13- Shariah Principles

Before we learn about the Islamic banking product proper, let’s understand some basic Shariah principles. As earlier mentioned, Islam permits trade and commerce but there there are rules to be observed, basically

a) avoidance of prohibitions;
b) observing that every contract possesses all its essential elements; and
c) that every essential element meets the necessary conditions.

There are many prohibitions, but these five prohibitions will make “akad” or contracts, invalid:

1. Producing or selling of impure goods e.g. liquor, non-halal food (including providing non-halal services like a Muslim serving liquor to a non-Muslim customer)

2. Producing or selling of goods that are of no use therefore of no value e.g. planting of tobacco, sale of cigarette, sale of musical instruments that can cause "ghairah or hayal"

3. “Gharar”, i.e. ambiguity or uncertainty. “Gharar” is divided into two namely (a) Gharar fahish, i.e. major or serious gharar, and (b) Gharar yasir, i.e. minor or slight gharar. The Gharar that causes a contract to be null and void is major “gharar” which arises out of one of the following:

# Asset or merchandise does not exist;
# Asset or merchandise cannot be delivered; or
# Asset or merchandise not according to specification.

4. Gambling i.e. anything that involves betting (to some scholars, this may include purchasing of "halal" stock and shares for speculating purposes i.e. although the transaction is valid but the intention may not)

5. “Riba” or usury; which means extra and it is of two kinds:

(a) Riba Duyun - riba out of lending and borrowing. This kind of riba is the extra amount of money that is either; imposed by the lender on the borrower in the contract; or promised by the borrower in the contract.

(b) Riba Buyu - riba in trading transactions. This kind of riba may arise out of an exchange between two ribawi materials in the same category if the rules are not observed.

What is "ribawi " materials? There are two categories or groups of ribawi materials.

(a) Medium of exchange such as i) gold in any form, ii) silver in any form, and iii) currencies ( the currency of each country is considered as one type).

Thus, technically when we purchase US1 dollar at RM3.50, it is considered riba. But due to "maslahah" (public interest) or "dharurat" (since current exchange mode is using currency or fiat money), most Shariah scholars agreed that the currency exchange is permisible under current form but it MUST BE DONE ON SPOT (immediate) basis. Currency cannot be sold or exchange on deferred payment nor can it be sold based on future value, thus future transaction is not allowed.

(b) Trading of all kinds of foodstuffs with broad classifications such as i) grains, ii) meats, iii) vegetables, iv) fruits, and v) salts which include sugars, oilments and medicines.

Riba in trading occurs when rules concerning the trading of ribawi materials are not observed. These rules are;

a) Same classifications in the same category,
Examples:-

916 gold exchanged with 750 gold, or Basmathi grade rice (less carbohydrate) exchanged with A1 rice. The weights or measurements or units of the materials must be the same, and the exchange must be immediate i.e. at the one and the same meeting. What it means here, one (1) bag of basmathi cannot be exchanged for half ( 1/2) bag of A1 rice (this is considered riba)


b) Different classifications in the same category,
Examples:

Malaysian currency of RM350 exchange with USD100, 10 grams of gold exchanged with RM350 or 1 tonne of palm oil or exchanged with 2 tonnes of wheat. Similar to the sale of gold, their exchange must be immediate (spot) i.e. at the one and the same meeting.

Note:
Different categories, (e.g. wheat or palm oil exchanged with money) no rules are required to be observed.

After taking out the types of muamalat (transactions) that are prohibited, those that are permitted can be divided into three broad categories as follows:

1. Trading Contracts;
2. Contracts of Profit Sharing;
3. Supporting Contracts.

Some of the most widely used transactions are;

(A) Cash Sales
# Normal cash sales;
# Foreign currency exchanges;
# Exchanges between ribawi materials of different classifications within the same category
(gold with money or wheat with palm oil)

(B) Deferred payment sales (debt financing contracts)
# Bai al-Murabahah (cost plus)
# Bai al-Salam;
# Bai al-Istisna’ (sale by order);
# Al-Bai Bithaman Ajil (deferred payment sale);
# Bai al-Istijrar (supply or whole sale financing);
# Al-Ijarah (leasing);
# Al-Kiraa wal-Iqtinaa’ (leasing then purchase);
# Al-Qardh (benevolent loan);

(C) Contracts for profit-sharing (equity financing) are:
# Al-Musharakah (joint venture profit sharing);
# Al-Mudharabah (trustee profit sharing);
# Al-Muzaraah (leasing of land for agriculture);
# Al-Musaqat (watering of orchard);

(D) Shariah also permits contracts to support and facilitate trading and mobilisation of capital. These contracts are:
# Al-Rahnu (mortgage);
# Al-Kafalah (guarantee);
# Al-Wakalah (agency);
# Al-Wadiah (safe custody);
# Al-Hiwalah (transfer of debt);
# Al-Ibraa’ (rebate);

Essential Element in a Contract
To make a permissible contract valid it must have essential elements and each essential element must meet the necessary conditions.

A) Contract of Sale

The essential elements and the necessary conditions in a contract of sale are:

1. Seller - capable of accepting responsibility:
# of sound mind;
# has attained the age of puberty;
# intelligent (has attained the age of majority);
# not restricted from dealing in business transactions;
# not a bankrupt;
# not a reckless spendthrift;
# not forced to enter into contract.

2. Buyer (same as seller)

3. Merchandise - exists.# of pure substance (halal/lawful).
# of some use therefore of some value.
# seller must be real owner.
# can be delivered to buyer.
# known (specifications).

4. Price - known in amount and type of currency.

5.Contract: Offer & acceptance# absolute, in definite and decisive language.
# acceptance must be consistent with offer.
# offer and acceptance made at the same meeting.


B) Contract of Leasing

The essential elements and the necessary conditions are:

1. Lessor - (same as buyer and seller);
2. Lessee - (same as buyer and seller);
3. Asset - belongs to lessor;
4. Known and specified;
5. In good working order;
6. Delivered to lessee;
7. Rental - known;
8. Use - can be fixed in value;
9. Lessor has the power and capability to use and lease the asset;
10. Period of leasing is known. If asset is multi-purposes, the type of use must also be defined and known;
11. Permissible;
12. Not for procurement of goods;
13. Contract - in definite and decisive language;
14. Acceptance must be in line with offer;
15. Offer and acceptance made at the same meeting.

C) Bai Al-Inah (this contract is acceptable by some Jurists)
Bai Al-Inah must meet the following requirements:

1. There must be two separate contracts. First the contract of sale by bank to customer on deferred payment term. Second the contract of repurchase by bank from customer on cash term;

2. The merchandise or the asset must not be a ribawi material in the medium of exchange category (gold, silver or currency) because all payments for purchases are made in money;

3. Each of the two contracts must have the essential elements and each of the essential elements must meet the necessary conditions.

D) Bai Al-Dayn (this contract is acceptable by some Jurists)
The requirements of Shariah concerning Bai Al- Dayn are:

1. A debt must have been created through a contract of deferred payment sale of goods or service;
2. The goods must have been delivered or the service must have been rendered;
3. The trading of the debt must be on cash term.

E) Qardh (benevolent loan)

In giving Qardh the two following matters must not be contravened:

1. The lender must not impose any extra payment in the contract;
2. The borrower must not promise in the contract to pay anything extra. Nevertheless, if the borrower decided to pay extra after the loan has been repaid (without promising any), it is acceptable.

F) Al-Mudharabah

The essential elements and necessary conditions of al-Mudharabah are:

1. Owner of capital - (same as buyer and seller);
2. Entrepreneur - (same as buyer and seller);
3. Capital - money only;
4. Not debt;
5. Specific amount;
6. Paid to entrepreneur;
7. From owner of capital only;
8. Business - halal;
9. Managed by entrepreneur only.

G) Profit/Loss contract e.g. Musharakah1. Profit shared according to agreement in fraction, ratio or percentage; not in absolute amount.
2. Loss borne by owner of capital – only.
3. Other characteristics - based on trust of owner of capital in entrepreneur.
4. Profit sharing ratio not necessary in accordance with the percentage of capital provided.

The sudden interest in Islamic banking is overwelming. There are banks runned by non-Muslims who are also keen to offer Islamic banking products. This is good and we hope that this development will continue. However, one wonder whether they truly understood the true intention of Islamic banking (usury free banking) or just taking advantage of the sudden interest in this banking system. Allah has showed that "usury or interest-backed banking system" has failed from time to time. The sub-prime and banking crisis in the West is a recent evidence that riba based financial system has failed. What more evidence do we need? Most important when offering Islamic banking product is not to take advantage of the recent interest and so call attracting muslim funds (particularly from the Arab world) but it is offered because one believed Usury (riba) is prohibited by God.

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12 - Islamic Banking Product Definition

Before we learn the practical aspects of Islamic banking, let's understand the types of products currently offered by Islamic banks throughout the world.

Murabahah

Murabahah (accurate transliteration murābaḥa) is defined as a cost-plus sale, where the seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or mark-up thereon which is known to the buyer. As the requirement includes an 'honest declaration of cost', murabaha is one of three types of bayu-al-amanah ('fiduciary' sale). Other two types of bayu-al-amanah are Tawliyah (sale at cost) and Wadiah (sale at specified loss)].

Istisna’a

Literally the word istisna’ derived from the root word sana’ or to manufacture or to construct something. Istisna’ is an order or request to manufacture something, whereby the requestor invited, induced or caused another to make or manufacture some goods for him. Technically, it is a contract to purchase for a definite price (agreed by both parties) something that may be manufactured later on according to agreed specifications between the parties. In other words, it is a contract of sale of specified items to be manufactured or constructed with an obligation on the part of the manufacturer or contractor to deliver them to the customer upon completion. The contract of Istisna’ creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work, any one of the parties may cancel the contract after giving a notice to the other. However, after the manufacturer has started the work, the contract cannot be cancelled unilaterally.

Ijarah

An agreement whereby the Bank (lessor) purchases or constructs an asset for lease according to the customer’s request (lessee), based on his promise to lease the asset for a specific period and against certain rent installments. Ijarah could end by transferring the ownership of the asset to the lessee and there must be usufruct. What does Usufruct means? Usufruct is a legal term describing a situation wherein a person or company has a temporary right to use and derive income from someone else's property (provided that it isn't damaged).

Musharakah

An agreement between the Bank and a customer to contribute to a certain investment enterprise, whether existing new, or the ownership of a certain property either permanently or according to a diminishing arrangement ending with the acquisition by the customer of the full ownership. The profit is shared as per the agreement set between parties while the loss is shared in proportion to their shares of capital in the enterprise.

Mudarabah
An agreement between the Bank and a third party whereby one party would provide a certain amount of funds which the other party (Mudarib) would invest in a specific enterprise or activity against a specific share in the profit. The Mudarib would bear the loss in case of default, negligence or violation of any of the terms and conditions of the Mudarabah.

Wakalah
An agreement between the Bank and an agent whereby the agent invests it according to specific conditions in return for a certain fee (a lump sum of money or a percentage of the amount invested). The agent is obliged to return the invested amount in case of default, negligence or violation of any of the terms and conditions of the Wakalah.

Sukuk

Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that comply with the Islamic law (Shari’ah) and its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.

Bai’ al-inah (sale and buy-back agreement)
The financier sells an asset to the customer on a deferred-payment basis, and then the asset is repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency. Some scholars believe that this is not compliant with Shari’ah principles but this principle is still being practice by some Muslim countries, particularly Malaysia.

Bai’ bithaman ajil (deferred payment sale)
This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except Bai’ bithaman ajil is normally offered for long-term deferred payment sale while Murabahah, is normally for short term deferred payment sale e.g. up to 1 year.

Bai muajjal (credit sale)
Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.

Musawamah
Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabahah and Musawamah with all other rules as described in Murabahah remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.

Bai salam
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies (these are “ribawi” items) based on these metals. Barring this, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship.

Actually there are more Islamic banking products currently being offered in the market but those described above are the most common offerings. It is interesting to note that some Islamic banks are trying to emulate products offered by conventional banks. My answer to this, in their effort of trying to be innovative, they may risk developing a disguished "riba" product instead a truly shariah-compliant product. To me, instead of moving forward with their so call "product innovation" they are actually moving backward. We must move forward by improving the Musharakah (equity-based) financing structure rather relying too much on debt-based products. Musharakah if properly structured, is safer than debt-based financing product. We will examine more on this in later section.

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