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Why do Islamic Banks use Arabic names for their contracts?

Why do Islamic Banks use Arabic names for their contracts?

By Nizar Alshubaily | October 26, 2018

One of the popular accusations often levied against Islamic Banks is that they simply use the same conventional commercial agreements but change the name to an Arabic/Islamic title and thus magically the agreement becomes a Shariah-compliant contract. 

“Interest-based loans with Islamic labels…”

“…The Islamic banking system is only considered to be a change of name.”

“Whether the product is dressed up in Arabic terminology, such as Mudarabah, or Ijarah, if it looks and feels like a mortgage, it is a mortgage and to say anything else is semantics.”

“The products that modern-day Islamic bankers have created are very similar to conventional products. So similar, in fact, that to an outside observer they could be considered the same.”

“The products promoted by the Islamic finance industry are sometimes indistinguishable from those of interest-based institutions.”

 

Of course, this is untrue. The critics would have everyone believe that the finance agreements that Islamic Banks execute are simply the Conventional Bank contracts with the English word erased and in its place an Arabic word was inserted to give it an Islamic flavour. Perhaps comment number four says it all when it remarks: “to an outside observer”, as in fact most critics of Islamic Finance are exactly that.

I am truly amazed at such an artificial analysis from individuals who seemingly are very well educated.

Comment number three is of especial interest, as today, many western historians and lawyers recognise that the “Commenda”, a form of maritime financing agreement observed in Italy in the 11th century was most probably copied from the Mudarabah.

There are five main factors that must be taken into account in this issue:

  1. Both Islamic and Conventional contracts are based on commercial contract laws that have evolved both in parallel and with transfer of information between civilisations from time immemorial.
  2. Islamic contract law had many of the same contracts such as Sales, Rents, Collateral, Guarantees, Auctions, and many others much earlier than Conventional contract law.
  3. Islamic Banks didn’t invent the Arabic words, nor did they invent the contracts they represent, they simply adapted these contracts to a new environment so that they fit under different jurisdictions such as English Law.
  4. There are differences in these contracts if one were to spend time in fact reviewing the documentation thoroughly.
  5. Some Shariah-compliant deals were innovated specifically to replicate the risk/return profile of Conventional deals, meaning the Islamic Banks utilised Islamic Contracts to give the client the same objective as the Conventional contract. (This I have discussed before in an earlier article)

Both Islamic and Conventional contracts are based on commercial transactions. Commerce is how people have interacted with each other for millennia. It’s not unusual at all to see similarities in the types of transactions and their evolution over time between different societies. In many places around the world, we see evidence of the history of commerce and the laws enacted for the purpose of protecting all parties in a transaction. After all, people have always bought and sold goods such as food and clothes, hired others for services such as transportation, and rented to others the use of a product such as property and tools.

We see evidence of financial and commercial transactions between people in Ancient Mesopotamia attested in clay tablets. In fact, some aspects of The Code of Hammurabi (2,000 B.C.) relates to commercial transactions as well as financial dealings, one of which deals with interest rates on loans.

Ancient Egypt was another place where finance and commerce were present. We have evidence of payments of goods in gold, and records of written withdrawal orders of grain from warehouses were used as a type of currency.

Ancient Greece also had its share of commerce. Individuals rented spaces to sell goods in the marketplace, much like retail shops today. Traders also borrowed money to finance their maritime voyages at interest rates.

The Romans also had a similar commercial landscape, where there were individuals looked at as bankers who lent money at interest and engaged in wholesale trading of goods, while others were retail merchants who worked in stalls and covered shops in the market.

Commerce and finance are old and were not invented in our modern era as some critics seem to imply, and they are very similar across civilisations throughout history.

All one has to do is to study history and see how much commerce was taking place between individuals, tribes, city-states, and civilisations. Many of the contracts were similar, whether on land or on the sea, people traded and invented structures to contract with each other and make profit. Innovation and the transfer of knowledge meant that in so many places we see similarities between types of transactions.

So it’s not strange at all to see a conventional leasing contract with the same clauses as an Islamic one called “Ijarah”. One should find similar terms such as: identification of the parties involved, specifications of the item to be leased, period of time, pricing, conditions of return, etc. 

In the Arabia of the 7th century during the earliest Islamic period, things were no different. Commerce and finance were abundant; not only between individuals and tribes, but also between Arab merchants and others in the Region. Regular caravans travelled to Syria to sell and buy goods, and vessels to India and Africa were popular.

Individuals and groups financed these trade caravans, as well as other commercial transactions. The Arabia of that period knew finance and knew lending at interest. Many of the names of Shariah-compliant contracts were known before Islam. 

In fact, Islam did not invent these contracts; they were there previously. What Shariah did was to regulate the markets by placing rules on transactions and modifying the rights and responsibilities in contracts. It also forbade some contracts such as lending at interest or requiring a higher payment after an agreed delay in an obligation. This specific act was what was described in The Quran as “Riba”.

Individuals and tribes in pre-Islamic Arabia also lent at interest on a regular basis for commercial purposes, and some individuals accepted money from people in safe custody and termed them loans, which they guaranteed, exactly as banks do today. Some individuals even went into partnerships with each other for the purpose of making commercial loans. Many of these acts continued well into the first Islamic period until they were fully forbidden or modified.

The Arabs before and after Islam also engaged in “Sharikat”, defined as partnerships or companies, in which individuals would pool their resources with a specific investment aim. There were many known forms of partnerships; the closest to what we have today was called “Anan” company. Other types included where one individual was the investor who takes the risk with his wealth and the other was the manager, who only lost his effort; both share in the profits at an agreed percentage; this was called “Mudarabah” and is still used today by Islamic Banks.

One of the early classical books by Imam Malik bin Anas in the 8th century, “Al-Muwatta” which is essentially an Islamic law book based on hadith, describes in detail stories and sayings concerning Mudarabah. In it Imam Malik also describes the rules of what is and isn’t allowed in a Mudarabah transaction. Many of these rules are still the same today.

We read in Al-Muwatta on page 475, in The Book of Qirad (another name for Mudarabah):

“A man gives another money by a Qirad agreement. Some of the money was lost before the second man began to trade in it. Then he traded with the remainder and made a profit. The second man wanted to consider the capital as only the amount of money after some of it was lost, so he can share the profits with the investor. This is not allowed, the capital is the original money given.”

He also dedicates a long chapter on “Sales”, in which he describes many types of sales and their rules, such as ‘Murabaha”, “Arboon”, and “Sarf”. 

We read in the same book on page 462, in The Book of Sales:

“If a man sells another a commodity on a Murabaha basis and declares his cost to have been 100 Dinars, then he later discovers it was in fact 120 Dinars, he may go to the buyer to try and change the price of sales. The Buyer can agree to the new higher cost or remain with what he agreed, but can not lower the price.”

They have the same names today and are used today and have been used by Islamic Banks. I myself utilized the “Arboon”, “Murabaha”, and “Ijarah” sale contracts to structure investment and financial products. I did not copy conventional contracts to do so, all I had to do was to study the rules of these contracts as are agreed upon today by our scholars. 

A great example of the existence of these commercial and financial transactions in the history of Islam can be gleamed simply by studying a famous book by Ibn Rushd called “Bidayat Al-Mujtahid wa Nihayat Al-Muqtasid” otherwise translated as “The Distinguished Jurists’ Primer”. I use this book, as it’s one of the few that non-Arabic speakers can easily access and read.

Ibn Rushd, a great scholar of Granada in Spain in the 12th century when it was under Muslim rule and was called “Al-Andalus”. In his book one can see the many chapters dedicated to Islamic contracts, such as The Book of Sales (Buyu), The Book of Sarf (Exchange), The Book of Salam (Advance Payment), The Book of Murabaha (Sale at Stated Cost price), The Book of Ijarah (Hire), and many others.

We read in Ibn Rushd’s book on page 273 of Volume II, in The Book of Ijarah:

“The jurists consider the kinds of Ijarah to be of two categories: Ijarah of the benefits of corporeal property; and the Ijarah of benefits existing as a liability, on the analogy of Bai’ (Sales).”

“One of the conditions of Ijarah through liability, according to Malik, is that payment should be immediate so that it is excluded from the category of (the exchange of) a debt for a debt.”

In the last section, Ibn Rushd refers by name to of course to the previous scholar Malik in his discussion of the rules of Ijarah.

Ijarah is of course rent or lease; it is also a contract of hiring people to perform work or services. Lease or Rent in English is the equivalent. Neither the word, nor the rules of Ijarah were invented in our modern day to give any Conventional contract an “Islamic Flavor” as the critics assert. It truly is a surprising accusation.

One will also find that many of these books, descriptions, and rules of commercial contracts pre-dated anything similar in the western conventional market. All one has to do is simply try to find a similar book in Europe to Ibn Rushd’s great masterpiece, one would fail.

Modern Islamic Banks did not invent these contracts, nor did they just simply take a conventional contract and just give it an “Islamic” name. As I have shown above, in fact, these contracts pre-dated Islam and conventional contracts.

The Arabic names used are not invented names, they are actual names of commercial transactions/contracts used for over a thousand years and well described in history books and classical literature on jurisprudence.

Modern Islamic Financial Institutions adapted these contracts to the modern legal arena. Today, each jurisdiction has different laws relating to taxes, possession of goods, delinquency of payments, rights and responsibilities of parties, and terms of contracts. Modern Islamic Banks re-drafted these contracts in light of this new reality. Nothing in this defies or breaks any Shariah issues. 

Custom has always been a foundation of Shariah and as such these contracts had to fit the customs of each jurisdiction. This is not a problem in Shariah as long as it doesn’t break fundamental rules. In fact, one of the main Five Fiqh Maxims is: “Custom is the basis of Judgment.” AAOIFI makes it clear in their Shariah Standard 18 on Possessions:

“The basis for acknowledging custom (’Urf) as the basis for the realisation of possession is the consensus (Ijma’) of the Jurists (Fuqaha). It is in this regard that Al-Khatib Al-Shirbini says: “The reason is that the Law-giver has used the term possession in an unqualified sense and has deemed it the basis of rules. He did not elaborate it, and there is no definition for it in the language. It is for this reason that recourse is to be had to custom (’Urf)”.”

If for example, a lease/rent, otherwise known in Arabic as Ijarah, were to be entered into by an Islamic Bank and a UK company, this of course would be under English Law. A UK lawyer would draft the documents. Obviously in doing so he would draft it according to local laws and customs. As long as those laws and customs do not break any rule in the approved Shariah-compliant rules of Ijarah, then there would be no problem whatsoever. The lawyer would organize the documents and language in much the same way as any other lease under English Law, paying attention to clauses forbidden by Shariah. 

Naturally, the finished document would appear on the surface much the same as any other conventional lease agreement. Both the English Law Lease and the Islamic Ijarah share so much in common as I have explained before, it would be strange if they didn’t have many clauses in common.

I speak here of personal experience. In the early 1990s in London I had the opportunity to structure many transactions in the hundreds of millions of dollars in Aircraft and Ship Leasing, Commodity Murabahas and Wakalas, with many UK, European, and International clients.

In doing so, I worked with many UK lawyers on drafting the legal documentation. They were always at ease with Shariah requirements as they saw many resemblances between English Law and Shariah. It was never really a problem to conclude these transactions from a legal documentation aspect under English Law.

However, having said that, there are differences, between a Shariah-compliant document and a conventional one, but one sometimes has to study the documentation very thoroughly to see some differences in the clauses. And of course it depends on the actual transaction or product itself.

Ijarah is a good example, as so many of the conditions are the same. But one of the differences is the treatment of “late payment interest”. In a Shariah-compliant Ijarah, if the Lessee is late, the rule is that he can’t be charged any late payment interest, this is not so in a conventional lease. Islamic Banks adapted their documentation to include this as some lessees may abuse the lack of such a statement. The difference, however, is that in the case of an Ijarah, any late payment interest would not benefit the Islamic Bank but would go straight to charity. In addition, in Ijarah, the subject matter of the lease is different than in a conventional lease. It is prohibited for example to be involved in the leases of certain premises that are used for Shariah illegitimate businesses. This can be seen in AAOIFI’s Shariah Standard 9 on Ijarah:

“The leased asset must be capable of being used while preserving the asset, and the benefit from an Ijarah must be permissible by Shari’ah. For example, a house or a chattel may not be leased for the purpose of an impermissible act by the lessee, such as leasing premises to be used as headquarters by an Institution dealing in interest or to a shopkeeper for selling or storing prohibited goods, or leasing a vehicle to transport prohibited merchandise."

In the case of some investment funds for example, the differences are very large indeed. This is a very confusing area for the critics. They mistake the objective of the product with the contracts that comprise it. Take the case of equities for example, you can have an International Equity Fund much the same as the Conventional market, but there are clear differences in the guidelines. In the Islamic Equity Fund, there are a) Prohibited Industries, b) Financial Ratios Screening, and c) Purification of Income, all three are absent in a conventional equity fund.

All one has to do really is to study a document such as AAOIFI’s Shariah Standards to see the many differences that constitute Shariah compliance. It’s not a secret document, it’s available freely online.

The final point is equally valid but many observers seem to have a particular confusion with it. I have touched upon this point in a previous article on Form and Function in the same website. Many Shariah-compliant products use the known Shariah contracts put together to create a particular risk/return profile of a conventional product. This means they use the investment objectives of the conventional product and use Islamic Contracts to create that objective. The headline however would only indicate the function of the product. For example, a product I worked on used a Bai Al-Arboon and a Bai bilthaman Al-Ajil to recreate an “Equity Linked Capital Protected Fund”. If you only read the headline, you wouldn’t know that its components are in fact all old Shariah contracts. Shariah does not forbid innovation. 

It has always puzzled me how critics can know so little about the history of commerce, how detailed and old Shariah contracts are, and the differences found in the actual rules of the transactions. Yet, they still criticize Islamic Finance with this particular unfounded criticism. 

I’ve heard these types of criticisms so many times, I now defend by launching a counter offensive.

So when a critic says to me that an Ijarah is just a lease given an Arabic name, I reply that in fact it’s the other way around. A lease is just an Ijarah with a western name slapped on it to make it sound Conventional, an Ijarah is much older, then I show them the proof.

Usually what follows is silence.


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12 Comments

Robert Hannah 1 month ago
N/A

I accept and respect the fact that you have intimate knowledge and experience in your work on sharia compliance. As you point out, there can be differences in the contractual underpinnings of sharia based and conventional financial instruments. What I would question is the divine justification for these differences. When the scholarly baggage is finally unwound, would Allah really care whether one used an Islamic copy of a mortgage or the conventional one (or the conventional copy of an Islamic Ijarah as you say)? I think not. The ethics of the transaction is the most important issue - transparency, full disclosure, fair dealing, suitability for the client, and cost. My understanding is that Islamic instruments are more expensive than comparable conventional ones.

I reference the following numerical example of the cash flows from Islamic and conventional mortgages by Mohammed Amin, in which he shows that they can be identical, with a similar risk profile.
https://www.mohammedamin.com/Islamic_fin....

Islamic finance does have something useful to say about issues such as excessive financial leverage, the capitalization of banks, risk management, and financial market ethics. Instead of erecting a parallel financial system, Muslims’ energies would be better directed towards engaging with regulators and legislators to communicate their views on these issues. (edited)


Banker, Writer, Volunteer

Dear Robert

Thank you for your comments, please allow me this brief reply:

1) As far as my beliefs, Divinity needs NO justification. It’s not the prerogative of man to change any Divine prohibitions, Duties, or Rights. Where it’s not divine, there’s plenty of wiggle room.
2) This of course can be seen in over a thousand years of scholarly work where the greatest scholars of the past have discussed, disputed, and then settled on particular forms of contracts. They laboured tirelessly on these issues.
3) Their aim was justice between contracting parties, and they outlined in details these issues to ensure this important substance in contracts.
4) The Substance of Islamic Contracts has been inbuilt into the Form.
5) I couldn’t open the link you provided so I went into the main page and I think I found what you’re referring to.
6) The issue of Islamic Finance being more expensive is in fact a myth based on isolated examples in smaller markets as the author clarified.
7) In main Islamic markets, this does not exist, Islamic Finance is very competitive and is in fact gaining market share.
8) I don’t know of any extensive report by any organisation showing Islamic products being overall more expensive. My own experience negates that proposition. It’s the same myth that Islamic Banks are less technologically developed than their conventional counterparts.
9) Similarity to conventional products isn’t a Shariah issue. All financing and investments carry similar risk return profiles, I have touched upon that in an earlier article here on Form and Function.
10) Similarity has always caused outside observers a problem in believing it’s all the same. This of course is a fallacy, no different than saying a Tiger is just a Lion with stripes painted on.

Please don’t hesitate to return for any further comments or clarification. This is an important subject and I’m very happy that someone is paying attention.

Thank you very much.


Assistant Accountant, Shaheen Freight Services

Very Great approach Mr. Nizar towards The Islamic finance ultimately to Islamic economic system.


N/A

Thank you for your reply and the elaboration of your views. Sorry that the link to Mohamed Amin did not work. I will share the motivation for my interest in Islamic finance. I think it is a bad thing to artificially segment financial markets, and that it is a disservice to devout Muslims to restrict their choice of financial market products by invoking sharia compliance upon them. Sharia based finance is questionable - modernist scholars such as Fazlur Rahman and Abdullah Saeed do a good job of questioning the riba=interest assertion, and my own reading on gharar and takaful insurance leaves me quite puzzled. Both conventional insurance and takaful use risk pooling, and both require premiums or "donations", or you do not get coverage. Takaful membership is a contract like conventional mutual insurance.

I share your respect for history and the fact that law and contractual forms are not modern inventions but have evolved over many years. I like your concluding lion-tiger metaphor, but we may ask whether one animal really warrants divine approval and the other does not.

As for costs: the references cited under "Challenges in Islamic finance" in wikipedia, section 5.4 - costs - lend credence to the finding that Islamic finance costs are higher (I am not relying on the wikipedia author's opinion, but on the references he cites). Mahmood El-Gamal (Rice University) provides analytic support and explanation for this view with his "sharia arbitrage" discussion (see his book Islamic Finance: Law, Economics, and Practice, 2006). Even if costs were the same, my point regarding the restriction of choice still stands.

I conclude with a question - what is the state of the dialogue among the "modernist" followers of Fazlur Rahman, "neo-revivalists" like Taqi Usmani, and the "Egyptian school" of some more liberal scholars at Al-Azhar like Tantawi? It would seem difficult to claim consensus among these groups.

Lastly, I hope these comments do not excessively revisit the debates you have had with others!


Banker, Writer, Volunteer

Hi Robert

Thank you for your comments.

The prohibition of Riba is an obligation on Muslims, no different than other aspects of Shariah. In fact it’s a great “service” to be able to provide to Muslims a Shariah compliant manner to manage their financial needs.
The titles “Modernist”, “Liberal”, or “neo-revivalists” holds no water with me. Only knowledge has weight.
Many writers on Islam or Islamic Finance don’t have the relevant credentials to do the type of “interpretive” work they have attempted, no surprise their work has been disputed and in many cases discredited in the Shariah scholarly community.
That stipulated interest on money is Riba is unquestionable, only those with a lack of knowledge would think otherwise, or perhaps they have other reasons to question it.
Not all books on Islamic Finance or Islam are credible. The more knowledge one gains, the easier to spot the mistakes.
Again, there has been no detailed and extensive report by any author comparing the costs across banks and products, trust me, you would have found it already.
I tend to read mainly Arabic scholarly work, as it uses primary sources in their original language. Matters lose a lot in translation. Unfortunately many writers are not fluent in the language and misunderstand meanings of words and confuse idioms with numbers and use very selective phrases taken out of context. So I just shy away from such unqualified opinions.
Takaful is not the same, but to understand it, one needs to understand the rules of “Munahada” and what constitutes a “Mu’awada” contract in Islamic law.
There is no state of dialogue as you asked in your last paragraph, these “modernist” ideas have no weight in any serious discussion. Unfortunately, much of those arguments have been published in Arabic and non-Arabic speakers didn’t get a chance to review, and so some perhaps still believe there’s credence.
Only through a proper and thorough reading of texts throughout history can one see that our modern Shariah scholars are quite accurate in their views.
In writing it’s always difficult, if I were sitting across from you, I would have been able easier to take these books and show you where exactly some authors made a mistake.
All the best.


Banker, Writer, Volunteer

Thank you very much brother Nisar, thanks for reading and commenting.


N/A

I understand and respect your views, and appreciate that we can discuss in this forum.
Robert


Banker, Writer, Volunteer

Absolutely
Same here


Andrei Juravliov 1 month ago
Moscow State University

It’s a most topical issue (though to me the title suggested a different subject). Yet, I dare say that the course of the discussion needs realignment with the real problem, which is at the root of claimed similarity between conventional and Islamic financial products.
Marketing.
Competition.
Replication of the conventional yield (return) curve.
Cutting angles in the name of maslaha.
Full fiqhi compliance through mokhatara (incidentally, another contribution of the Middle Eastern ways to the contemporary European commercial practice of the olden days, this time in the form of a legal ruse).
I am deliberately saying “fiqhi compliance”, which is not the same as following Sharia: form against substance.
One may say that return smoothing for URIAHs is indispensable in to-day’s world and Islam has displayed its wisdom through ability to adjust to circumstances. OK. But one has to recognize then that the spirit is thus emasculated. (I am not mentioning the custom of distributing prizes for saving account holders by way of draw as another example; all right, you got me: I have).
The hugest thing, after all, is the very purpose of Islamic finance, in theory at least. There is a saying attributed to Sadr that Islam has come to organize the economic life and to evolve a system based on social justice. By default, Islamic banking, or finance if you wish, must have the same goal. After 40 years (Mit Ghamr Bank experiment excluded) can you see a slightest sign attesting to the industry in question being really set on this? (edited)


Banker, Writer, Volunteer

Hi Andrei

Thank you for your comments.

I disagree with the idea that it's the burden of Islamic Banking to "organize the economic life and to evolve a system based on social justice."

There are many other stakeholders that should also play a role and be held accountable. Yet, we see so many people criticizing the industry and wish to hold it accountable for every problem, like poverty, environment, etc. That is not my view and is unfair.

Having been for so long and from early on in the industry, I can honestly say that it has grown to this size, over $ 2 Trillion, was beyond our imagination. If people only understood the odds against us in the early days and the problems we faced, they would actually realize it was a miracle for this to have been accomplished in one generation. It's only now really getting started.

The main purpose was and still is, to offer Muslims an alternative financial services industry to obey the prohibition of Riba. Everything else that comes with it is a bonus.

This was our goal then, and now, and the goal we agreed with our scholars. All the other plans, while laudable, are mainly born in the minds of many who have had no practical experience within Islamic Banking, especially in the difficult old days.

In fact, I feel quite positive about the industry and that it is achieving its goals. But I guess, for some people, the glass will always look half empty. I prefer to look on the positive side.


Moscow State University

Thanks, Nizar. I see your point. It must be pretty hard to reconcile it with what I wrote. All in all, you will always have an advantage in a dispute, as a person who tried and did, over the one who has been mostly a theoretician. Yet, from the theoretician's point of view, however, based on conversations with some practitioners and consumers, the industry is heading to becoming an exotic business model of commercial banking. On the other hand, if the founding "fathers and brothers" saw implementation of Sharia precepts on a wider scale as the overarching motive they would not have structured the project as a commercial bank in the first place.


Banker, Writer, Volunteer

Perhaps you’re right Andrei.

However, as a commercial bank it’s the easiest and shortest route to change the norm, impacting money has a big effect on people.

It was important to do to gain acceptance.

When I first started, it was looked at as a weird thing, some people even laughed, right to my face.

Now however, most deals, at least in many countries of the Gulf, is assumed to be structured islamically.

I’d say that’s not a bad result.

It’s only recently that regulators even began to discuss it seriously.

There’s still a long way to go before we focus on a more wholistic approach.

Be patient please.