The Growth of Islamic Finance

and Banking

This book covers the recent literature concerning Islamic banking and
finance (IBF), focuses on the history of IBF since its inception and intro-
duces the latest innovative concepts and practices in the field.
The authors cover important topics such as the role of ownership, Shari’ah
compliance and governance structures in raising debt capital using IBF
practices, including Fatwa issues and the use of benchmarking practices.
The book also addresses topics like archival data, the influence of leverage
on ownership structure and sukuk structures, as well as misconceptions,
threats, challenges and opportunities in IBF. Finally, the book deals with
prominent issues such as business score-carding, Takāful (Islamic Insur-
ance), IBF implications for block-chain-based fintech and finance hub con-
cepts in Islamic microfinance models.
This edited volume is an important contribution to the IBF literature as
it provides a much-needed in-depth look into industry practices through the
perspective of corporate finance and governance. With its interdisciplinary
approach covering legal and financial issues along with a wide variety of
notable contributors, this book will be a valuable reference guide to both
teachers and students of Islamic banking and economics.

Hussain Mohi-ud-Din Qadri is an Associate Professor at the School of Eco-

nomics and Finance, Minhaj University, Lahore, Pakistan.

M. Ishaq Bhatti is an Associate Professor and the Founding Director of the

Islamic Banking and Finance Programme at Latrobe University, Australia.
Islamic Business and Finance Series
Series Editor: M. Ishaq Bhatti

There is an increasing need for western politicians, financiers, bankers, and

indeed the western business community in general to have access to high
quality and authoritative texts on Islamic financial and business practices.
Drawing on expertise from across the Islamic world, this new series will
provide carefully chosen and focused monographs and collections, each au-
thored/edited by an expert in their respective field all over the world.
The series will be pitched at a level to appeal to middle and senior man-
agement in both the western and the Islamic business communities. For the
manager with a western background the series will provide detailed and
up-to-date briefings on important topics; for the academics, postgraduates,
business communities, manager with western and an Islamic background
the series will provide a guide to best practice in business in Islamic com-
munities around the world, including Muslim minorities in the west and
majorities in the rest of the world.

Islamic Social Finance

Entrepreneurship, Cooperation and the Sharing Economy
Edited by Valentino Cattelan

Rethinking Islamic Finance

Markets, Regulations and Islamic Law
Ayesha Bhatti and Saad Azmat

Social Justice and Islamic Economics

Theory, Issues and Practice
Edited by Toseef Azid and Lutfi Sunar

The Growth of Islamic Finance and Banking

Innovation, Governance and Risk Mitigation
Edited by Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti

For more information about this series, please visit www.routledge.com/

Islamic-Business-and-Finance-Series/book-series/ISLAMICFINANCE
The Growth of Islamic Finance
and Banking
Innovation, Governance and Risk
Mitigation

Edited by
Hussain Mohi-ud-Din Qadri and
M. Ishaq Bhatti
First published 2020
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
52 Vanderbilt Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa
business
© 2020 selection and editorial matter, Hussain Mohi-ud-Din Qadri
and M. Ishaq Bhatti; individual chapters, the contributors
The right of Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti to be
identified as the authors of the editorial material, and of the authors
for their individual chapters, has been asserted in accordance with
sections 77 and 78 of the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or
reproduced or utilised in any form or by any electronic, mechanical,
or other means, now known or hereafter invented, including
photocopying and recording, or in any information storage or
retrieval system, without permission in writing from the publishers.
Trademark notice: Product or corporate names may be trademarks
or registered trademarks, and are used only for identification and
explanation without intent to infringe.
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British
Library
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A catalog record has been requested for this book

ISBN: 978-0-367-20588-1 (hbk)

ISBN: 978-0-429-26243-2 (ebk)
Typeset in Times New Roman
by codeMantra
Contents

List of figures ix
List of tables xi
List of contributors xv
Preface xix
Acknowledgements xxi

The growth of the Islamic finance and banking industry:

an introductory note 1
H US SA I N MOH I - U D - DI N QA DR I A N D M. I SH AQ BH AT T I

1 Standardization in the Islamic banking & financial system:

the methodology of inclusion (Taqlid al-Madh’hab) 6
SH AY K H - U L - I SL A M M U H A M M A D TA H I R- U L - QA DR I

2 Recent development in Islamic finance and financial products 32

M. I SH AQ BH AT T I , NA SE E M A L R A H A H L E H A N D H US SA I N
MOH I - U D - DI N QA DR I

3 On the role of ownership and governance structure

in raising capital: a sukuk example 50
MOH SI N K H AWA JA , M. I SH AQ BH AT T I A N D DA R R E N H E N RY

4 Takāful (Islamic insurance) on the blockchain 77

H A Z I K MOH A M E D

5 IT-based Finance Hub: a new horizon towards transparent

Zakat distribution model 87
U M A R DR A Z , TA R IQ A L I , SA NA YA SI N , A H M A D SH A F A N D
R A I H A TA L L AT
vi Contents
6 The way towards standardizing Islamic economic, financial,
and banking fatawa 101
M A S U DU L A L A M C HOU DH U RY

7 The fallacy of conventional benchmarks in Islamic banking and

finance: defining, defending and discussing with evidence
from archival data 109
I M A M U DDI N M U H A M M A D SH UJAT SA L E E M A N D
A BDU R R A H M A N A L E E M I

8 Influence of leverage on ownership structure-performance

relationship: a panel data approach of Islamic and conventional
banks of Pakistan 121
U M M A R A FAT I M A A N D SU N DA S S OH A I L

9 Dynamic correlation and volatility linkage between

stocks and sukuk 136
M A S OU M E H SH A H SAVA R I

10 Provision of riba by religious faith: A comparative analysis 152

M USF E R A H M E H FO OZ

11 Layers of misconceptions about IB: are Islamic banks threats,

challenges and opportunities for investors 167
M A L I K SH A H Z A D SH A BBI R A N D AWA I S U R R E H M A N

12 Overview of progress in Islamic commercial and social finance

in Pakistan 187
SA L M A N A H M E D SH A I K H , MOH D A DI B I SM A I L ,
A BDU L GH A FA R I SM A I L , SH A H I DA SH A H I M I A N D
M U H A M M A D H A K I M I MOH D. SH A F I A I

13 Translation of economic verses by Shaykh-ul-Islam

Muhammad Tahir-ul-Qadri in the light of translation studies:
comparison with other translators 206
SH A I R A L I K H A N

14 Drawing inferences from Ali ibn Abi Talib’s Teachings on

social and collective responsibility for a fair and just economy 219
NA JA M A BBA S

15 Pricing anomaly: tale of two similar credit-rated bonds with

different yields 233
MOH A M E D A R I F F, A L I R E Z A Z A R E I A N D M. I SH AQ BH AT T I
 Contents vii
16 Resolving Islamic finance disputes through arbitration in the
Middle East 254
M A R I A BH AT T I

17 Formation of tangible capital from intangible capital and

venture philanthropy: an innovation in Islamic finance 262
T O SE E F A Z I D, O SA M A H A L R AWA SH DE H , A N D M U H A M M A D
OM E R C H AU DH RY

18 Theoretical, practical vis-à-vis legal development in Islamic

banking: a case of Pakistan 281
H US SA I N MOH I - U D - DI N QA DR I

19 Islamic safety nets for the poor: Pakistan’s experience 314

NA SI M SH A H SH I R A Z I

Concluding remarks on the growth of the IBF industry 331

H US SA I N MOH I - U D - DI N QA DR I A N D M. I SH AQ BH AT T I

Index 333
List of figures

2.1 Classification of risks in IBFs 44

3.1 A visual display of the trade-off between the desire of
ownership control and risk aversion, namely equity, bonds,
loans, and sukuk. Equity is the least risky security for an
issuer but dilutes ownership control while loans are the
most risky but do not lead to ownership dilution 51
3.2 The histogram shows on the x-axis the number of issues
made by the sample firms and on the y-axis the frequency
density of the number of firms that issued a security in any
quarter during 2000–2015. The highest density is for zero
issues implying that the majority of firms did not raise
capital during the sample period. The number of firms that
made a single issue during the sample period is second to
highest after non-issuers 61
5.1 IT-based Finance Hub 88
5.2 Flowchart of finance hub 90
5.3 Proof of correctness through VDM-SL tool box 98
6.1 Methodological independence between tawhid as law and
‘Shari’ah-compliance’ 106
8.1 The conceptual frame of the relationship between leverage,
ownership structure and performance 125
9.1 Time series of stock index in 2015/03–2017/03 144
9.2 Time series of sukuk index in 2015/03–2017/03 145
9.3 Return on the total stock index of 50 active companies of
Tehran Stock Exchange in 2015/03–2017/03 145
9.4 Return on the price index of sukuk listed in Iran Fara
Bourse in 2015/03–2017/03 145
9.5 Dynamic correlation between stocks and sukuk 147
12.1 KSE-100 index daily values (adjusted closing) for 1998–2018 189
12.2 KSE-100 and KMI-30 index for 2009–2018 190
12.3 Zakāt receipts (in million Rs.) 198
13.1 Translational strategies and translated words for
90 Quranic words 216
x List of figures
15.1 Zero risk common bond vs. sukuk bond yields 242
15.2 AAA common bond vs. AAA sukuk bond yields for
identical issuers 243
16.1 Global Islamic banking assets top 10 countries (2014) 255
16.2 Asset growth comparison: Islamic banks versus
conventional banks 2008–2014 256
18.1 Market share of assets, deposits and financing and
investment of Islamic banking sector (%) 288
18.2 Total assets, deposits and financing and investments of
Islamic banking sector (PKR Billion) 288
18.3 Financing mix (% share) 289
18.4 Financing mix (% share) 289
18.5 Financing mix (% share) 290
18.6 Financing mix (% share) 290
18.7 Islamic banking branch network in Pakistan (June, 2017) 293
18.8 Islamic banking branches of conventional banks (June, 2017) 293
18.9 Subbranches of IBI’s in Pakistan (June, 2017) 294
18.10 Year-wise domestic sukuk summary 301
18.11 Entity-wise and year-wise breakup of sukuk (cumulative as
of end year in per cent) 301
18.12 International sukuk issued by the government of Pakistan 301
18.13 Sukuk issuance trend 302
18.14 S ̣ukuk issuances by jurisdiction and share (2017) 302
18.15 Sovereign sukuk issuance by jurisdiction (2017) 303
18.16 Corporate sukuk issuance trend 304
18.17 Corporate sukuk issuance by jurisdiction (2017) 304
18.18 Growth in assets under management and number of
Islamic funds 305
18.19 Islamic fund assets by domicile (2017) 306
18.20 Islamic fund assets by geographical focus (2017) 307
19.1 GINI index 319
List of tables

2.1 Islamic Banking at an Historical Glance 35

2.2 Modern History Islamic Banking and Finance from 1962 to 2016 36
3.1 Descriptive Statistics of Control, Ownership, Governance,
and Information Asymmetry Variables. The Quarterly
Data Ranges from Year 2000 to 2015 for Our Sample
Firms from Countries of Dual Issuers of Bonds and
Sukuk. These Countries are Malaysia, Indonesia,
Singapore, and Pakistan. Definitions of the Variables are
Given in Appendix A 62
3.2 Descriptive Statistics of Firms Segregated by Their
Issuance Trend. Issuers of More than One Security during
a Quarter Are Placed in the High Risk Issuer Category.
The Quarterly Data Ranges from Year 2000 to 2015 for
Our Sample Countries: Malaysia, Indonesia, Singapore,
and Pakistan with Issuers of Equity, Bonds, Sukuk and
Loans. The Definitions of Variables are Given in Appendix A 64
3.3 Matrix of Correlation Coefficients 66
3.4 HOP Model. Equations (1) and (4) Describe How the
Variables in Column 1 Determine the Firm’s Decision
to Raise Capital in Column 2, and Choice of Security
in Column 3. The Dependent Variable CHOICE is an
Ordered Variable Ranging from 1 to 4 to Indicate the
Level of Risk-Sharing Based on the Chosen Security.
Quarterly Data Ranges from 2000 to 2015. Standard
Errors in Parentheses Where *** p<0.01, ** p<0.05, * p<0.1 67
5.1 High-Level Pseudocode of the System 91
5.2 Algorithm of ITB-FH 92
5.3 Analysis of State, Functions, and Operations 97
8.1 Measurement of the Study Variables 126
8.2 Summary of Descriptive Measures of Conventional Banks 127
8.3 Summary of Descriptive Measures of Islamic Banks 127
8.4 Correlation Matrix of Conventional Banks 128
xii List of tables
8.5 Correlation Matrix of Islamic Banks 128
8.6 Panel Regression Results (Conventional and Islamic Banks) 129
8.7 Moderating Effect of Leverage on Ownership Structure-
Performance (ROE) Relationship of Conventional Banks 129
8.8 Moderating Effect of Leverage on Ownership Structure-
Performance (EPS) Relationship of Conventional Banks 130
8.9 Moderating Effect of Leverage on Ownership Structure
and Performance (ROE) of Islamic Banks 131
8.10 Moderating Effect of Leverage on Ownership Structure
and Performance (EPS) of Islamic Banks 132
9.1 Statistics of the Stock Index and the Sukuk Index 146
9.2 Non-conditional Correlation of Stock Returns and Sukuk
Index Return 146
9.3 Results of Univariate Models 146
9.4 Results of the Multivariate Model 147
11.1 Mean Values 176
11.2 Group Mean Variables 177
11.3 ANOVA 179
11.4 Multiple Comparisons LSD 180
11.5 ANOVA 181
11.6 Multiple Comparisons LSD 182
12.1 Screening Criteria of Global Indices 193
12.2 Assets under Management in Islamic Funds (in million Rs.) 193
12.3 Market Share in Mutual Funds Industry – 2017 194
12.4 Stylized Facts about Microfinance in Pakistan 195
12.5 Microfinance Outreach – Province wise 196
12.6 Distinctive Features of Islamic Philanthropy 199
12.7 Comparison of Regulatory Framework in Regional Countries 201
15.1 Test Hypotheses Developed for Testing Differences in
Deposits and Zero-Risk Yields 240
15.2 Descriptive Statistics of the Series Used in the Tests 241
15.3 Mean and Median Difference Test Statistics on Islamic
and Conventional Yields 243
15.4 Result from Cointegration Test (Treasuries) 245
15.5 Results from Causality Test (Treasuries) 246
15.6 Result from Cointegration Test (Corporate Securities) 247
15.7 Results from Cointegration and Causality Test (Corporate
Securities) 248
15.8 Correlation of the Common Bond and Sukuk Bond yields 250
17.1 Formation of Intangible Capital from Tangible Capital in
Moral Economy 269
17.2 Traditional Vs. Venture Philanthropy 271
17.3 Types of Venture Philanthropist 274
17.4 Venture Philanthropy in Context 275
18.1 Industry Progress and Market Share (June 30, 2017) 295
 List of tables xiii
18.2 Branch Network of Islamic Banking Industry (June 30, 2017) 295
18.3 Financing Mix (% Share) 295
18.4 Financing Concentration (% Share) 296
18.5 Breakup of Deposits 296
18.6 Capital Ratios (%) 296
18.7 Profitability and Earning 297
19.1 Pakistan: Trends in Poverty (Head-count Ratios) 316
19.2 Estimated Headcount (%) by HIES year 318
19.3 Zakat Utilized and Number of Beneficiaries 323
19.4 Disbursement of Zakat 324
List of contributors

Dr Najam Abbas
East West Institute, Brussels, Belgium
[email protected]
Dr Tariq Ali
CS. Department (CUI) Sahiwal, Pakistan
[email protected]
Professor Dr Mohamed Ariff
Sunway Business School, Sunway University Selangor, Malaysia
[email protected]
Professor Dr Toseef Azid
Department of Finance and Economics, College of Business and Economics,
Qassim University Qassim, Saudi Arabia
[email protected]
Associate Professor M. Ishaq Bhatti
La Trobe University, Melbourne, Australia
[email protected]
Associate Professor Darren Henry
La Trobe University, Melbourne, Australia
[email protected]
Dr Maria Bhatti
Western Sydney University, Penrith, Australia
[email protected]
Associate Professor Dr Muhammad Omer Chaudhry
Department of Economics, Bahauddin Zakariya University, Multan, Pakistan
[email protected]
Professor Dr Masudul Alam Choudhury
Faculty of Economics, Trisakti University, Jakarta, Indonesia
[email protected]
Umar Draz
CS. Department (CUI) Sahiwal, Pakistan
[email protected]
xvi List of contributors
Ummara Fatima
School of Commerce & Accounting, Minhaj University, Lahore, Pakistan
[email protected]
Professor Dr Abdul Ghafar Ismail
School of Commerce and Accountancy of Malaysia, Selangor, Malaysia
[email protected]
Dr Mohd Adib Ismail
School of Economics, National University of Malaysia, Selangor, Malaysia
[email protected]
Dr Shair Ali Khan
International Islamic University Islamabad, Pakistan
[email protected]
Mohsin Khawaja
La Trobe Business School, Latrobe University, Bundoora, Australia
[email protected]
Professor Dr Musferah Mehfooz
Humanities, COMSATS, Lahore, Pakistan
[email protected]
Dr Hazik Mohamed
Stellar Consulting Group, Singapore
[email protected]
Dr Hussain Mohi-ud-Din Qadri
School of Economics and Finance, Minhaj University, Lahore, Pakistan
[email protected]
Dr Naseem Al Rahahleh
King Abdulaziz University, Jeddah, Saudi Arabia
[email protected]
Associate Professor Dr Osamah Al Rawashdeh
College of Business and Economics, Qassim University, Saudi Arabia
[email protected]
Awais ur Rehman
University of Brunei Darussalm, Bandar Seri Begawan, Brunei
[email protected]
Muhammad Shujat Saleem
Institute of Business Management, Karachi, Pakistan
[email protected]
Malik Shahzad Shabbir
University of Brunei Darussalm, Bandar Seri Begawan, Brunei
[email protected]
 List of contributors xvii
Ahmad Shaf
CS. Department (CUI) Sahiwal, Pakistan
[email protected]
Dr Muhammad Hakimi Mohd. Shafiai
School of Economics, National University of Malaysia, Selangor, Malaysia
[email protected]
Dr Shahida Shahimi
School of Economics, National University of Malaysia, Selangor, Malaysia
[email protected]
Dr Masoumeh Shahsavari
Iran Fara Bourse, Iran
[email protected]
Dr Salman Ahmed Shaikh
School of Economics, National University of Malaysia, Selangor, Malaysia
[email protected]
Professor Nasim Shah Shirazi
College of Islamic Studies - Hamad Bin Khalifa University, Doha, Qatar
[email protected]
Sundas Sohail
School of Commerce & Accounting, Minhaj University, Lahore, Pakistan
[email protected]

Professor Dr Muhammad Tahir-ul-Qadri

Chairman, MQI and the Board of Governor, Minhaj University Lahore,
Pakistan
[email protected]
Raiha Tallat
CS. Department (CUI) Sahiwal, Pakistan
[email protected]
xviii List of contributors
Dr Imam Uddin
Institute of Business Management, Karachi, Pakistan
[email protected]
Sana Yasin
CS. Department (CUI) Sahiwal, Pakistan
[email protected]
Dr Alireza Zarei
Sunway Business School, Sunway University Selangor, Malaysia
[email protected]
Preface
Rodney Wilson
EMERITUS PROFESSOR, DURHAM UNIVERSITY, UNITED KINGDOM

This edited volume represents a valuable contribution to the growing litera-

ture on Islamic banking and finance. It covers a wide range of topics which
have been debated and written about already, but the studies included here
take the discussions further and provide fresh insights. The work is inter-
disciplinary, as it covers legal, financial and developmental issues. Notable
contributions include the debates over the standardisation of Islamic finan-
cial contracts and the evolution of fatawa rulings by Islamic scholars. There
is a fascinating contribution which critiques the different approaches to the
translation of the verses dealing with economic matters in the Quran. An-
other chapter provides a history of opinions concerning riba in an inter-faith
context.
Although many of the studies are focused on Islamic banking there is
also coverage of sukuk securities, takaful Islamic insurance and zakat. One
of the chapters on sukuk examines the significance of ownership and gov-
ernance structure when raising funds. The second chapter on sukuk uses
Iranian data to examine the relationship between stock and sukuk prices.
A third chapter on sukuk pricing uses Malaysian data, as Kuala Lumpur
has become the leading international centre for sukuk issuance and trading.
The chapter on takaful is particularly innovative as the author examines the
benefits of using a block-chain approach, which has been applied to conven-
tional financial products, but not hitherto to Islamic insurance.
In another highly innovative chapter, the researcher considers the merits
of applying Information Technology to zakat collection and administration.
This could facilitate the devolution of collection and local accountability,
increasing the confidence of zakat payers through increased transparency.
The development of a common platform for financial reporting purposes
could enable meaningful comparisons to be made between regions, high-
lighting success and best practices. Similar issues arise in the case of Islamic
philanthropy, which is the subject of a separate chapter on the relationships
between the public, private and voluntary sectors. The authors support the
case for tax relief for charitable giving, although unfortunately in many
Muslim countries tax collection remains inefficient.
xx Preface
As the book contains the papers presented at an Islamic banking and
finance conference in Lahore, it is appropriate that the experience of
Pakistan is covered in depth, with lessons for other countries. Pakistan’s
large population and favourable demographic trends make it one of the
leading markets in the world for Islamic banking and finance. The two
chapters on the country’s experience are complementary, with one focus-
ing on social finance and the other on Shari’ah compliance in financing in
Pakistan.
Overall the work expands the boundaries of research in Islamic banking
and finance. The conference organisers and editors are to be congratulated
in bringing such an excellent group of researchers together, many of whom
are young scholars at the start of promising academic careers.
Acknowledgements

We are grateful to all the referees who helped with the reviewing process in
both conference papers and chapters of the book. Our special thanks are due
to Rodney Wilson, Nasim Shirazi, Maria Bhatti and Toseef Azid, who sup-
ported us to finalise this book in a timely manner. We are also thankful to
all the authors for their great contribution in the cross-reviewing process of
all chapters. We appreciate the publisher team, especially Kristina Abbotts
and Christiana Mandizha, for all their helpful assistance. We acknowledge
the partial financial support from Minhaj University and La Trobe Business
School. Our thanks are due to Umair Abbas, Khurram Shahzad (Minhaj
University) and Quoc Cuong Phan (La Trobe Business School) in their as-
sistantship in this project. However, we take all responsibilities of any po-
tential errors.

Thanks and kind regards,

Dr Hussain Mohi-ud-Din Qadri1 and Dr M. Ishaq Bhatti2

1
Minhaj University, Lahore, Pakistan
Email: [email protected]
2
La Trobe Business School, Melbourne, Australia.
E-mail: [email protected]
December, 2019.
The growth of the Islamic finance
and banking industry
An introductory note
Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti

This edited volume comprises of the best papers chosen from those pre-
sented at the First World Islamic Economics and Finance Conference
(WIEFC 2018), held on 3 and 4 January, 2018. The conference was organized
by the Minhaj University Lahore (MUL) in collaboration with the Islamic
Development Bank’s Jeddah-based Research Institute (IRTI) and La Trobe
University, Melbourne, Australia. The theme of the conference was devel-
oping Muslim economies through Islamic finance. This edited volume con-
tains 19 chapters based on selected articles, each reviewed by two referees
and the editorial committee. The volume begins with a preface by Rodney
Wilson, an Emeritus Professor at Durham University, and an introductory
note by the editors, H. M. Qadri and M. I. Bhatti, summarizing the con-
tents. The book covers the following important topics;

– Standardization of Islamic banking and finance (IBF) products under

inclusion (Taqlid al-Madh’hab)
– Islamic bonds (sukuk)
– Islamic insurance (takāful)
– An information technology-based zakat distribution model
– Fatawa on the IBF industry
– The Islamic Interbank Offer Rate (IBOR)
– The pricing volatility of Islamic stocks and sukuk
– Provision on interest (riba)
– Misconceptions concerning IBF
– Islamic commercial and social finance
– Tale of two similar credit-rated bonds (sukuk)
– Islamic finance disputes and arbitration

The book begins with Chapter 1 by Shaykh-ul-Islam Professor Dr Muhammad

Tahir-ul-Qadri, Chairman of MQI, BOG and MUL. He argues the case for the
standardization of the IBF products across various schools of Islamic thought.
Tahir-ul-Qadri proposes the adoption of a uniform model of IBF products
using Taqlid al-Madh’hab – an inclusive research methodology which is ac-
ceptable to the adherents of the major schools of Islamic economic thought.
2 Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti
In Chapter 2 M. Ishaq Bhatti, Naseem Al Rahahleh and Hussain
Mohi-ud-Din Qadri discuss recent developments in Islamic finance and the
financial products currently offered. The authors briefly review the historical
development of IBF products from the early days of Islam to the 21st century.
They address the issue of risk management in the IBF industry. The ability
of IBF institutions to safeguard the global finance industry during periods
of financial crises is also explored, particularly how the performance of IBF
institutions is anti-cyclical, providing a hedge for international finance.
Chapter 3 deals with the issuance of Islamic bonds (sukuk), focusing on
the role of ownership and governance structure in raising capital. A sukuk
case study undertaken by Mohsin Khawaja and M. Ishaq Bhatti addresses
the issue of whether the ownership and the governance structure of firms
influence the decision to raise funds. They also address the question of how
to select financial instruments to ensure Shari’ah compliance.
In Chapter 4, Hafiz Mohamed of the Stellar Consulting Group of Singa-
pore addresses the topic of Islamic insurance – takāful, using an innovative
block-chain approach. The takāful Islamic insurance industry is evolving
processes to safeguard the assets of its clients from losses and reduce un-
certainty. It may be described as a social device to reduce or even eliminate
the risks of loss to life and property. In this chapter, the author provides
a strategic discourse on how the adoption of a block-chain methodology
can provide additional value to the insurance and takāful industries. Hafiz
Mohamed demonstrates his detailed understanding of the industry by iden-
tifying the issues which need urgent attention, in order to achieve the pro-
jected cost savings through careful risk management.
In Chapter 5 the merits of the application of information technology to
zakat collection are discussed. The five co-authors, Umar Draz, Tariq Ali,
Sana Yasin, Ahmad Shaf and Raiha Tallat, propose the establishment of an
information technology-based finance hub at a local Union Consul (UC)
level rather than the collection of zakat being centralized at national level,
as is currently the policy in Pakistan and several other countries. The au-
thors believe a UC level hub collection could improve the current zakat col-
lection and distribution system, which would result in greater confidence
among zakat donors by ensuring local accountability.
In Chapter 6, Professor Masudul Alam Choudhury proposes a method
for standardizing Islamic economic, financial and banking practices
through the adoption of consensual, comprehensive fatawa. The author
critically examines current practices of ensuring Shari’ah compliance, in
particular the increasing diversity of fatawa concerning matters of mua-
malat, finance, banking and the real economy. To overcome the inevitable
confusion Masudul Alam Choudhury proposes a unified system for the is-
suance of fatawa.
Chapter 7 contains an examination of the fallacy of using conventional
benchmarks in IBF. Imam Uddin and M. Shujat Saleem use archival data to
demonstrate why it is inappropriate to use conventional indices, especially
 Growth of Islamic finance & banking industry 3
as Shari’ah compliant indices have been developed in recent years, which
are already widely used. Researchers and professional financial analysts
who use Shari’ah compliant indices have found them to be useful bench-
marks when measuring the performance of Islamic securities. The two au-
thors of the chapter advocate the use of the IBOR instead of conventional
benchmarks, as this minimizes misconceptions and misunderstandings
among end users.
Chapter 8 is an empirical study authored by Ummara Fatima of MUL. The
focus of the study is on the influence of leverage on the ownership structure-
performance relationship. Through the use of panel data, it provides in-
teresting insights into the ownership structure-performance relationship
of Islamic and conventional banks on parallel lines. The findings provide
a better understanding of the management challenges facing both Islamic
and conventional banks. Ummara Fatima explores how both Islamic and
conventional banks can improve their systems of ownership structure to im-
prove their financial performance.
In Chapter 9 Masoumeh Shahsavari from Iran’s Fara Bourse considers
the dynamic correlation and volatility linkages between stocks and sukuk.
He explores the issue of how volatility influences investment behavior and
the statistical co-variance between returns on sukuk and Iran’s Islamic stock
indexes. The author explains the main reasons for the importance of insti-
tutional investors and asset managers. Especially crucial are their timing
and expertise in selecting securities in order to maintain a diversified sukuk
portfolio, a challenge which demands specialist skills.
In Chapter 10 the acceptability or rejection of riba in various religious
faiths is examined. A key disputed issue is whether riba, an addition to a
principal sum, equates with interest or usury or both. Excessive interest
payments on debt are often argued as being exploitative, with excessive
power in the hands of the lending institutions, which may offer unfair con-
tracts given their monopolistic or oligopolistic positions in the absence of
meaningful competition. The critique in this chapter adopts a comparative
analysis starting from ancient scriptures regarding riba and examining how
attitudes have evolved over the centuries until the present day. In some re-
spects the treatment is evidence based, with the examination of riba based
on its social impact as a matter of historical fact.
In Chapter 11 Malik Shahzad Shabbir and Awais ur Rehman of the Uni-
versity of Brunei Darussalam examine the misconceptions surrounding
IBF. The authors focus on the threats, challenges and opportunities which
confront Islamic banks and the implications for portfolio management by
investors. The misconceptions about Islamic banking by depositors, cli-
ents who have obtained finance and potential, but skeptical, customers are
addressed.
Pakistan is one of the most important markets for IBF, and the confer-
ence upon which this book is based was held in Lahore. Hence, the volume
would not have been complete without a country study of IBF in Pakistan.
4 Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti
In Chapter 12 Salman Ahmed Shaikh of Greenwich University undertakes
a review of Islamic commercial and social finance in Pakistan. There is an
objective evaluation of the growth of the IBF industry in Pakistan focusing
on its achievements and ongoing challenges. The chapter covers the finan-
cial performance of Shari’ah compliant equities and sukuk. In addition, the
author also provides a brief account of the Islamic asset management sector
and the footprint of the Islamic microfinance sector in Pakistan.
In Chapter 13 Shair Ali Khan of the International Islamic University of
Islamabad provides a translation of the verses in the Quran dealing with
economic issues. The author draws on earlier translations, notably that by
Shaykh-al-Islam Professor Dr Tahir-ul-Qadri. The main aim of the chap-
ter is to elaborate on the translational strategies used by Tahir-ul-Qadri in
comparison with the translations of three other renowned translators of the
Quran: Mohammad Asad, Pickthal and Abdullah Yousaf Ali. Shair Ali
Khan also analyses the structural level of both the source language and
target language. He also examines the level equivalence in terms of termi-
nologies, specifically those of an economic nature.
In Chapter 14, Najam Abbas of the East West Research Centre in London
highlights the contribution of IBF to socio-economic development, a largely
neglected topic in the field. The focus is on the teaching of Ali ibn Talib on
socio-economic development, notably his advocacy of collective responsi-
bility toward the destitute in a multi-ethical society, and how the destitute
can be employed in modern economies.
The findings from an empirical study of sukuk pricing by M. Ariff, A.
Zarei and M. I. Bhatti are presented in Chapter 15. The investigation is of
two similar credit-rated sukuk and conventional bonds with different yields.
The theory of sukuk and conventional bond pricing is the same for both
types of security as yields are determined by market expectations and rat-
ings by independent agencies, the latter reflecting risk perceptions. The
empirical data is drawn from Malaysia where both the government and cor-
porations raise funds by issuing sukuk. The sukuk market in Malaysia is the
most developed in the world in terms of both issuance and trading. Never-
theless, the lessons from this study have relevance for other countries, even
though their markets are less active.
In Chapter 16 Maria Bhatti addresses the issue of resolving IBF disputes
through arbitration with special references to the Middle East. This region
has experienced rapid growth in IBF while becoming a significant player in
international commercial and financial markets. A crucial issue is whether
disputes involving Islamic financial institutions can be dealt with by na-
tional secular courts or arbitration bodies. As Islamic financial contracts
are subject to Shari’ah law, it can be argued that disputes would be best
dealt with by Shari’ah courts, where scholars specialized in fiqh can adjudi-
cate. Maria Bhatti finds that Islamic traditions influence arbitration in the
Middle East, and therefore Islamic jurisprudence plays a crucial role when
 Growth of Islamic finance & banking industry 5
trying to understand and analyze the function of international commercial
arbitration in resolving IBF disputes. Nevertheless, she argues that it is vital
for countries in the Islamic Middle East to consistently recognize and en-
force arbitral awards under the New York Convention, and ensure Shari’ah
laws are in harmony to avoid legal conflict and uncertainty.
In Chapter 17 Toseef Azid, Osamah Al Rawashdeh and Muhammad
Omer examine the formation of tangible and intangible capital through
venture philanthropy from an Islamic finance perspective. The authors ar-
gue that philanthropy can be significant in strengthening social solidar-
ity and community bonds. There is a two-way causality of happiness and
satisfaction between givers and receivers. Moreover, there is a gap in the
provision of goods and services which cannot be filled by either the pub-
lic or private sectors. This gap can instead be filled through philanthropy
involving the voluntary sector. In the western society, this sector is well
organized, as governments provide tax deductions which encourage char-
itable donations, whereas in Islamic societies the voluntary sector is often
unorganized. The chapter concludes by suggesting that Islamic financial
intuitions can play a significant role in strengthening the relationship in
between the market and philanthropy with a resultant positive impact on
social well-being. An active voluntary sector comprising of Islamic char-
ities can facilitate economic inclusion and help ensure the poor become
stakeholders in wider society.
Hussain Qadri, the author of Chapter 18, discusses the development of the
IBF industry in Pakistan from an ideological, practical and legal perspective.
He reviews the workings of various socio-economic systems, notably those
based on capitalism and socialism, and then presents an alternative Islamic
economic system based on Shari’ah compliant finance. Hussain Qadri fo-
cuses on Pakistan as a case study that demonstrates the shortcomings of
capitalism and socialism, both of which are incompatible with religious val-
ues as is apparent from discourses by academics, students, religious scholars
and government agencies. In contrast, the adoption of Shari’ah compliant
finance as a way forward for economic development appears to have wide-
spread support.
In the last chapter, Chapter 19, Shirazi analyses poverty in the context of
Pakistan. Although the government introduced multiple measures to tackle
this challenge in the last six decades, there was no sign of this problem being
significantly slowed down. This article overviews the incidence of poverty,
social safety nets including Islamic social finance programs of the country
and discusses why these programs did not bring results as expected. From
his analysis, Shirazi also highlights some recommendations to efficiently
mitigate poverty in Pakistan.
Concluding remarks are provided by the editors in the Conclusion, which
evaluates the contribution of this volume to wider literature on Islamic eco-
nomics and finance.
1 Standardization in the Islamic
banking & financial system
The methodology of inclusion
(Taqlid al-Madh’hab)
Shaykh-ul-Islam Muhammad Tahir-ul-Qadri

1.1 Introduction
Islamic banking and finance (IBF) industry is making enormous contribu-
tion in terms of its products development, delivery and services around the
globe. It is estimated that Shari’ah compliant assets are reached to more
than US$2.431 trillion with a double digital over the world. Its growth is
much above global average when it comes to Islamic countries; for example
Pakistan is considered to be one of the fastest growing IBF industries in the
world followed by Saudi Arabia, Iran and Malaysia. Main objective of this
chapter is to contribute towards standardization of the IBF; hence, build-
ing bridges among various schools of thoughts to suggest a uniform model
based on the Taqlid al-Madh’hab philosophy of Islamic Shari’ah. This new
research methodology is to avoid exclusion of various schools of thoughts
within Muslim majority or Muslim minority’s countries. It presents histori-
cal context of the problem, Qur’anic Injunctions on the Principle of Facilita-
tion (al-Tashil) and Flexibility (al-Tawassu‘). This chapter also explains about
the principle of distinction and option of choice between different juristic
verdicts, including al-Hanafi, al-Maliki, al-Shafi‘i and al-Hanbali’s. This
chapter also highlights on three main jurist’s intra-school position based on
the guiding principles for the methodology of inclusion and flexibility:

i Ashab al-Takhrij (Jurists: Who are competent to conduct inference)

ii Ashab al-Tarjih (Jurists: Who are competent to conduct preference)
iii Ashab al-Tamyiz (Jurists: Who are competent to conduct distinction)

This chapter also reviews some of the work of the earlier jurists and their
laws of making Ijtihad based on some juristic principles, agreed upon and
practiced by all great scholars of the earlier day’s pre-formation of various
schools of law. One of these principles relates to interactions. According to
this principle, wherever flexibility and facilitation is necessarily required,
anyone of the four schools or anyone of the Shari’ah evidences will be
adopted on the basis of compatibility between the spirit of Islamic teachings
and the need and demands of the time.
 Methodology of inclusion 7
The rest of the chapter is organized as follows. In the subsequent sections
research problem is presented followed by historical context of the prob-
lem and its suggested solution in light of the two main sources of Shari’ah.
In Section 5, research methodology of juristic inclusion is discussed, while
Section 6 concentrates on the principle of distinction and option of choice
between different juristic verdicts. The issue of juristic strategy for resolv-
ing contemporary issues through the principle of inclusion and expansion is
presented in Section 7. Section 8 contains guiding principles for the meth-
odology of inclusion, fairness and flexibility, whereas Section 9 presents cat-
egories of conformist jurists and their ways of framing the opinions on the
application of intra-school position based on four main school of thoughts.
The final section contains some concluding remarks.

1.2 Research problem

One of the major challenges the IBF industry is facing is the lack of har-
monized rules and regulations, and the non-uniformity in Islamic banking
products and services being offered in various parts of the world. For ex-
ample, different standards are applied for financial reporting, accounting,
disclosure and transparency,1 different countries follow different standards,
i.e., the Gulf Cooperation Council (GCC) and Malaysia.2 Moreover, the
lack of standardization of Islamic principles3 in a Muslim majority coun-
try is different from Muslim minority countries. In literature, a number of
studies are conducted to discuss the advantages of unified standardization
of IBF product, e.g. reducing the time and cost, increasing the efficiency and
decreasing the confusion among the stakeholders.4
Some researchers have pointed out this issue without due regard being
given to the solution. Some indicated the validity or invalidity of certain
products offered by the Islamic banks across the world which is due to di-
vergence of opinion among Muslim jurists on the basis of the schools of
fiqh (Hanafi, Maliki, Shafi‘i and Hanbali) they follow. Regional differences
in interpretation and derivation of rulings, in accordance with the popular
school of law of that region, stand as the main reason for not having a stand-
ardized, harmonized, uniform and universal Islamic banking system across
the world. For example, as mentioned by Smolo and Habibovic (2012), “The
practice of BBA in Malaysia is allowed by the Shafi’i school. On the other
hand, this practice in not allowed in the Middle East because of bay’ al-’inah
structure embedded in BBA” (p. 18).
The resultant multiple interpretations by various schools of law and dif-
ferent jurists belonging to different madhahib al-fiqh regarding Islamic fi-
nancial products result in minor and major disparities and became hurdle in
launching the different products.5 In view of this fact, it is logical that, with-
out a universally unified and uniform Shari’ah Code, the acceptability of
products introduced in Islamic financial industry will remain fragmented.6
8 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
Prompt attention and action by Muslim scholars and Islamic finance ex-
perts is essential. A failure would damage the growth of the IBF industry in
the years ahead.
If global harmony and universal standardization of Islamic banking
products and services cannot be achieved within the Muslim world, how can
the Islamic economic and banking system be proposed as a viable alterna-
tive to the conventional economic and banking system to the world at large?
Considering the necessity and importance of the issue of standardization
of products, we have made this particular point the subject of our research.

1.3 Historical context of the problem

Countries differ in their approach to Shari’ah governance. For instance, Bah-
rain has both a Shari’ah governance committee at the institutional level and the
National Shari’ah Advisory Board at the national level, i.e., in the Central Bank
of Bahrain. However, its role is limited to advise the central bank on Shari’ah
matters. Malaysia and Indonesia have a higher Shari’ah authority at the na-
tional level to standardize fatwa and Shari’ah practices in IFIs (Islamic finan-
cial institutions). In the case of other GCC countries such as Kuwait, UAE and
Qatar, they have their own Shari’ah committees at the institutional level and
another independent body, i.e., the Ministry of Awqaf and Religious Affairs
or the Ministry of Justice and Islamic Affairs, which are given the authority to
oversee Shari’ah governance practices. The higher Shari’ah authorities in UAE,
Qatar and Kuwait only act when there are conflicts of opinion among Shari’ah
scholars regarding Shari’ah rulings. In the case of Saudi Arabia, it prefers leav-
ing the Shari’ah governance practices at the voluntary choice of IFIs and at the
influence of the market. They further state that the higher Shari’ah authority is
not effective in controlling the Shari’ah compliance for IFIs resulting in nega-
tive impacts on the stability of the Islamic finance industry.7
The different interpretations of Shari’ah rules amongst Shari’ah scholars
create confusion in the general public as well as in banking communities.
This difference of opinion applies not only to some of the products, but also
to some of the operations of the Islamic banks.
For example, there is no uniformity in opinion pertaining to the principle
of the trust financing contract (al-mudaraba) in business transactions. The
Maliki and Shafi‘i schools of jurisprudence are of the view that al-mudaraba
should be confined to trade and trade-related activities alone, and should
not include the activities of manufacturing. According to them, the con-
tract for manufacturing should be excluded from al-mudaraba, which is a
profit-loss sharing contract but formed under a specific long-term contract
whereby a party undertakes to manufacture, i.e., al-istisna‘. However, the
Hanafi school of law does not object to the application of al-mudaraba for
manufacturing activities, while the Hanbali school of law allows two sepa-
rate agreements using al-mudaraba and al-istisna‘ principles as long as the
two agreements do not impose conditions upon each other.8
 Methodology of inclusion 9
Such non-uniformity of opinion amongst the Islamic scholars from differ-
ent schools of law generates confusion amongst the bankers, the customers
as well as the public. Customers will not really understand what are the
‘dos and don’ts’ of the Islamic banking industry, and will make their own
personal interpretations. This situation is unhealthy for banker-customer
relations, as both parties may have different interpretations.9

1.4 Suggested solution

The reason behind this issue lies in strict conformity with one school of
law (Taqlid al-Madh’hab) in a particular region and with some other school
of law in another region. A third school of law may be strictly followed by
people of a third locality, while a fourth may be adhered to in yet another
community. This principle of Taqlid al-Madh’hab—strict conformity with
one school of law—seems to be the sole reason behind the whole confusion
in the matter of standardization. The solution to this problem lies in adopt-
ing a “neo-juristic approach of inclusive accommodation and flexibility.”
This approach is based on the Qur’anic principle of facilitation and juristic
principle of expansion. This approach will be known as conformity with all
schools of law (Taqlid al-Madh’hab).

1.4.1 Qur’anic injunctions on the principle of facilitation (al-Tashil)

and flexibility (al-Tawassu‘)
Islam as a religion was revealed to the Prophet (blessings and peace be upon
him) in order to facilitate human kind and remove burdens, difficulties and
hardships from their lives.

i The Qur’an states:

Allah desires ease for you and does not desire hardship for you.10
ii The entire religion of Islam is structured upon the provision of ease and
the removal of difficulty. Almighty Allah says:
He has chosen you, and has not laid upon you any hardship or constric-
tion in the matter of Din.11
iii He also said:
Allah does not want to make things hard for you.12
Since Allah knows the weakness of human beings, He has lightened
for them the legal responsibilities and lessened from them the obliga-
tions that they would not be able to fulfil.
iv Allah said:
Allah intends to lighten your burden. And man has been created weak
(and infirm).13
v He also said:
Allah has, at present, lightened the burden (of His commandment) on
you. He knows that there is (some degree of) weakness in you.14
10 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
1.4.2 Evidence from the Hadith
i Jabir (may Allah be well pleased with him) reported that Holy Prophet
(blessings and peace be upon him) said:
“Indeed, Allah did not send me to be harsh or cause harm; He sent me
to teach and make things easy.”15
ii ‘A’isha (may Allah be well pleased with her) said:
“Never was Allah’s Messenger (blessings and peace be upon him) pre-
sented with two options except that he would choose the easier of the
two, so long as it was not a sin.”16
Agreed upon.
iii According to Anas b. Malik (may Allah be well pleased with him), the
Prophet (blessings and peace be upon him) said:
“Make things easy and do not make things difficult. Give glad tidings
and do not make people feel averse.”17
Agreed upon.
iv Abu Hurayra (may Allah be well pleased with him) reports that Allah’s
Messenger (blessings and peace be upon him) said:
“You were sent to make things easy and not to make things difficult.”18
Agreed upon.
v Imam Ahmad b. Hanbal narrated in al-Musnad that the Holy Prophet
(blessings and peace be upon him) said:
“Verily, the best of your Din is the easier part. Verily, the best of your
Din is the easier part. Verily, the best of your Din is the easier part.”19

That’s why ‘Allama Ibn Qudama—a great jurist of al-Fiqh al-Hanbali—

writes in his book “Rawda al-Nazir fi Usul al-Fiqh”: “If a jurist is approached
for an edict and his edict remains devoid of openness and flexibility because
of his rigidity the edict-seeker should be guided towards some other jurist
who is open-minded and flexible.”20
Furthermore, ‘Allama Ibn Qudama reports that al-Husayn b. Bashshar
inquired from Imam Ahmad b. Hanbal about an issue. He said, “If he does
it, he will become a perjurer.” al-Husayn b. Bashshar said, “If someone is-
sues me the edict that he will not be a perjurer then (what will be the case)?
Imam Ahmad replied, “Do you know of the Medinans’ session (at Rasafa)?”
He asked, “If they issue the edict, would that be permissible?” Imam Ahmad
replied in affirmative.21
Here, Imam Ahmad himself is guiding the inquirer to go to Rasafa and
get the answer from the Medinan scholars because their opinion was based
on openness, inclusion, flexibility and facilitation. These juristic principles
are always closer to the basic spirit of Islamic teachings.

1.5 Research methodology of juristic inclusion

Someone may question where the idea of Taqlid al-Madh’hab—benefitting
from all schools of law instead of one particular school—has sprung from?
 Methodology of inclusion 11
1 Addressing this question, I would quote Imam Hasan b. ‘Ammar
al-Shurunbulali al-Hanafi, the author of Nur al-Idah and Maraqi
al-Falah. He has promulgated this concept of Taqlid al-Madh’hab in
his treatise— al-‘Iqd al-Farid li-Bayan al-Rajih mina’l-Khilaf fi Jawaz
al-Taqlid. He has quoted Imam Abu al-Mahasin al-Ruyani al-Shafi‘i
(415–502 ah), one of the great ancient jurists, who says:
Conforming to different schools of law or departing from one and
shifting towards others is permissible on three conditions.
Firstly, a person should not accumulate or assimilate them in a way
that contravenes the consensus of Umma (ijma‘).
Secondly, He should believe that Prophetic traditions on the subject
in question have reached the one he wants to conform with, which were
possibly not available to the madh’hab he is conforming with currently.
“Thirdly, he should not follow the objective of the licenses and free-
doms provided by different schools of law in order to avoid the com-
mandments of Shari’ah (i.e. adopting and following only all lenient
instructions and exemptions offered by every school and abandoning
the strict ones).”22
2 ‘Allama al-Shinqiti al-Maliki (1152–1233 ah) supports the same view-
point in his book Nashr al-Bunud ‘ala Maraqi al-Sa‘ud.23
3 A similar viewpoint has been promoted by Imam Abu al-‘Abbas
Ahmad b. Idris al-Qarafi al-Maliki (d. 684 ah) in his book Sharh Tanqih
al-Fusul ila Ikhtisar al-Mahsul fi’l-Usul. He states quoting Imam Yahya
al-Zanati:
Conformity with schools of law and shifting from one school to the
other in peripheral matters is permissible under three conditions:
First, one should not accumulate or assimilate two schools in a way
that contravenes the consensus of the Umma (ijma‘).
Second, he should believe that hadiths on the subject in question have
reached the one he wants to conform with.
“Third, he must not be looking for the licenses provided by different
schools of law. Indeed, all the schools of law are paths that lead to piety
and Paradise. The one who treads anyone of these paths, will certainly
reach the ultimate goal.
“Admonition: (Apart from al-Zanati) other Jurists have said, “Con-
formity with and turning towards schools of law is permissible in every
matter wherein the Lawgiver’s decree is not infringed. Remember that
the Lawgiver’s decree is breached in four ways: violation of the con-
sensus of the Umma (ijma‘), basic principles of Shari’ah, Divine text or
manifest analogy.”24
4 Imam al-Qarafi al-Maliki further describes a rule with these words:
“There is consensus on it that a person who embraces Islam has the
choice to adopt conformity with any of the Imams without any restric-
tion. Similarly, there was a common consensus between the Compan-
ions (may Allah be well pleased with them) about a person who sought
12 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
an edict from Abu Bakr al-Siddiq and ‘Umar b. al-Khattab (may Allah
be well pleased with both of them), or conformed to them, had the right
to seek an edict from Abu Hurayra, Mu‘adh b. Jabal (may Allah be well
pleased with both of them) and others and could also abide by their
verdict without any constraint.”25
5 Imam al-Qarafi al-Maliki further quotes Imam ‘Izz al-Din b. ‘Abd al-
Salam al-Shafi‘i (577–660 ah) with the following words:
“We believe in permissibility of conformity as well as in shifting from
one school of law to the other. However, we maintain it only in issues
where the ruling of the judge is not breached.”26
6 He elaborates the idea by saying:
“This is the adopted view of ‘Izz al-Din b. ‘Abd al-Salam, Sayf al-Din
al-Amidi and a group of other scholars as already described, it is gov-
erned by the condition that one should not assimilate all schools of law
in a way that goes against the consensus of the Umma.”
7 al-Qarafi commenting on the issue, further says:
“The Prophet (blessings and peace be upon him) has said: ‘I have
been raised with the Din that provides facilitation.’27 This Prophetic
statement demands its permissibility at large because this is a type of
ease and lenience. The Islamic law does not want to put people in trou-
ble, rather it declares mandatory the acquisition of special and better
expediencies, if they are burdened heavily.”28
8 Imam Sayf al-Din Abu al-Hasan al-Amidi al-Shafi‘i (551–631 ah) writes
in al-Ihkam fi Usul al-Ahkam:
“When a conformist, following his Imam, acts upon his verdict about
a matter pertaining to ritual prayer (al-sala al-maktuba), the Imams
agree that, in regard to this matter, he does not have the right to turn
towards some other Imam. However, in matters other than acts of wor-
ship, the Imams disagree about turning towards other Imams and fol-
lowing them. It has been prohibited as well as permitted by different
jurists. The consensus amongst the Companions (may Allah be well
pleased with them) makes it evident that a conformist has the right to
seek a verdict from any scholar regarding any disputation. Nothing has
been reported about any Imam from the pious predecessors, prohibiting
common people from it. Had it been prohibited, it would not have been
permissible for the Companions (may Allah be well pleased with them)
to be negligent of this prohibition or observe silence on this forbiddance.”
“In view of that, if a person determines to fix for himself a school of
law for adherence, like Shafi‘i or Hanafi or any other school, and de-
clares to stick to it, a large group of Imams have accorded permissibility
to following another Imam or school of law in a given matter.”29
9 Imam Kamal al-Din b. al-Humam al-Hanafi (790–861 ah) writes in
al-Tahrir fi Usul al-Fiqh, al-Jami‘ bayn Istilahay al-Hanafiyya wa’l-
Shafi‘iyya, which is his masterpiece on the amalgamation and combina-
tion of terminologies of the Hanafi and Shafi‘i schools of law:
 Methodology of inclusion 13
“The conformist should not turn towards any other imam about an
issue for which he abides by a specific school. This idea raises the ques-
tion whether or not the conformist should pursue, for a disputation, an
imam other than the one whom he adheres to in other matters. Accord-
ing to the adopted school (al-madh’hab al-mukhtar), he can certainly
do it because people have been seeking edicts the first time from one
scholar and the second time from another, without conforming to only
one jurist for all the matters. It is said that if one adopts a specific school
of law such as Hanafi or Shafi‘i, then one must hold it fast. However, at
the same time, it has also been said that he should not adhere to one
school alone for all the issues in consideration. It is also viewed that
such a person would be perceived as if he was not originally bound to
any school. So, he adheres to one jurist in one matter and to the other in
another. He further states: This also establishes the conformist’s justifi-
cation of following the permissions provided by different schools of law.
There is no legal prohibition to stop him from this option, because one
has the lawful right to adopt the easier option, while the mode to utilize
it is also available. This is so because he has not adopted the verdict of
other Imam in this regard. The Prophet (blessings and peace be upon
him) too would like ease and comfort for his followers.”30
10 Ibn Amir al-Hajj al-Halabi al-Hanafi (d. 879 ah) wrote the explanation
of the above-mentioned book of Ibn al-Humam. He says:
“The Prophet (blessings and peace be upon him) would like ease and
comfort for his followers. As has been described in the preceding sec-
tion about preference, Imam al-Bukhari has narrated a hadith reported
by ‘A’isha (may Allah be well pleased with her) with the word ‘an-hum
(for them), while another narration has reported ma yukhaffif-u ‘an-
hum. The Prophet (blessings and peace be upon him) would like any-
thing that causes ease and relaxation for his Umma. Therefore, we have
mentioned several hadith reports that prove the principles (of ease and
relaxation).”
He further elaborates the concept, saying:
“It connotes that, apart from the Imam one has conformed with in
one issue, he can also conform with another Imam (in another dispu-
tation), like the conformist who would abide by Imam Abu Hanifa in
a problem and followed some other Imam in some other issue. (This is
the adopted view) as has been described by al-Amidi and Ibn al-Hajib.
(Yes, most certainly) he can do it on the basis of ample and accom-
plished proofs (al-istiqra’ al-tam). (Indeed) in the Companions’ times,
the edict seekers of every era and their Successors (used to get a verdict
now from this and then from that mujtahid, without tenaciously adher-
ing to any mufti). This has been a general and repeated practice, and,
this has not been denied. … Moreover, it is stated by Imam al-Rafi‘i and
others that determining according to a particular school of law in every
matter is not mandatory. Nothing is imperative for a man other than
14 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
what Allah and His Messenger (blessings and peace be upon him) have
declared obligatory. Allah and His Messenger (blessings and peace be
upon him) have not made it imperative for a person to adopt the way of
anyone of the Umma and only conform with what he says and give up
everything else.”31
11 ‘Allama ‘Abd al-Hayy al-Faqih al-Hanafi al-Laknawi has also sup-
ported the same idea answering a particular question in his Majmua‘
al-Fatawa:
“The Hanafi school does not imply hiding the truth so that the
searcher of that truth should exit from the Hanafi school of law. Many
of the eminent Hanafi authorities have endorsed this permission in
their books. One of the eminent scholars Mufti al-Hanafiyya of Mecca
(d. 1061 AH) Muhammad b. ‘Abd al-‘Azim al-Makki has written in his
booklet al-Qawl al-Sadid fi Ba‘d Masa’il al-Ijtihad wa’l-Taqlid:
‘It is not binding on us that we should not accept the opinion or the
evidence from what appears right against our own opinion, because
Almighty Allah has plentifully blessed us with the wealth of contempla-
tion through which it is possible to find what is right or appropriate in a
given situation. Despite this openness, thank God, we do not exit from
the conformity with Imam Abu Hanifa’.”32, 33

1.6 The principle of distinction and option of choice between

different juristic verdicts
The intent of the wholesome of Shari’ah is to create ease and facilitation
for humankind. Keeping in view this principle, the jurists have promoted
ease, expansion and facilitation for humans in making inferences from the
sources. While describing various disputations, they have reported different
verdicts and opinions that contain greater flexibility and facilitation. Men-
tioning these verdicts, the Imams have frequently referred to statements,
using descriptions like:

• Hadha asahh (This is the most correct.)

• Hadha awsa‘ (This is the vastest.)
• Hadha ahwat (This is the safest.)
• Hadha aqyas (This is the best analogy.)
• Hadha awla (That is better.)
• Hadha awdah (This is more evident.)
• Hadha awfaq li’l-qiyas (This is more compatible to analogy.)
• Hadha arfaq li’n-nas (This is more lenient and easier for the people.)

The jurists who have used such epithets do not represent any specific period,
nor do they belong to any single school of law; rather they belong to all
the eras and all the schools of law. They include Imam Abu Hanifa, Imam
Malik, Imam al-Shafi‘i, Imam Ahmad b. Hanbal, Imam Muhammad, Imam
 Methodology of inclusion 15
Abu Yusuf, al-Samarqandi, al-Sarakhsi, al-Kasani, al-Zayla‘i, al-Subki, al-
Nawawi, al-Shurbini, al-Ramli, Ibn Hazm, Ibn Muflih, Ibn Qudama, Ibn
Taymiyya, Ibn Nujaym, al-Haskafi, Ibn ‘Abidin al-Shami, etc. Here are
some examples of their inclusive accommodation and flexible approach:

1.6.1 al-Hanafi authorities

1 Ibn Nujaym states in al-Bahr al-Ra’iq:
“He [Qasim b. Qutlubugha] says at the end: It is proven that the posi-
tion (qawl) of Imam Abu Hanifa is the most correct view (asahh). And
by this it is apparent that no legal ruling ( fatwa) is to be passed or acted
upon unless it is the verdict (qawl) of al-Imam al-A‘zam [Abu Hanifa].
His position will not be abandoned for the position of [Imam Abu Yusuf
and Imam Muhammad], or either of them, or anyone else besides them,
except in the case of necessity due to weakness of evidence or in the case
where popular practice and conventions are against his verdict, such as
sharecropping (al-muzara‘a) [for example].
“If the scholars declare that the legal ruling ( fatwa) is on the verdict
of [Imam Abu Yusuf and Imam Muhammad], as in this example and
quoted in al-Siraj al-Wahhaj, then their position is [to be viewed as] the
more accommodating (awsa‘) position, whereas the Imam’s position is
the more precautionary (ahwat).”34
2 Ibn Nujaym says at another occasion:
“Something more accommodating (awsa‘) than that has been stated by
our teachers/colleagues, and that is: if an upright jurist ( faqih) is asked for
a legal ruling (fatwa) and he passes judgement on the nullification of an
oath (al-yamin), it is permitted for him to act upon his legal ruling (fatwa)
or to withhold it. Even something more accommodating (awsa‘) than this
has also been reported, and that is: if a legal expert (mufti) passes a legal
ruling (fatwa) for permissibility and then another [legal expert (mufti)]
passes a legal ruling (fatwa) for impermissibility after the first legal rul-
ing (fatwa) has been passed, then the second legal ruling (fatwa) can be
implemented with regards to another woman, but not the first. Both legal
rulings can be implemented in two (separate) incidents.”35
3 In a matter of theft, al-Haskafi quotes two verdicts, The Hanafite and
the Shafi‘ite. Regarding the first he says: It is the most correct view
(asahh). And about the second verdict he says: It is the more accommo-
dating (awsa‘) position, thus it would be adopted for practice in times of
necessity.36
4 al-Haskafi discussing the time of the Maghrib ritual prayer quotes two
positions on determining the meanings of twilight. He says:
In al-Mabsut, it is related that Imam Abu Hanifa’s position is the saf-
est (ahwat), whereas their (Imam Abu Yusuf, Imam Muhammad and
Imam al-Shafi‘i) position is the more accommodating (awsa‘), i.e., more
lenient for people.37
16 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
5 Imam al-Sarakhsi relates two positions regarding the size of the water
basin in order to explain the apparent standpoint of the madh’hab in
interpreting what constitutes ritual ablution; first the position of Imam
Abu Hanifa and the second of Imam Abu Yusuf. Finally he says, the re-
port of Imam Abu Hanifa, however, is more accommodating (awsa‘).38
6 Imam al-Sarakhsi writes in al-Mabsut:
“If two people entrusted a person with gold coins (dinar), silver coins
(dirham), clothes, riding beasts and servants, and then one of them went
back to reclaim his possessions from him, according to Imam Abu Han-
ifa it would not be permitted for him to do so unless both are present.
Whereas according to Imam Abu Yusuf and Imam Muhammad, he will
be ordered to divide the property and pay him his rightful share.
“Imam Muhammad states in al-Amali: The verdict of Imam Abu
Hanifa is closer to juristic reasoning (aqyas), while the verdict of Imam
Abu Yusuf is more accommodating (awsa‘).”39
7 It is stated in Bada’i‘ al-Sana’i‘:
“As for the case of a well—where it [first] becomes impure, then its
water sinks into the earth with its bottom part becoming dry, and then
it is replenished with water again—in the opinion of Nusayr b. Yahya,
it is pure, whereas according to Muhammad b. Salama it is impure. The
same is said to be the opinion of Imam Abu Yusuf.”
Imam al-Kasani commenting on both opinions, says:
“The second position is more precautionary (ahwat), whereas the for-
mer is the more accommodating (awsa‘).”40
8 At another occasion, Imam al-Kasani reports:
“Nusayr b. Yahya and Abu Bakr al-Iskaf said: ‘There is no good in it.’
Ibn al-Mubarak was asked about it and he said, ‘There is no harm in it.’
It is also the verdict of Shaykh Abu Hafs al-Kabir, and this is the more
accommodating (awsa‘) position, but the first is the more precautionary
(ahwat).”41
9 At another place, al-Kasani, after quoting two different opinions, says:
“What is stated by Imam Muhammad is closer to juristic reasoning
(aqyas), but the position of Imam Abu Yusuf is more accommodating
(awsa‘).”42
10 Imam al-Kasani states in the section of ritual seclusion (al-i‘tikaf ):
“If he leaves the mosque without an excuse, then his ritual seclusion
(al-i‘tikaf ) in the mosque is nullified according to Imam Abu Hanifa, even
if it is momentarily. Whereas according to Imam Abu Yusuf and Imam
Muhammad, it is not nullified unless he leaves for more than half a day.
“Imam Muhammad said, ‘The verdict of Imam Abu Hanifa is closer
to juristic reasoning (aqyas), while the verdict of Imam Abu Yusuf is
more accommodating (awsa‘).’”43
11 The same approach has been endorsed by al-Zayla‘i in these words:
“His position is closer to juristic reasoning (aqyas), whereas their po-
sition is based on juristic preference (al-istihsan), and it is the more ac-
commodating (awsa‘) position.44
 Methodology of inclusion 17
12 Abu al-Layth al-Samarqandi also reports the same comments in Tuhfa
al-Fuqaha’.
13 Ibn ‘Abidin al-Shami, discussing a situation related to the question of
purity, says:
“The former opinion is closer to juristic reasoning (aqyas), whereas
the latter is more accommodating (awsa‘). And this is the position
adopted in al-Durar as the legal ruling (fatwa).”45
14 Ibn ‘Abidin al-Shami discussing about the purification of honey and oil,
mentions two positions, and states:
“This is according to Imam Abu Yusuf, whose position is in con-
trast to Imam Muhammad. His position is the more accommodating
(awsa‘), and it is upon this position the legal ruling (fatwa) is based. This
is what has been stated in the commentary of Shaykh Isma‘il from Jami‘
al-Fatawa.”46
15 Ibn ‘Abidin al-Shami says:
“It is stated in al-Hilya: ‘Yes, there is a difference of opinion between the
scholars concerning the beginning of dawn, the scattering of light or its
spread over the horizon as mentioned in Sharh al-Zahidi from al-Muhit.’”
“It is mentioned in Khizana al-Fatawa from Sharh al-Sarakhsi ‘ala
al-Kafi that the first position is more precautionary (ahwat), while the
second is more accommodating (awsa‘). He says in al-Bahr: ‘The appar-
ent position (of the madh’hab) is the last opinion.’”47
16 The Hanafi jurists have decreed on several issues pertaining to the pro-
tection of people’s rights on the basis of the rules of other schools. For
example, a person owes money to someone but does not pay him. Then
it so happens that some belonging of the debtor, somehow, gets into the
hands of the creditor. In the Hanafi original view, it is not permissible
for the creditor to sell it for the compensation of his right. However, the
later Hanafi jurists declared it permissible, following the Shafi‘i verdict.
‘Allama Ibn ‘Abidin al-Shami reports from al-Hamawi:
“Non-permissibility of recovering one’s right from the opposite gen-
der in the olden times of jurists was owing to the common practice of
observance of the rights of the people. However, in modern times, by
having power and possession of other’s property or wealth, an edict ex-
ists on the permissibility of recovering from that, especially in case of our
countries, because people are persistently practising disobedience.”48
17 The original text of al-Durr al-Mukhtar reads as under:
“It is not lawful for a (legally) rightful person to recover his right
from other than the gender of his own right. However Imam al-Shafi‘i,
has declared it permissible, and this is the more capacious view. (This
provides facility to the people, so this should be adopted.)”49
18 In the case of a sale before time or its advance payment, the Hanafis
make it a pre-requisite that the material sold must remain in the market
until the stipulated time expires. However, Shafi‘is find it sufficient if it
is present on the time of actual sale. As found in al-Hidaya, there is no
harm if this verdict is followed in the time of need; this is allowed.50
18 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
19 The Hanafi school does not hold silent or sleeping partnership lawful,
but Imam Malik regards it permissible.51 Some modern Hanafi jurists
have held that the partners setting up a company shall not have only
an investing partnership (al-shirka bi’l-nafaqa), rather their partnership
can also be operational and material in business (al-shirka bi’l-‘urud).52
It is stated:
“According to a report narrated by Imam Ahmad b. Hanbal, part-
nership in operation and investment in material (for sale) is permissible.
As described in al-Mughni, this is the verdict of Imam Malik and Ibn
Abi Layla as well.”53

1.6.2 al-Maliki view

20 It is stated in al-Mudawwana al-Kubra, Ibn al-Qasim said that this is
what reached him from Imam Malik as he adopted the accommodat-
ing (awsa‘) position in respect to performing the tayammum over some-
thing frozen.54

1.6.3 al-Shafi‘i view

21 Imam al-Shafi‘i says, explaining a verse of the Holy Qur’an:
“Some of my companions said to me: it applies only to the distribu-
tion of inheritance. And others said: it includes the distribution of in-
heritance and other similar matters, such as the spoil of war. This is the
more accommodating (awsa‘) position and it is dearer to me.”55
22 The same approach is found in the words of Sulayman al-Jamal al-
Shafi‘i. But the statement of al-Zarkashi is more accommodating (awsa‘)
than it.56
23 Shams al-Din al-Ramli also uses the same legal expression in the words:
“‘The first is the more accommodating (awsa‘) [and hence
permissible].’”57
24 al-Mawardi elucidates the rationale of this approach in these words:
“This command relates to the common good and this principle can
also be extended to other transactions and agreements.”58

1.6.4 al-Hanbali view

25 Ibn Hazm states expressing the same principle:
“Rabi‘a said: ‘I do not think there is anything more accommodating
(awsa‘) on the issue of the animal’s foetus than the ijtihad adopted by
the Imam.’”59
26 Ibn Muflih al-Hanbali also expresses the same juristic rule in the words:
“This comes under public interest (al-masalih al-mursala). But al-
Qadi has adopted a position more accommodating (awsa‘) than this in
al-Ahkam al-Sultaniyya.”60
 Methodology of inclusion 19
27 Imam Ibn Muflih further says at another occasion:
“However, the absolute nature of cash is more accommodating
(awsa‘), and for this reason it is validated in kinds of transactions.”61
28 Imam Ibn Qudama states:
“This is because letting out (al-ijara) for the same purpose is per-
missible but borrowing (al-i‘ara) is the more accommodating situation
(awsa‘).62
29 ‘Allama Ibn Taymiyya states:
“The position of Imam Ahmad (on this issue) is more accommodat-
ing (awsa‘) than others.”63

1.7 Juristic strategy for resolving contemporary issues through

the principle of inclusion and expansion
In this regard, a reasoned strategy needs to be developed, which will enable
us to benefit from the juristic reservoir of all the four schools in order to sort
out the complexities of life without any deferment and hindrance.

1 Pursuing this principle, Imam Shah Wali Allah al-Muhaddith al-

Dihlawi states:
i In most of the juristic reasoning characterized by difference of
opinions, the truth spreads through all of these opinions.
ii There is no narrowness in Din; rather it offers ease, expansion and
accommodation.
iii Sticking only to one way and believing firmly that the opponent’s
viewpoint is definitely wrong is baseless.64
2 Imam ‘Izz al-Din b. ‘Abd al-Salam, expressing the same strategy, states:
“Successful is the person who acted upon things the scholars agreed
upon and refrained from things that the scholars declared unlawful
without any disagreement, and believed in the permissibility of matters,
which the scholars and jurists decreed unanimously, also performed
the acts, which the scholars unanimously regarded commendable;
and abstained from the acts that the scholars unanimously agreed to
disapprove.
“However, the things where the scholars disagreed and could not con-
cur on one opinion can be divided into two forms.
i The matter wherein they have had difference of opinion on the
disputations about which the command of the Lawgiver can be re-
pealed. In this case, no chance of following that opinion remains
permissible, because such a ruling will be considered a mistake in
totality. It will be rejected because the mistake lies in its original
legality, and this mistake has detached the ruling from the basic will
of the Lawgiver and spirit of the textual law.
20 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
ii The second form is related to the matter where difference of opin-
ion does not pertain to the issues about which the command of the
Lawgiver can be repealed. There is no harm in obeying or disobey-
ing such a ruling, with the condition that one should follow some
authentic juristic opinion and not an unauthentic one. The prac-
tice in the early centuries of Muslim Umma, when the traditional
schools of law were not formulated and enforced, was not to follow
any specific jurisprudence; but people used to follow any legal opin-
ion of a competent scholar, which at least enjoyed the consensus of
some jurists.”65
3 Imam ‘Izz al-Din b. ‘Abd al-Salam further asserted on a question:
“If the school that he is abandoning and the one that he is adopting
are without much distance closer to one another in their sources and or-
igins, then it is permissible to leave one and join the other. It is because
from the period of the Companions until the formation of four juristic
schools, the Muslims have been following all the schools of jurispru-
dence instead of one of them. Whoever, one would consider a better
scholar, superior in God-consciousness, he would approach him for an
edict and follow him. Nobody used to dislike this way, nor was consid-
ered disliking by anyone worth any notice. Had it been the wrong way,
the scholars would have rejected it and stopped others to follow it.”66

1.7.1 Categories of juristic opinions

Imam Shah Wali Allah al-Dihlawi further writes that the difference of opin-
ion is of four kinds:

1 Determined Opinion: The difference of opinion is not justified in mat-

ters wherein the truth is absolutely and certainly determined. Its com-
pliance is mandatory and differing from this position is definitely void.
2 Preferred Opinion: The problem where the truth is determined by ma-
jority vote of the schools and the jurists, and it weighs in predominant
scale. Differing from this position is probably voidable.
3 Un-preferred Opinion: This is a problem where both aspects are under
equal authority and none of the aspects is preferred to the other. In this
matter, an open choice between the two opinions is granted definitely.
4 Compatible Opinion: This is an issue where similar choice is given on
both sides with a dominant opinion. Therefore, in this case also, a jurist
is free to adopt either of the two authorities or opinions, based on the
compatibility of the evidence and the given circumstances.67

Therefore, the scholars and jurists, leaving the first kind aside, can use their
juristic discretion in adopting any viewpoint in the last three situations, fol-
lowing the above-mentioned principles of jurisprudence.
 Methodology of inclusion 21
1.7.2 The occasions to differ
Imam Shah Wali Allah al-Dihlawi describes the occasions to differ at an-
other place in his book ‘Iqd al-Jid:
It is an established fact that the difference amongst the jurists and mujta-
hidun arose due to four reasons:

1 A mujtahid found a hadith about an incident, while the other missed it.
In this case, the one who found the truth is called mujtahid mu‘ayyan.
2 Every mujtahid has hadiths of the Prophet (blessings and peace be upon
him) and the reports of the Companions. Every one of them exercised
ijtihad (deductive reasoning) in preferring or finding compatibility
among hadiths and Companions’ reports regarding any given legal sit-
uation. Their ijtihad (deductive reasoning) took it to the status of a de-
termined command, due to which the difference of opinion transpired
to the scope of adopting any of the opinions.
3 The mujtahids differed in the following matters:
i The connotations and interpretation of words and idioms in use
and determining their meanings and implications.
ii Pinpointing and determining the confines of usages.
iii The true recognition of conditions and constituent elements of a
legal act or its effects. Thus, ijtihad (deductive reasoning) of every
mujtahid took him to a separate and permanent opinion in framing
the legal position of that act.
iv A different approach in formulating the juristic principles. Since
the framed juristic principles or conditions were different from one
another, resultantly, difference of legal opinion occurred also in pe-
ripheral issues.
That is why the Prophet (blessings and peace be upon him) said: “Difference
of opinion amongst my Umma is a blessing.”68
This difference of opinion has been declared to be a blessing of Almighty
Allah, because none of them is negating the command of God. All of them
are trying to determine the meanings and specify the implications of a par-
ticular verse, hadith or word in question in different ways. Therefore, these
juristic differences have expanded the scope of legal options for the Umma.
“Therefore, all of the mujtahids are on straight path in all the above-
mentioned forms when their sources are akin to and compatible with the
indicated methodology. That is why, one can easily accept anyone of them
without any confusion.”69

1.7.3 Qur’anic verdict on shifting from one school to another

It can be asserted in the light of legal arguments that, apart from the Proph-
ets, it is not legally prohibited to differ with any person of any exalted posi-
tion in any issue under any circumstances. This station is only exclusive for
22 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
Allah and His exalted Messenger (blessings and peace be upon him). The
four Imams too have expanded upon this matter. The Qur’an states:

Ya ayyuha’l-ladhin-a amanu ati‘ul-Lah-a wa ati‘ur-Rasula wa uli’l-amr-i

min-kum [O believers! Obey Allah and obey the Messenger (blessings and
peace be upon him) and those who hold the authority amongst you.]70

The Qur’an and Sunna come under the article of:

Ati‘ul-Lah-a wa ati‘ur-Rasula [Obey Allah and obey the Messenger

(blessings and peace be upon him).]71

The schools of law and their Imams fall under the article of:

Uli’l-amr-i min-kum [Those who hold the authority amongst you.]72

As mentioned in this verse, the commandment of “ati‘u” [obey] has been

repeated for Rasul in the same way as for Allah, to declare the absolute and
unconditional authority vested with the commandment of the Holy Prophet
(blessings and peace be upon him). However, in the case of “uli’l-amr”, the
command of obeying “ati‘u” has not been verbally repeated. This style of
linguistic composition signifies that the obedience rendered to “uli’l-amr” is
qualified, conditional and challengeable. That is why, Almighty Allah has
further commanded:

Fa-in tanaza‘tum fi shay’in fa-rudduhu ilal-Lah-i wa’r-Rasul-i in kuntum

tu’minun-a bilLah-i wa’l-yawm-il akhir [Then if you disagree amongst
yourselves over any issue, refer it to Allah and the Messenger ([blessings
and peace be upon him] for final judgment), if you believe in Allah and
the Last Day.]73

This Qur’anic article promulgates three basic principles:

i
The principle of the supreme and absolute juristic authority of the
Qur’an and Sunna.
ii The principle of subordinate and conditional authority of the juristic
opinions.
iii The principle of permissibility of differing from one opinion and adopt-
ing the other, due to the reason of stronger supporting evidence of the
Qur’an and Sunna.

1 Imam Shah Wali Allah al-Dihlawi states:

“The overwhelming majority of scholars belonging to the four schools
have followed the middle course between two extremes of excess and
paucity we have mentioned. All the four Imams instructed their follow-
ers of the same path of moderation. Shaykh ‘Abd al-Wahhab al-Sha‘rani
 Methodology of inclusion 23
has reported from Imam Abu Hanifa in al-Yawaqit wa al-Jawahir, say-
ing, ‘It is unjust for a person who is not acquainted with the proof con-
tained in my words to issue an edict just on the basis of my words.’
When he decreed his edict he would point towards himself and say, ‘As
far as I know, this is the opinion of al-Nu‘man b. Thabit [Abu Hanifa],
and, this is more acceptable to me. If there is a better opinion, that is
more authentic and would be closer to the truth.’ Similarly, Imam Malik
used to say, ‘Except for the Messenger of Allah (blessings and peace be
upon him), everyone can be seized for his words and his words can be
rejected.’ al-Hakim and al-Bayhaqi have reported from Imam al-Shafi‘i,
saying, ‘When the authenticity of hadith is proved, that is my school.’”74
2 al-Zarkashi states:
“The Companions had a common agreement on this point that there
was a difference in their level of knowledge and understanding but,
despite that, there was consensus among them on the permissibility of
following a path of a person of lower rank in the presence of a person
enjoying a higher rank in knowledge and wisdom.”75

This principle reveals that, under peculiar circumstances, it is permissible to

prefer another Imam’s verdict due to legal expediency, evidential strength or
circumstantial necessity. The majority of jurists maintain the same standpoint.
However, the juristic conditions and limits have to be observed compulsorily.

3 Ibn Taymiyya states:

“Sometimes, Allah Most High bestows upon a scholar the wisdom
and insight which the other lacks.”76
4 Ibn ‘Abidin al-Shami al-Hanafi has stated with reference to al-‘Iqd al-
Farid authored by ‘Allama al-Shurunbulali al-Hanafi:
“It is not imperative for a person to follow a particular school of law
in all cases, without any exception.”
He further states:
“In certain issues, it is permissible for a person to follow another
Imam’s school against the school of his own Imam, provided he cares
for all the terms and conditions fixed by the other Imam.”77

We learn from these proofs and statements that, about a given disputation,
shifting from one juristic school to the other is permissible. However, this
permissibility is dependent upon the fulfilment of certain conditions de-
scribed by the jurists.

1.8 Categories of conformist jurists and their ways of framing

the opinions
According to the juristic classification, after the three levels of Mujtahi-
din (al-Mujtahid fi’l-Shar‘, al-Mujtahid fi’l-Madh’hab and al-Mujtahid fi’l-
Masa’il), there are three categories of conformist jurists:
24 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
1.8.1 Ashab al-Takhrij (Jurists: Who are competent to conduct
inference)
They get to the origin of the proof and apply it to new circumstances accord-
ing to the similarity or compatibility of the origin (asl) and the branch ( far‘).
In this way, they conduct juristic research with analogies and examples and
continue extending and applying the rules on newly emerging situations.

1.8.2 Ashab al-Tarjih (Jurists: Who are competent to conduct

preference)
They give priority or preference to rulings and verdicts available within their
own school on the basis of analogies and strength of other evidences in or-
der to prove them more capacious, facilitating and beneficial for the people.

1.8.3 Ashab al-Tamyiz (Jurists: Who are competent to conduct

distinction)
They are equipped with the capability of making distinctions, as to which
verdict or evidence is stronger, strong or weak, or which opinion is the most
correct, correct or incorrect.
On the basis of the principles of takhrij (inference) and tarjih preference
and tamyiz (distinction), the jurists continue expanding the juristic vision
and its content, to make it all-inclusive and accommodating based on the
inherent vastness of the legal evidence.78

1.9 Application of intra-school position to inter-school position

In like manner, the above-mentioned intra-school principles should be ap-
plied to inter-school matters, in order to infer, extend, prefer or adopt a
verdict of any of the schools of law as per requirements. This is how the
truthfulness and veracity of all the four schools of law would be practically
applied and enforced. Otherwise, it will negate Islam’s global immensity
and vastness.
One of the main Divine objectives, and why various schools of law earned
acceptance and popularity amongst the Umma, was that all the commands
and teachings of the Prophet Muhammad (blessings and peace be upon him)
should be protected, practiced and transmitted in their real manifestation.
In this way every single Sunna of the Holy Prophet (blessings and peace
be upon him) would always remain alive. None of the Prophets’ practices,
teachings and commands may be abandoned at any given time. Almighty
Allah has practically protected all aspects of the holy life of the Prophet
(blessings and peace be upon him) in the form of different schools of law.
Nevertheless, the protection of the whole of the Sunna of Holy Prophet
(blessings and peace be upon him) would not have been possible through one
 Methodology of inclusion 25
school of law only, because some variations and alterations gradually took
place in the Sunna from time to time, in accordance with occasional needs
and circumstantial requirements. Therefore, the real purpose of the exist-
ence of different madhahib is to create a total comprehension of the Prophetic
practices, and not to create a narrow and rigid vision of Islamic commands.

1.10 Guiding principles for the methodology of inclusion and

flexibility
The following are the guiding principles for finding juristic solutions for
modern issues, through the methodology of inclusive accommodation and
flexibility (al-tawassu‘).

1 As far as possible and whatever way it works, we should normally try

to draw inferences from the rulings of the great Imams and must not
exit from all of the four schools of jurisprudence. There is no harm in
deserting one school of law and taking up the other in solving a specific
complicated issue.
2 Of the followed schools, whichever offers any key or solution to any
modern-day complication or complex development, should be adopted
to solve the problem. Therefore, conducting a modern ijtihad does not
become the only solution, nor do we open the door of ijtihad to every
Tom, Dick and Harry.
3 This is so because the demand of necessity or compulsive intervention
of time neither does open the door of ijtihad wide apart nor shuts it ab-
solutely. The right and moderate path lies between these two extremes,
so that juristic reasoning is practiced under real necessity. And this ju-
ristic reasoning does not transgress or go independent of the principles
and juristic procedures laid down by the schools of law. In brief, if the
desired solution is found in the master books of any of the four schools,
the edict can be issued from there, and so new juristic reasoning re-
mains beyond any need.
4 The change of school of law should not be due to personal desire; it
should rather be owing to religious necessity or general expediency as
stated by ‘Allama Ibn ‘Abidin al-Shami:
“A person’s change from one juristic school to the other due to
worldly desires and pursuits without a solid reason will be an extremely
condemnable act, because he has followed the prohibitions of Din and
degraded his School of law.”79
5 Leaving one’s own Imam’s verdict and following the other’s should be
based on the strength of proof, legal expediency or circumstantial neces-
sity. It should not be for the sake of avoiding the Divine commandments.
6 Only such a person is allowed to shift from one school to another who is
sufficiently competent to distinguish between weak and strong reasons
and equipped with knowledge of legal expediencies.
26 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
7 If a solution is not explicitly found, even in any of these sources, there
is no harm in exercising analogical deduction [al-ijtihad al-qiyasi] for
unsolved matters provided the analogy is not absolutely differential [al-
qiyas ma‘ al-fariq].
8 However, if all the four schools do not offer any analogical solution to
a modern-day problem, then we should go for exegetical deduction (al-
ijtihad al-bayani). This is reinterpretation of the text, following the exe-
getical and juristic principles and general legal provisions of the Qur’an
and Sunna.
9 Last but not the least, if we do not find any clear text of the Divine
command that can be used as juristic basis for the above-mentioned
deductions, then we should go for deductive reasoning based on pub-
lic interest. This can be conducted in the forms of juristic preference
(al-istihsan), presumption of continuity (al-istis’hab), public good (al-
istislah), common benefit (al-masalih al-mursala)’, ‘usage (al-‘urf ) and
convention (al-‘ada)’, ‘legal necessity (al-darura)’, ‘change of law by
change of time (taghayyur al-ahkam bi taghayyur al-zaman)’, etc.
10 Finale

In view of the current national and international complexities and changing

ground realities, the jurists have followed the path of openness, flexibility
and liberality (al-tawassu‘) instead of tenacious adherence to a single school
of law or the path of narrowness and rigidity. As the basis of the problems
grows wider and expands in span and novelty, the rules to resolve the prob-
lems also demand adoption of an open-minded and a holistic approach. If
the issue is related to personal matters, adherence to a particular school of
law will be preferred. However, if the problem happens to be wide-spectrum
and involves a broader span of activity and extensive international reper-
cussions, the methodology to deal with it would also be all-inclusive, liberal
and wide-ranging.
Keeping the above in view, the IFIs in the current complex situation of in-
ternational financial market should follow the way of flexibility and should
be more open towards the formulation of their policies, launching the new
products and dealing with the customers but they have to follow the lines of
Qur’an and Sunna.

Notes
1 Robinson, K. (2007) “Islamic Finance Is Seeing Spectacular Growth,” NY Times
(5 November). www.nytimes.com/2007/11/05/business/worldbusiness/05iht-
bankco l06.3.8193171.html (accessed 15 June 2009). And Ahmed, (2006) Islamic
Banking Finance and Insurance: A Global Overview (Kuala Lumpur: A.S.
Noordeen).
2 Smolo, E. and Habibovic, E. (2012) Barriers to Growth of Islamic Finance: Issue
of Standardisations, in Trakic, A. and Tajuddin, H. H. A. Islamic Banking and
Finance: Principles, Instruments, Operations, CLJ Publications, Malaysia.
 Methodology of inclusion 27
3 Shanmugam, B. and Zahari, Z. R. (2009) A Primer on Islamic Finance (Char-
lottesville, VA: Research Foundation of CFA Institute).
4 Ainley, M. (1997) “Under a Veil of Regulation,” The Banker, October 01; KPMG
International; Seera Investment Bank; Shanmugam and Zahari.
Jassar Al-Jassar (2002) “Islamic Finance: Successes, Prospects, and Neglected
Areas,” in Islamic Finance: The Task Ahead – Proceedings of the Fourth Har-
vard University Forum on Islamic Finance (Cambridge, MA: Center for Middle
Eastern Studies, Harvard University); Ijlal Alvi (2009) “Standardization of Doc-
umentation in Islamic Finance & Role of the International Islamic Financial
Market (Iifm),” in Islamic Financial Sector Development (IFSD) Forum 2009
(Ashgabat, Turkmenistan, May);
Shanmugam and Zahari; Smolo, “Sustainable Growth of Islamic Financial
Industry (Ifi): Some Unresolved Issues.”; Smolo, “Sustaining the Growth of
Islamic Financial Industry: What Needs to Be Done?.”
5 “There are many examples where this industry suffers due to the lack of stand-
ardisation. An example of problem in this industry due to the standardisation
problem is Japan Bank for International Cooperation’s (‘JBIC’) plan to issue
sukuk. Initially, JBIC was about to issue its first sukuk in May 2008. Two re-
spective banks were selected to arrange the deal, namely Citibank of Dubai and
CIMB Malaysia. However, due to the disagreement that existed between the
Shari’ah boards of the two banks on whether sukuk are Shari’ah-compliant or
not, the issuing of sukuk was delayed. As a result, the deal had to be restructured
from the original murabahah structure to musharakah. All of this created addi-
tional problems in terms of time, cost and frustration for the issuer”( Smolo and
Habibovic 2012, p. 17).
6 Rafay, Abdul, Ramla Sadiq and Mobeen Ajmal. “Fragmentation of Islamic
Financial Products: An Exploratory Study of Islamic Schools of Thought.”
Abasyn Journal of Social Sciences—Special Issue: Towards Financial Inclusion: 48.
7 Kasim, Nawal, Sheila Nu Nu Htay and Syed Ahmed Salman. “Empowering the
Shari’ah Committee towards Strengthening Shari’ah Governance Practices in
Islamic Financial Institutions.” Review of European Studies 8 (March 2016): 144.
8 Ahmad Shaharudin Bin Abdul Latiff (2013) “The Need for an Information Sys-
tem for the Dissemination of Knowledge on Islamic Banking.”
9 Ibid.
10 Qur’an 2:185.
11 Ibid., 22:78.
12 Ibid., 5:6.
13 Ibid., 4:28.
14 Ibid., 8:66.
15 Set forth by •Muslim in al-Sahih: Bk.: al-Talaq [The Divorce], Ch.: “Merely Giv-
ing a Woman the Option of Divorce Does not Make the Divorce Effective, But
Only When it is Actually Intended,” 2:1104 §1478.
16 Set forth by •al-Bukhari in al-Sahih: Bk.: al-Manaqib [The Exemplary Virtues],
Ch.: “The Qualities of the Prophet (blessings and peace be upon him),” 3:1306
§3367; •Muslim in al-Sahih: Bk.: al-Fada’il [Virtues], Ch.: “The Prophet’s Dis-
tance Away from Sins,” 4:1813 §2327.
17 Set forth by •al-Bukhari in al-Sahih: Bk.: al-‘Ilm [Knowledge], Ch.: “On the
Prophet (blessings and peace be upon him) Being Careful about Giving People
Admonition and Knowledge Lest They Feel Aversion to It,” 1:38 §69; •Muslim
in al-Sahih: Bk.: al-Jihad wa al-siyar [The Striving and Military Expeditions],
Ch.: “The Command to Make Things Easy and Not Making Others Feel Aver-
sion,” 3:1359 §1734.
18 Set forth by •al-Bukhari in al-Sahih: Bk.: al-Wudu’ [The Ablution], Ch.: “Pouring
Water Over Urine in the Mosque,” 1:89 §217; •Muslim in al-Sahih: Bk.: al-Tahara
28 Shaykh-ul-Islam Muhammad Tahir-ul-Qadri
[The Purification], Ch.: “The Obligation to Wash Away Urine and Other Impu-
rities,” 1:236 §§284–285.
19 Imam Ahmad b. Hanbal, al-Musnad, 3:479; 4:338; 5:32.
20 Ibn Qudama, Rawda al-Nazir, 1:386.
21 Ibid.
22 al-Shurunbulali, al-‘Iqd al-Farid li-Bayan al-Rajih mina’l-Khilaf fi Jawaz al-
Taqlid, University of King Sa ‘ud, Saudi Arabia.
23 al-Shinqiti, Nashr al-Bunud ‘ala Maraqi al-Sa‘ud, p. 349.
24 al-Qarafi, Sharh Tanqih al-Fusul ila Ikhtisar al-Mahsul fi’l-Usul, p. 339.
25 Ibid.
26 Ibid., Nafa’is al-Usul fi Sharh al-Mahsul, 9:3964.
27 Set forth by •Ahmad b. Hanbal on the authority of Abu Umama in al-Musnad,
5:266 §22345. •al-Ruyani in al-Musnad, 2:317 §1279. •al-Tabarani in al-Mu‘ jam
al-Kabir, 8:170, 216, 222 §§§7715, 7868, 7883.
28 al-Qarafi, Nafa’is al-Usul fi Sharh al-Mahsul, 9:3965.
29 al-Amidi, al-Ihkam fi Usul al-Ahkam, 4:244–245. al-Qarafi, Nafa’is al-Usul fi
Sharh al-Mahsul, 9:3962–3963.
30 Ibn al-Humam, al-Tahrir fi Usul al-Fiqh, al-Jami‘ bayn Istilahay al-Hanafiyya
wa’l-Shafi‘iyya, pp. 551–552.
31 Ibn Amir al-Hajj, al-Taqrir wa al-Tahbir ‘ala al-Tahrir fi Usul al-Fiqh, al-Jami‘
bayn Istilahay al-Hanafiyya wa’l-Shafi‘iyya, 3:446.
32 Ibn Mulla Farrukh, al-Qawl al-Sadid fi Ba‘d Masa’il al-Ijtihad wa’l-Taqlid,
p. 129.
33 ‘Abd al-Hayy al-Hanafi al-Laknawi, Majmu‘a Fatawa, pp. 319–320.
34 Ibn Nujaym, al-Bahr al-Ra’iq, 1:259.
35 Ibid., 4:7.
36 al-Haskafi, al-Durr al-Mukhtar, p. 323.
37 Ibid., Majma‘ al-Anhur fi Sharh Multaqa al-Abhur, 1:106.
38 al-Sarakhasi, al-Mabsut, 1:71.
39 Ibid., 11:123.
40 al-Kasani, Bada’i‘ al-Sana’i‘, 1:73.
41 Ibid., 1:74.
42 Ibid., 1:89.
43 Ibid., 2:115.
44 al-Zayla ‘i, Tabyin al-Haqa’iq, 1:351.
45 Ibn ‘Abidin al-Shami, Radd al-Muhtar, 1:332.
46 Ibid., 1:334.
47 Ibid., 1:357.
48 Ibid., 6:151.
49 al-Haskafi, al-Durr al-Mukhtar, p. 688.
50 al-Marghinani, al-Hidaya, 3:71.
51 al-Sarakhsi, al-Mabsut, 11:160. al-Marghinani, al-Hidaya, 3:6.
52 al-Kasani, Bada’i‘ al-Sana’i‘, 6:62.
53 Ibn Qudama, al-Mughni, 5:11.
54 Malik b. Anas, al-Mudawwana al-Kubra, 1:46.
55 al-Shafi ‘i, Kitab al-Umm, 5:102.
56 Sulayman al-Jamal, Hashiya al-Jamal ‘ala Sharh al-Manhaj, 2:514.
57 Ibid., 2:459.
58 al-Mawardi, al-Ahkam al-Sultaniyya, p. 48.
59 Ibn Hazm, al-Muhalla, 11:38.
60 Ibn Muflih, al-Furu‘, 6:116.
61 Ibid., al-Nukat wa al-Saniyya ‘ala Mukhskil al-Muharrar, 1:303.
62 Ibn Qudama, al-Mughni, 5:135.
63 Ibn Taymiyya, Majmu‘ al-Fatawa, 21:139.
 Methodology of inclusion 29
64 Shah Wali Allah al-Muhaddith al-Dihlawi, ‘Iqd al-Jid fi Ahkam al-Ijtihad wa
al-Taqlid, p. 178.
65 Ibid., pp. 178–179.
66 ‘Izz al-Din ‘Abd al- ‘Aziz b. ‘Abd al-Salam, Qawa‘id al-Ahkam fi Masalih
al-Anam, 2:158.
67 Shah Wali Allah al-Muhaddith al-Dihlawi, ‘Iqd al-Jid fi Ahkam al-Ijtihad wa
al-Taqlid, p. 172.
68 Set forth by •al-Jassas in Ahkam al-Qur’an, 2:314; •al-Ghazali in Ihya’ ‘Ulum
al-Din, 1:27; •al-Nawawi in Sharh Sahih Muslim, 11:91–92; •Mulla ‘Ali al-Qari in
Mirqat al-Mafatih, 1:59; •al-Hindi in Kanz al-‘Ummal, 10:59.
69 Wali Allah al-Dihlawi, ‘Iqd al-Jid fi Ahkam al-Ijtihad wa al-Taqlid, pp. 173–174.
70 Qur’an 4:59.
71 Ibid.
72 Ibid.
73 Ibid.
74 al-Sha‘rani, al-Yawaqit wa al-Jawahir, 2:478. Shah Wali Allah al-Dihlawi, ‘Iqd
al-Jid fi Ahkam al-Ijtihad wa al-Taqlid, p. 216.
75 al-Zarkashi, al-Bahr al-Muhit fi Usul al-Fiqh, 4:577.
76 Ibn Taymiyya, Majmu‘ al-Fatawa, 20:19.
77 Ibn ‘Abidin al-Shami, Radd al-Muhtar ‘ala al-Durr al-Mukhtar, 1:87.
78 Ibid., Sharh ‘Uqud Rasm al-Mutfi, pp. 6–8.
79 Ibid., Radd al-Muhtar ‘ala al-Durr al-Mukhtar, 4:80.

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2 Recent development in Islamic
finance and financial products
M. Ishaq Bhatti, Naseem Al Rahahleh and
Hussain Mohi-ud-Din Qadri

2.1 Introduction
In general, banks and financial institutions1 operate as service providers to
connect between borrowers and lenders. Their main function is to receive
money from individuals (depositors) and channel it to clients who need the
money (entrepreneurs) for joint venture and/or infrastructure investment
projects. Most of these transactions and services are based on interest
(Ribah) in conventional banking industry. However, practicing Muslim
clients are not using interest-based banking because under Islamic Shari’ah
jurisdiction Ribah-based transactions are strictly prohibited. Islam encour-
age trade but paying and/or charging interest (Ribah) is not allowed. To
overcome on this issue Muslim jurists proposed interest-free (without usury)
financial transactions which is an ethical approach to banking services
called Islamic Banking and Finance (IBF). The demand for an IBF industry
is expanding to cater the need of more than 1.4 billion Muslims around the
world. The general consensus amongst orthodox interpretations recognize
clear regulations in the “Quran”,2 which states that all business transactions
should be free from ‘Ribah’.3 The demand for IBF around the world creates
this niche market, so banking industry is rushing to tap-up their services to
attract Muslim clients. IBF is an interest-free banking system based on the
strict adherence of Shari’ah norms, which are stated in the Quran as below.

Those who consume interest cannot stand [on the Day of Resurrection]
except as one stands who is being beaten by Satan into insanity. That is
because they say, ‘Trade is (just) like interest’. But Allah has permitted
trade and has forbidden interest. So whoever has received an admoni-
tion from his Lord and desists may have what is past, and his affair rests
with Allah. But whoever returns to (dealing in interest or usury) – those
are the companions of the Fire; they will abide eternally therein.
Quran 2:275

O you who have believed, do not consume usury, doubled and multi-
plied, but fear Allah that you may be successful.
Quran 3:130
 Development in Islamic financial products 33
The IBF model can be derived from the two verses of the Quran above,
which prohibit Ribah in any business transaction. Therefore, the IBF in-
dustry is regulated under five pillars of Shari’ah principles (Islamic law)4:
(i) interest-free, (ii) ethical financial activities – halal or permissible, (iii)
asset-based and asset-backed, (iv) partnership investment based on PLS be-
tween financer and entrepreneur, and (v) sharing the risk.5
In recent years, IBF has proven to be the fastest growing (12%–15%) sec-
tor. Its popularity is increasing globally, particularly in regions with a large
Islamic population, such as the Gulf Cooperation Council (GCC), Bangla-
desh, Brunei, India, Indonesia, Iran, Malaysia, and Pakistan. This growth
in IBF can be seen largely as a result of the technology boom, as well as
record high oil and commodity prices. The Islamic banking system enjoys
higher positive returns compared to its conventional counterparts. Addi-
tionally, returns in the IBF sector have been relatively stable during recent
financial crises, such as the global financial crisis (GFC) in 2007 and the
Asian financial crisis (AFC) in 1997.
Moreover, IBF has the potential to play a crucial role in supporting the
implementation of the Sustainable Development Goals (SDGs). In the face
of significant financing needs for the SDGs, Islamic finance has untapped
potential as a substantial and non-traditional source of financing for the
SDGs. The growth of Islamic finance has been rapid over the past two dec-
ades, including GFC and AFC periods.6 This can be seen as a result of re-
ligiously based investment made by a large number of Muslims. The main
motivating factor may be the risk-sharing characteristics, which can play a
key role in mobilizing funds to long-term investments. This is a pertinent
example of how IBF can be utilized to release the potential of long-term
financing that advances social, environmental, and economic goals (see
Islamic Development Bank Group 2018).7
The aim of this chapter is to review recent literature on the IBF industry.
Divided into four sections, the chapter follows the development of Islamic
finance from its historical background to its modern advancement. It begins
with a brief introduction of the history associated with the IBF industry in
the time of the Prophet Muhammad (PBUH). The proceeding sections pres-
ent the major products of IBF and discuss the complexity of risk associated
with the industry. The final section contains some concluding remarks.

2.2 History of Islamic banking and its recent development

The establishment of Islamic banking, in its wider sense, dates back to the
early days of Islam and the rise of the Islamic Empire in the 6th century.
Various consequential Islamic governments thrived in internal and exter-
nal trades, and thus formed Islamic financial tools such as deposits, money
transfers, checks and bills of exchange to cope with these commercial de-
velopments. IBF history is a new phenomenon based on old financial in-
strument. Its historical development can be divided into three parts: (i) the
34 M. Ishaq Bhatti et al.
Era of the Prophet and the orthodox caliphs, (ii) the Umayyad and Abbasid
Eras, and (iii) the modern day. In the following section, we will briefly elab-
orate on the development of IBF in various eras.

2.2.1 The Era of the Prophet and the orthodox caliphs

The concept of IBF started in 595 CE, when Prophet Muhammad (PBUH)
entered into a profit-and-loss sharing (PLS) contract with Khadijah, a
wealthy business woman who later became his wife. Throughout his life-
time, Prophet Muhammad (PBUH) was involved in various modes of fi-
nancial transaction. Some of these include Shirkah (partnership based on
PLS), Al qard Al hassan (benevolent loan), Salam (Forward contract), Sarf
(exchange), and Ijarah (leasing). These fundamental modes of IBF were de-
veloped further by the four rightly guided caliphs, following the death of the
Prophet. The first caliph, Abu Bakr Assidique (632–634 CE) established an
institution of zakat to be paid by capable individuals to the state’s central
bank, as a compulsory alms (or charity) and one of the five pillars of Islam –
all Muslim must pay 2.5% zakat out of their annual savings if the total is
more than the Nisab for an entire year at any given month.
The second caliph, Umar ibn Al-Khattab (634–644 CE), made dramatic
reforms in the economic policy of the Islamic state. Namely, the introduc-
tion of a centralized and permanent Bait al-mal (the Treasury House) in
which all the state’s earnings, including Zakat and tax, should be depos-
ited for appropriate use by the government. The third caliph, Uthman ibn
Affan (644–656 CE) was the first Muslim ruler who adopted precious metal
coins as the state money. He introduced gold and silver coins into an Islamic
financial system to run Islamic state business with rest of the world. The
last caliph, Ali ibn Abi Talib (656–661 CE) established equidistributional of
wealth and financial justices based on Islamic financial products which were
established by earlier caliphs. He instructed governors of various regions
under Islamic state to adopt simple lifestyle and establish strict financial
management system to encourage savings and investment in infrastructure
development. The post-661 CE era is called the Period of the Noble Com-
panions and the Succeeding Generations, who further advanced as a result
of the tremendous increase in commercial interaction between merchants
in the Islamic state and the rest of the world. During this period, academic
scholars concentrated on the development of fiqh (Islamic jurisprudence)
and furthered economic reforms which were based on self-exerted judgment
(Ijtihad) to cater for the rising demand of IBF.

2.2.2 The Umayyad and Abbasid Eras

The Umayyad Caliphate (661–750 and 1031 CE) became one of the largest
unitary states in history and one of the few states to ever extend direct rule
over three continents. When the Abbasid’s took over from the Umayyad,
 Development in Islamic financial products 35
one of the Umayyad family members, Abd al-Rahman ibn Mu’awiya, mi-
grated to modern Spain, resulting in an Umayyad Caliphate in Al-Andalus
(or the Caliphate of Córdoba), which lasted until 1031 CE. The period was
characterized by an expansion of trade and culture, where the IBF industry
thrived and advanced. As the financial hub of Europe, the state of Córdoba
saw the innovation and successful practice of IBF products such as PLS,
Musharkah, Mudarbah and Murabaha, deposits, money transfers, checks
and bills of exchange. As the capital of the Umayyad Caliphate shifted to
Damascus, the Treasury House was formed as a separate building desig-
nated as Bait al-mal, which was still significant during the Abbasid and
Mamluk periods that followed. The Abbasid’s used Gold dinar and silver
dirham as mediums of exchange. On the other hand, the Ottoman empire
had minimal contribution to IBF, as they focused on socio-economic devel-
opment. The historical details are summarized in Table 2.1.

2.2.3 Modern-days experiments of Islamic banking and finance

Islamic financial practices gradually withered as a result of the demise of
Islamic empires such as the Umayyad, Mughal, and Ottoman empires.
The rise of western colonial powers in the 16th century resulted in the re-
placement of IBF practices by interest bearing western financial models.

Table 2.1 Islamic Banking at an Historical Glance

Islamic Banking Brief History

During Prophet Era Period of the Caliphs: The Umayyad and Abbasid
570– 632 CE (632– 661 CE) Eras (661–1258 CE)

1 Musharkah or Shirkah 1 Abu Bakr Siddiq – 1 Issuance of Islamic

(partnership) based on Established obligatory dirham and dinar coins.
PLS. Zakat Institution. 2 Treasury House
2 Al-Qard al-Hassan (No 2 Umar ibn Al-Khattab – extension as central Bait
interest – benevolent Established Bait al-mal al-mal.
loan). (the Federal Treasury 3 The Central Bank/
3 Salam (Forward) House). Treasury House became
contract. 3 Uthman ibn Affan – The significant during the
4 Sarf (exchange of introduction of the first Abbasid era and the
money), i.e. gold for gold Muslim Gold/Silver dinar (Gold) and dirham
and silver for silver at the coins. (Silver) were still being
same sitting. 4 Ali ibn Abi Talib – used as mediums of
5 Ijarah (leasing). Strengthened the exchange
6 Trans-regional trade Prophet and former 4 Establishment of House
involved trade caravans caliphs’ established of Wisdom. (To innovate
from Makkah to greater sustainable economic new business, promote
Syria and back. and financial policies. science, engineering, and
7 Zakat (2.5% the finance.)
obligatory giving of alms 5 Establishment of the
to the poor and needy) Institution of Ijtihad.
 36 M. Ishaq Bhatti et al.
However, the demise of these powers after the Second World War led to
the revival of IBF in Muslim countries – an event widely known as the
beginning of the era of Islamic resurgence. The emergence of several Is-
lamic scholars and movements became the impetus for Muslims to apply
Islamic teachings in all areas of human endeavors, including economics
and finance, as part of mumalat. As a result, the elimination of Ribah from
the economic and banking system became an increasingly common focus
amongst contemporary Islamic scholars. The historical date-wise events in
this new era of IBF industry are given in Table 2.2.

Table 2.2 Modern History IBF from 1962 to 2016

Time line Country IBF Activities

1940 Malaysia The objective of the first institution in Malaysia was to

invest prospective pilgrim savings in the real estate
and plantations in accordance with Shari’ah but it was
unsuccessful.
1947–1962 Pakistan In 1947, Pakistan establishment a local Islamic Bank in the
rural area in which land owners deposited their money
to the bank, which was later loaned to other land owners
for the purpose of agriculture development. In 1962 when
the State Bank of Pakistan (SBP) was asked to explore
the possibilities of implementing IBF in the country. The
IBF products included PLS, Mudarbah, Musharkah, and
Islamic deposits – held by fully-fledged Islamic banks
and Islamic windows of conventional banks. These banks
attract 9.7% of total bank deposits and offer Islamic
Financial Services with a value of 9% of banking assets
in the country. Pakistan becomes the first nation to
“Islamize” banking practices at the state level, and this
process continues until 1985. Currently, there are eight
IBFs in Pakistan.
1963–1967 Egypt Mit Ghamr Local Savings Bank in Egypt started the first
modern-day trial of Islamic banking by Ahmad El Najjar
but there is no reference to Islam due to the secular
dictatorial regime of Gamal Abdel Nasser.
1963–1969 Malaysia The Malaysian Pilgrims Savings Corporation was
incorporated in 1962 but not launched until 30
September 1963. It became the Board of Tabung Haji
in 1969, facilitating Islamic believers’ savings for their
pilgrimage to Makkah by investing in Shari’ah-compliant
investment.
1975 Saudi In October 1975, the umbrella Islamic financing institution,
Arabia the Islamic Development Bank (www.isdb.org) opens in
Jeddah, Saudi Arabia. It gave the Islamic finance industry
an international presence, recruited member countries,
and then offered them financial products to promote
economic and community development. Between 1975
and 2005 it funded more than $50 billion worth of projects
in Organisation of Islamic Cooperation (OIC) member
countries.
Time line Country IBF Activities

1975 UAE Dubai Islamic Bank (DIB) was the first fully-fledged Islamic
world commercial bank to start operating in 1975. The
DIB model was based on five main business operations:
retail banking, corporate banking, real estate, investment
banking, and proprietary trading investments.
1976 The Islamic Economics Institute (IEI) is an academic
institution that promotes the ‘Just economic system’ as a
way to achieve human happiness. IEI believes in concerted
efforts to make this aim possible. It was established in
1976 as a research center, and evolved into an “Institute”
in 2011, to provide educational graduate programs, and
to serve the private sector by conferring diplomas and
implementing training courses.
1977 Egypt and Faisal Islamic Bank was established with major branches in
Sudan Egypt and in Sudan.
1977 Kuwait Kuwait Finance House was established in 1977, and it is
the largest IBF in the world with branches in the UK,
Australia, and Malaysia.
1978 Jordan Jordan Islamic Bank established in Amman in 1978.
1979 Sudan In 1979, the first Islamic insurance (or Takāful) company
– the Islamic Insurance Company of Sudan – was
established. (Muslims cannot purchase conventional
insurance products because those products involve
interest-based transactions, uncertainty, and gambling,
which are all prohibited by Islamic law.)
1979 Iran Soon after the Islamic revolution in 1979 (lead by Ayatollah
Khomeini) the Islamic Republic of Iran’s national banking
system was transformed to 100% IBF. In 1983, the Law of
Usury-Free Banking was passed, and on March 21, 1984,
it was implemented to all sorts of public and private banks
and financial institutions.
1983 Malaysia July 1983: Malaysia opens its first official Shari’ah-compliant
bank, known as Bank Islam Malaysia. Other banks also
offer Islamic products and are supervised by the central
bank, which is advised by a board of Shari’ah scholars.
1983 Sudan Sudan reforms its banking system on Islamic principles after
President Gaafar Al-Nimeiry establishes Shari’ah law.
Dual banking system develops, wherein it is Islamic in the
north and conventional in the south.
1984 Iran Iran switches to interest-free banking at the national
level after passing a 1983 Islamic banking law that was
promised in the 1979 Islamic revolution. The second
country to fully Islamisize it’s banking services.
1986 USA The Amana Income Fund, the world’s first Islamic mutual
fund (which invests only in Shari’ah-compliant equities),
was created in Indiana.
1987 Saudi Al Rajhi Bank was established, and it is now one of the largest
Arabia banks in the Muslim world. Its branches are now operating
in the KSA, UAE, Malaysia, Indonesia, and Turkey.
1990 Bahrain The international Islamic accounting standards organization
known as Accounting and Auditing Organization for
Islamic Financial Institutions (www.aaoifi.com) was
established in Bahrain by the IDB.
(Continued)
 38 M. Ishaq Bhatti et al.
Time line Country IBF Activities

1991 Indonesia Indonesia’s first officially sponsored Islamic bank, Bank

Muamalat, established.
1993 Malaysia Negara Malaysia (BNM) began offering Shari’ah-approved
products and services through the Islamic window which
is also known as the Interest-free Banking Scheme (IFBS)
in 1993.
1996 Bahrain Citibank began offering Islamic banking services when it
established the Citi Islamic Investment Bank in Bahrain.
1999 USA, The Dow Jones Islamic Market Index (DJIMI) was
Malaysia, established, becoming the first successful benchmark for
UAE the performance of Islamic investment funds.
2002 Malaysia The international standard setting organization known as
the Islamic Financial Services Board (IFSB, see www.ifsb.
org) was established in Kuala Lumpur to set the standards
for Islamic financial institutions.
2004 UK Islamic Bank of Britain – the country’s first Shari’ah-
compliant high street bank – opens in London.
2006 UAE Dubai’s main stock exchange, the Dubai Financial Market,
announces it is restructuring itself to become the world’s
first Islamic bourse.
2009 Singapore Singapore launches the first Islamic bond program in its
competition with Malaysia for market share.
2009 Indonesia Indonesia, the world’s most populous Muslim country, sells
its first retail Shari’ah-compliant bonds, known as sukuk.
2009–2010 Australia Launches the first ever IBF program and organizes the
world’s largest IF conference in the Australasian region.
At the 2010 IFN conference in Malaysia, Federal Minister
Nick Sherry announces government’s commitment to IBF
with new IBF regulations.
2014 UAE The UAE Islamic banking sector was valued at US$127
billion at the beginning of 2014 and is expected to reach to
US$265 billion by the end of 2019.
2016 North Thomson and Reuters in its 2016 report estimate that in
America Canada alone, 8–10 billion IF activities will be required
in the near future. It states that Canada’s Islamic finance
aspirations are strong in several areas: across asset
management, Islamic investment fund, Shari’ah mortgages,
sukuk, retail and wholesale banking, and as a source of
foreign capital. These will benefit the country’s companies
and its government operations, given that Canada has large
infrastructure investment needs to carry on future projects.

However, the inability of IBF to successfully integrate within the econ-

omy in the early 20th century can be seen as a result of various factors, the
most prominent of which was excess demand in credit – where the number of
borrowers exceeded the amount of money being leant. This rising dynamic
between available capital and credit demand, as well as a lack of autonomy
for employees in the banking system, can be seen as major setbacks in the
integration of IBF in the early 20th century.
 Development in Islamic financial products 39
2.3 IBF products and its recent development
The process of Ijtihad allows innovation within the IBF industry to meet
the increasing demand of both Muslims and non-Muslims. In general, the
modes of Islamic finance are divided in four major types: (i) participatory
mode, (ii) sale mode, (iii) rent-based mode, and (iv) Islamic capital market
(ICM) based modes of financing capital.

Participatory Mode Sale Mode Rent-Based Mode ICM

Mudarba Murabaha Ijarah Sukuk

Musharkah Istisna Tawarruq Takāful
Diminishing Salam Re-takāful
Partnership

The most popular and practiced products in the Islamic Financial Industry
are Murabaha, Bai Bithaman Ajil (BBA), and Tawarruq. The second most
frequently used is Ijarah, and the least practiced modes of finance in the
world are Musharkah and Mudarbah. For financing capital, the most popular
products among Muslims and non-Muslims are sukuk and Takāful. For the
sake of continuity in our understanding, these products are defined below:

2.3.1 Brief explanation of historical IBF products

The IBF products can broadly be divided into two major classes: equity-
based and debt-based. Among equity-based products the most common are
Mudarbah and Musharkah (partnership financing). Equity financing are the
joint ventures between the banks and individuals. Debt-based financing,
which tends to involve lending and providing credit, is the more popular
group of products, and is provided by Islamic banks. In terms of debt-based
products, there is a very broad range, and can be divided into leasing and
forward sale financing.8

i BBA: It is a sale in which the payment is at a deferred time and price,

with the bank purchasing goods on a deferred payment basis (Shan-
mugam and Zaharina, 2009). The sale is on a cost-plus basis, in which
there is a guarantee on the deferred payment price of goods, regard-
less of the costs which amount to the price (such as markups). In such
sales, both parties involved must agree and know the costs, profits, and
markup of the transaction in question. In most occasions, such sales in-
volve a third party (Obaidullah, 2005). BBA is however a predominantly
Malaysian practice but is now being practiced in other countries.
ii Murabahah: A debt-based product whereby the bank, on a customers’
request, purchases goods and then sells it to the customer at a marked-up
price. This form of financing tends to be used on the short term and cur-
rently is the backbone of Islamic financing (Shanmugam and Zaharina,
2009).
40 M. Ishaq Bhatti et al.
iii Ijarah (leasing): It is the hiring of a physical object or asset, in which
payments are made on predetermined rentals. The bank is never the
actual user of the asset, as they have purchased the asset on the request
of the customer. However, the bank legally owns the asset, regardless of
whether the full payment has been received for the asset. Based on the
pre-agreed rentals of the item, the bank is able to receive substantial
returns on the asset over time. The bank essentially is the vendor of the
asset for the period of the leasing. At the end of the period of leasing,
the asset still remains owned by the bank. This differs from Murabahah,
where the assest’s ownership is then transferred to the customer.
iv Salam (Deferred Delivery Sale): It is when there is a forward agreement
established for goods, where delivery is deferred. Under such an agree-
ment the trader can sell the goods and attain short-term funds imme-
diately, and then would receive the full payment once the delivery has
taken place. Bai Salam is a form of deferred delivery whereby the bank
purchases goods from sellers as a forward sale and then sells the goods
upon attainment in the market.
v Istisna (Manufacturer Sale): It is a form of forward sale which is spe-
cific to manufactured goods. Both the buyer and the seller form a con-
tract for a sale on goods which will be manufactured in the future, with
the price set beforehand. The buyer must however be fully aware of the
specifications of the sale. The sale takes place with the bank as the me-
diator between the buyer and seller.
vi Istijrar: It is the delivery of a commodity in installment, over a period of
time. The payment is made for total commodity over a period of time.
The time and payment price of the commodity is fixed when the con-
tract is made.
vii Qard or Qard Hassan (no interest loans): This is when an amount of
capital is borrowed by a customer and then returned on maturity with-
out any additional charges of interest. Essentially, it is an interest-free
loan, with the borrower only charged a small sum to cover the adminis-
trative expenses. Recent development in the application of Qard Hassan
can be seen in Australia.9
viii Partnerships financing: There are two main asset-based and assets-
backed products provided by Islamic banks (Mudarbah and Musharkah)
in the form of financial partnerships between the bank and the investor/
entrepreneur.
a Mudarbah: It is more entrepreneurial in financing than Musharkah.
Both forms of financial involve the bank providing capital fi-
nance for a certain or specific venture identified by the customer.
Although the bank is the owner of the capital, management and
success lies with the entrepreneur. When setting up such a partner-
ship, the bank and the entrepreneur first establish a business plan
which indicates the venture and the purpose and flow of capital.
After this the entrepreneur establishes the business and operation
 Development in Islamic financial products 41
and generates (after a period of time) either a profit or loss. The
profit is shared on a predetermined ration between the bank and
the entrepreneur with any loss being absorbed by the bank, which
would reduce the overall value of the assets and investment.
b Musharkah: This is more so a joint venture, in which both the cus-
tomer and the bank equally contribute to the investment. Both the
bank and the customer pool capital together which is then invested
into a venture, with the profit-sharing ratio being predetermined.
The losses are also shared in relation to the amount of capital in-
vested by each party. After both the customer and the client have
established a business plan for the venture, they jointly contribute
capital and share responsibilities of managing the business and its
operations on pre-agreed terms.
Adeinat, Al Rahahleh, and Bhatti (2019) stated that IBF in the current bank-
ing environment concentrates on debt-based financing and is hesitant to of-
fer equity-based financing contracts. The main reason is the higher credit
risk associated with equity financing as compared with debt-based financ-
ing, as a result of greater risk in equity financing for banks if the lessee does
not provide collateral (Ariffin, Kassim, and Abdul Razak, 2015). Samad,
Gardner, and Cook (2005) have shown that in the IBF context, mark-up
products, such as Murabahah and Ijarah, are easily the most popular such
that they dominate Islamic banking.

2.3.2 New financial products (new innovations)

i Cryptocurrency-Bitcoin
Meera (2018) stated that “cryptocurrency is a digital money that is
made highly secure using some leading edge cryptography technology.
It secures the issuance of the digital money, its transfers and its histori-
cal chronological transactions record” (p. 477). Currently, Bitcoin is the
most popular form of cryptocurrency.
Bitcoin has long been subject to debate on its compliance with the
Islamic world of finance. Meera (2018) concludes that cryptocurrencies
that are not backed with real assets are not Shari’ah-compliant. How-
ever, the majority of Shari’ah scholars are leaning towards approving
Bitcoin on a basis of maslahah. Meera (2018) also concludes that gold-
backed cryptocurrencies are argued to be desirable and consistent with
the maqasid al Shari’ah. Asif (2018) concludes that although the technol-
ogy of cryptocurrencies in itself is Halal, the cryptocurrency ecosystem
consists of both Halal and Haram elements. Evans (2015) analyses the
blockchain technology along with Bitcoin, he concludes that both con-
form to the requirements laid out by Islamic law. Adam (2017) argues
that although Bitcoin possesses the traits of wealth and legal value, it
fails to stand as a currency, yet any return attained would be lawful
according to Islam.
42 M. Ishaq Bhatti et al.
ii Islamic Derivatives Products
In this subsection, we will examine IBF contracts that have derivative-
like features that can be used for the same purpose of hedging as for-
wards, futures, options, and swaps. Kunhibava (2010) states that there
are two main schools of thought regarding the status of derivatives in
Islamic finance. The first one, with the majority of scholars opposed to
the conventional derivatives (i.e., forwards, futures, and options) are im-
permissible in Islamic finance. However, there is a need to find Islamic
alternatives that comply with the Shari’ah or develop derivative-like
instruments (e.g., salam, istisna, arbun, wa’d, and Jialah). Uddin (2015)
pointed out that majority of the scholars argue that conventional futures
are not permissible under Islamic law because of specific features, such
as delay in both counter values, sale of one debt for another, excessive
uncertainty, and speculation. The second school of thought,10 which is
the minority view, believes that conventional derivatives are a greatly
needed tool to enable Islamic finance to proceed to further heights.
Research on Islamic derivatives from the perspective of Islamic law is
still in its early stages. Uddin (2015) pointed out that futures contracts
are being urged to be reconsidered by the ulama’ for hedging purposes
and still unresolved. He further states that “although the issue has been
addressed by a number of institutions, such as Makkah-based Fiqh
Academy, ……. the outcome of these discussions has been to urge the
prohibition of derivatives”(pp. 4).
Kunhibava (2010) and Uddin (2015) pointed out that Malaysia re-
solved that commodity futures, as well as several others, are permissible
and in accord with Shari’ah law. In 1997, the Shari’ah Advisory Council
(SAC) of the Securities Commission in Malaysia concluded that com-
modity futures on Crude Palm Oil contracts are permissible and in ac-
cordance with Shari’ah principles. In 1998, SAC resolved that trading
stock-index futures contracts are allowed, which is accomplished by
ensuring that the index component is made up of Shari’ah-compliant
securities. In November 2006, Malaysia witnessed the signing of the de-
rivative master agreement to document Islamic derivative transactions
between Bank Islam Malaysia Bhd. and Bank Muamalat Malaysia Bhd.
Nevertheless, these developments have been primarily based in
Malaysia; there has yet to be a similar movement to adopt derivatives
in other parts of the Islamic financial world. Perhaps this is due to the
overwhelming objections to these instruments.

2.4 Risk associated with IBF industry11

The concept of risk in financial institutions consists of two unique attributes
that can be applied to both IBF and conventional banks (CB) (Hazli Zakaria
and Ghafar Ismail, 2008). Risk in financial institutions can be grouped into
systematic and unsystematic risks. Both types of risks will have a negative
consequence for financial institutions’ performance if they fail to manage
 Development in Islamic financial products 43
operations well. Excessive risk exposure can affect not only the profitability
of the banks but also the safety and soundness of banks in the future. The
GFC in 2008–2009 witnessed a few established commercial banks collapsing
due to their excessive risk-taking activities. Abedifar et al. (2015) find there
has been an increased interest in risk in banking in general as well as in
the Islamic world following the GFC. Saunders and Cornett (2006) explain
in more detail about the types of risks in financial institutions. According
to them risk can be categorized into five types: (i) credit risk, (ii) interest
rate, (iii) liquidity risk, (iv) underwriting risk, and (v) operating risk. A few
scholars claim that in the case of commercial banks these five categories
can be further narrowed down to three major risks: credit risk, market risk,
and operational risk (Apostolik, Donohue, and Wnet, 2009; Basel, 2003a;
Carey and Stulz, 2005). They argued that these further classifications will
help banks’ management be more focused and develop better risk manage-
ment frameworks. These three risk types are explained in more detail below.
Credit risk is defined as risk where the value of a portfolio may change due
to unexpected changes in the credit quality of the issuer or trading partner
(McNeil, Frey, and Embrechts, 2005). Changes in credit quality such as down-
grading of borrowers in an internal or external rating system can cause losses
to financial institutions. Marrison (2002), Hull (2007) and Arunkumar and
Kotreshwar (2005) define credit risk as the possibility of the borrower, bond
issuers, or counter-parties defaulting or being unable to meet the contractual
obligation and repay back the promised amount. Financing is the main source
of income for commercial banks, and therefore credit risk cannot be avoided.
Market risk arises due to uncertainty about cash flows emanating from
changes in the value of financial instruments caused by the adverse move-
ment of market indicators. These include, for example, interest rates, market
prices, and exchange rates. Bangia et al. (2002) claim that market risk is a
risk related to portfolio value changes driven by trading returns. Trading re-
turn can be calculated by estimating the difference between bids and asking
price of financial instruments. Therefore, the more volatile the prices, the
greater the market risk.
Operating risk is a potential risk where the technology or support sys-
tem may malfunction or break down. A failure in back-office systems is one
example of operational risk. However, according to Saunders and Cornett
(2006) operational risk is not only limited to technology or system failure,
but at least five sources of operational risk: technology, employees, cus-
tomer relationships, capital assets, and external events. Basel (2003b) de-
fines operational risk as the risk of losses resulting either from inadequate
or failed internal processes, people, and systems, or from external events.
Operational risk has become an important part of financial institutions’ risk
management partly because it was highlighted by the Basel Committee on
Banking Supervision (BCBS), and partly because of disruptions associated
with the September 11, 2001, attacks. Since then financial institutions have
increasingly allocated capital to operational risk (Carey and Stulz, 2005).
A survey done by Vasseux (2009) on ten large international banks reveals
44 M. Ishaq Bhatti et al.
that banks allocated 53% of their economic capital to credit risk, 26% to
operational risk and other risks, and 21% to market risk and asset-liability
rate risks.12 A higher proportion of operational risk compared to market
risk shows that banks start to realize the impact of operational risk on their
functions and therefore are making more effort to allocate more capital.
Iqbal and Mirakhor (2007) discuss risks in IBFs. They classified risk in
IBFs into four major categories: financial risk, business risk, treasury risk,
and governance risk. In the discussion of categories of risk by Iqbal and
Mirakhor (2007), they do not explain which one belongs to systematic and
unsystematic risk. Al Rahahleh, Bhatti, and Misman (2018) proposed a
framework for the grouping of risk for IBFs by making some changes to
the previous discussions. Figure 2.1 illustrates the risk profile of IBFs by
considering systematic and unsystematic risk classification. This frame-
work divides risk into three main groups: systematic, unsystematic, and a

Rate of return risk

Systematic risk Business risk

Displaced
commercial risk

Operational risk

Unsystematic risk Governance risk Reputation risk

Risk in Islamic
Banks Shari’ah risk

Credit risk

Financial risk Market risk

Equity risk
Systematic and
unsystematic risk

Liquidity and
solvency risk
Treasury risk

Hedging risk

Figure 2.1 Classification of risks in IBFs.

 Development in Islamic financial products 45
combination of the two called SUR. Under this new framework, only busi-
ness risk belongs to systematic risk. Governance risk that consists of oper-
ational, reputation, and Shari’ah risk is classified under unsystematic risk.
The other two groups of risks are financial risk and treasury risk, and they
are classified under SUR and not under the traditional types of risk. This
is because systematic and unsystematic risks are due to their very nature.
Financial risk consists of credit, market, and equity risk and cannot only
be classified under systematic or unsystematic risk because the risk involved
comes from both external and internal sources. For example, credit risk is of
a default payment by the borrower, but in the case of IBFs, banks operating
as an entrepreneur or buyer, in that IBFs provide financing rather than just
a normal loan. Therefore, credit risk in IBFs may result from changes in
economic or market conditions or from internal weaknesses of the banks.
In Shari’ah an Islamic bank is either an investor or seller when it provides
financing to its customers. In this way, it will be able to control risk ex-
posure when making decisions about providing any finance. The failure to
making the right decision will contribute to the possibility of credit risk in
the future. Risk becomes a big challenge in IBFs particularly in an age of
globalization. In order to ensure the survival of IBFs in the finance market,
any issues concerning risk and its management must be handled properly
and not jeopardize Shari’ah prohibitions.

2.5 Development in ICM

Recent trends in global capital markets have been driven by a gradual pickup
in economic conditions, global policy uncertainties, and emerging and de-
veloped markets’ causality forward and backward relations in terms of risk
vis-à-vis return balance. The year 2016/2017 witnesses an increase in inves-
tors’ risk appetite, strengthening of the stock market in many jurisdictions,
and a moderation in financial volatility amid a generally optimistic global
financial and liquidity environment. In this section, we attempt to show the
ICM expansion and current situation effecting the future IBF industry.

2.5.1 Sukuk industry

Global sukuk issuances in 2017 saw a growth of 22.8%, with the total volume
of annual issuances reaching US$91.9 billion as at the end of 2017, compared
to US$74.8 billion in 2016. This continues the gradual recovery of sukuk
markets over the past two years following the sharp contraction observed
in 2015. At the end of 2017, the total volume of sukuk outstanding stood
at US$399.92 billion, which represents a 10% growth in volume of sukuk
outstanding from 2016. However, total issuances for 2017 still remain below
the US$131 billion mark – the highest annual volume of sukuk issuances to
date – although the recent growth trajectory indicates a gradual closing of
this gap (IFSB 2018).
46 M. Ishaq Bhatti et al.
2.5.2 Takāful industry
The global takāful industry has sustained double-digit growth in recent
years although growth has moderated in key markets, owing to challenging
economic conditions, complex regulations, and compliance and operational
challenges in the takāful industry. In 2016, the global insurance market re-
ported steady growth rates, supported mainly by emerging markets. Non-
life premiums in emerging Asia expanded at a rate of 7.3% in 2016, after a
strong 9% growth in 2015. Another notable trend in emerging Asia was the
slowdown in motor insurance uptake following lower car sales. The expan-
sion of general takāful business outpaced that of family product line, aided
mainly by mandatory covers in the medical and motor businesses.

2.5.3 Future of Islamic finance industry

The global IBF industry has grown rapidly over the past two decades, reach-
ing total assets of US$2.2 trillion as of the end of December 2016 – an increase
of 7% over 2015. In keeping with this growth, Shari’ah-compliant financial
products and services have increased their reach to more than 50 Muslim
and non-Muslim countries. Asian countries such as Japan, South Korea,
Hong Kong, and China are tapping up with the industry. In predominantly
Muslim countries, governments have enacted laws such as the Islamic Fi-
nancial Services Act 2013 in Malaysia and Act No. 21 of 2008 in Indonesia
to provide Shari’ah-compliant legal frameworks for the regulation of Islamic
banks and their business operations. There is also growing demand for IBF
in non-Muslim countries, fueled by individuals and corporations seeking
safe and ethical banking solutions. This broader popularity is evident in the
change of Australian regulation can now cater the need of IBF regulations.
Similarly, UK Financial Services Authority’s policy of fairness and justice is
in line with the guidelines set out by the IFSB 2018. The sector is expected to
continue to expand in 2018 with the same rate as previous years.

2.6 Concluding remarks

This is a comprehensive review chapter covering all the aspects of IBF in-
dustry. It begins with the first ever IBF contract between Prophet Muham-
mad (PBUH) in 595 CE with Khadija, the richest business women of Arabia
at that time. Since then the practice of various IBF contracts continued
during his life time and soon after. The IBF contract practices strictly fol-
low Shari’ah laws which were implemented by all caliphs in all over Islamic
empire, called Caliphate from 632 CE. The IBF institutional structure was
observed by Umayyad, Abbasid, Al-Andalus (Spain – 1031 CE), and Otto-
mans and the Moghuls empires (1530 CE).
IBF’s recent operation started from Pakistan in 1947, followed by Ma-
laysia and Egypt in 1963 from a small town of Mit Ghamr’s (MG). The
 Development in Islamic financial products 47
chapter discuss historical development of IBF products from the very be-
ginning until the 21st century. It reviews various products in a summarized
tabular format and analyses issues of risk associated with the IBF industry.
The chapter concludes with a summary of many new contracts and prod-
ucts based on derivatives, cryptocurrencies, blockchain, and an innovative
approach to IBF industry.

Notes
1 Banking functions operated, as deposit-taking institutions (ADIs), facilitate in-
termediation between savers and investors; transfer funds from surplus units to
deficit units; and manage payments and clearing systems (EFTPOS, cards, BPAY,
cheques, etc.). IBF is based on three main rules: They (i) are not involved in busi-
ness activities where there is Ribah (interest, usury), gharar (excessive uncertainty),
and haram (impermissible) activities; (ii) operate on PLS principle; and (iii) em-
phasize productivity and real economic activity rather than credit worthiness.
2 The Quran is the holy book for all Muslims and their main source of guidance
when conducting their daily lives and activities, to seek pleasure of God –
Almighty Allah (Ω) ∞ through two major kinds of actions: first, doing Ibadah (Ωi:
man-to-God relationship to enhance spirituality); and second, Muamalat (Ωm:
man-to-man relationship) which covers socio-economic, geopolitical, business,
social, and education activities. Thus, the objective is to maximize Ω = Ωi U Ωm.
If Ωm is not achieved up to the required level then life after death will be one of
miseries spent in hell. So, there exists a positive unidirectional causality between
Ωm and paradise.
3 Ribah is divided into two major categories: (i) Ribah An-Nasee’ah relates to
Ribah in debt and (ii) Ribah Al-Fadl which refers to Ribah in exchange.
4 For Choudhury’s epistemological Tauhidi Model, see details in Choudhury and
Bhatti (2016). Islamic finance assets are expected to reach US$3.2 trillion by the
end of 2020 (refer to www.arabianbusiness.com).
5 Basov and Bhatti (2016).
6 https://blogs.worldbank.org/category/tags/islamic-finance.
7 www.irti.org/English/News/Documents/GRIF-2018-Overview.pdf.
8 Some of these definitions are taken from Basov and Bhatti (2016), Shanmugam
and Zaharina (2009) and Obaidullah (2005).
9 Islamic council of victoria Qard Hassan product building bridges between
Muslims and non-Muslims: www.icv.org.au/icv-stories-nils.
10 For more information on these differing views, please refer to Kunhibava (2010)
and Uddin (2015).
11 Some of the material in this section is taken from our joint paper entitled “De-
velopments in Risk Management in Islamic Finance: A Review”. Working paper
1440–1, Dept of Finance, King Abdulaziz University, Jeddah, KSA.
12 See Kuritzkes, Schuermann and Weiner (2002).

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3 On the role of ownership
and governance structure
in raising capital
A sukuk example
Mohsin Khawaja, M. Ishaq Bhatti
and Darren Henry

3.1 Introduction
The decision of a firm to raise capital comes with a number of difficult
choices, one of which is the type of security to choose from a range of secu-
rities with different features. While raising funds externally the firm faces
the trade-off of either choosing equity, which dilutes the ownership stake
(Admati et al., 2018; Ellul, 2008; Harris and Raviv, 1998; Israel, 1991; Lu
et al., 2012; Stulz, 1988), or issuing debt and facing potential bankruptcy
costs (Fama, 1980; Fama and Jensen, 1983; Masulis, 1988). The trade-off
eventually leads to the formulation of the firm’s capital structure. In other
words, the choice of security reflects the shareholders’ view through the
board of directors on relative risk aversion and their desire for the control
of firm. This paper attempts to examine the role of ownership and govern-
ance structure of a firm in determining the choice of security to raise capital
related to Shari’ah compliance product, ‘sukuk’.
In most of the corporate finance literature, the decision to choose between
debt and equity is evaluated based on debt as a set of homogenous instru-
ments (Dong et al., 2012; Jung et al., 1996; Loughran, 2008; MacKie-Mason,
1990; Walsh and Ryan, 1997). In other studies the focus remained solely on
hybrid securities such as non-core assets (Edmans and Mann, forthcoming
2018), convertible debt, warrants, or preferred shares (Balachandran et al.,
2017; Gatchev et al., 2009; Lewis et al., 2003; Suchard and Singh, 2006).
However, there are other instruments that firms may use to raise long-term
funds with varying degrees of impact on their ownership and governance
mechanisms. Our choice of securities for this study includes equity, bonds,
syndicated loans, and a recent innovation called sukuk – usually referred to
as Islamic bonds. Sukuk, although branded as debt shares, is categorized as
equity due to its risk-sharing nature. Furthermore, sukuks are certificates of
shares and rights in assets which could be tangible assets, services, or equity
of a given project (Yatim, 2009). Hence, from a risk-sharing perspective they
lie between equity and debt. Figure 3.1 highlights each of these instruments
in a graph based on their relative risk aversion and the shareholders’ desire
for control.
 A sukuk example 51

Desire for ownership control

Equity
Sukuk

Bonds

Commercial loans

Risk-sharing

Figure 3.1 A visual display of the trade-off between the desire of ownership con-
trol and risk aversion, namely equity, bonds, loans, and sukuk. Equity is
the least risky security for an issuer but dilutes ownership control while
loans are the most risky but do not lead to ownership dilution.

The major capital structure theories addressing firm behaviour related

to the choice of funding instruments are static trade-off theory, pecking
order theory, market timing theory, and agency theory. Trade-off theory
suggests that the choice of new capital instrument, whether equity or debt, is
a trade-off of tax shields and bankruptcy costs.1 Pecking order theory sug-
gests firms prefer debt issuance over equity.2 Market timing theory, on the
other hand, indicates that firms benefit from their high valuation by issuing
equity.3 Agency theory highlights the conflict of interest between sharehold-
ers and management in a firm that could lead to circumstances whereby
management does not act in the interest of the shareholders.4 One of the
shortcomings of these major capital structure theories, with the exception
of agency theory, is that they do not incorporate the influence of ownership
structure. Instead, they largely consider the benefit of tax shields or firm’s
financial strength as the major determinant of security issuance. Findings
by Ellul (2008), Liu et al. (2011), Santos et al. (2014), and Mak and Kusnadi
(2005) suggest that a firm’s ownership structure, and the independence and
structure of their board of directors, affects capital issuance (for details re-
fer to Modigliani and Miller 1958). This study extends the corporate finance
literature by exploring whether ownership structure and governance mech-
anisms play any role in the choice of instruments to raise long-term funds
subject to the decision of raising funds externally.
Both decisions to raise funds and the selection of a specific financing in-
strument suggest the presence of a sample selection bias. This is because
issuance decisions can be observed over a non-random subsample of firms
raising funds. To avoid sample selection bias we use a simultaneous equation
52 Mohsin Khawaja et al.
model to determine the factors affecting the decision to raise funds and,
conditional on the decision to raise funds, the choice of financing instru-
ment based on control and risk aversion motives. We assume that share-
holders do not play an active role in the first decision to raise capital, but
their role in the second decision of the choice of security is much more pro-
nounced. Management and the board of directors initiate the decision to
choose the appropriate security. However, since the board is a proxy for the
shareholders, we believe that they reflect the shareholders’ desires when they
make the second decision. Since the first decision is primarily a binary de-
cision, which does not involve shareholders’ views, the board does not have
to incorporate shareholders’ interests, i.e. they can decide independently if
raising capital would be beneficial for the firm or not.
By using a sample of 1,565 firms with 67,734 firm-quarter observations
from Malaysia, Indonesia, Singapore, and Pakistan from 2000 to 2015, we
find that firms with concentrated ownership are less likely to issue equities
to avoid ownership dilution. Similarly, firms with a concentration of power
(CEO also acting as the chairperson of the board of directors) prefer debt
instruments if such firms are to raise funds externally. Furthermore, the size
of boards of directors and the proportion of female members on the board
also lead to a higher probability of raising funds externally. However, the
higher probability does not reflect any particular preference towards a spe-
cific type of financing instrument. Among firm-specific variables, we find
that leverage and firm size affects the choice of instruments. Firms that are
highly leveraged and larger in size prefer to raise capital using debt-based
instruments. However, firms with high future growth potential prefer to
raise funds externally using equity financing.
This paper contributes to the literature in several ways. Currently, there
is limited research identifying the factors of security issuance based on the
nexus of relative risk aversion and firm control. One of the key distinguish-
ing features of this paper is the use of a two-staged model which treats the
two decisions on security issuance and risk choice separately, whilst deal-
ing with endogeneity bias. Furthermore, this study extends the literature
by testing whether ownership and governance structures affect the choice
of security for raising funds. In this study we use a unique data set of firms
from countries where corporations have access to a variety of financing in-
struments when seeking to raise funds (including sukuk), allowing us to ob-
serve a wider range of securities, each carrying unique risk characteristics.
Findings of this study provide an insight into understanding the nexus of
shareholders’ desire to control their firms and their relative risk aversion in
raising funds, and the choice of financing instrument. These findings could
be of interest to investors in better understanding the financing preferences
of firms where higher ownership concentration and CEO duality is associ-
ated with higher degrees of control and lower risk aversion. Furthermore,
such firms have a greater tendency to be highly leveraged, which could po-
tentially drive down firm valuation.
 A sukuk example 53
The remainder of the chapter is structured as follows. Paper is motivated
by description of the past literature reviews which is presented in Section 2.
In Section 3, we describe the model and research methodology used in the
chapter. Section 4 is devoted to the summary of the interesting variables
used in this study along with research question and hypothesis develop-
ment. The data details and the measures of important statistics are reported
in Section 5. In Section 6, we provide details of multivariate analysis in-
cluding section reports the estimation results for the empirical model. The
model incorporates an equation for the issuance decision for the choice of
instrument to raise capital based on the trade-off between control and risk
motives. The final section contains some interesting concluding remarks.

3.2 Literature review

One of the major decisions when deciding to raise funds is the choice be-
tween debt and equity. This choice reflects the trade-off between control
and risk-reduction. Firms may resist equity issuance to avoid dilution of
ownership, or they may oppose excessive debt issuance, particularly loans,
as they might lead to covenants that reduce their shareholders’ potential
dividend earnings (Jensen and Meckling, 1976).
Most of the empirical literature investigates the debt-equity trade-off in
the context of capital structure and focuses on the change in the proportion
of debt and equity in the capital structure. For example, profitable firms
adjust their capital structure more rapidly than less profitable firms (Lemma
and Negash, 2014). Furthermore, it is well known in the literature that a
change in capital structure is a function of the size of operating cash flows
which include dividend-paying firms and those with higher credit ratings
benefit from having better access to the capital market. Consequently, this
leads to the raise of debt more often (Faulkender et al., 2012). However,
Lemmon et al. (2008) illustrate empirically through a 38-year study on US
firms beginning from 1965 to 2003 that the capital structure of firms is usu-
ally stable and does not change more frequently.
On the issue of the choice among debt and/or equity financing, the em-
pirical literature provides mixed findings. On the one hand, proponents of
pecking order theory assert that firms use equity financing as a last resort
due to information asymmetries, whereas advocates of market timing the-
ory suggest firms would use time equity issuance when they are overvalued
or profitable. Furthermore, Dong et al. (2012) suggest that pecking order
theory is applicable only when firms are financially constrained. However,
Suchard and Singh (2006) find that firms under high financial risk tend
to issue warrants as opposed to convertible debt. In another study, Jung
et al. (1996), while comparing the role of the agency theory, pecking or-
der theory, and market timing theory in equity issuance, conclude that it
is, in fact, agency theory that best explains the equity issuance decision
by firms. One of their major findings was that equity financing enhances
54 Mohsin Khawaja et al.
management’s discretion as opposed to that of shareholders. This may sug-
gest that the choice of instrument can be influenced by a conflict of interest
between the firm’s ownership and its management.
A key element of pecking order theory is the presence of a tax shield
which tempts firms to choose debt over equity. MacKie-Mason (1990) found
strong evidence of a relationship between tax shields and marginal tax rates,
implying that marginal tax rates affect financing decisions. However, Walsh
and Ryan (1997) disagree finding that while both tax and agency consider-
ations are important in explaining corporate financing decisions, it is the
agency effect that appears to dominate financing decisions. Balachandran
et al. (2017) also contend that agency costs are among the prime drivers of
equity issuance. The presence of agency conflicts highlights the importance
of observing how the governance structure influences financing decisions.
Findings are inconclusive as to how ownership structure can affect the
security selection decision when raising funds. Rajan and Zingales (1995)
theorize that the presence of a large shareholder lowers agency costs and en-
courages more equity issuances, whilst raising aversion to debt. Santos et al.
(2014) found a negative relationship between ownership concentration and
leverage among European firms. Farooq (2015) found similar results while
analysing firms from the Middle East and North Africa (MENA) region. He
argues that lower levels of leverage is due to information asymmetry associ-
ated with ownership concentration. Autore and Kovacs (2010) also contend
that higher information asymmetry leads to fewer equity issuances.
The trade-off between control motive and risk-taking (risk aversion) may
not be relevant for those firms with higher government ownership, as higher
government ownership may encourage more debt issuance due to implied
guarantees by the government. Liu et al. (2011) found higher leverage ratios
associated with Chinese state-owned enterprises. However, Borisova et al.
(2015) found that firms with higher government ownership face higher costs
of debt. Evidence regarding institutional ownership suggests that higher in-
stitutional ownership has little influence on capital structure (Gillian and
Starks, 2000; Karpoff, 2001; Wahal, 1996). However, Boubaker et al. (forth-
coming 2017) suggest that long-term institutional ownership not only pre-
fers debt to equity but also makes slower adjustments to capital structure,
implying fewer issuance of securities.
Berkovitch and Israel (1996) argue that corporate governance structure
also plays a vital role in defining a firm’s capital structure. However, Daily
et al. (1998) and Vafeas and Theodorou (1998) assert that the duality of CEO
and Chairman role (CEO duality) appears to have an insignificant influence
on capital structure. CEO duality may also increase agency costs, and lower
cost efficiency and profitability (Pi and Timme, 1993). However, Brickley
et al. (1997) found empirical evidence which implied that separating the
roles of the CEO and the Chairman of the board results in greater agency
costs than having dual roles.
The composition of the board of directors may have an influence on the
capital structure of the firm. Heng et al. (2012) found evidence of a positive
 A sukuk example 55
relationship between independent non-executive directors with leverage
and an inverse relation between the board size and leverage ratio. How-
ever, Pearce and Zahra (1992) suggest that firms with a larger board size
have greater reliance on debt financing. On a different note, Eisenberg et al.
(1998) found that small boards would have fewer communication and co-
ordination problems, helping to achieve consistent and timely decisions on
capital structure. One of the important limitation of this strand of the lit-
erature is the limited focus on leverage of firms without any consideration
to the efficiency of the financing process and especially the choice of instru-
ment to raise funds.
In terms of board diversity, Adams and Funk (2012) suggest that financ-
ing preferences of directors can be different based on gender. More pre-
cisely, female board members have a higher tolerance of risk in relation to
capital structure. Sila et al. (2016) and Matsa and Miller (2013), on the other
hand, assert that risk-seeking or risk aversion is not a significant part of
women’s approach towards corporate decision-making.
Autore and Kovacs (2010) and Bayless and Chaplinsky (1996) suggest
that the presence of information asymmetry plays a vital role in deciding
whether a firm uses equity financing. In the presence of information asym-
metry, potential investors would be less likely to invest in the equity of firms.
They suggest that large firms and those with a greater number of analysts
providing recommendations to invest bridge the information asymmetry
gap leading to lower information asymmetry, consequently encouraging
equity issuance. However, Gatchev et al. (2009) found no evidence of in-
formation asymmetry having a significant impact over equity issuance.
Instead, their findings suggest that small firms and those with low profit-
ability are more inclined to issue equity. Empirical studies by Titman and
Wessels (1988), Rajan and Zingales (1995), Booth et al. (2001), Frank and
Goyal (2009), De Jong et al. (2011), Alam et al. (2018), Al Rahahleh et al.
(2017), and Al Rahahleh and Bhatti (2017) help to explain that the firm size,
asset tangibility, and profitability lean towards raising capital through debt
financing while firms with higher growth opportunities may prefer equity is-
suance. Hovakimian (2006) found that the market-to-book (MBV) ratio has
a significant impact on a firm’s financing decisions. Similarly, Graham and
Harvey (2001), while using multiyear survey data of chief financial officers
(CFO) from US corporations, suggest that profitability and stock price over-
valuation influence equity issuance, while credit rating, interest rates, and
financial flexibility determine bond issuance.
In terms of security choice for raising funds, the empirical literature usu-
ally analyses two classes of capital, namely bonds and equities (Hovakimian
et al., 2004). However, firms often raise long-term funds using syndicated
finance, and, in some jurisdictions, now use sukuk. Sukuk has largely been
the missing link in the corporate finance literature as an instrument of
choice for raising capital. Sukuk has emerged globally as an Islamic finance
product to raise external funds with over $97 billion worth of sukuk issued
in 2017.5 Research on sukuk has recently gained momentum, with sukuk
56 Mohsin Khawaja et al.
having been analysed in the context of economic determinants of sukuk
market development (Smaoui and Khawaja, 2016), motivation for issuing
sukuk (Abdul Halim et al., 2017; Alam et al., 2018; Nagano, 2017), issuer’s
choice of the type of sukuk (Azmat et al., 2014), application of bond rat-
ings on sukuk (Azmat et al., 2015), market reactions upon issuance of sukuk
(Godlewski et al., 2013, 2016; Klein et al., 2018), and corporate determinants
of sukuk issues (Klein and Weill, 2016; Mohamed et al., 2015; Nagano, 2016).
Most of the studies on the determinants of raising capital analyse the de-
cision of fund raising in a single decision framework although clearly the
decision to raise funds and the choice of instruments are two simultaneous
decisions. This study attempts to fill this gap by analysing four major sources
of capital for long-term funding, namely loans, bonds, sukuk, and equity fi-
nancing in a simultaneous equation framework by focusing on the interaction
of ownership control motives and relative riskiness associated with the source
of funding. The next section develops a methodology for empirical analysis.

3.3 The model and methodology

The empirical methodology used in this paper is based on the model which
premise that a firm decides to raise capital in a two-step sequential process.
Once a firm makes the decision to raise capital, in the basic financing model
each firm chooses instrument I among J alternatives based on decreasing
levels of desired control and higher risk levels. We can only observe the ac-
tual choice Ij, where j ϵ {1, …, j}, not the desired instrument I *j , a latent con-
tinuous variable reflecting the desired level of control and relative riskiness.
Each firm chooses the instrument that maximizes the expected utility of
alternative instruments Ij, given some observable characteristics x:

MAX j ∈{1,..., j }r( I j | x ) − c ( I j | x ) (1)

Each firm maximizes the expected utility by maximizing control c and min-
imizing relative risk r, associated with raising fund using instrument Ij. The
utility maximizing function j c (j r ) is affected by a set of observable varia-
bles x and other random unobservable factors e c ( e r ). The optimal instru-
ment I *j maximizes the utility given certain assumptions (see Lauer, 2002,
2003) that:
 1 1 
Pr( I j | x ) = Pr m j −1 < ln e ≤ h j (2)
 j (x) j ( x ) 
where in Equation (2), j( x ) is expressed as,

jc e  r (I ) − r ( I ) 
j (x ) = , e = − c and m j = ln  j +1 j


jr er  ( j +1 )
c I − c ( I j )

The odds that a firm chooses the desired instrument Ij with expected control
and risk are given by the probability that the error term falls between two
 A sukuk example 57
thresholds. This implies that firms may choose increasing levels of control
and riskiness for raising capital given their respective constraints x. The
levels of control and riskiness can be expressed in thresholds whereby firms
may opt for instrument Ij+1 if it increases the marginal utility for higher lev-
els of control and lower level of riskiness, and vice versa. j( x ) and e measure
the net impact of observable characteristics and unobservable individual
heterogeneity on the thresholds hj, respectively. From Equation (2), one can-
not assess the actual control benefits and cost of financial risk related to the
behavioural choice of firms for each alternative instrument. However, it is
enough to determine how observed variables x influence the perceived mar-
ginal benefit of control to the financial risk ratio and, therefore, the choice
of instrument.
Assuming that j ( x ) = exp [ b x] and that ln e is normally distributed with
mean zero and variance one, we can rewrite Equation (2) as:

Pr( I j | x ) = Φ ( h j − b x) − Φ ( h j −1 − b x) (3)

where Φ is the cumulative standard normal distribution function. This ex-

pression corresponds to an ordered probit model for behavioural choice.
The behaviour of firms towards risk and control in terms of choice of
instruments can be observed only over a non-random sample of those firms
who have raised capital. To examine the behaviour of firms in raising capi-
tal using a single equation model like ordered probit model as proposed in
Equation (3) assuming homogeneity is unrealistic due to the unobserved
heterogeneity of non-issuing firms (Heckman et al., 2006). Essentially, the
estimation model is similar to Cameron and Heckman (1998) where there is
a need to account for two decisions: a binary choice selection decision and a
discrete choice of observed ordered behavioural decision.
To account for the two decisions a firm makes, i.e. raise capital and choose
security, De Luca and Perotti (2011) suggest an ordered probit model with
sample selection through the following bivariate threshold crossing models:

I it* = a 0 + a ′wit i = 1, …., I (4)

I *jt = b0 + b1xit + e it if I it = 1 (5)

where I it* is a latent variable related to the first decision and indicates the
likelihood of firm i to raise capital in year t, if I it* + uit > 0. wit is a vector
of covariates with coefficients a to be estimated. Equation (4) is observed
over all sample firms. I *jt is continuous latent variables choice of instrument
J
and is observable through I jt = ∑ h I (l h < I *jt ≤ lh+1 ) , where l = 1,......, lh
j =0
that partition I *jt into (h+1) exhaustive and mutually exclusive thresholds.
Equation (5) is observable only for those firms that issue any instrument,
i.e. where Iit = 1. In Equations (4) and (5), the error terms are assumed to be
jointly normally distributed (bivariate normal) with a (unknown) coefficient
58 Mohsin Khawaja et al.
of correlation between the latent errors uit and e it. For empirical estimation,
the dependent variable, in the case of Equation (5), is a categorical variable
based on control-risk motives.

3.4 The variables and hypothesis

Appendix A provides a summary list of variable definitions and their ex-
pected signs. We classify our independent variables largely as those related
to ownership structure, corporate governance, information asymmetry,
macroeconomic factors, and firm-specific control variables.

3.4.1 Ownership structure

Control motive theory suggests that share dilution is a concern for those
firms with concentrated ownership. Studies in the literature have found that
ownership structure significantly determines a firm’s risk-taking behaviour
(Borisova et al., 2015; Santos et al., 2014; Su, 2010). Furthermore, studies by
Farooq (2015), Santos et al. (2014), and Mitton (2002) suggest that ownership
concentration affects firms’ decisions on capital structure and performance.
We believe that shareholders do not actively participate in the initial de-
cision on whether or not to raise capital, but they do participate in the sec-
ond decision of the choice of instrument since this potentially affects their
ability to exert influence over the firm. Based on this premise our owner-
ship variables are included in Equation (2) on the choice of risk, but not in
Equation (1) on raising funds. We estimate how ownership concentration
leads to the choice of a certain level of risk by the firm. The concentration
variable is incorporated in our model as this indicates share ownership by
the highest shareholder in the firm. We expect highly concentrated owner-
ship may prefer to raise funds from debt financing in order to avoid own-
ership dilution.
Type of ownership may also affect the choice of instrument for raising
funds. To reflect the impact of types of ownership, we included three distinct
categories of shareholders. Govt, which is the percentage of share owner-
ship by government, is included to control for state-ownership in the firm.
An aggregate variable named Financials is included to control for the effect
of institutional ownership including banks, hedge funds, venture capital,
mutual funds, private equities, and insurance firms. We further control the
effects of ownership by individual/family shareholding with variable, Indi-
vidual representing the proportion of ownership by a person or family in the
overall ownership structure.

3.4.2 Corporate governance

The governance structure of a firm directly affects the decisions of issuance
as well as the choice of instrument due to the direct involvement of the board
 A sukuk example 59
of directors in such decision-making. We account for the board’s structure
through several variables.
Sundaramurthy and Lewis (2003), Daily et al. (1998), Brickley et al. (1997),
and Boyd (1994) have argued how the dual role of CEO and Chairman af-
fects a firm’s decision-making process. To control for the unitary leadership
structure with shared incumbency of the Chairman and CEO positions, a
dummy variable CEO duality equals 1 if the CEO and Chairman positions
are held by the same individual and 0 otherwise.
Studies by Heng et al. (2012) and Falaye et al. (2011) discuss the effects on
capital structure as the independence of the board changes. We include the
variable Board independence, which takes on numeric values corresponding
to the BvD independence indicator by Orbis,6 which assigns independence
indicators of A+, A, A−, B+, B, B−. We choose discrete numbers with higher
values indicating a greater degree of board independence.
Board size and its diversity are important indicators of corporate govern-
ance. Several studies including Heng et al. (2012), Mak and Kusnadi (2005),
Yermack (1996), Eisenberg et al. (1998), and Pearce and Zahra (1992) have
mixed findings on the effect of board size on firm’s leverage choice. Board
size, the number of directors on the board, is included as a control variable
for this purpose.
Adams and Funk (2012) found female board members exhibit a higher
tolerance towards risk in regard to capital structure. To account for the ef-
fect of gender diversity, we include the proportion of female members on the
board of directors through the variable Female ratio.

3.4.3 Information asymmetry

In the presence of higher information asymmetry, investors are less keen to
invest in firms as equity. Large firms and those with a greater number of an-
alysts’ coverage may face lower information asymmetry and consequently
be able to raise more capital using equity. Based on the existing literature,
we use several proxies that can be considered as important in mitigating in-
formation asymmetry. Firm size, indicated by the logarithm of total assets,
is often considered to reduce information asymmetry (Autore and Kovacs,
2010; Frank and Goyal, 2003). Furthermore, large firms are also found to
have easier access to debt financing (Sakai et al., 2010; Zeghal, 1984).
We use the number of analysts covering each firm through the variable
Analyst coverage (Gomes and Phillips, 2012; Krishnaswami and Subra-
maniam, 1999). Analyst variance, which is the standard deviation among
the analyst recommendations, is another variable to address information
asymmetry. It helps us determine whether analysts arrive at a wider scale of
recommendations for the firm that indicates high information asymmetry.
Autore and Kovacs (2010) have utilized asset tangibility to represent in-
formation asymmetry. They claim that firms with higher growth opportu-
nities would resort to debt in the presence of high information asymmetry.
60 Mohsin Khawaja et al.
Hence, we have control variables Tangibility and ROA, representing the ra-
tio of tangible assets to total assets and the return on assets, respectively, to
control for information asymmetry.

3.4.4 Macroeconomic variables

Korajczyk and Levy (2003) highlight the significance of macroeconomic
variables in the choice of security. Tawatnuntachai and Yaman (2007) found
that GDP growth has a negative effect on bond issuance. In another study,
Choe et al. (1993) observe the effect of certain macroeconomic factors on eq-
uity issuance, asserting that equity issues rise during business cycle expan-
sions. Therefore, GDP, measured as the gross domestic product in millions
of US dollars, is included as a control variable for economic growth.
Graham and Harvey (2001) suggest that financial flexibility, credit rating,
and interest rates influence the decision to issue bonds. This is consistent
with the earlier findings of Flannery (1986) that firms issue short-term debt
securities when their credit ratings improve. We control for interest rates
through our variable Interbank rate, which is the three-month interbank
rate prevalent in the respective country where the firm is based.

3.4.5 Other control variables

Adjustment in capital structure has conventionally been evaluated by ob-
serving leverage ratios, as evident from studies by Öztekin and Flannery
(2012), Kayo and Kimura (2011), Korajczyk and Levy (2003), Kayhan and
Titman (2007), Leary and Roberts (2005), and Welch (2004). Leverage,
which is the ratio of total debt to equity, is included to measure the effect of
leverage on issuance and risk choices.
Empirical studies endorsing static trade-off theory by Titman and Wessels
(1988), Rajan and Zingales (1995), Booth et al. (2001), Frank and Goyal (2009),
and De Jong et al. (2011) help explain that firm size, asset tangibility, and prof-
itability indicators of firms’ decision to raise debt. We can assume that high
tangibility offers opportunities to issue bond and sukuk by acting as collateral.
Our variables Firm size, Tangibility, and ROA incorporate these three factors.
Market timing theory regards the market-to-book ratio (MBV) as a
significant determinant of equity issuance (Hovakimian, 2006; Kayo and
Kimura, 2011). MBV, which reflects the ratio of market capitalization to
the book value of equity, is also added as a control variable. It is meant
to describe price overvaluation, which offers market timing opportunities
to the firm issuing equity (Baker and Wurgler, 2002). Rajan and Zingales
(1995) suggest that asset tangibility is another important control variable.
We expect growth firms to issue debt according to pecking order theory
and so generate growth measures by taking the ratio of capital expenditures
with total assets, and name it Capex. We also expect firms with relatively
large amounts of cash on their balance sheets to raise capital less frequently.
Cash, ratio of cash to total assets, serves to control for this.
 A sukuk example 61
3.5 The data sources and statistics
The data set includes non-financial firms from those countries where a
variety of instruments are available to raise funds, namely equity, sukuk,
bonds, and loans. The sample consists of all non-financial firms listed on the
stock exchanges of Malaysia, Indonesia, Singapore, and Pakistan. Financial
statement data is extracted from Thomson Reuters Worldscope Global, is-
suance data from Bloomberg, and the data related to ownership and board
of directors is acquired from Orbis. We also use Institutional Broker’s Esti-
mate System (IBES) for data on analyst’s recommendations on firms.
Due to multiple sources of data, we use the firm name up to 92% match-
ing as the common identifier. All observations with missing data on assets,
debt, equity, board of directors, or ownership information are dropped. We
further winsorize data at the 1st and 99th percentile to account for the outli-
ers. The final data set consists of 1,565 firms with 67,734 firm-quarter obser-
vations over the years 2000–2015. A graphical representation of the number
of security issues made by the sample firms is shown in Figure 3.2. Clearly,
the majority either did not issue or only made a small number of security
issues during the sample period.
Table 3.1 presents the summary descriptive statistics of the non-
dummy variables used in this study. The statistics are divided into three

2.5

1.5
Density

.5

0
0 2 4 6 8 10
Number of Issues

Figure 3.2 The histogram shows on the x-axis the number of issues made by the
sample firms and on the y-axis the frequency density of the number of
firms that issued a security in any quarter during 2000–2015. The highest
density is for zero issues implying that the majority of firms did not raise
capital during the sample period. The number of firms that made a single
issue during the sample period is second to highest after non-issuers.
Table 3.1 Descriptive Statistics of Control, Ownership, Governance, and Information Asymmetry Variables. The Quarterly Data Ranges
from Year 2000 to 2015 for Our Sample Firms from Countries of Dual Issuers of Bonds and Sukuk. These Countries Are
Malaysia, Indonesia, Singapore, and Pakistan. Definitions of the Variables Are Given in Appendix A

Variable Panel A: All Firms Panel B: Issuing Firms Panel C: Non-Issuing Firms K-Wallis

Obs. Mean SD Obs. Mean SD Obs. Mean SD

Firm size 67,734 18.447 1.6 38,786 18.686 1.647 28,948 18.127 1.474 2,044***
Leverage 67,700 0.617 1.207 38,776 0.627 1.102 28,924 0.605 1.334 676***
MBV 64,865 1.445 1.723 37,218 1.482 1.693 27,647 1.397 1.76 184***
Capex 67,734 0.003 0.008 38,786 0.003 0.008 28,948 0.003 0.008 205***
Tangibility 67,549 0.364 0.225 38,729 0.365 0.224 28,820 0.363 0.227 3.524*
ROA 59,634 0.048 0.095 34,536 0.047 0.093 25,098 0.051 0.097 21.679***
Cash 67,658 0.13 0.131 38,738 0.127 0.124 28,920 0.133 0.14 28.902***
Analyst coverage 67,734 1.7 4.332 38,786 2.19 4.927 28,948 1.044 3.261 1,626***
Analyst variance 67,734 0.18 0.418 38,786 0.226 0.457 28,948 0.119 0.351 1,221***
Concentration 66,478 37.903 21.377 38,300 37.754 20.429 28,178 38.105 22.601 0.052
Govt 67,734 0.996 7.447 38,786 1.328 8.45 28,948 0.552 5.809 209***
Individual 67,734 12.328 17.948 38,786 11.702 16.779 28,948 13.167 19.374 18.327***
Financials 67,734 14.521 22.325 38,786 14.671 21.91 28,948 14.319 22.87 43.174***
CEO duality 67,680 0.029 0.167 38,786 0.025 0.155 28,894 0.034 0.182 54.050***
Board size 67,680 7.097 2.465 38,786 7.17 2.345 28,894 7.000 2.614 43.158***
Board 67,562 3.739 1.201 38,687 3.759 1.178 28,875 3.712 1.231 8.124***
independence
Female ratio 67,427 0.116 0.138 38,766 0.121 0.138 28,661 0.111 0.138 130***

Notes: where *** p < 0.01; ** p < 0.05; * p < 0.1.

 A sukuk example 63
panels: Panel A reports the summary statistics of the overall sample,
whereas Panels B and C report the summary statistics of subsample issu-
ers and non-issuer firms, respectively. Issuer firms include all those firms
that have raised funds externally during the sample period. The last col-
umn of Table 3.1 reports the Kruskal-Wallis test statistics for differences
in means to understand if issuing firms are significantly different in their
ownership and governance structures, information asymmetry, and fi-
nancial attributes as compared to those of non-issuing firms.
The variables on ownership structure show significant differences in
terms of the type of ownership, albeit the variable on ownership concentra-
tion does not vary significantly across the two types of firms. Issuing firms,
on average, have a significantly higher ownership stake held by the govern-
ment as compared with non-issuing firms. Interestingly, higher ownership
concentration associated with individual or family shareholding is found to
be significantly less frequent among issuing firms, which may highlight the
conservative nature of such shareholders. Firms with high financial institu-
tion ownership appear to be frequent issuers.
In terms of the difference in governance variables of issuer and non-issuer
firms, Table 3.1 shows a statistically significant difference among the two
groups. For example, board size, female ratio, and proportion of board of
directors with dual management roles are significantly higher in issuing
firms, accompanied with lower standard deviation except for the female ra-
tio. CEO duality, on the other hand, is lower in the case of issuing firms.
This further supports the argument that separation of the two roles can be
an influential determinant of the decision to raise capital externally.
Table 3.1 also indicates that issuing firms, on average, are larger in size,
highly leveraged, and growth oriented as compared to firms that did not
issue any security during the sample period. Variables on tangibility and
market-to-book ratio show the same trend. However, non-issuing firms have
significantly higher profitability and cash holdings. Intuitively, we would ex-
pect firms with high cash holdings to be averse to raising capital. Finally,
variables on information asymmetry, including analyst coverage and var-
iance, are on the higher end in the case of issuing firms and have a higher
standard deviation.
To further understand the dynamics of the sample, Table 3.2 provides
descriptive statistics based on a breakdown of instruments that firms used
to raise capital in our sample. Firms that issued multiple securities during
the same quarters are placed in the respective risk panel depending on the
size of issue, i.e. amount of capital raised would determine the level of risk
assumed by the firm. The Kruskal-Wallis test for differences in means is
shown in the last column.
One of the interesting findings from Table 3.2 is that the average size of
issuing firms decreases in the order of loans, bonds, sukuk, and then equity
that is the exact order observed in Figure 3.1. A similar pattern can be ob-
served in the case of leverage whereby firms issuing equities are the least
Table 3.2 Descriptive Statistics of Firms Segregated by Their Issuance Trend. Issuers of More than One Security during a Quarter
Are Placed in the High Risk Issuer Category. The Quarterly Data Ranges from Year 2000 to 2015 for Our Sample Countries:
Malaysia, Indonesia, Singapore, and Pakistan with Issuers of Equity, Bonds, Sukuk, and Loans. The Definitions of Variables
Are Given in Appendix A

Variable Loans Bonds Sukuk Equity K-Wallis

Obs Mean SD Obs Mean SD Obs Mean SD Obs Mean SD

Firm size 521 20.419 1.518 692 19.951 1.537 593 19.849 1.453 764 18.320 1.880 1,606***
Leverage 521 1.063 1.133 692 1.210 1.148 593 0.874 0.531 764 0.570 0.860 1,155***
MBV 504 2.128 2.050 671 1.492 1.470 586 1.273 1.022 585 2.400 2.270 428***
Capex 521 0.004 0.010 692 0.003 0.009 593 0.002 0.007 764 0.000 0.010 35.540***
Tangibility 521 0.421 0.252 692 0.385 0.203 592 0.390 0.201 764 0.330 0.240 72.840***
ROA 465 0.072 0.076 632 0.047 0.059 578 0.049 0.051 448 0.060 0.120 56.297***
Cash 521 0.106 0.087 692 0.113 0.095 593 0.087 0.065 760 0.160 0.130 76.444***
Analyst coverage 521 6.392 7.800 692 4.608 6.698 593 5.137 7.527 764 2.414 5.429 1,168***
Analyst variance 521 0.502 0.543 692 0.423 0.526 593 0.503 0.587 764 0.197 0.395 1,078***
Concentration 501 51.589 20.818 691 39.406 19.314 567 39.670 20.372 760 33.482 19.530 242***
Govt 521 4.556 15.627 692 2.200 11.112 593 0.688 4.599 764 1.034 7.129 148***
Individual 521 2.489 8.758 692 8.662 14.038 593 7.907 12.636 764 13.631 16.547 338***
Financials 521 22.882 27.816 692 20.185 25.722 593 21.673 28.060 764 15.722 22.789 126***
CEO duality 521 0.021 0.144 692 0.027 0.164 593 0.002 0.041 764 0.020 0.139 19.460***
Board size 521 7.455 2.753 692 8.042 2.254 593 8.233 2.272 764 7.215 2.441 280***
Board 519 3.175 1.223 691 3.592 1.145 593 3.629 1.264 763 4.010 1.106 162***
independence
Female ratio 521 0.131 0.142 691 0.128 0.113 593 0.152 0.151 764 0.114 0.139 64.187***

Notes: where *** p < 0.01; ** p < 0.05; * p < 0.1.

 A sukuk example 65
leveraged as compared to firms who prefer borrowing from banks. Financ-
ing using loans may be associated with the sophisticated evaluation and
monitoring functions of banks (Rajan, 1992; Zeghal, 1984). Furthermore,
firms issuing equities reflect higher future growth potential as reflected by
the market-to-book ratio. In line with Rajan and Zingales (1995), we find
that tangible assets are higher in firms that prefer to issue debt including
loan and sukuk issuers. This is intuitive as well since sukuk is largely an
asset-backed security and banks often require collateral for financing.
Both variables on ownership concentration and CEO duality are signifi-
cantly different in each of the four categories of issuing firms. The independ-
ence of the board of directors is also associated with higher equity financing
as compared with loan financing where boards of directors are least inde-
pendent. Other variables on ownership and governance structure also differ
significantly across different types of issuers but do not reflect any specific
patterns.
Table 3.3 shows the correlation matrix of the variables related to owner-
ship, governance, and the type of issuance by firms in the sample. The neg-
ative correlation sign between individual ownership and type of issuances
indicates that firms with a higher percentage of ownership with individ-
ual or families exhibit a lower tendency towards raising capital. A simi-
lar trend can be seen in the case of firms with CEO duality. For all other
variables the sign and level of association are in line with our expectations
and warrant multivariate analysis to shed light on the significance of how
ownership and governance affect a firm’s tendency to raise capital and the
desired level of risk.

3.6 Multivariate analysis

This section reports the estimation results for the empirical model. The
model incorporates an equation for the issuance decision and, conditional
on this decision, an equation for the choice of instrument to raise capital
based on the trade-off between control and risk motives. In the issuance
equation, the dependent variable is binary indicating whether the firm is-
sued any security or not by assuming a value of 1 in the case of issuance
and 0 otherwise. To incorporate the second decision regarding choice of
instrument, we use a categorical variable that takes the value of 1, 2, 3, and
4 if a firm has raised funds using loans, bonds, sukuk, or equity, respectively.
The categorical variable reflects an order based on the ownership control
(see Zhang et al., 2012) and relative risk aversion as shown in Figure 3.1. For
empirical estimation, we use the Heckman ordered probit (HOP) model.
During the sample period, 867 of the 1,565 firms issued one of the four
securities at some point reflecting the selection effects that have to be taken
into consideration while performing a multivariate analysis. Although the
data set indicates the application of the HOP model as appropriate due to
observed sample selection bias, to further confirm the existence of sample
Table 3.3 Matrix of Correlation Coefficients

Concentration Individual Govt Financials CEO Board Board size Female Loan Bond Sukuk Equity
duality independence ratio

Concentration 1
Individual −0.2609 1
Govt 0.1373 −0.09 1
Financials 0.1669 −0.1697 −0.0502 1
CEO duality −0.0016 0.0548 −0.0231 0.0523 1
Board −0.8293 0.2508 −0.1549 −0.1838 −0.0144 1
independence
Board size −0.0973 −0.0379 0.0818 0.1039 0.0313 0.0073 1
Female ratio 0.0747 −0.0078 −0.0163 0.0203 −0.0313 −0.0581 −0.0207 1
Loan 0.0148 −0.018 0.0166 0.027 −0.0038 −0.0147 0.0153 0.0025 1
Bond 0.0091 −0.0103 0.0106 0.0347 0.0014 −0.015 0.0238 0.0053 0.0204 1
Sukuk 0.0167 −0.0243 −0.0047 0.0577 −0.0078 −0.0132 0.0345 0.0393 0.0064 0.0008 1
Equity 0.0155 −0.0163 0.0188 0.0216 −0.0035 −0.0123 0.0197 0.0096 0.0085 0.0025 0.0113 1

Notes: where *** p < 0.01; ** p < 0.05; * p < 0.1.

 A sukuk example 67
selection bias, we perform a z-test of the null hypothesis, in which the dis-
turbance terms in the issuance and choice equations are uncorrelated (H0 :
ρ = 0), that produces z = 612.99 (p-value =0.000). A Wald test of the same
null hypothesis produces χ2(1) = 15.349 (p-value = 0.000). Both results sup-
port the use of the HOP model.
Table 3.4 reports the empirical results using the HOP model. The selec-
tion of independent variables in both equations are on the premise that
the decision to raise capital largely rests on the governance structure, the
needs of the firm, and economic environment. However, the choice decision

Table 3.4 HOP Model. Equations (1) and (4) Describe How the Variables in
Column 1 Determine the Firm’s Decision to Raise Capital in Column 2
and Choice of Security in Column 3. The Dependent Variable CHOICE
is an Ordered Variable Ranging from 1 to 4 to Indicate the Level of
Risk-Sharing Based on the Chosen Security. Quarterly Data Ranges
from 2000 to 2015. Standard Errors in Parentheses

Ordered Probit Model

Variables Issued Choice

Concentration −0.0062***
(0.0023)
Individual 0.0041*
(0.0023)
Govt −0.0012
(0.0028)
Financials −0.0004
(0.0011)
CEO duality −0.3517*** −0.9157***
(0.0762) (0.3247)
Board independence −0.0175** 0.0360
(0.0087) (0.0403)
Board size 0.0297*** 0.0140
(0.0043) (0.0226)
Female ratio 0.3575*** 0.4588
(0.0755) (0.3032)
Firm size −0.2139***
(0.0277)
Analyst coverage 0.0017
(0.0060)
Analyst variance 0.4327*** 0.0658
(0.0204) (0.2800)
Tangibility 0.0042 −0.1480
(0.0495) (0.1219)
Capex 0.6667 −7.3552**
(1.2641) (2.9127)
Leverage 0.1008*** −0.1612**
(0.0084) (0.0636)
MBV 0.0140** 0.1212***
(0.0062) (0.0228)
ROA 0.0133 −0.0603
(0.1308) (0.3768)
(Continued)
68 Mohsin Khawaja et al.
Ordered Probit Model

Variables Issued Choice

Cash −0.7482*** 1.1209**

(0.1042) (0.5147)
Interbank rate −3.7289*** −14.5156***
(0.3718) (3.3206)
GDP −0.0559
(0.0567)
Constant −1.9698***
(0.0581)
Chi2 (20) 561.80***
Hausman 15,349.11***
Observations 57,163

Notes: where *** p < 0.01; ** p < 0.05; * p < 0.1.

depends not only on firm-specific and economic factors but also depends
on the ownership structure of the firm. Accordingly, the independent varia-
bles representing the percentage of ownership by government, institutional
investors, individual/family, and concentration of ownership by the highest
shareholder are considered in the choice equation only. Firm-specific fac-
tors, whether related to governance, financial, or economic variables, are
considered in both equations.
One of the important findings from Table 3.4 is that ownership concentra-
tion is associated with low risk aversion. The negative and significant coeffi-
cient of ownership concentration with the issue decision suggests that firms
with a higher concentration of ownership irrespective of the category of share-
holdings, on average, prefer to raise capital via debt-based instruments. This
suggests shareholders prefer to avoid ownership dilution over risk-reduction.
This result complements the findings of Friend and Lang (1988) regarding the
positive relationship between ownership concentration and debt ratios.
The empirical evidence suggests that governance structure significantly
influences a firm’s decision to raise capital. The coefficient of the CEO du-
ality is negative and significant in both ISSUE and CHOICE equations,
namely Equations (4) and (5), suggesting that firms with a concentration of
power at the top level prefer not to raise capital externally. Subsequently,
if those firms are to raise capital externally, they would prefer bank loans.
This is in line with stewardship theory (Donaldson and Davis, 1991). Eva-
sion of external capital may be due to the fact that external financiers, es-
pecially those from capital markets, may challenge power concentration
and require better governance mechanisms with separate management and
board structures. On the other hand, Rajan (1992) and Zeghal (1984) suggest
that banks usually lend to those firms with whom they have established a
strong relationship and prefer to deal with a unitary leadership structure.
Among other governance-related covariates, board independence is neg-
ative and significant in the ISSUE decision. However, it is insignificant in
the CHOICE Equation (5). The significant negative coefficient in the ISSUE
 A sukuk example 69
decision suggests that firms with more independent boards prefer not to
raise capital externally. However, once the decision to raise capital is made,
higher board independence is not associated with any specific form of cap-
ital financing.
Board size and the proportion of female members on the board are posi-
tive and significant in the ISSUE decision suggesting that firms with a larger
board and a higher proportion of female board members prefer to raise cap-
ital externally. However, depending on the decision to raise capital, both fac-
tors do not affect the choice of any specific mode of financing. This supports
the findings of Sila et al. (2016) that female board members do not necessarily
tend to be risk averse or risk-seekers, contradicting the findings of Adams and
Funk (2012) whose research suggests women have a higher tolerance of risk.
The variables on information asymmetry include the number of analysts
covering a firm, standard deviation of the analysts’ recommendations, firm
size, and tangibility. We assume the observed variance in opinion and tangi-
bility of assets can affect both decisions; however, firm size and the number
of analysts providing coverage may affect the choice of instrument decision
only. Interestingly, we find that the higher variance in analysts’ opinions
positively influences the decision to raise capital. However, once the deci-
sion to raise capital is reached the variance of analysts’ opinions is insig-
nificant. The association of tangibility of assets and firm’s profitability are
insignificant in both decisions.
We find that firms that are larger in size or are highly leveraged exhibit
lower risk aversion and prefer to raise capital through debt-like securities.
The inclination towards debt financing associated with leverage and firm
size in the CHOICE decision is consistent with the view that larger and
highly leveraged firms are more likely to borrow from banks (Rajan, 1992;
Zeghal, 1984), or through bonds (Tawatnuntachai and Yaman, 2007).
Among other firm-specific variables we find that firms with higher fu-
ture potential as reflected by the market-to-book ratio (MBV) are associated
with a higher likelihood for raising funds externally and, depending on the
ISSUE decision, are more likely to raise funds through equity financing.
These findings are in line with the common belief that firms with higher
future potential are more likely to raise funds through equity (Baker and
Wurgler, 2002; Viswanath, 1993). We also find that firms with a higher pro-
portion of liquid assets prefer not to raise capital as reflected by the negative
and significant coefficient of the Cash variable in the ISSUE decision. How-
ever, if such firms raise capital externally there is evidence, albeit weak, that
they will raise capital through equity financing.
Regarding the macroeconomic variables, we find evidence that firms do
not raise capital in a higher interest rate environment. However, if the deci-
sion to raise funds is reached in such an environment, the preferred mode of
financing is debt. The GDP does not appear to be a statistically significant
factor in the choice of instruments.
In summary, the empirical results in Table 3.4 highlight that ownership
concentration and CEO duality are important determinants in the choice
70 Mohsin Khawaja et al.
of security for raising funds. Firms with high ownership concentration and
CEO duality, on average, prefer to raise capital using debt instruments.
However, firms with higher future growth potential are more inclined to
raise capital using equity financing.

3.7 Concluding remarks

Based on the control and risk-reduction hypotheses, we investigated how
firm ownership and governance structure affects decisions on raising capital
and the choice of security. We find evidence that firm ownership and govern-
ance structure play a significant role in external financing decisions in firms
from Malaysia, Indonesia, Singapore, and Pakistan. Our sample consisting
of multiple issuers of sukuk, bonds, equity, and bank loans helps us deter-
mine how firms adjust their choice of risk while raising capital.
One of the important contributions of this study is the application of bet-
ter estimation methodology where the decision to raise capital and the choice
of instrument for capital financing are treated separately. By incorporating
the HOP model, this study demonstrated that capital financing decisions
can be better understood by taking each of these two decisions sequentially.
We find support for control theory suggesting that firms with higher own-
ership concentration prefer to raise capital through debt instruments such
as loans and bonds. The empirical findings further suggest that companies
prefer to adopt debt financing in the case of CEO duality. Larger board size
and the proportion of females on the board of directors have the opposite
influence in the decision to raise capital, although the choice of instruments
stays unaffected.
The results of this study imply that firm ownership and governance struc-
ture play a significant role in a firm’s decision to raise capital and, subse-
quently, to choose the relative riskiness of the security. Further research
can investigate how similar sets of factors explain the volume of issuance
by firms.
One of the possible limitations of this study is that it incorporates four
different types of instruments which are commonly observed for raising
capital, namely equity, bonds, bank loans, and sukuk. However, this list is
not exhaustive, and instruments such as convertible bonds, global bonds,
warrants, and preferred shares have been the subject of study by Balachan-
dran et al. (2017), Lewis et al. (2003), Tawatnuntachai and Yaman (2007),
and Suchard and Singh (2006). A broader list of securities could expand the
data and open future research opportunities, but the scope of the study in
terms of risk and control would still be the same.

Acknowledgement
We would like to thank Dawood Ashraf for his constructive comments to
improve the presentation of this chapter.
 Appendix A
List of variables with their
descriptions, accompanied by their
expected impact on a firm’s decision
to raise capital and their choice of
product in terms of riskiness

Variable Description Expected Sign

Issuance Selection

CEO duality Dummy variable indicating CEO and Chairman − +

are the same person
Concentration Percentage ownership of highest shareholder −
Board BvD indicator value for board independence − +
independence
Board size Number of directors on the board − +
Female ratio Percentage of females on the board of directors +/−
Individual Percentage ownership by individuals/families −
Govt Percentage ownership by government +/−
Financials Percentage ownership by financial institutions +/−
Firm size Logarithm function applied to total assets + +/−
Leverage Total debt-to-equity ratio + −
ROA Return on assets + +
Cash Cash-to-asset ratio − +/−
MBV Market-to-book value of equity + +/−
Capex Ratio of capital expenditure to total assets +/−
Tangibility Ratio of plant, property, and equipment to assets + −
Analyst Number of analysts that gave a forecast on firm + +
coverage performance
Analyst Standard deviation among analyst
variance recommendations
GDP Logarithm function applied to the GDP of the +/−
firm’s country in millions of US dollars
Interbank rate Three-month interbank rate of the country where +/− −
the firm is based where the company is based

Notes
1 Tradeoff theory (Kraus and Litzenberger, 1973; Myers, 2001; Zou and Xiao,
2006).
2 Pecking order theory (Myers, 1984; Myers and Majluf, 1984).
3 Market timing theory (Baker and Wurgler, 2002).
4 Agency theory (Jensen and Meckling, 1976).
72 Mohsin Khawaja et al.
5 Global Sukuk Market Outlook: Another Strong Performance in 2018: available
at www.spratings.com/.
6 BvD independence indicator is issued by Bureau van Dijk. It shows each com-
pany’s degree of independence with regard to its shareholders. Available at:
www.bvdinfo.com/en-us/our-products/our-expertise/find-out-how-we-add-
value-to-company-information/corporate-ownership-structures.

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4 Takāful (Islamic insurance) on
the blockchain
Hazik Mohamed

4.1 Introduction
The takāful and insurance is an evolving process of preserving individuals
and businesses from loss and uncertainty. It can be described as a financial
product to decrease or eradicate risk of loss and protection, be it life or prop-
erty. Insurance offers financial protection to both individuals and business,
in the risk of loss hence playing a vital function in reducing risks through
risk-sharing in the face of uncertain but likely losses or damages. Insurance
and takāful companies take on risk dangers of individuals and businesses so
that they can survive such events to develop in a sustainable way. The risk
landscape is continually evolving, and in order to keep up, the insurance in-
dustry needs to trace and provide customized insurance policies that can serve
specific indemnity needs of the new economy. The insurers have to possess
full understanding of every risk covered in their policies, and when disaster
hits, compensation and claims will be done in a sensible and timely manner.
Latest developments in fintech promise more efficiency and reduced
costs causing significant shifts in the financial landscape, and the impend-
ing disruption in the insurance industry is inevitable. Blockchain today is
something like where the internet was in 1990s – on the strategic interest
of forward-looking companies, but still a while from extensive implemen-
tation. For that reason, the question is not whether should one accept the
blockchain revolution, but instead when and what to start with.
In this paper, we provide a strategic discussion of how blockchain can
provide additional value to the insurance and takāful industries, how to
understand the change in processes, issues that need to be overcome, and
efficiency benefits, projected cost-saving, and risk management.

4.1.1 Blockchain-based takāful (Islamic insurance)

As a niche section of the insurance sector, the takāful segment is signifi-
cantly interrelated with disruptions occurring in the insurance sector. The
global insurance market had a reasonable growth rate, with global real
premium growth rates of 2.9% in the advanced economies and 7.4% in the
emerging and developing countries in 2014, an improvement over the 2012
78 Hazik Mohamed
and 2013 rates (IFSB, 2016). Likewise, the growth rate of gross contributions
in the takāful sector demonstrated a recovery in 2014 from 2013, when the
growth rate of premiums was by far the lowest historically.
In its Islamic Financial Services Industry (IFSI) Stability 2016 report,
Islamic Financial Services Board (IFSB) observed that the reinvigorated
gross contributions of the takāful sector reached US$22.1 billion in 2014,
up from only around US$5 billion in 2006. The biggest share of the takā-
ful sector belonged to the Gulf Cooperation Council (GCC) countries, fol-
lowed by Iran and the East Asia and Pacific region. The other three regions
(Africa, South Asia, and Levant) had a very much lesser share in total. As
takāful’s share of the insurance sector is only 1%, there is a long way to go
for the takāful sector. Indeed, the low penetration rates in certain countries
in which the takāful industry operates indicate an available market for the
takāful sector. Since many of the target markets like Turkey, Saudi Arabia,
Pakistan, Qatar, and Egypt have a growing middle-class and young popu-
lations with solid growth prospects, there is promise for the takāful sector
to grow further.
Three jurisdictions account for 84% of the global takāful contributions:
Saudi Arabia (37%), Iran (34%), and Malaysia (14%). However, the types
of takāful provision are different for different jurisdictions; for example,
in Malaysia nearly two-thirds of the takāful contributions are for family
takāful (which features a strong savings/investment component). In Saudi
Arabia and Iran, insurance such as medical/health or motor takāful is pre-
vailing. The current low diffusion of takāful services indicate there is ample
opportunity for further growth of the insurance/takāful industry, combined
with high population growth and a growing middle class.
Also, the IFSI report revealed that the business profiles of takāful oper-
ators differ among the countries to a great extent. They found that in Ma-
laysia, family takāful is 68.1% of the total business line, which is the highest
number in the sample. The combination of a relatively young population, a
high percentage of working population, a vibrant social security system, and
saving incentives for retirement plays a part in the high proportion of life in-
surance in its society, including family takāful. Behind Malaysia is Pakistan
and the UAE which comprise a reasonable share of family takāful – around
30%. This is not so in Saudi Arabia, where health coverage is compulsory
and a tradition of long-term saving using insurance/takāful products is
non-existent. Other countries with low shares of family takāful are Kuwait
(at 8.6%) and Bangladesh and Qatar (both at 0%). From the rising trends
of births and the middle class, policies geared towards increasing public
awareness on such services as well as those encouraging long-term savings
such as unit-linked instruments could grow the family takāful business.
Motor takāful is the second-most important business line in the sample
countries of the IFSI report, with an average of 27.7% over the entire sample
of countries. Kuwait has the highest share of motor takāful, followed by Sri
Lanka, Pakistan, and Qatar.
 Takāful on the blockchain 79
The third-most important business line for takāful was fire, property and
accidents, with the highest levels of domestic markets in Qatar and Bangla-
desh. Other business lines in the takāful sector include workmen’s compen-
sation and energy takāful, which has a considerable traction in the UAE and
Sri Lanka.

4.2 Blockchain-based takāful

Smart contracts deployed through the blockchain will provide customers
and takāful (insurance) companies a system to manage claims in a trans-
parent, quick, and indisputable manner. Takāful policies, along with its
terms and conditions, and potential claims can be recorded onto the block-
chain and validated by the network, ensuring valid claims are dispensed
and rejecting false claims.1 For example, the blockchain will reject multiple
claims for one accident because the network would know that a claim has
already been made. Smart contracts would also process claims efficiently,
by triggering payments automatically when certain conditions are met and
validated. To more effectively detect identity fraud, falsified injury, or dam-
age reports, blockchain can be used as a cross-industry, distributed registry
with external and customer data to

• Confirm authenticity, ownership, and origin of goods as well as legiti-

macy of documents (e.g., medical reports).
• Check for police reports indicating theft, claims history as well as a
person’s verified identity and expose patterns of deception related to a
particular person or identity.
• Proof of date and time stamps of policy issuance or purchase of a
product/asset.
• Validate ownership and site changes.

Still, to attain full blockchain-specific benefits from these applications above

what is achievable with traditional solutions and other current types of co-
operation, e.g. via industry associations, broad cooperation between insur-
ers, customers, manufacturers, and other stakeholders, is needed. This is an
example of an ecosystem growing beyond the traditional industry practice
in the sharing economy of the digital era. Emerging blockchain applications
and four key areas where we see the most potential for evolution and trans-
formation are as follows:

• Fraud Detection and Risk Mitigation

The blockchain has the potential to eradicate mistakes and detect
deceptive activity because of its ability to be a public ledger across mul-
tiple unknown parties. A distributed digital depot can autonomously
confirm the legitimacy of customers, policies, and transactions (such
as claims) by presenting a comprehensive historical record. As such,
80 Hazik Mohamed
insurers would be able to spot fake or counterfeit transactions involving
doubtful people and suspect entities.
First-movers insurers are already evaluating the use of blockchain to
mitigate scams and risks related to cross-border payments and transac-
tions linking multiple currencies. In forte insurance and reinsurance seg-
ments, where insurers are often disconnected from the clients, blockchain
may be used to tackle the significant inefficiencies, disparities, and errors
caused by bad data quality from the front and back offices. In the US,
health insurers and regulators view blockchain as a powerful tool for fight-
ing Medicare deceit. Validation and verification form the nucleus of the
blockchain business case, which can improve many insurance processes.
Blockchain will lessen administrative and operational costs through
automated verification of policyholder identity and contract validity,
auditable record of claims and information from third parties (e.g. en-
crypted patient data between doctor and injured party manageable by
insurer to authenticate payment), and disbursement for claims through
a blockchain-based payments infrastructure or smart contracts-linked
escrow account. Providing reinsurers controlled access to claims and
claims histories recorded on the blockchain increases transparency for
the reinsurer in an automated yet auditable manner.
• Claims Processing and Management
Besides mobile and digital technologies, blockchain is essential to es-
tablishing an efficient, transparent, and customer-focused claims model
based on higher degrees of trust through transparency. Within claims
management, new data streams can enhance the risk selection process
by combining location, external risk, and data analytics. A distributed
ledger integrated to existing systems can enable the insurer and various
third parties to easily and instantly access and update relevant informa-
tion (e.g., claim forms, photo evidence, police reports, and eyewitness or
third-party accounts).
The application of data from a mobile phone can simplify claims sub-
mission, reduce loss adjustment costs, and increase client satisfaction,
with blockchain systems connecting communications to all parties.
Correspondingly, the use of mobile technologies, satellite imagery,
sensor data, and blockchain could facilitate claims payments and res-
cue services when natural disasters occur in remote areas. Information
collected from weather stations could establish claims sum based on
actual climate readings, with blockchain facilitating more efficient data
sharing and stronger protection against fraud.
In addition, advanced technology will be able to work effortlessly
through the concept of Internet of Things (IoT) where massive devices
are linked via the internet. For example, accident claims can be made
through an app provided by the insurer by taking pictures or sending
videos of accidents which are time-stamped. Together with blockchain
solutions for know-your-client (KYC) data, a client can send the verified
 Takāful on the blockchain 81
identity data to other companies for confirmation with the same app,
avoiding the need to repeat the verification process, thus expediting ef-
ficiency in the onboarding of new users.
• New Distribution and Payment Models
Some international insurers are already developing partnerships and
exploring new payment systems and business models (cryptocurrencies
and digital wallets) to achieve capital efficiencies through a truly public
global ledger system. Increased computerization to acquire risk infor-
mation in contracts also suggests new opportunities to build market
intelligence, simplify payments, and build financing risk. At the very
least, global insurers can use the blockchain to remove asset manage-
ment costs or hedging fees required for mitigating currency fluctuations
in cross-border and international transactions.
In the new business model, the focus of the insurers would be on
matching supply and demand to risk calculation research, instead of
asset management. The insurer could create a marketplace-like plat-
form where customers can post their insurance demand, which could
be either a standardized product or even a specific demand. The insurer
then would use its risk models along with ‘risk assessment intelligence’,
based on available historical information, to perform a premium cal-
culation for the expected return. With this expected return, interested
investors can bid or subscribe to the demanded insurance.
With the use of smart contracts and records on a decentralized
ledger, the payment from the investor to the customer in the event of an
insurance claim become cheaper, transparent, and more efficient than
long-established ways. In addition, the investors know their maximum
exposure as the amount defined in the smart contracts.
The insurer can also now play the role of assessor of the damage to
validate the authenticity of the insurance claim. But this could as eas-
ily be outsourced to a third party and by connecting the blockchain to
other ledgers where verification can be done automatically.
• Reinsurance
Property and casualty insurers seeking clearer visibility into their re-
insurance contracts and risk exposures may gain it through blockchain.
Consider the case of an insurer seeking to offload an equal amount of
risk to two separate reinsurers. A blockchain ledger could provide in-
sight and notification if one of those reinsurers then tried to offload
some of its portion to a subsidiary of the other reinsurer. It also would
help insurers gain confidence that, as they pay out claims, they are ap-
propriately rebalancing their capital exposures against specific risks.
Within reinsurance, the benefits of blockchain include more accurate
reserve calculations based on actual participating contracts and auto-
matic calculation updates once the primary information and data are
updated. On top of that, insurers obtain more room to move capital
and improve transparency into known risks, capital productivity, and
82 Hazik Mohamed
compliance. Operationally, the process of audit trails becomes simpler
to chart, modelling requirements are significantly reduced, and there is
less coordination required between the finance and IT functions.

4.3 Enablers to blockchain-based insurance

In order to help develop takāful services offered by takāful insurers to their
customers, the required enablers to systematize these services are smart con-
tracts and instant payment infrastructures. These enablers will amplify the
benefits for takāful insurers, banks, financial institutions, and businesses
using digitally dispersed ledgers in fraud detection, claims management,
and reinsurance.

4.3.1 Blockchain-based smart contracts

The idea of automating the insurance policy once it is written into a smart
contract is appealing. The transparency of events along the supply chain
via the blockchain is itself a major enabler of faster payment and improved
financing, increased efficiency, reduced risk of fraud, and lower costs. Smart
contracts are self-executing computer codes that automatically carry out
functions once a triggering event has taken place. It is a linear contract that
can include multiple parties (buyer, seller, banks, insurance companies, etc.)
and that cannot be altered.
For example, if a smart contract is written between a buyer and a seller
to say that once goods have been cleared by customs, 25% of the funds will
be released to the seller, a smart contract would automatically pay out once
authentication is made via a distributed ledger that the customs office has
cleared the goods. The clearance by customs does not trigger any action by
a bank but the confirmation entered into the system triggers the payment.
With a smart contract, legal terms and conditions are set in the computer
program, which facilitates the preset execution of functions determined by
a contractual agreement.

4.3.2 What is a smart contract, and how does it work?2

Smart contracts are a multifarious set of software codes with parts created to
computerize the execution and completion of contractual agreements. In other
words, they are programmable agreements which self-execute the terms and
conditions of an agreement when preset conditions are set off. Once counter-
parties assent to all of the terms within the contract, they cryptographically
sign the smart contract and release it to a dispersed ledger. When a stipulation
specified in the program is satisfied, the code automatically prompts a conse-
quent action. By removing the need for direct human involvement, a deployed
smart contract on a distributed ledger could make legal agreements more effi-
cient and cost-effective with fewer errors, delays, or disputes.
 Takāful on the blockchain 83

Smart contracts on the blockchain

Smart contracts on the blockchain can be referred to Figure 6.1,

page 140 in DOI:10.1515/9781547400966-202, by the same authors (see
for details: Mohamed and Ali 2018) in which author explains the criti-
cal characteristics of smart contracts are

i programmability,
ii multi-signature (or multisig) authentication escrow capability, and
iii predictive inputs.

• A smart contract automatically performs according to programmed logic.

• Multisig allows two or more parties to the contract to consent the exe-
cution of an operation independently – an essential requisite for multi-
party contracts.
• The escrow facility guarantees the securing of funds with a mediator
(e.g. a bank or an online market) which can be released under provi-
sions satisfactory to contracting parties. Sometimes, external data such
as prices, performance, or other real-world inputs may be required to
carry out an operation, and predictive services help smart contracts
with inputs such as these.

There are several types of smart contracts being developed currently but
the principal blockchain-based technology uses public key encryption in-
frastructure (PKI) to program the stipulations of a contract. PKI is a system
of cryptography that uses of two types of keys: a public key apparent to all
parties and a private key only to its recipient. In a smart contract transac-
tion initiated on a blockchain, the sending recipient encrypts their message
into an unreadable ‘cipher text’ using mathematical algorithms to protect
and mask the data. Only the use of a private key can decode the ‘cipher text’
back into a readable ‘plain text’. The vital advantage of PKI is in its security,
as it is extremely difficult, to reconfigure a public key to a private one, mak-
ing it very resilient to failures or hacks.
Smart contracts can be seen as the future of legal agreements, as they
enable more efficiencies in commercial contracts through a decrease in
manual processing, initiation of contract terms, and risk reduction through
the elimination of manual errors and duplicate invoice financing. However,
legal and regulatory challenges surround smart contracts in many jurisdic-
tions, and many companies exploring the use of smart contracts are still in
the proof of concept stage. To accelerate maturity of this technology, smart
contract terms need to be standardized, small-scale B2B smart contract ap-
plications need to succeed and grow, and adoption for use in trade finance
will pave the way to the actualization of the theoretical benefits.
84 Hazik Mohamed

How the blockchain cryptography works for smart contracts

The detail structure of the blockchain cryptography work can be re-

ferred to Figure 6.2, page 141 in DOI 10.1515/9781547400966-202, by
the same authors (see for details: Mohamed and Ali, 2018).

4.3.3 Instant payment structures

The development of instant payment infrastructures is another key enabler
that will add speed and efficiency to trade transactions. Over 20 countries
around the world have already implemented instant payment infrastruc-
tures, and major markets such as Australia, the US, the Eurozone, and Asia
are in the process of developing and testing instant payment systems. With
the ability to send and receive domestic payments within seconds, the move-
ment of money triggered by events along the supply chain can proceed more
rapidly, which means that shipping companies, customs offices, and sellers
have quicker access to funds. Instant payments can also enable both buyers
and sellers to obtain funding from their banks faster than they do today,
which can lead to a further optimization of working capital and unlock li-
quidity from supply chains.

4.4 Moving forward

Blockchain functions as a distributed system, and thus, its value will
mostly depend on collaboration with all actors in the value chain like cus-
tomers, service providers, payment systems, and regulators. Blockchain is
an IT investment with a perspective of presumably five years until full real-
ization of benefits. In application areas that do not strongly rely on block-
chain’s distributed mechanisms, alternative solutions can provide similar
benefits much sooner. For the industry as a whole, this means starting to
work with consortia, technology experts and start-ups, regulators, and
other market participants to identify the challenges around and leverage
upon blockchain’s open and decentralized nature. Among these challenges
are technology limitations as well as market, legal/regulatory (who regu-
lates in the absence of an intermediary or in cross-border transactions),
and operational requirements regarding, for example, data protection and
standardization.
Individual takāful companies should start with a holistic understanding
of customer engagement needs and their own pain points to assess where
the most promising blockchain use cases exist. As an innovative technol-
ogy, blockchain presents a threat for incumbents in the form of innovative
business models and/or cost advantages. But there is a range of options
to counteract this threat by adopting the way of working of start-ups,
 Takāful on the blockchain 85
partnering with, or acquiring them. Key to shaping the future of the block-
chain takāful ecosystem is getting involved in partnerships and industry
activities early on.

4.5 Conclusion
The use of distributed ledgers to exchange data related to transfer of goods
and information could also enable more granular payments along the sup-
ply chain. Enabling all actors in the supply chain to directly input infor-
mation into a distributed ledger means that there is more visibility of each
step along the supply chain. These events could facilitate smaller portions of
financing to be released, thereby unlocking liquidity and reducing the risk
of non-payment.
In an era of ‘point innovations’ such as mobile apps and robo-advisory
models, blockchain stands out as a more foundational or architectural de-
velopment. In that sense, blockchain may support, and subsequently drive,
increased use and broader adoption of the many other digital innovations
that have helped reshape the insurance landscape.
Takāful operations management should recognize how the blockchain
can increase trust and transparency, which speaks to the heart of the insur-
ance business. After all, the industry’s inherent bond of trust and ‘promise
to pay’ are based on disclosure of accurate personal data describing the in-
surable interests of the client, the agreement to a contract between two par-
ties, and timely exchange of payment. Blockchain can help remove friction,
errors, and risks from all of these essential steps. There is substance behind
the hype, but the insurance industry must make investments now to be in
a position to take advantage of efficiencies and opportunities blockchain
technology can deliver long term.
It is vital that the Islamic economic actors surmount current and future
challenges related to insurance by manifesting the objectives of the Shari’ah.
One of the most fundamental functions of takāful is to provide the efficient
compliance to settlements of claims according to agreed contractual stipu-
lations and timely payouts of those genuine claims. The development of a
blockchain-based insurance system would help to propel the Islamic takā-
ful industry into a competitive one through cost-efficient processes, faster
verifications, and better fraud detection capabilities. This way the takāful
operators show nimbleness by adjusting to changing trends and landscapes,
and after all, mitigating risks through takāful insurance is perceived as pro-
tecting one’s lifestyle and livelihood.

Notes
1 An estimated 5%–10% of all claims are fraudulent. According to the estimated
global size of the takāful industry, this costs takāful operators more than US$2
billion per year.
86 Hazik Mohamed
2 Taken from an article I wrote for https://journal.wahedinvest.com/smart-
contracts-in-islamic-economic-transactions with similar section.

References
Islamic Financial Services Board (IFSB), Islamic Financial Services Industry Sta-
bility Report 2016, www.ifsb.org/docs/IFSI%20Stability%20Report%202016%
20(final).pdf.
Mohamed, H., and Ali, H. (2018). “Blockchain, Fintech and Islamic Finance”,
De|G Press, Walter de Gruyter Inc., Boston/Berlin. DOI 10.1515/9781547400966-202.
5 IT-based Finance Hub
A new horizon towards
transparent Zakat distribution
model
Umar Draz, Tariq Ali, Sana Yasin, Ahmad Shaf
and Raiha Tallat

5.1 Introduction
More than 70% of the population of this world live in a very poor miser-
able condition. The total wealth of this world is circulating among some
millionaire families. The unbalance of wealth may cause several conflicts
in society. In the 21st century, the ratio of poverty is increased day-by-day.
According to Oxfam [1, 2], the 64 richest billionaires have enough wealth
that is nearly equal to the half poorer population of the world. Due to this
biggest fact, all small countries that have no enough resources do not meet
the normal living standards. Due to lack of food and agriculture resources,
famine becomes the dominant attack on these types of small countries. But
there is a very interesting fact about all these small countries where the fam-
ine comes two to three times in last two decades concluded that the lack of
food and resources does not cause the occurrence of famine. The unbalance
of wealth is the major cause that famine occurs in these areas. In these types
of countries where rich become richer and poor become poorer, the house of
poverty come into exists for a long time [3]. Due to all these fundamental
reasons, Islam teaches us a very efficient concept of Zakat. Being the fifth
pillar of Islam, Zakat is very important for the humanity to make it balance.
Salah and Zakat simultaneously discussed in Quran at 70 different places.
The importance of Zakat in Islam can never be underestimated. Zakat is
basically the name of purification of wealth through some Islamic manners.
There are many selective parameters that cover the Zakat donor as well as
acceptor. The most influential parameters that are more deserving of Zakat
are disabled persons. These persons do not perform any single duty due to
their disability [5].
Pakistan, being a Muslim country, has established several laws for the
collection of Zakat as there are various banks who deduct Zakat amount
automatically from the account if account holder meets the requirement of
Zakat [6, 7]. Many banking systems are present that performed the mech-
anism of Zakat at charity month. In charity month they deduct the Zakat
88 Umar Draz et al.
amount automatically without the willingness of account holder. The ac-
count holder is also not sure about whether its deducted wealth is being
given to deserving people or not. Due to these several reasons, it forces the
account holder to withdraw their amount at the beginning of charity month
and to resubmit at the end of charity month [8]. This chapter presents a new
idea: an Information Technology (IT)-based Finance Hub that will be es-
tablished at Union Council (UC) level under the control of Government of
Pakistan. The graphical model of proposed IT-based Finance Hub is shown
in Figure 5.1 for a semiformal representation.
Initially, this Finance Hub will support the disabled people in respec-
tive areas. This Finance Hub will be responsible to collect Zakat from
the wealthy people of their areas and distribute Zakat equally among the
registered disabled people for their whole life. The elected heads of the
centers will morally counsel the wealthy people in their respective areas
towards a donation of Zakat, and they will also be responsible for in-
vestigation and registration of deserving disabled people to maintain the
transparency of Zakat distribution. The donors will pay Zakat to the fi-
nancial hub, and the Finance Hub will be linked to the banking systems
to ensure that their Zakat will not be deducted again by the banks. All
the above process gives the additional confidence to the donor such that
they will willingly give the charity to proposed Finance Hub. To make
the system clear in a well- disciplined manner the proposed Finance Hub

Figure 5.1 IT-based Finance Hub.

 IT-based Finance Hub 89
is attached to all types of banks that are under the radius of UC. Most of
the work on Zakat distribution is already be done in the form of survey
or some comparative studies, which have a lot of drawbacks [2, 9–12].
For example, all the proposed model and comparative Zakat system do
not provide the correctness of the model. Formal specifications that are
applied to formal methods are more effective and efficient to provide the
correctness proof of the model.
The Vienna Development Methods-Specification Language (VDM-SL)
is used in this research work. The VDM-SL toolbox is used to provide a for-
mal specification of IT-based Finance Hub. To the best of our knowledge,
this is the first work that used formal methods in this domain. Previously
there are not any formal specifications present that formalize the Zakat
system.
Rest of this chapter covers the related work in this area described in Sec-
tion 2. The proposed high-level algorithm is discussed in Section 3. Section
4 is used to describe the formal section and its invariants of IT-based Fi-
nance Hub. At the end, Section 5 concludes the chapter.

5.2 Related work

Many models are present based on Zakat distribution, as Islamic banking is
also an example of this domain. A lot of systems and strategies are proposed
that manage and control the Zakat transparency and its collection. Accord-
ing to the survey of Organization of Islamic Countries (OIC) that consists
of 17 member countries, we found that the ratio of Zakat to GDP exceeds
the poverty gap [1, 13, 14]. Pakistan is also the member of this organization
so that the poverty ratio is rapidly increased in last five years. In order to
evaluate the growth of the economy, there is a need to refine the Zakat sys-
tem. To mitigate the gap between poor and rich the alternative approach
with the Zakat system is used in [15]. ‘Zakat’ and ‘user’ are two fundamental
programs of Pakistan with three main objectives discussed in [16] which
adopted some different types of the banking system. The detailed survey
that covers the aspect of poverty index, welfare index, wealth index, ma-
terial poverty index, absolute poverty index, and spiritual poverty index is
used a tool of analysis [3, 17]. The objective of this analysis is used to gather
information about all relative indexes that directly or indirectly affect the
performance of Zakat distribution model. All the welfare potential insti-
tutions of Pakistan that have the literature of livestock, tradable inventory,
currency in circulation, foreign exchange reserves, and financial assets like
national saving scheme are presented in [13]. Nowadays most of the research
communities have focused the semiformal specifications; for example, sim-
ulation and testing of the proposed model have been done in VDM-SL for
this research work.
Recently the researchers used VDM-SL to verify the algorithm and
models to overcome the cons of non-formal techniques [18–20]. Z-notation
90 Umar Draz et al.
is also used for the verification and validation purposes. Recently the
earthquake management system and the forest fire detection system are
formalized under the VDM-SL platform. Formal methods are also used
for safety-critical systems like to rescue the victim alive or not in disas-
ter management, air traffic control system, railway interlocking system,
and intelligent buildings system [21–26]. This work is done with the help of
formal specification due to its descriptive power for formal modeling and
verification.

5.3 Working mechanism for IT-based Finance Hub

The basic working diagram of this proposed IT-based Finance Hub is start-
ing with creating the hub under the umbrella of government. The collection
of Zakat from wealthy people is performed by a transparent method that
encourages disabled people under three defined categories. The VDM-SL
toolbox is used to verify and validate each credential of this model. The
basic flow chart of this hub is discussed in Figure 5.2.

START

Create Finance
Hub

Bank not
If give Collect Zakat
deduct Zakat

Verify the
Disable people

If not
Rejected
If verified

Registered and
received Zakat

END

Figure 5.2 Flowchart of Finance Hub.

 IT-based Finance Hub 91
5.4 High-level pseudocode of IT-based Finance Hub algorithm
We proposed the IT-based Finance Hub algorithm (ITB-FHA), which proac-
tively defines the finance hub centers at union council level. This Finance Hub
further links all types of the banking system that is under the radius of UC.
The main purpose of linking the banking system with the Finance Hub is to
ensure that the Zakat amount paid by the donor to the financial hub is not
again deducted by banks. The dedicated staff of the Finance Hub will pursue
and guide the wealthy people of the UC level to give the Zakat donation to this
worthy and transparent Finance Hub. In the next step, the ITB-FHA makes
the criteria for disability. The disability is either in major state or in minor state
or in between these two states. To find out the disability and condition the Fi-
nance Hub staff makes the policy of giving the total amount of Zakat [27–29].
The entire Zakat amount is distributed according to the disability ratio (DR).
The registration of disabled persons is set with its name and its credentials. The
DR is also attached to the record of delivering the Zakat amount as per criteria.
Collection of Zakat is sent to their homes monthly after ensuring all process. So
in this process, the ITB-FHA is transparently not only distributing the Zakat
but also achieving the satisfaction of donor people. All the donor and acceptor
people will be confidential in the record of the Finance Hub. The high-level
pseudocode of the Finance Hub model is described in Table 5.1.

Table 5.1 High-Level Pseudocode of the System

1 The new proposed Finance Hub will be established at the UC level, and it will
be controlled by the government.
2 Finance Hub will be linked to the banking systems to ensure that Zakat
amount paid by donor to the financial hub will not be deducted by the banks.
3 First, Finance Hub staff will pursue the wealthy people of the UC to give the
Zakat donation to the financial hub.
4 Finance Hub center will have eligibility criteria to give the Zakat amount to
the disabled people.
5 It divides the disabled people into three categories: major, average, and minor.
6 The people that have no background and their DR is 80% then it will fall un-
der the ‘major’ category.
7 If people have 60% DR and have some background support then it will fall
under the ‘average’ category.
8 The strong financial background with 40% DR people will fall under the ‘mi-
nor’ category.
9 Zakat amount will be given according to the DR of the people.
10 Each Finance Hub will be able to purely register the disabled person with
their name, age, and DR.
11 Total Zakat amount will be equally distributed in the 12th month. Disabled
person will be received Zakat amount on monthly basis not annually.
12 In case of any emergency Finance Hub staff will have authority to register,
remove, or update the record of disabled people.
13 This center will provide a transparent process that gives the confidence to the
wealthy people, and they will willingly give charity to proposed centers.
14 The following process will be continued to provide the transparent way of
Zakat distribution.
92 Umar Draz et al.
5.5 IT-based Finance Hub algorithm
The form of inputs examined all the drawbacks of the existing model of
Zakat and proposed the first IT-based model that uses the formal specifi-
cation and verification. Under the umbrella of government, the IT-based
Finance Hub model is developing at UC level (line 1). In every UC, develop-
ment of the Finance Hub is responsible to connect all types of banks. Each
bank is linked to the Finance Hub server that makes the records of donor
people and informs to bank system (line 2–3). If the donor account already
exists in the bank, the Finance Hub informs the bank authority not to de-
duct the money again in the charity month. Distribution criteria are set and
applied to all the disabled persons (line 4–5). Records of all disabled persons
are managed in line 6. The distribution criteria and its ratio according to the
category of disability are discussed in line 7. If the disabled people find out
as per the criteria then distribution of the Zakat ratio as deal in line 8–10 of
ITB-FHA. The high-level pseudocode algorithm is shown in Table 5.2.

5.6 Formal specification of ITB-FHA using VDM-SL

In this section formal specifications are to be applied with the help of formal
methods using VDM-SL. A lot of terms and constructs are used to identify
each formal specification, for example, composite objects, sets, invariants,
types, union, and pre/postconditions. Pre- and postconditions play part and
parcel role to develop the formal specification of any constructs, and these

Table 5.2 Algorithm of ITB-FH

INPUT: Existing traditional Zakat distribution system

OUTPUT: A new IT-based transparent model for the collection and distribution
of Zakat
1 Finance Hub establishment at union council level under government
2 ∀ Finance Hub Fk for K = 1,2,…… n
3 Bank relation (Finance Hub) // Link each Finance Hub with banking system
4 ∀ Finance Hub Fk for K = 1,2,…… n
5 Set distribution criteria (disabled people)
6 If disability ratio<= 40%
7 Then low=disabled people
8 If disability ratio<= 60%
9 Then average=disabled people
10 If disability ratio<= 80%
11 Then major=disabled people;
12 ∀ Disable people Pk for K = 1,2,…… n
13 While d 0< d Do where do=Disability ratio, d=Distribution criteria
14 Find disabled people ( Pk ).
15 If found the disable people go to line 16
16 Distribute (Di , Pi)
Di = Distribution criteria, Pi = Disable people
17 This process continues to provide transparent Zakat distribution
18 End While
19 End if
20 End For
 IT-based Finance Hub 93
strategies usually lead towards the verification and validation of the proposed
system. With the help of the dynamic and static nature of the formal specifi-
cations that is already defined in the proposed model. The static model deals
with all the definition of data types and its related values, whereas the dy-
namic model deals with the corresponding state and its operations.
The Finance Hub consists of finance staff, disabled people, and its cate-
gory. All these attributes are generally described as a composite object with
the type of Token. The Finance Hub consists of basic rules like types of
disabled people with its category, major, minor, and average. Initially, at
each UC level, 500 disable people will be selected for Zakat. The decision of
distribution money will be taken while observing the category of disability.
From the total decided amount of Zakat, the 30% is given to those with
minor disabilities. Similarly, for average and major disabilities, the 60% and
80% is given. Registration field deals with the set of all disabled people, and
registration of staff field registered the set of all staff members. The total
possible category of disability is also registered separately. The formal spec-
ification of central hub represents hub_reg as the composite object type. The
formal condition of staff registration is less than the proposed limit value.

Invariants: (1) The main state called Finance Hub in which the registration of
each module is separately defined. The staff registration consists of staff people
that are worked for the Finance Hub. Minor, major, and average disabilities are
separately defined to take the specification clear in a scene of Zakat distribu-
tion. The specific amount of Zakat is equally distributed according to this three
defined categories. The possible invariants and initialization are defined in
which the total number of disabled people does not exceed the proposed limit.
94 Umar Draz et al.
In our proposed algorithm the first operation that needs to be investi-
gated is the creation of the Finance Hub. The type of Finance Hub is set
because the Finance Hub further deals with the collection of items. The
external class deals with the registration of all hubs that are further linked
with all types of banks in the area of union council. The possible precon-
dition of registration is to include finance center if it is not the part of hub.
The formal postcondition is that the existing registration hub is taking the
union of all new registration.

Before adding the disabled persons in a system there is a need to set the eli-
gibility criteria for disabled people in the Finance Hub. The formal specifi-
cation of these statements is composite type because the set of all categories
becomes the part of eligibility criteria.
Invariants: The eligibility criteria deals with three classes like minor, av-
erage, and major that cover the disable registration. The main invariants in
this regard are that the cardinality of this entire category does not exceed
the proposed existing value. In this way, this condition becomes the pre-
condition that is to be executed before postcondition. The post condition
deals three possibilities like if the Zakat acceptor fails in minor, major, and
average disability then the registered.

Invariant Add disabled people: In the formal specification of “add disabled

people” in the system, the state is a collection of sets by default data types.
If the new people are already the part of the system then do not add them
and vice versa.
 IT-based Finance Hub 95
Invariant Remove disabled people: In the formal specification, the remove
and add option is frequently used. To remove the already-registered people,
the precondition is to ensure if the people are already registered or not. If
yes, then they are removed from the system.

Get Record of disabled people: To take record of the people, the formal speci-
fication takes the input as people and the output is also a set of people. There
is no such precondition involved here, but formally the ‘true’ is written in
front of precondition. The postcondition is that set of all registered people
belong to any category. Is Registered: To make sure that particular people
are registered or not, there are two invariants present with formally defined
pre- and postconditions. The possible input is the set of people, and the out-
put is the Boolean type. The Boolean-type function is used in this scenario
because only true or false output will come that ensures the specification of
registration.

Is Eligible: The eligibility criteria of the disabled person is already men-

tioned. All the pre- and post-conditions that decide the eligibility in any
category is formally defined in the particular state of the system. The output
of this system is also Boolean type. If the people are satisfied with the crite-
ria mentioned in algorithm, then precondition is true. Total disabled people:
To find out the cardinality of disabled people that are registered with this
system the formal specification is set of all people. The external class is only
in reading because there is no need of any operation. If pre condition is true
by default then the post condition shows the total number of people that
already part of the system.
96 Umar Draz et al.
Criteria for disability person: For the distribution of Zakat there are differ-
ent disability categories like major, minor, and average. (1) In case of ma-
jor disability, about 80% of the total amount of Zakat is distributed. (2) In
case of minor and average disability about 60%–40% of the whole amount
is distributed.

Distribution of Zakat: The formal specification of the distribution of Zakat

among different categories is mentioned in below coding section. To make
the transparent and fair distribution there is a need to apply the formal
methods if the individuals do not fall into more than one category at the
same time. The possible specification of this is divided into two formal con-
ditions. (1) First of all, check whether the disabled people are eligible for
the Zakat amount; if yes, then it is sure the assigned category in which the
person falls is best suited under the proposed criteria, then register them for
the best-suited categories like major, minor, and average.

Bank Verification: For the verification purposes, the Boolean-type data set is
used which have two possible values: either yes or no. If the Zakat of individ-
ual is deducted by the Finance Hub then the hub administration informs the
linked banks to stop deduction the Zakat at the charity month of the same
person. If all the stakeholders are the part of the Finance Hub management
then their amount will not be deducted from any bank inside the area.
 IT-based Finance Hub 97

5.7 Model analysis

The proposed formal specification for the IT-based Finance Hub through the
technique is available in the VDM-SL toolbox. For the verification and vali-
dation purposes, the formal specification is analyzed through a different syn-
tax checker, type checker, C++ code generator, and pretty printer. The main
objective of verification through syntax and type checker is to check whether
the formal specification is according to the syntax of VDM-SL. Through a
type checker, it verifies the correct usage of different data types. Through
the code generator of C++, the proposed formal specification is converted
into object-oriented language. To avoid the inconsistency the pretty printer
is used. The runtime error and the dynamic behavior of the formal spec-
ification of the IT-based Finance Hub deal with the pretty printer. It also
validates all related properties of type and data checking of some invariants
like pre- and postconditions. The model analysis through VDM-SL is shown
in Table 5.2. And the formal summary of the proposed result is shown in
Table 5.3 (Figure 5.3).

Table 5.3 Analysis of State, Functions, and Operations

Composite object, State, Syntax Type Pretty Integrity

Function, and Operations Check Check Check Check

Banks Y Y Y Y
Finance Hub Y Y Y Y
Disable people Y Y Y -
Staff/administration Y Y Y Y
Eligibility criteria Y Y Y Y
Model/pseudocode Y Y Y Y
Algorithm/mechanism Y Y Y Y
Zakat donor Y Y Y -
Zakat acceptor Y Y Y -
Zakat record Y Y Y -
Distribution Y Y Y -
Attribute operations Y Y Y -
Values Y Y Y Y
Bank verification Y Y Y Y
Area of UC Y Y Y Y
People of UC Y Y Y Y
Collection Y Y Y Y
Registration Y Y Y Y
Verification and validation Y Y Y Y
98 Umar Draz et al.

Figure 5.3 Proof of correctness through VDM-SL toolbox.

5.8 Conclusion
Pakistan, being a Muslim country, has established several laws to col-
lect the Zakat as there are various banks who deduct Zakat amount au-
tomatically from the account if account holder meets the requirement of
Zakat. This system has many problems like account holder willingness is
not involved and they are not sure whether their amount is being given
to deserving people or not. This chapter presents a new idea: a IT-based
Finance Hub that will be established at Union Consul (UC) level under
the control of Government of Pakistan. This Finance Hub will be respon-
sible to collect Zakat from the wealthy people in their areas and distribute
Zakat equally among the registered disabled people for their whole lives.
The elected heads of the centers will morally counsel the wealthy people
in their respective areas towards a donation of Zakat, and they will also
be responsible for investigation and registration of eligible disabled people
to maintain the transparency of Zakat distribution. Up to our best knowl-
edge, through formal specification first time, this work is done on this do-
main to propose the IT-based Finance Hub. With the help of verification
and validation, this work not only achieves the transparent distribution
model but also takes the happy willingness of Zakat donor. These centers
can also play a vital role to discourage the increasing mendicant’s system
in the society.
 IT-based Finance Hub 99
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6 The way towards standardizing
Islamic economic, financial,
and banking fatawa
Masudul Alam Choudhury

6.1 Introduction
This is a short chapter focusing on the problems encountered by ‘Shari’ah-
compliance’ idea and practices of Islamic banking on the issues of standard-
ization of rules and opinions concerning unification of financial fatawa. The
chapter presents the authentic alternative means that could be adopted by
Islamic banks to universally harmonize ‘Shari’ah-compliance’ fatawa and
practices in Islamic banking. These areas are now riddled with problems
such as the following one: prevalence of the problem of interpretation of
jurisprudence (fiqh) by diversity of views of Islamic schools. This is particu-
larly noted for the Shafei school (madhab) in Malaysia, and oppositely by
Hanbali and Hanafi madhabs in the Arab region and elsewhere. A concern
of this chapter is on the topic of standardizing of fiqh interpretations and
practices of Islamic banks. Along with this is the question: How can Islamic
banks adjust their financial fatawa within the international monetary and
financial system? How can fatawa be applied to matters of financial loans,
deposits, and commercial matters including market exchange issues? How
can multiplicity of fatawa, sometime by the same mujtahid (e.g. Shafei, Shat-
ibi), and their contending juristic consequences on ‘Shari’ah-compliance’
and product development be treated for unification under a standardized
shar’iah rule? In answer to all of these questions, this chapter seeks for al-
ternative views on financial pricing:

6.2 Objective
This chapter is simply a critique of the approach to standardization of fatawa
around madhabi diversity and the alternative recommendation regarding prac-
tices of muamalat in its broad sense of finance, banking, and market exchange.
The criticism here points out that the idea of ‘Shari’ah-compliance’ cannot be
upheld in light of the epistemic worldview of what truly is Islam when unequiv-
ocally understood and furthered upon her most indelible law that applies to
‘everything’. This is the law of tawhid, oneness of Allah as the episteme of unity
of knowledge as methodology leading to applications and inferences.
102 Masudul Alam Choudhury
By tawhid as law, this chapter means the primal ontology of monothe-
istic unity of knowledge, and its induction and inquiry of all details of the
world-system. Such world-systems are muamalat, money, finance, and Is-
lamic banking. We will examine how tawhid as law can be uniquely and
uniformly studied in and for standardization. Tawhid as law has a distinc-
tive methodology that applies to formalism, interpretation, application,
and sustainability of unity of knowledge in the framework of evolutionary
learning on monotheistic unity of knowledge. While the vast details of the
field of tawhidi methodological development as primal ontological law and
applications are not covered in this chapter, the topic concerning these can
be found in the works of Choudhury. Some of these are Choudhury (2006,
2014, 2016a, 2016b, 2017).
This chapter only picks up a few points of contention on the way towards
financial standardization of juristic interpretations. By tawhid as law of uni-
fication and its methodological worldview this chapter points out how it can
be universally acceptable. This is true not only for Muslims, but can also fit
in with analytical and practical soundness of monetary, financial, banking,
and market exchange matters in the global scene. Tawhid as law provides the
gateway to all of these and more issues with an endless breadth of intellec-
tion and legal command.

6.3 Towards inevitability of tawhidi methodological worldview:

problem with ‘Shari’ah-compliance’
‘Shari’ah-compliance’ is a human-concocted variant for legitimating prod-
uct development. Yet it has no legitimate and established groundwork for
attaining this goal, except by an institutional juristic imposition (e.g. AAO-
IFI, OIC, IDB, Bank Negare Malaysia, Bank Indonesia). Consider the case
of almost all Islamic financial instruments, which altogether are debt instru-
ments. The fatwa of permitting 1/3 of financial resources to be held in debt
is sheer clergy pronouncement that has now permeated into shari’ah ruling.
Then there is the entire pricing mechanism of delayed payments (e.g. ijara,
murabaha, takaful, sukuk, asset valuation). These are all deeply embroiled
in subjectivity of rate-setting, there being no rigorous knowledge and model
in ‘Shari’ah-compliance’. The result is a form of riba-setting in asset valua-
tion. The tawhidi alternative of valuation based on the episteme of unity of
knowledge remains unknown.
The tawhidi methodological worldview formalizes the model of immers-
ing all pricing matters of muamalat, finance, and banking into their com-
plementary interrelationship by inter-causality between these functions and
with their inner defining variables. In the absence of understanding the for-
malism of tawhidi law of monotheistic unity of knowledge (qurànic pairing),
all forms of interest rates have remained inextricably embedded in Islamic
asset valuation, in financial instruments, and thereby in Islamic product
development.
 Islamic economic, financial, banking fatawa 103
‘Shari’ah-compliance’ is now overloading muamalat matters with fatawa,
not recognizing the precision of mathematical and analytical scientific
methodology that arises from the tawhidi law of the Qur’an. The tawhidi
law of epistemic unity of knowledge is transmitted by sunnah, and intelli-
gently discoursed by the learned and devoted Islamic scholars. Contrarily,
shari’ah regulations have now embarrassed lock, stock, and barrel the entire
body of Islamic economics, finance, and banking. This has caused a state
of impossibility with the complications and confusions of ‘shar’iah compli-
ance’ idea that have befogged the true Islamic worldview.

6.4 Generalizing the methodology and application of tawhidi

law contra ‘Shari’ah-compliance’
The universality and uniqueness of tawhidi law, though not including in
this the hidden attributes (sifat), can resolve the standardization problem
of muamalat and Islamic banking caused by ‘Shari’ah-compliance’ fatawa.
The positive complementary interrelationship we refer to here is between
money, finance, banking, and real economy. We now raise the question:
How the debt problem of Islamic financing instruments, Islamic product
development, and absence of formalism and applicative methods can be re-
solved? ‘Shari’ah-compliance’ has not resolved this problem.
Thereby, the inherent pricing mechanisms and product developments
have remained mired. For example, ‘Shari’ah-compliance’ continues to
commit the dire mistake of focusing on shareholder model of asset valua-
tion as opposed to a stakeholder model along with its extensions beyond the
mere five elements of maqasid as-shari’ah. Thereby, ‘Shari’ah-compliance’
overly focuses on property rights in its narrow financial sense. The goal of
maximization of shareholder’s wealth with exogenous ethical excitement
as opposed to conscious endogeneity is proffered. Thereby, no analytical
substantiation is offered regarding valuation with the conscious nature of
endogenous inter-variable relations in the well-being function (maslaha) as
according to tawhidi law. This is a substantive issue of mathematical for-
malism and applications.

6.5 Well-being criterion

The well-being criterion (maslaha) would otherwise comprise the abstrac-
tion and applied way of asset valuation, product development, and the as-
sociated learned ways of quantitatively evaluating the well-being objective
criterion. The cardinal, universal, and unique precepts of tawhid as the
primal ontological law of monotheistic unity of knowledge could not be
embodied in the generality and details of muamalat. This would otherwise
comprise the financial world-system of good choices (maqasid), while avoid-
ing the false and questionable ones, even as the evolutionary learning pro-
ceeds on discursively (shura).
104 Masudul Alam Choudhury
‘Shari’ah-compliance’ has fallen deeply into confusion. The non-
standardization of fatawa by the various fatawa and fiqh interpretations has
gone into quagmire of juristic proliferation. A scientific study of muamalat,
finance, banking, and real economy, which tawhidi methodology offers, is
absent in ‘Shari’ah-compliance’ approach.
Consequently, as the global order of intellection is today boldly march-
ing forward with great alacrity into reexamining the epistemological foun-
dations that overarch transdisciplinary areas, so also Islamic economics,
finance, banking, real economy, and the archaic practice of fiqh and fatawa
must give way to the great tawhidi epistemic questioning. Today’s Islamic
intellection is confined to innovated ideas of ‘Shari’ah-compliance’. The ab-
straction and applications by the Qur’anic monotheistic primal ontology of
tawhid as law and its world-system embedding for the common good must
be evaluated by the well-being criterion (maslaha). Tawhid as law with its
epistemic abstraction and methodological worldview with applications in
the Islamic economic, finance, banking, and real economy issues remain
forgotten in ‘Shari’ah-compliance’.

6.6 Islamic product development by tawhidi law of unity of

knowledge
As another example of contrast between the tawhidi methodological world-
view and the ‘Shari’ah-compliance’ way, we briefly examine the nature of
property rights concerning any and everything in Islamic economics, fi-
nance, banking, and real economy. The old maqasid as-shari’ah, despite
being the blessed gateway towards tawhidi law of unity of knowledge, has
been marginalized due to lack of intellection. What has resulted is a narrow
understanding of the five elements of maqasid as-shari’ah as permissible
independent states of maslaha (Masud, 1984). Thereby, all such untenable
goals as maximization of shareholder’s wealth replaced by the maslaha func-
tion remain absent. Similarly, all the five elements of maqasid as-shari’ah
remain static concepts. No conceptualization is done regarding the vista
of extensions for well-being (maslaha). This would include Muslims, non-
Muslims, and the international monetary system in the case of muamalat,
finance, and banking. Contrarily, ‘Shari’ah-compliance’ has remained dis-
tanced by its approach of methodological individualism and archaic pos-
tulates of rational choice. Thereby, much of the analytical methodology, as
otherwise established by the study of tawhid as law, has remained distanced,
forgotten, and unintelligible to latter-day Muslims. Such Muslims are today
working in borrowed mainstream and concocted ideas regarding Islamic
everything. Tawhid as law in socio-scientific inquiry presents the unified in-
quiry of inter- causal relations, and construction of endogenous regulations,
policies, inferences, and development of learning institutions. Endogenous
intellection in such cases is contrary to Central Bank’s exogenously formed
regulatory policies and rules.
 Islamic economic, financial, banking fatawa 105
6.7 Riba problem in muamalat explained by tawhidi law contra
‘Shari’ah -compliance’
According to tawhid as law, product development is secured from riba-like
interventions in muamalat, financing, and banking contrarily by the partic-
ipatory principle of unity between these areas. According to tawhid as law
even as inter-causality increases between the functions, so also the debt-
ridden instruments of ‘Shari’ah-compliance’ are phased out. Conversely,
the episteme of unity of knowledge by complementary pairing increases as
evolutionary learning proceeds. The result is a true Islamicization (tawhid-
ization) of muamalat, finance, banking, and real economy along with their
endogenous complementary internal variables.
The problem of riba and riba-like pricing of debt-ridden Islamic financing
instruments as ‘Shari’ah-compliance’ ruling on this matter is resolved by
taking recourse to the tawhidi organic relational worldview intra-systems
and inter-systems with the selected variables. For instance, riba-like pricing
is not discounting of futuristic probabilistic expectations according to taw-
hidi law of unity of knowledge. Rather, such pricing is done at the ‘nearest’
point of occurrence of contingencies characterizing various resource flows
at these points. At such points the tawhidi unity of knowledge by systems
works in unifying the monetary, financial, banking, and real economy sys-
tems. For sustainability, these systems remain interactive, integrative, and
evolutionary by learning processes over knowledge and time. A debt prob-
lem is thereby avoided when every event point of temporal valuation with
contingencies is evaluated by equivalence between money, finance, and real
value of assets. Islamic banks ought to do this kind of participatory financ-
ing and carry out the underlying knowledge dissemination. The Central
Bank ought to take stock of this kind of learning and valuation. The tawhidi
methodological worldview of participative organic pairing (Quràn 36:36) is
now active.

6.8 Tawhidi methodology contra ‘Shari’ah -compliance’ and

Kantian rationalism
Figure 6.1 briefly outlines the contrasting opposites, between tawhid as the
primal ontological law of monotheistic unity of knowledge and the human-
concocted notion of ‘Shari’ah-compliance’. Figure 6.1 explains that reason-
ing in ‘Shari’ah-compliance’ is discontinuous, as in the case of the Kantian
philosophy rationalism (Friedrich, 1977). Although Kant was a thinker
along lines of moral imperative (a priori reasoning), yet his methodology
relegated the moral origin of reasoning to the human world-system (a pos-
teriori reasoning). By rationalist reasoning, even though a priori reasoning
carries the primacy of moral imperative, yet it remains distanced from the
origin of monotheism. Thereby, a priori normative reasoning remains sep-
arated from a posteriori positivistic reasoning (this nullity is symbolized
106 Masudul Alam Choudhury

Figure 6.1 Methodological independence between tawhid as law and ‘Shari’ah-

compliance’.

by ϕ). Any attempt to unify a priori and a posteriori reasoning in the

monotheistic sense failed in Occidentalism. This Kantian way of treating
the moral imperative within the dichotomy between God and the unified
world-system is repeated in ‘Shari’ah-compliance’. Thereby, the existing ap-
proach to the study of Islamic economics, finance, banking, and the needed
transdisciplinary inquiry of socio-scientific world-systems with diverse de-
tails reflects Kantian rationalism. Morality remained an embellishment of
moral philosophy and fails in critical realism (Bhaskar, 1994). Therefore,
anything that remains independent of and not substantively embedded by
tawhidi law such as monotheistic episteme of unity of knowledge is of hu-
man innovation. This is how Ibn al-Arabi explained reality entrenched in
tawhid (Chittick, 1989).
Symbols: ∩ denotes integration commonly between domains. ϕ denotes
null and void interaction between the domains. ⇔ denotes inter-causality
of pairing relations (Quràn 36:36). Ω denotes supercardinal knowledge
completed in the Qur’an. S denotes transmission of Qur’an by reference
to sunnah. {θ*} denotes learned discursive interpretation of Qur’anic
verses (ayaths) transmitted by S; thus, {θ*} ∈ (Ω,S). f(θ,X(θ)) are multi-
ple ‘functional ontologies’, ‘f’ (Gruber, 1993) derived from the tawhidi
epistemology. Epistemology as knowledge derivation is denoted by {θ}.
{θ} induces the multivariate vector of systems with their inner variables,
such as money, financial instruments, real economy as systems defined
by their variables in the vector, X(θ) = {X1,X 2 ,..,X n}[θ] in given interac-
tive, integrative, evolutionary learning processes (i.e. ijtihad = shura-
consensus, evolutionary learning in unity of knowledge intra-system and
 Islamic economic, financial, banking fatawa 107
inter-system), i.e. within monetary, finance, banking and economic intra-
systems, and across these inter-systems. W (.) is the conceptual form of
well-being criterion (maslaha) that establishes the most critical overall
unifying effect of tawhidi law on standardization of rules and method-
ical applications derived from the primal ontology and its methodology
as shown above. The resulting complementarities evaluated and recon-
structed (simulated) in terms of the tawhidi knowledge-induced variables
of the well-being functional n-dimensional vector are done by the circu-
lar causation equations in accordance with the parameterized values of
knowledge, {θ}. The circular causation equations are denoted by X i(θ) =
f i(Xj(θ),θ); i,j=1,2,…,n; i≠j. θ = F(θ,X(θ)) denotes the quantitatively evalu-
ated form of the well-being function (maslaha) in the conceptual form,
W(θ,X(θ)). The primal ontology is continuously recalled intra-systems and
inter-systems over continuums of evolutionary learning processes across
the historical consciousness of knowledge, knowledge-induced space and
time (Qur’an, 76:1). This is the meaning of sustainability of the standard-
ized rules according to tawhidi law of unity of knowledge (inter-causal
pairing, complementarities, and participation). The universality, uni-
formity, and positivistic applications are recursively interrelated with the
normative methodology of tawhid as law.

6.9 Summarizing
In conclusion it is noted that, although there is a claimed derivation of in-
junctions by ‘Shari’ah-compliance’ towards tawhid, this does not form a
methodological groundwork, except for the use of fiqh and fatawa that sup-
port human-concocted implications of ‘Shari’ah-compliance’. The result,
thereby, has throughout been its failure to derive the universal and unique
foundation as of the tawhidi ontological, epistemological, and phenomeno-
logical worldview of a truly meta-scientific nature in unity of knowledge and
the unified world-system. No standardization of fiqh and fatawa is possible
in the existing framework of ‘Shari’ah-compliance’.
How will the tawhidi law be used to gain and sustain standardization
of fiqh and fatawa and Shari’ah rulings for Islamic banking on appropri-
ateness of instruments, mainly of the secondary financing type, around
which product development is carried out? Tawhid as law represents itself
in unity of knowledge and the specific issues under discussion in Islamic
banks that arise by means of the principle of pervasive organic pairing as
complementarities and participations. This feature of tawhidi rule extends
into general-system understanding of the Qur’anic idea of pairing in wid-
ening domains of moral-material oneness. Evaluation of the effectiveness
of such participatory or complementary processes of adopted rules, instru-
ments, and endogenously derived policies and regulations by discourse is to
be done by the estimation and simulation results of the well-being function
in terms of the inner variables of the objective criterion.
108 Masudul Alam Choudhury
An example is of organic unity of being between money, finance, banking,
and real economy, in terms of the functional defining variables and their ex-
tensive inter-causal relations signifying the Qur’anic meaning of pairing the
universe and its specific details, as in muamalat, finance, and banking. The
result is a substantive simulation of the multivariate well-being function in
the maqasid choices while avoiding the false and unrecommended ones. The
resulting fiqh and fatawa in all such universal and unique determination of
tawhidi unity of knowledge by extensive participation as organic pairing
signifies inter-system and inter-variable endogenous complementarities in
transdisciplinary phenomenology. This approach does not accept differen-
tiation by systemic disjointness except for unrecommended variables.
Figure 6.1 depicts the human-concocted fiqh and fatawa independently of
and not substantively related with tawhidi law that arises from the learning
multiverse (a’lameen) by complementary pairing. The pairing indicator of
standardization of issues of Islamic economics, finance, banking, and soci-
ety is derived from the Qur’an (azwaja kullaha) via sunnah and learned dis-
course on specific issues. These all reflect the Signs of Allah (ayath Allah).

References
Bhaskar, R. (1994). Critical Realism. Verso, London, Eng.
Chittick, W.C. (1989). Sufi Path of Knowledge, State University of New York Press,
Albany, NY.
Choudhury, M.A. (2006). Koran and Science (with Generic Titles). 5 volumes. Edwin
Mellen Press, Lewiston, NY.
Choudhury, M.A. (2014). Tawhidi Epistemology and Its Applications (Economics,
Finance, Science, and Society). Cambridge Scholars Publishing, Cambridge, UK.
Choudhury, M.A. (2016a). Heterodox Islamic Economics: The Emergence of an
Ethico-Economic Theory. Routledge, London, Eng.
Choudhury, M.A. (2016b). The Absolute Reality in the Qur’an. New Palgrave
Macmillan, London, Eng.
Choudhury, M.A. (2017). A Phenomenological Theory of Islamic Economics.
University of Malaya Press, Kuala Lumpur, Malaysia.
Friedrich, C.J., (transl.) (1977). The Philosophy of Kant: Immanuel Kant’s Moral and
Political Writings. The Modern Library, New York, NY.
Gruber, T.R. (1993). “A translation approach to portable ontologies”. Knowledge
Acquisition, 5:2.
Masud, M.K. (1984). Islamic Legal Philosophy: A Study of Abu Ishaq al-Shatibi’s
Life and Work, Islamic Research Institute, Islamabad, Pakistan.
7 The fallacy of conventional
benchmarks in Islamic
banking and finance
Defining, defending and
discussing with evidence
from archival data
Imam Uddin Muhammad Shujat Saleem and
Abdur Rahman Aleemi

7.1 Introduction
Traditionally, Gulf Cooperation Council (GCC) countries along with
Southeast Asian countries were considered to be the only regions for Islamic
financial markets; however, at present, Islamic financial markets have sur-
passed to non-traditional markets including Africa, East Asia and Canada
which is considered to be the North American hub for Islamic finance. The
total worth of global Islamic financial assets including banks, capital mar-
kets and Takaful companies is USD 2 trillion which was expected to reach
USD 3 trillion by 2018 (IFDNTM 2016).1 Despite tremendous worldwide
growth of Islamic Banking and Finance (IBF) along with its strong resil-
ience to economic shocks compared to its conventional counterparts, Is-
lamic banks still face some impediments that hinder its growth. Among
these are the masses that misinterpret the true essence of IBF due to lack of
knowledge about the same. Factually, there is no difference in the business
models of both conventional and Islamic banks (Beck 2010). It is argued
that Islamic banks are a replica to the interest-based conventional banks
as both systems use the same benchmark for pricing their products which
makes the de jure distinction but not the de facto difference (Maclean 2007;
Pervaiz 2015; Samdhani 2013; Shaikh 2013; Zaharuddin 2013; Zubair &
Chaudhry 2014). To counter this argument, many IBF advocates have al-
ready done voluminous works in which they inscribed that using conven-
tional benchmark in pricing IBF products does not make it impermissible
in the eye of Shari’ah (Usmani 2002; Jalil & Rehman 2010). So, who’s right:
opponents or the proponents of the IBF in this sense? Therefore, a valid
question to ask: what is the status of conventional benchmark in Shari’ah
viewpoint if the same is used for pricing IBF’s products? This critical review
attempts to investigate the permissibility or impermissibility of the use of
conventional benchmark in IBF products by taking Murabaha financing as
110 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
a proxy for the same. Hence, this research paper aims to answer the follow-
ing question: does the use of conventional benchmark in pricing Murabaha
products render it impermissible in the eye of Shari’ah?

7.2 Literature review

Irrespective of the fact that both Murabaha financing and interest-based
loan products fulfill similar financing needs of customers, Murabaha is not
a loan extended on interest; rather, it is simply a sale with profit in which the
seller is obliged to disclose the cost as well as profit to the buyer (Usmani
2002). Jalil and Rehman (2010) complement Usmani by stating that Mura-
baha transactions are distinct from loan by conventional banks due to the
fact that in Murabaha, Islamic bank purchases the products of real nature
on the request of customer and sells the same on profit. Contrarily, Abbas et
al. (2014) inscribed that theoretical and philosophical differences exist be-
tween Murabaha and loan transaction but when it comes to practice, there
is no implicit difference between the two. The Dawn2 reports that Murabaha
transaction of Islamic banks is similar to that of the loan transaction of
conventional banks because Islamic banks charge the same rate of interest
in the name of profit which is charged by the conventional banks in loan
transaction. In the support of Abbas et al. (2014), Saeed (2010) in his work
Is Islamic banking really Islamic? raised an objection that contemporary Is-
lamic banks use the same ‘term Sheets of KIBOR’ that are being used by
conventional banks in pricing their loan products.
Similarly, Zubair and Chaudry (2014) argue that in the Murabaha trans-
actions, Islamic banks charge interest rates rather than market rates of the
products, which makes no de facto difference between the loan transaction
of conventional banks and the Murabaha transaction. Similarly, Holden
(2007) puts that, most of the classical jurists do not allow the Murabaha
transaction as it follows markup similar to interest rates. To reinforce his
findings, Holden quotes an article published in the Fortune magazine ac-
cording to which a customer buys an automobile from an Islamic bank and
paid exactly the pre-agreed same markup to the bank as he would have paid
to conventional bank, had the financing been acquired from the conven-
tional bank. However, on the other hand, Wahab et al. (2014) support the
findings of Jalil and Rehman (2010) and contrast with Holden (2007) as he
argues that the Murabaha is useful for both short- and medium-term fi-
nancing because of its asset-backed provision. Similarly, Maclean (2007)
holds that, when someone approaches a bank for financing, the conven-
tional bank after thorough examinations and procedures grants a loan on
which the bank charges interest. Similarly, the same is true for an Islamic
bank. Islamic bank after thorough examination purchases the required item
from a supplier and sells it to the customer on profit similar to the interest
rates charged by the conventional bank; hence, the Murabaha transaction
is similar to loan transaction. In contrast, Kuran (2004), in his voluminous
 Fallacy of conventional benchmarks in IBF 111
work, argued that there is no prescribed time in Shari’ah which limits the
bank to take risk of the product after acquiring from the supplier. Only a
millisecond would be sufficient to make the Islamic bank entitled for the
profit which in his point of view makes no difference between the Murabaha
transaction of Islamic bank and loan transaction of conventional bank.
To sum up, it can be easily concluded that people who argue that the Mu-
rabaha financing is nothing but a replica to a loan by conventional banks
generally takes into account only one factor i.e. ‘Financial burden’ shoul-
dered on the customer. They argue that if, for instance, Mr. A goes to con-
ventional bank to get loanable funds of Rs. 2 million for a year and pays
back Rs. 2.2 million (principal plus interest) at maturity, in the same way,
an Islamic bank charges almost the same amount from the customer in the
Murabaha transaction by merely changing its name. As a result, financial
burden on Mr. A remains the same regardless of the bank he chooses to get
the financing from. This study in particular intends to extend this discussion
in light of archival evidence.

7.3 Research methodology

This critical review uses archival research strategy to answer the research
questions by following Bryman (1989). Archival research uses the archival
documents as the main source of data. The sources of these documents in-
clude: The Holy Quran, Ahadiths, Verdicts of Shari’ah’ Scholars from var-
ious forums including Accounting and Auditing organization for Islamic
Financial Institutions (AAOIFI), and verdicts issued by the Counsel of Is-
lamic Ideology of Pakistan. Moreover, the chapter follows the inductive ap-
proach to determine the main intent of the study.

7.4 Data analysis and discussion

By using archival data from the aforementioned sources, this section ana-
lyzes the main intent of the study; the structure of which is as follows: Section
4.1 introduces the Murabaha financing being undertaken by the contem-
porary Islamic banks in Pakistan along with Shari’ah references. Section
4.1.1 details the Shari’ah conditions which should be taken into account by
the Islamic banks while undertaking the Murabaha transaction. Section 4.2
discusses the simplistic version of the Murabaha financing. Section 4.3 pro-
vides the practical implementation or step-by-step procedures followed by
the Islamic banks in order to undertake the Murabaha transaction. Section
4.4 explains Shari’ah conditions for profit determination along with what
percentage of profit is permissible in Shari’ah viewpoint. Section 4.5 deals
with benchmarking with KIBOR in determining the selling price of the sub-
ject matter of the Murabaha financing along with Shari’ah conditions for
the same. Section 4.6 presents the difference between both conventional and
Islamic banks pertaining to the use of KIBOR. Section 4.7 discusses the
112 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
rationale for benchmarking with KIBOR. Section 4.8 provides the refer-
ences for the permissibility of the use of KIBOR as benchmark, and Sec-
tion 5 concludes.

7.4.1 Murabaha financing

Murabaha is a sale on profit in which the seller is obliged to disclose the cost
as well as profit to the buyer. It has nothing to do with financing in its orig-
inal sense, however, in order to escape from interest, and when Musharaka
and Mudaraba cannot be undertaken, Murabaha contract on deferred pay-
ment basis may be used as a financing instrument after taking into account
the following conditions of Shari’ah (Usmani 2002).

7.4.1.1 Shari’ah’ conditions for sale: the seller cannot sell an article
unless following conditions are met

a Existence: One cannot sell a commodity unless it has come into exist-
ence; hence, non-existent3 thing cannot be sold out.
b Ownership: The seller should own the commodity at the time of con-
tract of sale.
c Possession: The commodity should either be in physical possession or in
constructive possession4 of the seller at the time of contract of sale.5
d Instant and Absolute: The contract of sale6 must be instant and abso-
lute, thus, forward and future sales are impermissible.
e Impermissible Use: A seller cannot sell something which can be used
only for impermissible purposes7.
f Specification: It is a set rule that the item being bought and sold should
be specifically known and pinpointed to both the buyer and seller, failing
of which makes the transaction invalid because of Gharar-e-Kaseer.8
g Certainty of Price: It is a necessary condition for the validity of contract
of sale that the price should be determined and fixed at the time of con-
tract of sale, again, failure of which makes the transaction invalid due
to Gharar-e-Kaseer.
h Certainty of Delivery of the Subject Matter: For the validity of the sale
contract, it is necessary for the seller to be able to deliver9 the subject
matter to the buyer. If the seller is not in a position to deliver the subject
matter to the buyer, the sale is void in Shari’ah viewpoint.
i Unconditional Contract: Contracts that are contingent to an uncertain
future event are void. Moreover, contracts that are conditional10 on
some other contracts are also void in Shari’ah viewpoint.

7.4.2 Simplistic version of the Murabaha financing

To understand the very basics of the Murabaha financing, we discuss a hy-
pothetical case as follows: Mr. A is a sugar mill owner and wants short-term
 Fallacy of conventional benchmarks in IBF 113
financing from Meezan Bank of PKR 10 million for 6 months. In this re-
spect, Mr. A requests the bank to purchase sugarcane with the promise to
repurchase the same. Meezan Bank purchases the required sugarcane from
open market and sells it to Mr. A for PKR 12 Million on deferred payment
basis of 6 months on Murabaha basis.11

7.4.3 Practical implementation of the Murabaha financing12

This section unveils detailed steps followed by Islamic banks for proper im-
plementation of the Murabaha financing. It is noteworthy that while im-
plementing the Murabaha financing, Islamic banks face business as well as
Shari’ah risks,13 unlike conventional banks which counter with only busi-
ness risks. The following are some steps in implementation of the simplistic
the Murabaha contract as mentioned in previous section.

a Promise
When Mr. A approaches Meezan Bank and requests to purchase sug-
arcane from the supplier,14 then the bank, after considering standard
normal procedures, asks the customer to sign a document of unilateral
promise in which the customer promises to repurchase sugarcane from
the bank. In this way, Islamic banks try to mitigate the risk of loss15 in
the case of refusal by the customer.
If the customer breaks the promise with reasons16 acceptable in
Shari’ah, then Islamic banks have no remedy to recover the actual loss;
however, if the customer does not fulfill his promise without any good
reason acceptable in Shari’ah, then Islamic banks can recover the ac-
tual loss from the customer by taking necessary legal actions. It is note-
worthy that Islamic banks cannot recover opportunity loss as the same
is impermissible in Shari’ah.
According the Accounting and Auditing Organization for Islamic Fi-
nancial Institutions (AAOIFI), Islamic banks are advised not to take
promise especially in those Murabaha transactions in which according
to the bank’s discretion bank faces no credit risk.17
b Agency
Islamic bank receives numerous requests from different customers to
purchase multiple items, and due to lack of purchase expertise, there is
possibility that the required specification may not be met which may
expose the bank to a huge risk of loss. To mitigate such risk and to fa-
cilitate the customer, Islamic banks enter into a contract of agency with
the customer,18 whereby Islamic bank becomes the principal and the
customer becomes the purchase agent who purchases the items from the
supplier on behalf of the bank.19
c Purchase
Once the promise and agency documents are singed, the customer
on behalf of the bank purchases the items from suppliers. According to
114 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
AAOIFI, it is preferable for the bank to purchase the item directly from
the supplier or appoint third party as an agent. However, in case of dire
need, it is also permissible for the bank to appoint customer as its agent.
d Offer
After purchasing the item from the supplier as an agent of the bank,
customer makes an offer to purchase the item.
e Acceptance
Bank accepts the offer made by the customer which concludes the
Murabaha contract with the customer, whereby Islamic bank becomes
the seller of the item and customer becomes the buyer.
As this Murabaha transaction is done on deferred payment basis,
buyer’s and seller’s relationship converts into debtor’s and creditor’s re-
lationship between the customer and the bank, respectively, and at the
same time, ‘Dain’20 is created on the customer which is equivalent to the
Murabaha price.21

7.4.4 Shari’ah rulings for price determination

The determination of price through the market forces of supply and demand
is not against the teachings of Islam, provided that it takes into account
certain conditions22 imposed by the Shari’ah. The permissibility of the price
determined by the market is evidenced by the following narration.

Once Hazrat Bilal went back from the city of Khyber to the city of
Madina and presented dates to Hazrat Muhammad Mustafa (PBUH)
on which after seeing the dates Hazrat Muhammad Mustafa (PBUH)
asked him, the meaning of which is, “Are these kinds of dates being
bought and sold in the city of Khyber?” On this question, Hazrat Bilal
said, no. He further said, I have exchanged two Saah of the low quality
date with one Saah of the high quality dates. On this answer from him,
Hazrat Muhammad Mustafa (PBUH) said the meaning of which is as
follow. Don’t do this Bilal, He further said, Sell the low quality date in
the market, get the money and purchase high quality dates.
(Reported by Muslim)

The permissibility of the price determined by the market forces of supply

and demand is also evidenced by the following sayings:

When the prices became high in the Prophet’s time and people asked
him to fix prices for them, he replied, Allah is the One Who fixes prices,
Who withholds, Who gives lavishly, and Who provides, and I hope that
when I meet Him none of you will have a claim against me for any injus-
tice with regard to blood or property.
(Reported by Ahmad, Abu Daoud, al-Tirmidhi,
Ibn Majah, al-Dari and Abu Y’ala.)
 Fallacy of conventional benchmarks in IBF 115
From the aforementioned, one should not be misunderstood that it is a com-
pulsory requirement for every seller to sell his product on the market price;
these narrations do not impose the compulsion to follow the market price
rather it prohibits external forces to enter into a market and ceil the market
price. That is, in general, even the government has no authority to fix the
price.23
Another important point to consider is that an individual seller can de-
mand more than the market price, less than the market price or equal to the
market price for his products after taking into account the aforementioned
conditions imposed by the Shari’ah. Following verse is the evidence to the
fact that any price can be set between the contracting parties with mutual
consent.

The Holy Quran says, “O Believers! Do not misappropriate one anoth-

er’s goods illegally. Indeed, you should undertake transactions by mu-
tual agreement”.
(4:29)

7.4.5 Price determination through benchmarking with KIBOR

An individual seller usually sets his product’s prices to be competitive
with its competitors, failing to do so may cause potential loss and closure
of business in no time. For instance, Pepsi-Cola has got all the rights to
increase prices for its products but it does not do so, because of the sub-
stitution effect towards Coca-Cola. In this connection, Islamic banks are
competing with conventional banks in the similar fashion in Pakistan,
and both coexist and try to fulfill similar financing needs of their custom-
ers. Thus, in order to be competitive in the market, Islamic banks should
set their products’ prices accordingly. For instance, going back to Mr. A’s
request for sugarcane financing, a request to the Meezan Bank, for in-
stance, is placed on 15th December, the bank purchases the same in open
market and resells it to Mr. A on 17th (taking into consideration all the
conditions discussed in Section 4.1.1). However, here lies a huge challenge
for the bank to determine the offer price to Mr. A. Although Shari’ah al-
lows the bank to charge mutually agreed rate (after taking into consider-
ation all the conditions of profit determination discussed in Section 4.4),
they can charge let’s say 10%, 20%, etc. However, they should consider
an alternative outlook that if Mr. A had gone to a conventional bank,
what rate of return they might have charged for that particular trans-
action? Let’s say, if conventional bank had charged 10%, then, so does
Islamic bank being the competitor of conventional bank. However, it is
noteworthy that merely charging the same rate of return does not render
the transaction impermissible in the eye of Shari’ah, as one should note
that what is being bought and sold, not for how much? Conventional bank
here sells money on 10% return, whereas Islamic bank sells sugarcane—a
116 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
commodity—on 10% return. The transaction of conventional bank here
is a loan which stipulates 10% interest that is forbidden in Shari’ah evi-
denced as:

Every loan transaction which derives benefit is interest

Harith ibn Abi Usamah (Musnad)

Thus, the conventional bank’s transaction is impermissible because of the

benefits drawn on loan transaction, whereas Islamic bank’s transaction is
permissible because of the benefit drawn on sale transaction which is evi-
denced by the following Ayah:

Sale is permissible and riba is impermissible

(2,275)

7.4.6 Difference between the use of KIBOR within both conventional

and Islamic banks
Certainty of price is one of the conditions imposed by Shari’ah. Thus, once
the selling price of the subject matter is determined under the Murabaha
transaction, it stays fixed and does not change with the changes in KIBOR
regardless of the time period. The AAOIFI puts it in this way:

The institution’s profit mark up in the Murabaha to the purchase or-

derer must be known, and the mere mention of the total selling price is
not sufficient. It is permissible that the profit be determined based on
a lump sum amount or a certain percentage of the cost price only or of
the cost price plus the expenses. This determination is completed by the
agreement and mutual consent of the two parties.

In contrast, conventional banks’ rate of return varies as per the varia-

tions in KIBOR which creates the de facto difference between the uses of
KIBOR in both systems. In short, Islamic banks are not linked with KIBOR
particularly in the Murabaha transaction as wrongly inferred by the advo-
cates of conventional finance (see Maclean 2007; Pervaiz 2015; Saeed 2010;
Samdhani 2013; Shaikh 2013; Zaharuddin 2013; Zubair & Chaudhry 2014).
Had Islamic banks been linked with the KIBOR, their selling prices would
have changed with the changes in KIBOR.

7.4.7 Rationale of benchmarking with KIBOR24

The foremost reason using KIBOR is being in close competition with con-
ventional banks, Islamic banks charge the same rate of return as that of
the conventional banks as stated in Section 4.5. Furthermore, prices of
commodities usually differ in different markets, for instance, a cup of tea is
 Fallacy of conventional benchmarks in IBF 117
charged for Rs. 50 in general, but the same may be charged for Rs. 500 in a
5-star hotel. This gives rise to market pricing, hence, Islamic banks are said
to be charging according to the banking market. Moreover, the State Bank
of Pakistan (SBP) declares that there are only 5 full-fledged Islamic banks
operating in Pakistan compared to 37 conventional banks which constitute
a very minimal part of the whole banking industry. Thus, in the present
scenario, if Islamic bank charges more than that of conventional counter-
parts, then most of the customers will rather be wooed towards conven-
tional banks and Islamic banks will be forced to shut down in no time. In
contrast, if Islamic banks charge lower than conventional bank then they
might not be able to survive due to

a High cost of operations: It is as high as 4.5% compared to 3% for con-

ventional banks. Thus, Islamic banks’ spreads are considerably lower
and makes it very difficult for Islamic banks to survive on low rates of
return.
b Rate of return to investment account holders (IAHs): If Islamic banks
receive low financing rates from customers, then it results into low de-
posit rates to IAHs due to which IAHs would be no more interested to
do banking with Islamic banks; consequently, Islamic banks may face
the situation of bank run.

7.4.8 Permissibility of benchmarking with KIBOR

To determine the Murabaha price, Islamic banks may choose to adopt any
formula or conventional benchmark such as KIBOR or LIBOR. It is not
necessary to disclose the formula to the customer but what is important
is that the institution has to disclose the amount of cost and profit to the
customer. Furthermore, profit should be fixed at the time of execution of
the Murabaha transaction, and it will remain unchanged until maturity, as
evident by the following clause 4/6 of the AAOIFI.

It is an obligation that both the price of the item and the institution’s
profit on the Murabaha to the purchase orderer transaction be fixed
and known to both parties on the signature of the contract of sale. It
is not permitted under any circumstances to subject the determinate
of the price or the profit to unknown variations or variations that are
determinable in the future, such as by concluding the sale and making
the profit dependent on the rate of LIBOR that will prevail in the fu-
ture. There is no objection to referring to any other known indicator
during the promise stage as a comfort indication to determine the rare
of profit, provided that the determination of the institutions’ profit at
the time of concluding the Murababah to the purchase order is based
on a certain percentage of the cost and is not tied up with LIBOR or a
time factor.
118 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
Moreover, the transaction of Murabaha is based on Islamic principles and
fulfills all its necessary requirements, and the rate of profit determined on
the basis of the rate of interest will not render the transaction as Haram (see
Usmani 2002).

7.5 Concluding remarks

On the basis of the analysis and discussion of the archival data presented in
Section 4, it can be concluded that the opinions of Abbas et al. (2014), Beck
(2010), Maclean (2007), 4Saeed (2010), and Shaikh (2013) are unsupported
by the evidence, and the opinions of Usmani (2002) and Jalil and Rehman
(2010) still hold true. Therefore, we conclude that the use of KIBOR in the
Murabaha financing for profit determination does not violate any condition
of Islamic jurisprudence. However, it is recommended for the Islamic banks
to strive for the implementation of Islamic Interbank Offer Rate (IBOR), as
the use of conventional benchmark creates misconceptions and misunder-
standings in the mind of general public, especially in those regions where
Islamic banks coexist with conventional banks.

Notes
1 Islamic Finance Development in Non Traditional Market report. See: http://
www.mifc.com/index.php?ch=28&pg=72&ac=160&bb=uploadpdf
2 See the article titled Time Value of Money, dated January 08th, 2007.
3 For example, unborn calf of the cow.
4 A seller is said to have constructive possession of something when the risk of de-
struction, control, obligations, responsibilities and duties have been transferred
on to him.
5 However these conditions are not applicable for Salam and Istisna.
6 There is a difference between the contract of sale and mere promise to sell in
Shari’ah. In promise, risk of destruction, control of items being sold, liabilities,
duties and obligations do not transfer from the promisor to the promisee unlike
contract of sale in which all these elements are transferred from the seller to the
buyer in instant and absolute terms.
7 It is permissible to sell those things which have both the permissible and imper-
missible usages.
8 Gharar-e-Kaseer is a major uncertainty within the clauses of the transaction.
9 For example, if Mr. A sells his stolen car to Mr. B. The sale is void as Mr. B may
not be able to deliver on his promise.
10 Conditional contracts are those in which the result of one contract is dependent
upon the outcome of another contract.
11 Before executing the contract, the bank is bound to disclose the cost as well as
profit to the customer. It is noteworthy here that people wrongly argue about the
transparency of Islamic banks. In Murabaha disclosure of cost and profit are
the requirements in Shari’ah’ viewpoint. Furthermore, in today’s market place,
banks purchase the requested items from the supplier identified by the customer
leaving no issue of transparency at least in Murabaha financing.
12 Islamic banks in Pakistan prepare a complete set of documents with the name
of Master Murabaha Agreement or Murabaha Facility Agreement in order to
 Fallacy of conventional benchmarks in IBF 119
execute Murabaha transactions. We, for the readers’ facilitation are present-
ing only those steps or stages which are essential to execute the Murabaha
transaction.
13 Refers to Shari’ah Non-Compliance Risks (SNCR). See (IFSB, 2016) for details.
14 In Pakistan, usually, the supplier is identified by the customer.
15 In case of customer’s refusal, Islamic bank may incur actual loss by in re-selling
the sugarcane in open market.
16 Reasons acceptable includes but not limited to the customer’s death, insanity,
insolvency etc.
17 Islamic bank faces no credit risk when the items can easily be sold in open mar-
ket with same price, or suppliers provide sale on return basis.
18 It is noteworthy that at the time of contract of agency, the customer has no rela-
tion with the bank in Shari’ah viewpoint except that of promisor & promisee.
19 During the purchase process, bank being the principal, bears the risk of
destruction.
20 When the liability is created through other than loan transaction, it is called
Dain’. However, rulings of debt and dain are similar in Shari’ah viewpoint.
21 It is immensely important in Shari’ah viewpoint that Islamic bank bears the risk
of destruction of the item before onward sale to customer.
22 Neither the commodity nor the purpose should be unlawful, Both the buyer and
seller must have free consent before entering into a contract, both do not apply
coercion, undue influence or commit fraud, there should be no hoardings, no
monopoly and no concealment of defects in the goods and the process of price
determination should not violate any explicit or implicit rulings of Shari’ah. Ac-
cording to the Holy Quran, “When they receive from someone; they receive in
full but when they give to others; they defraud” (83:1). In another verse, it is said,
“Give the correct quantity and weigh properly and do not cause loss to others”
(7:84). Moreover, It has further been directed, “And don’t steal the belongings of
others” (2:188). The Prophet (PBUH) was asked that which earning is better. He
replied; the one which the man earns through his physical labor. (Ahmed). On
the issue of hoarding the prophet said; “That who stock the general commodities
or items for the sake of maximum benefits and do not supply them in the mar-
ket is prohibited [Ahmed-Bin-Hanbal: 19802]. “That those who hoard things are
sinners. No one hoard in this earth “(Abu Da’ud, No. 2990). “That who import
essential commodity into the town for good benefits or hoarding there, Allah’s
curse upon him.” (IbneMaajah, No: 2144).
23 In case of dire need, if the price is too high for ordinary person to buy his live-
lihood then the Government may ceil the price for a particular period of time.
Following is the meaning of the verse which permits the Government to impose
such conditions; “O’ believer, obey Allah, and obey prophet, and who has authority
over you”. In this translation of the Aayah, there is a difference between obedi-
ence of Allah and His Prophet; and the people of Authority.
24 The State Bank of Pakistan has recently allowed Islamic banks to be de-linked
with KIBOR which is a very good development.

References
Abbas, M., Sohaib, A. Q., & Chaudary, N. S. (2014). Is the Current Practice of Mu-
rabaha In Pakistan Literally Based on Islam? Al-Adwa, 29(42), 11–20. Shaikh
Zayed Islamic Center-University of Punjab.
Beck, K. (2010). “Islamic vs. Conventional Banking: Business Model, Efficiency and
Stability, Policy Research” Working Paper 5446. The World Bank, Development
Research Group, Finance and Private Sector Development Team.
120 Imam Uddin Muhammad Shujat Saleem and Abdur Rahman Aleemi
Bryman, A. (1989). Research Methods and Organization Studies (Illustrated, Re-
print, Revised Ed.).
Holden, K. (2007). Islamic Finance: “Legal Hypocrisy” Moot Point, Problematic
Future Bigger Concern. Boston University International Law Journal, 25, 341,
342–367.
IFSB. (2016). Shari‘ah Non-Compliance Risk in the Banking Sector: Impact on
Capital Adequacy Framework of Islamic Banks. WP No. WP-05/03/2016.
IFDNTM. (2016). Islamic Finance: Development in Non-Traditional Markets. Re-
trieved from www.mifc.com/index.php?ch=28&pg=72&ac=160&bb=uploadpdf.
Jalil, M. A., & Rehman, M. K. (2010). Financial Transactions in Islamic Banking
are Viable Alternatives to the Conventional Banking Transactions. International
Journal of Business and Social Science, 01(03), 2010.
Kuran, T. (2004). Islam and mammon. Princeton: Princeton University Press.
MacLean, A. (2007, March 16). Islamic Banking: Is It Really Kosher? Retrieved
from www.aei.org/publication/islamic-banking-is-it-really-kosher/
Pervaiz, S. (2015). “Comparison of Islamic and Conventional Finance” whyislam2.
wordpress.com/2015/02/05/islamic-finance/
Saeed, S. U. (2010, June 25). Is Islamic Banking Really Islamic? Retrieved from
http://blogs.tribune.com.pk/story/194/is-islamic-banking-really-islamic/ The Ex-
press Tribune Blogs.
Samdhani, A. E. (2013). Difference between islamic and conventional banking.
Karachi: Maktaba Kamilpooray.
Shaikh, A. (2013). Islamic Banking in Pakistan: A Critical Analysis. Journal of
Islamic Economics, Banking and Finance, 113(913), 1–18.
Dawn (2007, January 08). Time Value of Money in Islamic Banking. Retrieved from
www.dawn.com/news/226780/time-value-of-money-in-islamic-banking.
Usmani, M. T. (2002). An introduction to Islamic finance (Vol. 20). Highwood: Brill.
Wahab, A. et al. (2014). A Comparative Study of Islamic Financial System and Con-
ventional Financial System. Global Business and Economics Research Journal,
3(5), 15–29.
Zaharuddin, A. (2013). Differences between Islamic Banking and Conventional
Banking in Terms of Shari‘ah’ Ruling Conformity. Journal of Islamic and Human
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Zubair, H. M., & Chaudhry, N. G. (2014). Islamic Banking in Pakistan: A Critical
Review. International Journal of Humanities and Social Science, 4(2), 161–176.
8 Influence of leverage on
ownership structure-
performance relationship
A panel data approach of
Islamic and conventional banks
of Pakistan
Ummara Fatima and Sundas Sohail

8.1 Introduction
Business needs capital to purchase assets and sustain operations. To fill this
need business utilizes either from the debt financing or from the equity fi-
nancing. It is subject to the formation of the company, size and techniques,
to take decision whether to pick equity, debt or a mixture of both. Debt and
equity make the financial structure of an organization. A good combination
of capital structure plays critical part in enhancing profitability of an organ-
ization. Capital structure essentially can be alluded to a company’s financial
framework, the strategy of a firm to finance its assets with a combination
of equity, debt or securities (Saad, 2010). An optimal capital structure em-
powers an organization to proceed effectively on its way to achieve progres-
sive development. Modigliani and Miller (1958) were the first who initiated
work on capital structure and introduced broad-spectrum theory of capital
structure, which is still under debate (Chakraborty, 2010; Karadeniz et al.,
2009). The idea of capital structure became popular after the mainstream of
work performed by Miller and Modigliani (1958). In their eminent “theory
of irrelevancy of capital structure,” it is recommended that in perfect capital
market the performance of firm is autonomous of its capital structure. Fu-
ture, they argued that this relationship can be changed in light of debt as it
offers “tax shield advantage” (Modigliani & Miller, 1963).
In theoretical point of view, the ownership structure is defined as the
choices that emulate the influence of shareholders in trading those shares
at country-level, according to the rules and regulations defined by stock
market. The ownership structure is explained through the equity distribu-
tion with respect to poll, level of investment and individuality of the equity
holders.
Performance determines the core of the firm’s efficiency such as maximiz-
ing return on assets and maximizing shareholder’s benefits (Bauer, 2004;
Chakravarthy, 1986; Deesomsak et al., 2004; Marsh, 1982).
122 Ummara Fatima and Sundas Sohail
Ownership structure significantly affects the firm performance. Berle
and Means (1932) started investigation for performance and ownership
structure relationship and brought about inconsistent connection be-
tween both. Jensen and Meckling (1976) clarified this work through the
hypothesis of “agency theory” by presenting “principal-agent frame-
work” featuring the “agency problem between the management and
shareholders.” The “agency cost” between management and shareholders
can be reduced by the use of debt in the capital structure and can also be
utilized as an analyzing tool to observe the company managers (Jensen &
Meckling, 1976). On the other hand, this “agency cost” can likewise be
reduced by increased “managerial ownership” (Jensen & Meckling, 1976)
and better capacity of “inside managerial owners” to establish an optimal
debt level for firm (Friend & Lang, 1988). Increased ownership of man-
agers increases the performance of the firm because the managers avoid
the depletion of assets, and thus, enhanced performance is guaranteed
(Smith, 1990).
The history of banking originates in the early world in Babylonia
around 2000 BC. Islamic banking originates 1400 years back, and now
it is developing quickly around the world. The rules of Islamic financing
follow Shari’ah standards. Rashid et al. (2017) explored that Islamic bank-
ing is initiated in Pakistan in February 1979 to basically wipe out Riba
(interest). Islamic banks are allowed by SBP to work in the same capacity
as conventional banks, with an essential target to give diversified banking
opportunities to construct a sound monetary framework rendering the
economic development opportunities through Shari’ah-compliant finan-
cial operations. In 2002, the exertion of building up the Islamic financial
system prompted the foundation of first Islamic bank (Meezan Bank Lim-
ited) in Pakistan.
The drive of this chapter is to investigate the impact of “ownership struc-
ture” on performance of both Islamic and conventional banks of Pakistan.
The previous studies focus only Islamic banks, but this study considers the
impact of “ownership structure” on financial performance in comparison to
full-fledged Islamic banks and conventional banks listed at PSE (Pakistan
Stock Exchange). The study further checks the moderating effect of leverage
on ownership structure-performance relation of Islamic and conventional
banks simultaneously, which is described below.

Objectives of the study

• Explore separately the effect of ownership structure on the financial
performance of Islamic and conventional banks of Pakistan, while con-
sidering size, growth and earnings volatility as control variables.
• To investigate the moderating effect of leverage on ownership structure-
performance relation of Islamic and conventional banks of Pakistan.
 Data approach of Islamic & conventional banks 123
8.2 Review of literature
The segment covers in detail the theoretic groundwork and empirical proofs
of the impact of ownership structure on performance, expanding further the
moderating role of leverage on the relationship mentioned above.

8.2.1 Ownership structure and performance

The important thing to indicate here is that numerous research scholars
have uncovered diverse outcomes for the developed and developing coun-
tries. Numerous researchers investigated direct connection between own-
ership structure and performance of an organization (Berle & Means, 1932;
Jensen & Meckling, 1976; Mehran, 1995). Some of them found a nonlinear
association (McConnell & Servaes, 1990, 1995; Morck et al., 1988; Push-
ner, 1995; Short & Keasey, 1999). Some studies explored significant re-
sults (Schultz, 2003), whereas others expressed insignificant outcomes
(Demsetz & Lehn, 1985; Kamerschen, 1968).
With an increase in “management ownership,” performance never in-
creases (Loderer & Martin, 1997), while Cho (1998) and Prowse (1999) have
revealed turnaround connection among performance and “managerial own-
ership.” The ownership structure is considered as a piece of the examination
to combat the agency issues, which can influence the firm performance of an
organization (Jensen & Meckling, 1976). The managers as agent have pos-
session in the company would adjust their interests to different stakeholders
and accordingly reduce agency cost; this will serve as a positive influence
for the firm valuation. Therefore, the performance and managerial own-
ership have positive association between them (Jensen & Meckling, 1976).
On the other side, when the least managerial ownership exists, the agency
conflict is reduced provoking to higher debt level, and then again if there is
increased “managerial ownership,” it would facilitate the managerial op-
portunism and along these lines cut down the debt level. Friend and Has-
brouck, (1988) and Friend and Lang (1988) explored a negative association
among leverage and managerial ownership and suggested to diminish the
level of debt of the firm in order to diminish the default risk.
Another relevant theory is the “stewardship theory” proposed by Donaldson
and Davis (1991), which argues that both groups (managers and owners) share
common objectives and the executives are stewards of the owners. It means
the board of directors have not much authority as proposed by “agency the-
ory.” Here, the board performs a supportive role by authorizing the executives
which upsurge the performance. The next theory is the “Resource Depend-
ence” (Hillman & Dalziel, 2003), which argues that the existence of board is
considered as the provider of resources to their executives to attain the goals
of the organization. Even the professional board members can use their skills
to train and guide the executives to enhance the performance.
124 Ummara Fatima and Sundas Sohail
8.2.2 Capital structure and performance
Numerous researchers strongly proposed that decisions about capital structure
have significant impact on firm performance (Grossman & Hart, 1986; Jensen,
1986; Mill & Modigliani, 1961; Stulz, 1990; Williamson, 1988). Numerous other
studies explore diverse results with respect to capital structure and firm perfor-
mance relationship. Some studies explore a negative association (Chakraborty,
2010; Huang &Tune, 2006; Karadeniz et al., 2009; Rajan & Zingales, 1995) while
others discovered positive relationship (Berger & di Patti, 2006; Khan, 2014).
All of the above examination clarified the use of debt in “capital struc-
ture” influences performance of an organization because the organizations
frequently agree to fix repayments for a particular period. These install-
ments occur irrespective of the performance of the firm. Equity financing
ordinarily keeps away from these repayments yet may expect organizations
to provide ownership stake in the organization and agency problem arises.
Agency theory states that as the probability of bankruptcy creeps up,
high debt confirms improved performance of the management (Jensen &
Meckling, 1976). On the other hand, the “pecking order theory” suggests
firms’ inclination to internal investment over external investment and the
debt over the equity (Myers, 1984). Meanwhile, different theories on cap-
ital structure are evolved by numerous researchers over time, effecting or
effected by performance. Therefore, theories provide relatively alternate in-
terpretations on leverage-performance relationship. This is when empirical
studies are appealed to decide between them. Researchers of the developed
and developing economies have discovered the leverage-performance rela-
tionship by considering these theories. Yet, the relation between leverage
and performance turns to more critical due to the less productive capital
markets of the developing countries (Ebaid, 2009). In developing countries,
the hostile features are the reason of inverse performance and leverage rela-
tion (Alipour & Pejman, 2015; Boadi & Li, 2015).
The research work is not same in nature and distinctive as compared to
other studies of Pakistan or anywhere. The study sought to explore first the
association between ownership structure and performance of the conven-
tional as well as the Islamic banks of Pakistan and then check the moder-
ated effect of leverage on ownership structure-performance of Islamic and
conventional banks separately.

8.3 Hypothesis
• H1: Ownership structure has a positive relation with the performance of
the conventional banks of Pakistan.
• H2: Ownership structure has a positive relation with the performance
of the Islamic banks of Pakistan.
• H3: Financial leverage moderates the ownership structure-performance
relationship of conventional banks of Pakistan.
• H4: Financial leverage moderates the ownership structure-performance
relationship of Islamic banks of Pakistan.
 Data approach of Islamic & conventional banks 125
8.3.1 Framework and methodology

8.3.1.1 Theoretical framework

This section covers the theoretical framework, sample size, data selection
and methodology of the research work. The study employed performance
measures, i.e. return on equity (ROE) and earning per share (EPS) both
as dependent variables. The independent variables include the ownership
structure and other control variables, whereas leverage is used as moder-
ating variable. The ownership structure is measured through managerial
and institutional ownership. The control variables measured through size,
earning volatility and growth. The conceptual framework of the study is
described in Figure 8.1:
The sample for this research is the financial sector over nine-year period
from 2008 to 2016. The study attempts to explore the comparison between
the conventional and Islamic banks of Pakistan. Full-fledged Islamic banks
in Pakistan are four. Thus, the study selected four Islamic and four conven-
tional banks for data analysis.

8.3.1.2 Data collection

A panel of secondary annual data of conventional and Islamic banks from
2008 to 2016 is applied in this research. The data is collected from the an-
nual reports of the banks. The further “Financial Statement Analysis” of
SBP is utilized to obtain the data.

Research Methodology
Leverage
Sample Selection
Ownership Structure Short Term Debt

Managerial Ownership Long Term Debt

Institutional Ownership

Financial Performance
Control Variables
Return on Equity
Growth
Earnings per share
Size

Earnings Volatility

Figure 8.1 The conceptual framework of the relationship between leverage, owner-
ship structure and performance.
126 Ummara Fatima and Sundas Sohail
8.4 Variables construction
Table 8.1 shows the variables used in the study and how they are measured
and operationalized:

8.5 Empirical model

The objective of the study is estimated by the panel regression model with
various variables which have been identified as important in the literature
(Li, Armstrong, & Clarke, 2014; Singh et al., 2003). The relationship between
ownership structure and performance under moderating effect of leverage
measured through the following equations:
ROE it = α + β1MOit + β2SDRit + β3MO*SDRit + β4SZ it (i)
+ +β5GRWit + β6EVOl it + e it
EPSit = α + β1MOit + β2LDRit + β3MO*LDRit + β4SZ it (ii)
+ +β5GRWit + β6EVOl it + e it
ROE it = α + β1IOit + β2SDRit + β3IO*SDRit + β4SZ it (iii)
+ +β5GRWit + β6EVOl it + e it
EPSit = α + β1IOit + β2LDRit + β3IO*LDRit + β4SZ it (iv)
+ +β5GRWit + β6EVOl it + e it

Table 8.1 Measurement of the Study Variables

Variables Measurements Notation

Independent Variables
Managerial ownership “Percentage of ordinary shares held MO
by all directors”
Institutional ownership “Shares owned by the financial IO
institutions/total outstanding
common stocks”

Moderating Variable
Short-term debt ratio “Short-term debt/total assets” SDR
Long-term debt ratio “Long-term debt/total assets” LDR

Dependent Variable
Return on equity “Net profit after tax/total share ROE
holders’ equity”
Earnings per share “Ratio of profit after tax to EPS
numbers of ordinary shares”

Control Variable
Bank size “Natural Logarithm of total assets” SZ
Growth “(Total assets − Total assetst-1)/ GRW
Total assetst-1”
Earnings volatility “(Profit before taxes − Profit before EVOL
taxest-1)/Profit before taxes t-1”

Source: Author’s own calculations.

 Data approach of Islamic & conventional banks 127
8.6 Research findings

8.6.1 Descriptive statistics

Table 8.2 shows the descriptive statistics in terms of mean, maximum, min-
imum and standard deviation values of dependent and independent varia-
bles of conventional banks.
Table 8.3 demonstrates the descriptive statistics summary of the independ-
ent, dependent and control variables of Islamic and conventional banks. The
table expresses the directions of variables of the model. It depicts that the sam-
pled conventional banks have been received 20% ROE if they get 30% leverage
by short-term debt and 3% by long-term debt; which is comparatively less for
Islamic banks. Both Islamic and conventional banks are financing more from
short-term debt as compared to long-term debt. Kunt and Maksimovic (1999)
signify that the firms in emerging countries use considerably less amounts of
long-term debt. The table depicts that the institutional investors and manage-
rial shareholders have 2% and 47% ownership, respectively, in case of conven-
tional banks of Pakistan, and 28% and 32% ownership, respectively, in case
of Islamic banks of Pakistan, which describes that conventional banks have
major contribution in managerial ownership as compared to Islamic banks

Table 8.2 Summary of Descriptive Measures of Conventional Banks

Variable OBS Mean Std. Dev. Min Max

Roe 36 .2030556 .0644014 .03 .29

Eps 36 6.77528 5.460953 6.43 24.47
Mo 36 .4733319 .1261828 .00935 .76
Io 36 .0259434 .0135294 .0049 .0623
Sdr 36 .303505 .0165797 .0016193 .0436644
Ldr 36 .037996 . 0016939 .0014386 .007959
Sz 36 20.11212 1.429869 14.79104 21.64243
Grw 36 .1401111 .0711898 .032 .413
Evol 36 .1270556 .2038313 −.554 .727

Source: Author’s own calculations.

Table 8.3 Summary of Descriptive Measures of Islamic Banks

Variable OBS Mean Std. Dev. Min Max

Roe 36 .035 .3160696 −1.34 .71

Eps 36 4.942222 8.960027 −1.25 24.5
Mo 36 .3287583 .2432607 0 .7289
Io 36 .2872072 .4215478 0 1
Sdr 36 .8238889 .1999 0 .93
Ldr 36 .0272222 .0215 0 .11
Sz 36 18.30702 .9443324 16.62113 20.31763
Grw 36 .2720556 .2108203 −.079 .85
Evol 36 .0961111 .5704 −.965 .99

Source: Author’s own calculations.

128 Ummara Fatima and Sundas Sohail
8.6.2 Correlation analysis
Tables 8.4 and 8.5 depict the findings of correlation analysis of the
independent variables of both conventional and Islamic banks of
Pakistan:
The results depict that there is no issue of multicollinearity, as values of
the correlation coefficient are within the range of −1 to 1 and very low.

8.6.3 Panel model regression results

Table 8.6 illustrates the effect of ownership structure on financial perfor-
mance of conventional and Islamic banks of Pakistan. The study results
depict that managerial ownership is showing significant positive relation-
ship with performance (Hill & Snell, 1989) in case of both Islamic and con-
ventional banks, the results are consistent with agency theory (Jensen &
Meckling, 1976). Institutional ownership is showing negative significant
relationship with ROE (Loderer & Martin, 1997) in case of conventional
banks of Pakistan. Bank size is depicting negative significant relationship in
case of conventional banks, and in case of Islamic banks it is showing pos-
itive significant relationship. Growth and earnings volatility have insignifi-
cant relationship with efficiency ratios of Islamic and conventional banks of
Pakistan (Tables 8.7 and 8.8).

Table 8.4 Correlation Matrix of Conventional Banks

| io mo sdr ldr sz grw evol

io | 1.0000
mo | −0.3652 1.0000
sdr | −0.4495 0.3254 1.0000
ldr | −0.1087-0.1524-0.3835 1.0000
sz | 0.2252 0.0875 0.0057 0.0435 1.0000
grw | −0.1380 0.2004-0.0285 0.3161-0.0024 1.0000
evol | 0.2135-0.0365-0.0129-0.0219-0.0135 0.2680 1.0000

Source: Author’s own calculations.

Table 8.5 Correlation Matrix of Islamic Banks

| mo io sdr ldr sz grw evol

mo | 1.0000
io | −0.3920 1.0000
sdr | 0.2543-0.5216 1.0000
ldr | −0.3576 0.1138-0.1622 1.0000
sz | −0.0647-0.4120 0.4983 0.4100 1.0000
grw | −0.0301-0.1093 0.0031 0.3368 0.0452 1.0000
evol | 0.2013-0.0777-0.2034-0.1427-0.0062-0.2406 1.0000

Source: Author’s own calculations.

 Data approach of Islamic & conventional banks 129
Table 8.6 Panel Regression Results (Conventional and Islamic Banks)

Conventional Banks Islamic Banks

Variables Eq1 Eq2 Eq1 Eq2

ROE EPS ROE EPS
Random Random Random Random

MO 0.57 2.29 1.75 1.82

0.56 0.00*** 0.08** 0.06**
IO −2.37 3.93 1.80 1.42
0.01** 0.00*** 0.07* 0.015**
Sz −2.45 −1.78 1.77 3.33
0.03** 0.07* 0.07* 0.06*
Grw −0.13 0.04 −0.66 0.43
0.89 0.96 0.50 0.66
Evol 1.66 −0.63 1.31 1.14
0.99 0.52 0.19 0.25
Cons 4.02 1.40 −1.96 −3.44
0.00 0.16 0.05 0.00
No. of Observation 36 36 36 36
No. of Cross-section 4 4 4 4
R-Square 0.55 0.68 0.46 0.60

Source: Author’s own calculations.

Robust standard errors in parentheses: *** p < 0.01; ** p < 0.05; * p < 0.1.

Table 8.7 Moderating Effect of Leverage on Ownership Structure-Performance

(ROE) Relationship of Conventional Banks

Variables Eq1 Eq2 Eq3 Eq4

Random Random Fixed Fixed

MO −2.27 1.61 1.91 1.34

0.02** 0.108 0.06* 0.19
IO −1.45 −2.70 0.21 1.07
0.147 0.00*** 0.83 0.29
SDR −2.36 1.83
0.01** 0.07**
LDR 0.87 −0.30
0.38 0.76
MO*SDR 2.42
0.01**
MO*LDR −1.48
0.139
IO*SDR 0.33
0.74
IO*LDR −0.81
0.42
Sz −1.70 −2.83 −1.28 −1.82
0.09** 0.00*** 0.212 0.08*
Grw −0.49 0.100 1.00 1.12
0.632 0.922 0.32 0.27
(Continued)
130 Ummara Fatima and Sundas Sohail
Variables Eq1 Eq2 Eq3 Eq4
Random Random Fixed Fixed

Evol 1.29 1.94 0.60 0.48

0.198 0.05* 0.55 0.632
Cons 3.91 4.50 −0.44 2.46
0.00 0.00 0.66 0.02
No. of Observation 36 36 36 36
No. of Cross-section 4 4 4 4
R-Square .45 .677 0.752 0.68

Source: Author’s own calculations.

Robust standard errors in parentheses: *** p < 0.01; ** p < 0.05; * p < 0.1.

Table 8.8 Moderating Effect of Leverage on Ownership Structure-Performance

(EPS) Relationship of Conventional Banks

Variables Eq1 Eq2 Eq3 Eq4

Fixed Fixed Fixed Fixed

MO −0.36 2.40 1.10 2.00

0.72 0.05* 0.28 0.05
IO 0.43 0.32 1.60 −1.64
0.67 0.74 0.12 0.11
SDR −2.72 −2.90
0.04** 0.00**
LDR 2.18 −1.26
0.03** 0.22
MO* SDR 0.49
0.063*
MO* LDR −1.65
0.11
IO* SDR −1.55
0.13
IO* LDR 2.57
0.21
Sz −4.91 −1.75 −3.95 −1.26
0.00*** 0.09*** 0.00*** 0.21
Grw 0.04 −0.04 0.14 0.24
0.966 0.972 0.89 0.81
Evol 1.01 1.32 1.11 1.57
0.323 0.19 0.27 0.12
Cons 3.47 1.14 4.92 2.35
0.00 0.26 0.00 0.02
No. of Observation 36 36 36 36
No. of Cross-section 4 4 4 4
R-Square 0.74 0.69 0.58 0.65

Source: Author’s own calculations.

Robust standard errors in parentheses: *** p < 0.01; ** p < 0.05; * p < 0.1.
 Data approach of Islamic & conventional banks 131
The interaction terms of ownership structure and leverage depict inter-
esting results. The results depict that the interaction term of MO*SDR is
showing positive significant relation with performance. This shows that
short-term debt ratio and managerial ownership both enhance bank perfor-
mance of conventional banks. The results are consistent with agency theory.
In case of institutional ownership, the leverage doesn’t have any moderat-
ing effect on ownership structure-performance relationship. The results are
consistent with Alipour & Pejman (2015) (Tables 8.9 and 8.10).
In case of Islamic banks of Pakistan, the results depict that the interac-
tion term of IO*LDR is showing negative significant relation with perfor-
mance. This shows long-term debt ratio and institutional ownership both
negatively affect bank performance of Islamic banks. In case of managerial

Table 8.9 Moderating Effect of Leverage on Ownership Structure and

Performance (ROE) of Islamic Banks

Variables Eq1 Eq2 Eq3 Eq4

Fixed Random Fixed Random

MO 2.39 0.95 2.19 1.58

0.02** 0.34 0.03** 0.11
IO −0.67 1.75 −1.51 1.93
0.51 0.08* 0.14 0.05*
SDR 0.37 –1.50
0.71 0.14
LDR 0.50 2.44
0.61 0.01**
MO*SDR −1.29
0.21
MO*LDR 0.57
0.56
IO*SDR 1.36
0.18
IO*LDR −1.65
0.09*
Sz −0.35 1.48 −.28
0.72 0.13 0.78
Grw −0.73 −0.73 −0.79 −1.00
0.47 0.46 0.44 0.31
Evol 0.25 1.26 0.21 1.14
.803 0.20 0.83 0.25
Cons 0.17 −1.57 0.46 −1.83
0.865 0.11 0.61 0.06
No. of Observation 36 36 36 36
No. of Cross-section 4 4 4 4
R-Square 0.662 0.65 0.79 0.68

Source: Author’s own calculations.

Robust standard errors in parentheses: *** p < 0.01; ** p < 0.05; * p < 0.1.
132 Ummara Fatima and Sundas Sohail
Table 8.10 Moderating Effect of Leverage on Ownership Structure and
Performance (EPS) of Islamic Banks

Variables Eq1 Eq2 Eq3 Eq4

Fixed Random Random Random

MO −0.60 −0.01 1.66 2.08

0.50 0.99 0.09* 0.03**
IO 0.48 1.11 1.12 2.43
0.63 0.26 0.26 0.01**
SDR −1.83 0.52
0.07* 0.601
LDR 0.07 2.88
0.94 0.00***
MO*SDR 1.44
0.163
MO*LDR 2.29
0.12
IO*SDR −0.55
0.58
IO*LDR −2.18
0.02**
Sz −0.89 2.61 3.94 2.68
0.37 0.00*** 0.00*** 0.00***
Grw −0.13 −0.03 0.80 0.48
0.90 0.97 0.432 0.63
Evol 0.23 0.23 0.33 0.86
0.80 0.30 0.10 0.39
Cons 1.27 −2.43 −3.82 −2.96
0.21 0.01 0.00 0.00
No. of Observation 36 36 36 36
No. of Cross-section 4 4 4 4
R-Square 0.622 0.54 0.75 0.50

Source: Author’s own calculations.

Robust standard errors in parentheses: *** p < 0.01; ** p < 0.05; * p < 0.1.

ownership, the leverage doesn’t have any moderating effect on ownership

structure-performance relationship. The results are consistent with Alipour &
Pejman (2015). In case of Islamic banks, the study results are showing incon-
sistency with agency theory.

8.7 Conclusion and recommendations

The overall results of the study depict that in case of both Islamic and con-
ventional banks managerial and institutional ownership is showing signifi-
cant positive relationship with ROE, and other than institutional ownership
is showing negative significant relationship with ROE in case of conven-
tional banks of Pakistan. In order to sum up the results of the study, there is
no consensus on the moderating effect of leverage on ownership structure-
performance relationship of conventional and Islamic banks of Pakistan;
further research is called for.
 Data approach of Islamic & conventional banks 133
The is a dire need for enhanced statistical justifications for pursuing more
corporate governance transformations in ownership structure of the banks,
in order to improve the financial strength of the banking sector. The govern-
ment should improve the ownership structure criteria to get best utilization
of funds collected through depositor.

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9 Dynamic correlation and
volatility linkage between
stocks and sukuk
Masoumeh Shahsavari

9.1 Introduction
The correlation between financial markets that identifies investment risk is
regarded as one of the most important ways to be successful in investment.
The prediction of the correlation structure and its use to select the best
portfolio is considered as a major step in the success of risk and portfolio
management. Additionally, monetary policy executives in countries use in-
formation and messages in asset prices to anticipate expected inflation rates
and economic periods.1
As Marquitz and other researchers have shown in their research stud-
ies, the greater the when correlation coefficient between the returns of the
collection members in an investing portfolio moves to (1-), the risk of port-
folio decreases. Portfolio risk is affected not only by the average standard
deviation of its members, but also by the diversity of investment and the
relationship between the returns of the members. Therefore, looking at
the correlation between different financial assets seems to be necessary for
investment.
Due to the nature of sukuk, which experiments low price fluctuations,
holders of these papers will not be exposed to the risk of price fluctu-
ations. In a situation where the risk of price fluctuations in the stock
market is detrimental to investors, such as a recession or a sharp drop in
prices, the investment in Sukuk can be covered by losses from stock price
fluctuations.
Despite the importance of correlations between different assets of a port-
folio, and the specific features of Islamic financial instruments, there is a few
related research studies. Still, some aspects of this market, including its type
and its relation with other financial markets of Iran, have not been investi-
gated. Since the investment and diversification of the investment portfolio
is of the same importance to the type and extent of the relationship between
the various investment instruments, this study tries to use the GARCH fam-
ily models and the price indices of the sukuk market accepted in Iran Fara
Bourse and the shares accepted in Tehran Stock Exchange; the behavior of
Sukuk compared to the shares reviewed and the relationship between the
 Dynamic correlation and volatility linkage 137
two markets, with the aim of examining the existence or absence of correla-
tion between two time series, should be studied.
Considering the expansion of Iran’s debt market and the expansion of
Islamic financial instruments in the world, it was necessary to examine the
relationship between sukuk and other financial instruments in order to un-
derstand more precisely the financial markets and the prediction of possible
economic situations.
In this research, the GARCH family models and sukuk price indices ac-
cepted Fara Bourse and the shares accepted in Tehran Stock Exchange have
examined the behavior of sukuk compared to stock and the relationship be-
tween two markets study.

9.1.1 Overview of sukuk features

Sukuk, as expressions of Islamic societies, should comply with religious
principles (Shari’ah) that govern economic, social and ethical aspects of
individuals and institutions (Iqbal and Mirakhor, 2007). Five principles
mainly distinguish Islamic financial products: the prohibition on explicit
interest rates (riba), the prohibition on transactions subject to excessive
uncertainty (gharar), the prohibition on specific markets or products
(pork, alcohol, weapons), a required sharing of profit and loss between
contractual parties and a direct link of each operation with the real
economy.2
We can classify sukuk in two categories, with effects on their credit risk
exposure:

1 Asset-backed sukuk: represents a true sale of assets, since the underly-

ing has been validly transferred to the Special Purpose Vehicle (SPV).
In the event of default, therefore, the underlying assets will remain
completely separate from the originator. The sukuk holders have the
full claim over the underlying asset, without any risk of the sale subse-
quently being inverted by local or Shari’ah courts;
2 Asset-based sukuk: This is where investors only have a beneficial own-
ership in the underlying asset instead of legal ownership over the
underlying asset. In this structure, assets are generally sold by the
originator to the SPV in the form of a trust. The trustee issues certif-
icates showing the investor’s ownership interest, while the proceeds
are used to purchase the assets. The investor receives a distribution
income representing a share of the return generated by the under-
lying assets or from other sources within the originator. Theoreti-
cally, in the event of bankruptcy, investors should have a claim or
right to the corporate assets. However, it is unsecured and ranked to-
gether with other unsecured creditors, without any priority and rated
accordingly.
138 Masoumeh Shahsavari
9.2 Literature review

9.2.1 Literature on conventional portfolio diversification

The interrelationship between markets is a key feature of investor asset al-
location because it is instrumental in determining the risk. Estimating the
correlation structure and using this to select superior portfolios is a central
key point for portfolio and risk managers. Furthermore, monetary policy
authorities use information contained in assets prices with the aim of devel-
oping expectations in terms of inflation and business cycle conditions. So,
understanding the co-movements between stocks and bonds may be useful
for their purposes.
Several papers have analyzed the cross-linkage between conventional
stock and bond markets. Earlier studies assume a constant relationship be-
tween stock and bonds over time. Shiller and Beltratti (1992) find a lower
correlation between the two asset classes caused by discount rates. In ac-
cordance with the previously mentioned authors, Campbell and Ammer
(1993) provide evidence of a similar lower positive correlation, explained
by news about future excess stock returns and inflation. Following research
studies provided a refinement by analyzing the time-varying correlations:
(Li (2004); Cappiello et al. (2006); Andersson et al. (2008); Chiang et al.,
(2015); Dimic et al. (2016), among others), showing that stock and bond
prices tend to move in the same direction, even if there are periods of nega-
tive correlations.
Despite the large literature, academic researchers have not reached a
consensus about the driving forces behind correlations. Connolly et al.
(2005) claim that stock-bond market correlation decreases with the in-
crease in stock market uncertainty, suggesting that bonds may be a better
hedge against stock market downturns. Kim et al. (2006), by analyzing the
stock-bond market integration in EMU countries, confirm the negative
relationship between stock market uncertainty and stock-bond market
correlations. Another strand of literature, investigating the flight-to-
quality phenomenon from bonds to stocks, shows negative correlations
between those asset classes. Baur and Lucey (2009) reveal that flights oc-
cur across countries, enhancing the diversification benefits when they are
needed most.
Focusing on macroeconomic driving forces, Li (2004) demonstrates
that the uncertainty about expected inflation rates is the primary driver of
co-movements between stocks and bonds, whereas unexpected inflation and
real interest rates are less influent. Also Andersson et al. (2008) confirm that
stock and bond prices tend to move together during periods of high inflation
expectations, whereas lower level of inflation seems to move prices in oppo-
site direction. Moreover, the authors provide further evidence of a negative
relationship between stock market volatility and correlations. Yang et al.
(2009), by using a large time span that covers 150 years of data at a monthly
 Dynamic correlation and volatility linkage 139
frequency, recognize that higher stock-bond correlations tend to follow
higher short rates or higher inflation rates. Aslanidis and Christiansen (2014)
find that macroeconomic fundamentals are the most useful explanatory var-
iables when the stock-bond correlation is largely negative. Christopher et al.
(2012) stress the importance of sovereign credit ratings on time-varying stock
and bond market correlations, while Chiang et al. (2015) find evidence that
stock-bond correlations are negatively correlated with stock market uncer-
tainty, as measured by the conditional variance and the implied volatility of
the S&P 500 index, but positively related to bond market uncertainty.

9.2.2 Literature review on Islamic finance portfolio diversification3

Despite the exponential growing of Shari’ah compliant debt instruments,
literature has not yet documented the interdependence between sukuk and
conventional stocks and the diversification benefits provided by this type of
instruments during stock market downturns.
A significant number of studies focus on sukuk (Abdulkader and Nathif,
2004; Iqbal and Mirakhor, 2007; Vishwanath and Sabahuddin, 2009), analyz-
ing their structure, features and their different exposure to risks. Rusgianto
and Ahmad (2013) examine their volatility through the Dow Jones Citigroup
Sukuk Index and their relationship with subprime financial crisis shock. They
find that precrisis and during-crisis volatility is more sensitive to market
events than later. Other authors compare the risk/return profile of sukuk with
conventional bonds (Zin et al., 2011; Fathurahman and Fitriati, 2013; Mo-
said and Boutti, 2014) through a case study analysis (Cakir and Raei, 2007).
Najeeb et al. (2014) analyze the portfolio diversification opportunities, includ-
ing sukuk in a well-diversified portfolio. They find that returns of local [Gulf
Cooperation Council (GCC) and Malaysian] currency sukuk have low levels
of long-term correlations, allowing gains in portfolio diversification, whereas
international currency sukuk exhibit high level of long-term correlations.
Recently, several papers explore the interdependencies between sukuk and
Shari’ah compliant stocks. Aloui et al. (2015a) assess co-movements between
Shari’ah stocks and sukuk in the GCC countries, finding a strong depend-
ence between them. They also show that Islamic assets don’t seem to have a
different behavior compared to conventional stock and bond counterparts,
with overall portfolio diversification varying across frequencies and time.
In a subsequent paper the same authors (Aloui et al., 2015b), investigating
the global factors driving the co-movement, show that oil prices and credit
event information had a positive relationship during 2008–2013 period. Kim
and Kang (2012), using a multivariate GARCH model, document the ex-
istence of unidirectional volatility spillovers from Shari’ah stocks to sukuk
during subprime financial crisis.
Those studies are important because they analyze co-movements and dy-
namic correlations between two different asset classes within Islamic capital
markets. Previous literature only investigates the degree of inter-asset class
140 Masoumeh Shahsavari
cointegration, among Islamic country stock markets (Marashdeh, 2005;
Bley and Chen, 2006; Majid et al., 2007) and the diversification benefits of
including Shari’ah compliant stock indexes in an international stock portfo-
lio (Achsani et al., 2007; Majid et al., 2009; Karim et al., 2010; Rahman and
Sidek, 2011; Saiti 2013, among others).
Finally, Aktar et al. (2015) argue that Islamic assets provide substantial
diversification benefits during financial crises. In particular, for the period
2007–2010, volatility linkages between Islamic stocks and bonds are lower
than volatility linkages between conventional stocks and bonds. Moreover,
the characteristics of Islamic financial markets also reduce volatility link-
ages between Islamic stocks and conventional bills.
Based on the literature, our hypothesis is that sukuk have high volatility
linkages and high dynamic correlations with conventional stocks, especially
during financial crisis, considering their special structure. In fact, the ma-
jority of Islamic bonds are issued with an asset-based mode, rather than
asset-backed. We consider them as a hybrid financial instrument between con-
ventional bonds and stocks. They shouldn’t, therefore, experience the flight-
to-quality phenomenon, considering their diversity compared to investment
grade conventional bonds, and they could have higher co-movements with
equity indexes than conventional bonds. But we also expect that dynamic
correlations between sukuk and conventional stocks are lower than those
among stocks, with Islamic bonds providing some diversification benefits.

9.3 Research methodology

In this research, the shares of all companies and securities accepted in Teh-
ran Stock Exchange and also all sukuk listed in exchanges in Iran have been
selected as the statistical community.
Since the index of top 50 active companies is built of more appropriate com-
bination of stocks from different groups with more efficient weights and is more
analytical, the total stock exchange index of Tehran for top 50 active compa-
nies has been selected as a sample in this study. So we use its total index stock.
This index, equivalently, is similar to the Dow Jones Index on the New
York Stock Exchange, which is the most prominent indicator of the US stock
exchange, reflects changes in the price of 50 shares of selected companies from
different industries, with the participation of selected companies represent-
ing each industry, by including 50 companies, other companies in each indus-
try have been omitted from the combination, and this has led to a significant
reduction in the double effect of improving a group’s position on the index.
The final price of Sukuk listed in Iran Fara bourse and Tehran Stock Ex-
change Index are the main variables of this research. In the following, we
describe them as below:

• Sukuk price: The final price of sukuk listed in Iran Fara Bourse is col-
lected on a daily basis and based on the database of Tehran Securi-
ties Exchange Technology Management Company. There are different
 Dynamic correlation and volatility linkage 141
kinds of sukuk in Iran Fara Bourse like ITBs (Islamic Treasury Builds),
musharaka, Murabaha and Ijara.
• Stock price: This index indicates the general trend of the total price of
stock companies listed in Tehran Exchange, and shows the general level
changes in prices relative to the date of origin. These data are based on
information published by Tehran Stock Exchange.

The theoretical domain of this research is to investigate the correlation be-

tween sukuk and Islamic stocks volatility.
The depth of this market was analyzed for the period of 2015/03–2017/03.
In this research, the shares of all companies and securities accepted in Teh-
ran Stock Exchange have been selected as the statistical population. Since
the index of 50 companies is more active than the appropriate combination
of shares in different groups and is more analytical, Tehran Stock Exchange
Index for 50 more active companies has been selected as a sample.
In this research, we try to verify the correlation of sukuk accepted in Iran
Fara Bourse and shares of companies accepted in Tehran Stock Exchange.
For this purpose, in the first step, the sukuk weighting index with the final
price weight is calculated as follows:

CLt =CLt −1 *
∑ Pt,i * Nt,i
(1)
∑ Pt −1,i * Nt −1,i

P (t, i): The price of the security i on the date t;

N (t, i): The number of bonds in the ith note market on t;
CL0: The index value on the first day (2015/25/03), which is equal to 100
units.

If a new security lists or expires, the above indicator will be adjusted

accordingly:

CLt =CLt −1 *
∑Pt,i *N t,i
(∑Pt-1,i *N t-1,i )+(∑Pt,i *N t,i Accept )-(∑Pt,i *N t,i Offer )
(2)

The sukuk price index includes all the sukuk accepted in Iran Fara Bourse
market.
In the next step, the logarithmic daily returns for the obtained index and
also the Tehran Stock Exchange Index are calculated. Daily returns are ex-
tracted based on the following logarithmic formula:

Yt = ln Pt − ln Pt −1 (3)

Multivariate GARCH models are designed with the aim of study volatilities
and correlations co-movements between markets, in order to provide bet-
ter decision tools in portfolio selection, asset pricing and risk management
techniques. Literature has provided several multivariate GARCH models,
such as VECH, BEKK, CCC and DCC (dynamic conditional correlation).
142 Masoumeh Shahsavari
Among the several multivariate models, we decided to use the DCC model of
Engle (2002); the choice of methodology follows Engle and Sheppard (2008):
even using standard univariate GARCH specifications, DCC offers better
performance in terms of portfolio allocation among the families applicable
to large panel models and therefore is more powerful than the constant cor-
relation estimator developed by Bollerslev (1990).
We implement our DCC model in three steps. First, univariate volatilities
are selected by using the Bayesian information criterion (BIC) from a class
of GARCH models capable of capturing the common features of financial
asset returns variances. We include the following models, all with one lag of
innovation and one lag of volatility: GARCH (Bollerslev, 1986) (Equation 4)
and EGARCH (Exponential GARCH) (Nelson, 1991) (Equation 5).
Once the univariate models are estimated, the standardized residuals are
used to estimate the correlation parameters and the persistence parameters
α and β. We implement the asymmetric DCC model, in order to take into
accounts the asymmetric return volatility of equity time series (Capiello
et al., 2006).

9.3.1 The univariate GARCH model and asymmetric extensions

The GARCH model introduced by Bollerslev (1986) expressed conditional
variance as a linear function of the square past values of the series. A ge-
neric GARCH (p,q) model can be described as follows:
q p
ht = w + ∑ a i e t2−i ∑b d 2
j t −i (4)
i =1 j =1

where the a i and b j are nonnegative constants and w is a positive constant.

Since the conditional variance in equation (4) is a function of the lagged
residuals and not their signs, the model enforces a symmetric response of
volatility to positive and negative shocks.
The EGARCH model is the first that investigate the leverage effects, which
refers to the fact that downward movements are more influential for pre-
dicting volatility than the upward movements. Nelson’s (1991) EGARCH
attempts to model fat tails in stock indexes returns by using a generalized ex-
ponential distribution; in formula the model can be represented as follows:
q q q
e t2−i e
log ( ht ) + w + ∑a i
d t −i
+ ∑ g i t −i +
d t −i ∑b j log d t2− j (5)
i =1 i =1 i =1
Equation (5) allows negative values of e t to have different impacts on vola-
tility. Since the coefficient g i is typically negative, the model claims for an
asymmetric behavior in volatility.
The univariate GARCH models were estimated through the maximum
likelihood approach of Bollerslev and Wooldridge (1992), where the log-
likelihood function from the Gaussian normal distribution.
 Dynamic correlation and volatility linkage 143
9.3.2 The multivariate GARCH model
The DCC model of Engle (2002) is a generalization of the CCC model, which
allows the correlation matrix to vary over time rather than requiring them
to be constant.
The DCC model of Engle is defined as:

Ht = Dt Rt Dt (6)

where

Ht is a n x n matrix of conditional variances;

Dt is a n x n diagonal matrix of time-varying standard deviations from uni-
variate GARCH models (), in formula:
 1 1 
Dt = diag  h11t …… hNNt 
2 2
  (7)

Rt is the correlation matrix defined as:

−1 −1
Rt = diag [Qt ] Qt diag [Qt ] (8)

where the n x n symmetric positive definite matrix Qt = (qij ,t ) is given by:

 
Qt = (1 − a − b )Q + a ut −1 u´ t −1+ bQt −1 + g  gt g´ t  (9)
 
e
with the standardized residuals ut = it , α and β are nonnegative scalar
hiit
parameters satisfying a + b < 1 and the vectors gt are defined as the negative
parts of utas follows:
 ui ,t if ui ,t < 0
gi ,t ≡  = 1,…, N . (10)
0 if ui ,t ≥ 0

DCC parameters are estimated by quasi-maximum likelihood by con-
struction because the model is implemented in three different steps: In
each of these stages a log-likelihood function is estimated. In the third
step, given the results of the Jarque-Bera test of normality, we relax the
normality assumption and we adopt a student t-multivariate distribution
for the time series returns, which is more suitable and gives better estima-
tion results.
We use a three-stage approach, rather than estimating all the volatility
models and correlation model simultaneously, because in practice is more
feasible for large portfolios even if the estimator is less efficient.
To test the accuracy of the univariate models, we use the L-Jung Box test
using ten interruptions.
144 Masoumeh Shahsavari
According to Hanan Quinn, Schwarz and Akaike and the highest log-
likelihood, we apply the best model and apply the output coefficients of the
selected model as input to the DCC dynamic multivariate variance model.
To test the accuracy of the DCC model, the Pierce, Hasking and Lee
McLeod test will be used. Finally, we look at the output of the model.

9.4 Results and discussion

The time chart shows the stock index of more active 50 companies and the
price chart of the sukuk price accepted in Iran Fara Bourse is shown in Fig-
ures 9.1 and 9.2.
Also the graph of the two time series of the yield of the stock price
index of the 50 more active companies and the sukuk are shown in Fig-
ures 9.3 and 9.4.
As shown in the two above-mentioned graphs, the Sukuk index is more
stable than the stock index, which can be attributed to the nature of the
sukuk and its trading volume.
A summary of the statistical characteristics of these two time series is
presented in Table 9.1. According to the calculated specification, two time
series are not normal.
At next step, the self-correlation of the conditional negation of the se-
ries is investigated. The results of our self-correlation, for both time series,
show the return on the stock index, and the yield of the sukuk, according to
Table 9.2, shows a low and positive correlation.
For each of the two time series, 36 average equations with different val-
ues of AR and MA are between 0 and 5; among all the above equations,

Figure 9.1 Time series of stock index in 2015/03–2017/03.

 Dynamic correlation and volatility linkage 145

Figure 9.2 Time series of sukuk index in 2015/03–2017/03.

Figure 9.3 Return on the total stock index of 50 active companies of Tehran Stock
Exchange in 2015/03–2017/03.

Figure 9.4 Return on the price index of sukuk listed in Iran Fara Bourse in
2015/03–2017/03.

which have the best results for Akaike, Hannan-Quinn and Schwarz tests,
the mean equation is AR = 2 and MA = 1 because of having the highest
LOG-LIKELIHOOD value, is selected
146 Masoumeh Shahsavari
Univariate models with ARMA4 coefficients are applied on both time se-
ries. The results of applying the model are shown in Table 9.3. Based on these
results, in the time series of the stock index, there are positive and significant
alpha values, indicating a positive and strong correlation between the fluctu-
ations of the index and market shocks. In both models, beta values are also
positive and significant. Therefore, in this series of conditional fluctuations,
they follow their past. In the EGARCH model, this parameter has a positive
and significant gamma parameter that indicates the leverage effect.
Because of asymetric fluctuations of stock and Sukuk index and the sig-
nificant value of g for both time series, which indicates asymmetric shocks
to both variables, the EGARCH model is more appropriate for this study.
We will analyze the results of the EGARCH model on this time series. As
shown in Table 9.3, all coefficients of the variance equation are significant at
95% confidence level. Therefore, in this time series, the leverage effect is pos-
itively correlated with past fluctuations and the reversal of market shocks.
Based on the output coefficients of the models presented in Table 9.3, we
can conclude that the sensitivity of sukuk to market shocks is less than sen-
sitivity of stock.
To test the significance level of self-correlation of the remaining models,
L-Jung Box (1987) tests were used.

Table 9.1 Statistics of the Stock Index and the Sukuk Index

Time Mean Median Maximum Minimum Std. Skewness Kurtosis

Series Dev

Sukuk 0.015% 0.01% 12.64% −12.6% 0.014 0.087 48.8

Stock 0.032% 0.02% 36.2% −21.2% 0.0065 1.42 10.14

Table 9.2 Non-Conditional Correlation of Stock Returns

and Sukuk Index Return

Stock Sukuk

Stock 1.00 0.067

Sukuk 0.067 1.00

Table 9.3 Results of Univariate Models

Mean Variance a g b
Constant Constant

Stock-GARCH −0.4326 0.04115* 0.2057* − 0.6752*

Stock-EGARCH −0.000145 −1.02153* 0.2102* 0.1144* 0.9173*
Sukuk-GARCH 0.004196 0.345117 0.09239 − 0.6796*
Sukuk-EGARCH 0.000329* −0.8921* −0.167* 0.4976* 0.8969*

*Significance at the 0.95 level.

 Dynamic correlation and volatility linkage 147
The Engle (2002) multivariate (DCC) model for the two time series of the
stock index and sukuk index is based on the results obtained in previous
steps, and the results are presented in Table 9.4. In Table 9.4, the alpha co-
efficient is not even significant at the 90% confidence level. Therefore, the
correlation between the time series of stock returns and the time series of
the Sukuk returns is not sensitive to market shocks. The beta coefficient
obtained at the 95% confidence level is significant. Therefore, it can be con-
cluded that the correlation between Sukuk fluctuations and stock fluctua-
tions follows its past.
In Figure 9.5, the correlation between the two time series of the stock
index and the sukuk index is shown. According to the above diagram, the
correlation between these two time series over time has been different. Al-
though two time series have experienced positive correlation in certain peri-
ods of the year, in many cases, there is a negative correlation between these
two time series.

Figure 9.5 Dynamic correlation between stocks and sukuk.

Table 9.4 Results of the Multivariate Model

Constant a b Log Likelihood

Stock-sukuk −0.19 0.0096 0.74* 1016.74

*Significance at the 0.95 level.

148 Masoumeh Shahsavari
9.5 Conclusion
This research was carried out using a correlation research method. Data
were analyzed in two levels of descriptive statistics and inferential statistics
in the form of a table of central indices and dispersion, diagrams and reli-
ability, and normality, self-correlation tests of time series, univariate and
multivariate GARCH models. In this research, a fundamental hypothesis
found that there is a direct relationship between the stock index fluctuations
and the sukuk index; according to the results of the research, there is a sig-
nificant correlation between the two variables that this correlation follows
from its past. Therefore, the value of this correlation varies over time. Given
the history of correlation between these two time series, despite the obser-
vation that there is a positive correlation between these two time series, in
most cases, the correlation between these two financial instruments is neg-
ative. Therefore, the two financial instruments can be used to diversify the
investment portfolio in order to reduce its risk.

9.5.1 Suggestions for future research

• Calculates different and appropriate indices with sukuk features
Due to unique features of fixed-income securities, suitable indicators
with this nature are required to take into account the different charac-
teristics of these papers for research, analytical and reporting purposes.
In spite of the use and accountability of the price index for fixed-income
securities in this study, in order to investigate the price behavior of these
securities, it should be noted that the price index will not be accountable
for all research because of fixed-income securities with specified matu-
rity and guaranteed coupons. Thus, the price index will not cover all
aspects and information about the bonds. And so, we cannot rely on this
index to examine the general behavior of the bonds. Therefore, it is rec-
ommended that researchers take the necessary measures in this regard.
• Investigation of correlation of sukuk with other important economic
parameters
Since the sukuk is a young tool in our beloved country, research on
this has been a key element. Therefore, it is suggested to carry out sev-
eral studies on the relationship between this financial instrument and
other economic parameters and the discovery of the behavior of this
tool at different times.
• Interviews between stocks and sukuk for a longer period
Due to the very low depth of the sukuk market in the capital market
of Iran in the years prior to 1394, the research has been conducted for
two years. But the result of this study will be more reliable over a longer
period of time. Therefore, it is suggested that this study should be done
for longer periods.
 Dynamic correlation and volatility linkage 149
Notes
1 Alex Sclip, Alberto Dreassi, Stefano Miani, Paltrinieri Andrea (8 June 2016).
Dynamic correlations and volatility linkages between stocks and sukuk Evi-
dence from international markets, Review of Financial Economics.
2 Alex Sclip, Alberto Dreassi, Stefano Miani, Paltrinieri Andrea (8 June 2016).
Dynamic correlations and volatility linkages between stocks and sukuk Evi-
dence from international markets, Review of Financial Economics.
3 Alex Sclip, Alberto Dreassi, Stefano Miani, Paltrinieri Andrea (8 June 2016).
Dynamic correlations and volatility linkages between stocks and sukuk Evi-
dence from international markets, Review of Financial Economics.

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10 Provision of riba by religious
faith
A comparative analysis
Musferah Mehfooz

10.1 Introduction
It remained a definitive goal of all religions in individual or aggregate frame
that genuine laws and commandments of God are in certainty for the pros-
perity of mankind. Doubtlessly, religion always identifies and recognized
great or awful, lawful or illicit, and the legitimate and unlawful. Since old
circumstances the above examined idea has been known to all humanity.
Especially the divine religions clarified the laws and rules to guarantee the
individual and collective rights in detail; in this way the uncovered direc-
tives enable regard to humankind. Islam underscores these in great detail.
As per Muslim’s regulation, from human verifiable viewpoint it was the
commitment of all dispatchers and furthermore was similar to the divine
teachings preached by Moses, Jesus and Muhammad (Peace be upon him).1
Islam proclaims to be a continuation of the Abrahamic tradition in the
prophetic line of the Near Eastern Prophets. In fact, Moses (As) is by far
the leading character in the Qur’ān, appearing 136 times and dwarfing
Muhammad’s 4 and Jesus’s (As) 25. Therefore, by analyzing Islam’s religious
predecessors (Judaism and Christianity) and the context of their definitions
of usury in the Old and New Testaments, the Qur’ān’s discussion of riba
can be put into greater historical perspective. Islam is a complete religion,
which provides complete code of life in every domain of human existence:
economic, political, legal, cultural, material, in short collective or individ-
ual. Above-mentioned activities are strongly connected with each other, so
all economic activities should abide by the given instruction according to
Islamic shari’ah (law). Holy Qur’ān has clear injunctions in business and
trading perspective that earnings from trade are permitted in Islam but in-
terest (usury)-related behavior is forbidden.

10.2 Literal meaning of riba

The Hebrew word “nashek” is translated as “usury” (“interest” in many re-
cent translations). In Leviticus, this Hebrew word “nashek’ is replaced with
“marbit,” which denotes a gain on the part of the creditor. This later became
 Provision of Riba by religious faith 153
the Hebrew word “ribbit,” from which the Arabic word “riba” was derived.2
The Greek term used in the New Testament for usury/interest is “tokos,”
which means “offspring.” Significantly, it is in consonance with the earlier
Hebraic term “marbit” and the later Arabic term in Qur’ān riba.3
In Arabic language, usury is called “riba” and according to Ibn Manẓūr,
riba is that which is compulsory to be paid by the borrower to the lender
along with the prime or actual given amount, which was the basic condition
for the loan at the time of debt agreement.4 al-Zubaīdī states: Every loan
from which an excess is drawn is riba,5 and al-Azharī states: Every loan from
which an excess is drawn or a benefit obtained is riba.6 Therefore, based
on al-Jazīrī, he states that according the consensus of all Islamic jurispru-
dences riba is clearly described as interest without any kind of exception.7 It
means any excess or addition above the principle lent, therefore it includes
both interest and usury.8
Khurshīd Ahmad, a prominent advocate of Islamic finance in Pakistan,
emphasized how riba is to be understood today, and argued that Islam for-
bids “any premium or excess, small, moderate or large, contractually agreed
upon at the time of lending money or loanable funds.”9 Because Islam treats
money as a medium of exchange and not a commodity.

10.3 Riba in Old Testament

The medieval Jewish commentator Rashi (Solomon ben Isaac) pointed out
that this Hebrew root meant “to bite,” from its painfulness to the debtor and
commented,

it resembles the bite of a snake… inflicting a small wound in a person’s

foot which he does not feel at first, but all at once it swells, and distends
the whole body up to the top of his head. So it is with interest.10

By this definition the disastrous consequences of riba have wonderfully de-

picted. And by the definition of St. Ambrose’s usury was understood that “it
is receiving more than one has given.”11
The Old Testament included a number of injunctions which protest
against any kind of activity that damages the effect of the relationships be-
tween the rich and the poor. The manuscript writer of Encyclopedia of so-
cial sciences explains: Since the law wished to restrict wealth and to prevent
poverty or at least to mitigate it as for as possible, the property less were
given the right to share the crops,12 because sacred text has advised about
forgotten sheaves that, it should not be brought in later, but should be left
for the gerim and widows.13 So the Jewish conception from the earliest times
has been that the needy are entitled to help, that is the giving of charity is
not a virtue but a duty.14
Charity is among the virtues that Jewish tradition sets forth as the duty of
all. Those who are in need of help are not to be treated as less than equals,
154 Musferah Mehfooz
and they, too, are the children of God. Judaism holds that charity is more
than compassion, that is a form of Justice itself, a restoration of what men
have been deprived of as a result of society’s shortcomings. Thus, charity in
Judaism is called Zedakah, “Justice,” which means not only assistance to
the needy but righteousness itself.15
The Prophet Ezekiel, which are mentioned in Holy Qur’ān (21:85) as Hizqīl,
states that ‘The upright man … oppresses no one, returns pledges, never steals,
gives his own bread to the hungry, his clothes to the naked. … He never charges
usury on loans, takes no interest.16 Charging of interest was sin in Moses law,
and shari’ah had strongly condemn this sin and clear commandments were
given about it.
In Leviticus commandments of usury had given. It is similar to the state-
ment in Exodus but adds some new information: “Now in case a countryman
of yours becomes poor and his means with regard to you falter, then you are
to sustain him, like a stranger or sojourner, that he may live with you. Do not
take usurious interest from him, but revere your God, that your countryman
may live with you. You shall not give him your silver at interest, nor your food
for gain.”17
According to Exodus18, ‘If you lend money to any of my people, to any poor
man among you, you must not play the usurer with him; you must not demand
interest from him.’ Although charging of interest was forbidden for Jews in
their laws but they amended the law by using the word “Brother” and spe-
cifically extract its meanings “The Jews,” and allowed to charge the interest
from “Gentile” non-Jews.
According to Deuteronomy, You shall not deduct interest from loans to
your countrymen, whether in money, or food [victuals], or anything else that
can be deducted as interest; but you may deduct interest from loans to foreign-
ers. Do not deduct interest from loans to your countrymen, so that the Lord
your God may bless you in all your undertakings in the land that you are about
to enter and possess.19
Interest on loan to a Jew either in kind or in money was expressly forbid-
den in Post-Biblical Judaism interoperated this law with extraordinary vigor
and forbade any transaction which bores even the remotest resemblance to
usury.20 There was a tendency to forbid all lending at interest, and the Tal-
mud painstakingly forbids even the shadow (‘dust’) of interest.21 Judaism
strictly forbids interest in any kind of business and trading exchange. Even
in Talmud it is strictly prohibited to have a shadow (dust) of interest. This is
clearly evident that in ancient Judaism every kind of interest was prohibited
because shari’ah considered everyone as equal Jews or non-Jews.
The prohibition of interest being of a charitable nature, its violation was
not treated as a criminal offense to which any penal sanctions attached. It
was only a moral transgression. According to the prophecies of Ezekiel that
usury came to be identified with the severest of crimes: it is mentioned in the
context of robbery, adultery, killing and other such crimes which are worthy
of death.22
 Provision of Riba by religious faith 155
Lord Stamp illustrates in this reference: It was a sin to charge interest but
this only applied strictly to transactions between Jews. To put money with
Gentiles could only be compensated by high rate of interest.23 Paradoxi-
cally, Jewish teaching became most well known in the Christian world not
through its prohibition on exploiting one’s neighbor but through a compro-
mise measure (Deuteronomy 22:21)24, allowing Jews to charge interest to
foreigners – although Jews still had to observe other ethical injunctions in
dealing with non-Jews.25
The early Fathers of the Church approached this Mosaic Law with con-
tradiction. They were all for community and brotherhood, but not at the
exclusion of some other. If they were to remain true to their ideal of univer-
sal brotherhood, they could not have allowed usury to anyone, anywhere.
Accordingly, there was a consensus in early Christianity that usury did not
accord with God’s will, and it was, therefore, based on the idea of universal
brotherhood, prohibited among Christians.
A development is seen in the laws prohibiting usury: the Old Testament
(Lev. 25:35 and Dt. 23:20–21) forbade interest only among the brethren; in
the Prophets (Ez. 18:8) all interest-taking is prohibited; the New Testament
takes another step by stipulating: “Lend to those from whom you can expect
nothing in return” (Luke. 6:34). So, the Deuteronomic prohibition had been
universalized by the Prophets and the New Testament, as Christians had
been enjoined to treat everyone as “brother.”

10.4 Harmful effects of riba on society in Jewish literature

In early rabbinical literature it is concluded that the homes of the Israelites
have been delivered to the empire because of four faults:

• On account of those who retain in their possession bills which have

been paid (in the hope of claiming them again).
• On account of those who lend money on usury.
• On account of those who had the power to protest against wrongdoing
and did not protest.
• On account of those who publicly declare their intention to give speci-
fied sums for charity and do not give.26

The Jerusalem Talmud declares, “Come and see the blindness of those who
lend at interest: if anyone calls another an idolater, an incestuous man or a
murderer, the other seeks vengeance on his life; but doesn’t one who hired
a notary and witness and tells them to attest (a usurious contract) deny the
Place? This brings out that everyone who lends at interest denies the Princi-
ple [of divine authority]”.27
Aristotle mentioned that “the worst kind of earning wealth with the
greatest reason, is usury,28 because the purpose of money is, to exchange
of goods, while here this purpose have an end”.29 He claimed that “usury is
156 Musferah Mehfooz
against the law of nature and justice”.30 Further according to Early Rabbin-
ical Period, Violation of the prohibition was considered very grave; at times
it was seen as equivalent even to the shedding of men’s blood and the denial
of Yahweh.31
St. Augustine (350–430) had described about the usurer that will forever
suffer in the hell fire with the devil and his companions.32 So in Judaism,
charging of usury was equal to polytheism, or for committing the adultery,
unlawful murder or like many other major sins described in divine teach-
ings, the punishment was hell forever.

10.5 Riba in Christianity

The New Testament has considerably less to say about usury than does the
Old Testament. The Gospels consistently mention that loans should not be
made with interest. One such example is Luke 6.35, where Jesus (As) says to
“lend freely, hoping nothing thereby.” Jesus recommended lending money to
others, even enemies, without demanding any interest. Love your enemy and
do good; lend without expecting repayment. Then will your reward be great.
You will rightly be called sons of the Most High; since He Himself is good to
the ungrateful and the wicked.33
Basil states that usury must be called tokos (offspring) because of all the
evils it engenders. But other offsprings grow only until they reach matu-
rity, whereas usury never ceases to grow, bringing with it ever-increasing
sorrow.34 St. Augustine states that they classified usury, which was syn-
onymous with interest till early 17th century, as theft under the seventh
commandment.35

10.6 Harmful effects of riba on society in Christian literature

In the medieval Christianity usury was considered a sin because it was a
theft of time. Usury was thought to sell the time elapsed between the time of
lending and that of collecting. Time, of course, belongs to God, and thus in
line with this reasoning usurers were stealing from God Himself.36
Moreover, usury was thought of as the sin that never rests. Le Goff vividly
depicts how the medieval preachers might have railed against usury. Sisters,
and brothers, do you know of a sin that never stops, that is being committed
at every moment? No? Of course you do! There is one, and only one, and I
will name it. It is usury. Money given out through usury never stops work-
ing, it never stops making money. Unjust, shameful, detestable money, but
money nonetheless. Brother, do you know a worker who does not stop on
Sunday or on holidays, who does not stop working while he is sleeping? No?
Well, usury continues working day and night, Sundays and holidays, asleep
and awake! Working while asleep? Under Satan’s direction, usury, diaboli-
cal miracle, succeeds in doing just that. In this too, usury is an insult to God
and to His established order. Usury, tireless and endless sin, a chastisement
 Provision of Riba by religious faith 157
without end, an unflinching henchman of Satan, can only lead to eternal
slavery, to Satan, to the endless punishment of Hell!37
Jacques Le Goff had illustrated the philosophy of strong opposition of
prohibition of riba/usury, so it was strongly condemned in Judaism and
Christianity.
The component of interest makes leaps in the smooth running of the
economy and one of the primary variables which achieves financial emer-
gency. Locke, an eminent political thinker, is of the assessment that high
rate of interest rots trade.38

10.7 Riba in Islam

Riba/usury is forbidden in shari’ah (Islamic law) and had announced
amongst the seven major sins (Shirk; Practicing magic; Murder; riba/usury;
Unlawfully taking orphans’ money; Running away from the battlefield;
Accusing chaste, believing women).39 The Qur’ān shapes all matters of life,
encompassing the spiritual as well as the physical and the personal as well
as the societal. The verb raba (derived noun: riba) has been described in
the Qur’an in several general meanings: Economic (increase in wealth),40
Political,41 Social and Biological,42 Theological43 Botanical,44 Geological,45
Hydrological, but46 mostly this word is described as “an excess,” and liter-
ally its meaning is an increase or excess in the prime or principle amount,
without any effort or sale contract is described in shari’ah. It defines that any
kind of excess in principal amount or any supplementary benefit upon the
prime amount would consider the element of riba.
Basically, the prohibition of riba in Qur’ān has occured in four stages
which are as follows:
“That which ye given in riba in order that it may increase on (other) peo-
ple’s property hath no increase with Allah; but that which ye give in charity;
seeking Allah’s countenance, hath increase manifold.”47
Conventional exegesis holds that riba is declared to be deprived of God’s
blessing in this verse of Sura-Rum which is Meccan and believed to be
chronologically the first in the riba prohibition process, having been re-
vealed around 615 CE. Here riba is regarded as simply disapproved, and not
yet prohibited. Ibn-e-Arabi states, Arabs were well aware about riba and it
was well-known to them. Because when a person sells something on the ba-
sis of deferred payment and when the maturity of dealing has occurred, the
creditor would demand to the debtor the increase amount on the original
debt.48 So on the first stage made a comparison between those who receive
riba and those who give alms to get Allah’s pleasure and those who give
alms to get Allah’s pleasure are given preference in righteousness and are
much closer to Him comparatively to those who are receiver of riba. This
verse encourages the giving of alms and charity which promotes the sense of
brotherhood and the welfare of society, because most of people just consider
the apparent quality of riba because it increases their principal amount and
158 Musferah Mehfooz
they ignore the hidden fatal and disastrous consequence of riba, and they
ignore the importance of charity and Zakat, but the Creator wants a happier
and prosperous life of His creature in both the worlds.
And further verse revealed in Madinah which explained that those who
taking usury or riba shall be punished by Allah Almighty
“That they took riba, though they were forbidden; and that they devoured
men’s substance wrongfully. We have prepared for those among them who
reject faith, a grievous punishment.”49
On the third stage verse was revealed around the second or third year
after Hijrah, which is a strong base for the prohibition of riba by declaring
it as forbidden activity. Allah Almighty has clearly announced the people to
avoid eating and earning from usury/riba, and it would be a source of their
ultimate success.
“O ye who believe! Devour not riba, doubled and multiplied; but fear Al-
lah; that ye may (really) prosper.”50
The last revelation about prohibition of riba occurred near the comple-
tion of the Prophet’s (Peace be upon him) mission. It mentioned that Allah
Almighty will not show his blessings upon riba-based dealings and he had
injunctions to uproot it, because He does not like the violent of his laws, and
due to the activities of charity Allah has promised of uncountable blessings.
“Those who devour usury will not stand except as stand one whom the
Evil one by his touch Hath driven to madness. That is because they say:
‘Trade is like riba’. But Allah hath permitted trade and forbidden riba”.51
“Allah will deprive usury of all blessing, but will give increase for deeds of
charity: For He loveth not creatures ungrateful and wicked”. 52
Allah Almighty has declared the final prohibition of riba in above-
mentioned verse. The persons who exercise the activities of riba are like those
who are touched by Satan and became poor condition in mind or unsound.
Because they thoughtlessly stated that trade is like riba. But by Allah Al-
mighty had declared, trade is permitted and riba is forbidden. Another place
it is stated that “O ye who believe! Fear Allah and give up what remains of
your demand for riba, if ye are indeed believers.” “If you do it not, take notice
of war from Allah and His Messenger. But if ye turn back, ye shall have your
capital sums. Deal not unjustly, and ye shall not be dealt with unjustly.”53
The Holy Prophet (Peace be upon him) provided the guidance to mankind
which covers all aspects of human life like social, religious and economic ac-
tivities. In Hadith [speech or saying of Holy Prophet (Peace be upon him)]
riba has been discussed repeatedly. Like Qur’ān interest-based transactions
are strictly prohibited and strongly condemned in Hadith, and the source of
it is excess on the principal without any contract of sale.54
Punishments for the bad deeds just not to be faced in this world but it
follows the life of hereafter. So in this Hadith the riba-based dealings and
activities indicate the terrible results. Punishments for those who were en-
gaged in Riba-oriented dealings have been explained by The Holy Prophet
Muhammad (Peace be upon him).
 Provision of Riba by religious faith 159
“On the night in which I was taken on the Night Journey (Al-Isra’),
I came to people whose stomachs were like houses, in which there were
snakes that could be seen from outside their stomachs. I said: ‘Who are
these, O Jibra’il?’ He said: ‘They are the ones who consumed usury.”’55
This Hadith shows the Gravity of the Sin of Riba which socially and mor-
ally swear disgrace a person, The Holy Prophet Muhammad (Peace be upon
him).
“There are seventy degrees of usury, the least of which is equivalent to a
man having intercourse with his mother.”56
So because of the harmful and vicious impact of riba four parties have
been cursed by the Prophet Muhammad (Peace be upon him) and they are
receiver, payer, witness and the person who document it. It is evident that in
the participated of sin all the parties are equally considered.57
The above-mentioned verses and Hadith regarding interest needs to set
up a monetary framework where there is no misuse by any means. It builds
up equity between the loan specialist and the borrower; the industrialist and
the business person prompts fellowship, brotherhood, financial advance and
a superior standard of life for all.

10.8 Harmful effects of riba on society in Muslim’s literature

Several scholars of the mid- to late-20th century also interpreted riba from
a “moral” perspective, away from the literalism that dominates much of the
thinking on riba.
Muhammad Asad, a modernist commentator on the Qur’ān, maintained
that riba involved “an exploitation of the economically weak by the strong
and resourceful.”58 Fazlur Rahmān argued that the reason of the prohibi-
tion of riba was injustice, as was stated in the Qur’ān (2:279), and that good
natured Muslims with extremely high-minded inner voices earnestly trust
that the Qur’ān has restricted all bank enthusiasm for all circumstances in
woeful negligence of what riba was verifiably, why the Qur’ān reprimanded
it as a gross and savage type of misuse and prohibited it.59
Sayyīd Maudūdī says, “Infact usury is the result of selfishness, merciless-
ness and also accretes these attributes in a human being.” Those people who
are poor and needy are unable to pay loan, and financiers are sucking their
blood. The solution of this atrocious cruelty is that usury should be com-
pletely prohibited. That’s why the shari’ah, which is based on justice and
equality, blessing and finesse, rescinds this curse to make those meek people
feel free.60
Due to the usury-based loans, the finance and economic condition of the
whole nation is destroyed, and leaving the harmonious effects on the eco-
nomic condition of this world. Then due to them they are in-between of
malice and enemity; at last due to them the youths of the nation hit with
adversity got upset and began to accept extremity and political, cultural
and economic philosophy, and began to find the solution of their national
160 Musferah Mehfooz
difficulties in a bloody revolution, a destructive war. Due to the usury the
international pressure enhances and sometimes its intensity became a cause
of war.61
Sayyīd Qutub illustrates that usury is curse which plays a massive role in
localizing wealth in the hands of the moon, and as a result, it promotes self-
ishness and greediness in society. In the world of business and trade, it sows
the seed of dishonesty and atrocity. The debtor has starves in his house,
and it doesn’t matter for the usurer. His only interest is to take his origi-
nal amount along usury on accurate time with no concern from someone’s
sufferings. Even the debtor is forced to sell all his utensils of his home and
costumes on his body.62
In a nation or country there are only less people who ignore money and
give interest. The interest receiver snatch people’s possessions from their
houses and inflict upon them endless sufferings and financial troubles. Fi-
nally, the situation reaches to an end where the money is concentrated in
specific hands and families that some poor communities are forced to stand
against them and many kingdoms get destroyed because of this. Law and
order situation shatters due to these actions. All this is the result of some
foolish minds/thoughts.
The original text of the Holy Qur’ān, unlike the other Holy Scriptures, is
still maintained in its pure form, and it allows trade but forbids riba/interest.
In trade, participants make profits or incur losses. Islam, in establishing a
socioeconomic justice system, insists that this risk be shared (not always
equally) between the two parties.63

10.9 Christian and Jewish efforts for promulgation of riba

The important section of the chapter takes an historical view by investi-
gating the change of attitudes toward usury from biblical times to the pres-
ent. By the 4th century CE, usury was officially prohibited for clergy of the
Catholic Church, and by the 5th century the law was extended to all laymen.
Usury was not declared a criminal offense until the 8th century, instituted
by Roman Emperor Charlemagne. As the anti-usury stance continued,
Pope Clement V “made the ban on usury absolute and declared all secular
legislation in its favor, null and void.”64
The Council of Nicea (AD 325), the Council of Laodicea (AD 364), The
Second (1139) and Third Lateran Councils (1179) and the Fourth Lateran
Council (AD 1205), and later the Councils of Lyon (1274) and Vienna (1311),
among others, all protested against usury and that any interest charged on
loans for any reason, whatsoever, was a violation of scriptural demands.65
Their moneymaking in usury was condemned by the Church, and they
were accused of participating in ritual murders. In fact, the famous rabbi
Moses Maimonides [1135–1204] and other Jewish legalists interpret the Deu-
teronomic verses as a positive commandment to take interest on loans to
Gentiles.66
 Provision of Riba by religious faith 161
The high proportion of Jews practicing usury increased their dependency
on their neighbors, and it increased social disharmony. Jewish usurers were
tolerated as long as there was a need for credit. At the turn of the 12th cen-
tury, however, a slow deterioration of their condition began to take place in
Europe, except where capital or specialized knowledge was still needed.67
Jews especially lent money to the clergy, abbeys and knights (the lesser
manorial lords) who underwent a significant crisis during the 13th century. It
is within this context that Jewish usurers turned over mortgages of knightly
property to the magnates for foreclosure.68 Jews became the symbol (and
intermediary) of a power relation between two other socioeconomic rivals,
the knights and the magnates.69
Katz argues that to set up a monetary framework where there is no misuse
by any means. It builds up equity between the loan specialist and the bor-
rower; the industrialist and the business person prompts fellowship, broth-
erhood, financial advance and a superior standard of life for all.70
Martin Luther (1483–1536), who helped start the drift of opinion on usury,
wavered on the issue of usury for much of his life. While he was critical of
usury, Luther was often willing to excuse it as a product of human moral
frailty. He was more critical of those who sought to erase debt altogether
and even out the social classes. Luther was also willing to accept civil au-
thority over that of Mosaic or Gospel Law (especially during debtor revolts),
even if it meant that usurious activity would continue. Luther rejected this
aspect of the concept of universal Christian brotherhood.71
The main culprit and a real game changer was John Calvin (1509–64).
Calvin stated that economic life was “part of the fallen world,”72 and he
enabled the modern attitude toward interest. Calvin broke with the Greek
philosophers and with earlier Church teachings by proclaiming that, in fact,
money was not sterile and unable to yield its own fruits.73 He stated that
charging of interest is as reasonable as charging rent for land. Calvin main-
tained that Luke 6:3574 had been twisted from its original sense. It merely
commands generous lending to the poor. Jesus merely wished to correct the
vicious custom of the world, whereby men readily lent to the rich who could
pay back and not to the poor. Deut. 23:1975 was political. The passages in
the Old Testament are to be interpreted as requiring only the observance of
charity and equity toward the poor, or, if they are to be interpreted more
strictly, they still may be considered only as positive political law appro-
priate for the Jewish economy, but no longer binding today.76 John Calvin’s
rejection of the Catholic Church’s treatment of usury fed the greed of the
emerging class of capitalists.77
The condemnation of usury never completely disappeared from Christian
thought or from the Christian sphere of influence. It remained important
even in the 20th century. Long after Christian usurers had become efficient
in competing with Jews, the sin of usury remained associated with Jewish
communities. Where Jews were deprived of access to landed property and
public office, they developed expertise in usury and banking. The transition
162 Musferah Mehfooz
to the modern era diminished neither the importance of this pattern of op-
portunity hoarding nor the denunciation of Jewish usury by the Catholic
press, the Protestant clergy, and some socialist and liberal circles.
The growth of finance, industry and land estates led the rabbis to develop
concerning contracts, partnerships and legal arrangements to circumvent
the biblical prohibition against usury.78 The traditional mode of life of the
Jews enabled them to participate in capitalistic activities, and their religion
did not hinder them from exploiting these opportunities, notwithstanding
the fact that the spirit of the both of the Old and New Testaments is diamet-
rically opposed to the spirit of capitalism.79
After all, the usury which condemned in divine scripture, and if some-
one charges it, consider the murder of divine law, has become the part of
economic system, and many modern economists started to write in favor of
usury. Chad Brand argues for the defence of usury that

In the Western world of today, there are mortgages, retirement invest-

ments, car loans, credit cards, and various other situations in which a
lender places financial resources into the hands of people who might not
pay it back, and situations where people place their money with institu-
tions that use it for investment, with the promise that investors will re-
ceive it back with interest. That is today’s world. With some exceptions
(for instance, Amish communities) people do not live in covenanted en-
claves like the people of ancient Israel. This is a place and time in which
paying and receiving interest is not only a fact of life but acceptable to
most people.80

10.10 Conclusion
The purpose of this article was to discuss the usury as censured and re-
stricted in the most grounded conceivable terms. There can be no doubt
about the disallowance. When we go to the meaning of usury there is no
space for distinction of assessment. Judaism and Islam both contain solid
good and lawful prohibitions against the taking of interest. Not surpris-
ingly, to show and avoid the least amount of interest Talmud and Hadith
used the similar word “dust.” Holy Prophet (Peace be upon him), said,
“There will certainly come a time for mankind when everyone will take riba
and if he does not do so, its dust will reach him,”81 and the Talmud pains-
takingly forbids even the “dust” (least amount) of interest.82 Both teachings
strictly prohibited to have a dust of interest. Allah Almighty forbade riba
(interest or usury) because of its hazardous and bad consequences in eco-
nomic system.
The distribution of wealth in a society becomes unbalanced due to inter-
est. Interest-based loans result in the exploitation of the poor and the needy
as it falls out to more poverty, by reducing their future earnings. On the
other hand, these interest-based loans make the rich creditors richer and
 Provision of Riba by religious faith 163
add to their future earnings. Therefore, around 60% of world’s resources
are controlled and consumed by the 20% rich. So, growing poverty is not
the problem of the Third World alone. The advanced countries face this
problem too.
If it is important for society to ease the suffering of the poor and allow
them to achieve economic self-sufficiency, then it is important to investi-
gate inexpensive lending services as a possible policy tool; for this purpose
Islamic banking is introduced which tried the best to exercise according to
shari’ah-based economic system. Although it has some lacks and not en-
tirely according to shari’ah injuctions, but working as interest-free banking
and operating in many countries, and also being consider the pleasant ad-
dition among the Muslims. But the genuine resolution of the problem of
interest will lie in the total enforcement of whole Islamic economic system.
Partial or slow enforcement of the Islamic economic system will not work.
Therefore, it entered in Islam and established Islamic economic system in
full. As mentioned in Quran that:
“O you who have attained to faith! Surrender yourselves wholly unto
God, and follow not Satan’s footsteps, for, verily, he is your open foe.”83
And if someone did not abide by the shari’ah laws, he is warned in these
words in Holy Qur’ān.
“But as for him who shall turn away from remembering Me- his shall be
a life of narrow scope and on the Day of Resurrection We shall raise him
up blind.”84
Not merely in Islam, also in Bible, there are many passages that confirm
the value of a good life. However, the solution to the economic problem, the
way to prosperity, like the way to God, is through the Law of Moses. God
promises to bless the children of Israel with abundance in the land given
that they adhere to the codes of law. For example, the lawgiver proclaims:
Listen to these ordinances, be true to them and observe them, and in return
Yahweh your God will be true to the covenant and the kindness he promised
your fathers solemnly. He will love you and bless you and increase your num-
bers; he will bless the fruit of your body and the produce of your soil, your corn,
your wine, your oil, the issue of your cattle, the young of your folk, in the land
he swore to your fathers he would give you.85
It is concluded that riba clashes with mankind’s ethics, belief and world-
view, and is an economic evil. In spite of appearances to the contrary, it
interferes with the balanced growth of man. It destroys the moral life by
promoting greed, jealousy, meanness and fraud. Allah would not have pro-
hibited anything if it were essential for human growth, and no evil thing can
ever be essential for human life.

Notes
1 Samuel Butler, Elementary Morality, (University of Chicago Press, Chicago1902).
2 Hudson, Michael. The Lost Tradition of Biblical Debt Cancellation. Harvard:
Henry George School of Social Science, 1993. Print. 41.
164 Musferah Mehfooz
3 Aristotle, The Politics, trans. T. A. Sinclair, revised and re-presented Trevor J.
Saunders, (London: Penguin Books, 1992), 87.
4 IbnManẓūr, Abū’l-FaḍlJamāl al-DīnMuḥammad, Lisān al-ʿArab, (Beirut: Dār
Beirut, 1906) vol. 8, p. 23.
5 Muḥammad al-Murtazā Ḥusaīnī al-Zubaidī, Tājulʿurūs: min jawāhir al-qāmūs,
(Beirut: Dār al-Fikr, 1414) vol. 10, p. 142–144.
6 Abū Mansūr al-Azharī, Tahdhīb al-Lugha, ed., Ibrāhīm al-Ibyārī, (Cairo: Dār
al-Kātib al-ᶜArabī, 1967), vol. 15, p. 473.
7 Jazīrī, ᶜAbd al-Rahmān. Kitāb al-Fiqhᶜalā al-MadhāhibaI-Arbaᶜa, (Cairo:
al-Maktabat al- Tijārīyyah al-Kubrā, n.d, 6th e), vol. 2, p. 245.
8 Shaikh Mahmud Ahmad, Economics of Islam, (Institute of Islamic Culture. 5th
Edition, 2005) p. 22.
9 Khurshīd Aḥmad, Elimination of riba: concept and problems, in Institute of Pol-
icy Studies (ed.), Elimination of riba from the economy, Islamabad 1994.
10 Solomon ben Isaac, Commentary on the Pentateuch, Quoted S.Childs, The
Book of Exodus: A critical Theological Commentry, Old Testament Library, gen.
ed. Peter Ackroyd, et al. (Philadelphia, PA: Westminster, 1974), p. 479.
11 St. Ambrose, Hexameron, Paradise, and Cain and Abel (The Fathers of the
Church, Vol. 42) Translated by John Savage, (Published by: Catholic University
of America Press, 1961), p. 269.
12 Encyclopedia of the Social Sciences, (The Macmillan Co., New York, London,
1964) vol. 8, p. 435.
13 Mordical Katz, Protection of the Weak in the Talmud, (Columbia University
Press, 1925. p. 78.
14 The Slandered Jewish Encyclopedia, (Ed. Cicil Roth, W.H. Allen, London,
1959). p. 427.
15 Collier’s Encyclopedia, (The Crowell-Collier Publishing Co., (1963) vol. 13,
p. 658.
16 Ezekiel, 18:4–8.
17 Leviticus 25; 35–37.
18 Exodus, 22:25.
19 Deuteronomy, 23:20–21.
20 Encyclopedia of Social Sciences, vol.8, p. 435; Mordical Katz, Protection of the
weak in the Talmud, p. 63.
21 The Slandered Jewish Encyclopedia pp. 1344, 1345.
22 Ez. 18:11–13.
23 Lord Stamp, Christianity and Economics, (Published by Macmillan, 1939) p. 12.
24 See Ref No: 19.
25 Nelson, The Idea of Usury from Tribal Brotherhood to Universal Brotherhood,
(University of Chicago Press, Chicago, 1969, 2nd ed).
26 The Babylonian Talmud, Sukkah, 29 a, b.
27 Gemara of Jerusalem Talmud, Baba Metzia, V, II d (Maloney transl. from Bon-
sirvcn), 462.
28 Aristotle 1258b, Politics.
29 Aristotle. Aristotle in 23 Volumes. Trans. H. Rackham, (Cambridge: Harvard
University Press, 1944), Vol. 21, Print: Aristotle: 1952, Great Books of the Western
World, (Nicomachean Ethics, Politics) (University of Chicago Press, Chicago).
Vol. 2.
30 Encyclopedia Americana “Usury” (New York: Americana Corporation,
1967), 824.
31 Maloney Robert Paul, “The Background for the Early Christian Teaching on
Usury.” (Doctor of Sacred Theology diss., School of Sacred Theology, The
Catholic University of America, 1969), p. 135.
 Provision of Riba by religious faith 165
32 Buckley, “A theological examination of the religious teachings on ‘usury’ within
the three monotheistic traditions of Judaism, Christianity and Islam, and its
relevance for the world today.” (Ph.D. diss., Aberdeen University, 1996), p. 97.
33 Luke, 6:35.
34 Maloney, “The Background for the Early Christian Teaching on Usury”, p. 148.
35 Buckley, “A theological examination of the religious teachings on ‘usury’ within
the three monotheistic traditions of Judaism, Christianity and Islam, and its
relevance for the world today” p. 88.
36 Jacques Le Goff, Your Money or Your Life: Economy and Religion in the Middle
Ages (New York, 1998), pp. 24–25.
37 Ibid, 30–31.
38 Shaīkh MaḥmudAḥmad, Economics of Islam, reprinted in 1968 (Lahore: Ashraf
Publications, 1952), p. 27.
39 Al-Saba al- Mubiqat.
40 al-Qur’ān,2:276; 30:39.
41 al-Qur’ān, 16:92.
42 al-Qur’ān, 17:24; 26:18.
43 al-Qur’ān, 69:10.
44 al-Qur’ān, 2:265.
45 al-Qur’ān, 22:5; 41:39; 23:50.
46 al-Qur’ān, 13:17.
47 al-Qur’ān, 30:39.
48 Ibn al-ᶜArabī, Ahkāmal-Qur’ān, (Beirut: n.p., 1988), vol.1, pp. 320–321.
49 al-Qur’ān, 4:161.
50 al-Qur’ān, 3:130.
51 al-Qur’ān, 2:275.
52 al-Qur’ān, 2:276.
53 al-Qur’ān, 2:278–279.
54 Ibn Kathīr, al-Nihāya (an authentic book explaining hadith terminology), (Beirut:
Dār al-Fikr, 1998).
55 Ibn Mājah, SunanIbn Mājah, The Chapters on Business Transactions, Hadith
2359.
56 Ibn Mājah, SunanIbn Mājah, The Chapters on Business Transactions, Hadith
2360.
57 Saḥiḥ Al Muslim,The Book of Musāqah, Chapter: Cursing the one who consumes
riba and the one who pays it, Hadith 3880.
58 Muḥammad Asad, The message of the Qur’an, (Gibraltar, 1984), p. 633.
59 Fazlur Rahmān, Riba and interest, in Islamic Studies (March 1964) p. 326.
60 Abū’l-‘Alā’Maudūdī, TafhīmulQur’ān, (Lahore:Islamic publications,2000) vol. 6,
p. 175.
61 Muḥammad Ashraf AlīUsmānī, Shirkat-o-Mazārbat ᶜAsr-e- Hāzir Main, p. 45.
62 Sayyīd Qutb, Fī Zilālal-Qur’ān,(Urdu) (Lahore: Islamī Academy, n.d.), vol.2,
p. 70.
63 Zineldin, The economics of money and banking. (Stockholm, Sweden: Wicksell
International,1990).
64 Birnie Arthur, The History and Ethics of Interest, (London: William Hodge,
1958).
65 David Jones, Reforming the Morality of Usury: A Study of the Differences that
Separated the Protestant Reforms (Dallas, TX: University Press of America,
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66 Maimonides, Moses, Mishneh Torah: The Book of Civil Laws. Trans.
J. J. Rabinowitz (Yale University Press, New Haven, 1949) (1180), p. 77.
67 Moore, The Formation of Persecuting Society, (Malden: Blackwell, 2000).
166 Musferah Mehfooz
68 Roth, A History of the Jew s in England, (Oxford: Clarendon Press 1978, Third
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69 Postan, The Medieval Economy and Society: vol. 1 in the Pelican Economic
History of England (Harmon’sworth: Penguin, 1972), pp. 152–3, 183–4.
70 Katz Nelson, Periodization and Preferences: Reflections on Purposive Action
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71 Nelson, The Idea of Usury: From Tribal Brotherhood to Universal Other hood,
(University of Chicago Press, Chicago, 1969, 2nd ed.), pp. 29–30.
72 Bruce Garden, Calvin (New Heaven. CT: Yale University Press, 2009), p. 297.
73 Homer and Sylla, A History of Interest Rates (Rutgers University Press, New
Brunswick, 1991, 3rd ed.), p. 80.
74 But love ye your enemies, and do good, and lend, hoping for nothing again; and
your reward shall be great, and ye shall be the children of the Highest: for he is
kind unto the unthankful and to the evil.
75 “You shall not charge interest to your countrymen: interest on money, food, or
anything that may be loaned at interest.”
76 Jean Calvin, Consilia Dc Ususris in Opera, X, cols. 248–249, cited in Buckley,
Theological Examination, pp. 127–128.
77 John R. Sutherland, “The Debate Concerning Usury in the Christian Church,”
Crux, vol. 22 (1986): 3–9.
78 Encyclopedia Britannica, (London, 1962 ) vol. 22, p. 412.
79 Encyclopedia of the Social Sciences, vol.8, pp. 435–438.
80 Chad Brand, USURY IN SCRIPTURE, Institute for Work, Faith & Economics,
2015, p. 12.
81 AbūDaᶜūd, SunanᶜAbūDaᶜūd, Kitāb-al-Būyuᶜ,Bāb fi ijtināb-al-Shubukāt,
82 The Slandered Jewish Encyclopedia pp. 1344, 1345.
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84 al-Qur’ān,20:124.
85 Deuteronomy, 7:12–14.
11 Layers of misconceptions
about IB
Are Islamic banks threats,
challenges and opportunities for
investors
Malik Shahzad Shabbir and Awais ur Rehman

11.1 Introduction
The principle of no riba (interest free) is the touchstone of Isslamic bank-
ing (IB) and finance industry and it is being practiced in nearly all major
religions. This way the principle is expected to be broadly familiar, but the
reality is opposite. Knowledge to IB principles is not well known among the
society. Even the university students of Islamic countries are not very much
aware. Literature has further divulged that the knowledge can synthesize a
better and positive perception about IBs (Hamid et al., 2001). This fact can
be a point of reference for competitive advantage. The economy of knowl-
edge can be vital for IBs to sustain in an environment of amassed competi-
tive pressure.
This study investigated the behavior and ideas of five layers of misconcep-
tions about the IB system, where the first layer identifies the ideology of lay-
men about IBs. However, this layman has no any account in interest-bearing
and non-interest-bearing financial institutions. During our survey, it is
noted that the behavior of layman was absolutely strange about IBs without
any strong evidence. When we asked them, why you should show this kind
of attitude; they replied straightway that we heard negative observations
from other people about Islamic financial system (IFS) that’s why we said it
is prohibited. However, the misconception behind this layman has personal
non-thinking power, lack of observations and misguided ideas about IBs.
In the second layer of misconception, we deal with those investors who
have only accounts in Islamic financial institutions (IFI). However, these
investors are doubtful about their investment because they still aren’t clear
about profit earned on their investment was interest-free or not. It is a gen-
eral observation that whenever some investors will meet each other in any
function, they must ask each other’s business and consult about new invest-
ment in the entire market. In our survey, it is observed that most of account
holders of Islamic financial institutions were unable to fetch the exact in-
formation to investors of conventional banks (CBs) and also incapable to
motivate the other investors to convert their investment in IBs. The mis-
conception behind the second layer of people was about the mechanics and
168 Malik Shahzad Shabbir and Awais ur Rehman
product structure of IBs either on the liability side or asset side (Arouri et al.
2013).
However, recently several studies (Causse, 2010a, 2010b, 2010c; Causse &
Abdelhafid, 2010; Causse & Hideur, 2010) investigated the properties of
IFI’s product development system through a proper analysis of investor’s
returns, risk sharing and performance in different markets. The third layer
consists of conventional economists who know and understand economics
very well but they don’t have strong knowledge about the Islamic system
of financial transactions (Fiqh-ul-Mamo’lat). Mostly, it is observed during
our survey that these economists identify and solve the problem of Islamic
financial transactions on the basic knowledge of conventional economics.
Actually, the third layer of misconception based on solving methods and use
of interpretation techniques, which is all most constructed on conventional
economics system (Shahzad and Rehman 2015). If the product development
team launches any new product or makes new innovations in existing prod-
ucts according to the needs and wants of customers, they get approval from
the shari‘ah advisory committee of their IFIs before launching product in
the market.
The second misconception found in this layer, sometimes it seems that
after approval of products from shari‘ah advisory committee, when prod-
ucts come to the market, the perception, structure and results are the same
as quoted by conventional economists; then these economists argued about
IBs are not working according to sharaih complaints in some conferences,
seminars and corner meeting. Arbouna (2007) found that IBs used differ-
ent combinations of sale and trade contracts to meet the legal requirement
of shari‘ah about the development of new products and services or make
necessary innovations in existing products and services of IFIs in order to
maintain the desires of investors.
It does not mean that if the results of some products are the same or near
to the same then some economists cited that IFI’s working and product de-
velopment methods are the same as the conventional system (Shabbir et al.
2015a). Actually, reason/misconception behinds this issue is the shari‘ah
scholars of IFIs make sure that every component of this product meets the
basic and essential criteria of shari‘ah. After completing this whole process,
training and development departments of IFIs give training to staff mem-
bers of banks. During this whole process, the perception and estimated re-
sults of economists meet at some extent with that particular product. The
conventional economists see the outer look of products and give their final
decision in term of neglecting. Actually, they didn’t understand the whole
process behind this product designing and purifying by the shari‘ah advi-
sory committee. Nathan and Rebiere (2007) investigated the performance of
IBs through different concepts such as wisdom, faith and knowledge and its
impact on investor’s behavior through Shari’a Supervisory Boards.
The fourth layer depends upon Islamic economists who have enough
knowledge of both economics and Figh-ul-Mamo’lat to understand the
Islamic financial systems. These people have only one major misconception
 Misconceptions about Islamic banking 169
about IFIs. According to them, most of the models used by IFIs are adapted
from CB, so these people base this issue and comment in such manners that
IFIs are not working accurately within the limits of shari‘ah. The answer for
this misconception is very simple and straight: if IFIs have adapted some
models of CB system and used these models after purifying from riba and
some other prohibited components, there would not be any shari‘ah issue
behind these financial models because all they are approved by shari‘ah
board of IFIs and then launching it in the market. Besides, before designing
any model for any product of IFIs one must understand the needs and wants
of their target customers. It is observed that IBS is more effective and stead-
ier in a proficient and alteration-free market (Shabbir et al. 2015b).
The second component of misconception of these Islamic economists is
valid for some extent. They raised the issue that Islam and its education is
most superior in the world from day one but why cannot we make new finan-
cial system from starting base for IFIs? They also claimed that more than
four decades ago IB was started in Arab countries but why didn’t they start
from the base point. After conducting survey about this fourth layer, we fur-
ther communicate with shari‘ah scholars, Head of IFIs, training and devel-
opment department of IFIs and some experts of Islamic finance to resolve
this misconception. Jouini and Pastré (2009) examined that Islamic finance
is the only choice for investors to reframe their previous finance through
its constraints, where risk was controllable and speculation was treated as
moderate.
The fifth layer consists of Ulema’s and religious/Islamic scholars who have
brilliant knowledge about Fiqh-ul-Mamo’lat and worships, but they don’t
have the same level of knowledge about financial transactions to differenti-
ate between assets driven, liability driven and/or spread, securitization and
credit creation according to shari‘ah rules and regulations (Shabbir et al.
2016a). Actually, these above-mentioned people of fifth layer are legends of
their own work because they spend a lot of time on Fiqh and its related
topics, so on the base of this knowledge they neglect the IFS. During our
survey, it is observed that some scholars totally disagree with IFS and refer
this system as completely prohibited, whereas most scholars consider IFS as
partially prohibited and rest of nominal scholars deny to give any kind of re-
marks about IFS. Aglietta (2010) and Aglietta and Rigot (2009) propose that
investors are interested and hopeful to convert their investment in IFIs due
to endurance investment in term of returns and risk-sharing factor in IBs.
Now we give a snapshot to differentiate among assets driven, liability
driven and other factors. The main source of earning in CBs is the difference
between the borrower and lender interest rates. This difference between both
interest charge amount is called “spread”. The relationship between cost of
funds and return on lending is called “liability driven”, which refers to CBs.
The relationship between return on assets (real estate and automobiles) and
investment returns (wadiah, safe custody) is called “assets driven”, which re-
fers to IBs. When constraint on leverage conducts then its results convert to
credit creation (Jawadi et al. 2014). However, these are the basic knowledge
170 Malik Shahzad Shabbir and Awais ur Rehman
of financial transaction, which will differentiate between both financial sys-
tems. If our fifth layer of people is unable to completely understand these
basic things then how we can expect from them to realize, review and give
decision on complicated financial transactions of IFIs. However, it is noted
that IBs treated their customers as partners in order to manage risk and
increase the returns on their investment. Whenever IBs enclosed its profit
and loss report, then the market will weed incompetent entrepreneurs. This
element shows the importance of market discipline and harmony. So de-
positors select the financial institutions carefully and understand that bank
is compactable within the limits of shari‘ah about investment perspectives
(Chong & Liu, 2006).

11.2 The advantages of IBs as an opportunity for investors

• The strong correlation found in IBs between financial institutions and
depositors on liability side, while on the assets side it transfers to finan-
cial institutions and its borrowers. It is a beauty of IBs that neither of
any participants face unequitable systematic shocks among them. How-
ever, conventional capital system of west has found such kinds of une-
quitable practice of shares/profit among their stakeholders. One of the
best examples for understanding of investors about conventional capital
system failed in 2007 financial crises especially in-house financing sec-
tor of the world economy.
• Return in IB is not merely the collection of a ‘spread’ between the costs
of funds mobilized and the return on funds advanced – conventional
debtor-creditor relationships.
• One of the fundamental requirements in Islamic form of intermediation
is that financial transactions must be supported by real economic activ-
ity. This requirement ensures the financial stability in general.
• Financial innovation in Islamic finance must be within these Shari’ah
parameters and tested against the ‘Maqasid al-Shari’ah’ (objectives of
the Shari’ah). Unnecessary financial engineering led to financial insta-
bility in 2008 global financial crisis. Sale of debt against debt is not al-
lowed in Islamic commercial law.
• Just and equitable aspect of distribution is absent in interest-based fi-
nancing, it may either exploit the debt holder or the financier. This is be-
cause the just and equitable aspect of distribution is absent in this way
of financing. Inflows (profit) of business are obviously random and are
affected by many uncontrollable factors, while outflows (interest pay-
ment) are fixed in case of business is financed by debt. If the inflows are
zero or less than the outflows it will be detrimental for the businesses.
This will certainly lead to bankruptcies, which in turn affect the growth
and production cutdowns, and hence result in greater unemployment.
On the other side, if businesses make huge revenues then the financier
is being exploited as the financing earned less than its actual share.
 Misconceptions about Islamic banking 171
However, in equity-based financing there is always just distribution
of revenues and both parties get their equitable share in both above-
mentioned scenarios.
• Debt-based financing always caters the needs of those segments of the
society who are able to give safe and fixed repayments. Financing only
well-secured businesses and giving less weightages to profit-potential
projects lead to income and wealth inequalities and misallocation of re-
sources. This security-oriented approach is fatal for the growth of small
business enterprises which may have enormous potential to grow and
hence have greater potential to contribute more to the gross national
product (GNP) but failed to provide an assurance of repayment to fi-
nancial institutions. The overreliance on pledges, securities and collat-
eral leave very small room for small-scale entrepreneurs to benefit from
these financing which is a great obstruction to the growth of economy.
• Islamic finance promises to enhance the discipline that contributes to-
wards ensuring growth and financial stability.
• Interest-based system leads to income and wealth inequalities and mis-
allocation of resources.

11.3 Ethical theory of IB

The decision to use IB services is not only based on profits but also on ob-
taining the blessings of Allah (SWT). One way to obtain these blessings is
to support programs to improve and expand Muslim communities. In this
regard, IBs function on an interest-free basis. Their wealth creation is con-
sidered as expanding Muslim communities, and Muslims who help these
banks are consequently considered as those who should attain salvation.
Profit and investment affect customers’ behaviors when they are making
decisions. Their choices are not only based on instant current financial re-
turns. They are also factors in long-term returns hereon.
Ethics are the moral behavior that underpins every human act. Every
human being has behavior traits, and Islam emphasizes the need for good
behavior. Religion defines moral behavior. To understand the meaning
of Islamic ethical behavior more fully, ethics are related to temperament,
and human behavior is found in people’s actions. According to Al-Ghazali
(505H), ethics are inherent in the nature of human souls and are born from
deeds done without hesitation, without thinking of oneself and without
prior reflection. Ibn Miskawaih (2010) has stated that ethics are a condi-
tion of themselves that guide people to pursue numerous modes of behavior
without thought or consideration. Mawardi (2011) wrote in his book enti-
tled Adab al-Dunya wa al-Din that ethics are not only controlled by the Al-
Quran and the Sunnah but they are in fact based on thoughts concerned
with three behavioral aspects: religious behavior, world behavior and indi-
vidual behavior. Religious behavior mostly leads to understanding, knowl-
edge and religion. World behavior, second behavioral form, focuses on the
172 Malik Shahzad Shabbir and Awais ur Rehman
behavior of the world and individual ethics. Individual behavior refers to
human virtues such as humility, good behavior, simplicity, self-control and
trust. Based on an observation of a number of previous studies, only one
has defined Islamic ethical behavior, which was that by Awan and Azhar
(2014). Their study, based in Pakistan, examined how customers chose IB
products because the banks offered good products and services without in-
terest, which is prohibited in Islam. Most customers preferred their banks
because of their religious motives for securing the confidentiality of their
customers, which led to there being a crucial ethical distinction drawn that
was based on the Al-Quran and the Sunnah. The study focused more on
religious obligations since there was a lack of definition on what constituted
Islamic ethical behavior.
Humans, as vicegerents of the divine on earth, have the ability to learn,
gain knowledge and make rules and policies based on their knowledge to
develop further knowledge and improve practices based on what has been
learned (Bunzel, 2015). Humans have the freedom to choose what is best
for them, and, at the same time, they must follow the rules of Allah (SWT).
For example, humans have to work to earn salaries that enable them to live
their own lives while helping others. The salaries received could be used for
many contingencies, and any excess could be saved in bank accounts. More-
over, Islam encourages Muslims to keep investing their money so that the in-
come from such investments may be used for good causes (Nurrachmi et al.,
2012). Once humans have chosen banks with which they would want to save
their money, they need to understand their roles as depositors. According to
Bollen (2010), depositors are defined as people who make others intermedi-
aries, who expect those intermediaries to repay them the amount they have
deposited on demand, although the amounts deposited need not have the
same real currency value when withdrawn as when initially invested. This
establishes debtor and creditor relationships between intermediaries and
depositors. In addition, the main sources of money at IBs come from their
depositor facilities (Amin, 2013). Depositors have the right to choose to de-
posit their savings either in CBs or in IBs, but Muslims are obliged to choose
the sort of intermediaries who will not harm or become a burden to them.

11.3.1 The ideal banking system

In order to create environments conducive to the development of the IB, the
development of the banking system should start with the development of a
concept for ideal IB. Below are the explanations on how such concept can
be established. The idea is to create a structure which can accommodate
the creation of double-tier Mudarabah banking through employing project
finance and asset securitization schemes which are widely known in CBs.
However, IB is part of the broader concept of Islamic economics which aims
at the introduction of value system and ethics of Islam into the economic
sphere. Because of this ethical foundation, the concept of IB for the follower
of Islamic faith is more than merely a concept on how to do banking. It is
 Misconceptions about Islamic banking 173
the embodiment of the submission to Allah (SWT) since following the Is-
lamic precepts is a religious obligation (Shabbir et al. 2016b). Based on this
tenet, the IB can be elaborated as a system of banking which provides just
financing, is free from factors unlawful to Islam and offers benefits not only
to the shareholders of the bank but also to the stakeholders of the bank.
The IB should avoid the potential huge divergence between real assets and
real liabilities which may be translated into a profit and loss sharing (PLS)
banking with some elements of morality and justice. In practice, the IB con-
sists of PLS and non-PLS mode of financing in assets side. However, heavy
reliance on the non-PLS mode often attracts sarcastic criticisms that most
Islamic financing techniques used at present bear no difference in substance
compared to the conventional finance and that the superficial distinction of
the Islamic finance and conventional finance is mainly centered in the use of
Arabic names and in the disguised trade transactions for conventional trans-
action which are substantially similar to those of conventional finance. Even
though this notion can be refuted by the development of myriad Shari’ah
justifications for a restricted scope of application of some conventional tech-
niques, it is sufficient to say that effort should be directed toward the revival
of the early concept of IB, the double-tier Mudarabah, in order to minimize
the effects of the above-mentioned sarcastic criticisms (Shabbir et al. 2015a).
The two-tier Mudarabah model, where the depositors will place their
fund as a Mudarabah deposit in the bank, which in turn invest the fund
through Mudarabah in several projects. The investment Mudarabah (the
second tier) is structured as a non-recourse project finance transaction using
leasing as a main vehicle where the repayment of the financing was con-
vened only to actual revenue generated by the project. Then, each individual
project is securitized and sold back to the bank. Because all projects are
converted into marketable quasi-equity security, the risk of maturity mis-
match between the first tier Mudarabah and the second tier Mudarabah can
be avoided. In this juncture, the viable alternative to this is an instrument
which is created through securitizing the assets of such an institution or any
subsidiary thereof. While the mobilization of resources does not need to be
conducted through securitization, it can be demonstrated that this vehicle
is the most suitable one in case of developing Islamic financial instruments
in conventional environment. One of the arguments for the suitability of the
securitization is the clarity of the source of the stream of income (Marliana
et al. 2011).

11.4 Literature review

Interest-free financing became a conceptual issue, and it has been primar-
ily focused by Ahmed (1981) through IBs around the world because strong
conceptual ideas of the investors left a good image for the rest of investors.
However, it is noted that the existing literature is unable to completely cover
the main factors such as facilitation of transactions, pool risk and mobilized
saving of IBs, which show the exact growth and viability of IBs. While some
174 Malik Shahzad Shabbir and Awais ur Rehman
studies exclude the interest from IFIs through their strategy consequence
(Khan 1986, Khan and Mirakhor 1987 and Bashir 2000), IFIs face new chal-
lenges as well as know some new realities of market after deregulation and
topical trends of financial liberalization. These trends create competitions
between interest-free and non-interest-free financial institutions after global
financial markets combination. IFIs consider this competition as an oppor-
tunity, and it starts to design innovational models according to the needs and
wants of their target customers in domestic and international markets. After
gaining this opportunity by IFIs, it gets more investment prospect from the
market within the viable retune rates and regulatory degree of risk (Bashir
et al. 1993, Bashir 1999, Zaher and Hassan 2001, Samad and Hassan 1999).
Muslim and non-Muslim are two main types of investors in IFIs, where
satisfaction is a basic and essential element of the any investor. Non-Muslim
investors get satisfaction by maximizing their profits, and still this incre-
ment of profit remains in their accounts continuously. Some of non-Muslim
investors don’t believe on Islamic faith; for their perspectives IBs are rea-
sonably a new concept, and it may become an opportunity for them as new
investor in existing market. However, the satisfaction levels of Muslim in-
vestors are different from non-Muslim investors because Muslims investors
got maximum utility from absolute relation with Allah (SWT) and well
deed behavior with his human beings. However, the Muslim investors and
consumers also face restrictions on what to invest and consume and where
to invest and consume according to shari‘ah, respectively. However, Quran
gives a clear indication about this perspective because charity is a function
of “good deeds” too (Qur’an, 46:15; 18:46), it is the one best form of good
deeds. Allah (SWT) admired disbursements on charity (Qur’an, 63:10). Ac-
tually, Islam teaches us how to manage and allocate your resources, differ-
ent activities of capital market, wealth and income distribution system and
how to manage production and consumption system (Asutay, 2008).
It is a general concept of Islamic economics that risk of venture will be
beared by mutual understanding of borrowers and lenders because success
or failure of venture is uncontrollable by them. Dar and Presley (2000) found
some theoretical models like PLS (Mudarabah) and joint venture (Mushar-
akah) concepts are mostly used in IB. Gait and Worthington (2008) inves-
tigate some obstacles exist to investors of IBs such as different risk-sharing
conditions, complications among management and unfamiliar business sit-
uations. It is also noted that financing method of IBs is related with visible
risk of its capital. Metwally (1997) and Rosly and Zaini (2008) highlighted
some of the difficulties about risk arising, classifying, observing and com-
puting through the financing instruments of IFIs. “All intellectual, practical,
political, constitutional and legal efforts undertaken to enforce an interest-free
system were not meant in earnest and therefore they inflicted a serious damage
to the cause of Islam as well as IB” (Khan and Bhatti, 2006, p. 145).
The Malaysian investors received 1.16% through return on Mudarabah
deposits (ROMD) which is less return on equity (ROE) rather than USA
fixed deposit holders. It shows an opportunity for the investors of IFIs.
 Misconceptions about Islamic banking 175
However, 11.82% gap found between ROE and ROMD of IBs of Malaysia is
higher than 8.61% return of USA interest-based banks. An internally snap-
shot of ROMD with others Islamic modes of financing in Malaysia shows
that an average of ROMD was 7.56 times higher than the Malaysian IBs
through their capital share. When we designed the rank of Malaysian banks
on the basis of ROMD then we come to know the highest position got by
Bank Islam Malaysia Berhad with 11.47 times higher than its share of capi-
tal, and the lowest position got by Maybank of Berhad with 2.9 times higher
than its capital share of market (Rosly and Zaini 2008).
However, IBs found an exclusive institution for investor’s perception to
provide financial products and services permitting the needs and wants of
their target customers within the limits of Islamic principles; IFIs also took
risk management as special challenge to compete this risk and it had showed
a positive effect on new and existing customers to easily motivated them
for more investment in IBs. After the global challenges and financial crises
damaged the international market, the priority of international investors
had converted from conventional to IBs globally because when all big brand
names had become the victim of crises and continuously declined their mar-
ket values, in that particular time IFIs are not only stable in their position
in the market but also have rapid growth in its market value. This is the
main cause, which pushes the minds of all kinds of investors but especially
non-Muslim investors to think about their investment and decide, are they
continuously facing this decline process or should they change their banks
(Sundararajan and Errico 2002)? “Today we have reached a tipping point,
which leaves us only one choice: change or face continued decline and misery”
(Chairman World Economic Forum 2010).

11.5 Methodology
This research is based on primary data. It includes the opinion of inves-
tors, layman, educationists and customers of different types of IBs. The
respondents belong to different age groups, educational and occupational
background, irrespective of gender. However, some branches of IB were se-
lected at random from Lahore city; we also interviewed some investors and
academician from Lahore to make our study more valuable and strong in
this regard, whereas 132 questionnaires were distributed among investors,
customers and other people of the society. The investors and academician
were interviewed on a structured questionnaire through experienced enu-
merators. We took 5% as level of confidence in data analysis. The sample
remained unweighted in respect to gender to avoid any bias. The areas of
questions consists of the following: Personal information, Preference for
bank selection, Opinion about shari‘ah compatibility of IBs, Knowledge
of investors about Islamic financial practices and products, Level of satis-
faction about service quality of banks and Islamic scholars or Ulema un-
derstand the basic concepts of IB such as asset driven, liability driven and
spread; IB is an opportunity or thread or challenge for the investors; and IBs
176 Malik Shahzad Shabbir and Awais ur Rehman
give opportunities and information about usage of services and facilities to
their investors. Questions were designed by keeping these areas in mind and
to confirm the objectives of the study.
A pilot survey was conducted, and necessary adjustments were made in
the questionnaire. However, we used adjusted sample and 5% level of con-
fidence in our study. On the average, it took 15–20 minutes of enumerator
to interview respondent investors. Furthermore, ANOVA and LSD (least
significant difference) tables explain the results of interview. The responses
of the questionnaires were summarized in SPSS software. Cross-tabulation
was done for getting the overall results of the research. All the results were
then converted into percentages/proportions.

11.6 Data analysis and discussion

Table 11.1 shows the mean values of all the variables in the questionnaires.
However, the purpose of mean values is to determine the center of tendency in
all the values given in the data. The maximum and minimum values of mean
are 2.772 and 1.184, respectively, in the above table, whereas the difference
between maximum and minimum value is 1.588. Most of the values are near
to maximum value of mean, and there is no negative value found in the whole
table, which shows that the positive relationship among all the mean values.
For overall IBs, if the highest mean values occur with the magnitude of 2.772
for both of these variables, do common investors know about the procedure
of products of IB like car and house financing? As per the questionnaire used

Table 11.1 Mean Values

Descriptions Mean

Do Islamic scholars or Ulema understand the basic concepts of IB such 1.538

as asset driven, liability driven and spread?
Do you think IB is a threat for the investors? 1.636
Do you think IB is a challenge for the investors? 1.409
Do you think IB is an opportunity for the investors? 1.184
How would you rate your level of satisfaction with IB? 2.453
Do you ask from your banks about the Shari‘ah compatibility of the 2.363
bank operations?
When you have a problem, your bank shows a sincere interest in solving 2.646
it for motivation of their investors?
IBs give opportunities and information about usage of services and 2.415
facilities to their investors.
What is your opinion about profit of IBs? 2.363
What is your opinion about Shari‘a compliant banking system? 2.061
Normally no IB approached common investors. 2.469
Procedure of opening an account is difficult in IB for laymen. 2.430
How many Islamic religious scholars understand the mechanism of IBs 2.484
such as financial transactions?
How much investors know that deposits are used and distributed in IBs? 2.484
Do common investors know about the procedure of products of IB like 2.772
car and house financing?
 Misconceptions about Islamic banking 177
to collect this data, the value 1 was representing highly disagree state and the
5 is for highly agree response. Hence, mean value of 2.772 shows that most of
the investors are agree in both of these cases. If the lowest mean value occur
at 1.184, do you think IB is an opportunity for the investors?
Table 11.2 divulges the results generated by the independent sample T-test.
The data was processed under this test with the aim of comparative analysis

Table 11.2 Group Mean Variables (* indicates less than 5% significance level)

Group Means Variables Bank Mean Means Sig.

Type Diff (2-tailed)

Do Islamic scholars or Ulema understand the CB 1.606 0.106 0.262

basic concepts of IB such as asset driven,
liability driven &spread?
Islamic 1.538
Do you think IB is a threat for the investors? CB 1.575 −0.102 0.238
Islamic 1.677
Do you think IB is a challenge for the CB 1.393 0.006 0.937
investors?
Islamic 1.387
Do you think IB is an opportunity for the CB 1.212 0.112 0.087
investors?
Islamic 1.1
How would you rate level of satisfaction CB 2.424 −0.162 0.211
with IBs?
Islamic 2.586
Do you ask from your banks about the CB 2.484 0.226 0.105
Shari‘ah compatibility of the bank
operations?
Islamic 2.258
When you have a problem, your bank shows a CB 2.606 −0.127 0.349
sincere interest in solving it for motivation
of their investors?
Islamic 2.733
Banks give opportunities and information CB 2.272 −0.394* 0.005
about usage of services and facilities to
their investors.
Islamic 2.666
What is your opinion about profit of IBs? CB 2.363 0.041 0.738
Islamic 2.322
What is your opinion about Shari‘ah CB 2 −0.129 0.242
compliant banking system?
Islamic 2.129
Normally no IB approached common CB 2.424 −0.059 0.693
investors.
Islamic 2.483
Procedure of opening an account is difficult CB 2.393 −0.107 0.477
in IB for laymen.
Islamic 2.5
(Continued)
 178 Malik Shahzad Shabbir and Awais ur Rehman
Group Means Variables Bank Mean Means Sig.
Type Diff (2-tailed)

How many Islamic religious scholars CB 2.636 0.282 0.056

understand the mechanism of IBs financial
transactions?
Islamic 2.354
How much investors know that deposits are CB 2.424 −0.092 0.522
used and distributed in IBs?
Islamic 2.516
Do common investors know about the CB 3.06 0.609* 0.000
procedure of products of IB like car and
house financing?
Islamic 2.451

of challenges, opportunities and threads in the way of correcting the mis-

conceptions for society about IBs. The significant differences between the
mean values were observed at the variables of how would you rate your
level of satisfaction with IBs; IB is a threat for the investors; when you have
a problem, your bank shows a sincere interest in solving it for motivation
of their investors, your opinion about Shari‘a compliant banking system;
banks give opportunities and information about usage of services and fa-
cilities to their investors; normally no IB approached common investors;
procedure of opening an account is difficult in IB for laymen and how much
investors know that deposits are used and distributed in IBs.
The significant value shows that these IBs observe statistically different
results under the variables of banks to give opportunities and information
about usage of services and facilities to their investors: Do common inves-
tors know about the procedure of products of IB like car and house financ-
ing? While between these variables the biggest mean difference occurs and
the common investors know about the procedure of products of IB like car
and house financing with the mean difference of 0.609. However, positive
mean difference is the evidence to state that this problem is present at a
bigger level in Islamic counterparts. It means that the CBs’ management in
Pakistan is not as much concerned with the service quality as the IB man-
agement. This issue is due to the new entry of IBs in the financial industry
for the investors.

11.6.2 Analysis of variance (ANOVA)

For the multiple comparisons, in order to observe the change in the inves-
tors’ perception with respect to religious education conducted, Table 11.3
describes the results of one way ANOVA. As evident through data analysis,
the investors’ perception of taking the IB as threat undergoes insignificant
difference with the change in religious education of significance value at
0.064, while the results are vice versa with the variables of challenge and
 Misconceptions about Islamic banking 179
Table 11.3 ANOVA – Analysis (* indicates less than 5% significance level)

Description Sum of Squares DF Mean F-stat Sig. p-Value

Square

Threat Between groups 2.145 4 0.536 2.326 0.064

Within groups 17.757 77 0.231
Total 19.902 81
Challenge Between groups 3.15 4 0.788 3.706* 0.008
Within groups 16.362 77 0.212
Total 19.512 81
Opportunity Between groups 5.014 4 1.253 9.548* 0.000
Within groups 10.108 77 0.131
Total 15.122 81

opportunity. Henceforth, the variable of threat was not taken to the further
test of LSD and vice versa for challenge and opportunity.
Table 11.4 entails the statistics generated for LSD. Here, the group differ-
ence becomes significant as the religious education goes from 1 to 2, with
significance value at 0.09 and the mean difference at −0.466. This negative
mean difference is representative of the fact that the investors’ perception
goes towards “No”. However, we say that increase in investor’s religious ed-
ucation from Amma to Khasa (primary to secondary level) makes them less
in taking the IB investments as a challenging one. When religious education
goes from 2 to 1 all the results are the same as discussed above with positive
mean difference value (0.466). Whereas, in the same dimension 3, the results
are different when religious education goes from 2 to 3 with mean difference
0.416 at 0.001 level of significant. It means that investor perception is posi-
tive about IB as a challenge. In dimension 2, religious education spirits from
3 to 2 with negative mean difference (−0.416) form at the above discussed
significant level (0.001), and all the results are converted into inverse form.
In opportunity table, when religious education moods from 1 to 3 and
1 to 4, the group difference becomes positively significant with 0.337 and
0.400 at 0.012 and 0.009 significant levels, respectively. These positive signs
represent that IBs are an opportunity for investors. However, in dimension 2,
when religious education transferred from 1 to 2 and 1 to 3, the differences
in mean values are 0.337 and 0.400 with significant levels of acceptance 0.012
and 0.009, respectively. In dimension 3, the relationships among religious
education find positively significant from 2 to 3, 2 to 4 and 2 to 5 with their
mean values 0.520, 0.583 and 0.583 at different levels of significant 0.000,
0.000 and 0.032, respectively. The results of this correlation among the vari-
ables represent that investors want to invest more in IBs through their port-
folio investment. In dimensions 3, 4 and 5, it has found negative correlation
among the variables as from 3 to 1 and 3 to 2, 4 to 1 and 4 to 2, and 5 to 2 with
mean difference values (−0.337, −0.520, −0.400, −0.583 and −0.583) at altered
affirmative level of significant values (0.012, 0.000, 0.009, 0.000 and 0.032).
180 Malik Shahzad Shabbir and Awais ur Rehman
Table 11.4 Religion Multiple Comparisons LSD (* indicates less than 5%
significance level)

Dependent (I) Education (J) Education Mean Std. Sig.

Variable Religious Religious Difference Error
(I-J)

Challenge 1 2 −0.466* 0.173 0.009

Dimension 3 3 −0.050 0.167 0.765
4 −0.228 0.190 0.235
5 0.2 0.357 0.577
Dimension 3 2 1 0.466* 0.173 0.009
3 0.416* 0.124 0.001
4 0.238 0.155 0.129
5 0.667 0.339 0.053
Dimension 2 3 1 0.050 0.167 0.765
2 −0.416* 0.124 0.001
Dimension 3 4 −0.178 0.147 0.230
5 0.250 0.335 0.459
Dimension 1 4 1 0.228 0.190 0.235
2 −0.238 0.155 0.129
Dimension 3 3 0.178 0.147 0.230
5 0.428 0.348 0.222
Dimension 3 5 1 −0.200 0.357 0.577
2 −0.667 0.339 0.053
3 −0.250 0.335 0.459
4 −0.428 0.348 0.222
Opportunity 1 2 −0.183 0.136 0.183
3 0.337* 0.131 0.012
Dimension 3 4 0.400* 0.150 0.009
Dimension 2 5 0.400 0.280 0.158
2 1 0.183 0.136 0.183
Dimension 3 3 0.520* 0.097 0.000
4.00 0.583* 0.121 0.000
5.00 0.583* 0.266 0.032
Dimension 3 3.00 1.00 −0.337* 0.131 0.012
2.00 −0.520* 0.097 0.000
4.00 0.062 0.116 0.592
5.00 0.062 0.264 0.814
Dimension 3 4.00 1.00 −0.400* 0.150 0.009
2.00 −0.583* 0.121 0.000
3.00 −0.062 0.116 0.592
5.00 0.000 0.273 1.000
Dimension 3 5.00 1.00 −0.400 0.280 0.158
2.00 −0.583* 0.266 0.032
3.00 −0.062 0.264 0.814
4.00 0.000 0.273 1.000

11.6.3 ANOVA – Analysis

In relative comparisons among three variables as threat, opportunity
and challenge in order to observe the change in the investors’ perception
with respect to religious education conducted, Table 11.5 describes the re-
sults of one way ANOVA. As evident through data analysis, the investors’
 Misconceptions about Islamic banking 181
Table 11.5 ANOVA – Analysis of Religiosity (* indicates less than 5%
significance level)

Description Sum of Squares Df Mean Square F-stat Sig. p-Value

Threat Between groups 0.755 4 0.189 0.805 0.524

Within groups 29.79 127 0.235
Total 30.545 131
Challenge Between groups 4.742 4 1.186 5.543* 0
Within groups 27.167 127 0.214
Total 31.909 131
Opportunity Between groups 2.169 4 0.542 3.896* 0.005
Within groups 17.4 125 0.139
Total 19.569 129

perception of taking the IB as challenge undergoes significant difference

with the change in religious education of significance value at 0.000, while
the results of opportunity are the same as challenge but result of threat is
different which shows insignificant value at 0.524 level of significant. Hence-
forth, the variable of threat was not taken to the further test of LSD and vice
versa for challenge and opportunity (Table 11.5).
Table 11.6 entails the statistics generated for LSD. Here, the group differ-
ence becomes significant as the religious education goes from 1 to 3, with
significance value at 0.02 and the mean difference at −0.833. This negative
mean difference is representative of the fact that the investors’ perception
goes towards “No”. However, we say that increase in investor’s religious ed-
ucation from Amma to Khasa (primary to secondary level) makes them less
in taking the IB investments as a challenging one. When religious education
goes from 2 to 3 all the results are the same as discussed above with positive
mean difference value (−0.833). Whereas, in the same dimension 3, the re-
sults are different when religious education goes from 3 to 1 with mean dif-
ference 0.833 at 0.02 level of significant. It means that investor perception is
positive about IB as a challenge. In dimension 2, religious education spirits
from 3 to 2 with negative mean difference (0.833) form at the above discussed
significant level (0.02), and all the results are converted into inverse form.
When religious education moods from 3 to 4, 3 to 5 and 5 to 4 the group
difference mean values become positively significant with 0.583, 0.333 and
0.250 at significant levels of 0.000, 0.024 and 0.004, respectively. Whereas,
in dimensions 3 and 1, variables show negative mean values with magnitude
of −0.583, −0.250 and −0.333 at significant level values (0.000, 0.004 and
0.024), where religious education transferred from 4 to 3, 4 to 5 and 5 to 3,
respectively. In the table of multi-comparisons of LSD test for opportunity
variable, religious education goes from 4 to 5 with value of mean difference
0.267 at significant level 0.000. This positive sign represents that IBs are an
opportunity for investors. However, in dimension 3, when religious educa-
tion transferred from 5 to 4, the difference in mean value is −0.267 with
significant level of acceptance 0.000.
182 Malik Shahzad Shabbir and Awais ur Rehman
Table 11.6 CB Multiple Comparisons LSD (* indicates less than 5% significance level)

Dependent (I) (J) Mean Difference Std. Error Sig.

Variable Education Education (I-J)
CB CB

Challenge 1 2 0 0.462 1
Dimension 3 3 −0.833* 0.353 0.02
4 −0.250 0.332 0.454
5 −0.500 0.332 0.135
Dimension 3 2 1 0 0.462 1
3 −0.833* 0.353 0.02
4 −0.250 0.332 0.454
5 −0.500 0.332 0.135
Dimension 2 3 1 0.833* 0.353 0.02
2 0.833* 0.353 0.02
Dimension 3 4 0.583* 0.147 0
5 0.333* 0.146 0.024
Dimension 3 4 1 0.25 0.332 0.454
2 0.25 0.332 0.454
3 −0.583* 0.147 0
5 −0.250* 0.085 0.004
Dimension 3 5 1 0.5 0.332 0.135
2 0.5 0.332 0.135
Dimension 1 3 −0.333* 0.146 0.024
4 0.250* 0.085 0.004
Opportunity 1 2 0 0.373 1
3 −0.167 0.284 0.56
Dimension 3 4 −0.333 0.268 0.217
5 −0.067 0.268 0.804
Dimension 3 2 1 0 0.373 1
3 −0.167 0.284 0.56
4 −0.333 0.268 0.217
5 −0.067 0.268 0.804
Dimension 2 3 1 0.167 0.284 0.56
2 0.167 0.284 0.56
Dimension 3 4 −0.167 0.119 0.164
5 0.1 0.117 0.398
Dimension 3 4 1 0.333 0.268 0.217
2 0.333 0.268 0.217
3 0.167 0.119 0.164
5 0.267* 0.069 0
Dimension 3 5 1 0.667 0.268 0.804
2 0.667 0.268 0.804
3 −0.100 0.117 0.398
4 −0.267* 0.069 0

11.7 Conclusion
This study investigated the behavior and ideas of five layers of misconcep-
tion about Islamic financial system, where the first layer identifies the ide-
ology of layman about IBs. However, this layman has no any account in
interest-bearing and non-interest-bearing financial institutions. However,
rest of four layers consist of account holder of IBs, Islamic economists,
 Misconceptions about Islamic banking 183
conventional economists and religious scholars or Ulema’s. In this study, we
find that IB is an opportunity, challenge and threat for investor perspective.
The results of this study show that two variables such as opportunity and
challenge out of three are positively significant and rest of one as threat is
insignificant. Results of individual mean values express that most of the val-
ues are near to origin and where the maximum and minimum values are as
2.774 and 1.184, respectively. T-test represents the individual significant and
insignificant results of model, and we elaborate all the individual values on
base of significant levels. Whereas F-test denotes the significant level as an
acceptance or rejection of the whole model. The table of multi-comparison
of LSD tests shows hybrid results in terms of positive and negative which
are based on dimensions, difference in mean values, standard errors, both
religious education (I, J) and significant levels.
Whereas, it is also noted in our survey that most of investors are not well
educated and they are unable to differentiate between function of asset
and liability side of balance sheet. In our survey, some investors share their
views that investors of CB system told us that IB will not work or exist
more in the global market. This news will draw bad effects on the new IBs
investors as well as the existing. So, it is suggested that IFIs should publish
small booklets in national/local language to motivate clients. The IFIs will
also organize corner meetings with their all investors but especially with
long-term investors. These facts must reduce the misconception of inves-
tors, and it also promoted the IFS in the world as an opportunity for new
investors.
Based upon the findings the study puts forward the following suggestions.
It was observed that the investors are not well to bear the knowledge of
Islamic finance; moreover, the more knowledgeable individuals were akin
to have a positive association towards Islamic finance. The lower level of
empathy received by IB employees is the fuel to the fire of this scarcity of
knowledge. Hence, the banks are encouraged to work on the principles
of economy of knowledge by instilling a better knowledge both among the
general public by arranging seminars and among employees by enhancing
the IB trainings. It was seen that the investors’ perception was strong to
take Islamic investments as an opportunity to invest. This fact be tailored
in the marketing strategy of IBs, and the investors are encouraged to opt for
Islamic investments to diversify their portfolios.
Suggestions for the father research can be granted in the way that this
study was questionnaire based by the nature of its methodology, and the re-
sults can be compared while arching the future research upon experimental
methods. The sample can be diversified as well, and the impact of knowledge
can be investigated upon different and larger samples. Study also suggested
that the bank employees are not well knowledgeable to guide with empathy.
A dedicated study can be conducted on IB employees to further spearhead
the significance of trainings and the level of employees’ knowledge. Bank
accounts were taken as the proxy for investments the future research can opt
for the different proxies like Islamic stocks and sukuks.
184 Malik Shahzad Shabbir and Awais ur Rehman
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12 Overview of progress in Islamic
commercial and social finance
in Pakistan
Salman Ahmed Shaikh, Mohd Adib Ismail,
Abdul Ghafar Ismail, Shahida Shahimi and
Muhammad Hakimi Mohd. Shafiai

12.1 Islamic banking in Pakistan

Financial institutions facilitate intertemporal finance between savers and
investors by providing efficient delegated monitoring and portfolio man-
agement services (Diamond, 1984). Financial credit institutions enable con-
sumers to access their potential lifetime resources when they are not readily
available in earlier stages of their lives. People can use their current endow-
ments or future stream of expected incomes as collateral to access credit
facilities in the present (Kahf, 1996).
Islam allows financing and investments, but without the element of in-
terest. Islam aims for circulation of wealth and pursuit of the productive
enterprise for earning a livelihood. On the other hand, providing a fixed re-
turn to money capital leads to continuous accumulation and concentration
of wealth among the wealthy capitalists. Islamic finance makes it necessary
that money capital cannot get stipulated returns unless it participates in
the productive enterprise by undertaking the risk. This enables circulation
of capital, full employment of resources and avoids the ills of the concen-
tration of wealth, economic stagnation, unemployment and simultaneous
existence of unused resources and unmet needs. Islamic teachings discour-
age idleness of capital by disallowing any stipulated increase to the lending
of money capital and by levying Zakāt on idle capital. This ensures capital
circulation in the real economy so that financial intermediation contributes
to socioeconomic development by having a direct and compulsory link with
the real sector of the economy.
The idea of Islamic banking was first materialized in the area of social
finance. In Egypt, El-Naggar in 1963 launched Mit Ghamr Islamic Savings
Bank. In addition to that, Tabung Haji (Pilgrims Fund Corporation) began
its operations in 1963 to enable Malaysian Muslims to save funds for the
journey of Hajj (Chachi, 2005). On the other hand, contemporary Islamic
banking started with the launch of Dubai Islamic bank in 1979.
After humble beginnings, Islamic financial institutions were launched
globally in Muslim majority regions of Asia, Africa and even Europe. Ac-
cording to the Global Islamic Finance Report (2018), global Islamic finance
188 Salman Ahmed Shaikh et al.
assets reached $2.43 trillion in 2017. Majority of the global Islamic finan-
cial assets are held by Islamic banks and conventional banks with Islamic
banking windows as they enjoy the share of 75% of the total global Islamic
banking assets. Looking at the market shares of Islamic banking in differ-
ent countries, it is revealed that Islamic banking share in overall banking
in Saudi Arabia, Kuwait, Bahrain, Qatar, the UAE, Malaysia and Pakistan
remains at 51.2%, 45.2%, 29.3%, 25.8%, 21.6%, 26% and 15%, respectively
(Ernst & Young, 2016).
During the early years after independence from British India, masses
in Pakistan had a keen interest in introducing Islamic socioeconomic in-
stitutions in the country. However, political instability became a hurdle in
making swift progress towards that end. The interest reemerged after the
increased focus in the 1970s around the Muslim countries to develop an
indigenous Islamic financial system. In Pakistan, the country’s constitu-
tion passed unanimously in 1973 clearly mentions in Section 38(f) that Ribā
should be eliminated as early as possible. This paved the way for Islamic
banking on the legal front. Furthermore, the Council of Islamic Ideology in
its report in 1980 on the elimination of Ribā from the economy conclusively
defined Ribā. The report emphasized that concrete steps should be taken to
introduce Islamic banking in place of Ribā-based banking. The report gave
the following conclusive definition of Ribā:

The term Ribā encompasses interest in all its manifestations irrespec-

tive of whether it relates to loans for consumption purposes or for pro-
ductive purposes, whether the loans are of a personal nature or of a
commercial type, whether the borrower is a government, a private indi-
vidual or a concern, and whether the rate of interest is low or high.

Finally, the verdict on interest by the Supreme Court of Pakistan in 1991

further consolidated the progress in paving the way for Islamic financial
institutions. With these legal developments, Islamic banking in Pakistan
made humble beginnings first in the 1980s, and then, the real impetus came
with the launch of the first full-fledged Islamic bank in Pakistan in the year
2002. As of now, Islamic banking is an established industry with 15% and
15.6% market share in total banking assets and deposits, respectively, as
of March 31, 2019. By end-March 2019, the total Islamic banking assets in
Pakistan stood at Rs. 2.79 trillion ($23.25 billion), while total Islamic bank-
ing deposits stood at Rs. 2.20 trillion ($18.33 billion). With increased partic-
ipation of conventional banks in the Islamic banking industry, the branch
network has swelled to 2,689 branches by end-March 2019. Nonetheless, the
country’s share in global Islamic banking industry remains at a meager 1%
despite hosting 12% of global Muslim population.
However, the scope of scaling up and finding new customer base is sig-
nificant. According to National Financial Inclusion Strategy by State Bank
of Pakistan (2015b), only 10.3% of adult population in Pakistan has a bank
 Islamic commercial & social finance overview 189
account, whereas the average for South Asia and lower middle-income
countries is 33% and 41.4%, respectively. The savings also do not channel
through financial institutions as out of 36% of adults who save, only 4% of
the people save in financial institutions. On the other hand, according to
State Bank of Pakistan’s Knowledge, Attitude and Practices Survey, 98%
people who do not operate bank accounts believe in the prohibition of inter-
est. Furthermore, more than 93% people overall consider bank interest as
prohibited (State Bank of Pakistan, 2015a).

12.2 Islamic capital market in Pakistan

12.2.1 Equity market in Pakistan

By and large, the capital market in Pakistan has provided competitive re-
turns as compared to the low-risk fixed-income investments historically.
Most of the people with investment motive and having adequate risk appe-
tite prefer capital market investments in the secondary market due to higher
expected return and greater liquidity. Figure 12.1 gives a snapshot of how
the broad market index (KSE-100) has moved during 1998–2018. It can be
seen that the growth had been consistent with a break during 2008–2010.
The twin peak is observed since the stock market fell substantially in re-
sponse to the global financial crisis which also had the contagion impact on
the domestic capital market.
Figure 12.2 shows the index values of the Karachi Stock Exchange Al-
Meezan Index (KMI-30) during 2009–2018. From plotting the KSE-100
index values for comparison, it is evident that KMI-30 index has steadily
increased ever since its launch.
Nonetheless, there had only been 28 new long-term corporate debt in-
struments issued during 2011–2018. From the perspective of savers, the cor-
porate bonds do not generate much interest in Pakistan partly because of

KSE-100 (1998 - 2018)

60,000
50,000
40,000
30,000
20,000
10,000
-
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

KSE-100

Figure 12.1 KSE-100 index daily values (adjusted closing) for 1998–2018.
190 Salman Ahmed Shaikh et al.

KMI-30 (2009 - 2018)

100,000

80,000

60,000

40,000

20,000

-
2009 2010 2011 2012 2013 2014 2015 2016 2017
KMI-30 KSE-100

Figure 12.2 KSE-100 and KMI-30 index for 2009–2018.

alternative high-yielding sovereign national savings scheme instruments

which have no default risk and enjoy tax exemption of returns. On the other
hand, the government of Pakistan minimally uses Islamic modes of financ-
ing for its budgetary needs. As a result, there are fewer Islamic investment
instruments as a substitute for sovereign investment instruments.
On the other hand, the corporate sector itself is facing stiff competition
globally for sustaining its exports. The security and energy crisis has de-
pleted firm-level competitiveness; hence, very few long-term big investments
have come in the country after the nationalization in the 1970s. Further-
more, indirect taxation and removal of import barriers had also reduced
the competitiveness of local producers following the Structural Adjustment
Programs of the World Bank and the IMF.

12.2.2 Sukuk market in Pakistan

For Muslim investors looking for regular long-term income, Sukuk invest-
ments are a Shari’ah compliant alternative to corporate and treasury bonds.
Sukuk certificate represents the Sukuk holder’s ownership in real assets.
Since Islamic law allows sale as well as the lease of real assets, the income
earned in the form of profit on the sale or rents on the lease of assets is
permissible.
Sukuk market in Pakistan is limited just like corporate bonds. As of 2018,
more than 100 Sukuk had been issued in the last decade or so by the corpo-
rate sector and by the government of Pakistan. Innovative structures have
also appeared in recent years to issue Sukuk in the service sector companies.
For example, airtime-based Sukuk using Ijarah and Sub-Ijarah of services
have been issued which use airtime (minutes) represented by prepaid calling
cards and identified by the serial number of each card as the underlying
assets. In recent years, some of the corporate Sukuk have also got listed on
the exchange.
 Islamic commercial & social finance overview 191
12.3 Islamic mutual funds
Islamic mutual funds like their conventional counterparts provide portfo-
lio management services to risk-averse and risk-neutral investors. Islamic
mutual funds have to follow Shari’ah compliance criteria in their portfo-
lio selection and revision. Furthermore, they also have to purify their non-
compliant portion of income from the total earnings to make their income
Shari’ah compliant. The screening methodology approved by the Shari’ah
advisors in Pakistan is explained below.

12.3.1 Business of the investee company

First and foremost, the business of the company should be Halāl (per-
missible). Thus, investments in common stocks of interest-based banks,
conventional insurance companies, interest-based leasing companies and
in companies which provide prohibited goods or services, such as liquor,
drugs and weapons, are not permissible. Stocks of these companies cannot
be included in the portfolio. Once the qualitative screening on the nature of
the business is passed, then the screening is done on quantitative indicators
related to business processes, such as the use of interest-based leverage, in-
vestments and share of the non-compliant portion of income.

12.3.2 Ceiling on interest-based debt

Interest-based debt must be lower than 37% of the total assets of the com-
pany. Interest-based debt includes borrowing through bonds, finance lease
and commercial paper, for instance. It also includes interest-based conven-
tional banking products, such as interest-based loans, capital lease and hire
purchase agreements.

12.3.3 Ceiling on interest-based investments

The Shari’ah screening criteria specify that disallowed investments must be
less than 33% of the total assets of the company. Investments in T-bills, con-
ventional funds, corporate bonds, sovereign bonds, national savings scheme
instruments and interest-based derivatives are impermissible. If a company
is declared as non-compliant due to a violation of any of these principles,
investments in such company would also be considered impermissible.

12.3.4 Cap on Shari’ah non-compliant income

The non-compliant portion of income must be less than 5% of the consol-
idated total revenue of the company. The definition of total revenue is as
follows:

Total Revenue = Gross Sales + Total Other Income (1)

192 Salman Ahmed Shaikh et al.
The prohibited income includes interest income from financial invest-
ments and overdue receivables. It also includes income from prohibited
goods and services, such as gambling, prostitution, casinos, tobacco and
liquor. Dividend income from such businesses is regarded as non-compliant
income.

12.3.5 Minimum requirement of illiquid assets

The Shari’ah screening criteria further stipulate that non-liquid assets must
be 25% or more of the total assets of the company. Non-liquid assets are
defined as follows:

NonLiquid Assets = Total Assets – Liquid Assets (2)

Liquid assets comprise cash, advances, trade receivables and prepayments.

Non-liquid assets include inventory, plant, equipment, machinery and fur-
niture. Non-liquid assets can be traded above or below par value.

12.3.6 Minimum price of a share as per Shari’ah

The financial worth of the company equals at least the monetary value of
liquid assets it holds. Thus, the minimum price per share is represented by
net liquid assets per share:
Per Share Net Liquid Assets =
Total Assets – Illiquid Assets – Current Liability – Long-term Liability (3)
Total Outstanding Shares
Other than these screening principles, the rules of sale in Islamic jurispru-
dence also have to be followed which prohibit short selling, options, forward
sale and futures sale. In order to provide a contrast in the screening meth-
odology applied in Pakistan as compared to globally, a summary of the
quantitative screens followed in three major indices globally is provided in
Table 12.1.
Next, some developments and indicators related to the Islamic asset man-
agement sector in Pakistan are presented. As of September 30, 2018, there
are 245 mutual funds in Pakistan, out of which 126 are Islamic funds and 119
are conventional funds. Table 12.2 reports total assets under management
(AUM) in Islamic mutual funds in each category of funds. It can be seen
that most funds are invested in equity. Compound Annual Growth Rate
(CAGR) for Islamic equity funds during 2011–2018 had stayed at 40.27%,
while the CAGR for Islamic income funds had been clocked at 5.93% during
the same period.
Table 12.3 presents the market share distribution of Islamic and con-
ventional funds in each category of funds. Islamic funds have 38% market
share as compared to 62% market share of conventional mutual funds as
at December 31, 2018. In asset allocation, balanced, commodities, fund of
 Islamic commercial & social finance overview 193
Table 12.1 Screening Criteria of Global Indices

Quantitative S&P Financial Times Dow Jones

Screens Stock Exchange

Leverage Debt to equity Debt should be lower Debt to equity (24-month

(12-month average) than 33% of the average) should be
must be less than total assets. lower than 33%.
33%.
Liquidity Accounts receivables Cash plus Cash plus interest-bearing
to equity (12-month interest-bearing securities divided
average) should be investments should by equity (24-month
lower than 49%. be lower than 33% average) should be
Cash plus interest- of the total assets. lower than 33%.
bearing securities Accounts receivables Accounts receivables
to equity (12-month and cash should be divided by equity
average) should be lower than 50% of (24-month average)
lower than 33%. the total assets. should be lower than
33%.
Revenue Non-compliant Non-compliant –
income other than income should be
interest income to less than 5% of the
revenue should be total revenue of the
lower than 5%. company.
Dividend  NonCompliant Income 
purification Dividends  
 Total Revenue 

Table 12.2 Assets under Management in Islamic Funds (in million Rs.)

Category 2011 2012 2013 2014 2015 2016 2017 2018

Equity 7,027 8,104 15,349 23,363 51,167 67,215 92,788 75,095

Income 20,888 29,944 36,414 36,783 21,028 29,692 31,508 31,273
Fund of – – 699 927 3,269 23,679 61,411 45,585
funds
Asset 1,264 1,120 870 1,116 4,784 10,818 31,193 29,088
allocation
Fund of – – – 11,533 20,671 9,168 379 14,006
funds –
CPPI
Money 6,353 7,762 7,088 5,189 13,483 5,920 7,337 8,927
market
Balanced 2,289 2,334 2,538 6,955 3,493 4,822 9,516 7,843
Aggressive 725 688 1,178 2,253 2,157 3,209 1,105 796
income
Capital 724 443 1,304 2,972 3,015 1,771 244 127
protected
Index tracker – 289 901 1,176 1,159 881 1,881 1,687
Commodities – – – – – 321 457 243
Total 39,270 50,684 66,341 92,267 124,226 157,496 237,819 139,575

Source: Mutual Funds Association of Pakistan.

194 Salman Ahmed Shaikh et al.
Table 12.3 Market Share in Mutual Funds Industry – 2018

Category Conventional (%) Islamic (%)

Aggressive fixed income 91 9

Asset allocation 32 68
Balanced 35 65
Capital protected 94 6
Commodities 0 100
Equity 67 33
Fund of funds 8 92
Fund of funds – CPPI 3 97
Income 65 35
Index tracker 21 79
Money market 93 7
Voluntary Pension Schemes 36 64
Total 62 38

Source: Mutual Funds Association of Pakistan.

funds and index tracker categories, Islamic funds have a greater market
share as compared to conventional mutual funds.

12.4 Islamic microfinance in Pakistan

The share of Muslim population in global poverty pool is almost two times as
much as their share in the total global population. Conventional microfinance
involves interest which is prohibited in Islam. Non-use of financing services
due to the prohibition of interest in the Islamic faith is also another reason
why conventional microfinance reach is low in Muslim majority regions.
Like conventional microfinance, Islamic microfinance targets people
who face liquidity constraints and who are otherwise non-bankable due to
their low, unstable or unverifiable income and non-ownership of assets that
can be used as collateral. Among the populous Muslim majority countries,
most of the poor population resides in Nigeria, Bangladesh, Pakistan and
Indonesia. Along with Bangladesh, Pakistan, Nigeria and Indonesia are the
other countries where there are more than a million microfinance clients.
However, apart from Bangladesh, the outreach gap computed as the differ-
ence between the number of poor people and the existing number of microf-
inance clients exceeds 90% in Pakistan, Nigeria and Indonesia.
There are two categories of Islamic microfinance models, i.e. non-market-
based not-for-profit models and market-based for-profit models (Obaidul-
lah, 2008). The former model uses Qard-e-Hasan, Waqf and Zakāt funds
for providing financing. Market-based commercial models provide microfi-
nancing using Murabaha, Ijarah and Salam.
Qard-e-Hasan-based financing ensures that there is no additional stip-
ulated increase paid over the principal amount. Thus, it enables the bor-
rower to benefit from the loan and repay the same amount of money. This
 Islamic commercial & social finance overview 195
increases the chances of taking benefit of the loan and enabling socioeco-
nomic mobility rather than getting trapped in interest-based compounded
debt. This form of financing also protects the lender since the principal
amount of money has to be repaid. Thus, while Qard-e-Hasan provides ease
in repayment burden for the borrower, it also protects the lender from moral
hazard. Qard-e-Hasan is a useful instrument to enable the poor client to
survive and graduate to a non-poor status by providing funds which can be
utilized for personal consumption needs as well as for purchasing the raw
materials, tools and business inventory for productive enterprise.
The economics of Islamic microfinance literature shows Islamic Micro-
finance Institutions (IMFIs) benefit from the social capital derived from
Islamic values and principles. Ahmed (2002) reasons that IMFIs can reduce
high monitoring costs and moral hazard problem since Islamic modes of fi-
nancing involve a real transaction. Komi and Croson (2013) find significantly
higher compliance rates for the Islamic-compliant contracts (profit-sharing
and joint venture) than for the traditional contract (interest-based). Ashraf
et al. (2014) in an empirical study provide evidence that high religious ori-
entation is associated with financial responsibility and completion of con-
tract obligations among the clients. Samad (2014) emphasizes that IMIFs
are responsible and do not encourage clients to overburden themselves in
indebtedness. He argues that if Islamic microfinance is offered in India, the
mass suicides committed especially by the Indian farmers can be contained
to a great extent. However, institutionalizing and establishing Islamic mi-
crofinance at large scale is needed to realize the benefit of these structural
benefits and positive externalities.
An estimated 58.7 million people in Pakistan are living in multidimen-
sional poverty, mostly in rural areas (Naveed and Ali, 2012). Comparing
this figure with a number of people served with microfinance shows a
huge potential outreach gap. Table 12.4 gives facts about microfinance in
Pakistan.
Currently, only 5.5 million people are served with microfinance in Paki-
stan. The share of Islamic microfinance segment in active borrowers and
gross loan portfolio stands at 16% and 7%, respectively, in 2017 (Source:
Pakistan Microfinance Network). Table 12.5 presents the province-wise

Table 12.4 Stylized Facts about Microfinance in Pakistan

Key Indicators 2010 2011 2012 2013 2014 2015 2016 2017

Number of borrowers 1.6 1.7 2.0 2.4 2.8 3.8 4.6 5.5
(million)
Gross loan portfolio 20.2 24.8 33.1 46.6 61.1 92.9 136.9 200
(bln Rs.)
Active women borrowers 0.8 0.9 1.3 1.4 1.6 2.1 2.5 2.7
Branches 1,405 1,550 1,460 1,606 1,747 2,960 3,220 3,533

Source: Pakistan Microfinance Network.

196 Salman Ahmed Shaikh et al.
Table 12.5 Microfinance Outreach – Province Wise

Key Indicators – Province Wise Sindh Punjab Balochistan KPK

Offices – fixed 651 2,284 17 107

Offices – mobile 26 14 2 –
Active borrowers 904,892 3,449,902 5,577 97,239
Potential microfinance market 2,400,000 12,600,000 500,000 500,000
Penetration rate (%) 37.7 27.4 1.1 1.9%

Source: Pakistan Microfinance Network.

outreach statistics. It can be seen that the penetration ratio is the lowest in
two of the most underdeveloped provinces of Pakistan, i.e. Balochistan and
Khyber Pakhtoon Khwah.
One would expect Islamic finance to have a greater focus on social fi-
nance given the general level of higher incidence of poverty and since the
philosophy and theoretical basis of Islamic finance are rooted in the socio-
ethical framework of Islam. Nevertheless, Islamic finance has not been able
to translate that potential and promise into practice substantially as yet.

12.4.1 Islamic microfinance institutions and operations

The prominent organizations that provide Islamic micro-financial services
include Akhuwat, Kashf Foundation, Wasil Foundation, Islamic Relief
Pakistan, Muslim Aid Pakistan, Kawish Welfare Trust, Esaar Foundation
and Naymet Trust.
One of the recent success stories has been the Qard-e-Hasan model of
Akhuwat. This institution with humble setup and uncomplicated proce-
dures has provided financing to 3.4 million clients with a nearly 99% re-
covery rate as of May 31, 2019. Kashf Foundation is another organization
with a sizable outreach with 237,573 clients served with a staff of 2,210 as at
end-December 2016. The microcredit loan portfolio stands at Rs. 5.9 billion
($57 million) as at December 31, 2016.
Wasil Foundation provides financing using Islamic modes of financing
which enable it to generate profits on sale and lease of assets. In the re-
ported statistics for 2010, the gross loan portfolio stood at Rs. 210 million
($2.1 million) with a 91% recovery rate. Naymet Trust provides financing
using Qard-e-Hasan and Murabaha with 60% and 40% shares, respectively,
in 2016. The total assets of the trust as at June 30, 2016, stood at Rs. 22.3
million ($213,000). Total credit portfolio was recorded at Rs. 11.3 million
($107,619) with Murabaha portfolio of Rs. 4.6 million ($44,000) and Qard-e-
Hasan portfolio of Rs. 6.7 million ($64,077).
Islamic Relief is an example of an incorporated microfinance institution
in Pakistan operating since 1992 with a presence in all four provinces of
Pakistan, especially in the northern areas of Pakistan. Their microcredit
portfolio stood at Rs. 38 million ($0.36 million) as at December 31, 2014.
 Islamic commercial & social finance overview 197
The institution has helped some 11 million families over its 25-year journey
in Pakistan with various programs including rehabilitation of internally dis-
placed persons, disaster risk reduction, climate change adaptation, water
and sanitation, food security and health programs.
In the next and last section of the chapter, a brief review of the use and
contribution of Islamic redistributive institutions is provided to show that
how much vibrant these institutions are in complementing the purchasing
power of poor people to meet the basic needs in Pakistan.

12.5 Role of redistributive institutions

Besides the financial institutions, Islamic redistributive institutions also
have ample potential to achieve resource redistribution at the household
level. There are various institutions in the Islamic framework that can play
an effective role in income and wealth redistribution. Effective use of these
redistributive institutions can help in the fulfillment of basic needs for all
members of the society, especially the underprivileged poor people who face
net endowment deficiency (Zarqa 1988). The two most prominent such non-
market-based redistributive institutions include Zakāt and Waqf.

12.5.1 Institution of Zakāt in Pakistan

In Islam, Zakāt is a religious obligation to pay a portion of net wealth and
production over the amount of Nisāb to the specified heads (Al-Qur’an,
Chapter Tauba 9: 60). The specified heads of Zakāt ensure the welfare of
poor, needy and weaker segments of society as well as provide collective
funds for public welfare and social protection.
The empirical studies on welfare potential of Infāq (charity) in Pakistan
show considerable potential to alleviate poverty in Pakistan. Malik et al.
(1994) use household data and establish that Infāq (charity) has a significant
effect on reducing the poverty gap. In a cross-country study, Shirazi and
Amin (2009) estimate that Pakistan needs 1% of GDP for poverty elimina-
tion under $1.25 a day and needs 6.77% of GDP for poverty elimination un-
der $2.00 a day. Previous estimates by Kahf (1989) show that Zakāt to GDP
ratio between 1.6% and 4.4% is needed to fill the poverty gap. In another
study, Azam et al. (2014) establish that Zakāt significantly enhances the wel-
fare of households in Pakistan. Finally, Akram and Afzal (2014) argue that
Zakāt disbursement among the poor, needy, destitute, orphans and widows
has played a significant role in poverty alleviation. The results reveal an
inverse relationship between poverty and Zakāt payment in the short run as
well as in the long run.
Nevertheless, Zakāt collection at the federal and province level is very
low in Pakistan as can be seen in Figure 12.3. In the year 2015, Rs. 5.74 bil-
lion (US$54 million) Zakāt was received by the central public Zakāt agency.
Lack of trust between the government and the people is one major reason
198 Salman Ahmed Shaikh et al.

Zakāt Collection by Government

7,000
6,000
5,000
4,000
3,000
2,000
1,000
-

Zakat (mln Rs.) Linear (Zakat (mln Rs.))

Figure 12.3 Zakāt receipts (in million Rs.).

behind low Zakāt collection at the federal level in Pakistan. Due to the lim-
ited availability of Zakāt funds collected by Zakāt and Ushr department,
the scale of providing assistance to the poor is very low. The most vibrant
Zakāt and Ushr department is in Punjab province, but even that is also ca-
tering to a very limited section of poor people. For instance, through the
Sustainable Economic Empowerment Program (SEEP), annually 30,000
young people are imparted technical and vocational training. In addition to
that, scholarships to some 2,000 students are provided annually by Punjab’s
Zakāt and Ushr department. However, these programs do not sufficiently
fill the gap in the country amidst 22 million out of school children between
the ages of 6 and 15. The total Zakāt budget for 2016/17 for Punjab was
Rs. 4.15 billion ($40 million). In addition to that, the total Zakāt budget for
2016/17 for Sindh was Rs. 249 millions ($2.4 million).
Most people usually disburse Zakāt obligation privately. They also pay
Sadqāt individually to the poor people or to the organizations working for
the welfare of the poor people. According to the Pakistan Center for Philan-
thropy, the total estimated charitable giving in Pakistan stands at Rs. 300
billion ($2.8 billion) in 2015. In the provincial studies, the amount contrib-
uted in the year 2013 stood at Rs. 67.9 billion ($0.65 billion) in Sindh (Paki-
stan Center for Philanthropy, 2013). Additionally, the amount contributed
in the year 2010 stood at Rs. 103.69 billion ($1 billion) in Punjab (Pakistan
Center for Philanthropy, 2010). A recent estimate by Pakistan Peace Ini-
tiative (2017) contends that people in Pakistan pay around Rs. 554 billion
($5.31 billion) in charity every year.
To give just a glimpse of how important the third sector is in the socio-
demography of Pakistan, a few major success stories are mentioned. The
Sindh Institute of Urology and Transplantation (SIUT) is a privately
funded dialysis and kidney transplant center in Karachi. It is the country’s
 Islamic commercial & social finance overview 199
largest public sector health organization providing services free of any
cost. Shaukat Khanam Cancer Hospital and Research Center is the coun-
try’s largest cancer hospital with an annual budget of Rs. 10 billion ($96
million). The hospital was built through private donation drive in 1994.
Edhi Foundation, which originated from Karachi, holds the world record
for the “largest volunteer ambulance organization”. Indus Hospital in
Karachi provides free of cost treatment. It is a private hospital working on
donations and has treated 2.3 million patients during 2007–2016. Among
the numerous food distribution centers, Saylani Welfare Trust provides
meals twice a day to more than 50,000 people in the city of Karachi alone
free of cost.

12.5.2 Institution of Waqf in Pakistan

Waqf implies donating identified physical assets by the donor (Waqif ) for
the continuous benefit of the community or a specified group of beneficiar-
ies. A Cash Waqf is “the confinement of an amount of money by a founder(s)
and the dedication of its usufruct in perpetuity to the welfare of society”.
Donating a piece of land for construction of masjid, school or hospital is an
example of Waqf. Mutawalli or Nazir is the trustee who safeguards the asset
and ensures that the asset is used for the intended purposes and the benefits
are enjoyed by the specified beneficiaries. Table 12.6 summarizes the distinc-
tive features of Zakāt, Waqf and Sadaqah.
In history, Awqaf provided several public goods and services, such as
roads, water and sewage system. Educational institutions and hospitals
were also established using the model of Waqf (Kuran, 2001). Even in cur-
rent times, Awqaf can help in capacity building and wealth creation through
building all forms of capital including human (education and health institu-
tions and services), physical (roads and infrastructure) and financial capital
(Waqf-based microfinance and banks).

Table 12.6 Distinctive Features of Islamic Philanthropy

Zakāt Waqf Ordinary Sadaqah

• Compulsory • Voluntary • Voluntary

• Heads of Zakāt are • Beneficiaries can be • Beneficiaries can be
specified in Holy Qur’an. anyone. anyone.
• Specific financial flows. • The flow of benefits on a • Specific financial flows.
sustained basis.
• Transfer of ownership • Naturally open to • May or may not be open
to a living Muslim institutionalization due to institutionalization
is necessary. Hence, to the donation being depending on the nature
allocation and of an asset that remains and value of Sadaqah.
disbursement are usually intact or has potential
contemporaneous. to grow.
200 Salman Ahmed Shaikh et al.
The legal framework for Waqf in Pakistan allows Waqf administrations
headed by a Chief Waqf Administrator in all provinces. The Chief Waqf
Administrator exercises complete powers in all matters relating to Waqf.
In Pakistan, Waqf is mostly used in establishing mosques and maintaining
shrines and, in some cases, Muslim graveyards. In the province of Punjab,
Awqaf Department maintains a hospital and 14 dispensaries. At Data Dar-
bar hospital, Rs. 28 million ($270,000) per annum is spent on healthcare.
In the 14 dispensaries, the poor and needy patients are treated freely. In
addition to that, Sindh government owns 31 Waqf properties in the Sindh
province. In Pakistan, corporate Waqf is uncommon, except for Hamdard
Laboratories. The main reason for the dormant Waqf sector in Pakistan
owes to the negative effects of nationalization of public property during the
1970s (Malik, 1990). Table 12.7 summarizes the regulatory framework for
Waqf administration around the world including Pakistan.

12.6 Conclusion & recommendations

Islamic finance in Pakistan is penetrating steadily in different financial
sectors of Pakistan. Islamic banking market share is 15% in the overall
banking assets, and the market share of Islamic mutual funds is 38% of
the overall mutual fund industry. More than 100 Sukuk had been issued to
date, and the government of Pakistan also meets its fiscal needs by issuing
Sukuk. Nonetheless, Islamic microfinance is yet to realize its true potential,
and there is a significant need for micro-financial services so that Islamic fi-
nance could facilitate consumption smoothing for net endowment- deficient
poor people in Pakistan. Islamic redistributive institutions have poten-
tial, but their use and focus in policymaking are limited. Lack of trust be-
tween public and government has resulted in the very limited mobilization
of Zakāt funds through the official government agencies in Pakistan. In
addition to that, nationalization in the 1970s and non-standardization of
rules have resulted in lower interest in the institution of Waqf. In light of
this overview, we present following recommendations for the promotion
of Islamic finance in Pakistan including both Islamic banking and Islamic
social finance sector.

12.6.1 Policy recommendations for mainstreaming Islamic banking

• Islamic banks need to allow hassle-free account opening at banks for
self-employed technicians, small entrepreneurs, tutors, housewives and
students to increase their outreach among the general masses. Sustained
growth in branchless banking is required to allow more outreach and to
avoid the scale disadvantage in underprivileged areas.
• Given the fact that Islamic banks mobilize around 35% of their total de-
posits from customers in the form of Qard, it is important to emphasize
that they shall provide at least 20% of their non-remunerative deposits
Table 12.7 Comparison of Regulatory Framework in Regional Countries

Attributes / Malaysia Indonesia Singapore India Pakistan Bangladesh

Countries

Permanence Temporal, perpetual Temporal, perpetual Perpetual Perpetual Perpetual Perpetual

Creation Only for one-third of Permission to create. Only for one- Permission to create. Permission to create. Permission to create.
assets. Waqf-Khas Registration third of assets. Registration Registration Registration
needs Sultan’s required. Un- Registration required. Un- required. Un- required. Un-
permission. No registration not necessary, else a registration not registration not registration not
private Mutawalli. punishable. fine. punishable. punishable. punishable.
Donor Muslims and Muslims and Muslims Muslims and Muslims Muslims and
non-Muslims non-Muslims. non-Muslims non-Muslims
Individuals as well
as organizations.
Endowed assets No mention of Specification of No specification of No specification of No specification of No specification of
financial assets. immovable financial assets. financial assets. financial assets. financial assets.
and movable
assets (including
financial).
Beneficiary Family Waqf not Family Waqf not Family Waqf not Family Waqf Family Waqf not Family Waqf
recognized. recognized. recognized. recognized. recognized. recognized.
Ownership and Waqf is registered Badan Wakaf Majlis Ugama State supervises, but State supervises. State supervises.
administration under the name Indonesia does not Islam Singapura does not own or Chief But, the Chief
of the Islamic own or manage administers all manage assets. Administrator Administrator
Religious Council, the assets, but Waqf. appoints a can assume
which acts as a supervise. manager to responsibility for
proprietor. control, manage administration by
and maintain notification.
Waqf assets.
Trustee Islamic Religious Private entities can Private entities can Private entities can Chief Administrator Private entities can
Council or Majlis be a trustee. be a trustee, but be a trustee. appoints a be a trustee.
is the sole nazir or with a limited role. manager. Mosques/
trustee. shrines have
religious purposes
committee.
202 Salman Ahmed Shaikh et al.
as Qard to the small farmers. This initiative will enable them to show-
case their contribution to social development and impact the lives of
underprivileged people more directly.
• Since agriculture provides employment to more than one-third of the
people in the labor force, Islamic banks need to increase their financing
share in agriculture, which is 0.4% of their financing mix as compared
to the industrial average of 4.1% as at March 31, 2019 (Islamic Banking
Bulletin March 2019, State Bank of Pakistan).

12.6.2 Policy recommendations for scaling up Islamic social finance

• To encourage the creation of Waqf other than in dormant real estate,
private entities shall be incentivised to establish, manage and admin-
ister Waqf with the role of Chief Administrator being a monitor and
supervisor. The Chief Administrator can oversee the preservation of
Waqf assets, but the development function shall rest with independent
managers who have the authority to make decisions.
• To retain public confidence, the Chief Administrator shall not have the
right to appropriate property unless through the court of law if there is
usurpation or abuse by the trustees. Minimal intervention in the rou-
tine administration is necessary in order to encourage the private estab-
lishment of Waqf on the demand side and for financial institutions and
corporations to offer wealth management services, especially in Cash
Waqf, on the supply side.
• The contributions to these Waqf by individual and corporate donors
shall be made eligible for tax credit like it is the case with other recog-
nized institutions in Section 61 of the Income Tax Ordinance 2001.
• If a donor dedicates real estate to an existing Waqf or establishes a new
Waqf, the taxes related to registration and transfer of property shall be
exempted.
• There should be a balance between development and preservation. To
encourage private participation, there should be flexibility in the use of
Waqf assets for investment in the form of leasing and financial invest-
ments. Furthermore, it is important to have risk management guide-
lines to ensure the preservation of Waqf assets.
• Provisions should be added in the existing laws regarding ‘ibdāl’ (ex-
change) and ‘istibdāl’ (substitution) of Waqf assets in order to revive
the old Waqf assets, revitalize the existing ones and ensure sustainable
existence and utility of Waqf assets.

12.6.3 Policy recommendations for financing social

development by IFIs
• Islamic banks can facilitate the development of old Waqf assets by way
of diminishing Musharakah, Sale and Leaseback and Istisnā in order to
 Islamic commercial & social finance overview 203
rebuild and renovate Waqf property for improved post-financing valua-
tion as commercial buildings.
• Microenterprise Waqf can be established by Islamic banks to mobilize peo-
ple’s social savings in the form of Cash Waqf donations and then disburse
these funds to the poor micro-entrepreneurs in the form of Qard-e-Hasan.
Initially, these funds can be disbursed to shortlisted projects approved by
business incubations centers at top business schools in the country.
• Family Waqf shall also be recognized in the law and can be offered by
financial institutions, providing private wealth management services,
such as by Takaful companies.
• Islamic banks like other banks collect donations for hospitals and ed-
ucational institutions. Such institutions can mobilize funds through
Cash Waqf, and the Islamic banks can become the collection, payment
and investment agents. If a special tax credit is allowed to those who
donate to Cash Waqf through banks, it will help in financial inclusion
and documenting the philanthropic third sector activities.
• The government can mobilize the funds through Cash Waqf for the
shortfall in the annual Public Sector Development Program (PSDP) by
engaging Islamic banks as the collecting agent to gain wide public par-
ticipation and engagement.
• Waqf-based IMFIs can be established where the seed capital can be
mobilized through Cash Waqf. Islamic banks can use their existing re-
sources, capacity and infrastructure to integrate financially excluded
micro-borrowers into the financial system through this mechanism.

12.6.4 Policy recommendations for central bank for

financial inclusion
• State Bank shall subsidize the financing cost of building and renovating
old Waqf assets by employing Islamic banks for financing the building
and renovation cost. The subsidy in financing cost will pay off in terms
of post-financing valuation of Waqf property as commercial buildings.
Malaysia has successfully used Waqf for building commercial malls and
hotels, such as Pantai Puteri (Malacca), Regency Seri Warisan (Perak),
Grand Puteri (Terengganu) and Klana Beach Resort (Negeri Sembilan).
Such activity will increase employment in the construction sector which
is interlinked with many other sectors.
• Since the contributors in Cash Waqf do not have commercial motives
and repayment expectations from the financial institution, the State
Bank shall allow opening microenterprise Waqf-based credit subsidi-
aries under Islamic banks with a reduced minimum paid up capital of
Rs. 100 million instead of Rs. 300 million which is the lowest paid-up
capital requirement for district-wide microfinance banks at the moment.
• In using the Family Waqf model, a special account for family members
shall be allowed to be offered in banks in which the deposit will be kept
204 Salman Ahmed Shaikh et al.
in safe custody by the bank and only withdrawable by nominated family
members after a certain time lapse. As an investment agent, the Islamic
bank would be allowed to use and invest these funds and be paid a fee
for this service. For providing further incentive, Takaful coverage can
also be offered simultaneously. This will help in financially including
those individuals who save their money at home or in Bisee system (a
kind of forced savings plan without any return) for the future needs of
their family members.
• Agency fee income for managing payments and disbursements related
to Cash Waqf shall be exempted or charged a reduced tax rate in order
to route charitable spending through banks.
• State Bank shall allow and promote impact investing accounts where
the donors will open a non-checking Cash Waqf-Am (General) account
in which the proceeds will be invested by the bank and any returns on
investments will top up the amount in Cash Waqf. The bank’s fees will
be proportionate to the returns generated. Periodic disbursements from
the Cash Waqf account will be credited to the identified welfare institu-
tions. The float money will provide liquidity to the bank and financial
system. Routing payment inflows and outflows through banks will pro-
vide transparency to the individual donor.
• Since Waqf-based IMFIs have donor clients which do not have the pri-
mary motive of impact rather than profits, State Bank shall devise flexi-
ble rules regarding debt burden ratio, collateral and percent of financing
allowed as a ratio of existing capital held by the micro-entrepreneur in
the prudential and risk management guidelines.

References
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13 Translation of economic verses
by Shaykh-ul-Islam Muhammad
Tahir-ul-Qadri in the light of
translation studies
Comparison with other
translators
Shair Ali Khan

13.1 Introduction
Text transfer is a material movement as Anthony Pym mentioned (2010:13–14),
considering translation a ‘semiotic activity’ which can represent and misrepre-
sent its materiality. According to Pym, the complexity between the material and
semiotic levels passes through various theoretical registers from culture to cul-
ture changes. This change, surely, has lasting effect on the target readers. Trans-
lation is the most difficult complex and serious text transferring activity. It needs
full commands and high degree of bilingual competencies. Translation does not
mean to deliver the meaning of the source text but it means to capture the linguis-
tic, rhetorical, cultural and suprasegmental features. This text transfer activity
becomes the most serious and dangerous while transferring the sacred word of
God. Because God is beyond human faculty, due to which God selected His
messengers to inculcate His divine deep-structured words to the human faculty.
Every word of God is of great significance in terms of containing various kinds
of meanings which the human intellectual cannot convert into other languages
with the same rhetorical, linguistic and cultural backgrounds. Translation stud-
ies opened new horizons in the field of translation by introducing new theories,
applying new principles and practicing (Nida & Taber, 1969) various types of
translation strategies in a diversity of text types (Reiss, 1977). Quran translation
is one of the complex and challenging fields of translation studies because it is the
only book in the actual words of Allah. Quran is miraculous, and no such book
can be produced by all the genius, intellectual and wise human; similarly, it is
miraculous in its translation, and according to accepted views of scholars “the
word of God cannot be translated by the word of human” (Hussain Abdulrauf).

13.2 Objectives of the study

The study aims at elaborating the translational strategies used by Dr Tahir-ul-
Qadri in his translation in comparison with the translations of three renowned
legendary translators of Quran. They are Muhamad Asad, M. Pickthall and
 Translation of economic verses 207
Abdullah Yousaf Ali. It, as well, aims to analyze the structural level of both
source language and target language, the level equivalence in terms of termi-
nologies specifically of economic nature.

13.3 Limitation of the study

The study is limited to the verses containing economic data. Five verses
of economic dealings have been selected randomly. The translations of
Dr Tahir-ul-Qadri along with three other renowned translators, i.e. Pick-
thall, Muhamad Asad and Abudllah Yousaf Ali, were selected.

13.4 Theoretical frame of the study

Theoretically, the study has applied the shifts of Catford (1965:73), i.e. level
shifts and category shifts and the translation strategies by Viney-Darbelnet
(Venuti 2000:84), Lawrence Venuti and Newmark (Newmark 1998:68–91).

13.5 Methodology
The study is descriptive and analytical in nature. For counting the words of
verses, manual method has been applied, and for the translated words of the
verses, the word count of Microsoft Word has been used.

13.6 Quran translation

The Quran is the ultimate source of guidance in all spheres of life. Econ-
omy is the power in the current world which is used by the big powers for
terrible games with the poor communities. Since the time of Pharaoh till
day the wealth is the source of ruling over the world. The Quran, looking to
its critical role in human life, mentioned the wealth as ‘qiyaam’ (Nisa 4:5).
The translation of the Quran is the most challenging task as compared to
the translation of other religious texts as it is, by intention, extraordinarily
structured to make it distinguished from the literary creation of human fac-
ulties. A slight deviation from the intended meaning of Allah, surely, dam-
ages the true sense of the Quran.
Scholars of high faculty tried, since its revelation, to transfer the message
and meaning of Quran for the purpose of preaching and communication. So
the companions of Prophet Muhammad (PBUH) who were sent to the kings
and leaders applied the communicative approach of translation to convey
the divine and prophetic messages.
The blessed and rewarded personalities tried to convert this text into
other languages using their linguistic competencies and proficiencies. They
rendered it by utilizing a range of translational strategies, principles and
methods.
208 Shair Ali Khan
13.6.1 Quran translation of economic verses
Economy is the backbone of human progress. Conveying a clear concept of
divine economic principles in target translation is essential and of great im-
portance in today’s human trans-culturalism and multi-socialism. Quran
presented the principles and rules of economic justice, the use of wealth
and dealings relating to trade and transactions. All these divine concepts
need to be translated clearly with the same linguistic, rhetorical, aesthetic
and spiritual senses.

13.6.2 Translational and linguistic analysis of economic verses

Example No. 1: Chapter 59: Verse 7

‫َي َل يَ ُكونَ دُولَةً بَيْنَ ْالَ ْغنِيَا ِء ِمن ُك ْم‬

ْ ‫ك‬
No. Translators Translations Analysis

1 Dr Mohammad This distribution The key singular word

Tahir-ul-Qadri system is to ensure “doolatan” occurred as
https://www. that (the whole noun of the copula verb
islamawakened.com/ wealth) may not has been shifted to
quran/59/7/default. circulate (only) single verb “circulate”
htm amongst the rich with mentioning the
of you (but should hidden and pre-
circulate amongst mentioned subject
all the classes of of the copula verb
society). at the beginning of
the sentence and the
additional linguistic
contents to domesticate
the Arabic sentence for
target readers.
The word “aghniya”
has been translated
semantically with
“rich”.
M. M. Pickthall That it become not a The singular noun
http://www.islam101. commodity between has been translated
com/quran/QTP/ the rich among you. with a single noun
QTP059.htm “commodity”, the style
https://www. is of old English, and
islamawakened.com/ type of translation is
quran/59/7/default. literal. No translation
htm strategy has been
applied.
The word “aghniya”
has been translated
semantically with
“rich”. Formal
equivalence is found.
 Translation of economic verses 209
No. Translators Translations Analysis

Muhammad Asad So that it may not be [a The key singular word

benefit] going round “doolatan” has been
and round among translated with a
such of you as may phrasal verb with
[already] be rich. four words, with two
additional words to
sublime the translation
according to the
Arabic text.
The word “aghniya”
has been translated
semantically with
“rich”.
Yusuf Ali (Saudi Rev. In order that it may The key word has been
1985) http://www. not (merely) make a translated with verbal
islam101.com/quran/ circuit between the phrase of three words
yusufAli/QURAN/ wealthy among you. “make a circuit”.
59.htm The word “aghniya” has
https://www. been translated lexically
islamawakened.com/ with “wealthy”.
quran/59/7/default.htm

Analysis
According to the science of translation studies Dr Qadri has applied the
strategy of shift (category shift), the strategy of annotation (explanation of
related meanings) and the strategy of addition to convey the hidden interre-
lated linguistic features in his translation for the target readers applying the
literal approach of translation. Whereas Pickthal did not apply any trans-
lation strategy with a formal equivalence at sentence level remaining close
to the sentence structure of the Quran producing semantic translation. Mu-
hammad Asad as well applied the strategy of shift (category shift) and ad-
dition and communicative. Yousaf Ali applied the strategy of addition only
along with literal type of translation keeping in view the source sentence
structure.

V.No.1 Translator Strategies No Verse Translated

Words Words

Dr Tahir ul Shift 5 8 28
Qadri Annotation
Addition
Literal translation
Formal equivalence at
sentence level
Pickthal Semantic translation 2 8 11
Formal equivalence

(Continued)
210 Shair Ali Khan
V.No.1 Translator Strategies No Verse Translated
Words Words

Asad Shift 3 8 21
Addition
Communicative
translation
Ali Addition 3 8 15
Literal translation
Formal equivalence

Example No. 2

(276-‫ار أَثِيم )بقرة‬ َّ ‫ت َو‬

ٍ َّ‫للاُ َل ي ُِحبُّ ُك َّل َكف‬ ِ ‫ص َدقَا‬ َّ ‫ق‬
َّ ‫للاُ الرِّ بَا َويُرْ بِي ال‬ ُ ‫يَ ْم َح‬
S. Translator Translation Strategies
No.

Dr Mohammad Allah eliminates usury (i.e., deprives Two explanation

Tahir-ul- usurious profits of prosperous strategies,
Qadri growth) and multiplies alms gifts Sentence/formal
(i.e., increases blessings of clean equivalence:
wealth manifold through charity Present sentence
donations). And Allah does not Semantic translation:
like anyone who is ungrateful and Eliminate: semantic
disobedient. features.
M. M. Pickthall Allah hath blighted usury and made Semantic translation:
almsgiving fruitful. Allah loveth Blight contains the
not the impious and guilty. semantic features
covering Quranic
meaning.
Perfect tense,
no sentence
equivalence
Muhammad God deprives usurious gains of all Formal equivalence
Asad blessing, whereas He blesses Communicative
charitable deeds with manifold translation
increase. And God does not love
anyone who is stubbornly ingrate
and persists in sinful ways.
Yusuf Ali Allah will deprive usury of all Formal equivalence
(Saudi Rev. blessing, but will give increase for Communicative
1985) deeds of charity: For He loveth not translation
creatures ungrateful and wicked.

Analysis
The verse contains two economical terminologies (‫ )الربا و الصدقات‬in objective
case preceding two verbs of present and future features (‫)يمحق و يربي‬. Dr Qadri
and Pickthall translated the first verb with single equivalent verbs “elimi-
nates” and “blighted”, the first term with “usury”, whereas the other two
translators explained the meaning of the Arabic first verb. Asad translated
the first term with explanatory words, whereas Ali translated with one word
 Translation of economic verses 211
as Dr Qadri and Pickthall have done. Dr Qadri translated the second verb
“‫ ”يربي‬with one verb “multiplies”, Pickthall used two words “made fruitful”,
Asad used four words “blesses with manifold increase” and Ali used two
words “give increase”. Dr Qadri and Asad used present indefinite tense
whereas Pickthall used present perfect tense and Ali used future tense. Dr
Qadri used strategy of explanation and addition in brackets inside the text to
remove the ambiguity from the verbs that contain connotative religious and
spiritual meanings. Dr Qadri and Pickthall focused on the semantic aspect of
the verbs, whereas the other two translators focused on the explanatory as-
pect of the verbs and terms.

V.No.2 Translator Strategies No of Verse Translated

Strategies Counts Words

Dr Tahir ul Explanation 3 13 34
Qadri Formal
equivalence
Semantic
translation
Pickthall Semantic 1 13 15
translation
Asad Formal 2 13 30
equivalence
Communicative
translation
Ali Formal 2 13 23
equivalence
Communicative
translation

Example No. 3

(188-‫ال ْث ِم َوأَنتُ ْم تَ ْعلَ ُمونَ )بقرة‬

ِ ْ ِ‫اس ب‬ ِ ‫اط ِل َوتُ ْدلُوا بِهَا إِلَى ْال ُح َّك ِام لِتَأْ ُكلُوا فَ ِريقًا ِّم ْن أَ ْم َو‬
ِ َّ‫ال الن‬ ِ َ‫َو َل تَأْ ُكلُوا أَ ْم َوالَ ُكم بَ ْينَ ُكم بِ ْالب‬
S. No. Translator Translation Strategies

Dr Mohammad And do not eat up one another’s wealth Addition

Tahir-ul-Qadri amongst yourselves through injustice, Literal translation
nor take wealth to the authorities (as a Shift of meaning: specific
bribe) so that, this way, you may (also) ‘hukkam’ to general:
swallow a portion of others’ wealth authorities
unfairly, whilst you are aware (that Formal equivalence
this is a sin).
M. M. Pickthall And eat not up your property among Semantic translation
yourselves in vanity, nor seek by it to Shift of meaning: general
gain the hearing of the judges that ye ‘hukkam’ to specific:
may knowingly devour a portion of judges
the property of others wrongfully.
S. No. Translator Translation Strategies
212 Shair Ali Khan

Muhammad AND DEVOUR NOT one another’s Communicative

Asad possessions wrongfully, and neither translation
employ legal artifices with a view to Shift of meaning: general
devouring sinfully, and knowingly, ‘hukkam’ to ‘legal
anything that by right belongs to artifices’ specific
others.
Yusuf Ali (Saudi And do not eat up your property among Addition
Rev. 1985) yourselves for vanities, nor use it as Semantic translation
bait for the judges, with intent that ye Shift of meaning :
may eat up wrongfully and knowingly ‘hukkam’ as ‘judges’
a little of (other) people’s property.

Analysis
The verse discusses economic dealings with one another in a social set up. The
key words are ‘eat up, devour, swallow’, ‘wealth or property or possessions’
and ‘authorities, judges and legal artifices’. These words are open for various
interpretations due to their ambiguous nature. Three translators use the word
‘eat up’ for the first verb, whereas one of them used the word ‘devour’ for the
word ‘‫’أموال‬. Dr Qadri used the world ‘wealth’, two translators used the word
‘property’ and one used the word ‘possession’. The verbs ‘eat up or devour’
with ‘property’ and ‘possession’ are not familiar as these cannot be eaten. But
the word ‘wealth’ has a semiotic relation with eating because wealth is the
source of all the edibles. Dr Qadri’s translation tries to familiarize the word of
God to the general public by selecting a semantically acceptable word. The
translation of “‫ ”الحكام‬is as well open to various interpretations. Dr Qadri trans-
lated it as “authorities”, two translators translated as “judges” and one of them
translated as “legal artifices”. The word ‘judges’ is specific but used by some
exegetes such as Qushairi,1 Ibni Abbas,2 Jalalain,3 while the word ‘authorities’
is more comprehensive and used in exegeses such as Kashani4 that covers all
sorts of judgments issued by the tribal and communal systems in various soci-
eties and cultures.

V.No.3 Translator Strategies No of Verse Translated

Strategies Counts Counts

Dr Tahir ul Addition 4 26 44
Qadri Literal translation
Shift of meaning
Formal equivalence
Pickthall Semantic translation 2 26 34
Shift of meaning
Asad Communicative 2 26 27
translation
Shift of meaning
Ali Addition 2 26 35
Semantic translation
Shift of meaning
 Translation of economic verses 213
Example No. 4

ِ َ‫يَ ا أَيُّ هَ ا الَّ ِذينَ آ َم نُ وا َل تَأْ ُك لُ وا أَ ْم َوالَ ُك م بَ ْي نَ ُك م بِ ْال ب‬

ٍ ‫اط ِل إِ َّل أَن تَ ُك ونَ تِ َج ا َرةً َع ن تَ َر‬
‫اض ِّم ن ُك ْم َو َل تَ ْق تُ لُ وا‬
(29-‫للاَ َك انَ بِ ُك ْم َر ِح ي ًم ا )نساء‬ َّ ‫أَن فُ َس ُك ْم إِ َّن‬

Dr Mohammad O believers! Do not devour one Class Shift:

Tahir-ul- another’s wealth unlawfully translation
Qadri amongst yourselves unless it is a of vocative
trade by your mutual agreement sentence with
and do not kill yourselves. one noun.
Surely, Allah is Kind to you. Literal translation
Adaptation: Allah
M. M. O ye who believe! Squander not Literal translation
Pickthall your wealth among yourselves Adaptation: Allah
in vanity, except it be a trade by
mutual consent, and kill not one
another.
Lo! Allah is ever Merciful unto you.
Muhammad O YOU who have attained to faith! Literal translation
Asad Do not devour one another’s Shift of sentence:
possessions wrongfully – not even vocative past
by way of trade based on mutual indefinite into
agreement – and do not destroy present prefect
one another: for, behold, God
is indeed a dispenser of grace
unto you!
Yusuf Ali O ye who believe! Eat not up your Literal translation
(Saudi Rev. property among yourselves Addition strategy
1985) in vanities: But let there be Adaptation: Allah
amongst you Traffic and trade
by mutual good-will: Nor kill (or
destroy) yourselves: for verily
Allah hath been to you Most
Merciful!

Analysis
The verse contains key concepts of economic dealings in Quranic specific
terms such as “‫”الباطل تراض و تجارة وأموال‬. All these terms contain, in their
semiotic dress, rules and principles of Islamic economics. In addition to
these terms, it contains vocative expression, proverbial expression in neg-
ative imperative forms which need to be translated carefully. From trans-
lational point of view Dr Qadri used the strategy of shift while translating
the first vocative phrase. He used the strategy of adaptation in translat-
ing the word of dignity “Allah” and a literal method for translating
the proverbial expression. Pickthall and Ali translated the vocative
phrase in literal method, whereas Asad translated the vocative past indef-
inite into present prefect form in a literal method which is a shift of
category. Pickthall and Ali adapted the Arabic word “Allah”. Pickthall
and Ali adopted the literal method keeping in view the structure of
214 Shair Ali Khan
Quranic sentence, whereas Dr Qadri and Asad adopted the structure of
target language in order to make the translation faithful but they both
translated the proverbial expression in literal method.

V.No.4 Translator Strategies No of Verse Translated

Strategies Counts Counts

Dr Tahir ul Class Shift 3 29 31

Qadri Literal translation
Adaptation: Allah
Pickthal Literal translation 2 29 32
Adaptation
Asad Literal translation 2 29 43
Shift of sentence
Ali Literal translation 3 29 39
Addition strategy
Adaptation

Example No. 5

(35 ‫يل )بني إسرائيل‬ َ ِ‫اس ْال ُم ْستَقِ ِيم ٰ َذل‬

ً ‫ك َخ ْي ٌر َوأَحْ َسنُ تَأْ ِو‬ ِ َ‫َوأَوْ فُوا ْال َك ْي َل إِ َذا ِك ْلتُ ْم َو ِزنُوا بِ ْالقِ ْسط‬
Dr Mohammad And measure in full whenever Strategy of addition
Tahir-ul-Qadri you measure out (anything), Strategy of
and (when you weigh anything) explanation
weigh with a straight balance. Modulation
This (honesty) is better, and Communicative
much better with regard to its translation
consequence (as well).
M. M. Pickthall Fill the measure when ye measure, Semantic
and weigh with a right balance; translation
that is meet, and better in the Formal equivalence
end.
Muhammad And give full measure whenever Strategy of addition
Asad you measure, and weigh with a Class Shift:
balance that is true: this will be translating noun
[for your own] good, and best in a sentence
in the end. Faithful translation
Yusuf Ali (Saudi Give full measure when ye Class Shift: single
Rev. 1985) measure, and weigh with a noun with a
balance that is straight: that sentence
is the most fitting and the Strategy of
most advantageous in the final explanation
determination. Communicative
translation
 Translation of economic verses 215
Analysis
The verse contains very important economic and trade dealings that have
far effects on the social life. The worthy translators tried their best to con-
vey the true sense of God’s message. They applied various translational
strategies for this purpose. Dr. Qadri and Asad applied the strategies of
addition within the holy text to remove the ambiguity and make the text
cohesive and coherent, whereas Asad and Ali both applied the strategy of
category (class) shift. Along with that Dr Qadri and Ali applied the strat-
egy of explanation. Pickthall kept in consideration the sentence level of the
source text while translating, where Dr Qadri, on the other hand, applied
the strategy of modulation in translating the first imperative verb and ob-
ject where he converted the object “‫ ”الكيل‬as verb “measure” and the verb
“‫ ”اوفوا‬as prepositional phrase “in full”. Dr Qadri used the strategy of ex-
planation as the word “‫ ”تأويل‬in many words “with regard to its consequence
(as well)”. Ali’s example of explanations is ‘most advantageous in the final
determination’. The translation of Pickthal and Asad is economical in
words, whereas Dr Qadri and Ali’s translations are less economical.
Grammatically Dr Qadri, Pickthall and Asad used the cohesive devices to
make the text coherent inside the text. Dr Qadri used the punctuation mark
‘full stop’ at the end of two consecutive commands, de-connecting the follow-
ing sentence and used the strategy of addition by adding the word ‘honesty’
putting an abstract noun in brackets for the actions of weighing, whereas Pick-
thall used semicolon (;) for connecting the following sentence with the previous
two commands. Asad and Ali both used colon (:) for showing the connection
between the commanding sentences and the resulting sentence (Figure 13.1).

V.No. 5 Translator Strategies No of Verse Translated

Strategies Counts Counts

Dr Tahir ul Strategy of addition 3 14 33

Qadri Strategy of
explanation
Modulation
Communicative
translation
Pickthal Semantic translation 2 14 20
Formal equivalence
Asad Strategy of addition 3 14 27
Class Shift
Faithful translation
Ali Class Shift 2 14 27
Communicative
translation
216 Shair Ali Khan
13.6.3 Translational strategies/methods analysis

No. Translators Total Used Total Verse Translated Count

Strategies Count

1 Muhammad 18 90 170
Tahir ul Qadri
2 Muhammad 9 90 112
Marmaduk
Pickthal
3 Muhammad 12 90 148
Asad
4 Abdullah Yousaf 12 90 139
Ali

Translational Strategies and translated words

for 90 Quranic words
strategies words

170
148 139
112

18 9 12 12

Dr Qadri Pickthal Asad Ali

Figure 13.1 Translational strategies and translated words for 90 Quranic words.

13.7 Conclusion
The Quran is the word of God, full of literary and linguistic sciences. The
translator spent their full faculty to transfer this linguistic and literary
treasure into the world languages. During their translating activity they ap-
plied various kinds of strategies to translate the text and transfer the words
with their semiotic feature faithfully. The discussion can be concluded in the
following points:

Findings
• All the four translators used various kinds of strategies in their
translation.
• They used the strategies of addition within the holy text to remove the
ambiguity and make the text comprehendible for the common readers.
 Translation of economic verses 217
• They have produced literal, semantic and faithful types of translations.
• They have applied the strategy of adaption for the words which need to
be adapted because the semantic meaning of the adapted word cannot
be rendered.
• Some of the translators applied the strategies of shifts of category and
level.
• The strategy of modulation is as well observed in the selected examples.
• The strategies are found in the translation of the verses.

Final Remarks
• Dr Qadri translations contain more translational strategies than other
translations including the strategies of addition, modulation, shifts and
explanation to remove the ambiguity from the text in order to familiar-
ize it to the general public. Sometime Dr Qadri adopted literal method
of transition but most of the time he remains faithful in his rendering by
using cohesive devices. Dr Qadri served his full faculty to convert the
word of God: the most complex text of the world that is why his trans-
lation is less economical.
• Pickthall translation is an example of keeping full consideration of sen-
tence structure of Quran. It, sometimes, forms very literal type of trans-
lation due to remaining close to the Quranic structure. He used the
punctuation markers as cohesive devices for streamlining the meaning of
the Quran. His translation is very much economical.
• Muhamamd Asad translation is as well economical but he sometimes uses
strategies to make the text coherent. He used the strategies of addition, ex-
planation and shifts. He sometimes adopts a semantic style of translation.
• Abdullah Yousaf Ali as well used strategies for removing the ambigui-
ties from the text and making it cohesive and coherent. His translation
is less economical in words. He used the strategies of shifts, addition,
explanation, adaptation and literal translation.

Notes
1 w w w. a lt a fs i r.c o m / Ta fa s i r. a s p? t M a d h No=3& tTa fs i rNo=10 8 & t S o r a
No=2&tAyahNo=188&tDisplay=yes&UserProfile=0&LanguageId=2
2 w w w. a l t a f s i r. c o m / Ta f a s i r. a s p? t M a d h No =2 & t Ta f s i rNo =73 & t S o r a
No=2&tAyahNo=188&tDisplay=yes&UserProfile=0&LanguageId=2
3 w w w. a l t a f s i r. c o m / Ta f a s i r. a s p? t M a d h N o =1& t Ta f s i rN o =74 & t S o r a
No=2&tAyahNo=188&tDisplay=yes&UserProfile=0&LanguageId=2
4 w w w. a lt a fs i r.c o m / Ta fa s i r. a s p? t M a d h No=2 & tTa fs i rNo=107& t S o r a
No=2&tAyahNo=188&tDisplay=yes&UserProfile=0&LanguageId=2

References
Asad, M. 1980. The Message. Dar ul Andalus: Gibralarter.
Ali, Y. 1983. The Holy Quran: The Translation and Commentary. Beirut: Dar
AI- Arabia.
218 Shair Ali Khan
Catford, J.C. 1965. A Linguistic Theory of Translation. London: Oxford University
Press.
Islamawakened.com
Example 1: https://www.islamawakened.com/quran/59/7/default.htm
Example 2: https://www.islamawakened.com/quran/2/276/default.htm
Example 3: https://www.islamawakened.com/quran/2/188/default.htm
Example 4: https://www.islamawakened.com/quran/4/29/default.htm
Example 5: https://www.islamawakened.com/quran/17/35/default.htm
Newmark, P. 1998. A Text book of Translation. London: Printice Hall.
Nida, E.A., & Taber, C.R. 1969. The Theory and Practice of Translation. Leiden: E.
J. Brill.
Pym, A. 2010. Translation and Text Transfer: An Essay on the Principles of Intercul-
tural Communication. Tarragona: Intercultural Studies Group.
Qadri, Mohammad Tahir ul. 2012. The Glorious Quran. Online Link: http://www.
irfan-ul-quran.com/quran/english/index.html
Reiss, K. 1977. Text Types, Translation Types and Translation Assessment, trans-
lated by A. Chesterman, ed. (1989), in Readings in Translation Theory, pp. 105–15.
Helsinki: Finn Lectura.
Venuti, L. 2000. Translation Studies Reader. London: Routledge.
14 Drawing inferences from Ali ibn
Abi Talib’s Teachings on social
and collective responsibility for
a fair and just economy
Najam Abbas

14.1 Introduction

14.1.1 Ali ibn Abi Talib’s teachings for a just economic conduct of
the government
There are several reasons to focus on Ali ibn Abi Talib and his reign as the
last among the four rightly guided caliphs. Ali was the closest male member
among all the Prophet’s relatives as cousin and as a reminder of support
the Prophet received from his uncle and Ali’s father Abu Talib. Ali’s five
years as the caliph (r. 35–40/656–660) marked a crucial transition phase in
economic and social dynamics of that time. That is why a close examination
of Ali’s vision about how economic affairs ought to run in the society, how
he assumed the role of a spiritual leader and exercised his authority, and
his words comes in a mentor’s voice when issuing instruction and entailing
correction of the waywardly.1
When looking for Ali ibn Abi Talib’s teachings for a just economic con-
duct of government, it is important to see how Ali ibn Abi Talib perceived
the causes of poverty. He noted three major flaws, namely, absence of free-
dom, equal opportunity and fair access to resources which creates both pov-
erty and disparity. Ali ibn Abi Talib pursued genuine justice, fair and equal
distribution since for him the objective of rule was the pursuit and promo-
tion of justice. Hence, he viewed deprivation and disparity as injustice.
The chapter shows how – in his guidance about the ideal conduct of the
Islamic government concerning economic matters through his theoreti-
cal elaborations, specific advice and practical actions – Ali ibn Abi Talib
teaches us to look at poverty in a comprehensive and holistic manner to
address its broad multifold dimensions encompassing economy, polity and
society. That is why we find Ali ibn Abi Talib pursuing a three-track ap-
proach consisting of (1) persuading the people through rhetorical appeals
and persuasion to encourage positive practices in society at large, combined
with (2) attempts to set ethical standards for senior state administrators to
follow, backed by (3) practical measures to curb negative traits and tenden-
cies among public officials to ensure they do not deviate from their social
and collective responsibilities.
220 Najam Abbas
14.1.1.1 Vision of value-based governance
This chapter highlights how Ali ibn Abi Talib’s deliberations show a clear
commitment to comprehensive justice. Ali ibn Abi Talib not only ad-
dressed the symptoms of injustice but treated their roots as part of an all-
encompassing effort covering legal, social as well as economic aspects of life.
This analysis of Ali ibn Abi Talib’s vision and action will cover several
important aspects: (1) the standards Ali ibn Abi Talib wished for his au-
thorities to meet; (2) the reforms Ali ibn Abi Talib proposed for the ruling
authorities; and (3) the qualities, objectives and values he required of his
officials to help enable the delivery of economic justice.

14.1.2 The tools Ali ibn Abi Talib devised for addressing
economic injustice
With the intention of providing guidance about the rights of the ruler and
the ruled over, Ali ibn Abi Talib put forward the guidance for reforming
the individuals, instruments and institutions of administration along with
laying down a code for ethical practices and professional conduct for all
members of society.
This chapter explains that Ali ibn Abi Talib not only provided theoretical
policies but also spelled out measures for their practical implementation.
Ali ibn Abi Talib observed that tax collectors and revenue administrators
tend to pursue a short-term approach for fulfilling immediate needs for
quick gains. He instead encouraged them to depart from such a practice
and broaden their perspectives to consider long-term gains which can be
accrued by applying taxes more considerately in order to contribute towards
much wider economic gains. In this manner he helped the treasury officials
to get their overall perspective rights. He attempted to shift the prevalent
approach from a narrow focus on revenue collection to a wide-ranging vi-
sion for growth, development and collective progress.
Concrete guidelines were provided concerning all fiscal and economic
matters and appropriate mechanisms to address them. The practice of not
withholding public money implied that it was disbursed when the need arose
and not held back to enrich the state. Ali ibn Abi Talib set up a clear frame-
work for a just and fair economy by promoting a sense of trusteeship to treat
natural resources as a responsibility for the larger and lasting interests of
not only present but also future generations.

14.1.2.1 Muslims’ public treasury: approaches for raising

state revenues
For Ali ibn Abi Talib the collection of tax revenues was a means rather than
an end. He was very clear that the priority was not raising funds but ensur-
ing the overall well-being of the larger Muslim community.
 Drawing inferences from Talib’s Teachings 221
14.1.2.2 Promoting positive practice in the market
This chapter also discusses how Ali ibn Abi Talib took practical measures
to ensure fair practice in the market (not as a one-off step but as a regular
exercise). This reflects the significance and the priority he attached to a fair
and just running of the market as something which touches the lives of the
common people on a daily basis. His direct interaction and close contact
with the people was aimed to encourage them to deal fairly. His regular
check-up visits to Kufa’s markets too served as a reminder of the sense of
ethical and moral accountability present and alive in the society generally
and among the traders specifically.

14.2 Review of selected literature on Ali ibn Abi Talib’s teachings

about justice through approach, attitude and action
In recent years, contemporary scholars of Islamic economics and Islam’s
distributive justice are drawing pertinent guidance from the primary sources
such as Nahj al-Balagha (in Arabic, Farsi and English). Furthermore, sec-
ondary sources comprising of contemporary publications published from
Iran, Iraq and Lebanon offer a more contemporary rendering of what in-
ferences could possibly be drawn from Ali ibn Abi Talib’s sermons, letters
and axioms.
In addition to guidance directed at government functionaries, Ali ibn
Abi Talib also issues instructions to individuals through his sermons and
advice to the common man. The overall purpose was to improve the mind-
set, inculcate correct attitudes, as well as to cultivate a purpose-driven and
principle-led way of life for members of the community both individually
and collectively. Taken together, these teachings encourage people to uphold
and exercise justice in a just and responsible manner. In both his speech and
conduct, Ali ibn Abi Talib paid due attention to the importance of economic
production and has set his own example as one of the active participants in
economic activities: encouraging others to take full advantage of available
opportunities, putting skills to productive purposes, donating wealth to the
poor and using resources to serve the Muslim community.
In his doctoral thesis Depiction of Ali in Jahiz’s works, Adrian J De Gi-
fis notes, ‘Alī’s eloquence is characterized by lucidity, concision and moral
intention. As a historical phenomenon, ancient wisdom designates a distinc-
tive cultural tradition and intellectual activity in the history of the Middle
East. One set of his sayings appeals to reason and conscience, and others
cater to the followers’ desire for knowledge and understanding. This is ev-
ident in varying forms found in Ali ibn Abi Talib’s sayings, whose primary
objective was to educate using the sentence, wise saying or proverb; the ad-
monitory precept; or maxim and meditative advice.2
Most of Ali ibn Abi Talib’s sayings which were later collected in writing
form have in common the theme of wisdom as a distinct virtue of life and
222 Najam Abbas
thought employing a characteristic vocabulary. Prominent among his prin-
ciple methods of teaching are instruction and counsel or persuasion.
As a crucial component of preaching, eloquence has the power to per-
suade its audience tacitly. Since brilliant exposition delivered in a beautiful
language can prove quite effective, hence, Ali ibn Abi Talib “attempted to stir
the hearts and minds of his audience with his verbal artistry, rhythmically
compounding his lessons in cadenced parallelisms and vivid metaphors”.3
Ali ibn Abi Talib’s sayings are often marked by alliteration or assonance
and are made memorable by vivid imagery or witty expression. It is noted by
Walter Ong that in an oral culture verbal expression is mnemonic. “In a pri-
mary oral culture, to solve the problem of retaining and retrieving carefully
articulated thought, you have to do your thinking in mnemonic patterns,
shaped for ready oral recurrence”.4
For Arabs, a way of thinking and an attitude to life traditionally empha-
sized an experience, reasoning, morality and general human concerns. Its
audience was both its individuals and their wider social settings (commu-
nity, society or nation).
Parallelism, “the hallmark of Ali’s verbal creations, produces a strong
acoustic rhythm, and pity sentences, repetition, assonance, and prose-rhyme
augment this rhythm”, notes Qutbuddin. She further points out a number of
features of oral-based verbal production are discernible including vivid im-
agery, testimonial citation, additive rather than subordinate phrases, aggre-
gative rather than analytic expositions, an agonistic tone and closeness to
the human lifeworld, shown through the use of mundane objects and daily
activities as metaphors physically showcasing abstract ideas.

14.2.1 Teaching and practice to encourage productive participation

One of the most important characteristics of Ali ibn Abi Talib was his atten-
tion to economic production. During the lifetime of the Prophet Muham-
mad and afterwards he remained engaged in different productive activities.
In the years after the migration to Medina, he is reported to have worked
as a wage earner in the garden, pulling water from wells for brick making in
order to support himself as well as the Prophet. At times, he would fetch one
bucket of water in exchange for one date. Repetitively pulling water buckets
from the well would cause blisters on his hands. But upon earning his day’s
wage he would collect his portion of dates and share them with the Prophet.
Ali ibn Abi Talib discouraged an indolent attitude towards mundane work
and said: “A man who is inert in his worldly matters would be even less ac-
tive in improving his Hereafter”.

14.3 Research methodology

This chapter analyses a selected range of works to help understand the views
of Ali ibn Abi Talib regarding the idea of equitable economic distribution
 Drawing inferences from Talib’s Teachings 223
put to action as just practice. This chapter takes a critical approach to texts
which can be descriptive or polemical. The methodology of this research is
based on the analysis of historical descriptions as an approach employed
as the primary means for the case study method. This then refers to the de-
scriptive material assembled by the writers and commentators of history to
shed light on the development of specific events. This chapter presents a set
of guidelines which Ali ibn Abi Talib provided during his reign as the caliph
from 35–40 A.H./656–661 A.D.
Scholars of Islamic Studies and History have written at length about Ali
ibn Abi Talib’s biography and about Nahj al-Balagha, i.e. the collection of
his sermons, sayings and letters which is considered to be an apex work of
eloquence. In recent years however, scholars and writers of social sciences
have attempted to see what inferences relevant to today’s society, such as
economic equality and distributive justice, could be drawn from earlier
history. Without going into deeper details, this chapter draws attention to
examples citing attempts made by Ali ibn Abi Talib to inculcate and imple-
ment notions of economic justice.
A survey of contemporary literature in Arabic, Persian and Urdu helps us
discern some useful guidelines comprising the following dimensions: (1) sa-
lient features of Ali ibn Abi Talib’s vision towards a fair economy which is to
be run with just practices; (2) the attitudes, morals and pressures necessary
to put such a system in order; (3) ethical prerequisites to ensure justice which
also entails observing and (4) specific criteria for value-based governance
when appointing government functionaries.
The chapter looks at the guidance issued by Ali ibn Abi Talib, as commu-
nicated formally in writing through edicts and decrees, as well as verbally
through maxims, sermons and instructions. It then focuses on classifying
such guidance under different themes in order to analyse and interpret the
motivations and objectives behind the texts and establish what possible
linkages could be made between the caliph’s overall vision and the instruc-
tion communicated by him. Step 1 in this study was to select and translate
from Arabic and Persian texts relevant to the topic. Step 2 was to classify
them under specific themes, while Step 3 was to conduct an analysis to un-
derstand the broader thinking behind the measures proposed, as well as
their possible implications. Pursuing such analysis at further levels could
help reveal the circumstances under which those guidelines were issued.
The selected examples serve as a case study of both the guidance offered
and challenges linked to the prevalent social situation of the time. The de-
scriptive method allows the cases to be placed in their fuller context, to reflect
the conditions which existed at that time. The descriptive method enables
the interpretation of historical statements as well as ascertains their present
relevance. Using the method of exposition helps in analysing and explaining
what motivated Ali ibn Abi Talib to invite the people to change the prac-
tices prevalent at that time. In this respect the main research method used
in this chapter is the textual analysis of historical accounts and statements
224 Najam Abbas
to present the social reality of those times, and thus to help draw inferences
for the present day.

14.4 Results and discussion: vision of value-based governance

Ali ibn Abi Talib gave a vision to ensure the administrators he appointed
aspired to meet the following objectives:
The first basis of such vision is to take steps against financial wrongdoing
and administrative misconduct, and inculcate a culture of a clean and stable
governance system based on integrity, equality and prevention of injustice.
According to Ali ibn Abi Talib, prerequisites for a good governance to
flourish involve building it on the foundations of ethical values as well as
laying down rules and regulations essential to run the system successfully. It
ensues, first, raising awareness and consciousness for the fight against finan-
cial and administrative corruption for a sound cultural upbringing of soci-
ety and the stable foundation of the economy. Ali ibn Abi Talib inculcated a
care for protecting the wealth of the community as an important priority to
ensure that it reached all who really deserved it.
A criteria for public officials is that (1) the appointee should be truthful
with the people and himself and not to use deal-making as an end, (2) the
official works to serve the common people and win their goodwill instead
of working for their comrades and cohort’s sake and (3) an individual who
takes a bold stand to get rid of injustice and to be strict with those who mess
with people’s properties.5

14.4.1 Setting a moral compass

According to the Lebanese writer George Jurdaq: [Ali] neither showed pride
nor humiliated himself unnecessarily. He presented himself as he was with-
out any pretentions or artifice. He was free from affectation and hypocrisy.
It is difficult to find a straightforward man like him. Once he purchased a
bagful of palm-dates and was carrying them home. Some persons observed
this and volunteered to carry the bag for him. He, however, told them po-
litely that it was more appropriate for the head of the family to carry it by
himself.6
In the recommendations made by him to his sons, Hasan and Husayn,
he said: “Be enemies of the oppressors and supporters of the oppressed”.
He further said: “Be enemies of the oppressor even though he may be your
near relative and support the oppressed person even though he may not be
related to you and may be a stranger”.7
Historical and traditional sources from both Sunni and Shia point out
that Ali ibn Abi Talib was not inclined to either favour or discriminate
against anyone when it came to distribution of wealth from the treasury.
There was no priority given to those who had embraced Islam earlier than
others, participated in more military campaigns than others, or by way of
 Drawing inferences from Talib’s Teachings 225
a relationship were closer either to the Prophet Muhammad or to Ali ibn
Abi Talib. Thus, when shares from the treasury were distributed, nobody
was treated preferentially on the basis of the tribe to which they belonged or
whether they were an Arab or a non-Arab.8
When distributing funds, Ali ibn Abi Talib handed out an equal share
to everyone, without favouring one individual over the other. A non-Arab
slave would get a same share as his Arab master. When some people raised
this issue with Ali ibn Abi Talib, he picked up a small twig from the ground,
held it in between two fingers and said: I have gone through the whole Quran
but couldn’t find if even this much preference is mentioned there for Banū
Isma‘īl over Banū Isḥaq.9

14.4.2 Practice of not withholding public money

On occasions when Ali ibn Abi Talib inspected the treasury and found that
the wealth deposited there was yet to be distributed, he would thus address
the people: “I cannot spend a night in peace, if there is even a dirham left
unspent from the treasury”.
At times when some wealth arrived at the treasury, he would distribute it
among the people declaring: I am not to act as a watchman to guard stored
wealth locked for safekeeping.
In all matters, Ali ibn Abi Talib followed the Prophet Muhammad and his
tradition. For him it was not possible to divide the shares except on the basis
of equality. When the caliphate was transferred to Ali ibn Abi Talib, those
who had enjoyed such privilege expected to benefit as before. However, Ali
ibn Abi Talib refused to continue those practices and decreed that every-
body must benefit equally from the public treasury, and it made some upset.
In response to the request of such people the Imam gave a sermon to explain
his principled position. It included the following points:

1 The end does not justify the means, although it was quite possible to
win the backing of some people by awarding them a large amount to
support a cause which was right in the first place, but Ali ibn Abi Talib
did not agree to serve a noble cause by pursuing an unjust approach.
2 Public property and national wealth should not be used to win the ap-
proval and support of a few.
3 Those who support a cause motivated by the promise of monetary gains
are quick to withdraw their support should their gains dry up.10

14.4.3 Muslims’ public treasury: approaches for raising

state revenues
From Ali ibn Abi Talib’s instructions to his deputies in the provinces it could
be deduced that governors were advised never to worry over pursuing a leni-
ent approach to tax collection, because it serves as an indirect investment in
226 Najam Abbas
developing the towns and provinces, and eases the burden over the people.
This is because fair treatment of the people will win them over and will lead
them to extend their increased support.11

14.4.4 Status for financial audit

Ali ibn Abi Talib reminded the tax collectors of their roles that as the treas-
urers of the people, they were also representatives of the community and the
ambassadors of the Imam.

The honour and status of revenue collectors attributes to the dignity,

worth and dignity of the treasury. Until the credibility of the public
treasury is established, the administrators cannot expect to earn impor-
tance and respect in the eyes of the people.

In his commentary on this matter, Ibn Abi al-Hadid offers three points:
(1) The tax authorities are the trustees of the people’s collective assets.12
(2) They look after the interest of the community.13 (3) The tax authorities
are the government’s emissaries to the people.14

14.4.4.1 The characteristics and functions of financial auditors

One of the main objectives of Islam is ensuring even justice for all members
of the community. The realization of such a cause depends on numerous
factors, among them the most important being the character displayed by
the revenue collectors in terms of their beliefs, morals and behaviour. There-
fore, Ali ibn Abi Talib on many occasions emphasizes the need to employ
the most appropriate for the task. This, in some cases, such as tax collection,
had an even greater significance.
Because the tax officer will collect the fruit of people’s savings, and their
labour and profit. It is necessary that such a person must possess a number
of competencies.

14.4.4.2 Principle of fairness

Ali ibn Abi Talib has enumerated the following attributes and duties of the
tax collectors: In relation to the collection of the taxes, exercise fairness and
lenience in carrying out your duties. The significance of fair handling will
result in taxpayers’ satisfaction.
In Ali ibn Abi Talib’s view a person who served others and shared their
burden was the best and perfect individual. Ali ibn Abi Talib himself par-
ticipated in many activities which contributed to lessen the burden of the
poor and the needy.15 He set an example for others and declined to live in
lodgings far bigger than one’s actual need.16 Ali ibn Abi Talib wanted to set
with his own example, a model of conduct for others to exercise moderation,
 Drawing inferences from Talib’s Teachings 227
and applied exacting standards on himself far more than demanding from
others.17
In Ali ibn Abi Talib’s view an ideal society is one in which everyone, espe-
cially those with less income, is able to meet their basic needs. The strategy
to reach such an aim is that those with higher income refrain from extrava-
gant expenditure over food items which can lead to wastage of excess food
by some and shortage for those who can’t afford to buy much.

14.4.4.3 Discouraging leaving the means of production idle

Ali ibn Abi Talib paid priority consideration to the universal provision of
life’s basic necessities.
Once a person saw Ali ibn Abi Talib carrying a load of palm kernels and
asked what he intended to do with that. In response Ali ibn Abi Talib said:
God willing, these kernels will produce 100,000 date trees. He then went on
to sow them all, and each one of them grew into a date tree.18
When it came to distributing his own wealth, Ali ibn Abi Talib helped
those in need, beginning with ones related to him. Yet, Ali ibn Abi Talib did
not make any distinction between acquaintances and strangers and distrib-
uted an equal share among them. In this manner he set an example of how to
serve the two ideals, namely, justice and unity in the community.19
Ali ibn Abi Talib toiled on the lands to make them useable and later do-
nated them for helping the needy people. At the time of death, all he had left
was his share of 700 dirham received from the public treasury.20
With a shovel in his hands as he dug hard, a well sprung out on the land of
Yanbu. Those who witnessed this fortune cried that it is time of glad tidings
for Ali’s inheritors. However, this is how Ali ibn Abi Talib reacted on this
occasion: “Tell this good news to all my inheritors that I am donating all
this to the needy, poor and destitute”. Ali ibn Abi Talib followed a similar
conduct regarding all of his properties.21
Most of Ali ibn Abi Talib’s income came from the lands, date palms and
the wells as a result of his own hard work in putting those resources to pro-
ductive use. Much of the revenue generated came as a result of him devel-
oping them from barren pieces of land abandoned by others owing to the
difficult conditions faced and hardships involved.22
Ali ibn Abi Talib was not in favour of leaving any sources of production
idle. In his view, wealth and other resources were meant to benefit the peo-
ple, and hoarding them was tantamount to unjust use of such resources.23

14.4.5 Looking after the needy ones

In Ali ibn Abi Talib’s opinion fulfilling the needs of a needy person is one
of the foremost responsibilities and one that cannot be ignored under any
circumstances. This remained an overriding concern throughout his life but
even more so after he took over the caliphate’s responsibility. He always
228 Najam Abbas
kept thinking if there was any destitute who still struggled to find a loaf
of bread.24

14.4.5.1 Monitoring the economic activities of the close ones

Although Ali ibn Abi Talib choose to lead a simple life as a role model, he
considered it pertinent to caution his appointed authorities to beware of
the deeds of their associates and relatives and remain mindful of possible
consequences of such deeds.
In a perfect model of an Islamic state it was necessary to conduct com-
prehensive economic reforms. In this regard, when Ali ibn Abi Talib was
informed that a relative of one of his appointees had confiscated a piece of
land inappropriately, the Imam reminded the appointee of his obligations
and ordered him either to get the property returned to its rightful owners
or face his sword. Ali ibn Abi Talib took serious corrective and reformative
measures to narrow the gap between the rich and the poor, for the social
uplifting of the poor and to elevate their dignity.

14.4.5.2 Putting the priorities right

Below are the few examples highlighting some instances where Ali ibn Abi
Talib is noted reminding both government officials and tradesmen and com-
mon folk of their social and collective responsibilities. He often reminded
that it is the duty of governors to make the subjects prosperous in the first
instance and then to think of collecting the revenue.
Once Ali ibn Abi Talib passed by a heap of garbage and pointed out that
it had ended up here as the result of the miserly withholding excess stuff to
themselves. If it were given out to the poor it would have contributed to the
betterment of the society.

14.4.5.3 Promoting positive practice in the market

Ali ibn Abi Talib used to begin his day in Kufa by making the rounds from
one market to another. He would stand at the entrance and thus address the
people of each market:
O traders fear Allah Almighty; Extend the good and seek blessing by be-
ing easy on others; Adorn yourself with courtesy and refrain from swearing;
Stay away from lies and wrongdoing and do justice to the oppressed; Do not
deal in usury; Keep your balances accurate; Do not devalue people nor their
possessions and do not cause mischief on the ground as spoilers.
He used to make the rounds in all the market places and would then sit
with the people.
Ali ibn Abi Talib took practical measures to ensure fair practice in
the market not as a one-off step but as a routine. This reflects the signifi-
cance and the priority attached to a fair and just running of the markets as
 Drawing inferences from Talib’s Teachings 229
something which touches the lives of common people on a daily basis. His
direct interaction and close touch with the people encouraged them to deal
fairly. His regular check-up visits to Kufa’s markets also kept the sense of
ethical and moral accountability present and alive in the society and specif-
ically among traders.

14.4.6 Ali ibn Abi Talib’s dedication to social reform, economic

governance and development
In its essence and purpose, the government following ideals of Imam Ali was
(Alavi) was founded to pursue comprehensive reforms, especially economic,
as it declared this to be a priority goal in its planning and policy. The Alawi
government’s reform programs in this sphere can be noted to be pursuing
an outline of five fundamental objectives: (1) To end discrimination in the
distribution of public funds, (2) Recovery of misappropriated public assets,
(3) Prevention of amassing excessive wealth in the new government, (4) To
strive for effort for developing lands for greater prosperity and (5) Social
Cover for the disabled and the disadvantaged.
The first three are corrective measures to undo past wrongs which were
preventing equity and growth. While the next two are initiatives aimed at
alleviating poverty and addressing disparities between different sections of
the society.
These measures were aimed to reduce the burden of the people and pro-
vide economic justice for the welfare of the individual. This is because the
rule of Ali ibn Abi Talib considered it as a divine obligation and a religious
necessity.
Thus, it is not limited to ensure material progress, but also to improve the
quality of life at both individual and collective levels.25
Ali ibn Abi Talib’s letters to a number of his officials serve as valuable
historical documents evident of how he commanded the political, religious
elements in his government to uphold the establishment of the rule of justice
in the face of all temptations.
Ali ibn Abi Talib discouraged the amassing of wealth and accumulation
of assets by officials or their close associates, from which no doors shall be
opened under any excuse or religious justification.

14.4.6.1 Discouraging harmful practices

Alongside Ali ibn Abi Talib’s sayings to encourage the desired economic
practices, we find clear instructions and teachings of what practices to
avoid. There are clear teachings discouraging unethical trade practices such
as adulteration, cheating and fraud: Look after the traders’ affairs before
yourself or wherever they may be in your area. Know, along with this, that
most of them are very narrow-minded, and awfully avaricious. They hoard
230 Najam Abbas
goods for profiteering and fix high prices for goods. This is a source of harm
to the people and a blot on the officers in charge.
Ali ibn Abi Talib issued clear instructions discouraging misleading or de-
ception in day-to-day trade: “So give full measure and weight and do not
defraud, diminish [the value of], people’s goods, and do not work corruption
in the earth, by way of unbelief and acts of disobedience, after it has been
set right, through the sending of messengers [thereto]. That, mentioned, is
better for you, if you are believers, [if you are] seekers of faith, so hasten to
it” [Tafsir Jalalayn 7: 85].
The Imam said, however cheating rises in trade, loss and poverty follow.
This is what the traders tend to indulge in but it causes poverty because
cheating in the balance reflects negatively on the poor people directly. Ac-
cording to the Imam, remaining idle in the world negatively affects one’s
religious dimension, whereas engaging in “productive work and earning a
livelihood helps in a person’s pious life”.

14.5 Conclusion
The passages referring to the selection of sayings (which encourages to
adopt virtue and abandon vice) offer a series of precepts to illustrate how
the moral order is realized at the levels of thought, speech and behaviour
concerning the following:

a The contrasting way of life of the contended and the greedy persons;
b The appropriate rewards and retribution in store for each, respectively;
c The qualities and behaviour of the righteous as evoking admiration;
d Correcting the person focus of pursuits in the world;
e Encouragement to lead a purposeful, productive and pro-active life.

When referring to social responsibility a good research needs to acknowl-

edge and appreciate where the teachings took their origins and evolved
forth. It is in that context that a retrospective look will enable researchers to
realize how Ali ibn Abi Talib’s teachings sharpen the individual’s conscience
by encouraging them to embrace particular virtues and shun specific vices.
The teachings are targeted at developing sound moral foundations for im-
proving ethical standards to build the character of individuals and commu-
nities who are prepared in order to promote justice and counter injustice. In
this regard, the teachings also draw attention to the question what it means
to be productive for a person individually, for a family, community and a
member of society at large. The guidance about the desired way of living
points to (1) the desired approach to strive for one’s well-being and (2) the
need to admonish procrastination, and offers (3) encouragement for the
pursuit of an active and productive life.
For a fuller appraisal of history, it is equally important to list those factors
owing to which ideals on social and collective responsibility provided by Ali
 Drawing inferences from Talib’s Teachings 231
ibn Abi Talib could not find their way into practice. It is therefore essential
to shed light on factors which impeded or prevented the implementation of
those ideals that will encourage and enable the new researchers to a holistic
and more meaningful appraisal of the economic vision, the guidelines for
the just distribution and the challenges to efforts to implement those ideals
on collective responsibility over the past centuries.

Notes
1 For a detailed biography detailing Ali ibn Talib and his vision of and pursuit for
justice see Shah-Kazemi 2005.
2 De Gifis 2010.
3 Qutbuddin 2013, p. xvii
4 Ong further points out: Your thought must come into being in heavily rhythmic,
balanced patterns, in repetitions or antitheses, in alliterations and assonances,
in epithetic and other formulary expressions, … in proverbs which are constantly
heard by everyone so that they come to mind readily and which themselves are
patterned for retention and ready recall, or in other mnemonic form. Serious
thought is intertwined with memory systems. Mnemonic needs determine even
syntax. p. 34
5 It may also be added that upon summoning an official for accountability Ali ibn
Talib reminded him: “It is not for you to be oppressive towards the ruled”. This
implies that an official should interact with the common people as per specified
rules and regulations. This also implies that he is not superior to others by any
exemption except for the authority vested in him to carry out his responsibilities.
6 Jordac 2010: 72
7 Jordac 2010: 66.
8 Yusufi 2008: 79
9 With reference to Ali ibn Talib’s practice, it has been reported that whatever
wealth was deposited in the treasury, he always distributed it among the peo-
ple without favouring one over the other. When the two Ṭalḥa b. Abdullah and
Zubayr b. al-Awam objected to equal distribution, Ali ibn Talib pointed out:
“Didn’t the Prophet of God distribute the wealth equally among the Muslims?”
He further told them that it wasn’t something that he decided himself or on his
own wish: “You and I both know well that this practice was introduced and car-
ried out by the Prophet himself”.
10 Nūrī Hamadānī. ‘Bayt al-Mal dar Nahj al-Balagha’, Sālnāma Al-Nahj, vol. 19–20/
Autumn/1385/2006.
11 Ayatollah Hassanzadeh thus elaborates: Paying sympathetic attention to the
people’s complaint and offering them tax concessions makes a positive impres-
sion of the government and hence in this way the rulers have little to lose. Be-
cause, first, developing the cities contributes to a rise in the revenues and profits;
second, development of idle land improves the government’s image; third, it
causes people to praise and trust their government as they trust in their gov-
ernment’s justice and fairness; and fourth, under the circumstances when the
government needs to borrow from people and needs them to make some sacrifice
financially or physically, they will respond readily (Rahmani 2000: 17 and 321).
12 Ali ibn Talib, letter 51.
13 Ali ibn Talib, letter 51.
14 Ali ibn Talib, letter 51.
15 Husayni 2007: 88.
16 Husayni 2007: 74.
232 Najam Abbas
17 Husayni 2007: 7.
18 Husayni 2007: 63.
19 Husayni 2007:95–96.
20 Husayni 2007: 97.
21 Husayni 2007: 97–98.
22 Husayni 2007: 112.
23 Husayni 2007: 116.
24 Husayni 2007: 92.
25 The above lines draw from Mustafa Jafar Pisha-Fard, Hukumati Alawi wa
Ihtimam ba Istilahat Ijtimai Iqtisadi tuse wa rafah, Retrieved 12 November 2017
from http://tinyurl.com/MJpisha1

References
De Gifis, Adrian J. (2010). The Theory of Virtuous Leadership in the Works of
al- Jahiz, Ph.D. Thesis, University of Chicago. Illinois: Chicago.
Husayni, Syed Rida. (2007). Sirah Iqtisad Ali ibn Abi Talib, Tehran. 1386 Shamsi.
Jordac, George. (2010). The Voice of Human Justice. Karachi: Islamic Seminary
Publications.
Nūrī Hamadānī. Bayt al-Mal dar Nahj al-Balagha. Sālnāma Al-Nahj, vol. 19–20/
Autumn /1385/2006.
Pisha-Fard, Mustafa Jafar. (2000). Hukumati Alawi wa Ihtimam ba Istilahat Ijtimai
Iqtisadi tuse wa rafah. Hukumat-i Islami, vol. 18, No. 4 (1379 Shamsi), pp. 56–97,
Retrieved 12 November 2017 from http://tinyurl.com/MJpisha1
Qutbuddin, Tahera. (2013). A Treasury of Virtues: Sayings, Sermons, and Teachings
of Ali, edition and translation of the Dustur ma‘alim al-hikam compiled by al-Qadi
al-Qudai, with the Miat kalimah (One Hundred Proverbs) attributed to al-Jahiz.
New York: New York University Press.
Rahmani, Muhammad. (2000). Bayt al-Mal dar Nahj al-Balagha. Hukumat-i
Islami, vol. 17, No. 3 (1379 Shamsi), pp. 315–346.
Rishad, Ali Akbar. (2000). Danish-nama-i Ali ibn Abi Talib, Vol. 7, Iqtisad (1380
Shamsi).
sssShah-Kazemi, Reza. (2005) Justice and Remembrance—Introducing the Spiritual-
ity of Imam Ali. London: I. B. Tauris.
Yusufi, Ahmad Ali. (2008). Nizam Iqtisad Alawi, mabani, ahdaf wa usul rahbardi.
Tehran: 1387 Shamsi.
15 Pricing anomaly
Tale of two similar credit-rated
bonds with different yields1
Mohamed Ariff, Alireza Zarei
and M. Ishaq Bhatti

15.1 Introduction
This chapter is about what to expect as per the bond pricing theory, consid-
ering the market practices and the actual yields as observed in the normal
bond market for two apparently similarly rated bonds. Type A bond is the
mainstream bond, and Type B is a new bond instrument designed and traded
under the product name Sukuk certificate. Both government bodies and cor-
porations raise funds by issuing either type of bonds since these are marketed
as equivalent instruments. There are several fixed income markets worldwide,
where Type B securities are traded alongside Type A securities, so the research
issue addressed in this chapter has global relevance to several other bond mar-
kets. About 65% of the Type B bonds are traded in Malaysia, so we chose this
market given the data availability to test the pricing behavior in this country.
There is strong historical evidence and theory-based reasoning to expect
returns to be identical for the two portfolios of bonds we study. A priori
reasoning suggests similarly rated bonds with same tenor ought to be priced
to yield the same returns to investors, especially since the issuers are known
to decide to offer either one as a matter of choice: identical companies are
known to raise money by issuing both types of bonds. Despite some argu-
ment that the two types of bonds have different contractual – indenture –
provisions,2 the price-relevant characteristics are the same. For example, a
AAA-rated mainstream Type A bond issued with a ten-year tenor should
be priced by investors to yield the same return to investors as an equivalent
AAA-rated Type B bond with the same tenor. Hence, a Type B, the Sukuk
certificate, should give investors equivalent return, on average, if the tenor
and ratings are the same, despite one being the mainstream bond and the
other being a new instrument that has begun trading just in the recent 20
years. Applying the existing debt pricing theory (Williams, 1938) as is widely
used in the industry, investors would expect returns to be the same for both
types of bonds. There is also literature-based evidence that equity market
equivalent securities (see Hassan, 2001) and equivalent mutual funds (see
Mansor, Bhatti, & Ariff, 2015, etc.) traded as Type A and Type B securities
are priced to yield the same returns.
234 Mohamed Ariff et al.
We explore the research question as to whether the debt markets for the
mainstream bond and the new bond instruments behave differently as re-
ported in Safari, Ariff, and Mohamad (2013). Since existing market prac-
tices relate to them as equivalent funding instruments, it is an interesting
research question to verify if the claim of significant differences can be ver-
ified in this study using newer data with newer methodology. This is the
motivation for undertaking this research to evaluate the pricing behavior
of a new emerging market while the mainstream bond has been around for
centuries.

15.1.1 Research issue

This study provides a report on how two equivalent pairs of Type A and
Type B debt market securities are traded in the largest bond market in Ma-
laysia. Since risk is involved in the case of corporate bonds, the returns of
any pair of corporate bonds with treasury must have higher returns as pre-
dicted by the liquidity premium theory (Hicks, 1946; Keynes, 1930; Lutz,
1940). Hence, one should observe risk-free securities to have lower returns
than the risky corporate ones across both types of bonds. Treasury bonds
of lower tenor would have lower returns compared to treasuries of higher
tenor; a priori, Type A and Type B securities should have the same returns to
investors. On a similar reasoning, a AAA-rated firm issuing a mainstream
bond and the same firm issuing a AAA-rated Type B bond with the same
tenor (and with the same order of claim to payments under bankruptcy
rules) should be priced such that the returns to investors of these equiva-
lent securities ought to be the same. Market players believe this is the case
as they go about trading in equivalent instruments, and the practice in the
marketplace from our discussions with market participants suggests that
they consider the pairs of equivalent instruments as substitutes fulfilling the
same funding requirements of the issuers.3 Conventional market practices
and the current concepts in the bond markets as well as the scant literature
on the pricing of Type B instruments also suggest that both types of bonds
are substitutes that would yield identical returns to investors.
There are 16 other financial centers, where Type B securities (government
bonds and AAA corporate bonds) are listed and traded as matching secu-
rities. The interesting facts about the two types of securities are that (i) the
common debt securities and (ii) the new Sukuk debt certificates are traded
side by side in the same markets.4
The mainstream bonds pay pre-negotiated interest payments in the form
of ordinary annuity on semi-annual and/or quarterly intervals to common
bondholders, while the Type B bonds pay similar fixed payments although the
payments are called dividend distribution (based on profit-sharing) as ordi-
nary annuity to investors. Conversations with scholars or industry people on
this topic suggest that the two forms of returns to investors (coupons and div-
idends paid to fund providers) are apparently close and that they are unlikely
to be any significant different in terms of rewards. The long-run relationship
 Pricing anomaly 235
between the dividend distribution and mainstream bond returns is an unan-
swered question as well. There is a market perception, indeed an assumption,
that the two yields are somehow interrelated, but not much is addressed about
the long-run relationship. Moreover, this research efforts to also verify if the
casual relationship of similar behavior is in fact observable in carefully struc-
tured tests. Third, data series are also available on corporate Type B yields.
Thus, in the case of the zero-risk treasury bonds and the AAA corporate
bonds, there should be a test with longer-dated and new data available.
Tests employed in this study are meant to examine the mean and median
differences between the return series of respective securities.5 The obtained
statistics from test on the difference are expected to provide evidence for
or against a significant difference in all the series. We also document a sig-
nificant long-run equilibrium relationship (or cointegration) and Granger
causality as existing between the respective variables. Therefore, our find-
ings suggest that the pricing behavior of the two types of bonds is converg-
ing to a long-run equilibrium with a testable speed of adjustment or error
correction. These appropriate tests applied to this topic are meant to pro-
duce more accurate test results on the topic. We provide useful information
to estimate a fully specified model using an autoregressive distributed lag
(ARDL) approach with lag orders being identified and optimized properly,
after performing many iterations of regression equations.
The rest of the chapter is organized as follows. The next two sections
cover relevant literature and test methodology. The results are presented in
Section 4 on zero-risk treasury securities and AAA corporate bonds. The
final section is a summary in Section 5.

15.2 Literature review

The literature is scant on Type B instruments as compared to the main-
stream debt instruments. Safari et al. (2013) show that there is a significant
difference across the two types of bonds and the difference ranges from 6
to about 56 basis points. A study by Mansor et al. (2015) suggests that the
Type A and Type B securities have identical returns to investors across the
samples of mutual funds. There is broad agreement that Type B financial
instruments yield about the same return as the common share instruments.
Overall, there seems to be no conclusive evidence for Type B (new) securities
to have higher or lower yields. One argument receiving wide support why
the two types of securities have similar yields is the empirical reality at this
stage of development of Type B financial services industry, where market
makers are simply cloning existing common old instruments to become the
new Type B instruments by some simple design differences. However, the
results of this study on two equivalent debt markets are about significant
differences in matched pairs of bond instruments.
There is extensive literature on Type A bonds with studies going back to
several decades. The relevant studies are those relating to rating, returns to
investors, valuation models on bond pricing, and liquidity preference theory.
236 Mohamed Ariff et al.
Williams (1938) and Lucas (1978) are relevant for the valuation model, which
is used for computing the yield to maturity. The model is specified as:
∞
CFt
V0 = ∑ (1 + r )
t =1
t (1)

where

V0: the value of the bond at time 0,

CFt : the stream of expected cash flows at time t, normally the coupons and
face value as the CFs, and
r: the discount or required rate of return.

Another theory is relevant for comparing the yields over time with different
times to maturity. Lutz (1940) suggested that the difference is due to the time
to maturity being a yardstick for how long the investors in the bond mar-
ket are losing liquidity. For parting with liquidity, investors require higher
yields to be offered by bond issuers for longer time to maturity.
While searching for data for this study, we noted that the Type B bonds
are evaluated using Williams’ model in the belief that investors treat the
Type A and B bonds as equivalent for fair price calculation. Thus, Equation
(1) is relevant for yield estimation while the idea of liquidity premium the-
ory enables us to test if the yields of short-tenor bonds are lower than those
of the medium- and long-term tenor bonds of Type A and B. Hence, the
bond valuation theorem and the liquidity preference theories are directly
relevant to this study. The support for the predictions of these theories is
quite strong, so these ideas are generally accepted for bond price behavior.
As for the evidence to support liquidity preference of investors, all standard
finance books have references to studies that maturity of bonds determines
the size of the investor returns (example, Bodie et al., 2018).
The final set of literature relates to bond rating and investor returns. It is
widely known in the marketplaces that the yields of treasury bonds are lower
than the yields of corporate bonds because the corporate bonds are riskier
than the treasury bonds. This too is found in any standard textbook with cita-
tions to the empirical literature. Thus, the relevant literature on the two types
of bonds is leaning towards the main idea that the yields of similarly rated
bonds with a given maturity ought to provide the same returns to investors.

15.3 Methodology
The data used in this study are on treasury bonds and AAA corporate
bonds. We group the instruments as matched pairs of two classes as de-
scribed in the earlier section. In the case of treasury or corporate bonds,
we match common Type A and the new Type B treasury bonds. Corporate
issues are grouped as follows: the medium term if tenor is five or fewer years,
 Pricing anomaly 237
and long term for tenors above five years. So, each pair relates to the Type A
common bonds and the Type B bonds. We test six pairs of observations with
the data covering ten-year period of issues.
The data series are collected from the central bank of Malaysia, the Bond
Pricing Agency (BPA), which is a private vendor and investment advisor
on debt securities. We also sourced some data from the Thomson Reuters
DataStream. The yields are computed on monthly basis, as reported in the
databases. If there is lack of trading in the monthly data on one instrument,
then the instrument is excluded. The yields are from traded data at the ex-
change. The total number of monthly observations amounts to 424, and the
total number of instruments is 52 (26 × 2) over the test period for each type.
A paired-sample-type mean difference test is applied to verify the existence
of significant yield differences in the pair of matched samples using the aver-
age and median series in the yields between the two types of securities as to
whether the difference is significantly higher (premium) or lower (discount).
Once the difference is computed, a test of difference can be done using the
mean and median differences. Mean and median difference formulae are:

Mean
t= (2)
s2
n −1

Median
t= (3)
s2
n −1

where the mean and median refer to the computed returns of each of the
Type A and Type B yields. The standard error shown as the denominator
is computed from the differenced series. The t-values are expected to be
significant when the differences in the several paired series are tested. Test
on median is done to satisfy the criticism that yields may not be normally
distributed (as per the central limit theorem).
As stated before, this study also investigates the evidence of long-run and
short-run relationship between the two types of securities using the cointe-
gration and causality analyses. The literature on econometric time series
suggests several approaches to estimating the dynamics of variables with
varying assumptions. The linear time series models using the early versions
of time series cointegrating estimators as the vector autoregressions (VARs),
proposed by Sims (1980), are found to have robust statistical properties sub-
ject to the presence of no parameter restrictions. It is important also to note
that the selection of series to be included as Yt as in the following equation
and the choice of lag order plays a crucial role to satisfy the preliminary
conditions for appropriate estimation.

Yt = mt + A ( L )Yt −1 + e t (4)
238 Mohamed Ariff et al.
The choice of lag orders can be achieved using information criteria but
is subject to adjustment by performing iterations. There has been a wide
array of applications of VARs in empirical economic and finance literature.
Examples are studies by Bates and Granger (1969), Granger and Newbold
(2014), Stock and Watson (2004), Clark and McCracken (2005), and Smith
and Wallis (2009). Nevertheless, there still exist some limitations in the VAR
approach pertaining to distortions in impulse responses resulted from the
effects of omitted variables and measurement errors or misspecifications
being embedded in the residuals which eventually leads to misinterpretation
of the obtained statistics. Moreover, the VAR models are a-theoretic, that is
they are not based on any economic theory, given there is no restrictions on
any of the parameters under estimation.
A significant issue relating to poor performance of the VAR or equivalent
models is generally due to formal misspecifications of the models such as
spurious relationship between variables, results from non-stationary pro-
cesses, as in Clements and Hendry (1998). Accordingly, the issue of varia-
ble stationarity and cointegration analysis has been extensively investigated
since the early 1980s by many scholars including Granger (1981); Granger
and Weiss (1983); Granger (1986); Engle and Granger (1987); Johansen
(1988); Johansson, Douglas, and Nonaka (1985); Banerjee, Dolado, and
Mestre (1998); and Harris, McInish, Shoesmith, and Wood (1995).
Given the non-stationary property of most economic time series, as can
be verified from their stochastic trend behavior, investigation of a genuine
long-run relationship in their trended behavior plays a significant role. This
approach calls for determination of the validity of the cointegrating series
by investigating the order of integration of the variables, which by definition
should be similar. As a precondition, all the variables must be integrated of
order 1 (i.e. I(1)) to be estimated in the model. Alternatively, the so-called
ARDL bound testing of Pesaran, Shin, and Smith (1999) and Pesaran, Shin,
and Smith (2001) employs a single equation setup wherein a combination of
I(0) and I(1) series can be taken into consideration. Further, different varia-
bles can be assigned different lag lengths as they enter the model. An ARDL
(p, q) regression model takes the following form:

yt = b0 + b1yt −1 +…+ b k yt − p + a 0 xt + a1xt −1 + a 2 xt −2 +…+ a q xt −q + e t (5)

where e t is a random “disturbance” term. The model follows an autore-

gressive representation, where yt is explained by lagged values of itself and
employs distributed successive lags of the xt explanatory variable. Using this
approach, the time series properties concerning serial correlation of resid-
uals and dynamic stability of the model will be controlled. The presence of
significant long-run relationship between the variables can be verified using
the so-called bound testing approach. Hence, the model is robust to the con-
ventional cointegration techniques. The ARDL has been extensively used
 Pricing anomaly 239
in the empirical economics and finance literature by many scholars, reasons
being more application and flexibility of test modeling for economic time
series estimation and forecasting. Examples are studies by Narayan (2005);
Duasa (2007); Rapach and Strauss (2010); Barhoumi, Darné, Ferrara, and
Pluyaud (2012); and Ariff and Zarei (2014).
A verified cointegrating relationship leads to error correction estimation
to identify the speed of adjustment of conventional and Type B securities,
respectively, as in the following specifications:

∑d ∆TYPE B + ∑q ∆TYPE A
∆TYPE At = a i + 1 t −i 1 t −h
i =1 h=0
+ l (TYPE A − a − dˆ TYPE B ) + e
1 i 1 t −i t (5a)

∆TYPE B = a + ∑d ∆TYPE A +∑q ∆TYPE A

t i 1 t −h 1 t −i
h =1 i =0
+ l2 TYPE Bt −i − bi − qˆ1 TYPE At −h + et
( ) (5b)

where the coefficients of l1 and l2 are used to measure the speed of adjust-
ment of the dependent variables to the long-run equilibrium, and the terms
in the brackets are representative of the long-run relationship, while other
variables are differenced used to measure the short-run dynamics.

15.3.1 Variables and hypotheses

There are four hypotheses developed for testing. These are identified and
described in Table 15.1. The short-run dynamics analysis is conducted us-
ing causality test with F-test on lagged values of the independent variables.
The cointegration analysis is performed using the ARDL bound testing
approach. The lag optimization process is followed using the Akaike Infor-
mation Criteria (AIC) with a maximum of 12 lags allowed for each model.
The short-run Granger causality test is then employed by imposing restric-
tions on the differenced independent variables within the equation which
imposes the error correction term (ECT) as the long-run component, af-
ter the optimum lags are determined and specified. In this way, the results
can be further extended to include the causality of short-run and long-run
components.
The hypotheses developed are meant to identify if the Type B (new) debt
instruments in the exchange provide the same yields to investors as pre-
dicted by theory and by the limited research on mutual funds and equity
of two types of instruments. Our prior is to assume no difference exists and
observe the results by rejecting the null hypotheses. Hence, the results we
expect to get may have quite significant implications either way. There is no
reason for a significant difference to exist for the yields on Type A and the
240 Mohamed Ariff et al.
Table 15.1 Test Hypotheses Developed for Testing Differences in Deposits and
Zero-Risk Yields

Hypotheses

H1 There is no significant difference between Type B Risk-free

Treasury bond yields and Type A Risk-free common Treasury
bonds: medium and long terms.
H2 There is no significant difference between the yields of the Type
B corporate bonds and the yields of common corporate bonds,
AAA-rated bonds.
H3 The yields of Risk-free Treasuries of Type B instruments and the
common Treasuries of Type A bonds are not cointegrated in the
long run.
H4 The yields of risky Type B AAA corporate bonds and the yields of
AAA corporate bonds are not cointegrated.

Type B (new) contracts. This appears to suggest that if the same functions
are fulfilled by two equivalent instruments as in these debt markets, then
the results must be the same. Hence, there are strong theoretical grounds on
which we suspect that the earlier report needs to be carefully retested.
The hypotheses related to the test on long-run relationship are for a
close relationship between the two series, meaning that the series are coin-
tegrated, even if significant average differences are evidenced or not evi-
denced. We have mean/median difference tests, cointegration tests, and
short-run as well as joint (long-run) causality tests. The results are expected
to show that there could be similar behavior of the two-matched series,
meaning no statistically proven differences. This would suggest that the two
contract modes are meant to fulfill the same function. If there is evidence
of significant differences, plus a lack of cointegration or lack of evidence of
causality, then the debt market behavior is peculiar enough for us to term
this puzzle since we do not know why there is difference between the iden-
tical pairs.

15.4 Findings
The findings on the sets of interrelated tests are reported and discussed in
this section. Table 15.2 is a summary of descriptive statistics on the varia-
bles used in this study. The results in the table are descriptive statistics on
treasury securities of both Type B (new) and the common Type A grouped
as (i) medium term for up to 5 years and long-term yields for above 5 years.
This time-based classification allows us to have subsamples of observations
to ensure accurate results for classes (for a discussion on yearly yield tests
please see the cited paper in the first section). Panel B is a summary on AAA
corporate bond yields of both types.
One regular pattern seen is that the yields of zero-risk treasuries are in-
creasing with increases in tenure of the bonds: this is in line with the liquidity
 Pricing anomaly 241
Table 15.2 Descriptive Statistics of the Series Used in the Tests
This table reports the descriptive statistics of Islamic and conventional government,
corporation (AAA), and agency bond rates as in panels A, B, and C, respectively.
Accordingly, the series are divided into three different terms to maturity including
short, medium, and long terms.

Types Mean Median Max Min Std. Skewness Kurtosis Obs.

Dev.

Panel 1: Government Bond Rates

Medium-term Type A 3.35 3.34 4.58 2.20 0.40 −0.02 3.76 318
Medium-term 3.42 3.40 4.65 2.30 0.39 0.03 3.68 318
Type B(new)
Long-term Type A 4.06 4.01 5.18 2.91 0.43 0.35 2.71 424
Long-term 4.11 4.07 5.18 3.00 0.41 0.29 2.55 424
Type B(new)

Panel 2: Corporations (AAA) Bond Rates

Medium-term Type A 4.07 3.97 5.44 3.32 0.41 1.04 3.89 318
Medium-term 4.01 3.93 5.40 3.30 0.38 0.91 3.72 318
Type B(new)
Long-term Type A 5.08 4.99 6.73 3.92 0.59 0.37 2.52 424
Long-term Type 5.08 4.97 6.69 3.88 0.65 0.42 2.34 424
B(new)

Note: Islamic denotes Sukuk issues in the same market. Some series are slightly skewed, and
the normality tests fail to support normal distribution. Our tests are also done on medians for
robustness checks.

preference theorem (Hicks, 1946), in which results are similar to the results
long since known. The short-term mean is about 3%, whereas the long-term
mean is about 4%. Thus, this means that the two markets are able to price
the duration of the instruments correctly for both the Type A and the Type
B common bonds.
The differences for the Type B vs. common Type A AAA-rated are as
follows: −0.06 or 6 basis points for medium term and 0.02 or 2 basis points
for the long term. Hence, the AAA-rated Type B corporate bond instru-
ments have lower returns to investors (discount). These numbers are yet
tested.
In the cases of AAA Type A bonds, we find the opposite results. Note that
the medium-term and long-term common corporate bonds have anywhere
between 2 and 4 basis point higher differences. Hence, the descriptive statis-
tics in this table provide an initial indication on the existence of differences
between the two types of securities. These differences are yet tested as will
be done later, but there is no good reason to suggest why there are differ-
ences. Figure 15.1 is a graph of the series over the test period. Plots show that
the Islamic zero-risk and the risky yields appear to dominate the conven-
tional yields across all maturities, short-, medium-, and long-term bonds.
There is a systematic higher yield for shari‘ah- compliant securities, which
should be tested to see if these are statistically significant.
242 Mohamed Ariff et al.

3.7 STGOVCON
STGOVIS

3.2

2.7

2.2

1.7

4.7
MTGOVCON
4.2 MTGOVIS

3.7

3.2

2.7

2.2

4.9

4.4

3.9

3.4 LTGOVCON
LTGOVIS
2.9

Figure 15.1 Zero-risk common bond vs. Sukuk bond yields.

Notes: Dotted line: Islamic rates, solid line: conventional rates. Upper graph: short-term
government bond yields, middle graph: medium-term government bond yields, lower graph:
long-term government bond yields.

Figure 15.2 provides the plots of the investment returns on AAA bonds
for identical term, risk, and issuers: the term of the Type B issues does not
have as many as the conventional issues. Hence, there are breaks in the se-
ries. It is mildly evident that there is slightly higher yields, which may or may
not be much different across the time until a test is done. However, in the
case of medium-term Type B, the difference appears to be much larger than
is the case for the other maturities. Only tests could show if these differences
are premium or discounts.

15.4.1 Test on differences in returns

Table 15.3 is a summary of the findings on the important issue of whether
there is observed systematic yield differences to the investors in the two
types of debt instruments. These tests are two-sided tests done on mean
and median differences in the paired samples of conventional and securities.
The maintained hypothesis is that the differences in means and the medians
 Pricing anomaly 243

STAAACON
4.2 STAAAIS

3.7

3.2

2.7

2.2

MTAAACON
5.2
MTAAAIS

4.7

4.2

3.7

3.2

6.8

6.3

5.8

5.3

4.8

4.3 LTAAACON
LTAAAIS
3.8

Figure 15.2 AAA common bond vs. AAA Sukuk bond yields for identical issuers.
Notes: Dotted line: Islamic rates, solid line: conventional rates. Upper graph: short-term
government bond yields, middle graph: medium-term government bond yields, lower graph:
long-term government bond yields.

Table 15.3 Mean and Median Difference Test Statistics on Islamic and
Conventional Yields
This table reports the test statistics for the mean and median of conventional and
Islamic government securities. The number of observations in each test is about
400 monthly yields.

Type Mean Median Comment

Government, Agency & Corporate Securities

Medium-term treasury Difference −0.065 −0.060 Islamic higher
bonds (t-stat) (−13.45)*** −12.28***
Long-term treasury Difference −0.054 −0.045 Islamic higher
bonds (t-stat) (−14.48)*** (−11.86)***
Medium-term AAA Difference 0.060 0.040 Conventional
bonds (t-stat) 11.75*** 7.798*** higher
Long-term AAA bonds Difference −0.008 0.040 Conventional
(t-stat) (−1.08) 4.92*** higher

Note: The t-values are significant at or higher than 0.01 probability. Where the entry is “0” in
the case of the median tests, the two series had the same medians, so no test is needed.
244 Mohamed Ariff et al.
are not significantly different from zero. The number of observations is close
to about monthly yields in tested data set pairs. Most of them have several
trades in each observation period, and some had continuous trade as evi-
denced by noting the volume of trades.
The t-tests on the means and on the medians all show that there is a signif-
icant difference in the returns to investors in the paired securities. The first
two tests (medium term and long term) show that there is a significant dif-
ference between the yields of the pairs of Risk-free Treasuries. The t-values
exceeding 4.423 indicate that the investment returns on common debt in-
struments are lower than in the Type B security yields maturities, medium
vs. long. This level of significance is acceptable at or above 0.01 probability,
which suggests to the reader the existence of a strong significant return dif-
ference in the treasury market prices.
The returns for the medium-term AAA corporate markets are lower for
the Type B (new) bonds although the investor return is higher only for the
longer-term Type B (new) bonds against the longer-term Type A bonds. It
is only in the cases of bonds with less than five-year maturities where we
find no difference, so we have some with no difference, some with higher,
and some with lower returns. This is an anomaly compared with all other
trends showing a Type B (new) security having a premium, which is sig-
nificantly higher than zero. Interestingly, thus, the private sector-led Type
B (new) listed bond markets have lower returns compared to the observed
higher returns in the cases of Type B (new) securities in the government-led
Treasuries instruments.

15.4.2 The long-run dependence of the both yield series

The results on the cointegration and causality tests are presented in this
subsection, as tests of long-run equivalence in the Type A and Type B be-
havior, that is the behavior of conventional and Islamic assets. The test
results help to answer a central pricing issue in the dual bond market. Meas-
ured as monthly yields of debt instruments, there is sufficient evidence of a
higher yield for treasury issues by the government. In the cases of private
sector-based corporate debt instruments, the returns for Type B (new) in-
struments are lower than those for Type A common debt instruments. As
we described in the early part of this study, the two debt types are perceived
in the market place as being fundamentally substitutes because firms and
governments could use either to fund themselves, except that one such as-
sets are priced using pre-agreed interest payments, and the other is based
on post-profit distribution of returns earned by issuers, which presumably
depends on risk and maturity differences. Hence, the two series, at least in
the long run, have to be cointegrated, which is what we are testing.
Table 15.4 is a summary of statistics from cointegration test on the pairs
of returns to investors in the government debt instruments. The test pro-
cedure applied in this study incorporates a fully specified model with op-
timum lags – after performing a large number of iterations of regression
 Pricing anomaly 245
equations – to be verified from high R-squared statistics and the absence
of serial correlation. The optimal lag specification is reported in the third
column of the table, which is used in our subsequent tests. The significant
f-statistics obtained for all models under the so-called bound testing ap-
proach of Pesaran et al. (1999) and Pesaran et al. (2001) indicates the pres-
ence of significant long-run relationship between the variables.
This fact can also be implied by the ECT statistics reported in the sixth
column of the table. The test requirement is that the sign on ECT should be
negative and be significance for at least one out of the two regression mod-
els being investigated. There is evidence of significant long-run relationship
between the respective pairs. The ECT also measures the speed of adjust-
ment to the long-run equilibrium following any structural instabilities in
the behavior of either variable in the regression equation. For instance, the
short-run Type A treasury securities tend to adjust to the long-run equilib-
rium level with the Type B securities of the same type over a 3-month period,

Table 15.4 Result from Cointegration Test (Treasuries)

This table provides statistical report from the ARDL cointegration test with variables being
fully optimized using the AIC, as can be verified from the substantial R-squared statistics
reported in the last column of the table. The obtained F-statistics of the bound testing
approach in column 4 as well as the ECT in column 6 affirm the presence of significant
long-run relationship between conventional and Sukuk government bond yields.

Type Wald Test F-Statistics

DV IV ARDL Bound Test Long-run Coefficient ECT R2

Lag (f-statistics) (t-statistic) (t-statistic)
Specification

ST A ST B (7,10) 15.07*** 0.949 –0.355 0.996

k=1 (66.81)*** (–4.85)***
ST B ST A (10,7) 18.92*** 1.031 –0.445 0.995
k=1 (91.74)*** (−5.96)***
MT A MT B (4,4) 12.79*** 0.952 −0.294 0.969
k=1 (22.83)*** (−4.75)***
MT B MT A (12,11) 6.50** 1.019 −0.259 0.973
k=1 (18.98)*** (−3.30)***
LT A LT B (11,12) 7.06** 1.061 −0.239 0.982
k=1 (25.40)*** (−3.71)***
LT B LT A (7,8) 11.98*** 0.883 –0.247 0.982
k=1 (23.95)*** (–4.42)***

Pesaran et al. (2001) Critical Lower Bound I(0) Upper

Value (k=1) Bound I(1)

99% level 6.84 7.84

95% level 4.94 5.73
90% level 4.04 4.78

Note: The figure in parenthesis (…) represents optimum lag length selected based on AIC. The re-
ported R-squared values are for the general regression equation with respective ARDL parameteri-
zation of the lag components.
246 Mohamed Ariff et al.
while the short-run Type B securities, that is Islamic securities, tend to have
faster speed of adjustment to the long-run equilibrium which is equivalent
to 2.25 months (1/0.445).
Assets with longer-term maturities are found to have relatively slower
adjustments, which is nearly four months, compared to the two- to three-
month adjustment of short-term Treasury securities. The adjustment speed
for Treasuries is due to its greatly superior liquidity in the market. Corpo-
rate bonds have very low liquidity since most investors hold to maturity.
Results reported in Table 15.5 are for the causality test between the two-
type treasury securities. We have implemented two tests of causality for
identification of short-run as well as joint (long-run) causality, by restrict-
ing, from the obtained error correction mechanism (ECM): (i) the several
lags of differenced independent variable for the short-run causality and
(ii) short-run and long-run (that is the ECT) components to examine if the
restriction null hypothesis is rejected using Wald-type F-statistic procedure.
This is a standard approach of the Granger causality test often applied in
economic and financial studies.
The test results show bidirectional causality. In such cases, the results
reported in the last two columns of Tables 15.3 and 15.4 help us to verify
evidence in support of significant bidirectional causal relationship between
Type A and Type B bond yields. Therefore, both types of securities are
found to have contemporaneous feedback on each other despite the fact that
there is a long-run cointegration between two instrument types, which is

Table 15.5 Results from Causality Test (Treasuries)

This table provides statistical report from tests of Granger causality for
identification of long-run and short-run dynamics. The obtained statistics
affirm the presence of significant short run and joint causality between
conventional and Islamic government bond yields.

Type Wald Test F-Statistic

DV IV Short-run Causality Joint Causality

(p-value) (p-value)

ST-A ST B 329.06*** 299.14***

(0.00) (0.00)
ST B ST A 402.89*** 356.17***
(0.00) (0.00)
MT A MT B 251.69*** 204.26***
(0.00) (0.00)
MT B MT A 78.72*** 72.36***
(0.00) (0.00)
LT A LT B 312.02*** 312.02***
(0.00) (0.00)
LT B LT A 475.15*** 426.35***
(0.00) (0.00)
 Pricing anomaly 247
consistently an evidence for arguing that the two instruments are equivalent
in terms of investor returns.
Table 15.6 reports statistics on the cointegration analysis for the two type
corporate AAA securities. Given the full specification of models with large
number of lagged variables, there is again evidence of significant long-run
relationship between the two pairs of assets, as can be verified from the
bound test and the ECT test statistics.
The speed of adjustment being significant and negative is relatively slower
for the longer maturity corporate securities than is the case for the short-term
assets. Further, the yields on Type A securities are found to adjust slower to
the long-run equilibrium than those on the Islamic or Type B securities, espe-
cially for the long-term assets, by about 4 months difference (that is 11 months
of adjustment of the Type A compared to 7 months of the Type B securities).

Table 15.6 Result from Cointegration Test (Corporate Securities)

This table provides statistical report from the ARDL cointegration test. The
obtained F-statistics of the bound testing approach in column 4 as well as
the ECT in column 6 affirm the presence of significant long-run relationship
between conventional and Islamic government bond yields.

Type Wald Test F-Statistic

DV IV ARDL Lag Bound Test Long-run ECT R2

Specification (f-statistics) Coefficient (t-statistic)
(t-statistic)

ST A ST B (10,12) 14.53*** 0.995*** −0.272*** 0.993

k=1 (40.80) (−5.31)
ST B ST A (12,10) 14.50*** 0.980*** −0.281*** 0.993
k=1 (42.85) (−5.36)
MT A MT B (7,12) 22.54*** 0.995*** −0.307*** 0.989
k=1 (37.89) (−6.66)
MT B MT A (12,11) 16.63*** 0.971*** −0.295*** 0.988
k=1 (36.99) (−5.76)
LT A LT B (11,12) 6.59** 0.956*** −0.090*** 0.990
k=1 (15.82) (−3.57)
LT B LT A (12,12) 11.64*** 0.973*** −0.131*** 0.989
k=1 (18.22) (−4.64)

Pesaran et al. (2001) Critical Lower Upper

Value (k=1) Bound I(0) Bound I(1)

99% level 6.84 7.84

95% level 4.94 5.73
90% level 4.04 4.78

The figure in parenthesis (…) represents optimum lag length selected based on AIC. The
reported R-squared values are for the general regression equation with respective ARDL
parameterization of the lag components.
The asterisks ***, ** and * indicate significance at 1%, 5% and 10%, respectively.
248 Mohamed Ariff et al.
Table 15.7 Results from Cointegration and Causality Test (Corporate
Securities)
This table reports statistics from short run as well as joint (long run)
causality test on conventional and Islamic corporate debt securities.
The results affirm the presence of bidirectional causality between the
two variables.

Type Wald Test F-Statistic

DV IV Short-run Causality Joint Causality

(p-value) (p-value)

ST A ST B 260.21*** 244.31***
(0.00) (0.00)
ST B ST A 334.62*** 308.16***
(0.00) (0.00)
MT-A MT-B 142.25*** 131.53***
(0.00) (0.00)
MT-B MT-A 149.90*** 147.86***
(0.00) (0.00)
LT-A LT-B 176.16*** 163.90***
(0.00) (0.00)
LT-B LT-A 195.08*** 181.35***
(0.00) (0.00)

The asterisks ***, ** and * indicate significance at 1%, 5% and 10%, respectively.

Results pertaining to the short- and long-run causality are reported in

Table 15.7. Likewise, there is evidence of significant joint causal relationship
between the variables in all six models. This indicates a contemporaneous
or simultaneous causal effect from each variable on the other. That is, in the
corporate conventional bond and Type B bond markets (where we found the
Type B instruments offer lower returns to investors) both types appear to
affect each other in terms of causality. Nevertheless, the earlier discussion
pointed to the long-run cointegration between the two, which means that
the two are equivalent in terms of generating the investor returns. We fur-
ther provide results from a correlation analysis between variables in Table
15.8 in the appendix.

15.5 Conclusion
Our study started with the aim of providing comprehensive testing to estab-
lish if the two types of debt securities popularly called conventional – Type
A and Type B debt instruments are yielding higher (lower) returns to inves-
tors in a dual market where these are traded in some 17 markets worldwide:
our study of one market has implications for 16 others. The issue at stake is
whether debt markets provide differential returns to otherwise equivalent
 Pricing anomaly 249
debt instruments being invested in. A related test we did is to establish if
the two types of instruments are equivalent by testing for cointegration and
causality.
The results can be summarized as providing confirmatory statistics on
these issues. Examining the cointegration between the two return series sug-
gests that mostly the series are causally related and there is cointegrated
in the short and long runs. The yields on almost all Type B securities are
determined by their conventional pairs over the long run, which is an impor-
tant contribution of this study, lending support for the idea that the present
Type B (new) instruments are clones of the older Type A instruments. This
is evident that, even if the returns are significantly different, the two instru-
ments appear to be substitutes for investment purposes as they have long-
run dependence on each other. Second, we found that (i) government issues
of securities appear to have higher returns to investors in Type B securities
and (ii) the private sector-originating conventional debt instruments have
significant higher returns to investors compared to the Type B in the private
sector and in the banks. Finally, in terms of causality, most of the tests sug-
gest the conventional series cause the other series to change: that is Type A
Granger-causing Type B. However, in the cases of Type A corporate bonds
and Type B corporate instruments the causality turns both ways, meaning
the two series are affecting each other.
The results would have us argue that there is a systematically and sig-
nificantly higher returns to investors in Type B instruments issued by gov-
ernment, whereas contrarily corporate bond yields in Type A bonds are
higher than those in the Type B instruments. That the two types appear
to be equivalent as substitutes for investors are held up via the evidence
of cointegration between the two. Finally, returns on conventional instru-
ments appear to Granger-cause the returns in Type B instruments: this is
a direct evidence supporting the recent published finding that the interest
rates serve as benchmark to the Type B profit-and-risk-sharing instrument
returns. In the cases of corporate bond and Type B securities, both series
are causally related (bidirectional). If, indeed, the differences are due to
yet-undiscovered structural features of the Type A and/or Type B bonds, it
beckons further research.
While stock market and mutual funds market yields to investors in Type
B and conventional Type A equity-like instruments provide about the same
returns to investors, our evidence is contrary when it comes to debt instru-
ments. There is differential returns to investors in the dual-type debt market
instruments. What are the factors associated with the evidence of differen-
tial returns to investors need to be researched in future research. As data
sets become available on debt instruments from other countries, more re-
search is encouraged to replicate our results in some of the other 16 dual
markets where Type A and Type B debts are traded.
Appendix A
Correlation Table
Table 15.8 Correlation of the Common Bond and Sukuk Bond Yields

ST-A ST-B MT-B MT-B LT-A LT-B ST-A ST-B MT-A MT-B LT-A LT-B ST-A ST-B MT-A MT-B

Panel A: Govt. Bonds

ST-A 1.00
ST-B 1.00 1.00
MT-A 0.87 0.88 1.00
MT-B 0.85 0.87 0.98 1.00
LT-A 0.11 0.14 0.50 0.52 1.00
LT-B 0.10 0.13 0.48 0.52 0.98 1.00

Panel B: AAA Bonds

ST-A 0.90 0.91 0.78 0.80 0.15 0.15 1.00
ST-B 0.91 0.91 0.79 0.81 0.16 0.15 1.00 1.00
MT-A 0.54 0.57 0.74 0.78 0.67 0.67 0.70 0.71 1.00
MT-B 0.51 0.54 0.68 0.74 0.61 0.62 0.71 0.71 0.96 1.00
LT-A −0.02 0.01 0.32 0.36 0.80 0.80 0.15 0.15 0.78 0.76 1.00
LT-B −0.03 0.00 0.31 0.35 0.79 0.79 0.13 0.14 0.75 0.75 0.99 1.00

Panel C: Agency Bonds

ST-A 1.00 1.00 0.87 0.85 0.11 0.10 0.90 0.91 0.54 0.51 –0.02 –0.03 1.00
ST-B 1.00 1.00 0.88 0.87 0.15 0.13 0.91 0.92 0.58 0.54 0.02 0.00 1.00 1.00
MT-A 0.55 0.55 0.64 0.63 0.22 0.20 0.52 0.54 0.43 0.38 0.09 0.10 0.55 0.55 1.00
MT-B 0.57 0.58 0.67 0.67 0.23 0.22 0.55 0.56 0.45 0.41 0.11 0.12 0.57 0.58 0.99 1.00

Note: ST-A: short-term common bond, ST-B: short-term bond, MT-A: medium-term common bond, LT-A: long-term common bond, LT-B: long-term Sukuk
bond.
 Pricing anomaly 251
Acknowledgment
We acknowledge, with sincere gratitude, the help provided by Meor Amri,
the CEO of Bond Pricing Agency of Malaysia, who gave access to their ex-
tensive data series for this research and the University of Putra Malaysia
for help in data collection via DataStream. We are also grateful for the con-
structive comments from Duc Nguyen and the participants of the fourth
Paris Financial Management Conference. Some of the contents in this chap-
ter is based on Ariff, Chazi, Safari, and Zarei (2017) and Ariff, Zarei, and
Bhatti (2018).

Notes
1 This paper was adapted from the article “Test on yields of equivalently-rated
bonds” published by Mohamed Ariff, Alireza Zarei, Ishaq Bhatti on Interna-
tional Journal of Islamic and Middle Eastern Finance and Management, 2018.
2 For example, Type B bonds have real asset backing, distributes the coupons
from profits of the assets backed with specific provisions of risk-sharing, etc.
3 The research team conducted face-to-face interviews to assess the attitude to
the two types of bonds. We found that the investors as well as the investment
advisors consider the two types as being equivalent. The stakeholders use the
standard algorithms to price both types of bonds.
4 Please refer to the following publications for definition of profit-shared con-
tracting and other details on certificates (Ariff & Iqbal, 2011; Ariff, Iqbal, &
Mohamad, 2012).
5 The tests were done with both means and medians in order to avoid spurious test
results if the distribution of returns is non-normal.

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16 Resolving Islamic finance
disputes through arbitration in
the Middle East1
Maria Bhatti

16.1 Introduction
During the past three decades, the Islamic Middle East has experienced
rapid economic growth and become a significant player in the international
commercial system. A growing interest has emerged in alternative forms of
financial and economic institutions in different parts of the world due to
commercial globalisation. The rapid development of commercial activity in
the Islamic world has also led to a growing interest in laws and procedures
regulating Islamic finance disputes, and the potential tension between the
Western model of commercial arbitration and Islamic legal principles.2
The majority of Islamic finance assets, according to the Thomson Reuters
Report notes that the majority of Islamic Finance assets are held by Saudi
Arabia, Malaysia, Iran and the UAE as per Figure 16.1.3 Furthermore, a re-
port by Standard & Poor’s Rating Services titled, ‘Islamic Finance Outlook
2016 Edition’ reports that Islamic banks in the GCC were growing faster
than conventional banks between 2008 and 2014 (Figure 16.2).4 For this rea-
son, Ayub observes that

Islamic principles of economics and finance…have already proved their

ability to attract policymakers and practitioners from all over the world
to develop the edifice of an efficient financial a system…Islamic finance
has been developing so vigorously that it has evolved from a nascent in-
dustry to a global market, where Muslim and non-Muslim are working
together and learning from each other for the development of relevant
products and services.5

Consequently, the arbitration of Islamic finance disputes becomes relevant.

Islamic traditions influence arbitration in the Middle East, and therefore,
Islamic jurisprudence plays a crucial role when trying to understand and
analyse the function of international commercial arbitration in resolving
Islamic finance disputes. This tension has the effect of rendering the Arab
world as an unpopular place for arbitration, and this may be due to the lack
of confidence the international world has in the arbitration laws of the Arab
countries.
 Resolving Islamic finance disputes 255

Global Islamic Banking Assets Top 10 Countries (FY 2014, US $Bn)

350 250

300
207
200
250

150
200

150
100

100
50
50 39 38
32 33
24 26
16
9 8 4
0 0
Iran Saudi Arabia Malaysia UAE Kuwait Qatar Bahrain Turkey Bangladesh Indonesia Other
Fully fledged Window No. of Islamic Finance Instuons

Figure 16.1 Global Islamic banking assets top 10 countries (2014).

Source: Thomson Reuters Islamic Finance Development Report 2015, page 6.

From 1998 till 2006, only 206 out of 8,085 arbitrators were Arab.6 Fur-
thermore, in 2006, 62 cases registered at the International Chamber of
Commerce involved at least one Arab party, and among these cases, only 11
had the seat of arbitration in an Arab country.7 This article will argue that
in order for the Arab world to excel in the international commercial world, it
is vital for countries from the Islamic Middle East to consistently recognize
and enforce arbitral awards as per the New York Convention and ensure
Shari’a laws are in harmony with dominant international legal conventions
and practices. In this way, arbitration will become a useful dispute resolu-
tion mechanism for Islamic finance disputes.

16.2 Arbitration in the Middle East

It is evident that the Middle East is beginning to make an effort to expand
their economic opportunities by attracting investors. For example, many
countries are now joining the World Trade Centre and registering at the
International Chamber of Commerce.8 Many new arbitration centres have
also been established, including the Euro-Arab Chambers of Commerce,
the Cairo Regional Centre for International Commercial Arbitration, GCC
Commercial Arbitration Centre, Dubai International Arbitration Cen-
tre, Abu Dhabi Commercial Conciliation and Arbitration Centre and the
International Islamic Centre for Reconciliation and Arbitration.9 Since the
early 1990’s, many Arab countries have moved towards modernizing their
arbitration legislation and codifying laws and regulatory systems regarding
commercial arbitration.10
An increasing number of Arab states have chosen to draft their arbi-
tration laws modelled on the UNCITRAL Model Law on International
256 Maria Bhatti

Asset Growth comparison: Islamic banks versus

Conventional banks 2008-2014
25.00%

20.00%

15.00%

10.00%

5.00%

0.00%
2008 2009 2010 2011 2012 2013 2014
Islamic banks Convenonal banks

Figure 16.2 Asset growth comparison: Islamic banks versus conventional banks
2008–2014.
Source: Standard & Poor’s Ratings Services: McGraw Hill Financial, Islamic Finance Out-
look 2016 Edition, (2016), page 40.

Commercial Arbitration. This includes countries, such as Bahrain, Egypt,

Jordan, Oman, and Tunisia. Furthermore, Kuwait and the UAE are also
considering introducing modern arbitration legislation based on the Model
Law.11 On the other hand, Algeria, Lebanon, and Morocco have adopted
the French approach.12
The international community has become more globalized concerning its
consensus on substituting international arbitration for domestic litigation
in areas of international investment and commercial disputes. The com-
munity has also provided space for fair and effective international dispute
resolution and encourages the role of states in establishing an international
and national legal environment as well as a supportive reciprocal relation-
ship between national courts and arbitral tribunals.13 For this reason, many
Arab countries have also ratified the New York Convention. These coun-
tries include Algeria, Bahrain, Djibouti, Egypt, Jordan, Kuwait, Lebanon,
Mauritania, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Syria, Tuni-
sia, and the UAE.14

16.3 Public policy

The notable Islamic scholar, Abu Hamid al-Ghazali (d. 1111) wrote in
length about the concept of public interest (maslahah) in his works, Shifa
al-Ghalil and al-Mustasfa.15 Although Ghazali was generally critical
about the concept of maslahah, he thought of it as a valid concept if it
promoted the maqasid (higher objectives) of Shari’a. Ghazali defined the
five higher objectives of Shari’a: faith, life, intellect, lineage, and property
 Resolving Islamic finance disputes 257
and emphasized the protection of the objectives as a matter of absolute
priority.16 The reason why this is important in the area of arbitration is
that parameters, such as the higher objectives of law and life after death,
are not recognized under secular law.17 Therefore, the fact that countries
such as Saudi Arabia are signatories to the New York Convention does
not provide security for foreign companies regarding the enforcement of
arbitral awards.18 Article V (2) of the New York Convention provides that
recognition and enforcement may be refused if (a) the subject matter of
the difference is not capable of settlement by arbitration under the law of
that country, or (b) the recognition or enforcement of the award would be
contrary to the public policy of that country.19 Signatories can, therefore,
avail themselves of Article V (2) (b) and not recognize an arbitral award
on the basis that it is contrary to public policy. This is an issue in Saudi
Arabia as public policy is determined by reference to Shari’a (including the
common good of humanity) as opposed to just the parties that are involved
in the dispute.20
Arguably, the public policy referred to under Article V (2) (b) is interna-
tional public policy, which refers to laws relating to exchange control, illegal
activities such as arms traffic and counterfeit currency, or the protection of
tenants.21 However, the national courts of some Islamic nations do not rec-
ognize foreign awards due to public policy under Shari’a law.22 For example,
Article 2 of the UAE Civil Code states, “one shall resort to the rules and
principles of the Moslem fiqh in the construction of the laws,” and Article
27 provides that “the provisions of all the laws which would be against the
Moslem Shari’a, public order or good morals of the State of the United Arab
Emirates shall not be applied.”23
Public policy under Shari’a relates to a procedural and substantial aspect.
The procedural aspect does not cause many issues as they require:

1 strict equal treatment of parties to the arbitral action;

2 Prohibition against the arbitrator deciding without listening to both the
plaintiff and defendant;
3 Prohibition against an arbitrator from making an award without giving
the parties the opportunity to submit their evidence, please and defence.24

However, in regard to the substantive aspect, as mentioned above, two main

differences may arise: (1) the Shari’a prohibition of interest (riba) and (2) un-
certainty/risk (gharar). This may cause tension between public policy under
secular law predicated on individual rights and public policy under Shari’a,
which is more focused on collective rights.25 It also worries many scholars
such as Mallat, who have a more cynical approach: ‘whether rejected openly
by legislation or hampered by administrative means, the uselessness in Leb-
anon of an arbitration clause…is true of Bahrain, of the UAE, of Kuwait, of
Jordan and Oman.’26
Similarly, Akaddaf states, “although Saudi Arabia ratified the New
York Convention….the Saudi legal system does not recognize or enforce
258 Maria Bhatti
agreements of foreign jurisdictions.”27 On the other hand, Al-Baharna ar-
gues that Kuwait and Syria have routinely enforced the New York Conven-
tion, and cites Merrill Lynch v Behbehani (1985).28 In this case, an English
arbitrator issued a $1,314,484.896 award against Behbehani. Roy views
Kuwait’s willingness to enforce an arbitral proceeding against itself as a
positive step in embracing the New York Convention.29 On the other hand,
Roy argued that

[a]s Saudi Arabian law and policy is diametrically opposed to the rules
and laws of many member nations, Saudi Arabian courts may find it
easy to reject non-domestic arbitral awards pursuant to New York Con-
vention Article V (2)(B). In essence, Saudi Arabia may not be required
to enforce any more non-domestic arbitral awards than it did prior to its
1994 accession to the New York Convention.30

The lack of enforcement is concerning as it ends up defeating the objective

of the New York Convention and in turn, the arbitration processes itself.31

16.4 Recent Reforms

Nevertheless, the new Saudi Arbitration Law 2012 introduced in 16 April
2012 reforms arbitration laws in Saudi Arabia to make them more com-
patible with international law. Saudi Arabia has also introduced the En-
forcement Law 2013 to ensure that arbitral awards are enforced as per
international standards. Although this is a step in the right direction, it still
unclear whether these new reforms will achieve these goals. Interestingly,
the Saudi Arbitration Law 2012 under Article 2 states ‘[w]ithout prejudice
to the provisions of Islamic law and the provisions of international conven-
tions in which the Kingdom is party, the provisions of this regulation are
applied to every arbitration.’ Therefore, the new law is aiming to adhere to
both Shari’a as well as international conventions. According to academics
Nesheiwat and Al-Khasawneh, ‘[t]he drafters of the New [Saudi] Law made
a conscious decision to base it on the UNCITRAL Model Law in order to
create a legal framework for arbitration that is more in tune with interna-
tional standards. At the same time, the drafters sought to maintain the es-
sential principles of Shari’a and local practice, thus creating a hybrid set
of rules that simultaneously deviate from a converge with the UNCITRAL
Model Law.’32 It will be interesting to see how these objectives are met.
Another new development in the area of Shari’a arbitration is the intro-
duction of institutional arbitration rules, known as the i-Arbitration Rules
2012 where the “i” indicates compliance with Shari’a.33 These rules were
developed by the Asian International Arbitration Centre (formerly known
as the Kuala Lumpur Regional Centre for Arbitration). The benefit of in-
stitutional arbitration rules is that they can be used by parties internation-
ally and are not limited to national boundaries. The i-Arbitration rules are
 Resolving Islamic finance disputes 259
consistent with international conventions and include a clause which allow
the arbitrator to use Shari‘ah-based penalties in the event of late payment
(as opposed to interest), known as gharamah or the concept of compensation
(ta’widh). One difference between interest and compensation is the reference
to the Islamic money market as established by the Bank Negara Malaysia
when calculating the profit rate awarded.34

16.5 Conclusion
In recent times, measures are being taken to address the alienation of the
Islamic world and the dismissive attitude toward Shari’a in the field of in-
ternational commercial arbitration in the Islamic Middle East. Countries
in the Islamic world are making more of an effort to expand their eco-
nomic opportunities and harmonize their commercial legal systems with
the international world, in order to attract investors. According to Profes-
sor A.S. El-Kosheri, the increasing popularity of international arbitration
suggests that

Arbitration will become the natural justice in business communities in-

side and outside the Arab world. Nowadays, complicated transactions
take place, and there is substantial inward and outward investment,
which means that we need to find a good forum for resolving disputes.35

This is evident by the fact that growing number of countries from the Islamic
Middle East are ratifying the New York Convention, and numerous coun-
tries have also based their arbitration laws on the UNCTRAL Model Law
on International Commercial Arbitration. Nevertheless, even after the rati-
fication of international conventions, the Arab world is seen as an unpopu-
lar place for arbitration due to the lack of confidence that the international
world has in the arbitration laws of the Arab countries. This is because
Shari’a law is highly complex and depending on the country, huge variations
exist regarding the incorporation and application of arbitration laws and
the practice and procedure in enforcing the arbitral awards.36 Complications
arise due to the complex interaction between secular law and Shari’a law
depending on the amount of influence each law plays in a particular coun-
try. Moreover, the fact that a country has ratified the New York Convention
does not guarantee the enforceability of the award due to the public policy
carve-out exemption.
In light of the global financial crisis, it is vital for the Middle East to
become a more popular destination for commercial arbitration. For this to
occur, the arbitration framework should recognize the rich Shari’a jurispru-
dence and its growing international emergence in the international commer-
cial world as well as the current dominant international legal conventions
and practices. Shari’a law can no longer be dismissed as a backward form of
legal system with no modern application because it is a matter of conscience
260 Maria Bhatti
that plays a huge role in influencing the mindset of individuals living in the
Middle East. However, at the same time, jurisprudential tools from within
the Shari’a, such as the concept of maqasid (higher objectives of Shari’a law)
consisting of maslaha (public interest), ijtihad (independent reasoning), and
re-interpretation should be used in order to harmonize Shari’a law more
effectively with the international system of arbitration. It is crucial for coun-
tries from the Islamic Middle East to consistently recognize and enforce
arbitral awards as per the New York Convention. A more consistent form
of ‘public policy’ in accordance with Shari’a law needs to be set out and
applied as a standard throughout the Islamic Middle East in order to give
Islamic Commercial Arbitration more legitimacy.

Notes
1 This article forms part of the author’s LLM research at the University of
Melbourne.
2 See generally, Maria Bhatti, Islamic Law and International Commercial Arbitra-
tion (Routledge, 2018).
3 Islamic Corporation for the Development of the Private Sector (ICD) - Thomson
Reuters, Islamic Finance Development Report 2015: Global Transformation
(2015). www.zawya.com/mena/en/ifg-publications/241115073158K/, 6.
4 Standard & Poor’s Ratings Services: McGraw Hill Financial, Islamic Finance
Outlook 2016 Edition (2016). www.spratings.com/documents/20184/86966/
Islamic_Finance_Outlook_2016_v2/4d9d6fd9-3b11-4ae2-9168-13ee2543b73b, 40.
5 Muhammad Ayub, Understanding Islamic Finance (Wiley, 2007), 15.
6 Lara Hammoud and Sami Houerbi, ‘ICC Arbitration in the Arab World’ (2008)
25 Journal of International Arbitration 231, 234.
7 Ibid.
8 Lara Hammoud and Sami Houerbi, ‘ICC Arbitration in the Arab World’ (2008)
25 Journal of International Arbitration 231.
9 Shaistah Akhtar, ‘Arbitration in the Islamic Middle East: Challenges and the
Way Ahead’ (2008) International Comparative Legal Guides 11 at www.iclg.co.uk/
index.php?area=4&show_chapter=2201&ifocus=1&kh_publications_id=83
10 Lara Hammoud and Sami Houerbi, ‘ICC Arbitration in the Arab World’ (2008)
25 Journal of International Arbitration 231, 235.
11 Ibid.
12 Ibid.
13 Charles Brower and Jeremy Sharpe, ‘International Arbitration and the Islamic
World: The Third Phase’ (2003) 97 The American Society of International Law
643, 647.
14 Lara Hammoud and Sami Houerbi, ‘ICC Arbitration in the Arab World’ (2008)
25 Journal of International Arbitration 231, 235.
15 Mohammad HashimKamali, Shari’ah Law: An Introduction (Oneworld Publica-
tions, 2008), 124.
16 Ibid 125.
17 Faisal Kutty, ‘The Shari’a Factor in International Commercial Arbitration’ (2006)
28Loyola of Los Angeles International and Comparative Law Review 565, 602.
18 See generally, Maria Bhatti, Islamic Law and International Commercial Arbitra-
tion (Routledge, 2018).
19 1958- New York Convention on the Recognition and Enforcement of Foreign Ar-
bitral Awards, art V(2)(b),7 June 1959 at www.uncitral.org/uncitral/en/uncitral_
texts/arbitration/NYConvention.html
 Resolving Islamic finance disputes 261
20 Faisal Kutty, ‘The Shari’a Factor in International Commercial Arbitration’
(2006) 28Loyola of Los Angeles International and Comparative Law Review 565.
21 Samir Saleh, ‘Recognition and Enforcement of Foreign Arbitral Awards in the
Arab Middle East’ in Julian DM Lew, Contemporary Problems in International
Arbitration (1987) 349, 347.
22 Faisal Kutty, ‘The Shari’a Factor in International Commercial Arbitration’
(2006) 28 Loyola of Los Angeles International and Comparative Law Review 565,
603.
23 Abdul Hamid El-Ahdab, Arbitration with the Arab Countries (Springer, 1990),
742.
24 Samir Saleh, ‘Recognition and Enforcement of Foreign Arbitral Awards in the
Arab Middle East’ in Julian DM Lew, Contemporary Problems in International
Arbitration (1987) 349, 347.
25 Faisal Kutty, ‘The Shari’a Factor in International Commercial Arbitration’
(2006) 28 Loyola of Los Angeles International and Comparative Law Review
565, 603.
26 Chibli Mallat, Introduction to Middle East Law (Oxford University Press, 2007)
349.
27 Fatima Akaddaf, ‘Application of the United Nations Convention on Contracts
for the International Sale of Goods (CISG) to Arab Islamic Countries: Is the
CISG Compatible with Islamic Law Principles?’ (2001) 13 Pace International
Law Review at www.cisg.law.pace.edu/cisg/biblio/akaddaf.html
28 Husain M. Al-Baharna, ‘The Enforcement of Foreign Judgments and Arbitral
Awards in the GCC Countries with Particular Reference to Bahrain’ (1989) 4
Arab Law Quarterly 332, 337.
29 Kristin T. Roy, ‘The New York Convention and Saudi Arabia: Can a Country
Use the Public Police Defense to Refuse Enforcement of Non-Domestic Arbitral
Awards?’ (1994) 18 Fordham International Law Journal 921, 937.
30 Ibid 954.
31 Shaistah Akhtar, ‘Arbitration in the Islamic Middle East: Challenges and the
Way Ahead’ (2008) International Comparative Legal Guides, 11 at www.iclg.co.uk/
index.php?area=4&show_chapter=2201&ifocus=1&kh_publications_id=83
32 Faris Nesheiwat and Ali Al-Khasawneh, ‘The 2012 Saudi Arbitration Law: A
Comparative Examination of the Law and Its Effect on Arbitration in Saudi
Arabia’ (2015) Santa Clara Journal of International Law 13(2), 445.
33 Kuala Lumpur Regional Centre for Arbitration, ‘KLRCA Arbitration Rules
(Revised 2013)’ (2013). http://klrca.org/rules/arbitration/.
34 Global Arbitration Review, ‘KLRCA to unveil Islamic Arbitration Rules’,
Global Arbitration Review (online), 17 September 2009. http://globalarbitration
review.com/article/1031606/klrca-to-unveil-islamic-arbitration-rules.
35 ‘Aseel Al-Ramahi, ‘Sulh: A Crucial Part of Islamic Arbitration’ (Working Paper
# 12, London School of Economics and Political Science, 2008) 20.
36 Shaistah Akhtar, ‘Arbitration in the Islamic Middle East: Challenges and the
Way Ahead’ (2008) International Comparative Legal Guides 11 at www.iclg.co.uk/
index.php?area=4&show_chapter=2201&ifocus=1&kh_publications_id=83
17 Formation of tangible capital
from intangible capital and
venture philanthropy
An innovation in Islamic
finance
Toseef Azid, Osamah Al Rawashdeh, and
Muhammad Omer Chaudhry

17.1 Introduction
Nobel Laureate Friedrich Hayek (1967, 1976, 1978, 1979, 1988) used “the
world of gift” and “the world of commerce” when he explained the term of
“extended order.” Aftermath a number of questions were raised, for exam-
ple: what if there is any difference between gifts and commerce? Is it possible
for us to distinguish between “commercial sector” from a “philanthropic
sector (voluntary sector),” or a “market economy” has different values and
norms than a “gift economy,” or “commercial transaction” has different
basis than a “gift”? Is it possible for us to find the relationship in between
commerce and philanthropy? Is the commercial and non-profit sectors more
efficient when they perform philanthropic activities? Or in a concise way
one can ask in this manner: “Is it better to have a market society in which
all transfer payments are defined by law in terms of rights and obligations,
or one in which they are gifts that depend exclusively on the benevolence of
individuals?” (Birner 2009, p.147).
From Hayek analysis, one has the impression that philanthropy is im-
pacting less than the market process and philanthropy is counterproductive
in the modern global economy. In his view market mechanism teaches us
that how to give the benefits to others, and he proposed to use the term mar-
ket economy instead of “catallaxy1”. According to him,

The morals of the market, is do lead us to benefit others, not by our in-
tending to do so, but by making us act in a manner which, nonetheless,
will have just that effect. The extended order circumvents individual ig-
norance … in a way that good intentions alone cannot do—and thereby
does make our efforts altruistic in their effects.
(Hayek 1988, p. 81)

According to Hayek, it is better for us not to know that who is getting the
benefits of the economic/social activities. Though, in contrast many of the
 An innovation in Islamic finance 263
social scientists have the different opinion, for example, Mises (1949) said,
“the ultimate end of action is always the satisfaction of some desires of the
acting man” (p.19), and similarly Frank Knight perceived,

it is a fundamental error to take the individual as the exclusive datum

because some sort of family life, and far beyond that, some kind of
wider group into which the individual is also born and develops and to
which he or she is, in varying degrees, loyal are also data for our under-
standing of human action.
(1982[1947], pp. 84–86)

Tönnies is in opine that we have two distinctive types of actions to the social
relations to the community, i.e., “natural or essential will and rational or
arbitrary will” (1940[1887], pp. 119–173).2 It means that rational or arbitrary
will is always inspired by the thought and the same applied to philanthropic
attitude towards one’s fellow human beings. However, according to Hayek
that we are continuously adjusting our different dimensions of lives (actions,
thoughts and emotions) with respect to different kinds of orders and rules,
i.e., altruism vs. extended order of market. Mauss defines the process of
philanthropy as “to give something is to give part of oneself” (1967 [1925],
p. 10). Approaches of Muass and Hayek have their own logic regarding the
issue of market and philanthropy.3
However, in the Islamic literature philanthropy has its own methodol-
ogy which we will discuss in detail in the next section. In Islamic system
there are two types of almsgiving, i.e., compulsory (Zakah, Ushaer, Fitrana)
and voluntary (any type of charity other than compulsory one). Moreover,
philanthropy is the fifth pillar of Islam, and it has its own significance for
the Muslim Ummah. Holy Qur’an mentioned a number of times about the
charity and its reward from Allah (SWT) in this life and life hereafter. The
teaching of Islam guides us that philanthropy is a complementary set to
the market set. And both have their own impact on the productivity and
efficiency on the system of a moral economy.
Asutay (2013) explained the scenario of market and non-market as:

As an extension of self- interest and private enterprise assumptions, Is-

lamic moral economy institutionalizes the market as the institutional
framework for exchange in the economic sphere. However, the market
mechanism is also filtered so that social priorities are served alongside
individually oriented utility and profit- maximizing motives. Thus, a
moral filter is expected to regulate the market. It should also be noted
that as a result of the moral filter system, to overcome the market and
government failure, Islamic moral economy relies on third- sector insti-
tutions such as waqf (voluntary organizations, pious foundations) and
zakah in serving the welfare needs of society.
(p. 62)
264 Toseef Azid et al.
According to the spirit of Islam that moral economy is started from the phi-
lanthropy. It has not only tangible impact but has the intangible effects, it
purifies the soul, it increases the degree of brotherhood and enhances the so-
cial network, it strengthens the sense of belonging among the member of the
community, it is a universal instead of local phenomenon and it increases
the bond and building the trust among the Muslim Ummah.
The structure of the present study is as follows: Section 2 discusses the
concept of philanthropy in the conventional as well in the Islamic periphery;
Section 3 presents the concept of tangible and intangible capital formation
in pure economic, social, psychological, human and religious framework;
and Section 4 explains the theory and practice of venture philanthropy. At
the end, study concludes the whole discussion and also gives some policy
suggestions.

17.2 Philanthropy in the conventional literature

Yet we do not have a standardized definition of philanthropy; however,
Dobuzinskis (2009) “defines the philanthropic order broadly, including not
merely the activities of donors and foundations but also a whole range of
processes that allocate material and symbolic resources through nonmar-
ket mechanisms fuelled by more or less explicitly altruistic motivations.”
He further added, “even gifts offered for self-centred reasons can generate
a sequence of reciprocal actions that evolve into deeper interpersonal or
social relationships. Trust is usually built in that way, for example” (2009,
p.131). Tocqueville defined as “to sacrifice a part of his interest to save the
rest” (p.503). Generally, most of the economists, on the one hand, give
the attention to the process of exchange as market phenomenon but, on
the other hand, do not consider the altruism and philanthropy in a proper
manner, i.e., individuals those are giving charity without any expectations
and do not want any reward. However, some economists emphasize on the
concept of Pareto optimality4 like Kolm (2006) discussed this very concept
and said that “Vilfredo Pareto’s forgotten distinction between utilities and
ophelimities” (Kolm 2004, pp. 16–23; 2006). In his view

the latter are estimations of individuals’ material welfare, whereas the

former take into account mutual interactions: my utility is a function at
the very least of your welfare, if not in a more complex (reflexive) man-
ner of your other-regarding utility.
(Dobuzinskis 2009, p. 136)

Dobuzinskis (2009) argued that market process and the philanthropy are
moving parallel to each other and provide the stability of the Hayek’s great
society. “Gifts exist only at the margin of the market economy” (Dobuzinskis
2009, p. 119). Karl Polanyi argued in The Great Transformation (2001[1944])
about the double movement, i.e. one is regulated by the market without any
 An innovation in Islamic finance 265
intervention of the external forces, whereas the other is the reaction of this
dimension and providing the protection of the economic and social agents
from the selfish behaviour of the market. In his opinion the existing system
of capitalism is the product of this double movement. Philanthropy belongs
to that sphere where collective, public and club goods are directly trans-
ferred to the individuals. It redistributes the income and wealth based on
the choice of the donors without there being any rights or on the part of the
receivers.
Carnegie in 1899 gave the idea of “indiscriminate almsgiving.” His em-
phasis was on the deserving and non-deserving people. Deserving are those
who are poor not because of their own fault but because of their fortune and
lack of opportunities despite their best efforts. On contrary, some are poor
because of their own decisions. He emphasizes that reward should be for
those who show the behaviours such as effort, industry and persistence
and not to those who show the behaviour of carelessness, negligence and
lethargy.
Islam condemns the non-deserving people and emphasizes almsgiving to
the deserving people. There is an authentic saying of the Prophet Muham-
mad (SAW) that on the day of judgement he does not want to see the sign of
begging on the forefront of any Muslim. He also taught that giving hand is
better than the receiving hand. But, on the other hand, it is also emphasized
that does not forget the deserving members of the community. Also Islam
encourages the Muslims to work hard instead of receiving the philanthropy,
and halal earnings are considered as someone is participating in the holy
war. Keeping that in view one cannot assume the existence of non-deserving
people in the true and pure Islamic society.
Sometimes a question is raised if no one is contributed then what will be
the situation? It has been observed in the conventional system there is no
compulsion on any individual to participate in the process of philanthropy
especially at the giving end. However, in the Islamic system, the situation is
not as the same as we have in the conventional environment. As it is men-
tioned above, in the Islamic system, compulsory charity is the one of the five
pillars of Islam, and this is the duty of the Islamic state to develop an admin-
istrative system for the collection of this religious duty. The real question
is when and why? Islam provides guidance for this question. Furthermore,
Islam accepts the right to receive payments transferred from other Muslim
Brothers. In Surah Tauba5 it is clearly mentioned that the categories where
this compulsory philanthropy must be distributed. The more one gives in
the way of Allah (SWT), in fact, the more reward he will receive in the life
hereafter. Islamic norms are so strong if they are implemented in their true
sense then charity is not for the individuals but for the development of the
society. Historically, it has been observed at the time of second Caliph Umar
bin Khatab that in the Capital of Islamic state people could not be able to
find anyone who was willing to receive the charity so they deposited it in the
treasury (Bait-ul-Ma’al).
266 Toseef Azid et al.
17.3 Formation of tangible capital from intangible capital
Generally capital formation refers to a net addition of capital stock. It is re-
alized that higher the capital formation of an economy, the faster its growth
and increases its production capacity, i.e., producing more goods and ser-
vices can lead to an increase in the level of national income. In the old
conventional literature, only traditional economic capital was discussed;
however, in the current literature different varieties of capital are discussed,
i.e., human, social, cultural, psychological and religious capital. All these
are known as intangible capital. Quite a number of social scientists dis-
cussed the importance of intangible capital and its impact on the national
income and welfare of the community.
Traditionally, economic capital (both financial and tangible assets such
as plant and equipment) has received all the attention.6 But enlightened
managers today recognize the importance not only of tangible assets, data
and physical resources, but also of intangible capital, i.e., religious, social,
psychological and human capital (intellectual capital)—“human” which in-
cludes all the workforce works for all the ranks of the organization, and
the economic term “capital” includes all those resources which are used for
investment.7
In Innaccone (1990) opinion that concept of religious capital is derived
from the theories of different types of intangible capital emerged, i.e. theo-
ries of social, cultural and human capital. He added all these are originated
from the social capital, i.e. the investment and participating of the people
in their social groups.8 It is observed that through religious capital, the
religious practices and satisfaction are produced (Iannaccone 1990; Finke
2003). Contrary to that Smith (2003) says that the natural foundations of
human behaviour are belief and moral values. Finke (2003, p.3) argued,
“Religious capital consists of the degree of mastery of an attachment to
a particular religious culture.” Finke’s definition of religious capital is
based on social capital, human capital and economic behaviour of house-
hold (Finke 2003, pp. 2–3). In general people through their practices are
enhancing and protecting their religious capital (Stark and Finke 2000,
pp. 120–121). Verter found that through religious capital, one can gain the
cultural capital.9 However in his opinion, if religious/spiritual capital was
not invested properly then it may disturb the other types of intangible cap-
ital (Verter 2003).
However in the periphery of Islam the generation of capital is started
from the economic capital but it is based on the God-fearing behaviour
(Taqwa). The whole community is developed on the basis of religion. All
behaviours towards the worldly affairs are dependent on the virtuous which
society has. Islam plays a very important role in building the character of
the Muslim individuals. God-fearing person (Muttaqi) is spending more in
the way of Allah (SWT) and expecting more reward from Allah (SWT) in the
life hereafter. So the foremost capital which is generated is religious capital.
 An innovation in Islamic finance 267
The desired behaviour is good intention, honesty, kindness, moral attitude,
virtuous behaviour, honours for others and towards brotherhood among the
members of the society, and the undesired behaviour is dishonesty, cheat-
ing, theft, jealousy, backbiting, dishonour and so on. This boosts up the
psychological state of the charity giver. In this scenario of Islamic economy,
out of religious capital the psychological capital generates and provides the
foundations of social capital. The term “psychological capital” is discussed
in detail in the different studies of economics, business, psychology, invest-
ment and sociology. A renowned psychologist Martin Seligman challenged
the prevailing understanding of the subject and introduced the concept of
positive psychology, i.e., changed the whole scenario from wrong to right,
bad to good, specifically, weaknesses to strengths, health and life rather
than illness and death. Seligman (2002) said, “when we are engaged (ab-
sorbed in flow), perhaps we are investing, building psychological capital for
our future” (cited in Luthans et al. 2004, p. 46).
In the words of Luthans et al. (2004, p. 46), “Applied to the workplace,
this ‘flow’ can be restated in terms of personal and organizational goal
alignment and job fit.” It depicts in Table 17.1 that psychological capital gen-
erates after religious capital while social and human capital lying beyond
psychological capital. In contrast, basically psychological capital consists
of “who you are” rather than what you believe and what or who you know.
Explicitly, desired behaviour consists of “confidence, hope, optimism, and
resilience—four states that have also been used by Stajkovic (2003) in his
core confidence factor for work motivation” (Luthans et al. p. 46).
Through positive organization behaviour (POB) or positive psychology
we can measure these types of capacities, more paths for the development,
more chances for the management and also the more efficient and effec-
tive work. Luthans (2002a, 2002b) drawn an axiom from POB that with the
generation of psychological capital more efficiency and productivity can be
enhanced. However, these four states have the positive impact on the work
performance, which prevails in the workplace and enhances the POB, i.e.,
higher level of productivity, better customer service and more employee
retention.
Similar to religious and psychological capital, social capital is consid-
erably more vague and unquantifiable and generally not easy to measure.
Particularly, it is based on the trust among the members of the society, mem-
bers’ personal relationship and network of the contacts. Table 17.1 describes
religious capital as “what you believe,” on the other hand social capital is
defined as “who you know.” It is worthwhile to note that social capital has
both dimensions, i.e. inside a firm (“Whom can I turn to for help in solving
this problem?”) and outside the firm (“Who can advise me on finding the
best price and quality in making this purchasing decision?”). Social capital
is generally measured and evaluated by the different dimensions of the net-
work, i.e., size, structure and its composition. Adler and Kwon (2002) after
surveying the literature on social capital have concluded that social capital
268 Toseef Azid et al.
has a significant positive impact on the human resources10 and organiza-
tional areas.11 Similar to other intangible capital, the investment on social
capital has positive impact both in the future and present on the success,
performance, efficiency and competitive advantage of the company.
On the contrary, most of the conventional literature argued that social
capital generates the cultural capital and then ultimately preparing the
foundations for the religious capital. However like Smith (2003) some are in
opine that beliefs and moral are the core value of human behaviour.
In the Islamic mythology the behaviour are developed on the basis of the
degree of piousness, i.e., how much one feels fear from God? The desired be-
haviour from social capital in the Islamic culture is good relationship, net-
work of contacts among the pious members of the society, environment of
brotherhood, good environment of friendship, helping others without selfish
behaviour and so on. However, these three intangible types of capital gen-
erate the another intangible capital known as human capital. Becker (1975)
defines “human capital as a means of production, similar to other means of
production.” In the system of Islam, human capital can thus also be built
through religious values, social network and psychological state of the com-
munity. The ingredients of human capital are rituals, knowledge, and moral
attitude that come from religious capital; hope resilience, optimism, and effi-
ciency that are taken from psychological capital; and relationship network of
contacts, friends, and brotherhood that are added from social capital. After
adding the recipe of education, training and healthcare, it emerges as the hu-
man capital. In a nutshell, ethical milieu needs an advancement in knowledge
and the desire to learn knowledge (not like a statue, it is flexible and dynamic),
improvement in experiences and skills, learning effectively the market strat-
egies and how to survive in the current state of market, behaviour, psycho-
logical state, social interaction and skill, and all of these collectively defined
as “human capital”. Thus, in the current scenario, human capital is the most
significant factor for the success of continuous performance of the firms.
Experts are differentiating religious capital and social capital from the
religious human and social human. It is a well-recognized phenomenon that
human capital plays a significant role in increasing the human efficiency
and productivity, whereas the role of social capital is also recognized the
relationships in production. Social networks have their own impact on the
economic and social life of the members of the society, e.g., from better job,
tension-free work place and social gatherings with the friends to happier
marriage. It is concluded by Putnam (2001) that religious communities and
the phenomenon of attending the church play a very important role in the
creation of social capital in USA. Because the source of the most of social
activities is based on the religious activities and hence is developing the so-
cial capital. It can be seen in Table 17.1.
Intangible capital other than human capital “can be measured in ways
similar to human capital – years of experience, practice and levels of knowl-
edge and skills” (Iannaccone and Klick 1993, p.6). In a nutshell, intangible
 An innovation in Islamic finance 269
capital cannot be evaluated as monetary capital; however, it is the degree of
“mastery or attachment.”
However, the transformation of these intangible capitals is extremely
different than economic capital, i.e., transformation cannot be purchased,
is irreversible, is a continuous process and has no limits because it creates
energy. However, it is interesting to note that the inherent feature of trans-
formation is that it is uncertain phenomenon. There is a clear-cut difference
between transformation and transaction, i.e. transformation is a universal,
wide spread and general phenomenon. Transformation has a number of
challenges to the expectations and patience because it is not continuous, it
has its own ways and own patterns and it may occur in steps. Transforma-
tion does not have homogenous impact on its participants, it is asymmetric
and its impact varies among the individuals. When we are considering sce-
nario of charity, it seems to have a multiplicative impacts on the partici-
pants. It has an empowering impact on the individual intellect ability. We
can assume the same process of transformation whenever we consider the
impact of philanthropy on the above intangible capitals. In the Islamic en-
vironment transmission of capital among the family members and genera-
tions is very much desired. It is observed from the different Qur’anic verses12
and sayings of Prophet (SAW)13 that this type of transmission has its own
impact on the building of moral society, consequently which has the impact
on the growth of the economy and society.

Table 17.1 Formation of Intangible Capital from Tangible Capital in Moral

Economy
Type of Traditional Religious Psychological Social Capital Human ∑ (End
Capital Economic Capital capital Capital Result)
Capital
Traits What you What you What you are What you What you Development
have believe know have of the
personality
Nature Finance Belief Confidence Relationship Experience Incremental
of Tangible Intentions Hope Network of Education change in
capital Assets Practice Optimism Contacts Skills capital
(plant, Rituals Resilience Friends Knowledge through
equipment, (Brotherhood) Ideas moral
patents, Healthcare economy
data)
Change Philanthropy Generation Generation of Generation of Generation New
of Resources Resources of Resources
Resources Resources
Expected Profit Reward in Happiness Satisfaction utility Falah in both
return the life of the lives
hereafter
Motivation to maximize gains (compassion, or some kind of inner fulfilment) while minimize the
losses
Source: Rawashdeh et al. (2017).
270 Toseef Azid et al.
17.4 Venture philanthropy
This is the John Rockefeller III who first introduced the term of “venture
philanthropy” in 1969; the objective is to fund those causes which are not
very much popular in the society but these causes extremely need the at-
tention of the society. However, this idea got more popularity in 1990. This
concept and term of venture philanthropy approached to that community
who wants to solve the social problems with its wealth and business wisdom.
Venture philanthropy is defined as “a field of philanthropic activity where
private equity/venture capital models are applied in the non-profit and char-
itable sectors with the overall objective to maximize social impact.” It is cat-
egorized into six key factors: “engaged partnership,” “tailored financing,”
“multi-year support,” “provision of non-financial services”, “assistance to
build organizational-capacity” and “performance measurement” (Ochs
200814). It is also worthwhile to note that venture philanthropy is not only
dealing with the charities or also not only works in earning the profit. It
works with different organization with vast varieties. These may be social
organizations, social industrialists, trading and business charities, and so-
cially driven commercial organizations. Venture philanthropy filled a gap
in between “traditional grants for non-profit” and “commercial market rate
equity and loans.” Some objectives of investment are similar to the commer-
cial organizations, i.e., sustainability and economies of scale. They are also
trying to use traditional business tools for promoting the start-up, enhanc-
ing the growth, taking the risk for certain social ventures and building sus-
tainable operating capacity, close relations in between donors and recipients
and clear target for the expected performance. These all are the sustainable
features of the best philanthropy. These are playing a very important role
in the diversification of capital market for not-profit and social organiza-
tions. In comparison with the small organizations, venture philanthropy is
more efficient because it creates higher degree of expertise and level of skill.
It is generally offering a long-term projects and core operations. The term
venturing is an approach which emphasized on determination, flexibility,
ability and the creativity which is required for the start-up venture to get
the success in the social and economic market. Moreover, it has a very im-
portant distinct feature, i.e., the venture philanthropist is always ready to
take the responsibility for success and also ready to take the risk on his
shoulders, and even always ready to play an effective role in the board of the
organization (Table 17.2).
Generally, it is observed that social- and grant-based organizations are
comparatively more risk-taking; however, the venture philanthropy has dif-
ferent characteristics and has a different policy for entry and exit. It is also
observed there is always conflict and tension in between the financial and
social returns on investment. So it is a big challenge for the venture philan-
thropist that how to match the different distinctive cultures with the differ-
ent economies, how to provide the human services and expertise and also
how to provide the capital. And on the reciprocal basis it is also necessary
 An innovation in Islamic finance 271
Table 17.2 Traditional vs. Venture Philanthropy

Features Traditional Philanthropy IFIs as Venture Philanthropists

High engagement Investors: not-engaged, Always ready to take an

gift givers, not involved active role in the growth,
beyond the grant and development and expansion
not in the process, want of the project and/or also
to know how resources committed and dedicated
are used, least concerned to a person whom they are
with effectiveness. supporting.
Tailored financing Finance: conservative, Flexible, revenue-generating
form of a grant/gift, no social enterprises; funds
payback. for infrastructure; project
delivery with growth, scale
and quality.
Multi-year support May commit to a multi- Venture philanthropists
year project funding, engage on a multi-year
no concern beyond that basis with the view toward
point, long-term project the project becoming
“dependent on grant self-sufficient.
funding”, tested and
proven projects may end
prematurely.
Non-financial Non-profits leaders and An engaged partnership with
support organizations are a venture philanthropist
usually responsible for means the delivery of
finding their own service non-financial services, e.g.,
providers are on an as- musharakah or mudharabah.
needed basis.
Organizational Supporting organizations Needs to succeed to deliver its
capacity-building that “do good”, focus services in the most effective
is on the reach and way possible support for
delivery. organizational set up.
Performance-based In traditional philanthropy, To work closely with the
measurement the evaluation person leading the project
stageconcentrates on the to develop targets, metrics,
initial project proposal and tracking methods,
screening. Performance- not only for internal
based measurement goes performance but also for
beyond reporting and impact assessment.
compares the achieved
outcomes with the
intended outcomes.

Source: Constructed by authors, information from Ochs(2008).

for the social organizations to learn from the venture capital community,
i.e., how to get the new ideas from the engagement of the venture philanthro-
pist in social issues, how to get the reputation in the community and how
to recruit the different factors of production. In the business, a number of
businesses are emerged which consider a lot of business opportunities in the
social innovation, i.e.
272 Toseef Azid et al.
for growing brand equity (through association with well-known chari-
ties or social enterprises); attracting talent (particularly younger people
who want to believe that their employer has a social conscience); and to
stimulate cultures of innovation in the mainstream business through
engagement with different types of organization.

In the business world one can see a significant growth of social organiza-
tions/social entrepreneurship. They have dual objective, i.e., earning profit
with focusing on the social goals. It creates a distinctive challenge for the so-
cial enterprise, on the one side, they are trying to preserve their commercial
position, whereas, on the other side, they are committing with their social
goals. Most of them are small in size and deficient in economies of scale
and scope. Due to this reason whenever they have a successful innovation,
the large business organizations are trying to capture their market and ul-
timately enjoying the innovation of the social entrepreneur. However, there
is also a new trend that social enterprises are developing a network which
enabled them to enjoy the facilities and services similar to the large enter-
prises. Currently it has been observed that the number of social enterprises
is increasing. At present one can see a significant financial investment trend
in the social enterprises. However, limited resources are allocated for the
development of human resources, whereas it is the dire need of the growth
and development of the social entrepreneurship and social innovation.
Keeping all the above challenges, it is considered that philanthropic
grants are ideal funding for the social innovations. Because in real terms
donors are not interested in the high level of returns as they have in the
private sector as well as they are able to handle the high level of risk. Even
though we have a lot of philanthropic funds but still there is not too much
funds allocated for the support of social innovations, there is not too much
attention about the mix of funding for individuals, how these enterprises
can work at optimal level or how to get the maximum benefits from these
funds. It is expecting that in future there will be more awareness and will be
more chances for the philanthropist to create more tools for hybrid ventures
with the combination of grants, equity and loans. Venture philanthropists
often place great importance on the role of the “social entrepreneur,” the
person not only with the vision but also with skills to carry out the project
of change.
In most of the developing countries and particularly in the Muslim coun-
tries, the issue of “brain drain” is getting a lot of attention especially in
the context of economic development, and most of their human capital is
working outside of the country of their origin. Islamic Financial Institutions
(IFIs) (and also as venture philanthropists), as being the ethical institutions,
should engage the skilled labour force in the different projects and also pro-
vide the necessary skill to the unskilled workers. This skill should be trans-
ferred to the community for the sustainable development. Additionally,
life-threatening, chronic illnesses such as HIV/AIDS and Hepatitis C are
 An innovation in Islamic finance 273
impacting the work force or shortening the amount of time that one is able
to work. Long-term sustainability of a project requires local talent. IFIs can
play a significant role in this direction also while playing the role of venture
philanthropist. Social capital and networks are very much important for the
development of the community and economy. IFIs as venture philanthro-
pists can bring social capital and networks to the projects and regions in
which they work, so their interaction with the local context could be useful.
Islamic finance has extraordinary uniqueness in the financial market.
At present it is approximately US$2.2 trillion industry. It is trying to meet
the banking requirements and needs of faith-conscious of the members of
Muslim Ummah. Those are avoiding the interest and other non-halal trans-
actions and products. It is also very important to note that approximately
1,407 IFIs all over the world. But unfortunately they are not able to provide
sufficient services to the Muslim Ummah. It may be due to the size of this
sector which is comparatively still small to conventional finance. Because
less than 1% of the total world financial assets are shari’ah compliant. How-
ever by using the philanthropy which is a significant in amount can be used
by these institutions (according to one survey that almost £371 each Muslim
on average pays charity), they can serve the Ummah in a better way. Keep-
ing the above in view, in the present study we are proposing that Islamic
venture philanthropy can use the basic tools of conventional philanthropy.
It may be in the format of tailored financing. Islamic venture philanthropy
may ask the professional financial advisors for their advice and assistance
for establishing the strong building of the community. It is assumed that the
wealth of philanthropist is used for the shari’ah compliant financial activi-
ties, and the profits of these activities can be reinvested for the development
of the larger communities. This proposed model will establish the strong
network among the IFIs and the local investors and philanthropists. This
will provide an opportunity for sharing the risk and profit which have the
well- defined development objectives. And it also has its financial and so-
cial impact through the venture philanthropy in the local as well as Muslim
community at large. For more understandings, Table 17.3 depicts the differ-
ent types of venture philanthropist.
The Islamic banks should invest socially and ethically. It is explained by
Asutay (2013) as:

IBF is a society- oriented financing proposition, as it aims to serve the

communities and not markets. Since IME aims to create a framework of
developmentalist financing, instruments of poverty reduction are an in-
herent part of IBF. For this, in addition to Islamic financing of economic
activity for development, zakah and qard hasan can be mentioned.
(p.64)

IFIs in this context can perform their ethical duty on the following frame-
work: open their doors for every type of ethical finance, deal with the
274 Toseef Azid et al.
Table 17.3 Types of Venture Philanthropist

Actors In Conventional Setting In an Islamic Setting

Investors Funds for social purposes Funds for social purpose but on
(loans, grants, equity the condition of Mudharabah/
financing), social, financial, Musharakah, benevolence
and ecologic returns, blended loans, Shari‘ah compliant
value, blended model. products.
Incubators Quite different from the Sweat equity and own concept
venture capital incubator, project but in the periphery of
sweat equity, own concept shari‘ah.
project.
Ally Supports the social Supports the individuals those
entrepreneur, or the are more pious but also social
person, rather than a social entrepreneurs, and creating the
enterprise or organization. ideas for the projects but under
the umbrella of Shari’ah.
Broker an organization that provides The same as we have in the
services by bringing together conventional set up
the social entrepreneur and
the philanthropist.
Nominator Nominating possible Nominating those organizations
organizations, projects, those have a high degree of
or social entrepreneurs to goodwill in term of their
receive sponsorship, but is efficiency, provider of social
not in and of itself a venture services and have the high
philanthropist. degree of moral values.

Source: Constructed by authors, information from Ochs (2008).

noneconomic results of economic action, are responsible for the efficiency

and equity of these funds, improve the common well-being of all the mem-
bers of the society/community through profit which is produced by the
ethical investment funds. There should be transparent process in all the
business and financial activities, and active involvement of the represent-
ative of the set of philanthropist in the process of decision-making should
be encouraged. These are some relevant points to be followed in addition to
the above points. So in this way they can emphasize on their social, financial
and religious goals. We are expecting that after observing the efficient per-
formance of the IFIs, these philanthropists (also known as business angles)
will provide more funds for the social ventures, will provide their advisory
service and also will persuade the other investors for the potential projects.
They will also be able to convince the other investors about the benefit of
these projects with the reference to this world and life hereafter.
Currently all over the world, there is a growing development in the IFIs
based on their ideology, and they can play a very important role in diversify-
ing the capital market, i.e., tangible and intangible. In that way they can also
efficiently promote the activities of social purpose organization. Because
their basic structure is different than the commercial bank, they can offer
 An innovation in Islamic finance 275
Table 17.4 Venture Philanthropy in Context
Blended Societal and Financial Values
Primary driver Primary driver is to
is to create create financial
societal values
values
Special Purpose Organizations (SPOs)
Charities Revenue generating social Socially Traditional Business
enterprises driven
Business
Grants Trading Potentially Breakeven Profitable Profit CSR Company Mainstream
only revenue sustainable all income surplus distributing allocating Market
not and > 75% from reinvested socially percentage Company
trading grants trading trading driven to charity
revenue
Impact only Impact First Finance First Financial
Impact first investors seek to optimize social Financial first only
impact with a floor of financial returns investors seek to
optimize financial
return with a floor
of social impact
Venture philanthropy focus
Grant making Social investment focus
Impact investing
Source: Balbo et al. (2010, p.18).

those packages which are the blend of social and financial returns. It is well
worth to note that skill and training of the human resources are very much
important for the growth of the social sector. However, it has been observed
that in most of the Muslim countries labour market is not well developed.
And also sufficient resources are not devoted for the development of these
resources. Regarding this issue IFIs through venture philanthropy can pro-
mote the enterprise of the social sector. Venture philanthropy and its related
impacts are summarized by Balbo et al. (2010) (see Table 17.4).

17.4.1 Status of venture philanthropy under the umbrella of Shari’ah

In the Islamic jurisprudence, the approach that is adopted by all school of
thoughts is based on the Qur’anic principle of facilitation, i.e., inclusive ac-
commodation and flexibility. Qura’an guides us as “Allah desires ease for
you and does not desire hardship for you” (2:185), and “He has chosen you,
and has not laid upon you any hardship or constriction in the matter of
Din” (28:78). “Allah does not want to make things hard for you” (5:6). And
Allah’s messenger said, narrated by A’isha (may Allah be well pleased with
her): “Never was Allah’s Messenger (blessings and peace be upon him) pre-
sented with two options except that he would choose the easier of the two,
so long as it was not a sin.” And narrated by Anas b. Malik (may Allah
be well pleased with him), the Prophet (blessings and peace be upon him):
“Make things easy and do not make things difficult. Give glad tidings and
276 Toseef Azid et al.
do not make people feel averse.” Similarly ‘Allama Ibn Qudama from Han-
bali school said, “If a jurist is approached for an edict and his edict remains
devoid of openness and flexibility because of his rigidity the edict-seeker
should be guided towards some other jurist who is open-minded and flexi-
ble.” So it is consensus among the jurists if there is need of time, then we can
adopt accommodating reasoning than the jurists’ reasoning. For example,
al-Sarakhsi narrated:

If two people entrusted a person with gold coins (dinar), silver coins
(dirham), clothes, riding beasts and servants, and then one of them went
back to reclaim his possessions from him, according to Imam Abu Han-
ifa it would not be permitted for him to do so unless both are present.
Whereas according to Imam Abu Yusuf and Imam Muhammad, he will
be ordered to divide the property and pay him his rightful share.

Imam Muhammad said, “The verdict of Imam Abu Hanifa is closer to ju-
ristic reasoning (aqyas), while the verdict of Imam Abu Yusuf is more ac-
commodating (awsa‘).” Other school of thoughts have the same opinion that
accommodating has more preference. On the basis of the above discussion
we have the opinion about the venture philanthropy, its structure should be
based on the views of accommodating (awsa).
Keeping the above in view that venture philanthropy has no any conflict
with the basic laws of Islam, and there is more ease for the public. If the
charity for the public interest is accommodating, then it can be used by the
IFI as venture philanthropy and can be used for the other purposes which
will enhance the welfare of the Islamic society.

17.5 Conclusions
The integration market and non-market institution can be established in
the system of Islam. Especially in the context of philanthropy and IFIs, this
idea is more practicable. Philanthropy is desirable and necessary for filling
the gaps of the Muslim countries. It also creates the bindings among the
members of the Muslim Ummah. Simultaneously, it gives the strength to
the brotherhood among the givers and receivers. From the religious point
of view it gives the more utility to the givers as Qur’an says that spend in
the way of Allah (SWT) which is beyond to your needs. It is very much im-
portant to note that in the process of philanthropy the benefits to both the
parties (givers and receivers) increase the relationship between them.
We observed in the different studies that philanthropy has the positive
impact on the development and growth of the personalities of the givers and
receivers. For example, receivers feel the importance of the philanthropy,
its influence on the society/community and its goodness, and then will try
to become on the side of givers. This will give him the sense of sharing
which ultimately increases the new resources and generates the tangible and
 An innovation in Islamic finance 277
intangible capital of the economy as well as society. It also creates the strong
motivational framework. However, the aspect of life hereafter and account-
ability are very much significant, and without considering these factors we
cannot be able to explain this phenomenon. Similarly, IFI will be able to
fill that gap which remains in the society even after the tremendous efforts
of public sector. Here venture philanthropy is the best tool which can be
used for the stability and solidarity of the community and society. And also
IFIs through venture philanthropy can integrate market and non-market
institutions.
We are aware that the needs of the Muslim Ummah are diverse and vary
significantly between countries and even within any specific region. Never-
theless, there are certain needs that are global, the first of which is educa-
tion. Intangible capital is the essential element for development, and is used
as one of the key criteria when assessing an investment opportunity. When
we look at investment in intangible capital, especially in the Muslim world,
data tells us that there is a significant underinvestment, especially at the
lower levels of the socio-economic stratum. Investment in venture philan-
thropy through IFIs within local institutions can generate significant return
on both the financial and social levels.
One more important aspect will be informal activities of IFIs. They can
involve themselves if there is any natural disasters, such as floods or earth-
quake. It has been observed that the performance of Muslim philanthropist
and philanthropic organization is significantly more rapid and efficient than
the typical government agencies, for example, the quick help they provided
to the Indonesian victims during the tsunami and victims of earthquake in
Pakistan in 2005.
At the country level, profit will be directed towards the building of social
infrastructure such as healthcare, community care, education, training, en-
vironmental programs and provision of accommodation that is affordable
to people on low income. IFIs with their local counterpart will also arrange
funding for these services.
Islam requires us, and in fact blesses us, with the obligation to give to
others. We can assert that this Shari‘ah compliant venture philanthropy pro-
gram in leveraging Zakat and Sadaqah can satisfy the development demands
of the poor communities of the different Muslim countries and simultane-
ously can generate the financial returns and growth in the financial sector.
This combined approach based on wealth creation and transfer, and new
ways and paths for the commercial approaches for the social change could
be able to attract the high level of new financial resources. Furthermore,
there will be better community development through Islamic venture phi-
lanthropy. Islamic venture philanthropy that integrates with modern and
merging approaches for social investment will be enabled to increase the
social capital; this will perform more than the traditional philanthropy and
will play a very significant role for the growth and development of oriented
models. It is suggested that Islamic finance industry which is offering an
278 Toseef Azid et al.
alternative to the conventional finance system can serve more humanity
particularly to the Muslim communities than its conventional counterpart,
and Islamic venture philanthropy can offer a sophisticated amended Islamic
finance which can fulfil the objective of social innovation.

Notes
1 (katalattein or katalassein) which has Greek rootsmeans both “to exchange” and
“to receive into the community” or “to turn from enemy into friends.”
2 “wesenwille (natural or essential will) and kürwille (rational or arbitrary will).
This distinction turns on the character of deliberation, between, on the one
hand, where the action (or the will) unavoidably includes thinking, and, on the
other, where thinking directs action (or the will). Kürwille is a form of action
motivated by the thought (thus, prior to the action) of satisfying one’s own need,
hence, the prototypical social relation is that of exchange. Characteristic of kür-
wille is the individual’s orientation toward the attainment of what is desired by
that individual, and as such it does not, according to Tönnies, encompass a ‘pos-
itive’ (or, philanthropic) attitude towards one’s fellow human beings” (Tönnies
1940 [1887], pp. 119–173; Cited in Steven 2009, pp.5–6).
3 “The differences between Hayek’s and Mauss’s approaches are clearly illus-
trated by their ideas on the emergence and function of credit. For Mauss, fi-
nancial credit as we know it has evolved out of a system of giving, accepting,
and reciprocating gifts that serve as a provision for the future for individuals.
Gift-giving, while creating cohesion, is not deprived of elements of self-interest.
For Hayek, on the contrary, credit is the result of the spontaneous emergence of
partial-reserve banking in a market economy. Not only did it make it possible for
individuals to permanently live beyond their means, it practically forced them
to do so, producing ever more in order to be able to pay their debts, thus making
credit one of the causes of economic growth” (Birner 2009, p.150).
4 Pareto optimality, is a state of allocation of resources in which it is impossible
to make any one individual better off without making at least one individual
worse off.
5 Chapter Tauba Verse 60.
6 “Consider the millionaire who continues to use his capital actively in enterprises
which give employment and develop the resources of the world. He who manages
the ships, the mines, the factories, cannot withdraw his capital, for this is the tool
with which he works such beneficent wonders; nor can he restrict his operations,
for the cessation of growth and improvement in any industrial undertaking marks
the beginning of decay” (Carnegie 2006, p. 50, cited in Otteson 2009, p.25).
7 “Bill Gates has been known to comment that the most important assets in his
company walk out the door every night. In other words, he recognizes that the
collective knowledge, skills, and abilities of his employees represent a distinctive
competency that has created value and set Microsoft apart from its competitor”
(Luthans et al. 2004, p.45).
8 “Rodney Stark and Roger Finkefurther developed the concept and have written
extensively on the subject, amongst other well-known sociologists of religion
such as Christian Smith, Jerry Z. Park, Wade Clark Roof, and Nancy Ammer-
man” (Albaugh, p.2 available at nazarene.org/files/docs/albaugh_ryan_paper.
visited on 10 November 2015).
9 It is a well-recognized phenomenon that if someone from any group of clergy,
people is listening him very carefully and giving him more prestige and honour.
 An innovation in Islamic finance 279
10 Success in career, turnover in jobs, compensation for the executives, and help in
searching jobs.
11 I exchange of resources among the different units, entrepreneurship, relations
with the suppliers, networks among the set of regional production units, and
learning from the different companies.
12 Surah Al Tour.
13 Saying of Prophet.
14 Table 17.2 portrays the more detail.

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18 Theoretical, practical vis-à-vis
legal development in Islamic
banking
A case of Pakistan
Hussain Mohi-ud-Din Qadri

18.1 Introduction
A system sought by any society is an organic manifestation of its members’
beliefs and perception on and of life, its purpose and their role in this world.
Thus, the social system can never be separated from its doctrinal roots. The
term “system” incorporates a set of relations, subsystems, beliefs and insti-
tutions activated in the life of people, as well as the activities, policies and
laws that underline their governance.
In order to transform the philosophy of the science of economics into a
practical form capable of addressing man’s needs and its implementation in
the society, economic systems are created. Based on the definitions given
above, we have four economic systems that are currently in vogue today:

• The capitalistic economic system

• The socialistic economic system
• The mixed economic system
• The Islamic economic system

18.1.1 The Islamic economic system

Islamic economics is the knowledge of injunctions and rules of the
Shari’ah that prevent injustice in the acquisition and disposal of ma-
terial resources in order to provide satisfaction to human beings and
enable them to perform their obligations to God and the society.

As is generally understood, the objective of any economic activity is satis-

faction of human wants, needs and desires. But in Islam, this is not an end
in itself. A man is not supposed to live for himself or for his kin only. His
obligations as a social being are much larger than this. He has obligations
and responsibility towards the needy of the society. A Muslim earns a living
not merely to satisfy his own and his family’s wants, but also to discharge his
obligations towards society at large. This is what God has ordained for him,
and this is an objective, which also makes his earning a pious act (‘ibadat),
in the sight of God.
282 Hussain Mohi-ud-Din Qadri
18.2 Historical background of Islamic economics and
banking in the world
The formation of financial institutions without Riba as a landmark of Is-
lamic bank was tried in the 1940s in Malaysia, but was unsuccessful (Erol
and El-Bdour, 1989). In the 1960s, the formation of Islamic banking has
become a reality in the world; it does not mean that concept of banking did
not exist before the arrival of Islam (Joni and Hadenan, 2006). Riba-based
banking was operational when Islam was introduced as a civilization. In
those days, Arabs used to lend their money to other parties for trading
through the methods of al-Qirad or al-Mudarabah for the sake of making
interest-based profits. These methods were popular among both the Qureshi
Arabs and the Jewish community (Karim, 1996). In the pre-Islam era, the
city of Mecca was the center of trade and was considered one of the main
routes for traders traveling from north to south. Facilities like money de-
posits and business loans were popular among the traders in those days
(Mohamad, 2013).
Even before the prophet hood was announced, Holy Prophet Muhammad
(pbuh) was famous for his moral demeanors such as honesty and veracity.
The Arabs of his time selected him as their wealth keeper until he migrated
to Medina (Hamoud, 1985). On the other hand, during the time of the Holy
Prophet (pbuh) there was a man (Al-Zubayr al-Awwam) who assumed the
role of banker and saved the deposits of other people. However, he modified
this form of money keeping into loans.
The origin of Islamic banking can be traced back to the time of the
Prophet Muhammad (pbuh), especially after his migration to Medina
(Qadri, 2008). The formation of the institution of “Bayt al-Mal” is an ex-
ample of the method of central banking in the Islamic state of Medina.
Bayt al-Mal contributed significantly while eradicating the poverty for the
society of Medina. The first office of Bayt al-Mal was established in the
Prophet’s mosque in Medina.1 However, the Caliph Umar bin al-Khattab
(634–644 AD) professionalized the operations of Bayt al-Mal by making it
an autonomous body.2 There were two main sources of revenue for the Bayt
al-Mal. The primary source was the zakat (alms collected for the poor or
wealth tax), kharaj (land tax), jizyah and donations. The secondary source
included property without an owner, the assets of apostates and the proper-
ties of individuals without legal heir (CIFP, 2006).
All these funds were spent in two ways. The first expense was for the de-
fense of the state and the salaries of government employees. The second
expense was for community and infrastructural development, such as the
construction of roads and an irrigation system (CIFP, 2006). In the early
days of Islam, the Finance Ministry of the country came under the com-
mand of the Bayt al-Mal. Facilities like money deposits and money lend-
ing were initially restricted. However, during the Caliphate of Umar bin
al-Khattab, these policies were relaxed and a limited number of individual
business loans were made available. For example,
 A case of Pakistan 283
The sons of Caliph Umar bin al-Khattab, Abd Allah and Ubayd Allah
received business loans from the Bayt al-Mal prior to their business
trip. Caliph Umar stated that the transaction that took place between
his two sons and the Bayt al-Mal was based on the Mudarabah prin-
ciple and he asked his sons to give a share of their profits to the Bayt
al-Mal.
(This episode is recorded in the Muwatta’ Imam Malik) (CIFP, 2006)3

During the early days of Islam, money orders and bills of exchange were
also used. Ibn al-Abbas once took a money deposit and notified Kufah of
its receipt (CIFP, 2006). Meanwhile, in the history of the Islamic banking
system, according to Al-Yaqubi (d. 897c), Umar bin al-Khattab, was the
first to draw cheques and to put his seal underneath and sign them4 (Mo-
hamad, 2013). A similar statement was made by Al-Jahashiyari (d. 942 CE)
in respect to Harun Ar-Rashid, “Al-Fadhl asked him (Ar-Rashid) to draw a
cheque in his own hand with regards to the sum of money”. Ibn Miskawaih
(d. 1030) in his Tajarib al-Umam also mentioned that the wages and sala-
ries of the army were paid via cheques and that one of the major charges
made against Muhammad bin Dawud was that he paid the army in cash in-
stead of cheques. So, the custom of using cheques became a common prac-
tice among the general populace. Thus, centers of money exchange were
established by the Muslim merchants in different parts of Muslim world
and beyond. Muslim states and dynasties all over the world embraced this
well-established banking and finance system, scrupulously avoiding Riba
in all shapes and forms.
The formation of Islamic banks has been sanctioned by divine revelation,
which allowed trade and the functioning of banking that was free of Riba
(Lee and Detta, 2007). K. H. Mas Mansur first formulated the argument
that the interest (Riba) charged by conventional bank was illegal (haram)
because it was based on extortion (Rahardjo, 1998; Karim, 2001).
The development of global sharī‘ah-compliant assets, however, is es-
timated at USD 1 trillion with a growth rate of 15%–20% per annum
(Abdul Kadir, 2009). In the 1980s, Islamic banks have started operations
in non-Muslim countries like Europe, America and Australia (Ebrahim
and Joo, 2001). Moreover, Islamic banks established in the UAE, Kuwait,
Qatar, Oman, Saudi Arabia and the adjoining countries were more profita-
ble than the conservative banks (Qadri, 2008). In the 1970s, Islamic banking
started to prosper after the launch of the First International Conference
on Islamic Economics organized by King Abdul Aziz University in Mecca,
Saudi Arabia, and after the foundation of first commercial Islamic Bank,
Dubai Islamic Bank (DIB), in the UAE. After this initiative, Saudi Arabia
established many private and semi-private commercial Islamic banks. Later
on, similar banks were established in Egypt, Sudan, Kuwait, Bahrain and so
on. The aim was to make Islamic banking an effectual and dynamic means
of financial mediation between surplus and deficit economic units.
284 Hussain Mohi-ud-Din Qadri
18.3 Islamic banking and finance: a case of Pakistan
Khan and Bhatti (2006, 2008) pointed out the reasons why Islamic banking
failed in Pakistan while it succeeded in other Muslim countries. In their
2008 book, the case of Pakistan’s complex geopolitics associate with Islamic
faith and sectorial division are discussed. This section links the literature
with Khan and Bhatti’s work with those of Chapra (2001) and Haron and
Yamirudeng (2003), among others who reported that the development of
Islamic banking in a particular economy is influenced by the support of
Muslims and the government. Pakistan was one of the first nations to in-
troduce Islamic banking in society. These efforts began in the mid-1960s
in response to both religious and economic needs in the country. Presently,
Islamic banking has been set up as an industry with a share of 13% of the
market. This development has been made possible with the assistance of the
State Bank of Pakistan (SBP). Other factors have also assisted the rise of
Islamic banking such as new regulatory measures supporting the banking
industry as well as the increase of foreign investors and population growth.

18.3.1 Pakistan’s economy at a glance

Pakistan is a country with a rapidly developing business sector within the
Organization of Islamic Cooperation (OIC). In 2015, it was thought that
Pakistan would be the next economic success story (Runde, 2015). As the
second largest economy in South Asia, Pakistan is anticipated to be the
world’s fastest developing Muslim economy in 2017, ahead of Indonesia,
Malaysia, Turkey and Egypt (Zahid, 2017). Pakistan benefits from invest-
ment in the China Pakistan Economic Corridor (CPEC) initiative5 which is
equivalent to USD 45 billion in infrastructure development projects includ-
ing roads, railways and power plants. The economic corridor provides a link
between the Xinjiang province in China and Gwadar, which is a port on the
south coast of Pakistan west of Karachi.
With the multibillion dollars of infrastructure proposed under CPEC,
opportunities to offer sukuk for infrastructure and demands for Islamic
project financing are expected to increase. The first CPEC transaction
was a USD 1.95 billion loan syndication, which was financed for the most
part by large Chinese banks. But the deal featured two Shari‘ah-compliant
branches worth a combined Pakistan rupees 16 billion extended by Faysal
Bank, Meezan Bank and Habib Bank (Vizcaino, 2016). The IMF predicts
that the CPEC will support the Pakistan economy6 to develop the gross do-
mestic product by more than 5% by 2020. By 2050, the gross domestic prod-
uct is forecast to reach USD 4.2 trillion from the current USD 988 billion.
The CPEC provides Pakistan with a chance to develop Islamic finance.7

18.4 Regulations governing Islamic banking and finance

in Pakistan
Islamic or Riba-free banking was introduced in Pakistan in the late 1970s
through several pioneering legal and regulatory initiatives that called for
 A case of Pakistan 285
the elimination of Riba from the banking system and for the full Islam-
ization of the country’s economy. These included changes to Banking
Companies Ordinance (BCO-1962) to accommodate non-interest-based
transactions, the Mudarabas Ordinance in 1980 to introduce Mudaraba as
a two-level fund structure for undertaking Shari‘ah complaint businesses
(GIFR, 2017).
In spite of the fact that there is no enabling legislation for Islamic bank-
ing in the country, Pakistan has made special arrangements under the
general market direction for Islamic finance by the ruling of the Federal
Shariat Court (FSC) in (November 1991) that declared the procedures
adopted by banks to be un-Islamic. However, these changes had very
limited success because of the inadequate infrastructure and the absence
of skilled human resources (HR). The greatest step towards promoting
Islamic banking in the country was the introduction of the Islamic Bank-
ing Policy in December 2001 (GIFR, 2017). This policy was adopted to
develop a policy according to which banks were allowed to offer Islamic
financial services in three forms: (i) full-fledged Islamic banks, (ii) Islamic
banking subsidiaries of conventional banks and (iii) independent
Islamic banking branches (IBBs) of conventional banks. Under this pol-
icy, the first full-fledged Islamic bank, “Meezan Bank”, was established
in 2003.8 This became the foundation stone for the second era of Islamic
banking in Pakistan.
Detailed directions for profit and loss distribution and pool management
in Islamic banking institutions were issued in 2012,9 replacing the 2008 “In-
structions & Guidelines for Shari’a Compliance in Islamic Banking Insti-
tutions”. These directions required Islamic banking institutions to set up
a well-defined pool management framework for administration purposes.
Each pool was to have distinct targets and risk reward features, which were
to be managed as virtual enterprises having clearly identifiable resources,
liabilities, incomes and expenses. These directions were required to bring
transparency and standardization across the banking industry and to safe-
guard investors’ interests.
Conventional banks charge interest in their operations. Islamic financial
institutions avoid interest and utilize more than one key instrument as the
basis for their intermediary activities (Ayub, 2007). In order to encourage
conventional banks to set up Islamic subsidiaries, the initial least capital
requirement for a subsidiary was brought down from Rs. 10 billion to Rs.
6 billion. In this manner, Meezan Commercial Bank was granted a license
from the SBP (State Bank of Pakistan) to set up the first Islamic banking
subsidiary. New standards for the operation of Islamic banking windows
were issued by SBP in 2014,10 which expected banks to get composed en-
dorsement from the central bank before opening each Islamic window, as
well as providing the regulator with additional details on staffing, training
and marketing arrangements.
A second five-year plan to increase support for the advancement of Is-
lamic finance in Pakistan was launched by SBP in 2015. The purpose of the
SBP’s five-year strategic plan was to set a common direction for Pakistan’s
286 Hussain Mohi-ud-Din Qadri
Islamic banking industry to augment the existing growth momentum and
to lead the industry to the next level of development. Key concentration
areas of the plan, which were supposed to run from 2014 to 2018, include
policy environment, Shari’a governance and compliance, awareness,
capacity-building and market development. The strategic plan expected the
banking business to increase to the amount of 15% of the country’s overall
banking system by 2018. Since then SBP has introduced numerous new prin-
ciples and guidelines, the most recent one being IBD Circular No. 01 of 2016
dated September 7, 2016. With this circular, Islamic banks are currently per-
mitted to benchmark their products based on participatory modes – known
as Musharaka and Mudaraba – and Wakala-based agency, with respect to
an index other than the Karachi Inter Bank Offered Rate (KIBOR). How-
ever, they are required to plot their alternative pricing mechanism for par-
ticipatory financing schemes. This decision by the central bank is expected
to enable Islamic banking to be more Shari’a authentic and prepare for
the improvement of a Shari’a-consistent evaluating benchmark by Islamic
banking institutions in the near future.

18.4.1 Islamic banking in Pakistan

The Islamization of the financial system of Pakistan paralleled the global
revival of the Islamic banking in the late 1970s (Akhtar, 2007). On Septem-
ber 29, 1977, the process was initiated by the presidential order to the na-
tional Council of Islamic Ideology (CII). The council was asked to develop a
plan for an interest-free banking system. The purpose was to eliminate Riba
from the financial system of Pakistan. This report is considered to be a mile-
stone towards the Islamization of the banking system in Pakistan. Practical
steps taken after the release of this report are given below:

• Practical measures included the operation of specialized financial in-

stitutions such as HBFC (House Building Finance Corporation), ICP
(Investment Corporation of Pakistan) and NIT (National Investment
Trust) in July 1979 and that of the commercial banks from January 1981
to June 1985.
• On June 26, 1980, the legal framework of Pakistan’s financial and corpo-
rate system was amended in order to permit the issuance of interest-free
corporate financing, which was called Participation Term Certificate
(PTC). An ordinance was publicized to permit the formation of Mu-
daraba companies and the issuance of Mudaraba certificates for risk-
based capital. The BCO of 1962 was also revised to cover the provision
of bank finance through profit and loss sharing (PLS), the markup in
prices and hire and leasing purchase.
• In 1981, distinct interest-free counters started operating in all the na-
tionalized commercial banks, and one foreign bank (Bank of Oman)
started accepting deposits on a PLS basis.
 A case of Pakistan 287
• In 1982, banks were permitted to offer finance on a selective basis under
the practice of Musharaka in order to meet the working capital require-
ments of trade and industry.
• In 1985, finance to all entities comprised of individuals had to be made
according to specified interest-free modes.
• In 1985, all commercial banking in Pakistan rupees was made interest-
free and banks in Pakistan no longer accepted interest-bearing depos-
its. All existing deposits were considered on the basis of PLS. Current
deposits continued to be accepted but no interest or share in profit or
loss was allowed for any of these accounts. Conversely, foreign currency
deposits in Pakistan continued as before.
• In 1991, the FSC declared the process known as ‘markup’ technique
with or without ‘buy-back arrangement’ to be unacceptable for Islam.
• In 2000, the Commission for the Transformation of Financial System
(CTFS) was established in SBP and a task force was established by the
Ministry of Finance of Pakistan to eradicate Riba from government
financial transactions.
• The CTFS report stated that a number of prior arrangements should be
made in preparation for changes in the financial system. The fundamen-
tals of Shari‘ah-compliant modes of financing and a draft seminal law
called “Islamization of Financial Transactions Ordinance 2001” as well
as model agreements for key modes of financing were also identified.
With regard to assets and liabilities, the Commission was responsible
for dealing with the major products of banks and financial institutions,
such as letters of credit or guarantee, bills of exchange, Term Finance
Certificates (TFCs), State Bank’s Re-finance Schemes, Credit Cards,
Interbank transactions, underwriting, foreign currency forward cover
and various kinds of bank accounts.

The Islamic banking industry in Pakistan has shown significant advance-

ment since its launch in 2001. Today it consists of 5 full-fledged Islamic banks
and 16 Islamic branches of conventional banks with some 2,322 outlets. In
2016, two Islamic banks – Burj Bank Limited and Al-Baraka Bank (Paki-
stan) Limited – merged into a single entity under the name Al-Baraka Bank
(Pakistan) Limited. On December 2016, there were 1,220 Islamic banking
windows operated by 9 conventional banks with separate IBBs. Together
they held 11.7% of market assets and 13.3% of deposits in the total banking
industry after recording PKR 1,853 billion and PKR 1,573 billion in assets
and deposits, respectively. The rapid development of Islamic banking is re-
flected in the increasing share of Islamic banking in assets, deposits and the
financing of the banking industry as shown in Figure 18.1. On the basis of
the development ratio noted in 2016, it is expected that the development rate
will have the capacity to accomplish the 15% target market share by 2018.
Both total assets and deposits have recorded consistent growth with a
compounded annual growth rate (CAGR) of 32% and 34% from 2006 to
288 Hussain Mohi-ud-Din Qadri
2016, respectively (Figure 18.2). In addition, the CAGR for financing and
investment reached 34% during the period 2006–2016. The diminishing
Musharaka remained the main mode of finance, followed by Murabaha and
Musharaka (Figure 18.3). However, Murabaha as a mode of finance has be-
come increasingly unpopular. The percentage share of Murabaha financing
was 16% in 2016, down from 41% in 2013 (Figures 18.3–18.6). Istisna became
consistently preferred as a mode of finance, reaching the figure of 8.4% of
the total number of Islamic banking institutions in 2016 as compared to
5.6% in 2013 (Figures 18.3–18.5).

14%
12%
10%
8%
6%
4%
2%
0%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Deposits and other accounts Total Assets Financing and Investment

Figure 18.1 Market Share of Assets, Deposits and Financing and Investment of Is-
lamic Banking Sector (%).
Source: State Bank of Pakistan.

2000
1800
1600
1400
1200
1000
800
600
400
200
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Deposits and other accounts Total Assets Financing and Investment

Figure 18.2 Total Assets, Deposits and Financing and Investments of Islamic
Banking Sector (PKR Billion).
Source: State Bank of Pakistan.
 A case of Pakistan 289

2013

Murabaha
4%
5% 4% ijara

Musharaka
41%
Diminishing
Musharaka
31% Salam

Istisna
7% 8%
Others

Figure 18.3 Financing mix (% Share).

Source: State Bank of Pakistan.

2014

Murabaha

6% ijara
4% 8%
30% Musharaka

Diminishing
Musharaka
Salam
33% 8%
Istisna
11%
Others

Figure 18.4 Financing mix (% Share).

Source: State Bank of Pakistan.
290 Hussain Mohi-ud-Din Qadri

2015
Murabaha

9% ijara
9% 24%
Musharaka
5%
Diminishing
7% Musharaka
Salam

32% 14% Istisna

Others

Figure 18.5 Financing mix (% Share).

Source: State Bank of Pakistan.

2016

Murabaha

14% 16% ijara

8% Musharaka
7%
4% Diminishing
Musharaka
16% Salam

Istisna
35%
Others

Figure 18.6 Financing mix (% Share).

Source: State Bank of Pakistan.

18.5 Theoretical development of Islamic banking in Pakistan

In the late 1970s, Islamic banking and finance has built up substantial mo-
mentum in the Muslim world. Most Muslim countries have brought their
Islamic banks into the private sector. So far, however, the economy of no
 A case of Pakistan 291
single country has completely accepted the terms of an Islamic economy.
Major steps for Islamic banking in Pakistan were taken in 1977 when the
President of Pakistan, Mohammed Ziaul Haq, directed the CII to develop
a plan to Islamize Pakistan’s economy within three years. The CII was
founded in 1957 under Articles 197 and 198 of the 1956 Constitution of
Pakistan. Officially recognized in 1962 and again in 1973, the CII was a
research-based Islamic center, which was set up to assist the government in
the implementation of Islamic ideology in different areas of government.
The responsibilities and role of the CII were defined in 1973 under Article
230 of the Constitution. Since the constitutional responsibility of the CII
was to protect the Islamic character of the polity in Pakistan, its recom-
mendations were to be given serious consideration by the government of
the day.
In March 1963, the first interest-based transaction in Pakistan was re-
ferred to the CII. In 1969, the CII advised the Government of Pakistan
(GoP) for the first time that borrowing on the basis of Riba should not be
permitted and that the establishment of an interest-free economy should no
longer be delayed. Later, in December 1969, the CII passed a resolution sug-
gesting that interest was forbidden by Islamic law and that the government
should constitute a committee consisting of Islamic jurists, legal experts and
economists to help the CII to strengthen and support the plan to Islamize
the national economy. In November 1977, a panel of 15 economists, bank-
ers and financial experts were appointed (see Appendix A) to examine the
technical aspects of restructuring the existing economy and finance sector
along Islamic lines. As a result, the panel examined the practice and existing
theory of Islamic banking and finance.
In February 1980, the panel submitted its findings to the CII. On the basis
of these findings, the CII made some necessary changes in light of the shari‘ah
and of Islamic jurisprudence. Later in 1980, the CII submitted its report,
known as “the 1980 CII Report”, to the government. The CII Report of 1980
became the first official, written statement on an interest-free economy and
financial system ever made in the Muslim world.
In 1983, President Muhammad Zia ul Haq requested Shaykh-ul-Islam
Prof. Dr. Muhammad Tahir ul-Qadri, an eminent scholar; expert in Qur’anic
exegesis, Hadith sciences and Islamic jurisprudence; writer of a biography
of the Prophet (pbuh); and the founder of Minhaj-ul-Quran International,
to develop a workable model for Islamic banking in the country while keep-
ing in view the CII 1980 report and other developments in Islamic banking
in various parts of the world. Consequently in 1984, a practical model for an
Islamic banking system was presented to the President and to his cabinet by
Shaykh-ul-Islam (Qadri, 1994).
In his presentation, Dr. Tahir ul-Qadri criticized the double standards
shown by the GoP in allowing two systems of banking to operate at the
same time, one system accepting interest and the other system refusing to
take interest.
292 Hussain Mohi-ud-Din Qadri
He listed the three main reasons for the failure of the Islamic banking
system in Pakistan as follows:

1 Partial and half-hearted enforcement of the new system

2 Continuation of the former, discredited system along with new
3 Desire for a new economic system without paying attention to its condi-
tions and requirements.

He suggested the elements of an Islamic banking system, its instruments,

products and right terminology as follows:

a Structure of bank funds

b Structure of public deposits
c Modes of lending
d Benevolent loan
e Ordinary lending
f The multiple counter loan
g Modes of financing and various instruments of investment
h Islamic modes of financing
i Various instruments of investment
j Agricultural banking
k Trade banking
l Inland trade banking
m Foreign trade banking
n Cooperative bank
o Specialized financial institutions
p Monetary policy and central banking
q Reserve ratio
r Liquidity ratio
s Selective credit control
t Moral persuasion
u Bank rate control
v Government transactions in the national economy
w Practical steps for loan-free economy

18.5.1 Policy instruments for eliminating interest

The CII 1980 report, Shaykh-ul-Islam’s Islamic banking model and other the-
oretical works explained the prohibition of interest in light of the Holy Qur’an
because of its exploitative nature (The 1980 CII Report, p. 5) and provided both
essential and optional strategic instruments for eliminating interest (Qadri,
1994). These documents all stated that charging interest on business and uti-
lization advances was the underlying cause of numerous financial disasters in
Pakistan, and, for this reason, charging interest should be abandoned.
These instruments were divided into three sets according to their capacity
to build up the IBF model. They approved PLS instruments as an alternative
to interest. Moreover, they endorsed leasing, venture selling, Bai Muajjal
(Murabaha or deferred payment sale), hire purchase, normal rate of return,
 A case of Pakistan 293
time multiple counter loans and special loan facilities as further alternatives
to interest. However, they rejected the service charge and indexation sys-
tems, judging them to be unsuitable alternatives to interest (The 1980 CII
Report, Chapter 1).

18.5.1.1 Primary and ideal instrument: the PLS system

Under the PLS system, rather than charging a fixed rate of interest on lend-
ing, the bank enters into an equity-sharing relationship with the customer
and shares the risk and return of a joint venture.

18.5.2 Practical developments of Islamic banking in Pakistan

Figures 18.7–18.9 have been taken from the State Bank bulletin of June
30, 2017, which presents the practical development of Islamic banking in
Pakistan.

Meezan Bank Limited

5% (571)
16% Al Baraka Islamic
Bank (178)
47% Bank Islami Pakistan
(204)
17%
Dubai Islami Pakistan
(200)
15% MCB-Islamic Bank
Limited (66)

Figure 18.7 IBB network in Pakistan (June, 2017).

Source: State Bank of Pakistan.

5% Allied Bank Limited

9%
1% 5% (83)

1% 8% 10%
Askari Bank Limited
1% 4% (91)
1% Bank AL-Habib
Limited (42)
14% 16%
Bank Alfalah Limited
(151)
5%
3% 17%
Faysal Bank Limited
(157)

Figure 18.8 Islamic banking branches of conventional banks (June, 2017).

Source: State Bank of Pakistan.
294 Hussain Mohi-ud-Din Qadri

1%
2% 1% AlBaraka Bank
2% (Pakistan) Limited (8)
9%
Askari bank Limited
(3)
Bank Islami Pakistan
Limited (118)
The Bank of Punjab (2)

Habib Bank Limited

85% (2)
United Bank Limited
(1)

Figure 18.9 Subbranches of IBI’s in Pakistan (June, 2017).

Source: State Bank of Pakistan.

18.6 The current state of Islamic banking in Pakistan

Between April and June, 2017, assets of the Islamic banking industry have
seen a growth of PKR 150 billion and were recorded at PKR 2,035 billion
compared with PKR 1,885 billion in the prior quarter. On the funding side,
deposits of Islamic banking industry have grown by PKR 156 billion during
the review quarter to reach PKR 1,720 billion compared with PKR 1,564 bil-
lion in the previous quarter. The market share of Islamic banking assets and
deposits in the overall banking industry was recorded at 11.6% and 13.7%,
respectively, by end of June 2017 (Tables 18.1–18.3).
Diminishing Musharaka remained as the leading method of financing
followed by Murabaha and Musharaka (Table 18.4).
A review of the financing of each sector shows that the major portion of
financing of the Islamic banking industry was extended to the production
and the transmission of the energy and the textile sectors. This is in line with
the overall trend of the banking industry (Table 18.5).
Current (non-remunerative) and saving deposits increased by PKR 74 bil-
lion and PKR 67 billion, respectively, while fixed deposits declined by PKR
14 billion during the review quarter (Table 18.6).
The capital base of the Islamic banking industry increased by 5.6% (PKR
7 billion) between April and June 2017, and reached PKR 134 billion com-
pared to PKR 127 billion in the previous quarter (Table 18.7).
 A case of Pakistan 295
Table 18.1 Industry Progress and Market Share (June 30, 2017)

Particulars Industry Progress YoY * Share in Overall

Growth Banking Industry (%)
(%)
Jun-16 Mar-17 Jun-17 Jun-17 Jun-16 Mar-17 Jun-17

Total assets (Rupees 1,745 1,885 2,035 16.6 11.4 11.7 11.6
in billions)
Deposits (Rupees in 1,461 1,564 1,720 17.8 13.2 13.2 13.7
billions)
Number of Islamic 22 21 21 (4.5) – – –
banking institutions
Number of Islamic 2,146 2,317 2,320 8.1 – – –
branchesa

Source: Data submitted by bank under quarterly reporting chart of account (RCOA); SBP (2017).
a Including subbranches.
* Year-over-Year (YoY).

Table 18.2 Branch Network of Islamic Banking Industry

(June 30, 2017)

Province/Region Total Number Share (%)

Punjab 1,091 47.0

Sindh 699 30.1
Khyber Pakhtunkhwa 258 11.1
Baluchistan 99 4.3
Gilgit Baltistan 10 0.4
FATA 8 0.3
Federal Capital 119 5.1
AJK 36 1.6
Total 2,320 100

Source: SBP (2017).

Table 18.3 Financing Mix (% Share)

Jun-16 Mar-17 Jun-17

Murabaha 20.1 16.4 17.0

Ijarah 7.2 6.4 6.8
Musharaka 12.9 16.3 17.9
Diminishing Musharaka 35.8 32.3 29.6
Salam 3.3 5.2 5.2
Istisna 7.3 8.9 7.2
Others 13.4 14.5 16.3
Total 100.0 100.0 100.0

Source: SBP (2017).

296 Hussain Mohi-ud-Din Qadri
Table 18.4 Financing Concentration (% Share)

Jun-16 Mar-17 Jun-17 Industry

Chemical and pharmaceuticals 6.5 6.1 5.4 4.1

Agribusiness 4.0 5.2 8.5 8.9
Textile 13.9 13.2 11.8 12.8
Cement 1.7 1.6 1.7 1.3
Sugar 2.8 4.7 4.1 3.9
Shoes and leather garments 0.6 0.5 0.4 0.4
Automobile and transportation 1.4 1.2 0.9 1.5
equipment
Financial 0.6 0.6 1.1 3.1
Electronics and electrical 1.1 1.2 1.2 1.2
appliances
Production and transmission 14.9 15.4 14.2 14.6
of energy
Individual 13.2 11.7 11.7 8.9
Others 39.2 38.6 39.0 39.3
Total 100.0 100.0 100.0 100.0

Source: SBP (2017).

Table 18.5 Breakup of Deposits

Rupees in Billion % Growth

Jun-16 Mar-17 Jun-17 YoY QoQ

Customers
Fixed deposits 314 344 330 5.1 (4.1)
Saving deposits 567 616 683 20.4 10.9
Current accounts – 9 7 9 – 28.6
remunerative
Current account – 460 507 581 26.3 14.6
non-remunerative
Others 9 9 14 55.6 9.0
Subtotal 1,359 1,483 1,617 18.9 9.0

Financial Institutions
Remunerative deposits 100 79 102 2.0 29.1
Non-remunerative 2 2 1 (50.0) (50.0)
deposits
Subtotal 102 81 103 0.9 27.2
Total 1,461 1,564 1,720 17.7 10.0

Source: SBP (2017).

Table 18.6 Capital Ratios (%)

Jun-16 Mar-17 Jun-17 Industry

Capital to total assets 6.2 6.7 6.6 7.8

Capital (net non-performing 6.1 6.3 6.1 7.2
assets) to total assets

Source: SBP (2017).

 A case of Pakistan 297
Table 18.7 Profitability and Earning

Jun-16 Mar-17 Jun-17 Industry

Profit after tax (rupees in 6.1 3.8 8.8 90.0

billions)
Return on assets 0.7 0.8 0.9 1.1
Return on equity 11.3 12.2 13.8 13.1
Operating expense to 75.6 71.1 68.2 55.8
gross income

Source: SBP (2017).

18.7 Islamic capital market

Following financial liberalization, Islamic capital markets (ICMs) experi-
enced economic growth. In Malaysia, ICM was launched in the 1980s, and
it commenced its operation in Pakistan, Bahrain and other countries in the
beginning of the 1990s. In the 1970s and 1980s, Structured Involvement of
Islamic Finance in Financial Markets was set up by creating many institutes
of takaful, Islamic financial institutes and investment corporations (Shah,
2015).
A slow but sure pickup in economic growth has been attributed to fresh
trends in international capital markets and the reduction of global policy
reservations since 2017. Moreover, the last year saw a surge in investors’
taking risks, moderation in financial instability and stability of the stock
market in hosts of jurisdictions in a positive international financial and li-
quidity environment.
Throughout 2017, ICMs experienced positive growth, particularly size-
able growth in sukuk driven by large sovereign issuances, an upturn in
Islamic assets under management and strong performances by Islamic
shares (IFSB, 2018).

18.7.1 ICM in Pakistan

The top regulator of capital markets in Pakistan is the Securities and Ex-
change Commission of Pakistan (SECP). Its functions include supervising
and controlling the development of the capital market, the intermediaries
operating in the capital market and the Self-Regulatory Organizations
(SROs). The SROs comprise the Pakistan Mercantile Exchange Limited
(PMEX), the National Clearing Company of Pakistan Limited (NCCPL),
the Central Depository Company of Pakistan Limited (CDC) as well as the
Pakistan Stock Exchange (PSX). The agents and intermediaries working in
the capital market are underwriters, brokers and managers, share registrars,
credit rating companies and security advisers. In Pakistan, sukuk issuance
was launched in 2006 when Islamic banking in the country was still at ado-
lescent stage.
298 Hussain Mohi-ud-Din Qadri
In the period under evaluation for the advancement of the ICM, the ensu-
ing big steps were taken:

• On August 31, 2016, tax neutrality for sukuk in relation to conventional

instruments was effected through an amendment to the Tax Ordinance.
• Under the enabling provision given in the proposed Companies Bill, an
all-inclusive shari‘ah governance structure was drafted.
• SECP consultative forum on Islamic finance, which comprised of repre-
sentatives from industry and financial sector, was established.
• All Shares Islamic Index was set up at PSX. The index represents cor-
porations which meet particular shari‘ah compliance criteria. Extra
disclosure requirements for corporations listed on PSX have been em-
braced in the suggested Companies Bill with the intention of Shari‘ah
screening; this measure aims at inclusion or removal of a scrip from the
index.
• In order to handle a range of industrial issues and challenges in Islamic
banking and finance, SECP-SBP Joint forum on Islamic business is
striving in an efficient and organized way. SBP-SECP, after evaluating
the Commodity Murabaha Product forwarded by PMEX, suggested al-
teration so that it might sit comfortably with shari‘ah directives.
• Through the Finance Act, 2016, a 2-percentage point tax refund for
shari‘ah-compliant listed corporations was introduced. Federal Board
of Revenue (FBR) has announced the criteria for the tax refund. The
tax refund for suitable listed companies, in addition to tax impartiality
for sukuk, will speed up the development of ICM.
• Comprising eminent Muslim academics, an Independent Shari‘ah Ad-
visory Board (SAB) was established at SECP. This board offered pro-
posals to the commission concerning issues associated with shari‘ah
(Economic Adviser’s Wing, Finance Division, Government of Pakistan,
2017).

18.7.2 Shari‘ah-compliant stock index

In 2008, KSE-Meezan Index (KMI-30) came to the fore so as to fulfill the
rising demand for Islamic equity investments. This stock index, compatible
with shari‘ah, was formed for those of the faithful who are eager to align
their financial activities with their creed and religious norms. On the one
hand, KMI-30 index won and boosted investor trust. On the other hand,
it conducted quality research in an attempt to measure the performance of
shari‘ah-compliant stocks.
At present, the Karachi Stock Exchange (KSE) has three key indices.
They are KSE-30 index, KSE-All Shares index and KSE-100 index. KMI-30
index consists of 30 stocks that are compatible with shari‘ah and is listed
at KSE. It is rebalanced every six months, and, for index construction,
“Free-float market capitalization” method is practiced: the world’s promi-
nent index providers (FTSE, S&P, MSCI, STOXX and SENSE) employ this
 A case of Pakistan 299
List of 30 Shari‘ah-Compliant Stocks

No. Name Symbol

1. Fauji Cement Ltd. FCCL

2. K-Electric Limited KEL
3. Pakistan Petroleum PPL
4. Hub Power Company HUBC
5. Engro Corporation ENGRO
6. Lucky Cement LUCK
7. National Refinery NRL
8. Sui Southern Gas Pakistan SSGC
9. Pakistan Oil Fields POL
10. Dawood Hercules Corporation DAWH
11. Sui Northern Gas Pakistan SNGP
12. Millat Tractors MTL
13. Engro Fertilizers EFERT
14. D.G Khan Cement DGKC
15. Treet Corporation Ltd TREET
16. Packages Ltd. PKGS
17. Nishat Mills NML
18. Maple Leaf Cement MLCF
19. Mari Gas Company MARI
20. Engro Polymer and Chemicals Ltd EPCL
21. GlaxoSmithKline Pakistan GLAXO
22. The Searle Company Ltd SEARL
23. Pak Elektron Ltd PAEL
24. Kot Addu Power Company Ltd KAPCO
25. Attock Petroleum Ltd APL
26. International Steels Ltd ISL
27. Attock Refinery Ltd ATRL
28. International Industries Ltd INIL
29. Oil and Gas Development OGDC
30. Hascol Petroleum Ltd HASCOL

Source: Chen and Jebran (2017).

method. Each stock is capped at 12% on weights and the SAB of Meezan
Bank regulates KMI-30 index.

18.7.3 Modaraba
In the growth and development of Islamic modes of financing at home,
modarabas have played a significant role; their certificate holders have
earned highest dividend percentage. The modarabas are offering diverse
Islamic financial products and services in agreement with Islamic directives.
So that they might benefit SMEs and groups on low incomes, the modara-
bas were directed to make efforts to expand their outreach. Four modara-
bas opened first Islamic financing facility centers in Rawalpindi in order to
offer inexpensive financing compatible with shari‘ah injunctions. Deriving
benefit from the Islamic financing facility centers, the people of the area buy
motorcycles and other products.
300 Hussain Mohi-ud-Din Qadri
18.7.3.1 Current developments for Modarabas
To overcome practical difficulties, currently the modaraba regulatory
framework is reconsidered and re-examined in accordance with interna-
tional practices. The resultant exercise will bring about operational flexibil-
ities. The key reforms are as follows:

• Stipulating fresh limits concerning certificate holding of Modaraba

Company and its linked parties in a modaraba so as to boost and in-
crease equity participation by the people.
• Presentation of fresh ideas of fund-raising through issuance of Term
Equity Certificates.
• Presentation of the idea of unlisted modarabas in order to assist re-
cent entrants and facilitate the development of Islamic financial services
industry.
• The suggested amendments, when they are sanctioned, would be effec-
tive in advancing modarabas as genuine Islamic financial institutions.
Moreover, they would offer stimulus for the development of the sector
(Economic survey Pakistan 2016–2017).

18.7.4 Sukuk
In 2017, global sukuk issuances saw a development of 22.8%. The full volume
of yearly issuances reached USD 91.9 billion at the end of 2017, compared
to USD 74.8 billion in 2016. This maintains the slow but sure recuperation
of sukuk markets over the last two years in the wake of the economic down-
turn of 2015. At the end of 2017, the entire volume of unpaid sukuk stood at
USD 399.92 billion – a 10% increase in volume of unpaid sukuk from 2016.
Nevertheless, full issuances for 2017 stayed below the USD 131 billion mark.
While the latest development trajectory points to a steady closing of this
gap, it is the highest yearly volume of sukuk issuances so far.
In the Pakistani market, on the whole 107 sukuk valuing USD 10,472 mil-
lion were issued in 2017. Of these, 19 are GoP Ijara Sukuk, whereas 88 have
been issued by corporate or quasi-sovereign bodies; the sukuk issued are
medium term. Although most of them are privately placed, some commer-
cial sukuk have been recorded at the stock exchange (Figures 18.10–18.13).
This subsection examines the development trends of the sukuk market
over the last year (Figure 18.14).

18.7.4.1 Sovereign sukuk

The complete sovereign issuances in 2017 comprised in the region of USD
4.8 billion (6.3%) of liquid assets raised by means of short-term sukuk (that
is, less than one-year maturity), which is less than in preceding years (2016:
19.7%; USD 11.7 billion).
 A case of Pakistan 301

350 323 25
Number of Sukuk Issues
300 Sukuk Value (in billion RS) 20
20 19

250

15
200
170 172
140 10
150 10 9 9 9
8 8
7
90
100
56 61 65 5 4
48
50 33 38 2 2
9
0 0
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

06
07
08
09
10
11
12
13
14
15
16
17
20
20
20
20
20
20
20
20
20
20
20
20
Figure 18.10 Year-wise domestic sukuk summary.
Source: State Bank of Pakistan (2018).

Year Corporate Sovereign Quasi-Sovereign

2006 7.2 0.0 92.8

2007 55.5 0.0 44.5
2008 48.6 14.0 37.4
2009 43.3 29.0 27.7
2010 27.1 55.7 17.2
2011 15.9 72.7 11.4
2012 11.5 79.3 9.2
2013 10.7 78.5 10.8
2014 11.0 78.3 10.7
2015 9.2 79.3 11.5
2016 8.9 74.2 16.9
2017 10.5 73.1 16.4

Figure 18.11 Entity-wise and year-wise breakup of sukuk (cumulative as of end year
in per cent).
Source: State Bank of Pakistan (2018).

Auction Issue Date Maturity Date Amount of Sukuk

Pakistan first International Sukuk Jan-05 Jan-10 US$ 600 million

Pakistan second International Sukuk Nov-14 Nov-19 US$ 1,000 million

Pakistan third International Sukuk Oct-16 Oct-21 US$ 1,000 million

Pakistan fourth International Sukuk Nov-17 Nov-22 US$ 1,000 million

Figure 18.12 International sukuk issued by the GoP.

Source: State Bank of Pakistan (2018).
302 Hussain Mohi-ud-Din Qadri

180

160

140

120
USD billions

100
Sovereign
80
Corporate
60

40

20

Figure 18.13 Sukuk issuance trend.

Source: IFSB (2018).

Oman, 2.80% Others, 2.80%

Bahrain, 2.00%
Turkey, 3.90%
Pakistan, 1.80%
UAE, 4.10%

Qatar, 5.50% Malaysia, 37.90%

Saudi Arabia, 33.10%

Indonesia, 6.10%

Figure 18.14 S ̣ukuk issuances by jurisdiction and share (2017).

Source: IFSB (2018).

The GoP took advantage of the sukuk market through two sukuk al-ijra,
increasing a total of around USD 1.7 billion which comprised of a 5-year
US dollar-denominated tranche of USD 1 billion, advancing a profit rate of
5.63%, and a 3-year local currency issuance of roughly USD 677.2 million,
advancing a profit rate of 5.24% (Figure 18.15).
 A case of Pakistan 303

Hong Brunei, 0.32% Jordan, 0.14% Gambia, 0.03%

Kong,
Nigeria, 0.56% Bangladesh, 0.05%
1.30%
Bahrain, 2.97%
Oman,
Turkey, 3.15% 3.25%
Pakistan, 2.18%

UAE, 2.21%

Malaysia, 32.89%
Qatar, 5.49%

Saudi Arabia, 38.81%

Indonesia, 6.66%

Figure 18.15 Sovereign sukuk issuance by jurisdiction (2017).

Particularly, the increase in sovereign issuances in the course of 2017 is

basically by reason of an upsurge in the volume of sovereign issuances by
four jurisdictions from the Gulf Cooperation Council (GCC) region: Bah-
rain, Oman, Saudi Arabia and Qatar. There was a conspicuous falloff in
sovereign issuances from the UAE, Indonesia and Pakistan in comparison
with the last year’s issuances, and decrease, in terms of total volume, of
issuances from Brunei, Malaysia, Jordan and Turkey.

18.7.4.2 Corporate sukuk

In 2017, business sukuk issuances, breaking the relentless sinking trend noted
in business issuances from 2012, experienced a humble recovery. Issuances
by corporates made a total of USD 15.75 billion in 2017; it signifies a 2.3%
growth from the last year [2016: USD 15.4 billion; 2015: USD 20.7 billion]
(Figures 18.16 and 18.17).
304 Hussain Mohi-ud-Din Qadri

40

35

30

25
USD billion

20

15

10

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 18.16 Corporate sukuk issuance trend.

Source: IFSB (2018).

Oman, 0.70%
Bahrain, 2.50%

Turkey,
Kuwait, 4.80% 7.20%

UAE, 12.90%

Malaysia, 60.60%
Qatar, 5.20%

Saudi Arabia, 3.20%

Indonesia, 2.80%

Figure 18.17 Corporate sukuk issuance by jurisdiction (2017).

Source: State Bank of Pakistan (2018).
 A case of Pakistan 305
The moderate general growth in corporate issuances was the outcome
of increases in issuance by corporates from Oman, Malaysia, Kuwait and
Indonesia, although the general volume of corporate issuances sank in a
good number of jurisdictions. The reduced levels of corporate issuances
from numerous jurisdictions are attributable to various factors such as high
charges of issuance of s ̣ukuk, complicated legal structures, dearth of stand-
ardization of s ̣ukuk as well as suitable assets, along with dearth of monetary
enticement and a level playing field in various jurisdictions for s ̣ukuk issu-
ance compared to bonds.

18.7.5 Islamic funds assets by domicile

In the Islamic funds industry, 1,161 Islamic funds were holding approx-
imately USD 66.7 billion of assets under management at the end of 2017
(2016: 1,167 Islamic funds, USD 56.1 billion AuM) (see Figure 18.18). Even
though the number of Islamic funds plummeted somewhat, the total AuM
rose by 18.8% – a conspicuous improvement from the constant decrease in
total AuM noted from 2014. Out of the entire number of Islamic funds, 821
funds were ranked effective, holding approximately USD 61.6 billion AuM
(2016: 826 active funds, USD 51.2 billion AuM). Even though the number
of funds has dropped, the size of funds increased on the whole in 2017, with
the typical AuM of all active funds standing at USD 79.8 million as at the
end of 2017 (2016: USD 64.9 million). This is an encouraging development
taking into consideration the need for Islamic funds to acquire greater econ-
omies of scale, a mighty challenge in this sector. The Islamic funds that have
become dormant added up to 29%, or 341 funds, holding roughly USD 5.1

1400 80

1200 70

60
1000
50
No of Funds

USD billions

800
40
600
30
400
20
200 10

0 0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

AuM No of Funds

Figure 18.18 Growth in assets under management and number of Islamic funds.
306 Hussain Mohi-ud-Din Qadri
billion AuM in total or an average of USD 15 million per fund; it implies
that minor Islamic funds may be confronting challenges.
In 2017, the allocation of Islamic funds by domicile and share of total AuM
across the top five jurisdictions was in keeping with 2016. Funds based in five
jurisdictions constitute approximately 88% of the total Islamic funds’ AuM
in 2017 (2016: 85%; 2015: 87%). The reminder of 12% AuM, worth USD 8.4
billion, was distributed across 29 jurisdictions (2016: 85%, USD 8.2 billion
across 32 jurisdictions). The number of jurisdictions in which Islamic funds
were domiciled sank to 34 in 2017, compared to 37 in 2016. However, an overall
growth occurred in total AuM to USD 66.7 billion (2016: USD 56.1 billion).
Shari‘ah-compliant mutual funds have touched colossal development in
Pakistan. The Share of Islamic Mutual Funds represented 38% of the total
Mutual Fund industry as on January 31, 2017, and there were 37 modaraba
corporations and 28 modarabas as on March 31, 2017. What is more, the ag-
gregated equity of modarabas was Rs. 20,712.00 million, while the complete
possessions of the modaraba sector stood at Rs. 41,473.00 million. Out of
the 25 operational ones, 19 modarabas announced cash dividends. The com-
plete possessions for Mutual Funds were recorded 2,391 million US dollars
and 130 million US dollars for Islamic Pension Funds.
In 2017, out of the 34 jurisdictions that were domiciles for Islamic funds,
20 jurisdictions are non-OIC countries. The main domiciles for Islamic funds
in this category were from Luxembourg, Ireland and the US (Figure 18.19).

Cayman Islands, 0.34% Others, 1.34%

Jersey, 0.45%
Luxembourg, 4.76%

South Africa, 2.40%

Kuwait, 2.49%
United States, 5.25%

Pakistan, 2.32%
UAE, 0.32% Malaysia, 31.66%

Ireland, 8.62%

Indonesia, 2.96%
Saudi Arabia, 37.10%

Figure 18.19 Islamic fund assets by domicile (2017).

Source: IFSB (2018).
 A case of Pakistan 307

Global
Malaysia
Saudi Arabia
GCC
Indonesia
Pakistan
Others
Kuwait
MENA
United States
Asia Pacific ex.…
Asia Pacific
South Africa
0 5000 10000 15000 20000 25000

(USD Million)

Figure 18.20 Islamic fund assets by geographical focus (2017).

Source: IFSB (2018).

In 2017, the three leading categories for geographical focus of investing

Islamic funds stayed in the main unaffected from 2016, with funds that had
an international investment focus remaining the chief category, making 35%
of total AuM in 2017 or USD 23.2 billion in dollar terms (2016: 34%, USD
18.9 billion) (see Figure 18.20). The mounting worldwide focus of Islamic
funds indicates the need for resources in order to attain greater portfolio
diversification in view of the volatility of recent geopolitical and economic
circumstances. Funds with a Malaysian focus were the second-largest class,
which multiplied in 2017, accounting for 26% of total AuM or USD 17.4 bil-
lion in dollar terms, compared to 25% of total AuM or USD 14.2 billion, in
2016. The Saudi market, accounting for 19% of total AuM, represented the
third-biggest focus [2016: 21%; 2015: 31%].

18.8 AAOIFI (Accounting and Auditing Organization for

Islamic Financial Institution)
In 1991, Accounting and Auditing Organization for Islamic Financial In-
stitution (AAOIFI) was established in Bahrain. It is an international not-
for-profit organization mainly responsible for the growth and determination
of standards for the global Islamic finance industry. Among its most out-
standing accomplishments so far is the determination of 94 standards in the
areas of Shari‘ah, accounting, auditing, ethics and governance. In a num-
ber of countries, central banks and regulatory authorities implement the
AAOIFI standards both on a compulsory basis and simply as a guideline.
308 Hussain Mohi-ud-Din Qadri
From over 45 countries, AAOIFI is supported by numbers of official af-
filiates; consisting of central banks; and governing authorities, financial
institutions, accounting and auditing firms and legal firms. Currently, the
leading Islamic financial institutions of Pakistan are following its standards
and have introduced a progressive degree of harmonization of international
Islamic finance practices.11

18.9 Establishment of Islamic Microfinance Banks

in Pakistan
With the growing popularity of this sector, it became necessary to rec-
ommend strategies for Islamic microfinance services in Pakistan. For
the smooth introduction of microfinance products and services that were
Shari‘ah compliant, the following steps were taken.
Under the Microfinance Institutions (MFI) Ordinance of 2001, all spon-
sors eager to establish full-fledged Islamic microfinance banks (IMFB) were
obliged to obtain licenses from SBP (SBP, 2005). This ordinance allowed
the formation of four categories of microfinance banking in the country as
follows:

1 National Microfinance Banks

2 Provincial Microfinance Banks
3 Regional Microfinance Banks
4 District Microfinance Banks

Under the MFIs Ordinance of 2001, the standards and conditions for ob-
taining a license for IMFB were made available through the official website
of SBP.12 Moreover, the following criteria were also determined for persons/
entities applying for an IMFB license:

i All financial transactions of IMFB would take place in accordance with

the principles of Shari‘ah.
ii Each IMFB may be required to name a Shari‘ah consultant who should
meet the established criteria of Shari‘ah advisors, which were issued in
IBD Round 2 in 2007 and which were subject to regular amendment.
The appointment of a Shari‘ah consultant may require the endorsement
of the SBP. Information about Shari‘ah consultants should be submitted
to the SBP on form SAP of the aforementioned circular.
iii The application should outline the modes of finance and the product
structures that will be adopted to create assets and to give financial
assistance to customers.
iv The applicant should also have the ability to guarantee that their mi-
crofinance banking business will run according to the principles of
Shari‘ah.
 A case of Pakistan 309
v All the deposits accepted by the microfinance banking should be ac-
knowledged either on demand or on PLS basis.
Since 2001, many Islamic microfinance institutions have been established,
which follow the guidelines provided by SBP. Examples of such institutions
are Akhuwat13 and Al-Mawakhat Islamic Microfinance14 (AMIM).

18.10 Islamic finance education in Pakistan

Three centers of excellence in Islamic finance were established by SBP
in renowned institutions15 such as the Institute of Business Administra-
tion, Karachi (IBA); Lahore University of Management Sciences, Lahore
(LUMS); and the Institute of Management Sciences (IMS), Peshawar
(GIFR, 2017). Other independently established Islamic financial institutes
have been set up in certain private sector universities of Pakistan such as the
School of Islamic Economics, Business and Finance at Minhaj University
Lahore. It is expected that these centers will increase the pool of skilled pro-
fessionals by enhancing the number of certifications, degree programs and
training programs related to Islamic banking and finance.16
Appendix A
Members of the Panel of
Economists and Bankers Appointed
by the Council of Islamic Ideology
in November 1977

Chairman
Dr. Ehsan Rashid
Professor of Economics and Director Applied Economic Research Centre
University of Karachi, Pakistan.

Memberseda
1 Dr. Rafiq Ahmed
Pro-Vice Chancellor, University of Punjab, Lahore, Pakistan
2 Sheikh Mahmood Ahmad
Lahore, Pakistan
3 Mr. Abdul Jabbar Khan
President Habib Bank Limited, Karachi, Pakistan
4 Dr. Nurul Islam Mian
Director, Institute of Economic Studies, University of Peshawar,
Peshawar, Pakistan
5 Dr. Syed Nawab Haider Naqvi
Director, Pakistan Institute of Development Economics, Islamabad,
Pakistan
6 Dr. Mian M Nazeer
Professor of Economics, University of Peshawar, Peshawar, Pakistan
7 Mr. D M Qureshi
Managing Director, Banker’s Equity Limited, Karachi, Pakistan
8 Professor Shakrullah
Head of the Economics, Department Baluchistan University, Quetta,
Pakistan
9 Dr. A H Siddiqi
Director of Studies, Administrative Staff College, Lahore, Pakistan
10 Mr. Khadim Hosain Siddiqui
Member of Pakistan Banking Council, Karachi, Pakistan
11 Mr. A K Sumar
Karachi, Pakistan
 A case of Pakistan 311
12 Mr. Abdu Wasay
Bank of Credit and Commerce International, Karachi, Pakistan
13 Dr. S M Hasan-uz-Zaman
Chief, Islamic Economics Division Research Department, State
Bank of Pakistan, Karachi, Pakistan

Convenor
Dr. Ziauddin Ahmad
Deputy Governor, State Bank of Pakistan

Notes
1 Abu ‘Ubayd, Kitab al-Amwal, p. 41, §82.
2 al-Suyuti, Tarikh al-Khulafa’, p. 110.
3 al-Sarakhsi, al-Mabsut, 18:22.
4 al-Ya‘qubi, al-Tarikh, 2:155.
5 www.ciis.org.cn/english/2017-11/10/content_40064710.htm
6 www.dawn.com/news/1290523
7 www2.deloitte.com/content/dam/Deloitte/pk/Documents/risk/pak-china- eco-
corridor-deloittepk-noexp.pdf
8 www.meezanbank.com/meezan-bank-awarded-as-the-best-islamic-bank-of-
pakistan/
9 IBD Circular No. 03 of 2012, November 19, 2012.
10 http://www.sbp.org.pk/ibd/bulletin/2014/IBB-Dec-2014.pdf
11 http://aaoifi.com on October 19, (2017).
12 www.sbp.org.pk/about/micro/criteria.htm
13 www.akhuwat.org.pk/
14 http://almawakhat.org/
15 www.sbp.org.pk/press/2016/SBP-Best-CB-08-Jan-16.pdf
16 www.mul.edu.pk/education/106/SIEBF.html

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19 Islamic safety nets for the poor
Pakistan’s experience
Nasim Shah Shirazi

19.1 Introduction
Islamic finance (IF) plays a pivotal role in the development of the real econ-
omy. It helps and stimulates economic activities and entrepreneurship,
addresses poverty and income inequality, ensures financial stability, and
promotes comprehensive human development in complex societies of the
21st century. IF and Islamic economics (IE) recognize the significant role
of the voluntary Islamic financial sectors which uplift poverty, and elimi-
nate homelessness and hunger. Some of the tools being used to accomplish
these targets include sadaqat, zakat, Khairat, and the development of the
institution of Bait-ul-Mal and qard-e-hasana1 (interest-free loans) in pro-
viding relief and assistance to the needy and the sparse population of the
country. The voluntary sector can be used not only for poverty alleviation
through simple transfers but also as a system of social protection and assis-
tance.2 These IE and IF tools target a broader group than the zakat recipi-
ents, but it can also be used to build social and public institutions in which
private for-profit sector may not have incentives to develop but which are
however needed for economic development and poverty alleviation of the
communities in developing and the developed countries where Muslims are
in minorities.
For example, obligation of zakat at the national zakat foundation (NZF)
and Qard Hassan Australia (QHA) at the Islamic council of Victoria encour-
age charity directly that address poverty issues and provide mechanisms to
bring people into mainstream economic activity, including their access to
a formal financial sector. There are many studies in the literature showing
that zakat has the potential to alleviate poverty from the country (see, for
example, Shirazi, 2014). However, if the proceeds of the voluntary sector
including zakat and Waqf are used in a more organized and planned man-
ner (see example of QHA online transactions in Australia), it can enable the
poor to not only meet their immediate consumption needs, but also develop
their skills and provide them the capital to start up small businesses and be-
come self-sustained, thus having a far more significant impact on economic
development.
 Islamic safety nets for the poor 315
This chapter is a review and summary of author’s previous work in this
area. It overviews the incidence of poverty and income distribution, and
analyzes the role of safety nets, including Islamic social protection programs
in reducing poverty. The present chapter is structured as follows: Section 2
discusses the incidence of poverty and income inequality covering method-
ological background and history of the poverty in Pakistan. Section 3 pre-
sents an overview of safety nets programs in Pakistan. Section 4 focuses on
the deficiency of the social protection programs in the country and seeks to
explore why social safety nets did not bring a significant change in poverty
reduction. The final section contains some concluding remarks.

19.2 Poverty and inequality in Pakistan3

19.2.1 Methodological background for poverty estimates

This section provides the methodological background of poverty estimates
and the incidence of poverty in the country and across the regions of the
state. The first step to measure the poverty ratios, a poverty line is needed.
Poverty lines have been determined differently by different authors over
time. Therefore, poverty estimates are not comparable across regions and
over time. Arif and Farooq (2012) divided the time period between 1963 and
2008 into two broad groups. First, 1963–1992, for which poverty estimates
are usually based on secondary or published grouped data, generally using
the calorific norm of 2,550 calories per day per person. The second group,
between 1992 and 2006, has been applying official poverty lines (based on
2,350 calories per adult per day) on micro-data (Household Income and
Expenditure Surveys, HIES). During the early period, or until 1992, it was
common to have different threshold levels for urban and rural areas, keep-
ing in view the higher calorific requirements of the rural population for
physical activities. In the late 1990s, a uniform threshold of 2,350 calories
per adult per day was used for rural as well as urban poverty estimates.
However, in general, poverty trends can be found despite the methodologi-
cal differences.

19.2.2 Poverty in Pakistan

Although poverty is widespread in Pakistan, it is more prevalent in rural
areas than in the urban ones. While there was an increase in the incidence
of poverty during the 1960s, the trend was reversed from 1970 onwards. The
changes occurring in the agrarian structure during the 1960s contributed
to rural poverty. Some of the factors responsible for the decline in poverty
from 1970 onwards and throughout the 1980s were overall economic growth
and foreign remittances. The introduction of zakat and ushr also played its
role in the 1980s.4 However, poverty re-emerged and aggravated further
during the 1990s and in the early 2000s.
316 Nasim Shah Shirazi
The estimates of the incidence of poverty presented in the following
Table 19.1 do not show unidirectional trends. The country has been expe-
riencing increasing poverty levels during the 1990s, rising from 26.8% in
1992–1993 to 30.6% in 1998–1999. Rural poverty increased from 28.3% to
34.7%, while urban poverty declined from 24.4% to 20.9% during the same
time. Rural poverty significantly contributed to the overall poverty levels of
the country during the 1990s. A number of factors including a decrease in
economic growth, political uncertainty, economic instability, and large fis-
cal and current account deficits were responsible for the increase in poverty
during the 1990s. The incidence of poverty, which was gradually increasing
in the 1990s, continued rising until it reached 34.5% in 2000–2001. Both ru-
ral and urban poverty rose to 39.3% and 22.7%, respectively. The incidence
of overall poverty then dropped, reaching 22.3% in 2005–2006. During the
same period, the drop in rural poverty was faster (12.3% points) than the
reduction (9.6% points) in urban poverty. The possible contributing factors
for the decline in poverty could be high economic growth combined with
increasing public sector spending on education, health, and infrastructure.
However, the country could not sustain the decline in poverty, and level of
poverty started rising again 2007–2008 onward. Since the mid-2000s, the
Pakistan economy has been facing a number of problems including declin-
ing economic growth, high food, and oil prices, and thus high inflation,
power shortage, week governance, and above all, terrorism. Among oth-
ers, these have been the main factors, which shattered the declining trend
in poverty that the country observed during 2000–2001 to 2004–2005 and
2005–2006.

Table 19.1 Pakistan: Trends in Poverty (Headcount Ratios)

Year Urban Rural Overall

1963–1964 44.53 38.94 40.24

1966–1967 40.96 45.62 44.50
1969–1970 38.76 49.11 46.53
1979 25.94 32.51 30.68
1984–1985 21.17 25.87 24.47
1987–1988 14.99 18.32 17.32
1990–1991 18.64 23.59 22.11
1992–1993 24.4 28.3 26.8
1996–1997 22.6 33.1 29.8
1998–1999 20.9 34.7 30.6
2000–2001 22.7 39.3 34.5
2004–2005 14.9 28.1 23.9
2005–2006 13.1 27.0 22.3

Source: Poverty estimates from 1963 to 1991 are reported from

Amjad and Kemal (1997) and from 1992 onward are reported from
Arif and Farooq (2011).
 Islamic safety nets for the poor 317
Malik and Whitney (2014) provide consistent estimates of money-metric
poverty based on HIES data sets during 2001/2002–2010/2011. Consistent
and realistic poverty estimates are essential for anti-poverty programs
and their impact evaluation. The estimates of poverty from 1998–1999 to
2005–2006 are based on official poverty lines. The official poverty line was
estimated in 2001–2002 based on HIES 1998–1999 data set, which has been
adjusted for inflation in the subsequent years using the Consumer Price In-
dex (CPI). The chapter finds following four problems in this methodology:
(1) outdated sampling frames underlying the HIES, (2) a non-representative
sample used initially for estimating the poverty line, (3) sensitivity of esti-
mates to caloric threshold underlying the poverty lines, and (4) changes in
the consumption basket due to price fluctuations not being adequately rep-
resented in the CPI and hence in the estimation. The food price increased
much faster (39.5% points during 2006–2008), which is not sufficiently cap-
tured in the CPI. The prices subsequent to 2007 are based on Food Ex-
penditure Survey that understates the weight of food category in overall
consumption than HIES data sets.

19.2.3 Poverty updates

Malik and Whitney (2014) estimated the calories expenditure function
from data for each of the available survey years. Poverty line expenditure
consistent with maintaining a minimum intake of 2,350 Kcal per adult
equivalent was estimated for each of the surveys. The Foster, Greer, and
Thorbecke (1984) class of decomposable money-metric poverty estimates
was computed for each of the years based on these poverty lines. In order
to account for the provincial variation and variation across rural and
urban sectors, the calories expenditure functions were estimated using
the intercept and slope dummies. The consistent results are presented in
Table 19.2. The results show a persistent increase in the headcount ra-
tios over the years. The official estimates based on official poverty lines
adjusted for inflation for the subsequent years are misleading. As it has
already been mentioned above, poverty is widespread but is primarily a
rural phenomenon. This is also evident from Table 19.2. The incidence
of poverty is high in all the rural areas of the four provinces. In the
year 2010–2011, the highest rate of poverty was found in Sindh-rural
(48.5%) followed by Baluchistan-rural (40.8%), Punjab-rural (38.0%),
and the lowest in KPK-rural (36.4%). However, the official figures show
that the incidence of poverty decreased to 24.3% during 2015–2016.5 The
poverty estimates presented by Social Policy and Development Centre
(SPDC) reveal that poverty increased to 38% in overall in 2015–2016 and
32% in the urban areas, while it was 41% in the rural years in the same
period.
318 Nasim Shah Shirazi
Table 19.2 Estimated Headcount (%) by HIES Year

Region 2001– 2004– 2005– 2007– 2010– 2015–

2002 2005 2006 2008 2011 2016 a

Pakistan 30.1 30.6 34 33.1 35.6(38) 24.3(38)

Urban 22 20.7 24.1 25 27.7(32) (32)
Rural 33.4 35.4 39.3 37.3 39.7(39) (41)
Punjab – Urban 24.8 22.9 24.1 24.7 28.5 …
Punjab – Rural 32 33.4 33.8 33.3 38 …
Sindh – Urban 16.5 15.7 21.2 23.5 24.8 …
Sindh – Rural 38.7 40.1 53.4 48.7 48.5
KPK – Urban 25.7 29 34.2 29.5 32.4
KPK – Rural 32.5 36.7 39.7 34.8 36.4
Baluchistan – 22.8 20.7 43.9 38 39.3
Urban
Baluchistan – 32.1 34.9 54.6 53.7 40.8
Rural

Source: Malik and Whitney (2014).

a Pakistan Economic Survey 2017–2018. The figures in parentheses under the year 2010–2011
and 2015–2016 are from http://spdc.org.pk/Data/Publication/PDF/RR-99.pdf.

19.2.4 Income inequality

Gini coefficient is commonly used for measuring income distribution. Figure
19.1 presents income distribution in the country over the last three decades.
The graph shows a moderate income inequality in the country. The Gini
index was 33.3% in 1987. Compared to 1987, income distribution improved
slightly in the subsequent years, and Gini index reached to 28.7% in 1996.
However, its trend reversed from 1996 onward, and Gini index increased to
33.1% in 1998. The decade starting from 2001 saw the income inequality in
the range of about 30%–33%. However, Gini index was recorded 33.5% in
2015, which is higher than the previous years. On the other hand, it may be
noted that the official estimates of poverty showed a declining trend dur-
ing 2010–2011 to 2015–2016. This was due to the modest economic growth
among other factors. During the same period, income inequality increased.
A comparison between the estimates of poverty with Gini coefficients re-
veals that the country experienced a negative correlation between poverty
reduction and income distribution. Economic growth reduced poverty but
increased income disparity, thus implying that benefits of growth were more
for the rich than for the poor.
Economic growth is a necessary but not a sufficient condition for the
reduction of poverty. Whether growth is pro-poor6 essentially depends on
how the benefits of growth are distributed amongst the different income
groups. Haq and Zia (2009) provided analysis of linkages between govern-
ance and pro-poor growth in Pakistan for the period 1996–2005. On the
aspect of pro-poor growth, they demonstrated that the poor do not benefit
 Islamic safety nets for the poor 319

GINI Index
34 33.3 33.5
33.2 33.1
33 32.7
32.5
32 31.6
30.9 30.7
31 30.4
29.8
30

29 28.7

28

27

26
1987 1990 1996 1998 2001 2004 2005 2007 2010 2011 2013 2015

Figure 19.1 GINI index.

Source: https://knoema.com/atlas/Pakistan/topics/Poverty/Income-Inequality/GINI-index.

proportionately from economic growth. The income and expenditure share

of the rich increased more than the income and spending share of the poor.
Over time the share in income and expenditure for the bottom 20% of the
population remained positive but decreased, while inflation for this lowest
income group was high as compared to the highest income group.

19.3 Social safety nets

In order to protect the hardcore poor and the vulnerable, the country has
started many social protection programs. These programs are considered
essential for creating an environment in which the hardcore poor are pro-
tected from the social and political costs of economic and structural re-
forms. Some social protection programs have been implemented over the
last three decades. While the Pakistan Poverty Alleviation Fund (PPAF)
was initiated in 2000, the Benazir Income Support Program (BISP) was
launched in 2008–2009.
Social protection or safety nets programs of Pakistan can be classified
into two categories. The first category is meant for the employed labor force
or those who have retired from the formal sector. This category does not
cover the employees in informal areas or contract employees. The other
one is much broader and includes those who are outside the labor market,
the poor and the indigent. The first set of programs provides benefits in
the event of contingencies like sickness, invalidity, maternity, old age, and
work-related injury. These include the Provincial Employees’ Social Secu-
rity Scheme, the Employees’ Old-Age Benefits Institution, the Government
320 Nasim Shah Shirazi
Servants’ Pension Fund, the Public Sector Benevolent Funds and Group
Insurance, the Workers’ Welfare Fund, and the Workers’ Children’s Educa-
tion Ordinance. The second category includes schemes like the PPAF, BISP,
the zakat and sadaqat program, the Pakistan Bait-ul-Mal (PBM) program,
and Qard al Hasan microfinance. The following sections will highlight these
vital safety nets including the Islamic social safety nets.

19.3.1 Pakistan Poverty Alleviation Fund

PPAF was established in 2000 as an apex body, with an aim to reach the
poor communities through NGOs and Community-Based Organizations
(CBOs). PPAF supports microcredit (major financier of microfinance mar-
ket), water and infrastructure, drought mitigation, education, health, and
emergency response interventions. PPAF disbursed Rs. 9.207 billion dur-
ing July 2016–March 2017 to its Partner Organizations (POs) under its core
interventions administered through various operational units. During the
year, PPAF disbursed about Rs. 5,415 million for Microfinance Portfolio
Management; paid Rs. 413 million for water and infrastructure projects;
and provided Rs. 375 million for health and education projects, Rs. 522 mil-
lion for institutional development and social mobilization, Rs. 213 million
for Livelihood, Employment and Enterprise Development, and Rs. 2,269
million for Prime Minister’s Interest-Free Loan.
PPAF has disbursed Rs. 178 billion since its establishment till June 2016.
Its credit and enterprise development programs received 61% of the funds fol-
lowed by project and relief activities, including Prime Minister Interest-Free
Loan Scheme and Waseela-e-Haq program (14%). Human and institutional
development (including social mobilization) /livelihood enhancement and
protection received 13%, and community physical infrastructure received
9%, while health and education received 3%.7

19.3.2 Benazir Income Support Program

BISP was launched in 2008 to provide direct and speedy relief to the poor
who have lost their purchasing power due to high inflation. BISP was
started with an initial allocation of Rs. 34 billion (the US$425 million ap-
proximately) to cover 3.5 million families in the financial year 2008–2009.
The program was initiated to provide a cash grant of Rs. 1,000 each month
(Rs. 3,000 quarterly) to the families having an income of less than Rs. 6,000
per month. However, the quarterly cash grant has been gradually increased
from Rs.3,000 per family to Rs. 3,600 in 2013–2014, Rs. 4,500 in 2014–2015,
Rs.4,700 in 2015–2016, and Rs.4,834 in 2016–2017. Since its inception in
2008, BISP has multiplied. It is now the largest single cash transfer program
in Pakistan’s history. The BISP has been successful in reducing poverty by
7% point and increasing consumption expenditure of Rs. 187 as per Oxford
Policy Management (Final Impact Evaluation Report, 2016).
 Islamic safety nets for the poor 321
The number of beneficiaries has increased from 1.7 million in FY 2009
to approximately 5.42 million at the end of March 2017. BISP’s annual
disbursement has risen from 16.0 billion in 2009 to Rs.115 billion in 2017.
Since inception, BISP has transferred Rs.486 billion (21 April 2017) as cash
transfers.
Initially, the targeting of the beneficiaries was the responsibility of pol-
iticians. A simple application form was designed and distributed among
the Members of Parliament in equal number (8,000 to each member of the
National Assembly and Senate and 1,000 to each member of the Provincial
Assemblies) for the selection of the poor families. In order to avoid subjec-
tivity in targeting the beneficiaries, the government stopped this practice
in 2010–2011 and replaced it with an objective poverty scorecard approach.
The BISP has been supported by multilateral and bilateral institutions
and donors including the World Bank, USAID, Asian Development Bank,
and DFID. BISP has been providing cash grants to an increasing number of
families. In addition to the cash grant, BISP includes graduation programs,
emergency relief, and expenditures on conducting a nationwide poverty
scorecard survey.
The graduation programs including Waseela-e-Rozgar, Waseela-e-Haq,
Waseela-e-Sehat, and Waseela-e-Taleem have been started to transform the
lives of the poor. Waseela-e-Rozgar was initiated by providing technical and
vocational training to one member per beneficiary family to enable them
to become the earning hand for the family. Such training is provided by
both public and private sector training institutions. About 39,374 members
are currently enrolled under this program, and 11,644 members have been
trained so far.
Under Waseela-e-Haq, interest-free loans of Rs. 300,000 each were pro-
vided to select (by monthly computerized random draw) members for start-
ing small businesses. Up till March 2013, Rs. 1.8 billion has been disbursed
among 40,868 beneficiaries.
Waseela-e-Sehat is a group life insurance scheme of Rs. 100,000 for the
bread earner of beneficiary families, which was launched in January 2011
in collaboration with State Life Insurance Corporation of Pakistan. Dur-
ing 2011–2013, about 7,000 death claims were processed. A comprehensive
Health Insurance Scheme covering all members of BISP beneficiaries’ fam-
ilies has been started in one district, Faisalabad, since April 2012. Other
districts will be brought gradually under this scheme.
Waseela-e-Taleem supports the beneficiaries’ children of ages between
5 and 12 years for their primary education. Under this scheme which tar-
geted to enroll about 2.0 million children by December 2018, a monthly cash
transfer of Rs. 250 per child (up to three children) will be provided subject
to their compliance with the school admission requirement and an encour-
aging level of school attendance. Since the initiation of the field of operation
of this program, over 1.3 million children have benefitted from about Rs. 2.9
billion disbursements as a stipend.
322 Nasim Shah Shirazi
19.3.3 Zakat
The President of Pakistan, on 20 June 1980, promulgated the zakat and ushr
Ordinance, 1980. The clauses of the Ordinance relating to zakat became ef-
fective from the same date, and the first deductions were made by the banks
on 21 June 1980. The clauses relating to ushr were enforced with effect from
15th of March 1983. Zakat funds are utilized for the needy, indigent, poor,
orphans, widows, handicapped, and disabled. The deserving people are
provided assistance directly through the local zakat committees (LZC) or
indirectly through the institutions.
Zakat is deducted compulsorily8 once a year at the rate of 2.5% on speci-
fied assets.9 The owners of all other assets10 related to the Schedule 2 of the
Ordinance on which zakat is payable under the Shari‘ah are expected to pay
zakat on self-assessment basis to the zakat fund or to other eligible benefi-
ciaries (mustahqueen), e.g., the poor of their choice.
The amount of zakat deducted at the source, as described in Schedule 1 of
the Ordinance, by the financial institutions is deposited in the central zakat
fund. Zakat funds have been established at three levels, namely, the central
level, the provincial level (in each province), and the local level (in each of the
localities). The provincial zakat funds receive six monthly transfers from the
central zakat fund, and similarly, the local zakat funds receive six monthly
transfers from the provincial zakat funds. A minimal amount of voluntary
zakat, atiyat (donations), and so on is also deposited with these funds.
The central zakat council has laid down guiding principles for the dis-
bursement of zakat funds by the provincial zakat councils and the LZC.
At the provincial level, the payment of zakat money from provincial zakat
funds has been suggested in the following manner:

1 Transfer to LZC 60%

2 Transfer to institutions for eligible beneficiaries (mustahiqueen) 40%

The breakdown of the transfer to institutions is given below:

i Educational institutions 18%

ii Dini Madaris 8%
iii Health institutions 6%
iv Social welfare institutions 4%
v Others 4%

At the level of the LZC, the utilization of zakat funds has been suggested
in the following way:

1 Subsistence grant to eligible beneficiaries (mustahiqueen). Not more

than 45%
2 Permanent rehabilitation of eligible recipients (mustahiqueen). At least 45%
3 Administrative expenses. Not more than 10%
 Islamic safety nets for the poor 323
The zakat program covers a small number of beneficiaries compared to
the number of poor in the country. The utilization of zakat has been min-
imal,and it remained between 0.04%and 0.06% of GDP during 2004–2008.
The total collection was 0.05% of GDP to 0.08% of GDP during the same
time, while it was about 0.3% during the 1980s. Compared to actual zakat
collection by the official sources, its potential is much higher, which is esti-
mated to be in between about 2% and 4% of the GDP (Shirazi and Amin,
2010).
The disbursement of zakat has remained uneven. The number of total
beneficiaries barely reached 1.5 million in 2010–2011, while it has consist-
ently hovered around 1 million. This is reported in Table 19.3. According
to Household Integrated Economic Survey (HIES, 1990–1991), about 18%
of the total households in the lowest income decile were benefited on an
overall basis, 16.5% in urban, and 18.5% in the rural areas. Out of the total
households in the second income decile, 3.6% overall, 3.7% in the urban, and
3.6% in the rural areas received zakat in the same year. The percentage of
households in third through fifth income deciles, who received zakat, varied
between 1.5% and 1.8% in overall Pakistan level. However, the total families
that benefited in all the income deciles were 2.7% on the whole basis, 1.4%
in the urban areas, and 3.2% in the rural areas of Pakistan in 1990–1991
(Shirazi, 1996). Issues and Policies Consultants (2004) reported that 2.7% of
poor households received 40% of zakat, while 1.4% of non-poor households
received 60% of zakat in 2001–2002, which clearly indicates possible misap-
propriation of zakat funds. The CPRSPD study (2007) reported 27% of the
non-poor households as zakat recipients. The same study pointed out that
32% of Guzara allowance and 45% of rehabilitation grant went to non-poor.
The contribution of zakat in poverty alleviation was just 0.5% in 1988 and
0.75% in 1990–1991 (Shirazi, 1996).
As mentioned above zakat deduction at source from specified assets was
mandatory until March 1999 and became optional after that. This has neg-
atively affected the collection of zakat by the government. Even before the
decision of the Supreme Court of Pakistan, people used to withdraw their
money before the date of deduction of the zakat by banks. Because of the
18th constitutional amendment, the institution of zakat, which was hitherto

Table 19.3 Zakat Utilized and Number of Beneficiaries

2008–2009 2009–2010 2010–2011 2011–2012 2012–2013

Amount 2,877 2,874 9,909.753 3,125.975 3,951.667

utilized
(Rs. million)
No. of 1,085,378 1,289,050 1,542,283 1,040,960 –
beneficiaries

Source: PRSP progress Report 2008/09–2010/2011 and PRSP progress Report 2011/2012.
Figures for the year 2012/2013 are reported from the Economic Survey of Pakistan (2013).
324 Nasim Shah Shirazi
Table 19.4 Disbursement of Zakat

S. No Provident/Other Areas (Rs. Million)

1 Punjab 4,038.687
2 Sindh 1,669.408
3 Khyber Pakhtunkhwa 973.059
4 Balochistan 359.792
5 ICT 186.230
6 Gilgit-Baltistan 98.414
7 FATA 245.320
Total 7,570.910

Source: Ministry of Religious Affairs and Inter-Faith Harmony.

centrally managed, devolved to the provinces. This has led to a change in

the business rules that assigned the collection and distribution of Zakat to
the Ministry of Religious Affairs and Inter-Faith Harmony at the federal
level. Overall, it appears that the collection of zakat has not been paid due
attention and consequently, an excellent institution that can potentially
make a dent on poverty has been neglected.
As at the end of 2017 Fiscal year, a total of Rs. 7,570.910 million was dis-
tributed among the provinces and administrative areas. This is depicted in
Table 19.4.

19.3.4 Pakistan Bait-Ul-Mal11

PBM was established in 1991 to provide financial assistance to the destitute,
widows, orphans, invalids, infirm, and other needy persons irrespective of
their gender, caste, and religion through its different projects and schemes.
Under the Individual Financial Assistance (IFA) scheme an amount of
Rs. 6,186.402 million was disbursed during the last four years to benefit
1,47,361 individuals including the poor, widows, destitute women, and or-
phans for their medical treatment, education, rehabilitation, and general
assistance. PBM has established 30 orphanages across the country, where
about 3,000 children have been registered. An amount of Rs. 261 million has
been spent to provide them with food, medical treatment, and education.
PBM is planning for an orphanage in every city. PBM provides wheelchairs
to disabled in the country. PBM has established 157 vocational training
centers for providing free training to widows, orphans, and poor girls in
different skills. PBM has spent an amount of Rs. 478.54 million since its
inception and trained about 60,000 female students.

19.3.5 Interest-free loans (Qarz Hasana)

Interest-free loans (Qarz Hasana) is another microfinance program that has
been started by Akhuwat in 2001 to support and empower the needy fami-
lies. The generosity and empathy of donors enabled Akhuwat to assist over
 Islamic safety nets for the poor 325
2.7 million low-income families in Pakistan through interest-free microfi-
nance. Akhuwat has been expanding and now has 789 branches in Pakistan.
Akhuwat has about PKRs 15.47 billion in outstanding loans as of 12 July
2018. Its total disbursement stands at about PKRs 65.35billion with a re-
covery rate of 99.67%.12 The financing process at Akhuwat involves the es-
tablishment of a credit pool and making small loans (Qard al Hasan) to the
poor from this pool. The pool itself is created through donations and the
spirit of brotherhood. It is like a revolving fund from which is continuously
depleted with disbursal of loans and replenished and enhanced with their
recovery and new donations. In July 2018, the cumulative disbursement was
PKR 65.35 billion.
In the initial years of operation, Akhuwat charged 5% of the loan amount
to recover the actual cost, which was termed anadministrative fee. Further,
small loans (amount less than PKR 4,000) were to be entirely cost-less as
these were targeted at the ultra-poor with least affordability. The sustained
growth in donations and the donations from the graduated borrowers ena-
bled Akhuwat to provide interest-free loans at zero cost in 2010.
The core administrative tasks relating to loan management are carried
out from the places of worship that result in substantial savings in admin-
istrative costs. Furthermore, the CEO and the top management and about
one-third of Akhuwat staff work voluntarily without any remuneration. The
organization has made minimal investments in office assets. It owns no ve-
hicles. Its team sits on the floor as its clients do. It has found a way to do
business with the poor keeping costs to a bare minimum. Consequently, its
operational expenses fell to 5% in 2015.13

19.3.6 Peoples’ Works Program-I and II

People Works Program (PWP)‐I and II was started in 2008–2009 replacing
the Khushal Pakistan Fund and the Village Electrification program. PWP-I
and PWP-II provide small development schemes for electricity, gas, farm to
market roads, telephone, education, health, and water supply to the rural
poor. PWP-I and PWP-II were politically motivated development projects,
which are implemented on recommendations of Parliamentarians as well as
utilized discretionary funds at the wishes and whims of the Prime Minister
of the country.
Rs. 4.3 billion and Rs. 33.6 billion were allocated for PWP-I and PWP-II,
respectively, in 2011–2012. Rs. 2.2 billion and Rs. 30.6 billion have been
spent on these two schemes sequentially up to the mid of the year 2012–2013.
During Pakistan People Party’s regime of five years, the government had
spent about Rs. 150 billion to Rs. 170 billion on PWP-1 and PWP-11.14

19.3.7 Employees’ Old Age Benefits Institution

Employees’ Old Age Benefits Institution (EOBI) provides monetary ben-
efits to the old age workers through different schemes including old age
326 Nasim Shah Shirazi
pension, invalidity pension, survivors’ pension, and old age grants. An
amount of Rs. 7,961.2 million has been spent during 9 months of the finan-
cial year 2011–2012. During July-December of the fiscal year 2012–2013,
an amount of Rs. 6,603 million has been utilized for the benefits of 373,433
individuals.
A minimum monthly payment of pension is Rs. 5,250. However, it will rise
to Rs. 10,920 depending on the wage of the insured person and the period
of the insurance scheme. A lump sum, which is equivalent to one months’
average salary, is paid as old age grant for every completed year of insurable
employment. From 1 July 2016 to 31 March 2017, an amount of Rs. 17,921.7
million was disbursed to about 405,460 beneficiaries. As of June 2017, an
additional Rs. 6,728.3 million was added to widen the net of recipients.

19.4 Reasons for low impact of social protection programs

Pakistan has witnessed a number of programs being started and imple-
mented to reduce poverty. But the fact remains that poverty and income ine-
quality persist. This is attributable to a number of factors. One may observe
that different social safety net programs are managed by various agencies,
and there is a distinct lack of coordination among them. This has led to du-
plication of efforts and identical recipients benefiting from different safety
net programs while leaving others who may be more deserving unserved.
It has been observed that when cash is transferred to the poor or they are
given funds/assets for rehabilitation under rehabilitation scheme, it has re-
sulted in misappropriation of funds. No proper records are maintained, nor
there is any systematic follow-up. In the case of zakat, for instance, the se-
lection of the poor/beneficiaries is supposed to be made by the LZC, but
local power structures play havoc with the selection process. As Arif (2006)
noted, 42% of zakat-recipient households in rural areas were selected on the
recommendation of local councilors or other influential persons, including
local landlords, religious leaders, or relatives of members of the LZC, while
the rest were selected by the LZC. The system is characterized by a high
degree of favoritism, nepotism, and lack of transparency. No lists of the
beneficiaries are available for any third-party evaluation/screening. Many
other deficiencies have also been highlighted by IMF (2010) in the context of
Poverty Reduction Strategy Paper-II (PRSP-II).
Funding for specific safety net programmes has traditionally been insuffi-
ciently given programme objectives and target populations. As a result, safety
net programmes are fragmented and often duplicative; have limited coverage
and are poorly targeted with small benefit levels relative to household income
and the poverty gap; payments are infrequent and irregular; administrative
arrangements are inadequate; and Monitoring and Evaluation capacity is not
up to the mark, which negatively affects programme efficiency and quality of
service delivery. Consequently, these programmes have limited impact on pov-
erty and vulnerability.
 Islamic safety nets for the poor 327
Arif and Farooq (2012) have identified some critical factors for failure to
get tangible results. Policy gaps or poor implementation, weak institutions,
poor governance, and deteriorating law and order situation, neglect of the
social sector, power structures in rural areas and lack of effective targeting
are significant factors responsible for affecting the economy and thus the
levels of poverty. They are of the view that the Afghan crisis, since the late
1970s, has changed Pakistan’s external and internal dynamics and has pro-
moted extremism, drugs, and weapons in Pakistan. The recent U.S.-led war
on terror in Afghanistan, since 2001, has significantly affected the internal
and external scenario of Pakistan, by promoting regional instability and
creating severe economic challenges for her.
However, there is a strong need for proper planning and management of
the safety net programs. These should be well-integrated and transparent,
remove duplication, pool the sources of funds, and provide benefits to the
targeted poor. These institutions, especially BISP, PBM, and zakat need to
be integrated and synergized for a significant quantitative change in the in-
cidence of poverty.

19.5 Concluding remarks

The chapter highlights the incidence of poverty and provides an analysis
of the safety nets program of the country. The official estimates show a de-
cline in poverty,but the independent sources reveal that poverty has been
increased in recent years. Income distribution is moderate but showing an
increasing trend in recent years.
The safety net programs including Islamic social safety nets are providing
support and financial assistance in cash and in kind. Despite the safety nets
program, poverty still persists in the country. One may observe that differ-
ent social safety net programs are managed by various agencies, and there
is a lack of coordination among them. This has led to duplication of efforts
and identical recipients benefiting from different safety net programs while
leaving others who may be more deserving unserved. Moreover, the govern-
ance problem has also been observed in the distribution of cash funds. For
the success of safety nets program, the coverage of the poor and the amount
of the transfer should be enough to cover the poverty gap. However, this is
not the case in Pakistan. Additionally, in Pakistan the targeting efficiency
is low (0.20%), which means a beneficiary gets only Rs. 0.20 when Rs. 1.0 is
transferred to fill the poverty gap. Consequently, these programmes have
limited impact on poverty and vulnerability.
However, there is a strong need for proper planning and management of
the safety net programs. These should be well-integrated and transparent,
remove duplication, pool the sources of funds. and provide benefits to the
targeted poor. These institutions, especially BISP, PBM, and zakat, need
to be integrated and synergized for a significant quantitative change in the
incidence of poverty.
328 Nasim Shah Shirazi
Notes
1 For example, Akhuwat, Pakistan and Qard Hassan Australia (QHA),www.icv.
org.au/icv-stories-nils/
2 NZF, Australia and the united kingdom nzf.org.au/ and NZF.org.uk
3 Part of the paper is based on my previous unpublished working paper No: 1435-
17, IRTI, Jeddah, Saudi Arabia.
4 For detail refer to Shirazi (1994).
5 Unfortunately, consistent incidence of poverty are not available for the all the
financial years.
6 Haq and Zia (2009) defined pro-poor growth as (1) a growth that is good for
the poor; a reduction in the proportion of the poor in the population; (2) or
growth that results in an increase in the income of the poor or (3) that associates
with larger proportionate increases in income of the poor than the rest of the
population.
7 PPAF, Directors’ Report & Audited Financial Statements, June 2016.
8 As per the decision of Supreme Court of Pakistan on March 9, 1999 any per-
son from all recognized fiqhs can claim zakat exemption from the compulsory
deduction at source on filing the requisite affidavit. These people can pay their
zakat of their own choice instead of paying to government. This is also one of
the reasons that Central Zakat Fund is getting small collection compared to
potential.
9 The zakatable assets which are mentioned in the first schedule of ordinance are:
Savings Bank Accounts and similar Accounts; Notice Deposits Accounts, re-
ceipts and similar Accounts and Receipts; Fixed Deposit Accounts and Receipts
and similar Accounts and Receipts, on which the return is receivable by the
holder periodically or is received earlier than maturity or withdrawal; Savings/
Deposit Certificates Accounts and Receipts and similar Certificates/Accounts/
Receipts on which return is receivable and is received by the holder only on
maturity or encashment; National Investment Trust Units (NIT);Investment
Corporation of Pakistan Mutual Funds Certificates; Government Securities on
which the return is receivable by the holder periodically; Securities including
Shares and Debentures of Companies and Statutory Corporations on which
return is paid; (Annuities; Life Insurance Policies; and Provident Fund Credit
Balances).
10 Gold, silver and manufacturing thereof; Cash; Prize bonds; Current accounts
and foreign currency accounts; Loans receivable, Securities including shares
and debentures; Stock in trade of Commercial undertakings [(i) Industrial un-
dertakings; (ii)Precious metals, stones and manufactures thereof; (iii) Fish and
other catch/produce of sea]; Agricultural produce other than that liable to com-
pulsory ushr; Animals fed free in pastures, and Wealth and financial assets other
than those listed in schedule on which ‘zakat’ is payable according to shari‘ah.
11 All figures in this section is reported from Economic Survey of Pakistan 2013.
12 Extracted on 24th July, 2018 from www.akhuwat.org.pk/progress-report/
13 For further details see Obaidullah, Shirazi and Izhar (2014).
14 See www.thenews.com.pk/Todays-News-13-23379-Govt-to-change-name-of-
Peoples-Works-Programme

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Shirazi, Nasim Shah, (1994).An Analysis of Pakistan’s Poverty Problem and Its Al-
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Shirazi, Nasim Shah, (1996). System of zakat in Pakistan: An Appraisal. IIIE, Inter-
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Shirazi, Nasim Shah, (2014). Integrating Zakātand Waqf into the Poverty Reduc-
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Concluding remarks on the growth
of the IBF industry
Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti

This chapter makes concluding remarks on the contribution of this volume

to the wider literature on Islamic economics and finance. The edited vol-
ume is a collection of selected papers on the theme of Muslim economies in
Islamic Finance. They are chosen from the WIEFC – 2018 conference, held
on 3rd and 4th January, 2018 at MUL in collaboration with IRTI and La
Trobe University. The book begins with a preface written by Rodney Wil-
son of Durham University, followed by an introductory note of editors and
an inspirational paper by Shaykh-ul-Islam Muhammad Tahir-ul-Qadri on
the standardisation of Islamic financial contracts using Taqlid al-Madh’hab
techniques to build bridges between various schools of thoughts. Moreover,
the book provides a fascinating contribution which critiques the different
approaches to the translation of the verses dealing with economic matters
in the Qur’an is a part of the present work. The present volume contains
a total of 19 chapters covering a wide range of topics including Islamic
bonds (sukuk), Islamic insurance (takaful), Zakat distribution, concept of
IBOR, riba, Islamic commercial and social finance, and the resolution of
disputes in Islamic finance through arbitration. As the book contains the
papers presented at an IBF conference in Pakistan, it includes more papers
based on Pakistani experiences and lessons learnt from Pakistan are applied
to the economy of other Islamic countries including Malaysia, Indonesia,
Saudi Arabia and Iran. The three last chapters on the country’s experience
are complementary, with one focusing on social finance and the other on
shari’ah compliance financing in Pakistan, and the last on Islamic Safety
Nets for the Poor: Pakistan’s Experience.
Overall, the work expands the boundaries of research in Islamic banking
and finance. The conference organisers, sponsors, referees, contributors,
research associates and publisher are to be congratulated for bringing to-
gether this edited volume.
Index

Note: Bold page numbers refer to tables; italic page numbers refer to figures and
page numbers followed by “n” denote endnotes.

AAA common bond vs. Sukuk bond Ali, Y. 207, 209, 213, 215, 217
yields 242, 243 Aloui, C. 139
AAOIFI see Accounting and Auditing Al-Quran 171–2
organization for Islamic Financial al-Tahrir fi Usul al-Fiqh 12
Institutions (AAOIFI) Amin, M. F. 197
Abbasid Era 34–5, 46 Ammer, J. 138
Abbas, M. 110, 118 analysis of variance (ANOVA): LSD
Abedifar, P. 43 statistics 179, 180, 181, 182; results
absolute poverty index 89 178, 179, 180, 181
Accounting and Auditing Organization Analyst coverage 59
for Islamic Financial Institutions Analyst variance 59
(AAOIFI) 111, 113–114, 116, 307–8 Andersson, M. 138
Adam, M. 41 Arbouna, M. B. 168
Adams, R. B. 55, 59, 69 ARDL approach see autoregressive
Adler, P. S. 267 distributed lag (ARDL) approach
AFC see Asian financial crisis (AFC) Ariff, M. 234, 239
Affan, Uthman ibn 34 Arif, G. M. 315, 327
Afzal, M. 197 Arunkumar, R. 43
agency costs 54, 122 Ashab al-Takhrij 6, 24
agency theory 51, 53, 122–3 Ashab al-Tamyiz 6, 24
Aglietta, M. 169 Ashab al-Tarjih 6, 24
Ahmad, N. 139 Asad, M. 206–7, 209–11, 159, 213,
Ahmed, H. 195 215, 217
Ahmad, Imam 19 Ashraf, A. 195
Ahmad, Khurshīd 152–3, 173 Asian financial crisis (AFC) 33
airtime-based Sukuk 190 Asif, S. 41
Akaddaf, Fatima 257 Aslanidis, N. 139
Akaike Information Criteria (AIC) asset-backed security 33, 65, 110
239, 245 asset-backed sukuk 33, 137
Akaike test 144–5 asset-based products 40
Akram, M. M. 197 asset-based sukuk 137
al-Amali 16 asset-liability rate risks 44
Alam, N. 55 assets-backed products 40
Alawi government’s reform asset securitization schemes 172
programs 229 assets under management (AUM) 192,
Alipour, Mohammad 131–2 297, 305, 305–6
Ali, Imam 229 Assidique, Abu Bakr 34
334 Index
Asutay, M. 263, 273 BPA 237; causality test 239–40, 246,
Autore, D. M. 54–5, 59 246, 248, 248; cointegration test 240,
autoregressive distributed lag (ARDL) 244–5, 245, 247–8, 247–8; corporate
approach 235, 238–9 issues 236; correlation analysis 248,
Awan, A. G. 172 250; debt markets 234, 248; descriptive
Awqaf 199–200 statistics 240–1, 241; dividend
Azam, M. 197 distribution 234; ECT 239, 245; error
Azhar, M. 172 correction estimation 239; F-test
239; Granger causality 235; liquidity
Bada’i‘ al-Sana’i‘ 16 premium theory 234; literature-
Bai Bithaman Ajil (BBA) 39 based evidence 233; long-run and
Bait al-mal 34–5 short-run relationship 237; market
Balachandran, B. 54, 70 participants 234; mean and median
al-Balagha, Nahj 221, 223 difference test statistics 240, 242, 243;
Banerjee, A. 238 non-stationary property 238; paired-
Bangia, A. 43 sample-type mean difference test 237;
banker-customer relations 9 pre-negotiated interest payments 234;
banking assets 254, 255 regression equations 235; Risk-free
Banking Companies Ordinance (BCO- Treasuries 244; short-run dynamics
1962) 285 analysis 239; short-term Treasury
bankruptcy costs 50 securities 246; stochastic trend
bankruptcy event 137 behavior 238; Sukuk certificate 233–4;
bank verification 96–7 test hypotheses 239, 240; time-based
Barhoumi, K. 239 classification 240; t-test 244; valuation
Basel Committee on Banking models 235; VARs 237; Williams’
Supervision (BCBS) 43 model 236; zero-risk common bond
Bashshar, al-Husayn b. 10 vs. Sukuk bond yields 241, 242; zero-
Bates J. M. 238 risk treasury bonds 235, 240
Baur, D. G. 138 Boolean-type function 95
bay’ al-’inah structure 7 Booth, L. 55, 60
Bayesian information criterion Borisova, G. 54
(BIC) 142 Boubaker, S. 54
al-Bayhaqi 23 bound testing approach 238
Bayless, M. 55 Boyd, B. K. 59
Becker, G. S. 268 BPA see Bond Pricing Agency (BPA)
Beck, K. 118 Brand, Chad 162
Beltratti, A. 138 Brickley, J. A. 54, 59
Benazir Income Support Program Bryman, A. 111
(BISP) 320–1 al-Bukhari, Imam 13
Berkovitch, E. 54 business risk 44
Berle, A. A. 122 business transactions 8
Bhatti, M. I. 41, 44, 55, 284
bivariate threshold crossing models 57 CAGR see Compound Annual Growth
blockchain-based insurance: benefits 82; Rate (CAGR)
instant payment structures 84; smart Calvin, John 161
contracts 82–4 Cameron, S. V. 57
blockchain cryptography 41, 84 Campbell, J. 138
Bollen, B. R. 172 capital and share responsibilities 41
Bollerslev, T. 142 capital market, Pakistan 148, 174, 270;
Bond Pricing Agency (BPA) 237 equity market 189–90, 189–190;
bond pricing theory: AAA common Sukuk market 190
bond vs. AAA Sukuk bond yields 242, capital ratios 294, 296
243; AIC 239; ARDL approach 235, Carnegie, A. 265
238–9; bound testing approach 238; Cash Waqf 203–4
 Index 335
causality test 239, 240, 246, 246, 248, 248 demand in credit 38
Central Depository Company of deposit-taking institutions 47n1
Pakistan Limited (CDC) 297 derivative-like instruments 42
Chaplinsky, S. 55 determined opinion 20
Chapra, M. U. 284 Deuteronomy 154
Chaudry, N. G. 110 al-Dihlawi, Imam Shah Wali Allah 20,
Chiang, T. C. 139 21, 22–3
China Pakistan Economic Corridor al-Dihlawi, Imam Shah Wali Allah
(CPEC) 284 al-Muhaddith 19
Choe, H. 60 disability person criteria 96
Cho, M.-H. 123 disputations opinion 19
Choudhury, M. A. 102 distributed digital depot 79
Christiansen, C. 139 District Microfinance Banks 308
Christopher, R. 139 Dobuzinskis, L. 264
CII see Council of Islamic Dolado, J. 238
Ideology (CII) Donaldson, L. 123
Clark, T. E. 238 Dong, M. 53
Clements, M. P. 238 Douglas, S. P. 238
cointegration test 240, 244–5, 245, Duasa, J. 239
247–8, 247–8 al-Durr al-Mukhtar 17
Commission for the Transformation of dynamic conditional correlation (DCC)
Financial System (CTFS) 287 model 142–4
Community-Based Organizations
(CBOs) 320 earning per share (EPS) 125, 128,
compatible opinion 20 130, 132
Compound Annual Growth Rate economic capital 266
(CAGR) 192, 287–8, 288 economic injustice 220–1; ethical
Connolly, R. 138 practices 220; market positive 221;
Consumer Price Index (CPI) 317 Muslims’ public treasury 220;
control motive theory 58 professional conduct 220
Cook, B. J. 41 economic policy 34
Cornett, M. M. 43 ECT see error correction term (ECT)
corporate governance 58–9 EGARCH model 142, 146
corporate sukuk 303, 304, 305 Eisenberg, T. 55, 59
correlation analysis 128, 128 Ellul, A. 51
correlation matrix 65, 66, 143 Employees’ Old Age Benefits Institution
Council of Islamic Ideology (CII) 286, (EOBI) 325–6
291–2, 310–11 Engle, R. F. 142–3, 147, 238
credit risk 43, 45, 137 EPS see earning per share (EPS)
Croson, R. 195 equity-based financing 41, 124
cross-border payments 80 equity-based products 39
cryptocurrency-Bitcoin 41–2 equity market 189–90, 189–190
customer-focused claims model 80 equity risk 45
error correction estimation 239
Daily, C. 54, 59 error correction mechanism
Dar, H. A. 174 (ECM) 246
Darné, O. 239 error correction term (ECT) 239, 245
Davis, J. H. 123 ethical financial activities 33
Dawud, Muhammad bin 283 ethical theory: ideal banking system
debt-based financing 41, 171 172–3; individual behavior 172;
debt-based products 39 interest-free basis 171; moral
debt markets 137, 234, 248 behavior 171
De Jong, A. 55, 60 Evans, C. W. 41
De Luca, G. 57 evolutionary learning 103
336 Index
Exodus 154 al-Ghazali, Abu Hamid Muhammad b.
Ezekiel 154 Muhammad al-Ghazali 171, 256
global finance industry 2
Falaye, O. 59 global financial crisis (GFC) 33, 43
fallacy: archival research strategy 111; global insurance market 46, 77
economic shocks 109; financial Global Islamic Finance Report 187–8
markets 109; GCC 109; interest-based global ledger system 81
conventional banks 109; KIBOR God-fearing behaviour (Taqwa) 266
116–118; Murabaha financing 109 God-fearing person (Muttaqi) 266
see also Murabaha financing; price governance-related covariates 68
determination 114–116; Sharia governance risk 44–5
viewpoint 109 Goyal, V. K. 55, 60
Farooq, O. 54, 58 Graham, J. R. 60
Farooq, Shujaat 315, 327 Granger causality 235
fatawa see ‘shari’ah-compliance’ fatawa Granger, C. W. J. 238
Federal Board of Revenue (FBR) 298 The Great Transformation (Polanyi) 264
Federal Shariat Court (FSC) 285 Greer, Joel 317
Ferrara, L. 239 gross national product (GNP) 171
finance assets 254 group mean variables 177, 177, 177–8
finance education 309 Gulf Cooperation Council (GCC) 7–8,
financial audit 226–7 78, 109, 303
financial credit institutions 187
financial inclusion, policy Habibovic, E. 7
recommendations 203–4 al-Hakim 23
financial products (new innovations): al-Hamawi 17
cryptocurrency-Bitcoin 41–2; Islamic al-Hanafi authorities 15–18
derivatives products 42 Hanafi schools of law 8, 12–14
financial risk 44–5 Hanan Quinn test 144–5
Finke, R. 266 Hanbal, Imam Ahmad b. 10, 18
fiqh schools 7, 34, 107–8 al-Hanbali view 18–19
First World Islamic Economics and Hanbali school of law 8
Finance Conference (WIEFC 2018) 1 Hanifa, Imam Abu 13–14, 15, 15–16, 23
fixed-income securities 148 al-Hanafi, ‘Allama al-Shurunbulali 23
Flannery, M. 60 al-Hanafi, Ibn ‘Abidin al-Shami 23
flight-to-quality phenomenon 140 al-Hanafi, Ibn Amir al-Hajj al-Halabi 13
Fortune magazine (Holden) 110 al-Hanafi, Imam Hasan b. ‘Ammar
Foster, James 317 al-Shurunbulali 11
Frank, M. Z. 55, 60 al-Hanafi, Imam Kamal al-Din b.
fraud detection 79–80 al-Humam 12
Friend, I. 68, 123 al-Hanafiyya, Mufti 14
Friend and Hasbrouck, (1988) 123 al-Hanbali, Ibn Muflih 18
F-test 183, 239 Haron, S. 284
funds assets 305–7, 305–7 Harris, F. H. 238
Funk, P. 55, 59, 69 Harvey, C. R. 60
al-Haskafi 15
Gait, A. 174 Hayek, F. A. 262–4
GARCH family models 136 Hazm, Ibn 18
Gardner, N. D. 41 Heckman, J. J. 57
Gatchev, V. A. 55 Heckman ordered probit (HOP) model
Gaussian normal distribution 142 65, 67–8, 70
GCC see Gulf Cooperation Hendry, D. F. 238
Council (GCC) Heng, T. 54, 59
GFC see global financial crisis (GFC) al-Hidaya 17
gharamah 259 al-Hilya 17
 Index 337
historical date-wise events 36, 36–8 interest-based profits 282
Holden, K. 110 interest-free financial transactions 32–3,
Hovakimian, A. 55 173–4
Hull, J. C. 43 interest-free loans (Qarz Hasana) 40,
human capital 268 324–5
Hurayra, Abu 10, 12 interest rate 43
internal/external rating system 43
IAHs see investment account holders international sukuk 300, 301
(IAHs) Internet of Things (IoT) concept 80
i-Arbitration Rules 258–9 intra-school principles 24–5
IBES see Institutional Broker’s Estimate investee company business 191
System (IBES) investment account holders (IAHs) 117
ICM see Islamic capital market (ICM) investment risk 136
ideal banking system 172–3 Iqbal, Z. 44
IFSB see Islamic Financial Services al-‘Iqd al- Farid 23
Board (IFSB) Iran Fara Bourse 136, 140–1, 144, 145
IFSI Stability see Islamic Financial al-Iskaf, Abu Bakr 16
Services Industry (IFSI) Stability Islamic banking branches (IBB)
Ijarah 40 293, 293
ijtihad 21, 25, 39 Islamic banking (IB) misconceptions:
income inequality 318–319, 319 advantages 170–1; ANOVA 176 see
indirect taxation 190 also analysis of variance (ANOVA);
individual behavior 172 capital market 174; conventional
Individual Financial Assistance (IFA) banks investors 167; economics 168;
scheme 324 ethical theory see ethical theory ;
information asymmetries 53, 55, Figh-ul-Mamo’lat 168–9; financial
59–60, 69 practices and products 175; financial
Information Technology (IT)-based transactions 169–70; F-test 183;
Finance Hub: absolute poverty index group mean variables 177, 177, 177–8;
89; economic growth 89; flowchart IFI 167–8, 174–5; IFS 167, 169;
90, 90; food and resources 87; formal interest-bearing financial institutions
methods 89–90; graphical model 88, 167; interest-free financing 173–4;
88; ITB-FHA see IT-based Finance investments proxy 183; investors,
Hub algorithm (ITB-FHA) ; material types 174; laymen ideology 167;
poverty index 89; model analysis 97, “liability driven” 169; LSD 176,
97, 98; national saving scheme 89; 183; mean values 176, 176; non-
non-formal techniques 89; OIC 89; interest-free financial institutions
poverty index 89; poverty ratio 87; 167, 174; principles 167; ROE 174–5;
Salah 87; spiritual poverty index 89; ROMD 174–5; Sharia compliant
UC level 88; VDM-SL 89–90; wealth banking system 178; shariah advisory
index 89; welfare index 89; Z-notation committee 168; solving methods
89–90 168; wealth and income distribution
infrastructure investment project 32 system 174
Innaccone, L. R. 266 Islamic capital markets (ICMs) 39;
instant payment structures 84 AUM 297; economic growth 297;
Institutional Broker’s Estimate System financial volatility 45; funds assets
(IBES) 61 305–7, 305–7; Modaraba 299–300;
institutional ownership 128, 131 Pakistan 297–8; Shariah-compliant
Interbank rate 60 stock index 298–9, 299; sukuk see
interest-based banking 32 sukuk; ṣukūk industry 45; takāful
interest-based conventional banks 109 industry 46
interest-based debt 191 Islamic commercial and social finance,
interest-based investments 191 Pakistan: capital circulation 187;
interest-based loan products 110, 162 capital market see capital market,
338 Index
Pakistan ; financial credit institutions Al-Jahashiyari 283
187; Global Islamic Finance Jalalain 212
Report 187–8; lifetime resources Jalil, M. A. 110, 118
187; microfinance see microfinance, Jarque-Bera test 143
Pakistan ; mutual funds see mutual Jensen, M. C. 122
funds ; National Financial Inclusion Jewish conception 153–4
Strategy 188; policy recommendations Johansen, S. 238
200, 202; redistributive institutions Johansson, J. K. 238
see redistributive institutions, joint venture projects 32
Pakistan ; Ribā 188; socioeconomic Jouini, E. 169
institutions 188 Jung, K. 53
Islamic derivatives products 42 Jurdaq, George 224
Islamic economic system: AAOIFI jurisprudence schools 25
307–8; “Bayt al-Mal” 282–3; juristic strategy, contemporary issues:
community development 282; compatible opinion 20; determined
finance see Pakistan’s economy; opinion 20; disputations opinion 19;
ICMs see Islamic capital markets God-consciousness 20; ijtihad 21;
(ICMs); infrastructural development jurisprudence principles 20; Lawgiver
282; interest-based profits 282; command 19; life complexities 19;
microfinance 308–9; Riba-based mujtahid 21; preferred opinion 20;
banking 282; sharī‘ah-compliant Qur’anic verdict 21–3; un-preferred
assets 283 opinion 20
Islamic Financial Industry 39 juristic verdicts: al-Hanafi authorities
Islamic Financial Institutions (IFIs) 15–18; al-Hanbali view 18–19;
167–8, 174–5, 272–4, 277, 285; policy al-Maliki view 18; statements 14
recommendations 202–3
Islamic Financial Services Board al-Kabir, Shaykh Abu Hafs 16
(IFSB) 78 Kahf, M. 197
Islamic Financial Services Industry Kang, S. H. 139
(IFSI) Stability 78 Kantian rationalism: ‘shari’ah-
Islamic financial system (IFS) 167, 169 compliance’ 105, 106; socio-scientific
Islamic financial tools 33 world-systems 106; symbols 106–7
Islamic Interbank Offer Rate Karachi Inter Bank Offered Rate
(IBOR) 118 (KIBOR) 286; commodities price
Islamic microfinance banks (IMFB) 308 116; cost and profit 117; IAHs 117;
Islamic Microfinance Institutions LIBOR 117; Murabaha financing
(IMFIs) 195; Waqf 203–4 116; operations cost 117; price
Islamic Middle East: arbitration 254–6; determination 115–116; profit rate 118
asset growth 254, 256; banking assets Karachi Stock Exchange (KSE) 298
254, 255; economic growth 254; Karachi Stock Exchange Al-Meezan
finance assets 254; global financial Index (KMI-30) 189, 189–90
crisis 259; i-Arbitration Rules 258–9; al-Kasani, Imam 16
public policy 256–8; Saudi Arbitration Kayhan, A. 60
Law 2012 258; Shari’a laws 255 Kayo, E. 60
Israel, R. 54 Khan, M. M. 284
Istijrar 40 Al-Khattab, Umar ibn 12, 34
al-istisna 8 KIBOR see Karachi Inter Bank Offered
IT-based Finance Hub see Information Rate (KIBOR)
Technology (IT)-based Finance Hub Kim, H. B. 139
IT-based Finance Hub algorithm (ITB- Kim, S. J. 138
FHA) 92; distribution criteria 92; Kimura, H. 60
high-level pseudocode 91, 91; UC level Knight, F. H. 263
92; VDM-SL 92–7 know-your-client (KYC) data 80–1
 Index 339
Kolm, S.-Ch. 264 Maclean, A. 110, 118
Komi, M. E. 195 macroeconomic variables 60, 69
Korajczyk, R. A. 60 madhahib 25
Kotreshwar, G. 43 al-Makki, Muhammad b. ‘Abd
Kovacs, T. 54–5, 59 al-‘Azim 14
Kruskal-Wallis test statistics 63 Maksimovic, V. 127
Kunhibava, Sherin 42 Mak, Y. T. 51, 59
Kunt, A. 127 Maliki schools 8
Kuran, T. 110–1 al-Maliki view 18
Kusnadi, Y. 51, 59 al-Maliki, ‘Allama al-Shinqiti 11
Kwon, S-W. 267 al-Maliki, Imam Abu al-‘Abbas Ahmad
b. Idris al-Qarafi 11
al-Laknawi, ‘Allama ‘Abd al-Hayy al-Maliki, Imam al-Qarafi 11–2
al-Faqih al-Hanafi 14 Malik, Anas b. 10
Lang, L. H. 68, 123 Malik, Imam 18, 23
Layla, Ibn Abi 18 Malik, S. J. 197, 317
Leary, M. 60 managerial ownership 122–3, 131–2
least significant difference (LSD) 176, Mansor, F. 235
179, 180, 181, 182, 183 Maqasid al-Shari’ah’ 41, 170
legal development: capitalistic economic Maraqi al-Falah 11
system 281; Islamic economic system market-based for-profit models 194
281 see Islamic economic system; market mechanism 263
mixed economic system 281; socialistic market risk 43–5
economic system 281 market share 192, 194, 194, 287, 288,
Le Goff, Jacques 156–7 294, 295
Lemmon, T. T. 53 market timing theory 51, 53, 60
leverage 60 see also ownership structure- market-to-book ratio (MBV) 60, 65, 69
performance relationship Marquitz 136
Leviticus commandments 154 Marrison, C. 43
Levy, A. 60 Mas Mansur, K. H. 283
Lewis, C. M. 70 material poverty index 89
Lewis, M. 59 Matsa, D. 55
Li, L. 138 Maududi, Abul A’la 36
liquidity premium theory 234 Mauss, M. 263
liquidity risk 43 Mawardi, A. H. A. I. M. I. H. 18, 171
Liu, Q. 51, 54 MBV see market-to-book ratio (MBV)
L-Jung Box tests 143, 146 mean and median difference test
local zakat committees (LZC) 322 statistics 240, 242, 243
long-term debt ratio 131 Means, G. C. 122
long-term financing 33 mean values 176, 176
low-risk fixed-income investments 189 Meckling, W. H. 122
LSD see least significant Meera, A. K. M. 41
difference (LSD) Merrill Lynch v Behbehani (1985) 258
Lucas, R. 236 Mestre, R. 238
Lucey, B. M. 138 Metwally, M. M. 174
Luthans, F. 267 Microfinance Institutions (MFI)
Luther, Martin 161 Ordinance 308
Lutz, F. A. 236 microfinance, Pakistan see also
Pakistan’s economy: compliance
al-Mabsut 15–16 rates 195; facts 195, 195; IMFIs
McCracken, M. W. 238 195; institutions and operations
McInish, T. H. 238 196–7; liquidity constraints 194;
MacKie-Mason, J. 54 market-based for-profit models 194;
340 Index
non-market-based not-for-profit mutual funds 248; AUM 192, 193;
models 194; province wise 195–6, 196; interest-based debt 191; interest-based
Qard-e-Hasan-based financing 194–5 investments 191; investee company
Miller, A. 55 business 191; market share 192, 194,
Miller, M. H. 121 194; minimum price per share 192;
Ministry of Awqaf and Religious non-liquid assets 192; risk-averse
Affairs 8 investors 191; risk-neutral investors
Ministry of Justice and Islamic Affairs 8 191; screening criteria 192, 193;
Mirakhor, A. 44 Shari’ah non-compliant income 191–2
Mises, L. V. 263
Miskawaih, I. 171 Najeeb, S. F. 139
Misman, F. 44 Narayan, P. K. 239
Mitton, T. 58 Nashr al-Bunud ‘ala Maraqi al-Sa‘ud 11
Modaraba 299–300 Nathan, S. 168
Modigliani, F. 121 National Clearing Company of Pakistan
Mohamad, S. 234 Limited (NCCPL) 297
monotheistic unity of knowledge 102, National Financial Inclusion
103, 105 Strategy 188
moral economy 268, 269 National Microfinance Banks 308
Mu‘adh b. Jabal 12 national saving scheme 89
Mu’awiya, Abd al-Rahman ibn 35 National Shari’ah Advisory Board 8
al-mudaraba 8 national zakat foundation (NZF) 314
Mudarabah banking 172 Nelson, D. B. 142
al-Mudawwana al-Kubra 18 Newbold, P. 238
Muflih, Imam Ibn 19 Newmark, P. 207
mujtahid 21 Nonaka, I. 238
Muhammad (Prophet) (PBUH) 33–4, 46 non-formal techniques 89
Muhammad, Imam 16–17 non-interest-free financial institutions
Mujtahidin 23 167, 174
multivariate analysis: CEO duality non-liquid assets 192
69–70; choice equation 68; debt-based non-market-based not-for-profit
instruments 68; firm-specific variables models 194
69; governance-related covariates 68; non-recourse project finance
HOP model 65, 67–8, 70; information transaction 173
asymmetry 69; issuance decision 65; Nujaym, Ibn 15
ISSUE and CHOICE equations 68–9; Nur al-Idah 11
macroeconomic variables 69; MBV Nursi, Said 36
69; ownership concentration 69–70;
stewardship theory 68; Wald test 67 oil and commodity prices 33
multivariate GARCH models 139, Ong, Walter 222
141–4, 147, 147–8 operational risk 43–4
Murabaha financing 39, 111; acceptance Organization of Islamic Cooperation
114; agency 113; asset-backed (OIC) 284
provision 110; financial burden 111; Organization of Islamic Countries 89
Fortune magazine (Holden) 110; Ottoman empire 35, 46
implementation 113; interest-based ownership and governance structure:
loan products 110; KIBOR 116; offer agency costs 54; asset-backed
114; promise 113; purchase 113–114; security 65; bankruptcy costs 50;
Sharia conditions 112 capital structure 51, 53; concentrated
Murabahah 39–40 ownership 58; control motive theory
Musharakah 202–3 58; corporate decision-making
Musharkah 40–1 55; corporate governance 58–9;
Muslims’ public treasury 220, 225–6 correlation matrix 65, 66; debt and
 Index 341
equity 50, 53; debt-based instruments concentration 294, 296; financing
52; descriptive statistics 61, 62, 63, 64; mix 288, 289–90, 294, 295; foreign
dual management roles 63; empirical remittances 315; FSC 285; IBB 293,
analysis 56–8; financial statement 293; IBI 293, 294; income inequality
data 61; firm control 52; IBES 61; 318–319, 319; industry progress 294,
information asymmetries 53, 55, 295; interest-based transaction 291;
59–60; issuance decisions 51; Kruskal- interest-free loans (Qarz Hasana)
Wallis test statistics 63; long-term 324–5; interest-free modes 287; Islamic
funds 50; macroeconomic variables financial institutions 285; KIBOR
60; marginal tax rates 54; market 286; market share 287, 288, 294, 295;
timing theory 60; MBV 55, 60, 65; ‘markup’ technique 287; microfinance
multivariate analysis see multivariate 308–9; OIC 284; PBM 324; PLS 286;
analysis ; non-financial firms 61; policy instruments 292–3; poverty
pecking order theory 53–4, 60; relative estimates 315; poverty trends 316, 316;
risk aversion 50, 52; risk-sharing 50; poverty updates 317, 318; PPAF 320;
risk-taking behaviour 58, 71; sample profitability and earning 294, 297;
selection bias 51–2; security issuance PTC 286; PWP‐I and II 325; Riba-free
52; security issues 61, 61; security banking 284; SBP 285–6; Zakat see
selection decision 54; shareholders 52; Zakat
state-ownership control 58; sukuk 50, Pakistan Stock Exchange (PSE) 122,
55–6; tax shields 54; trade-off 50, 51 297–8
ownership structure-performance panel regression model 126, 128, 129–32,
relationship: agency cost 122; agency 131–2
theory 122–3; capital structure 121, Pareto optimality 264, 278n4
124; control variables 125; correlation Participation Term Certificate (PTC) 286
analysis 128, 128; data collection 125; participatory mode 39, 286
definition 121; descriptive statistics partnership investment 33
127, 127; EPS 125; framework 125, partnerships financing 40
125; managerial ownership 122–3; Pastré, O. 169
nonlinear association 123; panel Pearce, J. A. 55, 59
regression model 126, 128, 129–32, pecking order theory 51, 53–4, 60, 124
131–2; PSE 122; ROE 125; rules and Pejman, Mohammad. Ebrahim 131–2
regulations 121; Shariah-compliant People Works Program (PWP)‐I and
financial operations 122; stewardship II 325
theory 123; “tax shield advantage” Period of the Noble Companions and the
121; variables construction 126, 126 Succeeding Generations 34
Oxfam 87 Perotti, V. 57
Öztekin, O. 60 Pesaran, M. H. 238, 245
Pickthall, M. 206–7, 210–11, 213,
paired-sample-type mean difference 215, 217
test 237 PKI see public key encryption
Pakistan Bait-Ul-Mal (PBM) 324 infrastructure (PKI)
Pakistan Poverty Alleviation Fund PLS banking see profit and loss sharing
(PPAF) 320 (PLS) banking
Pakistan’s economy: banking system Pluyaud, B. 239
failure 292; BCO-1962 285; BISP Polanyi, K. 264
320–1; branch network 294, 295; portfolio diversification: benefits 140;
CAGR 287–8, 288; capital ratios 294, flight-to-quality phenomenon 140;
296; CII 286, 291, 310–11; CPEC macroeconomic driving forces 138;
284; CPI 317; CTFS 287; deposits monetary policy authorities 138;
breakup 294, 296; economic growth multivariate GARCH model 139; risk/
315; elements 292; EOBI 325–6; return profile 139; Sharia compliant
finance education 309; financing debt instruments 139; stock-bond
342 Index
market correlation 138–9; time- Rawda al-Nazir fi Usul al-Fiqh (Allama
varying correlations 138 Ibn Qudama) 10
positive organization behaviour Rebiere, V. 168
(POB) 267 redistributive institutions, Pakistan:
Post-Biblical Judaism 154 income and wealth 197; Waqf 199,
poverty index 89 199–200, 200; Zakāt 197–9, 198
poverty ratio 87 Regional Microfinance Banks 308
preferred opinion 20 regression equations 235
Presley, J. R. 174 Rehman, M. K. 110, 118
price determination: KIBOR reinsurance 81–2
benchmarking 115–116; Sharia rulings religious capital 266–8
114–115 rent-based mode 39
pricing mechanisms 102–3, 103 return on equity (ROE) 125, 128,
private equity/venture capital models 270 129–31, 174–5
productive participation 222 return on Mudarabah deposits (ROMD)
profit and loss sharing (PLS) banking 8, 174–5
34, 173, 286, 292–3 riba 188; biblical times usury 160;
profit-sharing ratio 41 christianity 156; Christian literature
Prophet and the orthodox caliphs 33 156–7; Church teachings 161;
Provincial Microfinance Banks 308 definition 152–3; economic activities
Prowse, S. 123 152; economic self-sufficiency 163;
PSE see Pakistan Stock Exchange (PSE) interest-based loans 162; Islam 157–9;
public key encryption infrastructure Islam proclaims 152; Jewish literature
(PKI) 83 155–6; Jewish usury 162; Muslim’s
Public Sector Development Program literature 159–60; Old Testament
(PSDP) 203 153–5; social disharmony 161
Putnam, R. D. 268 Riba-free banking 284
Pym, A. 206 Ribah-based transactions 32, 47n3
Rigot, S. 169
Qard-e-Hasan model 194–6, 203 risk assessment intelligence 81
Qard Hassan Australia (QHA) 314 risk-averse investors 191
quasi-equity security 173 risk-free Treasuries 244
Qudama, Allama Ibn 10 risk management 2; GFC 43; systematic
Qudama, Imam Ibn 19 and unsystematic risks 42; types 43, 44
Qur’anic Injunctions on the Principle of risk mitigation 79–80
Facilitation and Flexibility 6, 9–10 risk-neutral investors 191
Qur’anic monotheistic primal risk selection process 80
ontology 104 risk-sharing characteristics 33
Qur’anic verdict 21–3 Roberts, M. 60
Quran translation: economic verses ROE see return on equity (ROE)
208–215, 208–216, 216; Prophet ROMD see return on Mudarabah
Muhammad (PBUG) 207; deposits (ROMD)
‘qiyaam’ 207 Rosly, A. S. 174
Qushairi 212 Roy, Kristin T. 258
Rusgianto, S. 139
al-Rafi‘I, Imam 13 Ryan, J. 54
Al Rahahleh, N. 41, 44, 55
Rahmān, Fazlur 159 Sadaqah 277
Rajan, R. G. 54–5, 60, 65, 68 Saeed, S. U. 110, 118
al-Ramli, Shams al-Din 18 Safari, M. 234, 235
Rapach, D. E. 239 safety nets: QHA 314; social protection
Rashi 153 and assistance 314, 326–7; Waqf 314;
Ar-Rashid, Harun 283 zakat 314
Rashid, R. G. 122 St. Augustine 156
 Index 343
Salah 87 Shariah-compliant stock index
Salam 40 298–9, 299
al-Salam, Imam ‘Izz al-Din b. ‘Abd Shari’ah governance 8–9
19, 20 Shari’ah non-compliant income 191–2
Salama, Muhammad b. 16 Shariah norms 32–3
sale mode 39 Shariah risk 45
Samad, A. 41 Shari’a laws 255, 257–60
Samad, M. A. 195 Sheppard, K. 142
al-Samarqandi, Abu al-Layth 17 Shiller, R. 138
Santos, M. 51, 54, 58 Shin, Y. 238
al-Sarakhsi, Imam 16 Shirazi, N. S. 197
Saudi Arbitration Law 2012 258 Shoesmith, G. L. 238
Saunders, A. 43 short-run dynamics analysis 239
Sayyīd Maudūdī 159 short-run Granger causality test 239
Sayyīd Qutub 160 short-term debt ratio 131
Schwarz test 144–5 short-term funds 40
SDGs see Sustainable Development short-term Treasury securities 246
Goals (SDGs) al-Siddiq, Abu Bakr 12
Securities and Exchange Commission of Sila, V. 55, 69
Pakistan (SECP) 297–8 Sims, C. A. 237
security-oriented approach 171 Sindh Institute of Urology and
self-correlation 144 Transplantation (SIUT) 198
self-exerted judgment 34 Singh, M. 53, 70
Self-Regulatory Organizations al-Siraj al-Wahhaj 15
(SROs) 297 smart contracts: blockchain
Seligman, M. E. P. 267 cryptography 84; distributed ledger 82;
al-Shafi‘I, Imam ‘Izz al-Din b. ‘Abd insurance policy 82; legal agreements
al-Salam 12 82–3; PKI 83; programmable
al-Shafi‘I, Imam Sayf al-Din Abu agreements 82; types 83
al-Hasan al-Amidi 12 Smith, C. 266, 268
Shafi‘i schools of law 8, 12–13, 101 Smith, J. 238
Shaikh, A. 118 Smith, R. P. 238
al-Shami, ‘Allama Ibn ‘Abidin 17, 25 Smolo, E. 7
al-Shami, Ibn ‘Abidin 17 social and collective responsibility:
al-Sha‘rani, Shaykh ‘Abd Arabic literature 223; attitude 222;
al-Wahhab 22–3 descriptive method 223; economic
Sharh Tanqih al-Fusul ila Ikhtisar distribution 222; economic injustice
al-Mahsul fi’l-Usul 11 220–1; economic production 221;
Sharia compliant banking system 178 ethical prerequisites 223; government,
Shariah 42 economic conduct 219–20; parallelism
shariah advisory committee 168 222; Persian literature 223; productive
Shariah Advisory Council (SAC) 42 participation 222; Urdu literature 223;
‘shari’ah-compliance’ fatawa 107; value-based governance see value-
fiqh 107–8; Islamic financial based governance
instruments 102; Kantian rationalism social capital 266–8
105–7, 106; madhabi diversity 101; social disharmony 161
pricing mechanisms 103; product social entrepreneurship 272
developments 103; riba problem Social Policy and Development Centre
105; Shafei school 101; tawhidi (SPDC) 317
methodological worldview 102–3; social security system 78
unity of knowledge 104; well-being socio-economic development 35, 35
criterion 103–4 socio-scientific world-systems 106
Shari’ah compliant assets 6, 283 sovereign sukuk 300, 302–3, 303
Shariah-compliant legal frameworks 46 Special Purpose Vehicle (SPV) 137
344 Index
spiritual poverty index 89 sukuk 39, 50, 55–6; certificate 233–4;
Stajkovic, A. D. 267 corporate sukuk 303, 304, 305;
stakeholder model 103 entity-wise and year-wise breakup
standardization, Taqlid al-Madhahib 300, 301; industry 45; international
philosophy: accounting 7; bay’ sukuk 300, 301; issuance trend 300,
al-’inah structure 7; conformist 302; jurisdiction and share 300, 302;
jurists 23–4; disclosure 7; Divine market 190; markets 300; sovereign
command 26; financial reporting sukuk 300, 302–3, 303; stock exchange
7; fiqh schools 7; GCC 7; Hadith 300, 301
evidence 10; ijtihad 25; intra- Sundaramurthy, C. 59
school principles 24–5; Islamic Sunnah 171–2
banking products and services Sustainable Development Goals
7; jurisprudence schools 25; (SDGs) 33
juristic inclusion 10–14; juristic Sustainable Economic Empowerment
strategy 7 see also juristic strategy, Program (SEEP) 198
contemporary issues ; juristic verdicts systematic risks 42, 44–5
see juristic verdicts ; legal expediency
25; neo-juristic approach 9; Qur’anic Tahir-ul-Qadri, Muhammad
Injunctions on the Principle of 206–217, 291
Facilitation and Flexibility 6, 9–10; Talib, Ali ibn Abi 34, 219–31
Shari’ah compliant assets 6; Shari’ah takāful 39, 204; blockchain-specific
governance 8–9; time and cost benefits 79 see also blockchain-
reduction 7; transparency 7; unified based insurance ; claims
and uniform Shari’ah Code 7 processing and management
static trade-off theory 51 80–1; customer engagement 84;
stewardship theory 68, 123 distribution and payment models
stochastic trend behavior 238 81; fraud detection 79–80; functions
stock-bond market correlation 138–9 85; GCC 78; global insurance
stock-index futures 42 market 77; IFSB 78; IFSI Stability
Stock, J. H. 238 78; industry 46; insurance policies
stock market 248 77; long-term savings 78;
stocks and sukuk see also sukuk: ARMA penetration rates 78; ‘point
coefficients 146; asset-backed sukuk innovations’ 85; policies 79;
137; asset-based sukuk 137; capital reinsurance 81–2; risk mitigation
market 148; correlation coefficient 79–80; risk-sharing 77; social
136; debt market 137; dynamic security system 78
correlation 147, 147; EGARCH model takhrij principle 24
146; financial markets 136; fixed- tangible and intangible capital:
income securities 148; GARCH family compulsory charity 265; compulsory
models 136; investment risk 136; Iran system 263; culture 268; economic
Fara Bourse 136, 140–1, 144, 145; capital 266; economic/social
L-Jung Box tests 146; multivariate activities 262; “extended order”
GARCH models 141–4, 147, 147, 262; God-fearing behaviour
148; non-conditional correlation 144, (Taqwa) 266; God-fearing person
146; portfolio diversification 138–40; (Muttaqi) 266; human capital 268;
portfolio risk 136; price 140–1, 144, “indiscriminate almsgiving” 265;
144–5; principles 137; self-correlation market mechanism 263; moral
144; statistical characteristics 144, 146; economy 268, 269; Pareto optimality
Tehran Stock Exchange 136, 140–1, 264; philanthropy, definition 264
144, 145; univariate GARCH models see also venture philanthropy ; POB
142, 146, 146 267; private enterprise assumptions
Strauss, J. K. 239 263; production capacity 266;
Suchard, J. A. 53, 70 psychological capital 267; religious
 Index 345
capital 266–8; self-interest 263; social 229; economic activities 228; equity
capital 266–8; transformation process and growth 229; ethical values 224;
269; voluntary system 263 financial audit 226–7; harmful
tarjih principle 24 practices 229–30; market practice
Tawarruq 39 228–9; Muslims’ public treasury
Tawatnuntachai, O. 60, 70 225–6; priorities 228; public money
tawhid law see ‘shari’ah-compliance’ 225; wealth distribution 224–5
fatawa Vasseux, M. 43
tax authorities 226 VDM-SL see Vienna Development
tax shields 54 Methods-Specification Language
Taymiyya, ‘Allama Ibn 19 (VDM-SL)
Taymiyyla, Ibn 23 vector autoregressions (VARs) 237
Tehran Stock Exchange 136, 140–1, venture philanthropy: capital market
144, 145 270; context 275, 275; definition 270;
Thabit, al-Nu‘man b. 23 IFIs 272–4; private equity/venture
Theodorou, E. 54 capital models 270; Shari’ah 275–6;
Thorbecke, Erik 317 social- and grant-based organizations
Titman, S. 55, 60 270; social entrepreneurship 272;
trade-off theory 50, 51 social innovation 272; traditional vs.
trans-culturalism 208 270, 271; types 273, 274
translation strategies: limitation 207; Venuti, L. 207
modulation strategy 217; Pickthall Vienna Development Methods-
translation 217; Quran translation Specification Language (VDM-SL)
206 see also Quran translation; text 89–90; add disabled people invariant
transfer 206; theoretical frame 207; 94; bank verification 96–7; Boolean-
word count 207 type function 95; disability person
treasury risk 44–5 criteria 96; eligibility criteria 94–5;
t-test 244 Finance Hub creation 94; formal
two-tier Mudarabah model 173 specification 92–3; model analysis
Type A and B Securities see bond 97, 97, 98; pre- and postconditions
pricing theory 95; remove disabled people invariant
95; staff registration 93; Zakat
Uddin, M. A. 42 distribution 93, 96
UK Financial Services Authority’s Viney-Darbelnet 207
policy 46
al-Umam, Tajarib 283 Wahab, A. 110
Umayyad Caliphate 34–5, 46 Wald test 67
UNCITRAL Model Law on Wald-type F-statistic procedure 246
International Commercial Arbitration Wallis, K. F. 238
255–6, 258–9 Walsh, E. J. 54
underwriting risk 43 Waqf 199, 199–200, 200, 202–3, 314
unified and uniform Shari’ah Code 7 Waseela-e-Haq 321
Union Council (UC) level 88, 92 Waseela-e-Rozgar 321
unity of knowledge 104 Waseela-e-Sehat 321
univariate GARCH models 142, Waseela-e-Taleem 321
146, 146 Watson, M. W. 238
unsystematic risks 42, 44 wealth index 89
Usmani, M. T. 118 Weiss, A. A. 238
usury-based loans 159 Welch, I. 60
welfare index 89
Vafeas, N. 54 Wessels, R. 55, 60
value-based governance 220; Alawi western financial models 35
government’s reform programs Whitney, Edward 317
346 Index
Williams, J. B. 236 study 323; disbursement 323,
Williams’ model 236 324; distribution see Information
Wood, R. A. 238 Technology (IT)-based Finance Hub;
Worthington, A. 174 LZC 322; provincial level 322; transfer
breakdown 322
Yahya, Nusayr b. 16 Zarei, A. 239
Yaman, D. 60, 70 al-Zayla‘i 16
Yamirudeng, K. M. 284 Zedakah 154
Yang, J. 138 Zeghal, D. 68
Al-Yaqubi 283 zero-risk common bond vs. Sukuk bond
Yermack, D. 59 yields 241, 242
Yusuf, Imam Abu 16–17 zero-risk treasury bonds 235, 240
Zia ul Haq, Muhammad 291
Zahra, S. A. 55, 59 Zingales, L. 54–5, 60, 65
Zaini, A. M. 174 al-Zubaīdī, Muḥammad al-Murtazā
Zakat 34, 197–9, 198, 277, 314; Ḥusaīnī 153
beneficiaries 323, 323; CPRSPD Zubair, H. M. 110