Islamic Finance and Law: Theory and Practice in a Globalized World (International Library of Economics)

  • Book Title:
 Islamic Finance And Law
  • Book Author:
Maha-Hanaan Balala
  • Total Pages
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  • List of cases xi
  • Acknowledgements xv
  • Preface xvii
    • Form versus substance in the Quran 4
      • Form versus substance in Islamic finance transactions 5
    • The role of interpretation under the common law 8
    • Form versus substance under the common law:
  • the Exfinco scenario 11
    • Scope 15
    • Methodology 16
    • Objective 17
    • Approach 19
    • Principles governing contract and finance in Islam 23
    • Specific rules of the sharia governing contract and finance
  • in Islam 24
  • Riba 24
  • Gambling (maysir) 25
  • Prohibited transactions/investments 26
  • Predetermined profit 26
  • Gharar 26
  • Hoarding 26
  • Financial assets 27
  • viiiISLAMIC FINANCE AND LAW                                               
  • 3.3 Transactions in Islamic finance                                               27
  • 3.3.1 Musharaka                                                                                   27
  • 3.3.2 Mudharaba                                                                                 28
  • 3.3.3 Murabaha                                                                                    28
  • 3.3.4 Ijara                                                                                               29
  • 3.4 Sukuk (Islamic bonds) and the development of a sukuk market   30
  • 3.5 Distinguishing sukuk from conventional bonds                31
  • 3.6 The four madhahibs (schools) of Islamic jurisprudence 32
  • 4   GHARAR IN ISLAMIC LAW                                                      35
  • 4.1 Origins of the prohibition                                                          35
  • 4.2 Defining gharar and the ‘gharar sale’                                 37
    • The principle behind the prohibition of gharar
    • The effect of gharar and the differing opinions within
  • Islamic jurisprudence     40
    • Gharar: conceptual or evidential?
    • Certainty under English common law: conceptual or evidential?  43
  • 4.6.1 Curing contracts of uncertainty under the common law                56
  • 4.7 Historical context and the rules of gharar                           59
  • 4.8 Present context application of Islamic law of transaction 60
  • 5   RIbA: MEANING, SCOPE AND APPLICATION                 62
  • 5.1 Riba redefined                                                                               65
  • 5.1.1 Riba according to the Quran                                                 68
  • 5.2 The principle behind riba and its implications for Islamic
  • finance 72
  • 74
    • Riba: the what or the how?
    • Principles of Islamic law on matters of commerce
  • vis-à-vis rituals 76
    • 5.3 Social justice and implications of the redefinition for
  • Islamic finance 
  • 80
  • 5.4 Riba and the common law doctrine of consideration      83
    • Equitable transaction versus adequate consideration
    • Raison d’être behind riba and the doctrine of
  • consideration     85
    • 5.4.3 Riba as a vitiating factor versus consideration as
  • a distinct element of contract formation 
  • 90
  • 5.5 Riba, consideration and intention to create legal relations             90
  • ITS SALE 96
  • The concept of debt 98
  • The relationship between debt and money under Islamic law 99
    • Is debt money? 100
  • The relationship between debt and money under English law 103
    • Defining money 103
    • Debt 103
    • Legal characteristics of physical money 104
    • The distinction between physical money and
  • intangible money 105
  • What is property? 106
    • Distinguishing personal from proprietary rights 108
    • Property: a right or a thing? 112
  • Debt vis-à-vis property under Islamic law 113
    • Is debt property? 114
    • Transferability of debt under Islamic law and
  • the contextual evolution of property rights 115
  • Future (debt) contracts under Islamic law and practice 118
    • Future (debt) contracts and gharar 120
    • Deferred ‘sale of debt’ transactions 121
  • The common law attitude to sale of future debts 123
  • The ‘asset-backed’ requirement under Islamic law 124
  • judicial support in acknowledging the proprietary nature of debt 126
    • Defining and outlining securitisation 129
    • Securitisation of receivables 130
    • Requirements of a securitised transaction 131
    • The benefits of securitisations 132
    • The drawbacks of securitisations and issues in application 134
    • True sale: the re-characterisation of a ‘sale’ as security interest 137
    • True sale: bankruptcy remoteness 138
  • COMMON LAW 140
  • Issues involving gharar, riba and bay al dayn 141
  • General issues arising from dual compatibility structuring 144
  • True sale and the risk of re-characterisation 145
  • Bankruptcy remoteness 147
  • Security interest 147
  • Tax 148
  • Uncertainty regarding choice of law and
  • enforcements of judgements 149
  • Asset selection 154
  • The use of the London inter-bank offered rate (Libor) 155
  • Late payment and penalty charges 155
  • The creation of a trust within a civil law framework 156
  • Interpretation of commercial laws and contracts
  • in sharia jurisdictions 158
  • The role of the sharia committee 159
  • EMULATE 161
  • Genesis and growth of Islamic finance in Malaysia 161
  • Malaysia’s distinct structural and institutional advantages
  • over other Islamic finance participants 165
  • A common law jurisdiction 165
  • Dual banking system 167
  • Multifaceted approach to Islamic banking 168
  • Labuan international offshore financial centre 168
  • Making a difference through Islamic finance 172
  • 10 THE WAY FORWARD 175
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Form versus substance in Islamic finance transactions

An enquiry into the purpose/s of the commercial forms of transactions employed by Islamic finance (a summary of all is provided in chapter 3) is not common. Most of these structures pre-date the Islamic civilisation. Others, like the salam contract (advance payment for future delivery of agricultural produce) and istina’ contract (commission to manufacture), are innovations of society a few generations after Muhammad.

Both the Salam and Istina’ contracts were created as exceptions to the general rule of contract law because they involve the sale of not-yet-existent objects or what the common law terms ‘potential property’.13 The salam contract, for instance, was an invention of the agricultural people of the Hijaz/Iraq – a contract otherwise characterised as ‘speculative’ for purposes of gharar14 and includes a price discount for time which is an element of riba as currently defined15 – yet the contract was permitted due to the social need it fulfilled.16

This, again, tallies with the common law position. Oditah explains that the permissibility of transferring ‘potential property’ as an exception to the general rule of transferring present property was confined almost exclusively to agricultural produce – mainly crops and livestock. That, ‘[t]he Common law courts never recognised that goods which a company may manufac- ture tomorrow or receivables expected from their sale, were things in potential’.17

Today, however, Muslims have widely applied the salam concept to structured financial transactions for future delivery of goods that society demands, proving that Islamic law concepts can be applied dynamically and progressively in light of the underlying principle they serve.18 Contrary to common perception, both the above named forms of transactions were neither revealed nor developed at the time of the prophet Muhammad; they simply comprise modes of transaction practiced by Muslim societies because they did not oppose any fundamental principle of Islam.

Muhammad did not need to sanction them personally, it is sufficient that he did not specifi- cally prohibit them, as he did the riba sale or the gharar sale, to deem them permissible. Moreover, as we shall discuss in detail in chapters 4 and 5, in prohibiting the gharar or riba sales, Muhammad prohibited not the form, because these were often identical to perfectly permissible transactions, but the economic substance that the transactions in question effected.19


The various forms (whether invented before the time of Muhammad or after) existed simply for purposes of serving a real and practical need within the society and commercial community.

Within this broad domain of ‘social need’, Islamic law of commerce plays a pivotal role of regulation by decreeing the twin principles of riba and gharar that seek to secure the twin objectives of equity between transacting parties and efficiency in transactions.

The point this chapter stresses there- fore is that Islamic contractual and financial structures must guard to serve above all else the principle of contractual fairness and social welfare. In this light, adherence to form must only be to serve the substance by effecting equity and social justice. For clarity, by substance it is here meant economic substance as opposed to legal or procedural substance – a key distinction between Islamic law and common law as we shall see in section 1.3 below.

El-Gamal suggests the achievement of such economic substance, today, through ‘marking to market’, that is, marking the terms of trade to market prices. He explains that, in the context of credit sales and lease to purchase financing, the substantive prohibition of riba, that is, aiming to ensure equity in exchange, dictates that credit in such transactions must be extended at the appropriate (market) interest rate.

Thus, it is said, that conventional finance has played an important role for contemporary Islamic finance by determining the market interest rates for various borrowers and, further, that such benchmarking of the implicit interest rates (built into the Islamic finance structures) is quite appropriate for purposes of equity through efficiency.

Contrary to El-Gamal’s allusion, the ‘marking to market’ concept is neither alien nor foreign to Islamic commercial practice.20 Muhammad prescribed the ‘marking to market’ formula of efficiency in the sixth century ad, before common law commercial principles even came into existence, when he specifically asked Bilal to sell his inferior dates at market price and with the proceeds buy the superior dates he wanted instead of bartering two portions for one, respectively. Implicit in the disapproval of the barter transaction is the potential for inequity in bartering two portions of inferior dates for one portion of superior dates without an objective criterion to

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