islamic jurisprudence trends past and future

8/9/2019 Islamic Jurisprudence Trends Past and Future

1/25

Islamic jurisprudence and

finance: Trends of the past, andpromises of the future

Mahmoud Amin El-Gamal

Rice University


2/25

Geneve: July 22, 2002 Mahmoud A. El-Gamal #2 of 25

Jurists, bankers & economists:

The permanent and the changing

Qurnand Sunnah

Fiqh(Islamic jurisprudence)

Ijmc(consensus) and Qiys(analogy)

Ideal PLS contracts: Mudraba(silent partnership).Mushraka(partnership),

istihsn(juristic approbation), istislh(benefit analysis), curf(custom),

Short-term substitutes (credit financing):

Murbaha(cost plus sales; usually with credit), Ijra(leasing),

Forbidden conventional financialtools as Ribawloan-based

Suggest ideal alternative on left

Islamic Economics and

Finance (1950s date)?


3/25


Historical Islamic economics

Influenced jurist perceptions of the (instigating factor)and (wisdom/ objective) of certain prohibitions

e.g. myths regarding the prohibition ofRib fixed rate of return what about leasing and credit sales?

return without risk what about credit risks and others?

exploitation of the poor is still possible. In fact, it appears that the prohibitions ofRiband

Ghararare built-in prudential financial regulations Prohibition ofRibenforces collateralizaion + marking to

market; see http://www.ruf.rice.edu/~elgamal/files/riba.pdf Prohibition ofGhararenforces optimal risk-sharing; see

http://www.ruf.rice.edu/~elgamal/files/gharar.pdf

Convinced jurists that there is a viable radically differentIslamic alternative, but failed to deliver for Islamic banks


4/25


What is the forbidden Riba?

Ribal-Jhiliyyah

Ribal-Nasah Ribal-Nas(deferment without increase)

Ribal-Fadl(increase without deferment) Muslim narrated on the authority of Ab Sacd Al-

Khudriy that the Prophet (pbuh) said:

Gold for gold, silver for silver, wheat for wheat,barley for barley, dates for dates, and salt for salt;like for like, hand-to-hand, in equal amounts, and anyincrease is Riba.

}Involve interest


5/25


Riba is neither interest nor usury

Not all interest is forbidden Rib:

permitted cost-plus (Murbaha), leasing(Ijra), etc. may contain interest.

Not all Ribis interest: Ribal-Nas and Ribal-Fadl

The percentage does not matter (even 0%can be Rib!)


6/25


Main Entry: 1interest

Pronunciation: 'in-t(&-)r&st; 'in-t&-"rest, -"trest; 'in-t&rst

Function: nounEtymology: Middle English, probably alteration of earlierinteresse, from Anglo-

French & Medieval Latin; Anglo-French, from Medieval Latin, from Latin, to be

between, make a difference, concern, from inter- + esse to be -- more at ISDate: 15th century

1 a (1) : right, title, or legal share in something (2) : participation in advantage andresponsibility b : BUSINESS, COMPANY

2 a : a charge for borrowed money generally a percentage of the amount borrowed

b : the profit in goods or money that is made on invested capital c : an excess

above what is due or expected 3 : ADVANTAGE, BENEFIT; also : SELF-INTEREST

4 : SPECIAL INTEREST

5 a : a feeling that accompanies or causes special attention to an object or class of

objects : CONCERN b : something that arouses such attention c : a quality in a thing

arousing interest


7/25


Main Entry: usuryPronunciation: 'y-zh&-rE, 'yzh-rEFunction: nounInflected Form(s):plural-ries

Etymology: Middle English, from Medieval Latin usuria, alteration of Latin usura,from usus, past participle ofutito useDate: 14th century1 archaic: INTEREST2 : the lending of money with an interest charge for its use; especially: the

lending of money at exorbitant interest rates3 : an unconscionable or exorbitant rate or amount of interest; specifically:interest in excess of a legal rate charged to a borrower for the use of money


8/25


The probhibition ofRiba is not

merely exploitation prevention

YsufcAl translation: [2:279] but if ye turn back, ye shall have your

capital sums; Deal not unjustly, and ye shall not be

dealt with unjustly. This translation gives the wrong impression about

the meaning of the verse ...ltazlimna wa l tuzlamn, as explained by Ibn cAbbs, Ab Jacfar,

and others. A correct translation as per theexplanation in Tabarand elsewhere:

but if you turn back, then you should collect

your principal, with no addition or subtraction.


9/25


Debunking the kindness

explanation T-D Al-Subk in the continuation of Al-Nawaws

Al-Majmcreports an opinion of ibn Kayyisnthat the reason for the prohibition ofRibisbased on kindness.

Proves it faulty by considering increase in tradingnon-Ribawgoods.

Consequences of the faulty explanation:

wrongly extends prohibition to permitted trades

wrongly permits non-exploitative forms ofRib


10/25


The prohibition ofRiba is not

about return without risk How about credit risk, and rate of return risk

Faulty application of the Hadth/juristic ruleal-kharju bi-d-Damn

Context: kharju l-cabdi bi-Damnih: returnsbelong to the one bearing the risk.

If understood as: returns-earned must becommensurate with risk-taken, the statement iseither a tautology, or does not apply to Murbaha

with very brief risk-exposure time period.


11/25


The prohibition does not

negate time value of money Logically, the return in Murbaha, Ijra, etc. is

permitted interest (check your Websters) Ml does grow (eligible for Riband Zakh)

Al-Sarakhs, Al-K

sn, Al-Zayla

c, ibn

c

Abidn:

The price may be increased with deferment.

Al-Shtib, ibn Rushd, Al-Dardr, Al-Nawaw, Al-

Sw, Al-Shirbn, ibn Taymiya: Time has a share in the price.

Al-Shfic, Al-Ghazl:

What is worth 5 in cash is worth 6 deferred.


12/25


The loan (qard) contract

A debt may originate from a sale (bayc), a lease

(ijra), a forward (salam), etc. or from a loan (qard)

Loans are charitable contracts: forfeit ownership of

the usufruct of the asset to help another

If used as a finance mechanism (as commutative

financial contracts), they violate the prohibition ofribal-Nas, even if they are interest free!

The rate of return on a qard hasanis Unknown


13/25


Can borrowing which seems to be

mutually beneficial be harmful? Most people

Prefer $100 today to $101 tomorrow;and prefer $101 in 51 days to $100 in 50 days ?

Prefer $9 today to $12 in a year;

and prefer $4000 in a year to $3000 today?

Discount future losses more than they discount futuregains?

Discount delays more than they discount speedups?

They suffer from Dynamic inconsistency


14/25


Dynamic inconsistency

If you knew that a juicy steak was bad for

you while a salad was good for you: Would you go to a steakhouse that serves

great salads, or go to a salad restaurant to

avoid the temptation? How else can you ensure that you will not eat

a steak?

The solution is through precommitment


15/25


Dynamic inconsistency

There are many individuals who:

Borrow today with the intention to save andpayoff debts next year, but

When next year comes, borrow even more!

The solution is precommitment:

In Islamic finance, debts are tied to the value

of the financed asset, Creditors are forced to avoid debt cycles (in

contrast to conventional credit card issuers).


16/25


Precommitment to mark to market

ibn Rushds Bidyah+ the Hadthof Bill:

Marking to market ensures that trading ratio

= 1/ratio of prices = ratio of marginal utilities

This ensures (Pareto) efficiency, a dominanteconomic notion of fairness in exchange:


17/25


It is thus apparent from the lawthat what is intended by theprohibition ofRibis what itcontains of excessive injustice(ghubn fhish). In this regard,justice in [exchange] transactionsis achieved by approachingequality. Since the attainment ofsuch equality in items of differentkinds is difficult, their values aredetermined instead in monetaryterms (with the Dirham and theDnr).

For things that are notmeasured by weight and volume,justice can be determined bymeans of proportionality. I mean,

the ratio between the value ofone item to its kind should beequal to the ratio of the value ofthe other item to its kind.

For example, if a person sells ahorse in exchange for clothes, justiceis attained by making the ratio of the

price of the horse to other horses thesame as the ratio of the price of theclothes [for which it is traded] toother clothes. Thus, if the value ofthe horse is fifty, the value of theclothes should be fifty. [If each pieceof clothing's value is five], then thehorse should be exchanged for 10pieces of clothing.

As for [fungible] goods measuredby volume or weight, they are

relatively homogenous, and thus havesimilar benefits [utilities]. Since it isnot necessary for a person owningone type of those goods to exchangeit for the exact same type, justice in

this case is achieved by equatingvolume or weight since the benefits[utilities] are very similar...

Ibn Rushd, M.Bidyat Al-Mujtahid wa

Nihyat Al-Muqtasid, Dr Al-Macrifah,

Beirut, 1997 (vol.3, pp.183-184)


18/25


Precommitment to mark to market

and control indebtedness For RibAl-Nasah, Islamic alternatives:

Force the interest rate in a financingcontract to be equal to the market determinedopportunity cost of similar opportunities(same risk profile, market-based residualvalue, etc.)

Encourage equity-based financing, which

ensures another form of precommitment


19/25


The forbidden bay`u al-Gharar

Jurisprudence and Prophetic Traditions : Ambiguity in contract language: e.g. two sales in one Unnecessary uncertainty: e.g. sale of the divers catch Undeliverable merchandise: e.g. sale of birds in the sky

Al-Bj:sale that is dominated by gharar( ( Professor Mustafa Al-Zarq:

Ghararis the sale of probable items whose existence orcharacteristics are not certain, due to the risky nature which makesthe trade similar to gambling

Professor Al-Darr: Ghararonly invalidates (i) commutative financial contracts, (ii) in

which it is substantial, (iii) integral to the contract, and (iv) for

which there is no viable substitute.


20/25


Baycu l-Gharar= trading in risk

Etymology: risk = re-secare(potential for loss) = risque [a ships] chance of being cut by a rock, definition of Qad cIyd.

Economics and Jurisprudence: Risk (gharar) vs.uncertainty (jahla); Al-Qarf (Al-Furq): The definitions ofghararandjahlaare each more general in some

respects and less general in others. This is the reason for thescholars differences over the respective natures ofghararandjahla.

Jurisprudence: Trading in risk is the essence of insurance and other sale-based

hedging mechanisms Fatwa Ibn cAbidn forbidding marine insurance

Options for risk allocation: selling vs. sharing risk Pricing is problematic due to loss aversion and other complications


21/25


Standardized Named Contracts

Asset-based financing (no Rib): Murbaha= cost-plus sale Baycbi-thaman jil= credit sale Ijra(wa -qtin) = Lease (to purchase)

Risk-sharing mechanisms (no Gharar): Mudraba= silent partnership (commenda) Mushraka= simple partnership

Exceptions (Istihsn, cUrfor Maslaha!): Salam= forward with pre-paid price Istisnc= Commission to manufacture

Named contracts are mostly pre-Islamic Through futyand qad, new contracts were legitimized ex

postby jurists Legal fine-print to avoid Riband Ghararwas documented

in jurisprudence


22/25


Convention () in named contracts

Appeals to convention ()reference count:Al-Mabst(Al-Sarakhs, Hanaf) 130references

BadicAl-Sanic(Al-Ksn, Hanaf)95 references

Radd Al-Muhtr(ibn-c

bidn, Hanaf)237 references

Sharh Mukhtasar Khall(Al-Kharsh,Mlik) 1182 references

Al-Majmc(Al-Nawaw+ Al-Subk,Shfic) 60 references

Al-Mughn(ibn-Qudma, Hanbal) 102references

Appeals Relate to all contracts,including:

Deposit contracts: even if unrestricted, arerestricted by

Acceptable forms for partnership capital:determined by

Acceptable conditions in contracts (esp.leases and credit sales):

Typical phrases:

and

(e.g. many of the lease restrictions imposedby todays Sharcaboards are based on ibn-cbidns acceptance of leasing conventionsin Damascus, two centuries ago).


23/25


Problems with Form above function?

in juristic analogy (

)

Consider contractsAand B,one forbidden and the otherpermissible based on juristicanalogy ( ). If contractsAand Bare shownto be economically identical (inthe Arrow-Debreu sense;AB),

do we: Forbid B, through the

apparent analogy ( )? Permit B, while forbiddingA allows for the fallacy of

composition; avoids iterativeanalogy = )? Or, revoke the earlier false

juristic analogy based on theeconomic analysis of its proof

() and reasoning ()?

The fallacy of composition andIslamic Financial engineering:

IfAB+C, and the jurists forbidA,see if they accept Band C(e.g.sukk al-salam, Murbaha lilmirbishshri)

IfBis forbidden, butAis

permissible, andAB+C, try to getjurists to accept C(e.g. syntheticembedded options)

Search the historical books ofjurisprudence forA, Bor C

In all cases, charge the customer apremium for the relatively inefficientIslamic (or Islamized) alternative:

Islamic finance as Sharcarbitrage

Primary beneficiaries: lawyers


24/25


Sharc arbitrage:

Marketing Islamic finance to customers asfundamentally different, and to regulators asessentially the same:

OCC #867, 1999 : lending takes many forms Murabahafinancing proposals are functionally equivalent to, or a logicaloutgrowth of secured real estate lending and inventory and

equipment financing, activities that are part of the business ofbanking.

OCC #806, 1997: Today, banks structure leases so that they

are equivalent to lending secured by private property alease that has the economic attributes of a loan is within thebusiness of banking. ...Here it is clear that [ ]s net lease isfunctionally equivalent to a financing transaction in which the

Branch occupies the position of a secured lender


25/25


The need for logical analogy

) ) and basic research The established rulings in classical jurisprudence are

of limited usefulness: What was deemed permissible two centuries ago may

result in forbidden Ribin todays financial environment

What was deemed forbidden two centuries ago may bepermissible within todays legal and regulatory framework

Sharcarbitrage is only profitable in the very-short-run (by definition), and self-defeating in the long-run(increased integration

islamic jurisprudence trends past and future

Documents