Understanding Islamic Finance (The Wiley Finance Series)

Understanding Islamic Finance......Page 3
Contents......Page 9
List of Boxes and Figures......Page 19
Foreword......Page 21
Preface......Page 23
Acknowledgements......Page 27
Part I Fundamentals......Page 29
1.1 Economic Scenario in the Neoclassical Framework......Page 31
1.2 Conventional Debt: A Recipe for Exploitation......Page 32
1.3 Growth per se May not Lead to Socio-economic Justice......Page 34
1.5 The Main Culprit......Page 36
1.6 The Need of the Hour......Page 37
1.7 Economics and Religion......Page 38
1.8 Islamic Principles Can Make the Difference......Page 39
1.9 Regulating Trade and Business......Page 41
1.10 Islamic Finance Passing Significant Milestones......Page 43
1.11 Could it Work to Achieve the Objectives?......Page 44
1.12 About this Book......Page 45
2.2.1 Sources of Sharī´ah Tenets......Page 49
2.2.2 Objectives (Maqāsid) of Sharī´ah......Page 50
2.3 Why Study Islamic Economics?......Page 53
2.3.1 The Role of Islamic Economists......Page 55
2.4 Islamic Economics: What should it be?......Page 58
2.4.1 Islamic Economics Defined......Page 59
2.5 Paraphernalia of Islamic Economics......Page 60
2.5.1 Ownership of Resources and Property Rights......Page 61
2.5.2 Islamic Welfare Approach......Page 62
2.5.3 The Factors of Production......Page 63
2.5.4 Restrained Individual Freedom......Page 65
2.5.5 Liberalism versus State Intervention......Page 66
2.6 Summary......Page 69
3.2 The Basic Prohibitions......Page 71
3.2.1 Prohibition of Riba......Page 72
3.2.2 Prohibition of Gharar......Page 85
3.2.3 Prohibition of Maisir/Qimār (Games of Chance)......Page 89
3.3.1 Justice and Fair Dealing......Page 92
3.3.2 Fulfilling the Covenants and Paying Liabilities......Page 95
3.3.4 Free Marketing and Fair Pricing......Page 96
3.3.5 Freedom from Dharar (Detriment)......Page 97
3.4 Summary and Conclusion......Page 98
4.2 The Philosophy of Islamic Finance......Page 101
4.2.1 Avoiding Interest......Page 102
4.2.2 Avoiding Gharar......Page 103
4.2.4 Alternative Financing Principles......Page 104
4.2.5 Valid Gains on Investment......Page 106
4.2.6 Entitlement to Profit – With Risk and Responsibility......Page 109
4.2.7 Islamic Banks Dealing in Goods not in Money......Page 110
4.2.8 Transparency and Documentation......Page 111
4.2.9 Additional Risks Faced by Islamic Banks......Page 112
4.3 Debt versus Equity......Page 113
4.4 Islamic Banking: Business versus Benevolence......Page 114
4.5 Exchange Rules......Page 115
4.6 Time Value of Money in Islamic Finance......Page 117
4.7 Money, Monetary Policy and Islamic Finance......Page 118
4.7.2 Trading in Currencies......Page 119
4.7.3 Creation of Money from the Islamic Perspective......Page 120
4.7.4 Currency Rate Fluctuation and Settlement of Debts......Page 122
4.8 Summary......Page 124
Part II Contractual Bases in Islamic Finance......Page 127
5.2 Māl (Wealth), Usufruct and Ownership......Page 129
5.2.1 Defining Various Related Terms......Page 131
5.3 General Framework of Contracts......Page 133
5.4.1 Offer and Acceptance: Form of the Contract......Page 134
5.4.2 Elements of the Subject Matter......Page 136
5.5.2 Prohibition of Gharar......Page 138
5.5.3 Avoiding Riba......Page 139
5.5.5 Prohibition of Two Mutually Contingent Contracts......Page 140
5.5.7 Profits with Liability......Page 141
5.6 W‘adah (Promise) and Related Matters......Page 142
5.6.1 Token Money (Hamish Jiddiyah) and ‘Arbūn......Page 144
5.7 Types of Contracts......Page 145
5.7.1 Valid Contracts......Page 146
5.7.2 Voidable (Fāsid) Contracts......Page 148
5.7.3 Void (Batil) Contracts......Page 151
5.8.1 Uqood-e-Mu‘awadha (Commutative Contracts)......Page 152
5.8.3 Legal Status of Commutative and Noncommutative Contracts......Page 153
5.9 Conditional or Contingent Contracts......Page 154
5.10 Summary......Page 155
6.1 Introduction......Page 157
6.2 Bai‘ – Exchange of Values......Page 158
6.3 Legality of Trading......Page 159
6.3.1 Trade (Profit) versus Interest: Permissibility versus Prohibition......Page 160
6.5 Requirements of a Valid Sale Contract......Page 161
6.5.1 The Object of the Sale Contract......Page 163
6.5.2 Prices and the Profit Margin......Page 166
6.5.3 Cash and Credit Prices......Page 167
6.6 Riba Involvement in Sales......Page 170
6.7 Gharar – A Cause of Prohibition of Sales......Page 171
6.8 Conditional Sales and “Two Bargains in One Sale”......Page 172
6.9 Bai‘ al‘Arbūn (Downpayment Sale)......Page 173
6.10 Bai‘ al Dayn (Sale of Debt)......Page 174
6.11 Al ‘Inah Sale and the Use of Ruses (Hiyal)......Page 175
6.12 Options in Sales (Khiyar)......Page 178
6.13 Summary......Page 180
7.2 The Terms Defined......Page 183
7.3 Illegality of Commercial Interest......Page 185
7.4 Loaning and the Banking System......Page 186
7.6 The Substance of Loans......Page 187
7.8 Time Value of Money in Loans and Debts......Page 188
7.9 Instructions for the Debtor......Page 189
7.11 Husnal Qadha (Gracious Payment of Loan/Debt)......Page 190
7.12 Remitting a Part of a Loan and Prepayment Rebate......Page 191
7.13 Penalty on Default......Page 193
7.14 Hawalah (Assignment of Debt)......Page 195
7.15 Security/Guarantee (Kafalah) in Loans......Page 196
7.15.1 Risk and Reward in Pledge......Page 198
7.15.2 Benefits from Pledge......Page 199
7.17 Impact of Inflation on Loans/Debts......Page 200
7.18 Summary......Page 202
Part III Islamic Finance – Products and Procedures......Page 205
8.2 What is Banking or a Bank?......Page 207
8.3 The Strategic Position of Banks and Financial Institutions......Page 208
8.4.1 Commercial Banking......Page 209
8.4.2 Investment Banking......Page 212
8.5 The Need for Islamic Banks and NBFIs......Page 213
8.5.1 The Structure of Islamic Banking......Page 214
8.5.2 The Deposits Side of Islamic Banking......Page 216
8.5.3 Instruments on the Assets Side......Page 219
8.6 The Issue of Mode Preference......Page 223
8.8 Islamic Financial Markets and Instruments......Page 227
8.8.1 Islamic Funds......Page 229
8.8.2 Principles Relating to Stocks......Page 231
8.8.3 Investment Sukuk as Islamic Market Instruments......Page 232
8.8.5 Inter-bank Funds Market......Page 233
8.8.6 Islamic Forward Markets......Page 234
8.8.8 Derivatives and Islamic Finance......Page 237
8.9 Summary and Conclusion......Page 239
9.1 Introduction......Page 241
9.2 Conditions of Valid Bai‘......Page 242
9.4 Bai‘ Murabaha in Classical Literature......Page 243
9.5 The Need for Murabaha......Page 244
9.6 Specific Conditions of Murabaha......Page 245
9.6.1 Bai‘ Murabaha and Credit Sale (Murabaha–Mu’ajjal)......Page 247
9.7 Possible Structures of Murabaha......Page 248
9.7.2 Bank Purchases Through a Third Party/Agent......Page 249
9.8 Murabaha to Purchase Orderer (MPO)......Page 250
9.8.2 Promise to Purchase in Murabaha......Page 252
9.8.3 MPO – The Customer as the Bank’s Agent to Buy and Related Matters......Page 253
9.9 Issues in Murabaha......Page 257
9.9.2 Khiyar (Option to Rescind the Sale) in Murabaha......Page 258
9.9.4 Defaults by the Clients......Page 259
9.9.6 Rollover in Murabaha......Page 260
9.10 Precautions in Murabaha Operations......Page 261
9.11 Musawamah (Bargaining on Price)......Page 262
9.12 Summary......Page 266
10.2 Bai‘ Salam/Salaf......Page 269
10.3 Benefits of Salam and the Economic Role of Bai‘ Salam......Page 270
10.4 Features of a Valid Salam Contract......Page 271
10.4.1 Subject Matter of Salam......Page 272
10.4.2 Payment of Price: Salam Capital......Page 274
10.4.3 Period and Place of Delivery......Page 275
10.4.5 Amending or Revoking the Salam Contract......Page 276
10.5 Security, Pledge and Liability of the Sureties......Page 277
10.6 Disposing of the Goods Purchased on Salam......Page 278
10.6.1 Alternatives for Marketing Salam Goods......Page 279
10.7.1 Supply of Goods as Per Contract......Page 280
10.7.3 Supply of Inferior Goods......Page 281
10.8 Salam-Based Securitization – Salam Certificates/Sukuk......Page 282
10.9 Summary of Salam Rules......Page 283
10.10 Salam as a Financing Technique by Banks......Page 285
10.10.1 Risks in Salam and their Management......Page 286
10.11.1 Definition and Concept......Page 291
10.11.2 Subject Matter of Istisna‘a......Page 292
10.11.3 Price in Istisna‘a......Page 293
10.11.5 The Binding Nature of an Istisna‘a Contract......Page 294
10.11.7 Parallel Contract – Subcontracting......Page 295
10.11.9 Post Execution Scenario......Page 296
10.11.11 Risk Management in Istisna‘a......Page 297
11.1 Introduction......Page 307
11.2.1 Ijarah and Bai‘ Compared......Page 308
11.3 General Juristic Rules of Ijarah......Page 309
11.3.1 Execution of an Ijarah Contract......Page 310
11.3.2 Determination of Rent......Page 311
11.3.3 Sub-lease by the Lessee......Page 312
11.3.5 Liabilities of the Parties......Page 313
11.3.6 Termination/Amendment of the Contract and Implications......Page 314
11.4 Modern Use of Ijarah......Page 315
11.4.2 Security or Financing Lease......Page 316
11.4.5 Combining Two Contracts......Page 317
11.5 Islamic Banks’ Ijarah Muntahia-bi-Tamleek......Page 319
11.5.1 Procedure for Ijarah Muntahia-bi-Tamleek......Page 321
11.5.2 Issues Concerning Modern Use of Ijarah......Page 323
11.5.4 Potential of Ijarah......Page 325
11.6 Summary of Guidelines for Islamic Bankers on Ijarah......Page 326
12.1 Introduction......Page 335
12.2 Legality, Forms and Definition of Partnership......Page 336
12.2.2 Partnership by Contract (Shirkatul‘aqd)......Page 337
12.3.1 Conditions with Respect to Partners......Page 340
12.3.2 Rules Relating to Musharakah Capital......Page 341
12.3.3 Mutual Relationship Among Partners and Musharakah Management Rules......Page 342
12.3.4 Treatment of Profit and Loss......Page 344
12.3.6 Maturity/Termination of Musharakah......Page 346
12.4 The Concept and Rules of Mudarabah......Page 348
12.4.1 The Nature of Mudarabah Capital......Page 351
12.4.2 Types of Mudarabah and Conditions Regarding Business......Page 352
12.4.4 Treatment of Profit/Loss......Page 353
12.5 Mudarabah Distinguished from Musharakah......Page 355
12.6 Modern Corporations: Joint Stock Companies......Page 356
12.7 Modern Application of the Concept of Shirkah......Page 358
12.7.1 Use of Shirkah on the Deposits Side of the Banking System......Page 359
12.7.2 Use of Shirkah on the Assets Side......Page 360
12.7.3 Securitization on a Shirkah Basis......Page 362
12.8 Diminishing Musharakah......Page 365
12.9.1 Diminishing Musharakah in Trade......Page 367
12.9.2 Procedure and Documentation in Diminishing Musharakah......Page 368
12.10 Summary and Conclusion......Page 371
13.2.1 Types of Wakalah......Page 375
13.3 Tawarruq......Page 377
13.4.1 Parties to Ju‘alah......Page 379
13.4.2 Subject Matter of Ju‘alah and Reward......Page 380
13.4.5 Practical Process in Ju‘alah by Islamic Banks......Page 381
13.4.6 Some Islamic Financial Products Based on Ju‘alah......Page 382
13.5 Bai‘ al Istijrar (Supply Contract)......Page 383
14.1 Introduction......Page 385
14.3 The Nature of Financial Services/Business......Page 386
14.3.1 Management of Deposit Pools and Investments......Page 387
14.3.2 Selection of the Mode for Financing......Page 388
14.3.3 Tenor of Financing......Page 390
14.3.4 Sharī´ah Compliance and Internal Sharī´ah Controls......Page 391
14.3.5 Operational Controls......Page 395
14.4.1 Working Capital Finance......Page 397
14.4.2 Trade Financing by Islamic Banks......Page 398
14.4.3 Project Financing......Page 401
14.4.4 Liquidity Management......Page 402
14.4.5 Forward Contracts and Foreign Exchange Dealings......Page 403
14.4.6 Refinancing by the Central Banks......Page 405
14.4.7 Cards: Debit, Charge, Credit and ATM......Page 407
14.6.2 Letters of Guarantee (L/G)......Page 412
14.6.3 Letters of Credit (L/C)......Page 413
14.7 Summary and Conclusion......Page 414
Appendix: The Major Functions of a Sharī´ah Supervisory Board In the Lightof the AAOIFI’s Sharī´ah Standard......Page 415
15.1 Introduction......Page 417
15.2 The Capital Market in an Islamic Framework......Page 418
15.3 Securitization and Sukuk......Page 419
15.3.1 Parties to Sukuk Issue/Securitization......Page 421
15.3.2 Special Purpose Vehicle (SPV)......Page 422
15.3.3 Risk, Contract and Cash Flow Analysis......Page 423
15.3.4 Sharī´ah Bases of Sukuk Issue......Page 424
15.3.5 Categories of Sukuk......Page 426
15.3.6 Tradability of Sukuk......Page 435
15.3.7 Issues in Terms and Structures of Sukuk......Page 437
15.3.8 Potential of Sukuk in Fund Management and Developing the Islamic Capital Market......Page 439
15.4 Summary and Conclusion......Page 440
16.2 The Need for Takaful Cover......Page 445
16.2.1 Why Conventional Insurance is Prohibited......Page 446
16.3 The Sharī´ah Basis of Takaful......Page 448
16.4 How the Takaful System Works......Page 450
16.4.1 Models of Takaful......Page 451
16.4.3 Issues in Wakalah and Wakalah–Mudarabah Models......Page 454
16.5 Takaful and Conventional Insurance Compared......Page 455
16.6 Status and Potential of the Takaful Industry......Page 456
16.7 Takaful Challenges......Page 457
Appendix: Fatāwa (Juristic Opinions) on Different Aspects of Insurance......Page 458
17.2 The Common Myths and Objections......Page 461
17.3.1 The Connotation of the Word Riba......Page 464
17.3.2 Rent on Money Capital......Page 465
17.3.3 Inflation and Interest......Page 466
17.3.4 Time Value of Money and Islamic Banking......Page 467
17.3.6 Different Sharī´ah Interpretations......Page 469
17.3.7 Islamic Banks Using Debt-creating Modes......Page 470
17.3.8 Islamic Financial Institutions – Banks or Trade Houses?......Page 472
17.4.1 Divergence between Theory and Practice......Page 473
17.4.2 IFIs using Interest Income as Seed/Base Capital......Page 474
17.4.3 Difference between Islamic and Conventional Banking......Page 475
17.4.4 Imposing Penalties on Defaulters......Page 482
17.4.6 Socio-economic Impact of the Present Islamic Banking System......Page 483
17.5 Conclusion......Page 484
18.2 Agenda for the Policymakers......Page 485
18.2.1 Muslim States and Islamic Finance......Page 487
18.3 Potential, Issues and Challenges for Islamic Banking......Page 489
18.3.1 Promising Potential......Page 491
18.3.2 Issues in Islamic Finance......Page 493
18.3.3 The Challenges......Page 502
18.4 Conclusion......Page 507
Acronyms......Page 509
Glossary......Page 513
Bibliography English Sources......Page 525
Arabic/Urdu Sources......Page 531
Suggested Further Readings......Page 533
Index......Page 537