ISLAMIC BANKING

Topic 2: Ethics & Prohibitions in Mu’amalat

 Ethics in Islamic Finance and Banking
"Assist one another in righteousness and piety. And do not assist
one another in sin and transgression…" (Qur’an 5:2)

• One objective of Islamic finance and banking is to assist in the

spread of economic prosperity. The other objective is to do
this in accordance with Shari’ah principles.
• Among the norms concerning Islamic finance are a free
market, where prices are determined by demand and supply,
freedom from manipulation, prevention of hoarding, profit
and loss sharing in partnerships, information efficiency etc.
 Among the norms in Islamic finance that we want to
elaborate on here are the following three topics:
• 1. The Prohibition of Riba (Interest or Usury) – Money is not
to be exchanged for money with profit. As a result of this
prohibition, alternative solutions are given which encourage
trade and equity participation.
• 2. The Prohibition of Gharar (Uncertainty) – This demands
transparency in contracts as well as in buying and selling.
Prices should be specified, there should be clarity of the
delivery details, quality of goods, quantity of goods etc. The
information should be available to all parties involved and the
outcomes of a contract should be free from ambiguity etc.
• 3. Sanctity of Contract – Contracts should be fair and agreed
upon by both parties. Therefore, the contract should be free
from the elements of Gharar and reach Shari’ah approval in
their content.
 1. The Prohibition of Riba (Interest or Usury)
• Definition of Riba: ‫الربا‬
• Riba in the Arabic language literally means increase. However,
according to the specific Shari’ah definition, it means unlawful
increase ‫الزيادة المحرمة‬. Under today’s literature and
terminologies, riba commonly refers to interest and usury.
• The Islamic Fiqh Academy which was initiated through the OIC
(Organization of the Islamic Conference), was established to
bring scholars from around the world in order to address
current issues and concerns. During the 2000 meeting, the
OIC reaffirmed the consensus of the historical prohibition of
interest. Riba is one of the core concerns in Islamic finance. In
order to avoid riba, many financial alternatives have been
adopted over the centuries. Although scholars describe
rationales as to why riba may be prohibited, the sole reason
for sincere Muslims to refrain from riba is to conform to what
the Law Maker has legislated.
 Riba ‫( الربا‬Interest or Usury)
• Riba is strongly prohibited in Islam. The many verses of the
Qur’an leave no question in this regard: “Allah has permitted
trade and forbidden riba.” (Qur’an: Surah Al-Baqarah 2:275).
The verses prohibiting riba are located in four Surahs of the
Qur’an; Surah Al-Baqarah 2:275-276, 278-280; Surah Aal
Imran 3:130; Surah An-Nisaa 4:161 and; Surah Ar-Room
30:39.
• Riba is further elaborated on in the Prophet’s Sunnah.
Numerous hadiths explain the details surrounding riba. In a
hadith narrated by the Prophet’s companion Jaabir: “Allah’s
Messenger cursed the one who accepts riba, the one who
gives it, the one who records it and the two witnesses to it,
saying, ‘They are all the same.’” (Collected By Muslim).
 Types of Riba:
• There are two major categories of riba.
• The first category is known as Riba An-Nasee’ah which relates
to riba in debt. It increases with time (e.g. interest on
borrowed money). This is the most common type of riba
today and it relates to return of money on money at any rate
(fixed or floating, compounded or simple interest).

• The other category is Riba Al-Fadl which refers to riba in

exchange. This type of riba refers to the six commodities (e.g.
Gold) mentioned in the hadith.
It increases with the transaction.
 2. The Prohibition of Gharar (Uncertainty)

• Gharar has a broad scope and is not limited to one simple

definition. For our purposes here, it relates to excessive
uncertainty or ignorance by way of a contract, or the goods
involved in a sale, the price, ownership, possession of goods,
deliverability, dates of exchange etc. A hadith collected by
Muslim narrated by Abu Hurairah states, “The Prophet
forbade selling by way of tossing stones to settle a sale (Al-
Haasah), and the sale of Gharar.”
 Minor and major Gharar
Minor Gharar
• Gharar has been categorized into two categories, namely
major and minor. It is expected that minor (or trivial) accounts
of gharar will exist and for that reason it is tolerated and not
given concern. Such is the case of catching a taxi, there is an
element of uncertainty in the price as it rises with the
mileage, yet this is a minor form of uncertainty and is
permissible. Another example is buying fruit without peeling
the skin to see inside.
Major Gharar
• Causes for alarm are the major or substantial forms of gharar
which are clearly condemned from a Shari’ah perspective.
Major Gharar will be simply referred to as gharar in the rest
of the lecture notes.
• Gharar can generally refer to the following:
• Lack of Transparency -The Shari’ah stipulates that
transparency must exist in order for contracts to be
legitimate. For example, the terms of the contract must be
clear to both parties involved in order to be just and fair.
Under such measures, individuals are protected from fraud,
deceit and exploitation.
• Deception - Gharar can also imply deceit.
Once Prophet Mohammad came upon a heap of grain in the
market of Madinah and thrust his hand onto it. His fingers felt
dampness. On being asked, the trader replied that rain had
fallen upon it. The Prophet observed, "Why did you not then
keep (the wet portion of) it above the dry grain, so that
people may see it? He who deceives, has nothing to do with
me” (Muslim). Therefore, relevant information cannot be
withheld.
• Selling what you do not have

Part of Gharar is selling what is not in one’s possession. The

common example of this is the selling of the fish in the ocean
which has not been caught yet, or selling vegetables that the
seller is yet to purchase (i.e. they are not in possession or
ownership). This can lead to settlement risk and is therefore
a form of gharar. One should therefore catch the fish and
then sell it, or buy the vegetables from a wholesaler, and then
sell them to avoid the risk of uncertainty.
An exception to this rule is a salam contract (Bai’ As-Salam)
which relates to farm produce which has not been harvested
yet. Such a contract is paid up-front and an agreed upon
amount of goods (e.g. one ton) must be delivered at a later
date when the produce is harvested.
• Ignorance - The buyer should have relevant information
about the goods they intend to buy or the contract they
intend to sign. This is why it is important to inspect the goods
one is about to buy. With regards to what the buyer is buying,
the buyer should know (for example) the quantity, the
attributes, species etc. Or in the case of a contract, both
parties should have a sufficient understanding of the details
and outcome of the contract in order to remove any doubt.
• Unspecified Price - The price of the sale should be stipulated.
This is important if the goods are purchased on credit, in
order to avoid disagreement at a later date.
• Unspecified dates - As for the delivery of goods, the price can
be delayed or the goods can be delayed in delivery, yet this
should be by mutual consent of the buyer and seller.
 3. Sanctity of Contract
Sanctity of Contract
• As excessive gharar is impermissible in Islam, the Shari’ah
emphasizes that contracts must include transparency and
honesty. Prices should be specified, there should be clarity of
the delivery details, quality of goods, quantity of goods etc.
The information should be available to all parties involved and
the outcomes of a contract should be free of ambiguity.
• When full disclosure is present, both parties eliminate or
reduce financial speculation and undue complexity in
contracts (due to gharar). This will include discloser of the risk
involved by providing as much information as possible for
buyers or investors.
 3. Sanctity of Contract (cont)
• If two or more parties come together for a partnership (e.g.
musharakah), all parties should be aware of their profit-
sharing ratio, underlying assets involved, and other conditions
of the contract.
• The parties involved must mutually agree on the sale or
contract, albeit orally or preferably in written form, without
coercion.
• Contracts must be in accordance with Shari’ah principles.
Therefore, investments considered unethical, unlawful
(haram), unjust etc, would not be considered. Although riba
and gharar may not be involved, one must make sure that
other unlawful practices are not present. For example, it is
prohibited to finance a casino or deal with alcohol etc.
 Case study: Riba & Gharar today
Identify role of Riba & Gharar in:
I. Global Financial Crisis (GFC)
II. European debt crisis (EDC)