Asian Regional Public Debt Management Forum, 5th November 2009

Assoc. Prof. Dr. Asyraf Wajdi Dusuki

Head, Research Affairs International Shariah Research Academy for Islamic Finance (ISRA)

Outline

Islamic Finance Master Class

Defining Shariah Compliant Shariah Parameter in Structuring Islamic Financial Products Underlying Principles of Islamic Finance Fundamental Characteristics of Shariah Compliant Finance Illustrations of various 2 Islamic Finance and Takaful Instruments

Maslahah Maqasid

Dharurah! Viability?

Legal Structure

How to structure financial products that comply with Shariah?

We need to finance our car, house, business

What is Shariah?
Literally means path to watering place Technical meaning Path to tread for guidance in this world Commands, prohibitions, values prescribed by Allah for His slaves either through Al-Quran or As-Sunnah (the teachings of the Prophet Muhammad s.a.w.) Normally, the Sharah is described as Islamic Law. But the boundaries of Sharah extend beyond the limited horizons of law (Sardar 2003). Sharah is a set of norms, values and laws that go to make up the Islamic way of life (Ahmad 2003). According to one observer, the Sharah is the epitome of Islamic thought, the most typical manifestation of the Islamic way of life, the core and kernel of Islam itself (See in Schact (1964)).

ISLAM & Components of Shariah

I`tiqadiyah (Belief) `Amaliyah (Dealings) Akhlaqiah (Morality)

Ibadah
(Human with Creator)

Muamalah
(Human with human)

Economics

Family Law

Criminal Law

Politics
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Issues in Islamic banking and finance

Approach in Deriving Hukm Syari (Islamic Legal Ruling)

Ibadah Fixed Determined by God Original Ruling is prohibited unless there is a valid justification that explains its permissibility Otherwise, it is considered bidaah (innovation) Muamalah Combination of fixed and flexibility Based on premise:

The original ruling is permissible Unless there is a clear and valid justification that suggest otherwise Understanding the illat (rationale) and maslahah
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What is Maqasid As-Syariah?

It outlines the objectives and wisdom (hikmah) as prescribed by Shariah (Allah & His Prophet s.a.w.) in all its rulings to protect and preserve the benefits and interests (maslahah) of society. What is Maslahah?
is the benefits or interests which are deemed necessary from Syariah perspectives to protect and preserve the five darurah. (AlMansul, Fakhruddin Ar-Razi, p.24)
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And We have sent you (O Muhammad) not but a mercy to the whole universe (Al-Ambiya:107)

Alleviate Hardship

Eliminate Prejudice

Justice

Maqasid as-Shariah (The Objectives of Shariah)

Religion Intelect Life Posterity

Wealth

Preservation and Promotion

Preservation of Wealth Alleviate Hardship Eliminate Prejudice Justice

Maqasid as-Shariah in Islamic Finance Macro Maqasid Micro Maqasid Assessment on the transactional instrument and mechanism Approach in Realization of the Objectives of Shariah

Assessment on the overall impact and contribution Ar-Rawaj (Distribution of Wealth)

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Any transfer of wealth or property has to be made through a valid contract or `aqad Theory of Contract
in Islam

Divine Sources (Quran & Sunnah)

Mutual Consent (Redho)

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Shariah Parameter in the Theory of Contract ()

SHARIAH-COMPLIANCE PARAMETERS
IBF Contract s

9 Lawful Objective/Purpose 9mutual consent No coercion, fraud, misrepresentation , influence, mistake etc. No Prohibited elements Riba Gharar Maysi r Nonhalal

HOW TO MAKE MONEY IN ISLAM?

Allah permits trading but prohibits Riba (2:275)

They said that indeed trading is just like riba (2:275)

RIBA
NO COUNTER-VALUE

PROFITS
Whats The Difference?
WITH COUNTER-VALUE (`IWAD)

15 Effort (AlRisk (AlLiability (Al-Dhaman)

General Classification of Contract in Islam

Profit-making Contracts

Charitable Contracts ()

Exchange Contracts () Cooperation Contracts ()

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Deposit-taking Contracts

Various forms of Islamic Contracts used in Banking

Wadiah Yad Amanah; Wadiah Yad Dhamanah, Mudarabah; al-Qard BBA deferred sale; Murabahah cost-plus sale; Bai al-Inah, Bai alTawarruq Ijarah Wa Iqtina; Ijarah Thumma Al-Bai, Ijarah Muntahia Bitamleek

Sales-based Contracts

Lease-based Contracts

Equity-based Contracts

Mudarabah, Musyarakah

Fee-based Contracts

Kafalah/Dhaman (Guarantee); Wakalah (agency) Musyarakah Mutanaqisah (Dimishing Partnership), AITAB etc.

Promise/Undertaking Wa`ad

Hybrid Contracts

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Major Components of Islamic Financial Services

ISLAMIC BANKING
Financing Deposit Investment

ISLAMIC CAPITAL MARKET

Equity Islamic Securities Funds & Unit Trust I-REITs Venture Capital/ Private Equity Derivatives

TAKAFUL/ ISLAMIC INSURANC E

Takaful Retakaful

Promote Maslahah Freedom from Riba

Entitlement to Equal, Adequate, Accurate Info.

Freedom from Gharar

Promote Brotherhood

Freedom from Dharar

Freedom to Contract

Characteristics of Shariah-compliant Banking and Financial System

Freedom from Price control & Manipulation

A system grounded on moral and ethics Entitlement to Transaction at Fair Price

Freedom from Qimar & Maysir

Some illustrations of Islamic Financial Products Available in the Market

BBA HOME FINANCING MODUS OPERANDI

5. Bank pay developer the 90% balance Sales & Purchase Agreement (S&P)

Developer/Vendo r

1. 10% down payment

1. Beneficial ownership

Property Sale Agreement (PSA) 3. BBA price (deferred payment) 3. House

2. House 2. Cash price (90% balance)

BANK

Property Purchase Agreement (PPA)

Customer

Tawarruq Model of Home Financing

4.Property 4.RM200,000 Property Owner/Developer 3.RM200,000
cal i r t s lec 3.E liance App

Customer

2.RM350,000 Deferred 2.Electrical Appliances

1.RM200,000 1.Electrical Appliances worth RM200,000 Electrical Appliances Wholesaler

Musyarakah Mutanaqisah (Modus Operandi)

Bank leases its 90% share of property to customer

90%

10%

0%

100%

Customer pays rent for usage of Banks 90% share of property Customer gradually buys share of property from Bank
Customers monthly installment payments

ILLUSTRATION of Musharakah Mutanaqisah

Customers Share
The asset is now mine. Thanks to

MM

Banks Share

100 90 80 70
Customer now owns 100% of the Assets 90% 80% 70% 60% 50% 40% 30% 20% 10% Banks share = 0

Islamic Bank

60 50 40 30 20

10%

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Commodity Murabahah Deposit Placement

US$ 1 Million on spot Client Broker A Where is this proceed invested? US$ 1.1 Million deferred

US$ 1 Million on spot Broker B Islamic Bank

Engage in construction

Ship Builder

Istisna Arrangement (1) Lessor is the beneficial owner of the to Construct vessel and the lessee is the registered owner and operator of the vessel Vessel (2) Lessor will lease its beneficial interest in
the vessel

Forward Lease Agreement

Istisna Agreement Seller/Lessee

(1) Purchaser and the Seller agree that the Seller will build the Vessel (2) Purchaser agrees to pay the Istisna cost as the price for the Seller per forming the works (3) Seller agrees to sell by way of Istisna to Purchaser its beneficial interest in the constructed Vessel and Purchaser agrees to purchase the constructed vessel for the Istisna; cost.

ORPHAN SPV (Mudarib/Purchas er/ Lessor Mudarabah Agreement

Financier (Rabbul-Maal)

No Claim

Profit
Premium

BASIC MECHANISM OF INSURANCE

Insurance Company

Policy holder
Peace of mind

Compensation

Calamity

Why is conventional insurance not Shariahcompliant?

Element of uncertainty (gharar) There is uncertainty of what the insurance policy-holder is buying or paying for If no loss occurs Policy-holder receives nothing If loss occurs Policy-holder gets compensation in varying amounts
Premium

Insurance Company

Coverage

Insurance Policy-holder

Element of gambling (maysir) The insurance company is gambling that total premiums collected will exceed total claims and thus producing underwriting surplus (profit) Total claims is predominantly affected by chance (will of God) Element of riba Insurance fund commonly invested in interest-bearing securities

ISLAMIC ALTERNATIVE TO INSURANCE

BASIC DESCRIPTION OF TAKAFUL INSDUSTRY

Takaful Operator

Manages fund for a fee or share in profits on investment

Takaful Participants
Contribute via unilateral contract (tabarruat)

Takaful Fund

Takaful participants contribute to a takaful fund based on the concept of mutual assistance The contribution is done via reciprocal/mutual donation (tabarruat) and does not represent a commercial sale of coverage Takaful entails a unilateral, charitable contract (tabarruat) in contrast with the conventional insurance contract which is a bilateral exchange contract (muawadat) Gharar is tolerated in a charitable unilateral contract

Models of Takaful

Among Participants

Between Participants and Takaful Operator Wakalah (Agency) Mudarabah (Partnership) Waqf (Endowment)

Tabarru` (mutual indemnity)

Hybrid

MODUS OPERANDI (MUDARABAH MODEL)

Takaful Participants Contribute
2nd Contract

Tabarru`
Takaful Funds Manage
1. 2. unilateral contract valid though no acceptance and consideration from the recipient

1st contract

Mudarabah

Invest

Takaful Operator

Pay Claims

Profit, if any, is shared between the two based on certain ratio or percentage & loss, if any, will be borne by the capital provider alone

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MODUS OPERANDI (WAKALAH MODEL)

Takaful Participants
Wakalah fee 2nd Contract

Contribute

Tabarru`
Risk Fund Manage Takaful Operator

1st contract

-retakaful -reserves -claims -investment income -stabilization reserves

Wakalah

Surplus
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In a nutshell as a Muslim, a man needs to abide with Shariah!

Every Transactions Must Be Shari`ah Compliant!

What Does it Mean By Shari`ah Compliance?

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SHARIAH-COMPLIANT IS NOT JUST ABOUT:

Satisfying the mechanics of financial operation; Fulfilling the legal documentation requirement Focusing on the legal form of a contract

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VALIDITY vs. PERMISSIBILITY

Validity (Sahih Qadaan) is based on the FORM of the Contract while Permissibility (Sahih Diyanatan) is A Valid Contract is not necessarily PERMISSABLE (HALAL) VALID(SAHIH) Based on the SUBSTANCE of the contract and Halal (Permissable) contract that is used contract that meets its to obtain Halal (Permissible) ends. requirements and conditions the INTENTION of the contractors.
36 Financial Contract MUST be BOTH HALAL (Permissable) & SAHIH (Valid)

Shariah-Compliant Requires
Financial Contract to be Shariah compliant both in terms of FORM and SUBSTANCE Operation to be Shariah compliant Islamic banking to be more ethical Socially Responsible

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ISRA @ INCEIF 2nd Floor, Annexe Block Menara Tun Razak Jalan Raja Laut 50350 Kuala Lumpur MALAYSIA General Line : +603-2781 4000 Fax : +603-2691 1940 Email Website : info@isra.my : www.isra.my