Islamic Banking & Finance; IT'S Operation and The Necessity for It's Accommodation In The Global Economy

Temple University
James E. Beasley School of Law
Guided Research Paper





From: Elwaleed M Ahmed
To: Prof. James J. McGrath
Re: Final Draft
Date: July 20, 2004









ISLAMIC BANKING AND FINANCE:
ITS OPERATION AND THE NECESSITY FOR
ITS ACCOMMODATION IN THE GLOBAL ECONOMY








ISLAMIC BANKING AND FINANCE:
ITS OPERATION AND THE NECESSITY FOR
ITS ACCOMMODATION IN THE GLOBAL ECONOMY

By: Elwaleed M Ahmed[1]


The recent phenomenon of Islamic banking and financial institutions

started in Egypt in the 1960s. These banks, which neither charged nor paid interest,

functioned essentially as a saving investment institution rather than commercial

banks, by engaging in trade and industry, directly or in partnership with others, and

shared the profit and loss with their customers and depositors. These banks systems

functioned under the mandates of “shari’a,” Islamic law that prohibits usury and interest.[2]

Thus Islamic finance is based on the principle of profit and loss sharing.[3]

Since then there have been growing demands from Muslims everywhere to have

their finance managed according to Islamic laws.[4] Therefore, in the 1970s, Islamic

financial institutions really took off, due at least in part to the new oil wealth in the gulf.[5]

Since then, “Islamic banking in the Middle East is growing and becoming important in

mobilizing local and regional saving, as well as providing an important source of

capital.”[6]

Contributing to the growth of Islamic banking in the Middle East was the

establishment of the Islamic Development Bank by the “Islamic Organization

Conference” in the early 1970s. The Islamic Development Bank serves as a “World

Bank” for Muslim countries, with the aim to facilitate the expansion of the Islamic

banking and financial institutions in the Muslim countries and world wide.[7] As a result,

the annual growth of the Islamic financial institutions has been an estimated almost 15%

worldwide over the last decades.[8] To understand the principle on which the Islamic

banking and finance is based, It is essential to have some an overview of the Islamic law

and its sources and jurisprudence.

Therefore, to assess the importance of the Islamic banking and

finance in meeting the Muslims community financial need, this article will explain how

the Islamic banking and finance works and the justification of the prohibition of “Riba”

interest in the Islamic law. Moreover, it will explain how the major allowed types of

Islamic financial services work and recommend the best way for Islamic financial

institutions to improve and get acceptance globally by nationally and globally unified

sharia board. Sharia board decides what type of finance is expected in the Islamic law

and recommends the unified accounting and regulatory standard body to

govern the Islamic banking and finance operation in national and global basis. The paper

also recommends the establishment of liquidity markets to handle the operation of the

Islamic banking and financial institutions. Moreover, the paper will recommend how to

accommodate the Islamic banking and finance systems in a global economy, especially in

the non-Islamic countries so as to meets the need of the growing Islamic communities.


In Part I, the paper will purpose that to understand the justification of the Islamic

prohibition of Riba: “Interest” and how the Islamic banking and finance works some

knowledge about Islamic law, its sources and jurisprudence is necessary. Therefore,

include the sources and jurisprudence of the Islamic law: "Figh," such as “Qur’an:”

which is the God “Allah's” word and instruction to his Prophet Mohamed (peace upon

him.) “Sunna:” the prophet’s words and deeds Ijtihad: "Refer to the formulation of the

law by the individual's struggle for proper understanding," Ijm'a: " Consensus of opinion

and Quiyas: " analogical-deduction." And finally, Madahib: "the different schools of

Islamic law Jurisprudence" approach to the issues of Islamic Finance and the prohibitions

of the “Riba” Interest. Part II, includes the types and definition of Riba: the Islamic

jurisprudence divine Riba in two types: “Riba Al-fadil” and Riba: “Al’ Nasia.” The paper

will offer the justification of the prohibition of Riba in the Islamic law and how the

financial affairs are addressed in the Islamic law. Furthermore, the paper will explain

how the Islamic faith is a way of life as well as a religion. Muslims whenever they have

been they always have to adhered to the Islamic principle.

Part III, will include how the Islamic banking and financial institutions operate

and will describe the most common types of the permissible Islamic financial methods,

and how they work and the justification of accepting interest according to the principle of

loss and profit sharing. The expected types of Islamic finance include, Mudraba: “Trust

Financing,” Igra wa-igtin: “Lease/hire-purchase,” Murabaha: “Cost-plus Financing,”

Musharaka: “Venture Capital,” Bai’salam Transaction. Further types include:

“Manazile scheme:” Islamic mortgage housing, property finance a Istisna contract: “is a

contract to manufacture,” Bai’ bi thamin ajil: “sale by deferred payment,” Al-wadiah:

“non-fund transaction” and Qurde-Hasan: “ Benevolent financing.”

Part IV, will include a comparison between the Islamic banking and finance

systems and the conventional banking systems: "Western banks" and the major criticism

of the Islamic banking and finance.

Part V, the final section of this paper will include recommendations.

(I): How to improve the operation and effectiveness of the Islamic banking and finance

system by :

A: The necessity of the existence of the unified Sharia board in the national and global

based so as to unify the decision on what are permissible types of Islamic financial

globally.

B: The necessity of the unified accounting and regulatory standard body to govern the

Islamic banking and finance nationally and globally. For the Islamic financial institution

to succeed and to achieve global acceptability and continue its rapid expansion it needs to

establish universally accepted accounting, auditing and regulatory standard.

C: One of the major challenges to Islamic financial institutions remains how to

handle their liquidity. Therefore, there is a necessity of the establishment of liquidity

markets to handle the operation of the Islamic banking and financial institutions.

(II): How to accommodate the Islamic banking and finance systems in global

economy especially in the non-Islamic countries so as to meets the need of the

growing Islamic communities including:

A: Since the Islamic law did not require the banks to be Islamic bank or all its

resources to be Halal “permitted,” then the conventional institution can have subsidiaries

offer Islamic finance to Muslim and non Muslim alike as an alternative to the interest-

finance. Therefore, there is a possibility of establishing Islamic financial institution in the

US as a subsidiary for the conventional banks.

B: The possibilities of opening non- banking Islamic financial Institution dealing

mainly in providing the basic Islamic financial services in the non – Islamic countries.

Part I: The Source and Jurisprudence of the Islamic law: “Figh:”

The science of Figh is directed no less toward understanding and analyzing the

deeds and sayings of the prophet Mohamed (Peace upon him), as toward the written

word of the God’s ‘Allah’ Mandates, and to find and collect the different norms of

Islamic law.[9]

In order to understand the justification of the Islamic prohibition of “Riba”

interest and how the Islamic banking and finance works you have to have some

knowledge about Islamic law its sources and jurisprudence what follows are some

illustration:
A: Qur’ an: “the holy book of the Islamic faith,” The Qur’an is understood by

Muslims to be the infallible words of God “Allah” and contain instruction in both

religious and daily aspects of life.[10] Thus the Qur’an consists of the revelation made by

God “Allah” to the prophet Mohamed (Peace upon him) and lays down the fundamentals

of the Islamic faith including beliefs and all aspects of the Islamic way of life.[11]

Therefore, the scholars have treated the holy Qur’an as a text that contain the general

principle by which all matter should be regulated. And where the meaning of the holy

Qur’an was imprecise they sought clarification from the “Sunna Hadeath.”[12]

B: Sunna: “Tradition of Prophet Mohamed” (Peace upon him). Because God

“Allah” was “revealed to the prophet Mohamed, his actions and sayings were and are

believed to be the best possible interpretation to God’s commandments contained in the

Qur’an.”[13] Thus Sunna is the teaching of the Islamic principle by the prophet

“Mohamed,” recorded only after having been deemed valid by religious scholars in

decades after the death of the prophet “Mohamed.”[14]

C: Ijtihad: refers to formulations of the law reached via the individual’s struggle

for proper understanding, using reason and judgement to determine a course of action in

keeping with the spirit of the holy Qur’an and Sunna.[15] Thus, Ijtihad “means the

independent interpretation of law by one who has learned to solve a situation that is new

or for which there is no precedent or authority or pronouncement in other sources of

Figh.”[16] Ijtihad was based on the linguistic and religious knowledge and was conducted

piously and in good faith. The “Mujtahid,” the one who conducted the Ijtihad, didn’t

have to fear retribution from God “Allah.”[17]

D: Ijm’a: “ consensus of opinion,” is the informed consensus of the community

of scholars, and was established not for matter of faith or fundamental observances,

which were agreed upon, but on the application of the shari’a law to world’s affair.[18]

E: Qiyas: “ Analogical deduction” or analogy from established law mean that by

comparing two things one may be evaluated in the light of the other.[19]

F: Madahib: refers to “schools of thoughts in the Islamic law.” There are two

major schools of law in the Islamic jurisprudence: “Shia” and “Sunna.”

I: Shia, which has various sub –section is predominate in Iran Iraq, India and

many of the Gulf states. There are considerable doctrinal differences between Shia and

Sunni in terms of who is permitted to interpret the Islamic law. The shia believe the

living religious scholar, known as “Mujtahids, have an equal right to interpret the divine

law as the eminent jurist of the past and their judgement replaces the Sunni source of

deduction by analogy, Qiyas.”[20]

II: Sunni, The majority of Muslims follow Sunni school of thoughts. Sunni legal

doctrine has four main schools of thoughts, each with its own system of theory and

application of law. However, they all recognize the legitimacy of all the others. In Sunni

the four schools of thoughts are Hanafi “Rationalist,” Malki “Traditionalist,” Hunbali

“Fundamentalist” and the Shafii “Moderate.”[21]Furthermore, these four schools of law

give different emphasis to the source of law, but all are anonymous in requiring that

Islamic law be God “ Allah,” is not man's creation and the holy Qur’an and Sunna are

fully binding. The other sources of authorities are in one way or another justified by

reference to these two basic laws.[22] These schools of jurisprudence differ in their

interpretation of the importance of the Ijtihad, the component of the Ijtihad and Ijma’a,

and the importance of how certain individuals can interpret almost all-religious issue.

Individuals are given much freedom in choosing the particular of the law they wish to

follow.[23]


Part II: The Types and Definition of “Riba” the Justification of its Prohibition in the Islamic Law and How the Financial Affair Addressed in Islamic Law:

(I): The definition of the “Riba” in Islamic law:

Riba is defined as any increase over the nominal value of the sum lent.[24]

Moreover, according to the Qur’an, “Riba” is neither a sale nor voluntary charitable act,

“it is an equitable exchange destructive to and out of place in fair economic

order.”[25]Thus, he definition of Riba as usury includes interest and other forms of profit or

gain that are not earned from work efforts.[26] “Islamic law prohibits any profiting from

supply of capital without any personal engagement or exposure to financial risk.”[27]

Therefore, Riba prohibits any predetermined fixed positive return to the

loan as a reward for the delay.[28] Also, considered Riba is any ‘excess to exchange of two

or more commodities of the same type taking place in the spot market. “This prohibition

aims to ensure that no legal trick or device will be used as back-door to Riba, associated

with deferred transaction.”[29] Furthermore, the purchase of the government bonds and

firm securities with fixed rate of return are considered Riba and hence prohibited.[30]

(II): Islamic Jurisprudence Divides Riba into Two Types:

A: Riba Al-fadl: “excess on exchange” defined as Riba arising out of barter or

sale. Riba Al-fadl involves an exchange of unequal quantities and qualities of the same

commodity simultaneously[31].

B: Riba Al-nasia: “excess on loan” defined as Riba arising out of money

exchanges “Loan.”[32] “Riba Al-nasia involves the non- simultaneous exchange of equal

qualities and quantities of the same commodity.”[33]

(III): The justification of why the Islamic law prohibits the Riba:

The prohibitions of Riba in Islam seek to prevent usurious condition in exchange

and loan,[34] because “the Islam’s economic ideal is one of legal fairness, of mercy, and

leniency in times of hardship.”[35] By prohibiting certain classes of interest in either trade

or loan, Islam seeks to correct the usurious practice which is a desirable result,[36] because

Riba is a raise from an unequal unfair exchange, namely an increase over the principle a

mount lent or the quantity traded.[37]

Thus, Riba is prohibited because “it is a contract that contains certainty, while

real life is not certain.”[38] Riba is an unearned profit without expected normal business

risk.[39]Moreover, “the practice of Riba enrich the class of money lenders and usurers who

accumulate wealth by impoverishing those who are forced to borrow money or

commodities from them for mere consumption, basic necessities, or for limited

production purposes.” Such lenders do so by charging interest or making uneven trades in

their favor.[40]Furthermore, Riba was an unearned income in the sense that the owner of

the capital who loaned his capital for an increment without contributing any productive

activities, collects profits that are considered illegitimate, because they didn’t give any

equivalent recompense return or counter value “Iwad” to other party.[41]

The prohibition of Riba extends to any and all forms of interest and there is no

difference between interest bearing funds for purposes of consumption or

investment.[42]Furthermore, interest as a predetermined cost of production can contribute

to unemployment and those interest charges can exacerbate business cycles and cause

international monetary crises. Because “interest involves a transfer of property without

counter value those who live on interest have little incentive to work and where

lenders are richer than borrowers interest result in increasing inequality and social

frictions.”[43]

Thus, the Islamic text does not distinguish between borrower and lender, and

supports the idea that the prohibition’s purpose is not redistribution of wealth but to

the assurance of fair economic exchange while allowing return of capital profit and

services charges.[44] It is contrary to Islamic law to make money out of money and that

wealth should accumulate from trade and ownership of real asset.[45]

The reasoning that justifies the prohibition of the Riba is rooted in four

different verses in the holy Qur’an. The first of these verses emphasizes that interest

deprives wealth of God blessing. The second condemns it, “placing interest in

juxtaposition with the wrongful appropriation of property belonging to others.” The third

verses enjoins Muslims to stay clear of interest for the sake of their own welfare. Finally,

the fourth “establishes a clear distinction between interest and trade, urging Muslims first

to take only the principle sum and second to forgo even this sum if the borrower is unable

to repay.”[46] Moreover, Prophet Mohamed (peace up on him) condemns, the one who

takes the Riba, the one who pays it, and the one who writes the agreement for it and the

one who witness to the agreement.[47]

Riba is prohibited in holy Qur’an: Chapter II verse 275 from holy Qur’an state:
Those who devour [riba]
Will not stand except
As stand one whom
The Evil one by his touch
Hath driven to madness
That is because they say:
“[Sale] is like usury [(riba)].”
But Allah hath permitted [Sale]
And forbidden [riba].[48]

And the Qur’an further warns:
O ye who believe!
Fear Allah, and give up
What remain of your demand
For [Riba], if ye are
Indeed believers.
If ye do it not,
Take notice of war
From Allah and his Messenger:
But if ye turn back,
Ye shall have
Your capital sums.
Deal not unjustly,
And ye shall not
Be dealt with unjustly.[49]

(IV): How Financial Affairs are addressed in Islamic law:

Under most schools of Islamic law an Islamic financial system would comply

with at a minimum the following principle: (1): the prohibition of Riba. (2): Risk –

sharing. (3): Prohibition of speculative behavior. (4): Sanctity of contract. (5): Activity

that conforms to Sharia[50]. Because man is an agent, not an original owner, he is not a free

agent in his exploitation of resources and must use methods and means within a frame

work given to him in the satisfaction of his economic means. And the guiding principle of

economic activity is the over all good of the society and nature. Moreover, individual

man being part of the over all fabric, must be given consideration for his wellbeing. Also,

“equitable reward must be given to man according to his effort, to all people according to

their efforts, and from all according to their abilities.”[51]

Therefore, Islam permits the development of wealth, but through socially

conscious means. Successful enterprises that earn a profit are laudable, but the

practitioner must not forget that Islamic principles direct that financial resources should

be utilized for bettering the condition and well being of other.[52] Furthermore, while Islam

permits the individual’s rights to seek his economic well being, Islam makes a clear

distinction between the “Halal:” what is lawful and “Haram:” what is forbidden in

pursuit of such economic activity. In broad terms, Islam forbids all forms of economic

activity, which are morally or socially, injurious.[53]

Part III: Operation of Islamic banking and financial institutions and the types and justification of the allowed Islamic finance:

(I): Operation of the Islamic banking and financial institutions:

On the surface, Islamic banking systems differ greatly from all Western banking

systems. Imagine being able to borrow money without paying interest and having the

financial institutions assume half the risk; this is a common transaction in the rapidly

growing world of Islamic banking.[54]

All Islamic banks or financial institutions have a religious supervisory board

(RSB), consisting of an Islamic scholar, who acts as advisory council to the official of the

Islamic institutions. The “RSB” is set up as permanent institutions located and financed

by the Islamic financial institution “IFI”. The “SRB” oversees the Islamic financial

institution activities according to Islamic law and publishes its opinion in the

Islamic financial institutions annual reports.[55] Thus, the business section of the Islamic

banks works in connection with the supervisory board of religious “SBR” to review

proposed financial transactions to conform to Islamic principle.[56]

The fundamental principle underlying the Sharia approach to finance is that

no one wishing to earn a return on money has any rights to retain the initial sum intact; in

order to earn profit in Islamic finance, it is necessary to take risk. Moreover, the

foundation of the Islamic banking is asset management.[57] Although, Islamic finance rests

on two main principles: (1): the main financed asset must exist. (2): “the financier must

bear the risk associated with this asset for some period of time, and that what will justify

a rate of return on the basis of this risk exposure.”[58]

Investment agencies in the Islamic financial systems work according to a contract,

in which an agent invests funds on behalf of the principal in exchange for a fixed wage or

share in profit.[59] “The principal owns the invested fund, therefore is entitled to the profit

of the investment and liable for its losses, while the agent is entitled to a fixed wage if the

agency stipulates that.”[60]

Furthermore, Islamic-banking systems are based on sales agreements; “Islamic

bank sells you the money, making a profit on that sale. On the other hand, the depositors

in the Islamic banking systems do not earn any return on their deposit while those

holding ‘investment accounts’ earn a shared of the profit and exposed to potential

losses.”[61]In project finance, Islamic banks will lend against the title of a key parts of

given project. Technically it is not a loan, but a purchase and sale agreement.[62]Moreover,

the Islamic bank can pursue sale by order such as “Salam and Istisna” financing, and

then can buy the non- existent goods at a discount such as “ the salam and Istisan price”

and sell the goods later on delivery at retail price.[63]


(II): The Types and Justification of the Allowed Islamic Finance:

The basic role of all Islamic finance is that there must be profit and loss sharing

between the financier and the entrepreneur to justify the interest collected from any

financing operation under Islamic law. Therefore, there has to be some kind of risk

sharing to justify any Islamic finance. Here are some types of the most accepted methods

of Islamic finance:

A: For the Islamic financial institution to succeed in obtaining profit they

concentrate in some specific types of finance, which is easy for them to control the

operation of the financed services so as to minimize the risk of losses. What follows is

the most Frequently used type of Islamic finance:


1:Mudraba: “Trust Financing” is financing transaction equivalent to

“venture capitalism.” It allows the entrepreneur with a business plan to make use of

investor’s capital[64]. Therefore, “Mudraba, in turn is a profit sharing agreement between

two parties in which one provides the finance and the other provides entrepreneurial and

management skill. The profit in this finance is divided on a pre-determined ratio and the

loss borne by the provider of the capital.”[65] In contrast, the bank can’t require any

guarantee such as security or collateral to secure his capital against any loss in the

transaction. But “if there is any negligence or mismanagement or any action beyond those

originally provided for in the contract from the entrepreneur, the entrepreneur will be

responsible for the financial loss and may be obligated to reimburse the financier.”[66] This

financial transaction is permitted because of the risk sharing involved: the investor risks

loss of his capital while the entrepreneur risks his time and effort.[67]

2: Murabaha: “Cost-plus financing” is one of the most familiar and commonly

used finance transactions, mostly in trade and commodity finance. “This finance

transaction involves the purchase of goods by the bank as requested by its client.

Therefore, it is a sale contract between the bank and its client for sale of goods for price

that include profit margin for both parties.”[68]The bank should have the custody of the

goods before signing the sales contract with the client and the bank also should not seek

any collateral that may make the client committed in any way towards the bank.[69] “The

bank in Murabaha bears the risk during the period between the purchasing of the goods

and reselling of it to the customer,”[70]also by the risk of allowing the client to refuse to

accept the goods procured on their behalf by the bank. Thus those risks are what justify

this transaction[71].



3: Igra wa-igtin: “Lease/hire-purchase.” In this transaction if the client requests

“the banks to purchase the equipment or goods and resell them to him, the bank will be

the owner of these items and the client pay a fixed amount for its use.”[72] “If the client is

committed to purchase the equipment from the bank at the end of the rental period, the

price is determined in advance and thus the installment payment would include both the

rental price and the purchase fee of the equipment.”[73] The fund on these financials is

secure, because in order to obtain the fund the investor must offer collateral[74].

Furthermore, the bank in this finance transaction bears the risk throughout the life of the

lease contract[75]. Therefore, the bank takes the owner obligation and that will justify its

return in accordance with Islamic law.[76]

4: Musharaka: “Venture Capital” “is an equity participation arrangement and

equivalent to a partnership arrangement. In this finance arrangement all partners share in

finance and management, and the profits are distributed according to pre-agreement ratio,

but losses are shared on the basis of equity participant.”[77] “This a true partnership where

investor and the agent have a joint profit and loss –sharing and decision making.” [78]

Furthermore, this involves active participation from both the financial institutions

and its client since all of them depend on the revenue sharing in the form of the

percentage of the net profit rather than the interest. And this will encourage close scrutiny

and assessment of the viability and the implementation of the their investment. On the

other hand since the client also contributes capital and becomes partner, he will be eager

for the success of the investment.[79]

B: In the following types of Islamic finance, the risk of loss is high because the Islamic

financial institution has no very effective procedure to monitor the operation of the

financed services, therefore, the following financial services are not frequently followed:

1: Bai’salam Transaction: “In this finance transaction the goods purchased are

paid for in advance at the time of the execution of the contract, but the delivery of the

goods is delayed until a later date.”[80] In order for this contract to be valid all conditions

associated with the contract such as price, quality and quantity of the goods have to be

determined when the contract is signed.[81] Hence, “this Salam contract is considered as an

exception to the general role of the Islamic law which prohibits the sale against advance

payment for future delivery of the goods, in order to meet the instant need for the

farmer’s sale,”[82]and to serve the public need. Therefore, this contract should be applied to

goods transactions and not to the transaction of currencies.[83]

2:Manzile Scheme: “Islamic Mortgage and Housing property finance:” This

finance is based on Musharaka and Ijra wa’ Igtina “lease and partnership” concept and

requires the financier and the client to participate in the joint ownership of the

property. “The share of the financier is divided into a number of units, and the client is

able to purchase those units one by one periodically.”[84]Therefore, “in the Islamic

mortgage, the repayments were based on the implicit rental value of the property rather

than on the basis of the interest. And that will provide a fixed repayment mortgages for

homebuyers and investors in private property.”[85]

3: Istisna contract: “a contract to manufacture” is a new concept in Islamic

finance. “In this finance transaction the manufacturer agrees to produce, build and to

deliver a well described good at given price on a given date in the future and the price

does not need to be paid in advance. It may be paid in installments while the job is being

completed or the asset being manufactured or constructed.”[86] “In this contract it should

be ensured that the goods subject to the contract are manufactured and not in their raw

status. Therefore, the Istisna contract is not applicable to grain millet and rude oil.”[87]

4: Bai’ bi thamin ajil: “sale by deferred payment:” This finance involves the

bank purchasing the asset, equipment or goods desired by its client to whom it then

resells the items for an agreed of cost-plus profit.[88] Therefore, this transaction involves

purchase and resale of property for a higher price on delayed basis[89]. It justifies that

because of the risk the bank had if the client refused to take the goods after the bank

purchased the good.

5:Al-wadiah: “non-fund transaction:” This is similar to a saving or investment

account in a conventional bank. “In these accounts the bank does not give interest and

they are in essence a safe keeping arrangement between the depositor and the bank. They

allows the depositors to withdraw their money at any time and to permits the bank to use

the depositor’s money.”[90]

6: Qurde-Hasan: “Benevolent financing:” This finance falls under the charitable

activities of these Islamic financial institutions. “It happens when the financial

institutions provide loans free of charge, basically with intent to provide financial

assistance to failing institutions or humanitarian assistance to individuals. Therefore, for

the financial institutions to make sure it is repaid they may require from the customer to

provide collateral and those institutions may charge a small fee to cover their

administration fee.”[91]


Part IV: Comparison to criticism of the Islamic financial institution:

A: The Comparison between the Islamic Banking System and Conventional Banking

System:

There are some basic differences between the Islamic banking system and the

Western banking systems “the conventional banks.” First Islamic banking systems do not

charge or pay interest and they will not invest in enterprises they believe to be immoral,

where the banker shares in the management of the borrowed fund during the life of the

loan.[92] Moreover, Islamic banks, unlike their counterpart “conventional banks” have to

share in the risk of their transaction.[93]

“In capitalist society, the ability for one to reap profit from investment is the

most valued concept of the economics and interest is a pivotal concept.[94] Therefore, The

capitalist motivational system is market oriented with particular emphasis on profit

motive. On the other hand, in the Islamic finance, the motivation is profit but guided by

moral and spiritual concerns rather than market concern.[95]Furthermore, it is accepted that

“the capitalist system uses profit not as a means but as an end that will satisfy the

individual, while the Islamic system uses profit as a mean to achieve its spiritual end.”[96]

In conventional banks the client is obligated to repay the bank, the principle amount

of the loan, plus a set rate of interest over a term of monthly installments.”[97] Thus, the

conventional banks is based on borrowing and lending and Islamic bank is based on

selling.[98] Furthermore, Islamic finance is asset –based, or based on “money for asset,”

opposite to “money for money” in the conventional banks.[99]


In contrast, there are differences between a conventional leasing and ajara in

Islamic finance. “In Islamic finance, a lease/hire begins the date the asset is delivered to

the client not the date the contract is signed as in the conventional banks. In Islamic

finance, the lessee is not liable for the full rent if the asset is destroyed and the factors in

the cost of insurance at the time the rent is fixed. Moreover, the purchase in Islamic

finance at the end of the contract can not be made binding.”[100]Furthermore, what

distinguishes “Mudaraba:” cost plus finance from traditional interest based –finance that

the recognition of the risk that assumed by the banks as a titleholder of the goods in

“Mudaraba:” cost plus finance transaction.[101]

B: Criticism of Islamic banking and finance:

It would seem that a banking system that is based on the moral and spiritual

principle could have no critics, but this not the case. In Islamic banking and finance,

loans tend to have a complicated buy and lease instruction and the interest-free financing

carries numerous services and finance charges that can make the cost equal to fund

advanced from the conventional banks.[102] This is true despite the fact that the Islamic

model of finance in some cases seems to guarantee a fixed rate of return, and in reality

no risk is shared by the financier with entrepreneur.[103]

Furthermore, the inflexible interpretation of Riba imposes on the borrower the

need to hire a legal advisor to instruct them on complex finances methods. On

the other hand, “the fee charged on the profit sharing simply replaces in form of thought

not in name the interest charges.”[104] Moreover, when Riba is interpreted broadly to

include all interest, the Islamic financial institution used the methods of trust financing,

equity participation and leasing to circumscribe the Riba’s problems.[105]

In consequence, Islamic financial institution is exposed to greater liability under

national and international law, because it assumes the ownership responsibilities. These

include not only the risk of the losses or damages to the asset being funded but also any

liability arising out of the use of the asset.[106] Therefore, “the Islamic banking and

financial systems can not survive and grow solely on the basis of committed ethical

depositors or investors.”[107] On the other hand, Since the risk costs are shared in the

Islamic banking and finance systems, as a result their products and services can be

competitive.[108]

“The US government criticizes the Islamic banking systems as being a soft touch

for money laundress and terrorism financier.”[109] On the other hand, the Islamic banking

and finance supporters argue that, money laundering is hard through Islamic banking

systems, because the element of risk sharing means there is “a closer know-your

customer” approach, and that may deter the money laundering.[110]Moreover, “high

transaction cost and low-level of capital will keep the Islamic bank from being

competitive with conventional banks.”[111]

Part V: Recommendation and Conclusion:

(I): How to improve the operation and effectiveness of the Islamic banking and finance system:

A: The necessity of the existence of the unified Sharia board in the national and

International levels in deciding what types of financial services are conforming to the

Islamic law:

There is a need for setting up Sharia board at global and central banks level, so as

expedite and perhaps assist in developing some standard guidelines for conducting

Islamic financial transaction.[112] Sharia board at individual banks actually defines what is

and is not Islamic banking. Thus, transaction will be interpreted differently and that will

lead to uncertainty about what is the acceptable way to do business in Islamic banking

and finance systems, which in turn will complicate the assessment of risk for both the

financial institution and its customer.[113]

B: Necessity of the unified accounting and regulatory standard body to govern the

Islamic banking and finance nationally and globally:

For an Islamic financial institution to succeed it needs to establish universally

accepted accounting, auditing and regulatory standard in order to achieve global

acceptability and continue its rapid expansion.[114]Therefore, “there is a need to develop

uniform accounting and reporting structures among Islamic financial institutions.

Furthermore, the Islamic financial institution needs to recognize the responsibilities of

regulators to apply national supervisory principle to all Islamic financial institutions

especially the effective liquidity management, the definition of a deposit and the

standardization of accounting and disclosure.”[115]The lack of a thorough comprehensive,

and consistent a counting standard and the lack of the effective regulation is vital for

Islamic banking to continue grow is to overcome those problems.[116]


Therefore, there is a need for unified Islamic accounting standard covering areas

such as the presentation of financial statement and disclosure in the Islamic financial

institutions. Thus, the Islamic accounting standard must seek to comply with international

accounting standard.[117]

C: Necessity of the existence of liquidity markets to handle the operation of the

Islamic banking and financial institutions:

“One of the major challenges to Islamic financial institutions remains how to

handle their liquidity, because those banks have been more successful in attracting

deposit than in identifying funding opportunities.”[118]Thus, liquidity has always been the

most critical issue for Islamic financial institutions, because there are only small

secondary market that exist to enable the Islamic financial institutions to manage their

liquidity, because the Islamic banks asset generally not saleable in any secondary

market.[119]Therefore, “the establishment of genuine inter-bank markets would be a

significant step towards providing Islamic financial institutions with the ability to

maintain an adequate liquidity without holding excessive amount of very short-term

asset.”[120] There is a need to establish international Islamic financial market “IIFM” to

facilitate the development of the an international Islamic money market and to harmonize

the standard regulation and the practices in the Islamic financial industry.[121]

(II): How to accommodate the Islamic banking and finances systems in global economy

especially in the non-Islamic countries so as to meets the need of the growing Islamic

communities:

A: Possibilities of establishing Islamic financial institution in the US:

The US remains relatively closed to Islamic financial institution, because the

federal banking law bars banks in US from holding stakes in their cooperate borrower,

and Islamic banks share in the management risk of any operation they finance.[122] On the

other hand, the Islamic law doesn’t require that the seller of the product be Muslim or

that his own income be “halal” permitted,[123]but the relationship with the seller must be

in line with the sharia but the seller relationship with other parties is not the

responsibilities of the purchaser. Therefore, the conventional banks “ interest-based banks

can offer sharia compliant financial services to both Muslims and non-Muslims

customers as alternative to the interest- based finance.[124]

Furthermore, the advantage of using Islamic finance affiliated with Multinational

institutions, is in their substantial size, perceived solidity and the possibilities of cross

selling Islamic services to existing Muslim clients. Moreover, the wealth of the in-house

expertise available and the efficiency with which they provide their services.[125]

Some conventional banks both within and outside the Muslim world have started to offer

Islamic financial services as an alternative to the interest –based finance. Thus, City Bank

became the first major US bank to venture into Islamic banking, by opening a subsidiary

in Bahrain.[126] Furthermore, several big international financial institutions set –up Islamic

financial subsidiaries such as HSBC’s “Amanah” Islamic financial institutions, and the

UBS’s Noriba had Islamic financial subsidiaries targeting Islamic mortgages and car

finance. Moreover, the Dow Jones established stock market of sharia compliant

companies.[127]

B: Possibilities of Opening Non- Banking Islamic Financial Institution Dealing

Mainly in Providing the Basic Islamic Financial Services to the Muslim Communities in

Non – Islamic Countries:

Since sharia permits using the conventional market as a benchmark or as standard

to Islamic financial services, some Islamic financial services could exist to the

Muslim communities in the US. “Amana Vehicle finance” for example could use a fixed

payment scheme that is competitive with conventional vehicle loans available in the

market.[128]

Conclusion:

Since the Cold-War era, there has been a massive Islamic movement within the

Islamic countries and the minorities Muslims communities around the glob. This

movement has demanded that the Islamic law governs all aspects of their life from

political, economic and daily life according to the Islamic principle.

Therefore, the need to expand the Islamic financial institutions services to

accommodate the Islamic communities needs will continue to grow rapidly in the near

future. There is need for collective efforts from the bankers, economists and the

Islamic legal scholars to develop financial solution that meet the religious requirement to

the Muslim’s communities.[129]Moreover, “the Islamic financial community must accept

that their institutions have to be regulated and supervised to meet the international

standard. Ultimately their ability to grow and compete will depend on international

acceptance of the regulatory regime.”[130]

There is need for universally accepted principal governing Islamic financial

dealing, before the system can be accepted internationally, because the weakness of the

Islamic financial market has also resulted from the lack of the common Islamic

accounting and legal framework governing the Islamic financial market.[131] Since the

Islamic law does not require the banks to be Islamic banks or all its resources to be Halal

“permitted” then the conventional institution could have subsidiaries offer Islamic

finance to Muslim and non-Muslim alike as an alternative to the interest-finance. This

might be used mainly to offer the most needed financial services such as mortgages and

car financing to the minorities’ Muslim community in the non-Islamic countries. Such

efforts are needed to meet the needs of an ever-growing Muslims communities trying to

live their lives according to their beliefs.

[1] Elwaleed M Ahmed, International LL.M (Master of Laws) student, James E Beasley School of Law, Temple University, Philadelphia-Pa U.S.A.(2004), B. A. (Sharia & Law) Omderman Islamic University, Sudan (1995).
[2] T. S. Twibell, Implementation of the United Nation Convention on Contracts for the Sale of Goods (CISG) Under Shari’a (Islamic Law); Will Article of (CISG) be Enforced when the Forum is in Islamic State? 9 Int’l Legal Persp.25 at 72 (Spring-Fall1997).

[3] Mahmoud A. El-Gamal, Fourteen Annual Philip D. Reed Memorial Issue, Islamic Law and Finance, ‘Interest’ and the Paradox of the Contemporary Islamic Law and Finance, 27 Fordham Int’l L. J. 108 at 124 (December, 2003).

[4] Wilson Rodney, Islamic Banking: Going Global-the Muslim Banking Worlds Faces the Challenge of Expanding International while Remaining True to Islamic Principles. The Banker. (March 1, 1995). (Available at LexisNexis ‘Magazine and stories/ combine’).

[5] Wilson Rodney, Islamic Banking, Book Review; Islamic Banking by Mervyn K. Lewis and Latifa M. Algaoud, Economic Society of Australia, Economic Record Vol. 78 at 375. (September 1, 2002). (Available at LexisNexis ‘Magazine and stories/ combine’).
[6] Ali Nazim, Points of law; Middle Eastern Banking, Business Intersperse Ltd. (UK). The Banker, Vol. 149 at 67 (February 1, 1999). (Available at LexisNexis ‘Magazine and stories/ combine’).
[7] Supra Note 4.

[8] Anouar Hassoune, Says Standard & Poor’s, Key Rating Factors for Islamic Banks-Although Sometimes Complex; Analyses Islamic Financial Institutions on the Same Basis as Conventional Financial Institutions. The Banker at 1 (February 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).

[9] M. Cherif Bassiouni, Gamal M. Badr, Saad El-Fishawy, Farooq A. Hassan and Erik Peterson, Islamic Law, A survey of Islamic International Law, Contract and Litigation in Islamic Law the Source of Islamic Law. 76 Am. Soc’y Int’l L. Proc.55 at 65 (April 22-24, 1982).
[10] J. Michael Taylor, Islamic Banking – the Feasibility of Establishing an Islamic Bank in the United States, 40 Am. Bus. L.J. 385 at 416 (winter 2003).


[11] Munawar Igbal, David T. Llewellyn, Islamic Banking and Finance; New Prospective on Profit Sharing and Risk. Edward Elgar Publishing Limited at xii (2002).

[12] Mervyn Lewis, Latifa Algaoud, Islamic Banking, Edward Elgar Publishing Limited at 22 (2001).
[13] Supra Note 9 at 65.
[14] Supra Note 10 at 416.

[15] Supra Note 12 at 22.

[16] Supra note 9 at 67.
[17] Supra Note 2 at 61.

[18] Supra Note 12 at 22.

[19] Id.
[20] Id. at 23.
[21] Id. at 24.
[22] Id.
[23] Id.

[24] Barbara L. Seniawski, Riba Today: Social Equity, the Economy and Doing Business under Islamic Law. 39 Colum. J. Transnat’l L. 701 at 717(2001).
[25] Id. at 707.
[26] Supra Note 10 at 416.
[27] Elias G. Kazarian, Islamic Versus Traditional Banking; Financial Innovation in Egypt. West View Press Inc. At 53 (1993). (Available at LexisNexis ‘Magazine and stories/ combine’).



[28] Id. at 50.
[29] Id.
[30] Id. at 53.
[31] Supra Note 21 at 35.
[32] Supra Note 24 at 710.

[33] Supra Note 21 at 35.
[34] Supra Note 24 at 717.
[35] Id. at 704.
[36] Id. at 707.
[37] Id.
[38] Supra Note 11 at 31.

[39] Supra Note 10 at 391.

[40] Supra Note 24 at 704.

[41] Id. at 728.
[42] Supra Note 10 at 385.

[43] Supra Note 5 at 373.
[44] Supra Note 24 at 711.
[45] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1 (October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).



[46] Supra Note 24 at 728.

[47] Id. at 36.
[48] Supra Note 24 at 728.


[49] Id.
[50] Supra Note 24 at 704.

[51] Supra Note 10 at 388.
[52] Id.
[53] Id. at 416.
[54] Martin Josh, Islamic Banking Raises Interest; Including Related Article on Islamic Business. American Management Association, Management Review, vol. 86 at 25 (November 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).


[55] Supra Note 27 at 54.


[56] Supra Note 10 at 394.

[57] Fitch, Islamic Banking Unveiled, Financial Times Business Limited, Pension Management, (January 1, 2002), (Available at LexisNexis ‘Magazine and stories/ combine’).

[58] Supra Note 3 at 129.
[59] Id. at 145.
[60] Id.
[61] Id. at 127.
[62] Supra Note 54 at 26.

[63] Supra Note 5 at 373.

[64] Id. at 168.
[65] Supra Note 54 at 28.

[66] Supra Note 27 at 163.

[67] Supra Note 64 at 168.

[68] Supra Note 54 at 18.

[69] Supra Note 6 at 68.


[70] Supra Note 3 at 129.


[71] Supra Note 64 at 170.


[72] Hesham M. Sharawy, Understanding the Islamic Prohibition of Interest. 29 Ga. J. Int’l & Comp. L. 153 at 170 (fall, 2000).
[73] Supra Note 54 at 18.
[74] Supra Note 27at 164.

[75] Supra Note 3 at 129.


[76] Supra Note 11 at 200.


[77] Supra Note 54 at 28.

[78] Supra Note 24 at 723.

[79] Supra Note 29 at 107.

[80] Supra Note 64 at 170.

[81] Supra Note 27 at 52.

[82] Kamal M. Amjad Main, Book Review. Specific Application: Commercial Transaction and Financing, Islamic Law and Finance; Religion Risk and Return. By. Frank E. Vogel & Samuel L. Hayes III. The Hague and Boston: KLumwer Law International. I5 J L. & Religion 475 at 477 (2000-2001).
[83] Supra Note 27 at 52.

[84] Supra Note 29 at 58.
[85] Supra Note 11 at 199.

[86] Id. at xii.
[87] Supra Note 6 at 68.

[88] Supra Note 24 at 728.

[89] Supra Note 62 at 170.
[90] Id. at 168.
[91] Supra Note 10 at 399.

[92] Supra Note 54 at 26.

[93] Id.
[94] Supra Note 64 at 153.
[95] Id.

[96] Id.
[97] Supra Note 64 at 153.


[98] Supra Note 54 at 28.


[99] Supra Note 3 at 129.

[100] Supra Note 10 at 396.

[101] Id at 416.
[102] Supra Note 54 at 25.

[103] Supra Note 64 at 170.
[104] Supra Note 24 at 727.
[105] Id. at 720.
[106] Supra Note 11 at 208.
[107] Supra Note 82 at 477.
[108] Supra Note 54 at 26.

[109] Nigel Dudley. Report From Bahrain, Islamic Banking –Structure is Necessary Target- Anew Institution Aim to Set Industry- Wide Standards for Islamic Banking. The Banker at 1 (March 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).
[110] Id.
[111] Islamic Banking’s Exposure to Risk, The Edge “Malaysia”(November 23, 1998). (Available at LexisNexis ‘Magazine and stories/ combine’).
.
[112] Supra Note 57 at 1.
[113] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1(October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).


[114] Supra Note 109 at 1.
[115] Id. at 3.
[116] Richard Dean, Islamic Banking; The Payoff Does the Stanching Rise of Islamic Banking in the Middle East Threaten the Region’s Conventional Banks? Arabia Trends (May 1, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).


[117] Financial Reporting Islamic Institutions A risk –free return? -It’s Forbidden. Accountancy (April 30, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).



[118] Supra Note 5 at 1.
[119] Supra Note 8 at 1.

[120] Supra Note 113 at 1.
[121] Islamic Banking in Malaysia, Euromoney Vol.33 Pg. SSSS4 (September 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).


[122] Supra Note 64 at 153.
[123] Supra Note 3 at 147.

[124] Id. at 148.
[125] Supra Note 11 at 1.

[126] Supra Note 54 at 26.

[127] West Meets East, The Economist “ U.S Edition,” (October 25, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).

[128] Supra Note 3 at 148.


[129] Supra Note 121 at 3.

[130] Supra Note 116 at 1.
[131] Sidek Kamiso, Islamic Financial Market Needs Universal Accepted Principles. The Edge “Malaysia” (February 20, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).