Introduction To Islamic Banking

Shari’a Department
INTRODUCTION TO ISLAMIC BANKING

SESSION-1
CONTENTS
 Importance of Banking
 Issues in Banking
 Islamic Banking
 What is Shari’a?
 Riba
 Gharar
BANKING AND ITS IMPORTANCE

 Banking is a very important sector of the modern day economy.
 Provides an investment opportunity to the household with surplus

capital in terms of returns and tenors & security.
 Provides an opportunity to Small and Large businesses & Governments

to finance their projects/activities through obtaining surplus funds.
ISSUES IN BANKING
 Lending money and getting it back with compounding interest is the
fundamental function of the conventional banks
 Functions and operating modes of conventional banking are based on

fully man made principles
 The investor is assured of a predetermined rate of interest
 It aims only at maximizing profits without any halal/haram restriction.

ISLAMIC BANKING
IMPORTANCE OF PURIFYING THE SOURCE ON INCOME IN ISLAM
 The body which is nourished by non-pure sources is bound to

hellfire.
 On the day of Judgment, a person will not be moved from the place
where he stands until he is asked about the sources of his income,
and the ways he spent it.
 Purifying the source of ones’ nourishment is one of the important

reasons for the acceptance of supplications by Allah.
 Concept of Taharat/Nijasat & Hillat/ Hurmat.

WHAT IS SHARI’A?
General Meaning:
Shari’a is synonym to Islam, which is the entire body of teachings revealed to the
Prophet (SAW) in the form of the Holy Quran and the Sunnah or derived from them
by the Shari’a scholars; and it contains:
 Aqayed,
 Ibadat, Mu’amalat,
 Mu’ashart, Akhlaqiat
Specific Meaning:
As a term recently has been used to denote that body of knowledge which discusses
rules governing practical affairs of day-to -day life.
‘A perfect combination is required by Islam’

UNANIMOUS SOURCES OF SHARI’A

1. Primary Sources:
1. Qur’an
2. Sunnah
2. Secondary Sources:
1. Ijma’a
2. Qiyas
RULES GOVERNING IBADAT AND MUAMLAT

 According to the rules of Shari’a all methods of Ibaadat are forbidden
except those that are described by Allah and His Prophet.
 However, all Muamalat are allowed except those made

Haram/forbidden by Allah and His Prophet.
 This means that if Haram elements of any financial transaction are

removed it becomes permissible and Shariah compliant.
Some Misconceptions
 Importance of Wahi (Revelation)
 Sharia rulings are based on their process flows not on their end
results.
 Sharia rulings are based on Illat (Effective Reasons) not on Hikmat
(Wisdoms/benefits).
 Meanings of Shariah Compliant/Jaiz/Islamic.
 Concept of bank in Islam.
 etc
“A fixed rate of return is not permitted under

Islamic Shariah”
Fixed return does not make a transaction halal or haram
For example:
• Profit on trading
• Rent on property
“Can Interest rate be used as a Bench Mark?”
 Using Interest Rate benchmark for determining the profit in halal

transactions does not render the transaction as invalid or haram.
 The nature of transactions determines the validity of the

transaction.
RIBA – INTEREST
 The Holy Qur’an did not give any definition of Riba for a very simple
reason. (e.g Adultery)
 The word Riba in Qur’an refers to practices* known as Riba not only to
Arabs but to all the previous societies as well.
*Advancing a term-loan with an increase over and above the principal
amount.
*Periodic payment of increase, principal payment at maturity or
rescheduling with new increase.
*Allowing additional time against additional amount in deferred
payment sale.
Types of RIBA – INTEREST

 Riba an Nasi’ah: Stipulated increase on the loan amount given for a
specified period OR increase charged in a deferred payment sale
directly linked with time.
 Riba al Fadl: This applies to barter (exchanging one
commodity/currency for another), where commodities of the same
type are exchanged in unequal amounts or one consideration is
deferred.
 The Prophet sallaAllahu 'alayhi wa sellem said, "Gold for gold, and
silver for silver, and wheat for wheat, and barley for barley, and dates
for dates, and salt for salt, like for like, equal for equal, from hand to
hand (the transaction must be completed before the two sides leave
each other). But if the types are different then sell as you wish, as
long as it is hand to hand." (Muslim)
RIBA – INTEREST
 If currencies are exchanged homogenously, quantity from both sides should
be the same and no deferment is allowed.
 If currencies are exchanged heterogeneously, the delivery must be

immediate. However, the quantities from both sides may differ.
 If one currency is delivered at spot and other is deferred there are two views:
i. The transaction is invalid (they apply the same rule of gold and silver)
ii. It is allowed provided that the price is that of spot sale
PROHIBITION OF RIBA IN ISLAM

Riba or Interest / Usury has been forbidden in Quran at following
different occasions:
 Al Baqara
 Aal Imran
 Al Nisa
 Al Roum
“Those who devour Riba shall rise up before Allah like men whom Shaitan
has demented by his touch; for they claim that trading is like usury. But
Allah has permitted trading and forbidden usury. He that receives an
admonition from his Rabb and mends his ways may keep what he has
already earned; his faith is in the hand of Allah. But he that pays no heed
shall be among the people of fire and shall remain in it forever.”
“O you who believe, Fear Allah and give up what remains of your demand
for Interest, if you are indeed a believer. If you do not, then you are
warned of the declaration of war from Allah and His Messenger; But if
you turn back you shall have your principal: Deal not unjustly and you
shall not be dealt with unjustly.”
PROHBITION OF RIBA – IN SUNNAH

 It is narrated from Jabir (RA), who said: the Messenger of Allah
(SAWS) cursed the one who charges riba, he who gives it, the one who
records it, and the two witnesses, saying that “they are all equal”
 The Messenger of Allah (SAWS) said: “every loan that entails benefit is
Riba”.
WHY RIBA IS HARAM?

An Example:
"All that we had borrowed up to 1985 or 1986 was around $5

billion and we have paid about $16 billion yet. We are still being
told that we owe about $28 billion. That $28 billion came about
because of the injustice in the foreign creditors' interest rates. If
you ask me what is the worst thing in the world, I will say it is
compound interest.“
President of Nigeria, G8 summit, Okinawa, 2000

FAQs ABOUT RIBA

1. What is interest? Is there any difference between interest and Riba?
2. Is interest/riba related only to consumption loans or does it apply to
commercial loans also?
3. Does the prohibition of Riba apply equally to the loans obtained from
or extended to Muslims as well as non-Muslims?
4. If Islamic banks do not invest in interest based activities then how do
they generate profit to pay to their customers?
5. Islamic banks use interest base system (KIBOR) as a Bench Mark while
determining profit; how Islamic banking can be said to be Islamic?
CLEARING DOUBTS
“Riba as practiced during the days of the Prophet (SAW) was

only usury”
 Islam when prohibiting something does not only prohibit the prevalent
form, but all forms that might erupt in future. The changed state does
not change the ruling.
 E.g. Liquor, Pork, Corruption/Immorality: Today’s modern and
sophisticated form does not change their rulings.
 The same applies to interest.
“Commercial interest did not exist in the days of Prophet (SAW)”
 This claim is incorrect as both forms of interest existed in Islamic and

pre Islamic history. Some examples:
 The tribe of Thaqeef advanced cash as well as commodities on interest
to the natives of Taif, the tribe of Mughairah and the business
community of Makkah.
 H. Abbas and H. Khalid bin Waleed (RA) formed a company with joint
capital whose prime business was cash advancement on interest.
GHARAR
 Lexically it means delusion, risk or uncertainty.
 Ambiguous situation which has chance of non agreement or dispute upon
disclosure of details.
Qimar (Gambling):
 Gambling has been strictly prohibited due to the inherent element of uncertainty
and chance.
 Lotteries are modern day examples that fall under the category of Qimar.
e.g. betting in cricket matches, paid mobile sms schemes etc.
 Conventional Insurance.
PROHBITED SALES
 Incompetency of the parties involved
 Incorrect form
 Sale of something non-existing or weak existence
 Sale of something which is not deliverable easily
 Sale of debt to someone other than the debtor
 Sale with Jahalah (subject matter or price or time is unknown)
 Sale with two different prices
 Contingent & future sale
 Sale before taking possession
 Bai Al Arboon
 Bai Ina’h (compared with “Tawarruq” and Murabaha for the purchase orderer)
PROHBITED SALES
 Bai Al Riba
 Sale with Haram money or consideration
 Hoarding (sale containing harm to the society)
 Sale of Haram or Najaiz subject matter
 Sale of grapes to the producer of wine
 Sale with wrong condition
 Combining sale with loan
SESSION-2
CONTENTS
 Kinds of Financial Contracts
 Contract of Sale
 Types of Sale
 Investment Contracts
KINDS OF FINANCIAL CONTRACTS

Contracts that include exchange of counter
Commutative values by both the transacting parties,
(Uqood Muawadha) such as a contract of sale/purchase, Ijara,
etc.
These are non compensatory contracts

Non-Commutative where the donor, donates his property
without consideration e.g. Qard-e-Hasan,
(Uqood Tabarru’)
Aariya, Hiba, sadaqah, Wasiyyah, Waqf,
etc.
DEFINITIONS OF SALE CONTRACT (Aqd ul Bai)
Exchange of a thing of value with another thing of value, with

mutual consent.
OR
It is the sale of a commodity in exchange for cash.

TYPES OF SALE (Aqd ul Bai)
 Valid Sale (Bai’ Sahih)
 Void Sale (Bai’ Batil)
 Executed but void due to defect (Bai’ Fasid)
 Valid but disliked sale (Bai’ Makrooh)

1. VALID SALE (BAI SAHIH-‫) ب يع ص حيح‬:

 A sale is valid if all its essential elements and conditions are
fulfilled.
 Essential elements of a valid sale are:
a) Contract (Aqd‫ عقد‬- )

b) Subject matter (Mabee’e‫ م بيع‬- )
c) Price (Thaman‫ث من‬- )
d) Possession (Qabdh‫ق بض‬- )
CONTRACT (AQD):
It is a combination of offer and acceptance in a manner that results in the desired
consequence (transfer of ownership) in the subject matter.
Features:
Offer and Acceptance (Ijab-wa-Qabool) can be:

 Explicit (Oral or Written)
 Implied (Hukmi)
Buyer and Seller (Muta’aqedain) must be:
 Sane
 Mature
Sale Contract must be:
 Non-contingent
 Immediate (Exceptions)
SUBJECT MATTER (MUBEE’E):

The thing that is being sold and purchased by the parties is called
“Subject Matter”
The subject matter must be:
1. Existing (Exception of Salam & Istisna’a)

2. Seller must have title/ownership and possession
3. Valuable (in the view of Shariah)
4. Usable
5. Specified and Quantified
6. Delivery must be certain and non-contingent
PRICE (THAMAN): Should be

- Specified
- Quantified
- Valuable in view of Shariah
- Certain
DELIVERY OR POSSESSION (QABDH):

The forms of taking delivery or possession of items differ according to their
nature and market practices. Taking possession can be:
- Actual/ Physical
- Constructive.
2. VOID SALE (BAI’ BATIL‫ ب يع ب اطل‬- ):

The sale becomes void if certain essential elements of a contract are not found,
such as:
- Conditions for buyer and seller
- Sane and Mature
Conditions for sold Goods where goods should be:

- Existing
- Valuable
- Usable
This means the sale cannot be executed under any circumstances and shall not
make any effect.
3. SALE EXECUTED BUT VOID DUE TO DEFECT (FASID‫ ف اسد‬- ):

Sale executed initially but void because certain conditions of the
contract are not fulfilled and ownership doesn’t transfer such as:
- Subject matter has not been identified or specified clearly

- Price is uncertain at the time of sale contract.
This sale must be corrected or canceled. It doesn’t transfer ownership to

the buyer until he possesses the subject matter with the permission of
the seller. Sale will be concluded on the market value or just cost. Profit
if any should be given in charity.
4. VALID BUT DISLIKED SALE (BAI MAKROOH ‫ب يع مكروه‬

- ):
Sale is valid but not liked due to certain external issues:
- Sale after Jum’a ‘Azan

- Sale by contriving with a third party to pose as a potential
buyer and attract the real buyer to purchase the asset, or to
raise the price.
OTHER KIND OF SALE CONTRACTS:

- Sale of the corpus: when the actual subject matter is sold in its
entirety. The title and ownership is transferred to the buyer.
- Sale of the usufruct: when the benefit or utility of a nonperishable

item is rented out or leased for a defined period of time. The title
and ownership is not transferred to the buyer.
- Bai’ Sarf: This refers to the sale of gold, silver and currency.
OTHER TYPES OF SALE

 Bai Murabaha: It is a sale contract in which a seller sells his goods/asset
at cost plus an agreed profit i.e. the cost and profit margin are both
disclosed. The sale price can be paid on spot or deferred to be paid in
lump sum or in installments.
 Bai Tawliya: In this sale contract the seller discloses his cost and sells the
goods at the cost price i.e. without any profit.
 Bai Wadi’a: In this sale contract the seller sells his goods at less than the
cost price i.e. incurring a loss on the sale.
 Bai Musawama: is a general and regular kind of sale in which price of the
commodity to be traded is bargained between seller and the buyer
without any reference to the price paid or cost incurred by the former.
 Ijara: this the sale of the usufruct. It is similar to an operating lease where an
assets is given on rent by the owner.
 Istisna: is a sale contract in which the buyer purchases from the

manufacturer fully described assets/goods which the manufacturer
undertakes to produce and deliver from raw material of his own. The
payment can be made through any mutually agreed terms.
 Salam: this is when full spot payment is made by the buyer for the delivery
of fully specified goods in the future. It is most commonly used in agriculture
finance.
INVESTMENT CONTRACTS
1. Mudaraba (Skill Financing)
2. Musharaka (Partnership based financing)
3. Wakala (Agency)
MUDARABA CONTRACT‫ مضاربة‬- :

- It is an investment contract in which one party (Rab ul-Mal‫رب لما ل‬
‫ ا‬-)
contributes capital while the other party (Mudarib ‫ م ضارب‬- ) makes
efforts for generation of profit.
- In Islamic banks, it is a contract in which the capital is provided by

the depositor/fund provider and the bank acts as Mudarib.
- The profit is shared in pre-agreed ratio and the loss (if any), unless
caused by negligence or violation of terms of the contract by the
Mudarib, is borne by the depositor.
TYPES OF MUDARABA:
 A Mudaraba contract is either an unrestricted or a restricted Mudaraba.
 An unrestricted Mudaraba is a contract in which the capital provider

permits the Mudarib to invest Mudaraba fund without any restriction.
 A restricted Mudaraba is a contract whereby the capital provider

restricts the Mudarib’s actions to a particular location or specific type of
investment.
 However, as per Mudaraba principles the restriction should not be in a

manner that would unduly constrain the Mudarib in his operations.
MUSHARAKA ‫ مشاركة‬- :
 Musharaka means commingling by two or more persons either their money or
work to earn a profit or appreciation in value and to share the profit and loss.
 In case of a loss it shall only be shared according to the partners proportionate

share in the Musharaka.
 The profit can be shared in any ratio if the partners are active/working
partners.
 However, a sleeping partner cannot have a profit sharing ration higher than his
proportionate share of investment.
 Diminishing Musharaka: it is a form of partnership in which one of the

partners promises to buy the equity share of the other partner gradually until
the title to the equity is completely transferred to him.
WAKALA:
Wakalah is a contract whereby the principal, appoints the agent, to
substitute him or perform on behalf of the principal. The principal
is called “Aseel/Muwakkil” and the agent is called “Wakeel”.
The profit/loss earned/sustained is solely of the principal and the

agent may take a fixed remuneration against its services.
WHAT DISTINGUISHES ISLAMIC BANKING FROM

CONVENTIONAL BANKING
Conventional Bank Islamic Bank

1. The functions and operating modes of 1. The functions and operating modes of
conventional banks are based on fully man Islamic banks are based on the principles of
made principles. Shari’a.
2. The investor is assured of a predetermined 2. In contrast, it promotes risk sharing

rate of interest. between provider of capital (investor) and the
user of funds (entrepreneur).
3. It aims at maximizing profit without any 3. It also aims at maximizing profit but subject
restriction. to Sharia restrictions.
4. Lending money and getting it back with 4. Participation in partnership business is the
compounding interest is the fundamental fundamental function of the Islamic banks. So
function of the conventional banks. we have to understand our customer's
business very well.
Conventional Bank Islamic Bank

5. It can charge additional money (penalty and 5. The Islamic banks have no provision to charge any
compounded interest) in case of default. extra money from the defaulters. Only small amount
of late payment penalty and these proceeds are
given to charity.
6. The conventional banks give greater emphasis on 6. The Islamic banks, on the other hand, give greater
credit-worthiness of the clients. emphasis on the viability of the projects.
7. The status of a conventional bank, in relation to 7. The status of Islamic bank in relation to its clients
its clients, is that of creditor and debtors. is that of partners, investors and trader, buyer and
seller.
8. A conventional bank has to guarantee all its 8. Islamic bank can only guarantee deposits for
deposits. Current Accounts, which is based on the principle of
Qarz, thus the depositors are guaranteed repayment
of their funds, however if the account is based on
the Mudarabah concept, client shall have to bear
loss in principal amount as well.
ISLAMIC BANKING IN
PRACTICE
SESSION - 3
LIABILITY SIDE OF AN ISLAMIC BANK

 Mudaraba (Savings A/c, Term Deposits etc.)
 Profit Sharing/ Loss Handling
 Profit Distribution & Weightages
 Common Mudaraba Pool Working
 Current Accounts and associated DONTs
 Liability Side FAQs
MUDARABA OVERVIEW‫ م ضاربة‬- :

 It is an investment contract in which one party (Rab ul-Mal‫ ربا لما ل‬-) contributes
‫ م ضارب‬- ) makes efforts for generation of profit.
capital while the other party (Mudarib
 In Islamic banks, it is a contract in which the capital is provided by the

depositor/fund provider and the bank acts as Mudarib.
 The profit is shared in pre-agreed ratio and loss (if any) unless caused by negligence
or violation of terms of the contract by the Mudarib, is borne by the
depositor/investors.
 Is it allowed for Mudarib to invest his/its own funds in Mudaraba pool?

PROFIT SHARING
 It is necessary for the validity 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.
 They can share the profit at any ratio they agreed upon.
 However in case the parties have entered into Mudarabah without

mentioning the exact proportions of the profit, it will be presumed that they
will share the profit in equal ratios.
 DIBP takes 50% of the profit as Mudarib and passes other 50% to the pool
which is shared among them according to pre-assigned weightages.
PROFIT SHARING
 Apart from the agreed proportion of the profit, the Mudarib cannot claim any
periodical salary or a fee or remuneration for the work done by him for the
Mudarabah.
 The Mudarib & Rab-ul-Maal 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.
PROFIT SHARING
 If the business has incurred loss in some transactions and has gained profit in
some others, the profit shall be used to offset the loss at the first instance, then
the remainder, if any, shall be distributed between the parties according to the
agreed ratio.
 The Mudarib only bears loss incase of its negligence.
 In normal circumstances all loss is to be borne by the Rab ul Maal.

PROFIT DISTRIBUTION
 The bank calculates the profit of the deposit pool every month
 In reality the bank does not distribute net profit it distributes gross profit.
 This means that the Mudarib does not deduct overheads such as salaries, rent,
utility bills etc. from the Mudaraba’s pool profit.
 All such expenses are borne by the Mudarib from its share of Mudaraba pool.
 Therefore, even though as per the Mudaraba contract the Rab ul Maal bears all the
loss, this does not mean that the Mudarib does not bear any loss.
 Incase there is no profit in a certain month that would mean that all the expense
done by the bank shall be from its own funds and without any return.
INTER DEPOSITOR RELATIONSHIP

 The relationship between depositors is based on Musharaka (Shirkat-ul-Aqd).
 The profit is distributed among the customers on the basis of predetermined

weightages, announced at the beginning of the month, based on their respective
category/tiers.
Loss Sharing:
 In case of any loss, it will be shared by the members of Investment Pool in ratio of
their investment.
WEIGHTAGES
 Weightage is the value of depositor’s money in the eye of Bank for the purpose of
Profit Distribution only.
 Weightages are assigned based on:
• Investment tenure
• Profit payment option
• Amount tiers
• Product Features
• Market Conditions
 Weightages are used for distributing profits among different types of depositors
having different maturities and values. These weightages are available on the
website and notice boards of the bank.
 Is it possible to have a tier of any remunerative account with ZERO weightage?

CURRENT ACCOUNTS
 The basis of deposit mobilization into current account is ‘Qard’.
 There is no distribution or sharing of profit or loss in this kind of accounts.
 Any profit or loss sustained shall solely be the bank’s.
 As per Shari’a principles the current accountholders should not be promised

any special benefits and services linked with their balances, except those
benefits and services provided to other accountholders, because as per
hadith every loan that entails benefit is Riba.
LIABILITY SIDE FAQs

 Can a bank offer free of cost services to Current account holders on
maintaining a certain amount of balance?
 If No, then How can Priority Banking be Sharia Compliant?
 What is Hiba? Are there any options available for a bank to facilitate its
depositors with higher return without giving any Hiba?.
 How is it possible for a bank to distribute profit to its depositors at

competitive rate despite of having overall Net Loss in its Profit & Loss Account
of Financial Statements.
 If a profit bearing account of Islamic Banks is based on PLS, why there is no

loss at all?
ASSET SIDE OF AN ISLAMIC BANK

 Murabaha
 Step by Step Murabaha financing
 Istisna
 Salam
 Ijarah
 Shirkat-ul-milk cum Ijarah
 Wakala Istithmar
 Running Musharaka
 Distinguishing features of an Islamic Bank
 Key Misconceptions
MURABAHA‫ مرابحة‬- :
 It is a sale contract in which a seller sells his goods/asset at cost plus
an agreed profit.
 The sale price could be paid on spot or deferred to be paid in lump

sum or in installments.
 In Islamic banking, normally the goods/asset is purchased after a

customer requests the bank to purchase the goods/asset in order to
sell the same to the customer on Murabaha (cost plus profit) basis
on deferred payment. This type of transaction is called Murabaha to
the Purchase Orderer
 Murabaha is used as a tool to finance working capital.
 It is also used to finance import of goods and assets.
 In Import Murabaha the bank makes payment for the goods to a

foreign supplier and sells them on deferred payment to customers
 Payment of Murabaha price may be:
1. At spot
2. In installments
3. In lump sum after a certain time
 Hence, Murabaha does not necessarily imply the concept of

deferred payment.
 It is a contract wherein the institution, upon request by the customer,
purchases an asset from the third party(a supplier) and sells the same to the
customer either against immediate payment or on a deferred payment basis.
 It is a bunch of contracts completed in steps and ultimately suffices the

financial needs of the client.
 The sequence of their execution is extremely important to make the

transaction Shari’a compliant.
Basic rules for Murabaha financing:
 Asset to be sold must exist.

 Sale price should be determined.
 Sale must be unconditional.
 The seller should be genuinely a third party.
Assets to be sold:
 Should not be used for un-Islamic purpose.
 Should be in ownership and possession of the seller at the time of sale;
physical or constructive.
STEP BY STEP MURABAHA FINANCING

1. Client and bank sign an agreement to enter into Master Murabaha

Agreement (MMA).
Bank Client
Agreement to
Murabaha
2. Client appointed as agent to purchase goods on bank’s behalf
Bank Client
Agency Agreement
3. Upon submission of Order form Bank gives money to agent/supplier

for purchase of goods.
Bank Agreement to Client

Murabaha
Agency
Agreement
Disbursement to the agent or supplier
Supplie
r
4. The agent takes possession of goods on bank’s behalf and informs the
bank.
Delivery of
Transfer of Risk Vendor goods
Bank Agent
5(a). Client makes an offer to purchase the goods from bank through a
Murabaha contract.
Bank
Client
Offer to
purchase
5(b). Bank accepts the offer and sale is concluded.
Murabaha Contract
+
Transfer of Title
Bank Client
6. Client pays agreed price to bank according to an agreed

schedule. Usually on a deferred payment basis (Bai Muajjal)
Bank Client
Payment of Price
ISTISNA’ ‫ استصناع‬- :
 Istisna’ is a sale contract in which the buyer purchases from the manufacturer/the would-be
seller fully described assets/goods which the manufacturer undertakes to produce and
deliver from raw material of his own.
 The subject matter of an Istisna' contract is always something which requires

manufacturing;
 Price may be paid under any agreed schedule;
 Contract may be cancelled unilaterally before the manufacturer starts work;
 May change with the consent of the contractors;
 Price in Istisna' should be preferably fixed but it may be tied up with the time of delivery; For
example the buyer may fix 'X' price for delivery in 10 days and 'Y' price (reduced price) if the
manufacturer delays delivery from the agreed time schedule; The reason for this flexibility is
resemblance of Istisna' with Ijara.
ISTISNA’ ‫ استصناع‬- :
 Istisna’ cum Wakala: Under this product, the customer manufactures fully
described goods for the Bank. After delivery of the goods to the bank, the Bank
appoints the customer its Agent to sell the goods in the market against at least the
following Sale Price:
 Sale Price = Cost Price + Desired Profit (Calculated on the basis of the desired profit
rate and the transaction tenure) + Any other costs incurred by the Bank (if any)
 If the Customer is able to sell the goods at a price higher than the agreed Sale
Price, the Bank may, at its own discretion, the additional amount as Incentive for
good performance.
SALAM :
 Salam is a type of Sale in which the seller undertakes to supply some specific goods to the buyer
at a future date, against an agreed fully paid advance price with deferred delivery of the sold
commodity.
 Salam sale is an exception to the general rules of sale because it is allowed before existence of
goods, so the element of Gharar is obvious here; To minimize the element of Gharar certain
conditions have been laid down by Shari'ah which makes element of Gharar for this special
type of sale in control (Gharar-e-Yaseer):
 Salam can be effected only in those commodities that can be exactly specified in quantity
and quality; ‘Dhawatul-Amthal’ (‫ ;) ذواتﺍﻷﻣﺜﺎﻝ‬The term ‘Dhawatul-Amthal’ refers to such
commodities, the units of which are homogeneous in characteristics;
 Subject matter of Salam should be of common nature; therefore Salam cannot be effected
on a particular commodity of a particular field or farm.
 Both the quality and quantity of the goods should be very clearly agreed upon.
 The exact date and place of delivery must be specified in the contract.
 The commodity which is the subject of Salam contract is normally available in the markets
at the time of delivery.
IJARA‫ اجارة‬-
 Ijara is leasing of a property under which a specified permissible
benefit, in the form of a usufruct, is obtained for a specified period
in return for a rental payment.
 Ijara Muntahiya Bit Tamleek‫– اجارة م نتهية ب ا لتمليك‬
 Ijara MBT is a lease that includes a promise from the lessor to

transfer the asset to the lessee.
 This can be done at the end of the lease term or by stages during
the term of the contract.
 The transfer can be done through gift or sale for an agreed price.
BASIC RULES OF IJARA

 Transferring of usufruct not ownership (To another person for an agreed price, at an agreed
consideration)
 Subject of lease (Valuable, Identified and Quantified)
 Consumable things cannot be leased out (Anything which cannot be used without consuming
cannot be leased out; e.g., money, wheat etc.)
 Period of lease (Must be determined in clear terms at the time of contract)
 Lessee as Ameen (The lessee is liable to compensate the lessor for every harm to the leased
asset caused by any misuse or negligence.)
 The leased asset shall remain in the risk of the lessor throughout the lease period. (All
Liabilities of ownership are borne by lessor)
BASIC RULES OF IJARA

 The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
 The rent or any part thereof may be payable in advance before the delivery of the asset to the
lessee, but the amount so collected by the lessor shall remain with him as 'on account' payment
and shall be adjusted towards the rent after its being due.
SHARIKAT UL MILK CUM IJARA (HOME FINANCE & AUTOS)
 It is a combination of two contracts namely Musharaka and Ijara.
 As per this product, the Bank and the Customer form a Musharaka to purchase
an Asset (Home/Auto)
 After this the Bank leases its share to the Customer for a pre-specified term
through an Ijara Agreement.
 Once the lease agreement is signed between the partners, the Musharaka
becomes non-operative and the relationship between the two partners, in
principle, changes to a lessor and lessee with all its implications and
consequences.
SHARIKAT UL MILK CUM IJARA (HOME FINANCE & AUTOS)

 The rental payments are calculated keeping in mind the following:
 Fixed Rent: This is the portion of rent that is taken against the principle amount.
 Variable Rent: This is the portion of rent that represents the bank’s profit.
 Advance/Supplementary Rent: This is a portion of rent that is charged to recover any
additional expense incurred by the bank such as takaful etc.
 Premature Termination: Incase a customer wants to completely settle the Sharikat ul Milk
cum Ijara financing facility he must purchase the bank’s share in the asset. From a Shari’a
point of view the bank can quote any price for its share in the asset. However, as per our
practice we ask the customer to pay the outstanding principle plus a certain percentage of
profit. Please note that the additional amount is profit and not a penalty.
 Difference b/w this product and Diminishing Musharaka

SHARIKAT UL MILK CUM IJARA (C&IB)
 This product is also used in the corporate sector to finance machinery and plants.
 It has also been applied to import machinery like turbines and generators.
 It is important to note that the lease payments cannot begin without the
machine/asset becoming usable.
WAKALA ISTITHMAR
 Wakala Istithmar has been developed with the purpose to facilitate exporters/local
suppliers.
 Generally, this medium is used to cater to the export based customer financial
needs. This will provide finance to the exporter before shipment has taken place
under an Export Order / Contract or an irrevocable Letter of Credit.
 The Wakala capital may be calculated as an amount net of the bank's profit from the
transaction on the basis of the number of days that the facility is being availed. In
other words, the value of LC less the bank's profit on the transaction that would
constitute the amount of Wakala capital. The client would thus receive not only the
amount it requires to prepare the export goods but also the full profit amount
upfront.
WAKALA ISTITHMAR
 The Agent shall be given a nominal amount as its fee for performing the agency
duties and functions.
 Since the cost of goods to be exported is pre-determined in the manner detailed

above, the Wakeel shall be authorized to purchase the goods from him/herself
(manufacture them at its own factory).
 It is upto the Wakeel to decide the time of receiving the Wakala capital. This gives
the structure a flexibility to cater to the requirements of pre-manufacturing and
post-manufacturing scenarios.

 Bank will ensure that the transport documents date should not be later than the
financing date as post shipment financing is prohibited in Sharia under Wakala
Istithmar arrangement.
RUNNING MUSHARAKAH
 Running Musharaka product is offered to those customers who may need funds from time
to time, but they cannot predict the amount and the time of disbursement accurately, and
they would like the funds to be used for all the activities of the Musharaka, whether it is a
specific project or transaction or the entire operating activities of the Customer.
 Accordingly, it provides the Customer with the ability to draw and deposit funds against a
Running Musharaka finance limit offered by the Bank as an alternative to the Running
Finance facility offered by Conventional Banks.
 The contract between the Bank and the Customer will be a Musharaka, based on Shirkat-ul-
Aqd through which the Bank and the Customer will invest in a specific project or segment of
the business of the Customer in order to share the generated profit as per an agreed
formula, while the losses, if any shall be borne in proportion to capital contribution of the
parties.
RUNNING MUSHARAKAH
 In principle, this kind of Musharaka should be entered into for a specific project,
series of transactions etc. which could be segregated from the overall business of
the Customer and separate accounts for the same could be maintained.
 If the Musharaka project could not be fully segregated from the general operating
activities of the Customer, whether it is manufacturing or trading, the Bank and the
Customer may enter into a Musharaka, in which the entire primary Operating
Activities of the Customer’s business would become the subject of the Musharaka.
 Operating Activities are defined as the principal revenue producing activities of the
Customer.
Deposits (Branches)
COMMON MUDARABA POOL
Auto & Home

Murabaha Musharka Ijara Istisna’ W. Istithmar Salam
Finance
Investmetn
Profit
WHAT DISTINGUISHES ISLAMIC BANKING FROM

CONVENTIONAL BANKING
We find the differences on three levels:
1. Conceptual & Socio-religious level

 Not money lenders
 Cannot deal with interest, impermissible contracts & non permissible
industries
2. Business model & Governing framework

 IB actively participates in trade and production process
 Governing framework in terms of Shariah Advisor &/or SSB
3. Product level implementation
 Usually asset backed & involve trading/renting of asset & participation on

profit & loss basis
 Implementation is not just a mere change of paper work and terms but it
involves
 Having the right intention
 The correct sequence of steps and timing of execution
 Taking due responsibility
WHAT DISTINGUISHES ISLAMIC BANKING
 Transactions are asset-based (Shariah Compliant)
 It is socially-responsible banking because it operates under

Shariah restrictions
 Does not permit financing of prohibited goods / Industries
 It starves evil out of the society
 Ethics and moral values play a major role in investment decisions.

Not a choice but a must.
CONVENTIONAL BANKING ISLAMIC BANKING
Conventional banking Islamic banking prices goods

prices money. and services which creates
real wealth in the society
leading to economic well-
being.
Is based on fixed return Is based on profit & loss

on both Sides of the sharing on deposits side,
balance sheet. and on profit & loss sharing
or profit on assets side.
CONVENTIONAL BANKING ISLAMIC BANKING
Does not involve itself in Actively participates in trade

trade and business and production.
Depositors get a fixed Profit is shared with the

rate regardless of the depositors, higher the
bank’s profitability, thus bank’s profit, higher the
insulating them from the depositors income.
bank’s true performance.
KEY MISCONCEPTIONS
ABOUT DIBPL SHARIA BOARD:

To ensure Shari’a Compliance in Dubai Islamic Bank Pakistan the Shari’a Board, also referred
to as Shari`a Executive Committee (SEC), with the assistance of the Shari’a Department
provides continuous guidance to business and trade units in order to ensure that the returns
generated for depositors and shareholders are free from Riba. Members of the Shari`a Board
are as follows:
Dr.Hussain Hamid Hassan:
- Dr. Hussein Hamid Hassan is considered as veteran of Islamic finance

- He received his PhD from the faculty of Sharia at the Al Azhar University in Cairo in 1965
- Holds two degrees in law from the International Institute of Comparative Law, University
of New York
- He chairs the Sharia Supervisory Committee of many Islamic banks in the Middle East
- And also has an adviser to several governments.
Mufti Muhammad Hassaan Kaleem:

Mufti Muhammad Hassaan Kaleem is a renowned figure in the field of Shari'a, particularly in Islamic Finance.
He is currently acting as a member of Shari'a Board and Country Head of Shari'a in Dubai Islamic Bank Pakistan
Limited. He holds vast experience in matters of Shari'a teachings and advisory as he has been teaching various
courses in Islamic Studies and Arabic at Jamia Dar-ul-Uloom, Karachi for the last 17 years.
Affiliations:
 Shari'a Board Member of Amana Bank Limited, Sri Lanka
 Shari'a Council Member of Al-Ameen UBL Funds
 Shari'a Advisor of Pakistan Mercantile Exchange
 Shari'a Consultant for Deloitte (Global Islamic Finance Team)
 Shari'a Board Member of Pak Kuwait Takaful Company Ltd, Pakistan
 Shari'a Board Member of Pak Qatar Family Takaful Ltd, Pakistan
 Shari'a Board Member of Hanover Re Takaful Bahrain
 Shari'a Board Member of Takaful Emirate, UAE
 Trainer of Shari'a standards at Accounting and Auditing Organization for Islamic Financial Institutions - Bahrain
 Permanent faculty member of Center for Islamic Economics Karachi
 Visiting faculty member of National Institute of Banking and Finance (State Bank of Pakistan)
 Furthermore, he is also a frequent speaker/trainer on the concept and issues related to Islamic banking and
finance, world-wide.
THANK YOU

Introduction To Islamic Banking

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Shari’a Department

INTRODUCTION TO ISLAMIC BANKING

BANKING AND ITS IMPORTANCE

 Provides an investment opportunity to the household with surplus

 Provides an opportunity to Small and Large businesses & Governments

 Functions and operating modes of conventional banking are based on

 The investor is assured of a predetermined rate of interest

 It aims only at maximizing profits without any halal/haram restriction.

IMPORTANCE OF PURIFYING THE SOURCE ON INCOME IN ISLAM

 The body which is nourished by non-pure sources is bound to

 Purifying the source of ones’ nourishment is one of the important

 Concept of Taharat/Nijasat & Hillat/ Hurmat.

‘A perfect combination is required by Islam’

UNANIMOUS SOURCES OF SHARI’A

RULES GOVERNING IBADAT AND MUAMLAT

 However, all Muamalat are allowed except those made

 This means that if Haram elements of any financial transaction are

“A fixed rate of return is not permitted under

Fixed return does not make a transaction halal or haram

“Can Interest rate be used as a Bench Mark?”

 Using Interest Rate benchmark for determining the profit in halal

 The nature of transactions determines the validity of the

Types of RIBA – INTEREST

 If currencies are exchanged heterogeneously, the delivery must be

PROHIBITION OF RIBA IN ISLAM

PROHBITION OF RIBA – IN SUNNAH

WHY RIBA IS HARAM?

"All that we had borrowed up to 1985 or 1986 was around $5

President of Nigeria, G8 summit, Okinawa, 2000

FAQs ABOUT RIBA

“Riba as practiced during the days of the Prophet (SAW) was

“Commercial interest did not exist in the days of Prophet (SAW)”

 This claim is incorrect as both forms of interest existed in Islamic and

 Kinds of Financial Contracts

KINDS OF FINANCIAL CONTRACTS

These are non compensatory contracts

DEFINITIONS OF SALE CONTRACT (Aqd ul Bai)

Exchange of a thing of value with another thing of value, with

It is the sale of a commodity in exchange for cash.

TYPES OF SALE (Aqd ul Bai)

 Valid Sale (Bai’ Sahih)

 Void Sale (Bai’ Batil)

 Executed but void due to defect (Bai’ Fasid)

 Valid but disliked sale (Bai’ Makrooh)

1. VALID SALE (BAI SAHIH-‫) ب يع ص حيح‬:

 Essential elements of a valid sale are:

a) Contract (Aqd‫ عقد‬- )

Offer and Acceptance (Ijab-wa-Qabool) can be:

SUBJECT MATTER (MUBEE’E):

The subject matter must be:

1. Existing (Exception of Salam & Istisna’a)

PRICE (THAMAN): Should be

DELIVERY OR POSSESSION (QABDH):

2. VOID SALE (BAI’ BATIL‫ ب يع ب اطل‬- ):

Conditions for sold Goods where goods should be:

3. SALE EXECUTED BUT VOID DUE TO DEFECT (FASID‫ ف اسد‬- ):

- Subject matter has not been identified or specified clearly

This sale must be corrected or canceled. It doesn’t transfer ownership to

4. VALID BUT DISLIKED SALE (BAI MAKROOH ‫ب يع مكروه‬

- Sale after Jum’a ‘Azan

OTHER KIND OF SALE CONTRACTS:

- Sale of the usufruct: when the benefit or utility of a nonperishable