Islamic Finance: Theory and Practice

Q.1: Please explain the difference between Riba al-Nasiyya and Riba al-Fadhl with
appropriate examples. Also provide the references from the authentic sources of Shariah to
differentiate the two?

Riba al-Nasiyya: Riba which is charged or paid against the borrowing or lending of money. It is also
called Riba of delay as the word ‘nasa’ come from Arabic word which means ‘delay’ or ‘defer’

 For example Ali needs Rs.100 from Ahmed but Ahmed agrees to give him on one condition that
Ali gives back Rs.120 when he will give back .The additional amount Rs 20 is Riba al-Nasiyya.
Here payment is deferred and paid on interest of Rs 20.

Prophet Muhammad (peace be upon him) said “Every loan that draws excess is Riba”,ahadith quoted
by Ali ibn at Talib (RA.A).

Anas ibn Malik narrated that Prophet (peace be on him) said: "If a man extends a loan to someone he
should not accept a gift." (Mishkat, op. cit., on the authority of Bukhari's Tarikh and Ibn Taymiyyah's al-
Muntaqa).

Riba al-Fadhl: The word ‘Fadhl’ is come from Arabic word which means “increment/increase”. It refers
to exchange or sale of same commodities in trade but quality and quantity is different where it may be
in increase of one quantity to another. For example exchange of good quality gold with low quality
gold’s.

'Ubada ibn al-Samit narrated that Prophet Muhammad (peace be upon him) said “Gold for gold, silver
for sliver ,barley for barley ,salt for salt ,wheat for wheat and dates for dates as like for like ,equal for
equal ,and hand to hand ; in case of different commodities ,you might sell upon your wish but the
exchange must be at spot(hand to hand).” [Muslim, Kitab al-Musaqat, Bab al-sarfi wa bay'i al-dhahabi
bi al-waraqi naqdan, #3853; also in Tirmidhi]

Q.2: Explain the exchange rules of Islam and its applications to modern currency exchange,
discounting of trade bills/ letters of credit and the concept of currency Salam?

Exchange rules of Islam:

Most of Islamic banking and finance product is based on the principle of exchange. The first evidence of
this rule/principle is come from the hadith of Prophet Muhammad (peace be upon him) from Abu
Sa'id ,when hazrat Bilal R.A. (companion of Prophet Muhammad (peace be upon him)) presented good
quality of dates to Prophet Muhammad (peace be upon him), He(peace be upon him) asked from
Bilal(R.A) where did you get these good quality dates then Bilal(R.A) answered, ‘I exchanged my low
quality two units of dates with one unit of high quality dates’.
 Prophet Muhammad (peace be upon him) said to Bilal(R.A.) ,‘this is Riba’, at same time Prophet
Muhammad (peace be upon him) explained to Bilal(R.A.) right method of doing. Prophet Muhammad
(peace be upon him) said sell your product in market on market price and then purchase your required
product with the price you get from selling inferior quality dates[Muslim, Kitab al-Musaqat, Bab al-
ta'ami mithlan bi mithlin; also Musnad Ahmad]

Another hadith of Prophet Muhammad (peace be upon him) mentioned the exchange of six
commodities which include gold, silver, wheat, date, barley, and salt. Prophet Muhammad (peace be
upon him) said if you want to exchange these six commodities you must follow the rule of ‘hand to
hand’ and ‘equal for equal’.
Many scholars opinion on Prophet Muhammad (peace be upon him) hadith and conclude that if you
want to exchange homogenizes product you must follow both principles (hand to hand and ‘equal for
equal’)
Sahih Muslim, Book 010, Number 3854: Abu Said al khudri reported Prophet Muhammad (peace be
upon him) saying: Gold is to be exchanged against gold ,silver against sliver, dates against dates, barley
against barely ,wheat against wheat and salt against as like by like ,amount being paid at spot. Whoever
took incremental amount or asked for increment on principle amount (additional), he dealt in riba. Both
parties (Receiver and Giver) are equally involved in guilty.

In case of heterogenic product, any two different commodities from six mentioned commodities like salt
against wheat or sliver against gold etc., then we should only follow one rule that is ‘hand to hand’
Sahih al-Bukhari, Volume 3, Book 34, Number 344: Umar bin al-khattab described that ‘the exchange of
gold for sliver is usually called Riba, except when exchange should be hand to hand.

Ubada ibn al-Samit narrated that Prophet Muhammad (peace be upon him) said “Gold for gold, silver for
sliver ,barley for barley ,salt for salt ,wheat for wheat and dates for dates as lie for like ,equal for
equal ,and hand to hand ; in case of different commodities ,you might sell upon your wish but the
exchange must be at spot(hand to hand).” [Muslim, Kitab al-Musaqat, Bab al-sarfi wa bay'i al-dhahabi
bi al-waraqi naqdan; also in Tirmidhi]

Applications to modern currency exchange

Modern sharaih scholar refers the paper money as like gold or silver. This is mutual consent decision of
OIC, issued in 1986 and organization of jurists. Sharaih view currency as medium of exchange, unit of
account and store of value.
Sharaih scholar said that gold and silver can be applied for any kind of currency it should be extended to
contemporary currencies. It means if we want to exchange rupees with $,Yen or other currency
,deficiency and excess is allowed but that exchange must be on spot .its means that Forex future and
Forex forward is not allowed in Islamic law. And when exchange homogenizes product as gold for gold,
rupees for rupees both should be at spot and equal to equal. Deferment is also not allowed in both
hetrogenizes and homogenizes product

Trade bills/ letters of credit

LC is basically letter of credit; here the responsibility of state is to provide grantee to both parties
(importer and exporter). For example, Pakistan bank gives grantee to exporter person on behalf of their
client. Islamic bank says that giving surety is subject of benevolence (any fee cannot be charged against
LC).This is issue here then Islamic bank do musharakah ,it means bank and client become partner and
then purchase the product and when product arrived then bank sold their ownership to client. For
example, total investment is 1million then bank give 50000 as a partner and client give 50000 and
purchase product from Canada .when product arrived bank take 50000 from client as to sell/transfer
their ownership (share) to clients.
Suppose that face value of bill is 1 million and today give me 4 lack (below face value).this is called trade
bill discounted .As per Islamic law trade bills not allowed because money should be exchanged on face
value .
Concept of currency Salam
In Arabic salam means ‘to advance’. It is trade based contract where a buyer paid in advance and deliver
of product will be postponed at future specific times.
In history, before banned of riba, farmer used riba based loan, for growing needs of crops but
prohibition of riba, salam transaction were allowed as an alternative to fulfill their needs. It’s basically a
form of forward contract where the pre determined payment is paid at time of establishing contract in
advance for specific goods to deliver them later.
When Prophet (peace be upon him) migrated from madina to macca where salam contract of two or
three year of time period is ordinary but there was issue that the sales were made without any
specification of weight, time of delivery ,quantity or quality.
The Holy Prophet(peace be upon him) said: “those who pays in advance(for fruit, to be deliver in future
)should pay it for known quality, specified measure and weight(of dates or fruits) and along with
price and time of delivery”
Salam Transaction by Islamic Bank
The bank will buy the goods from seller and with prescribed advance payment and agreed to deliver
goods on specified date. The seller deliver goods to bank on which date is specified and then the bank
sell that goods to third party on credit and make delivery to third party with
signing promising note against credit payment that agreed to pay on specified
time.

Some of Islamic bank is used a currencies as an alternative of bill

discounting .AFFOI and state bank of Pakistan banned currency salam as it should be on spot

Q.3: Discuss the concept of money and modern paper currencies from Islamic point of view.
Also discuss the concept of Fuloos and Fiat money and difference of opinion among Shariah
scholars on it?
In Islam, money is used or performs as social-role and it should be used to promote in favor of benefit of
whole community.
“…and give them from the wealth of Allah which He has given you.”[Qur’an 24:33]
Concept of Money
In conventional economics, there are four characteristic of money
1. Medium of exchange
2. Unit of account
3. Store of value
4. Commodity
On other hand Islamic finance only accepted first three characteristic as Islamic finance claimed money
is not a commodity because money has no intrinsic value, it can be exchange for commodities (goods
and services)
The medium of exchange means that it is generally accepted payment for any goods/services. It can’t be
rent out or sold to create additional/surplus value by itself that’s the reason money is consider as
medium of exchange. The unit of account means that it has ability to keep track of asset worth and can
have capability to purchase expensive assets as well as cheap assets. Over passage of time the form of
money have various types of form that may be used as metallic money to paper or electronic money.
Now’s a day fait money is used around the globe.
Concept of Fuloos and Fiat money .
Fuloos currency is made of inferior material like metal etc. Some scholar said rupees or paper currency is
like fuloos because they are made of inferior quality. AAOIFI rejected this claimed because at the time of
Prophet, gold and silver is standardized currency and paper currency is also standardized currency and
having legal tender. It also considers as fait money as government say it has a value and having two
main characteristic which involve money instrumental value is high and intrinsic value is less and like
treated as gold and silver. The principle of exchange of gold and silver can apply on any currency that
may be plastic or electronic that has legal tender and standardized
Shariat Appellate Bench of Pakistan’s state that today’s paper money is almost consider as real natural
money as its equal in subject matter of exchange and provide same facilitation and has credibility
feature of past gold and silver coins.
Islamic Fiqh Council of the OIC also has same opinion on paper money as it’s like real money in the light
of shar’iah rules of exchange.

Q.4: Read carefully and summarize the AAOIFI standard on “currency exchange”?
AAOIFI standard highlight the issues of constructive and actual ,both of possession of currencies as
currency trading in modern world, and exchange of currency regarding the subject matter relating debt,
money market, promise of selling and purchasing of currency and delay of delivery on both sides of
parties
It is permitted to trade in currencies accordance with following sahraih rules and principles which are:
 Before disseminate, the both sides of parties must take ownership (possession) of the counter
values that may be either constructive or actual and counter values must equal in amount
having same currency and contract is not liable on any deferment of delivery on both sides of
counter values. The contract shall be made on fair and loyal intentions without any evil
intentions or any unjustified interest.
 The transactions should not be executed on forward/future market as it is not permitted to
enter such forward/future currency contracts regardless the purpose is to manage the risk (loss
of profit) on contract transactions. To deal with risk managing, Islamic sharaih allowed to used
hedging from preventing devaluation of currency that require interest free loan and without any
extra benefits regarding execution in different currencies. It is also permitted for institution that
clients can made re-payment of a credit transcation on installment in another currency but it
should be on spot at specified exchange rate on payment day.

The sales of currencies are permit to accordance with following sahraih rules and principles which are:

 At the point of closing transactions, the ownership must be taken for total amount of currency
and if both parties take possession as a part, is valid only if it’s in respect of part. Other part of
transcation is considered to be invalid. The possession should be in form of physical (by hand at
the time of delivery) or constructively (possession taken is not physical).

The sales of currencies are permitted to accordance with following sahraih rules and principles which
are:
 Islamic sharaih allowed owner to appoint an agent on their behalf to execute currency sale
contract and give authority to take ownership and deliver the contract of counter values. The
agent can also sell currency without taking amount sold possession before elimination of
principal parties and contract.

The Use of modern means of communication for currency trading is permit accordance with following
sahraih rules and principles which are:
 In promising contract, when two parties grabbing possession of their counter values at specified
time period with modern means(that is prescribe) of communication at different remote areas
has same obligations consequences as in one place at time of executions.

The Bilateral agreement to sell and purchase of currencies are permit accordance with following
sahraih rules and principles which are:
 The promise between both parties to sell or buy currency is not allowed/banned even its
unbreakable or even the purpose is to minimize the risk of devaluation of currency. Also parallel
buy or sale of currencies not allowed as there is no delivery or receipt is bought or sold of two
currencies .In Musharakah or Mudarabha ,both parties can’t give guarantee for safeguarding the
latter in high risk currency dealing matters, only third party can volunteer provide grantees .
References
 https://islamicmarkets.com/education/riba-in-hadith
 https://sunnah.com/bukhari/3
 https://sunnah.com/bukhari/34/148
 Supreme Court of Pakistan. The Text of the Historic Judgment on Interest [1999; exact date: 14
Ramadan, 1420]
 http://www.stopprintingmoney.com/Learning/What_is_Money/
 https://www.linkedin.com/pulse/concept-money-islamic-economics-mudhakkir-abdul-cife-/
 https://www.youtube.com/watch?v=UZ6bDatDwnI&t=55s&ab_channel=MarifaAcademy
 Alfatakh, Amir (2008-01-23). "Financing : Bai Salam". Islamic Bankers Resource Centre. Retrieved
2017-08-19.
 Sharaih standards Rules