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Session 1

Overview of Islamic Finance

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AQIDAH

(Faith & Beliefs)

SHARIAH

(Practices & Activities)

AKHLAK

(Moral & Ethics)

IBADAH

(Man-(Worship)

MUAMALAT

(Human Interactions)

Political Activities Economics Social

Banking &

Financial Activities

Islam is a way of Life

There are rules governing the many facets and aspects of life.

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Islamic Finance

It represents an assertion of religious law in the capital market transactions where financing transactions should be free from the involvement of prohibited activities by Islam as well as free from the elements such as :

• Riba• Maisir • Gharar

Islamic Finance revolves around activities carried out in ways that do not conflict with the conscience of Man and Islam.

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Objective of Islamic Banking

• Non-Involvement in Haram Activities

• To Provide Transactions Free from Riba, Gharar and Maisir

• To Provide an Alternative Financing to the Conventional Financing

• To Provide for a More Equitable Financial System

• To Mobilise Muslim Funds Efficiently & Effectively

• Create Viable Islamic Assets

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Granting of Money in Islamic Finance

Arises From:

Financial Transactions In Islam

Fee-based financial services

Contracts of Exchange

Partnership ventures

Lease

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•Sources of Funds are from Permissible Activities and Applied Toward Permissible Activities

•Takes the Role of a Trader

•Financing is Backed by Real Assets

•Real Asset-Owners in the case of Ijarah

•Pricing is based on True Market-Based Mark-Up or Service Rate

•No Penalty Interest

Holistic Approach in Islamic Finance

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•Riba

•Gharar

•Maisir

•Haram Activities

Core Prohibitions in Islamic Finance

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Time Value of Money

• Time value of money has a place in

Islamic Finance.

• The return available to an individual

saver, need not relate to an interest

of riba-based transaction. The return

available on the next best

“permissible” investment (from trade

of otherwise) constitutes time value

of money in Islamic Finance.

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Gharar is the lack of information disclosure, uncertainty, ambiguity, and the presence of

excessive risks.

Gharar

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Maisir

Maisir can be defined as gambling i.e. games of

chance often involving money or belongings.

One More on my side

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Non-Halal Activities

• Financial services based on Riba;

• Gambling and gaming;

• Manufacture or sale of non-halal products or related

products;

• Conventional insurance;

• Entertainment activities that are non-permissible

according to Shariah;

• Manufacture or sale of tobacco-based products or

related products;

• Stockbroking or share trading in Shariah-non compliant

securities

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Musyarakah

Mudharabah

Ijarah

Murabahah

Istisna’

Salam

Pre-Islamic Mode of Financing

•Existed even before the coming of the Holy Prophet Muhammad

Pre Islamic Trading

Pre Islamic Coin

•The Prophet himself practised Mudharabah

•The Prophet endorsed these facilities as acceptable in Islam

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•It was mostly illegal in Christian medieval Europe to charge interest on a loan of money, for much the same reasons Islamic law forbids it: That, as money is intrinsically unproductive, it is ethically wrong to make money from money.

•In Central Europe, those who sought to borrow (interest-based) had to resort to illegitimate borrowing.

The Rise in Usury

• The rise in acceptance of usury began to the time of King Henry VIII when he broke ranks from Rome. Free from Rome’s oversight, the influence of the Church over the State waned. Within two centuries, usury had taken prominence. Interest- based lending became acceptable. •England was the birthplace of formal conventional banking

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The revival of Islamic Finance was mainly fuelled by the

(1) Independence after WW II

(2) Iran Islamic Revolution

(3) new wealth of the Arab Nations arising from the discovery of oil

Islamic Finance Revival

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A successful Islamic savings Institution, albeit set with an objective of enabling depositors to perform their Haj

Lembaga Tabung Haji

•Malaysia’s first Islamic Bank

•Incorporated in 1983 under the

Islamic Banking Act 1983

Bank Islam

Malaysia’s first Takaful Operator Incorporated in 1984 under the Takaful Act 1984

Syarikat Takaful Malaysia

First issuance in 1990Sukuk Market

Evolution of Malaysia’s Islamic Finance

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Evolution of Islamic Capital Markets

1990

2002

1994

2006

Issuance of Bai Bithaman Ajil Islamic Bonds by Shell MDS

• Issuance of Ittikal Fund – an Islamic Unit Trusts by

AmInvestment

• Malaysia’s first full fledge Islamic stock broking company

• The first Global Sukuk by Guthrie - $US395 Million Sukuk Ijarah

• The first Sovereign Global Sukuk by Malaysia - $US600 Million Sukuk Ijarah

In 2006 – MIFC as a one stop Islamic Financial Centre

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Session II

Shariah Commercial Contracts

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Sources of Shariah

Quran

Ijma’ Qiyas

Sunnah

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The Quran

The Book of Revelation and Last Testament

Contains divine guidance and direction for mankind

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Sunnah

The Sunnah is the living example of Prophet Muhammad – the practical example of the implementation of the Qur'anic guidance.

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Is the consensus of Islamic scholars which is legally binding, in a given generation on

particular points of Islamic Law

Ijma’

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Qiyas is the process of analogical reasoning from a known injunction to a

new injunction.

Qiyas

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Qiyas can be applied only when there is no solution to the matter in Quran or in the

Hadith;

Qiyas must not go against the principles of Islam;

Qiyas must not go against the contents of Quran neither must it be in conflict with the

traditions of the Prophet (pbuh); and

It must be a strict Qiyas based on either Quran, Hadith or the Ijma.

QIYAS

– Conditions for Application

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Contracts of Exchange

MurabahahBai’ Bithaman AJilBai’ InnahSalaamIstisna’

Participatory Contracts

MudharabahMusharakah

Islamic Financing Contracts

Lease

Ijarah

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PARTIES

MURABAHAH – Cost Plus Sales

BUYERSELLER FINANCIER

Most popular Islamic financing globally

• because the mechanics of the financing is widely accepted by Syariah scholars

• easy in terms of operations

• low risk and avoids liquidity problem by virtue of it being a short-term financing

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Buyer Financier Seller

2. Financier Pays Seller

3. Seller deliver goods

4. Buyer pays

Financier Selling Price

as per stipulated

period

MURABAHAH

1. Initiationa. Buyer requests Financier to finance purchaseb. Settlement to Financier on deferred termc. Financier quotes order selling price (Cost + Mark-Up)

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Buyer Financier Developer

1. Initiation

a. Buyer requests Financier to finance purchase of property

b. Settlement to Financier on deferred installments

c. Financier quotes order selling price (Cost + Mark-Up)

BAI’ BITHAMAN AJIL

3. Developer hands

over property

2. Financier Pays Developer4. Buyer pays Financier

Selling Price in

Installments as stipulated

Murabahah and BBA

• Rules and application in Murabahah and BBA

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BAI’ INNAH

Financier Borrower Merchandise

1. Financier owns Merchandise

2. Financier sells

Merchandise at RM X.

Settlement to Financier

on deferred terms

3.Buyer resells merchandise to Financier

at RMX - RMY= RMZ

Financier pays Borrower RM Z

immediately.

4. Buyer pays

Financier Selling

Price as per

stipulated period

BAI’ INAH

• Rules and application in Inah

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A contract for the sale of goods where delivery is made in the future.

BAI’ SALAM

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Buyer Financier Seller

3. Seller deliver

goods at the

pre-determined

future date

4. Buyer pays Financier

Selling Price as per

stipulated period

BAI’ SALAM

1. Initiation

a. Buyer requests Financier to finance order with future delivery

b. Settlement to Financier on deferred term

c. Financier quotes order selling price (Cost + Mark-Up)

2. Financier Pays Seller

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BAI’ ISTISNA

A contract for the sale of goods which skilled workman commits himself to manufacture for the buyer.

Contract of SaleSkilled Worker Buyer

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Buyer Financier Craftsman

3. Craftsman

deliver

goods upon

completion

4. Buyer pays Financier

Selling Price as per

stipulated period

BAI’ ISTISNA

1. Initiation

a. Buyer requests Financier to finance manufacturing order

b. Settlement to Financier on deferred term

c. Financier quotes manufacturing order selling price (Cost + Mark-

Up)

2. Financier Pays

Craftsman to

enable to start work

Salam and Istisna’

• Rules and application in Salam and Istisna’

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IJARAH

The right to use and derive benefit from a property with lease rental paid to the Owner

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IJARAH

2. Assets leased to

usufructuary

3. Lessee pays rental

for usufruct

1. Owns Asset

4. Maintains upkeep

of asset

OWNER USUFRUCTUARY

/ LESSEEASSETS

Ijarah

• Rules and application in Ijarah

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PARTIES

Partnership - MUDHARABAH

MUDHARIBRABBUL

MAL

•Provides capital, assets

•Entitled to profit

according to pre-agreed

ratio

•Bears loss of capital

•Entrepreneur-Trustee

•contributes to talent, expertise,

skills or labour

•Holds in trust the capital

•Entitled to profit according to pre-

agreed ratio

•Does not bear any liabilities arising

from losses unless due to his

negligence or breach in fiduciary

duties

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RABBULMAL

MUDHARABAH

MUDHARIB

CAPITAL

RIGHTS

VENTURE

PROFIT LOSS

SKILLS / LABOUR

Pre-

Agree Ratio

Borne

By

Rabbulmal

Pre-Determined

Partnership–MUDHARABAH(cont.)

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•Where two or more persons contribute capital, assets or labour into the partnership.

•Partners enjoy similar rights

• Partners share profit in pre-agreed ratio. It is not necessary to share profit according to ratio of capital contribution.

• Losses shall be borne together.

Partnership - Musharakah

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MUSHARAKAH

PARTNER PARTNER

PARTNER

CAPITAL

OR

LABOUR

VENTURE

PROFIT/ LOSS

Pro-Rated or Equal

RIGHTS

Equal

Partnership–MUSHARAKAH(cont.)

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Buyer Financier Developer

1. Initiation

a. Buyer requests Financier to finance purchase of property

b. Settlement to Financier on diminishing partnership basis

c. Financier quotes its Participatory Value

MUSHARAKAH MUTANAQISAH

3. Developer hands

over property

2. Financier Pays Developer4. Buyer pays Financier

Selling Price in

Installments as stipulated

Mudarabah and Musharakah

• Rules and application in Mudarabah and

Musharakah

Riba, Gharar and Maisir in Insurance

• Insurance

–A contract of buy and sell

–Based on the concept of guarantee by the

insurer to the policy holder

–Premium belongs to insurer

• If amount of premium collected more

than claims, insurer will make a profit

• If it is lesser, it will result in a loss

Riba, Gharar and Maisir in Insurance

• Riba

– Money in exchange for money

• In the event of claims, premium paid is not at par

to the claims - riba

– Investment/savings in interest bearing instruments

• Fixed deposits

• Bonds

• Non-shariah approved investments

Riba, Gharar and Maisir in Insurance

• Gharar

– Uncertainty on

• The subject matter,

– in terms price

»Sale price; how much is the premium?

»Counter value; how much will be the claims

paid?

– in terms of time (when claims will be paid?)

• The event of the insurable risk happening/not

happening

Riba, Gharar and Maisir in Insurance

• Maisir

– Uncertainty that may lead to gambling characteristics; risk transfer is uncertain and based on chance

– Quick money on gambling of the risk covered

• Non-Shariah compliant contract of guarantee

– For a contract of guarantee, there should not be any charge

– It should be a benevolent act

Riba, Gharar and Maisir in Insurance

• Takaful– Contract of tabarru’ (contribution); one sided and need

not to have counter value

– Based on the concepts of guarantee to indemnify among participants

– Contribution belongs to the fund (not the takaful operator); participants are the beneficiaries of the fund

– Takaful operator acts as an agent for the participants and receives fee (based on contract of wakalah)

Wallahua’lam

Thank you