Chapter 6: Islamic Financial System

CHAPTER 6:
ISLAMIC FINANCIAL SYSTEM

BPMS1013 Theory & Practice of Islamic Business

1

Introduction
• What is Islamic Financial System?


2

Introduction
A financial system that is based on Islamic principles and
values, which eliminates riba and ensure a profit sharing
mechanism in the financial system.
It may be characterized by the absence of interest based
financial institution and transactions, doubtful transactions or
gharar, stocks of companies dealing in unlawful
activities, unethical or immoral transactions such as market
manipulation, insider trading short-selling etc.


3

The Principles Of Islamic Finance
• Wealth must be generated from legitimate trade and
asset-based investment. (The use of money for the
purposes of making money is expressly forbidden)
• Investment should also have a social and an ethical
benefit to wider society beyond pure return.
• Risk should be shared.
• All harmful activities (haram) should be avoided.

4

Prohibited Elements In Islamic
Finance
Riba
Definition

Literally, it means excess, expansion, increase, addition
or growth.
Technically, it refers to the “premium” that must be paid
by the borrower to the lender along with the principal
amount as a condition for the loan or an extension in its
maturity.


5

Types of riba
a) Riba al-nasi’ah
• Pertaining to loan contracts. The term nasi’ah means
to postpone, defer or wait and refers to the time that
is allowed for the borrower to repay the loan in return
for the addition or the premium.
• Example:- selling and buying properties
- personal loans


6

b) Riba al-fadl
• Pertaining to trade contracts. It refers to the exchange of
different quantities or qualities of the same commodity.
• Example:- a kilo of wheat being exchanged for 1.5 kilos of
wheat.


7

Differences between profit and riba
RIBA

PROFIT

Definition

Stipulated surplus of debt. Riba exist
as long as the exchange/transaction
gives rise to inequality of counter
values (al-fadl) and determent in time
of exchange (al-nasiah).

Profit is the return on trade, which is
the result of difference between
revenue and cost, encompassing the
effort and risk undertaken by the
entrepreneur.

Prohibition

Prohibited in Islam.

Permitted in Islam.

Counter
value

Unequal counter value.

Equal counter value.

Wealth
Creation

Deals only with money thus do not
create real stock of wealth.

Deals with real assets thus creates
real stock of wealth from:
i.
Additional values of the goods
sold.
ii. Increase in utility through
exchange.

Arguments

i.
ii.

Always justified in Islam.

Money as commodity – invalid
Riba actually brings soma
benefits - invalid


8

Gharar
Definition
 Literally, it means deception, danger, risk, and uncertainty.
 Technically, it means exposing oneself to excessive risk and danger in a
business transaction as a result of uncertainty about the price, the quality
and the quantity of the counter value, the date of delivery, the ability of
either the buyer or the seller to fulfill their commitment, or ambiguity in the
terms of the deal.
 Ibn al-Qayyim described gharar as a sale in which the vendor is not in a
position to hand over the subject matter to the buyer, whether the subject
matter is in existence or not.
 Imam al-Sarakhsi defined gharar as any bargain in which the result of it is
hidden.
 Sheikh Wahbah al-Zuhaily defined gharar as a contract which contains a
risk to any one of the parties which could lead to his loss of properties.


9

Types of gharar

a) Gharar yasir (minor/slight) – tolerated and will not
invalidate a contract.
b) Gharar fahish (excessive/major) – not tolerated and
may result in voidability of a contract.
Examples:-

- the sale of fish in the sea
- the sale of bird in the air
- the sale of unborn animals
- lost items

10

Maysir (Gambling)
Definition

Also known as qimar.
Refers to easily available wealth or acquisition of
wealth by chance, whether or not it deprives the other’s
right.
Qimar means the games of chance – one gains at the
cost of other.
Example:- lotteries, illegal racing,


11

Islamic Banking Activities
And Money Market
Partnership
Mudarabah (Profit sharing)
A profit sharing contract, with one party providing 100 per cent of the
capital and the other party (the mudarib) providing its expertise to invest
the capital, manage the investment project and, if appropriate, provide
labour.
Profits generated distributed according to a predetermined ratio, but
cannot be guaranteed.
Losses accrued are borne by the provider of capital, who has no
control over the management of the project.
Often used for investment funds, with investors providing money to the
Islamic bank, which it invests as mudarib, taking a management fee.

12

M
U
S
H
A
R
A
K
A

A partnership between two
parties who both provide
capital towards the financing
of new or established
projects.
Both parties share the
profits on a pre-agreed
ratio, with losses being shared
on the basis of equity
participation.


13

Cost-plus financing /
buy-sell arrangement

M
U
R
A
B
A
H
A

A method of asset acquisition
finance.
A contract between the bank and
its client for the sale of goods at a
price that includes an agreed profit
margin, either a percentage of the
purchase price or a lump sum.
The bank will purchase the goods
as requested by its client and will
sell them to the client with a markup.
The profit mark-up is fixed before
the deal closes and cannot be
increased, even if the client does not
take the goods within the time
stipulated in the contract.

14

Based On Saving
Al wadi’ah ( Safe-keeping)
The bank may request permission to use customer funds deposited in
these accounts as long as these funds will remain within the bank’s
discretion.
 The bank does not share with the customer profits earned from the
use of the customer ’s funds but does guarantee the customer ’s
deposits.
The bank may, however, reward customers with a hibah (gift) as a
token of its appreciation for being allowed to use the funds.
 Hibah could be a portion of the profit generated from the use of the
funds.
Hibah may be paid at any time, but in practice, most Islamic banks
pay hibah at a regular periodic interval, such as quarterly or
semiannually.


15

lease (sewa pajak)
Ijarah (leasing)

PERSONAL
FINANCING & ASSET

A contract where the bank
buys and leases out equipment
required by the client for a rental
fee.
Ownership of the equipment
remains with the lessor
bank, which will seek to recover
the capital cost of the equipment
plus a profit margin out of the
rentals payable

16

Purchase asset
Use a shari’ah system refers to the islamic law based on divine
guidance ,as given by the Qur’an and the sunnah ,and embodies all
aspect of the islamic faith ,including belief and practice.Based on
mudarabah and musyarakah

Ar-Rahn, or mortgage or collateral, is defined in the

AR -RAHNU

Islamic jurisprudence as “possessions offered as
security for a debt so that the debt will be taken
from it in case the debtor failed to pay back the due
money.”
Ar-Rahn is a permissible contract in Shari’ah. It
is known from the Sunnah that when the Prophet of
Allah, Muhammad (SAW),.


17

Islamic Letter Of Credit
• It is a written undertaking given by the Islamic bank to the seller (the
beneficiary) at the request and on the instructions of the buyer (the
applicant) to pay at sight, or at a determinable future date, a stated sum
of money within a prescribed time limit and against stipulated
documents which must comply with terms and conditions.


18

Islamic Bank Guarantee
• A guarantee Is promised by a third party to carry out the
obligations owed by one person to another in the event
of default.
• Under the syariah, and in accordance with the principles
of kafalah, an islamic bank may issue, at the request of
the customer, an islamic bank guarantee (IBG) to a
beneficiary named by the customer.
• The kafalah principle used in (IBG) is a surely given by
the first party who agree to discharge the liability of a
third party in case the second party defaults in fulfilling
his obligation

19

Qard Hassan Loan
•interest-free loans or loans given to the purpose
of welfare assistance
•Debt repayments by certain parties to the other
without profit or payment of any refunds made
over time.
•social responsibility or welfare assistance from
the wealthy to those in need.


20

CONT…
•No one should owe the creditors want to return
the favor by giving a little consolation
•“Sesiapa yang berbuat baik kepada kamu maka
hendaklah kamu memberinya balasan yang
baik.”
(Riwayat Ahmad)


21

The Equity of Islamic Financial System
 Equity is an ordinary share issued by a company
 Equity market is a wide market that involves many
sellers and buyers around the world
 equity shares of companies are traded in equity market
that are further classified as primary and secondary
market


22

The Instruments Of Equity
1.

normal share


2.

Major stock


3.

Owner warrants or TSR has the right to buy a certain number of shares at a
price set over a specified period

Call Warrants


5.

Structured so as to meet Islamic requirements such as payment of dividends
Irregular

Subscription right (TSRs & warrants)


4.

Shareholders have the right ownership, profit sharing rights, rights voting
member of the Board of Directors

Refer to instruments which entitle the owner to purchase the number of
shares particular at a set price during the prescribed period.

Trust Based on Islam


Refers to investment trusts in a managed fund by professional fund managers

23

1.

partnership


All operations are carried out in the form of Islamic banking and finance must be
parallel or follow the rules set by the Shariah. General principles of Islam can be
summarized as follows


every transaction carried out must be with the full consent of the contracting
parties.



The contracting membership must be perfect and the contract is not impaired
by the things that can cancel it as coercion (duress) misstatement
(misrepresentation) and err (mistakes)



Goods become the object of a contract must be known to the
type, nature, and capable of delivered volume. It is also beneficial and clean
in the eyes of Shariah.



Muamalah is not created on the basis of riba al-qimar (gambling), almaysir, al-gharar (element not sure) and things that are prohibited.



Muamalah shall be protected from the elements of oppression (ihtikar)
embargoed goods (talaqqi al-rukban) or excess profit that cause huge losses
to the other contracting party (ghabn al-fahish)

24

Cont…
2. Based on waged
 In Islam, the source of financing is not practice
the riba’
 ensure fair wages policy for labor
 The forms of Islamic financing sources such as
Mudarabah, Musharakah, Bai Bissaman
Ajil, Ijarah and others


25

Sukuk
DEFINITION
 Sukuk : is the Arabic name for a financial certificate or an Islamic bond.

 Sukuk are certificates of investment in a project in which the sukuk
holders have an interest (or ownership) of the underlying asset or project
sukuk issue.
 Sukuk differ because sukuk shares do not have ownership over the assets
of the company but have an interest / ownership of certain assets or
projects.
 Publisher sukuk issue sukuk as to raise funds to meet the capital
requirements of the project or where the holder may sell sukuk in the
secondary market or held to maturity sukuk.
 Sukuk are generally in the form of equity, although can be secured
through purchase of undertakings (purchase undertaking) in some sukuk
structures.


26

Obective Sukuk
- To enable organizations:
(1)to raise capital
(2) expanding the investor base and
(3) offering investment opportunities to new groups.


27

Types Of Sukuk
1.) Musharaka Sukuk
- Are used to finance businesses on the basis of partnership contracts.
- Musharaka Sukuk are used for mobilizing the funds for establishing a new project or
developing an existing one or financing a business activity on the basis of partnership
contracts.
2.) Ijara Sukuk
- These are sukuk that represent ownership of equal shares in a rented real estate or the
usufruct of the real estate. These sukuk give their owners the right to own the real
estate, and receive the rent.
3.) Mudaraba Sukuk
- Are often used for profit sharing between investors and entrepreneurs in ventures.
- are used for enhancing public participation in big investment projects.
4.) Istisna Sukuk
- The aim of Istisna Sukuk is mobilising the funds required for producing products that are
owned by the certificate holders.
- Istisna Sukuk are quite useful for financing large infrastructure projects.


28

Fiqh Rules In Investment
• "(For) Profit (yield investments) must be to run the risk
(meaning no fixed profit promise and investors must
ensure keelokan goods sold if a sale contract)" [Hadith
narrated by Imam
Ash-Shafi `i, Imam Ahmad, Imam Ibn Hibban, Imam
Abu Dawood: No. 3508; According to Shaykh
Albanian: This Hadith Hasan]


29

Conclusion
 Basically, stand based on Islamic banking institution
is a must. However, each activity to be implemented
should be reviewed carefully so as not to conflict with
Islamic law. Recovery in the economy as a whole
must be borne by the government so that justice can
be applied in the lives of Muslims as a whole.


30

Q&A

31

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