Fatwa

A fatwa (plural fatawa) is a legal opinion on a question of Islamic law, given by a qualified scholar in response to a question. In Islamic finance, the term refers to the ruling, issued by an individual scholar, an institution's Sharia supervisory board or a national Sharia authority, that a product, contract structure or transaction is, or is not, compliant with Sharia. A fatwa of this kind is usually a precondition for launching an Islamic banking product, issuing sukuk or marketing a fund as Sharia-compliant.

The scholar who issues a fatwa is called a mufti, and the activity of issuing opinions is known as ifta'. The person or institution that asks the question is the mustafti.

In classical Islamic legal theory a fatwa is an opinion, not a court judgment. It applies the sources of law, principally the Quran, the Sunnah, scholarly consensus and analogical reasoning, to the facts presented, and it is binding in conscience on the person who seeks it rather than enforceable by the state. Different scholars may reach different conclusions on the same question, particularly where the schools of law differ, and a later fatwa can revise an earlier one if the facts or reasoning change. This pluralism is a recognized feature of Islamic law, though it creates uncertainty for financial institutions operating across several markets.

Fatwas on financial matters draw on fiqh al-mu'amalat, the jurisprudence of commercial transactions, and on the broader objectives of the law, the maqasid al-Sharia. Scholars examine whether a structure involves prohibited elements such as riba al-nasi'ah, excessive uncertainty or gharar, and gambling or maysir.

For a new product, the institution's product team prepares a term sheet and draft contracts, which the Sharia board reviews, often over several rounds. If satisfied, the board issues a fatwa or pronouncement approving the structure, sometimes with conditions. A murabaha financing, for instance, may be approved only if the bank genuinely takes ownership and risk of the asset before selling it on. After launch, Sharia audit and review functions check that transactions follow the approved structure, because a fatwa covers the product as designed, not deviations in practice. Income from transactions found to be non-compliant may require income purification.

• Institutional Sharia boards, appointed by banks, takaful operators and fund managers, are the most common source.
• National Sharia authorities exist in several countries. Malaysia's Shariah Advisory Council at Bank Negara Malaysia issues rulings that, under the Central Bank of Malaysia Act 2009, bind Islamic financial institutions and courts on Islamic finance questions. Centralized bodies have also been established in Pakistan, the United Arab Emirates, Bahrain and elsewhere.
• Standard-setters such as AAOIFI issue Sharia standards drafted by scholars, which many regulators make mandatory.
• International bodies such as the International Islamic Fiqh Academy of the Organisation of Islamic Cooperation issue collective resolutions, for example its 2009 resolution rejecting organized tawarruq.

Because institutions select and pay their own Sharia scholars, critics have raised concerns about "fatwa shopping," in which a firm seeks out a scholar willing to approve a structure others would reject. A small number of prominent scholars sitting on many boards has also raised questions about independence and conflicts of interest. A well-known episode came in 2007 and 2008, when the chairman of AAOIFI's Sharia board criticized many sukuk structures as non-compliant, leading AAOIFI to issue guidance and disrupting the market. Regulators have responded with governance rules, such as the IFSB guiding principles on Sharia governance, limits on multiple board seats and centralized national authorities.

A fatwa does not guarantee that a court will treat a contract as compliant, or that a secular court will consider compliance relevant at all. English courts, which govern many international Islamic finance contracts, have generally enforced such contracts according to their terms and declined to rule on Sharia compliance. The gap between a fatwa and the legal enforceability of the documents is a key component of Sharia non-compliance risk, which institutions must manage alongside other operational risks.