Monday, November 30, 2009


Parties in a contract involving Islamic finance are free to structure their dealing to take into account Shariah requirements governing transactions, and have their terms documented in the relevant contractual documents. They can insert whatever clauses of their choice in so far as these clauses are not in any way repugnant to any established Shariah rules and principles. In many jurisdictions it is the requirement of regulatory laws that these parties need to ensure that their transactions are free from any element inconsistent with Islamic teachings. However it is very sad indeed to find out that some parties may sometimes indicate through their agreements that in case any dispute should arise in future between them, they would like to settle the possible dispute not in accordance with any Shariah compliant mechanism of dispute settlement.

What may happen is that the parties would instead prefer to settle such a future dispute through trials conducted by courts that are very clear from the very way they are constituted are far from being a suitable forum to dispose of the case in a Shariah compliant manner. Given that these courts are conventional courts in various jurisdictions that as a matter of judicial process are not from the outset suppose to decide cases brought before them in line with Shariah requirements. Hence the big question is how can it be said that the relevant dispute is to be disposed of in an Islamic way?

It is important that dispute related to Islamic financial transactions is settled in a Shariah compliant manner for two major reasons. Firstly when the parties hold out that they are conducting their affairs in Shariah compliant ways, they thereby make a representation to the general public that they are going to abide by the Shariah requirements in all their dealings. So when it turns out to be that they prefer to settle their future disputes in the above described manner, and to turn a blind eye on Islamic alternatives, the general public has all the reasons to ask why it remains so when other Shariah compliant alternatives are available. Secondly, assuming that an award may have been made by the non-Shariah compliant courts, does it mean that the amount so awarded in the judgment cannot be treated as halal/legitimate incomes for the relevant parties, or at least be described as questionable incomes that need to be purified.

What happened in Malaysia recently in the context of the latest amendment to the Malaysian Central Bank law is very interesting development to note. The amendment made it clear that the Malaysian civil courts and arbitrators must consider the published Shariah resolution passed by the Shariah Advisory Council of the Central Bank in deciding Islamic banking cases brought before them. The amendment also made it mandatory for the Court and the Arbitrator to refer any Shariah issue raised in the dispute which is not yet addressed by any published resolution mentioned above, and they must abide by any decision that the SAC may provide.

It remains to be seen whether this approach will solve the dilemma faced by Islamic finance in this respect. Strictly speaking, from an Islamic classical perspective, a Muslim judge is always reminded to consult learned parties before issuing any judgment, and it is held that this approach, although is not mandatory to be taken, is accepted to be a highly recommended thing to be done by any presiding judge. But to put it in the manner that it is mandatory to be undertaken is something new, firstly because at the end of the day it will be the judge himself who is going to be responsible for the issued judgment.

Secondly, with respect to any opinion that may be possibly given by the consulted learned party the most that can be said is that it is a form of fatwa or shariah opinion that is basically not binding. Any court judgment on the contrary is binding on the disputing parties as a matter of authoritative expediency. Perhaps the reason that may have been relied upon by the Malaysian Parliament when the house passed the amendment is based on the fact that civil court judges were not trained in Islamic law, hence they need to abide by the SAC resolutions. But then, judgments are normally not given solely based on rules or law but they are based also on facts of the cases in question for which only the trial judges have the opportunity to establish. Furthermore trials in the civil court do not involve the same procedural process as normally employed in the Shariah court especially in the context of the role that can be played by oaths in establishing civil claims. The fact is that to dispose any given Islamic finance case is not just limited to the law aspect alone, but also the evidential and procedural aspects as well. Unless the relevant additional issues are properly addressed taking into consideration all that need to be considered in terms of Shariah requirements, the hope to achieve full settlement based on Islamic principle will remain something to be very genuine.

Tuesday, July 14, 2009


There is a near consensus about derivatives (structured products included)being one of the culprits to blame for causing the financial meltdown that no one know for sure how the world can get out. Bailouts, tightening regulations, rescue plans, extra deposit guarantee schemes: all have being pursued but still there has been no clear sign that things are actually better. The last we heard was about a number of banks and brokerage firms thathad been banned by the Singaporean authority from further marketing structured financial products that have caused investors there millions in losses due to the toxic investment schemes. Luckily some have been partly compensated. But still we are not able to understand why there are many proponents of derivatives among the growing number of Islamic finance practitioners as if they have turned a blind eye on the devastating effects of such products that even the conventional players and regulators themselves have admitted. The main reason given in support of the so-called Islamic derivative products is that they are needed for risk management purpose i.e for hedging. Everyone knows that in the world of modern financial markets the distinction between hedging and speculation is not easy to be made. After all, once a door is opened, there is no assurance that only good guys will come in. The truth is that risk management is embedded in the Islamic law of contract and financial transactions such that if they are truly implemented as provided, there is actually no real need to address the issue of risk the way it is pursued in the conventional sense. Hence the biggest question to answer here is whether all that need to be followed in term of Shariah rules are actually implemented. Some concerned observers have expressed their serious dismay at the ways and manners Islamic finance has been practiced of late... Coming back to Islamic view on derivative: for those who want to read more on this please get a copy of a very well-researched book (in Arabic) on Islamic view on derivatives written originally based on a request of OIC Fiqh Academy. ( Al-Mushtaqqat al- Maliyyah: dirasah muqaranah bayna al-nuzum al-wadi'yyah wa ahkam al-shariah al-islamiyyah,-by Dr. Samir Abdel Hamid Radwan, 2005, Dar al-Nashr li'l Jamiaat, Cairo.). Notes: The author at the end of the book swear in God's name that to the best of his knowledge, based on the research conducted to prepare for the book, his finding is that derivatives, as they are, are far from being shariah compliant. It is worth-noting also that the OIC Fiqh Academy had issued similar resolution several years ago.

Friday, July 3, 2009


International commodity murabahah and tawarruq are the two topics that have being raised quite prominently these days especially after the Islamic Fiqh Academy of OIC issued its resolution on tawarruq in April. The use of murabahah concept in transactions involving sales of goods and assets, when used in its correct form is not a controversial topic in itself because murabahah in its classical form is recognised as valid by the majority of Muslim jurists right from the earliest days of Islamic law.
Conceptually in order to have a valid Murabahah there must be two sales involved: the first being between a supplier of goods and a seller in murabahah while the second leg is between the murabahah seller ( who is himself a buyer in the transaction with the supplier) and the murabahah buyer. In order for the second contract of sale to be valid, the murabahah seller must have obtained full title and ownership of the goods sold in the first contract with the supplier in a full Shariah compliant manner: meaning that the goods and its economic/ ownership risk has been fully transferred to the murabahah seller. This will only happens when the goods has been actually or constructively delivered to the possession of the murabahah seller such that if anything should happen to the goods after that possession, loss is to be borne by the murabahan seller as a new owner. When this requirement is fulfilled, there is no question as to the right of the murabahah seller to sell the same goods to the murabahah buyer in the subsequent sale. This is obvious due to the Shariah rule that provides only an owner or his agent can affect a valid sale contract.
The issue as far as the current confusion as to the validity or otherwise of transactions involving either commodity murabahah or tawarruq is not so much of the conceptual aspect of the sales but more of whether the current practices adhere or not to rule as explained. In practice, most financial institutions that utilises both of the above concepts have been dealing with international commodity exchanges that are in fact, more often than not, parties involved in future commodity markets rather than normal physical markets. One such metal exchange that the present writer has access to some published information, states clearly that in practice as far as this metal exchange is concerned, only 1 % of their commodity (future) contracts ends up with physical delivery of the relevant metals. This is not surprising given the fact that such an exchange is known to be one of the many similar exchanges that are involved in commodity future market. So the big issues here is how come the Islamic financial institutions did not realise this fact as many of them are likely to be aware of several earlier resolutions by the OIC Fiqh Council that had disallowed involvement in future markets which was declared as non-shariah compliant in its current format.
The recent resolution by IFA does not mention this point directly but the concern can be understood by implication when the resolution mentions about the absence of genuine sales in tawarruq as currently practiced. Buy right the resolution should have reiterated its earlier resolutions concerning future market to support its present resolution on tawarruq. Perhap it is worth noting also that in the past few years or so there have been calls by concerned parties including Shariah scholars for Islamic financial institutions to use local commodities in their murabahah or tawarruq transactions. The reason given was that in the case of local commodity markets, there should be no difficulty in ensuring the existence of the relevant commodities and the truthfulness of the sales. So in short the major concern that underlines the Fiqh Academy resolution is so directly tied up to the way the relevant transactions are carried out, and not their conceptual acceptance from Shariah perspective. This is understandable considering what the Shariah says about sales as allowed in Islam where they must mean true sales and not money lending in disguise: hence when sale are intended it must be clear that transfer of ownership together with economic risk has taken place as between the parties in the first transaction before the second sale can take place. After all, in Shariah it is sale and only true sale that can be taken as justification for profit. So when the existence of true sale is doubtful, then there is no reason for the relevant transaction to be considered valid or Shariah compliant. Hence the biggest question posed indirectly by the resolution is how many of those so-called Islamic finance practitioners are sincerely willing to wear the title of genuine traders in their activities, and not as money-lenders in disguise.

Thursday, July 2, 2009

Before answering the question, it is best to consider the concept of modern corporations or companies in the light of the major rules and regulations as practised today. Although these corporation have some similarities with Islamic sharikah by virtue of the fact that they all can come into being when at least two individuals "form" the company or sharikah, and have them registered with the Registrar of Companies, yet once established and registered with the relevant authority these modern companies are recognized by the law as separate legal entities distinct from their shareholders.
In the context of Islamic sharikah however, the shariah envisages the role of the partners as individuals who are to carry out their business activities jointly with a view of making profit. This furthermore boils down to whether what is formed is a mufawadah or inan structure: in the case of the former the partners are agents and guarantors among themselves, whereas in the later case, they are only agents. Hence in the context of Inan, a partner is considered to be acting personally with regard to his portion of the equity of the sharikah, and at the same acting as an agent with regard to his partner’s portion. It is a requirement in Islamic law however that all partners need to put their capitals in an indistinguishable form in a common fund or account separated from their other assets. Nevertheless the liability of the parties in the context of their business dealings with third parties is not necessarily limited to their shares in the sharikah as any act carried out properly in accordance with the agency will bind the respective partners, although loss is to be shared in proportion to their capital contribution.
But if we look closer at modern corporations it will become clear that the purpose or objective of the separate legal entity is to allow for a separate account be created for the entities so that it will be made possible to identify their assets and liabilities because those need to be treated independently from the assets or liabilities of their shareholders. These entities can sue and be sued in the course of their business dealings with outsiders. In a company limited by shares however the liability of the shareholders are limited to the number of shares of certain value subscribed by them precisely because the law consider these corporation as different from their shareholders. Given this position one may think of a mudarabah structure in Islamic law, where the manager is supposed to be different from the capital provider meaning that this mudarib is a different or separate legal entity distinct from the entity of the capital provider. Hence can we consider modern corporations as individual managers/mudaribs in the context of their dealing with the shareholders?
In the case of Islamic mudarabah, it is provided that the rabulmal is going to be held liable up to the amount of the capital he actually contributed and duly handed over to the mudarib. He will not be made answerable for any liability of the mudarabah in excess of the capital so contributed. However in modern company structure, it is the requirement that a shareholder must pay up all shares that he owns but he is not duty bound to pay up for the share until a call is made by the company, and he will be imposed with interest charge in favour of the company if he fails to do just that after the call. This effectively means that he is considered indebted to the company by not obliging to the demand of the call, hence a debt is thus created for which interest is charged.
From an Islamic perspective in the context of mudarabah and musharkah all capitals must be passed on to the account of the mudarabah or partnership otherwise the contract is compromised in term of effectiveness and validity. Because a party in mudarabah if he a capital provider, is free to withdraw from the mudarabah, non payment of the capital to the account of the mudarabah will practically end the agreement as this contract is in the nature of non-binding contract, or at least the mudarabahis to be valid only up to the amount of capital actually contributed. Similarly in the context of sharikah it is part of the requirement of the Islamic scheme that the capital is to be pooled together to create common ownership available for all partners to utilize in the name of the musharakah in line with the concept of mutual agency as between all the partners. However if one party refuses to provide the capital in such a manner, he can be considered as to withdraw from the sharikah since to effectively establish the partnership all capitals contributions must be actually made and not just promised. Like in the case of the parties in mudarabah, partners also can withdraw from the sharikah as a matter of general rule if they so wish.
From a different perspective, practically the operation of modern companies and corporations is not necessarily in line with the rules and conditions of the Islamic sharikah . Modern companies issue shares and loan capitals of various kinds, some of which are subject to interest. Debentures, for instance, are resorted to by modern companies when they want to raise additional money through debt instruments, which are, in essence, interest-based and thus not approved by Islam. They may also issue securities (loan stocks) that pay a fixed rate of return to holders - a process which is also contrary to Islamic law. Then there are the issues of preference share that gives more priority to a certain class of shareholders in relation to profits or returns and the right to repayment of capital upon dissolution of the companies. Therefore, there are many issues that need to handled if the companies and modern corporations are to achieve Shariah compliant status. Not only that they must avoid dealing in haram goods and services, they also need to ensure that their setup and structure are Shariah compliant.

Friday, May 15, 2009


I received the following e-mail today asking for my comment:

"We know well that literally Shariah means “ path leading to water” which means path leading to “ life itself”. Shariah are rules and regulations prescribe to the Believers (mukallaf) by God Almighty embodied in the Quran and Sunnah of the Holy Prophet pbuh.

But some of these rules and regulation are also man-made, which we call fiqh. Fiqh is the product of the ‘aql (intellect) through the process of qiyas,Ijtihad,Istishab, Istihsan. The ulama derive new rules or fatwa to solve current problems of Muslims. This body of Shariah is call fiqh.

Some rules resulting from fiqh have caused serious disagreement (khilaf)among Shariah scholars (ulama). Issues such as bay enah, tawarruq,CM,Islamic hedge funds are some examples. These are not distinctly Quranic (ie not explicitly revealed in the Quran) in nature but sponsored by some ulama at the supervisory level (government or corporate) through Fiqh, under the pretext of darura,maslaha,uruf,umum balwa etc."

Such concepts as you mentioned, i.e darura, maslaha, uruf, umum balwa are all have their basis in the original sources of the Shariah. But the issue here is that of whether those parties truly apply them in the right context/circumstances. For me if all those legitimate concepts are employed
just to facilitate money/debt trading (ribawi practices), of course that is not acceptable. Although some may argue that (modern application) may not necessarily be haram, but at least they are Makruh/shubhah where the best option is not to make use of them. According to a well-known hadith, the halal is clear, so is the haram, but between these two there are grey areas/shubhah, and for a Muslim to avoid shubhah is a better option for the sake of his religion and his standing/reputation.

On the second point about fiqh, fiqhi opinions are not purely of 'aql origin as the 'aql is only employed to discover what the law is; it is not the process of inventing the law they way modern legislation is. In ijtihad, the jurists with the aids of those techniques do the search for the law in the original sources trying all the best that they can. It’s like in oil exploration where the geologists and all the other experts employ the best of their knowledge and skills to do the search. When they discover the oil, can we say that they have thus made oil for us?. Or you may go treasure hunting and you are given all the signposts/clues; you may be able to find the treasures or you may not but the fact is that you have been given all the major signs leading to the place. Similarly the jurists/fuqaha’ study the signs/shariah evidence and techniques (via usul al-fiqh) and they go “law hunting”, they may get it or they may fail; but they must employ the best of their knowledge and skills to do that, just like in the process of the oil discovery operation.
However the true shariah law/hukm remains with Allah the Al Mighty. If the jurist got it right he will be given 2 rewards otherwise only one, for the best efforts carried out to help discover the law of Allah SWT.

Wednesday, May 13, 2009



Islamic finance has been a catch-word at least for the past 10-15 years, and in that context many Islamic-Arabic terminologies have been introduced into English reading materials both at professional and academic levels. The term like sukuk, which was itself barely known some 5-6 years ago has become so popular now that anyone who does not know its meaning will simply be considered as uncultured. Month after month hundreds of seminars and conferences on Islamic finance have been organized covering many aspects related to the theme. While there seems to be an endless interest in Islamic finance worldwide, the fact is that the true nature of Islamic finance is sometimes not clear to many players in the market, let alone newcomers, such that many a time one is told that there is no difference between Islamic and the well-established conventional practices. This misunderstanding has been going on for quite some times partly due to the fact that in many circumstances the so-called Islamic financial products have been replicated from the conventional ones; the fact that many are confused as to whether these products are really shariah compliant if the whole Shariah scheme of things is to be used to test them. No doubt in most cases Islamic terminologies have been used to describe the products, yet in essence it was argued, they are rather conventional concepts in disguise.

One feature that differentiate true Islamic finance from its conventional counter-part is that the former relies heavily on guidance from the Shariah law, thus giving rise to the well-understood notion among practitioners as shariah compliant products and instruments. However one big question to ask at this moment in time, after seeing through the three decades or so of the rapid development of this field is whether the Islamic finance movement has come closer to the main objectives of the Shariah itself or has it deviated from its straight path? Or whether despite the use of some nomenclatures that sound Islamic or at least Arabic, things have really evolved the way they should?

What is noticed is that more and more products or instruments are introduced into the market taking the existing conventional models as the basis. It has to be sincerely admitted that it is not difficult to understand, that in many circumstances, it seems many Islamic classical rulings have been “tamed” in such a way that they can be made appropriate to be applied in this so called modern world of ours which is dominated by conventional finance that revolves around interest and the dominant force of financial intermediation which itself is based on interest and interest payment.

As known, Islamic or Shariah law was not revealed to facilitate interest based transactions but quite the opposite, it was and is still among others, a weapon to fight injustices of the interest base system. The biggest mistake that one can think of in retrospect as far as modern Islamic finance is concerned is the fact that it was firstly started through the banking sector. Banking itself is a term that is in essence widely accepted to refer to the business of financial intermediation, although there are a number of services provided by banks that are based on fees and commission.

So when Muslims were celebrating the birth of the first few Islamic banks several decades ago, their hopes at that time were to see that things would slowly be moving toward Islamic concept of economic justice and fairness inspired by a true spirit of partnership and co-operation through the overall application of Shariah principles and rulings. However after nearly 30 years of experiment, it seems that banks are banks whether they are Islamic or otherwise. Banks can never free themselves from the yoke of financial intermediation theory because that is their identity by definition. In many jurisdictions Islamic banks are still regulated within the same frameworks that regulate conventional institutions.

Given the predominance of this line of thinking among the majority of players, who are mainly imported from conventional practices into the so-called Islamic one, hardly that we find them able to really appreciate the distinctive feature of Islamic transactions as compared to the conventional ones. For many, Islamic bank or financial institutions are no less different from their conventional counterparts at least in one major role; they are to collect as much deposit from customers, and give financing when suitable customers are found for the purpose. It is the business of intermediation between the surplus and deficit sides, nothing more or less, as economists may recall. But then one may justifiably ask why can’t Islamic bank do just that, is there anything not Islamic about the role as financial intermediary as described?.

The answer lies squarely on the fact that in conventional interest-based system, money, goods or commodities are treated the same way; the treatment that has lead to the acceptance of the notion of a fixed price for the use of money in the form of interest charges justified within the ambit of the time value of money doctrine. On the contrary, Islamic law is quite clear about the need to distinguish money from commodity or goods as money is defined as price cum medium of exchange. Hence riba’ or usury/interest is made illegal under the Shariah system seemingly to avoid money being treated as commodity that can be given a price, contrary to its basic function as price determination medium. In line with this conception, Islamic law is quite straight forward when it provides that there must be a proper distinction between money trading and money investment, the later means to use money as capital for investment and not money itself is to be traded. In Islam what needs to be traded are goods/assets and services and not money as such. This is actually the essence of difference between the Islamic worldview on finance and that of the conventional perspectives.

The current financial turmoil that has been engulfing the world shows very clearly that in the conventional system, trading in money and debt of various classes is something that is taken for granted. In fact within this system, not only money is traded on spot basis but also sold in forward and future markets; the last two methods make it possible for any relevant parties to resort to speculative trading of money and currencies. Apart from this, debts are bundled together to make it possible for securitization to take place, purportedly to help the issuer to have what is known as the advantages of off balance sheet treatment of their assets. These securitized debts, previously were mainly made of mortgage debts now also come from many other non ending classes of debts. Then they invented derivative instruments that were purportedly structured to help various parties to hedge their positions in the financial market as part of the so-called risk mitigation strategy. The issue here is that whether such a strategy works in a long run or is it not the case that it is the source of the problem in itself. The current crisis speaks for itself as far as the dark side of derivatives is concerned.

Muslim jurists and thinkers on the other hand had warned since around 1000 years ago that when money is allowed to be treated as commodity of trade, people have to wait a little while for financial crisis to emerge the scale of which is difficult to be described. Ibn al-Qayyim, a prominent jurist from the Hanbali school of Islam of law, for one had this statement in one of his celebrated works to state the point:
“It is illegal for anyone to corrupt people’s money or to cause changes or fluctuation in its value. Similarly it is illegal (from Shariah perspective) to treat money as commodity of trade, since if it is not, serious problem will be faced by the people in the scale or magnitude only Allah will know. What is required is that money should be treated as capital for business and not as commodity of trade. When the government prohibits the use of any currency, such must be accordingly withdrawn from circulation”

On the nature of Islamic finance, perhaps the Syrians are better than the rest of us when it comes to understanding the real difference between Islamic and conventional banking. Although they are late comers to the so-called Islamic club of banking and finance, their analysis is sharper than that of others. It was reported in March last year that they would start introducing Islamic banking products in their country but not on conventional footings as have been done by the rest. Theirs would be Islamic investment banking in the true sense of the word. They envisaged a more accurate role of Islamic financial institutions as predominately investment companies rather than banking institutions per se. The implication of this, if we were to read between the lines of this news, is that their institutions will never be allowed to fall into the trap of conventional mentality that cannot free itself from the magic word of financial intermediation in the context of banking business. What is expected is that their institutions must adhere to their status as real traders of assets or goods and not money or currency traders .

That being said, the likely outcome would be, once again other investment contracts will be given prominence in their operations. The contracts like mudarabah and musharakah which are investment/partnership -based are likely to be relied upon more frequently. These two concepts when practically put into proper operation will redefine the nature and scope of risk management strategy of the players given that in Mudarabah and Musharakah structures both the bank or the financial institutions and investors or customers will equally share the associated risk arising from the relevant business activities. The likely outcome would be that the institutions will be able to absorb jointly with their providers of funds unexpected shocks happening in the market.

With respect to trading in money and debts, in so far as these institutions remain truthful to the Islamic rules and principles governing these aspects, there would be no chance for them to behave the way conventional institutions have behaved in the context of unlimited ways of trading in money and debts. Precisely because Islamic law prohibits money exchange or trading other than on spot and at par basis only the possibility of such institutions to fall into the same scenario as currently faced by conventional banks in major western countries is slim. However as it was recently pointed out by a Reuter coverage on Islamic finance, that will only be possible if Islamic financial institutions remain truthful to the true teaching of Islam in this context. Meaning that if they should behave the way their western conventional counter parts have been conducting themselves, definitely they would fall into the same trap primarily due to the treatment of money and debt as commodities of trade.

Other interesting point to see is whether the concept of two-tier mudarabah will also be fully employed in the operation of these Islamic banks given the fact that this is the closest that Islam has reached with respect to the notion of financial intermediation. Of course two tier mudarabah can only be implemented with prior approval of the capital provider as allowed by some schools of Islamic law. The only major differences between two-tier mudarabah and conventional intermediation is that in the case of the first, reliance is placed on expected rate of actual return of investment as opposed to fixed rate of return/interest in conventional financing.

But regrettably, the rest of the Muslim world is not learning the way the Syrians have done in term of their understanding about this very important point. Hardly any day should pass now in many corner of the globe without there be some reports about parties who are rushing to come out with derivative-based instruments for hedging purposes in addition to Murabahah and deferred payment-based structures that have been widely resorted to despite calls by many scholars for these instruments to be minimised. And then came Inah and tawarruk munazzam (organized tawarruk) as the two champions of personal finance facilities granted to customers cum consumers in needs. The essence of all these is that debt financing has been in essence been relied upon, and techniques have been be put in place to handle the relevant risks, typical of strategies employed by conventional financial institutions.

In truth, we have to go back to basic and ask the most valid question of our time as far as modern application of Islamic finance is concerned, that is what is money and financial intermediation from Shariah perspective?. Without properly answering this basic question it is doubtful that we can arrive at our true destination in achieving the Islamic objective of justice and fairness . There is no denying the fact that there are forces around that are relentlessly trying to prevent us from leaving the comfort zone of conventional thinking and customary ways of doing things saying that the march toward a more deep-rooted Islamic thinking is so risky to try. In answer we may recall the fact that the Muslim world had prospered in the past when there was not a single bank, as we know it today, to help them. What were there are no other than the true spirit of business risk taking based on the full understanding of the concept of mudarabah and musharakah applied truthfully in line with the golden principle that says “no pain no gain” . Why can’t the Muslim world repeat its history once again in term of prosperity and success in a way that is truthful to its traditions and past records? Surely if it is to happen it will not be within the framework of interest-based system because Allah Almighty will never make riba’-based activities prosperous in the true sense of the word. After all the world is now fully aware of the peril and instability of the interest-based system.

Monday, May 4, 2009



ISLAMIC business and finance are about ways of conducting financial transactions in accordance with the tenets of Islam. For individuals, it may relate to methods employed to manage daily financial activities at various levels that may essentially involve the sale and purchase of goods and services on a daily basis. The way we conduct ourselves determines how we treat our fellow citizens in the process of buying and selling. In Islam, the key principles are fairness and justice for all. Although Islam does not forbid us from making profits in commercial dealings, it prescribes honesty as the mainstay of conducting business.


Islam cares for the interest of both parties in a dealing. Take the case of a mortgage or charge in a loan or credit transactions. In the conventional system, upon failure of the borrower to repay the loan on time the creditor will begin foreclosure proceedings, starting with the issuance of notice to the borrower to remedy the breach within a certain period. Failing this, the creditor will ask for an order of sale at the High Court to sell off the collateral by public auction i.e. a forced sale.

In contrast, Islam tells us that if a borrower is unable to repay the money debt when it is due, then according to the Quranic injunction, he must be given time to settle it provided that he is facing a genuine case of hardship. In the case of the creditor's right to sell off the collateral or charged property, Islamic law says he cannot ask the court and the court cannot make an order for the forced sale of the property until and unless the borrower is given an opportunity to sell the property himself. Juristic opinions, however, differ as to whether a borrower's refusal to dispose off the charged asset entitles the court to make an order of sale.

Some schools of Islamic law are of the opinion that the court can proceed with the sale. Other schools maintain that contempt proceedings can be taken against the borrower for not complying with the court order and the court can imprison him until he is willing to sell the property and pay off the debt. The wisdom behind the Islamic ruling is that the charged asset is the borrower's property, so only he can sell it. He needs to be given time to find a suitable buyer who is willing to pay the market price for the property.

Islamic law is thus more considerate in its treatment of the borrower but at the same time protects the interest of the lender in allowing the court to intervene. Islam respects the right of ownership to the fullest extent when it says that the owner must be given a chance to sell the property first because only he will try to sell it at the highest possible price. Only if he failed or refused to do so is such right to be delegated to an independent party after the court grants an order of sale.


In sales, Islam requires sellers to disclose all that they know about defects in their goods. Buyers must be told of the existence of such defects and be allowed to make up their mind whether or not to buy the goods based on informed judgment. Concealment of defects is considered unlawful. The position is different in certain other systems where buyers are expected to discover for themselves all material facts about the products they are buying. Here, the concept of caveat emptor (buyers beware) is followed.


Some observers have maintained that there are no differences between the Islamic and conventional ways of conducting commercial dealings given the perception on the ways Islamic finance has been pursued. For many it seems that Islamic finance products and services are more or less replicas of the conventional ones such that their distinctive Islamic features are difficult to be known. Others have argued that such perception is not necessarily true given the rationale for the introduction of the Islamic financial system in many Muslim countries? Why can't the Muslims just accept the conventional way of conducting business if there are no true differences between the two systems?


The fact is that there are many major differences between the Islamic and conventional systems, the most striking of which relates to the concept of money. Islam views money as primarily a medium of exchange and unit of account, whereas in the capitalistic world money is more of a commodity of trade and as such can be bought, sold and speculated freely. Money, thus, has a time value and one who uses other peoples' money must pay for it in the form of interest. The basic position in Islam is that money lending or qard must remain a benevolent act worthy of being rewarded highly by Allah the Almighty. Money lending should never be allowed to be used for profit-making activities. In the conventional sense, lending is primarily for unjustified gain in the form of riba' (interest).

The current provision of financial services by Islamic financial institutions is said to be coloured by doubtful elements such that many parties have reservations about some of the financial instruments introduced in the market. Some institutions, they argue, have resorted to back-door money lending activities that involves interest. What they mean is that these institutions which claim to follow the Islamic way have remained essentially as financial intermediaries that use certain modes of financing which raise doubts as to their motives. By twisting words and phrases, they have coined certain concepts to make them look Islamic, while the true intention or motive of the institutions' activities is hidden behind the veil of the permissibility of sale.

In Islam, forms or words used shall never take precedence over intention and motive not only in contractual matters but in fact in all affairs. Islamic finance, if it is to be truly successful, must avoid impurities in form and essence, as it is a system based on the highest standard of morality and religious conscience. When Islam abolished interest, it naturally disallowed everything that might lead to it.

Hence, it is high time now, given the speed of the development of Islamic finance, that serious efforts be made by all parties involved to re-examine whether the process followed so far is truly in line with the teachings of Islam. It is true that innovation is badly needed, especially now. It should not however , in any way, sacrifice the true spirit and injunctions of Islam. Islam is a system that seeks to act as a benchmark for acceptable rules of conducts considered to be just for all. It is therefore very naive to think, in the context of being innovative, that everything the capitalistic system provides us with must be replicated since not all the so-called modern and sophisticated products are just and good for us.

Monday, April 6, 2009



Sukuk have gained acceptance as viable instruments for both investment and project financing purposes. Investors worldwide have readily accepted these certificates in diversifying their portfolio such that for quite sometime demand over strips supply given that whoever buy them will keep the papers until maturity. For the purpose of funding, more and more relevant parties have resorted to sukuk as a method of raising funds needed for business and infrastructure projects. As such demand for sukuk is anticipated to grow further especially if we take into account the surplus liquidity currently present in the market as a result of the high oil revenues kept by many oil exporting countries especially in the Middle East.

But why in the first place an investor would buy sukuk rather than normal conventional bonds? The answer lies, putting Islamic motive aside, partly because investment in sukuk gives some sort of relief to investors when it is said that sukuk are less volatile as compared to conventional bonds since they are basically asset-backed and not just a mere securitization of future cash flow in the form of debts payable in future as practiced in conventional securitization.

In sukuk, when an investor purchases the certificates, he in fact purchases an undivided share or interest in the underlying assets which back the sukuk issuance. In order to comply with Shariah requirements these assets must be essentially tangible assets, and the position of the investor must be one of a full owner throughout the tenure of the sukuk. Ownership in this contact must means full ownership as understood in Shariah law that confers all rights and privileges to the relevant owner who, on his part, is entitled to receive whatever income that can be generated by the asset including possible rise in its value.

However a pertinent issue would arise if sukuk structure does not take Shariah guideline seriously for example when sukuk are structured based on methods used in conventional securization which is typically a lending by investors to the seekers of fund in the capital market. Sukuk are not debt instruments simply because they are essentially backed by real tangible assets as opposed to debts or receivable as is the case with conventional bonds. This major difference leads to a different outcome; since sukuk are not based on debts, returns of investment to the relevant investors can not be viewed in the context of fixed incomes because what the investors would received depends largely on the real performance of the underlying asset. Therefore to talk of sukuk as fixed income instruments is both misleading and inaccurate.

Even in the context of Sukuk al-Ijarah where the anticipated returns to investors are likely to flow from rental streams, investors can not be guaranteed of fixed incomes based on such streams that in themselves can not assured. It may happen that the relevant underlying tenancies or leasing contracts need to be terminated earlier due to some misfortune or natural calamities or the asset may be lost or destroyed due to faults of no one. Under these kinds of circumstances, the right of the investors to the payment of the stipulated returns or income could not be continued and nothing could be done in term of the manager’s liability. In fact the contract itself will become frustrated due to the reasons. Furthermore, a future income stream as previously described can not under the Shariah law be securitized in the first place as it constitutes a non-established liability on the part of the tenants. It will become established only when the tenants have utilized the period of leasing, but have yet to pay the necessary rental to the owner of the assets.

Given the fact that sukuk are basically financial instruments used for investment purposes, the issue of risk for return is central to the operation of the sukuk. Investors who buy them are expected, as owners of the underlying assets, to be ready to face risk of loss or diminution of their capital or value of the purchased assets. In line with this, the issuer is not duty bound to guarantee any payment of fixed income to the investors be it in the form of regular dividend or capital gain emanating from any possible increase in the value of the underlying assets. What the issuer must do however is to provide an undertaking to exercise his level best to manage the investment so that it is profitable, in which case the parties will share the realized profit based on an agreed ratio. Any form of guarantee that covers capital protection or payment of certain fixed rate return or dividend runs counter to the Islamic theory or notion of risk for return principle.

One issue that has been recently raised is related to the way sukuk were structured in the past few years when it was discovered that in many cases, the issuers normally made non-revocable undertaking to repurchase the sukuk at certain prices fixed in advance in case of default or non-adherence to the term of the issuance. This kind of undertaking that creates an obligation on the part of the issuer when the triggering events do take place will undoubtedly lead to a guarantee of capital that is not in line with the Shariah requirement.

However this point needs further clarification to clear the doubt that has been lingering around about the shariah compliance aspect of these sukuk. Any undertaking to repurchase made on the basis of possible breach or wrongdoing or negligence on the part of the issuer, who is possibly a fund or project manager (sukuk Mudarabah) or even a partner in an Islamic partnership (sukuk Musharakah), will not violate any shariah principle because as per the Shariah, the manager is to be held liable for any loss resulting from either his negligence or wrongdoing or both.

In other words, the insertion of such an undertaking is just to reemphasize a shariah rule pertaining to the possible liability of the manager/issuer in case of negligence or wrongdoing. If however, the undertaking seeks to cover the investor more that what he is entitled to under the Shariah law i.e to cover for the manager’s liability even though there is no fault on his part, then this will trigger a Shariah compliance issue.

In the context of obligation to repurchase in the event of default as is commonly provided in Sukuk documents, if default here means inability to pay returns or dividend as agreed, this condition/undertaking needs to be further clarified to refer only to cases where such inability is due to the issuer’s negligence or wrongdoing. From Shariah perspective once negligence or wrongdoing is committed, the issuer or manager by that account has changed his Shariah status from that of a trustee (whose liability is based on fault) to one of a wrongdoer who by thus is under the duty to repay the investors their investment capital. In order to discharge this duty, the relevant assets must be liquidated or sold for value, and the money be paid back to the investors.

Whatever the outcome of the present discourse on the Shariah compliance aspect of sukuk, one thing that must be understood by all is that the notion of risk for return or no pain no gain is there in the Shariah to be implemented in practice and not just be treated as a mere theory repeated time after time. Furthermore if Islamic finance is to be conducted truly on the basis of Shariah guidance, then it is incumbent on all parties involved to subscribe sincerely to the relevant rule both in form and substance.