Accepted Manuscript

Title: Uncertainty and risk management from Islamic

perspective

Author: Ghassen Bouslama

PII: S0275-5319(15)30060-X
DOI: http://dx.doi.org/doi:10.1016/j.ribaf.2015.11.018
Reference: RIBAF 472

To appear in: Research in International Business and Finance

Received date: 31-5-2015

Revised date: 16-10-2015
Accepted date: 23-11-2015

Please cite this article as: Bouslama, G.,Uncertainty and risk management from
Islamic perspective, Research in International Business and Finance (2016),
http://dx.doi.org/10.1016/j.ribaf.2015.11.018

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UNCERTAINTY AND RISK MANAGEMENT

FROM ISLAMIC PERSPECTIVE

Abstract
Most decisions are taken in very uncertain contexts and all objective economic behavior is
dictated by the efforts of different agents to protect themselves against uncertainty. So, how to

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act in the face of uncertainty to minimise the harmful consequences of recurrent financial

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crises? The purpose of this article is to answer this question by highlighting the ethical aspect
of investments and finance from the Islamic perspective, which notoriously, forbids excessive
uncertainty, gharar. Islamic law proposes a legal framework that specifies the rules by which

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risk is understood, managed, taken or shared. The way the Islamic financial system resisted
the recent crisis leads us to study its unusual interpretation of risk. We also investigate

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whether Islamic ethics as an alternative could help to prevent the disaster of repeated financial
crises.

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ed
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Page 1 of 15
1. Introduction

The study of recent or older financial crises always raises the same question: why do such
crises recur? We can always learn from previous crises, but we can be almost certain that they
will reoccur in the future. From a post Keynesian perspective, the feature shared by the recent
subprime crisis and those that preceded it – such as the American savings and loan crisis at
the beginning of the 1980s or the Japanese bubble economy at the end of the 1980s – is our
inability to deal with “uncertainty.”
The consequences of current individual actions come about in the future. To take rational,

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objective decisions, it is first necessary to draw up congruent forecasts. However, in the real

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world, most decisions are taken in very uncertain contexts. According to the Keynesian
approach, all objective economic behaviour is dictated by the efforts of different agents to
protect themselves against uncertainty. This raises the question of how to act in the face of

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uncertainty to minimise the harmful consequences of recurrent financial crises. This article
attempts to answer this question by highlighting the ethical aspect that distinguishes

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investment and finance in the Islamic approach, which notoriously forbids excessive
uncertainty (gharar).
Islamic finance came to prominence in the 1960s thanks to renewed interest in religion in
Muslim countries and the accumulation of large foreign exchange surpluses in the Gulf
an
countries. It has internationalized rapidly due to migration but also to the increasingly urgent
need for moral attitudes and practices at a time when financial excesses are too often the
cause of economic crises (Warde, 2010). Indeed, many people asserted during the last
financial crisis that the aim of Islamic finance is to make ethical finance available for the real
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economy. Therefore, the principles underpinning this type of finance are that it could be an
ethical alternative to conventional finance, the limitations of which have become clear during
the recent crisis.
ed

The aim of this article is to analyse the notion of risk from an alternative angle, using
Islamic financial and economic principles. Islamic law proposes a legal framework that
specifies the rules by which risk is understood, managed, taken or shared. The way the
Islamic financial system resisted the recent crisis (Ben Khediri et al., 2015) leads us to study
pt

its unusual interpretation of risk. We also investigate whether Islamic ethics as an alternative
could help to prevent the disaster of repeated financial crises.
First, the article describes the principles of Islamic economics and finance. The second
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section investigates the Islamic approach to risk in individual decision making. In the third
section, we discuss the Islamic approach to uncertainty, gharar, in bilateral and multilateral
transactions. Finally, the article illustrates the Islamic conception of risk management.
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2. Foundations of economic and financial principles in Islam

To the extent that all economic and financial transactions involve a more or less significant,
more or less fleeting degree of more or less implicit trust, Algan and Cahuc (2010) show that
distrust can have an extremely negative impact on economic and financial activities. This
makes it useful and/or necessary to resort to theological and religious values in that they allow
the establishment of trust between individuals. In this sense, Islam is a religion that embraces
all aspects of life and does not restrict itself to religious worship. Indeed, through its two
principal sources, the Koran and the Sunnah (the words and action of the prophet of Islam, set
down by his companions), Islam guides Muslims and frames every area of their existence on
earth (worship, interpersonal relations, organisation of society, economy, civilization, way of
life, etc.), which is by definition limited and transitory. Its initial aim is earthly wellbeing, and
its ultimate goal is salvation and eternal happiness hereafter.

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Page 2 of 15
 The Islamic approach to economics and finance aims to guarantee the interest and long-
term development of human being by making the most of the earthly resources that God has
created for us. This endeavour to steward and develop the earth is based on the pursuit of
good, equity, solidarity, cooperation, mutual help and sharing, and on the proscription of evil,
individualism, excess and exploitation of the weak or of those in precarious or vulnerable
situations. Islam takes into account the overall, lasting dimension of people’s interests,
including personal, social, political, economic, environmental and civilizational aspects
(Sabiq, 1999; Warde, 2010; Charkaoui Malqi, 2000).
Whilst the leading scholars in Islamic law have not developed genuine economic and
financial theory, the Islamic approach in this area nonetheless favours solidarity, as

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mentioned, but is also liberal and non-monetarist. Indeed, it approves of private property,

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individual initiative and free pricing without using currency price adjustments. Moreover, the
Islamic conception promotes economy regulation to encourage progress and sustainable

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development and, more generally, economic activities with positive collective value
(investment in infrastructure, human capital, innovation, technology, etc.).

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2.1. Islam and private ownership of capital

According to Koranic texts, the absolute and highest right to property belongs only to God.
On earth, the Muslim only holds the usufruct of this property. This religious conception is not
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opposed to the earthly practice of property rights, whose limits are defined by Sharia: goods
legitimately acquired (purchase, inheritance, exchange, gift, etc.). Sharia sanctions private
property and full enjoyment of this property, as long as this does not harm society or public
interests. Muslims must make good use of their resources and develop them in harmony with
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the principles of Islam, for their own benefit but also to share a part of his wealth and allow
society to profit from it.
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2.2. Islam and work

The right to private property, which is sacred in Islam, encourages the Muslim to work and be
productive. The importance of work is so great in Islam that it is raised to the level of
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worship. The vision of work covers all lawful activities that are genuinely useful for human
being and for the satisfaction of his legitimate needs. Fundamental to production and wealth
creation, all work deserves an adequate and equitable reward.
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2.3. Islam and redistribution of wealth

Whilst differences between individuals exist and can lead to both conflict and
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complementarity, Islam seeks to reduce their extent by promoting solidarity and social justice.
Indeed, the enjoyment of wealth is only authorised if it is reasonable and balanced, and
insofar as a proportion of it is given to the needy. Thus, wealth must be used first to satisfy
personal needs1 and then to help others. Zakat, obligatory almsgiving, is one of the five pillars
of Islam; it constitutes what may be described as an annual solidarity tax to help the needy,
whoever they may be2. Furthermore, the Waqf, or houbous, enables to dedicate a productive
asset permanently in favour of a specifically designated cause, person or group of persons.
Thus, Zakat and Waqf can be seen as the instruments of intra- and inter-generational solidarity
within the Islamic framework.

1
Needs should be satisfied according to a number of priorities: first necessities, then utilities and
finally refinements.
2
Zakat is not the same as Sadaqa, optional almsgiving that is, nonetheless, strongly recommended.
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2.4. Islam and finance

The Islamic approach sees finance as serving the real economy. More precisely, Islam
considers that money is only the measure of wealth, not wealth itself. Money is thus not a
good in itself, it is intrinsically unproductive and as such, there is no reason to pay for it. As a
general rule, excessive, unavoidable risk, uncertainty, the use of interest (riba)3, speculation
(maysir), monopolies (ihtikar), hoarding wealth (iktinaz), gain without work and/or
appropriate risk-taking, deception and investment in unlawful activities or assets such as
gambling and alcohol, are prohibited4. The Islamic alternative is that capital and work should
be linked in participatory operations. It is important in this context to note that given the

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principle that everything that is not contrary to the precepts of Sharia is considered as lawful

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and that of "easing" (yusr), Islamic finance intrinsically promotes strong innovation. This
means that the range of possible Islamic financial solutions and contracts is very wide.

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Indeed, the main standard contracts (Mudaraba, Mucharaka Salam, Istisna'e, Murabaha,
Ijara, etc.) should not be considered an exhaustive list of Islamic contracts but only those that
are currently most used by a still very young Islamic financial industry (Foster, 2007)5, acting

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at present as a “processing” industry rather than a pure “innovation” industry6.

3. Risk in individual decision making

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The definition of risk varies, depending on its application or the discipline. It also has
different connotations and suggests different meanings to different people.

3.1. Definitions and origins

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In microeconomics, risk refers to uncertainty over the consequences (positive or negative) of
a decision. For financial economists, its connotation is generally negative, referring to
potential losses. Despite the apparent ambiguity around the definition of the word risk, it is
ed

possible to consider risky situations as characterized by the possibility of identifying various

future situations and the ability to assign to each of them a probability of occurrence7.
If we study the etymological roots of the word risk, we find that it comes from the Italian
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term rischio (Magne, 2010). This refers to the possible damage or negative consequences
resulting from unforeseeable circumstances. The connotation here is clearly negative. The
origins of the word rischio are to be found in the terms risico and risco. These expressions
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3
Beyond divine prohibition, it is possible to advance two main explanations for the prohibition of the
use of interest. First, it is like asking the borrower (deficit agent) to increase the lender's resources
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(surplus agent), which is illogical and unreasonable, and can be seen as a form of morally
reprehensible exploitation. Second, the cost to the borrower entrepreneur is more important, ceteris
paribus, than that of an entrepreneur with no debt. This difference in cost may, in some cases, lead the
indebted entrepreneur, under pressure (legal and contractual commitments and obligation of project’s
success), to fraudulent practices (sale of poor quality products or services, infringement of
professional ethics, etc.) that can harm not only the entrepreneur himself but also other parties (clients,
institutional partners, population, environment, etc.) not concerned by the original loan agreement.
4
These prohibitions are counterbalanced by the obligation to remunerate lawful work and legitimate
risk taking.
5
Indeed, Islamic finance is around forty years old, compared with more than four centuries in the case
of conventional finance.
6
Indeed, the Islamic financial industry is currently mainly a “processing” industry attempting to make
conventional financial paradigms, solutions and products Sharia compliant.
7
As opposed to uncertainty, which characterizes a situation where, because of its complexity and/or
opacity, the future is unknown.
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Page 4 of 15
were common among traders as early as the thirteenth century. They were used to refer to
companies that could make a profit or a loss. Before this, the terms had been used to refer to
the results of hazardous, uncertain situations. The Latin root is unclear, but they might be
related to the term resecare (re = back and secare = cut) which means to cut away or to
remove. According to Magne (2010) and El-Gamal (2000), the meaning of the word may
originate in sea transport, referring to the possibility for a ship’s hull to be holed by a rock or
a reef. More widely, it could refer to the “risk shared by two contracting parties” and therefore
“the risk of losing merchandise at sea.” In other words, risk means “danger of loss.”
However, the origins of risico and risco are not quite clear. The most frequent hypothesis
links the Italian risico to the Arabic word rizq. The modern conception of this Arabic word

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refers to “a thing from which a person profits” or “something that is loaned to someone

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without gain.” Rizq therefore has generally neutral connotations. In its religious sense, the
term rizq means “the daily provision allotted by God to each man.” At the beginnings of

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Islam, rizq referred to “the regular wages soldiers are entitled to.” The word rizq entered
Arabic via Syriac Aramaic, originating in the Pahlavi (a Persian language spoken between
300BC and 950AD) rôcik, which means daily bread, from Roc "day" (-Ruz in modern

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Persian). This term is related to the Avestan (spoken before 400BC) term raocah “light” and a
Sanskrit (after 1800BC) term meaning “brilliant, radiant.” The Pahlavi term rôcik entered
Arameic as “daily provisions”, and then changed its meaning to become “bread.” It then
entered Syriac (third to seventh centuries AD), where it signified “daily portion.” From there,
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it became part of Arabic. Until mediaeval times, the word risk had apparently neutral
connotations, referring to the future, Man’s “income,” which is subject to uncertainty.
Thereafter, the term seems to have been restricted to negative results compared to its sense in
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mediaeval Italian. What is clear is that the word risk has a long and fascinating history, which
may well explain the ambiguity surrounding its definition today.

3.2. Risk in Islamic approach

ed

Islam distinguishes clearly between two different forms of risk. Although there can be cases
when it is difficult to distinguish between them, the general frame is nonetheless clear. The
two types of risk are:
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 Risk linked to economic transactions, in other words activities that create value added or
wealth;
 Risk associated with gambling “eating wealth for nothing” or, according to Al-Suwailem
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(2002) referring to zero sum activities, where no additional wealth is created.

According to Al-Suwailem (2002), associating risk with the possibility of losing is
unacceptable to the Islamic approach, given that its principles clearly call for the conservation
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and development of wealth. Risking a loss of wealth cannot be an aim in itself. This can be
considered in the same way as difficulties. Many actions involve difficulties that are not
desirable in themselves. According to Sabiq (1999), the reward for such actions is based on
their usefulness and not on the difficulty of carrying them out. A good action may be difficult,
but if it is considered good, this is not because of its intrinsic difficulty but because of its
usefulness and its impact. More precisely, the reward for an action can be significant if it is
difficult; not because the difficulty is the aim, but because the action involves difficulties. In
other words, when determining the value of an action, difficulties are a secondary
consideration. The principal concern is its usefulness. Consequently, the value of the action is
a reflection of its difficulty, but only if the action is useful.
According to Al-Suwailem, (2006), the same reasoning applies to risk, since it is a form of
difficulty. Risk is not in itself desirable, even if it is an intrinsic part of almost all economic
activity. However, the value of an economic decision is not mainly determined by the risk it

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involves, but by the wealth and value added it creates. Consequently, the value reflects the
risk, but the risk does not determine the value. Hence, risk taking is permitted for the value it
adds and wealth it creates, not because the risk is desirable. This distinction creates a
fundamental difference between legitimate risk and forbidden risk. Risk is legitimate when it
is necessary for the creation of value. However, when no value is created, risk is considered as
a form of gambling. The question that arises here is how to differentiate between legitimate
and forbidden risk in the context of the Islamic approach?
Three principal criteria are generally used to determine whether the risk is acceptable: its
degree of inevitability; its importance; and finally the degree to which it is intentional.
The first criterion implies that value cannot be created without the risk of loss or

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bankruptcy. Risk is inseparable from real transactions and value creation. In the Islamic

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context, separating risk from real transactions would create more risk and would lead to
greater instability in the economy. For example, trading debt for a specific price is forbidden

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(conventional securitisation). More generally, all derivative products in finance, whose
structure is based on separating risk from ownership, and hence from operating activities are
forbidden in Islamic finance.

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The second criterion concerns the degree of risk. According to Islamic thought, for the risk
to be acceptable, the possibility of failure must be lower than that of success. Thus, gambling,
which is based on a strong possibility of losing, is forbidden in Islam. This type of behaviour
is correctly described as a deception and an illusion. The decider is fooled by the size of the
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prize to be won, and so behaves as if the probability of obtaining the prize was high, whereas
in fact, the possibility is tiny, and the risk of losing your stake is very high.
The third criterion follows on from the other two. The purpose of normal economic activity
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is the value that it creates, and not the risk that it involves. This risk cannot therefore be
planned as part of the transaction. An agent’s decision should be motivated by an intention to
succeed and to create value, and not based on a strong possibility of losing. This rule makes it
possible to distinguish between investment and gambling. The principal difference between
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the two is the probability of success. An entrepreneur launches a project because he is

convinced that it will succeed. A gambler knows in advance that he will probably lose, but the
size of the prize to be won persuades him to commit himself to a project that will probably not
succeed. Thus, an action that more often leads to failure than to success cannot be considered
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as a cause of success; it is a cause of failure.

3.3. Risk approach and financial crises: main stability factors of the Islamic framework
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Conventional finance has suffered from its own excesses whose climax was reached at the
last crisis of end of 2007 (Warde, 2010). Indeed, excessive risk taking, systematization of
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information asymmetry situations and unbridled financial technicality are engines of out-and-
out private profit maximization which has shown its dangers. Excessive use of derivatives
before during and even after the last financial crisis had negative consequences on the
stability of banking system (Keffala, 2015). Similarly, past research has shown some resilience
of Islamic banks during the last crisis. In this sense, Ben Khedhiri et al. (2015) found that the
risk level is lower for Islamic banks than for their conventional peers. In this context, it is
possible to identify in Islamic approach some stability factors, in particular:

 The materialization through the backing of funding to a related specific real assets makes
that yield can only come from a real asset,
 The proscription of the total or partial transfer of liabilities and short sales that are
intrinsically speculative transactions providing no real added value to the economy.

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 Furthermore, financial techniques such as securitization disconnect the assets created
from their underlying particularly in terms of risk assessment which accentuates
information asymmetry situations, catalyst of all-around speculation,
 The specific approach to risk and the coupling of the asset funding cost with its actual
performance. Indeed, unlike conventional finance, which seeks to separate the risk from
its underlying asset8, Islamic finance emphasizes risk to better understand and control it9
and requires it to be an unavoidable part of lawful productive activities. Specifically, the
Islamic approach extols the pooling of risk and therefore the equitable sharing of profit
and loss (Haberbeck, 1987)10 between the parties in a balanced agreement where one
person’s gain is not based on another’s loss11. In these conditions, the risk of an asset or

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project (which is the basis for determining the cost of the funds that have financed it) is

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genuinely linked to its yield. The excessive use of financial leverage is thereby
considerably limited, since the remuneration of the capital lessor depends directly on the

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real operating profitability of the asset, as opposed to financial profitability, which can be
“boosted” through high gearing,
 The screened and responsible process of assets selection, taking into account the intrinsic

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nature of the project, its quality, its viability, its profitability but also the implied risk and
not only the quality of the entrepreneur and guarantees he brings. The compliance with
Sharia is another important selection criterion, which excludes all assets and activities
that are unlawful, unethical and directly or indirectly harmful to people, their integrity
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and their environment. Islamic financial institutions are therefore more protected against
loss of assets than their conventional counterparts, and in doing so, at least in theory,
enjoy greater capacity to absorb shocks.
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4. Risk in bilateral and multilateral decisions: concept of gharar

While the previous section discusses risk in individual decision making, this section
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concentrates on the Islamic approach to risk in bilateral and multilateral decisions formalized
through contracts12.
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8
The concept of risk-free assets, techniques such as securitization, structuring and financial
derivatives respectively aim to minimize, mitigate or break free of risk by transferring it to others.
9
However, it is necessary for the risk taken to be identifiable and not excessive.
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10
Specifically, it is possible to consider different profit-sharing rules for different risk profiles. This
would lead investors to become more involved in choosing the projects they intend to participate in
and of which ultimately they bear the related risks.
11
This describes the zero-sum games situations regarded as morally weak or reprehensible.
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12
A contract allows two pledges to be linked and leads to legal obligation in favor of a single party in
the case of unilateral contracts such as donation contracts, or for the benefit of all parties in the case of
bilateral and multilateral contracts, such as sales contracts, rental contracts, company contracts, etc.
For the latter type of contracts, the presence and consent of the parties are required for validity (Sabiq,
1999; Noor, 1988). According to their purpose, it is possible to distinguish two main types of
contracts:
- Contracts aiming at capital fructification, through which each party seeks what belongs to the other
party. In doing so, each contracting party gets a counterpart to what it offers, such as the sale or lease.
These contracts give rise to reciprocal obligations to contracting parties. Besides the legal ability of the
parties to contract and discernment, the validity of this type of contract is dependent on the lawfulness,
precise specification and availability of its object and on the determination of the transaction price
(Noor, 1988),
- Contracts aiming to perform charity work (unilateral or donation contracts) are contracts that give
rise to liabilities for a single party, namely the donor who agrees to deliver the object of the donation
to the recipient of the donation.
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4.1. Presentation and Analysis of the Concept of Gharar

In general way, the word gharar means risk (El-Gamal, 2000, 2006). It can also mean
deception and illusion. The two meanings are quite similar in contexts where there is a high
probability of failure of winning a very large prize, such as in lotteries or forms of gambling
where the size of the prize encourages the agent to take part in a competition he is almost
certain to lose (Al-Suwailem, 2006).
After the ban of riba, that of gharar is the second most important Islamic prohibition in the
area of economic transactions. It has been very widely studied by Islamic contract law
scholars (Sabiq, 1999).

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Etymologically, the word gharar means trickery, deception or imposture and describes

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everything that appears attractive, but behind which danger is hidden (Sabiq, 1999). It comes
from the verb "gharrara" or "gharra" which means to profit from a person’s naivety or

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ignorance and expose him or his property to danger or loss. We see from this that the most
important feature of gharar is deception, and giving the victim erroneous or partial
information that hides the truth. Used as a verb, the term means to deceive, but as a noun, it

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can have other meanings such as danger or unknown quantity.
According to Sabiq (1999), gharar had been defined in various ways. Three principal
points of view have emerged. First, gharar applies to cases of uncertainty such as when an
event may or may not occur. A second point of view considers gharar as the trading of an
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unspecified object. Thus, in sales contracts, gharar occurs when the buyer (seller) does not
know what he has bought (sold). The third approach is a combination of the first two. Thus,
gharar covers both what is unknown and what is uncertain, and occurs when the
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consequences of a contract are unknown. Gharar is thus one of the most difficult Islamic
legal concepts to define. It can cover various aspects such as unknown quantities or
contingence, uncertainty, excessive, avoidable risk, speculation, ambiguity and information
asymmetry.
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A bilateral or multilateral contract tainted by gharar is a contract whose consequences are

uncertain, and which aims to wrongfully gain possession of another’s property. More
specifically, gharar can concern either the legal formulation or the subject matter of the
contract. Gharar in the legal formulation refers to the existence of ambiguous, opaque terms
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or clauses leading to contingency or ignorance, such as making two transactions in one, sales
contracts with circumstantial conditions and so on. Gharar in the subject matter of the
contract might be due to incomplete information or ignorance of key features of the contract,
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such as the identity, nature, type and features of the principal goods or services covered by the
contract, the quantity, the date, or delivery conditions and procedure.
The prohibition of gharar in the Islamic approach is based on several factors:
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 In its sense as the unknown, contingency or chance, which is close to the concept of
"maysir"13: on the immorality of gains that are not justified by work,
 In its sense as uncertainty or risk: on excessive avoidable risk taken by the parties to a
contract and the need to protect them from this14. Conditional contracts, due to the
uncertainly that they entail, are generally considered invalid since the parties do not know
whether or when the contract will be executed,

13
Risk taking prohibited by Islam is related to uncertainty that is not part of everyday life. Taking such
risk, for example that which is inherent in gambling, is unnecessary both at the microeconomic level,
since individuals who do not take part do not have to bear the risk for those who do, and at the
macroeconomic level, since it adds no real value to the economy.
14
However, entrepreneurial risk, inherent to legal activity, is not included in this prohibition.
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Page 8 of 15
 In its sense as speculation: on the danger to society represented by speculation and by
monopolizing goods and services,
 In its sense as ambiguity or information asymmetry: on the need to prevent parties from
deceiving, profiting from or exploiting others fraudulently and dishonestly. Zero-sum
trading sums up exactly what is to be avoided: these are transactions in which one party
makes a profit at the expense of the other, which results in a win-lose situation. The
prohibition thus aims to prevent injustice, animosity and hatred between individuals.

4.2. Quantification of Gharar

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Since it is impossible for contracts to be absolutely watertight, a certain degree of risk and

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uncertainty is almost always involved. Thus, the evaluation of gharar varies from one
situation to another. It is almost impossible to quantify it exactly using precise criteria. It is

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therefore a relative concept, and it prohibition is not as generalised and systematic in every
situation as, for example, riba. Gharar is prohibited in cases where uncertainty or vagueness
gives rise to the possibility of iniquitous or unwarranted consequences or gains that benefit

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one party at the expense of the other. The degree of gharar is evaluated by a rigorous analysis
of the costs and benefits.
According to Sabiq (1999), scholars identify two principle types of gharar:
 Major or excessive gharar: invalidates bilateral contracts in which it is present insofar as
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it cannot be avoided without causing significant prejudice to one of the parties and
leading to a possibility of conflict in the long term. Legal experts identify four different
criteria for excessive gharar: uncertainty over availability of the principal goods or
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service covered by the contract; uncertainty over delivery and obtaining the goods or
services; uncertainty over the quality or value of the goods or services (the amount of
compensation in case of accident or loss for example) or uncertainty over the term (date
of compensation payments in the case of an insurance policy, for example),
ed

 Minor or trivial gharar: the presence of this type of gharar is tolerated in bilateral
contracts, since it does not prevent execution of the key features of the contract. The
principal features of this type of gharar are:
 It’s extremely limited significance to the main purpose of the contract. For
pt

example when hiring an object for one month, the exact number of days can be
more or less than 30 days. In this case the cost of the uncertainty is very limited
(3.33%) relative to the monthly hire charge,
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 Its subsidiary and unpremeditated character; it is unrelated to the main purpose of

the contract. It is often ancillary to this purpose and independent of the parties’
wishes. This is the case, for example, when one sells a house without knowing
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how solid the foundations are,

 Its unavoidable nature; if this gharar is forbidden it may well result in significant
danger for one or both of the parties. In cases of forward sales – salam and
istisna’e – the goods covered by the contract does not yet exist when the contract
is signed, which implies the existence of excessive gharar. However, since this
type of contract funds industrial and agricultural activity that could not be carried
out without such funding it is considered valid despite the gharar that is involved.
Similarly, whilst conventional insurance activity involving excessive gharar is
prohibited due to the existence of alternative lawful forms namely takaful
insurance companies, the latter may use conventional reinsurance methods since
alternative legal reinsurance companies do not exist, at least at the present time.
According to Sabiq (1999), excessive gharar invalidates bilateral and multilateral contracts
since it implies that one of the parties will not obtain part or all of the compensation that he

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deserves15. Concerning minor gharar, it is deemed that it does not invalidate bilateral,
multilateral or unilateral contracts.
Finally, whilst intermediate gharar (midway between major and minor gharar) does not
invalidate unilateral contracts, its impact on bilateral or multilateral contracts depends on the
opinions of different legal schools.

4.3. Principal Exceptions

Islamic Sharia allows a certain number of exceptions to the prohibition of gharar in contracts,
firstly due to the type or nature of certain contracts and secondly due to consideration of the

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notion of necessity (Sabiq, 1999; Charkaoui Malqi, 2000).

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Exceptions due to the type or nature of certain contracts: Gharar inherent in the
mechanism of specific contracts is allowed when it does not result in prejudice for either of
the parties, and in particular:

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 Uncertainty in a profit-sharing contract is not illicit, since the purpose of the contract is to
share the profits. However, the risk must be shared between all the associates, following
the principle of “gain against guarantee” (al kharaj bi damane). Indeed, unlike bilateral

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contracts based on competition between buyers and sellers, company contracts are
contracts involving cooperation and complementary activity. Moreover, in this type of
contract, uncertainty (making a profit) is not the principal aim but is ancillary and
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inherent in the activity. Moreover an economy cannot exist without companies which are
the basis for production and the distribution of goods and services. They are useful for the
community and therefore in the general interest,
 The Jiala contract (reward): this contract involves more or less uncertainty. It consists in
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giving a predetermined compensation for a task or a service to be accomplished, such as
finding lost property, mining or water table exploration, debt recovery and so on. The
work that will be necessary in such cases cannot be precisely predetermined 16,
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 Muzara’a and Musakat contracts: in these contracts, one party farms land belonging to
the other, and receives part of the harvest. By its nature, this part cannot be
predetermined17.
Exceptions due to necessity (darura): Ardent or imperious necessity18 or darura, makes it
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possible to deviate from the general rule of prohibition and gives scholars some room for
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15
Sabiq (1999) stipulates that the Maliki legal school of Islamic thought considers that excessive
gharar does not invalidate unilateral contracts since the beneficiary offers nothing to deserve
compensation. He has thus no reason to fear for the loss of that which he offers as in the case of
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bilateral or multilateral contracts, since he has not given anything up. The fact that the donation is
large or small, or that it is to be made immediately or later, is therefore of no importance.
16
In the case of the jiala contract, the exception to the prohibition of gharar is also based on the need
for the party offering the reward (ja’il) to have the licit task or service carried out by another, without
being able to so using a work contract because of the uncertain nature, importance and place of the
task or service. Note that this uncertainty is not necessarily disadvantageous to the worker; since the
result may be attained by more or less work. Moreover, this type of work can be terminated without
prejudice by either of the parties except when the worker has already begun work or when the worker
undertakes not to break the contract for a predetermined period (Wahidul Islam, 1998).
17
The validity of this type of contract is based on the fact that the imprecise nature of the
compensation is dependent on the very nature of the contract, which can be seen as a profit-sharing
contract by which the profit is shared between the associates, the owner of the land and the farmer.
Moreover, this uncertainty is not organised and does not benefit one of the parties at the expense of the
other. The compensation is indeed dependent on the quality of the work provided by the farmer, but
also on the weather conditions.
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manoeuvre. It results from the important principle of “easing” or “avoiding difficulty”. Thus,
in cases of necessity, the presence even of excessive gharar in certain contracts does not
automatically invalidate them.

5. The Islamic approach to risk management: the case of Islamic insurance

This section is divided into two points. The first deals with the Islamic attitude towards risk
management, while the second offers a comparative approach to risk management in Islamic
and conventional frameworks.

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5.1. Islam and Risk Management

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The conservation of capital, goods and property is one of the aims of Sharia. Similarly,
Sharia strongly recommends solidarity, cooperation and mutual assistance to circumvent the

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risk individuals may encounter. However, the purpose of risk management must not be profit,
and must not take the form of bilateral or multilateral trading contracts, given the high degree
of uncertainty inherent to contracts transferring risk from one party to the other in exchange

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for compensation. The core principle in this context is that everything possible must be
undertaken individually and/or collectively to avoid or reduce risk. Muslims are required to
use all available means even when insufficient to attain their objectives. Indeed, the end result

totally control, and ultimately on the will of God.

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of the actions they undertaken depends on a huge number of factors that human being cannot

Thus, Islam encourages us to manage risk as long as it does not involve any practices
prohibited by gharar, chance, the charging of interest or injustice. Nor must it be carried out
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merely for reasons of profit.

5.2. Risk Management: Conventional Approach Vs Islamic Approach

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Generally speaking, risk management consists in identifying and analysing it before

attempting to control it, understand its limits and assess its potential impact. Controlling or
funding risk is most often split between controlling material risk, which involves making
every effort to reduce it in terms of frequency and impact, and controlling financial risk,
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which can be undertaken within physical or corporate entities or externally. Internal control is
possible when the entity has sufficient resources of its own to deal with the potential impact
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represented by the risk. This is the case in particular for risk involving potentially very
frequent events resulting in low levels of loss. For high-level risk, which entities do not have
sufficient available internal resources to tackle, two principal approaches are possible. The
first conventional approach is to transfer the risk to exogenous entities, i.e., insurance
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companies or financial markets. This makes it possible to exchange the uncertainty inherent in
potential risk for the payment of a premium or a price. Note that insurance companies only
cover non-systematic risk and pure risk subject to variables whose behaviour is dictated by a
law that can be described and anticipated, commonly known under the term probability
distribution. Pure risk only results in loss, unlike speculative risk,19 which arises from
individual behaviour and can result in loss or gain. However, it is important to stress that the
main purpose of the entity to which the risk is transferred, the insurance or financial market, is

18
The ardent or imperious necessity must be effective and must have no legal alternative. It occurs
particularly when the life and/or property of an individual are seriously threatened or may be lost if he
respects the prohibition.
19
Financial markets offer financial products known as derivatives, which enable speculative risk to be
covered.
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to make a profit, which is not necessarily in any way to the advantage or benefit of the entity
that faces the initial risk.
Alongside this first conventional approach, an alternative approach consists in sharing or
mutualising20 comparable risk face by different entities within an ad hoc organisation. This
ethical perspective is typical of risk management in the Islamic context. Indeed, as well as
attempting purely and simply to avoid gharar and/or to reduce it to a bearable level, this type
of management can involve using Islamic insurance services, or takaful, based on the
principles of solidarity and mutual assistance, to deal with material, and in particular financial
risk (Khorshid, 2010; Haberbeck, 1987)21.
Takaful insurance consists of an agreement between the Islamic insurance company, as

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representative of the members, and an individual or company who wishes to be insured.

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Under this agreement, the latter undertakes to pay an insurance policy in the form of a
donation (principal and income) to the insured members’ account. In return for this, the

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member receives compensation from the company in the event of accident or loss, in
accordance with the technical clauses of the insurance contract and the statutes of the
insurance company (Khorshid, 2010). Unlike conventional insurance companies, the

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policyholder insures himself in a takaful scheme. Furthermore, the moral hazards are low in
takaful insurance, and more generally in schemes based on sharing, cooperation and
solidarity. Indeed, since it is in the members’ interest to reduce potential risk as much as
possible, since they pay the cost of this risk, and not a third-party insurance company. Their
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aim is not to make money but to cooperate to overcome the accidents and loss that each of
them can suffer from.
The accounts of the takaful company are separate from the members’ account. The
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insurance company has a mandate to manage the account of the policyholders, to collect
premiums and to pay compensation. It invoices the members’ account for administrative costs
and reinsurance, as well as fixed management charges or a percentage of any surpluses on the
account. If premiums and payments by reinsurance companies are not enough to cover
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compensation, the Islamic insurance company does not cover this deficit as is the case for
commercial insurance companies, but makes an interest-free loan to the members’ account,
which it recovers gradually over a period of time. If it makes a profit, the takaful company
distributes all or part of it, after setting aside a reserve, to members who have not benefited
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from compensation, in proportion to their premium payments.

The directors of the takaful company must ensure that the activity is properly managed:
identification and precise analysis of risk; management of subscriptions to enable
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compensation payments but maintain members’ payments at an acceptable level; balanced

participation and risk sharing. They are simply “agents” for the members, responsible for
taking care of members’ interests. They must take care to increase the value added of their
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work, which means they firstly must constantly improve their work by analysing risk and
subscription assessments ever more finely and secondly have to justify their decisions to the
members. These two factors make takaful a totally integrated risk management system, since
the risk is not transferred to a third party (insurance company or financial market). Moreover,
takaful is completely in line with good organisational management practices, notably
transparency and the obligation to justify decisions.

20
Statistically, insulated high intensity risks grouping allows, at the aggregate level, reducing them
individually.
21
In theory, given the prohibition of gharar and maysir, derivatives are illegal. However, in certain
conditions, the use of certain derivatives is authorised and has been standardised as part of the
Tahawwut agreement signed in 2010 between ISDA and IIFM (Causse Broquet, 2012; Foster, 2007).
Moreover, to manage risk, Islamic institutions may, as well as building up reserves, use contracts such
as arbun and waad, which are similar to options contracts.
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6. Conclusion

Whilst risk and its management are one of the fundamental areas of conventional modern
finance, the Islamic approach to this subject is unique, and its characteristics are worthy of
note. First, Islam forbids gharar as it involves deception and iniquity, which are inadmissible.
Second, reasonable risk taking is authorised in a context of legal, productive, economic or
financial activity. Specifically, operational risk is inherent to commercial, industrial or
services activities and therefore unavoidable. Moreover, it justifies the profit made. This type
of risk is allowed as long as the probability of making a profit is predominant, in other words
if mathematically there is more chance of a positive result.

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Further, since the conservation of capital and goods is one of the principal objectives of

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Sharia, Islam encourages risk management as long as the ultimate aim is not purely and
simply to make money and it does not involve prohibited practices such as riba or gharar.

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The use of solidarity, cooperation and mutual assistance in particular are strongly
recommended in this area.
Whilst it is permissible to circumvent one of the principles of Sharia in exceptional cases,

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for example necessity (darura), in order to manage exceptional or complex situations
involving a high degree of danger and/or difficulty, the use of such concessions must be
managed to prevent them becoming the rule. Indeed, the danger is that unfounded exceptional
situations will be claimed by the use of trickery (hiyal), leading to large-scale reorientation
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towards conventional practices. The risk is that the potential of the Islamic economic and
financial approach as an alternative model will be artificially curbed, in a context where there
is an ever-greater need for ethics, morals and equity to counter the greed, abuse and excesses
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that too often lead to economic and financial crises.
Specifically, Islamic finance appears as a source of diversification with respect to the
abundant liquidity it can afford and also to high ethical asset class it offers.
Moreover, Islamic finance is also able to offer an alternative approach that can make a
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significant contribution to economic and financial recovery and stability, due to the
accessibility and compatibility of its financing and investment solutions with all actors,
without exception.
However, the effective development of Islamic finance remains heavily dependent on
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political will and that of the corporate managers and customers, not simply on technical issues
that can be more or less easily solved.
Furthermore, the implementation of any system or approach is always a human experience,
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with its advantages and drawbacks, which remains more or less distinct from the system as
such, depending on the degree to which its spirit and aims are faithfully observed, rather than
its rules alone. Islam is an inseparable whole, a genuinely integrated system covering all
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aspects of life. It will not achieve its full potential unless the paradigm underlying its vision,
values and principles is sincerely applied.
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Al-Suwailem, S. (2006). Hedging in Islamic Finance. Working paper, Islamic Development
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Ben Khediri, K., Charfeddine L. & Ben Youssef, S. (2015). Islamic versus conventional
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El-Gamal, M. (2006). Islamic Finance: Law, Economics, and Practice. New York:

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Cambridge University Press.
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Keffala, M.R. (2015). How using derivatives affects bank stability in emerging countries?
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Khorshid, A. (2010). Islamic Insurance. New York: Routledge Curzon Editions.
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Sabiq, S. (1999). Fiqh Assunna. Cairo: Dar al fath lil i’elam al arabi.
Wahidul Islam, M. (1998). Dissolution of Contract in Islamic Law. Arab Law Quarterly, 13,
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Warde, I. (2010). Islamic Finance in the Global Economy. Edinburgh: Edinburgh University
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*Graphical Abstract

UNCERTAINTY AND RISK MANAGEMENT

FROM ISLAMIC PERSPECTIVE

Abstract
Most decisions are taken in very uncertain contexts and all objective economic behavior is
dictated by the efforts of different agents to protect themselves against uncertainty. So, how to

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act in the face of uncertainty to minimise the harmful consequences of recurrent financial

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crises? The purpose of this article is to answer this question by highlighting the ethical aspect
of investments and finance from the Islamic perspective, which notoriously, forbids excessive
uncertainty, gharar. Islamic law proposes a legal framework that specifies the rules by which

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risk is understood, managed, taken or shared. The way the Islamic financial system resisted
the recent crisis leads us to study its unusual interpretation of risk. We also investigate

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whether Islamic ethics as an alternative could help to prevent the disaster of repeated financial
crises.

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