Two-day Module on "Overview of Islamic Banking"

for pre-induction training program SEATS (Statistical officers and Economic Analysts Training Scheme)

Delivered by: Mufti Syed Umer Amad uddin

Resident Shari`a Board Member (RSBM)

June 07, 2024

 Agenda
• Evolution of Islamic Banking
• Role of International organizations
• Global Bodies
• AAOIFI standards
• Global Outlook
• Role of State Bank of Pakistan
• Regulatory Developments at SBP
 Evolution of Islamic Banking in Pakistan
Phase 1 : Initial Foundation Phase 2 : Evolution of Practical Phase 3 : Efforts for a Riba-free
models and framework financial system and Islamic Economy
Phase

• Era of initial efforts and

foundation work for the Emergence of Practical model of Era marked by the historic ruling of the
establishment of Islamic Financial Islamic banking and Islamic Honorable Federal Shariat Court – For
system. financial institutions. the complete elimination of Riba
• Key work was done by Council of • Development of workable and requires sincere efforts from all
Islamic Ideology during that time. innovative products for key stakeholders to enable the complete
During 80s enabling regulations market segments. conversion of the economy.
and legal provisions were made • Development of framework • From its inception in the 2000s, Islamic
in BCO. and regulations in the area of banking in Pakistan has had a
• • Experiments were done by banking, Insurance, capital continuous growth journey.
several institutions for introduction markets, mutual funds, takaful, • There are six full-fledged Islamic
of Riba Free system. government financing, taxation - banks and 16 Islamic Banking Windows
providing an enabling
environment for Islamic financial
sector to present workable
solutions
Quaid`s vision and constitutional obligation
 I – Constitutional Provisions for Islamic Banking

The Preamble of the 1973 Constitution of Islamic Republic of Pakistan states:

✓..the Muslims shall be enabled to order their lives in the individual and collective spheres in accordance
with the teachings and requirements of Islam as set out in the Holy Quran and Sunnah…
➢ The Section 31 of the constitution of Pakistan states
✓“Steps shall be taken to enable the Muslims of Pakistan, individually and collectively, to order their lives in
accordance with the fundamental principles and basic concepts of Islam.”
➢ The Section 38 (f) of the constitution of Pakistan states
✓“The State shall eliminate Riba (interest) as early as possible.”
➢ Section 227 of the constitution of Islamic Republic of Pakistan reads as;
✓“All existing laws shall be brought in conformity with the Injunctions of Islam as laid down in the Holy
Quran and Sunnah, in this Part referred to as the Injunctions of Islam, and no law shall be enacted which is
repugnant to such injunctions.”
 I – Constitutional Provisions for Islamic Banking

EXISTING LEGAL FRAMEWORK

➢ Banking Companies Ordinance, 1962

➢ State Bank Of Pakistan Act, 1956*
➢ Banks Nationalization Act, 1974
➢ Foreign Exchange Regulations Act, 1947
➢ Financial Institutions (Recovery Of Finances) Ordinance, 2001
➢ Companies Ordinance, 1984*
➢ Payment Systems and Electronic Fund Transfer Act, 2007
➢ Deposit Protection Act 2016
➢ Other laws
Ruling –Federal Shariah Court
Ruling –Federal Shariah Court
 Ruling –Federal Shariah Court

• The Federal Shariah Court on April 28,2022 announced a verdict in a long

pending case on Riba:

“Declaring the prevailing interest based banking system against Shariah and directed
the Government to facilitate all loans under an interest free system”. The court also
declared all the provisions of the interest Act 1839,which facilitate interest , as
unlawful.

• In written judgement, the bench said the prohibition of Riba is the “corner stone of
the Islamic economic system". The ruling added that “elimination of Riba from our
economic system is our religious as well as constitutional duty, hence it has to be
eliminated from Pakistan”.

• Finance Minister welcomed the Court’s decision. He said the government and
central Bank would study this important decision and then seek guidance and
clarification from the FSC about its implementation process, steps and time Frame.
II- Role of International Organizations
Key Global Central Banks that support Islamic Finance
Global Bodies for Islamic Banking and finance
AAOIFI – Brief Introduction
AAOIFI – Brief Introduction
Islamic finance and banking : global outlook

ISLAMIC FINANCIAL SERVICES INDUSTRY STABILITY REPORT 2023

Islamic finance and banking : global outlook

ISLAMIC FINANCIAL SERVICES INDUSTRY STABILITY REPORT 2023

II- Role of State Bank of Pakistan
 II – Role of State Bank of Pakistan

QUAID’S VISION

➢ July 01,1948, on the occasion of inauguration of State Bank of Pakistan, Quaid said;
➢ “I shall watch with keenness the work of your Research Organization in evolving banking
practices compatible with Islamic ideas of social and economic life…. The adoption of
Western economic theory and practice will not help us in achieving our goal of creating a
happy and contented people. We must work our destiny in our own way and present to the
world an economic system based on true Islamic concept of equality of manhood and social
justice. We will thereby be fulfilling our mission as Muslims and giving to humanity the
message of peace which alone can save and secure the welfare, happiness and prosperity of
mankind. ”
 II – Role of State Bank of Pakistan

Key Figures Pertaining to Islamic Banking in Pakistan

➢ Branch network of IB participants – 4,086

➢ Asset base of IB – Rs 8,118 Billion i.e. 19.9% of Overall Banking Industry

➢ Deposit base of IB – Rs. 5,870 Billion i.e. 21.9% of Overall Banking Industry

➢ Growth rate YoY of Asset base is around 19.7%

➢ Growth rate YoY of Deposit base is around 20.9%

➢ SBP Strategic Plan for Islamic banking – 30% asset and deposit share by 2025
 Summary : Regulatory framework
• Gradual approach for transformation of economy
• Full fledged Islamic banks
• Islamic banking Subsidiaries
• Islamic banking branches in Conventional banks
• Conversion of a conventional branch into an Islamic Banking branch

• Islamic banking windows in Conventional branches

• Conversion of a conventional bank into an Islamic bank

 Six Pillars – SBP’s Strategic Plan 2021-2025

Reinforcing Bolstering
Enhancing Improving Expanding
Strengthening Comprehensive Human
Conduciveness Liquidity Outreach &
Legal Shariah Capital &
of Regulatory Management Market
Landscape Governance Raising
Framework Framework Development
Framework Awareness

22
Working Groups
 Objectives of Working Groups for IB in SBP
Working Group-1 : Legal Reforms :
Propose amendments in the existing legal framework related to banking in the light of FSC’s judgment
Working Group-2: Regulatory & Supervisory Reforms
Propose changes in the regulatory & supervisory framework to fast track transformation of conventional banking into
Islamic
Working Group-3: Awareness Creation & Capacity Building
Suggest and take measures for awareness creation about Islamic banking and finance & capacity building of related
stakeholders
Working Group-4: Review of Conversion Plans of Banks/DFIs
Guide banks/DFIs in developing their conversion plans and monitor progress of implementation
Working Group-5: Fast track adoption of International Standards
To provide guidance on fast track adoption of international standards (Shariah, governance , prudential, accounting etc.)
Working Group-6: Coordination with Government and other stakeholders
Coordinate with Government and other stakeholders to ensure smooth and fast-track transformation.
 Two-day Module on "Overview of Islamic Banking"
for pre-induction training program SEATS (Statistical officers and Economic Analysts Training Scheme)

Delivered by: Mufti Syed Umer Amad uddin

Resident Shari`a Board Member (RSBM)

June 07-08, 2024

 Agenda

• Deposit mobilization
• Islamic Solutions against Conventional Products
• Product development
• Islamic Modes of financing
• Profit and loss distribution
• Disclosure requirements
Liability Side
Deposits
 Deposits
• Current Accounts The Islamic current account products are offered on the
basis of Qard where the principal amount of the customers are
guaranteed.

• Saving Accounts/Islamic Investment Certificates

The Islamic saving products are offered on the basis of Mudarabah-

Musharakah model where in Mudarabah the Bank acts as Mudarib and
the account holder acts as Rabb-ul-Maal.
The profit earned on Mudarabah based products is distributed as per the
pre-determined profit sharing ratio and weightages
 Deposits

Loan Based Mudarabah

Based Mudarabah
• Current-Non Based
Remunerative
• Saving
• Current
Remunerative
• TDRs
 Investment Accounts
Investment accounts are further divided into two types i.e...:

Types of Investment
Accounts

General Investment Specific Investment

Accounts Account
Deposits
 Mudarabah

A partnership whereby one party provides capital and the other party
provides Labor/Services.
• Investor is called “Rabb-ul-Maal” and
• The working partner is called “Mudarib”
• Investment is called “Raas-ul-Maal”.
 Mudarabah
Mudarabah Mutlaqah (Un-Restricted Mudarabah)

• No restriction from the Rabb-ul-Mal regarding investment in any specific sector/

business

• In this type of Mudarabah working partner can do any profitable business according to
its market norm.

Mudarabah Muqayyadah (Restricted Mudarabah)

• Business avenues/ sector specified from the Rabb-ul-Mal (Investor)

• Mudarib is bound to comply to these restrictions. However they should not unduly
constrain the Mudarib from general business operations.
 Capacities of Mudarib

AMEEN (Trustee)
WAKEEL (Agent) Mudarib will not be responsible for any loss in
business without his negligence.
Mudarib is bound to comply with the instructions of
Rub-ul-Maal as an agent / wakeel. SHAREEK (Partner)
In case of profit, Mudarib is partner in that
ZAMIN (Liable) businesses to the extent of his profit share.
If Mudarib do not comply with the instructions of
Rab- ul-Mal, he is liable for loss.
AJEER (Employee)
If Mudarabah ends then Mudarib is entitled to get
compensation as if he was an employee (Ujrat-e-Misl).
Mudarabah
Rules in Mudarabah
Mudarabah
Mudarabah
 Profit and loss Mudarabah
Unknown ratio or
ratio attributed to A lump sum
future settlement or settlement as profit
ratio linked with the is not allowed.
The profit sharing capital (in terms of
ratio should be x% of the capital) is
The contracting specific & of the not allowed and the
parties should profit expected to be transaction becomes
stipulate in the earned by the void.
contract the profit venture.
shares (in defined
terms) for each one.
 Profit and loss Mudarabah
Increase in value of
Mudaraba capital
before start of
business without any
The Mudarib shall efforts of Mudarib,
only be responsible will be considered
for losses if they part of capital and
Losses in Mudaraba
occur due to his will not be treated as
shall only be borne
negligence and wilful Profit.
by Rabb-ul-Mal and
misconduct.
not the Mudarib.
 Islamic Solutions against Conventional Products
Islamic Banking Conventional Banking
Current Account Loan Loan

CA Remunerative & Saving Account Mudarabah Loan

Term Deposit Mudarabah Loan

Types of Sale
Car Finance
Contents 02 Diminishing Musharakah / Ijara Loan

Home Finance & Term

Contents 03 Finance Diminishing Musharakah Loan

Credit Card & Personal Musawamah / Tawarruq Loan

Contents 04 Finance

Business & Working Capital Finance Murabaha / Istisna / Salam / Tijara Loan
 Islamic Solutions against Conventional Products

Types of Sale
Product development
 Product development
Proposing a Contract of Sale as an alternative to Customer

Debtors Cash

Murabaha/
Musawamah
Tijarah Finished Raw
Goods Material Cotton, Furnace
Oil, Edible Oil, Iron

Work in
Process

Electricity Bills,
Salaries & Wages Istisn’ā/ Salam
 Product development
Understanding Customer Business Cycle

• Nature of business: Trading/ Manufacturing/ Distribution/ Hybrid

• Relationship with supplier : Brother/ Blood relations

• Price finalization: Before/ After/ At the time of delivery

• Payment mode of making payment to supplier: Direct / Indirect then proper justification &
controls are required (Evidence of payment)

• Payment mechanism to the supplier: Advance/ Credit/ Spot/ Hybrid

• Delivery period by supplier: 5 days/ 7 days etc

 Product development

• Place of delivery of Goods: Customer premises/ Third-party premises

• Method of separation of goods: Tagging/ Bin-card/ Separate go-down

• Point of Risk transfer: During transit/ After receipt of goods by customers

• Minimum Inventory holding period of the customer: 15 days/ 30 days etc.

Islamic Modes of Financing
 Financing Needs of a client

Long Term Short Term

Financing Financing Needs
Needs

Trade Finance Investment and Fund

Needs Management Needs
Financing Needs of a client
 Financing Needs of a client

Islamic Financing Modes

Partnership
Sale Based Rental Based
Based

- Musawamah
- Ijarah - Mudarabah
- Murabaha
- Salam - Diminishing - Musharaka
- Istisna Musharakah Running
- Tijarah Musharakah
Sale and Lease Back
- Wakalatul Istismar
 (1) - Musawama
❖Musawama is a general kind of Sale in which price of the commodity to be
traded is stipulated between seller and the buyer without any reference to
the price paid or cost incurred by the former.
❖Sale by way of bargain is also covered under Musawama.

❖Seller is not obliged to reveal his cost.

❖Payment may be : (a)-Advance, (b)-Spot, (c)-Deferred, (d)-in Installments
or (e)- Combination of them.
❖This contract may be used for short term as well as for long term depending
on risk management policies.
 (2) - Murabaha
Murabaha is a particular kind of sale where the transaction is done on
a “cost plus profit” basis i.e. the seller discloses the cost to the buyer
and adds a certain profit to it to arrive at the final selling price.

• The distinguishing feature of Murabaha from ordinary sale is:

- The seller discloses the cost to the buyer.
- And a known profit is added
✓It is a “Fixed Price” Sale of Asset contract.
✓Subject Matter (Assets) may be Fixed Asset or Working Capital.
✓Murabaha finance is Not a Loan given on interest… No cash
disbursement at all.
 (2) - Murabaha
✓ May be used for short term or long term depending on bank’s risk
management policy.
✓ After sale, its price cannot be restructured.
✓ It cannot be repriced due to default.
✓ Only period can be rescheduled.

• Payment of Murabaha price may be:

1) Advance
2) At spot
2) In installments
3) In lump sum after a certain time
 Basic Rules of Murabaha

1 Asset to be sold must exist

Sale price should be disclosed

2
3 Sale must be unconditional.

4 Assets to be sold should:

not be used only for un-Islamic purpose.
be in ownership of the seller at the time of sale
be in physical or constructive possession of the seller
 Banking Murabaha
• It is a contract wherein the bank, upon request by the customer, purchases
an asset from third party(a supplier) and sells the same to the customer
either against immediate payment or on a deferred payment basis.

• It is a bunch of contracts completed in steps and ultimately suffices the

financial needs of the client.

• The sequence of their execution is extremely important to make the

transaction Shariah complaint.
Banking Murabaha
Banking Murabaha
 Summary : How Murabaha works in Islamic
finance?

Customer Bank appoints

Facility Customer
Master identifies customer as
requested & promises to
agreements supplier & agent to
credit buy the goods
signed obtains purchase
approvals at cost + profit
quotation goods
 Summary : How Murabaha works in Islamic
finance?

Agent Agent informs Bank sells the

Bank pays the purchases bank about goods to Customer
price of goods goods & purchase of customer on makes payment
to supplier obtains goods and credit at cost + when it is due
possession possession profit
 What is the Difference between Murabaha and
Conventional Loan
Conventional Loan Murabaha

• It is loan contract • It is sale contract.

• Bank advancing loans and charging • Bank sells an assets and charges
interest profit
• Conversion of cash into assets in • Conversions of cash into
not compulsory commodities in compulsory
• In case of delay, more interest will • In Murabaha profit portion cannot
be charged by the bank be increased due late payment
Different Capacities at different Stages:
Promise to purchase and
Master Murabaha Agreement promise to sell

Agency Agreement Relation of principle and

agent

Payment of Purchase Price

Relation between the bank
and the supplier is that of a
Order Form
buyer and seller

Purchase

Possession Relation of buyer and seller

comes into operation
between the bank and the
Offer & Acceptance client
Relation between bank and
Payment of Murabaha Price client is that of debater and
creditor
 (3) - Salam
Three (03) must conditions for Subject Matter of normal Sale contracts are :
1. Subject matter must exist before sale.
2. It must be in the ownership of seller.
3. It must be in enforceable possession of seller.

But Salam & Istisn’a contracts are exception to these conditions.

Salam
•A Salam transaction is the purchase of a commodity for deferred delivery in
exchange for immediate payment.
•Price is fully paid at spot while the delivery of goods is deferred.
 (3) - Salam
Basic Conditions of Shariah for Salam transaction
• Buyer must pay full price – in advance
• Seller may use cash on any purpose unlike Murabaha contract.
• Normally subject matter should be Zawat-al-Amsal or Homogeneous
commodities.
• Quantity, quality of commodity & venue must be defined clearly.
• Processed commodities may become subject matter of Salam depending upon
fulfillment of other conditions
• Time and place of delivery must be defined
• Availability of subject matter in market at time of delivery is must condition.
• Salam Contract cannot be done for monetary assets (exchange of currencies)
(3) - Salam
(3) - Salam
 (4) – Istisn’a
• Istisn’a is spot sale of a particular asset before it exists/ manufactured.
• It an order to manufacture (or processing) a specified asset wherein Customer
will commit to manufacture/ provide the subject matter at a tentative future date.
• For this purpose buyer will disburse the required financing amount to Customer.
• Funds may be used at the Customer's discretion.
• Upon delivery of the specified items, buyer(financer) may appoint the Customer
(seller) as its agent to sell the goods to its buyers.
• Customer may adjust the financing through the sale proceeds of the specified
items.
• It is relatively a more flexible contract as compare to Salam where price may be
paid in advance, spot or in installment. It may be linked with completion of
manufacturing.
(4) – Istisn’a
(4) – Istisn’a
 (5) - Ijarah
❖Ijarah is an Islamic alternative of Conventional Leasing.

❖Transferring of Usufruct of an Asset to another person for an agreed

period, at an agreed consideration.

❖The term “Ijarah” is used in two situations:

➢One type of Ijarah relates to paying rent for use of an asset or

property.
➢Another type of Ijarah means ‘To employ the services of a person
on wages’ e.g. “A” hires a porter at the airport to carry his luggage.
 (5) - Ijarah

Literally Ijarah means “To give

something on rent”
Ijarah is an Islamic alternative of
Leasing
To employ the services of a person on
wages.
An acceptable contract under Shariah
To pay rent for use of an asset or
property.
Several characteristics of conventional
Leasing are not conform to Shariah.
(5) - Ijarah
 Ijarah Muntahia Bittamleek
The Ijarah Muntahia Bittamleek, on the other hand, is not different in its rules
from an ordinary Ijarah, except that it is associated with a promise by the
lessor to transfer ownership at the end of the Ijarah term like:
A promise to sell for a token or other consideration, or by accelerating the
payment of the remaining amount of rental, or by paying the market value of
the leased property.
A promise to give it as a gift (for no consideration).

A promise to give it as a gift, contingent upon the payment of the remaining

installments
(6) - Shirkah / Musharaka

MUSHARAKAH
(6) - Shirkah / Musharaka
(6) - Shirkah / Musharaka
 (6) - Shirkah / Musharaka

Shirkah

Shirkat-ul-Milk Shirkat-ul-Aqad

Joint ownership of two or more persons in a Joint venture of two or more persons
particular property with out any with commercial intention.
commercial intention.
 (6) - Musharaka

Partnership is one of A joint enterprises It is an ideal Musharakah may be

the main formed for alternative for the used for:
transactions in all conducting some interest based • Long-term Finance.
• Investment
societies since the business in which all financing with far
Banking;
advent of Islam. This partners share the reaching effects on
• Project Financing
constitutes, profit according to the economy.
• Private Equity
therefore, a practical an agreed ratio Placement
consensus for the while the loss is • Redeemable capital
permissibility and shared as per the investment.
validity of ratio of investment
partnerships
01 02 03 04
 (6) - Musharaka
Basic conditions
 (6) - Musharaka
Rights of partners

Deprived
Every partner has right to take part in management
unless he expressly withdraws this right and opt for
nonworking status

No partner can be deprived from (1) share in profit, (2) Management

share in assets

No partner has priority over other partner in (1) claim

on assets and (2) claim on profit No Guarantee

No Priority
Any term that provides guarantee from one partner to
other of capital, part of capital, profit or part of profit
is invalid
 (6) – Musharaka vs Mudarabah

Mudarabah Musharakah
Investment from Rub-ul-Maal Investment from each partner

Mudarib is a working Partner Each partner can be a working partner

Rub-ul-Maal is a Non-working partner Any partner can be Non-working

& cannot work for Mudarabah partner at his own will

Only Rub-ul-Maal will bear loss if Each partner will bear loss according
not due to Mudarib’s negligence to investment ratio
Profit between Rub-ul-Maal & Mudarib Profit Ratio of a Non-working partner
will be according to PSR. cannot be more than investment ratio.
 Rights of Partners in Musharakah

Deprived
Every partner has right to take part in management
unless he expressly withdraws this right and opt for
nonworking status

No partner can be deprived from (1) share in profit, (2) Management

share in assets

No partner has priority over other partner in (1) claim

on assets and (2) claim on profit No Guarantee

No Priority
Any term that provides guarantee from one partner to
other of capital, part of capital, profit or part of profit
is invalid
 Mudarabah vs Musharakah

Mudarabah Musharakah
Investment from Rub-ul-Maal Investment from each partner

Mudarib is a working Partner Each partner can be a working partner

Rub-ul-Maal is a Non-working partner Any partner can be Non-working

& cannot work for Mudarabah partner at his own will

Only Rub-ul-Maal will bear loss if Each partner will bear loss according
not due to Mudarib’s negligence to investment ratio
Profit between Rub-ul-Maal & Mudarib Profit Ratio of a Non-working partner
will be according to PSR. cannot be more than investment ratio.
 Diminishing Musharakah
Diminishing or declining Musharakah is just a
Shirkat / Musharakah (partnership) between
two or more persons
The additional feature of DM is decreasing
ownership of one party through purchase by 01
one and selling by other

This differs from normal Musharakah, where 02

decrease in ownership is not the objective of
the contract 03
DM is possible in both Shrikah-tul-Aqd and
Shrikah-tul-Milk 04
 Diminishing Musharakah
Diminishing Musharaka is a combination of
different products/agreements

Diminishing Musharakah as a product could be

offered in several ways. Normally it is presented
with combination of Shirkat + Ijarah + Sale. 05
Several agreements take place in DM offering. 06
Shariah prohibits Combination of two agreements
in one, a well-known principle in Islamic finance
07
A basic rule for combined products is that every
agreement should be independent of the other 08
 Diminishing Musharakah
All other agreements should conform to this rule
that all undertakings/promises should also be
separate from each other.
Agreement for Shirkah should not be affected by
agreement for Ijarah and/or agreement for sale 09
It is necessary that this buying and selling should
not be stipulated in the partnership contract. In 10
other words, the buying partner is allowed to give
only a promise to buy. 11
It is not permitted that one contract be entered
into as a condition for concluding the other 12
Diminishing Musharakah
Business Product Map - based on Multiple Modes
 Profit and loss distribution

• Islamic banks collects funds from customers in different contracts like

Mudarabah, Musharakah and on Qard basis.

• IBIs use these funds for further investment by pooling these funds in
different pools.

• In pools banks invest Mudarabah based collected funds in pools as Mudarib

and invest Qard based funds as equity.

• SBP regulate the pool management process of IBIs where Islamic banks
share the risk as well as customers of Mudarabah.
 Pool management

Deposit Pools are made up of funds received from

customers in different remunerative schemes such as:

• Saving Account;

• Certificate of Investment (COIs); and

• Term Deposit Account.

 Pool management
Common types of investment pools

General Deposit
Pools (PKR & FCYs)

Islamic Export Treasury / Financial

Refinance Scheme Institutions (F.I.)
(IERS) Pool Pools

Specific
Equity Pool Customers’
Pools
 Pool management

CREATION OF POOLS
• IBIs shall have a well-defined profit and loss distribution and pool
management framework for creation of one or more pools of assets to
be financed by different types of Mudaraba-based (individual,
corporate or financial institutions) deposits. The framework shall
interalia specify the objectives, investment strategy, and risk
characteristics of each pool.

INCOME & EXPENSES

• The direct expenses shall be charged to respective pool, while indirect

expenses including the establishment cost shall be borne by IBIs as
Mudarib.
 Pool management

Investment & Financing Losses

• The losses on financings and investments due to misconduct/negligence/breach
of contract by IBI shall not be charged to the pool; the IBI as Mudarib shall be
responsible for absorbing such losses.
 Pool management

Weightages

• The more risk, the more weightage.

• The longer the period, more the risk.
• More the uses of Bank’s facility, less the weightage.
• Less the Uses of Bank’s facility, more the benefit weightage.
• Moral Dimension / Ethical values
• Any other
 Pool management

Weightages
• The weightages to different categories of deposits in a pool shall be
assigned based on parameters / criteria defined in the pool
management framework.
• The weightages shall be announced at least 3 working days before the
beginning of period concerned and shall not be changed during the
period.
• The maximum weightage to the Mudaraba based deposit of any nature,
tenor and amount shall not exceed 3 times of the weightages assigned
to saving deposits.
 Disclosure requirements
Disclosures in Notes to Financial Statements:
• The number and nature of pools maintained by the IBI along with their key features and risk & reward
characteristics.
• Avenues/sectors of economy/business where Mudaraba based deposits have been deployed.
• Instructions For Profit & Loss Distribution and Pool Management for Islamic Banking Institutions (IBIs)
• Parameters used for allocation of profit, charging expenses and provisions etc. along with a brief description of
their major components.
• Mudarib Share (in amount and Percentage of Distributable income).
• Amount and percentage of Mudarib share transferred to the depositors through Hiba (if any).
• Profit rate earned vs. profit rate distributed to the depositors during the year.

Disclosures on IBI’s website and notice board of each branch:

• Percentage of Mudarib Share for period concerned and at least two previous periods in each category of
deposits.
• Weightages assigned to each category of deposits for period concerned and at least two previous periods.
• The actual monthly/periodic profit/loss distributed to each category of deposits during last 2
• years.
 Pool management

Example of General Deposit Pool

DEPOSITS ASSETS

►Saving Deposit 75 % ►Murabaha 60 %

►Bank Equity 25 % ►Cooperate Ijarah 40 %

 Pool management

Example of General Deposit Pool

Income Expenses

►Murabaha 60 ►Broker fee 5

►Taxes 5
►Corporate Ijarah 40 ►Takaful 10
✓ Declared Profit Sharing Ratio (PSR)Profit
40:60 and loss distribution
✓ Declared Weightages as per Schedule.
• Different Average Deposits Step – 1 Step – 2
• Different Deposit Products Income distribution between Income distribution
• Different TDRs tenors. among Rub-ul-Maal
• Different profit payment frequencies TDRs Mudarib & Rub-ul-Maal
through PSR through Weightages.

Sharia’ah PKR 40,000/- Clients

Income 100,000/- PKR 60,000/-
Compliant Rub-ul- Maal
Islamic Bank
Assets
The Mudarib Loss among
Funds / Investment Funds / Deposit
Rub-ul-Maal will be
distributed as per
Capital / Investment
Loss PKR 100,000/- (Without Negligence of Mudarib)
Ratio.

Note: The above example is of a Profit Distribution scenario, where the Bank’s own equity is not involved.
Break-up of Islamic Financing under various modes
Break-up of Sector Wise Islamic Financing
 Two-day Module on "Overview of Islamic Banking"
for pre-induction training program SEATS (Statistical officers and Economic Analysts Training Scheme)

Delivered by: Mufti Syed Umer Amad uddin

Resident Shari`a Board Member (RSBM)

June 07, 2024

 Agenda
• Regulatory framework for Islamic banking
• Shariah compliance structure
• Shariah Governance Framework
• Shariah Board
• Shariah compliance department
 Regulatory framework
➢Comprehensive Shariah Governance Framework for Islamic Banking Institutions
2018
➢Profit and Loss Distribution and Pool Management Guidelines for Islamic Banking
Institutions
➢Prudential Regulations for IBIs
➢Adoption/Issuance of Shariah Standards
✓35 AAOIFI Shariah Standards have been adopted ( continuously adopting )
✓01 SBP Shariah Standard has been issued
➢Essentials of Islamic Modes
➢SBP Shariah Compliance Inspection / Guidelines for External Shariah Audit
 Regulatory framework

➢SBP has offered Islamic alternatives to Conventional Refinance

schemes for the Customers on Mudaraba / Musharakah basis

➢Shariah Non-Compliance Risk Management Guidelines

 Regulatory framework
• Gradual approach for transformation of economy
• Full fledged Islamic banks
• Islamic banking Subsidiaries
• Islamic banking branches in Conventional banks
• Conversion of a conventional branch into an Islamic Banking branch

• Islamic banking windows in Conventional branches

• Conversion of a conventional bank into an Islamic bank

 Shariah compliance structure

SBP Shari’a Advisory

Shari’a Advisors’ Forum
Committee

Adoption of AAOIFI
Shari’a Board Shari’a Standards

Shari’a Compliance SBP Shari’a Compliance

Department (on-site) inspection

Instructions and
PLS & Pool Management
Internal Shari’a Audit Unit guidelines for Shari’a
Framework
Compliance incl. SGF

Essentials and model

Shari’a Non-Compliance Enhanced Capacity
agreements of Islamic
Risk Management by RMG Building Measures in IBIs
modes of financing
SBP Shariah Governance Framework

Executive
management

Board of Sharia
Directors Board

Shariah
Governance
framework

Internal
Sharia
Shariah
Compliance
Audit/Exte department
rnal

Product
developme
nt
 Shari’a Board

• Oversee the Development of all Banking & Financing Projects

• Issue Shari’a Pronouncements – Source of Expert Knowledge Islamic
Principles
• Analyse Unprecedented Situation Not Covered by Shari’a
Pronouncements
• Analyse Contracts and Agreements Concerning Bank’s Transactions
• Supervise Shari’a Training Programs for Bank’s Stuff
• Prepare Annual Report on the Bank’s Balance Sheet with respect to
Shari’a Compliance
• Ensure Immediate Correction of Breaches (If Any) in Compliance to
Shari’a
 Shari’a Board

• The SB shall be empowered to consider, decide and supervise all Shari’ah

related matters of the IBI. All decisions, rulings, fatawa of the SB shall be
binding on the IBI
• The SB shall review and approve all the procedure manuals, product
programs/ structures, process flows, related agreements, marketing
advertisements, sales illustrations and brochures so that they are in
conformity with the rules and principles of Shari’ah.
• The SB shall have at all reasonable times unhindered access to all books
of accounts, records, documents and information from all sources
 Shariah compliance department

• Secretariat of Shari’ah Board

• Conduit between Management and the Shari’ah Board

• Shari’ah Compliance Review

• Enforcement of Shari’ah Audit Reports

• Training on Shari’ah Compliance

• Other Functions
Pakistan Zindabad
 Two-day Module on "Overview of Islamic Banking"
for pre-induction training program SEATS (Statistical officers and Economic Analysts Training Scheme)

Delivered by: Mufti Syed Umer Amad uddin

Resident Shari`a Board Member (RSBM)

June 07-08, 2024

 Agenda
• Conceptual Foundations of Islamic Economic and Islamic
Banking
• Principles of Islamic Economics and Shariah guidelines
• Objectives of Islamic Economics and Finance
• Islamic Law of contract
• Principles of trading
• Key prohibitions
• Differences between Conventional & Islamic Banking
• Balance sheet of an Islamic bank
 Conceptual Foundations

Islam
AQIDAH FIQH AKHLAQ
Faith & Belief Practices & Activities Moralities &Ethics

IBĀDĀT MU’ĀMALĀT
Man-to-Allah Worship Man-to-Man Relationship

Political Activities Economic Activities Social Activities

Banking & Financial

Other Economic Activities
Activities
Conceptual Foundations
 Conceptual Foundations

▪ There are two types of sources of Shari'ah:

▪ Primary Sources: means the first source which is used for extraction of laws.
▪ Secondary / derived Sources: mean the second level source which is used for extraction of
rules in light of primary sources.

Primary Sources
▪ There are two sources fall under this type:
(1) Qur’an - The book of Allah, and
(2) Sunnah or Hadees.
 Conceptual Foundations
Qur’an: ‘The Qur’an is the Book revealed to the Messenger of Allah,
Muhammad (PBUH) as written in the masahif and transmitted to us from
him through an authentic continuous narration (tawatur) without doubt’.
(Al-Bazdawi)
 Conceptual Foundations
Sunnah: Sunnah includes Sayings, Practices, No-objection (Silent
Approvals) of the holy Prophet (SAWS) and practices of four caliphs and
other companions of holy Prophet (SAWS).Sunnah is explainer of Qura'n
in view of all Muslim schools of thoughts.
Acts

Sunnah
Hadith Sayings

• Both Qura'n and Sunnah are

primary and main sources of Endorsements

rulings and guidelines of Shari'ah.

 Conceptual Foundations

Secondary/ Derived Sources

• Ijma (Consensus of Ulema)
• Qiyas (Analogy)
 Types of Rulings of Shariah
• The regulations of the Shari‘ah can be divided into two groups:
(A)- Regulations on Worship and Ritual Duties;
• This type is known as 'Ibaadat' or 'Huqooqullah' (rights of Allah) and this
type of rules and guidelines deal with 'Man-to-God' relations;

(B)- Regulations on Public Relations and issues of juridical and political

nature;
• This type is known as 'Muaamlaat' or 'Hoqooqul Ibaad' (human dealings)
and this type deals with 'Man-to-Man' relations;
• Human relationships of social, political and economic nature fall in ambit
of this type;
Principles of Islamic Economics and Shariah guidelines
 Principles of Islamic Economics and Shariah guidelines

• Giving and taking interest is impermissible (note: Interest, usury or Sood is

impermissible in all Abrahamic religions)
• Definition of Interest: Excess amount over principle in a loan contract is called
interest. (Every gain or profit is not interest... it has a very specific definition)
• Sale of permissible commodities at a fix profit is allowed provided rules of sales are
followed
• Short sell, sale of debt,, future sale, is not allowed for any Muslim as per Islamic
law(including businessmen or investor or banker)
• It is not allowed to involve in sale of impermissible goods like alcohol, pork, blood,
human organs etc.
 Principles of Islamic Economics and Shariah guidelines

• It is not allowed to invest or support or finance unethical / impermissible

businesses activities like gambling, casino, bars, pubs, entertainment
activities that are not permissible in Islam.
• Financing of anti social business activities is also not encouraged in Islamic
like tobacco and weapon sale (that can create disorder in society or promotes
wars)
• It is allowed to earn rental income on a fixed asset like house, car, machinery.
• Islam declares loan as a non-commercial transaction and encourages Muslim
to help each other by providing interest free loans (as an act of Ihsan & piety)
• In order to earn profit, one is required to take risk of business or real asset
hence trading/business profits are allowed.
 Principles of Islamic Economics and Shariah guidelines

Obligations of an Islamic Society

• Propagate good values of life (Ma’aruf) and to restrict the evils (Munkar).
• Promotion of justice and benevolence (Al-Adl wa Al-Ihsan).

Distribution of output/income among the people should be in accordance with the tenets of justice enshrined
in Shari’ah (Islamic Scheme of Distribution)

• Provide equal chances to the individuals to work and earn their livelihood through permissible means and to
protect their lives.
• Facilitate and encourage legitimate business and investment leading to the growth of income and wealth and
to prohibit their destruction and wastage.
• Only Halal goods & services should be allowed to be produced, exchanged & consumed.
• All economic activities should be take place through contracts and transactions that are permitted
• by Shari’ah.
Objectives of Islamic Economics and Finance
Objectives of Shariah
 Objectives of Islamic Economics and Finance

Importance of Economic Goals

Economic activities of a man are of three levels:

o Obligatory & Necessary: Earning minimum means to live is essential. Prophet (SAW)
said: “... and that you leave your heirs well off (or he said: prosperous) is better than to leave
them (poor and) begging from people…” (Sahih al-Bukhari)

o Lawful & Permissible: Earning more than basic needs but with due care of all rights of
Allah and his creations.

o Prohibited & Impermissible: Earning through impermissible ways (Harmful Economic

Activities in Islam) and low or no attention to rights of Allah and His creations.
o Because economic activities are not the basic problem therefore economic progress is not
the ultimate and the only target of human existence
 Objectives of Islamic Economics and Finance

Islamic Scheme of Distribution

Islam suggests a good mechanism of Distribution of Wealth;

Opportunity Level – the pre-production stage

• Everyone has the right to earn his livelihood by fair means – Equal opportunity.
• Hence, discourages monopolies, hoarding and wasteful utilization of resources and
regulates the market.

Production Level – which may further sub-divided into two:

• Distribution among those directly participating into production process

• Islam wants justice in remunerations to the factors of production – reward to
labour (emphasized in teachings), land & entrepreneur.
• Redistribution among the non-participating poor & destitute
• Voluntary charities: Sadaqaat-e-Nafilah, Infaq-fi-Sabil-e-Allah
 Objectives of Islamic Economics and Finance

Post-production Level – Fulfillment of Shari’ah-justified minimum needs (as discussed in

Obligatory & Necessary: Nafaqaat-e-Wajibah)
Annual redistribution through implementation of Zakah, Sadaqah Fitr & Udhahi (Slaughtering of
cattle) etc.

Inter-generational redistribution through law of inheritance.

Islam accepts the following economic laws within a certain limits:

• Market forces: Laws of demand and supply;
• Exchange of services and goods;
• Motive of personal profit;
• Natural relation of employer and employee;
• Profit and loss distribution;
• Asset based system
Objectives of Islamic Economics and Finance
 Objectives of Islamic Economics and Finance

Equitable Distribution & Fulfilling the Halal

Circulation of Wealth Customer Needs

Avoid Impermissible Ensuring Shariah

Transactions Compliance

Promote participation &

Banking Free of
Asset backed financing
Riba, Gharrar, Maysar
 Components of Islamic economics and finance

Islamic
Principles Real Social Prohibited
& the Economic Islamic
Risk & Justice & Activities
Assertion Transaction
Profit Ethical & Finance
& Asset
of Sharing Value Elements
Backed
Religious
Law
 Islamic Law of contract
▪ The contract is known in Arabic as ‘Aqd’, which translated means ‘to tie’ or ‘to knot’.
In simple words, a contract ties both the parties of the contract ( i.e. the offeror
and the offeree).

▪ Contracts may be political, religious, commercial or social such as marriage and

divorce.

▪ Legally a contract is ‘an agreement between two or more persons or parties that
creates an obligation to do or not to do a particular thing/ act’.

▪ The effect of a contract is as important as the formation of a contract because a

contract could be:
❖ Valid (Sahīh - ‫;)صحيح‬
❖ Invalid (Bātil - ‫ ;)باطل‬or
❖ Voidable (Fāsid - ‫)فاسد‬.

▪ Contract has different types for which the rules and law are different. (Discussed later
in section Classification of Contracts)
 Classification of contract
A contract can be of two nature:

▪ Compensatory/ Commutative or Financial Contract

(‘Uqūd al-Mu’āwadāt - ‫)عقود المعاوضات‬
This is a contract in which there is exchange of counter-values from both the contracting parties
(goods/services against an agreed compensation / price / fee / charges).

As the compensatory contracts involve rights and obligations from both sides, the are some strict
conditions attached with these contracts. (Covered in the next part ‘Formation of Contract’)

▪ Non-compensatory/ Gratuitous Contract

(‘Uqūd al-Tabarrū’āt - ‫)عقود التبرعات‬
This is a contract in which there is no exchange of either goods or services against an agreed compensation
/ price / fee / charges.

There are certain exemptions to these contracts such as Gharar. (Covered in detail in under the topic
‘Invalidating & Defecting Factors: Gharar).
 Classification of contract
CONTRACT

Compensatory / Financial Contract Non Compensatory / Social Contract

Trade Gift (Hibah)

Leasing Bequest (Wasiyyah)

Employment Money lending (Āriyah/

Qard)

Partnership Guarantee (Kafalah)

Services against fee Non-paid agency

Paid agency Waqf (Endowment)

 Types of Contract

‫معاوضات‬ Compensatory Contracts | Sale, Leasing, Manufacturing

‫غير‬
‫معاوضات‬ Non Compensatory Contracts | Gift, Loan, Waqf

‫ضمنيات‬ Supporting Contracts | Wakalah , Mortgage, Kafalah, Hawalah

 Essential Elements of Contract
Contractors Wording of Contract Consideration Subject Matter
‫متعاقدين‬ ‫الفاظ عقد‬
ِ ‫معقود بہ‬ ‫معقود عليہ‬

Offer & Acceptance •Specified

•Non-restricted •Existence
‫ایجاب و قول‬ •Quantified
•Sane •Specified
•Mature •Present or Past •Ascertained •Quantified
•Non-Contingent •Valuable
•Unconditional •Useable under
•Must be in one Islamic Law
session •Capable of:
Ownership, Title,
Delivery &
Possession
*In Compensatory
Contracts only
 Essential Elements of Contract
• Offer and acceptance
• Lawful subject matter
• Agreement not declared void.
• Intention to create legal
Relationship.
• Free consent
• Capacity of parties to contract
• Performance possibility
• Lawful consideration
 General Principles governing Islamic Commercial Contracts

• Free Mutual Consent

▪ Free mutual consent of both parties is an essential pre-requisite for validity of a
contract.
▪ Factors impairing free consent: coercion, undue influence, fraud,
misrepresentation, state of intoxication, mistake or by way of jest.
▪ Both parties must have certain and definite knowledge of rights and obligations
arising from the contract.
▪ This is ensured through law of offer and acceptance.

• Legality and Lawfulness of Subject Matter

▪ Lawfulness and Legality of subject matter (services or goods) of the contract.
▪ Exchange of impermissible good or services is not allowed.
▪ Examples: wine, pork, intoxicants.
▪ This will be discussed in detail under Elements of Contracts: Subject Matter
 Definition of Sale
Sale is defined in Shariah as:

“Exchange of a thing of value, by another thing of value, with mutual consent”

Permissibility

“Allah has permitted Sale (trade) and prohibited Riba”

(Al Baqarah)

30
 Types of sale contracts

1. Valid sale ( Bai Sahih)

2. Void/Non existing Sale ( Bai Baatil )

3. Existing sale but void due to defect ( Bai Fasid )

4. Valid but disliked sale ( Bai Makrooh )

 Types of sale contracts

Sahīh (Valid) Contract

▪ A Sahīh contract is that whose asl (nature and essence) and wasf (accessory circumstances or attributes) are
in accordance with law. Thus a contract will be deemed valid when:
o Its elements are complete
o Conditions relating to elements have been met; and
o It is free from external prohibited attributes.

▪ Example: where all the conditions are met ( as discussed in the previous section)

Bātil (Void) Contract

▪ A Bātil contract is that whose asl is not in accordance with law (illegal).

▪ Example:
o Unlawful subject matter (wine, pork etc)
o Absence of contractual capacity (contract with insane person)
 Types of Contracts in terms of legality

Fāsid (Voidable) Contract

▪ A Fāsid contract is that whose elements (asl) are present and all essential conditions are met, but external
attribute (wasf) attached to the contract has been prohibited by the Law-giver.

▪ Example:
o Offer & Acceptance is made but defective consent (e.g. consent taken through coercion)
o Problem in external attributes (e.g. Gharar or Rība)
o Bai al-Majhūl
o Bai’ al-Ghā’ib

▪ An irregular contract can become a valid contract by the removal of the cause of irregularity.
 Summary of types of Sale

Exchange of Goods - Trade

Cash sale Cost undisclosed sale General sale

On spot delivery and payment

General bargain sale - Musawama

Credit sale – Bai' Muajjal

Cost disclosed sales
Delivery on spot and one payment at the end
Barter Sale
Cost + profit sale - Murabaha
Delivery on spot and payment in instalments
Below cost sale – Wazee'ah
Advance sale – Bai' Mua'jjal
Cost to cost sale - Tauwliya
Payment on spot with deferred delivery

Future sale Sale of Gold & Silver

Payment and delivery both deferred – illegal sale

 Six Basic Principles of contract
Fairness :
No Riba / (i)- No Gharar or
Interest : Uncertainty in
(i)-All types of No Remunerative Economic
Sanctity of
interests are Invalid Contracts; (ii)- No
Contract : purpose/
prohibited. comingling of
(i)- Contract Risk Sharing : Subject Activity :
(ii)-Time Value inconsistent
is Valid for Assumption Matter or (i)- Economic
of Money in contracts; (iii)- Full
(ii)-Halal SM of Risk of Purpose of
loan or Activity : disclosure of
& (iii)- ownership is Transactions;
Opportunity despite terms &
Legitimate must for profit (ii)- Backing
Cost not permission conditions &
reason entitlement. of real asset
allowed .; (iii)- in laws of other related
needed. land. issues. (iv)- Form or service is
Time Value of
Asset allowed; must be must .
(iv)-Reference compatible with
Rates allowed. Substance; (v)-
Ethics will prevail.
35
 Rules of Sale
Rule 1 : The subject of sale must exist at the time of sale
Rule 2 : The subject of sale must be in the ownership of seller at the time of sale. Hence, what is not
owned by the seller cannot be sold.
Rule 3 : The subject matter of a sale must be in the physical or constructive possession of seller at the
time of sale.
Rule 4 : The sale must be instant and absolute. Thus a sale attributed to a future date or a sale
contingent on a future event is void.
Rule 5 : The subject of sale should be an object of value. A thing having no value according to the
usage of trade cannot be sold.
Rule 6 : The subject of sale should not be a thing used for a Haram purpose, e.g. pork, wine etc. The
subject should be Maal-e-mutaqawwam.
Rule 7 : The subject of sale should be specifically known and identified to the buyer. The subject of sale
must be identified by pointing out or by detailed specification which can distinguish it from other
things not sold.
 Rules of Sale
Rule 8 : The delivery of the sold commodity to the buyer should be certain and should not
depend on a contingency or chance.

Rule 9 : The certainty of price is a necessary condition for the validity of sale.

Rule 10 : The sale must be unconditional. A conditional sale is invalid, unless the condition is
recognized as a usual practice of trade.

Rule 11: The sale must be unconditional. A conditional sale is invalid, unless the condition is
recognized as a usual practice of trade

NOTE
A valid sale contract exhibits two features:

1. Knowledge; i.e. parties’ full knowledge of the object of sale

2. Existence; a concrete sale object

Absence of these features introduces Gharar in the transaction

 Islamic Law of Options (Khayārāt / ‫خيار‬
▪ Khayārāt (pural of word Khiyār) is a device to safeguard the weaker party from being
harmed. It maintains balance and protect the buyer or seller from any unexpected
eventuality.

▪ The term Khiyār refers to the option or right of the buyer or seller to ratify or revoke a
contract of sale within the period of option.

▪ Some of the Khayārāt are as follows:

o Khiyār al- Shart (Option of Condition)
o Khiyār al-Ru’yah (Option of Inspection)
o Khiyār al-Āyb (Option of Defect)
o Khiyār al-Wasf (Option of Quality)
o Khiyār al-Ghaban (Option of Cheating in Price)
o Khiyār al-Ta’yīn (Option of Determination)
 Islamic Law of Options (Khayārāt / ‫خيار‬
▪ Khiyar-e-Shart (Option of Condition):
o This option gives both the Buyer and Seller a right to revoke the sale within the specific period. It
can be 'option of buyer' or 'option of seller’.
o This is a time bound option which expires after lapse of that time period.

▪ Khiyar-e-Roiyyat (Option of Inspection):

o This option give right of returning the goods upon inspection. This option applies as a built-in
option.

▪ Khiyar-e-Aib (Option of Defect):

o This option give the buyer a right to reject if the goods found defective.
o Unless expressly told by the seller otherwise, this is a built-in right.

▪ Khiyar-e-Wasf (Option of Quality):

o This option give the buyer a right to reject the good if they not qualify specific standards or agreed
parameters.
 Islamic Law of Options (Khayārāt / ‫خيار‬

▪ Khiyar-e-Ghaban (Option of Cheating in Price):

o This option give the seller or buyer a right to cross-check the validity of price charged or paid
to him.
o This helps seller from being quoted extraordinarily lower price, similarly it give right to buyer
to revoke the sale or ask for return of excess price if he is charged more than the market price
extraordinarily.

▪ Khiyār al-Ta’yīn (Option of Determination)

o This option give the buyer to choose or determine the object out of two or more within the
specified time.
 Ancillary/ Accessory Contracts

Meaning of Ancillary or Accessory Contract

A contract (aqd) which is incident or auxiliary to another contract (usually a principal contract).
Accessory contracts are mainly used for assuring the performance of other contracts, either by
the same parties or by third-parties.

Some of the Ancillary Contracts discussed here are as follows:

Contract of Security:
Kafalāh/‫( كفالة‬Suretyship), Rahn/ ‫( رهن‬Pledge), Hawalah/‫( حوالة‬Transfer of Debt)

Contract of Safe Custody:

Amanah/ ‫( أمانة‬Trust),

Contracts pertaining to do a work:

Wakalah/ ‫( وكالة‬Agency), Jua’lah ‫( جعالة‬Reward-based)
 Key Prohibitions in Commercial Dealings
▪ Islam prohibits some economic activities and consider them harmful
for human society. Some big problems are listed below and we call it
(8 ills):

❑ Haram Economic dealings and activities (general prohibitions);

❑ Riba (interest);
❑ Gharar (excessive uncertainty);
❑ Qimar (gambling);
❑ Violation of law of contract;
❑ Concentration of wealth [Irtikaaz] (circulation in hand of few);
❑ Hoarding [Ihtikaar] (gathering for creation of scarcity) ;
❑ Concealment of wealth [Iktinaaz] (non-fulfillment of obligations
related to wealth – Zakat, Sadaqaat etc.);
 Key Prohibitions in Commercial Dealings
As per Islamic law of contract, following three elements are
prohibited which will lead to invalidity of compensatory
contracts:
• Riba
• Maysir / Qimar (gambling)
• Gharar (uncertainty)
Prohibition of Riba
 Prohibition of Riba

“O you who believe, Fear Allah and give up what remains of your demand for
Interest, if you are indeed a believer. If you do not, then you are warned of the
declaration of war from Allah and His Messenger; But if you turn back you shall
have your principal: Deal not unjustly and you shall not be dealt with unjustly.”
Prohibition of Riba
Prohibition of Riba
Prohibition of Riba
 Prohibition of Riba
From Hazrat Jabir Ibn-e-Abdullah (RA):
The Prophet (peace be upon him) cursed :
• The receiver and the payer of interest,
• The one who records it and
• The witnesses to the transaction
And said: "They are all alike [in guilt]."
(Muslim, Tirmidhi)
 (A) - Definition of Riba
oAccording to a definition:
▪ It is any excess compensation over and above the principal which is
without due consideration.

o Another definition of Riba is that:

▪“Riba means and includes any increase over & above the principal
amount payable in a contract obligation, not covered by a corresponding
increase in labor, commodity, risk or expertise.”

Riba ul Nasiyah or Jahiliya

Classification
of Riba Riba ul Fadl or Bai
Definition of Riba
 (a)-Definition of Riba ul Nasiyah or Jahiliya

Riba means : the Conditional or customary increase which a creditor (owner of

the loan) receives from his debtor (user of the loan) for giving him time to
repay his debt.
• Compensation may include monetary as well as non monetary benefits.
• Unconditional increase in principal as gesture of thank and without
predetermination is Not Riba.
 (a)-Definition of Riba ul Fadl

• Excess taken in exchange of specific commodities which are

homogeneous.

Hadith prohibiting Riba-al-Fadl

• Gold for gold, silver for silver, wheat for wheat, barley for barley, dates
for dates, salt for salt – like for like, equal for equal, and hand to hand
(spot); if the commodities differ, then you may sell as you wish, provided
that the exchange is hand to hand or spot transaction
 Time Value of Money and Interest

❖ Time and Location are important factors in determining the price of any asset /
good/commodity;
■ Jurists allow the difference between cash and credit prices of a commodity
considering it a genuine market practice;
■ It is quite natural that in the market credit price of a commodity is more than its
cash price at a point of time;
❖ Time has a value which is recognized by Islam but Time value in loans is not acceptable.
❖ Valuation of money is allowed if it enters in circulation of exchange. Time value of Asset
is permissible.
 Misconceptions about Riba
1. “Riba as practiced during the days of the Prophet (SAW) was only Usury”.
2. Only Compounding of interest is prohibited.
3. Interest on consumption loans is prohibited and not on Production loans.
4. Debtors are not poor in current times – they earn huge profit so they pay interest.
5. Commercial interest / Banking Interest that prevails now, is different from 1400 years
old Riba.
6. Usury is prohibited but banking interest is not.
7. Interest keeps value of currency/money intact in future – solution of inflation.
8. Riba should be allowed on the basis of doctrine of Necessity – since its focal point of
modern banking & trade so must be allowed.
 The Issue of Reference Rate

❖ Reference rates is always needed for any market including financial markets;
❖ Financial intermediaries need it for executing and pricing the trade and leasing
transactions;
❖ Different types of reference scales are needed for different kinds of financial contracts;

❖ While for Conventional finance, there is only one reference rate (interest rate), Islamic
finance will have two basic groups of financial contracts: debt/semi-debt contracts and
non-debt (equity) contracts,
 (B) - Gharar/Uncertainty/Ambiguity
• Explanation
• The contract must be free from uncertainty about
the subject-matter and its counter-value in
exchange.

• There should be no jahl or uncertainty about

availability, existence and deliverability of goods
and the parties should know the actual state of
the goods (quality & quantity).

• Price must be clearly defined and clearly known

to the contracting parties.

• Time of delivery & future performance must be

clearly defined.

• Gharar also refers to undue complexity in

structures of contracts e.g. Combining two
inconsistent contracts, combining two sales in one
is not permitted.
 (C) – Qimar and maysir
Every form of money acquisition of which depends upon luck or chance.

Qimar & Maysir means getting something too easily. In other words you gain what you have not
earned. Maysir is the word from Yusr.

Technically, it is an arrangement in which possession of a property is contingent upon the

happening of an uncertain event.

By implication it applies to a situation in which there is a loss for one party and a gain for the
other without specifying which party will lose and which will gain.

Abdullah ibne Abbas ( )‫رضي هللا عنه‬defined gambling in these words: The risk of losing on both
sides (mukhatarah) is gambling.� (Ahkam al-Qur�an, 2/11).

Examples: Mobilizing resources on the basis of lottery & draws/ Futures & Options contracts that
are settled through price differences only.
 Key Features - Islamic Banking
• The philosophy of Islamic Banking takes the lead from Islamic
Shariah, refers to finance or banking activities in compliant of Sharaih
principles.
Key principles of Islamic Banking are :
• Profit and loss sharing and prohibition of interest payments from
investors and customers.
• No Compromise on Shariah Compliance.
• Backing of Real Assets or Service
• Halal & Legitimate Subject Matter
• Transparency in financial transactions
• Sanctity of Contracts
• In financial dealings, there is permissibility as a General Rule.
• Time Value of Asset against Time Value of Money
Summary
 Prohibition & Permission in Islamic Financial System

Haram Economic dealings Preferable & Permissible Economic dealings

and activities and activities

Trade &
Violation of Dealing in Partnership
business
Islamic law of Haram goods
contract and services
Equitable distribution
Rental business
of wealth
Maiser & Qimar
(gambling) [a type of Riba (interest)
Gharar] Rights Vs Rewards
Profit Vs Loss

Gharar (excessive
Exchange of services
uncertainty
 Part-III

Differences between
Conventional &
Islamic Banking
Islamic banking and finance
 Islamic banking and finance

We find the differences are on three levels:

1. Conceptual & Socio-religious level

• Islamic banks are not money lenders
• cannot deal in interest & non permissible industries/goods.
• Decision making has to be ethical and abide moral values
2. Business model & Governing framework
• IB actively participates in trade and production process. E.g: Islamic Banks trade in
commodities and carry inventory risk till sale of that commodity

• Governing framework in terms of Shariah Advisor &/or SSB

 Islamic banking and finance

3. Product Level Implementation

• usually asset backed & involve trading/renting of asset &
participation on profit & loss basis

• Implementation is not just a mere change of paper work and terms

but it involves:
I. having the right intention,
II. the correct sequence of steps and timing of execution
III. clarity of roles of contracting parties
Conventional Banking System
Islamic Banking System
Islamic Banking General Working Model
 Possibility of Islamization of Banking System
Islamic banks receive remunerative deposit on partnership basis and non remunerative
deposits on Qard/Loan basis;
They give financing to customers using trade, rental, partnership, providing services against
fee and combined modes of financing;

► As Partner under Musharakah/ Mudarabah.

► As Seller in Murabaha Musawamah, Salam & Istisna’a.
► As Owner In Islamic Leasing/Ijarah for transferring Usufruct

Participate in business 1.Trade;

1.Mudarabah 2.Rental;
2.Musharakah; 3.Participation;
3.Investment agency; 4.Investment agency
ISLAMIC
DEPOSITORS CUSTOMERS
BANK
1.Profit in trade
2.Rent in rental;
Share in profit 3.Share in profit
in participation;
 Islamic Model of Banking System – Financing

Islamic banks provide financing using various modes of financing;

These are four modes of financing which Islamic banks use to finance:
• Trade:
• Islamic bank can act as buyer or seller;
• Rental:
• Islamic bank can be a lessor or lessee;
• Partnership:
• Islamic bank provide fund on partnership basis. The profit or loss are shared
according to the mechanism of the modes used;
• Services:
• Provisioning of services against charges /fees;
 Comparison of Islamic and Conventional Banking
ISLAMIC BANK CONVENTIONAL BANK

Relation between bank and depositors is of Partnership

(Mudarabah) i.e. profit and loss sharing arrangement; Relation between bank and depositors is of Lender and Borrowers;

Money is not a commodity & it does not has any intrinsic

value. Money is considered a Commodity (has intrinsic value) so it can be sold or rented.

Loan contract cannot be used as a compensatory contract. So Whole banking is based on Loan Contract on both sides of Balance Sheets
other legitimate contracts are used for banking.
Interest is contractual Obligation. So Depositor’s principal as well as profit are
Distributable Profit is actual and not of fixed nature (not guaranteed.
Guaranteed)
Transactions are real asset based . Merely documents are not
considered assets; Transactions are financial asset based that may not a physical asset;

Mere Time Value of Money is not basis for calculations of

returns but actual earned profit becomes distributable Time Value of Money becomes basis for calculation of Interest.
amount.
Ethics and moral values play a major role in investment Documents, obligations and receivables are considered as assets;
decisions. Not a choice but a must.
Conclusion
 What is Islamic Banking?
Islamic banking is the form of financial intermediation based on the Islamic
modes of partnership, sale, agency, rent and free from Riba (interest), Maysir
(gambling), Gharar (uncertainty) and other elements prohibited in Shari’ah
Balance sheet of an Islamic Bank
Statement of Inventory
Brief comparison of balance sheet