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Islamic Finance Principles and Practice pdf

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 Islamic Finance Principles And Practice
  • Book Author:
Hans Visser
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  1. Abbreviations vii
  2. Acknowledgements viii
  3. Introduction ix
  4. Why Islamic finance? 1
    1. Introduction 1
    2. The origins: Maulana Maududi 1
    3. Digression: the Islamization of the financial system in
  5. Pakistan; a chequered history 4
  1. Islam against the rest of the world? 5
  2. Conclusions 8
  3. Sources of Islamic law 10
    1. Introduction 10
    2. Primary and secondary sources 10
    3. Law schools 15
    4. How strict should one be in observing the sharia? 17
    5. Muslims among a non-Muslim majority 20
    6. Conclusions 23
  4. The Islamic economy 25
    1. Introduction 25
    2. Zakat 27
    3. Riba 31
    4. Gharar and maysir 45
    5. The economic order 48
    6. Dreams of a separate Muslim economy 49
    7. Conclusions 50
  5. Financial instruments 52
    1. Introduction 52
    2. Halal instruments 53
    3. Grey areas 67
    4. Islamic contract law 75
    5. Conclusions 79
  6. Islamic banks 81
    1. Introduction 81
    2. The liabilities of Islamic banks 81
  7. vi Islamic finance
  1. Problems with Islamic assets 84
  2. The practice of Islamic banking 92
  3. Conclusions 99
  4. Special sectors 102
    1. Introduction 102
    2. Insurance 102
    3. Home finance 106
    4. Investment 113
    5. Conclusions 118
  5. Public finance and the monetary authorities 121
    1. Introduction 121
    2. Public finance 122
    3. Monetary policy 124
    4. Supervision of the financial sector 128
    5. Conclusions 132
  6. Islamic finance: a tentative verdict 134
    1. Introduction 134
    2. Pros and cons in comparison with conventional finance 134
    3. The demand for Islamic financial products 141
    4. Islamic finance: hopes fulfilled? 144
  7. Appendices 147
  1. The Quran on riba 147
  2. The Quran on maysir 148
  3. The Bible on interest 148
  4. Useful web adresses 150
  5. References 152
  6. Glossary 172
  7. Index 177
  8. 22.   vii


  1. AAOIFI: Accounting and Auditing Organization for Islamic Financial Institutions
  2. BCCI: Bank of Credit and Commerce International BMA: Bahrain Monetary Authority
  3. CBI: Central Bank of Iran
  4. CMC: Central Bank Musharaka Certificates (Sudan) DJI: Dow Jones Islamic Market Index
  5. DJS: Down Jones Sustainability World Index DJW: Dow Jones World Index
  6. EURIBOR: Euro Interbank Offered Rate FSA: Financial Services Authority (UK)
  7. GII: Government Investment Issues (Malaysia) IAS: International Accounting Standards
  8. IDB: Islamic Development Bank IFSB: Islamic Financial Services Board
  9. IIFM: International Islamic Financial Market IIRA: Islamic International Rating Agency LIBOR: London Interbank Offered Rate
  10. NPP: National Participation Paper (Iran) PLS: Proft-and-Loss Sharing
  11. REIT: Real Estate Investment Trust
  12. SMEs: Small- and Medium-Sized Enterprises SPV: Special Purpose Vehicle
  13. UAE: United Arab Emirates

Why Islamic finance?


This chapter is about the motives for Muslims to advocate the use of financial instruments that obey specific Islamic requirements. The movement for an Islamic economy, and an Islamic financial system in particular, is rooted in the experience of Muslims in what they, or at least some of them, felt in the past was an unfriendly non-Muslim environment.

 A new impetus was given with the rise in oil wealth in a number of Muslim countries after the 1973–74 oil crisis and the success of Malaysia as a fast grower, both of which may have contributed to a formerly unknown level of self-confidence that made it possible for Muslim governments and firms to develop new financial instruments in close cooperation with Western firms, without the feelings of resentment that underlay the first attempts to Islamize the economy. The history of the movement for Islamic finance, and Islamic economics in general, is sketched and the chapter ends with highlighting the diversity of views among Muslims on this matter.


Islamic finance is a way to put Islamic principles about the economy into practice. Attempts to develop a specific Islamic type of economy, based upon the precepts of the holy book of Muslims, the Quran, and on Islamic religious law, the sharia, can be seen as a manifestation of the wish harboured by Muslims to retain, or regain, their own identity vis-à-vis the capitalist West and, until the fall of communism, the socialist East.

There is a deep-rooted idea among large parts of the Muslim intelligentsia, in particular in the Middle East, that the forces of the globalizing world, in their view characterized by materialism and sex, are incompatible with the values cherished by Muslims (Najjar 2005). Thus, Islamic economics can also be seen as an attempt to prevent Muslims from assimilating in this globalizing world dominated by Western culture (Kuran 1996, 2006, ch. 4).

The idea of Islamic economics was introduced around the time of the Partition of India by a number of people, first of all maulana or

mawlana Sayyid Abu’l-A’la Maududi (1903–79).1 Maududi (also spelled Mawdudi or Maudoodi) had already delivered an address on the subject in 1941 (Maududi 1941). An economy based on Islamic principles was also advocated by Anwar Iqbal Qureshi in 1946 (Qureshi 1991), who was influenced by Maududi, Naiem Siddiqhi in 1948 and Sheikh Mahmud Ahmad in 1952 (see Gafoor 1996, p. 37; Mahmud Ahmad 1999).

It should not come as a surprise that pre-Partition India and later Pakistan provided a fertile environment for developing ideas on an Islamic economy, as Pakistan was founded expressly to be a homeland for Muslims. Maududi is the main figure behind the movement to organize society along orthodox, fundamentalist lines (Slomp 2003, p. 239). Sayyid Qutb (1906–66), a prominent leader of Egypt’s Muslim Brotherhood, and Muhammad Baqir al-Sadr (1931–80) from Iraq were also in the forefront of the development of Islamic economics.

One important motivation for developing specific Islamic views on the economy was the conviction that Islam was seen as backward by the dominant European civilization, which had little time for the tenets of Islam in the economic sphere. From the nineteenth century on, Islam was not taken seriously and was regarded as rather benighted and incompatible with modern scientific views, people such as Maududi, Qutb and al-Sadr felt; and not without some justification (see the Introductions by Syed Sulaiman Nadvi and Manazir Ahsan Gilani to Qureshi 1991; Kuran 2006, pp. 86–7). Maududi, as editor of a journal he founded in 1932, wrote about its objective:

The plan of action I had in mind was that I should first break the hold which Western culture and ideas had come to acquire over the Muslim intelligentsia, and to instill in them the fact that Islam has a code of life of its own, its own culture, its own political and economic systems and a philosophy and an educa- tional system which are all superior to anything that Western civilization could offer. I wanted to rid them of the wrong notion that they needed to borrow from others in the matter of culture and civilization. (Quoted from Slomp 2003, p. 240)

They said farewell to the defensive attitude and went on the offensive, in their discussion on economics in particular impugning existing interest theories and justifications of interest (extensively in Qureshi 1991, ch. I). Mahmud Ahmad even states that intellectual bankruptcy is the hallmark of every theory of interest (Mahmud Ahmad 1999, p. 30).

Communism could not find favour with Maududi, as, in his words, Islam does not approve of any political or economic organization that seeks to submerge the individual in the society, and stultify the flowering of his per- sonality (Maududi 1999, p. 5). Nationalization of all means of production would lead to social regimentation, read: dictatorship (Maududi 1999, pp. 5, 27).

Fascism and national-socialism are as bad as communism in this respect (Maududi 1999, pp. 28–9, this is still from his 1941 address). On the other hand, Islam, according to Maududi, also abhors laissez faire, because that would open the way for individuals to pursuit their own ends at the cost of society as a whole. Capitalism is associated, in his view, with the French revolution, which propagated individual liberty, liberalism, capitalism and the system of secular democracy (Maududi 1999, p. 107). For French revolution we may probably read Enlightenment.

Maududi was the most outspoken advocate of an Islamic economy. He was born in 1903 in Aurangabad, in the Muslim state of Hyderabad in the Deccan. His family belonged to the upper crust of Indian Muslims and claimed to descend from the relatives of the Prophet.

His father was strongly under the influence of a movement that, in reaction to the European values that had come to India with the British, strove to purify Islam from  syncretistic practices and revive the strength of the Muslim community. Maududi himself, as editor-in-chief of a variety of Muslim journals, was opposed to Muhammad Ali Jinnah’s All-India Muslim League and its ideal to found an independent Muslim state, because Islam pretends to express universal values and should not be used as an ideological foundation for a nation state. Rather, he would bolster the Islamic community in order to prepare for life in an independent India dominated by Hindus often hostile to the Muslim minority (Kuran 2006, pp. 83–4). Some people suspect a personal antipathy vis-à-vis Jinnah (Mazari 1998). Nonetheless, after the Partition he moved to Lahore and propagated the view that the moral and ethical principles of Islam can only be put into practice if the state imposes them.

Maududi founded a political party, the Jamaat-e-Islami (Islamic Society or Party) in 1941. This party, which is still active in Pakistan, is based on the idea that all present-day problems can be solved with the help of the Quran and the sunna (from sunnat al-nabi or practices of the Prophet, see Chapter 2), as delivered in the ahadith, or traditions.

 Maududi distinguished himself by combining a strictly literal interpreta- tion of the Quran with modern political terminology in order to show the relevance of the Quran and the sunna for twentieth-century society. Maududi’s ideal society was the supposedly pure one under the Prophet and his four successors before the Umayyad dynasty took over, Abu Bakr, Umar, Uthman and the Prophet’s cousin and son-in-law Ali, collectively known as the rightly-guided caliphs. Remember that the first three are not acknowledged by Shiites, as they were no relatives of Muhammad.

It was all fine and well to have a Muslim state, or a state for Muslims, but that was still far removed from an Islamic state. What Maududi was after was a fundamentalist theocracy, which he dubbed a ‘theo-democracy’, a form of government that should not only be forced upon Pakistan or the Muslim world, but on the whole human race. The Muslim population should freely choose a leader, but with the choice restricted to people, or rather males, with an impeccable sunna-respecting track record.

He only differed from traditionalist ulama, or religious scholars, in that he still left a small place for the modernization of Islamic law, as traditional Islamic law does not have the answer to each and every problem confronting present- day Muslims. His views did not go down too well with the modernists in the Pakistani government and the army, nor were these enamoured of the well-organized Jamaat-e-Islami machinery that spread his message.

Maududi was several times imprisoned and in 1953 he was even sentenced to death by a court martial, but under public pressure the sentence was commuted to two years imprisonment. He died in 1979 in New York, where he had gone for heart surgery. In the same year his follower Kurshid Ahmad became a cabinet minister (1979–80) under President Muhammad Zia ul-Haq (1977–88), who declared Pakistan an Islamic state and began to enforce sharia law (see on Maududi Adams 1966; Aziz Ahmad 1967; Otto 2001; Slomp 2003).

Maududi held strong views on the way society should be run. He advo- cated strict gender separation and was strongly in favour of the death sentence for apostates, even if prominent Muslim scholars argue that in the early times of Islam the death sentence was only issued for soldiers that converted to Judaism or Christianity, in order to evade military service (Slomp 2002). He was very strict as regards expenditure on leisure and even culture. Muslims, in his eyes, should not only stay away from such things as wine and gambling, but also from ‘music and dances and other means of self-indulgence’ and are furthermore forbidden to wear silken dresses, to use golden ornaments and jewels (except in the case of women, parentheses Maududi’s), or to decorate their house with pictures and jewels (Maududi 1999, p. 31). This rejection of culture sounds not too different from the views of some of the more puritan currents within Protestantism, and, like there, cannot be seen as representative of the views of the whole community of believers.


The ideas about what an Islamic economy should look like took some time to develop. For the founding fathers in British India and later Pakistan it was a process of trial and error; they did not start out with a detailed blueprint. Also harsh realities impeded a fast adoption of the principles of Islamic economics. Anwar Iqbal Qureshi notes that he, as Economic Advisor to the Government of Pakistan after Partition, actively tried to introduce interest-free banking, but did not pull it off because of practical difficulties (Qureshi 1991, p. 199). An important step in the process was that President Muhammad Zia ul-Haq, who had seized power in 1977, in February 1979 decided that interest-based transactions were to be phased out. Banks were ordered to offer interest-free alternatives to conventional savings accounts and to completely switch to interest-free banking within five years.

Zia started in the same year by making three financial institu- tions interest free. Even if some specialized credit institutions were quick to shift to interest-free financial products, in the commercial banking field the process proved time-consuming and the government itself did not refrain from fixed-interest borrowing activities. In the mid-1980s the Islamization of the financial sector ran out of steam, but the Sharia Bench of Pakistan’s Supreme Court became active with a verdict given in December 1991 under which a number of laws based on riba or interest were declared unlawful. The governments that followed upon Zia’s death in an air accident that nobody believes was an accident, did all they could to stymie the efforts of the Court and its supporters.2

The struggle has been dragging on since. The Sharia Bench had ordered the government to eliminate interest from the economy by 30 July 2002. An appeal by Pakistani banks for the court to review its earlier decision was backed by the government, which claimed that the initial ruling was flawed and that modern banking did not conflict with Islamic principles. The government also argued that interest-free banking would create financial anarchy in the country. The Supreme Court on 24 June 2002, a few weeks before its earlier deadline, duly reviewed the earlier judgement and remanded the case back to the Federal Sharia Court for a fresh decision (Supreme Court of Pakistan 2003, pp. 35–8).3 So banking is to a great deal interest-free, but interest-based transactions are still possible.


Maulana Maududi can be credited with launching the idea of an Islamic economy. In his approach, it is associated with an ideology where the state sees to it that Islamic rules are strictly observed. This idea of an Islamic economy not only proved attractive to Pakistanis, but also to non-Pakistanis in search of an Islamic answer or alternative to capitalism and communism. It was embraced by the Muslim Brotherhood in Egypt, which, like Maududi, advocated Islamic forms of finance as part and parcel of a rather aggressive drive to Islamize society at large.

 Members of the Muslim Brotherhood also played a prominent role in the establishment in 1977 of the first Islamic bank in Sudan, Faisal Islamic Bank (rival groups set up their own Islamic banks, see Coutsoukis 2004). Indeed, political Islam, the ideology that seeks the establishment of an Islamic state based on the sharia, is commonly seen as having been born with the establish- ment of the Muslim Brotherhood in 1928. In the eyes of the leader of one of its more radical wings, Sayyid Qutb, who was executed by the Nasser regime in 1966, people have to choose between ‘God’s absolute rule’ and ‘total pagan ignorance’ (jahiliyyah).

People who are deemed not to follow ‘God’s absolute rule’ have to be struck by takfir, that is, they are declared unbelievers, kuffar. Muslims that turn unbelievers are guilty of apostasy and deserve the death penalty. Sunnites are not allowed to rise against a Muslim ruler, but declaring him an unbeliever frees the way for insurgents. Through takfir, attempts on the life of Muslim rulers that stand in the way of the establishment of a fully Islamized society can be justified (Best et al. 2004). The Muslim Brotherhood and similar movements attacked, after their countries had gained independence, the ruling classes in their own societies, who they felt were guilty of social injustice and oppression. A return to what they preached to be the true Islamic way of life was seen as necessary to end these evils (Hoebink 2008). As a reaction, some argue, the ruling classes embraced the cause of Islamic finance in order to legitimize their rule and evade takfir (Barenberg 2004–05).

Timur Kuran (2006, pp. xii, 73), for instance, suggests that in countries where the propagandists of political Islam or Islamists do not eschew violence, such as Pakistan, politicians and intellectuals have supported efforts to introduce Islamic economic institutions, including Islamic banks, not

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