Islamic Finance 3

Name: Ahmed Mujuthaba

ID: S101022274

ContentsQuestion 1........................................................................................................................................1

a.1. Meaning, definition and concept of Riba..........................................................................1

a.2. Types of Riba....................................................................................................................2

a.2.1. Riba Al-Dhuyun.........................................................................................................2

a.2.2. Riba Al-Buyu’...........................................................................................................3

a.3. Sources in which riba arises..............................................................................................3

a.4. Shariah ruling on riba........................................................................................................4

a.5. Prohibition of Riba in Quran.............................................................................................4

a.6. Prohibition of Riba in Sunnah...........................................................................................5

a.7. Rationale for prohibition of riba.......................................................................................5

a.8. Interest and usury in other religion...................................................................................6

a.9. Common misconception about riba..................................................................................6

a.10. Meaning, definition and concept of Gharar...................................................................7

a.11. Types of Gharar.............................................................................................................7

a.12. The aspects of Gharar....................................................................................................7

a.13. Prohibition of Gharar.....................................................................................................8

a.14. Conditions of affective gharar.......................................................................................9

a.15. Rationale for prohibition Gharar.................................................................................10

b. Explain how Riba is different from profit..........................................................................11

b.1. Definition of profit..........................................................................................................11

b.2. Definition of Riba...........................................................................................................11

b.3. Profit versus Riba............................................................................................................12

b.4. Concept of Time Value of Money..................................................................................13

Question 2......................................................................................................................................15

i. Definition of Wadi’ah.........................................................................................................15

ii. Evidence of its legality.......................................................................................................15

iii. Types of wadi’ah concept...............................................................................................16

iv. Rewards for Wadi’ah deposits........................................................................................17

v. Difference between two wadi’ah concepts.........................................................................18

Question 3......................................................................................................................................19

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a. Definition............................................................................................................................19

b. Legitimacy of Mudharabah Contract..................................................................................19

c. Types of Mudharabah.........................................................................................................20

d. Basic rules of Mudharabah.................................................................................................21

e. Two-Tier Mudharabah........................................................................................................21

f. Single tier Mudharabah illustration....................................................................................22

g. Two-tier Mudharabah illustration.......................................................................................23

Question 4......................................................................................................................................25

i. Introduction.........................................................................................................................25

ii. Islamic capital market- Islamic equity products.................................................................25

iii. Shariah- compliant shares...............................................................................................26

iv. Principles in an Islamic financial system........................................................................26

v. Screening Methodology for Shariah-Compliant Stocks.....................................................27

vi. Islamic stock screening criteria.......................................................................................28

Appendixes....................................................................................................................................30

Appendix 1- Stages for Prohibition of Riba in Quran...............................................................30

Appendix 2 – Prohibition of Riba in Sunnah.............................................................................32

Appendix 3 – Screen Methodology for SAC.............................................................................33

Appendix 4- Screening Methodology for DJIM........................................................................35

References......................................................................................................................................37

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Question 1

a.1. Meaning, definition and concept of RibaMuslims are encouraged to undertake business as a profession in life as guided by the Sunnah,

according to which 90% of the livelihood, income, subsistence, food, nourishment and good

fortune come from business.

Basically, in any trade transaction from the Islamic perspective, the following principles need to

be observed in order to ensure that the dealings are in compliance with Islamic dictates. These

principles cover Al-Riba or usury, or interest, Al-Gharar, Al-Maisir and the forbidden dealings.

Riba is an Arabic word which literally means increase (Al-Ziyada), to grow (Al-Numuw), to

multiply, to expand, to rise and to become lofty (Al-Irtifa and Al-Uluw). It is also defined as

extra or excess in lending and borrowing or additional in terms of weights or measurement in an

exchange or a buy and sells transaction. It is also relates to deferment of time of delivery of

ribawi items in the process of exchange. (Mohamed Nasir, 2008)

In Islamic concept of riba has a broader meaning than that contained in modern nations of usury

and interest. Riba covers usurious practices in both loans and exchanges, which feed on poor’s,

tending to concentrate the ownership of wealth in the hands of usurers and merchants. This

usually involved a prohibitive mode of production of small peasants and artisans who, in general,

produced for their own consumption or for the local market on a small scale, unlike the capitalist

mode of production, which involves production of goods for wider markets. From the Shariah

point of view, riba technically refers to the “premium” that must be paid by a borrower to the

lender along with the principle amount as a condition for the loan or for an extension on its

maturity (Chapra, 1992).

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a.2. Types of RibaThere are two major kinds of riba. They are;

a.2.1. Riba Al-Dhuyun It is the kind of riba created out of lending and borrowing activities. Riba dhuyun is of two

types namely, riba qardh which is imposed as a term and condition in lending and borrowing.

Another type is riba jahiliya, which is compounding interest in default of loan. Riba An

Nasiah is an example of Riba dhuyun. In riba An Nasia, it allows the borrower to repay the

loan after its due date. In return, the borrower must pay the additional or premium for the

extension in duration. Riba An-Nasi’ah comes from the root “nasa’a” which means “to

delay”, “defer” or “wait” and refers to the time that is permitted for the borrower to repay the

loan in return for the “extra” or the “premium”. Therefore Riba An-Nasi’ah refers to interest

on loans.

Examples of Riba Al-Dhuyun

A person borrowed money to be paid in certain time, and the amount to be paid is

more than the amount borrowed- Riba Gardh

A bank gives a periodic loan and takes monthly interest. The capital sum lasts until

the expiration of the period. Upon expiry, if the borrower cannot pay, the period to

pay back the capital will be extended and interest will be charged- Riba Gardh

Arising out of exchange contract (‘uqud mu’ awadhat), a buyer must pay a

consideration. If he failed to settle on time, the period will be extended by increasing

the amount (principle+ interest)- Riba Jahiliyyah


a.2.2. Riba Al-Buyu’ This kind of riba is created out of trading transactions. It occurs out of an exchange between

two ribawi materials or items of the same category where the necessary rules are not

observed. It is also of two types namely, riba fadhl and riab nasiah or riba yad.

Riba Al-Fadl is the excess over and above the loan paid in kind. It lies in the payment of an

addition by the debtors to the creditor in exchange of commodities of same kind. Riba nasiah

or riba yad occurs when payment of the price and delivery of the goods are made at two

different times, not immediate or when the exchange is not made on concurrent basis.

a.3. Sources in which riba arisesThere are three sources in which interest arises they are;

1. It could be arising from a loan or debt either in the form of simple interest or

compounding interest.

2. It could be arising from a buy and sell transaction, where in such an exchange, the weight

or measurement is unknown or not predetermined and

3. It could be arising from an exchange of currencies or any ribawi item, which involves

deferment of the delivery of each one of the currencies or ribawi items. (Mohamed Nasir,

2008)

Ribawi items with categories

Currencies Food stuffsGold Grains- rice, wheat, cornSilver Meats- beef, mutton, chicken, fishCurrencies – Maldivian Rufiyaa, United States Dollars, Malaysian Ringgits, Japanese Yen, Hong Kong dollar, Australian Dollar

Vegetables- beansFruits- dates, grapesCondiments- salt, sugar and medicines


a.4. Shariah ruling on ribaNature of ribawi item Example RulingSame kind of same basis 10g of 916-gold for 10g of 750-

gold

10kg of Basmathi rise for 10kg of super special rise

Payment must be on cash term

Items must be of the same weights, measurement or number of units

Different kind of the same basis

1gm of gold for RM 40US$ 1,000 for RM 3,800

5kg of rise for 7.5 kg of wheatI tonne of palm oil for 2 tonnes of sugar

Payment must be on cash term

Difference in weights, measurement or number of units is allowed.

Different kinds of different basis

20kg of dates for 1g of gold30kg of wheat for US$10

1 tonne of palm oil for RM1500

No rule is imposed. Therefore, difference in weights, measurement or number of units is allowed.

a.5. Prohibition of Riba in QuranThe principle of Al-Riba relating to prohibition of usury is clearly stated in the Qur’an. The

prohibition of riba in Qur’an developed gradually and its prohibition is mentioned in four

different chapters and there are 12 verses deal with Riba. In Qur’an the word riba occurs in eight

times (Ahmad & Hassan). The four different chapters constitute the four stages of prohibition.

(See Appendix 1 for more details)

When we look at those verses related to the riba, the first chapter related to riba on Qura’n

emphasizes that interest deprives wealth of God’s blessing, the second chapter condemns it,

placing interest in juxtaposition with wrongful appropriation of property belonging to others, the

third chapter enjoins Muslims to stay clear from interest for the sake of their welfare and the

fourth establishes a clear distinction between interest and trade. The fourth chapter, al-Bagarah

has also severely condemned and prohibited riba in its strongest possible term.


Therefore, the act of giving and taking as well as managing usury or interest is forbidden in

Islam. Usury is an exorbitant percentage of earnings paid in return for deposited or loaned

money. Earnings that fluctuate with investment profits and losses do not constitute usury.

a.6. Prohibition of Riba in SunnahThe ban of Riba is clearly defined in Sunnah and there are many narrations regarding its

prohibition. (See Appendix 2 for more details)

The first three hadiths relates to the riba in loan contracts and attempts to explain and elaborate

upon the Quranic prohibition of riba in loan contracts. The next two hadiths relates to the

prohibition of riba in exchange contracts and finally the last two hadiths relates to the prohibition

of riba in general.

a.7. Rationale for prohibition of riba Riba as unearned income

When we compare interest (riba) with profit, interest is fixed and a person who lends money

to the debtor will knows his return as interest and this interest will be always positive. For

this reason interest or riba is considered as an unearned income.

Since Islam only permits trade and for bids riba, these unearned income gained by the lenders

through interest is forbidden in Islam.

Riba as exploitation of the needy

Riba exploits the needy. This means when a borrower fails or default in paying the

installment he will be penalized by charging interest. The banks or the lenders will not take

into consideration of the situation or the status of the borrower when charging the interest.

Riba as a Mechanism of Inequitable Redistribution of Wealth


Today when we look the mechanism of riba taken by banks or lenders it is found that it act as

the rich get richer and poor gets poor. Because in most of the time people take or borrow

loans when they are in need of cash in fulfilling their needs and sometimes it is found that

these borrowers are not able to pay their installments on time. Some try to pay on time and

others ignore in paying their installment even if they have cash. When banks charge interest

on those who do not have any money but are trying to pay their installment on time will

allow distributing wealth unequally.

a.8. Interest and usury in other religionThe prohibition of riba is not a new concept when it was prohibited on Islam, the other major

religions such as Judaism and Christianity had both prohibited interest for many centuries. But

today it is found that both Christian and Jewish leader allowed charging interest.

a.9. Common misconception about riba Commercial versus consumer lending

Some people assume that prohibition of riba was aimed only for consumer lending not for

commercial lending. But this is a misconception among people.

Compounding of interest

The common misconception of usury is that it is only aimed to prevent excessive or compound

interest over time. But in Islam all the types of riba are prohibited.

Adjust for inflation

Many people argue that interest can be charged because it is merely an adjustment for inflation

or an indexation to changes in consumer purchasing power. Shariah allows indexation for

adjustments of wages, salaries, pensions, etc., but it does not allow indexation of financial assets.

a.10. Meaning, definition and concept of Gharar


The Arabic word Gharar means risk, or excessive uncertainty. According to the jurists of Islamic

schools, the concept of gharar has been defined as any bargain in which the result of it is hidden,

where details concerning the sale item are unknown or uncertain. (Al Maali Islamic Finance

Training & Consultancy)

According to (AL-SAATI, 2003) the uncertainty which refers to the Gharar is the uncertainty

that can be reduced simply by adding more information to the contract and the prohibition of

Gharar is meant to reduce the speculation and to make sales as fair as possible for both parties.

Unlike riba, gharar is precisely defined. Gharar is also considered to be lesser significance that

riba, while the prohibition of riba is absolute; some degree of gharar or uncertainty is acceptable

in the Islamic framework.

a.11. Types of GhararThe Gharar is divided into two types namely, they are;

1. Gharar yasir - This is minor ambiguity

2. Gharar fahish- this refers to excessive ambiguity that may cause a contract to be invalid.

a.12. The aspects of GhararA gharar happens in most details of contracts;

Price: for example when some one says to another “ I sold you this item at a thousand in cash

today and at a five thousand and ten in a year hence”, and the buyer says “ I accept” without

specifying at the price which he buys the item.

The object of contract: for example, when the seller says “ I sell you my house at such price

if you sell me your cat at such price”.


The form of contract: for example gharar occurs when a person tells another “ I would sell

you this house of mine at such price if a person some me his. Then, the buyer accepts the

offer.” So, this contract is called illegal because both the buyer and seller do not know

whether the sale will be concluded or not.

a.13. Prohibition of GhararIn today’s conventional business world, risk-taking and uncertainty are a fact even though most

people naturally seek to minimize their losses due to unforeseen circumstances which will occur

in their day to day business dealings. However in Islamic Law, it is forbidden to take risk-taking

or uncertainty (Gharar).

In Quran it forbids trades that are considered to have excessive risk due to uncertainty and all

business transactions which cause injustice in any form to any of the parties.

Some of the scholars of Islam has interpreted that vanity is Gharar. Al-Arabi explains that vanity

is unlawful because it is prohibited by Shariah such as usury and Gharar, and Al-Tabari


considers vanity as eating up others property in a manner which was not permitted by Shariah

while Zamakshari considers the act which was forbidden by Shariah as vanity such as theft,

dishonesty, gambling and Gharar (AL-SAATI, 2003).

In Quran chapter 2, verse 188 it is stated that:

�#نت م و#أ & �م &ث �&اإل ب ,اس& الن م�و#ال&# أ �م4ن ف#ر& يق5ا �ك ل وا #أ &ت ل & ,ام �ح ك ال &ل#ى إ &ه#ا ب و#ت د�ل وا #اط&ل& �ب &ال ب #ك م �ن #ي ب #ك م م�و#ال

# أ �ك ل وا #أ ت و#ال#

#م ون# #ع�ل ﴾١٨٨﴿ت

“And do not consume one another's wealth unjustly or send it [in bribery] to the rulers in order

that [they might aid] you [to] consume a portion of the wealth of the people in sin, while you

know [it is unlawful].”

It further states in chapter 4, verse 29 that;

﴿ م�ا ح�ي ر م� ك ح� ر� ر�ا ر� ��ـ ر ال ر�� ح�ا م� ك ر� ك� ر�ان ك�وا �ك م� ر ر"ا ر# م� ك م%ن ض' ر(ا ر ر+ن م, ر ر-ا ح ر� ك و ر ر�ا� ر�"ا ح�ا ح. ح/ ر0ا مل ح�ا � ك رن مي ر� � ك رل روا م% ر�ا ك�وا ك� م�ا ر ر"ا كنوا ر% آا رن ح3ي �ل ر ا ر4ا ك�ي ر�ا ٢٩ريا ﴾

“O you who have believed, do not consume one another's wealth unjustly but only [in lawful]

business by mutual consent. And do not kill yourselves [or one another]. Indeed, Allah is to you

ever Merciful.”

The prohibition of Gharar and what it means is also clearly found in hadith of Prophet Mohamed.

In business there is always risk associated with it, no one knows whether the business will be

profitable or not at the end of year because all the future incidents that could affect the business

operation will not be known.

a.14. Conditions of affective gharar According to Al Maali Islamic Finance Training & Consultancy (2010) there are four conditions

for the affective of gharar. They are;


http://tanzil.net/#2:188

1. It should be excessive or exorbitant

2. It should be a contract of exchange

3. It must affect the principle object of the contract

4. That there is no need to be met by the contract

If any of the above mentioned conditions is absent, gharar, then will have no effect on the

validity of contract.

a.15. Rationale for prohibition Gharar To ensure full consent and satisfaction of all parties in a contract

Without full consent and satisfaction the contract is null and void

Full consent can only be achieved through certainty, full knowledge, full disclosure and

transparency, and zero deceit or fraud

Gharar also results in the risk being built into the contract at its inception which may

result in a profit for one party and corresponding loss to other party (zero-sum game or

gambling)


b. Explain how Riba is different from profit

b.1.Definition of profitProfit is the margin between the price paid by the traders and the price they charged for it, or the

difference between sales price and purchase price. This can also be described as the difference

between the total revenue and the total cost.

The difference between the sale price and the purchase price or the total revenue and total cost is

not always positive. Sometime this can be negative. The positive figure that arises is called profit

and if the difference is negative this is called loss.

The profit or loss that arises is by means of trade that has been conducted by the buyer and seller

or traders. Trade facilitates the exchange and creates value. Since the early ages, trade has been a

morally accepted activity in the human societies with regardless of their religion.

b.2.Definition of RibaRiba is an Arabic word which literally means increase (Al-Ziyada), to grow (Al-Numuw), to

multiply, to expand, to rise and to become lofty (Al-Irtifa and Al-Uluw). It is also defined as

extra or excess in lending and borrowing or additional in terms of weights or measurement in an

exchange or a buy and sells transaction. It is also relates to deferment of time of delivery of

ribawi items in the process of exchange. (Mohamed Nasir, 2008)

In Islamic concept of riba has a broader meaning than that contained in modern nations of usury

and interest. Riba covers usurious practices in both loans and exchanges, which feed on poor’s,

tending to concentrate the ownership of wealth in the hands of usurers and merchants. This

usually involved a prohibitive mode of production of small peasants and artisans who, in general,


produced for their own consumption or for the local market on a small scale, unlike the capitalist

mode of production, which involves production of goods for wider markets.

From the Shariah point of view, riba technically refers to the “premium” that must be paid by a

borrower to the lender along with the principle amount as a condition for the loan or for an

extension on its maturity (Chapra, 1992).

b.3.Profit versus RibaOne of the major differences between the profit and riba is that profit accrues only once and once

accrued it will not increase whether it is for cash or credit sale involved transaction. But for riba

it will go on increasing with a passage of time. For example, the loan interest charge by the

banks will go on increasing if the customer is deferred on paying loan installments.

The other most important characteristic of riba is that it is always positive and definite result of

money when changed. But when we look to the profit it is not always positive, sometimes it is

negative or zero. If the trader or business man is not able to cover his/her cost then he will incur

a loss during the period.

From Shariah point of view riba is haram or prohibited. Today some try to equal profit to riba.

This claim was rejected in Quran. In Quran, chapter 2, verse 275 it is stated that:

�م#س4 ال م&ن# �ط#ان ي الش, ,ط ه ب #خ# #ت ي ,ذ&ي ال #ق وم ي #م#ا ك &ال, إ #ق وم ون# ي ال# #ا الر4 ب �ك ل ون# #أ ي ,ذ&ين# ,م#ا ل &ن إ ق#ال وا �,ه م ن# &أ ب &ك# ذ#Zل

#ا الر4 ب �ل م&ث �ع #ي �ب #ا ال الر4 ب و#ح#ر, م# �ع# #ي �ب ال ه ـ, الل #ح#ل, ل#ف# و#أ س# م#ا #ه ف#ل Zه#ى# ف#انت 4ه& ر, ب م4ن cع&ظ#ة�م#و اء#ه ج# ف#م#ن

ه& ـ, الل &ل#ى إ م�ر ه # ,ار& و#أ الن ص�ح#اب

# أ &ك# Zئ ـ# ف#أ ول ع#اد# �&د ون# و#م#ن ال خ# ف&يه#ا �﴾٢٧٥﴿ه م

“Those who swallow down usury cannot arise except as one whom Shaitan has prostrated by

(his) touch does rise. That is because they say, trading is only like usury; and Allah has allowed

trading and forbidden usury. To whomsoever then the admonition has come from his Lord, then



he desists, he shall have what has already passed, and his affair is in the hands of Allah; and

whoever returns (to it)…. these are the inmates of the fire; they shall abide in it”

According to the above verse it is well known that usury or riba is prohibited and trade is

allowed in Islam. Since people do trade to earn profit, Islam has allowed earning profit from their

trade not usury or interest.

Today those who equal trade to the interest ignores the uncertainty face by the trader, the

possibility and the occurrence of losses exist in trade. Sometimes in trade the trader or investor

will not be able to recover his initial investment. It also ignores the fact that profits are not

predetermined as regard their size, unlike interest whose size is the part of contract and there will

not be any uncertainty in interest and ensures the lender the recovery of capital and seeks a

positive return.

When we compare riba with the profit on counter-value, Hanafi, Shafii and Maliki schools all

agrees that riba is unequal in counter-value because riba occurs in unjust inequitable exchange of

one commodity against another but when we look to the profit, the figh scholars agrees that

profit is justified increase, because it is usually generated by exchange of two goods.

Today is conventional economies debt-based is that transfer risk to others such as loans, but

Islamic economies are asset-based that emphasize on risk sharing. In Islam there is a great

emphasize on the distinction between trade and riba. Trade promotes partnership and exchange

in a just and fair way while riba is unjustified monetary benefit. Therefore trade leads to a more

equitable distribution of income, and a more just economic system.


b.4.Concept of Time Value of MoneyIn today’s conventional banking system, time value of money is an important concept. Time

value of money is simply that money has a time value, having money today is more valuable

than having it future date. Therefore sacrificing today’s consumption for the future consumption

must be compensated.

But in Islam this concept is not permitted. Islam does not allow reward for time but allow reward

for efforts and risk taking activity in business. The reason is that money is just a medium of

exchange; therefore it cannot earn money by itself without putting it into real productive actions

such as sale, lease and investment. The time value of money is only accepted for sales contracts

in Islam not in debt contracts.

Therefore profit which generates through sales contacts is permitted or halal in Islam and

whereas interest which arises from money is not permitted in Islam.


Question 2

i. Definition of Wadi’ahThe banks accept deposits for current and saving account under the Islamic principle of Al-

Wadi’ah. Al Wadi’ah is a contract between two parties, the owner of goods and the custodian

holder of goods. The custodian guarantees the safe custody of such goods, that they may not be

stolen; lost, destroyed, etc. goods in this discussion can refer to anything of value including

assets, money, jewelry, stock certificates, etc. (Mohamed Nasir, 2008)

The contract of Al-Wadi’ah has four tenets to ensure the validity of this contract. They are

i. There must be goods under custodian,

ii. There must be a legitimate owner of goods,

iii. There must be a custodian holder of goods. And,

iv. There must be ijab (offer) or qabul (acceptance).

ii. Evidence of its legalityIn Quran it does not specifically mentioned the concept of Wadi’ah, however there are verses

which relates to the concept of trust. In Quran, chapter no 23, verse no 8-10 it says that;

ر# اع ون# �و#ع#ه�د&ه&م �&ه&م #ات م#ان# أل& �ه م ,ذ&ين# ي ح#اف&ظ ون# ﴾٨﴿و#ال �&ه&م #و#ات ص#ل Zع#ل#ى �ه م ,ذ&ين# ه م ﴾٩﴿و#ال &ك# Zئ ـ# أ ول

�و#ار& ث ون# ﴾١٠﴿ال

“Those who are faithfully true to their trust (amanah) and to their covenants. And those who

strictly guard their prayers. These are indeed the inheritors”

And also in chapter 4, verse no 58 it says that;

�ع#د�ل& &ال ب #ح�ك م وا ت #ن أ ,اس& الن �ن# #ي ب #م�ت م ح#ك &ذ#ا و#إ &ه#ا ه�ل# أ Zى# &ل إ #ات& #م#ان �األ ت ؤ#دsوا #ن أ �م ر ك م

� #أ ي ه# ـ, الل &ن, &ع&م,ا إ ن ه# ـ, الل &ن, إ

&ه& ب #ع&ظ ك م #ص&ير5 ا ي ب م&يع5ا س# #ان# ك ه# ـ, الل &ن, ﴾٥٨﴿إ






“Allah commands that you should render back the trust to those, to whom they are due.”

From the above verses from Quran, Allah tells is that those who enter the paradise are who keep

their trust and covenants and commands to return the trusts to their rightful owners. And there

are other verses which talks about trust in Quran.

In Sunnah, there are several hadiths which relates to the concept of Wadi’ah. One of the hadith

which relates to this concept is as follows;

On the authority of Yazid Master of al-Munba’th that he heard Zayd bin Khalid al-Jahni a

companion of the Prophet (s.a.w) saying: the Prophet was asked about lost but found gold or

silver, thus, the Prophet said ‘know its suitability (benefits) and bitterness (liabilities) then find

or wait for the owner for a year, if no one ask after it, then spend/use it, however, you are just a

trustee for it, whenever the owner come for it, do return it to him’. (Sahih Muslim, 5/4599)

From the above hadith it cleraly says that trust or amanah have to return to its owners.

iii. Types of wadi’ah conceptThere are two types of Al-Wadi’ah concept. They are;

1. Wadi’ah Yad Amanah or Trustee custodian And,

2. Wadi’ah Yad Dhamanah or Guarantee custodian.

Under the concept of Wadi’ah Yad Amanah, the bank acts as a trustee to the fund. If the money

in the custody is incidentally depleted in value or deteriorated naturally over time, the custodian

holder is not obligated to replace or reinstate or compensate such diminished value.

The custodian holder’s responsibility is automatically being held under guaranteed custodian or

Wadi’ah Yad Dhamanah if the custodian conforms to any of the following features:


i. The money under the custody is being pooled together and not being segregated or isolated

according to the accounts.

ii. The money under the custodian of the bank is being utilized or subject to utilized as the

funding of investment or financing by the bank.

iii. Bank imposes charges for the custodian services.

iv. The bank allows depositors to withdraw money as and when it is needed.

The types of deposit accounts offered by a bank using this principle are current account, saving

account and safety deposit account. There are various types of saving account under this

principle. They are;

Accounts for individual or two or more persons(joint accounts)

Minors

Societies

Associates and

Clubs.

iv. Rewards for Wadi’ah depositsUnder the principle of Al-Wadi’ah, the custodian holder is not allowed to promise any returns as

reward to the depositors. On the other hand, the depositors are also not allowed to demand any

returns as rewards on their deposits. Any promise in rewarding the depositors is construed as

committing riba. This is the rationale for disallowing it, as riba is strictly prohibited in Islam.

Such reward is also not limited to monetary form. It includes incentives such as coin box and

other durables. Since under this principle, any kind of rewards on deposits cannot be given under

a promise or be mentioned at the time of execution of the Wadi’ah contract, a bank as a


custodian holder may reward the depositors at its own discretion under the principle of hibah.

(Mohamed Nasir, 2008)

v. Difference between two wadi’ah conceptsThe main difference between the two concepts of the wadi’ah deposits are that under the concept

of Wadi’ah Yad Ananah, the custodian holder is not responsible for the deterioration or depletion

of the goods due to the reason other than an act of negligence on part of the custodian holder.

Whereas under the concept of Wadi’ah Yad dhamanah, the custodian holder is responsible for

any depletion or losses of goods under the custodian.

Another point to be noted is that the contract of wadi’ah yad dhamanah, all the benefits and

profits earned from using the goods or money under the custodian belongs to the custodian

holder. However, the custodian holder is encouraged to distribute a portion of the profit to the

owner on the basis of giving hibah (gift).


Question 3

a. Definition“Mudharabah” is a special kind of partnership where one partner gives money to another for

investing it in a commercial enterprise. The investment comes from the first partner who is called

“rabb-ul-mal”, while the management and work is an exclusive responsibility of the other, who is

called “mudarib” (Usmani, 1998).

In Mudharba financing the Rab-Ul-Mal or the financier provides the capital to the Mudarib to

run the business. This is a special partnership where the Rab-Ul-Mal acts as a sleeping partner.

As in the normal partnership, the profit derived from the Mudharaba is shared between the Rab-

Ul-Mal and the Mudarab according to the predetermined profit-sharing ratio. For example 90:10

where the Mudarab get 90% of the profit and the Rab-Ul-Mal gets 10% of the business profit.

But unlike the normal partnership, during the event of losses to the business, the Shariah

stipulates that the losses should be borne by the Rab-Ul-Mal or the financier.

In Mudharabah financing, the financier is not allowed to interfere the running of the business and

any party can terminate the Mudharabah agreement at any time. For this reason Islamic banks

consider Mudharabah finance as to be equivalent to equity financing. Because in equity

financing shareholders are not involving in the day to day management of the company and they

can sell their shares anytime.

b. Legitimacy of Mudharabah ContractThe legitimacy of the Mudharabah contract is founded on the basis of the Quran and Sunnah, and

the consensus of Muslim jurists (Ijma’). The following verse implies the general permissibility of

commercial ventures including Mudharabah;


In Quran, chapter 73, verse no 20; it says that;

م#ع#ك# ,ذ&ين# ال م4ن# cف#ة& و#ط#ائ #ه و#ث ل ث &ص�ف#ه و#ن �ل& ,ي الل #ي& ث ل ث م&ن Zى# #د�ن أ #ق وم ت ,ك# #ن أ #م #ع�ل ي ,ك# ر# ب &ن, �ل# إ ,ي الل ي ق#د4ر ه ـ, و#الل

,ه#ار# �ك م� و#الن #ي ع#ل #اب# ف#ت ت ح�ص وه ل,ن #ن أ &م# �ق ر� آن& ع#ل ال م&ن# ر# #س, #ي ت م#ا م&نك م ف#اق�ر# ء وا #ك ون ي س# #ن أ &م# ع#ل

Zض#ى �ه& م,ر ـ, الل ف#ض�ل& م&ن #غ ون# �ت #ب ي ر� ض&# �األ ف&ي #ض�ر& ب ون# ي ه& و#آخ#ر ون# ـ, الل &يل& ب س# ف&ي &ل ون# ي ق#ات و#آخ#ر ون#

�ه م&ن ر# #س, #ي ت م#ا 5ا ف#اق�ر# ء وا ن ح#س# ق#ر� ض5ا ه# ـ, الل #ق�ر& ض وا و#أ #اة# ك الز, و#آت وا ة# الص,ال# #ق&يم وا ت ق#د4م وا و#أ و#م#ا

#ج�ر5 ا أ #ع�ظ#م# و#أ �ر5 ا ي خ# ه و# ه& ـ, الل ع&ند# #ج&د وه ت �ر� ي خ# �م4ن ك م #نف س& ه# أل& ـ, الل #غ�ف&ر وا ت �ر, ح&يمc و#اس cغ#ف ور ه# ـ, الل &ن, ﴿إ

٢٠﴾

“…others travelling through the land, seeking Allah’s bounty…” (Al-Muzammil: 20)

And in Sunnah, there are also hadiths which permits the Mudharabah contract in Islam. The

following hadith permits the Mudharabah contract in Islam.

Ibnu Abbas r.a reported that: “When our leader, Abbas Ibn Abd al- Mutallib, gave his property to

someone for Mudharabah, he stipulated conditions for his partner not to bring the capital

throughout the sea; and not to bring with him the capital crossing a valley; and not to buy

livestock with the capital; and if his partner violates the conditions, he should guarantee the loss

occurred. These conditions have been brought to the attention of Prophet Muhammad (S.A.W)

and he approved them.” (Mu’jam Al-Awsat; Al-Tabrani).

c. Types of MudharabahThere are two types of Mudharabah. They are;

Al-Mudharabah Al-Muqayyadah (Restricted Mudharabah)

The rabb Al-Maal states specific conditions which the mudarib must comply with e.g

which types of business or market to enter or not to enter. If the mudarib fails to do so, he

would violate the partnership agreement and would be liable for any losses incurred.

Al-Mudharabah Al- Mutalaqah (Unrestricted Mudharabah)



The rabb Al-Maal does not specify any condition. Thus, the mudarib has the liberty to

conduct the business according to his judgment.

d. Basic rules of MudharabahMudharabah is not a loan to the entrepreneur. It is a capital forwarded in partnership venture.

There are several rules that must be observed in this partnership. Some of the basic rules in

Mudharabah financing are;

Distribution of Profit and Loss

In Mudharabah, the partners must determine a profit-sharing ratio at the start of the

contract and the profit of the partnership should be distributed according to this ratio. The

entrepreneur is not entitled for any salary. If there is loss the Rab-Ul-Mal should have to

absorb all the losses because the entrepreneur will lose all the effort and time put into

business. However if the loss was occurred due to the negligence of the entrepreneur in

conducting business, he will have to bear the losses.

Rights of the Entrepreneur

In Mudharabah, the entrepreneur is the active partner hence has the right to transact with

the capital provided. Therefore the entrepreneur has the right to buy and sell goods as he

wish as long as it is in line with the customs of trade. Beside that the entrepreneur has the

right to enter into a partnership with third party and give out capital to third party on the

basis of two-tier mudharabah.

Although the entrepreneur has the above rights, he needs the explicit consent of the

capital provider to conduct these acts;

i. Purchase on credit beyond the capital of Mudharabah.

ii. Lend money to the third part or extend gift or donations with Mudharabah capital


e. Two-Tier MudharabahToday it is found that the Mudharabah is commonly done in two-tier system by Islamic Financial

Institutions. Multiple investors invest or deposit their money into an Islamic bank and the bank

act as investor by investing this money in different entrepreneurs and shares profit with the

original first-tier depositors or investors. The basic concept of the two-tier mudharabah model is

that both funds mobilization and fund utilization are on the same basis of profit sharing among

the investors or depositors, the bank and the entrepreneur.

In this concept there will be two contracts. The first tier mudharabah contract is between the

depositors of money and the bank, where the depositor acts as the supplier of funds and the bank

act as the mudarib. In this contract the funds deposited by the supplier are placed in an

investment account of the bank, thus the liabilities and equity of the balance sheet will shows the

deposits accepted on a mudharabah basis and the profit sharing investment deposits are not

liabilities because this capital is not guaranteed and the depositor will incur losses if the bank

does so. Therefore this investment deposits are in the form of limited-term, non-voting equity.

The second tier contract is between the bank and the entrepreneur. In this contract the bank acts

as the supplier of fund. In this contract the entrepreneur agree to share profit with the bank

according to the certain percentage specified in the contract.

f. Single tier Mudharabah illustrationIf the bank generate profit of MRF 100,000 or loss of MRF 80,000

InvestMRF 1,000,000 (70:30)

Profit MRF 70,000 Profit MRF 30,000Loss MRF 80,000 Loss MRF 0


Bank(Mudarib)

Investor(Rab-ul-Mal)

As shown in the above diagram, it shows that Investor invests MRF 1,000,000 in a bank, where

the bank was able to generate a profit of MRF 100,000 from the investment. In this case the

investor act as Rab-Ul-Mal and the bank act as manager and the profit sharing between the two

parties are 70:30, where investor gets 70% of the profit and the bank will enjoy 30% of the

profit. When the bank generates MRF 100,000 as profit the investor will get MRF 70,000 and

the bank will get MRF 30,000, but if the bank get a loss of MRF 80,000, all this losses will be

borne by the Rab-Ul-Mal.

g. Two-tier Mudharabah illustration

Invest MRF 10,000 Invest MRF 10,000 Profit sharing (70:30) Profit sharing (80:20)

MRF 2,800 MRF 1,200 MRF 1000

Loss MRF 2000

Profit sharingPartners Total Profit (MRF) Profit sharing ratio Profit distribution(MRF)IFI (investors)

5,00080 4,000

Manager 20 2,000

Partners Total Profit (MRF) Profit sharing ratio Profit distribution(MRF)IFI (manager)

4,00030 1,200

A (investor) 70 2,800

As shown in the above diagram, it shows that A invest MRF 10,000 in Bank with a profit sharing

ratio of 70:30, and the Bank reinvest this money in Entrepreneur with profit sharing ratio of


Profit MRF 5,000

Loss MRF 2000

EntrepreneurBank (IFI)A

80:20. As the entrepreneur makes a profit of MRF 5,000, the entrepreneur will get MRF 1000

(5000 x 20%) and the remaining MRF 4,000 will be given to Bank, and again this MRF 4,000

will be shared between the bank and the initial investor at the profit sharing ratio of 70:30, where

the Initial investor (A) will get MRF 2,800 (MRF 4,000 x 70%) and the Bank will gets MRF

1,200 (MRF 4,000 x 30%) and if the business makes a loss of MRF 2,000, all this losses will be

borne by the initial investor (A) , because A is the owner of the fund.

One of the main features that separate the single tier with the two–tier mudharabah is the profit

sharing among the partners. In single tier contract there will exist only one profit sharing

agreement. But in two-tier mudharabah contract there will be more than one profit sharing

agreement that will exist between the investor and IFI followed by IFI and the manager. The

below diagram will show how the profits will be distributed among the parties, in first tier and

two-tier mudharaba contract.


Question 4

i. IntroductionToday it is found that the demand for Islamic equity funds are significantly increasing among the

Islamic and Non-Islamic investors due to the rewards offered by such funds are increasing

compare to other funds. The primary difference between Islamic equity funds and non- Islamic

equity funds are relates to the nature of business of the underlying companies. Today there are

various Islamic equity markets where investors can trade Islamic equity funds across the world.

ii. Islamic capital market- Islamic equity productsIslamic equity market is a vehicle which transfer funds from surplus to deficit units and allows

the owners of capital to invest according to their preference in terms of the extent of risk

involvement, rate of return and period of investment and these investments and all market

activities must be based on the principles of Shariah (Jamal, Hambali, & Ali, 2010). And

according to Securities Commission Malaysia (2009) Islamic equity market is characterized by

the absence of interest-based transactions, doubtful transactions and unlawful stocks of

companies which deal in non-Shariah compliance activities or items. Its market activities must

be free from any form of unethical or immoral elements. The Islamic capital market is divided in

to two markets. They are;

Equity Market and

Bond Market

When we look to the equity market, it is done normally through the profit or loss sharing

contracts of;

Mudharabah and


Musharakah

iii. Shariah- compliant sharesWhen a company wants to list shares as Shariah compliance in order to attract the investors,

especially investors who are seeking in investing Shariah compliance stock or Islamic equities,

companies need to follow certain rules and regulations imposed by Shariah boards of a particular

country. When we say Islamic equity, it means shares of halah companies. In order to justify the

halalness of a particular company’s share, the majority of the company’s revenue must be

primarily derived from activities other than trading of alcohol, arms, tobacco, pork, pornography,

or gambling or from profits associated with charging interest. For this purpose Islamic stock

screening will be conducted by Shariah scholars to know whether the company’s activities are

permissible under Shariah principles.

iv. Principles in an Islamic financial systemThe Islamic scholars have established the basic principles which govern the Islamic financial

system after a thorough examination of the two primary sources of Shariah, Quran and Sunnah.

According to Obaidulla (2005) there are eight important norms of Islamic ethics applicable to

Islamic financial system. They are;

Freedom to contract

Freedom from riba

Freedom from Al-Gharar

Freedom from Al-Gimar and Al-Maysir

Freedom from price control and manipulation

Entitlement to transact at fair price

Entitlement to equal, adequate and accurate information and


Freedom from Dharara

v. Screening Methodology for Shariah-Compliant StocksThe existence of Shariah screening process of stock will lead to enable investors to invest in

companies that run the permissible activities.

Different Shariah boards have different approaches in screening for Shariah compliance. The

Shariah stock screening criteria is essentially qualitative for all Shariah boards of different

countries, but some quantitative criteria are also used. Usually the stock screening process is

divided in to two stages. They are;

Company evaluation in terms of its activities, nature of the business, products and

industry and

Computation of a set of financial ratios and compare them against specified benchmarks

In Shariah certain activities are haram for Muslims, hence, investing in the shares of the

companies whose main activities are based on these haram activities are clearly impermissible

under Shariah.

In the Quran it is stated that;


#ا الر4 ب �ل م&ث �ع #ي �ب #ا ال الر4 ب و#ح#ر, م# �ع# #ي �ب ال ه ـ, الل #ح#ل, ل#ف# و#أ س# م#ا #ه ف#ل Zه#ى# ف#انت 4ه& ر, ب م4ن cع&ظ#ة�م#و اء#ه ج# ف#م#ن

ه& ـ, الل &ل#ى إ م�ر ه # ,ار& و#أ الن ص�ح#اب

# أ &ك# Zئ ـ# ف#أ ول ع#اد# �&د ون# و#م#ن ال خ# ف&يه#ا �﴾٢٧٥﴿ه م

“Those who swallow down usury cannot arise except as one whom Shaitan has prostrated by

(his) touch does rise. That is because they say, trading is only like usury; and Allah has allowed

trading and forbidden usury. To whomsoever then the admonition has come from his Lord, then



he desists, he shall have what has already passed, and his affair is in the hands of Allah; and

whoever returns (to it)…. these are the inmates of the fire; they shall abide in it” (al-Bagarah,

verse 275)

Since, Quran and Sunnah, forbids usury or interest and allows trading it is a must for us to create

our wealth with this regard. Thus, investment is one way to crate our wealth it is very important

to avoid all the financial services based on riba, ghrara, and all the non-halal activities involve in

creating our wealth.

vi. Islamic stock screening criteria In order to screen for Shariah compliant stocks, Security Commission of and well knows index

providers such as DOW Jones Islamic Market Index (DJIM) Shariah board and FTSE Global

Islamic Index Series have established Islamic indices. These indices are usually similar, but there

are some differences among these Shariah boards. When we compare Malaysian stock screening

criteria with Financial Times (FTSE) and Dow Jones Islamic Market Indexes, the Malaysian

criteria specifically prohibits companies involved in meat production or sale if the animals are

slaughtered according to Islamic rites. SAC also provides screening criteria for mixed

companies. For companies whose carries both halal and haram activities are screening through

benchmarks.

The Islamic stock screening criteria used by Malaysia’ Shariah Advisory Council (See Appendix

3 for more information) and other entities like DJIM (See Appendix 4 for more information),

are essentially qualitative, but some quantitative criteria are also used. The quantitative methods

normally used are financial ratios of the company. However, Muslim scholars have raised

question of how to determine the financial ratios of the company, the justification about the

ratios such as debts should be less than 33% and the other issue raised by the scholars are about


the interest income which should be less than 5%. But in Islam it is clearly mentioned that riba is

prohibited in Islam.

The concept of screening corporations before investing in them is derived from the Shariah

principle that Muslims should not partake in activities that do not comply with the teachings of

Islam. As in the legal convention, the Shariah also recognises that the ownership of shares in a

company is considered a proportionate ownership of the company’s business and assets. Muslim

investors therefore cannot own an entity that is involved in Shariah non-compliant activities. Due

to the prevalence of the interest-based conventional banking system, most of the corporations

end up with dealings that have elements of interest, even though it is not part of their major

business activities. (Securities Commision Malaysia, 2011)


Appendixes

Appendix 1- Stages for Prohibition of Riba in QuranFIRST STAGE

The first chapter was revealed in Makkah before the prohibition of riba for which the verse paved the way. It says:

ه& ـ, الل ع&ند# #ر� ب و ي ف#ال# ,اس& الن م�و#ال&# أ ف&ي #ر� ب و# 4ي ل 5ا ر4 ب م4ن �ت م #ي آت &ك# و#م#ا Zئ ـ# ف#أ ول ه& ـ, الل و#ج�ه# ت ر& يد ون# #اة� ك ز# م4ن �ت م #ي آت و#م#ا

�م ض�ع&ف ون# ال ﴾٣٩﴿ه م

“And whatever you lay out with the people in order to obtain an increased return, this increases you nothing with Allah, but whatever you give in alms, seeking Allah’s pleasure, it is those who receive multiplied recompense”, [Chapter al-Rum (The Romans) 39].

This verse draws a comparison between those who give money to get an increase

This verse declares that the increase in wealth sought through taking riba from people to whom it is given is not blessed by Allah. This as being the first revelation worked as a motive for people at the earlier stage of Islam to abolish loans with a view of interest (riba) and in alternative, it encourage the giving of alms and charity.

SECOND STAGE

The second chapter was revealed in Madinah, it says:

&ير5 ا #ث ك ه& ـ, الل &يل& ب س# ع#ن �&ص#د4ه&م و#ب �#ه م ل �أ ح&ل,ت #ات� 4ب ط#ي ��ه&م #ي ع#ل #ا ر, م�ن ح# ه#اد وا ,ذ&ين# ال م4ن# � �م &ظ ل #ا ﴾١٦٠﴿ف#ب الر4 ب #خ�ذ&ه&م و#أ#اط&ل& �ب &ال ب ,اس& الن م�و#ال#

# أ �&ه&م �ل ك# و#أ �ه ع#ن ن ه وا �&يم5ا و#ق#د #ل أ 5ا ع#ذ#اب ��ه م م&ن #اف&ر& ين# �ك &ل ل #ا #د�ن #ع�ت ﴾١٦١﴿و#أ

“Because of the sinfulness of the Jews, We have forbidden to them certain good things that were permitted to them, and for their hindering many from Allah’s Way. And for their taking riba, though they were forbidden, and that they devoured people’s wealth in falsehood, and We have prepared for the unbelievers among them a grievous chastisement” [Al-Nisa` (Women), 160-161].

These verses inform us that riba, which has been prohibited for us, was also prohibited for Jews, thus providing us a new means of understanding the meaning of riba.

THIRD STAGE

The first verse which expresses the prohibition of riba and bans it for first time is mentioned in the following verse of Chapter ‘Al-Imran”. It says:

مsض#اع#ف#ة5 #ض�ع#اف5ا أ #ا الر4 ب �ك ل وا #أ ت ال# آم#ن وا ,ذ&ين# ال sه#ا ي# أ #ا ت ف�ل&ح ون# ي �,ك م #ع#ل ل ه# ـ, الل ,ق وا ﴾١٣٠﴿و#ات

“O you who believe! Do not devour riba multiplying it over, and keep your duty to Allah that you may prosper” [3:130].






This verse was the first verse revealed in Median to impose a ban on riba. In reading this verse, the exegetes agreed that expression ‘multiplying it over’ does not restrict the ban but expresses riba which people were accustomed to practice, assuming that this matter of multiples of multiples is no more than a description of state of affairs and not a condition relevant to the imposition. (Rahman, Ahmad, & Ali, 2011)

FOURTH STAGE

The prohibition of riba was intensified in Chapter al-Baqarah. The verses in question, the last to be revealed in Madinah concerning the prohibition of riba reads as follows:


#ا الر4 ب �ل م&ث �ع #ي �ب #ا ال الر4 ب و#ح#ر, م# �ع# #ي �ب ال ه ـ, الل #ح#ل, ل#ف# و#أ س# م#ا #ه ف#ل Zه#ى# ف#انت 4ه& ر, ب م4ن cع&ظ#ة�م#و اء#ه ج# ف#م#نه& ـ, الل &ل#ى إ م�ر ه

# ,ار& و#أ الن ص�ح#اب # أ &ك# Zئ ـ# ف#أ ول ع#اد# �&د ون# و#م#ن ال خ# ف&يه#ا �﴾٢٧٥﴿ه م

“Those who swallow down usury cannot arise except as one whom Shaitan has prostrated by (his) touch does rise. That is because they say, trading is only like usury; and Allah has allowed trading and forbidden usury. To whomsoever then the admonition has come from his Lord, then he desists, he shall have what has already passed, and his affair is in the hands of Allah; and whoever returns (to it)…. these are the inmates of the fire; they shall abide in it” (al-Bagarah, verse 275)

And also in Qur’an, chapter on al-Bagarah, verses 278 and 279 it is stated that;

﴿ رن حني ح% م< ك�% ��ك ك�ن ح�ا� ر�ا م(‌ ال رن ح% ر@ ح� ر� ر%ا ك‌#ا Aر ر# ر� ��ـ ر ال ك�وا � ر ا كنوا ر% آا رن ح3ي �ل ر ا ر4ا ك�ي ر�ا &ه& ٢٧٨ريا ول و#ر# س ه& ـ, الل م4ن# &ح#ر� ب� ب �ذ#ن وا ف#أ #ف�ع#ل وا ت �,م ل &ن ف#إ &ن ﴾ و#إ ﴿ ر� ك�و ر� Cم ك ر"ا ر# ر� ك�و ح� Cم ر ر"ا م� ك حل روا م% ر�ا Dك #Eك ك‌ م� ك ر� Fر م� �ك م0 ﴾٢٧٩ك

“O you who believe! Fear Allah and give up what remains of your demand for usury, if you are indeed believers. If you do not do it, take notice of war from Allah and His Messenger; but if you turn back, you shall have your capital sums; deal not unjustly, and you shall not be dealt with unjustly.”

And also in Qur’an, chapter on al-Bagarah, verses 280 and 281 it is further stated that;

ض, ر(‌ ر� مي ر% Gى رل ح�ا ة, ر(‌ Cح رن Fر ض, ر(‌ م� ك+ #Aك ر� ر�ا ح�ا� ,ك م� ر# ل cر� ي خ# #ص#د,ق وا ت #ن ﴿ و#أ ر� ك�و ر� Jم ر م� �ك ك�ن ح�ا� &ل#ى ٢٨٠ إ ف&يه& ت ر� ج#ع ون# #و�م5ا ي ,ق وا و#ات ﴾ ه& ـ, ﴿ الل ر� ك�و ر� Cم كي ر"ا م� Lك ر# Mم ر0 ر� ر� �%ا ر Nض م� رن ك�. ك� Gى F� ر رو ك �� ر Oك ٢٨١﴾

“If a debtor is in want, give him time until his circumstances improve; but if you forego (the debt) as charity, that will be to your good, if you really understand. Have fear of the day when you go back to God. Then each will be paid back in full his reward, and no one will be wronged.”







Appendix 2 – Prohibition of Riba in Sunnah

“Zaid B. Aslam reported that interest in pagan times was of this nature: when a person owed money to another man for a certain period and the period expired, the creditor would say: You pay me the amount or pay the interest. If he paid the amount, it was well and good; otherwise the creditor increased the loan amount and extended the period for payment again.” ( Al-Muwatta, Imam Malik)

The prophet (pbuh), during his last sermon addressed his revered companions, “Every form of riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting riba. I start with the amount of interest, which people owe to Abbas and declare it all cancelled. He then, on behalf of his uncle, Abbas, cancelled the total amount of interest due on his loan capital from his debtors” ( Tafsir Al-Khazin, vol. 1, p.301)

The Prophet (pbuh) said: “ Gold for Gold, Silver for Silver, Wheat for What, barley for barley, dates for dates, salt for salt - like for like, hand to hand. Whoever pays more or takes more, indulges in Riba. The taker and giver are alike (in guilt). Narrated by : Abu Saeed Khudri, Reported by: bukhari

“ Gold for gold, silver for silver, wheat for wheat, barely for barely, 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” Narrated by: Abu Hurayrah

“God will not allow four persons to enter paradise or to taste its blessings: he who drinks wine, he who takes riba, he who usurps an orphan’s property without right and he who is undutiful to his parents.” Narrated by: Abu Hurayrah

From Jabir: “ The Prophet (pbuh) cursed the receiver, the payer of interest, the one who records it and the two witnesses of the transaction and said: They are all alike (in guilt) [Reported by Muslim, Tirmidhi and Ahmad]


Appendix 3 – Screen Methodology for SACThe SAC has applied a standard criterion in focusing on the activities of the companies listed on Bursa Malaysia. As such, subject to certain conditions, companies whose activities are not contrary to the Shariah principles will be classified as Shariah-compliant securities. On the other hand, companies will be classified as Shariah non-compliant securities if they are involved in the following core activities:

(a) Financial services based on riba (interest);(b) Gambling and gaming;(c) Manufacture or sale of non-halal products or related products;(d) Conventional insurance;(e) Entertainment activities that are non-permissible according to Shariah;(f) Manufacture or sale of tobacco-based products or related products;(g) Stockbroking or share trading in Shariah non-compliant securities; and(h) Other activities deemed non-permissible according to Shariah.The SAC also takes into account the level of contribution of interest income received by the company from conventional fixed deposits or other interest bearing financial instruments. In addition, dividends received from investment in Shariah non-compliant securities are also considered in the analysis carried out by the SAC.

For companies with activities comprising both permissible and non-permissible elements, the SAC considers two additional criteria:(a) The public perception or image of the company must be good; and(b) The core activities of the company are important and considered maslahah (benefit in general) to the Muslim ummah (nation) and the country, and the non-permissible element is very small and involves matters such as ùmum balwa (common plight and difficult to avoid), ùruf (custom) and the rights of the non-Muslim community which are accepted by Islam.

To determine the tolerable level of mixed contributions from permissible and non-permissible activities towards turnover and profit before tax of a company, the SAC has established several benchmarks based on ijtihad (reasoning from the source of Shariah by qualified Shariah scholars). If the contributions from non-permissible activities exceed the benchmark, the securities of the company will be classified as Shariah non-compliant. The benchmarks are:

a. The five-percent benchmarkThis benchmark is used to assess the level of mixed contributions from the activities that are clearly prohibited such as riba (interest-based companies like conventional banks), gambling, liquor and pork.

b. The 10-percent benchmarkThis benchmark is used to assess the level of mixed contributions from the activities that involve the element of ùmum balwa which is a prohibited element affecting most people and difficult to


avoid. An example of such a contribution is the interest income from fixed deposits in conventional banks. This benchmark is also used for tobacco-related activities.

c. The 20-percent benchmarkThis benchmark is used to asses the level of contribution from mixed rental payment from Shariah non- ompliant activities such as the rental payment from the premise that involved in gambling, sale of liquor etc.

d. The 25-percent benchmarkThis benchmark is used to assess the level of mixed contributions from the activities that are generally permissible according to Shariah and have an element of maslahah to the public, but there are other elements that may affect the Shariah status of these activities. Among the activities that belong to this benchmark are hotel and resort operations, share trading, stockbroking and others, as these activities may also involve other activities that are deemed non-permissible according to the Shariah.

Shariah-compliant securities include ordinary shares, warrants and transferable subscription rights (TSRs). This means that warrants and TSRs are classified as Shariah-compliant securities provided the underlying shares are also Shariah compliant. On the other hand, loan stocks and bonds are Shariah non-compliant securities unless they are issued based on Shariah principles.


Appendix 4- Screening Methodology for DJIM

Screens for Acceptable Business Activities Activities of the companies should not be inconsistent with shariah precepts. Therefore, based on revenue allocation, if any company has business activities in the shariah inconsistent group or sub-group of industries it is excluded from the Islamic index universe. The DJIMI Shariah Supervisory Board established the following broad categories of industries as inconsistent with shariah precepts: alcohol, pork related products, conventional financial services (banking, insurance, etc.), hotels, entertainment (casinos/gambling, cinema, pornography, music, etc.), tobacco, and weapons and defense industries.

Screens for Acceptable Financial Ratios After removing companies with unacceptable primary business activities, it removes companies with unacceptable levels of debt, liquid assets and receivables by applying the following screens:

Debt to Market Cap


Exclude companies for which Total Debt divided by Trailing Twelve Month Average Market Capitalization (TTMAMC) is greater than or equal to 33%. (Note: Total Debt = Short-Term Debt + Current Portion of Long-Term Debt + Long-Term Debt).

Liquid Assets to Market Cap Exclude companies for which the sum of Cash and Interest-Bearing Securities divided by TTMAMC is greater than or equal to 33%.

Receivables to Market Cap Exclude companies if Accounts Receivables divided by TTMAMC is greater than or equal to 33%. (Note: Accounts Receivables = Current Receivables + Long-Term Receivables). Companies passing the above screens are qualified to be included as components of the Dow Jones Islamic Market index.


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