An Introduction to Islamic Finance by Taqi Usmani

Top 20 FREQUENT WORDS

islamic 232 price 232 musharakah 201 sale 193 murabahah 187 shari 182 commodity 171 profit 168 financing 149 business 139 client 134 financier 129 transaction 128 assets 120 basis 112 amount 107 financial 106 purchase 100 banks 98 lease 97

DOCUMENT KEY POINTS

a i i i c i i i i i Ri i i i i Ri i i ca a i i i i i i i i i i i i i i i i i i Ri i i i i oi Ri a O a i i i i i i i i i i Oi i Oi a a i i i i i i i i i Oi i c i i i i i i Ya O a i i i i i i i i i i i i i fi i Oi a a i i f i i Ri i i i i i a c e e over the last few decades the muslims have been trying to restructure their lives on the basis of islamic principles

the present book is a revised collection of my different articles that aimed at providing basic information about the principles and precepts of islamic finance with special reference to the modes of financing used by the islamic banks and non banking financial institutions
but if he is advancing money to share the profits earned by the other party he can claim a stipulated proportion of profit actually earned by him and must share his loss also if he suffers a loss

on the basis of this approach it is the firm belief of every muslim that the commands given by the divine revelations through the last messenger a i a are to be followed in letter and spirit and cannot be violated or ignored on the basis of one s rational arguments or his inner desires
all those theories of the past which are held today to be fallacious claimed in their respective times to be rational but it was after centuries that their fallacy was discovered and their absurdity was universally proved

it is sometimes appreciated in a secular capitalist economy that a certain economic activity is not in the interest of the society yet it is allowed to be continued because it goes against the interest of some influential circles who dominate the legislature on the strength of their majority
the evils emanating from this attitude can never be curbed unless humanity submits to the divine authority and obeys its commands by accepting them as absolute truth and super human injunctions which should be followed in any case and at any price

money has no intrinsic utility it is only a medium of exchange each unit of money is equal to another unit of the same denomination therefore there is no room for making profit through the exchange of these units inter se
but in order to meet some needs they have been reshaped in a manner that they can be used as modes of financing subject to certain conditions in those sectors where musharakah mudarabah salam or istisnaa are not workable for some reasons

it is one of the basic requirements for the validity of murabahah that the commodity is purchased by the financier which means that he assumes the risk of the commodity before selling it to the customer
ee Y e e Y that they are not ideal modes of financing and they should be used only in cases of need with full observation of the conditions prescribed by sharia ah

since in the context of the modern practice it is the banks and financial institutions who provide capital to the commercial activities out of the deposits made with them the flow of the actual profits earned by the society may be directed towards the depositors in equitable proportions which may distribute wealth in a wider circle and may hamper concentration of wealth in the hands of the few
they have to work under a large number of constraints therefore some of them have not been able to comply with all the requirements of sharia ah in all their transactions therefore each and every transaction carried out by them cannot be attributed to sharia ah

at the outset the ideal islamic principles of finance have been elaborated and later on we have discussed the best possible concessions that may be availed of in the transitory period where the islamic institutions are working under pressure of the existing legal and fiscal system
this may not serve the basic purpose of establishing a true islamic order yet it may help one refrain from a glaring sin and save him from the evil fate of disobedience which in itself is a cherished goal of a muslim though at individual level

if the debtor suffers a loss it is unjust on the part of the creditor to claim a fixed rate of return and if the debtor earns a very high rate of profit it is injustice to the creditor to give him only a small proportion of the profit leaving the rest for the debtor
the financier in an interest bearing loan cannot suffer loss while the financier in musharakah can suffer loss if the joint venture fails to produce fruits

the net result is that all the profit of the enterprise is earned by the persons whose own capital does not exceed of the total investment while the people owning of the investment get no more than the fixed rate of interest which is often repaid by them through the increased prices of the products
according to islamic principles a financier must determine whether he is advancing a loan to assist the debtor on humanitarian grounds or he desires to share his profits

in fact every new form can be acceptable to the sharia ah in so far as it does not violate any basic principle laid down by the holy qur an the sunnah or the consensus of the muslim jurists
shirkah means sharing and in the terminology of islamic fiqh it has been divided into two kinds shirkat ul milk it means joint ownership of two or more persons in a particular property

for example if two persons agree to undertake tailoring services for their customers on the condition that the wages so earned will go to a joint pool which shall be distributed between them irrespective of the size of work each partner has actually done this partnership will be a shirkat ul a mal which is also called shirkat ut taqabbul or shirkat us sana i or shirkat ul abdan

if a lump sum amount or a certain percentage of the investment has been agreed for any one of the partners it must be expressly mentioned in the agreement that it will be subject to the final settlement at the end of the term meaning thereby that any amount so drawn by any partner shall be treated as a on account payment and will be adjusted to the actual profit he may deserve at the end of the term
therefore if a and b enter into a partnership and it is agreed between them that a shall be given rs per month as his share in the profit and the rest will go to b the partnership is invalid

on the contrary the view of imam ahmad is that the ratio of profit may differ from the ratio of investment if it is agreed between the partners with their free consent
however if a partner has put an express condition in the agreement that he will never work for the musharakah and will remain a sleeping partner throughout the term of musharakah then his share of profit cannot be more than the ratio of his investment

imam malik is of the view that the liquidity of capital is not a condition for the validity of musharakah therefore it is permissible that a partner contributes to the musharakah in kind but his share shall be determined on the basis of evaluation according to the market price prevalent at the date of the contract
but according to imam abu hanifah and imam ahmad the ratio of the profit may differ from the ratio of investment according to the agreement of the partners but the loss must be divided between them exactly in accordance with the ratio of capital invested by each one of them

if the capital is repaid on the basis of its value the value may have increased and there is a possibility that a partner gets all the profit of the business because of the appreciation in the value of the commodities he has invested leaving nothing for the other partner
he says that the commodities are of two kinds i dhawat ul amthal a i i i i i i i i oi i a ie the commodities which if destroyed can be compensated by the similar commodities in quality and quantity e

in short if a partner wants to participate in a musharakah by contributing some commodities to it he can do so according to imam malik without any restriction and his share in the musharakah shall be determined on the basis of the current market value of the commodities prevalent at the date of the commencement of musharakah
by this distinction between dhawat ul amthal and dhawat ulqeemah imam al shafi i has met the second objection on a participation by commodities as was raised by imam ahmad

however if all the partners agree to work for the joint venture each one of them shall be treated as the agent of the other in all the matters of the business and any work done by one of them in the normal course of business shall be deemed to be authorized by all the partners
termination of musharakah musharakah is deemed to be terminated in any one of the following events every partner has a right to terminate the musharakah at any time after giving his partner a notice to this effect whereby the musharakah will come to an end

the question arises whether the partners can agree while entering into the contract of the musharakah on a condition that the liquidation or separation of the business shall not be effected unless all the partners or the majority of them wants to do so and that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation
however in this case the price of the share of the leaving partner must be determined by mutual consent and if there is a dispute about the valuation of the share and the partners do not arrive at an agreed price the leaving partner may compel other partners on the liquidation or on the distribution of the assets themselves

if a particular business has been started with huge amounts of money which has been invested in a long term project and one of the partners seeks liquidation in the infancy of the project it may be fatal to the interests of the partners as well as to the economic growth of the society to give him such an arbitrary power of liquidation or separation
therefore such a condition seems to be justified and it can be supported by the general principle laid down by the holy prophet m in his famous hadith a i i Oi i i i Ri Y i i i i i Ri i fi i c i i i i Ri fi i i i i i Ri i i i i i i Ri i i i a all the conditions agreed upon by the muslims are upheld except a condition which allows what is prohibited or prohibits what is lawful

in musharakah all the partners can participate in the management of the business and can work for it while in mudarabah the rabb ul mal has no right to participate in the management which is carried out by the mudarib only
his loss is restricted to the fact that his labor has gone in vain and his work has not brought any fruit to him

here all the goods purchased by the mudarib are solely owned by the rabb ul mal and the mudarib can earn his share in the profit only in case he sells the goods profitably
for example if the capital was in the form of sheep and lambs were born to some of them these lambs will be taken as profit and will be shared between the parties according to the agreed proportions see al nawawi rawdat al talibin

distribution of the profit it is necessary for the validity of mudarabah that the parties agree right at the beginning on a definite proportion of the actual profit to which each one of them is entitled
similarly he can say if you do the business in your town you will be entitled to of the profit and if you do it in another town your share will be of the profit

if the business has incurred loss in some transactions and has gained profit in some others the profit shall be used to offset the loss at the first instance then the remainder if any shall be distributed between the parties according to the agreed ratio

it means to participation in the business and in the case of musharakah sharing in the assets of the business to the extent of the ratio of financing
keeping these broad principles in view we proceed to see how musharakah and mudarabah can be used in different sectors of financing project financing in the case of project financing the traditional method of musharakah or mudarabah can be easily adopted

if the sale of the share on one time basis is not feasible for the lack of liquidity in the project the share of the financier can be divided into smaller units and each unit can be sold after a suitable interval
every subscriber can be given a musharakah certificate which represents his proportionate ownership in the assets of the musharakah and after the project is started by acquiring substantial non liquid assets these musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary market

in this case it will be allowed by the sharia ah to sell these certificates in the secondary market for any price agreed upon between the parties which may be more than the face value of the certificate because the subject matter of the sale is a share in the tangible assets and not in money only therefore the certificates may be taken as any other commodities which may be sold with profit or at a loss
the question arises about the rule of sharia ah in a situation where the assets of the project are a mixture of liquid and non liquid assets whether the musharakah certificates of such a project can be traded in the opinions of the contemporary muslim jurists are different on this point

the hanafi school however is of the opinion that whenever there is a combination of liquid and non liquid assets it can be sold and purchased for an amount greater than the amount of liquid assets in the combination in which case money will be taken as sold at an equal amount and the excess will be taken as the price of the non liquid assets owned by the business

this musharakah can be restricted to an agreed term and if the imported goods are not sold in the market up to the expiry of the term the importer may himself purchase the share of the financier making himself the sole owner of the goods
however the sale in this case should take place at the market rate or at a price agreed between the parties on the date of sale and not at pre greed price at the time of entering into musharakah

it can also mean that the working partner has purchased the share of the financier in the assets of the business and the price of his share has been determined on the basis of valuation keeping in view the ratio of profit allocated for him according to the terms of musharakah
it is already mentioned while discussing the traditional concept of musharakah that it is not necessary according to imam malik that the capital of musharakah is contributed in cash form

in order to solve this problem the parties may agree on the principle that instead of net profit the gross profit will be distributed between the parties that is the indirect expenses shall not be deducted from the distribute able profit
financing on the basis of musharakah according to the above procedure may be difficult in a business having a large number of fixed assets particularly in a running industry because the valuation of all its assets and their depreciation or appreciation may create accounting problems giving rise to disputes

practically it means that the parties have agreed to the principle that the profit accrued to the musharakah portfolio at the end of the term will be divided on the capital utilized per day which will lead to the average of the profit earned by each rupee per day
some contemporary scholars do not allow this method of calculating profits on the ground that it is just a conjectural method which does not reflect the actual profits really earned by a partner of the musharakah because the business may have earned huge profits during a period when a particular investor had no money invested in the business at all or had a very negligible amount invested still he will be treated at par with other investors who had huge amounts invested in the business during that period

therefore if all of them agree with mutual consent to distribute the profits on daily products basis there is no injunction of sharia ah which makes it impermissible rather it is covered under the general guideline given by the holy prophet m in his famous hadith quoted in this book more than once a i i Oi i i i Ri Y i i i i i Ri i fi i c i i i i Ri fi i i i i i Ri i i i i i i Ri i i i a all the conditions agreed upon by the muslims are upheld except a condition which allows what is prohibited or prohibits what is lawful

the depositors being constantly exposed to the risk of loss will not want to deposit their money in the banks and financial institutions and thus their savings will either remain idle or will be used in transactions outside of the banking channels which will not contribute to the economic development at national level

the problem is created by the system which separates the banking and financing from the normal trade activities and which has compelled the people to believe that banks and financial institutions deal in money and papers only and that they have nothing to do with the actual results emerging in trade and industry

it is true that even after taking all such precautions there will remain a possibility of some cases where dishonest clients may succeed in their evil designs but the punitive steps and the general atmosphere of the business will gradually reduce the number of such cases even in an interest based economy the defaulters have always been creating the problem of bad debts but it should not be taken as a justification or as an excuse for rejecting the whole system of musharakah
however if any misconduct dishonesty or negligence is established against a client he will be subjected to punitive steps and may be deprived of availing any facility from any bank in the country at least for a specified period

the client while entering into the musharakah may put a condition that the financier will not interfere with the management affairs and he will not disclose any information about the business to any person without prior permission of the client

they think that the bank has no right to share in the actual profit which may be substantial because the bank has nothing to do with the management or running of the business and why should they the clients share the fruit of their labour with the bank who merely provides funds
by making a legitimate arrangement for obtaining funds for their business by way of musharakah not only do they earn allah s pleasure but also a legitimate return for themselves as well as for the islamic banks

the share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically thus increasing his own share till all the units of the financier are purchased by him so as to make him the sole owner of the property or the commercial enterprise as the case may be
after purchasing the property jointly the client uses the house for his residential requirement and pays rent to the financier for using his share in the property

therefore each one of the foregoing three forms of diminishing musharakah is discussed below in the light of the islamic principles e c Y Y Y Y o a Y o Y j o e a o the proposed arrangement is composed of the following transactions
it has already been explained in the beginning of this chapter that a shirkat al milk joint ownership can come into existence in different ways including joint purchase by the parties

however the proposed scheme suggests that instead of making two transactions conditional to each other there should be one sided promise from the client firstly to take share of the financier on lease and pay the agreed rent and secondly to purchase different units of the share of the financier of the house at different stages
imam abu hanifah and imam zufar are of the view that the undivided share cannot be leased out to a third party while imam malik and imam shafi i abu yusuf and muhammad ibn hasan hold that the undivided share can be leased out to any person

one may raise an objection that if the promise of resale has been taken before entering into an actual sale it practically amounts to putting a condition on the sale itself because the promise is understood to have been entered into between the parties at the time of sale and therefore even if the sale is without an express condition it should be taken as conditional because a promise in an express term has preceded it

c it will be preferable that the purchase of different units by the client is effected on the basis of the market value of the house as prevalent on the date of purchase of that unit but it is also permissible that a particular price is agreed in the promise of purchase signed by the client
the most the promise can do is to compel the promisor through court of law to fulfil his promise and if the promisor is unable to fulfil the promise the promise can claim actual damages he has suffered because of the default

here the price of units of the financier cannot be fixed in the promise to purchase because if the price is fixed before hand at the time of entering into musharakah it will practically mean that the client has ensured the principal invested by the financier with or without profit which is strictly prohibited in the case of musharakah
this arrangement is composed of two ingredients only in the first place the arrangement is simply a musharakah whereby two partners invest different amounts of capital in a joint enterprise

then we shall discuss some special rules governing the sale of murabahah in particular and in the end the correct procedure for using the murabahah as an acceptable mode of financing will be explained
if a person sells a commodity for a lump sum price without any reference to the cost this is not a murabahah even though he is earning some profit on his cost because the sale is not based on a cost plus concept

constructive possession means a situation where the possessor has not taken the physical delivery of the commodity yet the commodity has come into his control and all the rights and liabilities of the commodity are passed on to him including the risk of its destruction
example a sells to b a car which is presently owned by c but a is hopeful that he will buy it from c and shall deliver it to b subsequently

in such cases the court may force the promisor to fulfil his promise ie to effect the sale and if he fails to do so the court may order him to pay the promise the actual damages he has incurred due to the default of the promisor
exception the rules mentioned in paragraphs to are relaxed with respect to two types of sale namely a bai salam b istisna the rules of these two types will be discussed later in a separate chapter

the price is uncertain and the sale is void unless anyone of the two alternatives is agreed upon by the parties at the time of sale
the due time of payment can be fixed either with reference to a particular date or by specifying a period like three months but it cannot be fixed with reference to a future event the exact date of which is unknown or is uncertain

in the light of the aforementioned principles a financial institution can use the murabahah as a mode of finance by adopting the following procedure firstly the client and the institution sign an over all agreement whereby the institution promises to sell and the client promises to buy the commodities from time to time on an agreed ratio of profit added to the cost

d at the fourth and fifth stage the relation of buyer and seller comes into operation between the institution and the client and since the sale is effected on deferred payment basis the relation of a debtor and creditor also emerges between them simultaneously
all these capacities must be kept in mind and must come into operation with all their consequential effects each at its relevant stage and these different capacities should never be mixed up or confused with each other

Y Y e Y Y Y by a debtor in favour of his creditor but the relation of debtor and creditor between the institution and the client begins only at the fifth stage whereupon the actual sale takes place between them
now it is proposed to discuss some relevant issues with reference to the underlying islamic principles and their practical applicability in murabahah transaction because without correct understanding of these issues the concept may remain ambiguous and its practical application may be susceptible to errors and misconceptions

on this basis they argue that the murabahah transactions as practiced in the islamic banks are not different in essence from the interest based loans advanced by the conventional banks
one can sell one dollar for two dollars on the spot as well as on credit just as he can sell a commodity valuing one dollar for two dollars

when he can sell his commodity at a higher price in a cash transaction he can also charge a higher price in a credit sale subject only to the condition that he neither deceives the purchaser nor compels him to purchase and the buyer agrees to pay the price with his free will
as this is true in a spot exchange transaction it is also true in a credit transaction where there is money on both sides because if some excess is claimed in a credit transaction where money is exchanged for money it will be against nothing but time

it is true that while increasing the price of the commodity the seller has kept in view the time of its payment but once the price is fixed it relates to the commodity and not to the time
a seller being the owner of a commodity which has intrinsic utility may charge a higher price and the purchaser may agree to pay it due to various reasons for example a his shop is nearer to the buyer who does not want to go to the market which is not so near

but if the sale has taken place at cash price and the seller has imposed a condition that in case of late payment he will charge per annum as a penalty or as interest this is totally prohibited because what is being charged is not a part of the price it is an interest charged on a debt

one may question the propriety of his approach in determining the rate of his profit but obviously no one can say that the profit charged by him in his halal business is haram because he has used the rate of profit of the business of liquor as a benchmark
it is however true that the islamic banks and financial institutions should get rid of this practice as soon as possible because firstly it takes the rate of interest as an ideal for a halal business which is not desirable and secondly because it does not advance the basic philosophy of islamic economy having no impact on the system of distribution

this arrangement may create inter bank market and the value of the units may serve as an indicator for determining the profit in murabahah and leasing also me m e o another important issue in murabahah financing which has been subject of debate between the contemporary sharia ah scholars is that the bank financier cannot enter into an actual sale at the time when the client seeks murabahah financing from him because the required commodity is not owned by the bank at this stage and as explained earlier one cannot sell a commodity not owned by him nor can he effect a forward sale

the same is the view of some maliki jurists and it is preferred by ibn al a arabi and ibn al shat and endorsed by al ghazzali the famous shafi i jurist who says the promise is binding if it is made in absolute ter miss the same is the view of ibn shubrumah
al qurtubi al jamia li ahkam al qur an hashiyah ibn al sh t a ala furuq al qarafi al ghazzali ihya ulum al din ibn hazm almuhalla

the gist of the discussion is that if repurchase by the seller is made a condition for the original sale it is not a valid transaction but if the parties have entered into the original sale unconditionally but the seller has signed a separate and independent promise to repurchase the sold property this promise will be binding on the promisor and enforceable through the courts
the question of validity of a bai bil wafa has already been discussed in detail in the first chapter while explaining the concept of house financing on the basis of a diminishing musharakah

the holy prophet a i a is reported to have said a i i i i i i i i a Oa i i i i i i i i fi i i a Oa i i i i i i T i i i a a i i i i i Oi i i i i i i Ta a i i i Ya there are three distinguishing features of a hypocrite when he speaks tells a lie when he promises he backs out and when he is given something in trust he breaches the trust

in this case if the security is possessed by the financier it will remain at his risk meaning thereby that if it is destroyed before the actual sale to the client he will have either to pay the market price of the mortgaged asset and cancel the agreement of murabahah or sell the commodity required by the client and deduct the market price of the mortgaged asset from the price of the sold property
it means that the purchaser shall take its delivery either physical or constructive from the seller then give it back to him as mortgage so that the transaction of mortgage is distinguished from ibn nujaym writes a i i i i i i i i C i i i i fi Ya O a i i i R i fi i i i i Ri i i i i Ri i fi Y i i i Ri i i i i a

the shafi i and hanbali jurists hold that if the car is destroyed by the negligence of the mortgagee he will have to bear the loss according to its market price but if the car is destroyed without any fault on his part he will not be liable to anything and the purchaser will bear the loss and will have to pay the full price
it is clear from the above example that the possession of a over the car as a seller carries effects and consequences different from his possession as a mortgagee and therefore it is necessary that the point of time on which the car is held by him as a mortgagee should the detailed discussion on the subject may be found in the revised edition of my arabic book a i i Ri T i i i i i i i i i i i i i Oi i i Ri a see ibn qudamah al mughni al ghazzali al wasit ibn a abidin radd al muhtar

if we allow to charge a fee for guarantee it will mean that c cannot charge dollars despite the fact that he has actually paid the amount and d can charge dollars despite the fact that he has merely committed himself to pay only when a fails to pay

they feel that guarantee has become a necessity especially in international trade where the sellers and the buyers do not know each other and the payment of the price by the purchaser cannot be simultaneous with the supply of the goods
this restriction is sometimes exploited by dishonest clients who deliberately avoid to pay the price at its due date because they know that they will not have to pay any additional amount on account of default

it can be argued that the above suggestion is theoretically different from the practice of jahiliyyah in that the suggestion is to grant the debtor a grace period of one month to make sure that he is avoiding payment without a valid cause and to exempt him from compensation if it appears that his non payment is due to poverty or a hardship
but in practical application of the concept these conditions are hardly fulfilled because every debtor may claim that his default is due to his financial inability at the due date and it is very difficult for a financial institution to hold an inquiry about the financial position of each client and to verify whether or not he was able to pay

moreover had it been a recognized punishment it should have been imposed even if the investment account has earned no profit during that period because the guilt of the defaulter is established and it has no nexus with the profit of the investment account of the bank
but this argument overlooks the fact that even if it is assumed that imposing fine or a monetary penalty is allowed in sharia ah it is imposed by a court of law and is normally paid to the government

it means that if the client withholds the price of murabahah after its maturity date and keeps it for another six months he will have to pay the compensation at the rate of p
here is the answer to this question we have already mentioned that the real solution to this problem is to develop a system where the defaulters are duly punished by depriving them from enjoying a financial facility in future

therefore the proper wording of the penalty clause would be on the following pattern the client hereby undertakes that if he defaults in payment of any of his dues under this agreement he shall pay to the charitable account fund maintained by the bank financier a sum calculated on the basis of per annum for each day of default unless he establishes through the evidence satisfactory to the bank financier that his non payment at the due date was caused due to poverty or some other factors beyond his control

the view of those who allow this arrangement is based on a hadith in which abdullah ibn abbas a i a is reported to have said that when the jews belonging to the tribe of banu nadir were banished from madinah because of their conspiracies some people came to the holy prophet a i a and said you have ordered them to be expelled but some people owe them some debts which have not yet matured

if the commodity intended to be sold to the customer is imported from a foreign country while the ultimate purchaser is in pakistan the price of the original sale has to be paid in a foreign currency and the price of the second sale will be determined in pak
secondly if the seller has purchased the commodity by converting pakistani rupees into dollars the exact amount of pak rupees paid by the seller to convert them into dollars can be taken as the cost price and the profit of murabahah can be added thereon

c instead of murabahah the deal may be on the basis of musawamah a sale without reference to the cost of the seller and the price may be fixed as to cover the anticipated fluctuation in the currency rates
conversely no murabahah can be effected on things which cannot be subject matter of sale for example murabahah is not possible in exchange of currencies because it must be spontaneous

at the time of payment however the purchaser may pay with the consent of the seller in a different currency on the basis of the exchange rate of that day ie the day of payment and not the rate of the date of transaction

some basic mistakes in murabahah financing after explaining the concept of murabahah and its relevant issues it will be pertinent to highlight some basic mistakes often committed by the financial institutions in the practical implementation of the concept
however if there is a mixed portfolio consisting of a number of transactions like musharakah leasing and murabahah then this portfolio may issue negotiable certificates subject to certain conditions more fully discussed in the chapter of islamic funds

b if it becomes necessary that the client is entrusted with funds to purchase the commodity on behalf of the financier his purchase should be evidenced by invoices or similar other documents which he should present to the financier

Y Y e Y Y Y the representatives of the sharia ah boards of the islamic banks when they check the transactions of the bank with regard to their compliance with sharia ah must make sure that all these stages have been really observed and every transaction is effected at its due time
in fact if the client has already purchased a commodity and he approaches the bank for funds he either wants to set off his liability towards his supplier or he wants to use the funds for some other purpose

it is the foremost condition for the validity of murabahah that the commodity comes in the ownership and physical or constructive possession of the financier before he sells it to the customer on murabahah basis
after he purchases the commodity in his capacity as agent he must inform the financier that in fulfilling his obligation as his agent he has

when in response to this offer the financier conveys his acceptance to this offer the sale will be deemed to be complete and the risk of the property will be passed on to the client as purchaser

similarly if a has hired the services of a porter to carry his baggage to the airport a is a musta jir while the porter is an ajir and in both cases the transaction between the parties is termed as ijarah
here the lessor is called a mu jir the lessee is called a musta jir and the rent payable to the lessor is called a ujrah

the only difference between ijarah and sale is that in the latter case the corpus of the property is transferred to the purchaser while in the case of ijarah the corpus of the property remains in the ownership of the transferor but only its usufruct ie the right to use it is transferred to the lessee
although the principles of ijarah are so numerous that a separate volume is required for their full discussion we will attempt in this chapter to summarize those basic principles only which are necessary for the proper understanding of the nature of the transaction and are generally needed in the context of modern

as the corpus of the leased property remains in the ownership of the lessor all the liabilities emerging from the ownership shall be borne by the lessor but the liabilities referable to the use of the property shall be borne by the lessee
if no such purpose is specified in the agreement the lessee can use it for whatever purpose it is used in the normal course

the determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor as normally done in financial leases is not against the rules of sharia ah if both parties agree to it provided that all other conditions of a valid lease prescribed by the sharia ah are fully adhered to

in some lease agreements the lease commences on the very day on which the price is paid by the lessor irrespective of whether the lessee has effected payment to the supplier and taken delivery of the asset or see ibn a abidin radd al muhtar
that is why they started using the same model agreements of leasing as were in vogue among the conventional financial institutions without any modification while a number of their provisions were not in conformity with sharia ah

ok a e Y o Y o m e it should be clearly understood that when the lessee himself has been entrusted with the purchase of the asset intended to be leased there are two separate relations between the institution and the client which come into operation one after the other
this is not allowed in sharia ah because it amounts to charging rent on the money given to the customer which is nothing but interest pure and simple

pk b e Y Y e Y l Y e o e as the lessor is the owner of the asset and he has purchased it from the supplier through his agent he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor
he can of course include all these expenses in his cost and can take them into consideration while fixing the rentals but as a matter of principle he is liable to bear all these expenses as the owner of the asset

b he can contract lease for a shorter period after which the parties can renew the lease at new terms and by mutual consent with full liberty to each one of them to refuse the renewal in which case the lessee is bound to vacate the leased property and return it back to the lessor

similarly if the leased asset looses its usufruct without any misuse or negligence on the part of the lessee the lessor cannot claim the rent while in the case of an interest based financing the financier is entitled to receive interest even if the debtor did not at all benefit from the money borrowed
therefore they want to tie up the rentals with the rate of interest and instead of fixing a definite amount of rental they calculate the cost of purchasing the lease assets and want to earn through rentals an amount equal to the rate of interest

for example it may be provided in the base contract that the rental amount after a given period will be changed according to the change in the rate of interest but it will in no case be higher than or lower than of the previous monthly rent
this reason is not applicable here because both parties have agreed with mutual consent upon a well defined benchmark that will serve as a criterion for determining the rent and whatever amount is determined based on this benchmark will be acceptable to both parties

to the charity fund maintained by the lessor which will be used by the lessor exclusively for charitable purposes approved by the sharia ah and shall in no case form part of the income of the lessor
the lessee may be asked to undertake that if he fails to pay rent on its due date he will pay certain amount to a charity

in some agreements of the a financial lease a condition has been found to the effect that in case of the termination of lease even at the option of the lessor the rent of the remaining lease period shall be paid by the lessee
uk f Y e Y o if the leased property is insured under the islamic mode of takaful it should be at the expense of the lessor and not at the expense of the lessee as is generally provided in the agreements of the current a financial leases

the original position in sharia ah is that the asset shall be the sole property of the lessor and after the expiry of the lease period the lessor shall be at liberty to take the asset back or to renew the lease or to lease it out to another party or sell it to the lessee or to any other person
the principle according to them is that a unilateral promise to enter into a contract at a future date is allowed whereby the promisor is bound to fulfil the promise but the promisee is not bound to enter into that contract

once this promise is signed by the lessor he is bound to fulfil it and the lessee may exercise his option to purchase at the end of the period if he has fully paid the amounts of rent according to the agreement of lease
the validity of this arrangement is subject to two basic conditions firstly the agreement of ijarah itself should not be subjected to signing this promise of sale or gift but the promise should he recorded in a separate document

although the view of imam abu hanifah is more precautious which should be acted upon to the best possible extent in cases of need the view of shafi i and hanbali schools may be followed because there is no express prohibition in the holy qur an or in the sunnah against the surplus claimed from the lessee
however if the sub lessor has developed the leased property by adding something to it or has rented it in a currency different from the currency in which he himself pays rent to the owner the original lessor he can claim a higher rent from his sub lessee and can enjoy the surplus

since the lessor in ijarah owns the leased assets he can sell the asset in whole or in part to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset
these certificates being an evidence of proportionate ownership in a tangible asset can be negotiated and traded in freely in the market and can serve as an instrument easily convertible into cash

the debt or any security representing debt only is not a negotiable instrument in sharia ah because trading in such an instrument amounts to trade in money or in monetary obligation which is not allowed except on the basis of equality and if the equality of value is observed while trading in such instruments the very purpose of securitization is defeated

first of all it is necessary for the validity of salam that the buyer pays the price in full to the seller at the time of effecting the sale
salam was beneficial to the seller because he received the price in advance and it was beneficial to the buyer also because normally the price in salam used to be lower than the price in spot sales

the most famous hadith in this context is the one in which the holy prophet a i a has said a i i i i Y i i Oi i Ri i i f i fi i a O a i i i fi i i i i i i i i i i i i i i i i i i Oi i Ri a a i i Oi i Ri a whoever wishes to enter into a contract of salam he must effect the salam according to the specified measure and the specified weight and the specified date of delivery

as far as the price is concerned it is not a necessary ingredient of salam that the price is always lower than the market price on that day
the seller himself is the best judge of his interest and if he accepts an earlier date of delivery with his free will and consent there is no reason why he should be forbidden from doing so

in the case of default in delivery the guarantor may be asked to deliver the same commodity and if there is a mortgage the buyer the financier can sell the mortgaged property and the sale proceeds can be used either to realize the required commodity by purchasing it from the market or to recover the price advanced by him
if these institutions want to earn a halal profit they shall have to deal in commodities in one way or the other because no profit is allowed in sharia ah on advancing loans only

the period of salam in the second parallel transaction being shorter the price may be a little higher than the price of the first transaction and the difference between the two prices shall be the profit earned by the institution
it is never permitted by the sharia ah that the purchased commodity is sold back to the seller before the buyer takes its delivery and if it is done at a higher price it will be tantamount to riba which is totally prohibited

even if the purchaser in the second contract is a separate legal entity but it is fully owned by the seller in the first contract the arrangement will not be allowed because in practical terms it will amount to a buy back arrangement
for example if a has purchased from b bags of wheat by way of salam to be delivered on december a can contract a parallel salam with c to deliver to him bags of wheat on december

this view has been preferred by the jurists of the ottoman empire and the hanafi law has been codified according to this view because it is damaging in the context of modern trade and industry that after the manufacturer has used all his resources to prepare the required goods the purchaser cancels the sale without assigning any reason even though the goods are in full conformity with the required specifications
in order to ensure that the goods will be delivered within the specified period some modern agreements of this nature contain a penal clause to the effect that in case the manufacturer delays the delivery after the appointed time he shall be liable to a penalty which shall be calculated on daily basis

however in case the fund suffers loss they will have to share it also unless the loss is caused by the negligence or mismanagement in which case the management and not the fund will be liable to compensate it
these documents may be called a certificates a units a shares or may be given any other name but their validity in terms of sharia ah will always be subject to two basic conditions firstly instead of a fixed return tied up with their face value they must carry a pro rata profit actually earned by the fund

similarly the contemporary sharia ah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with sharia ah which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account its shares can be purchased held and sold without any hindrance from the sharia ah side

now if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also and will not use that proportion of the dividend for his own benefit how can it be said that he has approved the transaction of interest and how can that transaction be attributed to him
in partnership all the policy decisions are taken through the consensus of all the partners and each one of them has a veto power with regard to the policy of the business

therefore the responsibility of committing a sinful act of borrowing on interest rests with the person who willfully indulged in a transaction of interest but this fact does render the whole business of a company as unlawful Y Y e f Yi Y Y p o e in the light of the foregoing discussion dealing in equity shares can be acceptable in sharia ah subject to the following conditions
therefore it is not permissible to acquire the shares of the companies providing financial services on interest like conventional banks insurance companies or the companies involved in some other business not approved by the sharia ah such as companies manufacturing selling or offering liquors pork haram meat or involved in gambling night club activities pornography etc

in this case if the price of the share is fixed as it will mean that dollars are in exchange of dollars owned by the share and the balance of dollars is in exchange of the fixed assets
they argue that if such assets are less than then most of the assets are in liquid form and therefore all its assets should be treated as liquid on the basis of the juristic principle a i i i i i oi R i i oi c i i i oi a the majority deserves to be treated as the whole of a thing

similarly if the price of the share in the above example is fixed as dollars it will not be permissible because if we presume that dollars of the price are against dollars owned by the share no part of the price can be attributed to the fixed assets owned by the share

particularly it is more equitable in an open ended equity fund because if the purification is not carried out on the appreciation and a person redeems his unit of the fund at a time when no dividend is received by it no amount of purification will be deducted from its price even though the price of the unit may have increased due to the appreciation in the prices of the shares held by the fund
in this case a certain percentage of the annual profit accrued to the fund may be determined as the reward of the management meaning thereby that the management will get its share only if the fund has earned some profit

however it should be kept in mind that the contracts of leasing must conform to the principles of sharia ah which substantially differ from the terms and conditions used in the agreements of this way may be justified on the analogy of simsar broker for whom the fee based on percentage is allowed

most of the muslim jurists are of the view that such a fund cannot be created on the basis of mudarabah because mudarabah according to them is restricted to the sale of commodities and does not extend to the business of services and leases

they normally refer to the ruling of shafi ite school wherein it is held that the sale of debt is allowed but they did not pay attention to the fact that the shafi ite jurists have allowed it only in a case where a debt is sold at its par value

but the loss cannot extend to his personal assets and if the assets of the company are not sufficient to discharge all its liabilities the creditors cannot claim the remaining part of their receivables from the personal assets of the shareholders
the limited liability in the modern economic and legal terminology is a condition under which a partner or a shareholder of a business secures himself from bearing a loss greater than the amount he has invested in a company or partner ship with limited liability

if the liabilities of a limited company exceed its assets the company becomes insolvent and is consequently liquidated the creditors may lose a considerable amount of their claims because they can only receive the liquidated value of the assets of the company and have no recourse to its shareholders for the rest of their clai miss even the directors of the company who may be responsible for such an unfortunate situation cannot be held responsible for satisfying the claims of the creditors

once the concept of a juridical person is accepted and it is admitted that despite its fictive nature a juridical person can be treated as a natural person in respect of the legal consequences of the transactions made in its name we will have to accept the concept of a limited liability which will follow as a logical result of the former concept
a company after becoming insolvent is bound to be liquidated and the liquidation of a company corresponds to the death of a person because a company after its liquidation cannot exist any more

o ee Y e amount of the nisab but the combined value of the total assets exceeds the prescribed limit of the nisab zakah will be payable on the whole joint stock including the share of the former and thus the person whose share is less than the nisab shall also contribute to the levy in proportion to his ownership in the total assets whereas he was not subject to the levy of zakah had it been levied on each person in his individual capacity
according to the jurists this property is neither owned by the deceased because he is no more alive nor is it owned by his heirs for the debts on the deceased have a preferential right over the property as compared to the rights of the heirs

if the assets do not suffice to settle all the debts there is no remedy left with its creditors to sue anybody including the heirs of the deceased for the rest of their clai miss these are some instances where the muslim jurists have affirmed a legal entity similar to that of a juridical person
if a a juridical person can be treated a natural person in its rights and obligations then every person is liable only to the limit of the assets he owns and in case he dies insolvent no other person can bear the burden of his remaining liabilities however closely related to him he may be

however if their claims would not be satisfied even after selling the slave and the slave would die in that state of indebtedness the creditors could not approach his master for the rest of their clai miss here the master was actually the owner of the whole business the slave being merely an intermediary tool to carry out the business transactions
o ee Y e questions pertaining to the trade of slaves are still beneficial to a student of islamic jurisprudence and we can avail of those principles while seeking solutions to our modern problems and in this respect it is believed that this example is the most relevant to the question at issue

as for the private companies or the partnerships the concept of limited liability should not be applied to them because practically each one of their shareholders and partners can easily acquire a knowledge of the day to day affairs of the business and should be held responsible for all its liabilities
if the sleeping partners have a limited liability under this agreement it means in terms of islamic jurisprudence that they have not allowed the working partners to incur debts exceeding the value of the assets of the business

another major contribution of the islamic banks is that being under supervision of their respective sharia ah boards they presented a wide spectrum of questions relating to modern business to the sharia ah scholars thus providing them with an opportunity not only to understand the contemporary practice of business and trade but also to evaluate it in the light of sharia ah and to find out other alternatives which may be acceptable according to the islamic principles

most of the islamic countries were captured by non muslim rulers who by enforcing with power the secular system of government deprived the socioeconomic life from the guidance provided by the sharia ah and the islamic teachings were restricted to a limited sphere of worship religious education and in some countries to the matter of marriage divorce and inheritance only

thus if a practice is held to be un islamic by the sharia ah scholars a suitable alternative is also sought by the joint efforts of the sharia ah scholars and the management of the islamic banks
after they earn profits they do not let the depositors share these profits except to the extent of a meager rate of interest and this is also taken by them by adding it to the cost of their products

i do not subscribe to the view of those people who do not find any difference between the transactions of conventional banks and murabahah and ijarah and who blame the instruments of murabahah and ijarah for perpetuating the same business with a different name because if murabahah and ijarah are implemented with their necessary conditions they have many points of difference which distinguish them from interest based transactions

if the client himself is made an agent to purchase the commodity his capacity as an agent must be distinguished from his capacity as a buyer which means that after purchasing commodity on behalf of the bank he must inform the bank that he has effected the purchase on its behalf

it is a prerequisite for a valid ijarah that the lessor bears the risks related to the ownership of the leased asset and that the usufruct of the leased asset must be made available to the lessee for which he pays rent
unless the sponsors of the bank as well as its management and its clientele realize this fact and are ready to accept different but not necessarily adverse results the islamic banks will keep using artificial devices and a true islamic system will not come into being

unlike the conventional financial institutions who strive for nothing but making enormous profits the islamic banks should have taken the fulfillment of the needs of the society as one of their major objectives and should have given preference to the products which may help the common people to raise their standard of living

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AlHuda Material\islamic banking

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contract price sale asset financing lease client purchase ijarah payment profit musharakah lessee amount commodity housing agreement contracts ownership project

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Published Date

2008-07-09 15:23:24

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An Introduction to Islamic Finance by Taqi Usmani

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