Shariah and Law in Relation to Islamic

Banking and Finance

Sherin Kunhibava* & Shanthy Rachagan**
Islam has a unitary approach to life. It does not put the various aspects of
human behaviour into water-tight compartments. It considers man as an
integral whole. In other words, the numerous functions that he or she
performs, e.g., economic, political, social and religious, are not independent
of each other. In the economic field, activities are conditioned by social
milieu, moral values, cultural heritage, and above all by religious beliefs. It
is therefore said that the word religion being just one aspect of life among
many others is an insufficient translation for the Arabic term deen, which is
often used to characterise Islam.
— “Islamic Banking in Europe — the Reintegration of Faith and
Economy” Rashid Mengers, the Assistant Director of the Institute of Islamic
Banking and Insurance in London, 5th SLIM Annual Lecture, Wednesday,
May 15, 2002, Southwark Cathedral.
This article is devoted to exploring the two sources of laws that governs Is-
lamic banking and finance. It starts off by explaining the sources of Shariah and
the sources of conventional laws, and comparing the two. Thereafter the funde-
mental principles of Shariah that governs Islamic banking and finance are high-
lighted. Lastly, a country case study will be done to show how the country has
accomodated their laws to incorporate Shariah to govern Islamic banking and fi-
nance. The country chosen is Malaysia.
Malaysia is chosen because of its advanced position in Islamic banking and
finance and because of its comprehensive legal and regulatory dual system, that is
where conventional banking and finance functions parallel to Islamic banking and
finance.

Cet article est consacré à l’examen des deux sources de lois qui régissent les
domaines bancaire et financier du monde islamique. L’auteur décrit d’abord les
origines de la charia et les origines des lois conventionnelles, puis compare les
deux. Les principes fondamentaux de la charia relatifs aux domaines bancaire et
financier du monde islamique sont ensuite mis en évidence. Une étude de cas
démontre comment le pays visé par l’étude, soit la Malaisie, a composé avec ses
lois afin d’intégrer la charia en vue de régir les domaines bancaire et financier.
La Malaisie a été retenue pour cette étude à raison de sa position avancée

* Sherin Kunhibava PhD is a Senior Lecturer at University of Malaya.

** Shanthy Rachagan PhD is an Associate Professor at Monash University.
544 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

dans le monde islamique, relativement aux activités bancaires et financières; le

caractère complet de son double système législatif et réglementaire y permet au
système traditionnel des mondes bancaire et financier de fonctionner en parallèle
avec les systèmes bancaire et financier du monde islamique.
1. INTRODUCTION
Conventional banking and finance as we know it today, is governed by the
laws of a nation, that is legislation passed by the State and common law decisions
made by judges when there is a lacuna in the law (collectively named as conven-
tional laws in this article). Islamic banking and finance on the other hand, is gov-
erned by two sets of law, one divine Islamic law (Shariah) the other man made
(conventional laws). This article is devoted to exploring these two sources of laws
that governs Islamic banking and finance. It starts off by explaining the sources of
Shariah and the sources of conventional laws, and comparing the two. Thereafter
the fundemental principles of Shariah that governs Islamic banking and finance are
highlighted. Lastly, a country case study will be done to show how the country has
accomodated their laws to incorporate Shariah to govern Islamic banking and fi-
nance. The country chosen is Malaysia. Malaysia is chosen because of its advanced
position in Islamic banking and finance and because of its comprehensive legal and
regulatory dual system, that is where conventional banking and finance functions
parallel to Islamic banking and finance.

2. SHARIAH AND CONVENTIONAL LAW

Shariah literally means “the way to a watering place”.1 It is the path that must
be followed by Muslims, and governs man in conducting his life in order to realize
the Divine Will. It includes all forms of behaviour — spiritual, mental and
physical.2
There are four fundamental sources of Shariah law: the Holy Book — Al-
Quran, the hadith, ijma and qiyas.3
The first source is the Islamic Holy Book called Al-Quran. The Holy Quran is
the original and eternal source of Shariah law. It constitutes messages that Allah
(swt) inspired the Prophet (pbuh) to relay for the guidance of mankind. These
messages are universal, eternal, and fundamental.4
The hadith, the second foundation of Shariah, is next in importance to the Al-
Quran. It is a piece of information, such as an account, narrative or story and con-
stitutes a record of the Sunnah of the Prophet (pbuh), handed down from generation
to generation and which has become the rules of faith and practice of Muslims. The
Sunnah (pl. sunan) signifies the custom, habit, or usage of the Prophet (pbuh). It
designates his behaviour, mode of action, his sayings and declarations under a vari-
ety of circumstances in life.5

1 Abdur Rahman I. Doi, Shariah the Islamic Law (A.S Noordeen, 1984) at 2.
2 M.A Laldin, Introduction to Shariah and Islamic Jurisprudence (Cert Publications,
2006) at 3.
3 Doi, supra, n. 1 at 7.
4 Laldin, supra, n. 2 at 56.
5 Ibid., at 75.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 545

The third source of Shariah law is the ijma. Ijma means a consensus of opin-
ion of the mujtahids (the learned scholars of Islam), or an agreement of the Muslim
jurists of a particular era on a question of law.6
Qiyas is the process of reasoning by analogy of the mujtahids with regard to
certain difficult and doubtful questions of doctrine or practice, by comparing them
with similar cases already settled by the authority of the Al-Quran and Sunnah and
thus arriving at the solution of undecided questions.7
As for conventional law, there are two defined sources of legal jurisdictions,
known as the Common law legal system and the Civil law legal system. Whether a
jurisdiction follows a Common law legal system as opposed to a Civil law legal
system typically depends on the historical background of a nation. Common law
systems usually descend from the English legal system, and therefore all Common-
wealth countries have Common law systems.8 Common law systems place empha-
sis on judicial decisions, which are considered “law” just as are statutes.9
Civil law jurisdictions, on the other hand, descend from Roman law through
either the Napoleonic Code or the German Civil Code and also from Canon law.
Roman law itself evolved in Rome before the Christian era. Canon law, on the
other hand, is the body of laws and regulations made by or adopted by ecclesiasti-
cal authority, for the government of the Christian organization and its members.10
Under Civil law jurisdictions case law was traditionally given less weight.
However, it would seem that the distinction between the two systems is becoming
blurred as the importance of judicial decisions in civil jurisdictions are increasingly
being given more weight and with the growing importance of statute law and codes
in Common law countries.11
While the Civil law system descended from Roman law and Canon law, Com-
mon law is vaguely described as having been developed and institutionalized from
the 11th to 12th centuries at the time of King Henry I and II.12 However Makdisi,13
believes that the origins of Common law are actually from Islamic law, due to the
uniqueness of Common law which is separate from any other European legal sys-
tem, including Roman law and Canon law, but has similarities with Islamic law.
Nevertheless, it is safe to say that Common law and Civil law share common char-
acteristics. They both deal with the interpretation of man-made laws whether it is

6 Ibid., at 91.
7 Ibid., at 97.
8 R. W. Lee, “The Civil Law and the Common Law: A World Survey” (1915) 14 Michi-
gan Law Review. “On the American Continent the Civil Law and the Common Law
exist side by side. The former prevails in the south, the latter in the north” at 93.
9 Roderick T. Long, “The Nature of Law, Part III: Law vs. Legislation” online:
<http://libertariannation.org/a/f21l3.html>.
10 A. Boudinhon, “Canon Law” Robert Appleton Company (1910), online:
<http://www.newadvent.org/cathen/09056a.htm>.
11 Lee, supra, n. 8 at 90.
12 George Burton Adams, “The Origin of the Common Law” (1924) 34 The Yale Law
Journal 116-117.
13 John A. Makdisi, “The Islamic Origins of the Common Law” (1999) 77 North Carolina
Law Review 1638.
546 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

case law or statute.

On the other hand, Shariah deals in religious matters and God-made laws, and
therefore differs from Common law and Civil law in that respect. However, it is not
a religious law the way Canon law is. Shariah deals not only with purely religious
matters but also with all those subjects which comprise the content of Common law
and Civil law systems. Shariah comprises of three basic elements, namely, aqidah,
fiqh and akhlaq.14 Aqidah concerns all forms of faith and belief in God Allah (swt)
and His will, held by a Muslim. Fiqh is concerned with governing the relationship
between man and his Creator and between man and man (fiqh will be further de-
fined below). Finally, akhlaq covers all aspects of a Muslim’s behaviour, attitudes
and work ethic with which he performs his practical actions.15 It is with the
Shariah branch of fiqh that Islamic finance is governed. Fiqh can be further divided
into two areas called ibadat and muamalat. Ibadat is concerned with the practicali-
ties of a Muslim’s worship of Allah, whereas muamalat is concerned with man-to-
man relationships. Nevertheless, aspects such as political activities, economic ac-
tivities and social activities fall within the ambit of muamalat.16 Islamic finance,
being part of economic activities, is thus linked with Shariah principles through
muamalat.
Injunctions relating to aqidah, ibadah and akhlaq are fixed and unchangeable
as they are considered to be suitable to be implemented at all times and places.
However, injunctions of Shariah which regulate the relationship between man and
man and other creatures may change with the changes in circumstance, custom,
time and place.17 This includes rulings relating to muamalat such as contractual
law transactions, criminal law, the judiciary and Islamic finance. It is this feature of
Shariah that makes it suitable to be implemented at all times as it can accommodate
the needs of people in different times and situations.18
The rulings in relation to muamalat are derived from the sources of Shariah.
However, due to the changing circumstances of the world and the needs and inter-
ests of the people (maslahah) many of the legal injunctions had to be formulated
from the sources of Shariah through reason by rightly qualified Muslim Jurists.
This is known as ijtihad, that is, “exerting one’s reasoning faculty to determine a
point of law.”19 During the time of the Prophet Mohammad (pbuh), the Qur’an was
clarified and exampled by the Prophet. After the Prophet’s death and the death of
the Sahaba (Companions), Muslims confronted a number of difficult questions
with the spread of Islam into new cultures and lands.20 There was a need for proper
guidelines on how to derive law from Islamic sources. Thus, law schools arose (or
madhab) which developed a comprehensive set of methodologies on how to inter-

14 Laldin, supra, n. 2 at 4.
15 S. Haron, Islamic Banking, Rules and Regulations (Pelanduk Publications, 1997) at 18.
16 Ibid., at 18-19.
17 Laldin, supra, n. 2 at 8, see explanation on fiqh.
18 Ibid., at 11.
19 Irshad Abdal-Haqq, “Islamic Law: An Overview of its Origin and Elements” (1996) 1
Journal of Islamic Law 9.
20 Ibid., at 44.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 547

pret Shariah.21 The process of applying and deducing laws from Shariah and the
laws thereby deduced is collectively known as fiqh.
There are four madhab or schools of law for Sunni Muslims.22 The teachings
of each school depends largely on the geographical area, although there is a scatter-
ing of the followers of all four schools in most of the Muslim world.The four
madhabs23 are the Hanafi, Maliki, Shafi’i and Hanbali.
Since the 10th century the main law-making activity had ceased, and activity
of the jurists remained limited to interpretation and explanation of the existing doc-
trines, bringing it up to date with life as conditions changed, because it was be-
lieved that any principle that could be deduced by ijtihad had already been deduced
or extracted.24 After this time any new decision or fatwa (legal opinion) was based
on previously recorded determinations made by a particular madhab. This concept
is known as taqlid or conformity and is sometimes compared to the concept of
stare decisis or judicial precedent in Common law.25 However many well known

21 Ibid., at 45.
22 Approximately 90 percent of the Muslims in the world are Sunni while the remaining
are Shia. The differences between the two are basically that the Shia principally in Iraq,
Iran, Lebanon and Syria, believe that the leadership of the Muslim community the Ca-
liph must be from the Prophets lineage, they await the emergence of a Muslim leader
from the line of the Prophet who will embody wisdom and spiritual power of the
twelfth Imam. Until that time his representatives, the ayatollahs provide interim leader-
ship. As for the Sunni they do not believe that physical lineage is necessary to be a
Caliph. The second difference is that the Shia continue to believe ijtihad (personal rea-
soning) as a legitimate source of Islamic law, whereas Sunni Muslim prohibit the cur-
rent use of ijtihad. Abdal-Haqq, supra, n. 19 at 51-52. This article will focus on the
legal opinions from the Sunni school of law.
23 The Hanafi school was formed in Kufa, Iraq, under Abu Hanafi who lived from 702 to
767. It preserves many of the older Mesopotamian traditions. It based its rulings largely
on ra’y — results of logic deduction of its scholars. Suzy Ashraf, On the Islamic
Schools of Law. (n.d.), online: <http://members.tripod.com/~SuzyAshraf/index.html>
essays.
The Maliki school comes from Medina, under Malik ibn Anas ibn Amir who lived
from 717 to 801. This school ruled heavily in favour of the practice (sunnah) of the
local community of Medina, because at the time it was formed, the word sunnah did
not yet mean “practice of the Prophet” Ashraf. Muhammad Idris ash-Shafi’i (760 to
820 in Egypt) was the first one to systematize Islamic Law. Originally, he studied in
Madina under Malik ibn Anas ibn Amir founder of the Maliki school. In his book, the
Risala (the Message), balancing the two trends, he laid down the sources of Law, Fiqh.
He fixed them (in order of priority) to be: Quran Sunnah of the Prophet, based on:
Hadith from the Prophet Hadith from the Companions of the Prophet Ijma and Qiyas
Abdal-Haqq, supra, n. 19 at 49. Ahmad Ibn Hanbal from 778 to 855 founder of the
Hanbali school, the latest of the four madhabs had followed Shafi’i method with ever
greater emphasis on the ahadith, avoiding reasoning as far as possible, but not com-
pletely denying it. Thus, the difference between the schools is primarily in the various
weight given to those four components, and in some original decisions remaining from
the very beginnings of these schools, and belonging to its first masters Ashraf.
24 Abdal-Haqq, supra, n. 19 at 26.
25 Ibid., at 37.
548 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

scholars have argued the relevance and importance of ijtihad in modern times (see
Doi26 and Kamali27).
Therefore, finding the injunctions of Islamic law requires reference to not only
the sources of Shariah but also the books of fiqh. Legal opinion of scholars in
Islamic finance often refers back to these sources of law when formulating an opin-
ion on the permissibility of a contract or instrument in Islamic finance.
Another significant feature of Islamic law which differentiates it from conven-
tional law is the fact that not all acts done under Shariah are characterized as legal
or illegal. There are intermediate values as to a person’s action.28 There are gener-
ally five categories of assessment. These are acts that are:29
i) obligatory, where performance will amount to a reward and omission
will amount to a punishment from God;
ii) recommended, performance of act is rewarded but neglect is not
punished;
iii) permitted, acts which neither get reward nor punishment;
iv) discouraged, acts where there is a reward for avoidance but no punish-
ment for performance; and,
v) forbidden, where there is reward for avoidance and punishment for
non avoidance.
While in other legal systems an act might be allowed, prohibited or indiffer-
ently treated, in Shariah an individual is not only guided as to what he is “entitled
or bound to do in law, but also what he or she ought, in conscience, to do or refrain
from doing”.30 In other words Shariah encompasses legal injunctions and moral or
ethical injunctions whereas conventional law is concerned with legal issues alone.
Thus Shariah encompasses religious laws and laws other than those based on
religion. It is derived from the Quran, Hadis, Ijma and Qiyas. The process of ap-
plying and deducing laws from Shariah and the laws thereby deduced is collec-
tively known as fiqh. Shariah is unwritten law like Common law. Common law
systems and Civil law systems, on the other hand, both involve the interpretation of
statutes and case law; they vary only in the degree of the weight given to either
statute law or case law.
Next this article discusses the main fundamental injunctions in Shariah which
govern Islamic banking and finance.

3. FUNDAMENTAL INJUNCTIONS IN SHARIAH

Islam permits and encourages its followers to become involved in trade activi-
ties. As stated in the Quran in verse 275 of Surah 2: “‘Trade is but like usury’, but

26 Doi, supra, n. 2 at 80-81.

27 M.H Kamali “Prospects for an Islamic Derivative Market in Malaysia” (1999) 4 Thun-
derbird International Business Review 539.
28 Abdal-Haqq, supra, n. 19 at 42.
29 Ibid., at 42-43.
30 Gamal Moursi Badr “Islamic Law: Its Relation to Other Legal Systems” (1978) 26 The
American Journal of Comparative Law 189.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 549

God hath permitted trade and forbidden usury.”31

The Prophet (pbuh) in his early life used to be a trader, and, similar to many of
his eminent companions, a businessman. The Prophet (pbuh) was once conferred
the title of “amin” or “trusted one” because of his honesty in all dealings.32 Like-
wise the principles of Islamic business include honesty and the belief that trade is
to be conducted in a faithful and beneficial manner. Trade manipulations and mal-
practices aimed at earning undue profit through operations like hoarding, black-
marketing, profiteering, short-weighting, hiding the defective quality of merchan-
dise, and adulteration cannot be regarded as honest trade.33 To ensure honesty,
transparency and ethical dealings in trade, fundamental injunctions were estab-
lished in Shariah, such as the prohibition of riba, gharar, maisir, qimar and jahala.
These injunctions are the fundamental principles governing Islamic banking and
finance today. These are described in greater detail below.

(a) Riba, Usury and Interest

The giving and receiving of riba is strictly prohibited in Islam. Literally, riba
means increase, addition, expansion or growth.34 However, not every increase or
growth is prohibited in Islam; the prohibition is related to the manner through
which an addition is gained.35 Riba, with regards to Islamic finance is taken to
mean interest paid to depositors and interest charged upon fund users, and is strictly
prohibited in Islam.36 Interest itself is defined as “an amount, or fee, payable for
loaning money to the borrower; interest is usually expressed in a percentage.”37
The prohibition of riba is not a new phenomenon. Until a few hundred years
ago any extra amount demanded by the lender in addition to his capital was called
usury. Early European philosophers such as Plato (350 BC)38 and Aristotle (350
BC)39 condemned the practice of taking usury. Further, the issue of riba is an old

31 Translated by, Abdullah Yusuf Ali, The Holy Quran Original Arabic Text with English
Translation and Selected Commentaries (Saba Islamic Media, 1999).
32 Haron, supra, n. 15 at 13.
33 Ibid., at 13.
34 Mohd Daud Bakar, Riba and Islamic Banking, 1–21, online:
<http://www.cert.com.my/> at 5.
35 Ibid., at 6.
36 Muhammad Taqi Usmani, “The Text of the Historic Judgment on Interest [14 Rama-
dan, 1420]”, Supreme Court of Pakistan (1999), online:
<http://tyo.ca/islambank.community/index.php?name=EZCMS&menu=2&page_id=2&POSTNUKESID=b193a0056c664d16cc69a0d71dc6c23a#Over
37 Pelanduk, Dictionary of Financial and Business Terms (Pelanduk, 2000) at 267-268.
38 Plato (427–347 BC), Laws, Book V: “In marrying and giving in marriage, no one shall
give or receive any dowry at all; and no one shall deposit money with another whom he
does not trust as a friend, nor shall he lend money upon interest; and the borrower
should be under no obligation to repay either capital or interest” Plato, Laws. (360
B.C.), online: <http://classics.mit.edu/Plato/laws.html>.
39 Aristotle (384-322 BC), Politics, Book I, Part 10: “There are two sorts of wealth-get-
ting, as I have said; one is a part of household management, the other is retail trade: the
former necessary and honorable, while that which consists in exchange is justly cen-
sured; for it is unnatural, and a mode by which men gain from one another. The most
550 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

religious issue, not only in Islam but also in Judaism, Christianity,40 Hinduism and
Buddhism.41
Ancient records from Vedic texts in India (2,000-1, 400 BC) and later in the
Sutra texts (700-100 BC) and in Buddhist Jatakas (600-400 BC) show a contempt
for usury.42
However, by the 2nd century AD and afterwards, the concept of usury was
less stringent where a differentiation was made between prevailing socially ac-
cepted range of interest and the amount charged above interest was termed as
usury, the latter being condemned.43
In Judaism, in the Old Testament (Torah) it is stated, “If you lend money to
any of my people with you who are poor, you shall not be to him as a creditor;
neither shall you require usury from him.” (Ex. 22:25). This statement, though, was
interpreted to mean that lending through usury was not allowed between Jews but
allowed to a non-Jew.44
The Christian Church also prohibited all usurious transactions,45 the Gospel
according to Luke reads, “And if ye do Good to them which do good to you, what
thanks have ye? For sinners also do the same. And if you lend to them of whom ye
receive. What thanks have ye? For sinners also lend to sinners to receive as much
again. But love ye your enemies, and do good, and lend hoping for nothing again;
and your reward shall be great and ye shall be the children of the highest for he is
kind unto the unthankful and to the evil.” (Luke 6:34-35).46
However this prohibition against usury changed, “by the end of the thirteenth
century, several factors appeared which considerably undermined the influence of
the Orthodox Church. Eventually, the reformist group, led by Luther (1483–1546)
and Zwingli (1484–1531), agreed to the charging of interest on the plea of human
weakness.”47 In the year 1545 the Act of “In restraint of usury” of Henry VIII in
England legalized the imposition of interest. This Act fixed a legal maximum inter-
est; any amount in excess of the maximum was usury. The practice of setting a

hated sort, and with the greatest reason, is usury, which makes a gain out of money
itself, and not from the natural object of it. For money was intended to be used in
exchange, but not to increase at interest. And this term interest, which means the birth
of money from money, is applied to the breeding of money because the offspring re-
sembles the parent. Wherefore of any modes of getting wealth this is the most unnatu-
ral” Aristotle, Politics. (350 B.C.), online:
<http://classics.mit.edu/Aristotle/politics.1.one.html>.
40 Ala Eddin Kharofa, Usury “Interest” or Riba (A.S. Noordeen, 1993) at 16.
41 Wayne, et al., “A Short Review of the Historical Critique of Usury” (1998) 8 Account-
ing, Business & Financial History 177.
42 Ibid., at 178.
43 Ibid., at 179.
44 Kharofa, supra, n. 40 at 15.
45 Abdul Gafoor, “Interest, Usury, Riba, and the Operational Costs of a Bank” Appropri-
ate Technology Foundation Groningen (2002–2004), online:
<http://users.bart.nl/~abdul/article4.html>.
46 Kharofa, supra, n. 40 at 16.
47 Gafoor, supra, n. 45.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 551

legal maximum on interest rates was later followed by most states of the United
States and most other Western nations.48 Hence interest was legalized and usury,
which was differentiated from interest only in the amount of interest charged, was
not legal. Usury today is referred to as “a very high rate of interest”.49
In Islam, riba is categorically prohibited through both the Qur’an50 and the
Sunnah51 of the Prophet leaving no room for any contrary or reverse opinion.52
However, the division of interest and usury has been claimed by a few scholars in
Islam;53 they believe that the Qur’an prohibited only usury and not interest.
This view is the minority. The majority and overwhelming view, which is the
view taken in Islamic finance, is that interest as well as usury is prohibited in Islam.
This was decided in the Council of the Islamic Fiqh Academy, during its second
session, held in Jeddah 22–28 December 1985, resolution 10/2:54
Any increase or interest on a debt which has matured, in return for an exten-
sion of the maturity date, in case the borrower is unable to pay and increase
(on interest) on the loan at the inception of its agreement, are both forms of
usury which is prohibited under Shari’a.
The taking or the giving of interest and usury is therefore prohibited in Islam.

(b) Maisir, Qimar, Jahala and Gharar

Qimar or gambling is strictly prohibited in Islam. As stated in verse 219 of
Surah 2 of the Qur’an: “They ask thee concerning wine and gambling. Say: In them
is great sin, and some profit, for men; but the sin is greater than the profit.”55

48 Ibid.
49 Pelanduk, supra, n. 37 at 466.
50 Surah 30, Surah al-Rum, verse 39, Surah 4, Surah al-Nisa, verse 161, Surah 3, Surah
Al-Imran, verse 130-2, and Surah 2, Surah al-Baqarah, verses 275–281.
51 There are many narrations of the prohibition of riba through the Sunnah of the Prophet
(pbuh), an often quoted and well known narration is from Ubada ibn al-Samit: The
Prophet, peace be on him, said: “Gold for gold, silver for silver, wheat for wheat, bar-
ley for barley, dates for dates, and salt for salt — like for like, equal for equal, and
hand-to-hand; if the commodities differ, then you may sell as you wish, provided that
the exchange is hand-to-hand” (Muslim, Kitab al-Musaqat, Bab al-sarf wa bay al-
dhahab bi al-waraq naqdan; also in Tirmidhi quoted from M. Umer Chapra, The Na-
ture of Riba in Islam. online:
<www.iriti.org/downloads/Distance_Learning_Files/The_Nature_of_Riba_in_Islam_Umer_Chapra.doc>.
52 Usmani, supra, n. 36.
53 See Fazlur Rahman “Riba and Interest” (1964) 3 Islamic Studies (Karachi); Ahmad
Shafaat, What is Riba? Islamic Perspectives, online:
<http://www.islamicperspectives.com/RibaIntro.htm>; M.O Farooq, Riba, Interest and
Six Hadiths, online:
<http://aa.f370.mail.yahoo.com/ym/ShowLetter?MsgId=8544_127222_85822_3604_62814_0_680_160441_1850555313&Idx=202&YY=74125&inc=
54 OIC Fiqh Academy, Resolution and Recommendations of the Council of the Islamic
Fiqh Academy (1985–2000). (2000), online:
<http://www.islamibankbd.com/page/oicres.htm#10(10/2)>.
55 Translation by Ali, Another injunction on the prohibition of gambling in the Qur’an
can be found in verse 90 Surah 5 of the Qur’an.
552 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

Qimar is often described as maisir which means something attained through no

effort.56 This is one of the main reasons that gambling is prohibited in Islam. Other
reasons include: gambling results in the taking away of one’s property without law-
ful or proper exchange; gambling causes anger and frustration caused by losing;
gambling can be addictive and compulsive which may lead to bankruptcy; and fur-
ther, gambling may cause a person to forget his duty as a Muslim.57
Jahala on the other hand means ignorance, and when applied to a sale, will
cause the sale to be defective. For example if the object of sale or price was un-
known to the buyer due to a buyer’s ignorance, it would be impossible to deliver or
receive the price or object of the sale. This sale would thus be invalid due to
jahala.58 Jahala sales are invalid because of information asymmetry, either party is
not privy to all the information, there is an unfair advantage or injustice.
Gharar, also prohibited in Islam, is more difficult to define,59 as it is more
general and encompasses a number of other elements such as maisir and jahala.
Gharar has been defined as “danger”,60 “risk”,61 and also a transaction equivalent
to “a zero-sum game with uncertain payoffs.”62 Al-Zarqa’s63 has defined a gharar
sale as the sale of probable items whose existence or characteristics are not certain,
and due to the risky nature, makes it akin to gambling.
Gharar sales are invalid precisely because of the excessive uncertainty and
risk involved. For example, the sale of the birds in the sky or the sale of the fish in
the sea. The sale of such items where the number of fish or birds is excessively
uncertain is invalid. Another example of such a sale can be found from the Hadith
narrated by Abu Huraira:
The Prophet forbade two kinds of sales, that is, Al-Limais and An-Nibadh
(the former is a kind of sale in which the deal is completed if the buyer
touches a thing, without seeing or checking it properly and the latter is a
kind of a sale in which the deal is completed when the seller throws a thing
towards the buyer giving him no opportunity to see, touch or check it) and
(the Prophet forbade) also Ishtimal-As-Samma’ and Al-Ihtiba’ in a single
garment.64

56 Abu Khadijah Damansari, The Sin Of Gambling Explained (2007), online:

<http://revivalry.blogspot.com/search/label/Mu’amalat%20-%20Rulings>.
57 Yusuf Al-Qaradawi, “The Lawful and the Prohibited in Islam” trans. by Kamal El-
Helbawy & M. Moiniddin Siddiqui (Islamic Book Trust, 1994) at 304-305.
58 Wahbah Al-Zuhayli, Financial Transactions in Islamic Jurisprudence §1 (El-Gamal
M.A trans., Dar al-Fikr, 2003) at 104.
59 Sami Al-Suwailem, “Towards an Objective Measure of Gharar in Exchange” (1999 &
2000) 7 Islamic Economic Studies at 61.
60 Al-Zuhayli, supra, n. 58 at 82.
61 Mahmoud A. El-Gamal, “An Economic Explication of the Prohibition of Gharar in
Classical Islamic Jurisprudence” (Paper presented at the 4th International Conference
on Islamic Economics, Liecester U.K., 2001) at 2.
62 Al-Suwailem, supra, n. 59 at 1.
63 (1964) in Al-Zuhayli, supra, n. 58 at 83.
64 Bukhari, Complete Sahih Bukhari, online:
<http://www.usc.edu/dept/MSA/fundamentals/hadithsunnah/bukhari/008.sbt.html#001.008.364>.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 553

Maisir or gambling due to its high risk and uncertain outcome, and jahala
sales in which ignorance can lead to uncertainty, are gharar and invalid. It follows
that maisir, qimar and jahala can be described as the subset of gharar. This is
because all jahala transactions would amount to gharar because of the excessive
uncertainty involved, but not all gharar sales are jahala. An example of the latter
would be “in the case of buying a runaway slave with known characteristics.”65
Likewise with maisir or qimar, all maisir or qimar transactions are gharar because
of the high risk involved and uncertain outcome, but not all gharar transactions are
maisir or qimar. This is because the term gharar does not always result in a zero-
sum66 outcome; for example the sale of milk in an udder, whereas gambling always
results in a zero-sum game.67 Between jahala and maisir or qimar there would be
no relationship unless in cases of extreme ignorance a person goes ahead with the
transaction; then this could amount to a gamble or where a person is gambling and
he is ignorant of the consequences or other facts of the game.

(c) Halal and Haram

Halal is that which is permitted, with respect to which no restriction exists,
and the doing of which Allah (swt) has allowed. Haram on the other hand is that
which Allah (swt) has absolutely prohibited. The principle is that all is permissible
unless it has been explicitly prohibited, that is, the general rule is permissibility and
the exception is those items which are haram.68
The reasons why items are declared to be haram are due to their impurity and
harmfulness. The impurity or harmfulness may be hidden or may not be discovered
during one’s lifetime. Examples of things which are haram include gambling, alco-
hol, prostitution and pork consumption.69
Having explained the fundamental injunctions in Shariah, next this article
turns to a case study, where it will be explained how Malaysia has combined
Shariah and conventional laws to govern its Islamic banking and finance industry.

4. CASE STUDY: MALAYSIAN LEGAL AND SHARIAH

INFRASTRUCTURE
Malaysia has become one of the leading countries in the world in the Islamic
banking sector.70
The era of Islamic banking can be traced back to 1963 when the Perbadanan
Wang Simpanan Bakal-bakal Haji (PWSBH, currently known as Lembaga Urusan
dan Tabung Haji) was established.
However, a new beginning to Islamic banking activities commenced from the

65 Al-Zuhayli, supra, n. 58 at 109.

66 This is a game in which whatever one party gains is what the other loses. Al-Suwailem,
supra, n. 59 at 62.
67 Ibid., at 69.
68 Al-Qaradawi, supra, n. 57 at 14.
69 Ibid., at 44.
70 Sherin Kunhibava, “Championing Islamic Banking and Finance in Malaysia” Islamic
Finance News 2010 at 15.
554 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

early 1980’s when Malaysia began developing its banking and financial infrastruc-
ture to accommodate a dual system. Malaysia officially introduced Islamic banking
and finance to its shores with the passing of the Islamic Banking Act 1983. Its main
purpose is to govern the operations of Islamic banks, such as stating requirements
for a bank to be licensed as an Islamic bank. The Islamic Banking Act 1983 defines
an Islamic bank as any company which carries on Islamic banking business and
holds a valid license. It defines “Islamic banking business” as any banking business
whose aims and operations do not involve any element which is not approved by
the religion of Islam. The religion of Islam is where Shariah comes in, and this is
not defined by the Islamic Banking Act 1983. Instead the Islamic Banking Act 1983
leaves Shariah interpretation and incorporation into Islamic banks through its s. 3.
According to s. 3 of the Islamic Banking Act 1983, every bank that wants to prac-
tice Islamic banking must establish a Shariah advisory body to advise the bank on
the operations of its banking business to ensure that the bank complies with the
“religion of Islam”. Thus, the Shariah Advisory body ensures that Shariah is com-
plied with by the Islamic bank.
To ensure uniformity and standardization in the decisions by the Shariah advi-
sory bodies of the various Islamic banks, there exists a National Shariah Advisory
Council which advises the Central Bank in Malaysia. The National Shariah Advi-
sory Council is the ultimate authority on Islam in Islamic banking and finance in
Malaysia. It was established in 1997 by the Central Bank and its primary objectives
are: to act as the sole authoritative body to advise the Central Bank of Malaysia on
Islamic banking and takaful operations; to co-ordinate Shariah issues with respect
to Islamic banking and finance (including takaful); and to analyze and evaluate
Shariah aspects of new products/schemes submitted by the banking institutions and
takaful companies.71 Generally, its role is to ensure overall coherence to principals
of Islam and also that all banks offering Islamic services conform to the same
principles.
Further, the recent passing of the Central Bank of Malaysia Act 2009 gives
greater clarity to the role of the National Shariah Advisory Council as the ultimate
authority and centre for any issues and questions on Shariah by financial institu-
tions and also the courts of law. Under the Central Bank of Malaysia Act 2009 any
ruling made by the National Shariah Advisory Council shall be binding on Islamic
financial institutions, the court and arbitrator.
The Islamic Banking Act 1983 also provides that an Islamic bank may seek the
advice of the National Shariah Advisory Council on Shariah matters relating to its
banking business, and the Islamic bank shall comply with the advice of the Na-
tional Shariah Advisory Council.
In Malaysia conventional banks licensed under the Banking and Financial In-
stitutions Act 1989 are also allowed to carry out Islamic banking and finance busi-
ness in addition to their conventional banking business, after consulting the Central
bank of Malaysia. Under the Banking and Financial Institutions Act 1989, Islamic
banking business has the same meaning as in Islamic Banking Act 1983, whilst
Islamic financial business is defined as any financial business the aims and opera-

71 See online:
<http://pkukmweb.ukm.my/~hairum/Ex3613/overview%20of%20Islamic%20Banking%20in%20Malaysia.pdf/assessed>.
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 555

tions of which do not involve any element which is not approved by the Religion of
Islam. Further like the Islamic Banking Act 1983, the Banking and Financial Insti-
tutions Act 1989 provides that any licensed institution carrying on Islamic banking
business and Islamic financial business may refer a question to the National
Shariah Advisory Council and shall comply with directions on Islamic banking
business and Islamic financial business issued by Bank Negara in consultation with
the National Shariah Advisory Council.
In addition to the National Shariah Advisory Council of the Central Bank,
there also exists a Shariah Advisory Council for the Securities Commission, whose
role is to advise the Securities Commission on Shariah related matters and to pro-
vide Shariah guidance on Islamic Capital Market transactions and activities.
556 BANKING & FINANCE LAW REVIEW [26 B.F.L.R.]

Thus, in Malaysia conventional law i.e., the Islamic Banking Act 1983, the
Banking and Financial Institutions Act 1989 and the Central Bank of Malaysia Act
2009 govern the operations of the Islamic banking and financial business, but
Shariah is left to the Shariah Advisory boards of each bank and the National
Shariah Advisory Councils of the Central Bank and the Securities Commission. In
this way both conventional laws and Shariah complement each other to ensure
proper governance and proper adherence to Shariah by Islamic banking and finan-
cial institutions in Malaysia.
One of the main lessons that can be learnt from Malaysia’s comprehensive
 SHARIAH & LAW IN RELATION TO ISLAMIC BANKING & FINANCE 557

regulatory framework with regards to Islamic banking and finance, is on the issue
of Shariah governance. In Malaysia, uniformity is maintained in decisions on
Shariah matters. It is important to ensure uniformity in the decisions of Shariah
issues to create certainty for investors and other stakeholders. Investors and other
stakeholders are certain of the outcome of Shariah matters. Uniformity and cer-
tainty in Shariah governance is maintained in Malaysia through the one National
Shariah Advisory Council that deals with all the Islamic banking and takaful mat-
ters in Malaysia. Even though each Islamic bank has its own Shariah advisory
board, each Shariah Advisory Board must comply with the directives of the Na-
tional Shariah Advisory Council. The National Shariah Advisory Council is the
ultimate authority in matters of Banking and takaful. With regards to the Islamic
capital market the sole Shariah authority is the Shariah Advisory Council of the
Securities Commission.
Another lesson that can be learnt from the Malaysian regulatory framework is
the transparency of the structure and the distinct roles of every organ in the Islamic
financial system. Each Islamic bank is governed by the Islamic Banking Act 1983,
and conventional banks are governed by the Banking and Financial Institutions Act
1989. These acts govern the operational aspect of the banks. On matters of sub-
stance that govern the Shariah compliance of the banks’ products and services
these are left to the Shariah Advisory Board, and National Shariah Advisory Coun-
cil. Each organ in the Islamic financial system has distinct clear roles for which
they are qualified for.

5. CONCLUSION
This article explained the sources of law of Islamic banking and finance as
Shariah and conventional law and compared them with each other. Shariah encom-
passes more than just law, it includes religious, moral and ethical injunctions. This
article also explained the Shariah injunctions of riba, maisir, qimar, jahala,
gharar, halal and haram that apply to Islamic banking and finance. An explanation
of how conventional laws and Shariah work in conjunction to govern Islamic bank-
ing and finance in Malaysia was made. While the laws of the country may take care
of the operation of Islamic banks and conventional banks offering Islamic products,
it is Shariah that governs the financial institutions’ business principles.