BWSS2013

PHILOSOPHY OF BUSINESS IN
ISLAMIC FINANCE AND BANKING
CHAPTER 3
PHILOSOPHY OF THE ISLAMIC
FINANCE AND BANKING
 CHAPTER OUTLINE
Introduction
Philosophy of finance and banking in Islam
Characteristics of Shariah
Forbidden practices in Islamic finance and
banking
Impediments of transaction in Islam
 Introduction to Philosophy
Islamic Finance and Banking
Islamic Shariah prohibits interest but it does not prohibit all gains on capital. It is
only the increase stipulated or sought over the principal of a loan or debt that is
prohibited. Islamic principles simply require that performance of capital should also
be considered while rewarding the capital.

The prohibition of a risk free return and permission of trading, as enshrined in the
Verse 2:275 of the Holy Quran, makes the financial activities in an Islamic set-up real
asset-backed with ability to cause value addition.

Islamic banking system is based on risk-sharing, owning and handling of physical

goods, involvement in the process of trading, leasing and construction contracts using
various Islamic modes of finance. As such, Islamic banks deal with asset management
for the purpose of income generation. They will have to prudently handle the unique
risks involved in management of assets by adherence to best practices of corporate
governance. Once the banks have stable stream of Halal income, depositors will also
receive stable and Halal income.
 The forms of businesses allowed by Islam at the time the Holy Quran was revealed
included joint ventures based on sharing of risks & profits and provision of services
through trading, both cash and credit, and leasing activities. In the Verse II:275,
Allah the Almighty did not deny the apparent similarity between trade profit in
credit sale and Riba in loaning, but resolutely informed that Allah has permitted
trade and prohibited Riba.

Profit has been recognized as reward for (use of) capital and Islam permits gainful
deployment of surplus resources for enhancement of their value. However,
alongwith the entitlement of profit, the liability of risk of loss on capital rests with
the capital itself; no other factor can be made to bear the burden of the risk of loss.
Financial transactions, in order to be permissible, should be associated with goods,
services or benefits. At macro level, this feature of Islamic finance can be helpful in
creating better discipline in conduct of fiscal and monetary policies.

Besides trading, Islam allows leasing of assets and getting rentals against the
usufruct taken by the lessee. All such things/assets corpus of which is not consumed
with their use can be leased out against fixed rentals. The ownership in leased assets
remains with the lessor who assumes risks and gets rewards of his ownership.
 WHAT IS SHARIAH?

Shariah is the moral code and religious law of Islam.

Sharia deals with many topics addressed by secular law,
including crime, politics and economics as well as
personal matters such as sexual intercourse, hygiene, diet,
prayer, and fasting. Though interpretations of shariah vary
between cultures, in its strictest definition it is considered
the infallible law of Godas opposed to the human
interpretation of the laws (fiqh).
 CHARACTERISTICS OF SHARIAH

From Allah - The first and the most important attribute of Islamic Shari`ah is
that it is from Allah.

Comprehensive, encompassing, and complete - Shari`ah is a

comprehensive guidance that takes into consideration all aspects of the
human life.

Balanced and moderate - It balances between the body and the soul,
between the intellect and the emotions, between this life and the eternal
one. It balances between theory and reality, between thinking and acting,
between the unseen and the apparent.

Release from burdens - One important attribute of Shari`ah is that it came to

make things easy and remove burdens.
 Practical - It acknowledges their needs and desires. Allah knows the humans He
created and knows that they need to eat, drink, and get married. They have
materialistic necessities and needs the same way they have their spiritual and
emotional needs.

Preserved - One important attribute of Shari`ah is that it is the last Shari`ah to

humanity. It will continue to remain and reach generation after generation. For
that, Allah preserved and protected its sources.

Synergetic - They create synergy between people, where they help one another to
promote the good and remove the evil. Shari`ah also establishes synergy between
people and their leadership at all levels.
FORBIDDEN PRACTICES IN
ISLAMIC FINANCE AND
BANKING

These are various practices which have been declared

forbidden by the Quran and the Sunnah. These include:

i. Hoarding
ii. Debasement of money
i. Hoarding of Money - Islam discourages hoarding of money (iktlnaz) which is
destructive to society and also harms individuals. The invention of money meant that a
buyer might pay the seller the price of his commodity, and the seller may buy some
other things from a third person and pay that sum of money to him. The money one
gets but does not spend, keeping it to oneself, is depriving the money of its natural
function as a medium of exchange and utilizing it for an unreal purpose. Hoarded
money cannot be equal to money in circulation. It should be allowed to circulate in
society as widely.

ii. Debasement of Money - During the prophets time, debasement of currency in all
forms was strictly forbidden. Trading in money encourages counterfeiting and so
confidence in the currency can be lost, resulting in inflation. Sale and purchase of
money as merchandise is a major cause of monetary instability. Even western
economist are of the view that it should not be allowed.
Impediments transaction in islam

Fraud Duress

Mistake
 Fraud
A transaction which involves fraud or adulteration, like, when one
commodity is mixed with another, and it is not possible to detect the
adulteration, nor does the seller inform the buyer about it, like, to sell ghee
mixed with fat.

This act is called cheating (ghish) or adulteration.

The holy Prophet of Islam (s.a.w.a) said: "If a person makes a deceitful
transaction with the Muslims, or puts them to a loss, or cheats them, he is not
one of my followers. And when a person cheats his fellow Muslim (i.e. sells
him an adulterated commodity), Allah deprives him of Blessings in his
livelihood, closes the means of his earnings, and leaves him to himself."
Among the forbidden fraud in Islam:
 Duress
Such transactions were to be arranged and executed under duress (with
Ikrah), they have no validity in the sight of the Shari'ah of Islam.

In normal practice, once the person concerned comes out of the state of
Ikrah (compulsion, duress), he will have the option to reassess the sale or
gift done under duress and exercise his free will to retain or cancel it.

And then it appears in Hadith:

The wealth and property of a Muslim does not become lawful unless it be
with a whole-hearted pleasure from the person.
Mistake
Islamic law conceives of mistake as a substantive or intrinsic element which
capable of occurring only during the formation of contractual agreement.

Mistake could arise from an assumption as to the existence, quality or quantity of

the contractual object or to the nature or existence of the contract itself.

The provisions concerning mistake are scattered and usually are to be found in the
books of fiqh among the discussion in option of description, defect or sight.

The Islamic concept of mistake is inextricably bound to the notion of consent in

contract.

The law lacks in formulated theory because the provision of mistake are in
actuality, mostly preclusions or safeguards designed to prevent its very incidence.
Conclusion

We have discussed the central ingredients of Islamic finance and some

relevant aspects that could be helpful in achieving Shariah compliance
for Islamic banks transactions. The term Islamic finance or Islamic
banking simply refers to a state of affairs wherein the financial institutions
and the clients have to fulfil the relevant principles of Islamic jurisprudence.
Some conditions have been put in place to ensure that contracts do not contain
the elements of Riba, Gharar and Maisir the main prohibitions as discussed
in Islamic law.

The Islamic banking system is based on risk-sharing, owning and handling of

physical goods, involvement in the process of trading and leasing and
construction contracts using various Islamic modes of business and finance.