UBFB3123 ISLAMIC BANKING (JAN2016)

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE
ACADEMIC YEAR 2015/2016
BACHELOR OF BUSINESS ADMINISTRATION (HONS) BANKING AND FINANCE
BACHELOR OF ECONOMICS (HONS) FINANCIAL ECONOMICS

GROUP ASSIGNMENT (COVER PAGE)

Topic: Arguments and acceptability of derivatives instruments
Tutorial Group: T2
Course: Banking and Finance
Tutors Name: Encik.Muhammad Ashraf Bin Anuar
Due date: Week 8, 7th March 2016 (Monday)
Important note: Submission of assignment is the responsibility of the students.
Group Members:
No
1
2
3
4
5

Student ID
1304115
1300306
1202146
1301282
1305709

Name
Christine Chin Shuen Teng
Chua Yuen Yee
Pun Kok Kent
Tan Sze Teng
Yeoh Zyn Guan

Marks awarded:

50
Comments from examiner:
______________________________________________________________________________
______________________________________________________________________________
Assessed by:____________________________________ Date:_________________________
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UBFB3123 ISLAMIC BANKING (JAN2016)

UNIVERSITI TUNKU ABDUL RAHMAN
FACULTY OF BUSINESS AND FINANCE
ACADEMIC YEAR 2015/2016
BACHELOR OF BUSINESS ADMINISTRATION (HONS) BANKING AND FINANCE
BACHELOR OF ECONOMICS (HONS) FINANCIAL ECONOMICS

MARKING SCHEME
Marks
Allocation

Assessment Item
(a) Introduction

(b) Literature Reviewby examining, discussing and

synthesizing findings and results. The content should
emphasize:
Key issues or highlights of the journals/ articles and
other pertinent information include:
- Purpose/ objective of the journals/ articles
- Research methodologies carried out (if any)
- Results and discussions
- Researchers/ writers recommendations/ comments/
opinions/ justifications
You may discuss the followings in detail (whichever
applicable):
- Significance of the journals/ articles towards
Islamic banking operations
- Key characteristics/ features
- Methodologies for implementation or any
restrictions imposed
- Pros and Cons
- Quoting of real Islamic banking practice
- Any other relevant issues

25

(c) Summary includes:

- Your recommendations/ comments/ opinions/
suggestions
Conclusion and implication

15

(d) Language, grammar, spelling, format and assignment

layout

TOTAL

50

Marks
Awarded

UBFB3123 ISLAMIC BANKING (JAN2016)

Table of Contents
Cover Page

Mark Sheet 2
Table of Content

Introduction 4
Literature review
Summary

11

References

13

Appendix

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UBFB3123 ISLAMIC BANKING (JAN2016)

Introduction
Islamic banking is referred as a banking system that must comply with the principles of Shariah
which known as Islamic rulings and it is guided by Islamic economics (ISRA, 2012). The main
function of Islamic banking system is similar with conventional bank which is also serving as
intermediaries between the surplus fund unit (lender) and deficit fund units (borrower). In
particular, Islamic law prohibits the collection and payment of interest (Samira Saya, 2006), that
is, conventional banking is the one who gives or receives of interest, activity which is
specifically prohibited by Shariah. For example a borrower promises to repay the loan plus fixed
interest to the lender. Moreover, Islamic banking prevents trading in financial risk, which is seen
as an activity of gambling and it also prohibits investing in businesses considered haram, such as
those selling alcohol or pork.
Islamic finance instrument are kinds of financial instruments which are based in compliance with
Shariah Rules & Regulations. There are different types of instruments such as Sukuk, Islamic
mortgage-backed securities (MBS), and Islamic futures contracts. Sukuk can be explained as
certificates with identical nominal value that after completion of subscription operations
evidence payment of a nominal amount mentioned in it by the purchaser to the issuer. Its holder
will be the beneficiary of a special investment activity or project, or will be the owner of a set of
assets. Generally, there are various types of Sukuk, such as Ijarah Sukuk, Istisna Sukuk,
Musharakah Sukuk, Gharzulhasan Sukuk, and Murabaha Sukuk.
Murabaha facilities and hire-purchase facilities are types of Islamic securities. On the other hand,
Islamic futures contract is special designed type of future contract which is based and complied
with the Shariah rules. At a future date, it is to purchase or sell a specified amount of real goods
in cash and it intends to delivery real goods.
Literature review
Although conventional banking and Islamic banking are considered as guardian of peoples
assets, they are very different from each other. Islamic banking has no interest based and it shares
profits and losses with customers. On the other hand, conventional banking can earn from
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UBFB3123 ISLAMIC BANKING (JAN2016)

charging peoples deposits or investments as it has interest based ideology, which is prohibited
by Shariah. Islamic banking must eliminate the interest in all its form, be it in cash term. To
avoid giving cash as interest, banks give others such as pens or saving boxes or umbrellas.
However, sometimes, in Islamic law, when there is an exchange of two resembles usurious assets
or items, the interest can be appreciated. Sometimes, Islamic banking shares services with
business intermediaries (Arif, 1988).
Furthermore, authority configuration is also a difference between conventional banking and
Islamic banking due to Islamic banking needs to follow the viewpoint of Muslim culture and
create a set of law or rules which shown in Holy Quran (Suleiman, 2001). In general, Islamic
banking provides some financial services to the customers like non-Islamic banking, and plays
responsibility in the economic extension. In this case, if conventional banking wants to serves
Muslim customers, it has to refer to the regulation of the Islamic Shariah in order to let the
financial products which contribute to customers must be according to Islamic Law.
In Islamic capital market, it has fixed income instruments and equity instruments that must
prevent some principles and elements of conventional from the perspectives of transactional and
contractual. The activities such as gambling which is zero-sum game, capital guarantee elements
in equity-based products, and investments in unlawful activities are to be prohibited. Unlike
conventional banking, Islamic banking has to be distinctive in its transactional and contractual
features even though it may achieve the same economic advantages.
Takaful, the insurance that does not provide indemnity as it is not accepted by Shariah
principles. The cases that policyholders pay premium and the protectors pay indemnity are
uncertain and thus are not allowable by Islamic banking due to they consist Gharar or
uncertainties. Takaful can be the substitution of the insurance for Muslims, introduced by
conventional banking which to seek for profit from offering like insurance to its customers as the
presence of uncertainty elements in this contract does not render it invalid. This purpose of any
unilateral contract is not a commercial gain.

UBFB3123 ISLAMIC BANKING (JAN2016)

According to Obiyathullah Ismath Bacha (n.d.), this journal discussed the current derivative
instruments and the Islamic point of view regarding the new instruments. This journal studied
about the forward, futures and option, and observed the evolution of these derivative instruments.
The purpose of this journal is to provide a better insight on how and why the derivative
instruments are developed and understanding their distinctive benefits and drawbacks to Islamic
businesses.
In the findings, Muslims experts generally found out that there is no objection for the use of
options when it is treated mainly as a promise in buying or selling asset at a fixed price at a given
time. However, there were some objections in using derivatives instruments. Some ulamas have
rejected that deferred sale such as bai salam is prohibited while others rejected the use of futures
due to speculation matters. In addition, some researchers have found out that option is
unacceptable in Islamic businesses. One of the reasons was that the buyer of an option is given
more advantages than the seller and this is deemed unfair in Islamic practices. Hashim Kamali
(n.d.) concluded that option should be banned because it is unfair for the seller to charge
premium on the option.
It is also found that it is not appropriate to resell the stock with put option at a later date due to
gharar. According to Mohammed Obaidullah (1998), he explained that gharar happened due to
lack of information and transparency. He argued that option, in which used as a cash settlement
entailed gharar and speculation. However, the argument is unacceptable because the profits from
options are not earned, thus ignoring the fact that the buyer and seller are taking the risk. Hence,
he concluded that trading of the options is mubaah (permissible) and can be considered as an
extension of the Quran.

UBFB3123 ISLAMIC BANKING (JAN2016)

Additionally, the derivatives instrument that have their underlying asset items that are haram
would need no further consideration. In this increasingly competitive business environment, not
using derivatives instrument could place them at a disadvantage. The researchers suggested that
the Islamic experts should have taken into consideration the potential welfare loss when deciding
on the permissibility of derivative instruments.
According to Awan & Azhar (2014) the construct of Islamic banking is one in every of the
foremost rising and also the most out-bursting ideals in international economies. Several studies
show that The Islamic banking is gaining wider acceptance and inspiration throughout the world
particularly within the areas occupied by Muslim communities which informs the very fact that
religion is that the core attraction behind Islamic banking however recent studies expose this
solely reason and consent with the very fact that is not solely the religion that is attracting the
people towards Islamic banking however it is essentially the merchandise and services provided
by the banks weather Islamic or any standard which attract the consumers towards banking. The
researcher in this journal provides some important information on the event of Islamic banking in
Pakistan that the result can facilitate the relevant parties to any enhance the event of Islamic
banking in Pakistan particularly choice criteria most popular by consumer behavior.
Nevertheless, banks ought to note of peoples lacking information and knowledge in Islamic
banking system into consideration especially once promoting Islamic financial services. Hence,
banks ought to renovation their marketing activities consequently and there should be additional
qualified experts or knowledge-based workforce absorbed into this trade to market larger
originality particularly in addressing Islamic financial products.
Moreover, participation of the each public and personal university within the banking sector may
supply additional input (e.g. planning Islamic financial instruments) for the expansion of the
Islamic banking. The management and Shariah advisors of the Islamic banking systems ought to
take selections to form their customers more satisfied with the products and services they are
providing them. This analysis relies on the factors touching and increasing Islamic banking.
Keeping visible all the factors, this analysis give some important and elaborate data on the event
of Islamic banking in Pakistan. The formulation of desired and relevant factors from this
information, as a result, can facilitate the relevant parties to any improve, enhance and develop
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the Islamic banking in Pakistan and different countries wherever people are facilitated through
Islamic banking. This information is very useful in choice criteria most popular by consumer
behaviours.
In addition, it also discloses the very fact that plenty of individuals are still unaware from the
construct of Islamic banking or from the products and also the services it provides. Thus, banks
ought to note of the peoples lack information in Islamic banking system and their products and
services, into consideration.
According to Bacha (n.d.) said that the existing instruments in Islamic finance that have
derivative like features we examine here a number of the mandatory features of Islamic financial
instruments. All financial instruments and transactions normally should meet a variety of criteria
so as to be thought of halal. At a primary level all financial instruments and transactions should
be freed from a minimum of the subsequent five things (i) riba (usury), (ii) rishwah (corruption),
(iii) maysir (gambling), (iv) gharar (unnecessary risk) and (v) jahl (ignorance). Riba which
accurately interpret to usury is more commonly referred to as the charging of interest. Riba are
often several forms and is prohibited altogether its forms. For instance, Riba can even occur once
one gets a positive return while not taking any risk. As found out earlier, there is no agreement
on what gharar suggests thst. It has been taken to mean unnecessary risk, deception or
intentionally induced uncertainty.
Within the context of financial transactions, gharar may be thought of as movability of the
underlying contract such one or each parties are uncertain about possible outcomes. Alternatively
that the contract may be scan in an exceedingly range of the way such that one party may simply
deceive (deception) the other party. Maysir from a financial instrument viewpoint would be one
wherever the result is purely dependent into probability alone- as in gambling.
Finally, Jahl refers to content. From a financial dealings viewpoint, it would be unacceptable if
one party to the transactions gains because of the other parties ignorance. Though their actual
definition should be open to interpretation, there cannot be any doubt on what is being supposed
by the Shariah in requiring that financial instruments and transactions be free from the higher
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UBFB3123 ISLAMIC BANKING (JAN2016)

than items. Clearly what is being supposed is truthful play and justice to any or all parties to a
transaction.
There are several pros for implementing derivative instrument in Islamic banking. The most
noticeable advantages for Islamic banking sector of using financial derivatives are in the
financial area. This includes predicting a future price trend, stabilizing costs and maximizing
sales profits. When the firm is concerned about the derivative market, the price of futures and
options and commodity price derivatives can easily help it to predict the future price trend of its
raw materials. Thus wise decisions on making instant large purchases or future purchases could
be made. If the predictions prove correct, unnecessary expense on raw materials can be avoided
(Guay, 1999). Another way could take advantages is to stabilize their purchase costs. If the firm
enters into a commodity price forward contract, it could possibly stabilize its purchase costs.
Since engaged in these derivative contracts, the firm has accepted to buy a certain commodity at
a special price, thus the purchase cost is fixed in contractual format. Or it could use foreign
currency forwards and options to minimize the impact of exchange rate fluctuation in the same
way.
Some of the cons we found in our study are derivatives may carry credit risks in one party to the
contract may default. Problems may also arise concerning the liquidity of derivative securities or
the ease with which they can be traded. These same risks are, to one degree or another,
associated with almost all financial assets. Certain large US multinational corporations choose
not to use derivatives as their hedging tools because of the high cost and riskiness of engaging
derivatives in the current volatile market and imperfectness of hedging itself. Randall Dodd
(2000) commented that the derivative usage in East Asia (especially Thailand) had negative
impact toward the 1997s crisis. His analysis was mainly drawn from the facts of reducing
transparency, lack of regulation and increased systemic and contagion effect.
Most dissimilarity of the findings is possibly due to the non-standardization or inconsistency of
comparable research material used for statistical regression technique utilized (Mohamad &
Amin, 2005). Besides, this research also found that banks offer the main currency derivatives but
some limitations on maturity and size of contracts exist, preventing an effective use of such
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UBFB3123 ISLAMIC BANKING (JAN2016)

instruments. The other limitation is lack of knowledge and perceived high costs make internal
hedging practices more attractive rather than the use of derivatives (Crabb, n.d.). Furthermore,
the result was that using financial derivatives is the most beneficial only for the companies with
the extremely high sensitivity of cash flows.
Summary
Recommendations
Islamic Banking are consider a banking industry that only famous or popular in the Muslim
country such as Indonesia, Pakistan, Saudi Arabia and others but it can be spread out into nonMuslim countries such as China, United Kingdom, Japan and others which can broaden up the
Islamic banking industry throughout the world. With this, Islamic banking system can play a
vital role in the world which can control the economy but it need some time to do with. For
example, Islamic banking in Malaysia already for 10 years like that but is consider new to the
public because of the low information to the public and it consume a lots of time of people to
change from one to the others. Thus, Islamic Banking should spread to the some strong countries
so can manipulate the world economy and make some policies which can grow to be better
banking system.
Conclusion
As conclusion, Islamic Banking has no interest based and it use profit sharing with customers
that bear the risk or uncertainty. Islamic Banking used to follow the rules of Muslims culture
and create a set of law shown in Holy Quran. If the conventional banks want to serve the Muslin
customers, they need to follow the Islamic Shariah law in order to contribute the services to the
customers. Takaful is the Islamic insurance that does not provide indemnity to the customers
which consist of uncertainty and Gharar. Due to the researchers above, it found that it is not
appropriate to resell the stock with put option at a later date due to Gharar which lack of
information and transparency.
Islamic banking is getting wider acceptance and inspiration over the world. Banking need to note
that people lacking of information or knowledge in Islamic Banking system when promoting
Islamic Financial System. Thus, bank need some renovation their marketing and qualified in
order to absorb bigger market when addressing Islamic Financial product. The Shariah advisor

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UBFB3123 ISLAMIC BANKING (JAN2016)

of Islamic Banking system supposed to take selection when they provide the products and
services to satisfy their customer more satisfaction.
The existing instruments in Islamic finance that have derivative like features we examine here a
number of the mandatory features of Islamic financial instruments. All financial instruments and
transactions should be halal. Riba which accurately interpret to the charging of interest. Riba is
prohibited altogether its forms. Riba can even occur once one gets a positive return while not
taking any risk. Maysir from a financial instrument viewpoint would be purely dependent into
probability alone- as in gambling which may cause one side to gain and another side to loss.

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UBFB3123 ISLAMIC BANKING (JAN2016)

References
Abdul, G.A., & Maliha, A. (2014). Consumer behaviour towards Islamic banking in Pakistan.
European Journal of Accounting Auditing and Finance Research, 2(9), 42-65.
Ali, L., Ali, A., & Khwaja, H. (2013). Comparison of Islamic and Conventional Banking on the
Basis of Riba and Services:A case study of Peshawar Region, 2(3).
Bacha, O. I. (n.d.). Derivative instruments and Islamic finance:some thoughts for a
reconsideration. International Journal of Islamic Financial Services, 1(1).
Chan, K. T., Yap, V. C., Yong, G. F., & Lam, W. H. (2014). Assessing Financial Performance of
Malaysian Islamic and Conventional Commercial Banks Using Financial Ratios. Journal of
Modern Accounting and Auditing, 10(4), 494-505.
Crabb, P. R. (n.d.). Foreign Exchange Risk Management Practices of Microfinance Institutions.
Journal of Microfinance, 6(2).
Mohammad Hashim Kamali. (n.d.). Islamic Commercial Law: An Analysis of Options. The
American Journal of Islamic Social Sciences, 14(3).
Mohamad, M. H., & Amin, M. F. M. (2005). Derivatives usage in non-finacial firms. Jounal of
International Studies.
Mohammed Obaidullah. (1998). Financial Engineering with Islamic Options. Islamic Economic
Studies, 6(1).

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Obiyathullah Ismath Bacha. (n.d.). Ethical Dimensions of Financial Risk: Some Thoughts for a
Reconsideration. International Journal of Islamic Financial Services, 1(1).

Pireh, M. (n.d.). Islamic Financial Instruments: Islamic Finance Expert Securities & Exchange
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discussions/presentation-on-sukuks-and-other-exchange-traded-islamic-capital-marketinstruments-and-their-regulatory-framework-in-iran-securities-and-exchange-organizationof-iran---seo.pdf
Tijani, O. M., & Mathias, G. O. (2013). Derivatives and Financial Risk Management in Nigeria:
Evidence from Non-Financial Firms. African Journal of Scientific Research, 11(1), 620640.

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