Article Review on Islamic Law and Finance

By: Shadman Shakib

Student ID: 2200155

Assignment 1

Course: Commercial Law and Legal Documentations for Islamic Financial

Services (SH 5053)

Lecturer: Associate Professor Dr Aishath Muneeza

Semester: September 2023 Semester

 Key Summary

The article "Islamic Law and Finance" represents an in-depth study of the relationship
between Islamic law and financial engagements, specifically on Islamic financial contracts.
The Article emphasizes the inherent differences between Islamic financial structures and
conventional finance, particularly regarding their convenience with Islamic law. The author
contends that Islamic finance presents a unique methodology for leading financial
transactions, distinguished by its distaste for interest (Usury) and focus on profit and loss
sharing (PLS). The historical origins of Islamic law provide the fundamentals for the nature
and various sorts of Islamic financial contracts.

The study focuses on the importance of Sharia Advisory Councils (SAC) in ensuring
adherence to Islamic principles in financial transactions, representing a dedication to ethical
and fair procedures. The article scrutinizes the legal rights and safeguards in Islamic finance,
highlighting the differences from interest-based systems and emphasizing the necessity for a
framework that better follows the aims of Sharia law, also known as Maqasid-al-Shariah
(Main Objectives of Shariah).

The authors said that the existing procedures in Islamic Financial Institutions only partly
adhere to the traditional appearances of Islamic contracts. The article proposes reforming
financial institutions, highlighting the unique feature of equity-based financing in Islamic
systems. This new framework aims to fasten a two-way mindset and ensure fair, valid, and
balanced economic development, which is essential for achieving Islamic finance's
objectives. The author's advice advocates adherence to religious principles and a strategic
approach to tackle current economic difficulties, thereby improving the attractiveness and
effectiveness of Islamic financing worldwide.

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 Key Findings of the Article
The article suggests an intrinsic connection between law and finance, as contracts are shaped
by legal rights and procedures to ensure their execution. A well-functioning legal system is
essential for markets and financial intermediaries to function effectively, enhance resource
allocation, and foster economic growth. The text also examines the evolution of financial
intermediaries within the context of legal and regulatory frameworks, with a specific
emphasis on Islamic law and its historical background. This includes exploring contracts such
as the sea loan and commend contracts.
The complex and diverse connection between finance and economic growth underscores the
significance of legislation in finance. The article explores many notions, including the
concept of "flight to quality" and the contrasting perspectives on financial development
between banks and enterprises' balance sheets. The article emphasizes the implication of legal
systems in safeguarding investors and inducing corporate governance, affecting financial
progress. The authors additionally examine the problems encountered by transitional
economies in establishing financial intermediation systems because of inadequate lawmaking
frameworks.
The author endeavored to create Islamic law based on fundamental texts such as the Quran
and Sunnah, which substantially influence financial contracts. For these contracts to be
considered genuine, they must adhere to Shariah principles. The authors also examine
financial mechanisms such as Mudharabah, stressing the fundamental principles of
collaboration and shared risk that form the basis of Islamic financial agreements. The
meaning of Mudharabah is clearly stated, and the article also provides a particular
explanation of the term "payment" concerning "Non-Performing Loan."
Islamic law grants specific rights and safeguards in matters related to financial transactions.
Under Islamic law, contracts are legally enforceable between the parties involved, entailing
specified duties and entitlements. The Mudharabah contract delineates the roles and
obligations of the funding provider and the entrepreneur. The author also explores the
distinctions between Islamic finance and conventional systems, specifically highlighting
Islamic banks' distinct governance processes and compliance with Islamic law. These
encompass methods for sharing profits and losses and participating in equity.
The governance framework of Islamic finance is shaped by Islamic legal principles and the
specific requirements of the Muslim community, which diverge significantly from traditional
banking systems. Islamic banks adhere to a framework that prioritizes communal morality

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and spirituality, influencing their financial and investment decision-making processes and the
interactions between the bank, depositors, and businesses.
Although Islamic contracts have theoretical benefits, their actual implementation encounters
substantial obstacles. This encompasses challenges in effectively adopting processes that
adhere to Shariah principles and facing competition from traditional banks.
This article also examines the hazards linked to profit-and-loss sharing contracts and the
constraints imposed by legal systems. Furthermore, concerns regarding contracts, such as
Murabaha, which unintentionally resemble interest-based funding, are emphasized. The
utilization of Islamic contracts exhibits variation throughout countries, wherever diverse
financing contracts prevail in distinct locations. Malaysia largely depends on Bai Bithaman
Ajil (BBA) and Ijarah contracts, while Indonesia engages with Musharaqah and Mudharabah
contracts. The article suggests that legal frameworks, financial structures, and understandings
of Islamic laws influence the frequency and efficacy of various forms of Islamic finance.

Analysis of the Findings

The article emphasizes the significance of equity-based financing in Islamic economics,

explicitly focusing on partnership modes such as Musharakah and Mudharabah. These modes
involve the sharing of risks and gains. Debt-based funding is less aligned with authentic
Islamic economic principles than this strategy. Malaysia primarily relies on non-equity forms
such as Bai Bithaman Ajil (BBA) and debt-based contracts. The presence of both Islamic and
conventional banking systems can limit this choice due to the competitive environment they
create.
To retain the interest of customers and depositors, Islamic banks frequently modify their
offerings to align with or surpass the profits generated by traditional banks, all while adhering
to Shariah principles.
The article recommends that countries adopting Islamic finance prioritize equity-based
financing. Equity-based financing exists because there is less competition from conventional
banking, which allows for the developing of a more authentic form of Islamic finance.
The essay posits that although they lack voting rights, depositors under Mudharabah contracts
might be considered 'quasi-shareholders.' They provide financial resources like
shareholders, but their involvement in managerial choices could be enhanced. Due to its
distinct stance, it is necessary to carefully evaluate regulatory and institutional factors

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to guarantee fairness and transparency. To protect the interests of depositors and promote
transparency in Islamic financial institutions, it is necessary to make institutional alterations
to accommodate the non-voting characteristic of Mudharabah. Non-voting characteristics
hold significant importance within the framework of risk-sharing and profit-sharing concepts
fundamental to Islamic banking.
In Malaysia, as of 2005, the proportion of equity-based finance (Musharakah and
Mudharabah) was less than 10% of the overall financing products. In contrast, Indonesia
exhibited a more significant proportion of these contracts in 2007, with Musharakah
accounting for 15.8% and Mudharabah for 20%. Pakistan accounted for 27% of the total
equity-based funding in the same period. These data show the various levels of application
and acceptance of Islamic financial principles across different Muslim countries.
The utilization of Incentive-Based View (IBV) and Knowledge-Based View (KBV) affects
Profit and Loss Sharing (PLS) financing. Loan-to-Deposit Ratios (LDR) and Financing-to-
Deposit Ratios (FDR) offer valuable information regarding the effectiveness of Islamic
banking operations. For example, Malaysia's FDR was approximately 40%, whereas
Indonesia's FDR averaged around 100%. This ratio suggests that Islamic banking in
Indonesia is more closely connected with actual economic activities than Malaysia's.
The need for innovative regulatory and institutional adaptations, such as the 100 percent
reserve system, gold dinar system, and the promotion of PLS Financing, can be implemented
against the Fiat money system, Fractional Reserve system, and the main objective of shariah
(Maqasid al shariah). These adjustments are crucial for reconciling the differences
between Islamic financial concepts and the operational methods of contemporary banking,
thus enabling the crucial and effective implementation of Islamic contracts in a competitive
setting. When economies shift towards Islamic finance, these difficulties indicate the need for
a careful strategy. Policymakers and financial institutions must focus on collaboratively
connecting Islamic financial products into their systems while also tackling the inherent
conflicts and compliance difficulties that may arise.
The journal article emphasizes the necessity for Islamic financial institutions to alter their
long-term planning and offerings to balance Shariah compliance and competitive pressures in
markets where they operate alongside conventional banks. The article's data and examples
demonstrate the various methods and degrees of achievement in adopting Islamic finance in
different countries, which are influenced by legal, cultural, and economic variables.

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 Opinion
After a thorough review of the article "Islamic Law and Finance," I have formulated an
opinion that appreciates the positive aspects of the article while also acknowledging areas for
improvement.

Positive Aspects:

Comprehensive Coverage of PLS Instruments: The essay extensively analyzes PLS

instruments, specifically focusing on mechanisms such as Mudharabah and Musharaqah,
which involve profit and loss sharing. This highlights their capacity to embody authentic
Islamic economic principles, providing a comprehensive comprehension of these equity-
oriented financing instruments.
Comparative Analysis: The analysis of countries that have embraced Islamic finance
principles, such as Malaysia, Indonesia, and Pakistan, provides valuable insights. This
comparison offers a comprehensive view and highlights the different levels of adoption and
difficulties among countries.
Insights into the Efficiency of Islamic Banking Operations: The paper effectively
emphasizes the necessity for precise regulatory and institutional modifications in Islamic
finance. The emphasis on this aspect is vital for improving the safeguarding of depositors,
guaranteeing clarity, and adhering to the principles of risk-sharing and profit-sharing that are
fundamental to Islamic finance.
Addressing Contemporary Challenges: The analysis of the Incentive-Based View (IBV)
and Knowledge-Based View (KBV) in connection to the Loan-to-Deposit Ratios (LDR) and
Financing-to-Deposit Ratios (FDR) provides useful insights into the operational efficiency of
Islamic banks. This methodology is especially beneficial for comprehending the intricacies of
Islamic finance in many economic contexts. The post addresses current difficulties such as
the Fiat money system and Fractional Reserve system. Introducing novel alternatives such as
the 100 percent reserve and gold dinar systems provides useful concepts for reconciling
Islamic financial precepts with contemporary banking practices.

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Areas for Improvement in the Article:

Inadequate Focus on Debt-Based Modes: While the article brilliantly details Musharaqah
and Mudharabah, it overlooks the potential of debt-based modes like Murabahah, Salam, and
Istisna in helping Islamic finance and law. These contracts also play a significant role in
Islamic finance and could offer a more widespread view of the field.
Lack of Real-World Legal Conflict Examples: The article could have been enriched by
discussing instances where national laws conflict with Islamic law, particularly in banking
disputes. Such examples would have provided practical insights into how Islamic finance
operates within diverse legal systems.
Overlooking Depositor Attitudes Towards PLS Accounts: The article needs to explore
why depositors might be hesitant towards Profit and Loss Sharing accounts. Including
depositor perspectives could offer a more rounded understanding of the challenges in Islamic
banking.
Need for More Practical Examples: The article could benefit from more real-world
examples to illustrate concepts like the Commenda Contract, the Transplant Effect, and Flight
Quality. This would aid in better understanding the practical application of Islamic financial
principles.

Ultimately, the article provides a comprehensive and enlightening perspective on Islamic

Law and Finance, particularly in its examination of equity-based financing and the
importance of regulatory factors. However, it might be enhanced by specifically targeting the
aforementioned areas.