Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

1. Islamic Modes for Agricultural FinancingPRINCIPLES OF ISLAMIC FINANCELahore 20th October, 2008Al – Huda Training Programme Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

2. Principles of Islamic Finance Prohibitions & Permissions 1. Prohibition of Riba: Riba means excess– Predetermined/fixed/time related Excess of weight or measure in one of the two homogenous articles in a contract of exchange • An increment on loan received by the lender (benefit of delay) - Riba al Nasi’ah(Riba al Jahiliyyah, Quranic Riba) • Discrepancy appropriated through exchange of goods (arising from weight or measure subjec to conditions) -Riba al Fadl Resolutions ofThe Azhar Islamic Research Academy Egypt, The Council of Islamic Ideology Pakistan, and The Islamic Fiqh Academy of OIC have concluded that:The bank interest in all its forms is Riba

3. Principles of Islamic Finance Principles of Islamic Finance A. Qur’an • Surah al-Room – [Undesirability of Riba was revealed where Allah (SWT) conveyed His displeasure on such transactions] (30:39) “That which you give as riba to increase the people’s wealth increases not with God: but that which you give in charity, seeking the goodwill of God multiplies manifols”

4. Principles of Islamic Finance Principles of Islamic Finance 2. Surah al-Nissa – [In response to provocations of Jews and recounting their sins, including charging of Riba, Allah (SWT) tells them about the punishment and rewards for the clear minded] (4:161-162) “And for their taking riba although forbidden for them, and their wrongful appropriation of other people’s property, we have prepared for those a painful doom for these disobedient persons. However, We will give a great reward to those among the jews) who are clear minded about the truth, without a grain of doubt, and who believe in the Quran and all other revealed books, establish salah, give zakat, and believe in allah and the day of judgment”

5. Principles of Islamic Finance Principles of Islamic Finance 3. Surah Aale-Imran – [Riba was expressly prohibited for Muslims] (3;130) “O believers, take not doubled and re-doubled riba, and fear Allah so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey Allah and the prophet so that you get mercy”

6. Principles of Islamic Finance Principles of Islamic Finance • Surah al-Baqarah – [In response to adversaries of Islam’s question of paralleling profit and Riba, Allah (SWT) permitted sale and prohibited Riba, and that the matter of already charged Riba was with Allah] 92:275-277) “Those who take riba shall be raised like those who have been driven to medness by the touch of the devil; this is because they say :’trade is just like interest’ while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their prevoiu gains, their case being entrusted to God, but those who revert shall be the inhabitants of fire and abide therein for ever”

7. Principles of Islamic Finance Principles of Islamic Finance 5. Surah al-Baqarah-[Declaration of war from Allah (SWT) and His Prophet (PBUH) against those who disobey the prohibition, and all previous Ribavi transactions were entitled to receive principal only, and that to give the debtor grace period until he can manage to clear the dues against him] (2;278-280) “O believers fear Allah, and give up what is still due to you from riba if you are true believers. If you do not do so, then there is declaration of war from allah and His Messenger. But if repent, you can have your principal. Neither you should commit injustice nor should you be subjected to it. And if the debtor is in misery, let him have respite until it is easier, but if you forego it as charity, it is better for you if you realize.

8. Principles of Islamic Finance Principles of Islamic Finance 1. Prohibition of Riba: Prohibition in Shariah: B. Ahadith Ahadith relate to the following subjects: • Prohibition of Riba [various parties to Ribawi transaction] • Consequences of indulging in Riba[…Night of ascendance to Heavens…, violators subject to the curse] • Forms of Riba in loans and other transactions […Varily/Indeed Riba was in lending, …exchange of radi with burney dates…, Riba al Fadl]

9. Principles of Islamic Finance Principles of Islamic Finance B. Ahadith Ahadith relate to the following subjects: • Creditor and debtir relationship […not to accept any gift or ride from borrower…, …even minute benefit transferring from debtor to creditor…] 5. Outstanding debt, the necessity of repaying the debt […all sins would be forgiven except o/s debt…, …dishonor and punishment for willful defaulter…, …allowance of repayment time for genuine defaulter…]

10. Principles of Islamic Finance Economic Rational For Prohibition of Riba • Interest (Price of Capital)– main factor for unjust distribution of production results • Capital receives the whole benefit but does not share losses • Entrepreneur is discriminated by paying fixed rate of interest even in case of loss • Capital is discriminated by receiving small amount of interest when entrepreneur earns large profits • Industrial borrower receives large profits and pays small part to depositors through conventional banking (net resource transfer from poor to the rich) –Concentration of income and wealth. Islamic finance prescribes Profit and Loss sharing as no one can determine the productivity of capital and entrepreneur before hand.

11. Principles of Islamic Finance Economic Rational For Prohibition of Riba • Credit worthiness preferred over productivity and proper utilization of loan – corporate sector appropriates the funds while Small businesses are neglected despite their economic feasibility Islamic banks downscale their operations as they share in the results of the business and credit worthiness occupies secondary position than productivity. 3. The interest system promotes passive behavior and risk aversion – absence of effort affects production and productivity Islamic finance brings active partners together (P&L sharing)

12. Principles of Islamic Finance Economic Rational For Prohibition of Riba 4. The conventional banking exposed to instability Islamic banking, working through the system of profit and loss sharing, demonstrates a stable system. 5. Banks funds are de-capitalized in interest based system P&L sharing saves from this loss as depreciation in value of money is compensated through price system • Moral hazard and adverse selection- Equity finance provides access to information [more even resource distribution]

13. Principles of Islamic Finance Principles of Islamic Finance 2. Profit belongs to one who bears responsibility of loss: - These two interrelated characteristics are expressed in the Prophet (PBUH)'s saying "al kharaj bi al daman “ –entitlement of gain is linked to the responsibility for loss”. - The principle of liability distinguishes profit from riba more clearly than prohibition of Riba. 3. Variable return: Profit Sharing Principle (PSP) or the Profit and Loss Sharing Principle (PLSP). • Mudarabah – Profit sharing principle • Musharakah – Profit and loss sharing principle

14. MONEY Conventional Finance Conventional Finance FI FI FI FI Client FI MONEY MONEY/GOODS Islamic Finance Islamic Finance FI FI FI FI Client MONEY/COUNTER VALUE Principles of Islamic Finance 4. Asset backed financing: Money cannot be considered as capital – real sector activity

15. Principles of Islamic Finance Principles of Islamic Finance 5. Prohibition of uncertainty: Gharar [minor vs. major] Uncertainty at very inception of the contract Sale of probable items whose existence or characteristics are uncertain. Such risky nature of trade is similar to gambling. • Bay al Mukhadarah – eg. Selling fruit before they ripen • Bay al Samak fi’l Ma – eg. Selling fish in the water • Bay Safqatan fi Saqfah – eg. Two prices in one sale, etc. • Selling goods without proper description – Pebbling Sale of milk in the udder of a cow

16. Principles of Islamic Finance Principles of Islamic Finance • Prohibition of maysir (gambling) Refers to acquisition of wealth at others cost Quran condemns maysir stating it Satan “wants only to sow enmity and hatred among you, and hinder you from remembrance of God and from prayer” • Prohibition of fraud and deception (Khilabah and Ghishish): Disclosure of full information/avoiding to deceive others, avoiding to appropriate property fraudulently 7. Prohibition of conditional sale or combining two inconsistent contracts;

17. Principles of Islamic Finance THANKS