Due Diligence in Islamic Finance Instruments: Principles and Avoiding Common Pitfalls

By: Wassem M Amin

Although the market for Islamic Finance was originally developed in the 1920s[1], it still remains relatively small compared to the global financial market.  The overall market of Islamic Finance instruments in 2010 was valued at one trillion dollars[2], a minuscule figure compared to market capitalizations of the Dow Jones Index alone.  However, the global Islamic Finance market has been expanding at a rate of 10-15% annually.[3]  Despite this rapid growth, legal scholarly literature surrounding the governance and due diligence of Islamic Finance products has remained relatively stagnant.  That may be due to the lack of British and American educational institutions that offer courses on Islamic Finance.

However, as the market for Islamic Finance products continues to expand and the adoption of it by various western banks[4], the need for practitioners, especially those working in the Middle East or for Middle Eastern clients, to have a rudimentary understanding is critical.  The market for Islamic Finance was originally developed in Egypt and is primarily based in Middle Eastern financial centers such as Dubai and Cairo.  Accordingly, part II of this paper will examine the brief history behind Islamic Finance, including its underlying principles and guidelines.  Part III will analyze the various Islamic Finance investment vehicles that are primarily used in today’s markets.  Part IV will analyze the necessary legal requirements necessary when conducting due diligence to make sure that financial products are compliant with Islamic Finance laws and principles.

History and Development of the Islamic Finance Markets

Shari’a Law

Islamic Finance can be broadly described as a financial system that is in compliance with Shari’a Law. Shari’a law is the primary source of guidance for all Muslims.[5] Translated into English, the term Shari’a roughly means “Islamic Law.” For sake of uniformity, I will use “Islamic Law” in lieu of the traditional term.  Islamic law is an umbrella for distinct sources of combination of legal and religious tradition.[6]  In order of significance, the primary sources of which Islamic Law is derived include, (1) the Qu’ran, (2) the hadith, (3) ijm’a, and (4) qiyas.[7]  Muslims believe the Qur’an contains the literal word revealed of God to their prophet.[8]  The hadith are the recordings of the Prophet’s actions and words as documented by his followers.[9]  These examples are in turn translated by religious scholars and applied to modern day conditions primarily through a form of analogical reasoning known as qiyas.[10]  Lastly, when Islamic scholars and jurists reach a consensus on the proper application of the qiyas, it results in a per se valid and binding religious law known as ijm’a,[11] known as a “consensus of the jurists.”

The Importance of Islamic Finance in the Modern Financial Landscape

Islamic Finance is a relatively new brand of finance.  Its roots could be traced to 1963 in a bank in Cairo, Egypt.[12]  However, since then the market for Islamic Finance has rapidly expanded at a rate of 10-15% per annum.[13]  Islamic Financial assets are expected to be valued at almost 1 trillion dollars at the end of this year.[14] Western economies are starting to realize the importance of Islamic Finance.  In a speech in 2006, Chancellor Gordon Brown declared his desire to see London become the international global center for Islamic Financial activity.[15]  He has also pledged his support to any legislative changes necessary to ensure a level playing field for Islamic Financial products.[16]  As a result, the regulatory body of England, the Financial Services Authority of England,[17] has dedicated a special division to develop the requisite legal framework.[18]  Additionally, major financial institutions, such as HSBC and Citibank, have developed networks of financial instruments that are compliant with Islamic Law.[19]  There is undoubtedly a growing demand for Islamic Financial Products globally.

The International Association of Islamic Banks requires every financial institution offering Shari’a compliant services to have a board of Islamic and Legal scholars directly elected by the shareholders.[20]  If the board refuses to validate a product proposal because of noncompliance, the bank must abandon it.[21]  In order to standardize the regulation of the industry, many Middle Eastern and Muslim governments have established regulatory boards to oversee compliance.[22] In countries that have done so, a special regulatory scheme governs conventional finance while a separate system of governance oversees Islamic Financial Services.[23]  As for industry oriented, non-governmental initiatives, advisory bodies in various countries have been established including the “Institute of Islamic Research  . . . at Al-Azhar University (established in Cairo, Egypt, 1961), the Islamic Jurisprudence Council . . . of the Muslim World League (established in Saudi Arabia in 1979),”[24] among others. Other industry sponsored bodies include the Accounting and Auditing Organization of the Islamic Financial Institutions, the Islamic Financial Services Board, the International Islamic Financial Market,[25] and the International Islamic Rating Agency.[26]

Many Middle Eastern countries have witnessed a revival of Islamic law at the governmental level in the late twentieth century.  For example, in Egypt, Article 2 of the Constitution, amended in May 1980, states that all subsequent laws and legislations must be derived from Islamic law.[27] This constitutional requirement was reinforced by the following ruling of Egyptian Supreme Constitutional Court, the equivalent of the United States Supreme Court:

It is therefore not permitted that a legislative text contradict those rules of Shari’a whose origin and interpretation are definitive, since these rules are the only ones regarding which new interpretive method is impossible, as they represent, in [Islam], the supreme principles and fixed foundations that admit neither allegorical interpretation, nor modification.  In addition, we should not contemplate that their meaning would change in time and place, from which it follows that they are impermeable to any amendment, and that is not permitted to go beyond them or change their meaning.[28]

Due to these changes, there have many instances of lawsuits in which Egyptian businesses have refused to pay interest or penalties on contracts with foreign companies[29].  That is despite the fact that the contracts already stipulated interest as one of their key terms.[30]  Similar lawsuits have taken place in other Muslim countries, such as Pakistan.[31]

As more International Law Firms establish locations in the Middle East, the need for Business and Corporate Law practitioners to become familiar with due diligence and compliance of these products has become critical.

Conventional Banking[32] versus Islamic Banking

One of the foremost legal Islamic jurists stated: “[T]he basic difference between the capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions.”[33]  The very entrepreneurial spirit of a capitalist society is dependent on the concept of interest.  For example, it is impossible to conceptualize how the American economy could survive if lending institutions were not given an incentive to make funds available to small businesses or homeowners, let alone corporations.  Indeed, interest is such a central concept of American financial markets that a mere statement regarding the lowering or raising of rates by the Federal Reserve Bank has the potential of crippling the economy.  Consequently, most Americans have a significant amount of capital and savings invested in different interest bearing accounts such as stocks, bonds, mutual funds, CDs or saving accounts.[34]  As we have seen during the housing market crash, instruments in interest based economies are so intertwined that the crash of one has the potential of depressing an entire economy.[35]

The theory behind Islamic Finance, although idealistic, is characterized in general as a distinction between a system that is driven purely by profits and one that contains the dual goals of religious piety and profit maximization.[36]  In practical terms, the primary differences are the various restrictions that Islamic Finance places on the types of permissible investments.[37] Due to the fact that Islamic Finance is based on Islamic teachings, it prohibits the investments the investment in products that are forbidden by the religion such as: the charging of riba (interest), the undertaking of excessively speculative or risky ventures, contractual uncertainty or ambiguity, traditional insurance products, and, not surprisingly, industries that deal in gambling, pornography, alcohol, tobacco, pork products and even industries that produce certain media products such as gossip magazines.[38]  Islamic Law jurists believe that no more than 5% of a business’s income should be derived from these activities in order for it to be compliant with Islamic Finance principles.[39]

  1. The Prohibition of Interest (“Riba”)

The prohibition of interest is perhaps the central tenet of Islamic Finance principles.[40]  Therefore, it is necessary to examine the extent of this prohibition in some more detail.  Islamic Law prohibits the accumulation of wealth through interest because it is believed to not be a product of one’s own effort.[41] Muslims believe that an interest based economic system will always lead to the accumulation of wealth in the hands of a few at the expense of many.[42]  This is based on the assumption that lenders choose to lend money to those with the most collateral, who, in turn, use that money to generate more profits.[43]

For many in the western world,[44] it is difficult to grasp the importance of this prohibition without understanding its origins.[45]  In order for practitioners to effectively understand the notion of Islamic Finance, it is critical to understand the reasons behind the prohibition on interest.  Despite many beliefs, the prohibition of interest does not stem from some benevolent notion or belief.[46] Instead, this prohibition is expressly stated in Islam’s Holy Book, the Qu’ran.[47]  However, although this prohibition comes directly from Islamic Law, it still creates ambiguity when applied in the modern world.[48]  Translated directly, the Arabic term “riba” literally means an addition.[49]  However, the exact definition of riba has been subject to one of the longest controversies in the Islamic Finance World.[50]  Does the prohibition refer to interest or usury? This is a very important distinction.  If riba was taken to mean the prohibition of usury, then only transactions which involve the unjust or illegal collection of interest are prohibited—which are also prohibited in many western contracts.[51]  Through this interpretation, the lawful charging of interest would be permitted under Islamic Finance Laws.  However, this is only the minority position.  The majority interpretation and the general consensus among Muslim jurists is that a narrow interpretation of riba should be used, outlawing all forms of interest, whether lawful or unlawful (usury).[52]  This prohibition also extends to currency lending transactions (or trading in futures and derivatives), and trading that involves other commodities, such as some types of foods, gold and silver.[53]

Practitioners seeking to maintain Shari’a compliant businesses need to avoid the prepayment trap.[54]  Many purported Shari’a compliant instruments use prepayments in lieu of the prohibition on interest.  Prepayment works by reducing the principal owed by borrowers.[55]  However, Shari’ah committees of most Islamic banks and Islamic Law expressly forbid this practice.[56]  Although not ideal, a possible work-around is to rebates instead.[57]  Another method is to offer advance purchases at a slight markup and distribute the payments evenly over a specified period.  However, it is strictly prohibited for Islamic Finance products to charge late fees on any loan or purchase.[58]

2.      The Prohibition Against Speculative and Excessively Risky Transactions (“Gharar”)

Another central feature of Islamic Banking is the prohibition of gharar, which roughly translates into “trading in risk”[59] or “risk taking.”[60]  This has been interpreted by Islamic jurist to prohibit the lack of specificity and speculative contracts or investments.  This is derived from the Qu’ran’s prohibition against games of chance, such as gambling.[61]  The practical consequences of this prohibition is that the sales of items that is not currently in existence (such as a futures or options contract) and contracts or financial instruments that are highly speculative in nature are expressly non-compliant with Islamic finance.[62]  In order for financial instruments to be legally compliant with this prohibition, an instrument must: (1) not have excessive speculation or risk; (2) the instrument or contract must have an underlying subject matter of the sale; and (3) society must not be in need of the contract in question (which explains the prohibition on food contracts and futures).[63]

Permissible Islamic Financial Products

Although the prohibition on interest and speculative risk taking may initially seem to muffle the possibility for any financial products, Islamic Finance Practitioners have developed innovative ways to circumvent the religious restrictions.  The most common forms of financing that are Shari’a-compliant are outlined below.  Although this list is by no means exhaustive, it represents the most common Islamic Finance Products in use today.[64]

  1. Mudharabah—This is a profit sharing contractual agreement that is employed typically between a financial institution and an entrepreneur.[65]  The entrepreneur, who seeks funding for his project, receives the money from the institution while in turn providing the labor and business expertise. [66] Prior to the contractual agreement, the two parties determine a ratio at which they will share profits, and all profits made in the venture are shared accordingly. [67] However, unlike western financial institutions, the bank also shares in the losses from the business venture—exposing itself to this risk—and therefore justifying its claim to a percentage of the profits.[68]
  2. Musharakah (literally means ‘sharing’)—Joint-venture financing, or musharakah, is widely used in project finance, real estate development, and other long term investment projects in the Middle East.[69]  Mimicking the default provision of the Uniform Partnership Act of 1914 (“UPA”), each partner in a musharakah agreement has equal management rights regardless of their respective investments.[70]  However—also similar to the UPA—the parties can deviate from the default provisions through a written contractual agreement.[71]
  3. Murabaha (“sharing profits”)—Murabaha has many variations.  This financial product is the Muslim version of a Mortgage—with a little shari’a compliant variation.[72]  A bank or financial institution buys an assets and sells it back to the customer, who will make a single or multiple deferred payments over an agreed upon period of time.[73]  The purchase price, sale price, and the expressly defined profit margin are all agreed upon prior to the contractual agreement. The profit here is justified on the theory that the bank is being compensated for the loss of the investment value of its money.[74]  Note that this system of financing—by definition—prohibits Adjustable Interest Rate Mortgages (“ARM Mortgages”) that many economists have speculated were one of the major causes of the recent economic crisis.
  4. Wadiah (“custody”)—a wadiah is a contract between a financial institution, usually a bank, and a customer-account holder where the customer places his money in trust with the bank.  In return, the bank invests the funds and guarantees repayment of any parts of the funds upon request.[75]  The major difference between a wadiah and a traditional bank account is that depositors in a wadiah are not entitled to any interest payments for their deposited funds.[76]  This allows shari’a compliance by preventing the prohibited act of interest payment and charging. [77]
  5. Sukuk—This is perhaps the most widely known Islamic Financial Product.  Commonly referred to as Islamic Bonds, sukuk varies from bonds in one major area—they do not draw traditional interest.[78]  A traditional bond is a debt obligation, and the bond issuer is obligated to pay the holders both interest and principal at contractually set intervals.[79]  On the other hand, with a sukuk investment certificates—as they more accurately represent—entitle the holders to an “undivided beneficial ownership interest in the underlying assets” and are allowed to share in the sukuk’s revenues as well as the proceeds of the underlying assets.[80]  However, practitioners should be aware that sukuk products have recently come under fire due to various questionable practices.  Most notably, Islamic Scholars have questioned whether the traditional sukuk model invariably provides interest guised in shari’a compliance.[81]  Scholars and regulators have questioned the now common practice of marketing asset backed returns on the basis of the London Interbank Offered Rate (“LIBOR”), which violates shari’a teachings of prohibiting interest based or backed products.[82]  Due to these questionable practices, sukuk issuances have dropped off dramatically.[83]

Pitfalls and Dangers of Islamic Finance

Due to the religion based, non-binding legal nature of Shari’a complaint financing, the danger of disagreements between Islamic scholars and regulatory bodies has a unique impact that is not present in other regulatory or legal systems.  Additionally, too few qualified scholars causes the issuance of many Islamic Financial products without proper “certification.”  Finally, the absence of a consistent and reliable system for determining shari’a compliant products results in tremendous uncertainty for investors.  Uniform regulation is critical to ensure the continued growth of Islamic Finance Products.  Practitioners need to be aware of the complex regulatory scheme—or lack thereof—which impacts the feasibility of marketing these products.

[1] Sayed Khatab & Gary D. Bouma, Democracy in Islam 110 (2007).

[2] See The 1st Ethical Charitable Guide To: Explaining Islamic Finance, available at http://www.1stethical.com [hereinafter Explaining Islamic Finance].

[3] See Andreas Junius, Islamic Finance: Issues Surrounding Islamic Law as a Choice of Law Under German Conflict of Laws Principles, 7 Chi. J. Int’l L. 537, 538 (2007) (discussing the increasing number of Islamic financial institutions worldwide); Theodore Karasik et al., Islamic Finance in a Global Context: Opportunities and Challenges, 7 Chi. J. Int’l L. 379, 379 (2007) (noting, as of 2006, growth rates nearing 15% per year).

[4] Explaining Islamic Finance, supra note 3.

[5] Glossary, in Structuring Islamic Finance Transactions 226, 232 (Abdulkader Thomas et al. eds., 2005).

[6] Haider Ala Hamoudi, Jurisprudential Schizophrenia: On Form and Function in Islamic Finance, 7 Chi.J. Int’l L. 605, 608 (2007).

[7] Irshad Abdal-Haqq, Islamic Law: An Overview of Its Origin and Elements, 7 J. Islamic L. & Culture 27, 36 (2002).

[8] Glossary, supra note 5, at 231.

[9] Gohar Bilal, Islamic Finance: Alternatives to the Western Model, Fletcher F. World Aff., Winter/Spring 1999, at 145,146.

[10] Hamoudi, supra note 6, at 608.

[11] Id.

[12] Khateb & Bouma, supra note 1.

[13] See Juan Solé, Islamic Banking Makes Headway, IMF Surv. Mag., Sept. 19, 2007, http://

www.imf.org/external/pubs/ft/survey/so/2007/RES0919A.htm  (asserting that the Islamic banking industry has grown 10%-15% per year over the last ten years).

[14] Oliver Agha, Islamic Finance in the Gulf: A Practitioner’s Perspective, 1 Berkeley J. Middle E. & Islamic L. 179, 179 (2008).

[15] Explaining Islamic Finance, supra note 2 at 4.

[16] Id.

[17] Id.

[18] Id.

[19]  For a list of compiled in the 1980s of banks and financial institutions across the world, including banks in Argentina, The Bahamas, Egypt, Saudi Arabia, Thailand and Malaysia, engaged in profit-sharing (non-interest) transactions with clients, see Hunaid Khorakiwala, The Banking Laws of India and Establishment of Profit Sharing Banks—Some Suggestions, 7 Islamic & Comp. L.Q. 59, 61-63 (1987).

[20] Ibrahim Warde, Islamic Finance in the Global Economy

[21] Id.

[22] For example, Malaysia has established the National Syariah (Shari’a) Board to standardize Islamic Finance products and advise the Central Bank. Pakistan has also established a Shari’a Board within the National Bank, and the United Arab Emirates, Bahrain, and Egypt have done the same.

[23] Id.

[24] Id.

[25] Id.

[26] Id.

[27] Egyptian Const. art. 2, available at http://www.sis.gov.eg/egyptinf/politics/parlment/htmal/constit.htm. Before the constitutional amendment stating Shari’a is “the principle source of legislation,” Article 2 read, “the principles of the Shari’a are a principal source of legislation.” See Rector of Azhar University v. President, infra note 32, at 103.  Under the original wording, the state did not have a mandatory obligation to conform legislation to Shari’a.  The key change was change the letter “a” to “the” in Article 2; therefore placing a limitation on the legislature that all laws passed must conform to Shari’a (Islamic Law).  Practitioners should note that the Court also ruled that this change was not retroactive, therefore inapplicable to contracts and laws in place before the Amendment are not subject to compliance. Id at 104.

[28]  See Rector of the Azhar University v. President of the Republic, Case No. 20 of the Judicial Year No. 1 (Sup. Constitutional Ct.) (Egypt), reprinted in Supreme Constitutional Court (Egypt)—Shari’a and Riba: Decision in Case No. 20 of Judicial Year No. 1, 1 Arab L.Q. 100 (1985) [hereinafter Rector of Azhar University v. President]; See also Oussama Arabi, Studies in Modern Islamic Law 21, 39-42, 63-65, 196 (2001).

[29] Interest is forbidden in Islamic Law, see infra Part

[30] See Rector of the Azhar University v. President of the Republic, Case No. 20 of the Judicial Year No. 1 (Sup. Constitutional Ct.) (Egypt), reprinted in Supreme Constitutional Court (Egypt)—Shari’a and Riba: Decision in Case No. 20 of Judicial Year No. 1, 1 Arab L.Q. 100 (1985)

[31] Ur-Rahman Faisal v. Seceretary, Ministry of Law, Justice, & Parl. Affairs, Gov’t of Pak., 44 (1992) P.L.D. I (Federal Shariat Ct. 1992) (Pak.).  Prior to this decision, the Federal Shariat (or Shari’a in Urdu) was unable to hear cases addressing the legality of interest due to a law prohibiting any court from ruling on the matter of the permissibility of interest. Id. at 97, 264.

[32] Conventional Banking or Conventional Finance are used interchangeably throughout this article.  I use the term “conventional” to denote the financial and banking order that dominates the world presently.  This dominance is a result of two distinct, yet intertwined, historical events.  See 27 Fordham Int’l L. J. 150, 156.  First, the colonial encroachment on the world by European powers, and, second, the late twentieth century globalization of the financial markets. Id.

[33] Muhammad Taqi Usmani, An Introduction to Islamic Finance, at xiv (2002).

[34] Id.

[35] See generally, Michael Lewis, The Big Short: Inside the Doomsday Machine (2010).

[36] See Usmani, supra note 33. (discussing the attempt of Islamic finance to protect societal interests and divine restrictions within a market-based economy); see also UmarF. Moghul & ArshadA. Ahmed, Contractual Forms in Islamic Finance Law and Islamic Inv. Co. of the Gulf (Bahamas) Ltd. v. Symphony Gems N.V. & Ors.: A First Impression of Islamic Finance, 27 Fordham Int’l L.J. 150, 152 (2004) (recounting that Islamic finance is closely tied to Islamic religious principles).

[37] Irshad Abdal-Haqq, Islamic Law: An Overview of Its Origin and Elements, 7 J. Islamic L. & Culture 27, 36 (2002).

[38] Shahzad Q. Qadri, Islamic Banking: An Introduction, Bus. L. Today, July-Aug. 2008, at 59, 59; see also Angela Jameson, Conventional Insurance in Conflict with Islam, Times Online, Mar. 1, 2008, http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_ finance/article3463702 (“Conventional insurance products are in conflict with Islamic beliefs for three reasons. Insurance involves an element of uncertainty, gambling and the charging of interest, which are prohibited by the Koran.”). This is not intended to be a complete list of all prohibited items in the Islamic financial system. However, those remain the most central and visible restrictions on Islamic investment as it currently exists

[39] See Zaineb Sefiani, Inside View: Islamic Finance, Funds Eur., July 2009, http://www.funds-europe.com/July-2009/INSIDE-VIEW-Islamic-finance/menu-id-228.html  (describing the first step in screening investments for Shari’a compliance as filtering out companies that derive more than 5% per year from forbidden business sectors).

[40] Id.

[41] Id.

[42] Id.

[43]  Whether or not this proposition is factually true is best left for another article.

[44] The author uses the phrase “western world” to generally refer to western, capitalist economies.

[45] See Sefiani, supra note 39.

[46] Id.

[47] Id.

[48] Id.

[49] The author is a fluent Arabic speaker.

[50] See TRAUTE WOHLERS-SCHARF, ARAB AND ISLAMIC BANKS NEW BUSINESS PARTNERS FOR DEVELOPING COUNTRIES 75-76 (1983). This controversy is likely one of the most significant factors contributing to the lack of a standard form of Islamic banking since the many different interpretations of the term riba have contributed to the numerous methods of banking and finance throughout the Islamic world.

[51] Many commercial Western promissory notes and purchase agreement contain express prohibitions against interest.  In fact, Massachusetts anti-usury laws require such clauses to be included in most consumer contracts.  Example on file with author.

[52] See S.H. AMIN, ISLAMIC BANKING AND FINANCE: THE EXPERIENCE OF IRAN 15 (1986) (“Until fairly recently, the entire banking system in all Muslim countries was patterned after the Western banking system … [which] was inconsistent with Islamic law primarily because of disapproval or [sic] riba …”); See also, e.g., Mohammed Uzair, Impact of Interest Free Banking, 1 J. Islamic Banking & Fin. 39, 40 (1984) (“By this time, there is a complete consensus of all . . . schools [of Islam] . . . and among Islamic economists that interest in all forms, of all kinds, and for all purposes is completely prohibited in Islam.  Gone are the days were people . . .  contended that the interest for commercial and business purposes, as presently charged by the banks, was not interest.”)

[53] See Imran Ahsan Khan Nyazee, The Concept of Riba and Islamic Banking 67 (1995); See generally Iqbal Ahmad Khan Suhail, What is Riba? (Rizwanullah & Zafarul-Islam Khan trans., Phoas Media & Publ’g. Pvt. Ltd. 1999) (1936).

[54] See Wahba al-Zuhayli, Financial Transaction in Islamic Jurisprudence: A Translation of Vol. 5 of Al-Fiqh al-Islami wa Adillatuhu 311-14 (explaining the types of riba).

[55] See, e.g., Muhammad Taqi Usmani, An Introduction to Islamic Finance 141-43 (1999).  Usmani claims that jurists permitting prepayment rely on hadith text the authenticity and authority of which has been disputed. See id. at 142.

[56] Id.

[57] Id.

[58] Some contemporary Islamic Jurists have allowed late charges to the extent to the costs actually incurred by the lender due to the payment being late.  Similarly, when a party defaults on its payment obligations, Islamic Law mandates that the defaulting party be required to donate a specific amount to charity in lieu of paying penalties. See Usmani, supra note 61, at 131-40.

[59] See Mohammed A. El-Ghamal, An Economic Explication of the Prohibition of Gharar in Classical Islamic Jurisprudence, at 1 (May 2, 2001), available at http://www.ruf.rice.edu/~elgamal/files/islamic.html.

[60] See Mohammad Hashim Kamali, Islamic Commercial Law: An Analysis of Futures and Options 84-98 (suggesting that the “basic concern in all discussion of gharar is with elements of risk-taking”).

[61] Nabil A. Saleh, Unlawful Gain and Legitimate Profit in Islamic Law 62, 85 (1986).

[62] See, e.g., Frank E. Vogel & Samuel L. Hayes III, Islamic Law and Finance: Religion, Risk, and Return 64 (1998); see generally Saleh, supra note 66.

[63] See Mahmoud A. El-Gamal, Islamic Finance: Law, Economics, and Practice 58-59 (2006) (relating the conditions necessary to invalidate a contract).

First, [uncertainty] must be excessive to invalidate a contract. Thus, minor uncertainty about an object of sale (e.g., if its weight is known only up to the nearest ounce) does not affect the contract. Second, the potentially affected contract must be a commutative financial contract (e.g., sales). Thus, giving a gift that is randomly determined (e.g., the catch of a diver) is valid, whereas selling the same item would be deemed invalid based on [uncertainty].

Third, for [uncertainty] to invalidate a contract, it must affect the principal components thereof (e.g., the price or object of sale). Thus, the sale of a pregnant cow was deemed valid, even though the status of the calf may not be known. Indeed, the price of a pregnant cow would be higher than the price of the same cow if it were not pregnant. However, the sale of its unborn calf by itself is not valid based on [uncertainty]. In the first case, the primary object of sale is the cow itself, whereas in the latter case the object of sale is the unborn calf, which may be still-born. Finally, if the commutative contract containing excessive [uncertainty] meets a need that cannot be met otherwise, the contract would not be deemed invalid based on that [uncertainty]. A canonical example is … [prepaid forward sale], wherein the object of sale does not exist at contract inception, giving rise to excessive [uncertainty]. However, since that contract allows financing of agricultural and industrial activities that cannot be financed otherwise, it is allowed despite that [uncertainty]. Similarly, while contemporary jurists forbade commercial insurance based on excessive [uncertainty] and availability of noncommutative [Islamic insurance] alternatives, they currently allow [Islamic insurance] companies to deal with conventional reinsurance companies, since [Islamic reinsurance] alternatives are not yet available.


[64] See, e.g., Shahzad L. Qadri, Islamic Banking: An Introduction, Bus. L. Today, July-Aug. 2008, at 59-60 (describing mudharabah, wadiah, musharakah, and murabaha as key basic concepts in Islamic Banking); Abdulkader Thomas, Introduction: The Origins and Nature of the Islamic Financial Market, in Structuring Islamic Financing Transactions, at 1, 7-8 (Abdulkader Thomas et al. eds., 2005) (naming mudharabah, musharakah, ijarah, and sukuk as core financing mechanisms); see also Ahmad Lutfil Abdull Mutalip & Mohd Herwan Sukri Mohammed Hussin, The Emergence of Islamic Financing Based on the Syariah Concept of Tawarruq 1 (2008) (unpublished manuscript, available at http://www.azmilaw.com.my/Article/Article _8_&_9/Article_9_Tawarruq_00093603_.pdf).

[65] Qadri, supra note 67, at 59.

[66] Id. at 59-60.

[67] Id.

[68] Id.

[69] Muhammad Taqi Usmani, The Concept of Musharakah and Its Application as an Islamic Method of Financing, 14 Arab L.Q. 203, 203 (1999).

[70] Husam Hourani, The Three Principles of Islamic Finance Explained, Int’l Fin. L. Rev., 46-47 (2004).

[71] Id.

[72] Id.

[73] Id.

[74] Id.

[75] Holger Timm, The Cultural and Demographic Aspects of the Islamic Financial System and the Potential for Islamic Financial Products in the German Market 40 (2004).

[76] Id.

[77] Id.

[78] Abdulkader Thomas, Opportunities with Sukuk and Securitizations, in Structuring Islamic Finance Transactions, supra note 67 at 154.

[79] Id.

[80] Id.

[81] Jeff Black, An Unhealthy Interest?, Middle E., July 2008, at 44.

[82] Id.  LIBOR stands for the London InterBank Offered Rate, which is the interest rate at which most banks offer to lend to each other.  British Bankers Ass’n, The Basics, available at http://bbalibor.com/bba/jsp/polopoly.jsp?d=1627.  The LIBOR rate is often used as the standard for quoting interest rates for many other types of loans, such as commercial loans and even student loans.

[83] Roula Khalaf, Islamic Finance Must Resolve Inner Tenstions, Fin. Times, Mar. 30, 2009, http://www.ft.com/cms/s/0/4894b482-1d44-11de-9eb3-00144feabdc0.html.

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