Understanding Islamic Finance
The Wiley Finance Series

Key features include:

• Discussion of the principles of Islamic finance;
• Introduction to the key products and procedures that International Financial Institutions are using or may adopt to fund a variety of clients ensuring Shar??ah compliance;
• Discussion of the role Islamic finance can play in the development of the financial system and of economies;
• Practical and operational examples that cover deposit and fund management by banks involving financing of various sectors of the economy, risk management, accounting treatment, and working of Islamic financial markets and instruments.

This book is not only an important text for all banks and financial institutions entering this particular market with a commitment to building Islamic financial solutions, but is also essential reading for undergraduate and postgraduate students of Islamic finance.

List of Boxes and Figures xvii

Foreword xix

Preface xxi

Acknowledgements xxv

PART I FUNDAMENTALS 1

1 Introduction 3

1.1 Economic Scenario in the Neoclassical Framework 3

1.2 Conventional Debt: A Recipe for Exploitation 4

1.3 Growth per se May not Lead to Socio-economic Justice 6

1.4 Social Welfare Activities of the States 8

1.5 The Main Culprit 8

1.6 The Need of the Hour 9

1.7 Economics and Religion 10

1.8 Islamic Principles Can Make the Difference 11

1.9 Regulating Trade and Business 13

1.10 Islamic Finance Passing Significant Milestones 15

1.11 Could it Work to Achieve the Objectives? 16

1.12 About this Book 17

2 Distinguishing Features of the Islamic Economic System 21

2.1 Introduction 21

2.2 Islamic Sharî´ah and its Objectives 21

2.3 Why Study Islamic Economics? 25

2.4 Islamic Economics: What should it be? 30

2.5 Paraphernalia of Islamic Economics 32

2.6 Summary 41

3 The Main Prohibitions and Business Ethics in Islamic Economics and Finance 43

3.1 Introduction 43

3.2 The Basic Prohibitions 43

3.3 Business Ethics and Norms 64

3.4 Summary and Conclusion 70

4 The Philosophy and Features of Islamic Finance 73

4.1 Introduction 73

4.2 The Philosophy of Islamic Finance 73

4.3 Debt versus Equity 85

4.4 Islamic Banking: Business versus Benevolence 86

4.5 Exchange Rules 87

4.6 Time Value of Money in Islamic Finance 89

4.7 Money, Monetary Policy and Islamic Finance 90

4.8 Summary 96

PART II CONTRACTUAL BASES IN ISLAMIC FINANCE 99

5 Islamic Law of Contracts and Business Transactions 101

5.1 Introduction 101

5.2 Mâl (Wealth), Usufruct and Ownership 101

5.3 General Framework of Contracts 105

5.4 Elements of a Contract 106

5.5 Broad Rules for the Validity of Mu‘âmalât 110

5.6 W‘adah (Promise) and Related Matters 114

5.7 Types of Contracts 117

5.8 Commutative and Noncommutative Contracts 124

5.9 Conditional or Contingent Contracts 126

5.10 Summary 127

6 Trading in Islamic Commercial Law 129

6.1 Introduction 129

6.2 Bai‘ – Exchange of Values 130

6.3 Legality of Trading 131

6.4 Types of Bai‘ 133

6.5 Requirements of a Valid Sale Contract 133

6.6 Riba Involvement in Sales 142

6.7 Gharar – A Cause of Prohibition of Sales 143

6.8 Conditional Sales and “Two Bargains in One Sale” 144

6.9 Bai‘ al‘Arbûn (Downpayment Sale) 145

6.10 Bai‘ al Dayn (Sale of Debt) 146

6.11 Al ‘Inah Sale and the Use of Ruses (Hiyal) 147

6.12 Options in Sales (Khiyar) 150

6.13 Summary 152

7 Loan and Debt in Islamic Commercial Law 155

7.1 Introduction 155

7.2 The Terms Defined 155

7.3 Illegality of Commercial Interest 157

7.4 Loaning and the Banking System 158

7.5 Guidance from the Holy Qur’ân on Loans and Debts 159

7.6 The Substance of Loans 159

7.7 Repayment of the Principal Only 160

7.8 Time Value of Money in Loans and Debts 160

7.9 Instructions for the Debtor 161

7.10 Instructions for the Creditor 162

7.11 Husnal Qadha (Gracious Payment of Loan/Debt) 162

7.12 Remitting a Part of a Loan and Prepayment Rebate 163

7.13 Penalty on Default 165

7.14 Hawalah (Assignment of Debt) 167

7.15 Security/Guarantee (Kafalah) in Loans 168

7.16 Bai‘ al Dayn (Sale of Debt/Debt Instruments) 172

7.17 Impact of Inflation on Loans/Debts 172

7.18 Summary 174

PART III ISLAMIC FINANCE – PRODUCTS AND PROCEDURES 177

8 Overview of Financial Institutions and Products: Conventional and Islamic 179

8.1 Introduction 179

8.2 What is Banking or a Bank? 179

8.3 The Strategic Position of Banks and Financial Institutions 180

8.4 Categories of Conventional Financial Business 181

8.5 The Need for Islamic Banks and NBFIs 185

8.6 The Issue of Mode Preference 195

8.7 Islamic Investment Banking 199

8.8 Islamic Financial Markets and Instruments 199

8.9 Summary and Conclusion 211

9 Murabaha and Musawamah 213

9.1 Introduction 213

9.2 Conditions of Valid Bai‘ 214

9.3 Murabaha – a Bai‘ al Amânah 215

9.4 Bai‘ Murabaha in Classical Literature 215

9.5 The Need for Murabaha 216

9.6 Specific Conditions of Murabaha 217

9.7 Possible Structures of Murabaha 220

9.8 Murabaha to Purchase Orderer (MPO) 222

9.9 Issues in Murabaha 229

9.10 Precautions in Murabaha Operations 233

9.11 Musawamah (Bargaining on Price) 234

9.12 Summary 238

10 Forward Sales: Salam and Istisna‘a 241

10.1 Introduction 241

10.2 Bai‘ Salam/Salaf 241

10.3 Benefits of Salam and the Economic Role of Bai‘ Salam 242

10.4 Features of a Valid Salam Contract 243

10.5 Security, Pledge and Liability of the Sureties 249

10.6 Disposing of the Goods Purchased on Salam 250

10.7 Salam – Post Execution Scenarios 252

10.8 Salam-Based Securitization – Salam Certificates/Sukuk 254

10.9 Summary of Salam Rules 255

10.10 Salam as a Financing Technique by Banks 257

10.11 Istisna‘a (Order to Manufacture) 263

11 Ijarah – Leasing 279

11.1 Introduction 279

11.2 Essentials of Ijarah Contracts 280

11.3 General Juristic Rules of Ijarah 281

11.4 Modern Use of Ijarah 287

11.5 Islamic Banks’ Ijarah Muntahia-bi-Tamleek 291

11.6 Summary of Guidelines for Islamic Bankers on Ijarah 298

12 Participatory Modes: Shirkah and its Variants 307

12.1 Introduction 307

12.2 Legality, Forms and Definition of Partnership 308

12.3 Basic Rules of Musharakah 312

12.4 The Concept and Rules of Mudarabah 320

12.5 Mudarabah Distinguished from Musharakah 327

12.6 Modern Corporations: Joint Stock Companies 328

12.7 Modern Application of the Concept of Shirkah 330

12.8 Diminishing Musharakah 337

12.9 Diminishing Musharakah as an Islamic Mode of Finance 339

12.10 Summary and Conclusion 343

13 Some Accessory Contracts 347

13.1 Introduction 347

13.2 Wakalah (Agency) 347

13.3 Tawarruq 349

13.4 Ju‘alah 351

13.5 Bai‘ al Istijrar (Supply Contract) 355

14 Application of the System: Financing Principles and Practices 357

14.1 Introduction 357

14.2 Product Development 358

14.3 The Nature of Financial Services/Business 358

14.4 Prospects and Issues in Specific Areas of Financing 369

14.5 Islamic Banks’ Relationship with Conventional Banks 384

14.6 Fee-based Islamic Banking Services 384

14.7 Summary and Conclusion 386

Appendix: The Major Functions of a Sharî´ah Supervisory Board In the Light of the AAOIFI’s Sharî´ah Standard 387

15 Sukuk and Securitization: Vital Issues in Islamic Capital Markets 389

15.1 Introduction 389

15.2 The Capital Market in an Islamic Framework 390

15.3 Securitization and Sukuk 391

15.4 Summary and Conclusion 412

16 Takaful: An Alternative to Conventional Insurance 417

16.1 Introduction 417

16.2 The Need for Takaful Cover 417

16.3 The Sharî´ah Basis of Takaful 420

16.4 How the Takaful System Works 422

16.5 Takaful and Conventional Insurance Compared 427

16.6 Status and Potential of the Takaful Industry 428

16.7 Takaful Challenges 429

Appendix: Fatâwa (Juristic Opinions) on Different Aspects of Insurance 430

17 An Appraisal of Common Criticism of Islamic Banking and Finance 433

17.1 Introduction 433

17.2 The Common Myths and Objections 433

17.3 Appraisal of Conceptual Criticism 436

17.4 Appraisal of Criticism on Islamic Banking Practice 445

17.5 Conclusion 456

18 The Way Forward 457

18.1 Introduction 457

18.2 Agenda for the Policymakers 457

18.3 Potential, Issues and Challenges for Islamic Banking 461

18.4 Conclusion 479

Acronyms 481

Glossary 485

Bibliography English Sources 497

Arabic/Urdu Sources 503

Suggested Further Readings 505

Index 509