Finance & Banking


In this article, Dr. Inam Ullah Khan discusses the juristic
differences in Islamic banking and finance. He highlights several
products on which there has been much discussion regarding
Shari’a compliancy and emphasises the need for the industry to
adopt a maqasid orientated approach in creating products.

Islamic banking is slowly emerging as an important area
of applied Islamic law and jurisprudence. The relationship
between classical Islamic law and Islamic finance has created
a new system of law-making under the Shari’a, one that has
evolved remarkably over the last 40 years. The syncretic
process of mining the classical texts, considering modern
sensibilities and accommodating state-law prescriptions
has undoubtedly made Islamic finance a thoroughfare of
progression in the Islamic legal derivation process.

Original interpretation and ijtihad are most essential today
for the development of Islamic law generally and of Islamic
commercial law in particular. Despite the existing weakness
concerning ijtihad, if there is a success story to be associated
with the revival of Islamic jurisprudence in modern times, that
story will certainly include Islamic finance. From little more than
a concept and an ideal, modern Islamic finance grew rapidly, with
the last two decades seeing the establishment of a variety of
financial institutions and the creation of a legal and governance

However, a constant concern for Islamic finance is the
differences of opinion on product structures. There is a
pressing need for harmonisation in the long run especially
in today’s interlinked global market. If one country prohibits
one product, while another permits, then this could have an
effect on cross-border transactions, and on the efficiency and
efficacy of the industry.

Zaki Badawi, former principal of the Muslim College in London,
emphasised the importance of the use of maqasid oriented
ijtihad for the development of an Islamic financial system. He
stated that little attention was paid by most fuqaha to the
basic objectives of the Shari’a. He pointed out that Al-Shatibi
as well as Al-Ghazali, Ibn Taymiyyah, and Ibn Qayyim advised
the fuqaha to take into consideration the purposes of the
Shari’a to address the individual and society’s needs when
issuing a fatwa. Badawi added that the task of identifying the
real need of society, along with their relevance to the purpose
of the Shari’a is not easy. It pushes the scholar to consider
the literal text on one hand and the abstract purposes of the
Shari’a on the other. He concluded that a new ijtihad must
begin by adopting the post Al-Shatibi approach to usul al-fiqh.

Hashim Kamali argues that usul al-fiqh has become a
theoretical discipline studied as a part of the legal heritage
rather than a tool to regulate and encourage ijtihad. He
added that usul al-fiqh is not without weaknesses and some
of the weaknesses are not new, but existed for almost as
long as the usul al-fiqh itself. A legitimate use of human
intellect in dealing with emerging circumstances is guided
only by the general principles of Shari’a based on justice and
benevolence (al-adl wa ihsan).

Al-Shatibi has emphasised the importance of maqasid for
ijtihad. He advocated a sound knowledge of the goals and
the objectives of the Shari’a as a pre-requisite to reach the
rank of a mujtahid. Sano Koutoub argued that the protection
and preservation of wealth is one of the essential elements
of maqasid al-Shari’a. Therefore, the continuity and growth
of wealth in society should be encouraged and maintained.
The continuous distribution of wealth in the society
should also be enhanced to bring happiness and financial
stability. To achieve these objectives, a supportive Islamic
jurisprudential framework is required based on the concept
of maslaha and the boarder objectives of the Shari’a.

There is no doubt Islamic banking and finance has gained
greater importance over the last two decades but the
soundness and stability of its infrastructure can be scored
through the robustness of its regulatory framework
supported by the sophistication of its products and services.
While it was initially developed to fulfil the needs of the
Muslims, Islamic banking and finance has gained universal
acceptance as there has always been a demand amongst
Muslims for financial products and services that conform
to the Shari’a. With the development of workable Islamic
alternatives to conventional finance, Muslims are beginning
to find Shari’a complaint solutions for their financial needs.

Although Islamic banking has made significant headway
in a short period of time, juristic disagreements still exist.
Debt financing is one of the core areas of concern, where
disagreements exist over products such as murabaha, bay
bithaman ajil, bay al-dayn and bay al-ina. Generally speaking,
the Middle Eastern scholars prohibit debt trading while the
Malaysian scholars in official rulings permit it.
Apart from this, there are many issues that have to be
addressed by Islamic banks both in terms of documentation
and transactional structure. The general legal framework in
many countries will need to be modified to promote Islamic
banking. The former governor of Bank Negara, Zeti Akhtar
Aziz argued that at present Islamic banking and financial
institutions have, to a large extend, have been governed
by the conventional regulatory framework, supplemented
and reinforced by the Shari’a framework and Islamic
accounting standards. However, Islamic banking is distinct
from conventional finance in terms of its philosophy of prohibiting interest, which in turn shapes the nature of
its financial transactions and its risk attributes. Therefore,
she suggested the development of a separate regulatory
framework in view of the unique risks associated with
Islamic financial transactions to provide for their effective
assessment and management. The focal point that needs
to be analysed is the presiding regulatory framework: does
it affect the process of fatwa and ijtihad or not?

Sudin Haron stated that there is no uniformity of laws
and procedures in the practice of Islamic banks around
the world. Islamic banks have to conform basically to two
types of laws: the Shari’a and positive laws. While Shari’a
law is based on religious foundations, positive laws are
promulgated by sovereign bodies to safeguard public
interest. The positive laws, in most cases, are under the
supervision of the Central Banks. In Malaysia, for example,
the establishment of an Islamic bank is governed by the
Companies Act 1965, and its operations are subjected
to the Islamic Banking Act 1983 and, to some extent, the
Banking and Financial Institutions Act 1989. Islamic banks
must conform to all requirements as stipulated in the above
stated Acts.

Similarly, other governments have passed special laws that
govern the operations of Islamic banks in their countries.
Islamic banks in Malaysia are subject to the Malaysian’s
Companies Act 1965; the Islamic banks of Bahrain are
subject to the Bahrain Commercial Companies Law 1975
and the Kuwait Finance House (KFH) is subject to Kuwait
Commercial Companies Law 1960. Whilst Malaysia and
Kuwait have recently legislated on Islamic Banks, Bahrain
has no special laws on the subject.

The social changes in modern times have introduced
complexities in the application of Islamic law. The prevailing
diversity in the contemporary application of Islamic law
as response to social change on one hand is perhaps a
welcome development; but on the other hand, it creates
new challenges too. The Islamic banking industry is the
most prominent example, where the emerging challenges
are significant and need to be addressed urgently.

While the diversity in fiqh opinion is presently contributed
in global growth, it may soon become a constraining
factor if the challenges arising out of it are not properly
addressed. The two distinct mechanisms that operate
side by side to carry out business according to the divine
revelation are equity financing and debt financing. Equity
financing is affected through profit sharing contracts, while
debt financing is affected through deferred contracts of
exchange. The Quran further elaborates debt financing with
the contracts of deferred exchange allowed and interestbased lending forbidden. The main disagreement which
prevails between the two regions under review, Malaysia
and the Gulf, is over debt based financial products such
as murabaha, bay bithaman ajil, bay al-dayn and bay al-ina.

Murabaha in fiqh literature is considered as a type of
sale. The only feature in murabaha distinguishing it from
other kinds of sale is that the seller expressly informs the
purchaser of his cost and the profit he intends to make. The
main objectives to murabaha are that there is a chance for
partaking in bay al-ina as practiced by some Islamic financial
institutions and that it combines two sales in one. There are
also differences of views amongst the scholars regarding
the binding nature of a promise to purchase.

The imposition of a compensation rate (ta’widh) is
contentious. A consensus has been reached in this regard as
contemporary jurists have allowed banks to stipulate late fees
on those clients who were able to pay but were nonetheless
delinquent. However, this amount shall not become a part of
the income of the bank. This opinion is being followed in the
Gulf. On the other hand, the Shar’a Advisory Council of Bank
Negara Malaysia has permitted the imposition of one percent
compensation rate on late payment and unlike the opinion
from the Gulf, this money can form part of the income of the
bank. This is regarded as ta’widh (compensation) for the bank
and cannot be compounded.

Another important area is the rebate. The majority of the
jurists agree that rebate can neither be stipulated in a
murabaha transaction affected by an Islamic bank nor can
the client claim it as a right. However, the bank can give the
customer a rebate on its own as gratuity. Nonetheless, the
Shari’a Advisory Council (SAC) of the Securities Commission
in Malaysia has issued a fatwa declaring that a rebate clause
and formula to calculate the amount for an early settlement
can be stipulated in the primary legal document of Islamic
bonds based on the contract of exchange.

There are controversies amongst Muslim scholars as to
whether the price charged by the seller under bay bithaman
ajil can be higher than the spot price. Even the scholars,
who are of the view that charging a higher price than the
spot price is permissible under Shari’a, do not recommend a
heavy reliance on it. Although, the validity of bay bithaman
ajil proven from the Quran and Sunna, certain practices
are not accepted internationally, specifically in the Middle
East, Pakistan and Europe because of the danger attached
to it of opening a back door to riba. The act of deferring
the payment of price in a sale is also accepted in the
rest of the world and the contract of murabaha is being
used predominantly. The main issue in certain types of
bay bithama ajil as practiced in Malaysia by some Islamic
financial institutions is that they use bay al-ina under the
guise of bay bithaman ajil. In this case, the contract of bay
bithaman ajil is preceded by a purchase of asset by the bank
from the same customer.

Bay al-dayn has always been an issue amongst the past
and present Muslim jurists. The jurists who do not allow
bay al-dayn have premised their objections mainly on the
prohibition of riba, and the increased risk to the buyer in
the event of a default. There were differences amongst the
classical Muslim jurists regarding the sale of debt from the
creditor to the debtor and the sale of debt from the creditor
to the third party.

The majority of the classical Muslim jurists were of the
opinion that it was not permissible because it was legal
excuse to legitimise riba. The opinion is being followed by
the jurists of Islamic finance of the Middle East. The Shari’a
advisors from the Middle East and Gulf region consider it as
a ‘back door’ to riba. However, bay al-ina is being practiced
by Islamic financial institution in Malaysia. It is considered
valid by the Shari’a Advisory Council of Bank Negara
Malaysia and the Shari’a Advisory Council of the Securities
Commission of Malaysia.

To sum up, the central issue pertaining to existing
disagreements between the scholars of Malaysia and
those of the Middle East is the interpretations of Shari’a
injunctions. Disagreements exist in juristic views and
rulings particularly between Malaysia and the Middle East.
The issue of disagreement is very important and has a farreaching impact on the Islamic banking and financial industry worldwide. It can be said that disagreement is inevitable, but
at the same time, there subsists a reconciliatory mechanism
in Islamic law to harmonise different interpretations from
either jurisprudential or administrative perspective or
both. Nevertheless, harmonisation of the different views
amongst the scholars from the different schools of thought
is necessary to enhance the global development of Islamic
banking and finance. It is recommended that any further
move in this direction be made under the purview of
siyasah Shari’a. This will create a much more robust system.

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