ISF 1101 – Foundation of Islamic Finance

Philosophical
Foundations
Outline

• Islam as way of life

• Why Islamic finance?
• What is Islamic finance?
• In what ways is Islamic finance different?
• Shari’ah
• Maqasid al-Shari’ah
• Time value of money
• Critical discussion
Islam as Way of Life (ad-Din)

• Islam prescribes a detailed code of

conduct for every aspect of human
activity
• Goes beyond activities categorized as
rituals (prayers, fasting, Hajj, etc.)
• In fact, all human activities (including
day-to-day mundane ones) can be
viewed as acts of worship (ibadah)
• This includes economic and financial
activities
Why Islamic Finance?

• No human endeavour is completely

value-free
• Our values are derived from our
worldview
• Given that the Islamic worldview is
different from the Western (Occidental)
worldview
 Principles and practices of conventional
banking and finance (which are based
primarily on the Western worldview) may
be inconsistent with the Islamic worldview
What is Islamic Finance?
• Islamic finance provides financial
services in accordance with the Shari’ah

• Islamic financial services emphasize

ethical and social dimensions of financial
transactions to enhance equity and
fairness for the general good of society
In what ways is Islamic finance different?

• Source of knowledge – Includes revealed

(divine) knowledge
• Supersedes scientific methods and human
intuition

• Intention – acts of worship to seek Allah’s

blessings
• Apart from fulfilling man’s needs

• Guiding principles – justice, cooperation,

empathy, altruism, entrepreneurship
• Not purely profit maximization
The Shari’ah

• Literal meaning – path to watering place

• Technical meaning
– Path to tread for guidance in this world
– Commands, prohibitions, values
• Fiqh
– Understanding of the Shari’ah
– Practical Shari’ah laws, principles and values
derived from sources of knowledge
– Product of human effort and aql
• Objectives of the Shari’ah (maqasid al-Shari’ah)
Components of the Shari’ah

Islamic Shari’ah

Tawhid Fiqh Akhlaq

• Belief in oneness • Rules and • Islamic code of
of Allah Guidelines conduct
• Economic • Al-muamalat – • Ethics, morality
resources rulings related to and positive
entrusted to man, economic attributes
will be held transactions (honesty,
accountable for kindness,
its use sincerity)
Maqasid al-Shari’ah

• Objectives and the rationale of the Shari’ah

– The Shari’ah aims to protect and preserve
public interest (maslahah) in all aspects and
segments of life
– Many Shari’ah texts clearly state the
reasoning behind certain Shari’ah rulings
• Elements that need to be protected
– Faith (din), human self (nafs), intellect (‘aql),
posterity (nasl), wealth (mal)
• Concept of maslahah often interchangeable
with maqasid
– Seeking benefit and repelling harm
Maqasid al-Shari’ah and Maslahah

• While Maqasid al-Shari’ah (objectives of the Shari’ah)

and the related concept of maslahah (benefit to society)
should become the foundation of Islamic finance
practices,
• It should not be over-emphasized, to the point of
rejecting or superseding definitive (qat’iyyat) textual
Shari’ah sources
– Need to recognize limitations of human
perception and cognitive ability
• Macro “maslahah” should override micro “maslahah”
• “They ask you concerning wine and maysir. Say: In
them is great sin as well as benefits to people, but the
sin is greater than the benefit.” (Qur’an, 2:219)
Maqasid al-Shari’ah – Implications to Islamic Finance

• A holistic view should be adopted in Shari’ah interpretation

– Micro vs. macro maslahah (tree vs. forest)
• Legal form vs. economic substance
– Validity [meeting all contractual conditions and
requirements] (sahih) vs. permissibility [having legitimate
purpose and intention] (halal)
• Purely financial goals (profit, growth, market share) alone
insufficient
– Need to develop proxies of spiritual well-being (e.g.
distributive justice, cooperation among economic agents,
equitable access to economic resources)
– These complementary yardsticks should be incorporated in
the performance measurement of Islamic financial
institutions
• Profit sharing schemes vs. fixed-return techniques
• Critical appraisal of the “infancy” argument
– Sustainability and viability vs. healthy direction of
development
Some Important Points to Note

• Islam provides a comprehensive solution, its

prescriptions encompasses all aspects of life
 A specific discipline (such as finance) must be viewed
and addressed within a larger context
 Holistic approach

• Conventional knowledge should not be completely

rejected
 There can be common grounds or areas of
conventional knowledge which are acceptable to
Islam
 Some general concepts can be adopted and amended
 Economic growth
 Efficiency
Time Value of Money

• A fundamental concept in finance

• The idea that a dollar today is worth more than
a dollar to be received in the future due to:
• Personal preference for current
consumption
• Risk (probability of receipt of future
dollars)
• Investment opportunities forgone (returns
on dollars invested today not available to
future dollars)
• Reduced purchasing power caused by
inflation
 Time Value of Money – An Islamic Perspective

• Islam does not reject the idea of positive time preference

• After all, time has economic value as consumption and
production activities consume time
• Islam recognizes that the lender makes a sacrifice
• Hence why lending is a virtuous act
• And why the debtor is encouraged to repay in excess
Narrated by Abu Huraira:
A man came to the Prophet and demanded a camel (the Prophet owed
him). Allah's Apostle told his companions to give him (a camel). They said,
"We do not find except an older camel (than what he demands). (The
Prophet ordered them to give him that camel). The man said, "You have
paid me in full and may Allah also pay you in full.“ Allah's Apostle said,
"Give him, for the best amongst the people is he who repays his debts in
the most handsome manner.“
Sahih Bukhari Vol.3, Book 41, No.577
• However, while voluntary extra repayment of debt is
encouraged, making it contractual amounts to the
prohibited riba
 Time Value of Money – An Islamic Perspective (2)

• Time value of money can however be incorporated in

commercial transactions
• Sale of goods on deferred payment terms (for e.g.,
murabahah)
• Time value of money built into calculation of profit
on sale or quantum of profit mark-up to reflect the
fact that receipt of sale proceeds is delayed
• Investor in a business has right to a share in profits (for
e.g., mudarabah)
• Investor foregoes use of funds in exchange for right
to proportion of returns generated by the invested
funds
• In this respect, time value is applied not to money itself but
on economic usage of money
• Money cannot be treated as a commodity
Critical Discussion

• Kudos to all stakeholders who have contributed to

development of Islamic finance
• Arguably all disciplines goes through a process of
evolution
• More so in the case of Islamic finance which is
relatively nascent
• To realize such an evolution, it is necessary to ask
probing, even painful, questions
• To challenge the status quo does not necessarily
imply what is currently being done is wrong
• We will only know for sure that we are doing the
right thing if we question ourselves constructively
Probing Questions

• Have we done enough? Is this the end game?

• Is contemporary Islamic finance significantly
and fundamentally different from
conventional (riba-based) practices?
• Is differentiation on the basis of nomenclature
and legal technicalities sufficient salvation
from the threat of war from Allah and His
Messenger?
• How should we address the present gap between
ideal and reality?
• Persist with idealism or focus efforts on
compromised objectives?
• Is Islamic finance an alternative or panacea
(solution)?
Role of the Shari’ah

• As guidance and source of reference, not

merely a tool
• The Shari’ah should not be relegated to being
a means to an end, should be used to
determine the end itself
• Source of differentiation with (and advantage
over) conventional knowledge – revelation
• Reason and observation should not dominate
over divine guidance, avoid secularized
practice of making science replace religion as
authority
Approach to be taken to develop Islamic Finance

• Current trends in Islamic finance reflect :

• “market demands”, “ground realities”, “the need to
acquire critical mass”
• One perspective
• Shari’ah should dictate manmade concoctions, not vice
versa
• We should not be force-fitting Islamic contracts into
conventional instruments
• Islam is for the benefit of mankind, not the reverse
• God Almighty does not suffer the slightest detriment if
Islamic finance is not prevalent or even present
• It is not a popularity contest
• Case for discussion
• If indeed money is not a commodity, is there a genuine
need for short term liquidity instruments?
Approach to be taken to develop Islamic Finance (2)

• Underlying precept of the prohibition of riba

• Islam allows (encourages) lending of money
• Islam allows (encourages) business activities
• Islam does not allow lending of money as a
business
• Critical questions for contemporary Islamic
financial institutions
• Are they in the business of lending money?
• Are they genuinely in the business of trade or
investment?
Important Caveat

• Halal and haram are the prerogative and domain

of our Creator
• The responsibility of dichotomizing human
activities into permissible and not permissible has
been delegated to a select few with the
prerequisite knowledge, competence and
attributes (mujtahid)
• The rest of us may have our own opinions and
perspectives but should strictly refrain from
making pronouncements regarding halal and
haram
• We ask critical questions and indulge in
articulated discussions as part of the learning
process