Risk, Piety, and the Islamic Investor Author(s): Alexandra R. Hardie and M.

Rabooy Source: British Journal of Middle Eastern Studies, Vol. 18, No. 1 (1991), pp. 52-66 Published by: Taylor & Francis, Ltd. Stable URL: http://www.jstor.org/stable/195381 Accessed: 17/09/2010 05:35
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The avoidance ofriba The most important restriction is that an Islamic investor must avoid riba in any form. AND THE ISLAMIC INVESTOR Alexandra R. Islam and Capitalism. preference shares and bonds. were used to get around the prohibition. such 1. A might then buy the item back for 100 units of currency now. with little attention to real assets. and B has acquired 100 units now. into real assets or into a business.e. on the understanding that 120 units of currency will be paid for it next year. they are ways of making an interest-bearing loan take on the appearance of a permitted transaction.1 states that the exact meaning of riba is not known for certain. London. with the result that he keeps the item. (The Qur'anic basis for this restriction is discussed below. This paper explains the principles which hold for Islamic investment and goes on to ask whether the Islamic Banks conform to these principles. In contrast to the Western investor. tr. 1974. into various kinds of financial asset.e. i. but the practice seems never to have been accepted and various hiyal. To simplify one type of ruse Rodinson describes: A might sell an object to B. however. but it might mean interest as such. business finance theory deals with investment in real assets. We interpret Rodinson's evidence as implying that riba has normally meant the charging of interest as such. Ethics are ignored. Rodinson gives examples from different periods of history of Muslims charging interest on loans made to other Muslims. Hardie and M. by B. PIETY. and the types of economic activity in which he invests. Pearce. Conventional Western finance theory analyses these separately: portfolio theory deals with investment in ordinary shares. Allen Lane. the root meaning is 'increase'. Rodinson. as carried out by conventional limited liability firms. Investment may be indirect. as all his examples of ruses indicate the need to circumvent a ban on interest. M. 52 .) M. or 'ruses'. but the restrictions which apply to the Islamic investor mean that Islamic investment differs from conventional Western investment in several important respects. The authors base their discussion on the Qur'an and hadHth. the Islamic investor must also take into account the ethical aspects of his investment.RISK. in his book Islam and Capitalism. or direct. or merely excessive interest. i. Rabooy Although ethical investment has only recently become an issue in the West. and a conventional investor will accept any investments that are not actually illegal. Investmenttheory in the Islamic context Conventional Western finance theory considers two dimensions of investment: risk and return. the ethical aspects of investment have always been important in the Islamic world. with a debt of 120 units to repay. The insights of conventional finance theory apply to Islamic investment. Rodinson.

The Islamic investor. holds that interest is needed to encourage individuals to invest their funds rather than to spend them on consumption. Arguments in favour of interest tend to be based on expediency. and also feasible in practice. For this reason also. the real rate of interest is negative. since different ruses would be needed for this. some economists have argued that interest is unjustified.as a sale with deferred payment. not principle. in Western countries. to which the argument does not apply. if interest at moderate levels had been considered permissible. or try to determine the price of goods. which set a maximum permitted interest rate. because money is inherently unproductive. who argued that interest was wrong. even in modern times. Rodinson is aware of the teaching about price-fixing. he does not explain that. for example. a ban on excessive interest requires that 'excessive' be defined. Jewish teaching. which will vary with time and place. many loans could have been arranged without the need for hiyal. has always condemned interest-as did Aristotle.S. Also. Conventional finance theory. while paying interest on only some deposits. since Islamic teaching condemns monopoly. But fixing interest rates is similar to fixing prices. generalprinciples If a Muslim invests in a partnership or in a real asset. then he is entitled to whatever return he receives. which is contrary to Islamic teaching. but does not stress that it applies also to the fixing of interest rates. most other ethical teaching on interest bans it outright. there is no need for Muslims to make interest-bearing loans. being unearned. Moreover. In terms of theory. This justification seems inadequate. Also. as banks are not consumers. if he builds a house and sells it. however. it is valid to interpret riba as meaning interest as such. Many U. states have also had usury laws. The government ought not to interfere in a market.g. however. in the absence of monopoly. since the evidence shows that people in Britain continue to save part of their income even when. By contrast. and at a lower rate. Banks create money. is both permissible for Muslims. with sharing of profit and loss. partnership. owing to inflation. although the prohibition weakened over time until usury merely meant excessive interest. As the return on 53 . In modern times. e. The ruses are not designed to circumvent a ban on excessive interest. Some person in authority would have to decide on the maximum permitted rate. ways of making the interest payment appear to be lower. Thus. a complete ban on interest is logical and easily understood. provided that he does not have a monopoly position. The Islamic view of the just price is that the businessman can put whatever price he wishes on his goods. the forces of supply and demand will give rise to the just price. for example. It is worth mentioning that in earlier times interest was also condemned in Europe. and then charge interest on loans. There are no objective criteria for this definition. except in the case of monopoly-the assumption being that.g. e. Indeed. as they can secure a return on investment in other ways. most lending is done by banks. although ribd is forbidden. and not a remuneration for current effort by the lender. by a process of expanding their deposits and loans simultaneously.

though unlimited liability is the Islamic principle. bonds.e. It might seem that ordinary shares are allowed. If a Muslim investor may not receive interest. the debt-holders suffer the loss. viz. borrow heavily.) A Muslim society would impose little tax upon profits. a man must pay off his debts. Moreover. It is worth pointing out that unlimited liability is not peculiar to Islam. a pre-determined percentage of return on investments. Conventional companies are limited liability companies. a partner's liability in an Islamic partnership (the various types of which are described below) is normally limited to the funds that he has put in. it had private property. In practice. other forms of 54 . production for sale rather than subsistence. Since the full repayment of debts is a duty. but this economic advantage may be offset by the disadvantage of the separation between ownership and control in conventional companies. Real Estate Investment Trusts in the U.and nineteenth-century Britain was capitalist. a similar argument applies here also. he may find that B has run up debts without his knowledge. since a share-holder does not get a pre-determined return. The basis for this is that if A invests in B's business. Limited liability is sometimes abused. or-as hardly needs to be said-some element of fraud. (This paper considers only one. Limited liability allows an active secondary market in shares.) However. at the start of the partnership. contrary to this agreement. and participates fully in the risk of the company.investment depends on market forces. if unsuccessful. The Islamic investor must therefore restrict himself to direct investment-of which there are several permissible methods. unless they are in a difficult business situation. If A and B are both good Muslims. if A agreed that B could incur debts. there are family firms in Britain which prefer to rely on internal funds rather than loans. He can guard against this by requiring an agreement from B.g. then A is also liable for these debts.S. incurs debts. the return actually received is justified. limited liability arrangements are unacceptable. (Prudence of this kind is not found only amongst Muslims. they ought not to borrow money on which they have to pay interest. that B will not incur any debts. he must avoid deposits with conventional banks. However. he alone is liable for them. the shareholders receive the profit. and the introduction of limited liability was opposed. lest it encourage dishonesty in business. Formerly. i. although there are Islamic rules about how this should be done in a partnership. and corporate bills. wihout being actively involved himself. large-scale production. This would facilitate re-investment of profits. Limited liability is not essential for capitalism: the economy of eighteenth. B will probably restrict the scale of his operations to what can easily be financed by the funds provided by A and himself. If the investment is successful. it applied in Europe. In Islam. fairly free markets. partnership with profit and loss sharing. unless there is an element of monopoly. and his death-even as a martyr-cannot cancel these debts. preference shares and convertible bonds. But the Islamic investor faces another restriction here. from a friend. and a considerable degree of technological progress. government bills or bonds. with its heavy responsibility. and they will be reluctant to accept an interest-free loan e. putting the money into speculative investments. If B then. yet it did not have the limited liability company until late in the nineteenth century.

or invest money alone. it will increase wheat production greatly. for example. for example. without taking any part in the management. however. running a casino. unless needed for medical purposes. pharmaceuticals. because there is no certainty of success. ecologically-sound. and hence. that the sea is dangerous. Islamic investors may disagree as to whether a given investment is ambiguous. Moreover. rearing or dealing in pigs or pork. but he must also consider the ethics of the transaction. letting his partners conduct the actual business. Muslim scholars generally agree that one of the known reasons why interest is prohibited is that interest is risk-free income. or other business. The Islamic investor also seeks return. The venture is risky. if all goes well. building and construction. For example. and his attitude to risk is therefore different. or in partnership with other people. Risky investment is when the investor invests in an asset in the hope. The conventional investor seeks return. from price movements in a commodity or an asset. hoping that the price will rise. if this works. He must avoid gambling. there may be some that a particular Islamic investor considers ambiguous. oil production and refining. the investor accepts risk as one aspect of his investment. such as partnerships with unlimited liability and building societies. and enable him to sell his wheat for more than he paid for it. but his activity does not increase the production of wheat. yet he may decide not to invest in a block if one of the offices is to be let to a wine merchant. he will not invest in shipping. electronics. For example. the more pious an investor is. He buys wheat.economic organization. It goes without saying that the Islamic investor must avoid forbidden economic activities. and avoids risk. which means that he will not actively seek risk. Islamic teaching favours economic endeavour: it approves of a man who invests his money in his own business. nearly all types of food production or trading. but the conventional 55 . transport. he is allowed to invest in the building of an office block. An observer cannot therefore be sure whether an Islamic investor will accept an investment in an allowable activity. iron and steel. are still important in Britain. a man may invest in a friend's textile factory. he may take an active role in a partnership. and there are numerous allowable investment opportunities available to the Islamic investor: they include. However. the speculator is a 'risk lover'. and engaging in any other activities likely to harm or exploit people. for example. but not certainty. He may make a profit or a loss. speculation. pesticide for wheat. Such activities include: producing or dealing in alcohol or intoxicating drugs. Activities are allowable unless explicitly forbidden. establishing a monopoly. of return. He is. His investment will increase production in the industry. and therefore avoids. Thus. in the short term. of course. in the category of allowable investments. and on this view. entitled to be prudent. In conventional theory. if he thinks. A speculator tries to profit. a Muslim investor should not seek risk-free income. textiles. the more scrupulous he will be in rejecting investments because of ambiguity. which is contrary to Islamic law. he might invest in a firm which is developing a new. The difference between risky investment and speculation is as follows. utilities.

) The Islamic investor is free to diversify as he pleases. or very low ones. Holding two investments. nor would he be unduly risk-averse. he bases his estimate of expected variance upon past data. or be financed by his suppliers. gives a strong chance of either very high returns. (The conventional investor does not know the future either. and should be ready to take investments with variable returns. his investments have just as good a chance of turning out very well as turning out very badly. If he accepts a riskier than average investment. reduces risk. as the outcomes are nearer to the expected value.e. the greater the risk. he would be 'risk-neutral'. high risk. but the variance is lower than for the first example. the expected value is 50%. if the returns on the two are not perfectly correlated. or diversify his portfolio of investments. Two investments can have the same expected value. The businessman may be able to set up his business from his own funds. He may invest in several small projects. The types of partnership allowed are discussed below. or he may want to invest in several different industries which appeal to him. The variance is a statistical measure showing the extent to which possible outcomes are likely to differ from the expected value. To sum up Islamic rules from the businessman's point of view. after allowing for normal prudence. if one gives a low return whenever the other gives a high one. e. rather than one.g. which is the one used as the basis of conventional finance theory. But if these sources of finance are not sufficient. i.investor is 'risk-averse'. i. investment. without demanding compensation for the risk. and be self-financing thereafter. The actual return might be any one of several possible returns. 56 . and vice versa. The explanation for this lies in the definition of risk. A high variance. if there is an equal chance of getting 100% or zero. not just one. investment gives the investor a better chance of an actual return close to the expected value. the businessman may enter into a partnership with one or more other people. Suppose that the probability of each outcome is known. The risk-averse investor seeks to reduce risk: he may select low risk investments. Suppose that another investment gives an equal chance of 40% or 60%. This means that he cannot use a loan from a conventional bank-a potential problem. which will reduce his risk. but different variance. should not worry about risk. He will not. since most conventional companies do need bank loans. or both. as defined above. A low variance. thus providing assistance to various entrepreneurs. The ideal Islamic investor would not be a risk-lover. The Islamic investor. for example. understanding that no human being knows the future.e. The variance of the possible outcomes is deemed to be the best measure of the risk of the investment. who may agree to defer payment for the goods with which they supply him (a form of trade credit). he demands a higher return from it. Consider an uncertain investment. get a lower return. The greater the variance. Weighting the outcomes by their respective probabilities gives the expected value of the return. the expected return is 50%. low risk. the only type of loan he should use is an interest-free one. which he may obtain from a welldisposed relative or friend. and his expectations often turn out to be wrong. on average.

Masri. The second rule is the one which is considered to allow money exchange in the Islamic banking system. Tahrike Tarsile Quran Inc. Kitdb al-Musaqat. From Ubada ibn al-Samit. Rafiq al-Masri. and the fourth is ii ('The Cow'): 275-281. also in Tirmidhi). The rules which follow are as follows. '3 These verses form the basis of the strict Islamic law on prohibition of interest.g. (Muslim. The third is found in sura iii 'The Family of Imran'. 4. al-Risala Establishment. and wheat for barley. Muslim jurists have discussed these had[th at length and there is widespread agreement that they must be observed in Islamic business. or being guilty of incest with one's own mother'.2 The last verses were revealed in 'the maturity of Islam' (to use Ibn 'Abbas's phrase). However.g. The Prophet said. but the transaction must be spot and not forward'. Elmhurst.. and are the ultimate authority to be followed by contemporary Muslim society with regard to interest prohibition. and hand-to-hand. That is because they say. 3. barley for barley. The Prophet said..D dissertation. Beirut. Shakir (New York. 'Gold for gold. e.). The taker and the giver are alike [in guilt]' (Muslim and Musnad Ahmad). barley for barley. wheat for wheat.d. those who draw up contracts involving it. those who pay it. n. and read as follows: 'Those who swallow down interest cannot arise except as one whom the Devil has prostrated by [his] touch does rise. dates for dates. silver for silver. like for like. 1981). Masraf. and hand-to-hand. Masraf al-Tanmiya al-Isldmi (Ph. Inded. then you may sell as you wish. if the commodities differ. From Abu Sa'id al-Khudri. trading is only like interest. and not forward. Bab al-sarf wa bay' al-dhahab bi-l-waraq naqdan. wheat for barley. by. M.H. Qur'an. and salt for salt. It is also reported that the Prophet said: 'People can exchange gold for silver. tr. it is reported of the Prophet: 'He even equated the taking and giving of interest to committing adultery thirty-six times. The second is iv: ('The Women'): 160-161. and the transaction must be spot. if one precious metal is exchanged for another. or one commodity for another. The first in order of revelation is Qur'an xxx ('the Greeks'): 39. 57 .. only one rule applies: the transaction must be spot. e. That is that there is no restriction on the exchange of precious metal for agricultural commodities: people can exchange them 2. provided that the transaction is hand-to-hand'. 'Gold for gold. whoever pays more or takes more has indulged in interest. There are also a number of important hadTth in which the Prophet condemned people who take interest. silver for silver.4 Among these hadith are the following. there are two requirements which apply: there must be equality of quantities in the transaction. and people who act as witnesses to such contracts.The Prohibition of Interest in the Qur'anand hadith The prohibition of interest appears in eight separate verses in four separate suras of the Qur'an. in different quantities. dates for dates. and Allah has allowed trading and prohibited interest . equal for equal. gold for silver. If the exchange involves the same precious metal or the same agricultural commodity.

The Prophet's teachings thus had the effect of discouraging barter.g. For loans. later. Umar. equal in amount. i. al-Iqtisdd al-Isldmi. of the commodity is different. like for like. As precious metals are taken to mean money. if the transaction is in the same sort of commodity. There is also interest in unequal transactions (riba al-fadE). in 'Jami' al-Usul'). but with a higher market value. unless it could fulfil very specific requirements. and pay for them. Two sorts of interest in trade are prohibited. These hadTth why people should be explicitly allowed to exchange a given quantity of a commodity with its own counterpart on the spot. He is taking advantage of the farmer's weak position. no. quality.' (alBukhar?. reaching a peak just before the next harvest is due. namely: 'Dinar for dinar.e. He expects that the price of wheat will rise over the course of the year. whose own wheat crop has failed. be argued that cash transactions are preferable.i. Chapra M. The Islamic Foundation. It is hard to understand trade.and interest in trade (riba al-buyu)5. Muslim scholars have discussed interest in trade in detail and the different schools have different about interest in opinions on. money. and reduce the scope for fraud. cash markets are more efficient than barter. al-Maktaba al-Tijariyya al-Kubra. and asks for wheat to take him through the year. He demands to be repaid at this time. agreeing to repay the same quantity later. From an economist's point of view. money. neither of the two parties to the transaction is allowed to defer delivery. as they reduce the chances of confusion about values. viz. Towards a Just Monetary System (Leicester. indeed. also Muslim. when grain is scarce. there must not be any specified or unspecified additional giving (e. in money. 58 . Another hadTthof the Prophet supports this view. dirham for dirham. as they give rise to a uniform price for each good. consider the case of a farmer. 2. Suppose that the farmer has harvested some 5. and in equal or different quantities. One is interest in forward transactions (riba al-nasd'). Fathi Lashln. the main hadTth referred to specific commodities. 1985). 'al-Riba wa Ahkamuhu fi al-Islam'. He needs wheat to feed his family but he has no money to buy it. The other kind of trade can occur when the grade. and let all goods be valued by the same standard of value.e. as there would be few occasions when they would want to do this. i.freely spot or forward. 'Abd alRahman al-Jaziri. A higher grade is normally worth more. al-Fiqh 'ala al-Madhdhib al-Arba'a (Cairo. vol. It could.). whoever pays more or takes more has indulged in interest. Suppose he goes to a merchant. a person can take goods now. a case where different quantities of the same commodity change hands. 5th ed. and agricultural commodities are taken to imply all ordinary goods. gifts or services) from borrower to lender. so that he will receive wheat. and encouraging people to use cash transactions in business deals.2. it is clear that the prohibited types of interest could arise in barter transactions. They are interest on loans (riba al-qurud). It is generally agreed amongst Islamic scholars that these teachings imply that there are two sorts of interest which are prohibited under Islamic Law. 16 (1983).e. This means that interest on loans made in money is prohibited. this implies that sale on credit is acceptable in Islam. The merchant does not ask for interest in the form of extra wheat. and different explanations for. However. As an example of disallowed trade.

In the East. Finance in Islam If it is accepted that Islamic Law forbids interest on loans. The Islamic Foundation. and same weight. it was determined. Islamic teaching also discourages borrowing and lending even when interest is not involved.N. There is widespread agreement amongst contemporary Muslim thinkers that the contracts between conventional banks and their depositors are indeed loans in the Islamic sense. Partnership and Profit-Sharing in Islamic Law (Leicester. The division of profit may be made according to the proportion of shares that a person owns. Udovitch. gold jewellery is regarded as a store of wealth.D dissertation. As explained above. and that its quality is good.L. Exchanging notes for coin of the same currency would also come into this category of allowable transaction. 'A. and exchanges gold jewellery for a gold bar of the same quality of gold.. but the exact method must be set out in the 6. the Islamic businessman will normally find a partnership the best method of getting external funds for his business. A gold bar is more convenient as a means of payment. A. at an important Islamic conference in Cairo in 1965.. In ii:280 we read: 'And if (the debtor) is in straitness. Islamic Publications Ltd. interest on bank deposits must be forbidden. He guarantees the value of the debt. except when they are in need. Contracts of loans should normally be written down. 59 . the lawfulness of interest on bank deposits must be questioned. This is made clear in Qur'an. Suppose that a person goes to a goldsmith. Indeed.'A. The criterion of an Islamic loan is that the ownership of the capital is transferred from creditor to debtor. idem. Partnershipand Profit in Medieval Islam (Princeton. 1970). various types of partnership were used.2. Thus. He wants to exchange it for a larger quantity of lower-quality wheat.wheat. 1973). In general. or it may be made in some other way. Western theory regards these as loans from depositors to banks. vol. and properly witnessed. and the goldsmith can sell the jewellery without further work. so both parties gain. 1985). al-Sharikat fJ al-Shar'a al-Isldmiyya wa-l-Qdnuin al-Wad'T (Ph. and is responsible for any losses suffered by it. the two most important being 'inancapital partnership and muddraba(qirad). Beirut. Siddiqi. At the time of the Prophet. al-Khayyat. and to give rather than to lend. The merchant could take advantage of him by giving him less of the low-quality wheat than the high-quality wheat is worth in terms of market prices. and that their relations are those of borrower and lender. and that you remit (it) as alms is better for you if you knew'. and the debtor can manage the capital as he wishes.. See also. The value of the workmanship is small relative to the gold value. and holds shares in proportion to his contribution. Mu'assasat al-Risala. Banking withoutInterest (Lahore. M. then let there be postponements until (he is in) ease. that bank interest should be prohibited. An example of a precious metal being exchanged for an equal quantity of the sarme precious metal is as follows. then write it down . ii:282-283: 'O you who believe! When you deal with each other in contracting a debt for a fixed time. There are two other important aspects of Islamic teaching about loans. 1983). '. Muslims are encouraged not to borrow.6 Capital partnership is a partnership where each member puts some capital in.

and that this should be set out in the contract.contract of the partnership. al-Awtar al-Turath Dar Nayl (Beirut. 60 . his first wife. He also observed this sort of partnership between Zayd ibn al-Arqam and al-Barra'. and the other uses the capital in a business which he controls and manages. The mudaraba partnership. al-ShawkanL. 'al-Badilal-Islamili-l-Fayda'ala al-Qurud'. Thus. His approval of this sort of partnership7 is the basis of its acceptance by Islamic jurists and scholars. then he is liable to repay the funds in case of loss. and used it in business. a person can put in half the capital and receive half the profit. The owner of the capital shares the profit with the partner who runs the business. He took over the capital belonging to Khadija bint Khuwaylid. (November1982). In the case of loss. and the contract has been signed. it is valid. The following. It is reported that he participated in such a partnership himself with al-Sa'ib ibn Sharik in Makka. When he asked the Prophet about such stipulations. that the owner of capital is entitled to demand any fair and just proportion of the profits. Ibn 'Abdal-Wahhab. one partner supplies the funds. he confirmed certain stipulations in the agreement: do not voyage at sea with the capital. for example. if there is one. and approved by. he must not demand a fixed percentage of return on his funds. about how the business should be run. subvol. Hasan 'AbbasZaki. His share of the profit. The owner of the funds may impose certain conditions upon the other partner. the other supplies the effort and labour. do not pass through a valley with it and do not buy animals with it. by all schools of jurisprudence.'9 Once the owner of the capital has made any such stipulations.n. 3. It is agreed. because it is a limited partnership-a restriction which prevents the partners finding that their debts are greater than the total value of the capital originally put in. The owner of the capital has entrusted his capital to 7. and both share the profits. in contrast.48. 9. is based on a contract arranged at the outset of the partnership.p.1973).p. This kind of partnership is not allowed to borrow money. It is reported that the Prophet practised mudaraba partnership before his mission. is strictly prohibited. the partners suffer the loss in proportion to the share of capital that they have put into the business at the start. Thus. A return fixed in terms of cash amount. appears in an account given by Ibn 'Abbas about his father: 'When he [the father] gave his capital to someone else to do business with it. and he approved of it. M. if you do any of these.ya' al-'Arabi..d. no. and may ask his partner not to engage in certain activities. STrat Mukhtasar al-Rasul (n. Ih. This kind of partnership was familiar to.14 al-Iqtisdd 2. he [the Prophet] agreed with him. However. say. 10% on the capital he puts in.5. and their liability is limited to their share. 8. but one partner puts in the capital. is not a capital partnership. Both partners share the profits and losses. but the agreement must not be that he gets a fixed.al-YisufiyyaPress. you have to guarantee the capital.8 The owner of capital is entitled to impose any restrictions he wishes. If the partner uses the funds contrary to the agreement. or percentage return on a person's capital share. al-Isldmi.Vol.). the Prophet.

First. and they come to an end as determined in the contract. and withdrawal of it.12 Some modifications to the theory of partnership are needed to make this possible. pp.10 Note that this refers to capital invested. they would share losses amongst them. according to his own judgement. al-Khayyat. Opinions differ as to the exact way in which profits or losses shoud be allocated. If he puts in both stipluations. Partnership. Siddiqi. i. pp. 19. are only valid and allowed after the settlement of accounts. the allocation of profit. in practice.65-6. and consist of suitable persons. According to the Hanbali school. Ibid. On losses. and there must not be any payments of profits part way through the period of the contract. However. 12.p.11 Thus. the owner of the capital bears any losses. 'All the different schools of Islamic Jurisprudence agree that any deficit or loss occurring in a firm must always be distributed in proportion to capital invested. shares in the partnership. al-Khafffs view. which decides on the exact practice that the bank should adopt. if losses occur. King 'Abd al'Azlz University.A. by 'A. the active partner in muddrababecomes the legal owner of the as yet unallocated profit as soon as it accrues to the business.the active partner. See also. Provided that he keeps strictly to the terms of the agreement. p. al-Nizam al-Masrafi al-ld-RabawT. both parties share in the profits. the owner of the capital can require that the active partner refrain from borrowing money. This suggests that. Shafi'i and Maliki schools.e. and checks that actual practice conforms to the rules. and various doctrines of the Shi'a. and if there are several owners of capital. Thus. then losses would not exceed the capital. M. to quote Shaykh 'A.daraba partnership. an Islamic Bank might be established solely upon the basis of Islamic partnership. only the most important points are mentioned here. As explained above. Siddiqi. 11. 1985). after the capital has been fully repaid to its owner-implying that the business has been wound up. Any contractual stipulation contravening this rule is invalid and must be ignored'. tr. Salama (Jeddah. Islamic Banking In theory. which have been worked out in detail. There is also a 10. In this kind of partnership. but. it will be able to operate in the modern world. According to the Hanafi.e. they are not perpetual. He can also require that the latter refrain from buying goods on credit.N. these schools also agree that the business must be wound up before any actual distribution of profit. i. the owner of the capital has to accept any losses. he is not held responsible for any loss which happens to the capital. they are taken out of the capital i. Sharikat. and yet not violate any Islamic principles. 61 . and the allocation of profit. partnerships are likely to be relatively short-term. who is empowered to manage it within the terms of the contract. an Islamic bank must have a Religious Supervisory Board. if there are any. No profits may be paid out until this has been done. Partnership contracts are for a fixed period.e.7-9. or for a specific purpose. most modern Islamic scholars seem to agree that it should be established so as to be both an Islamic partnership and a limited liability company.30. This board must be independent of the management of the bank. in the mu.

unlike the conventional bank.H. al-Iqtisdd al-IslimF. of an Islamic Bank must all be devout Muslims. n. Vol. be an intermediary between depositors and business borrowers. Zu'ayr. M. it combines two roles into one. no. the Supreme Board of Fatawa and Islamic Legislation and Supervision over Islamic Banks. 61-2. Wherever conventional banking practices conflict with Islamic principles. 15. It must be involved in the business operations of those to whom it provides funds.14 Shares may be transferred only to Muslims. The current accounts of these banks resemble those of conventional banks. al-Mughn (Beirut. 24-5. they have a secure place for their money. 52 and 53 (November/December 1985).'A. 5. al-Iqtisdd al-Isldmi. shareholders. People who hold these accounts receive a cheque-book. The International Association of Islamic Banks was established on 21 August 1977 by the Chairmen of Islamic banks and approved by the Foreign Ministers of the Islamic states on 28 April 1978. and control their activities in order to keep them within the Islamic frame. savings accounts and longterm deposit accounts. 62 . Its verdicts.g. M. where these do not clash with Islamic principles. the bank acts as the active partner in mu. as a result of bereavement. 20 (April/May 1983). Dar al-Kitab al-Misr. no. there are current accounts. amongst other designated purposes. 14. El-Gammal. Shahata. 1980). The founders. The payment of zaka is a religious obligation for Muslims. al-Iqtisdd al-Isldml. and the money is used to assist the poor. employees. 16. and they provide similar services. 50-1. 2. p. They have two areas of banking operations: banking and investment. al-Iqtisad al-Isldmi. and this partnership too is a mu. Their investment is based upon partnership. 15 (December 1982). 17. so that they can make payments conveniently.daraba. and the businessman puts in the management.). It aims to help and support the Islamic banks in different ways. interest-free. The Banks also make benevolent. 49-59. The Islamic bank cannot. and they can have credit cards or 13. To do this. 60-70. it must check that the rules of conduct adopted by individual Islamic banks are in accordance with Islamic principles. 2-3. and bear part of the risk. unlike the investment of conventional banks. Their deposits resemble those of conventional banks. ordinary shares are allowed. H. nos.supervisory body. Ibn Qudama. Its head office is in Cairo. nos.15 The management and accounting practices of the Banks must be organised on Islamic principles. opinions and decisions are binding on the members if they are unanimous. 52 and 53 (November/December 1985). they can withdraw it easily. al-Ansari. and managers.13 This Supreme Board has duties of supervision and control. and the sharing of profit and loss.daraba Islamic Banks have adopted the operating methods of conventional banks. Islamic Economy (Cairo. and it provides the management of the capital. 'al-Raqaba al-Shar'iyya Farq Jawhari bayn al-Bunfukal-Islamiyya wa-l-Bunuk al-Rabawiyya'.16 This is true also for the system of finance. In respect of its agreements with the businessman. loans to those of their depositors who are in need.g. the bank is the owner of capital:17 the bank puts in the capital.d. the Banks must adopt practices that do conform to these principles. and it ensures that Islamic banks keep to Islamic practice. 2. M. it decides on any disputed points about banking practice. 2.A. they provide the capital. such as the payment of zaka on their deposits. As far as the depositors and shareholders are concerned. 'Dawr al-'AmilYnfi Tatwir MasTratal-Bunuk al-Islamiyya'. 'Alam al-Kutub. e. if away from home.444. They also have social welfare duries. but bonds are not. 'al-Dawabit al-Idariyya wa-l-Muhasabiyya li-Tatwir Masirat al-Masarif alIslamiyya'. laws. e.

They say that. interest-free. Dar Ihya' al-Turath al-'Arabi. Vol. indeed. if funds are left in for the full period. some of whom have switched to Islamic Banks from conventional banks. and knows that his money is secure.1. Vol. for shorter-term investment. but the banks can use these also.). if they wish. Holders of current accounts and non-investment savings accounts can withdraw their funds easily but. but no fees are charged. 63 . a return is given. The Banks are also allowed to use part of these funds for their investment activities. al-Tubrusl. but partnership arrangements are not suited to such short periods. and that he can withdraw it at any time. Others have opened bank accounts for the first time. 1982). the holder receives a pass-book. loans to their business customers. interest.1. the funds in investment accounts proper can be used for financing partnerships with businessmen. in any form. requires the deposit of money for a given term. al-Hasan. Tafslr al-Qur'anal-'AzTm (Beirut. which also offers a return. the holders cannot withdraw their funds at short notice without loss of return. and witnessed. Although these Banks were set up to conform to Islamic principles. The investment savings account is similar to the investment account proper. to write contracts of loans. From the Banks' point of view. consider that it is preferable. Modern Muslim scholars and jurists tend to accept the second view with 18. an Assessment Islamic Banks have proved popular with Muslim investors. the governments have made it clear that they favour Islamic Banks. There is also a rule that contracts should normally be written down. including Abu Sa'id al-Khudri. there is no return. at the time of the Prophet. and al-Sha'bi al-Tubrusl. Some scholars. three months.cash withdrawal cards. The Banks may use part of these funds to make short-term.18 and that this custom was not condemned. or pay. the difference is that investment accounts are longer-term than investment savings accounts. they may be asked to pay fees for the services they receive. Loans may be neeeded for. but if funds are withdrawn early. n. the Banks know that most holders will not wish to withdraw their funds at the same time. Dar al-Ma'rifa. Most others. like al-Rabi' and Ka'b. The other kind of savings account. This assessment of Islamic Banks asks whether their practices are in strict accordance with the principles that would be accepted by a pious Muslim investor. They get no return on their funds. One kind of savings account resembles the current account. 397.d. the essential rule is that it is forbidden to take. Ibn Kathir. Majma' al-Baydnfi Tafslr al-Qur'an (Beirut. but not obligatory. a careful examination of their banking and investment practices reveals serious weaknesses in terms of conformity to these principles. He cannot draw cheques. Muslims did borrow and lend money without making written contracts. and in some Muslim countries. in not giving a return. believe that the verses of the Qur'an which relate to loan contracts are binding law. See also. say. The funds in investment savings accounts are shorterterm. As noted above. as with current accounts at a conventional bank. Islamic Banking. the investment savings account.

Khartoum. or alternatively. There are other doubtful points about deposits. then the borrower is unjust'. and the same would apply every time a businessman increased his actual borrowing on overdraft by however little. al-Ittihdd. the borrower should repay the loan as soon as he has the funds to do so. relates to current accounts and non-investment savings accounts. and witnessed. al-Muthanna Bookshop.). A. 4.19 The major problem. Ahmad 'Ali 'Abdulla. Many of the Prophet's hadlth20 relate to this topic. See also Ibn al-Athir al-Jazri. 'If the borrower delays the repayment of the debt. because he considers that the lender is rich. Tadamun Islamic Bank. Muslims should use loans only if really necessary. Another problem is that. 17. In general. 183 and 190-2. If the banks offer these services free of charge. if these deposits are loans. Irshdd al-Sdrl li-Sharh SahThal-Bukhdri (Baghdad. as they may do in practice. Another saying of the Prophet is that 'Allah forgives everything (every sin) for a martyr except debt'. then the depositors are getting a return on their money in the form of free services. If these deposits are loans. Ahaddth 21. 20. 'A study about distribution of profit between shareholders and investors'. however. following Islamic principles. therefore. have an obligation to repay them in full. Jami' al-Usul min al-Rasul (Beirut. the Banks. Shalabi. These are not so serious as far as investment accounts and investment savings accounts are concerned. ways:21 'If the borrower is able to repay the debt and he does not repay it. 16 December 1984. In the opinion of many Islamic scholars. and he replied 'Yes'. Vol. a borrower should not delay repaying a loan. whatever happens to the Banks.d. 64 . since they offer no cash return. the Banks' status as limited liability companies means that. and also the Islamic banks. a contract would have to be written. Also. they are unsatisfactory in Islamic terms. Dar Ihya' al-Turath al-'Arabl. n. when they could easily repay it. One of the had7thcan be interpreted in two. regard them as interest-free from the depositor to the bank.respect to Islamic banking. the Bank might be able to avoid paying full compensation. then he is unjust'. thus. slightly different. They hold these accounts in order to get various services. although there is disagreement about the correct way to determine and distribute the profits arising from the investment of these deposits. 3 September 1985. each time a customer added even a small sum of money to his bank deposits. These deposits are affected by traditional Islamic teaching about loans. 5. whether it takes the form of money or services. A loan imposes a heavy obligation on the borrower. A further point is that many of the depositors probably do not understand that these accounts are 19. They argue that the rules are too restrictive for routine banking use. The Prophet is reported to have said: 'I seek refuge in Allah from godlessness and debt'. The majority of scholars who have discussed them. under conventional law. fixed or otherwise. and would conflict with the need for confidentiality. A man asked him whether he equated godlessness with debt. Current accounts and non-investment savings accounts appear to be allowable. On either interpretation. Vol. because interest is forbidden. 1984). This would be time-consuming. 223. the banks act unjustly in keeping the money. However. Abfi al-'Abbas al-Qastalani. But depositors holding accounts of this type do get an implicit return on their money.

there are reasons for thinking that these deposits are not loans in the strictly Islamic sense. If these rules were adopted. the banks make the depositors pay the zaka. who is now able to use it as he wishes. and share in both profits and losses. in practice. if this mu. But actual practice does not seem to be satisfactory. but it would conform to Islamic principles. in addition to using these deposits to make interest-free loans. then the problem is especially serious for the Banks. a Bank. yet these also occur. There is another unsatisfactory point about these deposits. If it is in the form of monay. and from shareholders' funds. The Banks would not lend or invest these deposits. A compromise is to base their returns upon their share of investment profits for the year. and others from depositors. if the depositors are confused. as some funds come from shareholders. this might be done every few years. both of which are contrary to Islamic law. The Islamic rules would base returns upon actual profits and losses. should cease business and return all capital.loans made by themselves to the banks. An Islamic loan transfers ownership of a property to the borrower. deceived. seeing that the shareholders appoint the managers. In theory. profits may be re-invested. when the shareholders can make profits using their money. it was decided that. or worse still. for their benefit. At the First Conference on Islamic Banking. they would keep the deposits safe for the customers. might ask whether the Banks favour their shareholders at the expense of their depositors. In some Banks. It would seem that. not as loans.the volume of such deposits would be small. But it seems unfair that the depositors should get no cash return. Ideally. In some countries. so there would be no chance of the Banks' shareholders getting an unfair advantage at the expense of the depositors. then it is the banks which should pay zakd on them. No re-investment of profits should occur until an Islamic partnership is wound up. shareholders do get more than their fair share of total profits. returns are partly estimated on this basis but managers also try to ensure that account holders get the rate of return they expect. Nor should there be any interim profit distributions. this looks inefficient. then there is either ambiguity or fraud. the Banks would also be allowed to invest them for the benefit of their shareholders. as an Islamic partnershp. in 1979. but as deposits in the Islamic sense. with 65 . because the depositors can genuinely be partners with the Banks' shareholders. An outside observer. separate from investment deposits. In reality. The Banks would charge for services provided. this rate is even linked to interest rates. then he has an obligation to pay Zaka out of it. Depositors would put most of their funds into investment savings accounts or investment accounts proper. The answer might be for the Banks to treat non-investment accounts. There is also the question of whether Islamic Banks are keeping to the rules about partnershps. Also. these investment accounts are satisfactory from an Islamic point of view. prior to the annual distribution. If these deposits are indeed loans. In theory. Compared with conventional banking. However.ddraba view is correct. Some scholars believe that the working partner in should not mix the capital of the various suppliers of funds. but investment account holders expect returns annually. before distribution of profits.

However. e. The investment practices of Islamic Banks also look doubtful. 66 . and then charges the customer a price which includes its profit. imported. and this does not conform to Islamic teaching. Even here. finance has to be long-term. Some of the defects could be remedied fairly easily. and potentially profitable. agreeing to pay for them when they arrive. Not all scholars would accept that modern murabaha trade is risk-free. there seem to be serious defects in the banking and investment practices of existing Islamic Banks.g. insurance. Such investment would promote social welfare in the relevant countries. the investment activities of Islamic banks do not. the usual rule is to look for a definite rate of return. this trade involves no risk.g. The goods may be domestic or. whereas the Banks can only offer fairly short-term finance. The dominant investment activity of Islamic banks is not partnership.g. on the criterion of conformity to Islamic principles. The problem is that. but also loan-free. but others probably could not. In a simple case. but the crucial point is that the activity is doubtful.seem to be in strict accordance with Islamic principles. but investment clubs. the return would be zero. Quite often. for industry. e. It seems unfortunate that the Banks have invested so little in industry. Some investment activities are doubtful. Islamic Banks also engage in some investment activities which are generally thought to be contrary to Islamic law. or investment trusts. speculation in precious metals. these institutions would resemble. investment opportunities for Muslims.g. and pious Muslims ought to avoid doubtful activities. The Bank pays for them. the Muslim investor will find this unsatisfactory.a fair division as between the depositors and shareholders. To sum up. and that their partnership arrangements would conform to Islamic principles. a customer orders goods through his Bank. and provide finance for industry. the Banks being certain of their profit. more often. if they are sure that the customer will take the goods. e. not conventional banks. based on the interest rate. as it is a form of sale with deferred payment. But risk-free return is forbidden to the Banks. It is probably fair to give some return to depositors who have to withdraw their funds early. Reforms of this type would mean that the Banks would be not only interest-free. e. construction. so much of which would provide allowable. and therefore to be avoided. In some years. We ourselves believe that Islamic institutions could be devised which would satisfy the religious requirements. As the Banks were set up in order to observe Islamic law in their investment activities. some modern Muslim scholars doubt whether the murabaha trade actually practised by these banks conforms to Islamic law. Overall. but murabaha trade. Little of their investment is in activities which Islamic scholars would regard as definitely lawful. This trade appears to be satisfactory.

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