Understanding Islamic Finance - Doha Academy of Tertiary Studies

The Philosophy and Features of Islamic Finance 75to Sharī´ah tenets, has to give away the lent goods/money to the borrower for the periodof the loan without seeking any worldly compensation. Therefore, Islamic banks will nottake or give any loan or enter into contracts seeking any increase over the principal ofloans or debts created as a result of any credit transaction. Buying/selling goods, both oncash payment and credit, for the purpose of earning profit is permissible. Pricing the goods,keeping in mind the time given for payment of the price in credit transactions, is alsoacceptable with the condition that it should not involve any addition or enhancement tothe principal amount of the debt created as a result of the sale transaction. This aspecthas been discussed in detail in Section 4.6 while discussing the concept of time valueof money.This implies that once any debt is created, the seller cannot demand more than the creditprice stipulated in the sale or other contracts. Those who were involved in usurious transactionsat the time the Holy Qur’ān was revealed protested and argued that lending oninterest was like an act of trade and that they should be allowed to add more and moreso long as the debtor did not pay. They were admonished through the revelation in theHoly Qur’ān that while “trade” was permitted, “Riba” was forbidden. Any increase over thereceivable of the sale was Riba and in loans or debts they were entitled to their principalsums only. Therefore, lending on interest is alien to Islamic banks and financial institutions.In case of any debts created by way of trade or Ijarah transactions, they are notallowed to charge anything over and above the principal of the debt. They are not allowedto charge costs of funds or rent on money in short-, medium- or long-term loans, overdrafts,guarantees, financing against bills, receivables or other instruments or sell their debtinstruments.4.2.2 Avoiding GhararAvoiding Gharar is another main principle of Islamic finance. Gharar, as discussed indetail in the previous chapter, refers to entering into a contract in absolute risk or uncertaintyabout the ultimate result of the contract and the nature and/or quality and specificationsof the subject matter or the rights and obligations of the parties. Gharar isalso involved if there is a lack of adequate value-relevant information (Jahl) or thereis inadequacy and inaccuracy of any vital information which leads to uncertainty andexploitation of any of the parties. Deceit, fraud or deliberate withholding of value-relevantinformation is tantamount to Gharar. Islamic banks should not engage in any bargainin which the result is hidden, as they would not be certain whether the delivery couldor would be made, which is necessary for the completion of any genuine businesstransaction.The current practices of financial institutions and insurance companies in the futures andoptions markets are un-Islamic because of the elements of Gharar, interest, gambling, etc.The transactions of contemporary stock markets, if cleansed of these elements, would beIslamic.The prohibition of Gharar requires Islamic banks not to engage in speculative trade inshares, short-selling, discounting of bills and securities or trading in unidentified items.Similarly, Islamic investment banks’ involvement in IPOs of joint stock companies wouldrequire care to avoid Gharar, as information asymmetry between the investors and promotersin the early stages of companies’ establishment may involve Gharar. Trading in derivativesalso involves Gharar and, therefore, is a grey area for Islamic banks.