First branch of Emirati Islamic Bank, ‘Noor’ opens in Tunis

e2_s_The first branch of the Emirates based Islamic Bank “Noor” opened in Tunis . The bank’s Tunisian branch which is also the first outside the United Arab Emirates , will provide banking services and solutions to the North African region.During a press conference given in Tunis on Friday, the bank’s General Manager, Mr Hussain Al Qemzi, said that the bank aims at strengthening cooperation with North Africa in general and Tunisia in particular, as well as making the most of the opportunities offered by the region.

He also cited Tunisia ’s political and social stability, as well as its sustained economic growth as the main factors that have prompted the decision to set up a branch in Tunisia .

For his part, the director of “Noor’s” Tunisian branch, Mr Sadok Attia, said that the bank will facilitate important transactions, as well as financing projects in the North Africa region.

“Noor” was set up in 2006 in Dubai and launched its operations in January 2008.


Islamic Banking and Corporate Social Responsibility

Each year, with the advent of the month of Ramadan, the Saudi Dallah Al Baraka group holds a jurisprudential seminar that brings together all the personnel and those concerned in the field of Islamic banking from all over the world. Held under the auspices of the Saudi Dallah Al Baraka group, this year’s seminar marks the 28th anniversary.

Twenty-eight years of achievements in the field of Islamic banking, the Dallah Al Baraka group has hosted scholars, researchers and economists, among others, over numerous pertinent and emerging issues related to the subject. Additionally, contentious matters that the legitimate bodies of Islamic financial institutions have disagreed upon are discussed with the intention of resolution.

The seminar lasts between two-to-three days in which a number of issues are brought to the table and debated. At the end of the seminar, recommendations are made and are the outcome of the scholars’ consensus following consultations over issues. They make recommendations that give the jurisprudential view of the issue at stake.

These recommendations have had an impact to the point that they have been adopted by the jurisprudential bodies, which examine them closely and issue various decisions based on them. Perhaps the most important of these recommendations were the ones that prohibited systematic ‘tawaruq’* banking and tampering with Shariah, issues that were discussed in the Dallah Al Baraka seminars before they were officially studied by the jurisprudential authorities.


Undoubtedly the credit goes to Dallah Al Baraka group, especially the businessman Salah Abdullah Kamel who is the chairman of Dallah Al Baraka group, for organizing the seminars every year since their inception, in addition to the group’s moral, financial and media support.

This proves the group’s awareness and dedication to fulfilling its social responsibility towards society, whilst paving the way for the dissemination of an outlook that values social responsibility among financial institutions and private sector companies in the Islamic world. The majority of these entities neglect their social responsibilities despite the fact that it is a crucial aspect of Islamic Shariah, which calls upon the community to unite and collaborate.

The Prophet (PBUH) said: You may liken the faithful having mercy for one another and in their love and kindness towards one another to the body; when one member of it ails, the entire body ails, one part calling out to the others with feverish sleeplessness.

How many of our major companies have made social responsibility part of their policies and targeted goals?! How many of our companies have programs dedicated to social responsibility?!

Without a doubt, social responsibility among companies is no longer a social aspect; rather, it has become an unwritten ethical code that companies must abide by and allocate a portion of their budget for. This approach aims to share the benefits with our societies, which would especially benefit the economies that do not impose taxes on companies, such as most of the economies in the Gulf States. Consider the number of Gulf companies that have devoted part of their budgets to nurture the gifted or grant scholarship opportunities to those who excel academically and for medical and academic research, in addition to environmental awareness programs, among others.

Social responsibility, or what is known as Corporate Social Responsibility (CSR), has become a basic component in major Western companies. However, this responsibility is not limited to financial donations for charity projects and institutions, but rather surpasses that to cover ethical management. Since everyone can reap the benefits when this approach is implemented, it follows that it serves all the different segments of society, which in turn serves the company through increased loyalty among the workers, thus resulting in more stability and productivity.

The United Nations (UN) has exerted practical efforts to set a universal code of standards for CSR, while some governments have established standards which they adhere to, such as Britain. Within this context of international efforts to establish CSR codes, I would like to take this opportunity to call upon the general council for Islamic banks and Islamic financial institutions to adopt a CSR code based on the Quran and Sunnah while benefiting from international experiences in the field.

* Lahem al Nasser is a Saudi Islamic banking expert

Tawaruq Finance

1) This form of Shariah-compliant finance helps businesses with their need for cash required to finance their operating capital and is based on the Tawaruq sale principles.

2) Tawaruq is a Shariah-compliant finance method, with which you can raise loan finance through buying installments in a local commodity, owned by the bank.

3) The customer buys a share in local or international commodity the bank owns. The customer then authorizes the bank to sell his share in this commodity, on his behalf, to a third party for cash and then deposit the proceeds into his account.

Source Riyad Bank




CORPORATE governance in banking has been analyzed almost exclusively in the context of conventional banking markets. For example, there has recently been some discussion of the role ‘market discipline’ exerted by bank shareholders and depositors in constraining the risk taking behavior of bank management. At the same time, there is growing interest in, and analysis of, banks as stockholders in companies themselves playing a central role in corporate governance, especially in Germany and other countries with universal banking structures of the traditional type.

By contrast, little is written on governance structures in Islamic banking, despite the rapid growth of Islamic banks since the mid 1970s and their increasing presence on world financial markets. There are now over 180 financial institutions world-wide which adhere to Islamic banking and financing principles. These banks operate in 45 countries encompassing most of the Muslim world, along with Europe, North America and various offshore locations. Islamic financing increasingly is a market segment of interest of Western banks, and the latest addition to the list of Islamic banks in October 1996 in the City Islamic Investment Bank, Bahrain a wholly owned subsidiary of Citicorp.

Islamic banking represents a radical departure from conventional banking, and from the viewpoint of corporate governance, it embodies a number of interesting features since equity participation, risk and profit-and-loss sharing arrangements from the basis of Islamic financing. Because of the bank on interest (riba), an Islamic bank cannot charge any fixed return in advance, but rather participates in the yield resulting from the use of funds. The depositors also share in the profits according to predetermined ratio, and are rewarded with profit returns for assuming risk. Unlike a conventional bank which is basically a borrower and lender of funds, an Islamic bank is essentially a partner with its depositors, on the one side, and also a partner with entrepreneurs, on the other side, when employing depositors’ funds in productive direct investment.

These financial arrangements imply quite different stockholder relationships, and by corollary governance structures, from the conventional model since depositors have a direct financial stake in the bank’s investment and equity participations. In addition, the Islamic bank is subject to an additional layer of governance since the suitability of its investment and financing must be in strict conformity with Islamic law and the expectations of the Muslim community. For this purpose, Islamic banks employ an individual sharia Advisor and/or Board.

My examination of corporate governance in Islamic banking begins with the comparing governance structures in the Islamic bank and will continues with the principles of Islamic banking. This study compares the Islamic banking, financial model and its implications for governance structures. The study intends to give a small picture on the principles of Islamic banking.


Governance structures are quite different from these under Islamic banking because the institution must obey a different set of rules – those of the Holy Qur’an – and meet the expectations of Muslim community by providing Islamically-acceptable financing modes. These profit-and-loss sharing methods, in turn, imply different relationships than under interest-based borrowing and lending.


Figure 1 sets out the key stockholders in an Islamic bank. There are two major difference from the conventional framework. First, and foremost, an Islamic organization must serve God. It must develop a distinctive corporate culture, the main purpose of which is to create a collective morality and spirituality which, when combined with the production of goods and services, sustains the growth and advancement of the Islamic way of life. To quote janachi (1995):


‘Islamic banks have a major responsibility to shoulder ….all the staff of such banks and customers dealing with them must be reformed Islamically and act within the framework of an Islamic formula, so that any person approaching an Islamic bank should be given the impression that he is entering a sacred place to perform a religious ritual, that is the use and employment of capital for what is acceptable and satisfactory to God.’ (p.42).


There are equivalent obligations upon employees:


‘The staff in an Islamic bank should, throughout their lives, be conducting in the Islamic way, whether at work or at leisure.’ (p.28).


Further, obligations also extend to the Islamic community:


‘Muslims who truly believe in their religion have a duty to prove, through their efforts in backing and supporting Islamic banks and financial institutions, that the Islamic economic system is an integral part of Islam and is indeed for all times … through making legitimate and Halal profits.’ (p.29).


Second, interest-free banking is based on the Islamic legal concepts of shirkah (partnership) and mudaraba (profit-sharing). An Islamic bank is conceived as financial intermediary mobilizing savings from the public on a mudaraba basis and advancing capital to entrepreneurs on the same basis. A two-tiered profit-and-loss sharing arrangement operates under the following rules:

  1. The bank receives funds from the public on the basis of unrestricted mudaraba. There are no restrictions imposed on the bank concerning the kind of activity, duration, and location of the enterprise, but the funds cannot be applied to activities which are forbidden by Islam

  2. The bank has the right to aggregate and pool the profit from different investments, and share the net profit (after deducting administrative costs, capital depreciation and Islamic tax) with depositors according to a specified formula. In the event of losses, the depositors lose a proportional share or the entire amount of their funds. The return to the financier has to be strictly maintained as a share of profits.

  3. The bank applies the restricted from of mudaraba when funds are provided to entrepreneurs. The bank has the right to determine the kind of activities, the duration, and location of the projects and monitor the investments. However, these restrictions may not be formulated in a way which harms the performance of the entrepreneur, and the bank cannot interfere with the management of the investment. Loan covenants and other such constraints usual in conventional commercial bank lending are allowed.

  4. The bank cannot require any guarantee such as security and collateral from the entrepreneur in order to insure its capital against the possibility of an eventual loss.

  5. The liability of the financier is limited to the capital provided. On the other hand, the liability of the entrepreneur is also restricted, but in this case solely to labor and effort employed. Nevertheless, if negligence or mismanagement can be proven, the entrepreneur may be liable for the financial loss and be obliged to remunerate financier accordingly.

  6. The entrepreneur shares the profit with bank according to previously agreed division. Until the investment yields a profit, the bank is able to pay a salary to the entrepreneur based on the ruling market salary.

Many of the same restrictions apply to musharaka financing, except that in this instance the losses are borne proportionately to the capital amounts contributed. Thus under these two Islamic modes of financing, the project is managed by the client and not by the bank, even though the bank shares the risk. Certain major decisions such as changes in the existing lines of business and the disposition of profits may be subject to the bank’s consent. The bank, as a partner, has the right to full access to the books and records, and can exercise monitoring and follow-up supervision. Nevertheless, the directors and management of the company retain independence in conducing the affairs of the company.


These conditions give the finance many of the characteristics of non-voting equity capital. From the viewpoint of the entrepreneur, there are no fixed annual payments needed to service the debt as under interest financing, while the financing does not increase the firm’s risk in the way that other borrowings do through increased leverage. Conversely, from the bank’s viewpoint, the returns come from profits – much like dividends – and the bank cannot take action to foreclose on the debt should profits no eventuate.



These structures are depicted in Figure 2 which sketches the conceptual framework of corporate governance for Islamic bank. Central to such a framework is the Sharia Supervisory Board (SSB) and the internal controls which support it. The SSB is vital for two reasons. First, those who deal with an Islamic bank require assurance that it is transacting with Islamic law. Should the SSB report that the management of the bank has violated the sharia, it would quickly lose the confidence of the majority of its investors and clients. Second, some Islamic scholars argue that strict adherence to Islamic religious principles will act as a counter to the incentive problems outlined above. The argument is that the Islamic moral code will prevent Muslims from behaving in ways which are ethically unsound, so minimizing the transaction costs arising from incentive issues. In effect, Islamic religious ideology acts as its own incentive mechanism to reduce the inefficiency that arises from asymmetric information and moral hazard.


Such matters are obviously basic to the successful operation of Islamic modes of finance, and they are assessed in the next section when I examine Principles of Islamic Banking.



An Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the sharia in all of its actions and deeds. The original meaning of the Arabic word sharia was ‘the way to the source of life’ and it is now used to refer to legal system in keeping with the code of behavior called for by the Holly Qur’an (Koran). Four rules govern investment behavior:

the absence of interest-based (riba) transactions;

the avoidance of economic activities involving speculation (Gharar);

the introduction of an Islamic tax, zakat; the discouragement of the production of goods and services which contradict the value pattern of Islamic (haram)


In the following part I explain these four elements give Islamic banking its distinctive religious identity.



Perhaps the most far reaching of these is the prohibition of interest (riba). The payment of riba and the taking as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an, and thus investors must be compensated by other means. Technically, riba refers to the addition in the amount of the principal of a loan according to the time for which it is loaned and the amount of the loan. While earlier there was a debate as to whether riba relates to interest or usury, there now appears to be consensus of opinion among Islamic scholars that the term extends to all forms of interest.


In banning riba, Islamic seeks to establish a society based upon fairness and justice (Qur’an 2.239). A loan provides the lender with a fixed return irrespective of the outcome of the borrower’s venture. It is much fairer to have a sharing of the profits and losses. Fairness in this context has two dimensions: the supplier of capital possesses a right to reward, but this reward should be commensurate with the risk and effort involved and thus be governed by the return on the individual project for which funds are supplied.


Hence, what is forbidden in Islamic is a predetermined return. The sharing of profit is legitimate and that practice has provided the foundation for Islamic banking.



Another feature condemned by Islamic is economic transactions involving elements of speculation, Gharar. Buying goods or shares at low and selling them for higher price in the future is considered to be illicit. Similarly an immediate sale in order to a void a loss in the future is condemned. The reason is that speculators generate their private gains at the expense of society at large.



A mechanism for the redistribution of income and wealth is inherent is Islam, so that every Muslim is guaranteed a fair standard of living, nisab. An Islamic tax, Zakat (a term derived from the Arabic zaka, meaning “pure”) is the most important instrument for the redistribution of wealth. This tax is a compulsory levy, one of the five basic tenets of Islam and the generally accepted amount of the zakat is one fortieth (2.5 per cent) of Muslim’s annual income in cash or kind from all forms of assessed wealth exceeding nisab.


Every Islamic bank has to establish a zakat fund for collecting the tax and distributing it exclusively to the poor directly or through other religious institutions. This tax is imposed on the initial capital of the bank, on the reserves, and on the profits as described in the Handbook of Islamic Banking.



A strict code of ‘ethical investment’ operates. Hence it is forbidden for Islamic banks to finance activities or items forbidden in Islam, haram, such as trade of alcoholic beverage and pork meat.


Furthermore, as the fulfillment or materials needs assures a religious freedom for Muslims, Islamic banks are required to give priority to the production of essential goods which satisfy the needs of the majority of the Muslim community, while the production and marketing of luxury activities, israf wa traf is considered as unacceptable from a religious viewpoint.


In order to ensure that the practices and activities of Islamic banks do not contradict the Islamic ethical standards, Islamic banks are expected to establish a Sharia Supervisory Board, consisting of Muslim jurisprudence, who act as advisers to the banks.



Although the restriction against the use of interest might seem to be a binding constraint upon expansion, Islamic banks and financial institutions have in fact grown rapidly. Table 1 sets out the number of banks, paid up capital, total deposits and total assets of these Islamic banks, classified by region. It shows that the total assets of these reporting banks amounted to US $155 billion in 1994, with employment in excess of 220,000 (data supplied by the International Association of Islamic Banks).


If the paying and receiving of interest is prohibited, how do Islamic banks operator It is necessary to distinguish between the expressions ‘rate of interest’ and ‘rate of return’. Whereas Islam clearly forbids the former, it not only permits, but rather encourages, trade. In the interest-free system sought by adherents to Muslim principles, people are able to earn a return on their money only by subjecting themselves to the risk involved in profit sharing. As the use of interest rates in financial transactions is prevented, Islamic banks are expected to undertake operations only on the basis of Profit and Loss Sharing (PLS) arrangements or other acceptable modes of financing. Mudaraba and musharaka are the two profit-sharing arrangements preferred under Islamic law.



A mudaraba can be defined as contract between at least two parties whereby one party, the financier (sahib al-mal), entrusts funds to another party, the entrepreneur (mudarib), to undertake an activity or venture. This type of contract is in contrast with musharaka. In arrangements based on musharaks there is also profit-sharing, but all parties have the right to participate in managerial decisions. In mudaraba, the financier is not allowed a role in management of the enterprise. Consequently, mudaraba represents a PLS contract where the return to lenders is a specified share in the profit/loss outcome of the project in which they have a stake, but no voice.


In interest lending, the loan is not contingent on the profit or loss outcome, and is usually secured, so that the debtor has to repay the borrowed capital plus the fixed interest amount regardless of the resulting yield of the capital.


Under mudaraba, the yield is not guaranteed in profit-sharing and financial losses are borne completely by the lender. The entrepreneur as such losses only the time and effort invested in the enterprise. This distribution effectively treats human capital with equally financial capital.



Under musharaka, the entrepreneur adds some of his own to that supplied by the investors, so exposing himself to the risk of capital loss. Profits and losses are shared according to pre-fixed proportions, but these proportions need not coincide with the ratio of financing input. The bank sometimes participates in the execution of the projects in which it has subscribed, perhaps by providing managerial expertise. Figure 3 illustrates the elements. Mudaraba and musharaka constitute, at least in principle if not always in practice, the twin pillars of Islamic banking. The two methods conform fully with Islamic principles, in that under both arrangements lenders share in the profits and losses of the enterprises for which funds are provided and shirkah (partnership) is involved. The musharaka principle in invoked in the equity structure of Islamic banks and is similar to the modern concepts of partnership and joint stock ownership.



For banking operations, the mudaraba concept has been extended to include three parties: the depositors as financiers, the bank as an intermediary, and the entrepreneur who requires funds. The bank acts as an entrepreneur when it receives funds from depositors, and as financier when it provides the funds to entrepreneurs. In other words, the bank operates a two-tier mudaraba system in which it acts both as the mudarib on the saving side of the equation and as the rubbul-mal (owner of capital) on the investment portfolio side. Insofar as the depositors are concerned, an Islamic bank acts as a mudarib which manages the funds of the depositors to generate profits subject to the rules of mudaraba. The bank may in turn use the depositors’ funds on a mudaraba basis in addition to other lawful (but less preferable) modes of financing, including mark up or deferred sales, lease purchase and beneficence loans. The funding and investment avenues are now listed.



Besides their own capital and equity, Islamic banks rely on two main sources of funds, a) transaction deposits, which are risk free but yield no return and, b) investment deposits, which carry the risks of capital loss for the promise of variable. In all, there are four main types of accounts:


Current accounts

Current accounts are based on the principle of al-wadiah, whereby the depositors are guaranteed repayment of their funds. At the same time, the depositor does not receive remuneration for depositing funds in a current account, because the guaranteed funds will not be used for PLS ventures. Rather, the funds accumulating in these accounts can only be used to balance the liquidity needs of the bank and for short-term transactions on the bank’s responsibility.


Savings accounts

Savings accounts also operate under the al-wadiah principle. Savings accounts differ from current deposits in that they earn the depositors income: depending upon financial results, the Islamic bank may decide to pay a premium, hiba, at its discretion, to the holders of savings accounts.


Investment accounts

An investment account operates under the mudaraba al-mutlaqa principle, in which the mudarib (active partner) must have absolute freedom in the management of the investment of the subscribed capital. The conditions of this account differ from those of the savings accounts by virtue of: a) a higher fixed minimum amount, b) a longer duration of deposits, and c) most importantly, the depositor may lose some of or all his funds in the event of the bank making losses.


Special investment accounts

Special investment accounts also operate under the mudaraba principle, and usually are directed towards larger investors and institutions. The difference between these accounts and the investment account is that the special investment account is related to a specified project, and the investor has the choice to invest directly in a preferred project carried out by the bank.



The mudaraba and musharaka modes, referred to earlier, are supposedly the main conduits for the outflow of funds from banks. In practice, however, other important methods applied by Islamic banks include:


Murabaha (mark up). The most commonly used mode of financing seems to be the ‘mark-up’ device. in a murabaha transactions, the bank finances the purchase of a good or assets by buying it on behalf of its client and adding a mark-up before reselling it to the client on a ‘cost-plus’ basis profit contract. Figure 4 illustrates the sequence.


Bai’ muajjal (deferred payment). Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to fiqh this does not amount to charging interest, since it is not a lending transaction but a trading one.


Bai’salam ( prepaid purchase). This method is really the opposite of the murabaha. There the bank gives the commodity first, and receives the money later. Here the bank pays the money first and receives the commodity later, and is normally used to finance agricultural products.


Istisnaa (manufacturing). This is a contract to acquire goods on behalf of a third party where the price is paid to the manufacturer in advance and the goods produced and delivered at a later date. Ijara and ijara wa iqtina (leasing). Under this mode, the banks buy the equipment or machinery and lease it out to their clients who may opt to buy the items eventually, in which case the monthly payments will consist of two components, i.e. rental for the use of the equipment and installment towards the purchases price.


Qard hasan (beneficence loans). This is the zero return type of loan that the Holly Qura’n urges Muslims to make available to those who need them. The borrower is obliged to repay only the principal amount of the loan, but is permitted to add a margin at his own discretion.


Islamic securities. Islamic financial institutions often maintain an international Islamic equity portfolio where the underlying assets comprise ordinary shares in well run businesses, the productive activities of which exclude those on the prohibited list (alcohol, pork, armaments) and financial service based on interest income.



  1.  Abdul Gafoor, A.L.M., 1995. Interest-free Commercial Banking. Groninigen, The Netherlands: Apptec Publications.

  2.  Ahmed, Z., lqbal, M., and Khan, M. f., 1983. Money and Banking in Islam. Jaddah: international Centre for Research in Islamic Economics, King Abdual Aziz University.

  3.  Algaoud, L. M. and Lewis, M. k., 1997. Bahrain as an International Centre for Islamic Baking, Proceedings of international Conference on Accounting, Commerce & Finance. The Islamic Perspective, University of West Sydney, Macarthur.

  4.  Arrif M. (ed), 1982. monetary policy in an interest free Islamic economy: nature and scope in Ariff, M. (ed), Monetary and Fiscal Economic of Islam, Jaddah: International Centre for Research in Islamic Economics.

  5. Handbook of Islamic Banking, 1977-86. Published in Arabic by the International Association of Islamic Banks, 6 Vols., Cairo.

  6. Islamic finance : Turning the Prophet’s profits. Economist, 8/24/96, Vol. 340 Issue 7980, p58, 2p.

  7. Janahi, A. L., 1995. Islamic Banking, Concept, Practice and Future, 2 nd edition. Manama: Bahrain Islamic Bank.

  8. Khalaf, Roula: Banking the Islamic way. World Press Review, Jan. 95, Vol. 42 Issue 1, p35, 5/6p.

  9. Khan, M S., 1986. Islamic interest-free banking: A Theoretical Analysis, IMF Staff Papers, Vol. 33, No. 1, pp. 1-25.

  10. Kuran, T., 1986. The Economic System in Contemporary Islamic Thought: Interpretation and Assessment, International Journal. Middle East Study, No. 18, pp. 135 – 154.

  11. Kuran, T., 1995. Islamic Economic and the Islamic Sub economy journal of Economic Perspectives, Vol. 9 No. 4, pp. 155-173.

  12. Lewis, M. k., 196. Universal banking in Europe: The Old the new, International Symposium on Universal banking, Korean institute of Finance, Seoul, January.

  13. Mannan, M. A., 1986. Islamic Economics: Theory Practice, Cambridge: Hodder and Stoughton.

  14. Siddiqi, M. N., 1988. Banking without Interest, Leicester: The Islamic Foundation.

  15. Ul-Haque, N. U. and Nirakhor, A., 1986. Optimal Profit-sharing Contracts and Investment in an interest-free Islamic Economy, IMF Working Paper, No. 12, Washington: international Monetary Fund.



  1. This treatise, first published in 1990, is distributed by the Baharain Islamic Bank.

  2. The concepts are examined in Siddiqi (1983) and Abdul Gafoor (1995).

  3. The incentive problems are examined in Ul-Haque and Mirakhor, (1986).

  4. The higher price shows in (HIB, 1982, vol., p.427).

  5. The five basic tenets ( or pillars) are: (1) acceptance of shahada, (2) prayer or namaz, (3) zakat or alms, (4) fasting, and (5) hajj or pilgrimage to Mecca.

  6. The Islam clearly forbids are examined in Khan, 1986, pp. 4-6.

***By: M. Nasser Sulaeiman


Financing Through Musharaka: Principles And Application



Virtually unknown three decades ago, Islamic financing is now practiced around the world. Since its official launch in the 1970’s, Islamic financial institutions have witnessed rapid international growth in both Muslim and Non-Muslim countries (Dudley 2001).

Although the concept of Islamic finance has existed for centuries, it only came into prominence during the last century (De Jonge 1996, p.3). The first successful application of Islamic finance was undertaken in 1963 by Egypt’s Mit Ghamr Savings Banks, which earned its income from profit-sharing investments rather than from interest (Lewis & Algaoud 2001, p.5). By the 1970’s, the push for Islamic finance had gained momentum. In 1973 the conference of foreign ministers of Muslim countries decided to establish the Islamic Development Bank with the aim of fostering  the economic development and social progress of Muslim countries in accordance with the principles of Shari’ah (Saeed 1996, p.13). This marked the first major step taken by Muslim governments in promoting Islamic finance.

Shari’ah law (Islamic law based on the teachings of the Koran) prohibits the followers of Islam from conducting any business involving Riba (interest). This means that Muslims cannot receive or pay interest, and they are, therefore, unable to conduct business with conventional financial institutions (Jaffe 2002). The creation of Islamic financial institutions came about as a method for servicing this niche market.

In order to compete with conventional modes of financing (interest-based financial instruments), Islamic financial institutions developed products that would fulfill  the Shari’ah obligation and provide the same value as conventional bank products (Malaysian Business 2001). The main Islamic financial products include profit-and-loss sharing (Mudaraba and Musharaka), cost plus mark-up, and leasing. The focus of this article is to analyze the profit-and-loss sharing instrument of Musharaka and the way it is implemented. The article begins by briefly describing the profit-and-loss sharing system, followed by a detailed analysis of Musharaka. The article then looks at the application of Musharaka as a home financing instrument, and concludes by analyzing the current issues affecting Musharaka, and the criticism leveled against it


 Profit and Loss  sharing system


Although Islam excludes interest earnings from financial activities, it does not necessarily mean that the financier cannot earn a profit. In order to do so, the financier has to ensure that gains made on the original amount are directly related to the risk undertaken on the investment (Siddiqui 1987). If there is no risk involved, the gains made represent interest rather than profit.

In order to understand how the Islamic system differentiates between profit and interest, one has to look at the differences in the economic ideology. In a capitalist system, capital and entrepreneurs are treated as two separate factors of production. The return on capital is interest, whereas the entrepreneur, who risks losing money, earns a profit. While interest is a fixed return for providing capital, profit can only be earned after distributing the fixed return to land, labor and capital (in the form of rent, wage and interest). Thus, the capitalist system seems to favor those who lend capital to entrepreneurs by providing them a secure return, entrepreneurs bear the risks of incurring losses and still making interest payments on borrowed capital.

In comparison, Islamic economic system does not consider providers of capital and entrepreneurship as separate factors of production. It believes that every person who contributes capital in the form of money to a business venture assumes the risk of loss and therefore is entitled to a proportional share in the actual profit (Siddiqui 1994, p.99). The system is protective of the entrepreneur, who in a capitalist economy would have to make fixed interest repayments even when the venture is losing money.  (Usmani, M.I. 2002, p.13). Capital has an intrinsic element of entrepreneurship, so far as the risk of the business is concerned and,  therefore, instead of a fixed return as interest, it derives profit. The greater is the profit earned by a  business,  the higher the return on capital will be. With no fixed interest repayments, profit in an Islamic economic system would be higher than in the capitalist economy. The system ensures that profits generated by commercial activities in the society are distributed equally amongst those who have contributed capital to the enterprise.

Another difference between the two economic systems lies in the way money is used. In economic terms money has no intrinsic value; it is only a medium of exchange, therefore, earning interest on a medium of exchange without bearing any risks does not sit well in the Islamic system (Rahman 1994, p.14). Islamic financing is, therefore, an asset-backed financing. When a financier contributes money on the basis of the profit-and-loss sharing instruments, it is bound to be converted into assets having intrinsic value (Usmani, M.T. 1998, p.19).

The profit-and-loss sharing system has its roots in the ancient form of financing practiced by Arabs since long before the advent of Islam. After the introduction of Islam, this system was permitted to continue and was legitimatized as a finance instrument. For this historical reason, scholars consider profit-and-loss sharing financial instruments to be the most authentic and most promising form of Islamic contracts (Ariff, 1982). Mudaraba (finance trusteeship) and Musharaka (equity partnership) are two such financial instruments based on the profit-and-loss sharing system, where instead of lending money to an entrepreneur at a fixed rate of return, the financier shares in the venture’s profits and losses (The Economist 2001).




The literal meaning of the word Musharaka is sharing. Under Islamic law, Musharaka refers to a joint partnership where two or more persons combine either their capital or labor, forming a  business in which all partners share the profit according to a specific ratio, while the loss is shared according to the ratio of the contribution (Usmani, M.I. 2002, p.87). It is based on a mutual contract, and, therefore, it needs to have the following features to enable it to be valid:

  • Parties should be capable of entering into a contract (that is, they should be of  legal age).
  • The contract must take place with the free consent of the parties (without any duress).

In Musharaka, every partner has a right to take part in the management, and to work for it (Gafoor 1996). However, the partners may agree upon a condition where the management is carried out by one of them, and no other partner works for the Musharaka. In such a case the “sleeping” (silent) partner shall be entitled to the profit only to the extent of his investment, and the ratio of profit allocated to him should not exceed the relative size of his investment in the business.

However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all matters of business, and work done by any of them in the normal course of business shall be deemed as being authorized by all partners (Usmani, M.I. 2002, p.92).

Musharaka can take the form of an unlimited, unrestricted, and equal partnership in which the partners enjoy complete equality in the areas of capital, management, and right of disposition. Each partner is both the agent and guarantor of the other. Another more limited investment partnership is also available. This type of partnership occurs when two or more parties contribute to a capital fund, either with money, contributions in kind, or labor. Each partner is only the agent and not the guarantor of his partner. For both forms, the partners share profits in an agreed  upon manner and bear losses in proportion to the size of their capital contributions (Lewis & Algaoud 2001, p. 43).

‘Interest’ predetermines a fixed rate of return on a loan advanced by the financier irrespective of the profit earned or loss suffered by the debtor, while Musharaka does not envisage a fixed rate of return. Rather, the return in Musharaka is based on the actual profit earned by the joint venture. The presence of risk in Musharaka makes it acceptable as an Islamic financing instrument. The financier in an interest-bearing loan cannot suffer loss, while the financier in Musharaka can suffer loss if the joint venture fails to produce fruits (Usmani, M.T. 1998, p. 27).

Musharak in home financing


When used in home financing, Musharaka is applied as a diminishing partnership. In home financing, the customer forms a partnership with the financial institution for the purchase of a property (Saeed 2001). The financial institution rents out their part of the property to the client and receives compensation in the form of rent, which is based on a mutually agreed fair market value. Any amount paid above the rental value increases the share of the customer in the property and reduces the share of the financial institution.

The application of diminishing Musharaka in home financing can be illustrated with the help of the following example, which the LaRiba bank in the U.S. follows:

Let us assume that a potential buyer is interested in purchasing a home worth $150,000. The buyer approaches an Islamic financial institution for the purchase of the property and puts 20 per cent of the price ($30,000) as down payment (the down payment required differs between financial institutions. In some cases it is as low as 5 percent ). The financial institution pays for the other 80 per cent of the price ($120,000). This agreement results in 20 per cent of the home ownership belonging to the client and the remaining 80 percent to the financial institution.

The next step for both parties would be to determine the fair rental value for the property. One way to determine the rental value is for both the client and financial institution to survey the market to obtain estimates for similar properties in the same neighborhood and negotiate an agreement. This fair rental value will remain constant over the life of the agreement. For this example, we will assume $1,000 per month as the rental value.

A rental value of $1,000 means that the client will pay $800 as rent for the 80 per cent share the financial institution holds. The two parties then agree on the period of financing. In this example we will assume that the financing period is 15 years (180 months). Based on the rental value and the financing period, the financial institution then determines the fixed monthly payments the client would have to make to own the house. 

Table 1

Example of payment schedule for a home-loan under Musharaka.

Month Rent $ Extra Payment $ Total Fixed Payments $ Bank’s Ownership $









































In this example the client starts by paying $1147, which includes the required 80% of the $1,000, and extra payment of $347. By doing so the client reduces the share of the financial institution by $347, and increases their own share by the same amount. The next month’s rental payment of the client would be reduced to $798, and again the payment made above the rent amount will result in an increase in the client’s ownership of the property. This continues on till the client buys back all the shares of the home that the financial institution holds at the end of the agreed financing period.

This example does not take into account fees and charges that the financial institution may charge such as insurance and taxes.

In the event of non-payment of rent from the client, the financial institution has to take into consideration the reason for the non-payment. If the client has a valid excuse for non-payment, the financial institution has to show leniency so that the client does not feel over-burdened, and the client should give more time to make the payment. In theory, if the financial institution charges any extra amount as compensation for the late payment, the amount would be considered as interest and therefore is not permitted in Islam. If there is no genuine reason for the late payment, the financial institution can ask the client to make a payment to a charity as penalty (Usmani, M.T. 1998, p.172). This prohibition of charging late fees makes it even more important for Islamic financial institutions to carefully evaluate each application before entering into an agreement.


Criticism of Musharaka



Musharaka is sometimes criticized as being an old instrument that cannot be applied in the modern world. However, this criticism is unjustified. Islam has not prescribed a specific form or procedure for Musharaka. Rather it has set some broad principles which can accommodate numerous forms and procedures (Usmani, M.T. 1998, p.29). A new form or procedure in Musharaka that would make it suitable for modern financial needs cannot be rejected merely because it has no precedent in the past. In fact, every new form can be acceptable as long as it conforms to the principles laid down by Shari’ah. Therefore, it is not necessary that Musharaka be implemented only in its traditional form (Usmani, M.T. 1998, p.30).

Another criticism leveled against Musharaka is based upon the issue of profits being guaranteed by some financial institutions. Even though Musharaka is considered to be the most authentic form of Islamic financing, the risk associated with sharing losses means that it is not as popular as the other modes. To make the product more appealing to the customer, some financial institutions have started guaranteeing profits in Musharaka. By doing so, these institutions are contravening the basic law of Islamic finance that requires linking rewards to risks (Warde 2000, p.5). If profits are guaranteed, the risk factor is eliminated, making the profit resemble interest. Although these actions may help Islamic banks grow in the short-run, the long-term costs (harm to reputation and authenticity) will outweigh the benefits. Such moves also provide ammunition to the critics of the system, who are already questioning whether the system is nothing more than an interest-based system operating under the guise of profit (The Economist 1994).




Although not as popular as other Islamic financial instruments, Musharaka is still considered to be one of the most authentic forms of Shari’ah approved financing. Recognising the problem that some financing instruments used by Islamic financial institution closely resemble interest-bearing instruments, Muslim scholars have voiced their opinion that more profit-and-loss sharing instruments should be developed and used. In recent times there have also been calls for Muslim countries to follow the lead of Iran and Pakistan, where their governments have enforced the Islamic financial system as the only available finance option. The push for such actions to be taken means that Musharaka’s use as an Islamic financial instrument will continue to rise in the future. Also, by relying on Musharaka for financing projects, Islamic financial institutions can erode any fears that Islamic financial institutions are essentially providing interest-bearing products under the guise of profit and mark-up has hurt their reputation. This is important for the survival and future growth of Islamic finance.




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De Jonge, A. (1996). Islamic Law And The Finance Of International Trade. Melbourne: Monash University Working Paper.

Dudley, N. (2001). ‘Islamic Banks Tap A Rich New Business’ Euromoney, December

Gafoor, A.L.M. (1996). Interest-Free Commercial Banking. Malaysia: A.S.Noordeen.

Jaffe, C.A. (2002). ‘Financial Forms Tailor Products To Lure Muslims’ Boston Globe, 20 January

Lewis, M.K. & Algaoud, L.M. (2001). Islamic Banking. Cheltenham, UK: Edward Elgar.

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Saeed, A. (1996). Islamic Banking And Interest: A Study Of The Prohibition Of Riba And Its Contemporary Interpretation. Leiden, The Netherlands: E.J.Brill.

Saeed, A. (2001), “Muslim Community Cooperative of Australia as an Islamic Financial Service Provider” in Abdullah Saeed and Shahram Akbarzadeh (eds.), Muslim Communities in Australia. Sydney: UNSW Press, pp.188-205.

Siddiqui, M.N. (1987). Partnership And Profit-Sharing In Islamic Law. Leicester, UK: The Islamic Foundation.

Siddiqui, M.N. (1994). Issues In Islamic Banking: Selected Papers. Leicester, UK: The Islamic Foundation.

The Economist. (1994). Islam And The West: A Survey – The Cash-Flow Of God. August 6th pp.9-10.

The Economist. (2001). Forced Devotion Series: Finance And Economics. February 17 pp.76-77

Usmani, M.I. (2002). Meezanbank’s Guide To Islamic Banking. Karachi, Pakistan: Darul-Ishaat.

Usmani, M.T. (1998). An Introduction To Islamic Finance. Karachi, Pakistan: Idaratul Ma’arif.

Warde, I. (2000). Islamic Finance In The Global Economy. Edinburgh: Edinburgh University Press.

The world’s biggest Muslim nation struggles to build its Islamic finance industry

imagesBank Indonesia Headquarters, Jakarta


In a bid to drive growth in the fledgling Islamic bonds industry, Indonesia’s central bank says it will relax the rules for investors who buy the bonds.

Despite being home to roughly 10 percent of the world’s estimated 1.3 billion Muslims, Indonesia has struggled to build up its Islamic finance industry, lagging well behind countries such as Malaysia, Singapore and even Pakistan.

However, the recent introduction of a new law that would allow the government to issue Sukuk, or Islamic bonds, is expected to trigger significant growth in the sector. The government announced this week it has already set aside US$2 billion in assets to back the bonds, which it expects to sell in two separate issues this August and October. Sukuk bondholders are paid income derived from assets such as rent from property because Islamic law bans lending for interest.

Mulya Siregar, Bank Indonesia’s head of Islamic finance, pledged this week that the central bank would change the rules surrounding Sukuk to boost investor interest in the securities.

As the rules stand, investors in Islamic bonds are required to hold them until maturity.

“We will change that regulation,” Siregar told an investment conference Thursday.

“That regulation was made in 2000 or 2002, when Bank Indonesia was still learning about how to develop Islamic finance so it just worried at that time whether the securities of Sukuk were an asset or not. But now, I think we agree they should be an asset so that investors are able to trade them.”

Pushed on the timing of the change and whether it would be before the government’s planned August issue, Siregar said it would be “as soon as possible.”

The move could be a significant boost for Sukuk in Indonesia, which have so far received little interest from traditional investors. In Malaysia, on the other hand, more than 50 per cent of Sukuk issuances are taken up by commercial bond traders.

“A real issue for Indonesia is that conventional investors do not participate in the Sukuk market,” said Badlisyah Ghani, head of CIMB Islamic Bank in Malaysia

“This is a peculiar situation that does not exist in Malaysia. All investors, including conventional banks, chase after Islamic instruments. As a result Islamic bonds in Malaysia are cheaper by 5 to 20 basis points compared to conventional bonds.”

If the Indonesian government and central bank get the regulatory framework right, a sovereign Sukuk would set a benchmark price for corporate bonds and allow the country to capture a significant share of the global market for Islamic bonds, which Moody’s estimates was worth US$100 billion last year.

“Sukuk is important for Islamic banking development,” says Siregar. “Right now, the problem for Islamic banking in Indonesia is liquidity.”

It would also allow Indonesia to attract investors from the Middle East and provide another funding source for the government, which is struggling to finance its budget deficit as the record-high oil price leaves it saddled with a bulging fuel subsidy bill. The government raised fuel prices by an average of 28.7percent Saturday in an effort to control its surging subsidy problems.

But experts warn Indonesia still has a long way to go to set up the right regulatory framework. The new Sukuk law, introduced last April, was restricted to dealing with the government’s ability to issue Islamic bonds. It did not deal with the unfavorable tax treatment of the securities or the lack of incentives for companies to issue Islamic bonds.

Most Islamic bonds involve a sale and purchase, or leaseback, of assets, which attracts Value Added Tax. That generally means they are taxed twice as much as conventional securities.

“The government is dealing with its own issue first and then with that liquidity, creating the necessary benchmark for industry, it needs to extend the regulatory system to have good laws for corporate issuers,” says Ghani.

Still, he believes demand is already strong, despite the lack of regulatory certainty.

“Even without those tax incentives, there have already been 17 Sukuk issues in the market worth 2.2 trillion rupiah or about US$250 million. It’s a very exciting market.”

There are only three purely Islamic banks in Indonesia with another 20 mainstream banks offering shariah services. Islamic banking made up just 1.6 per cent of national banking assets in 2006, according to Bank Indonesia and the capital markets regulator Bapepam estimates Sukuk bonds make up about 2.5 per cent of total issuance.

According to Moody’s, the global Islamic finance market has grown by about 15 per cent for each of the past three years and is worth US$700 billion. Sukuk is the fastest growing part of the market with volumes of US$97.3 billion last year. New issuance increased 71 per cent to US$32.65 billion.

source : asia sentinel

Dow Jones Islamic Market launched

910-162-07Dow Jones Indexes, a leading global index provider, yesterday launched the Dow Jones Islamic Market (DJIM) China Offshore Hong Kong Index.

The index represents the performance of companies that have been screened for compliance with Islamic principles and whose primary operations are in mainland China but trade on the Hong Kong stock exchange.

Stocks included in the index are H-Shares and Red Chips.

The index is designed to serve as underlying for investment products such as mutual funds, exchange-traded funds and other investable products.

“The Dow Jones Islamic Market China Offshore Hong Kong Index is another innovative addition to the highly successful Dow Jones Islamic Market index series following a unique and superior methodology,” Dow Jones Indexes editor and executive director John Prestbo was quoted by IINA as saying.

Islamic finance firms provide unique mortgage alternative

The mortgage industry may be in meltdown, but at least one class of lender appears to be flourishing: Islamic finance companies that offer Muslim home buyers alternative arrangements such as lease-to-own deals so they can avoid making the sort of interest payments that many believe their religion forbids.

Officials at Guidance Residential, a Reston, Va., company that has financed more than 5,000 home purchases since it began in 2002, said the company is having its best year yet, with business up 7 percent in the first quarter of 2008 from the first quarter of 2007.

At University Islamic Financial, which began in Ann Arbor, Mich., and has expanded its operations to Virginia, California, Ohio, Illinois, Indiana, Maryland, New Jersey, Texas and New York, officials said the number of home-financing applications quadrupled from last March to this March.

Representatives of the four major Islamic home-finance institutions in the United States said they do not track the reasons customers choose them over conventional mortgage brokers.

Several speculated that it was due to the natural growth of what is still a fledgling retail industry, as well as two side effects of the mortgage crisis: The drop in prices in many regions has brought homes back within reach of first-time buyers, who make up a sizable chunk of Islamic financiers’ customers. And the drumbeat of negative publicity about the practices of subprime mortgage lenders has amplified the distrust and discomfort the conventional mortgage industry already inspired in many Muslims.

“Folks have to be questioning the methods used by conventional mortgage companies over the last three or four years based on what’s happening today,” said Hussam Qutub, a spokesman for Guidance. “And I think that makes more people think, ‘Well what about the emergence of this (Islamic-) compliant financing industry? Let me give it a look and educate myself about it to see if it could perhaps be more beneficial to me.’ ”

That was the prevailing sentiment among potential customers who approached an advertising booth staffed by Guidance representatives at the annual spring fair held by the All Dulles Area Muslim Society in Sterling, Va., on a recent weekend.

Nabila Zerrarka, an Algerian-born woman wearing a white-and-green headscarf and pushing a stroller, wanted to find out if Guidance’s home-finance options were more straightforward than those offered by traditional mortgage brokers.

“Deep down, I don’t feel comfortable paying interest because it is against my beliefs,” said Zerrarka, 29, who is searching for her first home and has already obtained a prequalification letter for a conventional loan from Bank of America. “But I also feel it’s against my financial interests to pay interest. … What we’ve seen is that with interest-bearing loans, there are all these gimmicks and hidden costs and tricks that they can surprise you with. … If there is a possibility of doing it the Islamic way, we’d like to explore it.”

Mounir Elhaj, 45, a native of Sudan who works at a moving company, wanted to know how Guidance deals with customers who fall behind on their payments. He said he recently helped move a woman whose house was foreclosed on after she missed payments.

“She had been paying her mortgage for 17 years, and the bank still took her house,” Elhaj said to the Guidance sales representative. “So I want to know if I bought a house and then fail to pay, can you help me?”

The representative, Amr Mohamed, smiled and replied, “Yes, we can,” adding that Islamic law, known as sharia, forbids businesses from profiting from a customer’s financial hardship. So if a customer is late on payments, Guidance charges him or her a flat administrative fee to cover processing costs but none of the percentage-based penalties and additional fees that conventional mortgage companies can pile on.

Islamic home financing aims to offer Muslim buyers the same opportunities as conventional lenders but with a twist that gets around sharia’s prohibition against the payment of riba. Generally defined as excessive gain, riba has over the years come to be considered the equivalent of making money by renting money — in other words, charging interest — because the borrower shoulders risk while the lender is guaranteed a return.

In one of the alternative arrangements offered by Islamic finance companies, the company buys the house, then sells it to the home buyer in fixed monthly installments at an agreed-upon marked-up price. The markup rate is kept competitive with the prevailing interest rate on a conventional mortgage. So apart from a few additional transaction costs from the atypical nature of the arrangement, the buyer’s monthly payment is roughly equivalent to what it would be with a conventional mortgage.

A second option is for the financier and the home buyer to enter a lease-to-own contract similar to those used to buy cars. Once again, the rental portion of the monthly payment is kept equivalent to prevailing interest payments. The third model, which is favored by Guidance, is also based on a lease-to-own arrangement, except that the buyer and the finance company form a limited-liability entity to own shares of the property.

All three arrangements got a major boost in 2001 when Freddie Mac agreed to begin buying them on the secondary market, ultimately including not just Guidance and University Islamic, but also Devon Bank in Chicago and American Finance House Lariba of Pasadena, Calif. Last year, Freddie Mac bought more than $250 million in Islamic home loans — a tiny fraction of the corporation’s $1.77 trillion business but nonetheless a slight increase over previous years, according to spokesman Brad German.

While Islamic finance companies have convened boards of prominent scholars to certify that their finance arrangements comply with sharia, not all Muslim thinkers are convinced that they are necessary.

Mahmoud Amin el-Gamal, an economics professor at Rice University specializing in Islamic finance, noted that even in Muslim countries, sharia-based financing was developed in only the past several decades. And he argued that because conventional mortgages are secured by a physical good, namely the home, that is usually the only asset the lender can repossess if the borrower fails to repay, such loans should not be considered the equivalent of making money by renting money.

In any case, el-Gamal maintained, Islamic home-finance products are so closely modeled on conventional mortgages as to constitute a distinction without a difference.

“This is an industry that preys on people’s religious insecurities by selling them a product that they claim is different when it’s not. It’s false advertising, and it’s a case of supply creating demand,” el-Gamal said.

But Hirsi Dirir, a Somali-born technology analyst who recently obtained financing from Lariba to buy a townhouse in Annandale, Va., said such objections pale in comparison with the peace of mind he has gained from making the extra effort to adhere to his faith.

“I wish I could avoid everything that Islam doesn’t allow, but I can’t,” said Dirir, 32. “So if I have the opportunity and the choice to avoid interest, then it’s very important to me not to mess with it.”

Rizwan Jaka, 35, president of the All Dulles Area Muslim Society, also said the emergence of such arrangements constitutes an important milestone in the integration of Muslims in the American mainstream.

“It definitely marks a coming of age for us. … It’s part of the whole process of being a part of this country while being able to have our faith accommodated,” he said. “The American dream is to purchase a house, and the American Muslim dream is to be able to do so in an Islamic manner.”

source : mailt