Assignment II

THE INSTITUTE OF ISLAMIC BANKING &

FINANCE

ASSIGNMENTS OF MODULE III & IV

ID. NO : PGDIBF/542/09

NAME : MOHAMED RIYAS.J

SUBMITTED TO:

THE INSTITUTE OF ISLAMIC

BANKING & FINANCE

SUBMITTED BY,

1

(MOHAMED RIYAS.J)

MODULE III

PART 1

SECTION 1 Each question carries 4 marks

Q1.How are investible funds mobilized by Islamic banks? Mention their sources.

A1. Profit – Loss Sharing principle is the best possible ethical alternative to the most unjust interest rate mechanism of banking and finance. Though the three great religions of the world Islam, Christianity and Judaism – denounce charging of interest, and foremost thinkers such – as Aristotle vehemently condemned birth of money from money., yet the humanity has witnessed the advent and development of banking and financial intermediation that has been solely based on interest rate. With the development of modem banking the influence of interest rate has grown so pervasive that virtually no human being can claim to have breathing without paying interest. While the whole humanity was forced to believe that interest-rate mechanism was as indispensable as God. A few bold and hi highly imaginative minds came forward to refute this belief.

Currently, the Islamic banks generate their funds through following five sources:

i. Shareholders. funds

ii. Customer.s deposits

iii. Mudarabah Inter-bank Money market

iv. Other Liabilities

v. Provision

Q2. Define the role, objectives and duties of Sharaiah Advisory Board.

A2. The role of Shari’ah advisors in Islamic banking

One of the most distinguishing features in Islamic banking is the fact that they are always advised by experts in Islamic Shari’ah. Because the raison d’etre of Islamic banks is the desire to follow the injunctions of Shari’ah in finance and investment, it became essential to give assurances to the public, particularly savers, that the bank is getting professional advise in that mater. Furthermore, since it was difficult to find bankers who are also well versed in Shari’ah board, nevertheless. Some, may have only one advisor. Others may seek the advice of many, but only when the need arises. The majority, however do retain a Shari’ah council which meets occasionally and clear model transactions and contracts, and issue an annual statement attesting the adherence of the management to the advice and instructions of the Shari’ah board vis-à-vis the religious aspects of the business.

2

Objectives:

This is a very important maxim, because the meaning is more revealing to the intention of the parties to a contract. It is because of this contracts in Shari’ah may, shift to be something different from what they are called just because of inclusion of one condition. A condition that makes the agent pledge the Mudarabah capital to the financier, alters the Mudarabah contract from a profit/loss sharing contract to loan contract.

Duties:

a. Provide opinion on matters referred to it from the management of the bank, relating to the activities of the bank and their compliance with Shari’ah requirements.

b. Endorsing model contracts and standard agreements and assuring their compliance with Shariah.

c. Over-seeing the activities of the bank in general and management’s implementation of Shari’ah guidelines issued by the board, in particular.

d. Issuing an annual declaration which accompanies the banks financial statement, recording the board’s views on the compliance of the bank with the Shari’ah requirements, addressed to the equity owners of the bank and its clients.

Q3. What are the instruments of conventional monetary policy found suitable for applicability to Islamic Monetary policy?

A3. Suitability of Conventional Techniques

Methods of credit control Suitability to Islamic economy

1. Legal Reserve Ratio Suitable

2. Bank Rate Policy Unsuitable

3. Open Market Operations Modification Necessary

4. Credit Ceiling Suitable

5. Selective Credit Controls Suitable

6. Lender of Last Resort Modification Necessary

7. Issue of Directives Suitable

8. Moral Suasion Suitable

3

Q4. Describe Istisnaa as an Islamic Mode of finance and the inherent risks involved in this type of finance.

A4. A contract of acquisition of goods by specification or order, where the price is paid in advance, or progressively in accordance with the progress of a job. For example, to purchase a yet to be constructed house, payments would be made to the builder according to the stage of work completed. This type of financing, along with Salam, is used as a purchasing mechanism, and Murabahah and Bai Bithaman Ajil are for financing sales.

Apart from the credit risk of the client of the bank, the bank, is istisna, will be carrying a performance risk. Since bank client has no recourse nor any contractual relationship with the actual manufacturer or contractor, the bank will always be liable for any failure. This risk, however, can be reduced by taking performance bond from the manufacturer or contractor. Furthermore, the contract to manufacture or construct will be based on the same blue prints and specifications provided by the client. The latter can also provide information concerning the best source of supply or the reliable contractor. The bank will have no incentive to choose a contractor or a manufacturer other than the one recommended by the client. Client can even participate in negotiation, without involvement decision making in the contract between the bank and the manufacturer or contractor. Further more, many scholars permitted the bank, once the goods are delivered, to be only guarantor the manufacturer or contractor. Hence, client can have a direct recourse to them while bears the risks only if they fail to honor their commitment Viz. client.

Q5. How is contract defined in Sharaiah? Mention the types of contracts permitted in Sharaiah.

A5. Contract in shari’ah Aqd, means a tie or a knot binding two parties together. The contract is a declaration of offer and acceptance. Unlike English law which developed through the work of judges, Islamic Law of contract developed through the work of Fugaha (jurists), based on the principle laid down by the Quran and the narrations from the prophet (P.B.U.H).

Classification of contracts in Shari’ah:

There are several classification for contracts in Shari’ah. What we are concerned with, however are those concerned with Islamic Banking.

a. Definitive and suspensive contracts

b. Binding (or obligatory) and Facultative (or permissible)

c. Correct and corrupt contracts

d. Contracts of Exchange and contracts of gratuities

e. Specific or nominate contracts

4

SECTION 2 EACH QUESTION CARRIES 4 MARKS

Q1. How does one define IJARAH and what are its benefits? Mention important sharaiah aspects of leasing.

A1. Leasing is well known in the west as a mode of finance. There are many reasons why an agent will opt for leasing rather than borrowing from the bank to purchase the needed asset.

For example:

(a) It is easier to lease than borrow for short term needs since it mostly does not require credit evaluation.

(b) Gives more freedom of changing equipment as technology advances.

(c) Easier to get finance through leasing for companies with lower credit standing. These kind of companies may not be able to borrow from banks or the public and if they do, have do pay high rate of interest.

(d) In many cases leasing can be advantageous from taxing point of view. These advantages may accrue to lessee and sometimes to the lessor since equipment leased remains the ownership of the lessor and hence can be counted, from tax point of view, an investment.

(e) In many countries leasing is an off balance sheet finance. As we are well aware, there are many types of leasing arrangement. These are but few:

1. Operating leases

2. Capital, financial or full-payment lease

3. Full-service or rental lease

4. Direct lease

5. Sale & lease back arrangement

6. Leveraged leases

Q2. Discuss any five Fatwas on Riba with their content any authority.

A2. Fatwas by the Egyptian office of the Multi – 1990 -1989.A.D

1. Subject: Prohibition of bank interest.

Question: Is the use of bank money permissible (Halal) or prohibited (Haram)? Is what is taken of it for trade considered Riba or not (i.e. are business loans taken from a bank at a fixed rate of interest considered to be Riba)?

5

Fatwa: To take business loans from a bank at a fixed rate of interest, as is the custom now, is Riba which is altogether forbidden. Allah, the Almighty knows best.

Source: Fatwas by the Egyptian office of the Mufti, supreme council for Islamic affairs; opinion given by sheikh bakri al sadafi, Egyptian Mufti, Muharram 1325 A.H. / 1907 A.D.

2. Subject: Prohibition of investing deposited money for a fixed interest.

Question: A person asks about the Shari’ah ruling on depositing the legacy of his deceased son’s two daughters in a bank for interest.

Fatwas: Islamic law does not permit the investment of money in bank at a fixed rate of interest because an investment such as this constitute Riba which is prohibited by the Shari’ah.

Source: Fatwa by sheikh abdel majeed saleem, Mufti of Egypt, 1348 A.H. / 1930 A.D.

3. Subject: Interest of bonds is a prohibited Riba.

Question: If one inherits from his father cotton loan bonds on which the government pays interest, is the interest accrued considered a prohibited Riba?

Fatwa: This interest is a type of Riba Prohibited by Allah the Almighty in His Holy book.

Source: Fatwa by sheikh abdel majeed saleem, Mufti of Egypt, 1362 A.H./ 1943 A.D.

4. Subject: Taking interest for money deposited in banks is prohibited; it may not be given as aims.

Question: Is it permitted to take interest for money deposited in banks and give it as aims to the poor?

Fatwa: Taking interest for money deposited in banks constitutes Riba and is prohibited. Giving this interest as aims is unacceptable to Allah, the almighty. He who does so has committed a sin.

Source: Fatwa by sheikh abdel majeed saleem, mufti of Egypt, 1362 A.H. / 1943 A.D.

5. Subject: Practicing work that involves Riba is helping to do something prohibited.

Question: A question was raised about a person who works as a clerk in the Agricultural Credit Bank. Is this allowed, given that he needs this work for his livelihood and that all banking work is based on interest? Is blame attached to him on this account?

6

Fatwa:Undertaking work that is linked to Riba, Clerical or otherwise, is helping to do something illegal. This is prohibited by shari’ah.

Source: Fatwa by sheikh abdel majeed saleem, mufti of Egypt, 1363 A.H./ 1944 A.D.

Q3. Is bank interest Riba? How do you justify it?

A3.

It is not difficult to see the interest in conventional banking is riba. It does fit the definition. It is an increase stipulated in a loan contract. Credit provided by the bank to its clients which is based on interest is clearly so. But even time deposits are nothing but loan (The lender here is the d positor and the borrower is the bank) with stipulated increase. (current accounts are also loans but with no stipulated increase). Furthermore, revolving credit is a type of loan where interest calculation is based on outstanding debt which is delayed in payment. Claiming that interest is not riba is therefore untenable.

Q4. Define few important issues to be discussed regarding Islamic Monetary Policy.

A4. The central bank performs following important functions in a modern economy:

i. Regulation of money supply in keeping with the requirements of the economy;

ii. Influencing the movement of bank finance in desirable directions; and

iii. Providing a measure of safety and ensuring the conduct of prudent banking.

It appears that these functions shall remain valid in an Islamic economy. A central bank would be required to supply the high powered money, to channel finance and investment in the socially desirable directions, to allocate resources in accordance with the priorities of the society and to regulate the functioning of commercial banking system. Commercial banks, in an Islamic Economy, shall be profit making entities like their counterparts in any modern economy. Although Islamic banks are expected to conduct their activities in accordance with the social and economic philosophy of Islam transactions will be profit motive. Hence, an agency shall be required to channel the efforts of different Islamic commercial banks to some common socially desirable goals. Naturally, this agency shall be the central bank of the country.

Q5. What are the major distinguishing elements of Islamic Economic system?

A5.

The economic system of Islam is the collection of rules, values and standards of conduct that organize economic life and relations of production in an Islamic society. These rules and standards are based on the Islamic order as recognized in the Koran and sunna and the huge body of jurisprudence which was developed over the last 1400 years by thousands of jurists, responding to the changing circumstances and evolving life of Muslims all over the globe.

7

Three aspects of the economic system are usually referred to as the major distinguishing elements of any economic system.

1. PROPERTY

In the Islamic system, property is a trust. The real owner is Allah (Subhanahu Wa Ta’ala) Man’s disposal of wordly goods is in the capacity of a viceroy and a trustee. His rights are, therefore, circumscribed by the limits Allah has prescribed, and should be exercised toward the ends Allah has defined. Unlike the capitalist system, the right to property is not absolute but has limitations and qualifications enforced not by the power of the government but by the power of one’s faith and desire to be a pious Muslim. Hence, the common-good is internalized in the decision making process of every Muslim.

2. DISTRIBUTION

Because al – adi (justice and fairness) is a basic value of the Islamic economic order, distributive justice is a major concern of the system. Equitable distribution of income and wealth is therefore an objective by itself. Operationally, this is accomplished through certain institutions which form the back-bone of the social security in Islam. Examples are a bound.

3. ZAKAH

Zakah is not charity, it is a right of the have-notes in the wealth of the haves. It is something entirely different from taxes. It is a measure designed to transfer part of the wealth from the well-to-d-o to the poor and not to the government, because the purpose is redistribution of income and wealth, it is not permissible to use it for building mosques, roads, or financing government expenditure. Furthermore, it is levied on the wealth and not on the individual, at a general rate of 2 ½% per annum.

2.2. LAWS OF INHERITANCE

It would not be possible to guarantee the functioning of the system free from injustices without a built-in-mechanism to prevent injustice reproducing it self generation after generation. Studies show that one of the major causes of inequity in income distribution, is the distribution of wealth. One major outcome of the Islamic laws of inheritance, is to prevent concentration of wealth. This is because legacy is distributed in pre-set ratios which take into consideration need and closeness to the deceased. Yet giving the deceased the right to assign part of his wealth (not exceeding 1/3) to charitable uses.

3. ECONOMIC FREEDOM

Freedom is a cornerstone in the Islamic economic system. In fact, it is so basic that the whole message of Islam came to free man from all kind of slavery. Freewill is a necessary condition for the validity of all contracts. The basic human rights which are now included in the laws of civilized countries have been part of legal system of Islam since the prophet (P.B.U.H). In fact, all the so called Magna-carta has been enjoyed as basic individual rights in Islam for centuries. Further more, to guarantee competition in the market place and freedom

8

of transaction, many measures were adopted by the Prophet (P.B.U.H). Prohibition of monopoly, manipulation of prices and restricting entry to the market are but a few of these measures.

4. THE ISLAMIC ECONOMY IS INTEREST – FREE

Today‘s trade and commerce in the whole world is run on the basis of debt for which interest rates are the bench mark. If we look at the banking system or the capital and money markets in any country we find that financial obligations and receivables are the subject of almost all the transactions and activities. It is no wonder that just the mere thought that interest rate may go up (or down) will bring have to all sectors of the economy. While there is little disagreement within the quarters of Islamic Economists about this “negative” aspect of it, it is always claimed that interest rates play some “positive” role in the economy. This suggested role is two fold: firstly, that it provides incentives for savings, and secondly that it performs an allocative function with regard to capital.

SECTION 3 EACH QUESTION CARRIES 4 MARKS

Q1. What is the basic objective of monetary policy in an Islamic economy?

A1.

The conception and execution of monetary policy of the central bank takes place within an overall policy framework. The raison detre of a discretionary monetary policy is that each of the commercial bank in the banking system can not be allowed to go its own way. Instead, a mechanism should be present to coordinate the credit and investment polices of different banks so that social goals of economic policy may be attained. Hence, the monetary policy must identify some objectives that are considered desirable. Then, it must identify the instruments through which the proposed objectives are to be achieved.

Maintaining price stability, achieving balance of payment equilibrium, promoting economic growth and assuring a reasonable amount of distributive justice are said to be the objective of monetary policy in any modern economy. Shall these goals be any different in an Islamic economy? The Islamic economists. Point out they need not be necessarily different. The specific goals of economic policy. In most of the developing countries following objectives of economic policy may be of special relevance:

1. To promote a sustained and balanced economic growth in the country and to mobilize resources for economic development.

2. To maintain stability in the value of many so as to avoid excessive periodic fluctuations.

3. To maintain stability in the external value of the currency.

4. To promote an equitable distribution of income and wealth.

9

It is pointed out that these general objectives of economic policy need not be any different in the Islamic economy.

Q2. What is MUDARABA? Discuss its Sharaiah aspects and the risks associated with this type of Islamic Finance.

A2.

Mudarabah is high-risk mode of finance. It is so risky that it is almost “unthinkable” to any bankers. This is because the bank ought to give capital to client relying completely on his integrity, ability and good management. The bank is not only risking the expected return but also capital itself. This high degree of moral hazard is present in the classical form of Mudarabah. Recently, however, many Islamic banks were able to develop a new, albeit Shari’ah based, forms of Mudarabah with significantly reduced degree of risks. For example:

(a) Mudarabah is used only with public limited companies, where a reasonable degree of transparency is possible i.e. audited accounts, and quarterly reported performance etc.

(b) Securities and guarantees are introduced in the contract, but not against profit or payment of capital. Rather, only against loss to negligence or mismanagement.

(c) Only those economic activities where the bank can easily see what the money is being used for can be financed on Mudarabah basis. For example, a car dealer who buys autos from manufacturer and then sells on installment will be suitable for such mode of finance.

Q3. How are the mobilized funds utilized by Islamic banks?

A3.

Contemporary Islamic banks have been founded on the banking model that existed in Europe and North America, with regard to their main layout, departmental structure and their basic functions of mobilizing financial resources and using them to finance those who are in need for investible funds. Obviously, the difference lies in the area of modes of financing that are, in the case of Islamic banks, derived from the Islamic system and structured within the Islamic legal framework.

Fund Mobilization

Resources are mobilized from shareholders and savings owners. Shareholders own the bank’s net equities while savers participate in the ownership of the bank’s investments. In other words, savings are mobilized on the basis of sharing rather than interest-based lending, of course, except for demand deposits that are loan-based and guaranteed by the bank. In Islamic banks, there are two kinds of depositors: those who are investors or in a sense a special category of shareholders and those who want their money intact and guaranteed by the bank.

10

Fund Utilization

Islamic banks use available funds by means of three major categories of financing modes: sharing modes, sale modes and leasing modes. None of them has any interest component. The principle of sharing modes is simple as much as it is natural. The Islamic banks provide financing to projects on the expectation of a share in the return. Obviously, if a project loses, all capital providers and financing contributors lose together and proportionately. There are two forms of applications of this principle: full partnership financing and non-voting partnership financing.

The idea of sale modes of financing is also simple. The bank would be asked to buy goods and give them to users (producers and/or consumers) against future repayment. Sale modes may take several forms. The simplest of them is derived from regular sale contract where the bank sells real goods, equipment and machinery to their users at an agreed upon marked-up price. Two other forms of sale-based placement of funds are also practiced by Islamic banks: construction/manufacturing contract and deferred delivery contract. Sale based modes can end up in one lump sum deferred payment or in installments spread throughout a certain period of time.

Finally, as practiced in leasing companies and recently in many conventional banks, leasing modes can have a variety of forms with fixed or variable rents, declining or fixed ownership, operational or financial, along with different conditions regarding the status of leased assets at the end of the lease period.

Q4. Name the elements not permitted in Islamic contracts.

A4. Contracts in suspense are not permitted

All exchange contracts must be definitive, categoric and validly concluded at the time contracting. When the offer and acceptance are kept in suspense then the contract is void from Shari’ah point of view. Mutual obligations (or binding promises) to contract in the future are also not permitted. One example of such contract in modern finance is found in the leasing contracts, where lessor offers that at the end of the contract (5 years for example) he will sell the equipment to the lessee for, say, $1000/- and the lessee accepting such offer. This means that a sale contract, though has been concluded, is kept in suspense for 5 years. This is not permitted. To avoid such shari’ah complications, Islamic banks usually make transfer of ownership just an option to sell.

A contract that contains Gharar is non permissible

Gharar is contractual uncertainty. An exchange contract that exhibits Gharar is void. The meaning of Gharar is, nevertheless, very intricate. In Shari’ah an exchange contract should spell out clearly the rights and obligations, if it is uncertain then Gharar is present. For example if one sells, for $ 5, an item which will be decided by a “draw’ of number from the hat of the seller, is purely Gharar contract. Clearly the obligation of the buyer is disposed off fully via the payment of the price. But there is uncertainty about the other parties obligations,

11

is it going to be an automobile or just a pencil. Certainly this example is exotic and can be found only in games of chance.

However, the possibilities of Gharar in all exchange contracts is very significant. For example if I sell an item to a buyer and tell him the exact price will be revealed to you later, this is also considered a Gharar contract, even if the buyer is willing to accept this uncertainty.

Q5. Distinguish between permanent and diminishing musharika with their characteristic features.

A5. a) Permanent Musharakah

In this case, the bank participates in the equity of a company and receives an annual share of the profits on a pro rata basis. The period of termination of the contract is not specified. This financing technique is also referred to as continued Musharakah.

b) Diminishing Musharakah

Digressive or diminishing Musharakah is a special form of Musharakah which ultimately culminates in the ownership of the asset or the project by the client. It operates in the following manner: The bank participates as a financial partner, in full or in part, in a project with a given income forecast. An agreement is signed by the partner and the bank through which the bank receives a share of the profits as a partner. However, the agreement also provides payment of a portion of the net income of the project as repayment of the principal financed by the bank. The partner is entitled to keep the rest. In this way, the bank’s share of the equity is progressively reduced and the partner eventually becomes the full owner.

This method of diminishing partnership has been successfully applied by the Jordan Islamic bank mainly to finance real estate projects and the construction of commercial buildings and housing projects. These projects are financed by the bank, fully or partially, on the basis that the bank obtains a proportion of the net profits as a partner and receives another payment toward the final payment of the principal advanced. When the original amount is fully repaid, the ownership is fully transferred to the partner and the bank has no claim whatsoever. The Jordan Islamic Bank has financed the construction of a commercial market in Irbid, a community college in Jerash and a hospital in Zerqa using this method of financing.

SECTION 4 EACH QUESTION CARRIES 4 MARKS

Q1. What is MURABAHA? Name the risks involved in this type of finance and how are they covered for protection?

A1. A form of credit that enables customers to make a purchase without having to take out an interest-bearing loan. The bank buys an item and sells it to the customer on a deferred basis. The price includes a profit margin agreed by both parties. Repayment, usually in

12

installments, is specified in the contract. The legality of this financing technique has been questioned because of its similarity to riba. However, the modern Murabahah has become the most popular financing technique among Islamic banks, used widely for consumer finance, real estate, and the purchase of machinery and for financing short-term trade.

Mudaraba mode of finance resembles, in its risk profile, conventional lending. Expect for bank’s purchase of the goods and resale to the client, Mudaraba creates a bank asset similar to that of conventional banks, with much the same risks, the main difference are basically,

a. Risks related to change in price of the goods owned by the bank prior to sale to the client. No specific length of time is required by Shari’ah. What is necessary, however, is that ownership as defined by Shariah is sustained. Hence, these risks can be significantly reduced through efficient procedures.

b. Shariah does not permit any financial penalty to be imposed on delinquent debtors for purpose of compensating the creditor. This is clearly a major disadvantage over conventional banking. (latter we see how this is managed within shariah). This makes the risk related to the client default or failure to pay in time relatively high.

c. Murabaha is a fixed-nature type of finance. It is naturally exposed to interest rate risks. Because of this, most Murabahas in Islamic banks are short-term.

Q2. Describe the Sharaiah parameters applicable to Musharika type of finance.

A2. An investment partnership in which all partners are entitled to a share in the profits of a project in a mutually agreed ratio. Losses are shared in proportion to the amount invested. All partners to a Musharakah contribute funds and have the right to exercise executive powers in that project, similar to a conventional partnership structure and the holding of voting stock in a limited company. This equity financing arrangement is widely regarded as the purest form of Islamic financing. The two main forms of Musharakah are: Permanent Musharakah: an Islamic bank participates in the equity of a project and receives a share of the profit on a pro rata basis. The length of contract is unspecified, making it suitable for financing projects where funds are committed over a long period. Diminishing Musharakah: this allows equity participation and sharing of profits on a pro rata basis, and provides a method through which the bank keeps on reducing its equity in the project, ultimately transferring ownership of the asset to the participants. The contract provides for payment over and above the bank's share in the profit for the equity held by the bank. Simultaneously the entrepreneur purchases some of the bank's equity, progressively reducing it until the bank has no equity and thus ceases to be a partner.

1. The basic difference from Mudarabah is that in Musharakah both parties are entitled to participate in management.

2. It is permissible to have an escalating (or variable) profit sharing ratio depending on the level of profits achieved.

13

Q3. What are the major problems faced by Islamic banks worldwide?

A1. 1. Lack of profit sharing on the asset side.

2. Adverse selection

3. Moral hazard

4. Lack of project appraisal machinery.

5. Lack of project monitoring.

6. Defaulters and the issue of penalties.

7. Illiquidity of Islamic financial market.

8. Short term asset structure.

9. Excess liquidity.

10. Short term placement of funds.

11. Lack of a lender of last resort.

12. Difficulties in issuing letters of guarantee.

13. Taxation problems.

Q4. Name the recommendations and suggestions to promote Islamic Banking in India.

A4.

1. Islamic banks should implement prudential norms in order to strengthen their quality of functioning and capital adequacy and asset upgradation should receive focused attention.

2. They should mobilize resources on the basis of .Mutual Funds. model and investment should be equity based and partnership – contract based. They should promote inter Islamic banks – trading in .contracts.. if Islamic banks can make offer to public through capital issues and get listed on stock exchanges then capital would become marketable and liquid. Inter-bank lending can be set up on the profit sharing basis.

3. They should diversify instruments of investment on, the lines done some of the countries.

4. Islamic banks should set up. Risk-Funds. to compensate their shareholders or depositors during the of losses. They can declare special dividend.

5. They have to enlarge their scale of operation through mergers and should modernize themselves to complete with other institutions.

14

6. They should set up training institutions on Islamic baking and should impart training to borrowers and other public to increase their clientele.

7. They should earmark some funds to finance poor people and should provide them job training so that they can create employment for themselves. Such experiments are already being done in Tamil Nadu by English Missionaries. But assisting poor people is not the only objective, this is one of the objectives.

Q5. What is Salam? Highlight the Sharaiah aspects of this instrument of finance and the risks associated with it.

A5. Advance payment for goods which are to be delivered at a specified future date. Under normal circumstances, a sale cannot be effected unless the goods are in existence at the time of the bargain. However, this type of sale is an exception, provided the goods are defined and the date of delivery is fixed. The objects of sale must be tangible goods that can be defined as to quantity, quality and workmanship. This mode of financing is often applied in the agricultural sector, where the bank advances money for various inputs to receive a share in the crop, which it then sells.

In addition to the credit risk (seller default) which is normal for any type of finance, the bank will be facing market risk. While prices at the time of delivery will most probably be higher than that of the Salam price, market may fluctuate in any direction. Unfortunately not many measures can be taken to mitigate this. Goods bought under a Salam contract can’t be sold before actual deliver and possession by the bank. Hence, bank will not be able to “unload”. If forecast of future prices changes before delivery. One possibility of hedging may be adopted through what is called “Parallel Salam”, In this case the bank will enter the market as a seller of goods of similar specification once Salam contract is concluded. Term can be designed to fall at same date of delivery. It is important to note here that bank is not actually selling those same goods which wee the subject of the first Salam, only at the same time. Hence there are separate contracts, in one the bank is the buyer the other a seller.

SECTION 5 EACH QUESTION CARRIES 4 MARKS

Q1. In which type of Islamic finance is hedging required and how is it done?

A1. One major drawback of Murabaha mode of finance is the fact that it is fixed-return type of transaction. It is because of this that Murabaha deals are always short-term. While a three year murabaha may still be short term, having a fixed – return feature gives rise to the need for hedging. All conventional hedging mechanisms involve non-permissible contracts. Unfortunately no method has yet come out of the Islamic Banking “laboratory”. Nevertheless, whatever a bank does to hedge such risks, it should always remember that this “bank-risks”, not client. He ought not be made to pay the cost of hedging if any is used.

15

Q2. Define Musharika and the risks involved in this type of financing.

A2. An investment partnership in which all partners are entitled to a share in the profits of a project in a mutually agreed ratio. Losses are shared in proportion to the amount invested. All partners to a Musharakah contribute funds and have the right to exercise executive powers in that project, similar to a conventional partnership structure and the holding of voting stock in a limited company. This equity financing arrangement is widely regarded as the purest form of Islamic financing. The two main forms of Musharakah are: Permanent Musharakah: an Islamic bank participates in the equity of a project and receives a share of the profit on a pro rata basis. The length of contract is unspecified, making it suitable for financing projects where funds are committed over a long period. Diminishing Musharakah: this allows equity participation and sharing of profits on a pro rata basis, and provides a method through which the bank keeps on reducing its equity in the project, ultimately transferring ownership of the asset to the participants. The contract provides for payment over and above the bank's share in the profit for the equity held by the bank. Simultaneously the entrepreneur purchases some of the bank's equity, progressively reducing it until the bank has no equity and thus ceases to be a partner.

If two parties provide shares of any size into the partnership. In case of loss, share of each party is based on its share of capital. “ The case of profit is difficult, They can be shared differently. This is very suitable to Islamic banks, because they can take a share of profit lower than their share in capital, and hence complete with conventional banks. In Musharakah the two partners may or may not participate in management. However, it is allowed for the one who manages, if he happened to be the partner to charge salary or a higher share of profit.

Q3. How is Musharika applied to different types of financing?

A3. Application of Musharakah in domestic trade:

The Al Barakah Islamic Bank of Sudan is using the technique of Musharakah to finance the sale and purchase of goods in the local (Sudanese) market. Musharakah financing of domestic trade operates in the following manner:

The bank enters into a partnership agreement with the client for the sale and purchase of local goods whose specifications are given by the client. The total cost of the goods is divided between the parties and both parties agree to contribute their shares of the cost of the goods. A special Musharakah account is opened at the bank immediately after the signing of the contract, which specifies all the transactions pertaining to this account. It is the responsibility of the partners to arrange the purchase and sale of the goods in question.

Profits are distributed as follows: An agreed percentage of the net profits is given to the client with the remainder distributed among the partners of the Musharakah agreement in the same proportion as their capital contribution. In the case of a loss, the partners bear the loss exactly in proportion to their capital contribution.

16

Application of Musharakah to the importation of goods:

The Al Barakah Islamic Bank of Sudan also employs the Musharakah technique to finance the import of goods. The contract is essentially the same as the one discussed above in terms of the sale and purchase of domestic goods, but differs in some details.

The importer requests the bank to participate in the import and sale of certain goods. The total cost of importing the goods is declared and the capital contribution of each party is specified. The cost of the whole transaction is designated in the appropriate foreign currency. The importer pays a part of his contribution immediately after the contract has been signed and pays the rest after receiving the invoices. A special Musharakah account is opened at the bank. The bank then opens a letter of credit to the importer and pays the full amount to the exporter after receiving the shipment document.

The cost of insurance is charged to the transaction account. The importer is responsible for the import, clearance and final sale of the goods in question. The net profits are distribution among the partners in the agreed proportion and any loss is shared in the same proportion as the actual capital contribution.

Letters of credit on a Musharakah basis:

The Bank Islam Malaysia issues Letters of Credit (L/C) under the principle of Musharakah. The method adopted is as follows: The customer is required to inform the bank of his letter of credit requirements and negotiate the terms of reference for Musharakah financing. The customer places with the bank a deposit for his share of the cost of goods imported which the bank accepts under the principle of Al Wad iah. The bank then issues the L/C and pays the proceeds to the negotiating bank utilizing the customer’s deposit as well as its own finances, and subsequently releases the documents to the customer. The customer takes possession of the goods and disposes of them in the manner stipulated in the agreement. Profits derived from this operation are shared as agreed.

Application of Musharakah in agriculture:

Islamic banks in Sudan and particularly the Sudanese Islamic Bank have development yet another application of Musharakah which has tremendous potential for rural and agriculture development in Islamic countries. The Sudanese Islamic Bank has, no an experimental basis, been providing finance to farmers by means of a Musharakah agreement. The method adopted for this kind of financing is as follows:

The Sudanese Islamic Bank and the farmer enter into a Musharakah contract under which the bank provides the farmer with certain fixed assets, such as ploughs, tractors, irrigation pumps, sprayers etc. and some working capital, such as fuel, oil, seeds, pesticides and fertilizers. The farmer’s equity is confined to the providing of land, labor and management. Since it is a partnership contract, there is no need of collateral or guarantees other than personal guarantees. Profits are shared between the farmer and the bank in such a way that the farmer is first paid 30 per cent of the net profit as compensation for his

17

management, and then the remaining 70 per cent is shared between the bank and the farmer on a pro rata basis based on each partner’s respective share in the equity.

Q4. What are the major problems faced by Islamic financial sector in India and what are the solution?

A4. Major problems faced by Islamic financial sector in India

Indian banking laws do not explicitly prohibit Islamic banking but there are provisions that make Islamic banking almost an unviable option. The financial institutions in India comprises of Banks and Non Banking Financial Institutions. Banks in India are governed through Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiable Instruments Act 1881, and Co-operative Societies Act 1961.

Certain provisions regarding this are mentioned below

Section 5 (b) and 5 (c) of the Banking Regulation Act, 1949 prohibit the banks to invest on Profit Loss Sharing basis -the very basis of Islamic banking.

Section 8 of the Banking Regulations Act (BR Act, 1949) reads, “No banking company shall directly or indirectly deal in buying or selling or bartering of goods…”

Section 9 of the Banking Regulations Act prohibits bank to use any sort of immovable property apart from private use –this is against Ijarah for home finance

Section 21 of the Banking Regulations Act requires payment of Interest which is against Sharia.

As regards to partnership by Islamic banks in a firm, the bank has to make sure that the manager does not avoid his responsibilities or obtain other non-pecuniary benefits at the expense of non-participating partners and ensure the veracity of the profit statements. Monitoring of data about firms in which Islamic bank invests would involve exorbitant cost. However, Islamic banks need to set up monitoring cell to keep them informed of the internal function of their joint venture. The implication is that banks and entrepreneur have to function very closely.

Islamic banking needs to introduce corporate governance with transparent accounting standards. It needs to perform detailed evaluation before embarking Profit Loss Sharing Scheme, which demand a pool of highly trained professionals. The imparting of professional training is costly. Detailed principles are still to be laid down and techniques and procedures evolved to carry them out. It is only after the satisfactory achievement of these that proper training can begin.

It is observed that inability to evaluate a projects’ profitability has tended to act against investment financing. Some borrowers frustrate the banks appraisal efforts as they are reluctant to provide full disclosures of their business. These exercises are not limited to

18

relatively few large loans but need to be carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable techniques are yet to be devised. Moreover, the borrowers do not observe business ethics which make it difficult to establish close bank-clientele relationship - a condition for successful Islamic banking. Adverse selection has been one of the major impediments in the world of Islamic banking.

Among the other disincentives from the borrower’s point of view are the need to disclose his accounts to the bank if he were to borrow on the Profit Loss Sharing basis. However, many small-time businessmen do not keep any accounts, leave alone proper accounts. And large conglomerates do not like to disclose their real accounts to anybody. The widespread lack of business ethics among certain business community will be another major hurdle in the path of Islamic banking in India.

The practices in use by the Islamic banks have evoked questions of morality. Some critics view Sukuk (Islamic Bond) as unIslamic in nature. Others criticize that financing through the purchase of client’s property with a buy-back agreement and sale of goods to clients on a mark-up, involved the least risk and are closest to the old interest-based operations. Bai’ mu’ajjal (sale with deferred payment) and Murabaha (cost-plus financing) are permitted in the Sharia under certain conditions. What is being done in many countries are fictitious deals which ensure a predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against the letter and spirit of Sharia.

Q5. From the Resolutions of various Al Baraka symposia mention at least five that you have found to be most relevant to your interest in the study of this subject.

A5. Paying taxes out of bank interest

Question: Is it permissible for a person gaining some interest-based profit in a non-Islamic country to pay taxes out of this amount for his income in that country?

Fatwa: The second conference advises the rich Muslim to direct their wealth, first to the Islamic banks, Islamic organizations, and the Islamic companies within the Arab and Muslim countries, and then in foreign countries. Until the time this is achieved the interest they gain is an evil gain and they should collect it and expend it on the general welfare of the Muslims. To continue to deposit it in the banks and institutions functioning on the principle of interest, while they can avoid it if they wish, is an unlawful act.

In the light of this principle any taxes due on this evil gain may be paid out of it, but it is not permissible to pay taxes due on any other activity out of it.

Taking a surety in a Murabaha sale

Question: Is it permissible to demand that a buyer have a guarantor in a Mudaraba sale on credit?

Fatwa: It is permissible to demand a guarantor from a buyer as in any other sale on credit.

A dilatory debtor who delays payment of a loan

19

Question: Is the principle of holding a dilatory debtor liable to pay damages to the creditor legitimate from the point of view of the Islamic law?

Fatwa:

a) In Islamic law it is permissible to hold responsible a financially capable debtor, who delays payment of debt without any genuine reason, and to compensate the lender for any loss resulting from late payment. Such a debtor is unjust as the prophet (peace be upon him) said, “A rich debtor who delays payment of debt is unjust”. The case of such a person is similar to that of a usurper concerning whom the jurists have decreed that besides returning the capital he should also be made to return any profit made by him on the usurped property. This was the majority opinion. Some are of the view that the obligation to pay this amount is a sort of penalty clause based on the principle of public welfare provided any income thus obtained is spent on legitimate charitable activities.

b) The amount of this compensation will be decided according to the loss incurred by the lender in the normal profit that he could have earned if he had invested this amount in a project during the period of the delayed payment.

The compensation court will, with the help of experts in Islamically approved methods of investment, and with the help of a financial institution if such an interest-free institution is found in the city of the lender (an Islamic bank, for instance), determine the amount of this compensation, taking an average of the profit actually earned by such

Transactions with the Insurance companies

Question: Is it permissible to deal with the non-Islamic insurance companies at a time when the Islamic insurance and re-insurance companies are emerging?

(The emergence of Islamic insurance and re-insurance companies was a plain fact in the opinion of the committee. This removes the need for which transactions with the non-Islamic insurance companies are allowed).

Fatwa: The committee advise the Muslims, banks, and Islamic organizations that they should deal with Islamic Insurance companies, wherever they are available, in order to keep their business transactions lawful.

The “No Liability Clause” in the Islamic insurance policies

Question: What is your opinion about inserting a “no liability clause” in the Islamic insurance policies?

Fatwa: Inserting a “no liability clause: in the policies of the Islamic insurance is permissible legally. Nevertheless, in the opinion of the committee it is better to include, in cases of great losses a full compensation clause, beyond the minimum agreed upon, without deducting it. The Islamic insurance companies should not in such a situation deduct a portion of the loss, but should avoid it as much as possible. And this avoidance on their part would

20

show the difference between them and others (non-Islamic insurance companies) and would provide an added incentive for others to deal with them on the basis of fairness and equity.

PART II

Section 1

MATCH THE FOLLOWING

1. Central bank in a modern economy - Regulates money supply

2. Profit sharing ratio - New interest free instrument of monetary policy.

3. Principal-agent contract - The period of termination of contract not specified.

4. Permanent musharika - Mudaraba

5. A type of guarantee implying

correctness of liability between

guarantor and the guaranteed - kafala

6. Rabbul Maal – Mudarib - Partnership

7. Ijma - Consensus of scholars

8. Same as Mudaraba & Muqarada - Qirad

9. Important application of Mudaraha - Letter of Credit

10. Pre production sale contract - Istisnaa

Section 2 TRUE OR FALSE

1. Legal reserve ratio is not suitable for Islamic central banks (False)

2. In Islamic banks all advances are balance sheet assets (False)

3. Salam can be used for intangibles also (True)

4. Agent in Mudaraba is not entitled to share profit (False)

5. The Quran gives a detailed rationale about prohibition of riba (True)

21

Section 3 FILL UP THE BLANKS

1. Monetary policy in an economy uses three instruments Quantitative Measure, Qualitative Measure, Prudential Measures.

2. The model of Islamic banking is built on Profit and Loss sharing arrangement.

3. Contract in Sharaiah is known as Murabaha.

4. An interesting application of Murabaha is in Letter of Credit.

5. Diminishing Musharika is also known as Digressive.

MODULE IV

PART - 1

SECTION 1 EACH QUESTION CARRIES 4 MARKS

Q1. Highlight at least 5 principles that apply to distribution of Zakah.

A1.

1. The poors, the needy (Fuqara and Masakeen)

2. Collectors of Zakah (Al-‘Aamileen)

3. Those whose hearts are to be won (Al-Mu’allafatu-Al-Quloob)

4. The cause of (freeing) the slaves (Ar-Riqaab)

5. Debtors (Gharimeen)

Q2. How did the discussion of Islamic Fiqh Academy and Ibn Abidin help the growth of Takaful industry in the area?

A2.

Islamic insurance aims to examine the position of both risk and insurable interest in the context of Islamic insurance theory and practice. It has been observed that since the introduction of the first Islamic insurance product in 1979 in Sudan, the issue of both risk and insurable interest has not been subjected to any serious and thorough study either by Muslim economists nor by the Muslim jurists.

There are almost 32 millions Muslims living in Europe(including 1.5 million in the united kingdom). These Muslim communities provide an enormous untapped opportunity for takaful (Islamically valid insurance).

22

The takaful market is estimated to be worth US$2 billion in premium income and is rapidly growing industry in the Muslim world. Largely facilitated by Islamic retail banking. Globally, there are currently more than 60 companies that offer takaful life and non-life products, either as their sole range or as a takaful ‘window’ alongside conventional policies. Malaysia and the Middle East (in particular Saudi Arabia, Iran and Bahrain) currently account for the largest share of the market.

This chapter provides a concise overview of takaful and the reason for its growth. Its summarises the current state of the market in Malaysia and the Middle East, then looks at the general insurance market in Europe and the United kingdom, as well as the potential of the UK Muslim insurance market. There are a number of organizations considering establishing takaful operations in the United Kingdom, and the legal and regulatory aspects discussed in this chapter would be relevant for them.

The permissibility in Islamic jurisprudence of conventional insurance has been the subject of debates among Islamic jurists since insurance was first discussed by the Hanafi scholar Ibn Abidin. Under a conventional contract of insurance, an insurer agrees to cover the insured or his property in return for a premium against the occurrence of a risk leading to actual loss as described in the contract. The insurer’s objective is that aggregate income exceeds the value of any claims paid. From an Islamic point of view, this is problematic because any sum of money paid in excess of the amount of premiums that the insured has paid is regarded as riba (interest or usury). Gharar (uncertainty, risk or speculation) is the uncertain element that arises in respect of a promise to pay a sum of money upon the occurrence of unspecified events. For these reasons, in 1985 the Islamic Fiqh Academy in Saudi Arabia resolved that conventional insurance is haram (prohibited) under the shari’a. However, the Academy approved the use of mutual insurance (takaful) that conforms to the principles of the Shari’a as an alternative to conventional insurance. This discussion provided the impetus for the enormous growth in this area.

Q3. What are the conclusions of study of Tax treatment in Malayasia?

A3.

In spite of existing difficulties, Islamic finance has grown rapidly within every short period. The main challenge for Islamic finance as a few phenomenon is the lack of integration between its theoretical background and its implementation. In other words, Islamic finance suffers from the lack of a comprehensive strategy to connect theory with practice by providing the proper environment in which it can expand.

Islamic financial instruments are genuine alternatives to interest-bearing financial instruments based on economic equity, justice and social-moral values. The function of these alternatives requires the implementation of a distinctive framework, including banking and tax regulations. Each Islamic financial instrument needs to be examined differently from the accounting and tax perspectives.

23

Malaysia has undergone important steps to provide Islamic with appropriate banking and tax regulations. These regulations have succeeded in presenting the Islamic financial system as a strong competitor to the conventional financial system.

However, the tax amendments which address Islamic finance are rather too general to handle the diverse structures of Islamic financial instruments. Islamic financial instruments deserve special tax treatment which cannot be provided through general provisions such a Section 2(7) ITA or Section 14A SDA. 16 For example, Section 2(7) does not provide a special treatment for Islamic financial instruments; rather, it ignores the different and inherent nature of Islamic instruments by treating them in the same manner as interest-bearing instruments.

Q4. What is insurable interest? Discuss.

A4.

Insurable interest as defined by the insurance dictionary refers to the interest an individual must have in insurance coverage carried by someone else. From a legal perspective, insurable interest means that the party to the insurance contract who is the insured or policyholder must have a particular relationship with the subject matter of the insurance, whether that be a life or property or a liability to which he might be exposed. The absence of the required relationship will render the contract illegal, void or simply unenforceable (depending on the type of insurance).

It seems from the discussion that the very purpose of stipulating this principle or test is to determine the motive for purchasing insurance, and in the assignment of a beneficiary in a life insurance policy. For example, a wage earner applies for life insurance, and names a spouse and children as beneficiaries. The insurance company recognizes that, in the event of the unexpected death of the insured person, the family would suffer an economic loss. Accordingly, they have an insurable interest. On the contrary, one individual may offer to pay the premiums on a life insurance policy of another person, if that person will name him as beneficiary. The insurance company will not issue the policy on this basis, as it is a wager rather than a contract for insurance.

Q5. Name of the categories of persons and who are entitled to receive zakah funds.

A5.

a) The poor

b) The needy (miskin)

c) Those, who are appointed to collect zakah

d) Islamic propagation (Al Mullafatu Qulubuhum)

e) Freeing slaves

24

f) The indebted

g) In the way of Allah

h) The Wayfarer

SECTION 2 EACH QUESTION CARRIES 4 MARKS

Q1. Calculate your zakah liability assuming it occurs in all types of assets owned by you.

A1.

Zakat on pure gold and gold jewellery

Zakat on pure silver, silver jewellery, House hold items etc.

Zakat on Landed property.

Zakat on Business Stock

Zakat on Factory building, Machinary and Goods produced.

Zakat on Partnership.

Zakat on Cash and Bank balances

Zakat on loans, government bonds, provident funds, LIC etc.

Zakat on company shares and mutual funds.

Zakat on agricultural produce

Zakat on animals including poultry and fish farming.

Q2. Discuss the various models of Takaful.

A2.

Each shari’a school of jurisprudence has different views on the most suitable structure. In practice, Wakala (agency) and Mudaraba (Limited partnership) are the two main models adopted. Both models are used in Malaysia and the Middle East where there is high penetration of takaful.

The Mudaraba model involves the capital provider (the participant) and the service provider (the takaful operator) in a limited partnership. The takaful operator manages the operation in return for a share of the surplus from underwriting or investment performance, which is distributed between the operator and the participants according to a pre-agreed ratio. In order to comply with the Shari’a, the takaful operator’s percentage is not guaranteed. The takaful operator does not share in any losses. However, if there are losses in the indemnity

25

pool, the takaful operator provides an interest-free loan (qard hassan) that has to be repaid when the indemnity pool returns to profitability and before any future surplus is distributed. The participant’s capital (the portion representing the risk premium) is used to pay any claims.

The Mudaraba takaful model:

In the Wakala model, the participants place their funds into a pool as a ‘donation’ and not a premium. The takaful operator acts as a wakil (agent) on behalf of the participants. The operator is paid a pre-agreed fee in respect of underwriting, management and investment services and does not share in any underwriting profits, as these are payable to the participants. On the maturity of a takaful life insuance policy or early surrender, the participant receives the balance in the participant account. If he dies early, the participant’s beneficiaries receive the balance of his account, plus the sum covered, which is defined at the beginning of each year or month.

Note that all charges, fees and profit-sharing percentages in both takaful models are declared at the outset of the contract and are therefore transparent to the parties involved. This is consistent with the concept of the avoidance of Gharar in Islamic law.

26

TAKAFUL OPERATOR UNDERWRITING SURPLUS

INVESTMENT INCOME FROM PARTICIPANT’S

ACCOUNT

CLAIMS AND EXPENSES PAID

FROM INDEMNITY RISK POOL

PARTICIPANT INVESTMENT

ACCOUNT

INDEMNITY ‘RISK’ POOL (COMMON ACCOUNT FOR

ALL PARTICIPANTS)

PARTICIPANT’S CONTRIBUTION

Takaful operator shares surplus

‘Risk premium

‘Investment’ premium

The Wakala takaful model:

Q3. What are the Dow Jones filters for Islamic Fund managers?

A3. The Dow Jones financial filters have become the standard for fund managers.

There are three primary financial filters.

Exclude companies if total debt dividend by trailing 12-month average market capitalization is greater than or equal to 33 percent. (Note: total debt = short-term debt + current portion of long-term debt + long-term debt)

27

Management and operational expenses

Takaful operator (Wakil)

Underwriting surplus

Investment income from participant’s

account

Claims and expenses paid

from indemnity risk pool

Participant indemnity account

Participant investment account

Participant’s contribution

Fixed percentage fee

Wakala fees on value of investment

A certain percentage is

distributed back to participant

Participant pays wakala fees on

contribution

Exclude companies if the sum of cash and interest-bearing securities dividend by trailing 12-month average market capitalization is greater than or equal to 33 per cent.

Exclude companies if accounts receivables dividend by total assets is greater than or equal to 45 per cent. (Note: accounts receivables = current receivables + long-term receivables.)

Q4. How do you describe a Shariah compliant Credit Card?

A4. Shariah compliance goes beyond product design. It encompasses, and you can observe, added benefits (Islamic Insurance), internal processes, pricing, transparency, advertisements and even merchants and places where you can or cannot spend on the Al-Islami credit card (alcohol, bars, casinos, etc.). We operate with a mission to provide customers with a 100% Shariah compliant solution.

Q5. Mention the highlights of Islamic Life Insurance.

A5.

Islam is the fastest growing religion worldwide.

As individuals prosper and gain wealth, there is a need for life insurance for them and their families in order to sustain their standard of living.

Traditional life insurance is forbidden in Islam.

Islamic religious authorities have ruled that cooperative insurance, based on Islamic principles, is acceptance.

The successful introduction of takaful products in Malaysia began in 1983. More recent introductions have been in Saudi Arabia (2001) and the UAE (2003).

The annual growth rates of takaful applications exceed conventional life insurance even in mature markets. For example, growth rates in Malaysia and Singapore are around 15 per cent annum.

The rediscovery of ancient principles of mutual risk-sharing(takaful) first occurred in Sudan in 1979 and, during the 1980s, no more than 12 takaful operators existed worldwide. In 2004, there were 65 re-takaful operators. ‘windows’ and takaful funds available in 24 countries.

Despite this impressive growth, several major challenges confront the takaful insurance sector:

Low penetration achieved by takaful operators, indicating the need for more public eduction;

A slow rate of product innovation;

Lack of public awareness of the benefits of insurance in emerging markets;

28

Reliance upon the agency-selling model increases acquisition costs, narrows distribution channels and limits customer access points;

Many takaful operators are not yet rated;

Limited risk capacity among re-takaful operators; and

Most savings tools are ‘pooled’ rather than unit-linked instruments.

SECTION 3 EACH QUESTION CARRIES 4 MARKS

Q1. Name at least FOUR leading Takaful companies with their characteristics.

A1.

SYARIKAT TAKAFUL MALAYSIA BERHAD (TAKAFUL MALAYSIA)

Syarikat Takaful Malaysia Berhad (Takaful Malaysia) was incorporated on the 29th of November 1984 with an authorised capital of RM500 million and a paid-up of RM10 million. It commenced operation on the 22nd of July, 1985 prior to its official launching on the 2nd of August 1985 by the then Prime Minister of Malaysia, Tun Dr. Mahathir Mohamed.

The incorporation of Takaful Malaysia was based on the recommendation of the “Task Force on the Study for the Establishment of an Islamic Insurance Company in Malaysia” (Task Force) set up by the Government of Malaysia in 1981. The Task Force in its report concluded that a takaful company based on the principle of al-Mudharabah would be a viable venture in view that its participants would have the opportunity to save, invest and earn profits based on this principle.

Takaful Malaysia was transformed into a public limited company on the 30th of July 1996 followed with the listing of its shares on the Main Board of Bursa Malaysia Securities Berhad. The capital was then raised to RM55 million. The capital structure since then has been further enhanced arising out of the restructuring exercise at the end of 2003, resulted in the paid-up share capital of Takaful Malaysia currently stands at RM152.643 million.

For further information, please visit our website at: http://www.takaful-malaysia.com

QATAR ISLAMIC INSURANCE COMPANY

Qatar Islamic Insurance Company, one of the fastest growing insurance companies in Qatar and a national company with international reach, started transacting business in 1995. Our company is committed to providing customers with the full range of comprehensive insurance products and services in conformity with Islamic Sharia standards and principles.

29

Our bouquet of insurance products is the most comprehensive in Qatar comprising all risks from aviation (for example) to personal lines – that is, covers for individuals and their families. Our clients include major companies, banks and public sector employers. At the same time, our personal lines are rapidly expanding. Whatever your requirements, and wherever in the world you are, QIIC has the products and services you need.

Because QIIC conducts its business on the basis of cooperative insurance in line with Islamic principles, our customers benefit in another way. This cooperative style of insurance means that any insurance surplus left after deduction of expenses is given back to the policyholders in the form of cash dividends. which have been made to policyholders every year since the company was founded back in 1995, and they have more than trebled in this time (from 5 % at the end of 1995 to 18 % in 2007).

QIIC was among the first Islamic insurance companies in the world to introduce Takaful services (the Islamic alternative to life insurance) back in 2000; and this is now one of our fastest growing classes of business. We are the first insurance company to offer our Takaful products on-line, giving all our customers the benefits of instant access to this popular product anywhere, any time.

QIIC has maintained a track record of consistent growth every year since its formation in 1995 in spite of increasing local, regional and global competition. We have posted consistently healthy gains in all classes of our business and achieved excellent aggregate net profits in 2007 exceeding QR 60.5 million ( USD 16.6 million ).

We look forward to the future with confidence and trust that we shall, by the grace of God, continue to provide comprehensive Takaful insurance products and services to our growing community of customers across the world, building on our successful record of developing innovative and attractive products and services and providing the highest standards of customer care.

ISLAMIC ARAB INSURANCE COMPANY, DUBAI

SALAMA Group - Strong Foundations for a Better Future

SALAMA - Islamic Arab Insurance Company is a leading provider of Shari’ah compliant insurance solutions (Takaful) around the world. Right from our incorporation in 1979 in Dubai, UAE as pioneers in the Takaful industry, to our present day distinction as the world's largest Takaful and Re-Takaful Company, we have always stayed true to our values and principles.

Our vision is to provide Shari’ah-compliant Takaful solutions of the highest standard to customers around the world. Therefore, our every endeavour over the last 30 years has given us the solid reputation of providing the most competitive and diverse portfolio of Takaful solutions.

Our stability and success can be attributed to our strategy of focusing on core business areas. SALAMA has a paid-up capital of AED 1 billion (USD 274 million) and is listed in the

30

Dubai Financial Market. SALAMA has been rated “A-” by A.M. Best and “BBB+” by Standard & Poor’s. BEST-Re, our Tunis-based operation, is the world’s largest Re-Takaful company, operating in more than 60 countries.

We serve both individual and institutional customers through our extensive global network. At present, we have 6 direct Takaful companies who provide solutions to customers in the UAE, Saudi Arabia, Egypt, Senegal, Algeria and Jordan. We plan to expand our geographical reach in the near future to all the GCC states, South East Asia and eventually Europe, in order to offer innovative Shari’ah-compliant solutions.

SALAMA UAE – Securing our Future together.

UAE is a central point having best of the West and East and over the time it has become the kind of hub that allows SALAMA to nurture and access international workforce to operate up to international standards. Takaful, is about dealing with the changing attitude of Muslims on religious or faith grounds, so UAE is a good platform for Shari’ah compliant insurance. As the country grows and develops, keeping track of the changes is essential and Muslims in UAE today stress on Shari’ah-compliant insurance, which allows us to deliver the best to the best. Among the several offices present in the UAE, its head office is located in Oud Mehta, claims office in Al Qusias and branches in Abu Dhabi, Al Ain, Dubai and Sharjah.

SALAMA is UAE’s specialised takaful company, it is one of the few takaful operators offering comprehensive range of general, family and health takaful solutions to individual, families and companies. Our credibility, reputation for quality, high standards of service and access to the Takaful’s best practices mean that SALAMA is uniquely placed to provide access to quality and affordable takaful solutions. As SALAMA continues to expand its customer base consisting of individuals, families and companies, we are dedicated to become the takaful operator of choice. Personalised service, customer dedication and development of Shari'ah compliant products that fulfil our customers’ needs are just some of the new promises that we are making. Our structure and products are designed around our customers.

SABB TAKAFUL COMPANY, SAUDI ARABIA

The Company is a Saudi Joint Stock Company authorised by Royal Decree no.M/60 dated 9 October 2006 and operates under Commercial Registration 1010234032 dated 6 June 2007. SABB Takaful Company is incorporated in the Kingdom of Saudi Arabia with a fully paid-up capital of a SAR 100 million. It is an associate company of SABB and HSBC, with 32.5% owned by SABB, 32.5% owned by subsidiaries of the HSBC Group and the balance owned by the public by way of an Initial Public Offering, The Company is listed in The Tadawul.

SABB

A Saudi Joint Stock Company with a strong track record and a heritage that stretches back almost 30 years. It operates throughout the Kingdom of Saudi Arabia with a team of

31

more than 2,500 employees. over 80% of whom are Saudi nationals. SABB is an associate company of the HSBC Group.

HSBC

One of the largest banking and financial services organisations in the world with an international network. It comprises around 10,000 offices in 82 countries and territories in Europe, the Asia-Pacific region, the Americas, the Middle East and Africa. HSBC also provides a broad range of insurance products and services to its personal, commercial, corporate, institutional and private banking customers in over 44 countries and territories.

Through HSBC Amanah, the global Islamic banking division of the HSBC Group, SABB Takaful Company is able to leverage on HSBC Amanah’s experience, Takaful know-how and expertise worldwide, including Singapore, Malaysia and the UK, to provide high quality Shariah compliant Takaful products in the Kingdom.

Distribution

SABB Takaful operates via SABB’s established distribution

Network

channels, through a network of over 70 branches throughout the Kingdom of Saudi Arabia, including 12 exclusive Ladies’ branches and SABB’s well-trained direct sales team.

Activities

SABB Takaful offers a range of Takaful plans to meet individuals and corporate customers’ protection needs in the Kingdom. These plans include:

Individual Family Takaful (protection and investments)

• Education Takaful Plan

Provides protected savings, reserved for children’s educational needs.

• Investment Takaful Plan

Provides the opportunity to invest in a broad range of investment strategies and Shariah-compliant funds with an element of protection for the family.

• Care Takaful Plan

Provides financial protection for the family against unforeseen events such as death or permanent disability (God forbid) over a period of time.

• Retirement Takaful Plan

Provides financial security when planning for a comfortable retirement.

• Savings Takaful Plan

32

Provides financial protection for the family whilst saving.

• Simple Savings Takaful Plan

Provides easy saving with a protection element that suits your budget.

General Takaful (property and accidents)

• Home Takaful Plan

Protects the home and its contents against fire, theft, storms and other perils

• Personal Accident Takaful Plan

Provides financial protection for the family from financial burdens of an accident.

• Travel Takaful Plan

Provides assistance for unexpected travel emergencies or misadventure whilst traveling.

Corporate and Commercial Takaful

• Marine Cargo Takaful Plan

Provides a tailored solution for cargo protection needs.

• Fire Takaful Plan

Provides financial protection to commercial buildings against fire and other perils such as storms, earthquakes and floods.

• Business Takaful Plan

Provides a one-stop solution for all protection needs of small and medium enterprises.

Group Takaful

• Group Care Takaful Plan

Allow employers to provide financial protection for their employees in the event of death, accident or disability (God forbid) during the term of the plan

• Group Savings Takaful Plan

Provides employees with an arrangement to facilitate savings for the employees, with an element of financial protection against death or disability (God forbid).

Q2. Discuss the tax treatment of Islamic financial instrument in Malaysia with specific reference to Mudaraba transactions.

A2. From a tax perspective, the prevailing Islamic instruments in Malaysia can be divided into three different categories: - instruments based on the concept of sale: Islamic sale

33

contracts such as bai’ bithaman ajil (credit sale), Murabaha (cost-plus sale) and istisna’ (pre-manufacturing sale);

- Instruments based on the concept of lease: Islamic lease contracts such as ijara (lease) and ijara waiqtina (hire-purchase agreement); and

- Instruments based on the concept of partnership: Islamic partnership contracts such as Musharaka (partnership) and mudharaba (sleeping partnership).

Q3. Name a few popular Islamic credit cards with their salient features and business achievements.

A3.

Bank Islam card (BIC) is the first credit card, which is purely based on Shariah contract, to be offered to Muslims and non-muslims. BIC is completely free from any “riba” or “Gharar”.

“Riba” is usually translated as “interest” which means an extra amount charged in transactions dealing with silver, gold or money. “Gharar” is defined as uncertainty or ambiguity, which has been removed from BIC since the maximum profit earned has been declared upfront.

BIC is also the first credit card in Malaysia using the SMART chip technology which adopts high security level in a credit card. In the operations of BIC, there are 3 main Shariah contracts being using, namely:

Bai Inah

Wadiah

Qardhul Hassan

Bai Inah comprises of two agreements (akad). In the first agreement, the bank sells a piece of land to the customer at an agreed price. While in the second agreement, the Bank re-purchases the land from the customer at a lower price. The difference in the price is therefore the Bank’s maximum profit, which is determined in advance, unlike the conventional credit card whereby the interest charged is undetermined and it may further increase.

The bank will then disburse the cash proceeds of the second agreement into the customer’s Wadiah BIC account created and maintained by the bank. Then after, the customer can use his/her BIC for retail purchases and cash withdrawals just like the conventional credit card, except that each transaction will be backed by the cash held in his/her Wadiah BIC account.

Qardhul Hassan is a facility granted during emergency situation, which allows the cardholder to utilize above the available financing limit upon approval. The Qardhul Hasan Amount would not be levied with any charges or fees, where the sum needs to be settled in full within a specified period.

34

Achievements

Awarded the platinum Award for Best E-commerce Related Initiative under MasterCard Asia/Pasific Marketing Leadership Award 2006 Awarded as the First Islamic Platinum MasterCard issued in South East Asia (2006).

Awarded as the first Islamic Visa smartchip credit card in Asia Pacific (2003)

Awarded as the first card issuer to implement the Global Clearing Management System (2002)

Awarded as the first card that is EMV 2000 complaint by MasterCard International (2002)

Bank Islam card centre (BICC) is proud to introduce multiple payment channels and various types of services to its cardholders. Cardholders can now make payment via;

- Auto-Debit from Bank Islam’s Saving / Current account.

- Internet Banking facilities via our website www.bankislam.biz

- Payment via SMS Banking

- Cash Deposit Machine at Bank Islam’s branches nationwide

- Mail your cheque to Bank Islam Card Centre

- Cash or Cheque at Bank Islam Malaysia Berhad branches

- Interbank GIRO facilities through other banks deposits accounts.

Q4. What is Takaful? How does it differ from conventional insurance?

A4.The central idea of Takaful (Islamic insurance) contract is that it is a financial

transaction of a mutual co-operation between two parties to protect one of them from unexpected future material risk. In a Takaful transaction, the party called the participant (insured) pays a particular amount of money known as the contribution (premium) to the another known as Takaful operator (insurer) with a mutual agreement that the insurer is under a legal responsibility to provide the participant with a financial protection against unexpected loss, should it happens within the agreed period. However, in a case whereby the loss does not occur against t the insured within the specified period, the insured is entitled for the whole amount of paid-premiums together with the share of profits made out of the cumulated paid-premiums based on the principle of al-Mudharabah financing technique. In such a transaction, both the insurer and the insured are mutually helping each other for financial protection.

DIFFERENCE BETWEEN TAKAFUL & INSURANCE

The fundamental difference lies in the fact that in the Takaful concept, the premium is paid on the basis of tabarru’. This changes the contract because with tabarru', it is the participants themselves who are carrying the risk and not the insurance company.

35

The Takaful operator is clearly not the owner of the fund but truly its custodian. As such, the Takaful operator cannot use the contributions except as intended by the donors i.e. for mutual help. By including the concept of tabarru’, the element of Gharar would be eliminated, which consequently eradicate maisir from the transaction. This is because with tabarru’, the contract is no longer that of exchange, thus eliminating the problem of deliverability. In addition, the tabarru' factor also inculcates the spirit of solidarity, brotherhood and mutual help.

Takaful companies invest their funds in financial instruments, which are not forbidden by Islam. General Takaful companies maintain two separate and distinct accounts - one known as the Participants Fund and other Shareholders Fund. Takaful companies must have Shariah Supervisory Council to monitor their operation to make sure they do not engage in forbidden practices such riba;

INSURANCE TAKAFULIt is a business institutions operated based on the principles of contract.

It is a co-operative institution based on the principles of contract for mutual co - operation (ta’awun).

The basic service offered by the conventional insurance to the community is the transfer of the indeterminate fortuitous economic losses associated with the stipulated risks in return for a pre-determined payment known as premium. Thus it has been said and recognized that through the mechanism of conventional insurance, the insured substitutes certainly for uncertainly

In Takaful which is based on the principle of mutuality member are insured and insurers themselves. All the losses are shared by the members themselves and as such to transfer of risk is involved.

In the case of conventional insurance the primary motivation is to earn profit from the insurance transactions for the shareholders

In Takaful shareholder of the company, if any, are not entitled to participate in the profits generated by the insurance operators.

The policy-holder in a conventional insurance company have no right to vote in the elections of the directors of the company or to see the annual accounts of the company

In Islamic insurance companies these facilities are available to all members who pay a certain stipulated amount of premiums

Q5. Narrate any FIVE Ayaaths from the Holy Quran provided in the Module about Zakah.

A1.“That which ye lay out for increase through the property of (other) people, will have

no increase with Allah; but that which ye lay out of Zakah, seeking the countenance of Allah, will increase; it is those who will get recompense multiplied”. (30:39).

36

“Those who establish regular prayers and give regular Zakah, and have (in their hearts) the assurance of the Hereafter”. (31:4)

“And be steadfast in prayer and regular in charity Zakah: And whatever good ye sent forth for your soul before you, ye shall find it with Allah; for Allah sees well all that ye do”. (2:110)

“Those who believe and do deeds of righteousness, and establish regular prayers and regular charity (Zakah) will have their reward with their Lord; on them shall be no fear, nor shall they grieve”. (2:27)

“Your (real) friends are (no less than) Allah, His Apostle, and the (Fellowship of) Believers, those who establish regular prayers and regular charity (Zakah), and they bow down humply (in worship)”. (5:58)

SECTION 4 EACH QUESTION CARRIES 4 MARKS

Q1. When is a rich and able bodied man entitled to receive Zakah? Should Zakah be paid only to individuals?A1.

Quoting Yahya Ibn Sad on the authority of Suflan Zaid Ibn Asian, Ata.Ibn yasar, Abu Ubaid reported the Messenger of Allah, as having said; A rich person is not lawfully entitled to Zakah except in the following five cases:

a) If he is a Zakah administrator and collectorb) If he has bought it with his own money.c) If his neighbor is poor and he gives aims to the poor man, but the poor man gives it

back to him.d) If he is fighting for the cause of Allah..e) If he is in debt.

The foregoing saying of the prophet (PBUH) was reported by Abu Dawud an Al-Thawri and quoted by Ibn Majah and Al-Darqutni.

Elaborating on the share of those who are in debt Al-Mawardi says: Among them are those who borrowed money to settle disputes amongst Muslims. These must be repaid as much as they had borrowed, with no excess, irrespective of whether one is poor or rich. Another category of people entitled to Zakah are those who had borrowed money for their own needs, but later became poor. Their debts can be repaid out of Zakah.

In the opinion of Abu Ubaid, if an able-bodied earner is in distress and despite his endeavor to support his dependents, falls short of meeting his needs, then he is entitled to receive a share of the Muslim funds in compliance with Allah’s injunction: “In whose wealth there is a right acknowledged for the beggar and the destitute”.

37

It is obviously clear that the Zakah does neither undermine nor weaken the motive for work. Any able-bodied earner who endeavors to gain his living but fails in the process is allowed to receive Zakah. For example a craftsman who is in need of the necessary production tools or working capital to make a living is entitled to Zakah.

Q2. Describe the salient features of Home Takaful offered by HSBC Amanah in U.K

A2.Introducing Home Takaful

The concept of protection is deeply embedded in the Islamic thought process.

Islamic insurance is essentially a means of production based on principles that are

good for society.

Type of cover

Home Takaful is a Shariah complaint household insurance policy, which can cover your

buildings, contents and personal possessions. The participants jointly donate contributions

into a cooperative fund (Takaful Fund) that provides them mutual protection.

Significant features and benefitsContents: cover is provided for an extensive range of events such as theft, fire, flood, storm and accidental damage.

- The amount of Takaful cover may be up to £50,000 in total (up to £5,000 per item unless specified in your schedule).

- Valuables, antiques and works of art are covered up to £1,500 per item unless specified in your schedule.

- Replacement locks if keys are lost or stolen (up to £500). - Spoilage of food in freezers (up to £400)

Buildings: cover is provided for an extensive range of events such as theft, fire, flood, storm and accidental damage.

- The amount of Takaful cover may be up to £400,000.- Accidental damage to glass, sanitary ware, service pipes and cables- Loss of rent or provision of alternative accommodation (up to 20% of your Takaful

cover)

Personal Possessions: Your personal belongings may be covered by this policy when you’re away from home.

- Theft or accidental loss of money anywhere in the world, up to £500 unless otherwise specified in your schedule.

- Individual items limit up to £2,500 unless specified in your schedule.

38

- Theft or accidental damage to pedal cycles anywhere in the world, up to £500 for any one pedal cycle unless specified in your schedule.

Q3. What is an Islamic Credit card? How does it differ from a conventional Credit Card?

A3.One of the latest banking products offered by Islamic institutions, is the Islamic Credit

Card. Using the principle of Al Bai Bithaman Ajil (deferred payment sale), the bank issue an interest-free and penalty free credit card. As goods are purchased using this credit card, your bank will render the transaction on your behalf and simultaneously sell it back to the customer. This credit is payable over a deferred period through installments within a certain time frame.

Q4. Describe the activities of Dubai Financial Market.A4.

Dubai Financial Market was established as a public institution having its own independent corporate body by a Resolution from the Ministry of Economy No 14 of 2000. DFM is operating as a secondary market for trading of securities issued by public joint-stock companies, bonds issued by the Federal Government or any of the Local Governments and public institutions in the country, units of investment funds and any other financial instruments, local or foreign, which are accepted by the Market. The Market commenced operations on 26th March 2000. As decided by the Executive Council Decree on 27th December 2005, DFM us set up as a Public Joint stock Company in the UAE with paid up capital of AED 8 Billion allocated over 8 Billion shares, with a par value of AED 1 per share, and the twenty percent (20%) of DFM shares be offered for public subscription. This IPO, the first of its kind in the region, was highly oversubscribed and generated more than AED 201 billion.

The trading of shares of Dubai Financial Market (DFM) began on Wednesday 7th March 2007. VISION

The Financial Market of Choice.

MISSION STATEMENTTo create a fair, efficient, liquid and transparent marketplace that provides choices

through the best utilization of available resources in order to serve all stakeholders.

DFM OBJECTIVES

Providing the opportunity to invest in securities in a manner that better serves the national economy.

39

Regulating the process of trading in securities ensuring the protection of investors from unfair and improper practices.

Creating highest liquidity in the marketplace through the interaction of supply and demand based on fair and equitable trading practices between investors.

Organizing the transfer of securities ownership through the Clearing, Depository and Settlement Department, which operates an electronic system ensuring efficiency and timeliness of transfers.

Implementing rules of professional conduct and discipline between brokers and DFM staff to maintain a high level of integrity and provide them with proper training.

Collecting data and statistics about securities and issuing reports based on this information.

Q5. Define the types of risks with their classification.

A5.

There is no single definition of risk. The work risk has been variously defined as the chance of loss, the possibility of loss, uncertainty, the dispersion of actual from expected results or the probability of Al-Quran, Al-Ma’idah, 2. The issue of sharing the surplus is one of the contentious issues under commercial takaful. The writer is of the view that sharing of the surplus under Mudarabah principle is not permissible. Perhaps, the basis of the contract of commercial takaful must be changed into ju’alah or Wakalah any outcome different from the one expected. While some books preferred the definition of risk as a condition in which there is a possibility of an adverse deviation from a uncertainty concerning the occurrence of a loss. Though it appears to be simple, this word may invite many uncertainties amongst the practitioners. As it is now, one could not appreciate the difference between risk and other risk-related terms such as uncertainty, peril, hazard, loss and other related terms. Also, one wonders whether these terms do matter in insurance because one insurance policy may cover one of these .terms. Whereas the other insurance policy may cover the other.

To be certain of the meaning of risk, particularly with regard to insurable interest, an attempt will be made to differentiate between these legal terms. The paper will reproduce briefly what has been said on these terms in some of the insurance books. Only after that, would this paper critically analyze the very meaning and concept of risk that is intended in the insurance dictionary. To begin with, we look at the word hazards. Hazards are acts or conditions that. increase the likelihood or severity of a loss. Hazard may be of physical hazard or moral hazard. Either one of these may contribute to the actions of hazards that may result in perils. Perils are used to refer to the cause of the risk and this includes fires, automobile accidents, thefts, earthquakes, windstorms, illness and hundreds of other causes of uncertainty. Therefore, even though the peril is the cause of uncertainty of loss, the hazard may increase this uncertainty.

For example, fire is the cause for the loss due to fire but the defective wiring is, for example, a physical hazard that increases the chance of a fire.

40

The peril, with or without the hazard, would create a risk in a given situation. If a car is totally destroyed in a collision with another motorist, collision is then the peril, or cause of risk of accident. Obviously, when the risk of accident took place, which was uncertain before the event, what would result is the loss.

The loss is the undesirable end result of risk against which the insurance would provide indemnity. The loss, generally speaking, is the decrease or disappearance of value that resulted in unexpected or at least unpredictable manner. From this brief analysis, we can conclude the whole discussion by saying that risk is the uncertain event caused by peril (that may be coupled by hazard), the result of which is the loss.

As risk is of different types and classifications, this section will shed some light on. These classifications as attempted by the Western economists and insurance theorists. Generally speaking, they have classified risk into many classifications according to many different perspectives. Risk, based on the nature of the loss, may be either financial risk or non-financial risk. While adversity in the former case involves financial loss, the adversity in the latter case involves non-financial loss.

Risk can also be classified as static and dynamic risks. Dynamic risks are those resulting from changes in the economy such as changes in the price level, consumer tastes, income and output and technology advancement. This risk changes with the change in the economy. Static risks, on the other hand, involve losses that would occur even if there were no changes in the economy. These losses arise from causes other than the changes in the economy, such as perils of nature and the dishonesty of other individuals. As static risks are generally predictable, static risks are more suited to treatment by insurance than are dynamic risks.

Another classification of risk that is relevant to the discussion is pure risk and speculative risk. Pure risk is .pure. in the sense that it does not mix both profits and losses. The business of insurance in concerned with the economic problems created by pure risk. A more common example of pure risk is that found in ownership of property. In regard to such a peril as windstorm, the owner may either suffer a loss or not have a loss. There cannot be a gain from having the loss. In contrast, speculative risk is defined as a situation where either profit or loss is possible. If one buys 100 shares of common stock, one would profit if the stock rises in price but would lose if the price declines.

Under the current practice, only pure risks are insurable for several reasons. Among other reasons, the law of large numbers can be applied more easily to pure risks than to speculative risks. Also, society may benefit from a speculative risk if a loss occurs, but it is harmed if a pure risk is present and a loss occurs. For example, a firm may develop a new technological process for producing computers more cheaply. As a result, a competitor may be forced into bankruptcy. Despite the bankruptcy, society benefits since the computers are produced more efficiently at a lower cost to consumers.

41

SECTION 5 EACH QUESTION CARRIES 4 MARKS

Q1. Mention the characteristics of planned expenditure from Zakah Funds defining the sectors in which this plan can be implemented.A1.

1. Payment of cash money to those who are completely disabled, unable to work or gain their living.

2. Payment in kind, in the form of light fixed assets, production tools and productive commodities.

3. Partnership that would culminate in ownership for the benefit of categories of people qualifying for the Zakah. This enterprise is to be financed by the Zakah foundation.

4. Engaging in a specific lawful Mudarabah project pertaining to a specific activity, with the Zakah foundation acting as owner of the capital, while Zakah beneficiaries act as workmen who take part in the Mudarabah as a partner contributing his work. Any ratio of profit is to be divided between them in accordance with an agreement made prior to commencement of the work.

5. Provision for leasing light fixed assets and production tools with nominal fees or rent to the poor and the needy.

Q2. How did Al Zarqa argue about Takaful vis a vis conventional insurance?A2.

The attraction to take a life policy, says, some of the readers, seems too strong when one considers the need for safety in life. My answer to all such questions is:

Insurance has become an essential part of business throughout the world. Because there are too many risks that could affect people’s lives and welfare, Insurance tries to alleviate the adverse effects of such risks. Insurance has become a highly sophisticated business, with large companies offering cover against a wide range of risks. People take out insurance policies to protect their homes, furniture, vehicles, and jobs, and they also take out health and life insurance.

In its modem form, insurance was introduced in Muslim countries when many of them were occupied by western powers, or when they came under western influence. In some cases, its introduction was delayed in a country until its international business flourished. Like every thing that came with a “colonial” or western color, insurance was first viewed by Muslim scholars with grave suspicion. A verdict of disapproval was common to most things thought to be introduced by non-Muslims.

Yet insurance is not new, and it was not invention by the western civilization. The idea of collaboration to reduce the effects of disaster that might hit one or more in a community is as old as human society.

In many Muslim cities, business people collaborated, establishing funds to look after anyone of them who might suffer a huge trade loss, as could happen when a cargo ship sank

42

during a storm. While these early efforts catered for a specific risk, the idea behind them is the same as that behind insurance.

In the last few decades, a number of eminent scholars discussed insurance at length, arriving at divergent views. One of the best theses written on the subject was published in a book in Arabic by the late prof. Mustafa Al-Zarqa, who ranked high among the top scholars of the twentieth century. His work is very scholarly, as it shows thorough understanding of the insurance system and how it works. He arrives at a verdict of permissibility of all types of insurance, including life insurance. He points out that insurance inevitably involves an element of Gharar, (risk of uncertainty) which in Islamic terminology means the sale of an “undefined” or unspecified product. However, he explains that it is rather marginal, and as such it is overlooked, as in other types of transactions involving marginal Gharar.

There are two main types of life insurance: Term policy and endowment policy. The term policy involves the payment by the insured of modest premiums over an agreed period, say, 20 years, in return for the benefit of his family receiving an agreed large sum of money in case of his death during the period. If the insured remains alive at the end of the policy, it lapses an gets nothing. What the insured actually buys with his payment is the peace of mind he gets from the knowledge that should he die, his dependent will have a large sum of money, to see them through life until, say, his young children came of age and were able to look after themselves.

The endowment policy involves the payment of larger premium which are invested by the insurance company. When the policy matures, the insured receives the sum assured as well as any share of profits to which he may be entitled under the terms of investments made on his behalf by the insurance company.

Both types are permissible from the Islamic point of view, as explained by professor Al-Zarqa, provided that the insured make sure that the insurance company invests in legitimate business. If the insurance company invests in what Islam forbids, then taking out his policies become forbidden.

Q3. Discuss the Characteristic features of a few Asian and Gulf Islamic Credit Cards.

A3.

The Asian SolutionLaunched in December 2001, the Al Taslif Card from AmBank in Malaysia (formely

the Arab Malaysian Banking Group) works off the Sharia princitwo ‘ple of Bai’ Al Inah that covers installment repayments over a fixed period. Cardholders are charged 1.25% per month or 15% per annum on the outstanding balance, with nothing to pay if the minimum payment requested is made on time. The Bai’ Al Inah contract works on the basis of two “akad’ agreements. The first is the bank’s agreement to sell an item to the customer at an agreed price, with the second agreement covering the customer selling back to the bank at a lower price. The difference is the bank’s profit on the transaction and is a predetermined amount.

43

Though a percentage repayment is being made, this differs from conventional structures in that payment of the minimum balance only does not trigger interest repayments for the outstanding balance. Just from spending on the card, consumers are also helping charities via the AmBonus scheme. For every RM100 spend on the Al Taslif card, an AmBonus of RM1 is earned that goes to pay off the annual card fee. Once that fee has been repaid, however, all future AmBonus points are donated to charities by the bank.

More recently, Bank Islam Malaysia launched its Bank Islam Card (BIC) the name of the product deliberately avoiding the word ‘credit’. The bank claims that this card, available in MasterCard Classic or Gold, is the first credit card to be based on sharia contracts and that is thus free from Riba or Gharar (uncertainty) due to the fact that the maximum profit earned is declared up front. BIC also has the distinction of being the first EMV Smart Chip card issued in Malaysia. The bank says that this card works off a combination of three Sharia contracts: Bai’ All Inah transaction has taken place, the item nominally transaction is transferred into the customer’s Wadiah BIC account at the bank. The customer can then use the BIC card to make payments with the collateral all coming from the funds in the Wadiah account. Finally the Qard Hassan contract is activated if the cardholder wants to spend more than the funds available in the Wadiah account and the bank agrees to make more funds available on an interest-free basis. The bank’s Chairman, Datuk Mohammed Youssef Nasir, says that Bank Islam will have targeted some 55,000 banking consumers with the BIC card this year.

“The extension of credit with a view to making profit is not a Qard Hassan loan and thus is unacceptable in religious terms for the creditor as well as the borrower”.

The more stringent Gulf View

Critics of solutions such as the two above say that the Bai’ Al Inah contract is ethically flimsy when applied in this manner as the sale transacted is a fake sale and thus just a means of masking Riba. As is the case with matters of Sharia-compliance, judgments are based on the Sharia board of each financial institution and so what may be acceptable to one board may yet be Haram for another. For many Middle East bankers, therefore, the solutions found by the Asian banks are simply not stringent enough in their interpretation of Qu’ranic rules. One Bahrain-based banker who prefers to remain anonymous believes that the Asian interpretation boils down to an injunction against using the card to purchase Haram items and services, and indeed the BIC card will reject transactions related to bars, gambling, massages and so on for payment.

44

Q4. Define the basis for Zakah being obligatory and what are the conditions to be

fulfilled to make it compulsory?

A4.

Zakah becomes obligatory when an individual freely owns and possesses a productive nisab (minimum) of property. The possession and ownership of productive assets or property, apparent or non-apparent, constitutes the extent and degree of wealth of an individual creating the obligation to pay Zakah.

1. Productivity2. Possession and full ownership3. The Nisab

Conditions for Zakah1. Reason and maturity

2. The state of being a Muslim

3. “Dimar” property

4. Property which lacks productivity, and basic essentials of life are exempt from Zakah

5. The property of minors and insane

6. Condition of completion of one year

Q5. Name a few Islamic Credit Cards offered by Emirates Islamic Bank.

A5.

Emirates Islamic Bank Credit Card is a credit card which is fully and truly compliant with Shari'a principles. No interest is charged on the outstanding amount of the credit card. The card retains the flexibility and convenience associated with normal credit card.

Classic card

Classic Plus card

Gold card

Gold Plus card

Platinum Card

Platinum plus Card

45

MODULE IV

PART 2

SECTION 1

State whether the following are TRUE or FALSE

1. Zakah Funds can be mixed with Kharaj (FALSE)

2. In a family takaful a participant can act for the benefit of a third party (FALSE)

3. The takaful operator shares in the losses of participants (FALSE)

4. Zakah Funds can be given as loans to individuals (TRUE)

5. A membership fee can be charged by the bank for issuing Islamic Credit card (TRUE)

SECTION 2

Fill up the blanks with appropriate words.

1. For an insurable interest to be valid the loss must be gambling and wagering practices.

2. Takaful is based on the principle of cooperate or Mutual model.

3. The Dow Jones Islamic Market family includes global, regional, country, industry and

market-cap-indexes based indexes.

4. Islamic Credit Cards use the principle of deferred payment sale.

5. For Zakah to be obligatory the property must be individual freely owns & possesses a

productive nisab (minimum)

SECTION 3

MATCH THE FOLLOWING

Possession and full ownership - condition for Nisab

A type of land tax - Kharaj

Niyyah - Intention

Malaysia central bank, Bank Negara - Al Taslif Credit Card

Credit Sale - Bai’ bithamin al ajil

Brotherhood, solidarity and mutual assistance - Concept of Takaful

Wakala - Agency

Dow Jones - Islamic Market Indexes

Dimar - property lost

Bai’al Inah - IBFS interest free banking scheme

46

SECTION 4

POWER POINTS

1. THREE categories of persons entitled to receive Zakah

1. The poor 2. The needy (miskin) 3. Income below nisab

2. Basis of Zakah

1. Productivity 2. Possession and full ownership 3. The Nisab

3. Five sources of collection of Zakah.

I. Zakah Al Fitr

II. Zakah on agriculture (mainly paddy crops)

III. Zakah on business

VI. Zakah on savings

V. Zakah on wealth

4. Five requirements for insurable risk.

The first requirement is the existence of a large number of units

A second requirement is that loss should be accidental and unintentional.

A third requirement is that the loss should be both determinable and measurable.

The fourth requirement is that the loss should not be catastrophic.

Another important requirement is that the chance of loss must be calculable.

A final requirement is that the premium must be economically feasible. The insured

must be able to pay the premim

5. Name eight categories of persons entitled to receive Zakah.

(a) The poor

(b) The needy (miskin)

(c) Those, who are appointed to collect Zakah

(d) Islamic propagation (Al Mullafatu Qulubuhum)

(e) Freeing Slaves

(f) The indebted

(g) In the way of Allah

(h) The Wayfarer

47