Shariah-Compliant Models for the Deposit Insurance System
Balance is the Solution
If we ponder over this vast universe, the heavens, the earth, the seas, and all living creatures, we will find everything based on a balance accurately established among all the components, and even within each individual component. Balance is the main factor that keeps all natural processes going without irregularities or malfunctions; Allah, the Almighty, says in the Qurʾān: “The Most Gracious (alRaḥmān), He has taught (you mankind) the Qurʾān. He created man and taught him to articulate. The sun and the moon follow their calculated courses; the plants and the trees prostrate; He has raised up the sky. He has set the balance.” According to the aforementioned verses, everything in the universe is regulated by a strict balance, which is why Almighty Allah has commanded man to manage the world in accordance with this balance: “…so that you may not exceed in the balance: weigh with justice and do not fall short in the balance. He set down the Earth for His Creatures...”
Almighty Allah has commanded humanity, to whom He has made this universe subservient, to maintain balance in all their activities and interaction with the universe and all its parts by avoiding all sorts of transgressions. He commanded us not to exceed the limits and to establish the balance in a fair and just manner and to scrupulously avoid causing any damage or harm to the balance. Almighty Allah has furthermore made it clear that even though He has created everything on Earth to be at the disposal of man, to invest and to make use of in the way that best contributes to the wellbeing of everyone, the Earth was created for all the creatures living on it, including human beings, plants, animals and ecosystems. All living creatures have rights which they are not to be denied.
Additionally, all divine messages have been revealed to maintain the balance between our duties to Allah, our duties toward one another, and even to maintain the balance between the various duties. The whole universe is based on balance, as Allah, the Almighty, states in the Qurʾān: “As for the earth, We have spread it out, set firm mountains on it, and made everything grow therein in due balance.”
Balance in Islamic Economics and Islamic Banking
In the course of studying the topic of balance in Islamic banking and economics, it can be observed that this balance is one of the most important traits of Islam in general in its legislation and rules, and of Islamic economics in particular. Islamic economics is founded on the balance between private, public and state ownership; the balance between production, consumption, distribution and redistribution; the balance between the role of individuals and the role of the state; the balance between the law of supply and demand; and, finally, the balance between macroeconomics and microeconomics.
Islamic financial products must also maintain this balance, first between the general objectives of the Sharī‘ah, and second by balancing risks and rewards. Additionally, Islamic financial products must maintain the balance between private and public interests; between contributing to comprehensive development and to social issues; between generating personal gains and serving the public welfare; between the inclination towards direct investments and guaranteed investments; and between maintaining liquidity and optimising the use of financial resources, etc.
Achieving such balance requires a thorough study of the pros and cons of each product, followed by a period of testing to determine how effective it is in achieving the desired effects and avoiding negative effects on the project itself and on the society
At this juncture, Islamic financial institutions must subject every product they use to the criteria of fiqh al-maʾālāt (the jurisprudence of consequences), which economists call “economic analysis”. It is based on collecting adequate information followed by the process of monitoring and controlling the outcomes of the product or project.
Sharī‘ah-Compliant Structures for the Bank Deposit Insurance System
It is well-known that Islamic fiqh academies have reached a conclusion on the issue of insurance. They have resolved the permissibility of cooperative insurance (takāful) and the impermissibility of commercial insurance. One particular resolution deserves particular mention, Resolution No. 9 (9/2) issued by the International Islamic Fiqh Academy (IFA) of the Organization of Islamic Cooperation (OIC) in its second session, held in Jeddah on 10–16 Rabīʿ al-Ᾱkhir, 1406 AH, corresponding to 22–28 December 1985 CE, which states:
“The IFA-OIC, after reviewing the presentations submitted by the scholars participating in the session on the topic of insurance and reinsurance; after discussing the presented studies, looking into the various types, structures, principles and objectives of insurance and reinsurance; and after considering the resolutions issued by Islamic fiqh academies and Sharī‘ah bodies in this regard, has decided the following:
First, commercial insurance contracts based on fixed installments as used by commercial insurance companies involve excessive uncertainty (gharar), which causes the contracts to become invalid. Therefore, the contract is prohibited (ḥarām) in the Sharī‘ah.
Second, the alternative contract that respects the principles of Islamic transactions is the cooperative insurance contract based on the concept of tabarruʿ (donation) and cooperation. The same applies to the case of reinsurance based on cooperative insurance.
Third, the IFA-OIC calls upon all Islamic countries to establish cooperative insurance and cooperative reinsurance institutions to free Islamic economies from the shackles of exploitation and to guard ourselves against violating the system that Allah, the Almighty, is pleased with for this Ummah. And Allah knows best.”
Takāful, or cooperative insurance, is in most cases based on a commitment to pay donations to the pool, or it may be based on the concept of nahd, which is our preference; or it may be based on a gift (hibah) with compensation, or on the concept of charitable endowment (waqf), as is the case with some institutions. There is no issue regarding the juristic classification of the underlying contract. What is most important is compliance with the relevant Sharī‘ah parameters. Therefore, this paper will not deal with any of these aspects. Rather, it will focus on Sharī‘ah-compliant structures for the bank deposit insurance system in terms of their permissibility, forms and mechanisms.
The Extent of Permissibility of Bank Deposit Insurance
Bank deposits, according to the customary practice in Islamic banking today, are the funds deposited by clients in any of the following accounts:
(a) Current account: An interest-free loan whereby customers become the creditors with the right to withdraw the deposit directly, via cheques, or through settlement, and the bank becomes the borrower with the right to make use of the deposit and assumes the consequent liabilities.
(b) Savings account: Managed according to the muḍārabah contract wherein the customer becomes the capital provider (rabb al-māl) and the bank becomes the entrepreneur (muḍārib), and the profit is divided as agreed. The distinguishing features of a savings account are that the customer is allowed to withdraw cash, and the profits generated are usually less than those generated through other investment accounts. A bank may grant its savings account customers some facilities such as an ATM card, telephone banking, free online banking, transfers through an automatic payment order, etc.
(c) Short, medium and long-term investment accounts, which are also based on the muḍārabah contract: The bank is the muḍārib and the customer is the rabb al-māl.
The aforesaid three accounts are permissible by the unanimous agreement of contemporary scholars provided they are structured based on Sharī‘ah contracts. The current account is based on an interest-free loan, so it is permissible from an Islamic viewpoint, and the other two types of accounts are based on the muḍārabah contract, which is permissible by the unanimous agreement of Sharī‘ah scholars. The following discussion relates to insurance of these three types of accounts.
Insurance for Current Accounts
This type of insurance refers to insurance on debts, which is impermissible when conducted through conventional commercial insurance companies due to gharar (uncertainty) and other violations of Sharī‘ah principles, as stated earlier in the IFA–OIC resolution. Commercial insurance on debts also involves other issues, in particular when the debt itself becomes the subject matter of the insurance contract; also, the issue of charging fees for the guarantee facility arises. Therefore, there is no Sharī‘ah authority that has permitted commercial insurance on debts, not even in exceptional cases or in cases of unavailability of Islamic insurance (takāful).
Islamic insurance (takāful) on debts is permissible in light of the following characterisation.
The juristic characterisation (or classification) of Islamic insurance on debts is the same as that of Islamic cooperative insurance. It is based either on nahd (a form of social cooperation), or commitment to pay donations, or offering a gift in exchange for compensation. All these forms fall under the category of donations, in which a certain degree of uncertainty is tolerated.
In addition to this general juristic classification, Islamic cooperative insurance on debts could possibly be classified under the principle of kafālah (guarantee) because the guaranteeing party joins his/her liability to the liability of the guaranteed party, undertaking to pay the underlying amount.
However, several criticisms may be raised against this classification; the most significant is that the guaranteeing company does not actually join its liability to the liability of the guaranteed party; rather, it undertakes to pay the debt only in the event of death or permanent disability. That is the case with all the Islamic insurance companies, as far as I know.
Before those trigger events, the insuring company is neither responsible for the debtor, nor a guarantor for him; and in the event of death or total disability the insured party (debtor) is no longer responsible for the debt. Accordingly, the concept of joining liabilities together is not realised; hence, kafālah is not realised except in the view of the Ẓāhirī School, which considers kafālah to be a transfer of the debt from the debtor to the guarantor. Even according to the Ẓāhirī view, the argument is not valid because, in the event that the condition is not satisfied, the insuring company remains free of any liability or responsibility.
From another angle, the kafālah contract implies that the creditor has the right to claim the underlying debt from both the guarantor and the guaranteed party, jointly or respectively; however, in conventional insurance on debts the creditor – that is, the financial institution – has no right but to request the payment from the debtor if the agreed conditions are unmet. The creditor can only request the payment from the insuring company in case the agreed conditions are met.
The response to this argument is as follows: this type of kafālah is considered a contingent guarantee (kafālah muʿallaqah), which is permissible according to the Mālikī School. Even the majority of scholars consider an unconditional guarantee (kafālah muṭlaqah) to give the creditor (the financial institution) the right to claim the underlying debt from both the guarantor and the debtor jointly or from one or the other. Abū Laylā, Ibn Shubrumah, Abū Thawr, Abū Sulaymān and the Ẓāhirī School disagreed with this view. All these scholars view kafālah to be like ḥawālah, which necessitates clearing the original debtor of any liability.
Moreover, the concept of a contingent guarantee applies completely to the practice of insurance on debts in the event of the death or permanent disability of the guaranteed party; it is like saying: “If so-and-so becomes bankrupt or dies, I guarantee his debt.”
Such a statement has been approved by the Ḥanafī School as long as the guarantee is contingent on a reasonable condition, such as to say: “If so-and-so (the debtor) cannot be found in the town, I will be the guarantor”, or any condition which is recognised by the customary practice of that land. This view is also adopted by the Mālikīs and is considered valid in the Shāfiʿī School (although another view is considered more correct). It is also one of two narrations from Imām Aḥmad in the Ḥanbalī School.
To conclude, insurance on debts is permissible provided it is arranged by means of Islamic cooperative insurance. This is in line with the resolution issued at the second forum of Dallah Al-Baraka, No. 2/9, indicating permissibility and stating as follows:
“Topic: Insurance against the Risk of Delayed Repayment (16/1)
Question: Is it permissible for an Islamic bank to obtain insurance for its debts against others in order to hedge itself against the risk of delayed repayment, whether the insurance is obtained via an Islamic insurance company or via an interbank Islamic fund for cooperative insurance?
Answer: It is permissible for an Islamic bank to obtain insurance for its debts against others to hedge itself against the risk of delayed repayment via the establishment of a cooperative fund with the participation of all beneficiary Islamic banks, and this is the solution that the Committee unanimously prefers.
As for insurance obtained via an established Islamic insurance company (takāful), it is also permissible. It is essential that a particular system be set up for both types of insurance and presented to the Committee for approval prior to application.”
A similar fatwā has been issued by the Sharī‘ah supervisory and fatwā committees of Islamic insurance companies in Qatar, Jordan and other countries.
The Permissibility of Charging a Fee for a Guarantee
Some have raised an issue regarding classifying insurance on debt as a form of kafālah, arguing that this kafālah would generate benefits and fees for the guarantor, which is not permissible according to the vast majority of scholars. To this effect, the IFA–OIC issued its Resolution No. 12 (12/2) stating:
“The answer to this argument: we assert that the issue of the guarantor benefiting from fees and profits is valid in the case of commercial insurance, which seeks profits from the insurance transaction itself, and consequently any surplus goes to the insurer. However, in the case of Islamic insurance, the argument is not valid because the company is acting as an agent on behalf of the takāful fund and is not actually the insurer. Thus, the fees charged by the takāful company are on the basis of wakālah (agency fee), which is permissible in Sharīʿah. The takāful fund does not take anything because it represents both the insurer and the insured, and any surplus is returned back to the takāful participants. Hence, the issue of charging fees for providing Islamic insurance on debt is completely irrelevant.
Based on the aforementioned discussion, takāful can be applied to provide insurance for current accounts for the benefit of the depositor (the account holder). Likewise, the third-party guarantee is also valid based on the kafālah contract, in addition to the fact that the lending bank (the creditor) is the primary guarantor.”
Insurance for Savings and Investment Accounts
(a) It is well known that bank deposits represent a large portion of the national income of countries where Islamic banks operate. As such, any substantial losses in these deposits would impact the status of the nation as a whole. Therefore, efforts to provide as much security and safety as possible for such deposits are eminently justifiable. This is consistent in principle with the objectives of the Sharī‘ah with regard to the preservation and development of wealth. That is why we find the longest verse in the Qur’ān instructing that debts be documented and that wealth be protected through rahn (pledge), kafālah (guarantee) and other mechanisms. Furthermore, earning profit is one of the objectives of investment. That is the reason that Almighty Allah has commanded those who invest the wealth of orphans to spend on the orphans from the profits generated from the investment, He states: “…make provision for them from it, clothe them, and address them kindly.…” Allah enjoins taking the expenses for provisions and clothing out of the profits generated, not from the original capital. Allah, the Exalted, also mentions in the Qur’ān: “then when the prayer has ended, disperse in the land and seek out God’s bounty. Remember God often so that you may prosper.” Almighty Allah enjoins seeking profit through work and trade.
(b) Some people claim that trade and investment in Islam are inherently linked to risk; however, this claim needs further elaboration. This is because commercial contracts in the Sharī‘ah do not carry the same features. In some contracts, risk is confined to debt repayment. Examples of such contracts are deferred-payment murābaḥah and other deferred-payment sales, salam (forward) sales, and istiṣnā‘ (the manufacturing contract). In these contracts, the counter-value becomes a debt that must be paid in all cases. As such, the debt is subject to all means of securities to ensure its repayment.
When there is a potential risk of loss or damage before concluding the deal with the customer, such risks are minimal and short-term and can be avoided through Islamic insurance (takāful) and reducing the period between the purchase and the sale to the customer.
Another category of Sharī‘ah contracts comprises usufruct-based contracts such as ijārah (lease contract), which involves very little risk, especially with a promise-of-ownership arrangement.
As for contracts that do involve risks, such as partnerships (mushārakāt), profit sharing (muḍārabah), and investment agency (wakālah bi al-istithmār), such contracts have their particular features, and they contain the same risks present in investments, which can be minimised through several instruments, as will be highlighted in this research.
Khaṭar (risk) means hazard and danger, and all its connotations indicate the possibility of incurring loss and harm that is likely to exceed the possibility of generating profit or benefit. Hence, when the matter is certain it is not called risk.
The possibility of damage and benefit, loss or profit, destruction or salvation is closely associated with the vast majority of human activities. The problem is when the possibility of danger exceeds reasonable limits. Therefore, a reasonable level of risk is acceptable, and the danger lies in what exceeds the limit and falls into hazard and gambling.
High risk is associated with gharar (uncertainty), which is prohibited in exchange contracts. Prophet Muḥammad (peace be upon him) forbade bay‘ al-gharar (sale contracts that involve considerable uncertainty). Risk and gharar (uncertainty) are related, overlapping concepts. When risk reaches a certain level it becomes a type of gambling, which is prohibited in Islam, based on conclusive texts from the Qur’ān and Sunnah as well as the consensus of Sharī‘ah scholars. As for minor or tolerable risk, it is permissible in some Sharī‘ah contracts within the following three parameters:
(i) Risk has to be accurately measurable and precisely recorded, which means any risk that cannot be analysed or measured is deemed unacceptable from an Islamic perspective. Therefore, the Islamic Financial Services Board has issued guiding principles of risk measurement in Islamic banking.
(ii) Risk has to be explained with due transparency to those involved in the transaction; Islam forbids deliberately concealing risk since the effect of risk in any contract is no less substantial than that of defects in the commodity that is the subject matter of a contract. This is why it is an obligation to clearly reveal any amount of risk in any transaction. To this effect, Prophet Muḥammad (peace be upon him) said: “Whoever cheats others is not of me.” Cheating is forbidden by the consensus of Islamic scholars. Therefore if a seller, for example, does not reveal the defects involved in the subject matter of the sale contract, he is responsible for the defects, and the buyer has the right to claim compensation from him or terminate the contract. This applies to any party that offers an investment product involving risk. The offer provider has an obligation to explain any amount of risk involved in the transaction; otherwise, he is responsible to guarantee the capital and the actual expenses incurred by the other party in the event of loss or damage.
(iii) Risk has to be in proportion to profits, as Prophet Muḥammad, peace be upon him, said: “Entitlement to revenues corresponds to liability for losses.” From this ḥadīth and other evidence, the well-known Islamic legal maxim has been derived: “Liability goes with gain.”
This equation is founded on the possibility of generating great profits in various types of partnership contracts – including contractual partnership (shirkat al-amwāl), profit-sharing (muḍārabah), agricultural partnerships like musāqāt and muzāraʿah,  and others – coupled with the possibility of loss in some cases. Losses in some deals can be compensated by the ample profits generated in other deals or at other times.
A major problem arises in some Islamic financial institutions when they deal in contracts that involve some risk, such as partnership contracts of various kinds, and the profit in those contracts is determined by benchmarking with the prevailing interest rate, for example, 5%. In case the deal generates ample profits, the Islamic financial institution cannot take more than the stipulated percentage (5%); then, if it suffers a loss in another deal, the institution will not be able to bear the loss.
(c) The principle that capital cannot be guaranteed in muḍārabah, mushārakah, wakālah, etc., except in cases of transgression, negligence, or violation of contractual terms is a fundamental issue in the Islamic economic system, which is founded on fairness and the prohibition of injustice and usury (ribā). Therefore, raising the issue of guaranteeing the capital, or the capital plus profit, on the pretext that times have changed is very dangerous. We will address some issues raised regarding capital guarantees in the following points:
(i) A guarantee of capital along with a stipulated increase is undoubtedly included under the prohibited ribā (usury). The issue of ribā is non-negotiable for Muslims because it is definitively prohibited by conclusive texts from the Qurʾān and the Sunnah. The prohibition of ribā includes banking interest, as was unanimously agreed by the authoritative international Islamic fiqh academies. On that note, the Qurʾān has condemned those who likened sale to ribā (usury): “…they say, ‹Trade is just like usury,’…” First, the Qurʾān condemned this claim from the aspect of religious belief by saying “…God has allowed trade and forbidden usury…” It is the obligation of Muslims to submit themselves to this command and declare, “…We hear and obey…”32 Second, ribā is unjust and causes an imbalance in commercial transactions because it entitles the usurer to take all the benefits involved in the transaction; his capital is guaranteed plus the fixed interest rate without making any effort or taking any risk. His money thus generates more money without worry or work. In contrast, the borrower alone has to bear all the negative consequences of the transaction; he is responsible to fully guarantee repayment of the debt along with the fixed interest at specific times. Otherwise, the interest will be compounded over time. Consequently, neither the concept of al-ghunm bi alghurm (no pain, no gain) nor al-kharāj bi al-ḍamān (entitlement to revenues corresponds to liability for losses) is applied. Instead, the borrower takes the risks and bears the liabilities while the creditor is assured of gain and revenue. In fact, the loan may not yield any revenues to be paid by the debtor.
Islamic economics is based on the recognition of individual ownership and of partnership, and is based on product activity. Partnership means sharing the returns after the deduction of actual expenses. On the other hand, interest is the cost of lending money, or put another way: a rental fee charged for leasing money for a certain period. It is a cost that is always present with borrowed money. It constitutes a burden on the borrower for a consumption loan and a burden on the borrower and the consumer in case the loan is used for production purposes.
The principles of partnership and profitmaking encourage savings and production in that the amount of profit is linked to the success of the investment project. Thus it is directly connected with production and feasibility studies and the huge efforts spent to make the project a success and to further develop it and a conducive environment for it.
The concept of partnership is one of the most effective incentives for promoting thinking and hard work to increase production. Investors are attracted to invest their funds in successful projects because they look at the anticipated returns. Even the conventional economic system confirms that profit generation (or the profit rate) is the main factor that encourages saving for investment. (Empirical evidence from financial markets across the world has proved that successful joint stock companies with profitable shares are able to attract as much individual savings as desired to cover their investment needs).
In fact, the concept of partnership is closely associated with the theory of marginal efficiency of investment. Projects with high returns attract more savings for investment, which increases their competitiveness and urges more production and profit maximisation for the benefit of all parties. “…Let those who strive, strive for this.”
From another angle, Islamic banks enjoy an added advantage of not taking a fixed interest rate on loans. Conventional banks select their customers primarily on the basis of their financial solvency. This is because the bank’s top priority is to guarantee repayment of its loan plus the interest. The bank does not care much whether the borrower is making high or low profits. It does not it care whether the loan is for production or consumption purposes. The only thing that matters to conventional banks is securing the loan with sufficient guarantees to ensure its repayment along with the added interest.
In contrast, when an Islamic bank gives financing to its customer on the basis of partnership (mushārakah) or profit sharing (muḍārabah), it cares about two things: protection of the capital as much as possible, and selection of successful investors who achieve the highest possible profits, since the bank is a partner in profit sharing. Thus, Islamic banks are the best choice when it comes to optimal use of financial resources.
Similarly, when an Islamic bank invests the capital of its customers on the basis of muḍārabah or mushārakah partnership, the bank is not responsible to guarantee the returns or the safety of the capital itself so long as it has not committed any act of transgression or negligence or any breach of contractual terms. This way, the capital does not form a burden to the bank: if profits are realised, the bank takes its share; otherwise, the bank loses nothing but the effort put into the project. However, conventional banks are responsible for both capital and the interest in any circumstance.
On the practical level, economic studies and the World Bank’s reports have explained that interest rates and credit management policies applied since the 1960s have had a negative impact on depositors and investors (creditors and debtors). Such policies also have led to misuse of financial resources and bias towards the distribution of credit in favour of major customers and have resulted in a sharp decrease in investment efficiency and a considerable rise in inflation rates.
Newspapers reported that when Brazil was unable to repay its debts it proposed to creditor countries to enter into mushārakah or muḍārabah contracts as a solution to outstanding debts because the mechanism of partnership contracts does not transfer all the responsibilities to the debtor alone (the partner). Hence, Islamic banking opens new channels for the distribution of financial resources among investors so long as they perform their roles according to the established Islamic principles.
(ii) Capital guarantee leads to the disruption of the concept of partnership. It inflicts injustice upon the managing partner, who may act with the utmost diligence and professionalism, despite which the project may incur losses due to circumstances beyond the manager’s control. Why should he be penalised and held liable for such a loss? The prohibition of guaranteeing the capital of investment is considered one of the major principles of Islamic economics. Not guaranteeing the capital in investments is thus one of the most important principles of Islamic economics for investments. No partner (neither a muḍārib nor a sharīk) can be held liable except in cases of transgression, negligence, or breach of contractual terms.
(iii) The claim that Islamic banks today are muḍāribmushtarak (joint entrepreneurs for multiple parties) and must be liable for the capital by analogy to the same case of al-ajīr al-mushtarak (an independent contractor offering services to the public at large), this argument has been answered earlier in detail.
Some Practical Alternatives
While it is important to preserve the concept of no capital guarantee, there are some procedures, which, if followed, could help reduce risks and provide a friendly and secure environment. These procedures are summarised as follows:
(a) Studies, information and adequate guarantees in cases of transgression, negligence, or breach of contractual terms;
(b) A third-party guarantee, as issued in Resolution No. 30 (4/3) of the International Islamic Fiqh Academy (IFA–OIC), which states:
“9. It is permissible to stipulate in the prospectus and ṣukūk muqāraḍah documents that a third party, with separate personality and financial abilities, commits to donate a sum of money without any assigned returns for any potential loss in the guaranteed project, provided that the guarantee is totally independent of the muḍārabah contract. That means fulfillment of the undertaking by the guarantor is not a condition for executing the contract and the related terms among the contracting parties. Thus, ṣukūk holders or the muḍārabah entrepreneur shall have no right to claim the invalidity of muḍārabah or to disrespect their agreed commitments under the pretext that the third-party guarantor has not fulfilled the guarantee commitment and/or under the pretext that the third-party guarantee was a pivotal element for consideration in the contract.” 
(c) Investment agency with the identification of the transacting party and the method of dealing; also, stipulating the right to sell to oneself within a short period of time; this mechanism does not involve a capital guarantee but reduces the period of bearing risk.
(d) Economic feasibility studies; as pointed out earlier, such studies are not a form of guarantee yet they constitute solid evidence that places a customer who claims loss or lower profit rates than those expected according to the studies in the position of a claimant in litigation. This means the customer is required to provide strong proof for his claim unless there are clear and manifest reasons for loss or for failure to realise the expected profits.
(e) Hedging against currency volatilities; currencies nowadays have become subject to large fluctuations, especially after the delinking of currencies from the gold standard. Due to this high volatility, constant changes in currency prices have become a conspicuous characteristic of contemporary economies. Therefore, Islamic financial institutions need to use hedging mechanisms, particularly in contracts based on deferred payments. Such hedging is intended to control undesirable fluctuations in prices generally and currency prices specifically.
The Major Problem
The major problem occurs when Islamic banks implement partnership contracts using an interest-based mentality. They do not execute mushārakah or muḍārabah contracts in the real sense of partnership which would realise major profits. The result is to undermine the partnership in terms of the consequences of the contract. They depend on LIBOR (plus a markup) in determining profit rates. This means that any profits above the prescribed percentage go solely to the entrepreneur or managing partner as an incentive or the like. Similarly, if the bank acts as managing partner it waives its right to any profits exceeding the prescribed percentage, in favour of the other party – that is, the customer.
As such, the Islamic bank bears the risk associated with the capital except in cases of transgression, negligence, or breach of contractual terms. Actually, this is a good practice; however, this partnership is not followed to its logical conclusion; the Islamic bank does not share profit based on its percentage of capital contribution or according to the mutually agreed ratio. This is where the defect occurs. In Islamic jurisprudence, parties bearing the risks in the partnership business are compensated with the possibility of generating major profits. When the Islamic bank is deprived of this privilege and allowed only a share of profit equal to the prevalent rate in interest based banks, the desired balance cannot be achieved. On the other hand, if the bank were to proceed with the partnership according to the correct Islamic mechanism, large profits in some projects would compensate for losses that may occur in other projects.
The solution to this issue lies in a root solution and an applied solution:
Root Solution: spread awareness among people on the objectives, the meanings and characteristics of Islamic economics so they may know how to apply Islamic finance correctly and make it a way of life.
Applied Solution: while forbidding fixed interest rates (by whatever name they may be called) in mushārakah and muḍārabah contracts, there are some solutions that can reduce difficulty in this issue. Convenient alternatives are available to give a sense of comfort to investors with regard to anticipated profits. These alternatives are as follows:
(a) Conducting accurate and reliable feasibility studies that meet all the required conditions and that analyse all the expected scenarios to determine the anticipated profit rates. These economic feasibility studies submitted by customers can be used as evidence for expecting profits. Hence, if the client claims loss or zero profit, he becomes responsible for providing reasonable evidence for such claims according to standard business practice. This is a useful mechanism that turns the entrepreneur or managing partner into a claimant who is responsible for providing proof and not the other way around where the bank is required to prove the claimant wrong by providing counterevidence.
(b) Reliance in mushārakah or muḍārabah contracts on the success stories of the successful projects and management with a high possibility of success, and careful selection of competent and trustworthy personnel with the requisite expertise, track record and repeated successes through accurate studies; this will undoubtedly expand the domain of Islamic financial institutions and will help achieve satisfactory profits that can make up for losses or failures, if any.
(c) Investment agency based on murābaḥah (cost-plus sale contract) with a specified percentage. For example, a bank would give a customer a sum of money to be invested on the basis of murābaḥah with a profit rate of 7.5%. Such a condition is absolutely valid, and the customer has to comply with it. The bank may not proceed with the deal if it does not find a customer to agree with this percentage of profit in murābaḥah.
(d) Ijārah (lease) contract with a promise of ownership at the end of the lease term. In this kind of transaction, profits can be determined with a considerable degree of certainty.
Cases of Insuring Savings and Investment Accounts
Commercial insurance coverage for savings accounts and Islamic investment deposits is prohibited in Sharī‘ah, as discussed earlier. However, cooperative Islamic insurance (takāful) is permissible in principle and can be applied to savings accounts and investment deposits in Islamic banks in view of the following cases:
(a) insuring the investment capital except in cases of transgression, negligence, or breach of contractual terms;
(b) insuring the investment capital in cases of transgression, negligence, or breach of contractual terms;
(c) insuring the capital in all cases;
(d) insuring both the capital and the expected profit.
Cooperative Islamic insurance (takāful) in the first case (insuring the investment capital except in cases of transgression, negligence, or breach of contractual terms) is permissible because it does not involve any contradiction to the Sharī‘ah. Rather, it involves cooperation in righteousness and piety as well as offering a helping hand to those who face difficulties beyond their control. This type of insurance is of real assistance to all parties. Furthermore, it resembles the third-party guarantee permitted in the IFA–OIC Resolution No. 30 (4/3).
As for takāful in the second case (insuring the investment capital in cases of transgression, negligence, or breach of contractual terms), it is also permissible. This is because the positive impact of the insurance goes to the capital provider, who has committed no sin or violation, unlike the muḍārib, who did commit sin or violation. To this effect, Allah, the Glorified, states in the Qur’ān: “No soul will bear the burden of another.” In addition, Islamic insurance actualises cooperation, apportions and distributes risks, and reduces the impact of loss of wealth, all of which are not only permissible but even recommended in the Sharī‘ah.
Some argue that such insurance is cooperation in committing sin and minimising its impact on those who have committed it and who deserve no assistance or cooperation because they have committed acts of transgression, negligence, or breach of contractual terms. All of these are violations and destruction of wealth and are prohibited and sinful. In this regard, the legal maxim states: “Concessions (rukhaṣ) cannot be used in cases of transgression.”
The answer to this argument is as follows: the argument is true; however, it applies only to the entrepreneur, agent, or partner that has committed the violation. Thus, if Islamic insurance (takāful) benefits go to the benefit of the transgressor (the entrepreneur) only, it would be impermissible. On the contrary, the takāful benefits go to the capital owner, who has not committed any of the aforementioned mistakes. The innocent party (the capital provider) should not be denied access to this compensation because of the wrongdoing of the other party (the entrepreneur). The capital provider is actually a victim who needs assistance and cooperation. Accordingly, the insurance is permissible in this, the second case, as well as the third case.
As for the fourth case, (the insurance for the capital and the expected profit) in all cases or in cases of transgression or negligence only, I prefer the view of impermissibility. This is because, if the profit is fixed in advance, it becomes forbidden in the Sharī‘ah and contradicts the principles of mushārakah (the partnership) contract. As a result, the contract would be void. If the entrepreneur/managing partner pays above and beyond the original capital, it falls under the category of ribā (usury). On the other hand, if profit is left undecided and unknown, it falls under the category of gharar (uncertainty) and ignorance, which is totally unacceptable even in Islamic insurance (takāful).
Besides, how is profit determined in the event of loss in a muḍārabah contract? Even if the profit is determined, it would still remain null and void. Hence, how is it allowed to offer takāful coverage for such a contract in particular when it violates the objective of the Sharī‘ah, as Imām al-Shāṭibī stated?
An Insurance Mechanism for the Three Types of Bank Deposits
Islamic insurance (takāful) can cover bank deposits in two ways:
First, Islamic insurance can cover bank deposits through Islamic insurance companies or through takāful branches of global insurance companies. I provide some proposals in this regard:
(a) It may be suggested that all or most Islamic banks (or at least all the Islamic banks in one country) negotiate with Islamic insurance (takāful) companies or takāful branches to receive the best offer. Since insurance has a cost that is ultimately borne by the consumer, the less the cost, the better for the Islamic banks to gain greater competitiveness in the market and to attract more investors who prefer to invest their deposits with Islamic banks rather than conventional banks. This can only be achieved through constructive cooperation.
(b) It is necessary to differentiate between three types of deposits in Islamic banks: shareholders’ funds, general deposits, and investment deposits for investors willing to bear acceptable risks in return for higher profits.
The first category (shareholders’ funds) can be invested in long-term projects, infrastructure, and whatever contributes to comprehensive development in accordance with economic feasibility studies and acceptable economic criteria, taking into account avoidance of unacceptable risks.
Regarding the second category (general deposits), it requires greater caution as it represents a large segment of customers with varying incomes, especially small depositors. This type of deposit can be invested in local murābaḥah (cost-plus) sale contracts, ijārah (lease) contracts that end with ownership, and istiṣnāʿ (manufacturing contracts) and the like.
With regard to the third category of deposits, it contains a wide range of opportunities for direct or indirect investment via portfolios and various investment funds. However, there is a need for accurate feasibility studies of each and every project and the avoidance of major or unreasonable risks. The bank must still display the utmost transparency and disclosure of the nature of the investment, the related risk and all relevant matters.
Second, Islamic insurance can also cover bank deposits through cooperation of all or most Islamic banks in establishing a special portfolio (or a special fund) to absorb losses, if any, connected with bank deposits in line with prescribed parameters. As such, each bank would participate via an annual contribution equivalent to the prevailing rate in the takāful market.
It is allowed to distribute the annual surplus among the participants in accordance with their contribution through any of the following techniques:
(a) to distribute the annual surplus among all participants in accordance with the contribution paid by each participant and irrespective of any losses;
(b) to distribute the surplus solely among the participants who did not receive claims;
(c) to distribute surplus to those without any claim or to those who claimed less than their contribution. The latter should be given the corresponding percentage of the surplus (and this is eminently fair).
This portfolio or fund should have a system and contracts to structure the repayment of contributions, expenditures and compensation, as well as distribution of the surplus, etc.
2 “Bayān” (communication) involves both expressing oneself and understanding what has been expressed by others, including the Qur’ān, which is called “bayān” and “mubīn” (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
3 “Sajada” means “to submit” and consequently also “to bow down” or “to prostrate oneself” (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
4 The Qur’ān, Sūrah al-Raḥmān, (55): 1–7 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
5 The Qur’ān, Sūrah al-Raḥmān, (55): 8–10 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
6 The Qur’ān, Sūrah al-Ḥijr, (15): 19 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
7 Al-Qaradaghi, Ali Muhyi al-Din (2012). Istrātijiyyāt al-Tanmiyah al-Shāmilah, (Dār al-Bashāʾir alIslāmiyyah: Beirut). Vol. 1, pp. 179–186.
8 The International Islamic Fiqh Academy of the Organization of Islamic Cooperation (IFA–OIC), Majallat Majma‘ al-Fiqh al-Islāmī, Issue No. 2, Vol. 2, p. 545.
9 Al-Qaradaghi, Ali Muhyi al-Din (2011). Al-Ta’mīn al-Takāfulī al-Islamī, (Dār al-Bashā’ir al-Islāmiyyah: Beirut).
11 Al-Qaradaghi, Ali Muhyi al-Din, “Insurance of Debts”, presented to the First Withāq Conference on Takāful Insurance, which was held in Kuwait, 1426 AH; Al-Qaradaghi, Ali Muhyi al-Din, Al-Ta’mīn alTakāfulī al-Islamī, op. cit.,Vol. 2, p. 538.
12 Al-Qaradaghi, Ali Muhyi al-Din (2011). Al-Ta’mīn al-Takāfulī al-Islamī, op. cit., Vol. 1 pp. 236–263, where juristic classifications are discussed and commitment to paying donations or use of al-nahd mechanism is held as the preferable classification.
13 For more information, see: Al-Kāsānī, ‘Alā’ al-Dīn (1986). Badāʾiʿ al-Ṣanāʾiʿ fī Tartīb al-Sharā’i‘, (Dār al-Kutub al-‘Ilmiyyah: Beirut ). Vol. 7, p. 3423; Ibn al-Humām, Kamāl al-Dīn (No date). Fatḥ al-Qadīr, (Dār al-Fikr: Beirut). Vol. 6, p. 399; Al-Dusūqī, Muḥammad (No date). Ḥāshiyat al-Dasūqī ʿalā Al-Sharḥ al-Kabīr, (Dār al-Fikr: Bierut). Vol. 2, p. 265; Ibn Qudāmah, Abū Muḥammad Muwafaq al-Dīn (1347). Al-Mughnī wa al-Sharḥ al-Kabīr, (Dār al-Kitāb al-‘Arabī: Beirut). Vol. 5, p. 423; Al-Sālūs, Ali Ahmad (1986). Al-Kafālah fī Ḍaw’ al-Sharī‘ah al-Islāmiyyah, (Maktabat al-Falāḥ). pp. 94–97.
14 Ibn ‘Abdīn, Muḥammad (1992). Ḥāshiyat Ibn ʿĀbidīn, (Dār al-Fikr: Beirut). Vol. 5, p. 295, 305–306; Ibn al-Humām, Kamāl al-Dīn (No date). Fatḥ al-Qadīr, op. cit., Vol. 6, pp. 291–294.
15 Al-Dusūqī, Muḥammad (No date). Ḥāshiyat al-Dasūqī ʿalā Al-Sharḥ al-Kabīr, op. cit., Vol. 3, p. 338; AlRamlī, Shams al-Dīn (1984). Nihāyat al-Muḥtāj, (Dār al-Fikr: Beirut). Vol. 4, p. 441; Al-Muḥallā, Jalāl al-Dīn (1995). Sharḥ al-Muḥallā maʿa Ḥāshiyat al-Qalyūbī wa ʿUmayrah, (Dār al-Fikr: Beirut). Vol. 2, p. 330; Ibn Qudāmah, Abū Muḥammad Muwafaq al-Dīn (1347). Al-Mughnī wa Al-Sharḥ al-Kabīr, op. cit., Vol. 5, pp. 100-102.
16 Islamic Juristic Rulings on Insurance, Dallah Al-Baraka, General Secretariat of the Juristic Board, compiled, edited and indexed by Dr. Abdul-Sattar Abū Ghuddah and Dr. Ezz al-Din Mohammad Khoja, p. 193.
17 Rulings of the Sharī‘ah Board of Jordan Islamic Insurance Company, issued on 27/8/1421, corresponding to 23/11/2000.
18 The International Islamic Fiqh Academy of Islamic Cooperation (IFA-OIC), Majallat Majma‘ al-Fiqh al-Islāmī, Issue No. 2, Vol. 2, p. 1035.
19 The Qur’ān, Sūrah al-Nisāʾ, (4):5 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
20 The Qur’ān, Sūrah al-Jumu‘ah, (62):10 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
21 Muslim, Abu al-Ḥasan (No date). Ṣaḥīḥ Muslim, (Dār Ihyā’ al-Turāth al-‘Arabī: Beirut). Vol. 3, p. 1153, ḥadīth no. 1513. On the authority of Abū Hurayrah: The Messenger of Allah (peace be upon him) forbade bay‘ al-ḥaṣāh (a type of random sale, prevalent in pre-Islamic times, where the object of sale was determined as the one on which a pebble thrown by a potential buyer randomly fell) and bay‘ algharar. Imām Aḥmad in his Musnad reports another narration of this ḥadīth with an authentic chain of transmitters, on the authority of Ibn ʿAbbās: “The Messenger of Allah forbade bay‘ al-gharar”. Aḥmad ibn Ḥanbal (1995). Musnad al-Imām Aḥmad, (Dār al-Ḥadīth: Cairo). Vol. 3, p. 226, ḥadīth no. 2752. Abū Dawūd in his Sunan also reports the latter narration. Al-Sajustānī, Abū Dawūd (2009). Sunan Abī Dawūd, (Dār al-Risālah al-‘Alamiyyah). Vol. 5, p. 259, ḥadīth No. 3376 and Ibn Ḥibbān in his Ṣaḥīḥ. Al-Dārmī, Ibn Ḥibbān (1993). Ṣaḥīḥ Ibn Ḥibbān, (Mu’assasat al-Risālah: Beirut). Vol. 11, p. 327, ḥadīth No. 4951.
22 See, regarding the issue of gharar. Al-Ḍarīr, Ṣiddīq (No date). Al-Gharar, (Dallat Al-Barakah: Jeddah).
23 See Wikipedia, “Financial Risk”; Al Suwailem, Sami (2007). Al-Taḥawwuṭ fī al-Tamwīl al-Islāmī, (Center for Islamic Economics Research: Jeddah); Al-Najlah, Marwan (No date). "Qiyās wa Taḥlīl wa Idārat al-Makhāṭīr al-Māliyyah", available at www.kantakji.com; and Bil-ʿAzūz, bin Ali (2009)."Istrātijiyyāt Idārat al-Makhāṭir fī al-Muʿāmalat al-Māliyyah al-Islāmiyyah", Majallat al-Bāḥith, Issue No. 7, p. 280.
25 Muslim, Abu al-Ḥasan (No date). Ṣaḥīḥ Muslim (Dār Ihyā’ al-Turāth al-‘Arabī: Beirut). Vol. 1, p. 99, ḥadīth no. 102; Al-Sajustānī, Abū Dawūd (2009). Sunan Abī Dawūd, (Dār al-Risālah al-‘Alamiyyah). Vol. 3, p. 272, ḥadīth No. 3452; Al-Tirmidhī, Muḥammad bin ’Issā (1998). Sunan al-Tirmidhī, (Dār alGharb al-Islāmī: Beirut). Vol. 2, p. 597, ḥadīth no. 1315.
26 Al-Nawawī, Abū Zakaryā (1392). Sharḥ Sahih Muslim, (Dār Iḥyā’ al-Turāth al-‘Arabī: Beirut). Vol. 2, pp. 108-109. The explanation of ḥadīth No. 102.
27 Al-Dārmī, Ibn Ḥibbān (1993). Ṣaḥīḥ Ibn Ḥibbān, (Mu’assasat al-Risālah: Beirut). Vol. 11, p. 299, ḥadīth No. 4928; Al-Tirmidhī, Muḥammad bin ’Issā (1998). Sunan al-Tirmidhī, (Dār al-Gharb al-Islāmī: Beirut). Vol. 2, p. 573, ḥadīth no. 1286. Al-Sajustānī, Abū Dawūd (2009). Sunan Abī Dawūd, op.cit., Vol. 5, p. 368, ḥadīth No. 3508. Al-Qazwīnī, Ibn Majah (No date). Sunan Ibn Mājah, (Dār Iḥyā’ al-Kutub al-‘Arabiyyah). Vol. 2, p. 754, ḥadīth No. 2243.
28 Al-Suyūṭī, ‘Abdul Raḥmān (1990). Al-Ashbāh wa al-Naẓāʾir, (Dār al-Kutub al-‘Ilmiyyah: Beirut). p. 255.
29 [Translator’s note:] Musāqah and muzāraʿah are two types of sharecropping contracts; the latter is based on an agreement between two parties whereby one allows a portion of his unplanted land to be cultivated by the other party in return for a part of the harvest. The former is similar except in one aspect: the labourer is responsible only for irrigation of an orchard.
30 The Qur’ān, Sūrah al-Baqarah (2):275 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
32 The Qur’ān, Sūrah An-Nūr (24):51 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
33 ‘Abdul-Raḥmān, Yusrī, "Al-Bunūk al-Islāmiyyah, al-Usus wa Āliyyāt al-ʿAmal wa Ḍarūriyyāt al-Taṭawwur", research paper submitted to the Financial Industry Symposium, held in Alexandria on 18–21 Rajab 1421, p. 9.
35 The Qur’ān, Sūrah al-Muṭaffifīn (83):26 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
36 ‘Abdul-Raḥmān, Yusrī, "Al-Bunūk al-Islāmiyyah, al-Usus wa Āliyyāt al-ʿAmal wa Ḍarūriyyāt al-Taṭawwur", op. cit., p. 11.
37 World Bank, World Development Report, Staff Report No. 410, April 1987, 16:715.
38 Al-Qaradaghi, Ali Muhyi al-Din "Madā Masʾūliyyat al-Muḍarib wa al-Sharīk ʿan al-Khasārah", research paper submitted to the Islamic Jurisprudence Council of the Muslim World League.
39 The International Islamic Fiqh Academy of Islamic Cooperation (IFA-OIC), Majallat Majma‘ al-Fiqh al-Islāmī, Issue No. 4, Vol. 3, p. 1809.
41 The Qur’ān, Sūrah al-Anʿām (6):164 (M. A. S. Abdel Haleem, The Qur’ān: A New Translation).
42 Al-Shātibī, Ibrahim (1997). Al-Muwāfaqāt, (Dār Ibn ‘Afān). Vol. 2, pp. 288-289.