Managing Finances A Shariah Compliant Way PDF

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Omar Mustafa Ansari
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Managing Finances A Shariah Compliant Way

Omar Mustafa Ansari
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In the name of ALLAH, the most Beneficent, the most Merciful
Dedicated to
All who helped me out in this humble effort and those who guided me for
preparation for the life hereafter, particularly my father Shamsuddin Khalid
Ahmed Ansari, my mother Aasia Khalid, my grandmother Umme Zubair
and my teacher and mentor M. Basheer Juma.
THE BOOK
The staggering development of Islamic banking at global level
has necessitated education and training for the bankers, business and
industrial communities and savers / investors who are looking
increasingly for financial products which are in harmony with the
tenets of the Shariah. The major challenge in Pakistan, where efforts to
promote Islamic banking were started afresh after the historic
judgment of the Supreme Court of Pakistan in 1999, is creating
awareness among all stakeholders about the theory and practice of
Islamic banking and finance.
The book Managing Finances A Shariah Compliant Way by
Omar Mustafa Ansari is a useful addition to the available material in
this regard and a valuable guide for all those who want to manage their
personal or Companies funds in lines with the tenets of the Shariah.
Being an Accountant and Auditor by profession and by dint of his
involvement in Shariah related audit of Islamic banking institutions
over last few years, the author sufficiently understands the most
proper way of banking operations and managing investments
according to the principles of the Shariah. The book has been written
with special reference to Pakistans financial market. I would say that it
is a must reading for the Companies CFOs and the general investors.
(Muhammad Ayub)
Director Training, Development and Shariah Matters
Institute of Islamic Banking and Insurance, London
June 19, 2007
THE AUTHOR
Omar is a Chartered Accountant by profession. Presently he is
associated with Ford Rhodes Sidat Hyder & Co. Chartered
Accountants (a member firm of Ernst & Young Global) as a Partner.
Omar has gained substantial experience in the audit and
related services to local and multinational companies operating in
diversified sectors. His area of specialization is providing audit and
other services for Islamic finance industry. His portfolio of clients in
Islamic finance industry, over past few years, includes Islamic
commercial banks, Takaful companies, Islamic Mutual Funds and
Modarabas.
Besides audits and related services, Omar has acquired
diversified experience in respect the fields of Islamic finance and
banking including Shariah compliance inspection, Shariah audits,
internal Shariah review, development of Shariah compliance inspection
manual and operating manual for Islamic commercial banking and
financial institutions.
Omar has been one of the key speakers and trainers for
training courses for Islamic bankers, arranged by the National Institute
of Banking And Finance (NIBAF) an institute run by the State Bank
of Pakistan. These courses are carried out by NIBAF in its campuses
in Karachi and Islamabad. His main topics include the accounting for
Islamic financial products, auditing the Islamic financial institutions,
governance and risk management for Islamic financial institutions,
besides a few basic Islamic financial products. He is also serving as an
alternate member on the committee for review of Takaful rules,
constituted by the Securities and Exchange Commission of Pakistan.
Omar has been speaker and anchor man for various seminars
and workshops on Islamic finance and related topics on various
forums, particularly various accounting and auditing professional
bodies. Topics for these Seminars include accounting issues for
Islamic banking, tax issues for Islamic banking, Takaful, Shariah
compliance and audit for Islamic finance and Sukuks.
TABLE OF CONTENTS
PREFACE .............................................................................................................1
INTRODUCTION TO ISLAMIC FINANCE ................................................... 3
BASIC DIFFERENCE BETWEEN THE ISLAMIC AND SECULAR ECONOMIC
SYSTEMS............................................................................................................................... 4
PILLARS OF ISLAMIC ECONOMIC SYSTEM .................................................................... 5
ZAKAT AND USHR .............................................................................................................. 6
SADAQAT AND KHAIRAT ................................................................................................... 6
PROHIBITION OF RIBA ..................................................................................................... 6
WHY INTEREST IS HARMFUL FOR THE SOCIETY?...................................................... 7
EMPHASIS ON PROHIBITION OF RIBA ........................................................................... 9
WHAT QURAN SAYS REGARDING RIBA? ........................................................................ 9
AHADITH AGAINST RIBA ................................................................................................ 10
IS MODERN DAYS INTEREST ALSO A TYPE OF RIBA?............................................. 11
LAW OF INHERITANCE ................................................................................................... 11
ENCOURAGEMENT OF TRADE AND COMMERCE ...................................................... 13
RESTRICTIONS ON UNFAIR TRADE PRACTICES.......................................................... 13
KHUMS ............................................................................................................................... 14
OTHER TAXES .................................................................................................................. 14
IS MERELY IMPLEMENTATION OF ISLAMIC ECONOMIC SYSTEM SUFFICIENT? 15
IS ISLAMIC BANKING TRULY ISLAMIC?....................................................................... 16
INTEREST-FREE BANKING INTRODUCED IN 1980S .................................................. 16
ISLAMIC BANKING AS INTRODUCED NOW ............................................................. 19
OPERATIONS OF ISLAMIC BANKS ................................................................................. 20
SOCIO-ECONOMIC EFFECTS OF ISLAMIC BANKING ................................................. 20
WHY ISLAMIC BANKING?............................................................................................... 21
SHARIAH COMPLIANT BUSINESS A FEW CHARACTERSTICS ......... 23
CORE ACTIVITIES OF BUSINESS ................................................................................... 24
UNLAWFUL BUSINESSES ................................................................................................ 24
CAPITAL STRUCTURE OF BUSINESS AND SOURCES OF FINANCING...................... 25
PROFIT AND LOSS SHARING AMONGST PARTNERS ................................................. 26
ARRANGEMENTS FOR FINANCING ............................................................................... 26
BASIC TOOLS OF INTEREST-FREE FINANCING ........................................................ 27
DEALINGS WITH THIRD PARTIES ................................................................................ 28
DEALINGS WITH EMPLOYEES ....................................................................................... 28
PROFIT AND LOSS SHARING BASED FINANCING .................................31
(i)
LOANS ................................................................................................................................ 31
MUSHARAKA AND MODARABA ...................................................................................... 32
MODARABA AND TYPES OF MODARABA ..................................................................... 33
WHY MODARABA? ........................................................................................................... 34
CERTAIN CONTROVERSIES REGARDING MODARABA ............................................. 36
SHARIAH PROVISIONS APPLICABLE TO MODARABA ................................................ 36
MUSHARAKA ..................................................................................................................... 39
BASIC TYPES OF SHIRKAH ............................................................................................. 40
TYPES OF MUSHARAKA ................................................................................................... 40
PRACTICAL APPLICATION OF MUSHARAKA BASED TRANSACTIONS ..................... 42
PARTNERSHIPS ................................................................................................................. 42
PROVISIONS OF PARTNERSHIP LAW NOT IN COMPLIANCE WITH SHARIAH ...... 43
LIMITED LIABILITY COMPANIES.................................................................................. 44
LIMITED LIABILITY CONCEPT ..................................................................................... 44
ARTIFICIAL JURISTIC PERSONALITY CONCEPT ........................................................ 45
ARE LIMITED LIABILITY COMPANIES BASED ON MODARABA RULES? ............... 46
BASIC NON-COMPLIANCES OF SHARIAH IN COMPANY LAW .................................. 46
DOS AND DONTS FOR MUSHARAKA ARRANGEMENTS ........................................... 47
DIMINISHING MUSHARAKA ........................................................................................... 50
DOS AND DONTS FOR DIMINISHING MUSHARAKA ARRANGEMENTS.................. 51
HOW TO DIFFERENTIATE A MUSHARAKA FROM MODARABA?.............................. 53
TRADE-BASED ALTERNATES TO FINANCING ...................................... 55
BAY .................................................................................................................................... 56
BASIC PRINCIPLES OF TRADE ....................................................................................... 56
BAY MURABAHA.............................................................................................................. 59
FACTORS DETERMINING SELLING PRICES................................................................ 59
TYPICAL MURABAHA SALE ............................................................................................ 61
MODERN-DAY MURABAHA ........................................................................................... 61
MURABAHA SALE AS A FINANCING TRANSACTION .............................................. 62
PROVISIONS IN APPLICABILITY OF MURABAHA ........................................................ 64
ISTIJRAR ............................................................................................................................. 67
TAWARRUQ........................................................................................................................ 68
BAY SALAM ....................................................................................................................... 70
APPLICABILITY OF SALAM SALE.................................................................................... 70
SHARIAH PROVISIONS IN SALAM .................................................................................. 73
PARALLEL SALAM............................................................................................................. 75
SHARIAH PROVISIONS IN PARALLEL SALAM .............................................................. 76
BAY ISTISNA ..................................................................................................................... 77
PRACTICAL APPLICABILITY OF ISTISNA ...................................................................... 77
SHARIAH PROVISIONS FOR ISTISNA ............................................................................. 80
PARALLEL ISTISNA .......................................................................................................... 82
LEASE-BASED ALTERNATES TO FINANCING........................................ 85
IJARA ................................................................................................................................... 85
(ii)
PRACTICAL APPLICABILITY OF IJARA .......................................................................... 85

IJARA MUNTAHIA BITTAMLEEK / IJARA WA IQTINA ............................................... 87
SALE AND LEASEBACK ..................................................................................................... 89
DOS AND DONTS FOR IJARA ........................................................................................ 89
DOS AND DONTS FOR IJARA MUNTAHIA BITTAMLEEK ........................................ 93
AGRICULTURAL FINANCING ..................................................................... 95
SALAM................................................................................................................................. 95
MUZARAA ......................................................................................................................... 96
DOS AND DONTS FOR MUZARAA .............................................................................. 98
MUSAQA .......................................................................................................................... 101
DIFFERENCE BETWEEN MUZARAA AND MUSAQA ............................................... 101
DOS AND DONTS FOR MUSAQA ............................................................................... 102
MUGHARASA ................................................................................................................... 102
NORMAL MODES OF ISLAMIC FINANCING APPLICABLE TO AGRICULTURE
SECTOR ............................................................................................................................ 103
CONSUMER FINANCING A CONSUMERS PERSPECTIVE ............... 105
HOUSING FINANCE ARRANGEMENTS (MORTGAGES)........................................... 107
MURABAHA BASED HOUSING FINANCE MODEL ................................................... 108
IJARA MUNTAHIA BITTAMLEEK BASED HOUSING FINANCE MODEL ............... 109
ISTISNA BASED HOUSING FINANCE MODEL .......................................................... 110
DIMINISHING MUSHARAKA BASED HOUSING FINANCE MODEL ....................... 111
CAR FINANCING AND LEASING .................................................................................. 116
CREDIT CARDS ............................................................................................................... 117
DEBIT CARDS, ATM CARDS AND CHARGE CARDS................................................. 119
PERSONAL LOANS ......................................................................................................... 120
INTEREST-FREE FINANCIAL MANAGEMENT...................................... 123
TIME VALUE OF MONEY.............................................................................................. 123
TIME VALUE OF ASSETS ............................................................................................... 125
TIME VALUE OF MONEY AS A PERFORMANCE MEASUREMENT TOOL ............. 126
MANAGING FINANCES WHY AND HOW? .............................................................. 128
WORKING CAPITAL MANAGEMENT........................................................................... 129
DEBTORS MANAGEMENT ........................................................................................... 130
BILLS DISCOUNTING OR FACTORING ....................................................................... 132
EXPORT BILLS DISCOUNTING .................................................................................... 133
GENERAL BILLS DISCOUNTING ................................................................................. 134
JUALA ................................................................................................................................ 135
SECURITIZATION OF RECEIVABLES ........................................................................... 136
SECURITIZATION OF FUTURE RECEIVABLES .......................................................... 137
INVENTORY MANAGEMENT STOCK LEVEL CONTROL ...................................... 138
CREDITORS MANAGEMENT ........................................................................................ 140
EQUITY FINANCING ..................................................................................................... 142
(iii)
EQUITY FINANCING ON MUSHARAKA BASIS ........................................................... 142

EQUITY FINANCING ON MODARABA BASIS ............................................................. 143
PERMISSIBILITY OF PREFERENCE SHARES .............................................................. 144
MODARABA PREFERENCE SHARES A PROPOSED MODEL ................................. 145
LONG-TERM FINANCING ............................................................................................ 146
SHORT-TERM FINANCING .......................................................................................... 147
SOURCES OF INTEREST-FREE FINANCING................................................................ 148
FAMILY AND FRIENDS ................................................................................................... 148
GENERAL PUBLIC .......................................................................................................... 149
ISLAMIC FINANCIAL INSTITUTIONS ........................................................................... 149
CONVENTIONAL FINANCIAL INSTITUTIONS............................................................ 150
INVESTMENT OF EXCESS FUNDS ............................................................................... 151
STOCK MARKET OPERATIONS .................................................................................... 152
MARGINAL TRADING AND BADLA ............................................................................. 153
SHORT-SELLING, FORWARD SELLING AND FORWARD PURCHASES ...................... 154
SELLING BEFORE POSSESSION .................................................................................... 155
EQUITY INVESTMENT IN JOINT STOCK COMPANIES ............................................ 156
PURIFICATION ................................................................................................................ 158
PURIFICATION OF INDIRECT INCOME AND CAPITAL GAINS ............................... 158
INVESTMENT IN REDEEMABLE CAPITAL ................................................................. 159
PREFERENCE SHARES .................................................................................................. 160
INVESTMENTS IN MUTUAL FUNDS............................................................................ 161
INVESTMENT IN MODARABAS .................................................................................... 161
INVESTMENTS IN GOVERNMENT SECURITIES........................................................ 162
PERSONAL LEVEL MUSHARAKA AND MODARABA ............................................... 163
FOREIGN EXCHANGE ................................................................................................... 163
INVESTMENTS IN REAL ESTATE ................................................................................ 164
ACCOUNTING AND TAXATION ISSUES FOR INVESTMENT IN REAL ESTATE .... 165
SHARIAH COMPLIANT SOLUTIONS FOR RAISING FINANCES ............................... 166
SPECIFIC SOLUTIONS FOR RAISING FINANCES ......................................................... 167
REDEEMABLE CAPITAL ................................................................................................. 167
SPECIAL PURPOSE VEHICLES ....................................................................................... 169
SPECIAL PURPOSE MODARABA .................................................................................... 169
GENERAL BUSINESS MATTERS ................................................................ 171
EMPLOYEES RELATIONS............................................................................................. 171
RETIREMENT BENEFITS .............................................................................................. 172
DEFINED CONTRIBUTION PLANS............................................................................... 172
DEFINED BENEFIT PLANS ........................................................................................... 174
INSURANCE ..................................................................................................................... 175
BANK GUARANTEES ...................................................................................................... 175
LETTERS OF CREDIT..................................................................................................... 177
TAXATION ....................................................................................................................... 178
DEALINGS IN FOREIGN CURRENCY .......................................................................... 180
FORWARD CONTRACTS................................................................................................. 182
(iv)
MARKETING .................................................................................................................... 183

ADHERENCE TO THE LAW OF THE LAND ................................................................. 183
INSURANCE AND TAKAFUL....................................................................... 185
WHY INSURANCE IS CONSIDERED HARAM.............................................................. 186
GHARAR UNCERTAINTY ........................................................................................... 186
MAISAR GAMBLING .................................................................................................... 187
RIBA INTEREST ........................................................................................................... 187
LACK OF RELIANCE ON TAQDEER ............................................................................. 188
ALTERNATE OF CONVENTIONAL INSURANCE SYSTEM TAKAFUL ................... 189
HOW TAKAFUL WORKS?................................................................................................ 189
RATIONALE FOR PERMISSIBILITY OF TAKAFUL ...................................................... 192
TAKAFUL BUSINESS IN PAKISTAN ............................................................................... 193
OTHER ALTERNATES TO INSURANCE ...................................................................... 194
FINANCIAL REPORTING PRINCIPLES .................................................... 195
HONESTY AND TRUTHFUL PRESENTATION ........................................................... 195
UNIFORMITY OF FORM AND SUBSTANCE................................................................. 197
AUDIT ...............................................................................................................................199
SELECTION OF AUDITOR .............................................................................................. 200
INTERNAL AUDIT .......................................................................................................... 202
CODES OF ETHICS ISSUED BY AAOIFI..................................................................... 202
PROBLEMS OF A MUSLIM EMPLOYEE....................................................203
SEEKING THE RIGHT JOB ............................................................................................. 203
TIME AND DUTY ............................................................................................................. 204
RETIREMENT BENEFITS .............................................................................................. 205
PROVIDENT FUND ........................................................................................................ 206
PENSION AND GRATUITY............................................................................................. 207
OTHER RETIREMENT BENEFITS ................................................................................ 209
LOANS AND ADVANCES ................................................................................................. 209
ALTERNATES FOR EMPLOYEE LOANS ...................................................................... 212
TRANSPORT FACILITIES ............................................................................................... 212
MEDICAL FACILITY ........................................................................................................ 215
ZAKAT .............................................................................................................. 217
SAHIB-E-NISAB .............................................................................................................. 217
NISAB ...............................................................................................................................217
BASIC EXEMPTIONS ...................................................................................................... 218
RATE OF ZAKAT ............................................................................................................. 218
ZAKAT YEAR ................................................................................................................... 219
RATIONALE FOR SELECTING 1ST OF RAMADAN ....................................................... 219
TO WHOM ZAKAT MAY BE PAID ................................................................................ 220
ZAKAT ON GOLD ............................................................................................................ 220
(v)
ZAKAT ON SILVER .......................................................................................................... 221

ZAKAT ON PRECIOUS STONES .................................................................................... 221
ZAKAT ON CASH AND RECEIVABLES ......................................................................... 221
ZAKAT ON PROVIDENT FUND BALANCES ................................................................ 223
ZAKAT ON REAL ESTATE ............................................................................................. 224
ZAKAT ON BUSINESS ..................................................................................................... 224
ZAKAT ON PARTNERSHIPS ........................................................................................... 224
ZAKAT ON SHARES IN LIMITED COMPANIES........................................................... 225
ZAKAT / USHR ON AGRICULTURAL PRODUCTS ...................................................... 226
ZAKAT ON LIVESTOCK .................................................................................................. 227
ZAKAT ON HOUSE, HOUSEHOLD ITEMS, VEHICLES AND NECESSITIES ........... 227
LIABILITIES DEDUCTIONS........................................................................................... 228
ZAKAT PAID TO GOVERNMENT .................................................................................. 229
ADJUSTMENT OF ZAKAT WITH INTEREST ................................................................ 230
IS ZAKAT DUE ON INTEREST-BEARING INSTRUMENTS? ..................................... 230
ZAKAT AND USHR SELF ASSESSMENT FORM ........................................................... 231
LEGAL AND TAXATION ISSUES IN PAKISTAN ......................................239
TAXES ON MURABAHA AND OTHER ISLAMIC FINANCE TRANSACTIONS ............ 240
WORKERS PROFITS PARTICIPATION FUND (WPPF)............................................ 242
ADDITIONAL TAX UNDER INCOME TAX AND SALES TAX LAW ........................... 244
INTEREST ON LEGAL CLAIMS ..................................................................................... 245
FUNDED RETIREMENT BENEFITS ............................................................................ 246
INTEREST AS A PROFIT TRANSFER TOOL ................................................................ 248
TAX BENEFITS ON INTEREST ..................................................................................... 249
GLOSSARY OF TERMS .................................................................................. 251
BIBLIOGRAPHY .............................................................................................267
(vi)
Preface
PREFACE
Islam by its real meaning denotes the phenomenon of
completely following somebodys commands or surrendering against
someones will. In general understanding, it is the state in which
somebody follows the instructions of Allah Almighty. By nature, it is
not a religion as is understood in general and instead, it is a Deen
( )which stands for a complete way of life. Allah Almighty declares
in His Book, at not less than three places in the same wordings, that
He is the ONE who has sent HIS Messenger (SAAWS) with divine
guidance and the true way of life to overpower all other ways of life,
irrespective of the opposition of the pagans or polytheists ( ).
And if understood in the same manner, our Deen provides us
with a complete set of instructions to be followed in our whole life.
The matter of being a Muslim duly includes the state of adherence to
the complete set of instructions made available to us through the Holy
Quran and Sunnah. Alhamdolillah, there is, and always remains, a
group of Ahl-e-Iman, who have the desire to perform all of their
activities in accordance with the rules set by Allah Almighty.
Besides all other areas of life, our Deen also provides guidance
on the business, trade and financing matters. This study is a humble
effort to overcome the need of entrepreneurs and businessmen in
Pakistan, as well as, students of accounting, finance and business,
having a keen desire for running their businesses in accordance with
the basic principles of Islam in order to please Allah Almighty for
assurance of betterment of the life hereafter. In the newer terminology
and theories, employment is also a type of entrepreneurship in which
the employee renders his services against a specific return, and
accordingly, certain matters particularly relating to the employees have
also been included in this study.
Page - 1
Preface
Any guidance generally provided by the religious scholars is of

principle nature which needs practical expertise and knowledge for its
implementation in complex business transactions nowadays. On the
other hand, it has also been observed that people have obtained
Fatawa in favour of certain transactions by presenting scenarios to
various scholars that were not in the true substance and spirit of the
transaction. The prime objective of this study is to make available a
guide to general public (particularly businessmen) for making
awareness of basic Islamic concepts for managing a businesss finances.
It is rather a business guide, instead of some sort of research material
on Islamic banking and finance, and should be construed as just a
guide for a businessman and finance professionals.
It should clearly be kept in mind that the person behind this
study is not a religious Scholar at all nor he claims to be one. He is an
accountant by profession and accordingly the matters purely relating to
Fiqh have not been discussed in detail and author has not given his
opinion in any such matter and instead, has just identified or rather
reproduced the opinions and views of various scholars. It is also
pertinent to note that there are certain differences of opinion between
scholars regarding the permissibility or otherwise of a few of the
transactions, for example Tawarruq. In such cases, it has been avoided
to comment on the permissibility of the same, although the dissenting
opinions have been disclosed just for the knowledge of the reader.
The author has diligently made efforts to the best of his
abilities to compile this study but he realizes his shortcomings and
weaknesses. Accordingly, the readers are strongly recommended to
follow their respective Fiqh and to obtain Fatwa from any respectable
scholar before taking any action. This study should not be considered
at all as a substitute to obtaining a Fatwa according to your respective
Fiqh and the author can not accept any responsibility in this respect.
Page - 2
Chapter One
Introduction to Islamic Finance
INTRODUCTION TO ISLAMIC
FINANCE
Islam by its real meaning denotes the phenomenon of
completely following the command of somebody. In general
understanding it is the state in which some body follows the
instructions of Allah Almighty. Islam, by its very nature, is not a
religion like any other religion. It is a Deen ( )which denotes a
complete way of living and provides us with a complete set of
instructions to be followed in the whole life of a Muslim. These
include the Ibadaat ( )and Muamlaat ( )i.e. the modes
of worship in different styles and the matters of dealings with others.
We know that being a Muslim demands the state of adherence to the
complete set of instructions made available to us through the Holy
Quran and Sunnah, irrespective of such instructions being included in
the Ibadaat or Muamlaat.
The set of instructions received, which we generally call our
Deen, in addition to other matters, provide us full guidance in the
matters relating to business. In this study, we will try to understand
and apply such principles in the affairs of managing the finances of a
business in Pakistan, within the framework provided by Allah
Almighty through its Messenger SAAWS.
Since, the most crucial issue for doing business in this era is
the matter of avoiding interest-bearing and similar transactions, a
major area of this study is devoted on interest-free financing alternates
and interest-free financial management. In this study, we have
considered most of the options available for an interest-free system. In
this respect, it is worthwhile to note that certain schools of thought
have objections of certain tools of Islamic finance on various grounds.
Similarly, it has also been established by almost all schools of thought
Page - 3
Chapter One
that a few of these tools are doubtful in a few aspects, hence, although
being permissible or Mubah (), it is advisable to avoid them.
Without going into the details for rationale of such comments, we
would just identify the situation in case of each of the tools and would
leave the matter on the judgment of the reader or recommend him to
consult his respective Shariah scholar to avoid any ambiguity.
Basic Difference between the Islamic
and Secular Economic Systems
The basic difference between the Islamic and Secular
economic systems is that Islam does not bind anybody to earn, save
and invest money except in such businesses which are declared
impermissible (Haram) on account of their very nature. On the
contrary, Islam does not allow concentration of wealth in a manner
that even a single person lives below the poverty line. In an Islamic
system, the poverty line does not reflect just a benchmark in form of
number of calories available to a human being, and instead, it reflects
the basic necessities of life in all respects. Zakat and Sadaqat are the
main tools used for the purpose in addition to the restrictions on
unreasonable trade practices, providing basic necessities to everybody
on controlled prices and prohibitions on earning profits over a
reasonable limit.
This study does not purport to cater the macro economics
issues, which we understand, have already been catered by works of
many of the respectable economists and scholars. Any of the readers
having interest in the subject, may consult such commendable studies.
Particularly, a few works by Maulana Syed Abul Aala Maududi,
Maulana Justice (Retired) M. Taqi Usmani, Dr. M. Nijatullah Siddiqui
and Dr. M. Umar Chapra should be consulted by every reader
interested in the concepts and details of an Islamic economic and
monetary system. Nevertheless, in order to bring the reader in the
same wavelength, we consider it necessary to discuss a few basic
concepts of Islamic economics.
Page - 4
Chapter One
If we consider the Islamic economic theories in brief, we will

come across two basic concepts. The first one the avoidance of
concentration of wealth whereas the second one is discouragement of
savings over and above the human needs and encouragement of
spending culture within certain limits. While practically applying both
these theories, economy that emerges which may rightly be termed as
an Islamic economy providing livelihood to each and every individual
of the Society with the lowest possible number of have-nots (ideally
zero, which has been evidenced during the regime of Khilafat-eRashida) and a minimum difference between the people having the
lowest earning and the class of people with the highest level of
earnings.
It is worth noting that Islam strongly encourages the social
equality amongst all the members of society through various cultural
effects particularly including Prayers in Mosque and Hajj. On the
contrary, it does not support the concepts of economic equality as
proposed by the Socialism and Communism. In this respect, various
respectable works are already available and the same is not a subject of
this study. All the interested readers are encouraged to consult to
various studies on this subject by a number of respectable scholars.
Pillars of Islamic Economic System
Now coming back to our topic, we may note that the Islamic
economic system uses the following basic instruments as its pillars to
achieve the above objectives:
Zakat and Ushr;

Sadaqat and Khairat;
Prohibition of Riba;
Law of inheritance;
Encouragement of trade and commerce;
Restrictions on unfair trade practices;
Khums; and
Other taxes.
Page - 5
Chapter One
Zakat and Ushr

The first and the most important instrument in this respect is
Zakat, which results in flow of economic resources from the Haves
to the Have-nots, as well as, discourages the savings and
concentration of wealth in a few hands. Similar and identical
instrument in most of the respects is Ushr except for the difference
that it is levied on the produce and not on the wealth (in form of land
and agricultural resources). Like Zakat, it also results in flow of
economic resources from well-off to the needy. Particularly in
agriculture based economy like Pakistan whereby the agricultural
produce is a significant portion of the countrys GDP, Ushr, if
effectively utilized, might prove to be a very effective tool in this
respect.
Sadaqat and Khairat
Second instrument in this respect is encouragement of
Sadaqat and Khairat of all sorts. All the Muslims have been advised to
spend maximum of their savings in the way of Allah, either through
helping people or through investing in the causes that are beneficial to
the society, as a whole. Although these are not mandatory, and their
quantum has been left by Allah Almighty on the individuals own will
and choice, but in an Islamic society people generally have a practice
of making Sadaqat and Khairat to get reward in the life hereafter.
Resultantly, these also play a vital role in de-concentration of wealth in
an economy.
Prohibition of Riba
The third instrument is prohibition of Riba (interest and
usury). Interest is one of the few prohibitions that are common in the
divine guidance of most of the known religions. Being a Muslim, our
basic object for this study is to ensure abidance of the rules set out by
Allah Almighty, irrespective of any enquiry as to the reason or
rationale for the same. However, our faith includes the basic principle
Page - 6
Chapter One
that anything declared Haram by Allah, must be dangerous and

harmful for us and if it does not appear as such to somebody at the
moment, it must be causing some problem with the society which
might be beyond our limited intellect.
Why Interest is Harmful for the
Society?
We will try to briefly discuss only two aspects of interest that
are harmful for the society in general and economy in particular. The
first aspect which is a social factor is that earning interest and facilities
to earn interest encourages people to get the benefit of someone elses
needs which is, and shall not be, something pleasant for the society if
such culture is cultivated in the society in general. Such practice also
results, in the long run, in the greedy approach of people which also
nullifies the basic instruments of Islamic economic system including
Zakat, Ushr and Sadaqat.
The second aspect, which is more directly relevant to our
study, is its economic aspect. If we try to define interest in pure
economic terms, it is generation of wealth without any productive or
trading activity. In other words, as also concluded by a number of
respectable economists, it is the prime cause for inflation in an
economy. Accordingly, we will briefly discuss this issue.
Assume that there is a closed economic model in which the
number of resources and productive assets remain constant for some
given period of time. Now, in each economy there is a movement
ideally through the productive activities, services, trading and use of
assets. All these movements result in profit taking by one party, but
provide a real benefit to the other party against such loss or expense.
Accordingly, in ideal circumstances, the total amount of money
remains the same in such economy and if the amount of money
increases, it is directly proportionate to the amount of production of
resources and services in the economy. Only in case of interest, the
situation is not the same. In case of interest, which is charged on the
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money lent to another party, it is not certain whether any real benefit
to the second party is achieved or not. On the other hand, the amount
of interest charged increases the amount of total circulation of money
in the economy. This amount of increase is generally not linked to the
productive activities, trading and services generated in the economy.
As a consequence of the same, the proportion between the amount of
money in circulation and the collective value of resources and assets
available in the economy is adversely disturbed resulting in inflation in
economy. This is a very simple example for understanding of the
concept for a general reader and is not intended to open door for
debates on the issue.
The governments, banks and other financial institutions have
now generated a huge volume of money in circulation, in excess of the
amounts of currency in circulation. This is generally created as a
consequence of interest-bearing loans in addition to the equity limits
and other techniques of creation of money used by the monetary
agencies / reserve banks, financial institutions and commercial banks.
Although as a part of risk management practices and through the
reserve banks monetary policies these practices are now controlled to
certain extent, even then, this ratio is not adequate in most of the
worlds economies. In view of the same, now our worlds whole
economic system has no foundations except for the public reliance on
the solvency of the financial institutions and rather on the respective
governments. Just imagine what will happen if American people loose
their reliance on the T-Bills. In past, we have evidenced a number of
bank failures which had an adverse impact on the whole economies.
Such weak foundations of the present economic system may
also be termed as the spiders web which, besides how large network
it has, is the weakest home as these systems do not take patronage
from Allah Almighty as proclaimed in the Holy Quran in the Surah
Ankabut Verse 41.
Because of the generation of wealth without corresponding
trading or productive activity or benefit in form of services, the whole
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economic system looses the equilibrium which is generally observed in

form of extra-ordinary increased or decreased market interest rates. A
very relevant example of such weaknesses in the system has been
observed in the recent past, by a decline in the market interest rate
throughout the world whereby the London Inter-Bank Operating Rate
(LIBOR) was ranging somewhere near to 1 percent per annum. Even
in the recent past, overnight inter-bank rates had once turned out to be
negative in Japanese inter-bank market.
Emphasis on Prohibition of Riba
It is also worthwhile discussing the emphasis that has been
drawn by Allah Almighty and the Holy Prophet SAAWS on the
prohibition of Riba. A few scholars are of the view that the accent of
Islamic Shariah is the hardest in case of Riba as compared to most of
other prohibitions, particularly, where it has been declared as a War
against Allah Almighty and the Holy Prophet SAAWS. In several
Ahadith, it has been termed as one of the worst sins, a human can
commit.
We should first have a look on certain Verses and Ahadith
against Riba, in order to just have an understanding of the stance of
Allah Almighty and His prophet SAAWS in this respect.
What Quran says regarding Riba?
In Verse 161 of Surah Al Nisa', Allah SWT declares that:
And for their taking interest even though it was forbidden
for them, and their wrongful appropriation of other peoples'
property, we have prepared for those among them who reject
faith a grievous punishment.
Verse 130 of Surah Ale Imran states that:
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Believers! Do not swallow Riba, doubled and redoubled, and

be mindful of Allah so that you may attain true success.
In addition to all above, in Surah Al Baqarah, Verses 274 to
281 Allah Almighty proclaims that:
Those who take Riba will not stand but as stands the one
whom the demon has driven crazy by his touch. That is
because they have said: Trading is but like Riba. So, whoever
receives an advice from his Lord and stops, he is allowed what
has passed, and his matter is upto Allah. And the ones who
revert back, those are the people of Fire. There they remain
forever. Allah destroys Riba and nourishes charities. And
Allah does not like any sinful disbeliever. Surely, those who
believe and do good deeds, establish Salah and Zakat have
their reward with their Lord, and there is no fear for them,
nor shall they grieve. O those who believe; fear Allah and give
up what still remains of the Riba if you are believers. But if
you don not, then listen to the declaration of war from Allah
and His Messenger. And if you repent, yours is your principal.
Neither you wrong, nor be wronged. And if there be one in
misery, then defer till ease. And that you leave it as alms is far
better for you, if you really know. And be fearful of a day
when you shall be returned to Allah, then everybody shall be
paid, in full, what he has earned. And they shall not be
wronged.
Ahadith against Riba
Besides this, there are a number of Ahadith that declare this
sin to be one of the worst sins a human can commit. Just for example,
following is the translation of a few Ahadith, taken from Mishkwat-ulMasabeeh ( ) Chapter of Riba:
The sin of taking Riba has 70 parts and the smallest part of
the same is equivalent to marrying ones mother.
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One Dirham (penny) of Riba that somebody knowingly eats

(or consumes) is worse than thirty-six times doing Rape.
The Hell has the first right on the person whose meat is
developed by eating Haram.
Is Modern Days Interest also a Type
of Riba?
Another issue or rather non-issue that has continuously been
raised by various circles during the last few decades is regarding the
definition of Riba which, according to the perspective of these so
called scholars and intellectuals, does not include the commercial
interest which is in practice in the recent days. Here we wish to avoid
any discussion on this topic, as it is not the subject of our study right
now and more importantly because we do not consider it necessary to
discuss on a topic that has already been well discussed and
exhaustively resolved by a number of respectable scholars in detail
with direct references from the holy Quran and Sunnah.
Since this is a very crucial issue hence we recommend the
readers to consult two books namely Sood ( )and Muashiat-eIslam (
)by Maulana Syed Abul Aala Maududi and the
historical judgments on Riba by the Honourable Federal Shariat Court
and the Shariat Appellate Bench of the Honourable Supreme Court of
Pakistan (Decisions written by Justice (R) Dr. Tanzeel-ur- Rehman and
Justice (R) Maulana Muhammad Taqi Usmani)
Law of Inheritance
The fourth instrument used for the purpose of development
of a just and equitable economic system, is the law of inheritance in
Islam. When considering as a layman nobody can identify the benefits
of this law towards the betterment of society. However, if we consider
its long-term impacts on the society, we can observe that it serves two
basic objectives.
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The first one which is the general understanding of a layman

is that since this rule has been specifically mentioned in Shariah, so it
helps in avoiding the disputes amongst the family members which may
arise if such distribution would not have been specifically mentioned
in the Holy Quran and Sunnah. This is the social aspect of the law of
inheritance whereas its economic impact is much pervasive in the
long-term. From economic perspective, one can observe that it also
results in avoidance of concentration of wealth and if applied in its
true spirit, it has always proved to be a very effective tool for deconcentration of wealth in the economy.
The division of inheritance according to Shariah is a
mandatory requirement and even a will made by a person can not
change such proportions. According to Shariah a will can only be
made upto the extent of one-third of somebodys wealth and the same
cannot be made in the favour of any of those who are entitled to
inheritance according to Holy Quran. Allah Almighty has declared in
Surah An Nisa that these laws of inheritance are the boundaries set by
Allah Almighty and those who do not obey Allah and His Messenger
will be entered into fire and will remain there forever. There are just a
few categories of sins in which Allah Almighty has declared that those
committing such sins will remain in Hell forever and there will not be
any forgiveness afterwards and disobeying Allah in the matter of
inheritance is amongst such worst sins. In addition, it should also be
noted that by disobeying these laws we also take someone elses right
in this worldly life, which we will have to pay for on the day of
judgment, whereby such aggrieved person will have a right to get the
Sawab ( )of our right-doings or to transfer his or her sins to us in
proportion to the right for which he or she was deprived.
In light of the above, we all Muslims, should reconsider our
attitude and make sure that we are not heading towards the Hell
forever. May Allah bless us all and forgive us by maximum of His
kindness and mercy.
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Encouragement of Trade and

Commerce
Fifth tool for the purpose is encouragement of trade and
commerce. Such encouragement affects the society from two sides.
First, the people invest directly in trade and commerce instead of
savings and investing in non-productive matters and take risk of loss
also, which results in overall resource mobilization and eventually in
the movement in the economy.
On the other hand it also involves people in trade and
commerce and instead of wasting money in futile avenues or earning
interest without any productive activity; such people become a better
and useful part of the society. Additionally, it also increases the overall
employment ratio, in form of either increased employments or more
adequately, in form of self-employments. It is also interesting to note
that in case of trade, a few transactions that apparently appear to be
very much similar to interest-bearing transactions, have also been
allowed by the jurists under the Shariah principles.
When considering the rationale for the same, we come across
a very interesting fact that trade results in movements in economy
whereas interest do not result any movement in the economy nor
directly results in or any other productive activity and accordingly
results in stagnancy of economy (if seen solitarily because it is not
dependent of any activity). If analyzed in detail, this also appears to be
a gift of divine guidance on the mankind for its own betterment.
Restrictions on Unfair Trade Practices
Sixth pillar for the purpose is restriction on unfair trade
practices. Such restrictions include, but are not limited to, prohibition
of black marketing, taking benefit from the ignorance of the supplier
and the customer, gambling and speculation businesses, contracts
without clarity on each aspect and avoiding Gharar i.e. uncertainty,
trade of Haram and impermissible commodities, and so on.
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Under these broad principles, the Islamic government has

been empowered to devise rules and regulations to ensure a fair trade
and commerce system in the economy. Under these principles, the
government has also been allowed to further make any other
temporary restrictions and prohibitions that might be considered
necessary to ensure stability of economy and benefit of the public at
large. These rules and regulations may include levy of taxes and duties
on certain items and providing subsidies on others. These may also
include the control over the prices of public necessities. Similarly,
these may include nationalization of certain commercial and industrial
activities if these are considered to be in the benefit of the general
public at large, although the same may not be considered as a
permanent solution of the situation.
Khums
Seventh tool in this respect is Khums which literally means
one fifth or 20 percent. Khums is the amount of governments share
in any Maal-e-Ghanimat (assets left by the defeated army), any buried
treasure and, according to a number of jurists, all minerals which are
found under the ground including, petroleum, gases, ores etc.. In the
days of Khilafat-e-Rashida and even afterwards, Khums arising on
Maal-e-Ghanimat were a major source of income for the government
which was then eventually distributed amongst the needy, as well as,
were used to pay for the governments needs. In these day, Khums on
minerals can be an excellent tool contributing for the benefit of the
poor and needy people because Khums shall also be distributed in the
manner like Zakat and Ushr, and even in a few books of Islamic
jurisprudence, it has been termed as Zakat on minerals etc..
Other Taxes
Eighth tool in this respect is levy of other taxes in accordance
with the Shariah requirements. Theses taxes may be divided in
different categories. The first category is the taxes applicable on NonMuslims including Jizya, Khiraj and Fay. Jizya is a tax levied by Islamic
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government on every individual Non-Muslim against the governments

duties for his safety and the social benefits to be provided to him.
Khiraj is the levy of tax on semi independent states, as well as, on
Non-Muslim land owners whose lands are not acquired by force by
the government, once a land is conquered by Muslim forces. Fay is a
tax on the landowners, generally the old landowners, with whom their
lands are left by the government for cultivation.
In addition to these taxes applicable on Non-Muslims, there
are a few taxes applicable on traders. These taxes are levied on Muslim,
Non-Muslim, citizens of the country and foreign traders (expatriates)
on different activities and commodities at different rates, as the
government may deem fit.
The prime objective of levying these taxes is to make available
enough funds for the collective social objectives, including but not
limited to, security of peoples life, assets and dignity, defense of the
country, provision of basic necessities to the have-nots, provision of
general public facilities like health, education and means of
transportation and so on. In any case, the moneys so collected are not
considered to be the personal property of any individual including the
Caliph or other officials of the government.
Is Merely Implementation of Islamic
Economic System Sufficient?
Islamic economic system is not something that can work in
isolation of the geo-political and legislative system, as well as, and
more importantly the societys behavior towards the injunctions of
Islamic Shariah in personal and collective matters. Accordingly, in an
economy whereby most of the businessmen are not honest in fairly
presenting the financial statements of their businesses, how difficult it
could prove to introduce a profit and loss sharing based financial
solution?
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Similarly, in most of the cases payment of Zakat and Sadaqat

depends on the individual and particularly, in view of the gigantic
volume of the black economy in the country (which according to
certain estimates is larger than the white economy in Pakistan) what
can be expected even if a good system for Zakat and Ushr is
introduced? Accordingly, the complete transition of economy to an
Islamic economic system can be performed when and only when the
overall consensus of the society is developed towards practical
application of Shariah in all the facets of human life, particularly
including the governmental, political and legislative structures.
Besides such an unsatisfactory and rather discouraging attitude
of the society towards application of Islamic Shariah, it should be
noted that such a situation does not relieve a Muslim from the
applicability of Shariah principles, but rather increases his
responsibilities in the way that it becomes his duty not only to try to
abide by all applicable Shariah requirements but also to put his
endeavors towards improvement in such system.
Is Islamic Banking Truly Islamic?
The question, as to whether Islamic banking is truly Islamic,
has two different facets. The first one is that whatever is being
performed in the name of Islamic banking is apparently quite similar
to the operations of a conventional financial institution hence creates
doubts in peoples mind. The second facet of this question is more
important and deals with the socio-economic factors associated with
the overall Islamic financial system.
Interest-free Banking Introduced in
1980s
As far as the first question is concerned, we may conclude that
Islamic banking in Pakistan may be divided in two different regimes.
The first one that is generally called interest-free banking was
introduced in the regime of General Mohammad Zia-ul-Haq, and
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which is still in operation in Pakistan with the conventional

commercial banks and other financial institutions. Without any doubt
on the intentions of the people who initiated the same and who
endeavored to convert the whole system on an Islamic basis, it may be
concluded that in the softest terms, we may call such experiment a
tragedy for Islamic banking which was not only a failed experiment of
its own but also resulted in practical impediments in the operation of
real Islamic banking in Pakistan.
The overall scheme implemented by General Zias team was
consisting of the following steps:
Replacement of complete interest-based banking

system with non-interest-based system;
Amendments in company law and certain other laws
to introduce certain Shariah compliant financial
solutions including interest-free redeemable capital
and certain restrictions on purely interest-based
instruments including debentures and preference
shares; and
Introduction of Modarabas as interest-free limited
financial service providers and special purpose
vehicles for raising interest-free finances.
Although we feel that the intentions of the initiators were

quite positive, but the system could not survive because of a few basic
factors, as follows:
The implementers (government officials, State Bank,

bankers and public at large) were generally not
convinced with the prohibition of Riba (particularly
the commercial interest) or were not aware of
practical alternatives of interest-based financial
solutions. Generally they were of the opinion that this
system cannot survive, or more appropriately we can
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say, that they were not willing to change it due to

reasons of their own;
People amongst the general public who were well
aware of prohibition of interest in Islam were
practically away from the banking and financial
markets and no sincere efforts were made to bring
them in, and accordingly they are still away from that
system. In other words we may say that banking
system, Islamic or conventional, has no impact on
them as they are already away from the same leaving
majority of such people in effective position (both
from the bankers and public including industrialists
and traders) who are practically unaware of their
responsibilities as a Muslim in this respect;
No adequate training of Islamic banking was carried
out for the bankers nor for the public at large;
The scheme of interest-free banking introduced
through the State Banks circulars, by itself contained
a few questionable options from Shariah perspective;
and
There was no monitoring structure for the same from
Shariah perspective by the regulators that caused a
situation that every banker got a few Shariah
compliant agreements prepared and then started
interpreting Islam of his own resulting in a purely
interest-based financing system with the title of markup and profit instead of interest.
The above mentioned factors should not be considered as all

inclusive, however, these may cause us to believe that the interest-free
banking system as in vogue in Pakistan is absolutely not Islamic. This
conclusion has already been reached by the Federal Shariat Court and
the Shariat Appellate Bench of the Supreme Court of Pakistan.
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Chapter One
Islamic Banking As Introduced Now

After the historical judgments on Riba, first by the
Honourable Federal Shariat Court and then by the Honourable Shariat
Appellate Bench Supreme Court of Pakistan on an appeal there
against, it has been established that the banking system in vogue in the
country is not Shariah-compliant at all and according to the
Constitution of the country any law repugnant to the principles of
Islamic Shariah shall be considered invalid and accordingly, both the
Honourable courts allowed the federal government with some time to
ensure transition of conventional banking and economic system into a
Shariah compliant economic system duly including the financial system
in practice.
Although with a subsequent judgment of the Honourable
Supreme Court of Pakistan, the said judgment has been set aside and
apparently the government quarters, as in the past, are not appearing
to do the needful. However, in order to lower the day by day raising
voice in demand of Islamic banking in the country, and to some extent
by the endeavors of the some sincere officials including the then
Governor State Bank, the State Bank decided to implement a parallel
Islamic Banking system in the country and is now allowing opening of
Islamic commercial banks and Islamic banking subsidiaries and
branches of conventional banks who operate under strict Shariah
compliance under monitoring by their respective Shariah advisors and
to some extent by the regulators also.
In this respect it should be appreciated that the State Bank has
offered its maximum support to these Islamic banks in form of
various Shariah compliant schemes for them particularly including an
Islamic Export Refinance Scheme which was a prominent demand of
the Islamic banking sector. Similarly, other support services and
guidance are also being provided.
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Operations of Islamic Banks

Now the Islamic banks in the country having been licensed as
Islamic commercial banks are operating under the requirements of
Islamic Shariah. These banks have their own Shariah boards generally
comprising renowned Shariah scholars and it may be concluded that
these banks do not do anything Haram by will except under
compulsion ( )for which they obtain approval from their
Shariah boards. If, for any reason, they earn some earning which is not
Halal, the same is contributed to charity under approval of their
Shariah boards.
However, when considering their operations it may be
observed that although their liability side is purely based on Musharaka
and Modaraba, their asset side generally comprise of Murabaha,
Diminishing Musharaka (Ijara Based) and Ijara Muntahia Bittamleek
which are although permissible but are considered less desired or
border-line transactions. In this respect, their perspective is also
important to be heard, according to which, unless an adequate
documentation and fair financial reporting culture is implemented in
the country, with due will of the business community, real profit and
loss sharing based financial products (Musharaka and Modaraba) may
not be offered at large.
Socio-economic Effects of Islamic
Banking
In this respect a few people, generally practicing Muslims, are
of the view that since the Islamic banking is also based on profit
motive and in present form it generally works on fixed return basis
although the risks it take are higher than the traditional banking, hence
the same cannot be a positive factor towards the socio-economic
changes Islam desires. This question is very important and the author
personally concurs with the concerns of those who raise the same, at
least to some extent.
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In this respect it can easily be concluded that the fixed return

based banking, although being Shariah compliant, is not what has been
desired by Islam as a complete way of living. On the contrary, besides
considering the fact that the Islamic banking industry in the country is
in its infancy stages, we should also bear in mind that only the change
in banking system is not a solution to the overall revolution of
economic system unless other facets of Islamic economic system are
not implemented simultaneously. Consequently, if the Islamic banking
is not contributing enough towards betterment of society, we cannot
blame the same alone.
Why Islamic Banking?
In some areas Haram and Halal have a very small difference.
For an example, only saying the name of Allah Almighty on an animal
at the time of slaughter makes it Halal and permissible while by not
saying that name it becomes Haram. Similarly, by just a few words of
acceptance in Nikah, in presence of a few persons, a man and woman
become Halal for each other. In a similar fashion, if a transaction can
be engineered in a way that the same becomes Shariah compliant, then
we should not conclude that the same is Haram only due to its
resemblance with the interest-based financing.
It is pertinent to note that since the Islamic financial services
sector is in its initial stages as compared to the conventional banking, it
has to follow the conventional system in the pattern of financial
products and is still not in a position to invent absolutely new financial
services. For example, if they have running finance and overdraft as a
financing tool, we have structured an alternate to the same in form of
Istijrar with Murabaha. Similarly, if they use finance leases as a
financing tool, we have converted the same in a Shariah compliant
form in form of Ijara Muntahia Bittamleek or in form of Diminishing
Musharaka. These are only two examples, but the tally is practically
very high and for each interest-based financial product except for
those explicitly Haram, more than one alternates have been engineered.
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In this respect, it also needs to be considered that during the

last few centuries, the conventional banking system has well read the
human needs and psychology and has invented a considerable number
of financial products and accordingly, it is not simple to just invent a
new financial tool just for the purpose of inventing one.
As a conclusion to this question, we may say that we are
required by our religion to implement a complete Islamic way of living
in our individual and collective lives and the society and the
government as well. The Islamic banking system is a part of such
system and is not construed to be applicable in isolation while other
laws and customs repugnant to the Shariah requirements are still in
force. However, for the sake of our own benefits, in order to avoid
interest by ourselves and providing interest-free opportunities to our
all Muslims, we should promote and support the Islamic banking in
the country with all our possible efforts and endeavors. Such Islamic
banking can provide us with a shelter from interest-based transactions
for the time being and might support us in augmenting a truly Islamic
financial system, and more appropriately said, will serve as an
experiment for the time when we will really be in a position to the
implement the complete Islamic way of living in our beloved country.
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Chapter Two
A Shariah Compliant Business A Few Characteristics
SHARIAH COMPLIANT BUSINESS A

FEW CHARACTERSTICS
It is always a matter of concern for a Muslim to ensure that
his livelihood is being earned through Halal sources. Earning Halal for
ones own livelihood and for spending on his dependants is an act
pleasing Allah Almighty and is one on the Ibadaat. On the contrary,
earning Haram is not only an act inviting anger of Allah Almighty but
also ruins all the other Ibadaat. Accordingly, a Muslim can never
consciously be ignoring the permissibility or otherwise of the income
he is earning, irrespective of the sources thereof. In case of business,
such cautiousness becomes more significant because, as compared to
employment and services, a business is a complex source of earnings
and consequently, the risk of mistakes and wrongdoings is on a higher
side.
From various principles set out by the Shariah, we can
summarize the basic characteristics of a Shariah compliant business as
follows:
The core activities of the business are Halal and

Lawful;
The capital structure and profit / loss sharing
agreements are in accordance with the rulings of
Shariah;
General principles related to trade and commerce
including prohibition of unfair trade practices, as
determined by Shariah are complied with, as well as,
the principles of truth and fairness are followed;
The sources of financing and investments of excess
funds are on an interest-free basis; and
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Dealings with third parties, including but not limited

to, employees, customers and suppliers are according
to the principles defined for the purpose by Shariah.
Core Activities of Business

This principle entails that the core activities of business are
Halal. In this context the first matter that needs to be decided is the
definition of core activities. According to a school of thought this
matter relates to the major part of business from where the major
portion of revenues and profits are derived. However, another school
is of the view that involvement of a minor part of Haram revenues
makes the whole bucket rotten. Being not capable of that, we do not
comment on the same and the readers are advised to follow their Fiqh
after obtaining advice from respective scholars. However, as a matter
of principle the core activities of the business should not be Haram in
Shariah.
We would like to list down a few of the activities in which a
Muslim Businessman should not indulge:
Manufacture, sale, marketing etc. of Haram Goods

e.g. Wines, Pork, etc.;
Financial services with involvement of interest and
other prohibited transactions;
Services which are principally not allowed by Shariah
e.g. Advertising services if the basic principles of
Shariah are not adhered to; and
Sales and services with regard to television, film,
music etc. save the productions whereby the Shariah
principles have been adhered to.
Unlawful Businesses
Another factor important in the decision is whether these
activities are lawful in the eyes of the present government. In order to
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make simple the decision we can take an example. All of us know that
smuggling of any sort is not a lawful activity. However, in Shariah
principles the business of purchasing some commodities e.g. wheat
from a country and selling it to another country is a Halal activity. In
such a situation it is difficult to decide whether smuggling of wheat is a
really Halal business.
In these circumstances, dissenting opinions of various
scholars are available. While it is considered advisable to obtain fatwa
in this respect, a general rule that may be derived is that the laws of the
land should be followed because these are generally developed in the
greater benefit of the society and the nation, unless these are against
the basic principles of Islam or unless the said nation is at war with
Muslims i.e. a Dar-ul-Hurb ( ) and Jihad has been declared
there against. Accordingly, in general, involvement in unlawful
businesses should be avoided although these appear to be Halal in
their substance.
Capital Structure of Business and
Sources of Financing
For a Shariah compliant business, the second condition is that
the capital structure of the business should be in accordance with the
injunctions of Islamic Shariah. Ideally the capital of the business
should be brought from Halal sources and should not contain any
interest-based or any other prohibited financing. In case of extreme
pressures; that may be termed as Iztirar, if such financing exists,
maintaining of an adequate debt equity ratio is a must for which
different benchmarks have been set by various scholars. Nevertheless,
the majority of scholars consents that such debts should, in any case
(even in Iztirar), not be higher than 1/3rd of the total capital.
Such impermissible debts include the interest-based loans,
debentures, lease financing under conventional finance lease,
redeemable capital and preference shares. Other financing and
financial services options including L/Cs particularly Usance L/Cs,
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suppliers credits, bank overdrafts and running finances should also

not be based on options prohibited by Shariah.
Profit and Loss Sharing Amongst
Partners
Profit and loss sharing arrangement amongst the partners, or
amongst the members, in case of a joint stock company, is also an
important aspect to be coped with. These arrangements should,
irrespective of the legal framework applicable thereto, be in
compliance with the basic principles of Musharaka or Modaraba as are
being discussed in detail in the ensuing pages.
Arrangements for Financing
We are living in an era whereby the prediction of a well
known Hadith has come true. According to the said Hadith, a time will
come when everybody will be involved in Riba and even if he is not
indulged in Riba, he will inhale its vapors. Now we can observe that
our overall economic and monetary systems are based on the
principles of interest and it has become a very difficult task for any
person to live in such systems, enter into business transactions and still
try to avoid interest and allied transactions.
The matter of obtaining interest-free financing is a hurdle for
most of the businessmen in Pakistan in expanding their businesses,
and when viewed in macro perspective, the same negatively impacts
the growth of the economy. In absence of such arrangements generally
the businessmen opt for making small financing arrangements through
private borrowings on Modaraba or Musharaka basis, or just leave
aside the options of any such borrowings. Similarly, small
entrepreneurs have no options available for obtaining interest-free
finances. In addition, keeping in view the fact that the efforts made in
the decade of 1980s to Islamize the economy had turned out to be
unsuccessful and eventually declared as repugnant to Shariah, our
Page - 26
Chapter Two
reliance on the proclamations and claims of promoting Islamic

banking is no more than zero.
Another important hurdle has been created by the so-called
Islamic banks and other financial institutions (particularly Modarabas),
constituted in Pakistan with a prime objective of getting benefit of
somebodys religious belief. As a consequence, it has been made
literally impossible to identify any purely Islamic financial institution.
In addition, a few of so-called Islamic banks have played a significant
role in establishing this reputation that no one can now rely on Islamic
banking and Islamic financial institutions.
In the ensuing pages, we will first discuss the options for
interest-free financing available in Pakistan. In this connection a few
suggestions would also be preferred in order to make a few options
available for the general public.
Basic Tools of Interest-Free
Financing
The basic tools of interest-free financing or in certain cases,
alternates to financing are based on any of the three options i.e.:
Profit and loss sharing based modes;

Trade-based modes; and
Lease based modes.
These are the general tools available according to the language

generally used by the scholars. While discussing on each option in
detail, we will try to clarify their meanings and the available alternates
for the same in the current business environment. In the ensuing pages,
we will endeavor to understand the basic themes and applicability of
the above discussed tools.
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Chapter Two
Dealings with Third Parties

Similarly, for a Shariah compliant business, the code of ethics
has been defined in the divine guidance. Such code basically consists
of the principles of truth, fairness, honesty, integrity and avoidance of
exorbitant profits e.g. by way of black marketing or taking benefit of
ignorance of the third party. All these principles, along with other
principles of life have been detailed in the holy Quran and Sunnah and
have duly been summarized by a number of jurists in the field of Fiqhul-Muamlat.
Third parties generally include suppliers and customers
besides other stakeholders. In the modern days management theories,
the suppliers, customers and other stakeholders are considered to be a
part of the business cycle and are considered business partners for all
practical purposes. Applying the principles defined by Shariah can not
only provide us with the benefits in the life hereafter, but can also
contribute a lot toward business success in this worldly life.
Dealings with Employees
In addition to the general principles applicable to all third
parties, there are a few principles applicable to employees. These
principles are derived from various Ahadith and holy verses. In short,
these principles include payment of wages on time, social equality
between the employer and the employee, and avoidance of
exploitation in any form and in any manner.
Particularly, according to Shariah principles, it is a must that
all the dues of the employees and the service providers should be paid
immediately, when these become due. This principle is derived from a
very common Hadith whereby it is ordered that the wages to the
labour should be paid before his sweat gets dried. In case of any
expected delay in payment, it should be pre-agreed with the employees
or the service providers.
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Chapter Two
Besides these factors, the most significant factor for the

success of a business is the satisfaction and devotion of the workforce,
which can be easily achieved, if all the basic principles of Shariah
applicable to dealing with employees are complied with, particularly
the social equality and the avoidance of exploitation.
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Chapter Two
Page - 30
Chapter Three
Profit and Loss Sharing Based Financing
PROFIT AND LOSS SHARING

BASED FINANCING
Profit and loss based modes of financing are the only
modes of financing available under the provisions of the Islamic
Shariah. It means that the trade-based and lease based modes are
actually not the modes of financing but rather these are actually
alternates to financing. These are considered financing activities just
for ease of reference. Otherwise, only Musharaka and Modaraba are
the modes of financing allowable in Islam, besides providing interestfree loan i.e. Qard or Qard-e-Hasana on which no return is allowed.
Another reason for their preference is that all the other tools,
particularly Bay Murabaha, and Ijara Muntahia Bittamleek, have some
resemblance to the interest-based financing and even have certain
controversial issues or gray areas, hence, are not preferred by a
number of scholars if Musharaka and Modaraba based options for
financing are available and even a few of scholars have not permitted a
few of such controversial options, at all.
Loans
In Islamic Shariah, loans called Qard ( )have only one
concept i.e. these are interest-free. These are repayable in exactly equal
amounts in which these are paid. From characteristics, these may be
divided in two types. The first type may be called Qard and the second
may be called Qard-e-Hasana. These may be distinguished only in one
manner i.e. in Qard-e-Hasana; the lender gives the debtor an option of
not making the repayment in case he is unable to do that, and has no
option to sue for recoveries.
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Chapter Three
FLOW OF TRANSACTION IN LOAN

(QARD-E-HASANA)
Rs. 1,000 (No impact of Time

Involved)
BORROWER
LENDER
Rs. 1,000
In Islamic society, all Muslims are not only encouraged but are
actually required to give loans to all those in need without any
hesitation. They are further required to waive such loan, if the debtor
is not in a position of making repayment. In other words for those
who believe in the life hereafter, the Qard-e-Hasana is the best option
in order to please Allah Almighty. However, it is not mandatory and in
Islamic society, no one can be forced to make loans on this principle.
Musharaka and Modaraba
Musharaka ( )or Shirkah ( )may be termed as a
partnership. It generally denotes a business run in partnership with
efforts and capital investment from all the partners. Modaraba
( )is another form of partnership in which any or a few of the
partners do not actively take part in the activities of the business which
may be termed as a dormant partnership in the modern terminology.
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Chapter Three
Although the rules used in for managing Musharaka and

Modaraba are a bit different, basic theme thereof remains the same
hence we would prefer to discuss both of these tools simultaneously,
which would also assist us in understanding the difference between the
two.
Needless to mention, the pure Islamic financing concepts are
mounted on these two tools. Particularly, the trade-based and lease
based modes of Islamic finance are not very much desirable in the
Islamic economic system because of being fixed return based,
although the financier takes the risk of loss on assets. Nevertheless, as
we will, later in this study, discuss in detail that these two options are
very much open and provide a wide range of Islamic financial
products to cater the basic needs of a business.
Modaraba and Types of Modaraba
Modaraba ( )which is also sometimes termed as
Muqarida ( )in Shariah terms; is a type of profit sharing against
loans which is one of the most practically applied forms of interestfree financing in Islamic society for centuries.
By definition, it is a partnership in profit between capital and
efforts (including entrepreneurship and labour). In Modaraba, one
party called Rab-ul-Mal ( ) brings capital and the other party
called Modarib ( )contributes his personal efforts. The
proportionate share in profit is determined in any ratio by mutual
agreement, but the loss, if any, is borne only by the capital investor
whereas the entrepreneur gets nothing for his efforts.
There are two types of Modaraba as follows:
Modaraba Al-Muqayyaddah ( ) or
Restricted Modaraba whereby purpose of
Modaraba is specifically mentioned and complied
with; and
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Chapter Three
Modaraba Al-Mutlaqah ( ) or
Unrestricted Modaraba in which the Modarib is
at freedom to undertake whatever business he deems
fit.
Why Modaraba?
Modaraba arrangement provides maximum benefit to both
the parties, i.e. the Rab-ul-Mal and the Modarib. It enables the Rab-ulMal to utilize his capital and the Modarib to utilize his
entrepreneurship and skills whereas the profit and loss distribution
system is based on the principles of logic and equitability.
Modaraba is generally used for the following purposes:
Practically the most important application of

Modaraba concepts is in form of dormant partnership,
particularly amongst family members and friends;
In 80s, a framework for Modarabas and Modaraba
Companies was devised and developed in Pakistan
which is still in application. However, such
Modarabas are generally not considered to be Shariah
compliant in all respects;
Modaraba is one of the most practical modes applied
by the Islamic Banks in their relationship with the
depositors who tender their moneys to the bank as
capital owners to be invested by the bank as Modarib
on the basis of profit sharing according to specific
ratios agreed upon;
The Islamic Banks provide finances under the same
mode to the investors who are capable to work in
exchange of a share in the profit to be agreed upon;
Modaraba is used by Islamic Banks in financing
imports against L/Cs with or without margin and in
export refinance; and
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Chapter Three
Modaraba may also be provided in form of

Redeemable capital issued as Participation Term
Certificates (TFCs) and Musharaka Certificates. In
this respect one should not be confused with the term
Musharaka Certificates because since the capital
provided has no say or practical efforts in running the
business, hence the same should be considered as a
Modaraba.
FLOW OF TRANSACTION IN MODARABA

RAB-UL-MAL
(LENDER /
FINANCIER)
MODARIB
(BORROWER)
EFFORTS
INVESTMENT
PROFIT
(In Agreed Ratio)
MODARABA (PARTNERSHIP)
LOSS
(To Be Borne By
the Rab-ul-Mal
Only)
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Chapter Three
Certain Controversies Regarding

Modaraba
It is also important to note that although the vast majority of
Shariah scholars have explicitly approved the permissibility of
Modaraba, and even the examples of its wide use in Islamic history are
evidenced (including the periods of Sahaba and Khilafat-e-Rashida),
still a few scholars particularly those who are also against Muzaraa and
Ijara or Kiraya (), have raised certain questions on the
permissibility of Modaraba also. In this respect we do not intend to
discuss these matters in details and the readers are advised to consult
various books of learned scholars. These and similar transactions have
been allowed by the vast majority of scholars, and in our view, these
are backed by the Ijma-e-Ummat.
Shariah Provisions Applicable to
Modaraba
Following are the basic provisions applicable to Modaraba:
Modaraba capital for both the parties must be specific

and clearly known to the contracting parties and
defined in terms of quality and quantity;
Capital must be in form of Gold or Silver or as an
alternate in form of a currency in circulation.
However, it can be merchandize or operating assets
only in a condition that these are valued at the time of
the contract and such value is agreed upon as capital
of Modaraba;
Capital should not be considered as a liability for the
Modarib and instead it should be considered as
amount held in trust;
The capital should be delivered or at least made
available to the Modarib immediately at the time of
commencement of Modaraba;
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Chapter Three
The capital owner may provide his capital to two or

more Modaribs in a single contract or two or more
capital providers may provide their capital to a single
Modarib in a single contract;
Restrictions and conditions may be imposed by the
capital provider on the Modarib if, and only if, these
are beneficial and do not constitute any constraint or
limitation on the agent to attain the profit required
and are conducive for the purpose of the Modaraba;
If the Modarib violates the restrictions and conditions
laid down in the Modaraba contract or contravenes
the beneficial condition, he has to guarantee the
capital to the capital owner;
Modarib may hire assistant or assistants in difficult
work that he is unable to do himself, at his own cost;
The capital provider for Modaraba is not allowed to
indulge in day to day activities of the business.
However, Modarib should preferably consult him
before making any major business decision or any
change to the existing business;
The authorities and powers in running the business
shall vest with the Modarib but these should be
limited to what is conducive and beneficial to the
Modaraba unless specifically allowed by the capital
provider;
Modarib must not lend or donate anything of the
Modaraba capital or to purchase, for Modaraba, with
more than its capital, or to go into partnership with
others using the Modaraba capital unless specifically
approved by the capital provider;
No security or guarantee with regard to the capital or
profit shall be stated in the Modaraba contract on the
Modarib. However, the Modarib may be required to
advance a guarantor or surety to cover his liability in
the event of a loss solely due to his negligence or
misconduct;
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Chapter Three
Rab-ul-Mal shall ensure that the Modarib invests the

capital of the Rab-ul-Mal in Halal activities that are
permissible by Shariah;
The profit sharing ratio should be specific because it
is the subject-matter of the contract and if it remains
unknown, it will render the contract as void. The
contacting parties should stipulate in the contract the
profit shares (in defined terms) for each one;
The investor must bear whole loss alone whereas the
Modarib bears only the loss of wastage of his services
against which he does not get anything;
Final profit and loss should be determined at the end
of the term of Modaraba and any profit that may be
distributed as interim profit shall has to be returned in
order to adjust the loss;
The loss sustained in one transaction can be offset
against the profit in other transactions, if so agreed by
the parties.
The Modarib and Rab-ul-Mal cannot allocate a lump
sum amount of profit nor can they determine the
share of any party at a specified rate tied up with the
capital;
The Modarib and the capital provider shall not be
entitled to collect there provisional share of the profit
before the term of Modaraba unless approved by the
counter party either at the commencement of the
Modaraba or at any later stage;
The profits realized through Modaraba may not be
distributed until all expenses have been paid, in
accordance with custom and original agreement. Final
accounting shall be undertaken against the net profits
of the Modaraba operation for the whole term. The
ownership of the profit to the Modarib becomes
assured after the liquidation of the Modaraba and
recovery of capital along with profit thereon by the
capital owner. However, finalization of accounts and
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Chapter Three
auditing thereof is also similar to the liquidation and

division and possession;
Modaraba can be terminated any time by either of the
parties by giving notice and if it is for a particular
term it will get consequentially terminated by the end
of the term. However, a number of scholars hold the
view that Modaraba becomes binding and it cannot
be rescinded if the Modarib commences work;
The liability of the capital provider is limited to the
amount of his investment unless he has permitted the
Modarib to incur debts on his behalf; and
If the Modarib has mixed up his own funds with the
Modaraba funds, the Modarib becomes a partner in
respect of his funds and a Modarib in respect of the
funds of the capital provider. The profit earned on
the two funds will be divided proportionately to the
amounts of the two funds. After such division, the
Modarib will be entitled to the whole amount of
profit attributable to his own fund, whereas the profit
attributable to the capital providers fund shall be
distributed between the Modarib and the capital
provider according to the provisions of the Modaraba
contract.
Musharaka
The literal meaning of Musharaka is sharing. The root of the
word Musharaka in Arabic is Shirkah, which means being a partner.
Musharaka is a very common mode of finance under Islamic modes of
financing. Particularly, on the liability side of an Islamic financial
institution, this mode is used as a first choice.
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Chapter Three
Basic Types of Shirkah

The first type of Shirkah is Shirkat-ul-Milk i.e. Partnership
by joint ownership. It means joint ownership of two or more persons
in a particular property. This type of Shirkah is generally through
inheritance. However, sometimes such a Shirkah is entered into with
an objective of pooling of capitals for purchase of joint property
which each of the partners cannot buy individually.
The second type of Shirkah is Shirkat-ul-Aqd i.e.
partnership by contract. For all practical purposes, this type of Shirkah
may be called a joint commercial enterprise. Shirkat-ul-Aqd is
further divided into various types by various scholars due to their
distinct natures. However, for the purpose of this study the most
significant one is Shirkat-ul-Amwal which means pooling of capital
to form a commercial enterprise.
The modern term Musharaka is limited to only one type of
Shirkah i.e. Shirkat-ul-Amwal. Under Islamic jurisprudence, Musharaka
means a joint enterprise formed for conducting some business, in
which all partners share the profit according to an agreed ratio while
the loss is shared according to the ratio of the capital contribution. It is
an ideal alternative for the interest-based financing with visible and
realizable positive effects on the overall economic system.
Types of Musharaka
The concepts of modern days partnership and limited liability
company and body corporate are also considered to be amongst basic
types of Musharaka. Besides making investments under these options,
as a financing tool, the Islamic financial institutions generally use two
types of Musharaka i.e. Permanent Musharaka and Diminishing
Musharaka.
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Chapter Three
Permanent Musharaka denotes a joint venture, business or

project in which the Islamic financial institution becomes a partner by
making investments. These are for unlimited period or for a fixed term,
may be short-term or long-term, after which these get terminated.
Diminishing Musharaka, denotes a type of Musharaka in which one
partner periodically buys the other partners share in ownership as per
pre-agreed terms.
FLOW OF TRANSACTION IN MUSHARAKA

MUSHARIK 1
(FINANCIER)
MUSHARIK 2
(BORROWER)
INVESTMENT +
EFFORTS
INVESTMENT
PROFIT
(In Agreed Ratio)
MUSHARAKA (PARTNERSHIP)
LOSS
(To Be Borne In
the Ratio of
Capital
Investment)
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Chapter Three
Practical Application of Musharaka

Based Transactions
This is considered to be the appropriate mode for collective
investment in modern economic life as an alternate to the mediumterm to long-term financing although it is also used for short-term
financing. Following are the most common uses of this mode of
financing:
Partnerships;
Limited liability companies and bodies corporate;
Term financing to customers in order to finance the
projects, as well as, to make sufficient liquidity
available to the customers, by the Islamic Banks and
financial institutions;
Redeemable capital having a few rights in running the
business, e.g. the right of appointment of director.
However, redeemable capital without any rights to
indulge in business should be governed under the
Modaraba principles;
Housing finance; and
Fixed assets financing.
Partnerships
In the perspective of general practices in vogue in Pakistan,
we can observe that the most common tool used as Permanent
Musharaka is partnership. However, it has been observed that certain
provisions of the relevant laws are not Shariah compliant. Having said
that, still, we may use the general partnership mechanism, duly
fulfilling the requirements of Shariah in the context, as our main
financing tool. It is worth noting that partnership practices in Pakistan
include the concept of dormant or sleeping partner which coincides
with the Modaraba concepts, instead of Musharaka concepts.
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Chapter Three
In partnership normally the following factors are considered

to be the driving force for determination of profit and loss sharing
ratios:
Capital investment ratio;

Goodwill; and
Effective participation in business affairs or the right
to participate in the business.
Provisions of Partnership Law Not in

Compliance with Shariah
General partnership contracts that are made in Pakistan are
normally Shariah compliant except for a few factors that need to be
addressed.
First of these factors is interest on capital which is generally
provided to give more profit to the person investing more in terms of
capital. It is although not very much common nor it can be attributed
as a direct interest because it is used merely as a formula for
distribution of profit or attribution of loss and is not actually paid as
interest. However, any resemblance from interest also makes it
doubtful and hence it should preferably be avoided.
The second factor i.e. loss sharing ratio is a more common
issue. According to the Modaraba principles, the dormant partner who
does not take any effective part in the running of business and only
provided capital support should bear the loss of capital. Similarly, in
Shirkah principles, the loss should be borne in the ratio in which the
capital is provided and no loss is attributable to the partner who
contributes through his work only. Accordingly, any loss to the
business should be borne in the ratio of capital investment and not in
the profit ratio.
The third factor is determination of salary of one or more
partners which is a bit disputed. A number of jurists do not allow any
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Chapter Three
such salary at all, whereas, a few of them allow such salary in case of
limited companies with a condition that such salaries should
commensurate the abilities of such partners and their responsibilities.
Another factor which, according to most of the jurists, is
necessary to be addressed the principle that the dormant partner can
not take a share of profit higher than his capital investment ratio.
The principles governing our law have basically been derived
from the British partnership practices and regulations that have been
inherited in Pakistan on an as is where is basis. We need to note
that although our Fiqh contains a rich and sizable set of regulations
available in respect the Partnership, Sale of Goods, and Contract laws,
we are following the same laws that had been enacted by the British
government before independence.
Limited Liability Companies
Limited liability companies are another common form of
business. These are generally used in larger businesses and their basic
benefit is that the liability of the members is limited to the extent of
their investment or in certain cases these are limited to the amount of
guarantee. Accordingly, the probabilities for loss over and above the
actual amount of investment are eliminated. The second important
factor is the institution of a judicial person.
Limited Liability Concept
According to the limited liability concept, an enterprise is
formed by one or more individuals for doing some business, with an
expressed and implied condition that the liability of the owners with
respect to that business shall be limited to a specific amount. Such
amount is either paid in advance in form of share capital or is
guaranteed to be paid in case of need. In case such enterprise suffers
losses, the owners are not obliged to make good that loss out of their
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Chapter Three
own moneys, exceeding the amount of capital contributed or

guaranteed.
The limited liability concept is a bit confusing for certain
Shariah scholars and they uphold that the limitation of liability is not in
compliance with Shariah principles. However, in this respect, the
majority of scholars is of the view that limited liability concept is not
repugnant to the injunctions of Islamic Shariah, if it is made known to
everyone who deals with the enterprise that the liability of the owners
is limited (which is generally done by including the word limited).
The permissibility of such option is based on a few precedence of
limited liability allowable in Islamic Shariah including the limited
liability of the properties in inheritance (in case of loans payable), the
limited liabilities of Waqf and the limited liability of Rab-ul-Mal in case
of Modaraba etc..
Artificial Juristic Personality Concept
The second concept implicit in the limited liability companies
and bodies corporate is the concept of artificial juristic personality.
According to this concept, the enterprise so incorporated is judicially
considered to be a person distinct from its owners and it may be sued
and it may sue in its own name, instead of the names of its owners.
This concept is generally in favour of the owners of the company, as in
case of any adverse legal consequences they are not held liable beyond
their limited liability or guarantee.
This concept is against the principles of Shariah to the extent
that any such concept should not relieve those who are responsible for
any wrongful act from the consequences of their wrong-doings.
Accordingly, in case of any loss to the owners, stakeholders, suppliers
or lenders or any other concerned party, suffered due to the acts of the
management, the management should be held responsible in this
respect. According to the Shariah Standards issued by the Accounting
and Auditing Organization for Islamic Financial Institutions (AAOIFI),
liability of a company may be limited subject to certain conditions.
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Chapter Three
This objection is to some extent practically eliminated from

the concept of lifting the corporate veil which denotes the principle
that in case of any wrongdoings of the management, the corporate veil
should be lifted and such persons should be directly held responsible
for their acts.
Are Limited Liability Companies
Based on Modaraba Rules?
It is generally understood that the limited liability companies
are based on the principles similar to Modaraba. However, according
to the basic concepts of company law, each owner has equal right to
participate in the business of the company through his agents i.e. the
directors who are elected by the shareholders through voting.
Accordingly, it may be concluded that the business of limited liability
companies is similar to both Musharaka and Modaraba and the
relevant rules should be applied thereto.
Basic Non-compliances of
Shariah in Company Law
Generally the limited liability companies are governed by such
principles which are in accordance with the basic injunctions of
Shariah. However, due care need to be given to a few factors which
are not considered to be in line with the injunctions of Shariah, which
are as follows:
The company law allows issuance of preference

shares which is a contravention of Shariah as most of
these shares offer a fixed guaranteed or preferred
return on capital;
The company law allows issuance of debentures or
redeemable capital under certain modes which are not
in line with Shariah, besides certain modes which may
be considered as allowable under Shariah;
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Chapter Three
The company law provides for certain restrictions,

which indirectly result in charging of interest e.g.
provisions related to provident funds etc.; and
The company law takes precedence for most of the
matters from English (or in certain cases other
countries company law) and accordingly, the same is
not directly linked to the provisions of Islamic
Shariah.
Dos and Donts for Musharaka

Arrangements
Following are the Shariah rulings applicable to Musharaka
transactions:
In Musharaka the capital is specific, existent and

under disposal. It is invalid to establish a Musharaka
on non-existent fund or debt. The purpose of
Musharaka is profit which cannot be affected through
debt or non-existent capital. The partners may have
varying shares in capital subject to agreement and the
capital of the Musharaka is money and valuables. It
may consist of merchandize or operating assets on a
condition that these are valued at the time of contract
and the value is agreed upon;
A Musharaka contract can be concluded by
agreement between the parties concerned on the basis
of offer and acceptance. It is permissible for the
partners to mutually agree to amend the terms of a
partnership contract, at any point of time but with
prospective effect;
A partner can not pay his share of the Musharaka by
means of Murabaha of goods by the same bank. This
is because one of the conditions of establishing a
Musharaka is the presence of capital by means of
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Chapter Three
which business may be conducted for the purpose of

making profits;
The partners may agree that the management of the
partnership will be restricted to certain partners or to
a single partner. In this case, the other partners are
bound to abide by their consent not to act on behalf
of the partnership. Partners can appoint a manager
other than one of the partners and pay him a fixed
remuneration that will be included in the expenses of
the Musharaka;
It is impermissible to impose condition forbidding
one of the partners from work. However, it is
permissible for one partner to singly work in the
Musharaka by mandate of other partners;
Capability of partners must be sane and mature and
able to enter into contract. The contract must take
place with free consent of the parties without any
fraud or misrepresentation;
The ratio of sleeping partner in profit should not
exceed the ratio which his investment bears to the
total capital investment;
Profit ratio for each partner must be known to avoid
uncertainty and it must be a pro rate ratio to all
partners and must not be a lump sum because this
contravenes the requirement of partnership. Profit
must be divided among partners in ratios as agreed at
the inception of Musharaka while each partner bears
loss proportionate to its ratio in the capital;
It is permissible to agree that if the profit realized is
above a certain ceiling, such profit belongs to a
particular partner or a few partners in pre-agreed rate;
It is not lawful to estimate expenses based on a
percentage of the capital invested in the Musharaka.
Rather, the expenses should fall within the limits of
what is customary for trade at current market prices.
Thus it is not lawful to base such estimates on the
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Chapter Three
capital invested when this is done without reference

to the actual costs;
It is not permitted, in a Musharaka contract, to
specify a fixed remuneration for a partner who
contributes in managing the Musharaka funds or
provides some form of other services, such as
accounting. It is, anyway, permissible to give him a
greater share of profit than he would receive solely on
the basis of his share in the partnership capital.
However, a few of the scholars have allowed that a
working partner may be entitled to a salary duly
commensurate to his capabilities and responsibilities,
however; the same shall be paid out of profits only.
Similarly, a few jurists allow that in case of a limited
liability company, a shareholder may be appointed as
an employee against normal market salaries and
benefits;
It is not permitted to defer the determination of the
profit percentages due to each partner until the
realization of profit. The profit percentage for each
partner must be determined at the conclusion of
Musharaka contract;
A partner is a trustee on the funds in his hand from
the Musharaka and he guarantees only in case of
trespass or negligence and it is permissible to take
security for profit or capital;
It is not lawful to introduce a partner to an
established Musharaka by using accounts payable as a
part of his / her share in the working capital;
A third party may provide a guarantee to make up a
loss of capital of some or all partners. This guarantee
is circumscribed with the conditions that:
the legal capacity and financial liability of such a
third party as a guarantor are independent from the
Musharaka contract;
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Chapter Three
the guarantee should neither be provided for

consideration nor linked in any manner to the
Musharaka contract;
the third party guarantor should not own more than
a half of the capital in the entity to be guaranteed;
and
the guaranteed entity should not own more than a
half of the capital in the entity should not own
provide a guarantee; and
Each partner is entitled to terminate the Musharaka
(i.e. to withdraw from the partnership) after giving his
partners due notice to this effect, in which case he
shall be entitled to his share in the partnership, and
this withdrawal would not necessitate the termination
of the partnership of the remaining partners.
Diminishing Musharaka
Diminishing Musharaka is a form of partnership in which one
of the partners promises to buy the equity share of the Musharaka
(which is divided in small units either as a legal document i.e. shares or
certificates of investment or units of a notional amount) from the
other partner gradually until the title to the equity is completely
transferred to him.
This transaction commences with the formation of a
partnership may be in form of Shirkat-ul-Milk (joint-ownership) or
Shirkat-ul-Amwal (commercial joint-venture), after which buying and
selling of the equity takes place between and amongst the two partners.
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Chapter Three
FLOW OF TRANSACTION IN DIMINISHING MUSHARAKA
(PARTNERSHIP AND JOINT OWNERSHIP)
MUSHARIK 1
(FINANCIER)
Purchase of Share / Units

over the Musharaka Term
INVESTMENT +
EFFORTS (If Required)
INVESTMENT
PROFIT OR
IJARA RENTALS
(In Agreed Ratio or
in the Ratio of JointOwnership)
MUSHARIK 2
(BORROWER)
MUSHARAKA OR SHIRKAT-UL-MILK
(PARTNERSHIP OR JOINT- OWNERSHIP)
LOSS
(To Be Borne In the
Ratio of Capital
Investment)
Dos and donts for Diminishing

Musharaka Arrangements
In addition to the Shariah rulings applicable to all types of
Musharaka, as discussed above, there are certain conditions and
provisions that are applicable to a diminishing Musharaka transaction,
which are being detailed as follows:
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Buying and selling of equity should not be stipulated

in the partnership contract. In other words, the
buying partner is allowed to give only a promise to
buy. This promise should be independent of the
partnership contract. In addition, the buying and
selling agreement must be independent of the
partnership contract. It is not permitted that one
contract be entered into as a condition for concluding
the other;
It shall not be a mere loan financing operation, but
there must be real determination to participate and all
the parties shall share profit or loss during the period
of the partnership. The financier must completely
own its share in the partnership and must have its
complete right in management and disposal. In case
the financier authorizes its partner to perform the
work, he shall have the right of supervision and
follow-up;
It is not permitted that the contract of diminishing
partnership include any clause that gives any of the
parties a right to withdraw his share in the capital
because it is not a mere loan;
It is permissible for one of the partners to give a
binding promise that entitles the other partner to
acquire, on the basis of a sale contract, his equity
share gradually, according to the market value or a
price agreed at the time of acquisition. A few jurists
also allow that such a condition may be stipulated for
other partner also i.e. in case of inability of the
partner to purchase the units as pre-agreed and to pay
rental on time, the financier may also be entitled to
purchase the units against amounts due to him;
It is not permitted to stipulate that the equity share be
acquired at their original or face value, as this would
constitute a guarantee of the value of the equity
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shares of one partner (the bank) by the other partner,

which is prohibited by Shariah;
Partners should bear all the expenses incidental to
ownership including costs of Takaful (insurance if
Takaful is not available) or major maintenance or any
loss on the common assets in the proportion of their
ownership; and
It is not permitted to stipulate that one partner has a
right to receive a lump sum out of the profits.
How to Differentiate a Musharaka

from Modaraba?
A Musharaka contract is distinguished from a Modaraba
contract in the following respects:
Musharaka
Profit in Musharaka is based
on contribution of capital by
all parties. However, their
shares may be adjusted for
goodwill, work, and other
factors.
In Musharaka, loss is borne
by all partners in their capital
contribution ratio.
In Musharaka, the work is to
be performed by all the
partners jointly; however,
they may assign an agent for
that.
Modaraba
Profits of a Modaraba have
two elements i.e. the capital
and the work.
In Modaraba, all the losses

are to be borne by the Rab-ulMal.
In Modaraba, it is the
Modarib who works.
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Chapter Three
Musharaka
In Musharaka, all the partners
have the right to participate in
business either directly or
through agents.
Modaraba
In Modaraba, Rab-ul-Mal, has
no option to interfere in
business affairs, however, he
can monitor the affairs of
business
without
any
intervention.
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Chapter Four
Trade-based Alternates to Financing
TRADE-BASED ALTERNATES TO
FINANCING
The modern Islamic banking includes a number of advanced
and complicated and intelligently engineered transactions, which are
although not financing in their very nature, but provide very good
alternatives for the same. These alternatives include trade-based
alternatives and lease based alternatives. The trade-based and lease
based alternatives have a good impact on the economy as a whole
because these ensure an economic activity underlying them i.e. sale,
purchase, usage and manufacture of a real asset, which in longer run is
beneficial for the whole economy.
The concept of trade-based alternates of financing has been
derived directly from the Holy Quran. In Verse 274 of Surah AlBaqarah, Allah SWT proclaims:
Those who take Riba will not stand but as stands the one
whom the demon has driven crazy by his touch. That is
because they have said: Trading is but like Riba. So, whoever
receives an advice from his Lord and stops, he is allowed what
has passed, and his matter is upto Allah. And the ones who
revert back, those are the people of Fire. There they remain
forever.
In this Verse, the alternative is directly provided by Allah
Almighty, based on which a number of trading options have been
devised by the experts in consultation with the Shariah scholars and
jurists. In this chapter we will consider the basic trade-based
alternatives available in Islamic financing available to businessmen in
Pakistan.
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Chapter Four
The basic tools of trade-based finance include the following:
Bay Murabaha;
Bay Musawwama or Bay Muajjal or Bay BitThaman-al-Aajil;
Bay Istijrar;
Bay Salam; and
Bay Istisna.
Bay
Literally Bay ( )denotes a sale or a trading transaction in
which the ownership of an asset is transferred from one party to
another in exchange of a consideration. It has many types which are
allowable and even a few ones which are not allowable in Islamic
Shariah. The sale is the transaction of transfer of title and possession
along with all the risks and rewards of an asset (generally tangible)
from one person (the seller) to another (the buyer), whereas both the
seller and the buyer should be knowledgeable and willing to the
transaction.
All the trade-based modes of Islamic finance are based on
Bay i.e. a sale transaction. In these transactions, an Islamic bank or
financial institution involves in various sales and purchase transactions,
similar to the activities of a large trading house. The Islamic financial
institution, in this type of transactions, facilitate different parties in
their commercial transactions by working as an intermediary between
them while making them the payments and providing repayment
structures according to the need of the customers.
Basic Principles of Trade
Before discussion in detail with respect to various trade-based
alternates of finance being used by various Islamic financial
institutions, it would be worthwhile to discuss a few basic principles of
trade as laid down by Shariah.
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Chapter Four
The first principle of trade in Islam is that the commodity or

asset being sold or the purpose of such sale should not be against the
basic injunctions of Islamic Shariah. This principle is a must for all
types of trade in order to discourage trade of impermissible items and
to reduce the tendency of profit taking without consideration of right
or wrong. This principle is derived from Ahadith whereby the Holy
Prophet disallowed the trade of wine and its accessories. This principle
is applicable even if the sale is being made to Non-Muslims. As a
common example of this phenomenon we can take the business of
garment exports whereby a number of businessmen, do not care what
they are exporting. Sometimes, the apparel being exported, particularly
womens apparel includes the apparel which may not be permissible
from Shariah perspective.
Second principle in this respect is adequate profit taking. In
other words, the profit margins being maintained by the businessmen
should be subject to certain limits as may be determined from time to
time taking into consideration various factors of determination of
profit including but not limited to inflation, necessity of items, market
competition and costs incurred. Arguments may be made that the
norms for profit taking have not been determined by the Holy
Prophet or any Fiqh. Nevertheless, such principle is established by the
Shariah and the norms need to be determined according to various
factors, a few of which have been discussed earlier.
Third principle which is directly related to the second
principle, as well as, support the same is the discouragement of
hoarding i.e. Ihtikar (). Ihtikar represents the phenomenon of
profit taking through making inordinate, artificial shortages of supply.
This phenomenon is strictly prohibited in the Shariah. If this principle
is used in its true sense, it will ensure that the profit margins are set at
adequate and market-friendly, as well as, consumer-friendly levels. It is
noteworthy that even a number of so-called practicing Muslims do not
comply with this principle.
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Chapter Four
Fourth principle of trade is open market competition concept.

According to a Hadith, the Holy Prophet had categorically disallowed
the purchase of commodities from the incoming trade-caravans,
before their arrival in the market and their awareness of the market
situation. This trend is discouraged because it may result in bulk
purchases of quantities by market-gurus before arrival of
commodities in the market and resultant increase in prices, as well as,
taking benefit of ignorance of those traders who are not aware of
prevailing prices in the market.
Fifth principle is truth and fairness in telling details and
characteristics of goods being sold. According to a Hadith, the Holy
Prophet disallowed presenting the better portion of the commodity on
the face and according to a few other Ahadith, he advised Muslims to
categorically inform the buyer about the deficiencies of the assets of
commodities being sold.
Just as an example one can note that an Islamic Mutual
Fund claims to be the first Shariah compliant open-ended mutual
fund whereby another open-ended Islamic mutual fund was in
operation for a period for around one year before subscription of this
mutual fund. Similarly, a few Islamic banks claim that their day to
day affairs are run under supervision of a renowned Shariah Scholar,
whereby such Shariah Advisors admit that they can monitor a very
small number out of hundreds of thousands of transactions being
carried out. Please note that the object of this example is not to blame
somebody, but to actually demonstrate the overall culture prevailing in
the Islamic finance industry.
Sixth principle is documentation of agreement and arranging
witnesses for all deferred or credit sales arrangements and other trade
and financial agreements. This principle is derived from the well
known verse of the Holy Quran (Surah Al Baqarah, Verse 282)
whereby the same has been advised.
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Chapter Four
Seventh principle is sale of goods under possession only.

According to this principle no one is allowed to sell goods,
commodities or assets which are not in his possession. This principle
is actually a deterrent against unfair trade practices, particularly to
avoid uncertainty, speculations and gambling in the name of trade.
Eighth principle relates to barter of commodities. According
to this principle, barter of certain similar items is allowed only in equal
quantities. A shortage or excess in such transfers is called Riba-al-Fadl
or Riba-al-Hadith.
Ninth principle relates to the sale of gold, silver and currencies.
According to this principle, these goods which are called Thaman ()
in Shariah should be sold against each other without deferred delivery.
However, a few scholars of Hanifite ( )school are of the view that
since the modern day currencies are not considered to be real Thaman
and instead these are man-created Thaman, these may be sold on a
deferred delivery basis.
Bay Murabaha
In literary terms, Bay Murabaha ( ) means the sale on
profit. It is technically a contract of sale in which the seller declares his
cost and profit. Before going in details of the options of using a
Murabaha transaction as an alternate to conventional financing
transaction, we should first consider the elements of a legal sale
transaction and the factors that determine the profit.
Factors Determining Selling Prices
The sale transactions which are routine in nature and are part
of somebodys business are generally with the profit motive. The
critical factors that generally determine the cost of an asset in a sale
transaction are as follows:
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Chapter Four
Cost of similar items in market This includes the

factor of the sellers own cost of purchase and the
prices other sellers are offering in the market on same
terms and conditions;
Market demand and supply equilibrium As
higher the demand in the market and lesser the supply
is, the price would be higher in the same proportion;
Specific Utility for the buyer Particularly the
specific utility at the time of purchase of the asset for
the buyer and other buyers in the market e.g. price of
air-conditioners and refrigerators increase in summer
and goes down in winter or at times something is
more important for a buyer compared to others e.g. if
somebodys car is stolen or destroyed, he will be
willing to buy a replacement, even at a higher price,
immediately;
Quality of product and the reputation of the seller
or manufacturer Even the prices of similar items
with similar features may differ according to the
reputation of the manufacturer e.g. a television
manufactured by a reputable Japanese company (even
smuggled with no warranty) will fetch much higher
price as compared to a Chinese brand;
Guarantees for the quality and performance of
the asset A product with better and longer
warranty will be sold for higher prices. Even the same
goods, with or without warranty, will fetch different
prices e.g. box packed Intel processor with three years
warranty will get higher price then a similar processor
imported in bulk with a ten months warranty;
Place of delivery If the asset is delivered to the
buyers place, the price would obviously be higher
than the ex-factory or ex-showroom price i.e. such
price will include the proportion for freight and
handling charges and the risk of loss during
transportation;
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Chapter Four
Time of delivery If the asset is immediately

delivered the price would be higher as compared to
the situation whereby the similar asset is supposed to
be supplied after some time e.g. taking some time for
manufacturing the assets;
Volume of transactions in case of higher volume
of purchases by a single customer, per unit price is
generally reduced in form of allowing volume
discounts and rebates;
Terms of payment Normally, in case of cash
purchase the price would be less (generally by
allowing cash discounts) and in case of credit
purchases the price would be higher. In other words,
it may include a price for getting the goods earlier
than making the payment. Since, the subject-matter of
such sale is goods or commodity so it may be
termed as time value of asset instead of time value
of money.
Typical Murabaha Sale

In a typical Murabaha sale, a seller informs the buyer about his
own cost of purchase and other cost incurred thereon, and asks for a
fixed profit based on various factors, mostly amongst those discussed
in the foregoing paragraphs.
Modern-Day Murabaha
In the modern Islamic banking and financial system,
Murabaha has been adopted (with certain modifications) as an
alternate to the conventional interest-based financing. In this kind of
Murabaha transaction the factor that is used for determination of
profit of the seller is the last one i.e. the terms of payment. In this
transaction one sells goods to another at the price on which he
purchased the same plus a markup, on deferred payment basis (either
in lump sum on a future date or as per agreed installments).
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Chapter Four
As already discussed earlier, the Murabaha transaction is not a

financial transaction in its very nature and instead it is a trading
transaction. However, since this transaction is based on the fixed rate
of mark-up which may easily be comparable with the prevailing market
interest rates, the same is commonly used by a large number of Islamic
financial institutions as an easy way out from the interest-based system.
As a financing technique, it involves a request by the client to the
financier to purchase a certain item for him. The financier does that
for a definite profit over the cost which is agreed and fixed in advance.
Bay Murabaha is generally termed to be a very controversial
transaction from the Shariah perspective. A considerable number of
scholars have considered this particular transaction to be Makrooh
( )or Makrooh-e-Tehreemi ( ) based on its
resemblance with the interest-based transactions coupled with the very
much quoted basic principle of Islamic Shariah that has been directly
derived from a very famous Hadith, that one should avoid anything
doubtful.
Notwithstanding, the views of such jurists, the majority of
scholars from all the schools of thought have allowed the same from
Shariah perspective with very stringent provisions, non compliance of
even any of them makes this transaction impermissible. Accordingly,
due care needs to be exercised by both the parties, i.e. the Islamic
financial institution, as well as, the customer while entering into a
Murabaha transaction.
Murabaha Sale As a Financing
Transaction
Murabaha is one of the most widely used modes of finance by
the Islamic Banks and Islamic financial institutions. Analysis reveals
that throughout the world, the most common form of financing
applied by Islamic financial institutions is Murabaha financing,
contributing approximately 50 to 60 percent of their financing
portfolio.
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Chapter Four
FLOW OF TRANSACTION IN MURABAHA
CUSTOME
R
SUPPLIER
Purchase
against
Cash (Say
Rs.
1,000)
through
Agent on
Spot
Basis
AGENT
(Generally
the
Customer)
GOODS /
ASSETS
Appointment of
Agent for Payment or
Delivery or Both
Sale
against
Deferred
Payment
on Cost
+ Profit
Basis
(Say Rs.
1,150)
BANK
The mode of Murabaha sale connected to a promise to

purchase (generally called Murabaha to the Purchase Orderer) is
commonly used by the Islamic Banks which undertake the purchase of
commodities and assets according to the specifications requested by
the customer through a purchase order and then reselling them on
deferred payment on Murabaha basis to the one who promised to buy
for its cost price plus a margin of profit agreed upon previously by the
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Chapter Four
two parties. Accordingly, the buyer gets the goods he needs at the time
and gets relaxation in the terms of payment of the consideration as per
agreement, whereas the banks enjoy the profit in form of markup on
the same.
It is generally used by Islamic financial institutions in the
following transactions:
Short-term financing requirements for financing of

working capital needs in the form of purchase and
resale of stocks etc., as an alternative to overdrafts
and running finance arrangements and for import and
export financing. This is the most common form of
Murabaha transactions;
Long-term financing requirements for financing of
fixed assets etc. in form of Installment sale for
financing of fixed assets e.g. purchase of machinery
or vehicles;
Normal Murabaha sale by the Islamic Bank working
as a trading house (rarely used);
Housing finance; and
Secondary market in different forms e.g. Murabaha
sale of securities and commodities which may be used
by the customer as a Tawarruq or Reverse-Murabaha
transaction and, similarly, purchase of securities and
commodities and on Murabaha basis whether or not
entailing for Tawarruq or Reverse-Murabaha.
However, certain other variants of Murabaha transactions are

also rarely used by the Islamic financial institutions.
Provisions in Applicability of
Murabaha
As discussed earlier, the Murabaha transaction as an alternate
to the conventional financing transactions is a very risky transaction
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Chapter Four
from Shariah perspective and due care needs to be exercised in its

applicability. Following are the basic Shariah provision in applicability
of such transactions:
Both the price of the item and the Sellers profit on

the Murabaha should be fixed and known to both
parties at the time of signature of the contract of sale
and should not be contingent on any event
whatsoever or left to be decided on some future time;
Sellers expenses incurred should also be known as a
part of Murabaha price and should be on the actual or
nearest approximation basis;
Once entered into a Murabaha transaction, the price
and other conditions cannot be changed. However, in
certain circumstances discount on early payment may
be given but the same should not be mandatory and
should be by option only;
Murabaha sale is applicable only on tangible assets
and is not permissible against expenses and services;
Sale and repurchase on Murabaha basis (buy-back
arrangement) i.e. Bay Wafa ( ) or Bay Inah (
)is not permissible;
If the seller gets some discount after the Murabaha
sale which could erroneously not be accounted for in
the costs, he should transfer such benefit to the
customer;
The seller must own, legally and constructively
(through possession), the goods before these are sold
on Murabaha i.e. the time when Murabaha agreement
is signed. It implies that the sellers purchase
transaction must have been consummated and he
must have obtained possession of the goods either
directly or through an agent. In this respect the buyer
may also be an agent if a separate agency agreement
has been entered into by the parties;
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Chapter Four
The seller may obtain promissory notes or other

guarantees from the buyer as a security, however, the
former one cannot be taken before the Murabaha sale
contract is consummated;
Murabaha on a deferred payment basis may not be
performed for equivalents of money e.g. gold and
silver. Similarly, the same cannot be performed for
foreign exchange;
For the time being when the seller is the owner of the
goods, i.e. after purchasing from the source supplier
and before selling to the buyer, the seller must absorb
all the risks and rewards of the goods including any
losses and insurance (Takaful) for losses;
The seller may obtain a sum of money as security
deposit. However, the same must be refunded to the
buyer and not adjusted directly with the selling price.
Similarly, he may take earnest money after concluding
the Murabaha sale with the customer;
Any commitment fee or similar charge or a fee for
providing a credit facility is not permissible;
Roll over in Murabaha or to charge any markup after
due date is not allowable, however, rescheduling the
remaining amount in installments is permissible
provided that the total amount due remains the same,
with no further increase; and
If the buyer defaults in timely payment of dues
against the Murabaha sale, the price cannot be
changed nor may any surcharge, service charges or
penalty be charged. However, in our society we face a
number of intentional defaulters, in which case, a selfimposed penalty may be stipulated in the contract
which shall preferably become applicable after giving
a suitable grace period. This penalty, however, shall
be paid in charity and any such income should not be
considered Halal by the seller for his own use.
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The conditions mentioned above should not be construed all

inclusive. Particularly, a few issues relating to the matter of purchase
ordering for Murabaha have not been included herein as the same are
generally applicable to Islamic financial institutions and not the general
public or the customers.
Istijrar
Istijrar is a continuous sales contract in which the parties agree
to buy and sell goods continuously at a price based on a pre-agreed
benchmark rate or at such a rate with a fixed profit margin. A simple
example of Istijrar is transactions one may enter into with the nearest
retails store. In such transactions, the customer and the seller agree
that they will buy and sell goods at the market rates or at the retail
rates printed on the items. If such arrangement is made, whenever, the
buyer takes some items from the shelf, the sale transaction
consummates and now he is liable to pay the price to the seller, as per
the agreed terms.
Islamic financial institutions use Istijrar coupled with certain
factors of Murabaha with their routine customers. It is generally
applied where continuous sales transactions take place within a single
fixed ceiling, whereby a customer is authorized by the Islamic financial
institution to purchase goods on its behalf as an agent and then these
are sold to him for a fixed profit within the limits of an agreed ceiling.
A similar form of such transactions is Circular Murabaha sale in which
all the transactions are distinct Murabaha transactions instead of an
Istijrar transaction. Such sales generally take place amongst retailers,
wholesalers, certain manufacturers and other traders who often need
to purchase different goods, and for whom it may be difficult to
repeatedly approach the bank for a new transaction every time they
need to purchase goods.
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Tawarruq
Tawarruq ( )is a transaction exactly opposite to a
Murabaha transaction and hence it is also called Reverse-Murabaha. In
this transaction, one purchases some liquid (immediately saleable)
commodity on the basis of Murabaha either from the source supplier
or from an intermediary (Islamic financial institution) and sell it in
market to get cash for his immediate needs.
FLOW OF TRANSACTION IN TAWARRUQ
SUPPLIER
Purchase against Cash

(Say Rs. 1,000), Direct
or through Agent, on
Spot Basis
COMMODITIES /
SECURITIES
(Must be Highly
Liquid in Nature)
CUSTOMER
IN OPEN
MARKET
Sale against Cash on

Spot Basis (Say Rs.
1,000 Approx.), Direct
or through Agent
BANK
Sale
against
Deferred
Payment
on Cost +
Profit
Basis (Say
Rs. 1,200)
CUSTOMER
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Chapter Four
Tawarruq is used by various Islamic financial institutions as an

alternate to various secondary market operations in order to ensure
their liquidity. It is also certain Islamic financial institutions to provide
personal loans. In this transaction, the customer or the Islamic
financial institution, as the case may be, purchases some commodity,
and particularly in case of secondary markets some investment
securities, and sells these on the current rate in the open market and
accordingly generates cash for use in its own operations. All the basic
rules and conditions that are applicable to a Murabaha transaction are
also applicable to the Tawarruq or Reverse-Murabaha transaction as it
is basically a Murabaha transaction.
Tawarruq, as a financing tool, is strongly criticized and even
there is a school of thought, amongst the Islamic jurists, who does not
allow it and distinguish it from a Murabaha transaction. Although they
agree that there is no binding on selling the goods purchased on
Murabaha basis before the payment because in a deferred payment sale,
the sale consummates with the signing of agreement and transfer of
possession and has no relation anymore to the time of payment.
However, they are of the opinion that, if it is not a routine business
transaction and the objective of the transaction is, merely, to obtain
cash, this transaction is not permissible.
Their opinion is based on the fact that in Shariah, all acts are
dealt according to their very nature and the intention behind such acts,
and not merely on the apparent legal form of such acts. Accordingly, if
the intention and purpose of entering into the Murabaha is not the
trade itself and instead it is to get the money, such transaction can not
be termed as Halal.
Accordingly, the readers are advised to consult their respective
Shariah scholar to ensure the permissibility of this sort of transaction
before entering into one, and being on the safer side, it is strongly
recommended to avoid the same. However, in case of an emergency,
and to avoid any interest-bearing loan or to convert any interest-
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bearing loan, such transactions may be applied with due approval of a

respectable Shariah jurist.
Bay Salam
Salam ( )sale refers to advance payment for goods which
are to be delivered later. In normal circumstances, it is strictly
prohibited that any sale be consummated unless the goods are in
existence and are in the ownership, as well as, physical or constructive
possession of the seller at the time of the bargain. Nevertheless, Salam
sale is an exclusion from this general rule subject to certain specific
provisions.
In Salam sales, the seller undertakes to supply specific goods
to the buyer at a future date in exchange of an advanced price fully
paid at spot. In this respect this type of sale is exactly opposite to the
normal Murabaha sale in which the goods are immediately delivered
and the payment is deferred.
It needs to be noted that Salam or Salaf (which is another
term used for such transactions in Fiqh and Ahadith) is specifically
allowed in Ahadith so its permissibility in Shariah is beyond any doubt.
Moreover, most of the basic rules in respect of Salam, are also
available from Ahadith. Accordingly, Salam transactions are free from
any doubts which are raised by a number of jurists in respect of certain
other trade-based modes of Islamic finance.
Applicability of Salam Sale
In Salam sale, the seller obtains advance payment against an
obligation to deliver the commodity later and accordingly, he gets the
benefits through covering his financial needs whether these are
personal expenses or expenses for productive or trading activity. On
the contrary, the purchaser gets the discounted prices for the
commodity and gets the commodity according to the time of his desire.
The Islamic financial institutions generally get the benefit of the
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difference between the prices. From another perspective, the buyer

also secures himself against fluctuations in prices and fixes a specific
price for the future delivery of commodity.
FLOW OF TRANSACTION IN SALAM
CUSTOMER
(Borrower)
Purchase against Advance

Cash Payment (Say Rs.
1,000) and Deferred
Delivery (Say 3 Months)
COMMODITY
(Any Commodity
Permissible for
Salam)
EVENTUAL
CUSTOMER
After taking Delivery,

Spot Basis (Say Rs.
1,200) through Agent
BANK
Appointment of
Agent for
taking
Delivery
and Sale
in Open
Market
AGENT
(Generally
Customer)
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Chapter Four
Salam sale is suitable for a number of trading and business

operations including as an alternate to the traditional finance of
agricultural operation and to finance the commercial and industrial
activities particularly, including the export activities. Similarly, it is a
very appropriate option of interest-free financing for small and
medium enterprises (SMEs).
In case of application of Salam transaction by Islamic financial
institutions, an issue arises of selling the commodity purchased on
Salam basis. In this respect the Islamic financial institutions have
different options.
First option, in this respect, is to sell the commodity in the
open market either directly or through an agent after obtaining the
possession. The Islamic financial institution may decide to take the
price risk or not. If it decides to take the price risk, then it waits for the
delivery of commodity and then sells it in the market, directly or
through an agent (may be the supplier himself).
Otherwise, the Islamic financial institution appoints an agent
(may be the supplier himself) to sell the commodity at any amount
over and above a fixed reasonable price. Anything fetched over and
above the subject price is paid to the agent as commission. At times,
instead of open market, such sale is made to an identified buyer who
has already consented to purchase such commodities through a
purchase order / indent.
The second option, in this respect, is to enter into another
independent Salam transaction to sell that commodity which is also
called a Parallel Salam transaction.
The third option is to obtain a promise to purchase from a
willing party. The sale is made, according to the promise, when the
commodity is delivered.
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Shariah Provisions in Salam

Salam sale is subject to specific Shariah rules, which are being
described in brief herein below:
In a Salam sale, the goods must be defined with due

specifications making it clear and understandable and
their description should not be left to be decided on
some future date.
Their quantity and quality both should be measurable
or may be adequate estimated. It may be conducted in
only such goods or commodities, each unit of which
have similar characteristics e.g. grains of a particular
type etc.. These types of commodities are called
Zawat-ul-Amthal () . It can not be carried
out in items in which each unit might have different
characteristics e.g. most of the animals like horses etc.;
The date of delivery of goods must be fixed and
preferably the place of delivery should also be fixed.
If place of delivery is not fixed, the place of
finalization of the Salam transaction shall be
considered to be the place of delivery;
Only tangible things excluding gold or silver or other
cash equivalents e.g. securities representing mainly
cash and receivables and foreign exchange as these all
are regarded as monetary values;
Payment against Salam purchase must be fully
advanced at the time of commencement of Salam
transaction;
Salam transaction is irrevocable by either party i.e. it
does not contain Khayar ( )i.e. the option to
accept or reject which is available in different types of
Bay, particularly the Khayar-e-Ruyat ( ) i.e.
the option to accept or reject after seeing the subjectmatter. However, incase the goods do not match with
the agreed description or if some defects are found,
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such transaction may be reversed. This option is

called Khayar-e-Aib ( ) i.e. Option to accept
or reject because of defects.
According to a number of jurists it is permissible,
when both parties agree due to any practical
impediment, to cancel the entire Salam contract in
return for repayment in full of the amount of the
purchase price advanced earlier at the time of
commencement of contract. Partial cancellation, that
is, cancellation of the delivery of part of goods, in
return for repayment of a corresponding part of the
purchase price, is also permissible. However, the
contract cannot be cancelled unilaterally;
The commodity for Salam contract should be
expected to be in market and in possession of the
seller on the agreed date of delivery;
It is impermissible for the buyer of goods on Salam
basis to sell these before actually receiving the same,
particularly in case of grains and edible items as it has
been explicitly prohibited in a Hadith. In case of
other than grains and edible items, a few jurists allow
to sell the same;
The goods sold on Salam basis are considered a
liability debt in form of goods (i.e. in exact quantity
and quality of the goods agreed) and not in form of
cash (i.e. the cash value of such goods). The seller is
obliged to deliver the same when it is due, according
to the specifications stipulated in the contract. In case,
due to any reason he could not produce or grow the
same, he should buy the same from market and
deliver to the buyer instead of returning the money
advanced. Accordingly, from accounting perspective,
the Salam receivables are commodity receivables and
are not financial instruments;
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In case of identification of inferior quality of goods at

the time of delivery, price may be changed with
mutual consent;
Any decline or increase in the market price at the time
of delivery of goods might result in a loss or gain.
Such loss or gain pertains to the buyer and both, the
seller and the buyer, have no recourse on sale;
No additional amount may be charged or levied on
the seller if he delays in the delivery of goods.
However, in such case, the sale may be cancelled and
the amount advanced may be returned to the buyer;
and
Salam sale is not allowable for any existing
commodity because in such case the title immediately
transfers and accordingly, the provisions of normal
sale apply instead of those of Salam sale. Similarly,
since the land is always in existence, its Salam sale is
not permissible at all.
Parallel Salam
As discussed briefly above, that the Islamic financial
institutions often use an option to enter into another independent
Salam transaction to sell the commodity which they have purchased on
Salam basis. This transaction is generally called as parallel Salam
transaction.
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Chapter Four
FLOW OF TRANSACTION IN SALAM WITH PARALLEL
SALAM
CUSTOMER
(Borrower)

Cash Payment (Say Rs.
1,000) and Deferred
Delivery (Say 3 Months)
COMMODITY
(Any Commodity
Permissible for Salam
Generally against an
Anticipated Purchase /
Export Order)
BANK
Sale against
Advance
Cash
Payment
(Say Rs.
1,100) and
Deferred
Delivery
(Same Date
as per Salam
Contract)
PARALLEL
SALAM
CUSTOMER
Shariah Provisions in Parallel Salam

In addition to general provisions applicable for Salam sale, a
Parallel Salam transaction is subject to specific Shariah rules, which are
briefly being summarized below:
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Chapter Four
In case of Parallel Salam, there must be two separate

and independent contracts. In case one contract
could not be completed for any reason whatsoever, it
does not automatically effect the other agreement,
and instead the seller in the Parallel Salam contract
(i.e. generally the Islamic financial institution) has to
buy the commodity from market and deliver the same
to the buyer in order to honour the second contract;
and
Parallel Salam arrangement cannot be used as a buy
back facility where the seller in the first contract is
also the purchaser in the second. Even if the
purchaser in the second contract is a separate legal
entity but owned by the owner of the legal entity
which is seller in the first case, this transaction would
be impermissible from Shariah perspective.
Bay Istisna
Bay Istisna ( )is a sale transaction where a commodity
is transacted before it is manufactured. In other words it is the
contract for manufacture of some specific commodity for the buyer by
the seller himself or through some other manufacturer. In Istisna price
has to be fixed with consent of all parties involved. All necessary
specifications of the commodity must also be settled. However, the
price may be paid according to the agreed schedule of payment that
may even be in advance, at the time of possession or even after that in
lump sum or in agreed installments.
Practical Applicability of Istisna
The most practicable applicability of Istisna which is generally
observed in our society is the construction contracts. As an alternate
to traditional financial services, this tool is used by the Islamic financial
institution for financing arrangements of manufactures and in certain
cases, for brokers and dealers also.
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FLOW OF TRANSACTION IN ISTISNA
CUSTOMER
(Borrower)

Payment (Say Rs. 1,000)
May be Lump-sum or in Two or More

Installments and Deferred Delivery (Say
6 Months)
COMMODITY
(Any Asset which is
Constructed or
Manufactured)
EVENTUAL
CUSTOMER
After taking Delivery,

Spot Basis (Say Rs.
1,200) through Agent
BANK
Appoint
-ment of
Agent
for
taking
Delivery
and Sale
in Open
Market
AGENT
(Generally
Customer)
Major Istisna contract based financing is also applied in high

technology industries such as aircraft industry, locomotive and ship
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Chapter Four
building industries. It is also used as an alternate to the conventional

housing finance services and in the construction industry such as
apartment buildings, factories, workshops, hospitals and educational
institutions etc.. Another important use of such contract is in case of
exports whereby the exporters produce is purchased in advance by the
bank and eventually the same is exported and the proceeds are
retained by the respective Islamic financial institution.
Once an asset is bought on Istisna basis, the Islamic financial
institutions have different options for its disposal which are more or
less similar to those in case of Salam. First option, in this respect, is to
sell the asset in the open market either directly or through an agent
after obtaining the possession. The Islamic financial institution may
decide to take the price risk or not. If it decides to take the price risk,
then it waits for the delivery of the asset and then sells it in the market,
directly or through an agent (may be the supplier / manufacturer
himself).
Otherwise, the Islamic financial institution appoints an agent
(may be the supplier / manufacturer himself) to sell the commodity at
any amount over and above a fixed reasonable price. Anything fetched
over and above the subject price is paid to the agent as commission.
At times, instead of open market, such sale is made to an identified
buyer who has already consented to purchase such commodities
through a purchase order / indent. This option is more often used in
financing the export business.
The second option, in this respect, is to enter into another
independent Istisna transaction to sell that commodity which is also
called a Parallel Istisna transaction.
The third option is to obtain a promise to purchase from a
willing party. The sale is made, according to the promise, when the
asset is delivered.
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Chapter Four
Shariah Provisions for Istisna

Following are the basic Shariah requirements applicable to an
Istisna sale:
Istisna contract must explicitly state the type,

dimensions and all the possible specification of the
goods required;
Time of delivery and the place of delivery must be
specified and agreed;
In an Istisna sale, the price may be paid fully in lump
sump at the commencement of contract or at delivery
or any other agreed date, or may be deferred in
installments as per schedule duly approved at the
commencement of the contract;
Like a Salam transaction, an Istisna transaction is
irrevocable by either party once the work is
commenced i.e. it does not contain Khayar ( )i.e.
the option to accept or reject which is available in
different types of Bay, particularly the Khayar-eRuyat ( ) i.e. the option to accept or reject
after seeing the subject-matter. However, incase the
goods / asset do not match with the agreed
description or if some defects are found, such
transaction may be reversed. This option is called
Khayar-e-Aib ( ) i.e. Option to accept or
reject because of defects.
Istisna contract is valid for objects that are
manufactured and is not permissible for natural
commodities which are sold under Salam contract.
Similarly, Istisna contract is not allowed at all for
assets already in existence or land etc.;
Once the contract is drawn, the ownership of the
asset is affirmed to the buyer and the ownership of
the price is affirmed to the buyer;
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Chapter Four
A contract of Istisna cannot be drawn up on the basis

of a Murabaha sale, for example, by determining the
price of Istisna on a cost-plus basis;
The seller in an Istisna sale, whether or not he is the
source manufacturer, is responsible for the
manufacture of goods as per specifications mentioned
and is liable for any defect therein;
The materials to be used for the purpose of
manufacture should be purchased by the seller and
should not be provided by the buyer. In case it is
necessary, then before entering into Istisna
transaction the same may be sold separately at the
prevailing market prices and should not be a part of
the same contract;
The goods sold on Istisna basis, are considered a
liability debt in form of exact same goods and not in
form of cash. The Istisna receivables are commodity
receivables and are not financial instruments;
The seller is obliged to deliver the same when it is due,
according to the specifications stipulated in the
contract. In Istisna, the seller has to provide the same
goods as agreed and not something similar;
If on account of any reason, the seller fails to
manufacture the same or to get these manufactured
the sale would be considered void and he would have
to pay back the amounts received on this account and
any loss or cost incurred to-date shall be borne by the
seller;
The goods manufactured under an Istisna contract
may be held subject to some warranty for defects as
may be stipulated in the agreement with due consent
of both the parties;
In certain circumstances, the price of Istisna
transactions may vary in accordance with variations in
delivery date by virtue of a bonus clause or a
penalty clause. However, the same must be
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Chapter Four
stipulated in the contract at the time of

commencement of the contract. This bonus or
penalty has nothing to do with the terms of payment
and instead the same are just for the purpose of
ensuring timely delivery or for compensating the loss
due to late delivery of asset. Penalty clause, may
stipulate an agreed amount of money as damages if
the delivery is not made as per the agreed schedule,
except any unforeseen event in which the
manufacturer is not at default (force majeure);
Any profit or loss on manufacture or by toll
manufacturing arrangement belongs to the seller and
the buyer has to pay the actually fixed amount only;
The seller may give security deposit which will be
refunded to him at the end of the contract or may be
forfeited if the contract is rescinded. However, any
amount to be forfeited should not exceed the amount
of actual losses suffered due to rescinding of contract;
The seller and the buyer may mutually agree that the
former will act as the agent of the latter one, to sell
the goods in case of delay by the buyer in taking
delivery on the due date or after some agreed grace
time. However, this condition must be agreed at the
time of commencement of the contract or preferably
it may be a separate agency agreement; and
Before the delivery of goods to the customer, as per
agreed schedule, all the risks and rewards of the
goods particularly, all maintenance costs and losses
(including expenses on Takaful) are to be borne by
the seller.
Parallel Istisna
As discussed above, similar to a Salam transaction, there is an
option for the Islamic financial institution to enter into another
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Chapter Four
contract of Istisna with some other person and sell these goods in
advance. Such a contract is also called a Parallel Istisna contract.
FLOW OF TRANSACTION IN ISTISNA WITH PARALLEL
ISTISNA (FOR MAJOR PROJECTS)
SUPPLIER
(Willing to
Construct and
Sell an Asset)
COMMODITY
(Any Asset which is Constructed or
Manufactured with Exact Specifications)
Purchase against Advance Payment

(Say Rs. 100 M). May be Lump-sum
or in Two or More Installments, As
Agreed and Deferred Delivery (Say
1 Year)
BANK
Sale against
Installments over
a Longterm
(Say Rs.
150 M
over Ten
Years)
Appointment of Agent
for Supervision and
taking Delivery
AGENT
(Generally
Customer or
Experts)
Willing to Buy the Asset but

Wants to Make Payments
over a Long-term
CUSTOMER
(Borrower)
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Chapter Four
Parallel Istisna contract is also used in another form whereby

the source seller and the source buyer come to the bank as their
financial arrangements are not compatible for each others needs. For
example, the source seller wants the total amount to be paid in
advance, whereas the buyer wants to pay in installments after the
delivery of goods, with a repayment schedule of his own choice.
In this case the Islamic financial institution acts as a financial
intermediary and enters into two different contracts with each of the
parties and while fulfilling their needs, gets the benefit of the price
differential between the two contracts.
In case of Parallel Istisna, all the terms and conditions of an
Istisna transaction remain applicable. In addition, it is a Shariah
requirement that both the contracts should be independent and default
of the source manufacturer does not relief the intermediary from his
liability in the second contract.
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Chapter Five
Lease-based Alternates to Financing
LEASE-BASED ALTERNATES TO
FINANCING
Similar to the trade-based alternates, a number of lease based
alternates for Islamic financing have also been developed by the jurists.
Most of these options have remained common for the known history
of mankind. In addition to such common options, a number of
complex transactions have also been devised by the experts in Islamic
finance and Shariah jurists. We will study just a few basic modes of
Islamic finance developed under such principles.
Ijara
Ijara ( )literally means service charges or rent for any sort
of services or usufruct or benefit of some asset. It includes the salaries,
wages, rent, lease, service charges and charges by whatever name called
against some services by individuals or against benefiting the usufruct
of some assets. In case of services it is also called Ujrah (). In a
better defined term, Ijara is the transfer of ownership of a service for
an agreed upon consideration for agreed period of time. It also refers
to a contract of land leased at a fixed rent payable in cash.
In the theory and practice of Islamic finance, it is generally
used as an alternate to leasing or renting of assets and accordingly, we
have also used it as a synonym to leasing of assets.
Practical Applicability of Ijara
Ijara, along with its various variants, is a very useful and
practicable interest-free alternate to the traditional banking
transactions. Practically it is one of the most commonly used forms of
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Chapter Five
interest-free banking used by Islamic financial institutions throughout

the world. It is an arrangement under which the Islamic bank leases
equipment, a building or other facility to a client, against an agreed
rental. The rent is so fixed that the bank gets its original investment
plus a profit on it. Practically Ijara is very much similar to the
traditional operating leases by the leasing companies and banks and
other conventional financial institutions.
FLOW OF TRANSACTION IN OPERATING IJARA
At End of Ijara Term

Asset to be Returned and
Deposit to be Refunded
CUSTOMER
(BORROWER)
PAYMENTS
(Deposit + Rentals)
INVESTMENT (Purchase
of Asset)
BANK
(FINANCIER)
IJARA RENTALS
ASSET
EXPENSES
INCIDENTAL TO
OWNERSHIP
EXPENSES
INCIDENTAL TO
USAGE
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Chapter Five
It is generally used in practice in the society in form of letting

the residential houses and other buildings on rent and giving land on
long-term leases. However, in Islamic financial institutions this is used
for leasing cars and other vehicles, electrical equipment, computers
and plant and machinery items. It is also used either directly or in form
of a complex transaction to finance the real estate and major
infrastructure projects.
Ijara Muntahia Bittamleek / Ijara Wa
Iqtina
Ijara Muntahia Bittamleek ( ) which is also
called as Ijara wa Iqtina ( ) is a form of Ijara which includes
a promise by the lessor to transfer the ownership of the leased asset to
the lessee, either at the end of the lease term or in stages during the
term of the contract. Such transfer may either be:
Through a promise by the lessor to gift the asset, at

the end of the lease term;
Through a promise by the lessor to sell the leased
asset to the lessee, at the end of the lease term at a pre
agreed price may be a token price; and
Gradually during the lease term through a gradual sale
of units of ownership of the lessor to the lessee under
a separate agreement (in some cases coupled with a
Diminishing Musharaka agreement).
In addition to other forms of title transfer, in certain

conditions, lease may be prematurely terminated and the lessor may
offer the lessee to buy the asset against payment of all the remaining
lease rentals or by offering some discount or by including certain other
conditions. Nevertheless, this transaction is a bit dubious from Shariah
perspective and should preferably be avoided.
Practically, in Islamic financial institutions and the current
business world, Ijara Muntahia Bittamleek has much more applicability
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Chapter Five
in contrast to the normal Ijara and practically it is the one which is

generally known by the name Ijara. It is used as a financing mode by
the Islamic banks and financial institutions at large including
Modarabas incorporated in Pakistan.
FLOW OF TRANSACTION IN IJARA MUNTAHIA
BITTAMLEEK
Sale of Asset at End of

Ijara Term Against
Promise to Sell /
CUSTOMER
(BORROWER)
PAYMENTS
(Deposit + Rentals)
INVESTMENT (Purchase
of Asset)
BANK
(FINANCIER)
IJARA RENTALS
ASSET
EXPENSES
INCIDENTAL TO
OWNERSHIP
EXPENSES
INCIDENTAL TO
USAGE
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Chapter Five
Sale and leaseback

One of the common forms of traditional leasing is what we
call sale and lease back transaction in which someone sells his asset to
a leasing company or other financial institution and then repurchases
the same on finance lease basis. From Shariah perspective it is very
much clear that if the execution of a sale transaction is accompanied
by some condition regarding the execution of a lease or repurchase
transaction, both the transactions turn out to be invalid. Accordingly, a
number of jurists have explicitly disallowed the sale and lease back
transactions for Islamic financial institutions. Nevertheless, a few
jurists have allowed alternatives to the same in form that it is
permissible for the parties to the contract to reach an understanding
between them or one party promises the other party to lease to / from
him the asset. However, such promise should not be binding on both
the parties; otherwise this transaction would turn out to be
impermissible. In addition, it is necessary that in such case all the risks
and rewards incidental to ownership of asset shall be transferred to the
lessor and shall remain vested in him for at least a considerable period
of the leased assets useful life.
Based on the basic principle of avoidance of doubtful, we may
conclude that it is always better to avoid sale and lease back
transactions under Ijara, save any real necessity e.g. someone is nearly
bankrupt and in order to save him and the money he owes to others,
his assets may be sold and leased back.
Dos and Donts for Ijara
Following are basic rules applicable to an Ijara transaction
under Islamic Shariah:
The Lessor should transfer the usufruct (benefit) of

an asset to another person for an agreed period, at an
agreed consideration and not the ownership;
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The asset and its respective benefits must be known

and mentioned in the contract with comprehensive
details to avoid any uncertainty and conflicts that may
arise in future;
It is mandatory that the Lessor must enjoy the legal
title to the asset or have right to its benefits under an
Ijara or any other agreement and the same shall
remain with him throughout the lease term;
The risks and reward of ownership and the legal title
of the asset shall remain with the Lessor throughout
the lease term and shall not be transferred to the
lessee before that date;
Asset subject to lease must be tangible in nature and
be capable of being used and should not consume or
perish during use, hence, any form of consumables or
perishable items may not be a subject of Ijara
transaction;
Ijara rentals become due when the asset is made
available to the lessee. However, advance or deferred
rentals may be paid subject to agreement between the
two parties. Even in this case, the term of Ijara needs
to be completed from the date when the asset is made
available to the lessee. Accordingly, no Ijara rental
may be charged for an asset under manufacture or
which is not yet delivered, or which has been taken
back for repairs, maintenance or replacement or has
been stolen or destroyed and the delivery for
replacement remains pending;
Period of lease must be known to both the parties
and agreed in advance. It may, however, be subject to
review by agreement of both the parties, during or at
the end of the period;
Rental amount must be known and expressed in
money terms, duly mentioning the currency, and paid
in money in the same currency as agreed or in
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equivalent amount of any other currency, if agreed by

both the parties;
The Lessor cannot increase the rent unilaterally, and
any agreement to this effect is void and makes the
Ijara contract questionable. However, floating rentals
are allowed if the first rental is agreed and some
benchmark for the floating rentals is agreed at the
commencement of the agreement, e.g. rent of similar
assets, or inflation or some other benchmark. Even
the State Banks rate or Inter Bank operating rate may
be used as a benchmark, although such practice
should preferably be avoided;
If the delivery of the asset takes place later than the
agreed dated, no rental is due for the intervening
period, apart from the situation whereby it is agreed
at the commencement of the agreement that in such
case the lease period be extended by an equivalent
period after its original expiry date. In such case, the
agreement shall continue for a further period, and in
case of Ijara Muntahia Bittamleek, the asset cannot be
sold before the expiry of the extended period because
the Ijara term continues for that time and the risk and
reward for the extended period shall be borne by the
Lessor;
If agreed at the commencement of the lease, the asset
may be sub-let wholly or partially at an equal, higher
or lower rental and any difference between the rental
pertains to the lessee;
Lessee shall ensure that the asset is not used for any
purpose other than those agreed with the Lessor;
Earnest money or any other security may be taken in
respect of lease at the execution of the contract of
lease and this may be treated as an advance rental.
The Lessor may adjust his actual damages with such
earnest money, in case the lease can not be
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consummated for any default on the part of the

lessee;
The lessee is a trustee for the asset and should take its
care like an asset held in trust. As far as the matter of
responsibility for damage is concerned, it is to be
borne by the one who caused it. Accordingly, if it is
by the willful act or gross negligence or default of the
lessee, it is to be borne by him. In any other situation
it is to be borne by the Lessor;
Major repairs, maintenance and overhaul of the asset
are the responsibility of the Lessor. Similarly, the risks
of theft and fire etc. belong to the Lessor and
accordingly, the Takaful expense should also be
borne by the Lessor during the lease term. The lessee
may incur these expenses on behalf of the Lessor on
his advice which shall eventually be reimbursed to
him by the Lessor or adjusted with the rentals payable;
A penalty for willful delay in payment, after allowing a
grace period, may be stipulated in the agreement. But
the Lessor should donate such money for charitable
purposes;
Both parties, may by mutual agreement terminate the
Ijara contract before its commencement;
The asset should be in good working condition and
capable of rendering services that are expected from
it, whereas in case of defect, the lessee has the option
to retract or to continue the lease and pay the rental;
In case the leased asset is damaged or not performing
up to the desired standard or has some other defects,
the contract does not terminate if the Lessor offers a
substitute with the same specifications agreed upon in
the lease contract; and
Any accessories of the asset that are necessary to
operate it are considered a part of asset whether or
not expressly mentioned at the commencement of
lease term.
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Chapter Five
Dos and Donts for Ijara Muntahia

Bittamleek
In addition to the basic Shariah provisions applicable to an
Ijara transaction as mentioned hereinabove, there are certain additional
requirements that are applicable in case of Ijara Muntahia Bittamleek
as being summarized below:
A promise by the Lessor whereby he offers to

transfer the ownership either by way of sale or by gift
at the end of the lease term is binding promise only
on the Lessor and not on the lessee, who has the
option to not to proceed. If the lessee accepts at the
inception of the lease, this transaction becomes
invalid from Shariah perspective. Similarly, such
transfer cannot be through a sale deed executed at the
commencement of or during the lease term which
might become effective on some future date, as in
Shariah such sale is equivalent to normal sale and the
lessor looses the rights of ownership which is a must
for Ijara contract. As an alternate, a promise to buy
the asset may be obtained from the buyer on similar
grounds;
The lessor may sell the leased asset during the lease
term to somebody, subject to the condition that he
should continue with the contract during the lease
term, and abide by the promise to sell or gift as
offered against such asset. However, both the parties
i.e. the new lessor and the lessee may by mutual
consent terminate the Ijara agreement;
Ijara Muntahia Bittamleek is different from the
installments sale as in an installment sales transaction,
the title of asset transfers to the purchaser on the very
first day and the installments paid are a part of agreed
price whereas in the Ijara Muntahia Bittamleek the
rentals paid are against usufruct of asset and not
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against the price, whereas the title may be transferred

to the lessee at the end of lease term as per the
stipulated promise; and
The correct legal conditioning of the Ijara Muntahia
Bittamleek is that it must consist of two separate
contracts, duly independent of each other, one of
which immediately goes into effect that is the Ijara
contract. The other contract is just a promise to offer
and goes into effect later at the end of the lease
period.
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Agricultural Financing
AGRICULTURAL FINANCING
In Pakistan, agriculture is the sector that not only contributes
a very significant portion to the GDP but also provides the livelihood
to the maximum number of individuals and families either through self
employment or through employment in any form. Accordingly, it is
not possible for us to ignore such an important area.
The financing to the agriculture sector has much more
options as compared to any other industry because of its very nature.
Accordingly, in addition to the normal options available to every
businessman and every industry, there are a few options specific with
agriculture that are available only for agriculture financing.
Following are the basic agricultural based Islamic modes of
financing:
1.
2.
3.
4.
Salam;
Muzaraa;
Musaqa; and
Mugharasa.
Salam
Salam is a very common form of financing for agriculture
sector. Besides being available as a financing option with the Islamic
financial institutions, it is still in practice in various forms in the
country. In this case, generally the commodity brokers called
Arhtees purchase fixed quantities of expected produce in advance
from the farmers.
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Over the centuries of illiteracy and lack of knowledge, the

original shape of the transaction has been acutely damaged and a
number of conditions that are required to be implicit in a Salam sale in
order to make it Shariah compliant are not fulfilled in the general
Salam transactions (by whatever name called) as being transacted in
the country. In addition, such form of sale as being practically applied
is also being used as an instrument of exploitation of the needs of
poor farmers by applying the exorbitantly high margins by such
brokers. Moreover, this form of transaction is mixed up by most of
the people with other similar transactions which are very much
questionable from Shariah perspective e.g. purchase of whole produce
of a garden, even before the fruits are ripen.
The concept of commodity exchange is also being introduced
in Pakistan. Although a number of transactions generally executed on
a commodity exchange are not in compliance with the Shariah
principles, using the commodity exchange for the purpose of
providing benefit to the farmer through Salam transactions may not
only provide benefits to the needy farmers, but will also result in
improvement in the agricultural sector. Now it is a matter requiring
attention of the decision makers to devise the options of Salam that
may be provided directly to the farmers or through the banks to the
farmers, by using the commodity exchange as a tool. Islamic banks
may also use the same as an option for financing to the farmers under
Salam contracts and selling the produce on the commodity exchanges.
Since, the principles and rules for Salam transaction have
already been discussed in detail in the previous chapters; we may
proceed further to other forms of agricultural financing options
available under Shariah principles.
Muzaraa
Muzaraa ( ) is the most common form of
agriculture finance in operation all over the Muslim world with slight
variations in schemes according to the customs, depending on the
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personalities and also depending on the basic knowledge of Islamic

teaching regarding this mode.
By definition, Muzaraa is arrangement between the owner of
land and the farmer, according to which the farmer cultivates the land
and the produce is divided amongst the parties in a fixed ratio which
has been agreed upon by them at the inception of the transaction.
Needless to mention, the overall Islamic financial system, as a
part of overall Islamic way of living, is based on the principle of
mutual respect and justice. Accordingly, there is a massive misuse of
the Muzaraa system in our society which is basically caused by the
ignorance of Islamic teachings, basically on the part of the land owners,
as well as, lack of monitoring by the respective governments over
various dynasties and even in the recent reign of so-called civilized
democratic society.
It is worthwhile to be noted that a number of Muslim jurists
including most respectable jurists i.e. Imam Abu Hanifa and Imam
Malik have raised certain questions on the permissibility of Muzaraa
or, more rightly said, have categorically disallowed it. This view is
based on certain Ahadith whereby the Holy Prophet SAAWS had
prohibited the application of Mukharaba ( )which was a form of
Muzaraa. On the contrary, the majority of jurists have consensus
regarding its permissibility under various modes, although they impose
a number of restrictions on both the parties, in order to ensure strict
compliance of the requirements of Islamic Shariah and to ensure
compliance of the basic Islamic principle of social justice.
There are two basic forms of Muzaraa:
1.
In the first type of Muzaraa, the landowner provides

the land for cultivation, and all the necessary supplies
required for cultivation mainly comprising the seeds,
water, fertilizers, pesticides and the necessary
machinery. In this case, the landowner practically
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2.
becomes the employer of the farmer who works on

the land in exchange of a fixed proportion of the
produce. This type of Muzaraa is very much similar
to an employment contract; and
In the second type of Muzaraa, the farmer brings the
seeds, fertilizers, pesticides and the required
machinery and becomes a tenant in exchange of some
of the produce. This type of Muzaraa may also be
termed as taking the land on rent.
FLOW OF TRANSACTION IN MUZARAA
LANDOWNER
(LENDER /
FINANCIER)
FARMER
(BORROWER)
EFFORTS + SUPPLIES
(MAY BE)
INVESTMENT
LAND + SUPPLIES
PRODUCE
(In Agreed Ratio)
MUZARAA
Dos and Donts for Muzaraa

Following are the basic rules that need to be followed for
Muzaraa transactions and arrangements:
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Chapter Six
In a Muzaraa transaction, it is a basic requirement

that the party providing the subject land should have
the legal right to enjoy usufruct thereof. Accordingly,
he should either own the land or enjoy the benefits
thereof and authorized to use and work on it under
any other legal right including, but not limited to,
lease of land from the government or the principal
owner;
It is better to always document any sort of agreement
under the teachings of Islamic Shariah. Nevertheless,
the culture we have in vogue in our country do not
allow to even consider to fulfill the same basically on
account of illiteracy and the behavior of the
landowners who always desire to have most of the
produce for themselves, and to allow only such a
minimal portion of produce to the farmers that is
never sufficient to them even to fulfill their basic
human needs, in order to retain them slaves for their
lives;
It is a basic requirement of Muzaraa transaction that
specifications, boundaries and area of the land should
be clearly fixed and known. The framework of duties,
responsibilities and obligations of the farmer must
also be specified in the Muzaraa agreement. It is also
imperative to ensure that the Muzaraa land is capable
of cultivation and yield the produce expected;
The Muzaraa period must be known and sufficient
for the cultivation of the land and harvesting the crop;
The owner must move out of the land subject to
Muzaraa transaction, for the period of cultivation in
order to make the land available to the farmer;
The responsibility of the farmer with regard to the
Muzaraa property is like that of a trustee.
Accordingly, it is his responsibility to use the land
only for the agreed purpose, except with prior
approval of the landowner;
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The crop to be cultivated must be specified and in

this respect the kind of seeds to be sown should also
be specified. The seeds may be provided by the
owner or brought by the farmer according to the
prevailing norms;
The farmer may hire someone and / or take a partner
for farming the land, but he is not permitted to
transfer the land to a third party without obtaining
the permission of the owner of the land;
Muzaraa contract is an obligatory contract, and is
therefore, binding on both the parties. It cannot be
annulled by one of the parties abrogating it
unilaterally. Moreover, the death of one or both
parties to a Muzaraa contract does not nullify the
agreement and their respective successors should
honor the contract;
It is a judicial ruling that if the Muzaraa is cancelled,
for any reason whatsoever, the entire yield, if any,
shall belong to the supplier of the seed, and the other
party, who may be the owner of the land, water and /
or work, will deserve equivalent wages proportionate
with what he has owned;
It is possible that a number of persons may enter into
one Muzaraa agreement in which one may be
responsible for land, another one for tilling, another
one for seed, and another one for other jobs or
supplies;
The manner of sharing the yield or produce should be
determined separately for each party, taking into
consideration the factors supplied by each one of the
parties. The produce, irrespective of quantity thereof,
is divided according to the ratios as already agreed
between the two parties at the time of establishment
of the contract. In case of complete destruction of
crop, farmer loses his efforts and the landowner loses
the utility of the land; and
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The preferred proportion of distribution of produce

is 50:50 in case whereby only land is provided by the
landowner and all the other responsibilities rest with
the farmer. In this respect, most known and quoted
example is that of the arrangement between the Holy
Prophet (SAWS) and the Jews of Khyber. However,
if the seed and other supplies are provided by the
landowner, this proportion may be altered in favour
of the landowner, subject to the basic condition that
any such proposition should not be against the
principles of social justice of Islam. Some jurists have
the opinion that such proportion should not be less
than 1/3rd of the produce even if all the supplies are
provided by the Landowner. However, it is a matter
within the jurisdiction of the government to set
norms in this respect in order to ensure compliance
of Shariah rulings as well as the principles of social
justice.
Musaqa
It is a transaction or agreement between the owner of a tree or
a cluster of trees and an agent (hereinafter referred to as the farmer for
ease of reference), against an agreed share from the yield of such trees
including fruits, flowers, leaves and other produce e.g. chemicals,
rubber, gum etc. as agreed. Nevertheless, non-yielding trees shall not
be the subject of Musaqa agreement and in such case the alternate
arrangement may be a service contract or employment.
Difference between Muzaraa and
Musaqa
The basic difference between the Muzaraa and Musaqa is
that in the former one is applicable on plants having smaller life cycle,
generally only one season, whereas in the latter one the trees and
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plants should be such as have gone into the ground as a fixed part of it
and are capable of staying in the ground for more than one year.
Dos and Donts for Musaqa
Following are the basic Dos and Donts in case of Musaqa
transactions and arrangements:
The period of the agreement for irrigation shall be

known. The period is generally fixed in such a
manner as to result in the yield of the trees;
Specifications, boundaries, type and number of trees
that are subject of Musaqa shall be specified;
The framework of duties and the commitments of
each of the parties, ratio of separate share of the yield,
mode of procurement and other necessary factors for
the performance of the subject shall be known and
specified; and
In a Musaqa arrangement, the farmer is a trustee for
the purpose of a Musaqa agreement, duly entrusted
with the trees and the land on which these are
cultivated and is accordingly, is not allowed to use
such land or trees for any purpose whatsoever, other
than the purpose for which he has been entrusted
with the same or to transfer the transaction to a third
party or take another partner, without prior consent
of the landowner. In this regard it is also worth
noting that he cannot take any part of yield for his
personal use save with prior approval or the owner,
with eventual adjustment with his share in yield.
Mugharasa
Mugharasa is a transaction or agreement between the owner
of the land and those, in respect of agriculture, who assume the
agricultural or horticultural against a clear cut share in the land and the
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plantation. This mode of agricultural financing is not yet practically by

Banks in both conventional and Islamic facilitated financial sector
neither this is in application in Pakistan in any practical manner.
Normal Modes of Islamic Financing
Applicable to Agriculture Sector
In addition to the above, the following modes of Islamic
finance may also be used to finance certain financing needs of the
agricultural industry:
1.
2.
3.
Murabaha;
Ijara and Ijara Muntahia Bittamleek; and
Diminishing Musharaka.
Murabaha may be used by the self-employed farmers,

landowners and farmers working on Muzaraa basic, for financing of
their supplies, including seeds, pesticides, fertilizers, machinery and
livestock, wherever required. Such facility may be obtained from the
source suppliers, as well as from any Islamic financial institution or any
other party willing to provide such arrangement.
Ijara may be used, and is practically used, to arrange for the
requirement of heavy machinery for the purpose, particularly including
the tractors, bulldozers, and threshers etc.. Generally these equipments
are and may be provided by their respective owners to the farmers and
landowners in their neighborhood on hourly or daily charge out rates.
Similarly, Ijara Muntahia Bittamleek may be used by the Islamic
financial institutions to finance the agriculturists for machinery if they
are not in a position to make lump sum payments for purchase of the
same.
Diminishing Musharaka may be used in financing of major
projects, including but not limited to the purchase of land and
machinery. It may also be used by the government to provide land to
small farmers in a manner similar to the house building loans. Such
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Diminishing Musharaka may be based on the unit by unit purchases by

the farmers whereas the benefits as land owner shall be shared
between the government and themselves in the respective proportion
of ownership of land. Such benefits may be termed in form of fixed
rent for land (as allowed by a number of jurist) or on a Muzaraa basis.
After unit by unit purchases, such land will eventually be transferred to
the farmers.
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Chapter Seven
Consumer Financing A Consumers Perspective
CONSUMER FINANCING A
CONSUMERS PERSPECTIVE
Now it would be better to have some discussion regarding the
retail banking system and the consumer financing. Consumer financing
denotes the loans that are directly disbursed to the general public for
personal purposes, including auto loans and loans for household
products (sometimes in form of leasing), house loans (mortgages),
credit cards financing, students loans and other personal loans. We all
who try to become practicing Muslims know that these financing are
based on the principles of interest and accordingly these are not
permissible from Shariah point of view. In this chapter, we will try to
discuss a few Shariah compliant models for consumer financing.
From the banking perspective these loans are assumed to be
more risky particularly with regard to the default by the party and
accordingly, risk premium is generally very high on these loans and
accordingly, the rate of return is extra-ordinary high as compared to
corporate and industrial loans and financing. On the contrary, it may
also be observed that the current banking system has developed a
stronghold in the economic sector and accordingly, its not that easy
for somebody to default his loan, whereas these banks also hedge their
risk through insurance and other techniques, besides having strong
securities. Consequently, this is generally the most profitable sector for
the Banks. In addition, generally the consumers are not in a position to
providing strong securities and as a consequence thereto, they agree to
pay comparatively higher returns.
Similarly, it can also be observed that particularly in the third
world countries, the major multinational banks invest a significant
portion of their portfolio in consumer banking particularly in credit
cards. Giving due consideration to the above facts, one can easily
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understand that the retail banking system is much more detrimental

for the society, as in case of industrial projects, financing at the least
some productive activity is anticipated. In case of consumer banking,
individuals are encouraged to spend more than what they have in their
hands, at comparatively higher rates. Although spending also ensures
move in the economy, nevertheless, it is easily understandable that
other than house loans, most of the personal loans are used in items
making ones life easy and maintain a living standard or simply
speaking lavish items particularly including cars and household items.
Particularly viewing it in the perspective of the third world
countries, even including the oil producing middle east countries, such
spending result in deterioration of economies (through damaging
balance of trade and balance of payments) because most of such items
are either imported directly from the West or even if these are to some
extent, assembled or packed in the respective countries, their
manufacturers etc. are generally the multinational companies.
Besides all above, such consumer financing culture is so
attractive that it may easily be observed that a number of Muslims,
even being practicing Muslims in person, have indulged themselves in
this attractive world resulting in involvement in Riba, without having
any way out. Generally these loans are offered at amounts equivalent
to several times of ones monthly earnings and consequently, a person
once getting involved in it always ends up in a situation whereby he is
busy in transferring loan from one facility to another and trying to
reduce the interest rate applicable thereon, which continues for a
considerable portion of his life.
It, however, does not appear feasible to discuss the matter in
detail, as neither is it the core subject of our study, nor the author has
any command on this subject as an expert. These are the views of an
accountant with a very little knowledge of economics. In this respect,
once again the interested readers are recommended to study the works
of certain very respectable and renowned economists on this subject.
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Chapter Seven
Housing Finance Arrangements

(Mortgages)
Home is one of the three basic needs of human beings, the
other two being food and clothing. In a materialistic society, for the
general public, the matter of owning a home is generally a dream and,
it is bitter truth that, such dream generally never comes true if
someone endeavors to save money enough to buy the same. The
corrupt economic system and its agents have also played with this
dream of the mankind in form of house loans and mortgages which
are purely based on interest and accordingly they involve people in the
web of interest-bearing loans for periods as long as even 25 to 30 years.
As a consequence, one gets trapped in this evil web for the whole life.
Although a number of Shariah compliant avenues are now
available as an alternate to the traditional housing finances or
mortgages, another important matter needs to be considered in this
respect. Viewing from the perspective of the members of society for
the purpose of obtaining housing loans we come across two basic
motives. The first one is to fulfill the basic need of having a roof on
ones head whereas the second one is to have a comparatively lavish
residence in contrast to the existing residence. Although the matter of
necessity and desire can never be settled unilaterally, it should always
be observed that according to basic teachings of Islamic Shariah one
should always spend moderately. Overspending and on the contrast,
savings beyond normal limits, both are not desirable from a Muslim
under the preaching of Islam.
On the contrary, for most of the general public in the country,
it is a real need to have a roof of their own. Accordingly, it is also
important for the government and the Haves to help community in
having their own homes. Luckily, now we have a few practical Shariah
compliant housing finance schemes in Pakistan the most important
being the scheme in vogue, at least theoretically, with the House
Building Finance Corporation (HBFC). A number of Islamic banks
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and financial institutions have also launched or are in the process of

launching their Shariah compliant housing finance schemes.
A Shariah compliant housing finance scheme can be derived
from any of the following main Islamic products:
Murabaha;
Ijara Muntahia Bittamleek;
Istisna and Parallel Istisna; and
Diminishing Musharaka.
Murabaha Based Housing Finance

Model
Under a Murabaha based housing finance scheme a house or a
portion of house may be purchased from an Islamic financial
institution on deferred payment basis who will buy the same from the
source seller in order to sell it to the customer on purchase price plus
fixed profit basis.
This scheme has been introduced by certain Islamic financial
institutions in various countries particularly in Malaysia; nevertheless,
the same is comparatively less practicable because of a few issues
relating to a Murabaha sale as follows:
the financing is generally for long periods of time e.g.

15 to 20 years and even upto 30 years and the sale
price once set cannot be changed in a Murabaha sale
and accordingly it becomes a fixed return financing
and it is very difficult for a financial institution to
enter into a transaction for such long period with a
fixed rate of return due to issues relating to its own
return on capital which varies according to market,
the return to the depositors, as well as, comparability
with market rates;
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in Murabaha, title is transferred to the customer as

soon as the sale agreement is entered into, generally
corresponding with the possession of the asset
transferred, which in case of default by the customer
makes the situation complicated particularly, if the
house is sold by him because once the legal title is
transferred, he has the entitlement to sell the house.
This situation is however, avoided through obtaining
securities, and if no security is available, through the
mortgage of the same house, which is, however,
questionable from Shariah perspective;
Murabaha (particularly long-term Murabaha) is not
allowed as permissible by certain scholars, because of
its resemblance with the interest-bearing transactions.
Although the majority of religious scholars has
consensus that it is permissible if the relevant
conditions are fulfilled, due to such doubts a number
of practicing Muslims try to avoid this sort of
transactions and accordingly they may not opt for any
Murabaha based housing finance scheme on
prudence basis.
Ijara Muntahia Bittamleek Based

Housing Finance Model
This scheme is generally suitable to finance a portion of house
or renovation or addition of a few items instead of being used as a tool
to finance a complete house because such scheme is generally suitable
for medium-term financing. This scheme is, anyway, not deemed fit
for long-term financing because in case the agreement is terminated at
any time or if any catastrophe happens, the lessee has no recourse on
the amount paid by him and the option to purchase the house at the
end of the lease term would not be exercisable. As a consequence
thereto, the customer would not feel secure for entering into a 15 year
Ijara contract, with no share in the property, even if the contract gets
terminated in the last year of the contract. Practice and financial
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modeling suggest that the term of an Ijara agreement should generally

be between 3 to 7 years which is considered suitable from both the
lessors and lessees perspective.
Besides the drawbacks as discussed above, this mode may be
very much helpful for financing of few expensive items e.g. air
conditioners or even a portion of the house, because of its
practicability and ease of arrangements. However, the subject items of
Ijara should not be consumables and should be tangible in nature
whose services may be utilized, e.g. electric equipment may be
financed through an Ijara contract, but the cement can not be
provided through an Ijara contract.
Istisna Based Housing Finance Model
Istisna based housing finance model may be applied only in
case of construction of new houses or construction or renovation of
an existing house and the same cannot be applied in purchase of an
existing house and accordingly the scope of application of this scheme
is already limited as compared to other schemes.
Under this scheme the person willing to get a house
constructed must own the respective land. In this arrangement he
contracts such construction through an Islamic financial institution or
any other party willing to act in the capacity of the financier of the
transaction. Istisna model is coupled with either Parallel Istisna or
Murabaha on the other end based on the expected payment schedule.
Islamic bank may enter into Istisna contract for the construction of
house, the bank may enter into Parallel Istisna with the third party
(contractor) for the construction of house.
Istisna based financing transaction are quiet risky from the
financiers perspective because these entail the involvement of a third
party, i.e. the sub-contractor who has to play a very major role in the
transaction and from whom no guarantee or security can generally be
obtained nor the customer can guarantee his performance of contract
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as per the terms of the contract. As a result of such increased risk, the
Islamic financial institutions generally avoid such type of transaction.
In addition, because of fixed price, these contracts are subject
to the same risks as discussed earlier in case of Murabaha based model.
Diminishing Musharaka Based
Housing Finance Model
The most commonly used Islamic mode for housing finance
used by the Islamic financial institutions is Diminishing Musharaka.
This is also the most practicable and the one nearest to the basic
principles of Islamic Shariah. However, a new variant of Istisna cum
Diminishing Musharaka based model is nowadays being offered by
certain Islamic financial institutions.
According to this concept, the financier and the person willing
to buy the house participate in the joint ownership or Shirkat-ul-Milk
of a property. This joint ownership is commenced in any of the
following ways:
The customer already owns a home and wishes such

arrangements for some renovation work or
construction of some new areas. In this case the cost
of new construction or renovation is either fully
provided by the financial institution or is jointly
borne by the two partners in the pre-agreed ratio;
The customer owns a land and wants to construct a
house on the same. In this case the land is awarded
with a value and the construction cost is either shared
by them in agreed ratio or is wholly financed by the
bank; or
The customer wants to buy a completely built
housing unit may be a bungalow or a flat. In this case
the cost of purchase is jointly borne by the two
partners in the agreed ratio.
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FLOW OF TRANSACTION IN HOUSING FINANCE

DIMINISHING MUSHARAKA MODEL
BANK
(FINANCIER)
Purchase of Units over

the Musharaka Term
(In Ratio of JointOwnership)
INVESTMENT
(LAND OR 20%/30 %)
INVESTMENT
IJARA
RENTALS
CONSUMER
(BORROWER)
HOUSE
(JOINT- OWNERSHIP)
CAPITAL GAIN / LOSS /
EXPENSES INCIDENTAL TO
OWNERSHIP
(In the Ratio of Capital Investment
The Bank May Waive Capital Gain)
On the contrary, in certain schemes only the new portion or

renovation is covered under the joint ownership and the older
portions or the land remains in complete ownership of the customer.
Nevertheless, the financial institutions always endeavor to include the
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whole property in joint ownership in order to reduce their risks and

increase the value of the security.
Under the scheme the ownership of the house is divided in
units of equal amount e.g. Rupees One hundred each and it is agreed
at the inception of the agreement that the customer will purchase the
units of the share of the financier as per the agreed schedule.
Accordingly, his own share will continuously increase until all the units
of the financier are purchased by him and he becomes the sole owner
of the property. In this respect, the customer promises under the
agreement to purchase the units of the share of the financier according
to the agreed schedule.
Under this scheme, it is agreed that the risk and reward of the
property shall be jointly enjoyed by both the partners in their
respective ownership ratio. However, under various schemes offered
by various Islamic financial institutions practical aspects are a bit
different. In the ensuing paragraphs we wish to have a brief analysis of
such schemes.
The rewards from a property are in two forms. The first one
is its rental value that if it is given on rent to somebody, it will earn
rent for the owners although some deterioration in its value will also
occur correspondingly. The second type of reward, which may also be
considered as a risk in rare circumstances, is the increase or decrease in
the value of property.
Now we wish to briefly discuss the modus operandi of sharing
risk and reward during the term of Diminishing Musharaka, under the
various variants of this scheme developed and operated by various
Islamic financial institutions and approved by various scholars. It is
assumed that the joint ownership has given the property on rent to the
customer who allocates the rent due in the proportion of the
ownership of both the partners and retains his own share with him
whereas pays the portion corresponding to the financiers share to him.
As far as he makes routine payments of rent and purchases units of
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ownership from the financier the amount of rent payable by him to

the financier reduces correspondingly.
Rent shall ideally be agreed in accordance with the norms of
the locality in which the property is situated duly considering various
other factors e.g. distance to the markets and main roads and access to
transport and amenities etc.. However, most financial institutions
charge the rent as per their desired rate of return and link it with some
benchmark interest rate e.g. KIBOR with periodical review of rental
rates, which is although not considered to be good in view of its
resemblance with the interest-based transactions (may be called
Makrooh by a few jurists), nevertheless, the same has been allowed by
a number of jurists on the premise that setting the benchmark on
market interest rates do not change the very nature of transaction
which in substance and in form, remains of a rent transaction.
The second factor of reward, i.e. the sharing of accretion
(rarely decline) in the value of property depends on the initial
arrangement. The preferred arrangement which is included in certain
schemes is that the market worth of the property is evaluated on
suitable timing intervals e.g. 2 3 years and accordingly the units are
revalued or the number of units is increased in the proportion of
ownership of both the partners. It may be observed that generally the
price of property increases and accordingly this condition is eventually
in favour of the financier. In few other schemes, this factor is ignored
because the market price is generally fluctuating and determination of
actual market value at a given point of time is something difficult
coupled with the general culture of revaluation of property in vogue in
the country which is mostly unreliable except when performed by any
of a very few reputable revaluation firms. Moreover, this practice will
also result in additional cost of determination of market value.
Accordingly, this factor is ignored by mutual consent in most of the
schemes of housing finance. In such schemes, the unit price of the
property is fixed for the whole tenure of Musharaka which is allowed
by most of the jurists on the premises that this tantamount to
agreement between both the partners to waive the profit share in
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favour of other. However, in case of decrease in value, the same

should be borne in the ratio of capital investment.
As far as the matter of sharing the risks and losses is
concerned, the minor repair and maintenance is the duty of the
customer under the agreement as he uses the property, either directly
or by sub-letting the same. Any major loss shall be borne by both the
parties in their respective ownership ratio. However, if arrangements
are possible for insurance against major losses under the Islamic mode
i.e. Takaful, the same may be arranged by mutual agreement cost
whereof shall also be borne by both the parties in their respective
ownership (capital) ratio.
Now, from Shariah perspective, one more matter needs to be
clarified. It is pertinent to note that the matter of joint ownership and
the laying the joint property on rent (may be called Ijara) to one of the
partners and offering units of joint ownership for sale to each other
are all Halal transactions but these cannot be tied up with each other
and made conditional by one another. Accordingly, (i) the agreement
of joint ownership through purchase or construction; (ii) the
agreement of renting out the property to the customer; and (iii) the
promise for offering units of ownership financier should not be tiedup together in one single contract and made conditional to each other.
However, certain jurists allow that the joint purchase and the contract
of lease may be joined in one document whereby the financier agrees
to lease his share, after joint purchase, to the client. Moreover, it is also
mandatory that at the time of the purchase of each unit, sale must be
affected by the exchange of offer and acceptance at that particular date.
In certain schemes, in order to avoid the risk of late payments
and defaults by the customer and to safeguard the interest of the
financier, it is also stipulated under a separate promise by the customer
that if he does not make payment of monthly rentals due to the
financier within a stipulated time, he will offer for sale the units of his
ownership of the same amount to the financier. As an alternate it is
implicit in the agreement that in case of delay, a penalty may be
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imposed by the financier, which according to most of the jurists is not

permissible and should be paid to charity by the financier and should
be used only as a penalizing tool and not as a source of income.
It is generally included in the scheme that in case of default
for a stipulated time the joint ownership will come to an end through
sale of the property and distribution of amount realized in the
proportion of units of entitlement as of the date of such sale, whereas,
any rent payable may be deducted by the financier while making
payment of respective proportion of sale proceeds to the customer.
Arrangements, in a similar manner, may be made for
construction, renovation or purchase of factories, workshops, shops,
offices and other commercial properties, as well as, for agricultural
land etc..
Car Financing and Leasing
Car financing and leasing is another important area of
consumer financing. In this respect it would be worthwhile to discuss
the difference between car financing and leasing. In general, car
financing denotes for providing a loan to the customer for purchase of
a car. The terms and conditions for the loans are agreed between the
parties and the car is pledged as a security against loan if no further
security is available. If other suitable securities are available, the title of
car may be free of any encumbrance. Title and ownership of the car is
in the name of the customer from the very first day. However, in
certain schemes, as a matter of security, the car remains in the name of
the financier although the customer remains its owner. The customer
repays the loan along with interest thereon in accordance with the
agreed terms and conditions.
Car leasing (finance lease) is an alternate arrangement in which
the car remains in the ownership of the financier till the end of the
term and the customer pays a rental there against. However, it is
implicit in the agreement that at the end of the term, the ownership of
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asset will be transferred to the customer against at agreed sum, which

is generally equivalent to the security deposit, or without any
consideration.
Fortunately, a number of Shariah compliant models are now
available for car financing and leasing which are being offered by
various Islamic financial institutions in Pakistan. For car financing, the
alternate method is Car Murabaha whereas for car leasing, the alternate
is available under various Car Ijara schemes.
Details regarding Murabaha and Ijara have already been
discussed in the previous chapters, along with Shariah rules and
provisions applicable thereto.
Credit Cards
The credit card is one of the most important tools of
consumer financing in the modern banking world. Nowadays, the
plastic currency, which generally comprises of credit cards, although it
includes debit cards, charge cards and ATM cards, is day by day
increasingly taking place of the paper currency through out the world.
In the past few years, it has also strengthened its position in Pakistani
market as well.
The concept of credit card surrounds the benefit of spending
beyond your monetary limits and is accordingly, very much attractive
for the medium and low income class individuals. However, it also
offers a number of other benefits including avoidance of carrying cash,
enjoying various discounts and other schemes and meeting emergency
cash needs.
The schemes of credit cards as launched by various banks and
financial institutions are generally similar to each other. These schemes
envisage an annual fee, which is sometimes waived or discounted as a
goodwill gesture, service charges from the sellers (not from the users,
although certain sellers charge these to the credit card users) and
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interest on delayed payments which is the primary source of income

from these operations. Credit limits are defined according to the
financial position of the individual coupled with his credit worthiness
based on past experience with the banks and financial institutions.
In this respect, we have generally observed a
misunderstanding amongst a number of people, including practicing
Muslims, who are of the view that as far as you pay the dues on time
and no interest is charged, using a credit card is permissible from
Shariah perspective. A few Fatawa are also available in this respect,
which are based on the principle that if you do not intend to pay
interest, that part of contract is not valid from Shariah perspective.
Having said that, it needs to be recalled that signing a contract
stipulating conditions for application of interest is absolutely not
permissible under Islamic Shariah, bar any situation in which it is
mandatory and no alternate is available. Similarly, each and every time
you enter into a transaction using your credit card, in terms of the
agreement of the same, you are entering into an interest-bearing
transaction with a grace period of 45 or 30 days as applicable.
Moreover, it needs to be noted that by entering into such commitment
and by using that card, you are promoting that interest-based business
which shall not be a conscious decision of a conscious Muslim.
Accordingly, it may be concluded that using a credit card for any
reason except for extreme urgency or stressing need, should not be
deemed permissible under Shariah.
However, there are a few situations in which using a credit
card may be termed permissible because of its utility although even in
such case it should not be used unless necessary. These situations may
include the following, although, even in a few of such cases alternates
in form of debit cards and ATM cards are now available and should be
preferred over conventional credit cards, if possible:
Travelling abroad or out of city whereby cash may

not be carried;
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Payment on internet whereby other modes of

payment are not practicable, e.g. examination and
registration fees of various international educational
institutions and against necessary purchases on the
net;
Purchasing valuables e.g. whereby due to the present
law and order situation, it is generally not possible to
carry cash;
Extreme emergency situations whereby you own
some cash or valuables, but the money could not be
remitted to you at the time when you need that; and
Any other exigency, which may be termed as
compulsion, e.g. medical needs.
If, however, somebody does not has enough money or

receivables enabling him to make payment on due date, entering into a
transaction based on credit card is doing a transaction purely on the
basis of interest which may only be allowed in such extreme situation
of compulsion ( )where every Haram becomes Halal.
Certain Islamic financial institutions have developed alternates
to conventional credit cards on various Shariah compliant basis,
nevertheless, these have not yet been launched in Pakistan, hence
these are not being discussed in detail. Instead we recommend that
Muslim individuals should use the more appropriate and Halal
alternate to the credit cards that are generally available in form of debit
cards, ATM cards and charge cards.
Debit Cards, ATM Cards and Charge
Cards
In a debit card, charge card and an ATM card, the credit is
directly made to ones personal bank account maintained with the
issuer bank. All these cards are used as a means of payment and no
credit is involved therein and accordingly, no Shariah issue arises
therein. These are the best suitable alternates to conventional credit
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cards. jurists have considered it allowable for the Islamic financial

institutions to charge a reasonable fee against such services as periodic
charges (e.g. annual fee) or as per transaction fee. Further, the issuing
financial institutions may also obtain commission from the suppliers.
Personal Loans
Personal loans are generally obtained against two motives.
The first motive is purchase of assets, whereas, the second motive is
against expenditure. Generally, there are a number of Islamic finance
options available for financing all sort of assets including household
items and other necessities. These are provided under a number of
different schemes offered by Islamic financial institutions and are
generally based on the principles of Murabaha and Ijara Muntahia
Bittamleek.
The matter of personal loans against expenditure is quite
complicated. Preferably, only the option of interest-free loan or Qarde-Hasana should be used, if available, to finance any expenditure.
Ideally, the government, relatives and friends and welfare
organizations should provide such loans on an interest-free basis.
Keeping in view the fact that our society is not yet that much
generous in general, one has to explore other options also. In this
respect, the options available are a bit questionable from Shariah
compliance perspective; nevertheless, the same may be applied in the
situation of compulsion or Iztirar. These options include the options
of Sale and lease back under Ijara mode; buy back of assets and
Tawarruq.
The first option i.e. Sale and lease back under Ijara mode is
the most desirable option amongst these options as the majority of
jurists have allowed the same subject to certain conditions. Such
option shall, however, remain limited to such persons who have any
asset which can be sold to the financier (generally Islamic financial
institutions) and then obtained on Ijara basis. A simple example of
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such assets may be household furniture, personal vehicle and electric

or electronic equipment. Nevertheless, any consumable items can not
be made a subject of an Ijara contract.
Second option i.e. buy back of assets is not allowed by the
vast majority of jurists under normal circumstances. However, the
same is allowed by certain jurists only in case of Iztirar and the same
shall be available to such persons who have certain assets available to
sell them to a financier (generally a financial institution) at spot at cash
price and then repurchase the same on deferred payment basis under a
Murabaha or Musawwama contract. Assets subject to such contract
may be of any type and these may include consumable items.
Third option, which is also not allowed by a majority of jurists,
is Tawarruq which shall also be used in case of Iztirar only. Under this
arrangement, the financier will sell a liquid commodity, generally a blue
chip security, to the customer on Murabaha or Musawwama basis. The
customer will immediately sell the same in ready market to get the cash
required for his needs and will repay to the financier according to the
terms agreed under their mutual contract.
These options have been described here just in order to
apprise the readers that even in such cases of Iztirar; Shariah has
provided a few options which can not be directly termed as Riba.
Anyway, we should make all our efforts to establish a society in which
no such situation of Iztirar arises for any individual and even if such
situation arises, the financier does not take benefit of such need
through these transactions. May Allah bless us all.
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Chapter Eight
Interest-Free Financial Management
INTEREST-FREE FINANCIAL
MANAGEMENT
Most of the basic concepts of financial management in a
purely secular business move around the concept of time value of
money. In the Islamic Shariah the concept of time value of money is
denied at all. However, the utility of money is not denied and it has
been advised to spend and invest money in all lawful means according
to the injunctions of Shariah. At the outset we should first discuss the
concept of time value of money and its impacts on society.
Time Value of Money
The fundamental concept of conventional financial
management is the time value of money. According to this concept,
capital or money is considered to be a prime factor of production
along with the labour, entrepreneurship and land. In this concept, is
assumed that every factor of production has its worth and time value
i.e. in order to acquire any of these factors for some time you need
some consideration to be paid in some manner, whatsoever, generally
in form of money. Being more practical, two most important factors
that are worked out are the entrepreneurship and money, as the
practical examples suggest that when these two factors are combined,
other factors may be easily borrowed or purchased, as desired.
In this concept, the results of every financial transaction are
calculated in form of time value of money. You can term this concept
as a barometer for computation the results of a financial transaction or
a series of financial transactions. As a base of this concept, it is
assumed that money in hand has more value than any amount
receivable because the former one may be invested and might get
return during the time, accordingly, any amount receivable after some
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agreed time or after indefinite time shall not be considered equal to a

notionally equal sum of cash or cash equivalent already in hand.
Accordingly, all the theories of financial management circle
around the concept of time value of money and all the computations,
comparisons and analyses of financial transactions and series of
financial transactions are performed using the same barometer.
When we try to understand its background, we come across
the fact that the time value of money concept is purely based on the
concept that every sum of money in hand may be invested and acquire
some fixed risk-free return thereon and all the economic factors
support this presumption in a capitalist society, although sometimes
the theoretical and actual rate of return are quite different. In other
words, this whole theory is based on the interest, as it always
anticipates accretion in cash and decrease in the value of receivables
based on the interest or discounting factors.
Since the very basic foundations of this concept are based on
interest, therefore we cannot accept it as the prime concept of an
Islamic financial management system. More importantly, a general
misunderstanding observed amongst a number of conscious
Muslims is that they feel that every form of return on investments
based on time value of money resembles to interest and should be
considered Haram. This is the reason that a number of people feel that
Murabaha and Ijara along with many other forms of Islamic finance
should be considered Haram because these ensure a fixed return based
on the time value of money concept as similar to the identical
financial products in vogue in the secular economic system.
At this stage, it would be pertinent to discuss the system of
time value of assets which is the alternate to this concept in an
Islamic financial system.
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Time Value of Assets

We all know that any form of interest including accretion or
discounting of receivables based on the time factor, is not Halal from
the Shariah perspective. Nevertheless, we should also appreciate that it
is permissible to charge for the benefits obtained from use of or
availability of assets and goods. And this idea is the basis for the
concept of time value of assets or goods. Any rent, Ijara or Kiraya are
permissible from Shariah perspective beyond any doubt. Only the
Kiraya for land and houses is questioned by a very negligible number
of jurists, based on certain Ahadith, although those allowing these also
have sought guidance from other Ahadith. On the other hand, getting
benefit of goods by purchasing them on a higher price with deferred
payment, or purchase at a lower price on the basis of delivery at a
future days are all allowable situations from Shariah perspective.
Now we should compare a Murabaha transaction carried out
as an Islamic financial instrument, with an interest-based transaction.
Besides many other conditions and rulings that distinguish a Murabaha
from a financing transaction, the basic difference between the two is
that in case of interest, the accretion is against availability of a specific
sum of money during the tenure of loan. On the contrary, in
Murabaha, the mark-up is against the availability of asset at an earlier
date so that the person purchasing the asset becomes able to get the
benefit of such asset.
Similarly, although an Ijara Muntahia Bittamleek is quite
similar to a loan repayable in installments or a conventional finance
lease, but the additional amount which is being paid is against the
benefit or usufruct of the asset, whereas many other Shariah
conditions make it different from the conventional installment loan or
a finance lease.
Being prudent one should always try to avoid anything
suspicious or for which he might has doubts in mind. Nevertheless,
nobody has the right to proclaim something Not-Haram as
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Haram. The objective of this debate is not to prove that Murabaha

and Ijara Muntahia Bittamleek are perfectly Shariah compliant
transactions. We know that because of being of a fixed-return basis
and to some extent being resembling to Riba these should be avoided
to the maximum extent possible and the profit and loss sharing modes
should be used to the maximum extent possible, but this would be
Taqwa, not Fatwa, because most of the Shariah scholars have
consensus on permissibility of these instruments, subject to strict
adherence to the rules applicable thereto.
Time Value of Money as a
Performance Measurement Tool
As discussed earlier, the time value of money concept is also
used as a performance measurement tool or as a tool for pricing of
financial instruments and transactions. This is the concept where it is
just applied theoretically in order to work out the real gains and losses
of a project, investment or loan.
Most of the Shariah jurists have allowed the Islamic financial
institutions to market their products on the pricing models very much
similar to those used by the conventional banks. For example, an Ijara
Muntahia Bittamleek transaction introduced by an Islamic financial
institution might be very similar to a finance lease transaction offered
by a conventional leasing company, except for a difference of Takaful
/ insurance cost which in Islamic mode is to be borne by the lessee
and accordingly, the same is built-in the rentals. Similarly, in a housing
finance based on diminishing Musharaka model, the overall cash-flow
model will be quite similar to that of a housing finance scheme of a
conventional bank (except where in certain Islamic models, the house
is revalued on suitable intervals).
The basic reason behind this similarity is to ensure three
objectives. The first one, which is more important one, is to provide
an even playing ground to the Islamic financial institutions in order
to ensure their survival in the overall banking system. The second one,
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is that even by Islamic financial institutions, it has to be ensured that

their shareholders and depositors get some return and preferably a
return equivalent to those of conventional banks. And the third reason
is to avoid arbitrage amongst Islamic and conventional financial
systems which may be exploited by a few big-guns to get the benefit of
the pricing difference between the two parallel financial systems. For
such reason, time value of money concept is used for performance
measurement and pricing of financial products.
The objective of this discussion was just to emphasize that
merely an amortization schedule similar to the one offered by a
conventional bank, is not a basis for declaring a Halal product to be
Haram. If just a pricing model or just the similarity of a cash-flow
model makes the transaction Haram, what you will say regarding a
conventional loan offered at a price much higher or much lower than
the market prevailing rates for which the pricing model and the cashflow model are not similar to those generally applied in the industry.
Does anybody think that such dissimilarity will make it Halal?
Accordingly, from Shariah principles it is rightly concluded that it is
the substance of a transaction what makes it Halal or Haram and not a
pricing model used to price the transaction or the cash-flow model
used for the payments and repayments in monetary terms.
Here it would be worthwhile to have a look on another
example for better understanding of the pricing issue. Suppose you
enter into a supermarket in UK and see that the pork, the beef and the
Halal beef are all being sold for GBP 2 per kg. Do you think that this
similarity of price or the fact that these products are being sold under
the same roof renders the Halal beef as Haram? If not, then we should
better understand the principle that it is the substance and form of the
transaction that makes it Halal or Haram and not its pricing, rate or
the cash-flow model or the institution that offers such transaction.
Similarly, even as an entrepreneur or as an individual willing to
obtain loans under Islamic modes, you have full right to compare the
pricing mechanism and the cash-flow models being proposed by the
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respective financial institutions in order to ensure as to whether these

are at competitive rates or not.
Due to the same reason, most of the Shariah boards have
allowed the respective Islamic financial institutions to engineer their
products even on the basis of floating rates etc. which may even be
subject to the interest rates benchmarks issued by the central banks or
the rates prevailing in the international market e.g. LIBOR or KIBOR.
It should be kept in mind that floating rates options are available in
leased based products only whereas in case of Murabaha and other
trade-based modes, each transaction may be subject to these
benchmarks prevailing as of the date of such transaction, nevertheless,
one the transaction is consummated, and the payable amount cannot
be changed. In certain profit and loss sharing based transactions, the
Shariah scholars have also allowed to set benchmarks (for sharing of
profits only) according to the prevailing market rates e.g. deciding that
the profit over and above a fixed benchmark will be divided in a
proportion different to the normal profit sharing ratio.
Similarly, the financial management decisions to be made by
the management of an enterprise may be made using the time value of
money concept, using it as a performance barometer or pricing tool.
Managing Finances Why and How?
Management of finances is a key to success of a business.
Although marketing, quality of products, and innovation are generally
considered to be the keys to success of business by various schools of
thought, nevertheless, it can easily be observed that the number of
businesses that have been failed due to inadequate financial
management is the highest as compared to the above factors.
Particularly, there are instances whereby certain mammoth business
empires failed even if all the three factors other than the financial
management were considered to be adequate. As a most recent
example you can consider the American energy giant Enron, which
was one of the Americas 10 largest companies and for consecutive
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many years was awarded as the Americas most innovative company.

The failure of Enron was an evidence of poor financial management
coupled with a fraudulent misreporting of financial statements, which
when identified, compelled Enron to declare itself to be bankrupt and
eventually resulted in a fall of that empire.
Accordingly, it may be concluded that the marketing,
innovation and the product quality, all are dependent on adequate
financial management for the success of a business, failing which
results in an anticipated disaster unless and until the other factors are
super normal. On the contrary, it has been observed that adequate
financial management coupled with just below average marketing,
minimal innovation and average product quality, resulted in success of
various businesses.
Before going into details of the topic, at the outset, it needs to
be clarified that the present financial management theories have been
imported directly from the West and these need to be studied by our
respectable scholars in order to ensure their desirability and
permissibility for Muslim world. This aspect, sadly, still appears to be
unaddressed.
Working Capital Management
Working capital management is generally a tough task for a
businessman. In working capital management, the prime objective is to
maintain liquidity of a business by ensuring the most effective and
efficient utilization of resources, financing facilities and funds available,
as well as, stretching to the maximum extent possible, the liabilities to
the maximum credit period available.
Working capital management is performed in various areas
with different techniques and approaches. The most significant areas
in this respect are the main areas of a business cycle i.e. Customers
(debtors), Suppliers (creditors) and the inventories and production
cycle. Generally, the short-term financing facilities are also considered
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to be a part of working capital cycle and their effective management is

also considered significant in this area.
Effective and efficient working capital management emerges
as more important, if the business is being run under the principles
defined by the Holy Quran and Sunnah. In the ensuing pages, a few
basic facets of working capital management under Islamic principles
have been discussed. Anyway, since, the utilization of financing
facilities is primarily dependant on the effectiveness of other aspects of
working capital management; the same need not be discussed in detail.
Debtors Management
Debtors management, which generally denotes the
management of receivables from trade debtors, is a key element for
effective working capital management. We all know that a delayed
payment by a debtor would result in an opportunity loss. This
opportunity loss is not allowed to be recovered from the customer
because it will tantamount to Riba, but the same may be avoided to the
maximum extent possible for improved business performance. A
delayed debtors collection period is an indication of a possible failure
of a business. In this respect, the first and the foremost issue is prompt
debtors recovery through an effective sales coordination and followup.
We know that once the sales price is determined it cannot be
changed i.e. no interest or additional charges may be levied if a debtor
delays (even intentionally) a payment. Nevertheless, most of the jurists
have ruled that it case of Islamic financial institutions, in order to
avoid intentional defaults, a self-imposed penalty may be stipulated in
the respective terms of sale, but the same should be paid in charity.
However, discount or rebate may be given at the sole discretion of the
seller.
In order to manage your working capital in an effective
manner, you may arrange Murabaha, Salam or Istisna arrangements
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with Islamic financial institutions, who will first buy your products on
cash payment and then sell these to your customer on extended credit
terms. However, for these financial products, it would be necessary for
all the concerned parties to ensure that the relevant Shariah
requirements are fulfilled. In case of Istisna and Salam you may also
obtain advance from the bank which will provide you further flexibility
in your working capital management, particularly in Salam whereby the
whole sum is required to be paid at spot, at the time of entering into
the contract.
It is also pertinent to discuss a common issue in our
traditional markets. Generally, while making purchases on credit basis,
particularly in retail and wholesale markets, the description of goods is
mentioned but the rates are not finalized and these are finalized at the
time of settlement. Generally, this is because of the sellers intention to
get the benefit of day by day increasing rates of commodities or to
ensure that lesser discount is offered if the actual payment is made
within a few days. In this respect it should be clear that once the title
and possession of goods is transferred, the sales transaction stands
consummated and accordingly, from Shariah perspective, it is
pertinent to finalize the rates at this very moment which shall never be
changed, failing which will make this transaction unlawful or even
Haram. However, as discussed earlier, most of the jurists allow that
the seller may later give any prompt payment discounts and rebates at
his own will without any mutual contract.
An alternate to the same is allowed in form of Bay Istijrar. In
this option, a seller and the customer agree that they will buy and sell
goods in routine according to some pre-agreed benchmark. As an
example they can agree for the market rate or a price with 10 percent
discount on the market rate. This option is allowed by most of the
jurists subject to the condition that there remains no ambiguity or
Gharar in the transaction. In the given example, if they have agreed at
a price equivalent to the prevailing market rate and the credit period as
one month from the date of taking delivery, such rate should be clearly
known and identifiable. Any negotiation after the sale is not allowed
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in Shariah because it becomes a negotiation on a debt and not on the

price. However, as discussed above, discounts may be allowed at this
stage at the absolute discretion of the seller and these shall not become
a practice.
Bills Discounting or Factoring
In debtors management, bills discounting is an area of prime
significance in the conventional financial management. The basic
concept behind this theory is the fact that if the amounts are stuck in
debtors for long periods and the enterprises own rate of return on
capital is higher than the rate of interest prevailing in the market, it is
beneficial for the business to get these bills discounted through banks
or other financial institutions, in order to ensure availability of required
liquidity.
Similarly, with the companies having adverse financial ratios, it
is sometimes difficult to obtain further financing and the only option
they have available for obtaining financing without further disturbing
their financial ratios is to get the bills receivable discounted or sold.
Generally, bills discounting is more important in case of
export sales whereby sales are made against Usance L/Cs and the
amounts are expected to be realized at a fixed time in future. During
the time of blockage of funds, the enterprise might be in need of
money and such need is fulfilled through discounting of bills.
Another area, whereby bills discounting or factoring option is
needed, is the area of retail or wholesale sales where the amounts are
stuck with the customers due to the nature of the industry. Generally
the wholesalers and retailers have a practice of not making the
payments unless they have made full sales of the goods or even unless
they get the new consignment. Even worse, a number of these guys do
not even bother to pay the money as they have a practice of financing
all their needs on the money of the suppliers, or in other words they
have a practice of maintaining sufficient credit from their suppliers.
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Similarly, in certain receivables form the government departments and

autonomous bodies there is a practice of delayed payments, due to the
prevailing culture in the country. Such a practice, by any means, is not
in compliance with the Shariah requirements.
In this respect, generally the option of commissions and
discounts are used and instead of banks and financial institutions,
individuals and service organizations are hired to perform such
services. Particularly, in case of the culture prevailing in Pakistan it is
least potential for banks and financial institutions to indulge in such
dirty sort of business.
From Shariah perspective, the matter of discounting of bills,
as prevailing in the conventional financial markets is not permissible at
all, being a kind of Riba. However, there are certain options available
as an alternate of the conventional bills discounting and factoring
products. In the ensuing paragraphs we shall discuss these options for
various kinds of bills receivable.
Export Bills Discounting
Export bills discounting is widely being used in Pakistan by
most of the exporters. Generally, the exporters have a practice of
depending on two forms of financing. The first one is the export
refinance, whereas the second is discounting of export bills receivable.
Particularly, in case of textile and garment exporters, these two types
of financing are considered sufficient and these fulfill their most of the
financing needs.
The most practicable model that may be used by the Islamic
financial institutions in bills discounting is a complex transactions and
even then, it does not fetch any material return. Under this option, the
bank may provide an interest-free loan to the customer in foreign
currency, equivalent to the amount of foreign currency bill receivable
after a given period. Such loan amount may be paid to the customer
after converting the same in the local currency at the rate prevailing at
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the date of transaction. The bank simultaneously enters in a promiseto-sell the foreign currency in the forward currency market at a rate
which is generally higher than the spot rate prevailing on that date.
The difference between these two rates is the profit earned by the
bank on such transaction. When the export proceeds are received the
bank may receive the same directly and adjust against the loan to the
customer, and then sell these at the pre-agreed promise-to-sell rate. As
an alternate, the bank may go for a risk and reward situation if it is
expected that the foreign currency rates are expected to rise in future
and in such case no promise-to-sell may be entered into and instead
such currency may be sold in the open market once the export
proceeds are realized.
It is also pertinent to note that certain Islamic financial
institutions are using the option of Salam of currency in a similar form
of transaction, which is not permissible in view of the most of the
jurists whereas, only a few jurists in the sub-continent have allowed
this on the premise that the paper currency is considered to be
Thaman Istilahi and not the Thaman Haqiqi.
Second option in this respect which is rarely used by the
Islamic financial institutions is to transfer such debt at an equal
amount and obtain nominal service charges, which are fairly equivalent
to the actual amount of expenses incurred or estimated to be incurred
on such transaction.
General Bills Discounting
Two options are generally available in Islamic finance against
bills discounting. In the first option, the amount of debt needs to be
transferred to the financial institution in exactly equal amount. It
means that a debt of Rs. 100 receivable after 1 month should be
transferred against an equal amount irrespective of the time of
payment by the bank to the customer in accordance with the Shariah
principles of Hawala (). In Hawala, the bank has recourse
available to the customer in case the eventual debtors do not make the
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payment. In view of the same, the banks are allowed to obtain

securities from the customers to make good their loss on account of
default.
Jurists have allowed the banks to charge service charges on
these transactions only to the extent of actual or reasonably estimated
expenses incurred by them on account of documentation,
administration and recovery. Such service charges do not include any
risk premium or notional cost of capital or opportunity cost and
accordingly these are generally very nominal. You might note that this
situation is against the interest of the bank and consequently, most of
the Islamic banks do not enter into these transaction.
Juala
The second option that may be used as an alternate to bills
discounting is called Juala (). Juala is a contract in which one party
undertakes to give a specific reward to anyone who may be able to
realize a specific or uncertain required result. Juala is an exception to
the general business contracts whereby uncertainty is not allowed
whereas Juala is not affected by uncertainty with regard to the subjectmatter of the contract, i.e. the work to be done. In a Juala contract it is
sufficient to determine the required outcome of the transaction.
In a normal Juala based bills discounting transaction, the
customer negotiates the bank for performance of an uncertain work i.e.
recovery of its bills receivable or general debtors, in a specified time
for an agreed reward. The bank agrees to perform work after
conducting a cost versus benefit analysis and a Juala contract is entered
into between bank and customer. Then the bank decides either to
perform the work by itself or to find a worker who has expertise to
perform such an uncertain work on its behalf and a parallel Juala
contract or a work contract (based on fixed fee or service charges) is
made with him.
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The work is completed by the bank or by the worker and an

agreed fee or reward is paid to him by bank, whereas the bank collects
his reward from the customer with whom an initial Juala contract had
been entered
In a Juala transaction, the indication of the task, duly involving
some effort, and the reward is necessary. Similarly, the reward should
be known valuable and a permissible consideration and it may or may
not be portion of the realized result. As an example, the bank may
agree that if it recovers full amount then it will be entitled for 3
percent of amount received and if it recovers 80 percent amount, then
it will be entitled for 2 percent of the amount recovered, and so on.
In Juala, there is an option that the reward may be paid in
advance in full or in part before completion of work, however in such
case the worker shall not be absolutely entitled for reward until the
required result would be realized and therefore, such payment shall be
refunded by him if he cannot fulfill the requirement. There are certain
further Shariah requirements that need to be complied at the time of
entering into a Juala contract.
This model generally works with a simultaneous interest-free
loan contract through which the bank pays the amount of need to the
customer at the inception of the transaction and instead of receivables
being sold to the bank; these are just held as security against such loan.
On the other hand, the bank earns the reward on the Juala contract
against recovery from debtors. Like any other complex Islamic
financial product, it is necessary that the agreement for these
transactions should not be linked to each other. Unfortunately, the
Islamic financial institutions have not yet commenced offering this
product in Pakistan.
Securitization of Receivables
In the organized service sectors, another practice is used
which is nowadays becoming more common in Pakistan. Under this
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practice, the organization sells its current or future receivables or both

to a financial intermediary or a special purpose vehicle (SPV) and
obtains cash there against at the very inception of the transaction. The
equity of such SPV is contributed by a consortium of financial
institutions or even may be subscribed by the general public.
Sale of current receivable is allowable in Islam in only one
condition, i.e. the sale proceeds are equal to the amount of receivables
without any discount or markup. However, in a Shariah compliant
securitization model, an SPV may be hired as a worker in the Juala
contract and the securitization may be performed under the mode of a
Juala contract, with a simultaneous interest-free loan contract, as
discussed above.
Securitization of Future Receivables
Securitization is more often used for sale of future receivables
of service providers. However, under Shariah principles, sale of future
receivables is not allowable at all, because a receivable that do not exist
as of the given date can not be transferred even at an equal amount.
Yet, there are alternate options for sale of future receivables in form of
sale of capacity, space, scope and functions. As an example, if a
telephone service provider is willing to sell its future receivables
amounting to Rs. 100 million to an SPV, such service provider may
identify a telephone exchange or a region whose total revenue for a
given period of time is equivalent to Rs. 100 million and then agree to
sell such capacity to the SPV for a discounted amount, say Rs. 90
million. It would, however, entail the risk of profit or loss which is the
essence of a Shariah compliant product.
Accordingly, during the given period, all the revenues earned
by such exchange or regions shall be assumed to be earned by such
SPV and any gain or loss thereon i.e. any excess or shortfall against the
amount of Rs. 90 million shall be the profit or loss of the SPV. While
finalizing the transaction the financial managers may include the risk
premium in the amount of sales. Similarly, an airline may go for selling
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a particular route or a given number of seats of an aircraft.

Accordingly, for all sort of service providers, securitization of future
receivable or rather future services is a practicable option for raising
funds for their needs.
Needless to mention, the engineering for securitization
transactions is a bit complex and involves legal and financial issues and
accordingly, it is always advisable to obtain adequate advices and
opinions from legal, corporate and financial consultants.
Inventory Management Stock Level
Control
Second key element of working capital management is the
management of inventory, predominantly the stock levels. Particularly,
in a manufacturing industry, it has more significance because in such
an industry, a number of stock items are not in a saleable condition,
including raw and packing materials and work-in-process.
Consequently, the stock holding costs including the physical costs, as
well as, the borrowing costs or the cost of capital is more significant in
a manufacturing business.
Generally the stock level controls have been developed by
various experts in different ways that are suitable for most of the
businesses. Following is a brief of the general techniques used by
various industries for management of stock levels:
Minimum Stocks Approach Under this approach

the enterprise plans to ensure that all the stocks and
inventories are procured in a minimum quantity. This
approach is generally not feasible for large businesses
and businesses where the lead time for procurement
is on the higher side. This is considered to be the
most suitable method for retail businesses;
Economic Order Quantity Approach Under this
approach, an enterprise plans for the minimum stock
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levels, maximum stock levels, and economic order

quantity, for each inventory item, based on a formula
depending on various factors including the holding
costs, order costs and lead time. This approach is
considered to be the best on a long-term basis for
medium sized enterprises. Particularly, this approach
do not mandate a comprehensive use of computer
software and may easily be applied manually;
Material Resource Planning (MRP) Approach
Under this approach, an enterprise plans for its
material use for a future period, generally on an
annual basis and accordingly, all procurements are
made in a planned manner. Various factors of cost
saving are considered in this approach. Nevertheless,
this approach generally requires good computer
software at the back end, in order to ensure that the
maximum benefits are reaped out of this approach.
This is the best approach for trading enterprises who
use their sales forecast as the prime basis for this
approach;
Manufacturing Resource Planning (MRP II)
Approach MRP II, is an advanced version of MRP
which is suitable for manufacturing industry and
similarly also requires some good computer software.
This approach is a bit complex because it commences
from the sales forecast and after taking into account
the proposed stock levels, production details and
estimated sales, it manages the procurement plan.
For this purpose, it requires a good budgetary control
in the enterprise, which is a by-product of this sort of
system. MRP II is now the most commonly used
stock managing approach for the manufacturing
concerns;
Just In Time (JIT) Approach In this approach,
which is basically developed by Japanese
manufactures, the overall objective is to ensure a zero
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inventory. The motto of this approach is to procure

when you need. In this approach, the procurement
plan is strictly in accordance with the manufacturing
plan and eventually with the sales forecast or the sales
orders. This is the most advanced approach for
managing inventories, nevertheless, it can not
function properly in most of the environments,
particularly those of countries like Pakistan where the
procurement lead times are really significant
(particularly keeping in view the import process) and
even then the deliveries are not guaranteed. Anyway,
this is the most beneficial method for enterprises
involved in manufacturing of machinery units,
vehicles, and major projects.
Any of the suitable methods may ensure that the enterprise
does not pile more than required level of inventories and eventually
results in savings in holding costs including physical storage and
borrowing costs.
The best practice that can be applied for ensuring adequate
working capital arrangement is to enter into suitable credit terms
agreements with the suppliers or to fix Murabaha arrangements for
terms equivalent to the normal inventory days-in-hand period. This
will ensure maximum utilization of the enterprises resources. Anyway,
in case of stocks, generally the Murabaha is the best available form. As
an alternate, options like Salam, Istisna or Istijrar may also be used
depending on the nature of business, as well as, the nature of material
to be procured.
Creditors Management
Managing creditors is the third important aspect of working
capital management. As a thumb rule, as long as you can stretch the
repayment time, it is better for the business because you are saving
your cost of capital. It may be evidenced that a few companies that are
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working at a minimum capital and even without borrowings of a single

penny. They are just doing their business against suppliers credit of six
month, irrespective of as to whether the suppliers have included the
premium for this credit period in the product price. In presence of
such credit, generally, they dont need any borrowings or even to
invest their own capital in order to meet the day to day business needs.
However, this was just an example and not a practical
situation for most of the companies, particularly those in
manufacturing business. From Shariah perspective, the basic idea that
can be derived in this manner is that if you need financing for working
capital, first try to negotiate with your suppliers. It is quiet possible
that you might need to sacrifice the prompt payment and cash
discounts and rebates that they were previously offering to you, or
even to pay more than the cash cost. Even then, if you can manage to
arrange it, you might not only save some bucks at the end, but might
also get rid of interest-bearing borrowings.
Another important tool relating to creditors management is
the use of Istijrar arrangement or cyclical Murabaha arrangement. In
such a case, you may arrange that all the supplies that you want to
purchase are first purchased by an Islamic financial institution and
then sold to you on a Murabaha basis at a price including mark-up
against the extended credit terms. This way you may easily get rid of
interest-bearing working capital loans and running finances.
Needless to mention, it is strictly prohibited in Shariah to
contradict a contract you have earlier made. You may recall that
according to a Hadith, not fulfilling the commitments is an indication
of Hypocrisy or Nifaq (). This means that if you have committed
to make a payment within thirty days, then not only ethically, but
literally religiously, you are required to fulfill your commitment.
Nevertheless, this is observed to be a general practice in the business
world that the customers try to avoid payment day by day through
false commitments and statements, as well as, by threatening against
loss of future business.
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This overall approach is against the basic injunctions of

Shariah and should be avoided and all the payments to the suppliers
and contractors should be paid immediately when due. In any case, an
additional payment against late payment is not allowed in Shariah.
Even if it is included just as a penalty, preferably a self-imposed
penalty, to discourage late payments, the same should be paid in
charity by the person who receives it.
A similar issue relates to the delays in payments to the
employees. From Shariah perspective, it is a must to pay the dues of an
employee, either on contract or on permanent basis, immediately when
these become due as per the terms of contract and any delay therein is
unlawful and against the very basic injunctions of Shariah.
Equity Financing
Logically the equity financing is the first issue in establishing a
business. From Shariah perspective, the equity financing may be based
on only one principle i.e. the profit and loss sharing. Profit and loss
sharing basis have two styles i.e. with active participation and without
participation.
Equity Financing on Musharaka Basis
Profit and loss sharing with active participation or right of
participation in business is, as discussed earlier generally called Shirkah
or Musharaka. Partnership and common shares of companies are
different forms of Musharaka that can generally be used for equity
financing. Nevertheless, in any form of Musharaka, all the partners
have the right to interfere into the business activities and particularly
the decision making either directly or through their agents (managers
and directors). Accordingly, it is never advised by the experts of
strategic financial management to acquire most of the capital through
this system i.e. through common shares or partnership capital.
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Partnership capital may be obtained from friends, relatives

and peer businessmen. Similar are the sources for subscription of
common share capital for limited liability companies. However, for
major companies, these shares are listed and are further subscribed to
the general public, as well as, the financial institutions.
Obtaining capital on either of these bases has two major setbacks. The first one, as discussed earlier is the fact that in such a case
all the partners and subscribers have the right to interfere in the
business affairs and decisions, either directly or through agents
(directors). This situation may eventually cause difficulties in running
the business and even might result in hostile takeovers. To avoid this
risk, in the partnership deed and articles and memorandum of
association, different rights may be assigned to different types of
capital in order to avoid these issues to the maximum extent possible.
The second issue in this form of equity financing, from
financial management perspective, is the fact that anything paid in
servicing of such equity is not tax deductible for the business and
eventually the cost of capital turns out to be on the higher side. These
rights etc. should, nevertheless, be in compliance with the Shariah
requirements.
Equity Financing on Modaraba Basis
The second option for equity financing is the Modaraba basis.
Modaraba is actually a dormant partnership so in case of a partnership
or entrepreneurship, it is a very effective tool. However, it is the
agreement that counts because a number of matters are supposed to
be based on the Modaraba contract. Such contract should, however,
be in compliance with the Dos and Donts for Modaraba.
The companies may currently obtain Modaraba financing
from banks and other financial institutions, as well as, from individuals
through issuance of redeemable capital or under various forms of
long-term Modaraba financing contracts. This is the direct method of
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obtaining Modaraba financing for companies, which has one very

important factor i.e. these all finances are repayable, or in other words,
all such Modarabas are for limited term.
As far as the permanent Modaraba financing for companies is
concerned, currently it is a bit typical or rather complexly engineered.
This mode is provided under the Modaraba Companies and
Modarabas laws. Under this mode the company has to register itself as
a Modaraba management company or has to form a subsidiary or
associated company for the purpose. If it does not want to get into
such hassle, then it has to contact an existing Modaraba management
company which should ideally be managed by a financial institution.
Such Modaraba company will then form a Modaraba, which
will provide finance to the first company under any approved mode of
Islamic finance.
Permissibility of Preference Shares
Preference shares are issued by companies under various
schemes. The most common structure of their issue is that these carry
a fixed dividend which is subject to profits of the company and is
accumulated for the periods during which an enterprise suffers losses
and the accumulated sum becomes payable whenever the company
gets in profits again. Generally they do not have any right to
participate in the business affairs of the Company.
These were allowed in the original Companies Act of 1913
(the inheritance of English rule on British India) whereas the same
were not allowed in the Companies Ordinance, 1984 (enacted under
General Zia ul Haqs regime). Only a few companies who had
originally issued them prior to 1984 used to have preference shares in
circulation. Since last few years, these are once again allowed to be
issued (probably an evidence of American rule instead of the British
one) and a few companies have just commenced to issue them.
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The Shariah conclusion regarding preference shares under all

the common models is divided. A few scholars render these to be to
be Haram beyond any doubt because these carry interest, with a
condition that in case of loss such interest will not be paid or the
principal might also get lost. Others are of the view that since these
profits (irrespective of being fixed or cumulative) are paid out of
profits only, hence, these are permissible though not preferable.
Another matter that this second group ignores is the matter of
preference, i.e. in case of losses and liquidation of a company, they get
preference over the normal shareholders, which is against Shariah
principles i.e. losses have be borne by the partners in proportion to
their capital investment. Another principle which is ignored is
regarding the profit sharing ratios, which according to most of the
jurists, can not be higher than the capital investment ratio of the
dormant partners. Needless to mention, that the preference
shareholder, by all means, are dormant shareholders while common
shareholders are working partner through their agent.
In view of the above discussion, it may be concluded that
preference shares may be declared Halal or Haram, not by name but
by a careful analysis of the legal structure and the rules governing these
shares.
Modaraba Preference Shares A
proposed Model
Still there is some food for thought for the corporate law
experts that they may devise a model of preference shares based on
Modaraba concept. These may also be termed as Permanent
Modaraba Shares. In such a proposed model, the preference shares (by
whatever name called) may carry any weightage in the profits of the
Company (but not exceeding the weightage of their capital to the total
capital) and would be sharing loss in the proportion of the respective
capital. These may and may not be listed. Their sharing in business
may be restricted to a special project or may comprise of the whole
business. In case of a limited project, it would be permissible to give
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them preference over the normal shareholders, which would ideally

not be possible in case of partnership in the whole enterprise.
We feel that the issuance of this sort of shares would be in the
benefit of the owners, as they might not want anybody to interfere in
the business matters. This will obviously also be in the benefit of the
investors who want to invest in Shariah compliant modes only. More
importantly, these will not be repayable like any form of redeemable
capital or financing from banks and other financial institutions.
Similarly, these may be transferable to any other person like ordinary
shares and may be traded in the capital market or even used in the
money market for security based instruments.
Long-Term Financing
The options for long-term financing are generally available in
most of the forms of Islamic financial instruments. Such arrangements
may be obtained by any business from the Islamic financial institutions,
as well as, the general public under any of the approved modes of
Islamic finance. For ease of reference, we may divide these in two
basic types i.e. redeemable capital and long-term financing. The
difference between these two basic modes is that in the first one i.e.
the redeemable capital, security instruments are issued which are easily
tradable and even sometimes these are listed on stock exchanges.
Whereas, the long-term financing are based on contracts and are
generally not transferable.
The most common mode currently used for redeemable
capital is issuance of Term Finance Certificates (TFCs). However, as
discussed earlier, mostly the TFCs issued in the country are not on a
Shariah Compliant basis.
Other options of redeemable capital include Musharaka TFCs,
Participation Term Certificates (PTCs) and Musharaka Certificates.
Details regarding these options have already been discussed in
previous chapters.
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Short-Term Financing
Conversion of short-term financing on Islamic principles has
proved to be the most crucial and complex for the purpose of
conversion of businesses on Islamic principles. It is because, generally
the options of short-term finances and overdrafts (running finances)
are very easy and practicable in the conventional banking, whereas in
case of Islamic banking, although a number of alternates have been
developed, these are not considered to be an easy alternate to the
conventional options.
Conventionally, the matter of running finances is dealt with by
determining a credit limit and an interest rate. Once these are mutually
agreed, the bank provides on open opportunity to the customer for
operating such an account just similar to a current account and the
financial charges are calculated on the basis of daily product balances.
Similarly, once the customer determines that his working capital needs
are somehow fixed to a minimum limit, he has an easy option available
to interchange these running finances with short-term loans and bridge
finances with comparatively lower rates of interest.
In contrast thereto, in Islamic modes of financing, the
alternates available for the purpose are not easy to operate. Generally
the first and the foremost used option in this respect is considered to
be the Murabaha. However, the term for Murabaha is always fixed and
accordingly it is not a real alternate to the running finances. Similarly,
its rate once fixed, cannot be changed and accordingly, it is not
comparable with the benefits of the running finance from business
perspective.
The only option which is available for running finances is
Musharaka based on daily product balance. In this model, the bank
and the customer become partner in the business pool of the customer
and profit thereon is distributed on the basis of computation of the
daily product balance of the contribution of the bank, as well as, the
customer in the respective pool. Nonetheless, this option is not very
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easy to use and requires complex computations, as well as, mandates a

timely and accurate financial reporting system of the customer.
Moreover, this also requires honesty and fairness in the financial
reporting by the customer. In view of these difficulties, this model is
rarely used by the Islamic financial institutions as an alternate to
running finance and short-term loans and accordingly, most of shortterm financing is made by them on the basis of Murabaha.
Sources of interest-free financing
Following are the general sources available for obtaining
interest-free financing:
Family and friends;

General public; and
Islamic financial institutions.
Family and friends

The first source that is generally available for interest-free
financing is the family and friends. In this respect the Muslims are
encouraged to provide Qard-e-Hasana to their relatives, friends and
even to general public if they have enough resources available.
Particularly, in a Hadith, it is made obligatory to lend Qard-e-Hasana
with regard to a person in need asking loan on such basis, for the one
who has sufficient funds available with him. This is the reason that
resulted in development of a school of thought which is against the
Modaraba, Muzaraa and Ijara or any other lending of assets or money
with return thereon irrespective of the mode of return, on the
principle of mutual cooperation.
In this respect, the majority of the jurists is of the view that it
is always preferred to lend money and assets on the basis of mutual
cooperation. Nevertheless, there is no bar on lending the moneys and
assets on any of the allowable principles particularly including, but not
restricted to, Modaraba, Musharaka and Ijara.
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Another issue that has earlier been discussed a bit, is the

matter of documentation of financial arrangements, dealings and
agreements. We have learnt that it is the basic guidance from the holy
Quran that any dealing, except hand by hand transfer, should be
documented and witnessed. It has been particularly observed that
amongst family members and friends such documentation is avoided
being considered to be just a formality. Practical experiences have
suggested that in absence of written agreements and documentation,
whenever some complexities and disputes arise, the relationships and
partnerships are spoiled whereas the businesses get collapsed.
General public
Obtaining finances from general public has now become easy
and practicable, as well as, more economical and easy to deal.
Generally the modes of obtaining finances from general public are
issue of public securities including shares, units of equity and
certificates or units of redeemable capital besides certificates of
investment through a Modaraba, and securitization through use of a
special purpose vehicle (SPV). The most common form amongst these
is the issue of equity shares.
This issue is of particular significance that, in Pakistan, it is
not legally possible to invite public deposits or any other form of
public investment except for through the listed securities, for which
the issuing enterprise has to follow the relevant laws, listing regulations
and the code of corporate governance.
Islamic financial institutions
Islamic financial institutions are now dealing a massive
portfolio of financial assets and investments of around US$ 300 billion
throughout the world and these are now actually enjoying a sizable
presence. Although a number of Islamic financial institutions are being
run on purely commercial terms, and there are certain indications that
they do not ensure to fulfill the Shariah compliance requirements in
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substance and instead their overall emphasis is on documentation,

which is sometimes completed simultaneously. However, still there are
a number of institutions that are being run by faithful Muslims with a
clear intention of abidance of the rules set out by Shariah.
Given these circumstances, one should remain careful
regarding the matter of identification of the right Islamic financial
institution. In this respect, I have observed that a few businessmen
have obtained finance on Islamic modes even from conventional
banks or Islamic banks (with bad reputation). In such case, the only
thing that needs to be ensured by the person obtaining the finance is
that all the contracts and documents are made according to Shariah
and these are actually complied with, in substance and in form.
Conventional financial institutions
Even in certain circumstances, various conventional financial
institutions also offer certain Shariah compliant financial services.
These services may be offered in two different forms. The first one is
through Islamic banking windows being operated in form of Islamic
banking subsidiaries and stand-alone Islamic banking branches of
these commercial banks, in which case these may be considered
equivalent to an Islamic financial institution as their operations are
licensed by the State Bank as Islamic bank and are subject to
supervision of their respective Shariah Advisors, as well as, the State
Bank.
In the second form, a number of conventional financial
institutions, which include commercial banks, investment finance
companies and investment banks, leasing companies and insurance
companies also invest in certain Shariah compliant avenues and
provide certain other financial services that are not repugnant to the
injunctions of Islamic Shariah.
The commercial banks that offer Islamic financial services
under their normal windows include certain banks that are subsidiaries
and branches of various multinational Islamic financial institutions and
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generally operate under the Islamic modes of financing but are

licensed under the conventional banking system and as a consequence,
have certain doubtful operations being a part of such banking system.
The second type of commercial banks is the one that offer
such services with purely commercial motive. These banks have
offered a few Shariah compliant financial arrangements in order to
attract such mob of people who do not indulge in any interest-bearing
transaction.
Similarly, it may be observed from a thorough understanding
of the banking system that a few financial services that are not based
on interest are compatible with the Shariah requirements, and in these
cases the services offered by these banks are identical to those offered
by an Islamic bank. These services include, but are not limited to,
providing lockers, current accounts, Usance L/Cs (in which the credit
is given by supplier and no interest is charged by the bank), money
transfers in various forms including pay order, drafts and cheques, as
well as, electronic and telegraphic transfers.
Generally the jurists declare that it is permissible to have
business relationships with these financial institutions subject to the
basic condition that the mutual agreement should be purely based on
Shariah compliant terms and conditions and the same should be in
effect in its substance and its legal form. However, in presence of
Islamic financial institutions, these should not be preferred by a
thoughtful conscious Muslim.
Investment of Excess Funds
This is the question most commonly asked by a person, who
desires to abide by the commands of Allah Almighty, because this
question is applicable to almost every person in the society. Saving
something for the rainy days is the very nature of a human being and
obviously, he wishes to earn some profit on the same. Accordingly,
this question has the same significance for a business and an individual,
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although the answers available to both of them might be different.

Generally the question asked from experts, has the following facets:
Would it be Halal?
Would it be Risk-Free?
What would be the return? and
Should I suspect a loss also?
In the ensuing pages we wish to discuss various Halal avenues

available to Muslim entrepreneurs and individuals for placement of
surplus funds i.e.:
Equity investment in Joint Stock Companies;

Mutual Funds;
Redeemable Capital;
Preference Shares;
Modarabas;
Government Securities;
Personal level Musharaka and Modarabas;
Foreign exchange;
Investment property; and
Islamic banks and financial institutions.
Investment in most of the above categories can be made

through private placements, as well as, through stock markets
wherever such opportunity is available.
Stock Market Operations
Before going into details for each of the above categories, it
would be better to discuss the stock market operations as a whole.
Generally, stock markets are the best way of investment for investors
who are conscious regarding the permissibility of their income from
Shariah perspective. Even before introduction of Islamic banking
operations, these were considered the only option for Shariah
compliant investments. Notwithstanding this general understanding,
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there are a number of stock market operations that cannot be termed

as Shariah compliant. This is generally because of a number of factors
which are not allowable from Shariah perspective, including but not
limited to, the impermissibility of core activities of the investee
company, marginal trading, short-selling, forward sales and purchases,
selling before possession, as well as, dealing in interest-bearing and
other questionable securities.
Marginal Trading and Badla
Marginal trading, continuous funding system (CFS), carried
over transactions (COT) and Badla are not considered to be
permissible from Shariah perspective with a consensus of most of the
jurists. The prime reason behind such conclusion is the fact that in
such transactions the buyer is not a real buyer with investment of the
total amount of money required to be invested but instead he is just a
risk taker in respect of price fluctuation with a minimum investment.
Accordingly, such transactions do not reflect a real sale-purchase
transaction and instead reflect just a sort of gambling, and
consequently, these are not permissible under Shariah perspective.
You would agree that taking risk beyond somebodys risk
taking appetite is a real risk for the market as a whole. This
phenomenon has, from time to time, proved to be disastrous for the
whole market. A simple example has been evidenced in the recent past
when the stock market crashed during the year 2005. If we just take
one script i.e. OGDCL as an example, we can easily understand the
issue. Before crash of market, when the market touched 10 thousand
mark for the first time in history, this scrip reached a price of around
Rs. 200. If we assume that mostly people had invested in the
proportion of 10 percent, they would have invested Rs. 20 only to buy
one share. Now, when the market crashed, nobody was ready to buy
this script and as a result the price of the script went down as low as
Rs. 117 when financial institutions intervened on the instructions of
the government and purchased the available scrips at Rs. 117. It means
that a person investing Rs. 20 had incurred a loss of Rs. 83 which was
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four times more than his amount of investment resulting in

bankruptcy and sale of residential houses and personal assets. On the
contrary, the person who had made real investment would have lost
around 40 percent of the amount of his investment, which would not
result in any bankruptcy, requiring sale of personal assets.
Besides the gambling factor, these transactions also carry
interest i.e. interest is charged on the daily balance when the
transactions are closed and netted off. In case of Badla and COT, such
interest is generally charged by the broker, as the risk of financing is
taken by him or at times, he involves financial institutions, particularly
the investment finance companies and commercial banks. In the
system of marginal trading and CFS, the financing is arranged by
commercial banks and other financial institutions and the broker just
arranges the financing according to the principles and guidelines
provided by the SECP and the stock exchanges.
Short-selling, forward selling and
forward purchases
Short-selling means selling something which is not owned by
the seller. This is a common practice applied in the stock markets,
particularly when the prices are on a declining trend. As an example, if
a security is currently being traded at Rs. 20 and it is expected that its
price will further go down, an investor short sells the same e.g. in a
quantity of 100 securities. When the price goes down at Rs. 19, he
purchases an equivalent quantity of securities and instead of actually
getting and making the delivery and payment for both of the
transactions, he just nets off his transactions and get the profit of Re. 1
per share. A few investors also use short-selling as a risk hedging
instrument to secure their position.
Forward sales is also similar, except for the fact that it is due
to delivery at a future date irrespective of whether the seller owns the
same or not at the time of entering into the transaction, whereas the
forward purchase transaction is just opposite of such transaction.
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Generally, separate counters are established for forward sales and

purchases in addition to the normal ready counters at the stock
exchanges. Short-selling is strictly prohibited in Shariah and
accordingly, all such transactions are considered to be gambling
transactions by a majority of the jurists. However, forward sales can be
made if the person entering into the transaction owns the required
quantity of securities, as of the date of transaction. Forward purchases
may be considered permissible, if and only if, it is known if the person
selling the securities is identified and it is known that he owns such
quantity of securities, as of the date of transaction.
It is pertinent to note that an alternate, two types of sales
transactions have been allowed by Shariah in which sale before
possession or even existence of goods can be made i.e. Salam and
Istisna transactions. Istisna is limited to the manufacturing and
contracting services, however, Salam transactions are allowed by a
number of jurists for sale-purchase of securities. In such case, all the
applicable conditions relating to a Salam transaction shall be followed
by both the parties, particularly full payment of selling price at the
commencement of the transaction.
Another alternate is considered permissible by the majority of
Jurist i.e. entering into a promise to sell. However, even in such case, a
number of jurists are of the view that before making such a promise
either the seller should already be in possession of such goods or he
should expect receiving the same through another source, as of or
before the date of expected delivery in the promised sale transaction.
In any case, such promise should be a unilateral promise to sell or
purchase. Otherwise, if the same is agreed by the other party
immediately, it will make the sale void from Shariah perspective.
Selling before possession
Selling anything before actually taking the physical or
constructive possession is an act which is strictly prohibited by Shariah.
This principle is generally ignored in the stock market operations
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whereby it is a common practice to net off the transactions at the end

of the day instead of actually taking delivery and making payments. In
the new system, most of the transactions are carried out on a T+3
basis, i.e. the delivery of shares in the account maintained with the
Central Depository Company (CDC account) and full payment is
made against each transaction. However, a few transactions are also
carried out at spot or T+1 basis, in different conditions. According to
most of the jurists, transfer of shares in CDC account or the brokers
account maintained with CDC is considered to be constructive
possession and no sale of such securities shall be made before such
transfer.
As an alternate, a Salam transaction may be entered into with
respect of such shares, however, the same cannot be carried out on the
floor of the stock exchange as the current system does not support the
same. Moreover, it is necessary to ensure all the applicable conditions
of Salam transaction in this case, particularly full payment at the time
of entering into the transaction.
Equity Investment in Joint Stock
Companies
Equity shares represent proportionate ownership share in the
capital of a company. The return from equity shares are derived
through capital gains, dividends distributed and bonus shares issued
whereas the risk of losses lies in the risk of business failure, as well as,
through capital losses. Investment in equity shares is considered to be
a permissible way of investment subject to compliance of certain basic
Shariah requirements.
In respect of permissibility of investment in equity shares of
any company, first and the prime requirement is that the core business
of the investee company shall be Halal as defined under Shariah
principles. In other words, we are not allowed to acquire shares and
other securities of companies involved in interest-based financial
services like conventional banks or the companies involved in
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businesses prohibited by Shariah like Insurance, trading in pork or

machine slaughtered meat, pornography or media services not in line
with Shariah requirements, gambling or night club activities etc.. In
this respect, jurists have, duly recognizing the practical difficulties have
recommended that even if an insignificant portion of income is earned
from Haram sources, the income from such sources should be
minimal i.e. not exceeding 5 percent of the total income. In addition,
they have recommended that any such proportion of income from
such investments, representing such Haram income, should be given
in charity.
The second requirement is that preferably, the investee
company shall not have any interest-bearing debts. Nevertheless, in
view of the practical difficulties, a majority of jurists have consented
that the significantly major portion of the sources of financing of
operations should be in line with Shariah requirements. Accordingly, if
the investee company has also obtained interest-bearing debts, the
ratio of such debt to equity shall not exceed 30:70. The jurists further
advise that the investor should draw attention of the management of
the company towards elimination of such interest based borrowings.
The third requirement is that the shares of a company are
negotiable only if it owns significant illiquid assets i.e. the assets other
than cash or cash equivalents e.g. fixed assets and inventories. If all the
assets of a company are in liquid form, these cannot be purchased or
sold except at break up value, because in this case the shares represent
money only and the money cannot be traded in except at an equivalent
amount.
The fourth requirement is that no assets of the investee shall
bear interest. However, in order to avoid practical difficulties, jurists
have recommended that mark up-bearing securities and cash balances
held by the investee company shall not be significant as a proportion
of total assets. Jurists have recommended that such balances shall not
exceed 33 percent of total assets. Jurists have further recommended
that total receivables and cash shall be less than 50 percent of total
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assets. In addition, they generally suggest that the investor should raise
his voice with the management to eliminate such interest-based
investments.
Purification
In view of a lack of concepts of Halal and Haram in the
business circles, it is often noted that the companies involved in purely
Halal activities have certain income from certain Haram sources
particularly, interest income on cash and short-term investments.
Based on the practical impediments, the respectable jurists have
allowed investment in such companies subject to three conditions.
The first condition, as discussed above, is that being a
stakeholder, and in case of shares, being a member of the company,
the investor should raise his voice against investment on the basis of
interest and involvement in other Haram activities.
Second condition is that the proportion of such activities in
contrast to the core activities (that must be Halal) should be minimal
and immaterial and for this purpose a benchmark of 5 percent has
been defined. Accordingly, no amount should be invested in the
companies having income from Haram sources, more than five
percent of their total income.
The third condition is purification of profits earned from such
companies. According to this concept, any amount, although
immaterial in nature, earned from such investments should be paid in
charity and should not be included in the income of the investor in
order to purify his income.
Purification of Indirect Income and
Capital Gains
Jurists have consensus that any direct income from such
investments including dividends, bonus shares and discounts on shares
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should be purified in the same manner. Nevertheless, the matter of

purification of indirect earning from such shares i.e. capital gain on
their sale is disputed amongst various jurists. In this respect, a few
scholars are of the view that since the capital gain includes the factors
of the current earnings, past earning trends and the potential of future
earnings hence the same should be purified in the same manner or by
a rather complex method of purification taking due impact of the
market factors e.g. the movement in stock index. The other school of
thought has a different perspective that capital gain is indirect earning
and has not direct relationship with the earning trends and earning
potential of the company and is basically gain on sale of a commodity
(treating shares as a commodity) and such gain principally depends on
the market forces hence its purification is not required.
What we can conclude from this issue is that on the basic
Islamic principle of prudence, we should preferably avoid everything
doubtful, and accordingly, irrespective of the dissenting opinions, it is
better to purify all sort of income, whether direct or indirect.
Nevertheless, computation in case of indirect earning may take impact
of the market changes which will give a result nearer to the actual
benefit earned from such sources.
Similar concept of purification applies for all other sort of
investments, wherever applicable.
Investment in Redeemable Capital
In Pakistan, the investors can also invest their surplus money
in instruments of redeemable capital, such as Participation Term
Certificates (PTCs), Term Finance Certificates (TFCs), Musharaka
Certificates and other instruments not based on interest issued under
various provisions of the Companies Ordinance, 1984 and other
relevant regulations. These certificates may or may not be listed on the
stock exchange and may have different terms of issue. Accordingly, it
is always necessary to consider their terms of issue each time or
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preferably get the opinion of a respectable Shariah scholar on the same

in order to ensure its permissibility under Shariah rules.
The basic rules for the investment in redeemable capital are
more or less similar to those mentioned in rules for investment in
equity securities. However, due to lack of sincerity in applicability in
theory, as well as, in practice, the investment in TFCs is no more
considered Halal by the respectable Shariah scholars. Moreover, the
Federal Shariat Court has also deleted TFCs from list of permissible
financial instruments under Shariah basically on account of deviation
from basic Shariah principles.
Preference Shares
The rules governing partnerships in Shariah law require
fairness and equity to be maintained by the partners. It is apparent that
the holder of a preference is not equal to the holder of an ordinary
share with regard to rights and obligations. However, in certain cases,
the partners may agree a different profit sharing ratio, although the
loss sharing ratio can never be changed with mutual consent which
shall be in proportion to the amount of capital invested. Moreover,
these principles further require that no fixed return can be guaranteed
to any partner particularly in excess of his ratio of capital (as
prohibited by most of the jurists in case of dormant partners).
Accordingly, as previously discussed in detail, the generally
prevalent forms of preference shares are not considered to be a
Shariah compliant investment. Anyway, any model of preference share
that follows the Shariah requirements shall be considered an allowable
investment and the same shall be decided on a case to case basis
considering the terms and conditions of the issue of such preference
shares.
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Investments in Mutual Funds

We are fortunate enough that we are living in an era whereby
the opportunities of Halal income by investing in a diversified
portfolio are available through various Islamic mutual funds operating
in the country. These mutual funds operate under the supervision of
their respectable Shariah Supervisory Boards and Shariah Advisors and
preferably are held subject to Shariah compliance audits by virtue of a
proviso inserted in their respective trust deeds. These funds provide an
opportunity whereby one can invest profitably his surplus funds into a
pool of equity investments managed by experienced professionals
hence minimizing the risk of loss to the investors. The documents
evidencing the investment in a mutual fund are called units (in case of
open ended mutual fund and closed ended mutual funds formed under
a Trust) and shares (in case of closed ended mutual funds formed as a
limited liability company).
In addition to the above discussed Islamic mutual funds, a
number of traditional mutual funds have been floated and managed by
renowned financial institutions in which investments may be made
subject to the compliance of the basic investment criterion mentioned
hereinabove and the condition that the subscribers must enter into the
fund with a clear understanding that the return on their subscription is
tied up with the actual profit earned or loss suffered by the Fund.
Therefore, neither the principal nor a rate of profit (tied up with the
principal) can be guaranteed. In this case close monitoring is necessary
in order to identify the portion of income that needs to be purified.
This would be necessary, as the same will not be identified by the
management of the mutual fund, as is identified and disclosed in the
financial statements by the management of an Islamic mutual fund.
Investment in Modarabas
If we start the discussion from the point that investment in
Modarabas is also questionable in most of the cases, a reader having a
very little knowledge of the issue would obviously be astonished.
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However, for those who are well aware the operations, practices (and
even malpractices) of these institutions, it is not something new.
Practically, what one can observe from whatever most of these
Modarabas (except a handful of them) have performed in past, is a
history of white-collar burglary coupled with a practical joke in the
name of Shariah. Most of these institutions were formed by various
groups of companies in order to finance their own companies through
siphoning money from the pockets of general public. This fact may
easily be evidenced from the past performance of the Modaraba sector
and the net asset values and market values of their certificates on the
ready board quotations.
On the other hand, most of these Modarabas have not
complied in principle with the injunctions of Islamic Shariah and
instead these have been involved in financing with Shariahcompliance-on-paper. However, there are still a few Modarabas that
have well-performed as Islamic financial institutions and have given
reasonable returns to their certificate-holders, as well.
Accordingly, for the purpose of investment in a Modaraba, it
should be ensured that all the conditions applicable to the investment
in companies as discussed earlier, are duly complied with and in case
of any doubtful income, purification procedure is also complied with.
Investments in Government Securities
Investment in interest-bearing government securities, like any
other interest-bearing security, is not permissible from Shariah
perspective. Up till recent past, no alternate to such securities were
available. As a part of efforts for developing alternates for Islamization
of economy, as well as to attract leading international Islamic financial
institutions for investment in Pakistani government securities, the
Pakistan government has, in recent past issued two Sukuks for the first
time while more are in the pipeline.
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By taking this step, the government has opened doors for

Shariah compliant government securities which will, Insha Allah
become quite common in the forthcoming future. At present, the
current issues of Sukuks are meant for the foreign investors and the
secondary market and the same have not been offered to the general
public. Hopefully, in near future, other similar securities will be issued
for general public under Shariah compliant principles.
Personal level Musharaka and
Modaraba
Personal level Musharaka and Modaraba are very much
common in our culture. However, it is generally not ensured as to
whether the basic conditions laid down by Shariah are complied with
or not. Such applicable conditions are being discussed in the ensuing
pages in reasonable details.
As discussed earlier, another important factor in this respect is
documentation of the partnership contract as required by Shariah
which is generally not complied with because of reliance on each other.
The prime cause of such negligence is the fact that in our society,
generally these arrangements are made between family members and
friends only and at the stage of commencement of business, it is not
considered necessary to bring the arrangements in black and white.
Nonetheless, the experience suggests that in case of absence of any
such documentation, complexities may arise in future, resulting in
disputes and even collapse of businesses.
Foreign Exchange
Investment in foreign exchange is a permissible investment
from Shariah perspective. However, its basic condition is hand to hand
deal at spot rate. Accordingly, any form of money should not be
interchanged or exchanged with any other form of money except
immediately at a mutually agreed rate, generally, the spot rate
applicable as of that date. Shariah scholars have approved that
immediate transfer to a bank account to the credit of one party may
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also be termed as immediate constructive transfer. In this case it is also

approved that in case of inter-bank transfers, the normal time that the
banks take in clearing the cheques i.e. 2 days may also be considered
immediate transfer. However, the rate of transaction should be taken
to be the rate prevalent at the time the transaction is finalized or
should be mutually agreed at that time.
Any short-selling of foreign currency is strictly prohibited,
although, sale at a future date at a pre-agreed price is considered
allowable by a few jurists. A few of them say that such sale is effected
immediately (like a Salam transaction) and only the delivery is deferred
hence the rate should be the rate prevailing at the time of transaction
and any difference should not be allowed as any such difference shall
tantamount to Riba-al-Fadl or Riba-al-Hadith. Few others consent that
such sale is not allowable and instead, a promise to sell may be allowed
for the purpose which should be binding on one party only while the
other party must have the option to abandon the transaction.
Dealings in FOREX market are generally not allowed by the
scholars, because these are based on marginal deals and generally imply
short-selling and future dealings and actual delivery of cash is generally
not made.
Investments in Real Estate
Investment in real estate is another option available to Muslim
entrepreneurs to invest their excess available funds for short as well as
long-terms. Generally investment in real estate is for two motives i.e.:
Earning rentals and other returns on the land or

buildings; and
Obtaining benefit from long-term investments due to
fluctuation in prices during which an investment in
real state is held by the investor.
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Basic Shariah principles applicable for investments in real

estate include the following:
It must be made for lawful purpose in Shariah

perspective;
In case of agricultural land, it should be used in
agricultural activities within three years of acquisition
either directly by the owner or through employees or
Muzaraa arrangement;
In case of agricultural land, Muzaraa or Musaqa
arrangements should be made according to the
principles applicable thereto;
In case of agricultural land, Ushr needs to paid on the
produce as applicable;
Rentals fixed in advance must not be compounded in
case of investment in real estate made to earn rentals;
and
Advance rentals should not be charged during the
construction stage.
Accounting and Taxation Issues for

Investment in Real Estate
Investment in real estate has two motives of earning profits.
The first one is capital accretion, whereas, the second one is to earn
rentals by lending such real estate on tenancy basis. A real estate
property can be classified and accordingly qualify for recognition
under relevant accounting treatments depending on the intended use
of property by the investor:
Investment Property; and

Fixed Assets (Property, Plant and Equipment).
In the accounts of an investor, a real estate property is

classified as investment property, if property is purchased for capital
appreciation or letting it out to others on one or more operating leases
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and not used substantially for own business. In this case the owner has
the option to value it at its fair market value.
On the contrary, real estate property qualifies for recognition
as fixed assets (property, plant and equipment), if it is owner occupied
and used substantially for business purposes. Investors can purchase
property and use for their own purposes or let it out to others and
generate economic benefits. In this case the property should preferably
be recorded at cost and depreciation should be charged thereon.
However, such assets may be revalued subject to the condition that
any unrealized gain should not be distributed as dividend. Any
agricultural land and properties should also be accounted for under the
latter category.
Similar to most parts of the world, since the gains on sale of
immovable property are considered capital gains these actually become
exempt from tax unless the person has a practice of continuous
dealings in sale and purchase of property in which case, the same is
considered his business and his income from such source is taxed.
Shariah Compliant Solutions for
Raising Finances
A number of general products of interest-free financing as
being offered in Pakistan by Islamic commercial banks and financial
institutions, as well as, a few other financial institutions and the Islamic
banking branches of conventional commercial banks. These products
are based on the Islamic financing modes as discussed in detail in the
previous chapters and particularly include Murabaha, Ijara, Ijara
Muntahia Bittamleek, Istijrar, Diminishing Musharaka and Salam based
products.
There is only one setback with such products that since these
are being offered by the Islamic banks and other financial institutions,
these are controlled by such financial institution. In other words, the
pricing for such financial products, securities there against and other
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material covenants are dictated by such financial institutions which are

sometimes not considered favourable to the customer. These options
are generally not considered feasible by the finance managers to
finance major projects because in such cases, the management remains
handicapped for taking any major business decision. In addition, such
financing also disturb the gearing ratios and at times it does not remain
possible to obtain further financing because of the restrictions
imposed by the prudential regulations.
Specific Solutions for Raising
Finances
In order to provide Shariah compliant alternates for financing
to such enterprises that want to finance their major projects, at its
terms and conditions, a number of complex engineered solutions have
been developed by Islamic financial institutions, which have practically
been applied and tested in different parts of the world, duly including
Pakistan. In addition, a number of solutions have further been
proposed by the scholars and experts, which are yet to be
experimented. It would not be possible for us to summarize all such
solutions available; nevertheless, we will endeavor to address a few
Shariah compliant special solutions for raising finances, available in
prevalent legal structure of Pakistan.
Redeemable Capital
Redeemable capital may be issued by the companies
incorporated in Pakistan under various options in accordance with the
provisions of the Companies Ordinance, 1984 and rules made under
that law. The common options that are available under Shariah
compliant modes are Participation Term Certificates (PTCs),
Musharaka TFCs and Musharaka certificates. In past, PTCs were the
best options available under Islamic finance modes; however, due to
practical difficulties these are currently not being used by the
companies in Pakistan. As far as Musharaka certificates are concerned,
these have practically not been applied in Pakistan except for certain
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Modarabas, which in fact, are not in compliance with the Shariah rules
in substance. No rules have been devised by the Government for
issuance of such certificates, although a provision for issuance of the
same is available under the Companies Ordinance, 1984.
In previous years, TFCs which were being issued on the basis
of a buy back arrangement were also considered to be a Shariah
compliant mode of financing. Nevertheless, in view of impermissibility
of such arrangement from Shariah perspective, most of the jurists did
not agree with such conclusion. After a decision by the Federal Shariat
Court in this respect, these are no more considered to be a Shariah
compliant mode of financing. TFCs are the most common type of
redeemable capital prevalent in the country and as an alternate thereto,
in the recent past, the TFCs under Musharaka mode have been
experienced which were listed on the stock exchange. This option has
proved to be a successful effort for development of interest-free
modes of financing.
In issuing redeemable capital, particularly the listed securities,
the companies generally enjoy three benefits. The first benefit is
regarding pricing i.e. generally the pricing for redeemable capital is in
the benefit of both the company and the financier because this is
generally the mid rate between the commercial banks borrowing and
lending rates. Even at times, it is higher than the market rates in order
to tempt the investors.
Second benefit is that the terms and conditions are not
dictated by the lenders and instead, they invest on the basis of the
terms and conditions of the issuer of the securities.
The third benefit is that other financial institutions e.g.
insurance companies, mutual funds and investment finance companies
generally invest in such securities and accordingly, the dependence on
the commercial banks is reduced. However, redeemable capital has
one setback i.e. like general financing arrangements, it disturbs the
gearing ratios and consequently the limits for prudential regulations
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need to be observed if the investor is a financial institution to whom

prudential regulations apply. In case of listed securities, the listing
regulations and the codes of corporate governance also become
applicable.
Special purpose vehicles
Special purpose vehicles can be used to finance major projects.
These vehicles can be established in form of corporate entities, trusts,
funds and Modarabas and may also be listed on the stock exchanges.
These may be established on the principles of Musharaka and
Modaraba. Once such institutions are formed, these may finance the
projects under the known basic modes of Islamic finance including
Musharaka, Modaraba, Ijara, Salam, Istisna and Murabaha.
These special purpose vehicles may also work on the
principles of securitization under the securitization law, as applicable in
Pakistan. In such case, it would be pertinent to ensure Shariah
compliance for the transaction, because the general modes of
securitization, as being applied in Pakistan, are mostly questionable
from Shariah perspective. Certain tax benefits are now available to
special purpose vehicles. In addition, certain forms of securitization do
not disturb the debt equity ratio as applicable under the Prudential
Regulations, and accordingly, are very much suitable for high leveraged
companies.
Special purpose Modaraba
In Pakistan the Modaraba laws and the taxation laws provide
certain benefits for raising finances under Islamic modes through a
Modaraba. These benefits, besides others, include tax benefits also. In
order to finance any major project, or a number of projects, a
Modaraba may be formed under the Modaraba law.
Such Modaraba can finance the projects under various modes
of Islamic finance, including Murabaha, Istijrar, Ijara, Salam, Istisna,
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Musharaka and Modaraba. In addition, such Modaraba can also

provide trading, manufacturing, indenting and other services for the
project. In a number of cases, all the arrangements can remain off
balance sheet which may be particularly be considered quite suitable
for any highly leveraged companies.
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Chapter Nine
General Business Matters
GENERAL BUSINESS MATTERS

In this chapter, we will discuss a few general business matters
that have significance in day to day affairs of a business, particularly
from financial perspective.
Employees Relations
In the known history, it was the first time when the Islamic
law devised and implemented the basic principles for employees
relations. Although various such principles are also found in thoughts
of various philosophers from Greece but it is clearly evident from
history, that such ideas always remained on paper and no dynasty had
the courage to implement such principles in real life. The basic reason
behind such controversy can be easily understood when we consider
the matter in view of the ideologies of modern days Mutrafeen
(). Mutrafeen is a Quranic definition for those who have more
wealth than general public. Even in this so called modern and civilized
reign, you can find the situation not very much different from the days
of any emperor of old roman dynasty.
Another misfortune we are facing nowadays is that the
employers who are, by any mean, brought into the net of labour laws
as applicable in Pakistan are somehow following such laws to some
extent. Nevertheless, they generally understand that after having
fulfilled the requirements of labour law as applicable in the country,
they are relieved from the basic duties that have been levied by Allah
Almighty on them in respect of their employees.
Another basic misunderstanding which has been observed,
even in a number of religious minded people, that they generally
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discriminate between domestic servants and commercial employees for

the purpose of following the principles laid down by Islam.
Our religion has clearly defined a set of principles for
employer-employee relationship. In this respect, the author requests
the some individual or a group of like minded people within the HR
management and consulting community to contribute to this topic, as
the author realizes his lack of knowledge and resources in this respect.
Retirement benefits
Retirement benefits may be termed as a benefit introduced for
employees by the West. In early days of Islamic philosophy no need
was considered for retirement benefits of employees because it was
understood to be the responsibility of the State to provide basic
necessities to the old and retired people. However, in the current
scenario we can generally term these a valuable gift from the West.
Retirement benefits are not only a benefit for the employees.
These generally have given a few benefits to the employers also. The
basic retirement benefits that are provided by the employers (including
governments) are generally divided by accountants in two categories i.e.
defined contribution plans and defined benefit plans. Defined benefit
plans are such plans in which the employer commits to provide a
specific benefit to the employee at the time of retirement. Such
benefits include pension and gratuity.
Defined contribution plans
Defined contribution plans are normally funded, and here is
the stage where a practicing Muslim concerns. According to Pakistan
Labour laws, every employer who has at least 20 employees in case of
a commercial establishment or 50 employees in case of an industrial
establishment is bound to pay either gratuity or provident fund to each
of its employees. These rules generally define that the contribution to
provident fund should not be less than one months salary for a year
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of continued service. Almost similar is the case of gratuity where the

commitment to pay gratuity should not be less that one months last
drawn salary for each completed year of service.
A simple solution to such issue is to avoid defined
contribution plans to the maximum extent possible and instead go for
unfunded defined benefit plans. This is particularly suitable for small
businesses. Anyway, this solution would not be suitable for large
businesses. Similarly, a number of finance professionals would disagree
with this solution as it is always considered prudent to have funded
retirement benefits in order to ensure payment to the employees in
case of a business failure. In addition, since the defined benefit plans
are generally linked to ever increasing salaries, the businesss liability
on this account increases in geometric progression and consequently,
results in increased expenditure in the later years of an employees
services. Similarly, this also discourages high increments and
consequently, at times, these result in lesser capabilities to retain
competent employees.
For defined contribution plan, two basic Shariah compliant
investment options are available. First option in this respect is
investment in Shariah compliant listed securities. According to the
rules devised under the company law and the taxation law, the
provident funds, as well as, other employee benefit funds can invest 30
percent of their investments in listed securities, with certain conditions.
In previous chapters, we have discussed in detail the rules and
principles for making investment in various securities. The same
principles shall be applied for investments by any defined benefit fund.
If a prudent and effective fund management practice is applied, these
can provide very good returns. As an alternate, investment can be
made in Shariah compliant mutual funds to the extent of limits
specified by law. In such case, the matter of assurance of Shariah
compliance of the respective securities and effective and efficient
funds management rests with the management of the mutual fund, and
the trustees of the provident fund remain least bothered regarding
such issues. It should, well be kept in mind that in such forms of
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investments, besides eminent opportunities for good profits, the risk

of loss does exist and the trustees and the members of the fund should
be well aware of such risk. Such investments can be made in public
securities and Musharaka TFCs etc. subject to conditions laid down by
law.
Second option is investment with any Shariah compliant
investment account offered by an Islamic commercial bank or Islamic
banking branches of conventional commercial banks. Needless to
mention, according to the company law and taxation law, investments
of provident funds, as well as, gratuity, pension and superannuation
funds can be made with any scheduled bank and accordingly, no
question can be raised on legal permissibility of such investments.
Nevertheless, their return is generally slightly lower than the
government securities and any conscious Muslim should be ready to
bear such opportunity loss with the corresponding opportunity to
please Allah Almighty for a better return in the life hereafter.
Third option, which is presently not available at a large scale,
but hopefully will be available in near future, is investment in
government securities issued on a Shariah compliant basis e.g. Sukuks.
Defined benefit plans
Defined benefit plans, as in vogue in Pakistan, generally
include gratuity and pension plans. Gratuity is applicable in most of
the cases because of a legal requirement, although a few enterprises
pay gratuity in addition to a provident fund scheme. Pension is not so
common except for most of the government enterprises and a few
multinational companies that have introduced a few lucrative pension
plans in order to attract competent employees for developing longterm career with them. Pension schemes are generally funded,
however, in gratuity a number of schemes are unfunded or even, we
can easily conclude that, a majority of schemes is unfunded.
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Even for defined benefit plans, the tax benefits for the
employer and the employee are increased if these are approved by the
taxation authorities and these are further increased, if the same are
funded. For a funded defined benefit plan, the provisions regarding
investment of funds as prescribed by the company law and taxation
law are similar to those applicable to a provident fund scheme.
Accordingly, same options shall remain available for these funds, as
discussed above in the case of provident fund.
Insurance
Insurance, as prevalent in the modern commercial culture, is
considered to be against the principles of Shariah by the consensus of
the majority of jurists. A conscious Muslim should always avoid
entering into insurance contracts, unless either a government
regulation or a situation of compulsion or Iztirar requires entering into
such contract. Even in such case, our attitude should be in line with
the condition laid down by Allah Almighty for any Iztirar i.e. eating
Haram in case of Iztirar should not be done by disobeying or desiring.
Alhamdolillah, now the concept of Islamic alternate to
insurance i.e. Takaful is very much in operation throughout the world
and even in Pakistan, the first company is commencing operations on
the principles of Takaful.
Since Insurance and its alternate require our further attention,
we will discuss them in detail at a later stage in this study.
Bank Guarantees
Different forms of guarantees are a necessity for running
businesses in the modern world. By definition, a guarantee is an
agreement whereby the guarantor assumes responsibility for the
discharge of the other persons obligation in the event of failure by
other person in discharging his obligation. The general guarantees
issued by the conventional commercial banks are considered to be
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impermissible from Shariah perspective. Such prohibition is generally

on two grounds i.e. (i) the wording and legal applicability of such
guarantees; and (ii) the fee charged for providing guarantees. We are,
anyway, fortunate enough that now Shariah compliant alternates are
available and the Islamic banks are issuing guarantees under Shariah
principles.
From judicial perspective, the guarantees issued by Islamic
financial institutions are generally based on the principles of Kafala
and Rahn. Kafala means the responsibility, amenability or suretyship.
In Kafala a third party becomes surety for the payment of debt, if
unpaid by the person originally liable. It is a pledge given to a creditor
that the debtor will pay the debt, fine or any other liability. Suretyship
is creation of an additional liability with regard to the claim, not to the
debt.
In contract of Kafala, a third party becomes surety for the
payment of debt, but in Rahn, the debtor hands over something as
pledge to ensure payment of debt. Mutual consent is the basis for
validity of both the contracts, as in other business transactions. In
Kafala the degree or scope of suretyship should be known and should
not be with preconditions. It is not permissible to give surety to an
unknown degree or scope.
When issuing a guarantee, the Islamic financial institutions
generally obtain a counter guarantee from the customer unless the
customer enjoys good reputation and financial position enabling the
Islamic financial institution to have recourse to the client in case of
need.
Regarding the guarantee charges issue, a few jurists have
allowed that Islamic financial institutions may issue guarantees on
behalf of their clients, for which they can charge commission or
service charges. The amount of commission can be a fixed amount
worked out as a certain percentage of the guaranteed amount or on the
basis of slab rates, irrespective of the period of guarantee. However, a
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majority of scholars do not allow recovery of commission and

conclude that only the secretarial expenses incurred on such charges
can be recovered. In such case, the overall expenses are estimated and
allocated on the expected amount and number of guarantees generally
issued, and then slab rates are determined for allocation of such
expenses to the respective customers. In such case, no profit margin
should be built in such fee.
Letters of Credit
A Letter of Credit, generally referred to as L/C, is a written
commitment to make payment by a Bank to the seller as per the
buyers request or for the Banks own use within a certain period of
time, on various agreed conditions. These are generally issued by
commercial banks and financial institutions in favour of their
customers to guarantee the amount of payment in case of trade and
services, particularly in case of import purchases. These have certain
characteristics in their mechanism which are not allowable under
Shariah principles.
L/Cs are issued by the Islamic Banks based on the principal
of Wakala or Agency. Wakala means to appoint another to act in
his stead or as his representative. With the increase in the volume and
scale of businesses, the role of agent has increased manifold and also
the concept of agency have become an important element of Islamic
partnerships. Even in modern law and business customs the nature of
the relationship between partners is known as a principal-agent
relationship. Proposal and acceptance of a position in an L/C
transaction is considered as the appointment of an agent (Wakil).
Permission to act on someone elses behalf also amounts to
appointment as an agent.
Islamic Bank can collect various charges (such as
documentation charges, correspondence, account maintenance, credit
assessment charges etc.) for the purpose of opening LC. However, the
Islamic Bank cannot charge any profit in case the LC is not settled by
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the importer in time or if the Nostro account of the Bank is debited

before the importer has made payment to the Bank. The permissibility
of charging fee for agency-related service in L/Cs is based on the
concepts that the amount constitutes payment for services provided by
the Bank. However, such fee shall not be directly linked with the
period and amount of exposure and should not be increased if, for any
reason, the period of exposure or the amount of exposure exceeds the
initially agreed period and amount.
In import L/Cs, generally the arrangement is made for an
immediate Murabaha transaction. The Islamic Bank acts as buyer of
goods, and the invoices and documents shall be in its name or in the
name of the customer under an agency agreement. The Islamic Bank
should take the delivery, physically or constructively as an agent, and
sell the goods to the client at a cost plus mark-up (Murabaha).
However, negotiation of the bill drawn against the LC and
reimbursement of the negotiating Banks claim shall be similar as in
conventional banking systems. In case of commercial importers, an
even better arrangement can be made as a Musharaka transaction in
which the Islamic bank and the customer will be joint owners of the
goods and will share the profit on their sale, in the agreed proportion.
Taxation
Shariah perspective regarding modern days taxation system is
a very complex issue. A few jurists are against the system as a whole,
whereas a few call it a mandatory duty. In Pakistan, there are a number
of honest businessmen, who are not that much honest in discharging
their liabilities to the society in form of taxation on the ground that it
is an unjust levy and the same needs to be abolished. This matter has
key significance and has already been debated on various forums, and
a comprehensive study of the same needs considerable time and effort.
Since the same is not the core subject of our study, we will just discuss
a few grounds on which the majority of jurists have concluded that
taxation, particularly levied by the government of a Muslim country
shall be paid honestly and justly.
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The first ground is that even if the government is not Islamic

and may not be following all the principles of Shariah in running its
affairs, it has a right under Islamic Shariah to levy taxes for running its
affairs and to provide facilities to general public. For details, the
readers may follow the old books of Fiqh, particularly Kitabul-Khiraj
by Qazi Abu Yousuf, who was one of the two most brilliant pupils of
Imam Abu Hanifa. Those who feel that there is no tax in Islam other
than Zakat are at a mistake because even in the history, at the time of
Khilafat-e-Rashida, we can find a number of taxes which were levied
in different manners on different classes of people and on different
activities.
The second ground it that even if the government is not
investing the taxation money exactly in the same way and the same
manner in which the same should ideally be invested, it is being
invested in the benefit of the general public as a whole e.g. in
development of hospitals, roads and schools, in providing subsidy for
the basic necessities of life e.g. wheat, in defense of the nation and so
on. If someone feels that the overall distribution of resources for
various categories of expenditure is not adequate, it does not release
him from his social responsibility to pay taxes.
The third ground is the abidance of the law of the land.
According to a majority of the jurists, one has to abide by any law
imposed by any government, in whose jurisdiction he lives, unless the
same is at war with the Islamic government i.e. Dar-ul-Harb (),
barring the situation whereby such law is against any basic provision of
Shariah.
The fourth and the most crucial of these grounds is the matter
of truth and fairness which is a part of our faith. You would agree that
in order to evade taxes, incorrect financial reporting, untruthful
representations with regard to details of income and wealth, and
dishonest record keeping become a prerequisite. Even if we disagree
with the first three grounds, this ground alone is that much significant
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that an honest and fair Muslim cannot tolerate distorting his faith just
to evade taxes and getting some benefits in this worldly life.
The fifth element, which also has similar significance, is the
involvement of corruption in case of evasion of taxation. You would
agree that in order to evade taxes, one has to incur some additional
cost which is a type of bribe or Rishwat (), by whatever name
called. Here we are not discussing the costs that, in our culture, are still
to be incurred to get the assessments finalized and to get the refunds
assessed. Such cost might not be termed as harsh from the payers
perspective, if the same has to be incurred to get someones right,
irrespective of all the truth and fairness in the disclosure of facts and
presentation of accounts and returns. It would be worthwhile to recall
that the Messenger of Allah SAAWS has cautioned in a well known
Hadith that the person paying the bribe and the one receiving the
bribe, both are destined to the Hell.
In view of the above, it may be concluded that a Muslim
businessman should be fair and honest enough to disclose his
accounts to taxation authorities. If this approach is developed, this will
also contribute towards improvement in the Islamic banking system,
particularly in the product being offered under Musharaka and
Modaraba modes, because at present, the bankers generally hesitate in
investing under these modes because of a general phenomenon of
untruthful presentation of accounts, mainly with an objective of
evasion of taxation.
Dealings in Foreign Currency
Dealings in currencies are allowed by Shariah with certain
conditions. According to majority of jurists, sale of currency against
other currency is a Sarf transaction i.e. similar to a transaction of sale
of gold against gold and silver against silver or gold against silver. In
such transactions, it is a clear Shariah ruling that the transaction should
be done on a spot basis and same commodity can not be sold against a
different quantity. Based on the same principle, dealing in currencies
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should not be done on deferred delivery basis and the same should be
made on a hand to hand basis.
It would also be interesting to note that a relatively small
school of thought contends that the currencies prevailing in the
modern day market are not real Thaman and accordingly, the
principles applicable to Thaman should not be applied thereto. In view
of such jurists, a sale of currency against other currency can be made
on deferred delivery basis and at any price that may be mutually agreed.
Such jurists also allow a Salam transaction for foreign currencies. Any
person having commonsense can easily understand that such practice
can open doors for earning interest under the shelter of foreign
currency transactions, and accordingly, most of the jurists have
strongly opposed such treatment. This debate is a bit tricky and
complex in nature. However, being prudent, it is advised that all the
foreign currency transactions should be carried out on a spot basis.
In view of practical difficulties, jurists have allowed that the
time lag in clearing of cheques, shall not be considered a deferred
payment for this case and instead, the same shall be considered a spot
payment. Similarly, it has also been consented that a debit or credit
note issued by a commercial bank or financial institution, evidencing a
money transfer or conversion shall also be considered to be a sport
payment for this purpose.
Investment in foreign currencies, for hedging of risks or with
a motive to earn profits from increasing currency rates, is also allowed
in Shariah without any further conditions. However, the marginal
trading of currencies as generally prevalent in the forex market, as well
as, short-selling or selling without possession of the same are also
prohibited because of the general principles applicable to sale
purchase transaction. Similarly, forward sale and purchase of foreign
currencies are not allowed, although a unilateral promise to buy and
sell currency at an agreed rate on a future date is considered
permissible by majority of jurists.
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Forward Contracts
As we have already discussed in the previous chapters,
forward sales and purchases, as in vogue in the business culture are not
permissible from Shariah perspective. Nevertheless, Allah Almighty
has been kind enough to provide us alternates to such transactions in
different forms. The first form of forward contracts which are
allowable under Shariah perspective is Bay Salam. However, in order
to avoid the element of uncertainties in a conventional forward
contract which makes it a sort of gambling, Shariah has prescribed a
number of conditions that need to be followed in case of a Salam
transaction. Such rules and provisions have been discussed in detail in
the previous chapters.
The second form of forward sales which is allowed by jurists,
is an Istisna contract i.e. a manufacturing or construction contract.
Like Salam, in case of Istisna also, there are a number of conditions
specified in Fiqh in order to ensure elimination of the uncertainty
factor from such transactions.
In addition to the above mentioned forms of forward sale
transactions, most of the jurists have considered allowable to enter
into a unilateral promise to buy or sell a commodity in future and such
promise may or may not be binding on the promising party.
Nevertheless, the same shall be considered merely as a promise and
can not be accepted by the counter party at the stage of promise.
There are a few other conditions also applicable to such transactions,
particularly, that the promising party should be in position to provide
the commodity or make the payment as of the promised date, as the
case may be. Similarly, the matter transfer of risk and reward of the
commodity shall be finalized once the actual transaction will be
consummated as of the future agreed date.
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Marketing
Marketing is the art to sell. In the commercial world,
marketing has emerged as the most important and dependable
segment of a business and has even surpassed the production segment.
It can be rightly said that the production of good quality, generally can
not and do not generate as good results for a business as marketing of
good quality can.
While not denying the benefits of good marketing, we wish to
draw attention of the entrepreneurs to the fact that sometimes the
basic marketing techniques being used by various businesses globally,
as well as, in the local market are clearly contravening the basic
principles laid down by Islamic Shariah in this respect. Under Shariah
principles, the marketing should be based on truth and honesty,
without any false claims. There are a number of Ahadith in which it is
prohibited to show better quality of commodity and to hide the
negative side and to make untruthful claims regarding quality of
commodity.
Similarly, for marketing and particularly advertising which is a
significant aspect of marketing, it is a general phenomenon that
women, sex and music are utilized at their maximum to attract the
buyer. Those who do not believe in the life hereafter, may not agree,
but for a Muslim it should be enough to understand that utilization of
such prohibited tools to attract customers may result in ruining our
Halal income from Halal activities. In this respect, we feel that it is the
duty of the Muslim marketing experts to develop a code of conduct
for marketing and advertisement strictly in compliance with the
Shariah requirements.
Adherence to the law of the land
Adherence to the law of the land is one of the basic principles
of Islamic Shariah. The only principle laid down in this respect is to
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adhere to the law of the land except those in contravention to the

Islamic Shariah.
Accordingly, we can classify the Pakistan laws in two
categories. The first one, which comprises of the Constitution and a
vast majority of laws, is in compliance with the basic principles of
Islamic Shariah. The second one, particularly including the banking
laws and family laws, and generally including various provisions of
other laws are in contravention to the principles of Islamic Shariah and
hence need not to be complied with or rather give rise to a need to get
changed.
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Insurance and Takaful
INSURANCE AND TAKAFUL

Insurance is an essential feature of business in the modern
economic culture. The concept of insurance emerges from the concept
of risks hedging on the first part and risk buying on the other hand.
Conceptually the insurance may be performed for literally each and
every risk which the businesses, individuals, families and society may
face. A person having a basic knowledge about the insurance system
feels that this is a real benefit for the humanity because the insurance
company hedges each individuals risks and supports him in case of
extra-ordinary losses.
We all know that in a civilized society, particularly in an
Islamic society, it is the duty of the society in general and the
government in particular to ensure to avoid losses for its citizens and
in case of any extra-ordinary loss, to try to compensate the aggrieved
one.
Now considering the situation particularly for an environment
whereby the governments attitude is practically pathetic regarding
efforts for saving the peoples lives, properties and other assets, a
number of people are of the view that it is a situation of compulsion to
obtain insurance policies to ensure that remedies are available in case
of losses or potential losses. In order to better understand this issue we
should take a few examples.
In Pakistan, we do not have enough hospitals available at
government level, capable enough to cater the needs of the citizens of
Pakistan and, not only this, the quality of service rendered by these
institutions is hopeless. Similarly, the functionality of police and other
law enforcing agencies is very much questionable, when the question
arises of saving the lives, properties and other assets from killings,
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burglary, thefts etc.. Similarly, the performance of fire fighting

departments and traffic system may also be categorically termed as
below the anticipated level. More importantly, if someone dies, leaving
widow and children and often including other dependants also, what is
the support that his family may expect from the society to compensate
the loss suffered by them? And being practicable we should realize
that the loss suffered by such dependants duly includes the financial
issues that arise just after the death of a person.
The most common forms of insurance include life insurance,
medical / health insurance, education insurance, business loss
insurance, marine insurance, theft and burglary insurance, automobile
insurance, fire insurance and group insurance for life, health and
disablement which generally cater to the most of the human needs in
case of losses.
Why Insurance is Considered Haram
For a layman, particularly, the one with a very little knowledge
of the Islamic financial system and knowing a little about the practical
benefits of insurance, this question is very crucial which is very well
addressed by a number of scholars. In the ensuing paragraphs we wish
to have a brief discussion on this issue.
Conventional insurance system includes three basic Shariah
non-compliance issues that cause this to be impermissible under
Shariah. These three issues are relating to involvement of:
Gharar ( )i.e. uncertainty;

Maisar ( ) i.e. gambling; and
Riba ( ) i.e. interest.
Gharar Uncertainty
Gharar literally means uncertainty. In Islamic contract law,
this term is used whereby any of the terms of the contract are not
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fixed and certain and includes uncertain and contingent factors. It is a

consensus amongst Muslim jurists that any financial contract
containing uncertainty shall not be considered permissible and is,
hence, considered void from Shariah perspective.
Analyzing a typical insurance contract from this perspective,
we find that an insurance contract is between an insurer and the one
insured containing contingent and uncertain provisions regarding the
outcome of the contract in various different conditions and
accordingly, it explicitly contains the Gharar factor hence is not
permissible at all, from the Shariah perspective.
Maisar Gambling
A conventional insurance contract may be termed as a
civilized form of gambling also if perceived from an independent
perspective. In this contract, you may realize, that the insured party
make fixed premium payments which are either lost at all or might
return in form of much higher amounts. Accordingly, you may find
that in the western societies the insurance has also become a gambling
game and theoretical and unrealistic assumed risks are also insured as a
part of business. However, there is a group of jurists who are of the
view that an insurance contract does not involve the Maisar element
because it always caters to a real financial risk.
Riba Interest
In normal insurance contracts, interest is included in three
forms. The first factor is in the very nature of the contract i.e. the
amount paid as premium is either less than the amount received
against claims or is, as generally the case is, higher than the amount of
claims received. In Shariah perspective, in any contract other than a
trade or service transaction, the amount received should always be
equivalent to the amount paid. Otherwise, any excess or deficit shall be
considered as a kind of Riba. Notwithstanding this general view of the
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jurists, there are a few scholars who do not consider it to be Riba from
this perspective.
The second factor is that the insurance companies generally
invest their savings in various securities and investments which bear
interest either directly or indirectly. These investments also might
include certain investments, whereby although the interest is not
involved but the core activities of the investee are not in compliance
with the injunctions of Shariah.
The third factor is specific to certain types of insurance
contracts, particularly life insurance contracts, which include the
concept of annuity. According to such schemes, in case the insured
person does not make any claim upto the date of expiry of policy or
another pre-agreed date, he is paid an amount equivalent to the
annuity of his premium payments worked out on the basis of a preagreed rate. The relevant details of such computation depend upon the
scheme of such pooling.
All of these forms of involvement of interest are not
permissible from the Shariah perspective and accordingly render the
insurance contracts void and impermissible.
Lack of Reliance on Taqdeer
Besides, the foregoing three legal issues involved in
insurance, another issue is raised by a number of Shariah scholars on
spiritual and religious grounds that relates to the faith ( )of a
Muslim on Taqdeer (). Needless to mention, faith on Taqdeer is
considered to be a prime facet of faith in Allah SWT. According to
these scholars, insurance lead to lack of a persons reliance on Taqdeer
and accordingly, it is an indication of weakness in ones faith.
Based on this concept, coupled with an assumption that
Gharar and Maisar can never be completely eliminated from an
insurance contract or any alternate thereto, there is a relatively small
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school of thought of Muslim jurists that strongly upholds that any

insurance contract or any alternate thereto is never permissible.
Nevertheless, such school of thought allows such contracts only in the
case of compulsion or Iztirar (), which denotes the condition
whereby the necessity is of such significance in which every Haram
becomes Halal for the time being.
Alternate of Conventional Insurance
System Takaful
The history declares that the first form of Insurance that was
practically applied in the business world was the marine insurance
scheme initiated by Muslim merchants. This scheme was based on the
concept of Takaful which implies mutual cooperation and social
security.
In modern Islamic finance, Takaful has emerged as an
alternate to conventional insurance business. Takaful companies are
now operating in most of the parts of this world, particularly the
Islamic world. In addition, to cater with the concept of re-insurance
which plays a vital role in stability of insurance business throughout
the world, the concept of Re-Takaful has also been introduced.
How Takaful works?
Takaful business works on the concept of mutual benefit. In
conventional insurance, the insurance company guarantees to make
good any loss being sustained by the customer against the insured sum.
Contrary thereto, in Takaful, the customers mutually agree to form a
Takaful fund for mutual benefit and the Takaful company acts merely
as the fund manager. Takaful company earns its management fee in
different forms and in certain models, also become a partner in the
Takaful pool.
All the contributions of the customers (i.e. the premiums, if
we call them conventionally) are deposited in the Takaful pool which
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is then invested in various Shariah compliant investment avenues.

These avenues include real estate, permissible securities including
shares, certificates and Sukuks and if law of the land permits, in
Islamic financing options also.
At the time of commencement of business, the Takaful
company provides funds to the Takaful fund. Under the model used in
Pakistan, these funds are provided as cede money. In other models, at
times, these funds are provided in form of Musharaka. Similarly, in
case of model used in Pakistan, in case of losses in the fund and cash
shortfalls, the Takaful company provides Qard-e-Hasana to the Fund,
while in some models; the Takaful company provides capital on
Musharaka basis.
Against the services provided in respect of administration and
marketing of the Fund, the Takaful Company is entitled to an upfront
a Wakala fee i.e. the agents commission which constitutes
reimbursement of its expenses, as well as, its profit margin / fee for
providing such services. This Wakala fee is worked out as a proportion
of total contributions earned. In addition, management fee i.e.
Modarib share is paid to the Takaful Company out of the profits of
the Takaful pool in line with the rates and proportions agreed. In
addition, in certain models, the Takaful company is also a partner i.e.
Musharik in the Takaful pool and accordingly, its share of profit is also
paid in respect of its amount of capital involved. All the remaining
profits are attributable to the Takaful pool.
All the losses reported (claims made) are paid out of the fund
and adequate provisions and reserves are made in the fund in line with
industry practices. If after payment of all losses, and after making all
adequate provisions and reserves, there arises a surplus, that surplus
may be refunded to the contributors through a pre-agreed mechanism.
Generally the modeling of a Takaful company, particularly,
the determination of sharing ratios, contribution rates and Takaful
limits are determined with the help of an actuary. Similarly, the
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determination of adequacy of different types of reserves and

provisions needs involvement of actuaries or insurance experts.
Generally these rates, limits etc. are kept in line with the general
insurance practices prevailing in the market, in order to ensure that the
product remains compatible to the market. In certain cases, a Takaful
company may establish more than one Takaful Funds to cater
different types of businesses.
HOW TAKAFUL WORKS?
CUSTOMER
(PARTICIPANT)
Payment of Contributions
TAKAFUL
COMPANY
(OPERATOR)
Qard-e-Hasana
in Case of
Excessive
Losses
Cede Money +
Contributions less Wakala
Fee
CLAIMS LOSSES
TAKAFUL FUND - WAQF
Funds Invested in Shariah Compliant
Opportunities Adequate Reserves and
Provisions Created
SURPLUS
(After Payment of
Qard-e-Hasana)
Modaribs Share for

Investment Income
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Chapter Ten
Re-Takaful concept entails partnership and Takaful agreement

amongst various Takaful funds through a Re-Takaful operator who
maintains a Re-Takaful pool under Shariah principles. Under these
contracts, all the Takaful funds become partner to each other in a
similar manner and the losses of the participants taken as a whole are
covered in the agreed proportions by the Re-Takaful pool.
Rationale for Permissibility of Takaful
A few people question the permissibility of Takaful on the
grounds that the factors that are considered base for prohibition of
Insurance from Shariah perspective are also applicable to Takaful in
one or another form. This is a very important question and needs
clarification for a readers mind.
Actually, in a Takaful arrangement, all the participants
collectively agree to bear losses against risks faced by each other in an
agreed proportion. The rationale for collective benefit is taken from a
few instances from the life of the Holy Prophet SAAWS and his
Sahaba. In such instances, at the time of any emergency, all of the
Muslims were asked to submit their entire available food and then
these were mixed up and then eaten collectively. These instances are a
raw example for a Takaful funds operations.
The first factor making insurance Haram i.e. Gharar also
exists in a Takaful contract but the same is not limited to an individual
and instead the same is now spread over the fund as a whole with the
mutual consent of all the partners. Accordingly, it is not a contract
between two persons out of whom one is guaranteeing the other that
he will make payment in case of loss and instead, all of them are
collectively agreeing that in case of a loss to any one of them, all of
them will bear the loss proportionately. The second factor i.e. Maisar is
also eliminated in the same manner. Moreover, in a Takaful fund, the
surplus relates to the participants and theoretically speaking, if there is
no loss to any participant, all the money will be returned to the
participants along with any proportionate profit earned thereon.
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The third factor i.e. Riba is also eliminated in this concept. As

far as investments of the funds are concerned, these are all made in
Shariah compliant ways. Similarly, no annuities are built in a Takaful
contract, however, in a family Takaful scheme, participants
investment funds are separately maintained and invested under Shariah
compliant options.
As regards to the other aspect of Riba applicable to insurance
contracts is concerned, we also take guidance from the above given
examples whereby the entire ration was first collected centrally which
also included the items for whom it is necessary to make transfer hand
by hand and in equal quantities like wheat and barley. Taking support
from the same principle, it may be concluded that in case of collective
benefits, such transfers do not tantamount to Riba.
Although it is just a brief understanding of the concepts of
Takaful, hopefully it would be sufficient to have an understanding of
the concept. Anyway, it would not be possible for us to go in further
details in this study. Interested readers are recommended to consult a
number of commendable works on the concepts and applicability of
Takaful written by a number of respectable scholars.
Takaful business in Pakistan
In Pakistan, Takaful business is now in formation stage just a
few Takaful companies have been established with an objective of
promotion of such business in Pakistan. Takaful Rules have been
finalized and enacted by the SECP providing foundations for
formation and functioning of Takaful companies.
A few companies are also waiting to commence business in
this field. Similarly, it is also expected that as soon as the Islamic
alternate to insurance will start taking a sizable share in the market, the
conventional insurance companies will also enter into this field by
opening Takaful companies or windows.
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The modeling of Takaful business in Pakistan has been

performed after due consultation and study of the existing Takaful
systems in vogue in different parts of the world. Since, this modeling is
taking place at a mature stage, it is being ensured that the mistakes and
doubtful options that were included in the earlier models, shall not
continue in such model.
It is a sad, but bitter, fact that at present there is no ReTakaful option available in Pakistan and accordingly, the Shariah
consultants have allowed the proposed Takaful companies to use the
option of Re-Takaful, from internationally renowned companies under
available modes until the time when better options becomes available,
within Pakistan.
Other Alternates to Insurance
Other alternates to insurance also work on the concept of
mutual benefit because the contract of guarantee against a loss is not
considered permissible from Shariah perspective. These alternates are
generally based on mutual benefit funds, benevolent funds and
contributory plans that are established against conventional group
insurance, medical and health insurance and life insurance schemes.
The modeling of these funds is not as complex as of a Takaful
company and more importantly, these are not subject to strict
statutory rules and regulations. In most of the cases, this sort of funds
also fetches some tax benefits on the concept of doctrine of
mutuality particularly, approved benevolent funds are considered to
be exempt from taxation.
However, generally no Re-Takaful option is available to these
funds and accordingly these are considered to be less stable. As a
consequence thereto, generally the benevolent funds established for
the benefits of employees are supported by the respective employers
against any loss.
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Financial Reporting Principles
FINANCIAL REPORTING
PRINCIPLES
Most of the experts in Islamic finance conclude that the real
Islamic banking and finance system, which should be ideally based on
profit and loss sharing, can not be implemented till the society, as a
whole, does not change its behavior through implementing a just and
fair financial reporting system. Particularly, complex models of profit
and loss sharing can not work if an accurate, honest, fair and timely
financial reporting system is not in place. Keeping in view the
significance of the same, in this chapter, we will discuss a few issues in
respect of financial reporting.
It is a prerequisite for a Shariah-compliant business that its
accounting and financial reporting is properly performed on the
principles of honesty, truth and fairness. Honesty, truth and fairness
are the basic principles taught to us by Islam and these are required to
be followed in all facets of our lives.
Honesty and Truthful Presentation
Telling and insisting on truth is one of the basic principles of
Islamic Shariah. This becomes more significant in view of the basic
principle of honesty that also requires a businessman to be truthful in
his representations relating to business.
In Islam, honesty is not a policy, but an integral and
fundamental principle on which the structure of Islamic way of living
has its foundations. In perspective of financial reporting honesty
becomes more and more important in contrast to the general business
reporting framework which has a great number of loopholes. These
loopholes are of such significance and impact that these can even
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cause disasters like Enron which not only affected its employees and
stakeholders along with their families but also resulted in fall of the
giant accounting firm Arthur Andersen. The prime cause of such
disaster was window dressing of Enrons financial statements in case
of special purpose entities.
Accordingly, in order to ensure compliance of Shariah with
respect to the matters of financial reporting of a business, it is
imperative to report everything honestly. In other words, the
loopholes available in customs, laws and practices, should not be
utilized to show incorrect picture of business to the outside world.
Such outside world includes shareholders, creditors, regulators and
others concerned.
The only exception in this area that may be given on business
grounds is to hide information where it may be harmful either for the
business or its owners. Such exemption does not entail hiding anything
that misleads any outsider. Moreover, whereby any information is
necessary to be disclosed for understanding of the financial reporting,
the same should be clearly disclosed.
The first and the foremost aspect of accounting in accordance
with the Shariah injunctions is truthful presentation of the state of
affairs and results of operations. Saying, writing and striving for the
truth is a motto for a Muslim whereas a lie is rightly said to be against
the basic principles of Islamic way of living.
Truthful presentation of the accounts is not only a basic
principle which an individual should follow, but is also serves as a
basis for the interest-free economy. This situation is defined by the
economists and bankers that the most stringent hurdle in the
transforming of economy on an interest-free basis is the matter of
unfair preparation of accounts.
This situation is very much apparent from the current position
of doubtful portfolio of Pakistani banks. According to an estimate an
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amount of approximately Rs. 200 billion is still stuck-up with the

defaulters. According to a general observation, most of these
defaulters are living a life with a lifestyle much lavish compared to the
one that was being lived by them earlier to obtaining these loans.
Similar is the situation of the directors of numerous companies listed
on the stock exchanges (including those subsequently de-listed) who
have a regular practice of depriving their shareholders, creditors and
regulators. The basic factor behind this tragedy is the fact that the
matter of faithful and truthful presentation of accounts and other facts
of business has been completely defeated.
When we consider this situation in our utopia of an interestfree economy, we come across a more severe situation as in case of
Musharaka and Modaraba it is easier to transfer fake losses to the
financier as compared to the options available in an interest-based
economy. Ex-Governor of the State Bank had rightly said that
presently a businessman prepares three different accounts for the
regulators including taxation authorities, the general public and for
himself whereas in an interest-free system, he will have to prepare an
additional set for the bank with a different bottom line.
Keeping in view the above scenario and the basic Islamic
principle of telling the truth, in all favourable and unfavourable
circumstances, it might be considered to be the most important aspect
of accounting of a Shariah compliant business.
Uniformity of Form and Substance
In the traditional accounting, a principle of substance over
form is very much common. This principle requires that the
accounting of an enterprise should be performed in accordance with
the basic substance of the transaction, irrespective, of the legal form of
transaction. For example, under the traditional accounting principles, it
is required to account for any finance lease as a purchase of asset and
relevant liability and financial charges should be accounted for as such,
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because in substance of such transaction, it is a purchase of an asset

and not a lease of the asset.
When you consider the basic theme behind this theory, you
will come across a very basic principle of secular business, i.e. molding
and engineering the design of transactions in order to get the
maximum benefits. For this purpose it is a general practice to evade
laws and principles and to misrepresent facts to others. The principle
of substance over form is devised to counter such theme of
businessmen, and to ensure fair presentation of business transactions
irrespective of the legal form designated to them.
According to the same principle you can observe that the
banks in Pakistan generally record the Islamic finance transactions as
merely finance transaction and do not account for the substance of
such transactions (e.g. trading or leasing or joint-ownership of assets)
as appearing in the relevant agreement. According to the Islamic
Shariah the substance and form of the transaction should always be
the same. Consequently, accounting there for should also be
performed in the same manner. The basic theme behind such theory is
the matter of truthful presentation for all. As an example, if we take
the case of Pakistani banks, we will observe that their basic business
remains providing finance on an interest carrying basis. On the
contrary, according to the laws prevailing in Pakistan, they cannot
provide such financing facility, so they design a transaction in a
fashion that on paper is appears to be a transaction of Murabaha or
Bay Muajjal. Being an interest-based financing in principal, its
accounting treatment is ensure to be just like any interest-based
financing in any other country, on the principle of substance over
form.
This situation is against the principle of Islamic Shariah that
the transaction of so called Islamic Finance is in principal similar to
the one being performed by a purely secular bank and merely drafting
an agreement in compliance with the injunctions of Islamic Shariah
does not transform a Haram transaction in Halal one. A Muslim
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should keep in mind another factor that the intent is always known to
Allah SWT, hence just trying to make a fool of others by making a
paper arrangement without changing the substance of transaction
might transform his business to be Shariah compliant in the eyes of
people, but this could not suffice to prevent him from grapple of Allah
SWT in the life hereafter.
This situation, in case of Murabaha, has improved after
implementation of the Islamic Financial Accounting Standard
(IFAS) 1 Murabaha which has now been adopted by a majority of
Islamic financial institutions. It is, anyway, an unfortunate fact that a
few Islamic financial institutions have not yet adopted this standard
and instead they are debating against its implementation. IFAS 2, on
Ijara is also expected to be applicable in the near future.
Audit
In an Islamic society, audit has dual significance when
compared to a conventional society. In a conventional society, if the
investor does not rely on the truthful presentation of financial
statements and other financial data by the investee, he has the option
to make investment based on fixed rate of return i.e. interest. However,
in Islamic financing, although certain products are available with fixed
rate of return including trade-based and lease based modes of
financing, the prime modes are based on profit and loss sharing which
require more realistic and truthful financial reporting culture. Even in
case of fixed return based financing, it is an obligation of Muslim
investors to waive any debt in case the debtor is really bankrupt, which
cannot be ensured unless the financial reporting system ensures
credible financial reporting.
The profit and loss based instruments of Islamic financing
always underlie a presumption of truth, honesty and faithfulness that
creates one partners reliance on other partners. This necessity arises
particularly where the profit and loss based financing options are used.
According to the very basic principles of Shirkah and Modaraba, it is
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eminent that each time a partnership is entered into all the partners
should invest in form of cash or cash equivalents (particularly, gold
and silver) and whenever the partnerships reach to an end it should be
fully dissolved and all the assets should be sold and the respective
shares and principal should be repaid to the respective partners.
Mostly, the jurists have allowed that in case an audit of accounts has
been performed, the partnership may be dissolved by transferring its
assets to the partners against their capital, as agreed and the profit and
loss be allocated accordingly.
Nonetheless, in view of the present economic scenario, it is
apparently not possible in case of most of the enterprises that the
Islamic financial institutions may opt for profit and loss based options
because of lack of reliance on the financial reporting. Consequently,
this matter is causing an impediment in the transition of financial and
economic system on Islamic principles.
Selection of auditor
Generally the matter of selection of auditor is not awarded
with the significance that it deserves, particularly, in an Islamic society.
It is generally observed that audit is considered to be something
forcefully levied on an enterprise and accordingly, it is the effort of
most of the entrepreneurs to get rid of this thing by going for the
cheapest and the most easy or rather cozy auditors.
While reserving our comments on the integrity, independence,
professionalism and honesty of a number of auditors working in this
country, we shall recall that the auditor serves the purpose of an
independent check on the financial affairs and besides this, a
competent auditor also assists the management in improvement of
financial reporting and financial affairs. Accordingly, the appointment
of an independent and competent auditor is generally in the benefit of
the organization.
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Besides this, an effective auditor also performs the duty of

representative of minority shareholders and external stakeholders,
including the financial institutions. Accordingly, while selecting the
auditor, the perspective of these stakeholders should also be
considered.
On the other hand, it is the responsibility of the Institute of
Chartered Accountants of Pakistan (ICAP) and the Securities and
Exchange Commission of Pakistan (SECP), as well as, the State Bank
(where applicable) to ensure that the quality control for auditors is
ensured at all levels. This will valuably assist the stakeholders in
identification of suitable auditors.
Regrettably, the procedures being applied by the regulators
and SECP for evaluation of quality of performance of auditors are still
not effective to the extent these should have been as evident by the
fact that still a number of brief case auditors are working in this
country. Unless these bodies make their role more effective in this area,
it would be difficult to improve the audit culture in the country.
In this respect, the dormant shareholders may also play an
important role by promoting the auditors by whose quality they are
satisfied, irrespective of the amount of fee being charged. Generally
the fee of a few hundred thousands or in certain cases a few millions
may be termed as peanuts in the volume of business of most of the
companies operating in Pakistan and any savings in such fees cannot
be considered to be a contribution to the bottom line. One should
appreciate that like any other business, in order to obtain the quality
services of an independent auditor you should pay him upto his
satisfaction. And if he is not satisfied with the fee he is being paid, it is
humanly possible that either his independence may be impaired by
obtaining additional assignments directly from the management or the
quality of service he is providing may be jeopardized.
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Internal Audit
Internal audit is also a very important function for a living
organization. While the external auditor performs a check on the
financial reporting and the financial affairs of the organization on a
test basis, an effective internal audit function maintains a check and
balance system within the organization particularly in operational and
financial areas.
Internal audit becomes more significant in the organizations
whereby the minority shareholders or the external financial institutions
have significant stake. In case of listed companies, the internal audit is
now a statutory requirement by virtue of the Code of Corporate
Governance. Nevertheless, other organizations are generally not
enjoying the benefits of internal audit function.
In order to safeguard the benefits of the minority shareholders,
financiers and other stakeholders, the internal audit function should be
reporting directly to the Board or the Audit Committee and its
functions and responsibilities should remain independent of general
management functions.
Codes of Ethics issued by AAOIFI
In respect of the responsibilities of the employees of Islamic
financial institutions and the professional accountants involved in
accounting, financial management and auditing of Islamic financial
institutions the Accounting, Auditing and Governance Standards
Board of AAOIFI has issued code of ethics for such professionals.
Such codes of ethics define the basic principles for the conduct of the
professional duties by such professionals and are considered to be a
recommended reading for every professional.
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Chapter Twelve
Problems of A Muslim Employee
PROBLEMS OF A MUSLIM
EMPLOYEE
Having discussed the problems with the entrepreneurs, now
we wish to discuss a few problems with the employees. You will,
however, observe that a number of these problems are also the matters
of concern for the entrepreneurs themselves.
Seeking the right job
Generally the interviewers allow the prospective employees to
ask a few questions at the end of a successful interview regarding the
job and the organization. The most common questions asked by the
employees include the following:
What will be the salary and what will be the benefits?

What will be the designation and to whom I shall be
reporting?
What are the duty timings and leave arrangements?
What will be the job description?
Certain smart candidates also ask a few questions like that:
What are my growth prospects and what career

opportunities do you offer to me?
What is the current organizational structure and what
sort of expansion is expected therein?
How much will be the job pressure and what are the
past trends of employee turnover?
What is the financial position and what growth
prospects of the organization can be foreseen?
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However, most of the candidates do not ask a question which

is supposed to be the most crucial question for a Muslim employee i.e.
whether or not this job is Halal for me? It is not necessary that this
question be asked directly or rather bluntly, but you would appreciate
that entering an organization without even knowing, as to whether the
earning from such organization is Halal for you, is something
questionable.
The factors that need to be considered in this area include the
following:
Whether or not the prime business of the

organization is Halal? i.e. it should not be an
organization involved in Haram activities. As an
example, doing a job in a conventional bank, an
insurance company, a brewery or a television channel
involved in activities not allowed by Shariah is not
permissible for a Muslim; and
Whether or not my duties include anything that is not
permissible by Shariah e.g. paying bribes, dealing with
banks for interest-bearing transactions, lying and
making untruthful presentations for the purpose of
marketing or financial reporting and like that.
You should remember that if your earnings are Haram, then

anything you do, cannot balance it, because according to a Hadith as
already discussed earlier, the Hell has the first right on the person
whose meat is developed by eating Haram. And remember that by
earning Haram one does not only makes himself a fuel of the Hell but
also endangers all his dependents to meet this eventuality.
Time and duty
Once you have joined a job with an organization involved in
Halal activities, and with a job description considered to be Halal, as
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well, the next question arises of making the earnings Halal by keeping
regard to the time and duty.
A school of thought has the vision of employment as a part
time slavery. On the contrary, another school is of the view that it is
just a transaction of selling your services. Supporters of the former
view are generally from those who are more lucky ones, i.e. from the
employers side. They view such an arrangement just as a gesture of
their kindheartedness that they have given an opportunity to such
person to serve them. They have various grounds that bring similarity
in the slavery and employment.
Viewing the matter in a purely secular perspective, one may
agree or disagree with any or both the perspective, nonetheless, in
Islamic Shariah the matter of employment is something different from
both the viewpoints. Although the latter standpoint is nearer to the
Islamic perspective, it also has a few weaknesses that should not be
tolerated.
Anyway, the matter of timing and duty are a main concern
regarding the honesty of an employee. This is not only considered to
be ethical but also a religious duty to ensure that a Muslim employee
abide by the terms of employment, including but not limited to, the
timing of duty and the responsibilities assigned as the duty.
Fulfilling all the duties in most effective and efficient manner,
at best of your capabilities and using the official timing for official
purposes ensures that as a Muslim employee you are making your
livelihood Halal.
Retirement benefits
Another basic problem, which generally a Muslim employee
faces, relates to the retirement benefits which also include the benefits
in case of death in service and injury compensations. These benefits
are generally paid through specially created funds and most of these
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funds, nowadays, consist of interest-based investments or at the least,

such investments comprise of the major chunk of such fund. Similarly,
in a few circumstances, these benefits involve insurance contract or
such a transaction that entails Gharar which makes them doubtful in
the eyes of a Muslim.
Following are the generally applicable retirement benefits.
Provident Fund;
Pension;
Gratuity;
Benevolent Fund;
Death / Injury compensation;
Group Life Insurance.
Provident Fund
Provident funds are very common category of retirement
benefits in Pakistan. Being generally applicable in the government
institutions make these further common. In a traditional provident
fund, each employee contributes a specific sum per month, which is
directly deducted by the employer from his salary. Such sum along
with an additional promised sum contributed by the employer, which
is generally equal in amount, is paid to a fund being administered by
trustees appointed by the employer including nominees from the
employees. The trustees invest such sum in various schemes that are
generally interest-based. Any return on such investment is also
credited to the employees account maintained by the trustees in
proportion of employees balances at the end of the year.
In a few arrangements, a minimum interest is also guaranteed
by the employer on the employees balances. In certain circumstances,
particularly in the government institutions, no separate fund is
established and the employer itself manages the fund in the similar
fashion and pays a fixed interest on such balances. .
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At the time of retirement, termination or death, the amount

appearing to the credit of a members account, including the amount
deducted from his salary, employers contribution thereon and the
interest earned during the service period is paid to the employee or in
case of his death, to his nominees.
Provident funds also grant loans according to their rules
which also generally bear interest. These loans are repaid along with
the interest thereon, by the employee through deductions in his
monthly salary. In certain circumstances, permanent withdrawals are
also allowed to the employees.
A few of the scholars opine that any amount paid by the
provident fund at the end of the service, since, it comes into the
ownership of the employee or its successors at that time. They are of
the view that since such amount was not in that employees control, so
his ownership is not complete and accordingly, he cannot invest such
amount in a Halal option of his choice. Accordingly, when such
amount is paid to him, it comes into his ownership for the first time so
even if it includes interest, it is Halal for him. This principle is
generally applied by scholars in case of government provident fund
whereby it is a mandatory fund and the same is not in the custody of
the employee or the trustees as his agents. This logic, on the contrary,
may not be applied in case of private provident funds.
Notwithstanding the said logic, in view of most of the other
scholars, such portion of such amount which represents interest
earned during the service life is not Halal for the employee.
Pension and Gratuity
The other common retirement benefits are pension and
gratuity. These are very much similar in most of the aspects because in
both the cases the employer promises a specific sum in lump sum or
according to certain formula that is paid to the employee after the
retirement or death. Pension is generally paid on monthly basis,
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nonetheless, in certain schemes an option of commutation is provided

to the employees, which makes it similar to gratuity. In most parts of
the world, the common wording of pension is used for all these type
of benefits.
Gratuity, according to Pakistani labour law, is applicable for
every employer having more than 20 employees (in case of commercial
establishment) or 50 employees (in case of industrial establishment),
subject to a proviso whereby an employer who has arranged a
provident fund is not obliged to pay gratuity. The statutory rate of
gratuity is 30 days wages (last drawn) for each completed year of
service.
On the other hand most of the government institutions and a
number of multinational corporations offer pension in addition to or
as a replacement of these benefits. Pension is paid under various
formulas which in some cases are dependent on the death or type of
retirement and even the number of successors etc..
Since the gratuity and pension are paid to the employee
according to the promise entailed in the terms of employment, these
are considered to be Halal.
Only one concern arises whereby a number of employers have
funded their schemes. In a funded scheme the employer pays
contributions to the respective fund and the trustees of the fund invest
the same in various investment schemes and profitable ventures,
which are generally not considered Halal. Nevertheless, such practice
may be termed as devastating because in a Muslim society, it needs to
be ensured that these funds are invested in Shariah compliant avenues
only.
Contributions to such funds are generally computed by
actuaries and experienced accountants and financial analysts in order
to ensure that the future liability on these accounts is best met by the
contributions and the return on investment of such contributions.
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However, in case of a loss or deficit in the fund, the employer is

responsible to make good the same and on the contrary, in case of a
surplus in the fund, the same is paid back to the employer either
directly or in form of reduction in future contributions.
Gratuity, pension and similar benefits are paid as per agreed
terms, irrespective of funding of the scheme and irrespective of the
amount of profits and losses on these funds. Moreover, any profit and
loss on such investments belongs to the employer. Accordingly, there
is a consensus amongst the scholars that the amount received by the
employee from a funded gratuity or pension scheme is considered
Halal for him because it is as per the agreed terms with the employer
against his Halal job description and it is the employer who is earning
Haram to make such payment.
Other retirement benefits
Other retirement benefits are also dealt with using the same
principles as defined above for the provident funds and pension /
gratuity schemes because these generally follow the same principles. In
case of any distinct nature scheme, it would be prudent to get advice
from an expert of the field or a Shariah scholar.
Loans and advances
Obtaining loans from employers is a common phenomenon
in Pakistani business culture of medium to large sized organizations,
provided that the employer is that much generous. In certain
circumstances, employers also prefer to lend loans to employees,
which help them retaining the employees for long periods.
Following are the general types of loans provided by the
employers:
Interest-free advances and loans;

Advances against expenses;
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Interest-bearing loans and advances;

Loans from provident funds;
Loans from benevolent or welfare funds.
Facility of interest-free loan is generally provided by a very

few employers. Instead, it is observed that providing a loan bearing
interest rate less than the market rate is considered to be a benefit to
the employees. Needless to mention, the amount or rate of interest
does not make it Haram, but it is the functionality it has. Accordingly,
low interest-bearing loans are as much Haram as are those carrying
high rates of interest. Short-term interest-free advances against salary
for a few months are comparatively a better option, if available. These
advances are generally not a common policy of most employers and
are granted against various specific needs. The only precaution in this
respect is the truthful application against genuine need. Obtaining an
advance against a fake need makes the transaction doubtful in
substance. Even in case of a genuine need, a fake application
mentioning wrongful contents brings doubts in the transaction.
Advances against expenses are provided to the employees
responsible for managing day to day purchasing and administration
functions. It is more common in case of employees who are in travel
or are stationed at other locations. For a Muslim employee, the main
concern in this area is the concept of Amana or Trust. According to
the very basic principles of Islam, an Amana needs to be returned to
the one to whom it belongs, as it is, without any intervention by the
holder. Accordingly, any advance received against expenses by the
employer should always be termed and treated as an Amana. The
employee holding such advance has no right under the Shariah to
utilize such amount in any of his personal uses except specific
permission from the employer for the effect.
Interest-bearing loans are generally against purchase of
property, construction of house, marriages, purchase of transport, etc..
From the perspective of an independent observer, none of these
objectives appear to be situation of Iztirar, i.e. situation in which
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Haram may turn Halal. Accordingly, without going into further detail
it may be concluded that such loans are impermissible for a Muslim
employee. Similar is the situation for interest-bearing loans from
provident fund or loans arranged by the employer through financial
institutions.
Loans from benevolent funds and welfare funds are sometime
interest-free and these may carry interest also, although on a lower rate.
These may be availed as long as these do not carry any interest.
However, the basic principle of truthful representation at the time of
application of loan is a prerequisite.
Owning ones own house is not only a dream for a person
from lower class to the middle class, but is also a necessity of life.
Accordingly, a house building loan generally tempts an employee more
than any other benefit that is offered by various employers. House
building loans are not very common in private organizations except
for banks and financial institutions. On the other hand these are very
much common in case of government organizations. Generally these
are provided by the employers to the employees at discounted interest
rates with an intention of retaining their employees on long-term basis.
These are repayable in long-periods of time generally not less than five
years.
Since these are mostly interest-bearing, accordingly these may
not be termed Halal irrespective of how low interest rate is offered by
the employer as a symbol of his generosity. Even in certain cases,
house building loans at rates as low as 3 percent have been observed
to be offered by the employers as a benefit to their employees whereas,
in most of the cases these are well below the market interest rates. In
this respect this principal needs to be recalled that interest-bearing
transactions are categorically impermissible irrespective of the rate of
interest implicit therein.
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Alternates for Employee Loans

As a basic rule, we all may agree, that all the interest-bearing
loans should be avoided by a Muslim employee, irrespective of the
amount / rate of interest being charged on such loans. Even the loans
which are provided through the provident fund should be avoided if
these carry interest. Just a few options available to a Muslim employee,
as an alternate to such loans, include the following:
Permanent withdrawals from provident fund

According to the provident fund rules provided by
the Income Tax Ordinance, 2001 and rules made
there under, an option is available to a member of
provident fund to obtain a permanent withdrawal
from his provident fund instead of obtaining a loan.
Such permanent withdrawal is available in case of
certain specific requirements e.g. purchase / building
of a house etc.;
Interest-free loan from provident fund In most of
the provident funds rules, if an employee has opted
not to take interest on his provident fund balance, no
interest shall be charged on any loan taken by him.
However, this rule is not common in all provident
funds and the same need to be checked before any
step is taken;
Arrangement through Islamic banks The employees
may obtain loans from Islamic banks and other
Islamic financial institutions. In certain cases, these
financing arrangements may require to be guaranteed
by the employers.
Transport Facilities
Transport facilities are provided by employers with two
different motives. The first one is as a facility in performing the duties
of an employee while the second one is to award perquisite for the
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employees. Generally in case of executives, the second motive is

applicable whereas for the field force and sales and marketing officials,
the first motive is more applicable. The facilities are provided in
various forms e.g.:
Employers maintained vehicle for official use;

Employers maintained vehicle for official cum
business purposes;
Transport allowances; and
Reimbursement of transport expenses.
For a Muslim employee there are a few issues in transport

facilities provided by the employers. These issues include the matters
of trust and misuse, leases and insurance.
The first issue that arises in the transport facilities is the
matter of trust. The vehicles and the facilities provided by the
employer are provided in trust and it is the responsibility of the
employee to take care of the same in a manner of an Amana. Any
negligence in this respect is not allowable from Shariah perspective,
and even, any loss caused due to willful neglect need to be borne by
the trustee under the Shariah principles unless the same is ignored by
the principal i.e. the employer.
Issue of lease and insurance of cars is another matter that
concerns Muslim employees. You would acknowledge that it is the
general practice of various employers that the cars and other vehicles
provided to employees are obtained on lease and as a matter of general
practice it is not ensured that the lease arrangement is in accordance
with the principles of Islamic Shariah. Similarly, these vehicles are
comprehensively insured by the employers under traditional insurance
schemes which may not be termed to be Shariah compliant. This
matter always concerns Muslim employees and those having fear of
Allah Almighty generally try to avoid the arrangement in which they
themselves get involved in transactions not allowed by the Shariah.
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Same principle applies to all other assets owned by the employer, held
in the custody of the employee.
Giving due regard to the significance of the matter, we have
to consider the basic agreement between the employee and the
employer. This agreement which is generally in form of appointment
or appraisal letters and service rules issued by the employer and their
expressed and implied acceptance by the employee. The matter that
concerns the employee is the one that is basically relating to his own
terms of employment. As discussed above, we have two motives for
providing vehicles to the employees i.e. official use and as a perquisite.
As far as vehicles provided for official use only, these matters become
totally irrelevant for the employee as to whether the vehicle has been
obtained on lease or through interest-based financing or has been
insured under traditional insurance schemes, as all these matters
concern the employer only.
On the other hand if the vehicle is provided to the employee
for both official cum personal use, basically as a part of his perquisites,
it becomes a matter of his concern also. At this stage we should refer
to the terms of employment. In most of these terms it is agreed that
the employer will provide a vehicle to the employee for use during the
period of his employment and the ownership, risk and rewards of the
asset will rest with the employer including the matters of purchasing
(either directly or on lease), payment of taxes, assuming risks of theft
and accidents (either directly or through insurance) and getting the
gain at the end of the term when the vehicle is disposed off. This
matter is very much similar to an operating Ijara contract whereby the
employee provides services and against such services the employer
provides a vehicle to the employee in addition to the agreed pay and
other benefits and the employee has absorbed no risk or reward with
regard to such vehicle except for the usufruct of the vehicle during the
tenure of his employment.
On the contrary, if it is agreed that the employer will provide a
vehicle to the employee and at the end of the agreed term, the vehicle
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will get transferred in the name of the employee, such arrangement

would be directly concerning the employee. Accordingly, the same
may not be termed permissible unless the employer has purchased the
asset from his own funds or has arranged financing from a financial
institution under various Shariah compliant schemes. Even in this case,
the matter of insurance will directly relate to the employee, if the same
is not absorbed by the lessor. Accordingly, the same should be insured
under Takaful mode, if possible. Otherwise, its insurance should be
avoided to the maximum extent possible.
Once again we should recall that in this respect it is the duty
of the employee that if most of the operations of his employer are
being performed in a way against the injunctions of Shariah he should
preferably try to find a new employment as although such an
employment may not be termed as Haram (if the duties being
performed are not against the Shariah), however, he is supporting a
un-Islamic business by his efforts.
Similar principles shall apply in case of all other assets
provided by the employer to the employee including but not limited to
household equipment and furniture, residential accommodation,
computers and office equipment, telephone and communication
facilities etc.
Medical facility
Another major facility provided by the employers is the
medical facility. It is generally provided in form of medical allowance,
medical reimbursements and the medical insurance. Generally there
arises no Shariah issue with respect to medical allowances because
these are unconditional allowances paid as a perquisite. Nevertheless,
the matters of medical expenses reimbursements and medical / health
insurance are subject to a number of Shariah issues.
Medical reimbursements, like any other reimbursement, are
supposed to be made against actual medical expenditure.
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Unfortunately, the corruption has this much penetrated in our culture

that such reimbursements are generally being misused. Without going
into the details of the frauds that our nation has invented in this
respect, we can just remind ourselves of the principle that the
reimbursements should be made strictly in line with the respective
principles and should be claimed keeping in view the principles of
truth, fairness and honesty.
Medical insurance, like any other insurance, is not considered
to be allowable from Shariah perspective and a vast majority of jurists
sticks to this decision. In view of the same, for a practicing Muslim,
there is no question of taking an insurance cover for his or his familys
medical needs. It should also be viewed from spiritual perspective,
whereby, once anybody gets ill, he and his family pray to Allah
Almighty for His mercy. How can somebody call Him, praying for
Shifa, which rests in His hands, while the expenditure on medical
requirements is being met from Haram sources? Similarly, God forbid,
if somebody dies during such treatment, having such meals and
medicine in his stomach, which are obtained from Haram sources,
how can somebody ask the mercy of Allah Almighty for that soul?
Fortunately, now we are in an era that a few Takaful
companies have commenced operation in the country and now it is
our duty to ensure that all the insurance arrangements are made under
the Takaful modes.
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Zakat
ZAKAT
Zakat ( )'is the mandatory monetary Ibadat that is Fard
( )on an annual basis on every Sahib-e-Nisab (
). It is a
basic and fundamental step towards development of an Islamic
economic system. Like Sadaqat and principles of heritage, it is one of
the basic instruments, and perhaps the most important one, that aims
for avoiding concentration of wealth in several hands.
Sahib-e-Nisab
Sahib-e-Nisab is the term defining a Muslim person who owns
at least sufficient wealth i.e. Nisab, in addition to his basic necessities.
In other words, if somebody owns some wealth over and above a
minimum exempt limit of wealth, he is Sahib-e-Nisab and accordingly,
Zakat becomes due on the wealth that he owns.
Women who have some assets particularly, jewellery are
required to pay Zakat by themselves being Sahib-e-Nisab. However, if
these ladies do not have enough money in form of cash to pay the
same, the family members may pay them some money to pay the
applicable Zakat. Otherwise, these ladies should pay Zakat by selling a
few of their assets.
Nisab
Different Nisab has been set by the Shariah for different kind
of wealth. The basic Nisab is calculated in terms of Gold and Silver.
For Gold, Nisab is seven and a half Toulay whereas for silver, it is 52
and a half Toulay. For money and other assets Nisab is calculated for
either of these two Nisab, whichever is lower.
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Nisab for animals etc. and its rate is defined separately for
most types of animals whereby in case of agricultural produce, no
Nisab is set for Ushr.
This Nisab is also important for determination of applicability
of Qurbani at Eid-ul-Azha (Baqar Eid). However, Qurbani is Wajib
( )on every Sahib-e-Nisab irrespective of whether a complete year
has passed on ownership of such Nisab or not. Even, if the wealth
equivalent to Nisab comes to ones ownership during the Eid days,
Qurbani becomes Wajib.
Basic Exemptions
The basic exemptions from Zakat may be described as a
matter of principle to be all the items of personal usage except those
intended to be sold. Personal furniture, house, vehicles, attire, and
other assets are considered exempt from Zakat. Business assets, e.g.
shops, showrooms, factories, machinery etc. are also considered to be
exempt from Zakat.
A few jurists are of the view that a number of modern days
inventions particularly including television, VCR etc. are not a personal
need hence should not be considered exempt for the purpose of
computation of Zakat. Accordingly, it is better to include all such
assets in computation of wealth for the purpose of computation of
Zakat.
Rate of Zakat
Except for agricultural produce and livestock, Zakat is payable
at the straight rate of one fortieth or 2.5% per annum (lunar year) on
ones wealth. It is always preferable that Zakat should be paid based
on lunar calendar year.
In order to avoid practical difficulties, a number of jurists
have allowed working out Zakat on the basis of Gregorian calendar. In
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such case the rate of Zakat needs to be adjusted for the difference of
number of days between both the calendars. Accordingly, such rate is
worked out to be slightly higher than the rate applicable for lunar
calendar.
Zakat Year
Zakat year is generally different for each and every individual
and commences from the very first day (of Hijrah / Lunar Calendar)
when he or she becomes a Sahib-e-Nisab and when one Hijrah year
passes on such balance still in ownership of the person, Zakat
becomes due.
Generally, it is difficult or rather impracticable to calculate the
completion of one year on each item of wealth, because purchase dates
may vary. Similarly, at times the balances of wealth may increase and
decrease on day to day or in some cases, on a minute to minute basis
(e.g. gold and stock market rates). To overcome this difficulty, a
practical method is to fix a date, generally 1st of Ramadan (), to
compute your total wealth on that date and calculate Zakat, thereon.
Rationale for selecting 1st of Ramadan
1st of Ramadan is selected by most of the individuals as the
day of commencement of Zakat year because in Ramadan, the Sawab
for every Fard is 70 times more than normal days. That is why most of
the scholars advise people to fix it as their Zakat computation day.
Since most of the people fix their Zakat year on this day,
generally the governments also fix it as the day of commencement of
the Zakat year for the government. Similarly, for mandatory Zakat
deductions and payments, 1st of Ramadan is considered to be the
assessment date.
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To Whom Zakat May be Paid

The utility of Zakat has been clearly set out in the Holy Quran.
Those to whom Zakat may be paid according to Quran include:
Poor (may or may not be asking for financial help);

Needy (but not asking);
Heart-winning (of Non-Muslims);
Freeing the slaves;
Travellers (in financial difficulties);
Trustees of Zakat;
Insolvent / bankrupt; and
In the way of Allah SWT.
According to the Islamic jurisprudence, Tamleek ( )is a

very important issue. According to most of the jurists it is a must for
making the payment of Zakat to make that person owner of that
money. It means that Zakat should always be paid in a persons hands
making him owner of that money and cannot be used in providing
indirect benefits to him. This principle is of particular significance in
Hanafi school of thought.
Notwithstanding the above rationale, a few other jurists are of
the view that Zakat may be paid in any manner in which Allah
Almighty is pleased, irrespective of the concept of Tamleek. Since the
objective is not to make a debate on this issue, it would be better for
all the readers to consult their respective scholars for the purpose of
determination of the correct method in their respective school of
thought.
Zakat on Gold
Zakat should be calculated on the value of gold items as of
the date of valuation. Most jurists favour the market value prevailing
as on the date of calculation and not the purchase price.
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According to experts, a reduction of 2% from the weight of

jewellery can be allowed towards studded stones jewellery and
reduction of upto 25% from the weight of kundan jewellery may be
allowed. If accurate weights etc. are not available then it will be better
to get these weighed and revalued on suitable intervals. Anyway, it
would always be advisable to obtain advice from a professional jeweler
before any calculation is made, if the amounts involved are material.
Zakat on Silver
Zakat is to be paid on silver in all forms including but not
limited to jewellery, utensils, decorative items and all household items
including crockery, cutlery made of silver. Their value should be
calculated at the current rate applicable in the market.
Zakat on Precious Stones
According to a majority of jurists, there is no Zakat on stones
irrespective of their being precious or not. However, if these are not
for use and meant for sale, these become a part of merchandise
inventory and accordingly Zakat become payable thereon. In contrary
thereto, a number of other jurists stay on the prudent side and
recommend paying Zakat on such stones. The readers are advised to
consult experts from their respective schools of thought to reach a
conclusion. If these are held for sale or you follow the prudent
approach, these should be valued and according to such value Zakat
should be paid thereon. One may calculate the saleable value of items
at hand on the date of Zakat calculation or get is calculated by some
expert if such estimate appears to be difficult.
Zakat on Cash and Receivables
Zakat should be paid on all cash balance and bank balances in
your savings, current or demand deposit accounts. Similarly, Zakat is
payable on all investments in saving schemes etc.. The amount
technically should be in the bank for one year, but usually the balance
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keeps on changing as per personal requirements. If it is not possible to

calculate the exact amount, the best option is to pay on remaining
amount on the day of calculation.
Similarly, Zakat is payable on loans given and amounts of cash
receivable against personal as well as business transactions. It should
be treated as cash in hand.
It is allowable to deduct any loans payable and liabilities
incurred against assets on which Zakat is payable. It needs to be noted
that preferably any loans for any other purpose should not be adjusted.
As an example, house building loans against personal house should not
be adjusted for this purpose because these are obtained against
purchase or construction of house whereas the personal houses are
exempt from Zakat.
Zakat is also payable with a similar rate on amounts invested
in all government securities, bonds, certificates of investment, paid-up
Insurance premiums, amounts invested in Takaful investment funds
and other forms of receivables. Such Zakat is payable at their cash
equivalent value which is generally the market value or the fair value, if
no active market exists.
In respect of a doubtful loan, no Zakat is payable immediately
with a consensus. In respect of the eventual liability on such account,
the jurists view is a bit divided. A few of them say that no Zakat is
payable because you dont have any right on that amount and the same
will become your money once you get it. Others have a prudent view,
which should be preferable for most of us, according to which even if
you dont pay any Zakat on such amount during the period in which it
was considered doubtful, you are obliged to pay Zakat for the
intervening period whenever you receive the same.
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Zakat
Zakat on Provident Fund Balances

Zakat is payable on paid-up portion of Provident Funds
(including interest thereon unless you have no intention to use interest
and to pay it completely in charity). The rationale behind such
principle is that you are the owner of that amount hence you should
consider it an amount receivable and pay Zakat thereon like any other
receivable.
According to a few jurists who have a dissenting opinion, no
Zakat is payable on the employers portion of provident fund as it is
still not at your disposal whereas the amount deducted from an
employees salary is his money deposited with the fund and
accordingly, Zakat should be paid on the same. In this respect, few
jurists conclude that if it is contingent that such portion will ever be
received by you, than you may defer the payment of Zakat and pay the
Zakat payable for the whole period once you receive that. There is,
however, a less prudent view that it is just like a receivable and no
Zakat is payable on receivables till these are received and the
employers contribution become your income when you receive it in
cash. So the only Zakat you need to pay is one years Zakat on
employees cumulative balance.
Similarly, in case of government provident funds, a few
respectable scholars have consented that since this is a mandatory
deduction and you have no control over the same, no Zakat is payable
on the same unless you get it. However, this view is not supported by
strong arguments because everybody knows that a provident fund
balance is an employees money held with the fund / government and
he enjoys a legitimate legal title on such money. At the least, if such
amount is considered contingent, the employee should preferably pay
the Zakat payable for all the past years once he receives the money.
Any outstanding loans from provident fund may be deducted
from the amount of provident fund on which Zakat is payable even if
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that loan is used in purchase of some asset which is not subject to

Zakat e.g. for purchase of house, furniture or personal vehicle.
Zakat on Real Estate
Zakat is not payable on personal residential house even if a
person owns more than one as far as these are meant for personal or
family residential purpose only or any other personal use. Moreover,
no Zakat is applicable on properties given on rent. Anyway, Zakat is
payable on the rental income when it is piled up for one year.
On the contrary, if ones prime motive for holding properties
is to sell these at a future date for a profit, then Zakat is payable on the
market value of such properties even if these are lying on rent.
Similarly, if your intention of holding properties changes in the current
year, i.e. from self use to business motive then you need to pay Zakat
on that property current market value from the year of change of
intention.
Zakat on Business
A businessman has to pay Zakat on the inventories (including
raw and packing materials, work-in-process and finished goods) and
receivables of the business as of the Zakat computation date. Needless
to mention, the value of inventories should be computed on the
market value. The amounts due to suppliers and creditors against the
items on which Zakat is applicable should be deducted from such
amount. Value of obsolete inventories should also be calculated on
realizable value. In case, it is not possible to calculate the market value
of inventories then the same may be calculated on the basis of
historical cost plus an estimated profit.
Zakat on Partnerships
Zakat on the assets of a partnership firm, Musharaka, joint
venture or Modaraba can be paid either by the venture or individually
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be each of the partners. It is always preferred that the business pay the
Zakat in order to ensure appropriate computation. Zakat is to be
calculated in a similar manner, as of an individual businessman, as
discussed earlier.
If the venture is not paying, and the partner wants to calculate
his share, he has two options to calculate his wealth in such venture
which is subject to Zakat. In the first option he may take the amount
standing to his capital, current and loan accounts as of the last
available balance sheet. Then the estimated proportionate profit
attributable to him should be added for the period between that date
and the date of computation of Zakat, and then Zakat should be
calculated in this account.
Since the above-mentioned method just provides an estimate
and does not adjust for assets and loans that are not adjustable for the
purpose of computation of Zakat, this is not the preferred method and
should be used only if accurate amounts are not available.
In the second i.e. the preferred method, the net assets subject
to Zakat as of the Zakat computation date should be computed and
then the amount attributable to the respective partners should be
allocated. In case an approximation of market value of inventories is
not possible, an estimated mark-up based on gross profit margins may
be used to arrive at an estimate value.
Zakat on Shares in Limited
Companies
Legally the Zakat on shares of companies is deductible by the
companies paying dividend at the rate of 2.5 percent of the paid up
amount of shares (at par value). This deduction is made once in each
Zakat year (commencing from 1st Ramadan each year. No Zakat is
paid during the years whereby no dividend is paid.
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These legal provisions are not in accordance with the Shariah

principles. In case of investment in limited companies the investor has
two options. In first option where he wants to sell these shares in near
future (particularly where these shares are listed) he should pay Zakat
on the current market / fair value of these shares. This value is either
their quoted price or a break-up value or a value calculated on any of
the pricing models in vogue.
In the second option, whereby he has invested the amount for
long-term investment motive or as a partnership or Musharaka venture,
Zakat is payable on the break-up value of inventories, receivables and
cash balances of the business. Zakat is not payable on fixed assets and
intangible assets being utilized in business. Any loans obtained for the
purpose of working capital (i.e. not against fixed assets etc.) may be
deducted from the total amount of assets before making calculation of
break-up value of assets. As discussed in the case of partnerships, an
estimated mark-up in the value of inventories should be used.
In both the options, it is allowable to consider the Zakat
deducted on dividends and paid in government treasury as an advance
payment of Zakat and this amount is not required to be paid again.
Zakat / Ushr on Agricultural Products
Zakat in form of Ushr is payable on all Agricultural produce
including fruits, commercially grown flowers, vegetables and all types
of grains at the harvest time itself, as well as, on other produce like
honey, rubber, grains, oils etc.. According to certain jurists, Ushr is not
payable on perishable agricultural products e.g. vegetables etc..
Accordingly, the readers are advised to follow their respective Fiqh by
consulting their respective Shariah scholars.
The passing of one year is not necessary for agricultural
produce, and instead Ushr is immediately payable at the time of
harvest. If there are two or more crops on the same land per year,
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then Ushr has to be paid as many times on the crop, irrespective of the
time.
On crops dependent purely on rain water Ushr, is calculated
at the rate of 10% of produce whereby on crops not irrigated through
rain water but use river water, canal water, tank water, water from any
lake, bore well, tube well and open wells, the Ushr is applicable at the
rate of 5% of the produce. For crops dependent partially on Rain
Water and partly on other water, the Zakat applicable would be 7.5%
of produce.
Zakat on Livestock
On all grazing animals and birds like goats, sheep, camel, cows,
broiler chickens the Zakat is payable at the rate of one animal / bird
for every 40 animals owned. One may decide to give cash in lieu of the
animal / bird itself which should be based on the estimated selling
price (not the cost) of the respective animals.
Notwithstanding the general rule as described above, a
number of specific rulings are made by jurists in case of various
animals particularly where the numbers are not in multiples of 40 and
their ages are different which results in difference in value. Owing to
this reason, no specific rule can be made in this respect and
accordingly, we advise you to consult any respectable scholar who can
guide you to the right direction, or refer to books of Fiqh if you would
like to have first hand confirmation of the Shariah requirements in this
respect.
Zakat on House, Household Items,
Vehicles and Necessities
It is Allah Almightys blessing to the mankind that the basic
necessities of life including houses, vehicles, household items and
other basic necessities of life have been exempted from Zakat. Such
exemption is applicable irrespective of the value of such items and
even quantity of such items. As an example, if someone owns more
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than one residential houses, if these are meant for personal or family
use, these are exempt from the applicability of Zakat. Similarly, if
someone owns a fleet of vehicles or even an aircraft, which is meant
for personal or family use, the same is exempt from the levy of Zakat.
Household items and other basic necessities are also exempt
from Zakat which include furniture, carpets, kitchen instruments and
utensils, electric equipment etc.. Nevertheless, as discussed earlier, a
number of jurists are of the view that certain household items like
television, VCR etc. are not a basic necessity of life and accordingly,
Zakat should be paid on their market value.
Liabilities Deductions
As discussed above, any loans from any person or institution
against purchase of assets subject to Zakat may be deducted from the
wealth. Any other genuine liabilities and commitments may also be
deducted. Particularly, any tax payable to the government or any other
levies payable, as of the date of Zakat calculation, may also be
deducted while computing the total wealth.
In this respect one issue needs to be considered i.e. the loans
against assets which are exempt from Zakat. As an example, if a Sahibe-Nisab owns wealth amounting to Rs. 1 million which is subject to
Zakat. Then he obtains a loan of Rs. 4.5 million for purchase of a
residential house having worth Rs. 5 million. Now the residential
house is exempt from Zakat and accordingly, the liabilities exceed the
amount of assets subject to Zakat and apparently there is no Zakat
payable. In these situations, only such liabilities should be deductible
from the wealth subject to Zakat which are obtained against assets
subject to Zakat. Otherwise it will always remain a Heela ( )to
avoid Zakat, and Allah Almighty knows all our intentions and illintentions.
It should also be noted that housing finance under Shariah
principles is generally based on diminishing Musharaka concept and
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Zakat
accordingly, it is not a liability and instead it represents the Islamic

financial institutions share in the jointly owned property which will
eventually be purchased by the customer in installments. As a result,
such finances should not be considered to be a loan for the purpose of
deduction from total wealth. Similarly, Ijara and Ijara Muntahia
Bittamleek facilities are also not a liability as these just represent an
asset which is leased out to the customer. However, any rental that has
already become due or overdue should be considered a liability for this
purpose. Any deposits paid under Ijara arrangements should also be
considered a receivable from the Islamic financial institution, instead
of treating the same as an advance payment of purchase price.
Consequently, such deposit should be included in the amount of total
wealth which is subject to Zakat. Anyway, any payment against a
Murabaha purchase or any other form of trade-based alternates of
Islamic finance should be considered as part payment of the price and
the asset should be included in the wealth if by its nature it is subject
to Zakat. Any remaining liability on this account i.e. gross amount of
liability without discounting for profit should be considered as a
liability and should be treated accordingly.
Zakat paid to Government
Any Zakat paid into government treasury either directly or
through withholding adjustments is considered to be full settlement of
Zakat and the same may be considered as an advance payment of
Zakat against your final liability on this account. Notwithstanding the
general rule, a number of people have doubts on the governments
ability (as well as intentions and practices) to utilize Zakat in the
correct manner. In such case people either pay Zakat again or submit
affidavits that they do not want the government to deduct their Zakat.
It is generally observed that a few people have submitted
affidavits without considering their wording. These wordings were
basically derived from the affidavits submitted by followers of Fiqh-eJafferia, which are not suitable for followers of other Fiqh. In this
respect it is advisable that before submitting any such affidavit, one
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Zakat
should consult a respective scholar or at least a knowledgeable person,

in order to ensure that such wording is not harmful for his faith.
Adjustment of Zakat with Interest
An option which is available to those who want to pay their
Zakat by themselves is that they may adjust any such Zakat with the
interest or mark-up on saving accounts or any other Haram income
which is intended to be paid in charity.
By using this option, however, you do not fulfill your Zakat
liability by itself and actually you have to pay Zakat additionally. In
other words, if you adjust the Zakat deducted by government with any
Haram income, then this Zakat should not be considered as paid.
Is Zakat Due on Interest-Bearing
Instruments?
This is a crucial question for every conscious Muslim.
Investing in interest-bearing instrument is a sin, beyond any doubt. On
the contrary any amount receivable from any other party is something
liable to Zakat, particularly where the matter of its realization is not
questionable. Now coming to another question which is quite similar,
assume somebody who has earned some wealth from any illegal and
Haram source of income, whether it will be liable to Zakat.
The conclusion that has been derived by the Shariah scholars
is that earning Haram by any means is a sin and should not be
tolerable in an Islamic society. Any income derived from sources
which are not Halal should be paid in charity without any intention of
donation, charity or Sadaqat and instead the same should be
considered as a mean of getting rid of something not pleasant to be
held in someones own wealth. On the other hand, even this wealth is
subject to Zakat if the same is not disposed off. Similarly, any Halal
amount invested in Haram transactions, is also subject to Zakat.
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Zakat
Zakat and Ushr Self Assessment Form

Following is a Zakat and Ushr Self Assessment Form for
the benefit of the readers. Similar forms and Zakat calculators are now
generally available and the inspiration for development of this form
has also been derived from a Zakat calculator, with due
acknowledgment, thanks and prayers for the person who devised that.
Unfortunately, the name of the person is not available with the author,
otherwise, acknowledgement could have been made by name.
ZAKAT AND USHR SELF ASSESSMENT FORM
Mr. / Miss. / Mrs. / Messrs
Zakat Year (Hijrah Year)
Estimated
Value
(Rs.)
Zakat on Gold
24 Carat
Gold/Jewellery
22 Carat
Gold/Jewellery
18 Carat
Gold/Jewellery
Other Gold
Valuables
Zakat
Payable
(Rs.)
Remarks
Exclude cost of
precious stones etc. if
attached to be dealt
separately
Exclude cost of
separately
Exclude cost of
separately
Exclude cost of
separately
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Zakat on
Precious Stones
Net Market Value
of Precious
Stones either
attached with
Jewellery or held
separately
Zakat on Silver
Jewellery
Household Silver
Utensils and
Artifacts
Zakat in Cash in
Hand /Bank
Cash in Hand
Cash in Bank in
Savings Accounts
Zakat
Payable
(Rs.)
Remarks
According to a
majority of jurists
there is no Zakat on
such stones. If you
follow them, do not
include any amount.
Include their realizable
value, if these are held
for sale and not for
personal use or you
follow the prudent
way to pay Zakat on
the same.
Exclude cost of
separately
For Utensils, unless
specifically known,
usually the silver is
90% pure so you
should take 90% of
the total weight for
valuation purpose.
Include the amount of

profit receivable if it
has become due.
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Cash in Bank in
Current Accounts
Cash held in
Fixed Deposits
Zakat on
Receivables and
Investments
Loans Receivable
from Friends,
Relatives and
others
Investment in
Government
Bonds
Provident Fund
Balance
Zakat
Payable
(Rs.)
Remarks
Include the amount of

profit receivable if it
has become due.
Exclude any doubtful

amounts on which
you want to pay Zakat
when these will be
actually received and
separately the record
the amount of Zakat
payable for ease of
reference in future.
Exclude the amount

of employers
contribution, if you
want to pay Zakat
thereon when it will
be received and
separately record the
amount of Zakat
payable for ease of
reference in future.
You may not include
the balance, if you
want to pay Zakat
when the amount is
receive.
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Insurance
Premiums
including bonus
up to date and
Balance of
Takaful
Participants
Investment Fund
Value of Shares
(stocks), Units of
Unit Funds,
TFCs, Musharaka
Certificates,
Modaraba
Certificates etc.
(Listed meant
for trading)
Value of Shares
in Companies
(meant for longterm investment)
Zakat
Payable
(Rs.)
Remarks
Take their market

value on the date of
calculation. If market
value is not available,
work out fair value of
investment. Include
Dividends and Profit
distribution declared
but not yet received.
To be worked out on
the basis of break up
value of assets of the
company subject to
Zakat less any
applicable liabilities.
See Zakat on
Business below.
Investment in
Private Chits,
Funds, etc
Deposits,
advances and
other receivables
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Zakat on Real
Estate
Property held as
an Investment /
Business (meant
for sale in future)
Zakat on
Business
Value of Saleable
Stock
Cash Equivalent
Value of Trade
and Other debts
Less: Liabilities
against purchases
and services
Net Value of
Assets
Less: Value of
Assets
attributable to
other partners /
shareholders
Net value of
assets subject to
Zakat
Zakat
Payable
(Rs.)
Remarks
Estimate the current

market value or fair
value.
Exclude advances for

purchase of fixed
assets and any other
assets which are not
subject to Zakat e.g.
household items
meant for personal or
family use.
Calculate on the basis

of capital ownership
Make it Nil if the
business is wholly
owned by you.
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Zakat on
Investment
made in
Partnership
Firms
Alternate
Method
Capital / Loan /
Current Balance
as per Last
balance Sheet
Capital
contributed /
loans Advanced
by you to the
Firm from the
date of balance
sheet to date
Less:
Withdrawals
made by you
during the
current Year or
repayment of
loan by the firm
Accumulated
Profit from the
date of Balance
Sheet to this Date
Zakat
Payable
(Rs.)
Remarks
This method should
be applied only if the
details regarding assets
subject to Zakat and
other assets and the
liabilities are not
available as of the
Zakat assessment date
or a date close thereto.
Estimate the profit

amount as it is
difficult to get exact
figures in the middle
of Accounting Year
Net Total Worth
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Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
Ushr On
Agricultural
Produce
Produce
Dependent on
Rain Water
Produce totally
dependent on
Artificial
Irrigation like
Canal, Tank, Bore
well, etc.
Produce
dependent
Partially on Rain
Water and
Partially on
Artificial
Irrigation
Zakat On
Animals,
Poultry and
Fish Farming
Animals/ Birds
more than 6
months Old
Zakat
Payable
(Rs.)
Remarks
10% of product (crop)

in Value or Kind
5% of Produce (crop)
in Value or in Kind
7.5% of the Produce

Value or in Kind
1 Animal or Bird per

40 either in kind or
value of the same
(market value or
realizable value). If
dairy animals are not
in the multiple of 40
or have different ages,
consult your
respective Shariah
scholar for details of
complex calculations.
Page - 237
Chapter Thirteen
Zakat
Estimated
Value
(Rs.)
General
Liabilities
Loans taken from
Friends /
Relatives
Loans Taken
from Banks /
Institutions
Taxes payable
Other liabilities
payable
Zakat
Payable
(Rs.)
Remarks
Preferably excluding
liabilities against assets
not subject to Zakat.
Total Liabilities
Total Zakat /
Ushr Payable
Less: Zakat /
Ushr already paid
or deducted
Net Zakat /
Ushr Payable
Page - 238
Chapter Fourteen
Legal And Taxation Issues In Pakistan
LEGAL AND TAXATION ISSUES

IN PAKISTAN
In Pakistan, we have inherited a number of laws and

lawmakers from the British heritage. Accordingly, despite the
applicability of the Objectives Resolution and other constitutional
requirements mandating a truly Shariah compliant legal structure in
Pakistan, we are still confused with the matter of applying the Shariah
in our judicial structure.
At the moment, the objective of the study is not to criticize on
such matters mandating the attention of our honorable jurists and
people who are part of legislation process. In this respect, we know
that only the legislative changes can not bring the whole system in line
with the injunctions of Shariah, whereas, being Muslim it is also our
duty to save ourselves from the applicability of such issues.
Following are certain legal issues involving interest and
causing hindrance in application of Islamic financial products:
Taxes on Murabaha and other Islamic finance

transactions;
Workers profits participation fund (WPPF);
Additional tax for the purpose of Income Tax and
Sales Tax;
Interest on legal claims; and
Funded retirement benefits.
We should always remember our duty to strive for the

changes in the relevant legislature upto the maximum efforts we can
make in this respect. Nevertheless, since we are living in the system
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and on account of inadequate and weak efforts in this regard, we have

to ensure that at least we, by ourselves, are not involved in the interest
involving issues in this respect. Accordingly, In the ensuing pages, we
shall endeavor to discuss these issues in brief with an understanding of
the way outs that may be applied by us in order to avoid applicability
of interest in our businesses.
Taxes on Murabaha and other Islamic
finance transactions
As present, generally the Islamic banking transactions are
being carried out in Pakistan, in an outside the system manner. In
these of the transactions, most of the activities are carried out under an
agency contract. The Islamic bank pays the desired amount to the
customer under an agency contract, who then buys the required goods
in his own name, under an agency of the Bank. Accordingly, all the
taxes including custom duties, withholding tax and the input sales tax
are paid by him in his own name, invoice or bill of lading is in his
name and the payments are made by him to the supplier. In this
manner, any tax exemptions available to the customer are also availed.
The transaction between the Islamic bank and the customer are carried
out ignoring the effect of such taxes.
This is a brief way of describing how such transactions are
being carried out in Pakistan. It is the authors humble opinion, with
due apologies, that in these transactions the real risk and reward are
not transferred to the Islamic bank for any moment, because in such
transactions the risk and reward of taxes and reclaimable taxes does
not transfer to the Islamic bank. Accordingly, their approval by
respectable scholars may be considered as a Heela and not a real
solution to this issue. These transactions have been allowed by the
respectable jurists, just with the sole objective of promoting Islamic
banking.
This issue has duly been addressed by the Shariah Board of
the State Bank of Pakistan, by proposing that the purchases for
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Chapter Fourteen
Murabaha transaction should be made in the name of the Islamic bank

instead of the name of the customer. Similarly, it has also been advised
to the Islamic banks, through the essentials of Islamic banking, that
payments should directly be made by the Islamic bank to the supplier
instead of making payment to the customer under agency.
In Pakistan, still certain similar issues are being faced and as a
consequence, similar techniques of avoiding the taxation regime are
being followed by the Islamic banks for most of the Islamic banking
transactions.
In the last few years, certain amendments have also been
made in the Sales Tax and the Income Tax law to ensure that no
additional tax is charged on transactions involving Islamic finance,
particularly on the Murabaha and other trade based transactions.
Hopefully in the near future, we will evidence a more appropriate and
Shariah compliant way of transactions under this mode.
In this respect, it should also be borne in mind by both the
management of the Islamic banks and their customers that after
making all endeavors to do business in a Shariah compliant way, we
can spoil all such efforts by not ensuring the real transfer of risk and
reward and committing other similar mistakes, just to avoid additional
costs. At this stage we should also ask a question from each other
about the reason why we are not ready to take any additional cost
which is incidental to the real transfer of risk and reward. It is a real
sorry state of affairs for all of us as we are not ready to bear the cost of
being a Muslim and following the requirements of Shariah. In other
words, we wish to be Shariah compliant to the extent that such
compliance does not hit our pockets. All customers or prospective
customers of the Islamic banking industry, should also make sure that
such transactions are Shariah compliant in all manners, even if some
additional costs need to be borne.
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Chapter Fourteen
Workers Profits Participation Fund

(WPPF)
WPPF is a levy which is applicable to every company engaged
in manufacturing activities under the Companies Profits (Workers
Participation) Ordinance meeting the criteria as specified under the
said law. Such criteria include:
Fixed Assets amounting to Rs. 200 thousand;

Issued and paid up capital of Rs. 500 thousand; or
Have at least 50 employees.
Under the said enactment, every manufacturing company

which meets the above mentioned criteria is required to contribute 5
percent of its profits (before tax, workers welfare fund (WWF) and
such levy) to a fund to be created for the benefit of the workers of the
company. Such amount contribute to the fund is invested for some
time and along with such return, the same is attributed amongst the
lower earning scaled workers according to certain criteria laid down
which is revised from time to time. Any leftover amount is submitted
in the Government treasury as a part of WWF. Nevertheless, it is a
general contention of the industrial community that the same levy has
been turned out to be a normal tax because generally most of the
amount attributable to the fund is eventually paid into the
Government treasury. Without going into details of the issues
concerning the payment of WPPF and interest thereon, we will try to
discuss the interest factor applicable in such charge.
According to the said law there are two stages when interest is
applicable to be charged:
In the hand of the Company for each day during

which payment is not made to the fund at the rate of
2.5 percent plus bank rate (generally specified to be
10%). It is worthwhile to be noted that such interest
is payable in every situation even if the company has
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no intention to utilize such fund in its business and is

just waiting to finalize its financial statements in order
to determine the amount applicable thereto; and
When the relevant sums (including principal
contribution and interest thereon calculated up to one
day before such payment) are paid into the fund,
these are invested in deposits of scheduled banks or
several approved investment schemes.
You would appreciate that the first matter is directly

applicable to the company and its shareholders whereas the second
matter indirectly involves both the management and employees
because the fund is jointly maintained and operated. Particularly it
needs to be addressed that the company should not directly get
involved in interest relating matters in this respect. Therefore, now we
are trying a draw a plan to avoid such applicability without any extra
cost to the company.
As the first step of the plan the management should ensure
prompt preparation of the financial statements of the company each
year. In this respect, preparation of profit and loss account for the
eleven months might also prove to be fruitful after which only a
reasonable estimate of profits for the last month of the financial year
would need to be estimated. Such exercise needs to be completed
latest on the first day of the next financial year and on the very same
day, ad hoc contribution should be made to the fund based on the best
estimate of the maximum amount of accounting profit for the year.
However, in case an appropriate estimate is not possible an amount
equal to the maximum expected liability in this respect should be paid
to the fund. Having made such payment the management would avoid
the payment of any form of interest directly.
Now coming to the indirect part of the fund, it may be
identified that this is the easier part to avoid involvement of interest
because investment may also be made in an Islamic commercial bank
under normal deposits or any other special scheme. Similarly, such
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amounts may also be invested in shares of various companies

according to the respective legal provisions, as well as, considering the
rules applicable to investments as discussed earlier.
Alternatively, investments can be made in National
Investment Trust Units and other mutual funds. Since NIT has certain
investments in companies from which the return on investments
cannot be considered Halal, hence the impact of purification might be
on the higher side, as well as, the same might appear to be difficult in
computation. However, a few Islamic mutual funds that have been
launched are a better option for the purpose.
Additional Tax under Income Tax and
Sales Tax Law
Additional tax is the term used by taxation authorities for the
interest charged on delayed payments of income tax and sales tax.
Although the very nature of the additional tax is that of interest,
nonetheless, a few scholars are of the view that its levy on the part of
the tax payer is just like a penalty and for the tax-payer it may not be
termed as interest.
When we consider the matter in detail, we come across two
types of delayed payments on which such charges are levied. The first
one is the case whereby the Assessing Officers raise some tax demands
and ask for the additional tax for the intervening period against some
issue which was neither noted nor was in the knowledge of the
management of the tax-payer. In this case nobody can blame the taxpayer for willful delay in payment and accordingly if additional tax is
claimed and accordingly paid, the same is just like an additional levy of
tax and shall not be considered payment of interest on the part of the
tax-payer.
On the contrary, we may assume another case whereby the
tax-payer has made willful delay in the payment of tax and / or has
neglected some issue on which the likelihood of the adverse decision
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was high and accordingly, he eventually had to pay additional tax. In

such case, apparently, he has not made efforts to avoid the interest
that is eventually going to be levied and accordingly, has willfully
indulged in the payment of interest. Accordingly, we may conclude
that in case of taxation no delay in payment should be committed not
only in order to abide by the law of the land, but also, and more
prominently, in order to avoid involvement of interest.
However, on the governments front, this issue needs to be
addressed that additional tax linked with the amount of tax and period
for which it remained outstanding clearly makes it interest under the
basic principles of Islamic Shariah and consequently such levy is
against the injunctions of Islamic Shariah. Accordingly, such law
should be changed and some alternate form of penalty be introduced
for the purpose in order to comply with the requirements of the
Islamic Shariah.
Interest on Legal Claims
Another inheritance from our British forefathers is the slow
or rather extremely sluggish judicial system in which often the decision
on a case takes decades of futile efforts in which the time, resources
and even lives of the families of all the parties are wasted. Such a slow
pace of decisions and the legal heritage has caused another practice in
the legal system which is the interest on the amounts of legal claims.
In this respect, generally the claimants include a clause of
applicability of interest on the amounts of claim in their appeals for
the period on which such amounts are actually due till the date of
actual payment of such amount. Generally the lawyers also follow this
practice and include such clause in each application / petition. It has
been observed that in most of the cases whereby the decision is
eventually held in the favor of the claimant, interest is also allowed to
be paid by the counter party.
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Being generous, it needs to be apprehended that such delay in

the decision of the cases often makes the claimant to loose a lot of its
purchasing powers on the initial amount of claim. It needs to be
repeated time and again, that the Islamic financial system is not
something that has to be applied solitarily and these are the instances
that cause us to believe the complete transformation of the legal and
legislative structure is also mandated for having a purely Islamic
society. Leaving this never-ending issue aside, we may discuss the
matter on the part of the two parties within the current legal scenario.
On the part of the claimant we may say that he should not claim any
interest directly linked with the amount of the claim and the time of
delay in the payment, as it is undoubtedly interest within the very
meaning of Riba. Nevertheless, in this respect, other compensations
may be claimed which shall not be linked directly to the amount of
claim and the time involved. Such compensations may be in form of
penalties, damages and other charges but it is always advisable that
before making any claim one should consult some reputable scholar so
as to ensure the permissibility of such compensation.
As far as the second party is concerned, at the outset, if the
claim is valid and he knows that it is valid, principally he shall not delay
the payment merely by getting the benefit of the sluggish judicial
system, as it is against the spirit of Islamic teachings as well as because
the same is likely to result in payment of interest also. Nevertheless, if
he honestly feels that such claim is not valid and still he is compelled
to pay the same along with interest thereon for the intervening period,
such amount may not be termed as interest on his part.
Funded Retirement Benefits
According to the prevailing law in the country, every company
or even an employer (whether sole proprietorship or partnership) if
employs more than twenty employees in case of a commercial
undertaking and more than fifty employees in case of industrial
undertaking, has to arrange for retirement benefits of its employees in
form of gratuity or provident funds.
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In case of gratuity, if it is not funded, no issue arises relating

to applicability of interest. But interestingly, you would note that if
gratuity, even if approved by the taxation authorities, is not funded the
tax benefits to the employee as well as to the employer are limited.
However, if the same is approved by the income tax authorities and
funded in form of a separate gratuity fund, the tax benefits are
enhanced. Without going in details of the doctrine behind such status,
it needs to be observed that if you want to avoid interest solely by not
getting the gratuity funded, you and your employees both have to
suffer.
The question of applicability of interest on the retirement
benefit funds arise because of the restrictions applicable to these funds
by the legislature. According to the relevant rules in the Income Tax
law, which also refer to the conditions imposed by the Company law
in this respect, an accordingly, even if the employer is not a company,
he has to follow the requirements of the company law in this respect
and the rules made there under.
According to the section 227 of the Companies Ordinance,
1984 and the rules made there under, the provident funds and gratuity
funds have to make their investments according to the certain criteria
in the scheduled banks, a number of government saving schemes, NIT
units and listed securities subject to certain conditions.
Being fortunate, we have a very favorable new scenario in this
respect. Up to a few years back, the name of provident funds
investments and gratuity fund investments was synonym to the
Defence Savings Certificates (DSCs) and other national saving
schemes that were offering the highest rate of return and were purely
based on interest. Now the situation has been changed to some extent
and these funds are no more allowed to invest in DSCs. As an
alternate, these funds have been offered comparatively liberal
investment policies including listed securities and mutual funds, as well
as, certain unlisted securities with certain conditions.
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Secondly, now we have a few Islamic financial institutions

available for investing such amounts including Islamic commercial
banks, Islamic banking branches of commercial banks and Islamic
mutual funds operating strictly in compliance with the principles laid
down by the Islamic scholars for their operations.
Interest as a Profit Transfer Tool
It has also been observed that a few groups of companies /
businesses in Pakistan have a policy to transfer profits from one
organization to another through charging interest on inter-company
and inter-associate accounts and sometimes at amounts due to the
shareholders or owners. Such profit transfers have no benefit at the
group level and are eventually reduced to NIL if the consolidated
figures for the whole group are seen. These transfers act merely as a
profit transfer tool and accordingly, these are permitted by certain
scholars. Due to resemblance of interest these transactions, even if
permitted by certain scholars, might not be considered a good practice
and should be avoided.
Moreover, at times the capital structure of different entities
within a group is different from each other. Accordingly, during the
profit transfers through this mechanism, a risk exists that the profit
attributable to one or some of the capital owners might be different
from the amount that would ideally have been attributable to them,
because of such difference in capital structure. Consequent to the
above discussion, and in line with the advise of most of the jurists,
such interest / markup on group balances should also be avoided and
even if it is necessary to transfer profits on an inter-company basis, the
same should be made either using the trade-based alternates e.g.
Murabaha or should be based on profit and loss sharing arrangements.
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Chapter Fourteen
Tax Benefits on Interest

This is another important issue from taxation perspective that
the companies have no tax benefit on payment of dividend whereas
payment of interest is considered to be a tax deductible expense.
Although, being a Muslim, one should be ensuring the
compliance of Shariah rules, irrespective of gains and losses on the
presumption that any loss in this worldly life will be beneficial for the
life hereafter. However, the basic alternate which is available in this
form is use of Islamic financial instruments through bank or through
issuance of redeemable capital under Islamic modes. Any profit paid to
the banks on Islamic financial instruments and the financial charges
and profits on redeemable capital are all deductible for the purpose of
tax.
Accordingly, generally it may be a wise decision to raise the
required capital through issuance of instruments of Islamic finance
instead of issuing further share capital. This might also be a wise
decision wherever the returns on capital of the business are very high
and the owner does not wish to make somebody partner in whole of
the profits. Particularly, issuance of redeemable capital under Islamic
modes of finance including Participation Term Certificates and
Musharaka Term Finance Certificates can easily cater to this issue.
Page - 249
Chapter Fourteen
Page - 250
Chapter Fifteen
Glossary of Terms
GLOSSARY OF TERMS
It is considered worthwhile to include a glossary of general
terms that have been used in this study along with certain other
important terms which are generally used in theory and practice of
Islamic finance. This glossary, although cannot be termed as a
complete dictionary of terms, but might be found helpful to the
readers.
TERM
Ahadith ()
Amana ()
Bay Bi-thaman Al
Ajil ()
Bay Muajjal
Bay Musawwama
/ Musawwama
Bait-ul-mal )
(
Cash
DEFINITION
Plural of Hadith.
Something held in trust.
Sale of goods on a deferred payment
basis.
The sale of goods on a deferred
payment basis or a credit sale.
A bargaining sale without disclosing or
referring to what the cost price is. Also
called simple sale in Arabic. May be
made on deferred payment basis.
Islamic governments treasury.
Cash comprises gold, silver, any form
of cash on hand in any currency, as well
as, include current accounts and
demand deposits with banks and
financial institutions.
Page - 251
Chapter Fifteen
Glossary of Terms
TERM
Commitment fee
Completedcontract method
Constant /
Permanent
Musharaka
Credit facility
Debt / Loan
DEFINITION
The percentage or amount which the
institution takes from the customer to
commence the proceedings for a
transaction. This amount is generally
not refundable.
An accounting method that recognizes
Istisna costs and revenues only in the
financial period in which the contract is
completed.
Type of Musharaka in which the
partners shares in the capital remain
constant throughout the period as
specified in the contract or until the
dissolution of Musharaka.
The upper limit for a customers
financial transactions or class of
financial transactions with a financial
institution. This is generally provided in
form of an Istijrar contract or a circular
Murabaha contract. This credit facility
may be restricted to a specified type of
item, or to a specified time period.
An amount receivable or payable, in
terms of monetary units or cash.
Deferred Debt
A deferred debt is a debt the payment

of which is due at a certain time in the
future, and it may also be due in
periodic installments over time.
Derivative
A financial instrument to be settled at a

future date, with no or negligible initial
investment and whose value changes in
Page - 252
Chapter Fifteen
Glossary of Terms
TERM
Diminishing
Musharaka
Documentary
credit / Letter of
Credit (L/C)
Exchange
difference
Exchange rate
Face value
DEFINITION
response to change in a specified
variable e.g. interest rate, security price,
commodity price, foreign exchange rate,
index of prices or rates, a credit rating
or credit index.
Musharaka in which one partner agrees
to transfer gradually to the other
partner its share in the Musharaka
(whether joint-ownership of assets or a
project), so that the first partners share
declines and the other partners share
increases until the second partner
becomes the sole owner of the asset(s)
/ project.
A written commitment to make
payment of specific amount in cash by a
financial institution (the issuer) given to
the seller (the beneficiary) as per the
buyers (the applicant or the orderer)
request.
A difference arising due to change in
the foreign exchange rates between two
dates. This may be positive or negative
and may also be called exchange gain /
loss.
The rate at which different currencies
(on spot basis) are exchanged at a
particular point in time.
The cash amount of receivable against a
Murabaha or any other trade-based
transaction equivalent to the price
agreed between the client and an
Page - 253
Chapter Fifteen
Glossary of Terms
TERM
Fair Value
Fatawa
Fatwa ()
Financial Asset /
Monetary asset
Financial
Instruments
Financial Liability
/ Monetary
liability
Fiqh ()
Foreign currency
Forward exchange
rate
Fuqahaa ()
Gharar ()
DEFINITION
Islamic financial institution including
the profit / mark-up.
Fair value is the amount for which an
asset could be exchanged or liability can
be settled, between knowledgeable,
willing parties in an arms length
transaction.
Plural of Fatwa.
A religious decree or judicial ruling.
This is the money held and assets to be
received in fixed amounts of money.
Contractual instruments to be settled in
agreed monetary values. Includes,
financial assets, financial liabilities and
derivatives.
This is the money held and liability to
be paid in determinable amounts of
money.
Islamic jurisprudence. Compiled form
of Islamic law and regulations.
Any currency other than the official
currency of the country.
The exchange rate for settlement of two
currencies on a future date, agreed now.
Islamic jurists. Shariah scholars.
The Shariah determined that in the
interests of fair, ethical dealing in
commutative contracts, unjustified
enrichment should be prohibited. This
policy precludes any element of
uncertainty or more speculative risk.
Page - 254
Chapter Fifteen
Glossary of Terms
TERM
Hadith ()
Halal ()
Hamish geddiyyah
/ Jeddeyyah
DEFINITION
The sayings of the Prophet Muhammad
SAAWS, which is the second important
pillar of Islamic Jurisprudence, after the
Holy Quran. Also termed as Sunnah.
Anything permitted by the Shariah.
Security deposit or retention money.
Haram ()
Anything prohibited by the Shariah.
Hawala ()
Transfer of a debt liability from the

transferor to the payer.
The original purchase price on
acquisition of an asset plus any other
expenses incurred thereon.
Ijara is the transfer of ownership of a
service for an agreed upon
consideration. Letting on lease or rent.
Conventional operating lease.
Refers to commission, fees or wages
charged for services.
One of the forms of Ijara commonly
used by Islamic financial institutions
whereby in addition to the leasing
contract, a promise is made by the
lessor to transfer the ownership in the
leased property to the lessee. However,
there are different modes of transfer of
title. In most of the matters it resembles
a conventional finance lease.
Consensus of the Islamic jurists on a
point of time or era on a certain
question. This is an important source of
Historical cost
Ijara ()
Ijara / Ujrah / Ajr

Ijara Muntahia
Bittamleek / Ijara
wa Iqtina
Ijma ()
Page - 255
Chapter Fifteen
Glossary of Terms
TERM
Ijtihad ()
Insolvency /
bankruptcy
Iqaala
Islamic Insurance
/ Takaful
Israf
DEFINITION
Islamic jurisprudence.
Effort, exertion, diligence, endeavors.
In Islamic jurisprudence, it is endeavor
of a jurist to derive or formulate a
ruling or legal decree on the basis of the
principles found in the basic sources of
Islamic jurisprudence.
Inability of the debtor to settle the debt
due because of an insufficiency or a
total lack of fund. Such a relative
condition of a persons or entitys assets
and liabilities that the former, if all
made immediately available, would not
be sufficient to discharge the later.
Iqaala or cancellation of a contract is a
bilateral agreement of the contracting
parties to abate and remove the legal
effect of a contract.
A system through which the
participants pay contributions to a
Takaful fund which is used to pay
claims for damages suffered by any of
the participants. It is based on mutual
cooperation and the Takaful companys
role is restricted to managing the
operations and investing the fund.
Immoderateness, exaggeration, waste.
Covers spending on lawful objects but
exceeding moderation in quantity or
quality; spending on superfluous objects
while necessities are unmet; spending
on objects which are incompatible with
Page - 256
Chapter Fifteen
Glossary of Terms
TERM
Istijrar ()
Istisna ()
Mahall
Maisar ()
Mal
Mithli ()
DEFINITION
the economic standard of the majority
of the population.
Istijrar means purchasing goods time to
time in different quantities. Istijrar is an
agreement where a buyer purchases
something from time to time; each time
there is no offer or acceptance or
bargain. There is one master agreement
where all terms and conditions are
finalized. There are two types:
The price is determined after all
transactions of purchase are
complete; or
The price is determined in
advance but the purchase is
executed from time to time.
Basically a contractual agreement for
processed goods and commodities,
allowing cash payment at spot, deferred
or in advance (in lump sum or as per
agreed schedule) and future delivery.
Subject-matter of Hawala contract.
An ancient Arabian game of chance
played with arrows without heads and
feathering, for stakes of slaughtered and
quartered camels. A form of gambling.
Wealth and property. Something which
can be hoarded or secured for use at the
time of need.
Goods returned in kind, i.e. gold for
gold, silver for silver, wheat for wheat.
Page - 257
Chapter Fifteen
Glossary of Terms
TERM
Modaraba ()
Modarib
Mubah ()
Muhal Alaihi
Muheel (the
transferor)
Murabaha
Murabaha Muajjal
Murabaha to the
purchase-orderer
DEFINITION
A form of partnership where one party
provides the funds while the other
provides the expertise and management.
Any profits accrued are shared between
the two parties on a pre-agreed basis,
while loss is borne by the partner
providing the capital.
In a Modaraba contract, the person
who acts an entrepreneur. Working
partner of a Modaraba.
Object must be lawful (i.e. something
which it is permissible to trade in)
The transferee or the Payer in Hawala
contract.
The transferor of debt in Hawala
contract.
Sale on profit. In Shariah terms, it is a
sale at stated cost price and profit. A
sale agreement whereby the seller sells
the goods at an agreed marked-up price,
the payment being settled at spot or
deferred either in installments or lump
sum.
Murabaha Muajjal is the Murabaha
whereby the payment is deferred and is
paid on a future date in lump sum or in
installments, as agreed.
Form of Murabaha used by Islamic
financial institutions. There are three
parties to it. The seller (supplier), the
buyer (the purchase-orderer) and the
Islamic financial institution as an
Page - 258
Chapter Fifteen
Glossary of Terms
TERM
Musaqa ()
Musharaka ()
Muzaraa ()
(Crop sharing)
Nisab
Operating Ijara
Parallel Istisna
DEFINITION
intermediary trader. The Islamic
financial institution purchases the goods
from the supplier on spot basis after
obtaining a purchase order from the
buyer and then sells them to him on
Murabaha basis.
A contract in which the owner of the
garden shares its produce with another
person in return for his services in
irrigating the garden.
A type of Shirkat-ul-Amwal (or more
precisely Shirkat-ul-Ainan), generally
used by Islamic banks and financial
institutions. The partnership whereby
two or more parties draw a contract to
work together by the capital they
contribute in condition of dividing the
accruing profit between them in a pre
agreed ratio. Loss is shared in the ratio
of their capital.
To give the agricultural land to whoever
can cultivate it or work in it in exchange
of a share in the crop.
Exemption limit for the payment of
Zakat. It is different for different types
/ categories of wealth.
Ijara contracts that do not end up with
the transfer of ownership of leased
assets to the lessee.
If the ultimate purchaser does not
stipulate in the contract that seller
should manufacture the asset / goods
Page - 259
Chapter Fifteen
Glossary of Terms
TERM
Parallel Salam
Procrastination by
a solvent debtor
Provision
Provision
Qard ()
Qard-e-Hasana
(
)
DEFINITION
by himself, then the seller /
manufacturer may enter into a second
Istisna contract in order to fulfill his
contractual obligations in the first
contract. The second contract is called
Parallel Istisna.
A Salam contract whereby the seller
depends, for executing his obligation,
on receiving what is due to him in his
capacity as purchaser from a sale in a
previous Salam contract, without
making the execution of the second
Salam contract dependent on the
execution of the first one.
Procrastination is the delay in fulfilling
an obligation, and procrastination of the
solvent is the delay on the part of a
solvent person and his evasion of
paying the debt without having an
excuse or being insolvent.
A provision is an obligation of
uncertain timing or amount. It is also
used as a reserve against impairment,
losses and doubts on realisability of
assets.
A provision is a contra-asset, and is
constituted by charges made as
expenses against income.
An interest-free loan paid to the
borrower for a specific period.
A Qard in which lender agrees for a
waiver if the borrower cannot pay it
Page - 260
Chapter Fifteen
Glossary of Terms
TERM
Qimar ()
Qirad /
Muqaradah
Qiyas
Quran ()
Rab-ul-Mal
Rahn ()
Receivables
Reinsurance
DEFINITION
back. This is the form of loan which is
encouraged in an Islamic society.
Gambling. From Shariah perspective
any agreement which is dependent on
some uncertain or contingent event.
A type of Modaraba.
Estimate, measure, example,
comparison, analogy. In Fiqh terms, it
means derivation of the law on the
analogy of another resembling law. It is
a primary source of Islamic
jurisprudence.
The book of Allah revealed to the
Prophet Muhammad SAAWS.
The financier in the Modaraba.
Mortgage, lien or charge with physical
possession. The collateral may be
disposed off in the event of a default.
Receivables are the amounts due from
other parties as a result of sale or any
other contractual transaction.
Reinsurance is a contractual
arrangement under which the reinsurer
is liable for part of or all of the risks
which the insurer has insured. In return,
the insurer pays a specific amount of
the contributions to the reinsurer. The
insured legal right are affected by the
reinsurance arrangement and the insurer
is liable to the insured for paying claims
Page - 261
Chapter Fifteen
Glossary of Terms
TERM
Riba ()
Riba-al-Fadl /
Riba-al-Hadith
Riba-al-Nasiah
Right of option /
Khiyar-al-Shart
()
Ruqa ()
Sadaqah ()
Sahib-e-Nisab
(
)
Sal Allah u Alaihi
Wa Sallam
DEFINITION
as per the insurance policy terms and
conditions.
An excess or increase. From Shariah
perspective, it is an increase on a debt
in any form or manner.
A sale or exchange or barter transaction
of certain commodities (in which the
injunction of Riba is applicable
according to Ahadith) whereby a
commodity is exchanged for the same
commodity in unequal quantity or
against deferred delivery of one or both
commodities. To avoid Riba al-Fadl, it
is a must that the exchange of such
commodities should equal and instant.
Increment on the principal of a loan
payable by the borrower.
It is the right of the parties in a contract
to proceed in the execution of the sale
on the basis of mutual promising, or to
decline. This may even be valid after
some time the sale is consummated or
the contract finalized.
Banking instrument of the early Muslim
period. It was a payment order to draw
money from the bank.
Charity. Donation.
One who owns enough wealth that
Zakat become obligatory.
Whenever the name of prophet
Mohammad is mentioned, a Muslim
Page - 262
Chapter Fifteen
Glossary of Terms
TERM
(SAAWS)
Salam / Bay
Salam ()
Sales
Sarf
Shariah ()
Shirkah ( )/
Shirkat
Shirkat-AlMufawada
Shirkat-ul-Aamal
DEFINITION
must repeat this saying, which means
may the peace and blessings of Allah be
upon him.
Sale of commodities through full
advance payment against deferred
delivery.
A sale is an exchange transaction using
any of the Islamic instruments such as
Murabaha, Salam or Istisna.
Sale of monetary value for monetary
value. Generally used for exchange of
Gold and Silver, however, in view of
most jurists, also include the exchange
of currencies.
Refers to divine guidance as given by
the Quran and the Sunnah of the
Prophet Muhammad (PBUH) and
embodies all aspects of the Islamic
faith, including believes and practices.
A contract between two or more
persons who launch a business or
financial enterprise to make profits.
Equal partnership. Type of Shirkah
whereby all partners equally share the
capital, management, profit and the risk.
Partnership in services. Type of Shirkah
whereby all partners jointly undertake
to render some services for their
customers, and the fee charged from
them is distributed among them
according to an agreed ratio.
Page - 263
Chapter Fifteen
Glossary of Terms
TERM
Shirkat-ul-Ainan
Shirkat-ul-Amwal
Shirkat-ul-Wujooh
Sunnah ()
Syndicated
financing
Takaful
DEFINITION
A type of Shirkat-ul-Aqd whereby
equality in capital, management or
liability is not a must. Musharaka is also
derived from this type of Shirkah.
Partnership in capital or ownership.
Type of Shirkah in which all the
partners invest some capital into a
commercial enterprise or in purchase of
an asset.
Partnership in goodwill. In this type of
Shirkah, the partners do not make any
investment and instead they purchase
commodities on deferred price, by
getting capital on loan and sell them at
spot. The profit and loss are distributed
between them at an agreed ratio.
Literally it is Custom, habit, way of life.
In Shariah terms it represents the
utterances of the Prophet Muhammad
SAAWS other than Quran known as
Ahadith, or his personal acts or saying
of others tacitly approved by him.
A syndicated financing is a partnership
relationship for financing a particular
project which two or more parties has
interest to finance.
Islamic alternate to Insurance. A
scheme of mutual support and
benevolence that provides insurance to
individuals against hazards of falling
into unexpected and dire need.
Page - 264
Chapter Fifteen
Glossary of Terms
TERM
Ummah
Urboun
Ushr ()
Ushur
Wadiya ()
Wakala ()
Zakat ()
DEFINITION
Muslim nation.
It is the advance amount paid by the
customer to the seller against purchase
of an asset. If the customer proceeds
with the sale and takes the asset, and
then the Urboun will be part of the
price, otherwise, the same will be
forfeited by the seller. However, there
are certain Shariah issues in this
treatment.
The meaning of Ushr (pl. Ushur) is a
tenth. As a technical term, Ushr refers
to the Zakat levied on agricultural
produce of land owned by Muslim at
the rate of ten per cent if the land is
irrigated by rainfall and at the rate of
five per cent on artificially irrigated
lands. Ushr is not levied if there is no
produce.
Means one-tenth, plural of Ushr. Ushur
were imposed in Muslim history on
merchants as a customs duty.
Deposit, trust. Technically a contract
whereby a person leaves valuables as a
trust for safe-keeping.
Agency.
Blessing, purification, increase and
cultivation of good deeds. In Shariah,
Zakat is an annual obligation in respect
of wealth held by somebody according
to the terms and conditions laid down
in Shariah.
Page - 265
Chapter Fifteen
Glossary of Terms
Page - 266
Bibliography
BIBLIOGRAPHY
I wish to express my regrets that I cannot pay my gratitude to
all those, whose commendable works not only encouraged me but also
enabled me to do this job, (irrespective of how humble is it).
Particularly, during my studies and research, I came across a number
of articles, research-papers, presentations, training materials and online
data which was consulted but could not be preserved in a manner that
I would be able to refer to them all. Similarly, I was fortunate enough
to attend a number of Seminars, training courses, meetings and
discussion forums in which I personally feel that I have learnt a lot,
but I have to apologize that I can not list down the names of learned
scholars, experts and officials who contributed a lot to my learning and
eventually in enabling me to complete this study.
Following is a summary of the books and works that were
mostly consulted for the purpose of my study:
NAME OF BOOK
Tafheem ul Quran (Tafseer of
Relevant Verses)
Sahih Bukhari (Relevant chapters)
Sahih Muslim (Relevant chapters)
Mishkwat ul Masabeeh (Relevant
chapters)
Muarif ul Hadith (Relevant
chapters)
Muatta Imam Malik (Relevant
chapters)
AUTHORS /
PUBLISHERS NAME
Maulana Syed Abul Ala
Maududi
Maulana Manzoor Nomani
Page - 267
Bibliography
NAME OF BOOK
Sood
Tafheem ul Masail
Muashiat e Islam
Shirkat o Muzarbat kay Sharai
Usool
Islam Ka Nizam e Muhasil (Kitab
ul Khiraj)
Islami Bankari
Maulana Maududi Kay Muashi
Nazariat
A Compendium of Legal Opinions
on the Operations of Islamic
Banks
Accounting and Auditing
Standards for Islamic Financial
Institutions
Anthology of Islamic Banking
Encyclopedia of Islamic Banking
and Insurance
Financing In Islam
Instruments of Islamic Investment
Islamic Banking and Finance
Theory and Practice
Islamic Banking and Its Operation
Islamic Finance
AUTHORS /
PUBLISHERS NAME
Maududi
Maulana Gohar Rehman
Maududi
Dr. M. Nijatullah Siddiqi
Qazi Abu Yousuf
Translated by Dr. Nijatullah
Siddiqi
Dr. M. Nijatullah Siddiqi
Compiled and Translated by
Yusuf Talal De Lorenzo
Organization For Islamic
Financial Institutions
(AAOIFI).
Edited by Asma Siddiqui
Published by Institute of
Islamic Banking and
Insurance
Mohammad Hafeez Arshad
Malik
Ezzedine Mohammad Khoja
/ Dallah Albaraka Group
Muhammad Ayub / State
Bank of Pakistan
Zafar Ahmed Khan
Justice(Retd) Moulana Mufti
Mohammad Taqi Usmani
Page - 268
Bibliography
NAME OF BOOK
Islamic Finance Innovation and
Guide
Meezan Banks Guide to Islamic
Banking
Sharia Standards
Historical Judgment on Riba

Islam ka Nazria e Milkiat
Murawwija Nizam e Zameendari
aur Islam
Shirkat o Muzarbat Ehd e Hazir
Main
Various Circulars on Islamic
Banking and Essentials and Model
Agreements
Occasional Papers
Islamic Financial Accounting
Standards
Fundamentals of Financial
Management
AUTHORS /
PUBLISHERS NAME
Rifaat Abdul Karim and
Simon Archor
Dr. Imran Ashraf Usmani /
Meezan Bank Limited
Organization For Islamic
Financial Institution
(AAOIFI).
Supreme Court of Pakistan
Shariat Appellate Bench
Dr. M. Nijat ullah Siddiqi
Maulana M. Taseen
Dr. Imran Ashraf Usmani
State Bank of Pakistan
Islamic Development Bank
Issued by the Institute of
Chartered Accountants of
Pakistan
Eugene F. Brigham
Page - 269
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A SHARIAH COMPLIANT WAY
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Omar Mustafa Ansari

Managing Finances A Shariah Compliant Way

PRACTICAL APPLICABILITY OF IJARA .......................................................................... 85

EQUITY FINANCING ON MUSHARAKA BASIS ........................................................... 142

MARKETING .................................................................................................................... 183

ZAKAT ON SILVER .......................................................................................................... 221

Any guidance generally provided by the religious scholars is of

If we consider the Islamic economic theories in brief, we will

Zakat and Ushr;

Zakat and Ushr

that anything declared Haram by Allah, must be dangerous and

economic system looses the equilibrium which is generally observed in

Believers! Do not swallow Riba, doubled and redoubled, and

One Dirham (penny) of Riba that somebody knowingly eats

The first one which is the general understanding of a layman

Encouragement of Trade and

Under these broad principles, the Islamic government has

government on every individual Non-Muslim against the governments

Similarly, in most of the cases payment of Zakat and Sadaqat

which is still in operation in Pakistan with the conventional

Replacement of complete interest-based banking

Although we feel that the intentions of the initiators were

The implementers (government officials, State Bank,

say, that they were not willing to change it due to

The above mentioned factors should not be considered as all

Islamic Banking As Introduced Now

Operations of Islamic Banks

In this respect it can easily be concluded that the fixed return

In this respect, it also needs to be considered that during the

SHARIAH COMPLIANT BUSINESS A

The core activities of the business are Halal and

Dealings with third parties, including but not limited

Core Activities of Business

Manufacture, sale, marketing etc. of Haram Goods

suppliers credits, bank overdrafts and running finances should also

reliance on the proclamations and claims of promoting Islamic

Profit and loss sharing based modes;

These are the general tools available according to the language

Dealings with Third Parties

Besides these factors, the most significant factor for the

PROFIT AND LOSS SHARING

FLOW OF TRANSACTION IN LOAN

Rs. 1,000 (No impact of Time

Although the rules used in for managing Musharaka and

Practically the most important application of

Modaraba may also be provided in form of

FLOW OF TRANSACTION IN MODARABA

Certain Controversies Regarding

Modaraba capital for both the parties must be specific

The capital owner may provide his capital to two or

Rab-ul-Mal shall ensure that the Modarib invests the

auditing thereof is also similar to the liquidation and

Basic Types of Shirkah

Permanent Musharaka denotes a joint venture, business or

FLOW OF TRANSACTION IN MUSHARAKA

Practical Application of Musharaka

In partnership normally the following factors are considered

Capital investment ratio;

Provisions of Partnership Law Not in

own moneys, exceeding the amount of capital contributed or

This objection is to some extent practically eliminated from