Sources of Banking Law

The Prohibition of Riba (Interest)

  • Quran

  •  

That which you give as interest to increase the people’s wealth increases not with God, but that which you give in charity, seeking the goodwill of God, multiplies manifold (30:39)

  • Quran
  •  

And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other people’s property. We have prepared for those among them who reject faith a grievous punishment. (4:161)

  • Quran

  •  

O believers, take not doubled and redoubled interest, and fear God so that you may prosper. Fear the fire which has been prepare for those who reject faith, and obey God and the Prophet so that you may receive mercy. (3:130)

  • Quran

  •  

Those who swallow usury (riba’) cannot rise up save as he arise whom the devil has prostrated by (his) touch. That is because they say: Trade is just like usury; whereas Allah has permitted trading and forbidden usury. He unto whom an admonition from his Lord cometh, and (he) refrained (in obedience thereto), he shall keep (the profits of) that which is past, and his affair (henceforth) is with Allah. As for him who returned (to usury) such as rightful owners of the fire. They will abide therein. (2:275)

  • Quran

  •  

Give up what remains (due to you) from usury, if you are (really) believers. And if you do not do it, then take a notice of war from Allah and His Messenger (2:278-279)

  • Sunnah

  •  

Abdullah ibn Mas’ud (r.a.h.) reported that the Prophet (p.b.u.h.) said, “There are seventy-three types of riba, the least of which is as abhorrent as a man having intercourse with his own mother and worst of which is (violating) a Muslim’s honor and sanctity”. (al-Hakim in al-Mustadrak 2:37 ; Sahih al-Jaami’ 3533)

  • Sunnah

  •  

Jaabir (r.a.h.) reported that the Messenger of Allah (p.b.u.h.) cursed “the one who consumes riba, the ones who gives it to others, the one who writes it down and the one who witnesses it.” He said, “They are all the same”. (Reported by Muslim 3:1219)

  • Sunnah

  • Muslim narrated on the authority of Abu Sa’id Al-Khudri : Bilal visited the Prophet (p.b.u.h.) with some high quality dates, and the Prophet (p.b.u.h.) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality dates. The Prophet (p.b.u.h.) said “This is precisely the forbidden riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other”.

    • Sunnah

     

Uthman bin Affan reported Allah’s Messenger (p.b.u.h.) as saying, “Do not sell a dinar for two dinars and one dirham for two dirhams”. (Sahih Muslim, Book 10:3849)

  • Sunnah

  •  

The Prophet (p.b.u.h.), during his last sermon addressed his revered companions, “Every form of riba’ (interest) is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandments 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 debtor” (Tafsir Al-Khazin, vol 1, p.301)

  • Sunnah

  •  

Ubaida bin al-Simit (r.a.h.) reported Allah’s Messenger (p.b.u.h.) as saying, “Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt, like for like and equal for equal, payment being made hand to hand. If these classes differ, then sell as you wish if payment is made hand to hand”. (Sahih Muslim, Book 10:3853) 

 Prohibition of Gharar

  • Sunnah.

  •  

The Prophet (pbuh) said :”Do not retain milk in the udders of a camel or goat so as to exaggerate its yield. Anyone who buys (it) has the choice, after having milked it, to return it with a measure of dates”. (Sahih Muslim, book 10:3634)

 Prohibition of Maisir & Qimar

  • Quran

  •  

O ye who believes! Strong drink and games of chance and idols and divining arrows are only an infamy of Satan’s handiwork. Leave it aside in order that ye may succeed.(5:90)

 Discouragement of Debts

  • Sunnah

  •  

Narrated by Aisha, Allah’s Apostle used to invoke Allah in the prayer saying “O Allah, I seek refuge with You from sins and from debt”. Somebody said to him, “Why do you so frequently seek refuge with Allah from being in debt?” The Prophet relied, “A person in debt tells lies whenever he speaks, and breaks promises whenever he makes (them)…” (Sahih Bukhari 1.795)

 The Bai Salam Transaction

  • Sunnah

  •  

Narrated by Abbas. The Prophet came to Medina and the people used to pay in advance the price of dates to be delivered within two or three years. He said (to them), “Whoever pays in advance the price of a thing to be delivered later should pay it for a specific measure at specified weight for a specific period”. (Sahih Bukhari 3.443)

 The Mudharabah Transaction

  • Sunnah

  • Al-Abbas ibn Abd Al-Muthalib used to stipulate a condition whenevr he gave his money in mudharabah that the entrepreneur will not take his money across any sea, into any valley, or buy any animal sith a soft belly (unfresh meat), and if the entrepreneur were to do any of those, then he must guarantee the capital. The Prophet p.b.u.h. heard of the practice and permitted it.

    • Sunnah

     

On the authority of Suhayb that the Prophet (p.b.u.h.) said, “There is a blessing in three transactions; al-bai ila ajal (credit sale), Mudharabah (profit sharing) and mixing wheat and barley for home, not for trading”. (Ibn Majah)

 The Musyarakah Transaction

  • Quran

  •  

If more than two, then they share in a third (4:12)

  • Quran

  •  

…Truly many are the partners (in business) who wrong each other, except for those who believe (in Allah) and work deeds of righteousness… (38:24)

  • Hadith Qudsi

  •  

Narrated by Abu Hurairah. “I (Allah) am a third party in a partnership of two so long as one of the partners does not betray the other. If however he does betray the other partner, I (Allah) will come out of the partnership”.

 The Qardhul Hassan Transaction

  • Quran

  •  

Who is he that will loan Allah a beautiful loan (qardhan hasanan)? For (Allah) will increase it manifold to his credit, and he will have (besides) a liberal reward (57:11)

  • Sunnah

  •  

Authority of Anas that Rasulullah (p.b.u.h) said, On the day I ascended to heaven, I saw a writing on the door of paradise that read: Every charity is rewarded ten-fold, and every loan is rewarded eighteen times. I said “O Jibril, why is the loan rewarded more than charity?”, He said “Because a person may ask charity when he does not need it, but the borrower only borrow in cases of dire need”.

 The Ijarah Transaction

  • Quran

  •  

And if they suckle your offspring, give them their recompense in kindness. (65:6)

  • Quran

  •  

Said one of them, “O Father, hire him on wages, for truly the best to employ is a strong and trustworthy man”. He said “I intend to wed one of my daughters to you, on condition that you work for me for eight years, and if you complete ten years, that will be grace from you” (28:26-27)

  • Sunnah

  •  

Prophet Muhammad (p.b.u.h.) said, “Pay the hired worker his wages before his sweat dries”. (Ibnu Majah, al-Tarmizi and al-Tabrani)

  • Sunnah

  • Narrated by Ahmad, Abu Dawud, and al-Nasa’i on the authority of Sa’ad (r.a.) : The farmers during the time of the Prophet (p.b.u.h.) used to pay rent for the land in water and seeds. He (p.b.u.h.) forbade them from doing that, and ordered them to use gold and silver (money) to pay the rent.

    • Sunnah

     

Prophet Muhammad (p.b.u.h.) said, “Whoever hires a worker, he should inform him of his wage” (Al-Baihaqi)

 The Profit Determination

  • Sunnah

  •  

Abdullah b Amr b al-As reported, I heard Allah’s Messenger (p.b.u.h) as saying, “Allah ordained the measures (of quality) of the creation fifty thousand years before He created the heavens and the earth, as His Throne was upon water”. (Sahih Muslim, 33.6416)

 The Takaful transaction

  • Quran

  •  

Never should a believer kill another believer; except by mistake, and whoever kills a believer by mistake it is ordained that he should free a believing slave, and pay blood-money to the deceased’s family, unless they remit it freely. If the deceased belonged to a people at war with you, and he was a believer, the freeing of a believing slave (is enough). If he belonged to a people with whom ye shall have treaty of mutual alliance, blood-money should be paid to his family, and a believing slave be freed. For those who find this beyond their means, (is prescribed) a fast for two months running; by way of repentance to Allah; for Allah hath all knowledge and all wisdom (4:92)

 Liability of a Guarantor

  • Sunnah

  •  

… then a third dead man was brought and the people said (to the Prophet), “Please lead his funeral prayer.” He said, “Has he left any wealth?” They said, “No”. He asked, “Is he in debt?” They said, “(Yes, he has to pay) three dinars”. He (refused to pray and) said, “Then pray for your (dead) companion”. Abu Qatada said, “O Allah’s Apostle! Lead his funeral prayer, and I will pay his debt.” So, he led the prayer. (Sahih Bukhari 3.488.1)

 

8 thoughts on “Sources of Banking Law

    • Hello Brother Azmil,

      Determining profit margin, how much can a bank earn from a financing, is always going to be tricky. The law said not to charge excessively, but the question is, who’s point of view are you looking from? For the customer, it will be too high or shouldn’t be as high as the non-Islamic loans as Islamic Banking is supposed to help the ummah. For the Banks, there are shareholders, risk of defaults, cost of funds and operational expenses to think about. So I guess, this is a better question to put to a Shariá scholar, which I am not one.

      As a practitioner in Islamic finance though, I have to say that it is an offer and acceptance kind of arrangement. Banks have their intended target returns to achieve to be economically viable in the future. Pricing is always an issue within the banking circle; if we price too high, the customers won’t come but too low puts the Bank at risk.

      As far as I know, there are no specific guidelines to a sale and purchase agreement, as the pricing that’s offered needs to be accepted by all parties. If the pricing is too high, the buyer should move on to the next seller… for a better offer. There are no specific formula to pricing, so it always gets benchmarked against a known pricing methodology, which is unfortunately, a conventional pricing mechanism. In Malaysia, where there is a dual banking system, it is always a matter of staying in competition with each other that results in the pricing being closely decided based on a conventional benchmark. When it comes to pricing, it is always competition between an Islamic Bank and a conventional Bank, never in competition with another Islamic Bank. In that sense, it will be hard to come up with a specific pricing formula that will benefit both the ummah and the banks due to the competition from conventional banks.

      Apologies if I can’t help much with your question. Appreciate your input.

  1. Bro Amir,

    I attended a one day course organised by INCIEF and regarding the profit margin, the professor mentioned that there is a provision in quran qouted only one third can treated as a profit margin…
    Maybe i heard wrong, but if it been told in quran, can you eleborate more on that and provide me with the surah. Thank

    • Hi Azmil,
      Unfortunately, I am not learned in the verses of the Quran. I am unable to quote you that verse, and am not sure if the verse refers to the same context of pricing. Apologies for that. Perhaps the right person for the quoting of that verse is the professor you mentioned?

  2. BRO AMIR

    CURRENTLY OUR PER IS MORE THAN 30%, WE DECIDED TO GIVE HIBAH TO OUR DEPOSITORS BASED ON PROFIT THAT THEY WILL RECEIVED ON YEAR END. CAN WE REVERSED DIRECTLY FROM PER B/S AND CHARGE TO DEPOSITORS?
    OR ANY SUGGESTION TO REDUCE THE PER

    • Dear Azmil,

      Many scholars are against the keeping of PER for extended period of time as it is rightfully the profit derived from investors funds and therefore should be distributed. I also understand the view that Banks prefer to retain PER as a matter of stabilising the returns to the investors.

      As a personal view, I believe PER can be taken from the investor’s profit portion with the intention of re-distribution of the PER quickly to the investors after a period of time. Many banks continue to take PER continuously and has retained a huge balance in PER. I feel there should be a policy where the Bank retains PER up until a maximum cap or period of time before distributing it.

      From the B/S, the PER can be re-distributed when certain events happens, based on internal Bank policies such as:
      1) when there is a drop in return to investors exceeding a certain percentage. For example, the previous period investment returns is 3%, but now the actual returns are 2.4% which is a 20% drop. PER should be distributed to improve this.
      2) when the monthly PER allocation greatly exceeds the default rate or market risk rates. As you mentioned above, you can reduce the PER allocation if the Bank feels it is too high. For example, as a benchmark, the default rates in the market is 3%, and the PER is 12%, which is 4x the default rates. The PER can be reduce to perhaps 6% or 7% of the gross ditributable profit because of this. The immediate impact is that moving forward, the investors get more of their profits on their investments.
      3) when it reached a certain threshold, for example the PER is more than 30% the monthly average balance of the Mudharabah assets, in such cases, PER allocation should be temporarily suspended. This means the investors will recieve better returns for the period as there are no PER deductions.
      4) when PER exceeds a certain time period. I believe PER should not be kept for an extended period of time, as most of the investors might have exited the Bank and will never enjoy the profit allocated into the PER from their investment. As a matter of Bank policy, a PER should be distributed every half yearly or yearly at a certain percentage, for example 40% of the outstanding PER is distributed each year-end to investors. Otherwise, a short-term investor who exits the Bank after 3 months may never see the profit allocated to PER from his investments if the PER is never re-distributed on a regular basis. I think there is an element of unfairness here.

      Of course, the above are all my personal views, and I know Banks are reluctant to re-distribute quickly as such reserves improves the Bank’s financial ratios at the very least. Banks stands to gains from a huge PER balance, but the investors may not be able to enjoy the profit until an extended period of time. I feel a policy needs to be drawn up to address these issues.

      I hope the above helps. Thanks.

    • Salam Brother,

      Try checking out some of the links I have on my site’s sidebar. Some of the links divert you to some useful sites on Islamic Banking.

      Wasalam

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