LEGAL ISSUES AND CHALLENGES IN ISLAMIC FINANCE

1. LEGAL ISSUES AND CHALLENGES IN ISLAMIC FINANCE By Prof. Dr. Zainal Azam Abd. Rahman (zainalazam@gmail.com)

2. ISLAMIC FINANCE IS BEING PURSUED WITHIN CONVENTIONAL LEGAL FRAMEWORK • Conventional finance/banking deals with 1) collection of deposit (borrowing contract) 2) granting of credit (lending contract) 3) collection services 4) provision of guarantee of various types • The bulk involves borrowing and lending based on interest, charged or paid • Hence the major contract used is lending and borrowing money: creditor/debtor relationship • As such money is the subject matter of the contract/business where interest is the major driving force • Small incomes are generated from fee-based services provided

3. BANKING ASSETS BEING MONEY AND DEBTS OWNED • Nature of banking business in conventional sense where money and debt (as financial assets) are freely traded like commodities • Banking law in many countries still disallows banking institution to hold tangible assets • In Shariah, money is not commodity of trade in itself but principally medium of exhange • Financial institution must own tangible assets before selling them to third parties: they have to do real sale • Ownership of trade goods /assets need to be reflected in book of account • Contract of contigencies are allowed in conventional law but strongly disallowed in Shariah: futures, options, derivative, selling of receivables and leveraging on financial assets because not in consonant with sale concept in Shariah • The concept of ownership and ownership risks need to be fully understood

4. INCONGRUENCE BETWEEN SHARIAH AND CIVIL/CONVENTIONAL LEGAL SYSTEMS • Civil law system is firmly based on rational thinking on the premise that man knows what to do best with his life • Law is will of the masses expressed in the form of codes or laid down by judges • Sometimes law is what the soveriegn wants to be law • It is man-made law rather than God’s revealed law • Shariah system is firmley based on divine justice and wisdom for the benefit man • It is manual of life prepared by the Creator for His servants • Hence there are aspects/principles that cannot be altered/ammended by man

5. ISLAMIC FINANCE AS SHARIAH-BASED COMMERCIAL ACTIVITIES • Certain Shariah principles are fixed not subject to change • Practices need to accomodate the Shariah principles without compromise not the other way round • Unlawfulness of riba, gharar, manipulation, monopoly, illicit gains/profits, gain without assuming risk, gain from haramactivities • The use of illicit devices (hiyal) by employing legal tricks to circumvent these prohibition is very unhealthy development • The end result: conventional practices in disguise: only Islamic in names • The way to minimise: install firewall in the form of sadd al-zari’(pre-emptive blocking of means leading to haram)

6. ISLAMIC FINANCE IS BASICALLY BASED ON SALE CONTRACTS:TRADING FRAMEWORK • Sale is not lending/borrowing where in sale the subject-matter is supposed to be tangible asstes/goods and services • Hence contractual framework differs from money-lending and borrowing as practiced in conventional finance • So the biggest challenge is to move from lending/borrowing culture to sale culture • In most cases documentation of Islamic finance contracts follow templets used for borrowing/lending contracts • As such failed to reflect the true implication of sale contracts as dictated by Shariah • Players want to do away with the need to deal with real physical assets as they do in conventional finance where the bulk of their assets are either money or receiables/debts

7. WHY THE DANGER HERE IS VERY SERIOUS !! • In sale, before you sell you have to own the assets first (real assets and services) • Short sale is not allowed since sale is intended to transfer ownership to buyer • If you do not own you cannot transfer • If you sell things not in your ownership, there is actually no sale unless you sell as an agent • Shariah compliant profit can come only through a valid sale contract if there is a mark-up ( to do mark-up is halal business) • But bankers just want to act as financial intermediaries: they do not want to act as real traders • However in Shariah only sale creats legitimate profit: there is no ther way-you must do tarding-not of money but real assets and services ( create trading subsidiaries) • Hence the key is to know how to provide intermediation the Islamic way.