Lecture 10

Introduction to Islamic Finance & Fiqh al Muamalat

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 INTRO TO ISLAMIC FINANCE
 When we speak of Islamic Finance or Islamic economic
principles, it is generally assumed that these principles
are emphasized by Muslim scholars only to satisfy the
religious requirement of Muslims, or that they are
meant only for Muslims to the exclusion of all others.
This is an incorrect assumption!!!
 Although Islam is basically represented by a set of
beliefs, the benefits of its social, political and
economic principles are not restricted to Muslims;
they are meant for the common good of humanity at
large.
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 SHARIAH : AN INTRODUCTION
 Shariah generally means Islamic law
 3 basic branches of Shariah  beliefs, the moral / ethic and
fiqh (code of laws / jurisprudence)
 Shariah
 The rules ordained by Allah s.w.t for His servants through
His Messenger
 Revealed
 Fiqh
 Islamic Jurisprudence
 the knowledge of the practical Shariah rules which is
deduced from their respective particular evidences.
 Ijtihad and power of reasoning is stressed
 Mazhab (school of thought) – Hanafi, Maliki, Shafie and
Hanbali
 Public – Shariah and fiqh are used interchangeably

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 COMPONENTS OF SHARIAH

AQIDAH FIQH AKHLAQ

(Faith & Belief) (Practices & Activities) (Moralities & Ethics)
Concerning faith and beliefs Concerning practical actions in manifesting his faith Concerning behaviour, attitude and
in ALLAH and His will and beliefs work ethics in taking practical actions

IBADAT MUAMALAT
(Man-to-God Worship) (Man-to-Man Activities)
Concerning practicalities of his worship Concerning practicalities of his daily life in
of ALLAH various forms of man-to-man activities

POLITICAL ECONOMIC SOCIAL

ACTIVITIES ACTIVITIES ACTIVITIES

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COMPONENTS OF SHARIAH (cont’d)

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SOURCES OF SHARIAH- Primary

6
SOURCES OF SHARIAH- Secondary

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 SHARIAH COUNCIL’S VIEW
 View of Shariah Committee is an ijtihad and
considered as source in Islamic jurisprudence.
 International level – Islamic Fiqh Academy of OIC and
Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI) Shariah Council.
 National level – Shariah Advisory Council (SAC) at BNM
and SC
 Bank level – Shariah Board/Committee of a Bank

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SHARIAH COMPLIANCE IN FINANCIAL ACTIVITIES
 Demarcation between devotional acts (ibadat) and commercial
matters (mua’malat)
 Initial Legal Ruling in Commercial Contract is permissibility
 Open a very wide door for innovations
 Every contract is considered lawful and acceptable if no principles
of Shari’ah has been contravened
 Islamic commercial contracts are free from:
i. Riba’ (interest/usury)
ii.Gharar (excessive ambiguities);
iii.Maysir (gambling);
iv.Transactions involving prohibited assets/commodities

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 Section 2

Prohibitions in Islamic Commercial Law

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WHAT ARE THE ELEMENTS NOT APPROVED UNDER ISLAM?

Riba (interest/
usury)

GHISH
Forbidden Gharar
concealment of (Excessive
information. uncertainty)
Transparency is
vital

Producing and Maysir

trading in (Gains from
“Haram” game of chance
goods/activities i.e. gambling)
Ihtikar
(Hoarding to bid-
up prices)

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WHAT ARE THE ELEMENTS NOT APPROVED UNDER ISLAM?

Riba
Literally means “to increase ; to grow up ; to exceed” and
generally translated as “usury” or “interest”.
Riba applies to unlawful gain derived from the quantitative
inequality of the counter values in any transaction. It is
specifically forbidden in the Quran in reference to interest
bearing loans.
Two types of riba :
i.Riba al-Qurudh – is created from loans i.e the borrower pays
the loan plus interest
ii.Riba al-Buyu` - is created from trade. The Prophet (pbuh)
has classified type of good which being considered as ribawi
goods.
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 RIBA

Riba Al-Qard (Riba of Debt)

Additional amount repaid in debt transactions.
a)The debtor borrowed a certain sum for a certain
period according to the agreed terms, the debtor must
pay back more than the capital sum or loan, or

b)A trader sold his product for a specific deferred

payment period. If the buyer failed to pay within that
period, the period was extended by increasing the
selling price or debt amount.

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 RIBA

Riba Al-Bai’ (Riba of Trading)

Occurs in the trading of “ribawi” products as stated by
the Prophet s.a.w. in his hadith:
“Exchange 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. If what
you have exchanged differs in type, you can trade as
you wish, provided that the exchange is hand to hand.”
(Narrated by Muslim)

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RIBAWI MATERIALS

Ribawi materials are divided into two bases and under each basis
are the different kinds as follows:

BASIS BASIS
(MEDIA OF EXCHANGE) (FOODSTUFFS)

• Gold • Grains – rice, wheat, corn

• Silver • Meats – beef, mutton, chicken

• RM • Vegetables – tomatoes, bean

• USD • Fruits – apples, oranges

• Salts – salt, sugar, condiments

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 RULES OF EXCHANGE OF RIBAWI MATERIALS
EXCHANGES RULES

Ribawi materials of the same • Materials must be of the same

kind of the same basis. weight, measurement or number of
units.
• Payment must be on cash terms

Ribawi materials of different • Difference in weights,

kinds of the same basis. measurements or number of
units allowed,
• Payment must still be on cash
terms.

Ribawi materials of different • No rules are imposed.

kinds of different bases. (Difference in weights,
measurements or number of
units allowed)

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 2) GHARAR (EXCESSIVE UNCERTAINTY/ AMBIGUITY)

 Literally : ambiguity/uncertainty
 It refers to the sale of probable item whose existence
or characteristics are not certain.
 The examples of Gharar as follows:
1) Selling goods that the seller is unable to deliver
2) Selling goods without proper description, such as
shop owner selling clothes with unspecified sizes
3) Selling goods without specifying the price
4) Selling goods on the basis of false description
5) Selling goods without allowing the buyer properly
examine the goods

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 GHARAR
Types of Gharar
1)Gharar Fahish (Major Uncertainty)
 uncertainty which is so great that it becomes unacceptable
e.g. sale of non existence object, sale of object that unable
to be delivered, sale of object not according to agreed
specifications
2)Gharar Yasir (Minor Uncertainty)
 uncertainty which is considered a normal phenomenon in
the market if it is not excessive where the effect on the
economy and society is considered minimal. This is
accepted by Shariah as it would be practically impossible to
eradicate it from the market.

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 3) MAYSIR (GAMBLING)

 Any activities which involve betting whereby the

winner will take the bets and the loser will loss his
bet.
 The examples of gambling activities are play card
(daun terup), mahjong, lottery, lotto, etc.
 In the case where the participants may try their luck
but not losing anything if not selected as winners, it
is allowable. For instance, Petronas Super Car Craze
Contest, where the winners get the car and others
still enjoy their car fuel.

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NEGATIVE LIST: GOODS AND BUSINESS ACTIVITIES
Apart from Riba, Gharar and Maysir, Islam prohibits us from producing,
financing, selling, purchasing and dealt with the following goods and
business activities:
1.Entertainment (Disco/ night club/ casino/ Prostitution service, etc);
2.Pornography such as video tape, magazine, book;
3.Weapons (for destructive purposes);
4.Alcohol;
5.Drug;
6.Pork-related production and non-halal foods;
7.Tobacco;
8.Stock broking or share trading in Shariah non-compliant securities;
9.Conventional financial services (banking, insurance, etc); and
10.Other activities deemed non permissible according to Shariah principles

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 Section 3
Comparison between Islamic Finance and
Conventional Banking

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ISLAMIC VS CONVENTIONAL BANKING

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ISLAMIC VS CONVENTIONAL BANKING

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 Section 4

“Most Common Shariah Principles and Its Application

in Islamic Banking”

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 CLASSIFICATIONS OF ISLAMIC COMMERCIAL
CONTRACTS
TYPES OF
CONTRACTS

SALE-BASED PARTNERSHIP-BASED LEASE-BASED

Murabahah (cost-plus)*  Ijarah (leasing) *

 Mudarabah (profit sharing)*
Istisna (construction)*  Ijarah Thumma Bay
 Musharakah (profit, loss (leasing followed by
Salam (deferred delivery) sharing)* sale/HP) *
Tawarruq (Monetization)*
Urbun (earnest money)
Inah (purchase and sale
back)*
Sarf (currency exchange) * OTHERS

 Qard (interest free loan)

FEE-BASED
 Kafalah (guarantee)
 Hibah (gift)
 Wadiah (safekeeping)
 Ibra ‘(rebate)
 Wakalah (agency)*
 Muqasah (set-off)
 Rahnu (pawn broking)
* Widely applied contracts in commercial transactions
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 COMMON SHARIAH CONTRACTS

There are few common Shariah contracts applied to various

Islamic capital market instruments which are as follows:
1.Mudarabah (profit sharing);
2.Musharakah (profit-loss sharing) + Musharakah Mutanaqisah
(diminishing partnership);
3.Murabahah (cost-plus/markup);
4.Ijarah (Leasing);
5.Istisna’ (Construction contract) + Istisna’ Ijarah;
6.Tawarruq/ Commodity Murabahah (Monetization);
7.Wakalah (Agency)

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 1) MUDARABAH

 mudarabah refers to a contract made by A Generic mudarabah Transaction is Illustrated

two (2) parties to finance a business Below:
venture.
 The parties are a Rabbul mal (investor)
who solely provide the capital and a
Mudharib (entrepreneur) who solely Rabb al Mal Mudharib
manages the project. If the venture is (capital Profits to be
shared while (entrepreneur)
provider)
profitable, the profit will be distributed losses are solely
based on a pre-agreed ratio. borne by the
Rabb al mall
 In the event of a business loss, the loss
shall be borne solely by the provider of Management
Capital
the capital. However, if the losses are Skills
caused by the Mudharib’s negligence or
misconduct, the Mudharib shall be liable
to bear all the losses. mudarabah
Venture
 The Mudharib cannot guarantee the
capital nor the return from the venture

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 TENETS OF MUDARABAH

mudarabah

1. Contracting parties
(rabb al-mal / mudharib)

2. Subject matter 3. Offer & Acceptance

(capital, profit
(Ijab wa qabul)
& loss)

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 2) MUSHARAKAH
 Musharakah refers to a partnership
arrangement between two parties or A Generic Musharakah Transaction Is Illustrated
more to finance a business venture Below:
whereby both parties contribute capital
either in the form of cash or in-kind for 2. Bank appoints client as
the purpose of financing the business the Musharik to
manage the
venture. Musharakah Venture

 Both parties may jointly manage the

BANK CLIENT
business or one partner manages the
business with another partner’s
consent.
Profit / loss
 Any profit derived from the business
venture will be distributed on a pre-
agreed profit sharing ratio and the loss 3. Profit and losses
will be shared on the basis of the 1. Bank and Client are shared
contributes capital based on the
capital participation. to the Musharakah capital
Venture MUSHARAKAH contributed by
 The partner cannot guarantee the VENTURE the partners.
capital not the return to another
partner from the venture.

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 TENETS OF MUSHARAKAH

MUSYARAKAH

1.Contracting parties
i.e partners

2. Subject matter
i.e capital contribution, 3. Offer & Acceptance
work, profit and (Ijab wa qabul)
loss sharing ratio

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 MUSHARAKAH MUTANAQISAH
(DIMINISHING PARTNERSHIP)
 Musharakah Mutanaqisah or musharakah muntahiyah
bit tamlik means diminishing musharakah
 It is a type of a partnership where a partner purchases
the units of the share of the other partner gradually,
until that particular partner finally hold the full
ownership of the asset/ business;
 This concept is a hybrid concept whereby it consists of
three contracts which are musharakah (partnership),
ijarah (leasing) and wa’ad/promise to purchase
(purchase undertaking).
 This hybrid concept is widely applied for home/project
financing.
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MUSHARAKAH MUTANAQISAH (DIMINISHING
PARTNERSHIP)
1. Musharakah Agreement
10% 90%
Partnership Contract to co own asset

Asset
(Partnership Purchases Asset)

4. Notice of Fulfillment
Customer Bank
Transfer of full ownership to Customer
upon fulfillment of Musharakah
terms

3. Ijarah Agreement
Customer pay rental for using Bank’s stake in the asset.

2. Purchase Undertaking
Customer undertakes to make monthly Musharakah Unit
purchases to gradually reduce Bank’s stake and increase
his/her % of the asset ownership
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 mudarabah VS MUSHARAKAH

mudarabah Musharakah
1. Only one party contributes 1. Both parties contribute
capital and only one party capital and both parties can
manages the business; manage the business;
2. Capital must be in form of 2. Capital can be CASH IN-
CASH; KIND;
3. Loss shall be borne by the 3. Loss shall be borne by the
Rabbul Mal partners based on capital
ratio

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 3) MURABAHAH
 Murabahah is a type of contract, A Generic Murabahah Transaction is Illustrated Below:
which is considered as a form of sale,
where the seller expressly mentions
the costs of the sold commodity he
has incurred, and sells it to another SUPPLIER
person by adding some profit or 1. Bank purchases
mark-up thereon. the goods.
Customer will
act as Bank’s 2. Bank
 The only feature distinguishing it agent makes
payment
from other kind of sale is that the upon
seller expressly discloses the cost of receipt of
trade
the asset sold and how much profit CUSTOMER document
he is going to charge in addition to
the cost 3. Bank sells the goods via
execution of
Murabahah Contract
 The Bank purchases the asset from Note
the supplier / vendor and sells it to
the customer at a mark-up price. BANK
CUSTOMER
 Being a sale, and not a loan, the 4. Customer shall make
payment as per
Murabahah should fulfill all the manner agreed
necessary conditions for a valid sale.

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 TENETS OF MURABAHAH

MURABAHAH

1. Contracting parties (seller

and buyer)

2. Subject matter 3. Offer & Acceptance

(ma`qud alaih)-
(Ijab wa qabul)
Underlying asset

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 4) IJARAH

 Ijarah refers to manfaah (usufruct/benefit) A Generic Ijarah Transaction is Illustrated Below:

type of contract whereby a lessor (owner)
3. Payment to Vendor
leases out an asset or an equipment to a
VENDOR
client at an agreed rental fee and pre-
determined lease period upon the aqad’
(contract).
 The ownership of the lease equipment 1. Customer
purchases
remains in the hands of the lessor.
the asset 2. Customer enters into a
 Ijarah can be divided into two types, i.e., purchase agreement with the
Bank.
finance lease and operating lease.
BANK
 For finance lease, it is known as Ijarah CUSTOMER
4. Execute the Ijarah Agreement
Muntahiyah bittamlik (leasing which ends and customers pays
with transfer of ownership). installment (rental) to the
Bank.
 In normal Ijarah, the leased asset must be
in existence upon execution of leasing 5. Bank sells the asset at the end
agreement. However, the specified under of tenure at a nominal amount
construction asset/property can be used as or any agreed price.
a leased asset under principle of Ijarah
Mawsufah fi Zimmah (forward lease).

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 IJARAH MUNTAHIYAH BI TAMLIK
(‫)ا إلجارة ا لمنتهية ب ا لتمليك‬
 It is a leasing contract which ends with ownership. It
is similar to practice of hire purchase in conventional
 It refers to an Ijarah (leasing/renting) contract to be
followed by contract of ownership such as bai`
(purchase) contract or hibah (gift).
 Under the first contract, the lessee leases the asset
from the owner (lessor) at an agreed rental over a
specified period. Upon expiry of the leasing period,
the ownership of the asset will be transferred to the
lessee through 2nd contract such as sale contract
(bai`) at an agreed price or hibah (gift).
 Completed asset.

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 IJARAH MAUSUFAH FI ZIMMAH
(‫)ا إلجارة ا لموصوفة ف يا لذمة‬
 It is an ijarah contract which is executed for an asset undertaken
by the lessor to be delivered to the lessee according to accurate
specifications, even if the asset is not owned by the lessor.
 During the period that the leased asset/property is under
construction, the lessor may ask the lessee to pay a certain
portion of pre agreed lease rental as a forward lease. The
forward lease rental payment will be considered as a debt to the
lessor until the delivery of the leased asset to the lessee.
 Ijarah Mausufah Fi Zimmah can be in a form of operating lease
or financial lease.
 Asset under construction or yet to be delivered.
 If the lessor fails to deliver the asset, the lessor is obliged to
repay the advance rental paid by the lessee.

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 TENETS OF IJARAH

There are three tenets of Ijarah which are as follows:

1.Contracting parties (lessor and lessee)

2.Subject matter of lease i.e., lease payment (rental)

and leased asset

3.Ijab and qabul (offer and acceptance)

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 5) ISTISNA'
 Istisna' is an order or request to A generic Istisna' transaction is illustrated below:
manufacture or construct
1) Single Istisna’
something, whereby the 1. Customer places an order to construct the
requestor invited, induced or Istisna’ asset and pays progress billings
caused another to make or
CUSTOMER BANK
manufacture goods for him.
2. Bank delivers Istisna’ asset upon full
settlement of progress billings
 Technically, it is a contract to
purchase for a definite price 2) Parallel Istisna’
something that may be CONTRACTOR
manufactured or later according (other than
to an agreed specifications customer)
2. Bank agrees
between the parties. and request
3. Upon completion,
contractor delivers
contractor to
Istisna’ asset to the
 In other words, it is a contract of construct the
Istisna’ asset
Bank
sale of a specified item to be
4. Bank delivers Istisna’ asset
manufactured or constructed with BANK CUSTOMER
an obligations on the part of the
manufacturer or contractor to
deliver the item to the customer 1. Customer places an order to
on completion. construct the Istisna’ asset
and pays progress billings

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 TENETS OF ISTISNA’

There are three tenets of Istisna’ which are as follows:

1.Contracting parties (orderer / mustasni’ and

contractor / soni’)

2.Subject matter of Istisna’ i.e. the construction

project, Istisna price and completion date.

3.Ijab and qabul (offer and acceptance)

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 ISTISNA` FOLLOWED BY IJARAH / IJARAH
MAUSUFAH FI ZIMMAH
Steps :
1. Customer enters to a contract with the Bank to construct
a project / asst (eg : home) and to lease upon completed
2. Simultaneously, the Bank will appoint a contractor to
construct based on parallel istisna. It is allowed to appoint
the customer as an agent to deal with the contractor.
3. Upon delivery of the project/ home to the Bank,
simultaneously the Bank will lease the project / asset to
the customer based on Ijarah principle.
4. The ijarah might kick-off during construction of the leased
asset using ‘ijarah mausufah fi zimmah’ (forward lease)
principal.
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 ISTISNA` FOLLOWED BY IJARAH / IJARAH MAUSUFAH FI
ZIMMAH
4

1
Bank Customer
2

Process Flow :
1. Customer applies for a financing to construct a vessel.
2. Bank will enter into Istisna Purchase Agreement to appoint Customer as its contractor to construct
and deliver the vessel to the Bank.
3. Bank and Customer subsequently enter into a Forward Lease (Ijarah mawsufah fi zimmah) Agreement
which states Customer to pay advance rental during the construction period and full rental upon
completion of the property.
4. Customer unilaterally signs the Purchase Undertaking.
5. Bank makes progressive payments to Customer.
6. Upon completion of the lease period or earlier, if there are no sums whatsoever due to the Bank, the
Customer will purchase the Asset at a nominal value or any agreed price.

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 6) TAWARRUQ/COMMODITY MURABAHAH
Literally, tawarruq is originated from word of wariq
which means dirham (money) which is made from
silver.
 Also known as “commodity murabahah”.
 Tawarruq has been approved by the scholars as a
solution for cash financing facility.
 A customer with a genuine need buys something on
credit from the financier / depositor / investor on a
deferred payment basis based on murabahah or
musawamah and then resells it for cash to a third party.
In this way, the customer can obtain cash without
taking an interest-based loan.
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TAWARRUQ/COMMODITY MURABAHAH
(FINANCING STRUCTURE)

1 - ABC request for financing via purchase request of commodity

to Maybank IB with ABC’s undertaking to purchase the commodity

Bank A ABC

4- Bank A sells the Bank A as

2 – Bank A commodity to customer on
purchases a deferred payment basis Agent
3-Commodity
commodity on a (Cost + profit).
spot basis from 5 – As owner of the
Commodity commodity, ABC
Broker1. 6 – Spot Price appoints Bank A as
RM agent to sell the
equivalent to commodity to
financing Commodity Broker
amount 2 on a spot basis
release to
ABC

Commodity Commodity
Commodi Broker 2
Broker 1 ty

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 TENETS OF TAWARRUQ/COMMODITY
MURABAHAH

The three tenets of Murabahah are as follows:

1. Contracting parties i.e. seller and buyer

2. Subject matter of the sale i.e. specified

commodities such as CPO, metal, etc.

3. Ijab & Qabul, i.e. offer and acceptance

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 AAOIFI STANDARD ON TAWARRUQ/CM

1. The requirement of the contract for purchasing

commodity must be well observed – Genuine Sale &
Purchase.
2. The commodity must be purchased and subsequently sell
to different party- no inah (back-to-back) element.
3. The purchase of commodity on spot basis and the sale the
commodity on deferred basis must be separated.
4. The Customer cannot appoint the Bank or its proxy to sell
the commodity on his/her behalf. However if there is any
genuine hurdle, the Bank may act as the Customer’s
agent.

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 WAKALAH (AGENCY)

 Wakalah is a contract whereby somebody

(principal) hires someone else to act on his
behalf i.e. as his agent for a specific task.
 The agent is entitled to receive a 1. Customer appoints the Bank
predetermined fee irrespective of whether he as its investment agent
is able to accomplish the assigned task to the
satisfaction of the principal or not as long as
Customer 2. Customer pay the Bank Bank
he acts in a trustworthy manner. However, the agency fee/ commission.
(principal) (agent)
agent would be liable to penalties only if it can
be proved that he violated the terms of the
trust or acted dishonestly. 3. The Bank distribute the return
& capital from the investment.
 In the case of a financial wakalah contract,
clients give funds to the bank/company that
serves as their investment manager. The
bank/company charges a predetermined fee
for its managerial services. Entire profit or loss
is passed back to the fund providers after
deducting such a fee.

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 TENETS OF WAKALAH

The three tenets of Wakalah which are as follows:

1. Contracting parties i.e. Muwakkil (principal) and

Wakil (agent);

2. Subject matter of wakalah: Specific responsibility

of Wakil and wakalah fee; and

3. Ijab & Qabul, i.e., Offer and Acceptance

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 APPLICATION OF THE CONTRACTS
Types of Use of Contract Underlying Asset Can Financiers take
Contract collaterals?
Murabahah Working Capital for Assets Tangible asset Yes
acquisitions
Ijarah Operating/Financial Lease Leased asset Yes

Istisna’ Construction/Project Financing Construction project Yes

mudarabah Deposit/Working capital for Customer’s Yes (to protect

business business/project capital in case of
negligence)
Musharakah Working capital for business Customer’s Yes (to protect
and asset acquisition business/project capital in case of
negligence)

Tawarruq/ Deposit/Working Capital/ Commodity. Normally Yes

CM Hedging instruments CPO
Wakalah Working capital for business/ Customer’s Yes (to protect
project business/project capital in case of
negligence)

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Q&A

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 THANK YOU & WASSALAM

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50000 Kuala Lumpur.
(Tel) +603-2031 1010 (Fax) +603-2031 9191
(E-mail) razli@ibfim.com / info@ibfim.com

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