Islamic Economics and Finance

Philosophical Foundation & Shari’ah compliant Business & Shariah compliant Insurance Contemporary Subjects &
Islamic Financial Market
Basic Rules Financial Contracts (Takaful) Shariah Compliance

Foundation & Basic

Concepts Murabahah Islamic Equity Market (Overview)

Islamic Economic System Salam & Istisna’a Money Market – Islamic Perspective

Sources of Shari'ah Ijarah Capital Market – Islamic Perspective

Key Prohibitions Mudarabah Shariah Compliant Stocks

Islamic Law of Contracts Screening of Shariah Compliant stocks

and Sale Musharakah
Major Shari’ah Prohibitions and their Implications
CHAPTER 4
 Contents

 Introduction
 Prohibition of Interest (Riba)
 Prohibition of Uncertain Dealings (Gharar)
 Prohibition of Speculative Behaviour (Maysir)
 Other Shari’ah compliant Issues
 Introduction

 Shari’ah law is a wide body of discipline. A part of it deals with business and commercial transactions,
and that includes the prohibitions and principles relating to the Islamic finance.

 The principle of halal (permissible) and haram (prohibited) provide a sort of moral filter for actions
taken by every individual in the society, and form a legal framework for Islamic Finance.
 Introduction

Three main Shari’ah prohibitions that impact the Islamic finance are:

1. Prohibition of Interest (Riba)

2. Prohibition of Uncertain dealings (Gharar)

3. Prohibition of Speculative behaviour (Maysir)

 Understanding Riba

Two aspects to understand Riba:

a) Among the most important teachings of Islam for establishing justice and eliminating exploitation in business
transactions is the prohibition of all sources of ‘unjustified’ enrichment (‘akl amwal an nas bi al batil). One of the
important sources of unjustified earning is receiving any monetary advantage in a business transaction without
giving a just counter value (represented by Riba).

b) In Islam, money is viewed as a medium of exchange and not as an asset by itself.

 Also, giving loan to someone at the time of need is an act of virtue in Islam and should be rewarded hereafter.
 Understanding Riba

 The Holy Qur’an uses the word Riba ( ‫ )ٱلِّر َبٰو ۟ا‬for interest/usury/mark-up.

 The root word ‘Riba’ literally means an addition, excess, growth, and increase.

In the Shari’ah context, riba refers to the ‘premium’ that must be paid by the borrower to the lender along with the
principal amount as a condition for the loan or for an extension in its maturity.

Every loan that draws benefit is one of the forms of Riba.*

In other words it can be defined as the ‘rent on a borrowed amount.’

 Types of Riba

Jurists classified riba into two categories:

1. Interest on money or Interest in Loan Contract (Riba al Nasiah or Riba al Duyun) (Riba al jahiliyyah -
mentioned in the Quran).

2. Interest related to barter trade or Interest in Exchange Contracts (Riba al Fadhl or Riba al buyu) –
(Mentioned in the Hadeeth)
 Types of Riba

1. Interest on money or Interest in Loan Contract (Riba al Nasiah or Riba al Duyun) refers to the increment
charged in relation to the duration of a loan or penalty due to late payment. (Riba al jahiliyyah - mentioned in the
Quran).

The prophet was reported to have said that “any added benefit for the lender that is contractually derived from a loan
transaction is riba”. (Ibn ali shaybah 1980:436)
 Types of Riba

2. Interest related to barter trade or Interest in Exchange Contracts (Riba al Fadhl or Riba al buyu) – the discussion of riba al
fadl has arisen from the ahadith requiring that if gold, silver, wheat, barley, dates and salt are exchanged against themselves they
should be exchanged spot and be equal and alike. This can be seen in some Prophetic traditions that prohibit excess and deferment
in a transaction that involves an exchange of ribawi commodities. (Mentioned in the Hadeeth)
The Hadith indicates than an exchange contract involving six items should observe the following criteria:
a) It must be affected on the spot basis.
b) It is done at par or in equal unit of measurement if the exchanged countervalues are of the same genus and denomination.

Although the jurists held different opinions on the ‘illah or underlying rationale for the six ribawi items mentioned in
the hadith, they had classified them into two categories:
c) Medium of exchange (currency) represented by gold and silver and extended to any items used as currency.
d) Food stuff represented by wheat, barley, dates and salt, but extended to other types of commodities according to different ‘illah by
different schools of law.
Identifying Ribawi Transaction

Type 1 Type 2 Type 3

Commodity – Money Money 1 for Money 1 Money 1 for Money 2

Can be Deferred No deferment No deferment
Can charge Surplus No Surplus Can have surplus
Commodity 1 for Commodity 1 for
Commodity 1 Commodity 2
No deferment No deferment
No Surplus Can have surplus
Types of Riba
 Cont …..

Does this hadith apply only to the items mentioned in it?

 Cont ….

Imam Abu Hanifah

 Imam Abu Hanifah sees only two common characteristics namely:
1) Weight
2) Volume
 Meaning all these six goods are sold by either weight or volume. Therefore all those commodities, which have weight or
volume and are being exchanged, with the same commodity will fall under the rules of Riba Al Fadl.
Imam Shafi’i
 The two characteristics observed by Imam Shafi’i are:
1) Medium of Exchange
2) Eatable
 Therefore this law will apply on everything edible or having the natural ability of becoming a medium of exchange
(currency).
 Cont ….

Imam Maalik
 Imam Maalik identified the following two characteristics:
1) Eatables
2) Preservable
Imam Ahmad Bin Hanbal
 Includes three characteristics at the same time namely:
1) Edible
2) Weight
3) Volume
 Imam Nawawi on identification of Riba al Fadhl

 When the underlying ‘illah of the two goods being exchanged is different, shortfall/excess and delay both are
permissible.

 When the commodities of exchange are similar, excess and delay both are prohibited.

 When the commodities of exchange are heterogeneous but the ‘illah is the same, as in the case of exchange of
gold for silver or USD for Yen (medium of exchange), or wheat for rice (‘illah being edibility), then the excess or
deficiency is allowed as long as on spot.
 Step by Step Prohibition of Riba in the light of Qur’an

And whatever you give for interest to increase within the wealth of people will not increase with Allah .
But what you give in Zakah, desiring the countenance of Allah - those are the multipliers. (Al-Rum-39-
Makki Surah)
‫ت‬ ‫ن‬ ‫ن‬ ‫ت‬ ‫ث‬ ‫ت‬ ‫ت‬ ‫ت‬ ‫ت‬
‫ے و وہ اﷲ کے زدی ک ہی ں ب ڑھے گا اور ج و مال م زک ۃ (و‬ ‫م‬
‫ے ہ و اکہ ( مہارا ا اث ہ) لوگوں کے مال می ں ل کر ب ڑھت ا ر‬
‫ٰو‬ ‫ہ‬ ‫اور ج و مال م سود پر د ی‬
‫ن‬ ‫ث‬ ‫ن‬ ‫ن‬ ‫ت ئ ت‬ ‫ض‬ ‫فق‬ ‫ت‬ ‫خ‬
‫ہ‬ ‫ہ‬
‫ے ہ و ( ط) اﷲ کی ر ا چ اے ہ وے و و ی لوگ (اپ ا مال ع د اﷲ) ک رت سے ب ڑھاے والے ہ ی ں‬ ‫ی‬ ‫د‬ ‫ں‬ ‫ی‬ ‫م‬ ) ‫رات‬ ‫ی‬
 Cont ….

And [for] their taking of usury while they had been forbidden from it, and their consuming of the people's
wealth unjustly. And we have prepared for the disbelievers among them a painful punishment. (Al-nisa –
161-Madani Surah)
‫ن‬ ‫ن‬ ‫ن‬ ‫ئ ت‬ ‫ن‬ ‫لن‬
‫ب‬
‫ اور ان کے لوگوں کا احق مال کھاے کی وج ہ سے ( ھی ا ہی ں‬،‫ے‬
‫ے ھ‬ ‫کے‬
‫و‬ ‫ر‬ ‫سے‬ ‫اس‬ ‫وہ‬ ‫کہ‬ ‫حاال‬ ،‫سے‬ ‫ب‬ ‫س‬ ‫کے‬ ‫ے‬
‫گ‬ ‫ب‬ ‫اور ان کے سود ی‬
‫ت‬ ‫ئ ن‬ ‫ف‬ ‫ن‬ ‫م‬
‫ے‬ ‫سزا لی) اور ہ م ے ان می ں سے کا روں کے ل‬،
‫ے درد اک عذاب ی ار کر رکھا ہ‬
 Cont ….

O you who have believed! do not consume usury, doubled and multiplied, but fear Allah that you may be
successful. (Al-Imran – 130 Madani Surah)
‫ن‬ ‫ت ت‬ ‫ت‬
‫ اور ہللا عالٰی سے ڈرو اکہ ہی ں ج ات ل‬،‫اے ای مان والو! ب ڑھا چ ڑھا کر سود ن ہ کھاؤ‬
‫ے‬‫م‬ ‫م‬
 Cont ….

Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by
Satan into insanity. That is because they say, "Trade is [just] like interest." But Allah has permitted trade and has
forbidden interest. So whoever has received an admonition from his Lord and desists may have what is past, and his
affair rests with Allah . But whoever returns to [dealing in interest or usury] - those are the companions of the Fire;
they will abide eternally therein. (Al Baqarah – 275)
‫ت ت‬ ‫خ‬ ‫ش‬ ‫ت‬ ‫خ‬
‫ئ‬ ‫ن‬ ‫و ر لو گ نہ ک ھڑ ہ‬
‫ے کہ‬ ‫ےل کہ یہ ک ہا ک ر ےھ‬ ‫ب‬
‫ے ی ط ا ن ھو ک ر ط ی ب ا دےیہ اس‬ ‫چ‬ ‫ے جس‬ ‫ہ‬ ‫ں ےم گ ر اسی ط ر حج س ط ر حو ہ ک ھڑ ا ہ و ا‬ ‫ےو گ‬ ‫سو د‬
‫ت‬ ‫ئ‬ ‫ئ‬ ‫ن‬ ‫شخ‬ ‫ن ت‬ ‫ت‬ ‫ت‬ ‫ت‬
‫ن‬
‫ہ‬
‫ےپ پ ا سآ ی و ی ہللا ع ا ل ٰی ک ی‬ ‫م و ص ا‬ ‫ج‬ ، ‫ت و ح ال لک ی ا او ر س و د ک و ح ر ا‬‫ے ار ک‬ ‫ج‬ ، ‫ا ر تب ھ ی و س و د ی ک ی ط ر حہ‬
‫ے ح ا ال ک ہ ہللا ع ا ٰیل‬ ‫ہ‬ ‫ن ج‬
‫ج ن‬ ‫ٹ‬ ‫ت‬ ‫ئ‬
‫ہ‬
‫ و ہ م ی‬، ‫ے او ر ج و پھر دو ب ا ر ہ ﴿ح ر امک ی ط ر ف﴾ لو ا‬ ، ‫ے و گ ز ر ا او ر اس کا مع ا م لہ ہللا ع ا ل ٰی ک ی ط ر فہ‬ ‫ےل و ہ ہ ج‬‫تس نک ر ر ک گ ی ا اس ک ے‬ ‫ص یح‬
‫ے لو گ ہ م ی ش ہ ہ ی اسم ی ںر ہ ی ں گ ے‬ ‫ے ا یس‬
،‫ہ‬
 Cont ….

Allah destroys interest and gives increase for charities. And Allah does not like every sinning disbeliever.
(Al Baqarah – 276)
‫ت‬ ‫ن‬ ‫ن‬ ‫نش‬ ‫ت‬ ‫ت‬ ‫ق‬ ‫ت‬ ‫ت‬
‫ے اور ہللا عالٰی کسی ا کرے اور گ ہگار سے محب ت ہی ں کر ا‬
‫ے اور صد ہ کو ب ڑھا ا ہ‬
‫ہللا عالٰی سود کو م ٹ ا ا ہ‬
 Cont ….

O you who have believed, fear Allah and give up what remains [due to you] of interest, if you should be
believers. (Al Baqarah – 278)
‫ت‬ ‫ق‬ ‫ت‬
‫ اگر م سچ مچ ای مان والے ہ و‬،‫ے وہ چ ھوڑ دو‬ ‫ا‬
‫گی ہ‬ ‫رہ‬ ‫ی‬ ‫ا‬ ‫ب‬ ‫سود‬ ‫و‬ ‫ج‬ ‫اور‬ ‫ڈرو‬ ‫سے‬ ‫اے ای مان والو !ہللا ٰی‬
‫عال‬

And if you do not, then be informed of a war [against you] from Allah and His Messenger. But if you
repent, you may have your principal - [thus] you do no wrong, nor are you wronged. (Al Baqarah – 279)
‫ت‬ ‫ت ت‬ ‫ت‬ ‫ت‬ ‫ئ‬ ‫ن‬ ‫ت‬ ‫ت ت‬ ‫ن‬
‫ہ‬ ‫ص‬
،‫ے‬‫ ہ اں اگر وب ہ کرلو و مہارا ا ل مال مہارا ی ہ‬،‫ے ی ار ہ و ج اؤ‬ ‫کے ل‬
‫ظ‬
‫اور اگر ایسا ہی ں کرے و ہللا عالٰی سے اور اس کے رسول سے لڑے‬
‫ت ظ‬
‫ئ‬ ‫ت‬
‫ن ہ م لم کرو ن ہ م پر لم ک ی ا ج اے گا‬
 The difference between interest (Riba) & sale (Bay’)

 In normal sale  seller, buyer, subject matter and price. Relationship between two parties is seller – buyer.

 The seller may produce the required product (subject matter) himself.

 The seller may buy it from other seller and sell it on cost + profit.

 In case of riba loan is extended on a condition of return of profit and interest and no efforts of the lender are involved. The
relationship between two parties is lender – borrower.

Three constituent parts of Riba are:

a) An addition to the principal sum.

b) Determination of this condition according to a fixed term.

c) The deal being conditioned on the payment of additional amount.

 Riba & Bay’

 In ba’y, the seller charges profit once at the time of sale.

 Interest is paid every month or year (during the contract period) on the remaining principal.

 In commerce, agriculture and business ventures, the entrepreneur invests his labour, capital and time to reap the
harvest of dividends.

 In interest based ventures, the lender provides capital only.

 Excess upon debt has no corresponding countervalue but time, which is not wealth, and the increase is thus
detached from real economic activity.
 Arguments in Favor of Interest and the Reply

Argument 1 (The lender risks his capital and sacrifice made)

The lender lends money which he could have used for himself, and thus there is gesture of sacrifice. If the borrower takes a
loan to satisfy some of his personal needs, he ought to pay rent on the money obtained through the loan in the way he does
for the house ha hires or furniture and means of conveyance that he borrows. The interest that he borrower thus covers this
element of risk that the lender has taken by offering him the loan, while at the same time being a compensation for the
sacrifice of loan amount he could have utilized for his personal needs.
The Reply
 The question is “How does risk and sacrifice justify the lender’s right to demand interest”.
 In order to reduce risk  ask for mortgage, surety, guarantor or other don’t lend.
 Sacrifice remain sacrifice if the benefit is not asked.
 The lending amount is an extra amount apart from the needs of the lender which is used for interest bearing activities which does
not make it a sacrifice.
 Rent is different than interest where a lessor lease the property (subject to devaluation because of wear and tear) and spend his
time, labour and capital on maintaining it.
 Cont ….

Argument 2
The financial worth of an opportunity given to someone to benefit from a loan that is extended to him can only really be
of value if it has been advanced for a business or commercial enterprise hence the lender has the right to ask for share
in benefits.
Reply
 The capital in itself has no capacity to generate dividends.
 Requires time, labor, and enterprise.
 What is the guarantee that the borrower will derive the benefits and as planned?
 If the profit earned by the borrower is more than assumed.
 Still how can a lender fix the rate in advance?
 How the borrower is compensated for the risk and the skill he applied in business?
 Cont ….

Argument 3 (Compensation for the Grace Period)

It is in lieu of grace period allowed to a borrower for use of the principal sum. The one who get loan gets grace days
otherwise he would not be able to convert it into profit. The lender is thus justified in determining the cost of this period
on the basis of its length and duration.
Reply:
 The guarantee that the borrower will definitely make profit
 How in advance the lender can calculate the exact profit the borrower will earn so that he can get his own share
(interest) out of it?
 Cont ….

Argument 4 (Sharing of Profit)

Profitability is intrinsic to capital and the mere fact the someone is using other’s money itself is a reason for lender to
ask for his share from the profit. Capital has the power to support production and supply for production for public use.
Hence, a commercial borrower should pay interest for taking that advantage.
Reply
 What if loan is taken for personal use?
 Sometimes the investment of more capital in an enterprise proves counter-productive.
 The profitability is not sole dependent on capital  dependent on other factors of production and macroeconomic
factors.
 Cont ….

Argument 5 (Compensation for time)

One gives more preference to present rather than future therefore, the money today has more value to us than future.
Therefore, we must compensate the value of principal received in future by an interest rate.
Reply:
 If it is so then why people save money for future?
 How exactly we can determine that the principal will by let say 8% in coming year and another 2% by next year.
 What is the guarantee of the upward trend?
 Arguments put forwarded in the Shari’ah Court

1. The verses of Holy Quran which prohibited Riba were revealed in the last days of the Holy Prophet Muhammad
‫ ﷺ‬and he did not get the opportunity to interpret them properly.

2. Riba of that time refers to usurious loans on which an excessive rate of interest was charged.

3. Riba used in Quran restricts the interest on consumption loan.

4. Quran mentions about Riba al Jahiliyyah where in the initial stage of contract, no interest rate is set however if
the borrower defaults on payment then an interest was charged.

5. Riba cannot be eliminated and be allowed on the basis of necessity.

 Quick Questions

 House sold for PKR 10m and the payment is deferred for 10 years where the borrower will pay in monthly installments.

 A 1998 model Corolla exchanged for 2010 Mehran on spot.

 12 grams of gold exchanged for 500 grams of silver on spot.

 USD 100 exchanged for PKR 17,000 on spot and PKR 18,500 after 1 month.

 PKR 100,000 exchanged for PKR 100,000 in deferment.

 I pay you an amount equal to 100kgs of silver with grace period of 10 months while you have to pay me an amount equal to 10kgs of silver every
month.

 I pay you an amount in PKR equal to USD 100,000 with grace period of 10 months while you have to pay me an amount in PKR equal to USD
10,000 each month.
 UNCERTAIN DEALINGS
Prohibition 2 (GHARAR)
 Excessive Uncertainty or Ambiguity (Gharar)

Gharar is another important element which could render a transaction void.

 Literally Gharar refers to deceit, uncertainty, ambiguity, risk and or hazard that might lead to destruction or loss.

 Technically, the element of gharar arises at the time of contract formation – Specifically in the sale contract.

 Such contracts are attractive to the buyer in its form but ambiguous/uncertain in its substance.
 Excessive Uncertainty or Ambiguity (Gharar)

Gharar in Islam refers to any transaction of probable objects whose existence or description are 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.

For example, selling an unborn animal, or selling what the diver will find, or selling what is an unknown genus or
species or features.
 Excessive Uncertainty or Ambiguity (Gharar)

 Is Gharar different from Risk?

 Gharar is uncertainty arise due to missing elements in the contract.
 Risk is a type of uncertainty that does not arise because of missing elements in the contract but because of external factors.
Method of Detecting Gharar
 Can material uncertainty be removed with reasonable effort and without impairing value of item?
 If YES, then there is gharar in sale of the item.
e.g. selling of the book with defect which could be found by putting reasonable effort and without damaging the book.
 Cont ….

 Unlike the prohibition of riba, no verse from the Qur’an could be found directly or explicitly prohibiting gharar.
However, the Qur’an clearly prohibits all forms of business transactions which cause injustice or zulm to any of
the parties.
 On the other hand, prohibition of gharar has been made conclusive in various ahadith of the prophet (PBUH).
 Abu Hurayrah (RA) reported to have said that two types of transactions were prohibited by the prophet (PUBH),
namely al-mulamashah and al-munabdhah.* In both cases, the sales are prohibited due to gharar.
 The prohibition of gharar is founded on the rule of justice and fair dealings. This is because the occurrence of
gharar in any transaction may result in oppression or injustice, and the loss of properties to one or even both of
the parties.
 Cont ….

Jurists classified Gharar into two categories:

a) Major Gharar (Gharar fahish) – relates to important and material information to the contract, would render the
contract void.

b) Minor Gharar or unavoidable Gharar (Gharar yasir) – would not affect the validity of the contract, due to the
nature of the subject matter and the likely potential of causing considerable damage to one of the parties.
 Cont ….

Three main types of gharar can be observed with reference to modern financial transactions:

a) Gharar due to the non-existence of the subject matter or not having control of the subject matter. Example: “He
who buys food grain should not sell it until he has taken possession of it.” (Al-Bukhari)

b) Gharar due to inadequacy or inaccuracy of information. Example: Non-disclosure of material information on the
subject matter.

c) Gharar due to the undue complexity of the contract such as combining two sales in one, two or more
interdependent contracts.
It should be noted that unlike riba, gharar is a phenomenal
issue which is open to change based on different
circumstances.
 SPECULATIVE BEHAVIOUR
Prohibition 3 (MAYSIR/QIMAR)
 Speculative Behaviour (Maysir/Qimar)

 Every action or word which involves wagering of property to be given to the winner is categorized as
gambling.
 According to Sirin, “Everything which involves a wager is gambling (maysir)” (Al-Tabari, 1420 AH,
4:323)
Based on the various definitions provided by jurists, it is concluded that gambling assumes the following
key characteristics:
1. It takes place between two or more parties.
2. Each participating party bets his property.
3. Each participating party has an equal probability of gain or loss.
4. The winning party’s gain corresponds exactly with the losing party’s loss.
 Speculative Behaviour (Maysir)

 Winner wins money without any efforts and loser lose without any fair compensation – even the win/lose was by
chance.

 Islam encourages earning from real activity through honest efforts and prohibits confiscation others money by
chance.

Qur’an explains the reason for the prohibition of gambling as it invokes enmity in society and distracts believers from
worshipping Allah (SWT). (Surah al Ma’idah: 5:90-1)
 Cont ….

To detect Maysir, ask the following questions:

Does the activity create needed value for society?

If NO, then ask:

Is the participant risking something of material value in hopes of gain?

If YES, then the activity involves Maysir.

 Other Shari’ah Rulings

 Whatever is prescribed haram in Islamic Shariah its dealings is also haram.

 Market manipulation and speculation is disallowed rather the market should work on natural forces.

 Dealing in the stolen/smuggled things is prohibited.

 Artificial fixing of market prices is generally not allowed.

 Other Shari’ah Rulings (Ethics)

 Honesty & Transparency

 Fair treatment
 Encouragement to use profit and loss sharing contracts
 Requirement for Shariah compliant contracts
 Avoid hoarding
 Avoid taking advantage of other party
 Freedom of contract (mutual consent)
 Original permissibility
 Interest of society
 Relieving of hardship