Essentials of Islamic Banking and Finance

1
Riba (interest) and Gharar (excessive uncertainty)
Essentials of Islamic Banking and Finance
Saturday, 630 930 IRSHAD AHMAD AIJAZ
irshad786_at_gmail.com
2
Contents of the lecture

• Riba (interest)
• Riba and its types
• Gharar (uncertainty)
• Gharar and its definition and explanation

3
Riba and its explanation
4
Introduction

• Prohibition of Riba is a core concept of Islamic
  financial law. All transactions and contracts
  must be free from elements of Riba
• The primary sources the Quran and the Sunnah are
  very clear on prohibition of Riba
• Understanding of Riba and its modern application
  is essential for understanding of Islamic
  financial system
• Let us now discuss the precise definition of Riba
  as explained by scholars of Islamic laws

5
Riba definition

• Riba
• The word Riba literally means 'increase' or
  'excess'. In terminological sense it implies
  'increase over and above the principal of loaned
  amount which is without due consideration'
• Riba in Arabic or 'Sood' ( ??? ) in Urdu or
  interest or usuary in English give similar
  meanings
• Classical and contemporary Islamic scholars
  define Riba as 'that increase which a creditor
  (owner of the loan) receives from his debtor
  (user of the loan) for giving him time to repay
  his debt
• So Riba is the name of every increase in lieu of
  which there is no Islamically acceptable
  consideration
• Increase in principal may be in form of cash or
  kind
• The increase is declared Riba if it is stipulated
  or becomes customary in the society. In case of
  increase as gesture of thank this increase is not
  Riba

6
Riba definition

• In modern financial system, interest or the
  excess (increase) in loan is the consideration or
  compensation for the period of re-payment of
  loan
• But this theory is not acceptable to Islam. Arabs
  and others used to give money with a condition
  that they will charge a particular amount monthly
  and the principal will remain due as it is. Then
  on the maturity date they demanded the debtor
  whether to pay the principal or they would
  increase the term and the payable amount both
• Islam has prohibited this way of charging
  compensation and declared it Haram
• Therefore, any increase in principal loan amount
  for just waiting is not allowed

7
Riba definition

• Interest Vs Riba
• The word interest" by and large, is now
  considered as Riba in view of big majority of
  Islamic scholars In a legal sense 'interest'
  implies that excess amount which a creditor
  settles to receive or recover from his debtor in
  consideration of giving time to the debtor for
  repayment of his loan
• But the word 'Riba', that was used in Qura'n, was
  meant for Riba al-jahiliyya or pre-Islamic Riba.
  This Riba manifests when the lender asks the
  borrower at maturity date if he would settle the
  debt or swap it for another larger debt of longer
  maturity period. The difference between the
  maturity value of old and new debt would be Riba
• This clearly shows that the Riba which was common
  in Arabs and others at the time of Revelation was
  the same thing which is now practiced in modern
  financial system
• Therefore, the present system of time-based
  compounding of debt clearly falls in this
  category and no difference is there between
  interest and Riba

8
Riba definition

• Explanation of definition of Riba
• The definition of Riba says 'it is any increase
  over and above the principal of loaned amount
  which is without due consideration'
• Sometimes meaning of 'due consideration' is
  confused and people think the increase in
  principal for waiting for a period of time is not
  an 'un-due consideration'
• But the point to understand is that, according to
  Islamic financial laws the 'period' or 'waiting
  for a period' for a loan is not a valuable
  property (mal) or service or goods for which any
  access or increase could be asked
• Therefore, if a person gives something to other
  as loan then he must forgo the period or time he
  waited the recovery of loan
• More precisely, loaning is a social activity
  rather than an economic one

9
Types of Riba

• There are two famous types of Riba
• Riba al-Jahiliyya or Riba an-Nasee'ah
  (pre-Islamic Riba, Riba in loans)
• This is the primary type of Riba. Riba An-Nasiah
  or Riba al-Jahiliyyah was a transaction
  well-known and recognized in the days of
  Jahiliyya. Arabs and others used to give money
  with a condition that they will charge a
  particular amount monthly and the principal will
  remain due as it is. Then on the maturity date
  they demanded the debtor to pay the principal. If
  he could not pay, they would increase the term
  and the payable amount. So it was the riba
  practiced by the people of Jahiliyya.
• So Riba al-Jahiliyyah is interest on loan
• This type is easy to understand and known to
  everyone easily
• Riba al-Fadl (Riba in trade, Riba in exchange)
• A secondary type of Riba is Riba in exchange of
  goods. This type of Riba was extracted from
  famous Hadees in which Holy Prophet (Sallallahu
  Alayhi Wa Sallam) said 'Sell gold for gold,
  silver for silver, wheat for wheat, barley for
  barley, date for date, salt for salt, in same
  quantities on the spot and when the commodities
  are different, sell as it suits you, but on the
  spot'. (Saheeh Muslim)

10
Types of Riba

• According to this Hadees Riba al-Fadl has been
  explained with regard to six defined
  things/commodities
• Exchange of these things (barter system of trade)
  should be with two conditions
• If the transacted commodities are of same nature
  then
• Spot delivery immediate delivery of both
  commodities
• Same quantity on both sides
• Like exchange of wheat with wheat
• If the transacted commodities are of different
  then
• Spot delivery immediat delivery of both
  commodities
• But the quantity may differ
• Like exchange of wheat with barley

11
Types of Riba

• Riba al-Fadl in modern times
• The rule of Riba al-Fadl is not limited to these
  six commodities in opinion of Fuqahaa and it is
  applicable to some other commodities as well
• First viewpoint
• The common feature of these six commodities is
  that they can either be weighed or measured,
  therefore, any commodity which is sold by
  weighing or measuring falls within this category
  and is subject to the same rule, if it is
  bartered with a similar commodity
• Second viewpoint
• The common feature of these six commodities is
  that they are either eatables or they are used as
  a universal legal tender. Wheat, barley, date,
  salt represent eatables while gold and silver
  represent universal legal tenders. Therefore, all
  eatables and universal legal tenders are subject
  to the rule mentioned in the hadith

12
Types of Riba

• Third viewpoint
• The common feature among these six commodities is
  that they are either food items or they can be
  stored. Therefore every thing that is a food item
  or can be stored is included in the same
  category, hence, subject to the same rule.
• Forth viewpoint
• The major characteristic on the basis of which
  the rules of Riba are applicable to other
  commodities by is 'their being in the nature of
  money'. Therefore, rules of Riba would apply to
  anything that serves the functions of money, such
  as, paper currency
• There are now two conditions for exchanging money
  for money
• Spot payment and delivery Hand-to-hand basis
• Equal quantity in case of same currency
• Like exchange of PKR with PKR and exchange of PKR
  with US

13
Types of Interest

• The modern forms of interest of two types
• Interest on loans
• This is main type of interest which is clear and
  easy to understand for everyone
• Lending and borrowing on interest is simple
  example of it like Banking interest
• Under this way cash is advanced to a borrower for
  receiving interest from him
• Interest on debts
• Debt originates with a loan and also with a sale
  and other transactions wherever the payment of
  money is deferred to a future date. The Quranic
  prohibition of Riba in debt, no increment is
  permissible when the debt is repaid or settled
• The settlement of debt sometimes involved its
  replacement with a new increased debt and this
  has been condemned as the worst form of Riba or
  Riba al-jahiliyya

14
Types of Interest

• The Riba in debts corresponds to the compounding
  mechanism used in case of interest-based debt.
  Therefore, the rules for exchange of debts is
  that
• Exchange of debt for money
• When a debt is exchanged for money, it must be at
  par
• Exchange of debt for debt
• When a debt is exchanged for debt, it must also
  be at par
• Rescheduling of debts
• When a debt is recheduled it should be without
  any increase or decrease
• Some implications of these are as follows
• The compounding and discounting of debt are two
  similar functions and both are prohibited
• Once the debt is established, it is repayable at
  par. Charging an increase for further deferment
  of the payment of such debts as a function of
  time (e.g. a late rental payment in a lease, or a
  late installment payment in a credit sale) would
  be Riba
• The opposite rule, in which the amount of the
  debt is reduced due to prepayment, is prohibited
  too

15
Gharar and its explanation
16
Gharar and its definition and explanation

• Gharar
• The Arabic word Gharar ( ??? ) means 'risk',
  'uncertainty', and hazard. Gharar is also defined
  by some scholars as 'any bargain in which the
  result of it is hidden'. Unlike Riba, Gharar is
  not precisely defined by Shari'ah. Gharar is also
  considered to be of lesser significance than
  Riba
• The prohibition of Riba is absolute but some
  degree of Gharar or uncertainty is acceptable in
  Shari'ah. Normal Gharar (that does not lead to
  conflict) is acceptable. Also Gharar is
  acceptable in some social contracts
• Gharar has two ways. First, Gharar implies
  uncertainty. Second, it implies deceit. Shari'ah
  has forbidden all business transactions, which
  cause injustice in any form to any of the
  parties
• Gharar may be in the form of hazard or peril
  leading to uncertainty in any business, or deceit
  or fraud or undue advantage

17
Gharar and its definition and explanation

• Explanation of Gharar
• Inadequacy and inaccuracy of information about
  the essentials of the contract
• The Gharar exist when a contract does not have
  clarity in its essential elements. Such a
  contract becomes matter of conflict between
  parties and become a way of cheating, deceiving
  and unjust dealing
• For example if price in a contract is not clear
  or the attributes of sold goods are not clear to
  buyer or the time of payment is not clear to
  seller the contract becomes a point of conflict
  between parties
• Hiring a cab without telling the deriver the
  destination or without agreeing on fare is case
  of Gharar. Also sale with through of stick on
  anything is a sale with element of Gharar
• Complexity in Contracts
• Gharar also refers to undue complexity in
  contracts. Shari'ah does not permit
  interdependent contracts. For instance,
  combining two sales in one is not permitted
• Pure Games of Chance (Al-Qimar Al-Maisir)
• The term Gharar is also used in the context of
  pure games of chance

18
Gharar and its definition and explanation

• Game of chance means one party's loss is confirm
  at the start of contract
• Contracting under conditions of uncertainty and
  gambling (qimar) are examples of this
• The two words, uncertainty and gambling are not
  synonymous, though related
• Uncertainty is same as Gharar and under such
  conditions, exchange or contracting is reduced to
  a gamble
• Contemporary scholars are of the view that
  forwards, futures and options contracts are
  financial example of this type
• They are almost always settled in price
  differences only. Hence, these are used more as
  tools of gambling than as tools of risk
  management

19
Gharar and its definition and explanation

• Gharar sometimes appear in mechanics of the
  Contract
• For example (a) two Sales in One, (b) the
  'Pebble', 'Touch' and 'Toss' Sales, (c) suspended
  (Mu'allaq) Sale and (d) the Future Sale are sales
  with element of Gharar
• Gharar sometimes appear in object of the
  Contract
• For example ignorance of the Genus, Species,
  Attributes and Quantity of the Object fall under
  Gharar
• Also ignorance of the essence of the object like
  Ignorance as to Time, inability to Deliver,
  Contracting on a Non-Existent Object and Sale of
  the Unseen items come in sense of Gharar

20
Rules for Gharar

• Any transaction with element of Gharar is not
  allowed in Islam
• Until the element of Gharar is removed the
  transaction become hung and sometimes void
• Gambling and conventional insurance is not
  allowed for this reason.

21
Questions?