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 Chapter 5
lslamic Contracts in Banking and
Finance

Contracts in Islamic finance basically classified as: (i) partnership or

profit sharing contracts; (ii) sale contracts; (iii) loan contracts; (iv) lease
contracts; (v) deposit contracts; (vi) agency contracts; (vii); security
contracts and (viii) gift contracts.

Partnership Contracts

Musharakah
Syaikh Wahbah Ztthayli in his book of al-fiqh al-islami wa-adillatuh
explains that jurists are slightly different in their definition ofpartnership.
For instance:

1. The Malikis defined partnership as a right for all the parfirers to

deal with any part of the joint property of the partnership.
2. The Hanbalis defined partnership as sharing the rights to collect
benefits from or deal in the properties of the partnership.
3. The Shaf is defined it as an estabiishment of collective rights
(pertaining to some properties) for two or more people.
4. The Hanafis defined it as a contract between a group of individuals
' who share capital and profits.

The defrnition provided by the Hanafis is considered as the best

definition since it explicitly states the nature ofpartnerships as a contract,
whereas the other definitions only mention the goals and outcomes of
having a partnership.
The legality ofpartnership contracts has been establishedbyAllah
SWT in the Qur'an, by the prophet Muhammad SAW in his sunnah and
by the consensus of the Muslim scholars.

FI 5 )
- Eanking and
as: (i) PartnershiP or
=d
loan contracts; (iv) lease
rontracts: (vii); securitY
al-islami w a-adillatuh
..rtqh
*it d.fioitlott of PartnershiP'
right for a1l the Partners to
1-of the ParbrershiP'
sharing the rights to collect
s of the PartnershiP'
ishment of collective rights
i-0 or more PeoPle'
-rreen a group ofindividuals
afis is considered as the best
e ofpartnershiPs as a contract'
of
rn the goals and outcomes
A1lah
has been established bY
mmad SAW in his sunnah and
Islamic flontracts in Banking and Finance
Allah SWT says in the Qur'an,
,-J*r ';"l-- -iJ' \l-=- lai ;l.J 'U''uJi ;\ i!
s
r\.)
.sie
:o1.*'-'
". . . truly rnany are the partners (in business) who rvrong each other;
not so rlo those rvho belier,e anri work deeds ol righteousness".."
l-18:241
Fufihermore, is rhen strengthened by the Hadith Qudsi where
it
Allah SWT says'."{ otlt the thifi of even'two pcu'tners as lortg as neither
one hetralts the other. Howeyer, if"one betrays the other, I Ieave their
partnership." This Hadith Qudsi l\,as flarrated on the authority of Ahu
Hurayrah RA by Abu Daw.ud. Another hadithreporled in Ibn Qudamah" s,
the prophet SAW sa3rs, "Allah suppofis the partners as long as they do
not betray one another."
In practice, there are general partflership and cr:ntract-based
partnership. l-or general partnership. jurists have dlvided the partnership
into trvo. which are:
\'oluntary general partnerships rn'hich originate fiom a joint purchase
1 .
or aioint receivership ofgifis or bequests that they accept'
2. Involuntary general partnerships which originate without any
action or approvai of the partners. For instance, heirs who inherit
a property are autolxaticaily general paftners in this property'
In contract-based pafinerships, there are three tlpes of partnerships,
which are:
1. Capitai Partnership, where twO or more individuals share their
capital, stipulating that whatever proflts they earn are shared among
them. The contract may either be limited (.svirkah al-'inan) ot
unlimited (s,,- irkah o l - muf atv acl ah)
-
Lirnited partnership (syirkah al-,inan) is the most ColTlmon
form of partnership. This parlnership needs neither to be equal in
their contributions to capital, nor equal in their legal rights for using
the property" The general rule in this fom of parlnership is"profits
B9
 Foundation of Islarnic Finance

are shared according to the conditions (agreed upon), but losses

are shared according to their shares in the capital."
Unlimited partnership (.syirkah al-mufawadaft) is built upon
the concept of mdawadal2, whereby each of the partners delegates
to the other (vufawwiduhu) the right to deal in his property. This
form requires full equality of the parties in terms of their shares in
the overall capital, their legal rights of controlling the affairs of the
partnership, and they must be of the same religion which makes
each of them responsible for all the dealings of the other, as they
share all rights and obligation equally.

2. Credit Partnership (syirkah al-wujuh), where two or more

creditworlhy individuais join in a credit purchase, and follow it
with a cash-and-cary sale, thus sharing the profits according to
the conditions stipulated in the contract.
According to Syaikh Wahbah Zuhayli in his book of al-Jiqh
al-islami wa-edillatuh, the Hanafis and Hanbalis pennitted this
type of partnership but the Malikis and Shaf is say that this type
of parlnership is invalid.
Those who permit this type of parlnership permit unequal
ownership of the object bought in the initial credit sale, based on
the hadith, "Muslims are bound by their conditions." In this case,
profits and losses must be detennined according to the partners'
shares in ownership. On the other hand, those who do not permit
this type of partnership view that parlnership must be over propefty
(capital) or work, neither of which exists in this case.

Physical Labor Parlnership (syirkah al-'ama[), where two or more

individuals agree to embark on a joint labor project (e.g. building a
house), sharing the wages according to their stipulated conditions in
the contract. The parlners may be of similar or different professions
(e.g. a carpenter and a contractor).
The Malikis, Hanafis, and Hanbalis permitted this type of
partnership while Syaf is said that it was an invalid contract'
However, Syaikh Wahbah Z;uhayli says that Ibnu Taymiya in his
book Muntaqa Al-Akhbar 'an Sayyidi Al-Akhyar pointed out that
this type of parlnership is valid based on the following hadiths.

90
 Islamic Contracts in Banking and Finance

"Ibnu Mas'ud RA said: 'Ammar, Sa'd, and I joined on the day of

'agreed upon), but losses
Badr, whereby Sa'd managed to captured two prisoners of war,
he capital."
while 'Ammar and I did not capture any, but the Prophet SAW did
nufawadnh) is built uPon
not deny us our share"
r of the parhers delegates
[Narrated by Abu Dawud, Al-Nasa'I, and Ibnu Majah on the
deal in his ProPertY. This authority of Abu Ubaydah ibn 'Abdallahl
in terms of their shares in
ruolling the affairs of the
Musyarakah
ne relision which makes
gs of the other, as theY

re t\vo or more
'.i he Contract-
--.-hase. and follow it
Based
Partnership
.- plstits according to

li in his book of al-fiqh

Flanbalis permitted this Cledit
Capital
--r'is say- that this tYPe Partnership Partnership

rmership permit unequal

nitial vrvlg!
ru4r sale, based
credit er.L-, ---'
on
eir conditions." In this case,
Limited Unlirnited
ed according to the Partners' Parlnership Partnership
hmd- those who do not Permit
rtnership must be over ProPertY Figure 5.1:The Stntcture of Musyarakah
€:rists in fhis case.

h al-'amal),where two or more Mudharabah

im laborproject (e.g' building a
Seir stipulated conditions in In mudharaba or silent parlnership, the owner of capital (Rabb Al-maal)
3 ro

f similar or different Professions gives it to a worker (mudharib) to trade on their behalf, and profits are
shared according to an agreed-upon formula. All financial losses are borne

lanbalis pemritted this tYPe of
hat it was an invalid contract.
i says that Ibnu TaYmiYa in his
fidi Al-Akhyar Pointed out that
sed on the following hadiths.
by the provider of capital (the silent partner), while the entrepreneur can
only lose his effort if no profits are made.
The above definition highlights two important distinctions between
silent partnership and other types of partnership:

91
 Foundation of Islamic Finance

1. lt is not valid to establish a silentpartnelship where the provided

capital takes the form of a usufruct (e"g. the right to live in a
house), or a debt to an entrepreneur or somebody else . The silent
pafiner must give capital to the entrepreneur to establish the silent
partnership.
2. The profit sharing affangement establishes the difference between
a silent partnership and an agency (tawkil).

The permissibility of this contract is viewed as an exception

to general rules prohibiting excessive risk and uncertainty in hiring
contracts" Ibn Hazm says that all chapters of Islamic jurisprudence have
folndations in the Qur'an except for silent parlnership, for u'hich there
is no foundation in the Qur'an. The contract is in fact legitimized by
consenslrs o1'jurists, especially since it did exist during the prophet SAW
time, ancl he permittetl it to continue. Otherwise. this contract would not
have been pennitted.

"Al-'Abbas ibn 'Abd Al-Muttaiib ttsed to stipulate a condition

whenever he gave his rnoney in a mudharaba that the entrepreneur
will not take his money across any sea. into any valiey, or buy any
animal rvith a soft belly, and if the enffepreneur were to do any of
those actions, then he must guarantec the capital. The messenger of
Aliah SAW heard of this practice and permitted it""
lNarated by Al-Tabarani on the authority of 'Ibn 'Abbas]

Fufihetmore,lbn TalT niyahad establishedthe legality of ruudharaba

through consensus that is based on a legal text" Ife argued that the contract
was commonly used by the prophet's tribe in pre-islamic times. tn this
context, the prophet SAW himself traveled tr: trade with other people's
money inctruciing that of the Lady Khadijah RA. When lslam came, the
prophet SAW continued to approve the contract al.ld his own companions
continued to use it with his implicit approval"
There are two types of silent parlnerships: (i) unrestricted silent
partnership and (ii) restricted silent parlnership.

1. In the form of unrestricted mudharaba,the capital ownel gives the

entrepreneur a cerlain allount of money, specifying oniy the profit
' sharing rule. Thus, he leaves unspecified the work to be done, its
time and place as long as it does not violate any shariah r-ules'

92
 Islamic C--ontracts in Banking and Finance

ip where the Provided

2. In the form of restricted mudharaba, the capital owner specifies a
list of conditions relating to the work" The example for this type
the right to live in a
has been given try Ai-'Abbas ibn 'Abd Al-lvluttalib in the previous
ebody e1se. The silent
mentioned hadiths.
r to establish the silent
.Iurists agree that the mudharuba conttact is non-binding prior to
the difference between commencement of the work, and may thus be dissolved by either party.
llow,ever, if the worker hail already begun his wo1k, jurists differ over
the characterization of the contract. Abu Hanifa, Ai Syaf i, andAhmad
as an excePtron
rtainty in hiring bin Hanbal ruled that the contract would still be non-binding. On the
risprudence have
other hand, Imam N4alik mled that once the work begins, the contract
r. for which there
becomes binding on both Parlies.
: 1.-gitimized bY
theprophet SAW Sale Contracts
rntract would not
Murabaha
a condition h:lurabohais a cost-ptrus saie rvhere the price is determined in lump-sum.
entrepreneur This contract is legally permissible with the following evidences:
y-. or buy anY

re to do anY of i. There are many verses in the Qur'an that explicitly permit sales in
messenger of general e.g. ".. .ancl Allah has permitted trade..." l2:275)," " 'but,
let there be arnang t ou trffic and tt'ade by mutuul good will'" 11:
Ibn'Abbasl 29]. In this regard, cost-plus sales are cleariy concluded by mutuai
consent"
btsd tre legalitY of mudharab a
2. [t was narrated that Ibn Mas'ud RA ruled that there was no hat.11,1
rrr He argued that the contract in declared lump-sum or percentage profit margins'
in pre-Islamic times. In this
Murabcrlta satisfies a1l the legal requirements for sale, and it
be
with other PeoPle's
3.
ed to uade
provicles a valuable sep,ice in economic markets since it a1l6ws
the
Fh R.{. When lslam came,
I
those knowleclgeable of market conditions to make profits and those
-t mrct andhis owrr companions
without such knowledge to obtain the goods at a good price'
oral-
:

Erships: (i) unrestricted silent

I The conditions for mw'abaha sale with regard to its price are:
oership.
1. Knowledge of the initial price. The sale is considered ciefective if
abs- fte caPital owner gives the the initial price is not knor,vn during the contract session'
mey, specifYing onlY the Profit 2. Knowleclge of the profit margin. The profit margin is a component
ecified the work to be done, its of the price at rvhich the buyer obtains the goods. Thus, knowledge
ot riolate anY shariah rules'

93
 Foundation of islamic Finance

of that margin is essential for knowledge of the price, which is in

turn a condition of validity for the sale.

Salam
Salam or forward sale is the sale of a deferred item in exchange for an
immediate (forward) price. In other words, it is the sale of a liability
whose characteristics are described in exchange for a price or capital-
sum paid in advance. As the permissibility of the practice of salam, it is
recorded that the prophet SAW said: "whoever participates in aforward
sale, let him buy a known volume or known weight for a known term of
deferment."
There are cerlain conditions of salam which must be fulfilled for
the price and the object traded.
Conditions for the price are:

1. The price has to be specified in monetary form (e.g. gold or silver

coins) and items measured by volume (e.g. wheat and barley) or
weight (e.g. cotton and iron).
2. If there are multiple types of the specified genus in the area (e.g.
multiple gold coins from different sovereign states, multiple types
of barley, etc.), then the type must be specified.
3. Specification of the amount of the price if it is measured in volume,
weight, or number. Therefore, it is not sufficient to point to the price
without explicitly stating its amount.
4. The payment and receipt of the price during the contract session
prior to the parling of the contractors is a condition. Thus if the
two parlies separate prior to the receipt of the price, the contract is
invalid and void.

Conditions for the object are:

l. Its genus must be known (e.g. specify whether it is wheat, barley,

durian, etc.)
2. its type and quality must be known (e.g. typeAwheat, type C wheat,
high quality wheat, low quality wheat, etc.)
3. Its amount should be known by volume, weight, number, or size.

94

edge of the Price, which is in
item in exchange for an
is the sale of a liabilitY
ge for a price or caPital-
k practice of salam, it is
participates in a forw ard
ightfor a l*town term of
hich must be fulfilled for
form (e.g. gold or silver
.g. wheat and barleY) or
d genus in the area (e'g.
ign states, multiPle tYPes
cified-
it is measured in volume,
icient to point to the Price
ring the conffact session
; a condition. Thus the if
f the price, the contract is
:ether it is wheat, barleY,
. pe ,\ wheat, tYPe C wheat,
:tc.
)
--. u'eight, number, or size'
Islamic Contracts in Banking and Finance
4. Its genus must exist in the market and it cannot be imagined to
become unavailable.
lstisna'
Istisna'evolved into Islamic jurisprudence historically due to specific
needs in the areas of manual work and production such as leather
products, shoes, carpentry housing, etc. This is evidence that Islam has
always been responsive to people',s needs, permitting and legalizing all
transactions that meet legitimate and lawful needs based on justice and
fair compensation in their commutative transactions.
Istisna'is a contract commissioning a worker to manufacture an
item that is defined as a liability on him. Thus, ls/isrza' is a contract to
purchase the item to be manufactured by the worker, where the worker
provides the both the raw materials as well as the labor to produce the
final product specified in the contract.
Jurists permitted is tisna' based on juristic approbation (is tihs an).
Its common usage in various times without any objections constituted a
consensus. This view was also supported by a statement by Ibn Mas'ud
who said that"whateyer the Muslims yiew as fair it is indeed.fair in the
eye of Allah St)[/T." Furthetmore, the prophet SAW is reported to have
commissioned the manufacture of a ring and a cupping. In the latter case,
he paid the cupper his wage, despite the fact that the act and frequency
of cupping is unregulated.
There are at least two similarities b et:Neen salam and istisna 'which
are (i) both contracts involving sales of non-existing items and (ii) both
are permitted to meet economic needs and is based on common practice.
on the other hand, the most important difference between salam and
istisna" is that price in salam is paid in full during the sale whereas
people usually pay in a progressive method of payment fot isti,gna"
Sarf
sarf or currency exchange is the exchange of one monetary tbrm for
another in the same or different genus (e.g. gold for gold, silver for
go1d, RM for USD, etc.) whether it is in the form ofjewelry or minted
coins.
95
 Foundation of Islamic Finance

There are two general conditions for the sarf contract:

l. N{utual receipt prior to the separation ofboth parties. Therefore, it

requires the absence of any deferment. This is to avoid the danger
of cornmitting the forbidden riba an-nasa'.
2. If a money is exchanged for another money of the same genus (e.g.
gold for gold, silver for silver, etc.), then the two compensations
must be equai in weight, even if one of the tr,vo compensations is
of a higher quality or workmanship than the other. This is to avoid
the danger of comr:nitting the forbidden riba at-fodt.

Loan Contracts

Al-Qard
TheArabic tenn fbr laans,'"qard," literally means "cutting-off a portion."
This rneans that th.: person extending the loan is giving the bororryer part
of his property or u.ealth.
some of the jurists argue that loans are a subcategory of sales since
they involve the exchange of properties. However, it can be fbuncl in
Syaikh \\rahbah Zuhayli's book that there are at least three clifferences
between sales and loans:

1. Loans may be made with goods eligible for riba.

2. For goods not eligible for riba, loans may be conducted where a
known is traded in exchange for an unknow.n.
3. For fungible goods, loans may involve selling that which is not in
the seller's possession, which is not permitted in sales.

Those three rules cannot be in existence in sales but relaxed in loans

because a loan is to facilitate charitable behavior whereby sale is to gain
profit. This is why a loan is forbidden if the intention is to gain profir.
Loans are permissible based on the sunnah of Rasulullah SAW. It
is nanated on the authority of 'Anas that the prophet SAW said:

"On the day I ascended to heaven. I sarv a writing on the door of'
paradise that read: 'Every charity is rewarded ten-fold, and every
loan is rewarded eighteen-times.'I said: 'O Jibril. r.vhy is a ktan

96

e sarfcontract:
fboth parties. Therefore, it
This is to avoid the danger
'of the same genus (e.g.
the two comPensations
e two compensations is
re other. This is to avoid
ba al-fadl.
ns "cutting-off a Portion. "
s gir.ing the borrower Part
zubcategory of sales since
never, it can be found in
: at least three differences
for riba.
La-v be conducted where a
nown.
.- irng that which is not in
rmitted in sales.
ce in sales but relaxed in loans
har-ior whereby sale is to gain
he intention is to gain Profit.
srmnah of Rasulullah SAW. It
rhe prophet SAW said:
n- a writing on the door of
narded ten-fold, and every
d: 'O Jibril, why is a loan
islamic Contlacts in Banking and Finance
rewarded more than charity'?.' He said: 'Because a person may ask
for charity rvhen he does not need it, but the bor:rower only borrou's
in cases ofdire need"'
fNarrated by 'Ibn Majah and Al-Bayhaqi on the authority
of 'Anas lbn Malikl
Lease Contracts
ljarah
Ijarah is defined as a contract over a desirable, known, permissible, and
accessible usufittct. in exchange for a known cotnpensation" Another
definition is the transfer of ownership of permitted usufruct for a known
period in exchange ibr compensation. Therefore, it can be observed from
the definition that there are at least four cornerstolles recognized by
the majority of the jurists, lr,hich are: (i) contracting parties (lessor and
lessee). (ii) contract language (offer and acceptance), (iii) lease payment
(rent), and (iv) extraction of benefit (usufiuct).
There are four conditions for the lease contract, paralleling the four
conditions for sale: conditions of conclusion. executabiliq', validity, and
bindingness:
1. Conditions of conclusion
Leases by an insane person or a young non-discetning child are not
concluded, in analogy to sales.
2. Conditions of executability
If the contract is permitted before the lessee extracts benefits
from the propefiy, the lease is pemissible.
If the owner gives pennission atler the benefit was derived
fiom the iease object, the lease is not valid.
3. Conditions of validity
Mutual consent is a condition of validity of the lease
contract.
97
 Foundation of Islamic Finance

There must be at least three components of knowledge for the

lease object: (i) knowledge of the type of benefit or usufiuct
to be derived from the object, (ii) knowledge of the period of
the lease, and (iii) knowledge of the nature of labor in leasing
the labor or skilled or unskilled workers.

4. Conditions for binding

Leased items must remain free of defects.

Every excuse that makes the satisfaction of the contract
impossible without causing harm to the person or property
of one of the contract parlies gives that party a right to void
the contract.

Deposit Contracts

Wadi'ah
Wadi'ah or deposit contract is defined as a contract that gives another
person a tawkil (agency) for safekeeping one's property or legal
possession. The deposit contract is permissible and recommended, based
on Qur'an and sunnah.
Allah SWT says in the Qur'an:

,,o.r, ..t', :-t .i,)r,i': :.

k&, Jl .rljt Yt r".: tj Jr 5,.1_ "lt 3t

"Allah commands you to retum trusts to those to whom they are

due" [4: 58]

1 ,o a n, o-
"-.
ait:i*;;t .5-'Jl ;j$
"... and if one deposits a thing or trust with another, let the trustee
discharge his trust. .." 12:2831
The prophet Muhammad SAW says,

"Retum trusts to the one who entrusted you, but do not betray the
one who betrayed you"
fNarrated by Abu Dawud and Al-Tirmidhi]

9B
- I '-:-.C Islamic Contracts in Banking and Finance

-: :'..nts of knowledge forthe The majority of jurists enumerated three cornerstones in deposit
' " : t;:r' of benefit or usufruct contracts, which are:
-:,tu.iedge of the Period of
1. Depositor and depository. The majority of jurists stipulated that
- r : :l-lture of labor in leasing
the depositor and depository must be sane and discerning, thus
:- -,.:.-fS,
restricting the insane and young children from making or receiving
deposits.
2. Deposited object. The object of deposit must be a form of property
ce ot cetects.
that can be possessed physically. Hence, deposits of runaway
Lc satisfaction of the contract animals or birds in the sky are not guaranteed by the depository.
harm to the person or ProPerfY 3. Offer and acceptance. The acceptance may be verbal (e.g. ..I accept
r 9rr-6 ftat parry a right to void your deposit"), or it may be implied through physical receipt and
silence.

Agency Contracts

Wakalah
ntract that gives another
The term Wakalah literally means "preservation." The term is also
me's propertY or legal used to mean delegation of one's affairs to another. Shaf is postulated
and recornmended, based
that wakalalz is the delegation of one living person to another of the
performance of an act that permits delegation, and that the first person is
permitted to perform himself. In this regard, the delegating party must be
living to distinguish the agency contract from a person's will. Dealings
ii tl V|'uir'ay that are permissible for agency contracts include financial dealings such
as trading and other actions that allow for legal representations such as
xe to whom theY are
permission for entry into a property.
The agency contract is permissible and recommended, based on
, /'., - i the Qur'an and Sunnah.
-: ---;L! .J"l vY
-\-J+ Allah SWT says in the Qur'an:
:...ther. 1et the trustee
.1 ' ,
vrlL ;i;\": qi "p* erJr JI .il :<;j;q J_r_i ,.;ou
, o-

U s;, r(+
d1-ou but do not betraY the
"Now send one of you with this money to the town; tO hmnna o*
which is the best food and bring some to you" [18: 19]
h Dawud and Al-Tirmidhil

99
 Foundation of Islarnic Finauce

-l tt -:l
\+.tc ;".t"UJl .
/,.
-fUJt, er,i;lJ ;GU1 I

"Alms are for the poor and the needy and those employed to
administer the lunds..." [9: 60]

There are many hadiths that establish the permissibility of agency.

one such hadith was narrated inAl-Bukhari that the prophet Muhammad
SAW commissioned an agent to give a camel as repayment of his debt,
saying: "the best among you are the best in repaying their debts."

Security Contracts

Al-Kafalah
The jurists define kafatah as a conjoining of the guarantor's liability to
the liability of the guaranteed. Thus, the debt would be established as a
joint liability on both of them. The creditor's right is not increased by
conjoining the guarantor's liability to that of the guaranteed. This follows
from the fact that the creditor is still entitled to one repayment, either
trom the guarantor or fiom the original debtor.
The kafatah contract is per-rnissible and recommended, based on
the Qur'an and Sunnah.
Allah SWT says in the Qur'an:
--'
ff): Ui; u- * il- Jj
))-.v
^,i I

"For the one who produces it (the King's beaker) is the reward of
a camel load: I will be his Za'im" 112:121.

(Ibn 'Abbas stated that Za'im is another word for kafil, i.e.
guarantor)
Al-Bukhari narrated in his shahih that the prophet Muhammad
SAW came to a funeral of a man to pray on his soul. He asked those
present: "did he leave any wealth?," they said: "No." Then he asked:
"did he die with any debts outsanding?," and they said: "Yes. He owed
two dinars." The prophet SAW was thus about to leave, and said: "then
you pray on your companion." At that time, Abu Qatadah RA said: "I

100

A -s:^Lsr r;y
sL- elrlployed to
rmissibilitY of agencY'
re prophet Muhammad
repayment of his debt,
,ing their debts."
suarantor' s liabilitY to
ruld be established as a
ght is not increased bY
uaranteed. This follows
r one repaYnent, either
:cornmended, based on
''. +LG:'J'e
=* 'i-
is heaker) is the reward of
:t-
another word for kafil, i'e'
that the ProPhet Muhammad
r on his soul' He asked those
+' said: 'T'{o." Then he
asked:
' "Yes. He owed
and they said:
about to leave, and said: "then
ime" Abu Qatadah RA said: "I
I
Islamic Contracts in Banking and Finance
guarantee his debts, Oh Messenger of Allah," and the prophet SAW
prayed for his soul.
Al-Hawalah
Thelermhawalah means "change" or "transfer." The juristic definition of
al-hs**alah is the transfer of debt from being a liability on the principal
debtor to being a liability on the transferee, as a means of ensuring the
debt. The transfers of debt must be distinguished from guaranty contracts,
since the iatter entails the conjoining of liabilities rather than the transfer
thereof. As a consequence, once the transfer of debt is concluded,
repayment may not be sought fi'om the original debtor.
The legality of al-ltawalah can be found from the sunnah which
has been reporled by Al-Bayhaqi that the prophet SAW said:
"Deiinqr.rency of rich debtors is a tbrm of transgression, so if one
ofyou has his debt translerred to a rich person; let him accept the
transler of debt"
fNarrated by Ahmad]
However, majority ofjurists only permitted the transfer of fungible
debts. it is not permissible for non-fungible debts since the transfer of
liability may only be effected for fungibles.
Al-Rahn
The Arabic term"raltn" refers to either to constancy or to holding and
binding. Of the two meanings, the holding aspect is more physical and
hence it is deemed to be the primary linguistic meaning. Often times,
one uses the term rahn to refer to the object that was par.vned to ensure
debt.
The Shaf is defined the pawning contract as takirrg a non-ftingible
properly as insurance against a fungible debt, whereby the debt may
be extracted from the held property if it is not repaid. The explicit
specification of non-fungible property implies that usufruct may not be
used as the object of a pawning conlract.
The rahn contract is perrlissible and recomrnended, based on the
Otr'an and Sunnah.
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 Foundation of Islamic Finance

Allah SWT says in the Qur'an:

' *.;;" -rlr; L;K \.-l-j -1. j- y $ Jri

/,
"If you joumey and cannot find
are on a a scribe, then use the receipt
ofpawned objects" [2: 283].

Narrated by Al-Bukhari on the authority of 'Aisyah RA that

the prophet Muhammad SAW bought some food from a Jew, and he
pawned his iron shield with him. In another narration of Al-Bukhari on
the authority of Abu Hurayrah RA, it is reported that the prophet SAW
said: "The ownership link between a pawned object and its owner is not
severed; he is still responsible for its expenses, and he is entitled to its
output."

Gift Contracts

Al-Hibah
Jurists define the gift contract as a voluntary contract that results in
uncompensated ownership transfer between living individuals. The
properties transfered may be known or unknown, but they must be
conventionally given as gifts, and the contract language must specifli
that it is a gift or a property transfer, et cetera. The condition of having
no compensation for the gift is required to exclude commutative
contracts.
Al-hibah is permissible and recommended, based on the Qur'an
and Sunnah.
Allah SWT says in the Qur'an:

L:, * r\) J( v7

"But if they, of their own good pleasure, remit any part of it to you,
take it and enjoy it with right good cheer" [4: 4].

t02
 Islamic Contracts in Banting and Finance

to
LJr V't.jr ,i"fuJ'
v' ,'-L:Jr' ),'."Jt
/ A *>'I
.<osi-)
Y) [G Jt;t 6t1
) / ,l
-.\ ,I "Spends the wealth that he cherhises, to his kinfolks, orphans. the
E ^ *
a
-.-/
needy, the wayfarer, ..." 12: 1171.
fre. 6en use the recelpt
Nar:rated in all major books of hadith on the authority of Abu
Hurayrah RA, the prophet Muhammad SAW said: "Exchange gifts so
orit-v of 'AisYah RA that that you may love one another." The prophet SAW was also narrated
l food from a Jew, and he by Al-Bukhari to have said: "Do not underestimate the significance of
nrration of Al-Bukhari on a neighbor's gift to her neighbor, even if it is only a sheep's foot." The
oned that the ProPhet
SAW
prophet SAW therefore admonished those who recall their gifts by saying:
is not
d object and its owner "The one who recalls his gift is a like a dog, who eats his vomit."
ses-md he is entitted to
its

Summary
This chapter deals with the explanation of Islamic contracts and their
application in the modern Islamic banking system. Contracts in Islamic
finance basically classified as: (i) parlnershiB or profit sharing contracts;
in (ii) sale contracts; (iii) loan contracts; (iv) lease contracts; (v) deposit
mMY contract that resultsThe contracts; (vi) agency contracts; (vii); security contracts and (viii) gift
t **; [ving individuals' be contracts.
. *..ho**, but theY must sPeciff Included in partnership contracts are musharakah and mudharabah,
E codlrffit language must whereby in sale contracts are murabqhah, salam, istisna', and sarf.Loan
cr *".t The condition
of having
contract, lease contract, deposit contract, and agency contract consist
conrmutative
ryired to exctude of al-qard, ijarah, wadi'ah and wakalalz respectively. Al-kaJatah, al-
hawalah and al-rahn are included in security contracts. Lastly, gift
.rryrrnende4 based on the Qur'an
contract consists of al-hibah.
With regard to the application of these contracts in modern Islamic
banking system, the discussion was divided by two, i.e. sources of funds
and uses of funds. There are some Islamic contracts applicable for
J/
.- ,z/t-.\ - ..9
,J- vY
-t -!-/ deposits (i.e. saving deposit and investment deposit) in an Islamic bank
any patt of it to you'
such as wadi'ah and mudharabah. Under uses of funds, the discussion
.-srre- rcmit
Ln this book focused on the vehicle financing, home financing, personal
d.{eer" [4: 4]'
-inancing, agricultural financing, manufacturing financing and equity-
:ased f,rnancing.

103
 Foundation of Islamic Finance

Questions
1 . Briefly exp lain the dehnitio n of mushorakah and mudku rabuh and
what are the dilTerences between them'l
2. Briefly explain the definition of salan"L and istisna ' and what are
the dift-erences betw'een them?
3. What contracts are used in deposit accounts of lslamic banking?
Briefly explain the w'odi'ah corr1.ract.

References
A1-Zuhayii, wahhah. [2003). FinnnciolTransactions in Islamic.Itu'isprtrdence
(Al-Fiqh A!-Islam w'a-Adillamh). Translated by Mahmoud A. Fll-Gainal,
revised by h'lLrliammad S. Eissa. Damascus: Dar al-Fikr'
BankIslan-r. (2010). Applir:utiottaf Sh*riohContracts inBunktrslarnl,q Products
anr.l Ser,-ices. Kuala Lumpur: Bank Islam.
lsmail,.Abdul Ghafar. (2010). Mr;nev, Islttmic Bcmks cmd the Real Economl'.
Singapore: Cengage Learning.
ISRA. (2011'). Islamic Iinanciol System: Principles & Operotiotrs. Kuala
Lumpur: ISRA.

104