Riba Revisited II (Part 1 of 10)
Riba in Rahn (Collateral/Mortgage/Pledge)
This is an important area in Islamic Finance as it’s at the heart of many credit activities such as deferred payment sales. It’s relevant therefore to know how Riba surfaces in such situations.
A collateral (Rahn) is well known to most people. It can also be called “Mortgage”.
AAOIFI in its Standard No. (5) on Guarantees defines it as:
“4. Mortgage (Rahn): It is to make a financial asset or so tied to a debt so that the asset or its value is used for repayment of the debt in case of default.”
Where Riba arises, is if the person taking such collateral, the mortgagee, benefits from such a collateral freely, and thus makes the credit activity fit into the admonition that “Every Loan that brings a benefit is Riba.”
AAOIFI states in clause 3/2/9 in Standard No. (39) on Mortgage: “…the mortgagee has no right at all to enjoy free of charge benefit from the mortgaged asset with or without the permission of the mortgagor.”
In the Appendix in the Shariah Basis of the standard they explain: “The mortgagee does not have the right to make free of charge benefit from the mortgaged asset, because otherwise he will be committing Riba.”
This can be found in such books as Al-Mughni by IBN QUDAMAH (died c. 1223 A.D.), where it states: “…what does not need to be fed (animals), such as a house or merchandise and others, it is not permissible for the mortgagee to benefit from it without the permission of the mortgagor, we do not know in this any dispute, since the collateral is owned by the mortgagor, so is its growth and benefit, thus no one can take them without his permission, so if the mortgagor permits the mortgagee to benefit without compensation, and it was a debt arising from a loan (Qard), it is NOT permissible, as it creates a loan that brings a benefit, which is Haram. Ahmad (Ibn Hanbal) stated: “I dislike the loan of a house, which is pure Riba.” He means when a house is collateral for a loan where the mortgagee benefits.” [P509, V6, Al-Mughni, Ibn Qudamah, Dar Alam Al-Kitab, 1986]
You may recall an earlier description of what is called Bay’ Al-Wafa’ where one borrows money and puts up his house as collateral until repayment. It is not permissible for the lender to utilize the benefit of the house, as it’s tantamount to Riba.
IBN QUDAMAH also explains in Al-Mughni in Kitab Al-Rahn (The Book of Collateral), that: “If the mortgagee (lender) benefits from the collateral…it will be deducted from the debt…” [P513, V6, Al-Mughni, Ibn Qudamah, Dar Alam Al-Kitab, 1986]
This is also found in the Hanbali Journal of Shariah Rulings: “The Mortgagee may benefit from the collateral with the permission of the Mortgagor, freely or for compensation, however, if the debt is in the form of a Loan (Qard), this is NOT permissible.” [Clause 974, P 333, Majallat Al-Ahkam Al-Shar’iya, 1981]
This is of course in the case of a debt arising from a loan (Qard), however debt can also arise out of a sale or Ijarah for example, in which case the transaction is one of compensation (Mu’awadah) which for some scholars has a different ruling on the issue of whether the creditor can benefit from the collateral.
In his book on “Fiqh Al-Mu’amalat”, Dr. OSAMAH AL-SALLABI, professor of Islamic Studies at University of Benghazi has an excellent discussion concerning this issue. He explains that scholars have agreed that if the collateral has arisen as part of a transaction other than a loan, such as a sale, then this is permissible based on two conditions: [P 608-613, Fiqh Al-Mu’amalat, Osamah Al-Sallabi, 2011]
- The benefit from the collateral must be part of the contract. And,
- The benefit must be known and time specific.
Professor AL-SALLABI states: “The stipulation of permission of benefitting (from the collateral), within the contract, makes the contract a Bay’ (Sale) or Rent (Ijarah), since the benefit is then from the Ijarah and not the loan (Qard), and the benefit is part of the price, thus avoiding any suspicion of Riba.” [P610, Fiqh Al-Mu’amalat, Osamah Al-Sallabi, 2011].
One curious paragraph I found in Al-Mughni by IBN QUDAMAH refers to the increase or further delay in repayment of the loan against an increase in the amount of collateral: “I give you my slave as collateral and you will delay the repayment, this is corrupt…this collateral contract is not permissible, because he has given it against it (Time), and this is similar to Riba Al-Jahiliyyah, they used to increase the debt by increasing the time of repayment.” [P508, V6, Kitab Al-Rahn, Al-Mughni, Ibn Qudamah]
It seems IBN QUDAMAH is comparing an increase in the collateral against a delay in repayment with Riba Al-Jahiliyyah, where the maturing debt of a person is delayed against an increase in the debt itself. But here, there is no increase in the debt whatsoever; there is only an increase in the collateral, which is generally allowed.
Al-BAHUTI (died c. 1641 A.D.) in Al-Rawd Al-Murbi’ states clearly on collateral: “It is permissible to increase the collateral, as it is an increase in Surety, but without the increase in Debt…” [P367, Bab Al-Rahn, Al-Rawd Al-Murbi’, Al-Bahuti]
If the Debt is repaid, at its principal value only, then the collateral is repaid to the borrower, and there was no benefit from the extra collateral as well as the earlier collateral to the lender, as the collateral is really an Amanah (on trust) as AL-BAHUTI states in the same book above: “If it (the collateral) is damaged in the hands of the lender (Mortgagee), without misconduct or negligence, he is not liable, as it is as Ali (RAA) stated, as it is an Amanah (trust) like a custody…” [P.367, Bab Al-Rahn, Al-Rawd Al-Murbi’, Al-Bahuti]
One modern application that is worthy of explanation is liens taken by banks on cash and investments of their clients when a financing deal occurs. If it’s a case of an investment, say for example in an investment account such as a Mudarabah fund, this is permissible to take such a lien on the amount and any profit on the investment accrues to the account of the debtor until the maturity of the debt where the amounts are settled. If however the cash is in the form of a current account, then it’s different, since a current account is a loan to the bank by the customer. As such, the bank guarantees the principal and is allowed to use it in its operations for its own benefit. However, if the bank takes a lien on it, it must become collateral and is thus removed as a loan to the bank and the bank cannot use it in its operations for its own benefit.
This is in section 5 of the AAOIFI Shariah Standard No. (39) on Mortgage: “5. Mortgage of Current Accounts and Cash Securities: When a current account is mortgaged for the benefit of the same institution with which it is opened, the institution should not use the account unless an agreement is reached between the two parties to transfer the account to an investment account, and thus, make it subject to the rulings on Mudarabah instead of the rulings on loan. This is so because the institution, as a mortgagee, has to avoid making free of charge benefit from the mortgaged account. On transference of the account to an investment account, the account holder becomes entitled to his profit share as the owner of the capital (Rab al-Mal), while the institution becomes entitled to his profit share as the owner of the capital (Rab Al-Mal), while the institution becomes entitled to its profit share as the worker (Mudarib).”
Dr. AL-ASHGAR (Rahimahu Allah), former professor at Shariah College, Riyadh and Islamic University of Madinah, makes this point very clear in his book on modern transactions: “…and it is not permissible for the bank to stipulate against someone who takes debt from the bank or places funds in a current account, that this becomes collateral whereby the bank has use of it, as this would be a loan, thus it would become a stipulation of a loan against a debt, which is not permissible as it is of the forbidden two transactions in one. If however, the bank stipulates that it is collateral, and it is not stipulated that he can use it, then there is no issue with that, and it is obligatory in that case not to utilize it (The Funds) but it can be reserved without usage.” [P 176, ‘Qadaya Fiqhiya Mu’asira, Dr. Muhammad Al-Ashgar, 1998]
Another important point that finds some dispute, and where Riba could arise, is to the object itself that is the subject of being the collateral, where we find in AAOIFI Shariah Standard No. (39) on Mortgage, the following clauses: “3/2/1 The mortgaged asset should be a Shari’ah-permissible property.”
“4/3 It is impermissible to mortgage the financial papers and Sukuk that should not be issued or transacted according to Shari’ah, such as interest-based bonds, preference shares and enjoyment shares [see Shari’ah Standard No. (21) on Financial Paper: Shares and Bonds, items 2/6 and 2/7]. Such financial papers include also traditional investment certificates, certificates of traditional investment deposits and shares of the companies that pursue impermissible activities like manufacturing of alcohols, swine trade and dealing in Riba [see Shari’ah Standard No. (21) on Financial Paper: Shares and Bonds, item 2/1 and Shari’ah Standard No. (14) on Documentary Credit, items 3/4/1 and 3/4/2]. Among these financial papers also are shares of traditional financial Institutions, shares of traditional financial companies, shares of traditional insurance companies and shares of companies which originally pursue permissible activities, yet Riba-based and other prohibited dealings constitute a predominant part of their activities.”
However, there is some dispute here, since some scholars view collateral differently than a sale, which demands a Shariah-Compliant asset.
This was the view of the Shariah Committee of Bahrain Islamic Bank concerning the use of collateral of Conventional Bank stocks dealing in Riba when they stated: “The basis is that it is forbidden to mortgage what you are not allowed to sell, because the Fiqhi Foundation is that what is allowed to be sold is allowed to be used as collateral and this is the way of the majority of scholars. But in exceptional circumstances, the way of the Maliki school may be taken that does not demand that a collateral be Shariah-Compliant asset, versus the rules of sales.” [2/22 of 2/1983, Fatawa Bahrain Islamic Bank, Rahn]
Bahrain Islamic Bank makes a note in its decision to refer to the Fatwa from Al-Baraka Group concerning the same issue, in which they state: “It is permissible for an Islamic Bank to accept the stocks of a bank that deals in Riba as a guarantee for the debt of a client up to the limit of the nominal value of the shares since that represents the capital of that bank before it dealt in Riba, and what can’t be forgiven in a sale can be forgiven in collateral as the Malikis have allowed the collateral of what can’t be sold…but this must be used in exceptional circumstances where there is no alternative.” [Ruling 7/11, Al-Baraka 11th Islamic Economy Conference, 1/2/1996, Jeddah, Saudi Arabia]
One can see this view in Maliki literature such as IBN RUSHD’s ‘Bidayat Al-Mujtahid’ where it is stated: “It is permitted according to Malik, to pledge things whose sale is not permitted at the time of the pledge…” [P 326, V 2, “The Distinguished Jurist’s Primer, Ibn Rushd]
Collateral is often forgotten or passed over as a subject in Islamic Finance when studying Riba. It shouldn’t. Riba can raise its ugly head in the most unexpected places.
…Continued in Part 2