Mohd Johan Lee
J. Lee & Associates
For Kowloon Mosque & Islamic Centre
ISLAMIC FINANCE & TAKAFUL:
AN INTRODUCTION
(c) Mohd Johan Lee 2012
3/17/2012
OUTLINES
Sources of the Shariah
 Framework of Islamic Finance
 Shariah, Fiqh & Mu’amalat
 Necessary Requirements of Islamic Finance
 Riba, Gharar, Maysir & Others
 Essential Contracts in Islamic Finance
 Products and Instruments

2
(c) Mohd Johan Lee 2012
3/17/2012
SOURCES OF THE SHARIAH

Primary Sources
 The
Holy Quran
 Sunnah
(the sayings, deeds and endorsements of
Prophet Muhammad PBUH)
3
(c) Mohd Johan Lee 2012
3/17/2012
SOURCES OF THE SHARIAH
•
Secondary Sources (mostly by the exercise of Ijtihad
(reasoning by the learned))
 Ijma (Unanimous decision of the Ulama)
 Qiyas (analogy)
 Istishan/ Istihab (equity in Islamic law)
 Maslahah (necessity of the people)
 Surdul Dara’ih (Blocking the means)
 U’ruf (custom)
4
(c) Mohd Johan Lee 2012
3/17/2012
FRAMEWORK OF ISLAMIC FINANCE




In general, the framework of Islamic finance is the same
framework used by the conventional finance practices.
These frameworks are, inter alia legal and regulatory
framework, taxation framework, accounting and auditing
standards, etc.
Might have different or additional framework, such as
accounting and auditing standard, etc, due to its peculiarity.
In certain jurisdiction, Islamic banking and finance might be
regulated by different sets of regulations, either separate or
additional, e.g. IBA 1983
5
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D
However, Islamic Finance, as the name
suggests, has another framework, which is
considered the major element that
differentiates IBF from the conventional
banking and finance.
 Any violation of this framework will definitely
effect the validity of Islamic finance itself.
 Shariah Compliance Framework

6
(c) Mohd Johan Lee 2012
3/17/2012
THE SHARI’AH FRAMEWORK OF ISLAMIC
BANKING AND FINANCE
Three main interrelated terminologies: Shariah,
Fiqh & Muamalat
 Shariah, when viewed from legal perspective is
the fixed elements of Islamic law, i.e. what has
been clearly stipulated and mentioned in the
text. E.g. five time prayers, prohibition of riba’,
etc.
 As such, it is revealed in nature

7
(c) Mohd Johan Lee 2012
3/17/2012
SHARIAH & FIQH






Shariah, in this sense, is wide and encompassing various
branches of Islam
Normally, it comes in its generality and it emphasizes only
on the principles and not the detailed rules (not all the time)
It is the duty of the judge (qadi), mufti and jurisconsult
(ulama’) to exert their intellectual efforts in deriving and
applying these principles on certain given scenarios.
The result of human reasoning and understanding to the
shariah is known as fiqh
Fixed v. Flexible
Agreements v. Differences
8
(c) Mohd Johan Lee 2012
3/17/2012
FIQH MU’AMALAT (ISLAMIC COMMERCIAL
LAW)



However, in its general usage, it is called al-syariat al-Islamiyyah
(Islamic law).
Islamic commercial law is one of the components of Islamic law
Other components of Islamic law include:






Islamic law of purification and worship
Islamic family law
Islamic criminal law
Islamic law of evidence and procedure
Islamic law of inheritance, etc
The main subjects of Islamic commercial law are commercial
contracts and the rules governing them
9
(c) Mohd Johan Lee 2012
3/17/2012
ISLAMIC FINANCE PARADIGM

Original rule of permissibility:
- Initial legal ruling in commercial contract is permissibility
- Contrary to acts of devotion (Ibadat)
- No legal injunction is needed in sanctioning new contract
- Every contract is considered lawful and acceptable if no
principle of shari’ah is violated
- Open a very wide door for further innovations


Real Economic Activities
Transactions-oriented not loan-based.
10
(c) Mohd Johan Lee 2012
3/17/2012
WHAT AMOUNTS TO SHARI`AH
COMPLIANCE?



In Islamic jurisprudence, the main source of law is the
Shari`ah or Islamic law as contained in the Quran and
Sunnah
Underlying rule: all contracts are deemed permissible
except when there is contravention of any established
principles of Islamic law / Shari`ah
Legal maxim (qa`idah fiqhiyyah):
“Al Asl fi al `Uqud al Ibahah”
-“the original rule in contracts is permissibility”

The parameter: Avoidance of any contravention of the
established principles and prohibitions in Islamic law
11
(c) Mohd Johan Lee 2012
3/17/2012
WHAT TO DO AND WHAT TO AVOID
Conclusion of contract by mutual consent
 The avoidance of riba’
 The avoidance of gharar
 The avoidance of transactions involving maysir
(gambling)
 The avoidance of transactions involving
prohibited commodities

12
(c) Mohd Johan Lee 2012
3/17/2012
WHAT TO BE AVOIDED


Riba – prohibited in many Quranic verses and sayings
of the Prophet s.a.w.
Meaning: riba is every excess in return of which no
reward or equivalent counter value is paid, in short,
every unjust enrichment is riba
13
(c) Mohd Johan Lee 2012
3/17/2012
THE AVOIDANCE OF RIBA’
Literally: excess, expand, increase, growth
 Any unjustified excess above and over the
capital, whether in loans (between creditor and
debtor) or in trade (with similar commodities)

14
(c) Mohd Johan Lee 2012
3/17/2012
PROHIBITION OF RIBA IN THE QURAN
4 STAGES
First Stage
(30:39)
• Compare riba with
zakat & charity
• Praising zakat &
charity, not riba
Second Stage
(4:160-161)
Third Stage
(3:130)
Fourth Stage
(2:275-281)
• Attaching the
practice of riba with
the Jews
• Consider the
practice as an
iniquity (zulm)
• Prohibiting the
practice of charging
double and multiple
riba
• Conclusively
prohibiting all forms
of riba
• Any excess over the
capital is disallowed
15
(c) Mohd Johan Lee 2012
3/17/2012
(AR RUM 30: 39)

“and that which you give in gift (to others), in
order that it may increase (your wealth by
expecting to get a better one in return) from
other people’s property, has no increase with
Allah…”
16
(c) Mohd Johan Lee 2012
3/17/2012
4:160 - 161

“… and their taking of Riba though they were
forbidden from taking it and their devouring of
men’s substance wrongfully…. and we have
prepared... a painful torment.”
17
(c) Mohd Johan Lee 2012
3/17/2012
3:130

“O you who believe, Eat not Riba doubled or
multiplied, but fear Allah that you may be
successful.”
18
(c) Mohd Johan Lee 2012
3/17/2012
2: 275

“those who eat riba will not stand (on the Day of
Resurrection) except like the standing of a person
beaten by Shaitan leading him to insanity. That is
because they say: trading is only like Riba,”
whereas Allah has permitted trading and forbidden
Riba. So whosoever receives an admonition from
his Lord and stops eating Riba, shall not be
punished for the passt; his case is for Allah (to
judge); but whoever returns (to riba), such are the
dwellers of the Fire – they will abide therein forever.
19
(c) Mohd Johan Lee 2012
3/17/2012
2: 276 - 278
Allah will destroy riba and will give increase for
sadaqat (deeds of charity, alms).
 ….
 O you who believe, be afraid of Allah and give
up what remains (due to you) from Riba (from
now onward), if you are really believers

20
(c) Mohd Johan Lee 2012
3/17/2012
2:279

And if you do not do it, then take a notice of war
from Allah and hiss Messenger but if you
repent, you shall have your capital sums. Deal
not unjustly (by asking more than our capital
sums), and you shall not be dealt with unjustly
(by receiving less than your capital sums).
21
(c) Mohd Johan Lee 2012
3/17/2012
2:280 - 281
And if the debtor is in a hard time (has no
money), then grant him time till it is easy for
him to repay; but if you remit it by way of charity,
that is better for you if you did but know.
 And be afraid of the Day when you shall be
brought back to Allah. Then every person shall
be paid what he earned, and they shall not be
dealt with unjustly.

22
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…


There are also a number of narrations from the
Sunnah on the prohibition of riba
Some of the narrations give general prohibitions
of riba, e.g.:
“The Prophet of Allah s.a.w. cursed the receiver
and the payer of riba, the one who records it and
the two witnesses to the transaction and said: they
are alike (in guilt)”.
23
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…

Under Islamic law, riba can occur in two main situations,
i.e.:


riba al duyun (loan): the riba or excess which occurs in debt
and loan transactions because of extension/delay in
repayment
riba al buyu` (exchange): the riba or excess which occurs in
trading transactions involving the exchange of riba-bearing
commodities without observing the required rules
24
(c) Mohd Johan Lee 2012
3/17/2012
PROHIBITION OF RIBA (LOAN)
Surah al-Baqarah, ayat 275
“ … But Allah hath permitted trade and forbidden usury
Interpretative Efforts
What amounts to
Trade
Criteria
■ Fair exchange of goods or value
■ Fair distribution of risk & return
Usury
Criteria
■ Oppressive / unfair distribution of
risk & return
■ Unjustified enrichment at expense of
others
25
(c) Mohd Johan Lee 2012
3/17/2012
PROHIBITION OF RIBA (EXCHANGE)
Sunnah of the Prophet:
Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt
- like for like, equal for equal, and hand-to-hand (spot); if the commodities differ, then you
may sell as you wish, provided that the exchange is hand-to-hand or spot transaction.”
Interpretative Efforts
Application
Currency
Staple Food
Rules
■ Same denomination
■ At Par
■ Spot
■ Different denomination
■ Spot
Rules
■ Same Type
■ At Par
■ Spot
■ Different Type
■ Spot
26
(c) Mohd Johan Lee 2012
3/17/2012
SUMMARY OF RULES UNDER THE HADITH
2 conditions:
• money1 + money1
=
– Equality
– Hand-to-hand
2 conditions:
• food1 + food1
=
• money1 + money2
=
• food1 + food2
=
• money + food
=
No condition – free trading
• others + others
=
No condition – free trading
– Equality
– Hand-to-hand
1 condition:
– Hand-to-hand
1 condition:
– Hand-to-hand
27
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…

In contemporary finance, riba can occur in:




All interest-based lending activities (e.g. all conventional
bonds)
Fixed return on deposits in conventional banking (e.g.
designated accounts for receivables of the bonds)
In the secondary trading of debt securities – if the
transaction is not spot & if there is discounting (according
to global Shari`ah standard)
Thus, to be Shari`ah compliant, all contracts in
Islamic finance cannot be involved in any of the
usurious activities mentioned above
28
(c) Mohd Johan Lee 2012
3/17/2012
THE AVOIDANCE OF RIBA’
Literally: excess, expand, increase, growth
 Any unjustified excess above and over the
capital, whether in loans (between creditor and
debtor) or in trade (with similar commodities)

29
(c) Mohd Johan Lee 2012
3/17/2012
DIVISION OF RIBA
Riba’ al-Duyun
(RIba’ in Loan
Contract)
Riba’ al-buyu’
(Riba in exchange
contracts )
30
(c) Mohd Johan Lee 2012
3/17/2012
RIBA’ AL-DUYUN



The debtor borrowed money to be paid in certain
time, and the amount is more than the amount
borrowed
A creditor gives a periodic loan and takes monthly
interest. The capital sum lasts until the expiration
of the period. Upon expiry, if the debtor cannot pay,
the period to pay back the capital will be extended
and interest will be charged
Arising out of exchange contract, a buyer must pay
a consideration. If he failed to settle on time, the
period will be extended by increasing the amount
(principle + interest).
31
(c) Mohd Johan Lee 2012
3/17/2012
RIBA AL-BUYU’

Mainly based on the saying of the Prophet:
“Gold for gold, silver for silver, wheat for wheat,
barley for barley, dates for dates, and salt for
salt; like for like, hand to hand, in equal
amounts; and any increase is riba’”.
32
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D


These commodities can be classified under two
main categories which make the illah (ratio
decidendi) for their prohibition:
- i- medium of exchange (currency): Gold and
Silver
-ii- Staple foods: Wheat, barley, dates and salt
Any other items, even though not mentioned in the
hadith but serve the same purpose will be
considered as having the same illah by way of qiyas
(analogy)
33
(c) Mohd Johan Lee 2012
3/17/2012
RIBA IN MODERN
FINANCIAL TRANSACTIONS

Riba’ al-duyun in loans and certain
controversial contracts (bay’ al-’inah, bay’ aldayn, etc)

Riba’ al-buyu’ mainly in bay’ al-sarf
(exchange of currencies)
34
THE AVOIDANCE
OF GHARAR

(c) Mohd Johan Lee 2012
3/17/2012
Meaning of gharar:
- Literally: risk, uncertainty, hazard
- The sale of probable item whose existence
or characteristics are not certain, due to the
risky nature which makes the trade similar to
gambling
35
(c) Mohd Johan Lee 2012
3/17/2012
EXAMPLES OF THIS KIND OF SALE
IN HADITH






Sale of fish in the sea, birds in the sky
Sale of unborn calf in its mother’s womb
Sale of runaway animal, slave
 Involve item which may or may not exist
However, the Prophet did not lay down the principles
(qawa’id) for the prohibition of gharar.
Examples given in the hadith were some of the
manifestations of the doctrine, but not principles.
This has led to the dispute among jurists on the area
and coverage of gharar.
36
(c) Mohd Johan Lee 2012
3/17/2012
GHARAR



Meaning: has a range of negative connotations,
such as, uncertainty, deception, risk, hazard,
ignorance etc.
If there is gharar, the contracting party/ies do not
really understand the attributes / consequence of
the contract
Under Islamic law, gharar is prohibited because its
existence in the contract may deny the parties of
equal bargaining power and they cannot make
informed decisions; or if there is risks on
deliverability of the object of the contract
37
(c) Mohd Johan Lee 2012
3/17/2012
PROHIBITION OF GHARAR
Surah an- Nisa’: ayat 29
“ … squander not your property amongst yourself unjustly (batil) except it be a
trade among you by mutual consent…”
Interpretative Efforts
What amounts to
Unjust (batil)
Trade by Mutual Consent
Criteria
Criteria
■ All illegal & defective elements in
contracts including gharar &
uncertainty
■ Offer & Acceptance, indicating
consent
■ Elimination of mistake, fraud etc
38
(c) Mohd Johan Lee 2012
3/17/2012
PROHIBITION OF GHARAR IN THE SUNNAH




The sunnah uses the word gharar and its derivatives much
more extensively than the Qur`an in the sense that several
new meanings are added
In relation to commercial transactions, the Prophet s.a.w. in
many of his sayings directly prohibited the sale involving
gharar (uncertainty) and jahalah (ignorance)
Thus, the prohibition of gharar is made conclusive by the
sunnah / hadith of the Prophet s.a.w.
Examples: the prohibition of gharar sale (i.e., the sale
contract affected by gharar), the prohibition of the sale of
fish in the sea, bird in the air, unborn animals, lost items,
etc.
39
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…

In Islamic law, gharar can be of two degrees:





Excessive or major (gharar fahish)
Minor and tolerable (gharar yasir)
Only major /excessive gharar will affect the validity of contracts,
where it will render the contract void / voidable, depending on the
degree of uncertainty
Gharar affects trading and exchange contracts (mu`awadat); not
charitable and unilateral contracts
In banking & finance – gharar can be triggered e.g. – in the sale
contract to create the indebtedness if the asset used is uncertain /
vaguely identified; the trading of a securitised debt which is
unconfirmed / not established, sale of insurance policy
40
(c) Mohd Johan Lee 2012
3/17/2012
APPLICATION OF GHARAR

Broadly speaking, gharar will effect the validity
of contract if it occurs in these areas:
- gharar in kind / type / attribute / quantity of
the object
- gharar due to delivery time
- gharar due to the price/ mode of payment
- doubt over the ability to deliver
41
(c) Mohd Johan Lee 2012
3/17/2012
THE BENCHMARK
Gharar which is excessive (gharar fahish)
occurs in exchange contracts (‘uqud almu’awadat)
 To prevent gharar, the parties to contract
must have adequate knowledge and
information on the subject matter:
i- Their existence and deliverability
ii- Its quality, quantity and attributes are
known
iii- Time –frame for payment and delivery

42
(c) Mohd Johan Lee 2012
3/17/2012
TOLERABLE GHARAR

However, gharar is tolerable if:
- i) it is trivial (gharar yasir)
- ii) It occurs in other than exchange
contracts, such as in gratuitous contracts.
-iii) It happens to the ancillary object
(appendages) only (not the principal and main
subject matter of contract)
- iv) the economic need for the contract
embodying the risk is substantial
43
(c) Mohd Johan Lee 2012
3/17/2012
OTHER THINGS TO BE AVOIDED…

Transactions involving the prohibited commodities,
e.g., pork and liquor



Surah al Maidah (5:3)
Surah al Maidah (5:90)
Transactions involving gambling or maysir/qimar

Surah al Maidah (5:90)
44
(c) Mohd Johan Lee 2012
3/17/2012
THE AVOIDANCE OF TRANSACTIONS
INVOLVING MAYSIR (GAMBLING)






Involves the creation of risk for the sake of risk
A combative relationship between two contracting
parties, each of whom undertakes the risk of loss and
the loss of one means gain for the other
Apply to all games of pure chance
No economic activities are gained in the practice. The
gambler will simply seek to amass wealth without
efforts.
Gambling is gharar in its worst scenario.
Prohibited by al-Qur’an in Surah al-Maidah (5:90)
45
(c) Mohd Johan Lee 2012
3/17/2012
TRANSACTION INVOLVING PROHIBITED
COMMODITIES
It is also not allowed to conclude contract on
illegal commodities such as pork, liquor etc.
 Illegality of certain commodities has been spelt
out clearly in the texts of al-Qur’an and Sunnah
of the Prophet.
 E.g. :
- Surah al-Maidah (5:3)
- Surah al-Maidah (5: 90)

46
(c) Mohd Johan Lee 2012
3/17/2012
ESSENTIAL CONTRACTS IN ISLAMIC FINANCE





Underlying principles utilised in devising products of IBF is
very important as they separate IBF from conventional
products.
Contrary to conventional finance, which is specification driven
product, Islamic finance is more structure and principle based
product
Rules and regulations will differ from one product to another,
depending on the structure employed
In general, various underlying Shariah principles have been
utilised in devising products of Islamic Banking and Finance.
They can be summarised as below:
- Sale based products
- Lease based products
- Participatory products
- Fee based products
47
(c) Mohd Johan Lee 2012
3/17/2012
EXAMPLES OF THE PRODUCTS AND
UNDERLYING PRINCIPLES
Banking products
 IIMM products
 Capital Market Products

48
(c) Mohd Johan Lee 2012
3/17/2012
SHARI`AH COMPLIANCE: MAIN PRINCIPLES
CONTRACTS
Mutual consent
Interest
(riba)
Avoid
Uncertainty
(gharar)
Gambling
(maysir/qimar)
Lawful Contractual
Objective
Other prohibitions
e.g. Liquor, pork
49
(c) Mohd Johan Lee 2012
3/17/2012
ENCOURAGEMENT OF TRADE BY MUTUAL
CONSENT



The Quran encourages work and trade
The Prophet (s.a.w.) himself was a trader
The encouragement of trade is evidenced by the
many instruments of trade available during the
Prophet's lifetime and in Islamic history thereafter
50
(c) Mohd Johan Lee 2012
BUSINESS CONTRACTS
RECOGNISED IN ISLAM

3/17/2012
Contracts of sale and purchase (bay`), including all its
subdivisions, like:






normal or spot sale
mark-up sale (murabahah)
deferred payment sale (BBA)
sale with advance payment but deferred delivery (bay` al
salam)
sale for future delivery of goods with flexible payment of the
price or manufacturing contracts (bay` al istisna`)
sale of currency (sarf), etc.
51
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…

Some controversial sales:



Islam recognises partnership contracts which are
mainly based on profit and loss sharing (PLS), e.g.:



Sell and buy back (bay’ al `inah)
Sale of Sale of debt (bay` al dayn)
mudharabah
musharakah
A relatively new invention in this regard is:

Musharakah mutanaqisah
52
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…

Islam recognises public and private project financing,
e.g.:

Leasing (ijarah) - private;
Endowment (waqf) – private/public;

State treasury (bayt al mal) – public.


Modern forms of private project financing:


Operational lease
Financial lease – AITAB (hybrid contract)
53
(c) Mohd Johan Lee 2012
3/17/2012
CONT’D…
 Islam recognises other additional contracts
to provide
security to the parties in a contract, i.e., the contracts of
security (`uqud al tawthiqat), e.g.:



These security contracts are normally combined with other
types of contracts, e.g.:


suretyship/guarantee (kafalah): involves three parties
mortgage (rahn): involves two parties
the contract of BBA may be secured by a contract of security
involving collateral (rahn)
Other contracts recognised in Islamic law:


contracts of trusts (al amanat), e.g.: safe-keeping (wadi`ah)
contracts to do a specified task, e.g.: commision (ju`alah);
agency (wakalah)
54
(c) Mohd Johan Lee 2012
3/17/2012
KEY ISLAMIC COMMERCIAL CONTRACTS
Gratuitous
Contracts
Gift
Trading
Contracts
Leasing
Sale
Waqf
Loan
Ibra’
Operational
Lease
Financial
Lease
Bay`
Bithaman Ajil
(BBA)
Investment
Contracts
Supporting
Contracts
Mudarabah
Kafalah
Musharakah
Rahn
Hiwalah
Wadiah
Murabahah
Wakalah
Salam
Istisna’ etc.
Jualah
Muqasah
55
(c) Mohd Johan Lee 2012
3/17/2012
Islamic Banking
SOURCES OF
FUND
APPLICATIONS
OF FUND
56
(c) Mohd Johan Lee 2012
EQUITY
FINANCING
Mudharabah
Musharakah
3/17/2012
DEBT FINANCING
Sale based financing
BBA / Murabahah
‘Inah/Tawaruq/dayn
Salam
Istisna
Comsumer
Banking
Lease Based Financing Fee Based Services
-Ijarah
Wakalah
-AITAB
Kafalah
Corporate
Banking
57
(c) Mohd Johan Lee 2012
3/17/2012
ISLAMIC CAPITAL MARKET
Equity
Market
Bond
Market
Musyarakah
Mudarabah
-Debt Based
-ABS
-Equity Based
Mutual Fund / Islamic
REITs
Wakalah / mudarabah
/ musharakah
Derivatives
Market?
-Future Contract
-Options
-Swap
Islamic
Hedge Fund
58
(c) Mohd Johan Lee 2012
3/17/2012
CONCLUSION




Besides various frameworks applied to banking
practices (be it Islamic or conventional), Shariah
framework is a framework which is peculiar to Islamic
finance alone
Yet, it forms the very substance of Islamic finance,
without which Islamic finance will loss its Islamicity
As such, in practicing Islamic finance, the do’s and
don’ts must be clearly observed
Islamic commercial law, from the fact that it subjects to
human interpretation and understanding admits
differences of opinion, as long as these differences are
grounded by valid evidence, produced by capable
personnel, done according to the right methodology
59
(c) Mohd Johan Lee 2012
TAKAFUL
3/17/2012
Derives from the word Kafalah, a verb,
which means to bail, guarantee, warrant
or to secure ones need.
 Means Joint Guarantee.
 An arrangement between members of
community to jointly guarantee each other
should mishaps befall to any of them

FOR MORE INFO...
Al Mawrid: A Modern Arabic-English Dictionary, Dar-el-Ilm
Lilmalayin, Beirut, Lebanon, 1991
60
(c) Mohd Johan Lee 2012
3/17/2012
PROLOGUE TO
MALAYSIAN TAKAFUL ACT 1984

National Fatwa Committee in Malaysia resolved that
the present-day life insurance business provided by
the conventional insurance companies was not in line
with the principles of Shariah as it contains elements
which are against Islam such as Riba (Usury), Gharar
(uncertainty) and Maisir (Gambling). ~~~ June 1972
61
(c) Mohd Johan Lee 2012
3/17/2012
PROLOGUE TO
MALAYSIAN TAKAFUL ACT 1984

Perak Fatwa Committee subsequently also
declared that: “life insurance is not permissible
as it is based on riba from which the profits of
policyholders are derived. The policyholders
must pay premiums for an indeterminate
period which lead to the element of gharar
(uncertainty)”.
62
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL PIONEERS

Takaful started some 30 years ago in the Middle
East with the launching of two companies in
1979:
The Islamic Arab Insurance Co. (IAIC) in the UAE and
 The Islamic Insurance Co. of Sudan

But it took some time for the movement to take
shape.
 Later in 1984, Malaysia played a pioneering role
in setting the first Legal framework specific to
Takaful (Takaful Act Malaysia).
 This was instrumental in the successful
launching of the Takaful movement in Malaysia
and in other countries of South East Asia.

63
(c) Mohd Johan Lee 2012
3/17/2012
OTHER ISLAMIC/ TAKAFUL LEGISLATIONS
Other markets such as the Sudan and Iran
have Islamic regulatory environments and
became naturally Takaful markets.
 In Pakistan Takaful Act is enacted in 2005.
 In the Gulf countries specific Takaful
legislations are coming through in Bahrain and
in Saudi Arabia

64
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL TODAY
From a handful of operators two decades
ago the Takaful movement has blossomed
into a fast growing phenomenon in many
Muslim countries with very promising
prospects in other countries with a large
Muslim community.
65
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL DRIVERS
This movement is driven by
 a strong demand from a public who would
not insure otherwise (because of religious
beliefs); and
 The successful development of Islamic
banking institutions providing capital and
Islamic financial instruments for asset
management and investment.
66
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL DRIVERS
Islamic banks and financial institutions play a
strategic and important role in the distribution
of Takaful products (especially Life Takaful
Products).
 Just as Bancassurance played an important
role in the distribution of personal lines
insurance products Bancatakaful is an
important driver for Takaful.

67
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL WORLDWIDE
The number of Takaful operators worldwide is now
estimated at:
 150 Takaful companies operating in 40
countries
 10 Retakaful companies and 6 Conventional
Reinsurance companies have established
Islamic windows.
 Takaful is one of the fastest growing segments
in insurance (at around 20% pa. on average)
 World Takaful contributions are conservatively
estimated at around US$ 3billions, of which:
60% General Takaful
 40% Family Takaful

68
(c) Mohd Johan Lee 2012
3/17/2012
TAKAFUL GEOGRAPHICAL SPREAD
 South&
East Asia :
 Middle East :
 Africa:
 Europe, USA & Others:
56%
36%
7%
1%
69
WORKING OF THE TAKAFUL BUSINESS: THE
MALAYSIAN CASE
(c) Mohd Johan Lee 2012
3/17/2012

Takaful Business is based on the concepts of
Mudarabah and Tabarru. Involvement of these two
Islamic forms of business eliminates the elements of
Riba from insurance contract and convert Gharar into
tolerable form.

In Family Takaful each Takaful installment is divided and
credited into two separate Accounts namely, the
Participants' Account(PA) and the Participants’ Special
Account(PSA). A substantial proportion of the
installments is credited into the PA solely for the
purpose of savings and investment.
70
(c) Mohd Johan Lee 2012



3/17/2012
The balance of the installments is credited into the PSA as
`tabarru' for Sharikah Takaful Malaysia to pay the Takaful
benefits to the heir(s) of any participant who may die
before the maturity of the contract.
The amount accumulated in the PA is invested in various
business according to Islamic financing techniques, and
the resultant profits are divided between the company
and the participants according to the agreed upon ratio,
e.g., 30-70.
The participant's share is calculated according to their
individual share in the PA, and credited into their
respective accounts, the PA and the PSA.
71
(c) Mohd Johan Lee 2012
Mudarabah Model
Family Takaful
3/17/2012
Profit Attributed
To Shareholders
Company’s Admin
& Manag. Expenses
Company
30%
Takaful Contract
based on Mudarabah
Investment
Profit
70%
PA
PA
FTF
Participant
PSA
PSA
Payment from
PA
Payment from
PSA
72
(c) Mohd Johan Lee 2012
3/17/2012
PAYMENT OF CLAIMS
Should the Participant die or suffer Permanent and
Total Disability in the fifth year of participation, Takaful
benefit will be paid in the following manner:


i. From Participant's Account =RM 4,890
(RM978 x 5)
profit if any, say
RM 400
ii. From Participants Special
RM 5,000
Accounts (RM1000 x 5)
Total Takaful Benefit Payable
RM 10,290
73
(c) Mohd Johan Lee 2012
3/17/2012
IN CASE THE PARTCIPANT SURVIVED
Should the Participant survive until the maturity
of his FTP, payment of Takaful benefit will be
made to him as follows:i. From his Participant's Account = RM 9,780
(RM978 x 10)
profit from investment
RM 1,800
ii. From Participants Special
RM XXXX
Account
Total Takaful Benefit =
RM 11,580 +
surplus determined
by Sharikah Takaful.
74
(c) Mohd Johan Lee 2012
MUDARABAH MODEL
General Takaful
3/17/2012
PROFITS
ATTRIBUTABLE TO
SHAREHOLDERS
COMPANY
COMPANY'S
ADMINISTRATION &
MANAGEMENT
EXPENSES
TAKAFUL CONTRACT
BASED ON PRINCIPLE OF
AL-MUDHARABAH
INVESTMENT BY
COMPANY
PROFITS
FROM
INVESTMENT
SHARE OF
SURPLUS FOR
THE COMPANY
OPERATIONAL
COST OF
TAKAFUL
PARTICIPANT
TAKAFUL
CONTRIBUTI
ON PAID BY
PARTICIPANT
GENERAL
TAKAFUL
FUND
GENERAL
TAKAFUL
FUND
OPERATIONAL
COST OF TAKAFUL
OPERATIONAL
COST OF
TAKAFUL
SURPLUS
(PROFIT)
40% (Example Only)
60% (Example Only)
SHARE OF
SURPLUS FOR THE
PARTICIPANT
75
(c) Mohd Johan Lee 2012
3/17/2012
WAKALAH MODEL
COMPANY
TAKAFUL ADMIN & MARKETING
EXPENSES 25% TO 35%
SHARE OF PROFIT
FOR THE COMPANY
MANAGEMENT
EXPENSES OF
COMPANY
PROFIT / LOSS
ATTRIBUTABLE TO
SHAREHOLDERS
40%
TAKAFUL
CONTRACT BASED
ON PRINCIPLE OF
AL-WAKALAH
INVESTMENT
BY FUND
PROFITS FROM
INVESTMENT
60%
PARTICIPANT
TAKAFUL
CONTRIBUTIO
N PAID BY
PARTICIPANT
GENERAL
TAKAFUL
FUND
65% TO 75%
OPERATIONAL COST
OF TAKAFUL /
RETAKAFUL
GENERAL
TAKAFUL
FUND
OPERATIONAL COST
OF TAKAFUL
OPERATIONAL COST
OF TAKAFUL
SURPLUS
(PROFIT)
SHARE OF
SURPLUS FOR
THE PARTICIPANT
100%
76
(c) Mohd Johan Lee 2012
3/17/2012
Waqf Model
77
(c) Mohd Johan Lee 2012
3/17/2012
DEFINITION OF WAQF



Waqf is an Arabic word and it means to stop to
withhold and not to let go.
In technical meaning Waqf means to allocate or
donate some property or cash for a specific purpose
to get pleasure of Allah and not to let it go through
consumption or sale.
The Waqf property comes into ownership of Allah
(SWT) and Waqif will have no property rights on it.
78
(c) Mohd Johan Lee 2012
3/17/2012
Waqif has right to set the rules for Waqf
and manage the Waqf.
 Waqf may be general purpose or specific
purpose, like Waqf ‘Ala al Aulad or
Waqf ‘Ala al Aqarib.
 In Islamic Law Waqf is a legal entity

79
WAQF MODEL
COMPANY
TAKAFUL OPERATOR FEES FOR
ADMIN & MARKETING EXPENSES
25% TO 35%
(c) Mohd Johan Lee 2012
SHARE OF PROFIT
FOR THE COMPANY
3/17/2012
MANAGEMENT
EXPENSES OF
COMPANY
PROFIT / LOSS
ATTRIBUTABLE TO
SHAREHOLDERS
40%
PROFIT SHARING ON
MUDARABHA BASES
INITIAL DONATION BY
SHAREHOLDERS TO
CREATE WAQF FUND
Waqf
Waqf
INVESTMENT
BY FUND
60%
TAKAFUL
CONTRACT BASED
ON PRINCIPLE OF
AL-WAKALAH
PARTICIPANT
PROFITS FROM
INVESTMENT
OPERATIONAL COST OF
TAKAFUL /RETAKAFUL
TAKAFUL
CONTRIBUTION
PAID BY
PARTICIPANT
WAQF FUND
65% TO 75%
WAQF FUND
OPERATIONAL COST OF
TAKAFUL
OPERATIONAL COST OF
TAKAFUL
SURPLUS
(PROFIT)
SHARE OF
SURPLUS FOR
THE PARTICIPANT
100%
80
(c) Mohd Johan Lee 2012
3/17/2012

A Waqf Fund would basically be a separate legal entity
to which the Shareholders would initially make a
donation to establish the Waqf Fund.

The donation can be of any reasonable amount (Shariah
Board may specify such an amount).

The objectives of the Waqf fund would be to provide
relief to participants against defined losses as per the
rules of the Waqf fund.
81
(c) Mohd Johan Lee 2012
3/17/2012
In this modified Wakala Model with Waqf, the relationship of
the participants and of the operator is directly with the Waqf
fund. The Operator is the Wakeel of the Waqf Fund and the
participants pay one sided donation to the WAQF fund (not
conditional) which also eliminates the issue of Gharar. The
WAQF fund rules may define the sharing of surplus and other
rules under which it would operate but there is no obligation
to distribute surplus. Further the Qard would be given by the
shareholders to the WAQF entity and not to individuals as in
the typical Wakalah model.
82
(c) Mohd Johan Lee 2012
3/17/2012
FUTURE OUTLOOK

Despite the remarkable growth rate recorded
by Islamic finance and Takaful industry,
penetration is still far below the enormous
market potential offered by the Muslim
community worldwide (23% of the total world
population).
83
(c) Mohd Johan Lee 2012
3/17/2012
GROWTH OUTLOOK
World Muslim population is estimated at 1.5
billions, of which around 97% are based in Asia
and Africa.
 A two-digit growth in the range of 15% to 20%
can be reasonably sustained for at least the
next 10 years in the existing markets (Far and
Middle East).

84
(c) Mohd Johan Lee 2012
3/17/2012
NEW TAKAFUL FRONTIERS
Markets like Europe, North and Latin America,
Central Asia, Australia where large Muslim
communities live are huge untapped reservoirs;
 The recent opening towards “Islamic windows”
in the banking sector in Europe is likely to be
followed by “Takaful windows” initiatives.

85
(c) Mohd Johan Lee 2012
3/17/2012
ISLAMIC FINANCE AND TAKAFUL
PRODUCTS TO NON-MUSLIMS
Islamic Finance and Takaful Products are not
exclusive to Muslims.
 Competitively priced and sold through the right
channel it could attract any consumer
irrespective of their origin or faith.

86
(c) Mohd Johan Lee 2012
3/17/2012
CONCLUSIONS
Despite the challenges facing this “new”
industry, exciting times are ahead once the
latent potential is unleashed.
 The success of Takaful largely depends on that
of Islamic Financial institutions on a global
basis.

87
(c) Mohd Johan Lee 2012
3/17/2012
THANK YOU & WASSALAM


Mohd Johan Lee
J. Lee & Associates
A-16-13, Tower A, Menara UOA Bangsar

59000 Kuala Lumpur
Tel:03-22881699 Fax:03-22881799

email:jlee@jlee-associates.com

mohdjohanlee@yahoo.co.uk
Also at:
Kuala Terengganu & Penang
88