Transcript Slide 1

FUNDAMENTALS OF ISLAMIC
BANKING:
PRODUCTS & INTRUMENTS
DR. AZNAN BIN HASAN
AHMAD IBRAHIM KULLIYYAH OF LAWS,
INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA
[email protected]
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Outlines
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Framework of Islamic Finance
Shariah, Fiqh & Mu’amalat
Necessary Requirements of Islamic Finance
Essential Contracts in Islamic Finance
Products and Instruments
Standardisation and harmonisation in Islamic
Finance
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Framework of Islamic Finance
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In general, the framework of Islamic finance is the
same framework used by the conventional finance
practices.
These frameworks are, inter alia legal and
regulatory framework, taxation framework,
accounting and auditing standards, etc.
Might have different or additional framework, such
as accounting and auditing standard, etc, due to its
peculiarity.
In certain jurisdiction, Islamic banking and finance
might be regulated by different sets of regulations,
either separate or additional, e.g. IBA 1983
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Cont’d
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However, Islamic Finance, as the name
suggests, has another framework, which is
considered the major element that
differentiates IBF from the conventional
banking and finance.
Any violation of this framework will definitely
effect the validity of Islamic finance itself.
Shariah Compliance Framework
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The Shari’ah Framework of Islamic
Banking and Finance
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Three main interrelated terminologies:
Shariah, Fiqh & Muamalat
Shariah, when viewed from legal perspective
is the fixed elements of Islamic law, i.e. what
has been clearly stipulated and mentioned in
the text. E.g. five time prayers, prohibition of
riba’, etc.
As such, it is revealed in nature
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Shariah & Fiqh
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Shariah, in this sense, is wide and encompassing
various branches of Islam
Normally, it comes in its generality and it emphasizes
only on the principles and not the detailed rules (not all
the time)
It is the duty of the judge (qadi), mufti and jurisconsult
(ulama’) to exert their intellectual efforts in deriving
and applying these principles on certain given
scenarios.
The result of human reasoning and understanding to
the shariah is known as fiqh
Fixed v. Flexible
Agreements v. Differences
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Fiqh Mu’amalat (Islamic Commercial Law)
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However, in its general usage, it is called al-syariat
al-Islamiyyah (Islamic law).
Islamic commercial law is one of the components of
Islamic law
Other components of Islamic law include:
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Islamic law of purification and worship
Islamic family law
Islamic criminal law
Islamic law of evidence and procedure
Islamic law of inheritance, etc
The main subjects of Islamic commercial law are
commercial contracts and the rules governing them
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Islamic Finance Paradigm
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Original rule of permissibility:
- Initial legal ruling in commercial contract is permissibility
- Contrary to acts of devotion (Ibadat)
- No legal injunction is needed in sanctioning new contract
- Every contract is considered lawful and acceptable if no
principle of shari’ah is violated
- Open a very wide door for further innovations
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Real Economic Activities
Transactions-oriented not loan-based.
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What to do and what to avoid
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Conclusion of contract by mutual consent
The avoidance of riba’
The avoidance of gharar
The avoidance of transactions involving
maysir (gambling)
The avoidance of transactions involving
prohibited commodities
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Mutual Consent
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al-Qur’an (4:29): “ O you who believe, devour not
your property among yourselves by unlawful means
except that it be trading by your mutual consent.
verse: al-Nisa’ (4:29)
Manifested through expression of the parties
No certain formalities in concluding contract
In general, mutual consent is achieved if it is
made freely by a competent person (puberty and
prudence)
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The avoidance of riba’
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Literally: excess, expand, increase, growth
Any unjustified excess above and over the
capital, whether in loans (between creditor
and debtor) or in trade (with similar
commodities)
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DIVISION OF RIBA
Type of Riba
Riba’ al-Duyun
(RIba’ in Loan
Contract)
Riba’ al-buyu’
(Riba in exchange
contracts )
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Riba’ al-duyun
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The debtor borrowed money to be paid in certain
time, and the amount is more that the amount
borrowed
A creditor gives a periodic loan and takes monthly
interest. The capital sum lasts until the expiration of
the period. Upon expiry, if the debtor cannot pay, the
period to pay back the capital will be extended and
interest will be charged
Arising out of exchange contract, a buyer must pay
a consideration. If he failed to settle on time, the
period will be extended by increasing the amount
(principle + interest).
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Riba al-Buyu’
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Mainly based on the saying of the Prophet:
“Gold for gold, silver for silver, wheat for
wheat, barley for barley, dates for dates, and
salt for salt; like for like, hand to hand, in
equal amounts; and any increase is riba’”.
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Cont’d
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These commodities can be classified under two main
categories which make the illah (ratio decidendi) for
their prohibition:
- i- medium of exchange (currency): Gold and Silver
-ii- Staple foods: Wheat, barley, dates and salt
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Any other items, even though not mentioned in the
hadith but serve the same purpose will be considered
as having the same illah by way of qiyas (analogy)
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RIBA IN MODERN
FINANCIAL TRANSACTIONS
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Riba’ al-duyun in loans and certain
controversial contracts (bay’ al-’inah, bay’ aldayn, etc)
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Riba’ al-buyu’ mainly in bay’ al-sarf
(exchange of currencies)
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THE AVOIDANCE
OF GHARAR
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Meaning of gharar:
- Literally: risk, uncertainty, hazard
- The sale of probable item whose
existence or characteristics are not certain,
due to the risky nature which makes the trade
similar to gambling
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EXAMPLES OF THIS KIND OF SALE
IN HADITH
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Sale of fish in the sea, birds in the sky
Sale of unborn calf in its mother’s womb
Sale of runaway animal, slave
 Involve item which may or may not exist
However, the Prophet did not lay down the
principles (qawa’id) for the prohibition of gharar.
Examples given in the hadith were some of the
manifestations of the doctrine, but not principles.
This has led to the dispute among jurists on the area
and coverage of gharar.
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Application of Gharar
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Broadly speaking, gharar will effect the validity of
contract if it occurs in these areas:
- gharar in kind / type / attribute / quantity of the
object
- gharar due to delivery time
- gharar due to the price/ mode of payment
- doubt over the ability to deliver
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The Benchmark
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Gharar is excessive (gharar fahish)
Occurs in exchange contracts (‘uqud al-mu’awadat)
Effects the subject matter of the contract directly, not
just the appendage
No public need (al-hajah al-’ammah) for the contract in
discussion.
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Cont’d
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However, the subjectivity of this benchmark is very
obvious
Demarcation on excessive and trivial gharar
Determining the public need? To what extend
Inevitably, this demarcation will be influenced by
differences in time, societies, individual taste and
preference, technology and the way certain
transaction is conducted as well as regulatory
framework.
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Cont’d
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To prevent gharar, the parties to contract must have
adequate knowledge and information on the subject
matter:
i- Their existence and deliverability
ii- Its quality, quantity and attributes are known
iii- Time –frame for payment and delivery
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Tolerable gharar
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However, gharar is tolerable if:
- i) it is trivial (gharar yasir)
- ii) It occurs in other than exchange contracts,such as in
gratuitous contracts.
-iii) It happens to the ancillary object (appendages) only
(not the principal and main subject matter of contract).
- iv) the economic need for the contract embodying
the risk is substantial
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The avoidance of transactions involving
maysir (gambling)
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Involves the creation of risk for the sake of risk
A combative relationship between two contracting
parties, each of whom undertakes the risk of loss
and the loss of one means gain for the other
Apply to all games of pure chance
No economic activities are gained in the practice.
The gambler will simply seek to amass wealth
without efforts.
Gambling is gharar in its worst scenario.
Prohibited by al-Qur’an in Surah al-Maidah (5:90)
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TRANSACTION INVOLVING
PROHIBITED COMMODITIES
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It is also not allowed to conclude contract on
illegal commodities such as pork, liquor etc.
Illegality of certain commodities has been
spelt out clearly in the texts of al-Qur’an and
Sunnah of the Prophet.
E.g. :
- Surah al-Maidah (5:3)
- Surah al-Maidah (5: 90)
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Essential Contracts in Islamic Finance
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Underlying principles utilised in devising products of IBF is very
important as they separate IBF from conventional products.
Contrary to conventional finance, which is specification driven
product, Islamic finance is more structure and principle based product
Rules and regulations will differ from one product to another,
depending on the structure employed
In general, various underlying Shariah principles have been utilised in
devising products of Islamic Banking and Finance.
They can be summarised as below:
- Sale based products
- Lease based products
- Participatory products
- Fee based products
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Examples of the products and underlying
principles
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Banking products
IIMM products
Capital Market Products
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Islamic Banking
ISLAMIC BANKING
SOURCES OF
FUND
APPLICATIONS
OF FUND
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SOURCES OF FUND
Sources of Fund
Current/ Saving
Account
General/ Special
Investment
Wadi’ah Yad
al-Dhamanah
Mudarabah
NIDC
Bay’ al-Inah
SBBA
Bay’ al-Dayn
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Applications of fund
EQUITY
FINANCING
Mudharabah
Musharakah
DEBT FINANCING
Sale based financing
BBA / Murabahah
‘Inah / dayn
Salam
Istisna
Comsumer
Banking
Lease Based Financing Fee Based Services
-Ijarah
Wakalah
-AITAB
Kafalah
Corporate
Banking
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IIMM
IIMM
MII
GII
BNNN
NIDC
Mudh.
Q. Hasan
al-’Inah
Al-’Inah
IAB
Bay’ al-Dayn
IPDS
Bay’ al-Dayn
Bay’ al-’Inah
Etc.
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ISLAMIC CAPITAL MARKET
ICM
Equity
Market
Bond
Market
Musyarakah
Mudarabah
-Debt Based
-ABS
-Equity Based
Mutual Fund / Islamic
REITs
Wakalah / mudarabah
/ musharakah
Derivatives
Market?
-Future Contract
-Options
-Swap
Islamic
Hedge Fund
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Shariah Differences
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Not all of these products and instruments are
accepted by all jurists.
Some differences arise as to the acceptability
or otherwise of these products and
instruments
But more convergence than divergence
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Examples of main divergence
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Utilisation of disputable contracts, e.g bay’ al-’Inah &
Tawarruq
Underlying Assets and its suitability in becoming SM, e.g.
future asset, deferment of both price and SM, financial right
and its tradaility), ect.
Terms and conditions of contracts, e.g. cross default, liberty to
stipulate terms and conditions
Purpose of Financing, e.g. Valid transaction but to be used for
unislamic purposes
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Reasons for divergence
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Differences of interpretation of the meaning of words
or intent of any particular injunction in the primary
text, either in the Quran or Sunnah: Human
Reasoning
Different need base:
- Legal framework
- Incentive mechanism
- Cultural preference
- Etc.
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How Islamic Law Views Divergence
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Back to basic: Divergence is the nature of
human being. Small or big, principles or
branches, anything that involves human
thinking, understanding and reasoning, the
divergence is inevitable.
Shariah vis-à-vis fiqh: Fixed and flexible
Pluralism has been part and parcel of Islamic
law, since its very initial days.
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Cont’d
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Jurists considered it permissible as long as:
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there is no clear-cut texts (nas qat`i) on the matter
the opinion is arrived at by using acceptable
methodology, such as, by way of analogy (qiyas).
Good or bad: Depends on how it is dealt with
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Should We Have Full Convergence
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Arguably, it is the most desirable one, but
Be realistic
In certain circumstances, divergence might have its
advantages
So, the more realistic approach  standardisation &
harmonisation
Differences in preference should not be standardise,
- e.g. current and savings accounts (wadi’ah or mudarabah)
- Takaful structures: wakalah or mudarabah
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The Needs for Shariah Standard
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Universal trading.
Issue of marketability
Consistency & stability to the product
It will facilitate other enhancement process
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Methods for standardisation/
harmonisation (Domestically /
Internationally
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Regulations and Guidelines (IBA, Guidelines on the
Issuance of Islamic Securities 2004, Islamic REITs
etc.
Circular: Circular on Asset Pricing by SC
Supervision: Central Bank Act 1958 (sec 16B)
Basic Guidelines for main contracts: Guidelines for
the issuance of Islamic Securities 2004
International Standard :AAOIFI Syariah Standard
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Case Study: AAIOFI
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The effort to create the standards has started with the
establishment of Accounting and Auditing Organization for
Islamic Financial Institution (AAOIFI) in Bahrain.
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AAOIFI has produced a number of Shari’ah standards for
Islamic financial institutions covering both products and
services
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Enforceability of these Shari’ah standards :
a)
Bahrain and Sudan
b)
Other jurisdictions
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Cont’d
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Members are representative from various
continents  can become a mechanism to
bridge the disagreement.
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Round-up Discussion on harmonization /
standardization
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Disagreement is inevitable
Approach to harmonise and standardise is more
practical, rather than full convergence
Administrative and regulatory approach
Continuous interaction among Shari’ah Advisors will
help to close gap and standardise understanding
Shariah Advisors: nurturing products which are
globally accepted.
International Shariah Advisory Council?
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Conclusion
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Besides various frameworks applied to banking practices
(be it Islamic or conventional), Shariah framework is a
framework which is peculiar to Islamic finance alone
Yet, it forms the very substance of Islamic finance, without
which Islamic finance will loss its Islamicity
As such, in practicing Islamic finance, the do’s and don’ts
must be clearly observed
Islamic commercial law, from the fact that it subjects to
human interpretation and understanding admits differences
of opinion, as long as these differences are grounded by
valid evidence, produced by capable personnel, done
according to the right methodology
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Cont’d
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Full convergence in all aspects might be too
idealistic
More practical is to have standardisation and
harmonisation of opinions
More efforts are needed in this aspect
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THANK YOU
WASSALAM
[email protected]
03-61964201
012-2121536
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