Riba and Islamic Modes of Finance
Table
of Contents
Executive
summary
RIBA
Prohibition
of Riba in Islam
·
Riba in the
Holy Qur’an
·
Riba in
Ahadith
Definition
of Riba
·
The
Meaning of Riba
al-NASI’AH.
Drawbacks of
Riba
·
Moral
Drawbacks of Riba
·
Bai’Murabaha as a
mode of financing
·
Bai’ Salam as a Mode of Financing
·
Bai’ Istisna as a Mode of Financing.
Partnership
·
Musharakah As a
Mode of Financing
·
Profit
Distribution
·
Types
of Musharakhah
·
Permannent
·
Decreasing
·
Profit
sharing
·
Mudarabah
As a Mode of financing
·
Distribution
of profit
·
Muzara’a
as a Mode of financing
Conclusion
EXECUTIVE
SUMMARY
Islam
is a complete code of life, not merely limited to belief or moral injunctions
for personal conduct. Although it is true that Islam has recognized the right of
ownership over one’s property, it is one of the fundamental beliefs of a Muslim
that everything
(including his walth ) ultimately
belongs to the creator. Thus, it is every Muslim’s duty to use, whatever the
creator has given him, according to the guidelines given by
Him.
The
most important guideline related to economics is the prohibition of Riba. Of all the things that are prohibited in Islam, fear
Allah and give up what still remains of Riba if you
are believers. But if you do not, then listen to the declaration of war from
Allah and His Messenger. And if you repent, yours is your principal. neither you wrong, nor be wronged” (Quran, 2:278-279).
Since
1979,
Riba, in
the Arabic language, refers to an increase, addition, expansion, or growth.
Riba was a well known transaction and was rampant all
over
Similarly,
people who argue that it is compound interest (or exorbitant rates of interest)
and not simple interest which is unlawful. are also incorrect in their assertion. They have
misunderstood the meaning of the following verse, and have taken it to be the
prohibition compound interest only:
“
O those
who believe, do not eat Riba multiplied many times.
And fear Allah so that you may be successful “(Qur,an, 3:130)
It is
an accepted rule of interpreting the Holy Qur’an a
verse revealed later takes precedence over a verse revealed earlier. The fact
that the verse of Surah Al - Baqarah and Surah An-Nisa which prohibit all from of interest were revealed later
that the verse presented above, is sufficient to prove the impressibility of
simple interest. Thus any excess which is predetermined over the principal sum
in a loan transaction constitutes Riba in all
circumstances. It does not make a difference whether the loan is for consumption
purpose or for a commercial purpose, and whether threat if interest is high or
low, simple or compound, short or long term, between Muslim and a non-Muslim or
between a citizen and a state or between two states. Islam has prohibited all
from of Riba, and as an alternative provides cetrgtain guidelines related to business and financial
transaction. These guidelines have been used but contemporary scholars to devise
Islamic modes of announcing based on ‘trading’, ‘Leasing’, ‘partnership’ and
‘profit sharing’.
Trading refers to the operation of buying with the intention of selling
at a higher price, there by making profit from the difference between the sale
price and the purchase price. Mode of financing based on ‘trading’ include
‘Bai’ Mu’ajjal’, ‘Bai, Murabaha’, ‘Bai’ Mu’ajjal is a sale on credit.
It is based on the delivery of the good by the seller to the buyer, there by the
enabling him to possess and benefit from the good with the understanding that
the buyer will pay the agreed upon price at a certain future date. The deferred
price is usually higher that the cash price, thereby enabling Bai’ Mu’ajjal to be used as a mode
of financing. Bai’ Murabaha
is a sale in which the seller discloses the actual cost he has incurred in
acquiring a particular good, and then adds some profit thereon. The profit is
determined by mutual cosset, either in lump sum or through an agreed ratio of
profit to be charged over the cost. The payment may be made at spot or on a
subsequent date agreed upon by the parties. Bai’ Salam and Bai’ Istisna are to only types of sale in which the subject
matter of sale does not exist at the time of the sale contract. As a result,
both types of sale are governed by specific rules. In Bai’ Salam, the seller undertakes
to supply some specific goods to the buyer at a future date in exchange of an
advanced price fully paid at spot. In Bai’ Istisna, the buyer places an order with a manufacturer to
manufacture a specific good for the buyer. The payment can be made at spot or in
installments.
Profit
Sharing refers to an exchange between capital on one hand and labor on the
other. It is a contract between two parties in which one party provides capital
to the other party that undertakes the management in exchange of a share in the
profit. Profit sharing includes contracts such as ‘Mudarabah’ and Mazurka’ which can be used as a mode of
financing. Mudarabah, which can be regarded as
a special kind of principal agent relationship, refers to a mode where one party
gives money to another for invent it in a business enterprise and both parties
share in the profits according to an agreed ratio, /the investment is made by
the principal, who is called ’Rabb-ul-Mal’, whereas
the management and work is the exclusive responsibility of the order party of
agent, who is called “Mudarib’ Mudarabah achieves the objective of both the parties: Rab-ul-mal may not have the time or the expertise and
experience to turn over capital and trade with it, whereas the Mudarib may not have the adequate capital to put to use his
experience and expertise. Unlike Musharakah, the loss
of capital, of any, is suffered by the Rabb-ul-mal
only (as the Mudarib has not invested anything), while
the Mudarib may not have the adequate capital to put
to use his experience and expertise. Unlike Musharakah, the loss of capital, if any, is suffered by the
Rabb-ul-mal only (as the Mudarib has not invested anything), while the Mudarib gets nothing for his effort. Muzara’a or ‘ crop sharing’ is to
give the land to whoever can cultivate it or work in it in exchange of a share
in the crop. Similar to Mudarabah, this transaction
achieves the interest of both the landowner and the agent. The landowner may not
be in a position of cultivating or working man the land while the agent may not
have the land to use his skill and resources.
Prohibition
of Riba in Islam.
The
discussion that follows shows that Riba is strongly
prohibited in Islam. this section discusses, the nature
and prohibition of Riba in the light of Holy Qur’an and Sunnah, some
misconceptions regarding Riba, and the various
drawbacks of dealing in Riba.
Riba in the
Holy Qur’an
Dealing
with the unlawfulness and prohibition of Riba, there
are in the Holy Qur’an verses of Surah Al-Baqarah two verses of
Surah An-Nisa, one verse
of Surah Al-Imran and one
verse of Surah Al-Rum, which are cited
below.
1) “Those who take
Riba (usury or interest ) ill not stand but as stands
the one whom the demon has driven crazy by his touch. That is because they’ve
said: ’trading is
but like Riba.’ And Allah has permitted
trading, and prohibited Riba. So, whoever receives an
advice from his Lord and stops, he is allowed what has passed, and his matters
up to Allah. And the ones who revert back, those are the people of Fire. There
they remain forever Allah destroys
Riba
and nourishes charities. And Allah does not like any sinful disbelieve. Surely
those who believe and do good deeds, establish Salat and Zakat have their reward
with their lord, and there is no fear for them, nor shall they grieve. O those
who believe, fear Allah and give up what still remains
of Riba if you are believers. But if you do not, then
listen to the declaration of war from Allah and His Messenger. And if you
repent, yours is your principal. Neither, you wrong, nor be wronged. And if there be one in misery,
then deferment till ease. And that you leave it as alms is far better
for you,
if you really know. And be fearful of a day when you shall be returned to Allah,
then everybody shall be paid, in full, what he has earned
, And they shall not be wronged. ”(Qur’an, 2:275-281)
2) “O those
who believe, do not eat Riba(usury or interest )
multiplied many times. And fear Allah, so that you may be
successful.”(Qur’an,3:130)
Riba in
Ahadith
The verses above clearly point out that Riba has been strongly prohibited in Islam. ample support can also be found in the Ahadith (sayings) of he holy prophet peace be upon him). A
representative sample of these Ahadith is presented
below to real firm the prohibition of Riba.
A.1. ” Abstain from the seven
disasters”. The people asked him “ What are they, O messenger of
Allah?” He replied: to ascribe partners to Allah, to practice sorcery, to
unjustly kill one whom Allah has declared inviolable ,
to take Riba(interest or usury), to exploit the
property of an orphan, to escape at the time of war and to slander the chaste
women who are believers, unwary.” (Shafi 1995a,p.11)
A.2.
“A dirham a man receives as
Riba (interest or usury ) is,
in the sight of Allah, more serious than thirty three acts of fornication or
adultery in Islam.”(Ibid., p13)
A.3.
“
The Holy prophet (peace be on upon him ) has forbidden the fruits to be
sold or purchased before they are eatable, and Sid, “When Zina (adultery and Riba usury or
interest ) become rampant in the people of a town they themselves invite the
punishment of Allah.”(Ibid.,p13)
A.4. ” The society in which Riba becomes rampant is punished with famine, and the
society where bribe is rampant is punished with horror(of others).” (Ibid.,p13)
A.5.
”Abstain from sins, which are
not forgiven: embezzling of the spoils, for whoever embezzles anything will come
with it on the Day of Judgment, and the other sin is Riba.:(Ibid., p14)
Definition
of Riba
The
meaning of Riba is, and for the last fourteen hundred
years has been, quite clear to religious scholars and the oriental lists. Al the
major ‘Tafasir’ of the Qur’an (i.e., detailed explanations of the Holy Qur’an) provide a uniform definition of Riba, as does the Encyclopedia of Islam and other oriental
lists’ works.
In the
Arabic language Riba, Literally, refers to increase,
addition, expansion, or growth (Zaman 1993), Riba we well known transaction and was rampant all over
1.
From
Ubada Ibn-al-Samit(may Allah be pleased
with him): the prophet (peace be upon him)said :” gold for gold, silver for
silver,wheat for wheat, barley for barley, dates for
dates, and salt for salt like for
like, equal for equal, and hand-to-hand ;If the commodities differ, then you may
sell as you wish, provided that the exchange is hand-to -hand.”(Ibid.,
pp.238-239)
2.
From
Abu Sa’id al -Khudri(may
Allah be pleased with him): The Prophet(peace be upon him) Said: ” Gold for
gold, silver for silver, wheat for wheat, barley for barley, dates for dates,
and salt for salt alike for like,
and -to hand. Whoever pays more or takes more has indulged in Riba. The taker and giver are alike (in guilt).”
(ibid,,p.239)
3.
From
Abu Sa’id and Abu Hurayrah
(May Allah be pleased with him): A man employed by the prophet (peace be upon
him) in Khyber brought for him janibs (dates of very
fine quality). upon the prophet’s asking him whether all the dates of Khyber
were such, the man replied that this was not the case and added that” they
exchanged a sa(a measure) of this kind for two or three(of the other
kind).” The Prophet(peace be upon him0 replied, “Do not
do so. sell(the lower quality dates) for dirhams and then use the dirhams
to but janibs..(When dates are exchanged against
dates) they should be equal in weight.”(lbid.,p.239).
4.
From
Abu’ Sa’id (May Allah be pleased with him): Bilal (May Allah be pleased with him) brought to the Holy
Prophet (Peace be Upon Him) some barni (good quality)
dates where upon, the prophet (peace be upon him) asked him where these were
from. Bilal (May Allah be pleased with him) replied,
“I had some inferior dates which I exchanged for these- two sa’s for a sa”. Thee prophet (peace be upon him) said, “Oh no, this is
exactly Riba. Do not do so, but when you wish to buy , sell the inferior dates against something (cash) and
then buy the better dates with the price you receive.”
(lbid.,p.239)
5.
From
Fadalah ibn Ubayd al-Ansari (may Allah be
pleased with him): On the day of Khyber he bought a necklace of gold and pearls
for twelve dinars. On separating the two, he found that the gold itself was
equal to more than twelve dinars. So he mentioned this
to the Prophet (peace be upon him) who replied, “ It
(jewelry) must not be sold until the contents have been valued separately.”
(lbid., p.239)
6.
From
Abu Umamah (May Allah be pleased with him): the
Prophet (peace be upon him) Said:”whoever makes a
recommendation for his brother and accepts a gift offered by him has entered
Riba through one of its large gates.”(Ibid.,
pp.239-240)
7.
From
Anas ibn Malik (May Allah be pleased with him): the (peace be upon him)said: Deceiving a
mustarsal(an unknowing entrant in to the market) is
Riba.”(Ibid.,p.240)
8.
. From
Abdullah ibn Abi
Awfa (May Allah be pleased
with him): The prophet (peace b e upon him) said:” A najish (one who serves as an agent bid up the price in an
auction) is Riba.”
(lbid.,p.240)
Muslim
scholars also have come up with two interpretations of Riba, based on the above and similar Ahadith.
Imam
al-Razi, a great Muslim scholar has said in his Tafsir that Riba takes two forms.
It could be Riba in trading transactions, and in
loans. The first kind is what comes through the Hadith
which rules that increase or decrease in the barter of same commodities is also
included under Riba, The second from was what commonly
prevailed in ‘Jahiliyyah’ (i.e. pre-Islamic) or pagan
Arabia. The known practice was that they would give their money on loan to
someone for a fixed period of time and receive ‘profit’against it every month. If the borrower failed to pay
back at the appointed time, the time , the time limit
was extended on condition that the amount of Riba was
to be further increased.
It appears in Ahkam al Qur’an of al Jassas that Riba is of two kinds, the Riba in
buying and selling and Riba without buying and
selling. The Riba of ‘Jahiliyyah’ (pre Islamic Arabia) belonged to the second
kind; by definition. it means the loan on which
‘profit’ is taken on the basis of time duration. Ibn
Rush, a great Muslim scholar, in Bidayah al-Mujtahid, has taken the same view, and has proved the
unlawfulness of Riba of taking ‘profit’ on loans, on
the authority of the Qur’an the Hadith and the consensus of the Muslim community (lbid.).
In sharha Ma’ani al
Athar, Imam al Tahawi, a
famous Hanafi Muslim scholar, has taken up this
subject in great detail. He has said that the Riba
mentioned in the Qur’an is openly and clearly, the
Riba that was given and taken on loans, and it was
known as Riba ‘al Jahiliyyah’/ After that it was through the statement of the
Holy Prophet increasing, decreasing or non cash dealing in particular types of
buying and selling activity. However, in the absence of fully clear detail
governing this kind of Riba, some companions for the
Holy Prophet faced difficulty and jurists differed
.
Shah Waliullah, a great Muslim Scholar, has
said in Hujjatullah-al-Balighah that these (forms of
Riba) are two separate things. One is the Riba in real terms, and the other is that which is included
in the prohibition of Riba. The Riba in real terms means something additional claimed over
the principal in a transaction of loan. But the Ahadith prohibiting Riba include
the prohibition of a transaction of bartering certain commodities whereby an
additional measure is claimed in exchange of the same commodity (lbid,).
From the Above discussion it can be concluded that Muslim jurists have
given two interpretations of Riba: ‘Riba al-Nasi’ah’, and Riba al-fadl’.
The
Meaning of Riba al-NASI’AH.
Riba
al-Nasi’ah has been defined as: “Any lending
arrangement that obligates the borrower to pay a certain extra amount over and
above the payment of the principal amount against the specified deferment.”
(Usmani 1992, p.21).The prevalent form of Riba was Riba al-Nasi’ah. The companions of the Holy Prophet (peace be upon him) understood the meaning of these verses in term
of Riba al-Nasi’ah; thus,
Riba al-Nasi’ah was
categorically regarded as unlawful.
Professor
khurshid Ahmad defined Riba as: “Riba is the Qur’anic term for usury or interest, and the definition of
Riba as given in the Qur’an
is very clear and unambiguous. It categorically forbids Riba as any claim excess of principal sum lent.” (Ahamd 1994,p.33) Similarly, Ibn Jarir, a renowned commentator
of the holy Qur’an, has reported from Sayyidna Mujahid that the Riba practiced in
In the
light of above explanations, it is clear that the word “interest’, as commonly
understood in context of banking and financial transaction, pertains to the
Riba al-Nasi’ah. There fore,
any extra payment specified in a loan contract over and above the principal
amount, falls under the definition of Riba al -Nasi’ah, irrespective of the rate or amount of the extra
payment.
Islam
wishes to eliminate not merely the exploitation that is intrinsic in the
institution of interest, but also that is inherent in all forms of dishonest and
unjust exchanges in business transactions. Such transactions are encompassed by
the generic term of Riba al-fadl, which is the second sense in which Riba has been used in Shari’ah
Riba al-Fadl occurs in those
commodity exchange contracts where a contract provides payment of any extra
quantity of the commodity(Usmani 1992).
Arguing
from gold and silver, all the Muslim jurists agree that this injunction applies
to all commodity money. arguing from the other four commodities, one view (Hanafi, Hambali, imami and Zaydi) holds that Riba al-Fadl is involved in all
goods which can be sold by weight and measure (but not length or count), while a
second view (Shafi’i and Hanbali) holds that it covers all edible goods.
To sum
up, the giving of loan and then taking interest on it is Riba, which was widely known and practiced during the
pre-Islamic
Drawbacks of Riba
There
is nothing in the entire creation for the world, which has no goodness or
utility at all. even in serpents, scorpions, wolves,
lions and in arsenic(fatal poison),
there are thousands of utilities for human beings. Is it then fair to conclude
that there is nothing in this vastness of nature ,which
could really be termed bad or harmful? Obviously,
not. The reason for this , as commonly recognized in every school of though, is
that things which have more benefits and less harms are called beneficial and
useful while things that cause more harm than benefit are taken to be harmful
and useless. for instance, in robbery, the gain of the
gangster and the benefit to the thief is all too obvious, but it is certainly
harmful for the entire community as it ruins peace and a sense of security from
the society. For this reason, theft is not considered a positive
act.
Even
the Holy Qur’an, while declaring liquor and gambling
to be unlawful, proclaims that they do hold some benefits for people , but the
harms they generate is far greater than the benefits they yield. there fore, these cannot be called good or useful, and it is
necessary that they be avoided.
The
case of Riba is not different. although the consumer of Riba does
have some temporal benefit apparently coming to him, its cost in this world and
in the Hereafter is much more than
the benefit. Riba has many negative economic and
social implications; some of them are discussed below.
Riba
results in the gain of some individuals and the loss of the whole humanity,
through concentration of wealth in the hands of few. The reason for this is that
the interest based system gives preference in extending
credit to those people who are rich and have a sound credit history or a large business. these people can create a large superstructure of finance
raised on a narrow equity base in the style of an inverted pyramid. One the
contrary, a person with a small capital and net worth cannot get access to
credit because he has little or no credit rating, and the banks do not trust him
enough to advance a loan ten times more than his worth.
Moreover,
due to the presence of interest, many business and projects are not undertaken
by businessmen, The end result is that many businesses
or projects, which would have been beneficial to the community as a whole, are
not undertaken. This in turn hampers the economic prosperity of the whole
nation, as stated by umer Chapra:
The
rate of interest tends to be a ‘perverted’ price and reflects price
discrimination in favor of the rich- the more ‘credit-worthy a borrower is
supposed to be, the lower is the rate of interest he pays and vice versa. the result is that ‘big’ business is able to get more funds
at a lower price because of its higher credit rating. Thus those
who are most able to bear the burden because of their bigness or claimed
‘higher’ productivity bear the least burden. In contrast, medium and small
businesses, which may sometimes be more productive in terms of contribution to the national product per unit of
financing used and at least equally ‘credit in terms of honesty and integrity,
may be able to secure relatively much smaller amounts at substantially higher
rates of interest. hence
many potentially high yielding investments are never made because
of lack of access to funds, which flow instead into, less productive but secure
hands. (Ibid,. p.109)
There
is yet another economic drawback. the concentration of
wealth results in the monopolization of markets by the large capitalists who
have the financial muscle to
squeeze out the small players. For example, a person with a large capital can
buy raw material from the market at a price so low and discounted which the
small
capitalist cannot get.
Injustice
to the lender is another economic/social peril caused by Riba. For example, consider a person with a capital of ten
thousand who goes in business worth a hundred thousand, the additional
capital advanced by a bank as interest bearing loan. If by chance,
he is hit by a loss, his capital sinks and he owes insolvent. The outcome is
quite interesting. He bears only ten percent of the loss, while the rest of the
loss, that is ninety- percent, is absorbed by the whole community, whose money
he had borrowed from the bank to invest in his business. Even if the bank writes
off the loss as an interim measure, it is clear that the
bank is the pocket of a nation, and
the loss ultimately hits the nation. On the contrary, if the borrower or
capitalist makes a huge profit in his business, the community gets only a small
fixed amount from it, no matter how large the profit is. The outcome is that
the borrower gets the major portion
of the profit, leaving very little for the community. It also needs to be
considered here that no matter what amount of interest is paid by the borrower,
in the end, the interest expense is passed on the final consumer(the community) because interest is considered as the
financial cost of doing a particular business.
In
1954, The cotton business of Pakistan suffered, to use a word of the Qur’an, with the calamity of ‘Muhaq’ The Government rescued the businessmen at a cost of millions of rupees but nobody
bothered to realize that all this was a curse of
Riba or interest, for the simple reason that cotton dealers
had taken mostly interest bearing loans to run the business. Their own capital was insignificant, As
Divine decree would have it, the cotton market fell so sharply that the price
zoomed down from RS. 125 to just RS. 10. The cotton traders were rendered
incapable of retiring money to cover bank margins. Left with no choice the
market was closed down and SOS was sent to the Government. The Government stepped in an
bought off the stocks, not at Rts.10 but at the raised price of RS 90. Thus, it
absorbed a loss of millions of rupees and saved these traders
from going insolvent . Whose money did the Government have? Naturally, it
belonged to the same helpless poor masses of the nation. In short, the naked
result of interest is that some individuals reap benefits out of the capital of
the entire community and the loss, when it comes, is made to fall on the nation.
Another
economic drawback of Riba lies in the predicament of
the borrower when he is hit by a major loss Once this
happens, he is unable to survive anymore. To begin with, he never had enough
capital the losses of which he could cushion, the loss
throws him into a double distress. not only does he
lose his profit and capital but also, at the same time, gets buried under the
bank loan for liquidation. As compared to this, should his loss be his entire
capital in an interest free business, he would, at the most become penniless but
not burdened with huge debt.
Moral
Drawbacks of Riba
Up to
this point, economic
and social implications regarding Riba
have been discussed. However, the drawbacks of Riba
also include the adverse affects on the morality of people.
Sacrifice
and generosity
are qualities in human morals. interest
loaded business invariably leads to the extinction of this emotional refinement.
As a
natural consequence, a compulsive consumer of interest would hardly bear to see
somebody else rising up to h is level with the help of personal effort and his
capital . the thought of passing some benefit to
somebody from his resources is a far cry . Rather than be merciful to the
distressed, the lender would be on the look out for an opportunity to take undue advantage of
the borrower’s distress, so that more can be lent to him to get even more
interest. Quite often short-term lending is undertaken when the need for
accommodation is essentially long term on the assumption that the credit will be
rolled over(Ibid).
The constant devouring of interest results in an increased greed for money.
this greed and unequal distribution of wealth results
in selfishness and jealousy among people ,
there by leading to the moral
degradation of the whole society.
SECTION-II
Islam
has not presented a model of financing, in its literal sense. Instead, it had
given certain guidelines related to business and financial transactions.
Contemporary scholars to devise Islamic modes of financing are using these
guidelines. Islamic modes financing, as devise by scholars,
are based on trading, leasing,’ following definitions because Islam treats all
transaction from the view point of ‘what is being exchanged’ or ‘what is being
traded’.
I. TRADING:
trading refers to complete exchange that affects the complete
possession’
II.
LEASING: Leasing refers
to ‘exchange which affects the possession of benefits for a specific
term’
III. PARTNERSHIP:
Partnership refers to ‘exchange by way of mixing assets throughout the
partnership’
IV. PROFIT SHARING: Profit
Sharing refers to ‘Exchange between capital on one hand and labor on the
other’
Trading
means the operation of buying with the intention of selling through the turnover
of capital to make profit from the difference between the sale price
and purchase cost (Ibid,) The most important features of trading
are:
1.
Supplying
the goods and services demanded by different individuals.
2.
Transferring
the possession of goods from the seller to the buyer at contracting.
3.
The
profit mingling with the price and becoming an inseparable part of the value of
the good.
Modes
of financing based on trading are ‘Bai’Muajjal’, Murabaha,’ Bai Salam and Bai’ Istisna’ Originally, all four modes
of financing based on ‘trading’ are different kinds of sale permissible in
Islam. In order to understand an employ these as modes of financing, some basic
rules of ‘sale’(or Bai’) need to be understood from an Islamic(or Shari’ah ) viewpoint.
Defination of
‘
If the
offer an acceptance relate to any future date, i.e. nothing is exchanged at
present, then , Islam considers such a contract to be
an agreement or promise to sale,’ not the ‘sale’ itself(Ibid.). Islam makes it
compulsory on everyone to honor one’s promise.; if one party does
not fulfill it promise, the other party can claim the actual monetary loss ,
which it incurred due to the promise not being fulfilled by going to the court.
For instance, if the seller incurred any transportation expenses to bring the good
to a certain place to make the
delivery, then, the seller has the right to claim those transportation expenses
from the buyer. However, the seller cannot demand any compensation for any’opportunity cost’ because Islam recognizes opportunity
cost as a risk inherent in ‘trading for cannot demand the buyer to compensate
him for the difference in price. the court, in case of not fulfilling one, promise, can turn to
imprisonment or corporal punishment, which in turn would deter people from
acting against their promises. \however, the promisor
cannot be held liable if he is unable to fulfill his promise due to any
uncontrollable event.
According
to Shari’ah, the seller has no right to ask for a
security from the buyer in a ‘promise to sale’ contract. \if the buyer
voluntarily advances any amount of money as a security in a ‘promise of sale
‘ contract, it should be adjusted for by the seller
when taking the final payment from the
buyer . The seller has no right to keep the advance and benefit from it
if the sale does not occur. According to justice Mufti Muhammad Taqi Usmani,.
The
promise to sell/ purchase is merely a promise. It does not effect the contract of sale itself, therefore, no rights or
obligations of an actual sale can arise out of a promise only. Hence no party
can ask for security or a collateral for the
fulfillment of a promise, because the security or a collateral is justified only
where a liability or a debt has actually come into existence, while in the case
of promise no debt or liability is created. It is only an undertaking to
sell/purchase a commodity in future. When the actual sale occurs on a deferred
payment basis, the debt will be created and at that time it will be justified to
ask for a security’.
Bai’ Mu’ajjal, which is allowed by Shari’ah according to the majority of Muslim jurists, is a
sale on credit. The sale on credit is based on the delivery of the good by the
seller to the buyer, thereby enabling him to possess and benefit from the good,
with the understanding that the buyer will pay the agreed upon price at a
certain future date; usually, the deferred price is higher than the cash price.
Such a sale can either be deferred payment sale’ or Installment Sale’ Deferred
payment sale refers to paying the price entirely at the end of a specified
period whereas installment sale refers to paying the price in determined
installments at specific periods of time agreed upon by the parties, There is a
consensus among majority of scholars on the permissibility of sale on credit if
the due date is known (Khoja
1195).
Bai’ Murabaha refers to a particular kind of sale, having nothing
to do with financing in its original sense. The basic ingredient of Murabaha is that the seller discloses the actual cost he has
incurred in acquiring that particular good, and then adds some profit thereon.
The profit can be determined by mutual consent, either in lump sum or through an
agreed ratio of profit to be charged over the cost. All the expenses incurred by
the seller in acquiring the good like freight, custom duty, etc. can be included
in the cost price and the mark up can be applied on the aggregate cos. Murabaha is valid only where the exact cost of a good can be
ascertained. If the exact cost cannot be ascertained, the good cannot be sold on
‘Murabaha basis’. The payment
in the case of Murabaha may be at the spot or may be
on a subsequent date agreed upon by the parties. Therefore, Murabaha does not necessarily imply the concept of deferred
payment, as generally believed. However, the contemporary Shari’ah experts have allowed, under certain conditions, to
use ‘Murabaha on deferred payment basis’ as a mode of
financing . In fact it is the observance of those
conditions which draw a clear line of distinction between the interest-bearing
loan and a transaction of Murabaha.
Bai;’
Salam is a sale of a good whose delivery will be in a
future date for a cash price, which means, it is a financial transaction in
which price is advanced in cash to the seller who abides the delivery of good of
determined specification on a definite due date. In other words, the seller
undertakes to supply some specific goods to the buyer at a future date in
exchange of an advanced price fully paid at the spot. There is a consensus among
jurists on the permissibility of Salam because the
good in the contract is a recompense for the price paid in advance .Thus ,
delivery of the good is deferred in Bai’ Salam as opposed to the price of the good (which is deferred
in Bai’ Mu’ajjal, i.e. sale
on credit.).
Bai’ Salam is
beneficial for the seller because he gets the money in advance to cover his
financial needs, whether they are personal expenses, family expenses or expenses
for any productive activity. On the other hand, the buyer or financier gets the
good he is planning to trade on in the time he decides, at a certain price; this
in turn protects the financier from any fluctuations in price of the good he
plans to trade in future.
The
general rule is that the sale of a thing not owned by the seller is void
according to Shari’ah. However, the Holy Prophet
(peace be upon him) has allowed Bai’ Salam subject to certain conditions, which would be
explained later. The basic purpose of Bai’Salam was to
meet the needs of the small farmers who needed money to grow their crops and to
feed their family up to the time of harvest. After the prohibition of Riba, they could not take usurious loans. Similarly, The
traders of
Bai’ Istisna as a Mode of Financing.
Istisna is the
second kind of sale where a commodity is transacted before it comes into
existence. It means to order a manufacturer to manufacture a specific commodity
for the buyer. If the manufacturer undertakes to manufacture the goods for the
buyer, the transaction of Istisna comes into
existence. The contract of Istisna creates a moral
obligation on the manufacturer to manufacture the good, but before he starts the
work, any one of the parties may cancel the contract after giving a notice to
the other. However, after the manufacturer has started the work, the contract
cannot be canceled unilaterally.
PARTNERSHIP
Partnership
refers to two or more parties drawing a contract to work together with the
condition of dividing the accruing profit between them. The most important
traits of a partnership are:
1.
Participation in capital whether it is an asset or
labor.
2
Partnership in work management and disposal where the rights of
ownership and disposal remains with each partner.
3.
Participation in the results of the business, whether profit or
loss.
Partnership
refers to ‘Shirkah’ in the terminology of Islamic
jurisprudence. Shirkah means ‘sharing’ and has been
divided into two kinds in Islamic jurisprudence:
Musharakah as a Mode of Financing.
Musharkah’ is
analogous to shirkat ul
Amwal where two or more persons invest some of their
capital in a joint commercial venture. Since Musharakah is a relationship established by the parties
through a mutual contract, therefore, all necessary ingredients of a valid
contract must be present. Fore example, the parties should be capable of
entering into a contract, the contract must take place
with free consent of the parties without any duress, fraud or misrepresentation,
etc.
Distribution
of Profit
1. The
proportion of profit to be distributed between the parties must be agreed upon
at the time of effecting the
contract.
2. The ratio
of profit for each partner must be determined in proportion to the actual profit
accrued to the business, and not in the proportion of the capital invested by
him. For instance, if X and Y enter into a partnership and it
is agreed between them that X shall be given RS. 10,000 per month as his share
in the profit, and the rest will go to Y, the Musharakah is invalid according to shari’ah. Similarly, if it is agreed that X will get 10% of
his investment in the business, Musharakah contract
invalid.
Is it
necessary that the ratio of profit of each partner conforms to the ratio of
capital invested by him? there is a difference of opinion among
the Muslim jurists about this
question. In the view of Imam Malice and Imam Sheriff’s it is essential for the
validity of Musharakah that each partner gets the
profit exactly in the proportion of his investment, For example, if x has
invested 50% of the total capital,
he must get 50% of the profit. On the contrary, the view of Imam Ahamd is that the ratio of profit may differ from the ratio
of investment if it is agreed between the partners with their free consent. The
third view is presented by Imam Abu Hanifah, which can
be taken as via media between the two opinions mentioned above. He says that the
ratio of profit can differ from the ratio of investment in normal condition,
However, if a partner has put an express condition in the agreement that
he will never work for the Musharakah and will remain
a sleeping partner throughout the
term of Musharakah, then his share of the
profit cannot be more than the ratio of his investment.
All the
Muslim jurists are unanimous on the point that each partner suffers the loss
exactly according to the ratio of his investment.
The
share capital in a Musharakah can be contributed
either in cash or in the form of commodities. In the latter case, the market
value of the commodities shall determine the share of the partner in the
capital.
1.
Every
partner has a right to take part in the management of Musharakah and to work for it. However, the partners can
agree upon a condition that the management shall be carried out by one of them,
and no other
partners shall work
for the Musharakah.
2.
If all
partners agree to work, each one of them is be treated as the agent of the other
in all the matters of the business and any work done by one of them in the normal course of
business is deemed to be authorized by all the
partners.
1.
Every
partner has a right to terminate the Musharakah at any
time after giving his partner a notice to this effect, whereby the Musharakah will come to an end. If the assets are in cash
form, all of them will be distributed prorata
between the partners. But if the assets are not liquid, the partners May agree
on the liquidation of the assets, or on their distribution or partition between
the partners as they are. If there is a dispute between the partners in this
matter, the partition or distribution of the non liquid assets as opposed to
liquidation is preferred, because after the termination of Musharakah, all the assets are in the are in their joint
owner ship of the partners, and a co owner has the right to seek partition or
separated or partitioned, such as machinery, then they should be sold and the
sale proceeds should be distributed.
2.
If any
of the partners dies, the contract of Musharakah with
him stands terminated. His heirs in this case, will have the option either to
draw the share of the deceased from the business, or to continue with the
contract of Musharakah with the other
partner(s).
3.
If any
one of the partners becomes insane or becomes incapable of effecting commercial
transactions, the Musharakah stands terminated.
4.
If one
of the partners wants termination of the Musharakah,
while the other partner or partners like to continue with the business, the is purpose can be achieved by mutual agreement. The
partners who want to run the business can purchase the share o0f the partner who
wants to terminate his partnership: termination of Musharakah with one partner does not imply Its termination between the other
partners.
5.
The
price of the share of the leaving partner must be determined by mutual consent.
If there is a dispute regarding the value of the share and the partners do not
arrive at an agreed price, the leaving partner may compel other partners on the liquidation
or on the distribution of the assets themselves.’
6.
It is
permissible that the partners can agree, while entering into
the contract of Musharakah, on a condition that the
liquidation or separation of the business shall not be effected unless all the
partners, or the majority of them wants to do so, and that a single partner who
wants to come out of the partner ship shall have to sell his share to the other
partners and shall not force them on liquidation or separation. this condition is justified because other wise it May cause
irreparable damage to the other partners. if a particular business has been
started with huge amount of money which has been invested in a long term project, an done
of the partners seeks liquidation in the infancy of the project, it may be fatal
to the interests of the partners as well as to the economic growth of the
society, to give him such an arbitrary power of liquidation or separation. such
a condition can be supported by the general principle laid down by the holy Prophet (peace be
upon him) in his famous Hadith, “All the conditions
agreed upon by the Muslims are upheld, except a
condition which allows what is prohibited or prohibits what is
lawful”(Ibid)
Other Rules
Regarding Musharakah
1.
A Musharakah can be created for general purposes as well as
for limited and well
defined purposes. The managers and executive partners enjoy full
freedom to undertake any
kind of transactions or businesses if the Musharakah is for general purpose. In limited Musharakah, the executive partners are bound to operate
within the limits predetermined by the agreement.
2.
A
partner can stipulate a higher rate of profit for himself in
consideration of some additional services or contributions rendered by him for
the business.
3.
A
business executive is liable for all the damages done to the business due to his
negligence, lack of proper car and prudence.’Ghabn
Fahish,’ which refers to purchasing some thing for
business at exorbitant rates, is considered gross negligence for which a person
responsible is personally able.
4.
An
executive partner of a Musharakah cannot run a parallel
personal business of the same nature and kind run and managed by
him for the Musharakah.
5.
A
partner is not authorized to include, without the permission of other partners,
his own business in that of the Musharakah. He is also
not authorized to enter into agreement with other Musharakahs without the permission of his partners. Any
executive partner is not authorized to give loan without specific approval by
other partners.
6.
It is
permissible to take a mortgage or a guarantee against trespass or negligence
from the executive partner but it is not permissible to take any security for
profit or capital.
TYPES
OF MUSHARAKAH
Musharakah can be
‘permanent’ or ‘decreasing’ permanent Musharakah and
Decreasing Musharakah are explained below:
1.
Permanent
Musharakah is represented
in the contribution of the partners to equal or unequal ratios of capital to
establish a new project or to participate in an established one(op. cit,) In
this Musharakah, each participant owns a share in the
capital permanently and deserves his share of the profit. The partnership
originally is intended to continue up to the dissolution of the company.
However, it is permissible that one of the parties sells its share to withdraw
from the project.
2.
Decreasing
Musarakah differs from
permanent Musharakah only in terms of continuity
(Ibid,). A single partner(or partners), which can be an
Islamic financial institutions,
from the very beginning does not intend to stay in and continue the
partnership up to the liquidation of the company(Ibid,). It gives the other
partners the right to take his place in the ownership of the project, and agrees
to assign his share in the partnership to the other partner(or partners ) for full payment at one and the same time or gradual
disbursement, in accordance with conditions agreed upon. It is a condition in
the Decreasing Musharakah that it should not be a mere
loan financing operation, but there must be real determination to participate
and all the parties should share profit or loss and the management during the
period of the partnership. However, a partner can authorize the other partner(or partners) to manage the Musharakah. It is impermissible to include in the contract
of Decreasing Musharakah a condition
that adjudges the other partner(or partners) to return to the ‘limited period’
partner, the total of his shares in capital in addition to profits accruing from
that share, because it would resemble a Riba- based
transaction. However, it is permissible for the ‘limited period’ partner to make
a promise to sell its shares in the company to the other partner(or partners). It is to be noted that the sale of
shares must be concluded as a separate deal with no connection to the contract
of Musharakah.
Profit
Sharing
Profit
sharing refers to a contract between two parties in which one party
provides capital to the other party who undertakes the management in exchange of a share in the profit(Ibid.) The most
important characteristics of Profit sharing are:
·
One
party (or parties ) provides capital whether it is
money (Modarabah) or a place of land(muzara’a) or fruit trees(Musaqah).
·
A party
(or parties), different than the one which provided capital, undertakes the
management and disposal of capital, where the right of ownership and the right
of disposal are separate.
·
Only
the capital owner bears the monetary loss whereas the two parties share the
profit.
Profit
sharing includes different kinds of contracts, such as Mudarabah, Muzara’a, Musaqh, etc.
Mudarabah and
Muzara’a which can be used as a mode of financing are
explained below.
Mudarabah
as a Mode of Financing
Mudarabah, which
can be regarded as a special kind of principal agent relationship, refers to a
mode where one party gives money to another for investing it in a business
enterprise. The investment comes from the first party or principal, who is called rabb-ul-mal’, Mudarabah achieves
the interest of both the parties: rabb-ul-mal may not
have the time or the expertise and experience to turn over capital and trade
with it whereas the Musharakah and Mudarabah can be summarized below(op.cit.):
1.
Investment in Musharakah comes from all the partners,
while in Mudarabah, investment is the sole responsibility of rabb-ul-mail.
2. In
Musharakah, all the partners can participate in the
management of the business and can work for it; in Mudarabah, rabb-ul-mal has no
right to participate in the management, which is carried out by the mudarib only.
3.In Musharakah,
all the partners share the loss to the extent. of the
ratio or their investment while in Mudarabah. the loss, if any, is suffered by the rabb-ul-mal only. this is because
the mudarib does not invest anything mudarib’s loss is restricted to the fact that his labor has
gone in vain and his work has not
brought any fruit to him. However,
if the mudarib has worked with negligence or has
committed dishonesty, he shall be liable for the loss.
4. The
liability of partners in Musharakah is usually
unlimited. There fore, if the liabilities of the business exceeded its assets and
the business is liquidated, all the exceeding liabilities shall be borne prorata by all the partners. however, if all the partners
have agreed that no partner shall incur any debt during the course of business, then the exceeding liabilities
shall be borne by that partner alone who has incurred a debt on the business in
violation of the aforesaid condition. contrary to this
is the casein Mudarabah. Her the liability of rabb-ul-mal is limited to his investment unless he has
permitted the mudarib to incur debts on his
behalf.
5. In
Musharakah, as soon as the partners mix up their
capital in a joint pool, all the assets of the Musharakah become jointly owned by all of
them according to the proportion of their respective investment. Thus, each one
of them can benefit from the appreciation the value of the assets, even If profit has not accrued through sales, The case of Mudarabah is different. Here all the goods received by the
mudarib are solely owned by the rabb-ul-mal and the mudarib
deserves his share in the profit only in case he sells the goods
profitably. There fore, the mudarib is not entitled to claim his share in the assets if
their value has increased.
A
contract of Mudarabah usually presumes that the mudarib has not invested any thing from his side to the Mudarabah. But there may be situations where the mudarib wants to invest some of his money in the
business of Mudarabah. In such cases, Musharakah and Mudarabah can be
combined together. In such a case, the mudarib may
allocate a certain percentage of actual profit on account of his investment as a
Sharik(i.e. partner), and at the same time, he allocate another
percentage for his management and work as a mudarib,
both the parties can agree on my proportion. However, the only condition is that
the sleeping partner or rabb0ul- mal cannot get a percentage of profit more than
the proportion of his investment.
LEGAL
RULES: Following rules need to be observed in Mudarabah with respect to the business of Mudarabah, distribution of profit and termination of Mudarabah:
1.
The
Rabb-ul-mal specify a particular business for the
mudarib, in which he shall invest the money, or he may
leave it open for the mudarib to undertake whatever
business he wishes whereupon the mudarib shall be
authorized to invest the money in any business he deems
fit.
2.
A rabb-ul-mal can contract Mudarabah
with more than one person in a single transaction.
3.
It
means that he can
offer his money to X and Y
both, so that each one of them can act for him as mudarib shall be distributed between them according to the
agreed proportion. In this case, both the mudaribs
shall run the business as if they were partners inter se. It is permissible for
rabb-ul-mal to variate between them
with respect to the share in profit because of their difference in diligence and
dexterity.
4.
The
mudarib or mudaribs, are authorized to
do anything which is normally done in the course of business. however, if they want to do a non- routine task, which is
beyond the normal routine of the business. they cannot do so without an express permission from the
rabb-ul-mal.
5.
It is
permissible to impose restrictions on the muidarib if
the restriction is beneficial and does not constitute a constriction on the
mudarib to attain the profit required and is not
counterproductive to the purpose of the Mudarabah.
6.
It is
permissible to take a surety or mortgage from them udaribn to guarantee the payment incase of negligence or
trespass or violation of conditions stipulated in the contract. This surety acts
as a guarantee to capital or profit.
7.
The
Mudarib shall collect its share of the profit only
after obtaining the permission of the rabb-ul-mal. The
mudarib is entitled to collect its share of the profit
only after capital is recovered according to the principle. “Profit is
protection of capital”. However in the exceptional case of temporary
division of profit before the final settlement (while the Mudarabah is still continuing), the losses incurred later
shall be made good from the profit distributed
earlier.
Distribution
of profit
1.
It is
necessary for the validity of Mudarabah that the
parties agree right at the beginning on a definite proportion of the actual
profit which
shall be received by each of them. Shari has prescribed no
particular proportions;
rather it has been
left to their mutual consent.
2.
Rabb-ul-mal and
the mudarib cannot agree upon a lump sum amount of
profit for
any party, nor can they determine each other’s share at a specific rate tied up with
the capital. Apart from the agreed proportion of the profit , the mudarib cannot claim any periodical salary or a fee or
remuneration for the work done by him for the Mudarabah.
3.
If the
business has incurred loss in some transactions and has gained profit in some
others, the profit shall be used to off set the loss at the first instance, then
the remainder, if any , shall be distributed between the parties
according to the agreed ratio.
Muzara’a
as a Mode of Financing
Muzara’a or’crop sharing’ is to give the land to whoever can
cultivate it or work in it in exchange of a share in the crop(op.cit). this transaction achieves the interest of both parties, the
land owner and the agent. The landowner may not be in a position of cultivating
or working in the land while the agent may not have the land to use his skill and
resources(Ibid).
1. The
landowner supplies the seeds and the machinery and becomes the employer of the
worker who works on the land in exchange of some of the
produce.
2.The agent
supplies the seeds and the machinery, and becomes a tenant in exchange of some
of the produce.
LEGAL
RULES: Following rules need to be observed in Muzara’a:
1)It is a
condition in Muzara’a that the land must be available
and the owner must move out of the land so that the agent can work without any
hindrance.
2) It
is a condition that the crop to be cultivated is specified in the
contract.
3) It
is a condition to specify the kind of seeds to be sown.
4) The
Muzara’a period must be
known and sufficient for the cultivation of the land and harvesting of the crop.
The landowner recovers the land at the end of the muzara’a contract. The two parties can renew the
contract.
5) It
is a condition that the two parties share the produce, and the share of each
partner is a known prorata ratio in the total. it is invalid to stipulate a specific amount of the produce
to either partner.
6)The
contract is invalid according to
Shari’ah if the share of either partner is something
other than the produce.
7) The
produce is to be divided according to the ratios agreed upon y the parties.
incase of crop failure,. neither gets anything: the agent loses the effort and the
Landowner loses the utility of the
land.
8)
Everything that is necessary for Muzara’a as lending
the farm is borne by the agent as it is in the contract. However, all expenses
on the crop are borne by the two parties in the in the ratio of their shares in
the produce.
Conclusion
All the
modes of financing discussed above are based on the principles of Shari’ah, The ideal modes of financing according the Shari’ah are Musharakah and Mudarabah because of their positive affect on the
distribution of wealth. However, in the perspective of the current economic
setup, there are certain difficulties in using Musharakah and Mudarabah
instruments in every type of financing.