Islamic banking and finance
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|Part of a series on financial services|
Islamic banking or Islamic finance (Arabic: مصرفية إسلامية) or sharia-compliant finance is banking or financing activity that complies with sharia (Islamic law) and its practical application through the development of Islamic economics. Some of the modes of Islamic banking/finance include Mudarabah (Profit and loss sharing), Wadiah (safekeeping), Musharaka (joint venture), Murabahah (cost plus), and Ijar (leasing).
Sharia prohibits riba, or usury, defined as interest paid on all loans of money (although some Muslims dispute whether there is a consensus that interest is equivalent to riba). Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also haraam ("sinful and prohibited").
These prohibitions have been applied historically in varying degrees in Muslim countries/communities to prevent un-Islamic practices. In the late 20th century, as part of the revival of Islamic identity,[Note 1] a number of Islamic banks formed to apply these principles to private or semi-private commercial institutions within the Muslim community. Their number and size has grown so that by 2009, there were over 300 banks and 250 mutual funds around the world complying with Islamic principles, and around $2 trillion were sharia-compliant by 2014. Sharia-compliant financial institutions represented approximately 1% of total world assets, concentrated in the Gulf Cooperation Council (GCC) countries, Iran, and Malaysia. Although Islamic Banking still makes up only a fraction of the banking assets of Muslims, since its inception it has been growing faster than banking assets as a whole, and is projected to continue to do so.
The industry has been lauded for returning to the path of "divine guidance" in rejecting the "political and economic dominance" of the West, and noted as the "most visible mark" of Islamic revivalism. Its most enthusiastic advocates promising "no inflation, no unemployment, no exploitation and no poverty" once it is fully implemented. But it has also been criticized for failing to develop profit and loss sharing or more ethical modes of investment promised by early promoters, and instead selling banking products that "comply with the formal requirements of Islamic law", but use "ruses and subterfuges to conceal interest", and entail "higher costs, bigger risks" than conventional (ribawi) banks.
- 1 History
- 2 Principles
- 3 Industry framework
- 4 Central Banking
- 5 Islamic financial transaction terminology
- 5.1 Aqad (contract)
- 5.2 Bai' al 'inah (sale and buy-back agreement)
- 5.3 Bai' bithaman ajil (deferred payment sale)
- 5.4 Bai' muajjal (credit sale)
- 5.5 Mudarabah
- 5.6 Murâbaḥah
- 5.7 Musawamah
- 5.8 Bai Salam
- 5.9 Hibah (gift)
- 5.10 Istisna
- 5.11 Ijarah
- 5.12 Qard hassan (good loan)
- 5.13 Sukuk (Islamic bonds)
- 5.14 Tawarruq
- 5.15 Takaful (Islamic insurance)
- 5.16 Wadiah (safekeeping)
- 5.17 Wakalah (power of attorney)
- 6 Other Sharia-compliant financing
- 7 Assessment and controversy
- 8 See also
- 9 References
- 10 External links
Usury in Islam
Although Islamic finance contains many prohibitions—such as on consumption of alcohol, gambling, uncertainty, etc. -- the belief that "all forms of interest are riba and hence prohibited" is the idea upon which it is based. The word "riba" literally means “excess or addition”, and has been translated as "interest", "usury", "excess", "increase" or "addition".
According to Islamic economists Choudhury and Malik, the elimination of interest followed a "gradual process" in early Islam, "culminating" with a "fully fledged Islamic economic system" under Caliph Umar (634-644 CE).
Other sources (Encyclopedia of Islam and the Muslim World, Timur Kuran), do not agree, and state that the giving and taking of interest continued in Muslim society "at times through the use of legal ruses (ḥiyal), often more or less openly," including during the Ottoman Empire. (Still another source, (International Business Publications), states that during the "Islamic Golden Age" the "common view of riba among classical jurists" of Islamic law and economics was that it was unlawful to apply interest to gold and silver currencies, "but that it is not riba and is therefore acceptable to apply interest to fiat money -- currencies made up of other materials such as paper or base metals -- to an extent.")[Note 2]
In the late 19th century Islamic Modernists reacted to the rise of European power and influence and its colonization of Muslim countries by reconsidering the prohibition on interest and whether interest rates and insurance were not among the "preconditions for productive investment" in a functioning modern economy. Syed Ahmad Khan, argued for a differentiation between sinful riba "usury", which they saw as restricted to charges on lending for consumption, and legitimate non-riba "interest", for lending for commercial investment.
However, in the 20th century, Islamic revivalists/Islamists/activists worked to define all interest as riba, to enjoin Muslims to lend and borrow at "Islamic Banks" that avoided fixed rates. By the 21st century this Islamic Banking movement had created "institutions of interest-free financial enterprises across the world”.
The movement started with activists and scholars such as Anwar Qureshi,Naeem Siddiqui, Abul A'la Maududi, Muhammad Hamidullah, in the late 1940 and early 1950s. They believed commercial banks were a "necessary evil," and proposed a banking system based on the concept of Mudarabah, where shared profit on investment would replace interest. Further works specifically devoted to the subject of interest-free banking were authored by Muhammad Uzair (1955), Abdullah al-Araby (1967), Mohammad Najatuallah Siddiqui, al-Najjar (1971) and Muhammad Baqir al-Sadr.
The involvement of institutions, governments, and various conferences and studies on Islamic banking (Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, The First International Conference on Islamic Economics in Mecca in 1976, and the International Economic Conference in London in 1977) were instrumental in applying the application of theory to practice for the first interest-free banks. At the First International Conference on Islamic Economics, "several hundred Muslim intellectuals, Shari'ah scholars and economists unequivocally declared ... that all forms of interest" were riba .
By 2004, the strength of this belief (which is the basis of Islamic finance) was demonstrated in the world's second largest Muslim country—Pakistan—when a minority (non-Muslim) member of the Pakistani parliament[Note 3] questioned it, pointing out that a scholar from Al-Azhar University, (one of the oldest Islamic Universities in the world), had issued a decree that bank interest was not un-Islamic. His statement resulted in "pandemonium" in the parliament, a demand by members of leading Islamist political party[Note 4] to immediately respond to these allegedly derogatory remarks, followed by a walkout when they were denied it. When the upset members of parliament returned, their leader (Sahibzada Fazal Karim), stated that since the Pakistan Council of Islamic ideology had decreed that interest in all its forms was haram (forbidden) in an Islamic society, no member of parliament had the right to "negate this settled issue".
The council's decree notwithstanding, over the years a minority of Islamic scholars (Muhammad Abduh, Rashid Rida, Mahmud Shaltut, Syed Ahmad Khan, Fazl al-Rahman, Muhammad Sayyid Tantawy and Yusuf al-Qaradawi) have questioned whether riba includes all interest payments. Others (Muhammad Akran Khan) have questioned whether riba is a crime like murder and theft, forbidden by sharia (Islamic law) and subject to punishment by human beings, or simply a sin to be inveighed against, with the reprimand left to God, since "neither the Prophet nor the first four caliphs nor any subsequent Islamic government ever enacted any law against riba."
While revivalists like Mohammed Naveed insist Islamic Banking is "as old as the religion itself with its principles primarily derived from the Quran", secular historians and Islamic modernists see it as a modern phenomenon or "invented tradition".
According to Timur Kuran, by "the tenth century, Islamic law supported credit and investment instruments" that were "as advanced" as anything in the non-Islamic world, but prior to the 19th century there were no "durable" financial institutions "recognizable as banks" in the Muslim world. The first Muslim majority-owned banks did not emerge until the 1920s.
An early market economy and an early form of mercantilism, sometimes called Islamic capitalism, was developed between the eighth and twelfth centuries. The monetary economy of the period was based on the widely circulated currency the gold dinar, and it tied together regions that were previously economically independent.
A number of economic concepts and techniques were applied in early Islamic banking, including bills of exchange, partnership (mufawada, including limited partnerships, or mudaraba), and forms of capital (al-mal), capital accumulation (nama al-mal), cheques, promissory notes, trusts (see Waqf), transactional accounts, loaning, ledgers and assignments. Muslim traders are known to have used the cheque or ṣakk system since the time of Harun al-Rashid (9th century) of the Abbasid Caliphate. Organizational enterprises independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced during that time. Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.
In the middle of the 20th century some organizational entities were found to offer financial services complying with Islamic laws. The first, experimental, local Islamic bank was established in the late 1950s in a rural area of Pakistan which charged no interest on its lending.
In 1963, the first modern Islamic bank on record was established in rural Egypt by economist Ahmad Elnaggar to appeal to people who lacked confidence in state-run banks. The profit-sharing experiment, in the Nile Delta town of Mit Ghamr, did not specifically advertise its Islamic nature for fear of being seen as a manifestation of Islamic fundamentalism that was anathema to the Gamal Nasser regime. Also in that year the Pilgrims Saving Corporation was founded in Malaysia (although not a bank, it incorporated basic Islamic banking concepts).
The Mit Ghamr experiment was shut down by the Egyptian government in 1968. Nonetheless it was considered a success by many, as by that time there were nine similar banks in the country. In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank, which as of 2016 was still in business in Egypt.
|SOURCE: Islamic Finance
The influx of "petro-dollars" and a "general re-Islamisation" following the Yom Kippur War and 1973 oil crisis encouraged the development of the Islamic banking sector, and since 1975 it has spread globally.
In 1975, the Islamic Development Bank was set up with the mission to provide funding to projects in the member countries. The first modern commercial Islamic bank, Dubai Islamic Bank, was established in 1979. The first Islamic insurance (or takaful) company — the Islamic Insurance Company of Sudan — was established in 1979. The Amana Income Fund, the world's first Islamic mutual fund (which invests only in sharia-compliant equities), was created in 1986 in Indiana.
From 1980-1985, Islamic investments underwent a "spectacular expansion" throughout the Muslim world, attracting deposits with the promise of "great gains" and "religious guarantees" supplied by Islamic jurists who were "recruited to issue fatwas denouncing conventional banks and recommending their Islamic rivals." This growth was temporarily reversed in 1988 in the largest Arab Muslim country, Egypt, when the Egyptian state — worried that Islamist movements were building up a "war chest" and being given financial independence — reversed its tacit support for the industry, and launched a media campaign against Islamic banks. The ensuing financial panic led to the bankruptcy of some companies.
In 1990 an accounting organization for Islamic financial institutions (Accounting and Auditing Organization for Islamic Financial Institutions, AAOIFI), was established in Algiers by a group of Islamic financial institutions. Also in that year the Islamic bond market emerged when the first tradable sukuk — the Islamic alternative to conventional bonds — were issued by Shell MDS in Malaysia. In 2002, the Malaysia-based Islamic Financial Services Board (IFSB) was established as an international standard-setting body for Islamic financial institutions.
By 1995, 144 Islamic financial institutions had been established worldwide, including 33 government-run banks, 40 private banks, and 71 investment companies. The large US-based Citibank began to offer Islamic banking services in 1996 when it established the Citi Islamic Investment Bank in Bahrain. The first successful benchmark for the performance of Islamic investment funds was established in 1999, with the Dow Jones Islamic Market Index (DJIMI).
Also in the 1990s, a false start was made in Islamic banking in the UK, where bankers declared returns "interest" for tax purposes, while insisting to depositors they were actually "profit" and so not riba. Islamic scholars issued a fatwa stating they had "no objection to the use of the term `interest'" in loan contracts for purposes of tax avoidance provided the transaction did not actually involve riba, and the Islamic bankers used the term for fear that lack of tax deductions available for interest (but not profit) would put them at a competitive disadvantage to conventional banks. Muslim customers were not persuaded, and a "bad taste" was left "in the mouth" of the market for Islamic financial products. The Islamic Bank of Britain, the first Islamic commercial bank established outside the Muslim world, was not established until 2004.
By 2008 Islamic banking was growing at a rate of 10–15% per year and continued growth was forecast. There were over 300 Islamic financial institutions spread over 51 countries, as well as an additional 250 mutual funds complying with Islamic principles. Worldwide, approximately 0.5% of financial assets were estimated to be under sharia-compliant management according to The Economist magazine.
But as the industry grew it also drew criticism (from M.T. Usmani among others) for not progressing from "debt based contracts", such as murabaha, to the more "genuine" profit and loss sharing mode, but instead moving in the opposite direction, "competing to present themselves with all of the same characteristics of the conventional, interest-based marketplace".
During the global financial crisis of 2008, Islamic banks were not initially impacted by the ‘toxic assets’ built up on the balance sheets of US banks as these were not shari’a compliant and not owned by Islamic banks. In 2009, the official newspaper of the Vatican ('L'Osservatore Romano) put forward the idea that "the ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service". (The Catholic Church forbids usury but began to relax its ban on all interest in the 16th century.) However the drop in valuation of real estate and private equity – two segments heavily invested by Islamic firms – following the collapse of Lehman Brothers Islamic did hurt Islamic financial institutions.
As of 2015, $2.004 trillion in assets were being managed in a sharia compliant manner according to the State of the Global Islamic Economy Report. Of these $342 billion were sukuk. The market for Islamic Sukuk bonds in that year was made up of 2,354 sukuk issues, and had become strong enough that several non-Muslim majority states — UK, Hong Kong, and Luxemburg — issued sukuk.
To be consistent with the principles of Islamic law (Shariah) -- or at least an orthodox interpretation of the law -- and guided by Islamic economics, the contemporary movement of Islamic banking and finance prohibits a variety of activities, some not illegal in secular states:
- Paying or charging interest. "All forms of interest are riba and hence prohibited". Islamic rules on transactions (known as Fiqh al-Muamalat) have been created to prevent use of interest.
- Investing in businesses involved in activities that are forbidden (haraam). These include things such as selling alcohol or pork, or producing media such as gossip columns or pornography.
- Charging extra for late payment. This applies to murâbaḥah or other fixed payment financing transactions, although some authors believe late fees may be charged if they are donated to charity, or if the buyer has "deliberately refused" to make a payment.
- Maisir. This is usually translated as "gambling" but used to mean "speculation" in Islamic finance. Involvement in contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future is maisir and forbidden in Islamic finance.
- Gharar. Gharar is usually translated as "uncertainty" or "ambiguity". Bans on both maisir and gharar tend to rule out derivatives, options and futures. Islamic finance supporters (such as Mervyn K. Lewis and Latifa M. Algaoud) believe these involve excessive risk and may foster uncertainty and fraudulent behaviour such as are found in derivative instruments used by conventional banking.
- Engaging in transactions lacking "`material finality`. All transactions must be "directly linked to a real underlying economic transaction", which excludes "options and most other derivatives".
Money on the most common type of Islamic financing — debt-based contracts — "must be made from a tangible asset that one owns and thus has the right to sell — and in financial transactions it demands that risk be shared." Money cannot be made from money. Another statement of the Islamic banking theory of finance is: "Money has no intrinsic utility; it is only a medium of exchange." Other restrictions include
- Islamic banks are to collect zakat (obligatory religious alms giving) from customers' accounts — at least according to some sources.
- A board of Shariah experts is to supervise and advise each Islamic bank on the propriety of transactions to "ensure that all activities are in line with Islamic principles". (Interpretations of Shariah may vary by country. According to Humayon Dar, interpretation of the Shariah is more strict in Turkey or Arab countries than in Malaysia, whose interpretation is in turn more strict than the Islamic Republic of Iran. Mohammed Ariff also found less exacting Shariah compliance in Iran where the Islamic government had decreed "that government borrowing on the basis of a fixed rate of return from the nationalized banking system would not amount to interest" and consequently would be permissible." Mahmud el-Gamal found interpretations most strict in Sudan and least in Malaysia.)
- Risk sharing. symmetrical risk and return on distribution to participants so that no one benefits disproportionately from the transaction.
In general, Islamic banking and finance has been described as having the "same purpose" as conventional banking but operating in accordance with the rules of shariah law (Institute of Islamic Banking and Insurance), or having the same "basic objective" as other private entities, i.e. "maximization of shareholder wealth" (Mohamed Warsame). In a similar vein, Mahmoud El-Gamal states that Islamic finance "is not constructively built from classical jurisprudence". It follows conventional banking and deviates from it "only insofar as some conventional practices are deemed forbidden under Sharia."[Note 5]
A broader description of its principles is given by the Islamic Research and Training Institute of the Islamic Development bank,
"The most important feature of Islamic banking is that it promotes risk sharing between the provider of funds (investor) on the one hand and both the financial intermediary (the bank) and the user of funds (the entrepreneur) on the other hand ... In conventional banking, all this risk is borne in principle by the entrepreneur."[Note 6]
Some proponents (Nizam Yaquby) believe Islamic banking has more far reaching purposes than conventional banking, and declare that the "guiding principles" for Islamic finance include: "fairness, justice, equality, transparency, and the pursuit of social harmony", although others describe these virtues as the natural benefits of following sharia. (Taqi Usmani describes the virtues as guiding principles in one section of his book on Islamic Banking, and benefits in another.)
Nizam Yaquby, for example declares that the "guiding principles" for Islamic finance include: "fairness, justice, equality, transparency, and the pursuit of social harmony". Some distinguish between sharia-compliant finance and a more holistic, pure and exacting sharia-based finance. "Ethical finance" has been called necessary, or at least desirable, for Islamic finance, as has a "gold-based currency". Taqi Usmani declares that Islamic banking would mean less lending because it paid no interest on loans, this should not be thought of as presenting a problem for borrowers finding funds, because — according to Usmani — it is in part to discourage excessive finance that Islam forbids interest. Zubair Hasan argues that the objectives of Islamic finance as envisaged by its pioneers were "promotion of growth with equity ... the alleviation of poverty ... [and] a long run vision to improve the condition of the Muslim communities across the world." Some (such as convert Umar Ibrahim Vadillo) believe the Islamic banking movement has so far failed to follow the principles of shariah law, or at least failed to follow them sufficiently strictly.[Note 7]
On the other hand, Usmani preached that an Islamic economy free of the "imbalances" in society — such as concentration of "wealth in the hands of the few", or monopolies which paralyze or hinder market forces — would follow from obeying "divine injunctions" by banning interest (along with other Islamic efforts). (Later in his book Introduction to Islamic Finance, he argues that Islamic principles should include "the fulfillment of the needs of the society" giving "preference to the products which may help the common people to raise their standard of living", but that few Islamic banks have followed this path.) Another source (Saleh Abdullah Kamel),[Note 8] described the changes anticipated for the Muslim community by following Islamic approach to economics, banking, finance, etc., as a "move towards economic development, creation of the value added factor, increased exports, less imports, job creation, rehabilitation of the incapacitated and training of capable elements".
Critic Feisal Khan argues that in many ways Islamic finance has not lived up to its defining characteristics. Risk-sharing is lacking because profit and loss sharing modes are so infrequently used. Underlying material transactions are also missing in such transactions as "tawarruq, commodity murabahas, Malaysian Islamic private debt securities, and Islamic short-sales". Exploitation is involved when high fees are charged for "doing nothing more substantial than mimicking conventional banking /finance products". Haram activities are not avoided when banks (following the customary practice) simply take the word of clients/financees/borrowers that they will not use funds for unIslamic activities.
The sharia law that forms the basis of Islamic banking is itself based on the Quran (revealed to the Islamic prophet Muhammad) and ahadith (the body of reports of the teachings, deeds and sayings of the Islamic prophet Muhammad that often explain verses in the Quran). Prohibition of gharar is based on ahadith declaring as forbidden gharar the sale of things like "the birds in the sky or the fish in the water". [Note 9] Maisir is thought to be banned by verses 2:219, 5:90, and 91 in the Quran.
However, "the Islamic evaluation" of modern banking centers around the definition of interest on loans as riba. Twelve verses in the Qur'an deal with riba, the word appearing eight times in total, three times in verses 2:275, and once in 2:276, 2:278, 3:130, 4:161 and 30:39. Riba is mentioned numerous times in ahadith, including Muhammad's Farewell Sermon.
A number of orthodox scholars point to Quranic verses (2:275-2:280) as declaring riba "categorically prohibited" and "unjust" (zulm), and defining it to mean any payment "over and above the principal" of a loan. (Although at least one source states "it is commonly argued" that riba is "defined by hadith".)
Those who devour usury shall not rise again except as he rises, whom Satan of the touch prostrates; that is because they say, 'Trafficking (trade) is like usury.' God has permitted trafficking, and forbidden usury. Whosoever receives an admonition from his Lord and gives over, he shall have his past gains, and his affair is committed to God; but whosoever reverts -- those are the inhabitants of the Fire, therein dwelling forever.
God blots out usury, but freewill offerings He augments with interest. God loves not any guilty ingrate.
Those who believe and do deeds of righteousness, and perform the prayer, and pay the alms - their wage awaits them with their Lord, and no fear shall be on them, neither shall they sorrow.
O believers, fear you God; and give up the usury that is outstanding, if you are believers.
But if you do not, then take notice that God shall war with you, and His Messenger; yet if you repent, you shall have your principal, unwronging and unwronged.
And if any man should be in difficulties, let him have respite till things are easier; but that you should give freewill offerings is better for you, did you but know. (Quran 2:275-280)
Some unorthodox (such as Raqiub Zaman) have asked why — if "God Almighty used the terms `doubling` and `quadrupling` (the sum lent)" as riba in verse 3:130, and if "there was no further clarification of this verse in the Quran or by the Prophet" — the orthodox are so certain that riba is defined as any "addition over and above the principal sum that is lent."
Nonetheless this is a minority view, and (according to the orthodox) an "increase over the principal sum" in loans of cash are riba. An increase over the principal sum in financing a purchase of some product or commodity is another matter. These are not riba — according to the orthodox interpretation — at least in some circumstances. (These are sometimes known as "credit sales".) According to noted Islamic scholar Taqi Usmani, this is because in Quran aya 2:275 ("they say, 'Trafficking (trade) is like usury,' [but] God has permitted trafficking, and forbidden usury") "trafficking (trade)" refers to credit sales such as murabaha, the "forbidden usury" refers to charging extra for late payment (late fees), and the "they" refers to non-Muslims who didn't understand why if the first was allowed both were not.[Note 10] For this reason (according to Usmani) it is not true that "whenever price is increased taking the time of payment into consideration, the transaction comes within the ambit of interest". Instead of "principal" and "interest rate", the credit taker is paying "cost" and "profit rate". (Another difference with conventional finance is that there is no penalty for late payment.)[Note 11]
Interest and credit sales
While Usmani and other Islamic Banking pioneers envisioned credit sales like murâbaḥah being a limited part of the Islamic Banking industry and subordinate to profit and loss sharing, it has become the "most common" mode of Islamic financing.
The distinction between credit sales and interest has also come under attack from critics such as Khalid Zaheer and Muhammad Akram Khan — criticizing it from opposite points of view. Zaheer considers profit from credit sales to be riba, the same as interest, and notes the lack of enthusiasm of orthodox scholars — such as the Council of Islamic Ideology — for credit sales-based Islamic Banking, which they (the council) call "no more than a second best solution from the viewpoint of an ideal Islamic system". Khan calls the distinction "frivolous and laboured", a way of charging interest using another name, necessary because businesses "cannot survive where cash and credit prices are equal". Others note that in terms of standard accounting practice and truth-in-lending regulations[Note 12] getting 90 days credit on a Rs10000 product and paying an extra Rs500, cost very nearly the same and is considered very nearly the same as paying in cash, using a three-month loan at 20% per annum.
Taqi Usmani, however, explains that this is a "misconception". Paying more for credit when buying a product ("an exchange of commodities for money") does not violate sharia law, but exchange of "one unit of money for another of the same denomination" ("an exchange of money for money") and charging for credit is a violation of sharia. The cash loan is different because "money has no intrinsic utility".
Other orthodox supporters (such as Kahf) have defended the sharia compliance of the practice saying that among other things, attaching commodities to money in finance prevents money from being used for speculative purposes. Critics report widespread abuses of "synthetic" murabaha, which are loans with interest in all but name.
Types of Islamic lending
One of the pioneers of Islamic banking, Mohammad Najatuallah Siddiqui, suggested a two-tier mudarabah model as the basis of a riba-free banking. The bank would act as the capital partner in mudarabah accounts with the depositor on one side and the entrepreneur on the other side. (Another pioneer Taqi Uthmani called mudarabah and another profit-sharing form of finance musharakah, the "real and ideal instruments of financing in Shari‘ah".) This model would be supplemented by a number of fixed-return models—mark-up (murabaha), leasing (ijara), cash advances for the purchase of agricultural produce (salam) and cash advances for the manufacture of assets (istisna`), etc. In practice, the fixed-return models, in particular murabaha model, became the industry staples, not supplements, as they bear results most similar to the interest-based finance models. Assets managed under these products far exceed those in "profit-loss-sharing modes" such as mudarabah and musharakah. 
Time value of money
The time value of money — the idea that there is greater benefit in receiving money now rather than later, so that savers/investors/lenders should be compensated for delayed gratification — has been called one of the "most significant" arguments in favor of charging interest on loans. As such, some Islamic finance supporters have opposed the concept, arguing that some consumption — such as eating — can only be done over time, and discounting for time encourages negative outcomes such as unsustainable production like desertification, since the desertification comes in the discounted future. However, since Islamic banking also calls for rewarding delayed gratification in the form of "return on investment" on both profit-sharing and credit sales, Islamic scholars and economists have tended to insist that time value of money is a valid concept "provided the rate of discount is the `rate of return` on capital rather than the rate of interest," a position critics find specious.
Early payment of debt
The opposite of credit sales (i.e. the opposite of charging more in exchange for giving the buyer time to pay) is reduced charges for early payment. This is considered haram by the four Sunni schools of juriprudence (Hanafi, Maliki, Shafi'i, Hanbali), but not by all jurists according to Ridha Saadullah. He notes that such reductions have
been permitted by some companions of the Prophet and some of their followers. This position has been advanced by Ibn Taymiyya and Ibn al-Qayyim, and it has, more recently, been adopted by the Islamic Fiqh Academy of the OIC. The Academy decided that `reduction of a deferred debt in order to accelerate its repayment, whether at the request of the debtor or the creditor is permissible under Shariah. It does not constitute forbidden riba if it is not agreed upon in advance and as long as the creditor-debtor relationship remains bilateral. ...
Islamic laws on trading
As noted above, the primary focus of Islamic banking is on financing without interest to avoid riba, while trade is not an issue (per the Quranic statement that "God has permitted trafficking [trade] and forbidden riba [usury]". However trade transactions that involve gambling (maisir), or excessive risk (bayu al-gharar) are not permitted. Among the financial instruments and activities common in conventional finance that are considered forbidden (or at least Islamically problematic) by many Islamic scholars and Muslims are:
- margin trading: This uses borrowed money to buy shares of stock or other financial instruments. It both involves forbidden interest on the borrowed money, and much greater risk than non-margin investing because loses can be greater than the amount borrowed;
- short selling: borrowing/renting shares of stock or some other instrument and selling it on the hope that its can be later repurchased at a lower price for a profit. It is traditionally thought to violate the hadith stating “Do not sell which you do not possess,” and has been declared impermissible by numerous sources (Raj Bhala, IslamQA, Taqi Usmani, Humayon Dar.
- day trading: very short term buying and selling of financial instruments) has been called unIslamic because the short period of "ownership" means day traders do not truly own what they trade, and furthermore pay interest. Among the sources calling it unIslamic include Yusuf Talal DeLorenzo, and Focus Business Services of the UAE.
- derivatives: contracts that derive their value from the performance of an underlying asset; (The "notional value" of the world's over-the-counter derivatives at the end of 2007 was $596 trillion and the gross market value of all outstanding derivatives was $14.5 trillion.) Options, futures and "other derivatives" are "generally" not used in Islamic finance "because of the prohibition against maisir", Sources stating that most derivative or some kinds of derivative are banned by Islamic scholars include Juan Sole and Andreas Jobst, P.S.Mills and J.R.Presley, Taqi Usmani, Investopedia. The most commonly used derivative are:
- forwards: customized contracts to buy or sell an asset at a specified price on a future date. unlike futures contracts forward contracts are not traded on any exchanges;
- futures: a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price at a specified time in the future;
- options: contracts offering the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date);
- swaps: contracts through which two parties exchange financial instruments to transfer risk.
On the other hand, at least one Islamic scholar (Mohammed Hashim Kamali) finds “nothing inherently objectionable" in selling and using options, which like other kinds of trade is mubah (permissible) in fiqh, and "simply an extension of the basic liberty that the Quran has granted”. And both Islamic finance practitioners and critics find benefit in at least some uses of derivatives and short selling — managing risk in times of financial trouble, improving market efficiency and employee productivity.
At least some in the Islamic finance industry use derivatives and make short sales, and permissibility of this is a subject of "heated debate". Global standards for trading Islamic profit-rate and currency swap derivatives were set in 2010 with the “Hedging Master Agreement”. (see below). A "shariah-certified" short-sale had been created by some Shariah-compliant hedge funds. However both have been criticized as unIslamic.
Islamic financial institutions take different forms. They may be
- Full-fledged Islamic financial institutions (for example Islami Bank Bangladesh Ltd, Meezan Bank in Pakistan);
- Islamic "windows" — i.e. separate, sharia-compliant units — in conventional financial institutions (for example: HSBC, American Express Bank, ANZ Grindlays, BNP-Paribas, Chase Manhattan, UBS, Kleinwort Benson, Commercial Bank of Saudi Arabia, Ahli United Bank Kuwait, Riyad Bank); (Scholars debate compliance of this form, according to Faleel Jamaldeen, "primarily" because of "where" the funds for these windows come from.)
- Islamic subsidiaries of conventional financial institutions (for example: Citibank subsidiary Citi Islamic Investment Bank (Bahrain), Union Bank of Switzerland subsidiary Noriba Bank).
|Percentage of world market share
of Islamic banking industry
by country, 2014
|Rest of the world||7.3|
|Source: World Islamic Banking
Competitiveness Report 2016
Sharia-compliant banking grew at an annual rate of 17.6% between 2009 and 2013, faster than conventional banking, and is estimated to be $2 trillion in size, but at 1% of total world, still much smaller than the conventional sector.
As of 2010, Islamic financial institutions operate in 105 countries. Statistics differ on which country has the largest Islamic banking sector. According to the 2016 World Islamic Banking Competitiveness Report, (table to the right) Saudi Arabia, Malaysia, United Arab Emirates, Kuwait, Qatar, and Turkey represented over 87% of the international Islamic banking assets. (A 2006 report by ISI Analytics also lists Saudi Arabia at the top and Iran as insignificant.)
But according to Ibrahim Warde, Shia-majority Iran dominates Islamic banking with $345 billion in Islamic assets; Saudi Arabia with $258 billion, Malaysia $142 billion, Kuwait with $118 billion and UAE with $112 billion. And according to Reuters, Iranian banks accounted for "over a third" of the estimated worldwide total of Islamic banking assets, (although sanctions have hurt Iran's banking industry and "its Islamic financial system has evolved in ways that will complicate ties with foreign banks"). According to the latest central bank data, Iran's banking assets as of March 2014 totalled 17,344 trillion riyals or $523 billion at the free market exchange rate. According to The Banker, as of November 2015, three out of ten top Islamic banks in the world based on return on assets were Iranian.
Sharia advisory councils and consultants
Because compliance with shariah law is the raison d'être of Islamic finance, Islamic banks and banking institutions that offer Islamic banking products and services should establish a Shariah Supervisory Board (SSB) — to advise them on whether or not some proposed transactions or products follows the Sharia, and to ensure that the operations and activities of the banking institutions comply with Shariah principles.
According to various Islamic banking organizations some requirements for SSBs include:
- that they be composed of jurists specializing in fiqh al-muamalat i.e. Islamic commercial jurisprudence, (Accounting and Auditing Organization for Islamic Financial Institutions, AAOIFI);
- their fatwas (legal opinions) and ruling be binding, (AAOIFI);
- that they have at least three members, (Institute of Islamic Banking and Insurance);
- that their members not be employees of the financial institution they supervise;
- and be appointed and have their remuneration set by a "general assembly" rather than the institution's board of directors, (International Association of Islamic Banks).
- calculating zakat payable by Islamic financial institutions, (AAOIFI);
- disposing of non-shariah-compliant income, (AAOIFI);
- advising on the distribution of income among investors and shareholders, (AAOIFI).
Since the beginning of modern Islamic finance, the work of the Shariah boards has become more standardized. Among the organizations that have issued guidelines and standards for Shariah compliance are the AAOIFI, Fiqh Academy of the OIC, Islamic Financial Services Board (IFSB) (2009). The guidelines and standards are not regulations though, and each Islamic financial institution has its own SSB, which are not generally obliged to follow them.
However, their home country many have a regulatory organization that they are required to follow. As of 2013, regulators in Bahrain, Indonesia, Jordan, Kuwait, Lebanon, Malaysia and Pakistan have developed guidelines for SSBs in their respective jurisdictions. Some countries, like Indonesia, Kuwait, Malaysia, Pakistan, Sudan, and the UAE have centralized SSBs (In Malaysia that SSB is called the Shariah Advisory Council, and was set up at Bank Negara Malaysia (BNM).) A number of Shariah advisory firms have now emerged to offer Shariah advisory services to the institutions offering Islamic financial services.
Some Islamic Banking observers believe the industry suffers from handpicked, highly-paid Shariah experts who have been approving financial products using ḥiyal (legal stratagem) to follow sharia law, "shunning controversial issues", and/or "rubber stamping" bank management decisions after perfunctory reviews, and that the banking practices approved by this small number of Islamic jurists have moved closer and closer to the practices of conventional non-Islamic banking.
- "Fatwa shopping", independence
Journalist John Foster quotes an "investment banker based in Dubai":
“We create the same type of products that we do for the conventional markets. We then phone up a Sharia scholar for a Fatwa ... If he doesn't give it to us, we phone up another scholar, offer him a sum of money for his services and ask him for a Fatwa. We do this until we get Sharia compliance. Then we are free to distribute the product as Islamic.”
According to Foster, this practice of "shopping" for an Islamic scholar who will issue a fatwa testifying that a banking product obeys Shari'ah law has led to "top scholars" earning "six-figure sums" for each fatwa, and to Islamic financing mechanisms that appear to outsiders to be mortgages "dressed up in Arabic terminology"—such as Mudarabah, or Ijarah (lease agreements).
Mahmoud El-Gamal believes that from the 1970s to the 2000s there has been an evolution of the industry towards "progressively closer approximations" of the practices of conventional banking, approved by "progressively smaller" numbers of jurists (with only a small group for example approving "unsecured lending" to retail and corporate customers through the tawarruq mode in the early 2000s). The scarcity of qualified shariah supervisors — who need to be trained in both Islamic commercial law and contemporary financial practices — has been noted. One study found the 20 most popular shariah scholars holding 621 sharia board positions, — creating potential conflicts of interest.
This scarcity also increases fees. Two researchers noted the small group of Shariah experts "earn as much as US$88,5000 per year per bank" and can "charge up to US$500,000 for advice on large capital market transactions." Income far in excess of what has been customary for Islamic scholars — luxury air travel and five star hotel — as well as being eagerly asked for their legal opinion by wealthy, high status people, may lead to what one writer (Muhammad O. Farooq) calls a "certain changes in viewpoint" resulting in "over-stretching the rules of Shariah".
A study of the practice of boards of financial institutions setting the pay and employment of SSB members found this arrangement "compromise(s) the independence of the SSB". Another study found Islamic financial institutions do "not have practices which ensure transparency in the role and functions of the SSBs".
Financial accounting standards
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), has been publishing standards and norms for Islamic financial institutions since 1993. By 2010, it had issued "25 accounting standards, seven auditing standards, six governance standards, 41 shari'ah standards and two codes of ethics." (By 2017 it had issued 94 standards in the "areas of Shari’ah, accounting, auditing, ethics and governance".) Although it is an independent body, its "pronouncements on the acceptability or otherwise of contractual structures in relation to Islamic financial instruments are to be viewed in the same vein as regulatory edicts." Its standards are mandatory for Islamic financial institutions in Bahrain, Sudan, Jordan and Saudi Arabia, and recommended for other Muslim countries and Islamic financial institutions according to Muhammad Akram Khan. [Note 13] Established in Algiers in 1990, its original name was Financial Accounting Organization for Islamic Banks and Financial Institutions. It later moved its headquarters to Bahrain.
The International Islamic Financial Market — a standardization body of the Islamic Financial Services Board for Islamic capital market products and operations — was founded in November 2001 through the cooperation of the governments and central banks of Brunei, Indonesia and Sudan. It's secretariat is located in Manama Bahrain. It is not a regulatory body and its recommendations are "not implemented by most Islamic banks". Faleel Jamaldeen differentiates it's controlling body (Islamic Financial Services Board) from the other Islamic Financial standards organ, the AAOIFI, saying,
the AAOIFI sets best practices for handling the financial reporting requirements of Islamic financial institutions, IFSB standards are mainly concerned with the identification, management, and disclosure of risk related to Islamic financial products.
Individual countries also have accounting standards. The Institute of Chartered Accountants of Pakistan issues Islamic Financial Accounting Standards (IFAS).
The Islamic Interbank Money Market was established by Bank Negara Malaysia on 3 January 1994, and has developed instruments to manage the liquidity needs of the Islamic financial institutions -- "funding and adjusting portfolios over the short term".
The Islamic Financial Services Board was founded on 3 November 2002 at Kuala Lumpur by central banks of Bahrain, Iran, Kuwait, Malaysia, Pakistan, Saudi Arabia, Sudan along with the Islamic Development Bank, AAOIFI, and IMF. As of April 2015, the 188 members of the IFSB comprise 61 regulatory and supervisory authorities, eight international inter-governmental organisations, and 119 market players (financial institutions, professional firms and industry associations) operating in 45 jurisdictions. From 2002 to 2012 it issued 17 standards, guiding principles and notes. Its objective is to standardize and harmonize the operation and supervision of Islamic financial institutions, standards and capital adequacy, risk management and corporate governance in consultation with a wide array of stakeholders and after following a lengthy process. It complements the task of the Basel Committee on Banking Supervision. As of 2015 it had published 17 standards and six guidance notes.
The Dow Jones Islamic Market Index (DJIMI) was established in 1996. The Index has been approved by Fiqh Academy of the OIC. It uses three levels of screening—eliminating businesses involved in activities not allowed by Islamic law (alcohol, pork, gambling, prostitution, pornography, etc.); eliminating companies whose total debts divided by their 12-month average market capitalization are 33% or more of their total sources of funds; eliminating companies that have `impure income or expenditure` (including, of course, interest) of more than 5-10 per cent of their income or expenditure (eliminating businesses with any `impure income` being considered impractical).
In 2006, Citigroup launched the Dow Jones Citigroup Sukuk Index. The sukuk making up the Index must be at least $250 million in size, have a maturity of at least one year and a minimum rating of BBB-/Baaa3. In 1998, the FTSE Global Islamic Index was launched. It has 15 Islamic indices for various regions. In 2007, the MSCI Islamic Index series was launched, one of the "MSCI ‘Faith-Based’ Indexes". It is constructed from the conventional MSCI country indices and covers 69 developed, emerging and frontier markets, including regions such as the Gulf Cooperation Council and Arabian markets.
- Islamic Economic Institute, previously Islamic Economics Research Centre, and before that International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah, (Saudi Arabia)
- Islamic Research and Training Institute (IRTI), Islamic Development Bank (IDB) Jeddah, (Saudi Arabia)
- School of Islamic Islamic Banking and Finance, previously International Institute of Islamic Economics, Islamabad, (Pakistan) (IIUI),
- Institute of Islamic Banking and Insurance, London (UK)
- International Centre for Education in Islamic Finance (INCEIF), Malaysia
- Islamic Finance Training, Kuala Lumpur
- Ethica Institute of Islamic Finance, Dubai
- Islamic Finance Academy, Dubai
- Centre for Islamic banking and Finance Training, Kuala Lumpur
- Institute of Islamic Finance, London (UK)
- Islamic Finance Advisory and Assurance Services, Birmingham (UK)
- Islamic Finance Institute of South Africa
- Centre for Islamic Finance of Bahrain, Institute of Banking and Finance (BIBF)
- Centre for Banking and Financial Studies, Qatar
Although no Muslim country has yet banned interest on loans completely, suggestions have been made as to how to deal with monetary policy when Central Banks operate in an interest-free environment and there are no longer any interest rates to lower or raise. Economist Mohammad N. Siddiqi has proposed that central banks offer "refinance facilities" to expand or contract credit as needed to deal with inflation or deflation.
He also proposes that short term credit for the production sector of the economy, be estimated by the Central Banks and the provided by them by manipulating the “refinance ratio” and the “lending ratio”.
According to economist and Islamic finance critic Feisal Khan, a "true" or strict Islamic banking and finance system of profit and loss sharing (the type supported by Taqi Usmani and the Shariah Appellate Bench of the Supreme Court of Pakistan) would severely cripple central banks' ability to fight a credit crunch or liquidity crisis that leads to a severe recession (such as happened in 2007-8). This is because if credit was provided by taking "a direct equity stake in every enterprise" (the PLS approach) it would contract in a credit crunch. But situations like this — when financiers are "less and less sure of the creditworthiness of their financial sector counterparties" and essentially stop lending to even the biggest and most stable borrowers or even other banks — is exactly the time when credit expansion and "flooding" the economy with liquidity is needed to prevent widespread business bankruptcy and unemployment.
Islamic financial transaction terminology
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A general term meaning a commitment between two parties, a shorter version 'Aqd' is used to specifically refer to marriage or the marriage contract. It is forbidden in Islam for a single contract to cover more than one agreement, this defeats many attempts to make Western financial deals Sharia compliant.
Bai' al 'inah (sale and buy-back agreement)
Literally, "A loan in the form of a sale". Bai' al inah is a financing arrangement where the financier buys an asset from the customer on spot basis, with the price paid by the financier constituting the "loan". Subsequently, the asset is sold back to the customer with deferred payment made in installments, constituting paying back the loan. The use of sale-and-buyback agreements varies on both jurisdictions and markets (reflecting the needs of consumers and investors in certain countries) these agreements are commonplace in Malaysia.
Bai' bithaman ajil (deferred payment sale)
This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. Like Bai' al 'inah, this concept is also used under an Islamic financing facility. Interest payment can be avoided as the customer is paying the sale price which is not the same as interest charged on a loan. The problem here is that this includes linking two transactions in one which is forbidden in Islam. The common perception is that this is simply straightforward charging of interest disguised as a sale.
Bai' muajjal (credit sale)
Literally bai' muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price. Bai' muajjal is also called a deferred-payment sale. This is the case where a bank acts as a retailer as the bank earns a profit for a margin on the purchase price of the commodity and resells it to the borrower at a higher price, and the customer is invoiced to pay this at a later date. With the profitability not on the rent of the money (disallowed under Sharia) or the rent of an asset such as land (allowed under Sharia) but the act of retailing physical commodities packaged in futures contracts such as gold, oil and copper.
"Mudaraba" or Profit-and-loss sharing contract is a kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The capital investment should normally come from both partners. Both should have some skin in the game.
The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capital and the other party providing its specialized knowledge to invest the capital and manage the investment project. Profits generated are shared between the parties according to a pre-agreed ratio. If there is a loss, the first partner "rabb-ul-mal" will lose his capital, and the other party "mudarib" will lose the time and effort invested in the project The profit is usually shared 50%-50% or 60%-40% for rabb-ul-mal.
According to economist Tarik M. Yousef, long-term financing with mudarabah or musharakah (both profit-and-loss-sharing mechanisms) is "far riskier and costlier" than the long term or medium-term lending of the conventional banks. As a consequence there has been a "divergence" between the theory of equity-based Islamic finance and the reality of murabahah-dominated practices of Islamic banks.
This concept refers to the sale of good(s) (such as real estate, commodities, or a vehicle) where the purchase and selling price, other costs, and the profit margin are clearly stated at the time of the sale agreement. With the rise of Islamic banking since 1975, Murabahah has become "the most prevalent" Islamic financing mechanism. Murabahah works as finance when the lender/buyer pays the bank/seller for the good(s) over a period of time, compensating the bank/seller for the time value of its money in the form of "profit" not interest. With a fixed rate of profit determined by the profit margin for the purchase of a real asset, this is a fixed-income loan. The bank is not compensated for the time value of money outside of the contracted term (i.e., the bank cannot charge additional profit on late payments); however, the asset remains as a mortgage with the bank until the default is settled.
This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are common in North American stores.
If the exact cost of the item(s) sold to the lender/buyer cannot be or are not ascertained, a financial transaction cannot be done on the basis of Murabahah, it is called musawamah (bargaining). Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabahah and Musawamah with all other rules as described in Murabahah remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals. Barring this, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship.
Basic features and conditions of Salam
- The transaction is considered Salam if the buyer has paid the purchase price to the seller in full at the time of sale. This is necessary so that the buyer can show that they are not entering into debt with a second party in order to eliminate the debt with the first party, an act prohibited under Sharia. The idea of Salam is normally different from the other either in its quality or in its size or weight and their exact specification is not generally possible.
- Salam cannot be effected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular tree, the salam will not be valid, because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery, and, given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity the supply of which is not certain.
- It is necessary that the quality of the commodity (intended to be purchased through salam) is fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect must be expressly mentioned.
- It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weight must be determined, and if it is quantified through measures, its exact measure should be known. What is normally weighed cannot be quantified in measures and vice versa.
- The exact date and place of delivery must be specified in the contract.
- Salam cannot be effected in respect of things which must be delivered at spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah, that the delivery of both be simultaneous. Here, salam cannot work. Similarly, if wheat is bartered for barley, the simultaneous delivery of both is necessary for the validity of sale. Therefore, the contract of salam in this case is not allowed.
- This is the most preferred financing structure and carries higher order Shariah compliance.
This is a token given voluntarily by a debtor in return for a loan. Hibah usually arises when Islamic banks pay their customers a 'gift' on savings account balances, representing a portion of the profit made lending funds from savings account balances. Unlike interest and like dividends on shares of stock, Hibah cannot be guaranteed. Additionally, it is not time bound.
Istisna (Manufacturing Finance) is a process where payments are made in stages to facilitate the work of manufacturing / processing / construction. An installment of Istisna, for example, may enable a construction company to finance construction of sections of a building or help manufacturers pay for an order of raw materials. Istisna helps use of limited funds to develop higher value goods/assets in different stages / contracts.
Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.
Ijarah thumma al bai' (hire purchase)
Parties enter into contracts that come into effect serially, to form a complete lease/ buyback transaction. The first contract is an Ijarah that outlines the terms for leasing or renting over a fixed period, and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is complete. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed amount over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price. The bank generates a profit by determining in advance the cost of the item, its residual value at the end of the term and the time value or profit margin for the money being invested in purchasing the product to be leased for the intended term. The combining of these three figures becomes the basis for the contract between the Bank and the client for the initial lease contract. This type of transaction is similar to the contractum trinius, a legal maneuver used by European bankers and merchants during the Middle Ages to sidestep the Church's prohibition on interest bearing loans. In a contractum, two parties would enter into three concurrent and interrelated legal contracts, the net effect being the paying of a fee for the use of money for the term of the loan. The use of concurrent interrelated contracts is also prohibited under Shariah Law.
A contract under which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the ome an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.
Musharakah (joint venture)
Musharakah is a relationship between two parties or more that contribute capital to a business and divide the net profit and loss pro rata. This is often used in investment projects, letters of credit, and the purchase or real estate or property. In the case of real estate or property, the bank assess an imputed rent and will share it as agreed in advance. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).
Qard hassan (good loan)
Qard hassan is a loan extended on a goodwill basis, with the debtor only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not violate the prohibition on riba, for it alone is a loan that truly does not compensate the creditor for the time value of money.
Sukuk (Islamic bonds)
Sukuk, plural of صك Sakk, is the Arabic name for financial certificates that share some similarities with conventional bonds hence are also commonly referred to as Islamic Bonds. A major difference between conventional bonds and sukuk is the structure of sukuk removes interest based elements which is replaced by an asset based income structure using most typically Ijara or Wakala contracts. Similarities are found at the issuance stage where Sukuk issuance in terms of documentation and regulation such as Reg S /144A and Reg S resembles closely that of a bond.
According to data published by the Islamic Financial Services Board, total outstanding sukuk as of end of 2014 was $294 Billion, of which $188 Billion was from Asia, and 95.5 Billion from the countries of the Gulf Cooperation Council.
(Literally "turns into silver") A product where a client customer buys an asset at a marked up price that is easily saleable and quickly sell the asset to raise cash. For example, a client might buy $1,000 worth of a commodity like iron from a bank, on condition he/she does not have to pay for it until 12 months later and then immediately sell the metal back to the bank for $900 to be paid immediately. (This would be the equivalent of borrowing $900 for a year at an interest rate of 11 per cent.) The product allows clients to raise money quickly and easily, in theory without breaking Muslim bans on interest. although the technique is controversial with some.
Takaful (Islamic insurance)
Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to be uncertain with respect to a very large number of similar individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of large numbers.
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with Hibah (see above) as a form of appreciation for the use of funds by the bank.
Wakalah (power of attorney)
This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar to a power of attorney.
Other Sharia-compliant financing
Islamic equity funds
Islamic investment equity funds market is one of the fastest-growing sectors within the Islamic financial system. Currently, there are approximately 100 Islamic equity funds worldwide. The total assets managed through these funds exceed US$5 billion and are growing by 12–15% per annum. With the continuous interest in the Islamic financial system, there are positive signs that more funds will be launched. Some Western majors have just joined the market or are thinking of launching similar Islamic equity products.
Despite these successes, this market has been undermarketed, as emphasis is on products rather than on addressing the needs of investors. Over the last few years, quite a number of funds have closed down. Most of the funds tend to target high-net-worth individuals and corporate institutions, with minimum investments ranging from US$50,000 to as high as US$1 million. Target markets for Islamic funds vary, some cater for their local markets (e.g. Malaysia and Gulf-based investment funds). Others cater to the Gulf and broader Middle East region, focusing on foreign rather than local market.
Since the launch of Islamic equity funds in the early 1990s, there has been the establishment of credible equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneered Islamic investment indexing in 1999) and the FTSE Global Islamic Index Series.
According to a study by Raphie Hayat and Roman Kraeussl of 145 Islamic equity funds from 2000 to 2009, the funds have under-performed Islamic as well as conventional equity benchmarks, particularly as the financial crisis set in. The study also found fund managers to be unsuccessful in their attempts to time the market.
With help of Bahrain-based International Islamic Financial Market and New York-based International Swaps and Derivatives Association, global standards for Islamic derivatives were set in 2010. One main objective in Islamic derivatives is to avoid "excessive" risk. The “Hedging Master Agreement” provides a structure under which institutions can trade derivatives such as profit-rate and currency swaps.
Microfinance is a concern for Muslims and shows great opportunity for growth for Islamic financial organizations. An estimated 72 percent of people living in Muslim-majority countries do not use formal financial services, often either because they are not available, and/or because potential customer believe conventional lending products incompatible with Islamic law.
According to the Islamic Microfinance Network website (as of circa 2013), there are more than 300 Islamic microfinance institutions in 32 countries. but a number of studies have found that outreach has far to go.
One report (by Humayon Dar and coauthors) found that Islamic microfinance made up less than 1 per cent of the global microfinance outreach, "despite the fact that almost half of the clients of microfinance live in Muslim countries and the demand for Islamic microfinance is very strong." 
A 2008 study of 126 microfinance institutions in 14 Muslim countries found Islamic microfinance had a total outreach of 380,000 from estimated total population of 77 million—only 0.5% "of total microfinance outreach". The largest Islamic microcredit outreach was Bangladesh, with over 100,000 clients and two active institutions, but this compared with nearly 8 million borrowers using conventional microfinance products (such as those of the Grameen Bank) leaving Islamic microfinance with only 1% of the Bangladesh microfinance market. (The total outstanding loan portfolio for Islamic Microfinance institutions studied was about $198 million in 2006, with an average loan size of $54.)
(Muhammad Yunus, the founder of the Grameen Bank and microfinance banking, and other supporters of microfinance, though not part of the Islamic Banking movement, argue that the lack of collateral and lack of excessive interest in micro-lending is consistent with the Islamic prohibition of usury (riba).)
Assessment and controversy
One of the controversies with regard to Islamic finance is the connection between the percentage return on accounts in Islamic banks and in conventional banks—specifically how closely the results match each other. This is thought by Islamic banking skeptics to be a suspicious coincidence suggesting manipulation of returns, but an important way of satisfying Islamic banking customers worried about risk to their deposits but who want to be Islamically correct. A 2014 study using "the most recent econometric techniques" of the long-term relationship between Conventional Banks’ term-deposit rates (TDRs) and the TDR of "participation banks’" (i.e. Islamic Banks) in Turkey found three of four participation banks term-deposit rates "significantly cointegrated" with those of Conventional Banks, and "permanent causality" from Conventional to all Islamic Banks.
Another study found "strong and consistent empirical evidence" that the development of Shariah-compliant Islamic banking in Muslim countries does not "crowd out" the conventional banking but leads to "higher banking sector development, as measured by the amount of private credit or bank deposits scaled to GDP."
In March 2009, Sheikh Muhammad Taqi Usmani of the Accounting and Auditing Organization for Islamic Finance Institutions (AAOIFI), a Bahrain-based regulatory institution that sets standards for the global Islamic Banking industry, declared that 85% of Sukuk, or Islamic bonds, were "un-Islamic". Usmani has been called "the granddaddy of modern-day Islamic finance". Another veteran of Islamic economics, Muhammad Akram Khan, criticizes Islamic banking as professing to have "put its business on a basis other than interest", but in practice, devising "a whole host of ruses and subterfuges to conceal interest". Mahmoud Amin El-Gamal, a professor of economics at Rice University (United States), has described modern Islamic finance as "sharia arbitrage—i.e. what is prohibited in conventional finance becomes permissible when deemed "shari'a-compliant" despite having similar, if not the same, economic substance.
In a 2006 dissertation Suliman Hamdan Albalawi concluded that the Islamic banking movement has "become mainstream", and Islamic banks at least in Saudi Arabia and Egypt have "departed from using profit-loss-sharing (PLS) techniques as a core principle of Islamic banking". Islamic economist Muhammad Akram Khan also complained Islamic banking has evolved toward convergence with conventional banking "imitating conventional banks in product development" rather than establishing "a different type of banking which was aligned to fairness, equitable income distribution, and ethical modes of investment." According to Mohammad Najatuallah Siddiqui, "while theory aspired to prove Islamic finance was different from conventional one, practitioners were busy searching for ways to make it similar to it. ... Starting sometime during nineteen eighties, Shariah advisors focused mainly on designing Shariah-compliant substitutes for financial products with which market was familiar."
Journalist John Foster complains that financing mechanisms that appear to outsiders to be mortgages "dressed up in Arabic terminology" (such as lease agreements, Mudarabah, or Ijarah), are made "shariah compliant" through the practice of “Fatwa shopping”—i.e. shopping for an Islamic scholar's seal of approval, confirming the product is sharia-compliant.
Foster quotes an "investment banker based in Dubai":
“We create the same type of products that we do for the conventional markets. We then phone up a Sharia scholar for a Fatwa ... If he doesn't give it to us, we phone up another scholar, offer him a sum of money for his services and ask him for a Fatwa. We do this until we get Sharia compliance. Then we are free to distribute the product as Islamic.”
According to Foster, "top scholars" often earn "six-figure sums" for each fatwa on a financial product.
Whether Islamic banking is more or less risky than conventional banking is disputed.
Zeti Akhtar Aziz, the head of the central bank of Malaysia maintains that sharia-compliant banks are "inherently more stable" than conventional peers and Speculation is forbidden. But according to the Economist magazine, "Dubai's debt crisis in 2009 showed that sukuk [Islamic bonds] can help to inflate debt to unsustainable levels." According to one author (Mahmoud A. El-Gamal), while Islamic banks often avoid use of the word "customer" or "depositor" in favor of the term ‘partner’,
In these institutions, investment-account holders neither have the protection of being creditors of the Islamic financial institution, nor do they have the protection of being equity holders with representation on those institutions’ boards of directors. This introduces a host of other well-documented risk factors for the institution ...
Islamic banks are also criticized by some for not applying the principle of Mudarabah in an acceptable manner. Where Mudarabah stresses the sharing of risk, critics point out that these banks are eager to take part in profit-sharing but they have little tolerance for risk. To some in the Muslim community, these banks may be conforming to the strict legal interpretations of Sharia but avoid recognizing the intent that made the law necessary in the first place.
For example, the Malaysian bank RHB offers Islamic banking products, including vehicle loans. The product disclosure sheet, however, explains that in the event that the borrower defaults on the loan, the vehicle may be repossessed and any the borrower will be "responsible to settle any shortfall after your motor vehicles is auctioned off." This is an obvious contradiction to claims of risk-sharing. But he have to bear in mind that there are some different contracts used in Islamic financing. The one used at the RHB in vehicle financing is AITAB which is not at the same level with Mudharabah contract in terms of risk-sharing.
Some Islamic banks charge for the time value of money, the common economic definition of interest (riba). These institutions are criticized in some quarters of the Muslim community for their lack of strict adherence to Sharia.
The concept of Ijarah is used by some Islamic Banks (the Islami Bank in Bangladesh, for example) to apply to the use of money instead of the more accepted application of supplying goods or services using money as a vehicle. A fixed fee is added to the amount of the loan that must be paid to the bank regardless if the loan generates a return on investment or not. The reasoning is that if the amount owed does not change over time, it is profit and not interest and therefore acceptable under Sharia.
According to the IMF, since Islamic banking forbids pure monetary speculation and stresses that deals should be based on real economic activity, it poses less risk than conventional banking to the stability of financial systems.
Critics believe that the Iranian Interest-Free banking law has simply created the context for legitimizing usury or riba. In reality all banks are charging their borrowers a pre-set amount at a rate of interest that is approved by the Central Bank at least once a year. No goods or services are exchanged as part of these contracts and banks rarely assume any Commercial Risk. High value collateral items such as real estate, commercial paper, bank guarantees and machinery eliminate any risk of loss. In case of defaults or bankruptcies, the principal amount, the expected interest and the late fees are collected through possession and or sale of secured collaterals.
The majority of Islamic banking clients are found in the Gulf states and in developed countries. The majority of financial institutions that offer Islamic banking services are majority owned by Non-Muslims. With Muslims working within these organizations being employed in the marketing of these services and having little input into the actual day-to-day management, the veracity of these institutions and their services are viewed with suspicion. One Malaysian Bank offering Islamic based investment funds was found to have the majority of these funds invested in the gaming industry; the managers administering these funds were non Muslim. These types of stories contribute to the general impression within the Muslim populace that Islamic banking is simply another means for banks to increase profits through growth of deposits and that only the rich derive benefits from implementation of Islamic Banking principles.
Riba as interest being a "settled issue"
Islamic finance is based on the belief that "all forms of interest are riba and hence prohibited". When a minority member (i.e. one of the non-Muslim MNA—Member of the National Assembly—representing their religious group, rather than an electoral district) of the National Assembly of Pakistan questioned this in 2004, members of leading Islamist political party in Pakistan, the Muttahida Majlis-e-Amal (MMA) party, staged a walkout from the Assembly, protest what they termed derogatory remarks on interest banking:
Taking part in the budget debate, M.P. Bhindara, a minority MNA ...referred to a decree by an Al-Azhar University's scholar that bank interest was not un-Islamic. He said without interest the country could not get foreign loans and could not achieve the desired progress. A pandemonium broke out in the house over his remarks as a number of MMA members...rose from their seats in protest and tried to respond to Mr Bhindara's observations. However, they were not allowed to speak on a point of order that led to their walkout.... Later, the opposition members were persuaded by a team of ministers...to return to the house...the government team accepted the right of the MMA to respond to the minority member's remarks.... Sahibzada Fazal Karim said the Council of Islamic ideology had decreed that interest in all its forms was haram in an Islamic society. Hence, he said, no member had the right to negate this settled issue.
The decree notwithstanding, a minority of scholars (Muhammad Abduh, Rashid Rida, Mahmud Shaltut, Syed Ahmad Khan, Fazl al-Rahman, Muhammad Sayyid Tantawy and Yusuf al-Qaradawi) have questioned whether riba includes all interest payments. Others (Muhammad Akran Khan) have questioned whether riba is a crime forbidden by sharia (Islamic law) and subject to punishment like murder and theft, or simply a sin to be preached against by human beings with the punishment left to God, since "neither the Prophet nor the first four caliphs nor any subsequent Islamic government ever enacted any law against riba."
- Profit and loss sharing
- Islamic finance products, services and contracts
- Sharia and securities trading
- Islamic economics
- Micro venture capital
- Economy of the OIC
- Mont de Piété
- List of Islamic terms in Arabic
- Fractional-reserve banking
- History of banking
- JAK Members Bank
- Islami Bank Bangladesh Ltd
- Guidance Residential
- "... Modern Islamic banking/finance movement has been deeply influenced by the contemporary Islamic movements
- Thus, when "currencies of base metal were first introduced in the Islamic world, no jurist ever thought that paying a debt in a higher number of units of this fiat money was riba" as they were concerned with "the real value of money."
- i.e. M.P. Bhindara, one of the non-Muslim MNA -- Member of the National Assembly of Pakistan -- representing their minority religious group -- in this case the Hindus -- rather than an electoral district.
- the Muttahida Majlis-e-Amal (MMA) party
- "At least according to banking law in Kuwait "the starting point in this formula" of Islamic banking "is conventional financial practice, from which Islamic finance deviates only insofar as some conventional practices are deemed forbidden under Sharia." ... Islamic finance "is not constructively built from classical jurisprudence. Rather, Islamic alternatives or modifications of conventional practices are sought whenever the latter is deemed forbidden. ... Ibn Taymiyya famously stated that two prohibitions can explain all distinctions between contracts that are deemed valid or invalid: those of riba and gharar."
- see also Hubar Hasan
- Convert Umar Ibrahim Vadillo states: "For the last one hundred years the way of the Islamic reformers have led us to Islamic banks, Islamic Insurance, Islamic democracy, Islamic credit cards, Islamic secularism, etc. This path is dead. It has shown its face of hypocrisy and has led the Muslim world to a place of servile docility to the world of capitalism." According to critic Critic Feisal Khan "there have thus been two broad categories of critic of the current version of IBF [Islamic Banking and Finance]: the Islamic Modernist/Minimalist position, and the Islamic ultra Orthodox/Maximalist one. ... The ultra Orthodox [such as the Islamic courts in Pakistan] ... agree with the Modernist/Minimalist criticism that contemporary Islamic banking is indeed nothing but disguised conventional banking but ... agitate for a truly Islamic banking and finance system".
- Winner of the 1997 IDB Prize in Islamic Banking
- Several ahadith, in addition to prohibiting games of chance, prohibit bayu al-gharar (literally "trading in risk", defined as sales in which gharar is the major component). Jurists have distinguished between this kind of gharar, and ghasar considered minor (yasir) and so permissible (halal), but disagree over what constitutes gharar that is minor and gharar that is substantial, (at least according to one source, Abu Umar Faruq Ahmad), have not agreed on an exact definition of the meaning and concept of gharar.
- Monzer Kahf argues that the quranic verse (in 2:275) where non-Muslims complain -- "... they say, `Trade is [just] like interest." But Allah has permitted trade and has forbidden interest" -- refers to credit sales.
- Taqi Usmani explains that in such transactions "the whole price ... is against a commodity and not against money" and so "... once the price is fixed, it relates to the commodity, and not to the time". Consequently "the price will remain the same and can never be increased by the seller." If the price had "been against time", (which is forbidden) "it might have been increased, if the seller allows ... more time" for repayment when the bill is past due.
- "Indeed, truth-in-lending regulations in the United States force Islamic and conventional financiers to report the implicit interest rates they charge their customers in such financing arrangements."
- According to Oxford-Analytica, as of 2010 AAOIFI’s standards are mandatory for Islamic financial institutions in Bahrain, Dubai International Financial Centre, Jordan, Sudan, Syria and Qatar
- Khan, Ajaz A., Sharia Compliant finance| halalmonk.com
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Even in countries where Islamic banking has a strong foothold, such as the Gulf states and in South East Asia, its share rarely accounts for more than one third of the market. In Indonesia, the world's most populous Muslim country, Islamic banking currently has less than 5% market share.
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This loose approach prevailed throughout the Muslim world until the 1970s, at which time the total ban on lending with interest was reactivated, in tandem with a general re-Islamisation in the cultural and political domains. ...until 1973, when the tidal wave of petro-dollars changed the entire [economic] waterfront.
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The prevalent position, however, seems to be that creditors may impose penalties for late payments, which have to be donated, whether by the creditor or directly by the client, to a charity, but a flat fee to be paid to the creditor as a recompense for the cost of collection is also acceptable to many fuqaha.
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The bank can only impose penalties for late payment by agreeing to `purify` them by donating them to charity.
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MNSMETwas invoked but never defined (see the help page).
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Books and journal articles
- Farooq, Mohammad Omar (November 2005). The Riba-Interest Equation and Islam: Re-examination of the Traditional Arguments. SSRN .</ref>
- el-Gamal, Mahmoud A. (2006). Islamic Finance : Law, Economics, and Practice (PDF). New York, NY: Cambridge. ISBN 9780521864145.
- Irfan, Harris (2015). Heaven's Bankers: Inside the Hidden World of Islamic Finance. Little, Brown Book Group. ISBN 9781472105066. Retrieved 28 October 2015.
- Jamaldeen, Faleel (2012). Islamic Finance For Dummies. John Wiley & Sons. ISBN 9781118233900. Retrieved 15 March 2017.
- Karim, Nimrah; Tarazi, Michael; Reilli., Zavier (August 2008). "Islamic microfinance: An emerging market niche" (PDF). CGAP Focus Notes. Consultative Group to Assist the Poor. 49: 1.
- Kepel, Gilles (2002). Jihad: The Trail of Political Islam. Harvard University Press. ISBN 9780674010901.
- Khan, Feisal (2015-12-22). Islamic Banking in Pakistan: Shariah-Compliant Finance and the Quest to Make Pakistan More Islamic. Routledge. ISBN 9781317366539. Retrieved 9 February 2017.
- Khan, Muhammad Akram (2013). What Is Wrong with Islamic Economics?: Analysing the Present State and Future Agenda. Edward Elgar Publishing. ISBN 9781782544159. Retrieved 26 March 2015.
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