From the legal point of view, the main ingredient of a Qard-ul Hassan contract is a loan that is not contaminated in any way by Riba. There is a lender and a borrower, with no reference to a market, which might give one the impression that there should be a ‘price’ for it. The relationship between lender and borrower is one of creditor and debtor, and the principal of the money loaned out remains the responsibility of the borrower. The lender cannot demand his dues before the end of the contract period.

Funds in this form are advanced to both real and legal entities with the aim of providing humanitarian assistance and creating financial strength for members of society who lack the wherewithal to meet their general and essential needs. When Qard-ul-Hassan is given to a real person (that is, a household), it may be just for humanitarian and individual welfare purposes. Many Muslim countries have had long experience of this type of finance and such funds have been set up as private institutions among many believers. They are quite often short-term, humanitarian arrangements (based on Qu’ranic teachings) to help people meet an immediate need. The borrowed money can be used for a variety of purposes, including the purchase of household durable goods. Such behavior, using interdependent utility functions, produces and develops a brotherly feeling among people within and between the households involved. These interest-free loans are in line with Qu’ranic injunctions to honor society as vice-regents of Allah (SWT).

A legitimate question may arise here as to how such loans would deal with inflation. The simple answer is that it is hard to imagine inflation arising within the grand cooperative system in the first place, except perhaps during the transition period from the old capitalist system. In such circumstances, to prevent injustice to the lender in the face of inflation, it is recommended that the principal amount of the loan be pegged to the price of a specified commodity such as rice or wheat, provided that the commodity is free of any speculative activities. At the end of the loan period, the borrower then pays an amount of money equivalent to the amount of the chosen commodity that could have been bought when the contract was initiated. In such circumstances, it is probably best to leave such funds in the hands of the private sector, which, for reasons outlined earlier, is normally more efficient than the public sector.

The more important aspect of Qard-ul-Hassan funds is that part, which involves both the state-owned Islamic banks and the legal entities. All persons, real or legal, depositing their so-called extra funds (over and above their immediate needs, and for the sake of pleasing Allah (SWT) into an Islamic bank in the form of Qard-ul-Hassan savings accounts will clearly see that the bank utilizes them for the immediate needs of the firms to which the bank has initially provided loans. Such properly justified needs might include cash flow, either to buy raw materials or to pay wages. These loans are of a short-term nature and are designed to alleviate temporary financial problems being experienced by enterprises, large or small. They undoubtedly have a beneficial effect, particularly in small regional towns and villages.

In cases where the problems are of a longer-term nature, the short-term humanitarian solution provided by Qard-ul-Hassan contracts would not suffice. The answer has to be found elsewhere.


Source: Prof. Iraj Toutounchian, Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Narrated by Camille Paldi. Republished with permission.
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