375

THE CONCEPT OF RISK SHARING IN

ISLAMIC FINANCIAL INSTITUTIONS

Prepared by:
YUSSUF ADAM AL-BADANI
(The researcher from Ghana).

A Part Time Lecturer

Department of Fiqh and Usul al-Fiqh,
International Islamic University Malaysia (IIUM)
Shariah Officer,
International Islamic Liquidity Management Corporation
(IILM)

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ABSTRACT

The sharing of risk and profit is one of the most essential

topics related to Islamic financial transaction (IFTs) that
has arisen recently. Participating in risk and profit sharing
is one of the most important Shariah objectives and
principles in IFTs, as it achieves justice, equality, fairness
and satisfaction between the contracting parties. Hence, it
is clear that studying profit and risk sharing, its basis in
Islamic jurisprudence and its contemporary applications
are very important. Thus, this paper explains the concept
of profit-and-risk participation in IFIs and its legitimacy in
Islamic jurisprudence.

Keywords: Risk sharing, Risk bearing, Risk transfer, Risk

shifting, Application, and Parameters.

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.
.
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INTRODUCTION

All praise and gratitude is due to Allah, and may the peace
and blessings of Allah be upon his final messenger, his
pure family, his companions and all those who follow
them with righteousness until the Day of Resurrection.
Whoever Allah guides, no one can misguide; and whoever
Allah misguides, no one can guide. I bear witness that
there is none worthy of worship but Allah, and I bear
witness that the Prophet Muhammadpeace be upon
himis Allahs messenger and slave.

The sharing of risk and profit is one of the most

essential topics related to Islamic financial transaction
(IFTs) that has arisen recently. Participating in risk
sharing is one of the most important Shariah objectives
and principles in IFTs, as it achieves justice, equality,
fairness and satisfaction between the contracting parties.
Hence, it is clear that studying risk sharing, its basis in
Islamic jurisprudence and its contemporary applications
are very important. Thus, this paper explains the concept
of profit-and-risk participation in IFIs and its legitimacy
in Islamic jurisprudence. The paper also addresses the
legality of transferring and shifting risk from one party to
another and the contracts by which risk are shared. The
paper will also touch upon the legality of one of the
contracting parties volunteering to take the risk. This is
followed by the conclusion and recommendations. Based
on the aforementioned, the paper will address the
following:

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The concept of risk sharing.

The legitimacy of risk sharing in Islamic
jurisprudence.
The rules on risk transfer and risk shifting.
The legality of one of the parties volunteering to
take the risk
The contracts by which risks are shared
The conclusion.

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THE CONCEPT OF RISK SHARING

The English word "risk" is a modern term derived from the

Latin "rescares", and the French "risques". It means a
deviation from the expected.1 The Arabic equivalent,
makhatir, is the plural of mukhatarah. The root word is
khatara/ukhatiru/mukhataratan; one of the meanings of
mukhatarah is participation in something, which implies
the existence of at least two relevant parties.
The three-letter root is khatar, which has two main
meanings: 1) weightiness or significance; 2) oscillation
and vibration. A usage derived from the second meaning is
murahanah (wager), as the outcome of a wager oscillates
between gain and loss. It is also used to mean gharar
(ambiguity) and jahalah (being unknown).2
Many technical definitions of risk have been offered
by both Western and Muslim economists. The most
notable definitions are as follows:

1
Barahiliyyah, Badruddin and Barahiliyyah Lialayimmah Fatimah, (2011),
Makhatir Al-Tamwil bi sighat al-Salam, a Paper presented to 8th International
Conference on Islamic Economics and Finance (Qatar), Pg. 8.
2
Abu al- Husseien, Ahmad bin Faris Zakariyya, (1979), Mujam Maqayis al-
Lughah, Abdussalam Haran (edt), (Beirut: Daral Fikr), Vol. 2, Pg. 199; Al-
Kafumi, Abul Baqa Ayyub bin Musa al-Hassani, (1998), Al-Kulliyyat, Adnan
Darwish and Muhammad El-Misr (edt), (Beirut: Mussasat al-Risalah), Vol.1,
Pg. 679; Ibn Manzur, Jamaluddin Muhammad Akram, Lisan Al-Arab (Beirut:
Dar Sadir, 1st edition), Vol.4, Pg. 249; A;-Fayyumi, Ahmad bin Muhammad, Al-
Misbah al-Munir fi Gharib Al-Sharh al-Kabir (Beirut: al-Maktabah al-
Ilmiyyah), Vol.1, Pg, 173; al-Zubaidi, Ahmad bin Muhammad, Tajul Arus Min
Jawahir al-Kamus (Daral Hidayah), Vol.13, Pg. 233.

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John Downs has defined risk as the "measurable

possibility of losing or not gaining money. Risk is
differentiated from uncertainty, which is not measurable."3
Frank Reilly and Keith Brown defined risk thus:
"Although there is a difference in the specific definition of
risk and uncertainty, one way to define risk is the
uncertainty of future outcomes. An alternative definition
might be the probability of an adverse outcome."4
Madura defined it as follows: "Risk is the probability
that the result of an event will differ from the expected
outcome."5
In the researchers view, the most comprehensive
definition among the abovementioned is that of Madura.
The reason for preferring it is that the first two definitions
focused more on the distinctions between risk and
uncertainty while Madura defined risk clearly.
Among the contemporary Muslim economists who have
defined risk are:
Mohammad Ali Elgari, who defined it as "a situation in
which we confront two possibilities, either of which could
occur".6
Sami al-Suwailem defines risk as "the possibility of loss".7

3
John. D. dictionary of Finance and Investment Terms, 2nd edition (New York:
Published by Barrons), pg. 347.
4
Frank K. Reilly & Keith C. Brown, (1996), Investment Analysis and Portfolio
Management, 5th edition (Publishers: The Dryden Press Harcourt Brace
College), Pg. 253.
5
Madura, Introduction to Financial Management (New York: Published by: west
publishing company), Pg. 110
6
Al-Ghari, Muhammad Ali, (1425 AH), Al-Mukaaarah Fi Al-Siyagh Al-Tamwil
Al-Islaai, Majallah Dallah Al-Barakah, Ramadhan, Vol.6, Pg. 281.

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THE DEFINITION OF RISK SHARING

It is quite difficult to find economic books, researches or

articles that clearly define the term risk sharing,
nevertheless, it can be define as follows:-
Risk sharing occur in the form of a business partnership in
which the resulting costs and benefits are distributed
amongst all the participating partners. In doing so, partners
rely on the commercial success of the business to receive
their share of financial benefit from the enterprise while
reducing the risk of individual loss in case the enterprise
loses money.8
In other words, risk sharing occurs when two
contracting parties enter into an investment and agree to
share the risk upon the occurrence of any loss or damage
in the transaction, or to share the profit if any.

TYPES OF RISK IN ISLAMIC FINANCIAL

INSTITUTIONS AND THEIR DEFINITIONS

There are many types of risk and many ways to classify

them. One classification scheme is primary versus
secondary risk: primary risk is associated with ownership
and is non-transferable. Secondary risk includes financial
7
Sami Ibrahim Al-Suwailim, (2007), Hedging in Islamic Finance (Jiddah: Islamic
Development Bank, IRTI, 1st edition), Pg. 55.
8
See: Risk Sharing Law & Legal Definition, USLEGAL.com
http://definitions.uslegal.com/r/risk-sharing/

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and non-financial risks. Financial risks include credit risk,

market risk and liquidity risk, among others. Non-financial
risks include operational risk, Shariah non-compliance
risk, legal risk, etc.

Credit Risk
Credit risk arises due to a counterparty defaulting on a
contract, or the potential that a counter party will fail to
meet its obligations in accordance with the agreed terms
and conditions of a credit-related contract. The exposure in
Islamic financial institutions arises in connection with
Murabahah (BBA) - account receivables
Salam and Parallel Salam - counterparty risk
Istisna and Parallel Istisna - account receivables
and counterparty risk
Ijarah - lease payment receivables
Musharakah and Mudharabah exposures to
counter party risk.9

Market Risk
Market risk is the risk that arises to the economic value of
an asset from the potential impact of adverse price

9
See Hj Mohd Nazri Chik, Credit Risk: Shariah Compliance Perspective, a paper
presented in the Seminar on Introduction to Risk Management in Islamic
Financial Institutions: Shariah Compliance Review, organized by Islamic
Banking and Finance Institute Malaysia, 22-23 May 2007, P 2; cf. Badrul
Hisham Mohd Salleh, Islamic Risk Management, a paper presented in the
Seminar on Risk Management in Islamic Financing, organized by Islamic
Banking and Finance Institute Malaysia, 7-8 March 2006, p.6.

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movements such as benchmark rates, foreign exchange

rates and equity prices.10

Liquidity Risk
Liquidity risk is the risk that arises due to a potential loss
from an institutions inability to meet its obligations or to
fund increases in assets as they fall due without incurring
unacceptable costs or losses.11

Operational Risk
Operational risk is the risk that arises from the inadequacy
or failure of internal business process or transaction flow,
a result of staff failure to perform, inefficient management
of human capital by the institution, an inadequate
defaulting system, or an external event.12

Shariah Non-Compliance Risk

Shariah non-compliance risk is the risk that arises from an
Islamic financial institutions failure to comply with the
Shariah rules, parameters and principles set out by the
relevant Shariah supervisory bodies, such as International
Islamic Fiqh Academy, AAIOFI, Shariah advisory
councils and the IFIs own Shariah committee.
In order to mitigate this type of risk, there should be
internal Shariah officers to ensure that all the financial
activities of the institution are compliance with Shariah.

10
Ibid.
11
Ibid.
12
Ibid.

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THE LEGITIMACY OF RISK SHARING IN

ISLAMIC JURISPRUDENCE

The basis of risk sharing is the maxim Kharaj (revenue)

goes with liability. The maxim is derived from several
texts. One of the more detailed is the Hadith narrated by
Aishah (may Allah be pleased with her) that a man bought
a slave. After some time, he discovered a defect in the
slave which the seller had not mentioned at the time of
their transaction. He then went to the Prophet (peace be
upon him) to complain. The Prophet (peace be upon him)
instructed him to return the slave to the seller and take
back what he had paid. The seller objected, Messenger of
Allah! He has used my slave. The Prophet said:
Revenue comes with liability.13

What he meant was that the buyer had assumed liability

for the slave when he took possession of him. That meant
that he would have borne the loss if the slave had been
injured or died. That liability was the basis for his
entitlement to the slaves labour during that period; thus,
the seller was not entitled to compensation for it. It is
understood from the above maxim that any revenue
benefits or profit should go with liability or indemnity. In
other words, if you want profit you have to be ready to
bear the attendant risk of loss.
13
Abu Daud Sulaimn Al-Sajistani, Sunan Abi Daud, Bab: Al-Kharaj bi Al-
Dhaman (Beirt:Daral Kitab Al-Arabi), 3:30.

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For example: in a mudharabah transaction, the capital

provider (rabb al-mal) is entitled to profit even though he
is not involve in managing it, as he bears the risk to the
capital. On the other hand, a creditor is not entitled to
profit in a loan contract as he doesnt bear any risk.

Another maxim that is in line with the above regarded as

the basis of risk sharing is the maxim Liability
accompanies [the right to] profit. The origin of this
maxim is the above mentioned hadith of Aishah may Allah
be pleased with her and some verses in Quran such as:
Allah has permitted sale and prohibited riba.14

It is understood from the aforementioned maxim that

revenue or profit is generated is legitimated along with
risk borne. For example: Islamic financial institutions are
entitled to profit from the funds deposited with them on
the basis of wadiah yad dhamanah, as they undertake to
bear any loss incurred to them.

These maxims are among the most important maxims that

relate to Islamic financial transactions, as they are linked
to some of the most important Shariah principles: justice,
fairness and equality. In fact, most of fiqh rulings on the
financial system are based on these maxims.
The participation in risk and profit sharing should be real,
not merely in words and forms. This is because, in

14
Al-Baqarah, 2:275.

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contracts, consideration is given to intention and meaning

rather than words and forms.15
Ibn Taymiyyah said, regarding the above maxims: The
goal of the two contracting parties in the investment is the
outcome; if there is any growth, they will share it between
them; otherwise, each of the contracting parties will lose
his benefit.16
Ibn al-Qayyim made a similar observation: The basis of
partnerships is justice between the two partners; therefore,
it would be unjust for one of the contracting partners to
claim all the profit and exclude the other. That is different
from each of them having a share of the profit with both of
them sharing in the gain and the loss. If there is profit they
should share it together, and if there is no profit they
should share the loss together.17
Dr. Al-Sawi says: This maxim is based on justice
and due balance and it represents the foundation upon
which investment is built. Profit-and-loss sharing is the

15
Ibn al-Qayyim, Zd al-Maad, 5:110, 5:813; Ibn al-Qayyim, Ighathat al-
Lahfan fa alaq al-Ghaban, Dar Alam al-FawAid, p. 38; Ibn al-Qayyim,
Ilm al-MuwaqqiIn, vol. 4, pp. 499, 500, 520, vol. 5, p. 74; al-SubkI, al-
Ashbah wa al-Naair, 1:175; al-Karkh, Risalah fi al-Usul, p. 162; Ibn
Nujaym, al-Ashbah wa al-Naair,, p. 18-19, al-Shatibi, al-Muwafaqat,
commentary by al-Darraz, 2:323; al-Wansharii, Idda al-Masalik, p. 98; Ibn
Rajab, al-Qawid, 1:64; Ibn Taymiyyah, Majmu al-Fatawa, 20:551; al-
Suyui, al-Ashbah wa al-Naair, 1:166; al-Zarkashi, al-Manthur fi al-
Qawaid, (Kuwait: Ministry of Awqaf, 1982), 2:371; al-Hin, al-
Qawaid, 1:401; Amad ibn Idris al-Qarafi, al-Dhakhirah fi al-Fiqh,
(Morocco, Dar al-Gharb al-Islami, 1994), 1:243-244, 6:336.
16
Ibn Taymiyyah, (1408AH, 1987AD), Al-Fatawa al-Kubra, Muhammad Abdul
Kadir Aa and Mutapha Abdul Kadir Aa (edt) (Beirut: Daral Kutub Al-
Ilmiyyah, 1st edition), 4:64.
17
Ibn Al-Qayyim, (1973), Ialmul Muaqqin An-Rabil AlamIn, Aha Abdul
Rauf Saad (edt) (Beirut: Daral Jil), 2:6.

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foundational principle that cannot be ignored. If it is, the

pure idea advocated by the Islamic economic system will
be flipped to the interest-based system, i.e., the profits will
be reserved for one of the contracting parties while the
other party is exclusively exposed to the risk and loss.18
These statements clearly indicate that the sharing of
risk and profit is the basis of justice and fairness in
financial transactions while making one of the contracting
parties bear all losses and risk and allowing the other party
to take all the profits is the essence of usury (riba),
ambiguity (gharar), gambling and consuming the wealth
of others unlawfully, which Islam forbids. Thus, in order
to apply justice, balance and fairness in financial
transactions, each of the contracting parties should be
liable accordingly and neither should profit at the expense
of the other.

ARE RISK TRANSFER AND RISK SHIFTING

PERMISSIBLE?

Linguistically, risk transfer and risk shifting are the same

thing, i.e., moving investment or business risk from one
party to another. However, some scholars differentiate
between the two, using the term risk transfer exclusively
for cases where the transfer occurs with the knowledge
and consent of the party who ends up bearing the risk.

18
Al-awi, Muhammad alah, (1410 AH), Mushkilatu Istithmar fi al-Bunuk ak-
Islamiyyah (Jiddah: Daral Majma li al-Nashr wa al-tawzia), Pg 440.

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Risk shifting, on the other hand, is used when the

transfer occurs without the receiving partys knowledge.
An example of the latter is the taxpayers who were
burdened with the expenses of bailing out insolvent banks
in the financial meltdown of 2008 without having any
share in the profits of those banks.
It requires little investigation to conclude that
Islamic law does not tolerate shifting risk to another party
without his knowledge. One of the main differences
between Islamic and conventional financial institutions is
the avoidance of riba. Riba is a means of investment that
transfers all risk of loss to the other party with his
knowledge and consent. It is a matter of common
knowledge among Muslimsand even among many non-
Muslimsthat Islam strictly prohibits riba. Therefore,
shifting risk to another party without his knowledge is
even more deserving of prohibition.
The prohibition of riba prevents an investor from
gaining profit without being liable for the investment. In
order for an investor to earn profits, he must bear the
minimum ownership risk. In supporting this argument, Dr.
Hussein Hamid Hassan, one of the prominent current
Islamic economists stated: Islamic law does not allow
risk transferring but allows sharing itIslam has
prevented the purchase and sale of risk because it involves
massive ambiguity (gharar jaseem), as, for example, in the
trading of impermissible debts; however, it allows the

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purchase and sale of currencies by observing the Shariah

parameters of spot payment and delivery.19
Dr. Najatullahi also mentioned: Islams prohibition of
gambling requires the prohibition of third-party purchase
of risk.20
Therefore, in line with implementing justice and fairness
in financial transactions, it is compulsory on each and
every Muslim investor to observe balance and justice
between his interests and the interests of the society in
investing his wealth.
Overburdening one party by transferring and shifting all
risk to him will harm him, and it is clear that Islam does
not tolerate harming others, in fact, it has forbid harming
them, as per the Prophetic maxims, Harm shall neither
be inflicted nor reciprocated, and Everything pertaining
to a Muslim is inviolable to another Muslim: his blood, his
property and his honor. In fact, these are among the most
important principles of Islamic economics.

IS RISK BEARING PERMISSIBLE?

Risk bearing refers to a situation where one of the

contracting parties volunteers to bear the risk of the
investment for the other party for an agreed amount to be

19
Hussein Hmid Hassan, The Tools of Risk Management in Islamic Financial
Institutions, 11th Shariah Committees Conference in Kingdom of Bahrain, Pg 8
9.
20
Ghassan Muhammad al-Shaygh and Muhammad Dawabah, Makhatir Istithmar
Amwal Al-Arabiyyah fi al-Duwal Ghayr al-Islamiyyah, a paper presented for
International conference for Islamic Economic, under the topic: Investment in
Foreign Countries: its parameters and risks, Kuwait, 09/04/2007, Pg 168.

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paid by the other party. Another way to describe it is

transferring risk from a party who doesnt want it to a
party who is ready to take it for an agreed amount. This
party can be an insurance company, trust company or any
other entity involved in this kind of transaction.
An example: supposing that a financial institution
takes a loan of $250 million dollars, to be repaid in euros.
Given that exchange rates fluctuate constantly, the
financial institution is afraid it will be harmed if the euros
price rises. Therefore, it purchases a call option from a
second party to buy euros at a future date, paying todays
price.
Some scholars such Dr. Hussein Hamid Hassan observed:
It is only permissible to bear risk as a charitable act,
although it contains all kinds of prohibited ambiguity; this
is because the one who has been promised a hibah by
another party should not pay for the promise.21
This view, which is consistent with the view of the
International Islamic Fiqh Academy, prohibits bearing risk
in exchange for compensation due to the high levels of
gharar that are intrinsic to the contract. However, the
suggested alternative, i.e., bearing another partys risk as a
charitable act, is far removed from market realities. It is
difficult to imagine any entity that would choose to do so.
This practical difficulty leads us to revisit the issue of
derivatives, which are almost unanimously prohibited by

21
Hassan, Hussein Hamid, Tools of Risk Management in Islamic Financial
Institutions, A paper presented in Shariah Committees conference in Bahrain, Pg.
9.

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the contemporary Islamic jurists, due to the presence of

riba, ambiguity, gambling, etc. in an exchange contract.
The particular derivative of interest in this regard is the
option. The subject matter of an option is a promise to buy
or sell a specified asset at a specified future date for a
specified price. The seller of the option is the promisor,
and the contract is binding upon him. The purchaser, on
the other hand, is not bound to exercise the option. He will
do so only if the pre-agreed price is more attractive than
the market price on the day the option can be exercised. If
it is not to his advantage, he can simply allow the option to
lapse unused and make his purchase or sale of the asset on
the open market. In that case, he loses the money paid for
the option.
Dr. Nazih Hammad is one of the contemporary
Islamic economists who make a compelling argument for
the permissibility of foreign exchange options when they
are used strictly for hedging the foreign exchange risks of
companies involved in transnational transactions. Dr.
Hammad supported this view with very solid evidence,
which may force Islamic jurists to review their decisions
on the issue of options. The most notable evidence is as
follows.
a) The Principle of the Removal of Difficulty: (
) :

It is clear that one of the principles and general

foundations of the Shariah is removal of difficulty
from people and avoidance of imposing duties that
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cause hardship. Such difficulty could result either

from performing an act or omitting an act. In this
regard, Allah says: Allah does not want to impose
difficulty upon you22 Allah also says: We have
not imposed any difficulty upon you in the
religion.23 In this regard, if the Lawgiver had
prevented people from concluding contracts of
which they are in dire need and cannot do without,
they would have fallen into hardship and harm;
therefore, Allah, in His fairness and benevolence to
people, permits all contracts and transactions of
which they are in need.24

b) It is well established in the Shariah that Dire need

necessitates permissibility of what is forbidden,
and that applies equally for both individuals and
groups. Darurah (dire need) is a situation which
forces a person to do what is forbidden, such that,
if he fails to do it, he is certain to die or he has
good reason to believe he will. The contracts or
sales which people need to rid themselves of
difficulty and hardship are considered tantamount
to dire need in causing the forbidden to become
permissible. Ibn Taymiyyah said: Anything which
people need to buy, concessions are made for it that
are not made for other things; thus the Lawgiver

22
Surah al-Maidah verse 6.
23
Sirah al-ajj verse 78.
24
See: Hammad, Nazih Kamal, Al-Muawadah an al-Iltizam bi-bay al-Umlat fi
al-Mustaqbal, pp. 35 39.

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permits it due to need, even though the effective

cause for its prohibition is present.25 Ibn al-Arabi
said: The seventh principle: consideration is given
to mid-level need (Hajah) in allowing the
forbidden (mamnu), just as consideration is given
to dire need (darurah) in making the prohibited
(haram) permissible.26

c) Traders, contractors, industrialists and the

likewho import goods and raw materials at
specific times for deferred payments in a certain
currency and then sell those goods, or the industrial
products made from those materials, in a currency
different from the purchase currency by spot or
deferred payments, or by salam contracts, or
parallel istisna, or continuous supply contracts,
etc.realize their goals by purchasing an
undertaking for a currency exchange to fulfill their
obligations at a future date. It is crystal clear that
prohibiting them from purchasing such pledges will
expose them to massive hardship, difficulty and
risk that may cause them to go bankrupt or to take
losses too huge to be borne. This due to their real
need for those currencies on the stipulated dates;
and the advance knowledge of the prices of those
commodities or raw materials in their local
currency in order to accurately calculate their costs

25
Al-Masail al-Mariiniyyah, p. 99; Ibn Taymiyyah, Majmu al-Fatawa, 29:488.
26
Al-Qabas ala al-Muwatta, 2:790.

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of doing business. This is to be able to maintain the

processes of import, supply, industrial production,
and early marketing without bearing the risks of
currency fluctuations, which may have catastrophic
effects on their trade or manufacturing or the
execution of the supply contracts which they have
committed themselves to.27

He then concluded his argument, saying, there is no

Shariah objection, in my view, to ruling that this
transaction is permissible for those who need it among
traders, industrialists, suppliers, etc. due to realization of a
special need (Hajah khasah) for it, since hajah khasah
induces the permissibility of what is forbidden, and
hajjah (mid-level need), whether general or special, is
given the same legal effect as darurah (dire need). These
are well established qawaid fiqhiyyah (Islamic legal
maxims).

Nevertheless, the question to be raised is, are market

players really in need of risk bearing? Are there any real
difficulties in their daily transactions that force them to
deal with non-permissible products such as options? Or is
it just a way of profit maximization? It is true that the
basic principle of Islam and the Shariah is to remove
hardship and anything that will cause harm for our lives.
On top of that, Allah does not command us to do what is
beyond our power. Thus, if the prohibition of dealing with

27
Ibid.

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impermissible products will cause hardship that may cause

harm to our lives and wealth, they should be ruled
temporary permissible until an alternative is provided.
This view is based on the maxim that says: anything that
people are in need of dealing with, such that their daily
transactions and lives will be exposed to harm without it,
should be permissible till a Shariah-compliant alternative
is provided.
(
)

Therefore, based on the aforementioned, bearing

risk is permissible, despite all the prohibited elements that
it contains, provided that the market players do not use it
for speculative purposes.
It is clear that some of the market players are using risk
bearing or transferring instruments as way of trading in
risk, which is non-Shariah-compliant.
The International Monetary Fund declared:
Financial markets have developed infinite methods to
trade risk through the use of financial derivatives
instruments.28
It is clear that the tools developed to transfer risk, such as
derivatives, have become instruments of pure speculation
and that their nominal monetary value far exceeds that of
the real economy.
28
Robert Heith, a staff member, IMF Working paper, the statistical measurements
of financial derivatives, pg. 14.

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Dr. Samir Ridhwan observed: Risks are sold

and bought in these markets just as commodities are sold
and bought in other markets.29 Similarly, Dr. Sami
Suwailem stated: The most important tools to address the
prevailing risk, which are derivatives, are having the
opposite tendency as they separate risk from ownership
and make it a commodity.30

This clearly shows that the tools that are being

developed for the purpose of addressing risk transfer are
being used for another purpose. Thus, in order for risk
bearing to be permissible, it should be real and be done by
risk transfer tools, and should be according to Shariah
parameters and ruling.

THE APPLICATION OF RISK SHARING IN

CONTRACTSIN ISLAMIC FINANCIAL
INSTITUTIONS

Risk sharing can be applicable to all exchange contracts as

well as partnership contracts, such as musharakah and
mudharabah. For example: an Islamic financial institution,
acting as a mudharib, collects deposits from depositors or
investors and then invests them; if there are any profits,
they will be shared between the institution and the
29
Ridhwan, Samir Abdul Hamid, (2005), Al-Mushtaqqat al-Maliyyah wa
Dawruha fi Idarat al-Makhatir wa Dawrul Handasah al-Maliyyah fi Sinaat
Adawatiha (Cairo: Daral Nashr, 1st edition), pg 294.
30
Sami bin Ibrahim Al-Suwailim, (2007), Hedging in Islamic Finance (IRTI,
Islamic Development Bank), p.15.

THE CONCEPT OF RISK SHARING IN ISLAMIC FINANCIAL INSTITUTIONS.

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depositors or investors; if there is a loss, they will share it

among themselves as well. By this there will be equality,
justice and fairness among the investors in financial
transactions. This is unlike conventional financial
institutions, which pay interest on deposits for the
depositors, whereby only the bank is exposed to the risk.

The Application of Risk Sharing in Sale

Contracts

Sale (al-bay) literally means: an exchange of property for

property, or an exchange without qualification.
Technically, it is the exchange of any property having
commercial value (mal mutaqawwam) for another such
item so that ownership of each item is transferred to the
other party. An alternative definition is to permanently
exchange the ownership of a tangible asset or permissible
benefit for financial compensation.
In a sale contract, the seller must bear all risk associated
with the commodity as long as the property is in his
possession until it is sold and delivered to the purchaser.
When the property is sold and delivered to the purchaser
and comes into his possession, all the ownership risks
related to the commodity will be transferred to the
purchaser, and any loss or damage to which the
commodity is exposed must be borne by him.

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Issue: 9 , Muharram 1436H. / November 2014
399

The Application of Risk Sharing in a

Mudharabah Contract

In the case of a mudharabah contract, the rabb al-mal

should bear all the risks associated with the mudharabah
assets, i.e. their physical damage or loss as well as a
decrease in their value, as long as it is not due to the
negligence of the mudharib or his error in taking
investment decisions. This because damage to or loss of
property and decrease of its value should be borne by its
owner (rabb al-mal).
However, the mudharib also bears a risk: the loss of his
effort if no profit is achieved. Likewise, he is entitled to a
portion of the profit earned (if any).

The Application of Risk Sharing in Ijarah

Contract

Ijarah literally means: compensation given for service

rendered. Technically, it is a contract for transferring the
ownership of usufruct for compensation, or sale of a
known usufruct for a known compensation.31
In the case of ijarah, the subject matter of the contract is
the usufruct (manfaah) or the use of the leased asset (al-
intifa bi al-Asl al-Muajjar). Once the lessor makes the
asset available to the lessee, the lessee must pay the rent

31
See: ibn Manzur, Lisan al-Arab 4:10, Durar al-Hukkam 2:423, Al-Tarifaat ,
p.23, Al-Mabsut Bidaayat al-Mujtahid 2:229.

THE CONCEPT OF RISK SHARING IN ISLAMIC FINANCIAL INSTITUTIONS.

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regardless of whether he/she uses it or not. The lessor

continues to own the asset itself; therefore, he/she should
bear any loss or damage that occurs to the property
without any negligence or transgression by the lessee, as
well as the insurance expenses of the asset, basic
maintenance, and the taxes imposed on the property.

THE PARAMETERS OF RISK SHARING IN

ISLAMIC FINANCIAL INSTITUTIONS

The main objective of laying down the foundation of the

parameters of risk is, to identify legitimate risk and
forbidden risk. If the risk is within the designated Shariah
parameters, the risk is permissible. However, if its not
under the Shariah parameters, then its not permissible.
The following are the main risk sharing parameters in
Islamic Financial Institutions:

The risk should meet the general Islamic objective

which is to save the nation and the system
sustainability of the validity of human goodness, as
the Shariah always demands securing benefit and
pealing harm. And this represents the main Shariah
objectives and parameters in risk Sharing.
Another parameter that is applicable on risk Shariah
is that, the objection of risk Sharing should for the
sake of wealth protection. The protection of wealth
is one of public interest in Shariah that should be

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Issue: 9 , Muharram 1436H. / November 2014
401

achieved. This is because the nation cannot be in the

right direction without it.32
Justice and fairness, i.e., the profit and the risk in
each contract and investment should be shared
accordingly. The Prophets prohibition of ambiguity
was because it contradicts the principle of justice
and fairness in risk sharing; Kharaj (revenue) goes
with liability.

-32 " :

: .

. :
- :

" :
" :
:
" :
" "
-
" :
" " :
" -
- .

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Refraining from usury. The Quran prohibits riba:

And Allah has permitted sale and forbidden
usury, verse 2:275.
Mitigation of financial and non-financial risks,
which are secondary, should not be at the expense
of ownership risk, which is primary.
Refraining from unacceptable ambiguity (Gharar
Fahish).

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Issue: 9 , Muharram 1436H. / November 2014
403

Conclusion
Risk sharing is the best treatment and solution for the
current problems facing the financial system. It is the basis
of justice and fairness in financial transactions. It is one of
the most important Shariah objectives regarding financial
institutions. Therefore, in order for Islamic financial
institutions to remain in business, save their reputations,
be distinguishable from conventional financial institutions
and be fit to carry the name Islamic, this principle
should be observed throughout the sequence of their daily
transactions. On the other hand, avoiding it may lead to
losing their reputation and the Islamic name, and perhaps
there will not be any differences between IFIs and CFIs.
Nevertheless, commercial contracts in which one party
bears risk foe compensation are permissible as long as
they are within the Shariah ruling and parameters. The
most important findings of this research are as follows:
1) Risk Sharing occurs when two parties enter into a
contract and agree to share the risk upon the
occurrence of any loss or damage in the transaction.
2) There are many types of risk, however, the most
common types faced by financial institutions are:
market risk, liquidity risk, operational risk, credit
risk, reputational risk and legal risk.
3) The legitimacy of risk and profit sharing Kharaj
(revenue) goes with liability. And the maxim
Liability accompanies [the right to] profit. The
origin of these maxims is the previously quoted

THE CONCEPT OF RISK SHARING IN ISLAMIC FINANCIAL INSTITUTIONS.

Yussuf Al-Badani.
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hadith of Aishah (may Allah be pleased with her)

and some verses in Quran such as: Allah has
permitted sale and prohibited riba.
4) Risk transfer or shifting from one party to another
party without his knowledge overburdens him, and
overburdening a party by transferring and shifting
all risk to him will harm him, and it is clear that
Islam does not tolerate harming others, in fact, it has
forbid harming them, as per the Prophetic maxim,
Harm shall neither be inflicted nor reciprocated.
5) Risk bearing is permissible if the market players are
really in need of it, whereby their daily transactions,
provided that it is not used as a way of trading in
risk.
6) Risk sharing can be applicable to all exchange
contracts as well as partnership contracts, such as
Musharakah and Mudharabah.
7) The most important parameters in sharing risk and
profit are justice and fairness, as the profit and the
risk of each investment should be shared
accordingly.
Finally, everything that I have said that is correct is from
Allah, and anything that I have said that is wrong is from
me and Satan. I seek Allahs forgiveness; indeed, He is the
Forgiver.
Allah knows best.

Al Hijaz International Refereed Journal for Islamic & Arabic Studies.

Issue: 9 , Muharram 1436H. / November 2014
405

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