In the Rapid Devolvement of ever complex Islamic Financial Products and Instruments

By: Elwaleed M. Ahmed

Elwaleed M. Ahmed is a legal Consultant, Head of Foreign Affair Department at Kuwaiti lawyer Firm- “KLF” (Yaqoub Y Al-Munayae & Partners) in Kuwait. KLF is one of the leading law firms with regard to Islamic Financial Transaction in the (GCC) Region. Elwaleed had legal experience in the US and participated recently as a leading legal consultant in Multi-National Islamic Musharaka Sukuk Transaction equal “Two Hundred Million Dollar” in Kuwait. Mr. Elwaleed as Legal
practitioner& researcher in the field of Islamic finance published many articles about Islamic finance & Participated as speaker in international Conferences about Islamic Finance Issues such as discussion leader at the 3rd Annual World: Islamic Funds & Capital Markets Conference in Bahrain May 2007 and as Speaker at Islamic Finance and Investment Europe 2007-London-UK June 2007. As US Citizen Elwaleed hold Bachelor’s of “Sharia & Law” Islamic law from Sudan & LL.M degree “Master of laws” specialized in Islamic investment” From Temple University school of Law, Philadelphia-Pa USA.


Sharia law is open to interpretation and religious boards frequently hold different views on key sharia issues. Furthermore, Islamic jurisdiction is not bound by precedent and legal opinions may deviate from previous decisions made by other sharia scholars Thus, sharia board has considerable discretion in the interpretation of Islamic law and may choose any other school of thought to inform their decision-making process. 

Even though, sharia is certainly dynamic and like all jurisprudence, opens to level of interpretation but lack the center level of standardization of Sharia board’s ruling and that is one of the challenges facing the global acceptance & growth of the Islamic finance. Because, there is no consistent ruling of Islamic law on the religious compliance of the eligibility of certain assets and transactions structures to sharia law.

Thus, Sharia boards from different Islamic financial institutions may have different interpretations and advise differently because, in Islam, there is no generally accepted codification of the jurisprudence and that will lead to uncertainty and confusion.

In this article I will mention the basic principle of the Islamic finance, define the role of sharia board’s in the Islamic financial institution and the absence of standardize sharia board’s ruling on the national and international level lead to negative effect on the growth and acceptance of the global Islamic finance. Furthermore, I will high-light the necessity of the existence of unified Sharia board in the national and international levels and I will state my recommendation about how sharia board should function to achieve the harmonization and configuration among sharia board ruling in the global level and to develop new Islamic finance instruments.

The Basic Principle of the Islamic Finance: –
In order for sharia board to approve any of the Islamic financial institution’s activity it must be in full conformity to the following Islamic finance principle: – 

1: Prohibitions Against Charging Interest (Riba):
One of the basic components of the sharia that affect economics is the prohibitions against charging interest or riba. Because, according to sharia, money is not a commodity which can be traded nor does it have value over time if it is not used. Interest is therefore considered to be unearned income and unjust.

2: Investors Sharing in the Profits and Losses: The fundamental principle in Islamic investment is that no one wishing to earn a return on money has any rights to retain the initial sum intact. Accordingly, since interest income is not permissible under sharia, any return on invested money should be earned from the profits of an investment. The Muslim investor or lender therefore becomes a partner in the investment rather than a lender, sharing in its profits and losses in proportion to the amount of capital and effort he contributes to it. In Islamic finance, there is no guarantee of a fixed return or a profit. The investor’s share in the profits is the reward for his effort and the risk which he bears. Thus, all wealth creation in Islamic investment should result from a partnership between the investor and the user of capital in which rewards and risks are shared.

3: Investments must be in Ethical Sectors & Sharia Approved Activities: Sharia requires that investments must be in ethical sectors and prohibits Investments in gambling or investing in businesses which purchase alcohol, pornography or pork products, since these are against Islamic law.

4: Prohibition of Speculation and Uncertainty in A contract (Gharar): Uncertainty “Gharar” is a sophisticated concept that covers certain types of uncertainty or contingency in a contract. Therefore, Sharia prohibits speculation and gambling. For example, futures, options, and swap contracts are not generally permissible because the return from such investments relies on the occurrence of events which may or may not take place and are therefore uncertain. Thus, an Islamic contract must be concluded by both parties with full knowledge of all the terms. Any type of transaction where the subject matter, the price or both are not determined and fixed in advance by the parties will not be permitted under Islamic law. Conclusion: Islamic law does not object to payment for the use of an asset, and the earnings of profits or returns from assets are encouraged as long as both lender and borrower share the investment risk together. Profits must not be guaranteed based on assumption, and can only accrue if the investment itself yields income. Hence, Islamic finance literally outlaws capital-based investment gains without entrepreneurial risk. Moreover, building upon these basic Islamic investment principles and contractual forms, Islamic financial institutions should develop a wide range of products and investment structures to meet the demands of increasingly wealthy Islamic investors.

The Absence of Standardize Sharia board’s Ruling on the National and International level lead to Negative Effect :-
1: Uncertainty and Confusion
The absence of a universally accepted central religious authority because of the lack of uniformity in religious principle applied in Islamic countries. Inconsequence, Since Sharia board at individual banks actually defines what is and is not Islamic banking. Therefore, transaction will be interpreted differently and that will lead to identical financial transaction will be interpreted differently from one Sharia board to another and that will lead to uncertainty about what is the acceptable way to do business in Islamic banking and finance systems, which in turn will complicate the assessment of risk for both the financial institution and its customer. Therefore, the way Sharia advisory boards of Islamic financial institutions function remains a source of confusion. 

2: The Inability of one Islamic financial institution to Copy another Islamic financial institution’s Products.
The difference of interpretations of Sharia laws, which lead to the inability of one Islamic bank to copy another Islamic bank’s products and this, will effect the growth and integration of Islamic finance in the national and international level.

The Need for Standardization of the Sharia Board’s Ruling:-
There is a need for setting up Sharia board at global and central banks level, so as expedite and perhaps assist in developing some standard guidelines for conducting Islamic financial transaction. Furthermore, there is a need for conformity or similarity to extend possible in concept and application among Sharia supervisory boards of Islamic financial institutions to avoid contradiction and inconsistency between Fatwa “Sharia Board’s Ruling” and the application by these institutions with the a view to activate the role of sharia supervisory boards of Islamic financial institution. 

Moreover, there is a need for mutual recognition of financial standards and products across jurisdictions. The progressive harmonization of Sharia, in this respect, needs to be viewed as a driver towards greater international financial integration. On the other hand, the national and regional oversight and regulation will be necessary to guard against the potential for improper practices which could cast doubt on the credibility of all participants. Therefore, Sharia scholars from around the world should contribute towards greater understanding and international convergence and such a convergence and harmonization can only happen with greater engagement among the regulators, practitioners and scholars in Islamic finance in the international community.

Therefore, there is a necessity of the existence of unified Sharia board in the national and international levels by forming a uniform council representing different Islamic schools of thought so as to decide what types of financial services are conforming to the Islamic law, to define cohesive rule and to expedite the process of introducing new product.

Necessary Steps for Promoting Global Standardization for Islamic Finance Instrument’s Standards:-
1: The Adoption of (AAOIFI) Standard:
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has taken a lead by preparing Sharia standards which a number of government authorities and central banks in certain countries have circulated these standards and obliged other financial institutions to comply with them by recognized these standards in their regulatory framework. That is why any party wishing to incorporate or set up an Islamic financial institution should be required to conform to these standards in order to avoid confusion, misunderstanding, and ambiguity, and to seek clarity and sound business activities. Thus, the adoption of these standards in other countries will pave the way not only for Sharia compliance but also product innovation. 

2: There should be cooperation and collaboration among major Islamic Financial institutions in the Global level and Central Banks in Islamic Countries to adopt common standard:
There should be cooperation and collaboration among major Islamic financial regulatory bodies such as Islamic Financial Services Board, The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and central banks in Islamic countries in developing international standards that can be universally applied. Moreover, there should be a collective effort with great international collaboration so as to contribute towards strengthening the fabric of Islamic finance.

Different Opinion of Sharia Board’s Ruling Will Bring More Innovation and Give Room for Variation in Islamic Finance Instruments:
On the other hand, some sharia scholars argue that Islamic finance is traditionally flexible. Flexibility is one of its major strengths. It means there can be a broad variety of products tailored to suit the client’s needs and there is a need to provide Islamic remedies without compromising Sharia principles. Thus, the different opinion between sharia board and other is good, because they bring more innovation and give room for variation in products that is essential in dynamic markets like the financial markets. Furthermore, there should be Sharia counseling: independent Companies offering consultation on sharia matters instead of having sharia board in each financial institution. 

Sharia boards; In the Islamic financial institutions Its Functions and roles:-
1: As Advisory to the Islamic Financial Institution:
Sharia Board, consisting of an Islamic scholar, who acts as advisory council to the official of the Islamic financial institutions with regard to the conformity of the Islamic financial institution’ activities to Islamic law. 

Thus, the sharia boards should review proposed financial transactions to confirm it to Islamic principle. Furthermore, Sharia Board shall also advise on the procedures for rectification of any error and purification of any gains which may be earned by it from sources that are later determined to be not compliant with the principles of Islamic Sharia.

On the other hand, Sharia board resolutions should be binding upon the financial institution’s management. Therefore, Islamic financial institutions’ managements are obligated to follow the decision made by their Sharia Boards when the product proposed or during the operational process.

2: Sharia Boards Should Provide Continued Supervision and Auditing to the Islamic Financial Institutions Transactional Procedures:
Sharia boards should provide continued supervision and permanent checking of contracts, transactions, and procedures carried by the Islamic financial institutions. Thus, Sharia Boards auditing of the operations of the Islamic financial institutions is very important to ensure that the actual practice complies with the requirements of Sharia. Furthermore, the sharia board as a whole should provides guidance and oversight through periodic assessment of the Islamic financial institutions’ program activities.

On the other hand, the financial institutional management should refer back to the Sharia board whenever there is a deviation to ensure that no inadvertent breach of Sharia or the compliance certificate has occurred. Therefore, sharia board should certify every product to ensure strict adherence to the principles of Sharia.

3: The Sharia Board should Supervise and Actively Participate in the Creation of Innovative Sharia-Compliant Investment and Financing Products and Services:
The Sharia Board should actively participate in developing and overseeing the financial institutions products. Thus, the Sharia advisory board works closely with the bankers and lawyers to structure instruments so that they meet Sharia and commercial requirements. Moreover, Sharia boards should be in continuous dialogue with economists and bankers to assess the feasibility of new proposals and assisting in project development and execution of new financial products in compliance with Sharia principles. Furthermore, sharia boards in its investigatory role should endeavours to answer the question whether or not proposals for new transactions or products conform to the Sharia, and offers constructive and creative recommendations. Therefore, the Sharia Boards essential role is to supervise the development and creation of innovative Sharia-compliant investment and financing products and services in collaboration with economists and bankers in the Islamic financial institutions.

Sharia Supervisory Board plays a vital role in guiding, supervising the implementation and compliance of Islamic Sharia principles in all Islamic financial institutions activities. Thus, the religious boards have both supervisory and consultative functions.

Recommendation on How to Improve Sharia Board’s Function
In Innovating and Developing New Product
And Achieving Global Standardization for Islamic Finance Instruments:-
1: The Sharia Boards need continue Training about Economics, Investments and Legal Issues Related to the Investment & Product Innovation:
There is a strong need for training for sharia board staff about economic and legal issues related to Islamic investment. The lack of knowledge about modern economic and legal issues puts a serious constraint on the ability of Sharia scholars to issue well-informed rulings on financial products and investments activities. Thus the training should include the discussion of these issues in meetings/workshops attended by both Sharia scholars and financial experts and experienced Bankers. Therefore, Sharia board’s staff should have knowledge about the financial environment and its operation. 

On the other hand, sharia scholars should educate the existing bankers and practitioners about Sharia principle, so they can easily understand and implement the sharia principle and the board’s ruling in their daily operations in a manner, which is explained to them by the Sharia scholars.

2: The need for specialized sharia board
Rather than maintain one Sharia Supervisory Board in the Islamic financial institutions for all of its activity, the Islamic financial institutions should form specialized Sharia scholars as a separate Sharia Board for each of its projects. This way, Sharia scholars are convened with more efficiency to work on projects best suited to the particular areas of their expertise. This process will ensure that the right scholars, in the right numbers so as to develop, certify and supervise the financial products and services endorsed by the Islamic financial institutions.

3: The Sharia Board should be Independent from the Financial Institutions:
The Sharia board members should be independent from the Islamic finance institution and not an employee; they should be independent and free to give opinions on proposed contracts and transaction. Just like the independent auditing firms to insure transparency and efficiency in their auditing and supervising of the financial institution transaction and activities.

4: Sharia Board should Work closely with the Bankers & Lawyers so as to develop new Islamic Financial Instruments:
Sharia boards should be in continuous dialogue with economists, bankers and lawyers to develop new financial products in compliance with Sharia principles. For Sharia boards To reduce the gap with the business world there is a vital need for active and continued participation from sharia boards with banking practitioners with regard to the innovation and developing of new Islamic financial product.

5: The sharia scholars are over Stretched:
The sharia scholars need to devote time and effort to devising more Sharia-compliant transactional procedures. There is a need for training to more new sharia scholar so they can have more time engaging with economic and investment practitioner to develop new Islamic financial products. Because, now there is a shortage of well- trained sharia scholar as a result there are only few well-known Sharia scholar working as sharia advisor for many financial institutions at the same time. Therefore, they will not be able to devote enough time and effort for new products’ innovation.

6: The Co-operation between the Financial Institutions Management and Sharia Board:
An Islamic financial institution is required to establish operating procedures to ensure that no form of investment or business activity is undertaken that has not been approved in advance by the religious board. Moreover, the management is required to periodically report and certify to the sharia board that the actual investments and business activities undertaken by the institution confirm to forms previously approved by the religious board.

7: The Best Way for Sharia Boards to Do its Work?
For active participation from the Sharia boards in overseeing of the activities of the Islamic financial institutions there should be:

1:In-house Sharia officers or advisers who will make an early inspection into the financial products. They will check on whether the concepts of the products are fully implemented according to Sharia. They will also ensure that the process flow of the products is in line with Sharia.

2: All standard contracts should be reviewed thoroughly where a need to discuss them with lawyers may arise to determine that all the crucial Sharia requirements can be fitted in the standard contracts and at the same time abide by sharia board ruling. Thus, the determination, alertness and Sharia qualification of an internal Sharia officer is a vital factor in ensuring the clean operations of the Islamic financial institutions