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The legal rules governing
Islamic investments
Elif Härkönen
1
Introduction 189
1.1 Methodological approach and purpose with
the study 189
2
A theoretical framework for Islamic finance and
investments 191
2.1 The growth of Islamic banking 191
2.2 Differences and similarities with other religions
2.3 The sources of Islamic law 196
2.4 The different forms of Islamic banking 200
2.5 Other conventional investment tools and their
permissibility according to Islamic law 205
2.6 The different types of Islamic funds 207
195
3
Qualitative & quantitative screens on investments
3.1 Qualitative screens on investments 214
3.2 Quantitative screens on investments 217
3.3 The purification process 226
214
4
Islamic banking in practice 228
4.1 The influence of Islamic law 228
4.2 The legal framework and operations of Islamic banks
in Egypt and the UAE 234
4.3 Court judgements and legal rules concerning the
permissibility of investments 241
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4.4 The securities markets in Egypt and the UAE and
their compliance with Islamic law 251
5
Some reflections and concluding remarks on Islamic
banking 255
5.1 Concluding remarks and reflections on the future
of Islamic investments 255
List of references
186
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Elif Härkönen
Göteborgs universitet
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The legal rules governing
Islamic investments 1
1
Introduction
1.1 Methodological approach and purpose
with the study
The purpose of this study is to describe and analyze the legal rules governing Islamic investments, both in theory and practice, with focus on investment funds and equity investments. Many people are aware of the
prohibition in the Holy Qur’an to charge interest, but lack the understanding of the broader context from where the prohibition comes from
and why it was given. Also, many of the other fundamental rules of Islamic
banking and equity investments are virtually unknown to non-Muslim
investors.
The study is composed of a theoretical and a practical part divided
into five chapters. The introduction chapter deals with methodological
questions for the study while chapter two outlines the legal rules and
background to Islamic banking with focus on Islamic equity and other
financial investments. Firstly, chapter two will describe the theoretical
framework for Islamic banking. Secondly, it will present the operational
1
I would like to thank Professor Rolf Dotevall at Gothenburg University, Sweden, for supporting and guiding my work, for reading the first draft and for giving useful comments and suggestions. I am also grateful to Mrs. Mouza Alneyadi, Dr. Abdulla H. Mohamed and Dr. Jassim
Ali Salem Al-Shamsi at UAE University, and officials at Abu Dhabi Islamic Bank, Dubai Islamic
Bank, American University of Cairo, Faisal Islamic Bank and Islamic Development and Investment Bank in Cairo. The case study part has been made possible only through the financial support from SIDA, Swedish International Development Co-operation Agency. Most of all, I would
like to thank Hamid Jalali for accompanying me on my research trips and for always supporting
me. The usual disclaimer applies.
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mechanisms used by Islamic banks today. Finally an in-depth study is
presented about investment funds and equity investments. Chapter three
deals with quantitative and qualitative screens on Islamic investments.
The theoretical part of the study is composed of material from various
sources including interviews, articles and other printed material. Textbooks on Islamic finance from a legal point of view are extremely scarce.
Most books are dealing with Islamic finance from an economic point of
view and those in the field of law are most often concerned with the theoretical aspects of Islamic finance instead of the application of the rules
in specific countries.
Rather than just describe the differences in Islamic banking I have
chosen to illustrate them in a case study which comprises of chapter four.
In the case study I compare the legal framework of Islamic banking in two
countries with different economic and political prerequisites. The purpose is to compare an Islamic country with a secular government, Egypt,
and a country based on Islamic values, the United Arab Emirates (the
UAE). I will also study the operational aspects of a few chosen Islamic
banks. One of the major objectives of Islamic banking is to contribute to
socio-economic justice and equal distribution of the assets in the society.2
A key question is if the Islamic equity and other financial investment
opportunities do enhance this goal and provide much needed capital to
investments in poor Islamic countries or if the mobilization of savings to
investments mainly create wealth to the already well-to-do proportion of
the society and is just another investment alternative without social benefits. This question will be answered in the practical part. Interviews, Shari’a
Board decisions and statutes of incorporation of banks and investment
houses will be the primary means of acquiring knowledge of the Islamic
banking industry. Finally, chapter five composes of reflections and concluding remarks on the subject, outlining some consequences of the recent
surge in Islamic financial instruments.
Hopefully this study can be a small step in bridging the gap between
legal theory on the one hand and practical feasibility studies in the society
on the other hand. I have chosen to cover the equity investments and in2
UMER CHAPRA, TOWARDS A JUST MONETARY SYSTEM 33–34 (The Islamic Foundation in Leicester 1985).
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vestment fund sector more carefully even if it encompasses a small share
of the Islamic banking sector today, because it is one of the fastest growing
sectors and has a huge growth potential among both Muslim and Western
ethically minded investors.3 The other sectors do not show the same growth
potential in the near future. I will only cover Islamic finance from a legal
viewpoint although I am well aware of the criticism which can be made
against focusing only on legalistic concerns. Islamic finance is a multifaceted phenomenon and to understand it fully it is necessary to combine
legal knowledge of the system with interdisciplinary research covering the
financial and religious areas as well. In this essay I will make a small study
of one part of Islamic finance with a narrow geographical focus, and do
not aspire to make a fully covered overview of Islamic finance in general. I
would also like to give a caveat when I in the following mention “... according to Islam” or “Muslims do ...” that any religion with 1.2 billion followers
who live all over the world, do naturally not agree on every issue on what
is allowed or not allowed to do according to Islam.
2
A theoretical framework for Islamic finance
and investments
2.1 The growth of Islamic banking
The last decade has seen an influx of new religiously and ethically influenced banking alternatives. One of the fastest growing ethically influenced
investment sectors has been the Islamic banking sector. The Islamic banking
sector derives its operational framework and is dedicated to the religious
commands established by Islam and Islamic economic philosophy.
Islamic economic philosophy started its development at the birth of
Islam in the 7th century. It has for various reasons 4 not received the same
attention by legal scholars as for example family law, and had a dormant
existence until the last half-century. Islamic banking and finance in its
3 Yusuf Talal DeLorenzo, Shari’ah Supervision of Islamic Mutual Funds 1 at http:// www.failaka.
com/Failaka%20Research.html
4 Colonization of the Muslim countries is the most recent cause to the historical underdevelopment.
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modern form took shape only in the 1970s. The first emergence of Islamic
banking was associated with the oil boom and the emerging pan-Islamism.5 The oil boom brought capital to the impoverished Arab countries
and the economic self-determination restored their cultural pride. Eventually this led to the establishment of an economic system which more
closely conformed to the cultural values of the region.6 At the third Islamic
conference of foreign ministers in 1972 Arab countries established a plan
to reform their financial systems so that they would conform to Shari’a.
The conference is considered to mark the birth of modern Islamic banking.7 There had been some early experiments with Islamic development
banks from the 1950s to the 1970s, in Egypt for example, but the first
commercially owned non-governmental Islamic bank is considered to
have opened in Dubai, United Arab Emirates, in 1975.
The Dubai Islamic Bank was quickly followed by others in the 1970s.
Faisal Islamic Bank of Egypt (1977), the Islamic Bank of Sudan (1977) and
the Jordan Islamic Bank for Finance and Investment (1978) are just a few
of them. The Dallah Al Baraka Group and Dar-Al-Maal Al-Islami (the
DMI group), both created by Saudi nationals in the late 1970s and early
1980s have become the most important players in the international Islamic
banking sector. In 1977 the International Association of Islamic Banks
(IAIB) was created. IAIB has played an important role in coordinating and
advising the newly created Islamic banks. The IAIB has created a higher
religious supervisory board, which is entrusted with making fatwas (religious opinions) on the transactions of Islamic banks and to coordinate
the various institutions Shari’a Board decisions.
During the 1990s a new phenomenon occurred in Islamic banking.
More and more conventional banks opened up Islamic branches or Islamic “windows” to profit from the quickly growing market. Today most
large banking corporations have an Islamic “window” to serve their Mus5 IBRAHIM WARDE, ISLAMIC FINANCE IN THE GLOBAL ECONOMY 73–84 (Edinburgh Univ. Press
2000).
6
PHILLIP MOORE, ISLAMIC FINANCE: A PARTNERSHIP FOR GROWTH 7 (Euromoney Publications
1997).
7 Elias Kazarian & Ari Kokko, Islamic Banking and development 21 MINOR FIELD STUDY SERIES
NO. 4 (1987) (On file with the Swedish International Development Co-operation Agency
library).
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lim customers. Among those who have Islamic branches are many of
the most prominent financial institutions such as JPMorgan Chase and
Goldman Sachs. The geographical area of the early banks widened to
include Malaysia as a new power player in the development of Islamic
banking together with Egypt and the Gulf states, who had dominated the
market since earlier.8
Islamic countries have embraced the Islamic financial system in varying degrees, with some countries changing the whole financial system to
follow Islamic principles (Iran, Pakistan and Sudan), while others are encouraging the Islamic banking system but also maintain a conventional
banking system (Bahrain, United Arab Emirates, Malaysia). Others nor
encourage neither discourage the Islamic banking sector (Egypt, Singapore) while some countries are negative to the creation of a separate Islamic
banking sector (Saudi Arabia and Oman).9
The resistance against Islamic banking in Saudi Arabia has nothing to
do with adherence to Islam, since the overwhelming majority of the population are devoted Muslims, but more with the structure of most companies in Saudi Arabia. More than 90 % of the companies are family
owned enterprises and there is a strong resistance against endangering the
survival of the family business by letting a bank be involved in the decision making of the company. Many are also unwilling to separate the
family’s cash flow from the businesses.10 The government in Saudi Arabia
has also been unwilling to certify Islamic banks because it would indirectly
imply that the rest of the banking sector operating in Saudi Arabia is nonIslamic. Saudi Arabia has not legalized the taking of interest and the country has deliberately not enacted a Civil Code, but follows the principles
entrusted in the Shari’a as the supreme law of the country. Most of the
banks operating in Saudi Arabia adhere to Islamic standards without calling
themselves Islamic banks. Individual Saudi nationals have been instrumental in developing the Islamic banking sector and products through
ownership in Islamic banks operating outside Saudi Arabia, such as the
Faisal Islamic banks and the Dallah Al Baraka Group of banks.
8
WARDE supra note 5, at 85.
Benjamin C. Esty, The equate project; An introduction to Islamic Project Finance, JOURNAL OF
PROJECT FINANCE, WINTER 2000 at 7.
10 JAN SAMUELSSON, ISLAMISK EKONOMI at 113 (Studentlitteratur Lund 2000).
9
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Islamic equity investment received a boost when the Dow Jones created
several Islamic Market Indexes (DJIMI) which are Shari’a compliant.
Currently included in the Islamic Market family of indexes are the broad
DJ Islamic Market Index, special indexes for geographic regions (US,
Canada, UK, Europe and Asia/Pacific) and for specific branches (technology and extra liquid stocks). The DJIMI tracks over 600 companies
inside and outside the Islamic world, with a heavy concentration on technology, consumer products, utilities and the energy sector.11 Islamic mutual
funds have generally performed well in the market. From the Dow Jones
Islamic Indexes, seven of the eight indexes outperformed their secular
competitors in 1999, the one exception being the technology index.12
Individual mutual funds have also generally received a good return on
their investments. Citi Bank’s Citi Islamic Portfolios Fund has been rated
the ninth best mutual fund in the world.13
Today Islamic banking has more than 150 institutions in 48 countries
including the UK, the USA and other Western countries. According to an
estimate the main growth market for Islamic banking today is in the USA
and the UK.14 The Islamic banking sector has an estimated US$100 billion to US$ 250 billion of funds under management and is enjoying an
annual growth rate of 15 %, a growth rate which is expected to continue
in the near future.15 The value of the Islamic mutual fund market is estimated at US$ 600 million invested in 104 mutual funds worldwide.16 The
majority of those are equity funds.17
11
Betsy Wangensteen, Muslims putting more into U.S.; Shari’a compliance the problem, INVESTNEWS, July 19, 1999, at 11.
12 at http:www.maxfunds.com/MF2000.nsf/DisplayContent/2206.
13 Islam: the new mover, THE BANKER, JUNE 2000, at 67. (Citi Bank’s Islamic fund was launched
already in 1977, and was one of the first Islamic funds).
14 Id.
15 Id.
16 Andrew Greene, Islamic Funds Struggle to Win U.S. Market, MUTUAL FUND MARKET NEWS,
July 30, 2001.
17 Richard P. Keigher &C. John Bauer, Islamic Equity Funds: Challenges & Opportunities for
Fund Managers presented at Fourth Harvard University Forum on Islamic Finance 30th September–1st October 2000 at http://www. failaka.com.
MENT
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Islam is the fastest growing religion in the USA 18 and in many European countries, which has made the conventional banking sector open its
eyes to the huge potential of the market. With 1.2 billion Muslims and
counting, who comprise approximately 25 % of the world population
and control approximately 10 % of the global GNP,19 Islamic banking
has become a force to reckon with in the financial community.
2.2 Differences and similarities with other religions
Islam is one of the three dominating Western monotheistic religions
together with Christianity and Judaism, and Muslim investors have many
things in common with faithful Christians and Jews. All three religions
emphasize collective action where the congregation is the basic unit of
worship. Many Asian religions, such as Shinto and Buddhism, center more
on private worship and allow the worship of many Gods, which in the
monotheistic religions is seen as defeating the purpose of worship. In Islam
one of the five pillars, which define the basic undertakings a religious Muslim shall follow, is the renouncing of all other faiths. “There is no God but
Allah and Mohammed was his last messenger on earth.”
As a result of the orientation towards collectivism and exclusivity the
monotheistic religions are more centered on collective production which
shall benefit the whole congregation (umma in Islam). Exclusivity is fundamental for religions which focus on collective production to avoid the
free-rider problem a less devoted worshiper would impose upon the
others.20 Islamic banking and investment in mutual funds have been
influenced of this and one of the fundamental rules for investment is that
it shall benefit everybody and not just the few persons who make the
investment. Islamic banking emphasizes the fair distribution of wealth.
All wealth is a gift from Allah to all human beings and should not be concentrated to a few persons.21
From the times of Prophet Mohammed, Islam has joined political and
religious leadership in one. Mohammed was both the religious and polit18
Greene, supra note 16.
Esty, supra note 9.
20 Laurence R. Iannaccone, Risk, rationality and religious portfolios, 285 ECONOMIC INQUIRY,
April 1995.
19
21
ELIAZ KAZARIAN, ISLAMIC BANKING IN EGYPT at 47 (Lund Economic Studies Nr. 45 1991).
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ical leader of the first Muslim society. Even today Muslim rulers justify
their power with that they are descendants of Mohammed, or as in Saudi
Arabia, that they are the guardians of the holy shrines in Mecca and Medina.
In Scandinavia we seldom think of religion when we make financial or
political decisions in our life, those two spheres are separated; religion is
more of a private conviction than a life norm. For a Muslim, Islam encompasses everything in the daily life. The Qur’an gives advice on what
you should eat, drink and how you should invest your money. There is no
division between secular and spiritual spheres of life, a division which happened early in the history of Christianity. In Europe a secular leader (the
king or parliament) and a spiritual leader (the bishop or pope) divided the
power between them. As a result of the division, the financial sphere of life
has always been fairly secularized in Christian societies. The Christian religious leaders have not gotten involved in the economic sector and, as a
result, the ethical aspects of an investment are less important than the profitability of the investment in conventional Western banking.22 However
during the last twenty years there has been a reaction in the Western world
towards the profit hungry society, and ethical mutual funds which base
their investment decisions on ethical concerns instead of only profitability
have emerged.
2.3 The sources of Islamic law
To be able to understand the recent upsurge in Islamic banking alternatives it is necessary to have a knowledge of Islamic law and its sources. As
mentioned earlier, for Muslims the economy is just one part of a whole,
where all parts of life are regulated by Shari’a. Shari’a defines the base for
all type of economic transactions. The most important source of Islamic
law is the holy Qur’an which was revealed to Prophet Mohammed in the
7th century CE. Mohammed was an illiterate salesman from Mecca on the
Arabian peninsula, in what is today Saudi Arabia. He started getting revelations from God in 622 CE transmitted by the angel Gabriel, and this is
when the Islamic era starts. Most of the secular provisions came after the
Prophet and the congregation had moved to Medina, where the congre-
22
SAMUELSSON, supra note 10 at 5–6.
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gation had its first change to establish a society.23 The holy Qur’an was
written down after Mohammed’s death 632 CE.
Even though Shari’a is based foremost on the Qur’an, other sources
are necessary for forming a legal school of thought. Firstly, because the
Qur’an itself does not contain legal references in more than approximately
500 verses out of the total of some 6000 verses 24 and secondly, because it
is written in the 7th century and does not give answers to many of the problems in the present-day society and investment milieu. During Mohammed’s lifetime and especially during the first centuries after his death, his
statements and his practices were transferred in an oral tradition and
saved as a guidance of how matters which were not mentioned in the
Qur’an should be dealt with. The path taken by the Prophet, his behavior,
and the oral tradition of Mohammed’s sayings is called sunnah.
The tradition established by these deeds and sayings and the deeds of
Mohammed’s closest men which was also transferred orally are in their
written form called hadiths. The hadiths were not written down until in
the second and third centuries after Mohammed’s death. Since the comments and explanations of the Qur’an were written down after Mohammed’s death some of them are less reliable and even invented stories. Every
hadith is divided into two parts, one giving the legal rule and the other
part consisting of a history of its origin. Every hadith has to trace its origins back to Mohammed and depending on how reliable the chain of persons who have told the hadith onwards back to Mohammed is, it is given
different value as a source of law. Six of the hadith collections have been
generally accepted as authentic and are by legal scholars named the Six
Canonical Collections. These six collections cover a wide range of economical material from the earlier periods of Islam.25 The Qur’an, sunnah and
hadiths consist of the primary sources of Islamic law, and are relied upon
in the same order, with the Holy Qur’an being the first source to consider.
According to Islam, whenever a group of religiously learned persons
formed the same opinion, or consensus in a matter, they could not be
wrong. The gathered wisdom of the umma was always leading in the right
23 NABIL A. SALEH, UNLAWFUL GAIN AND LEGITIMATE PROFIT IN ISLAMIC LAW
24
GLENN PATRICK H., LEGAL TRADITIONS
2000).
25 KAZARIAN
OF THE
1 (1992).
WORLD 159 (Oxford University Press,
supra note 21 at 83.
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direction. Consensus, or ijma has to be based on the primary sources of Islamic law. Ijma is especially important in the context of Islamic finance,
since many of the modern rules used in Islamic finance today are derived
from primary sources according to the consensus of the religious authorities of today.26
Another source of Islamic law is the qiyas or ijtihad, which means drawing analogies from the Qur’an and the hadith texts. Jurists try to figure out
how the Prophet or the four first right learned caliphs would have reasoned
in the same situation or how the umma as a whole would prescribe. The
analogies must be based on primary sources. In the early period of Islam
it was allowed to search for answers through this kind of independent reasoning and develop new legal rules. Ijtihad is characterised by “le fait d’user
de toutes ses capacités et de déployer un effort dans la reserche du statut
légal.” 27 Note that a scholar’s ijtihad was supposed to come after the analysis of the other sources, and remain within the parameters established by
them. Sometime during the 13th century there was consensus among the
legal scholars to close the door to independent reasoning. After that all legal
reasoning was to be conducted according to the rules of ijma. Many Islamic scholars do not agree on that the door to independent legal reasoning
has ever been closed 28 and others argue that it should be re-opened to
provide answers in the fast changing world of today.29 The shia schools of
legal thought have taken a different approach to independent reasoning,
in them it is allowed and even encouraged even today. Organizations such
as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)30 see as one of their tasks to develop collective personal
reasoning, ijma, and keep persons away from individualism and individual reasoning in the field of Islamic finance.31 In practice most of the legal
26
Id. at 84.
Éric Chaumont, Ijtihād et Histoire en Islam sunnite classique selon quelques juristes et théologiens, in ISLAMIC LAW, THEORY AND PRACTICE (Robert Gleave ed., I.B. Tauris, 1997).
“To make use of all your capacities and make an effort in the search of the legal statute” (the author’s translation!).
28 See for example id.
29 KAZARIAN, note 21 at 85.
30 See for example http://www.aaoifi.com/
31 NIZAM YAQUBI, PARTICIPATION AND TRADING IN EQUITIES OF COMPANIES WHICH MAIN BUSINESS IS PRIMARLY LAWFUL BUT FRAUGHT WITH SOME PROHIBITED TRANSACTIONS At
http://www.djindexes.com/downloads/yaquby.pdf
27
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advisors in Islamic banks are admitting collective personal reasoning to be
highly important if not the most important tool in the further development
of Islamic banking.32 It is difficult to find answers to the permissibility of
sophisticated investment tools of today in the legal texts from the Middle
Ages.
Islamic law has formed five schools of legal thought during the first
centuries of Islam. From the beginning there were probably hundreds of
different schools, but only five have survived until today. Four of the schools,
which form part of Sunni Islam, are recognized by each other and have been
interacting with each other even though they maintain their differences.
They are called the four orthodox schools of thought. The fifth school of
thought is the legal reasoning conducted by Shiite Muslims. The Shia school
is really a group of schools developed after the split with Sunni Islam.
One of the two oldest schools of legal reasoning is the Maliki school
which has its origins in the Prophet’s home town of Medina, in today’s
Saudi Arabia. Today, most adherents to the Maliki school live in North
and Western Africa. Egypt is one country where most people follow the
Maliki school. The Hanafi legal school with its origins in Kufa, Iraq is considered the oldest school and has today most followers. Today it has spread
to Israel, Syria, Jordan, Iraq, India, the former Soviet republics, Turkey,
Afghanistan and Pakistan. The both oldest schools were established in
the 8th century CE. The two other schools are called al-Shafi (present in
south-east Asia) and the Hanbali school (present in Saudi Arabia), named
after two great jurists who lived in the 9th century CE.33
The legal schools combine different amounts of religious texts and
analogical reasoning. It depends on the subject which school has a more
strict or lenient interpretation of the rules. On some issues one legal
school can have detailed rules while another one is silent. Also, different
schools have authenticated different hadiths among those which were considered controversial in the beginning and whose origin was not certain.
In general the Hanbalis give more weight to literal interpretations of religious texts while the Maliki and Hanafi schools allow wider discretion in
the interpretation of such texts.34
32
33
34
based on interviews with officials at Dubai Islamic Bank and Abu Dhabi Islamic Bank.
PATRICK, supra note 24 at 180.
WARDE, supra note 5 at 33.
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Which legal school to belong to was an individual choice for a long
period of time, and one could follow a school of choice irrespective of the
country and place of residence. Today most countries enact laws after one
or another school and claim territorial sovereignty over everybody residing
on the territory. Algeria and Morocco for example acknowledge only the
Maliki school in courts, however in Egypt you can still refer to any of the
four orthodox schools in court.35 The late development of the field of
economics has resulted in the lack of any major differences between the
five schools.
2.4 The different forms of Islamic banking
The development of Islamic economics started with the Islamic development banks who were the first ones to embrace Islamic banking in the
1960s. Most of these government supported banks focused on rural areas
and small capital depositors, who were in need of small loans to improve
the profitability of small farms and agriculture areas. The aim was social
and economic development for the poorest strata of the society. There
was no need to develop sophisticated financial instruments to serve the
needs of this customer base, and the different techniques used today in
Islamic banking started to develop first after the establishment of commercial Islamic banks
Islamic commercial banks have developed several different investment mechanisms which are allowed according to Shari’a and fulfill the
needs of the Islamic banking community. Most banks are following one
or several of these acknowledged banking mechanisms although new
transactions mechanisms are invented constantly according to the needs
of every bank.
Al Ijarah is a mechanism which resembles conventional leasing, where
the bank buys the product and leases it to the customer. There are certain
conditions that must be fulfilled; the leased product must be specified and
individually known to both parties, the lessor is responsible for maintenance and if the object does not function as it is supposed to during the
leasing period, the contract becomes invalid.36 The duration of an Ijarah
contract must be specified in the contract, it is not permissible to lease a
35 WARDE,
36
supra note 5 at 34.
FAHIM M. KHAN, ESSAYS IN ISLAMIC ECONOMICS 82 (The Islamic Foundation 1995).
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product for an undetermined time period. Since Islamic investment has
traditionally been geared towards the real estate market, many new alternatives have sprung up for Ijarah funds where the profits from the leases are
shared between several investors. The property which is leased out must
be leased for permissible activities according to Shari’a, a house may not
be rented for the purpose of establishing a bar or a car be leased for transporting pornographic magazines. There is no prohibition against executing Ijarah contracts with non-Muslims as long as the lessor has no reason
to presume that the leased object will be used for impermissible causes.37
The same prohibition is valid for all the other investment methods
too, it is not permissible to support impermissible acts, contrary to the
Shari’a, in any of the transactions. The fact that Islamic banks are forced to
look into the transaction more closely, to determine if it is permissible or
not, should provide an advantage compared to the Western banks, in that
they can better judge misrepresentation and deny financing for unfeasible projects. At the same time the transaction costs are necessary going
to be higher, since the banks need more well-educated personnel to make
the decisions and the decision making is more time consuming.
A Murabahah transaction is the sale of an item which the bank buys
and then sells to the customer at a mark-up, similar to the Western letter
of credit system. Murabahah transactions account for more than 80 % of
all transactions in Islamic banks.38 The idea with a Murabahah transaction
is that it involves some risk for the bank, otherwise it is earning the markup without any just cause, and the mark-up would be analogous to charging interest. Therefore the bank has to take possession of the item before
it sells it further to the customer. In practice the taking of possession is
satisfied by receiving the receipt of the bill of lading or certificates of storage from a warehouse, which the bank can sign on to the customer who
can take actual possession of the goods.39 It is not permissible to buy
37
SHARI’A RULES FOR INVESTMENT AND FINANCING INSTRUMENTS NO. (2), IJARAH AND IJARAH
MUNTAHIA BITTAMLEEK (Accounting and Auditing Organization for Islamic Financial Institutions, 2000).
38 FRANK E. VOGEL & SAMUEL L. HAYES III ISLAMIC LAW AND FINANCE; RELIGION, RISK AND
RETURN 135 (Kluwer Law International, 1998)
39 I am indebted for this information to Mr. Mohammed Aslam Aseem at Dubai Islamic Bank,
Letter of Credit Department.
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gold, silver or currencies on deferred payment basis, which is the most
usual form of a Murabahah transaction.
Many banking institutions have developed the technique of Murabahah further and use a mechanism called “Murabahah to the purchase
orderer”. A “Murabahah to the purchase orderer” differs from the normal
Murabahah transaction in that the purchaser gives a promise to the bank
that he will buy the item. It is permissible to prepare a single set of documentation, where the customer agrees to buy the item and states a wish
that the bank buys the item from the supplier. It is not permissible for the
document to include a bilateral promise by the bank to sell the item to the
customer, because it would involve uncertainty 40 to sell an item which the
bank has not yet acquired. A “Murabahah to the purchase orderer” must
involve a transaction where the bank sells an existing item in its possession.41 Two popular spheres of Murabahah transactions under increase are
car sales and home mortgages. An advantage for the customer compared
with Western style banking is that if he is late with a debt repayment there
are no interest charges even if the delay lasts for a period of time, Islamic
banks are only allowed to be compensated for a proven loss which is caused
by the delayed payment. In practice banks seldom choose to pursue the
matter to that point.42
There are two basic types of profit-and-loss sharing (PLS) schemes,
used by the Islamic banks; the Musharakah contract and the Mudarabhah
contract. Both of them are normally for longer-term investments. The
PLS schemes are seen as the most authentic forms of Islamic finance since
they resemble contracts which were common in the early days of Islam,
and are therefore most consistent with the value system laid down by
Shari’a.43 In a Musharakah contract two partners contribute jointly capital
to an investment. Profit sharing can be mutually agreed upon, and could
be different from the ratio of the initial investment because it can take
into account the time each partner commits to the project. Losses are
40
See further infra Chapter 3.2.
SHARI’A RULES FOR INVESTMENT AND FINANCING INSTRUMENTS NO. (1), IJARAH AND IJARAH
MURABAHA TO THE PURCHASE ORDERER (Accounting and Auditing Organization for Islamic
Financial Institutions, 2000).
41
42
Supra note 39.
supra note 5 at 135.
43 WARDE
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shared proportionally taken into account each partner’s initial investment, it is the exact proportion of capital initially invested, which determines the proportion of the loss sharing.44 Participation in a Musharakah
contract can involve either a new project or an already existing one.45
The other type of a PLS scheme is a sleeping partnership called a
Mudarabhah contract. In a Mudarabhah contract one party invests money
and the other party invests time and work to make the sum multiply. The
sleeping partner has no right to interfere with the management of the
partnership but can only expect a return on his investment. He can not
demand to be paid back a specific sum of money but shares in the profit
or loss made by the principal.46 The managing partner gets a predetermined percentage of the profit (often 50/50) but it is only the person providing the capital who stands for all losses.47 If the investor can prove
fraud or negligence from the part of the managing partner the contract
can be declared null and void, and the managing partner can be held responsible for more than his labour.48 Mudarabhah contracts are more
favorable for poor lenders because they do not have to pay back anything
if their project collapses, instead of as in traditional loan-based lending,
where the principal and interest has to be paid back even if the investment does not succeed.49 Even though mutual funds did not exist at the
time of the creation of the Mudarabhah contract, mutual funds conform
with the concept of Mudarabhah.
There are several other varieties of financing in interest free banking,
but these four basic types and combinations of them remain the most
common in commercial banking.
Although the focus on this essay will be on Mudarabhah type contracts, Islamic banks tend to keep an overwhelming part of their assets in
44 KHAN,
supra note 36 at 81.
supra note 5 at 137.
46 Islamic Financial Institutions: Theoretical Structures and Aspects of their Application in SubSaharan Africa in CREDIT, CURRENCIES AND CULTURE; AFRICAN FINANCIAL INSTITUTIONS IN
HISTORICAL PERSPECTIVE 83 (Endre Stiansen & Jane I. Guyer ed., Nordiska Afrikainstitutet,1999).
45 WARDE,
47
Endre Stiansen, Islamic banking in Sudan: Aspects of the Laws and the Debate in id. at 103.
supra note 5 at 137.
Id. at 136.
48 WARDE
49
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short-term investments such as trade finance, involving the resale of
goods, leasing and Murabahah contracts. Long term investments such as
Mudarabhah and Musharakah contracts form a small share of the total
investment portfolio.50
One of the defining characters of Islamic banks is that they have a
religious authority who is the leading advisor of the bank. Every Islamic
mutual fund has similarly established a board of religiously learned men
to give advice on which investments the mutual fund can make and be in
compliance with Shari’a. These Shari’a Boards are often composed of
highly respected religiously learned men from different countries to give
the mutual fund the highest possible legitimacy among Muslims from
different countries. A mutual fund is as good as its Shari’a Board. If the
Shari’a Board is respected, then the reputation of the fund as a rightlearned Islamic mutual fund is good, if it composes of lower ranking authority, then the investments of the mutual fund can easily be questioned.
The Dow Jones Shari’a Board is a good example. It includes a member of
the Supreme Court of Pakistan, and other prominent members from
Syria, Bahrain, Saudi Arabia and USA and is as a result highly respected.
A Shari’a Board is a prerequisite for a bank to be accepted to the
IAIB.51 Members of the Shari’a Board shall not be subjected to the
authority of the Board of Directors and they cannot work in the bank, to
guarantee their independence.52 In general, Shari’a Boards in South East
Asia tend to be more lenient than the ones operating in the Gulf region,
who are known for their strict rulings.53 The IAIB and the AAOIFI,
based in Bahrain, have tried to promote uniformity in Shari’a rulings.
Other initiatives include the effort by many Shari’a Boards to try to arrive
at collective positions on financial issues in organisations such as the
Organisation of Islamic Conferences (OIC) and The Islamic Fiqh Academy.54
50
CHOUDHURY MASUDUL ALAM, A STUDY IN ISLAMIC
International Studies in Money and Banking, 1997).
51 WARDE,
52
53
54
supra note 5 at 226.
Id. at 227.
Id. at 228.
at http://www.ihilal.com/wealth/roleofShari’a.asp
204
POLITICAL ECONOMY
242 (Routledge
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Many Shari’a Boards see as one of their most important tasks to develop new financial instruments, which are in compliance with Islamic law,
in co-operation with bankers and other economists. The Shari’a Boards
of many of the Islamic banks or Islamic windows are the same persons
which is a result of the fact that there are not many scholars who are both
knowledgeable in the Shari’a and the capital markets of today. It does
promote unity of fatwas, which has been one of the biggest problems of
Islamic finance, but at the same time it can lead to conflicts of interest. A
protection against this is the fact that Shari’a Boards are largely unpaid,
except for their operating expenses.
An alarming circumstance considering the importance of the Shari’a
Board is that almost a half of the mutual funds do not have their own Shari’a
Boards, although many of them defend themselves with that they are
index funds and therefore do not see the need for their own Shari’a Board.
Yusuf Talal DeLorenzo, who is a member of the Dow Jones Islamic Index
Shari’a Board, stresses that it is necessary for every mutual fund to have
their own Shari’a Board, for a number of reasons.55 The lack of Shari’a
Boards on many mutual funds suggests that the institutions marketing
them are not seriously dedicated to the Islamic ideals but just want to
benefit from the name recognition of Islamic funds. Even if the Shari’a
Boards have screened a company and approved an investment it is ultimately up to the individual investor to assure that the investment is Shari’a
compliant.
2.5 Other conventional investment tools and their
permissibility according to Islamic law
There are several conventional investment mechanisms which have been
either permitted or forbidden by Shari’a Boards. Some of the most important and also controversial are trading in currencies, bonds and bills of
exchange. It is permissible according to Shari’a to trade in different currencies provided that certain rules are followed. To avoid uncertainty it is
necessary that both parties take possession of the traded currencies, and
55
See further DELORENZO supra note 3.
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that no trading is carried out on the forward currency market. Forwarding
is a popular form of hedging to avoid losses on particular transactions
effected in currencies which are expected to decline in value and is widely
used in traditional financial investment strategies. Most companies try to
limit their exposure to exchange rate changes by binding up their loans or
income on the forward or futures market, but even if the purpose is not to
speculate it is still forbidden because of the uncertainty involved according to Shari’a.
The AAOIFI gives alternative ways to hedge against future exchange
rate changes in its Shari’a standards. It is permissible to execute back-toback interest free loans in different currencies provided that the two
agreements are not contractually connected to each other. It is also permissible to sell goods on credit in the currency of exposure if the exposure
is in the form of accounts payable. The Shari’a standards are based on a
hadith where the Prophet said: equal shall be traded for equal, gold for
gold but it is permissible to sell different assets as you wish if the sale is
not on deferred payment basis.56 Two different currencies are clearly considered to be different assets according to the International Islamic Fiqh
Academy and therefore there is no prohibition to trade in currencies as
long as you follow the restrictions set out above.57
Two other investment options are bonds and bills of exchange. The
difference from currency trading is that both bonds and bills of exchange
are debt-bearing instruments. Conventional bonds are totally unacceptable financial instruments according to almost all Islamic scholars because
they are based on interest returns. The exceptions are the Egyptian Muftis
who have authorized government bonds even if they are interest bearing.
There have been some attempts by the rest of the Islamic countries to designate Islamic bonds, most recently by Malaysia who completed the
world’s first Islamic global bond issue in 2002.
56
The prophet himself is quoted as saying in a hadith “Or pour or, a-t-il-dit, argent pour argent,
froment pour froment, orge pour orge, dattes pour dattes, sel pour sel, donnant donnant et à
quantité égale. Mais entre espéces différentes, l’échange sera libre, à condition que ce soit de
main en main”. translated by SHEIKH DRAZ MOHAMED ABD ALLAH, L’USURE EN DROIT MUSULMAN 11 (Faisal Islamic Bank of Egypt).
57 SHARI’A STANDARDS 1421H-2000 (Accounting and Auditing Organization for Islamic Financial Institutions, Safar 1421H- June 2000).
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An investment in the bond market would be acceptable if the investment is in zero-coupon bonds which do not yield any interest. The problem with zero-coupon bonds is that they are often issued to the purchaser
at a discount, to compensate for the return on other securities on the market and thereby anyway become related to the interest returns on other
financial instruments. Zero-coupon bonds can be acceptable investments
for Muslims if certain conditions are fulfilled. The zero-coupon bonds
have to relate their income to other Islamic financial instruments instead
of to interest based instruments. This can be achieved by limiting the bond
issue to Muslims only or to an Islamic country where financial dealings
follow Shari’a for example. The Saudi Arabian Monetary Agency has for
example issued this type of bonds.58
It is permitted for the Islamic investor to invest in common stock
because it is a share in a company, and not a claim on the debt of the company. For the same reasons it is prohibited for an Islamic investor to buy
preferred stock, preferred stock gives a predetermined return and is indirectly a claim on the company. Since common stock is a permissible
investment it is also permissible to create mutual funds with many companies common stock. 59
2.6 The different types of Islamic funds
In recent years mutual funds have become widely popular in the conventional finance sector. People invest more and more of their savings and
pension funds in different types of mutual funds, and more people open
up their first mutual fund account. It is seen as the ideal investment
option, which combines the high return rates of the stock market with
the safety of diversifying the risks in different companies. If one company
does not perform well or even goes bankrupt it does not affect the overall
return rate for mutual funds in as high degree as for a stock portfolio you
put together yourself, because of the hundreds of companies a mutual
fund can invest in. Most countries also have rules limiting the percentage
a mutual fund can invest in one company. As an investor you currently
58
Rodney Wilson, Islamic Financial Instruments, 6 ARAB LAW QUARTERLY 210 (Graham & Trotham 1991).
59 Mahmoud Amin El-Gamall, A Basic Guide to Contemporary Islamic Banking and Finance
18–19 (Rice University, June 2000) at http:// www.failaka.com.
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have the option of investing in specialized mutual funds, concentrating on
a specific region or market sector or, as the Islamic mutual funds among
others do, concentrating on investments following an ethical ideology.
During the last decade socially responsible investment options have
boomed, and in the wake of them, Islamic mutual funds have emerged in
both Islamic countries and the USA and the UK. Islamic mutual funds are
similar to other socially responsible funds in that they do not only concentrate on profitability of a company but also measure the investments
they make after an ethical and a moral yardstick,60 which in the case of
Islamic mutual funds is the Shari’a.
Islam does not see anything wrong in acquiring material richness, if it
is earned without breaking any of the prohibitions in the Shari’a, and does
not distract from worship of Allah. There is a difference with Christianity
and many other religions which glorify and require the denouncement of
material things if you want to serve God. There has been a connection
between commerce and Islam from the beginning, Mohammed was a
trader and came from a kinship (Quraish) who conducted long way trade
from Medina to the Mediterranean. In several passages in the Qur’an
trade is deemed lawful and desirable;
“O ye who believe, consume not your property between yourself unlawfully; it being lawful to acquire property through trade with mutual consent; and destroy not yourselves. Surely, Allah is Ever Merciful to you.
Whoever seeks to acquire property by way of transgression and injustice;
We shall cast him into the Fire; and that is easy for Allah.”61
According to Islam it is also prohibited to hoard money. If you have some
money to spare you are supposed to put it into productive use whenever
possible. This rule gives great potential to the market for Islamic mutual
funds because many devoted Muslims keep money on their bank account
when they cannot find any acceptable means of investing it. Investing
your money is encouraged within Islam and if there exist acceptable
means to invest your money it is your duty to do it.
60 WARDE
supra note 5 at 142.
Al-Nisā Sura 4:30-32 (Mohammed Zafrulla Khan trans. Curzon Press
Ltd, 1981).
61 THE HOLY QUR’AN,
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There are four major types of funds that are accepted by Islamic authorities, with each of them having subcategories: Istisna’, Murabahah,
Mudarabah, and Ijara funds.
In an Istisna fund the investors agree to pay a manufacturer of a project the cost of the manufacturing and the purchaser agrees to pay the
investors in the fund either in advance, progressively or upon completion
of the project. The investors in the fund assume the risk that the manufacturer will not perform or the purchaser will not pay and charge more
for it. The profits of the difference are shared among the fund owners.
The shares of the fund are not negotiable if the debt-to-equity ratios are
too high (see further infra chapter 3) To avoid uncertainty, the project
must be described in great detail.62
In a Murabahah fund the investors buy assets for their clients and sell
them to the clients at a mark-up. The price is normally on deferred payment basis. A Murabahah fund must be a closed-end fund and the shares
cannot be sold on a secondary market because the fund does not own any
tangible assets but has as its only asset the debt from their clients and the
cash payments already made by them. The cash assets can not have a
secondary value because money can not be purchased or sold except at par
value according to the prohibition of speculation with future events (see
Chapter 3 infra).63 The Islamic Fiqh Academy has in a decision decided
that “in order for units in a fund to be freely tradable, the preponderance
of that fund’s assets (this means more than 50 %) should be composed of
tangible property and beneficial interests therein, as opposed to cash and
debts”.64
A commodity fund is structured in the same way as a Murabahah fund,
but the price of the commodities sold cannot be paid on a deferred payment basis. The investors buy commodities and resell them with a profit.
The profits are distributed among the shareholders of the fund. The commodity must be owned by the seller at the time it is resold, because short
selling is not allowed in the Shari’a and the commodities must be per-
62
Esty supra note 9 and Keigher supra note 17.
Taqi Usmani, Investment funds at http://www.failaka.com/Failaka%20Research.html
64 Letter from Ahmed El Shall, SVP Strategic Planning & Financial Control at Abu Dhabi Islamic Bank to author (on file with author).
63
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missible goods (halal). As in a “Murabahah to the purchaser”-transaction,
the seller must have actual or constructive possession of the goods before
selling them further. The price of the commodity must also be fixed, because uncertainty is not allowed in sale contracts.65
An Ijara funds invest in leases. The fund buys and leases out for a rental
fee equipment required by the client. Ownership remains with the fund,
and the rental agreement must not force the lessee to buy the equipment
after the rental period. An Ijara fund can for example be investors who
team up together and buy real estate or cars and then rent them out and
share the profits. A share in a Ijara fund is fully negotiable because the
assets are the ownership of the leased equipment, and not the accumulated
amount of the debts from the lease contracts. The share can therefore be
sold on the secondary market. The share certificates are called sukuk in
traditional Islamic jurisprudence. It is important that the lease contract
conform to Islamic jurisprudence, with the most important rule being
that the leased asset must be of a nature that its permissible use is possible.
The rental period must also be fixed at the beginning of the contract.66
Mudarabhah funds are agreements between two parties: the investor,
who provides the capital for the project, and the fund manager who takes
care of the management of the investment. The manager takes out a certain predetermined amount or percentage of the profits as a management
fee. Since the manager is acting as a mudarib for the subscriber he only
gets a share if the fund has turned in a profit.67 Another option is for the
manager to act as an agent for the subscribers. In that case he can be given
a pre-agreed fee for his services even if the fund does not turn in any profit.
A Mudarabhah fund can be an equity fund, a property fund, or a
commodity fund. Many Islamic scholars are of the opinion that a Mudarabhah fund is restricted to the sale of goods and can not be used in the
case of rendering services or leases.68 According to the Hanbali School
however, a Mudarabhah contract can be used also in the case of leases and
services, and the Hanbali view finds support among a number of con65
Taqi Usmani, Principles of Shari’a governing Islamic Mutual funds, at http://www.citiislamic.com/ciib/articles/pdfs/taqiif.pdf
66
67
68
Id.
at http://www.islamiqdaily.com/surfout_scholars.htm
Taqi Usmani supra note 63.
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temporary scholars.69 Most common in this category of funds are the
common stock funds.70
Lastly, there exist many hybrids of these four types of funds, which
can be called mixed funds. Mixed funds can combine leases with common stock purchases, mark-up schemes with Istisna contracts and so on.
If the fund follows the rules mentioned infra when it comes to tangible
assets requirements, debt levels etc. the shares in the fund are negotiable.
Otherwise it has to be a closed-end fund.71
A new type of funds where the principal is “protected” is becoming
intensely popular in the Islamic investment fund market. A ground rule of
Islamic funds is that there cannot be any guaranteed returns on an investment, no guaranteed dividends or other income. All income is related to
how well the fund performs. The new protected funds are set up after a
structure where the investors can choose the level of capital protection
within a range of 90 to 100 %. The investors cannot withdraw the investment whenever they want but have to commit themselves for a predetermined time period. Most of the fund’s assets are invested in safe Murabahah transactions with institutions with extremely low credit risk. A
small part of the assets are invested on the international stock market. In
that way the investors can benefit from the higher stock market returns,
while their principal is protected with Murabahah transactions which are
set to mature every six months, if that is the predetermined time period.
The amount invested in Murabahah and the profit made of it will together always mature to the amount protected by the fund, i.e. between
90–100 %. The fund managers are careful to point out that an extremely
low capital risk remains, and that the assets are protected, not guaranteed.
Otherwise the investment would not be Shari’a compliant.72
Many Islamic institutions offer a mutual fund which is managed by
an external investment manager who undertakes to comply with the
restrictions set up by the Islamic institution’s Shari’a Board. This has been
done for example by Abu Dhabi Islamic Bank and their Al Hilal Fund.
69
Id.
Keigher supra note 17.
71 Taqi Usmani supra note 63.
72 See for example Faysal Islamic Bank of Bahrain (part of the DMI group) prospectus for its
shield fund at http://www.shamilbank.com.bh/shieldfund/shieldfund.html.
70
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Shari’a experts are unanimous in declaring this kind of fund permissible.
The Shari’a experts are on the other hand divided on the subject of the permissibility of conventional institutions setting up so called “Islamic windows” or marketing products labelled as “Islamic”. Those who are against
setting up of such windows,73 argue that the funds for setting up the Islamic products are drawn from prohibited earnings, since the banks in
the first place do not conform to Shari’a, and therefore such products can
not be permissible to invest in.
Other legal scholars74 argue that such investments are permissible if
the institutions follow Shari’a principles, and find support in the opinions
of famous jurists, such as Sheikh Ol-Eslam Ibn Tamiyah, who said that it
is permissible to deal with mixed funds, with both legal and illegal money
in them. The profits just have to be purified. There are some important
conditions to be aware of for conventional banks who want to set up
“Islamic windows”;
1) The funds between the Islamic products and the bank’s other products
must be completely segregated.
2) There should be a Shari’a advisory Board.
3) The management must be trained so that they are fully convinced and
dedicated to the purpose of investing in accordance with Shari’a.
4) The conventional banks setting up the “window” must also be able to
guarantee the investors funds against fraud, negligence and trespass,
and comply with the auditing and accounting rules of AAOIFI.75
The same topical discussion which has been held about “Islamic windows” is also relevant for businesses who derive a minor part of their funds
from prohibited activities. There are several collective Ijtihads on the subject
of investing in such businesses. The Islamic Fiqh Academy stated during
its 7th session that in principle the dealing with companies who derive a
minor part of their income from forbidden activity is impermissible. This
73
For example Shaikh Abdulla Bin Beyyah, Shaikh Dr. Ajeel Al Nashmi, Shaikh Dr. Ahmed Al
Hajji Al Kurdi, Shaikh Dr. Mohammed Fawzi Faydhallah and Shaikh Dr. Ali Ahmed Al Saloos
according to YAQUBI supra note 31.
74
For example Shaikh Mohammed Bin Saleh Bin Uthaymeen, Shaikh Mustafa Al Zarqa,
Shaikh Abdulla Bin Sulaiman Al Manea, Shaikh Mohammed Taqi Al Othmani, Dr. Abdul Sattar
Abu Ghuddah and Dr. Ali Muhiddin Al Qara Daghi according to id.
75 Id.
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was backed up by the participants of a seminar on the subject hold under
the auspices of Islamic Fiqh Academy in year 1992.
Many legal scholars also argue that when you buy a share of a company you become a partner of the company and therefore according to
Islamic jurisprudence every partner is an agent for the other shareholders
in a joint business. If the management or any of the shareholders are aware
that the company is involved in a prohibited transaction, the transaction
will be attributed to all of them, since the shareholders have by their shareholding authorised the management to deal in whatever way it seems fit.76
A more recent opinion on the subject is the recommendation issued by
a seminar with more than a hundred Islamic scholars, held under the auspices of the Islamic Fiqh Academy and Islamic research and training Institute in year 1998. The recommendation confirms the view of the Fiqh
Academy but outlines some exceptions to the rule, which should be allowed. According to the exceptions it is allowed to buy stock in companies
where the new shareholders are able to make the company follow Shari’a
principles on the first general assembly meeting of the company. It is also
permissible to deal with companies in Islamic countries who produce
necessary items or provide basic services for the public if there are no other
alternatives and the company does not seek out interest based financing.
Some exceptions are also made for international development banks.
In practice many Islamic institutions have already established funds
who deal with companies where a minor part of the income is forbidden,
while the jurisprudence is more cautious in its approach to the issue.
Among those who have such funds are influential banks such as Dallah
Al Baraka, the DMI group and First Islamic Bank in Bahrain.77 The
practical necessities have most likely influenced the banking sector to
lead the development instead of conforming their products to already
existing principles. Islamic investors are already deprived of many of the
financial instruments on the market, such as futures, bonds and currency
speculation. If they were to follow the more cautious approach taken by
many scholars it would not leave many possibilities for investment in the
most profitable financial instruments and, in the long run, hinder the
development of the whole sector.
76
Taqi Usmani supra note 65.
supra note 31.
77 YAQUBI
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Qualitative & quantitative screens on
investments
3.1 Qualitative screens on investments
Islam has traditionally had some rules and prohibitions involving the
every day life of a Muslim. In Islamic economics the rules have been
transformed to qualitative screens on investments. Islamic guidelines
exclude investments in sectors, which have traditionally been out of limits
for Muslims, such as alcoholic beverages, tobacco, gambling and games
of chance, companies who serve or manufacture pork products and arms
manufacturing or publishers dealing with pornography.
One of the most well known prohibitions in Islam is the prohibition
to drink alcohol. The Qur’an condemns both alcohol and gambling clearly
in several places.
“They ask thee concerning liquor and gambling. Tell them: there is great
harm in both and also some benefit for people, but their harm is greater
than their benefit.”78
“O ye who believe, liquor, gambling, idols and divining arrows are but
abominations and Satanic devices. So turn wholly away from each one
of them that you may prosper. Satan desires only to create enmity and
hatred between you by means of liquor and gambling, and to keep you
back from the remembrance of Allah and from prayer.”79
Any investment in companies who derive their income from alcohol production or purchases is forbidden. Because of their intoxicating effect,
drugs are considered analogous to alcohol. Moreover, drugs can have terrible effects on the society and destroy family units because of its addictive nature, which makes it even more important to forbid investment in
them. All Islamic investments have to be for the benefit of the whole society.
It is not prohibited to invest in companies who are manufacturing drugs
for legal purposes, such as pharmaceuticals companies. It is the illegal drug
trade with its harmful effects which is denounced. The Shari’a Boards
have discussed if it is allowed to invest in companies who derive a minor
78
79
Supra note 61 at Al-Baqarah Sura 2:220.
Id. at Al-Ma¯’idah Sura 5:91–93.
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part of their income from alcohol related activities, as for example airline
companies. Most Shari’a Boards have acknowledged investments in such
companies, but the part of the profit which comes from forbidden activities must go through the purification process described below.
Other rules in the Qur’an are the prohibition to eat food which is not
wholesome for you, if you can avoid it.
Allah “... has made unlawful for you only that which has died, and
blood and the flesh of swine, and that on which the name of any other
than Allah has been invoked. But he who is driven by extreme need to
partake any of them, not being defiant of the law nor exceeding the limit
of his need, it shall be no sin for him.”80
On the investment side this means that an Islamic mutual fund or other
investor is forbidden to invest in butchery houses and other businesses
which derive their main income from handling pork products. Grocery
chains has been an example of firms, which are controversial to invest in.
Some Shari’a advisors have advised against investing in them, but more
lenient mutual funds have only purified the part of the profit, which
comes from pork products and alcohol.
It is impermissible according to Shari’a to promote debauchery and
the means of propagating it. This means that extra-marital sexual relationships are forbidden in Islam. The Qur’an talks about adultery, which is forbidden but makes also direct reference to “loose behaviour” which includes
prostitution. Any profit made of such activities is forbidden.
“Confront those of your women who are guilty of unbecoming conduct
with four witnesses. If they bear witness, then confine the women to their
houses till death overtakes them or Allah opens a way for them.”81
The profitable pornography business is also a forbidden area of investment
through analogous reasoning. Exploiting other people is against the fundamentals of Islam.
80
Id. at Al-Baqarah Sura 2:173–75.
Al-Nisā Sura 4: 16 (Mohammed Zafrulla Khan, trans. Curzon Press Ltd,
1981). The Sura continues in 4:18 with “Surely, Allah is Oft-Returning with compassion and is
Ever Merciful. Allah would accept the repentance of those who do evil in ignorance and then are
quick to repent. These are they who Allah turns with mercy. Allah is All-Knowing, Wise.”
81 THE HOLY QUR’AN,
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The hotel and entertainment sector is largely forbidden for a combination of reasons. Most tourist establishments are serving alcohol on their
premises, and maybe have a casino or a nightclub there too. Since alcohol
and promiscuous relationships are forbidden in Islam it is not allowed to
support establishments who are involved in supporting such illegal acts.
The entertainment sector, such as the cinema and music industries are
mostly involved in unmoral acts, such as sex and alcohol drinking on the
screen or explicit lyrics in songs and it is difficult to sort out those parts
which would conform to the principles of Shari’a. In most companies the
illegal part would be more than the limit set for Islamic investments. In
countries with a Muslim population Islamic banks are involved in the
hotel industry, as long as the hotels follow the guidelines. Mostly the hotels
are wholly owned investments so that the institution investing the money
has full control over future changes of the hotel.
Theoretically it would be permissible to invest in the music industry if
there is a company who produces music without explicit lyrics or videos.
It is important to bear in mind that this is a much stricter definition of
what is explicit than the USA government agency ratings. Islamic investment is also prohibited in sectors that are harming people, be it Muslims
or non-Muslims. Therefore it is forbidden to invest in defense and weapon
companies, who are manufacturing products which are aimed at killing or
disabling people.
As a Muslim you have a duty to look at the business practices of the
company. Many scholars recommend therefore fund managers to avoid
investments in companies who treat their workers or employers badly. The
recent reports from factories located in less developed countries, where all
security measures are abolished and people are treated as slaves, brings
new actuality to the subject. Other forbidden areas are environment polluting companies and companies who are engaged in the biotechnology
sector with human cloning and research with aborted embryos. These
guidelines are similar to the ethical funds without religious values that
have become so popular during the last decades.82
82 YAQUBI
216
supra note 31.
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3.2 Quantitative screens on investments
Another area of screens is dealing with rules which are more difficult to
define. These rules are not singling out certain sectors or products which
are prohibited to invest in but are more concerned with the effect of the
whole transaction or the quantity of certain components in the transaction
and are therefore called quantitative screens.
Islam forbids investing in uncertainty or risk (gharar), in other words
you can not sell something you don’t own, fish you have not caught yet
or an unborn calf in its mother’s womb. In modern times it applies to
gambling, because of the moment of uncertainty involved in gambling
activities. Gharar is not directly mentioned in the Qur’an, but it is mentioned in other Shari’a sources. In the hadiths gharar is condemned in several different hadiths. According to one hadith it is the Prophet himself
who has prohibited gharar.83
If the major component of a sale contract is gharar then the contract is
invalid, but all transactions involve uncertainty in some degree and a minor
uncertainty does not make a contract invalid. A contract with gharar is
on the other hand invalid if the same need met by the contract can be fulfilled in another way which does not involve gharar moments.84 A costbenefit-analysis is made in the Prophet’s prohibition on gambling where
he acknowledges that there is some benefit in gambling but prohibits it
because the harm is greater than the benefit,85 with the same analysis
made through analogy to other transactions involving uncertainty.86
Scholars argue over how much risk is permissible for one party in a transaction, and condemn different transactions depending of their assessment of risk. Often the prohibition is overruled if the transaction involves
clear economic benefit even if some risk is involved following the costbenefit-analysis.87
One could argue that stocks in general are riskier investment than
government bonds for example, and therefore should be forbidden when
there is a less riskier investment alternative. Surveys have however shown
83
84
85
86
87
El-Gamal supra note 59 at 2.
Id. at 3–4.
See footnote 78 at Sura 2:220.
El-Gamal supra note 59 at 8–9.
Id. at 1.
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that the return on stocks is historically much higher than just to compensate for the risk premium and therefore government bonds are in fact a
more riskier long term investment because the consumer price indexes
have varied considerably over time.88 It is as a result permissible to invest
in stocks because the efficiency return compensates for the higher risk.
Mutual funds are an even more favourable investment because they combine the high returns but maintain a low risk level.
There are several different definitions of gharar among Islamic scholars,
Mahmoud El Gamal has made a summary of the different definitions in
different legal schools:
“1. Al-Sarakhs¯y of the H. anaf¯y school de.ned g¯arar thus: “gharar is
that whose consequences are hidden”.
2. Al-Sh¯yra¯az¯y of the Sh¯a.‘¯y school said: “gharar is that whose
nature and consequences are hidden”.
3. Al-’Isnaw¯y of the Sh¯a.‘¯ys school said: “gharar is that which admits
two possibilities, with the less desireable one being more likely.”
4. ’Ibn Taymiya of the H. anbal¯y school said: “gharar is that whose consequences are unknown”. His student ’Ibn Al-Qayyim said: “it is that
which is undeliverable, whether it exists or not.”
5. ’Ibn H. azm of the Z. ¯ahir¯y school said: “gharar is where the buyer
does not know what he bought, or the seller does not know what he
sold.” 89
Frank Vogel has defined occasions when gharar arises according to the
many prohibitions in the hadiths; gharar arises when there is a lack of
knowledge about the object, if the object does not exist right now or if the
object evades the parties’ control.90
Certain legal schools tolerate gharar when it cannot be avoided or
when there exists great difficulty in avoiding it.91 It is important to make
a difference between risk, which is permitted in Islamic finance as long as
it is shared equally, and speculating in uncertainty of future events which
is forbidden.92
88
89
90
91
92
Id. at 14–15.
Id. at 4.
VOGEL supra note 38.
WARDE, supra, note 5 at 59 and SALEH supra note 23 at 53.
WARDE supra note 5 at 53.
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Islamic mutual funds should not purchase stocks for short periods of
time, because this is seen as the equivalent of speculation, which is a form
of gambling according to some jurists. According to other jurists it is permitted to buy stocks for a short period of time, if the investors have analyzed the stock market, and react on changing financial fundaments, but
it is not permitted to act on rumors or manipulate the market which is a
form of gambling.93 The arguments for speculation in stocks are that speculation in productive trade creates value for the society, and therefore
should be permitted. It cannot be compared to gambling because in
gambling money is invested without any underlying productive activity
taking place, while speculation in stocks allow capital flows to be allocated
to different companies, who have productive activity, as effectively as possible for new investments.94
It depends on the intentions of the trader, if he sees it as a “buy low, sell
high” market or approaches it as gambling, if purchasing of stocks for a
short period of time is forbidden or not. A “buy low, sell high” strategy is
in the bottom of all trade and it cannot be prohibited on that criteria only.
If the trader has analysed the market carefully he is permitted to buy
stocks for a short period of time, but on most circumstances day traders
act on a whim and do not make analysed decisions and in that case it is too
close to gambling.95 According to a hadith one of Prophet Mohammed’s
closest men had an amazing capability to create wealth. One day he without any wealth went to the market with an axe, and returned at the end of
the day with a small fortune. His abilities were legendary, but that did not
reduce his religious status.96
Futures, options and some life insurance are forbidden investments
just as pure speculation with stocks, because it is speculation with future
events. Although there is consensus among scholars that investments in
futures and other derivatives are prohibited, many Islamic countries, such
as Kuwait and Malaysia are introducing futures trading on their stock
93 Mr Saad Al-Harran, The Islamic Stock Exchange at http://www.muslim-investor.com/mi/
stocks.phtml
94
95
96
El-Gamall supra note 59 at 27.
Id. at 28–29
Id.
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exchanges.97 Commercial insurance, in its present form is prohibited,
because you pay money for something that may or may not happen. The
insurer gets to keep all the money, or if too many claims occur, may end
up with a loss.98 Other alternatives to commercial insurance exist, such as
the co-operative insurance. The co-operative insurance takes care of the
need to insure yourself against big losses, so there are no efficiency gains
in commercial insurance which overweigh the risks. Many insurance
companies are also prohibited because they put most of their funds in
government bonds and derive interest-related income from them.99 The
interest-related income they derive is prohibited by Islam.
When the Qur’an prohibited interest in the 7th century the idea had
already surfaced earlier in different civilizations and different times. It has
for example been a prevailing thought in Western economic philosophy
historically, starting from Aristotle and Plato to Thomas of Aquinas and
Keynes, who argued that a ceiling on interest rates would increase investment. The idea has however largely been abandoned in modern times.100
In the Old Testament the taking of interest was explicitly prohibited
if it was on a loan made to poor people, to a brother Israelite or if it was
unrighteous interest.
“If thou lend money to any of my people that is poor by thee, thou shalt
not be to him as an usurer, neither shall thou lay upon him usury.”101
“Thou shalt not lend upon usury to thy brother; usury of money, usury
of victuals, usury of any thing that is lent upon usury:
97 MOORE
98
99
supra note 6 at 87.
At http://www.Muslim-investor.com/mi/prohibited.phtml.
El-Gamall supra note 59 at 8, 25.
100
PLATO, REPUBLIC 223 (Benjamin Jowett, trans., Infomotions Inc. 2001) (EBRARY, Gothenburg University library), LAWS 89, 210 (Benjamin Jowett, trans., Infomotions Inc. 2001)
(EBRARY, Gothenburg University library), KEYNES, THE GENERAL THEORY OF EMPLOYMENT,
INTEREST AND MONEY 352 (London, MacMillan, 1939), see also ARISTOTLE, POLITICS, 11
(Benjamin Jowett, trans., Infomotions Inc. 2001) (EBRARY, Gothenburg University library),
“The most hated sort, and with the greatest reason, is usury, which makes a gain out of money
itself, and not from the natural object of it. For money was intended to be used in exchange, but
not to increase at interest. And this term interest, which means the birth of money from money,
is applied to the breeding of money because the offspring resembles the parent. Wherefore of
any modes of getting wealth this is the most unnatural.”
101 OLD TESTAMENT, BOOK OF EXODUS 22:25.
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Unto a stranger thou mayest lend upon usury; but unto thy brother
thou shall not lend upon usury: that the LORD thy God may bless thee
in all that thou settest thine hand to in the land whither thou goest to
possess it.102
The Jewish communities have tended to observe the prohibition on charging interest when they lent money within their communities but charged
interest when lending money to outsiders.103 In the Muslim societies particularly Jews and to a lesser degree other minorities became interestbased moneylenders, because they did not have to follow the prohibition
on charging interest.104
The Christian Church has had a more lenient but not an all-forgiving
attitude towards interest. There is nothing in the New Testament directly
forbidding interest, even if a forgiving attitude was proscribed against poor
lenders. Until the 10th century, interest was considered by the Christian
Church to be a sign of greed and uncharitable. Usurers were placed in the
same category as prostitutes.105 Pressure from the secular world forced
the church to adopt a more compromising attitude towards interest, and
they finally accepted a moderate interest rate when charged to those who
could afford it. It was still a sensitive subject in the Christian world and
the Vatican formally recognized the legitimacy of interest as late as in
1917.106, 107 Although the recognition of interest came as late as in the 20th
century it has not had the same consequences as a similar prohibition has
had in the Islamic societies because religion has not played the same role
in the Western world in establishing legal rules and the New Testament is
not a source of legislation in any country.
Today the religious concerns regarding interest have diminished even
more in the Western world and people are instead looking at the practical
advantages of a prohibition on interest for a market economy. If interest
102
Id. BOOK OF DEUTERONOMY 23:19–20.
MILLS PAUL S & PRESLEY JOHN R., ISLAMIC FINANCE 102–103 (MacMillan Press Ltd,
1999).
103
104
105
106
107
Id. at 49
DANTE consigned moneylenders to the seventh circle of hell in his INFERNO.
Codex Iuris Canonici C.1735.
MILLS supra note 103 at 103–104.
221
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free banking is to have a broad revival in the Western world the focus
must be on the profitability and feasibility of it instead of ethical and religious concerns.108
In the Qur’an interest is mentioned in three different passages, and the
condemnation of interest increases the later the revelation is. In the earlier
suras it is just renounced, while in the later taking interest is seen as waging
a war against God.109
“O ye who believe, devour not interest, for it goes on multiplying itself;
and be mindful of your obligation to Allah that you may prosper; and
safeguard yourselves against the Fire which is prepared for the disbelievers.”110
“Whatever you lay out at interest that it may foster the wealth of the
people, it does not increase in the sight of Allah; but whatever you remit
as Zakat, seeking the pleasure of Allah, that is multiplied manifold.”111
“Those who devour interest stand like one whom Satan has smitten with
insanity. That is so because they keep saying: The business of buying and
selling is also like lending money on interest; whereas Allah has made
buying and selling lawful and has made the taking of interest unlawful
... O Ye who believe, be mindful of your duty to Allah and relinquish
your claim to what remains of interest, if you are truly believers. But if
you do it not, then beware of war from the side of Allah and his messenger.”112
In the hadiths interest is placed on the same level of disobedience against
God’s will as repeated adultery or maternal incest, however no specific
punishment is administered against it in this world.113
Some scholars have discussed if the term interest is the same as the
Qur’an’s riba, which literally means “increase”, or if riba only means a pro108
Id. at 113.
109 ABD ALLAH
supra note 56 at 8–10.
Al-‘Imra¯n Sura 3:131–139 (Mohammed Zafrulla Khan, trans. Curzon
Press Ltd, 1981).
110 THE HOLY QUR’AN,
111
112
113
Id. at Al-Rûm Sura 30: 34–41.
Id. at Al-Baqarah, parts of Sura 2:276–282.
CHAPRA supra note 2 at 236–7.
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hibition on excessive interest. Most Islamic scholars agree however on that
if there would had been any exception from the prohibition, it would have
been spelled out in the Qur’an. Every transaction where the lender receives
any advantage is riba, including gifts from the person who lends the
money or any other increase. The lender can only accept to receive the
principal back.114
Saudi Arabia is one of the countries, which has not legalized the charging of interest at all, not even in commercial matters, although it has
enacted royal degrees to facilitate business transactions in other ways.115
The Saudi courts have been very strict in their interpretations of the ban
on interest. They have for example not awarded any interest in a case
concerning an eight-year delay in paying 18 million Saudi riyals.116 The
Saudi Banks have continued to charge interest, sometimes in the disguise
of commission or cost of funds, and customers pay the interest charges as
long as they want to do business with the bank, even though the courts
will not force the debtors to pay the agreed interest.117
Shari’a Boards have generally not accepted investments in companies
that are associated with interest income. An important fatwa in 1987
from three respected Islamic scholars legalized non-operating interest
income if the proportion was small.118 Companies that are acceptable to
invest in should not generate a significant amount of their income from
interest income, which excludes investments in the banking sector for the
faithful Muslim. This includes banks, credit card-, financing- and mortgage companies. Islamic banks differ in defining the ratios of how much
of the income can come from forbidden activity, depending on each bank’s
Shari’a Board. The Dow Jones Shari’a Board did earlier exclude companies
whose non-operating interest income was more than 5 % of the company’s
total revenue. Other mutual funds put the percentage at 10 % or 15 %,
114 MILLS
supra note 103 at 8.
DR. NAYLA COMAIR-OBEID, THE LAW OF BUSINESS CONTRACTS IN THE ARAB MIDDLE EAST
192 (Kluwer Law International,1996).
116 Judgement of the Shari’a Court of Riyadh, 1413 (1993) in Id. at 201.
117 SALEH, supra note 23 at 6–7.
118 Mufti Taqi Usmani of Pakistan, Saleh Tuq from Turkey and Shaikh Mohammas Al-Tayeb Al
Najar of Egypt in MOORE supra note 6 at 78
115
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and so on.119 There is no source that dictates a rule of exactly 5 % or
10 %. Such a small portion of the income should come from interest that
it is a negligible amount, and therefore there exists variations between the
funds in what the Shari’a Boards consider a negligible amount.120 The
Dow Jones Shari’a Board has recently retracted its recommendation on
investment in companies which derive part of their income from nonoperating interest and skipped the 5 % limit on non-operating interest
on the companies. Most investors are likely to follow the DJIMI recommendations.
Shari’a principles are also applicable to mutual funds and private
investors and the funds they invest in. The mutual fund or investor can
not borrow money to investments if the loan is interest based. This
means that a Muslim investor can not invest in leveraged buy-out (LBO)
funds, hedge funds or arbitrage funds because they all borrow heavily to
get investment funds.121
Muslim investors have to follow financial restraints when they choose
the companies they invest in. The companies can in general not have a
greater debt-to-equity ratio than 33,3 % of the value of their total assets.
Ideally there should not be any interest based debt in a company, but since
very few companies fulfill this criterion, many mutual funds have adopted
the Islamic principle “li al-akthar hukm al-kul (to the majority goes the
verdict of the whole)”.122 The compromise of 33,3 % is based on a famous
hadith where the Prophet answers a question of how much of one’s wealth
should be give to charity and the answer is; one third and that is plenty.
The hadith is not used as legal proof of the “debt-to-equity-ratio-rule”,
since it does not even mention debt levels, but more as a comforting distant
analogy.123
Investors differ on how the equity of the shareholders should be measured, whether it means the market value of the shares, the paid capital,
119 MURRY S. HERMAN, ISLAMIC FUNDS INVESTING WITH
com/MF2000.nsf/DisplayContent/2206
120
121
122
123
El-Gamall supra note 59 at 21.
At http://www.ihilal.com/wealth/invest3.asp.
Id.
El-Gamall supra note 59 at 21.
224
PRINCIPLES
at http://www.maxfunds.
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the total assets or the net asset value, which could make the amount to
differ considerably depending on how the shareholder equity is calculated.
According to Sheikh Nizam Yaqubi from the DJIMI, “companies themselves differ on this, for each company has its own criteria”.124 The DJIMI
has decided to use the market capitalisation method. The market capitalisation is defined as the 12-month trailing average.
Another quantitative screen is the ratios for liquid assets in a company. Liquid assets include accounts receivable, other bank accounts and
securities which are traded on the public stock exchanges. There are variations in what percentages are acceptable with some mutual funds accepting 49 % liquid assets. A few say that 67 % can be liquid assets and the
shares are still negotiable.125 The 49 % rule is an analogy from the same
Islamic principle, “to the majority goes the verdict of the whole” which
was mentioned in the debt-to-equity section.126 The Hanafi School has
developed a third method for determining when a share is negotiable and
when it is not, concerning the liquid assets part. An asset is negotiable
whenever it consists of a combination of illiquid and liquid assets if it fulfils two conditions; the illiquid part cannot be an ignorable small quantity and the price of the combination should be more than the value of the
liquid part therein.127
Islamic mutual funds are as a result of the quantitative screens normally investing in companies which are minimally leveraged and with a
small amount of income derived from interest. The fund managers justify
the investment strategy in purely economical terms. Companies that do
not have income from interest suggest that they are investing their surplus
funds in the development of the company. The companies are also minimally leveraged which indicates that they are not at risk of a bankruptcy and
that their earnings are balanced.128 Historically companies who have large
cash balances are subjected to shareholder pressure to invest the money
and if they still keep them in interest bearing accounts it indicates that the
124 YAQUBI
125
126
127
128
supra note 31.
Supra note 122.
El-Gamall supra note 59 at 21.
Taqi Usmani, supra note 63.
MOORE supra note 6 at 79.
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growth potential of the company is limited or that the management is
incapable of seeing the growth potential.
An important aspect is that Islamic funds have generally outperformed
their counterparts during the last years. Islamic funds will however logically always perform better than their counterparts in extended bull markets, because the companies they choose from invest most of their money
instead of keeping surplus money in cash balance accounts. For the same
reason, Islamic funds ought to underperform when the markets are heading downwards, the companies they invest in cannot hide their assets in
interest bearing accounts or short-term bonds and wait for the upturn
before making their investment.129
3.3 The purification process
An opinion among some Shari’a scholars is that any investment in a company that derives any income from prohibited activities is forbidden.
Most Shari’a Boards agree however that it is permissible to invest in companies that derive a minor part of their income from forbidden activity,
such as income from interest. The advocates of permissibility are finding
support in the legal maxim, which says that an impermissible act is permissible when done in company with permissible acts. In the hadiths this
is supported by the act of selling the unborn offspring of a pregnant animal
together with the animal while it would have been forbidden to sell the
unborn offspring alone. If the permissible acts are in clear majority compared to the impermissible acts then the lawful acts outweigh the unlawful.
According to different Shari’a Boards the percentage of income which
can come from prohibited activity varies between 25 % to 33.3 %.130 Most
mutual funds face the dilemma that they operate in markets where they
get interest on their cash balance even if they do not want it. Many
mutual funds are required by law to keep a part of their assets in cash so
that they can respond to demands from people who want to liquidate
their share in the fund. To summarise there are several ways impure income can come into an Islamic mutual fund.
129
130
Id. at 84.
Supra note 98.
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Investors can however not profit from this income in any way. The
solution to the problem is the purification process. According to the purification process a fund can maintain its Islamic profile if it gets rid of all
the interest based income and income from non-permitted activity by
donating it to charity. This process has been approved by Shari’a Boards,
in view of the practically impossible goal of investing in a totally interest
free area for mutual funds operating outside countries with Islamic banking systems.131 Some mutual funds just report what part of the profit is
from forbidden activities and leave it up to the investor to decide what to
do with it.132
One of the five pillars in Islam is the Zakat. Every person who can afford
it shall donate 2,5 % of their income as a tax to help the poor members of
the community. Islamic mutual funds do not act on the Zakat requirements even if most of them donate the impure income from fund income
to charity. It is difficult for mutual funds to act on the Zakat requirements
because of the different circumstances of every investor, and therefore
none of them deduct a Zakat tax from the profits.133 It is not permissible
to get rid of the impure fund income by donating it as a zakat; the impure
income has separately to be given to charity.134 The charity cannot involve
anything where a Muslim reaps the benefit of the impure income inside
his body. Therefore it is impermissible to donate purified funds to food
for poor Muslims for example.135
It is a debated question if purification is necessary for income from
companies who derive a minor part of their profits from interest income,
when the profits of the shares are made through capital gains (by buying
low, selling high). Some scholars argue that no purification is necessary
because such a small amount of the value is created from the forbidden
business and it is difficult to allocate a share of the price gain to the inter131
Id.
Keigher supra note 17.
133 DELORENZO, supra note 3 at 11.
134 Sheikh Abdullah Bin Suleiman Al-Maniya et al. Sharia Criteria for Sale and Purchase of Shares
in Local and International Equity Funds, Islamic Shari’a Rules for Investments in Company Shares
at http://www.ncb.com.sa/islamic_banking/Shari’a_committee.asp#4
135 Interview with Ehsan Ilahi, In charge-Supervision and follow up Direct Investment, Dubai
Islamic Bank, Dubai, UAE (Oct. 2001).
132
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est received by the company. “To the majority goes the verdict of the
whole” is the maxim they support their opinion with. Other scholars
argue that it is more equitable to carry out purification even if the profits
are made through capital gains. Otherwise a person who sells his share in
the fund before the fund has received any dividends gets a better price
without a sum deducted for purification, than the person who sells his
share in the fund after the fund has received dividends, and where purification has been carried out.136
4
Islamic banking in practice
4.1 The influence of Islamic law
The application of law is a prerequisite to the further development of it.
The theoretical rules of Islamic finance have developed so fast during the
last decades only thanks to individuals and countries in the Muslim world
who have been prepared to support the application of the theoretical rules
in practice. All countries are however not so eager to support the development of Islamic finance. Muslim countries have in varying degrees applied
Islamic law in the legal frameworks of their jurisdictions. This case study
will study the legal framework and operational prerequisites for Islamic
investments in two different countries in an effort to understand the
background to the support of Islamic finance.
One of the chosen countries is the United Arab Emirates. The UAE
was chosen as a study object because it was one of the pioneers in Islamic
commercial banking and has a long track record in developing Shari’a
standards for Islamic banking. While the first Islamic bank was founded
in 1963 in Egypt (the Mit-Ghamr Bank, a government owned bank which
emphasized social and economic development of the rural population),
Dubai is arguably the birth place of modern commercial banking. The
Dubai Islamic Bank, established in 1975, was the first non-government
owned commercial bank, which operated according to the principles of
Shari’a. United Arab Emirates is also situated in a region which is one of
the growth areas for Islamic banking. The countries situated around the
136
Supra note 67.
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Persian Gulf are very active in sponsoring Islamic economic institutes all
over the world, and have established new Islamic banks in many countries.
Bahrain is the leading off-shore center for Islamic banks and the Gulf
region as a whole has many wealthy individuals who are increasingly investing in Islamic finance.
Egypt was chosen as the second country because it was also one of the
pioneers of Islamic banking, as mentioned above, but mostly because its
importance as a cultural model for the rest of the Arab world. Egypt does
not have large amounts of liquid funds which could be invested in Islamic
banks, but if Egyptians embrace the Islamic investment concept it could
have a huge ideological impact on the rest of the Arab speaking countries.
Egypt is considered as one of the centers of Sunni Islam, both because of
its geographical location in the middle of Arab Muslim countries, and its
history with the Umayaad and Fatimid caliphates ruling the Islamic world
from Egypt. The oldest university still in use in the Middle East and
North Africa is the Islamic university al-Azhar in Cairo, which has educated Islamic scholars since the Middle Ages.137 Egypt is known as one of
the most secular countries in the MENA138 region but during the last
thirty years Egypt has tried to find its own cultural roots with the gradual
islamisation of the legal system. The question is if the new legal rules
merely represent a symbolic concession to the strong social demands for
re-islamisation in the society or if there has been more than a symbolic
change which will result in the re-evaluation of the whole judicial system
and will have a great impact in other Arab countries.
Egypt has for a long time been inspired by Western style legal systems
and made strong attempts to westernize their legal system as early as during
the era of the Ottoman Empire. During the late 19th century legal reforms
were introduced in the fields of commercial, civil, maritime and procedural matters. Particularly France and the Code Napoleon inspired these
reforms. Egypt has been a leading lawmaker in the Arab countries in the
region since this period. Egypt gained its independence in 1922 and the
first constitution was enacted thereafter. All the following constitutions
137 The al-Azhar University and mosque was built in 970 A.D. as the crowning piece of the
Fatimid Cairo.
138
Middle Eastern and North African countries
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followed, just like the first one, Western precedence and there was no mention of Shari’a in them. Not until 1971 does the Egyptian Constitution
mention Shari’a as a principal source of law. This was later changed to
Shari’a as the principal source of law.139, 140
Other countries in the MENA region have adopted Western style
legislation to a varying degree, with the depth of the reforms going from
totally westernized legal systems (Lebanon) to the more cautious approach
taken by most other countries.141 Saudi Arabia and Oman totally lack a
Civil Code and derive all their inspiration in civil matters from the Shari’a.
In between fall countries like Iraq and Jordan, with a moderate influence,
and the UAE and Kuwait, with a more pronounced influence from the
Shari’a in their legislation.142
Egypt’s Civil Code, adopted in 1949, is a mixture of modern Western
legal maxims and traditional Shari’a rules. Dr. Al Sanhuri who wrote the
Code has also been active in most other Arab nations’ Civil Code drafting.
In the Civil Code Shari’a is mentioned as a source of law in a secular codification for the first time in the MENA region, even though the practical
importance of Shari’a as a source of law is less important than it appears
from the piece of legislation. The Egyptian Civil Code instructs the judge
to refer to Shari’a after applicable legislation and custom. Except for the
reference made to Shari’a as a source of law, there are certain provisions in
the Code which derive their origins from Shari’a, or conform to both international law and Shari’a.
One of the countries influenced by Egyptian legislation was the
United Arab Emirates. The UAE was established as a federation in 1971.
An Egyptian jurist, Professor Wahid Ra’fat, drafted the UAE Constitution, after the model of the Kuwaiti Constitution, which was also drafted
by an Egyptian jurist, the above mentioned Dr. Al Sanhuri. One can see a
significant influence from the Egyptian Constitution and recourse can
often be made to Egyptian jurisprudence when interpreting the UAE
139
Article 2 of the Constitution of 1979.
Ian Edge, Shari’a and commerce in contemporary Egypt 34–36 in ISLAMIC LAW AND FINANCE
(Mallat Chibli,ed., 1988).
141 COMAIR-OBEID supra note 115 at 121–123.
142 Id. at 121–126.
140
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Constitution.143 In the UAE Constitution, Shari’a is mentioned as the
main source of legislation and the first one to be consulted when enacting
new laws. Islam is the official religion of the country.144 A well-established
principle of Islamic law is that if there is a special legislation covering the
subject, no discretionary interpretation is allowed.145 This is followed in
the UAE Constitution. The article in the Constitution establishing Shari’a
as a material source of law is targeted at the legislature rather than the judiciary or the public in general.
The Islamists in the country argue that all legislation should be made
to conform with Shari’a, but they disagree among themselves as to whether
all laws enacted before the Constitution are unconstitutional or if the
article concerns only legislation enacted after the promulgation of the
Constitution. When the same question was brought up for decision in
Egypt the Egyptian Supreme Court denied the Constitution retroactive
effect. The general lawlessness which would be the result of challenging
the constitutionality of all laws prior to the promulgation of the Constitution did have a deterrent effect on declaring all laws which do not conform to Shari’a unconstitutional.
The Constitution Chamber of the Supreme Court in the UAE held
in a case which challenged the constitutionality of preceding legislation
that articles 61 and 62 of the Civil Procedure Code of Abu Dhabi (allowing interest) were in force before the promulgation of the Constitution
and therefore are constitutional, as is all other local legislation, which was
in force before the Constitution was enacted.146
The UAE Civil Code is, contrary to the Constitution, directed to the
judiciary. Kuwait (1980) and the UAE (1986) have both adopted Civil
Codes where the judge is to apply Shari’a principles if there is no applic143
Butti Sultan Butti Ali Al-Muhairi, The position of Shari’a within the UAE Constitution and
the Federal Supreme Court’s application of the Constitutional clause concerning Shari’a, 11 ARAB
LAW QUARTERLY 219, 220–221 (1996).
144 Article 7, UAE 2/1997 Provisional Constitution “Islam is the official religion of the Federation and the Islamic Shari’a is the main source of legislation. The official language of the Federation is the Arabic language.” In IV BUSINESS LAWS OF THE UNITED ARAB EMIRATE 4.12-2.
(Hall J Marjorie & El Alami Dawoud Sudqi, trans. 1997).
145 SABAH M A MAHMOUD, UAE COMPANY LAW AND PRACTICE 4 (2nd ed., Gulf Legal Services, 1991).
146
Al-Muhairi supra note 143 at 236.
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able legislation in the matter. The UAE Civil Code is based on the Egyptian Civil Code adopted thirty-two years earlier.147 The judiciary has followed the directions and held in a criminal case where the prosecution
demanded Shari’a penalties for a Muslim accused of drunkenness that
both Shari’a and secular legislation could be applicable in the same case
since the secular penalties for drunkenness applied to all, while the Shari’a
penalties applied only to Muslims. The Supreme Court established in the
case that Shari’a is to have a position over other laws even if the Constitution only refers to “a main source of law” since the legislator has explained
this intention in other parts of the Constitution.148 It should be noted
that the Supreme Court has emphasized the application of Shari’a in criminal matters but been less willing to apply Shari’a in commercial matters
as we will see later in the chapter.149, 150
The seven emirates in the UAE were free to choose if they wanted to
incorporate their legal system into the federation or maintain their own
legal systems. This has resulted in there being three different Court of
Cassation in the federation. The Abu Dhabi Court of Cassation is the
federal Court, under which the emirates of Abu Dhabi, Sharjah, Ajman,
Umm al-Qaiwain and Fujairah judicial systems operate. Dubai and Ras
al-Khaimah have their own court systems and rarely follow the precedents
set by the Abu Dhabi Court of Cassation. The seven emirates were authorized to regulate local matters themselves but commercial law was to
be regulated by the federation.151 The separated court system has resulted
in that the two most influential emirates, the conservative emirate of Abu
Dhabi and the more liberal emirate of Dubai are sometimes giving conflicting judgements on many federal issues. In addition to the civil court
system, a Shari’a court system has traditionally operated in the UAE.152
147 HALL
supra note 144 at Vol. I 1.0–20.
Case nr. 4 year 9 in UAE Official Gazette 83–93, issue nr 135 of 29 February 1984, quoted
in Al-Muhairi supra note 143 at 240.
149 Id. at 244.
150 Many other Muslim countries where Shari’a is a source of legislation have followed the same
path, amongst others the neighboring Iran.
148
151
152
MAHMOUD supra note 145.
Id.
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Shari’a courts have traditionally exercised jurisdiction in all matters
where the litigants were subjected to the local ruler’s jurisdiction and
operated alongside the British courts established during the colonial era.
When the British retracted from the area new civil courts were established according to the wish of the British. The Shari’a courts were given
jurisdiction essentially only over personal law of Muslims.153 Today the
Shari’a courts are administered locally in the seven emirates and have a
greater jurisdiction in some of the emirates than others. An important
move to strengthen the Shari’a Courts was made by Abu Dhabi who
increased the competence of the Shari’a courts to include all matters of
personal status, civil and commercial disputes and serious crimes.154 The
Shari’a courts have during the course of time been included in the judicial system and a judgement from a Shari’a Court is possible to appeal
first to the Court of Appeals, and finally to the Court of Cassation.155
Dubai has moved cases involving banking or financial transactions,
where a bank or a financial entity is a party, from the Shari’a courts and
transferred them to the civil courts. The different emirates have traditionally adhered to different schools of law. Abu Dhabi and Dubai follow the
Maliki School, Fujeirah follows the Shafi school and the four other emirates have traditionally followed the Hanbali school of law.156
The traditional judicial system with Shari’a courts has had a diminishing jurisdiction in Egypt since the nineteenth century. Before the nineteenth century they had an exclusive and supreme jurisdiction over all
cases. In the first half of the nineteenth century Shari’a courts lost jurisdiction over more and more matters, starting with the commercial area,
and finally had only jurisdiction over personal matters. The civil courts
built up after European model took over most of the Shari’a courts cases.
In 1955 the separate system with Shari’a courts was abolished in Egypt
and the Shari’a courts were incorporated into the secular court system.157
153
HALL supra note 144 at Vol. I 1.0–5.
supra note 145 at 2.
HALL supra note 144 at Vol. I 1.0–9.
Id. at 1.0–4.
Edge supra note 140 at 32–34.
154 MAHMOUD
155
156
157
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4.2 The legal framework and operations of
Islamic banks in Egypt and the UAE
With the evolvement of Islamic finance it soon became necessary to enact
special legislation covering the Islamic financial field instead of relying on
the general legal maxims expressed in the Constitution and the Civil
Codes. The two countries Egypt and the UAE chose different ways of
dealing with the new situation with Islamic banks.
Egypt has chosen not to enact any specific laws governing Islamic
banks. Each bank is regulated by an individual law, which set them up
and describes their status and obligations and exemptions from the general
Banking Act. One of the most successful modern banks in Egypt is the
Faisal Islamic Bank of Egypt (FIBE), which was established in the late
seventies. FIBE is ranked as the third largest Islamic bank in the world.158
The bank was established in co-operation with Saudi interests, and they
initially had a 49 % stake in the bank, with the remaining 51 % being
under Egyptian ownership. The bank maintains close ties with the Muslim Brotherhood but it is considered Saudi-controlled.
FIBE was established by Special Act No. 48 of 1977. The act gives
several privileges to the bank compared to other commercial banks. It is
exempt from laws governing public institutions and public sector companies and many of the labour regulations and company law requirements.
It also has tax and customs exemptions and is guaranteed against nationalization, confiscation, sequestration or administrative seizures without a
final court order. The bank is permitted to own direct investments and
engage in trade.159 Upon establishment of the bank it was granted fifteen
years of tax exemption, this was later reduced to two years under political
pressure. The tax exemptions amount to a government subsidy and FIBE
enjoys an autonomy from the government which other banks who are
governed by the general banking law do not enjoy. FIBE participates
among other areas in equity investment and has both established new
companies and bought shares in already existing companies.160
158 MOORE
supra note 6 at 155.
Kazarian & Kokko, supra note 7 at 25.
160 Ahmed El-Ashker, Egypt: An evaluation of the major Islamic banks in ISLAMIC FINANCIAL
MARKETS 63 (Rodney Wilson, ed., Routledge, 1990).
159
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The government in Egypt exercises very little control over where the
Islamic banks invest their funds. Some critics have raised concerns that
all of the Islamic banks’ investments are not Shari’a compliant, but since
the banks are not forced to disclose their accounts it is difficult to monitor
the banks.161 It is clear that the early growth of FIBE’s deposits could be
attributed to the fact that FIBE kept a high proportion (74 % in 1990)
of deposits in foreign currencies, mainly US dollars. With the gradual
devaluation of the Egyptian pound this was an attractive incentive for
depositors. The FIBE also kept a large part of its assets, up to 60 %, abroad
in return for a London Inter Bank Offering rate (LIBOR), despite the
prohibition in Shari’a to deal with interest.
During the 1990s the bank shifted a major part of its assets to the
domestic market, but a large part of them remained in interest bearing
accounts in commercial banks and the Central Bank. FIBE has however
tried to fulfill its socio-economic goals by committing itself to housing
projects for poor in Cairo and by distributing the zakat directly from its
annual profits. The bank is also sponsoring studies of how low-income
people can increase their productivity for example in the agricultural sector. It also provides credit to entrepreneurs who otherwise would not be
able to obtain it in commercial banks. The Islamic banks surfaced in just
the right time for providing credit to the politically dissatisfied segment of
the population who did not benefit from the privatizations of the Sadat
era, and it was probably not a coincidence that they received the back-up
they did from the government.162
The other operating fully-fledged Islamic bank in Egypt, the International Islamic Bank for Investment and Development (IIBID), also had
assets deposited with the Central Bank on interest-bearing accounts and
was involved in speculation with foreign currencies, precious metals and
other goods. The bank was told by Islamic jurists to stop its speculation
activities, because it is forbidden in Islam, and has followed the advice.
Both banks establish companies and own shares in companies but neither
FIBE nor IIBID have any equity sharing instruments for small capital
161
Edge supra note 140 at 43.
Islamic Banking and Policies in the Sadat Era 46–49 1 ARAB
London Press Ltd, November 1985).
162
LAW
QUARTERLY, (Lloyd’s of
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investors (unit trust funds). This left an unfulfilled demand in the market which was soon exploited by other participants.163
Islamic Investment Companies (IIC’s) soon filled the void left by the
Islamic banks. IIC’s are a phenomenon which occurred in Egypt during
the late 1970s and early 1980s. More than 100 IIC’s were set up in Egypt
during a five-year period. These investment companies had their origin
in the foreign exchange black market with the founders of the biggest
companies being money exchangers who were engaged in sending home
the money from Egyptian guest workers in the Gulf region. The Islamic
investment companies existed in a legal limbo and operated wholly outside any laws. Company laws did not govern them, nor did the banking
laws or other legislation. They were not under the supervision of the
Egyptian Monetary Authority either. The IIC’s did not follow any Egyptian positive laws and even if their name always had “Islamic” in it they
were often involved in currency and gold speculation on the foreign markets. The depositors were attracted by the Islamic nature of the investments (PLS schemes) and the high returns of up to 30 %, which for some
of the companies were based on pyramid schemes.164
The UAE has not followed the example of Egypt but has chosen to
establish a general law governing Islamic banks and investment companies.165 The law was enacted in 1985, which is ten years after the formation of the first Islamic bank in the UAE. The Islamic banking law gives
certain exceptions from the general banking law. For example are the Islamic banks exempted from the provisions regarding interest payments on
their deposits and interest charges on their loans. The Islamic banks have
to include in their articles of incorporation and memorandum an obligation to follow the Islamic Shari’a in their transactions. The law calls for
the formation of a Shari’a controlling authority consisting of a minimum
of three persons in all Islamic banks.166 The banks have the right to com163
Mahmoud Mohieldin, Islamic Finance in Egypt in 17–21 WORKING PAPER NO. 17, (The
Egyptian Center for Economic Studies, October 1997).
164 Id. at 28–34.
165 FEDERAL LAW NO. 6 OF 1985 RE Islamic banks, financial establishments and investment
companies.
166 Art. 6 Federal Law NO. 6 of 1985 RE Islamic banks, financial establishments and investment companies
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mence all types of services and operations specified in the federal law for
banking establishments.167 The Islamic banks also have the right to establish companies and share in existing projects which conform to Shari’a.
By expressly giving the Islamic banks and investment establishments the
right to establish companies and participate in projects the UAE legislation
did not have to face the same problem Egypt had with no regulation governing the Islamic investment companies.
The Gulf region is recognized as the most advanced region in developing the Islamic banking industry, and is the home to four out of the five
largest Islamic banks (Al Rajhi Banking & Investment Corp., Kuwait
Finance House, Faisal Islamic Bank of Bahrain and Dubai Islamic Bank).
There are two domestic Islamic banks in the UAE, Abu Dhabi Islamic
Bank (ADIB) and Dubai Islamic Bank (DIB), with a third, Sharjah
National Bank under reconstruction to become an Islamic bank. Islamic
banks in the UAE receive support from their local governments, with
ownership stakes in the banks ranging from 10–30 %, although they do
not receive any other direct support from the government. Formally, the
UAE has income tax laws for corporations, while individuals are exempted
from paying any tax. Most of the corporate entities have in practice been
exempt from paying taxes, after being granted an exemption from their
respective rulers. This is also true for the banks operating in the Emirate.
In some of the emirates, such as Sharjah, banks are in general exempted
from paying taxes. In all the other emirates it is only the foreign branches
of banks and oil producing companies who pay taxes. All other companies
are exempted from it.168
Today a substantial amount of the liquid funds in poor countries are
invested in Western stock exchanges and benefit Western companies and
society. Many people are afraid of investing in their home countries due
to unstable political conditions or lack of trust in their own currency. A
question is if the Islamic banking industry has succeeded in bringing
back the capital from Western stock markets and invested them in their
own societies. The World Bank has estimated that the capital outflow
from the Middle East and North African (MENA) countries amounts to
167
168
FEDERAL LAW NO 10 OF 1980.
At http://www.uae-ypages.com/html/uae_information.htm
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around US$ 350 billion, which is the highest figure, when compared to
the GDP, of any region of the world. Most of this money comes from the
GCC countries.169 The MENA countries have been slow in developing
trade amongst themselves, most trade has been geared towards the USA,
EU or other Asian countries instead of developing regional trade ties. An
objective of the Islamic banks has been to develop the trade ties between
Islamic countries. This is also expressed in the UAE Constitution.
One problem with comparing the outflow of capital with the success
of Islamic banking is that the Islamic banks hold a small share of the total
market. The two Islamic banks in the UAE,170 DIB and ADIB each calculate their market share in single digits. Therefore it is necessary to look
at the banks’ business practices to see if the socio-economic goals of Islam
are followed in practice. The percentages invested in the global market are
not a sure indicator of the beneficial role of investments but put together
with the type of investments made and the goals expressed in the Annual
Reports of the banks it gives a picture of the role of investments in each
bank. In general the developmental role is less stressed in the UAE than
the formal adherence to the Islamic financial techniques and the commercial success of the bank.
The Abu Dhabi Islamic Bank has 64 % of its total assets invested in
Mudarabah and Murabahah transactions with international banks and
financial institutions. The numbers do not show if it is invested in the
neighboring or other Arab countries, but a major part is most likely invested on the European, North American and Japanese markets. On the
other hand the bank is participating as a founding shareholder in banks in
war-torn and impoverished Muslim countries, such as Bosnia (the Bosna
Bank International).171 Dubai Islamic Bank’s financing and investing
activities are based in the UAE to 61.7 % with 38.3 % invested outside
the UAE.172
169 MOORE
supra note 6 at 148.
National bank of Sharjah has recently changed to a full-fledged Islamic Bank after a directive by the ruler of Sharjah, H.H. Sheikh Sultan bin Mohammed Al Qasimi. This brings up the
number of UAE Islamic banks to three. It is too early to calculate its market share after the transformation, but it is assumed to be smaller than for DIB or ADIB.
171 ANNUAL REPORT 2000, Abu Dhabi Islamic Bank (2000).
172 ANNUAL REPORT 2000 Dubai Islamic Bank (2000).
170
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An argument from advocates of a purely Islamic system is that the debt
crisis of many of the Islamic countries could have been avoided if Islamic
techniques would have been used in making loan agreements. Since loans
in Islamic banks are not made on interest basis but profit and loss sharing
basis it is more likely that a bank approves projects which are productive
and profitable and not only for consumption purposes.173 A research of
the portfolios of Islamic banks, shows that a very small share of the assets
is invested on profit and loss sharing basis. The main activity of the banks
are the mark-up schemes, which account for over 80 % of the business of
the banks. It is estimated that only 3–4 % of the assets in Islamic banking
are invested in equity financing.174
Istisna
Other
Musharakah
Murabahah
The figure shows the shares of Dubai Islamic Bank’s different financing and investment activities.
Source: Annual Report 2000, Dubai Islamic Bank
The Dubai Islamic Bank showed for the year of 2000 similar figures to
many other Islamic banks. Investments in securities and different types
of companies are still composing a small part of the total investments at
approximately 4 %. The reason for not focusing on PLS investments is
according to the bank’s officials that there is not enough demand in the
UAE market for securities. However the bank plans to launch an Islamic
mutual fund in the near future.175 The opinion of practitioners indicates
that the underdeveloped equity markets in most Arab countries are more
a reflection of cultural attitudes and level of development than the restrictions made by government policy and legislation. As discussed infra it is
173 MOORE
174
175
supra note 6 at 20.
Id. at 75.
Interview with Ehsan Ilahi at DIB Direct Investment Department in October 2001.
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true that the liquidity in the secondary market is limited and needs to be
developed further in all Arab countries.
The FIBE and Abu Dhabi Islamic Bank do not give any numbers on
their Murabahah, Musharakah or Mudarabah investments but combine
everything to one post in their annual report, which makes it impossible
to make an exact comparison between the banks.
The fact that most Islamic banks do have a major part of their assets
in Murabahah financing and concentrate on mark-up schemes makes one
skeptical about the developmental role Islamic banks stress that they have.
Most of the assets are invested in short-term financing which gives an immediate return or in capital intensive big projects. The allocation of funds
to the foreign market also indicates that the developmental role is more
stressed in the by-laws than adhered to in practice.176 This is more understandable in the case of the UAE, which is a developed nation with a small
fraction of its population in need of economic help. The state has also
taken a bigger role in providing welfare arrangements to the citizens and
is investing in the infrastructure of the state. Egypt, which does not have
the same natural resources and government income as the UAE has, is in
desperate need of socio-economic redistribution of assets to the poorer
segment of the population. With the downsizing of the welfare state in
the 1980s and the flirtation with market economies the Egyptian middle
class and poorer strata of the population has gotten it worst. In such a
economical situation it is not justifiable for Islamic banks in the region to
invest their funds in foreign markets or have deposit minimums on their
investment accounts.
The claim from Islamic banks that their activities do not generate
inflation because their investments are made in productive activities in the
first place and do not finance consumption, is based on the calculation
that most assets of the Islamic banks are invested in PLS arrangements.177
Since the mark-up schemes take up such a major part of the assets there
should not be any difference between traditional banks and Islamic banks
when it comes to inflation creating investment. On the contrary, a pro176
Mohieldin supra note 163 at 26
Sherif Abd El-Hamid Hassan, Islamic Banks versus Traditional Banks (Simple Idea), (unpublished paper) (on file with author).
177
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blem with the Islamic banks is that a large part of the assets are invested in
financing import of durable consumer goods through Murabahah.178
It is only a minor part, which is invested according to PLS-contracts.
The Islamic banks in Egypt do not even carry any mutual fund products
and those which exist in the UAE are recently developed, with the oldest
commercial Islamic bank, Dubai Islamic Bank, not having any such products. Even those banks which do have equity participation schemes and
trust fund products have high limits on initial investments which indicates that they are marketed to high net-worth individuals instead of giving the poor members of the society a chance to participate in the profits
of such investments. The high entrance levels suggest that the poorest
people do not benefit from the profit-sharing system. That belongs to the
middle (in FIBE the initial investment for opening an account with the
bank is LE £ 200) and upper classes (in the Al Hilal mutual fund of Abu
Dhabi Islamic Bank the initial investment is US $ 10,000). On the other
hand the Islamic banks are involved in many companies providing job
opportunities in Egypt while the Islamic banking sector in the UAE is
mostly investing in the international market. If the Islamic banking sector is to develop further it is important that the mutual fund alternatives
are made accessible for all members of the society.
4.3 Court judgements and legal rules concerning
the permissibility of investments
Egypt has like other countries in the region turned more to its Islamic
roots. Political pressure from the influential Muslim Brotherhood resulted
in a new Draft Civil Code 1981, where the charging of interest is totally
forbidden in both commercial and civil transactions.179 By the time the
draft code was ready for enactment the government had changed its
policy and was no longer willing to support the islamisation of the legal
system. After the assassination of President Sadat the government sought
confrontation instead of conciliation with the Islamic groups and the parliamentary committees provided ample possibilities to thwart any bill the
government did not want to have enacted.
178
179
Mohieldin supra note 163 at 26.
Edge supra note 140 at 41.
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When the Islamists in the government tried to bring up the subject
during the next legislative session the government dismissed the issue by
proclaiming that the Code had elapsed when it was not enacted during
the preceding legislative session. After the dismissal of the draft Civil Code
the advocates of a ban on interest found new ways to attack the provisions
concerning interest in the existing Civil Code.180 Today the Egyptian
Civil Code expressly allows interest on delayed payment on debts, with a
ceiling of 4 % in civil matters and 7 % in commercial matters.181
Since the amendment of the Constitution which now enlists Shari’a as
the principal source of law, the rector of Al Azhar University tried to get
the Civil Code articles on interest overruled as unconstitutional (Rector of
Al Azhar v. Fouad Goudah at al S.C.C. May 1985). The Court did however not have to consider the claim on its merits since the law in question
dated back to the time before the amendment to the Constitution. The
Court only noted that the amendment did not apply retrospectively (“La
loi ne dispose que pour l’avenir”) and that article 2 of the Constitution was
directed to the legislative branch of the government, i.e. the People’s
Assembly, and not to the judiciary or the general public.182 The court also
noted that it favoured revision of the existing legislation instead of a substitution of the whole secular legislation,183 probably as a reference to the
failed attempt to enact a new Civil Code.
The judiciary is taking a restrictive position in declaring laws unconstitutional just because they are against the Shari’a. There has not been
any case where the Supreme Court has found any legislation unconstitutional because it has been contrary to the Shari’a.184 The courts have
resorted to other means when controversial laws have been enacted, like
180
Peters Rudolph, Divine Law or Man-made Law? Egypt and the application of the Shari’a,
3 ARAB LAW QUARTERLY, No. 3, (Graham& Trotman August 1988).
181 CIVIL CODE OF 1949 §226–227 quoted in Edge supra note 140 at 41.
182 The principle of retroactivity has been repeated in numerous cases after that, for a list of cases
see Baudouin Dupret, A propos de la Constitutionnalité de la Shari’a, note 9 4 ISLAMIC LAW &
SOCIETY No. 1 (January 1997).
183 Habachy Saba, Commentary on the decision of the Supreme Court of Egypt given on 4 May
1985 concerning the legitimacy of interest and the constitutionality of article 226 of the new Egyptian Civil Code of 1948, 1 ARAB LAW QUARTERLY, (Lloyds of London Press Ltd, February 1986).
184 Edge supra note 140 at 45–46.
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the “Jihan law”,185 which made controversial changes to the personal status
law, such as giving women the right to divorce on the grounds of polygamy. The “Jihan Law” was invalidated on purely formal grounds, thus
evading the question of its compliance with Shari’a.186
The Egyptian Grand Muftis (the country’s chief Islamic jurists) have
taken a controversial position concerning the legitimacy of interest. Both
sheikh Tantawi and the succeeding Grand Mufti have in fatwas (religious
opinions) said that interest-bearing government bonds underwritten by
Egyptian banks are allowed to invest in. So long as the bank invest the
depositors money in halal (permissible) objects, even if giving interest, the
transaction is halal.187 Both the Ulama of al-Azhar (the clergy of the
most famous mosque and theological university in the Islamic world)
and the Grand Muftis of Egypt have generally been supportive of the
leaders of the state over generations. They have often issued fatwas legitimating controversial government policies. Both the grand muftis and the
sheikh of al-Azhar owe their posts to the government. The previous
Grand Mufti (Sheikh Tantawi) who issued the controversial fatwa is now
the sheikh of al-Azhar. The new Grand Mufti Sheikh al-Haqq argues that
even if the leadership of the country permits interest, they do believe in
its abolishment and other Shari’a principles and implement them within
the limits of their capacity.188
The UAE legislation, which closely follows Shari’a, made the charging
of interest absolutely forbidden. The Constitution provides for Shari’a as
a main source of law in the country, and the Civil Code clarifies this and
expressly speaks about interest payments. According to the Civil Code all
provisions providing for interest payments in loan contracts are rendered
null and void.189 Since the Gulf region and the UAE particularly is promoting itself as the leading trade hub in the Middle East, it was necessary
185
named after Sadat’s wife who initiated the law
Bernard Botiveau, Contemporary reinterpretations of Islamic Law; The case of Egypt 270–271
in ISLAMIC LAW AND FINANCE supra note 140.
187 WARDE, supra note 5 at 57.
188 Shahrough Akhavi, The Clergy’s concept of rule in Egypt and Iran, The Annals of the American Academy, pp.92–102 ANNALS, AAPSS, 524, November 1992.
189 Article 714 of Federal Law No.5 in respect of Civil transactions, from www.tamimi.com/
indexl.html
186
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to find a compromise between the strict prohibition in dealing with riba
transactions and the necessities of the global market.190
As a compromise the government made a distinction between civil
law, where it is still prohibited to charge interest, and commercial matters
where interest is allowed. Federal law No.(1) of 1987 formally excluded
commercial transactions from the Civil Code even if previously enacted
federal laws already allowed interest in banking transactions. Before the
enactment of the Commercial Code191 charging of interest was regulated
by a Federal law192 which held that the Central Bank had authority to fix
the interest rates paid and charged by commercial banks. The rate of
interest was not to go beyond 12 %. Compound interest was forbidden.
When the Commercial Code was enacted in 1994 it followed the Federal
law and provided for the charging of interest in commercial matters. Article 76 allows the charging of interest at an agreed rate or maximum 12 %
in commercial loans. It follows from article 88 of the Code that it is allowed to charge interest in all commercial transactions where the payment
is delayed according to the same rules. According to article 409 in the Code,
banks are continuously allowed to charge simple interest up to 12 % on
their banking transactions.
The new Commercial Code also sets out principles governing the operation of most banking activities.193 According to article 399 194 no interest shall be charged on current accounts if there has not been an agreement that the payments shall yield interest. The rate of interest shall in
any case not exceed 12 % for current accounts.
The Abu Dhabi Court of Cassation held already in 1981 that the Abu
Dhabi procedural laws allowing interest were constitutional. It motivated
the judgement with that banks had become a necessity for the economic
existence of the UAE and it was in the best interest of the people of the
190
COMAIR-OBEID supra note 115 at 189.
Commercial Transactions Law of 1994.
192 Federal law NO 10 of 1980 RE: The central Bank, the monetary system and organization
of banking.
193 HALL supra note 144 at Vol. I 1.0–22.
194 Article 399 (1) in The Commercial Transactions Law. Articles 440 and 441 allow the taking
of interest in transactions where the customer transfers title to commercial papers to the bank
before maturity and the bank pays the customer in advance.
191
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nation to allow banks to charge simple interest.195 For a long time after the
judgement the Abu Dhabi courts continued to dismiss any in their eyes
excessive interest claims.
Until recently the Abu Dhabi courts have only awarded interest up to
12 % and ignored the rest of article 76 in the Commercial Code which
says that interest shall be awarded at the agreed rate if there is an agreement between the parties. This recently changed in a judgement issued on
May 7, 2000, where a local bank demanded that a customer who had
defaulted on his loan should pay the outstanding amount and interest on
the sum. They had agreed between themselves on an interest rate of 16 %.
The court gave judgement for the bank and awarded it 16 % of interest.
Two conditions must be fulfilled if a court is to award an agreed amount
of interest, the court stated. The total amount of interest must not exceed
the principal amount of the loan and interest awarded must be simple
interest. The Court justified its new position with that interaction with
banks had become a commonplace practice in the society and it was necessary to award the agreed amount of interest in furtherance of public
interest. Therefore the bank was entitled to an exception from the general
prohibition to charge interest.196
In another case in the Abu Dhabi Court of Cassation, Shari’a was
identified as a major source of law within the country. It is impermissible
to apply any law in the UAE which is contrary to the principles of Shari’a.
The case was about commercial transactions where a bank wanted to
charge compound interest. In this case the charging of compound interest
was held to be contrary to Islamic principles and therefore invalid. The
banks still continue to charge compound interest even if they cannot be
awarded it in courts. According to the Abu Dhabi Code of Civil Procedure197 which all the Emirates follow, except for Dubai, interest can be
195
Decision No. 14/9 issued on 28 June 1981.
Judgement of the Federal Supreme Court/Abu Dhabi, No. 245/20, issued on 7 May 2000.
In a recent judgement the Abu Dhabi court has reaffirmed its position, acknowledging that it is
forbidden to charge interest according to Shari’a, but approving of it again with the motivation
that banks are necessary prerequisites for the economic life in a modern state, which the UAE is
part of, at http://www.tamimi.com.
197 LAW NO. (3) OF 1970 OF ABU DHABI as amended by LAW NO. (3) AND LAW NO. (4) OF
1987.
196
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awarded at a rate which is customary or has been decided between two
parties. If there has been no such prior understanding or practice, interest
can be awarded at a maximum of 9 % for private transactions and 12 %
simple interest in commercial transactions after the due date.
There seems to be a contradiction between earlier and more recent
judgements of the Abu Dhabi Court of Cassation with regard to how
closely Shari’a principles are to be followed in commercial transaction.
The problem is that nowhere in the Civil Code or the new Commercial
Code is the term commercial transaction defined. It creates uncertainty
with regard to which transactions are governed by the Commercial Code
and which transactions are covered by the Civil Code.198
The Dubai courts have been less hesitant in furthering the demands of
the international business community. A reason might be that Dubai is
more dependent on trade than Abu Dhabi, which owns a major part of the
country’s oil resources. Dubai has also traditionally been the most modern
and secular of the seven emirates. The Dubai Court of Cassation ruled in
1991 that interest as high as 24 % is allowed in commercial transactions.
An international credit card company that wanted to charge interest on
the principal on a defaulted debt payment brought the action. The Court
of Cassation held that having reference to the common practice for commercial transactions, interest rates should be charged according to the rate
agreed upon between the parties. It dismissed the defendant’s argument that
the lower courts were wrong to held that there was no ceiling on interest
rates and that the interest rates were excessive.199 The Dubai highest court
reaffirmed its position in another judgement in 1997 where it again held
that the parties are free to determine amongst themselves the interest rates
applied on late debt payments. The Court has no right to change such an
agreement if it does not contradict the UAE public policy.200
The Dubai courts have clearly taken a position for the legality of
interest payments and are generally awarding interest in a situation where
198 HALL
supra note 144 at Vol. III 3.1-i.
RICHARD PRICE, UNITED ARAB EMIRATES COURT OF CASSATION JUDGEMENTS 33–34 (Kluwer Law Int., 1998) (Dubai Court of Cassation Judgement No. 201/91 issued 28 December
1991.
200 Dubai Court of Cassation Judgement No. 261/96 issued 22 February 1997 at supra note
144 at 51.
199
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it is agreed upon or otherwise supported by the laws. In a recent judgement it held that banks are allowed to charge interest on late payments
even if there is no agreement.201
Another field where Shari’a rules seem to conflict with the existing
legislation in the UAE is in the area of currency transactions. The subject
of gambling has also acquired new relevance in the many conflicting decisions regarding currency transactions by the UAE courts. The judgements have discussed the connection between speculation in the financial
markets and gambling. A claim is that speculation with currencies is similar to gambling and therefore forbidden. The UAE Civil Code has been
clear in its condemnation of gambling.
“Article 1021(2) of the Civil Code provides (where relevant) as follows:
Article 1021 (2): ‘Whoever loses a bet or a prohibited competition may
recover what he has paid within a period of six months commencing
from the time at which he paid over what he lost, notwithstanding that
there may be an agreement to the contrary, and he may prove his claim
by all proper means.’
Article 1014 of the Civil Code provides (where relevant) as follows:
Article 1014: ‘The following conditions must be satisfied for a contract
of competition to be valid:
(a) the prize must be known and the person who is obliged to give it
must be specified in person; and
(b) the description of the subject matter of the contract must be sufficient for the avoidance of uncertainty, as in a race, where the distance between the start and finish must be specified, and, in the case of a shooting
match, the number of shots and the winning hit must be defined.’”202
The legal rules governing currency exchange are less clear and have been
differently interpreted by the different courts. One composition of the Abu
Dhabi Court of Cassation made an analogy between currency speculation
and gambling in the case. An individual gave money to a currency broker
who acted as an agent to a trading company. The trading company speculated and lost Dhs 105,072,21 on currency markets whereafter the
201
Dubai Court of Cassation Judgement No. 321/99 issued 19 December 1999 at www.
tamimi.com (Husam Hourani & Hind Tamimi trans.).
202
at www.tamimi.com/indexl.html (Rima Fahl trans.).
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individual sued and claimed that the contracts were null and void,
because they were against the principles of Shari’a.
The court ordered the defendant to pay the full amount back to the
individual and declared the contracts void on the ground that currency
speculation was a sort of gambling and therefore illegal in the country.
Any contract, which was contrary to the Islamic principles of Shari’a, was
held to be null and void. The court dismissed the defendant’s arguments
that trading in currencies and metals was legal under UAE law, and that
they were not aware of the plaintiff ’s intention of speculation with the
currencies. Since it was never the intention of the defendant to deliver the
currency but only to trade on margin and benefit from the changes in currency fluctuations the Court held that it was an act of illegal trading with
currencies. The fact that the plaintiff had for two years benefited from the
contracts and received profits from it and that the losses were according to
the plaintiff ’s own decisions did not change the opinion of the court.203
In two judgements delivered in 2001, two different compositions of
the Abu Dhabi Court of Cassation further developed the subject. The two
courts answered the question of legality differently. The first judgement
was published in March 2001, where the court held that a currency exchange contract in and itself is a “stake contract” based on the movement
of currencies. The buyer does not pay a real price when the contract is executed, but deposits an amount on an account as an insurance against perceived future losses. The purchaser does not receive the commodity at the
time of the closure of the contract and never has an intention of doing so,
therefore currency exchange contracts are not any different from gambling
and speculation and are in themselves illegal according to Shari’a and UAE
law. The respondent was not given an opportunity to prove otherwise.204
Two months later the same court with other judges delivered a different
opinion on currency contracts. It held that foreign currency contracts
and other futures contracts in themselves are valid contracts unless they
are deemed to be risky and there is an inability to deliver the object of the
contract. The respondent is always given an opportunity to prove that so
203
Abu Dhabi Federal Court Judgement no 144 of 1999 issued 28 March 2000 at http://
www.tamimi.com/lawupdate/may00d.html.
204 Abu Dhabi Federal Court Judgement no 290/1996 issued on 21 March 2001 at http://
www.tamimi.com/lawupdate/indexl.html.
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is not the case.205 The discussion is likely to go on between the different
fractions of the Abu Dhabi Court of Cassation...
The different opinions in the Abu Dhabi Court of Cassation are not
the only confusing aspect of the question of the legality of currency dealing in the UAE. The opinion varies also between the different Emirates.
The Dubai Supreme Court has approved of currency dealing as valid
under UAE law while the Abu Dhabi Court has been more restrictive.
The Dubai Court of Cassation has held that all types of currency trading
is legal, even trading on the margin. In case No. 17/189 206 a brokerage
firm was involved in trading on the margin for a customer. The Court said
in its judgement that trading on the margin by a brokerage firm licensed
for the purpose was legal and binding on both parties. Such transactions
were not similar to gambling or wagering. The court relied on the banking
law 207 which authorized banks to deal with currencies and a circular
issued by the Central Bank which according to the court authorized dealing in foreign currencies on the margin.208
The difference between the positions taken by the two Court of Cassation is partly due to the fact that they are relying on different legal texts
to support their decisions. As earlier mentioned, in Dubai commercial
matters have been transferred from the Shari ‘a courts to civil courts, while
in Abu Dhabi Shari’a courts have jurisdiction over commercial cases and
apply Shari’a law to the cases. The Dubai Court never even brought up
the issue of compliance with Shari’a in its discussion, as the Abu Dhabi
Court has centered its discussion around.209 The uncertainty created by
the different opinions in the different Emirates and even in the same
court are likely to continue for the time being. It is clear that the different
Emirates have chosen different levels of secularization of their legislation
in the financial field. What remains to be seen is if Abu Dhabi will follow
Dubai and the more secular line or if it continues the more conservative
attitude with legislation more closely following Shari’a.
205
206
207
208
209
Abu Dhabi Federal Court judgement no 434 of 1996 issued 5 June 2001 at id.
Dubai Court of Cassation case no 17/189 at id.
FEDERAL LAW NO. 10 OF 1980.
At http:// www.tamimi.com/indexl.hmtl.
at http://www.tamimi.com.
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The fraction in the different court rulings in the UAE is caused by a
fundamental ideological difference between the Islamists who interpret
the constitutional clause to place Shari’a above all other sources of law,
and the liberals who place Shari’a among other sources of law on an equal
footing. The constitutional clause is ambiguous in that a “main source”
and “legislation” are not defined in the Constitution, which leaves the
field open for different interpretations. The Liberals argue that since the
Constitution considers Shari’a a main source and not the main source, as
in Egypt, there is room for other sources of law which are better tailored
to the needs of the modern society, for example in fields like finance and
banking. It is not clear whether the term “legislation” refers to federal or
local legislation, which has also led to different interpretations in different
Emirates.
The Egyptian courts have not had to deal with the question of currency speculation as the courts in the UAE have. The Egyptian pound has
been very unstable and many people who can afford to save money have
their savings in other currencies to avoid depreciation of their savings. The
Islamic investment houses and banks who have supported the political
Muslim movement have themselves been involved in currency speculation so the issue has not been put to the People’s Assembly’s agenda in the
same way as the abolishment of interest. The Egyptian law provides that
approved banks and other authorized entities are permitted to deal in
foreign currencies without any restrictions concerning speculation. They
are also permitted to conclude time-deferred contracts for selling and
buying foreign currencies, which is not permitted in Islam.210 It is interesting to see how a law which does not follow fundamental Islamic economical principles can be enacted in Egypt after the constitutional change
declaring Shari’a the main source of legislation and exist without any challenges raised against it. Part of the reason is the government’s changed attitude towards Islamisation of the legal system and economic necessity.
One of the purposes of executing time deferred currency transactions is to
stabilize the exchange rate of the Egyptian pound.211
210
LAW NO. 38 OF THE YEAR 1994, reorganizing dealings in foreign currency as amended by law
no. 228/1996 article 22, 26,27, in official journal issue 22, dated 2 June 1994.
211
I have been unable to find any court cases challenging the law.
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4.4 The securities markets in Egypt and the UAE
and their compliance with Islamic law
A characteristic of most of the Islamic countries including Egypt and the
UAE is that the private sector is not contributing in a significant amount
to the economy. The public sector, which has often been inefficiently run,
accounts for between 30–95 % of the work force in the economies.212
The governments are becoming aware of the problems with a large inefficient public sector and Egypt among others has embarked on ambitious
privatization programs. Egypt is also opening up its market for foreign investors in a way, which is yet to be followed by the other Arab countries.213
This means that the equity investment opportunities are vastly increasing
on a daily basis. The negative effects of the widespread privatizations are
job losses and inequalities in wealth distribution according to critics of the
privatizations.214 This has lead to increased support of fundamentalist
movements in Egypt among others. The Muslim Brotherhood has taken
the place of the government in providing the basic needs of poor people
who lost their jobs and government subsidies in the widespread privatization programs.
The Egyptian stock market has not only profited from the many privatization programs but also from legislative approaches, such as the
Company Law of 1981 which require all public companies to list their
shares on the exchange a year after their first public offering. Although
the listings have increased with great speed the volumes traded are
minuscule compared to the stock markets in London or New York for
example.215 The government has enacted new laws in 1993 for investment funds and companies operating in the field of equity investment.
With the legislative attempt to regulate investment funds and other play212 MOORE
supra note 6 at 147.
213
See for example for banks: “The percentage of ownership by non-Egyptians in the capital of
joint banks and private banks may exceed 49 % of the issued capital of any bank, & all other
contradictory provisions shall be superseded” Bank and Credit Law, as amended by virtue of law
97 of 1996, Article (21/Bis1) HASSAN A. AHMED, INVESTMENT BANKING SERVICES FOR EGYPT,
SYNOPSIS OF THE REGULATING LAWS OF THE CAPITAL MARKET AND JOINT STOCK COMPANIES
(US Agency for International development) at www.dec.org/pdf_docs/PNACJ009.pdf
214 MOORE supra note 6 at 73.
215 Edge supra note 140 at 48.
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ers on the stock market the Egyptian government has learned from its
mistakes concerning the unregulated IIC’s and provide a framework and
tool for further development of the investment fund and stock market.216
The privatizations and new liberal financial regulations in Egypt have
provided for the revival of the stock market. With the new regulative
framework the country has a better chance to fight off speculative schemes
such as the IIC’s. A problem is that the new regulations can easily be challenged as unconstitutional because many of the new financial tools permitted by the new laws are not following Shari’a. Even if they never will
be declared unconstitutional their credibility among Egyptians will no
doubt be lower and might hurt further development of the stock market.
The UAE has also supported the development of a formal stock market.217 The emirates of Abu Dhabi and Dubai have both established rivaling stock markets but due to the strict restrictions on trading and registrations, neither of them is flourishing. The government rules governing
equity investment have always set strict limits on foreign ownership, without doubt as a sad reminder from the exploitation of oil resources by
foreigners at the beginning of the oil boom.218 The restrictions have led
to underdeveloped stock markets in most of the GCC countries. Some of
them have made efforts to open up their stock markets to foreign investment, notably Bahrain and Oman,219 while the Dubai stock market for
example still is restricted only to GCC nationals. The UAE has made an
effort to enact new laws similar to other modern equity investment centers. It has for example established the Securities and Commodities Authority (SCA). The SCA was established in 2000 220 and has commenced
its task of establishing new rules for the securities and commodities market in the UAE. Hitherto it has proclaimed new rules for brokerages operating in the UAE.
216
Degree no 135/1993 promulgating the executive statutes of the law on capital market
§ 140–162 concerning investment funds in Degree no 135/1993 promulgating the executive
statutes of the law on capital market.
217 MOORE supra note 6 at 71.
218 Until the 1950’s the host governments only received minimal royalty payments on the lucrative oil exploitation business, which was dominated by foreign companies such as British Petroleum, Texas Oil Co. and Standard Oil in MOORE supra note 6 at 7.
219 Id. at 156.
220 FEDERAL LAW NO. 4 OF 2000 ON THE SECURITIES AND COMMODITIES MARKET.
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According to Cabinet resolution No. 12 of 2000 it is now possible to
list bonds and debt instruments approved by the SCA on the UAE stock
market.221 There are two official trading floors in the UAE, The Dubai
Financial Market and the Abu Dhabi Bourse which both opened in 2000.
Neither of the markets have more than a dozen companies registered on
their trading floors, even though the hopes are high that this will change.
Other Islamic countries have been more successful in developing a stock
market. Malaysia, Indonesia and Iran were strong performers in the
1990’s and Sudan has established the first purely Islamic stock market in
Khartoum.222
The UAE had for five years a Finance and Currency brokers regulation
which stated that all brokers must be UAE citizens or if companies, the
share of domestic shareholders must be not less than 60 % in the brokerage firms.223 The new brokerage rules effective directly from 8th of April
2000, are keeping the 60 % UAE shareholder requirement for brokerage
firms. The individual brokers in the firm must be UAE nationals or of
other nationality, but there must be a plan of gradual emiratization (jobs
only available for UAE nationals) of all brokers in the firm. According to
resolution NO 164/8/94 224 the proportion of domestic shareholders in
any investment company shall not be less than 51 % and the majority of
the Board of Directors must be nationals.225 This effectively keeps many
foreign actors away from the market and hinders its development. Other
regulations on financial investment companies are that they are forbidden
to invest more than 10 % of their final take in any single institution or
company.226
In many ways the UAE is still a developing jurisdiction with most of
the securities and financial instruments legislation enacted recently. The
exact boundaries of the legislation and how well it conforms to Islamic
221
In 16 ARAB LAW QUARTERLY (Kluwer Law International, 2001).
supra note 6 at 75.
223 Resolution of the Board of Directors of the Central Bank NO. 126/5/95, regarding the
finance and currency brokers regulation, art. 5 (2)(b). In Hall supra note 145 at Vol. II 2.9-75.
224 Resolution of the Board of directors of the central Bank No. 164/8/94, regulation for financial investment companies, and banking, finance and investment consultancy establishments
and companies in HALL supra note 145 at Vol. II 2.9-59.
225 Id. art. 8 (3) (b) at Vol. II p. 2.9-67.
226 Id. art. 12(2) at Vol. II 2.9-69.
222 MOORE
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values in the Constitution still remains to be tested in the court system.
What can be said already is that there exists a gap between Shari’a in theory
and financial regulation in practice. Even though both the UAE and Egypt
are supposed to enact only legislation which is not contrary to Shari’a
there is an ample area of financial legislation which does not conform to
Shari’a. Examples are the allowed trade in bonds and debt instruments
on the stock market. Even if the governments in the Gulf region are eager
to conform to the realities of the global market they seem more concerned
with keeping the assets restricted to nationals, and more willing to yield
in the field of religion. Could it be that the idea of a nation state is becoming more important than the identification as a religious community
in the modern UAE?
A problem in investing in securities is that most companies are prohibited if one follows a strict implementation of the Shari’a. Therefore most
scholars support a compromise which allows investment in stocks that do
not strictly conform to the Shari’a. The bankers say that it is an economic
necessity to allow small variations from the strict Shari’a requirements, for
example when they allow limited interest revenue.227 If the Shari’a Boards
would outlaw investment in equities and the bond market is prohibited
because of the debt-based borrowing, devoted Muslims who own funds
would necessary be hoarding money, which is also forbidden according to
Islam.228 It is a balance act between different Shari’a rules, where most
Shari’a Boards agree on the fundamental values of Islamic finance but have
different opinions on the amount of variations allowed.
The Egyptian mutual fund market has expanded rapidly together with
other North African countries.229 Islamic mutual funds have expanded
even more than traditional funds on the market. Part of the reason for the
popularity of Islamic mutual funds is that the MENA economies offer so
few Shari’a permissible stocks in their local stock markets.230 The mutual
funds are excessively investing on the European and North American
227
Interview with Dr. Habil, Legal Counsel at Abu Dhabi Islamic Bank, Abu Dhabi UAE
(October 2001).
228 MOORE
229
230
supra note 6 at 77.
Id. at 72.
Id. at 80.
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stock market and not in their home economies. This can be explained by
the fact that domestic financial assets and liability structures are not diversified. The diversification and development of the domestic stock market
depends largely on the financial strength of contractual savings, insurance and pension funds which accumulate large amounts of long term
financial resources. In Egypt the total assets of such institutions are 30 %
of GDP which is characterized as an underdeveloped market. Poor countries have underdeveloped contractual savings markets in general, because
of low income levels, but even a poor country can influence the development in some ways.231 Egypt has unfortunately not done that. It has
badly managed social security systems and has a depreciating currency,
which hinders the development of contractual savings and in the long
run the development of the stock market.
5
Some reflections and concluding remarks on
Islamic banking
5.1 Concluding remarks and reflections on the future
of Islamic investments
Shari’a has for centuries been weaker in the legislation of the Arab world
than its actual role in society. This also goes for economic principles, such
as the charging of interest, enshrined in Shari’a. Today the situation is different. Political pressure in many Arab countries have led to the revival of
Shari’a principles in judicial circles and the popular demand of Islamic
banking services has contributed to the success of them and other investment opinions, such as Islamic equity investments. The development in
Egypt is especially important because of the similarity of the legislation in
Egypt and other Arab jurisdiction whose codes are inspired by the Egyptian ones and where consequently the Egyptian jurisprudence is of uttermost importance.
231 Al Saadauy Nermine Ibrahim, Banking fragility: cuases (sic!) and indications with application to the Egyptian banking sector during the period 1980–1997, 31–32 (Spring 1997) unpublished MBA thesis, American University in Cairo (on file with the American University of
Cairo library).
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Some consequences of the Islamic wave is the legalization attempts of
Shari’a in Egypt. A problem for the government surfaced when they shifted from a conciliatory strategy to a strategy of confrontation with the
religious forces in the country. The same legislation which was to legitimate the government’s position as the leader of the Islamic congregation
posed an obstacle when the government changed its policy and wanted to
legislate for a secular society. The concessions given to the Islamic movement which had strong support on grass root level were not as easy to retract as they had been to introduce. The constitutional principle of Shari’a
as the main source of law has functioned as an obstacle to changes in the
financial sector, where the government has tried to accommodate the
interests of global economic markets and liberalize financial regulations.
The government is in a difficult position because it cannot retract the concessions it has made to Islamic Shari’a in codification without being considered as against Islam. The Supreme Court has followed government
policy and been reluctant to handle over more fields of legislation to the
proponents of Shari’a. This creates a gap between the Supreme Court and
government on one hand and the constitutional principles and will of the
majority of the population on the other hand. A number of judges on
lower levels continue to ban interest for example, even if they know that
their sentences will be quashed on appeal.232, 233
The Egyptian government has learned from the collapse of the Islamic
investment houses in the late 1980s the importance of having legislation
governing financial investments but the question remains how to accommodate the special needs of the Islamic banking sector into the conventional finance sector. The Islamic banks in Egypt have received greater privileges in participating and owning companies than the traditional banks
but they have not taken this opportunity to be innovative in structuring
their range of products to accommodate the need for more PLS schemes
(trust finance) for all segments of the society. Another problem is how to
fulfill the demands from the global market and international organizations, like the International Monetary Fund, for free capital markets with232
Rudolph supra note 180 at 243.
A theoretical discussion about the role of law can be found in Ziad Bahaa-Eldin, Legal Constraints on the Role of Financial Regulators in Egypt (January 2001) at http://63.151.44.169/NE/
projects/financial/regulators/pdf.
233
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out restrictions, for bond markets and free currency trading and trade in
futures, all of them being instruments which are contrary to Shari’a.
Neither Egypt nor the UAE has solved this question. The financial markets are still largely governed by Western style legislation, even if the UAE
judiciary has made some attempts to conform their legislation with Islamic law.
The general development of Islamic banking is very structured. The
problems with different opinions from the Shari’a Boards, which could
have been a weakening and dividing factor has been solved and institutions are set up to deliver consistent Shari’a rules for investment. With
the emergence of a global regulative framework for Islamic investment it
will succeed in establishing the credibility which is necessary for its survival. The positive effects of the Islamic finance sector are that segments
of the large informal financial sector in most Arab countries are depositing their funds in Islamic banks, because many Muslims are not willing
to deposit their money in interest bearing accounts. The mobilization of
capital to investments can be said to be the most positive consequence of
Islamic banking, but it is up to the Islamic banks to use this opportunity
for enhancing the socio-economic goals.
Although the future seems bright when considering the asset growth
potential of Islamic banks, Islamic finance faces problems in developing
their products in the Western influenced global financial environment.
Most countries legislation is not tailored for Islamic products, as we have
seen in the case study for two countries. One interesting subject, which
must be left for further study, is the tax effect of Islamic investments. Most
Western tax systems give tax exemptions for interest payments on loans
etc. Islamically structured investments lack the possibility to benefit from
these tax benefits. It is interesting to see in the future how Islamic investment techniques develop to overcome the challenges posed by tax systems
and other legislation tailored after Western banking systems.234
234
See further at MOORE supra note 6 at 111.
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