The reader should be additionally aware that Islam limited the sale of certain goods to be on spot basis. These goods are referred to as ribbawi items. Such goods can only be bought or sold in a spot transaction where buyers and sellers are present.
The reader may be unaware of the permissibility of the difference between a spot price and a credit price or a deferred price. This permissibility allows a seller of goods to charge a price X for the sale of goods if the buyer pays the full purchase price on spot, and allows the seller to sell the same goods at a price Y, which is greater than X, if the buyer pays in installments in the future or via a balloon payment, but takes immediate possession of the goods at time of contract initiation.
Another prohibition is that two contracts cannot be part of one contract, or that one contract cannot be conditional on another. Party A cannot sell a good to Party B on the condition that he sells another good to Party A or even to Party C.
These prohibitions are not chronologically organized in the texts, nor are they neatly arranged in a chapter of any handbook. These prohibitions have been passed on by the Law Giver in different situations and within specific circumstances. The historical background and context of these rulings are touched on where necessary.
The reader may have discovered that certain assumptions may not be adequate. A Muslim in general may think that there are specific criteria for calculating profit over a cost price; after all, we are always bargaining with sellers in the bazaars, but yet none exist. However, several other legal maxims exist of which the ordinary Muslim of today may not have heard.
To be fair to all Muslim readers of various backgrounds and levels of education we examine the contracts that are the fundamental pillars of Islamic finance. We examine their classical structures (as they were used in the time of the Prophet [saw]), and we shall identify the “enhancements” made to these contracts to adapt to the modern economic times of today. We leave it up to the reader to decide if these enhancements defeat the purpose of prohibitions, circumvent them to achieve impermissible outcomes, or are beneficial innovations that are for the good of the ummah (Muslim Community). The reader may also conclude that the amendments made are necessary to achieve the goals of modern economic life, but may question whether the goals of modern economic life are worth striving for. Let us say at the outset, that discussion is beyond the scope of this work.
We begin our discussion with the most controversial contract in Islamic finance, that of bai al inah, but before we do, here is a word on who the Law Giver is today. In 620 A.D. the Law Giver was Allah (swt) who spoke through Muhammad (saw) and appointed him as another Law Giver for mankind. No Muslim contests that there is no other primary source of law in Islam. But how many laws did the Law Giver actually spell out? The reality is very few. As times changed, situations changed, the Prophet (saw) left our world, as did His companions, the successors of his companions and the successors of successors. New dominions came under Muslim rule, and Islamic law evolved over time. In the case of selling what one does not own, the enhancements came by the original Law Giver himself.
The question to ask is who is the rightful Law Giver today? Every Muslim country is today either a democracy or a monarchy with Iran being the only official theocracy. Within democracies, elected members of Parliament pass laws in a country. If these members of Parliament are Muslims, it can be expected that they will pass laws within the guidelines set by the shariah. In a monarchy, the monarch is the Law Giver and in a theocracy, the cleric. In the space of Islamic finance certain bodies have been set up that are funded by the various Muslim countries, and these bodies have gathered together a bodice of shariah scholars who now issue legal guidelines or fatwas. They assemble in an ijmah and pass certain rulings based on their research and understanding. Whatever we as authors of this work are commenting on is not based on fatwas we have individually devised.
A reader can also argue: Who gave shariah scholars the authority or the right to pass fatwas? The answer is no one. These fatwas are not binding legislation of all member countries, although some are; however, the infrastructure of developing a sound education system of developing shariah scholars and having benchmarks for their qualifications is sadly missing from the Muslim world and we acknowledge that. Any reader of Islamic finance should view the websites of the following entities:
Accounting and Auditing of Islamic Financial Institutions (AAOIFI)
Islamic Financial Services Board (IFSB)
Islamic Development Bank
International Shariah Research Academy
Organization of Islamic Countries Fiqh Academy
Bank Negara Malaysia Shariah Advisory Council
Shariah boards of the Central Banks of various countries
Dow Jones Islamic indices
We also advise the reader to download a version of Sahih Muslim and the Holy Quran in his or her language to keep as a reference.
Chapter 1
The Islamic Finance Space
As a historical religion, Islam has been in existence for 1,400 years. The word religion comes from the Latin word religio, which means to bind oneself.1 Religious principles bind mankind to a way of life that is meant to be pleasing to God. Human history provides enough evidence that mankind has not always followed religious principles in their true spirit and has had to pay the consequences from time to time.
Finance has been around as long as man has inhabited this earth. The most basic form of finance in prehistory was money lending and remains so today. All the Semitic religions of Christianity, Judaism, and Islam warn mankind against the practice of usury, which allows interest to be the reward for money lent. Islam is not the only religion to forbid the taking of interest. The word used in the Quran is riba,2
Finance was also an integral part of the Muslim empires of the Ummayads, the Abbasids, the Fatimids, the Mamlukes, the Seljuks, and also of the Ottomans. Islam dawned on Arab traders (most previous Prophets were either craftsmen or farmers). The Prophet ([saw] peace be upon him) himself was a trader. Trade has such an importance on the fabric of Islam that the Quran itself endorses trade or bai.3
What kind of trade did Islam permit? Certainly Islam permitted certain trade practices and forbade others, like hoarding of goods,4 inflating prices by meeting merchants outside city walls and buying their goods before they come to market,5 or selling goods not in one's ownership.6 These obligations had an impact on the trading practices endorsed within the Muslim world. Principles of fairness, keeping one's oath, fulfilling terms of contracts were endorsed not just in conversation but in the Quran itself.7
Much of the Muslim world remained an agriculture-based economy, with a monarchical political system of rule. The Muslim world is famous for its bazaars, where traders came from across the globe to trade wares and to be exposed to this new religion that had shown its face on the pages of history. Although much of Orientalist literature8 focuses on the military conquests of the Muslim rulers, little is talked about of the impact of trade with the Muslim world, or the institutions of trade. Scholars such as Donald Quateart are working on archives found in the libraries of Istanbul to give a more clear picture of what life was like in the most recent episode of Islamic history, that of the Ottoman Empire.
In an empire as vast as the Ottoman Empire with Istanbul being the center of trade for much of the civilized world, trade and finance must have gone hand in hand. There is no evidence of the existence of modern-day banks in Istanbul; certainly, however, the oldest banks and banking families belonged to Italy and lived in the 1500s.