Ship Financing in Germany: A possible Area of Application for Islamic Finance?

TABLE OF CONTENT

II. Figures and Tables

III. Abbreviations

1. Introduction

2. Does the German Shipping Industry Need Islamic Finance?

3. The Principles of Islamic Finance
3.1 Sources and Interpretations of Sharia Law
3.2 Islamic Commercial Law
3.2.1 Basic Principles
3.2.2 Islamic Contracts
3.2.3 The Underlying Asset Rule
3.2.4 Forbidden Assets
3.2.5 The Prohibition of Riba, Gharar and Maysir
3.2.6 Summarizing Islamic Commercial Law
3.3 Islamic Financing Modes at a Glance
3.3.1 Credit-based Modes
3.3.2 Equity-based Modes
3.3.3 Islamic Leasing
3.3.4 Forward Transactions

4. Ship Financing and the Industry around It
4.1 An Overview of the Shipping Industry
4.2 Distinctive Features of Ship Financing
4.2.1 Shipping Company Structures
4.2.2 Investment Environment
4.2.3 Risk Environment
4.2.4 Summarizing Distinctive Features of Ship Financing
4.3 Current Ship Financing Modes
4.3.1 Modes at a Glance
4.3.2 The Prevalent System in Germany: KG-Funds
4.3.3 Leasing: A new Trend in Ship Financing

5. The Construction of Sharia -compliant Schemes for Ship Financing in Germany
5.1 Some Common Ground between Ship Financing and the Sharia
5.2 Existing Sharia -compliant Offers in Ship Financing
5.3 Possible Sharia -compliant Ship Financing Schemes
5.3.1 Making the German KG-System Sharia -compliant
5.3.2 Countervailing Shipping Cycles with the Help of Islamic Leasing
5.4 General Impediments for Sharia -compliant Ship Financing

6. Conclusion

IV.References

II. Figures and Tables

Figure 1: The constitution of Sharia law

Figure 2: World cargo fleet in million dwt

Figure 3: The ship supply cycle

Figure 4: Direct or indirect ship financing

Figure 5: A typical structure for KG-funds

Figure 6: Typical finance lease structure in ship financing

Figure 7: Musharaka -based ship financing scheme

Figure 8: Ijara -based ship financing scheme

Figure 9: Combining ijara and musharaka

Table 1: Principles and prohibitions in Islamic commercial law

Table 2: An overview of Islamic financing modes

Table 3: Top ten world container liner companies

Table 4: Distinctive features of ship financing

Table 5: Direct and indirect ship financing in the shipping companies’ perspective

Table 6: Comparing Islamic and shipping finance

Table 7: Example of cash-flow schedule for ship financing under musharaka

III. Abbreviations

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1. Introduction

The beginnings of modern Islamic finance date back to the 1970s when some financial institutions in Egypt and the Middle East started to offer interest-free financial services in order to comply with the rules laid down in the Sharia . Services, however, were not yet totally Sharia -compliant. Besides a lack of the necessary infrastructure and trained staff, a commonly accepted definition of what constitutes Sharia -compliance was missing.^[1] Even today, opinions differ widely if certain presumably Sharia -compliant financial products really deserve the branding. Nevertheless,a wide array of Islamic financial products ranging from home financing to insurance are nowadays available. Though the industry is currently managing Sharia -compliant assets of USD 895 billion,^[2] Islamic finance certainly must still be considered as niche market. However, globalization in general and the flow of funds into Muslim oil producing countries in particular could further strengthen the position of Islamic financial products.^[3] In comparison, the concept of joining forces to finance ships dates back to the 16th century.^[4] Only few could afford to individually provide all the funds needed to finance an entire vessel. Although financing schemes in the shipping industry have become more sophisticated over the centuries, the basic strategy to put the financial risks on many shoulders has prevailed until today.

As this work will point out, sharing risks and rewards along with a strong emphasis on asset-backed financing are the key features of both, Islamic and shipping finance. Therefore, using Islamic financing techniques to fund vessels, at least at first glance, does not seem to be far-fetched. Indeed, a few presumably Sharia -compliant ship financing schemes have been implemented in the past. To my knowledge, however,no scientific research about the expedienceof linkingIslamic finance tofunding ships has been provided yet. Thus, this work aims at analyzing the feasibility of connectingthese two fields with each other. Note that legal aspects as well as tax issues go beyond the scope of this work and, therefore, can only be touched but by no means exhaustively analyzed.

To provide a comprehensive analysis about the practicabilityand purpose of combining Islamic finance and ship financingI sub-divided the research question into three constitutive parts: is it possible to link Islamic finance with shipping finance? Is it useful to conjoin these two fields with each other? Is Islamic finance even superior to conventional finance when it comes to funding ships?

Firstly, I will come to the question whether the German shipping industry needs Islamic finance. In that context, I will point out some rationale why ship financiers could be appealed to the potentials of Islamic finance. In chapter three, the principles and prerequisites of Sharia -compliant financing will be introduced. Therefore, it is important to know about the constitution of the Sharia and its relevance in everyday life, especially in economic matters. Afterwards, the Islamic commercial codex will be analyzed in detail and all possibly relevant Islamic financing modes will be outlined. In the next chapter, I will give an overview of the shipping industry and describe the mechanisms of ship financing while I will pay special attention to the German ship financing industry. I will, furthermore, define special features that distinguish the funding of vessels from other financing ventures. Afterwards, in chapter five, I will bring together my findings of the previous sections to analyze the advantages and drawbacks of Islamic finance in the context of ship financing. At the end, before drawing a conclusion, I will design Sharia -compliant ship financing schemes based on the results of the preceding chapters.

2. Does the German Shipping Industry Need Islamic Finance?

The prevalent ship financing mode in Germany is the so called KG-system.^[5] Benefitting from the advantages of the KG-system,German companies have been quite successful in financing and managing large fleets especially in the container segment. This success story has got some scratches when the financial crisis hit world trade and, consequently, the shipping markets. In the aftermath of the crisis, various shipping funds had to employ restructuring programs; many of them had to raise additional funds, either from existing shareholder or from new ones. Thus, the German KG-system has been declared dead by some industry commentators and analysts. They believe investors and banks have lost their trust in the system. Others say the system will survive, though some modifications are necessary. One of those modifications may bethat banks will ask for higher equity ratios when financing KG-based shipping companies. Either way, new vessels have to be financed in the future. The order books of the shipyards indicate massive demand for new tonnage, even though many of these orders are not yet financed.^[6] If Germany wants to defend its role in the international ship financing industry, new sources of funds will have to be tapped in the future.Innovative financing modes might be the key to maintain a leading position in the further expansion of the world fleet.^[7]

From an International perspective, ship owners are already relying on diverse and sometimes innovating financing modes. Many shipping companies have listings on capital markets, among them the industry giant Maersk. Some ship owners have raised money in the past by issuing bonds. Others rely on innovative leasing structures to extend their fleet.^[8] Evenpresumably Sharia -compliant structures have already been employed a few times in ship financing.^[9]

Indeed, Islamic finance has some favorable features that go well together with ship financing, as this work will show. Furthermore, prominent observers of the growing Islamic finance industry are of the opinion that thedemand for Sharia -compliant investment opportunities is far greater than the current supply.^[10] On the other hand, only four percent of the 32 Million Muslims living in Europe use Sharia -compliant financial products, which leaves room for a significant upside potential at the demand side.^[11] At the time being, conventional shipping funds are mostly Western financed, whereas Sharia -compliant offers appeal to Middle Eastern and Asian investors.^[12] Given the necessity for German ship financiers to find new capital sources, Islamic finance and the German ship financing industry could turn out to be aninnovative and efficient match.

3.The Principles of Islamic Finance

3.1 Sources and Interpretations of Sharia Law

Sharia law is the canonical law devout Muslims follow. It plays a decisive role not only in religious matters but also in many aspects of everyday life. Inheritance, sanitation, criminal law, commercial activities and many other matters are directly or indirectly regulated by the Sharia . To understand the implications of Sharia law for commercial interaction it is essential to know its constitution and the mechanisms behind it.^[13]

Islam is not a homogenous belief system. There is no highest authority, representing god’s will on earth that has the ultimate say over right and wrong. Furthermore, the Sharia is not a single codified body of law but, instead, consists of various sources and is very much open to interpretation. Hence, within Sunnis and Shias there are various different schools of thought that generally agree on the broad principles of Islam and the Sharia but frequentlydisagree about specific matters.^[14] Certainly, there is no dispute about the status of the Quran as most important source of Sharia law. In the Quran the words of god are written down as they were delivered to the Prophet Mohammed. None of the other sources may interfere with or contradict the ideasof the Quran . Second in line is the sunna , which is also considered to be a primary source of law. The sunna is a collection of accounts stating what the Prophet did, said or silently approved. These accounts are called hadith . They were transmitted not by Mohammed himself but by people that were directly or indirectly in touch with the Prophet. The stronger the line of transmission of a hadith to Mohammed the more followers acknowledge its authenticity. Different schools of thought may weigh the importance of a hadith differently or may even reject its legal validity altogether.^[15]

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Figure 1: Theconstitution of Sharia law^[16]

The differences between the schools of thought are even larger when it comes to thesecondary sources of the Sharia . These secondary sources are needed to adjust the teachings of the Quran and sunna to problems that have evolved during the centuries and, thus, are not explicitly mentioned in the primary sources.^[17] There are three secondary sources, though not all of them are accepted throughout the entire Muslim world. Ijma describes the consensus of all Muslims within a defined community. This can be a geographic community, for instance all Muslims within a village, or an academic community, for instance all scholars in a specific organization.^[18] The reasoning behind ijma is that the Prophet’s community will never agree on an error, which is laid down in a hadith .^[19] Ironically, there is no broad consensus about what consensus consists of. Opinions differ if really all Muslims within a community have to agree on a specific topic or if only designated scholars need to find a consensus. Furthermore, it is often difficult to define the boundaries of a certain community. Qiyas describes the process, howrules of the primary sources are applied to questions that are not explicitly answered in the Quran or sunna . Analogy would be an adequate translation for qiyas . An example of such an analogy would be to rule that the use of synthetic drugs is forbidden because of the prohibition of alcohol, which is laid down in the Quran . Ijtihad represents the independent reasoning of a qualified Islamic jurist that leads to new legal rules. This third secondary source is particularly controversial. Some Islamic scholars are of the opinion, since all important questions have been settled long ago, there is no place for ijtihad in today’s world anymore. The conservative hanbali school rejects to a large extent all secondary sources believing only in the literal truth of the Quran and the sunna . Ironically, this sometimes leads to liberal views towards present-day phenomena that are not mentioned in the primary sources. Since using analogies or other reasoning is not allowed in the hanbali school the Islamic axiom, which deems everything that is not prohibited to be allowed, counts.^[20]

Whenever there is ambiguity over what Sharia law requires from a Muslim in a certain situation, individuals or a court can ask for the issuance of a legal opinion called fatwa .^[21] Such a fatwa must be issued by a Muslim jurist; however, its relevance reaches only as far as the authority of the jurist who has issued it because generally, a fatwa is not binding.^[22]

3.2 Islamic Commercial Law

3.2.1 Basic Principles

When it comes to commerce, the most basic principle of Islamic Sharia law can be described as the pursuit of justice within the community.^[23] This basic principle, however, does not preclude Muslims from seeking wealth.^[24] On the contrary, the Quran states that after the prayers are finished one shall disperse through the country and seek prosperity that Allah may grant.^[25] Though, the attitude of Islam towards commercial activities is generally positive, the Sharia comprises certain rules and limitations regarding Islamic finance. Some of these rules are accepted universally throughout the Muslim community, others are controversial due todifferent interpretations.^[26] Both, controversial as well as uncontroversial rules will be introduced in the following.

First and foremost, society as a whole should profit from commercial activities. If one person realizes profits at the expense of another person, there is no added value for society. The deal is seen as a zero-sum game and, therefore, does not qualify for the label Sharia -compliant. Furthermore, in case a person is in financial distress, this person should be treated generously especially if he or she is a member of the religious community. Penalty clauses to ensure that the counterparty meets its payment obligations on time are, hence, hard to enforce. Charges for delayed payments are not only regarded as unjust, they are usually also interpreted as interest. Interest, however, falls under the Islamic prohibition of riba .^[27]

The Sharia , moreover, restricts the use of loans. Generally, any predetermined charges above the principal are forbidden. Commerce and trade should not be financed with excessive debt capital.^[28] Instead, investors and entrepreneurs should engage in partnerships and share any profits, losses and, thus, risks that might result from this partnership.Askari, Iqbal, and Mirakhor argue that “promoting maximum risk-sharing is […] the ultimate objective of Islamic finance.”^[29] If one party is granted a predetermined return, the risks of the undertaking are considered to be allocated unequally.Profit-sharing arrangements are superior to credit-based financing in terms of Sharia -compliance.^[30]

The past has shown that the architects of the Islamic finance industry try to create new investment instruments either based on already existing ones or by transforming conventional instruments into Sharia -compliant replicates. In recent years, however, some financing instruments have been developed that have a close resemblance to interest-bearing loans but are by most scholars still regarded as Sharia -compliant.^[31] One example of such an instrument is called murabaha,^[32] where afee or mark-up is chargedon top of the actual transaction value.This financing scheme has to fulfill two preconditions in order to be Sharia -compliant. Firstly, the mark-up has to be a fixed sum and cannot be dependent on other parameters. A floating rate would be considered as interest and is, therefore, prohibited. Secondly, the financier, for example a bank, has to carry some of the risks associated with owning the demanded good. The bank could buy the good, own it for a certain period of time,^[33] and then sell it to the client.^[34] In this scenario the financier would face the risk that the good could be damaged or the market price of the good could change while being in his possession. The possibility that the client could back out of the deal after the investor has already purchased the good poses another risk to the financier. Such kinds of deals are not regarded as loans but as sales on credit. For a sale on credit it is legitimate to ask for a fee on top of the value of the associated good.^[35]

In addition to possible disagreements whether a certain financing mode is Sharia -compliant or not, many Muslims accept the concept of darura (necessity) while others do not. The concept indicates that due to economic necessities it might be permissible to employ financial means that are, in fact, not compliant with Islam, if there are no Sharia -compliant instruments available. Vissermentions in that context the example of home financing in Europe and North America. Fatwas issued by the ‘European Council of Research and Fatwas ’ and the ‘League of Scholars of Sharia ’ in the USA allow Muslims living in Europe and North America to take out interest-based loans for home financing if Sharia -compliant equivalents are not readily available.^[36]

After having described broad principles of Islamic finance, there are some specific aspects left that should be examined more closely. These aspects are considered in single sub-chapters because they have far-reaching consequences for any Islamic financing scheme and, thus, also for the schemes I will construct later on for ship financing in Germany.

3.2.2 Islamic Contracts

Islamic contract law contains some decisive features that usually do not play a role in conventional business contracts. To ensure limited complexity in Islamic commerce, business contracts are not allowed to cover more than one transaction at a time. Furthermore, contracts that are entailed or directly linked to each other are also prohibited.Often, of course, it is necessary to execute more than one transaction in order to complete a business deal. If we take the example of murabaha again, then,the financier has to close separate contracts with the third party, from whom he buys the good, and his client, to whom he sells the demanded good. Another example would be, when party A sells a good to party B and, afterwards, buys it back at a higher price. Such a deal is not allowed if both transactions are arranged together and at the same time. Otherwise, there would be either two transactions within one contract or the first contract would presuppose the second one. Though, there are some hurdles to take, in general, Islamic financial products can be structured as long as there are individual contracts to each transaction and as long as each transaction itself is Sharia -compliant. Moreover, most scholars demand a time lag between each transaction, so that, at least in theory, one contract does not entail another contract.^[37]

3.2.3 The Underlying Asset Rule

Islamic finance endorses a strong linkage between the real economy and the financial sector. Being opposed to credit-based financing, Islamic finance advocates financial transactions that are backed by tangible assets. The financing activities of a company, thus, have to be directly linked to underlying assets.The main goal in strictly coupling financing with underlying assets is to restrict speculation. Critics, however, emphasize the downside of these financing techniques, which are namely limited possibilities to hedge against certain risks.^[38]

Another critique often brought forward is that these financing restrictions can formally, but not in essence, be overcome in a Sharia -compliant way. Tawarruq is one example of an Islamic financing instrument where Sharia -compliance is formally maintained, although the basic intention of the underlying asset rule is circumvented.^[39]

3.2.4 Forbidden Assets

The Sharia bans the production, consumption or usage of certain assets and services that are assumed to be contradictoryto Islamic norms. These assets or services are referred to as haram . ^[40] In the followingthose goods and services where there is broad agreement in the Muslim world about their classification as haram are listed:

- alcohol
- weapons
- tobacco
- pork
- gambling
- pornography

Not just direct trading with these goods is forbidden but also, for example, the investment in shares of a company that produces pork or alcoholic beverages. At first sight, it seems easy to avoid investing in these goods. However, it is questionable how ample the relation between the investment and the haram goods can be. For instance, is it permissible to buy shares of a company, which itself owns shares of a company that produces beer? How far must this line be extended in order to be still haram ?A typical example is the investment in a hotel. Usually, in a hotel alcoholic beverages are sold. Opinions differ if such an investment is Sharia -compliant or not. Furthermore, the definitions of pornography and gambling may vary widely. In many Muslim countries a plunging neckline is considered as outright pornography; in other Muslim countries the interpretation of pornography may be more liberal.^[41]

Besides the above listed goods there are also some assets and services where there is controversy whether they are haram or not. Conservative Islamic scholars, for example, interpret investments in entertainment such as movies and music as not compliant with the Sharia . One also cannot invest in companies that supposedlyprofit from unethical practices. The debatable question here certainly is: what is unethical? Opinions again differ. One example could be biotechnology firms that engage in genetic engineering. Since a large part of the profits in the conventional financial service sector derives from interest, investments in this sector do not pass as Sharia -compliant either.^[42] In general, however, the investmentmust not be of a special Islamic character in order to be consistent with Sharia law as long as it goes along with all the rules laid out in the Sharia .^[43]

3.2.5 The Prohibition of Riba, Gharar and Maysir

In the Islamic world, the view that riba and interest are two different words for the same thing is prevalent today. Literally translated riba means “excess” and could, hence, be closer to usury than to interest. Among experts there is still a controversial dispute going on if the prohibition of riba originally covered all forms of interest or just excessive rates that were unjustified and lead to impoverished borrowers. However, in today’s Islamic finance industry all forms and rates of interest are off-limits.In addition to arguments concerning Sharia -conformity, often, secular arguments are invoked by Muslim scholars to justify the complete ban on riba . In their opinion, interest boosts the transfer of wealth from the poor to the already rich and turns people away from productive enterprises. Interest, they say, determines profits ex ante irrespective of the outcome of the business venture and, hence, abets the party with the stronger bargaining power without necessarily creating additional wealth forsociety.^[44]

The ban on riba does not only affect loans and other forms of credit-financing but also covers the purchase of goods and penalties for delayed payments.Any accessory charge on top of the principal amount is considered as riba , as long as this accessory charge is not regarded as compensation for an increase in incurred risks or additional services.^[45] Frequently, there is a thin line between forbidden interest and allowed mark-ups or fees. The fact that in Islamic financial practice conventional reference interest rates such as LIBOR^[46] are often taken as benchmark to calculate such mark-ups further blurs this thin line.^[47] Sharia law acknowledges that the price of a given good can be higher in the future compared to the present market price; nevertheless, Islamic finance does not accept the perception of money having a time value. Money, in Islamic philosophy, is not an asset in its own right but only becomes an asset if put to productive use. Therefore, any “mark-up” on a purely financial asset is interpreted as interest and, thus, would not be compliant with Sharia law. In a murabaha scheme, for instance, a bank buys a pre-specified good on behalf of the customer. In contrast to granting a loan, the bank carries risksassociated with ownership for a certain amount of time, this is until the bank sells on the good to the customer. Furthermore, by engaging in the described purchasing transactions the bank provides a service to its customer. Thus, given that all relevant rules of the Sharia have been followed, the bank is allowed to add a mark-up on top of the purchase value of the good.^[48]

As already mentioned above, a bank or any kind of lender is not allowed to increase the mark-up or charge any additional fees in case the borrower defers the repayment. A penalty on late payments would make the mark-up time dependent and, therefore, indistinguishable from interest.There are two possibilities for a lender to incentivize a borrower to pay on time. Firstly, the only universally accepted penalty clause in Islamic finance is to oblige the borrower to donate a certain sum of money to a charity in case of deferred payments. Secondly, some Islamic financial institutions include a charge for late repayment in the initial mark-up and grant a rebate for timely repayment. Many Islamic scholars insist, nevertheless, that such a rebate cannot be promised beforehand because, again, it would make the mark-up openly time dependent. However, a voluntary rebate out of kindness and generosity is very much appreciated in Islamic society and, thus, cannot be frowned upon.^[49]

Often, the term gharar is translated as “risk”, which leads to the misunderstanding that taking risks is discouraged or even forbidden in Islamic financial transactions.A more accurate translation for gharar , however, is “uncertainty”. In Islamic finance, uncertainties in regard to the subject of a contract or the price of a good have to be avoided. In contrast to the strict prohibition of riba , a certain degree of gharar in a business transaction can be permissible and might even be inevitable.^[50]

Mahlknecht identified the following aspects as possible indicators for gharar :

- two purchase transactions within one contract
- purchase or sale in the future
- uncertainty about the character or constitution of the subject of the contract
- uncertainty about the amount of goods to be traded
- uncertainty about the exact point of time when the agreed price has to be paid
- probable inability to deliver the good that is subject of the contract
- the subject of the contract does not exist yet
- the subject of the contract is not yet in the possession of the seller^[51]

It does not necessarily mean that a contract is void if one or more of the above listed aspects occur. When constructing a building, for instance, it is obvious that the subject of the contract does not exist yet and, hence, the seller does not possess the subject yet. Nevertheless, such a construction contract is not per se void because Islamic finance acknowledges the economic necessity ( darura ) and the special requirements of construction contracts.However, to keep the risks of gharar within narrow confines certain conditions must be fulfilled. Firstly, the subject of the contract must be clearly and unmistakably defined. Furthermore, the price for the subject of the contract cannot depend on preconditions which are contingent on future events. For example, it is not permissible to fix the price of the underlying good according to future going prices. Lastly, all contracting parties should have full knowledge of the actual state, existence and availability of the subject of the contract. There should be no information asymmetries between the contracting parties, that is, one contracting party should not take advantage of the nescience of another contracting party.^[52]

The prohibition of gharar limits the use and engineering of certain investment instruments in Islamic finance including the use of hedging devices.^[53] Selling debt capital is, therefore, not allowed. The only way to shift debt capital to another person or enterprise is to convey it at par value. Another example of such a limitation due to gharar is short-selling. Since the goods to be sold have to be in the possession of the seller at the time when the contract is concluded, it is not allowed to sell goods short.^[54] There are two types of forward transactions in Islamic finance, called salam and istisna , that can be considered as exemptions to this general rule.^[55]

Maysir describes a situation in which someone attains assets due to pure luck and not because of effort or merit. Therefore, an adequate translation for maysir is “speculation” or“gambling”, whereupon the prohibition of maysir is much more far-reaching than common gambling. Besides casino games and lotteries also speculative business dealings, many forms of derivatives and even conventional insurances^[56] are not compliant with Sharia law because most Islamic scholars consider these activities as being forms of maysir . From an Islamic point of view, the key critique on activities being considered as maysir is that the profit of one party comes along with a loss of the counterparty. There is no added value for society and no increase for the general welfare. At the same timean imminent threat that wealth will be distributed improperly prevails.^[57]

[...]

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^[1] Askari, et al., 2010 pp. 14-16

^[2] see Caplen, et al., 2010

^[3] Alasrag, 2010 p. 4

^[4] see Stopford, 2009 pp. 270-271

^[5] see chapter 4.3.2 for a detailed explanation of the German KG-system

^[6] see Clarkson Research Services Limited, 2011a pp. 14-15

^[7] cf. Endlweber, 2011andJansen, et al., 2011

^[8] cf. Stopford, 2009 pp. 296-309

^[9] Macqueen, 2010 and Endlweber, 2011 p. 22

^[10] Mahlknecht states in an academic article that “[…] the current supply of attractive Islamic products is still far smaller than the existing demand of Islamic banks, insurances (‘Takaful’) and other Islamic institutions […]”. Deutsche Bank comes in an academic paper to the conclusion that “[…] development of the Islamic financial market is not in fact a function of demand, despite clear evidence of such demand. Instead development of the Islamic financial markets is driven by the ability to remove the constraints on the supply side.” See Mahlknecht, 2010 pp. 255-256 and Deutsche Bank, 2007 p. 22

^[11] Mahlknecht, 2009 p. 79 citing ‘Institute of Islamic Banking and Insurance’

^[12] Macqueen, 2010

^[13] see also figure below

^[14] The four largest schools of thought of Sunni Islam are the Hanafi, the Maliki, the Shafii and the Hanbalischool. The largest school of Shia Islam is the Jafarischool. Some countries follow exclusively one school, in other countries there is more than one school predominant. In Egypt, for example, all four major Sunni schools can be found. See Rohe, 2009 pp. 24-33

^[15] cf.Rohe, 2009 pp. 43-57;Alasrag, 2010 pp. 9-10; Askari, et al., 2010 p. 11 and Dourish, et al., 2009 p. 537

^[16] own illustration, cf. Alasrag, 2010 pp. 9-10 and Rohe, 2009 pp. 43-73

^[17] Often there is even dissent about rules laid down in the primary sources. Numerous rules of the Quran or the sunna contradict each other. A good example is the attitude of a devout Muslim towards alcohol. Sura 16:67 speaks in favor of the consumption of alcohol whereas sura 5:90 demonizes alcohol as work of the devil. A well accepted mechanism to decide which sura should be followed is abrogation that is the later sura overrules the earlier one (note that the suras are not arranged in chronological order but in order of length). Cf. Rohe, 2009 pp. 46-52; also see Haleem, 2004 and sura 5:90 and 16:67

^[18] Two examples of such an organizational Muslim community shall be mentioned here. First of all, the fatwa committee of the al-Azhar University in Cairo can be considered as such an organization. Scholars of all four major Sunni schools sit in the committee. Thus, fatwas issued from this committee are held in particularly high esteem. ‘The Accounting and Auditing Organization for Islamic Financial Institutions’ (AAOIFI), which issues accounting standards for Islamic finance can be regarded as a second example of an organizational Muslim community. See Visser, 2009 pp. 12, 24

^[19] Visser, 2009 p. 11

^[20] cf. Rohe, 2009 pp. 43-64 and Alasrag, 2010 pp. 9-10

^[21] One of the best known fatwa s in the western world is certainly the fatwa Ayatollah Khomeini declared against Salman Rushdie after he published his book ‘The Satanic Verses’. See. Rohe, 2009 p. 135

^[22] Visser, 2009 p. 14

^[23] The religious community of Muslims is called umma

^[24] cf. Venardos, et al., 2010 pp. 155-156 and Visser, 2009 p. 78

^[25] see s ura 62:10

^[26] There are four leading law schools in Sunni Islam. Shiites, of course, have their own schools of law. Even within these schools divergent opinions among scholars can be quite prevalent especially if it comes to commercial activities. For a conclusive overview of the most important law schools and the differences between them, see Visser, 2009 pp. 15-17

^[27] cf. Venardos, et al., 2010 p. 54; Visser, 2009 pp. 76-78 and Cattelan, 2010 pp. 76-77; for a detailed analysis of the prohibition of riba see chapter 3.2.5

^[28] The reason for the general aversion of the Sharia towards debt financing can be found in the origins of Islam. In pre-Islamic Arabia it was common to double the principal if the borrower could not repay the loan on time. Since it was unrealistic to repay twice the sum if he could not even repay the original amount on time the borrower often ended up being enslaved to the lender. See Visser, 2009 pp. 31-32

^[29] Askari, et al., 2010 pp. 60-61

^[30] cf. Porzio, 2010 p. 92; Visser, 2009 p. 52; Venardos, et al., 2010 pp. 151-152 and Askari, et al., 2010 pp. 12-13

^[31] Porzio, 2010 p. 109

^[32] Murabaha is the classic example of so called mark-up financing. See also chapter 3.3.1

^[33] How long such a period has to be in order to carry some risks of ownership is strongly controversial. See Mahlknecht, 2009 p. 107

^[34] cf. Mahlknecht, 2009 pp. 101-106 andVisser, 2009 pp. 53-54

^[35] Mahlknecht, 2009 pp. 20-21

^[36] Visser, 2009 p. 106

^[37] cf. Mahlknecht, 2009 pp. 21-22, 37-39 and Visser, 2009 pp. 70-75

^[38] Askari, et al., 2010 pp. 12-13 and Visser, 2009 p. 70

^[39] for a detailed description of tawarruq see chapter 3.3.1

^[40] Haram means “forbidden” and is the opposite of halal , which means “allowed”.

^[41] Venardos, et al., 2010 p. 154 and Visser, 2009 pp. 113-114

^[42] In 2004, HSBC Amanah, the Islamic window of HSBC, launched an Islamic pension fund. Being a conventional bank, investments in shares of HSBC were ironically excluded from the fund. See Wilson, 2010 p. 220

^[43] Visser, 2009 pp. 113-114

^[44] cf. Askari, et al., 2010 pp. 12-13 and Visser, 2009 pp. 31-32, 38

^[45] Usually a compensation for inflation is also considered as riba . See Visser, 2009 pp. 35-36

^[46] “London Interbank Offered Rate” (LIBOR) is a reference rate to which banks borrow money to each other.

^[47] Mahlknecht, 2010 p. 261andMahlknecht, 2009 p. 24. The often quoted example of two brothers, one selling haram alcoholic beverages and the other one selling halal fruit juices or soft drinks, illustrates the legitimacy of taking conventional reference rates as benchmark for Islamic transactions. Since the brother who sells soft drinks wants his business to be as profitable as the one of his brother who sells alcoholic beverages, he adds the same margin on top of the soft drinks’ price as his brother does for alcoholic beverages. See for example Deutsche Bank, 2007 p. 22

^[48] see chapter 3.1.1 and cf. Mahlknecht, 2009 pp. 19-21, 101-106 and Visser, 2009 p. 25

^[49] Concerning penalties, many conflicting opinions existin the Islamic world. More liberal scholarsadvocate the legality of “conventional” penalty fees due to darura. Conservatives are of the opinion that besides of donations to charities the only acceptable penalties for late or non-repayment are non-monetary ones usually amounting to imprisonment. Visser, 2009 pp. 59, 76-77

^[50] Alasrag, 2010 p. 13 and Mahlknecht, 2009 p. 24

^[51] Mahlknecht, 2009 pp. 25-26

^[52] cf. Visser, 2009 pp. 46-48;Mahlknecht, 2009 pp. 26-27 and Alasrag, 2010 p. 13

^[53] Some scholars are of the opinion that hedging reduces uncertainties and, thus, gharar ; therefore hedging should be allowed. In practice, however, since futures and options are commonly regarded as gharar most hedging activities are off-limits. Nevertheless, there are some current approaches to develop Sharia -compliant hedging devices. See Visser, 2009 pp. 71-74 and for approaches to design Sharia -compliant hedges see Mahlknecht, 2009 pp. 143-170

^[54] Mahlknecht, 2009 pp. 35-36 and see Calder, 2010 for approaches to replicate short-selling devices in Islamic finance

^[55] see chapter 3.3.4

^[56] From the Islamic perspective, the main critiques on conventional insurances are that risks and profits are unevenly distributed between the insurance company and the insurants and that these profits for the insurance company are due to a bet on whether a certain incident takes place or not. Recently, Islamic forms of insurances, called takaful , have been introduced. Takafuls are jointly owned by the insurants themselves. The insurants put money into a fund that is managed by the insurance company. The fund will be invested in Sharia -compliant assets and businesses. The profits of the fund mostly go to the insurants, while the insurance company collects a fee for its services. See Bhatty, 2007

^[57] cf. Alasrag, 2010 p. 6 and Mahlknecht, 2009 pp. 27-28