Islamic Banking Portal

Nature of Capital in Musharakah

bahzadahm@gmail.com (Bahzad Ahmad) — Sat, 20 Feb 2010 10:41:00 +0000

In previous post we studied about Musharakah in detail. This post is also relates to Musharakah as shown by title. Here we will discuss nature of capital introduced by partners in Musharakah business, its types and nature.

There are different views about nature of capital invested by partners in musharakah business. Most of the Muslim jurists are of the opinion that capital must be in liqid form i.e in cash/money. According to them Musharakah can't be executed or formed on capital contributed in commodities. It is mandatory that whole capital must be in form of money or liquid cash and no part of capital should be in form of commodities.
However, there are different views in this respect discussed below in detail.

In view of Imam Malik, there is no restriction of liquidity of capital in musharakah contract. It is not a condition for a valid contract of musharakah. Partners can invest in form of liquid cash or commodities or both. However if a partner invests in form commodities, his share of capital shall be determined on basis of current market price of commodities. This view is also adopted by some Hanbali jurists.

Imam Abu Hanifah and Imam Ahmad are of the view that no contribution in kind is acceptable in a musharakah. Their standpoint is based on two reasons:

Firstly they are of the opinion that if partners contribute in form of commodities, that are always distinguishable from the commodities contributed by other partner. For example, if a partner contributes a vehicle and the other contributes furniture as a capital in a business. In this case, commodities of each partner is distinguishable from the other and no partnership can take place. On the other hand if both partners invest in form of liquid cash, it can't be distinguished and will goes to a common pool. In this case valid partnership can be established.

Secondly they say that in case of redistribution of share capital in musharakah contract, if a capital is in form of commodities it will create problems and redistribution can't take place because commodities have to be sold at that time.It the capital is repaid on the bases of its market value, it may be increased or decreased and whole benefit or loss due to change in market value may go to one partner.

Imam al-Shafi has come in between the two points of view explained above. He says that the commodities are of two kinds:

(i) Dhawat-ul-amthal the commodities which, if destroyed, can be compensated by the similar commodities in quality and quantity e.g. wheat, rice etc. If 100 kilograms of wheat are destroyed, they can easily be replaced by another 100 kg. of wheat of the same quality.

(ii) Dhawat-ul-qeemah the commodities which cannot be compensated by the similar commodities, like the cattle. Each head of sheep, for example, has its own characteristics which cannot be found in any other head. Therefore, if somebody kills the sheep of a person, he cannot compensate him by giving him similar sheep. Rather, he is required to pay their price.

Imam al-Shafi is of the point of view that if the commodities pertains to first kind i.e Dhawat-ul-amthal, it may be contributed to Musharakah as a share capital while the commodities of second kind i.e Dhawat-ul-qeemah are not allowed to contribute as a capital in Musharakah contract.

By this distinction between Dhawat-ul-amthal and Dhawat-ul-qeemah, Imam al-Shafi has met the second objection on 'participation by commodities' as was raised by Imam Ahmad. For in the case of Dhawat-ul-amthal, redistribution of capital may take place by giving to each partner the similar commodities he had invested. However, the first objection remains still unanswered by Imam al-Shafi.

In order to meet this objection also, Imam Abu Hanifah is on the point of view that if commodities pertains to Dhawat-ul-amthal, it should be mixed in such a way that the commodities of each partner can't be distinguished from other. If commodities are distinguishable from other, musharakah is not valid.

In short, in view of Imam Malik, musharakah can be executed by contributing commodities as capital, without any restriction. Share of capital is determined on bases of current market value of commodities. While Imam Shafi says that commodities can only be contributed as share capital in musharakah it they pertains to Dhawat-ul-amthal. Imam abu Hanifah says that if commodities are in category of Dhawat-ul-amthal, musharakah contract can be executed by mixing of commodities in such a way that can't be distinguished from other partners, and if commodities are of Dhawat-ul-qeemah, that commodities can't be form part of share capital and no musharakah can be executed.

The view of Imam Malik is more simple and reasonable and meets the needs of modern business. It is more likely to act upon on this view. We may conclude that a musharakah business can be formed on both cash and commodities. However in case of commodoties, current market value should be determined on that date and considered as value of capital.

Musharakah

bahzadahm@gmail.com (Bahzad Ahmad) — Tue, 16 Feb 2010 08:35:00 +0000

Musharakah is word of Arabic origin which literally means sharing. In financial world or banking & finance industry, it means a joint enterprise in which all the partners share the profit of a business or partnership according to predetermined profit sharing ratio while the loss is distributed in the ratio of contribution (capital)

The word Musharakah is derived from 'Shirkah' means sharing, while the term 'Musharakah' is not found in the books of Fiqh. This term has been introduced recently by those who have written on the subject of Islamic Finance and it is normally restricted to a particular type of 'Shirkah', that is, the Shirkat-ul-amwal where two or more persons invest some of their capital in a joint commercial venture. However, sometimes it includes Shirkat-ul-amal also, where partnership takes place in the business of services. (These terms will be discussed later in this article).

Musharakah does not envisage a fixed rate of return to the investors rather the return depends on the actual earnings of business. If a business earns profit, it is distributed among partners according to predetermined profit sharing ratio and in case of loss, each partner will suffer according to ratio of his investment(capital).

This article covers the following aspects of Musharakah

Types of Musharakah

Distribution of Profit

Sharing of Loss

Management of Musharakah

Termination of Musharakah

Termination without Closing the Business

Types of Musharakah

There are two basic types of Musharakah

Shirkat-ul-Milk

It means joint ownership of two or more persons in a particular property. This kind of "Shirkah" may come into existence in two different ways:

By Option of the Parties:
If two or more persons purchase a property, it will be owned jointly by both of them and the relationship between them with regard to that property is called 'Shirkat-ul-milk', here this relationship has come into existence at their own option.

By Enforcement of Law:
After the death of a person, all his heirs inherit his property which comes into their joint ownership as an automatic consequence of the death of that person.

Shirkat-ul-Aqd

Shirkah-ul-Aqd means "a partnership executed by a mutual contract". It may be translated as "joint commercial enterprise.

Shirkat-ul-aqd is further divided into three kinds:

Shirkat-ul-amwal
where all the partners invest some capital into a commercial enterprise.

Shirkat-ul-Amal
where all the partners jointly undertake to render some services for their customers, and the fee charged from them is distributed among them according to an agreed ratio.

Shirkat-ul-wujooh
Here the partners have no investment at all. All they do is that they purchase the commodities on a deferred price and sell them at spot. The profit so earned is distributed between them at an agreed ratio.

Distribution of Profit

The profit sharing ratio must be defined and agreed between the partners at the time of agreement. If no such ratio is determined, the contract is not valid in shariah

The partners are not allowed to fixed rate of return or fixed ratio of profit with respect to their capital. They can only get their share of profit/loss.

Therefore, if A and B enter into a partnership and it is agreed between them that A shall be given Rs 10,000/- per month as his share in the profit, and the rest will go to B, the partnership is invalid. Similarly, if it is agreed between them that A will get 15% of his investment, the contract is not valid. The correct basis for distribution would be an agreed percentage of the actual profit accrued to the business.

If a lump sum amount or a certain percentage of the investment has been agreed for any one of the partners, it must be expressly mentioned in the agreement that it will be subject to the final settlement at the end of the term, meaning thereby that any amount so drawn by any partner shall be treated as 'on account payment' and will be adjusted to the actual profit he may deserve at the end of the term. But if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned.

Is it necessary that the ratio of profit of each partner conforms to the ratio of capital invested by him? There is a difference of opinion among the Muslim jurists about this question.

In the view of Imam Malik and Imam Shafi‘i, it is necessary for the validity of musharakah that each partner gets the profit exactly in the proportion of his investment. Therefore, if A has invested 40% of the total capital, he must get 40% of the profit. Any agreement to the contrary which makes him entitled to get more or less than 40% will render the musharakah invalid in Shari‘ah.

On the contrary, the view of Imam Ahmad is that the ratio of profit may differ from the ratio of investment if it is agreed between the partners with their free consent. Therefore, it is permissible that a partner with 40% of investment gets 60% or 70% of the profit, while the other partner with 60% of investment gets only 40% or 30%.

The third view is presented by Imam Abu Hanifah which can be taken as a via media between the two opinions mentioned above. He says that the ratio of profit may differ from the ratio of investment in normal conditions. However, if a partner has put an express condition in the agreement that he will never work for the musharakah and will remain a sleeping partner throughout the term of musharakah, then his share of profit cannot be more than the ratio of his investment.

Sharing of Loss

In case of loss, all muslim jurists are agreed that loss will be distributed accoriding to their ratio of investment. For example if partner has invested 30% of total capital, he will suffer 30% in case of loss. If there is any condition to the contrary, it will be deemed void.

Management of Musharakah

The management of Musharakah business will be done by all partners, every partner has right to take part in management of Musharakah business. However, partners may agree on a condition that management of Musharakah business will be carried out by one or few of them. In such a condition sleeping partners are allowed to the profit only to the extent of their investment.

However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all the matters of the business and any work done by one of them in the normal course of business shall be deemed to be authorized by all the partners.

Termination of Musharakah

Musharakah is deemed to be terminated in any one of the following events:
1) Every partner has a right to terminate the contract of musharakah at any time after serving a notice to other partners.
2) In case of death of a partner, the contract of musharakah come to an end. His heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of musharakah.
3) If any one of the partner becomes insane or incapable of being a partner, the musharakah agreement stands terminated.

Termination of Musharakah without Closing the Business

If one of the partners wants termination of the Musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. The partners who want to run the business may purchase the share of the partner who wants to terminate his partnership, because the termination of the Musharakah with one partner does not imply its termination between the other partners.

However, in this case, the price of the share of the leaving partner must be determined by mutual consent, and if there is a dispute about the valuation of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or the distribution of the assets themselves.

The question arises whether the partners can agree, while entering into the contract of the Musharakah, on a condition that the liquidation or separation of the business shall not be effected unless all the partners, or the majority of them wants to do so, and that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation. Most of the traditional books of Islamic Fiqh seem to be silent on this question. However, it appears that there is no bar from the Shari’ah point of view if the partners agree to such a condition right at the beginning of the Musharakah. This is expressly permitted by some Hanbali jurists. This condition may be justified, especially in the modern situations, on the ground that the nature of business, in most cases today, requires continuity for it’s success, and the liquidation or separation at the instance of a single partner only may cause irreparable damage to the other partners.

If a particular business has been started with huge amounts of money which has been invested in a long term project, and one of the partners seeks liquidation in the infancy of the project, it may be fatal to the interests of the partners, as well as to the economic growth of the society, to give him such an arbitrary power of liquidation or separation. Therefore such a condition seems to be justified.

Mudarabah

bahzadahm@gmail.com (Bahzad Ahmad) — Thu, 11 Jun 2009 11:56:00 +0000

Mudarabah is a very common mode of finance used by islamic institutions. Mudarabah is mostly used in deposit base products like as saving accounts, term deposits etc. This article is covers the following aspects of Mudarabah.

Definition

Types of Mudarabah

Business of the Mudarabah

Joint Mudarabah

Distribution of the profit

Termination of Mudarabah

Definition

Mudarabah is a special kind of partnership permitted by Shariah where one partner gives money to another for investments it in a commercial enterprise (mortgage, insurance, credit, financing and other business). The investments comes from the first partner who is called "rabb-ul mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib".

Types of Mudarabah

There are two types of Mudarabah

Al-Mudarabah Al-Muqayyadah (restricted mudarabah)

The rabb-ul-mal may specify a particular business for the mudarib i.e. (mortgage, insurance, credit, financing, banking, investment funds, bonds investment and any other business), in which case he shall invest the money in that particular business only. This is called al-Mudarabah al-muqayyadah (restricted mudarabah).

Al-Mudarabah Al-Mutlaqah (unrestricted mudarabah)

But if he has left it open for the mudarib to undertake whatever business he wishes, the mudarib shall be authorized to invest the money in any business he deems fit. This type of mudarabah is called 'al-mudarabah al-mutlaqah" (unrestricted mudarabah)

Business of the Mudarabah

Mudarabah is partnership business and any type of business can be formed under Mudarabah. There is no restriction by rules to do a specific business under Mudarabah agreement. It is mutual agreement of rabb-ul-mal (The Investor) and mudarib (The Manager) to select the type of business i.e. (mortgage, insurance, credit, financing, banking, investment funds, bonds investment and any other business).

Joint Mudarabah

A rabbul-mal can contract mudarabah with more than one person through a single transaction. It means that he can offer his money to A and B both, so that each one of them can act for him as mudarib and the capital of the mudarabah shall be utilized by both of them jointly, and the share of the mudarib shall be distributed between them according to the agreed proportion. In this case both the mudaribs shall run the business as if they were partner’s interest. The mudarib or mudaribs, as the case may be, are authorized to do anything which is normally done in the course of business. However, if they want to do an extraordinary work, which is beyond the normal routine of the traders, they cannot do so without express permission from the rabb-ul-mal.

Distribution of the profit

It is necessary for vaidity of mudarabah that parties should define profit sharing ratio at the beginning of business. There is no particular proportion has been prescribed by the Shariah. It has been left on mutual consent of paraties. They can share the profit in equal proportions, and they can also allocate different proportions for the rabb-ul-mal and the mudarib. However, a lump sum amount of profit cannot be allocated to any party and they cannot fix a specific rate of profit tied up with capital. For example, if the capital is USD 1,000,000/- they cannot agree on a condition that USD 100,000/- out of the profit shall be the share of the mudarib, nor can they say that 20% of the capital shall be given to rabb-ul-mal. However, they can agree on that 40% of the actual profit shall go to the mudarib and 60% to the rabb-ul-mal or vice versa.

However they can fix different ratios of profit for different situations i.e. the rabbul-mal can say to mudarib, "If you trade in cloth, you will get 30% of the profit and if you trade in made-ups, you will have 50% of the profit. In same way he can say "If you do the business in your town, you will be entitled to 30% of the profit, and if you do it in another town, your share will be 50% of the profit. Mudarib cannot claim any salay, remuneration or fee for work done other than his share of profit. All the schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed for the mudarib drawing his daily expenses of food only from the mudarabah account.

The Hanafi jurists restrict this right of the mudarib only to a situation when he is on a business trip outside his own city. In this case he can claim his personal expenses, accommodation, food, etc., but he is not entitled to get anything as daily allowances when he is in his own city. If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, and then the remainder, if any, shall be distributed between the parties according to the agreed ratio.

Termination of Mudarabah

The contract of mudarabah can be terminated at any time by either of the two parties. The only condition is to give a notice to the other party. If all the assets of the mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the agreed ratio. However, if the assets of the mudarabah are not in the cash form, the mudarib shall be given an opportunity to sell and liquidate them, so that the actual profit may be determined.

There is a difference of opinion among the Muslim jurists about the question whether the contract of mudarabah can be affected for a specified period after which it terminates automatically. The Hanafi and Hanbali schools are of the view that the mudarabah can be restricted to a particular term, like one year, six months, etc, after which it will come to an end without a notice. On the contrary, Shafi‘i and Maliki schools are of the opinion that the mudarabah cannot be restricted to a particular time.

However, this difference of opinion relates only to the maximum time-limit of the mudarabah. Can a minimum time-limit also be fixed by the parties before which mudarabah cannot be terminated? No express answer to this question is found in the books of Islamic Fiqh, but it appears from the general principles enumerated therein that no such limit can be fixed, and each party is at liberty to terminate the contract whenever he wishes.

This unlimited power of the parties to terminate the mudarabah at their pleasure may create some difficulties in the context of the present circumstances, because most of the commercial enterprises today need time to bring fruits. They also demand constant and complex efforts. Therefore, it may be disastrous to the project, if the rabb-ul-mal terminates the mudarabah right in the beginning of the enterprise. Specially, it may bring a severe set-back to the mudarib who will earn nothing despite all his efforts. Therefore, if the parties agree, when entering into the mudarabah, that no party shall terminate it during a specified period, except in specified circumstances, it does not seem to violate any principle of Shariah.

Islamic Banking and Finance

bahzadahm@gmail.com (Bahzad Ahmad) — Mon, 08 Jun 2009 06:49:00 +0000

There are different terms that are used for Islamic banking and Finance as Islamic Banking, Islamic Finance, Halal Finance, Halal Investment, Halal Mortgages, Islamic Investment, Islamic Loans, Sharia Banking, Sharia Finance and Sharia Investment etc.

Islamic banking and finance or Islamic Finance refers to a system of banking or banking activity(s) that is consistent with Sharia based principles and rules and guidelines of Islamic finance.

Islamic law prohibits interest (usury) commonly called riba, the collection and payment of interest, trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered unlawful, or haraam.

Islamic finance has been gaining momentum on a global scale for the last few years. Many Islamic Banks have sprung up over the last few years. These changes are occurring both in Muslim and in western countries, and are driven by a global trend amongst Muslims to become more observant of their faith. It might have been the reason why Islamic Banking emerged, however, today Islamic Banking is sought by Muslims and non-Muslims due to the benefits it offers.

MODES OF ISLAMIC FINANCE

There are different modes of Islamic Finance that are used by Islamic Financial Institutions in financial transactions. Here is a brief summary of modes of Islamic Finance. For more details please visit links in mode of finance.

Mudarabah

Musharakah

Diminishing Musharakah

Mudarabah

Mudarabah is a special kind of partnership permitted by Sharia where one partner provide funds to another for investments it in a commercial enterprise (mortgage, insurance, credit, financing and other business). The partner who invests is called "rabb-ul mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib".

Visit this link to read more about Mudarabah

Musharakah

Musharakah means a joint enterprise formed for conducting some business in which all partners contribute to capital and management is done by all and any one acting for all. Profit is shared according to a predetermined specific ratio while the loss is shared according to the ratio of the contribution (capital).

Read more details about Musharakah

Diminishing Musharakah

Another form of Musharakah, developed in the near past, is 'Diminishing Musharakah'. According to this concept, a financier and his client participate either in the joint ownership of a property or an equipment, or in a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financier are purchased by him so as to make him the sole owner of the property, or the commercial enterprise, as the case may be.

Murabaha

Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance.

Ijarah

Ijarah is a contract of transfer of known and proposed usufruct against a specified and lawful return or consideration of a product or service. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.

Ijarah-Wal-Iqtina

A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

Istisna

It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways.

Salam

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

Istijrar

Istijrar means purchasing goods time to time in different quantities. In Islamic jurisprudence Istijrar is an agreement where a buyer purchases something from time to time; each time there is no offer or acceptance or bargain. There is one master agreement where all terms and conditions are finalized.

Islamic Banking FAQs

bahzadahm@gmail.com (Bahzad Ahmad) — Tue, 06 Jan 2009 09:37:00 +0000

FAQs on Islamic Banking cover all possible questions that can be raised in your mind. However in case of any question or problem, you can clarify through Contact Me form.

Q 1) What is Islamic Banking?

Islamic banking is defined as banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and un-social practices.

In practical sense,Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic prosperity.

Q 2). What is the philosophy of Islamic banking?

The philosophy of Islamic banking takes the lead from Islamic Shariah. According to Islamic Shariah, Islamic banking cannot deal in transactions involving interest/riba (an increase stipulated or sought over the principal of a loan or debt). Further, they cannot deal in the transactions having the element of Gharar (Excessive level of uncertainty or ambiguity created due to the lack of information or control in a contract.) or Maiser (Game of Chance). Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of Islam).

Islamic banks focus on generating returns through investment tools which are Shariah compliant as well. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of finance.The prohibition of a risk free return and permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities asset-backed in an Islamic set-up with ability to cause ‘value addition’.

Q 3) What is Meant By Riba?

The word "Riba" means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). This definition of Riba is derived from the Quran and is unanimously accepted by all Islamic scholars.

The meaning of Riba has been clarified in the following verses of Quran.

"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 be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your principal; neither will you do wrong nor will you be wronged.(Surah Al Baqarah 2:278-9)"

Q 4) What is interest? Is there any difference between interest and Riba?

The origination of term interest dates back to 17th century with the emergence of banking system at global level. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning/value as that of Riba as defined in the previous question. Further, it is narrated that “the loan that draws interest is Riba”. There is consensus among the Muslim scholars of all the fiqhs that interest is Riba in all its forms and manifestations.

Q 5) What are the different kinds of Riba?

There are two kinds of Riba:

Riba-An-Nasiyah/Riba-Al-Quran

Riba-Al-Fadl/Riba-Al-Hadith

Riba An Nasiyah/Riba Al-Quran:

In the Holy Quran, Allah (SWT) says in Sura Al-Baqarah (2-279):

"…..And if you repent, yours is your principal"

It is reported by Harith ibe Abi Usamah in his Musnad that Sayyidna Ali Radi-Allahu Anhu reportedly referred that the Holy Prophet said:

"Every loan that derives a benefit (to the lender) is riba".

(Al-Syuti, Al-Jame’ al-Saghir V.2, P.94)

Example of Riba-al-Nasiyah/Interest: If Mr. A lends Rs.100 to Mr. B (a borrower) with a condition that Mr. B shall return him Rs.110 after one month. In this case, the extra amount of Rs. 10 is Riba or Interest.

Riba-al-Fadl:

Abu Said al Khudri Radi-Allahu anhu narrated that Holy Prophet (Peace be Upon Him) said:

"Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, like for like, payment made hand by hand. If anyone gives more or asks for more, he has dealt in riba. The receiver and giver are equally guilty".

Based on aforesaid definition, it may be noted that economically speaking it would be irrational to exchange one kilogram of wheat with one and a half kilogram of wheat in a spot exchange. Therefore, some fuqaha have pointed out that Riba-al-Fadl has been prohibited because if it was left un-prohibited it could be used as a subterfuge for getting Riba-al-Nasiyah. Of the six commodities specified in the hadith, two (gold and silver) unmistakably represent commodity money used at that time.

One of the basic characteristics of gold and silver is that they are monetary commodities. As a matter of fact, each of the six commodities mentioned in the hadith has been used as a medium of exchange at some time or the other.During the dark ages, only the first form (Riba An Nasiyah) was considered to beRiba. However, the Holy Prophet (Peace be Upon Him) also classified the second form (Riba-al-Fadl) also as Riba.

Q 6) What are the revelations/verses in Holy Quran regarding prohibition of Riba/interest?

There are four sets of revelations about Riba which were revealed on different occasions.

1. First Revelation: In Surah-Ar-Rum, verse 39 , dealing in riba has been discouraged in the following words:

"And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah." [Surah Ar-Rum 30:39]

2. Second Revelation: Muslims have been informed about the practice of taking riba by Jews in Surah An-Nisaa:

"And because of their charging riba while they were prohibited from it." [Surah An-Nisaa 4-161]

3. Third Revelation: Riba/Interest has been abolished in the third verse of Surah Ali-Imran. The prohibition of riba is laid down in the following words:

"O those who believe do not eat up riba doubled and redoubled." [Surah Al-e-Imran 3- 130]

4. Fourth Revelation: In the fourth revelation, Riba has categorically been prohibited in all its forms. The following set of verses is found in the Surah Al-Baqarah, verse 275-281 in the following words:

"Those who take interest will not stand but as stands whom the demon has driven crazy by his touch. That is because they have said: 'Trading is but like riba'. And Allah has permitted trading and prohibited riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to Allah. And the ones who revert back, those are the people of Fire. There they remain for ever. Allah destroys riba and nourishes charities. And Allah does not like any sinful disbeliever. Surely those who believe and do good deeds, establish Salah and pay Zakah, have their reward with their Lord, and there is no fear for them, nor shall they grieve. Othose who believe, fear Allah and give up what still remains of the riba if you are believers. But if you do not, 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. And if there be one in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. And they shall not be wronged." [Surah Al-Baqarah 2:275-281]

Q 7) What are the sayings/Ahadith9 about Riba/Interest?

According to Islamic jurists and scholars, there are around 40 different Ahadith on the subject of riba and its prohibition from Holy Prophet (peace be upon him). Few of these are as follows:

1. From Hazrat 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]."

2. Jabir ibn Abdallah (May Allah be pleased with him), giving a report on the Prophets Farewell Pilgrimage, said: The Prophet addressed the people and said "All of the riba of Jahiliyyah is annulled. The first riba that I annul is our riba, that accruing to Abbas ibn Abd al-Muttalib (the Prophet’s uncle); it is being cancelled completely."

3. From Hazrat Abdallah ibn Hanzalah (May Allah be pleased with him): The Prophet, said: "A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times."

4. Bayhaqi has also reported the above hadith in Shuab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful."

5. From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest."

6. From Hazrat 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."

7. From Hazrat Abu Hurayrah (May Allah be pleased with him): 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."

8. From Hazrat Abu Hurayrah (May Allah be pleased with him): 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 orphans property without right, and he who is undutiful to his parents."

Q 8) Are there any injunctions against Riba/usury in religious texts other than Holy Quran?

The following references against the prohibition of Riba/usury are drawn from the old testament of the bible:

Deuteronomy 23:19: "Thou shall not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything that is lent upon usury."

Psalms 15:1, 2, 5: "Lord, who shall abide in thy tabernacle? Who shall dwell in thy holy hill? He that walketh uprightly, and worketh righteousness and speaketh the truth in his heart. He that putteth not out of his money to usury, nor taketh reward against the innocent."

Proverbs 28:8: "He that by usury and unjust gain increaseth his substance, he shall gather it for him that will pity the poor."

Nehemiah 5:7: "Then I consulted with myself, and I rebuked the nobles, and rules and said unto them, Ye exact usury, every one of his brother. And I set a great assembly
against them."

Ezekiel 18:8.9: "He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniguity, hath executed true judgment between man and man, hath walked in my statues, and hath kept my judgments, to deal truly; he is just. He shall surely live, said the Lord God."

Ezekiel 22:12: "In thee have they taken gifts to shed blood; thou hast taken usury and increase, and though hast greedily gained of thy neighbors by extortion, and hast forgotten me, said the Lord God."

In these excerpts of the Bible the word usury is used in the sense of any amount claimed by the creditor over and above the principal advanced by him to the debtor. The word riba used in the Holy Qur'an carries the same meaning because the verse of Surah An-Nisaa (4-161) explicitly mentions that riba was prohibited for the Jews also.

Q 9) Does interest/Riba is related only to consumption loans or it applies to commercial loans also?

The interest is prohibited whether it is consumption loan (loan for meeting day to day human needs) or commercial loan (loan for business purpose). There are quite a number of ahadith which clarify that in the days of Holy prophet, people not only borrowed for consumption purposes but also for productive purposes. A few of the ahadith are given as follows for reference:

(i) Ibn Saad has reported Hazrat Umar ( Radi-Allahu anhu), wanted to send a trade caravan to Syriya. He borrowed four thousand dirhams from Sayyidna Abdurrahman ibn Awaf, Radi-Allahu anhu for this purpose.

(ii) Ibn Jarrir has reported that Hind, daughter of Utbah and wife of Abu Sufyan borrowed four thousand dirhams from Sayyidna Umar, Radi-Allahu anhu, for the purpose of her trade. She invested this money in purchasing goods and selling them in the market of the tribe of Kalb.

Q 10) Does the prohibition of Riba apply equally to the loans obtained from or extended to Muslims as well as non-Muslims?

With respect to the receipt and payment of interest, there is no distinction between Muslims and non-Muslims or between individuals and states because interest is prohibited not only in Islamic scriptures but also in other religious scriptures of the world as given in Question No. 8 above. Therefore, prohibitions of interest apply to Muslims as well as to non-Muslims.

Q 11): What are the basic principles of Islamic banking?

There are at least six basic principles which are taken into consideration while executing any Islamic banking transaction. These principles differentiate a financial transaction from a Riba/interest based transaction to an Islamic banking transaction.

1. Sanctity of contract: Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the eyes of Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or voidable. An invalid contract is a contract, which by virtue of its nature is invalid according to Shariah rulings. Whereas a voidable contract is a contract, which by nature is valid, but some invalid components are inserted in the valid contract. Unless these invalid components are eliminated from the valid contract, the contract will remain voidable.

2. Risk sharing: Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkhiraj Biddamaan 21 ” and “Alghunun Bilghurum22”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit. Thus in every Islamic banking transaction, the Islamic financial institution and/or its deposit holder take(s) the risk of ownership of the tangible asset, real services or capital before earning any profit there from.

3. No Riba/interest: Islamic banks cannot involve in riba/interest related transactions. They cannot lend money to earn additional amount on it. However as stated in point No. 2 above, it earns profit by taking risk of tangible assets, real services or capital and passes on this profit/loss to its deposit holders who also take the risk of their capital.

4. Economic purpose/activity: Every Islamic banking transaction has certain economic purpose/activity. Further, Islamic banking transactions are backed by tangible asset or real service.

5. Fairness: Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.

6. No invalid subject matter: While executing an Islamic banking transaction, it is ensured that no invalid subject matter or activity is financed by the Islamic financial transaction. Some subject matter or activities may be allowed by the law of the land but if the same are not allowed by Shariah, these can not be financed by an Islamic bank.

Q 12) What is meant by Shariah/Islamic Law?

Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the divine law of Islam is derived from the following four sources:

1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)

Q 13): The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar?

The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. If a transaction is done according to the rules of Islamic Shariah it is halal even if the end result of the product may look similar to conventional banking product.

For example a normal McDonalds burger in USA and Pakistan may look similar, smell similar and taste similar but the former is haram and the later is halal due to its compliance of Islamic guidelines of slaughtering animals.

Similarly, if a person is feeling hungry, he may steal a piece of bread and eat or alternatively buy a piece of bread to eat. The apparent end result would be same but one is permissible in Shariah and the other is not allowed.

The same is also true for Islamic and conventional banking. Therefore, it can be concluded that it is the underlying transaction that makes something “Halal” (allowed) or “Haram” (prohibited) and not the result itself. Apparently, Islamic banks may look similar to conventional banks, however the contracts and product structures used by Islamic banks are quite different from that of the conventional bank. In the verse 2:275 of the Holy Quran, Allah the Almighty has responded to the apparent similarity between trade and interest by resolutely informing that he has permitted trade and prohibited Riba (though they may look similar to someone).

Q 14) If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers?

The Islamic bank uses its funds in various trade, investment and service related Shariah compliant activities and earns profit thereupon. The profit earned from such activities is passed on to the depositors according to the agreed terms.

Q 15). Are not Islamic banks just paying interest and dressing it as profit on trade and investments?

No, Islamic banks accept the deposits either on profit and loss sharing basis or on Qard basis. These deposits are deployed in financing, trading or investment activities by using the Shariah compliant modes of finance. The profit so earned by the bank is passed on to the depositors according to the pre-agreed ratio which, therefore, cannot be termed as interest.

Q 16): Islamic banks use interest base system (KIBOR) as a Bench Mark while determining profit; how Islamic banking can be said to be Islamic?

Islamic banks should ideally have their own benchmark system for determination of profit. Since, the industry is in its initial stage of development, it is using the available benchmark for the banking industry. It is expected that once it is grown to a sizable level, it would have its own benchmark. However, using Interest Rate benchmark for determining the profit of any permissible transaction does not render the transaction as invalid or haram. It is the nature/mechanism of the transaction that determines its validity or otherwise.

For example Mr. A and Mr. B are two neighbors. Mr. A sells liquor which is totall prohibited in Islam whereas Mr. B, being a practicing Muslim dislikes the business of Mr. A and starts the business of soft drinks. Mr. A wants his business to earn as much profit as Mr. A earns through trading in liquor. Therefore he decides that he will charge the same rate of profit from his customers as Mr. A charges over the sale of liquor. Thus he has tied up his rate of profit with the rate used by Mr. A in his prohibited business.

One may say that Mr. B uses an undesirable benchmark in determining the rate of profit, but obviously no one can say that the profit charged by him is haram because he has used the rate of profit of the business of liquor only as a benchmark. The same is true for Islamic banks, it is most desirable and preferable that Islamic banks develop their own benchmark however; in the absence of any such alternative, interest rate related benchmark can be used.

Q 17) Is Islamic banking meant only for Muslims?

The teachings of Islam are not confined to Muslims, rather these equally address the non-Muslims due to their universal nature. The basis of Islamic banks is laid down on ethical values and socially responsible system. The values like justice, mutual help, fee consent and honesty on the part of the parties to a contract, avoiding fraud, misrepresentation and misstatement of facts and negation of injustice or exploitation form the basic principles of Islamic banking. Therefore, the principles of Islamic banking lead the economic system to achieve the common good and economic prosperity. On this premise, Islamic banking becomes a viable option for everyone irrespective of their religion.

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bahzadahm@gmail.com (Bahzad Ahmad) — Mon, 15 Dec 2008 14:56:00 +0000

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Islamic Banking Portal

Nature of Capital in Musharakah

Musharakah

Types of Musharakah

Shirkat-ul-Milk

Shirkat-ul-Aqd

Distribution of Profit

Sharing of Loss

Management of Musharakah

Termination of Musharakah

Termination of Musharakah without Closing the Business

Mudarabah

Definition

Types of Mudarabah

Al-Mudarabah Al-Muqayyadah (restricted mudarabah)

Al-Mudarabah Al-Mutlaqah (unrestricted mudarabah)

Business of the Mudarabah

Joint Mudarabah

Distribution of the profit

Termination of Mudarabah

Islamic Banking and Finance

MODES OF ISLAMIC FINANCE

Mudarabah

Musharakah

Diminishing Musharakah

Murabaha

Ijarah

Ijarah-Wal-Iqtina

Istisna

Salam

Istijrar

Islamic Banking FAQs

Q 1) What is Islamic Banking?

Q 2). What is the philosophy of Islamic banking?

Q 3) What is Meant By Riba?

Q 4) What is interest? Is there any difference between interest and Riba?

Q 5) What are the different kinds of Riba?

Riba-An-Nasiyah/Riba-Al-Quran

Riba-Al-Fadl/Riba-Al-Hadith

Riba An Nasiyah/Riba Al-Quran:

Riba-al-Fadl:

Q 6) What are the revelations/verses in Holy Quran regarding prohibition of Riba/interest?

Q 7) What are the sayings/Ahadith9 about Riba/Interest?

Q 8) Are there any injunctions against Riba/usury in religious texts other than Holy Quran?

Q 9) Does interest/Riba is related only to consumption loans or it applies to commercial loans also?

Q 10) Does the prohibition of Riba apply equally to the loans obtained from or extended to Muslims as well as non-Muslims?

Q 11): What are the basic principles of Islamic banking?

Q 12) What is meant by Shariah/Islamic Law?

Q 13): The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar?

Q 14) If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers?

Q 15). Are not Islamic banks just paying interest and dressing it as profit on trade and investments?

Q 16): Islamic banks use interest base system (KIBOR) as a Bench Mark while determining profit; how Islamic banking can be said to be Islamic?

Q 17) Is Islamic banking meant only for Muslims?

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