Islamic Modes of Finance

Mian M. Niaz ShakirLecturer

College of Commerce

GC University Faisalabad

What is Finance?

Definition of FinanceFinance can be defined as that activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise.

What is Islamic Finance?

Definition of Islamic Finance Islamic Finance

that activity which is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise according to the Islamic Jurisprudents/ Shariah complaints (According to Quran and Sunnah).

Islamic Modes of Financ

(1) Sharakat (Partnership)

(2) Modarbah(3) Bai Salam(4) Bai

Marabaha(5) Bai Muajjal(6) Ajara

Partnership Partnership (Shirakah)(Shirakah)

Definition:-Definition:-When two or more persons join to

do business with a fixed capital for the purpose of gaining profit and for sharing in the profit or loss of business according to a fixed ratio.

Justification

At the time of Muhammad’s (SAW) call to Prophethood various forms of business were in vogue.

The Apostle of Allah (SAW) prescribed wrong modes of business, or reformed those elements in business, which were contrary to ethics, justice, and equity.

He forbade all forms of business in which disputes, conflicts or strife was likely to arise in which the gain of one party meant loss to the other.

Justification

After a careful study of those modes of industry, trade and agriculture which were proscribed or in which amendments were prescribed by the Holy Prophet (SAW), The Juristic have derived a standard of good and bad to determine lawful or unlawful nature of a business. By applying this standard we can investigate other forms of business and judge whether they are legal or illegal.

Ahadith on PartnershipAhadith on Partnership

The following Ahadith clearly provide justification for partnership:

1. The Apostle of Allah (SAW) is reported to have said:

“Allah Almighty Says that untill one partner plays false to another I am a third member of their Partnership.”

[Abu Dawud / Hakim / Baihaqi]

2. A man came to the Apostle of Allah (SAW) and said:“While I conduct business in the market, one of my partners offers prayers in the Mosque.”“This perhaps is the cause of your thriving business,” said the Holy Prophet (SAW)

3. The Apostle of Allah (SAW) said: “Conduct business on the basis of equal share. This brings ample returns.”[Abu Dawud]4. The Holy Prophet (SAW) said: “Allah’s helping hand is with those partners who are not dishonest.”[Abu Dawud]

5. The Apostle of Allah (SAW) had entered into business partnership with Saib bin Sharik in Makkah. When He (SAW) met him in Madina, He (SAW) reminisced about their partnership with approval.”

The Following Rational Arguments Also Provide Ground For The Justification Of Partnership:

1. By pooling their resources the two partners can invest more capital, conduct business on a wider scale and earn more profit. Partnership facilitate funding for business on a high scale.

• 2. A man may have capital but lack business sense or a man may have too vast a business to look after himself. In these cases partnership is the best mode of running business successfully.

• 3. Partnership makes it possible to work on the principle of division of labour

Conditions of Partnership

1. Mutual Agreement

2. Maturity of the Partners

3. Sound Mind

4. The Business must be Lawful

5. Fixing the Rate of Profit

6. Liability for Loss (With Capital Ratio)

Partnership(The Hanafi view)

1.By Agreement(Shirakah Alkud) 2. In Property

In Goodwill(Shirakata-al-Wagu)

With Equal Shares(Shirakata-al-

Mafawada)

In Art(Shirakata-al-Badan)

In Capital(Shirakata-bil-Mal)

With Unequal Shares

(Shirakata-al-Anan)

With Equal Shares(Shirakata-al-

Mafawada)

With Unequal Shares

(Shirakata-al-Anan)

With Equal Shares(Shirakata-al-

Mafawada)

With Unequal Shares

(Shirakata-al-Anan)

At Will(Voluntary

Partnership)

Compulsory (Shares in Inheritance)

Features Of P/S With Equal Shares(Shirakata-al-mafawada)

• Equal capital Investment• Each Partner represents the other• All partners should be

• Sound mind• Adult• Free• Faithful• Accountable to other for his dealings and acts of

ommission and commission.

Profit and Loss shall be equally shared

Features of P/S with Unequal Shares (Shirakata-al-Anan)

• Two or more parties with unequal shares• Capital investment may be different• Parties may be of different faith-Muslims with infidels• A minor and adult can be partners• Agreed rate of profit• Losses will be shared in proportion to their capital

investment• In P/S in ownership the powers and functions of

partners may differ, but it is not essential that their capital investment should be equal.

P/S In Work, Action, Craft Or Art

• In this mode of p/s there are two or more parties. Craftsmen like two or more carpenters or iron smith can enter into p/s.

• The p/s in work is declared lawful by Hanfi, Malki and Hanbli jurists, while jurists of the shafi and Jaffria school of thoughts regarded it as unlawfull.

Partnership in Goodwill

In this mode of partnership there is no capital investment, but investment of goodwill of a company or a firm. A firm on the strength of its goodwill purchases goods on credit and sells them on cash basis. Partnership with such a firm or company is called Partnership in Goodwill.

The p/s in work is declared lawful by Hanfi, Malki and Hanbli jurists, while jurists of the shafi and Jaffria school of thoughts regarded it as unlawfull.

Modern Forms of Partnership

1. Joint Stock Company

2. Partnership

3. Limited Companies

4. Cooperatives

Law of PartnershipDistribution of ProfitDistribution of Profit

a) With the agreed ratio, no amount of profit shall be allocated in advanceb) In determining rate of profit, capital investment, participation and responsibility shall be taken into account.c) Despite equal capital investment the ratio of profit for each partner may vary.d) In ongoing business current loss may be offset against future profits.e) In the auditing of accounts first the capital shall be set apart. Next the surplus shall be computed. If there is surplus it shall be entered as profit. If the capital has diminished it is loss.f) Those who are entitled to profit shall receive it only when the capital has been returned to its owner. The owners can receive capital de facto or de jure.

Modarbah

Meaning of Modarbah:Modarbah is derived from the word ‘Al-Al-Zarab’Zarab’ which means ‘to travelto travel’.

This is related to trade because trade usually Involves travelling.

Furthermore, it is derived from ‘Zarba Fi Al-Zarba Fi Al-ArdArd’ which implies travelling over the length and breadth of the earth.

This is related to Modarba Modarba because the Zarib Zarib ((the person who enters into Modarba) adds his labour to the capital of the Financier.

Modarbah

In the Hanafi and Hanbali jurisprudence, Modarbah is known as ‘Modarbaha’

while the Shafii and Malki jurists use the term ‘Qiraad’ for Modarbah.

The meaning in both cases, however is the same, that is, a man receives another’s money or goods, adds

his labour to it and earns profit. The Rb-al-Mal (the finacier or owner of goods) is

called “Maqarz” and the worker is called ‘Muqarad’.

Modarbah

The other term used for the Modarba are ‘Qirrad’ and ‘Miqarza’ which is derived from ‘Qaraza’. Qaraza means to cut. In relation to Modarbah it means that the financier (or the capitalist) accumulates capital by saving from his income and invests it in business.

Definition

“Two or more persons enter into a deal in which one party provides capital and the other party conducts business with this capital under an agreement of receiving a fixed share in the profit”.

In this mode of business the FinancierFinancier (Rab-al-Mal) provides capital and the Modarib Modarib by adding his labour to increase it.

The increase is then shared by the parties in accordance with an agreed ratio.

Name of Parties InvolvedName of Parties Involved

The term ‘‘Rab-al-MalRab-al-Mal’’ is used for the Finacier and

The person who adds his labourlabour to the capital of the financier is called ‘Modarib’‘Modarib’

Different terms of Modarbah1- Two persons enter into a contract of

Modarbah: one, the Rab-al –MalRab-al –Mal the and other Modarib.Modarib.

2- More than two persons can also enter into Modarbah, then the position will be

1.1. More than one Financer and more than More than one Financer and more than one Modaribone Modarib

2.2. The Financer is one and more than one The Financer is one and more than one ModaribModarib

3.3. The capital is provided by a cartel of The capital is provided by a cartel of few persons and one person as Modaribfew persons and one person as Modarib

All the above forms are lawful.All the above forms are lawful.

Ahadith on Modarabah

1- The Holly Prophet (PBUH) Observed:“The man who brings up three girls is like a prisoner. So O men of Allah! Enter into Modarbah with him, give him loan” (Al- Mabsoot)

2- Abbas bin Muttlab (Allah may pleased with him) used to enter into modarabah on some special terms. When this came to the knowledge of Holly Prophet (PBUH), He (PBUH) disapproved of it. (Al- Mabsoot)

3- Hakeem bin Hazaam (Allah may pleased with him) used to enter into modarabah on the same terms. (Al- Mabsoot)

Ahadith on Modarabah

4- Abu Naeem reported that before His call to Prophethood (PBUH) , the Apostal of Allah (PBUH) had conducted business in Syria with the capital provided by Hazrat Khadija (Allah may pleased with him) on Terms of Modarbah. (Al- Mabsoot)

5- The Apostal of Allah (PBUH) is reported to have said that there is blessing in Modarbah. (Abu Dawood)

6- Hazrat Uthman (Allah may pleased with him) used to conduct business on Modarbah.

7- Hazray Ayesha (Allah may pleased with him) used to invest the money deposited with her by the people in Modarbah.

Ahadith on Modarabah

8- Hazrat Umar (Allah may pleased with him) entered into Modaebah with Zaid bin Khaleeda.

9- Hazrat Umar (Allah may pleased with him) also extended money from the Bait-ul-Mal for use in business on the Principal of Modarbah.

10- Example of Hazrat Abdullah and Hazrat Ubaiddullah two sons of Hazrat Umar (Allah may pleased with him) .

Importance

1- Peoples having capital but lack of capability

can invest through Modarbah.2- Banks can adopt Modarbah as

alternative to the interest bearing transactions.3- Companies engaged in big business

can build up their capital resources

through Modarbah.

Rules of Modarbah: • So long as the Modarib, having received the capital,

does not invest it in business, the capital remains with him as trust. It is, therefore, the responsibility of the Modarib to safeguard this trust. It is also his duty to return the capital to the Rab-a’.-Mal on demand. If the capital is lost, destroyed or wasted, the Modarib

is not liable to fine.• (ii)        When the Modarib invests the capital in the

business he becomes the agent of the Rab-al-Mal.• (iii)       In the case of the business yielding a profit

the Modarib becomes a party to a financial agreement in which each party shares in the profit according to an agreed ratio.

Rules

• (iv)    if for some reason the contract of Modarbah is dissolved it vv ill turn into a contract of employment and the Modarib will become an employee of the Rab-al-Mal. In this case profit or loss will belong to the Rab-al-Mal. The Modarib shall receive his pay only.

• (v)       If the Modarib does not accept any term of the contract of Modarbah, he shall be deemed an embezzler and shall be held liable to return the capital.

Rules• (vi)  If the contract of Modarbah contains the term that

the whole profit will go to the Modarib, it will not be a contract of Modarbah, but a contract of debt. • The Modarib will become a debtor. The Modarib will take the

profit and bear the loss. If the capital is lost, the debtor shall be liable to pay the whole of it to the Rab-al-Mal. 

• (vii) If the contract of Modarbah contains the term that the entire profit shall go to the Rab-al-Mal, it will be a contract of al‑bazaata.

Relationship B/W Rab-al- Mal and Modarib

1- Modarib asTrusteeModarib asTrustee: Before Investment. Responsible to protect the Investment/ capital.

2- Agent:Agent: On investment work as Agent.3- Party:Party: On yielding profit in the Business

become a party to a agreement.4- Employee:Employee: If the Contract of Modarbah is

dissolved it will turn into a contract of Employment. Profit and loss will belong to Rab-al-mal.Modarib shall receive his pay only.

5- Embezzler:Embezzler: If the Modarib does not accept any term of the contract of Modarbah. Held responsible to return the capital.

Relationship B/W Rab-al- Mal and Modarib

6- Debtor:Debtor: If the whole profit goes to Modarib under contract, it will not be contract of Modarbah but a contract of Debt. The Modarib will be responsible for profit and losses. If capital is lost, He will have to pay the capital to the creditor/ Rab-al Mal.

7- If the contract of Modarbah contains the term that the entire profit shall go to the Rab-al-Mal,it will be a contract of Al-bazaata.Al-bazaata.

Articles of Modarabah

• Offer• Acceptance

• The parties must express their agreement in formal words like one party says, “Take this capital and use it in Modarabah and if there is a profit we shall divide it by half”.

• In reply the Modarib says, “I take this capital”.• “I accept this agreement” or Simply• “I accept”Agreement may be Written or oral.

Terms of Modarbah

1- Ras-ul-mal (Capital) Should be in the form of Money, gold or Silver.Modarabah with traded goods is not valid Because the price of the trade goods

fluctuate.Modarbaha requires Proffering (Offer for acceptance) of money.

2- Amount of Ras-ul-mal (Capital) proffered Should be clearly stated so that no dispute may arise on this account.

Terms of Modarbah

3- Rab-ul-mal should posses ready cash at the time of entering into contract.

4- Rab-ul-mal should transfer ready cash to the Modarib at the time of entering into contract so that he may use it.

5- The Ratio or percentage of the Modarib’s share in the expected profit must be fixed at the time of contract.

Terms of Modarbah

6- The Modarib’s share be fixed out of the profit, not out of the capital.

7- If the Rab-ul-mal holds the goods or financial assets of the Modarib in mortgage as guarantee for a loan advanced to him, no valid contract of Modarabah be made on the basis of this capital which is mortgaged.

Right and Duties of Modarib• 1- The Modarib should abide by all the

terms and conditions of Modarbah.• 2- The Modarib is free to enter into

Modarbah contract with any other party when he has not been expressly debarred (Prevent officially from doing something) from doing so.

• 3- A third party can extend gratis (free of charge) help to the Modarbah to run

the business along the better lines.

Right and Duties of Modarib• 4- Most jurists holds that Rab-ul-mal can not

take an active part in the business with the Modarib, his powers are curtailed. However, some Ulema of Shafi School of jurisprudence allow the Rab-ul-mal to take active part in the affairs of the business.

• 5-In a contract of Modarabah, if the guarantee is sought for the safe return of the Ras-ul-mal the contract become void.

• Hence, a guarantee may be sought from the Modarib that he will conduct the business with due care and a sense of responsibility.

Right and Duties of Modarib

• 6- The Modarib has the power of sale and purchase in connection with the business.• He can keep goods in his custody.• He can execute a deed of pledge with

some one.• He can enter into Modarbah with an

other person .

• 7-The Modarib has no power to lend or gift the capital of Rab-ul-mal to any one otherwise with the concent of Rab-ul-mal.

Right and Duties of Modarib• 8- In a contract of Modarabah, the

financial liability of the Rab-ul-mal is limited to the amount he has provided to the Modarib except when he has premitted to the Modarib to raise a loan purchase goods on his credit.

• 9-The Modarib has power to sell goods on credit except he has been expressly stopped from doing so by Rab-ul-mal.

Period of Modarbah

• 1- Modarbah contract can be terminated by either party at will.

• 2- If there are more than two parties, they can keep the contract intact even when one or two parties have repudiated it.

• 3- Contract for a specified or Indefinite period.• 4- Contract is terminated at the death of one

party. However, If there are more than two parties, they can keep the contract intact .

• 5- Contract may be kept in force on the previously agreed terms.

Rules of profit and loss sharing• The entire loss will have to be born by the Financer

(Rab-ul- Mal)• Profit sharing according to the fixed Ratio, mentioned

in contract.• No fixed sum shall be allocated to any party in

advance.• According to the Hanfi school of thought, distribution

of profit before return of capital to Rab-ul-Mal is not valid.

• In an ongoing business the losses will be offset against the profits till the business is wounded up and final account is settled.

Rules of Profit and Loss Sharin :…

• The amount of profit and loss accruing to each party shall be determined at the winding up of the business.

• The parties are entitled to receive profit only when the capital has been returned to Rab-ul- Mal.

• The profit will enhance the capital, if there is no real profit, the Modarib is entitled to compensation for his labour.

• All matters are settled by mutual agreement.

Application of Modarbah in Modern Times: • The working of the modern Banking System and

financial institutions has become very complex. Their operations and procedures are by and large inconsistent with the teachings of Islam.

• Muslim scholars and economics are now striving to organize their institutions in accordance with the tenets of Islam. Their efforts are not confined to the reform of the Banking System, but extend to the restructuring of all institutions which use public savings for business purposes. These institutions may with reference to the raising of financial resources for investment and operations be classified

into two types.

Joint Stock Companies and Modarbah• (a)  In this business the Modarib can receive capital

from more than one financier. All the jurists allow joint business of this kind on terms of Modarbah. For this purpose there are two valid modes of procuring capital:(i) Capital for investment should be procured before the commencement of the business.(ii)    Money in hand should be invested in business and later the capital may be procured.

It is an essential duty of the Modarib that he should invest in the joint business with the consent of all the financiers from whom he has obtained capital. Secondly he should invest in a proper manner.

Joint Stock Companies and Modarbah• b)     The second mode of Modarbah is the continuation of a

running Modarbah business. In other words, a business- is commenced to run for a specified period. When this period expires the business may be continued on the existing terms.

• According to first mode referred to above an individual or individuals give their capital to a company or institution for investment. This too would be called Modarbah. The financial institutions can issue general or special investment certificates to procure capital. 

• The mode in partnership business is that the company raising the capital either invests it directly or indirectly through another company. 

Banking Companies and Modarbah

• The Banking business runs along the same lines. Besides deposits which can be ‘‘‘ ithdrawn on demand, the Banks provide several kinds of services. Banking bears resemblance to the business of the Finance Companies. The Banks obtain capital by selling shares and from investment accounts. To procure more capital the Banks can issue certificates. The Banks can then use this capital to buy stock and investment certificates or for direct investment.

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