What are the shariah-compliant alternatives to commodity riba in conventional finance?
As we discussed in a previous entry, commodity riba is the unfair or excessive gain that could arise from the trade or exchange of the same good or type of good but in different quantities and at a deferred delivery.
This places heavy restrictions on the types of transactions that can be made on the six ribawi commodities that this rule applies to. Commodity riba can manifest in several conventional finance transactions.
That is why it is important to identify which transactions that can be perceived as commodity riba in order to avoid them. It is also noteworthy that there are shariah-compliant methods that serve as alternatives to these transactions. As these non-shariah-compliant transactions are too numerous, we will only look at some of the most commonly used ones here today.
Read more about: What is commodity riba – what are the 6 ribawi items?
1- Futures contracts
Futures contracts – one of the most commonly traded financial instruments – is considered a form of commodity riba as it is currently applied in conventional finance.
Futures contracts are those where a commodity price is locked in today for a future delivery date, making them a blatant form of Riba Al Nasyah – especially if the underlying commodity is among the six ribawi items.
And as futures contracts are traded in the open market, they are also prohibited due to other violations in Islamic finance, namely, that the buyer and seller of a futures contract does not typically own the actual underlying commodity, which is a violation of Islamic principles.
Finally, futures contracts are traded to financialize and maximize gains from a particular commodity outside the inherent value of that commodity. This makes them riskier and potentially violating gharar regulations.
Alternatives to futures contracts
Salam contracts: As an Islamic forward contract, the principles of a salam contract is the same, except that payment is made upfront for a specific good with certain qualifications with delivery taking place at a later date.
Read more about: Salam Contracts vs. Future contracts
2-Short-selling commodities
Short-selling is the borrowing of a commodity or financial instrument, selling it at the current price, then repurchasing it when the price drops and returning it, while pocketing the return.
This allows the trader to make a profit on the price of that commodity or instrument falling. In conventional finance, borrowing that commodity is done on interest, which is riba in Islam. If the trader exchanges the goods in unequal amounts, then this an obvious case of Riba Al Fadl.
Other reasons as to why it is forbidden includes, the sale of a product which the short-seller does not own, as well as short-selling being a form of speculation, which in its extreme version is also a clear-cut violation of anti-gharar restrictions.
Alternatives to short-selling
Arbun: By using the arbun – otherwise known as earnest money contract or downpayment – the short-seller can effectively own the commodity, negating the need for borrowing and interest.
they must also ensure that the goods are exchanged in an equal amount. That, however, eliminates the profits that can be generated from that transaction, defeating the point of short-selling.
3- Commodity repo transactions
Collateralized commodity lending transactions (or repo transactions) occur when a trader sells a commodity to the bank with an agreement to buy back the goods at a later date and at a higher price.
This type of transactions violates riba principles in a number of ways. First, the price differential in the transactions essentially is the interest on a loan from a bank.
The arrangement to buyback the commodity at a later date would make it a blatant form of riba al nasyah. Furthermore, the commodity itself acts as a collateral and not the object of the trade.
Alternatives to commodity repo
Tawarruq (or commodity Murabaha): in a tawarruq transaction, the lender purchases an asset, then sells or leases it at a markup to the borrower, who will then sell off the asset.
This provides the borrower the flexibility of obtaining the liquidity without tying them down with the initial underlying asset.
Read more about: What is Monetization (Tawarruq)?
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
