The Islamic Banking and Finance Workbook pdf

THE ISLAMIC BANKING AND FINANCE WORKBOOK – Book Sample

Sources of Sharia’a Law and the Role of Sharia’a Boards                            

LEARNING OUTCOMES, SUMMARY OVERVIEW AND PROBLEMS

Learning Outcomes

After reading Chapter 2 you should be able to do the following:

• Explain the role of Allah as the law giver.
• Define the Sharia’a.
• Describe the sources of Sharia’a law.
• Explain Ijtihad.
• Describe the role of the Qur’an within Islam.
• Define Qiyas.
• Describe the role of the Hadith within Islam.
• Contrast the role of the Qur’an and the Hadith within Islam.
• Define the Sunnah.
• Distinguish Qiyas from Ijma.
• Describe the role of promises within the Sharia’a.
• Define Ijma.
• Contrast the Qur’an with the Sunnah within the Sharia’a.
• Describe the role and importance of Sharia’a Supervisory Boards.
• Describe the role of the Sharia’a Supervisory Board within an Islamic financial institution.
• Test that you have fully understood the principles of Sharia’a law that drive Islamic

banking and finance.

 Summary Overview

According to Muslims, Sharia’a law is founded on the words of Allah as revealed in the Qur’an, and traditions (ahadith) gathered from the life of the Prophet Mohammed. Mohammed was born c. AD 570 in Mecca, a trading city in the Arabian desert. In addition to being a centre of trade on the caravan routes, Mecca was a place of pilgrimage for Arabs of many beliefs. The focus of religion in Mecca was the Ka’aba, a stone building believed to have been built by Adam at the beginning of time, and rebuilt by the Prophet Abraham and his son Ishmael.

Mecca was inhabited by the Quraysh, a pagan tribe with some Jews and Christians among them. Mohammed was orphaned at an early age, and came under the protection of an uncle. He grew up to become a trader and married his employer, a prosperous merchant named Khadija. It was in middle age that Mohammed began to speak of revelations received from Allah through the angel Gabriel. Mohammed told others of his revelations, and attracted followers

The Islamic Banking and Finance Workbook

who transcribed them onto available materials. In the 20 years following his first revelation until his death, Islam became the dominant force in the Arabian peninsula, and a serious challenge to the Byzantine and Sasanian empires.

After Mohammed’s death, the revelations were collected and organised into the Qur’an, and accounts of his life eventually formed the basis for the Sunnah.

In pre-Islamic Arabia, bonds of common ancestry formed the basis for tribal association. The advent of Islam brought the tribes together under a single religion. As Islam is not just a religion, but also a way of life, a new common basis of law and personal behaviour, Sharia’a, began to take shape.

Sharia’a continued to undergo fundamental changes, beginning with the reigns of caliphs Abu Bakr (632–634) and Umar (634–644), during which time many questions were brought to the attention of Mohammed’s closest comrades for consultation. During the reign of Muawiya (b. Abu Sufyan ibn Harb, c. 662), Islam undertook an urban transformation, raising questions not originally covered by Islamic law. Since then, changes in Islamic society have played an ongoing role in developing Sharia’a.

Sharia’a, which means ‘way or path’, is the sacred law of Islam. All Muslims believe that Sharia’a is God’s law, but differences exist between groups as to exactly what it entails. Modernists, traditionalists and fundamentalists all hold varying views of Sharia’a, as do adherents to different schools of Islamic thought and jurisprudence. Different countries and cultures also have different interpretations of Sharia’a.

Muslims believe that all Sharia’a is derived from two primary sources: the divine revelations set forth in the Qur’an, and the sayings and example set by the Prophet Mohammed in the Sunnah. Fiqh (jurisprudence) interprets and extends the application of Sharia’a to questions not directly addressed in these primary sources, by including secondary sources. These secondary sources usually include the consensus of the religious scholars embodied in Ijma, and analogy from the Qur’an and Sunnah through Qiyas.

Where it enjoys official status, Sharia’a is applied by Islamic judges, or Qadis.

The imam has varying responsibilities depending on the interpretation of Sharia’a. Although the term is commonly used to refer to the leader of communal prayers, the imam may also be a scholar, religious leader or political leader.

Sharia’a deals with many topics addressed by secular law, including crime, politics and economics, as well as personal matters such as sexuality, hygiene, diet, prayer and fasting.

Traditional Perspectives on Sharia’a

The majority of Muslims regard themselves as belonging to either the Sunni or Shia sect of Islam. Within these sects, there are different schools of religious study and jurispru- dence. The schools within each sect have common characteristics, although each differs in its details.

The Sunni Perspective

In addition to the ‘Basic Code’ of the Qur’an and Sunnah, traditional Sunni Muslims also add the consensus (Ijma) of Mohammed’s companions (Sahaba) and Islamic Jurists (Ulema) on certain issues. In situations where no concrete rule exists in the sources, law scholars use Qiyas – various forms of reasoning, including analogy – to derive law from the essence of divine principles and preceding rulings. The consensus of the community, public interest and

 Sources of Sharia’a Law and the Role of Sharia’a Boards 13

other sources are used as an adjunct to Sharia’a where the primary and secondary sources allow. This description can be applied to the major schools of Sunni Fiqh, which include the Hanafi, Shafii, Maliki and Hanbali.

The Shia Perspective

Shia Muslims also extend the ‘Basic Code’ with Fiqh, but strongly reject analogy (Qiyas) as an easy way to innovations (bid’ah), and reject consensus (Ijma) as not having any particular value in its own right.

During the period that the Sunni scholars developed those two tools, the Shia imams were alive, and Shia view them as an extension of the Sunnah, and so they view themselves as deriving their laws (Fiqh) only from the Qur’an and Sunnah.

In Imami-Shii law, the sources of law (usul al-fiqh) are the Qur’an, anecdotes of Mo- hammed’s practices and those of The Twelve Imams, and the intellect (‘aql). The practices called Sharia’a today, however, also have roots in comparative law and local customs (urf).

Shia Jurists replace Qiyas analogy with ‘aql (reason). Most Shia Muslims follow the Jaafari school of thought.

Muslim countries including Pakistan, Indonesia, Afghanistan, Egypt, Nigeria, Sudan, Mo- rocco and Malaysia have legal systems strongly influenced by Sharia’a, but also cede ultimate authority to their constitutions and the rule of law. These countries conduct elections, although some are also under the influence of authoritarian leaders. In these countries, politicians and Jurists make law, rather than religious scholars. Most of these countries have modernised their laws and now have legal systems with significant differences when compared to classical Sharia’a.

Saudi Arabia and some of the Gulf states do not have constitutions or legislatures. Their rulers have, to some extent, limited authority to change laws, given that they are based on Sharia’a as it is interpreted by their religious scholars. Iran shares some of these characteristics, but also has a parliament that legislates in a manner consistent with Sharia’a.

Although there are many different interpretations of Sharia’a, and differing perspectives on each interpretation, there is consensus among Muslims that Sharia’a is a reflection of God’s will for mankind. Sharia’a must therefore be, in its purest sense, perfect and unchanging. The evolution or refinement of Sharia’a is an effort to reflect God’s will more perfectly.

Trade and Banking

Islamic law recognises private and community property, as well as overlapping forms of entitlement for charitable purposes, known as waqf (trusts). Under Sharia’a law, however, ownership of all property ultimately rests with God. Although individual property rights are upheld, there is a corresponding obligation to share, particularly with those in need.

The laws of contract and obligation are also formed around this egalitarian Qur’anic require- ment, prohibiting unequal exchanges or unfair advantage in trade. On this basis, the charging of interest on loans is prohibited, as are other transactions in which risks are borne dispro- portionately to the potential returns between parties to a transaction. The limits on personal liability afforded by incorporation are seen as a form of usury in this sense, as is conventional insurance.

All these inequities in risk and reward between parties to a transaction, known collec- tively as riba, are prohibited. For this reason, Islamic banking and financing arrangements are partnerships between customers and institutions, where risk and reward are distributed equi- tably. Partnerships, rather than corporations, are the key concept in collective Islamic business. Financing and investments are accomplished in this manner, with equity shifting over time between the institution and the client as payments are made or returns recognised.

The Islamic financial and investment models have taken root in the West and begun to flourish. Classic Islamic law details the manner of contracting, the types of transactions, the assignment of liability and reward, and the responsibilities of the parties in Islamic trade.

 Sharia’a Supervisory Board

Islamic banks and banking institutions that offer Islamic banking products and services are required to establish a Sharia’a Supervisory Board (SSB) to advise them and to ensure that the operations and activities of the banking institutions comply with Sharia’a principles.

In Malaysia, the National Sharia’a Advisory Council, which has been set up at Bank Negara Malaysia (BNM), the central bank, advises BNM on the Sharia’a aspects of the operations of these institutions and on their products and services.

QUESTIONS

Circle true (T) or false (F) in the statements below. Note: you need to indicate T or F for each statement.

1. Under the Sharia’a, riba transactions are disliked but not explicitly prohibited in the

Qur’an. T F

• One of the key questions that a Sharia’a Supervisory Board asks ‘Is this the best investment for the Rab ul Mall?’ T F
• One of the key questions that a Sharia’a Supervisory Board asks is ‘As an asset manager is this a transaction in which a banker, as an individual, would be prepared to invest his own money?’ T F
• A key Sharia’a principle, applied to Islamic banking, is that the good concerned in the transaction does not have to already exist. T F
• A key Sharia’a principle, applied to Islamic banking, is that money can be sold for money of more value than the original sum (Bay-al-Mithl). T F
• A key Sharia’a principle, applied to Islamic banking, is that any profits made in business transactions are haram. T F
• A key Sharia’a principle, applied to Islamic banking, is that a deferred sale at a lower price than the spot price is normal. T F
• A key Sharia’a principle, applied to Islamic banking, is that a deferred sale at a higher price than the spot price is normal. T F
• Models of Islamic banking are not mentioned in the Qur’an or in the Hadith, although the basic principles that govern the financial system are. T F
• The development of Islamic banking is based to a large degree on Ijma. T F
• Ijma is the direct and unmediated Word of Allah – the primary source of Sharia’a

law. T F

 Sources of Sharia’a Law and the Role of Sharia’a Boards 15

1. The sources of the Sharia’a, ranked in order of importance are as follows:
   1. Holy Qur’an
   1. Qiyas
   1. Hadith and Sunnah
   1. Ijma

T F

1. The sources of the Sharia’a, ranked in order of importance are as follows:
   1. Holy Qur’an
   1. Ijma
   1. Qiyas
   1. Hadith and Sunnah

T F

1. The sources of the Sharia’a, ranked in order of importance are as follows:
   1. Holy Qur’an
   1. Hadith and Sunnah
   1. Qiyas
   1. Ijma

T F

1. The sources of the Sharia’a, ranked in order of importance are as follows:
   1. Holy Qur’an
   1. Hadith and Sunnah
   1. Ijma
   1. Qiyas

T F

1. Sunnah means ‘ancestral precedent’ or ‘custom of the tribe’. T F
2. Qiyas means the informed consensus of the community of scholars. T F
3. Ijma means the principle of using past analogies as precedent. T F
4. Qiyas means the principle of using past analogies as precedent. T F
5. Sunnah means the informed consensus of the community of scholars on the application of Sharia’a to worldly affairs. T F
6. Ijma means the informed consensus of the community of scholars on the application of

Sharia’a to worldly affairs. T F

• Sharia’a rules applied to Islamic banking are
  • It is lawful to charge a higher price for a good than its current price if payments are to be made at a later date due to the fact that ‘deferred payment’ is Sharia’a compliant. T F
  • The good concerned under Sharia’a rulings:
    • must be in existence.
    • must be owned and possessed by the bank.
    • must have an instant and absolute sale.
    • must have a certain price with no conditions attached.

If conditions (i–iv) above hold the Fiqh ruling is that a lending transaction and not a trading transaction are taking place. T F

• If conditions (i–iv) above hold the Fiqh ruling is that a trading transaction and not a lending transaction is taking place. T F

16 The Islamic Banking and Finance Workbook

• General Sharia’a rules applied to Islamic banking are
  • Money cannot be sold for money of more value than the original sum (Bay-al- Mithl). T F
  • Any profits made are haram. T F
  • A deferred sale at a lower price than the spot price is usual. T F
  • A deferred sale at a higher price than the spot price is usual. T F
• The Sharia’a prohibits investing in companies associated with pork production because
  • It is an act of obedience to the commands of Allah. T F
  • Pigs are deemed dirty animals and it is forbidden to eat the meat of an animal that feeds on dirt and filth. T F
  • Research shows there is a harmful effect on health of pork meat, lard (pork fat) and other pork by-products and any product that is harmful to people’s health is deemed undesirable in Islam. T F
  • The Qur’anic injunction ‘forbidden to you (for food) are: dead meat, blood, the flesh of swine and that on which hath been invoked the name of other than Allah’. T F
• The Sharia’a prohibits investing in companies associated with gambling because
  • People can become very rich overnight and this is deemed unjust Islamically. T F
  • Islam promotes all that is pure and strives to exclude all impurities based on the principle that if something is entirely harmful it is haram, and if it is entirely beneficial it is halal. T F
  • It is a game of chance and does not necessarily promote a healthy attitude towards life with the effect that instead of investing energies into hard work and productive activities people can depend on, or daydream about, winning the lottery or in gambling. This behaviour can be counterproductive to the health of society. T F
• The Sharia’a prohibits investing in companies associated with tobacco because
  • Islam prohibits buying, selling and usage of harmful substances. T F
  • Tobacco is highly addictive and extremely hazardous to health, not only of the smokers themselves but to those around them. T F
  • The Hadith, (teaching of prophet or his companions), states there should not be any infliction of harm to oneself or others. T F
  • It is proven that smoking of tobacco is very harmful given that tobacco is a cause of lung cancer. T F
  • Tobacco companies make vast profits, which is deemed an unIslamic concept. T F

2.2.2 Responsibilities of the Parties to the Sharia’a Contracts

Circle true (T) or false (F) in the statements below. Note: you need to indicate T or F for each statement.

• Murabaha is a type of leasing. T F
• Salam is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F
• Ijara is a contract whereby the bank buys the goods for the customer and sells them to the customer at a later date. T F
• Istisna’a is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F

 Sources of Sharia’a Law and the Role of Sharia’a Boards 17

• Salam is a purchase by a bank whereby the goods are delivered later but the payment is up front. T F
• Istisna’a is a project whereby the bank and an investor both invest capital with both sharing the risks. T F
• Mudaraba is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F
• Murabaha is a project whereby the bank and an investor both invest capital with both sharing the risks. T F
• Istisna’a is a contract whereby the bank buys the goods for the customer and sells them to the customer at a later date. T F
• Murabaha is a contract whereby the bank buys the goods for the customer and then sells them to the customer at a later date. T F
• Salam is a type of leasing. T F
• Murabaha is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Istisna’a is a purchase by a bank whereby the goods are delivered later but the payment is upfront. T F
• Murabaha is a purchase by a bank whereby the goods are delivered later but the payment is upfront. T F
• Mudaraba is a contract whereby the bank buys the goods for the customer and sells them to the customer at a later date. T F
• Musharaka is a type of leasing. T F
• Istisna’a is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Musharaka is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F
• Mudaraba is a project whereby the bank and an investor both invest capital with both sharing the risks. T F
• Ijara is a type of leasing. T F
• Mudaraba is a purchase by a bank whereby the goods are delivered later but the payment is upfront. T F
• Ijara is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F
• Musharaka is a project whereby the bank, and an investor, both invest capital with both sharing the risks. T F
• Mudaraba is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Salam is a project whereby the bank and an investor both invest capital with both sharing the risks. T F
• Ijara is a project whereby the bank, and an investor, both invest capital with both sharing the risks. T F
• Musharaka is a contract whereby the bank buys the goods for the customer and sells them to the customer at a later date. T F
• Ijara is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Murabaha is a contract whereby the bank accepts an investment by the customer and invests the funds on the customer’s behalf. T F

 18 The Islamic Banking and Finance Workbook

• Ijara is a purchase by a bank whereby the goods are delivered later but the payment is up front. T F
• Salam is a contract whereby the bank buys the goods for the customer and sells them to the customer at a later date. T F
• Musharaka is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Mudaraba is a type of leasing. T F
• Musharaka is a purchase by a bank whereby the goods are delivered later but the payment is upfront. T F
• Salam is an order by the bank to manufacture a specific physical capital asset for the purchaser. T F
• Istisna’a is a type of leasing. T F
• Musharaka is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Mudaraba is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Murabaha is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Ijara is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Istisna’a is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Salam is a project whereby the bank and a partner both invest capital, with only the partner taking the risk of capital loss. T F
• Mudaraba is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F
• Musharaka is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F
• Murabaha is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F
• Istisna’a is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F
• Ijara is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F
• Salam is a project whereby the bank invests capital and a partner provides managerial expertise, with only the bank taking the risk of capital loss. T F

• Islamic Finance Terminology Quiz

Fill in the missing words indicated by the numbers in square brackets.

• Ijara Contract

Ijara is a form of [75. ]. It involves a contract where the Rab ul Mall [76. ] and then leases an asset to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are agreed in advance. The bank retains [77. ] of the item throughout the arrangement and takes back the asset at the end of the contract.