Essentials of Islamic Finance IU Gulshan Campus, Slide # 1

Essentials of Islamic Banking and Finance

TALHA SALEEM KAPADIA
talhasaleemkapadia@gmail.com

Riba (interest) and Gharar (excessive
uncertainty)
Essentials of Islamic Finance IU Gulshan Campus, Slide # 2
Contents of the lecture
Riba (interest);
Riba and its types
Gharar (uncertainty);
Gharar and its definition and explanation;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 3
Riba and its explanation
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 6
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;
Riba: definition
Essentials of Islamic Finance IU Gulshan Campus, Slide # 7
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;
Riba: definition
Essentials of Islamic Finance IU Gulshan Campus, Slide # 8
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;
Riba: definition
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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);
Essentials of Islamic Finance IU Gulshan Campus, Slide # 10
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;
Types of Riba
Essentials of Islamic Finance IU Gulshan Campus, Slide # 11
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;
Types of Riba
Essentials of Islamic Finance IU Gulshan Campus, Slide # 12
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 $;
Types of Riba
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 15
Gharar and its explanation
Essentials of Islamic Finance IU Gulshan Campus, Slide # 16
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;
Gharar and its definition and explanation
Essentials of Islamic Finance IU Gulshan Campus, Slide # 17
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;
Gharar and its definition and explanation
Essentials of Islamic Finance IU Gulshan Campus, Slide # 18
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;
Gharar and its definition and explanation
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 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.
Essentials of Islamic Finance IU Gulshan Campus, Slide # 21
Questions?