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Shari'ah Rulings and Finance

In practice, the permissibility or otherwise
of a transaction or business activity is governed
by the Shari'ah, that provides the framework for a
set of rules and laws, governing economic, social,
political, and cultural aspects of Islamic societies.
 
 
The rules governing Islamic Finance are derived from the Shari'ah. The Shari'ah is a framework of Islamic Jurisprudence derived from the primary sources: The Qur'an and the teachings of the Prophet Muhammad (pbuh) known as the Sunnah. In addition to which there is a dynamic secondary source of common law rulings and scholarly interpretations referred to as Fatwa's. These fatwas are the results of human interpretation of the Shari' ah, of its texts, or its principles, or a combination of the two; they are not the word of God. Islamic law, it must be remembered, is more a process than a code, and the results of legal deliberations may differ when different methods are employed. Several fatwas are indicative of an acceptance on the part of Shari'ah Supervisory Boards of new realities in the marketplace and of their willingness to understand and work with these to the extent that Islamic religious and legal principles will allow. Such an attitude has ever characterized the best in Islamic legal thought.
 
 

 
 
The originators of modern banking based their system on ‘interest-oriented investments and earnings which are clearly prohibited in the Shari'ah of Islam. Therefore, modern banking institutions, which gradually became essential to the commercial activity of the entire world, were totally antithetical to the guidance revealed to humankind through the Qur'an and the Sunnah of the Prophet Muhammad (pbuh).
 
Many Muslims, believing in the prohibition of interest, remained aloof from this modern system of banking, and those who did enter the field restricted themselves to the routine work necessary for their employment. This was done because they had reservations about interest-based transactions and also because, owing to their political decline, they were unable to control the wheel of international commercial transactions.
 
 
 
The rules of Islamic finance adhere to the broad principles of avoiding Maysir and Qimar which are gambling and speculation along with Gharar which is uncertainty coupled with exploitation and unfairness. This closes the door to the concept of interest and precludes the use of conventional debt-based instruments. The Islamic financial system encourages risk-sharing, promotes entrepreneurship, discourages speculative behavior, and emphasises the sanctity of contracts.

The central tenet of the Islamic financial system is the prohibition of Riba, a term literally meaning "an excess" and interpreted as "any unjustifiable increase of capital whether in loans or sales". More precisely, any guaranteed increase in return tied to the maturity and the amount of principal, regardless of the performance of the investment, would be considered riba and is strictly prohibited.

Islamic finance offers different instruments to satisfy providers and users of funds in a variety of ways. Basic instruments include cost-plus markup financing (murabaha), profit-sharing (mudarabah), leasing (ijarah), partnership (musharakah), and forward sale (bai' salam). These instruments serve as the basic building blocks for developing a wide array of more complex financial instruments, suggesting that there is great potential for financial innovation and expansion in Islamic financial markets

The Islamic scholars and Shari'ah Supervisory Boards of different Islamic financial institutions have passed a large number of resolutions through collective ijtihad interpreting the basic principles underlying Islamic transactions and the requirements of the Shari'ah with regard to different modes of financing, as well as some details of their practical implementation. This understanding is necessary to facilitate not only their compliance with the Shari' ah, but also helps Islamic financial institutions to use the new products in the light of Islamic principles.

If an Islamic financial institution is not in compliance with Shari'ah precepts, there is nothing but its name to distinguish it from a conventional institution. One of the goals in publishing this work is to enhance the appreciation of practioners for the importance of Shari'ah compliance and its significance for consumers.

The bedrock of Islamic banking is the Shari'ah law enshrined in the Qur'an and the Sunnah of the Prophet Muhammad (pbuh). Unfortunately there is an impression in certain quarters, especially in the West, that there is no agreement among the Shari'ah scholars on what actually constitutes Islamic banking. Late Sir Edward George, Governor of the Bank of England highlighted this impression, in address to a recent conference on Islamic Banking. He said,

There are a number of issues that we need to address. One is that, as I understand it, there is no single definition of what constitutes Islamic banking. Different institutions interpret the acceptability of Islamic banking products in their own way. Individual boards of Shari'ah advisers apparently have equal authority, so that in some jurisdictions there is no definitive answer as to the status of a particular Islamic banking product. This leads to uncertainty about what is, and what is not, the ‘acceptable' way to do a particular business, which in turn can complicate assessment of risk both for the bank and its customers.

Rather, it will be seen by the involvement of Shari'ah scholars that they are quite definitive, and in agreement, on what constitutes Islamic banking. The minor differences of opinion, if and when they exist, relate to matters of procedure or detail, but not to substance. Such differences are common among judges in courts of law throughout the world.
 
The Shari’ah has evolved within the guidelines set by three broad principles agreed upon by Islamic scholars and jurists over the centuries. These are:
 
  1. Interest of the community takes precedence over the interests of the individual;
  2. Relieving hardship takes precedence over promoting benefit;
  3. A bigger loss cannot be prescribed to alleviate a smaller loss and a bigger benefit takes precedence over a smaller one. Conversely a smaller harm can be prescribed to avoid a bigger harm and a smaller benefit canbe dispensed with in preference to a bigger one.
 
SHARI'AH SUPERVISORY BOARDS
Introduction by (Ret'd) Justice Muhammad Taqi Uthmani, International Shari'ah Scholar

Compendium of Legal Opinions Volume I
Published by the Institute of Islamic Banking and Insurance, London

Modern banking developed in an era that witnessed the political decline of the Muslim Ummab throughout the world. The originators of modern banking based their system on ‘interest-oriented investments and earnings which are clearly prohibited in the Shari'ah of Islam. Therefore, modern banking institutions, which gradually became essential to the commercial activity of the entire world, were totally antithetical to the guidance revealed to humankind through the Qur'an and the Sunnah of the Prophet, upon him be peace and blessings.

Many Muslims, believing in the prohibition of interest, remained aloof from this modern system of banking, and those who did enter the field restricted themselves to the routine work necessary for their employment. This was done because they had reservations about interest-based transactions and also because, owing to their political decline, they were unable to control the wheel of international commercial transactions.

Since the acquisition of political freedom by many Muslim countries during the past thirty years, it has been the cherished dream of the Muslim Ummah to develop a new banking system based on Islamic principles. Unfortunately, the political authorities of the Muslim countries paid precious little if any attention to bringing their socio-economic activities into harmony with the principles of the Shari'ah. Hence, certain groups of Muslims individuals were forced to establish Islamic banking institutions on their own, and without any meaningful support from their governments. Several Islamic banks were established in the decade of the Seventies and through them the cherished dream of Islamic banking was translated into reality, at least at the private level.

From the very beginning, Islamic banking institutions have been constantly guided by Religious scholars on their respective Shari'ah Supervisory Boards who are responsible for designing their transactions in accordance with the principles of the Shari'ah and subsequently keeping a watchful eye over their operations. These boards have devised new modes of financing to replace interest-based transactions. The management of an Islamic banking institution brings its day to day problems before its Board which, after examining the relevant details, will decide whether or not the proposed transactions are in line with Shari'ah principles. Such decisions by the Boards are called fatwas.

The function of a Shari'ah Supervisory Board is of a very delicate nature. On the one hand, they are meant to abide strictly by Islamic principles, and on the other they have to fulfill the requirements of the constantly emerging needs of the contemporary marketplace. The task entrusted to the Shari'ah boards is indeed a difficult one; because when we claim that Islam provides solutions to the problems of every time and place, it does not mean that Islam has given a specific rule for each and every minute detail of every transaction.

In fact, the sacred sources of the Shari' ah, the Qur'an and the Sunnah, have provided Muslims with a set of eternal principles, but their application to the practical situations of each age requires the exercise of ijtihad. This means consultations in which the individual deliberations of many scholars play a vital role in reaching many firm conclusions. This exercise sometimes brings different answers from different Shari'ah Supervisory Boards with regard to the same question. The Shari' ah Supervisory Boards, being comprised of a number of Islamic scholars, decide the matter placed before them after mutual deliberations, which is tantamount to collective ijtihad.

The Islamic Fiqh Academy, constituted under the auspices of the Organization of the Islamic Conference (OIC) represented by all its member countries, in its Second Session held at Jeddah during December 22-28, 1985 adopted a resolution which, inter alia, provided:
  1. Any excess or profit on a loan for a deferred payment when the borrower is unable to repay it after the fixed period and similarly any excess or profit on a loan at the time of contract are both forbidden as riba in the Shari' ah.
  2. Alternative banks should be established according to the injunctions of Islam to provide economic facilities.
  3. The Academy resolves to request all Islamic countries to establish banks on Shari'ah principles to fulfill all the requirements of a Muslim according to his beliefs so that he may not face any repugnance. 
Edited and Translated by Yusuf Talal DeLorenzo, Independent Shari'ah Scholar Director, Master's Program for Imams
The Graduate School of Islamic and Social Sciences, Leesburg, Virginia USA
Published by the Institute of Islamic Banking and Insurance, London

Extract from Translator's Introduction - Volume I
If the numbers indicate anything about Islamic banking, it is that an exciting chapter in the religious, cultural, and intellectual life of Muslims is opening. The relatively new field of Islamic economics and banking is particularly challenging for the reason that it brings together scholarship from jurists and economists. Realistically speaking, however, there is much about this novel interdisciplinary field that is not well understood, even at the conceptual level; and a great deal of groundwork still needs to be done. The problem at the present time, if we seek to reduce the matter to its lowest common denominator, is that scholars from both fields bring their own intellectual and disciplinary predilections to their understanding of the new phenomenon, and these are often at ideological and even paradigmatic loggerheads with one another. For example, many Muslim jurists are reluctant to exercise any sort of independent thinking on economic issues, preferring instead to rely on the scholarship of past ages. Thus, their response to new questions is to locate in the classical legal literature questions of a similar nature, through the liberal use of what may at best be termed “rough” analogy, and then to ‘graft the old solutions prescribed there to the questions at hand.2 In contrast to the literalist and traditionalist orientations of many Muslim jurists, our economists have suffered from a lack of Islamic contributions to their field. A former official of the State Bank of Pakistan asserts that Muslims writing on economics often apply western standards in proposing their “Islamic” models. “Let us admit that we Muslims are oriented in western theories of economics and are apt to believe them to be a fair standard of judging policies and decisions.”3 Moreover, in their inability to appreciate Shari'ah principles and purposes, many Muslim economists appear in their thinking to assume that the only purpose of fiqh is to regulate and facilitate economic activity. At a very fundamental level, they would endow homo Islamicus with the same traits as the neoclassical homo economicus whose primary motivation is utility and precious little else.

In modern times the appearance of serious thought, from an Islamic perspective, on the subject of economics coincided closely with the emergence of Muslim nation states following the colonial experience, at a time when Muslims sought not only to repair their ailing economies, but to reestablish their cultural and religious identities. Gradually, the ideas generated by this preliminary thinking led some Muslims to speak in terms of “Islamic Economics,” and a respectable body of literature on the subject (however tentative) was developed in several different languages, especially in Arabic, English, Persian, and Urdu, with significant contributions by both Muslim economists and jurists. Clearly, these works contributed to the establishment of Islamic banks as the most immediately implementable manifestation of the desire on the part of Muslims for working models of an “Islamic” economic system. The success of the first handful of Islamic banks, particularly in the decade of the seventies, led to the growth in the next decade of Islamic banks and banking all over the Muslim world. Today western economists are busy studying the potential impact of Islamic banking on economic relationships, as well as some of those aspects of Islamic banking which have met with success and show promise as profitable alternatives to established norms.

In the coming stages the work of economic historians will become increasingly important as their studies begin to inform the thinking of both Muslim economists and jurists, further increasing the complexity of the interdisciplinary mix, and further emphasizing the inadequacy of present classifications to encompass this fascinating new field. No doubt, the economic history of Muslims is fraught with lacunae; and there is much in our past that may be of relevance to the economic activity of our future. In particular, the ways in which Muslim scholars, especially the jurists among them, wrestled with problems of credit, trade, and production in the centuries prior to the depredations of the colonial powers may have much to tell us about how these issues may be dealt with today. Until recently, this has been a subject that failed to gain the attention of modern Muslim jurists, owing perhaps to their preoccupation with the classical period and its texts, so that many legal scholars remain in the dark with regard to the practices and strategies developed in the recent legal past.

Indeed, the point has been made, and it seems a valid one, that we are dealing with an interrupted process. Between the “medieval” and “modern” forms of Islamic banking transactions, as described by Nicholas Ray in his work on Islamic Banking, there lies a historical hiatus of as yet undetermined proportions and significance.

The areas of chief concern in the operations of Islamic Banks at present have been identified as trade financing and participatory or investment financing; the fatawa relevant to the three particularly Islamic modes of finance which represent the basis for, and majority of, operations within Islamic Banks are murabaha, mudarabah, and musharakah, each of which is used for investing. Murabaha, a form of trade financing, represents the most widely used of the three, yet the most suspect from an Islamic legal perspective. The other two operations are in no wise controversial, and musharakah may be understood to correspond to private investment funds, and mudarabah to public joint investment funds.

Extract from Translator's Introduction - Volume II
Leasing operations continue to be one of the mainstays of all Islamic banking and finance. Moreover, ijarah, like its three uniquely Islamic counterparts, murabaha, mudarabah, and musharakah, is essentially a contract developed in the classical period (i.e., the first four hijrah centuries). With the passage of time, however, and the changing of circumstances, these contracts have taken on refinements as Muslim scholars and investors have found ways to expand the utility of the contracts.

It can never be emphasized enough that Islamic law or fiqh is a process and not a code. Differences within and between legal schools of thought are often the blocks upon which lasting edifices may be built. In the short run, however, such differences may appear to represent serious obstacles to progress. The encouraging thing about contemporary Islamic banking and finance is that the will exists to overcome all such obstacles. Thus, today religious scholars, bankers, economists, lawyers, and financial experts are working together to develop products and services that both satisfy the needs of their clients and institutions, and at the same time comply with the moral and legal teachings of the Islamic faith. Perhaps even more encouraging is the interest and cooperation of experts who may not necessarily profess the Muslim faith, but whose efforts and diligence for the success of the new Islamic financial enterprise are equalled only by the most zealous of Muslims.

Several of the fatwas are quite innovative in their treatment of questions and to deal with the problem at hand in light of the changed circumstances, this is a situation that was not imagined in the experience of the classical jurists. This and several other such fatwas are indicative of an acceptance on the part of Shari'ah Supervisory Boards of new realities in the marketplace and of their willingness to understand and work with these to the extent that Islamic religious and legal principles will allow. Such an attitude has ever characterized the best in Islamic legal thought

These fatwas will probably mean little to those who have not previously acquainted themselves with the basic principles of the contracts represented.

For many the treatment of the subject matter of riba presents a real challenge on both a theoretical and a practical level. The concept requires a greater understanding and appreciation of riba as a prohibited element in Shari'ah compliant contracts and exchanges, as well as on Leasing and Exchange.

Extract from Translator's Introduction - Volume III
Wakalah (agency), kafalah (surety), rahn (collateral), and takaful (insurance) are integral elements of modern banking involving guarantee and commitment business, and are therefore closely interrelated subjects with particular interest to those laboring to provide an authentic Islamic alternative to “commercial insurance” (as it is termed in this volume). Indeed, while Islamic banking has enjoyed considerable growth and success, there are several sectors into which new Islamic financial alternatives have only now begun to make inroads. It is the hope of many that before long Muslims the world over will have access to all of the new Islamic alternatives to conventional, riba-based or riba ta¬inted, financial products.

Of key importance to any new undertaking is the matter of consumer trust. This is especially true in regard to Islamic financial products and needs bearing in mind by every Islamic financial operation. In its formal opinion on the issue of bank deposits, the Islamic Fiqh Academy of the organization of the Islamic Conference (97/3/90 of 1995), wrote:

“The foundations of lawful dealings are trust and truth [that are] achieved by openly reporting facts in a way that dispels all confusion and ambiguity, accords with reality, and harmonizes with the Shari'ah perspective. This is especially important for [Islamic] banks in relation to the accounts they hold because their business is directly related to the need for trust, and because they must dispel ambiguity for everyone concerned.”


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