancing. This contract is ideal for these nancing products as the customer, who
is normally the project owner or contractor or investee company, would need a capital injection to
start the work. In practice, this contract rarely takes place in real banking products. It is, however, not
uncommon to capital market products, particularly in the form of Sukuk and asset management.
9.2.1.2 Equity-based nancing - Musharakah

The second contract is called Musharakah, loosely translated as a joint venture under which both
prots and losses are shared by the joint-venture partners, one of which is typically an Islamic bank.
Unlike Mudarabah, both partners must contribute the capital to the joint ventures, be it in cash or
kind. Prots are distributed in pre-agreed ratios, while losses are allocated in proportion to capital
contributions. Unlike Mudarabah the presence of this contract, in the realm of banking products, is
156
relatively more signicant and it is often applied to trade nancing by virtue of letters of credit (LC).
Both the bank, (the issuer of the LC) and the customer (importer) will contribute some capital to
cover the amount required for the LC. The resulting proceeds from the sale of the imported goods
will be shared between the bank and the customer on an agreed prot-sharing basis. Losses, if any,
will be borne by both parties proportionately as per their respective capital contribution.
Musharakah is also widely used to nance the acquisition of assets, be it a house or equipment. In
this case Musharakah is structured to decline or diminish over time and is known as Musharakah
Mutanaqisah, whereby the dominant partner, normally the bank, will allow the other partner,
normally the user of the service of the asset, to redeem the banks shareholding over time. At some
time in the future all ownership in the asset will be vested with the customer.
The following discussion briey outlines some of the leading nancing products offered by IFIs that
are essentially based on debt-based contracts.
9.2.1.3 Debt-based nancing - Murabahah

The most widely used contract for asset nancing is Murabahah, which can be loosely translated as
cost plus. This is a sale under which the seller must disclose to the buyer the cost and mark-up of an
asset to be sold to the buyer. This contract avoids interest and promotes interest-free transactions
through a sale mechanism. Under this contract the bank, being the nancier, will simply purchase an
asset from the vendor as required by the customer at x price and subsequently sell the same asset to
the customer at x+y. This constitutes the Murabahah selling price that will be settled in the future.
This contract is, therefore, suitable for any form of asset nancing, be it a house, consumer goods or
working capital in terms of raw material, etc.
9.2.1.4 Debt-based nancing - Ijarah muntahia bi tamleek

Asset nancing with the purpose of transferring ownership of an asset to the customer may be
done through Ijarah muntahia bi tamleek or a lease ending with the transfer of ownership. It is a
combination of lease and sale. Typically, the bank will lease an asset to the customer for a particular
period of time with an undertaking to sell the same asset (leased asset) to the customer at the
request of the customer. This has been used widely in house and vehicle nancing respectively.
9.2.1.5 Debt-based nancing - cash nancing

Islamic banks also provide cash nancing, as well as personal nancing to their customers. Cash
nancing is structured using the Inah contract in some jurisdictions such as in Malaysia, or Tawarruq
in jurisdictions inclusive of Malaysia. As explained, Tawarruq has to have at least a three-party
contract to sell and buy an asset to facilitate cash nancing. Unlike Tawarruq, Inah is simply a selland-buy-back agreement between two parties. The purpose is to obtain some cash for the customer.
The customer, under both a Tawarruq and Inah contract, owes the bank the selling price that
comprises the principal and prot which is payable in the future.
Personal nancing can also be affected through Inah and Tawarruq. Personal nancing, to cover the
cost of education, travel and medical treatment can also be affected via an Ijarah or lease contract. A
service provider would normally lease a specied service to the bank at x amount of money for the
bank to sub-lease this to a customer who requires this service for x+y.
Key points
Islamic nancing products can be classied into equity-based nancing and debt-based
nancing.
Equity-based nancing is equitable in character in that both parties are willing to put in the
capital and work to share the future prot. They are equally willing to bear the loss arising
from the venture.
Debt-based nancing creates an obligation upon the customer to pay a particular amount of
money to the bank in all circumstances whereby the obligation of payment is not linked to any
attainment of prot.
157
Exercise 9.3
What is the basic difference between Murabahah nancing and Tawarruq nancing?
9.3 Islamic insurance (Takaful)

The previous paragraphs briey outlined nancing products commonly offered by IFIs. The following
section will consider contracts used for Takaful products.
Islamic insurance is a way of providing indemnity or compensation to policyholders in accordance
with Shariah principles. Conventional insurance is a contract in which one, the insurer, agrees
to indemnify another, the insured, for a consideration called a premium. In short, it is a contract
providing indemnity in exchange for a premium. Conventional insurance is based on a sale contract
that is affected between the insurer (the insurance company) and the insured (policyholder).
9.3.1 Prohibition of Gharar in Islamic commercial law

Islamic commercial law, as previously explained under the discussion of Gharar or uncertainty,
requires the subject matter and the price to be certain. In the case of conventional insurance the
subject matter and premium are not certain as they depend on many events that are beyond the
control of the parties. For example, one policyholder may pay the premium throughout the tenure of
the policy, while another may only pay a few instalments before dying. While the latter policyholder
will receive insurance compensation, the former will not.
Conventional insurance has been viewed as non-compliant because it contains the element of
Gharar, that is, uncertainty. Also, insurance policy monies are normally invested in conventionalbased instruments such as equities, which are not approved, or nancial products, which are interestbased. Islamic insurance or Takaful removes this issue by adopting a contract of donation (Tabarru)
instead of a sale contract. Essentially, each and every policyholder will donate a sum of money, a
contribution, to a Takaful fund. This contribution is based on a Tabarru contract which does not
aim to gain commercially. For this reason, any uncertainty with regard to the amount, time, etc, is
tolerated because no party will be disadvantaged.
9.3.2 Tabarru contract as the basis of Takaful

A Tabarru contract, being a unilateral contract, tolerates any uncertainty in terms of, for example,
total payment or entitlement to compensation. Under Islamic commercial law an element of
uncertainty can be tolerated in all unilateral or gratuitous contracts, such as wills, rebate, donations
waivers and gifts. A unilateral contract is normally meant for gratuitous purposes wherein the
consent and consideration from an offeree or recipient are not required to make the contract valid.
Following this principle, the certainty of any object to be given away to the recipient is no longer
relevant as the recipient has no obligation to pay any counter value. Thus, a donation of any amount
of money that is not disclosed to the recipient is still valid simply because it would not trigger an
argument of injustice and unfairness due to the absence of a consideration from the recipient. In the
context of Takaful, a donation contract or Tabarru has been viewed and accepted as the best possible
contract to replace the sale contract in conventional insurance.
9.3.3 Takaful as mutual Insurance

Takaful is based on mutual help among the participants. The Takaful operator is not the insurer.
There is an insurer-insured relationship in an Islamic insurance contract between participants. A
contract of Takaful takes place between the participants themselves. Each and every participant has
to donate an amount of money to the Takaful fund, which is managed by a third party referred to
as the Takaful operator. The Takaful fund operates on the basis of mutuality and mutual help among
the participants to the effect that if one were to suffer an accident, the fund would provide them
with an indemnity. This is the meaning and philosophy of the mutuality; that all the participating
members are themselves both the insured and the insurers providing no particular advantage to one
member over the other.
158
Figure 9.1 A Takaful scheme

Participants
1
Takaful
operator
3
4
Investment
Takaful fund
Surplus
Notes on the operational and contractual ow

1.
Participants transfer an amount of money or pay the premium to the Takaful fund, which is to
be divided according to agreed ratio and channelled into the donation and investment fund.
2.
Participants appoint a Takaful operator to manage the business activities and the investment of
Takaful funds under the Wakalah (agency) contract.
3.
The Takaful operator will manage the Takaful fund according to the standard operating
procedures of a prudent insurance scheme such as underwriting policies, payment of claims,
marketing and subrogation.
4.
The Takaful operator manages the Takaful investment fund.
5.
The total of the Takaful fund plus investment prot less Takaful costs is deemed a surplus.
Key points
Islamic insurance provides indemnity or compensation to policyholders according to Shariah
principles.
Conventional insurance has been viewed as non compliant because it contains the element of
Gharar, that is, uncertainty.
Insurance policy monies are normally invested in conventional-based instruments such as
equities, which are not approved, or nancial products, which are interest-based and therefore
non-Shariah compliant.
Exercise 9.4
Which one of the following descriptions is correct in relation to Takaful?
A. Takaful is a mutual insurance scheme between the participants/policy holders
and Takaful operator.
B. Takaful business does not contain any element of uncertainly or Gharar.
C. Takaful is a mutual insurance scheme among all participants/policy holders.
D. Takaful is not necessarily based on the Tabarru contract.
159
9.4 The Islamic capital market

Islamic capital markets can be broadly split into two main classications, namely the equity market
and structured products comprising both securitisation and derivative products. The whole idea of a
capital market, be it Islamic or conventional, is to facilitate fund raising and mobilisation in a manner
that is time-efcient and cost-effective. An Islamic capital market is distinctive because all products
used are Shariah-compliant. The next section will briey explain how Shariah principles relate to both
equity and structured products. A more detailed discussion will be provided in Study Guide Three.
9.4.1 Screening compliant stocks

In the equity market, the most important task is to screen what stock is compliant and what is not.
Investment in shares through the contribution of capital is obviously compliant because it is free
from Riba as there is no lending and borrowing in the contract. Investors or shareholders will share
the prot and loss among themselves proportionately, based on a Musharakah contract which is
permissible.
Contemporary Shariah scholars, such as the Shariah board of the Dow Jones Islamic Index Market
(DJIM), have established criteria to screen stock to ensure compliance. The stock screening criteria as
per DJIM standard are both qualitative and quantitative.
The qualitative aspect of the screening means a Muslim investor is not allowed to invest in
companies that deal primarily with activities deemed non Shariah compliant. The list of prohibited
activities and industries is listed in the following table:
Table 9.3 Prohibited activities/industries

Interest-based nancial institutions
Production of non-Halal food and drink
Entertainment
Conventional insurance
Weaponry
Tobacco-related products
Pornography
Other activities which may be deemed

non-compliant
The quantitative aspect requires that stocks deemed to be compliant are then evaluated according
to several nancial ratio lters, which look at the leverage and composition of cash and interestbearing accounts, as well as accounts receivable. A detailed discussion of this screening process will
be undertaken in Study Guide Three.
9.4.2 Sukuks
In addition to the equity market, the Islamic capital market also provides products such as Sukuk,
which roughly corresponds to conventional bonds and notes, and some derivatives products.
Sukuk are securities issued by either the government or corporations to raise funds directly from
investors. The issuing of these securities provides liquidity to the nancial market as well as allowing
corporations to have direct access to funds. Sukuk or Islamic securities are tradable in the secondary
market.
To some extent, Sukuk are products that mirror the behaviour of conventional bonds. A conventional
bond is a debt security in which the issuer owes the holders a debt. The obligation to repay the
principal and interest (the coupon) at a later date is in the form of a security that can be traded
freely in the secondary market. As bonds are issued to enable the issuer to nance a long-term
investment with external funds, the same is true with Sukuk. The issuance of Sukuk would benet
both the issuer and the investor respectively.
Sukuk are essentially the product of securitisation. Securitisation, or Taskeek in Arabic, refers to
the division of tangible assets or rights into units of equal value and the issuance of those units to
investors. In simple terms, securitisation describes the process of aggregating assets and packaging
them into marketable securities. In the Taskeek model, Sukuks are often issued by a special purpose
vehicle established to own the assets.
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A Sukuk is frequently referred to as an Islamic bond, but a more accurate translation of the Arabic
word would be an Islamic investment certicate. The distinction being that, at its simplest, a
conventional bond is a contractual debt obligation whereby the issuer is contractually obliged
to pay to bond holders on a particular date, interest and principal. In comparison, under a Sukuk
structure, Sukuk holders each hold an undivided benecial ownership interest in the underlying
assets. Consequently, Sukuk holders are entitled to share in the revenues generated by the Sukuk
assets. Sukuks are therefore monetary-denominated participation certicates of equal unit value to
be issued to investors.
9.4.3 Sukuk al-Ijarah

There are many structures of Islamic Sukuk in contemporary Islamic xed-income securities. The
details of these structures will be discussed in Study Guide Three. This section will consider a single
Sukuk that is based on an Ijarah contract. Sukuk al-Ijarah is based on a sale and lease back concept
whereby the issuer, who is in need of nancing, will rst sell their asset to the investors for the
nancing amount. This asset is then leased to the issuer for a lease rental - the Islamic nancial
obligation. The issuer will issue the bonds or Sukuk al-Ijarah to the investors. The Sukuk evidences
the undivided proportionate ownership of the investors over the leased asset, giving them the right
to the lease rental. Sukuk are tradable on the secondary market because they are backed by real
tangible assets and not pure indebtedness in the form of monetary receivables.
Figure 9.2 A diagrammatic structure of a basic Sukuk al-Ijarah
Company
SPC leases asset to corporate for 5 years
Payment of
x amount
to company
Company pays lease

rental for 5 years
Special
purpose
company
Payment of
purchase price
SPC issues sukuk to investors

(sukuk represents pro-rata
ownership in the asset)
Investor
The above diagram illustrates the basic structure of asset-based securitisation in the form of Sukuk
al-Ijarah. The company is a party who needs capital. To facilitate this, the company or originator will
identify an asset that can be sold to the Special Purpose Company (SPC), lets say at $500 million.
The SPC, as the purchaser, will issue a Sukuk to purchase the asset and will lease the asset back to
the originator. By subscribing to these Sukuks investors are deemed to be the benecial owners of
the asset. The proceeds of the sale amounting to $500 million will be channeled by the SPC to the
company/originator for the latters use. Subsequently, the SPC will lease the asset to the corporate/
originator at $500 [cost of fund x spread] x number of years which will be equivalent to the rental
payment. The proceeds of the rental payment will be distributed amongst the Sukuk holders
proportionately. The investors receive the full payments of the rental proceeds as there are no costs
to be deducted from these proceeds except the insurance and maintenance costs.
Key points
Islamic capital markets can be categorised into two main classications; the equity market and
structured products.
The objective of a capital market is to facilitate fund raising and mobilisation in a manner that
is time-efcient and cost-effective.
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Having studied the components of Islamic nance, which are basically comprised of
Islamic banking, Islamic insurance and Islamic capital market, do you see any synergy and
correlation between these components?
Solution
The synergy and correlation between the three components of Islamic nance can be
illustrated as follows. A customer may seek Islamic house nancing under Murabahah or
Ijarah nancing. To secure the interest of the bank, the bank may impose on the customer
to subscribe to mortgage Takaful. Under this scheme, if the customer were to die during the
nancing period, then the Takaful fund, which is based on donation, will settle all outstanding
nancing amount to the bank. On the other hand, a Takaful company will also have to invest
the Takaful contribution or premium in approved shares and xed income instruments. The
Islamic capital market will provide products for this purpose. Also, Islamic banks may need
to hedge some risks in their operations. Islamic risk management tools or Islamic derivatives
provided by Islamic capital market will be useful in this respect.
Exercise 9.5
Briey explain:
(i) what is meant by an Islamic capital market
(ii) the role of Shariah scholars, such as the Shariah board of DJIM
(iii) how Sukuks have helped in the development of Islamic capital markets.
9.5 Conclusion
This chapter introduced you to the leading nancial products and services which are currently offered
in the Islamic banking, Takaful and the capital market sectors. Once again you were introduced to the
contracts used to generate such nancial products. You should now understand how the characteristic
traits of each contract can be used to meet the intended nancial aim and objective of each nancial
product. You should now also have an understanding of the link between Islamic nancial products
and the relevant contracts and how this dictates the way the products behave in the nancial markets.
In the following chapter we will explore the reasons why particular contracts might be chosen to full
a particular nancial need.
9.6 Summary
162
1.
an Islamic savings account uses the concept of Wadiah (safe custody), Qard / Hassan (interest
free loan), Mudarabah (prot sharing) and Tawarruq (sale contract for the purpose of cash facility)
2.
Qard / Hassan allows a person to borrow without having to pay interest; the borrower may at
his discretion offer a gift to the lender for providing the loan provided but such gifts cannot form
part of the original nancing agreement.
3.
Wadiah is used by banks as a contract to safeguard the depositors cash
4.
a Mudarabah contract is used as the basis for investment accounts whereby the bank and the
customer enter into an agreement to share prots from an investment; any losses however will
be borne solely by the customer
5.
Tawarruq assists in providing a xed income account to the customer by entering into a sale
transaction involving the customer, the bank and the market
6.
under equity-based nancing, the customer owes no nancial obligation to the bank; the
relationship is based on a prot and loss sharing agreement
7.
debt-based nancing creates an obligation upon the customer to pay a xed amount of money
to the bank arising from either sale or lease contract
8.
asset nancing is principally effected through Murabahah and Ijarah muntahia bi tamleek
(hire purchase)
9.
Islamic cash nancing is also available in Islamic nance either through the contract of Inah as
practiced in Malaysia or Tawarruq as practiced in Malaysia and elsewhere
10. Takaful adopts the principle of Tabarru (donation) to implement a concept of mutual help
among participants
11. stock screening is key to Islamic equity investors to allow them to select the Shariahpermissible companies to invest in
12. Sukuks are monetary denominated participation certicates of equal unit value issued to
investors; essentially Sukuk represent an ownership right in the underlying asset, which would
generate income to be distributed among the Sukuk holders.
Chapter 9 Answers
Exercise 9.1
1. There are three main objectives of a savings account:
(a) the safekeeping of depositors money
(b) to allow depositors the exibility to withdraw money
(c) to give depositors the opportunity to benet and receive income from their savings.
2. Qard / Hassan is an interest-free loan given by the lender to the borrower. Wadiah is a safe
custody contract between the depositors and the bank, which acts as the custodian. In this way
the customer deposits his money in the safe custody of the bank.
3. The following arrangement exists in a Mudarabah investment account.
(a) The depositors provide the capital, while the IFI provides the work and the management.
(b) The prot is shared between the depositors and the IFI, while losses are borne by the
depositors only.
4. An Islamic xed income account is based on a sale transaction instead of a loan contract. The
depositor will get a xed return simply because he purchased an asset at x and sells to the
bank at x+y. The y portion is his xed income. Conventional xed deposits simply guarantee
interest paid on the loan.
Exercise 9.2
Under debt-based nancing, the customer has an obligation to pay the bank irrespective of
whether the customer is in a protable situation or not. Under equity-based nancing, there is no
such obligation to pay. The bank only has the right to share prots, if any, according to a pre-agreed
prot sharing ratio.
Exercise 9.3
Murabahah nancing facilitates ownership of an asset which is essentially sought by the customer.
Tawarruq nancing allows the customer to obtain cash instead of an asset. He may however use
the proceeds of a Tawarruq contract to purchase an asset.
Exercise 9.4
C. Takaful is a mutual insurance scheme among all participants. The Takaful operator is just a
manager. Like conventional insurance business, Takaful business contains many aspects of
uncertainly which are peculiar to the insurance industry. However, since the basis of Takaful is a
Tabarru contract, these uncertainties are acceptable and tolerable.
Exercise 9.5
(i) An Islamic capital market is where one can raise and mobilise funds efciently with regard
to time and cost using nancial products that are Shariah compliant according to particular
Shariah principles. An Islamic capital market can be broadly categorised into the Islamic equity
market and the market for Islamic structured products.
(ii) Shariah scholars have established criteria to screen equities to ensure their compliance. Stock
screening is the most important task to ensure stocks are free from Riba and not involved in
activities that are non complaint.
(iii) The issuing of Sukuk provides liquidity to the nancial market as well as allowing corporates to
have direct access to funds. Sukuk are also tradable in the secondary market.
163
Revision questions
Revision Questions
1.1 Which of the following is the basis of the Qard / Hassan concept?
(A)
Discounted loan.
(B)
Interest free loan.
(C)
Sale contract.
(D)
Purchase contract.
1.2 Prot sharing practice under Mudarabah is done through what?

(A)
The measurement of contribution .
(B)
The measurement of revenue.
(C)
A pre-agreed prot sharing ratio.
(D)
The measurement of cash level.
1.3 In a Musharakah partnership a loss is borne by whom?

(A)
All partners on an equal basis.
(B)
The majority partner.
(C)
All partners based on their capital contribution.
(D)
The manager of the business.
1.4 Tawarruq is a form of which type of nancing?

(A)
Purchase nancing.
(B)
Sales nancing.
(C)
Mark up nancing.
(D)
Cash nancing.
1.5 Which of the following best describes the concept of Tabarru?

(A)
A donation.
(B)
Revenue.
(C)
A purchase consideration.
(D)
Taxation.
Question 2
Which of the following activities are permissible for Islamic equity investors to invest in?
Tick () the permissible activities and cross () the non permissible activities.
Tobacco manufacturing
Computer manufacturing
Conventional Bank
Film Distributor
Automobile manufacturer
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1.1 (B) Qard / Hassan is the concept of interest free loan, whereby the lender cannot impose on
the borrower to pay more than the sum he has borrowed.
Revision questions
Answers
1.2 (C) Under Mudarabah, the prot-sharing practice is done through a pre-agreed protsharing ratio between the Mudarib (manager) and the Rab al-mal (investor). This ratio can be
negotiated.
1.3 (C) Under Musharakah, loss is shared by all partners based on the amount of capital
contributed. The loss is limited to their respective capital contribution.
1.4 (D) Tawarruq is a form of cash nancing that involves the process of buying and selling of asset
between many parties. The purpose is to facilitate the obtainment of cash for the customer.
1.5 (A) Tabarru is the concept of donation. This concept is widely applied Takaful products as
uncertainty, which is a peculiar feature of the Takaful business, is acceptable or tolerable in
donation based contract.
Question 2
Tobacco manufacturing
Tobacco because it is harmful to ones life.
Computer manufacturing
Conventional Bank
A conventional bank typically pays and charges

interest which is prohibited.
Film Distributor
Relates to entertainment industry which potentially

contains prohibited elements or activities.
Automobile manufacturer
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Chapter ten
Application of
Islamic contracts
in Islamic nance
Learning outcomes
explain the reasons why some contracts are preferable

over other contracts in Islamic nance
discuss briey product development in Islamic

nancing using the traditional contracts.
166
Application of Islamic contracts in Islamic nance

Choosing the correct contract.
Product development in conventional and Islamic nance.
Selecting the correct contract.
Selecting the correct solution.
Combining contracts to achieve synergy and form new hybrid contracts.
Areas of challenge - the Islamic credit card.
Product enhancement.
10.0 Introduction
This chapter introduces you to the reasons why a particular contract (or
contracts) is chosen to meet a particular nancial need. It also explains in
practical terms the development of nancial products that are comparable
with conventional nancial products and reinforces the previous discussion
on contracts, classications of contracts and the transformation of
contracts into nancial products.
10.1 Choosing the correct contract in modern Islamic nance
The previous chapter explained the classication of contracts and their bases. This chapter will
compare and contrast the various contracts with a view to determining whether there is any
common ground between them. Naturally, such comparisons will also lead to the discovery of some
dissimilarity. Knowledge of this is useful in understanding Islamic nancial product design as well as
in contributing to product development and enhancement.
Although all Islamic contracts are essentially Shariah compliant, some of these contracts are less
popular than others. There are many reasons why some Islamic contracts are viewed less favourably,
including complicated structuring, issues in relation to their compliance with respective legal
requirements, tax implications, risk tolerance and marketing.
This section will introduce you to the problems faced by nanciers with regard to their selection
of particular contracts to meet particular purposes. It will also help you appreciate why different
jurisdictions and markets have adopted different contracts and structures to satisfy similar needs.
Except for a few controversial contracts from the Shariah compliance perspective, the adoption of
a variety of contracts for one common banking business may reect both the impediments facing
that product in various market conditions as well as the exibility that Islamic commercial law
has accorded to product development in Islamic nance, for example, there are sometimes several
correct solutions to the same problem.
10.2 Wadiah, Qard / Hassan and Mudarabah

We saw in the last chapter that it was possible to have a number of contracts that met the
requirements of common products. In both savings and current accounts, three contracts are used,
namely Wadiah, Qard / Hassan and Mudarabah. The selection of either Wadiah or Qard / Hassan
is normally down to personal preference as both assign liability to the banks as the custodian and
borrower respectively. What is applicable to one is also applicable to another in terms of features,
terms and conditions. Although both contracts are fundamentally different from each other, they
will have the same contractual effect when the subject matter is money on deposit. This is because
under both contracts money received must be returned to the owner, raising the possibility of Riba.
In other non-monetary assets, both contracts are essentially distinct from one another because the
possibility of money giving more income to the lender or depositor is removed.
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10.2.1 The Mudarabah contract

The Mudarabah contract allows savings or deposit account holders the opportunity to benet from
sharing with the bank the prot generated from the banks investment using this pool of funds. The
selection of the Mudarabah contract implies willingness by the depositors to take on investment risk
in order to benet from prot sharing. These two aspects of risk and prot sharing are absent in both
Wadiah and Qard / Hassan-based savings and current accounts.
In addition to the above, under Mudarabah-based savings and current accounts, gifts are permissible
and can be given to depositors upon opening a Mudarabah account. This additional feature can also
be advertised prior to the opening of an account based on the Mudarabah contract. Such gifts are
not possible under Wadiah and Qard / Hassan-based accounts where advertising gifts on opening
an account would be tantamount to Riba (usury/interest) as Wadiah (when depositing money) and
Qard / Hassan are loan contracts. Therefore, any premium to the lender, in cash or in kind, is not
permissible. A gift, particularly one preceded by an advertisement, is deemed as a premium payable
to the lender in kind.
10.2.2 Combining Qard / Hassan and Mudarabah

The situation becomes clearer when a combination of Qard / Hassan and Mudarabah contracts are
adopted in both savings and current accounts. The features of the product indicate, among others,
that if the balance on deposit is maintained at or above a particular amount on a daily basis, it will
be treated as a Mudarabah account, otherwise it will be treated as a Qard / Hassan account.
This reects why preference is given to one contract over the other in deposit-based products. It is
because of reasons that ultimately support the preference of one contract, for example Mudarabah,
over other contracts. This allows some depositors to share the risk of investment with the bank
and entitles them to benet from any prot generated. This exibility, particularly in an account
combining both Wadiah or Qard / Hassan and Mudarabah contracts, would entitle the depositors
to benet from prot sharing at a particular agreed ratio, provided they maintain the amount of
deposit at a particular level. Normally, this feature is used for Islamic current accounts.
Table 10.1 Islamic deposits

Mudarabah
Wadiah or Qard / Hassan
Advertised gift prior and upon opening an

account is permissible.
Advertised gift prior and upon opening an

account is not permissible.
A share of the prot.
No share of the prot (but a Hibah/gift may

be granted at banks sole discretion).
The account holder bears the loss of capital.
No bearing of loss by the depositor. On the

contrary, the money will be guaranteed or
deemed as liability on the bank.
Exercise 10.1
Why would many depositors generally prefer to open an investment account instead of a
savings account based on either Wadiah or loan contract?
10.3 Murabahah sale, Ijarah muntahia bi tamleek and Musharakah

Mutanaqisah
The same methodology of selection of a particular contract to support the nancial needs of a
bank is true with regards to Islamic nancing products. From the Shariah perspective, nancing
someone to purchase a house could take the form of a Murabahah sale, Ijarah muntahia bi tamleek
or Musharakah Mutanaqisah.
10.3.1 Murabahah sales

Under a Murabahah sale, there will be two sales transactions, namely between the nancier and
the vendor and later between the nancier and the customer or homebuyer. These transactions
involve two separate contracts. To be registered and legally effective, the relevant documents must
168
be stamped, resulting in the payment of stamp duty. As there are two contracts, both technically
resulting in the payment of stamp duty on each contract, the double payment of stamp duty
would make the product uncompetitive, as such extra costs are normally charged to the customer.
Therefore, for countries and jurisdictions that adopt a Murabahah facility involving landed property,
stamp duty, if any, will be an impeding factor.
This issue has been resolved in Malaysia where stamp duty is now only imposed on the rst
transaction. This is based on the argument that the bank is buying a property not for itself but to
facilitate house nancing for a customer. Similarly the UK, where the relevant stamp duty legislation
was amended in 2006, ensures that under a Murabahah house-buying facility stamp duty is only
charged once. Singapore has adopted a similar position. In addition, Malaysia has amended its real
property gains tax to avoid unnecessary taxation on the prot arising from the sale of a property to
a customer after purchasing the property from a vendor.
10.3.2 Ijarah muntahia bi tamleek or Musharakah Mutanaqisah sales

In other jurisdictions, such as the UK, USA, and the United Arab Emirates, house nancing could take
the form of Ijarah muntahia bi tamleek or Musharakah Mutanaqisah. Among other benets these
two nancing structures allow the nancier to convert the ownership rights over leased assets or
properties into securities or Sukuk, which are tradable in the secondary market. Finance houses
using either Ijarah muntahia bi tamleek or Musharakah Mutanaqisah allow the nancier to sell their
assets to a third party, such as a mortgage corporation, which will then issue securities in the capital
market. The proceeds from the sale of the securities would be used to purchase these assets from
the nanciers/owners.
The ability to turn Ijarah muntahia bi tamleek or Musharakah Mutanaqisah into securities is a
value-added benet that can make the nancing an off-balance sheet item. Receivables under
Murabahah, unlike Ijarah and Musharakah, once securitised, cannot be traded freely at market value
as they reect monetary assets that can only be traded at face value according to the Accounting
and Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shariah standards. The
securitisation of assets and receivables will be discussed in Study Guide 3.
Both these structures are essentially based on an Ijarah contract designed to generate income for the
nancier or, in a joint venture, for the nancier and the customer. This would allow the nancier to
have a oating rental rate to suit market conditions, particularly given the uctuations of the cost
of funds and the issue of a mismatch of assets and liabilities for the bank/nancier. If a Murabahah
contract were to be adopted, there is no possibility that the margin rate of prot can be revised
and adjusted. The bank and the customer would have to be content with a xed rate sometimes for
quite a long nancing term. Financing an asset for a xed rate and for a long time poses many issues
that can be avoided through either Ijarah muntahia bi tamleek or Musharakah Mutanaqisah as the
contract of Ijarah would allow the rate of rental to be oating and adjusted for particular market
conditions. Under Musharakah Mutanaqisah it is also possible for the customer to benet from their
shareholding portion by withdrawing cash from their accumulated shareholding.
Murabahah has a feature that may be preferable to both Ijarah muntahia bi tamleek and Musharakah
Mutanaqisah. As the ownership of the asset is passed to the customer once the bank has sold the
asset to him on a Murabahah arrangement, the cost of insurance and major maintenance and so
on, which are related to ownership expenses, are borne by the customer as the owner. This is not
applicable to Ijarah muntahia bi tamleek and Musharakah Mutanaqisah. The ownership of the asset
under these two nancial arrangements is still vested with the bank. Therefore the bank, from a
Shariah perspective, is responsible to the cost of ownership expenses such as insurance and major
maintenance. Also in the case of total damage to the property or asset, the rental ceases to be
operative until the usufruct of the asset is available to the lessee.
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Table 10.2 Islamic house nancing

Murabahah vs. Ijarah muntahia bi tamleek/Musharakah Mutanaqisah
Murabahah
Ijarah muntahia bi tamleek/

Musharakah Mutanaqisah
Fixed margin of prot.
Fixed and oating rental rate.
No securitisation with possible free trading of Securitisation with possible free trading of
Sukuk on secondary market according to
Sukuk on the secondary market.
international Shariah standards.
Ownership risk on the customer.
Ownership risk on the nancier.
The preference, and thus adoption, of a particular contract as the basis of a particular product in a
particular place or market is motivated primarily by the added values that the contract could bring
compared with other contracts.
Key point
From the Shariah perspective, nancing someone to purchase a house could take the form of a
Murabahah sale, Ijarah muntahia bi tamleek or Musharakah Mutanaqisah.

Why is the securitisation of the assets of an Islamic Financial Institution (IFI) important to
the IFI?
Solution
Securitisation will enable the IFI to package all its assets, such as ijarah assets, to be sold to
the SPV/issuer for a cash payment. The proceeds of the sale of the assets will inject more
funds into the IFI. This will allow it to undertake more nancing activities. Otherwise, these
assets will be reected in the balance sheet of the IFI throughout the tenor of nancing.
Securitisation also indirectly reects the rating of the IFI. This is because the securities to
be issued will be rated and this rating will be mainly based on the quality of assets and the
reputation of the IFI that manages those assets.
10.4 Product development in Islamic nancing using traditional contracts

Product development as well as product enhancement are critical in both Islamic and conventional
nance. Product development in the conventional banking system is centred on the loan contract.
However, in Islamic nance, product development involves many varieties of contract that make
the exercise more complex. While product development in the conventional banking system mainly
concerns the features of a particular product, such as the method of payment or manner of interest
calculation, product development in Islamic nance involves both the structure of contracts and the
features of the product.
10.4.1 Product development - conventional vs Islamic nance

Under conventional nance a term loan for house nancing, which is simply a loan in return
for capital repayment and interest, will still operate on the basis of a loan for interest. Product
development tends to deal with matters of technicalities only without changing the basic contract
of lending money for interest. Such technicalities include issues such as the method of calculating
interest by either charging the interest on the outstanding balance or otherwise, a rebate for early
repayment, whether the interest is based on daily or monthly interest and the ability to reschedule
the tenor of repayment.
Product development in Islamic banking is wider in scope. It may offer a new contract entirely to
substitute or complement an existing compliant contract. It may also change some of the features
of the existing compliant contract. The latter refers to product enhancement instead of product
development. An example of this may relate to an Ijarah-based nancing product. In the early stages
of Islamic nance, all Ijarah-based nancing products were based on xed rental payments. However,
recently, some IFIs have started offering the same product but the rental is oating, based on an
170
agreed benchmark or formula. This represents a change to the features of the rental payment and
both products are compliant. Both of these will be discussed in this section to allow for a better
understanding of the exibility of Islamic nance.
10.4.2 Islamic contracts and product innovation

As previously stated, products are essentially based on contracts. A new contract will theoretically
offer a new product with a new set of features, which differ from the features of another contract.
Product development is, however, a more challenging task because it requires a thorough and
comprehensive knowledge of all available contracts in Islamic commercial law and their salient
features. Knowledge of the nancial behaviour of a product vis--vis an existing legal and taxation
framework is essential to the process of product development.
Initially, a good understanding of all available contracts in Islamic commercial law is required before
undertaking product development. This is a wide area of knowledge and in most cases advice is
normally sought from Shariah advisers as they are expected to understand or at least be able to
research these contracts. Unfortunately, there is as yet no list that puts all these contracts in one place
for easy reference as the coverage of the subject matter and its supporting literature is too wide.
10.4.3 Forward lease or Ijarah Mausufah al-dhimmah

A good example of a contract which was once widely rejected but which is now gaining favour is
the Ijarah Mausufah al-dhimmah or simply forward lease. This contract was not approved by the
majority of classical Muslim jurists in the past. It was, however, advocated by a few jurists in the
Hanbalis school of law. The basic argument of this contract is simple. If a sale on forward delivery,
namely Salam or Istisna is permissible, provided the object of the sale is specied to a degree that
removes uncertainty (Gharar), the same logic would also apply to an Ijarah contract. This contract of
forward lease would allow the lessor of a future asset to collect rental in advance, although the leased
asset is yet to be delivered to the lessee. However, if the delivery of the leased asset to the lessee
fails for any reason, or the delivery does not conform to agreed specications, the rental paid must be
refunded to the lessee under this forward lease. The forward lease could replace the function of the
Istina contract in nancing a project where the construction or manufacturing of an asset is required.
This contract, although not widely accepted in the past, has been promoted as an innovative product
that could facilitate areas such as project nancing. The AAOIFI Shariah Standard on Ijarah and Ijarah
muntahia bi tamleek (No.9) has accepted this contract as a legitimate means of nancing.
Clause 3/5 of the standard provides: An Ijarah contract may be executed for assets undertaken
by the lessor to be delivered to the lessee according to accurate specications, even if the asset so
described is not owned by the lessor. In this case, an agreement is reached to make the described
asset available during the duration of the contract, giving the lessor the opportunity to acquire or to
produce it. It is not a requirement of this lease that the rental should be paid in advance as long as
the lease is not executed according to the contract of Salam (or Salaf). Should the lessee receive an
asset that does not conrm to the agreed description, then he is entitled to reject it and demand an
asset that conforms to the description.
The adoption of this contract in the AAOIFI Shariah Standard, and the implementation of this new
contract in the industry, demonstrates the exibility of Islamic commercial law towards product
development. In project nancing, an Islamic nancier may consider this forward lease contract as
a potential product in addition to more established contracts and products such as Istina (parallel
Istina), Mudarabah and Musharakah. This ongoing approach to product development simply
attempts to utilise already established contracts, particularly those that are not well known but are
useful to modern requirements.
Exercise 10.2
Project nancing can be nanced using parallel Istisna nancing. Which other contract can
duplicate this mode of nancing?
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10.4.4 Tawarruq
Another example of product innovation is the contract of Tawarruq, which is a transaction between
three or more parties allowing one of them to obtain cash through a sale mechanism. Tawarruq
would facilitate this purpose by having a nancier as the purchaser of an asset from a vendor. Upon
delivery of this asset to the nancier, either actually or constructively, the nancier would sell the
same asset to the customer who is seeking cash or personal nancing at a mark-up price, that is, cost
price plus a particular margin of prot, for example, 120,000. The customer is granted a deferment
to pay this selling price to the nancier, for example, within 12 months. Upon the delivery of asset,
the customer may dispose of it in the market at a cash price, for example, at 100,000. By having
this facility based on a Tawarruq contract, the customer will have cash nancing amounting to
100,000 via a sale contract with the nancier and later with the market.
The adoption of a Tawarruq contract is an innovative development because it provides cash nancing
to customers. All other available sale contracts are meant to assist the customers to own a particular
asset. Tawarruq, on the other hand, through a sale mechanism, will facilitate cash nancing.
Tawarruq is currently being used on the London Metal Exchange (LME) to facilitate the transaction
of commodities between brokers, banks and customers. The detailed structure and ow of contract
involving these parties is explained in Study Guide Two, chapter 5, section 5.8.2.
Key point
Product development in Islamic banking is wider in scope where it may offer a new contract
entirely to substitute conventional products. While product development in conventional
banking is largely based on adjusting the loan contract or features, product development in
Islamic nance may use a new contract altogether, for example Murabahah house nancing to
Ijarah house nancing to Musharakah Mutanaqisah house nancing.
10.5 Synergy and the combination of products

Product development can also take place in the form of synergy, the combination of two contracts,
which results in the effect the customer is seeking.
10.5.1 Ijarah muntahia bi tamleek

The exibility of owning a house through a lease contract with an option to purchase is well
demonstrated in Ijarah muntahia bi tamleek. This product is a hybrid of both a lease contract and a
contract that can transfer ownership, such as a sale or gift contract. In order that the customer can
exercise this option, a sale undertaking based on Wad (unilateral promise) is added so the customer/
lessee can request that the nancier/lessee sell the leased asset to the customer. The nancier is
under an obligation to sell as he has given an undertaking to sell as and when requested or exercised
by the customer/lessee. This product can apply to many types of assets including houses, vehicles
and equipment, provided they relate to a valid lease contract.
10.5.2 Musharakah Mutanaqisah

Musharakah Mutanaqisah is also a hybrid combining the joint venture or Musharakah contract, the
lease contract and a sale undertaking by the nancier to sell their shareholding in the venture to the
customer/lessee through progressive redemption.
172
Figure 10.1 Hybrid products
Hybrid
products
Ijarah muntahia
bi tamleek
Musharakah
Mutanaqisah
Lease
Joint venture/Musharakah
Sale or gift undertaking
Lease
Sale or gift
Sale undertaking via progressive

redemption of the shareholding
of the nancier
10.6 Product development - nding contracts to match existing

product offerings
Conventional nance has developed over many centuries. The variety of products on offer is almost
limitless. Each of these conventional products has been developed to meet the needs of particular
users. In order for Islamic nance to meet the needs of its customers, which in many ways mirror
those of the conventional market, a key requirement is to nd a contract or group of contracts
that mirror the features of an existing conventional product, but in a Shariah-compliant way. In
attempting to match conventional products the Islamic nance product must be able to achieve the
same economic benets as the conventional product. Adjustments are acceptable, provided they do
not change the basic structure of the product and its framework.
10.6.1 Islamic debit and credit cards

The introduction of Islamic debit cards and charge cards was relatively easy as they are not revolving
in character. Under both cards, the cardholder, that is the customer, is under an obligation to settle
the full payment outstanding as printed on the statement. A debit card, for example, requires the
cardholder to have sufcient funds in their banking account. Any purchase made by him or her using
this card will be debited from their account almost immediately. If the amount in their account is not
sufcient, the usage of the card to effect the payment will not be processed, that is, it will be blocked.
A debit card is meant to facilitate the payment without cash. This product is essentially based on
Hiwalah (transfer of debt). The cardholder transfers their debt owed to the merchants to the bank,
which holds a deposit account of the cardholders account.
The merchant, instead of demanding the payment from the cardholder, will debit the amount from
the customers account at the bank. The debit card typically has the banks name printed on the card
and will contain detailed account information about the cardholder. Through this mechanism, all the
payments are settled and there is no revolving feature.
The same feature of the full settlement of any outstanding amount is also provided by a charge
card, for example, an American Express charge card. The charge card allows its holder to pay for the
purchase of goods and services whereby the merchant can claim payment from the card issuer, for
example, the bank.
From a Shariah perspective, this could be structured as a Qard / Hassan or an interest-free loan
contract that is provided by the card issuer to the cardholder. This works well because the cardholder
under this scheme must pay all amounts outstanding to the card issuer as shown in the statement.
Full payment by the cardholder means no revolving feature as the cardholder is not allowed to carry
forward their obligation. All payments outstanding under this interest-free loan must be settled in full.
The introduction of Islamic credit cards was more of a challenge, as one of the features of a
conventional credit card is the option given to the cardholder to make only minimum payments
173
toward the outstanding balance. The consumer is able to continue to use the credit card as long as
they remain within their overall credit limit and make the minimum payments each month. In return
for this facility, a nancial charge will be levied in the form of interest that reects a premium imposed
on the money advanced.
10.6.2 Replacing the interest charge

As charging of interest is specically prohibited under Shariah law. This is where product development
is required to create something as exible as the conventional credit card that does not require the
charging of interest.
Some IFIs have adopted the contract of Tawarruq as the underlying contract for Islamic credit cards. A
Tawarruq contract allows the customer to withdraw money from the account through an automated
teller machine (ATM) or by using the card to purchase goods and services. In the latter case the
merchant debits the payment of goods purchased to the credit card account. Under the contract of
Tawarruq, the cardholder is also obliged to pay the selling price at a mark-up price as he is effectively
using credit from the bank/issuer. Refer to section 10.4.3.
This contract also allows for a revolving feature whereby the customer may use their credit card and
pay all or part of their nancial obligation (under Tawarruq selling price) until they reach the limit of
the selling price arising from the Tawarruq contract entered into by both the card issuer and cardholder
prior to the credit card being issued. This structuring process does not change the existing features
of a credit card except in two aspects, namely that there is a limit to the use of the card, the amount
of selling price arising from the Tawarruq contract and the cards usage will be blocked for some lines
of business, such as gambling and the purchase of non-Halal food and drinks. All of these will be
documented in the contract as a matter of limitation of the product as well as for proper disclosure.
The cardholder may also withdraw cash using their card. Essentially, they are withdrawing their money
from their own account which is created out of a Tawarruq contract. The card issuer will impose a xed
fee for administering the cash withdrawal. This fee cannot be a percentage linked to the amount of
money withdrawn.
10.6.3 Maximum credit allowed

As with conventional credit cards, the issuer of the Islamic credit card will agree to a nancial limit for
the card. This limit is equivalent to the selling price created under a Tawarruq contract. For example, a
customer seeking to have a credit limit of $50,000 will approach the bank for an Islamic credit card
facility. In order to facilitate this, the bank will purchase an asset at $50,000 from a prime broker
using, normally, a broker at the London Metal Exchange. Thereafter the bank will sell this asset to this
customer at $70,000 payable within for example three years. Subsequently the bank will facilitate the
customer to sell his asset to another prime broker of metal at $50,000. This $50,000 will be credited to
the customer account.
The customer now has $50,000 in his account, but owes the bank $70,000, payable in the future. It
is against this background that an Islamic credit card is issued to the customer having a credit limit
of $50,000. Any purchase of goods and services by the cardholder will be charged to this account. If
the cardholder, for example, has purchased house furniture worth $10,000 using his credit card, he
will normally be given a grace period to make the full payment to the card issuer. If the cardholder is
able to make the full payment, he will not be asked to pay any prot. The payment of $10,000 will be
debited from his account that has $50,000 at any point in time. However, if he is unable to pay all or
part of the payment, this credit card account will record a prot payable to card issuer. However, this
extra payment will be treated in line with the Tawarruq selling price that is owed to the card issuer, for
example $70,000 (principal plus mark-up).
An Islamic credit card allows for a revolving feature whereby the holder may use the credit card and
pay all or part of his nancial obligation until they reach the limit of the selling price arising from the
Tawarruq contract entered into by both the card issuer and cardholder.
10.6.4 Non Shariah-compliant purchases

Purchases made under a Tawarruq contract will be blocked for some lines of business, such as gambling
and the non-Halal food and drinks. Prohibited purchases will be documented in the contract between
the card issuer and holder as a limitation of the product as well as for proper disclosure. However,
the terms and conditions of the Islamic credit card cannot control the entire transactions of the
cardholders. The credit card company or issuer can only block the use of the card in obvious prohibited
174
lines of business that are recognised by particular codes in the market. Any transactions that are
accidental or mixed will not be taken into consideration. This is obviously one of the challenges facing
Islamic credit cards, particularly with regard to their usage.
Exercise 10.3
A credit card holder has a credit limit of $20,000. He has used the card to pay for goods
purchased totalling $18,000. He subsequently received a statement asking him to pay the
$18,000 to the card issuer/bank. He was unable to pay the amount within the allocated time.
How will the non-payment be reected in his statement for the subsequent month?

As explained above, Islamic credit cards have been structured on the basis of a Tawarruq
contract that was entered into prior to issuing the card. The card holder, when using his card
to purchase goods and services or to withdraw money from an ATM machine, is actually
using his own money or account that was initially created by the Tawarruq contract. Explain
whether this is technically a credit card?
Solution
The features of this card as explained do not match the technical features of a conventional
credit card. To some extent, the features of an Islamic credit card resemble the features of
debit card more than a credit card. This is simply because the credit facility is backed by an
account which is created prior to the issuance of the credit card.
Key points
Product development can also take place in the form of a synergy involving the combination
of two or more contracts.
In attempting to match conventional products, Islamic nance products must be able to
achieve the same economic benets as that of conventional product.
10.7 Product enhancement

Product enhancement is no less important than product development. Unlike product development,
product enhancement aims to improve the features of a contract to make the nancial product more
attractive, competitive or more secured by offering a third-party guarantee. Many of these issues will
be discussed in Study Guide Three.
Product enhancement is also common in conventional banking, although enhancement features
are conned to the loan contract only. Whatever enhanced features are introduced to conventional
deposits or funding, they are still centred around a loan contract for interest to the lender, for
example the depositor. In a conventional deposit account, there could be a deposit account that
gives extra benet in terms of interest if a particular balance is maintained throughout the year.
Another may give extra interest if the depositor were to pay regular amounts into the account
each month. These are features introduced to make particular deposit accounts attractive. Although
these are enhanced features, they are still based on a loan contract that gives interest to the lender
(depositor). The extra benet received is still in the domain of interest out of lending activities.
Key point
Product development in conventional nance centres on the enhancement of some features
pertaining to interest payable to depositors. Products are still fundamentally based on lending
for interest.
175
10.7.1 The contract of Murabahah

As with conventional nance, there are many examples of product enhancement in the Islamic
nance industry. The impetus to enhance is to add value to a product, either for the benet of the
nancier, the customer or both. As previously explained a hybrid account of both Wadiah or Qard /
Hassan and Mudarabah is a good example of an enhanced Islamic current account. Another example
is the nancial Murabahah vis--vis traditional Murabahah.
The traditional contract of Murabahah presupposes that the seller already owns an asset before he
can sell it to a customer at a mark-up price. This contract has been adopted by some IFIs, such as the
Kuwait Finance House.
Traditional Murabahah requires the seller to own the asset rst prior to the subsequent sale to the
customer under Murabahah. That is to say that the seller (the bank) shall have already purchased
and owned the assets before it can enter into Murabahah nancing. This practice would pose the
problem of, for example, storage and risk of non-saleability. However, other IFIs have enhanced the
original contract of Murabahah by adopting a nancial Murabahah known as al-Murabahah li al-amir
bi al-shira (Murabahah to the purchase orderer).
Under the Murabahah to the purchase orderer arrangement the bank will only purchase goods from
the supplier upon the request of the customer. The customer is also required to give an undertaking
or promise to purchase the said goods from the bank under the Murabahah contract once the bank
has purchased the same from the supplier. Following this approach, which is a kind of product
enhancement, the bank faces no problem with regard to storage as the bank will only purchase the
assets as and when approached and requested by a customer.
10.7.2 Other enhancement features

Product enhancement features can also come in the form of payment and other incentives given
to the customer. For example, payments could be arranged in such a way that the customer pays
a smaller instalment in the rst few years of nancing, but the amount gradually increases in
subsequent years. This facility would be an attempt to match the customers potential earnings as
they may have earned less early in their careers, but are expected to earn more in subsequent years.
Islamic principles of Murabahah do not require regular or xed instalments to be paid by a
customer/buyer. Technically, any kind of arrangement towards the manner and amount of payment
is permissible provided that the selling price of Murabahah (cost plus mark-up) has been agreed at
the time of the Murabahah contract. Any variation of payment is permissible so long as this agreed
selling price is not changed.
10.7.3 Interrelated accounts

Incentives or bonuses are always appealing to both Islamic and conventional customers. As
mentioned above, the Islamic credit card allows the customer/card holder to withdraw cash.
Normally the customer would need to have corresponding funds kept in an escrow account that
could be either a current or investment account. To make the product more competitive and
attractive, these funds could be deposited in the Islamic investment account under the principle of
Mudarabah. The money in this account could be invested and the prot could be distributed on a
daily basis. The prot generated can also be used to offset against the outstanding payment as the
result of using the Islamic credit card to purchase goods or services.
In conclusion, although traditional contracts look simple and unsophisticated, they can be
transformed into products that can meet modern nancial requirements yet remain compliant to
Shariah principles. This exibility is useful in both product development and product enhancement.
Key point
Product enhancement aims to improve particular features of an existing compliant product in
an attempt to make the nancial product more attractive, competitive or more secure.
Exercise 10.4
The exibility of products and incentives are as important to Islamic nance as they are to
conventional nance. How could exibility be added to Murabahah nancing?
176
10.8 Conclusion
In this chapter we explained the reasons why a particular contract is chosen to meet a particular
nancial need. We then outlined in practical terms the product development of Islamic nancial
products in comparison to conventional nancial products. This chapter should have reinforced the
previous discussion on contracts, classications of contracts and transformation of contracts into
nancial products. It should also have highlighted to you the fact that the interrelationship of the
various contracts enables a great degree of product enhancement within Islamic nancial products.
In the following chapter we will explain the objective of Shariah standards and the attempts that
have been made by Shariah Scholars to ensure harmonisation of standards across the industry.
10.9 Summary
1.
as contracts are central to product development the application of the right contract or their
combination is very important in supporting Islamic nance
2.
there are sometimes several contract solutions to one nancial need and preference of one
contract over another may be due to some features that are not available in other contracts;
while Murabahah is superior to Ijarah muntahia bi tamleek and Musharakah Mutanaqisah
in house nancing in some features, both Ijarah muntahia bi tamleek and Musharakah
Mutanaqisah are superior to Murabahah in different features of a product offering.
3.
product development in conventional nance centres on the enhancement of some features

pertaining to interest payable to depositors; products are still fundamentally based on lending
for interest
4.
product development in Islamic nance may take different forms of contract, from sale, to
lease, to partnership in order to facilitate perhaps one common nancial need
5.
in the spirit of product development, a contract that may have been advocated by a minority
of scholars could be promoted as an innovative product to meet contemporary nancial
challenges, for example, a forward-lease contract
6.
the offering of a Tawarruq contract in selling and buying a commodity in the London Metal
Exchange to facilitate cash nancing represents the application of a traditional contract in a
sophisticated manner
7.
a combination of contracts could be synergised to form a new hybrid contract to address the
specic needs of a product, such as Ijarah muntahia bi tamleek and Musharakah Mutanaqisah
8.
in some areas, product development becomes more challenging. One example is the Islamic
credit card, which typically offers a credit facility through a revolving feature; Islamic credit
cards based on Tawarruq, among others, can solve most of the issues with regard to Shariah
compliance
9.
product enhancement is equally important to make the product more appealing, competitive
and prudent; the adoption of nancial Murabahah by most IFIs instead of traditional
Murabahah reects the legitimate need to enhance some features in the contract to suit
modern nancial requirements.
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Chapter 10 Answers
Exercise 10.1
Where the customer is willing to take the risk of loss of capital in an anticipation of a higher
rate of return, an investment account is preferable compared to the historical rate of return he
would earn under the discretionary gift available with either a Wadiah or loan contract savings
account.
Exercise 10.2
A forward lease contract could duplicate the function of Istisna in many respects. In the case
of parallel Istisna, the IFI as the nancier, will provide the cost of construction to the ultimate
contractor by progress payments whereby the ultimate purchaser/customer will pay the
purchase price of the completed asset to the nancier over a longer period in line with their
nancing requirements. In a forward lease arrangement, there are only two parties involved in
this arrangement. The IFI, being the nancier, will advance the rental payment to the client to
nance the cost of construction. The proceeds of this advance rental payment will be used to
cover the cost of the construction. Hence, nancing the cost of construction of an asset to be
delivered in the future, can be achieved through parallel Istisna as well as forward lease.
Exercise 10.3
If he fails to make the payment as requested, the next statement will show an amount charged
on the outstanding balance equivalent to a prot margin at a rate as agreed in the initial
Tawarruq contract. This amount is, however, not interest but prot payable to the bank as
originally agreed under a Tawarruq contract.
Exercise 10.4
Although Murabahah nancing refers to xed sale nancing, the quantum to be paid
periodically can be made exible or oating to suit the nancial position of the customer,
provided it does not alter the agreed selling price, which is agreed at the time of contracts.
Under this arrangement, the customer may choose to make lower monthly payments in the
rst few years and later pay higher amounts to suit their nancial capabilities.
178
179
Revision questions
Revision Questions
1.1 Why is a hybrid Islamic current account based on Wadiah or Qard / Hassan and Mudarabah
contracts deemed to be more appealing to depositors?
(A)
There is risk taking involved.
(B)
The prot share is xed.
(C)
It offers the possibility of sharing in the prot.
(D)
Ones capital is guaranteed.
1.2 Which of the following is not a correct description of Murabahah house nancing?
(A)
The prot rate can be oating.
(B)
The tenor of payment is normally long.
(C)
The cost of insurance is vested with the house owner.
(D)
The instalment payment is still due to the bank even after the house is destroyed.
1.3 What is the aim of product development in Islamic nance?

(A)
To produce new products that are compliant to Shariah principles.
(B)
To review existing conventional products to eliminate prohibited elements and features.
(C)
To produce new products that are not only Shariah-compliant but also compete
favourably with conventional products.
(D)
To enhance the key features of existing Shariah-compliant products.
1.4 An Islamic credit card could be structured on the basis of Tawarruq. How is an enhancement
relevant to this product different from a conventional credit card?
(A)
The card can be used to pay the purchase price as well as to withdraw cash advances.
(B)
A rebate on the payment outstanding can be given using the prot generated from a
Mudarabah deposit.
(C)
In the case of loss and damage, the card can be replaced.
(D)
The card can be used only to purchase Halal goods and services.
1.5 If a traditional Murabahah were to be adopted by IFIs, what would be the consequence?
(A)
The promise by the customer to purchase would be binding.
(B)
IFIs would be able to provide all assets required by the customer more effectively.
(C)
The IFIs would face increased storage problems.
(D)
The guarantee on the safety of the asset would be vested with the customer.
Question 2
Are the following statements true or false?
180
1.
Murabahah house nancing is based on a xed prot margin.
2.
Securitisation, with possible free trading of Sukuk on the secondary market is acceptable
for Murabahah house nancing.
3.
Ownership risk is bourne by the nancier in the case of Musharakah Mutanaqisah house
nancing.
4.
Ijarah Muntahia Bittamleek house nancing can be based on either a xed or oating
rental rate.
5.
A hybrid of Islamic contracts cannot be used for Islamic house nancing.

1.1 (C) The hybrid contract with Mudarabah allows the depositor to take on some risk and be
rewarded through the sharing of prot.
Revision questions
Answers
1.2 (A) Under Murabahah, the mark up portion of the sale price must be xed as per the
requirement of the sale contract. Any oating rate of prot in a sale contract will render the
contract uncertain, thus invalid.
1.3 (C) The product development process in Islamic nance aims to produce Shariah compliant
products that will offer an effective alternative to conventional products.
1.4 (B) Card holders will be able to reduce the outstanding payment from the usage of the card by
offsetting it against the prot that is generated from the account of Tawarruq, which is placed
in the Mudarabah investment account.
1.5 (C) Traditional Murabahah requires that the seller owns the asset before receiving the request
for Murabahah nancing from the buyer. This would lead to, amongst other things, storage
problems. In the case of IFIs that provide nancing for the purchase of cars, they would have
to own warehouses to keep the cars before they could enter into a Murabahah with the buyer.
This situation would present a storage issue for them. Also, cars purchased and stored may not
be sold as the appetite of customers changes. Some models may be less preferred, thus, the risk
of non-salability.
Question 2
1.
True.
2.
False.
Securitisation based on Murabahah is not acceptable for free trading in the secondary
market as the Murabahah sale price manifest receivables only that are deemed as nancial or
monetary assets. These can only be sold at par value.
3.
True.
4.
True.
5.
False.
Islamic house nancing may be structured on Ijarah muntahia bi tamleek or Musharakah
Mutanaqisah, which comprises of more than one contract to facilitate these products.
181
Chapter eleven
Implementation of
Shariah standards,
policies and rulings
in Islamic nance
Learning outcomes
describe the objectives of Shariah standards

explain how to deal with different rulings arising from
different interpretations of the sources and techniques
of law
identify solutions to enhance Shariah compliance.
182
Implementation of Shariah standards, policies and rulings in Islamic nance

Introduction to Shariah standards.
The development of a Shariah standard to achieve harmonisation.
The International Islamic Academy of Fiqh and Accounting and Auditing
Organisation for Islamic Financial Institutions (AAOIFI).
Achieving common standards.

Solutions to enhance Shariah compliance.
11.0 Introduction
The previous chapters have highlighted that there could be many Shariah
interpretations on a particular case. Although this reects the dynamism of
Islamic law, it could affect the nancial market. In this nal chapter you will
be introduced to the objective of Shariah standards, the attempts being
made by Shariah scholars to ensure harmonisation of standards across the
industry and some of the solutions proposed. You will discover whether
Islamic nance has achieved a kind of harmonisation if not standardisation.
Finally, you will be introduced to a variety of proposed solutions aimed at
achieving this objective.
11.1 Objective of Shariah standards
You may wonder what a standard is. You may also question why we need a standard, especially
a Shariah standard, in contemporary Islamic nance. Briey, a standard is something by which
other similar things are measured. A standard is needed to ensure that practices are consistent and
applicable to all cases or persons, or circumstances, irrespective of different backgrounds.
Exercise 11.1
Can you think of a standard that is related to the working environment?
As with any other standards, Shariah standards aim to achieve a common platform or base
that is applicable to the same industry or market and against which others can measure their
performance. These standards seek to achieve harmonisation and convergence in the concepts and
applications emerging from the various Shariah supervisory boards of IFIs. Such standards help avoid
contradictions or inconsistencies between the Fatwas and applications by these institutions. The
development of Shariah standards also provides a base against which the performance of Shariah
compliance can be measured or benchmarked, which is meant for global application. Deviations from
the standard should be exceptions to the rule and should be justied by those creating them. Where
exceptions continue or are used by Islamic institutions they will become standards in themselves as
they start to gain wider acceptance.
Key point
Shariah standards aim to achieve a common platform or base that is applicable to the same
industry or market and forms a benchmark which is measurable and comparable across
jurisdictions in terms of compliance.
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11.2 Established Shariah standards and standard setters

11.2.1 International Islamic Academy of Fiqh
Since its establishment in Jeddah, the International Islamic Academy of Fiqh is regarded as the
highest reference with regard to any decisions and resolutions on any issue on Islamic law.
This academy is part of the Organisation of Islamic Conference (OIC), which is the umbrella
organisation for all Islamic countries. The Academy is represented by scholars who are appointed
by their respective countries. They are assisted by a group of Shariah experts who prepare research
papers and studies to be deliberated on by the Academy. Resolutions endorsed by the Academy are
accorded great respect and would be adhered to by member countries. Essentially, these resolutions
represent a kind of consensus among contemporary Muslims scholars on any point of law that has
been deliberated by the Academy.
Zakat is a form of religious levy
on the wealth of Muslims. It is
based on wealth that exceeds
the specied quantum for a
dened period (where relevant)
and is meant for the poor and
needy as well as other specied
beneciaries mentioned in the
Quran. It is the third pillar of
Islam and is made obligatory for
Muslims who have the nancial
means to discharge such
obligations.
The Academy is not dedicated to serve the Islamic nance industry per se. Its charter is wider and
covers other issues as well. The Academy has examined issues such as Zakat, donation and Waqf,
medical issues that have a Shariah bearing, such as organ transplantation. Members of the Academy
are also not necessarily experts on Islamic commercial law. These two factors made the Academy
unsuitable to address issues relating to Islamic nance Shariah standards on a regular and organised
basis. Hence, a need was felt to establish another body to undertake this task more effectively.
11.2.2 The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
The AAOIFI was established in 1991. Its main tasks are to develop the accounting, auditing and
governance standards relating to the activities of Islamic nancial institutions. Essentially, its aim
is to develop standards in Islamic accounting and auditing with Shariah issues being central to the
issue. With Islamic nancial institutions applying various concepts and practices, even on the same
contract, the Shariah board of the AAOIFI was set up to harmonise the Shariah Fatwas to facilitate
such application.
The Shariah board of the AAOIFI is composed of not more than 15 members appointed by the
board of trustees for a four-year term. Members are drawn from among Fiqh scholars who represent
Shariah supervisory boards in IFIs that are members of AAOIFI and the Shariah supervisory boards
in central banks. The powers of the Shariah board of AAOIFI include, among others, the following:
(a)
achieving harmonisation and convergence in the concepts and application among the Shariah
supervisory boards of IFIs to avoid inconsistency between their Fatwas and applications; this
provides a pro-active role for the Shariah supervisory boards of IFIs and central banks.
(b)
helping in the development of Shariah approved instruments, thereby enabling IFIs to cope
with developments taking place in the elds of nance, investment and other banking services
(c)
examining any inquiries referred to the Shariah board from IFIs or from their Shariah
supervisory boards, either to give divergent points of view or to act as an arbitrator
(d)
reviewing the standards that the AAOIFI issues in accounting and auditing and its code of
ethics and related statements throughout the various stages of the due process; this is to
ensure that these issues are in compliance with the rules and principles of Islamic Shariah.
Exercise 11.2
Explain how AAOIFI Shariah standards relate to the decisions of the International Islamic
Academy of Fiqh of OIC?
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11.3 Achieving a common standard

A key objective of the Islamic nance industry concerns the need to achieve common standards in
all the concepts and applications of IFIs. Islamic nancial products are based on particular contracts
that may have contradicting salient features and terms according to various schools of law. This need
for standardisation also relates to the implementation of the various products across the industry.
IFIs may have different practices that are not common to each other. Shariah standards aim to set
parameters to eliminate wide discrepancy of practice in the industry.
11.3.1 Setting standards

The creation of a standard starts with identifying a particular contract that is used in the industry.
A group of researchers, including both Shariah advisers and academics, are appointed to undertake
a thorough research, combining both the concepts and actual implementation of this contract
across countries and institutions. Their ndings will be discussed in a working group appointed by
the Shariah board of the AAOIFI. Comments and views are then incorporated into the research and
an exposure draft prepared. Both the research work and the draft will be further discussed by the
Shariah board of the AAOIFI. The nal version of the exposure draft will be endorsed by the Shariah
board and discussed in a public hearing. Comments and views are documented and if they are of
signicant merit will be tabled again before the Shariah board. Otherwise, a standard can be issued
for reference by the industry.
11.3.2 Binding effect of standards

Some jurisdictions have made Shariah standards, issued by the AAOIFI, binding on all IFIs operating
under their regulatory framework. These include, among others, Bahrain, Sudan and the Dubai
Financial Services Authority (DFSA). In these countries, a kind of standardisation of Shariah opinions
and Fatwas is likely. Other countries, such as Kuwait, Malaysia, Indonesia, Saudi Arabia and Qatar,
although they regard AAOIFI Shariah standards as of a high quality that warrant adherence, have not
established legal or statutory provision to ensure compliance.
These standards have become very persuasive, if not binding, benchmarks for other IFIs outside
the above mentioned jurisdictions. Both the resolutions of the Islamic Academy of Fiqh and AAOIFI
Shariah standards are, relatively speaking, conclusive and persuasive documents that all IFIs are
recommended to adopt and follow.
Key point
The fact that Islamic nancial products are based on contracts that may have contradicting
salient features and terms according to various schools of law means that there is a need for
standardisation.
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11.4 Measuring compliance

Another objective of having these Shariah standards is to be able to measure the degree of
compliance by IFIs across the globe. A benchmarking exercise is not possible without having a
common standard that is prescribed by all the parties. This is very clear in Islamic accounting
standards vis--vis, say, the nancial performance of a bank.
By 2007 there have been 21 Shariah standards issued, which cover both banking and capital market
products and services. These 21 standards are as follows:
Figure 11.1 AAOIFI Shariah Standards
AAOIFI Shariah standards

1.
Trading in currencies
2.
Debit card, charge card and credit card
3.
Default in payment by a debtor
4.
Settlement of debt by set-off
5.
Guarantees
6.
Conversion of conventional bank to an Islamic bank
7.
Hawala (transfer of debt)
8.
Murabaha to purchase orderer
9.
Ijarah and Ijarah muntahia bi tamleek
10.
Salam and Parallel Salam
11.
Istisna and Parallel Istisna
12.
Shirkah (Musharakah) and modern corporations
13.
Mudarabah
14.
Documentary credit
15.
Juàla (commission)
16.
Commercial papers
17.
Investment Sukuk
18.
Possession (Qabd)
19.
Qard / Hassan (loan)
20.
Sale of commodities in organised markets
21.
Financial paper (shares and bonds)
These Shariah standards guide IFIs in their products offerings and, at the same time, are useful
in achieving a certain degree of harmonisation in the future. Benchmarking exercises will only be
relevant if an increasing number of IFIs adopt these Shariah standards as a matter of policy. Such
benchmarking could lead to the proper rating of IFIs.
186

AAOIFI is a standard setting body whose task is to ensure the development of global
standards for global application. In your opinion, what would be the implication(s) if there
were no bodies like AAOIFI in Islamic nance industry?
Solution
The absence of standard-setting bodies such as AAOIFI would mean that standards would
be more difcult to set. This might lead to differences of opinion even in the same region as
the Ijtihad decisions of individual scholars might lead to a variety of fatwas being formulated.
Also, the task of measuring the performance of IFIs would not be possible as IFIs would be
working on different premises and bases. It is equally interesting to note that nance is a
regulated market and therefore, a standard must be established to ensure proper regulation
of the industry. That includes accounting treatment, risk management and in the context of
Islamic nance, Shariah compliance. To a large extent, the establishment of standards through
AAOIFI has made Islamic nance practice more appealing to the global market because it has
promoted the practice to the level of a standard.
Key point
An objective of having Shariah standards is to be able to measure the degree of compliance
by IFIs across the globe.
11.5 Dealing with different rulings arising from different interpretations of

the sources and techniques of law
The previous section and much of chapter three highlighted that Islamic law, although based on
revelation, has to resort to deliberation or Ijtihad to address issues that are not provided for in the
texts or in cases where the texts are given, but are speculative and probable in character. This has
been a common phenomenon throughout the history of Islamic law. Differences of opinion among
scholars enrich the exibility and dynamism of Islamic law and are well documented in the body of
Islamic law books and literature.
The same phenomenon is not uncommon to the Islamic nance industry as Islamic nance is part
of the wider coverage of Fiqh al-Muamalah or Islamic commercial law. The classical differences on a
particular contract, for example, will always be relevant in the modern context.
11.5.1 The contract of Istisna

An example of a contract that has divided scholars in the past on its object or deliverables is the
contract of Istisna, which is a construction or manufacturing. Debate ranges around whether it is
possible to conclude an Istisna contract on an existing asset, or whether it should be made on a
future asset yet to be constructed or manufactured? Some scholars particularly the Shais have
viewed an Istisna contract on existing assets as permissible, but the majority of scholars consisting
of the Malikis, the Hanas and Hanbalis have not. The argument of the majority of scholars is that
the Istisna contract, logically has to construct new assets, which are not yet in existence. If the
asset to be sold under the Istisna contract is something that is already available, the meaning of
Istisna, which is an order sale is lost. Contracts such as Murabahah would be more relevant in such a
circumstance.
The AAOIFI Shariah board has pronounced that an Istisna contract is permitted only for raw
materials that can be transformed from the natural state by a manufacturing or construction process
involving labour. Therefore, it is not permissible that the subject matter of an Istisna contract is an
existing asset. This is an illustration of how AAOIFI Shariah standards attempt to deal with such
differences of opinion. Shariah standards do not accept the practice of Istisna on an asset that is
already in existence as this contradicts the very logic of an Istisna contract. In this context, AAOIFI
Shariah standards has preferred one view over the other when they conict, which is quite a logical
approach. Having said this, some IFIs may decide to use an Istisna product on an asset that already
exists and they may quote the view of the Shais to support their action. This could possibly happen
because the meaning of Shariah compliance is quite wide.
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Islamic nance is new and still developing and may need some time to achieve maturity.
Given this hypothesis, are Shariah standards needed to govern this immature industry or
might such standards impede its development?
Solution
There are arguments for and against Shariah standardisation. On the plus side, standards
are needed to govern the industry so as to avoid the issue of ad hoc issuance and treatment
of Shariah Fatwas. On the other hand, the establishment of standards at this stage may
impede the desired growth of the industry. To address both views, standards must be exible
enough to accommodate change but at the same time capable of driving the agenda of
standardisation and harmonisation.
11.6 AAOIFI Shariah standards - methodology

AAOIFI has adopted a general methodology to accommodate as many juristic perspectives as
possible as long as the subsequent Shariah standard is supported by some authority and is expected
to benet the industry signicantly. However, where a minority view is supported by a juristic
opinion, as well as by a valid analogy to another case, and this view is likely to benet the industry at
large, the AAOIFI Shariah board is likely to adopt the view of the minority.
This was the case with regard to forward lease or Ijarah al-Mausufah al-dhimmah. Juristically
speaking, the forward lease was advocated by few scholars, but it had some appeal to an analogy on
forward sale, that is, the sale of something that is not yet available, which is permissible in Islamic
commercial law. It also has legitimate benets. Based on these arguments, among others, the AAOIFI
Shariah board has endorsed the contract of forward lease in Standard No (9) that provides that an
Ijarah contract may be executed for an asset undertaken by the lessor to be delivered to the lessee
according to accurate specications, even if the asset so described is not owned by the lessor.
Other international agencies may have adopted the same approach as the AAOIFI when dealing with
issues of cross-border transactions. As with international standards, some of the principles have to
be reviewed and amended as circumstances change. The review and amendment does not, however,
reduce the integrity of previous principles or standards, as the case may be. From an Islamic legal
perspective, a new principle or standard is only valid and effective from the date of pronouncement
and this new Fatwa has no retrospective effect on the previous Fatwa, rule, principle or the like.
This maxim is important to maintain the stability of the law and, at the same time, allow room for
improvement and enhancement.
11.7 Standards and best t

The Shariah standard of any contract or product does not claim to be comprehensive and allembracing. The Shariah standard is the best effort to standardise the concept and application of a
particular contract. A new practice that the market may have produced has, however, two possible
scenarios with regard to AAOIFI Shariah standards.
11.7.1 Example 1 - settlement of debts by set-off

In the rst scenario, a new product could be in line with the existing standard, according to its spirit.
Therefore, an accurate understanding of the standard is equally important to ensure it does not
restrict something that is basically a logical extension or application of the relevant standard. In the
Shariah standard of the settlement of debts by set-off (Muqasah), the denition of set-off is centred
on the discharge of a debt receivable against a debt payable. The basic requirement for a set off to
take place is the meeting of two debts that could cancel each other. In the market, the practice of
set off is normally tied together with the right of consolidation of all relevant accounts that one has
in the bank.
The consolidation clause normally gives a nancier the right to consolidate all the accounts of the
customer who owes a nancial obligation to the nancier under some Islamic nancing scheme such
as a Murabahah sale or rental under an Ijarah contract. The purpose is to set off the debt owed by
the customer against all their accounts held by the bank. Therefore, the bank/nancier cum creditor
can set off what the customer owes the bank from all the customers accounts that they have with
the bank.
188
Usually, set off in the banking industry takes place between a debt and a right instead of another
debt as the result of a prior agreement by the parties. Set off is the discharge of two debts or two
nancial obligations without any need to settle by way of actual payment. However, the practice
has been extended to allow the setmoff between a debt owed by the customer and a right that the
customer has in the bank. This takes place when a set off is agreed between a nancial obligation
arising from a Murabahah sale or lease rental, for example, a rental to be set-off against an
investment account that the customer has in the bank. The set off takes place despite the fact that
the investment account based on Mudarabah is not a debt or liability of the bank and therefore
would not normally be set off against any debt that the investment account holder owes to the bank
under either Murabahah or Ijarah nancing. This is not contradictory to the standard as it requires
the set-off of two debt obligations. This approach is permissible based on the fact that the customer
can settle the payment outstanding by debiting the investment account, although the latter is not a
debt or a liability on the bank.
11.7.2 Example 2 - Shariah Fatwas that contradict a standard

The second scenario relates to a practice or a term that obviously contradicts the provision of
a particular section of the relevant Shariah standard. This new practice or term, although not
in tandem with AAOIFI Shariah standards, has obtained a Shariah Fatwa or endorsement on its
permissibility by a Shariah board.
An specic example may help clarify the position. Shariah Standard (No 21) on Financial Papers
(Shares and Bonds) has the following provision on future contracts involving shares: The contract
of Salam is not permitted in shares. By virtue of this clear-cut provision, it is not permissible for a
bank or fund to buy or sell forward or future on shares. The basis for the impermissibility of Salam
in shares is that the subject matter of Salam should be a debt and not an ascertained thing, for
example, shares of corporations. In addition, the constant availability of specied shares in the
market, such as British Telecom shares, and the ability of the seller to deliver them at the end of the
period is something that cannot be guaranteed.
However, some Islamic institutions, particularly Islamic funds, have used the contract of Salam on
shares to replicate the functions of a short-sale in the conventional market. By deploying Salam,
either the buyer or seller of Salam has to take the market risk. A seller of Salam, for example, could
sell a basket of shares to a buyer on a Salam contract for a price. The expectation of the seller would
normally be that the price of the same shares at the time of delivery would be lower than the
contracted Salam price. Above all, the seller has received a full advance payment from the Salam
buyer and the proceeds could generate an income during the tenure of the Salam period up to the
delivery date. The buyer would normally expect to benet from a capital gain of the disposal of these
assets on the delivery date if there is an increase in price from what was originally paid.
Ideally, IFIs must, on a best effort basis, adhere strictly to all the provisions of AAOIFI Shariah
standards. However, if they or their Shariah board decide to adopt a contract or practice that is
different to AAOIFI Shariah standards, then they have to put forward a comprehensive reason and
argument as to why they have done so. Relevant stakeholders would then be aware of this departure
and the reason for so doing.
Exercise 11.3
Explain why Shariah Standard (No 21) does not allow the forward sale/purchase of shares such
as XYZ shares.
AAOIFI Shariah standards are useful in removing and eliminating unnecessary conicts and
contradictions of Fatwas and resolutions by various Shariah boards. However, these Shariah
standards are not rigid in the sense that they are open for review and amendment. Many new
practices could be included in the existing provisions directly or indirectly. Where practices are in
direct conict with the relevant AAOIFI Shariah standard provisions, a concerted effort must be
made to bridge the gap, if not to eliminate it entirely. However, some recognition can be given to a
differing Fatwa as long as it is supported by conclusive and valid arguments. Islamic law is exible
enough to allow interpretation that may result in more than one decision.
189
Exercise 11.4
Briey explain:
(i) why there can be more than one opinion on a particular issue
(ii) how AAOIFI Shariah standards resolve the issue of any divergence of opinion on a
particular issue
(iii) whether a Shariah board can depart from Shariah standard provisions issued by AAOIFI.
11.8 Proposed solutions to enhance Shariah compliance

By now it should be clear that Shariah compliance is central to the whole philosophy and activities
of Islamic nance. This has resulted in the production of high quality Shariah standards by the
AAOIFI. These standards depend on other relevant agencies and approaches to enhance Shariah
compliance. The following list includes proposed solutions to enhance Shariah compliance.
(i)
The establishment of a dedicated Shariah board that is supervisory in character. The members
of the board would be well qualied to understand not only the design and structure of a
product but also the supporting legal documents, accounting treatment and its IT solutions,
appropriate risk management strategies, if relevant, and other services that have Shariah
implications. The function of the Shariah board is not only to issue a decision but also to
supervise the day-to-day operations of IFIs in accordance with the decisions issued by the
Shariah board.
(ii)
The appointment of a dedicated full-time Shariah ofcer who acts as the Shariah compliance
ofcer. This post will relate closely to the duties of a Shariah supervisory board as the ofcer
will help members of the board to review the practices of IFIs in all aspects of compliance.
(iii) Incorporation of a Shariah review exercise in the audit committee of IFIs. More often than not,
the existing audit committee is detached from a Shariah review. An integrated approach of
internal auditing would add value to the quality of Shariah compliance. According to AAOIFIs
Governance Standards for Islamic Financial Institutions No.3 (Internal Shariah Review), the
internal Shariah review shall be carried out by an independent division/department as part of
the internal audit department, depending on the size of an Islamic Financial Institution. It shall
be established within an IFI to examine and evaluate the extent of compliance with Islamic
Shariah rules and principles, Fatwas, guidelines and instructions issued by the Shariah board.
(iv) Imposition of an external Shariah audit by the respective regulator is a long outstanding effort
to ensure compliance with Shariah principles is a critical requirement.
(v)
An annual Shariah compliance report is believed to improve compliance with Shariah

principles. The report should be comprehensive and objective in highlighting areas of
compliance and areas of non or less compliance.
(vi) Active participation by shareholders will denitely contribute to a better achievement of

Shariah compliance.
(vii) A clear statement by the management in the annual report that the management is
responsible for properly complying with Shariah principles and Fatwas issued by the banks
Shariah board. Also, a letter of representation by the management that all of the operations
are conducted according to Shariah principles is another mechanism to make the management
accountable and responsible for Shariah compliance.
(viii) The rating of IFIs in terms of their Shariah compliance process would be useful to enhance
the objective of Shariah compliance. Unlike a normal credit rating exercise, which evaluates
the solvency of nancial institutions and their capability of payment towards their nancial
obligations, an Islamic rating is concerned with issuing an independent opinion about the
quality of Shariah compliance for nancial institutions, securities or nancial products. Among
other things, an Islamic rating will examine the procedures of authentication of the products
and schemes offered by IFIs. In looking at the Fatwas, the independence of the scholars will be
of ultimate importance. An Islamic rating does not aim to give a Shariah opinion on Islamic
nancial products or to comment on the decisions of the Shariah boards of banks and nancial
institutions or to correct their Fatwas. It is expected to examine whether there is a mechanism
within the institution to evaluate its compliance with Shariah and whether their Shariah board
has sufcient authority to conduct the examination and evaluation, and also the necessary
information and resources to do so.
190
A synergy between these efforts would make the requirements of Shariah compliance more
attainable. It goes without saying that a recognised and reputable global rating or ranking would
stimulate the culture of Shariah compliance not only at the banks or regulators level but, more
importantly, within the public and media at large. This is important because IFIs have a duty to all
stakeholders with regard to Shariah compliance. Here lies the importance of transparency and duty
of disclosure as Shariah compliance is the most important pillar of Islamic corporate governance.
Exercise 11.5
Which of the following relates to an Islamic rating?
(A) Shariah compliance
(B) The quality of Shariah compliance.
(C) Financial ability to pay from a Shariah perspective.
(D) The independence of Shariah scholars to issue Fatwa.

It could be said that Islamic nance is fundamentally centred around Shariah compliance.
Products, mechanisms and standards are all clustered around the same principle. It has been
explained throughout this guide that compliance is decided by the IFIs Shariah scholars
who operate at less than arms length from the IFI. Explain how the industry could ensure
that there is no loss of condence in society with regard to the processes adopted for
ensuring Shariah compliance.
Solution
There are many steps that are essential which include:
(a) disclosure of the fullest version of the Fatwa for the information of the public and
other stakeholders
(b) emphasis being placed on the quality of the scholarship of the scholars used
(c) the avoidance of any conict of interest between the scholars and the IFIs.
11.9 Conclusion
No introduction to Islamic nance would be complete without a look at the attempts which have
been made to harmonise practices across the world. Islamic law is dynamic and, as the previous
chapters highlighted, various schools of law have developed and are dominant in different parts of
the world. The nature of Ijtihad means that numerous acceptable interpretations could be made
based on a single case. These differences in interpretation could adversely affect the Islamic nancial
market. This chapter explained the importance of developing acceptable Shariah standards which
would set agreed boundaries on interpretation. The chapter also introduced you to the attempts
that have been made by Shariah Scholars to ensure harmonisation of standards across the industry,
including specic solutions which have been proposed. You should now understand that while
standardisation is an ideal which has yet to be achieved, Islamic nance has already achieved a level
of harmonisation which allows it to operate successfully.
Having completed this study guide you should now be in a good position to move on to the
remaining three study guides which will introduce to you in more detail to the subjects of Islamic
banking, Takaful, Islamic capital markets and the accounting and analysis of Islamic nancial
institutions.
191
11.10 Summary
Having read this chapter, the main points that you should understand are as follows:
192
1.
the development of a Shariah standard is aimed at achieving harmonisation in products and

services by providing a basis for avoiding contradictions between the Fatwas and applications
by various IFIs
2.
Shariah standard setting is currently represented by two main bodies, namely the
International Islamic Academy of Fiqh and Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI)
3.
relatively speaking, the AAOIFI is more specialised and devoted to issuing relevant Shariah
standards addressing issues of harmonisation of concepts and applications, and product
development; it also acts as a focal point of reference for any Shariah query relating to
Islamic nance
4.
achieving a common standard is important to standardise contracts and their application; this
is achieved through the setting up of standards based on a relatively global consensus and
making them binding on IFIs
5.
being a standard, it should prevail over any other view that is contradictory. In the case of an
Istisna standard, for example, an Istisna contract is not allowed where an asset is already in
existence - although there is a juristic view to the contrary
6.
A Shariah standard could also incorporate a minority view, provided it can accommodate
the industry better; a good case is the permissibility of forward lease (Ijarah Mausufah aldhimmah)
7.
there are two possible responses to Shariah standards being issued by the AAOIFI; the rst
relates to Fatwas that enhance and extend existing standards, while the second scenario
contradicts the prevailing standard
8.
proposed solutions to enhance Shariah compliance, either to Shariah principles in general

or AAOIFI Shariah standards in particular, may take different forms; these may include an
establishment of a Shariah, the appointment of a full-time Shariah ofcer for an IFIs, an
internal Shariah review, an external Shariah audit, an annual Shariah compliance report,
and an Islamic rating exercise to rate and rank the degree of Shariah compliance in terms of
infrastructure.
Chapter 11 Answers
Exercise 11.1
Depending on which country you are studying in there may be a variety of standards applicable
to the working environment. You may have a standard working day (often eight hours),
you may have a standard working rate per hour or you may have a standard educational
requirement before you can work in certain areas of employment. The point about these
standards is that actual hours worked or wages paid can be judged against the standard. In the
context of Islamic nance, a standard could be related to a substantive Shariah viewpoint or
a governance standard. A substantive Shariah view, for example in a standard on Murabahah
nancing, is that the asset to be nanced under a Murabahah contract should not already have
been sold to the customer by the original vendor. The asset must be owned by the vendor
prior to Murabahah nancing because the sequence of contracts requires the Islamic Financial
Institution (IFI) to purchase the asset from the original vendor before the IFI sells the asset
to the customer at a mark-up sale. A governance standard could be, for example, that the
appointed Shariah board members must be independent from the management or ownership
structure of the IFIs.
Exercise 11.2
The Shariah standards issued by the AAOIFI are narrow and are specic to nancial matters,
whereas the decisions of the International Islamic Academy of Fiqh are wider in coverage and
include matters other than nancial issues.
Exercise 11.3
Salam is a forward sale contract whereby the full payment is paid in advance with the delivery
of the asset being deferred. The asset must be something that is generally available in the
market. Shares of a particular company do not meet the requirements of Shariah Standard
(No 21) as there can be no guarantee that the company will be in existence in the future, for
example it could be liquidated.
Exercise 11.4
(i) There could be more than one opinion in any commercial issue as many of these issues are
subject to Ijtihad.
(ii) The AAOIFI, whose Shariah board consists of globally acknowledged scholars, may decide
to prefer one opinion over another to settle a divergence of opinion on a particular issue.
(iii) Departures from AAOIFI Shariah standards are not encouraged, but any Shariah board may
adopt a different view, provided it is supported by an established authority and argument.
Exercise 11.5
(B) The main task of an Islamic rating is to signify that the recommended processes for
ensuring Shariah compliance have been performed by the relevant IFI. This is about
ensuring consistently high quality processes in achieving Shariah compliance and does not
relate to the status of Shariah compliance per se.
193
Revision questions
Revision Questions
1.1 Which of the following are not desired objectives of having a Shariah standard?
(A)
To achieve harmonisation and convergence in the Fatwas.
(B)
To avoid Fatwas contradicting each other.
(C)
To reduce the function of the Shariah board.
(D)
To measure the performance of IFIs with regard to Shariah compliance.
1.2 Why is the AAOIFI more effective in issuing Shariah standards on Islamic nance than the
International Islamic Academy of Fiqh?
(A)
The AAOIFI is a global establishment.
(B)
The AAOIFI has a strong Shariah board.
(C)
The AOIFI is an independent body.
(D)
The AAOIFI was established primarily to issue standards inclusive of Shariah standards.
1.3 Why is the benchmarking of IFIs based on Shariah compliance not feasible at the present time?
(A)
Standards are incomplete.
(B)
Only a few IFIs have adopted AAOIFI Shariah standards as a matter of policy and law.
(C)
There is no urgent need for Shariah compliance benchmarking.
(D)
External Shariah audit is optional in most jurisdictions.
1.4 What is the proposed methodology when a Fatwa issued by a Shariah board contradicts existing
Shariah standards?
(A)
The Fatwa of this board is deemed invalid and not enforceable.
(B)
Revision of the Fatwa.
(C)
Disclosure of the basis of the Fatwa for the consideration of the standard setting body.
(D)
Revision of the standard.
1.5 Which of the following is an accurate description of an internal Shariah review?

(A)
An internal Shariah review is undertaken by the board of directors of the IFI on behalf of
its shareholders.
(B)
An internal Shariah review is similar in purpose to an external Shariah audit.
(C)
An internal Shariah review has no provision in any standard of Islamic governance

standard.
(D)
An internal Shariah review is part of the internal audit exercise undertaken by IFIs.
Question 2
What are the roles of the Shariah board of the AAOIFI?
Question 3
What is the coverage of Shariah compliance?
Question 4
Compare and contrast the following terms
(A) Shariah adviser vs Shariah ofcer.
(B) Internal Shariah review vs external Shariah audit.
(C) Shariah standards vs Fatwa.
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1.1 (C) The objective of having a Shariah standard is to encourage uniform practice in the industry.
A Shariah board is still required to oversee and make sure that these standards are adhered to.
Revision questions
Answers
1.2 (D) The AAOIFI was established with the objective of issuing standards. Therefore its activities
are focused towards such an objective which is in line with its charter as a standard setting body.
1.3 (B) It is quite hard to benchmark IFIs when many of them adopt different Shariah compliance
practices and norms. It will be comparatively easier when IFs adopt a similar standard.
1.4 (C) As the research and development process in Islamic nance is always ongoing, there are
bound to be cases where a Shariah board might issue a new Fatwa based on new ndings. These
ndings should be shared with the standard-setting organisation in order for modications to be
made to the current standard, if required.
1.5 (D) Audit is a practice that ensures that the IFIs maintain compliance with certain standards.
These standards include the need to be Shariah compliant.
Question 2
The roles of the AAOIFI Shariah board includes efforts to achieve the harmonisation of Fatwas
as well as the development and creation of more compliant products. In addition, the roles of the
board extend to examining any inquiries posed to it and also to reviewing standards on accounting,
auditing and code of ethics and other related statements issued by the AAOIFI.
Question 3
Shariah compliance deals with all aspects of an IFIs adherence to Shariah standards in all aspects of
nance, such as product structure, legal documentation, accounting treatment, IT solution, marketing
and advertising and risk management methodologies.
Question 4
(A) A Shariah adviser is a scholar sitting on
the Shariah board, but he is not a full-time
employee of the IFI.
A Shariah ofcer is a full-time employee to

assist in the day-to-day compliance of IFIs.
(B) An internal Shariah review produces a report

for internal consumption.
An external Shariah audit produces a report on

compliance, especially to regulators.
(C) A Shariah standard is a Fatwa that has gone

through a process of deliberation and been
accepted as a global standard.
A Fatwa is a view or decision issued by some

individual scholars or some Shariah boards that
did not go through a process of deliberation,
and did not gain any adoption by a relevant
international standard setting body.
195
Bibliography
1.
AAOIFI Shariah Standard 2003, Accounting and Auditing of Islamic Financial Institution, Bahrain
2.
Abdullah, M. R. M., Hassan M. H. & Thani, N. N. 2003, Law and Practice of Islamic Banking and
Finance, Thomson Sweet & Maxwell Asia.
3.
Al Zuhayli, W. 2003, Financial Transactions in Islamic Jurisprudence, Vol.1, Al- Arabi, D. A. & ElGamal, M. (translators), Daral Fikr, Damascus & Dar al-Filer al-Muasir, Beirut.
4.
Archer, S. & Karim, R. A. (eds) 2002, Islamic Finance: Innovation and Growth, Euromoney Books
and AAOIFI
5.
Bakar, M. D. 2002, The Shariah Supervisory Board and Issues of Shariah Rulings and their
Harmonisation in Islamic Banking and Finance, Islamic Finance: Innovation and Growth, Archer, S.
& Karim, R. A. (eds), Euromoney Books and AAOIFI
6.
Formal Rationality in Islamic Law and the Common Law, 1985-86, Cleveland State Law Review 34
7.
Habib, A. 2006, Islamic Law, Adaptability and Financial Development, Islamic Economics Studies,
Vol 13, Islamic Development Bank and Islamic Research and Training Institute
8.
Hallaq, W. B. 1985-86, The Logic of Legal Reasoning in Religious and Non-Religious Cultures: The
Case of Islamic Law and the Common Law, Cleveland State Law Review 34
9.
Homoud, S. H. 1985, Islamic Banking, Arabian Information, London
10. Institute of Islamic Banking and Insurance 1992, Encyclopedia of Islamic Banking and Insurance,
IIBI, London
11. Islamic Development Bank, Islamic Research and Training Institute 2000, Regulation and
Supervision of Islamic Banks, Islamic Development Bank
12. Islamic Financial Services Board Research Report 2007, Survey on Shariah Boards of Institutions
Offering Islamic Financial Services (Iifs) Across Jurisdictions, Amanie Business Solutions.
13. Jaffer, S. 2007, Managing Takaful and Assurance Networks, Euromoney Books, Euromoney
Institutional Investor Plc
14. Juynboll, G. H. A. 1914, Law (Muhammadan), Encyclopedia of Religion and Ethics, Hastings, J.
(ed.), T&T. Clark, Edinburgh
15. Kamali, M. H. 1989, Principles of Islamic Jurisprudence, Pelanduk Publications, Malaysia
16. Kamali, M. H. 1999, Law and Society: The Interplay of Revelation and Reason in the Shariah, The
Oxford History of Islam, Esposito, J. L. (ed.), Oxford University Press, USA
17. Maksidi, J. 1985, Legal Theory and Equity in Islamic Law, American Journal of Comparative Law 33
18. Masud, M. K. 1977, Islamic Legal Philosophy, Islamic Research Institute, Pakistan
19. Obaidullah, M. 2005, Islamic Financial Services, Islamic Economics Research Center, King Abdul
Aziz University, Jeddah, Saudi Arabia
20. Owsia, P. 1991, Sources of Law under English, French, Islamic and Iranian Law - a Comparative
Review of Legal Techniques, Arab Law Quarterly 6
21. Presley, J. R. (ed.) 1988, Directory of Islamic Financial Institutions, Croom Helm
22. Rayner, S. E. 1991, The Theory of Contracts in Islamic Law, London: Graham and Trotman, 1991
23. Saleh, N. 1992, Unlawful Gains and Legitimate Prots in Islamic Law, Graham & Trotman, UK
196
24.
TheMejelle (Being an English Translation of Majallah al Ahkam al Adliyah and a Complete Code
on Islamic Civil Law, Translated by C.R Tyser), Law Publishing Company, Lahore
25. Umer, C. M. 1985, Towards A Just Monetary System, The Islamic Foundation, Leicester, UK
26. Usmani, M. T. 2002, An Introduction to Islamic Finance, Springer
27. Vesey-Fitzgerald, S. G. 1955, Nature and Sources of the Sharia, Law in The Middle East, Khadduri,
M. & Liebesny, H. J. (eds), The Middle East Institute, Washington D.C.
28. Weiss, B. G. 1978, Interpretation in Islamic Law: The Theory of Ijtihad, American Journal of
Comparative Law 206
197
Sample examination
CIMA Certicate in Islamic Finance, Module One in Islamic Commercial Law
CIMA Certicate in Islamic Finance

Module One: Islamic Commercial Law
Sample examination
This sample paper gives an indication of the type of questions that appear in the nal test,
which is administered by computer.
This sample examination consists of 40 multiple choice questions. For each item you should
mark your chosen answer by circling the answer A, B, C or D.
In all cases there is only ONE correct answer.
The answer key is given at the end of the examination.
1.
2.
3.
4.
5.
6.
198
What does Shariah refer to?

(A)
An Islamic law introduced by the jurists after the demise of the prophet Muhammad.
(B)
An Islamic law referring to transactions in economic activities.
(C)
Commands, prohibitions, guidance and principles of human activities based on the

religion of Islam.
(D)
Principles laid down by the Islamic scholars pertaining to Zakat management.
What is Islamic nance?

(A)
Financial business that is mostly practiced in the Middle East jurisdictions.
(B )
Financial business that is accordance with Shariah principles and rules.
(C )
The newly-formulated methodologies of interest free banking.
(D)
The process of wealth distribution between the government and citizens.
In Islamic banking, which of the following customer/banker contractual relationships is not

permitted?
(A)
Depositor-custodian.
(B )
Interest bearing borrower-lender.
(C )
Investor-entrepreneur.
(D)
Principal-agent.
All transactions made by Islamic Financial Institutions must:

(A)
Always involve at least one Muslim party.
(B )
Always be prot and loss sharing.
(C )
Be free from uncertain contractual conditions.
(D)
Have interest nancing of less than 5 %, in the case of sale transaction.
Which of the following would be deemed as Gharar?

(A)
An agreement to sell and deliver an item in that is specied by description in Salam sale.
(B )
An interest free loan.
(C )
The sale of an option.
(D)
The sale of pork products.
Which of the following is a salient feature of Islamic nance?

(A)
A long term capital guaranteed investment.
(B)
The elimination of risk.
(C)
The sharing of ownership of an asset.
(D)
The sharing of prot and loss.
8.
9.
How can money be put to productive use through Islamic nancial activities?
(A)
Money can be generated from a Zakat distribution agency.
(B)
Money must be mobilised into a xed income deposit of another nancial institution in
the same country.
(C)
Money must be mobilised into real business activities to earn extra money.
(D)
The bank must invest the money into a government bond of an OIC member country.
Sample examination
7.
What is the essential criterion for a business entity to be deemed Shariah compliant for
investment?
(A)
All the shareholders must be Muslim.
(B )
The company must be engaged in Halal and protable business activities.
(C )
The company must be engaged in protable business activities.
(D)
The company must have a Shariah board to review business decisions.
Which of the following are sources of law in Islam?

(A)
The Fatwa issued by the Islamic Fiqh Academy in Saudi Arabia.
(B )
The Quran and the law of the Islamic States.
(C )
The Quran and the Traditions of the Prophet Muhammad.
(D)
The Traditions of Prophet Muhammad only.
10. Which of the following combinations of legal matters are dealt in Islamic law?
(A)
Ritual, marriage, divorce, succession, commercial transactions and penal laws.
(B)
Ritual, marriage, divorce, succession, commercial transactions, penal, labour and land law.
(C)
Ritual, marriage, divorce, succession, commercial transactions, penal and arbitration

methodology.
(D)
Ritual, marriage, divorce, succession, commercial transactions, penal and custom duty law.
11. The Traditions of the Prophet Mohammed are relevant to Islamic law because:
(A)
the Traditions are historical accounts on Prophet Muhammad life and success
(B )
the Traditions involve systematic compilation of Prophet Muhammads life
(C )
the Traditions conrmed Prophet Muhammad as leader of the Ummah
(D)
the Traditions explain and interpret divine guidance for legal solutions.
12. In the context of Islam, what is meant by the term primary source of law?
(A)
Law that is based from the Traditions of the Prophet Muhammad only.
(B)
Law that is based on human interpretation and reasoning.
(C)
Law that is based on primary information of all leaders in the history of Islam.
(D)
Law that is based on revelation and divine guidance through the Quran and the
Traditions of the Prophet Muhammad.
13. What is the difference between Shariah and Fiqh?

(A)
Shariah can be changed and developed into a better form while Fiqh must remain xed.
(B)
Shariah is divinely prescribed; Fiqh relates to formulation of rules and law by the scholars.
(C)
Shariah is applicable to the Arab Muslims while Fiqh applies to others.
(D)
Shariah is the law for Islam while Fiqh focuses on Islamic nance.
199
Sample examination
14. What, in most cases, does Ijtihad rely on?

(A)
Case studies of previous issues, problems and practices.
(B)
Intuition of Shariah opinion and rulings.
(C)
References to the majority opinion of the scholars.
(D)
The exertion of faculty of mind and reason guided by the primary sources of Shariah.
15. On what matters are Islamic schools of law always in agreement?

(A)
The authority of the Quran and the Traditions of the Prophet Muhammad.
(B)
The status of injunctions in Islamic nance law.
(C)
The status of other schools of law in dealing with matters of Islamic nance.
(D)
The unity of the major schools of thought in Islam.
16. Which of the following correctly describes Qiyas?

(A)
A case in Islamic nance that describes the importance of honouring a promise or Aqad.
(B)
A case in Islamic law that extends a ruling already applied to a new but different case.
(C)
A method of Fiqh in applying the ruling for an existing case to a new but similar case.
(D)
A form of Shariah that extends a ruling already applied to a new but similar case.
17. The process of Ijtihad is particularly relevant to Islamic nance because:

(A)
it allows jurists to reach Shariah compliant solutions to new problems
(B)
it allows the auditor to ensure the products in Islamic nance comply with Shariah
requirements
(C)
it enhances the correct corporate governance issues in Islamic nance
(D)
it helps to provide the transparency of the business operations in Islamic nance.
18. What is the legal method employed to express opinion on Sukuk al-Ijarah?
(A)
Custom.
(B)
Istihsan.
(C)
Ijtihad.
(D)
Qiyas.
19. An original Ijtihad is one which:

(A)
describes the importance of honouring a promise or Aqad in Islamic nance
(B)
extends a ruling already applied to a new but similar case
(C)
has not occurred in the past, but is based on very similar previous views
(D)
is new and distinctive as opposed to being based on previous views.
20. The correct term for Islamic commercial law is:

(A)
Fiqh al-Ibadah.
(B)
Fiqh al-Muamalah.
(C )
Fiqh al-Munakahat.
(D)
Fiqh al-Musyarakah.
21. Which of the following lists the elements for a valid and enforceable contract under Islamic
commercial law?
200
(A)
Offer, acceptance, offeror, offeree, object, consideration.
(B)
Offer, acceptance, offeror, offeree, chargeable fee, cash.
(C)
Offer, acceptance, offeror, offeree, Halal transaction, cash
(D)
Place, time, offer, acceptance, object, consideration.
(A)
Ijarah muntahia bi tamleek is based on sale, while Musharakah Mutanaqisah is based on

partnership.
(B)
Ijarah muntahia bi tamleek is only suitable for property under construction whereas
Musharakah Mutanaqisah is suitable for both completed property as well as property
under construction.
(C )
Transfer of ownership asset under Ijarah muntahia bi tamleek takes place at the end,
whereas transfer of rights of equity claim takes place progressively under Musharakah
Mutanaqisah.
(D)
Unlike Ijarah muntahia bi tamleek, Musharakah Mutanaqisah is not fully Shariah

compliant.
Sample examination
22. How do the contracts of Ijarah muntahia bi tamleek and Musharakah Mutanaqisah differ in
terms of application with regard to an IFI customers house property nancing?
23. Which of the following contracts is suitable for an investor or nancier who also wishes to
actively participate in the management of a business venture?
(A)
Ijarah.
(B)
Mudarabah and Qard / Hassan.
(C )
Musharakah and Mudarabah.
(D)
Musharakah.
24. Which of the following is a basic requirement for an offer to be recognised under Islamic law?
(A)
Clear, absolute and communicated to the offeree.
(B )
Clear, absolute and communicated to the offeree and the witness.
(C )
Clear, absolute and communicated to the offeree but must get prior approval from
Shariah board members.
(D)
Clear, absolute but communication to the offeree is optional.
25. When is acceptance of a contract deemed to have occurred in the case of a face to face
meeting?
(A)
At anytime during the conversation between the two parties.
(B )
At the time and place that it is heard by the offeror.
(C )
At the time when both parties are about to disperse the meeting.
(D)
The immediate moment when both parties meet face to face to offer and accept
accordingly.
26. What is the minimum number of parties required to render an exchange contract legal?
(A)
Three.
(B)
Three with a witness.
(C)
Two.
(D)
Two with a witness.
27. What are the basic classications of contracts for Islamic commercial law?
(A)
Aqad and Muamalat.
(B )
Shariah and Fiqh.
(C )
Unilateral and bilateral.
(D)
Unilateral and multilateral.
28. Which of the following is a salient feature of an Ijarah contract?

(A)
The title of the leased asset is transferred to the lessee at inception of lease.
(B )
The lessee must renew the Ijarah contract on an annual basis.
(C )
The lessor must be the owner of the leased asset.
(D)
The lessor must sell the leased asset at the end of the contract period.
201
Sample examination
29. How can shareholders funds of IFI be mobilised in a protable manner which is Shariah
compliant?
(A)
By utilising the funds for investments in securities.
(B)
By pooling the shareholders funds with other deposit funds for investment in Shariah
approved nancing.
(C)
By pooling the funds with other deposit funds for loans and advances.
(D)
By pooling the funds to assume risk exposure of investment accounts.
30. In developing a new nancial product, what is the principal consideration to ensure
feasibility and its compliance?
(A)
Selection of a suitable contract.
(B )
Selection of a suitable contract together with its governing principles.
(C )
Legal compliance and transparency.
(D)
Consent of the contracting parties.
31. Which of the following best describes the concept of Tabarru?

(A)
A donation.
(B )
A purchase consideration.
(C )
A sale.
(D)
A lease.
32. In Musharakah partnership, how is loss borne by the partners?

(A)
All partners share losses based on their capital contribution.
(B )
All partners share losses based on agreed loss sharing ratio.
(C )
The lead partner assumes all losses.
(D)
The managing partner of the business does not bear any loss.
33. Which of the following is based on the Qard / Hassan concept?

(A)
Discounted loan.
(B )
Interest free loan.
(C )
Purchase contract.
(D)
Sales contract.
34. What is the advantage of structuring an Islamic credit card on the basis of Tawarruq?
(A)
The card can be used to withdraw cash as well as pay the purchase price.
(B )
No annual fee is charged to the customer regardless of the outstanding balance.
(C )
The card can be used only for purchasing Halal goods and services.
(D)
A rebate on the outstanding payment can be given using the prot generated from a
Mudarabah deposit.
35. Why do depositors generally prefer a hybrid Islamic current account based on either Wadiah
or Qard / Hassan with Mudarabah contracts?
202
(A)
There is no element of risk taking.
(B)
Their share of the prot is xed.
(C)
They can receive a share of eventual prots if the balance of the deposits exceeds
certain amount.
(D)
Their capital investment is guaranteed.
(A)
Shareholders.
(B)
Other members of the Shariah board.
(C)
The board of directors.
(D)
The regulators.
Sample examination
36. Based on AAOIFI standards, who approves the appointment and dismissal of member of a
Shariah board?
37. Which of the following describes a Shariah compliance ofcer?

(A)
A Shariah audit ofcer appointed by the regulator.
(B )
A full time ofcer who ensures that the nancial institution complies with Shariah
principles.
(C )
A representative of the board of directors
(D)
A member of the audit committee of the bank.
38. To be deemed Shariah compliant a product must adhere to:

(A)
All Shariah principles and timelines required in a given contract.
(B )
All Shariah principles governing contracts and all supporting materials and processes.
(C )
Regulations issued by regulators and AAIOFI.
(D)
The Fatwa of a Shariah board.
39. What is the appropriate course of action in the case where a Fatwa issued by a Shariah
board contradicts existing Shariah standards?
(A)
Revision of the existing standard to reect the ndings of the Shariah board must take
place within six months.
(B )
The Fatwa should be submitted for the consideration of the standard setting body.
(C )
The Fatwa of the Shariah board is deemed invalid and unenforceable.
(D)
The Fatwa of the Shariah board is revised with immediate effect.
40. Why is the international benchmarking of IFIs based on Shariah compliance currently
snot feasible?
(A)
International audit guidelines are adopted in most jurisdictions.
(B )
Standards and best practices are formulated for the Islamic Financial Services
Industry (IFSI).
(C )
Only a few jurisdictions have adopted AAOIFI Shariah standards as a matter of

policy and law.
(D)
There is no urgent need for Shariah compliance benchmarking.
Answers
1- (C)
8-(D)
15-(A)
22-(C)
29-(B)
36-(A)
2- (B)
9-(C)
16-(C)
23-(D)
30-(C)
37-(B)
3- (B )
10-(A)
17-(A)
24-(A)
31-(A)
38-(B)
4- (C)
11-(D)
18-(C)
25-(D)
32-(A)
39-(B)
5- (C)
12-(D)
19-(D)
26-(C)
33-(B)
40-(C)
6- (D)
13-(B)
20-(B)
27-(C)
34-(D)
7- (C)
14-(D)
21-(A)
28-(C)
35-(C)
203
Glossary
Glossary of terms and contracts

Absentes a contract where the parties are not present at the time of agreement
Al-kharaj bi al-daman the concept that reward should correspond to risk involved
Amanah is not a contract as such, but is a feature or a requirement in some specic contracts
that impose on one of the parties to disclose the actual cost price, such as in Murabahah sale as
compared to negotiated price sale (Musawwamah) with no requirement for such disclosure. Amanah
relates to the part of the buyer/seller relationship that is based on trust. This might occur where
the nancial institution buys goods from a third party vendor on the request of the institutions
customers, which will subsequently purchase the goods from the nancial institution. Upon
purchasing the goods from the vendor, the nancial institution assumes risks relating to the specied
asset until the point of purchase by the buyer. An Amanah, or trusteeship, is required of the seller/
nancier to disclose the actual cost of the goods purchased from the vendor before selling it to the
customer at cost plus mark-up.
Another example of Amanah being introduced into an Islamic nancial arrangement would be
Wadiah Yad-Amanah, which is where a bank as the custodian undertakes the task of safekeeping
the assets or funds deposited by a customer in a safe custody contract, based on trusteeship. It is
executed between two parties, namely the depositor (owner) and the bank (custodian). The liability
of the custodian triggers only in cases of negligence and misconduct. This is to distinguish between
safe custody contracts, which are based on liability, and this safe custody contract, which relies
on trusteeship. It establishes the liability of one of the parties, whereby a contract that is featured
as Amanah will not inict any legal liability on the part of the custodian, except in the case of
negligence and misconduct.
Key principles of Amanah
Requires a true and honest disclosure of the cost price in all Amanah-based sales.
Establishes liability on trustees only in cases of negligence and misconduct.
Aqd contract
Ashum shares
Bay muajjal deferred payment sale
Bay sale
Bay al-dayn the sale of debt
Bay al-murabahah sale of a commodity at cost price plus a known prot
Bay al-tawliyah sale at cost without prot or loss
Bayal-wadiah sale below the cost price or at a discounted price
Bayt al-mal government treasury
Bulugh physical puberty
Dayn a debt or the obligation to deliver an asset
Diminishing Musharakah see Musharakah Mutanaqisah
204
Fiqh Islamic substantive law
Gharar uncertainty
Glossary
Fiqh al-muamalah Islamic commercial law
Gharar fahish major uncertainty

Gharar yasir minor uncertainty
Halal acceptable and lawful
Hana particular school of law
Hanbali particular school of law
Haram unacceptable or prohibited
Hasuna pleasing, appealing or nice
Hiba gift
Hiwalah transfer of debt/right to claim
Hukm a ruling in the Quran or the Traditions of the Prophet Muhammad, or derived through
reasoning of jurists
Ibra can be dened as a discount or rebate. An example of Ibra in practise might be where a bank
which is owed a set amount from one of its clients and accepts less for early payment. This practice
of discount or rebate avoids unjust enrichment and maintains the competitiveness of the bank.
Key principles of Ibra
Relates to the forfeiting of rights to claim.
Involves a discount or rebate for early repayment of an amount owed.
Ijarah a lease contract

Ijarah ala al-ashkhas hire of people
Ijarah al-ayan lease of the asset
Ijarah mausufah al-dhimmah forward lease
Ijarah muntahia bi tamleek where an option to transfer the title of the asset to the
customer is provided for in the lease, the lease arrangement is Ijarah muntahiah bi tamleek. It is also
known as Ijarah Thumma al bay (lease followed by sale) or Ijarah wa al-iqtina (hire and purchase).
The objective of this nancing is to transfer the legal title of the leased asset to the lessee at the
end of the lease period. At the end of this contract, the bank will surrender its ownership of the
asset to the client in consideration of the total accumulated rental claim that is inclusive of the
prot. The concept Ijarah muntahia bi tamleek is an alternative to nance leasing and in particular
hire-purchase nancing. There are several forms of Ijarah muntahia bi tamleek nancing which
reect the different modes of transferring the ownership of the asset such as gift, sale and transfer
of equity claim from the lessor to the lessee.
205
Glossary
Key principles of Ijarah muntahia bi tamleek

Involves a lease with an option to purchase the leaseed asset.
At the end of the lease period title transfers to the lessee.
Several forms exist to reect the mode of transfer of ownership.
Ijarah tasqhilliyyah refers to an operating lease, where the nancial institution transfers the
usufruct (right of benecial use) of a particular property to another person in exchange for a rent
claimed from the lessee. The nancial institution, such as a bank, will purchase an asset, for example
plant and machinery, from a vendor and lease it to the lessee or client at an agreed rate for a
dened period. The operating lease will clearly state that the lessee has the right over the usufruct
in exchange of a rental claim. The ownership of the asset will not be transferred to the lessee during
the period of the Ijarah contract. At the end of each Ijarah period, the bank will negotiate a new
lease with the lessee and the lease period will continue until the bank chooses to scrap the asset. No
option or right to purchase is granted to the lessee.
Key principles of Ijarah tasqhilliyyah
Involves a straightforward operating lease.
At the end of the lease period title does not transfer to the lessee.
At the end of the lease period the owner of the asset will negotiate a new lease or sell/scrap
the asset.
Ijarah thumma al bay see Ijarah muntahia bi tamleek

Ijarah wa al-iqtina see Ijarah muntahia bi tamleek
Ijtihad interpretation
Ijma consensus or agreement of all Muslim scholars over interpretation
Illah effective cause or ratio legis
In rem action relating to property rather than the person
Inter absentes not physically present
Inter praesentes contract physically present
Istihsan equity consideration
Istishab presumption of permissibility
Istisna is a contract to build, manufacture, construct or develop the object of sale at a denite
price, over a dened period of time, according to agreed specications between the parties. An Istisna
contract can be established between a bank and contractor, developer or producer that allows the
bank to make progress payments as construction progresses. Istisna nancing is provided in the form
of advance progress payment(s) to the customer who builds, manufactures, constructs or develops
the object of sale. Upon completion of the project, the asset is delivered to parties who agreed to
take delivery of the asset. Parallel Istisna arises when the party that intends to take delivery provides
advance progress payment to the bank to engage the builder, manufacturer, contractor and developer.
Variations of timing and cash ow expectations, between the purchaser and the parties that deliver
the object of sale, are bridged by the bank.
206
Key principles of Istisna

Progress payments are normally made by instalments as construction progresses.
On completion of the project the asset is delivered to those that originally commissioned it.
Glossary
Involves the purchase of an item that has yet to be built, manufactured or constructed.
Parallel Istisna is where those that commission the asset make progress payments to the nancier
as the asset is constructed by another contractor or developer .
Parallel Istisna allows for any mismatch in the timing or amount of cash ows between those that
commission the asset and those that construct it.
Istisna muwazi (parallel Istisna) see above

Jualah commission-based
Kafalah is a contract of guarantee or surety that provides assurance in terms of performance and
value when the object of the transaction is exposed to adverse change due to varying outcomes. In
trade nancing, a bank guarantee is issued when the owner of goods discharges the liability for the
goods on behalf of a third party. Such guarantees are often used in cases of goods being imported. The
exporter knows that the goods will be paid for and can feel free to allow the goods to be uplifted by
the importer. The importer may be required to offer some form of collateral as surety and will normally
pay a fee for the service. The purpose of a Kafalah contract is to facilitate international trade.
Key principles of Kafalah
Involves a guarantee or surety.
Used when something being bought or sold could change in value if exposed to adverse
conditions.
Often used when importing/exporting goods.
Facilitates international trade.
Litera legis literal rule

Madhhab schools of Islamic law
Madhahib plural of Madhhab
Mafsadah evil and harm
Maisir gambling
Majallah al-ahkam al-adliyyah the Islamic Civil Code of the Ottoman Empire
Mejelle English translation of Majallah al-Ahkam al- Adliyyah
Maliki particular school of law
Maqasid objectives and ultimate purposes of Islamic law
Maslahah what is good or benecial
Maslahah mursalah benet or interest / unrestricted public interest
207
Glossary
Mudarabah (capital provider Rabb al-mal, entrepreneur Mudarib) a Mudarabah contract is a

prot sharing contract. Under a Mudarabah contract, the capital provider agrees to share the prots
between themselves and the entrepreneur at an agreed ratio or percentage. (1) As a source of capital for
a business venture, a businessman might consider undertaking a commercial project nanced by funds
from a bank under a Mudarabah contract. If agreeable, the bank supplies the nance to the businessman
on the understanding that both parties will share the prots of the venture. (2) As a deposit taking
activity, money deposited in a bank by an individual or institution under a Mudarabah contract is
treated as an investment in the bank by the individual or institution. The bank will use this investment
to help make prots from its trading activities, i.e. nancing of individuals and businessmen. Under the
Mudarabah contract, the bank will have agreed to give the depositor a share of its prots in return for
the investment, based on a pre-agreed ratio.
Investment nancing through Mudarabah is a commitment to participate in the risk associated with
business ventures, with the aim of sharing the prot generated from a given business venture. Parties
to the Mudarabah contract will only benet if the venture is successful. Should the project fail, the
nancier will lose his investment, whereas the businessman will only lose the time and effort expended
on the project.
In general, conditions imposed and agreed on by both parties limit the mobilisation of the funds raised
under a Mudarabah contract, such as pooling with other funds, types of business venture or investment,
as well as prot and loss sharing among the funds. In the case of a savings account, a Mudarabah
contract without conditions and restrictions is usually adopted, which is intended for public and retail
investors. Mudarabah, unlike Musharakah, does not entitle the capital provider to an executive function
in the management of the business venture.
Key principles of Mudarabah
Prot sharing contract.
Returns depend on a prot being earned.
Conditions could apply to what the investment can be used for.
Requires a commitment to participate in the risk associated with business venture.
The businessman only loses the time and effort expended on the project, where the nancier
assumes the nancial loss.
Does not entitle the nancier to any say in the running of the venture.
Mudarabah muqayyadah This type of contract is used in specic bank accounts known as
restricted investment accounts (RIAs), where the bank acts as an agent for the investor(s) simply
by acting upon their instructions. Here, the funds deposited based on the Mudarabah contract are
never really under the control of the bank because the depositor(s) determine the manner as to
where, how and for what purpose the funds are to be invested. Commingling of the funds raised
under this type of contract with the banks shareholder and other deposit funds is usually restricted
or prohibited. The returns distributed to restricted investment account holders (RIAHs) is based on
an agreed prot sharing ratio conned to the returns earned on a designated specic investment
portfolio involving the funds agreed upon by the RIAHs.
Any distribution between the bank and the depositor will be in accordance with an agreed prot
sharing ratio, or agency fee if the contract is based on wakalah or agency for investment. Mudarabah
prots or income distributable to RIAHs are derived from the performance of designated nancing
assets or investments managed by the bank.
Key principles of Mudarabah muqayyadah
Financial institutions act as entrepreneurs or agents for investors.
Investors decide where funds will be invested.
Commingling of funds is either restricted or prohibited.
Returns paid to investors come only from returns earned on the specied investments.
208
Glossary
Mudarabah mutlaqah unlike Mudarabah Muqayyadah, this contract relates to investment

accounts where the account holder fully authorises the bank to invest the funds without restrictions
imposed by the account holder and is in accordance to the Shariah principles and rules. The funds are
pooled with the banks shareholder funds and other deposits to facilitate nancing and investments
by the bank. The returns depend on the level of prots earned, and are shared and distributed across
the varying classes of investment account holders based on different investment horizons from one
to 60 months or more. Usually, returns to investment account holders are computed and accrued
on a month-to-month basis. The investment account holder must submit written notice to Islamic
banks prior to the withdrawal of funds and a minimum notication period is required. Mudarabah
prots or income distributable to unrestricted investment account holders are derived from the
performance of the banks nancing assets and investments.
Key principles Mudarabah mutlaqah
Financial institutions fully authorised to invest deposited funds without restrictions.
Commingling of funds can take place.
Returns paid to investors come only from returns earned across all investments of the nancial
institution.
Returns paid to investors depend on class and time horizon of investment.
Muhammad the Last Prophet of Islam

Mujtahid the person who performs Ijtihad
Muqasah set-off
Murabahah a Murabahah contract refers to a cost plus mark-up transaction between parties.
Murabahah nancing is the prevalent mode of asset nancing undertaken by a large number of
Islamic banks. It represents a signicant portion of Islamic bank nancing of either short term or
long term asset nancing. Under this contract, a three party arrangement is made where the
customer places an order with the nancial institution to purchase goods from a supplier. The
customer can pay a security deposit with the nancial institution and the amount of nancing
outstanding can be secured either in the form of collateral or a guarantee. The nancial institution,
having purchased the goods from the supplier, then sells them to the customer at a credit price
including mark-up, with a xed credit period. The nature of the buyer and seller relationship is based
on the principle of trust (Amanah), mentioned above, where the seller upon purchasing the goods
from the vendor must honestly disclose to the customer the actual cost price of the purchase, prior
to selling the asset to the customer under a Murabahah.
Under this contract, the customer is always aware of the mark-up, i.e. it is set in advance, and pays
the Murabahah selling price either on an instalment basis or at the end of the nancing period. The
mark-up or prot agreed in the price does not change over the period. Hence there is a price ceiling
for the Murabahah nancing to ensure certainty in the price. Rebates may be granted for early
settlement, provided the rebate provision is not contractually documented in the contract. On the
other hand, provision for penalty charges for delinquent payments could be included in the contract
as a form of compensation but to bedistributed to charity as the provision is only to deter moral
hazard behaviour. The bank may take some of this compensation money to cover the actual cost
incurred by the bank due to the default. Compensating for loss of opportunity cost or cost of funds
is not acceptable.
Key principles of Murabahah
Cost plus mark-up arrangement.
Usually involves a nancial institution, the customer and a third party vendor.
Based on a relationship of trust between the parties.
Can be secured by collateral or guarantee.
Sets a xed priced between the nancier and customer.
The price is paid over an agreed period of time.
Early repayments are allowed and can result in a reduction of the overall price charged.
Penalties can be applied for late payment as a deterrent.
209
Glossary
Murabahah-tawarruq contract to realise cash

Murabahah li al-amir bi al-shira Murabahah to the purchase orderer
Musharakah a Musharakah contract is a form of equity partnership investment. It is similar to
equity investment in a conventional capital market but the investments made must be conned
to stocks and nancial securities or other assets that are consistent with the principles of Shariah.
Note, partnership contracts come in three forms, namely Shirkah al-Amal (work partnership), Shirkah
al Wujoh (partnership by reputation) and Shirkah al-Amwal (partnership by capital). Musharakah
nancing is based on Shirkah al-Amwal (partnership by capital).
As a form of equity based nancing, like Mudarabah investment nancing, Musharakah nancing is
a commitment by the nancier to participate in risks associated with business ventures. Musharakah
also means a joint enterprise in which all partners share the prots or losses of the venture. While the
prot sharing ratio may be negotiated, the loss sharing ratio must always be proportionate to capital
contribution. It also allows the institution to be involved in the executive decision on administration,
operations and management of the business activity. The nancial institution would be able to mitigate
any form of operational risks by assuming an element of control in the conduct of business.
The Musharakah nancing mechanism operates on a capital contribution basis for a dened existing
or potential project or assets. The outstanding nancing amount could increase or decrease depending
on the demands for funding during the nancing period. At any point in time, the outstanding capital
contribution provides the basis for determining the prot or loss sharing ratio. As a prot and loss sharing
arrangement, Musharakah takes various forms, depending on the parties capital contribution and their
effort in managing the venture. Musharakah is considered as the most exible form of equity nancial
claim that can be adopted for various economic sectors, including services, production and distribution.
Key principles of Musharakah
Prot and loss sharing contract.
The nancier invests in the venture.
Requires the participants to work in partnership.
The nancial institution or lender has a say in the running of the project.
Relates to a specic project or asset.
Returns depend on a prot being earned.
Allows for the level of nance outstanding to uctuate up or down.
Requires a commitment to participate in the risk and loss associated with business venture.
Musharakah mutanaqisah is a variety of Musharakah contract, where the term Mutanaqisah

means to diminish. Thus, Musharakah mutanaqisah, also referred to as Diminishing Musharakah,
means a form of partnership which creates an avenue for the capital provider to reduce or be
free of the joint ownership after the initial investment period has been satised. As mentioned
above, a normal Musharaka contract allows for uctuating levels of investment, but a Musharakah
Mutanaqisah contract specically relates to a reducing investment.
Diminishing Musharakah provides an avenue for the nancial institution to systematically reduce
its exposure over the nancing period, with planned and scheduled redemption of the contribution
amount. This form of nance is often used in the purchase of a house in the form of a joint venture.
The nancier contributes the bulk of the house price with the individual customer contributing the
remaining balance. The joint venture accepts rental repayments from the individual who is now
living in the house. The rental is split between the nancial institution and the homebuyer with the
homebuyers share going toward the redemption or dilution of the nanciers shareholding.
Key principles of Musharakah mutanaqisah
As with Musharakah above.
Allows for planned diminution in investment to the point where the nancier exits the venture
Effectively nances the customer to acquire an asset through a joint venture scheme.
210
Musawamah negotiated sale
Parallel Istisna see Istisna two contracts operated in parallel
Glossary
Musawamah, Tawliyah negotiated sale at agreed price
Parallel Salam see Salam two contracts operated in parallel

Praesentes where the parties to the contract are present at time of agreement
Qard / Hassan interest free loan
Qiyas analogy
Qiyas al-tard extension of a legal rule from one case to another due to a material similarity
Qur an the Holy Book revealed to the Prophet Muhammad
Rahn pledge
Ray personal opinion
Ratio decidendi legal basis
Rem see in rem
Riba interest/usury
Riba al-fadl interest by an excess of countervalues
Riba al-nasiah interest by deferment in the delivery
Ribawi usurious or interest-based
Rushd prudence
Sadd al-dharai blocking the means
Sahm a share
Salam refers to the purchase of a commodity for deferred delivery in exchange for immediate
payment. Thus, in a Salam contract, the price is paid in full and in advance while the commodity is
deferred to an agreed date in the future. This type of contract might be used where the commodity
price is subject to change. The buyer is locked with the purchase price at contract date and thus
hedged against price increase. Stringent conditions are applied to ensure a binding and legally
enforceable contract such as reasonableness of delivery and specications of quality type and
quantity of commodities. Any variations of quality and quantity of goods as well as timeliness of
delivery would not affect the agreed price.
The object of a Salam contract must be commodities that can be specied clearly, due to the non
existence of the object of sale at the time when the contract is concluded. The detailed features
and specications of the product of sale must be agreed upon to avoid ambiguity that would render
the contract unknown to the parties. When there arises a disparity or mismatch in terms of types,
quality and timing of delivery, the buyer has either the choice to take delivery without discount or
premium on price, or to revoke the contract. Advance payment made by the bank to the seller or
exporter to deliver or produce the goods constitutes Salam nancing. Parallel Salam is based on
two independent Salam contracts whereby the nancier will be both the seller and the buyer in this
211
Glossary
arrangement. In the rst Salam contract, the IFI will be the buyer of the Salam asset by providing
a full payment to the seller against a future delivery of an asset. Then, this IFI may enter into a
Salam contract as a seller with another party for a shorter period of delivery of the asset. the spread
between the rst and second Salam contracts is the prot earned by the IFI through this parallel
Salam arrangement.
Key principles of Salam
Involves a forward purchase of a commodity
Full payment is made at the beginning of the contract period
Goods are received at the end of the contract period
The goods must be clearly identiable
Remedies available for failure to complete the contract as specied
Parallel Salam is useful to nance the ultimate producer as the IFI is neither the ultimate producer
nor the user.
Sanadat al-dayn certicates of debt

Shai particular school of law
Shariàh sacred law revealed by God Almighty
Shirkah partnership
Shirkah al-mufawadah equal partnership
Sukuk certicates of investment
Sukuk al-ijarah certicates of investment in leased assets
Sunnah The Traditions of The Prophet Mohammad
Taawun cooperation
Tabarru donation contracts
Takaful is an Arabic term derived from the root word kafala, meaning to guarantee. To be more
precise, it is derived from the verb Takafala meaning to mutually guarantee and protect one another.
Therefore, literally, it means mutual help and assistance. It can be noted that the contract of Takaful
is based on the concept of helping one another, whereby each and every participant contributes
to the common fund in order to provide nancial assistance to any member who needs help, as
dened in the mutual protection scheme. In principle, Takaful is very similar to conventional mutual
insurance in terms of its philosophy and structure. However, it differs signicantly from conventional
mutual insurance as all its operations should be based on Islamic principles, including investment
activities, the establishment of the Shariah board and causes for legitimate claim, which exclude
causes such as suicide and death under the inuence of alcohol.
Key principles of Takaful
Relates to the idea of mutual guarantee.
Used in the context of mutual help of assistance.
Similar to conventional mutual insurance. but differs in terms of investment portfolio and
legitimate causes for claims.
Claims restricted under Shariah principles.
Takharuj exit from partnership by selling the shares to another party
212
Tanazul is an act to waive certain rights of claim in favour of another party in a contract. In
Glossary
Islamic nance, it is applied where the right to share some portion of the prots is given to another
party. For example, in a Mudarabah contract, the capital providers may agree to limit the rate of
return to a dened percentage whereby the excess can be given to the manager as an incentive
or performance fee. The decision of the investors to waive their right to the prot is based on the
principle of Tanazul that is specied as a condition of the contract to waive such a right.
Key principles of Tanazul
Involves the waiving of rights in favour of someone else.
Often seen where the capital providers agree to waive their right to a portion of the prots in a
venture in favour of, say, a manager on the project.
Taskeek securitisation
Tawarruq buy spot and sell deferred payment or vice versa to facilitate cash liquidity
Tijarah private commercial transactions
Ujrah fee
Ummah Islamic nation
Umum balwa common plight and difcult to avoid
Urf customary practice
Urbun is essentially a down payment made by a buyer to a seller after both parties have entered
into a valid contract. The down payment represents the commitment to purchase the goods. If the
buyer is able or decides to pay the remaining outstanding payment during a prescribed period, the
amount paid as down payment will be counted as part of the purchase price. Otherwise, the down
payment will be forfeited by the seller. This is the original version of Urbun in Islamic commercial
law. This feature is often used to mirror the behaviour of conventional options by providing an
opportunity to the buyer (the person making the down payment) to benet from the market
up-side (call option) of the underlying asset and by limiting the potential loss to the amount paid
under the down-payment scheme.
Key principles of Urbun
Involves the payment of a down payment to secure an option or right to purchase something in
the future.
Mimics the economic benets of purchasing conventional options.
If the option to complete the purchase is not taken up the down payment is forfeited.
Usufruct the right to use

Usul al-qh Islamic legal theory providing principles and guidelines on interpretation
Wad is a feature attached to a contract and is a unilateral promise made by one party to
another, binding on the party that makes the promise. In nancing transactions this feature provides
assurance that the transaction will be executed as per the specications of the contract. For example,
an importer who has foreign exchange transaction exposure in terms of payment of imports in
foreign currency upon delivery of goods might hedge the risk of appreciation of foreign currency by
undertaking a promise to buy the foreign currency in the future that matches the real exposure to
currency risk of import transaction upon delivery.
Key principles of Wad
Involves a unilateral promise made by one party to another.
Binds the promisor to full some obligation in the future.
Ensures that the contract is fullled as set out in the terms
213
Glossary
Wadiah safe custody

Wadiah yad dhamanah guaranteed safe-custody deposit contracts
Wakalah is a contract between an agent and principal. This contract enables the agent to render
services and be paid a fee (Ujrah). For example, in a case where the importer applies for a letter of
credit based on Wakalah, the importer will authorise the bank to issue the letter of credit on his
behalf to the exporters bank. The issuing bank will act as the agent to process the issuance of the
letter of credit and for this will impose a fee on the importer for the services rendered.
Key principles of Wakalah
Involves an agency contract between an agent and principal.
Used as a facility to enable transactions to take place.
The agent earns a fee (Ujrah) for his services.
Wakil agent
Waqf permanent endowment
Wasiyyah will contract
Zahiris literalists
Zakat is a form of religious levy on the wealth of Muslims. It is based on wealth that exceeds
the specied quantum for a dened period (where relevant) and is meant for the poor and needy
as well as other specied beneciaries mentioned in the Quran. It is the third pillar of Islam and is
made obligatory for Muslims who have the nancial means to discharge such obligations. Methods
of Zakat computation are prescribed to facilitate determination of Zakatable wealth as well as
the prescribed rate. In the case of investment or deposit funds, there is no specic date set for
the payment of zakat, but it should be paid on all accumulated wealth for the period twelve lunar
months. Zakat is not payable on the value of the individuals home, furniture, transport or tools of
trade, nor is it paid on personal jewellery.
Key principles of Zakat
Religious levy on wealth of Muslims who possess a certain amount of specic assets.
Payable on all accumulated wealth held for the period of 12 lunar months.
Not payable on specied items that are personal in character.
214
Glossary
215
Index
Index
Index
216
Accounting and Auditing Organisation for Islamic

Financial Institutions (AAOIFI) 44, 184
Amanah 20, 110, 114
Anas, Malik bin 67
Aqd 91-93
Bayal-murabahah 110
Bayal Muajjal 112
Bayal-tawliyah 110
Bayal-wadiah 110
Contracts 90-100
application in Islamic nance 166-177
bilateral 107-109
classication 104-119
comparison of classications 124-133
sale 110
security 128
traditional Islamic 140-147
unilateral 107-108
Credit cards 173-174
Current Accounts 154
Financing products 155-157
Fiqh 65, 184
Fixed income account 154
Gharar 20, 22, 24, 28, 98, 107, 109, 158, 171
Hanbal, Ahmad bin 68
Hanifah, Abu 67
Hiwalah 97, 116
Idris al-shai, Muhammad bin 68
Ijarah 146
Ijarah al-Mausufah al-dhimmah 171, 189
Ijarah muntahia bi tamleek 114-115, 146, 157, 169, 172
Ijarah Tashghiliyah 114-115
Ijma 61
Ijtihad 60, 66, 76-86
Illah 62
International Islamic Academy of Fiqh 184
Investment accounts 154
Islamic banking products 153-157
Islamic capital market 160
Islamic commercial law 54-69
sources 56-66
Islamic nance compared to conventional nance 29
Islamic nance-features 23
Islamic nance-meaning 20
Islamic schools of law 67
Hanbali 68
Hana 67, 78, 82
Maliki 67, 78, 82
Shai 68, 78, 82
Istihsan 63
Istishab 64
Istisna 113, 129, 131, 171, 187
Jualah 118, 130
Kafalah 117
Maslahah 63, 81
Mudarabah 24, 83, 113, 116, 126, 127, 154, 156,
167, 168
Murabahah 20, 129, 143, 156, 168, 176
Musawamah 111, 112, 113, 129
Muskarakah 24, 30, 116, 126, 127, 156

Mutanaqisah 125, 169, 172
Qard / Hassan 109, 154, 167
Product development 170
Prot and loss sharing 24, 29
Qiyas 61, 82
Qiyas al-tard 61
Rahn 117
Riba 21, 26-28, 77, 109
Roman law 79
Sadd al-dharai 63
Salam 112, 129, 171, 189
Savings Accounts 153
Shariah advisory and supervisory boards 42-45
Shariah compliance 38-47, 190
features 40-41
ofcers 46
regulators 42-45
shareholders 45
stakeholders 42
Shariah standards 183-191
Shirkah al-Mufawadah 98
Sukuk 85, 160
Sukuk al Ijarah 161
Tabarru 158
Takaful 22, 107, 158
Tawarruq 172
Tawliyah 113
Urbun 113
Urf 64
Usufruct 114
Wadiah 113, 118, 154, 167
Wakalah 99, 118, 130
Zakat 184
Islamic Finance is a fascinating and dynamic

multi-disciplinary area of the international
nancial services sector. As an established niche
of the nance industry it is set to grow at an
exponential rate over the next few years. The
current annual industry growth rate is estimated to
be between 15% and 20%.
As a result of the rapid growth experienced in this emerging area
most individuals and nance organisations have minimal exposure
to and understanding of its unique and profound nature, leading
to a signicant skills shortage. To date, few institutions offer
qualications in the subject nor do any professional bodies offer a
global qualication. CIMA, through its Centre of Excellence, and in
conjunction with the International Institute of Islamic Finance Inc.,
has developed the Certicate in Islamic Finance to meet this global
shortfall in human capital.
The Certicate comprises of four modules which build a strong
foundation of knowledge and skills based on standards and
industry wide experience to assist candidates in meeting the
challenges of this exciting and fast changing area of nance:

Islamic Banking and Takaful (Products and Services)
Islamic Capital Markets and Instruments
Accounting and Analysis of Islamic Financial Institutions.
The CIMA Certicate in Islamic Finance learning system includes:
comprehensive syllabi leading to a higher professional

qualication in Islamic Finance
step by step subject coverage directly linked to specic

learning outcomes
fusion between theory and practice

chapter summaries
contemporary and user friendly glossary of Islamic
Finance terms
self learning and self assessment approaches

extensive question practice
revision sections for each chapter
easy to follow format
full length mock examination at the end of each guide.
All materials included in the CIMA Certicate in Islamic Finance

have been subject to the scrutiny of a global advisory panel
comprising experts in all the areas covered within the modules.
CIMA is proud to be the rst professional accounting body to offer
a truly global product in this area your passport to success in
Islamic Finance.
www.cimaglobal.com/islamicnance

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Islamic

Certicate in Islamic Finance

Islamic Commercial Law

Chartered Institute of Management Accountants (CIMA)

CIMA Certicate in Islamic Finance, set: ISBN 978-1-85971-585-7

Certicate in Islamic Finance and Banking Book one

Certicate in Islamic Finance and Banking Book one

How to use this guide

Realising your potential with this study guide

Islamic Commercial Law

Study guide two:

Islamic Banking and Takaful (Products and Services)

Study guide three: Islamic Capital Markets and Instruments

Accounting and Analysis of Islamic Financial Institutions.

Certicate in Islamic Finance and Banking Book one

How to use this guide

Self study - the guides

Certicate in Islamic Finance and Banking Book one

How to use this guide

Quotes and examples from real life

Exercises with solutions

Islamic nance challenges

Revision questions with answers

Certicate in Islamic Finance and Banking Book one

How to use this guide

Examples from real life

CIMA CIF website

The nal examinations

Certicate in Islamic Finance and Banking Book one

Certicate in Islamic Finance and Banking Book one

What is Islamic nance?

Certicate in Islamic Finance and Banking Book one

Shariah advisory boards

The importance of contracts

Islamic nancial institutions: products and services

Certicate in Islamic Finance and Banking Book one

The Islamic Capital Market (ICM)

The Islamic equity market

The Islamic xed-income instruments or Sukuk market

Certicate in Islamic Finance and Banking Book one

The Islamic derivatives or Islamic structured products market

Accounting and analysis of Islamic nancial transactions

Certicate in Islamic nance - content

Benets and objectives

Certicate in Islamic Finance and Banking Book one

Certicate in Islamic Finance - overview of study guides

Study guide three: Islamic Capital Markets and Instruments

Study guide four: Accounting and Analysis of Islamic Financial Institutions

Study plan for Certicate in Islamic Finance

For further information and advice please visit the website

Certicate in Islamic Finance and Banking Book one

Islamic Commercial Law

The CIMA Certicate in Islamic Finance Introduction

Certicate in Islamic Finance and Banking Book one

Islamic Commercial Law

Terms and contracts

Study Guide One

Islamic Commercial Law

Chapter one: An Introduction to Islamic nance

Describe the salient features of Islamic nance comprising of interest-free transactions,

Chapter two: Shariah compliance

Dene the meaning of Shariah compliance.

Appreciate the importance of Shariah compliance in all nancial activities of an IFI.