Reprinted from Tobin 2016, 117-121 © Cornell University Press
Such prohibitions and interpretations of interest have resulted in three primary forms or methods of banking and financial services, which approximate the venture capitalism and lease financing found at conventional, or non-Islamic, banks. The first form is mudaraba, in which an investor or group of investors entrusts an entrepreneur with capital, who then invests in a particular productive or trade venture for a share of the profits or a commission. Upon completing the venture, the entrepreneur returns the principal and a prespecified share of the resulting profits to the investors (Kuran 2004, 8). This is the model that the Prophet Mohammed and his first wife, Khadija,are said to have exemplified in their joint commercial enterprises.
According to the hadith and historical sources (Lings 1994, 33–35), Khadija bint Khuwaylid had inherited wealth from her father, a successful sixth-century merchant, and had managed it quite well. A wealthy woman in pre-Islamic Arabia, Khadija had married and been widowed twice before Mohammed, and had received many other offers of marriage. Khadija’s business strategy was to send out trade caravans from Mecca to areas as far north as Syria. She relied on the traders to make profitable sales on her behalf, compensating them with commissions. At the end of the sixth century, Khadija, then forty years old, needed a reliable trader to bring a caravan to Syria. Family members recommended Mohammed, a twenty-five-year-old relative of Khadija’s who had gained a reputation as honest and trustworthy. In fact, his reputation was so outstanding and the need for this trade caravan to be successful was so high that Khadija offered Mohammed twice the normal commission. Her investment paid off: based on Mohammed’s business savvy, profits doubled and business flourished. The endeavor was successful enough that Khadija and Mohammed became endeared to each other and married the following year.
Whether this story is an example of divine intervention or merely good business sense, the fact remains that this relationship is often upheld as the first model for an ideal Islamic business relationship. In this method, Khadija was the mudarib and source for capital, and Mohammed was the entrepreneur entrusted with capital for trade. Though this arrangement existed prior to the revelation of Islam, because this was the Prophet Mohammed’s model economic relationship it served as the first halal, or permissible, financing practice in the Islamic tradition.
Musharaka is similar to mudaraba. However, in this second form the entrepreneur exposes her own capital for both profit and loss, rather than solely the capital of the mudarib. This second model is based upon the relationship established between the Muslims from Mecca and the Prophet Mohammed’s ansaar, or helper hosts in Medina. For many Muslims, this the most important story in the history of Islam. In 622, Mohammed and his early followers were warned of an assassination plot in Mecca. Over the course of two weeks, the Muslims left Mecca in the Hijra, a series of movements designed to help them escape capture and ultimately find safe refuge in Medina. There, the Muslim ansaar offered up their resources to assist the Meccan emigrants. Initially, the group directed their energies toward building the first house of worship in Islam, the Quba Mosque, which exists today. To further solidify the shared work and shared outcomes model for a new, integrated life between the Meccans and Medinans, Mohammed set about matching Meccan emigrants, or muhajerun, with host Medinans, or ansaar, in shares of work, land, and capital far beyond the mosque construction. These “brothers” and fictive kin shared their labor, and profits and losses were incurred together at a prescribed ratio. As Martin Lings explains:
In order to unite the community of believers still further, the Prophet now instituted a pact of brotherhood between the Helpers (ansaar) and the Emigrants (muhajerun), so that each of the Helpers would have an This document may not be reproduced or distributed in any form Emigrant brother who was nearer to him than any of the Helpers, and each Emigrant would have a Helper brother who was nearer to him than any Emigrant. But the Prophet made himself and his family an exception, for it would have been too invidious for him to choose as his brother one of the Helpers rather than another. (Lings 1994, 128)
This arrangement comprises the earliest justification and incorporation of musharaka into Islamic tradition and Shariʿa. The third form of business relationship involves cost-plus or lease financing. Murabaha is a cost-plus form of ownership transfer for goods and is the most popular financing or sale mode in Islamic banks (Kuran 2004,10). Again, following the idea that banks should not profit without taking on some risk, a producer or trader tells them about the types of goods she is interested in purchasing. The bank purchases the items, marks up the price by a known margin, and then physically and/or contractually transfers ownership to the client, who pays the elevated amount either on the spot or in scheduled payments.
Despite this financing mode’s popularity, there is no singular Qurʾanic or hadith-based example after which this is modeled. Murabaha is believed to have existed prior to the advent of Islam; it was folded into the economic practices of early Muslims and later documented and explicated in the hadith.
In a departure from mudaraba relationships, there is no sacred story rendering this arrangement distinctly “Islamic.” It was a part of “the tradition” in a vague way that persisted without direct reference in the Qurʾan. In the first formally coded book of the Prophet Mohammed’s traditions, Al-Muwatta, Imam Malik reports:
The generally agreed on way of doing things among us about a man buying cloth in one city, and then taking it to another city to sell as a murabaha, is that he is not reckoned to have the wage of an agent, or any allowance for ironing, folding, straightening, expenses, or the rent of a house. As for the cost of transporting the cloth, it is included in the basic price, and no share of the profit is allocated to it unless the agent tells all of that to the investor. If they agree to share the profits accordingly after knowledge of it, there is no harm in that. (Book 31, Hadith 36; Cited in Ibn Anas 1989, 271)
This hadith models two important facets of murabaha transactions. First, the seller discloses his cost—narrowly defined—to the buyer. Second, the profit is transparent, known to and agreed upon by both parties. The disclosure of cost and profit in sales and financing assumes transparency and honesty in dealings, which lends itself to discussions of the role of Islamic ethics in such transactions. This cost-plus financing becomes legitimate from an Islamic standpoint because there is technically no interest involved in the sale, and the banks or traders have taken on ownership and exposed themselves to risk for some time. Physical or contractual ownership for even a fraction of a second can legitimate this, exposing the bank or trader to a measure of risk.
The Shariʿa grounds for this arrangement is retroactively legitimated with Qurʾan 2:279, in which “Allah has permitted trade and forbidden ribaʾ,” which scholars have interpreted to mean that trade with a profit (ribah) is valid, but a trade with interest (ribaʾ) is not. In addition, the goods sold must meet some basic criteria for sale; for example, their condition must be clear, transparent, and known before the sale, in order to avoid gharrar, or speculation, which is also forbidden (Warde 2010). The goods must exist in tangible form, and they cannot be used in a “buy-back” arrangement in which only two parties contract to buy, sell, and resell them to each other.
Islamic Banking and Finance: Shariʿa-Derived Understandings
These three types of Islamic financing remain the center of technical and methodological efforts in Islamic banking and finance. Most Islamic banks offer these services and most Shariʿa committees would agree on their Islamic “soundness.” Beyond this point, however, the Islamic underpinnings for transactions and financing have more variability and lack strong consensus. In the case of mudaraba or musharaka, the average consumer educated in basic Islamic history may consider the Qurʾanic examples of Khadija and Mohammed as well as the socio-economic relationships between the muhajerun and ansaar in Medina striking, clear, and understandable. However, when moving into types of murabaha, the rulings and establishments of the methods are based more clearly upon extrapolation from guiding principles in Shariʿa rather than a more direct imitation of Qurʾanic examples.
One means by which extrapolation and inference occurs when examining the permissibility of Islamic banking and finance arrangements, rather than a more strict modeling found mudaraba and musharaka, is by way of systematizing, categorizing, and then approving or disallowing the products and services for investment; they are considered technically haram (forbidden) or halal (permissible). This expansion of audit culture (Strathern 2000) into Islamizing products and services demonstrate that assessments of the processes of economization in Islamic banking and finance are highly rationalized. Products and services have now been vetted for investment in accordance with nine categories or “screens” (Alchaar and Sandra 2006, Warde 2010). The industry forbids:
1. Committing business with conventional banks in such a way that violates Islamic fundamentals such as through interest payments or debts; derivatives, futures, or securities; and Foreign Exchange for fixed-terms.
2. Engaging in conventional insurance or accompanying activities.
3. Profiting from alcohol production, consumption, selling, and marketing.
4. Dealing in illicit drugs.
5. Profiting from gambling, even if it falls under a name like “lotto,” sports betting, or financing the structures for that purpose.
6. Profiting from pork production, processing, or sales.
7. Financing any sexually explicit entertainment, prostitution, nightclubs, or other related activities, which usually include pornography but not beachwear or lingerie sales.
8. Making any transactions that lack appropriate levels of knowledge and awareness, or take on excessive risk, or involve interest.
9. Transacting any business involving weaponry.
This last item, “Any business involving weaponry,” is highly debated. Some sources do not reference this at all. Some say that investing in weaponry is acceptable as long as the weapons are not used against Muslims (Salam 2009).
Reading List:
Alchaar, Mohamad Nedal, and Abboud Sandra. 2006. Islamic Finance Qualification. London: Securities & Investment Institute.
Kuran, Timur. 2004. Islam and Mammon: The Economic Predicaments of Islamism. Princeton, NJ: Princeton University Press.
Ibn Anas, Malik. 1989. Al-Muwatta of Imam Malik ibn Anas: The First Formulation of Islamic Law. Edited by Aisha Abdurrahman Bewley. Islamic Classical Library. London: Kegan Paul International.
Lings, Martin. 1994. Muhammad: His Life Based on the Earliest Sources. Jakarta: Penerbit Serambi.
Salam, Monem. 2009. “Investing in the Stock Market in a Halal Way.” Paper presented October 17 at the Islamic Council of New England 24th Annual Conference, Boston.
Strathern, Marilyn. 2000. Audit Cultures: Anthropological Studies in Accountability, Ethics and the Academy. London: Routledge.
Warde, Ibrahim. 2010. Islamic Finance in the Global Economy. Edinburgh: Edinburgh University Press.