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Islamic Finance and Banking

Prepared By:
Dr. H. M. Mosarof Hossain
Department of Finance
University of Dhaka

Shariah Framework and Principles for the
Islamic Financial System
Definition of shariah:
Sharia or sharia law ( )is the Islamic legal system derived
from the religious precepts of Islam, particularly the Quran
and the Hadith. The term sharia comes from the Arabic
language term sharah, which means a body of moral and
religious law derived from religious prophecy, as opposed to
human legislation. It deals with many topics, including crime,
politics, and economics, as well as personal matters such as
hygiene, diet, prayer, everyday etiquette and fasting.
Adherence to sharia has served as one of the distinguishing
characteristics of the Muslim faith historically.

Shariah Framework and Principles for the
Islamic Financial System
In its strictest and most historically coherent
definition, sharia is considered in Islam as the
infallible law of God. Literally it means the road to
the watering place. According to Quran; Then We have
put you on a plain way ( )of commandment. So
follow you that ( Islamic monotheism and its laws),
and follow not the desires of those who know not.
(Al-Quran, 45:18). It is the sum of the islamic
teachings and system, which was revealed to
prophet Muhammad (Pbuh), recorded in the Quran
as well as deducible from the prophets divinely-
guided lifestyle called the sunnah.
Components of Shariah

The Shari;ah, which contains all different commandments of

Allah (swt) to mankind, can be divided into three fields such
i. Al-ahkam al-i-tiqadiyyah i.e. the sanctions relating to beliefs
such as the belief in Allah (swt) and the day of judgement,
ii. Al-ahkam al-akhlaqiyyah i.e. the sanctions relating
to morals and ethics such as the injunction to the
truth, be sincere, be honest etc.
iii. Al-ahkam al-amaliyyah i.e. sanctions relating to the
sayings and doings of the individual and his
relationss called fiqh

Sources of Islamic Law (Shariah)

A: Primary sources Quran, Sunnah, Ijma and Qiyas.

B: Secondary sources juristic preference (istihsan),
presumption of continuity (istishab), custom (urf),
consideration of public interest (maslahah al-mursalah),
blocking of means (sadd al-dharai), and the practice of the
people of Madinah (amal ahl al-Madinah).

Maqasid Al-shariah vis--vis Islamic finance

Maqasid Al-shariah is defined as the deeper

meanings and inner aspects of wisdom (hikam)
considered by the lawgiver in all or most of the
areas and circumstances of legislation. It also
explained the importance of the knowledge of
maqasid al-shariah for mujtahids not only in
understanding and interpreting the text of shariah,
but also to find solutions to the new problems
facing muslims and about which those text are

Maqasid Al-shariah vis--vis Islamic finance

In islamic finance and banking, equity-based

financing like musharakah and mudarabah are
closer to the realisation of maqasid al-shariah. On
the other hand, debt-based personal financing like
ijara transactions, sale transactions and bay al-
inah are not fully in line with maqasid al-shariah. In
most situations, the customers are in real need of
cash for some legitimate purposes for inah and
tawarruq are shariah compliant.

Legal maxims pertinent to Islamic finance
Legal maxims are defined as the general fiqh
principles which are presented in a simple format
consisting of the general rules of shariah in a
particular field related to it. The function of legal
maxims is to facilitate the understanding of how
problems and principles could be used to deduce
the many rules of fiqh. These are formulated based
on certain evidences from the Quran or Sunnah.
For example, The burden of proof is on him who
claims, and the oath is on him who denies. These
are also constructed upon principles of pure justice,
interest of human beings and principles are
generally confirmed by the shariah. 8
Legal maxims pertinent to Islamic finance
Modern issues in islamic finance which have no
precedent from the classical texts arise from time to
time and these issues need to be addressed
according to islamic rulings. Thus the solution is
founded in the application of legal maxims to develop
the parameters of islamic banking and finance and
its general principles. Generally following five legal
maxims are considered as unanimously accepted for
covering the most issues of fiqh:
1. Matters are determined according to intentions (Al-
umur bi maqasidiha): This is originated from Deeds
are judged by intentions and every person is judged
according his intention (Al Bukhari). 9
Legal maxims pertinent to Islamic finance
All human acts, once done, must be valued in
accordance with intention. The intention of the
parties in a transaction is relevant in determining its
legal effect. An example of this in modern banking is
the imposition of tawidh that is the compensation
paid by the intentionally defaulting parties that is
allowed on the basis of preventing intentional
defaults by customers.
2. Hardship begets facility (Al-mashaqqatu tujlab at-
taysir): Difficulty is to be accompanied by easiness.
Necessity renders prohibited things permissible.
According to this, exceptions must be granted in
order to avoid the injustice. 10
Legal maxims pertinent to Islamic finance
Allah has not laid down upon you in religion any hardship
(Surah Al-Hajj, 78). Also He intends every facility for
you, and he does not want to put you in hardship,
(Surah Al-Baqara, 286).This is found to be of important
relevance in modern islamic finance, for example, the
permission to deal with conventional banking for the
muslim minority living in non-muslim countries to some
3. Harm should not be inflicted nor reciprocated (La darara
wa la dirar): It means injurious or harmful acts must be
avoided and prevented in all cases. Based on this
principle, the debtors act of delaying payment which
could harm the creditor must be avoided by having a
compensation/penalty clause.
Legal maxims pertinent to Islamic finance
4. What is certain cannot be removed by doubt (Al-yaginu la
yuzala bi ash-shakk): This is pertinent in solving the cases
of doubt. The origin of all things is permissibility. It means
all things or creatures in this world are permissible for
consumption or use by humans, unless Allah says
otherwise. The Quran states in Surah Al Baqarah, verse
29: And he has created for you every creation on earth.
In sunnah, The Prophet (pbuh) said, What is permitted by
Allah in the Quran is halal and what is prohibited is haram,
what is left unmentioned is permitted so accept the leave
given by Allah, verily Allah does not forget anything. This
rule widens and paves the way for the innovation of
different tools and instruments for financial transactions
without necessarily finding the authority for their
Legal maxims pertinent to Islamic finance
5. Customary practices as a basis of judgements (Al-adatu
muhakkamatun): Customary practices of society in terms
of their words and actions are acknowledged and
recognised by the shariah in the absence of textual
injunction, provided they have fulfilled the following
a) The custom must not violate a divine text of the Quran
and Sunnah or any shariah principles.
b) The custom must be consistently applied and prevailing in
the society.
c) The custom must have been in effect at the time the
activity or transaction was carried out.

Legal maxims pertinent to Islamic finance
d) The two contracting parties must not have agreed to a
condition contrary to the customary practice. If they have
agreed to the contrary, then the customary practice is not

Differences of opinion among scholars
The differences of opinion among the jurists take place in all
stages of the development of islamic jurisprudence. The
nature of textual evidences either from the Quran or
Sunnah allows room for differences of opinion. It is natural
that muslims across the eras and jurisdictions have
differences of opinion in economic transactions law, even
from the early stage of islamic laws development in the
hands of the early jurists. With regard to modern islamic
finance and banking, the difference across jurisdictions as
well as among individual jurists is an acceptable fact. This
is due to the fact that modern islamic finance emerged
amidst the complicated conventional system, striving to
provide alternatives to muslims. Basically, there are four
main reasons for conflicting rulings among the jurists:
Differences of opinion among scholars

a) Variation in understanding the meaning of a

word in the texts
b)Differences over the narrations of the Sunnah
c) Conflict in the application of principles
d) Divergence in the method of Qiyas

Role of ijtihad and mujtahid in Islamic banking
and finance
It is an effort made by the mujtahid in seeking knowledge
of the legal rules of shariah through interpretation.
Thus, ijtihad entails the effort made by the qualified
scholars in order to derive rulings, by using the
principles of interpretation of law known as usul al-
fiqh. Ijtihad might need to be performed collectively.
Modern issues like islamic finance might need
collective rather than individual ijtihad. This is
classified as:
a) Ijtihad to discover the laws directly from the text
whether it is explicitly or impliedly mentioned by the
text. This involves direct interpretations by the
mujtahid on the specific meaning of the available text.
Role of ijtihad and mujtahid in Islamic banking
and finance
b) Ijtihad to extend the law to new cases that might be
mentioned in the text requires to apply qiyas by
looking at the illah or underlying rationale.
c) Ijtihad to extend the law to new cases that are not
covered by the previous two methods by extending
the general principles of law or maqasid al-shariah as
laid down by the text. Many issues of modern islamic
finance fall within this type of issue, and hence
necessitate the exercise of collective ijtihad.

Fundamental prohibited elements in islamic
i. Prohibition of riba- Riba literally means excess,
expansion, increase, addition or growth. It could be
defined as unlawful gain derived from the quantitative
inequality of the counter values in any transaction
purporting to affect the exchange of two or more
species which belong to the same genus and
governed by the same efficient cause. Riba may be
the following two types:
(a) Riba al duyun or riba al-nasiah (Lending-borrowing)
(b) Riba al-buyu or riba al-fadl ( Trading or exchanging)

Fundamental prohibited elements in islamic
ii. Prohibition of gharar- literally it means risk, uncertainty
and hazard. A contract which contains a risk to any
one of the parties which could lead to his loss of
property is known as gharar. O you who believe!
Eat not your property among yourselves unjustly by
falsehood and deception, except it be a trade
amongst you, by mutual consent (Surah Al-Nisa,
iii. Prohibition of maysir- it means games of pure chance
where any party might gain at the expense of the loss
of the other party. O believers, wine and gambling,
idols and divination by arrows are but abominations
devised by satan; avoid them so that you may
Indeed satan seeks to stir up enmity and hatred among
you by means of wine and gambling and to keep you
away from remembrance of Allah (S.w.t.) and from
your prayers (Surah al-Maidah, 90-91).
Mutuality of risk sharing:
The Quran had permitted sale due to fairness in risk
and return that assumes risk-taking where the
seller deserves the profit from the sale. Risk can
be divided into the following three types:
i. Entrepreneurial risk that might occur as part of the
normal course of business in every economic
ii. Natural risk that might occur from natural disasters and
calamities that can be minimized through cooperative
iii. Unnecessary risk which are not part of everyday life but
arise from games of chance created by people.
Governance and transparency:
The significance of shariah governance transpires via
its role of ensuring the confidence of the islamic
finance industry in the eyes of the public. More
importantly, shariah governance ensures that the
industry is at all times in accordance with the
wishes and laws of the Almighty by ensuring the
legitimacy of the products offered.
Effective shariah governance requires the setting up of a
clear and comprehensive framework to regulate the
islamic finance industry and guide its development by
forming shariah advisors. IFIs must abide and
adhere to the same regulatory requirements when it
comes to the issue of disclosures that will ensure the
smooth management.

Issues and challenges

1. Ensuring the maximum utilization of the shariah

principles in developing islamic financial products.
2. Addressing the need for harmonisation of the
interpretation of shariah across jurisdictions.
3. Ensuring a high quality and standard of shariah
4. Realising maqasid al-shariah at the level of general
framework of islamic finance or product development.