Topic Six. Selected Issues in Islamic Finance Riba and Alternative Islamic Contracts

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1 Topic Six Chapter Preview Selected Issues in Islamic Finance Riba and Alternative Islamic Contracts This chapter deals with riba and commercial contracts in Islamic economics and finance. Riba has increasingly become a recurring issue as different interpretations are given to its meaning and its Illah. Such interpretations also give different implications to economic activities in Islam. On the other hand, the chapter discusses some selected applications of commercial contracts in the Islamic financial markets. The important issues of debt trading versus equity financing are also addressed. Hence at the end of the chapter, students are expected to learn The meanings, types and issues related to Riba The rational for the gradual prohibition of Riba The pillars and main elements of commercial contracts in Islam Issues related to Islamic financial products Outline Riba Meaning, prohibition, types, issues Contracts Meaning, elements, issues Financial Contracts Debt trading, lease, equity financing, issues 75

2 6.1 Introduction This topic basically tries to address the concept of Riba and its prohibitions in Islam. The topic will also introduce Islamic contracts such as murabahah, bai bithamanin ajil, mudarabah, mushanakah, ijarah, etc that are presently being used as modes of financing in banking. Our discussion shall be divided into the following sections: Riba: - Its meaning - Legal prohibitions - Types and - Selected issues Contracts: - Trading - Leasing - Equity - Selected Issues 6.2 Riba Riba Meaning Prohibitions Types Selected Issues The meaning of Riba The literal meaning of riba is increase, addition, excess or growth. The hukm in the Quran regarding riba is haram. However, its not that every kind of increase is prohibited, but increase bil batil is. In Shariah, riba technically 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 for an extension in its maturity (Chapra; 19XX). Other terms that denote increase include fa idah which refers to what one gains that can be anything property, knowledge, profit, benefit, a general term that includes inheritance, gifts (not necessarily in monetary terms). Also a term used is ribh, which means profit or gain. It refers to the gain when money is converted into goods then sold at higher prices. A term ghallah is also used to refer to revenue or income accruing from produce of land or sale of animals (buys, grow then sell). 76

3 Technically, many Islamic scholars have given different meanings to Riba. For example, Ibn Hajar Askalani defines the essence of Riba as excess whether it is in the commodity (itself) or in money, as two dinars in exchange for one dinar. Shah Waliullah of Delhi said the element of Riba exists in the debt, which is advanced in the condition that the borrower will pay more or better than what he has received from the lender. In the view of Abu Bakr Ibn al-arabi, every excess in return for which no reward is paid is Riba. This view is thus general. It includes both material and immaterial gains. It also implies that even the gains from exploiting situations are Riba. For example, if an employer exploits the situations of an employee in dire need of job and pays the latter far below the market price, is considered Riba due to any excess of productivity without return. In the Pre-Islamic days (Jahiliyyah), whenever a person contracted a loan from someone, he would ask the creditor to give him more time for payment and that he would, in return, pay him a fixed amount in excess of the principle loan. Thus, it was a custom in the Pre-Islamic times that they advanced a sum of money to a person for a specified time and received from him a fixed amount of money every month as interest; when the time expired, the borrower was asked to repay the debt, if he could not repay the debt, he was given extension in the time for repayment and the interest was increased. Therefore, as in the modern Jahiliyyah, Riba is earned when a man/institution lends its capital to another on the condition that after a certain time it would charge a fixed amount of money in addition to its capital. This additional amount, which is Riba (interest), is a consideration not of any labor or commodity but of the time for which the principle has been borrowed. According to Afzal-ur-Rahman, Riba contains the following three elements: a. Excess or surplus over and above the loan capital b. Determination of this surplus in relation to time; and c. Bargain to be conditional on the payment of a pre-determined surplus Prohibition of Riba in the Shari ah (i) It is worth noting that, besides the Qur an, earlier scriptures before Islam had also prohibited usury. The Qur an (4:161) reminded the Jews that their scriptures had prohibited usury. The medieval church prohibited interest based on clear instructions in the Bible, Lend, hoping for nothing again (LUKE). Greek philosophers such as Plato, Aristotle, Catos, Ceciro, Pantus, etc. disapproved the productivity of money loans. The doctrine of Aristotle was, A peace of money cannot beget 77

4 another piece. Great scholastic thinkers such as Thomas Aquinas was of the opinion that, To take usury for money lend is unjust in itself, because this is to sale what does not exist. Furthermore, neo-classical economists like Keynes criticized the view that interest is a reward for saving for people can save without lending money not saved (ii) The Qur an The institution of Riba had become a part and parcel of the economic system of the people of Arabia in the Pre-Islamic days as is also as the case today. Allah, the most Wise, revealed His commandments about the prohibition of Riba in stages (like that of the prohibition of alcohol) so that it might not upset the economic life of the people and cause unnecessary inconvenience and hardship to them. The following are the stages to the prohibition of Riba; a. The first injunction of the Qur an lays stress upon the fact that Riba (interest) does not increase individual or national wealth, but on the other hand, it decreases wealth (al-qur an, 30:39) b. In the second injunction, the Muslims are also warned to obey Allah s command regarding interest or suffer the same fate as the Jews who were forbidden in their scripture to take interest but they continued to do so (al-qur an, 4:161) c. In the third injunction, the Muslims are told not to take compounds (usury) interest if they want real success in life (al-qur an, 3:130) d. The fourth injunction distinguishes between trade and Riba (interest) and points out that interest, in fact, destroys national wealth of a country. Then it admonishes the believers to refrain from interest or else they shall suffer evil consequences both in this world and in the Hereafter (al-qur an, 2: ) e. The final injunction prohibited interest and declared it unlawful in a Muslim Society (al-qur an, 2: ) (iii) Hadeeth. There are several prophetic traditions re-affirming the prohibition of interest. One of them is as follows: 78

5 Abdullah Ibn Mas ud reported that the prophet s.a.w. cursed the receiver of interest as well as its giver; the scribe of the interest deed and the witnesses to it and further said that they are all equal (in the act of committing the sin). Thus, the Hadeeth covers nearly all the parties involved in the Riba transaction the lender, borrower, the party drafting the contract (lawyers, agents, etc.) and all those who are witnesses to the deal Types of Riba For the purpose of this course, we shall confine ourselves to two (2) main types of Riba, namely Riba al Nasiah Riba al Fadhl Riba al Nasiah Also known as Riba al Quran, nasihah comes from the root word nasa a meaning postponement, to defer or to wait. It refers to the time that is allowed for the borrower to repay the loan in return for the addition or the premium. Therefore it can mean the interest paid on loans as practiced today. It is mentioned in the Quran (2:275) explicitly and also by the Prophet (saw) is quoted as saying that there is no riba except in nasihah. The prohibition against riba al nasihah is absolute and without ambiguity and there is no differences of opinion among jurists that it is haram. The reason for the prohibition is due to the fixing in advance of a positive return. There is no difference if the amount is fixed or varies according to a percentage, paid in advance or maturity, gift or as a service. The main reason thus, for the prohibition is the predetermined positiveness of the return. According to Shariah, the waiting involved in the repayment does not justify a positive reward as argued by some. It is not an issue whether only usury is prohibited or interest since Prophet (s.a.w) prohibited taking of even a small gift service or favor as a condition for the loan in addition to the principle. Riba al Fadl Islam seeks to eliminate exploitation not only through interest but also through any form of dishonest and unjust exchanges in business transactions. All the various types of such unjust transactions are encompassed under riba al fadl or also known as riba al Sunnah or riba al Kahfi. In the Shariah definition, it refers to the riba encountered in hand-to-hand purchases and sale of commodities. It 79

6 covers all spot transactions involving cash payment on the one hand and immediate delivery of the communication on the other. The discussion on riba al fadl arose due to the saying of the Prophet (saw) narrated by Ubada ibn al Samit, Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt like for like, equal for equal, and hand to hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand to hand. Two questions arise from the Hadith, firstly, why the six commodities only and secondly why exactly the same reciprocal payment is required. It has been debated whether riba al fadl refers to only these six items or can it be generalized to include other commodities- if so what should be the illat (reason) for doing so. Regarding the first two items all the jurists agree that they refer to the money being used at that time. Thus, it has been concluded that all commodities used as money are placed in the category of riba al fadl. For the last four items, wheat, barley, dates and salt there are differing opinions from different schools of thought. Firstly, Imam Hanafi and Hanbali are of the opinion that all the four items are sold by weight or measure; therefore all such saleable items are subjected to riba al fadl. Imam Shafie and Hanbali state that items that are edible are included in this category. The third opinion established by Imam Malik however, is that the opinion that since all these item are necessary for subsistence and are storable it would include all such items. Zahiri School is the only one that confines riba al fadl to strictly these four items. The fourth and most recognized opinion is that all the six commodities were used as money in and around Madinah, particularly among the Bedouins, therefore riba al fadl would be involved in the exchange of any good against cash or any commodity used as money. Regarding the second question of why exactly the same amount is required is because of the importance of justice and fair play in spot transactions. The price and counter value should be just in all transactions where cash payment (irrespective of what constitutes money) is made by one party and commodity delivered to the other. Anything that is perceived as extra by one of the two parties is considered as riba. Ibn al Arabi also explained the extra as all excess over what is justified by the counter value will be considered as riba al fadl. Justice is only rendered when the two balances are equal as demonstrated by the Prophet (saw) in the hadith above, since it is very difficult to provide the exact counter value product for another as practiced in barter trade. Therefore Prophet (saw) also discouraged barter exchange and asked that the commodity be exchanged against cash and this cash can be used to buy the needed commodity because except for an expert, the fair equivalent of another product cannot be visualized. 80

7 As a result of this all commodities exchanged in the market are subjected to riba al fadl. The purpose is to remove all forms of exploitation and to maintain justice. Justice in all matters of life is very important in Islam, as emphasized by the Prophet (saw) when he said that leave whatever creates doubt in you mind in favor of what doesn t. Caliph Umar also reiterated the message by saying that abstains from not only riba but ribah (doubt) also. Therefore if there is any doubt that a certain transaction is causing exploitation or has resemblance to riba, one should leave the transaction. Riba al fadl is thus taken to refer to all sorts of injustices on any transaction, including monopoly, speculation, rigging etc to ensure fairness. Caliph Umar said that the Prophet (saw) was taken without explaining to us riba al fadl. Being vaguely defined by the Prophet (saw), riba al fadl is again one of the examples of a numerous Quranic injunctions that need to be re interpreted and re analyzed and defined in detail by the jurists of the time, thus representing the dynamism of Islam Selected Issues on Riba I. Issues regarding Riba Jahilliyah (al Quran) There are a number of issues that have led to discourse on the details of riba, what it encompasses, and what it meant at the time of Jahilliyah. These are discussed below. Quran does not specify what riba is but the word used in the Quran Al Riba, suggests that it is referring to a particular practice at the time. Prophet (saw) was also quoted as saying at the time of the conquest of Makkah that Beware, Riba of Jahilliyah has been abolished. As mentioned in Al Baqarah: , Quran made a distinction between bai (trade) and riba. Thus, it suggests that both were considered similar at the time and it was necessary to make a distinction between the two. Trade is different from riba since although both involve profit motive but firstly riba results in an increase in price due to the time involved in paying or repaying the loan while trade involves increase, which is due to the transaction itself. Secondly, riba is a predetermined positive gain while the ultimate outcome of business maybe positive or negative. Imam Razi said that while earning of profit is uncertain, the payment of interest is predetermined and certain, and thus, the payment for something uncertain inflicts harm At the pre Islamic time, the lenders used to either lend money or seller used to sell items on credit. When the first time period was up, the lender or credit seller would ask for payment. If buyer or borrower could not pay, lender or credit seller would say, will you repay or will you increase (in extreme cases, the increase would double and redouble form the original price/loan/amount). An issue that 81

8 arose was that whether the initial credit/loan free of charge or was there already a charge i.e. excess? And also if there was a charge, was this charge fixed or some percentage of the amount or mark up etc. In order to answer this, we have to consider the Meccan society of the time. It was a commercial society, the Madinan Jewish community was conducting business for a long period there, and thus it is very probable that there was an initial increase at the beginning of the deal. Also reports from Ibn Abbas and Said ibn Jubayer confirmed that an initial increase existed in loans and credit sales of the time. Secondly the question of whether the amount was fixed or some percentage etc is not of concern, since as already explained the Prophet (saw) condemned even a small gift or service in exchange for a business transaction. Also a question that has arisen is that is riba only in cases where there is a doubling or redoubling for second time period and if not doubling then its alright and allowed? Riba Jahilliyah refers to the operation in which debt used to multiply, therefore as mentioned in the Quran doubling or redoubling refers to all kinds of increase in all kinds of transactions which increased the principle amount in any amount. The third issue that needs consideration is that whether riba is meant only for consumption loans (for buying food and other consumables) while business loans are to earn profit; hence it is all right to charge riba. It has been argued that riba is prohibited on only consumption loans since it is exploitation and unjust because people took loans for fulfilling consumption needs. This argument does not stand since firstly, pre Islamic Arabia was mainly a commercial community; therefore taking loans for business were very common. Also the Quranic verse Al Baqarah: 275, makes the distinction between trade and riba implies that riba was a practice they were accustomed to in the trade that they conducted. Therefore the Quranic verse made a very clear distinction between the two. The Sunnah also affirms that loans for commercial purposes were existing in early pre Islamic days since on the occasion of farewell pilgrimage, Prophet (saw) abolished riba and announced the remission of interest accumulated in favor of his uncle Abbas ibn al Muttalib. This was interest on a business loan to Banu Thaqif tribe who had taken the loan from Abbas for their business. II. Why Riba is Prohibited (Between Illah and Hikmah) In conclusion, it is clear from the Shariah that riba is haram. The reason and wisdom in this prohibition is also very clear since it results in exploitation one party by the other. Thus, the main reason or illah is not the use of fund or how much money it involves, it is injustice. Injustice occurs since debtor faces risk and pressure while creditor gets return for doing nothing. Therefore, in order to maintain one s taqwa and iman, one should avoid participating in any form of injustice. This kind of systems results in depriving the poor of their share in the 82

9 wealth of society. It would stop people from working since such system results in the rich getting richer and poor getting poorer. It would therefore result in unhealthy relations and unrest in the society. And a system without riba also enables to eliminate suspicion or doubt in transactions. III. Implications if Riba is Interpreted Differently The question regarding riba is not whether it is haram or not, the question is how to define riba and what exactly constitutes riba. Thus, for today s Muslims economists the task is to define riba in today s context and economic situation. Since the implications on the whole system will change if riba is interpreted differently. If riba is interpreted as interest, this would imply that policies which promote interest free finance. As a result an Islamic country today will either replace the entire system or have dual banking systems as practiced in Malaysia. The reason for the limited share of Islamic banks in the economies of the various Islamic countries practicing is due to the higher costs, higher charges which some people find more exploitatory. The reason however is that since Islamic banks have limited options, limited trading partners and insufficient institutions they often render higher costs. Also problems arise due to duplication of financial instruments in conventional systems. If riba is interpreted as usury, it implies that interest rates can be charged. But the questions that arise and need to be settled by the economists and jurists are that usury is considered on business loans and what about consumption loans? Secondly, if the rates are not double and redouble what about the default charges. Also how to decide fair rate, should that be left to the free markets to decide. If riba is taken to be any sort of unearned gain, then it would not be limited only to finance only. But the question remains as to how to determine unearned gain. For issue of return to land factor, how do we determine portion of land contribution to total product (similar to Ricardian view). If riba is taken to be exploitation, there is a need to eliminate all kinds of exploitation. The issue then arises as to how to determine exploitation, since an interest free economy may still be exploitative. It might call for other structural reforms e.g. asset distribution. IV. Moral ills of Riba It is exploitative. It devours other people s wealth, especially the poor It destroys moral values. It destroys feelings of natural sympathy, human goodliness and gratitude. It breeds hatred, especially towards the rich 83

10 The rich grows richer and the poor poorer. This is also true for the case of nations. In fact, most developing countries that had been relying on the IMF loans are still paying their compounded (usury) interests let alone the principle. There are several studies done refuting previous claims about the dominant role of interest in the economy, especially in relations to savings, investments, etc. Time does not allow us to present all the arguments here. Some Muslim and fatwa bodies try to justify that bank interest is not Riba. Some of their arguments are: a. Bank loan is similar to mudarabah, where the creditor (Bank) advances loan to the investor (Mudarib) and receives interest as share of profit. This view has, however, failed to establish the relationship between loss and bank interest as compared to Mudarabah where the creditor and the investor share profit and loss. In the interest-based transaction, the socalled profit (interest) is guaranteed and the issue of loss does not arise. b. Bank interest should be allowed based on Maslahah (welfare) as outlined in Maqasid al-shari ah (the objectives of Shari ah). Again, the proponents have failed to establish how an exploitative institution can be a Maslahah. Rather the prevention of evil such as bank interest is considered a Maslahah. 6.3 Contracts As explained in earlier topics, Islam prefers a market system. The market leads to specialization and the need to exchange. This exchange needs to be taken place according to rules and regulations, which have been defined by the Shariah for an Islamic Economy. A contract in Islam is known as aqd and the contracting parites are called Al Aqidayn. The contracting parties must be competent and qualified to conduct a transaction. The Shariah has defined the rules as to who is and who is not eligible to make a contract. The object of the contract is called the Mahal al Aqd. The object can be a thing, service, rights, debt etc. A contract is complete by the offer and acceptance by the two parties. The conditions that apply include the proper intention and consent, methods of expressing consent, the majis al aqd and the conditions of nullification of the contract. The objective of the contract also needs to be decided by the parties whether to transfer the ownership of object, or usufuctory rights or both etc. 84

11 The Fuqaha have identified the following four elements ( Anaasir) that are necessary for contract formation ( Aqd) 1 : i) Contracting Parties ( Aqidaan) ii) Subject matter (Mahal al- Aqd) iii) Medium or Channel of Communication (al-siighah) iv) Primary Objective (Mawdhu al-a qd) The first three elements, i.e., contracting parties, subject matter and medium are termed as the pillars (Arkaan) of contract 2. They are applicable to all kinds of Islamic contracts; unilateral, bilateral, trilateral, etc. Hence in a bilateral contract, as shown in the diagram below Contracting Party Medium Subject-matter Contracting Party The contracting parties could be an individual, group, organization or a state. The medium of communication between the two contracting parties could be verbally, by letter, telephone, sign language, or electronically through the computers, which also include mobile phones as in the case of mobile commerce. On the other hand, the subject of the contract could be physical goods/product or services. Finally, the two contracting parties have to adhere to the primary objectives, which is the Shari ah objective stipulated for each contract. For example, in al-bai (sale), the Shari ah objective is the exchange and benefits of counter-values, e.g. price for good, with compensation/return ( Iwadh) 3. If such exchange is done free of charge, then the objective of the contract is no longer that of al-bai, but of a Hibah (gift). Hence the contracting parties in their transaction dealings must always ensure that their motive (secondary objective) does not conflict with the primary objectives set by the Shari ah. The three elements, which form the pillars of a contract (namely, Aqidaan, Siighah and Mahal al- Aqd) must be present for the contract to be valid. The absence of any one of them or their representative (such as Wakeel or agent for example) would render the contract Batil (void). Contracts in Islamic Financing The discussion on the subject shall focus on selected Islamic contracts in Islamic financing as follows: 1 See Wahbah al-zuhayli (1984, vol. 4, pp ) 2 See Al-Mawsu ah al-fiqhiyyah (1992) 3 See Ibn Rushd (2003, vol. 3, pp ), see also Abdullah Alwi (1986, p 65) 85

12 a) Trading-Based Arrangements Murabahah Bay c Bithamanin Ajil (sale on deferred payment) b) Leasing-Based Arrangements Operating Lease Al-Ijarah al-muntahiyyah Bi al-tamlik c) Equity-Based Arrangements Mudarabah (Trustee Profit-sharing) Musharakah (Joint-venture profit sharing) Trading-Based Arrangements Presently, most of the products of Islamic banks are trading-based, particularly Murabahah and Bai c Bithamanin Ajil (BBA). In Malaysia for example, BIMB has been using Murabahah and BBA as its main income generating product of up to 90.5 percent of total assets (BIMB, Annual Reports (1998)). a) Murabahah In the classical Fiqh literatures, Murabahah is defined as resale above the cost price, i.e., on profit. Some of the shariah conditions related to the validity of the Murabahah contract are: The units of the good, its kind, type and attribute must be clearly specified. The price to be paid, including the amount of profit, must be agreed and fixed at the time of the deal. Complete/total possession of the good must be given to the buyer. The transaction must be free from the elements of Riba (interest), gharar (uncertainty), Maisir (gambling), etc. There should be two separate contracts, one between the bank and the supplier and the other between the bank and the client. b) Bai Bithamanin Ajil (BBA) From the Fiqh perspective, any form of deferred payment is referred to as BBA. Hence BBA is a branch of Murabahah where the payment of Murabahah is deferred to a certain date agreed upon by both parties. In the modern practice of Islamic banks in Malaysia, however, Murabahah and BBA are treated separately. Some of the main distinctions between the two are summarized as follows: 86

13 Murabahah i) Used for short-term financing (less than one year) ii) Payment is made in lump sum. iii) Used to finance working capital. iv) It is not applicable for refinancing BBA i) Used for medium and long term financing ii) Payment is made by installment iii) It is used to finance the acquisition of assets iv) Refinancing is applicable Trading: Islamic Banks (BBA) (4) Deferred Price Bank Bank Client (2) Good (3) Good (1) Cash payment Supplier Trading: Conventional Banks Bank (1) Loan Bank Client Guide to diagram Financial flows (2 ) Principal + Interest Return Financial lows (3) Good (2) Cash Payment Supplier Real flows Trading: Islamic vs. conventional banks Islamic Conventional 1. Financial flows run parallel to real flows 1. There is dichotomy between financing and the use of funds 2. Claims of Bank/obligations of Bank Client are time-invariant 2. Claims of Bank/obligations of bank Client are adjustable 87

14 6.2.2 Leasing-Based Arrangements Leasing or al-ijarah is a contract for the usufruct of an asset while its ownership still remains with the original owner, i.e., the lessor. There are four fundamental conditions for a valid Ijarah contract: i) The asset be the property of the lessor ii) The period of contract be specified iii) The rental and its payment schedule be precisely stated iv) The asset remains in working condition during the period of the (lessor s responsibility) Leasing: Islamic Bank Bank (4) Rental (3) Usufruct of asset Bank Client (2) Asset (1) Cash payment Asset Owner 88

15 Leasing: Conventional Bank Bank (1) Loan (2 ) Principal + Interest Bank Client (3) Usufruct of asset (2) Rental Asset-Owner Leasing: Islamic vs. conventional banks Islamic Conventional 1. Financial flows are tied to real flows 2. Claims of Bank/obligations of Bank client are time-invariant 1. There is a dichotomy between financing and the use of funds 2. Claims of Bank/obligations of Bank client are adjustable There are primarily two kinds of leasing: financial or capital leasing and operating leasing. Operating leasing The bank can adopt the course of operating lease with its client. The obligation to arrange the asset can also be delegated to the client through wakalah (contract of agency). Al-Ijarah al-muntahiyyah Bi al-tamlik This type of leasing is also called al-ijara wa al-iqtina. The leasing ends with the transfer of the asset to the ownership of the lessee. There are differences of opinions among Muslim scholars regarding the validity of this type of leasing, although the majority goes in favor Equity-Based Arrangement The common modes of financing in the equity-based arrangements are Mudarabah and Musharakah. These are two partnership modes that allow two or more parties to share both the contributions to and the fruits economic activity. 89

16 Mudarabah is a case where one partner (called rabbul mal or owner of capital) provides capital while the other (called Mudarib or entrepreneur) provides his effort or expertise. Musharakah is when both parties contribute to capital. The quantum of effort put in by either partner is not critical in this regard. A. Mudarabah Financing Bank (4a) Principal + Share in Profits (1a) Funds (2) Application of Funds Mudarabah (3) Capital + Profits Economic Activity Bank Client (1b) Effort (4b) Share in Profits (no wage) B. Musharakah Financing Bank Client (4a) Principal + Share in Profits (1a) Funds (2) Application of Funds (1b.1) Funds Musharakah (3) Capital + Profits Economic Activity Bank Client (1.b. 2) Effort (4b) Principal + Share in Profits (no wage) In case of loss to Mudarabah (Musharakah): (3) would change into Capital minus Loss ( Capital minus Loss ) (4a) would change into Principal minus Loss ( Principal minus Share in Loss ) (4b) would be Nil (Principal minus Share in Loss ), along with no wage. 90

17 Conventional Bank: Bank (1) Loan (2) Loan Capital Bank Client Economic Activity (2 ) Principal + Fixed Interest (3) Capital + Profits Some of the critical points and conditions about Mudarabah and Musharakah from the shariah perspective are as follows: i) All the arrangements represent a situation in which (a) Ownership of capital is shared, albeit for the duration of the contract, (b) rewards are addressed through a share in the outcome of the activity, and (c) material losses are shared in proportion to ownership stakes of the various partners along with labor going totally unrewarded. ii) The nature and scope of the partnership must be defined iii) The nature of the role of mudarib/entrepreneurs must be explicitly stated. iv) The ratio of sharing the fruits of economic activity need not be proportion to equity-stakes of the partners (e.g. when capital ratio is 50:50 the profit sharing ratio can vary, such as 70:30). Nevertheless the ratios must be precise and set before the contract goes into effect Selected Issues There have been several issues raised in relation to the practices of modern Islamic banking. Firstly, there are contentions regarding the Shariah compliance of some trading and leasing products, especially Murabahah, BBA and financial leasing, service charges on loans, credits, etc. Some Muslim scholars believe that these products operate on the basis of time value of money, which is basically tantamount to Riba al-nasi ah discussed earlier. Secondly, Muslim economists have been analyzing why trading based arrangements such as Murabaha and BBA are becoming more popular than the equity based arrangements. Some of the reasons they give are, among others: Islamic banks still maintain the structure of conventional banks whose function is primarily the middle man between surplus funds from 91

18 depositors and deficit funds needed by the investors. This structure is basically a trading structure, which conforms well with the Islamic trading based arrangements. Hence there is a need to restructure Islamic banks so that it can accommodate the long-term equity based arrangements. Some scholars like Professor Zubair Hasan of the IIUM suggests restructuring Islamic banks based on products and functions, e.g. Mudarabah Islamic bank, Murabahah Islamic bank, etc. Islamic banks are still largely governed by the same rules and regulations for traditional commercial banks although the presence of Shariah boards has greatly helped to minimize the discrepancy. Thus such man made rules and regulations constrain the spheres of Ijtihad in Islamic products. There has been a positive move lately by Bank Negara Malaysia to encourage wider application of Islamic banks. Islamic banks are viewed to be risk averse when they largely go for secured investments under the trading based arrangements. Some also believe that Islamic banks are concerned about defaults, which discourages them to go for equity financing. Nevertheless equity based is long-term investment arrangements. The participation is real and the investment is mostly in value added industries, which have greater returns for the national income. Other benefits include entrepreneurship training, employment opportunities and transfer of technology, among others. Thus, the issues that need to be addressed by the Islamic Banks and financial institutions are foremost to identify the problem. Also to determine if we can and should have different types of Islamic banks and financial institutions, suiting the needs of different countries. Does the present system enable the development of Islamic banks and financial institutions? Malaysia has been in the forefront among the Muslim countries in the development of the Islamic banking and financial system. Malaysia has adopted a gradual approach of introducing and integrating this system with its present system. It has been a gradual change since there are a number of issues that still need to be resolved which include the need for structural reform, the need for a mind shift, a new thinking that of understanding further Islamic banking and finance and treating it as a practical and viable alternative. 92