DAWN - the Internet Edition

February 22, 2008 Friday Safar 14, 1429

Principles of Islamic finance

By Sidrah Unis

THE age of globalisation has ushered in an era of advanced cooperation, increase in bilateral as well as multilateral trade, massive investments in infrastructure for energy rich countries, industrialisation and the works.

The linchpin in all the above is capital or money which is generated through investments, then reinvested for generation of a bigger amount. Fruitful and lucrative ventures bring in greater amount of capital; risky ventures have an element of risk which cannot be overlooked. Stock markets boom and crash; an air of speculation prevails. Interest based economy dominates the scene where many a small fry cannot compete with big businesses.

Islam has devised its own set of rules with regard to financial enterprises. The underlying principle operating in Islamic market law is twofold: individual autonomy to own productive resources to further one’s economic interest and protecting the consumer from harm. Individual interest has to be so pursued that collective interest of society is not put at risk. Thus any individual business undertaken to cause harm to the fabric of society has been strictly prohibited.

In short, the basic principles of the Islamic economic system are that moral values are guiding factors for all economic activities; there should be maximum utilisation of human and material resources, the same to be managed equitably; wealth should be distributed and circulated fairly.

In order to achieve what has been stated in broad terms above, the following are some of the rules laid down.

Prohibition of Maysir (gambling and games of chance): “They ask you concerning wine (strong drink) and gambling. Say: “In them is great sin and some profit for men; but the sin is greater than the profit.”

Prohibition of Gharar (risk or uncertainty) : The term Gharar connotes risk or uncertainty. It refers to transactions wherein the characteristics of the subject matter itself are not certain or clearly laid down be it with regard to form or quantity. So such a deal involves an element of risk similar to gambling.

The Prophet (pbuh) has forbidden the purchase of unborn animal in its mother’s womb, sale of milk in the udder without measurement, purchase of spoils of war prior to their distribution, purchase of charities prior to their receipt and of the catch of a diver. The last prohibition in this hadith pertains to payment for whatever a diver may catch on his next dive. This has been prohibited because the payer does not know what he is paying for.

Prohibition of riba (interest or usury): Riba literally means ‘increase’. In Shariah, it is an addition over and above the principal amount i.e. paying money for the use of money. The Holy Quran and the Sunnah of the Holy Prophet expressly prohibit riba. “And that which you give in gift (to others), in order that it may increase (your wealth by expecting to get a better one in return) from other people’s property has no increase with Allah…” (30: 39)

It has been narrated that Bilal once visited the Messenger of Allah with some high quality dates. The Prophet inquired as to where he got them from. Bilal explained that he traded two volumes of lower quality dates for one volume of a higher quality one. The Messenger of Allah said: “this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates and use the proceeds to buy the other.”

Prohibition on dealing in forbidden commodities: Keeping in view public good and for the purpose of discouraging unethical investments, Islam has forbidden dealing in commodities declared haram i.e. pork, wine, drugs etc whose use and consumption has been forbidden to Muslims.

Payment of Zakat (Charity): Zakat, a principal component of social security, is a portion of wealth which a Muslim is obliged to give to a predetermined category of beneficiaries, if the value of his assets is above a specified limit. The Holy Quran says: “And perform As-salat, and give Zakat and obey the Messenger (Muhammad) that you may receive mercy (from Allah).” (24: 56); it is the state’s responsibility to collect Zakat and distribute it among the needy.

The basic principles narrated above serve as guidelines for Muslims to fashion their economic activities in accordance with Divine injunctions. Keeping in view the intricacies of contractual relationships and business dealings, Islam has also laid down certain methods by which partnerships can be created, profits derived and benefited from, losses equitably shared and smooth running of business managed.

Some of the prominent financial instruments being mudarabah (capital trusts); musharakah (full partnerships) ; murabaha (mark-ups on sale); bai muajjal (deferred payments); bai salam (prepaid purchases) istisna (manufacturing contracts) and qard hassan (benevolent loans). Mudarabah, also known as sleeping partnership, is a form of partnership wherein the investor (rab al maal) provides capital to an entrepreneur (mudarib) for the purpose of undertaking a business activity. Profits in this case are shared according to a predetermined ratio but losses are born by the investor only. The mudarib only loses his share of the income in case of a loss.

Further, the investor cannot interfere in the running of the business but can specify conditions for the purpose of better management of the capital invested by him. Musharakah is an active partnership wherein all partners invest in the business and take active part in executive affairs. Profits are enjoyed on the basis of a predetermined ratio, whereas losses are shared in proportion with the amounts invested.

Murabaha is a transaction which enables a buyer to make a purchase without taking a loan from a bank and incurring interest on borrowing the same. A bank or a financial institution in this case purchases an item specified by the client for the latter. Having so bought it, the bank or financial institution sells it to the client at a price which includes a profit margin agreed to by both the parties.

Bai Muajjil is a sale of goods where the payment for the same is deferred. The buyer can pay either in lump sum or in instalments as agreed between the buyer and the seller.

Bai Salam is a form of sale where advanced payment is made for goods clearly described which are to be delivered at a specified date in the future. Istisna is a form of sale where the subject matter of the sale is bought before it has been manufactured or built.

Qard Hassan is lending of money to help out another. The lender in this case cannot take back more than the amount he so lent. The borrower however, of his own volition, may pay back a larger amount to the lender provided that this has not been demanded of him under the contract.



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