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A Basic Guide to Contemporary Islamic Banking and Finance Mahmoud Amin El Gamal Rice University June 2000 Why Islamic Finance ? I would like to preempt two opposing reactions that many readers may have once they recognize that Islamic finance is in many ways very similar to (and at times identical with) conventional finance. Some may feel that this similarity is an attempt to dilute the Islamic teachings to simplify our lives, while others may feel that the Islamic Legal distinctions etween
  A Basic Guide to Contemporary Islamic Banking and Finance Mahmoud Amin El Gamal Rice University  June 2000 Why Islamic Finance ?  I would like to preempt two opposing reactions that many readers may have once they recognize that Islamic finance is in many ways very similar to (and at times identical with) conventional finance. Some may feel that this similarity is an attempt to dilute the Islamic teachings to simplify our lives, while others may feel that the Islamic Legal distinctions etween Islamic and regular finance are artificial means of creating an industry where none is needed. I will e among the first to admit that the terms Islamic anking or Islamic finance can e !uite misleading given the many similarities etween Islamic and conventional financial contracts. o e#plain my point of view aout this issue, let me use a good analogy$ the issue of Islamic marriage .here are no ostacles that prevent %uslims in &orth 'merica from having an Islamic marriage, a contract that adheres to the legal re!uirements of the state as well as the Islamic legal re!uirements. In certain respects, a marriage is a marriage , ut in other respects, to aide y all the re!uirements of the Islamic marriage contract, the %uslim man and woman need to do some e#tra work. Local Islamic centers, as well as continent wide organizations like IS&', provide information and contract forms to help potential %uslim families aide y oth sets of laws (e.g. providing local religious marriage services , providing forms for an Islamic will to ensure aidance y Islamic inheritance laws, etc.).Similarly, the notion that a marriage is a marriage may e applied in the realm of finance, e.g. a lease is a lease . In this domain also, the %uslim needs to ensure that the contract he signs with the lessor or lessee agrees with the conditions of the lease contract ( `aqd al 'ijarah or `aqd al 'ijdr  ) in Islamic urisprudence. hose conditions are put in place to ensure that the contract would not contain elements of Riba  or Gharar  , which are foridden in Islam.In this sense, Islamic anks or Islamic financial institutions try to ensure that all their contracts adhere to Islamic legal re!uirements as well as state re!uirements. 's with marriage, the outer form of an Islamic lease may seem to a. casual oserver to e identical to a regular lease. *ecognizing the differences re!uires alertness to some of the legal re!uirements that may seem sutle to the casual oserver. I hope that this primer will wet the readers appetites to educate themselves regarding those important Legal financial re!uirements of Islam.  'uses of the terms Islamic anking and finance in a numer of Islamic countries have precipitated a degree of skepticism among the %uslim population. he view that the field consists of nothing more than mere nomenclature has ecome too deeply rooted in the minds of many sincere %uslims ecause of those auses. hat skepticism turned cynical when educated %uslims e#amined careless statements y early proponents of the field of Islamic anking in those countries. hose statements suggested that the differences etween the Islamic model of finance and its conventional (western) counterpart should e ovious without any need for further education. Since the ehavior of early Islamic anks seemed to casual oservers to e very similar in function and form to conventional anks, the field was summarily dismissed as window dressing. hose early tactics were particularly ill advised given the fact that 'llah (swt) did not deny the similarity etween Islamic and conventional (or western) finance. +hen the 'ras argued that trade is ut like riba -$-/0, 'llah (swt) did not deny that apparent similarity, ut decisively informed that ut 'llah has permitted trade and foridden riba  -$-/0. he legal differences etween the two are clear, and have een detailed over the centuries y capale %uslim urists. 1owever, the fact remains that the sophisticated 'ra traders of %akkah did not at first see any discernile difference etween the Islamic model and the one ased on ria. &ote$ 'l hnam 'l aari (233-, vo2.4, p.256), 'l 7urtui (2338, vol.4 6, p.-45) report in the e#egesis of (-$-/2 that the 'ras efore Islam knew only one type of ria$ 9nce a persons det was due for payment, the creditor gave him the choice either you pay, or you increase the det . hey argued that there is no difference etween this type of increase and the increase in the price of a credit sale over the price of a cash sale is identical to what they were doing. 1owever, 'llah (swt) made the fundamental distinction, which was later e#plained y the :rophet (puh) and analyzed y Islamic scholars.0  herefore, the reader seeking to understand this difference should e#pect that understanding the difference is a non trivial process. %y hope as stated in the preface is to dispel some of the misconceptions aout this area, and encourage the reader to seek more re!uisite Islamic knowledge.  Chapter 1 !rohiitions o# Riba  and Gharar   It is commonplace in Islamic discourse to stress the positive inunctions to do good and forid evil efore discussing prohiitions and other negative inunctions. 1owever, in the interest of saving the readers time, we go directly to the need for having an Islamic finance . In this regard, financial tools, like all other tools of social and economic interaction, can e used for good or for evil. ;sing the tools of finance for good rather than evil is of course of primary concern in the Islamic vs. un<Islamic distinction. 1owever, those aspects of the distinction important as they are lie eyond the scope of this asic guide.9ur primary concern, instead, is the %uslim individual, group, or usiness, with a legitimate and good financial oective (e.g. purchase a. home to house his family, purchase real estate to estalish a Masjid   or school, invest availale funds in productive and permitted ways, etc.). 's we shall see,, many of the conventional financial tools currently availale in &orth 'merica (and most of the rest of the world) are legally prohiited in Islam. In this chapter, we shall review the two fundamental Islamic prohiitions which render financial contracts invalid ( batil  ) and foridden ( haram ).  =efore proceedings to the specific prohiitions, I must reiterate that we are here concentrating on the Islamic legal aspects pertaining to the contract itself. &eedless to say, an Islamically permissile contract may still e unIslamic for other reasons. >or instance, a legal contract for purchasing an automoile may e permissile, ut the uyer may intend to use the car for evil rather than good. ?oncentrating on the legality of the sale contract does not imply that it is more important than the other considerations. It simply means that it is one important consideration.  The prohibition of Riba %ost proaly, the reader is familiar with the verses of prohiition of *ia in the 7uran. ;nfortunately, negligent interpretations of the meaning of those verses has led many individuals to assume that the prohiition only relates to situations where the creditor is likely to charge e#ploitatively high rates of interest. 9ne of the most popular translations of the meaning of the 7uran, @usuf 'li (2332), translates the meaning of verses -$-A -30 thus$-A. O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are Indeed believers. -3. If ye do not, take notice of war from Allah and His essenger but if ye turn back, ye shall have your capital sums #eal not un$ustly, and ye shall not be dealt with un$ustly. hus, the Bnglish reader who is not familiar with the end of verse -3 la tazlimuna wa la tuzlamun , reads this translation as a proof that the (soleC) oective served y the prohiition of Riba  is the avoidance of inustice (in the sense of e#ploitation of the poor detor y the rich creditor). 1owever, the meaning of the ending of the verse as e#plained y 'u Dafar, In 'as, and others (c.f. 'l Imam 'l aari (233-, vol.4, pp.253 225)) is much closer to$ if you turn ack, then you should collect your principal, without inflicting or receiving inustice . he e#egetes (iid.) then e#plain without inflicting or receiving inustice as without increase or diminution , where oth an increase or a decrease of the amount returned relative to the amount lent would e considered inustice.;nderstanding the 9ectives of the Law is important for students of Islamic Law. &ote$ In this regard, Islamic scholars have long deunked the e#planation of the prohiition of Riba , solely on the asis of its e#ploitative nature. he interested reader my refer to 'l &awawi (continuation y 'l Suki) (233/, vo2.3$ E far` fi madhahib al. `ulama' fi bayan `lllat al riba fi al 'ajnas al 'arba'ah ).0  1owever, laymen and religious scholars alike must aide y the Law. herefore, what we need to understand is$ what constitutes the foridden Riba , and how can we avoid itC In the remainder of this section, we shall cite 1adiths and urists analyses which e#plain the foridden Riba . Later chapters will deal with the Islamic alternatives to *ia.here are numerous 1adiths which detail the prohiition of Riba . In the interest of revity, I list only two here$2.%uslim narrated on the authority of 'u Said 'l FhudriyG he %essenger of 'llah (puh) said$  Hold for gold, silver for silver, wheat for wheat, arley for arley, dates for dates, and salt for saltG like for like, hand to hand, in e!ual amountsG and any increase is Riba . -.%uslim narrated on the authority of 'u Said 'l Fhudriy$ =ilal visited the %essenger of 'llah (puh) with some high !uality dates, and the :rophet (puh) in!uired aout their source. =ilal e#plained that he traded two volumes of lower !uality dates for one volume of higher !uality. he %essenger of 'llah (puh) said$ this is precisely the foridden Riba  ao not do this. Instead, sell the first type of dates, and use the proceeds to uy the other. he first 1adith enumerates si# goods which are eligile for Riba . Since arter trading (e.g. dates for dates, as in the second 1ad it h) is rarely of concern today, we shall mainly e concerned with Riba  as it pertains to gold and silver, the monies (*oman and :ersian, respectively) used during the :rophets (puh) time. +ith the e#ception of uristic schools which denied the use of reasoning y legal analogy ( qiyas ) as a source of legislation (e.g. the Jahiris), and a few contemporary detractors, most Islamic schools of urisprudence accepted gold and silver in the first 1adit h to signify money in general, including contemporary monies. &ote$ he interested reader may consult In *ushd (233 i G vo2.4, pp.2A4 2A6) for a summary of the maor Sunni school generalizations ased on this 1adith.0  In this regard, the Islamic >i!h ?ouncil of the 9rganization of Islamic ?onference (9I?), in its third meeting in 265 '.1., ruled as follows$'fter reading the studies presented to this ?ouncil regarding this topic, the ?ouncil has determined regarding the legal status of paper currency that it is a form of independent money, for which apply all the legal rulings which apply to gold and silver, including the rulings regarding Riba , Zakah , and salam . he legal reason for this ruling is the use of such monies as monetary numeraires, in terms of which prices are specified ( al thmaniyyah ,).he first cited 1adith makes it clear that there are two conditions for e#changing money for money$ hand to hand, and in e!ual !uantity. his is what is known as a currency e#change contract ( `aqd al sarf  ), where money is traded at the current e#change rate. 1owever, any violation of the 1adith will result in one of two forms of foridden Riba $2. Riba al fail,:  where money is e#changed for money hand to hand, ut in different !uantities, or-. Riba al nasi'ah $ where money is e#changed for money with deferment. he latter form ( Riba al nasi'ah ) is the one upon which most of western finance has een uilt. In the conventional financial sector, financial intermediation is effected through lending, and the tune value of money is reflected in interest payments. 's we have seen, this is une!uivocal Riba , the devourer of which was warned of a war from 'llah and 1is 'postle. Indeed, 'u Kawud narrated on the authority of In %asud (m'pwh) thathe %essenger of 'llah (puh) cursed the one who devours Riba , the one who pays it, the one who witnesses it, and the one who documents it.Similar traditions with slightly different language were narrated in %uslim, 'l =ukhari, and 'l irmidhi. 'nother most damning Iadith was narrated y In %aah and 'l 1akim on the authority of In %asud (m'pwh) that the :rophet (puh) said$
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