Chapter 22-11-16 1

Fundamentals of Islamic Finance and Banking

Shariah Law and Shariah Supervisory

Chapter 22-11-16 2
Fundamentals of Islamic Finance and Banking
2-2
 Chapter 2 - Learning outcomes
1. Define Shariah Law and explain Its main sources.

2. Explain Shariah Prohibitions and Principles and their impact on Islamic finance
and banking.

3. Describe the Shariah Supervisory Board, its formation & functions.

4. Discuss the Shariah Governance Process.

Chapter 22-11-16 3
Fundamentals of Islamic Finance and Banking
2-3
 Shariah Law
• Introduction to Islamic Law or Shariah Law
The Arabic word ‘Shariah’ means path to the watering place. It is also called the Islamic
law. It is a comprehensive code of conduct for Muslims everywhere.
The Shariah rulings can be grouped into two types – obligatory rulings and declaratory
rulings.
1. Obligatory rulings: they are 5 types: Wajib (which need to be followed like mutual consent
in a contract), Mustahabb (which are recommended, like ensuring the contract is
written) Mubah (which are permissible and neither rewarded nor punished, like having
two parties to a contract or having more than two),Makruh (which are discouraged, for
example a poor person donating whatever they own rather than leaving it for their poor
heir) and Haram (which are forbidden, like taking interest on a loan contract).
2. Declaratory ruling: are those that make it easy to implement the obligatory rulings by
describing causes, conditions and obstacles related to the obligatory rulings.

Chapter 22-11-16 4
Fundamentals of Islamic Finance and Banking
2-4
 Shariah Law
Maslahah (the best interest of the general public) and is of utmost importance in the Shariah
law. Maslahah has three categories. The first is Daruriyyat, the essential elements for a
person, like their faith, their life, their intellect, wealth and the continuity of their family.
The second category is Hajiyyat, the complementary elements, the lack of which will cause
hardship but not disrupt life totally, like the availability of transportation or being involved
in an economic activity. The third category is Tahsiniyyat, additional elements that make life
nicer, customs and ways of behaviour, like being polite and pleasant in dealings with
people.
Sources of Shariah
• Quran – holy book of Islam
• Sunnah – sayings, practices and conducts of the Prophet Mohammad
• Ijma – consensus of jurists
• Qiyas – analogical deductions (original ruling is applied to a new matter with similar
characteristics)
Chapter 22-11-16 5
Fundamentals of Islamic Finance and Banking
2-5
 Shariah Law
• Ways of Shariah law elaboration
Ijtihad (which meant independent interpretation by a scholar)
Ikhtiyar (choosing from past views)
Dururah (some relaxation in rules may be considered if it is a necessity)
Istihsan (which is the preference of a jurist) and Istishab (which is the presumption that a
situation existing previously continues to exist unless proven otherwise)
• Schools of Islamic Jurisprudence
- Sunni Schools – Maliki, Hambali, Shafi and Hanafi
- Shiite School - Jaafari

Chapter 22-11-16 6
Fundamentals of Islamic Finance and Banking
2-6
 Shariah Law
• Ethics in Shariah compliant business and finance
Honesty. All parties should be truthful, fair and just to each other and fulfil their obligations.
Transparency. All contracts should clearly specify the quality, quantity and price of the goods or
services being transacted; they should also specify delivery details, and the rights and obligations of
all parties.
Mutual consent. All parties in the contract should have entered into it with mutual consent, without
any coercion or exploitation.
Property. No property can be appropriated wrongfully or unjustly.
Employees. All employees of the business should be treated fairly.
Price stability. Shariah prohibits hoarding or cheating, which achieves price stability.
Generosity and leniency. Shariah encourages parties in the business transaction to be considerate of
all other parties, and be generous whenever possible, sell or buy at a fair price and allow additional
time to borrowers if they really need it.
Halal versus Haram. Only Halal businesses, products and transactions should be dealt with and all
Haram or prohibited items should be avoided.
Chapter 22-11-16 7
Fundamentals of Islamic Finance and Banking
2-7
 Major Shariah Prohibitions and Principles
Prohibition of interest or Riba
• Riba is earning money from money
• Riba is fixed and positive, depending on the amount and time of the loan
• Originally prohibited in all 3 Abrahamic religions
• Two types
Riba al Nasiah – main type, interest paid on loans
Riba al Fadl – exchanging same type of goods, smaller amounts of superior quality with
larger amount of inferior quality, money exchanged with money in different amounts, or
exchange of money like commodities like gold, silver, dates, wheat etc. In contemporary
Islamic finance, foreign currency transactions are acceptable as long as they are
concluded on the spot, hand to hand.

Chapter 22-11-16 8
Fundamentals of Islamic Finance and Banking
2-8
 Major Shariah Prohibitions and Principles
Prohibition of Gharar or uncertain dealings
• Involves taking excessive risks or unnecessary uncertainty
• Two types – Gharar Fahish - substantial amount and not allowed; Gharar Yasir - trivial amount
and is tolerated
Prohibition of Maysir
• Involves all kinds of games chance or dealings where one can gain significantly or lose all
depending on the way the deal moves.
• Maysir is prohibited in Islam because it leads to winning at the expense of others losing, so it is
socially unacceptable. Maysir is different from risk in everyday life or in business, which is
acceptable. It is risk taken to win without any productive activity involved and has the possibility
of losing everything.

Chapter 22-11-16 9
Fundamentals of Islamic Finance and Banking
2-9
 Major Shariah Prohibitions and Principles
Other Principles of Shariah Law
• Encouragement to Use Profit & Loss
• Requirement for Sharia Compliant Contracts
• Avoid Hoarding (store up)
• Avoid Taking Advantage of the Seller
• Freedom of Contract
• Original Permissibility
• Interest of Society
• Relieving of Hardship versus Providing of Benefits (Both are important, but if one has to be
chosen over the other then relieving of hardship would be given more importance)
• Remove Extreme Hardship (When no other choice exists to remove extreme hardship even
an unlawful thing is accepted, like eating pork when no other food is available and one could
starve)
Chapter 22-11-16 10
Fundamentals of Islamic Finance and Banking
2-10
 Shariah Supervisory Board or SSB
Environment of Islamic financial institutions:
Islamic banks are set up in three different environments.
Firstly, they could be established in a Muslim country where by State law all financial
institutions are required to be Shariah-compliant. (Iran, Sudan and Pakistan)
Secondly, they could be established in a Muslim or non-Muslim country where
central bank and State regulations allow both conventional and Islamic banks to
operate and often have some differences in the rulings for Islamic financial
institutions (IFIs) in accordance with their different operational framework. This is
called the dual banking environment. (GCC countries, South Asia and South-East Asia
and the Middle East and North African Muslim-majority countries.)
Thirdly, they could be set up in a non-Muslim country where central bank regulations
do not provide any separate rulings or facilities for IFIs to operate. (like the UK, other
European countries, the USA, Canada, Australia).
Chapter 22-11-16 11
Fundamentals of Islamic Finance and Banking
2-11
 Shariah Supervisory Board or SSB
The first and second categories, the setting up of a Shariah Supervisory Board
is mandatory, while in the third category it is optional for the IFI.
Most IFIs that operate within the third category voluntarily set up an SSB to
give confidence to their stakeholders rather than to satisfy the regulatory
authorities of the jurisdiction they operate in.
The SSB is a body set up with a group of Islamic Shariah scholars or jurists to
assist the IFI to operate in accordance with Islamic Shariah law. The SSB is
also sometimes called the Shariah Board, Shariah Committee, Shariah
Advisory Committee, Shariah Council, Shariah Control Committee or simply
the Religious Board.

Chapter 22-11-16 12
Fundamentals of Islamic Finance and Banking
2-12