Common Questions About Islamic Finance (Part 4 of 5)

This week…
— Stocks are like gambling, but Islam permits stocks and forbids gambling. Why?
— What’s the difference between an ordinary lease and an Islamic lease (ijarah)? They look the same.
— If Islam forbids fixed-income interest, what’s wrong with floating-rate interest? Doesn’t it also rise and fall like profit?

Previous weeks…
— There was no Islamic bank during the Prophet’s (Allah bless him and give him peace) time, so how can there be Islamic banking now? Sounds like a bid’a. (Click here to view)
— Don’t Islamic banks simply change labels, by replacing the word “interest” with “profit”? (Click here to view)
— Why does Islam forbid interest when money is just another commodity that comes at a price? (Click here to view)
— Where should I keep my money? Islamic banking doesn’t adequately address the inflation problem and you say interest banking is forbidden. (Click here to view)

Coming up…
— I don’t have enough money to buy factory equipment (or a car, a home or pay for an education)? How do I avoid interest and still fulfill my short-term financing requirements?
— Is there a secondary market for Islamic instruments?

Stocks are like gambling, but Islam permits stocks and forbids gambling. Why?

This returns to the basic principle of asset and service backing. Stocks invest in real assets (a company’s property, plant and equipment) and actual services (a company’s management expertise). Gambling invests in nothing. Even if a lottery funds charities or finances public works, the money with which it does so is still haraam. Stocks provide risk-based returns based on publicly available information. Gambling provides only uncertainty, and the distant prospect of huge gains based entirely on chance. To the casual observer “buying low and selling high” resembles gambling, but because there is no Islamic stipulation on the price at which something is sold (barring artificial interventions like bidding up or hoarding) and the duration for which it is held, the primary concern relates to what is actually bought and sold. Provided the main business of the company is permissible, the company owns some illiquid assets, and the investor removes the proportion of his profits that correspond to the company’s interest earnings, then purchasing the stock may be permissible.

What’s the difference between an ordinary lease and an Islamic lease (ijarah)? They look the same.

An ijarah lease, like a conventional lease, is an agreement to rent out property or services. In an ijarah lease the lessor (the person granting the lease) maintains ownership of the property or service while the lessee (the person to whom the lease is granted) gains use of the property and the resulting profit. In conventional financial leasing, the interest payments have to be made to the lessor whether the lessee gains benefit from the property or not. If the property is damaged through no fault of the lessee’s, the interest payments are still payable.

So the ownership risk does not entirely rest in the owner’s hands. Ijarahs, on the other hand, clearly distinguish between ownership and usufruct, or the use and profit of a thing, and stipulate that rental rates, unlike interest rates, be known and agreed upon beforehand. The central component of a valid ijarah agreement is the appropriation of risk, specifically the ownership of risk. In an Islamic lease, risk associated with the leased property or service remains with the lessor, the beneficiary of the rental payments.

If Islam forbids fixed-income interest, what’s wrong with floating-rate interest? Doesn’t it also rise and fall like profit?

Islam does not forbid fixation. It is permissible to fix profits (in percentage, not absolute, terms), prices, rents and installment plans, to name a few measures. But it is forbidden to exchange money for a larger amount of money (unless the currency is different, in which case it is permissible at spot). The unlike exchange of like moneys creates riba. But exchanging assets or services for money and money for assets or services is entirely permissible. So the problem does not relate to whether an interest rate is fixed or floating, but to the interest itself.

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