Critic Feisal Khan argues that in many ways Islamic finance has not lived up to its defining characteristics. Risk-sharing is lacking because profit and loss sharing
modes are so infrequently used. Underlying material transactions are also missing in such transactions as "tawarruq
, commodity murabahas
, Malaysian Islamic private debt securities, and Islamic short-sales". Exploitation is involved when high fees are charged for "doing nothing more substantial than mimicking conventional banking /finance products". Haram
activities are not avoided when banks (following the customary practice) simply take the word of clients/financees/borrowers that they will not use funds for unIslamic activities.
law that forms the basis of Islamic banking is itself based on the Quran
(revealed to the Islamic prophet Muhammad
) and ahadith
(the body of reports of the teachings, deeds and sayings of the Islamic prophet Muhammad
that often explain verses in the Quran).
Prohibition of gharar
is based on ahadith
declaring as forbidden gharar
the sale of things like "the birds in the sky or the fish in the water". [Note 9] Maisir
is thought to be banned by verses 2:219, 5:90, and 91 in the Quran.
However, "the Islamic evaluation" of modern banking centers around the definition of interest on loans
Twelve verses in the Qur'an deal with riba
, the word appearing eight times in total, three times in verses 2:275, and once in 2:276, 2:278,
and 30:39. Riba
is mentioned numerous times in ahadith
, including Muhammad's Farewell Sermon
A number of orthodox scholars point to Quranic verses (2:275-2:280) as declaring riba
"categorically prohibited" and "unjust" (zulm
), and defining it to mean any payment "over and above the principal" of a loan.
(Although at least one source states "it is commonly argued" that riba
is "defined by hadith".)
Those who devour usury shall not rise again except as he rises, whom Satan of the touch prostrates; that is because they say, 'Trafficking (trade) is like usury.' God has permitted trafficking, and forbidden usury. Whosoever receives an admonition from his Lord and gives over, he shall have his past gains, and his affair is committed to God; but whosoever reverts -- those are the inhabitants of the Fire, therein dwelling forever.
God blots out usury, but freewill offerings He augments with interest. God loves not any guilty ingrate.
Those who believe and do deeds of righteousness, and perform the prayer, and pay the alms - their wage awaits them with their Lord, and no fear shall be on them, neither shall they sorrow.
O believers, fear you God; and give up the usury that is outstanding, if you are believers.
But if you do not, then take notice that God shall war with you, and His Messenger; yet if you repent, you shall have your principal, unwronging and unwronged.
And if any man should be in difficulties, let him have respite till things are easier; but that you should give freewill offerings is better for you, did you but know. (Quran 2:275-280)
Some unorthodox (such as Raqiub Zaman) have asked why — if "God Almighty used the terms `doubling` and `quadrupling` (the sum lent)" as riba
in verse 3:130, and if "there was no further clarification of this verse in the Quran or by the Prophet" — the orthodox are so certain that riba
is defined as any "addition over and above the principal sum that is lent."
Nonetheless this is a minority view,
and (according to the orthodox) an "increase over the principal sum" in loans of cash
are riba. An increase over the principal sum in financing a purchase
of some product or commodity is another matter. These are not
riba — according to the orthodox interpretation — at least in some circumstances.
(These are sometimes known as "credit sales".) According to noted Islamic scholar Taqi Usmani
, this is because in Quran
aya 2:275 ("they say, 'Trafficking (trade) is like usury,' [but] God has permitted trafficking, and forbidden usury"
"trafficking (trade)" refers to credit sales such as murabaha
, the "forbidden usury" refers to charging extra for late payment (late fees
), and the "they" refers to non-Muslims who didn't understand why if the first was allowed both were not.[Note 10]
For this reason (according to Usmani) it is not
true that "whenever price is increased taking the time of payment into consideration, the transaction comes within the ambit of interest".
Instead of "principal" and "interest rate", the credit taker is paying "cost" and "profit rate".
(Another difference with conventional finance is that there is no penalty for late payment.)[Note 11]
Interest and credit sales
While Usmani and other Islamic Banking pioneers envisioned credit sales like murâbaḥah
being a limited part of the Islamic Banking industry and subordinate to profit and loss sharing
, it has become the "most common" mode of Islamic financing.
The distinction between credit sales and interest has also come under attack from critics such as Khalid Zaheer and Muhammad Akram Khan — criticizing it from opposite points of view. Zaheer considers profit from credit sales to be riba
, the same as interest, and notes the lack of enthusiasm of orthodox scholars — such as the Council of Islamic Ideology
— for credit sales-based Islamic Banking, which they (the council) call "no more than a second best solution from the viewpoint of an ideal Islamic system".
Khan calls the distinction "frivolous and laboured", a way of charging interest using another name, necessary because businesses "cannot survive where cash and credit prices are equal".
Others note that in terms of standard accounting practice
and truth-in-lending regulations[Note 12]
getting 90 days credit on a Rs10000 product and paying an extra Rs500, cost very nearly the same and is considered very nearly the same as paying in cash, using a three-month loan at 20% per annum.
Taqi Usmani, however, explains that this is a "misconception". Paying more for credit when buying a product ("an exchange of commodities for money")
does not violate sharia law, but exchange of "one unit of money for another of the same denomination" ("an exchange of money for money")
and charging for credit is
a violation of sharia.
The cash loan is different because "money has no intrinsic utility".
Other orthodox supporters (such as Kahf) have defended the sharia compliance of the practice saying that among other things, attaching commodities to money in finance prevents money from being used for speculative purposes.
Critics report widespread abuses of "synthetic" murabaha
, which are loans with interest in all but name.
Types of Islamic lending
One of the pioneers of Islamic banking, Mohammad Najatuallah Siddiqui
, suggested a two-tier mudarabah
model as the basis of a riba
-free banking. The bank would act as the capital partner in mudarabah
accounts with the depositor on one side and the entrepreneur on the other side.
(Another pioneer Taqi Uthmani called mudarabah
and another profit-sharing form of finance musharakah
, the "real and ideal instruments of financing in Shari‘ah".)
This model would be supplemented by a number of fixed-return models—mark-up (murabaha
), leasing (ijara
), cash advances for the purchase of agricultural produce (salam
) and cash advances for the manufacture of assets (istisna`
), etc. In practice, the fixed-return models, in particular murabaha
model, became the industry staples, not supplements, as they bear results most similar to the interest-based finance models. Assets managed under these products far exceed those in "profit-loss-sharing
modes" such as mudarabah
Time value of money
The time value of money
— the idea that there is greater benefit in receiving money now rather than later, so that savers/investors/lenders should be compensated for delayed gratification — has been called one of the "most significant" arguments in favor of charging interest on loans.
As such, some Islamic finance supporters have opposed the concept, arguing that some consumption — such as eating — can only be done over time, and discounting for time encourages negative outcomes such as unsustainable production like desertification
, since the desertification comes in the discounted future.
However, since Islamic banking also calls for rewarding delayed gratification in the form of "return on investment" on both profit-sharing and credit sales, Islamic scholars and economists have tended to insist that time value of money is a valid concept "provided the rate of discount is the `rate of return` on capital rather than the rate of interest," a position critics find specious.
Early payment of debt
The opposite of credit sales (i.e. the opposite of charging more in exchange for giving the buyer time to pay) is reduced charges for early payment. This is considered haram
by the four Sunni schools of jurisprudence (Hanafi
), but not by all jurists according to Ridha Saadullah. He notes that such reductions have been permitted by some companions of the Prophet
and some of their followers. This position has been advanced by Ibn Taymiyya
and Ibn al-Qayyim
, and it has, more recently, been adopted by the Islamic Fiqh
Academy of the OIC
. The Academy decided that `reduction of a deferred debt in order to accelerate its repayment, whether at the request of the debtor or the creditor is permissible under Shariah
. It does not constitute forbidden riba
if it is not agreed upon in advance and as long as the creditor-debtor relationship remains bilateral. ...
Islamic laws on trading
An Islamic Development Bank branch in Dhaka
As noted above, the primary focus of Islamic banking is on financing without interest to avoid riba
while trade is not an issue (per the Quranic
statement that "God has permitted trafficking [trade] and forbidden riba [usury]"
However trade transactions that involve gambling
), or excessive risk (bayu al-gharar
) are not
permitted. Among the financial instruments and activities common in conventional finance that are considered forbidden (or at least Islamically problematic) by many Islamic scholars and Muslims are:
- margin trading: This uses borrowed money to buy shares of stock or other financial instruments. It both involves forbidden interest on the borrowed money, and much greater risk than non-margin investing because loses can be greater than the amount borrowed;
- short selling: borrowing/renting shares of stock or some other instrument and selling it on the hope that its can be later repurchased at a lower price for a profit. It is traditionally thought to violate the hadith stating “Do not sell which you do not possess,” and has been declared impermissible by numerous sources (Raj Bhala, IslamQA, Taqi Usmani, Humayon Dar.
- day trading: very short term buying and selling of financial instruments) has been called unIslamic because the short period of "ownership" means day traders do not truly own what they trade, and furthermore pay interest. Among the sources calling it unIslamic include Yusuf Talal DeLorenzo, and Focus Business Services of the UAE.
- derivatives: contracts that derive their value from the performance of an underlying asset; (The "notional value" of the world's over-the-counter derivatives at the end of 2007 was $596 trillion and the gross market value of all outstanding derivatives was $14.5 trillion.) Options, futures and "other derivatives" are "generally" not used in Islamic finance "because of the prohibition against maisir", Sources stating that most derivative or some kinds of derivative are banned by Islamic scholars include Juan Sole and Andreas Jobst, P.S.Mills and J.R.Presley, Taqi Usmani, Investopedia. The most commonly used derivative are:
- forwards: customized contracts to buy or sell an asset at a specified price on a future date. unlike futures contracts forward contracts are not traded on any exchanges;
- futures: a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price at a specified time in the future;
- options: contracts offering the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date);
- swaps: contracts through which two parties exchange financial instruments to transfer risk.
On the other hand, at least one Islamic scholar (Mohammed Hashim Kamali) finds “nothing inherently objectionable" in selling and using options, which like other kinds of trade is mubah
(permissible) in fiqh
, and "simply an extension of the basic liberty that the Quran has granted”.
And both Islamic finance practitioners and critics find benefit in at least some uses of derivatives and short selling — managing risk in times of financial trouble,
improving market efficiency and employee productivity.
At least some in the Islamic finance industry use derivatives and make short sales, and permissibility of this is a subject of "heated debate".
Global standards for trading Islamic profit-rate and currency swap derivatives
were set in 2010 with the "Hedging Master Agreement"
(see below). A "shariah-certified" short-sale had been created by some Shariah-compliant hedge funds.
However both have been criticized as unIslamic.