Introduction

to Islamic
Economics
MEHTAB SIDDIQUI
Foundations of Western
Economics
The classical economists argued the real purpose of our existence is
maximization of utility and the utility can only be maximized by
consuming things.
Nobel Laureate Milton Friedman (2005) argues that the responsibility of
the firm is to pursue wealth and not social goals.
Islamic Versus Western
Economics
The Biblical statement that “money is the root of all
evil” might be closer to Islam then the western idea
as discussed by Shaw that “ Lack of money is the
root of all evil”
Mufti Shafee Usmani very eloquently explains:
“ There is no doubt that Islam is opposed to
monasticism and considers economic activities to be
permissible, desirable, and even necessary and
required at times.
Islamic Versus Western
Economics
Economic progress is desirable for men, and the earning of Halal
livelihood is required after the religious requirements. At the same time
it is equally self evident that the fundamental problem of man is not
economic , and economic progress is not a goal or objective of life for
humans “
It is on the basis of this fundamental principle that
Islam has constructed its economic system. If it
tolerates the minority of the rich, it imposes on
them heavier obligations: they have to pay taxes in
the interest of the poor, and they are prevented
from practicing immoral means of exploitation,
hoarding and accumulation of wealth. For this end
there will be some orders or injunctions, and also
some recommendations - for charity and sacrifice -
with the promise of spiritual (other worldly) reward.
Further, it makes, on the one hand, a distinction
between the necessary minimum and the
desirable plenitude, and on the other hand
between those orders and injunctions which are
accompanied by material sanctions and those
which are not so, but for which Islam contents itself
with persuasion and education only.
Foundations of Islamic
Economics
The idea of excessive consumptions as a means to maximize utility is
censured in Islam.
Hence, an institution that encourages the idea of bringing ones future
wealth to the present and creating artificially high demand does not
fit with the Islamic ethos.
Islamic Economics
From an Islamic perspective an institution that takes peoples money
and converts into waste projects does not fit well with the Islamic spirit.
 ISLAMIC ECONOMIC SYSTEM
A System Which Is Governed In Conformity With The Rules
Of Sharia’h.
Sharia’h "Way to be followed" or set of divine commands
and laws that controls every aspect of human beings in
their individual and collective lives.
Individual and collective life aspects can be divided into five
parts.
1) Beliefs (Aqaid)
2) Acts of Worship (Ibadaat)
3) Dealing with others (Muamlaat)
4) Manners (Ikhlaqiat)
5) Economics (Maishat)
The Nature Of Sharia’h Rulings Are As
Follows
Dos (orders to undertake any act) and Don’ts (prohibition from some
acts),
 divided into the Ibadaat (matters of worship) that are considered as rights of Allah
(SWT) and Muamlaat (the matters for disciplining human life) that constitute the
rights of human beings.
 Allah may forgive us on any lapse in respect of Ibadaat, while lapses in respect of the
Muamlaat would have to be forgiven only by the aggrieved person.
 HALAL
 HARAM
 FARAIZ
 SUNNAH
Main characteristics of
Economic System of
Islam are
The Concept of Private Property.
Consumption of wealth.
Production of wealth.
Distribution of wealth.
The concept of Zakat.
Interest free
Economy. Economic
Growth.
Responsibilities of the Government.
 Sources of Sharia’h
Rule and regulation of Islamic Sharia’h can be driven from
following sources.1) Quran
Quran is the word of Allah Ta’ala revealed over Prophet
Muhammad (PBUH).
the first and main source
commands obligatory to follow
denies commands of the Holy Quran is considered to be
a non-Muslim.
rigid in nature( Salah) just order are mentioned
detailed information about offering Salah may be
obtained from other sources of Sharia’h such as Sunnah.
“And obey Allah and His Messenger, if you are
believers.” (8:1)
 2)Sunnah:
 sayings of and the actions done and/or ratified by the holy
Prophet (PBUH),
 significant source of information in Islamic law.
 Sunnah provides detailed information
 considered as Divine Revelation.
 “Indeed you have in the Messenger of Allah an excellent
example for the one who hopes in Allah and looks to the
Last Day” (33: 21).
 obligatory to observe
 The details about Sunnah are preserved in the form of A
hadiths.
 Sunnah can thus be regarded as the second source of
Islamic Sharia'h after Quran
e.g.RulesforRibaalFadlhasbeenextractedfrom
3) Ijma:
 The consensus of scholar of Ummah on a particular
issue is termed as Ijma.
 most authoritative source of Islamic Sharia’h
 unanimous opinion of the scholars
 "My Ummah shall never be combined on an error.“
4) Qiyas:
 finding solutions through analogy in the light of the
text of the Qur’an and Sunnah,
 drinks like beer, whisky or brandy. Neither the Qur'an,
nor the Hadith, names these. However, Quran mention
that khamr (date wine) is Haram, on this ground, that
all the aforementioned drinks cause intoxication, all
sorts of alcoholic beverages are declared Haraam
Ijtihad:
Ijtihad literary means “Ultimate Effort” and precisely it means to apply
utmost effort to ascertain the ruling of Sharia’h about a particular
situation.
Ijtihad has been duly endorsed by the Prophet
“When the Holy Prophet intended to send his companion Mu’adh, to
Yemen as a ruler and as a judge, He asked him: How will you adjudicate
a matter when it will come to you?” He said, "I shall decide on the basis
of Allah's Book (the Holy Quran)."The Holy Prophet asked, "If you do
not find it in Allah's Book (what will you do)?”He said: "then, on the
basis of the Sunnah of Allah's Messenger".
"If you do not find it even in the Sunnah of Allah's Messenger (what will
you do)?” The Holy Prophet asked.
He replied: "I shall make Ijtihad on the basis of my understanding and
will not spare any effort (to reach the truth).”
On this, the Holy Prophet tapped the chest of Hazrat Mu'adh with
happiness and said, "Praise be to Allah, who has let the messenger of the m
Now days the implementation of Ijtihad is misunderstood most of
Sharia'h scholars. Ijtihad cannot be done on those issues where
there are clear injunctions of Holy Quran, Sunnah and Ijma. All
those new issues and situations where clear commands of Sharia’h
are not prescribed or some changes required on particular issues
by the scholar, these can only be done by Ijtihad.
Ijtihad is not just one’s own opinion based on rational judgment
but it is indeed the result of un-biased and ultimate effort of
Mujtahid on the basis of principles laid down by Sharia'h and it
must not contradict with any clear defined rule of Islamic Sharia'h.
Just because of complex nature of Ijtihad, the most senior, learned
and pious scholar of Sharia'h are eligible for Mujtahid and perform
Ijtihad. A Mujtahid must have in-depth knowledge and
understanding of Quran, Tafasir, Arabic, Background of the
revelation of verses of Quran, Ahadiths, Usool e Fiqh etc.
Economic Philosophy Of Islam &
Interest
NO CONCEPT OF RIBA IN THE ECONOMIC PHILOSOPHY OF ISLAM
Riba is that curse in society, which causes wealth to mount
up among handful of people and it results unavoidably in
creating monopolies, inequality and oppression,
opening doors for selfishness and greed
In world of trade and business dishonesty and fraud
flourish in interest based economy.
However Islam does not allow interest based economy
rather it primarily encourages highest moral ethics such as
universal brotherhood, collective welfare, prosperity, social
fairness and justice
IT WAS NARRATED THAT ABU SA'EED AL-
KHUDRI SAID:

"THE MESSENGER OF ALLAH (SAW2) SAID:

‘GOLD FOR GOLD, SILVER FOR SILVER, WHEAT
FOR WHEAT, BARLEY FOR BARLEY, DATES FOR
DATES, SALT FOR SALT, LIKE FOR LIKE, HAND
TO HAND. WHOEVER GIVES MORE OR ASKS FOR
MORE, HE HAS ENGAGED IN RIBA, AND THE
TAKER AND THE GIVER ARE THE SAME.’"

(SAHIH MUSLIM, HADITH 1584, DARUSSALAM

TRANS. 2007, VOL. 4, P. 306
 According to materialistic
economics: "Livelihood is the
fundamental problem of man and
economic developments are the ultimate
end of
human life."

While we find in the Holy Quran, the

disapproval of monasticism and the
order to: "Seek the grace of
Allah."(62:10)
"Livelihood is necessary and indispensable, b
While according to Islamic
economics:
 Money in Islam is limited to either precious
metals such as gold or silver, or commodities
such as wheat, barley, dates or salt, which have
shelf- life and could be used as money in case of
shortage in precious metals.
 Commodities used as money (precious metal,
foodstuff or others with shelf-life) should be
traded for their intrinsic value, not for their
nominal value such as contemporary paper
currency
 Lastly, Hosein argues that money must be located
in commodities that are created by Allah (SWT)
and their values are assigned by Himself
Chapter two

FACTORS OF
PRODUCTION IN ISLAM
 Different Economic Systems
TRADITIONAL ECONOMIC SYSTEM COMMAND ECONOMY
 Economic system is based on
customs and traditions  A central authority
(handed down from 1 (government) has to
generation to another). answer the big
 Allocation of scarce
three questions
resources stems from ritual,
habit, or customs
 BARTER!! Means trade! No
 Government decides the
money! needs of the people, the
best way to produce it
 Examples: Africa, parts of and for everyone!
India, the Australian Aborigines
The Big Three Questions
Every economic system in the world, past and
present, has to answer these three questions:

What to produce? (How did economists answer this

question?)

For whom to produce it?

How to produce it? (Who owns the factors

of production?)
Does a traditional economy answer the big
three questions?
What will be produced?
Whatever tradition, values, and rituals
dictate How will it be produced?
However tradition, values, and rituals
dictate For whom will it be produced?
Whomever tradition, values and rituals
dictate Does a command economy answer
the big three questions?
What is being produced?
Whatever the government
decides How is it being
produced?
The government will tell someone to
make it For whom is it being
produced?
Whom ever the government decides needs it
Difference between Capitalism
and Islam
In Islamic view the reward for ‘capital’ is different from
capitalist economy; here ‘profit’ is paid over capital
while pre-agreed ‘interest’ on capital is given in
capitalist economy.

The definition of “Labor” has been generalized too, so as

to include mental efforts such as
planning and organizing.
Capitalism defines "Capital'' as "the produced means of
production." Whereas, in addition to money (Gold, silver
or paper currency) and foodstuff the capital is supposed
to include machinery, building, vehicles etc. as well.
Under Islamic law the definition of "Capital" has been
defined in a different manner, it includes only those
things which cannot be utilized unless they are wholly
consumed or altered their original form, in other words,
which cannot be let or leased - for example money (gold,
silver and paper currency). According to this definition
machinery, land and vehicles are excluded from capital

All such things which do not have to be wholly consumed

or altered their original form during a process of
production have been taken under the head of “Land”.
Hence, vehicles, building and machinery fall under this
category.
KEY TAKEAWAYS
• Socialism is an economic and political system based
on collective ownership of the means of production.
• All legal production and distribution decisions are
made by the government in a socialist system. The
government also determines all output and pricing
levels and supplies its citizens with everything from
food to healthcare.
• Proponents of socialism believe that it leads to a more
equal distribution of goods and services and a more
equitable society.
• Socialist ideals include production for use, rather than
for profit; an equitable distribution of wealth and
material resources among all people; no more
competitive buying and selling in the market; and free
access to goods and services.
• Capitalism, with its belief in private ownership and the
goal to maximize profits, stands in contrast to
socialism, but most capitalist economies today have
some socialist aspects.
 Socialism and Islam
Islamic socialism is a political philosophy that
incorporates Islamic principles to socialism.
They draw inspiration from the early Medinan
welfare state established by Muhammad. Muslim
socialists found their roots in anti-imperialism.
Socialism does not admit the idea of private
property, wealth under the Socialist system is
distributed only in the form of wages. On the
contrary, according to the Islamic principles of the
distribution of wealth, which we have outlined
above, all the things that exist in the universe are in
principle the property of Allah Himself
Under Islamic view only three factors are
considered as factors of production
instead of four, the entrepreneur has
been excluded from the list of factor of
production as a regular factor. This does
not mean that the very existence of the
entrepreneur has been denied. It implies
that Islam does not recognize the
entrepreneur as an independent factor;
rather it includes it in any one of the
three factors.
The capitalist, in most of the cases
provides capital and takes the risk of
loss, is an entrepreneur too, and the
man who is an entrepreneur is a
Capitalist as well
Assignemnt no
2:
DIFFERENCE BETWEEN
CAPITALISM,SOCIALISM AND ISLAMIC
ECONOMICS
Doctrine Of Islamic
Islam conveys a positive outlook
Individuals are expected to
earn luxury is frowned upon
Muslims are required to pay zakat
inequalities in the distribution of income and wealth
must not be allowed
Islamic law recognizes private ownership of the
means of production. Nationalization and state
control of the economy are only permissible in
exceptional circumstances.
 Continued……..
Land and capital become productive only as
factors of production when combined with labor.
Prices should be just
antisocial and other damaging consequences are
forbidden,
Types of Capital investment (Business
Venture)
1:Sole Proprietorship:
1.

Private business, without any help of any partner of co-

sharer. economic terms, this "reward" would be made up
of
"Profit", in as much as Capital has been invested,
and "Wages", as earnings of management.
2. Partnership: Fiqh terminology "Shirkat-ul-Aqd"
second most common form of investment, few persons
may jointly invest capital; jointly run the business, jointly
bear the risk of profit and loss. Shirkat-ul-aqd, to share
“profit” as per agreed
ratio, and also entitled to “wages” because they have
taken part in management of business.
Co-operation of Capital and
Organization (Mudarbah)
One provides capital while another skills and
exploit the funds, manage the business, share in
the profit as per agreed sharing ratio.
"Rabb-ul-Mal“ compensated with profit
“Mudarib”, wages
("Mudarib") eventually suffers a loss in the
business, his labor will go wasted just as the
capital of the investor would go wasted. This
form of business organization too is permissible
in Islam. The Holy Prophet (PBUH) made such an
agreement with Hazrat Khadijah (R.A) before
their marriage. Since then, there has been a
complete consensus of opinion on this among
the jurists of Islam.
Money Lending Business
Before the advent of Islam investing capital on loan had
been practiced ever since from the beginning, money
lending is the fourth form of investing Capital. In this
business, one person lends money in form of loan or debt
on interest, second person accepting that debt and
utilizes the amount in running a business, and bears the
risk of loss or profit. If there is a loss, it has to be borne by
person who is managing the business with borrowed
money, but regardless of profit or loss, interest does
accrue to Capital in any case. Islam has prohibited this
form of venture.

If one wants to earn the share in the profit by lending

money, then two options are available for lender to adopt
the mode of "partnership" (Musharkah) or that of "Co-
operation'' (Mudarbah), where lender will have to bear the
risk of profit or loss as well. If the business concern earns
the profit, the lender will have a share in the profit; in
case of loss, it will be borne by all parties according to
their investment. This discussion makes it clear that Islam
stressed on the responsibility of ''taking the risk of loss''
on Capital. The man who provides capital in a risk-bearing
business enterprise will have risk of loss or profit.
Consumer Side of
Banking: a Western
Perspective
Since the goal of the consumer is to maximize consumption, bank loans
offer an attractive prospect to convert ones future wealth into present
by a price called interest.
By providing easy access to loans bank has become a channel to create
artificial demand in the economy.
The Supply Side of
Banking
From the supply the reason ones needs an
institute such as a bank to channel idle which
people save into projects that are beneficial for the
economy.
However, since the western economic system is
based on selfishness the money is channeled into
areas which maximizes their profit irrespective of
its social or economic impact.
Supply Side of Banking
In a country where people are dying of poverty, the banking system
is enabling the rich capitalists to build big houses, drive luxury cars
and own multinational organizations.
 What Is Paper Money?
Paper money is a country's official.

paper currency that is circulated for the transactions involved in acquiring goods and
services

What Is Credit Money?

Credit money is monetary value created as the result of some future obligation or
claim.

Extension of credit or issuance of debt

Money is considered as blood for an economy and the main element of many
transactions
The banking activity that is consistent
with Sharia’h Ruling (Islamic Laws) and
its practical application through
development of Islamic Economics

Sharia’h prohibits the giving and taking

of interest on loan or debt or any kind
of fee for provision of loans whether
the payment is fixed or floating
Islamic Banking
Islamic Banking is a response to make the
capitalistic financial system Sharia-
compliant.
Rodney Wilson argues that:
“ Ultimately Islamic banking and finance is about
the emergence of a distinctively Islamic form of
capitalism that may co-exist and interact with
Western, Chinese, Russian or any other capitalism.
Such a development should be welcomed and
facilitated, and not hindered or suppressed”
Capitalism and Banking
A closer look at the transitory economies suggest that it was the
banking system which enabled communist countries to shift to
capitalist ones.
Across the Middle East, Africa, and Asia, Islamic banking has grown to
become a prominent means of financial management, while it is also
emerging in Western economies that have not typically been
associated with it in the past.
RIBA
Arabic: Riba( ‫ الر ٰبوة‬،‫الربا‬, ‫ ربا‬IPA: al-ribā, or ribā
[ˈrɪbæː]) can be roughly translated as "usury", or
unjust, exploitative gains made in trade or business
under Islamic law.
Riba is mentioned and condemned in several
different verses in the Qur'an (3:130, 4:161, 30:39
and perhaps most commonly in 2:275-2:280).
It is also mentioned in many hadith (reports
describing the words, actions, or habits of
the Islamic prophet Muhammad).
CONTINUED
While Muslims agree that riba is prohibited, not all
agree on what precisely it is, or whether its use
should be punished by humans rather than Allah.
It is often used as an Islamic term for interest
charged on loans and the belief this is based on
— that there is a consensus among Muslims that
all loan/bank interest is riba —
However not all scholars equated riba with all
forms of interest, or agree whether its use is a
major sin and against sharia (Islamic law), or simply
discouraged (makruh).
BASED ON DEFINITION
Unjustified increment in borrowing or lending
money, paid in kind or in money above the
amount of loan, as a condition imposed by the
lender or voluntarily by the borrower. Riba
defined in this way is called in fiqh riba al-duyun
(debt usury). (Abdel-Rahman Yousri Ahmad)
An increase in a particular item. The word is
derived from a root meaning increase or growth.
(Saalih al-Munajjid, IslamQA website)
CONTINUED
Non-equality in an exchange. Besides increase in repaying
a loan, this can be different results from the exchange
of nonequivalent quantities (riba al-fadl) or from the
presence of a risk in which the other contractual party
does not share. (Olivier Roy)
All forms of interest, "any excess on the principal sum of
loan", i.e. any and all interest, irrespective of how much is
lent, whether the borrower is rich or poor, using the loan
for productive investment or consumption. (Some
translations of verses of the Quran substitute the word
"interest" for riba or "usury".)
 TYPES OF RIBA
Riba Duyun
Unjustified increment in money
lent whether in kind or cash
over and above the principal amount.

Riba Buyu`
Occurs in trading and exchange transactions,
in which unequal exchange of certain commodities
(gold, silver, dates, etc.)
of same kind and same basis.
CONTINUED
Riba Qard
Increase (interest) on the principal sum of the loan is agreed upon at the point of
contract

Riba Jahiliyyah
Increase levied on the borrower for late repayment or failure to repay the
financial loan

Riba Fadl
Due to unequal amount/quantity

Riba Nasi`ah
Due to extension of time of deliver
 DIVISION OF LABOR
The division of labor is the separation of tasks in
any economic system so that participants
may specialize (specialization).
Individuals, organizations, and nations are
endowed with or acquire specialized capabilities
and either form combinations or trade to take
advantage of the capabilities of others in
addition to their own
 CONTRAST BETWEEN
DIVISION OF LABOR
DIVISION OF WORK

the division of a large task, contract, allocation of tasks to individuals or

or project into smaller tasks—each organizations according to the
with a separate schedule within the skills and/or equipment those
overall project schedule people or organizations possess
we can divide the work into different division of labor is the
tasks with deadlines to finish each task so specialization of an individual
that subsequent dependent tasks can workers' or organizations' skills,
proceed to meet the overall deadline for through education, training, and
the project. practice
IMPORTANCE
ITS IMPORTANCE IN ECONOMICS LIES IN THE FACT THAT A
GIVEN NUMBER OF WORKERS CAN PRODUCE FAR MORE OUTPUT
USING DIVISION OF LABOR COMPARED TO THE SAME NUMBER OF
WORKERS EACH WORKING ALONE
DIVISION OF LABOR
The 14th-century scholar Ibn Khaldun emphasized the importance of the
division of labor in the production process. In his Muqaddimah, he states:

The power of the individual human being is not sufficient for him to obtain
(the food) he needs, and does not provide him with as much as he requires to
live. Even if we assume an absolute minimum of food...that amount of food
could be obtained only after much preparation...Thus, he cannot do without a
combination of many powers from among his fellow beings, if he is to obtain
food for himself and for them. Through cooperation, the needs of a number of
persons, many times greater than their own number, can be satisfied.
The importance of the role of labour in the creation of wealth was underlined by
al-Ghazali (1058-1111), Ibn Taymiyya (1263-1328) and Ibn Khaldun (1332-1406).

Seven centuries earlier than Adam Smith, al-Ghazali highlighted the importance of
the division of labour required by the necessary diversity of human activities.

It is astonishing to see that Ghazali used the example of a needle factory to

illustrate his point while Adam Smith used the example of a pin factory.

Ibn al-Qayyim (1292-1350) emphasized the necessity of establishing economic

cooperation between the different parties of a society, which constitute the
whole.

Cooperation among human beings allows them to obtain results that would never
have been realized individually.

The division of labor induces multiplication and diversification of economic

activities.
It is Ibn Khaldun who should receive credit for analysing with a greater scientific
rigor the concepts of labour, value and the division of labor- five centuries before
David Ricardo and Karl Marx.
FINANCING
Financing is the process of providing
funds for business activities, making
purchases or investing. Financial
institutions such as banks are in the
business of providing capital to
businesses, consumers, and investors
to help them achieve their goals.
DIFFERENCE BETWEEN CONVENTIONAL AND
ISLAMIC FINANCE
CONVENTIONAL FINANCING ISLAMIC FINANCING

Deposits are loans to the bank as Depositors are investors rather

debt Assets are invested in fixed than lenders Risk sharing
income securities and loans Bank through profit and loss sharing
has fixed obligations on deposits Assets and liabilities are
but uncertainty on assets returns
matched
Bank is exposed to assets and Ethical and socially responsible
liabilities mismatch risk assets
INVESTMENT
activities, but the common target in these
activities is to “employ” the money (funds) during
the time period seeking to enhance the investor’s
wealth.
Funds to be invested come from assets
already owned, borrowed money and savings.
By foregoing consumption today and investing their
savings, investors expect to enhance their future
consumption possibilities by increasing their wealth.
Property

Property is also considered as a growth investment

because the price of houses and other properties can
rise substantially over a medium to long term period.

However, just like shares, property can also fall

in value and carries the risk of losses.

It is possible to invest directly by buying a property

but also indirectly, through a property investment
fund.
PROPERTY
According to authors F. Nomani and A. Rahnema, the Qur'an states that God
is the sole owner of all matter in the heavens and the earth, but man is God's
vicegerent on earth and holds God's possessions in trust (amanat).

Islamic jurists divide properties into public, state, private categories

PUBLIC PROPERTY
Natural resources (forests, pastures, uncultivated land, water, mines, oceanic
resources etc.) to which all humans have equal right.
Such resources are considered the common property of the community.
Such property is placed under the guardianship and control of the Islamic
state, and can be used by any citizen, as long as that use does not undermine
the rights of other citizens, according to Nomani and Rahnema
STATE PROPERTY
Natural resources, as well as other property that can't immediately be privatized.
Islamic state property can be movable, or immovable, and can be acquired
through conquest or peaceful means.
Unclaimed, unoccupied and heir-less properties, including uncultivated land
(mawat), can be considered state property
PRIVATE PROPERTY
Muhammad said that he who dies defending his property was like a martyr
There is consensus amongst Islamic jurists and social scientists that Islam
recognizes and upholds the individual's right to private ownership. The Qur'an
extensively discusses taxation, inheritance, prohibition against stealing,
legality of ownership, recommendation to give charity and other topics related
to private property. Islam also guarantees the protection of private property
by imposing stringent punishments on thieves
Involuntary means are inheritances, bequests, and gifts. Non-contractual
acquisition involves the collection and exploitation of natural resources that
have not previously been claimed as private property. Contractual acquisition
includes activities such as trading, buying, renting, hiring labor etc
TYPES OF ISLAMIC
FINANCING
INSTRUMENTS
Islamic financial instruments: Banking
Islamic financial instruments:
Capital Markets
 IF Instruments: Banking
a. Murabahah: sale on profit (money is not lent to the customer)
b. Musharakah: joint venture partnership (2 or more parties contribute capital to
a business and participate with the related profits and losses)
c. Mudarabah: profit sharing (investor with capital develops a partnership with
an entrepreneur with an agreement to share the profits. Entrepreneur does not
bring in capital, brings in management)
d. Ijara: leasing (right to use the object for a specified period of time)
e. Bay al Salam: forward contracts (buyer pays the seller the full negotiated
price of a specific product which the seller promises to deliver at a specified
future date – payment is made at the deal date)
 IF Instruments: Capital
Markets
Sukuk (certificates – asset based long term partnership)
Where the investor shares the asset
Sukuk have become extremely popular since 2000, when
the first sukuk was issued by Malaysia. Bahrain followed
suit in 2001. Fast forward to current times, and sukuk are
used by Islamic corporations and state-run organizations
alike, taking up a large share of the global bond market.
"Islamic Modes of Finance
systematic and detailed rules, stipulations
and steps to be followed for accomplishing
a specific thing.
any of the different types of investment
activities (trade, leasing, real estate,
manufacturing, agriculture, agriculture
production etc., or, using Shariah expressions
Murabaha, Mudaraba, Musharaka, Ijarah,
Istisna, etc.
"Modes" literally means "methods"
"Islamic Modes of Finance"
The word "Finance" in one of its different meanings refers to the supply of
money capital or credit, provided by either a person (household), or an
organization (private or public - financial or non financial).
"Islamic" is inserted in the above expression to restrict the type of rules that can
govern different modes of finance to the Shariah

"The systematic and detailed Shariah rules that govern

the contractual relationship of an investment activity that
can be applied for attracting money capital" (Fahmy &
Sarkar).
BAI-MURABAHA
derived from Arabic words Bai and Ribhun.
word 'Bai' means purchase and sale and the word 'Ribhun' means an agreed
upon profit
"Bai-Murabaha" means sale for an agreed upon profit
contract between a buyer and a seller under which the seller sells certain
specific goods permissible under Islamic Shariah and the Law of the land to the
buyer at a cost plus an agreed upon profit payable today or on some date in
the future in lump-sum or by installments.
The profit may be either a fixed sum or based on a percentage of the price of
the goods.
Types of Murabaha
Ordinary Bai-Murabaha
direct transaction between a buyer and a seller
the seller is an ordinary trader who purchases
goods from the market in the hope of selling
these goods to another party for a profit. In this
case, the seller undertakes the entire risk of his
capital investment in the goods purchased.
Whether or not he earns a profit depends on his
ability to find a buyer for the merchandise he has
acquired.
continued
Bai-Murabaha order on and Promise
involves three parties - the buyer, the seller
and the bank
the bank acts as an intermediary trader between
the buyer and the seller. In other words, upon
receipt of an order and agreement to purchase a
certain product from the buyer, the bank will
purchase the product from the seller to fulfill the
order.
Contrary to conventional
However, it should be noted here that the Islamic Bank acts as a financier in
this transaction. This is the case, not in the sense that the bank finances the
purchase of goods by the consumers; rather it is a financier by deferring
payment to the seller of the product. Thus, there is a chance that this
transaction could resemble nothing more than a loan for which interest (Riba)
is earned, which is contrary to Islamic beliefs.

Therefore, to avoid this potential misuse of the Bai-Murabaha relationship,

the bank should purchase the goods on behalf of the bank from the seller and
sell the goods to the buyer, receiving payment on behalf of the bank as well. In
this way, the profits generated by the transaction to each of the parties
involved cannot be misconstrued as interest or (Riba) profits.
Important features of Bai-
Murabaha
CONTINUED
Stock and availability of goods is a basic condition for signing a Bai-Murabaha
Agreement. Therefore, the bank must purchase the goods in accordance with the
specifications of the client, thereby taking ownership of the goods before signing
the Bai-Murabaha agreement with the client.

Upon acquiring the goods, the bank assumes the risk of ownership. In other words,
the bank is responsible for damages, defects, and /or spoilage to the merchandise
until such time that it is actually delivered to the buyer.

The bank must deliver the goods to the client at the date, time, and place
specified in the contract.
CONTINUED
The bank sells the goods at a price above the cost to obtain a profit. The sale
price that is charged by the bank is agreed upon in the Bai-Murabaha. The
profit can be stated in terms of a flat dollar amount or on a percentage of the
purchase price. If a percentage is used, the percentage shall never be
expressed in terms of time, in order to avoid confusion that the price is a
form of interest (Riba), which is not allowed.
The price agreed to in the agreement is binding on both parties.

It is permissible for the bank to contract with a third party to buy and receive
the goods on its behalf. This agreement must be a separate contract.
Steps of Bai-Murabaha
First Step: The client submits a proposal regarding his
requirements of the bank. The client sends a proposal with
the specifications of the commodity to be acquired from
the bank. The proposal also indicates details regarding the
date, time and place of delivery as well as price and form of
payment information. The bank responds by sending a
counter proposal either accepting the buyer's price or
stipulating a different price.
Second Step: The client promises to buy the
commodity from the bank on a Bai-Murabaha basis, for
the stipulated price. The bank accepts the order and
establishes the terms and conditions of the transaction.
continued
Third Step: The bank informs the client (ultimate buyer) of
its approval of the agreement to purchase. The bank may
pay for the goods immediately or in accordance with the
agreement.

The seller expresses its approval to the sale and sends the
invoice(s).

Fourth Step: The two parties (the bank and the client) sign
the Bai-Murabaha Sale contract according to the
agreement to purchase.
continued
Fifth Step: The Bank authorizes the client or its
nominee to receive the commodity

The seller sends the commodity to the place of

delivery agreed upon. The client undertakes the
receipt of the commodity in its capacity as legal
representative and notifies the bank of the
execution of the proxy.
musharakha
MEANING OF MUSHARAKA

The word Musharaka is derived from the Arabic

word Sharikah meaning partnership. Islamic jurists
point out that the legality and permissibility of
Musharaka is based on the injunctions of the
Qura'n, Sunnah, and Ijma (consensus) of the
scholars. It may be noted that Islamic banks are
inclined to use various forms of Shariakt-al-Inan
because of its built-in flexibility. At an Islamic
bank, a typical Musharaka transaction may be
conducted in the following manner.
 Cont…….
One, two or more entrepreneurs approach an Islamic
bank to request the financing required for a project. The
bank, along with other partners, provides the necessary
capital for the project. All partners, including the bank,
have the right to participate in the project. They can also
waive this right. The profits are to be distributed
according to an agreed ratio, which need not be the
same as the capital proportion. However, losses are
shared in exactly the same proportion in which the
different partners have provided the finance for the
project (Hussain 1986, p.61).
Types of Musharaka
Permanent Musharaka
In this case, the bank participates in the equity of a company and receives an
annual share of the profits on a pre-rate basis. The period of termination of the
contract is not specified. This financing technique is also referred to as continued
Musharaka.
The contributions of the partners under this mode may be equal or unequal
percentages of capital for the purpose of establishing a new income-generating
project or to participate in an existing one. In this arrangement, each participant
owns a permanent share in the capital structure and receives his share of the
profits accordingly. This type of a partnership is intended to continue until the
company is dissolved. However, one can exit the partnership by selling his share of
the capital to another investor.
Cont…
Permanent Musharaka is used by Islamic
Banks in many income generating projects.
They can provide financing to their
customers, in exchange for ownership and
profit sharing in the proportion agreed upon
by both parties. In addition, the bank may
leave the responsibility of management to
the customer-partner and retain the right of
supervision and follow up.
steps to establishing Permanent Musharaka
One - Partnership in Capital: The bank tenders part of the capital required in its
capacity as a partner and authorizes the customer/partner to manage the project.
The Partner tenders part of the capital required for the project and is entrusted
with what he holds from the bank funds.
Two - Results of the Projects: The intent of the project is growth. However, the
project may be profitable or it may loss money.

Three - The Distribution of wealth accrued from the Project: In the event a loss is
incurred, each partner bears part of the loss proportionate to his share in capital. In
the event the venture is profitable, earnings are divided between the two parties
(the bank and the partner) in accordance with the agreement.
Rules for Permanent Musharaka
It is a condition that the capital provided by each partner is specific, existent and
easily accessible. It is inappropriate to establish a company with borrowed money,
for the purpose of profit.

It is permissible for partners to have unequal ownership in the project. The

percent of ownership is set forth in the agreement.

It is a condition that the capital of the company is money and valuables. Some of
the jurists permit contributing merchandise as invested capital. However, the
merchandise must be evaluated, and the value agreed upon by all parties. Once
the value has been established, it is counted as capital and stipulated in the
contract as such.
Cont…
It is impermissible to impose conditions forbidding one of the partners from
work. The company is built on honor and each partner implicitly permits and
gives power of attorney to the other partner(s) to dispose of and work with
capital as is deemed necessary to conduct business. However, it is permissible
for one partner to have full responsibility for the operations of the company,
provided he is granted this authority by the other partners.

A partner is a trustee of company funds in his possession and is held responsible

for their proper use. It is permissible to take a mortgage or a guarantee against
company assets, but it is impermissible to take security for profit or capital.
Cont….
It is a condition that each partners' share of the profits be known to avoid
uncertainty. Also, it is required that the ownership interest be in percentage
terms and not a fixed sum, because this would violate the requirements of a
partnership.

In principle, profit must be divided among partners in ratios proportionate to

their shares in capital but some of the jurists permit variation in profit shares, so
long as it is agreed to by all of the partners. This may be the case when one of
the partners is more dexterous and more diligent and does not agree to parity,
so variation in the sharing of profits becomes necessary.
Cont.
In principle, a partnership is a permissible and non-binding contract.
Thus, if a partner wishes, he could rescind the agreement provided that
this occurs with the knowledge of the other partner or partners.
Rescinding the agreement without the knowledge of the other
partners' prejudices the rescinding partner's interest. On the other
hand, some of the jurists take the view that the partnership contract is
binding up to the liquidation of capital or the accomplishment of the
job accepted at the contract.
Application of Permanent
Musharaka
Permanent Musharaka is helpful in providing financing for large investments in
modern economic activities. Islamic banks can engage in Musharaka partnerships
for new or established companies and activities.
Islamic banks may become active partners in determining the methods of
production cost control, marketing, and other day-to-day operations of a company
to ensure the objectives of the company are met.
On the other hand, they can also choose to either directly supervise or simply
follow up on the overall activities of the firm.
As part of the agreement, Islamic banks will share in both profits and losses with
its partners or clients in operations of the business.
Question?
Are not Islamic banks just paying
interest and dressing it as profit
on trade and investments?
Answer: No, Islamic banks accept the
deposits either on profit and loss sharing
basis or on qard basis. These deposits are
deployed in financing, trading or investment
activities by using the Shariah compliant
modes of finance. The profit so earned by
the bank is passed on to the depositors
according to the pre-agreed ratio which,
therefore, cannot be termed as interest.
WHAT IS DIMINISHING MUSHARAKAH?
Diminishing Musharakah is a type of partnership (or
shirkah) where one partner purchases the other
partner’s share gradually, over the period of time. This
type of partnership is also called “Shirkah-al-
Mutanaqisah”
According to this concept, a financier and his client
participate either in the joint ownership of a property or
an equipment, or in a joint commercial enterprise.
The share of the financier is divided into a number of
units and it is understood that the client will purchase
the units of the share of the financier, one by one
periodically, until he becomes the sole owner of the
property, or the commercial enterprise, as the case
may be.
FUNDAMENTALS OF DIMINISHING MUSHARAKAH
AGREEMENT
The proposed arrangement is composed of the
following transactions:

To create joint ownership in the property

(Shirkat- ul-Milk).
Giving the share of the financier to the client on
rent.
Promise from the client to purchase the units of
share of the financier.
Actual purchase of the units at different stages.
HOW DIMINISHING MUSHARAKAH
WORKS?
The Diminishing Musharaka based on the above concept has taken different
shapes in different transactions. Some examples are given below:

It has been used mostly in house financing. The client wants to purchase a house
for which he does not have adequate funds. It approaches the financier who
agrees to participate with him in purchasing the required house 20% of the price is
paid by the client and 80% of the price by the financier. Thus, the financier owns
80% of the house while the client owns 20%. After purchasing the property jointly,
the client uses the house for his residential requirement and pays rent to the
financier for using his share in the property.
cont.
At the same time, the share of financier is further divided in eight equal units,
each unit representing 10% ownership of the house. The client promises to the
financier that he will purchase one unit after three months. Accordingly months,
he purchases one unit of the share of the financier by paying 1/10th of the price
of the house. It reduces the share of the financier from 80% to 70%. Finance, the
rent payable to the financier is also reduced to that extent. At the end of the
second term, he purchases another unit increasing his share in the property to
40% and reducing the share of the financier to 60% and consequently reducing
the rent to that proportion. This process goes on in the same fashion until after
the end of two years, the client purchases the whole share of the financier
reducing the share of the financier to ‘zero’ and increasing his own share to
100%
Cont.
This arrangement allows the financier to claim rent according to his proportion
of ownership in the property and at the same time allows him periodical
return of a part of his principal through purchases of the units of his share.
Example:2
A’ wants to purchase a taxi to use it for offering transport services to passengers
and to earn income through fares recovered from them, but he is short of
funds. ‘B’ agrees to participate in the purchase of the taxi, therefore, both of
them
purchase a taxi jointly. 80% of the price is paid by ‘B’ and 20% is paid by A. After
the taxi is purchased, it is employed to provide transport to the passengers
whereby the net income of $1000/- is earned on daily basis. Since ‘B’ has 80%
share in the taxi, it is agreed that 80% of the fare will be given to him and the
rest of 20% will be retained by ‘A’ who has a 20% share in the taxi. It means that
$800/- is earned by ‘B’ and $200/- by ‘A’ on daily basis.
Cont.
At the same time the share of ‘B’ is further divided into eight units. After three
months ‘A’ purchases one unit from the share of ‘B’. Consequently the share
of ‘B’ is reduced to 70% and share of ‘A’ is increased, after the first term of
three months increased to 30% meaning thereby that as from that date ‘A’ will
be entitled to $300/- from the daily income of the taxi and ‘B’ will earn $700/-.
This process will go on until after the expiry of two years, the whole taxi will be
owned by ‘A’ and ‘B’ will take back his original investment along with income
distributed to him as aforesaid.
Example 3
‘A’ wishes to start the business of ready-made garments but lacks the required
funds for that business. ‘B’ agrees to participate with him for a specified period,
say two years. 40% of the investment is contributed by ‘A’ and 60% by ‘B’. Both
start the business on the basis of Diminishing Musharakah. The proportion of
profit allocated for each one of them is expressly agreed upon. But at the same
time ‘B’s share in the business is divided to six equal units and ‘A’ keeps
purchasing these units on gradual basis until after the end of two years ‘B’
comes out of the business, leaving its exclusive ownership to A. Apart from
periodical profits earned by ‘B’, he gains the price of the units of his share
which, in practical terms, tend to repay to him the original amount invested by
him.
 DIMINISHING MUSHARAKAH IN SHIRKAT-UL-AAQD
(JOINT VENTURE)
FEATURES: Two partners start business in Shirkah to earn profit. One of the
partners undertakes to purchase the share of another partner gradually, each
month or each year.
RULES:
There will be an agreement of Shirkat-ul-Aqd between both partners where in
investment of everyone and ratio of profit will be agreed.
One partner undertakes to purchase the share of other partner. In this promise
two conditions should be considered:
The price of unit will not be agreed in this promise but promise to purchase
should be at market value at the time of purchasing. If promise is not fulfilled,
then it can be forced by Court of law.
DIMINISHING MUSHARAKAH IN
SHIRKAT-UL-MILK (JOINT OWNERSHIP)
Two partners purchase any asset (machinery/property) and their intention is
that one or both partners will use this asset or they rent out their share and one
share holder undertakes to purchase the share of other gradually.

Diminishing Musharakah usually being used in House Financing for four purposes:
Purchase of House.
Construction of
House. Renovation of
House.
Balance Transfer Facility (BTF).
Balance Transfer Facility (BTF
Valuation of house will be made and this value will be treated as investment
of client in Diminishing Musharakah Agreement and amount of loan paid by
bank will be investment of bank.
Diminishing Musharakah Agreement will be signed between bank and client in
which investment of everyone will be agreed.
The both partners will be owner of the property in same ratio as ratio of
investment.
).
The property will be in the name of the client.
This is Shirkat-ul-Milk.
According to the ratio of ownership, each one is responsible for the loss.
Cont.
Bank will divide its own part of asset into units, which is promised by the client
to purchase on pre-agreed price.
Ijarah Agreement will be signed and bank will give his share of house on rent to
the client.
Rent may be fixed on prevailing market value or with mutual consent.
Bank’s monthly profit may also be decided, as monthly rent of the house and
principal amount will be recovered in the unit price.
In Ijarah Agreement, a lump sum amount of rent is necessary to be fixed for a
certain period. Rent for the rest of the period, may be linked with agreed
Benchmark.
Before one year, client cannot purchase bank units.
Each unit will be purchase on the basis of Offer & Acceptance.
Question?
What if in diminishing musharika both parties participate in utilizing
the asset. What will be the condition of agreed profit and units to be
purchased.
\
Rules for profit sharing
1. The ratio of profit must denote a percentage of actual
profit earned at the end of period. Anyrate or ratio tied
up to the investment is not acceptable in contract of
partnership. For example, if it is decided between
partners that 'A' will get 1% of his investment, the
contract is not valid.
2. In valid Musharakah it is not allowed to fix a lump
sum amount for anyone of the partnersTherefore, if 'A'
& 'B' enter into a partnership and it is decided that 'A'
shall be given Rs.10,000/-per month as his share in the
profit and the rest will go to 'B', the partnership is
invalid.
Cont.
3. It is allowed in Islam to agree upon a condition
that no partner will share profit just according
tothe ratio of investment, whether both take
part in management or not. However sleeping
partner cannot claim more than his share in
investment.
4. Any percentage can be agreed for sharing profit
between partners, if a partner is contributingmore
in managing the business may share more than his
ratio of investment.
 C o n t.
5. If bo th are working partners, the
share of profit can differ from the ratio of
investment. For
example, ‘Zaid’ & ‘Bakar’ both have invested
Rs.1,000/- each. However, Zaid gets 1/3rd of the
total profit and Bakar gets 2/3rd, this is allowed.
This opinion of Imam Abu Hanifa is based on the
fact that capital is not the only factor for profit
distribution but also labor and work. Although
the investment of two partners is the same but
in some cases, quantity and quality of work
might differ.
Description:
According to Nomani and Rahnema, Islam
accepts markets as the basic coordinating
mechanism of the economic system. Islamic
teaching holds that the market, given perfect
competition, allows consumers to obtain desired
goods and producers to sell their goods at a
mutually acceptable price.
Main characteristics of
Economic System of
Islam are
The Concept of Private Property.
Consumption of wealth.
Production of wealth.
Distribution of wealth.
The concept of Zakat.
Interest free
Economy. Economic
Growth.
Responsibilities of the Government.