Islamic Banking and Insurance - Course Outline PDF

**FACULTY OF ECONOMIC, SOCIAL & ENVIRONMENTAL STUDIES** **SPECIALIZATION APPLIED ECONOMICS.** **ISLAMIC BANKING & INSURANCE** **Mr. Mussa Ramadhani\ ** **Course outline** Topics 1. **Introduction of Islamic finance** 1. Meaning of Islamic Finance 2. Short History of Islamic Finance 3. Principles of Islamic Finance 4. Difference between Islamic Finance and conventional finance 5. Sub-Sector in Islamic Finance 1. Islamic Banking 2. Islamic Insurance 3. Islamic Capital market 4. Islamic Microfinance 5. Islamic non-banking institutions 2. **Meaning and scope of Islamic banking** 6. Definition of Islamic Banking 7. Short History of Islamic Banking 8. Islamic banking Products 6. Retail Islamic banking Product 7. Cooperate Islamic banking products 9. Islamic Banking Model 8. Full fledge Islamic Banking 9. Subsidiary Islamic Banking 10. Window Islamic Banking 10. Challenges faced by Islamic Banking 3. **Source of fund of Islamic banking** 11. Internal Source of Fund 11. Shareholders Capital 12. Reserve 13. Returned Earnings 12. External Source of Fund 14. Deposits 13. Shariah Principle in deposits 15. Wadiah Principle 16. Mudarabah Principle 4. **Uses of fund of Islamic banking** 14. Trade-based modes of financing 17. Murabaha 18. Musawamah 19. Tawwaruk 20. Salam 21. Istisnaa 15. Rental-based modes of financing 22. Ijarah 16. Participation-based modes of financing 23. Musharakah 24. Mudarabah 5. **Meaning and Scope of Takaful** 17. Introduction of conventional Insurance 25. Meaning of Insurance 26. Function of Insurance 27. Benefit of Insurance 28. Principle of Insurance 18. Insurance from the shariah perspective 29. Interest 30. Gharar 31. Maysir 19. Meaning of Islamic Insurance 20. Takaful Product 32. Family Takaful 33. General Takaful 6. **Takaful models** 21. Wakalah Model 22. Mudarabah Model 23. Wakalah Mudarabah Model 7. **Re-Takaful** 24. Re-Insurance 25. Re-Takaful **INTRODUCTION TO ISLAMIC FINANCE** 1. Introduction to Islamic finance 1. Meaning of Islamic Finance 2. Principles of Islamic Finance 3. **Difference between Islamic Finance and conventional finance** 4. Sub-Sector in Islamic Finance 1. Islamic Banking 2. Islamic Insurance 3. Islamic Capital market 4. Islamic Microfinance 5. Islamic non-banking institutions **INTRODUCTION** The core concepts of Islamic finance are as old as Islam. Islam is not just a religion but a way of life. It provides guidance to its followers encompassing the social, religious, economic and political aspects of their lives. **Meaning of Islamic finance** Islamic finance is a faith-based financial system, and its foundation is laid down in Shariah law and the principles of Islamic economics. The guiding principles of Islamic finance emphasize fairness, justice, empathy, cooperation, entrepreneurship, ethics and the general good of the environment and society, not just profit maximization. **Islamic Finance Practices During the Prophet's Time** 1. **Mudarabah (Profit-Sharing Partnership)**: Mudarabah, a profit-sharing partnership where capital is provided by one party and expertise by another, reflects the Prophet's teaching of shared risk and reward. 2. **Wadi\'ah (Safe Custody)**: The Prophet emphasized trust and honesty in Wadi\'ah, a practice of safekeeping goods or money, which laid the foundation for modern deposit accounts in Islamic finance. 3. **Salam (Advance Payment for Future Delivery)**: The Prophet introduced Salam contracts, allowing advance payments for future goods, promoting fair trade and risk management, especially in agriculture. 4. **Prohibition of Riba (Interest)**: The Prophet Muhammad (SAW) strictly prohibited riba (interest), promoting fairness in transactions and ensuring wealth is earned through trade and profit-sharing, not exploitation. 5. **Murabaha (Cost-Plus Financing)**: The Prophet emphasized transparency in trade by promoting Murabaha, where the seller discloses the cost and profit margin, ensuring honesty and fairness in pricing. **Short History of Islamic Finance** ------------ ---------------------- **Period** **Key Developments** ------------ ---------------------- ----------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **1890s** **Barclays Bank**: Opened in Cairo, introduced commercial banking to facilitate Suez Canal construction. Brought criticism from Islamic scholars for interest-based operations. ----------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------------- --------------------------------------------------------------------------------------------------------------------------------------------- **1900--1950** Discussions on the prohibition of Riba (interest) started among Islamic scholars and economists in the Middle East and Indian Subcontinent. ---------------- --------------------------------------------------------------------------------------------------------------------------------------------- ---------------- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **1951--1962** Design of interest-free banking models such as two-tier Mudarabah and Wakalah methods. An experimental interest-free savings and loan society was established in Pakistan. ---------------- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ----------------------------------------------------------------------------------------------------------------------------------------------------------------- **1963** **Mit Ghamr Savings Association**: Founded by Dr. Ahmad El-Najjar in Egypt, followed the model of German savings banks, based on Profit and Loss Sharing (PLS). ---------- ----------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------------------------------------------------------------- **1963** **Tabung Haji (Pilgrims Fund Corporation)**: Malaysia's Shariah-compliant savings institution to help Muslims save for Hajj expenditures. ---------- ------------------------------------------------------------------------------------------------------------------------------------------- ---------------- ------------------------------------------------------------------------------------------------------------------------- **1963--1975** The foundation of Islamic finance and banking institutions began, moving from experimental efforts to moderate success. ---------------- ------------------------------------------------------------------------------------------------------------------------- ---------- -------------------------------------------------------------------------------------------------------------------------------------------------------------- **1972** **Nasr Social Bank**: Established in Egypt, it integrated the Mit Ghamr project and served low-income individuals, not focused on profit but social welfare. ---------- -------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- -------------------------------------------------------------------------------------------------------------------------------------------------- **1973** **Philippines Amanah Bank**: Created to meet the banking needs of the Muslim community, operating with both Islamic and interest-based products. ---------- -------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------------------------------------------------------------ **1975** **Islamic Development Bank**: Multilateral institution fostering economic development in member countries and promoting Islamic finance. ---------- ------------------------------------------------------------------------------------------------------------------------------------------ ---------- -------------------------------------------------------------------------------------------------------------- **1975** **Dubai Islamic Bank**: The first major Islamic commercial bank, fully supported by the government of Dubai. ---------- -------------------------------------------------------------------------------------------------------------- ---------- -------------------------------------------------------------------------------------------------------------------- **1976** **First International Conference on Islamic Economics**: Held in Makkah, focused on Islamic economics and finance. ---------- -------------------------------------------------------------------------------------------------------------------- ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **1977** **Kuwait Finance House, Bahrain Islamic Bank, Faisal Islamic Bank of Sudan, Faisal Islamic Bank of Egypt**: Pioneering Islamic banks established in their respective countries. ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------ **1978** **Jordan Islamic Bank**: Established to formalize Islamic banking in Jordan. ---------- ------------------------------------------------------------------------------ ---------- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **1978** **Centre for Research in Islamic Economics**: Set up at King Abdul Aziz University in Jeddah, Saudi Arabia, as the first research institution for Islamic economics and finance. ---------- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------- **1978** **Islamic Finance House, Luxembourg**: First Islamic finance institution in Europe. ---------- ------------------------------------------------------------------------------------- ---------- --------------------------------------------------------------------------------------------------------- **1979** **Sudanese Islamic Insurance Company**: First Takaful company, founded by Faisal Islamic Bank of Sudan. ---------- --------------------------------------------------------------------------------------------------------- ---------- ----------------------------------------------------------------------------------------------------------------------------- **1980** Pakistan passed legislation to establish Shariah compliance in its financial system, though it was never fully implemented. ---------- ----------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ **1981** **Islamic Research and Training Institute**: Established by the Islamic Development Bank (IDB) in Jeddah, Saudi Arabia, to provide research and training in Islamic finance. ---------- ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **1981** **Dar Al-Maal Al-Islami Trust**: Provided Islamic banking, investment, and insurance services to Muslim communities worldwide, including the GCC, Switzerland, and Egypt. ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------ **1983** **Bank Islam Malaysia Berhad**: Malaysia's first fully-fledged Islamic bank. ---------- ------------------------------------------------------------------------------ ---------- ------------------------------------------------------------------------------------------------------------------------ **1983** Sudan reformed its banking system based on Shariah principles in the North, while dual banking continued in the South. ---------- ------------------------------------------------------------------------------------------------------------------------ ---------- --------------------------------------------------------------------------- **1983** **Bank Islami Bangladesh**: First Islamic bank established in Bangladesh. ---------- --------------------------------------------------------------------------- ---------- --------------------------------------------------------------------------------------------------- **1984** Iran established interest-free banking throughout the country as part of post-revolution reforms. ---------- --------------------------------------------------------------------------------------------------- ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------- **1987** **Al Rajhi Bank**: Consolidated into Al Rajhi Banking and Investment Saudi Joint Stock Company in 1987, becoming a major Islamic financial institution. ---------- --------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ---------------------------------------------------------------------------------------------------------------------------------------------------------- **1990** **Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)**: Established in Bahrain to standardize Islamic financial practices. ---------- ---------------------------------------------------------------------------------------------------------------------------------------------------------- ---------- ---------------------------------------------------- **1991** **Bank Muamalat**: Indonesia's first Islamic bank. ---------- ---------------------------------------------------- ----------- ---------------------------------------------------------------------------------------------------------------------------------------------------------- **1990s** Islamic finance expanded globally with the creation of Islamic indexes (Dow Jones, Financial Times) and the Islamic Finance Forum at Harvard University. ----------- ---------------------------------------------------------------------------------------------------------------------------------------------------------- ----------- --------------------------------------------------------------------------------------------------------------------------- **2000s** Entry of large conventional banks like UBS, HSBC, and Citibank offering Islamic finance services through Islamic windows. ----------- --------------------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------------------------------------- **2002** The UK and Singapore governments extended support to Islamic finance institutions through tax-neutrality rulings. ---------- ------------------------------------------------------------------------------------------------------------------- ---------- ---------------------------------------------------------------------------------------------------------------- **2004** **Islamic Bank of Britain (now Al Rayan Bank)**: Europe's first Shariah-compliant bank, established in the UK. ---------- ---------------------------------------------------------------------------------------------------------------- **2006** **Dubai Financial Market**: Announced plans to restructure and establish the world's first Islamic stock exchange. --------------------- -------------------------------------------------------------------------------------------------------------------- **2006- Up to Now** **There are number of Islamic Finance practice** **PRINCIPLE OF ISLAMIC FINANCE** Shariah law encompasses rules for various aspects of life, including business and finance. In Islamic finance and banking, key prohibitions like Riba (interest), Gharar (uncertainty), and Maysir (gambling) are crucial. These, along with other principles, shape the practices within this sector. 1. **PROHIBITION OF INTEREST OR RIBA** Definitions - In the Islamic Finance terminology, **interest means** "effortless profit or profit that increases the principal amount without putting any effort. - Riba, refers to any predetermined and conditional extra amount, big or small, that must be paid by the borrower to the lender above and over the principal, for the loan to be materialized or for an extension in its maturity. **Stage of prohibition of Riba in the Holy Quran** - **First Revelation**: Dealing in riba **has been discouraged** in the following words: - **Second Revelation**: Muslims have been informed about **the practice of taking riba by Jews** - **Third Revelation**: Riba/Interest **has been abolished.** Riba has categorically been prohibited in all its forms. - **Fourth Revelation:** Al-bay (Trading) **as the alternative to Ribah.** **Prohibition of Riba from Hadith** - According to Islamic jurists and scholars, there are around 40 different Al-hadith on the subject of riba and its prohibition from Holy Prophet (peace be upon him). a. Abu Hurairah - (said the Prophet (PBUH) said "exchange gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt**, must be equal on both sides and hand to hand**. Whoever pays more or demands more (on either side) indulges in Riba." (Sahihi Muslim) b. **Jabir** (May Allah be pleased with him): The Prophet, **cursed the receiver and the payer of interest**, the one who records it and the two witnesses to the transaction and said: \"They are all alike \[in guilt\]'' c. From Abu Hurayrah (May Allah be pleased with him): The Prophet said: \"Riba has **seventy segments**, the least serious being equivalent to a **man committing adultery** with his own mother." d. From Hazrat Abdallah ibn Hanzalah - The Prophet, said: \"A dirham of riba which a man **receives knowingly is worse than committing adultery thirty-six times**" e. From Hazrat Abu Hurayrah - The Prophet said: \"There will certainly come a time for mankind when everyone will take riba and if he does not do so, its dust will reach him." f. From Hazrat Abu Hurayrah - The Prophet said: \"God would be justified in **not allowing four persons to enter paradise or to taste its blessings**: he who drinks habitually, **he who takes riba**, he who usurps an orphan's property without right, and he who is undutiful to his parents.\" **Types of Riba** Riba al-Fadl and Riba al-Nasia are two specific types of riba that are prohibited in Islamic finance due to their exploitative nature. Here is an explanation of each type: a. **Riba al-Nasia:** This is the main type of Riba, which is the interest paid on loans. It is the additional amount paid along with the principal and it is decided based on the principal amount of the loan and the period for which the loan is given. It is considered as an unjust increase in the amount of the loan, which is fixed in advance and has no connection to the economic activity for which the loan was taken. The occurrence of riba al-nasia, in Islamic finance is a significant concern as it goes against the principles of fairness and justice in financial transactions. Riba al-nasia specifically relates to situations where there is a delay in the exchange of goods or commodities, leading to potential exploitation. 1. **Riba al-Fadl:** Riba al-Fadl refers to the excess in a transaction where goods of the same kind are exchanged but in unequal quantities. In this type of riba, one party receives more of the goods than the other party without any corresponding value being exchanged. This imbalance in the exchange, where one party benefits unfairly at the expense of the other, is considered riba and is prohibited in Islamic finance. The essence of riba al-Fadl lies in the unjust enrichment of one party through an unequal exchange of goods. Riba al-Fadl, also known as riba of excess or usury of surplus, is a type of riba that pertains to the exchange of goods of the same kind but in unequal quantities. In this context, riba al-fadl prohibits transactions where one party receives more than the other in a trade involving similar commodities. This type of riba is rooted in the principle of fairness and equity in Islamic finance. 2. **PROHIBITION OF GHARAR** Literally: Deceit, risk, fraud, uncertainty or hazard that may be lead to destruction loss. Technically: When a matter that is concealed by one party. Occurs when a party undertake venture blindly without sufficient knowledge. Minor uncertainties can be permitted when there is a necessary. Both of contracting parties must have a perfect knowledge regarding to transaction. - The Hanafi school of Islamic jurisprudence defined gharar as \"**that whose consequences are hidden**.\" - The *Shafi\'I* school defined *gharar* as \"**that whose nature and consequences are hidden**\" or \"**that which admits two possibilities, with the less desirable one being more likely.**" - The *Hanbali *school defined it as \"**that whose consequences are unknown**\" or \"that which is undeliverable, whether it exists or not.\" - Ibn Hazn of the *Zahini* school wrote \" ***Gharar* is where the buyer does not know what he bought, or the seller does not know what he sold**." **Example of Gharar**: - Sell good that seller is not in position to deliver. Sell known or unknown goods against unknown price. Make a contract conditional on an unknown event. Sell good on basis of false description. Sell good without proper examination. Gambling. Types Meaning --------------------- ----------------------------------------------------------- Gharar-fil-Sifah Uncertainty with respect to characteristics of the goods. Gharar-fi-al-Ajal Uncertainty with respect to time of the delivery. Gharar-fi-al-Miqdar Uncertainty with respect to quantity of goods. Gharar-fi-al-Taslim Uncertainty with respect to delivery of the goods. Gharar Yasir A small amount of gharar that may be unavoidable. **The Evidence from The Qur-an** - "O ye who believe! eat not up your property among yourselves In vanities: but let there be amongst you trade by mutual good-will: nor kill (or destroy) yourselves: for Verily Allah hath been to you Most Merciful!"4:20 **The Evidence from The Hadith** - Evidence for the prohibition of contracts containing gharar comes in the hadith of the prophet Muhammad (pbuh) who prohibited the sale of fish in water that it is a gharar sale. Hence, it seems clear that if an object of sale is not owned by person A, then it cannot be sold to Person B. Hakīm ibn Hizām asked the Prophet (pbuh): *\'Oh Prophet of Allāh! A man comes to me and asks me to sell him what is not with me, so I sell him \[what he wants\] and then buy the goods for him in the market \[and deliver\]\'. And the Prophet (pbuh) said: \'sell not what is not with you'* Hadīth: Sunan Abī Dāwūd, 3. **PROHIBITION OF MAYSIR** Maysir: - Refers to the easy acquisition of wealth by chance, whether or not it deprives the other's right. Qimar means the game of chance in which one gains at the cost of others. This is Haram (unlawful) and considered as a major sin in Islam. **Elements of Maysir** - There is a contract of exchange (mu'awadat) between the parties. - Under the contract, each party puts its ownership in danger. - No party has control over the event. - Each party either loses its property or gains ownership of another party's property. **The Evidence from The Qur-an** - They ask you about intoxicants and games of chances. Say: in both of them there is a great sin (2:219 Qur-an) - "You who believe! Intoxicants and games of chance and divining by arrows are only an uncleanness, the Shaitan work; shun it therefore that you may be successful. (5:90) Qur-an) **The Evidence from The Hadith** - "Some people spend Allah's wealth (i.e. Muslim's Wealth) in an unjust manner, such people will be put in the (Hell) fire on the day of resurrection" (Bukhari and Ahmad). - "The one who invites his companions: Come let us gamble", should expiate his sin by giving in charity." (Bukhari). 4. **THE PROHIBITION OF HARAM (FORBIDDEN) ACTIVITIES** The prohibition of haram (forbidden) activities is a fundamental principle in Islamic finance that guides investment decisions and financial transactions based on Sharia (Islamic law) guidelines. Islamic finance adheres to ethical and moral principles derived from the Quran and the teachings of the Prophet Muhammad, which prohibit certain activities or products that are considered harmful, exploitative, or contrary to Islamic values. Here is an explanation of the prohibition of haram activities in Islamic finance: **Why is Islam Prohibits Haram Activities:** 1. **Ethical Guidelines**: Islamic finance operates on the principles of fairness, justice, and ethical conduct. Investments in activities or products that are deemed haram are avoided to ensure that financial transactions are in line with Islamic values and principles. 2. **Sharia Compliance**: Sharia prohibits certain activities that are considered sinful or harmful to individuals and society. These include but are not limited to alcohol, gambling, pork, tobacco, pornography, and interest-based transactions (riba). 3. **Social Responsibility**: By avoiding investments in haram activities, Islamic finance promotes social responsibility and ethical investing. It aims to support businesses and industries that contribute positively to society and avoid those that engage in unethical practices or produce harmful products. 4. **Risk Management**: Investing in haram activities can expose investors to legal, reputational, and ethical risks. By adhering to Sharia principles and avoiding haram investments, Islamic financial institutions seek to mitigate these risks and uphold their ethical standards. 5. **Community Welfare**: The prohibition of haram activities in Islamic finance is intended to protect the welfare and interests of the community. By avoiding investments in harmful or exploitative industries, Islamic finance aims to promote economic development, social justice, and sustainable growth. 6. **Spiritual Considerations**: For Muslims, engaging in haram activities is not only a financial concern but also a spiritual one. By adhering to Sharia principles in their financial dealings, Muslims seek to earn halal (permissible) income and avoid sources of income that are tainted by sin or unethical behavior. **Examples of Haram Activities:** 1. **Alcohol**: Investments in companies involved in the production, distribution, or sale of alcohol are considered haram in Islamic finance due to the prohibition of alcohol consumption in Islam. 2. **Gambling**: Engaging in gambling activities or investing in gambling-related businesses is prohibited in Islamic finance because of the harmful effects of gambling on individuals and society. 3. **Pork**: Transactions involving pork products or businesses related to the production or sale of pork are considered haram in Islam due to the prohibition of pork consumption. 4. **Tobacco**: Investments in tobacco companies or products are avoided in Islamic finance because of the health risks associated with tobacco use and the addictive nature of tobacco products. In conclusion, the prohibition of haram activities in Islamic finance reflects the ethical and moral principles of Sharia and aims to promote responsible investing, social welfare, and ethical conduct in financial transactions. By avoiding investments in haram activities, Islamic finance seeks to uphold Islamic values, protect the interests of investors, and contribute to the well-being of society. **Difference between Islamic Finance and conventional finance** LET'S DISCUSS ACCORDING TO THE PRINCIPLE OF THE ISLAMIC FINANCE **SUB-SECTOR IN ISLAMIC FINANCE** The Islamic finance and banking industry today comprises the following sub-sectors. **1. Islamic banking.** This includes the deposit-taking banks that operate within Shariah guidance, like the Bahrain Islamic Bank. Conventional banks offering Shariah-compliant products may also participate via an Islamic window within their main operations or an independent subsidiary, like HSBC Amanah. **2. Islamic insurance or Takaful.** These are the Shariah-compliant insurance companies, like the Qatar Takaful Company. **3. Islamic capital markets.** These include Shariah-compliant shares, bonds, mutual and other investment funds and products, indices and the secondary markets. **4. Islamic non-bank financial institutions.** Within this sub-sector are the variety of financial institutions that are not banks and operate within the Islamic financial principles. Some of these are Islamic finance companies, Islamic housing cooperatives, Islamic leasing and factoring companies, Islamic microfinance, charitable endowments (called Waqf in Arabic), private equity and venture capital firms, Hajj and Zakat management bodies, etc. **TOPIC TWO** 1. **Meaning and scope of Islamic banking** 1. Definition of Islamic Banking 2. The core objectives of an Islamic bank. 3. Short History of Islamic Banking 4. Islamic banking Products 1. Retail Islamic banking Product 2. Cooperate Islamic banking products 5. Islamic Banking Model 3. Full fledge Islamic Banking 4. Subsidiary Islamic Banking 5. Window Islamic Banking 6. Challenges faced by Islamic Banking **MEANING AND SCOPE OF ISLAMIC BANKING** Definition of Islamic Banking Islamic banking is an interest free banking system and is governed by the principles laid down by Islamic Shari'ah. **The core objectives of an Islamic bank:** 1. To offer Shariah-compliant financial services. 2. To avoid all Haram activities and be involved in Halal activities only. Examples of Haram activities are those involving alcohol, pork, adult entertainment, gambling, interest-based businesses, etc. 3. To develop transactions that are free of Riba, Gharar and Maysir. 4. To refrain from using money as a commodity and earning more money from it, and rather backing every financial transaction with real assets. 5. To give more value to human efforts in the business venture, rather than the money only; money becomes capital only after it is invested in the business. 6. To allocate resources efficiently and distribute income equitably. 7. To encourage savers to invest rather than keep their money idle, stimulating the economy and encouraging entrepreneurs to maximum efficiency. **Short History of Islamic Banking** ------------ -------------------------------------- **Period** **Key Developments (Islamic Banks)** ------------ -------------------------------------- ---------- -------------------------------------------------------------------------------------------------------------------------------- **1963** **Mit Ghamr Savings Association**: First interest-free Islamic financial institution in Egypt, founded by Dr. Ahmad El-Najjar. ---------- -------------------------------------------------------------------------------------------------------------------------------- ---------- ---------------------------------------------------------------------------------------------------------------- **1972** **Nasr Social Bank**: Egypt, integrated Mit Ghamr project, served low-income individuals, not profit-oriented. ---------- ---------------------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------------------------------- **1975** **Dubai Islamic Bank**: First major Islamic commercial bank, fully supported by the Dubai government. ---------- ------------------------------------------------------------------------------------------------------- ---------- -------------------------------------------------------------------------------------- **1977** **Kuwait Finance House**: One of the pioneering Islamic banks established in Kuwait. ---------- -------------------------------------------------------------------------------------- ---------- --------------------------------------------------------------------- **1977** **Faisal Islamic Bank of Sudan**: Pioneering Islamic bank in Sudan. ---------- --------------------------------------------------------------------- ---------- ---------------------------------------------------------------------------- **1977** **Faisal Islamic Bank of Egypt**: Early Islamic bank established in Egypt. ---------- ---------------------------------------------------------------------------- ---------- ---------------------------------------------------------- **1977** **Bahrain Islamic Bank**: First Islamic bank in Bahrain. ---------- ---------------------------------------------------------- ---------- --------------------------------------------------------------------------------------------------- **1978** **Jordan Islamic Bank**: First Islamic bank in Jordan, formalized Islamic banking in the country. ---------- --------------------------------------------------------------------------------------------------- ---------- ------------------------------------------------------------------------------- **1983** **Bank Islam Malaysia Berhad**: First fully-fledged Islamic bank in Malaysia. ---------- ------------------------------------------------------------------------------- ---------- --------------------------------------------------------------- **1983** **Bank Islami Bangladesh**: First Islamic bank in Bangladesh. ---------- --------------------------------------------------------------- ---------- ---------------------------------------------------------------------------------------------------------------------------------------- **1987** **Al Rajhi Bank**: Consolidated into Al Rajhi Banking and Investment Saudi Joint Stock Company, a major Islamic financial institution. ---------- ---------------------------------------------------------------------------------------------------------------------------------------- ---------- ---------------------------------------------------- **1991** **Bank Muamalat**: Indonesia's first Islamic bank. ---------- ---------------------------------------------------- ---------- ---------------------------------------------------------------------------------------------------------------- **2004** **Islamic Bank of Britain (now Al Rayan Bank)**: Europe's first Shariah-compliant bank, established in the UK. ---------- ---------------------------------------------------------------------------------------------------------------- **Islamic banking Products** According to Dr. Sharifah Faigah Syed Alwi (Hasan, 2014), **Shariah-compliant products** are modified versions of conventional financial products that are adjusted to meet Islamic law (Shariah) requirements. They are designed to fulfill similar purposes as their conventional counterparts but with features aligned to Islamic principles. In contrast, **Shariah-based products** are entirely new creations, developed by Islamic bankers or scholars, with no foundation in conventional finance. These products are built from the ground up to comply fully with Shariah law. Both types of products are necessary depending on various factors, such as customer needs, market competition, product complexity, and the challenges in applying Shariah principles in certain contexts. Modern Islamic banks cater to individuals, businesses, and governments with a combination of both product types. **Retail Islamic Banking Products** 1. **Current, Savings, and Investment Accounts**: These are basic accounts that allow customers to deposit, save, and invest money according to Islamic principles. 2. **Credit Cards**: Islamic banks offer credit cards with alternative ways to charge fees instead of interest: - **Service Charge**: A fixed monthly or annual fee. - **Deferred Payment Sale**: The bank buys an item for the customer, then sells it to them at a markup, paid in instalments. - **Lease Purchase**: The bank owns the item until the customer makes the final payment, paying rental fees in the meantime. - **Prepaid Credit Card**: Customers load money onto the card and use it to make purchases. 3. **Home Financing**: Islamic banks use methods like: - **Murabaha**: The bank buys the home and sells it to the customer at a markup. - **Diminishing Musharaka**: Joint ownership between the bank and the customer, with the customer gradually buying out the bank's share. - **Ijara (Lease Financing)**: The bank leases the home to the customer with an option to buy. 4. **Personal Loans**: Islamic banks offer loans using: - **Lease and Hire Purchase**: The bank buys an asset and leases it to the customer, who pays rent and the price of the asset over time. - **Murabaha**: The bank buys an asset and sells it to the customer at a markup, with repayment in instalments. **Corporate Islamic Banking Products (Simplified)** Islamic banks offer a variety of products and services for corporate clients, including equity or Sukuk issuance, joint venture financing, acquisitions, working capital, and trade or project financing. Below are some of the common corporate products: 1. **Trade Finance**: - **Murabaha and Ijara Contracts**: Used for import/export financing to help overcome geographical barriers and trust issues between exporters and importers. - **Letter of Credit**: A guarantee from the bank ensuring payment upon receipt of necessary documents. Islamic banks charge a fixed administration fee for this service. - **Bill of Exchange**: A document written by the exporter stating the payment claim and terms, ensuring payment by the importer. - **Banker's Acceptance**: A payment claim that can be sold by the exporter to raise funds before actual payment is received. - **Bank Guarantees**: The bank guarantees payment to the exporter, protecting against non-payment by the importer. 2. **Project Finance**: - **Build, Operate, Transfer (BOT)**: A common method where Islamic banks provide financing for projects through options like leasing, renting, and ownership transfer after the project is complete. 3. **Syndication**: - **Large or Risky Financing**: When a project is too large or risky for one bank, multiple Islamic banks pool resources to provide the required funding. One bank, known as the **lead bank**, manages the syndication, including negotiation, documentation, and communication. Benefits include shared risk, income, and the combined expertise and reputation of the participating banks. **\ ** **Islamic Banking Model** 1. **Fully-Fledged Islamic Banks**: These are independent banks that operate entirely according to Islamic principles. They offer only Islamic banking products and have a complete range of services, unlike Islamic windows of conventional banks. - **Independent Operation**: Operate entirely according to Islamic principles and regulations, without any association with conventional banking. - **Complete Product Range**: Offer a full suite of Shariah-compliant financial products and services, including retail, corporate, and investment banking. - **Dedicated Infrastructure**: Maintain separate facilities, staff, and technology designed specifically for Islamic banking operations. - **Regulatory Compliance**: Subject to regulations specific to Islamic banking, often involving Shariah supervisory boards to ensure adherence to Islamic law. **Full-Fledged Islamic Banks in Sudan:** 1. Bank of Khartoum 2. Sudanese Islamic Bank 3. Al Baraka Bank Sudan 4. Faisal Islamic Bank of Sudan 5. Qatar Islamic Bank (Sudan) 2. **Islamic Subsidiary**: A part of a conventional bank that offers Islamic financial products. Its operations and distribution are separate from the parent bank, and the parent company provides the initial capital using Shariah-approved contracts. - **Separate Entity**: Operates independently from the parent conventional bank, with its own management and operational systems. - **Capital Funding**: Initially funded by the parent bank using Shariah-compliant contracts, with funds earmarked specifically for Islamic operations. - **Shariah Compliance**: Adheres to Islamic principles, with a Shariah board overseeing compliance and product development. - **Operational Autonomy**: Although linked to the parent bank, it functions as a distinct entity with its own set of products and services. **Islamic Bank Subsidiary in Sudan** 1. United Bank for Africa (UBA) - United Capital Bank 2. Saudi British Bank (SABB) - SGBS Bank 3. Arab Bank - Arab Sudanese Bank 4. Standard Chartered Bank - Islamic banking window 5. Barclays Bank - Islamic banking services 3. **Islamic Banking Windows**: Conventional banks offering Islamic banking products and services through their existing infrastructure (staff, branches). While operations are shared with the conventional side, funds, accounts, and reporting must be kept separate to comply with Shariah law. - **Integrated Infrastructure**: Utilizes the conventional bank's existing branches, staff, and technology to offer Islamic products. - **Separate Funds and Reporting**: Maintains separate accounts and reporting for Islamic and conventional operations to comply with Shariah requirements. - **Operational Separation**: Despite sharing infrastructure, Islamic windows operate with distinct processes and procedures for Islamic products. - **Limited Product Range**: Generally offer a narrower range of Shariah-compliant products compared to fully-fledged Islamic banks. **Islamic Bank Windows in Sudan:** 1. National Bank of Sudan (Islamic window) 2. Jubilee Bank (Islamic window) 3. Bank of Commerce and Development (Islamic window) 4. Darfur Bank (Islamic window) 5. Trade Bank of Sudan (Islamic window) **Challenges Faced by Islamic Banking** 1. **Profit and Loss System**: Islamic banks operate on a profit and loss-sharing model, unlike the interest-based system of conventional banks. This unique mechanism is not widely understood or accepted by many in the industry or by customers. 2. **Regulatory Issues**: Global regulations are primarily designed for conventional interest-based finance, making it difficult for Islamic banks to fit within existing legal frameworks. 3. **Default Penalty**: Unlike conventional banks that charge interest on late payments, Islamic banks cannot increase profits on defaults. They can impose penalties but must donate them to charity. 4. **Skilled Employees**: There is a shortage of trained professionals in Islamic finance due to a lack of education and awareness, leading to a gap in skilled employees for the industry. 5. **Shariah Scholar Confusion**: Shariah scholars, who ensure compliance with Islamic law, often have differing interpretations, leading to confusion and inconsistency in product development and implementation. 6. **Shortage of Multi-Skilled Scholars**: There are few qualified Shariah scholars, and even fewer who have expertise in both Islamic law and finance, creating a shortage of experts for the industry. TOPIC THREE 1. **Source of fund of Islamic banking** 1. Internal Source of Fund 1. Shareholders Capital 2. Reserve 3. Returned Earnings 2. External Source of Fund 4. Deposits 3. Shariah Principle in deposits 5. Wadiah Principle 6. Mudarabah Principle **\ ** **ISLAMIC BANKING SOURCES OF FUNDS** - Internal Sources of the Funds - External Sources of the Funds 1. **Internal Sources of the Funds** a. **Capital** - Capital is the basic source of the funds to start the activity. Capital is the amount injected into the Islamic bank during the setting-up stages i.e. the paid-up capital of the Islamic bank. Return of capital is profit in the form of dividends. - Capital is the safety and protection and the source of trust for the depositors. The original source of the funds must be ascertained to ensure it comes from "halal' sources. **Shareholders' working capital.** The **primary** source of funding, initial paid-up capital, is typically provided on an **al-Qard Hassan basis**, meaning a \"good loan.\" In essence, qard hasan refers to a loan extended without charging any return, profit, or interest. Any form of return associated with the loan would negate its status as qard hasan. Allah treats qard hasan as a form of assistance to Himself, and consequently, promises great rewards for those who engage in it. From Quran *From Hadithi* b. **RESERVES** Islamic banks allocate funds from their profits to establish legal or special reserves aimed at bolstering their financial stability. These **reserves adhere to foundational principles outlined in banking laws** and are typically capped at a predetermined ratio of the bank\'s capital. Additionally, Islamic banks create various reserve categories to safeguard their capital, ensure the security of deposits, and uphold the stability of earnings and deposit values. c. **RETAINED EARNINGS** Retained earnings represent **a segment** of the **net income** reserved by the bank for subsequent reinvestment, aimed at bolstering or enhancing its financial standing. This excludes profits earmarked for distribution but not claimed by certain shareholders. Islamic banks retain profits in a manner consistent with Islamic Shariah principles, ensuring adherence to ethical and legal guidelines. **EXTERNAL SOURCES OF THE FUNDS** **DEPOSITS** Islamic banks rely primarily on deposits as their **main source of funds**. These deposits can consist of cash, cheques, or other claims placed in depositors\' accounts, encompassing individuals, corporations, and governments. Deposits are collected for varying time frames and across different types of accounts. The funds gathered from deposits are utilized for financing purposes, a function commonly referred to as financial intermediation. Through financial intermediation, Islamic banks acquire funds via mechanisms such as wadiah, qard and mudharabah, and then redistribute these funds through financing products like musharaka, Murabaha, ijara, istisnaa, salaam and mudharabah. Islamic deposits are structured in compliance with Shariah principles, ensuring that the relationship between depositors and Islamic banks is one of partnership, reflecting mutual benefit and shared risk. **SHARIAH PRINCIPLE IN DEPOSITS** a. **WADIAH PRINCIPLE** Wadiah, rooted in Islamic banking principles, refers to the act of entrusting belongings to someone for safekeeping. Specifically concerning monetary deposits, Wadiah allows depositors to claim their funds when needed. In this relationship, the depositor (mudi) entrusts their assets (wadia) to the bank (wadi), which acts as a trustee or custodian, preserving and safeguarding the deposited funds. Additionally, depositors may be eligible for a discretionary reward (hibah) from the bank. **Classes of Wadiah:** Wadiah can be categorized into two classes: a\) **Wadiah yad Amanah (Trustee Safe Custody):** - The bank acts as a trustee, taking care of deposited funds. - No guarantee is provided by the bank regarding the return of funds in case of losses like theft or fire. - The bank\'s duty includes safeguarding the property by refraining from mixing funds, using the property, or charging safe custody fees, ensuring protection against loss or damage. b\) **Wadiah yad Dhamanah (Guarantee Safe Custody):** - The bank guarantees the refund of deposited funds. - Customers permit the bank to utilize the funds according to Shariah principles. - Profits or losses resulting from fund utilization belong to the bank, which may voluntarily provide bonuses to customers. **Evidence**: **[DIFFERENCES BETWEEN DEPOSITS UNDER ISLAMIC AND CONVECTIONAL BANKING]** ![](media/image2.jpeg) Top of Form **\ MUDARABAH PRINCIPLE** Mudharabah is an investment arrangement wherein one party provides the capital (depositor), and another party (the Islamic Bank) manages this capital, with profits shared according to a pre-agreed ratio, while losses are borne by the capital provider. **Key features of Mudharabah**: 1. **Profit-sharing agreement**: The depositor determines the profit-sharing ratio in advance, and details are agreed upon at the account\'s opening. 2. **Shariah-compliant investments**: The bank pools all deposits and seeks suitable investment opportunities in accordance with Shariah principles. However, the bank does not guarantee investment profits. 3. **Shared returns**: Profits from investments are shared with depositors, with the type of account and deposit terms determining the depositor\'s share. 4. **Limited liability**: In the event of losses, the depositor bears the losses, with the maximum liability being the deposited sum. 5. **Premature investment penalties**: Fine may be charged for premature withdrawal from investment accounts. **Types of Mudharabah**: 1. **Mudharbah Muthalaqah (Unrestricted):** - In this agreement, the owner of the account or fund does not limit the bank\'s management of the funds. - The bank has the authority to manage the funds without constraints such as time periods, types of business, business locations, or service types. 2. **Mudharabah Muqayyadah (Restricted):** - This agreement involves the depositor limiting the bank\'s management of the funds. - The bank\'s management of the funds is restricted based on factors such as time periods, types of business, business locations, or service types, as specified by the depositor. **TYPES OF ACCOUNT IN ISLAMIC BANKING** Islamic banking operates based on principles derived from Islamic law (Shariah), which prohibits certain practices like **riba** (interest), **gharar** (excessive uncertainty), and **haram** (unlawful) activities. Instead, it emphasizes **profit-sharing**, **ethical investments**, and **real economic activity**. Here's a breakdown of the common accounts in Islamic banking: **1. Current Accounts (Wadiah or Qard)** - **Wadiah (Safekeeping)**: Customers deposit their money, and the bank guarantees its safety. While no return is provided, the bank may offer discretionary gifts (hibah) as a gesture of goodwill. - **Qard (Loan)**: The deposit is treated as a loan from the customer to the bank, with no interest, but with an assurance that the principal will be returned upon demand. **2. Savings Accounts (Mudarabah, WADIAH, QARD)** - **Wadiah (Safekeeping)**: Customers deposit their money, and the bank guarantees its safety. While no return is provided, the bank may offer discretionary gifts (hibah) as a gesture of goodwill. - **Qard (Loan)**: The deposit is treated as a loan from the customer to the bank, with no interest, but with an assurance that the principal will be returned upon demand. - Based on a **profit-sharing** principle (Mudarabah), the customer (rabb al-mal) provides the capital, while the bank (mudarib) manages it. Profits are shared between the bank and the customer at an agreed ratio, but any losses are borne by the depositor unless negligence occurs on the bank\'s part. **3. Investment Accounts (Mudarabah or Musharakah)** - These accounts are similar to savings accounts but typically involve longer-term commitments and higher returns. - **Mudarabah**: Like savings accounts, but for long-term investments, where profits are shared between the bank and the customer. - **Musharakah (Partnership)**: Both the customer and the bank contribute capital to a joint venture, sharing profits and losses based on their contributions. **4. Term Deposit Accounts (Murabaha or Wakalah)** - These accounts function similarly to fixed-term deposits in conventional banking but are structured according to Shariah rules. - **Murabaha**: The bank may use the deposited funds to purchase assets and sell them at a markup, with profits shared according to a pre-agreed arrangement. - **Wakalah (Agency)**: The customer appoints the bank as an agent to invest on their behalf. The bank may charge a fee and distribute profits as per the terms. **5. Zakat Accounts** - Some Islamic banks also offer Zakat accounts where customers can deposit funds specifically to fulfill their Zakat obligations. The bank ensures that the funds are distributed to eligible recipients in line with Islamic law. **6. Charity Accounts (Waqf)** - These accounts allow customers to contribute to charitable endowments (waqf). The bank manages the fund, with the returns going toward social causes like education, healthcare, and poverty alleviation. Islamic banking aims to ensure that all financial transactions are transparent, ethical, and in alignment with the principles of justice and fairness. TOPIC FOUR 1. **Uses of fund of Islamic banking** 1. Trade-based modes of financing 1. Murabaha 2. Bai Bitahm Ajil 3. Musawamah 4. tawwaruq 5. Salam 6. Istisnaa 2. Rental-based modes of financing 7. Ijarah 3. Participation-based modes of financing 8. Musharakah 9. Mudarabah **APPLICATIONS (USES) OF FUNDS** - Recall that the basis of Islamic finance is risk sharing between the parties in an underlying asset-based transaction, so profit-and loss sharing is a prominent feature of Islamic finance. - Recall also that Islamic financial products and practices must avoid gharar (uncertainty, risk, and speculation), maysir and riba and pursue investment in halal (religiously permissible) activities. - Islamic bank **uses its collected fund** under different Islamic financial contract/ Islamic financial instrument or Islamic Modes of Finance **What are Islamic Financial Instruments?** Islamic financial instruments adhere to Shariah principles, enabling productive economic activities while upholding Islamic values, unlike certain conventional financial products. These instruments are founded on specific types of contracts in accordance with Islamic law (Shariah). Under the Islamic concept of funds supply, three main classifications of financial instruments are available: 1. **Trade-based modes of financing**: These instruments facilitate trade transactions, such as Murabaha (cost-plus financing) and Salam (deferred delivery sale), Istisna (manufacturing contracts). 2. **Rental-based modes of financing**: These instruments involve leasing arrangements, such as Ijarah (leasing) 3. **Participation-based modes of financing**: These instruments entail partnerships and profit-sharing arrangements, such as Mudharabah (profit-sharing) and Musharakah (joint venture). **TRADE-BASED MODES OF FINANCING** Trade means the action of **buying and selling** goods or services. Selling of an item begins with an Offer from the seller, which is he accepted by the buyer. For that matter both seller & buyer must be **sane, adults** and **capable of completing the Offer & Acceptance**. As such a child or mentally incapable person cannot conduct the Sale. **Honesty & fairness** on both parties is fundamental to selling in Isam. \"An honest Trader will be with Prophets, Shuhadaa and Saaleheen on day of Judgement\". Hadith E-Nabawi (Saying \'s of the Holy Prophet Peace be upon Him) **Rules for a Sale to be Considered Valid in Islam** 1. The subject of Sale must 'Exist' at the time of Sale. 2. The Seller must Own the item at the time of Sale. 3. The subject of Sale must be in Physical or Constructive Possession of the seller when he sells. 4. The sale must be agreed & finalized at that place & time. Payment of Price & Delivery of goods could be in future, however. 5. The subject of sale must be a property of value. An item having no value according to the usage of trade cannot be sold or purchased. 6. The subject of sale should not be a thing which is used for a Haram purpose only, like pork, wine etc. 7. The subject of the sale must be specifically identified and known to the buyer. For example, a specific apartment in a multi-store building. 8. The delivery of the sold commodity to the buyer must be certain and should not depend on a chance or unforeseen event. 9. The certainty of price is a necessary condition for the validity of a sale. If the price is uncertain, the sale is void. 10. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of trade. **Trade-based Modes Contracts** These are contract that are nature in trade that include buying and selling of lawful subject matter. **Trade-based Modes of Financing are:** a. Bai bithaman Ajil (Defferred payment) b. Musawwama (Bargain Sale) c. Murabaha (cost plus markup) d. Tawarruq (Commodity Murabaha) e. Salam (Forward sale) f. Istisnaa (Manufacturing sale) **Let's differentiate first.** - Bai bithaman Ajil (Defferred payment) price (Cost and Profit are Unknown) - Musawwama (Bargain Sale) price (Cost and Profit are Unknown) - Murabaha (cost plus markup) price (Cost and Profit Known and agreed) **BAI BITHAMAN AJIL (BBA)** Bai bithaman Ajil sale of goods with differed payments, i.e. bai(sale), bithaman (price), ajil (deferment). Bai Bithaman Ajil is a "deferred payment sale", which works like a Murabaha contract, but with payment generally made on a deferred basis. In some countries Bai Bithaman Ajil is also known as Bay' al Muajjal Technically, this financing facility is based on the activities of buying and selling. The asset that the customer wishes to purchase, for example, is bought by the bank and sold to the customer at an agreed price after the bank and customer determines the term and the manner of the instalment. **EVIDENCE** In general, no issue arises from the practice of deferring the payment of sale price. It is reported in a Hadith by a Companion, Jabir, that the Prophet (s.a.w) **bought a camel from him outside the city of Madinah whereby the payment was settled later on in Madinah**. In another Hadith, it was narrated by Aisha r.a that the prophet s.a.w bought a meal from one Yahudi with deferred payment, and he mortgaged his iron shirt which is made from iron. **CONDITIONS OF BBA** 1. BBA is permitted in Islam only for non-ribawi commodities. 2. Majority of jurist stated that duration of contract must be clearly stated in a precise manner whether using Islamic calendar or any foreign calendar provided it is reliable. 3. The payment of BBA could be made in several form: a. b. c. ![](media/image4.png) **MUSAWAMA (BARGAINING ON PRICE)** Musawamah is a general and regular kind of sale in which the price of the commodity to be traded is bargained between the seller and the buyer without any reference to the price paid or cost incurred by the Seller. Thus, it is different from Murabahah in respect of the pricing formula. Unlike Murabahah, the seller in Musawamah is not obliged to reveal his cost. All other conditions relevant to Murabahah are valid for Musawamah. **MURABAHA (COST PLUS MARKUP)** Murabaha is selling a commodity as per the purchasing price with a defined and agreed profit mark-up. A contract of sale between the bank and its client for the sale of goods at a price plus an agreed profit margin for the bank. The seller is obliged to tell the buyer his cost price and the profit he is making. This contract has been modified a little for application in the financial sector in its modern form Murabaha has become the single most popular technique of financing amongst the Islamic banks all over the world. **Permissibility of Murabahah** - ***{"\...Allah has permitted trade\..."}*.2:275.** **ESSENTIAL CONDITION OF MURABAHAH CONTRACT** 1. Buyers should know the cost price of goods in Murabahah transactions. 2. Currencies subject to currency exchange rules can\'t be sold through Murabahah. 3. Credit documents cannot be subject to Murabahah. 4. Sellers must **honestly** state the original price and any additional expenses. 5. Sellers must disclose all aspects of the commodity and payment mode. 6. Both buyer and seller must agree on the profit margin. **MURABAHA TO PURCHASE ORDERER (MPO):** The bank finances the purchase of goods on behalf of the customer and sells them to them at a markup price. Modern Murabaha transactions by banks normally take the form of Murabaha to Purchase Oder (MPO) Which is arrangement wherein the bank, upon request by the customer, purchases an asset from a third party and sell the same to the customer, on a differed payment basis. **NEED OF MPO** 1. Islamic banks avoid maintaining inventories due to the high costs associated with storage and holding. 2. It\'s impractical for Islamic banks to purchase all items in advance for Murabaha transactions due to the extensive and continuously changing list of goods. 3. Clients may require specific quality goods that banks may not be aware of or have access to sources for, making inventory management challenging. 4. Keeping similar items in inventory may not be acceptable if clients demand specific goods. 5. Central banks typically prohibit banks from engaging in trading activities. **HOW DOES MURABAHAH WORK?** Murabaha is widely used in Islamic banking, in line with Shariah principles, as an interest-free alternative to conventional loans. In a Murabaha contract, the bank and the customer mutually agree on sale specifics, including goods cost, profit margin, payment terms, and delivery date. The markup generally corresponds to prevailing market rates for similar goods. **Murabaha in Islamic banking involves four stages:** 1. **Promise Stage**: The client requests goods from the Islamic bank and promises to buy them once procured from a third-party vendor. 2. **Agency Stage:** The bank appoints the client as an agent to purchase the specified goods on its behalf. 3. **Possession Stage:** After purchase, the bank takes possession of the goods, transferring the risk to itself. The customer acts both as the bank\'s agent and as the purchaser, ensuring segregation of roles for a Halal transaction. 4. **Execution Stage**: The bank sells the goods to the client, finalizing the Murabaha contract. The contract specifies the cost and profit margin, with payment terms being immediate or deferred. Possession of the goods is necessary for execution, and the goods must exist at the time of the transaction. A screen shot of a computer Description automatically generated **Challenges in Murabahah Financing** Special care is required when implementing the Murabahah and the underlying Islamic principles. 1. Interest as Benchmark Rate: 2. Payment: customer fail to repay the amount due. 3. Penalty on late payments: charity accounts. 4. Rescheduling of payments: The amount of the Murabaha price WILL REMAIN THE SAME IN THE SAME CURRENCY. 5. Rollover in Murabaha: This extends the payment period with an additional markup charged to the client, effectively creating a new Murabaha agreement on the same commodity. **TAWARRUQ** **What is Tawarruq?** Tawarruq is a financing arrangement where the customer will be receiving cash at the end of it for his needs through a series of sale transactions. **How Tawarruq is done?** The bank will purchase commodities from a supplier (first sale) and sells them to customer (second sale). The customer then, will sell the commodities to a different supplier to get the required cash(third sale). ![A diagram of a financial institution Description automatically generated](media/image6.jpg) **Is Tawarruq a Murabaha?** Tawarruq is the whole financing arrangement to get cash whereas Murabaha is the most common sale contract used between the Bank and the customer (second sale). **What commodities could be used in Tawarruq?** All commodities except for gold and silver are suitable for Tawarruq but usually metals, palm oil and others are being used. **What is the Shari'a ruling on Tawarruq?** Tawarruq is permissible as long as all three sale transactions (the first, second and third sale) satisfy the Shari'a requirements of a valid sale in addition to the customer selling the commodities to a different supplier in the third sale. **When would Tawarruq is considered invalid? ** It is considered invalid upon not observing the Sharia requirements such as existence of commodities, taking ownership and possession of commodities before selling them and not selling to the same supplier twice. **What is done to ensure that the sales in Tawarruq observed the Shari'a requirements?** Every sale in Tawarruq is properly executed and documented to evidence that the commodities exist, ownership transfer, possession taking and other requirements apart from conducting Shari'a audit on every stage of the transaction. **Can the customer appoint an agent to sell the commodities on his behalf in the third sale?** The customer may appoint an agent to sell the commodities on his behalf and should preferably someone other than the seller of the second sale (the Bank). **RENTAL-BASED MODES OF FINANCING** **IJARA (LEASING)** **Introduction to Ijara:** The term \"Ijara\" originates from the Arabic root word \'ajr\', meaning reward or wages for services rendered. In the financial context, Ijara is a bilateral contract involving the transfer of the use of an asset for an agreed period in exchange for consideration. It entails two parties: the lessor (Muajir), who owns the asset, and the lessee (Mustajir), who utilizes the asset. **Key Elements of Ijara:** 1. **Transfer of Usufruct:** The lessor temporarily transfers the right to use the asset to the lessee for an agreed period. However, ownership remains with the lessor, along with associated risks. 2. **Ownership and Risks:** The lessor retains ownership of the leased asset, bearing all risks related to ownership. The lessee holds physical possession of the asset in trust but is not liable for losses unless due to misuse or intentional negligence. 3. **Dual Usage of Term Ijara:** In Islamic jurisprudence, Ijara refers to both the lease of assets and employment for services, such as teachers, lawyers, and doctors. 4. **Contractual Elements:** Ijara, like all contracts, involves offer and acceptance (Ijab and Qabul). The parties include the lessor and lessee, with the leased asset (Majur) and the rent (Ujrah) being the subject matter of the contract. **TYPES OF IJARA:** 1. **Ijara:** This type of Ijara involves the leasing of an asset for an agreed period in exchange for rental payments. At the end of the lease term, the lessee has no obligation to purchase the asset, and the lessor retains ownership. It operates similarly to an operating lease in conventional finance. 2. **Ijara wa Iqtina:** Also known as Ijara with the option of ownership, this type of Ijara offers the lessee the option to purchase the leased asset at the end of the lease term. Throughout the lease period, the lessee pays rent to the lessor. If the lessee decides to exercise the purchase option, a portion of the rent paid may be considered as equity towards the purchase price. Once the purchase option is exercised, ownership of the asset is transferred to the lessee. **SHARIAH RULES AND GENERAL PRINCIPLES GUIDING IJARA CONTRACTS** **Rental or Lease in Islamic Finance** 1. **Determining Rental Amount** - **Fixed Rent**: The rental amount must be agreed upon and determined at the time of the contract. - **Variable Rent**: Different amounts of rent can be set for different phases of the lease period. It\'s allowed to link the rent to a variable benchmark, but there must be a clear ceiling and floor limit. The lessor cannot increase the rent unilaterally. 2. **Lease Period** - The duration of the lease must be clearly specified at the start of the contract. 3. **Purpose of Lease** - If the lease agreement does not specify a particular purpose, the asset can be used for any normal purpose for which it is typically used. 4. **Responsibilities of the Lessor** - **Asset Destruction**: If the asset is destroyed during the lease period, the lessor bears the loss. - **Loss of Usufruct**: If the asset loses its utility without any negligence from the lessee, the lessor cannot claim the rent. - **Expenses**: The lessor is responsible for all costs related to purchasing and importing the asset, including taxes, registration fees (e.g., for a car), and insurance. 5. **Responsibilities of the Lessee** - **Damage and Negligence**: The lessee must cover any costs associated with damage from misuse or negligence, including taxes related to the use of the asset. - **Normal Wear and Tear**: The lessee is also responsible for normal wear and tear of the asset. 6. **Rental Payments** - Rent, or part of it, may be paid in advance before the asset is delivered. In financial leases, rent can be based on aggregate costs. **PARTICIPATION-BASED MODES OF FINANCING** **Participation-Based Modes of Finance** Participation-based modes of finance in Islamic finance focus on collaborative partnerships and profit-and-loss sharing. They are based on the principles of shared risk and reward. The two main types of participation-based financing are **Mudarabah** and **Musharakah**. **Mudarabah** **Mudarabah** is a partnership where one party provides capital (Rabbul-mal) and the other provides expertise and management (Mudarib). Here's how it works: 1. **Types of Mudarabah:** - **Mudarabah Muqayyadah (Restricted):** The capital provider sets specific conditions on how the investment can be used. - **Mudarabah Muthalaqah (Unrestricted):** The entrepreneur has more freedom in using the funds without specific conditions. 2. **Conditions:** - **Consent:** Both parties must agree on terms, including profit-sharing ratio, investment goals, and venture duration. - **Capital Contribution:** The capital provider gives the money, and the entrepreneur contributes labor and expertise. - **Profit-Sharing Ratio:** Profits are shared based on a pre-agreed ratio. - **Loss Bearing:** The capital provider bears the financial loss, except if caused by the entrepreneur's negligence. - **Termination:** Either party can end the Mudarabah at any time with notice. At termination, if assets are in cash, they are distributed as per the ratio. If not, assets are sold to determine profit or loss. **Musharakah** **Musharakah** is a partnership where all parties contribute capital and share in profits and losses. It's an ideal alternative to interest-based financing. 1. **Types of Musharakah:** - **Shirkah al-Aqad (Commercial Partnership):** For business purposes. - **Shirkah al-Milk (Joint Ownership):** For ownership of specific assets. 2. **Shariah Legitimacy:** - Based on Hadith, where Allah is a partner if no cheating occurs. 3. **Rules:** - **Capital:** Contributions must be specified and assets liquid or valued. - **Management:** Partners can manage or appoint a manager. Some may choose to be silent partners. - **Profit & Loss:** Profits are shared according to the agreed ratio. Losses are shared in proportion to the investment. - **Termination:** Any partner can end the Musharakah with notice. Assets are distributed or liquidated based on agreement. 4. **Diminishing Musharakah:** - **Definition:** A partnership where one partner buys out the shares of the other gradually. - **Components:** 1. **Joint Ownership:** Both partners own the asset initially. 2. **Usage:** One partner uses the asset while paying rent. 3. **Redemption:** The buying partner gradually acquires full ownership. - **Application:** Commonly used for financing fixed assets like houses, cars, or machinery. **Diminishing Musharakah Example:** 1. Client selects a house and enters into a Diminishing Musharakah with the bank. 2. Both parties own the house based on their investment ratios. 3. The bank leases its share to the client. 4. The client buys units of the bank's share over time. 5. Rent and purchase terms are agreed upon, including possible benchmarks for adjustment. 1. **Meaning and Scope of Takaful** 1. Introduction of conventional Insurance 1. Meaning of Insurance 2. Function of Insurance 3. Benefit of Insurance 4. Principle of Insurance 2. Insurance from the shariah perspective 5. Interest 6. Gharar 7. Maysir 3. Meaning of Islamic Insurance 4. Takaful Product 8. Family Takaful 9. General Takaful 10. Health Takaful **Introduction to Conventional Insurance** Conventional insurance helps people manage and reduce risks. Individuals or businesses pay premiums to an insurance company, and in return, the company promises to provide financial support if something unexpected happens, like a death, illness, or property damage. The company gathers these premiums into a fund, which is used to pay compensation to clients when a covered event occurs. This system works best when many people participate, as it helps spread the risk across a large group. However, conventional insurance faces criticism from an Islamic perspective because it includes elements of uncertainty (gharar), gambling (maysir), and interest (riba), which go against Shariah law. To address these concerns, Takaful was created as a Shariah-compliant alternative for managing risks. **Definition of Insurance** Insurance is a financial mechanism where a client transfers risk to an insurance provider, which offers compensation **if an insured event happens**. Insurance types include life, health, fire, motor, and marine insurance, and it involves an agreement between at least two parties: the client (or policyholder) and the insurer. **Functions of Insurance** Modern insurance typically serves three key functions: 1. **Risk Transfer** 2. **Creating a Common Pool** 3. **Setting Fair Premiums** **Benefits of Insurance** Insurance plays a vital role in a strong economy and is often mandatory in many areas. It also supports industrial growth. Here are some key benefits: 1. **Peace of Mind** 2. **Controlling Loss** 3. **Social Benefits** 4. **Economic Benefits** **\ ** **Principles of Insurance** Insurance contracts between clients and insurers are based on several key principles: 1. **Insurable Interest** 2. **Utmost Good Faith** 3. **Indemnity**\ The principle of indemnity ensures that the client is compensated only for the actual loss incurred, not more. The goal is to restore the client to their previous financial position. For example, if a car is damaged, the insurer will cover the repair costs but will not pay more than the car\'s value. Life insurance is an exception because, upon the death of the insured, the payout is not meant to restore financial status but to support the beneficiaries. 4. **Subrogation**\ Subrogation allows the insurer to claim any benefits from the insured item after compensating the client. For instance, if the insurer pays a claim for damages caused by a third party, the insurer can pursue that third party for recovery. This principle prevents the insured from receiving more than their loss, in line with indemnity. 5. **Proximate Cause** **TAKAFUL (ISLAMIC INSURANCE)** **Introduction** Insurance functions as a risk-transfer mechanism wherein the insured entity shifts its risk to an insurer in exchange for a premium. Clients view insurance as a means of risk mitigation, alleviating the financial burden from potential losses like accidents, theft, or death. In response to the criticisms of conventional insurance by Islamic scholars, **Takaful** was developed as an alternative that aligns with Shariah principles, offering a faith-based approach to risk management. **Risk Mitigation from the Shariah Perspective** Shariah encompasses a comprehensive framework based on Quranic teachings and the practices of the Prophet Muhammad (peace be upon him), advocating for risk mitigation as a valuable function. The story of Prophet Yousuf, who managed resources wisely, illustrates the importance of financial planning. Moreover, the Hadith encouraging preparation--- "Tie it and rely \[upon Allah\]"---supports taking proactive measures against risk. While Shariah supports risk mitigation, it rejects conventional insurance due to elements like riba, gharar, and maysir. Acceptable risk-mitigation mechanisms must not contain these prohibited features. **Cooperation** Islam promotes cooperation and mutual assistance among individuals. In the insurance model, losses suffered by some are compensated by contributions from many. This cooperative principle aligns with the Quranic directive to assist each other in righteousness and prohibits aiding in sinful actions. Insurance facilitates this cooperation by pooling resources to address individual losses collectively. **The Mechanism of Insurance** While Islam endorses risk mitigation, the conventional insurance mechanism is deemed impermissible due to the presence of riba, gharar, and qimar. **Takaful**, on the other hand, adheres to Shariah principles and thus is considered a valid form of risk mitigation. **How the Insurance System Works** In traditional insurance, customers pay premiums to protect against financial losses from events like death or accidents. Life insurance also includes components of savings and investment, encouraging clients to save. Insurance can be categorized into two types: life insurance, which involves protection, investment, and expenses; and non-life (general) insurance, which typically involves protection and expenses. **Protection, Investment, and Expenses in Insurance** - **Protection**: Insurance provides financial security against uncertain events. For instance, life insurance can alleviate financial burdens for families following the death of a breadwinner. - **Investment**: Life insurance combines risk coverage with investment, offering returns based on premiums paid. If the insured person survives the coverage period, they receive a maturity claim. - **Expenses**: Insurance companies incur various costs, including claims payments, administration expenses, and shareholder dividends. **The Generic Insurance Model** Insurance operates on a model where companies provide policies in exchange for premiums. The premiums collected are pooled and invested to generate income, which is critical for the insurer\'s profitability. There is typically a delay between premium payments and claims, allowing insurers to invest funds for income. The financial health of an insurance company is assessed by comparing total expenses against the claim fund, which consists of both premium contributions and investment income. **Riba, Gharar, and Maysir in Conventional Insurance** In Islamic law (Shariah), conventional insurance is considered impermissible due to the presence of three major prohibited elements: **riba** (interest), **gharar** (excessive uncertainty), and **maysir** (gambling). Below is an analysis of these elements in the context of conventional insurance. **Riba, Gharar, and Maysir in Conventional Insurance** In Islamic law (Shariah), conventional insurance is considered impermissible due to the presence of three major prohibited elements: **riba** (interest), **gharar** (excessive uncertainty), and **maysir** (gambling). Below is an analysis of these elements in the context of conventional insurance. **1. Riba (Interest)** **Definition**: Riba refers to an excess, increase, or unjust gain in a transaction, particularly related to loans or debts. In practice, it involves the payment and receipt of interest. **Why Riba is Prohibited**: The prohibition of riba is emphasized in both the Quran and the Hadith. Riba is forbidden because it leads to exploitative gains, where one party benefits at the expense of another without any productive exchange. It disrupts economic justice by making money from money rather than providing real goods or services. **How it Applies in Insurance**: - **Investment of Premiums**: In conventional insurance, companies typically invest the premiums they collect from policyholders into various financial instruments, many of which involve interest-bearing assets like government bonds or corporate debt. The returns on these investments are based on interest (riba), which is forbidden in Islam. - **Fixed Returns**: In some life insurance policies, the payout is predetermined. For instance, in \"whole life\" insurance or \"endowment\" policies, the insurer promises a guaranteed return or profit over time, which is often generated from interest-bearing investments. The element of riba in insurance contradicts Islamic finance principles, which prohibit making money simply from money. In Islamic finance, returns must be linked to real economic activities or investments in halal (permissible) ventures, not to interest. **2. Gharar (Uncertainty)** **Definition**: Gharar means uncertainty or ambiguity in a contract. Shariah prohibits contracts that involve excessive uncertainty, as it can lead to disputes, undue loss for one party, and unfair enrichment for the other. **How it Applies in Insurance**: - **Uncertainty of Outcome**: In conventional insurance, the policyholder pays a premium, but it is uncertain whether they will ever receive a payout. If no insured event (like an accident, fire, or death) occurs, the insured loses the entire premium. Conversely, if a loss happens, they may receive a payout far exceeding what they paid in premiums. This uncertainty, particularly over whether a payout will occur and how much it will be, introduces gharar into the contract. - **Unknown Timing of Payouts**: Neither the insurer nor the insured knows when or if the insured event will occur. For example, in life insurance, it is unknown when the policyholder will die, making the payout date uncertain. This uncertainty is viewed as a form of gharar, as the terms of the contract depend on unpredictable events. For example, if someone buys car insurance and no accident occurs, they lose the premium they paid. However, if an accident occurs, the person may receive a payout far greater than the amount of premiums they contributed. This imbalance creates uncertainty about the obligations of the insurer and the benefit to the insured. **Conditions of Gharar**: Gharar is present in a contract when: - There is uncertainty in the core elements like the subject, price, or outcome. - The degree of uncertainty is excessive (gharar e kaseer), meaning it substantially affects the fairness of the contract. **3. Maysir (Gambling)** **Definition**: Maysir refers to any transaction or contract in which one party gains at the expense of another based on an uncertain outcome. It often involves easy gain or loss without a fair exchange of goods or services. **Maysir in Insurance**: - In a conventional insurance policy, the outcome is uncertain for both parties. The policyholder may either lose their premium (if no claim is made) or gain a significant amount (if a claim is made). Similarly, the insurer either profits from not paying claims or suffers losses when claims exceed premiums. - This uncertain gain/loss structure resembles gambling, where the potential for profit or loss is determined by chance rather than productive activities. **How it Applies in Insurance**: - **Risk and Profit Based on Uncertain Events**: In conventional insurance, the transaction resembles a gamble in that the policyholder pays a premium in the hope that they won't need to make a claim. If no claim is made, they lose the premium paid to the insurer, just as a gambler might lose their bet. On the other hand, if an insured event occurs, the policyholder may receive a large payout (much more than the premiums they paid), and the insurer suffers a loss. This gain-or-loss structure, dependent on an uncertain event, is similar to gambling. For example: - A person pays \$2,000 annually for home insurance. If their home burns down, the insurer may pay them \$100,000. If no such event occurs, the policyholder loses the \$2,000. Both the policyholder and the insurance company are engaging in an uncertain outcome, where one party's profit is directly tied to the other's loss---an aspect of maysir. - **Profit Motive of Insurers**: Insurance companies operate for profit, and their profitability depends on fewer claims than expected. If most policyholders do not experience losses and thus do not make claims, the insurance company profits significantly from the premiums collected. However, this profitability is driven by the unpredictability of claims, which aligns closely with the concept of maysir. **Islamic Perspective on Risk Mitigation and Takaful as an Alternative** **Risk Mitigation**: Shariah encourages risk mitigation and proactive financial planning, as evidenced by the teachings of the Quran and Hadith. However, it strictly requires that the methods used to mitigate risk do not involve prohibited elements like riba, gharar, or maysir. **Takaful (Islamic Insurance)**: - Takaful offers a Shariah-compliant alternative to conventional insurance. In Takaful, participants contribute to a pool of funds used to mutually assist members who suffer losses. Unlike conventional insurance, Takaful operates on the principles of shared responsibility, mutual cooperation, and donation (tabarru'). - It eliminates riba by ensuring that funds are invested in halal (permissible) businesses. Gharar is minimized because participants know in advance the nature of their contributions and the mechanism of compensation. Finally, maysir is avoided as Takaful is based on mutual assistance, rather than profit-driven risk. **TAKAFUL PRODUCTS** Takaful operators have developed a diverse range of products tailored to meet the specific needs of customers, ensuring that anything of value can be protected. These products fall under three broad categories: 1. **Family Takaful (Life Insurance)** 2. **General Takaful (Non-Life Insurance)** 3. **Health Takaful** In this chapter, we\'ll explore each of these categories in detail to understand the variety of Takaful products available and how they can benefit individuals and businesses alike. **1. Family Takaful (Life Insurance)** **Family Takaful** is an Islamic alternative to conventional life insurance, designed to provide financial security for individuals and their families in case of death or disability. Participants in a Family Takaful plan contribute to a shared fund that is used to provide benefits to members or their families if a specified event occurs, such as death or illness. - **Coverage**: Family Takaful offers protection for individuals\' lives, and the plan can include options for providing funds to beneficiaries, covering funeral costs, or supporting loved ones financially. - **Key Features**: - No interest (riba) or gambling (maysir) involved. - Contributions are considered **donations** to the Takaful fund. - Profits are shared among participants or reinvested in the fund. **2. General Takaful (Non-Life Insurance)** **General Takaful** covers non-life risks and provides protection for a wide range of physical assets. This can include homes, cars, businesses, and goods in transit. General Takaful is often used by individuals and businesses to protect against damage, theft, or accidents that could result in financial losses. - **Coverage**: - Personal property (homes, vehicles, valuables). - Commercial assets (factories, buildings, machinery, business vehicles, and inventory). - Public liability (such as employer's liability for employee safety or third-party claims). - **Key Features**: - Protects tangible assets from risks like fire, theft, accidents, or natural disasters. - Flexible options to suit personal or business needs. **3. Health Takaful** **Health Takaful** provides coverage for medical expenses, ensuring that participants have access to healthcare when they need it. This includes hospitalization, surgeries, doctor visits, and medication. It is similar to conventional health insurance but adheres to Shariah principles by avoiding interest and uncertainty. - **Coverage**: - Hospitalization, surgery, and medical treatments. - Regular health check-ups and consultations. - Other medical expenses depending on the plan. - **Key Features**: - Collective contributions from participants fund the medical expenses of those in need. - Designed to ensure access to medical care without financial strain.

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