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EXPLORING AND IDENTIFYING STRUCTURING TECHNIQUES TO CREATE FINANCIAL PRODUCTS THAT COMPLY WITH SHARIA RULES ON ACCEPTABLE INVESTMENTS

November 14, 2011adminBusiness and FinanceComments Off on EXPLORING AND IDENTIFYING STRUCTURING TECHNIQUES TO CREATE FINANCIAL PRODUCTS THAT COMPLY WITH SHARIA RULES ON ACCEPTABLE INVESTMENTS

By Glenn M. Stewart

In this paper I intend to address the impact of the Sharia upon financial transactions to highlight what I consider are some essential aspects of the Sharia that must be considered when structuring financial products in compliance with Sharia. I believe, that when understood, the Sharia is a clear guide to anyone structuring and creating financial products which comply with Islamic Law. In my opinion, these principles are,  fairly clear and in respect of any areas of doubt, sufficient commentary exists by learned scholars to provide additional guidance to anyone studying the sources of Islamic Law. Thus, the simple, in fact the only answer to the problem of structuring Islamic Financial Products and the ways in which this challenge can be met is to understand the Sharia.

Although, it could take a lifetime of study to be thoroughly versed in all aspects of Sharia law, parts pertaining to commercial transactions (fiqh Al-muamallat) is manageable. Sufficient works exist in English to give anyone who takes the time to consult them an adequate knowledge of this area of fiqh. The application of that knowledge can only have a positive effect on the approach to designing financial products which conform to the Sharia.

During the course of this paper, I intend to refer to a number of these works. I also wish to attempt to communicate to the non-muslim reader, what I see as the essential framework of the Sharia which all non-muslims need to grasp in order to enable them to meet this challenge.

It is important to understand two basic concepts.  First, that the Sharia is a divinely revealed law and that it is therefore immutable; and secondly, there is no differentiation between sacred and profane acts in Islam. All human activities including commercial transactions are governed by divine law and therefore such transactions must be structured in accordance with Sharia.

I recommend that a good starting point for westerners who wish to begin to understand the Islamic view of law and the role of law in human society would be to read J. Schachts’ book on Islamic Law together with N.J. Coulson’s book A History of Islamic Law.

The latter succinctly defines the first concept I have referred to: Coulson states:

“In contrast with legal systems based upon human reason such a divine law possesses two major distinctive characteristics. Firstly, it is a rigid and immutable system, embodying norms of an absolute and eternal validity, which are not susceptible to modification by an legislative authority. Secondly, for the many different peoples who constitute the world of Islam, the divinely ordained Sharia represents the Standard of Uniformity as against the variety of legal systems which would be the inevitable result if law were the product of human reason based upon the local circumstances and the particular needs of a given community. In so far, then, as the historical evolution of Sharia law falls into the three main stages of the growth, the predominance and the decline of the classical concept of law, the process may be measured in terms of these two criteria of rigidity and uniformity.” ((Coulson, N.J. A History of Islamic Law, Edinburgh University Press, Edinburgh, 1964))

Please bear in mind that Coulson’s use of the word rigidity in this context results from his examination of Islamic Law from the point of view of an historian of the Law. Personally, I believe immutability better describes in English the effect on the law that Coulson is highlighting. It is this fact of immutability which makes Sharia accessible to all of us today and why it plays an absolute role in defining and guiding the task of creating Islamic financial products.

This absolute role relates to the second concept that was raised above. As a result of the fact that the sacred and the profane are inseparable, it follows that it is both appropriate and incumbent upon a banker or financier to understand the divine law and its moral basis in his or her work.

Rodney Wilson and David Baldwin clearly identified this fact in an article entitled Islamic Finance in Principle and Practice which appeared in Islamic Law and Finance edited by Chibli Mallat.

They said:

The theory of Islamic finance is normative rather than positive. Finance is viewed as merely one facet of social relationships and an integral part of a wider economic system. It is not solely regarded as a field for the specialist. The need for specialist knowledge is of course recognized, but the specialist should not be isolated and concern himself with only narrowly defined interest. Rather the specialist should be conversant with the wider moral framework, and aware of spiritual as well as material needs. ((Baldwin, David and Rodney Wilson, Islamic Finance in Principle and Practice (with Special Reference to Turkey) in Islamic Law and Finance, Editied by Chibli Mallat, Graham & Trotman, London, 1988))

I am of course assuming that many of the readers of this paper will be cognizant of the material matters with which we are dealing but that many of the non-muslims are not cognizant of the Islamic ‘moral framework’. As a result, I would like to briefly discuss the sources of Islamic Law for their benefit and then to use that framework to analyze certain aspects of the Islamic contract and the prohibitions of riba and gharar which are pertinent to a discussion of structuring Islamic financial products.

There are two primary sources of Islamic Law and two dependent ones.

In order to amplify what has been said previously, I intend to make reference to an excellent book entitled Islamic Juisprudence by a former Justice of the Supreme Court of Sri Lanka, C.G. Weeramantry who writes:
The Qur’an…is…the bedrock of Islamic jurisprudence.

Amidst the vast mass of juristic writing one turns again and again to the basic words of the Qur’an to ensure that argumentation and the deductive process have not taken one astray from the foundation of it all….

The legal attitude to it, at all periods of Islamic history, was well summarized at the UN Conference on International Organization 1945 (Documents, Vol. XIV pp. 375-9) by Muhammed Abd Allah Darz of All-Azhar University in the following terms: ‘The Qur’an, the word of God, is perfection itself – it is unchallengeably true, infallibly just.’

It is important for the foreign lawyer attempting to understand the place of the Qur’an as a source of law to remember that ‘its constant interweaving of spiritual teachings with practical legislation’ is due to the Qur’an ‘being a guidance not only to the spiritual good of the hereafter but also towards the good life – spiritual, physical and social –attainable in this world’ (Asad, 1980, p. iii) Continuing this theme of unity, one must note also that the various injunctions and exhortations contained in the Qur’an are not to be read as individual provisions but as parts of one integral whole. This has led to the expressive statement of Muhammed Abduh (1849-1905), one of the most outstanding of modern Islamic thinkers, that the Qur’an is ‘its own best commentary’ (Asad, 1980a, p. vii). ((Weeramantry, G.C., Islamic Jurisprudence An International Perspective, Macmillan Press, Basingstoke, 1988))

The second primary source of Islamic law is the Sunnah. To cite Weeramantry again:

If on a given matter the Qur’an is silent we need some guidance from a source external to it, and what better guidance than the teaching and example of the Prophet himself? This was ordained in several passages of the Qur’an itself, as for example, in terms that ‘whatsoever the Messenger give you, take it and whatsoever he forbids, abstain from it’ (LIX:7). Hence the authority of the traditions of the Prophet, collectively known as the Sunnah is Islamic law. In the event of contradiction between the Qur’an and the Sunnah, the two must be harmonized if possible but otherwise the Quran prevails.

The word Sunnah means literally a manner of acting, a rule of conduct, a mode of life. Applied to the life of the Prophet this meant, therefore, a rule deduced from the sayings or conduct of the Prophet. Such saying or conduct could take the form of a specific utterance of the Prophet, an action or practice of the Prophet, or the approval by the Prophet of the action or practice of someone else, as narrated in a hadith or tradition.  The term hadith thus refers to the report of a particular occurrence. Although one often comes across the words Sunna and hadith used almost interchangeably, the latter refers to a tradition or story of the Prophet while the former term relates to the rule of law deuced from it. (Fyzee, 1964a, p.19).

Islamic literature sometimes describes the Qur’an and the Sunna as an integrated whole, each supporting the other in the fashion of a book and a candle. The life and work of the Prophet provided the candle by the light of which the book is to be read. The book without the candle or the candle without the book would not achieve its purpose. ((Idem. pp 34-35))

In addition to these two primary sources of law there are two dependent sources of law namely ijma (consensus) and qiyas (reasoning by analogy).

Weeramantry continues:

If one cannot find either a passage from the Qur’an or a hadith bearing on the matter in hand, then one turns to a third sources – the general consensus among Islamic scholars of a particular age in relation to the legal rule correctly applicable to the situation. The rule that had thus been unanimously decided upon became fixed and definite and part of the permanent body of Islamic jurisprudence.

The authority of ijma is based upon distrust of individual opinion. There is assurance of freedom from error in the communal mind. The Prophet had observed, ‘My nation will not agree unanimously in error.’ The theory of consensus or ijma offered a principle of development in Islam for after God and the Prophet there was now the Islamic community. The custody of dogma and worship and all their incidentals was in the community. If the community had a common mind (not a mere majority view) on any particular matter, and that view was not inconsistent with the Qur’an or the hadith and was in an area on which they were silent, that view had validity.

An obvious limitation upon the authority of ijma or consensus is that it must not be in conflict with the Qur’an or the Sunna.

If all the three sources enunciated above should fail to provide a rule to solve the problem in hand, jurists must strive by deep and devoted study to derive an appropriate rule by logical inferences and analogy. Such resort to reasoning or ijtihad, as it was called, is often traced back in the Islamic books to the conversation between the Prophet and the Governor of Yemen (Muadh Ibn Jabal).

Logical reasoning by analogy was known as qiyas and was the subject of much philosophical inquiry in sorting out the underlying principal and separating it from the particular facts of the past and present cases. There was a similarity between this process and that of the English lawyer seeking to extract the general principle underlying a decision from the particular facts of the case and applying it to the analogous case that arises later. ((Idem. pp 29-41))

The question of the role of ijtihad and the continuing debate about the role of ijtihad among Muslim jurists are two of the most important aspects of Islamic law both historically and in the present time.

I cannot recommend strongly enough that all westerners interested in understanding the Sharia should make some effort to acquaint themselves with the debate entered into by many of the leading Muslim jurists concerning ijtihad.

At a bare minimum, a non-muslim banker should have some knowledge of the work of the four great jurists of the classical period. Abu Hanifa, Anas Ibn Malik, Muhammed Al Shaf’i and Ahmad Ibn Hanbal.

The work of these jurists has specific bearing on the structuring of financial products again, both historically and contemporarily, as a result of the corpus of hiyal literature developed by these schools. Hiyal  means stratagems and

“refers to methods that were developed to work out a path around Sharia doctrines that were considered inconvenient or unsuited to contemporary practice. Such devices were used to get over the prohibition of Riba.” ((Idem. pp 41))

An appreciation of the positions developed by these four great schools of Islamic legal thought in respect of hiyal transactions is vital to any western banker who is serious about developing Islamic financial products.

In addition to the four jurists referred to above, I also recommend that those involved in this industry should acquaint themselves with the thought of the great Hanbali jurist Ibn Taimiyyah. Ibn Taimiyyah dealt at length with hiyal practices.

“He does not agree with the jurisprudents who validate such practices, but he gives weight to the intention in certain cases, arguing that if such transactions were done without the prior agreement of the two parties, or the intention was really to trade in goods and not lend or borrow money at interest in this way, it might be permitted.” ((Islahi, Abdul Azim, Economic Concepts of Ibn Taimyah, The Islamic Foundation, Leicester, 1988))

For a further elaboration of the position of Ibn Taimiyyah, may I recommend Economic Concepts of Ibn Taimiyyah by Abdul Azim Islahi published by the Islamic Foundation in Leicester.

Finally, non-Muslimin interested in the development of fiqh should absolutely acquaint themselves with the work of the Egyptian jurist Muhammed Abduh (1849-1905). His influence on contemporary Islamic debate cannot be underestimated. Even if one does not take the time to read some of his works one should at least be aware of his stature and influence on contemporary Islam.

My remarks up to this point have been intended to emphasize that the challenge facing the financial industry in respect of structuring Islamic products can only be met through an understanding of Sharia. I cannot stress this strongly enough.

The second of my sub-headings is entitled examining the principles upon which these financial products can be structured.

As I believed the first part of this topic to require a need to address the macro issue of the Sharia, so I believe that the second part of the topic should look at certain micro issues.

Specifically, I wish to examine the nature of the Islamic contract itself. Then I believe that it would be useful to consider some aspects of the Islamic prohibition of riba and gharar and by doing so we can hopefully come to look at what is permissible in more detail by first eliminating what is not.

There are four concepts integral to Islamic contract law which have a bearing on the development of any Islamic Financial Products. They are; Fair Contract, Commercial Integrity, Freedom from Riba and Freedom from Uncertainty.

To quote Weeramantry once more:

“The notion of fairness in contract runs through the entire Islamic law of contract. Contract law is thus free of the technicalities which exist in many a European system, particularly the common law system of contract with its technicalities of consideration. The honoring of one’s engagements is stressed in many passages of the Qur’an.”

“Islamic thinking analyzes the completion of the contract by reference to the requirements of offer (ijab) and acceptance (qabul). Consideration is not essential, unlike in the common law. Fairness to both parties and reciprocity are of the utmost importance, so that, for example, a contract which involves risk or uncertainty even to a party willing to accept it can be invalidated. A buyer may return an article for defect even after he has seen the property. Interest is forbidden, as the introduction of doubt enables the stronger party to make an unfair contract out of the weakness of the other. This rule as we shall see, has however been circumvented to some extent by juristic interpretation. Subjects covered by the law of contract include gifts, agency, guarantee, deposit and loan.”

“The notice of honor in all commercial dealings and of the sanctity of the pledged word pervades Islamic trading.”

“The Qur’an enjoins trading honesty in the severest terms, with strict prohibitions against the use of false weights and measures. Many passages re-echo the general principle of fairness of commercial dealing.”

“The notion of equity and fairness in commerce is reflected also in the Qur’anic prohibition against usury.” ((Weeramantry, Op. Cit, pp. 65-66))

I wish also to draw the reader’s attention to some other aspects of the Islamic contract and how it validates three financing techniques available to Muslim: that is to say: bay’salam, istisna; and ijara.

I can not communicate these concepts better than Nabil Saleh has done in an article entitled Financial Transactions and The Islamic Theory of Obligations and Contracts, an article, which I strongly recommend should be read in its entirety.

This article also appears in the Book, Islamic Law and Finance edited by Chilbli Mallat which contains the Proceedings of a conference covered by the Centre of Near and Middle Eastern Studies and the Law Department of the School of Oriental and African Studies of the University of London.

To quote Mr. Saleh;

“A contract under Islamic law is expected to exhaust all its purposes as soon as it is concluded.  That is not a sign of primitiveness, but an inescapable aspect of the theoretical system.  The religiously-rooted requisite that transactions should be devoid of riba (unlawful advantage) and gharar (uncertainty , speculation, risk), has deeply stamped the entire Islamic system of law and most particularly the Law of Contract.  The dual abhorrence of riba and gharar means that whenever a transaction involves the exchange of two countervalues, (a) that exchange, if it has to take place under conditions which could result in riba an-nasi’a (riba by way of deferment), should be concluded immediately and (b) these countervalues must be in existence, in their essence at least, and known to the contracting parties.

“This theory strongly appealed to scholars and jurists, and they consequently overlooked the concept of obligation arising out of contracting, focusing their attention, instead, on the subject-matter.  For them the accord of the contracting parties is expected to have an immediate impact on the subject-matter; nothing else really mattered.  The logical complement of that theory is that an agreement to agree is a nullity in Islamic law (Coulson 1984, 44 and Vesey-Fitzgerald 1979, 183) and that an exchange of obligation for obligation (bay’ ad-dayn bid-dayn) is prohibited (Schacht 1984, 146).  Therefore a promise has no binding effect, even when the promisee expresses acceptance of the promisor’s undertaking (Chehata 1970, 133-135).

“But it is a fact that contracts do not always exhaust their purpose at the time of their conclusion.  It may happen that, owing to a variety of reasons, the subject-matter remains for a time unaffected by the contract.  That was acknowledged by traditional scholars who made room for a certain number of transactions deemed as exceptions to the principle.  In that way, the validity of a sale with advance payment (bay’ salam), of a contract of manufacture (istisna’), and of a hire contract (ijara), is not seriously questioned.  But the legal requisites for the conclusion of such contacts are detailed in such a way as to minimize the risks of riba and gharar.

“Although in bay’ salam one of the countervalues is not at hand at the time of contracting, an exact description of the unavailable countervalues was deemed sufficient to remedy the situation and to legitimize these contacts.” ((Saleh, Nabil A, Financial Transactions and the Islamic Theory of Obligations and Contracts in Islamic Law and Finance, Edited by Chibli Mallat, Graham & Trotman, London 1988))

Let us continue this examination of the underlying principles upon which Islamic products should be based by examining certain specific hadith which form the basis of the prohibition of riba.  Once again, I believe, that it is important for non-muslim engaged in structuring Islamic financial transactions to become familiar with and refer to the sound ahadith. This will enable them to come to heave a feel  and an appreciation for the way in which the science of fiqh has been built up over the centuries.  Excellent translations of both Bukhari and Muslim exist in English for those who wish to become familiar with a more comprehensive view of the sources of Islamic Sunna.

For those who wish to examine only the more narrow area of muamallat, I highly recommend that they obtain a copy of the Economic Teachings of Prophet Muhammad (May peace by upon him), A Select Anthology of Hadith Literature on Economics, complied by Muhammad Akram Khan and Published by the International Institute of Islamic Economics and the Institute of Policy Studies in Islamabad.

The Quranic prohibition of Riba is unconditional and absolute and appears in Surah Ar Rum, Surah An Nisa’, Surah Al Imran and Surah Al Baqara.  This unconditionality and absoluteness is the view expressed by the jurists such as Ibn Taimiyyah in his Majmu’ Fatawa Shaikh Al Islam.

Since I assume that everyone is familiar with this basic prohibition I believe it will be of greater interest to examine certain elaborations on the prohibition by looking at specifics as contained in the ahadith.

There are a number of ahadith dealing with riba but for the purposes of this presentation I would like to draw your attention to five of them:

1.    Abu Sa ‘id al-Khudri reported Allah’s Messenger (may peace be upon him) as saying: “Do not sell gold for gold, except like for like, and do not increase something of it upon something; and don’t sell silver unless like for like, and don’t increase something of it upon something, and do not sell for ready money something to be given later.”

2.    ‘Uthman b ‘Affan reported Allah’s Messenger (may peace be upon him) as saying: “Do not sell a dinar for two dinars and one dirham for two dirhams.”

3.    Malik b. Aus b. Al-Hadathan reported: I came saying who was prepared to exchange dirhams (for my gold), whereupon Talah b. ‘Ubaidullah (Allah be pleased with him) (as he was sitting with ‘Umar b. Khattab) said: “Show us your gold and then come to us (at a later time).  When our servant would come we would give you your silver (dirhams owed to you).” Thereupon ‘Umar b. Khattab (Allah be pleased with him) said: “Not at all.” By Allah, either give him his silver (coins), or return his gold to him, for Allah’s Messenger (may peace be upon him) said: Exchange of silver for gold (has an element of) riba in it, except when (it is exchanged) on the spot; and wheat for wheat is riba unless both are handed over on the spot; barley for barley is riba unless both are handed over on the spot; dates for dates is riba unless both are handed over on the spot.

4.    Abu Huraira (Allah be pleased with him) reported that the Messenger of Allah (may peace be upon him) said: “If a person conducts two transactions contained in one he should stick to the lower or he will commit an act (involving) riba.

5.    Jabir said that Allah’s Messenger (may peace be upon him) cursed the accepter of interest and its payer, and one who records it, and the two witnesses; and he said: “They are all equal.” ((Khan, Muhammad Akram, Economic Teachings of Prophet Muhammad (may peace be upon him) A Select Anthology of Hadith Literature on Economics, pages 155, 157, 159 & 160, International Institute of Islamic Economics & Institute of Islamic Economics & Institute of Policy Studies, Islamabad, 1989))

These and other ahadith concerning riba have been elaborated on at length by many of the leading Islamic jurists.  As a result, there is no confusion as to the nature of riba or its prohibition.  Riba has been extremely well defined in all of its categories of which there are three; Riba Al Fadl, Riba Al Nasi’a and Riba Al Jahiliyya.

I could not give a more succinct definition of riba than that contained in a book which should be mandatory reading for all non-Muslims working the field of Islamic finance.  That book is Unlawful Gain and Legitimate Profit in Islamic Law by Nabil A. Saleh.

Riba is generally translated into English as “usury” or “interest” but in fact has a much broader sense under Sharia, as already suggested by its dictionary meaning, which is “increase” or “gain.”

Riba, in its Sharia context, can be defined, as generally agreed, as an unlawful gain derived from the quantitative inequality of the counter-values in any transaction purporting to effect the exchange of two or more species (anwa’, sing. Naw’), which belong to the same genus (jins) and are governed by the same efficient cause (illa, p, ‘ilal). Deferred completion of exchange of such species, or even of species which belong to different genera but are governed by the same ‘illa, is also riba, whether or not the deferment is accompanied by an increase in any of the exchanged countervalues.

That being the case, usurious transactions were classified into two categories: (a) riba al-fadl, which is produced by the unlawful excess of one of the countervalues as described above, and (b) riba al-nasi’a, which is produced by delaying completion of the exchange of the countervalues, as also described above, with or without an increase or a profit.

Some scholars, including the Hanbali Ibn Qayyim al-Jawziyya, added a third category, which they have named riba al-jahiliyya or pre Islamic riba, often manifested by the lender asking the borrower at maturity date if he will settle the debt or increase it.  Increase normally occurred by charging interest on the debt initially accrued.  For the authors who advocated the classification of usurious transactions into three categories, this pre-Islamic riba (riba al-jahiliyya) was regarded as the one directly referred to in the Quran, while the other two categories, namely riba fadl and riba al-nasi’a, were referred to in the Prophet’s Tradition (Hadith). ((Saleh, Nabil A., Unlawful Gain and Legitimate Profit in Islamic Law, pps 16-17, Graham & Trotman, London, 1992))

Of further interest to the prohibition of riba al fadl is the elaboration of Ibn Al-Qayyim referred to previously, a disciple of Ibn Taimiyyah contained in I’lam Al Muwaqq’in:

He establishes two distinct categories: riba al-jali (open interest) and riba al-khafi (disguised interest) and says that riba al-jali is prohibited expressly as such, while riba al-khafi is prohibited to stop it from becoming a means to interest.  He concludes that the thing prohibited as a precautionary measure is permitted for the sake of a higher good (al-maslahah al-rajihah).

The prohibition of gharar is contained in the following hadith:

“Abu Huraira (Allah be pleased with him) reported that Allah’s Messenger (May peace be upon him) forbade a transaction determined by throwing stones, and the type which involves some uncertainty.” ((Khan, Muhammad Akram, Op. Cit pg. 146))

Although there is a large amount of fiqh literature on gharar to which we could refer to elaborate on the probation of gharar, I believe that the cited hadith is explicit and needs no further explanation.

The preceding, I hope, clearly establishes the principles upon which Islamic financial products can be structured; that is to say there must be a fair contract of commercial integrity which adheres to the Islamic norms governing contracts and which cannot contain any element of either riba or gharar.

Before we turn to the types of products which I believe these principles indicate, I would briefly like to touch on the cognate views of riba contained in the Bible.

These should be, I believe, of interest to non-muslim working in the financial sector generally, and should be of relevance to Christians who also have an interest in seeking to establish a moral basis for financial transactions.

There are a number of specific references to usury in the Bible in the Old Testament. These passages influenced the development of Jewish law as well as the Christian interpretation of the moral law as it applied to financial transactions.

From Exodus Chapter 22 Verse 25

If you lend money to one of my people among you who is needy, do not be like a money-lender; charge him no interest. ((Holy Bible, New International Version, International Bible Society, Colorado Springs, 1973))

Ezekiel Chapter 18 Verse 8 states:

He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniquity, hath executed true judgment between man and man. ((The Holy Bible (translated out of the original tongues and with the former translations diligently compared and revised by His Majesty’s Special Command), Edition 1982))

And Leviticus Chapter 25 Verses 35-37 reas:

If one of your countrymen becomes poor and is unable to support himself among you, help him as you would an alien or a temporary resident, so that he can continue living among you.  Do not take interest of any kind from him, but fear your God, so that your countryman may continue to live among you.  You must not lend him money at interest or sell him food at a profit. ((Holy Bible, New International Version, Op. Cit. pp. 90))

Clearly, these verses establish the fact that usury was considered both an iniquitous financial transaction and oppressive to the poor.

In many ways the most interesting verses concerning usury in the Old Testament are contained in Deuteronomy: Chapter 23 Verses 19 &20.

Verse 19 is very clear and I believe establishes an utmost prohibition of usury upon Christians.

Do not charge your brother interest, whether on money or food or anything else that may earn interest. ((Idem pp. 142))

Verse 20 is very interesting and formed the basis of Jewish law permitting the lending of money to gentiles at interest:

You may charge a foreigner interest, but not a brother Israelite, so that the Lord your God may bless you in everything you put your hand to in the land you are entering to possess. ((Idem pp. 142))

In fact, the Jewish scholar Maimonides went so far as to interpret this verse as laying an obligation upon Jews to lend at interest to Gentiles.

This interpretation, notwithstanding, there was a clear consensus among Jews, Christians and Muslims arising from divine revelation that usurious transactions were iniquitous.

In terms of this paper, I am concerned with ensuring that financial transactions structured in accordance with Sharia conform to the divine commands and prohibitions.

I have attempted to indicate what those divine prohibitions are and to suggest how those working in this area of finance can come to have a better understanding of them.

That leads me to the third sub heading of this paper which looks at what is permitted.

This area is open to greater latitude and interpretation than the question of what is forbidden.  However, the ways in which financial dealings should be structured is also fairly clear and clearly derived from Sunnah.

In this area, a great deal of work has been done by a number of scholars such as Dr. Muhammad Uzair, Dr. Mahmud Abu Saud and Dr. Muhammad Nejatullah Siddiqi to name just a few.

The work done in this area is accessible through a number of publications produced by the International Centre For Research in Islamic Economics at King Abdul Aziz University in Jeddah and by the Islamic Foundation in Leicester.  I thoroughly recommend that any one seriously interested in Islamic Finance should become familiar with the literature produced by these two institutions.

The single most effective way to conduct finance acceptable under Islam, is through a Modaraba structure.  One of the best books dealing with this subject is Banking Without Interest by Dr. Muhammad Nejatullah Siddiqi.

As Professor Khushid Ahmad says in his foreword to the book.

The real question that Muslim economist and bankers have to face squarely is how to eliminate interest and evolve new institutions and practices which would enable economic activities to flourish with resorting to riba in any form.

Dr. Muhammad Nejatullah Siddiqi, one of the pioneers of Islamic economics, is also amongst the few economists who initiated research and dialogue on the subject of interest-free banking two decades before the issue came to the fore in the context of contemporary Islamic resurgence…He has been able to develop a workable model of banking on an interest-free basis. ((Siddiqi, M.N., Banking Without Interest, The Islamic Foundation, Leicester, 1988))

The two basic structures under which financing on an interest free basis should be carried out are Mudarabah and Shirkah. These two types of structure are the framework as opposed to specific  contracts under which other permissible types of transactions can be effected  We previously referred to Ijara, Bae Salam and Istithna.  These together with  Murabaha are the main permissible types of Islamic financing contract but in most cases and certainly where the transaction has been arranged by a third party, they will fall within the framework of either Mudaraba or Shirkah.

Thus I believe that it is most valuable to us in the Islamic financial services industry to concentrate on understanding these forms as they are the only bases upon which financial resources can be mobilized from the sector of the population having surplus capital and utilized by the sector of the population requiring it for business purposes.
The Sharia basis for Mudarabah and Shirkah is well established.

In his book Partnership and Profit-Sharing in Islamic Law, Dr. Siddiqi drawing from the Al Mabsut of Al Sarakhsi, The Sunan of Abu Dawud and from Al-Khafif gives a useful summary of the relevant ahadith and precedents:

The Prophet had entered into a partnership with Sa’ib ibn Sharik at Makka.  When he met him at Madina he recollected the incident and mentioned it with approval.

It is reported from the Prophet (upon him be peace) said that God affirms that until one of the two partners breaks the trust I remain their third partner.

It is reported that a man came to the Prophet and said, ‘I work at the market and my partner engages himself in prayers in the mosque.’ The Prophet remarked, ‘Probably the prosperity of your business is due to this fact.’
‘Abbas bin ‘Abdul Muttalib engaged in mudarabah deals with certain conditions and when the Prophet came to know of it, he expressed his approval.

Hakin Ibn Hizam was also engaged in mudarabah with the same conditions.

Abu Na’im reports that the Prophet, before attaining prophethood went to Syria for trade with Khadija’s merchandize on the basis of profit-sharing.

Ibn Majah reports the Prophet to have remarked: ‘Prosperity lies in mudarabah.’

‘Uthman practiced mudarabah and Qasim bin Muhammad reports that we had deposited some of our savings with A’isha who lent them out on mudarabah for business purposes.  Likewise ‘Umar concluded a mudarabah contract with Zaid Ibn Khulaida. ((Siddiqi, M.N., Partnership and Profit-Sharing in Islamic Law, The Islamic Foundation, Leicester, 1985))

All the schools of law accept these basic structures.  There are some variations between the schools in certain areas but we do not need to go into those here.

Siddiqi defines Shirkah and Mudarabah as follows:

Shirkah means participation of two or more persons in a certain business with defined amounts of capital according to a contract for jointly carrying out a business and for sharing profit and loss in specified proportions.

Mudarabah means that one party provides capital and the other utilizes it for business purposes under the agreement that profits from the business will be shared according to a specified proportion. ((Idem pp. 15))

When a third party such as an Islamic bank or a Western bank structures a financial transaction in accordance with Sharia the appropriate mechanism to use is the mudarabah structure.

I do not believe that it is necessary to go into the various details regarding the distribution of profits and the liability for losses or specifics of the Mudarabah contract.  Siddiqi covers all of this adequately in his book.

The main point with which we need to be concerned is that whether the Mudarib is an interest-free bank, a western bank or a specialized investment company. A lawful contract for investment will exist between the investor (the rabb al mal¬) on the one side and the Mudarib in the middle. A separate lawful contract between the Mudarib and the entrepreneur will exist on the other side.

The totality of these contracts ensures that what is being invested, the way in which it is being invested, the profit being earned on the investment and its distribution to the concerned parties is done in a manner consistent with the divine commands and prohibitions we have been examining.

This will be true for money Mudarabah, a commodity Mudarabah or a productive Mudarabah.

Knowledge of and due care in the application of those commands and prohibitions indicate that Shirkah and Mudarabah are the best ways of conducting business and financial products must comply with the commands and prohibitions we have been examining.

Let us not forget that the Sharia as derived from the Qur’an is for all Muslim eternal in and of itself.  As you will recall, the scholars of the third century after the hijra recognized and upheld the concept that the Qur’an as the primary source of Islamic law, is co-eternal with God, himself.

Thus the duty of mankind is not to attempt to devise new modes of action or endeavor.  Rather, it is incumbent upon them to implement the existing and eternal commands and prohibitions as divinely revealed.  In Islam, that way is clear even in finance and commerce.

Thus the role of either Islamic or conventional banks in the development of acceptable products as referred to in the topic heading is defined and limited by the Sharia.

As we have seen the primary business function of either Islamic or conventional banks is essentially limited to that of Mudarab or partner, and the primary moral function of these institutions is to ensure that their Islamic business is conducted in conformity with the Devine Law.

In reflecting on these issues, I cannot help but recall the words of Ecclesiastes Chapter 1 Verse 9 which states:

What has been will be again, what has been done will be done again; There is nothing new under the sun. ((Holy Bible Op. Cit. pp.))

Glenn StewartGlenn M. Stewart is a renowned expert on Middle Eastern affairs and business. a graduate of Oxford University, Glenn M.Stewart holds an advanced degree in Islamic History and Arabic and lived in the Middle East for 27 years. A successful entrepreneur and businessman, Stewart has a unique insight into this critical and important area of the world.

If you would like to see my other writing, please visit www.glennmstewart.com

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