Category Archives: Sheikh Yusuf Talal DeLorenzo

Rationale for the Prohibition of Riba: Answered by Sheikh Yusuf Talal DeLorenzo

Rationale for the Prohibition of Riba: Answered by Sheikh Yusuf Talal DeLorenzo

Question: While I understand that the shariah is strongly opposed to riba in all its forms, I was considering what the rationale for this is. The Quranic text and prophetic tradition are clear in prohibiting it but I haven’t yet seen a clear explanation of why it is problematic. I also fail to see WHY asset-backed ownership is the only permissible type in Islam and exactly what the problem is with other purely financial instruments. Are there any other readings you could recommend to help answer these questions?

Answer: Please keep in mind that the prohibition is very much a moral issue, and that it is closely related to the concept of khilafah or stewardship. The Islamic concept of monotheism views the Almighty as the Fashioner and Possessor of all creation.

His is all that is in the heavens and on earth. Everything submits to Him (2:116).

When the earth and everything in it belong to the Almighty, the role of humankind is no more thanthat of caretakers. Even so, humankind has been granted an awesome responsibility, one which, in the poetic language of the Qur’an, even the mountains dared not accept.

The terms of this stewardship are that the Almighty allows humankind the use of the physical universe, hopefully for good (though possibly for evil, because humans have the ability to choose), and in return humankind agrees to be accountable for how the physical universe is used.

This agreement is the foundation of all worldly justice, and this leads to the Shariah orreligious law which includes guidelines for using the Almighty’s property for profit and acceptable gain. Unjust enrichment, according to the Shariah, may take many forms; but the most iniquitous of all is enrichment at the expense of others, and this includes lending for profit.

Money lending and financing belong to two entirely different spheres; one is charity, pure and simple, and the other is business. The repercussions of this bifurcation range far and wide, and shape much of what is unique about Islamic notions concerning economy and society.

Equity investing offers Muslims the opportunity to profit, not by lending at a guaranteed rate of return, but by sharing in ownership, and thus commiting to share in the risks associated with ownership. Such a commitment is clearly in consonance with the concept of stewardship, and this, more than anything else, explains how the Islamic prohibition against interest is as much a moral matter as it is a legal one.

Investing in the Financial Sector: Answered by Sheikh Yusuf Talal DeLorenzo

Investing in the Financial Sector: Answered by Sheikh Yusuf Talal DeLorenzo

Question: I was particularly interested to know what kinds of sectors islamic investors should avoid, like the financial sector. I assume that some smaller banks generate more revenue from profits arising investment returns on deposits received.

Does it make sense to say that in a scenario where 80% of the bank’s revenue is generated from investment returns (from financing development projects), then from whatever returns I might make as a Muslim investor in this bank, I would have to cleanse 20%?

I know that I am oversimplifying the scenario for most banks am not taking into account the fact that halaal investment projects in the bank might constitute only a small part of the bank’s overall profit. But assuming a direct relationship (each % of halaal investment by the bank contributes 1% of profit to the banks bottom line), is my reasoning correct.

I am also wondering to what extent my assumptions about the ratio of halaal to haram (investment vs loan financing) business dealings in a typical bank are sound.

Answer: The financial sector in general, and banks and insurance companies in particular, represent dangerous ground for Muslim investors owing to their involvement, in a very fundamental way, with riba. As a result, the entire sector has been declared “off limits” by most Shari`ah boards. The Dow Jones Islamic Market Indexes, for example, include no banking or insurance securities.

If, however, you are considering an investment in a bank that transacts with a minimum of riba, your answer is at least theoretically correct. However, the real problem is determining the amount of the income the bank actually earns from riba and this, in practical terms, is nearly impossible.

Therefore, my advice would be to stay away from such an investment. In addition, several of our most respected Shariah scholars have given the opinion that it is unlawful to deposit in riba-based banks (if an Islamic alternative is available) because to do so encourages and supports the riba-based system of finance. Then, when this is their opinion on deposits, their opinion in regard to investing in such banks is that to do so is clearly unlawful.

And Allah knows best.

Mufti Taqi Usmani’s critique of contemporary Sukuk issues

The following paper was presented by Mufti Taqi Usmani at the AAOIFI Shariah Council meeting. It has been translated from the original Arabic by Sheikh Yusuf Talal DeLorenzo:

Sukuk and Their Contemporary Applications

Questioning “Shari’ah Conversion Technology”: Yusuf Talal Delorenzo

Questioning “Shari’ah Conversion Technology”: Yusuf Talal Delorenzo

Innovation is a cornerstone of the financial markets. Without the development of securitization, derivatives, and other complex financial instruments it’s safe to argue that it would be impossible to fuel the growth of the global economy. Since the growing Islamic Finance industry exists as a subset of the global financial system there is always a steady stream of new ideas being proposed and tested by Islamic financial institutions. At the center of this process of testing new ideas are the Shari’ah (Islamic law) supervisors who advise Islamic finance institutions on the Shari’ah compliance of their products and investments.

Yusuf Talal DeLorenzo is currently Chief Shari’ah Officer and Board Member at Shari’ah Capital. He is a well-known and respected Shari’ah advisor and Islamic scholar whose career spans more than 30 years. He serves as a Shari’ah advisor to over 20 global financial entities, including index providers, banks, mutual funds, real estate funds, leasing funds, institutional investors, home finance providers, alternative asset managers and others.

Shaikh Yusuf is also author of the three volume “Compendium of Legal Opinions on the Operations of Islamic Banks”, the first English reference on the fatawa (religious ruling) issued by Shari’ah boards. Shaikh Yusuf is also a special consultant, appointed by the Asian Development Bank and the Islamic Development Bank in Jeddah to the International Financial Services Board (“IFSB”) on the subject of Sukuk.

He recently delivered a paper questioning the validity of a proposed structure whose purpose is to “wrap a non-Shari’ah compliant underlying into a Shari’ah compliant structure.” The paper is a bold attempt to correct some of the recent attempts to ostensibly make halal (lawful) what is clearly haram (unlawful) by calling for due consideration for both the letter and the spirit of the Shari’ah.

Following is part of the paper’s introduction that lays out the issue [available for download here]:

Recently, a financial stratagem known as “Shariah Conversion Technology” was developed, the purpose of which is to affect a total returns swap or to “Wrap a non-Shariah compliant underlying into a Shariah compliant structure.”

In other words, the objective of the mechanism is to use non-compliant assets and their performance to bring returns into a so-called Shariah-compliant investment or investment portfolio. This point is key to the entire transaction, and for that reason it needs repeating. What the product proposes to accomplish is to bring to the Islamic investor returns from investments that are not compliant with Shariah principles and precepts.

In June of this year, 2007, a pioneering Islamic bank in the Gulf launched a principal protected note that was the first product using this “Shariah Conversion Technology’ to be offered to the investing public. This was followed by another such product, also offered by a Gulf-based Islamic bank. Prior to this, the stratagem was used in structured products offered by multinational banks to institutional investors and the treasuries of Islamic banks and finance houses. All of these products have been approved and certified by Shariah supervisory boards. Not all of these products, however, bring to the Islamic investor returns from investments that are compliant with Shariah.

The questions that such a product immediately bring to mind are: How can Shariah boards approve such returns? Does the circumstance of direct or indirect delivery to the Islamic investor change the ruling? When the Shariah of Islam is understood to differ from other legal systems because it may be characterized as both positive law and morality, is it possible to ignore the moral aspect of a financial transaction like this?

The means of delivery, a wa’d or promise, is widely seen to comply with Shariah norms. Since it is compliant, at least to the letter of the law, some Shariah scholars have approved products that use a wa’d to deliver returns from non-compliant investments. By doing so, however, they have failed to consider the purpose of the transaction, they have failed to consider the movement of the cash and, most importantly, they have failed to consider the ramifications for the industry as a whole.

At a very fundamental level, the reason for these failings is that they have not discerned the difference between the use of LIBOR as a benchmark for pricing and the use of non-Shariah compliant assets as a determinant for returns.

Dinar Standard recently spoke to Sh. DeLorenzo about total returns swap, its impact on Islamic finance industry, and the role and responsibility of Shari’ah supervisors today.

DS: What is the difference between abiding by the Shari’ah (as in “Shari’ah compliant) and circumventing it?

YTD: The difference is authenticity. Unless a financial product or service can be certified as Shari’ah compliant by a competent Shari’ah supervisory board, that product’s authenticity is dubious. At that point, it will be the responsibility of the individual investor or consumer to determine on his or her own that the product complies with the principles and precepts of the Shari’ah.

In matters as complex as modern finance, there is a reason that international standards (such as those set by AAOIFI, the Auditing and Accounting Organization of Islamic Financial Institutions) insist that such decisions must be made by a Shari’ah supervisory board that includes at least three Shari’ah scholars with specialized knowledge of the Islamic laws for transacting, fiqh al mu`amalat, in addition to knowledge of modern business, finance and economics.

DS: Do you believe some people in the industry see both as being compliant?

YTD: Those who attempt to circumvent compliance may perhaps be confused. Only Allah knows whether or not their intentions are sincere. There can be little doubt, however, that their actions are counterproductive and probably of benefit to no one but themselves.

DS: How serious is the problem – of making something haram halal?

YTD: Making the halal haram or the haram halal is the right of the Almighty and the Almighty alone. So, this is no small matter. However, what we have here is a situation in which qualified jurists have performed ijtihad. In other words, the members of the Shari’ah supervisory boards that have approved these swaps (download the paper to read about the “Total Return Swap”) have given due consideration to the matter and the result of their ijtihad is their approval for the swaps and the products that are based on them.

My view is that they have made a serious mistake. So serious, in fact, that in my paper on the subject I have called their decision the Doomsday Fatwa. Even so, as qualified scholars, they have a right to their own opinions. My own opinion of such scholars (some of whom have been my colleagues for more than twenty five years) is to say that it is likely that those scholars fell into the trap of literalism. In Urdu there is an expression for literalists… lakeer ka faqeer.

Whatever you call it, it seems to me that when jurists lose sight of the big picture, of the maqasid, of the Islamic financial industry and its meaning for the future of the entire Muslim community then it is possible to explain why they might approve such swaps. I am happy to share with you the knowledge that several of the scholars who first approved these swaps have since reversed their opinions. And I am certainly hopeful that the market itself will reject these products. That, perhaps more than anything else, will be the most important step in the process of ridding the industry of this problem and others like it.

DS: Comment on the morality of finance – isn’t the right attitude “business is business”? How does Islam invest business with morality?

YTD: Business, in the Qur’anic sense of “profitable trade” or tijarat’un rabihah is business that brings blessings to those who conduct it. Obviously, profits are important as ends, but the means by which those profits are earned are even more important. Indeed, the reason for the emphasis in the Shari’ah on proper transacting is that Islam accords great importance to the economic welfare of society.

DS: What is your view on how Shari’ah Supervisory Boards function? Is there really any independence if they are retained by financial institutions?

YTD: The concept of collective decision-making, in other words, decisions made by more than one scholar, is especially important. Shari’ah Supervisory Boards (SSBs) function to ensure that decisions are not unilateral, and that difficult issues of finance receive adequate consideration by a number of qualified people. The members of such boards are paid as professionals who, like consultants, offer their opinions to management. Whether those opinions are acceptable to management or not, the consultants will receive their professional fees.

DS: What should be the model for Shari’ah compliance be in the future – uniform/multilateral; uniform/unilateral (government); or heterogeneous/private sector based?

YTD: Personally, I’m a great believer in market forces. Much like the concept of ijma’, I believe that decisions made over time by large majorities of concerned and informed people are good decisions. At the present time, the Islamic financial industry is just beginning. As more professionals join its ranks, the intellectual capital of the industry will grow; and when that happens, I expect that better decisions will be made, better processes will be developed, and the quality of every aspect of the industry will improve. This is what progress is all about.

DS: What has the reaction been to your paper? – By practitioners, other advisors, and the industry as a whole?

YTD: I have had a great deal of positive feed back by colleagues on Shari’ah boards, by lawyers, bankers and by financial professionals all over the world. I will mention Shaikh Taqi Usmani, in particular, who wrote to me to request a copy of the paper and who, after reading it, thanked me for performing what he called “fard kifayah”. Equally as important is that I have heard from investors who feel very strongly about the issue of authenticity; and many are upset that Shari’ah scholars have actually approved such swaps.

DS: In recent weeks we saw reports surface of Mufti Taqi Usmani’s criticism of the sukuk sector. With the sector growing so rapidly within Islamic finance, how has the market reacted to Mufti Taqi’s observations? How did the problem get so bad?

YTD: I must again point to the relative newness of this industry, and of this product, Sukuk, in particular. Sukuk are based on very complex contracts; and nearly every one is different, even if many are based on the same model. For, even when you begin with a single concept on which to base a Sukuk issuance, if the jurisdictions are different, if the size, the tenor, the credit enhancements, in short if all the business and legal aspects are different, then of course the end product is going to be very different.

Then, while AAOIFI has promulgated detailed standards for Sukuk, those standards are applicable at the conceptual level. At the practical level, however, where all the details are, those standards are often subject to interpretation; and that will lead inevitably to differences. So, in a way, it should come as no surprise that there is such divergence. The contribution of Shaikh Taqi is a responsible way of dealing with all of this. In a like manner, I am hopeful that my paper will stimulate further discussion and debate in keeping with the finest traditions of Muslim legal scholarship. Finally, all of us must say: Allah knows best!

Booming Islamic bond market embroiled in debate over religious compliance: Mufti Taqi Usmani’s criticism of contemporary sukuk issues

Booming Islamic bond market embroiled in debate over religious compliance: Mufti Taqi Usmani’s criticism of contemporary sukuk issues

The booming market for financial products that comply with Islamic law was thrown for a loop recently by criticism from a leading scholar, who has set off a debate about whether the industry has sacrificed religious principles for the sake of growth at a time of surging Mideast oil revenue.

Shariah, or Islamic law, prohibits charging or paying interest, so bankers and lawyers have developed a rapidly growing financial market by restructuring conventional products like bonds to make them compliant with Islam. Shariah-compliant products attempt to replicate the concept of interest through cost-plus transactions, leasing arrangements or by linking payments to returns on underlying assets. The process is normally blessed by a board of religious scholars affiliated with a bank.

However, one of the world’s leading Shariah finance scholars recently rattled the market by saying 85 percent of Islamic bonds, or sukuk, are not Shariah-compliant. Sheik Mohammed Taqi Usmani argued that, in essence, they were structured too much like conventional bonds.

Many industry participants say Shariah scholars knew the bonds had structural issues but approved them to jump-start market growth — raising questions about how the gatekeepers of the Islamic banking industry weigh potential profit versus religious principles.

Others downplay the controversy, saying debate was expected given the rapid evolution of the market and the nature of Islamic law, which encourages multiple viewpoints from different scholars.

The influential Shariah board headed by Usmani at the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions, one of the leading groups trying to establish standards for the market, is scheduled to meet Jan. 15 with the hope of resolving the dispute and mitigating its impact on the industry.

Some say the race to grow the market has led to questionable religious rulings — a problem that is hard to police because of the lack of standardization across Shariah approval boards and the shortage of Islamic scholars well-versed in finance.

“Increasing the market in volume or numbers with false product that is against Islam is not a big success. It should be according to Shariah, that is the main thing,” said Sheik Saleh Abdullah Kamel, chairman of the Bahrain-based General Council for Islamic Banks and Financial Institutions, one of several organizations attempting to monitor the industry.

Islamic banking assets outside Iran totaled $400 billion to $450 billion in 2006 and are projected to rise to $1 trillion by 2010, according to a recent report by McKinsey & Co. Total assets, including those in Iran, totaled $750 billion in 2006, a small fraction of global financial assets, but one that is growing quickly.

Experts say growth has been driven by booming Persian Gulf oil revenue, Muslims’ growing preference for an expanding range of Shariah-compliant products and increasing acceptance of Islamic banking practices by financial regulators around the world.

The development of the sukuk market has been particularly important because previously there was a scarcity of Islamic products that could provide mid- to long-term investment and potentially be traded in the secondary market.

Sukuk issuance has grown almost 85 percent per year since 2001, with the total value of Islamic bonds issued in 2007 reaching $39 billion as of October, according to McKinsey.

“There has been this perception in the past that Islamic finance doesn’t lend itself to overly complicated structures, but sukuk rebuts that view,” said Nadim Khan, a Dubai-based lawyer who specializes in Islamic banking.

“It’s a real demonstration from the perspective of the Islamic financing industry that it is possible to structure widely acceptable, quite sophisticated Sharia compliance structures,” he added.

Islam prohibits interest based on the belief that money alone should not be used to generate profit and the returns are seen as riskless gain. So most sukuk are structured with a profit-sharing arrangement where returns are based on the value of the assets purchased with the initial investment.

However, many sukuk have been sold with a repurchase agreement, stipulating the borrower will pay back the face value at maturity, mirroring the structure of a conventional bond.

Usmani, the Shariah scholar, estimates 85 percent of sukuk have been sold with these repurchase agreements and believes the promise to pay back the capital runs counter to Islamic law.

“This is against the risk sharing principle of Shariah,” said Usmani.

Sheik Nizam Yaquby, another renowned scholar on the Shariah board chaired by Usmani, agreed that bonds with repurchase agreements should be made more Shariah-compliant.

“We need enhancement, improvement, innovation and we need more risk taking,” said Yaquby. “Many scholars have reluctantly approved such (sukuk) structures to take us away from the conventional bond market, but that stage has ended, so we should start creating more innovative structures.”

Kamel, who monitors the market, criticized this willingness to approve sukuk structures based on the assumption that they could be made more Shariah compliant once the market had grown, saying it was dangerous for the industry.

“The golden rule of Islamic banking is if you want a profit, you should accept the losses,” said Kamel. “If this rule is broken in any of the product, it is not according to Shariah.”

However, Afaq Khan, the head of Saadiq, Standard Chartered Bank’s Islamic banking arm, does not believe sukuk currently in the market can be considered counter to Shariah because they were blessed by their respective approval boards.

“Nobody comes to the sukuk market without a Shariah fatwa (religious ruling), so at least some Shariah scholars approved it,” said Khan.

Nevertheless, Khan said the current debate was productive. “Anytime a new industry evolves, it will try to test the boundaries,” he said.

“It is very healthy for the industry to take a breath, review and then move on,” said Khan. “Hopefully some consensus will evolve and it will be beneficial for the industry.”