Chapter 3

Islamic Commercial Law

There has always been a close historical connection between

Islam and commerce. The Prophet came from the Arabian town
of Makkah, or, as it is known today, Mecca. At the time of
Muhammad, Makkah had already been a major Middle East-
ern commercial centre for over a century. Makkah was home
to the Quraysh tribe and during this period the Quraysh had
grown quite prosperous, in their desert world, primarily as
brokers of trade between the Eastern and Western worlds.
The principle reason for their success was a geographical one:
Makkah was strategically located on the main commercial
artery running from Yemen in Southern Arabia, where goods
from the East arrived, northwards to the Mediterranean, where
European traders eagerly waited with their own goods or cash.
Makkah was also at the centre of another major trading route
between the Persian Gulf (another arrival point for Eastern
commodities), and the Red Sea Port of Jiddah, where goods
from Egypt and other points in Africa entered into the sphere
of East-West commerce.35 Commerce was thus the lifeblood
of Makkah and Muhammad, who was of the Quraysh tribe,
was himself a successful businessman who after his marriage
to his first wife, Khadijah, undertook several trading ventures
to various places in Arabia, including Yemen and Bahrain.

35
Ferrara, Peter J. and Saffuri, Khaled, “Islam and the free market”, Islamic
Free Market Institute Foundation (www.islamicinstitute.org).

42
 Islamic Commercial Law 43

Not surprisingly, then, the attitude of Islam towards com-

mercial activities is a generally positive one and there are many
verses in the Quran which actually encourage trade and com-
merce. Morally, the guiding principle here is that there should
be no impediment to honest and legitimate trade and business,
which enables people to earn a living, support their families
and give charity to those less fortunate than themselves. But if
Islam does not expect believers to give away all their posses-
sions and live the life of ascetics, it nevertheless requires that all
Muslims conduct their business activities in accordance with
the requirements of their religion, namely to be fair, honest
and just towards others. Nor should Muslims allow their busi-
ness activities to dominate their lives to the extent that making
money becomes a first priority and they neglect their religious
duties — it is stipulated in the Quran that all trading must cease
during the time of the Friday congregational prayer. And just
as the Shari’ah regulates and influences every other sphere of
life, so too with business and commercial activities, which are
subject to a rigorous code of conduct so that they may conform
with Islamic principles.

3.1 Islamic vs. Non-Islamic Commercial Transactions

Perhaps the most important single difference between Islamic
commerce and conventional commercial transactions is the
Islamic prohibition on paying or receiving interest (riba). But
there are also other significant divergences, which also need
to be taken into account. One of these is the notion that prop-
erty is God-created and God-given. Clearly, the construction
of property here differs radically from the common modern
conception of property as a secular value, to be defined and
redefined as needed to further utility, or else as the aggregate of
whatever property claims the legal system chooses to respect.
In Islamic law, by contrast, property is irreducible, sacrosanct
44 Islamic Banking and Finance in South-east Asia

and virtually transcendent. The lawfulness of its acquisition

and use is grounded in the Quran and the Sunnah, whose
source lies above reason, and is a matter with which God is
minutely concerned.
Ultimately, the aim of the Islamic economic system is to
allow people to earn their living in a fair and profitable way,
without exploiting others, so that the whole of society may
benefit. In this last respect, Islam emphasises the welfare of the
community over individual rights. This is in line with recent
Western thinking which criticises open-market approaches
to economic management because they emphasise economic
growth at all cost without regard for quality of life and the
widening gap between rich and poor in society.36 Clearly,
Islamic religious precepts are fundamentally opposed to the
doctrines of unbridled capitalism, which are seen by Islamic
countries as posing a threat to society by undermining Shari’ah
values.

3.2 Principal Requirements of the Shari’ah in

Relation to Commercial Activities
As we have seen, the most striking difference between Islamic
commercial activities and conventional business activities is
that Islam expressly forbids the giving or receiving of interest,
which in the eyes of the Quran is tantamount to usury (riba).
The prohibition of interest in Islam should be seen in the
context of the basic characteristics of an Islamic economic sys-
tem, which may be enumerated as follows:

(i) All persons should have at least the minimum economic

resources needed for subsistence.

36
Baydoun, N. and P. Blunt, “Notes on Islam, culture and organisational
behaviour”, 1997, p. 2. Unpublished Paper, Northern Territory University.
 Islamic Commercial Law 45

(ii) Undue concentration of wealth in a few hands should be

prevented.
(iii) Hoarding should be discouraged and the use of wealth
for productive purposes should be encouraged.
(iv) The economic system should function so that there is no
room for idlers; reward should accrue solely as a result of
the expending of effort, except in the case of the naturally
handicapped and involuntarily unemployed.37
Apart from this prohibition regarding receiving and giving
interest, there are two other activities prohibited by Shari’ah
law that have had a significant impact on Islamic finance.
They are a ban on gambling (maysir) and the prohibition of
uncertainty or risk-taking (gharar). The prohibition on maysir
is often used as grounds for the criticism of conventional finan-
cial practices such as speculation, conventional insurance and
derivatives, while the prohibition of gharar can be applied to
various types of uncertainty or contingency in a contract. In
the latter instance, the prohibition on gharar is used as the
basis for criticism of conventional financial practices such as
short selling, speculation and derivatives. Obviously gener-
alised prohibitions on increase and risk, if interpreted in the
widest possible sense, run contrary to the very core of the
concept of commercial gain,38 but here the legitimacy of gain
through trade — a vexed issue at the intersection of ethics, eco-
nomics and contract law — is resolved in a strikingly liberal
fashion.
For example, risk-taking, though normally prohibited by
Shari’ah law, when related to a commercial enterprise can be

37
El-Badour, R.I., “The Islamic economic system: A theoretical and empir-
ical analysis of money and banking in the Islamic economic framework”,
1984, p. 135. Unpublished PhD dissertation, Utah State University, Logan,
UT, USA.
38
Vogel and Hayes, Islamic Law and Finance: Religion, Risk and Return, 1998,
pp. 68–69.
46 Islamic Banking and Finance in South-east Asia

a socially productive economic activity and is consequently

entitled to a reward. Second, and a related point, the creation of
loans that are intended to finance socially productive economic
activities receive a similar endorsement. Third, financial risk is
acceptable if the risk lies solely with the lenders and not with
the managers and agents.
Hence, it can be seen that Islam offers a unique and ideal
perspective of business ethics. It regards commercial activities
as part of one’s religious life, provided that they are conducted
in accordance with the commands of Allah, and the moral code
of conduct prescribed by Islam. In this context, fundamental
Islamic principles such as truthfulness, honesty, trust, sincerity,
brotherhood, science and knowledge, and justice, provide a
moral and ethical background to the way in which business
should be conducted.39

3.3 Islam: the Difference between Equity and Debt

The distinction between equity and debt in Islam is the same
as in conventional economic systems except that the Shari’ah
prohibits any return on a debt and does not consider lending to
be a legitimate profitable activity. All wealth creation should
result from a partnership between the investor and the user
of capital in which rewards and risks are shared. Returns on
invested capital should be earned rather than pre-determined.
Equity represents an investment exposed to all kinds of
business risks and sharing in the profits of the business. It may
be of a permanent nature, that is, redeemable only upon liq-
uidation of the business — or earlier by mutual agreement —
but not on demand. Debt on the other hand, is a contractual

39
Elati, Mas, “The ethical responsibility of business: Islamic principles and
implications”, OIC Exchange (www.oicexchange.com), 2 May 2002.
 Islamic Commercial Law 47

obligation to pay a specific value, whether in cash or kind, on

an agreed date or on demand, for value consideration received,
with the important proviso that value at both ends of the trans-
action must be equal in terms of whatever commodity or cur-
rency they are denominated in. Any discount or excess on
account of a contractual obligation falls in the category of riba
(interest or usury), which, of course, is expressly forbidden in
the Quran.

3.4 Rationale of the Prohibition of Interest

The representation in the holy Quran of the practice of interest
as an act of “war with Allah and his messenger” provides an
insight into the philosophy behind the prohibition of interest
in Islam. It is a clear pointer that the institution of interest is
something which runs counter to the scheme of things which
Islam stands for and which Allah wanted to see established
on earth. That the words “Allah has blighteth riba and made
sadaqat [gift-giving] fruitful”, which occur in verse 276 of Surah
Al-Baqara, also point towards the fact that the practice of inter-
est militates against the objectives of an Islamic society, while
sadaqat promotes these objectives. The main points of the ratio-
nale for the prohibition of interest in Muslim countries may be
listed as follows:

(i) Transactions based on interest violate the equity aspect

of economic organisation. The borrower is obliged to pay
a pre-determined rate of interest on the sum borrowed
even though he may have incurred a loss. To insist on
payment of a pre-determined rate of interest irrespective
of the economic circumstances of the borrowers of money
is against the Islamic norm of justice.
(ii) An interest-based system discourages innovation, par-
ticularly on the part of small-scale enterprises. Large
48 Islamic Banking and Finance in South-east Asia

industrial firms and big landholders can afford to

experiment with new techniques of production as they
have reserves of their own to fall back upon in case the
adoption of new practices does not yield a good dividend.
Small-scale enterprises hesitate to go in for new meth-
ods of production with the help of money borrowed from
banks because the liability of the banks for the principal
sum and interest has to be met, irrespective of what the
results might be and the fact that small-scale enterprises
usually have little reserves of their own.
(iii) In an interest-based system, banks are only interested in
recovering their capital along with interest. Their interest
in the ventures they finance is therefore strictly limited to
satisfying themselves about the viability and profitability
of such ventures from the point of view of the safety of
their capital and the ability of the venture to generate a
cash flow which can meet the interest liability. Since the
return the banks get on the capital sum lent by them is
fixed and is not linked in any way to the actual profits
of the ventures to whom they lend, there is no incentive
for the banks to give priority to ventures with the highest
profit potential.
(iv) An interest-based system dampens investment activity
because it adds to the costs of investment. If interest
rates are raised to contain monetary demand in situa-
tions where excessive fiscal deficits are fuelling inflation,
private investment receives a severe setback leading to
“stagflation”. This has actually been the experience of a
number of developed countries in recent years.
(v) The interest-based system is security oriented rather than
growth oriented. Because of the commitment to pay a
pre-determined rate of interest to depositors, banks, in
their lending operations, are mostly concerned about the
safe return of the principal loan along with the stipulated
 Islamic Commercial Law 49

interest. This leads them to confine their lending to the

already well-established, big business houses or such
parties as are in a position to pledge sufficient secu-
rity. If they find that such avenues of lending are not
sufficient to absorb all their investable resources, they
prefer to invest in government securities with a guaran-
teed return. This exaggerated security orientation acts as
a great impediment to growth because it does not allow a
smooth flow of bank resources to a large number of poten-
tial entrepreneurs who could add to the gross national
product by their productive endeavour, but do not pos-
sess sufficient security to pledge to the banks to satisfy
their criteria of creditworthiness.

3.5 Conventional Banking and the Prohibition

of Riba in Islam
In a capitalist market economy, the banks are profit-making
institutions. They need to maximise their profit by advancing
money at a higher rate than the rate at which they obtain it. The
borrowing and lending of money takes place at a price called
the interest rate, which is the pivotal point of all banking activ-
ity. In this last respect, the practices of the modern commercial
banking system are directly in conflict with the principles of
Islam, which strictly prohibit riba (interest or usury).
Seen from an Islamic perspective, the prevailing banking
and finance system strikes at the very root of a fundamental
principle of the Shari’ah in that it tends to promote a concen-
tration of wealth in a few hands and thus breeds inequalities in
society. Interest, which is the kingpin of the modern banking
and financial system, serves as a powerful tool of exploita-
tion of one sector of society by another. From the Islamic
viewpoint, it has created “haves” and “have-nots”, and acts
as a barrier to the achievement of maximum welfare for the
50 Islamic Banking and Finance in South-east Asia

maximum number of people. It is in this context that Islam

forbids interest and it is with the aim of achieving the egalitar-
ian objectives of Islam that the Muslim world is now embarked
on the task of Islamising the financial system by unfettering it
from interest;40 it is to this process of transforming conven-
tional financial arrangements into Shari’ah-approved (halah)
alternatives that we now turn to.

3.6 Treatment of Deposits with Interest

As stated previously, the most striking difference between
Islamic banking and Western-style banking is the Islamic view
of interest. Because Shari’ah law prohibits interest, direct loans
and other forms of lending such as guaranteed investment
certificates, are interest-free. Consequently, Islamic financing
must rely instead on a kind of joint venture, or mutual partic-
ipation, between the customer and the Islamic bank, in order
to generate profits. To this end, Islamic banking converts exist-
ing deposits into Islamic investment deposits, whereby the
bank acts as agent or trustee (mudarib) instead of borrower.
In order to persuade depositors to go along with this, it must
be demonstrated that the performance of Islamic banks com-
pares very favourably with that of conventional banks in terms
of returns.
In the event of being left with depositors who are not
willing to convert to Islamic investment deposits, a ruling is
adopted under the Shari’ah necessity principle, which allows
the continued payment of interest, as per the contract, till the
maturation of the deposit, with the interest payments being
sourced from borrowers of the same category.41

40
See Al-Harran, Saad, Islamic Finance: Partnership Financing, 1993, pp. 4–5.
41
See Hassan, Hussein Hamed, “Conversion of National Bank of Sharjah
into an Islamic bank: A Case Study”, The International Islamic Finance
Forum, International Institute of Research, Dubai, March 2002.
 Islamic Commercial Law 51

3.7 Profit and Loss Sharing

Commonly, business ventures start off with a loan. For
Muslims, loans cannot be made or accepted according to
traditional banking methods because this invariably entails
the payment and receipt of interest and therefore is not halah.
Skipping past the laws of conventional finance and banking,
Islamic banking allows prospective clients to borrow money
while still adhering to Shari’ah law through a profit- and loss-
sharing scheme of financing. Profit-and-loss-sharing (PLS)
financing is a form of partnership where partners share prof-
its and losses on the basis of their capital share and effort.
Unlike interest-based financing, there is no guaranteed rate of
return. Islam supports the view that Muslims do not act as
nominal creditors in any investment, but are actual partners
in the business. This is an equity-based system of financing,
where the justification for the PLS-financier’s share in profit
rests on their effort and the risk that they carry. In other words,
they deserve to be rewarded since this profit would have been
impossible without their investment and, furthermore, if the
investment were to make a loss, then their money would also
be lost.42

3.8 Profit-Sharing Enterprises

Islamic law recognises two principal forms of profit-sharing
enterprises (PSE) based on PLS partnerships:43
(i) Shirkah al-‘inan or limited partnership. In this kind of
partnership, partners contribute capital, property and/or

42
Al Tamimi & Company, “Islamic finance: A UAE legal perspective”, The
International Islamic Finance Forum, International Institute of Research,
Dubai, March 2002, p. 2.
43
Doi, Abdur Rahman I., Shari’ah: The Islamic Law, pp. 365–367.
52 Islamic Banking and Finance in South-east Asia

labour. Profits and losses are shared in an agreed manner.

The difference between this and other forms of partner-
ship is that each partner is only the agent and not a surety
for his co-partners, which means that a partner is not liable
for a debt contracted by his co-partners and is only able
to sue someone with whom he himself has contracted.44
(ii) Mudarabah or dormant partnership (also called qirad). This
is a contract whereby one person (the dormant partner)
gives funds or property to another on the basis that the
lender will share in the active partner’s profits in a pro-
portion agreed in advance. They may not agree on a fixed
return since this would amount to riba. Equally, if there
is a loss, they also share this loss proportionally, but
the liability of the person who has provided the capi-
tal is limited to the amount of that capital. The dormant
partner remains the owner of the capital, but takes no
active part in the enterprise. The trader is responsible only
for negligence or breach of contract. Legitimate expenses
of the venture such as employees’ wages and travelling
expenses are deductible from the capital. The contract can
be drawn by either party as long as notice is given to the
other.45

3.9 Islamic Contract Law

Contracts are drawn to ensure the existence of clearly recog-
nised guidelines for all parties involved. They state the
standings of all those involved and the condition(s) of the
transaction(s) that are to take place. This occurs in both conven-
tional and Islamic banking. The general principle of the Islamic

44
Saleh, Nabil, Unlawful Gain and Legitimate Profit in Islamic Law, 1986, p. 93.
45
Hussain, Jamila, Islamic Law and Society, 1999, pp. 166–167.
 Islamic Commercial Law 53

law of contract is contained in the Quranic verse: “O you who

believe, fulfil all obligations”.46 The definition of contract (al-
’aqd) in Shari’ah law is similar to that in English common law,
but is wider in that it includes dispositions which are gratu-
itous as well as endowments and trusts.
A contract in Islamic law consists of an agreement made
between two or more parties and the basic elements are quite
similar to those of English common law:
(i) Offer and acceptance — a contract requires an offer (ijab)
and acceptance (qabul). The contract can be oral or in writ-
ing, made by signs or gestures, by conduct or through an
agent. If the offer is made in writing it remains in force
until received by the other party who must then reply
promptly.
(ii) Consideration — as in English common law, considera-
tion may consist of money, goods or services. It must be
something which is capable of being given, or, in the case
of a service, capable of being performed, and it must not
involve materials or acts which are prohibited according
to Islamic law.
(iii) Capacity — the parties entering into a contract must be
legally competent. A minor, a person of unsound mind,
an insolvent person, a person legally declared a prodigal,
an intoxicated person or a person suffering from an illness
which leads to his or her death (mard al-mawt) cannot enter
into a binding contract.
(iv) Legality — the purpose of the contract must be legal in
terms of the Shari’ah. A contract to grow grapes for wine-
making, for example, would be illegal, as would a con-
tract to sell firearms to criminals or to make a loan with
interest.

46
Quran, 5:1.
54 Islamic Banking and Finance in South-east Asia

(v) Absence of duress — the parties must enter into the con-
tract of their own free will. A contract concluded under
duress is null and void.

3.10 Types of Contract in Shari’ah

There are seven types of contract recognised by Shari’ah law
and they are as follows:
(i) Al-Tamlikat (acquiring of ownership)
This kind of contract relates to the acquisition of owner-
ship of properties, or the rights to the benefits of prop-
erties. The kinds of contract which fall into this category
can be further divided into two subgroups, namely:
(a) Uqud al-Muawadhat (contracts of exchange)
In this instance, the acquisition of ownership involves
some kind of exchange between two parties involv-
ing a sale, hire, money changing, compromise, parti-
tion, sale by order and the like.
(b) Uqad al-Tabarruat (contracts of charity)
This kind of contract relates to situations where
the ownership of a property is acquired without
involving an exchange, for example as a gift, alms,
endowment, benevolent loan (al-qard al-hasan) or the
assignment of debt. Sometimes a contract may be
initiated as a contract of charity, but then later the
receiving party is required to give an exchange.
Examples of such a contract are guarantees requested
by the debtor and gifts with the condition of an
exchange. Contracts such as these commence as con-
tracts of charity at the beginning, ending as contracts
of exchange.
(ii) Al-Isqatat (releases)
These contracts relate to the dropping of rights against
others with or without exchange. If the release is without
 Islamic Commercial Law 55

compensation from the other party, then the release is an

absolute release and includes repudiation, remission of
the penalty of talion, release from debt and withdrawal
from the right to pre-emption. If the release is with com-
pensation from the other party, then it is a release with
exchange.
(iii) Al-Itlaqat (permissions)
This kind of contract includes giving total responsibil-
ity to individuals, firms or agencies in the appointment
of governors and judges; giving a person who is dis-
possessed of the power of administration, permission to
administer his property, or giving permission to a minor
to carry on trade; and the appointment of a nominee to
take care of one’s children after death.
(iv) Al-Taqyidat (restrictions)
Contracts in this group prevent or terminate the perfor-
mance of certain functions. They include the dismissal
of governors, judges and supervisors; the termination of
endowments; the termination of the appointment of nom-
inees and agents; and dispossession of the administration
of property because of insanity, mental disorder, prodi-
gality or infancy.
(v) Al-Tauthiqat (securities)
This kind of contract is meant to secure debts for their
owners and guarantee creditors of debts owing to them.
They include guarantees and the assignment of debt and
mortgages.
(vi) Al-Ishtirak (partnerships)
These contracts relate to sharing in projects and prof-
its. They include al-mudarabah, where a person gives an
amount of money to another to trade or invest with the
condition that they share in the profit while the loss is
borne by the owner of the capital. They also include
56 Islamic Banking and Finance in South-east Asia

partnerships involving the cultivation of land and taking

care of trees.47
(vii) Al-Hifz (safe custody)
Contracts in this group relate to keeping property safe for
its owner and include some of the functions of agency.

3.11 Islamic Financing in a Contemporary Setting

Before the modern era, mudarabah partnerships, in which some
of the partners contribute only capital and the other partners
only labour, worked perfectly well, especially in traditional set-
tings which typically involved simple commercial, agricultural
or manufacturing ventures, where the number of investors
was usually limited and the size of capital invested relatively
small. Today, however, contemporary economic circumstances
require a much more flexible institutional framework, whereby
a PLS company arrangement is able to accommodate itself to
a huge number of investors, enormous financial resources and
ever-expanding technological frontiers. The problem here has
been one of adapting what are essentially mediaeval finan-
cial practices to the modern world of banking and investment.
This is a challenge that has been met by modifying present-
day financial institutions to the extent that they can embody
the principle implicit in the former, whilst still remaining com-
patible with contemporary practices.

3.12 The Problem of Uncertainty (gharar)

Risk-taking and uncertainty are a fact of life in the conventional
world of business, even though most people will naturally

47
Some financing principles of Islam stem from ancient practices in agri-
cultural which allowed parties to deal in crop-sharing for cultivable land
and fruit orchards in accordance with Shari’ah law.
 Islamic Commercial Law 57

seek to minimise the chances of something going wrong due to

unforeseen circumstances. However, as we have seen, under
Islamic law, risk-taking or uncertainty (gharar) is expressly for-
bidden. In legal and business terms, gharar means to enter into
a commercial venture blindly, without sufficient knowledge,
or else to undertake an excessively risky transaction, and it can
apply in a number of different circumstances. They include:
• Transactions where the seller is not in a position to hand over
the goods to the buyer.
• Transactions where the item or commodity for sale cannot be
immediately acquired — for example the sale of fruit which
has not yet ripened, or fish or birds not yet caught.
• Speculative investments such as trading in futures or on the
stock market.
• Transactions where the purchaser is not given the opportu-
nity of inspecting goods before purchasing item.
However, minor uncertainties may be permitted in sit-
uations, provided certain necessary conditions are fulfilled,
namely:
• The goods or service of the transaction be in existence.
• The characteristics of the goods or service are known.
• The parties to the contract should have such control over the
subject as to be able to ensure that exchange will take place.
• If the transaction or exchange is to take place in future, then
the date when it is to take place should be certain.
In Islamic law, the principle underlying most illegal con-
tracts is to prevent benefiting from others for nothing and
unfairly. A zero-sum exchange encapsulates precisely what is
to be avoided: it is an exchange in which one party gains at
the expense of another leading to a win-lose outcome. Natu-
rally, no one of sound mind would enter into a game where
losing was an absolute certainty; it is only when the outcome
58 Islamic Banking and Finance in South-east Asia

is uncertain that such game is played; uncertainty or risk is

what tempts rational agents to engage in exchanges where they
know in advance that only one party will gain, whilst the other
must surely lose. It is this temptation which is best described
by the term gharar and it follows that a gharar contract is char-
acterised as a zero-sum game with uncertain payoffs.48

3.13 Summary
It can thus be seen that there has always been a close historical
connection between Islam and commerce. The attitude of Islam
towards commercial activities is generally seen as a positive
one. Hence, the principles and guidelines regarding Islamic
finance, in essence, can be simply summarised as follows:

(i) Any predetermined payment over and above the actual

amount of principal is prohibited. Islam allows only one
kind of loan and that is qard-el-hassan (literally a “good
loan”) whereby the lender does not charge any interest
or additional amount over the money lent. Traditional
Muslim jurists have construed this principle so strictly
that, according to one commentator, “this prohibition
applies to any advantage or benefits that the lender might
secure out of the qard (loan) such as riding the borrower’s
mule, eating at his table, or even taking advantage of the
shade of his wall.” The principle derived from the quo-
tation emphasises that associated or indirect benefits are
also prohibited.
(ii) Lenders must share in the profits or losses arising out of
the enterprise for which the money was lent.

48
Al-Suwailem, Sami, “Towards an objective measure of Ghararin
exchange”, Islamic Economic Studies, Vol. 7, Nos. 1 & 2, 2000.
 Islamic Commercial Law 59

Islam encourages Muslims to invest their money and to

become partners in order to share profits and risks in
the business instead of becoming creditors. As defined
in the Shari’ah, or Islamic law, Islamic finance is based
on the belief that the provider of capital and the user of
capital should equally share the risk of business ventures,
whether those are industries, farms, service companies
or simple trade deals. Translated into banking terms, the
depositor, the bank and the borrower should all share the
risks and the rewards of financing business ventures. This
is unlike the interest-based commercial banking system,
where all the pressure is on the borrower: he must pay
back his loan, with the agreed interest, regardless of the
success or failure of his venture.
The principle which emerges here is that Islam encour-
ages investment in order that the community as a whole
may benefit. It is not willing to allow a loophole for those
who do not wish to invest and take risks, but rather are
content with hoarding their money or else depositing it
in a bank in order to receive an increase on their capi-
tal for no risk (other than the bank becoming insolvent).
Within Islam, either people invest with risk, or else suf-
fer loss through devaluation by inflation by keeping their
money idle. Islam encourages the notion of higher risks
and higher returns and promotes it by leaving no other
avenue available to investors. The objective is that high-
risk investments will act as a stimulus to the economy and
encourage entrepreneurs to maximise their efforts.
(iii) Making money from money is not Islamically acceptable.
From an Islamic point of view money is only a medium of
exchange, a way of defining the value of a thing; it has no
value in itself, and therefore should not be allowed to give
rise to more money simply by being put in a bank or lent
to someone else at a fixed interest rate. The human effort,
60 Islamic Banking and Finance in South-east Asia

initiative and risk involved in a productive venture are

more important than the money used to finance it. Muslim
jurists consider money as potential capital rather than cap-
ital, meaning that money becomes capital only when it
is invested in business. Accordingly, money advanced to
a business as a loan is regarded as a debt of the busi-
ness and not capital and, as such, it is not entitled to any
return (i.e. interest). Muslims are encouraged to purchase
and are discouraged from keeping money idle so that, for
instance, hoarding money is regarded as being unaccept-
able. In Islam, money represents purchasing power which
is considered to be the only proper use of money. This
purchasing power (money) cannot be used to make more
purchasing power (money) without undergoing the inter-
mediate step of it being used for the purchase of goods and
services.
(iv) Gharar (uncertainty, risk or speculation) is also prohibited.
Under this prohibition, any transaction entered into
should be free from uncertainty, risk and speculation.
Contracting parties should have perfect knowledge of
the counter values intended to be exchanged as a result
of their transactions. At the same time, though, par-
ties cannot pre-determine a guaranteed profit. This is
based on the principle of “uncertain gains” which, on
a strict interpretation, does not even allow an undertak-
ing from the customer to repay the borrowed principal
plus an amount to take into account inflation. The ratio-
nale behind the prohibition is the wish to protect the
weak from exploitation. Therefore, options and futures
are considered as un-Islamic and so are forward foreign
exchange transactions because rates are determined by
interest differentials.
A number of Islamic scholars disapprove the indexation
of indebtedness to inflation and explain this prohibition
 Islamic Commercial Law 61

within the framework of qard-el-hassan. According to

those scholars, the creditor advances the loan to win
the blessings of Allah and expects to obtain the reward
from Allah alone. A number of transactions are treated as
exceptions to the principle of gharar: sales with advanced
payment (bai’ bithaman ajil); contract to manufacture
(istisna); and hire contract (ijara). However, there are legal
requirements for the conclusion of these contracts to be
organised in a way which minimises risk.
(v) Investments should only support practices or products
that are not forbidden — or even discouraged — by Islam.
Trade in alcohol, for example would not be financed by
an Islamic bank; a real-estate loan could not be made for
the construction of a casino; and the bank could not lend
money to other banks at interest.49
Thus in conclusion, it can be seen that ultimately the aim
of the Islamic financial system is to allow individuals to earn a
living in a fair and profitable manner, without exploitation of
others, so that all society benefits.

49
“Principles of Islamic banking”, Nida’ul Islam Magazine (www.islam.
org.au), November–December 1995.