Principle of Islamic finance

Man-Brothers-Islamic-Financial-Institution1- Prohibition of Riba

The term “Riba” means, in Muslim law, any advantage or surplus perceived  by one of the contracting parties without any compensation acceptable and legitimate from pint of view of Sharia. Riba has two main forms:

  • Riba-Al-fadl :  It is  all concrete surplus perceived during a direct exchange between two things of same nature which are sold by weight or measurement.
  • Riba-Annassia :   The surplus collected during paying off of a due, whose payment was made ​​as condition explicitly or implicitly in the contract, because of the deadline granted for the deferred  settlement. Riba-Annassia is the most prevalent  type in the society, especially through the credits, loans and investments offered by the banking institutions and traditional financial bodies.

This differentiates Riba in its both forms for sale of a good or service, as the compensation collected is considered acceptable in  Muslim law, only if it aims to compensate something legitimate, such as:

  • Loss of value related to the use of an asset (in case of renting of an asset),
  • the effort made for fulfillment of an objective (in case of sale of a good produced by the seller)
  • or work performed  to obtain a tangible asset  and the risk involved in its care (in case of sale of goods purchased from others).

According to the French orientalist Austruy Jaques (“Islam in relation to economic development,”  economic collection and humanism, workers editions. Paris 2006), prohibition of Riba in all its forms seems to be one of the consequences of egalitarianism sought in Islamic law. Because according to him, this prohibition is based on double affirmation that time belongs to God alone and cannot be sold, and that the money, in itself, is not productive. Thus, prohibit the withdrawal by the lender of any benefit from its loan, unless this benefit is freely granted by the borrower after loan repayment and without constituting a tacit or explicit condition for it.

2- Prohibition of Gharar and Maysir

Sharia also requires, in business and commerce, that it is not allowed  to conclude the transaction that contains Gharar. Gharar can be defined as being any significant blur for one of its  tradable assets and/or which has in itself hazardous and uncertain character. This is the case particularly:

  • when the sale covers a commodity that is not accurately determined.
  • when the transaction is concluded without the price of the commodity  being clearly fixed.
  • when the transaction covers a specific good that the seller not yet owns.
  • when the transfer of ownership is dependent upon a hazardous event.

This corresponds in conventional finance to the products or future transactions characterized by an obvious uncertainty regarding their realization, such as Futures, Swaps or  other complex financial products such as Subprimes.

Similarly, Sharia prohibits transactions based on Maysir. Etymologically,  Maysir was a game of chance, in the economic field, it means any form of contract in which the right of contracting parties depends on a random event. Thus, each contract must have all the basic terms (such as objective, price, turnaround time and identity of the parties) clearly defined on the day of its conclusion. However, Muslim jurists strongly encourage  satisfaction of all prior conditions before signing the contract. This clearly differentiates the Islamic banks from the institutions interest loan, based on the principle that one can buy without paying and sell without holding, constantly fueling speculation and undermining the stability of the banking system.

The calculated risk of an investment is permitted by Sharia, however the prohibition  of future contracts involving Gharar and Maysir arises from the fact that the risk of false anticipation of market developments could jeopardize  carrying out of transactions based on uncertainty, speculation, or even tortious possession of privileged and prior information. Muslim jurists also justify  prohibition of these transactions by the need to direct the funds available for financing the real economy, instead of  leaving them to feed empty  financial bubbles of any useful productivity and wealth.