 Najeeeb Ullah Baig 84-B

 Deedar Karim 53-A

 Naveed Akhtar 89-B
 Shahid Ahmed -C

 SUBMITTED TO:

• Sir. Faseeh Ullah Khan

 REMARKS:
_________________
_________________
_________________
AKNOWLEDGEMENT
We are thankful to my great and devoted teacher
who has provided us an opportunity to develop
this report and his support to enhance our
conceptual capabilities in practical scenarios in
our near future. And I am thankful to all those to
whom I have consulted to gain real knowledge for
research purposes.
DEDICATION
It is no doubt that parents devoted their selves for the nourishment of
their children. They sacrifice all the happiness, enjoyments and all
pleasures of their lives to take care of their children and love them with
affection without any lust and greed. Parents take care of their children and
provide all their needs at every stages of life; even it doesn’t guaranteed that
they will favor in the same way when parents expect from them when they
will be in their baby booming stage of life. God is witnessed of their hard
work to earn and provide all those opportunities to facilitate their children
with every change of world. However it’s impossible to pay their love and
affection for children with a measurable sustainity. However the parents do
their utmost for their children while On the other hand teachers are those
who are devoted to compare with the parents. Teachers teach us to become
human; they try their best to transform knowledge for the development of
their student intellectually and professionally so they could survive in
society and have their own dignity.

The reason to narrate the entire tale in script is to tribute and dedicates all
my efforts to collect data and develop this report, in respect of my parent
and teachers. May Allah bless our parents and teachers Ameen
Q – 1. What is Islamic Banking; illuminate the purpose of Islamic banking?

Islamic banking has the same purpose as conventional banking except that it operates in
accordance with the rules of Shari’ah, known as Fiqh al-Muamalat (Islamic rules on
transactions). Islamic banking activities must be practiced consistent with the Shari’ah
and its practical application through the development of Islamic economics. Many of
these principles upon which Islamic banking is based are commonly accepted all over
the world, for centuries rather than decades. These principles are not new but arguably,
their original state has been altered over the centuries.

The principle source of the Shari’ah is The Quran followed by the recorded sayings and
actions of Prophet Muhammad (pbuh) – the Hadith. Where solutions to problems
cannot be found in these two sources, rulings are made based on the consensus of a
community leaned scholars, independent reasoning of an Islamic scholar and custom,
so long as such rulings to not deviate from the fundamental teachings in The Qur’an.

It is evident that Islamic finance was practiced predominantly in the Muslim world
throughout the Middle Ages, fostering trade and business activities. In Spain and the
Mediterranean and Baltic States, Islamic merchants became indispensable middlemen
for trading activities. It is claimed that many concepts, techniques, and instruments of
Islamic finance were later adopted by European financiers and businessmen.

The revival of Islamic banking coincided with the world-wide celebration of the advent
of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial
resources of Muslims particularly those of the oil producing countries, received a boost
due to rationalization of the oil prices, which had hitherto been under the control of
foreign oil Corporations. These events led Muslims' to strive to model their lives in
accordance with the ethics and principles of Islam.

Disenchantment with the value neutral capitalist and socialist financial systems led not
only Muslims but also others to look for ethical values in their financial dealings and in
the West some financial organizations have opted for ethical operations.

Q – 2. What are the basic principles of Islamic Banking? Are there any rules
of permissibility?

The Shari’ah prohibits the payment of charges for the renting of money (riba, which in
the definition of Islamic scholars covers any excess in financial dealings, usury or
interest) for specific terms, as well as investing in businesses that provide goods or
services considered contrary to its principles (Haram, forbidden). While these principles
were used as the basis for a flourishing economy in earlier times, it is only in the late
20th century that a number of Islamic banks were formed to apply these principles to
private or semi-private commercial institutions within the Muslim community.

"While a basic tenant of Islamic banking - the outlawing of riba, a term that
encompasses not only the concept of usury, but also that of interest - has seldom been
recognized as applicable beyond the Islamic world, many of its guiding principles have.
The majority of these principles are based on simple morality and common sense, which
form the bases of many religions, including Islam.

"The universal nature of these principles is immediately apparent even at a cursory

glance of non-Muslim literature. Usury was prohibited in both the Old and New
Testaments of the Bible, while Shakespeare and many other writers, particularly those
writing in the 19th century, have attacked the barbarity of the practice. Much of the
morality championed by Victorian writers such as Dickens - ranging from the equitable
distribution of wealth through to man's fundamental right to work - is clearly present in
modern Islamic society.

"Although the western media frequently suggest that Islamic banking in its present form
is a recent phenomenon, in fact, the basic practices and principles date back to the early
part of the seventh century

Muslims believe that all things have been provided by God, and the benefits derived
from them, are essentially for man’s use, and so are permissible except what is expressly
prohibited in The Qur’an or Hadith. When guidance is not clearly given in he Qur’an
there are several other sources of law. For example, guidance can be sought from Fiqh,
which means ‘understanding’ and is the science of jurisprudence: the science of human
intelligence, debate and discussion

Q – 3. How and why interest is prohibited in Islamic banking System? Are

there other system factors in the banking systems that are prohibited in
Islamic banking?

Riba best translated today as the charging of any interest, meaning money earned on the
lending out of money itself. The prohibition on paying or receiving fixed interest is
based on the Islamic tenet that money is only a medium of exchange, a way of defining
the value of a thing; it has no value in itself, and therefore should not be allowed to give
rise to more money, via fixed interest payments, simply by being put in a bank or lent to
someone else. The human effort, initiative, and risk involved in a productive venture are
more important than the money used to finance it.

Money in Islam is not regarded as an asset from which it is ethically permissible to earn
a direct return. Money tends to be viewed purely as a medium of exchange. Interest can
leads to injustice and exploitation in society; The Quran (2:279) characterizes it as
unfair, as implied by the word zulm (oppression, exploitation, opposite of adl i.e. justice)
There is no real 'lending' in Islam since all 'lenders' obtain ownership interests in the
assets that they finance, or earn a profit-share or purely fee-based remuneration. In
order for an Islamic bank to earn a return on money lent, it is necessary to obtain an
equity, or ownership, interest in a non-monetary asset. This requires the lender to also
participate in the sharing of risk.

Individuals and the world as a whole probably know too well the burden of interest and
misery and suffering that irresponsible lenders have inflicted on individuals and
societies. It has become so completely institutionalized and accepted in modern
economies that it is almost impossible to conceive that there are some who completely
oppose it and refuse to enter into any transactions that involve interest.
Islam's prohibition of interest and usury was not unprecedented. The early Jewish and
Christian traditions also forbade riba. Even the renowned Greek philosopher, Aristotle,
condemned acquiring of wealth by the practice of charging interest on money.

“Very much disliked also is the practice of charging interest: and the dislike is fully
justified for interest is a yield arising out of money itself, not a product of that for which
money was provided. Money was intended to be a means of exchange; interest
represents an increase in the money itself. Hence of all ways of getting wealth, this is the
most contrary to nature." Aristotle, The Politics, tr. Sinclair, pg. 46, Penguin

“Do not charge your brother interest, whether on money or food or anything else that
may earn interest.” (Deuteronomy 23:19)

“If you lend money to My people, to the poor among you, you are not to act as a creditor
to him; you shall not charge him interest.” The Holy Bible (American Standard Bible)

Islam not only prohibits dealing in interest and investment in unlawful activities that
Islam deems harmful to society, but also transactions involving excessive uncertainty
(gharar) and all forms of gambling (maysir).

[Jesus said], “If you have money, do not lend it at interest, but give [it] to one from
whom you will not get it back.” Gospel St Thomas, V95

Q – 4. How can we determine the importance of the preferred banking

system in a comparison of commercial/conventional banking system versus
the Islamic banking system?

Before we define what an Islamic banking is like, it is better to give a short description of
conventional banking. Conventional banking does not follow one pattern. In Anglo-
Saxon countries, commercial banking dominates, while in Germany, Switzerland, the
Netherlands, and Japan, universal banking is the rule. Naturally, then, a comparison
between banking patterns becomes inevitable
Commercial banking is based on a pure financial intermediation model, whereby banks
mainly borrow from savers and then lend to enterprises or individuals. They make their
profit from the margin between the borrowing and lending rates of interest. They also
provide banking services, like letters of credit and guarantees. A proportion of their
profit comes from the low-cost funds that they obtain through demand deposits.
Commercial banks are prohibited from trading and their shareholding is severely
restricted to a small proportion of their net worth.
Because of the fractional reserve system, they produce derivative deposits, which allow
them to multiply their low-cost resources. The process of bank lending is, however,
subject to some problems that can make it inefficient. Borrowers usually know more
about their own operations than lenders. Acting as lenders, banks face this information
asymmetry. Because borrowers are in a position to hold back information from banks,
they can use the loans they obtain for purposes other than those specified in the loan
agreement exposing banks to unknown risks. They can also misreport their cash flows or
declare bankruptcy fraudulently. Such problems are known as moral hazard. The ability
of banks to secure repayment depends a great deal on whether the loan is effectively
used for its purpose to produce enough returns for debt servicing. Even at government
level, several countries have borrowed billions of dollars, used them unproductively for
other purposes and ended up with serious debt problems. Banks can ascertain the
proper use of loans through monitoring but it is either discouraged by clients or is too
costly and, hence, not commercially feasible. Hence, why the purpose for which the loan
is given plays a minimal role in commercial banking. It is the credit rating of the
borrower that plays a more important role.
By contrast, universal banks are allowed to hold equity and also carry out operations like
trading and insurance, which usually lie beyond the sphere of commercial banking.
Universal banks are better equipped to deal with information asymmetry than their
commercial counterparts. They finance their business customers through a combination
of shareholding and lending. Shareholding allows universal banks to sit on the boards of
directors of their business customers, which enables them to monitor the use of their
funds at a low cost. The reduction of the monitoring costs reduces business failures and
adds efficiency to the banking system.
Following the above logic, many economists have given their preference to universal
banking, because of its being more efficient. Commercial banks are not allowed to trade,
except within the narrow limits of their own net worth. As we have noticed, many
Islamic finance modes involve trading. The same rule cannot, therefore, be applied to
Islamic banks. It may be possible for Islamic banks to establish trading companies that
finance the credit purchase of commodities as well as assets. Those companies would
buy commodities and assets and sell them back to their customers on the basis of
deferred payment. However, this involves equity participation. We may, therefore, say
that Islamic banks are closer to the universal banking model. They are allowed to
provide finance through a multitude of modes including the taking of equity. Islamic
banks would benefit from this by using a combination of shareholding and other Islamic
modes of finance. Even when they use trade-based, debt creating modes, the financing is
closely linked to real sector activities. Credit worthiness remains relevant but the crucial
role is played by the productivity/profitability of the project financed.

Major Differences between Islamic and Banking System

Conventional System Islamic System

Money is a product besides medium of Real Asset is a product. Money is just a

exchange and store of value. medium of exchange.

Time value is the basis for charging Profit on exchange of goods & services is
interest on capital. the basis for earning profit.

Interest is charged even in case, the Loss is shared when the organization
organization suffers losses. Thus no suffers loss.
concept of sharing loss.

While disbursing cash finance, running The execution of agreements for the
finance or working capital finance, no exchange of goods & services is must, while
agreement for exchange of goods & disbursing funds under Murabaha, Salam &
services is made. Istisna contracts.

Due to non existence of goods & services Due to existence of goods & services no
behind the money while disbursing funds, expansion of money takes place and thus no
the expansion of money takes place, which inflation is created.
creates inflation.

Due to inflation the entrepreneur increases Due to control over inflation, no extra price
prices of his goods & services, due to is charged by the entrepreneur.
incorporating inflationary effect into cost
of product.

Bridge financing and long term loans
lending are not made on the basis of
existence of capital goods. Rather, they are
disbursed on the basis of Windo Dressed
project feasibility and credibility of the
entrepreneur.
Musharakah & Diminishing Musharakah
agreements are made after making sure the
existence of capital good before disbursing
funds for a capital project.

Government very easily obtains loans from Government cannot obtain loans from the
Central Bank through Money Market Monetary Agency without making sure the
Operations without initiating capital delivery of goods to National Investment
 development expenditure. fund.

The expanded money in the money market Balance budget is the outcome of no
without backing the real assets, results expansion of money.
deficit financing.

Real growth of wealth does not take place, Real growth in the wealth of the people of
as the money remains in few hands. the society takes place, due to multiplier
effect and real wealth goes into the
ownership of lot of hands.

Due to failure of the projects the loan is Due to failure of the project, the
written off as it becomes non performing management of the organization can be
loan. taken over to hand over to a better
management.

Debts financing gets the advantage of
leverage for an enterprise, due to interest
expense as deductible item form taxable
profits. This causes huge burden of taxes
on salaried persons. Thus the saving and
disposable income of the people is affected
badly. This results decrease in the real
gross domestic product.
Sharing profits in case of Mudarabah and
sharing in the organization of business
venture in case of Musharakah, provides
extra tax to Federal Government. This leads
to minimize the tax burden over salaried
persons. Due to which savings & disposable
income of the people is increased, this
results the increase in the real gross
domestic product.

Due to decrease in the real GDP, the net Due to increase in the real GDP, the net
exports amount becomes negative. This exports amount becomes positive, this
invites further foreign debts and the local- reduces foreign debts burden and local-
currency becomes weaker. currency becomes stronger

Q - 5. Islamic Banking system is a burning question in the present scenarios

of economic recession throughout the world how its credibility can be
realized in practical on grounds?

Shopping for a business loan during a global credit crisis is tough work even if you're a
fast-growing start-up like Ireland's Blue Ocean Wireless. And the scrutiny can cut both
ways. Blue Ocean, which supplies wireless communications for merchant shipping, was
giving a closer-than-normal look at whether possible lenders could be counted on amid
the ongoing financial shakeout.
When the company got a $25 million loan this fall, it came from what might seem an
unusual source: the Bank of London and the Middle East, or BLME, which strictly
follows Islamic sharia law rather than conventional western banking practices. Islamic
banking requires transactions be structured in alternative ways since the rules ban
interest and trading in debt. Blue Ocean is one of many European companies benefiting
from a surge in Islamic financing that's pushing sharia-compliant banking into the
mainstream and extending its appeal to non-Muslims. The sector's growth comes at a
time when the western banking system is caught in a liquidity crisis. Blue Ocean took
comfort in the fact that BLME draws on the petrodollar surpluses of Persian Gulf oil
producers. "The liquidity was there," says Blue Ocean's chief financial officer, Tariq
Aslam.

The boom in Islamic banking is providing a crescent-shaped sliver of good news for the
City, London's beleaguered financial district. It's fast becoming the main hub of Islamic
banking outside the Middle East, a development encouraged by Britain's Labor
government, which laid out the welcome mat to sharia-compliant banks several years
ago. "The government sees it as another way to draw business to London, to bring
investors to the U.K.," says Duncan McKenzie, director of economics at International
Financial Services London.

Growth field. London now is home to 25 companies offering some form of Islamic
financing. BLME is the largest of five wholly sharia-compliant banks operating in
Britain. The first, the Islamic Bank of Britain, opened in 2004, and the number is
expected to double within five years. Moreover, most of Britain's conventional banks
also have established "Islamic windows," units that offer sharia-compliant products.
Globally, the sector's total assets are pegged at between $500 billion and $1 trillion and
growing at a rate of 10 to 15 percent a year.

Certainly, business is brisk at Kuwaiti-owned BLME, which is somewhat ironic, given

that it opened its doors in July 2007, on the eve of the banking crisis. It is just
completing a big leasing project for a major transportation company, and other deals it
has sealed this year include financing for apartment buildings and a language school in
London. It also provided an $11 million loan to RecovCo, a British aluminum
preprocessor that is expanding its operations in France. For the first six months of this
year, BLME reported pretax profits of $2.7 million and its assets more than doubled, to
$931 million.

The basic concepts of Islamic banking go back 1,400 years, but the world's first modern
Islamic bank didn't open until 1975. And the sector didn't really blossom until five years
ago, when it was buoyed by rising oil prices and the strengthening economies of Asia's
Muslim countries. Sharia law prohibits investing in certain industries or products,
including alcohol, tobacco, pork, and pornography. The Koran also forbids usury, so
financial transactions are structured to rely on income in the form of rents or profits
from the loan, technically not interest. Sukuks, for instance, are a type of Islamic bond
backed by ownership of a tangible asset that produces a financial return. Another
popular instrument is the commodity murabahah, essentially cost-plus financing, which
involves the sale and repurchase of a commodity to fund a loan.

The financing BLME arranged for Blue Ocean, for example, was a commodity
murabahah. Here's how it worked: The amount of the first portion that Blue Ocean
wanted from its $25 million loan arrangement was relatively small. So an appropriate,
low-cost commodity was selected to accommodate the transaction, in this case special
high-grade zinc. The bank purchased the commodity—an amount equal to the cash Blue
Ocean wanted to withdraw—then sold it at a small profit to the company for the same
price on a deferred payment

basis. Blue Ocean, with the bank's assistance, then resold the metal at the original
purchase price, thus raising the cash it wanted. All transactions occurred nearly
simultaneously so that the deal wasn't whipsawed by market price fluctuations.

Conservative approach. Islamic banks have avoided the subprime fiasco. "There are no
toxic assets," says Natalie Schoon, BLME's head of product development. "As a result,
there are no problems with big write-offs. One of the advantages that the Islamic sector
has as a whole is that there is still liquidity." That, as well as the conservative nature of
its business model, is a big reason that it's attracting more non-Muslim clients. Middle
Eastern investors have amassed so many petrodollars they have no choice but to look for
opportunities beyond the Persian Gulf region, particularly in the politically stable
environments of the United Kingdom and Europe. That's why Islamic banks are setting
up operations there. Also, London is attracting those outposts because of Britain's
historical links to the region and the strong financial talent pool to draw on. In fact,
most of the top executives at the Islamic banks in London are British or European and
they are old hands in City banking. The government's concerted wooing efforts have also
helped. "The government is actually supporting Islamic finance," Schoon says. "It's not
seen as a threat; it's seen as an opportunity."

As with traditional banks, the Islamic banks in London must meet levels of transparency
sometimes lacking in other parts of the world. "Regulation is important," Schoon
explains. "Investors like the fact that you are regulated." The London Stock Exchange
began listing sukuks this year, and 18 are now trading there, a useful increase of
liquidity. The British government, as early as next year, is expected to make the country
the first in the West to issue its own sovereign sukuks to raise as much as $3 billion.
That should help set a benchmark price and encourage more banks to issue the bonds.

The government's sukuks, which would be the first in the world to be triple-A rated,
would also give the United Kingdom an alternative route to raise money from the oil-
rich Middle East. The plan is not without critics, however, who claim the government is
giving religious-based Sharia law official standing. Critics also raise concerns that
sukuks could be used to finance terrorism. But Rodney Wilson, an expert on Islamic
finance at Durham University, says that's an unlikely scenario. "Most Gulf banks do
have fairly sophisticated monitoring systems in place" to ferret out money-laundering,
terrorism, or other abuses, Wilson says. The 9/11 terrorists, he notes, used western
banks to finance their operations.

A more practical problem is a lack of product standardization. Sharia-compliant

financing relies on Islamic scholars to determine if products are in accordance with the
Koran. But definitions of what is acceptable can vary greatly, not only from region to
region but from bank to bank. Typically, Malaysian scholars tend to offer more flexible
interpretations of Sharia law than do their counterparts in the Gulf. Each bank has its
own board of scholars, and even among the London banks there's no uniformity. Schoon
says she's seen deals arranged by rival London banks that BLME's board—which
comprises two scholars from the Gulf and two from Asia—would have vetoed.
BLME's toxic-free balance sheet helped convince Blue Ocean's board that, despite being
a new bank, it was fundamentally strong. The company also liked the "shared-risk,
shared-reward" ethos of Islamic banking, Aslam says. Essentially, each is making a vote
of confidence in the other. If they're both right, that bodes well not only for the future of
BLME but for the continued growth of Islamic banking in London. And that should give
City burghers at least one thing to smile about.

Q – 6. Mostly Muslim population is living in the inflationary countries

which are under developing. So how interest can be avoided to deal with
inflationary gap of economy, as riba is prohibited in Islam?

Limitations of Riba

The main concern of the Muslim community is its desire to avoid dealing in riba,
because riba is strictly prohibited in their religion — Islam As far as money is
concerned, Riba is loosely translated as interest. Whether this translation is accurate or
not — whether the Arabic word riba and the English word interest mean the same thing
— is the subject of a long-standing debate. This question needs to be satisfactorily
resolved in order to find a proper solution to the problem. In the meantime, onea
comprehensive and commonly accepted definition form definition of riba??? the ribawi
items include more than just money … perhaps mention riba al-fadl/riba al-nasia, or
just keep my amendment as inserted ??? (in matters of money) is that: when one lends
some money is lentto another, if the lender demands more than his principal to be
returned, the excess amount so demanded is riba. Islam strictly prohibits demanding
and/or receiving riba, paying riba, and witnessing or writing such a transaction.

In the context of modern banking, the depositors receive interest, borrowers pay
interest, and the bank both pays and receives interest, witnesses writes and perhaps also
witnesses??? ‘perhaps also witnesses’ because maybe the bank cannot act as a witness to
its own transaction?? the transaction and as well as keepings account of it. It is on this
account basis that modern banking is repugnant to the Muslims.. Their dilemma is that
it is difficult to be part of today’s world without the medium of modern banking. Hence
the search for a riba-free alternative.

We can begin by asking whether all the operations of a commercial bank are
unacceptable to the Muslims on account of the riba prohibition. Can they make use of
some and seek alternatives for others? To do that, we need to first look first at the
working of a conventional bank in some detail
Q – 8. What is the Islamic economics order? What is the concept of wealth
in Islamic System?

Islamic banking is an instrument for the development of an Islamic economic order.

Some of the salient features of this order may be summed up as:

1. While permitting the individual the right to seek economic well-being,

Islam makes a clear distinction between what is halal (lawful) and what
is haram (forbidden or unlawful) in pursuit of such economic activity. In
broad terms, Islam forbids all forms of economic activity, which are
morally or socially injurious.

2. While acknowledging the individual's right to ownership of wealth

legitimately acquired, Islam makes it obligatory on the individual to
spend his wealth judiciously and not to hoard it, keep it idle or to
squander it.

3. While allowing an individual to retain any surplus wealth, Islam seeks to

reduce the margin of the surplus for the well-being of the community as
a whole, in particular the destitute and deprived sections of society by
participation in the process of Zakat (a tax on wealth that is distributed
to the needy).

4. While making allowance for the ways of human nature and yet not
yielding to the consequences of its worst propensities, Islam seeks to
prevent the accumulation of wealth in a few hands to the detriment of
society as a whole, by its laws of inheritance.

5. Viewed as a whole, the economic system envisaged by Islam aims at

social justice without inhibiting individual enterprise beyond the point
where it becomes not only collectively injurious but also individually
self-destructive

Islam has a unique dispensation on the theme of wealth, its ownership,

distribution and social relationship. Islam enjoins wealth creation not for its
own sake.

The theme of Islamic dispensation of wealth is treated as a deeply moral study

of self and society. The true nature of wealth in Islam requires social
preferences and market exchange mechanisms that are ethicized by human
consciousness of the Moral Law. Islam gives precise moral injunctions as to
what are, and are not acceptable kinds of wealth. They point out how individual
preferences on wealth formation ought to be utilized within the social meaning.

According to Shaikh Yusuf Talal DeLorenzo, well-known and respected

Shari’ah advisor and Islamic scholar as well as also author of the three volume
“Compendium of Legal Opinions on the Operations of Islamic Banks” the first
English reference on the fatwa (religious ruling) issued and published by the
Institute, business, in the Quranic sense of "profitable trade" or tijarat'un
rabihah is business that brings blessings to those who conduct it. Obviously,
profits are important as ends, but the means by which those profits are earned
are even more important. Indeed, the reason for the emphasis in the Shari’ah
on proper transacting is that Islam accords great importance to the economic
welfare of society.

Q-9. How profits are justified in the Islamic banking system?

The profits in Islamic banks are linked to risk-taking and there is no concept of riskless
capital (interest and rent seeking). Risk management is implied by shirah compliance
wherein the banks and investors have to take risk to get the rewards. While in case of
conventional finance risk free capital leads to excessive exposures due to lack of risk
sharing that create bubbles in financial markets.

Islamic shariah principles for earning profits from an asset or capital have been derived
from the Ahadith which give the following principles:

• Alkhiraj biddaman

• Alghurum Bilghunum

These have similar meanings- i.e. you cannot earn profits from an asset or capital unless
you have taken responsibility of that particular asset or capital.

Q.10. It is well published that the Islamic banking system is based on the
principles of Islamic economic order how will elaborate?

Islamic banking is an instrument for the development of an Islamic economic order.

Some of the salient features of this order may be assumed as:

1. While permitting the individual the right to seek his economic well-being. Islam
makes a clear distinction between what is lawful and what is forbidden in pursuit
of such economic activity. In broad terms, Islam forbids all forms of economic
activity, which are morally or socially injurious.
2. While acknowledging the individual’s right to ownership of wealth legitimately
acquired, Islam makes it obligatory on the individual to spend his wealth
judiciously and not to hoard it, keep it idle or to squander it.

3. While allowing an individual to retain any surplus wealth, Islam seeks to reduce
the margin of the surplus for the well-being of the community as a whole, in
particular the destitute and deprived sections of society by participation in the
process of Zakat.

4. While making allowance for the ways of human nature and yet not yielding to the
consequences of its worst propensities, Islam seeks to prevent the accumulation
of wealth in a few hands to determinant of society as a whole, by its laws of
inheritance.

5. Viewed as a whole, the economic system envisaged by Islam aims at social justice
without inhibiting individual enterprise beyond the point where it becomes not
only collectively injurious but also individually self-destructive.

The Islamic financial system employs the concept of participation in the enterprise,
utilizing the funds at risk on a profit-and-lose sharing basis. This by no means
implies that investments with financial institutions are necessarily speculative. This
can be excluded by careful investment policy, diversification of risk and prudent
management by Islamic financial institutions.

It is possible that in Islamic financial institutions can provide potential profit in

proportion to the risk assumed to satisfy the differing demands of participants in the
contemporary environment and within the guidelines of the shariah. The concept of
profit and loss sharing, as a basis of financial transactions is a progressive one as it
distinguishes good performance from the bad and the mediocre. This concept
therefore encourages better resource management.

Q-11. What is the origination of Islamic Banking system in Pakistan and

state bank of Pakistan’s role?

The Islamic banking in Pakistan was initiated in early 1980s. Different modes of
Islamic financing were introduced under the existing legal and regulatory
framework. The SPB issued landmark BCD circular 13, dated 20th June 184. The
circular gave the roadmap for Islamization of banking system during the course of
next financial year. The basic modes of financing were prescribed, however interest
based lending was allowed during the interim period. It was also outlined that
government financing and deposit will also become interest free at the start of fiscal
year 198.

Further to these instructions, circular 32, 33, and 34 dated 26th November 1984,
instructed:
 1) To convert interest charges to markup and markdown basis besides bearing
banks from charging any overdue penalties.

2) To convert liquidity support of SBP to the market on profit and loss sharing
basis and

3) Banks on computation of PLS based returns distribution on deposits, PLS

borrowing and equity.

While through separate instruction through BCD circular 39 and 40 dated 10th
December 1984, the concessionary financing schemes for LLM and EFS were also made
interest free. In addition, various other instructions were also issued by SBP on other
areas that outlined a comprehensive path for transformation of the banking system.

The process of Islamization during 19802s had a lot of promise but it failed to deliver
the goal of transforming banking system to non interest based. The pertinent issues that
resulted in failure of those efforts included lack of Shariah compliance framework, lack
of an enabling and separate regulatory and legal framework, lack of commitment by the
stakeholders, and lack of training to employees of banks. Subsequently, the federal
shariah court (FSC) declared the transformed system as being un Islamic in November
1991. The system declared as being based largely on markup techniques with or without
buyback arrangement that means that interest was replaced by the word markup and
there was no change in substance.

The FCS declared that various provisions of the laws held repugnant to the injunctions
of Islam would and instructed that these laws will cease to have effect from FY93.
However, the government and some banks preferred appeals to the Shariat Appellate
Bench (SAB) of the supreme court of Pakistan. The SAB delivered its judgment on
December 23, 1999 rejecting the appeals and directing that laws involving interest
would cease to have effect finally by Junee 30, 2001.

In the judgment, the court concluded that the prevalent financial system had to be
subjected to radical changes to bring it into conformity with the shariah. It also directed
the government to set up, within given time frame, a commission for transformation of
the financial system and two task forces to plan and implement the process of the
transformation. The court indicated some measures, which needed to be taken, and the
infrastructure and legal framework to be provided in order to have an economy
conforming to the injunctions of Islam.

As directed by the supreme court, a commission for transformation of financial system

and task forces in the ministry of finance and ministry law were established in February
2000. A committee on development of financial instruments and standardized
documents was also set up by the commission in SBP to review exiting products and
services of banks and other financial institutions, develop new financial instruments and
draft standardized documents for submission to the commission for final approval.
The Commission presented two interim reports to the government in October 2000 and
May 2001. In these reports, commission recommended various measures to implement
court orders, identified the major shariah compliant modes of financing, their
essentials, models agreements for major modes of financing, and guidelines for
conversion of products and services of banks and financial institutions.

However, the verdict was later set aside by a SC verdict that asked the FSC to revisit the
whole case anew. This implies that the compulsion to transform the entire banking
system to interest (Riba) free basis was no more there. Nonetheless, SBP continued
efforts to transform the banking system and the conventional banking. In this respect,
SBP formulated a three pronged strategy. The strategy was to allow

1) Opening sector

2) Existing banks to establish subsidiaries for Islamic banking and

3) Existing banks to open separate branches for Islamic banking

Subsequently, SBP issued criteria for setting up of Islamic banks in December 2001. In
November 2002, conventional banks were allowed to open subsidiaries for Islamic
banking operations. Moreover, state bank issued detailed policies for promotion of
Islamic banking containing criteria for establishment of full-fledged Islamic banks;
Islamic banking subsidiaries and guidelines for opening of standalone Islamic banking
branches. In September, 2003 a fledged Islamic Banking Department was established in
state bank of Pakistan to deal with all issues relating to Islamic Banking.

THE ROLE OF SBP TO ENSURE SHARIAH COMPLIANCE AND OVERALL

REGULATION OF ISLAMIC BANKING

The lack of Shariah compliance mechanism was one of the major hindrances in precious
effort to Islamize the banking system. Therefore, a comprehensive framework for
shariah compliance was prepared. Accordingly a shariah board was established in the
SBP that will guide SBP on issues relating to Islamic banking. Moreover, all Islamic
financial institutions. Were required to have a shariah advisor in order to facilitate
banking operations and financial innovations. A fit and proper criterion was also
prescribed by SBP for selection of shariah advisor. Each bank was required to conduct
internal shariah audit at least once a year. Moreover, guidelines on Islamic banking in
the form of shariah essentials and model agreements of various Islamic modes of
financing have been issued by SBP.

SBP has over the years attempted to develop a supportive regulatory, supervisory and
shariah compliance framework that is in line with best international practices. Some
areas worth mentioning in this regard are as follows:

A- Regulatory & Supervisory Framework

Three pronged strategy under which the following criteria/guidelines have been
put in place:
 1. Detailed criteria for setting up of scheduled Islamic commercial bank
based on principles of shariah in the private sector.

2. Guidelines criteria for setting up of Islamic banking subsidiaries by

existing commercial banks.

3. Guidelines for opening of standalone branches for Islamic banking by

existing commercial banks

• Risk management Guidelines for Islamic banking institutions.

• Guidelines for Islamic Microfinance business

• Segregation of Funds for Conventional Banks having IBBs

• Shariah Compliance Inspection

• Separate Schedule of Service Charges for IBBs

• Offsite Monitoring of the performance of Islamic banking institutions

B. Shari’ah Compliance Framework

• Essential and Models Agreements for Islamic Models of Financing

• Models Agreements for Islamic Models of Financing

• Shari’ah Advisor (as per Fit and proper Criteria ) for each Islamic Bkg. Institution

• Shari’ah Board at SBP

• Instructions & Guidelines for Shari’ah Compliance

• Shari’ah Advisors Forum

• Standardization of Shari’ah Practices

Going forward SBP envisages further strengthening of the regulatory and Shariah
compliance regime primarily through adaptation of standards developed by
international Islamic Financial Institutions (AAOIBI).
Q.12. what are the recent challenges to Islamic Banking and how it can
overcome?

• Dearth/ absence of Liquidity management instruments & Institutions.

The absence of liquidity management instruments, such as bonds and other marketable
securities, which could be utilized to either cover liquidity, is a major challenge for
Islamic Banking Institutions. Developments of Shariah compliant Instruments.
Interbank market and capital market is very important to resolve different issues
relating to the liquidity managements, by Islamic financial institutions and monitory
management by the central bank/government. Although various alternatives have been
developed/ suggested by the researcher but related nitty-gritty for their proper
implementation, still required strenuous work on the part of governments, regulators,
legislators and policy makers.

• Limited investment and efforts towards training, education and

research and development

Capacity building is another major challenge been faced by Islamic financial

industry. Proper understanding of Islamic banking service and their equal
treatments vis-à-vis conventional products is vital for the practitioners in
Islamic finance industry for product innovations and differentiations.
Islamic finance requires a different mindset because an institution is what its
employees make it. It is, therefore extremely important to have the people
with the right kind of skill and commitments to run Islamic financial
institutions.

The importance of R&D could not be over estimated it is particularly more

important for the progress of Islamic financial industry because it has yet to
achieve its full potential and objectives. Innovation is required for developing
products that are not just the mimics of their conventional counterpart but
they also have the ability to help in achieving the objectives of Islamic
economic system. Focus of product development need to be shifted need
base.

Therefore to sustain the Islamic banking industry’s growth it is imperative to

create a progressive research and knowledge based environment where it not
only because easy for the Islamic banking institutions to deal with
contemporary problems but which also foster futuristic view of the industry
and aims to innovate and develop newer and better products and services.
 • Limited outreach and distribution network of Islamic banks

Another major issue been faced by the industry is its limited outreach and
distribution network. Islamic banking has a strong growth potential in
emerging fields like micro-financing, agriculture financing, infrastructure
finance, small & medium enterprises etc. and due to its appeal among the
masses because of its ethical and religious dimensions. Moreover is the
demand for launching of diversified and integrated Islamic financial system
in the country is on the rise, there is a great potential for Islamic banking
products in these areas.

An additional factor in extending the outreach of Islamic banks is facilitation

of its network expansion. The Islamic banking institutions also need to
utilize alternate delivery channels for improving the accessibility of the
Islamic banking services across the length and breadth of the country.

• Lack of public awareness about the concept of the Islamic banking

and finance

Like any other “new” concepts, Islamic banking and finance is also going to
take some time to be fully comprehended by the people at large. Any new
product when introduced in a market we go through the natural dynamics of
initially being understood by a few and with the passage of time as its need
and practicability is felt and appreciated by more and more people greater
efforts are employed to make it recognizable for everyone. In Pakistan failure
of implementing the Islamic banking system in its true spirit in the 1980s is
another major factor that contributes to the high level of skepticism
expressed by many commentators. These two factors along with many others
make task of creating awareness about Islamic banking among the masses a
daunting one.

Q.13. where do you see the future of Islamic banking system in Pakistan?
Are you satisfied with the performance of the Islamic banks providing
services in Pakistan?

It is strongly believed that factors like unmet demand, geographical coverage and
product development in combinations with the introduction of new sectors into the fold
of Islamic banking will enable the industry to soon increase its market share to a
sizeable level.

The industry will have to cope with the following challenges in near future:

• Increased competition from conventional banks that are now bigger and
better capitalized as a result of consolidation and mergers.
 • Conventional banking segment is also highly profitable, putting pressure on
Islamic banks to demonstrate growth with profitability.

• Demanding consumers expect differentiated products (credibility and

reputation risk).

• “Islamic Banking” is an increasingly popular subject with the domestic print

and electronic media (need for media management).

Total assets in Islamic banking in Pakistan reached Rs. 210 billion in March 2008.
Similarly financing and investment portfolio of Islamic banks reached Rs. 151 billion. In
terms of market share, total assets and financing and investment reached to 4.3% and
4% respectively in March 2008. Moreover in terms of branch network the 6 full fledge
Islamic banks and 12 conventional banks (having dedicated IBBs) are operating through
over 310 branches in over 45 cities and towns.

The industry over the years has managed to offer a wide array of products encompassing
almost the entire range of Islamic modes of financing that are able to cater to the needs
of majority of the sectors of the economy. The segments covered by the industry include
Corporate/ commercial, Agriculture, consumer, commodity financing, SME sector,
treasury and financial institutions and manufacturing and services concerns through
various shariah compliant modes such as Muarabaha, Mudaraba, Musharaka, Ijarah,
Diminishing Musharaka, Salam, Istisna, Wakala and Islamic Export Refinance etc. also
with the increased issuance Sukut their investment in these shariah compliant
instruments is one the rise. Muhabaha, Ijaraha, and Diminishing Musharaka are the
preferred modes used by the industry.

On the liability side, Islamic banking industry offers various shari’ah compliant deposit
schemes that are available for customers to invest their funds in. these include current
accounts, basic banking account, checking accounts, saving accounts, term deposits, and
certificates of investment etc, current account is mostly being offered on Qard basis
whereas Mudaraba is the preferred mode used by Islamic banks while offering saving
accounts, term deposits and certificates of investment.

Further, a variety of other ancillary services such as guarantees, remittances ( local and
international), online banking, ATM/ debit card, safe depost lockers and utility bill
payments etc. are also being offered in a shariah compliant manner.
Q.14. Can Islamic banking system fruitful under no-Islamic economic
system or even one component is against the principles of Islamic system of
financing?

Islamic banking is among one of the many instruments for the development of an
Islamic economic order. Some of the salient features of this order may be summed up
as:

• While permitting the individual the right to seek his economic well-being, Islam
makes a clear distinction between what is lawful and what is forbidden in pursuit
of such economic activity. In broad terms, Islam forbids all forms of economic
activity, which are morally or socially injurious.

• While acknowledging the individual’s right to ownership of wealth legitimately

acquired, Islam makes it obligatory on the individual to spend his wealth
judiciously and not to hoard it, keep it idle or to squander it.

• While allowing an individual to retain any surplus wealth, Islam seeks to reduce
the margin of the surplus for the well-being of the community as a whole, in
particular the destitute and deprived sections of society by participation in the
process of zakat.

• While making allowance for the ways o human nature and yet not yielding to the
consequences of its worst propensities, Islam seeks to prevent the accumulation
of wealth in a few hands to the detriment of society as a whole, by its laws of
inheritance.

• Viewed as a whole, the economic system envisaged by Islam aims at social justice
without inhibiting individual enterprise beyond the point where it becomes not
only collectively injurious but also individually self destructive.

It is therefore evident that Islamic banking being only a part of the overall economic
system can exercise a limited level of influence of the whole system. It is sometimes
argued against the Islamic financial sytem that Islamic financial institutions working
since last four decades did not bring any visible change even in the field of financing.
This indicates that the boasful claims of creating distributive justice under the umbrella
of Islamic banking are exaggerated.
This criticism is not realistic as it does not take into account the fact that in proportion
to conventional banking Islamic baking is no more than a drop in a ocean and therefore
they cannot be supposed to revolutionize the economy. Secondly the Islamic financial
institutions are not normally supported by the governments, legal and taxation system
and the central banks their respective countries, under these circumstances they have
been given certain concessions, on the ground of need or necessity. Living under
constraints they are mostly relying on the relaxed sets of rules (given in a visible change.
However Islamic banking in the whole financing system is based on the ideal principles
of Islam it will certainly bring a discernable impact on the economies as whole.

Q.15. which is the forum from where shari’ah laws applicable to Islamic
banks are formulated and/ or endorsed? Elaborate the merits and demerits
of Islamic banking system with regard to attracting customers?

State Bank of Pakistan has through approval of its shari’ah board out lined shari’ah
essential for the Islamic modes of finance. These are the minimum requirement to be
met by Islamic banking institutions while offering Islamic banking products.
Furthermore the shariah advisors of the institutions are responsible for ensuring that
the procedures, products, manuals, agreements etc. of the Islamic banking institutions
are shariah compliant.

MERITS

• Being religiously oriented Islamic banking is highly attractive

• Being based on more prudent principles such as proactive risk management and
transparency etc. customers feel relatively more secure.

DEMERITS

• Since more documentation is involved customers may find it lengthy process to

follow.

• Since currently many products mimic the conventional side therefore perception
related problems arise.
 MUSHARAKAH
Q1: Define Musharakh in brief?

Musharakah is a term frequently referred to in the context of Islamic modes of

financing. The connotation of this term is rather limited than the term “shirkah” more
commonly used in the Islamic jurisprudence. For the purpose of clarity in the basic
concepts, it will be pertinent at the outset to explain the meaning of the each term, as
distinguished from the other.

Shirkah means sharing it means that sharing of two or more than two people in a single
business is called Musharakh. In general sense Musharakh is not proper use the correct
use of Musharakh is Shirkah which means sharing, but in the modes of Islamic
financing we use Musharakh.

Q2: Define and explain kinds of Musharakah?

In the terminology of Islamic Fiqh, it has been divided into two kinds:

1: Shirkat-ul-milk- 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. Sometimes it comes into
operation at the option of the parties. For example, if two or more persons purchase
equipment, it will be owned jointly by both of them and the relationship between them
regard to that property id called Shirkat-ul-milk. Here this relationship has come into
existence at their own option as they themselves elected to purchase the equipment
jointly.

Shirkat-ul-aqd:

This is the second type of shirkah which means a partnership affected by a mutual
contract. For the purpose of brevity it may also be translated as “joint commercial
enterprise”.

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

1: Shirkat-ul-amwal:

Where all the partners invest some capital into a commercial enterprise such investment
is called Shirkat-ul-amwal.

2: Shifkat-ul-A’mal:

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 ration.
This partnership is also called Shirkat-ul-taqabbul or Shirkat-ul-abdan.

3: Shirkat-ul-wujooh:

Here 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.

Q3: What are the basic rules of the Musharakah?

1: Musharakah is a partnership established by the parties through a mutual contract.

Therefore, it goes without saying that all the necessary ingredients of valid contract
must be present here also. For example, the parties should be capable of entering into a
contract; the contract must take place with free consent of the parties without any
duress, fraud or misrepresentation, etc.

Distribution of the profit:

2: The proportion of the profit to be distributed among the partners must be agreed
upon at the time of affecting the contract. If no such proportion has been determined
the contract in not valid in shari’ah.

3: The ratio of the profit for each partner must be determined in proportion to the actual
profit accrued to the business, and not in proportion to the capital invested by him. It is
not allowed to fix a lump sum amount for any one of the partner or any rate of tied up
with his investment.
Ratio of Profit:

4: Is it necessary that the ratio of profit of each partner conforms to the ratio of the
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 Ahmed 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% of 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 Musharakah then his share of profit
cannot get more than the ratio of his investment.

Q4: How loss is distributed in the Musharakah mode of financing?

In the case of loss all the Muslim jurists are unanimous on the point that each partner
shall suffer the loss exactly according to the ratio of his investment. Therefore, if a
partner has invested 40% of the capital, he must suffer 40% of the loss, not more, not
less and any condition to the contrary shall render the contract invalid. There is a
complete consensus of jurists on this principle. Therefore, according to Imam Shafi’I the
ratio of the share of a partner in profit and loss both must conform to the ratio of his
investment. Buy according to Imam Abu Hanifah and Imam Ahmed, the ratio of the
profit may differ from the ratio of investment according to the agreement of the
partners, but the loss must be divided between them exactly in accordance with the ratio
of capital invested by each one of them. It is this principle that has been mentioned in
the famous maxim:

Profit is based on the agreement of the partners, but loss is always subject
to the ratio of investment.

Q5: How to invest the capital in Musharakah form of the business?

Most of the Muslim jurists are of the opinion that the capital invested by each partner
must be in liquid form. It means that the contract of the Musharakah can be based only
on money, and not on commodities. In other words, the share capital of a joint venture
must be in monetary form. No part of it can be contributed in kind. However, there are
different views in this respect.

1: Imam Maliki is of the view that the liquidity of capital is not a condition for the
validity of Musharakah therefore; it is permissible that a partner contributes to the
Musharakah in kind, but his share shall be determined on the basis of evaluation
according to the market price prevalent at the date of the contract. This view is also
adopted by some Hanbali jurists.

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

Firstly, they say that the commodities of each partner are always distinguishable from
the commodities of the other. For example, if A has contributed one motor car to the
business, and B has come with another motor car, each one of the two cars is the
exclusive property of its original owner. Now, if the car of A is sold, its sale-proceeds
should go to A. B has no right to claim a share in its price. Therefore, so far as the
property of each partner is distinguished from the property of the other, no partnership
can take place. On the contrary if the capital invested by every partner is in the form of
money the share capital of each partner cannot be distinguished from that of the other,
because the units of money are not distinguishable, therefore, they will be deemed to
form a common pool and thus the partnership comes into existence.

Secondly they say, there are a number of situations in a contact of Musharakah where
the partners have to resort to redistribution of the share-capital to each partner. If the
share-capital was in the form of commodities, such redistribution cannot take place,
because the commodities may have been sold at that time. If the capital is repaid on the
basis of its value, the value may gave increased and there is a possibility that a partner
gets all the profit of the business, because of the appreciation in the value of the
commodities he has invested leaving nothing for the other partner. Conversely, if the
value of those commodities decreases, there is a possibility that one partner secures
some part of the original price of the commodity of the other partner in addition to his
own investment.

Q6: What is the normal management principle in the Musharakah?

The normal principle of Musharakah is that every partner has a right to take part in its
management and to work for it. However, the partners may agree upon a condition that
the management shall be carried out by one of them and no other partner shall work for
the Musharakah. But in this case the sleeping partner shall be entitled to the profit only
to the extent of his investment, and the ratio of his investment, as discussed earlier.

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

Q7: How Musharakah terminate for ever?

Musharakah is deemed to be terminated in any one of the following events:

1: Every partner has a right to terminate the Musharakah at any time after giving his
partner a notice to this effect, whereby the Musharakah will come to an end.
In this case, if the assets of the Musharakah are in cash form, all of them will be
distributed pro rata between the partners. But if the assets are not liquidated, the
partners may agree either on the liquidation of the assets, or on their distribution or
partition between the partners as they are. If there is a dispute between the partners in
this matter i.e. one partner seeks liquidation while the other wants partition of the non-
liquid assets themselves, the latter shall be preferred, because after the termination of
Musharakah all the assets are in the joint ownership of the partners, and a co-owner has
a right to seek partition or separation, and no one can compel him on liquidation.
However, if the assets are such that they cannot be separated or partitioned such as
machinery then they shall be sold and the sale-proceeds shall be distributed.

2: If any one of the partner dies during the currency of Musharakah the contract of
Musharakah with him stands terminated. 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 partners becomes insane or otherwise becomes incapable of effecting
commercial transactions, the Musharakah stands terminated.
Q8: What is the difference between Musharakah and general Partnership?

MUSHARAKAH GENERAL PARTNERSHIP

Limit of partners: Limit of partners:

In Musharakah there is no any limit of In general partnership maximum partners

partners. should be 20 and not more than this.

Interest: Interest:

Here partners can borrow money from

Musharakah is free of interest partnership. band as an interest bearing loans.

Distribution of loss:
Distribution of loss:
Here loss and profit distributed an agreed
Here loss is distributed among the ratio.
partners on the bases of investment. Type of business:

Here no any restriction whatever business

Type of business:
you what you can do it.

Here partners can do only those businesses

which are according to Islam.
 MUDARABAH

Q1: What is mudarabah?

Mudarabah is a special kind of partnership where one partner gives money to another
for inverting it in a commercial enterprise. The investment 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”.

Q2: What are differences between Musharakah and Mudarabah?

The difference between Musharakah and mudarabah can be summarized in the

following points:

1: The investment in Musharakah comes from all the partners, while in mudarabah
investment is sole responsibility of rabb-ul-mal.

2: In musharakah all the partners can participate in the management of the business
and can work for it, while in mudarabah the rabb-ul-mal has no right to participate in
the management which is carried out by the mudarib only.

3: In musharakah all partners share the loss to the extent of the ratio of their investment
while in mudarabah the loss, if any is suffered by the rabb-ul-mal only.

4: The liability of the partners in musharakah is normally unlimited. Therefore, if the

liabilities of the business exceed its assets and business goes in liquidation, all the
exceeding liabilities shall be borne pr rata by all the partners. However, if all the
partners have agreed that no partner shall incur any debt during the course of business,
then the exceeding liabilities shall be borne by that partner alone who has incurred a
debt on the business in violation of the aforesaid condition.

Contrary to this is the case of mudarabah. Here the liability of rabb-ul-mal is limited to
his investment unless he has permitted the mudarib to incur debts on his behalf.
5: In musharakah as soon as the partners mix up their capital in a joint pool, all the
assets of the musharakah become jointly owned by all of them according to the
proportion of their respective investment. Therefore, each one of them can benefit from
the appreciation in the value of the assets, even if profit has not accrued through sales.

The case of mudarabah is different. Here all the goods purchased by the mudarib are
solely owned by the rabb-ul-mal, and the mudarib can earn his share in the profit only
in case he sells the goods profitably. Therefore, he is not entitled to claim his share in
the assets themselves, even if their value has increased.

Q3: How the business of the mudarabah does it carried out?

The rabb-ul-mal may specify a particular business for the mudarib in which case he shall
invest the money in that particular business only. This in called al-mudarabah al-
muqayyadah (restricted 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).

A rabb-ul-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 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 partners inter se.

The mudarib or mudaribs, as the case may be are authorized to do anything which is
normally dome in the course of the 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.
Q4: How profit is distributed in mudarabah business?

It is necessary for the avidity of mudarabah that the parties agree, right at the beginning
on a definite proportion of the actual profit to which each one of them is entitled. No
particular proportion has been prescribed by the shari’sh rather; it has been left to their
mutual consent. They can share the profit equal proportions, and they can also allocate
different proportions for the rabb-ul-mal- mal and the mudarib. However, they cannot
allocate a lump sum amount of profit for any party, nor can they determine the share of
any party at a specific rate tied up with the capital. For example, if the capital is Rs.
100000 they cannot agree on a condition that Rs. 10000 out of the profit shall be share
of the mudarib, nor can they say 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.

Q5: When the business of mudarabah comes in to termination?

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 restrict a particular time.
Q6: What are the conditions for combination of musharakah and
mudarabah?

A contact of mudarabah normally presumes that the mudarib has not invested anything
to the mudarabah. He is responsible of the management only, while all the investment
comes from rabb-ul-mal. But there may be situations where mudarib also wants to
invest some of his money into the business of mudarabah. In such cases, musharakah
and mudarabah are combined together. For example, A gave to B Rs. 100000 in a
contract of mudarabah. B added Rs. 50000 from his own pocket with the permission of
A. This type of partnership will be treated as a combination of musharakah and
mudarabah. Here the mudarib may allocate for himself a certain percentage of profit on
account of his investment as a sharik, and at the same time he may allocate another
percentage for his management and work as a mudarib. The normal basis for allocation
of the profit in the above example would be that B shall secure one third of the actual
profit on account of his investment and the remaining two thirds of the profit shall be
distributed between them equally. However, the parties may agree on any other
proportion. The only condition is that the sleeping partner should not get more
percentage than the proportion of his investment.
 MURABAHAH

Q1: Explain the concept of murabahah in Islamic mode of financing?

Most of the Islamic banks and financial institutions are using “Murabahah” as an
Islamic mode of financing, and most of their financing operations are based on
Murabahah. That is why this term has been taken in the economic circles today as a
method of banking operations, while the original concept of Murabahah is different
from this assumption.

Murabahah is in fact a term of Islamic Fiqh and it refers to a particular kind of sale
having nothing to do with financing in its original sense. If a seller agrees with his
purchaser to provide him a specific commodity on a certain profit added to his cost, it is
called a murabahah transaction. The basic ingredient of murabahah is that the seller
discloses the actual cost he has incurred in acquiring the commodity, and then adds
some profit thereon. This profit may be in lump sum or may be based on a percentage.

The payment in the case of murabahah may be at spot, and may be on a subsequent date
agreed upon by the parties. Therefore, murabahah does not necessarily imply the
concept of deferred payment as generally believed by some people who are not
acquainted with the Islamic jurisprudence and who have heard about murabahah only
in relation with the banking transactions.

Q2: What are the basic rules in the murabahah for the sale of commodities?

Sale is defined in Shari’ah as the exchange of a thing of value by another thing of value
with mutual consent. Islamic jurisprudence has laid down enormous rules governing the
contract of sale, and the Muslim jurists have written a large number of books, in a
number of volumes, to elaborate them in detail. There are some rules regarding to the
sale of commodities in murabahah:

1: The subject of sale must be exists at the time of sale. Thus, a thing which has not yet
come into existence cannot be sold. If a non-existent thing has been sold, though by
mutual consent, the sale is void according to shari’ah.

2: The subject of sale must be in the ownership of the seller at the time of sale. Thus,
what is not owned by the seller cannot be sold. If he sees something before acquiring its
ownership the sale is void.

3: The subject of sale must be a property of value. Thus, a thing having no value
according to the usage of the trade cannot be sold or purchased.

4: The subject of sale should not be a thing which is not used except for a haram
purpose, like pork, wine etc.
5: The subject of sale must be specifically known and identified to the buyer.

6: The delivery of the sold commodity to the buyer must be certain and should not
depend on a contingency or chance.

7: The certainty of price is a necessary condition for the validity of a sale. If the price is
uncertain, the sale is void.

Q3: Do you think murabahah is a mode of financing illustrates it?

Originally, murabahah is a particular type of sale and not a mode of financing. The ideal
mode of financing according to Shari’ah is mudarabah or musharakah. However, in the
perspective of the current economic set p there are certain practical difficulties in using
mudarabah and musharakah instruments in some areas of financing. Therefore the
contemporary Shari’ah experts have allowed subject to certain conditions, the use of the
murabahah on deferred payment basis as a mode of financing. But there are two
essential points which must be fully understood in this respect:

1: It should never be overlooked that, originally murabahah in not ma mode of

financing. It is only a device to escape from “interest” and not an ideal instrument for
carrying out the real economic objectives of Islam. Therefore, this instrument should be
used as a transitory step taken in that process of the Islamization of the economy and its
use should be restricted only to those cases where mudarabah or musharakah are not
practicable.

2: The second important point is that the murabahah transaction does not come into
existence by merely replacing the word of “interest” by the words of “profit” or “mark-
up. Actually murabahah as a mode of finance has been allowed by the Shari’ah scholars
with some conditions. Unless these conditions are fully observed murabahah is not
permissible. In fact, it is the observance of these conditions which can draw a clear line
of distinction between an interest-bearing loan and a transaction of murabahah. If these
conditions are neglected the transaction becomes invalid according to Shari’ah.

Q4: What are the basic features of murabahah financing?

1: Murabahah is not a loan given on interest. It is the sale of a commodity for a deferred
price which includes an agreed profit added to the cost.

2: Being a sale and not a loan the murabahah should fulfill all the conditions necessary
for a valid sale.

3: The financer must have owned the commodity before he sells it to his client.
4: The commodity must come into the possession of the financier whether physical or
constructive, in the sense that the commodity must be in his risk, though for a short
period.

5: The sale cannot take place unless the commodity comes into the possession of the
seller, but the seller can promise to sell even when the commodity is not in his
possession. The same rule is applicable to murabahah.

Q5: What are the basic mistakes in murabahah financing?

After explaining the concept of murabahah and its relevant issues, it will be pertinent to
highlight some basic mistakes often committed by the financial institutions in the
practical implementation of the concept.

2: The first and most glaring mistake is to assume that murabahah is a universal
instrument which can be used for every type of financing offered by conventional
interest based banks and NBFIs. Under this false assumption some financial institutions
are found using murabahah for financing overhead expenses of a firm or company like
paying salaries of their staff, paying the bills of electricity etc. and setting off their debts
payable to other parties. This practice is totally unacceptable because murabahah can be
used only where a commodity is intended to be purchased by the customer. If funds are
required for some other purpose murabahah cannot work. In such cases, some other
suitable modes of financing like musharakah, leasing etc. can be used according to the
nature of the requirement.

2: International commodity transactions are often resorted to for liquidity management.

Some Islamic banks feel that these transactions being assets based can easily be entered
into on murabahah basis and they enter the field ignoring the fact that the commodity
operations as in vogue in the international markets, do not conform to the principles of
Shari’ah. In many cases they are fictitious transactions where no delivery takes place.
The parties end up paying differences. In some cases there are real commodities but
they are subjected to forward sales which are not allowed in Shari’ah. Even if the
transactions are restricted to spot sales they should be formulated on the basis of
Islamic principles of murabahah by fulfilling all the necessary conditions.
 IJARAH (LEASING)
Q1: What do you meant by the term Ijarah or leasing?

Ijarah is a tem of Islamic fiqh. Lexically, it means to give something on rent. In the
Islamic jurisprudence the term Ijarah is used for two different situations. In the first
place it means to employ the services of a person on wages given to him as a
consideration for his hired services. The employer is called “mustajir” while the
employee is called “ajir”.

Q2: What are the basic rules of Ijarah or leasing?

There are some basic rules for Ijarah or leasing which are as under:

1: Leasing is a contract whereby the owner of something transfers its usufruct to another
person for an agreed period, at an agreed consideration.

2: The subject of lease must have a valuable use. Therefore, things having no usufruct at
all cannot be leased.

3: As the corpus of the leased property remains in the ownership of the lesser, all the
liabilities emerging from the ownership shall be borne by the lesser, but the liabilities
referable to the use of the property shall be borne by the lessee.

4: The period of lease must be determined in clear terms.

5: The lessee is liable to compensate the lesser for every harm to the leased asset caused
by any misuse or negligence on the part of the lessee.

6: The leased asset shall remain in the risk of the lesser throughout the lease period in
the sense that any harm or loss caused by the factors beyond the control of the lessee
shall be borne by the lesser.

7: A property jointly owned by two or more pennons can be leased out , and the rental
shall be distributed between all the joint owners according to he proportion of their
respective share in the property.

8: A joint owner of a property can lease his proportionate share to his co-sharer only
and not to any other person.

Q3: How does leasing is a mode of financing?

Like murabahah lease in not originally a mode of financing. It is simply a transaction

meant to transfer the usufruct of a property from one person to another for an agreed
period against an agreed consideration. However, certain financial institutions have
adopted leasing as a mode of financing instead of long term lending on the basis of
interest. This kind of lease in generally known as the financial lease as distinguished
from the operating lease and many basic features of actual leasing transaction have been
dispensed with therein.

When the financial institutions were established in the near past they found that leasing
is a recognized mode of finance throughout the world. On the other hand they realized
that leasing is a lawful transaction according to Shari’ah and it can be used as an interest
free mode of financing. Therefore, leasing has been adopted by the Islamic financial
institutions but very few of them paid attention to the fact that the financial lease has a
number of characteristics more similar to interest than to the actual lease transaction.
That is why started using the same model agreements of leasing as wee in vogue among
the conventional financial institutions without any modification while a number of their
provisions were not in conformity with shari’ah.

Q4: What is difference between murabahah and leasing?

However, there is a point of difference between murabahah and leasing. In murabahah

actual sale should take place after the client takes delivery from the supplier, and the
previous agreement of murabahah is not enough for affecting the actual sale. Therefore,
after taking possession of him asset as an agent he is bound to give intimation to the
institution and make an offer for the purchase from him. The sale takes place after the
institution accepts the offer.

The procedure in leasing is different, and a little shorter. Here the parties need not affect
the lease contract after taking delivery. If the institution, while appointing the client its
agent has agreed to lease the asset with effect from the date of delivery the lease will
automatically start on that date without any additional procedure.

Q5: Who will responsible in case of loss to the asset?

In the basic principle of leasing the lessee is responsible for any loss caused to the asset
by his misuse of negligence. He can also be made liable to the wear and tear which
normally occurs during its use. But he cannot be making liable to a loss caused by the
factors beyond his control. The agreements of the traditional financial lease generally do
not differentiate between the two situations. In a lease based on the Islamic principles.
Both the situations should be dealt with separately.

Q6: What is the term Head-Lease?

Another concept developed in the modern leasing business is that of head leasing. In
this arrangement a lessee sub-leases the property to anther of sunglasses. Then he
invites others to participate in his business by making them share the rentals received
by his sub-leases. For making them participates in receiving rentals. He charges a
specified amount from them. This arrangement is not in accordance with the principles
of shari’ah. The reason is obvious. The lessee does not own the property. He is entitled
to benefit from it usufruct only. That usufruct he has passed on to his subleases by
contracting a sublease with them. Now he does not own anything neither the corpus of
the property nor its usufruct. What he has is the right to recover rent only there for he
assigns a part of this right to other persons. It is already explained in detail that this
right cannot be traded in because it amounts to selling a receivable debt at a discount
which is one of the forms of riba prohibited by the holy Quran and Sunnah. There for
this concept is not acceptable.

These are some basic features of the financial lease which are not in conformity with the
dictates of shari’ah. While using the lease as an Islamic mode of finance, these
shortcomings must be avoided.

The list of the possible shortcomings in the lease agreement is not restricted to what has
been mentioned above but only the basic errors found in different agreements have been
pointed out and the basic principle s of Islamic leasing have been summarized. An
Islamic lease agreement must conform to all of them.
 Sukuk

Q1: What do meant by sukuk?

Sukuk (Arabic: ‫صكوك‬, plural of ‫ صك‬Sakk, "legal instrument, deed, check") is the Arabic
name for a financial certificate but can be seen as an Islamic equivalent of bond.
However, fixed income, interest bearing bonds are not permissible in Islam, hence
Sukuk are securities that comply with the Islamic law and its investment principles,
which prohibits the charging, or paying of interest. Financial assets that comply with the
Islamic law can be classified in accordance with their tradability and non-tradability in
the secondary markets.

Conservative estimates by the Ten-Year Framework and Strategies suggest that over
$700 billion of assets are managed according to Islamic investment principles. Such
principles form part of Shari'ah, which is often understood to be ‘Islamic Law’, but it is
actually broader than this in that it also encompasses the general body of spiritual and
moral obligations and duties in Islam.

Sharia-compliant assets worldwide are worth an estimated $500 billion and have grown
at more than 10 per cent per year over the past decade, placing Islamic finance in a
global asset class all of its own. In the Persian Gulf and Asia, Standard & Poor's
estimates that 20 per cent of banking customers would now spontaneously choose an
Islamic financial product over a conventional one with a similar risk-return profile.

With its Arabic terminology and unusual prohibitions, Sukuk financing can be quite
mystifying for the outsider. A good analogy is one of ethical or green investing. Here the
universe of invest able securities is limited by certain criteria based on moral and ethical
considerations. Islamic Finance is also a subset of the global market and there is nothing
that prevents the conventional investor from participating in the Islamic market.

Q2: Define history of the Sukuk?

In classical period Islam Sakk (sukuk) – which is cognate with the European root
"cheque" from Persian '(‫ )چک‬pronounced check' - meant any document representing a
contract or conveyance of rights, obligations or monies done in conformity with the
Shari’ah. Empirical evidence shows that sukuk were a product extensively used during
medieval Islam for the transferring of financial obligations originating from trade and
other commercial activities.

The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset
monetization - the so called securitization - that is achieved through the process of
issuance of sukuk (tasked). Its great potential is in transforming an asset’s future cash
flow into present cash flow. Sukuk may be issued on existing as well as specific assets
that may become available at a future date.
Q3: What are the main principles of Sukuk?

Sukuk can be structured alongside different techniques. While a conventional bond is a

promise to repay a loan, Sukuk constitutes partial ownership in a debt (Sukuk
Murabahah), asset (Sukuk Al Ijarah), project (Sukuk Al Istisna), business (Sukuk Al
Musharakah), or investment (Sukuk Al Istithmar).

Most commonly used Sukuk structures replicate the cash flows of conventional bonds.
Such structures are listed on exchanges, commonly Luxembourg Stock Exchange and
London Stock Exchange in Europe, and made tradable through conventional
organizations like Euro clear or Clear stream. A key technique to achieve capital
protection without amounting to a loan is a binding promise to repurchase certain
assets, e.g. in the case of Sukuk Al Ijarah, by the issuer. In the meantime a rent is being
paid, which is often benchmarked to an interest rate like LIBOR (which is disliked by
Sharia Scholars).

From a Sharia perspective, certificates of debt are not tradable (although a different
view is held by many in Malaysia), and certain structuring elements for Sukuk Al
Musharakah, Sukuk Al Mudarabah and Sukuk Al Istithmar faced severe criticism in late
2007 by Sheik Muhammad Taqi Usmani, followed by a meeting of the Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI).

The most accepted structure, which is tradable, is thereafter the Sukuk Al Ijarah. Debt
certificates can be only bought before the finance occurs and then held to maturity from
an Islamic perspective, which is critical on debt trading at market value regarding any
difference to be like the prohibited Riba (interest on money).

As Shari’ah considers money to be a measuring tool for value and not an asset in itself, it
requires that one should not receive income from money (or anything that has the genus
of money) alone. This generation of money from money (simplistically, interest) is
"Riba", and is forbidden. The implication for Islamic financial institutions is that the
trading and selling of debts, receivables (for anything other than par), conventional loan
lending and credit cards are not permissible.

This principle is widely understood to mean uncertainty in the contractual terms and/or
the uncertainty in the existence of an underlying asset in a contract, which causes issues
for Islamic scholars when considering the application of derivatives. Sharia also
incorporates the concept of maslahah or "public benefit", denoting that if something is
overwhelmingly in the public good, it may yet be transacted – and so hedging or
mitigation of avoidable business risks may fall into this category, but there is still much
discussion yet to come on this issue.
Q4: What is the sukuk secondary market?

Sukuk securities tend to be bought and held and, as a result, little of the securities enter
the secondary market (allowing them to be traded). Furthermore, only public Sukuk are
able to enter this market, as they are listed on stock exchanges.

The secondary market whilst developing remains a niche segment with virtually all of
the trading done at the institution level. The size of the secondary market remains
unknown, though LMC Bahrain state they traded $55.5 million of Sukuk in 2007. The
European Islamic Investment Bank (EIIB) in an interview published on Sukuk.net
stated "Secondary market trading volume has contracted significantly in the first half of
2008 when compared to 2007 where Sukuk with a nominal value of approximately
$0.5bn was traded.

Q5: What are the controversies regarding to the sukuk?

Sukuk are widely regarded as controversial due to their perceived purpose of evading
the restrictions on Riba. Conservative scholars do not believe that this is effective, citing
the fact that a Sakk (Islamic bond) effectively requires payment for the time-value of
money. This can be regarded as the fundamental test of interest. Sukuk offer investors
fixed return on their investments which is also similar in appearance to interest in that
the investor's return is not necessarily dependent on the risks of that particular venture.
However, banks that issue Sukuk are investing in assets--not currency. The return on
such assets takes the form of rent, and is evenly spread over the rental period. The
productivity of the asset forms the basis of the fixed income stream and the return on
investment. Given that there is an asset underlying the value of the certificate, there is
more security for the investors involved, accounting for the additional appeal of Sukuk
as a method of financing for investors.

Q6: What are the basics of Sukuk?

• Basics of Sukuk

Sukuk is popularly known as an Islamic or Sharia compliant ‘Bond’ whilst in actual fact;
it is an asset-backed trust certificate.

In its simplest form Sukuk is a certificate evidencing ownership of an asset or its

usufruct.

The Sukuk structures rely on the creation of a Special Purpose Vehicle (SPV).
SPV would issue Sukuk certificates which represent for example the ownership of an
asset, entitlement to a debt or to rental incomes or even accumulation of returns from
various Sukuk (a hybrid Sukuk).

The return provided to Sukuk holders therefore come in the form of profit from a sale,
rental or a combination of both.

Sukuk could be based on Mudarabah, Musharakah, Murabahah, Salam, Istisna, Ijarah

or hybrid of these.

Q7: What is difference between conventional bond and Sukuk?

• Difference between conventional bond and Sukuk

In its simplest form, a bond is a contractual debt obligation whereby the issuer is
contractually obliged to pay to bondholders, on certain specified dates, interest and
principal.

In comparison, under Sukuk structure the Sukuk holders each hold an undivided
beneficial ownership in the underlying assets. Consequently, Sukuk holders are entitled
to share in the revenues generated by the Sukuk assets as well as being entitled to share
in the proceeds of the realization of the Sukuk assets.

Q8: What are the basic similarities between conventional bond and Sukuk?

• Similarities between conventional bond and Sukuk

Marketability: Sukuk are monetized real assets that are liquid, easily transferred and
traded in the financial markets

Ratability: Sukuk can be easily rated

Enhance ability: Different Sukuk structures may allow for credit enhancements

Versatility: the variety of Sukuk structures (as many as over 27 possibilities) allow for:
structuring across legal and fiscal domains, fixed and variable income options etc.

• Issuing of Sukuk involves a number of steps like;

Q9: What type of issues involves in the business of Sukuk?

Preparing a detailed feasibility study (stating clear objectives to be achieved from the
proposed Sharia-compliant business) and setting up of general framework and
organizational structure to support the issuance process;

Working out an appropriate Sharia structure to achieve the set objectives in compliance
with Sharia;
Arranging lead manager (s) to underwrite the Sukuk issue;

Arranging legal documentation around the agreed Sharia structures (both from the
Issuer’s as well as arranger’s perspective);

Setting up the SPV to represent the investors (Sukuk holders); and

Putting the Sukuk into circulation.

Q10: What are the roles of shari’ah advisors in Sukuk?

• Role of Sharia Advisors in Sukuk

Sharia advisor (Sharia scholars or Sharia advisory firms with recourse to Sharia
scholars) have a significant role to play. Amongst others, following may be listed as
examples:

Advising on proposed Sukuk structure and suggest a Sharia structure which otherwise
fulfils the set economic aims;

Working closely with legal counsel of the issuer to ensure that the legal documents are in
line with

Sharia requirements;

Working closely with legal counsel of the arranger to ensure that the legal documents
are in line with Sharia requirements;

Issuing Fatwa on the whole Sukuk deal before the same can be put into circulation.
 Takaful
Q1: Define the term Takaful?

Takaful (‫ )التكافففل‬is an Islamic insurance concept which is grounded in Islamic

muamalat (banking transactions), observing the rules and regulations of Islamic law.
This concept has been practiced in various forms for over 1400 years. Muslim jurists
acknowledge that the basis of shared responsibility in the system of aquila as practised
between Muslims of Mecca and Medina laid the foundation of mutual insurance.

Q2: What are the Islamic references to Takaful?

These fundamentals are based on the sayings of the Islamic prophet Muhammad
(s.a.w.). Based on the hadith and Quranic verses mentioned below, Islamic scholars had
decided that there should be a concerted effort to implement the Takaful concept as the
best way to resolve these needs. Some of the examples are:

• Basis of Co-operation Help one another in al-Birr and in al-Taqwa (virtue,

righteousness and piety): but do not help one another in sin and transgression. (Surah
Al-Maidah, Verse 2)

• Allah will always help His servant for as long as he helps others. (Narrated by Imam
Ahmad bin Hanbal and Imam Abu Daud)

• Basis of Responsibility The place of relationships and feelings of people with faith,
between each other, is just like the body; when one of its parts is afflicted with pain, then
the rest of the body will be affected. (Narrated by Imam al-Bukhari and Imam Muslim)

• One true Muslim (Mu’min) and another true Muslim (Mu’min) is just like a building
whereby every part in it strengthens the other part. (Narrated by Imam al-Bukhari and
Imam Muslim)

• Basis of Mutual Protection By my life, which is in Allah’s power, nobody will enter
Paradise if he does not protect his neighbour who is in distress. (Narrated by Imam
Ahmad bin Hanbal)

“The basic fundamentals underlying the Takaful concept are very similar to co-operative
and mutual principles, to the extent that the co-operative and mutual model is one that
is accepted under Islamic Law."

• “Some Muslims believe insurance is unnecessary, as society should help its victims.
Muslims can no longer ignore the fact that they live, trade and communicate with open
global systems, and they can no longer ignore the need for banking and insurance. Aly
Khorshid demonstrates how initial clerical apprehensions were overcome to create
pioneering Muslim-friendly banking systems, and applies the lessons learnt to a
workable insurance framework by which Muslims can compete with non-Muslims in
business and have cover in daily life. The book uses relevant Quranic and Sunnah
 extracts, and the arguments of pro- and anti-insurance jurists to arrive at its conclusion
that Muslims can enjoy the peace of mind and equity of an Islamic insurance scheme."

Q3: What are the basic principles of the Takaful?

Principles of Takaful

The principles of Takaful are as follows:

• Policyholders cooperate among themselves for their common good.

• Every policyholder pays his subscription to help those that need assistance.
• Losses are divided and liabilities spread according to the community pooling system.
• Uncertainty is eliminated in respect of subscription and compensation.
• It does not derive advantage at the cost of others.

Theoretically, Takaful is perceived as cooperative insurance, where members contribute

a certain sum of money to a common pool. The purpose of this system is not profits but
to uphold the principle of "bear ye one another's burden." Commercial insurance is
strictly not allowed for Muslims as agreed upon by most contemporary scholars because
it contains the following elements: i) Al-Gharar (Uncertainty) ii) Al-Maisir (Gambling)
iii) Riba (Interest)

There are three (3) models and several variations on how takaful can be implemented.

1. Mudarabah Model
2. Wakalah Model
3. Combination of both

Q4: How will we justify that the Takaful is an Islamic Insurance?

Islamic Insurance

A book by Dr Aly Khorshid "Islamic insurance, with modern approach to Islamic

Banking" Some Muslims believe insurance is unnecessary, as society should help its
victims. Muslims can no longer ignore the fact that they live, trade and communicate
with open global systems, and they can no longer ignore the need for banking and
insurance. Aly Khorshid demonstrates how initial clerical apprehensions were overcome
to create pioneering Muslim-friendly banking systems, and applies the lessons learnt to
a workable insurance framework by which Muslims can compete with non-Muslims in
business and have cover in daily life. The book uses relevant Quranic and Sunnah
extracts, and the arguments of pro- and anti-insurance jurists to arrive at its conclusion
that Muslims can enjoy the peace of mind and equity of an Islamic insurance scheme.