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There’s a lot of intersectionality between conventional finance and Islamic finance – so long as it avoids interest (riba), activities and goods forbidden outright by Islam (alcohol, gambling, drugs, etc), and gharar.
While the first two are clear cut, the final stipulation on gharar is more difficult to assess, as it involves things like intention, a lack of clear, all encompassing ground rules, and a grey area between what is considered acceptable business risk and excessive speculation and uncertainty.
That said, there are parts of the conventional finance landscape that are considered gharar. We look at some of these elements and discuss why they are considered gharar.
Read more about: Gharar: What exactly is it and how to avoid it?
Although common in modern day conventional finance, trading in derivatives – financial instruments whose value is derived from an underlying good or commodity – are widely considered gharar.
Notable examples include futures contracts, whose value comes from the underlying commodity price, and in the case of equities and stocks, these include options (calls and puts), forwards and swaps.
It is perhaps ironic that derivatives have a reputation for being overly speculative, because they were initially intended as a form of risk mitigation.
Futures were intended to provide a hedge against wild swings in the prices of commodities by locking down a price today for a future delivery date.
This has then evolved into a multi-trillion dollar industry built on the back of trading that is more often than not speculative, as they have financialized the trading of goods and products that
In addition to being considered overly speculative, derivatives are considered gharar for being opaque on the true ownership of the underlying good, according to a paper by the Shariah Review Bureau – an organization dedicated to assessing Shariah compliance in business and finance.
Derivatives contracts can exchange hands and be traded without the underlying good having changed hands. A key characteristic of gharar is that the true ownership of a good or service isn’t known.
Futures contracts see the deferment of both pricing and delivery of goods to a later date. “A sale is only valid under Shariah law as long as only the price or delivery, but not both, is postponed.”
Short-selling is a strategy by which an investor makes money off the value of a stock falling.
It involves borrowing or renting shares on interest and then the sale of the stock when the price remains high.
If the price declines, the investor buys back the stock at the lower price, then returns it to the lender, while pocketing the difference.
In addition to violating Islamic principles through interest, short-selling involves the sale of a good that one does not own, which is a violation of gharar laws,
according to Humayon Dar, the director general of the Cambridge Institute of Islamic Finance and former CEO of BMB Islamic, a Shariah advisory firm.
Short-selling is also much riskier as losses from a short position can be infinite, depending on when the investor buys back the stock.
Day trading – a common strategy among retail investors and hedge funds alike – is a strategy that involves the buying and selling of securities within the same day.
It is a high-paced strategy that focuses on technical analysis, which focuses on past prices and trends to predict future prices, and momentum analysis, which hopes to piggyback off of short-term gains and trends.
While the returns on day trading can be highly lucrative, day trading is among the most speculative and riskiest trading strategies out there.
This puts them squarely in gharar territory and potentially even in gambling territory, as daily volatility and shifts in the market are unpredictable no matter how much technical and momentum analysis goes into the stock picks.
Furthermore, scholars, including Sheikh Yusuf Talal DeLorenzo, question whether owning a stock for a single day constitutes real ownership.
Insurance is when someone pays an insurance provider premium over the lifespan of an insurance policy to protect against an adverse impact laid out in the insurance policy.
The insurance provider invests these premiums and from those returns they are able to pay out the claims.
Read more: Comparing Conventional Insurance and Takaful "Islamic Insurance"
Conventional insurance is considered gharar for a variety of reason. For one, the benefit that someone paying premiums gets only comes following an unforeseen and negative outcome in the future that may or may not arise. When outcomes are uncertain, then it is considered gharar.
One of the main criticisms levied against conventional insurance providers is that the terms of the claim payouts are unclear, with many insurance providers bargaining down and refusing to pay for certain outcomes,
even though the policyholder has understood the terms to be different. The oblique nature and uncertainty of the terms in an insurance policy also places it within gharar statutes.
Read more about: The red line between gharar and business risk
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
