Risk Management Guidelines

for

Islamic Banking Institutions

State Bank of Pakistan
Islamic Banking Department

www.sbp.org.pk

The Team

Name Designation Contact

Pervez Said Director
(9221)921 2495

pervez.said@sbp.org.pk

Mahmood Shafqat
Senior Joint

Director
(9221)921 2509

mahmood.shafqat@sbp.org.pk

Zahid ur Rehman
Junior Joint

Director

(9221)245 3744

Table of Contents

Preamble:............................................................................................................................ 1

1. General Requirement:................................................................................................ 2

Principle 1.0: ................................................................................................................2
Board of directors (BOD) and senior management oversight: ..................................2
Risk Management Process:..........................................................................................2

2. Credit Risk :................................................................................................................ 4

Definition and Profiles of Credit Risk:.......................................................................4
Principle 2.1: ................................................................................................................4
Principle 2.2.................................................................................................................5
Principle 2.3: ................................................................................................................6
Principle 2.4: ................................................................................................................6

3. Equity Investment Risk:............................................................................................. 8

Principle 3.1: ..............................................................................................................10
Principle 3.2: ..............................................................................................................11
Principle 3.3: ..............................................................................................................11

4. Market Risk .............................................................................................................. 12

Principle 4.1: ..............................................................................................................12

5. Liquidity Risk: .......................................................................................................... 12

Profiles of Fund Providers: .......................................................................................13
Principle 5.1: ..............................................................................................................13
Principle 5.2: ..............................................................................................................14

6 Rate of Return Risk: ................................................................................................. 15

Definition and Profiles of Rate of Return Risk........................................................16
Principle 6.1: ..............................................................................................................16
Principle 6.2: ..............................................................................................................17

7. Operational Risk:...................................................................................................... 18

Principle 7.1: ..............................................................................................................18
Principle 7.2:...............................................................................................................19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

RISK MANAGEMENT GUIDELINES FOR
ISLAMIC BANKING INSTITUTIONS

Preamble:
i) With the intention of rolling out standards issued by Islamic Financial Services Board
(IFSB) in Pakistan, Risk Management guidelines for Islamic Banking Institutions (IBIs) have been
compiled by tailoring the IFSB guiding principles on Risk Management to our market. However,
these guidelines should be considered in addition to the various Risk Management Guidelines
issued by SBP from time to time and IBIs will be required to comply with both set of guidelines.
These Guidelines for IBIs will further complement and enhance the current Risk Management
regime of SBP by identifying and suggesting technique to manage various types of risks unique to
IBIs.

ii) These Risk Management Guidelines provide a set of best practices for establishing and
implementing effective risk management in IBIs. These Guidelines set out fifteen principles of risk
management that give practical effect to managing the risks underlying the business objectives
that IBIs may adopt. The principles contained in these Guidelines are designed to complement the
current risk management principles issued by the ‘Basel Committee on Banking Supervision’
(BCBS) and other international standard-setting bodies.

iii) These Risk Management Guidelines for IBIs provide specific guidance for each category of
risk, drawn from discussion on industry practices, outlining a set of principles applicable to the
following six categories of risk:

• Credit risk
• Equity investment risk
• Market risk
• Liquidity risk
• Rate of return risk
• Operational risk

iv) All IBIs are expected to make meaningful risk assessments based on the principles
described in these Guidelines. However, it is crucial for IBIs to recognize and evaluate the
overlapping nature and transformation of risks that exist between and among the categories of the
above-mentioned risks. In addition, IBIs may face consequential business risks relating to
developments in the external marketplace. Adverse changes in IBIs’ markets, counterparties, or
products as well as changes in the economic and political environments in which IBI operate and
the effects of different Shariah rulings are examples of business risk. These changes may affect
IBI’s business plans, supporting systems and financial position. In this regard, IBIs are expected to
view the management of these risks from a holistic perspective.

v) IBIs are also exposed to reputational risk arising from failures in governance, business
strategy and process. Negative publicity about the IBIs’ business practices, particularly relating to
Shariah non-compliance in their products and services, could have an impact upon their market
position, profitability and liquidity.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

1. General Requirement:
Principle 1.0: IBIs shall have in place a comprehensive risk management and reporting process,
including appropriate board and senior management oversight, to identify, measure, monitor,
report and control relevant categories of risks. The process shall take into account appropriate
steps to comply with Shariah rules and principles and to ensure the adequacy of relevant risk
reporting to the supervisory authority.

Board of directors (BOD) and senior management oversight:
1. As with any financial institution, the risk management activities of IBIs require active
oversight by the BOD and senior management. The BOD shall approve the risk management
objectives, strategies, policies and procedures that are consistent with the IBIs’ financial condition,
risk profile and risk tolerance. Such approvals shall be communicated to all levels in the IBI
involved in the implementation of risk management guidelines.

2. The BOD shall ensure the existence of an effective risk management structure for
conducting IBI’s activities, including adequate systems for measuring, monitoring, reporting and
controlling risk exposures.

3. IBIs shall have in place a Shariah Advisor, in accordance with sound principles of
corporate governance and SBP’s Fit and Proper Criteria for Shariah Advisors, to oversee that IBIs’
products and activities comply with Shariah rules and principles as advised by SBP and Shariah
Advisor.

4. The BOD shall approve limits on aggregate financing and investment exposures to avoid
concentration of risk and ensure that IBIs hold adequate capital against these exposures. The BOD
shall review the effectiveness of the risk management activities periodically and make appropriate
changes as and when necessary.

5. Senior management shall execute the strategic direction set by the BOD on an ongoing
basis and set clear lines of authority and responsibility for managing, monitoring and reporting
risks. The senior management shall ensure that the financing and investment activities are within
the approved limits.

6. Senior management shall ensure that the risk management function should be separated
from risk taking function and is reporting directly to the BOD or senior management. Depending
on the scope, size and complexity of IBI’s business activities, the risk management function is
carried out by personnel from an independent risk management unit. These personnel shall define
the policies, establishes procedures, monitor compliance with the established limits and report to
top management on risk matters accordingly.

Risk Management Process:
7. IBIs shall have a sound process for executing all elements of risk management, including
risk identification, measurement, mitigation, monitoring, reporting and control. This process
requires the implementation of appropriate policies, limits, procedures and effective management

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

information systems (MIS) for internal risk reporting and decision making that are commensurate
with the scope, complexity and nature of IBIs’ activities.

8. IBIs shall ensure that an adequate system of controls with appropriate checks and balances
is in place. The controls shall (a) comply with the Shariah rules and principles; (b) comply with
applicable regulatory and internal policies and procedures; and (c) take into account the integrity
of risk management processes.

9. IBIs shall make appropriate and timely disclosure of information to depositors having
deposits on Profit and Loss Sharing basis, minimum requirements of which are specified by SBP in
its Guidelines for Shariah Compliance in IBIs”, so that they are able to assess the potential risks
and rewards of their deposits and to protect their own interests in their decision making process.

10. In addition to the above, following general requirements shall also be taken into account
by the IBI.

a) Application of Emergency and Contingency Plan: The senior management shall draw up
an emergency and contingency plan, approved by the board of directors in order to be
able to deal with risks and problems which may arise from unforeseen events.

b) Integration of Risk Management: While assessing and managing risk, the management
should have an overall view of risks the institutions is exposed to. This requires having a
structure in place to look at risk interrelationships across the organization. Such a setup
could be in the form of a separate department or bank’s Risk Management Committee
could perform such function. The structure should be such that ensures effective
monitoring and control over risks being taken.

c) Risk Measu ement: For each category of risk, IBIs are encouraged to establish
systems/models that quantify their risk profile. The results of these models should be
assessed by independent risk review function.

r

d) Utilization: The IBIs should develop a mechanism which should, to the possible extent,
monitor that funds provided by them were utilized for the purpose these were advanced.

e) Role of Finance Administration Department: It should be separated from finance
origination department. It should be among the responsibilities of Finance Administration
Department to monitor that the documents are obtained according to the requirement as
specified in the product. For example, the dates play a very important role in Murabaha
transactions and any transaction can be rendered invalid if the sequencing of obtaining
documents is changed.

f) Management Information System: The IBIs should specify control reports to be prepared
by independent department that should be periodically submitted to board or senior
management committee.

g) Human Resource: IBI shall ensure that staff has been adequately trained regarding Shariah
principles and procedures. There should be ongoing emphasis on staff training and
development planning with clear objective for individual staff members. For this purpose,
periodic workshops should be arranged by the IBI in coordination with Shariah Advisor.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

2. Credit Risk:

11. These guidelines address the credit risk associated with specific features of Islamic
financing contracts. The risk assessment and measurement processes undertaken by IBIs shall also
be applicable to profit sharing assets (Mudarabah and Musharakah) which are classified under
equity investments. Rigorous risk evaluation (including due diligence) and controls of these
investments are necessary in view of their exposure to capital impairment.

12. The credit risk principles in this section are also applicable to credit risks associated with
securitization and investment activities because, in the IBIs, an investment certificate or sukuk
generally represents a direct pro-rata beneficial ownership of the holder in the assets of the
underlying project.

Definition and Profiles of Credit Risk:

13. Credit risk is generally defined as the potential that a counterparty fails to meet its
obligations in accordance with agreed terms. This definition is applicable to IBIs managing the
financing exposures of receivables and leases (for example, Murabahah, Diminishing Musharakah
and Ijarah) and working capital financing transactions/projects (for example, Salam, Istisna or
Mudarabah). IBIs need to manage credit risks inherent in their financings and investment
portfolios relating to default, downgrading and concentration. Credit risk includes the risk arising
in the settlement and clearing transactions.

14. The following premises relate to the sound processes of credit risk management in IBIs:
• The role of IBIs can embrace those of financiers, suppliers, Mudarib and Musharakah

partners. IBIs concern themselves with the risk of a counterparty’s failure to meet their
obligations in terms of receiving deferred payment and making or taking delivery of an
asset. A failure could relate to a delay or default in payment, or in delivery of the subject
matter of Salam or Parallel Istisna, entailing a potential loss of income and even capital
for the IBIs.

• Due to the unique characteristics of each financing instrument, such as the non-binding
nature of some contracts, the commencement stage involving credit risk varies.
Therefore, credit risk shall be assessed separately for each financing instrument to
facilitate appropriate internal controls and risk management systems.

• IBIs will consider other types of risks that give rise to credit risk. For example, during
the contract life, the risk inherent in a Murabahah contract is transformed from market
risk to credit risk. In another example, the invested capital in a Mudarabah or
Musharakah contract will be transformed to debt in case of proven negligence or
misconduct of the Mudarib or the Musharakah’s managing partner.

• IBIs are prohibited from using the amount of any penalty for their own benefit; they
must donate any such amount to charity. This increases the cost of default.

Principle 2.1: IBIs shall have in place a strategy for financing, using various instruments in
compliance with Shariah, whereby they recognize the potential credit exposures that may arise at
different stages of the various financing agreements.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

15. The BOD of IBIs shall define and set the institution’s overall levels of risk appetite, risk
diversification and asset allocation strategies applicable to each Islamic financing instrument,
economic activity, geographical spread, season, currency and tenor. IBIs shall be mindful of and
take into account the permissible types of financing instruments available in different locations
wherever IBIs undertake cross-border transactions.

16. IBIs will take into account seasonal aspects resulting from a shifting or termination of use
of certain financing instruments, thus affecting the overall concentration exposures of the IBIs’s
financing portfolio. For example, the IBIs may offer Salam contracts during a certain season where
a product can most likely be delivered and sold at maturity.

17. IBIs’ financing strategies shall include a list of all types of applicable and approved
transactions and financings. The approved list must include formal exclusions from any
engagement by the IBIs in industries dealing in Haram or unlawful goods and services. The
approved list will be kept up to date and communicated to the relevant personnel within the IBIs,
and an internal compliance function will be organized and empowered to ensure that such rules
are applied.

18. IBIs shall be aware of the commencement of exposure to credit risk inherent in different
financing instruments and in various jurisdictions when developing the strategy. The non-binding
promise and legal enforcement aspects may give rise to operational risks and other risk
management problems relating to Shariah compliance.

19. When setting the level of risk appetite relating to counterparties, IBIs shall ensure that (a)
the expected rate of return on a transaction is commensurate with the risks incurred; and (b)
excessive credit risk (at both individual and portfolio levels) and risk concentration (for example
financing instruments, economic activity, geographical spread) are being managed effectively.

Principle 2.2: IBIs shall carry out a due diligence review in respect of counterparties prior to
deciding on the choice of an appropriate Islamic financing instrument.

20. IBIs shall establish policies and procedures defining eligible counterparties
(retail/consumer, corporate or sovereign), the nature of approved Shariah Compliant financings
and types of appropriate financing instruments. IBIs shall obtain sufficient information to permit a
comprehensive assessment of the risk profile of the counterparty prior to the financing being
granted.

21. IBIs shall have a policy for carrying out a due diligence process 1  in evaluating
counterparties, in particular, for transactions involving:

• New ventures with multiple financing modes: IBIs shall carry out due diligence
processes on customers or sovereigns using multiple financing modes to meet specific
financial objectives designed to address Shariah, legal or tax issues of customers.

1  The process may include Value at Risk, stress testing and sensitivity analysis, amongst others.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

• Creditworthiness that may be influenced by external factors: Where significant
investment risks are present in participatory instruments, especially in the case of
Mudarabah financings, additional counterparty reviews and evaluations will focus on
the business purpose, operational capability, enforcement and economic substance of
the proposed project including the assessment of realistic forecasts of estimated future
cash flows. Risk mitigating structures should be put in place by IBIs as far as possible.

22. IBIs, in their policy for approval, shall engage appropriate experts, including a Shariah
advisor to review and ensure that new financing proposals that have not been proposed before or
amendments to existing contracts are Shariah-compliant at all times. IBIs may also engage an
appropriate technical expert (for example an engineer) to evaluate the feasibility of a proposed
new project and to assess and approve progress billings to be made under the contract.

23. In a financing involving several related agreements, IBIs need to be aware of the binding
obligations arising in connection with credit risks associated with the underlying assets for each
agreement. To be Shariah compliant, subject to the interpretation of its Shariah scholars, IBIs shall
ensure that all components of the financial structure are contractually independent, although
these may be executed in a parallel manner despite their interrelated nature.

Principle 2.3: IBIs shall have in place appropriate methodologies for measuring and reporting
the credit risk exposures arising under each Islamic financing instrument.

24. IBIs shall develop and implement appropriate risk measurement and reporting
methodologies relevant to each Islamic financing instrument in respect of managing their
counterparty risks, which may arise at different contract stages (including counterparty
performance risk in Salam and Istisna contracts). Depending on the Islamic financing instrument,
the IBIs may employ an appropriate methodology that takes into account the price volatilities of
the underlying assets. The selected methodology shall be appropriate given the nature, size and
complexity of the IBIs’s credit related activities. IBIs shall ensure that adequate systems and
resources are available to implement this methodology.

Principle 2.4: IBIs shall have in place Shariah-compliant credit risk mitigating techniques
appropriate for each Islamic financing instrument.

25. IBIs shall clearly define their credit risk-mitigating techniques including, but not limited
to, having in place:

• a methodology for setting mark-up rates according to the risk rating of the
counterparties, where expected risks should have been taken into account in the pricing
decisions;

• permissible and enforceable collateral2 and guarantees;
• clear documentation as to whether or not purchase orders are cancelable; and
• Clear procedures for taking account of governing laws for contracts relating to financing

transactions.

2 IBIs are expected to include in its process, an ongoing monitoring of quality and valuation of any collateral.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

26. IBIs shall establish limits on the degree of reliance and the enforceability of collateral and
guarantees. They shall protect themselves against legal impediments that may restrict the
accessibility of collateral when they need to enforce their rights in respect of a debt. IBIs shall
formally agree with the counterparty at the time of signing the contract on the usage, redemption
and utilization of collateral if the counterparty defaults in payment.

27. IBIs shall have policies to define adequately the action to be taken by the IBIs when a
customer cancels a non-binding purchase order. The policies will describe how the IBIs (a)
monitor and control their exposures to suppliers, and especially during delivery between suppliers
to the IBIs where a customer is acting as an agent; and (b) identify whether the risks associated
with the assets will be borne by the supplier or the customer (which acts as agent and accepts the
assets from the supplier). For example, the IBIs may enter into a purchase contract with a supplier
on a “sale or return” basis, with an option to return the purchased item within a specified period.

28. IBIs shall have appropriate credit management systems and administrative procedures in
place to undertake early remedial action in the case of financial distress of a counterparty or, in
particular, for managing problem credits, potential and defaulting counterparties. This system will
be reviewed on a regular basis. Remedial actions will include both administrative and financial
measures.

29. Administrative measures may, inter-alia, include:

• negotiating and following-up pro-actively with the counterparty through maintaining
frequent contact with the counterparty;

• setting an allowable timeframe for payment or to offer debt-rescheduling or
restructuring arrangements (without an increase in the amount of the debt);

• using a debt-collection agency;
• resorting to legal action, including the attachment of any credit balance belongs to

defaulters according to the agreement between them;

And financial measures may include, among others:

• imposing penalties, the proceeds of which should be disposed of in charitable causes in
compliance with Shariah as decided by the IBIs Shariah Advisor; and

• Establishing the enforceability of collateral or third party guarantees.

30. IBIs shall set appropriate measures for early settlements, which are permissible under their
Shariah rules and principles for each Islamic financing instrument.

31. IBIs shall assess and establish appropriate policies and procedures pertaining to the risks
associated with their own exposures in parallel transactions. For instance, in the case of an Istisna
transaction, the IBIs enter into an Istisna contract as sellers to provide manufactured goods or a
building to a customer. The IBIs will then enter into another (parallel) Istisna contract as buyers
with a supplier (manufacturer or builder), using the specifications drawn up for the original
contract. If the supplier fails to deliver the manufactured goods or the building according to the
agreed specifications, IBIs would equally be in default of their obligation. If necessary, an outside
expert may be engaged to evaluate, approve and monitor the technical aspects. IBIs may also

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

stipulate that the party to the first contract must inspect the manufactured goods or building from
time to time during the production or construction process to satisfy themselves that the
specifications are being met.

32. IBIs shall establish appropriate policies and procedures that require them to honour their
commitment to the parallel contract counterparty. However, there must be no legal linkages
between the two contracts.

33. IBIs shall have in place a system to ascertain and fulfill their obligations in respect of
leased assets, which are permanently impaired through no default of the lessee. In case of such
impairment, IBIs are required to provide the lessee with a replacement asset with similar
specifications, if such specifications were agreed upon, or if the contract was renewed, or to refund
the additional amounts (capital payments) included in the Ijarah Muntahia Bittamleek lease
rentals as compared with those in an operating Ijarah. IBIs shall establish appropriate risk
management policies to mitigate losses arising from such damage during the term of the lease.

34. IBIs shall ensure, whenever possible, that there is sufficient Shariah-compliant insurance
(takaful) coverage of the value of the assets, subject to availability. If necessary, IBIs shall engage
an insurance advisor at an early stage to review the insurance coverage of the leased assets.

35. If a loss arises from negligence by the lessee, IBIs are permitted to claim compensation
from the lessee. The IBIs (as lessors) bear the risks associated with the leased assets and cannot use
lessees’ guarantees to recover the amount of the losses on the leased assets (unless these are due to
misconduct, negligence or breach of contract on the part of the lessees).

36. IBIs shall have in place an appropriate policy for determining and allocating provisions for
(a) doubtful debts including counterparty exposures; and (b) estimated impairment in value of
leased assets.

3. Equity Investment Risk:

37. This section sets out the principles pertaining to the management of risks inherent in the
holding of equity instruments for investment purposes. In particular, for IBIs, the relevant
instruments are typically those based on the Mudarabah and Musharakah contracts. This section
focuses on such instruments. The risks entailed by holding equity instruments for trading or
liquidity purposes are dealt with under market risk in Section 4 below. While investments made
via Mudarabah and Musharakah instruments may contribute substantially to IBIs’ earnings, they
entail significant market, liquidity, credit3 and other risks, potentially giving rise to volatility in
earnings and capital.

38. The capital invested through Mudarabah and Musharakah may be used to purchase shares
in a publicly traded company or privately held equity or invested in a specific project, portfolio or

3 One example of credit risk exposure arises from the Mudarib’s obligation to pay the agreed share of profit to
the IBIs as Rabb al-mal when such payment falls due. Failure to meet this obligation constitutes a case of
misconduct and negligence in the part of the Mudarib.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

through a pooled investment vehicle. In the case of a specific project, IBIs may invest at different
investment stages.

39. One distinct difference between Mudarabah and Musharakah financings is in terms of
IBIs’ involvement in the investments during the contract period. In Mudarabah, the IBIs invest
their money as silent partners and, the management is the exclusive responsibility of the other
party, namely the Mudarib. In contrast, in Musharakah financing the IBIs (and its partner or
partners) invest their funds together, and the IBIs may be silent partners, or may participate in
management. Regardless of the authority under which the profit sharing instruments are used,
both Musharakah and Mudarabah are profit-sharing financings, under which the capital invested
by the provider of finance does not constitute a fixed return, but is explicitly exposed to
impairment in the event of losses (capital impairment risk).

40. The type of equity investment risk dealt with in this section may be broadly defined as the
risk arising from entering into a partnership for the purpose of undertaking or participating in a
particular financing or general business activity as described in the contract, and in which the
provider of finance shares in the business risk.

41. The characteristics of such equity investments include considerations as to the quality of
the partner, underlying business activities and ongoing operational matters. By nature, this type of
equity investment is exposed to a confluence of risks associated with Mudarib or Musharakah
partner, business activity and operations.

42. In evaluating the risk of an investment using the profit sharing instruments of Mudarabah
or Musharakah, the risk profiles of potential partners (Mudarib or Musharakah partner) are crucial
considerations for the undertaking of due diligence. Such due diligence is essential to the
fulfillment of IBIs’ fiduciary responsibilities as an investor of deposits on a profit-sharing and loss-
bearing basis (Mudarabah) or a profit and loss sharing basis (Musharakah). These risk profiles
include the past record of the management team and quality of the business plan of, and human
resources involved in, the proposed Mudarabah or Musharakah activity.

43. Factors relating to the legal and regulatory environment affect equity investment
performance, and need to be considered in the risk evaluation. These factors include policies
pertaining to tariffs, quotas, taxation or subsidies and any sudden policy changes affecting the
quality and viability of an investment.

44. Moreover, risks of change in technology and risk of substitution by new innovations being
introduced in the marketplace can also affect the investment performance in a particular business.

45. IBIs are exposed to the risks attaching to a lack of reliable information on which to base
their investment appraisals, such as an inadequate financial control system. The mitigation of
these risks may require the investor to take an active role in monitoring the investment, or the use
of specific risk mitigating structures.

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STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

46. Although timely allocation of profit can be agreed upfront, IBIs should be prepared for
delays and variations in cash flow patterns and possible difficulties in executing a successful exit
strategy.

47. The risks arising from the use of profit sharing instruments for financing purposes do not
include credit risk in the conventional sense, but share a crucial characteristic of credit risk
because of the risk of capital impairment.

Principle 3.1: IBIs shall have in place appropriate strategies, risk management and reporting
processes in respect of the risk characteristics of equity investments, including Mudarabah and
Musharakah investments.

48. IBIs shall define and set the objectives of, and criteria for, investments using profit sharing
instruments, including the types of investment, tolerance for risk, expected returns and desired
holding periods. For example, a Musharakah structure may contain an option for redemption
whereby the IBIs as financiers have a contractual right to require their partner periodically to
purchase, under a separate contract, a proportion of the IBIs’s share in the investment at net asset
value or, if the contract so specifies on some agreed basis (Diminishing Musharakah).

49. IBIs shall have, and keep under review, policies, procedures and an appropriate
management structure for evaluating and managing the risks involved in the acquisition of,
holding and exiting from profit sharing investments. IBIs shall ensure proper infrastructure and
capacity are in place to monitor continuously the performance and operations of the entity in
which IBIs invest as partners. These should include evaluation of Shariah compliance, adequate
financial reporting by, and periodical meetings with, partners and proper recordkeeping of these
meetings.

50. IBIs shall identify and monitor the transformation of risks at various stages of investment
lifecycles, for example, where the investee’s business involves innovative or new products and
services in the marketplace. IBIs that employ different financing instruments (where one of which
include Musharakah) at different contract stages shall have appropriate procedures and controls in
place, as different stages may give rise to different risks.

51. IBIs shall analyze and determine possible factors affecting the expected volume and timing
of cash flows for both returns and capital gains arising from equity investments.

52. IBIs shall use Shariah compliant risk-mitigating techniques, which reduce the impact of
possible capital impairment of an investment. This may include the use of Shariah permissible
security4 from the partner.

4 Any collateral/security obtained by IBIs for Musharaka and Mudaraba shall not be applied or utilized to cover
losses of the IBI except where Shariah permits application or usage of such collateral/security.

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Principle 3.2: IBIs shall ensure that their valuation methodologies are appropriate and consistent,
and shall assess the potential impacts of their methods on profit calculations and allocations. The
methods shall be mutually agreed between the IBIs and the Mudarib and/or Musharakah partners.

53. IBIs shall agree with the Mudarib and/or Musharakah partners before entering into any
agreement, on the appropriate valuation methods and periods for which the profit is to be
calculated and allocated taking into account market practices and liquidity features.

54. Valuation and accounting play an important role in measuring the quality of an equity
investment, especially in a privately held entity, for which independent price quotations are
neither available nor sufficient in volume to provide a basis for meaningful liquidity or market
valuation. An appropriate and agreed method to be applied to determine the profit of the
investment can be in the form of a certain percentage of either gross or net profit earned by the
Mudarabah or Musharakah business, or any other mutually agreed terms. In the case of a change
of the partnership’s shares in a Musharakah (for example in a Diminishing Musharakah), the
shares changing hands shall be valued at fair value or on some other mutually agreed basis.

55. IBIs shall assess and take measures to deal with the risks associated with potential
manipulation of reported results leading to overstatements or understatements of partnership
earnings. Reported earnings can be either gross or net. If for some reason the practices of
smoothing profits over accounting periods and the establishment of escrow accounts to hold
certain profit portions during the life of an equity investment are recognized and agreed by all the
investing parties, the IBIs will incorporate their potential impact in the IBIs’s overall earnings.

56. IBIs may agree with the Mudarib and/or Musharakah partners to engage independent
parties where necessary to carry out audits and valuations of the investments. Provided these are
properly executed and completed, these measures will help to ensure transparency and objectivity
in valuation and in the distribution of profits and the determination of amounts to be redeemed.

Principle 3.3: IBIs shall define and establish the exit strategies in respect of their equity
investment activities, including extension and redemption conditions for Mudarabah and
Musharakah investments, subject to the approval of the institution’s Shariah Advisor.

57. IBIs shall establish the criteria for exit strategies, including the redemption of equity
investments and the divestiture of under-performing investments. The criteria may include
alternative exit routes and the timing of exit. In case of losses where improved business prospects
exist, IBIs may indicate an investment extension period. IBIs’ expectations should be based on
their assessment that there are plausible grounds for believing that there will be a business
turnaround during the period resulting in the view that the investment will, in time, recover and
yield profits.

58. IBIs shall recognize that, as a going concern, an investee may not always have the liquidity
necessary to enable making profit distributions. Hence, IBIs shall agree with the investment
partner the methods for the treatment of retained profits by the investee.

Risk Management Guidelines for IBIs                                      Page 11 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

4. Market Risk

Principle 4.1: IBIs shall have in place an appropriate framework for market risk management
(including reporting) in respect of all assets held, including those that do not have a ready market
and/or are exposed to high price volatility.

Definition and Profiles of Market Risk
59. Market risk is defined as the risk of losses in on- and off-balance sheet positions arising
from movements in market prices i.e. fluctuations in values in tradable, marketable or leaseable
assets (including sukuk) and in off-balance sheet individual portfolios The risks relate to the
current and future volatility of market values of specific assets (for example, the commodity price
of a Salam asset, the market value of a sukuk, the market value of Murabahah assets purchased to
be delivered over a specific period) and of foreign exchange rates.

60. In operating Ijarah, a lessor is exposed to market risk on the residual value of the leased
asset at the term of the lease or if the lessee terminates the lease earlier (by defaulting), during the
contract. In Ijarah Muntahia Bittamleek, a lessor is exposed to market risk on the carrying value of
the leased asset (as collateral) in the event that the lessee defaults on the lease obligations.

61. In Salam, IBIs are exposed to commodity price fluctuations on a long position after
entering into a contract and while holding the subject matter until it is disposed of. In the case of
parallel Salam, there is also the risk that a failure of delivery of the subject matter would leave the
IBIs exposed to commodity price risk as a result of the need to purchase a similar asset in the spot
market in order to honour the parallel Salam contract.

62. When IBIs are involved in buying assets that are not actively traded with the intention of
selling them, it is important to analyze and assess the factors attributable to changes in liquidity of
the markets in which the assets are traded and which give rise to greater market risk. Assets traded
in illiquid markets may not be realizable at prices quoted in other more active markets.

63. IBIs are also exposed to foreign exchange fluctuations arising from general FX spot rate
changes in both cross-border transactions and the resultant foreign currency receivables and
payables. These exposures may be hedged using Shariah compliant methods.

64. In addition to the above, there should be middle office to perform market risk
management function and to independently monitor, measure and analyze risks inherent in
treasury operations of Islamic Banks. Besides the unit should also prepare control reports
indicating deviations for the information of senior management.

5. Liquidity Risk:
65. Liquidity risk is the potential loss to IBIs arising from their inability either to meet their
obligations or to fund increases in assets as they fall due without incurring unacceptable costs or
losses.

Risk Management Guidelines for IBIs                                      Page 12 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

Profiles of Fund Providers:
66. There are two major types of fund providers: (a) current account holders; and (b) PLS
deposit holders. These account holders require a degree of liquidity to be maintained by the IBIs to
meet their requirements for withdrawals.

67. As current account holders do not participate in the profits of the IBIs’ business activities,
a sound repayment capacity is required to meet fully cash withdrawal requests as and when they
arise.  IBIs may rely heavily on funds provided by current account holders. Repayment by the IBIs
of the principal amounts deposited by current account holders is guaranteed without any rights to
share in profits, as the current account holders do not share in the risks of the IBIs.

68. PLS deposit holders are those depositors who participate in the uncertainties of IBIs’
business; therefore, they share in profits and bear losses arising from investments made on their
behalf, to the extent of their share. Apart from general withdrawal needs, the withdrawals made
by PLS deposit holders may be the result of (a) lower than expected or acceptable rates of return;
(b) concerns about the financial condition of the IBIs; and (c) non-compliance by the IBIs with
Shariah rules and principles in various contracts and activities.

69. Where the principle of Mudarabah is employed to source the funds, from an asset-liability
management perspective, IBIs may be viewed as being hedged to the extent that the PLS deposit
holders bear the risks of the assets in which their funds are invested. This statement is true only if
the Mudarib (IBI) has acted in accordance with its fiduciary duties under the Mudarabah contracts
and without misconduct or negligence.

70. PLS deposit holders do not share in the risks on assets financed by current accounts, which
are borne by shareholders alone.

71. As fiduciary agents, the IBIs are concerned with matching their investment policies with
risk appetites of PLS deposit holders and shareholders. If these investment policies are not
consistent with the expectations and risk appetites of PLS deposit holders, the latter may withdraw
their funds leading to a liquidity crisis for the IBIs. This applies particularly to PLS deposit holders.

Principle 5.1: IBIs shall have in place a liquidity management framework (including reporting)
taking into account separately and on an overall basis their liquidity exposures in respect of each
category of current accounts and PLS deposits.

72. IBIs need to identify any future shortfalls in liquidity by constructing maturity ladders
based on appropriate time bands. The IBIs may have their own criteria for classifying cashflows,
including behavioural methods, and may consider differentiating the types of cashflows as
indicated below:

• Known cash flows – the maturities and the amounts are known in advance. This

category includes receivables from Murabahah, Ijarah, Ijarah Muntahia Bittamleek
receivables and Diminishing Musharakah.

Risk Management Guidelines for IBIs                                      Page 13 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

• Conditional but predictable cashflows (Salam and Istisna) – conditionality is defined
in terms of the type of contract or performance of work based on the agreed terms
and conditions over an agreed period.

• Conditional and unpredictable cash flows – in some cases, an investment in a
Musharakah is for an open-ended period and an exit strategy may be assessed
periodically. The redemption of invested capital and possible levels of return on
investment is conditional upon the performance of the activities.

73. When calculating net funding requirements (NFR), a substantial influence on the
liquidity situation of IBIs relates to the management of their PLS deposit holders’ expectations.
While the basis of an NFR calculation is to assume that the funds are repaid at the contractual
maturity date, it may not be realistic to assume that all PLS deposit holders will maintain their
funds at the IBIs until maturity. Therefore, an internal assessment of their expectations and
incentives will be part of an NFR calculation.

74. Due to IBIs’ dual role in meeting their obligations to current account holders and
managing the expectations of their PLS deposit holders, the IBIs should make periodical
cash-flow analyses under various market scenarios and conditions. The scenarios may vary,
depending on local market conditions, and may be based on (a) a “normal” operating
environment (for example a steady state condition); and (b) scenarios of adverse circumstances
(for example non-linear events and chaotic conditions). For example:

• The analysis shall include assumptions about the repayment of invested capital to the
PLS deposit holders.

• The scenarios shall be based on relevant assumptions based on factors affecting the
IBIs’ on- and off-balance sheet exposures. Liquidity levels and early withdrawal
profiles computed under these scenarios will be back-tested periodically to validate
the underlying assumptions of the measurement process.

• In analyses based on behavioural assumptions and scenarios, IBIs will assess and
apply the liquidity measures that reflect the specificities of each portfolio.

75. IBIs shall establish the maximum amounts of cumulative liquidity mismatches which
they consider acceptable (within the regulatory requirements) and manageable for different
time bands, as a percentage of total assets available. The effects of liquidity shortages may vary
according to the fund providers’ liquidity preferences; hence, separate limits on liquidity
mismatches should be set up accordingly. These limits shall be regularly reviewed, taking into
account the IBIs’ liquidity situation, economic climate and market conditions.

Principle 5.2: IBIs shall assume liquidity risk commensurate with their ability to have
sufficient recourse to Shariah-compliant funds to mitigate such risk.

76. IBIs shall assess the necessity and extent of their access to available funding sources. In
managing their liquidity, IBIs have the following possible funding sources – natural cash flows
arising from their usual banking activities, the realisation of tradable invested assets, asset
securitisation, and their capacity to access shareholders’ and/or head office funds.

Risk Management Guidelines for IBIs                                      Page 14 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

77. IBIs’ liquidity management policies shall include some form of contractually agreed
orderly liquidation procedures ensuring maximum possible yield, to avoid having to liquidate
assets at unfavourable prices, resulting in the erosion of the PLS deposit holders’ capital and
damage to the IBIs’ reputation and viability.

78. IBIs must have a liquidity contingency plan addressing various stages of a liquidity crisis.
IBIs should define the classification of these stages but may consider differentiating the stages as
follows:

• Identification of a liquidity gap or a situation which acts as a triggering event where
withdrawals do not follow predictable patterns when, for example, the IBIs may suffer
an institutional rating downgrade;

• A need to liquidate assets or investments in an orderly manner to meet such a liquidity
gap or situation; and

• Emergency measures to be taken in the event that the previous steps fail to meet the
liquidity gap adequately.

79. Where appropriate, IBIs shall include in their contingency plans the following factors and
define appropriate action points at each stage:

• Holdings of tradable high quality liquid assets, which may be readily disposed of in
sizeable amounts in deep markets taking into account the likelihood that it will not be
possible to realise full book value;

• Profile of other assets and the degree of liquidity of these assets;
• Assessment of Shariah-compliant and available funding products in the market

including possible cooperation agreements with either other IBIs or conventional
institutions on an interest-free basis for accessing temporary funding, or sale and
leaseback arrangements for longer term funding;

• Possible liquidity arrangements with the central bank (on an interest-free basis);
• Establishment of a crisis management team or personnel responsible for taking actions at

different stages of the liquidity crisis; and
• Notification procedures for communication with IBIs’ head office and/or supervisory

authorities.

80. However, to the extent that IBIs intend to rely on the types of cooperation agreements
mentioned above, they need to ensure that willing counterparties will exist for such arrangements.

6 Rate of Return Risk:
81. This section sets out principles in respect of rate of return risks. The rate of return risk is
generally associated with overall balance sheet exposures where mismatches arise between assets
and balances from fund providers.

82. Since IBIs’ responsibility is to manage their PLS deposit holders’ expectations and their
liabilities to current account holders, the rate of return risk is a strategic risk issue forming part of
IBIs’ balance sheet risk management.

Risk Management Guidelines for IBIs                                      Page 15 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

Definition and Profiles of Rate of Return Risk
83. IBIs are exposed to rate of return risk in the context of their overall balance sheet
exposures. An increase in benchmark rates may result in PLS deposit holders’ having
expectations of a higher rate of return. Rate of return risk differs from interest rate risk in that
IBIs are concerned with the result of their investment activities at the end of the investment-
holding period. Such results cannot be pre-determined exactly.

84. A consequence of rate of return risk may be displaced commercial risk. IBIs may be
under market pressure to pay a return that exceeds the rate that has been earned on assets
financed by PLS deposit holders when the return on assets is under-performing as compared
with competitors’ rates. IBIs may decide to waive their rights to part or their entire Mudarib
share of profits in order to satisfy and retain their fund providers and dissuade them from
withdrawing their funds. Displaced commercial risk derives from competitive pressures on
IBIs to attract and retain investors (fund providers). The decision of IBIs to waive their rights
to part or all of their Mudarib share in profits in favour of PLS deposit holders is a commercial
decision, the basis for which needs to be subject to clear and well defined policies and
procedures approved by the IBIs’s BOD.

Operational Considerations:

Principle 6.1: IBIs shall establish a comprehensive risk management and reporting process
to assess the potential impacts of market factors affecting rates of return on assets in
comparison with the expected rates of return for PLS deposit holders.

85. IBIs shall take necessary steps to ensure that the management processes relating to the
identification, measurement, monitoring, reporting and control of the rate of return risk
(including appropriate structure) are in place. Since the rate of return risks are emanating from
various balance sheet positions, IBIs shall have in place competent staff to undertake the
analysis of risk exposures arising from their consolidated balance sheet activities.

86. IBIs shall be aware of the factors that give rise to rate of return risk. The primary form
of rate of return risk to which the IBIs are exposed comprises increasing long-term fixed rates
in the market. In general, profit rates earned on assets reflect the benchmark of the previous
period and do not correspond immediately to changes in increased benchmark rates.

87. IBIs shall assess the effect of the level of their dependency on current account holders’
funds. Although no returns are expected by current account holders, the sudden withdrawal of
these funds would have an adverse impact on the overall potential rate of return for IBIs.

Rate of Return Risk Management
88. IBIs shall have in place appropriate systems for identifying and measuring the factors
which give rise to rate of return risk.

Risk Management Guidelines for IBIs                                      Page 16 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

89. When calculating a rate of return, IBIs shall employ a gapping method for allocating
positions into time bands with remaining maturities or repricing dates, whichever is earlier.

90. Fixed and floating rate assets of IBIs will be classified according to their receivable dates
because the returns on these receivables represent the fund providers’ direct and beneficial
ownership of the assets. Actual cash flows may indicate a gap for a given time band, affecting
the rate of return for that period. Depending on the complexity and the nature of their business
operations, IBIs may employ techniques ranging from simple gap to advance simulation or
dynamic approaches to assess future cash flow variability and net income. The estimates
derived from selected approaches may provide acceptable approximations of periodic future
earnings’ variability; hence, the outcomes will yield different levels of expected returns to PLS
deposit holders.

91. The measurement of rate of return risk highlights the importance of cash flow
forecasting for instruments and contracts where IBIs are required to simulate and assess their
behavioural maturity, underlying assumptions and parameters, which must be reviewed
periodically for reliability. The materiality of potential threats to future earnings and the
usefulness of the resulting information shall be considered in determining the type and extent
of forecasted behaviour for IBIs.

92. In assessing whether a potential threat is likely to have a material, likely and imminent
impact on a balance sheet position, IBIs will ensure that they understand the different
characteristics of their balance sheet positions in the different currencies and jurisdictions
within which they operate.

93. In assessing exposure to rate of return risks, IBIs shall take into account the non-
contractual behavioural maturity of the transactions in the context of the environment in
which they operate and changing market conditions.

94. IBIs are encouraged to employ balance sheet techniques to minimize their exposures
using the following strategies, among others:

• Determining and varying future profit ratios according to expectations of market
conditions;

• Developing new Shariah-compliant instruments; and
• Issuing securitization tranches of Shariah permissible assets.

Displaced Commercial Risk Management
Principle 6.2: IBIs shall have in place an appropriate framework for managing displaced
commercial risk, where applicable.

95. IBIs shall have in place a policy and framework for managing the expectations of their
shareholders and PLS deposit holders. Where market rates of returns of competitors’ PLS
deposit holders are higher than those of IBIs’ PLS deposit holders, the IBIs will evaluate the
nature and extent of the expectations of their PLS deposit holders and assess the amount of the
gap between competitors’ rates and their own PLS deposit holders’ expected rates.

Risk Management Guidelines for IBIs                                      Page 17 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

7. Operational Risk:

96. IBIs are exposed to risks arising from failures in their internal controls involving
processes, people and systems. The controls should provide reasonable assurance of the
soundness of operations and reliability of reporting.

97. IBIs are also exposed to reputational risk arising from failures in governance, business
strategy and process. Negative publicity about the IBI’s business practices, particularly relating
to Shariah non-compliance in their products and services, could have an impact upon their
market position, profitability and liquidity.

98. IBIs shall consider the full range of material operational risks affecting their operations,
including the risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events. IBIs shall also incorporate possible causes of loss resulting
from Shariah non-compliance and the failure in their fiduciary responsibilities.

99. IBIs are exposed to risks relating to Shariah non-compliance and risks associated with
the IBIs’ fiduciary responsibilities towards different fund providers. These risks expose IBIs to
fund providers’ withdrawals, loss of income or voiding of contracts leading to a diminished
reputation or the limitation of business opportunities.

100. A reliable IT system is a must for profit sharing mechanism, failure of which may lead
to Sharia non-compliance risk. The bank should identify key risk indicators and should place
key control activities like Code of Conduct, Delegation of authority, segregation of duties,
succession planning, mandatory leave, staff compensation, recruitment and training, dealing
with customers, complaint handling, record keeping, MIS, physical controls etc.

Principle 7.1: IBIs shall have in place adequate systems and controls, including Shariah
Advisor, to ensure compliance with Shariah rules and principles.

Shariah Non-Compliance Risk:
101. Shariah non-compliance risk is the risk that arises from IBIs’ failure to comply with the
Shariah rules and principles prescribed by State Bank of Pakistan and Shariah Advisor of the
IBIs.  Shariah compliance is critical to IBIs’ operations and such compliance requirements must
permeate throughout the organisation and their products and activities. As a majority of the
fund providers use Shariah-compliant banking services as a matter of principle, their
perception regarding IBIs’ compliance with Shariah rules and principles is of great importance
to sustainability of IBIs. In this regard, Shariah compliance is considered as falling within a
higher priority category in relation to other identified risks.

102. IBIs shall ensure that they comply at all times with the Shariah rules and principles as
advised by the Shariah Advisor as well as SBP, with respect to their products and activities. This
means that Shariah compliance considerations are taken into account whenever the IBIs accept
deposits and investment funds, provide finance and carry out investment services for their
customers.

Risk Management Guidelines for IBIs                                      Page 18 of 19

STATE BANK OF PAKISTAN      ISLAMIC BANKING DEPARTMENT

103. IBIs shall ensure that their contract documentation complies with Shariah rules and
principles – with regard to formation, termination and elements possibly affecting contract
performance such as fraud, misrepresentation, duress or any other rights and obligations.

104. IBIs shall undertake a Shariah compliance review at least annually, performed either by
a separate Shariah audit department or as part of the existing internal audit function by persons
having the required knowledge and expertise for the purpose. The objective is to ensure that (a)
the nature of the IBIs’s financing and equity investment and (b) their operations are executed
in adherence to the applicable Shariah rules and principles as per the fatwa, policies and
procedures approved by the IBIs’s Shariah Advisor.

105. IBIs shall keep track of income not recognized arising out of Shariah non-compliance
and assess the probability of similar cases arising in the future. Based on historical reviews and
potential areas of Shariah non-compliance, the IBIs may assess potential profits that cannot be
recognized as eligible IBIs’ profits.

Principle 7.2: IBIs shall have in place appropriate mechanisms to safeguard the interests of all
fund providers. Where PLS deposit holders’ funds are commingled with the IBIs’ own funds, the
IBIs shall ensure that the bases for asset, revenue, expense and profit allocations are established,
applied and reported in a manner consistent with the IBIs’ fiduciary responsibilities.

Fiduciary risk:
106. Fiduciary risk is the risk that arises from IBIs’ failure to perform in accordance with
explicit and implicit standards applicable to their fiduciary responsibilities. As a result of losses in
investments, IBIs may become insolvent and therefore unable to (a) meet the demands of current
account holders for repayment of their funds; and (b) safeguard the interests of their PLS deposit
holders. IBIs may fail to act with due care when managing investments resulting in the risk of
possible forgone profits to PLS deposit holders.

107. IBIs shall establish and implement a clear and formal policy for undertaking their
different and potentially conflicting roles in respect of managing different types of investment
accounts. The policy relating to safeguarding the interests of their PLS deposit holders may
include the following:

• Identification of investing activities that contribute to investment returns and taking
reasonable steps to carry on those activities in accordance with the IBIs’s fiduciary
and agency duties and to treat all their fund providers appropriately and in
accordance with the terms and conditions of their investment agreements;

• Allocation of assets and profits between the IBIs and their PLS deposit holders will
be managed and applied appropriately to PLS deposit holders having funds invested
over different investment periods; and

• Limiting the risk transmission between current and investment accounts.

108. IBIs shall adequately disclose information on a timely basis to their PLS deposit holders
and the markets in order to provide a reliable basis for assessing their risk profiles and
investment performance, as prescribed by SBP from time to time.

Risk Management Guidelines for IBIs                                        Page 19 of 19


2/7/2014 Abdullaah Jalil © 2006 1

THE CONCEPT OF MASLAHAH AND DOCTRINE

OF

MAQASID (OBJECTIVES) AL-SHARIAH

IN PROJECT EVALUATION

Presenter:

Abdullaah Jalil

Faculty of Economics and Muamalat

Ta’amulat Ilmu FEM

2/7/2014 Abdullaah Jalil © 2006 2

Presentation Outline

• Introduction

• Shariah Objectives

• Classification of Maslahah

• Prioritization of Shariah Objectives

• Pyramid of Maslahah & Its Relation to the
Maqasid al-Shariah

• Beneath the Maslahah

• Beyond the Maslahah

• Application of Maslahah and Maqasid al-Shariah
on the Project Evaluation Procedure

• Conclusions and Recommendations

2/7/2014 Abdullaah Jalil © 2006 3

Introduction

• The significances of the concept of maslahah and

doctrine of Maqasid (objectives) al-Shariah as put

forward predominantly by Al-Ghazali and Al-

Shatibi have a great impact on the project

evaluation procedure in an Islamic framework.

• The incorporation of this concept into the project

evaluation framework will greatly distinguish the

Islamic framework from the mainstream one.

2/7/2014 Abdullaah Jalil © 2006 4

Introduction

• Other jurists who have discussed the same subject

are, for examples, Al-Juwayni, Al-Izz Ibn Abd Al-

Salam, Ibn Khaldun, Ibnu Taymiyyah and Ibn Al-

Qayyim Al-Jawziyyah

2/7/2014 Abdullaah Jalil © 2006 5

Shariah Objectives

• Al-Ghazali: “…the Shari‘ah objectives for the

(welfare of) creation are five matters. They are

preservation of the religion, life, mind, offspring

and wealth. And everything that leads to the

preservation of these five foundations is

considered maslahah, and everything that leads to

the disruption of these foundations is mafsadah,

and its removal is maslahah,” (Al-Masri, 1999;

Hasan, 1993).

2/7/2014 Abdullaah Jalil © 2006 6

Classification of Maslahah

First view:

• Daruriyyat

• Mukammilatuha

• Hajiyyat

• Mukammilatuha

• Tahsiniyyat

• Mukammilatuha

Second view:

• Daruriyyat &

Mukammilatuha

• Hajiyyat &

Mukammilatuha

• Tahsiniyyat &

Mukammilatuha

*Mukammilat: Complementarities

2/7/2014 Abdullaah Jalil © 2006 7

Prioritization of Shariah Objectives

Jumhur Hanafiyyah

Religion

Life

Mind

Offspring

Wealth

Religion

Life

Mind

Offspring

Wealth

2/7/2014 Abdullaah Jalil © 2006 8
R

el
ig

io
n

L
if

e

M
in

d

O
ff

sp
ri

n
g

W
ea

lt
h

Pyramid of Maslahah & Its Relation to the Maqasid

al-Shariah

M
a
sl

a
h

a
h

Maqasid al-Shariah

Bring into existence and

maintain

Preserve

Enhance and put comfort

2/7/2014 Abdullaah Jalil © 2006 9

Tahsiniyyat

R
el

ig
io

n

L
if

e

M
in

d

O
ff

sp
ri

n
g

W
ea

lt
h

Diamond of Maslahah & Its Relation to the Maqasid

al-Shariah

M
a
sl

a
h

a
h

Maqasid al-Shariah

Bring into existence and

maintain

Preserve

Enhance and put comfort

Daruriyyat

Hajiyyat

2/7/2014 Abdullaah Jalil © 2006 10

Beneath the Maslahah

• Al-Taqtir is a sort of niggardliness (bukhl) which

is condemned by the Prophet PBUH (Al-Masri,

1999).

2/7/2014 Abdullaah Jalil © 2006 11

Beyond the Maslahah

• Al-Isr af: This refers to the act of spending or investment

in permissible ( hal al) activities but more than what is

required. Self-indulgence (al-taraf) or living in great

unnecessary luxury also falls under this category (cAfar,

1992).

• Al-Tabdh ir: This can be defined as any disbursement on

unlawful ( har am) or unjustifiable activities. Similarly, the

fulfillment of lower-level needs in the presence of higher-

level needs that are not being satisfied is perceived as an

act of al-tabdh ir (cAfar, 1992).

2/7/2014 Abdullaah Jalil © 2006 12

Application of Maslahah and

Maqasid al-Shariah on the Project

Evaluation Procedure

2/7/2014 Abdullaah Jalil © 2006 13

Classification and Priority of Projects According to the

Concept of Maslahah and Maqasid al-Shariah

The most

highly ranked

project

The least

preferable

project

2/7/2014 Abdullaah Jalil © 2006 14

Project’s Category, Status and Value According to the

Concept of Maslahah and Maqasid al-Shariah

2/7/2014 Abdullaah Jalil © 2006 15

The Integration of Maslahah Analysis into the Project

Evaluation

2/7/2014 Abdullaah Jalil © 2006 16

The Objectives of Project Evaluation

• Provision of necessary information on a project.

• Establishment of an order of priority among

competing projects.

• Assessment of the profitability of a project.

• Rationalization of the allocation of resources

among the various sectors and projects at the

macroeconomic and microeconomic levels.

2/7/2014 Abdullaah Jalil © 2006 17

Project Evaluation

Framework in Mainstream

Economics

- Complex and thorough, yet

has been developed in

isolation of Islamic input.

-The GUIDELINES were

developed by UNIDO and

IDCAS (at macro level).

-Several technical methods

were introduced, most well-

known: NPV and IRR

2/7/2014 Abdullaah Jalil © 2006 18

An Integrative Islamic

Framework for Project

Evaluation

Qualitative Approach:

Maslahah Analysis

Quantitative Approach:

Commercial and

National Profitability

Analysis

2/7/2014 Abdullaah Jalil © 2006 19

Conclusions and Recommendations

• It is observed that the concept of maslahah or

Shariah objectives has a significant impact on an

Islamic framework for project evaluation and

would greatly distinguish the Islamic framework

from the mainstream one.

• It could determine an order of priorities in an

Islamic framework.

2/7/2014 Abdullaah Jalil © 2006 20

Conclusions and Recommendations

• Maslahah analysis of project is imperative to

ensure the coherence of the selected project with

the Shariah objectives and the Islamic system as a

whole.

• Furthermore, the maslahah analysis could

rationalise the choice of a project in an Islamic

framework

2/7/2014 Abdullaah Jalil © 2006 21

Conclusions and Recommendations

• It is hoped that the international Islamic
organisations such as the Islamic Development
Bank (IDB) and the Islamic Fiqh Academy could
collaborate and provide detailed guidelines for
project evaluation from the Islamic perspective
that are theoretically Islamic and practically viable
as they have the expertise, data and experience to
perform such a task.

2/7/2014 Abdullaah Jalil © 2006 22

 وباهلل التوفيق والهداية

 والسالم عليكم ورحمة اهلل وبركاته


429 Too Many Requests

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