Islamic finance principles revisited

Md Akther Uddin | Published: October 20, 2018 22:00:03 | Updated: October 21, 2018 20:32:11

-Reuters file photo

The Economist published an article last week titled 'Not interest-free' which  posits that Islamic banks are drawing non-Muslims in increasing numbers not mainly because of ethical issues; rather, they are driven by higher profit motive. Islamic banks in the UK can offer more attractive return compared to their conventional counterparts due to regulatory issues.

However, it is fundamentally wrong to compare Islamic finance with conventional finance as this is like comparing apples with oranges..

Islamic finance has been thriving mainly due to phenomenal growth of Islamic banking industry since its inception in Mit-Ghamr of Egypt back in 1963. Currently, there are over 1,000 Islamic financial institutions worldwide that include many even in non-Muslim countries. Islamic finance has already crossed its USD 2.0 trillion benchmark and is projected to grow to $3.3 trillion by 2020. At the same time, Islamic banking assets are expected to reach $2.6 trillion. Compared to global financial assets of over $250 trillion, it looks really tiny and insignificant. But we have to remember that Islamic finance is only at its early stage of development compared to centuries-old conventional financial system.

It is well-known that Islamic banking has opened up a window of opportunity for the Muslims who are eager to have interest-free and Shari'ah-compliant banking system, in absence of which most of them wouldn't have involved in the financial system at all. In addition, international financial systems get benefitted from diversified financial products and operations, available in Islamic banks, Islamic insurance and Islamic bond, which are characterised by distinct risk-sharing features for each type of contract.

Prohibition of Riba (interest), Gharar (ambiguous/unnecessary risk), and Maysir (gambling) in financial transactions is the fundamental of Islamic finance that distinguishes it from conventional finance. These unique features of Islamic finance have been discussed from the Shari'ah, Quran and Sunnah, perspective.

Riba is derived from the derivative word "raba-wa," which has certain meanings like to increase; to grow; to grow up, to exceed, be more than. In a specific sense, Riba is translated into English generally as usury or interest, but in fact it has a much broader sense under Shari'ah. On Riba, the direct Quranic references are to be found in four surahs or chapters. These verses are an ascending scale which starts with a mere judgment of value, followed by an implicit prohibition, then a limited one and finally, a total and conclusive prohibition (Al-Rum, 30:39; Al-Nisa, 4:161; Al-Imran, 3:130 and Al-Bakarah, 2:275-9).

In the modern days, Riba arises with loan - car loan, home loan, term loan or overdraft, hire purchase loan and personal loan; Riba is also involved  in savings and fixed deposit account; Riba is evident in credit card. More often than not, Riba is intertwined with modern banking and finance. However, there are group of Islamic scholars who argue current interest rate is different from the Riba mentioned in the Quran. On the contrary, majority of scholars are of the opinion that interest and Riba are the same thing. To be more specific, the Quran prohibited reward of capital without taking due risk and allowed reward of human labour i.e., al-bay.

The second principle, Gharar is a fairly broad concept that literally means deceit, risk, fraud, uncertainty or hazard that might lead to destruction or loss. Hanafi scholars, dominant school in Islamic jurisprudence, have defined Gharar as "something consequence of which is undetermined." While Shafi'i scholars, another school of thought mainly prevalent in Malaysia and Indonesia, have described it as "something which in its manner and its consequence is hidden." According to Al-Sarakshi, "anything that the end result is hidden or the risk is equally uncommon, whether it exists or not." Therefore, Gharar in Islamic finance refers to any transaction of probable objects, existence or description of which is not certain, due to lack of information and knowledge of the ultimate outcome of the contract or the nature and quality of the subject matter of it. However, there is no specific evidence from the Quran that connotes Gharar.

Gharar occurs in all sorts of transactions where the subject matter, the price or the two, are not determined and fixed in advance. Speculative activities in capital market, derivatives instruments and short-selling contracts are bright examples of Gharar in modern finance. Moreover, Gharar in practice relates potentially to issues such as pricing, delivery, quantity and quality of assets that are transactional-based and would affect the degree or quality of consent of the parties to a contract. For example, one cannot buy an 'option' at a certain price to have the right to purchase its underlying shares, as an 'option' is not ascertainable and is thus uncertain. An option is just a right. It is not an asset, specifications of which are clear and attainable. In conventional insurance, the premium paid by policyholders and the indemnity provided by the insurer, upon a claim, are equally uncertain - thus making conventional insurance non-compliant from an Islamic legal perspective.

Maysir, the third principle, literally means gambling. Islam has also categorically prohibited all forms of gambling. Maysir refers to the easy acquisition of wealth by chance, whether or not it deprives other's right()s). Maysir can also be any form of business activity where monetary gains are derived from mere chance, speculation or conjecture. In holy Quran, Allah (SWT) clearly prohibited gambling (Al-Bakarah, 2:219 and Al-Maidah, 5:93). For example, uncertainty of the timing of benefits of a pure life insurance contract creates an element of Maysir. Casinos are also common example of Maysir, where simply transfer of wealth take place from losers to winners without creating a new stock of wealth. In brief, contracts involving pure speculation, conventional insurance and derivatives are examples of Maysir.

In addition to above three fundamental principles, Islamic financial transactions strictly prohibit investment in haram things like pork, alcohol, tobacco, pornography, weapons and other malicious and harmful things.

There is, of course, a big difference as to how Islamic banks and financial institutions are currently running and how they should run. The article in The Economist pointed out that Islamic banks are predominantly using Murabaha and other fixed rate instruments, which are similar to conventional finance. If Islamic institutions are not following the well-established principles of Islam, it is not the problem of Islamic finance - rather it is the problem of the Islamic financial institutions. However, it is necessary that Islamic financial transactions must be completely free from Riba, Gharar and Maysir.  [The article has been abridged.]

Dr. Md Akther Uddin, an MSc in Islamic Finance from INCEIF Malaysia, is Senior Lecturer, Programme Coordinator (School of Business) and Assistant Proctor, University of Creative Technology, Chittagong.

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