Principles of Islamic Financial

System
 Summary of the Previous Lecture
1. Allah is the Sustainer
2. God is Real Owner of Everything and Man is Merely a
Trustee
3. Everything Created for Service and Use of Man
4. Concept of Halal and Haram
5. System of Sadaqat and Zakat
6. Prohibition of Interest
7. Ban on Hoarding of Wealth
8. Policy of Moderation
9. Condemnation of Monasticism and Materialism
10. Equity and not Equality
 Learning Outcomes
After this lecture you will be able to understand
the principles of Islamic Financial System
(Financial institutions and financial markets)
Based on the basic characteristics of the Islamic
Economic System
 Principles of Islamic Financial System

Basic idea of Islamic Financial System is

prohibition of receipt and payment of interest.
Literature based on the divine guidance about
Islamic financial system suggest the following
principles.
1. Money as potential capital
2. Prohibition of Interest
3. Risk Sharing
4. Sanctity of Contracts
Principles of Islamic Financial System

5. Sharia Approved Activities

6. Individual Liberty
7. Right to Own Property
8. Economic Inequality and Charity
9. Social Equality
10. Circulation of Wealth
 1. Money as Potential Capital

1. Money is not an asset but a piece of document or

a claim.
2. It becomes capital only when it joins hands with
other resources to undertake a productive
activity.
3. Money cannot be bought and sold as a
commodity.
4. Money not backed by assets cannot increase in
value over time.
 1. Money as Potential Capital
Islamic Currency is Dinar and Dirham made of gold and silver.
1. The Islamic Dinar can be used for saving because they are
wealth in themselves.

2. They are used to pay Zakat as they carry value in itself.

Instead of paying Zakat in paper currency gold and silver is
used to pay Zakat as part of wealth.

3. They are used to buy and sell since they are a legitimate
medium of exchange.
 1. Money as Potential Capital
1. Gold cannot be inflated by printing more of it.

2. It cannot be devalued by government decree.

3. Unlike paper currency it is an asset which does not depend

upon anybody's promise to pay.

4. Portability and anonymity of gold are both important, but

the most significant fact is that gold is an asset not the
liability.
 2. Prohibition of Interest
Islam categorically Prohibits the payment or receipt of any
predetermined, guaranteed rate of return (Riba). And this
act of involvement of interest or Riba, is declared as an act
of war against the Almighty Allah and his Prophet.
 2. Prohibition of Interest
What is interest or RIBA?
Literal meaning are expansion, increase, addition and growth

Technical meaning are a predetermined increase as a

condition for the loan, irrespective of whether the increment
is small or big.

When any one of you grants a loan and the borrower offers
him a dish [of food], he should not accepted it; and if he
offers him a ride on an animal, he should not ride, unless the
two of them are accustomed to exchanging such favours
mutually (reported by Al-bayhaqi in his Sunan from Anas ibn
Malik)
 2. Prohibition of Interest

Contemporary definition of interest is a fee paid by a

borrower of assets to the owner as a form of compensation
for the use of the assets. It is most commonly the price paid
for the use of borrowed money, or money earned by
deposited funds.
Islamic sharia considers the Riba and interest as same thing.
•
 2. Prohibition of Interest
Quran and Hadith categorically prohibited riba.
Four revelations have prohibited riba:
1. Surah al-rum (30:39)
2. Surah al-nisa’ (4:161)
3. Surah al-‘imran (3:130-2)
4. Surah al-baqarah (2:1275-281)
 2. Prohibition of Interest
Allah (SWT) says in Quran
1. Those who benefit from interest shall be raised on the day
of judgment like those who have been driven to madness
by the touch of the devil; this is because they say: “trade is
like interest”, while Allah has permitted trade and
forbidden interest: (2:275).

2. O believers! Fear Allah, and give up the interest that

remains outstanding, if you are believers (2:278).

3. If you do not do so, then be aware of being at war with

Allah and his Messenger. But if you repent, you can have
your principal. Neither should you commit injustice, nor
should you be subjected to it. (2:279)
 2. Prohibition of Interest
There are several Ahadith condemning Interest
1. The Prophet, peace and blessings of Allah be on him,
cursed the receiver and the payer of interest, the one
who records the transaction, and the two witnesses, and
said: “they are all alike [in guilt].
(Tirmizi and Musnad
Ahmad).
2. The Prophet, peace and blessings of god be on him, said:
“a dirham of riba which a person receives knowingly is
worse than committing adultery thirty-six times.
(Ahmad)
3. The Prophet, peace and blessings of god be on him, said:
“there will come a time for mankind when everyone will
take riba, and if he does not do so, its dust will reach
him. (Abu Dawud , ibn Majah)
 2. Prohibition of Interest
Interest is prohibited in almost all religions
• Hinduism
• Judaism
• Christianity
• A number of philosophers and scholars
 2. Prohibition of Interest
Types of interest
1. Riba al-nasiah
“There is no riba except in nasiah” (Al-bukhari)

“The benefit derived form any loan is one of the different

aspects of riba” (reported by al-buyhaqi from Fadalah ibn
‘Uhayd).
This hadith is mawquf, implying that it is not necessarily from
the Prophet; it could be an explanation provided by Fadalah,
a companion of the Prophet, peace and blessings of Allah be
on him.
 2. Prohibition of Interest

2. Riba al-fadl
From Abū Umamah: the Prophet, peace be on him, said:
“whoever makes a recommendation for his brother and
accepts a gift offered by him has entered ribā through one
of its large gates.” (Ahmad and Abu Dawud)

From Anas ibn Mālik: the Prophet, peace be on him, said:

“deceiving a mustarsal [an unknowing entrant into the
market] is ribā.
(Suyūti, al-jāmi‘ al-saghīr, under the word ghabn; kanz al-
‘ummāl, kitāb al-buyū‘, al-bāb al-thānī, al-fasl al-thānī, on
the authority of sunan al- bayhaqī)
 2. Prohibition of Interest

From ‘Ubādah ibn al-Sāmit: the Prophet, peace be on him,

said: “gold for gold, silver for silver, wheat for wheat,
barley 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, Tirmizi)
 NIGERIAN PRESIDENT ABOUT INTEREST

All that we had borrowed up to 1985 was around $5 billion,

•

and we have paid about $16 billion; yet we are still being
told that we owe about $28 billion. That $28 billion came
about because of the injustice in the foreign creditors’
interest rates. If you ask me, what is the worst thing in the
world? I will say it is compound interest. ……. Former
President Olusegun Obasanjo speaking after the G8 Summit
in Okinawa, Japan in the year 2000.
 3. Risk Sharing

Because interest is prohibited, the suppliers of capital

become investors instead of creditors. The provider of
financial capital and the entrepreneur share business risk in
return for shares of the profits.
 4. Sanctity of Contracts

Islam upholds contractual obligations and the disclosure of

information as a sacred duty. This feature is intended to
reduce the risk of false information and moral hazard.
Quran clearly emphasize the importance of the contract and
say;
1.“O you who believe! Fulfill your obligations.” (5:1)

2.“… and fulfill your promise, surely you will be questioned

about your promises.” (17: 34)
 4. Sanctity of Contract

Abu Hurairah (RA) reported: Rasulullah (SAW) said

“Three are the signs of a hypocrite:
•When he speaks, he lies;
•when he makes a promise, he breaks it; and
•when he is trusted, he betrays his trust.” (Al-
Bukhari)
Another narration adds the words: “Even if he
observes Saum (fasts), performs Salaat (prayer) and
claims to be a Muslim.”
 5. Sharia Approved Activities

• Allah says in Quran “O you who believe!

Intoxicants and games of chance and (sacrificing
to) stones set up and (dividing by) arrows are only
an uncleanness, the Satan's work; shun it
therefore that you may be successful” (5:90) .

• Islamic economy rules out the speculative

behavior, anti social and harmful practices in the
society.
 6. Individual Liberty

The liberty that Islam grants is based on

commitment and responsibility without which there
can be no true freedom. In an Islamic state the
individual has a
• complete liberty in his/her thoughts and activities
• but are not allowed to pose threats or creates
problems for the society
 7. Right to Own Property
There are several verses in Quran explaining the
relationship of individual and the property,
which explain the rights and wrongs for the
individuals to claim and earn property. For
example;
• Do not devour one another’s property by foul
means; (instead of it) do business. (4:29)
• Allah has made trade lawful and interest
unlawful. (2: 275)
 8. Economic Inequality and Charity

Quran describes the economic inequality among

people in these words,
“We portion out among them their livelihood in
the life of this world, and We exalt some of
them above others in rank, that some of them
may take others in service. (43:32)
 9. Social Equality
• So long as the differences in wealth and rank
do not create classes in the society, it is
permissible.
• Tagging a part of the community as rulers,
masters or superiors and the others as ruled,
servants and inferiors is strictly forbidden.
• Individual and the community are dependent
upon one another. The prosperity of one
means the prosperity of the other.
 10. Circulation of Wealth
Islam condemns hoarding in a very strong language; Allah
says,

“And there are those who bury gold and silver and
spend it not in the way of Allah: announce unto them a
most grievous penalty On the Day when heat will be
produced out of that (wealth) in the fire of Hell, and with it
will be branded their foreheads, their flanks, and their
backs. "This is the (treasure) which you buried for
yourselves: taste you, then, the (treasures) you buried!
(9:34-35)”
 Summary of the lecture
After this lecture you will be able to understand
the principles of Islamic Financial System
(Financial institutions and financial markets);
1. Money as potential capital
2. Prohibition of Interest
3. Risk Sharing
4. Sanctity of Contracts
5. Sharia Approved Activities
 Summary of the Lecture
After this lecture you will be able to understand
the principles of Islamic Financial System
(Financial institutions and financial markets);
6.Individual Liberty
7.Right to Own Property
8.Economic Inequality and Charity
9.Social Equality
10. Circulation of Wealth