Islamic Banking Practices PDF

TABLE OF CONTENTS LESSON 1 – ISLAMIC ECONOMIC SYSTEM....................................................................... 1 INTRODUCTION................................................................................................................... 1 NATURE OF SHARIA’H RULING............................................................................................ 1 SOURCES OF SHARIA’H....................................................................................................... 1 INTRODUCTION TO ISLAMIC ECONOMICS............................................................................ 3 DISTRIBUTION OF WEALTH – AN ISLAMIC PERCPECTIVE..................................................... 4 IMPORTANCE OF ECONOMIC GOALS.................................................................................... 4 NATURE OF WEALTH AND PROPERTY IN ISLAM................................................................... 5 LESSON 2 – FACTORS OF PRODUCTION IS ISLAM.......................................................... 8 CAPITALISTIC VIEW............................................................................................................ 8 SOCIALISTIC VIEW.............................................................................................................. 9 ISLAMIC VIEW..................................................................................................................... 9 SOCIALISM AND ISLAM..................................................................................................... 10 CAPITALISM AND ISLAM................................................................................................... 10 TYPES OF CAPITAL INVESTMENT........................................................................................ 11 LESSON 3 – INTRODUCTION, HISTORY AND EVOLUTION......................................... 14 ISLAMIC BANKING............................................................................................................ 14 HISTORY OF ISLAMIC BANKING......................................................................................... 14 EVOLUTION OF ISLAMIC BANKING IN PAKISTAN............................................................... 15 LESSON 4 – RIBA, DEFINITION, PROHIBITION AND TYPES....................................... 17 PROHIBITION IN QURAN.................................................................................................... 17 PROHIBITION IN HADITH................................................................................................... 19 CLASSIFICATION OF RIBA................................................................................................. 19 LAWS OF RIBA AL FADL.................................................................................................... 22 LESSON 5 –ISLAMIC CONTRACTS..................................................................................... 24 UNILATERAL PROMISE...................................................................................................... 24 BILATERAL PROMISE......................................................................................................... 25 CONTRACT AND TYPES...................................................................................................... 25 ESSENTIAL OF CONTRACT................................................................................................. 26 OTHER ISSUES IN CONTRACT............................................................................................ 27 LESSON 6 – SALE AND ITS TYPES....................................................................................... 29 VALID SALE AND ESSENTIALS........................................................................................... 29 BAATIL, FAASID AND MAKROOH SALE.............................................................................. 32 OTHER TYPES OF SALE..................................................................................................... 32 PROHIBITED SALE............................................................................................................. 33 OPTIONS TO SALE(KHIYARS)............................................................................................ 34 LESSON 7 – BANKING FRAMEWORK............................................................................... 35 UNDERSTANDING THE DIFFERENCE................................................................................. 35 PRODUCT WISE COMPARISON (ISLAMIC VS CONVENTIONAL)............................................ 37 NEW CHALLENGES FOR THE INDUSTRY............................................................................. 40 LESSON 8 – LIABILITY SIDE ON ISLAMIC BANK........................................................... 41 DEPOSIT SIDE OF ISLAMIC BANKS..................................................................................... 41 MUDARABAH.................................................................................................................... 41 TYPES OF MUDARABAH.................................................................................................... 42 INVESTEMENT IN MUDARABAH........................................................................................ 42 CONDITION FOR PROFIT SHARING, EXPENSES IN MUDARABAH.......................................... 43 ROLE OF ISLAMIC BANK IN MUDARABAH......................................................................... 44 MANAGEMENT OF DEPOSIT POOL..................................................................................... 44 PROFIT CALCULATION AND DISTRIBUTION........................................................................ 46 ASSIGNING OF WEIGHTAGES............................................................................................. 47 PROFIT SHARING MECHANISM.......................................................................................... 47 Islamic Banking Practices (BNK610) VU ISLAMIC ECONOMIC SYSTEM Lesson - 1 Introduction The Islamic Economic system is defined as a system which is governed in conformity with the rules of Sharia’h. Sharia’h can be explained as a "Way to be followed" and can be explained as a set of divine commands and laws that controls every aspect of human beings in their individual and collective lives. Individual and collective life aspects can be divided into five parts. Thus, Sharia’h provides a pathway to be followed in all these five classes. The five categories are: 1) Beliefs (Aqaid) 2) Acts of Worship (Ibadaat) 3) Dealing with others (Muamlaat) 4) Manners (Ikhlaqiat) 5) Economics (Maishat) The nature of Sharia’h rulings are as follows Sharia’h rules can be divided into Dos (orders to undertake any act) and Don’ts (prohibition from some acts), which can further be divided into the Ibadaat (matters of worship) that are considered as rights of Allah (SWT) and Muamlaat (the matters for disciplining human life) that constitute the rights of human beings. Ibadaat (worship) govern the relationship between man and Allah the general principle in Ibadaat is that “nothing is permitted unless explicitly permitted by Sharia’h, the acts have to be accomplished strictly according to the Sharia’h principles, the latter matters that pertain to socio-economic rights and obligations are governed by the rule of “General Permissibility”, all acts are permitted unless clearly prohibited by Sharia’h. it is important to note that, Allah may forgive us on any lapse in respect of Ibadaat, while lapses in respect of the Muamlaat would have to be forgiven only by the aggrieved person. 1) Halaal: All those actions that are allowed and declared permitted by Sharia’h. 2) Haraam: All those actions that are forbidden and declared unlawful by Shariah and their impressibility are derived from either the Holy Quran or Hadiths or Ijma. Sunnah e Mutawaatirah as the strongest narrations of the Holy Prophet in terms of their narrators, i.e. the narrators is in such a large number that it is impossible for all of them to have agreed on a false issue. 3) Faraiz: All those actions that are declared mandatory by either Quran or Sunnah. 5) Sunnah: All those actions that are recommended to be performed by Muslims, based upon the association of those actions with Holy Prophet (PBUH). Sources of Sharia’h: Rule and regulation of Islamic Sharia’h can be driven from following sources. 1) Quran 2) Hadiths 3) Ijma © Copyright Virtual University of Pakistan 1 Islamic Banking Practices (BNK610) VU 4) Qiyas 5) Ijtihad Quran: Quran is the word of Allah Ta’ala revealed over Prophet Muhammad (PBUH). Holy Quran is the first and main source of Sharia’h for Muslims. The commands mentioned in the Holy Quran are obligatory to follow and anyone who denies commands of the Holy Quran is considered to be a non-Muslim. Most of the ruling mentioned in Holy Quran is rigid in nature such as for offering Salah just order are mentioned in Quran but information about method and other detailed information about offering Salah may be obtained from other sources of Sharia’h such as Sunnah. “And obey Allah and His Messenger, if you are believers.” (8:1) Sunnah: Sunnah can be defined as the sayings of and the actions done and/or ratified by the holy Prophet (PBUH), is an equally significant source of information in Islamic law. Sunnah provides detailed information about the code of conduct for every spheres of life and is also considered as Divine Revelation. The significance of obeying Sunnah can be judged from the following verse of Holy Quran, “Indeed you have in the Messenger of Allah an excellent example for the one who hopes in Allah and looks to the Last Day” (33: 21). All Muslims consider obligatory to observe to the order of the holy Prophet (PBUH), it is necessary for being a Muslim. The details about Sunnah are preserved in the form of Ahadiths. On the basis of clear injunctions of Holy Quran, Sunnah can thus be regarded as the second source of Islamic Shariah after Quran e.g. Rules for Riba al Fadl has been extracted from Sunnah. Ijma: The consensus of scholar of Ummah on a particular issue is termed as Ijma. After Sunnah it is considered as most authoritative source of Islamic Sharia’h since it involves the unanimous opinion of the scholars of a particular era with the interpretation of Holy Quran and Hadiths on s particular issue. The status of Ijma as an authoritative source of Shariah has also been established from the following saying of Holy Prophet (PBUH). "My Ummah shall never be combined on an error." Qiyas: Qiyas means to apply a familiar rule of Sharia’h specifically mentioned in the Holy Quran and Sunnah, to a similar thing or situation by way of analogy. Qiyas, or finding solutions through analogy in the light of the text of the Qur’an and Sunnah, are the secondary sources for derivation of rules and regulation for any upcoming events or issues. Meaning of Qiyas can further be explained with example; one law derived from Qiyas is the ruling on drinks like beer, whisky or brandy. Neither the Qur’aan, nor the Hadith, names these. However, Quran mention that khamr (date wine) is Haraam, on this ground, that all the aforementioned drinks cause intoxication, all sorts of alcoholic beverages are declared Haraam. © Copyright Virtual University of Pakistan 2 Islamic Banking Practices (BNK610) VU Ijtihad: Ijtihad literary means “Ultimate Effort” and precisely it means to apply utmost effort to ascertain the ruling of Sharia’h about a particular situation. The practice of Ijtihad has been duly endorsed by the Prophet Muhammad in following narration: “When the Holy Prophet intended to send his companion Mu’adh, to Yemen as a ruler and as a judge, He asked him: How will you adjudicate a matter when it will come to you?” He said, "I shall decide on the basis of Allah's Book (the Holy Quran)." The Holy Prophet asked, "If you do not find it in Allah's Book (what will you do)?” He said: "then, on the basis of the Sunnah of Allah's Messenger". "If you do not find it even in the Sunnah of Allah's Messenger (what will you do)?” The Holy Prophet asked. He replied: "I shall make Ijtihad on the basis of my understanding and will not spare any effort (to reach the truth).” On this, the Holy Prophet tapped the chest of Hazrat Mu'adh with happiness and said, "Praise be to Allah, who has let the messenger of the messenger of Allah to do what pleases Allah's messenger". (Abu Dawood, Hadith No. 3592). Now days the implementation of Ijtihad is misunderstood most of Shaira’h scholars. Ijtihad cannot be done on those issues where there are clear injunctions of Holy Quran, Sunnah and Ijma. All those new issues and situations where clear commands of Sharia’h are not prescribed or some changes required on particular issues by the scholar, these can only be done by Ijtihad. Ijtihad is not just one’s own opinion based on rational judgment but it is indeed the result of un-biased and ultimate effort of Mujtahid on the basis of principles laid down by Shariah and it must not contradict with any clear defined rule of Islamic Shariah. Just because of complex nature of Ijtihad, the most senior, learned and pious scholar of sharia’h are eligible for Mujtahid and perform Ijtihad. A Mujtahid must have in-depth knowledge and understanding of Quran, Tafasir, Arabic, Background of the revelation of verses of Quran, Ahadiths, Usool e Fiqh etc. Introduction of Islamic Economics: In non-Islamic societies of the world the interest based economic system has been flourished, is one of the form of Capitalism. In such economic system there are usually two parties to the financial transaction, one is the investor who provides the funds on interest and other is the person who manages the funds to run business. The person who invests the funds has no concern over the profitability of business, whether business turned into profit or loss, he will get interest in both outcomes at fixed or variable rate on his invested capital. Islam forbids this kind of business and the Holy Prophet (PBUH) enforced the ruling, not in the form of some moral teaching, but as the law of the land in Islam. It is very important to understand the definition and forbiddance of Riba and the commands relating to its unlawfulness in all respects. It is important to note that on one hand, Quran and Sunnah have strictly warned against Riba, on the other it has become an integral part of today’s economy. The desired liberation from Riba seems to be infested with difficulties as the problem is very complex, important steps and has to be taken up in all possible aspects. First of all, we have to deliberate into the correct understanding of the Quranic verses on Riba and what has been said in authentic Ahadith and then determine what Riba is in the terminology of the Quran and Sunnah, which transactions it covers, what is the fundamental wisdom behind its prohibition and what sort of wrong it brings to the society. First we will look where interest stands in economic philosophy of Islam. © Copyright Virtual University of Pakistan 3 Islamic Banking Practices (BNK610) VU The economic philosophy of Islam and Interest: There is no concept of Riba in the economic philosophy of Islam, because according to Islam, Riba is that curse in society, which causes wealth to mount up among handful of people and it results unavoidably in creating monopolies, inequality and oppression, opening doors for selfishness and greed. In world of trade and business dishonesty and fraud flourish in interest based economy. However Islam does not allow interest based economy rather it primarily encourages highest moral ethics such as universal brotherhood, collective welfare, prosperity, social fairness and justice. Due to this reason, Islam renders Riba as absolutely haram and strictly prohibits all types of interest based transactions. The prohibition of Riba in the light of economic philosophy of Islam can be explained vis-a-vis distribution of wealth in a society. Distribution of wealth: In economic system of human beings the most important and controversial question is regarding distribution of wealth among factor of production. Distribution of wealth has given birth to global revolutions in today's world and has affected every field of human activity from international politics down to the private life of the individuals. For many centuries now, the question of distribution of wealth lead different nation not only in fervent debates, but also in warfare. The fact, however, remains that whatever has been said on the subject without seeking guidance from Divine Revelation and relying just on human reason has had the only and unavoidable result of making the confusion worse confounded. Distribution of wealth – An Islamic perspective: Rulings regarding distribution of wealth are extracted from the Holy Qur'an, the Sunnah and the writings of the Sharia’h research scholars. But before explaining the point, it is very important to clarify certain basic principles which distinguish the Islamic point of view about economics from the non-Islamic point of view. 1. The importance of the economic goals: No doubt, Islam is opposes monasticism, and views the economic activities of man quite lawful, meritorious, and sometimes even necessary and obligatory. Islam acknowledges the economic progress of man, and also accounts for lawful and honest livelihood an obligation for every Muslim. Apart from all this, it is not justifiable to say that Islam does not consider "economic activity" to be the basic purpose of man, nor does it consider the economic progress as end purpose of life. There is confusion between two facts in Islamic economics and many misinterpretations prevail in current scenario i.e. economic progress is considered as ultimate goal of life and further considering it as a necessity in order to have a successful life through lawful means. Even human logic can understand to show that an activity being lawful, or meritorious or necessary is different from it being the ultimate goal of human life and the center of thought and action. It is therefore, from very beginning it is deemed necessary to make this distinction as clear as possible. In fact the intense, basic and far-reaching difference between Islamic economics and materialistic economics can be summarized as: According to materialistic economics: "Livelihood is the fundamental problem of man and economic developments are the ultimate end of human life." While we find in the Holy Quran, the disapproval of monasticism and the order to: "Seek the grace of Allah."(62:10) © Copyright Virtual University of Pakistan 4 Islamic Banking Practices (BNK610) VU While according to Islamic economics: "Livelihood is necessary and indispensable, but cannot be the ultimate purpose of human life." At the same time, we also find in the Quran has forbidden from temptations of worldly life. All these worldly things as a whole have been labeled as "Ad-Dunya" ("the mean") – a term which, in its literal sense does not have a pleasant implication. Apparently, one might feel that the these two commands are contradictory, but the fact is that according to the Quran, all the means of livelihood are no more than just stages of man's journey, his final destination lies beyond them. A man can achieve this ultimate goal through rightful means of earnings livelihood and with good intention is this world. The attainment of these two goals is the real problem and fundamental purpose of a man’s life. Dealing with the worldly life is fundamental headway in attaining these two goals. So, all those things too which are essential for his worldly life, become necessary for man. With above mentioned discussion one can easily understand that the means of livelihood is a path leading towards the final and ultimate destination, but as soon as man gets lost in the networks of this pathway and allows himself to forget his real destination, the very same means of livelihood turn into a “temptation” or into a "trial": “And be aware that your possessions and your children are but a trial." (8:28). The Holy Quran has articulated this basic truth very precisely in a brief verse: “And seek the (betterment of the) Ultimate Abode with what Allah has given to you.”(28:77) This principle has been stated in several other verses too. This attitude of the Holy Quran towards "the economic activity" of man and its two aspects would be very helpful in solving problems of man in Islamic economics. 2. Nature of wealth and property in Islam: The concept of ‘wealth’ in Islam is another fundamental principle for solving the problem of distribution of wealth. According to the illustration of the Holy Quran, ‘wealth’ in all its possible forms is a thing created by Allah, and is, in principle His "property". Allah grant right of His property to use, men are answerable to Him over His property. The Holy Quran explicitly says: “Give to them from the property of Allah which He has bestowed upon you.” (24:33). According to the Holy Quran, all a man can do is devote his labor into the process of production, is the main reason for this philosophy. But Allah alone, and no one else, can cause this exertion to be productive and actually fruitful. Man can do no more than sow the seed in the soil, but to bring out a seedling from the seed and make the seedling grow into a tree is the work of someone other than man. The Holy Quran says: © Copyright Virtual University of Pakistan 5 Islamic Banking Practices (BNK610) VU “Well, tell Me about that (seed) which you sow: Is it you who grow it, or are We the One who grows?” (56:63-64) In another verse: "Did they not see that We have created for them cattle, among things made (directly) by Our hands, and then they become their owners?” (36:71) Above mentioned verse throw the ample light on fundamental principle that ‘wealth’ in every form is the ‘property’ of Allah, and it is He who has conferred upon man the right to exploit it. So Allah has the right to demand that a man who is granted the right to use His property to exploit it according to the instructions of Allah. Thus, man has the "right of property" over the things he exploits, but this right is not absolute or arbitrary or boundless, certain limitations and restrictions are rooted upon these rights, which have been imposed by the real Owner of the 'wealth'. We must spend it where Allah has ordered it to be spent, and refrain from spending it where Allah has forbidden. This point has been explained more clearly in the following verse: “And seek the (betterment of the) Ultimate Abode with what Allah has given to you, and do not neglect your share from this world, and do good as Allah did good to you, and do not seek to make mischief in the land.” (28:77) This verse fully explains the Islamic point of view on the question of property. It places the following guidelines before us: 1. Allah has given all the wealth what a man possess. 2. Man has to use it in such a way that his ultimate purpose should be to seek the bounties and blessings of Allah in this world and hereafter. 3. Use of wealth by man must be necessarily being subject to commandment of Allah, since Allah has bestowed wealth to men. Two divine commandments have been formed: a) Allah may command man to spend a specified production of “Wealth” to another man. This Commandment must be obeyed, because Allah has done good to you, so He may command you to do good to others – “do good as Allah has done good to you.” b) Allah may forbid you to use the “wealth” in any of the way where He wants. Because the primary right belongs to Allah, He cannot allow you to use “wealth” in a way which is likely to produce mutual harms or spread chaos in this world. That’s how Islamic economics differentiates the view of property and wealth from capitalistic and socialist viewpoints. The rational background of capitalistic and socialistic is materialistic and it gives man unconditional and arbitrary power over property they held and all allow them to exploit these resources as © Copyright Virtual University of Pakistan 6 Islamic Banking Practices (BNK610) VU they wish. Islam has adopted an attitude of disapproval of these theories of property, can be revealed in Holy Quran, in quoting the words of the nation of Hazrat Shu’aib (A.S). They used to say: "Does your Salah (prayer) command you that we should forsake what our fathers used to worship or that we should not deal with our wealth as we please?" (11:87) These people used to consider their property as really theirs or "Our property", and hence the claim of "doing what we like" was the necessary conclusion of their position. But the Holy Quran has, in the chapter "Light" substituted the expression “Our possessions” for the term "the property of Allah", and has thus struck a blow at the very root of the Capitalistic way of thinking. And at the same time, by adding the qualification "what Allah has bestowed upon you", it has cut the roots of Socialism as well, which starts by denying man's right to private property. Similarly, "Thus they acquired the right property over them." - A verse in the Chapter "Seen", explicitly affirms the right to private property as a gift from Allah. © Copyright Virtual University of Pakistan 7 Islamic Banking Practices (BNK610) VU FACTORS OF PRODUCTION IN ISLAM Lesson – 2 Conventional economic theory practices particular classification of factors of production. The classification is arbitrary and has no scientific purity attached to it as such. Now the attempts are being made to review and reformulate the theories of production and distribution in Islamic framework, it is high time to review the nature of factors of production. It is the need of the hour to have our own Islamic directions to develop the theories of production and distribution of wealth In this chapter a new classification of factors of production which is not only derived from the Islamic concepts but may be considered more rational even for the conventional theoretical framework. A brief analysis of the factor of production in non-Islamic and Islamic framework is carried out in this chapter. In order to get complete understating on factor of production in Islamic view, we need to compare all factor of production in their associated economic systems including socialism and capitalism. The Capitalist View Capitalistic economic system can be defined as an economic and political system in which a country's trade and industry are controlled by private owners for profit, rather than by the state. In this system private property rights provide individuals with the freedom to produce goods and services they can sell in the market. Before we go further in exploring factor of production in Islamic economy we must have developed and understanding on capitalistic economic view. Distribution of wealth on capitalistic economy can be better understood by looking on the following statement. “Wealth should be distributed only among those who have taken part in producing it, and who are described in the terminology of economics as the factors of production.” There are four factors that are considered to be useful in any production process. 1. Capital: Which has been defined as "the produced means of production" - In other words, capital includes commodity which has already gone through one process of human production, and is again being used as a means of another process of production. Sometimes semi-finished goods are further used for process of production; for example in textile industry finished goods of one company is used as raw material in other company (e.g. thread manufactured in one concern is further used in process of production of cloth). Examples of capital are Money, Machinery, material, semi-finished goods. 2. Labor: It is defined as, any exertion on the part of man. 3. Land: Land can be defined as the “natural resources”. It refers to those things which are used in process of production without having previously been through any process of production. According to the definition of land it will include land and other natural resources like mines etc. 4. Entrepreneur or Organization: Entrepreneur is the fourth factor of production under capitalistic view because it brings the other three factors together, exploits them in the process of production and bears the risk of profit and loss in production. It is considered that wealth is produced by the combination of all four factors, so only these factors have direct right over the wealth because they directly took part in actual process of production and in generating wealth. Wealth generated by process of production is allocated between these four factors in following forms; one share is given to Capital in the form of interest, the second share to Labor in the form of wages, the third share to Land in the form of rent (or revenue), and the fourth share (or the remainder) is kept for the Entrepreneur in the form of profit. © Copyright Virtual University of Pakistan 8 Islamic Banking Practices (BNK610) VU The Socialist View Socialistic economy can be defined as a political and economic system which advocates that the means of production, distribution, and exchange should be owned or regulated by the state as a whole. This system does not allow private ownership over wealth or resources rather state owns all resources of a country. The major difference in socialist and capitalist view is that Socialism stresses equality rather than achievement. Under socialist economy the citizens are fully dependent on the state for everything like food, health and accommodation. Capital and land instead of being private property, these belong to the state and considered as collective property in Socialist economy. So under the philosophy of this system no question arises for distribution of wealth in term of interest and rent on Capital and land respectively. As far as the entrepreneur is concerned, under socialist economy entrepreneurship is also done by the state itself, so, payment of profit is also out of question here. Under socialist economy the state owns everything including land, capital entrepreneurship, there is only one factor left in this philosophy i.e. labor. Labor alone is considered to have a right to wealth under the Socialist system, which it gets in the shape of "Wages". It is pertinent to mention here that although actual practice in socialist countries is quite different from the basic philosophy and theory of socialism, we are just concerned here with the basic concept of the socialistic theory. The Islamic View Under Islamic economics the system of the sharing of wealth is different from both the Capitalist and Socialist economic system. According to Islamic point of view, there are two kinds of people who have right to wealth: 1. Primary Right to Wealth The primary right denotes the right to wealth of those people who have directly taken part in the process of production. In other words, primary right is for those factors of production that have directly contributed in the process of producing some kind of wealth. 2. Secondary Right to Wealth The Secondary right holders are those who have not directly contributed in the process of production, but it has been made compulsion upon the producers to make them co-sharers in their wealth (e.g. beneficiaries of Sadaqat-ul-Wajibaat). Islamic Theory The primary right to wealth is enjoyed by those factors of production which directly take part in process of production, technically Islamic theory has not specifically define the factors of production, but all factors which are directly involved in are neither deprived of their share nor they exploit any. From the Islamic point of view, the actual factors of production are three instead of four. 1. Capital: It can be defined as those means of production which cannot be used in process of production until of unless they either wholly or completely consumed of changed in form during the process of production, these means cannot be leased or fetch any rent (for example, liquid money or food stuff etc.). The share of capital is in the form of profit and not interest. So the profit on any capital is the remaining revenue of a business conducted with that capital after making payment to all other parties; if the residual is negative, the capital owner has to suffer a loss that is the shortfall in the principal employed in the business. © Copyright Virtual University of Pakistan 9 Islamic Banking Practices (BNK610) VU 2. Land: In Islamic perspective land can be termed as those means of production, that are used in the process of production in such a way that their corpus and original form remains unaltered, and which can hence be let or leased (for example, land houses, machines etc.), and their compensation is rent. For example, an owner of a factory would claim rent of land and that of the installed machinery and plant; similarly, owners of houses, vehicles, machines, etc. are entitled to rent. 3. Labor: That is, human exertion, whether of the physical, mental or heart. Organization and planning are also included in these exertions. The share of labor comes in the form of wages. An entrepreneur who, for example, brings together factors like land, labor, machinery and uses his own capital, has to pay wages and rental for the labor and the use of land or machinery as per decided terms; the reward for his entrepreneurship will be earned in the form of profit on his capital provided that there must be some residual after payment of the rental, wages and other expenses on raw materials. Difference between Socialism and Islam After discussing factors of production in detail we can say, the Islamic economic system of the distribution of wealth is different from Socialism and Capitalism both. We can easily make a distinction between Islamic economy and socialist economy, which is quite clear. The concept of private property is not considered in socialism, under socialistic economy labor is the only factor that is entitled to wealth in form of wages. On the other hand, according to the Islamic principles of the distribution of wealth, which we have discussed above, all the things that exist in the universe are in principle the property of Allah Himself. Then, the greater part of these things has been given equally to all human beings as a collective trust. It includes earth, air, light, fire, water, wild grass, hunting, fishing, mines, un-owned and un-cultivated lands etc., nobody can claim over all these things because they are not the property of any individual, but a common trust. Everyone is equally entitled to exploit it; every human being is the beneficiary of this trust. On contrary in socialism there are certain things where the right to private property is necessary to be recognized in order to efficiently establish the real economic system. If all resources like land, capital and organization are totally surrendered to the state, like it is adopted in socialist economy, then eventually it will result as, everyone would be discharging a large number of smaller Capitalists and putting the huge resources of national wealth at the disposal of a single big Capitalist - the state, which can deal with this reservoir of wealth quite arbitrarily, thus would lead to the worst form of the concentration of wealth. Moreover, another evil that is cause by socialism is that, human labor is deprived of their natural right for individual choice and control, compulsion and force becomes inevitable in order to make use of this labor, such pressure effects directly on effectiveness of process of production and on mental health of labor. All this goes to show that the Socialist system harms two out of the three objects of the Islamic theory of the distribution of wealth i.e. the establishment of a natural system of economy, and restricting everyone from what rightfully belongs to them. In unnatural system of socialist economy many evils are inherent to this system, Islam has not chosen to forbid the right to private property altogether, but has rather acknowledged the right to private property on those things of the physical universe which are not held as a common trust. A separate status is given to land and to capital in Islamic economy, and at the same time Islam made use of the natural law of "supply and demand" too in a true spirit. Therefore Islam does not distribute wealth merely in the form of wages, as does Socialism, but in the form of profit and rent as well. Along with this, Islam has also put a prohibition on the category of' 'Interest'', and also given us a long list of the people who have a secondary right to wealth. The great evil of concentration of wealth on handful people is eradicated in Islam, which is an essential characteristic associated in Capitalism. Islamic view has a clear distinction of distribution of wealth as compared to socialism, which sets apart it from socialistic economy. Difference between Capitalism and Islam It is equally essential to understand fully the difference that exists between the Islamic view of the distribution of wealth and the Capitalist point of view. This distinction being rather delicate and complicated, here we will discuss the difference in greater detail. Differentiation between Islamic and capitalist system can be drafted in the following manner. © Copyright Virtual University of Pakistan 10 Islamic Banking Practices (BNK610) VU 1. In Islamic view the reward for ‘capital’ is different from capitalist economy; here ‘profit’ is paid over capital while pre-agreed ‘interest’ on capital is given in capitalist economy. 2. The factors of production have been defined in a different manner in Capitalism and Islam. Capitalism defines "Capital'' as "the produced means of production." Whereas, in addition to money (Gold, silver or paper currency) and foodstuff the capital is supposed to include machinery, building, vehicles etc. as well. Under Islamic law the definition of "Capital" has been defined in a different manner, it includes only those things which cannot be utilized unless they are wholly consumed or altered their original form, in other words, which cannot be let or leased - for example money (gold, silver and paper currency). According to this definition machinery, land and vehicles are excluded from capital. 3. All such things which do not have to be wholly consumed or altered their original form during a process of production have been taken under the head of “Land”. Hence, vehicles, building and machinery fall under this category. 4. The definition of “Labor” has been generalized too, so as to include mental efforts such as planning and organizing. 5. Under Islamic view only three factors are considered as factors of production instead of four, the entrepreneur has been excluded from the list of factor of production as a regular factor. This does not mean that the very existence of the entrepreneur has been denied. It implies that Islam does not recognize the entrepreneur as an independent factor; rather it includes it in any one of the three factors. We will look into the detail of above point. The most important characteristic under capitalistic economy is of the entrepreneur (which gets the profit). Here the entrepreneur is supposed to bear the risk of business whether it gains profit or it turns into loss. Under Capitalist point of view, "profit'' is a kind of compensation for his courage to enter into a commercial venture where he alone is considered to bear the burden of a possible loss. The other three factor of production will remain immune from loss; pre-agreed ‘interest’ is given for Capital, Land will get the specified rent and Labor will be entitled to wages they earn. On contrary, according to Islamic view the ability to take the risk of loss, is the inherent characteristic of capital itself, therefore no other individual factor should be made liable to bear the burden of risk of loss. Consequently, the capitalist, in most of the cases provides capital and takes the risk of loss, is an entrepreneur too, and the man who is an entrepreneur is a Capitalist as well. Capital can be invested in different ways, under Islamic view the capital can be invested in following ways. Moreover we will understand from below mention discussion regarding types of capital investment in pre and post Islamic society. Types of Capital investment (Business Venture): 1. Sole Proprietorship: Private business is the most common way to invest capital and perform business activities, in such concerns the man who provide capital may manages the funds himself and runs the business without any help of any partner of co-sharer. In such kind or business ventures the return received from business activity will be call “profit” from legal point of view. But, in economic terms, this "reward" would be made up of (i) "Profit", in as much as Capital has been invested, and (ii) "Wages", as earnings of management. 2. Partnership: The second most common form of investment is that few persons may jointly invest capital; they may decide to jointly run the business and will jointly bear the risk of profit and loss. In Fiqh terminology, such jointly operated business venture is called "Shirkat-ul-Aqd" or Partnership in contract. According to the terminology of Islamic economics, business run through Shirkat-ul-aqd, if all partners are managing the business, all partners will be entitled to share “profit” as per agreed ratio, and also entitled to “wages” because they have taken part in management of business. Islam © Copyright Virtual University of Pakistan 11 Islamic Banking Practices (BNK610) VU has authorized such form of business association as well. Partnership (Shirkat-ul-Aqd) was common before the time of the Holy Prophet (PBUH) until he allowed people to continue the practice of it, and since then there has been a consensus of opinion on its permissibility. 3. Co-operation of Capital and Organization (Mudarbah) The third type of business venture is that where one person provides capital while another using his skills and exploit the funds, manage the business, and each may have a share in the profit as per agreed sharing ratio. In the terminology of Fiqh, it is called "Mudarbah". In Mudarbah according to the terminology of Islamic economics, the person who invests his capital is called "Rabb-ul-Mal", and will get his share in the form of "profit", while the person who is managing the business is called “Mudarib”, he will be compensated in the form of "wages". But if the person who has been managing the business ("Mudarib") eventually suffers a loss in the business, his labor will go wasted just as the capital of the investor would go wasted. This form of business organization too is permissible in Islam. The Holy Prophet (PBUH) made such an agreement with Hakzrat Khadijah (R.A) before their marriage. Since then, there has been a complete consensus of opinion on this among the jurists of Islam. 4. Money Lending Business Before the advent of Islam investing capital on loan had been practiced ever since from the beginning, money lending is the fourth form of investing Capital. In this business, one person lends money in form of loan or debt on interest, second person accepting that debt and utilizes the amount in running a business, and bears the risk of loss or profit. If there is a loss, it has to be borne by person who is managing the business with borrowed money, but regardless of profit or loss, interest does accrue to Capital in any case. Islam has prohibited this form of venture. "O you, who believe, fear Allah and give up what still remains of riba, if you are believers." (2:278) The Holy Quran also says: "But if you do not (give it up), then listen to the declaration of war from Allah and His Messenger. However, if you repent, yours is your principal. Neither wrong, nor be wronged." (2:279) In these two verses, the phrases ''what is still due to you from the interest" and "you shall have the principal" makes it quite explicit that Allah does not forgive the least quantity of interest, that "giving up the interest" implies that the creditor should get back only the principal. Thus, one thing to be noted here that Islam prohibits all sort of interest either calculated on high or low rate. People of certain Arab tribes used to carry on their business on borrowed money; on borrowed money certain amount of interest is paid to lender (i.e. other Arab tribes); this practice was excessive in market of Arab before Islam. After Islam such transactions were strictly prohibited. © Copyright Virtual University of Pakistan 12 Islamic Banking Practices (BNK610) VU “After the conquest of Makkah, the holy Prophet (pbuh) had declared as void all the amounts of Riba that were due at that time. The declaration embodied that nobody could claim any interest on any loan advanced by him. Then the holy Prophet (pbuh) proceeded to Taaif, which could not be conquered, but later on the inhabitants of Taaif, who belonged mostly to the tribe of Thaqif, came to him and after embracing Islam surrendered to the holy Prophet (pbuh) and entered into a treaty with him. One of the proposed clauses of the treaty was that Banu Thaqif would not forego the amounts of interest due on their debtors but their creditors would forego the amounts of interest. The holy Prophet (pbuh) instead of signing that treaty simply ordered to write a sentence on the proposed draft that Banu Thaqif will have the same rights as other Muslims have. Banu Thaqif, having the impression that their proposed treaty was accepted by the holy Prophet (pbuh), claimed the amount of interest from Banu Amr Ibnal- Mughirah, but they declined to pay interest on the ground that Riba was prohibited after embracing Islam. The matter was placed before Attaab ibn Aseed (God be pleased with him), the Governor of Makkah. Banu Thaqif argued that according to the treaty they were not bound to forego the amounts of interest. Attaab ibn Aseed placed the matter before the holy Prophet (pbuh) on which the following verses of Surah al-Baqarah were revealed: ‘O those who believe fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be wronged.’ (278–279) Let us be very clear about the trade of Arab, tribes of Arab were like a joint company, they carried on their trade on collective capital of individuals. Sometimes one tribe in need of money borrow collectively from other tribe, in such cases the lending was done on interest, and the borrowed money ultimately used in trade activities. The Holy Quran has prohibited even this practice. Thus, under Islamic system of economy, there are two ways for lending the money for business purpose; one is to help the businessman with Qard without interest or Riba or to share in profit with the businessman. If one wants to earn the share in the profit by lending money, then two options are available for lender to adopt the mode of "partnership" (Musharkah) or that of "Co-operation'' (Mudarbah), where lender will have to bear the risk of profit or loss as well. If the business concern earns the profit, the lender will have a share in the profit; in case of loss, it will be borne by all parties according to their investment. This discussion makes it clear that Islam stressed on the responsibility of ''taking the risk of loss'' on Capital. The man who provides capital in a risk-bearing business enterprise will have risk of loss or profit. © Copyright Virtual University of Pakistan 13 Islamic Banking Practices (BNK610) VU Islamic Banking – Introduction, History and Evolution Lesson - 3 Islamic Banking: The banking activity that is consistent with Sharia’h Ruling (Islamic Laws) and its practical application through development of Islamic Economics. In more appropriate form we must say that banking with Sharia Compliant activities is called Islamic Banking. Sharia’h prohibits the giving and taking of interest on loan or debt or any kind of fee for provision of loans whether the payment is fixed or floating. All those business activities that involve buying and selling of goods or services that are prohibited in Islam is also void (Haram). In late 20th century most of the Islamic countries tried to prevent non-Islamic means of financing and number of Islamic banks is formed. The contemporary movement of Islamic Banking is based on the belief that all financial transaction must be free from Riba. Furthermore Sharia’h prohibits Maysir (gambling) and Gharar (uncertainty) in financial transactions. Maysir exist in all those contracts in which performance of a transaction depend upon the occurrence of an uncertain event in future. This can be exemplified in the case of insurance where a person pays a little sum with the hope of claiming a larger amount in the event accidental loss, which is uncertain. Maysir is regarded by most Islamic scholars as gambling or any games of chance (including lotteries, casino-type games and betting on the outcomes of animal races), whereas gharar means uncertainty in transitions, it is described as a risky or hazardous sale, where details concerning the item on sale are unknown or uncertain (e.g. The Prophet (pbuh) has forbidden the purchase of the unborn animal in its mother's womb). Islamic bank has the same purpose as the conventional banks have that is to make money for banking institution by lending out the funds as financing according to the rules of Sharia’h. The last decade has seen a sharp growth in Islamic banking sector, in which banking institutions starting to offer a real and attractive alternative parallel to conventional banking products. Across the Middle East, Africa, and Asia, Islamic banking has grown to become a prominent means of financial management, while it is also emerging in Western economies that have not typically been associated with it in the past. As of 2014, 1% of total world assets are held by Sharia’h compliant financial institutions. Whole world’s banking sector is now turning their operation on Islamic basis, currently there are numerous Banks and several Mutual funds were working on Sharia compliant financing techniques. Islamic banking is an emerging field and growing fastly as compared to conventional institutions. History of Islamic Banking: Islamic Banking can be said to come in existence with the advent of Islam, in the time of Prophet Muhammad (PBUH). Prophet Muhammad (PBUH) started trading based on the basis of Mudarbah for His wife. “MUDARBAH” a term used for Islamic way of Partnerships has been the primary and most appreciated way for Muslim business community to carry out their trading operations. However, because the conventional banking system plays a very critical role in any country`s economy and businesses, now a days it is very difficult to decide by the most of the businessmen that which conventional banking product they can use in their business or other day- to-day activities. This is exactly where Islamic Banking plays a role for providing the customers with a solution that not only solve their financial problems but also to make sure that the solution observes the Islamic teachings as well. Very first proper Islamic Banking model came into existence in Egypt in 1963. The main philosophy of this bank was to provide Riba-Free banking products to the society. Ahmed Al Najjar was the founder and the actual visionary of this bank. This bank offered products that were © Copyright Virtual University of Pakistan 14 Islamic Banking Practices (BNK610) VU completely according to the Sharia’h ruling about the trade, and was completely different from the conventional banks as it was completely interest free. Tabung Haji (TH) is the Pilgrims management and fund board of Malaysia. It started its operation in 1963 to assist the Muslim in Malaysia with the financial cost of performing the hajj to Saudi Arabia on Islamic financial model. In 1974, Islamic Development Bank (IDB) was formed with the efforts of the Organization of Islamic Countries (OIC) and the support of the king of Saudi Arabia, it began its activities on 20 October 1975, and it was the first officially registered Islamic Bank in the history. The main objective of IDB is to provide all Banking financial solution on profit sharing ratio basis instead of interest. In 1975, the first privately held commercial Islamic Bank was formed in Dubai, UAE. In the same year, an agreement was signed to re-establish the Islamic Development Bank as an Inter- Governmental Plan Islamic Bank. The major purpose of this bank was to offer financial facility to the development projects through the Muslim world, and make sure that all financial solution adheres to the Sharia’h Principle. In 1977, Faysal Islamic Bank was formed in Egypt, which was followed by the formation of Bahrain Islamic & Jordan Islamic Banks in 1978. The first Islamic bank in Malaysia was established in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS). Mid 1980s witnessed an irresistible awareness in Islamic Banking and numerous banks were formed just to provide Islamic Law based financial products to their customers globally. The major improvement in this trend was seen in Middle East and South Asia. Also such financial institutions begin establishing their own market in countries where Muslims are in minorities, such as: UK, USA, Denmark, India, Australia, etc. This gave the customers an ultimate relief, as they knew; now they can enjoy financial services which are free from Riba (interest), which is strictly prohibited in Islam. Evolution of Islamic Banking in Pakistan Pakistan is the country which achieves its independence on basis of Islamic ideology. Being an Islamic Republic, flexibility exists in its constitution to develop Islamic economic system with socio –economic justice. As per Article 2 of the Constitution, Islam is the State Religion of Pakistan. Mohammad Ali Jinnah, while inaugurating State Bank of Pakistan on July 01 1948 has advised State bank of Pakistan to help develop Islamic Economic system which based on equality and brotherhood. o "We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice" Constitution of Pakistan also laydown the objective to eliminate Riba from the society. Article 38(f) of 1973 constitution of Pakistan quoted as under. o “The state shall eliminate Riba as early as possible”. The Objectives Resolution was agreed by the first Constituent Assembly in 1949, it was the preface of the Constitutions of 1956, 1962 and 1973. It provided that no law should be passed that is objectionable to the injunctions of Islam. It was made substantive part of the Constitution in 1985. In continuation of the constitution of Pakistan, the Eighth Amendment of the 1973 Constitution, adopted by the National Assembly in 1985, also made room for creation of the Federal Shariat Court (FSC). Creation of the Council of Islamic Ideology (CII) in 1962. The report of the CII on Elimination of Interest (June, 1980) is genuinely considered to be first major comprehensive work in the world undertaken on Islamic banking and finance. © Copyright Virtual University of Pakistan 15 Islamic Banking Practices (BNK610) VU In the era of 1970s early efforts were made to eliminate Riba from financial system of Pakistan for this purpose Council of Islamic Ideology (CII) was appointed the task to prepare a draft of Interest free economy in 1977. In February 1979 President of Pakistan announced that interest will be removed from the economy in a period of 3 years. At the first step House Building Finance Corporation (HBFC), National Investment Trust (NIT), and Mutual Funds Investment Corporation (MFIC) were selected for removal of interest in their operations. Council of Islamic Ideology (CII) advised reduction of dependence on interest bearing foreign loans as it was not possible to eliminate interest in it, techniques of PLS and Qard e Hasna. In 1981 government ordered banks to offer separate counters for deposit on PLS basis; and it continued till June 1985. All the banks were turned into the all deposit account in PLS accounts but later Government announced the discontinuation of the adopted systems from July 1985 since it was just a change of nomenclature. The movement towards the interest free economy suffered a setback when in August 1985 banks were allowed to invest even their Profit and Loss sharing deposits in interest bearing government securities. In 1991 the Federal Sharia’h Council declared the procedure adopted by the banks in 1985 as un- Islamic. In response the government and some banks made appeals to the Sharia’h appellate Bench of the supreme court of Pakistan. In 1999 the Sharia’h Appellate Bench of Supreme court rejected the appeals and directed all laws on interest banking to be ceased. However in 2001 Sharia appellate bench allowed dealing with foreign parties on basis of interest. State Bank of Pakistan has developed the following three point strategies relating to development of Islamic Banks o Full-fledged banks can be established in Pakistan. o Islamic Banks can set up their subsidiaries. o Stand-alone Islamic Banking branches can be opened by conventional banks in Pakistan. The government set up a high level commission, task forces and committees to institute and promotes Islamic Banking on a parallel basis with the conventional banking system. After that in 2002 State bank of Pakistan issued its first ever Islamic banking license to Meezan bank Limited to start its operations as a full-fledged Islamic Bank. We can say that officially and practically Pakistan has started on operating of Islamic banks after 2002. After this many of the Islamic banks started working in Pakistan, and operating on Islamic sharia’h laws. © Copyright Virtual University of Pakistan 16 Islamic Banking Practices (BNK610) VU RIBA – DEFINITION, PROHIBITION AND TYPES Lesson - 4 Riba (Interest): The word "Riba" means excess, increase or addition. According to Sharia’h terminology, it implies any excess compensation without due consideration, it is pertinent to note here that this consideration does not include time value of money. Riba can also be defined as giving and taking, paying and receiving of any excess amount in exchange for a loan at an agreed rate, regardless of whether being calculated at a high or low rate. According to above definition of riba, we can conclude that transaction involving Riba has three main factors i.e. any excess given or taken, there must be contract of loan or debt, excess that is given or taken must be pre-agreed. Prohibition of Riba in Quran In Quran Riba was not forbidden at once; rather Quran made prohibition on riba gradually. Four verses of Quran that were revealed gradually and make riba prohibited are described below. First Revelation (Surah al-Rum, verse 39) "Whatever Riba (increased amount) you give, so that it may increase in the wealth of the people, it does not increase with Allah; and whatever zakah you give, seeking Allah's pleasure with it, (it is multiplied by Allah, and) it is such people who multiply (their wealth in real terms)." (30: 39) It was the first verse revealed against riba and revealed in Makkah. According to different jurists prohibition of riba is not directly mentioned in this verse, but is simply elaborate that riba does not increase your wealth and also not accounted for with Allah, it does not carry any reward and benefit in the life hereafter. However charity does your wealth near Allah. Different sharia’h scholar added that here the word Riba does not mean interest or usury. But here it means any gift offered by one person to another with the intention to get greater in return. Second Revelation (Surah al-Nisa', verse 161) "And for their charging Riba (usury or interest) while they were forbidden from it, and for their devouring of the properties of the people by false means. We have prepared, for the disbelievers among them, a painful punishment.” (4: 161)" © Copyright Virtual University of Pakistan 17 Islamic Banking Practices (BNK610) VU This verse was revealed before 4th year of Hijra. It was revealed in answer to the argument of the Jews who came to the Holy Prophet (PBUH) and asked him to bring down a book from heavens like the one given to them by Prophet Musa (A.S.) According to Sharia’h scholars the word Riba in this verse, definitely, denotes to usury or interest. In this verse the evil deed of Jews were mentioned as they were used to take ribe, and riba was prohibited for them, on the other hand, we cannot determine the prohibition of interest for Muslims as well. However one can infer that giving and taking of riba is sinful act for Muslims too. So, the prohibition of riba for Muslims was still not clearly mentioned in the verse. Third Revelation (Surah Al 'Imran, verses 130-132) "O you believe, do not eat up the amounts acquired through Riba (interest), doubled and multiplied. Fear Allah, so that you may be successful, and fear the fire that has been prepared for the disbelievers. Obey Allah and the Messenger, so that you may be blessed.” This verse was revealed in the 2nd year after Hijra, near about the time of the battle of Uhud. The reason behind this verse's revelation was that the invaders of Makkah had financed their army by taking usurious loans to be equipped against Muslims and it was feared that the Muslims might follow the same practice; prohibition of Riba for Muslims was clearly mentioned in this verse. Fourth Revelation (Surah al-Baqarah, verses 275-281) "Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said:"Sale is but like riba", while Allah has permitted sale, and prohibited riba. So, whoever receives an advice from his Lord and desists (from indulging in riba), then what has passed is allowed for him, and his matter is up to Allah. As for the ones who revert back, those are the people of Fire. There they will remain forever. © Copyright Virtual University of Pakistan 18 Islamic Banking Practices (BNK610) VU Allah destroys riba and nourishes charities, and Allah does not Surely those who believe and do good deeds, and establish Salah (prayer) and pay Zakah will have their reward with their Lord, and there is no fear for them, nor shall they grieve. O you, who believe, fear Allah and give up what still remains of But if you do not (give it up), then listen to the declaration of war from Allah and His Messenger. However, if you repent, yours is your principal. Neither wrong, nor be wronged. If there is one in misery, then (the creditor should allow) deferment till (his) ease, and that you forgo it as alms is much better for you, if you really know. Be fearful of a day when you shall be returned to Allah, then every person shall be paid, in full, what he has earned, and they shall not be wronged.” Prohibition of Riba in Hadith: A. General 1. Narrated by Jabir (R.A):”The Prophet (PBUH) 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]." 2. Narrated by 'Abdallah ibn Hanzalah (R.A),” The Prophet (PBUH), said: "A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times" (narrated in Musnad-e- Ahmed and Ad- Daruqutni). Bayhaqi has also reported the above hadith in Shu'ab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful." 3. Narrated by Abu Hurayrah(R.A) , The Prophet (PBUH)said: "Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother." 4. Narrated by Abu Hurayrah (R.A), the Prophet (PBUH) 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." 5. Narrated by Anas ibn Malik (R.A) the Prophet (PBUH) said: "When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favors mutually." Classification of Riba Hence from the following verses riba can be defined as any excess, addition or increase over loan or debt which is predetermined. Riba can be classified into two categories by sharia’h scholar namely ‘Riba Al Nasiyah and Riba Al Fadl. Riba An Nasiyah Any increased or excess amount which a lender (Ras ul Maal) receives over and above its principal through a pre-agreed interest (Sood) based transaction is called as Riba An Nasiyah. Verses of Holy Quran directly prohibit this form of interest directly hence technically it is the primary form of Riba, it is also known as ‘Riba Al Quran’ sometimes it is also known as Riba Al Jahiliyyah as this type was considered in early dark ages. Imam Abu Bakr Jassas Razi has drawn a complete legal definition of Riba An Nasiyah in the following words: "That kind of loan where specified repayment period and an amount in excess of capital is predetermined." © Copyright Virtual University of Pakistan 19 Islamic Banking Practices (BNK610) VU Surah al-Baqarah (Verse 278-281) Surah al Baqarah renders this kind of interest in its verses of 278 to 281. "O you who believe, fear Allah and give up what still remains of riba, if you are believers.But if you do not (give it up), then listen to the declaration of war from Allah and His Messenger. However, if you repent, yours is your principal. Neither wrong, nor be wronged. If there is one in misery, then (the creditor should allow) deferment till (his) ease, and that you forgo it as alms is much better for you, if you really know. Be fearful of a day when you shall be returned to Allah, then every person shall be paid, in full, what he has earned, and they shall not be wronged.” (2:278-281) We can see from the above mentioned verses, that riba is considered in term of any excess or extra return over and above the principal in a loan transaction; however one can note that Allah has not forbidden all kind of excess, it is present in trade transactions as well, it is permissible there. Quran renders haram a special type of excess which is known as Riba. Before Islam the people of Arab used to take loans on interest which were payable with interest, also they considered riba as a type of sale and they used to say that Sale is just like as Riba. Islam has clearly mentioned that any excess which results from a sale transaction is different from interest; excess amount which results through sale agreement is permissible in Islam any loan which draws excess amount is forbidden and rendered Haram. "That is because they have said:"Sale is but like riba", while Allah has permitted sale, and prohibited riba.” (2:275) Few Hadith are mentioned which tell us about Riba An Nasiyah Ali Ibn Abi Talib narrated that the Holy Prophet (PBUH) said, “Every loan that draws interest is Riba." The famous Sahabi Fazala Bin Obaid has also defined Riba in similar words: "Every loan that draws profit is one of the forms of Riba" Hence we can easily draw a definition of Riba An Nasiyah as any additional amount which a borrower pay to the lender in transaction of loan or debt is termed as Riba. It is pertinent to note here that prohibition of Riba is not restricted to the religion Islam but also a major concern which have been confirmed in other revealed laws of all Prophets (A.S) Some of the old evidences has rendered Riba as haram (See Exodus 22:25, Leviticus 25:35- 36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezakhiel 18:8, 13, 17 & 22:12). From definition of Riba An Nasiyah, we can infer that; giving and taking, paying and receiving of any excess amount without due consideration in a loan transaction with a pre-agreed rate. It has been proven in various ahadith that Holy Prophet (PBUH) repaid loan in a better way, it cannot be called interest hence the excess is not predetermined. The word ‘draw’ in hadith means that paying and receiving excess amount as a predetermined condition in loan transaction. Riba An Nasiyah is unconditionally prohibited and there is consensus among all Muslim jurist globally. Why Riba An Nasiyah is prohibited? Technically speaking nothing is described in Quran or narrated in Hadiths as the reason of prohibition of Riba. However some evils and faults appeared in the society due to prevalence of riba based activities, which are as follows: Being a Muslim we must realize the fact that anything is this world have some goodness or utility, nothing is created without any utility. But it is commonly recognize in the book of Allah and religion that things imparts some harms and benefits to the society, those things which causes more benefit to society is considered more useful. However while declaring gambling and liquor to be haram the Holy Quran stated © Copyright Virtual University of Pakistan 20 Islamic Banking Practices (BNK610) VU that they do hold some benefits in it but the harm and sins they produce is far worse than the benefits they produce. Therefore taking these things is intensely harmful and destructive, it is necessary for a human to abstain from such things which are rendered Haram in Quran, same is the case with interest. Practically the consumer of interest has some apparent or temporary benefits, but the curse of interest miles severe as compared to the benefits in this world and hereafter. Those who is indulged in giving and taking of interest does have some casual profit but in front of Allah he is losing his moral or spiritual character. Similarly, no sane and just person will say that personal and individual gain which causes loss to the whole community or group is useful. In theft and robbery for example, the gain of the gangster and the take (loot) of the thief is all too obvious but it is certainly harmful for the entire community since it ruins its peace and sense of security. Riba Al Fadl The second classification of Riba is Riba Al Fadl. The prohibition of this Riba has been established on the basis of Sunnah, it is also called “Riba Al Hadees.” It is defined as any excess given or taken in exchange of barter transaction or exchange of homogenous commodities in spot sale or purchase. It can be clarified by the following Hadith; The Prophet (PBUH) said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to- hand (spot)." This hadith counts six commodities in which riba can occur in case of sale or purchase of commodities in exchange mode, which are gold, silver, wheat, barley, dates and salt. These six can be exchanged in such a way that similar commodity must be exchanged in equal quantity and on spot, however unequal defer exchange of similar commodity will establish interest. In Fiqh terminology these six commodities which cause Riba in case of exchabge is called Amwaal-e-Ribawiyyah. After reviewing above hadith few questions arises in human mind that, Does this hadith apply only to the items mentioned in it? Does it concern sales of barley or wheat but not rice? or of dates but not raisins? Complete legal definition of amwaal-e-ribawiyyah is different in every fiqh. Such as few scholars believed that amwaal-e-Ribawiyyah includes only these six commodities while majority believed that some other commodities should be included in these goods. How can we determine that other commodities should be included in Amwaal-e-Ribawiyyah, for this purpose some fiqhs explained, certain characteristics which must be present in a commodity to be considered as Amwaal-e-Ribawiyyah. The features which are common among these items can be used as foundation/illat for Riba Al Fadl. Illat can be defined as the attribute of an event that requires a particular divine ruling in all cases holding that attribute; it can be said a process of analogy. Various schools define these attributes differently: Imam Abu Hanifa Imam Abu Hanifa affirms only two common characteristics as: Weight or Volume Exchange is between similar commodities © Copyright Virtual University of Pakistan 21 Islamic Banking Practices (BNK610) VU According to Imam Abu Hanifa all those goods which can be sold or purchased in term of weight or volume is included in Amwaal-e-Ribawiyyah and all rules of Riba Al Fadl will be applicable to all such goods. Hence commodities which can be measured in units of weight or volume fall under this category. Imam Shafi The two attributes are observed by Imam Shafi are: Medium of Exchange Eatable (Edible) According to Imam Shafi those things or goods which have the natural ability to be used as currency (medium of Exchange) fall under this category. Therefore, as per Imam Shafi finding this law will also apply on everything edible. Imam Maalik Imam Maalik identified the following two characteristics: 1) Eatables (Edibles) 2) Preserve-able According to Imam Maalik eatables and all such goods which the people in society try to preserve it for future needs is included in Amwaal-e-Ribwiyyah and subject to the rule of Riba Al Fadl in case of exchange. Imam Ahmad Bin Hanbal Three citations have been related to Imam Ahmad Bin Hanbal: First citation follows to the opinion of Imam Abu Hanifa Second citation conforms to the opinion of Imam Shafi Third citation includes three characteristics at the same time i.e. edible, weight and volume. Why Riba Al Fadl is prohibited The rationale behind prohibition of riba is to ensure justice and use of power of exploitation through biased or unfair exchange. It also renders back doors of Riba An Nasiyah closed, because in the Islamic Sharia’h, anything that serves as a means to the unlawful is also unlawful The laws of Riba Al Fadl Jurists have developed rules and laws that govern Riba Al Fadl on the basis of above narrated hadith and its interpretation with reference to issues raised by Hanafi Fiqh. Explanation of rules derived is as follows; 1. Now it is obvious the question for exchanging the homogenous commodities only arise when they differ in quality and in characteristic e.g. different species of wheat and rice, inferior quality gold or silver exchanged with superior quality of gold or silver, different genus of barley or sea salt is exchanged for mineral salt. It is prohibited in Sharia’h to exchange of all six commodities with itself with unequal quantity but differing in quality/type, in such case we must ignore quality and exchange in equal quantity. In unequal exchange there is fear for constituting interest if amount or quantity differs while exchanging, such transaction may lead to deceiving. In order to prevent this stage sharia’h has developed ruling for barter (exchange) transaction in any of these commodities with itself but differing in quality or type, is allowed only if the following conditions are adhered. © Copyright Virtual University of Pakistan 22 Islamic Banking Practices (BNK610) VU a) Any difference in type/value/quality should be ignored and the commodities should be exchanged in equal amounts (equal weight and volume). b) another way for transacting this exchange is, instead of direct exchange of commodities of the same kind, for this one should sell his commodity against cash at the market value and buy someone else's commodity in exchange of cash proceeds at the market value. 2. One another way for exchanging same type of commodity is that a person has material and other person have finished product made up of that material and both decided to exchange their goods. In such a case exchange transaction will take place in following way a) First we have to look whether characteristics of the product have been totally altered by the industry: For e.g. the cotton industry that convert raw cotton into cloth or iron into machinery. In this case, it is allowed to transact lesser amount of cloth against greater amount of raw cotton or raw iron having more weight against machinery having lighter weight. b) In case where a little difference has been made to the original form after its making: For e.g. gold which changes its shape in the form of jewelry. In this case, the Sharia’h holds that such a transaction must not take place in a way that one provide raw gold less than the weight of jewelry, it should not happen in the first place or if it does, the exchange between two commodities should be in equal weights in order to discourage unfair deals. Another alternative can be used in such exchange, one will sell the gold in market against cash from this cash he buy the jewelry. Hence, the equivalent may be established only up to an approximate value thus leading to some injustice to one party or the other. The use of money could therefore help reduce the possibility of an unfair exchange. 3. Third rule for transacting good in exchange is, different commodities can be unequally exchanged but deferred payment is not allowed. For e.g. five kg wheat can be sold against two kg date or fifty gram of gold can be exchanged against one kilograms of silver on the condition that all exchange should be spot transactions. The general condition of sale, however, that needs to be borne in mind while making a sale transaction is that the goods are specified in addition to the cash aspect of the transaction. The correct way of specifying is that gold and silver should be under the possession of the sellers or delivered at the place of contract. To sum up, the Hanafi jurists maintain that in case of commodities that weigh or measure, it is illegal to transact unequally or on credit if the transaction is between two similar commodities. But in case of different commodities, unequal exchange is legal but credit remains illegal; the transaction in this case too should be spot. Commercial Interest and Usury In the 17th century, two new practical terms of interest arose after the formation of banking system, namely: 1. Tijarti Sood (Commercial Interest): Interest paid on loan taken for productive and profitable purposes, which is used in commercial transactions and for the purpose of business. 2. Sarfi Sood (Usury): Interest paid on loan taken for personal need and expenses. © Copyright Virtual University of Pakistan 23 Islamic Banking Practices (BNK610) VU ISLAMIC CONTRACT Lesson - 5 The contracts used in Islam are the agreement and engagement between more than one party in a legally accepted and binding manner. There are many different types of contracts which suits to different needs and situations in Islamic economy, moreover legal and rightful relationship in these contracts involves a bilateral declaration from which flow legal consequences with regard to the subject matter and the price. These contracts execute the actual transaction and create the rights and obligation of the parties. Under legal perspective the Islamic contracts are theoretically divided into two main categories i.e. unilateral and bilateral promise. These are the terminologies used in Islamic jurisprudence (i.e Fiqh) which are pertinent to be clearly understood at the outset of this course. Unilateral promise comprises of a transaction in which one party gets the benefit, such as promise to give loan, gift and wasiyyat etc. on the other hand bilateral promise or contract is more bound to follow strict ruling and guidelines on sharia’h because in bilateral promise consent of both parties is essential, it covers all other permissible commercial transaction, such as contract of exchange that primarily concern trading, buying and selling activities, contract of Security that deal with Kafalah, and many other contracts. Before we go for actual Islamic banking products we need develop a complete understanding of unilateral promise, bilateral promise and essentials of a contract. 1) Unilateral Promise (Wa'da) 2) Bilateral Promise (Muwa'adah or Muahaidah) 3) Contract (Aqd) 1. Unilateral Promise (Wa’da) Unilateral promise refers to the one sided undertaking or promise by one person to execute a specific transaction or contract in future. For example one person promises to sell his furniture to Mr. B in future, since it will be termed as unilateral promise to sell his furniture. Since it is just a promise, no question arises for future sale or future contract hence in Islam future sale is prohibited. For example ‘Mr. A’ promises to sell his house to ‘Mr. B’ within six months from now for rupees five hundred thousand only (Rs. 500,000.00) , now we can see in this example it is just one sided promise or Wa’da. Enforceability Unilateral promise or Wa'da is enforceable under the present law. Under Hanafi School; unilateral promise is not enforceable by law, rather it is considered as a moral obligation on the promisor, it is a moral responsibility of a promisor whether he execute his promise or not. However, some of the Hanafi jurists argue that unilateral promises can be made enforceable in situation whereby it seems necessary. According to Imam Maalik unilateral promise is enforceable by law. In present days there is a consensus (Ijma) of sharia’h scholars that, unilateral promise is enforceable by law until or unless the promisor who has made the promise is not in a position to fulfil the promise. In this case, if it is not due to any of his negligence then he has to make good the loss to the promisee. For example, ‘Mr. A’ promises to sell a camel to ‘Mr. B’ and the camel dies despite of care taken by Mr. A, in this ‘B’ cannot claim damages are from ‘A’ for his loss. On the other hand if this happens due to the negligence of ‘A’ then he has to pay for the damages of promisee. There may be the situation where ‘A’ promises to sell his camel to ‘B’ for Rs. 10,000 within the next month and after making this promise ‘A’ sells it to another person ‘C’ before the month elapses, now we can see that this is willful act of the promisor that leads to his inability to fulfill his promise to the promisee, therefore, the promisor is liable to compensate the promisee. Consider another example ‘X’ made a promise to purchase a Horse from ‘Y’ for Rs. 10,000/-. As a result of promise which is made by ‘X’, to fulfil this promise ‘Y’ purchase a horse from market for Rs. 8,000 to sell it to ‘X’ for agreed price of Rs. 10,000/-. on the promise execution date ‘X’ refuses to purchase the horse from ‘Y’, he breaches his promise to purchase, as a result ‘Y’ sell that © Copyright Virtual University of Pakistan 24 Islamic Banking Practices (BNK610) VU horse in the market for Rs. 7,500/- and bears a loss of Rs. 500/-. Now it is clear that due to breach of promise from ‘X’, ‘Y’ suffers actual loss, in this case ‘X’ is liable to make good the loss of ‘Y’. 2. Bilateral Promise (Muwa’adah or Mu'ahadah)/Agreement A bilateral contract is opposed to a unilateral contract or Wa’da, this kind of promise generally comes to mind when we talk about contracts. It is a contract between two people or parties. Bilateral promise would be contract when the actual promise executed. In this case example would be the contract for the sale of a home. One person promises to sell his house for Rs. 500,000/- to ‘Mr. A’, ‘A’ also made a promise to purchase his house for same amount, this will be called bilateral promise. When both the parties execute the actual transaction it will become the contract. Bilateral promises are enforceable by law and if parties does not fulfil the promise, it is considered as the breach of contract and can be enforced by law, When the contract is not fulfilled there is a breach in contract. Enforceability From above discussion it means bilateral undertaking (Mutual promise) or agreement is enforceable under law. According to majority of the present day Scholars of Islamic Jurisprudence, Muwa’adah (Bilateral promise) is not allowed in situations where contract is also not allowed (e.g. forward contracts), and thus is not enforceable by law. This view is adapted by majority of Islamic Financial Institutions of present day and even by AAOIFI (Accounting and Auditing Organization of Islamic financial institution). According to some Scholars of the Sub-continent (followers of Hanafi School), Bilateral promise is enforceable by law, however, Muwa’adah of transactions like short-selling of currencies or shares is not allowed (in which subject matter is not in a possession of seller at the time of sale). 3. Contract (Aqd') An Aqd' or contract is that bilateral agreement which has been executed between two or more parties. A valid contract is binding on all parties and enforceable under court of law, all parties to contract are legally bound to perform the contract. If either party refuses to execute the contract, other can enforce through court. Example: Some examples of contracts are quoted below. ‘A’ promises to sell his car to ‘B’ for Rs. 200,000/-, and ‘B’ accepted his offer to sale. It is a lagal agreement because it creates legal obligation. It is called contract. ‘X’ offers his horse to sale in market for rupees 10,000/-, one buyer came accepted his offer and purchase X’s horse. It is a contract. Moreover contract of sale, contract of marriage, contract of agency are the example of contract. Types of Aqd' Contract or Aqd can be divided into two types with respect to compensation. 1) Uqood e Mu’awadah (Compensatory Contract) 2) Uqood e Ghaer Mu’awadah (Non Compensatory Contract) Uqood e Mu’awadah (Compensatory Contract) In Uqood e Mu’awadah all parties to the contract gets something in return as compensation. These are compensatory contract where one person sells something to someone else for a price or compensation, for example, sale of a pen by ‘A’ to ‘B’ for Rs. 50/-. In this contract ‘B’ will get the pen and ‘A’ will be compensated in term of money. © Copyright Virtual University of Pakistan 25 Islamic Banking Practices (BNK610) VU Uqood e Ghaer Mu’awadah (Non Compensatory Contract) In Uqood e Ghaer Mu’awadah, it is not necessary that all parties to contract get something in return as compensation. These are non-compensatory contract where one person gives something to someone else without any compensation for example a contract of loan, contract of Hiba (gift), contract of Guarantee. Essentials of Aqd' Four essential elements are required to establish a valid contract (Aqd). 1) Parties to Contract (Mutaa'qidain) 2) Wording of Contract (Alfaz e Aqd) 3) Subject Matter (Ma'qood Alaih) 4) Consideration (Ma'qood Bi'hi) 1) Parties to contract/Contractors (Mutaa'qidain) The contracting parties must be competent to contract is the first essential of a contract. Every party to contract who is major, of sound mind and not a slave of his principal is competent to perform contract. However a minor, person of unsound mind are incompetent to contract. In Islamic contract the contractors must not be mahjoor i.e. restricted to make contract. Islamic Sharia’h identifies three types of people as mahjoor. An insane person ‘S’ agreed to sell his house worth Rs.25000 for Rs. 7000 only, later it was discovered that ‘S’ was insane by birth. He is incompetent to enter into a contract A child not mature enough to understand the nature of transaction Example: ‘A’, a minor sold his shop to ‘B’, the amount was paid to ‘A’ but the sale deed could not be registered as ‘A’ was minor, on a suit made by ‘B’, it was held that as A was minor, so agreement/ contract was void from beginning. A slave not permitted by his master to enter into a contract 2) Wording of Contract (Alfaz e Aqd) The wording of a contract should be absolute, immediate and non-contingent to a future event, future contracts are not allowed in Islam. Also the wordings should be unconditional. If the wordings of the contract are conditional, the condition must adhere to the following rules of Islamic jurisprudence. Basic Rules for the Validity of Conditions in Contract: There are four basic rules for judging the validity of conditions in a contract: 1) A condition which is not against the contract is a valid condition. For example ABC co. made a contract with xyz Co. to sell its inventory. ABC co put a condition that both company will use e- mail as a medium of communication. Such condition does not make the contract void. 2) A condition which apparently seems to be against the contract, but is in the market practice, these kinds of conditions is permissible unless specific prohibition is proven with clear rules of Sharia’h. For example, Mr. Ahmad buys an air conditioner from Al-fateh store on a condition that the seller will provide him five-year guarantee and one year free service. This type of condition does not invalidate the contract hence contract is valid. 3) A condition that is against the contract and not i

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