A] Basic Facts from the Qur’an
The basic and most fundamental precept of Islam in the area of economics is that all resources that our economic system relies upon are created by Allah. He alone has the ability to make these resources of benefit to us and He alone has allowed us as human beings to benefit from these resources.
This point becomes very clear when one reflects upon the following verses of the Qur’an:
“It is He Who has made the earth manageable for you, so traverse ye through its tracts and enjoy of the Sustenance which He furnishes: but unto Him is the Resurrection.” (Qur’an 67: 15)
“And it is He who spread out the earth, and set thereon mountains standing firm and (flowing) rivers: and fruit of every kind He made in pairs, two and two: He draweth the night as a veil o’er the Day. Behold, verily in these things there are signs for those who consider!” (Qur’an 13: 3)
“It is He Who hath created for you all things that are on earth; Moreover His design comprehended the heavens, for He gave order and perfection to the seven firmaments; and of all things He hath perfect knowledge.” (Qur’an 2: 29)
“It is We Who have placed you with authority on earth, and provided you therein with means for the fulfilment of your life: small are the thanks that ye give!” (Qur’an 7: 10)
“See ye the seed that ye sow in the ground? Is it ye that cause it to grow, or are We the Cause?” (Qur’an 56: 63-64)
This series is primarily adapted from https://cief.wordpress.com/2006/01/16/definition-of-contract/
B] Definition of Contract
Much of Islamic economics and finance is based on contracts between two or more parties. Whether it is a contract to purchase goods or a contract to make a loan, one needs to understand the concept of contract in Islam and how/if it differs from the one we see in the man-made law.
Definition of Contract in Islam
According to Kharofa, the word ‘aqd (contract) in Arabic language means tying tightly, as in tying a rope. Arabs used the word to speak about firm belief or determination. They used to say ‘aqd al ‘ahd to mean ‘make a covenant’ and ‘aqd al yamin to mean ‘give an oath’. Along the same line is ‘adqat al nikah meaning a marriage contract.
The word ‘aqd also carries the meaning of obligations, as used in the first verse of Surah al-Maida. O ye who believe! Fulfil your obligations.
In Islamic jurisprudence the word contract is used to mean an engagement and agreement between two persons in a legally accepted, impactful and binding manner.
Definition of Contract in Man-Made Laws
The definition of a contract according to the French Civil Law in article 1101 is ‘an agreement which commits a person or a group of persons to give something, do something or refrain from something to another person or group of persons.’
The definition of a contract in both Islamic jurisprudence and the civil law are fairly similar. Kharofa states that the Islamic definition is stronger.
C] The Pillars of a Contract
The pillars of a contract in Islam are two:
- Ijaab – the positive proposal; and
- Qabool – the acceptance.
The coming together of ijaab and qabool makes up the contract.
There are three other conditions that Kharofa specifies for a contact to be legally acceptable and impactful:
- the existence of two properly and aptly qualified contractors;
- a format; and
a place of reference or subject matter.
D] Types and Classifications of Contracts
There are two main types of contracts, namely: Unilateral and Bilateral.
1. Unilateral contract
A unilateral contract is gratuitous in character and does not require the consent (qabool) of the recipient. Examples of a unilateral contract include gift (hadiah, hibah), off-set of the debt (ibra), wills (wassiyyat) endowment (waqf) and loan (qard). Each of these transactions will be explained later in more detail.
2. Bilateral Contract
A bilateral contract requires the consent of both parties and covers the remaining transactions in Islamic law. The scholars have traditionally divided bilateral contracts into six classifications:
- Contracts of exchange (mu’awadat);
- Contracts of security (tawthiqat);
- Contracts of partnership (shirkah);
- Contracts of safe custody (wadi’ah);
- Contracts pertaining to the utilization of usufruct (manfa’ah); and
- Contracts pertaining to do a work (e.g., Wakalah and ju’alah).
These classifications and various contracts that come under these will form the basis of later discussion under contracts and transactions in Islamic law.
E] Difference between a Promise and a Contract
The distinction between a promise and a contract has vast implications for Islamic finance in the contemporary era (especially in Murabahah financing) as we will explore later.
Kahrofa describes a promise as a verbal proposition made by one party to undertake something to the benefit of the other. Note the absence here of an explicit ijaab and qabool. Mufti Taqi Usmani further explains a promise as a one-sided commitment as opposed to a contract which typically requires two sides (with the exception of unilateral contracts that are rare in nature).
Kharofa explains that a contract has to be executed both from the legal and moral point-of-view, whereas a promise implies only a moral duty. Kharofa argues that fulfilling a promise is not an obligation (wajib), however, it is a noble quality. This view is particularly ascribed to Imam Abu Hanifah, Imam Shafi’e and Imam Ahmad.
Both Kharofa and Mufti Taqi point out that a promise is enforceable in the court under certain circumstances in accordance with the views held by Hasan al-Basri, Sa’id bin al-Ashwa, Imam Bukhari, Ibn al-‘Arabi, al-Ghazali to name a few. This implies that a promise is legally enforceable.
Mufti Taqi argues that circumstances in the modern economy necessitate that a promise, for the purposes of Islamic commercial law, be considered binding.
We will not go into the details of the proofs provided for each of these positions as they are available on the internet in Taqi Usmani’s book. For our purposes what is important to understand is that promises are considered binding in Islamic commercial law by the majority of the contemporary scholars with the following conditions:
- it should be a one-sided promise;
- the promise must have caused the promisor to incur some liability;
- If the promise is to purchase something, the actual sale must take place at the appointed time by the exchange of offer and acceptance. Mere promise itself should not be taken as the concluded sale; and
If the promisor backs out of his promise, the court may force him either to purchase the commodity or pay actual damages to the seller. The actual damages will include the actual monetary loss suffered by him but will not include the opportunity cost.
F] Conditions for a Valid Contract
Scholars describe a valid contract as a contract that is sound in both its pillars and characteristics. That means, it does not contain anything that is prohibited by Shariah.
An invalid contract, thus, would be one which is not sound in either its pillars or its characteristics, or both. According to the Hanafi scholars there is a type, a corrupt contract, that is sound in its pillars but not in its characteristics. We will currently ignore the corrupt contract.
Kharofa divides the conditions as below:
Conditions of Confirmation (en’eqad)
- The existence of two contracting parties;
- The format and the subject; and
- Particular conditions for certain contracts to be valid (e.g., presence of two witnesses in a marriage contact without which the contract is nugatory).
Conditions of Execution (nafath)
- The contractor should be in possession of the subject, or at least should be able to hand it over if it is not in his possession; and
- There should be no claim from other parties to the subject of the contract.
Conditions of Obligation (lozum)
- The contract should not contain an element of choice or option; and
- The subject matter of the contract should be free from defects (that are not disclosed to the contacting party).
Conditions of Correctness (Sehah)
The contract must have met each of the three pillars.
G] Contract of Sale and its Conditions
The most basic type of an exchange (mu’awadat) contract is a contract of sale. Kharofa outlines seven conditions for a sales contract to be valid as follows:
- The contract should be concluded willingly and with mutual consent as per the Qur’anic injunction in Surah an-Nisaa 26.
- Both parties to the contract must have the capacity to conduct such a sale. A sale by an insane person (temporarily or permanently insane), a child or a drunken person is not valid. Hanafis permit such a contract by a child as long as the guardians permit it. Hanbalis permit such a contract by a child as long as the child is mature enough to make a decision. The Hanbali position is based on verse 6 of Surah an-Nisaa.
- The object of sale should carry a legal benefit to the buyer, usually in the form of property or service received.
- The object of sale must be owned by the seller or the seller should have the owner’s express permission. In an agency situation if the owner gives a belated permission, after the sale has taken place, the contract is considered valid but without it the contract is void.
- The seller must be capable of delivering the subject of the contract to the buyer, or the sale is nugatory. One cannot, therefore, sell something that is not in his or her possession (e.g., cannot sell a bird in the sky or fish in the water until possession has been taken).
- The object of sale should be made known to the purchaser by sight or by ample description. If the object being sold is not seen by the purchaser and has not been sufficiently described, the sale is invalid. A major implication of this is the obligation on the seller to disclose any and all defects in the object of sale to the buyer for the sale to be valid. A strong opinion among the scholars is that the sale will be valid but the buyer will have the option to invalidate it upon inspecting the object bought.
The price, or consideration due, must be known to both parties. Therefore, a contract of ribaa where the price ultimately paid changes by the timing of the payment is not valid due to the uncertainty involved with respect to the price.
H] Al-Ijarah Hire, Rent or Lease
Though there are various definitions of Al-Ijarah given by the scholars of jurisprudence, they all agree that this contract is a contract on using the benefits or services in return for compensation. In our context, Al-Ijarah refers to a contract to hire, rent or lease. We see the evidence of hire in the story of Musa (Al-Qasas: 26-27) where Musa was hired by his father-in-law to provide a service.
There are two main types of subjects in an Ijarah contract:
- Tasks, where the compensation is for effort expended of skill used (by an employee or a contractor), and
- Property, where the compensation is for the use of a property (such as a car or a house).
An Ijarah contract cannot be cancelled unless both parties agree or if one of the parties fails to deliver.
The pillars of an Ijarah contract are:
- Presence of two parties
- Offer and acceptance
- Reimbursement or compensation
- Specified usage
Without any of the above the contract is not valid. A point to note here is the necessity to specify the reimbursement and the usage. If these are missing, the contract is valid only if the two parties agree on them later.
Terms and Conditions of Al-Ijarah
Al-Ijarah (rent/lease/hire) contract has a number of terms and conditions in addition to the common terms and conditions that apply to all contracts, these include:
- The property rented or leased must be in a useable condition (i.e., the lessee should be able to use the property for its intended purpose). Similarly, in a hire contract, the employee must be able to perform the job required of him or her.
- Ijarah has to be for inconsumable goods.
- The lessee or the employee is not permitted to use the subject in a manner contrary to what is permitted by the contract. Specifically, the lessee or the employee is not allowed to inflict any harm on the subject of the contract.
- Ijarah contract cannot be made for a task that is a religious obligation. For example, it is prohibited to enter into an employment contract for leading the prayer of making the azaan. Ijarah is valid, however, for teaching the Qur’an or religious sciences, as well as secular subjects because these are not religious obligations.
- If the two parties disagree on the value of the reimbursement or the rent/lease on the property, after the contract commences, the word of the lessor/employer is accepted under oath upto the time of disagreement. At that point the contract is then invalidated.
The majority of the scholars say that the Ijarah contract does not end by the death of one of the two parties, as long as both parties can fulfill their end of the contract. The Hanafis, to the contrary, deem the contract invalidated with the death of one party.
I] Jua’alah Payment on Completion of Task
Jua’alah is similar to Ijarah, however, it involves a fixed payment for a specific task that is not well-structured. An example of a Jua’alah would be offering a payment for finding a missing item. In a Jua’alah arrangement, the payment is made after the task has been completed.
According to a tradition in Al-Bukhari and Al-Muslim, the Prophet approved of taking a sum as Jua’alah for blessing a sick person with the recitation of the Qur’an.
Difference Between a Jua’alah and an Ijarah
The primary differences between a Jua’alah and an Ijarah are:
- The specified payment in Jua’alah cannot be paid until the task is completed, whereas interim payments are accepted in an Ijarah In a Jua’alah contract, payments in advance or interim payments are not legal.
- Jua’alah has some gharar in it, which is approved by the Shariah, whereas an Ijarah contract has no gharar.
- The Jua’alah contract is a permissible contract, which means it can be invalidated by either of the parties at any time, whereas an Ijarah contract is an obligatory contract which cannot be invalidated after being signed.
- An Ijarah contract has a specified time-frame attached to it, whereas a Jua’alah contract has no time-frame (though a minority opinion among the Malikies argues that a time-frame is necessary).
The Jua’alah cannot be increased or decreased once the task has started.
J] Al-Hewalah Debt Transfer
Al-Hewalah means to move. The term is typically used where the debtor moves his debt to a third party.
For Al-Hewalah to take place, there are two necessary steps that must take place:
- The third party (“C”) will become indebted to the creditor (“A”) for the original debt under the same terms and conditions, as well as the amount, or the original debt between A and the original debtor (“B”).
- A new debt will be created, whereby B will be indebted to C, for consideration similar in value to that of the original debt.
Al-Hewalah has been used by the Jewish scholars extensively to get around ribaa. The Muslim scholars, however, have clearly laid down the requirement for the original and the new debt to be of similar value. This difference between the Muslim scholars and the Jewish scholars stems from different core methodologies; the Muslim scholars emphasize the spirit of the law, whereas the Jewish scholars emphasize the letter of the law.
The Hewalah contract cannot take place unless all three parties agree to the arrangement.
K] Ar-Rahn Collateral
Ar-Rahn, or mortgage or collateral, is defined in the Islamic jurisprudence as “possessions offered as security for a debt so that the debt will be taken from it in case the debtor failed to pay back the due money.”
Ar-Rahn is a permissible contract in Shariah. It is known from the Sunnah that when the Prophet passed away, his shield was with a Jewish man in Medina as a collateral.
The conditions of Ar-Rahn:
- The indebted party cannot be coerced into putting up a collateral;
- An orphan’s property cannot be put up as a collateral by the trustee, unless under exceptional circumstances;
- The property held as collateral must be liquid;
- The property held as collateral must be distinct from other properties;
- The ownership does not change, therefore the owner is responsible for the cost of upkeeping the property even when it is pledged as a collateral. Likewise, the owner continues to enjoy any secondary benefits to the property;
- There is disagreement among the scholars on whether the property pledged as a collateral can be used. Many of the scholars say that the property cannot be used by either the debtor or the borrower, while many argue that the owner (the borrower in this case) can continue to use the property;
- If the property held as collateral is lost or damaged while in possession of the trustee, without any negligence on his part, there is no guarantee by the trustee;
- The ownership of the property cannot be transferred until the debt is settled or the debtor allows for such a transaction;
If the borrower cannot pay back at the expiry of the term, the judge will order the property pledged as collateral to be sold in the open market, even if it is the residence of the borrower.
L] Bai’ Mu’ajjal Deferred Payment Sale
Bai' Mu'ajjal is a deferred payment sale contract in which the parties agree to payment of the price at a time in future.
A deferred payment sale contract is valid if the date of payment is set unambiguously. That means, the date can set with reference to a specific date (e.g. 24 December) or a specific period (e.g. six months from the date of delivery of goods or services, or as otherwise agreed upon between the parties).
However, the date of payment cannot be set with reference to a future event when the exact date of the occurrence of that event is either unknown or uncertain. If there is ambiguity in the date of payment, the sale is considered void.
Deferred Price could be more than Spot Price
The deferred price could be set higher than the spot price – there is no restriction on that – as long as the price is set at the time of purchase. The price cannot be changed once the sale contract has been concluded. Even if the purchaser settles the account at a time earlier than that stipulated in the contract, the amount of payment must equal that agreed upon, and not be lower in consideration of earlier payment.
Dealing with Default
In an interest-based system, the seller would impose penalties (interest) on the buyer in case of a late payment. Such would not be permissible under Islam. However, the scholars agree that the seller may impose penalties for late payment in the form of mandatory charity (e.g., in the event of late payment, the buyer would pay $X per day to a specified charitable organization).
This must act solely as an incentive for the buyer to settle the account in a timely fashion. The seller must not benefit from the penalties paid by the buyer.
If the sale is concluded with payment in installments, it is permissible for the seller to stipulate in the contract that if the buyer fails to make a payment, the whole amount will come due immediately.
It is also permissible for the seller to demand a security, either as a mortgage or a lien. The seller may also demand a promissory note or a bill of exchange.
M] Bai’ Bithaman Ajil Deferred Payment Sale (Single Instalment)
A deferred payment sale where the payment is made in a single installment is called Bai' Bithaman Ajil. The deferred payment sale contract would include all the terms and conditions present in Bai' al-Mu'ajjal.
This particular contract has become exceedingly popular in the Islamic banking context.
N] Istisna Contract of Advance Financing for Pre-Manufactured Assets
Istisna is a contract of exchange, whereby the funding party agrees to deliver a commodity or an asset at a pre-determined future time at an agreed price.
Istisna is widely used by Islamic banks and financial institutions to finance the construction of real estate related activity like buildings, warehouses, showrooms, shopping malls, residential towers and villas, as well as manufacturing activity like aircrafts, ships, machines and equipment.
Istisna are based on a contract for a future delivery of manufactured or constructed asset(s). At the delivery date(s), which can be single or multiple, the obligor will deliver the asset(s). The investors do not intend to hold the assets, they will be on-sold to an ultimate buyer, which could be the obligor. The investors will receive the proceeds of this sale. Often sukuk al-Istisna is combined with a forward lease arrangement to enable investors to receive a return before the delivery of the asset(s).
O] Salam Contract of Advance Financing for Pre-Delivered Assets
Salam is a forward financing transaction, where the financial institution pays in advance for buying specified assets, which the seller will supply on a pre-agreed date. What is given in exchange for the advance payment of the price should not in itself be in the nature of money. For the payment in advance, the contracting parties stipulate a future date for the supply of goods of specified quantity and quality.
Salam may be considered as a kind of debt, because the object of the Salam contract is the liability of the seller, up to the agreed future date, to deliver the object for which advanced payment of the price has already been made.
There is consensus among Muslim jurists on the permissibility of Salam, notwithstanding the general principle of the Shariah that does not permit the sale of a commodity which is not in the possession of the seller, because the object of the contract is that the goods are a recompense for the price paid in advance, just as the price is recompense paid for getting the goods in advance.
The transaction is considered Salam if the buyer has paid the purchase price to the seller in full at the time of sale. The idea of Salam is to provide a mechanism that ensures that the seller has the liquidity they expected from entering into the transaction in the first place.
Muslim jurists are unanimous that full payment of the purchase price is key for Salam to exist. However, Salam cannot take place in money or currencies as these are subject to rules relating to bai al-sarf, wherein exchange has to be simultaneous.
Difference between Istisnaa and Salam,
Istisnaa, like Salam, is a special kind of sale contract where a sale is transacted before the goods come into existence. However, there are several points of difference between Istisnaa and Salam.
- Istisnaa is always a thing which needs manufacturing, while Salam can be effected on anything, no matter whether it needs manufacturing or not
- It is necessary for Salam that the price is paid in full in advance, while it is not necessary in Istisnaa where payment can be made in staggered basis.
- The object of the Salam is a liability on the seller to deliver, thus should be in the form of fungible.
- For Istisnaa, the asset manufactured must meet specification of the order and the buyer has the right not to take possession of the asset if the specifications are not met.
- The time of delivery is an essential part of the sale in Salam while it is not necessary in Istisnaa that the time of delivery is fixed.
- Late delivery can reduce the price of an Istisnaa contract but in a Salam, the penalty amount is paid should not be taken as benefit for the buyer (i.e. should be given to charity).
P] Kafalah Contract of Guarantee
Kafalah is the act of someone adding himself to another person and making himself liable to perform the responsibility together with the person.
A guarantee to perform the promise or discharge the liability of a third person in case of his default. Accordingly, the claim and demand should be made on both the principle debtor or the surety.
Three words are used interchangeably – himalah, za’amah, Kafalah.
Al-Mawradi gave more accurate definitions:
- Kafalah for individuals
- Himalah for blood-money
- Za’amah for substantial financial sums
It should be stressed that unlike Hiwalah (transfer of debt), Kafalah would not release the principal debtor from the debt as Kafalah is only an additional obligation of the guarantor to the existing obligation.
Normally, one is not allowed any remuneration against the guarantee as the guarantors payment of guarantee will resemble a loan generating a profit to the lender which is prohibited in Islam. However, a fee representing actual administrative expenses is allowed for the services rendered.
Q] Murabaha Contract of Sale and Purchase
Murabaha is a contract of exchange based on sale-and-purchase contracts with a predetermined cost and profit. The seller states the cost he has incurred on the asset to be sold and sells it to another person by adding some profit or mark-up to the buyer.
The bank must take constructive or actual possession of the goods before selling it to the customer. It is a very popular form of financing used by Islamic Banks to finance for example Car purchases, as well in Sukuk, where it is seen as a structure which is relatively close to conventional bonds, and along with Ijara it is the most common contract structure used.
Criticisms of Murabaha Contracts
Murabaha contracts are not without controversy with some Islamic scholars argue that Murabaha contracts don’t share risk and thus are not Shariah compliant — and experts estimate that such contracts constitute up to 80 percent of the global Islamic finance volume.
R] Musawamah Contract of Sale and Purchase
A commodity trading arrangement similar to Murabaha financing when the customer requests the bank to purchase certain assets or commodity from a third party. However, unlike a Murabaha (where a buyer knows the cost of the underlying asset), in a Musawamah, the price of the commodity is unknown to the customer. On acquiring the commodity, the bank adds its profit amount and offers to sell it to the customer who has the right to accept, refuse, or negotiate the price. If accepted, the customer repays the total amount to the agreed instalments.
A Musawamah usually occurs when it is difficult to determine what the cost of a particular good or service was, or when the good is comprised of products.
In order to comply with Sharia, there are a number of restrictions on a Musawamah:
- The underlying asset must be in existence and in the seller's possession at the time of the sale.
- The sale must be immediate; future sale dates are void.
- The asset must be of value and be usable.
S] Sarf Contract of Exchange of Currency
Bay al-Sarf is a contract of exchange of money for money. This contract is tightly regulated under Shariah because it can be easily manipulated for the purpose of producing an interest-bearing loan, which is prohibited in Islam.
Ibn Rushd examines the three forms of sale that can arise in a market where goods and money are in existence: "when two commodities are exchanged, one may serve as a currency and the other as a priced commodity, or both may be currencies. When a currency is exchanged for a currency the sale is called sarf, and when a currency is exchanged for a priced commodity, the transaction is sale proper (bay). Similar is the sale of a priced commodity for another priced commodity (barter)"
ibn Rushd: Bidayat al-Mujtahid (p. 154, Garnet, 1996)
The rules of bay al-sarf derive largely from the hadith: "Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt - like for like, equal for equal, payment being made on the spot. If the species differ, sell as you wish provided that payment is made on the spot". (Sahih Muslim)
T] Wadiah Contract of Custody or Safekeeping
Also called Wadia or Al Wadi'ah, a contract of safekeeping under Sharia law. In contemporary Islamic finance a deposit or deposit account. A depositor places property with another party for safekeeping.
A Wadiah Yad Dhamanah is a contract of Wadiah with a repayment guarantee. Under a Wadiah Yad Dhamanah the depositary guarantees the return of the deposited property.
Wadiah is a contract by virtue of which one party keeps an asset with a counterparty for safekeeping purposes for a specific period of time. The counterparty accepts the responsibility of looking after the asset voluntarily and typically does not charge a fee for this service.
U] Wakalah Contract of Agency
Wakalah is the process whereby a person (principal; in Arabic: Muwakkel) empowers another person (agent; in Arabic: Wakeel) to perform some task or act (authorized act) on behalf of him. The latter stands ready to assume the powers of the former in fulfilling that task or act. For example, one person may authorize another to sell a property for a specific price during a set period of time.
Agency (Wakalah) may be classified in various forms including: general agency (Wakalah 'ammah), specific agency (Wakalah khassah), limited or restricted agency (Wakalah muqayyadah), absolute or unrestricted agency (Wakalah mutlaqah), binding Wakalah (Wakalah mulzimah), non-binding Wakalah (Wakalah ghair mulzimah), paid agency, non-paid agency, etc.
Criteria of classification are: the subject-matter of the agency contract, the scope of authority, the right to revoke, and the remuneration to the agent.
Classifications of agency:
- General agency: the principal grants a full authority to the agent to do whatever needed to achieve the purpose of the agency contract, provided that in so doing the agent duly observes the interest of the principal and applicable customary practices. In principle, the agent's acts don't include making donations, unless the principal officially authorizes the agent to do so.
- Specific agency: the principal specifies a certain condition(s) on the agent's acts so that if he doesn't heed the principal order, his actions will not be binding on the principal. In the case where the agent acts in contravention to the principal's authorization but only in good faith, then- according to some schools of thought- his acts will not be deemed to be in violation of the agency contract.
- Limited agency: it restricts the agent's acts to a set of criteria or limitations as stipulated by the principal in the contract of agency. However, the agent may on some occasions act in contravention to the principal's conditions if his acts are proved to be in the very interest of the principal.
- Absolute agency: it involves an unfettered authority granted by the principal to the agent. However, absolute agency is usually bound by urf (customary practices) and the interest of the principal. For example, an agent with absolute authority is not allowed to sell at less or buy at more than the market price. Restrictions attached to absolute agency may also include impermissibility of barter sale (ba'i al-muqayadah), deferred payment sale (ba'i ajil), installment sale, and so on, unless with permission from the principal.
- Binding agency: each of the parties to the agency contract is bound to fulfill his obligations towards the other. Neither party has the right to revoke the contract without the mutual consent of both parties. Typically, this agency is based on an agreement of both parties for a specific reward to be paid by the principal in return for the efforts exerted by the agent. Binding agency is also referred to in Arabic as Wakalah lazimah.
- Non-binding agency: in essence, agency is non-binding, i.e., each of the two parties has the right to revoke the contract without denying its effects that may remain binding after revocation. Non-binding agency is also known in Arabic as Wakalah ghair lazimah.
- Paid agency: the agent receives a certain remuneration from the principal for doing the tasks of agency or providing the services associated therewith. The Arabic term for paid agency is Wakalah bil ajr.
- Non-paid agency: the agent undertakes the tasks of agency for free. Non-payment of remuneration doesn't affect the responsibility of the agent towards the principal for fulfillment of his obligations. The Arabic term for non-paid agency is Wakalah bi-ghair ajr (also Wakalah bi-doon ajr).
In general, Wakalah can be classified into the following categories, all of which is undertaken by the agent on behalf of the principal:
- Wakalah bil khusoomah: agency for taking up disputes or legal cases.
- Wakalah bi taqadhi al-Dayn: agency for receiving debt.
- Wakalah bi qabdh al-Dayn: agency for taking possession of debt.
- Wakalah bil shira’: agency for undertaking purchase.
- Wakalah bil ba’i: agency for undertaking sale.
A1] Sharekah: Partnership – Definition and Types
The Arabic word Sharekah means partnership or company and denotes mixing of two shares in a way as to make them indistinguishable.
In Islamic jurisprudence, there are several definitions of partnership:
- Hanafi scholars define partnership as “a contract between partners on both capital and profit.”
- Shafi scholars define partnership as “a contract giving the right in something to two or more people, making it common.”
- Hanbali scholars define partnership as “the coming together of two or more people in disposal or acting.”
Partnerships are primarily of two kinds, namely: partnerships of ownership and partnerships of contracts.
A2] Partnerships of Ownership (Amlaak)
A partnership of ownership means that two or more people share the ownership of a single property, either by their own choice (e.g. by agreeing to buy the property) or without their own choice (e.g. inheriting the property). Each of the parties is a partner and none of the parties can dispose of the object on his or her own, without the permission of all other partners.
A3] Partnership of Contracts (Uqood)
A partnership of contacts is between two or more people to have partnership in capital and profit. Such partnerships are subdivided into four kinds:
- Amwal – financial company, where two partners contribute finances to start the company. This type further includes Al-‘Inan or unequal share partnership and Al-Mufawadah or equal share partnership;
- Wojuh – eminence, where a partner only contributes his or her eminence to the partnership (e.g. Al-Azhar University giving accreditation to an institute in Canada is a partnership where Al-Azhar is exchanging its eminence for a consideration);
- Sana’i – workmanship, where the partners contribute labour to the partnership;
- Mudarabah – capital-labour partnership, where one partner contributes labour and the other partner contributes capital.
D] Musharakah Profit & Loss Based on Capital Contribution
Musharakah is a type of Shirkat-ul-Amwal which literally means sharing. In the context of business, it refers to a joint enterprise in which partners (or parties) to the enterprise share the profit and loss of the enterprise. Musharakah has far reaching implications for Islamic banking and finance in the modern context and provides an excellent alternative to the interest-based economy.
In a Musharakah, the party investing the capital shares equally in both the profit and loss, which is different from an interest-based system where the upside is limited while the downside is very nearly non-existent.
The Basic Rules of Musharakah
Since Musharakah is in essence a contract, all conditions and rules of a contract must be met. Apart from those, there are some basic rules that apply specifically to Musharakah.
Distribution of Profits
The proportion of profit to be distributed among the partners must be determined and agreed upon at the time of the contract. Otherwise the contract is not valid under Shariah.
- According to Imam Malik and Imam Shafi, it is necessary that each partner’s share in the profit is exactly equal to the proportion of initial investment into the partnership.
- According to Imam Ahmed, the ratio of profit distribution may vary, without restriction, from the ratio of investment.
- According to Imam Abu Hanifah, the ratio of profit distribution may vary, however, for silent partners (non-active partners, who only contribute capital), it cannot be any higher than the ratio of investment.
Distribution of Loss
All the Muslim jurists are unanimous that each partner’s share in loss must be exactly equal to the ratio of initial investment. Anything to the contrary will render the contract invalid.
The Nature of Capital
- According to Imam Malik and some Hanbali jurists, the nature of capital is not a restriction in a Musharakah Therefore, in-kind (non-cash) contributions by partners are allowed. The share in partnership will be determined based on the market value of the commodity contributed.
- According to Imam Abu Hanifah and Imam Ahmed, no in-kind contributions are allowed in a Musharakah This is because they believe it poses problems if the partnership needs to be liquidated or redistributed.
- Imam Shafi makes a distinction between replaceable commodities and irreplaceable commodities (like cattle). The view is rather complex, and not important for our purposes.
For the purposes of modern business, the view of Imam Malik has been widely accepted.
Management of Musharakah
The norm is for each partner to take part in the management of the partnership, with each partner acting as an agent of the partnership and any work done by one partner deemed to be authorized by all partners. However, if the partners wish they can contract under alternate arrangements for the management of the partnership.
Termination of Musharakah
It is agreed upon by the jurists that a partnership is terminated if:
- One of the partners terminates the partnership;
- One of the partners dies (where the heirs get the choice to continue the partnership or liquidate it to draw their share from the partnership);
- One of the partners becomes insane.
If the remaining partners want to continue the business under any of the above scenarios, it is achievable with mutual agreement. The remaining partners would have to purchase the share of the out-going partner.
Another question raised is whether the partners can agree, at the time of contracting, that the partnership will not be terminated unless all partners agree to the termination. Though the earlier fiqh books are silent on the issue, there is nothing in the Shariah that would prohibit such an arrangement.
E] Diminishing Musharakah
Diminishing Musharakah is a type of Shirkat, where one partner purchases the shares of the other partner, gradually. According to the concept of Diminishing Musharaka, an investor jointly own fixed asset with another person. The asset could be a house, car, plan, or machinery. Shares of the investor are then divided into units, and it is pre-agreed that the person will purchase all those units over a period of time, and will become a sole owner of that asset. It is also called “Shirkah Al Mutanaqisah”
Fundamentals of Diminishing Musharakah Agreement:
The proposed arrangement is composed of the following transactions:
- To create joint ownership in the property (Shirkat-ul-Milk).
- Giving the share of the financier to the client on rent.
- Promise from the client to purchase the units of share of the financier.
- Actual purchase of the units at different stages.
Types of Diminishing Musharakah:
Diminishing Musharakah in Shirkat-Ul-Aaqd (Joint Venture)
Two partners start business in Shirkah to earn profit. One of the partners undertakes to purchase the share of another partner gradually, each month or each year.
- There will be an agreement of Shirkat-ul-Aqd between both partners wherein the investment of everyone and ratio of profit will be agreed.
- One partner undertakes to purchase the share of other partner. In this promise three conditions should be considered:
- This promise will not be a part of Shirkah The price of unit will not be agreed in this promise but promise to purchase should be at market value at the time of purchasing.
At the time of purchase, the price of unit will be decided on the basis of market value of business.
Unit will be purchased through Offer & Acceptance.
Diminishing Musharakah in Shirkat-Ul-Milk (Joint Ownership)
Two partners purchase any asset (machinery/property) and their intention is that one or both partners will use this asset or they rent out their share and one share holder undertakes to purchase the share of other gradually.
- There will be an agreement of Shirkat-ul-Milk and it will be decided how much investment will be made by each partner?
- Asset will be purchased and everyone will be owner of this asset as per ratio of his investment and all other rules of Shirkat-ul-Milk will be applicable
- One Shareek can rent out his share to other partner or to a third party and Ijarah Agreement will be signed.
- Within period of Ijarah, Shriah Ahkaam relating to Ijarah will be applicable.
- One of the partners can promise to purchase the share of another partner and in this promise the price of unit may be decided.
- Unit can be purchased on the basis of Offer & Acceptance.
All the above-mentioned agreements and undertaking should be independent and not tide-up with each other.
F] Mudarabah Profit & Loss Based on Capital and Labour Contributed
Mudarabah is a special kind of partnership where one partner providers the capital (Rabb-ul-Maal) to the other (Mudarib) for investment in a commercial enterprise.
According to Mufti Taqi Usmani, a Mudarabah arrangement differs from the Musharakah in five ways:
- The investment in Musharakah comes from all the partners, while in Mudarabah, investment is the sole responsibility of Rabb-ul-Maal.
- In Musharakah, all the partners can participate in the management of the business and can work for it, while in Mudarabah, the Rabb-ul-Maal has no right to participate in the management which is carried out by the Mudarib
- In Musharakah all the partners share the loss to the extent of the ratio of their investment while in Mudarabah the loss, if any, is suffered by the Rabb-ul-Maal only, because the Mudarib does not invest anything. His loss is restricted to the fact that his labor has gone in vain and his work has not brought any fruit to him. However, this principle is subject to a condition that the Mudarib has worked with due diligence which is normally required for the business of that type. If he has worked with negligence or has committed dishonesty, he shall be liable for the loss caused by his negligence or misconduct.
- The liability of the partners in Musharakah is normally unlimited. Therefore, if the liabilities of the business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all the partners. However, if all the partners have agreed that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. In Mudarabah the liability of Rabb-ul-Maal is limited to his investment, unless he has permitted the Mudarib to incur debts on his behalf.
- In Musharakah, as soon as the partners mix up their capital in a joint pool, all the assets of the Musharakah become jointly owned by all of them according to the proportion of their respective investment. Therefore, each one of them can benefit from the appreciation in the value of the assets, even if profit has not accrued through sales. In Mudarabah all the goods purchased by the Mudarib are solely owned by the Rabb-ul-Maal, and the Mudarib can earn his share in the profit only in case he sells the goods profitably. Therefore, he is not entitled to claim his share in the assets themselves, even if their value has increased.
Types of Mudarabah
- Restricted: The Rabb-ul-Maal may specify a business in which to invest, in which case the Mudarib is restricted only to such business as pointed out by Rabb-ul-Maal. This is called restricted Mudarabah or Al-Mudarabah Al-Muqayyadah.
- Unrestricted: The Rabb-ul-Maal does not specified a business in which to invest, it is considered an unrestricted Mudarabah or Al-Mudarabah Al-Mutalaqah.
Distribution of Profit
The distribution of profit must be pre-determined by the two parties. Furthermore, the amount of profit ascribed to either of the parties must be independent of the capital amount, (and) dependent solely on the actual profit realized by the commercial enterprise. That is, the profit assigned to a party cannot be a percentage of capital amount contributed as that would be considered a fixed return, or interest. The profit assigned to either of the parties cannot be a lumpsum amount either as this would also constitute interest.
As such, the only determination of profit distribution that is permissible is based on the actual profit earned by the enterprise.
The Shariah does not restrict or specify proportions to be distributed between the parties, leaving it to the best judgement of the two independent parties.
Termination of Mudarabah
The Mudarabah contract can be terminated by either of the two parties at any time as long as a notice, per the contract terms, is given to the other party.
- The Hanafi and Hanbali jurists are of the opinion that a maximum term of the Mudarabah contract can be set, where-after the contract is terminated automatically.
- The Shafi and Maleki jurists are of the opinion that no term restriction can be added to the Mudarabah
All jurists agree that one may not specify a minimum term of the Mudarabah contract.
A] Prohibited Transactions
Sale by coercion
If a person is coerced into contracting a sale, the contract is considered invalid. The Hanafi and Maliki scholars give room for the coerced party‘s belated consent once the force is removed. The Shafi and the Hanbali scholars consider the sale to be invalid. According to the Hanafi jurists, if a person is forced to sell his property without will, this will be considered an illegal act — meaning that not only is the contract not valid but the coercing party is punishable.
Sale by an insane person
By agreement among all scholars, a sale to an insane person is not valid. By analogy, a sale made to a drunken or a drugged person, or any person unable to reason at the time the sale is made, is also invalid. Interdiction due to illness making the person non compos mentis will fall under insanity as well.
Sale to a blind person
The Shafi scholars do not consider a sale to a blind person to be valid. The majority of the jurists, however, agree that if sufficient description is given to the blind person, the sale will be valid.
Sale by a child
A sale by a child (or to a child) is not valid if the child is not discerning or capable of reasoning. There is consensus of the scholars on this. However, when the child is discerning or capable of reasoning, most scholars allow the sale with the requirement of the guardian’s permission. The Shafis do not allow such a sale.
Sale of the which is not owned
A sale by a person who does not own the object of sale, and does not have the permission to sell from the owner, is not valid. This stems from the Prophet’s injunction, “Do not sell something which you do not own.” The Malikis and Hanafis allow this sale if the owner gives a belated permission, after the fact.
Sale of non-existent or near non-existent things
These sales were prohibited in the context of yet unborn offspring. This has wide-spread application in the present-day context.
Sale of things that cannot be delivered
These sales include fish in the sea and bird in the sky and are prohibited. Though the bird or the fish might eventually be caught and delivered on time, it is impossible to point to a specific or give ample description before the contract is accepted.
Sale involving ignorance or doubt
This typically refers to doubt with respect to the price, or consideration paid. An example of this is contracting to sell a commodity on “market price” where the term “market price” has not been defined in units of money.
Two sale proposals in one
This refers to proposing (first step of the contract) to sell one object at one of two different prices. For example, a proposal to sell a widget at R100 in cash or R150 six months hence is invalid even though the two proposals are valid on their own, independent of each other.
Sale of an impurity
Things considered unclean in Islam like wine, pork, meat of a dead animal and blood, to name a few.
Sale of water
Most jurists allow sale of water if it is from a privately owned source, though the Dhaheri scholars state the sale of water to be prohibited whether from a public or a private source (e.g., fountain or a well). One may, however, charge for the effort to retrieve or treat this water.
Sale of something before receiving the price
The Prophet said, narrated by Ahmad and Muslim from Jaber, “If you have bought foodstuff, do not sell it until you have received it in full.”
Sale of ‘inah
‘Inah or deferred-payment contract is a special arrangement whereby Party A sells an object to Party B for Price X to be paid at a later time and then purchases it back from Party B at Price Y in cash, where Y is lower than X. This effectively results in creating a ribaa like transaction. This sale is considered nugatory or invalid by all jurists, except a small minority among the Shafi and Dhaheri schools, who consider it makruh. Unfortunately, this type of sale contract is widely used in Islamic banking in Malaysia based on the minority opinion.
Selling Islamically legal goods for illegal ones
Like selling something halal for wine, pork, dead animal’s meat or idols in return.
Sale by a city-dweller to a desert-dweller
The Prophet prohibited the city-dwellers from purchasing from the desert-dwellers. In another narration, city-dwellers were prohibited from purchasing merchandise from merchants before they reach the market-place. Here, the city-dwellers are people who have the knowledge of the price whereas the merchants traveling from other places and the desert-dwellers are ignorant of the prevailing market prices. Availability of information here gives an unfair advantage to one party, which is discouraged in Islam. This prohibition is fundamentally important in an era where those who lack information are commonly taken advantage of.
Sale of grapes to a wine-maker
Though this sale meets all the requirements of a contract (the object sold, grapes, is halal) the sale contract is discouraged by the Hanafi and the Shafi jurists while it has been considered invalid and nugatory by the Malekis and the Hanbalis. This shows that if the halal object being sold is to be used in a haram manner, the sale of that halal object becomes haram as well. This also applies to sale of weapons during times of sedition and similar examples.
This refers to the seller artificially increasing the price in an auction by conspiring with a bidder who does not intend to buy but bids just to raise the price.
Sale contract with alien condition
Though there are a number of opinions on this, the general opinion seems to be that having an unrelated condition in a sale contract is highly discouraged. One example of an unrelated condition is the seller prohibiting the buyer from on-selling the merchandise purchased.
Two contracts in oneIt is prohibited to bring together in one contract two transactions like sale and commission, partnership and exchanging and marriage, agricultural partnership and trade-labour partnership.
A] Norms of Ethics in an Islamic Economic System
In light of the Qur’an and the Sunnah, the scholars have defined some norms of ethics in an Islamic economics system and include:
- Freedom to contract
- Freedom from coercion
- Freedom from misrepresentation
- Freedom from Ar-Ribaa (interest)
- Freedom from Al-Gharar (excessive uncertainty)
- Freedom from Al-Qimaar (gambling)
- Freedom from Al-Maysir (unearned income)
- Freedom from price control and manipulation
- Freedom from impulse
- Right to trade at efficient prices
- Entitlement to transact at fair prices
- Right to equal bargaining power
- Entitlement to equal, adequate and accurate information
- Freedom from Darar (detriment)
- Mutual cooperation and solidarity
- Maslahah Mursalah (unrestricted public interest)
B] Definition of Money
Most of the economists will define money by its four classical functions:
- Means of exchange;
- Measure of value;
- Medium of deferred value; and
- Store of value.
C] Definition of Gharar
The Arabic word gharar means risk, uncertainty, and hazard. Unlike ribaa, gharar is not precisely defined. Gharar is also considered to be of lesser significance than ribaa. While the prohibition of ribaa is absolute, some degree of gharar or uncertainty is acceptable in the Islamic framework. Only conditions of excessive gharar need be avoided.
The concept of gharar has been broadly defined by the scholars in two ways, namely: uncertainty and deceit.
The Qur’an has clearly forbidden all business transactions, which cause injustice in any form to any of the parties. It may be in the form of hazard or peril leading to uncertainty in any business, or deceit or fraud or undue advantage.
Apart from the above simplistic definition of gharar, some definitions of gharar seem to have a parallel in the concept of uncertainty in conventional finance. Gharar is defined by the Hanafi jurist al-Sarakhsi as any bargain in which the result of it is hidden.
D] Literal Meaning of Ribaa
The most well-known and the most central concept in Islamic economics is the prohibition of ribaa, defined as interest. All transactions in Islam must be free of ribaa. In its literal meaning, the word ribaa (raa-baa-vow) means increase or rise. For example, the root word of it is used in the Qur’an as follows: But when We pour down rain on it, it is stirred (to life), it swells. (Qur’an 22: 5)
In the above verse, the word rabat is used to indicate the swelling of barren and lifeless earth. Similarly Allah (SWT) says: Lest one party should be more numerous than another. (Qur’an 16: 92)
In the above verse the word arbaa has also been translated as overcoming or increasing. The word can also be translated as being higher in relation to something else.
In the following verse Allah (SWT) describes how Mary and her son took refuge on a higher ground by using the word rabwa: And We made the son of Mary and his mother as a Sign: We gave them both shelter on a high ground. (Qur’an 23: 50)
The above verses make it clear that the word riba refers to an increase from the original status. This is how the term is then used in Islam with reference to interest.
D1] Pre-Islamic Ribaa
An argument often presented by many Muslims is that ribaa mentioned in the Qur’an is actually different from what we call ‘interest’ nowadays. It is important, therefore, to look at what qualified as ribaa in the pre-Islamic times (Ribaa al-Jahiliyyah).
We find various kinds of situations where ribaa comes into play. A brief look at these reveals that there is no difference between the pre-Islamic ribaa and the present-day notion of interest.
“Qatadah narrates that the ribaa of pre-Islamic times was that where one person bought property from another with a promise to pay at a later time. If the buyer could not pay the agreed upon amount on the settlement date, the seller would extend the payment period and the amount owed.”
According to this example by Qatadah, the Arabs of the pre-Islamic times considered as ribaa the increase in the amount owed from the original settlement date to the revised settlement date.
“Mujahid held the opinion that the ribaa of the pre-Islamic times was that where the borrower would agree to pay more than the borrowed sum if given a specific time horizon to pay.”
This is increase in amount owed due to failure to pay or additional time is precisely what we call interest in the present-day economic system. In both cases, we see the debt being swapped for a larger amount based on the passage of time.
“According to Imam Razi the norm of the pre-Islamic days was that the borrower of monies would agree to pay an agreed upon amount on a monthly basis for an agreed upon period of time. At the expiration of that period, the borrower would return the original sum. However, if he could not pay, he would be given more time in return for higher monthly payments.”
These monthly payments were also called ribaa by the pre-Islamic Arabs.
D2] Prohibition of Ribaa
The evidence on the Qur’an and Sunnah relating to the prohibition of ribaa is reproduced below:
“O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper.” (Qur’an 3: 130)
“Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: “Trade is like usury,” but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (The offence) are companions of the Fire: They will abide therein (for ever).” (Qur’an 2: 275)
“Allah will deprive usury of all blessing, but will give increase for deeds of charity: For He loveth not creatures ungrateful and wicked.” (Qur’an 2: 276)
“O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers.” (Qur’an 2: 278)
Most important here is the distinction the Qur’an makes between interest and sale. We will explore this distinction in much more detail later but let us analyse the explanation provided by the Sunnah.
Zaid bin Aslam reported that interest in pagan times was of this nature: When a person owed money to another man for a certain period and the period expired, the creditor would say: You pay me the amount or pay the interest. If he paid the amount, it was well and good, otherwise the creditor increased the loan amount and extended the period for payment again.” (Al-Muwatta, Imam Malik)
The Prophet (pbuh), during his last sermon addressed his revered companions, “Every form of riba (interest) is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting riba. I start with the amount of interest, which people owe to Abbas and declare it all cancelled. He then, on behalf of his uncle, Abbas, cancelled the total amount of interest due on his loan capital from his debtor” (Tafsir Al-Khazin, vol.1, p.301)
The Prophet (pbuh) is reported to have said “Sell gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, in same quantities on the spot; and when the commodities are different, sell as it suits you, but on the spot” (Muslim)
Bilal visited the Messenger of Allah (pbuh) with some high quality dates, and the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah (pbuh) said: “this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other.” (Muslim)
One may note here that the first two ahadith relate to the prohibition of interest in a loan contract whereas the last two relate to the prohibition in an exchange contract.
D3] Interest, its meaning, definition and context of use
Following is a comprehensive understanding of interest, from an email message posted by Mark Robbani of the Institute of Islamic Finance, on the IBF-NET YahooGroup.
Regarding the meaning of the word ‘interest’: It would be better to define the context of its use first, before discussing its meaning. Putting aside the true linguistic origins of the word, since ‘interest’ is currently an English word, then for our purposes – we should really use the English meaning of it only in financial and economic contexts.
In finance, interest has three general definitions.
- Interest is a surcharge on the repayment of debt (borrowed money).
- Interest is the return derived from an investment.
- Interest is the right to one’s claim in a corporation, such as that of an owner or creditor.
In economics, interest is the return to capital achieved over time or as the result of an event.
In population dynamics the rate of population growth (the interest rate) is sometimes referred to as the Malthusian parameter. This article covers the “financial” use of the term.
The fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate. Here, interest per year divided by principal amount, expressed as a percentage. also called interest rate.
The return earned on an investment.
Partial or total ownership in an asset.
In common use the term “interest” is seen as rent paid for the use of money. As with any rental, the market price (or rate) is subject to change to reflect market conditions. The fraction by which the balances grow is called the interest rate. The original balance is called the principal. Interest rates are very closely watched indicators of a financial market, and have a dramatic effect on finance and economics.
The fact that lenders demand interest for loans can be attributed to the following reasons:
- Time Value of Money or Time Preference
- (TVM: Having money now is more valuable than having it at some future time because interest is earned)
- (TP: Interest is the value borrowers place on having money now)
- Opportunity Cost
- (OC: The cost in terms of options no longer available once one particular option is chosen)
We should narrow down the use of the generic term ‘interest’ to the more specific ‘interest rate’ and also accept the practical application of ‘interest rates’ as the Central Banks of the English speaking and western European countries apply it.
An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. Interest rates are normally expressed as a percentage over the period of one year. Interest rates are also a vital tool of monetary policy and are used to control variables like investment, inflation, and unemployment.
The Bank of England sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks, building societies and other institutions for their own savers and borrowers. It also tends to affect the price of financial assets, such as bonds and shares, and the exchange rate, which affect consumer and business demand in a variety of ways. Lowering or raising interest rates affects spending in the economy.
Thus, the meaning and definition of interest appropriate for our purposes is the one ‘in common use’ – which happens to be a “surcharge on the repayment of debt (borrowed money)”, “rent paid for the use of money”, “The fee charged by a lender to a borrower for the use of borrowed money”, etc. All of these definitions are actually far the more relevant and specific term, ‘interest rate’ – and are similar to my own definition, which is a monetary charge applied for the use of money.
Here, the surcharge, rent or fee is actually money, which is exchanged for more money (i.e. with a contractual difference in the corresponding/counter values). Since any contractual difference in the value of 2 or more items of the same type, quality and value when they are exchanged (irrespective of the time-period involved or the type, magnitude or form of the difference) is Riba, it therefore follows that the surcharge, rent or fee (in this context) is also riba [as any such surcharge, rent or fee (i.e. monetary charge) is an ‘increase’ or an ‘excess’ in a like-for-like (money-for-money exchange) – thus haraam].
Regarding the variations in the application and meaning of the word ‘interest’ in different countries and languages. This is really more to do with sociology rather than the financial sciences.
Although in the German language “… jurists categorise rent as being interest (while rent is not riba), and in Dutch interest is even called rent and accountants sometimes go as far as talking about interest on equity (which will finally confuse everybody to mix up profit with interest…” – when the German and Dutch (and most other) central banks set the base interest rate, they set it as their monetary charge for lending to financial institutions, and not as the base property/asset rental amount, or equity dividend, etc. This alone should make clear the true meaning of interest (and the context of its use) for our purposes. All other meanings are culturally subjective and thus not suitable for our universal and legalistic use.
My own personal opinion still remains that ‘interest’ (the form in common English and use) and more specifically, ‘interest rates’ riba (as defined by the authentic sources), but riba (again, as defined by the authentic sources) is not restricted to ‘interest’.