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Journal of Islamic Banking and Finance Oct.- Dec. 2013 1

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In The Name of Allah, The most Beneficent, The most Merciful

“O Believers: devour not Riba, doubled and redoubled;

and fear Allah, in the hope that you may get prosperity.”

Sura Ale-Imran (verse No. 130)

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The articles published in this Journal contain references from the sacred verses of Holy Qur’an and Traditions of the prophet

(p.b.u.h) printed for the understanding and the benefit of our readers. Please maintain their due sanctity and ensure that the pages on which these are printed should be disposed of in the

proper Islamic manner

4 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Journal of Islamic Banking and Finance

Volume 30 Oct – December 2013 No. 4 Founding Chairman Muazzam Ali (Late) Former –Vice Chairman Dar Al-Maal Al-Islami Trust, Geneva, Switzerland

Board of Editorial Advisors

Ahmed Ali Siddiqui Mufti Bilal Qazi S. A. Q. Haqqani Dr. Hasan uz Zaman Dr. Mohammad Uzair Altaf Noor Ali (ACA)

Chairman Basheer Ahmed Chowdry

Editor Aftab Ahmad Siddiqi

Co-ordinator Research & Marketing Mohammad Farhan Business Executive A. N. Haqqani Published by International Association of Islamic Banks Karachi, Pakistan. Ph: 35837315 Fax: 35837315 Email: ia _ ib @ yahoo.com Follow us on Facebook: http://www.facebook.com/JIBFK

http://external.worldbankimflib.org/uhtbin/cgisirsi/x/0/0/5/?searchdata1=37177{ckey}

Registration No. 0154 Printed at M/S Maaz Prints, Karachi

International Advisory Panel

Professor Dr. Mohd. Ma’sum Billah Vice – Chancellor of UCTECH, Malaysia

Professor Dr. Rodney Wilson School of Government and International Affairs, Durham University, UK

Dr, R. Ibrahim Adebayo Department of Religions, University of Ilorin, Nigeria Dr. Huud Shittu Department of Religion and Philosophy, faculty of Art University of Jos – Plateau State, Nigeria Prof. Dr. Zubair Hasan The Global University of Islamic Finance, Kuala Lumpur, Malaysia Dr. Waheed Akhtar Assistant Professor, Comsats Institute of Information Technology (CIIT), Lahore, Pakistan Dr. Manzoor Ahmed Al-Azhari, PhD Legal Policy (Shariah Law) Chair, Department of Islamic Studies, Institute of Religious Education & Research, (IRER) HITEC University Taxila Cantt, Pakistan.

Professor Dr. Khawaja Amjad Saeed FCA, FCMA Hailey College of Banking & Finance University of Punjab, Lahore, Pakistan Dr. Mehboob ul Hassan Professor, Department of Business Administration Sindh Madarsatul Islam University, Karachi, Pakistan Mr. Salman Ahmed Sheikh External Reviewer Bankers Academy USA, Research Associate & Faculty Member IBA Karachi and also Heads of Islamic Economics Project

Prof/ Dr. Habib ur Rahman Head Business Administration Deptt Sarhad University of Science & Information Technology, Peshawar, Pakistan

Dr Muhammad Zubair Usmani Jamia Daraluloom Karachi

Journal of Islamic Banking and Finance Oct.- Dec. 2013 5

Journal of Islamic Banking and Finance

Volume 30 Oct – December 2013 No. 4

C O N T E N T S 1. Editor’s Note ..........................................................................................................05 2. Risk Tolerance and Intertemporal Consumption in Islamic Finance ..............09

By Salman Ahmed Shaikh

3. PEST & SWOT Analysis of Islamic Banking in Pakistan.................................17 By Qaiser Imtiaz & Mohammad Shahid

4. KSE Meezan Index (KMI-30) – Stellar Performance........................................28

5. Examining the Prudence of Islamic Bank: A Risk Management Perspective .........................................................................32 By Dr. Mohammad Imran Ashraf Usmani

6. Now Brewing: Islamic Finance and Takaful in China ......................................39

By Jeffery Kirk

7. Credit Card in Islamic Perspective .....................................................................43 By Dr. Manzoor Ahmed Al-Azhari

8. Adoption of AAOIFI Shariah Standards: Case of Pakistan .............................63 Sharika (Musharaka) and Modern Corporation

9. An Inquiry into the Islamic Cooperative Societies in Ilorin Vis-à-vis Their Utilization of Islamic Financial Products.......................71

By Sikirullahi Bukhari 10. Lexical Analysis of Islamic Banking & Terminologies......................................82 By Shafiq ur Rahman

11. Country Model:

Kingdom of Saudi Arabia .....................................................................................88

12. News Monitor .......................................................................................................90 

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Journal of Islamic Banking and Finance Oct.- Dec. 2013 7

Editor’s Note

Islamic finance industry has come a long way to be recognized as a viable alternative to conventional banking. Islamic financial institutions are currently offering a wide range of services catering both to Muslim and non-Muslim communities. Introduction of Sukuk and Islamic stock market indices have also added the necessary breadth to Islamic financial market. Sukuk has proved to be a powerful tool in attracting investors and building confidence in Islamic finance.

Islamic banking has established its identity in challenging times. Global Islamic finance has now witnessed significant progress and world wide acceptance, growing more than 30% annually. Many developed non-Muslim countries are recognizing the Islamic financial system as a viable and even desirable alternative financial system. It is reported that Islamic finance worldwide now has a network of 430 Islamic banking and financial institutions managing assets of approximately more than US $1.3 trillion present in over 75 countries, including Australia, France, UK, USA, Hong Kong, Singapore, Luxemburg, China, South Africa, Sri Lanka and Malaysia. The World Bank intends to open its first Global Islamic Finance Development Center on Islamic banking at Borsa* Istanbul, Turkey. The CEO Borsa, Dr. Ibrahim M. Turhan, has stated that Istanbul has become more popular in recent month as a Center of Islamic Finance especially in Islamic instruments.

David Cameron, Prime Minister of U.K. recently made a bid to position London as a leading hub for Islamic finance announcing plans to issues a sovereign Sukuk or Islamic bond worth approximately GBP 200 Million ($323 M). According to Ernest and Young - consultants, the global Islamic banking industry is expected to tip $ 1.8 trillion by the end of this year. The UK, well ahead of most western countries, is promoting Islamic finance. The sector is facing the challenge of severe human resource shortage, especially experienced middle and senior management. This would however require commitment from policy maker as well as bank’s managements and significant investment in development and training of human resources in Islamic finance.

The State Bank of Pakistan has played a leading role in the promotion and development of Islamic banking in the country. The SBP has provided a comprehensive legal, regulatory and supervisory framework, mobilized the industry to launch nationwide mass media campaign to create awareness and address the perception issues and now Islamic banks hold over 10 percent of the country’s banking system with an assets base of above Rs. 900 billion and a network of more than 1,100 branches. This expansionary trend is likely to continue and the industry is well set and expected to double its market share by 2020.

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This significant successful trajectory has been possible only because of the positive steps taken by the State Bank of Pakistan, in setting the direction of the industry, providing support for its promotion, development and promoting Islamic finance as a viable and competitive component of the financial system.

It is hoped that the SBP and central banks of other countries shall continue to support the Islamic Financial institutions and the banks themselves invest in developing both usable products and human resources to sustain the Islamic banking industry.

This issue of Journal of Islamic Banking & Finance documents scholarly contributions from authors around the globe. Scholarly contributions in this current issue discuss the theoretical underpinnings of an Islamic economy, contemporary issues in Islamic finance and performance based empirical studies on Islamic banking and finance. Below, we introduce the research contributions with their key findings that are selected for inclusion in this issue.

The first paper on “Risk Tolerance and Inter-temporal Consumption in Islamic Finance”, written by Salman Ahmed Shaikh presents how consumption smoothening is achieved and supported in an Islamic economy through a set of institutions and behavioral norms, given that the consumers want to spend resources fairly equally though their lifetimes. Moreover, he talks of Islamic financial instrument available depending upon the risk appetite of the investor.

The second article is on “PEST & SWOT Analyses of Islamic Banking in Pakistan” jointly written by Qaiser Imtiaz and Mohammad Shahid. This paper explores the PEST & SWOT factors of Islamic Banking in Pakistan. The research looks at how efficiently Islamic banks conduct marketing and operational practices given the conditions in Pakistan. The analysis would strengthen the knowledge related to Islamic banking. It is recommended that Islamic banking system evaluate the professional competence of employees and expand the network at par with conventional banks and their marketing strategy not only in Pakistan but also build Islamic branches abroad.

This issue also includes the “Meezan KMI 30 index-Stellar Performance”, the basis and logic of its calculation and how it has been out-performing the conventional stock market indices.

The fourth paper is on “Examining the Prudence of Islamic Banks: A Risk Management Perspective” written by Dr. Muhammad Imran Ashraf Usmani. This is a synopsis of all the permissible and impermissible acts in the economic fields as enumerated by Islamic Shariah which are based on the commandments of Allah in the Holy Book and the Sayings of the Prophet (p.b.u.h) as well as Ijma and Ijtihad. Ijma is the concurrence of Muslims on the solution of an issue and Ijtihad is the inductive derivation of result in respect of an issue from these sources. The instructions cover the whole gamut of the economic activities and the problems that are encountered in its working.

Islam not only lays down rules for religious observance but it covers every aspect of life including economic activities, ethics and even one’s responsibilities to fellow beings. In economic life Riba and Gharar have been banned and indulgence in these practices have been ruled against, as it is these malpractices which lead to frequent

Journal of Islamic Banking and Finance Oct.- Dec. 2013 9

visitation of recession and other calamities in conventional financial system but Islamic financial system has withstood such storms with great resilience owing to the efficacy of this system and its avoidance of the pitfalls with which conventional financial road is interspersed.

Following the fourth article, the next article is “Now Brewing: Islamic Finance and Takaful in China”, by Jeffery Kirk who writes about the desire of Hong Kong’s Monetary Authority to capitalize on the popularity that Islamic financial instruments are gaining in Asian markets and discusses the potential role that Islamic Financial Products can play in the continuously growing economy of China and the latent demand of Shariah compliant financial products such as sukuks and takaful in a country with a sizable Muslim population. He also speaks of how Hong Kong, as the financial gateway to China is gearing itself up to this demand.

This sixth article is on “Credit Cards in Islamic Legal Perspective” by Dr. Manzoor Ahmed Al-Azhari. He has given a brief history of credit cards and legal opinions of Muslim jurists from eminent Islamic institutions like Al-Azhar University etc. who have considered the question in great detail and examined it from different angles. He says that cards agreement does not fit with a living legal contact but it appears to be a new compound contract with permanent personality of every one of them (component contracts) provided that there is no illegal condition in any one of those contracts.

Moving ahead, the seventh paper is on “Adoption of AAOIFI Shariah Standards: Case of Pakistan”. AAOIFI is one of globally recognized international bodies that prepare Shariah based accounting, auditing, governance, ethics and Shariah Standards for the Islamic financial industry. AAOIFI based standards are generally considered to be globally acceptance and are adopted in various jurisdictions of the world.

The eight article is on “An inquiry into the Islamic Cooperative Societies in Ilorin vis-à-vis their utilization of Islamic Financial Products” by Sikirullahi Bukhari. In his paper he writes on developments in Nigeria by looking at the role that Islamic cooperative societies can play in introducing Islamic finance products to Nigerian muslims.

The ninth article is on “Lexical Analysis of Islamic Banking Terminologies” by Shafiq ur Rahman. The author has traced the root of the Arabic terms being used in Islamic banking terminology and given their different meanings. This will help the readers of material on Islamic banking to understand the subject better.

The last article “Country Model: Kingdom of Saudi Arabia”, is taken from the SBP’s Islamic Banking Bulletin, April – June 2013 and touches upon the Islamic banking model in the Kingdom of Saudi Arabia and how it is impacting on the country’s Capital and Takaful markets.

At the end of this issue are summarized the significant “Islamic Banking News Monitor”- items that show not only the development but also the impact that proponents of Islamic banking and finance are making in their respective markets.

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Editor * The Borsa Istanbul (abbreviated as BIST) is the sole exchange entity of Turkey

combining the former Istanbul Stock Exchange (ISE) (Turkish: İstanbul Menkul Kıymetler Borsası, IMKB), the Istanbul Gold Exchange (Turkish: İstanbul Altın Borsası, İAB) and the Derivatives Exchange of Turkey (Turkish: Vadeli İşlem Opsiyon Borsası, VOB) under one umbrella. It was established as an incorporated company on April 3, 2013, and began to operate on April 5, 2013.

Disclaimer

The authors themselves are responsible for the views and opinions expressed in their articles published in this Journal.

The opinions, suggestions from our worthy readers are welcome, may be communicated on e-mail: [email protected] / facebook link: http://www.facebook.com/JIBFK

Journal of Islamic Banking and Finance Oct.- Dec. 2013 11

Risk Tolerance and Intertemporal Consumption in Islamic Finance

By Salman Ahmed Shaikh1

Abstract It is empirically established that consumers by and large prefer consumption smoothening over their lifetimes. Consumption smoothening is achieved through optimal intertemporal consumption choices. The microeconomic foundation is based on optimal choice of consumption levels in each time period so that marginal utilities across different time periods are all equal. A related issue in intertemporal consumption is the tolerance for risk. It is also empirically established that consumers often are risk averse. In this paper, we discuss that intertemporal consumption is achievable with different levels of risk preferences. We also discuss the alternative for insurance in Islamic finance. Finally, we provide brief explanation of investment alternatives for intertemporal consumption. Our empirical data support that these instruments or asset classes for intertemporal consumption are effective means of earning enough asset income to achieve the consumption smoothening motive.

Keywords Risk, Risk Aversion, Consumption, Intertemporal Consumption, Insurance, Consumption Smoothening

JEL Code G11, G21, G22

1. Consumption Smoothening It is an empirical observation that people desire to have smooth consumption

through their lifetimes. Lifecycle income hypothesis by Modigilani & Brumberg (1954) and permanent income hypothesis by Friedman (1957) try to explain this. Both negate the Keynes (1936) assertion that average propensity to consume (APC) falls as income rises. Microeconomic evidence is also consistent with lifecycle income hypothesis in various empirical studies in literature.

1 Author is Research Associate and Faculty Member at IBA, Karachi. He is pursuing PhD in

Economics from IBA, Karachi. He can be contacted at: [email protected]

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In this section, we try to explain how consumption smoothing is achieved and supported in an Islamic economy through a set of institutions and behavioral norms given that people want to spend their resources fairly equally through their lifetimes.

• Prohibition of Scrupulous Consumption

• Fixed Proportional Taxation

• Automatic Stabilizers

• Inheritance Distribution

• Private Transfer Payments: Infaq and Waqf

• Circulation of Wealth

1.1 Prohibition of Scrupulous Consumption Islam discourages lavish consumption, i.e. Israaf (extravagance even in lawful

things) and Tabzeer (consumption in unlawful things like liquor, free sex etc). Islam encourages modesty and balance and hence, with rise in income, consumption will not rise proportionally and hence, average propensity to consume for ‘self’ will reduce. However, this may not reduce APC as with increase in income, Islam encourages spending on society with directives for Infaq.

1.2 Fixed Proportional Taxation Proportional Zakat linked with income acts as an automatic stabilizer. When

aggregate personal disposable income increases, more Zakat is collected and more amount remains at the disposal of government to allocate as transfer payments to Fuqura (poor and needy), Masakeen (extremely poor and needy) and Gharimeen (borrowers in trouble). When personal disposable income decreases, obligatory Zakat also decreases and thereby providing an automatic relief to the income earner who is going through a lean patch. Moreover, fixed proportional income tax will reinforce ricardian equivalence.

1.3 Automatic Stabilizers When the personal disposable incomes decline in recessions, more people will

become eligible for Zakat. Since Zakat is levied on both income and wealth, the redistribution of wealth will always be functional and operative in an Islamic economy due to wealth based Zakat irrespective of the phase of business cycle. Transfer payments to unemployed, poor, needy, debtors etc will continue when the economy faces a recession.

1.4 Inheritance Distribution Family system of Islam brings social capital into existence. It ensures empathy and

responsibility. It brings a very lasting and durable social safety net. Islamic injunctions about how to treat orphans ensure social security for individuals with special circumstances. Furthermore, the inheritance laws ensure that the wealth of the deceased is distributed widely among the members of the family of the deceased and this permanently and systematically ensures doing away with the concentration of wealth in every generation.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 13

1.5 Private Transfer Payments: Infaq and Waqf Private transfer payments in the form of ‘Infaaq’ and through the institution of

‘Waqf’ ensure that people have enough income for their autonomous consumption even if markets are not ready to generate incomes for them during some periods.

1.6 Circulation of Wealth With prohibition of interest, the surplus wealth can only be protected against

inflation by investing in productive enterprise. That will raise income and purchasing power in the process. In essence, Say’s law of markets could prevail in an economy in which supply is increased through the use of scarce economic resources with intrinsic value. These resources or factors will receive compensation out of production process. When supply is created with excessive leveraging, it may not create enough demand and hence result in business cycle fluctuations (unplanned increase in inventory) and recessions.

2. Risk Aversion and Islamic Financial Economics Risk aversion is an observed behavior and there is empirical evidence that people

generally are risk averse. By risk averse, we mean to say that people are willing to pay a higher risk premia than what is necessary to compensate for undertaking given risk level. In other words, people demand higher expected return for the risk taken than they actually should based on expected value of outcome in terms of wealth.

The question arises that if people are generally risk averse, are interest based investments and lending not the safest option to these people in which except for default risk, people are safe from fluctuations and there is less uncertainty in payoffs.

It needs to be emphasized that unlike in mainstream economics, Islamic economics is not just about description of behavior in a passive way. Islam has a comprehensive plan, a prescription, which has in past and can now still help in bringing equitable distribution of resources and socio-economic justice without sacrificing economic growth. Indeed, with a broad worldview that Islam has and the concept of afterlife accountability and provision of absolute justice, we can achieve the desired change in behavior even where markets and independent choices of people cannot solve the externalities and unethical but un-coded and unregulated behavior in grey areas.

Having said that, if we now take up the evidence which favors risk aversion, we can analyze risk aversion as an admissible behavior in Islam and also study how Islamic economic system will incorporate such diversity in risk preferences. Finally, we want to discuss that how do these risk preferences and the equity based financial intermediation that Islam encourages coexist and the impact of this on the market competitiveness, financial intermediation, market efficiency and distribution of resources.

First, there is no compulsion in Islam that people have to be entrepreneurs. People who want to take lesser risk can gain skills and then provide the use of their skills in labor market for wage. People who want to have regular stream of income can invest in physical assets or financial securities that are derivatives of these physical assets and have intrinsic value like gold, silver, other metals, real estate etc. Furthermore, real estate investment trust, energy funds, commodity funds, equity funds etc are useful means of

14 Journal of Islamic Banking and Finance Oct.- Dec. 2013

indirect investments using an intermediary. Part ownership in an enterprise with limited liability is also allowed in Islam and hence, the risk is minimized in such investments as compared to having unlimited liability in proprietorship and partnership.

As we know that Islam does not allow interest based financial intermediation. The likely basis of financial intermediation will be based on equity participation in an Islamic economy. Equity based financial intermediation increases participation in upside business growth. Additionally, the real ex post returns to equity investments had been more than the returns from investments in fixed income securities. Appropriate portfolio management and diversification and exposure to risk based on one’s risk tolerance is rational and allowed in Islam.

As against equity based intermediation, interest based financing and investments create distributional inequity by providing fixed compensation to one party while the payoffs to the other party are uncertain. This way the risk is avoided by one party (the lender), but it is not neutralized in the economy. Someone has to take entrepreneurial risk. What Islamic principles do is that rather than concentrating this risk taking with one party in the economy, Islam encourages widespread risk taking through participation. This way the distributional justice is ensured as the payoffs are linked with productive enterprise and are shared mutually in a just manner.

On the fiscal front, the system of Zakat shall provide impetus to investment so as to avoid erosion of wealth. Since investment can only be in productive enterprise directly or indirectly through an intermediary, there is expected to be increased investment. This will make markets more competitive. Finally, socio-economic justice in the way risk and return are distributed will also help in stabilizing business cycles.

Hence, the often repeated neoclassical policy proposals of having fixed and passive macroeconomic policies and letting the market work on its own can be entertained and achieved, but where, Islamic economic system is importantly and fundamentally different from mainstream economics is in the role of institutions and principles which govern policy and under whose influence, the economic system works and economic agents act.

3. Risk Aversion and Insurance In conventional insurance, element of interest and gambling makes it unacceptable

under Islamic principles. The premiums paid to the insurance company by the people are invested in interest based financial instruments and from those funds, compensation is provided to the insured in case of contingencies. The contingent nature of consideration to the insured brings the element of gambling and uncertainty as well.

In recent years, Muslim scholars have proposed an alternate system of insurance which is known as “Takaful” system. But, in that, the shareholders establish the Takaful Company for the purpose of profit. Seeking profit from the business of guaranteeing risk against certain events is not ideal.

Muslim scholars have also unanimously favored equity based financial intermediation over debt based financial intermediation. But, it is to be noted that when debt based financial intermediation would no longer remain a predominant feature of financial system, then, both the conventional insurance and “Takaful” would not have risk free fixed contractual cash inflows to depend on.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 15

Fostering an economy which predominantly uses equity based financial intermediation; an alternate system of insurance is recommended which would not depend on debt based financial intermediation.

The alternative is as follows:

People can insure themselves against contingencies on their own by investing in mutual funds, pension funds, REITs, equity markets etc. The insurance needs of salaried individuals can be catered by the employers themselves by establishing the mutual insurance system on their own.

Regarding commercial insurance, it needs to be kept in mind that not all risks are insurable. In fact, the risks generally insured by the commercial enterprises against accidents, fire, destruction etc are remote risks than the frequently occurring business risks which are uninsurable i.e. loss of customer’s confidence, increased competition, regulation, decreased sales etc.

Furthermore, in equity based financial intermediation, losses will be mutually borne rather than creditors getting fixed stipulated interest at the cost of only shareholders suffering from business cycle downturns.

Furthermore, ‘Gharimeen’ is a head of Zakat. The Zakat funds allocated for distribution in this head can be used to pay the debts and accidental losses of the commercial enterprises.

Proportional Zakat linked with income would act as an automatic stabilizer in an Islamic economy. Besides, the proportional income levy, Zakat on wealth redistributes stock of wealth too in the economy. Zakat enables the distributive allocation that works independently of business cycles and help stabilize the extremes of the business cycles

4. Non-Banking Alternatives for Investments in Islamic Finance In Pakistan, banking spreads are one of the highest in the world. In Pakistan’s

economy, the policy rate set by the central bank was as high as 14 percent not long ago which has now seen a downward movement only lately. Tight monetary policy was ineffectively used to tame rising inflation which has remained in double digits since last few years. Such high banking spreads and high inflation make banking investments less lucrative.

Indeed, if we look at average yield on term deposits of even longer maturities, the real rate of return comes out to be negative amidst high inflation rate and low rate offered on deposits by banks in Pakistan.

In this section, we list and discuss alternate investment options to individuals/institutions beyond the traditional remunerative schemes offered by Islamic banks.

4.1 Investments in Stocks Individuals as well as corporate finance managers of financial and non-financial

institutions can make equity investments in common stock of different companies to diversify risk and stabilize portfolio returns.

16 Journal of Islamic Banking and Finance Oct.- Dec. 2013

The Karachi Meezan Index (KMI-30) has gained top slot in the world indices by posting 107.4 percent dollar-based returns in 2009. The KMI-30 which is the only Shariah Compliant Index in Pakistan secured the top position by outperforming all the international stock markets’ indices in 2009 followed by DJIMPK with 92.2 percent dollar-based returns and Bovespa Brazil with 82.7 percent. This goes on to show that better returns could be achieved by investing in Stocks which comply with principles laid down by Islamic scholars.

In table 2, we present descriptive statistics of equity yields in different sectors. It can be seen that average yield has remained in double digits in all sectors for the 1973-2010 period. There is variance, but that is where, financial intermediation becomes significant. With effective portfolio diversification, unsystematic risk could be mitigated. The portfolio could be managed by Islamic financial institutions providing equity finance to firms in these sectors.

Descriptive Statistics Textile Fuel &

Power

Construction &

Engineering

Transport & Communication

Paper & Board Chemicals Sugar

Minimum 1.16 3.98 0.67 0.00 2.19 6.53 1.38 Maximum 50.91 44.68 45.61 60.90 43.97 35.84 52.36

Range 49.75 40.70 44.94 60.90 41.78 29.31 50.98 Average 12.04 21.89 14.74 19.18 15.57 17.63 18.51

Var 151 122 102 225 91 43 146 Standard Deviation 12 11 10 15 10 7 12

4.2 Islamic Mutual Funds Mutual Funds also offer a very good investment option to people who are not well

versed in managing portfolios due to shortage of expertise or time required to do research in selecting the best stocks for the portfolio. Such people can invest in diverse categories of mutual funds. Islamic funds now come in the categories of Income Funds, Cash Funds, Sovereign Funds, Equity Funds, Balanced Funds, and Capital Protected Funds etc.

Islamic mutual fund industry has also enjoyed success in attracting investment funds from Muslim investors and also from non-Muslim investors due to their impressive performance. In a study conducted in Malaysia, Abdullah et al (2007) concluded that Islamic funds performed better than the conventional funds during bearish economic trends. Elfakhani (2005) also noted that Islamic mutual funds might be a good hedging investment for equity investors, if used to hedge against market downturns and recessions.

Islamic mutual fund industry has grown by leaps and bounds globally and in Pakistan as well. Mahmud (2011) analyzing the performance of fund types acknowledged that Islamic funds have shown strong growth. Razzaq et al. (2012) investigated 9 Islamic mutual funds in Pakistan and concluded that returns of these funds were according to their levels of risk.

Currently in Pakistan, there are 15 AMCs (Asset Management Companies) managing Islamic mutual funds. There are 29 open ended funds that are Islamic in the open ended funds category. There are 18 voluntary pension funds and 1 closed ended fund.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 17

In Table 2, we present average annualized return of Islamic and non-Islamic open ended mutual funds in various categories during the last 365 days computed on July 12, 2012.

Table 2: Annualized Return for last 365 Days (%)

Fund Category Return on Islamic Funds (%)

Return on Non-Islamic Funds (%)

Aggressive Fixed Income 10.94 7.01 Asset Allocation 9.76 8.48 Balanced Funds 18.00 11.59 Capital Protected Funds 14.64 5.68 Equity Funds 24.67 17.67 Income Funds 10.44 9.32 Money Market Funds 10.47 11.25 Average Return 14.13 10.14

Source: MUFAP It can be seen that apart from money market funds category, Islamic mutual funds

have had higher returns than conventional mutual funds.

In Table 3, we present average annualized return of Islamic and non-Islamic voluntary pension funds in various categories during the last 365 days computed on July 12, 2012.

Table 3: Annualized Return for last 365 Days (%)

Fund Category Return on Islamic Funds (%)

Return on Non-Islamic Funds (%)

Debt Funds 8.86 10.67 Equity Funds 24.10 19.54 Money Market Funds 9.45 10.37

Source: MUFAP It can be seen that equity funds in Islamic voluntary pension schemes have

performed better than their counterparts. But, in debt and money market category, Islamic voluntary pension funds fall behind conventional funds marginally.

4.3 Investments in Sovereign Sukuk Corporate finance managers and treasuries of financial and non-financial

institutions can invest in Sukuk which are issued by statutory bodies for project finance and development finance. In Pakistan, Government of Pakistan (GoP) had issued several Ijarah Sukuk and its public sector units like National Highway Authority and WAPDA has also issued Sukuk in past. Such instruments provide consistent long term returns and are fully backed by assets at all times during the life of the Sukuk and hence have relatively lesser risk.

18 Journal of Islamic Banking and Finance Oct.- Dec. 2013

4.4 Investments in Corporate Sukuk Corporate finance managers and treasuries of financial and non-financial

institutions can invest in Corporate Sukuk which are issued by corporations for project finance and for the finance of fixed tangible assets using Ijarah, Istisna and Diminishing Musharakah as an underlying mode of financing.

In this regard, one suggestion that can be put forward here is that the service payments on these bonds could be made tax deductible. Tax deductible feature would benefit issuer and the regular stream of income would benefit investors to invest in blue chip companies.

4.5 Investments in Venture Capital Funds Islamic principles favor entrepreneurship and productive economic pursuits

immensely. High Net Worth Individuals (HNWIs) and Corporate finance managers of financial and non-financial institutions can make equity investments in Venture Capital (VC) funds or providing seed/bridge financing as an angel investor if their Free Cash Flow (FCF) permits to diversify risk and income stream.

Conclusions In this paper, we discussed that intertemporal consumption is achievable with

different levels of risk preferences in an Islamic economy. We also discussed the alternative for insurance in an Islamic economy for risk averse individuals and firms. Finally, we provided brief explanation of investment alternatives for intertemporal consumption with empirical data. Our empirical data support that these instruments or asset classes for intertemporal consumption are effective means of earning enough asset income to achieve the intertemporal consumption.

References Friedman, Milton (1957). “A Theory of the Consumption Function”, Princeton University

Press. Keynes, John M. (1936), “The general theory of Employment, Interest and Money”, London:

Macmillan. Modigliani, Franco, and Richard H. Brumberg (1954), “Utility analysis and the consumption

function: an interpretation of cross-section data,” in Kenneth K. Kurihara, ed., Post Keynesian Economics, New Brunswick, NJ. Rutgers University Press, pp. 388–436.

Abdullah, Fikriyah (2007). ‘Investigation of performance of Malaysian Islamic unit trust funds: Comparison with conventional unit trust funds’. Managerial Finance. Vol. 33 (2), pp. 142-153.

Elfakhani, Said & Hassan, Kabir (2005), ‘Performance of Islamic Mutual Funds’. Economic Research Forum. Global Development Network.

Mahmud, Mahreen & Mirza, Nawazish (2011). ‘An Evaluation of Mutual Fund Performance in an Emerging Economy: The Case of Pakistan’. Lahore School of Economics. Vol. 16 (SE), pp. 301-316.

MUFAP (2012). Performance Summary of Mutual Funds. Available at: www.mufap.com.pk (Accessed on July 12, 2012).

Razzaq, N., Gul, S., Sajid, M., Mughal S. & Asma B. (2012). ‘Performance of Islamic Mutual Funds in Pakistan’. Economics and Finance Review. Vol. 2 (2), pp. 16 – 25.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 19

PEST & SWOT Analysis of Islamic Banking in Pakistan

By Qaiser Imtiaz & Mohammad Shahid*

Abstract The research was conducted on Islamic banks to see how they utilise marketing and operational practices in very efficient way despite the crucial condition of Pakistan. The analysis would strengthen the knowledge related to Islamic banking. It is recommended that Islamic banking system evaluate the professional competence of employees and expand the network at par with conventional banks and thier marketing strategy not only in Pakistan but also build the Islamic branches abroad.

Key words: PEST, SWOT, Analysis, Islamic Banks

Introduction Before the influx of modern banking form, there was a system of direct finance

where the owner of capital dealt directly with the user of capital. So the savers were dealing with the investors directly. With the passage of time, there was observed a rapid growth in trade and manufacturing industries that led to an increased demand in their financial requirements. Direct financing seemed to be unable to fulfill the financial requirements of the investors at this stage and banks came into existence to facilitate financial transactions between savers and investors. Now banks are dealing in various transactions like receiving, collecting, transferring, paying, lending, investing and many more in order to facilitate and achieve excellence in their consumer’s insights. (Woelfel & Charles 1993)

Islamic banking and Pakistan The need to provide comprehensive comparative review of the literature on the

Islamic banking sector in Pakistan, to discuss basic features of Islamic finance and banking, there is a need to introduce Islamic financial instruments in order to compare such to existing Western financial instruments and discuss the legal problems that

* Authors: Qaiser Imtiaz, M.Phil, & Mohammad Shahid, M.Phil are Research Scholars,

associated with Hamdard Institute of Education and Social Sciences, Hamdard University, Karachi Pakistan.

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investors in Pakistan can encounter. Indeed, there is importance of having an empirical assessment of performance of Islamic banking in Pakistan which will highlight regulations, challenges and problems in the Islamic banking market. Thus, the main objectives is to review the growth of Islamic banking on global basis, assess its performance based on latest financial data available, discuss its salient products/services, evaluate for departures from traditional Islamic principles, to offer suggestions for improvement based on the experience of the authors and evidence provided by literature studies in research area. Furthermore, the need to integrate several performance of Islamic banking in Pakistan

There has been large scale growth in Islamic banking in Muslim countries and around the world during the last twenty years as the performance growth is influenced by factors including the introduction of broad macroeconomic and structural reforms in financial systems, the liberalization of capital movements, privatization, the global integration of financial markets, and the introduction of innovative and new Islamic products. Islamic finance is now reaching new levels of sophistication. However, present Islamic financial system with its identifiable instruments and markets are still very much at an early stage of evolution. Many problems and challenges relating to Islamic instruments, financial markets, and regulations must be addressed and resolved. In Islamic banking, rules apply which differ from those in traditional banking in thier consequences of financial operations.

Considering the drastic change in procedures since 1985, the effect of Islamisation on the banking sector performance has been moderate. One reason for the reality is that banks in Pakistan have consistently opted for financial instruments closely resembling interest based finance, …… determined within large extent by the fact that the banking sectors is owned by the state of Pakistan (Cornelisse and Steffelaar, 2008).

Before the birth of Pakistan, which is an Islamic country, Muslims of the subcontinent were not fully allowed to participate in the banking sector. There was only a small Australasia bank at that time with only few branches mainly in Lahore. Then in 1941, HABIB bank came into being that was run by the Muslims of the subcontinent. At that time, Quaid-e-Azam (The founder of Pakistan) also gave the idea of a Muslim Commercial bank.

Before Independence, all the financial system was mainly of British origin. In the early stages of Pakistan, government really worked hard to strengthen the banking system in Pakistan. And State Bank of Pakistan came into being in 1948. Then National Bank of Pakistan came into being in 1950 and it was another milestone in the history of banking system in Pakistan. Currently the Islamic Banking Industry in Pakistan consists of five full-fledged Islamic Banks. viz: Meezan Bank Limited, Al Baraka Bank (Pakistan) Limited, Dubai Islamic Bank Pakistan Limited, Burj Bank Limited and BankIslami Pakistan Limited comprising 730 branches including Sub Branches of Islamic Banks and 367 Islamic Branches of Conventional Banks. Their cumulative deposit portfolio is Rs. 706.5 billion. (SBP, Islamic Banking Bulletin, December, 2012). Islamic banks are trying to fulfill Shariah based needs of their customers with innovative products and services to market competition requirements. According to SBP Islamic Banking Bulletin Islamic banking assets internationally raised upto US$ 1.3 trillion in 2011, signifying an average annual enhanced of 19% over past four years (24% in 2011).

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Islamic Banking and Principle of Financing Interest is forbidden in Islam. Thus, the basic difference between Islamic banks

and conventional banks is that Islamic banks offer interest-free banking, while conventional banks offer (Kahf, 2006). Although, interest and profit are very clear concepts, but misunderstood. The difference between the two os based on the basic interests of the reward money and profit return on capital investment. In other words, money, interest and capital investments generate profits (Toutounchian, 2004).

Islamic finance has gripped the world with a strong commitment and passion. It has been depicted that interest in this segment has grown rapidly in almost 60 countries, not only in Islamic countries but in the leading global financial centers. Even United Kingdom has adopted an open door policy and provided a level playing field to Islamic finance and now Singapore is following its lead.

Islamic banks are trying to fulfill the requirements of their customers by offering innovative products and services so as to compete the market. There are five basic Islamic financing contracts.

Murabaha: (Cost plus) A Murabaha (profit-making sales) transaction is essentially cost-plus financing

transactions, Islamic bank purchases tangible assets on the request of customer to buy from suppliers. Islamic banking assets are sold to customers with the bank's profit on deferred sales. The transaction is done on a cost plus profit basis i.e. the seller unveil the cost to the buyer and adds a definite profit to it to arrive at the final selling price. The Murabaha (profit-making sales) transactions provide sufficient flexibility in real estate project financing.

Ijara and Ijara wa-Iqtina: (leasing and lease purchase) Ijara and Ijara wa-iqtina are alike to western operating and finance leases. Ijara is

similar to conventional operating lease, where in an Islamic bank (lessor) leases the asset to the client (lessee) for standard lease payments for a specified period of time, but with no option of ownership for the lessee. The maintenance and insurance is the liability of the lessor. In other word a leasing contract where the owner of an asset transfers its use to another person against an agreed consideration. On the other hand, in ijara wa iqtina, lessee has the choice of due the asset at the termination of the lease. In both types of leasing, the lease payments must be granted in advance to avoid any speculation.

Modaraba Zubair (2002) stated that it is a kind of partnership, which has two parties like any

other business, but here the investor and the working party is separated. One party is the investor who provides the fund for the business while the other party works for carrying out the business. The party which provides investment is known as Rabb-ul-Mal while, the working party that has done all the setup and runs the management with their management skills is known as Modarib. This concept is very old and is considered to be initiated almost fourteen hundred years back in Islam. However, in modern era it was introduced and practiced in 1980 where one party participated with the funds while other gave the hard work through skills. However, the establishment of Modaraba was not easy

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and took years to prosper due to the issue with the knowing of the concept properly and moreover investors found it hard to follow something unusual. With the passage of time Modaraba started to increase and by 1991, it has reached 20 in the number.

A typical Modaraba can do investment or business in any economic activity that is being permitted by Islamic Financial system like project for the benefit of society, any other legal business, production and distribution of commodities that is acceptable in Islamic law (Zubair, 2002).

Musharka Musharka according to Anwar (2003) has stemmed out of an Arabic word Shirkah

which means partner. In this type of business, the partnership is established between two parties on the basis of capital, work skills or any other investment and enjoys equal profits and rights. In Musharka the profit sharing is equal but the loss is suffered according to the investment done. The operation of such contract depends upon both the parties and they can either agrees on buying each commodity required on partnership or can also do vice versa. Musharka is a usual contract; therefore, all the conditions applied must be similar to that of a usual one. Unlike in Modaraba, here each partner can enjoy working in the management and has a similar share of contribution but if the partners would like to assign a task on mutual consent then it is also acceptable. Profit sharing depends upon the profit incurred not on the investment made as in Musharka all the partners are equal, therefore, equal distribution of profit takes place and fixing a guaranteed return of profit is not allowed. But if both the partners decided a way of working according to which one partner will invest and also work, then he may keep his share of profit higher due to the extra efforts.

Musharka contract can end if the reason for establishing the contract is over. Each partner has the right to end the contract, but a prior notice must be given before the ending month. As the assets are bought on the name of each partner, therefore, they can either sell the assets or repurchase or simple give the share of money to the leaving partner according to the market value. The contract of Musharka also gets terminated if any one among all the partners dies (Visser, 2009).

Islamic Banking in Pakistan (PEST Analysis Factor): The uncontainable ecological issues and factors for Islamic banking in Pakistan are

presented in the following heads:

Political and Legal Environment: Pakistan has tried various forms of parliament, the army and the President of the

Government's efforts to achieve political stability. Through democratic and constitutional struggle, Pakistan received its independence in 1947. Although the history of democratic government is not so good and many of the crises in Pakistan are evidenced again after return to democracy. The constitution of the Islamic Republic of Pakistan adopted in 1985 provides for a federal parliamentary system with a president as head of state and a popularly elected prime minister as head of government. Another legacy involved in Pakistan politics is military force. It has ruled many times after the independence based on action by the doctrine of necessity. In Pakistan the military has remained the most cohesive national establishment. United States has played a significant part in Pakistan's

Journal of Islamic Banking and Finance Oct.- Dec. 2013 23

politicians and government policies. Pakistan's relations with the United States in the context of the Cold War. Now, Pakistan to fight terrorism as a strategic partner with the United States before the state's role.

Pakistan opened up its economy for private investors to finance and boost their economy from the beginning in every sector of the country. Consequently in 1960s, Pakistan's economy represents itself as a prosperity model in developing countries. But ordinary people's living standards did not improve. In 1972, the new government nationalized 40 business and industrial groups and as result there occurred an outflow of private capital from the country. General Zia, a military dictator took control of government in 1977 and introduced free economy. With the passage of time many new Government and private banks started their operations in Pakistan. In 1980s there was given emphasis for the introduction of Islamic banking (Interest free banking) by the government. The government (Ziaul Haq’s government (a military dictator) of Pakistan took initiative to institutionalize the interest free banking but never pursued it seriously. On one hand, government wanted to eliminate interest from the economy but on the other hand, it put a ten year ban on the Federal Shari’at Court (FSC) to issue any verdict against the interest based government transactions. The governments that came after the departure of Ziaul Haq did not take any serious interest in implementing interest free banking. In 1991 FSC judgment on riba in the SC of Pakistan that had ordered the government to clean interest from the national economy within six months. The government argued that bank interest is not riba and it is completely impossible in the present day circumstances to break up the economy of Pakistan from the international economy by abolishing interest. These contradictions in the sayings and actions of the IJI government revealed that it took these Islamic measures to win the support of people, not for actually implementing it. Government of Nawaz Sharif in 1990s introduced liberalization and deregulation in the economy on large level. Pervez Musharaf, a military dictator took the control of command in 1999 and his government introduced many new policies for open economy and provided incentives to private investors. On 18 February, 2008 there is again an elected new government which was formed after the elections and after completion of 5 year Pakistan economical dimension not in sound tone. All through political interference and harassment Islamic banking industry was fully born during Musharaf regime, and is a flourish economic phenomena.

Economical Environment: Pakistan’s economy has made admirable progress in last couple of years through a

comprehensive program. The main aims and goals of this program included, restoring investor’s confidence through stability and consistency in economic policies, issuance of relax work permits, tax reforms, increasing domestic savings, restructuring and privatizing state enterprises, boosting agriculture and reviving industry. Government also introduced a program of financial reforms in order to enhance a competition in banking sector by eliminating direct credit and improving regulation and supervision. GDP growth rate of Pakistan has been showing a consistency of 6 % plus during last four years. There is also seen an increase in per capita incomes that marked almost $ 850. Rate of unemployment has gone down to some extent and the size of economy is double which is now $ 130 billion. Large scale manufacturing has grown in double digits and the cumulative private sector credit by banking system in last three years was more than $15 billion compared to less than $10 billion in the previous ten years. Foreign direct

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investment (FDI) in Pakistan is increasing every year and is amounting to $ 3 billion and it is the highest FDI amount in South Asia. (Husain 2006) Fast and sustained growth of Pakistan’s economy has enabled Pakistan to position itself as one of the fastest growing economies of the Asian region. This economic growth of Pakistan has got the attention of foreign investors and leading companies and they are investing in different projects in Pakistan. The gradual increase in oil prices and food prices is impacting the economy of whole world including Pakistan. There was a big disaster in Pakistan as a result of a severe Earth quake of October, 2005, but Pakistan’s growth for the year remained impressive despite of these all issues. The service sector showed continuity in its performance and grew by 8 % as against the target of 7 %. Spending power of consumers is also going in upward directions.

Housing is one of the basic necessities of human and the demand of housing in urban areas of Pakistan is increasing at the rate of 8 %. Pakistan is facing real problem in housing units and price of real estate is increasing day by day and as a result it’s becoming very difficult for a common man to have his own house. Pakistan is facing a shortage of 7.5 million housing units and 3 to 6 persons are living in a house of one room on average. Mainly the mortgage market is being held and dominated by House Building finance Corporation (HBFC) with a market share of 82 %. Government is giving priority to housing sector and allocated significant resources for the development of his sector. In 2009-10 flood disaster has disturbed every financial sector of Pakistan.

The potential effects of growth in the housing sector will be employment opportunities besides generating industrial, commerce and trade activities. SBP is playing its role as a facilitator, guide and catalyst for the sector. (Javaid 2006) Consumer financing was noted at 15.4 billion at end of September, 2007 against Rs. 6.4 billion as at end June, 2006. The overall size of financial sector Pakistan has grown by 15 % and it was noted as 6.9 trillion in the 1st half of 2007 as compared to Rs. 5.96 trillion in the full year of 2006. Islamic banking assets are currently holding 837 billion of total banking assets but its growth has been recorded as 12.8 % in the end of December 2012.

Socio-cultural Environment: There are mainly five ethnic groups in Pakistan - Punjabi, Sindhi, Pashto, Muhajirs

and Baloch. Languages are the most common identity of ethnicity in Pakistan. There are more than twenty five languages that are spoken in Pakistan, but the most common languages are Punjabi, Sindhi, Urdu, Pashto and Balochi. Urdu is the official language and is spoken and read all over Pakistan. English is the medium of education in most of the schools and universities; therefore it is an effectively national language of Pakistan.

The society of Pakistan is greatly influenced by the cultures of Central Asia, India and the Middle East. Pakistan has a rich civilizing and traditional background going back to Indus valley civilization. The region of Pakistan has been invaded in the past, occupied and settled by many different people, including Dravidians, Aryans, Greeks, White Huns, Persians, Arabs, Turks, Mongols and various Eurasian groups. And indeed the region has formed a distinct cultural unit within the main cultural complex of South Asia from prehistoric times. There are differences in culture among the different ethnic groups in matters such as dress, food, and religion, especially where pre-Islamic customs differ from Islamic practices. The cultural origins come from the civilizations of North India and eastern Afghanistan, with significant influences from Persia, Turkistan and

Journal of Islamic Banking and Finance Oct.- Dec. 2013 25

Hellenistic Greece. However, it was the first part of the subcontinent to receive the full impact of Islam. Hence it has developed an identity of its own.

Technology: Technology is a common word used nowadays referring to methods and techniques

for facilitating the work of different people. Technology is important in almost every field of life from e-shopping to e-banking. Information technology is now the backbone of the growth of every country.

Pakistan government has launched its technology policy in year 2000 to keep pace with the fast moving world. Many companies in Pakistan are now relying on different technologies, mainly IT for improving their work standards and to satisfy their customers. For example, before the use of IT, Pakistan banking sector was very slow but almost every bank is using different technologies to satisfy their customers now. One important thing in the technology development is the technology acceptance, how employees and customers react emotionally to the acceptance of the new technology. (Wajeeh 2008) In Pakistan, branchless banking is becoming very common and showing tremendous growth. Banks are introducing new techniques to facilitate their clients. Internet banking, mobile banking, ATM’s are some examples. But still banking in Pakistan is being conducted through branches using papers and forms mainly. (Asad 2007)

Online banking was the first step towards the use of technology in banking. Now people can do transactions through their mobile phones. People can pay their utility bills through the simple method from their mobile phones. The chances of bank robberies would go down automatically and bank customers would be more secure and safe in making banking transactions. It not only saved cost but also provided convenience for the customers as they are now able to carry out transactions from their place without travelling to the adjacent bank branch. (Husain 2006)

Islamic Banking in Pakistan (SWOT Analysis): Strengths:

In Pakistan, conventional banks are running in parallel with Islamic banks providing the choice to the customers. Before Islamic banks. Most of the Pakistani people were not doing business with the banks because of their strong believes against interest based banking. These people were mostly from the middle class and low class, now have the opportunity to invest in different businesses by taking loans from Islamic banks without any interest. (Husain 2006) Meezan Bank was the First full fledged Islamic bank in Pakistan that started its operations in January 2002. For the promotion of Islamic banking, SBP allowed financial institutions to establish full fledge Islamic banks or subsidiaries of Islamic banking or different stand alone branches by already running commercial banks.

Islamic banking is now available in more than 80 cities of Pakistan, however conventional banks are covering almost the whole Pakistan including small and big cities. There are large numbers of foreign banks present in Pakistan which are also opening Islamic banking branches. (Qureshi 2007). In money market, the objective is to meet the liquidity requirements whenever they arise. The market facilitates those banks which

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need money to borrow the surplus amount of the other banks. Islamic money market performs the same function of meeting the short term liquidity needs but instead of taking interest, it facilitates Islamic banks to share surplus amount on profit and loss basis. The conventional banks are taking advantage of Islamic money market through their Islamic branches. But full fledge Islamic banks will only have to deal with in Islamic money market and can’t take advantage from conventional money market.

There is not much differentiation among the products within Islamic banking; however the products are slightly different from the conventional banks. But as now conventional banks are also opening Islamic branches, that’s why product differentiation is very less.

Exclusive strengths of Islamic Bank which eminent Islamic banking Practices are as follows:

• Perception – Brand image

• Senior team’s commitment towards Islamic Banking

• Strong Shariah Board

Weakness: State Bank of Pakistan has the sole authority in issuing of license to the banks.

Currently, banks are required to meet the capital requirements of $ 50 million that were to reached to $100 million by 31st December 2009. SBP has given the suspension order of issuance of new bank license. SBP has stopped giving licenses to commercial banks but they are giving license to Islamic banks. Foreign interest in Pakistan banking sector and even in Islamic banking sector is very high and this banking sector has attracted almost $ 33 billion foreign capital inflow. Foreign banks have interest in expanding their businesses. Foreign interest in Islamic banking is very strong and four out of five banks are foreign in this sector. Market share of Islamic banking assets and deposits in overall banking industry accelerated to 8.6% by the end of December 2012. In terms of profitability, profit of Islamic banking industry remained Rs. 10 billion in the last quarter of 2012. Reflecting relatively better growth in assets of Islamic banking industry compared to assets of overall banking industry.

Distribution costs of Islamic banking products as well as documentary and legal expenses are very high as compared to conventional banks. This is because Islamic banks focus on single transaction. They don’t have some universal frame to do all the transactions. There is also not standardization of Islamic banking instruments. Approval of each transaction by Shariah board is also a big hurdle in proper development of Islamic banking. Shariah board is the new board that is unique to Islamic banking. There is shortage of good Shariah scholars and there exits wide different point of view about the same product by different scholars, that’s why time required for proper structuring the new product and transactions becomes elongated.

Exclusive weakness of Islamic Bank which distinguished Islamic banking Practices are as follows:

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• Not widely known as a commercial bank

• Growth in size with lack of adequately trained staff

• One stop range of Product at par with conventional banks

• Lack of ongoing training for staff – both Islamic and general banking

Opportunities: Govt. has provided a framework regarding legislative which helped in reducing the

difficulties and time delays in recovery of defaulted loans. (Khan 1999) Although the risk involved in doing Islamic banking transactions is very high but this framework will considerably reduce the risks.

Now Islamic banks have more opportunity to do business in Pakistan because government has competitive tax structure. Government is promoting Islamic banking in Pakistan which will help Islamic banks gaining more market share in coming years.

Growing GDP rate and increase in per capital income reflects that economy of Pakistan will improve. FDI is little bit better in Pakistan and one of the major attractive sectors for foreign investors is financial business. An expanding economy and increase of consuming power can act as a fueling demand for Islamic loans and investments from consumers and companies.

Although the literacy rate of Pakistan is low but it is increasing. There are more educated persons in the market who have brilliant ideas but don’t have the sufficient investment to start new business or study abroad for higher education. Islamic banking can give more loans and by introducing new transactions for these young people can really enjoy more market share and also it will help in the reducing unemployment in Pakistan.

Micro financing is one of the major businesses of Islamic banks and it is also the largest sector in Pakistan in terms of potential clients. So Islamic banks have great opportunity to invest heavily in this sector and get profit.

Exclusive opportunities of Islamic Bank which illustrious Islamic banking Practices are as follows:

• Growing awareness of Islamic Banking among business entities and the general public.

• Favorable financial environment. Growing industrial investments

• Growing acceptance of a consumer credit culture

• Product innovation will get us market share

Threats: There is a relationship between political insatiability and per capita GDP growth,

political instability has adverse effects on economic growth as the long term policies are not implemented affectively. (Swagel 1996) There has been political instability in Pakistan as Governments have been changing frequently. Every new Govt. starts with a new set of policies and old policies are terminated often. This is a major threat for new

28 Journal of Islamic Banking and Finance Oct.- Dec. 2013

growing Islamic banking sector as they have to face problems in implementing long term policies.

It has been common practice in Pakistan that some people of influential groups take loans from the banks and don’t pay back their loans. People of Pakistan come in the category of uncertainty avoidance group. People believe in rumors without any confirmation and justification. A large number of people in Pakistani are doubtful about whether these banks are Islamic or they are just using name of Islam and doing the same thing as conventional banks. This is a big threat to Islamic banks.

Exclusive Threats of Islamic Bank. Here we define as under:

• Growing competition.

• Employee attrition / Unemployment

• Interest Transaction / Illegal Profit

Conclusion There has come a swift transition in the financial services in the world including

Pakistan. A new mode of banking i.e. Islamic banking has been introduced and accepted widely in many countries of the world including Pakistan. This article has portrayed the current situation for Islamic banking in Pakistan by investigating the current competition of the industry using porter five forces model and at macro level using PEST analysis. There is much more potential for already running Islamic banks and newly investors in this segment as well. Although there is a political instability in Pakistan, but the autonomous position of SBP is providing a shelter to this sector against political instability. SBP has provided the Islamic banking sector with sufficient legislations and policies, so as to assist this sector and increase its efficiency. Although economy of Pakistan has shown a consistent growth in the last couple of years but the rise in inflation rate (due to multiple factors) can cause problems for investors. The socio-cultural factors of Pakistan are in favor of Islamic banking but needs to be addressed properly and carefully. Pakistan is an Islamic democratic country, so there is much space and opportunity available for Islamic financial service providers including Islamic banks. There is also one problem that people are not very educated and literacy rate of Pakistan is very low that’s why many people think that Islamic banks are just using the name of the Islam otherwise they are same like conventional banks.

Technology wise Islamic banks have many opportunities because in Pakistan there is a boom of telecom sector and IT industry. Most of the banks are using these services like e-banking, online banking and ATM machines for facilitating their customers.

References Anwar, M. 2003. Islamicity of Banking and Modes of Islamic Banking, 1st edition,

Netherlands.

Asad, A. 2007. policy paper on regulatory framework for mobile banking in Pakistan. Available at: http://www.sbp.org.pk

Husain, I, 2006. “Economic Policy reforms in Pakistan 1999-2006”, Conference on Economic policy reforms in Asia. Stanford University, June 2006.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 29

Javaid, Q, 2006. “Low Cost Housing Solutions”, Institute of Bankers Pakistan. Vol.75, Jan-Mar 2008.

Kahf, M. 2006.Islamic Banks at the Threshold of the Third Millennium, Available at http://www.kahf.net

Khan, M.Z. 1999. Transforming banking in Pakistan. http://uoit.ca/sas/International%20Finance/TransbankPak.pdf

Qureshi, S. 2007. The bank’s new cloths. Available at: http://www.newsline.com.pk/NewsFeb2007

State Bank of Pakistan, (Dec, 2010), “Islamic Banking Bulletin”, Vol. 5 No.4

Swagel, P. 1996. Political instability and economical growth. Journal of economy growth. Springer Netherland. June 1996.

Toutounchian, I. 2004. New Horizon: Islamic Banking, A last Ditch to save Capitalism. The institute of Islamic Banking and Insurance. London

Visser, H. 2009. Islamic finance: principles and practice. Business Economics, 1st edition, pp 184.

Wajeeh, R. 2008. Technology acceptance issue in Pakistan. Available at: http://www.thetechnologypad.com/Technology/Technology-Acceptance-Issues-in-Pakistan.html

Woelfel, Charles j 1993, Encyclopedia of Banking and Finance, Chicago, 1993 Cornelisse, P. and Steffelaar, W. (2008). Islamic Banking in Practice: the Case of Pakistan.

Development and Change Volume 26 Issue 4, Pages 687 - 699 Published Online: 22 Oct 2008, 2009 Institute of Social Studies

Zubair, H.2002. Mudaraba as a mode of finance in Islamic banking: theory, practice and problems. Journal of Middle East Business and Economics, 14(2), pp. 41-53.

30 Journal of Islamic Banking and Finance Oct.- Dec. 2013

KSE Meezan Index (KMI-30) – Stellar Performance

Islamic Index outperforms other indices

Abstract KSE Meezan Index (KMI-30) is a stock market index on the Karachi Stock Exchange in Pakistan of thirty companies that have been screened for Islamic Shariah criteria. The index was introduced in September 2008 and the base period for this Islamic index is June 30, 2008. It was created as a joint effort by the Karachi Stock Exchange and Al-Meezan Investment Bank

The index is calculated using free float market capitalization. At any point in time, the level of the index reflects the free float market value of selected Shariah-compliant shares in comparison with the base period. KMI-30 is rebalanced semi-annually.

Guidance is taken from qualified and well reputed Shariah expert when Shariah compliance of stocks is done.

Key Word: KSE Meezan Index (KMI-30)

Introduction The previous decade saw tremendous rise in the acceptability and growth of Islamic

financial products in Pakistan. Deposits of Islamic Banks grew from an insignificant amount in 2002 to over Rs. 530 billion as on March 30, 2012, representing 8.4% market share of the entire deposits in banks. With the development of the financial markets in the country, there was a need felt for new investment products to facilitate the growth and promotion of savings. Mutual Funds industry has played an active role in providing new investment alternatives. Presently, the Mutual Funds industry stands at Rs. 410 billion as on June 30, 2012, in which the size of Islamic Funds is Rs.53 million. The market share of Islamic mutual funds has shown incredible growth over the period and has increased to 13.71% from 7.54% in mid 2008, also illustrated in the Figure below:

Journal of Islamic Banking and Finance Oct.- Dec. 2013 31

Need for an Islamic benchmark With the rapid growth and acceptance of Islamic products in the market, a void was

created for a benchmark that can accurately compare the performance of Islamic equity funds. As a result, KSE-Meezan Index (KMI-30) was established by the collaboration between Al Meezan Investment Management Ltd. (Al Meezan) and the Karachi Stock Exchange (KSE) in 2008. Al Meezan, in consultation with Shari’ah Department of Meezan Bank, provides Shari’ah expertise, guidelines, skills and stocks screening towards the activities pertaining the re-composition of the Index; whereas, KSE provides maintenance and dissemination support for the index.

The index helps Shari’ah conscious investors to identify the Halal equity investments. It also provides them with a suitable benchmark to compare the performance of their investments. Besides tracking the performance of Shari’ah compliant equities, its construction was meant to increase trust of Shari’ah conscious investors and enhance their participation.

The following table lists the Islamic Equity Funds in Pakistan, all of which use the KMI-30 Index as a benchmark. In addition, it is also used by five Islamic Balanced Funds or Islamic Asset Allocation Funds for benchmarking.

Islamic Equity Funds in Pakistan

Fund Manager Benchmark

Meezan Islamic Fund Al Meezan Investments KMI-30

Al Meezan Mutual Fund Al Meezan Investments KMI-30

Atlas Islamic Fund Atlas Asset Management KMI-30

HBL Islamic Stock Fund HBL Asset Management KMI-30

JS Islamic Fund JS Investments Limited KMI-30

Pakistan International Islamic Fund Arif Habib Investments 70% KMI-30 Index + 30% DJIM-World Index

Market Share of Islamic Funds

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Performance & Returns of KMI-30 Index We attempt to evaluate the performance of the KMI-30 Index against the other

indices on Karachi Stock Exchange since its launch in 2008. Some interesting facts emerge through this exercise:

Index Performance

FY09 FY10 FY11 FY12 Cumulative KSE Meezan - 30 Index -28% 34% 45% 14% 59% Karachi Stock Exchange - 100 Index -41% 34% 29% 10% 12% Karachi Stock Exchange - 30 Index -46% 24% 21% 3% -17%

Since inception, the KMI-30 index has provided a return of 59% to its investors. During the same period, KSE-100 (which tracks the performance of the top 100 market capitalized companies) and KSE-30 (which tracks the performance of the top 30 most liquid stocks based on free float methodology) both underperformed considerably; and, in fact, provided negative returns. The time when KMI-30 Index was launched concurred with a financial crisis that swept the global markets, which also affected Pakistan’s Capital Market. Despite these setbacks, the KMI-30 has been able to outperform KSE-100 and KSE-30 by 47% and 76% respectively.

Let us illustrate this with an example. We take three hypothetical passive investors, each of whom invested a capital of Rs. 1,000 in the stock market at the start of the FY’08. They chose to invest differently however. Investor A invested in the KMI-30 index, while B and C invested in KSE-100 and KSE-30 respectively. The following graph illustrates how each fared at the end of FY’12.

Investor A’s investment has grown to Rs. 1,585 yielding 59%. Investor B’s portfolio was worth Rs. 1,123 (a profit of 12%) and investor C lost 17% of his investment, which was worth Rs. 823.

It can be inferred from the same figure that once recovery began in the market, KMI-30 index outperformed the KSE-100 and KSE-30 indices over the entire period. At times, the gap widened substantially.

A: Rs 1,585

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Now we dwell upon the reasons for the phenomenal performance of KMI-30 in the last 4 years.

1. Underperformance of Financial sector

2. Over leverage increases risk and affect return

3. Awareness about & Investors’ inclination towards Islamic products

Since the onset of the global economic crisis, the overall risk of financial assets had increased which raised concerns for increased provisioning in the banking sector. As a result, investors avoided stocks of banking sector which noticeably underperformed in the last three years.

Another factor that contributed to this difference in earnings was the excessive use of leverage by some companies. For example, we can take the example of Engro Corporation and Fauji Fertilizer (FFC), both operating in the lucrative fertilizer sector. In case of Engro, we witnessed sharp increase in leverage as it increased its Debt to Asset ratio from 63% in June 2008 to remain at the same level in Dec 2011. Due to excessive leverage, Engro’s stock became non-compliant and hence has been ousted from the universe of KMI-30 since 2009. Meanwhile, in the case of FFC, its leverage position decreased from 30% to 25% during the same period.

Now what happened to the prices of these two stocks? A person who had invested in Engro since July 1, 2008 has not been able to recover his principal investment, as now the stock is worth lower (on adjusted basis) than it was on July 1, 2008. On the other hand, a person who invested in FFC in the same period got returns of 255%. This is a classic example of how a low leveraged and hence Shari’ah compliant company outperformed one with very high leverage.

Conclusion The KMI-30 index was developed to serve as a benchmark for investments in

Shari’ah compliant avenues. It has not only done well in fulfilling this need, but also proved to be an effective investment guide. In the tough economic conditions of the recent past, companies that qualified as Shari’ah compliant and thus featured on the KMI-30 index have performed far better than those which did not. These firms have characteristically low levels of leverage. Since the economic outlook for the near future suggests more problems with a weakening global economy, closely tied with our market; the KMI-30 index can be relied on to again outperform the KSE-100 index, and thus is a suitable investment platform for all investors.

Free Float Methodology On the Karachi Stock

Exchange, the KSE-100 and the KSE All indices are assorted using the market capitalization of the listed companies. Market capitalization is number of outstanding shares times the current market price. The investment community uses this figure to determine a company's size. The KSE-Meezan Index, on the other hand, uses the Free Float methodology for this purpose. The Free Float of a company is the number of shares that are available for trade on the exchange; thus, it excludes all the locked in shares held by the sponsors, directors, promoters and the government, thereby reflecting the true liquidity of the market.

34 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Examining the Prudence of Islamic Banks: A risk management perspective

By Dr Muhammad Imran Ashraf Usmani*

Abstract Islam is a complete code of life. It not only lays down rules for religious affairs but it also covers every aspect of human activities including economic matters. It not only bans riba and gharar but also all ancillary practices which under the subterfuge of trade may surreptitiously be adopted to dodge the ban. It has, therefore, specified the types of transactions which should not be undertaken and closed all back doors for trespass of these evil practices into Muslim economic arena. It is on account of these restrictions that risk in Islamic finance is well managed and the system remains immune from the ravages of the storms which often appear on the financial firmament of the world.

Keywords: Prudence, perspective, riba, gharar, risk mitigant tools, hedge funds, put options and straddle options.

Riba (interest) free and Gharar (uncertainty) free nature of Islamic banking together with real asset/service-backed transactions ensure that an efficient, effective and robust risk management mechanism is in place in Islamic banks. Innovative collateral arrangements and keeping away from investments in complex, risky and speculative instruments maintains the risk quality of the assets of Islamic banking institutions.This article discusses and explains the theoretical foundations of Islamic finance and examines how Islamic banks ensure the risk quality of their assets facing additional risks than conventional banks due to their Shariah compliant operations.A brief comparison of the investment operations of conventional and Islamic banks is made and it is argued that Islamic banks are in a better position to manage risks and avoid such financial crisis which the banking industry is currently facing globally.

* Author: Dr Muhammad Imran Ashraf Usmani is A Shariah Advisor and Group Head of

Product, Development & Shariah Compliance Department at Meezan Bank Ltd. Author of numerous Publications related to Islamic finance & other Shariah related subjects. Email: [email protected]

Journal of Islamic Banking and Finance Oct.- Dec. 2013 35

The theoretical foundation of Islamic finance Islam is a complete religion in which we find teachings about all spheres of life,

from beliefs to worship and from socio economic issues of life to ethical values. Adhering to the teachings of Islam does not merely fulfill our duty to Allah Almighty; it is also in favour of humanity in this world as well.

In our economic life, Islam provides certain rules to be followed in our economic pursuits.These rules are derived mainly from the sources of Shariah i.e. rules of Islam which are:

1. Holy Quran. 2. Sunnah (the way of the Holy Prophet, peace be upon him). 3. Ijma (consensus of Muslims on a particular issue). 4. Ijtehad and Qiyaas (inductively seeking ruling of Islam on a particular issue

in the light of the Holy Quran, Sunnah, Ijma and objectives of Shariah derived from them).

If we try to cover all the rules of Islam concerned with our economic life, it would be very difficult to collect and mention all of them in this brief article. However, some of the basic rules would be worth mentioning, through which other rulings towards some particular business transactions could be determined.These basic rules are as follows:

Riba Riba (Interest) is not allowed in Islam. Riba has two basic kinds:

i) Riba Al Dain: Any excess benefit required or given as the case maybe as consideration in a loan transaction. Due to the prohibition of Riba Al Dain, all of the following types of transactions are not allowed:

• Interest-based loans.

• Discounting of receivables.

• Trade of debts with profit.

• Trade of all interest-based securities.

ii) Riba Al Fadhl: Any excess in spot or deferred barter trade of some specific homogeneous commodities (such as gold, silver, all weighable or measurable things like wheat, petrol or commodities that are used as a medium of exchange like currencies). Any excess on spot or deferred barter trade of such commodities is not allowed if they are homogeneous, even if they are different in quality. However, if they are exchanged heterogeneously in a spot sale (one genre of good with another genre of good, i.e. wheat with barley or dates with salt), then excess of any one of the goods or difference in value is allowed.

This type of Riba was disallowed by the Sunnah (the Sayings of the Holy Prophet p.b.u.h.) and not by the Holy Quran.The reason for the prohibition of Riba-al-Fadl is that by exchanging these homogenous commodities in unequal amounts, there is a fear of

36 Journal of Islamic Banking and Finance Oct.- Dec. 2013

developing the rationale in a person eventually leading to interest-based earnings.Therefore, spot and credit sale of unequal amounts of some specific homogenous commodities and the credit sale of heterogeneous commodities (one genre of good with another genre of good) is disallowed to avoid bringing interest from the back door.

─ Due to the prohibition of this type of Riba, the following transactions are not allowed:

• Spot or credit sale of gold with gold in excess.

• Exchange of currencies of same country in excess as all the currency notes of same denomination are considered same and equal.

• Credit sale of gold with silver in excess is not allowed. But in spot sale, difference in value is allowed as the market exchange rate is ascertainable in spot sale.

• Credit sale of one country’s currency with the other country’s currency with excess in amount is not allowed, but in spot sale, excess in amount is allowed.

• Trade of one litre petrol with two litres of petrol or one kilo steel with two kilos of steel is not allowed as sale of petrol with petrol and steel with steel falls under the ambit of sale of homogenous commodities.

Gharar Gharar is not allowed in Islam. Literal meaning of Gharar is deception and

uncertainty. In Islamic Shariah, it includes the following types of transactions:

• Deception, cheating or fraud in a transaction.

• Uncertainty or ambiguity in the transaction. It includes the following types of features in transactions: (i) Diction of the contract is unclear, subject matter or price of transaction

is not known, or the contract is contingent to an uncertain event or chance.

(ii) One party’s consideration is certain and the other’s is uncertain. (iii) One party’s consideration is based on the loss of the other’s. It means

that either party only gains at the loss of the other as in a zero-sum game.

Due to the two prohibited types of transactions mentioned above, the following transactions are not allowed:

• Gambling or speculative transactions having any of the abovementioned elements present in such contracts.

• Purchasing a risk for any consideration without owning an asset, because of having the abovementioned second type of Gharar, as in the case of insurance.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 37

• Sale of debt or receivable, because one party’s consideration is predetermined while the other‘s is not certain. For instance, if the debtor defaults, the buyer of the debt does not remain to have any recourse to the seller of debt or receivable. Secondly, if there is any profit obtained by discounting of debt, it will be tantamount to Riba as any excess over and above the principal amount on a loan is Riba.

• Selling, transferring or assigning a risk with consideration is not allowed because if one party purchases the risk of the other party at a predetermined consideration, then one party’s consideration is known while the other’s is not known or uncertain. However, the following situations are allowed:

(i) Assigning a debt having recourse to the assignor in case the debtor defaults.

(ii) Providing a guarantee while the guarantor has recourse to cover the guaranteed amount from the guaranteed person if the guarantee is invoked.

(iii) If some or any one person assumes the risks of the other voluntarily without any consideration.

• Future or forward transaction in which both sides of consideration i.e. price and subject matter of sale is deferred is not allowed due to the following reasons:

(i) Sale of debt with debt.

(ii) Sale contract is contingent to a future period, performance of which is uncertain as it is not executed now and it is not certain that both the parties as well as both the considerations i.e. price and subject matter of sale would be present or available at the time of maturity. They could only promise to do something at a future date, but cannot execute a transaction now which is contingent to a future date.

(iii) Short sale or sale before goods actually come into existence or sale of a thing without owning, taking possession and bearing the risk and reward of the subject matter is not allowed because of uncertainty of deliverability of the subject matter in the sale contract.

Furthermore, Shariah compliance also ensures Corporate Social Responsibility (CSR) and ethical compliance. Islamic banks discourage business and transactions with companies producing tobacco, alcohol, drugs or engaged in the business of gambling, casinos, nightclubs, prostitution, etc.

Risk management in Islamic banking: An applied perspective Now a question may be asked that if the above mentioned transactions are not

allowed, then how can the different types of risks be managed or mitigated in a Shariah compliant investment framework?

38 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Before we answer this question, we should keep in mind the above mentioned rules as well as the following rules:

• It is not allowed to earn money without taking risk of an asset.

• Risk alone cannot be sold or transferred with a consideration without transfer of ownership of the asset.

• On voluntary basis, one can assume the risk of other/s.

Now, we will answer the above mentioned question concerning how different risks could be managed, mitigated, covered or hedged in Islam.There are different types of risks in trade and there are various ways available to mitigate these risks.We can name these tools as Shariah Compliant Risk Mitigating tools. First, we compare what are the types of risks in conventional banking and Islamic banking.

Risks in conventional and Islamic banking Risk management is a continuous and vigilant process. It is an activity more than an

action. It is designed to manage the risks inherent in the bank’s business.The goal of an effective risk management system is not only to avoid financial losses, but also to ensure that the bank achieves its targeted financial results with a high degree of reliability and consistency.

A conventional bank is generally exposed to the following types of risks: credit risk, market risk, liquidity risk, operational risk, regulatory risk and reputation risk.

A conventional bank lends money and earns interest on the lent money. It lends money for any financial need, be it for the purchase of assets or not. Even, if it provides financing for the purchase of assets, it does not own the assets and is only concerned with the return of its principal amount and interest. Therefore, it avoids facing many risks that Islamic banks have to face due to their Shariah compliant operations.

However, the flipside to this is that conventional banks – by way of freedom to lend money only – get themselves involved in excessive leveraging and their money – based financial assets are theoretically exposed to unlimited risks as compared to Islamic banks who by way of asset-backed financing are exposed to risks only to the extent of diminishing value of the real asset.

An Islamic bank faces a variety of risks in addition to the risks faced by a conventional bank i.e. reputation risk, Shariah non-compliance risk, product/mode of financing risk, process risk, counterparty risk, etc. Apparently, Islamic banking transactions look more risky compared with the conventional banking transactions. But, if we thoroughly consider many prevalent products of conventional banking and finance, we can easily differentiate that Islamic finance has limited risks on its assets as all financing provided by Islamic banks are real asset/service backed. Figure 1 shows the risk management framework in Islamic banking.

Risk mitigant tools in Islamic banking There are different Shariah compliant ways to mitigate or minimise the risks mentioned above in Islamic banking which are as follows:

Journal of Islamic Banking and Finance Oct.- Dec. 2013 39

• Innovation in collateral arrangements.This mitigates the credit and default risk. Credit and default risks are more important in Islamic banks as rollover and sale of debt at a discount/premium is not allowed in Islamic Shariah.

• Third-party guarantees.This mitigates the credit, default and counter-party risk.This ensures that the bank has recourse to cover its actual losses in case the counter-party defaults.

• Seeking credit ratings of clients from specialised and credible institutions.This mitigates credit risk, default risk, counter-party risk, information risk and asset quality risk. Furthermore, it solves the problem of moral hazard and adverse selection arising from asymmetric information.

• Selection of appropriate financial instruments available in the Islamic financial product mix to manage risks profitably. Appropriate use of Islamic financial instruments in a particular transaction mitigates process risk and liquidity risk.Wrong use of a mode of financing may result in profits going into charity or the bank having to disinvest immediately creating liquidity crunch for the bank.

Figure 1: Risk management framework in Islamic banking

Islamic and conventional banking operations: A risk management perspective Now we will compare briefly the investment operations of Islamic and conventional

banks. Following is a list of securities and investment operations which are very risky and prohibited in Islamic Shariah. But, they are allowed and used in conventional banking and finance and have caused financial crisis in East Asia in the 1990s and even more severe and disastrous financial and economic crisis today, the depth of which is still not known.

• Securitisation of receivables without being 100% backed by fixed assets.

• Issue of bonds especially junk bonds and convertible bonds which can disrupt the company’s capital structure without it being willing to do so.

40 Journal of Islamic Banking and Finance Oct.- Dec. 2013

• Short selling of stocks, commodities and other securities.

• Future and forward transactions in stocks and commodities.

• Sale of debt or debt swap which increases the size of financial claims and not the real assets and hence eventually brings inflation in the economy.

• Discounting/factoring of receivables.The difference between the discounted value and par value is Riba and hence it is not allowed.

• Buy back agreements, and repos/reverse repos.

• Margin financing which multiplies the investment one can make and hence increasing the leverage. In economic downturns, it may result in loss beyond original investment.

• Lending financial securities as financial securities themselves are just equivalent to cash i.e. consumables and hence no consideration can be asked or given as the case maybe on consumables. Permissible financial securities (not involving Riba and Gharar and conforming to other Islamic Shariah rules) can only be sold with transfer of ownership as well as risk.

• Derivatives like forwards, futures, swaps, credit default swaps, FRAs, put options, call options, straddle options, etc.

• Hedge funds which take on unnecessary risk and make capital markets more volatile wherever they go.

• Credit sale of currencies for speculation.

• Other similar transactions.

Concluding remarks The above mentioned transactions involve either Riba and/or Gharar.Therefore,

they are not allowed by Islamic Shariah and if we analyse the current financial crisis, we would find that a major cause for such crisis is rooted in the use of Riba and Gharar based transactions. If the rules of Islamic Shariah are followed, we can save ourselves from very risky transactions ensuring smooth running of the financial institutions and hence the economy. Furthermore, the objectives of fair distribution of wealth based on real business and productive enterprise will be achieved as Islamic Shariah only permits taking on risk proportionate to the real value of asset and not beyond the value of the real asset.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 41

Now brewing: Islamic finance and takaful in China

By Jeffrey Kirk*

Abstract We may be witnessing the seeds of a possible lasting recovery to the global recession. This development presents unique opportunities and challenges to market players; opportunities as to the expansion of finance products and services and challenges in identifying future trends, most profitable sectors and the most effective deployment of capital and expertise. A financial sector which demands attention due to its growth and continuing appeal is Islamic finance. At present, there are more than 300 Islamic banking institutions and over 250 Shariah-compliant funds operating in over 50 countries. The number of such institutions and investment vehicles and the assets held and managed by them are continuing to grow on an almost daily basis. Assets invested in Islamic law-compliant structures are currently (conservatively) estimated as exceeding US$1 trillion globally. This figure is expected to rise, particularly in light of factors such as the recovery from the lingering effects of the global financial crisis, the increase in the flow of petro- dollars and the growth in the GDP of economies in Asia and Africa that have a healthy and expanding appetite for Islamic finance products and services. Indonesia and Malaysia are examples of such states, where GDP expanded by 6.1% and 2.9%, respectively, in the fourth quarter of 2012 over the previous quarter.

Key Word: China, Islamic Finance & Takaful a unique opportunity and challenges

Islamic finance and China As has been noted in other articles, the correlation between China and Islamic

finance is not readily identifiable. However, such connections do exist and are continuing to grow. * The author Jeffery Kirk, Global Head of the Appleby Islamic Finance Group and a partner

in the Appleby office in Hong Kong. The article, reproduced, published in Middle East Insurance review, issue Sept 2013

42 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Historically, we have seen substantial Islamic finance investments into China by institutions, particularly in the real estate sector. In the sukuk market, we have witnessed the success of the numerous sukuks listed on the Hong Kong Stock Exchange. A number of Shariah-compliant funds have also been launched in Hong Kong, for instance, the Hang Seng Islamic China Index Fund. China’s continued growth as the world’s second-largest economy is likely to continue to render it an attractive investment destination for Islamic finance funds.

One of the most focused exercises in the expansion of the availability of Islamic finance in China was undertaken in 2009. This pioneering project facilitated the provision of Islamic finance products and services as well as the launch of requisite institutions in the Ningxia Hui Autonomous Region catering to the needs of its 2.2-million Muslim population. This initiative was actively supported by the PRC government through the encouragement of the China Bank Regulatory Commission.

Hong Kong as a hub for Islamic finance The Hong Kong Monetary Authority and the Hong Kong Financial Secretary,

Mr John Tsang, have repeatedly stated their objectives to develop the special administrative region as a hub for Islamic finance. A recent development that gives credence to these statements has been the amendments introduced to the Inland Revenue and stamp duty legislation in Hong Kong. The amendments became effective on 19 July 2013 and have the effect of leveling the tax framework playing field to facilitate the sukuk market in Hong Kong.

The consensus is that this development in respect of sukuks is likely to lead to expansion in other Islamic finance products and services such as takaful and investment funds.

Indeed, the Hong Kong Secretary for Financial Services and the Treasury, Professor KC Chan, noted that the intention in introducing t he se c changes is t o “ help establish a conducive plat f or m f or the development of Islamic finance in Hong Kong, thereby diversifying the types of products and services available”.

Similarly, Director of the Hong Kong Economic and Trade Office, Ms. Subrina Chow, noted on a recent visit to Brunei that “we’re trying to see if we can further increase the volume and diversify the kind of (Islamic finance) products that are available in Hong Kong”.

Takaful and China Prior to the global financial crisis, the takaful industry was growing at an

annual rate of 20%. Deloitte quoted industry data indicating that the global takaful business will reach $20 billion by 2017. Historically, the GCC market, led by Saudi Arabia, has contributed the largest proportion of gross takaful premiums.

Whilst there is limited data available as to the gross premium flows of takaful and retakaful in China (PRC and Hong Kong), it is market consensus that these premium flows are currently negligible in comparison to the GCC region.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 43

The PRC’s (re)insurance market generally, and its (re)takaful market in particular, remains a challenging market to foreign (re)insurers, (re)takaful providers and investors. However, the world’s second largest economy with the largest population remains a market that cannot be ignored by international (re)insurers and (re)takaful providers.

The emerging Asian market is forecast to grow at a rate that will continue to outperform developed markets. AIA’s CEO Mark Tucker has remarked that recent studies have revealed a “protection gap” of $40 trillion in the life sector in Asia and that this relates only to mortality cover; if health cover is added, that figure could double.

Insurance growth trends In 2011, the real growth rate of life insurance in PRC was weak, estimated by

Swiss Re at 6%. However, the expectation (as enunciated by Swiss Re in its 2012 sigma report) is that life insurance premiums and life savings products generally will grow in the PRC as alternative savings products become less attractive due to increased regulatory oversight, at rates expected to be 10% per annum. China as the largest emerging insurance market is anticipated to become the third-largest life market in the world with a premium volume of $650 billion. The market view is that this growth in protection- type products, added to the demand for annuities and health products, bodes well.

According to a recent PwC study, the growth in annual premiums for foreign life insurers in the PRC in 2011 was in the range of 20% to 40%. The vast majority of participants of the study anticipate growth in 2014 to surpass 30%. In the non-life sector, premium growth in the PRC was strong, at 15% in 2011. Increasing demand for car ownership as well as health and personal accident products may continue to drive this growth. The PwC study also revealed that in respect of foreign property and casualty companies, only one of nine participants expect the growth rate to be below 25%. Looking to 2014, growth rates are generally expected to be in the 30% to 50% range.

The appetite in the China market for risk mitigation and protection products generally is growing. This represents a unique opportunity to (re)takaful providers.

In Hong Kong, the Commissioner of Insurance reported growth in both the life and non-life sectors over the past year. This follows an 11% growth in total gross premium written in the previous year. Further, the continuing development of renminbi business is regarded as one of the growth engines for the Hong Kong (re)insurance industry.

Potential growth areas

Considering the growth of the corporate sector in China and with the attraction of self-insurance, a sector that could potentially see strong growth is the captive insurance/ takaful offering, accordingly, the appetite in the China

44 Journal of Islamic Banking and Finance Oct.- Dec. 2013

market for risk mitigation and protection products generally is growing. This represents a unique opportunity to (re)takaf ul providers, particularly on the back of growing use and exposure of other Islamic finance products, most notably sukuk

.China – a unique opportunity and challenge Timing is everything. With global markets coming back on line after the recession, the question will be: how best to ride the recovery and utilize available capital and expertise to achieve the best possible results and profitability?

Much has been said in the past regarding the rise of Islamic finance. China represents a unique opportunity and challenge in the context of Islamic finance. Unquestionably, as can be seen from recent developments in China, the support exists in China to grow Islamic finance. One of the indicators as to the future of Islamic finance will be whether it achieves its potential in China.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 45

Credit Cards in Islamic Legal Perspective By

Dr. Manzoor Ahmad Al-Azhari*

Abstract Interest is prohibited almost in all religions for its several setbacks. The interest based institutions are strongly propagating their products, among them are credit cards. These cards provide debt for short & long term periods. People need thesecard to run their life in many disciplines, specially while traveling abroad. They don’t want to face theft, security problems and bankruptcy etc. So having no care of the demerits of cards they use them frequently. Modern Muslims scholars, paying their duty, tried to guide them about card use.

In this paper we try to present and analyse their opinion about the legal adjustment of credit cards raising some questions about the legitimacy of different aspects of cards for example:

i) Can we accept card’s transactions as a whole? ii) Is the issuance and annual fee acceptable Islamicaly? iii) Is the deduction from buyers’ bills legal? iv) Does the card agreement resemble some existing model

transaction? We throw light firstly on brief history of credit cards then come to the legal opinions of Muslim jurists.

Key Word: Credit Cards in Islamic Legal Perspective

PART-1 An Introduction to Credit Cards

a) Visional Definition: It is a card issued by banks and other monetary companies to a person with his

particulars (name & picture etc.), and 13-16 numbers on it. These Numbers express banks * Author: Dr. Manzoor Ahmad Al-Azhar, PhD Legal Policy (Shariah Law), Chair,

Department of Islamic Studies, Institute of Religious Education & Research (IRER) HITEC University Taxila Cantt.

46 Journal of Islamic Banking and Finance Oct.- Dec. 2013

membership, type of card, bank branch, card serial Numbers and Number 16 is computer Number or Security Number 1.

b) Linguistic Definition: Credit means Bank balance, bank account, confidence, good fame, dignity &

pride2. Almost all these meanings apply to credit cards.

─ Bank balance applies to the debit card (issued on bank balance)

─ Free bank account for a credit card.

─ Other meanings also harmonize with card because a bank relies on a person to give him a credit card for his good fame & personality, as it is considered sometime a reason of pride for some people.

c) Economic Definition: It is a debt used by card holder to purchase things or to withdraw money from

ATMs, payable to the card issuer within a limited period in all or in installments with interest.3

d) Bank’s definition of Credit Cards: It is a payment instrument used instead of money between cardholders, traders and

issuers. The cardholder signs the bills which traders send to the issuer for payment. It is called electronic payment also4.

e) Legal Definition: In the opinion of legal experts, credit cards enable the holders to purchase or get

money from certain sides5.

In the light of previous definitions we can say that credit card is a mean of debt used by the cardholder for purchases or cash to be returned in a certain period with a grace time for purchase and with interest on cash withdrawals.

2. History of Credit Cards6 Some restaurants issued tokens to their customers for late payment. In 1914 Mobil

Oil Company of California issued cards like that for their employees. Then in 1948, two friends Franklin McNamara and Ralf Shneder ate meal at a restaurant in Los Angeles and found no money in their pockets. After a hot discussion with the hotel owner, they were able to settle the problem. Thus Mr. McNamara thought with his friend Blumungdale about establishment of a club for their friends based on the saying “Dine & Sign”. That was the beginning of the famous Diner’s Club. Then American Express, a tourist company introduced the Amex card and after that banks jumped into the field, feeling it their duty to provide credit for their customers. In 1951 the Franklin National Bank in N.Y. issued the first credit card. In 1958, The Bank of America issued Bank Ameri card. After that a serious competition began between banks. Barclay Card was issued in U.K. in 1966. Eight American Banks established Inter Bank Card Association in 1967 which expanded and they all issued Master Charge Card,that is common as Master Card since 1979. Bank of American group issued visa card and the first credit card to enter the Arab

Journal of Islamic Banking and Finance Oct.- Dec. 2013 47

world was issued by Arab African Bank of Egypt in 1982. Bank of Egypt issued visa card in the decade of 1990 and Bank of Cairo also entered in this competition in 1996.

Now-a-days there are Visa, Master Card, Diners’ Club, American Express, Barclay etc. spread in the Middle East in a large number estimated to one million in 2001. According to Master Card Dubai Centre, they fulfill 40% need of cards in Gulf area, issuing Affinity, Gold & Business Cards. Master Card Univ. in America plays a key role in research about card’s marketing, developing and training of employees. Visa also claimed that their presence in Gulf is 70% with Electron, Classic, Gold and Business Cards. In 1995, the business of $547 million was done with cards. In September 1990 there were 1 billion Visa cards in the world, which were accepted by 18 million traders at 20,000 places. Cardholders could attain money from 55,400 ATMs in 120 currencies, while 21,000 trade centers accepted cards.

Visa has its own Automated Clearing House (ACH), alongwith multimedia network called visa net, which deals with 3700 transactions/second in 160 currencies so the visa is not a card issuer company but a comprehensive payment system.

With this brief information we can guess the card presence in the world. Now we look at their functions.

3 Procedure:7 Simply, cardholder comes to a sale point, picks the goods, shows his card to the

buyer for billing. The buyer puts the card into the machine to attain information about the credit of cardholder. When he is satisfied about payment by the acquirer bank, he writes the bill, gets it signed by the cardholder and sends it to the bank (acquirer) who transfers the money to the buyer’s account after deducting the service charges (2-5% for example). If the type of card is online-debit card the money is transferred on the someday if it is off line debit card the money can take three days to be transferred. One transaction may be processed in 20 seconds with electronic means. Cardholders can get cash from ATMs (Automated Teller Machines) 24 hours a week with finance changes from the beginning of the withdrawal. These cards are of different types.

4. Types of Cards: Credit cards are mainly of two types:

a) Revolving Credit Card (b) Charge Card.

a) Revolving Credit Card: As its name reveals the bank gives the cardholder a revolving credit line that

enables him to purchase or get cash to a certain limit, and pay back in installments with finance charges (interest) with a regular minimum payment of 5 or 10% monthly. Credit period of every card may differ from the other like 30, 45 or 60 days.

Characteristics of Revolving Credit Cards:8

i) This card demonstrates a real credit for a person.

ii) Some of its types are issued without fee.

48 Journal of Islamic Banking and Finance Oct.- Dec. 2013

iii) No bank balance is required for this card. iv) Additional cards for kids and wife are issued on behalf of a Revolving Credit

Card. v) This card can be used nationally and internationally. Vi) It can be used to purchase online. vii) No interest on purchasing but on withdrawal of cash from the first

transaction. viii) There is interest and penalty on defaulters. ix) Defaulters can be prisoned also.

b) Charge Card: i) It is issued by banks and commercial companies. ii) The payment is made within the credit period, otherwise the card is canceled . iii) This type of card is issued on fee in general and can be used for purchasing

online also. * These cards have different grades like: i) Visa Silver Card. It is a charge card for common people. ii) Visa Classic or Commercial Card: It is for rich people, including Visa cash

card. This type has a big credit line or can be without credit limit with many other characteristics like9. i) It provides life insurance upto $35000. ii) Insurance on accidents, medical insurance during travelling, insurance

on emergency return to homeland, facilitation for returning, provision of travellers cheques.

iii) Financial assistance in journeys. iv) Alternate of lost card. v) Priority in booking hotels and air tickets. vi) Online Service 24 hrs. vii) Purchasing from International Markets without long queries.

c) Debit Cards: This type of cards is issued upon bank balance, so` it is not considered a credit

card. This card can be used to get money from ATMs and buy commodities and services also. The money is transferred from card holder’s account to the service provider. There is no credit line but all payments are bound to the balance available. Many Islamic banks have issued this type of cards.

5. Parties of Card System All these cards are issued after an agreement, initially signed between the issuer

and Card holder but some other parties are also involved in that agreement, they are as below:

Journal of Islamic Banking and Finance Oct.- Dec. 2013 49

i) International Institutions: Mother institutions of card system are Visa, Master Cards, Diner’s Club. American

Express, Barclay etc. They possess trademarks, allow the banks issuance of cards holding their monograms, fix the types of cards, clarify the regulations and conditions, make clearings of daily transactions, provide experience to banks and help them in chasing the defaulters and counterfieters against a percentage or reserve money according to the agreement between them.

ii) Card Issuer: This is the bank or company that issues a card with help of modern technology and skilful staff.

iii) Cardholder: He is the client or customer to whom the card is issued with certain conditions and terms that we will mention in coming lines.

iv) The Trader: He is the buyer who relies upon cards and sells on debt initially.

v) Bank of trader (Acquirer): That is the bank which deals with the buyer and the issuer to transfer money to the buyer’s account.

These five parties are involved in the agreement of card system that mainly consists of the following terms and conditions.

6. Agreement of Credit Cards10 These agreements are mainly same that include:

i) Important Definitions: The agreement relates the definitions of card, its holder, the issuer, the buyer, the acquirer and additional card holder.

ii) Bond of the agreement: The card holder, the issuer, the acquirer, the buyer and additional card holder are held responsible in the card agreement.

iii) Period of Validity: The period of card validity is mentioned in the agreement alongwith the card itself.

iv) Card Fee. If the card has issuance fee, it is mentioned in card agreement. It was $100 in the beginning, then reduced or demolished.

v) Signature of the holder: The card holder undertakes to sign the bills properly according to the signs on the card.

50 Journal of Islamic Banking and Finance Oct.- Dec. 2013

vi) Undertaking of the bank: The bank (acquirer) undertakes to pay all bills to the buyer.

vii) Credit line: The agreement relates the maximum amount to be used for purchase or cash.

viii) Usage of the Card: The card agreement limits the usage of the card in purchasing or withdrawal of money or both.

ix) Promise of Payment: The cardholder promises to make payments in time and to bear penalty in case of

defaulting.

x) Usage of the account: The agreement includes the details about the account to use the card for purchasing cash withdrawal from ATMs, get debt from other banks, attain travellers cheques, etc.

xi) Change in Conditions & Terms: Only the bank (issuer) or the mother issuer can amend the agreement.

xii) I. D. No.: A secret password is issued to the cardholder with the issuance form.

xiii) To pass the personal informations: The card holder allows the issuer to pass his particulars to the concerning authorities.

xiv) Complaints of Bills: The card holder undertakes to solve the goals quality problems with the buyers not banks.

xv) Misuse of Card: The card holder accepts the responsibility of misuse of the card by his family etc.

xvi) Foreign Currency: The cardholder allows the bank to fix prices of the foreign currency, in case of purchasing or getting cash abroad.

xvii) Finance Charges: Cardholder allows the issuer to buy finance charges monthly or yearly. The wall street journal announces the interest rates regularly in USA alongwith the prime rate.

xviii) Mode of Payment: The agreement expresses the type of payment, in full or installments.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 51

xix) Fee of execution:

If the issuer is enforced to execute the holder in court the fee will be born by the holder.

xx) Final Law for decisions: The problems of cards are solved according to the regional or International law. Beyond these common terms and conditions every bank can make its own frame of conditions.

This agreement creates some relationship among the above mentioned parties. Basically this relationship is established between the bank (issuer) and the card holder. To examine this relationship is our topic of the paper.

Part II: Fiqh Boards Opinions on Credit Cards (Analytical Study)

Cards entered the Middle East in 1980’s. In the next decade of 1990’s they were examined as effective on different aspects of life i.e. (social, economic, religious etc.) Card issuers introduced many facilities and incentives to adopt cards. Many changes came into card system itself, so the opinions of modern Muslim scholars also travelled with the card industry, in order to examine credit cards from Shariah (legal) perspective for the purpose of mass guidance. The institutions that promoted the legal opinions about cards are as below:

1. Islamic Research Institute of Al-Azhar University, Egypt 2. Kuwait Finance House 3. Ummul Qura University (Makkah Mukarrama) 4. King Abdul Aziz University, Jeddah 5. Al-e-Bait Fiqh Council Qum, Iran 6. Admn. of Bank Services , National Commercial Bank of Saudi Arabia. 7. Islamic Law Council, Jeddah. 8. University of Arab Emirates.

Islamic Jurisprudence has provided basic principles in every sphere of life. Now it is the duty of Muslim Scholars to present the new coming issues to those regulations and examine them properly to make them practicable for a Muslim society. The above mentioned institutes contributed to analyse the transaction of credit cards Islamically and gave their sound and precious opinions about this innovation. We present those opinions here to promote the topic:

1. Islamic Research Institute of Al-Azhar University Saleh Kamel Centre for Islamic Economic at Al-Azhar University carries out the

research in Economic matters as a part of Islamic Research Institute. Its Director, Prof. Dr. A.H. Omar represented Al-Azhar through his lecture on credit cards at Ummul Qura University (Makkah) in 1990 then he wrote a paper on the topic, duly published in the

52 Journal of Islamic Banking and Finance Oct.- Dec. 2013

scientific journal of Faculty of Economics & Management, University of Ain Shams, Cairo, in 1992. In 1997 Prof. Dr. Shoqi Dunya represented Al-Azhar in the meeting of International Islamic Fiqh Council, Jeddah on credit cards. Prof. Dr. A.H. Omar participated in National Commercial Bank of Saudi Arabia’s seminar on Credit Cards held in Jordon in 1998. Dean, Faculty of Shariah & Law. Prof. Dr. M. Rafat Osman, Participated as a representative of Islamic Research Institute of Al-Azhar University in the annual meeting of International Fiqh Council, Jeddah held in Riyadh in September 2000 and passed a resolution on Credit Cards (that will be mentioned).

Prof. Dr. A.H. Omar explained the view point of Al-Azhar saying: the relationship between the issuer ans the Card holder can be resembled to the transaction of Kafalah (guarantee) in Islamic Jurisprudence, due to the following arguments11.

i) Meaning of Kafalah (guarantee)

The issuing bank guarantees the card holder to the buyer (trader). According to Islamic Jurists Kafalah means the acceptance of responsibility for a gazzetted right on a person.12 Law experts also say that the issuer is considered the guarantator of the card holder. Moreover there are three parties involved in a guarantee as the card agreement is held also among three parties.

ii) Guarantee before occurrence of debt

To consider the card agreement as a guarantee is possible because the Card (guarantee) is issued before the debt occurs. Jurists explain it as guarantee before the existence of debt, as Imam Sirakhsi says, If a person says to the other, “Give something to a person, it is valid” 13. Like this are the quotations of Maliki, Shafee & Humbli Jurists.

iii) Cash Guarantee

The Bank demands the Card holder to have a balance for a debit card. Although this relationship; appears to be Wakalah (Agency) but it can be Kafalah too as some Hanafi jurists say, if a person takes cash guarantee for a cash debt, it is legitimate 14.

iv) Reception after payment

The issuer pays first to the buyer then get back his money from the card holder. This pattern has been illustrated in jurist’s examples that guarantator has no right to demand money before payment 15.

v) Credit line

The issuer bank gives the Card holder a credit line to which he can purchase goods or get cash. This behaviour also has been mentioned in jurists quotations like, “If a person says that he is responsible of a debt of (1-10 Dirhams) for someone, so it is an acceptable statement 16.

vi) Right of Card Cancellation

The Bank reserves the right to cancel the card anytime. Jurists allow for that saying, “The guaranatator has the right to withdraw his guarantee and he is the guarantator only for the transaction completed”.17

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vii) Purchase from different buyers and Cash from different ATMs The above mentioned facility came in the quotations of Imam Sirakhasi, “If

someone says to some buyers”, Give someone his needs and I am responsible for the prices, that is true.18 If someone asks the other to give someone cash, so the giver will refund it from the first who asked 19. This applies to the ATMs.

viii) Validity Period of Card and Multiple Purchases Card validity date is mentioned at the card in which the card holder can purchase

several times, Imam Sirakhsi explained it saying. “If a person asks other to sell goods to someone today or until the end of the year, it will be countable” 20

ix) Purchase Bills The buyer sends purchase bills signed by the card holder to the issuer as a proof of

sale, this situation has been related in Imam Sirakhasi’s quotation, “The guarantor is not bound of anything until there is a proof on purchase”. 21

x) Durability of goods The card agreement states that if the goods are returned on account of defects the

issuer bank will not consider the bills. Imam Sirakhsi illustrates that saying, “If the goods are returned for their defects the guarantor will be free of his responsibility”. 22

xi) Credit Period: The issuer gives the card holder a credit time of 30, 45 or 60 days to pay the debt

without interest on purchasing. Islamic jurists verify it, so the guarantor will not be asked to pay immediately but the time given will be considered not more. 23

For the above mentioned arguments Prof. Dr. A.H. Omar considered the card agreement as kafalah. Some other jurists also were of the same opinion as Dr. A. Sattar Abu Ghudah of Dallah Company said, “It is kafalah with right of withdrawal from it. 24 The same point of view was in the Fatava (legal opinion) of Kuwait Finance House.25

Now we take a critical view of the above mentioned opinion. No doubt that the “Kafalah” contract cannot be ignored at the time of legal determination of the relationship between bank & cardholder but Islamic jurists has established certain principles necessary to the legitimacy of a contract. If they lose one of those conditions, they cannot be acceptable. Now we see that some important elements of a legal Kafalah contract do not exist in card agreement.

i) Debt should be obligatory, stable and known. In the previous adjustment the author took card agreement as “Guarantee of

unobligatory debt”. Shafee jurist did not accept it saying, “Debt should be an obligatory existing right at the time of Kafalah contract”26. Imam Ibn Hazm says, “Guarantee of a unknown thing is not legal”27 because ignorance in a contract brings to loss that spoils the whole transaction.

ii) Withdrawal from a Guarantee

The issuer can cancel the card any time as it is mentioned in every agreement. But Kafalah contract in Islamic Law is a compulsory one to both sides as Allama Ibn-e-

54 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Qudamah said. “Scholars are of collective opinion that Guarantee Contract has no choice to be dissolved from one side.” 28

iii) Demand of Payment The buyer cannot demand the card holder of the payment, whole in Kafala the

debtor can demand the borrower and the guarantor.29 Imam Shafee also confirms the above opinion.30.

iv) Wages on Guarantee The bank charges many fees from the card holder like issue fee, renewal fee,

penalty on late payment, charges on cash withdrawals etc. If we consider their relationship as Kafalah (guarantee) so all these wages (fees) become illegitimate because Kafalah in Islamic jurisprudence is a volunteer contract. Imam Sirakhasi considered these wages as bribery, 31 Imam Malik declared it against virtue. 32

v) Number of Involved Parties In the previous adjustment, the author mentioned three parties of card agreement

like of Kafalah, but the fact is that the International Parental issuers like Visa, Master Card etc. play the basic role in card system. The acquirer (bank) also cannot be ignored so they are five parties unlike Kafalah contract.

vi) Issuers point of view The bank never admits or declares in any of his agreements that it is the guarantor

of the customer but it always relates that the card holder is borrowing money with so and so conditions. 33An other bank considers the card account a debt with “finance charges”.34 It means that card issuing is a profitable business of banks.

vii) Change in amount of debt In Islamic point of view there is a facility to solve the issue of debt between two

persons. So if the borrower agrees with the guarantor upon 500 instead of 1000 the debt will be considered as paid fully. 35 But we see that the acquirer receives full debt from the issuer and pays less to the buyer deducting its commission.

So we cannot adjust card agreement as Kafalah due to the above mentioned points. Now we come to another opinion about relationship of the issuer and the card holder.

2. Kuwait Finance House Shariah advisory board of Kuwait Finance House was of opinion that the card

holder takes the issuer as agent to pay for his purchases and withdrawals of cash, while the bank takes its service charges that are legal, Islamically 36 because the Holy Prophet (peace be upon him) made Hazrat Orwa (R.A) his agent without wages to buy a goat and he appointed some other as his agents on wages to collect Zakah (Income Tax).37

Dr. A. Sattar Abu Guddah argued on confirming this opinion and concluded that the bank although is the agent of the card holder and it must pay the holder’s money but not its own so it pays first then receives back just to facilitate the transaction. 38

Council of Fatwa & Shariah Supervision at Dubai Islamic Bank also considered the above mentioned relationship as agency.39, Dr. M. Ali Al-Qarri of King Abdul Aziz University, Jeddah also declared the wages of agent legal. 40

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Let’s have a critical look at the previous opinion:

i) Agency or Guarantee Agency means to pay a task instead of someone with his permission but if the

agent pays from his pocket it will be guarantee of money, not the agency.

ii) Time of Transaction The acquirer pays to the buyer in one week or three days. If the transaction is

cleared electronically fast the payment takes one day. The debt with time limit and different charges leads to interest involvement which is prohibited.

3. Real Function We can consider the card transactions as agency if the buyer accepts to let the bank

receive money first then to transfer to the buyers account later but the real function is receipt of money after paying to the buyers.

4, Bank balance and Agency We find in the agreements of the buyer and the card holder that bank considers the

latter indebted that means it is a debt contract not agency, specially when there is no bank balance.

5. Relationship between buyer and card holder If this relationship is considered agency it should not expire after purchase but we

see that the card holder has no concerns with the trader after he signs the bills but buyer is who contacts the bank (acquire) for payment.41

In the light of above mentioned observations we can’t apply the agency contract to the relationship between the buyer & the card holder.

We come to another opinion. –

3. Ummul Qura University (Makkah Mukarramah)

Representing the Ummul Qura University Prof. Dr. A. Wahab said that credit cards are a mere debt contract, because42:

i) This application is according to the real practice

ii) Governments, legal Financial and Economic Institutions consider this application.

iii) For many years card issuers have been functioning and their disputes are being solved on this base.

iv) The basic objective of cards is supply of debt, so the bank is lender and cardholder is the borrower.

v) The basic elements of debt contract are there in card agreement (i.e. two main parties, code of acceptance and compensation). In card agreement debt contract means the release of money for cardholder to use it anytime. So we can say that it is a debt contract from any perspective.

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Inspite of the significance of this illustration we think that it has to face some critique:

i) In Islamic Law (Qardh) debt means to cut money for the other or to give money in his possession physically to get it back in the same amount. The bank does not give money direct to the cardholder for purchasing except some cash by ATMs. If the cardholder returns the goods he can’t get the price back so he may not use the money without bank’s interference. So we can’t resemble this case to Islamic contract of debt (Qardh).

ii) The objective of debt in Islamic perspective is virtue and to fulfill the need of a needy without wishing reward but the debts of cards have no pity on the cardholders as they have to pay high finance charges and penalties on delayed payments.

iii) Islamic law prohibits interest on debt that makes a contract illegal while bank charges interest on cash obtained by cards. This condition can’t be changed also. So we are unable to take it as Islamic debt contract.

iv) Bank can cancel the card anytime while Islamic debt contract requires the lender to allow the borrower avail the debt. So the cancellation of card even without use opposes the conditions of Qardh.43

v) If the card is a debit card the debt does not exist in fact. Then it will be more logical to consider this contract as agency, guarantee or transfer of money, not a debt contract.

vi) Some card agreements mention that the buyer sends the bills to the issuer who possesses the goods with acceptance. It means that the bank purchased and sold on debt. To collect and sale debt in one contract is prohibited44.

vii) Card is used mainly for purchasing and hardly for getting cash while (Qardh) means gaining cash only so the Mudayanat contract is nearer to the card agreement than the Qardh (Debt) contract.

viii) Some Islamic Banks require balance to issue cards that makes the contract agency with wages and not a debt contract. They provide free loan if the cardholder defaults for a certain period.

The debt contract appears to be the real one with credit cards but due to the above mentioned observations it is difficult to accept it like that. The second important aspect is the Relationship between the Issuer and the Buyer

The banks sign agreements with several retailers who agree to accept cards instead of cash. The banks charge a certain amount from the bills presented for payments. Muslim jurists have different views about this deduction. Some of them say that it is a back door to interest. Some others consider this deduction as wages of intermediation, while they are service charges according to another opinion. Moreover some take it for discount and it is deduction of commercial papers as counted by some others.

We take a glimpse of these opinions:

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4. King Abdul Aziz University, Jeddah

The Director of Islamic Economics Research Centre, King Abdul Aziz University, Prof. Dr. M. Ali AlQarri says that when a buyer sends the bills to the bank it deducts its fee and pays to the buyer. This transaction resembles to the deduction of commercial papers. The bill signed by cardholder is a payable draft. What strengthens this idea is the condition of banks for buyers that they won’t be paid if the bank is not paid.

Before we observe this opinion we come to a juristic point. When we see this transaction it appears to be as sale of debt to other than the borrower "بيع الدين لغير من هو عليه ”. Jurists have two opinions about that.

1. This is prohibited in the opinion of majority of the jurists because:45

a) sale occurs upon existing, priceable goods (مال متقوم) and debt is not like that

b) Sale requires the ability to supply the commodity while debt is not like that

c) It is essential that debt is recent, proved and stable

d) To receive the two alternatives at the same place is also necessary.

Second Opinion is of Imam Zufar. He says that purchase of debt from the borrow and other than him is allowed.46 because Ibn-Omar used to exchange gold and silver on debt.47 This proves the exchange of currencies on debt. But the first opinion of majority is stronger. So if we consider the card transactions deductions as per commercial papers, it is prohibited.

On the other hand: (i) Commercial papers mean late payable papers. The banks pay in advance and

charges for that. But the cards bills are promptly payable contrary to the commercial papers.

(ii) To accept the commercial papers is not compulsory to the banks while card’s bills are compulsorily acceptable by the banks.

(iii) The traders benefit from early payments of the commercial papers while they have to pay for card bills reimbursement.

For the said reasons it is difficult to accept this relationship as deductions of commercial papers.

Another opinion is of the King Abdulaziz University’s Dr. Rafiq Al-Masri as he said that the bank sends customers to the buyer and charges its legal commission whether fixed or in percentage48. The same opinion was of Mr. A. Sattar Qattan of Kuwait Finance House.49 Justice Taqi Osmani also supported this opinion arguing that:

(i) Banks provide service to the buyers on wages.

ii) This deduction of bank differs from the interest rate usually so it is wages of intermediation. Although it is a strong opinion but we can observe some points like:

58 Journal of Islamic Banking and Finance Oct.- Dec. 2013

a) When we look at intermediary’s work we found that he works hard to sell a good (i.e. advertisement, commencement etc). But the bank doesn’t has any concern with the sale except it enlists the sale points. So the job of both is different.

b) When there is no balance the card holder can get loan from the bank while intermediary does not do that.

c) The acquirer (bank) pays to the buyer less than the issuer receives from the cardholder. This amount is interest in contrary to agent’s job.

d) Agency (intermediation) is not a compulsory task while card’s agreement is compulsory to the buyer and the bank.50 For that we can say that there are certain differences between intermediation and card agreement.

5. Aal-e-Bait Fiqh Council – Qum-Iran The members of this council has revealed their opinions about credit cards.

According to Sheikh Hasan Al-Jawahiri we can suppose a sale agreement between the buyer and the bank that purchases on less rates and sells to the cardholder on high rates. So the bank is real purchaser not the cardholder because:51

a) The buyer neither knows the cardholder nor wants to give him loan, especially abroad.

b) The bills of prices are paid by the bank not the cardholder.

c) If the buyer could not get payments for some reasons he is unable to chase the cardholder.

For these points we can say that the bank is the real purchaser, not the cardholder. So there are two agreements; first between the buyer and the bank at low price, and the second between the bank and the cardholder at proportionally high price (with profit). What supports this adjustment is that if the cardholder returns the goods he can’t get the price back. So he is not the real purchaser. There are somethings notable;

a) We observe that this adjustment has an obvious artificiality because the cardholder chooses, purchases and signs the bills then bank knows. How can a supposed contract between bank and buyers be acceptable?

b) If Murabaha contract (sale on profit) is applied here it also does not justify because in Murabaha contract the purchaser requests the bank to purchase for him a specific item but here the card holder purchases himself.

c) The impact of card agreement doesn’t appear to the side of the bank, for example, in this case the goods should have to enter in bank’s possession and it has to collect them that does not happen. The saying that the buyer does not recognize the card holder is not correct also because he agrees to sell on card which is considered the cardholder’s recognition. Perhaps the buyer would not agree to sell without card, but seeing the card he sells.

d) Bank’s payment is guarantee of money and not purchase, if there is a bank balance it is agency.

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e) The buyer can chase the cardholder if not paid by the bank as allowed in Islamic law and some other laws also.

f) If the goods are returned for defects the buyer does not return the money to avoid cardholder’s utilization of debt without bank profit on money.

For these observations we are unable to accept this adjustment. Another opinion is of Sheikh M. Ali Taskheeri of Qum, as he considers it the contract of debt transfer, Sheikh Ali Indleeb also supports this opinion as the chairman of Qum Fiqh Council Sheikh Momin Qummi also is of the same opinion.52

Although this is a precious opinion because the cardholder transfers his debt to the bank for the buyer but there are some conditions for legal debt-transfer that are not found in cards process. We can examine that as below:

1) In Shafee School of jurisprudence, there are 6 pillars of debt transfer contract, one of them is loan of the borrower on one who is being loaded with debt transfer,53 while in credit card the situation is opposite.

2) Imam Ibne Qudamah has mentioned the unanimous opinions of Jurists 54 On that the debt contract is a virtual one without any wages or output, while the banks don’t know that.

3. Hambli and Maliki jurists55 put the condition of equality in the two amounts in number, characteristics and time that means equality of currency and prompt payment. If the payment is delayed one month the transfer contract will be void. The banks charges for cash, the currency differs while the transaction takes place abroad. The banks give credit period for purchasing and cash withdrawal which is contrary to transfer, contract in Islamic Law.

Even we can’t negate the presence of debt transfer contract in card agreement but the above mentioned points make its acceptance difficult. We come to another point of view about cards.

6. Bank Services Division - National Commercial Bank, Jeddah. NCB hosted a seminar on credit cards in Manama, Bahrain in Sept. 1998, that

included the scientific opinions of the following scholars.

1. Dr. Ahmad Abdullah, Secretary General, Higher Finance Council of Sudan. He is of opinion that the relationship between the bank and the cardholder is of borrowing. The cardholder purchases the card against fee and bank holds guarantor or agent for him.56

These opinions have been discussed in previous pages.

2. Dr. Abdullah Mosleh (member Shariah board of NCB). He accepted the previous adjustments like, debt contract, transfer of debt etc.

3. Mr. Amr Hamza (Credit Cards Centre NCB, Jeddah). He was of a professional opinion that cards are bank’s credit facility with a mere commercial relationship between the bank and the cardholder as an adhesion contract (unconditional acceptance from the cardholder). This opinion reveals the fact of card’s function but we need to determine their legal position

60 Journal of Islamic Banking and Finance Oct.- Dec. 2013

4. Sheikh Ibne Manee (Member, Scholars Supreme Council, Kingdom of Saudi Arabia). He considered the cards’ contract as debt transfer with guarantee of money by the bank on valid wages.57 Dr. Abu Ghuddah also supported this opinion58 (comments passed).

5. Prof. Siddique Al-Dharir ( University of Khartoom, Sudan). In his opinion, it is a debt transfer contract but interest involved transactions are legally prohibited. He suggested an alternative; installment card issued by Islamic banks with their own trade centers dealing on non interest basis.

It is a valuable thought that needs for its implementation, a long term project and possibilities to establish a parallel system.

6. Prof. Dr. M. Ali- Al-Qari (Islamic Economics Research Centre K.A.A. University, Jeddah). He is of opinion that cards’ contract is a guarantee with charges but these charges are not legal. So he suggested an alternate card called Murabaha cost plus card only for purchasing, in which the cardholder would purchase for the bank and then purchase from the bank on profit. Top hold the contract from both sides is allowed in Islamic Law as father can sell for his son as his agent and purchase it for himself.

This is also a good idea but needs a solid strategy to be applied, but in the present situation people are using cards issued by international companies and they want to know the legitimacy of their behavour. Some institutions have provided guidance in this regard among them is:

7. Islamic Fiqh Council of OIC, Jeddah. In this Council Muslim jurists deliver their well thought opinions among them is Dr. Wahaba Zohaili who considered the cards’ a debt transfer contract or agency on wages.59 In its lately held session in Riyadh (KSA) Sept. 2000, the council introduced Dr. Abu Ghuddah opinion that card contract is a guarantee of money before use and a debt transfer after use. Dr. Nazih Kamal considered it guarantee of money. The council issued some resolutions in this regard that:60

i) With condition of interest card issuance and use is prohibited.

ii) a) Debit or charge card with bank balance is allowed with service charges.

b) Deduction of bank charges from buyer’s payment is legal provided he doesn’t add it to the prices.

iii) Cash withdrawals are debt with interest.

vi) To purchase gold and silver with credit card is not allowed as the currency purchase also.

According to this opinion bank’s deduction from buyers bills is allowed but it is a back door to interest on money investment, because if transaction took place in London the acquirer (bank) will be a third party about which there is a previous resolution of the council that it leads to the deduction of commercial papers which is prohibited. So we can’t consider this deduction as legal.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 61

To purchase gold and silver with a debit card also like a credit card, so how we can legalize one and prohibit the other while prompt possession of price is not in both cards.

Some Hanafi jurists have allowed artificial receiption possession of money61 and possession as the council also allowed it in its resolution No.(53/4/6).62 So we can say that if the other transactions of a card are legal, the purchase of gold and silver also may be legal.

We examine another opinion about credit cards. Arab Emirates University. This University held a conference in Dubai in May 2003. World Class Muslim Jurists participated. Mufti of Tunis Sheikh Mukhtar Sullamni halted from the previous resolution of the Fiqh council of OIC63, Dr. A. Haleem Omar considered it incomprehensive64. The participants concluded that:65

i) Usage of Debit Card is legally allowed

ii) Condition of penalty in Card agreement is not legitimate

iii) Credit card with interest is prohibited.

iv) It is recommended that legislation should be launched to regulate card use and stop its illegal use.

The author attended this conference and found a sound compliance between his conclusion and conference’s resolutions.

Conclusion: We conclude that cards agreement does not fit with a living legal contract but it

appears to be a compound of different contracts. So we can say:

i) It can be called guarantee at the time of issuance when there is no debt or it can be agency.

ii) With bank balance it can be an agency to pay bills.

iii) With no balance it will be a debt contract.

iv) Debt transfer contract also exists there with force.

So the card agreement is a new compound contract with a permanent personality of everyone of them provided that there is no illegal condition in any of those contracts.

To support our point of view we can say that:

i) Maliki School of thought says. Lease with sale is not illegal.66

ii) It is said that Mudarabah (money management) is a compound of three contracts.

a) It is like Wadeea (deposit) at the time of giving money to the counterpart.

b) It is as agency while giving him power of attorney.

c) It is Musharakah (partnership) when the profit is divided.67

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It is necessary to care for two things while combining different contracts:68

a) There should not be created a prohibited contract at the time of combination as the combination of sale and debt at the same time.

b) No contract should be contrary to the other so that it may not lead to contradiction that ends to cheating or interest.

For alternative we can suggest the debit cards issued by some Islamic Banks like Dubai Islamic Bank, Kuwait Finance House’s Visa. Rajhi card, Qatar Islamic Bank.

They do not charge interest even if there is no balance at some times, but they will provide Qardh Hasan (debt free of charge). Also we can adopt the decisions of Dubai Conference on Electronic Banking.

May Allah guide as to the right path.

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Nahzat al-Arbia, Misr-1998, Prof. Dr. M. Abdul Haleem Umer, Shariah Bankari of Credit Card and Accounting System, P. 115, Published by Itrak 1997, Misr. Payment with Plastic by Events & Schmalensee, P-7, The Mirt Press U.S.A.2000.

2. Al-Maurid Al-Qareeb, P.O. 104, Published by Darul Elam lilmalayin, Beirut 1999. 3. Dr. Khalid Wohai, Transaction of External Banking, P.O. 30, Darul Manahij, Uman-

2000. 4. Working Paper on Credit Card of National Bank of Misr for the Seminar of Police

Academy, Cairo, December 14, 1998. 5. Crimes of Credit Card by Riaz Fathullah, P.O. 14, Published by Darul Sharooq, 1995. 6. The Credit Card Industry, A History, by Lewis Mandell, P. 2-5, Twyne Publishers,

Boston, U.S.A., 1990. - (Gulf marketing Review, March 1996, P. 29, 30) - Credit Cards: User & Consumer Attitudes, Published by the Federal Reserve

bulletin Washington D.C., Sep. 2000 P. 623-624. - Practical Banking & Building Society Law, P. 241. - The Cashless Society by Robert A. Hendrickson, p. 11, Printed by the Comwall

Press, Inc. Comwall, N.Y. 1972. 7. [email protected] 8. Practical Banking & Building Society Law, P. 242, by Prof. Anu Arora Blackstone

Ltd., London, 1997. 9. Visa leaflet for customers. 10. Association National Bank (Delaware), Masrecard & Visa agreement TX, U.S.A. 11. Prof. Dr. M. Abdul Haleem Umer, Accounting & Shariah Aspect Credit Card, P.O. 57,

Published by Itraq, 1997, Misr. 12. Mghni al-Muhtaj, 1973. 13. Al-Mabsoot 20/50, Published al-Saadata, Misr 1974,H. 14. Fathul Qadeer 1887, Published by Darul Akhia al-Turas al-Arbi, Lebnan

Journal of Islamic Banking and Finance Oct.- Dec. 2013 63

15. Kitab al-Hadaya 3/91. 16. Mughni al-Mukhtaj 2/203 17. Al-Kharshi Ali Mukhtasar Khalil, 6/52, Sharaha Fathul Qadeer, 7/183 18. Al-Darul Mukhtar Lilhaskafi, 2/119. 19. Magazine, Islamic Fiqh, Jeddah, 7/1/368 20. Al-Fatawa al-Shariah Fil-Masail al-Iqtasadia, Juz 1, 2, 3, Fatwa No.477. 21. Mughni al-Mukhtaj, 2/200-202. 22. Al-Mukhali, 8/117 Masalat (1231) Published by Darul Turas, Misr. 23. Al-Mughni, 4/555. 24. Fathuul Qadeer, 6/299. 25. Al-Umm, 3/231. 26. Al-Mabsoot 2/32, Bab-al-Kafalah Bil-maal. 27. Hamish Mawahib al-Jalil, 5/111. 28. Announcement of Visa Master Card, (National Bank of Misr Band-6). 29. Announcement of America Belaware Bank Visa Card. 30. Kitab al-Hadaya 3/91, Fasal-al-Kafala. 31. Abdul Sattar Booklet of Kuwait Finance House, P.O. 14, Fatawa Shariah. 32. Mughni Ibn-e-Qudama, 5/58 33. Magazine Majma al-Fiqh al-Islami 7/1/366 34. Fatawa al-Khidmat al-Masrafia, P.O. 289, Fatwa No.65, Published by Dala Company,

Al-Barakat al-Saudia, 1998. 35. Magazine Majma al-Fiqhj, 7/1/397. 36. Al-Sheikh Ibn al-Manee, Magazine al-Majma, 10/3/70 37. Moghni Ibne Qudama 5/58. 38. Legal System of Payment card (44 Al-Hadith) (Abu Daud (3405) Tarmizi 1234) 39. Fatawi of Bank Services P. 289 40. Magazine al-Majma 7/1/391. 41. Sheikh Ibn-el-Manee, Magzine al-Majma 10/3/60. 42. Dr. Abu Sulaiman’s book, Debt Card published by Darul Qalam Damascuss 1998. 43. Mughni Al-Muhtaj, 3/225 44. Fata No.65. 45. Al-Mabsoot 14/123 al-Badaigh 7/3104, Mughni Al-Muhtaj 2/71. 46. Al-Mabsoot 14/22. 47. Ibn Maja (2262). 48. Kashaf al-Kana 3/302. 49. Magazine al-Majma 7/1/410. 50. Booklet of Kuwait Finance House, P.O. 20 (Murja Sabiq). 51. Prof. Dr. Ramzan Hafiz Al-Sauoti, Jamai al-Azhar. 52. Magazine al-Majma 8/634. 53. Article of Credit Cards, Iranian Magazine Akl-Taqreeb, Vol.no.3, No.1414 H. 54. Mughni al-Muhtaj, 2/193. 55. Al-Mughni 4/521, Mawahib al-Jalil 5/93. 56. Article on Credit Card, their Shariah and Legal Adjustment, Manama, Bahrain 7-

8/9/1998 arrangements by Saudi National Commercial Bank, Jeddah.

64 Journal of Islamic Banking and Finance Oct.- Dec. 2013

57. Previous Seminar, article on Credit Card, P. 9. 58. “ Seminar: Traditional Article Credit Card. “ Seminar: Article on Credit Card, P. 10. “ Seminar: Article on Credit Card, its report, their relationship and legal adjustment. “ Seminar: Article on Credit Card, P. 20. “ Seminar: Article on Transactions of Credit Card and Shariah Change. 59. Magazine al-Majma, 7/1/669. 60. Resolution of Islamic Fiqh Council No.108 (2-12) Al-Riyadh (23-28 Sept. 2000). 61. Ibn Abidin 4/562. 62. Resolutions & Suggestions of Islamic Fiqh Council, Jeddah, P.113. 63. Articles on Electronic Banking, Conference of Emirates University Dubai 5/2320. 64 Comments of Prof. Dr. M. Abdul Haleem, Director Markaz Saleh Kamel, Jamai Al-

azhar 65. Resolutions & Suggestions of Electronic Banking Conference Dubai. 66. Mawahib al-Jalil 5/396 67. Comments of Prof. Dr. M. Abdul Haleem, Director Markaz Saleh Kamel, Jamai Al-

azhar 68. Dr. Nunzia Hamad, Contemporary Transactions, Magazine al-Majma, 10/2/73

Journal of Islamic Banking and Finance Oct.- Dec. 2013 65

Adoption of AAOIFI Shariah Standards: Case of Pakistan.

Sharika (Musharaka) and Modern Corporation

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI): Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an independent body dedicated to the development of international standards applicable for Islamic financial institutions. The Bahrain-based organization was registered as an international autonomous non-profit making corporate body in 1991 and started producing standards in 1993. AAOIFI is supported by institutional members including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry. To date AAOIFI has developed standards related to accounting (26), auditing (5), governance (7), ethics (2) and Shariah (45) for Islamic financial industry.

Sharika Sharika means “Sharing” and in broader terms of Islamic Fiqh it covers two main

kinds5;

(i) Shirkat-ul-Milk –A joint ownership of two or more persons in a particular property

(ii) Shirkat-ul-Aqad.-A partnership effected by a mutual contract

Shariah standard No. 12 is applicable to Sharikat al aqd (contractual partnership), including modern corporations. However, following partnerships are specifically excluded in the scope of the standard Partnership where parties jointly own an asset

• Sharik al-mufawada

• Mudaraba (AAOIFI Shariah Standard no. 13 is applicable to this form of partnership)

• Sharecropping partnership (irrigation and agricultural partnership) Source: State Bank of Pakistan Quarterly Bulletin April-June 2013

66 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Definition: Sharikat al aqd According to the AAOIFI Shariah Standard no. 12 Sharika al-aqd implies “an

agreement between two or more parties to combine their assets, labour or li abilities for the purpose of making profits”. The standard provides detailed classification of partnership under two main categories;

(i) Traditional fiqh-nominate partnerships; (a) Sharikat al-Inan (contractual partnership), (b) Sharikat al wojooh or dhimam (liability partnership), (c) Sharikat al amal (vocational partnership and partnerships for undertaking difficult work or accepting jobs)

(ii) Modern corporations; (a) Stock company (b) joint-liability company (c) Partnership in commendum (d) company limited by shares (e) Allotment (muhassa) partnership (f) Diminishing partnership ( originated from Sharikat al-Inan)

The above mentioned two main categories have been made two main sections of the standard while overall the standard has got five major clauses including Scope and Definition.

Bulletin for this quarter will discuss only the first part; Traditional fiqh-nominate partnerships, of the standard while the second part on Modern Corporations will be discussed in the coming bulletin. The clause related to the first category has been sub-divided into three sub clauses;

1. General rulings for Sharika especially Sharikat al Inan

2. Partnership in creditworthiness or reputation

3. Service Partnerships (professional or vocational partnerships and partnerships in skilled trades)

Brief overview of these clauses is as follows;

1. General rulings for Sharika especially Sharikat al Inan According to the standard “Sharikat al-Inan is a partnership between two or more

parties whereby each partner contributes a specific amount of money in a manner that gives each one a right to deal in the assets of partnership, on condition that the profit is distributed according to the partnership agreement and the losses are borne in accordance with the contribution of each partner to the capital”. General rulings of the standard provide detailed guidelines on following areas;

i. Conclusion of a Sharika contract: This sub-clause discusses that a Sharika contract can be concluded by agreement between parties and the contract can be registered officially in case of necessity. Objectives of partnership are clearly expressed in the document of partnership or in the articles of the association of the company while amendments like change in profit sharing ratio, share in loss with respect to share in capital etc can be made at any time of the contract.

It has been mentioned explicitly that it is permissible to enter into partnership with non-Muslim or conventional banks, however it is important to ensure while making

Journal of Islamic Banking and Finance Oct.- Dec. 2013 67

arrangements that all rules and operations of this partnership will be in conformity with Shariah rules. In similar context, inclusion of conventional bank as partner in syndicated financing is also allowed unless and until the right to manages remain with Shariah compliant institution and the operation of partnership is subject to Shariah supervision.

ii. The Capital of Sharika: While explaining rules about capital of Sharika, this clause states that it is must determine to each partner‟ s share in the capital whether paid lump sum or in forms of more than one payments.

It has been explicitly mentioned that capital of Sharika should be contributed in the form of monetary assets and in case of tangible commodities (with agreement of parties) monetary value of those asset need to be determined to know each partners share. In case of contribution in different currencies, the standard recommends that these currencies must be converted into Sharika currency at current exchange to determine share and liabilities of each partner. It has been allowed to contribute funds of current account as contribution to capital; however, debts (receivables) alone can not be used as contribution to the Sharika capital; however they can be made one part of the contribution when they become inseparable from other assets.

iii. Managing a Sharika venture: This clause of the standard lists transactions in which each partner is principally entitled to act in the interest of partnership and explicitly mentions that a partner is not allowed to act against the interest of partnership.

Regarding the management of partnership, this clause guides that it is permissible to restrict the management of partnership to certain partners or a single partner; therefore all other partners will not be entitled to act on behalf of partnership. However to specify a fixed amount for partner who will be managing the partnership is not permitted. To appoint a manager on fixed remunerations is also permitted and even the partner can be appointed as a manger, however, in this case his appointment as a manger will be based on an independent contract.

iv. Guarantee in a Sharika contract: In case of Sharika contract, one partner can not guarantee the capital of another partner unless there are cases of misconduct, negligence or breach of contract. It is permissible to specify a partner to provide personal guarantee or a pledge to cover cases of misconduct, negligence or breach of contract. A third party may guarantee to make up a loss of capital of some or all partners, however is subject to conditions; (a) the legal capacity and financial liability of such a third party as a guarantor are independent from Sharika contract (b) the guarantee should neither be provided for consideration nor linked in any manner to the Sharika contract; (c) the third party guarantor should not own more than a half of the capital in the entity to be guaranteed and (d) the guaranteed entity should not own more than a half of the capital in the entity that undertakes to provide a guarantee. However, it is important noticing that in case of failure of guarantor to meet his voluntary promise to cover the loss of capital, no partner will be entitled either to claim Sharika contract as null and void or to meet his voluntary promise to cover the loss of his capital.

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v. The outcome of Sharika investments ( profit and loss) Sharika contract should clearly stipulate the manner of sharing profits between partners in the contract and these profit percentages should be clearly determined at the conclusion of Sharika contract. However, it is allowed that parties among themselves agree to amend percentages of profit sharing on the date of distribution.

With reference to profit shares, principally it should be in proportion to relative capital share, however with agreement these sharing ratio can be changed though a sleeping partner cannot have more than its capital share. To stipulate lump sum from the profit or percentage of the capital of Sharika is not permitted. In case where profit earned is above the ceiling profit, the excess amount will be given to a particular partner while agreed sharing ratio in the contract will be followed when profit is below the ceiling. As far as loss is concerned, it is strictly with reference to proportionate share in the Sharika capital.

Profit will always be distributed on the basis of actual or contractual valuation of assets and it will always be distributed when capital remains intact after deducting operating costs, expenses and taxes while any method can be adopted for allocation of profit. This clause explicitly mentions that any condition, term or mode of profit allocation that may violate the principle of sharing profit will make partnership contract void.

Final allocation of the profit will be on the basis of actual profit and not on expected profit. However, it is allowed to provide some advance funds to any of partners on the condition of final settlement at later stage. In this regard parties should undertake to reimburse any amount if they receive in excess of their share of profit after actual or constructive valuation. In case where subject matter of Sharika is either by acquiring asset for income earning through leasing or by rendering some service, amount distribution will be on annual account basis subject to settlement at the end of the contract.

This clause explicitly mentions that to set aside a certain portion periodically as solvency reserve or as a reserve for meeting losses of capital (investment risk reserve) or as a profit equalization reserve is allowed while setting aside a charitable proportion is permitted with agreement of partners.

vi. Maturity of Sharika : With due notice, the Sharika can be terminated before the expiry date while the partner will remain entitled to his share in the partnership and withdrawal of one partner will not necessitate the termination of the contract between all remaining parties.

With the liquidation of asset which forms the partnership Sharika venture comes to an end at expiry date or even before that as discussed above. The termination of a Sharika can be possible on the basis of constructive liquidation; in this case it will be considered that Sharika contract has been ended while assets that are not sold through actual liquidation will be considered as the capital of new partnership.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 69

When Sharika venture comes to an end with expiry date, all existing assets shall be sold on current market value and proceeds will be spent on (a) liquidation expenses (b) financial liabilities from the net assets of the partnership and (c) distribution of remaining assets among partners in accordance to their percentage share in capital, however, where assets fall short pro rata basis will be used for distribution among partners.

2. Partnership in creditworthiness or reputation (liability partnership) The standard explains partnership in creditworthiness or reputation as “bilateral

agreement between two or more parties to conclude a partnership to buy assets on credit on the basis of their reputation for the purpose of making profit, whereby they undertake to fulfill their obligations according to the percentages determined by the parties.”

As definition explains that there is no monetary capital in such partnership, therefore the agreement between parties should explicitly discuss the agreement on the ratio of liability which each partner has to pay while paying such debt (debt created through purchase on credit).

The standard also stipulates that profit shall be in accordance to the agreement though it can not be specified as a lump sum profit, however the loss will be according to the ratio that each partner had undertaken to bear in proportion to overall assets that are purchased on credit.

3. Service Partnerships (professional or vocational partnerships and partnerships in skilled trades) The standard defines partnership as “an agreement between two or more parties to

provide services pertaining to a profession, vocation or skilled trade or to render some services or professional advice or to manufacture goods, and to share profit according to an agreed upon ratio”. With reference to proportion of services partners or their representatives have rendered, there is no Shariah implication implying that partners may distribute different types of services among themselves and may assign some or all partners a set of services or a particular service. In case where capital is required to render service each party is allowed to share capital for his/her relevant service, however, the ownership will be with the party who has provided the capital. According to the standard, Sharika contract is also allowed for a party to provide the capital goods required by the partnership in consideration for fees that will be charged against the Sharika operation as expenses. For profit distribution, the agreed ratio according to thecontract will be executed; however, a lump sum amount can not be paid or specified in the contract.

Adoption of Shariah Standard No. 12 AAOIFI Shariah Standard No. 12 related to „Sharika (Musharaka) and Modern

Corporations‟ is adopted vide circular no. IBD Circular No. 01 of 2013 w.e.f July 01, 2013 in Pakistan with following clarifications/amendments in the continuous process of standardization and harmonization of the Shariah practices in Islamic banking industry;

70 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Clause No Original Clause Amendment Clarification Scope of the standard

This standard is applicable to all forms of traditional fiqh –nominate partnerships thatoperate on the basis of Shraika al-aqd (contractualpartnership), except the partnerships that are explicitly excluded by this standard as indicated below. The standard also applies to all modern form of partnerships including diminishing Musharaka. The standard is not applicable toownership partnership where the parties jointly own an asset. It does not include rules for Sharika al- mufawada because the practical application to this form of partnership is rare and, if need be, reference should be madeto fiqh books. The standard does not apply to Mudaraba, because this form ofpartnership has a separate standard. In the same vein, it is not applicable to sharecropping partnerships, such as irrigation and agricultural partnerships. The standard does not deal, as faras modern partnerships are concerned, with regulatory policies and proceduresnecessary for operations in the market.

The standard would not beapplicable on Sharikat-ul-Milk as separate standard is issued on the same. Further, the standard would not be applicable on Sukuk al Musharakah as the same has been covered under AAOIFI Shariah Standard No. 17 related to “Investment Sukuk Standard.

Clause 3/1/1/3

It is permissible for the institutions to includeconventional banks as partners in a syndicated financingwhich operates on the basis ofShari�a, provided that the institution secures the right to manage the partnership’soperations and that such operations are subject to the Shari’a supervision.

The conventional bank, not having duly licensed Islamic banking divisionshall not act as leadarranger in a syndicated Islamic financing; it may however participate in the syndicate as partner.

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Clause 3/1/4/1

All partners in Sharika contract maintain the assets ofthe Sharika on trust basis. Therefore, no one is liable to except in cases of conduct,negligence or breach of the contract. It is not permitted to stipulate that a partner in aSharika contract guaranteesthe capital of another partner.

All partners of Sharika shall be deemed to betrustees in respect of Sharika assets; however, as trusteesthey shall be jointly and severally liable for misconduct, negligence or breach of contract.

Clause 3/1/5/6

It is not permitted to start the allocation of profit between the partners unless the operating costs, expenses and taxes are deducted incalculating the profit and the capital of the sharika is maintained intact

Islamic Banking Institutions (IBIs) mayshare/distribute profits on gross or net basis while ensuring equity,justice and transparency.

Clause 3/1/5/9

Taking into account the provision of items 3/1/5/3, it is permissible to agree that if the profit realized is above a certain ceiling, the profit inexcess of such ceiling belongs to particular partner. The parties may also agree that ifthe profit is not over theceiling or is below the ceiling, the distribution will be in accordance with theiragreement

Taking into accountthe provision of item3/1/5/3, it is permissible to agree that if the profitrealized is above a certain ceiling, the profit in excess ofsuch ceiling may, atthe discretion of otherparty, be given to a particular partner.” Further, the word “may” appearing in the second sentence of the clause is replaced with the word “shall ”.The revised sentence shallbe read as:

The partiesshall also agree ceiling thedistribution will be inaccordance with their agreement.

Clause 3/1/6/2

It is permissible for a partnerto issue a binding promise tobuy, either within the period of

Being Sharikat ul Aqd, it is not permissible,however, to promise to

72 Journal of Islamic Banking and Finance Oct.- Dec. 2013

operation or at the time of liquidation, all the assets of the Sharika as per their marketvalue or per agreement at thedate of buying. It is not permissible, however, to promise to buy the assets ofthe Sharika on the basis of face value.

buy the assets of the Sharika on the basis offace value or pre-agreed value.

Clause 3/2/1 A partnership increditworthiness (partnership of liability) is a bilateral agreement between two ormore parties to conclude apartnership to buy assets on credit on the basis of theirreputation for the purpose ofmaking profit, whereby theyundertake to fulfill their obligations according to thepercentages determined by the parties

A Credit Partnership isan agreement betweentwo or more parties tobuy assets on credit and bear liability for theprice of purchase ofgoods and share profit according to the ratio determined by the parties.

Clause 3/3/1 A service partnership is an agreement between two or more parties to provide services pertaining to a profession, vocation or skilled trade or to render some services or professional advice or to manufacture goods, and to share profit according to an agreed upon ratio.

In case of loss to service partnership due to negligence of either ofthe partners orotherwise, the same shall be borne by all the partners as per theiragreed profit sharingratio.

Sources: • Shariah Standards for Islamic Financial Institutions, AAOIFI (2010) • Website of State Bank of Pakistan (www.sbp.org.pk) • Website of AAOIFI (www.aaoifi.com) • Usmani, T.M. (2000); An Introduction to Islamic Finance; Idaratul Ma‟ arif, Karachi

Journal of Islamic Banking and Finance Oct.- Dec. 2013 73

An Inquiry In to the Islamic Cooperative Societies in Ilorin Vis- A-Vis Their

Utilization of Islamic Financial Products By

Sikirullahi Bukhari*

ABSTRACT Islamic economic system has continued to gain ground and to play a substantial role in the world economy. In Nigeria, Islamic cooperative society is one of the avenues through which the impact of the Islamic economic system could be felt. It represents the Islamic economic system to Nigerian Muslims and non Muslims alike- since other Islamic financial impacts are yet to be felt, more so that they are not yet in place. This work, therefore, exposes the extent to which the Islamic cooperative societies are making use of Islamic Financial Products and pinpoints their areas and levels of conformity and vice-versa with the principles guiding these products. Since the work is empirical in nature, it uses questionnaire and interview majorly to gather the needed data, even though some literatures are also contacted.

KEY WORD: Islamic Economic System, Gain Ground and to play a Substantial Role in the World Economy

INTRODUCTION From the time immemorial, it has never been possible for man to divorce himself

from economy. Islam, being a faith that caters for all aspects of human life, realizes this and, among other things, makes economic transactions lawful. However, in order to make these transactions devoid of oppression and injustice of all forms, Islam forbids riba of all nature and kind. Thus, the syndrome of interest – free transactions came into being with this prohibition, and became more established and more pronounced with the Prophet’s condemnation of riba al-Jahiliyyah. The prohibition of interest did not expose the Muslim world into any decline economic-wise. Rather prosperity remained the order of the day as history abounds with numerous examples.

* Author – Sikirullahi Bukhari is a Postgraduate Candidate, Department of Religions,

University of Ilorin, Ilorin, Nigeria. Email: [email protected]

74 Journal of Islamic Banking and Finance Oct.- Dec. 2013

The trend continued throughout the succeeding ages with this syndrome combating with its interest-based counterparts at varying degrees in some instances. In the world today, the syndrome has given birth to Islamic banking system which is playing a substantial role in the world economy. According to a source, there are over 200 Islamic banks (excluding branches) and financial institutions across the globe with over one hundred and twenty billion US dollars value.1

In the Nigerian contexts, though no Islamic bank has practically existed, the awareness for it has gained ground in people’s hearts especially the Muslims. This was demonstrated in the Initial Public Offer (IPO) for Jaiz International Plc in which the promoters’ target of 2.5 billion was over subscribed by 120%.2 This suggests that Nigerian Muslims are ready to forgo usurious transactions and are prepared to embrace Islamic financial system. More so, Adebayo highlighted the global success of Islamic banking system, it’s constitutionality in Nigeria, re-introduction of Shariah in part of the northern Nigeria and Islamic finance courses in some Nigerian Universities as some of the motivating factors for the viability of Islamic banking in Nigeria.3

Based on the popular premise “If you don’t get it all, you don’t miss it all”, the Nigerian Muslims who want to better their lots economic-wise, but are afraid of the spiritual and otherwise evils of interest resort to establishing Islamic Cooperative Societies with a view to utilizing the Islamic financial instruments as alternative to riba – based ones.

Meaning of Cooperative Society The term cooperative can be a noun on its own or an adjective in which case the

word society would be added to it. Different attempts are being made to define the term in question. Going by the dictionary meaning, it is defined as “a business owned and ran by the people involved, with the profits shared by them.”4 This definition appears not to be accurate enough because, some of the elements that make up a cooperative are missing in it as we shall later see. The Encyclopedia Americana defines cooperative as a voluntary economic association in which the members share the “earned dividends” – the financial benefits – that result from doing business at cost or without profits.5 Another definition reads: “It is an organization formed by a group of volunteers to serve their own needs. Each member of the group has an equal vote on operative decisions and profits are shared equally between members.”6 A critical thinking on this definition especially, its last clause, reveals its incoherence. This is because economic benefits are distributed proportionally according to each member’s level of participation in the cooperative rather than being shared according to capital invested or equal share. Hence we agree with the Dictionary of Marketing and Advertising’s definition which says: “It is a voluntary organization set up by producers and/or consumers to service their own needs by democratic control, distributing profit according to purchases, sales or fixed return on capital”.7

From the above definitions of cooperative, it can be deduced that a cooperative society is featured or characterized by being a voluntary organization which is economic oriented, whose members have at least one economic interest in common and which is aimed at bettering the lot of its members economically. Besides, it is democratically controlled. Hence any cooperative which is devoid of any of these features is really not a cooperative.

Journal of Islamic Banking and Finance Oct.- Dec. 2013 75

An Over View of the Islamic Cooperative Societies in Ilorin Though Ilorin is known for its antecedence in everything that has to do with Islam

among the Yoruba speaking towns, the operation of an interest free cooperative society could not witness the light of the day until around 1990s. This presupposes that hitherto this period Muslims have being engaging in interest-based cooperative societies which have been flourishing in the town some years earlier. This might be owing to one of the following reasons:

─ People’s unawareness on the position of Islam on riba.

─ Their non-chalant attitude towards Allah’s injunction

─ Their pretext of being under duress

However, investigations reveal that the first interest-free cooperative society in Ilorin emerged in 19968 from among the descendants of a renowned Islamic scholar of the town in the 17th century known as Shaykh Abubakar Ikokoro. It was a development association of the Ikokoro descendants that later metamorphosed into a cooperative society. It was named Iyonu Oluwa Thrift and Credit Society. This society could not see a predecessor from which it could borrow ideas and as such, it was faced with a number of challenges part of which was its inability to get registered with the government since the bye-law endorsed by the Ministry in charge was interest-oriented.

Between the years 1996 and 2000, this cooperative remained the only interest-free cooperative society though it has been split to about three autonomous societies for administrative conveniences. In the year 2000, another interest-free cooperative society emerged at the Kwara State College of Arabic and Islamic Legal Studies with the name At-Taqwa Multipurpose Cooperative Society.9 Later on, came some others among which were Al-Burhan Multipurpose Cooperative Society of University of Ilorin (Unilorin) established in 2002.10 It is pertinent to note that, it was this Al-Burhan that was first registered as an interest-free cooperative society with the government through the Ministry of Commerce and Cooperatives, Kwara State.

In the late 2008, Al-Barka Trust Fund under the chairmanship of Mallam Is-haq Abdul-Kareem felt the need to re-direct and re-orientate the Islamic Cooperative Societies of the dangers in usury as well as to form an Association of Free Interest Cooperative Society of Nigeria. To achieve this, the Fund organized a 2-day seminar/workshop on “Cooperative Society as a Panacea to Poverty Alleviation” held on 7th and 8th of February 2009 at International Islamic Relief Organization Centre, Osere, Saw-mill area, Ilorin which witnessed forty-five cooperative societies in attendance with two from Osun state, one each from Offa and Idofian with all others from various parts of Ilorin.11

During the course of the seminar, it was realized that most of the so-called Islamic cooperative societies operate on conventional oriented bye-law.12 Consequent upon this, the fund felt the need to have a bye-law that will be Shari’ah compliant. Hence, it sets up a committee consisting of representatives of some of these cooperatives in addition to the invited experts such as lawyers and academia to draft a bye-law that would take into cognizance the Islamic principles and rules guiding transactions.

76 Journal of Islamic Banking and Finance Oct.- Dec. 2013

The committee came up with a twenty-two page draft bye-law which was given to another committee tagged the Shari’ah committee consisting of experts in Islamic Commercial Jurisprudence for review and sanction which the committee did after some corrections and amendments. Later on, the two committees met for clarifications and harmonization. The bye-law was then submitted to the Ministry of Commerce and Cooperatives which was eventually approved. Thus, the bye-law became recognized with the government and it is this bye-law that the Ministry provides for any cooperative registering as an interest-free one in place of the interest oriented bye-law prepared by them.

So far, the Fund has been able to achieve its goal of having an association of interest-free cooperative societies which is named: Al-Hidayah Islamic Cooperative Union where representatives of the various cooperative societies meet periodically to deliberate on issues affecting them both as individual cooperatives as well as union with a view to getting rid of them. More importantly, the union is out to achieve the aim of having an interest-free micro-finance bank on the premise that “don't miss it all when you cannot get it all”.

Result of Findings The questionnaire administered for the purpose of this study has two sections: A

and B. Section A contains two items meant to solicit background information on individual cooperative while section B contains four research questions each of which has several items. Forty copies of questionnaire were administered though one got missed making the number analyzed as thirty-nine.

a. Background Information of the Responding Cooperatives i Years of Experience

Details Frequency % Percentage

Less than two years 13 33.3 Two to five years 16 41.06 More than five years 10 25.64

The Table above shows that the rate at which Islamic cooperative is emerging in Ilorin is increasing. In other words, Islamic cooperative in the last five years has grown higher than it used to be before the period in question.

ii. Types of Cooperative

S/N Details Frequency % percentage

1. Multipurpose 22 56.41 2. Thrift and Credit 11 28.20 3. Others Nil 0 4. Undecided 6 15.38

Journal of Islamic Banking and Finance Oct.- Dec. 2013 77

The above table reveals that majority of the Islamic cooperative societies in Ilorin (56%) belongs to the multipurpose types of cooperative, followed by the thrift and credit type with 28% while the remaining 15% of cooperative societies are being run without necessarily having a particular type in mind.

b. The Research Questions i. ─ Does Cooperative system have base in Islam?

A N D S/N ITEMS F % F % F % 1 Islam has solution on every human

problem 31 79.4 5 12.8 3 7.7

2 Islam encourages helping one another. 39 100 - - - - 3 There should be limitation to cooperation

among Muslims. 28 71.8 5 12.8 6 15.4

4 Islam is against saving for a rainy day 34 87.1 3 7.7 2 5.1 5 Islam encourages the act of lending. 36 92.3 3 7.7 - - 6 Cooperative system could be run based on

Islamic injunctions. 32 82.1 4 10.3 3 7.7

From the above table, it is shown that majority of the respondents (represented by 79.4%) agreed that Islam has solution to every human problem, while 12.8% of them maintained neutrality and the remaining 7.7% disagreed with the stand. As for helping one another, all respondents unanimously agree that it is an act that is highly encouraged in Islam as it is indicated in the second item. However, this does not mean that Muslim should assist their fellow beings in perpetrating evils or encouraging vices. The respondents’ reaction to item 3 where 71.8% of them agreed that cooperation among Muslim should have limitation validated this position.

Furthermore, the fourth item on the table showed that 87.1% of the operators of the Islamic cooperative society are in concordance with the fact that Islam encourages saving one’s excess at a point in times against other times. In the same vein, over 90% of the respondents are also in concordance with the assertion that Islam encourages the act of lending. Likewise, 82.1% of them are of the view that cooperative system could be run based on Islamic principle, while only 10% and 8% disagreed and remained neutral respectively.

ii. Are the Conventional and Islamic Cooperatives the same?

A C D

S/N ITEMS F % F % F %

1 Everybody in my cooperative has equal right.

28 71.8 10 25.6 1 2.6

2 The society’s constitution is above all other laws and constitutions.

6 15.4 6 15.4 27 69.2

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3 Religion has place in Islamic cooperative society

39 100 - - - -

4 A cooperative society can survive without charging interest on loans.

28 71.8 7 17.9 4 10.3

5 Islamic cooperative invests on interest bearing businesses.

4 10.3 - - 35 89.7

6 Islamic cooperative differentiates between interest and charges

30 76.9 2 5.1 7 17.9

7 Membership is open to non Muslims in my society.

24 61.5 7 17.9 8 20.5

As shown in the above table, having equal right is affirmed by the majority of operators of Islamic cooperative system, where 72% of them agree to the standpoint as against only one respondent (2.6%) who disagree and the rest 25.6% kept neutral. More so, it is also apparent from item 2 of the table that Islamic cooperative system will not acknowledge that their constitution be placed above their scripture, (i.e Qur’an). This is evident in the fact that about 70% of the respondents are in agreement with the notion where agreement and neutrality share the leftover (i.e 30.8%) democratically.

Additionally, akin to the above is that the entire respondents accept that religion has place in their society even though they might differ when it comes to the extent to which religion will have impact. This is established by having neither negative non neutral reaction from any respondent.

Furthermore, jettisoning all that has to do with Riba by Islamic cooperative societies is certified in items 4, 5 and 6 above where greater percentage of the respondents responded in favour of this avowal. Lastly, with regard to membership being open to non-Muslims, the result unveils that over 60% of the Islamic cooperative societies approve membership of non-Muslim in their societies.

iii. What are the lawful alternatives to Riba and how have they been utilized by Islamic cooperative?

A N D

S/N ITEMS F % F % F % 1 My cooperative operates joint business

among its members. 21 53.8 3 7.7 15 38.5

2 My cooperative acts as an entrepreneur working with members’ capital.

27 69.2 5 12.8 7 17.9

3 My cooperative provides capital for member to invest, the profit from which they later share.

5 12.8 5 12.8 29 74.4

4 In my cooperative, the entrepreneur solely bears the liability while the profit is mutually shared among the partners.

21 53.8 7 17.9 11 28.2

5 The formula to be used for sharing the dividend would be determined by the capital provider.

18 46.2 7 17.9 14 35.9

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6 My cooperative engages in forward sale such as buying farm produce in advance.

- - 10 25.6 29 74.4

7 We do quantify those things to be sold with forward sale.

- - 29 74.4 10 25.6

8 My cooperative does order for the manufacture/production of certain items to be sold to its members or the larger society.

- - 11 28.2 28 71.8

9 We do have the contract agreement containing the required specifications.

- - 26 66.7 13 33.3

10 We do reject the end product provided it does not meet our specifications.

- - 24 61.5 15 38.5

11 My cooperative does engage in lease contracts as means of fund generation.

33 84.6 - - 6 15.4

12 My cooperative works as contractor for government and non governmental agencies.

1 2.6 15 38.4 23 59.0

13 My cooperative buys and sells some commodities with added declared profit.

6 15.4 12 30.8 21 53.8

14 My cooperative acquires items for its members on request the charges of which the latter bears after the former has added its known profit.

7 17.9 9 23.1 23 59.9

15 My cooperative has various ways of empowering members through provision of jobs, working tools, provision of shelter etc.

5 12.8 4 10.3 30 76.9

The first four items of the above table centre on the concept of Musharakah and Mudarabah. The first item discloses that more than half (i.e 53.8%) of the Islamic cooperatives engage in joint business in one way or the other which might fall under one of the concepts mentioned above. While the second and the third items, to some extent, reveal the extent to which they engage in these products, most of these cooperatives prefer being the entrepreneur to being the capital provider. These positions are represented by 69.2% and 12.8% respectively. More interestingly, it is exposed, according to item 4 of the table in view that the entrepreneur is usually liable in the case of loss in some cooperative societies. 53.8% of the total respondent affirmed this whereas 28.2% of them stayed aloof of the stand and the rest 18% voted neutrality.

In item 5 above, it is unveiled that 46.2% of the responding cooperatives hold that the sharing formula for the accruing profit from a joint deal should be determined by the capital provider, while 36% of them disagree and the remaining 18% did neither support nor oppose the idea.

Withal, it is exhibited that all Islamic co-operative societies in Ilorin have not been engaging in Salam and Istisna based transaction. This is in accordance with the above table where no one responded positively to items 6 and 7 which centre on Salam and items 8 to 10 that focus on Istisna. However, the table uncovers that Ijarah and Murabahah are not alien to these cooperatives even though much have not been exploited

80 Journal of Islamic Banking and Finance Oct.- Dec. 2013

of the benefits inherent in these products. Item 11 indicates that 85% of respondents confirm that their societies are engaging in one form of lease or the other, while only 15% of them have not been doing so. Working as a contractor which is also a form of Ijarah is not yet in practice among over 96% of the Islamic cooperatives in Ilorin as manifested in item 12.

In the case of Murabahah, the rate at which Islamic cooperative societies are making use of the concept is low beyond expectation. Items 13 and 14 represent the two types of Murabahah; classical and modern respectively. According to item 13, only 20.5% of the responding cooperatives engage in selling commodities with declared profit while 53.8% of them do not and the remaining 25.5% perhaps do not know the concept in question. In its own case, only 18% of these cooperatives have a provision where members could identify their needed commodities and request the cooperatives to buy such for them which the latter sells to the former with added profits.

The last item in the table also exposes the insensitivity of the Islamic cooperatives to the virgin and untapped opportunities they have through various products of Islamic finance. Only less than one-seventh of the responding cooperatives (i.e 13%) claim to have means of providing jobs, working tools and housing schemes for their members, while over 60% of them don’t have such programmes, 21% do not know where to belong.

Discussion From the analysis made so far, it is established that the Islamic co operative

society has basis in Islam, hence the assertion that nothing has been left un-catered for by Shari’ah is not an over statement. Furthermore the analysis also made it clear that Islamic cooperatives society is in accord with the conventional one in some aspects, whereas the reverse is the case in some other aspects. Some of the areas were they dissent from one another include dealing with interest which is the biggest line of demarcation between the two systems, even though some Islamic cooperative societies still involve in interest based dealings directly or indirectly. This explains why the result could not indicate 100% freedom from interest.

Further still, “open and voluntary” is a cardinal principle in cooperative system. However, some Islamic co operatives’ definition of openness is contingent upon being a Muslim. More importantly, Islamic cooperative system gives due regard and consideration to the faith to which it is attached (i.e Islam) hence the latter’s wish becomes the former’s command.

On the aspect of Islamic financial products, the analysis disclosed that there is much room for improvement. That is to say that some of the available means through which wealth could be grown beside the normal buying and selling are not known to many Islamic cooperative operators. That is why they don’t engage in some of them while those they are making use of are not properly précised. For instance, it is wrong in any joint dealing that a partner be immune against loss while they both share the profit. More so, the formula to be used to share the profit should not be one man business.

On a final note, the analysis revealed that the Islamic cooperative societies in question are insensitive to the one thousand and one chances and opportunities that

Journal of Islamic Banking and Finance Oct.- Dec. 2013 81

abound in Islamic financial products. For example, cooperative societies can jointly finance a project with the members to be empowered on such project as house or factory construction. The cooperative who is the financier would bear a larger proportion of the capital. The share of the cooperative would later be divided into units to be purchased one after the other by the client who eventually becomes the owner after having bought all the shares of the cooperative.

More so, Musharakah could also be used to finance a working capital where the client will have to, along with cooperative, value the investment before the cooperative merge some amount as its own share in the capital of the business.

Ijarah as well as Murabahah could also be used to empower members depending on the financial status of the interested members as well as their tastes and choices. Equipments or working tools or even factories could be acquired by cooperative and released to members based on lease contracts (Ijarah) or total sale to them on the basis of Murabahah where they would be expected to add some profits to the total cost.

Conclusion So far, this paper has attempted to prove the correctness of the assertion that Islam

is a total way of life whose law is all encompassing, especially in the area of economics. It established that cooperative society is no alien to Islam even though there are some restrictions that are to be observed while practicing it. It also established that, as there are some areas of similarities between Islamic and conventional cooperatives, there are also areas of differences. More so, the result of the examination conducted on the awareness of the Islamic cooperators about the Islamic alternatives to riba was also negative.

Earlier on, attempt had been made at tracing the journey of Islamic cooperatives in Ilorin so far, where all steps towards interest-free cooperative in Ilorin from the onset to the recent innovations and developments witnessed in the sector are brought to the fore.

Recommendations The following recommendations are hereby put forward consequent upon the

findings of this research work:

─ The mother body of interest-free cooperative that is formed in Kwara State should endeavour to liaise and work hand in hand with other bodies outside the State with similar objectives such as National Council of Islamic Credit and Savings Scheme (NACICASS) formed in Oyo State in May, 2001 with a view to realizing a viable National Islamic microfinance bank among others things.

─ More so, it is pertinent that every Islamic cooperative has a Shari’ah supervisory (and not advisory) committee/Shari’ah supervisor who would be versed in both the Islamic commercial jurisprudence as well as in modern day economics.

─ The said union should take the responsibility of enlightening the operators of the individual cooperatives on the available lawful means of investment as well as their practicability.

─ Diversifying is encouraged in Islam. Let there emerge more types of cooperative among the interest-free ones such as housing and farming/agriculture types of cooperative.

82 Journal of Islamic Banking and Finance Oct.- Dec. 2013

─ Replica of this work should be carried out in other towns and states of the federation. This will reveal their situation for necessary attention.

─ The areas of cooperative societies not covered by this research work should be looked into by other researchers.

Note and References 1. M.G.I Bagsiraj, Islamic Financial Institutions of India Progress, problems and

prospects, Saudi Arabia, Scientific Publishing Centre ND Pv

2. W.W.W Wikipedia. Com (on Jaiz International Islamic Bank) retrieved on 12/12/2009.

3. R.I. Adebayo “The Motivating factors for the viability of Islamic Banking in Nigeria” Journal of Islamic Banking and Finance. Vol. 27. No. 2, 2010 pp. 97 – 105 A. S. Hornby, Oxford Advanced Learner’s Dictionary New York, Oxford University Press 2001, P. 256.

4. A. S. Hornby, Oxford Advanced Learner’s Dictionary New York, Oxford University Press 2001, P. 256.

5. Scholastic Library Publishing, Encyclopedia Americana USA, Scholastic Library Publishing Inc. 2006, Vol. 7, P. 746.

6. Geddes and Grosset, A Dictionary of Business Terms Scotland, Geddes and Grosset 2005, p. 47.

7. J. Farrah, Dictionary of Marketing and Advertising Malaysia, Golden Books Centre 1998, p. 54.

8. We are able to gather this during the course of the field work from Al-Barkah Trust Fund as well as the founders of the said cooperative.

9. S.T. Afolabi: A Critical Study of Al-Amanah Multipurpose Cooperative society Ltd CAILS, Ilorin. A Long Essay of the Department of Religions, University of Ilorin, 2007. p. 12.

10. Interview with Dr. I.A. Abikan of Faculty of Law University of Ilorin in his office at University of Ilorin Main Campus, at 11:00am on 07/01/2011. He is one of the foundation members of the society.

11. Al-Barkah Trust Fund, Report of the implementation Committee on the 2-day Seminar/workshop on cooperative society as a panacea to Poverty Alleviation Feb. 2009.

12. Interview with Mallam Is-haq Abdulkareem, the Controller of Finance Kwara State Government House, Ilorin, who is the Chairman and Founder of Al-Barka Trust Fund, Ilorin in his office at Al-Barka Multilinks, Oko-Erin, Ilorin on 12/01/2011, at 5:00pm.

13. S. Bukhari, An Examination of the Islamic Economic System as Practised by Islamic Cooperative Societies in Ilorin, An M.A Dissertation Submitted to the Department of Religions, University of Ilorin, Ilorin. July, 2011 p.

14. Dar -us- Salam Publication, (TR) “Attainment of the Objective” in I. H. Al-Asqalāni, Bulûgul-Marām, Saudi Arabia, Dar-us-Salām Publication (nd).

Journal of Islamic Banking and Finance Oct.- Dec. 2013 83

15. See Qur’an 33:36

16. M. T. Al-Hilali, and M.M Khan, The Noble Qur’an in the English Language, Saudi Arabia, Dar-us-salam 1996. Q2:280

17. M.M. Khan, (TR) “Summarized Sahih Al-Bukhāri Arabic English in A.A. Az-Zubaidi Mukhtasar Sahih Al-Bukhari. Saudi Arabia, Dar-us-Salam Publications 1994 p467

18. M. T. Al-Hilali, and M.M Khan, Q5:1

19. M.M. Khan, p497.

84 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Lexical Analysis of Islamic Banking Terminologies

By Shafiq ur Rahman*

The products launched by the Islamic Banks of the world today have their roots in the Shari’ah Law (Fiqh al Masrifi). This article is aimed at finding lexical nitty-gritty of these terminologies with reference to their originality in the basic source of the Shari’ah Law i.e The Holy Qur’an.

Ba’i ( ): In Shari’ah law, Ba’i means exchange of a valuable thing against a valuable thing

with mutual consent of both the parties. The ‘seller’ is called and ‘buyer’ is called while the ‘item’ being sold is termed as .The word is normally amplified with

the appropriate kind of sale intended from the deal e.g.

The word Ba’i has root in Arabic as ‘ ’ meaning to sell or do business. The past tense becomes Ba’a and present cum future tense as Yabi’u

In the above sense the word has been used in the Holy Qur’an in Surah Al Juma verse: 9, “O ye who believe! When the call is proclaimed to prayer on Friday (the Day of Assembly), hasten earnestly to the Remembrance of Allah, and leave off business (and traffic): that is best for you if ye but knew!”

The word Ba’i has also been used in Surah Al Baqarah verse: 254 as “O ye who believe! Spend out of (the bounties) we have provided for you, before the Day comes when no bargaining (will avail), nor friendship nor intercession. Those who reject Faith, they are the wrong-doers.”

Surah Ibrahim verse: 31 also contain the word as “Speak to My servants who have believed, that they may establish regular prayers, and spend (in charity) out of the

* The author is holder of Shahadatul Alamiyyah fil Ulumil Islamiyyah wal Arabiyyah(Wifaq ul

Madaris al Arabiyyah) Masters in Arabic and Islamic Studies with distinction. He is also LL.B (Hons) Shari’ah and Law (International Islamic University, Islamabad), LL.M (University of Karachi) and LL.M in International Maritime Law (with distinction) from IMLI, Malta. E-Mail: <[email protected]>

Journal of Islamic Banking and Finance Oct.- Dec. 2013 85

Sustenance We have given them, secretly and openly, before the coming of a Day in which there will be neither mutual bargaining nor befriending.”

Riba :

‘Riba’ technically refer to the premium that must be paid by the borrower to the lender with the principal amount as a condition for loan. In Shari’ah law the word Riba, as per consensus of the scholars, generally means the interest prevalent in conventional banks.

The word ‘Riba’ is derived from root word ‘Rabw’ which means ‘addition’ or ‘increase’. The past and present cum future tenses become ‘Raba’ and ‘Yarbu’ respectively. The word in different forms has been used in many places in Holy Qur’an. Surah Ar Rum verse: 39 reads “That which ye lay out for increase through the property of (other) people, will have no increase with Allah: but that which ye lay out for charity, seeking the Countenance of Allah, (will increase): it is these who will get a recompense multiplied.”

It is due to the very meaning of the word that an elevated, high and fertile place on the surface of earth is called ‘Rabwa’ as is also reported in Surah Al Baqarah verse: 265 as “And the likeness of those who spend their substance, seeking to please Allah and to strengthen their souls, is as a garden, high and fertile; heavy rain falls on it but makes it yield a double increase of harvest, and if it receives not heavy rain, light moisture sufficeth it. Allah seeth well whatever ye do.”

While commenting on this verse Imam Qurtubi in his Tafseer has mentioned that a slightly elevated place with little hard soil is called ‘Rabwa’ because in Arab Peninsula it was known for being good for better cultivation (and increasing production).

In Surah Ar Ra’d verse 17, the word has been used in a little different sense. The verse containing the word ‘Rabia’ reads as “He sends down water from the skies, and the channels flow, each according to its measure: but the torrent bears away the foam that mounts up to the surface.”

In Surah Al Haqqah verse: 10 the word ‘Rabiah’ has been used in the sense of extended or an abundant thing. The verse reads as “And disobeyed (each) the Messenger of their Lord; so He punished them with an abundant Penalty.”

In Surah Al Baqarah verse: 276 the word has been used in present cum future tense as “Allah will deprive usury of all blessing, but will give increase for

deeds of charity; for He loveth not creatures ungrateful and wicked.”

As per Shari’ah, ‘Riba’ is of two kinds ‘Riba an Nasi’ah’ interest of credit or loans, and ‘Riba al Fadl’ the interest of addition. (Details can be seen in relevant books)

‘Riba an Nasi’ah’ is also called Riba al Qur’an , Riba al Duyun , ‘Riba al Mubashir’ or ‘Riba al Jali’ .

On the other hand ‘Riba al Fadl’ is also called Riba as Sunnah , ‘Riba al Buy’u’ ,‘Riba Ghayr al Mubashir’ or ‘Riba al Khafi’ .’

86 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Murabahah In general perception of Islamic banking, Murabahah means mark up. The term is

lexically used for a product of financing in which the banks receive profit (mark up) in the transaction by explicitly mentioning the cost expended for purchase of an item for customer.

Murabahah is derived from Arabic root word Ribh meaning profit. Past and present tenses for Murabahah are (Rabaha) and (Yurabehu). The word ‘Rabehat’ is reported in Surah Al Baqarah verse: 16 as “These are they who have bartered guidance for error: but their traffic is profitless, and they have lost true direction.”

Ijarah Ijarah is an Arabic word, which denotes lease or renting. The past tense becomes

‘Aajara’ and present cum future tense becomes Yujeru’ . The word ‘Ajr’ having been used in as many as fifteen verses of the Holy Qur’an means ‘reward‘.

Surah Al Qasas verse: 26 contain the word Ist’ejar in the sense of hiring services of some one on payment. Reportedly, daughter of Shoaib (AS) recommended Moses (AS) to be hired for their house. The verse reads as “Said one of the (damsels): "O my (dear) father! Engage him on wages: truly the best of men for thee to employ is the (man) who is strong and trusty."

In Shari’ah Law, Ijarah can be classified mainly into two types, (i) Ijarah ul Ashkhas (Hiring Human services) and (ii) Ijarah ul Ashya (Hiring usufructs of property). Ijarah ul Ashkhas is further divided as (a) Ijarah Alal Waqt

- on monthly or periodical salary, and (b) Ijarah Alal Amal on provisions of some services, e.g hiring a porter at air port or a ‘cooli’ at Railway station.

In general apprehension of today’s world Ijarah only denotes Ijarah ul Ashya Hiring usufructs of property): This is synonym to English term ‘leasing’. In

this case ‘Lessor’ is called Mujir the ‘Lessee’ is called Mustajir , and ‘rent’ is called ‘Ujrah’

Ijarah wa Iqtinaa

Since the Ijarah is widely being used as mode of financing and on completion of the period of Ijarah the lessee owns the item, the transaction is called as ‘Ijarah wa Iqtin’a’which literally means the lease ending up into ownership. The word Iqtinaa

in dictionary means acquisition, obtainment or owning (Al Mawrid, A Modern Arabic English Dictionary, Beirut, Lebanon, 2004, page 147)

Musharakah مشارآة: Musharakah is a root word from which ‘sharaka’ is taken as past tense.

‘Ishtaraka’ or Sharaka literally meaning to join, to participate to share (Al Mawrid, A Modern Arabic English Dictionary, Beirut, Lebanon, 2004, page 111). A ‘company’ or ‘firm’ is called in Arabic ‘Sharekah’ or ‘shirkah’ (ibid, page 668)

Journal of Islamic Banking and Finance Oct.- Dec. 2013 87

The word ‘Sharaka’ has been used in Surah Israa verse 64 in the sense of mutually sharing some thing. The verse read as "Lead to destruction those whom thou canst among them, with thy (seductive) voice, make assaults on them with thy cavalry and thy infantry; mutually share with them wealth and children; and make promises to them. "But Satan promises them nothing but deceit.

Khultat ) خلطت( is also an Arabic word used for denoting partnership. In Surah Sad verse: 24 the word Khulat`a )خلطاء( has been used to denote partners. The verse reads as (David) said: "He has undoubtedly wronged thee in demanding thy (single) ewe to be added to his (flock of) ewes; truly many are the Partners (in business) who wrong each other:

In today’s scenario Musharakah has limited scope than Shirkah شرکه (as per details housed in Islamic law). It only denotes Shikat-ul-Amwal .as discussed hereafter شرکةاالموالSkirkah is mainly divided into two kinds.

a. Shirkat-ul-Milk: )الملک شرکه ( means joint ownership of a particular property. It can either be optional (by act of parties) or automatic (through inheritance)

b. Shirkat-ul-Aqd: )شرکةالعقد( means joint commercial enterprise. It is further classified in three kinds. (i) Shirkat-ul-Amwal: )شرکةاالموال( when money is jointly invested in an enterprise. (ii) Shirkat-ul-Amal: )شرکةاالعمال( when partners (e.g tailors) jointly provide service to the customers and earning would be distributed amongst them. This kind is also named as Shirkat-ul-taqabbul )شرکةالتقبل( , Shirkat-us-Sana’i )شرکةالصنائع( or Shirkat-ul-Abdan

)شرکةاالبدان( . (iii) Shirkat-ul-Wujooh: )هشرکة الوجو( when no money is invested and partners take things/items on credit from market on their reputation and sell them. The earning is divided as per agreed ratio.

Musharakah Mutanaqisa : Tanaqus in Arabic means to decrease, shrink, drop, or fall-off etc. (Al Mawrid,

page 376). If a thing gradually decreases it is called in Arabic as . The Musharakah when used as mode of financing is normally called Musharakah Mutanaqisa (Diminishing Musharakah) in the sense that after completion of the tenure of transaction the item is entirely owned and handed over by the bank to the client.

The word has been used in verse 4 of Surah Qaf as “We already know how much of them the earth takes away: with Us is a Record guarding (the full account).”

Mudarabah : In Shari’ah Law, Mudarabah means giving money to another person for

establishing or investing in a business. The first partner (investor) is called Rabb-ul-Mal and other as Mudarib (undertaker of business).

The word has been derived from root word ‘Darabun’ which in Arabic language means to strike, to punch, or to hit (Al Mawrid, page 710) as used in Surah As Saffat verse: 93, Aal Imran verse: 112. It is also used to denote “quoting an example” as is there in many places like Surah Ibrahim verse: 24 etc.

88 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Another meaning of the word is to roam, to wander or to travel. In fact the word Mudarabah has been taken from this type of meaning which conveys the sense of traveling and roaming around while undertaking a business. The word with this sense has been used in Surah An Nisaa verse 94 and 101, Surah Al Baqarah: 273, Almaida: 106, Aal Imran verse: 156 etc.

Most close verse to this sense of Mudarabah is in Surah Al Muzzammil, verse: 20 where traveling is qualified for the sake of Allah’ bounties (Rizq). “He knoweth that there may be (some) among you in ill-health; others travelling through the land, seeking of Allah's bounty; yet others fighting in Allah's Cause. Read ye, therefore, as much of the Qur-an as may be easy (for you); and establish regular Prayer and give regular Charity……..

Salam : Salam is a sale in which vendor takes the responsibility of providing a particular

item in future in exchange for money (cost) fully paid in advance. In other words to advance money for getting delivery of an item is called Salam. The vendee in this sale is called “Musallam Ilaihe” مسلم اليه, the vendor as ‘Rabbus Salam’ رب السلم and the item as “Musallam Fihe”مسلم فيه

Unfortunately the word Salam in the sense narrated above has not been used in Holy Qur’an. However the word Salam used in Surah Az Zumar verse: 29 conveys the meaning that can be hauled to denote something fully paid or owned by some one. The verse reads as “Allah puts forth a Parable - a man belonging to many partners at variance with each other, and a man belonging entirely to one master: are those two equal in comparison? - Praise be to Allah! but most of them have no knowledge.”

In numerous Ahadith (traditions) of the Holy Prophet (SAW) instead of Salam, the word Islaaf has been used. As reported in Sahih Bukhari (Kitab as Salam), and other books of Ahadith that Hadrat Ibn ‘Abbas reported that when Allah’s Messenger (SAW) came (to Medina), people were paying in advance (for the fruits etc.). He said to them “He, who makes advance payment, should do so for a specified measure and weight (and for a specified period) only.

The word Islaaf in this sense has been used in Holy Qur’an. Surah Yunus verse: 30 reads “There will every soul prove (the fruits of) the deeds it sent before: they will be brought back to Allah their rightful Lord, and their invented falsehoods will leave them in the lurch.”

Surah Al Haqqah verse: 24 reads "Eat ye and drink ye, with full satisfaction; because of the (good) that ye sent before you, in the days that are gone!"

Istisna’a :

To order a manufacturer to manufacture a particular item for the purchaser with the raw material to be arranged by the manufacturer. The consent of both the parties and specification of the item must be pre-determined.

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The word Istisn’a finds its root in word ‘San’a’ meaning to fabricate manufacture or produce (Al Mawrid, page 701). The word in the same sense has been used in many places in the Holy Qur’an. Surah An Naml verse: 88 reads as -“Thou seest the mountains and thinkest them firmly fixed: but they shall pass away as the clouds pass away: (such is) the artistry of Allah, Who disposes of all things in perfect order: for He is well acquainted with all that ye do.”

Surah Al Kahf verse: 104 says “Those whose efforts have been wasted in this life. While they thought that they were acquiring good by their works?”

Surah Anbiya verse: 80 reads “It was We Who taught him the making of coats of mail for your benefit, to guard you from each other's violence: will ye then be grateful?”

Surah Al A’raf verse: 137 reads “The fair promise of thy Lord was fulfilled for the Children of Israel, because they had patience and constancy, and We leveled to the ground the Great Works and fine Buildings which Pharaoh and his people erected (with such pride).”

It may be apt to note that the Arabic words derived from the class of Istif’al have a peculiarity that it has inherent meaning of ‘seeking’ the activity

denoted in the verb e.g. Istighfar means to ‘seek forgiveness’. It is due to this peculiarity that, the word Istisn’a and Ist’ejar used above inherently means to seek manufacturing and seek for employing respectively.

90 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Country Model: Kingdom of Saudi Arabia Kingdom of Saudi Arabia (KSA), the largest in GCC in terms of Islamic banking

assets while occupies second position (after Iran) globally; Islamic banking industry (IBI) in the country has an asset base of US $ 207 billion by end 2011; nearly 50 percent assets of overall banking system of the Kingdom. KSA is the second largest for Sukuk issuance and the largest in Takaful market1.

The role of KSA in the history of Islamic banking is the most prominent of all, mainly owing to its efforts for establishing Organization of Islamic Conference (OIC) and consequently the Islamic Fiqh Academy and Islamic Development Bank (IDB) during the decade of 70’s. Since then the industry is growing at considerable pace and IDB, having highest capital share of Saudi Arabia (27.9 percent share holding), has remained instrumental in developing the industry at global scale.

The kingdom has four full fledged retail Islamic banks (Al Rajhi Bank, Bank Al jazira, Alinma Bank and Bank Albilad), further, almost all conventional banks have large Islamic windows as depicted by almost similar share of conventional banking assets during 2011. However, in terms of regulatory environment the kingdom has not been very active. Saudi Arabia Monetary Authority (SAMA), the Central Bank, and the Capital Market Authority (CMA) do not have any distinct or separate regulations for Islamic financial institutions. Unlike most countries having Islamic banking, KSA does not have any Central Shariah Board for Shariah screening of financial products; however, institutions offering Shariah compliant products and services are obligated to have their own Shariah boards who are responsible for ensuring Shariah compliance in these institutions.

Islamic Capital Market The liberalization of financial market of Saudi Arabia since 2005 after joining

World Trade Organization (WTO) has favoured the growth of Islamic financial industry by permitting international investors and financial institutions to enter the country. At present there are 153 Shariah compliant funds in 15 categories2

while kingdom is leading Sukuk and Takaful market.

1 Source: World Takaful Report 2012 2 This data is of Aug 2010 3 Source: Standard & Poor’s Rating’s Direct: Investor Appetite Is Pushing Sukuk Into The

Mainstream ------------------------------------ Source: Islamic Banking Bulletin, April-June 2013, State Bank of Pakistan

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Sukuk Saudi Market witnessed the very first Sukuk in 2003 when IDB issued its first

Sukuk; IDB Trust Services Ltd. Global Sukuk of $ 8 billion for the finance of infrastructure projects. This was followed by corporate Sukuk issued by the country’s eading car leasing and rental company in 2004 while the first sovereign Sukuk was issued in 2012. One of the significant corporate Sukuk was the 14 years Sukuk by Saudi Aramco of US $ 1 billion for its new refinery project and it was oversubscribed by three times. On the other hand, the recently issued sovereign Sukuk is the largest Sukuk of 15 billion Riyals (US $ 4 billion) and proceeds of this ten year Islamic bond will be used for expansion of King Abdul Aziz International Airport in Jeddah.

The growth of Sukuk has remained considerable throughout in the country, however, it had some hit after the credit crisis, though, is now again on high growth trajectory and occupies 8 percent of global Sukuk market (US $ 131.1 billion). Factors like limited avenues for Shariah complaint financial institutions due to the absence of Islamic money market, sectors of energy and petroleum and real estate (especially after approval of Saudi Mortgage Law) signifies that Sukuk market is expected to grow at a higher pace in coming years.

Takaful Market Pre 2003 insurance companies were not allowed to operate in the country due to

non permissibility under Shariah which is the prevalent law in the country and only state owned National Company for Cooperative Insurance was offering this service. The state owned company was operating it on the model of “cooperative” which is Shariah Compliant while after passing the Cooperating Insurance Regulations in 2003 new players started in the market. At present the market contains nearly 30 issuers offering insurance services on the basis of co-operative model.

Not only Islamic banking industry is growing significantly in the country but Saudi based Islamic financial institutions are contributing significantly towards growth of the industry globally. However, the lack of enabling environment in terms of distinct regulations may hinder the growth potential of the country.

References: • Standard & Poor’s Rating’s Direct: Investor Appetite Is Pushing Sukuk Into The

Mainstream, March 2013 • Global Islamic Finance Report 2013, Edbiz Consulting Limited, Uk • World Takaful Report 2012 • Global Islamic Finance Report 2011, Edbiz Consulting Limited, Uk • Global Perspective on Islamic Banking & Insurance: New Horizon; Issue No. 168,

July-September 2008 • MUNAWAR IQBAL and PHILIP MOLYNEUX Thirty Years of Islamic Banking:

History, Performance and Prospects, Palgrave Macmillan, London, UK, 2005, pp.190 • www.marketresearch.com/RNCOS-v3175/Saudi-Arabia-Banking-Sector-Outlook-

6992870/ • Saud S., BINTAWIM Samar; “Some evidence from Saudi Arabian banking Sector:

Performance analysis of Islamic banking” • Saudi Arabia; The World Fact Book, CIA www.cia.gov/library/publications/the-

world- factbook/geos/sa.html

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NEWS MONITOR

Pakistan

Pakistan launched interest free banking in the early 1980s, the policymakers in early 2001 realised the importance of Islamic finance as a tool for attracting investment, and concerted efforts were made to develop it. The Islamic banking in Pakistan has witnessed significant growth during the last decade and now constitutes over 10pc of the banking system with an asset base of above Rs. 900bn. It is likely to double its market share by 2020. Different Islamic products like Ijara, Wakala and Musharaka are now available to savers and investors.

The Experts say Islamic finance affords huge opportunities for the equitable distribution of wealth and fair trade. Prime Minister Nawaz Sharif believes it can help bridge the gulf between the Muslim world and the West, and improve the Muslims’ image as a progressive people who can contribute immensely to world prosperity. This may be taken as a sign of his government’s resolve to promote Islamic finance. Source: Dawn News

Meezan Bank’s New Deposit Product, Meezan Kafalah Meezan Bank is introducing a unique Saving product with Takaful cover which is

all ready for “roll-out” with a grand launch. The latest addition to Meezan’s bouquet of offerings Meezan Kalafah (MK) is indeed a first in the industry. This product shall be a harbinger for a positive change in the industry leading to moderate sales incentives from the current huge sales incentive trend in Takaful / Insurance industry that is causing sales by deception. Meezan Kafalah has a unique structure where the customer can

(i) withdraw all his investment without any deductions at any time, unlike the bancatakaful/ banc insurance where the customer faces hefty erosion of investment in case of withdrawal within the first seven years and

(ii) the takaful cover contribution shall be made by the Bank on behalf of the customer.

Source: Meezan Bank Limited Burj Bank Limited Conducts Ration Distribution Activity with Alamgir Welfare International Trust

Burj Bank Limited conducted a ration distribution activity in collaboration with Alamgir Welfare International Trust whereby 100 ration packets were distributed to the underprivileged members of the society. The recipients of these ration packs were welcomed in a comfortable setting and a peaceful distribution was conducted. The ration packets contained household consumables as per the monthly requirement of an average family & mutton  chickpea,  gram flour,  dal masoor,  dal moong,  gram pulse,  rice,  tea, 

Journal of Islamic Banking and Finance Oct.- Dec. 2013 93

sugar,  ghee,  included flour, clothing for children. The senior officials present at the occasion included Chairman, Alamgir Trust & Mr. Naushad Kamil and Mufti Syed Zahid Siraj represented Burj Bank Limited. The volunteers from both organizations played an instrumental role in the packaging and distribution of the ration packets.  Source: Burj Bank Limited

AAOIFI and Ernst & Young on Islamic Core Banking System Certification

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Ernst & Young have entered into an exclusive agreement to carry out certification of financial software products or core banking systems for Islamic banking and finance industry.

The certification program will see AAOIFI and Ernst & Young working together in benchmarking financial software products or core banking systems against AAOIFI's Shari'a and Accounting standards. Under the certification program, banking and financial information technology providers will have the opportunity to properly incorporate AAOIFI standards in their products and systems.

Dr. Khaled R Al Fakih, Secretary General and CEO of AAOIFI said that "AAOIFI certification ensures that information technology systems in Islamic financial institutions can give further support to those institutions and mitigate risks of Shari'a non-compliance."

He also added that the certification process, which also involves regular periodical review, will be carried out under the supervision of a committee of Shari'a scholars from AAOIFI standards boards. Essa Al-Jowder, Partner,

Ernst & Young views the development as a game-changer for the Islamic banking industry. "Regulators are becoming increasingly stringent when it comes to Shari'a compliance. Core banking vendors have to adapt their systems to incorporate the unique features and processes of Islamic products. Such an endorsement should ideally come from a credible organization like AAOIFI. Given the need for a combination of Shari'a, IT, accounting and banking skills and experience, Ernst & Young's industry credentials are the ideal fit for this joint initiative. We believe that this is an important step for the industry and will go a long way to help reduce operational risk of Islamic banks" stated Mr. Al-Jowder.

AAOIFI has issued 88 standards in the areas of Shari'a, accounting, auditing, ethics, and governance for international Islamic finance. Its standards are currently followed by most of the leading Islamic financial institutions across the world and have introduced a progressive degree of harmonisation of international Islamic finance practices. Source: AAOIFI Official Website

Meezan Bank and MasterCard sign agreement to launch MasterCard Titanium Debit Card

Meezan Bank, Pakistan’s first and largest Islamic bank, has entered into an agreement with Master Card to launch the MasterCard Titanium Debit Card for its customers.

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Meezan Bank’s collaboration with MasterCard will cater to the specific demands of its high net worth customers and offer a vast range of benefits including free access to Airport lounges across the Middle East, as well as other rewards.

The signing ceremony was attended by Mr. Irfan Siddiqui, President & CEO - Meezan Bank, Mr. Ariful Islam, Deputy CEO - Meezan Bank, Mr. Omer Salimullah, National Manager Alternate Delivery Channels – Meezan Bank, Mr. Raghu Malhotra, Divisional President - MasterCard and Mr. Aurangzaib Khan, Country Manager - MasterCard.

Speaking at the occasion, Mr. Irfan Siddiqui said: “The MasterCard Titanium debit card will be a significant addition to the Bank’s portfolio and provide a wide range of additional benefits to our customers within the bounds of Shariah.” Source: Meezan Bank Limited

Bank Islami finalizes rights issue worth Rs400 million Bank Islami Pakistan Limited has decided to issue 63.191 ordinary shares as right

shares at Rs. 6.33 per share, amounting to Rs. 400 million to meet the minimum capital requirement of the State Bank of Pakistan, as the exemption granted by the SBP for minimum capital requirement expired on March 31, a statement said.

The SBP had declined to extend the extension unless Bank Islami improves its equity position substantially, it said.

The SBP through a circular of 2009 increased the MCR for banks up to Rs. 10 billion to be achieved in a phased manner by December 31.

The SBP in March 2011 had given extension to Bank Islami for meeting the MCR (free of losses), amounting to Rs6 billion till June 30, 2011. However, the paid-up capital of the bank (free of losses) as of June 30, amounts to Rs. 5.28 billion, it said.

The board of the bank in their meeting held on February 7, 2011 had, in principle, agreed to issue right shares to increase its paid-up capital (free of losses) to Rs. 6 billion.

The SBP in March had further extended the timeline for meeting the paid-up capital of Rs. 6 billion and to submit the reassessed issue price of right shares till March, the statement said.

Moreover, the bank has also been advised by the central bank to submit concrete time bound capital plan by March 31 to comply with the future and prevailing regulatory capital requirements.

The management of the bank in August had requested the SBP for extension in complying with the MCR till September 16 and in response, the SBP has not acceded to the bank’s request and advised the bank to maintain a minimum CAR of 14.5 percent at all times, which can be further enhanced in the case of non-injection of fresh capital by the sponsors by the end of December. Source: The News

Journal of Islamic Banking and Finance Oct.- Dec. 2013 95

Meezan Bank Limited to assist Akhuwat for implementation of Islamic Microfinance Musharakah

Meezan Bank Limited (MBL), the premier and largest Islamic Bank of Pakistan has entered into a Memorandum of Understanding (MoU) with Akhuwat (Akh), country’s leading non-profit organization which provides interest free microfinance facility to deserving people, for facilitating the implementation of Musharakah based financing without its linkage to any banking benchmark like KIBOR, LIBOR etc.

Under this MoU, MBL will support Akh for capacity building and provide other Shari’ah technical services and support for paving the way to launch Musharakah based financing for micro-businesses without its linkage to any banking benchmark. A Musharakah fund will be created from which a second Musharakah will be executed to provide financial assistance to deserving individuals after their credit evaluation. In this regard, MBL will provide product development and ensure Shari’ah compliance.

This cooperation will assist Akh in increasing its operations in the field of Islamic micro-finance to reach out to the poor, needy and underprivileged, under its vision to eradicate poverty from the society. This MoU reinforces MBL’s commitment towards its vision of facilitating the implementation of equitable economic system, providing a strong foundation for establishing a fair and just society for the mankind.

Mr. Ahmed Ali Siddiqui, Executive Vice President & Head Product Development & Shariah Compliance of Meezan Bank and Dr. Muhammad Amjad Saqib, Executive Director of Akhuwat signed the MoU on behalf of their respective organizations.

Launch of Islamic Finance Media Campaign Held on July 18, 2013 at LRC, SBP.

SBP hosted the launching ceremony of industry-driven mass media campaign for improving the Islamic finance literacy in the country on July 18, 2013 at LRC, SBP. Governor SBP, Mr. Yaseen Anwar was the Chief Guest on the occasion which was well attended by Presidents/ Executives and Shariah Advisors of Islamic Banking Institutions along with media personnel.

Islamic Finance News Roadshow – 2013 Held on August 27, 2013 at LRC Auditorium, SBP.

Islamic Banking Department supported “Islamic Finance News (IFN) Roadshow – 2013” being organized by Redmoney on August 27, 2013 at LRC Auditorium, SBP. The roadshow was well attended by the participants from financial institutions, Islamic scholars, academia, etc, while number of renowned scholars and Islamic finance experts attended the program as speakers/ panelists. Governor SBP, Mr. Yaseen Anwar inaugurated the event and delivered the Keynote Address.

Pakistan regulator sets up Sharia advisory board Pakistan's securities commission has established a nine-member sharia advisory

board to oversee Islamic finance instruments in the world's second most populous Muslim nation, a centralised approach increasingly being adopted elsewhere around the globe. A country-level approach to regulating Islamic products was pioneered by

96 Journal of Islamic Banking and Finance Oct.- Dec. 2013

Malaysia, and in recent months other economies have introduced central sharia boards of their own including Dubai, Oman and Nigeria.

http://www.reuters.com/article/2013/05/09/pakistan-islamic-finance-idUSL 6N0DQ03L20130509

Global:

U.K: Global alternative: Islamic finance BRITISH Prime Minister David Cameron’s announcement at the World Islamic

Economic Forum of a $323m sovereign sukuk, or Islamic bond, to attract new money to London is not surprising given the swift growth of Islamic finance — Sharia-compliant money — in and outside Muslim countries. Islamic finance assets stood at $1.6tr at the end of 2012, and are projected to soar to $6.5tr by the end of 2020. As many as 375 banks and financial institutions practice dedicated Islamic finance while another 110 conventional banks and financial institutions have opened windows to meet the needs of customers. The globally traded sukuk market has shot up to $0.5tr in the last seven years. Islamic finance is naturally more popular among Muslims because of their religious beliefs, with Malaysia leading the rest of the Muslim world. But its acceptance has also grown fast in the West in recent years as it offers an ‘ethically acceptable’ alternative to conventional banking, besides affording an opportunity to governments and businesses to attract money from Muslim countries. Indeed, Britain’s push to become the first Western state to launch an Islamic bond is driven by its desire to replace Kuala Lumpur as the Islamic finance hub and to woo wealthy investors from the Gulf economies.

Turkey The World Bank will open its first centre on Islamic Finance at Borsa Istanbul

premises. A statement on Borsa Istanbul's website says a ceremony will be held later on Monday to inaugurate the World Bank Global Islamic Finance Development Centre, the first of its kind. Deputy Prime Minister Ali Babacan, World Bank President Dr. Jim Yong Kim, Treasury Undersecretary Ibrahim Halil Canakci and Borsa Istanbul Chairman & CEO Dr. Ibrahim M. Turhan will participate in the ceremony, the statement adds. Istanbul has become more popular in recent months as a centre of finance, specifically in Islamic instruments. Turkey issued its first sukuk, Islamic equivalent of bonds, in September 2012, and this year in the same month Istanbul hosted an international forum on financial systems where the topic of Islamic finance featured prominently. http://www.globalislamicfinancemagazine.com/?com=news_list&nid=2986

Sharjah Islamic Plans Dollar Sukuk Sharjah Islamic Bank (NBS) is planning to sell dollar-denominated sukuk after

offerings of the securities in the U.S. currency reached an eight-month high in March. Bond risk in Asia was little changed today. The lender, from the third-largest of the seven emirates in the U.A.E., is planning to meet investors in Asia and Europe from April 4 ahead of a possible sale of Islamic securities, according to a person familiar with the deal, who asked not to be identified because the matter is private.

http://www.bloomberg.com/news/2013-04-02/sharjah-islamic-plans-dollar-sukuk-as-issues-surge-to-july-high.html

Journal of Islamic Banking and Finance Oct.- Dec. 2013 97

Thomson Reuters launches Islamic Finance Indicator With The Islamic Corporation for the Development Of the private sector

Thomson Reuters, the world's leading provider of intelligent information for businesses and professionals, Islamic Banking Bulletin Apr-June 2013 22 launched an Islamic Finance Development Indicator in collaboration with the Islamic Corporation for the Development of the Private Sector (ICD), the private sector development arm of the Islamic Development Bank (IDB).

http://www.ameinfo.com/thomson-reuters-launches-islamic-finance-indicator-342592

Islamic Development Bank sets guidance for USD1bn sukuk Islamic Development Bank , a Jeddah-based multilateral institution, set price

guidance for a $1 billion Islamic bond sale on Tuesday, a statement from the lead banks arranging the issue showed. The AAA-rated bank, whose largest shareholder is Saudi Arabia, is offering a price guidance of midswaps plus high 30 basis points for the five-year sukuk, the document said.

http://www.zawya.com/story/Islamic_Development_Bank_sets_guidance_for_USD1bn_sukuk-TR20130528nL5N0E910X3/

IIFM Publishes Islamic Inter-bank Unrestricted Master Investment Wakalah Agreement

Bahrain based international standard-setting body the International Islamic Financial Market (IIFM) announced the launch of IIFM Inter-Bank Unrestricted Master Investment Wakalah Agreement at the IIFM Industry Seminar that was held at the pre-conference day of the 4th Annual World Islamic Banking Conference: Asia Summit (WIBC Asia 2013) in Singapore under the patronage of the Monetary Authority of Singapore.

http://www.ramadan.com/news/iifm-publishes-islamic-inter-bank-investment-wakala-agreement-2.html

Disclaimer: The News included here is on the basis of information obtained from local and international print and electronic media sources. JIBF team does not accept any responsibility about its bona-fide

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Journal of Islamic Banking and Finance is an official publication of International Association of Islamic Banks Karachi, Pakistan. It is a refereed quarterly journal, as well as a pioneer in the field of Islamic banking and finance being published since 1984. It provides a forum for researchers, particularly in Islamic Banking and Finance, wishing to share their expertise with a vast intelligentsia in the form of articles, research and discussion papers and book reviews. Major areas of interest for the journal include: (i) Theoretical issues in banking and financial industry specially from Islamic perspective; (ii) Empirical studies about the Islamic banking and financial institutions; (iii) Survey studies on issues in Islamic banking and finance; (iv) Analytical studies of applied Islamic banking; (v) Comparative studies on Islamic and conventional banking systems; and (vi) Short communications and interviews investigating the perceptions of leading bankers and banking experts as well as policy makers. Articles Submission:

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