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Understanding Islamic Finance


In Understanding Islamic Finance Muhammad Ayub introduces all the essential elements of this growing market by providing an in-depth background to the subject and clear descriptions of all the major products and processes associated with Islamic finance.

Key features include:

  • Discussion of the principles of Islamic finance;
  • Introduction to the key products and procedures that International Financial Institutions are using or may adopt to fund a variety of clients ensuring Shar+´ah compliance;
  • Discussion of the role Islamic finance can play in the development of the financial system and of economies;
  • Practical and operational examples that cover deposit and fund management by banks involving financing of various sectors of the economy, risk management, accounting treatment, and working of Islamic financial markets and instruments.

This book is not only an important text for all banks and financial institutions entering this particular market with a commitment to building Islamic financial solutions, but is also essential reading for undergraduate and postgraduate students of Islamic finance.

MUHAMMAD AYUB is Director Training, Development and Shari’ah Aspects at IIBI, London. Formerly, he was with the State Bank of Pakistan (central bank) where he headed the Islamic Economics Division and Shari’ah Compliance Division as Senior Joint Director in the Research and Islamic Banking Departments. He also served as Head of Islamic Banking at NIBAF, the training wing of SBP. Besides contributing a large amount of material, he has been serving as Master Trainer on theory and practice of Islamic finance.
For last two decades, he has been involved in R&D for facilitating I.B. Industry, Products Development, IB Prudential regulations, Risk management and Shari’ah related controls and audit of Islamic banking institutions. This, along with his association with various Commissions set up from time to time on application of Islamic banking system, has lent him a pragmatic and balanced approach, a prerequisite for presenting such a book.
List of Boxes and Figures.





1 Introduction.

1.1 Economic Scenario in the Neoclassical Framework.

1.2 Conventional Debt: A Recipe for Exploitation.

1.3 Growth per se May not Lead to Socio-economic Justice.

1.4 Social Welfare Activities of the States.

1.5 The Main Culprit.

1.6 The Need of the Hour.

1.7 Economics and Religion.

1.8 Islamic Principles Can Make the Difference.

1.9 Regulating Trade and Business.

1.10 Islamic Finance Passing Significant Milestones.

1.11 Could it Work to Achieve the Objectives?

1.12 About this Book.

2 Distinguishing Features of the Islamic Economic System.

2.1 Introduction.

2.2 Islamic Shar+´ah and its Objectives.

2.3 Why Study Islamic Economics?

2.4 Islamic Economics: What should it be?

2.5 Paraphernalia of Islamic Economics.

2.6 Summary.

3 The Main Prohibitions and Business Ethics in Islamic Economics and Finance.

3.1 Introduction.

3.2 The Basic Prohibitions.

3.2.1 Prohibition of Riba.

3.3 Business Ethics and Norms.

3.4 Summary and Conclusion.

4 The Philosophy and Features of Islamic Finance.

4.1 Introduction.

4.2 The Philosophy of Islamic Finance.

4.3 Debt versus Equity.

4.4 Islamic Banking: Business versus Benevolence.

4.5 Exchange Rules.

4.6 Time Value of Money in Islamic Finance.

4.7 Money, Monetary Policy and Islamic Finance.

4.8 Summary.


5 Islamic Law of Contracts and Business Transactions.

5.1 Introduction.

5.2 Ml (Wealth), Usufruct and Ownership.

5.2.1 Defining Various Related Terms.

5.3 General Framework of Contracts.

5.4 Elements of a Contract.

5.5 Broad Rules for the Validity of Mu’malt.

5.6 W’adah (Promise) and Related Matters.

5.7 Types of Contracts.

5.8 Commutative and NonCommutative Contracts.

5.9 Conditional or Contingent Contracts.

5.10 Summary.

6 Trading in Islamic Commercial Law.

6.1 Introduction.

6.2 Bai' – Exchange of Values.

6.3 Legality of Trading.

6.3.1 Trade (Profit) versus Interest: Permissibility versus Prohibition.

6.4 Types of Bai'.

6.5 Requirements of a Valid Sale Contract.

6.6 Riba Involvement in Sales.

6.7 Gharar – A Cause of Prohibition of Sales.

6.8 Conditional Sales and “Two Bargains in One Sale”

6.9 Bai' al’Arbkn (Downpayment Sale).

6.10 Bai' al Dayn (Sale of Debt).

6.11 Al ’Inah Sale and the Use of Ruses (Hiyal).

6.12 Options in Sales (Khiyar).

6.13 Summary.

7 Loan and Debt in Islamic Commercial Law.

7.1 Introduction.

7.2 The Terms Defined.

7.3 Illegality of Commercial Interest.

7.4 Loaning and the Banking System.

7.5 Guidance from the Holy Qur’n on Loans and Debts.

7.6 The Substance of Loans.

7.7 Repayment of the Principal Only.

7.8 Time Value of Money in Loans and Debts.

7.9 Instructions for the Debtor.

7.10 Instructions for the Creditor.

7.11 Husnal Qadha (Gracious Payment of Loan/Debt).

7.12 Remitting a Part of a Loan and Prepayment Rebate.

7.13 Penalty on Default.

7.13.1 Insolvency of the Debtor.

7.14 Hawalah (Assignment of Debt).

7.15 Security/Guarantee (Kafalah) in Loans.

7.16 Bai´ al Dayn (Sale of Debt/Debt Instruments).

7.17 Impact of Inflation on Loans/Debts.

7.18 Summary.


8 Overview of Financial Institutions and Products: Conventional and Islamic.

8.1 Introduction.

8.2 What is Banking or a Bank?

8.3 The Strategic Position of Banks and Financial Institutions.

8.4 Categories of Conventional Financial Business.

8.5 The Need for Islamic Banks and NBFIs.

8.6 The Issue of Mode Preference.

8.7 Islamic Investment Banking.

8.8 Islamic Financial Markets and Instruments.

8.9 Summary and Conclusion.

9 Murabaha and Musawamah.

9.1 Introduction.

9.2 Conditions of Valid Bai'.

9.3 Murabaha – a Bai' al Amnah.

9.4 Bai' Murabaha in Classical Literature.

9.5 The Need for Murabaha.

9.6 Specific Conditions of Murabaha.

9.6.1 Bai' Murabaha and Credit Sale (Murabaha–Mu’ajjal).

9.7 Possible Structures of Murabaha.

9.8 Murabaha to Purchase Orderer (MPO).

9.9 Issues in Murabaha.

9.10 Precautions in Murabaha Operations.

9.11 Musawamah (Bargaining on Price).

9.12 Summary.

10 Forward Sales: Salam and Istisna’a.

10.1 Introduction.

10.2 Bai' Salam/Salaf.

10.3 Benefits of Salam and the Economic Role of Bai' Salam.

10.4 Features of a Valid Salam Contract.

10.5 Security, Pledge and Liability of the Sureties.

10.6 Disposing of the Goods Purchased on Salam.

10.6.1 Alternatives for Marketing Salam Goods.

10.7 Salam – Post Execution Scenarios.

10.8 Salam-Based Securitization – Salam Certificates/Sukuk.

10.9 Summary of Salam Rules.

10.10 Salam as a Financing Technique by Banks.

10.11 Istisna’a (Order to Manufacture).

11 Ijarah – Leasing 279.

11.1 Introduction.

11.2 Essentials of Ijarah Contracts.

11.3 General Juristic Rules of Ijarah.

11.4 Modern Use of Ijarah.

11.5 Islamic Banks’ Ijarah Muntahia-bi-Tamleek.

11.6 Summary of Guidelines for Islamic Bankers on Ijarah.

12 Participatory Modes: Shirkah and its Variants.

12.1 Introduction.

12.2 Legality, Forms and Definition of Partnership.

12.3 Basic Rules of Musharakah.

12.4 The Concept and Rules of Mudarabah.

12.5 Mudarabah Distinguished from Musharakah.

12.6 Modern Corporations: Joint Stock Companies.

12.7 Modern Application of the Concept of Shirkah.

12.8 Diminishing Musharakah.

12.9 Diminishing Musharakah as an Islamic Mode of Finance.

12.10 Summary and Conclusion.

13 Some Accessory Contracts.

13.1 Introduction.

13.2 Wakalah (Agency).

13.3 Tawarruq.

13.4 Ju’alah

13.5 Bai´ al Istijrar (Supply Contract).

14 Application of the System: Financing Principles and Practices.

14.1 Introduction.

14.2 Product Development.

14.3 The Nature of Financial Services/Business.

14.4 Prospects and Issues in Specific Areas of Financing.

14.5 Islamic Banks’ Relationship with Conventional Banks.

14.6 Fee-based Islamic Banking Services.

14.7 Summary and Conclusion.

Appendix: The Major Functions of a Shar+´ah Supervisory Board in the Light of the AAOIFI’S Shar¯1´ah Standard.

15 Sukuk and Securitization: Vital Issues in Islamic Capital Markets.

15.1 Introduction.

15.2 The Capital Market in an Islamic Framework.

15.3 Securitization and Sukuk.

15.4 Summary and Conclusion.

16 Takaful: An Alternative to Conventional Insurance.

16.1 Introduction.

16.2 The Need for Takaful Cover.

16.3 The Shar+´ah Basis of Takaful.

16.4 How the Takaful System Works.

16.5 Takaful and Conventional Insurance Compared.

16.6 Status and Potential of the Takaful Industry.

16.7 Takaful Challenges.

Appendix: Fatwa (Juristic Opinions) on Different Aspects of Insurance.

17 An Appraisal of Common Criticism of Islamic Banking and Finance.

17.1 Introduction.

17.2 The Common Myths and Objections.

17.3 Appraisal of Conceptual Criticism.

17.4 Appraisal of Criticism on Islamic Banking Practice.

17.5 Conclusion.

18 The Way Forward.

18.1 Introduction.

18.2 Agenda for the Policymakers.

18.3 Potential, Issues and Challenges for Islamic Banking.

18.4 Conclusion.




Arabic/Urdu References.

Suggested Further Reading.