Archive for the ‘Islamic finance’ Category

Business and the work ethic in Islam

Monday, August 19th, 2013

I came across the following last week and thought to talk about it a bit today:

From unemployment to self employment:

A beggar from Medina came to the Prophet (PBUH) and asked him for money. The Prophet (PBUH) asked him, “Have you nothing in your house?” The man replied, “Only a cloth, part of which we wear and part we use for carpet. And a wooden bowl from which we drink water.” The Prophet (PBUH) told him to bring them to him. He did.

The Prophet (PBUH) held the items in his hand and started an auction, “Who will buy these?” One man bid a Dirham (a silver coin). Another bid two Dirhams and bought the two items.

The Prophet (PBUH) gave the two Dirhams to the beggar and told him, “With one Dirham, go buy food and clothes for your family. With the other Dirham, buy and axe, go out with it and chop wood and sell it in the market. I don’t want to see you again for fifteen days!”

Fifteen days later, the man came back to the Prophet (PBUH) and reported to him that he made ten Dirhams selling the firewood that he chopped!

This story is reported by Abu-Daawood from a narration by Anas ibn Maalik. He did not immediately rate it, but indicated later that its authenticity was sound. The tenor of the story is confirmed by a hadeeth, reported and authenticated by Muslim and narrated by Abu-Hurayra that the Prophet (PBUH) said, “Carrying a bundle of firewood on your back and selling it is better for any of you than begging for money that he may or may not get.” Also reported by Al-Bukhaari from a narration by Az-Zubayr ibn Al-`Awwaam (RA).

Islam encourages business, trade and self employment. Did you expect that Islam and capitalism have something in common? This is one aspect of pre-Islamic era that Islam has approved and encouraged.

The perils of the wrong mindset

Monday, July 8th, 2013


I understand that riba (usury) is wrong. I understand that riba is like gambling. I understand that there are many views on insurance.

But, I need to have a fundamental understanding of why speculation is wrong. I know we have to work for our money.

I need to have the sin explained to me. Trust me I have done my share of reading on the matter. Yet, I do not have the basic definition of the sin of riba and gambling and it seems that they share the same root.

Indeed they do, and the Quran calls it Al-Maysir. The word means tools for easy gain.

It is not the ease that is wrong though. It is the belief in it. The central point, IMHO, is what you alluded to when you said that we have to work for our money. The biggest problem with all games of chance, and speculation is one of them, is that they set the wrong mindset. They entice people to believe that there is a shortcut out there. That is contrary to the laws of God which state that means, not gimmicks, lead to results. Gimmicks may work sometimes, or else no one would have ever tried them. But they are short lived and cause more harm than good.

Even Wall Street knows that, or at least they used to. When you open a trading account, you have to sign forms that can fill a book. Forms to explain to you the risks involved, some may even exceed the value of the entire portfolio! When you open an investment account, on the other hand, there are far fewer forms to sign. That is because, even though investments too carry risk, they are natural risks, whereas speculative risks are random. The difference between the two is that investments involve an asset: property, product or service, while speculation is a bet on how such investment will do. In financial circles this is called a derivative. We all know from the global financial crisis of 2008, the extent of harm speculative derivatives can do.

That is the peril of the mindset that is convinced that there is a shortcut to riches that requires no work, no sweat, and no asset. There is no such thing, but speculators won’t accept that disappointing conclusion, just like a gambler keeps telling himself that the next time he will recoup all his losses.

Investments can be win-win affairs, while speculation is always a zero-sum game.

Usury fits that profile too. It stems from the wrong mindset that treats money as a commodity and thus finds what it thinks is a great business model: buy money cheap and sell it for more. That’s right; economists actually call interest the price of money! Money is price, it doesn’t, and shouldn’t have a price.

While you did not ask it, other readers may be wondering: how else can an economy run? How can banking be done without interest? How does an Islamic system finance start-up companies or real estate purchases, etc.?

The answer is quite simple: partnerships. A financier may decide to finance a project in return for a percentage of its equity and profits. But that also means sharing the risk. That is a natural mechanism in the law of God that makes a financier scrutinize the project like his networth depends on it. The result is that frivolous projects won’t find financing, but quality ones will. Mortgage lenders would never lend money to home buyers whom they are almost sure cannot repay the loan, which is what caused the foreclosure crisis of 2008. On the flip side, rich people will still put their money in worthwhile and promising projects, which by their nature benefit a lot more people than the stakeholders.

That, in a nutshell, is Islamic finance. It brings wealth to investors and far reaching benefits to society, advancement of the economy and, most important of all, the right perception of money and finance. It is not a game for clever quants to play, it’s life enhancement for millions of people.

I apologize for not having a MBA. Your response was detailed, as usual. However, I need to go to a simpler and deeper understanding.

My question thus becomes this: How does interest oppress those who are the meek and poor. How is usury a tool of the oppressor.

In other words how is this haraam (forbidden). On a grand scale I see the consequences of poor decision making, giving loans to those who do not have the means of paying back thus leading to bankruptcy. But break it down for me.

For example the issue of adultery is simple to understand as it does destroy the fabric of the family.

I am not trying to be stubborn or argumentative. I need to be able to place my finger on the essence of the sin of interest.

Many people question why adultery is a sin. If the reason is, as you stated, that it breaks up families, then divorce should also be a sin, because it too breaks up families. But it isn’t. It is only strongly discouraged.

Many scholars, past and modern, have attempted to find material reasons why adultery is a sin. Some postulated that it results in paternity uncertainty. If that’s the reason, then modern science can solve this problem with a DNA test. Would that make adultery OK? Of course not.

Some suggest that the reason is unwanted pregnancies. If that’s the reason, then foster homes can solve this problem. Does that make adultery OK. Of course not.

Some guess that the reason is sexually transmitted diseases. If that’s the reason, then immunizations and other protections can take care of this risk. Would that make adultery OK? Of course not.

The interesting thing is that God already told us why adultery is a sin. He says in the holy Quran, “And do not approach fornication; it is a debauchery and a wretched path.” (17:32). It sets a wrong mindset. It makes people view sex, women and marriage differently from God’s moral law. That is what makes it a sin. Sin is violation of God’s law. God designed His laws for maximum benefit to mankind. When man breaks God’s law, it is an objection to God. Adultery sets the sinner on an evil path because he is deviated from the Straight Path and is distanced from God and becomes an easy prey to Satan.

You will observe the same about other sins prohibited in the Quran. Intoxication and unearned gain are prohibited in 5:90. God explains why in the next verse, “Satan only wants to sew between you enmity and hatred with intoxicants and unearned gain, shun you from the remembrance of God and from prayer. Are you ceasing?” (5:91)

God doesn’t say that intoxication can ruin your liver, or that it may endanger other people when you drive drunk. God doesn’t say that gambling can wipe out one’s life savings. God doesn’t mention that both are addictions that are very hard to be free from. God’s reasons are moral. Other material reasons may apply, but they are not why something is a forbidden sin. Intoxication sets a wrong mindset. It makes a person “drink to forget” his problems, instead of heading them on and solving them, gaining strength of character and wisdom in the process. Unearned gain sets the wrong mindset. It makes a person view others as “marks”, to borrow from con artists vocabulary. The right mindset that Islam encourages is that others are fellow human beings, dignified, worthy of respect and care, and having full capacity to be good and contribute to positive human progress.

The sin of interest is that it sets the perception and belief that you can have your money work for you instead of you working for your money. The Prophet (PBUH) said, “None of you would eat better food than food he earned by the work of his hands. God’s prophet David, upon him be peace, did.”, narrated by Al-Miqdaam ibn Ma`dikarib and reported and rated authentic by Al-Bukhaari.

I find it fascinating that God quotes people who have argued that usury is like trading. He does not refute their argument! Instead, He states unequivocally that He made trading lawful and usury unlawful (2:275). God doesn’t want us to be distracted by arguments why something He forbade is bad for us.

I beg you to help me with this. Where do trust funds find themselves. And what is the difference in Islam between a trust fund and inheritance?

Trusts are called Waqf in Islam. The word means holding an asset from being sold or donated and dedicating its income and facilities to designated people or purpose.

Waqf has two types: (1) Waqf Khayri (charitable trust/endowment) and (2) Waqf Ahli (familial trust). The first type is very highly praised in Islam. The Prophet (PBUH) has famously said, “All the work of a child of Adam ceases with his death, except three: an ongoing charity, a knowledge that benefits and a righteous child who prays for him.” Narrated by Abu-Hurayra and reported and rated authentic by Muslim. This has motivated multitudes of Muslims throughout the ages to found thousands of charitable projects and endowments. The result was that nearly all needs of society were taken care of without the government having to do any of it! A stranded traveler knew that he can find a hostel where he could stay the night, warm and safe, at no cost. Orphans and widows didn’t have to be scared or hungry. Desert travelers knew there would be plenty of water wells they could drink from.

Waqf Ahli, on the other hand, has been controversial for a good part of a century now. It is banned by many Muslim countries, such as Turkey, Syria and Egypt. The reason is that they saw much abuse of it. They saw it as a way to concentrate wealth in a family, instead of letting it into the economy. Many people used it as a way to circumvent inheritance law. With familial trusts, they could favor some relatives over others, whereas inheritance law fixes heir eligibility and distribution amounts of an estate.

IMHO, abuse of a system is no reason to ban it, but rather is reason to regulate it. Waqf Ahli has been allowed, even suggested, by the Prophet (PBUH) when one has needy relatives, as has been reported about Abu-Talha dedicating his best garden to his poor relatives after he heard this verse, “You shall not attain godliness until you spend from what you love” (3:92). It is a good way to take care of one’s poor relatives while one is still alive, as well as after he, the trustee, dies. That is the difference between trusts and inheritance. The other difference is what I mentioned above about allotment of shares and designation of beneficiaries.

Nobody ever owns the asset under Waqf and the trustee’s heirs are supposed to carry on the upkeep of the trust. Perhaps that’s why many Waqf assets were neglected to the point of deterioration. That was another reason governments moved to ban them. It would’ve been better IMHO if governments took over the maintenance.

Islamic economic theory and finance

Thursday, February 17th, 2011

Can you tell me briefly what is Islam’s view of economic theory and finance?

Money, in Islam, is a means and not a commodity. So, there is no price for money. And because gold and silver (or checks fully backed by them) are the only valid money, there is no price for time. Exchanging gold and silver must be “same metal, same weight, same time, hand-to-hand.”

Islamic finance has two primary vehicles: partnerships (Mushaaraka), or interest-free loans (Qardh Hasan). Under the banner of partnership are many financing techniques, such as leases (Ijaara), equity participation (Sharikaat), venture capital (Mudhaaraba), profit sharing (Muraabaha), stocks, etc. With partnerships, a financier puts up the money and the investor or business person puts up the work (aka sweat equity). They share equally in the profits and in the loss. This way a financier will never part with his or her money financing a bad business idea or unpromising project. Non-Islamic lenders do that with ease because they can repossess the investment, or sell the loan in the secondary market, or be bailed out by the government!

Is declaring bankruptcy allowed in Islam?

Thursday, October 21st, 2010

Bankruptcy is allowed in Islam. And the court has the authority to declare a person bankrupt in order to liquidate his assets to pay his creditors.

Abdur-Rahmaan ibn Ka`b ibn Maalik narrated that Mu`aazh ibn Jabal (RA) was a very generous young man and he spent money left and right, until he owed more than he had. He went to the Prophet (PBUH) to talk to his creditors. The Prophet (PBUH) sold off Mu`aazh’s assets and paid the creditors.

Maalik and Ash-Shaafi`i both ruled that a bankrupted person’s property is put under guardianship and he is not allowed access to his money until creditors settle. Ash-Shaafi`i and Ibn Hanbal ruled that creditors divide up the bankrupted man’s property by the ratio of their original debts.

Abu-Haneefa, however, ruled that the debtor is jailed until he pays off his debts and that he must not lose control of his money.

There are other fine points in the law, such as paying the Zakah first, encouraging creditors to forgive the debt of a man experiencing hardship, excluding the man’s home and enough stipend to live on, etc.

You can read these details in books such as Fiqh-us-Sunna by Sayyid Saabiq and Nayl-ul-Awtaar by Ash-Shawkaani.

Hope this helps.

Abuse of Islamic finance

Thursday, April 15th, 2010

This article that appeared in the Economist magazine tells about the troubled state of the Sukook market in the Gulf states, an investment similar to bonds but without interest. Instead, it pays investors from income generated by the bonded assets, e.g., real estate.

What went wrong? This paragraph tells,

Many seem to have thought that the bonds were “asset-backed”, giving them a claim on the assets in the event of a default. Most sukuk, however, are “asset-based”, handing investors ownership of the cashflows but not of the assets themselves. “Many sukuk holders have a perception that they hold a security that is collateralised,” says Anouar Hassoune of Moody’s, a rating agency. “In 90% of cases, that is incorrect.”

That makes the investment not Sharee`a compliant. Partnership is partnership in the acquired assets, not in their income. Be sure when you invest in Sukook that your investment is asset-backed, not asset-based. Your investment buys you a piece of the property.

In this article,…WYV7WEcc&pos=7

it is predicted that the demand for Islamic finance will reach $2.8 Billion in a few years. With this kind of money, there is huge room for fraud and abuse, so be careful you all. Islamic finance is quite simple: You the investor are a full partner in the investment, not just a beneficiary. Do not accept “asset-based” investments where you are handed dividend. Insist on “asset-backed” investments where the investment manager shares with you in profit and loss.

Could you put that in very plain, simple English? You know, for those of us who know zip about finance and economics.  If necessary, use diagrams and cartoon figures.

LOL! I’ll try. A bond investment is when you the investor finances a project. Western style bonds give you a fixed return on your investment, called the bond yield.

To avoid the fixed yield, which Islamic law prohibits as Riba, the Sukook bonds were introduced. Instead of a fixed interest, they pay the investors from income generated by the project. For example, the Sukook may have bought an apartment building and the investors will be paid a dividend from the rents collected.

Is this better?

P.S. The word “Sukook” is an Arabic word. It’s the plural of “Sakk” صك which means “a check.” In fact, it is the origin of the word Check. The concept of checks was first introduced by Muslim merchants.

But what about our business, salaries, etc.? All of  its dealings are done using “paper/plastic money” (i.e. notes, credit cards) or electronic money. and this *money* has no real value. its no more based on gold or silver but on just demand.

So, isn’t it the same then?

None of that is investment, brother. All the examples you quoted are expenditures. We are talking here about investments and how to make them Sharee`a compliant.

The way to do that is partnership. The investor puts up the money (financing) and the manager of the project contributes the work (known in finance as sweat equity). The two of you agree on what each of these contributions are worth. Say 50-50. That means whatever income he generates from the project, he splits it with you 50-50, whatever loss is incurred is also split 50-50. When both of you decide to sell the project, you split the proceeds 50-50. That’s a perfect example of a Sharee`a compliant investment.

If banks were partners, instead of lenders, in real estate financing, the real estate crisis would not have happened, because no bank in their right mind would partner with a family who cannot afford to buy a house. And when recession hits, it is shared by all, not just by the home “owner”.

You are right about currency. It’s all worthless paper. We are playing a game of pretend when we buy and sell from each other, because what we use for money actually has no value. The currency rates published in the newspaper is a myth and reflects only the relative strength of economies, not the intrinsic value of the currency. Only when a currency is fully backed by gold is currency valuable.

Why is interest on money forbidden in Islam?

Saturday, February 27th, 2010

Islam prohibits it because in Islam, time is NOT money. Money is not a commodity to be bought and sold, which is what usurers do. Money is a means by which to acquire property or investments. In Islam, legitimate profit is one gained from merchandising actual products and services, or appreciation of investments. Money does not appreciate.

To understand this better, consider that the only money in Islamic finance is gold and silver. If you compare the value of the dollar, for instance, with the price of gold, you will notice a remarkable reverse relationship! What cost a gold Dinar a thousand years ago, still costs pretty much a gold Dinar today

What exactly is Islamic banking/financial system?

Wednesday, March 4th, 2009

In a nutshell:

  • Gold and silver are the only money,
  • Interest rate is always zero,
  • No gambling is ever allowed, whatever name is given to it,
  • No financial transaction involving forbidden issues, such as alcoholic beverages, pork, pornography, tobacco and narcotics, etc.

Thanks, but I don’t understand one thing: what about income? How will banks make money?

Through appreciation of investments and businesses that they buy or partner in. Much like what Warren Buffet often does. In Islam, money is not a commodity and therefore should not be bought, sold or rented. The Western expression, “The price of money” is an oxymoron in Islam. Money does not earn money, it buys investments that earn money.

Just to check whether I understood:
A comes to a bank and wants a loan to buy a machine.
The bank buys the machine and gives A the machine.
But the bank takes some extra money, so it has earned a bit.
Is this correct?

The bank may choose to lease the machine to the businessman for a lease amount and duration they both agree to. The bank may also give the machine to the businessman for an agreed on percentage partnership in the business.