Global (عربي)
KSA (عربي)
Global (عربي)
Riba, or usury, is a well-known crime in Islamic finance, as the religion views it as violating principles of fairness and ethical trade. Riba as it applies to lending, borrowing and charging interest is commonly known.
What is not as renown is commodity riba, which arises during the exchange of money and the trade of commodities. Understanding commodity riba is essential for anyone operating within the Islamic finance framework to ensure compliance with Shariah law.
Read more about: Islamic view of debt, lending and borrowing.
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. Islam considers this a form of cheating and an unethical trading practice.
The rationale behind the prohibition is to ensure that there are no exploitative trades in these commodities, which are considered essential (more on that below), with no party gaining an unfair advantage over the other.
Eliminating uncertainty and preventing excessive speculation (or Gharar) is another reason for the prohibition on commodity riba. And finally, prohibition of commodity riba is a way to help maintain market stability as it prevents excessive price shocks, hoarding and monopolies, albeit significantly reducing the amount trade that takes place.
Read more about: What is Gharar & How to avoid it?
Commodity riba primarily applies to the trade of six commodities known as the six ribawi goods.
These are goods that characterized as being fungible, essential (for both commerce and survival) and often serve or have served in the past as mediums of exchange.
These six ribawi goods are classified into two main categories:
1- Monetary commodities: This includes gold, silver, and other currencies.
2- Food commodities: These are wheat, barley, dates, and salt – which are considered essential food commodities during the classical Islamic period.
There are two main types of commodity riba:
Riba Al Fadl (or excessive gain in exchange) refers to the exchange of the same ribawi commodity but in unequal amounts. A common example is if a gold trader buys 1 kg of gold and then exchanges it for 2 kg of gold.
This occurs when ribawi commodities are exchanged at a later date or through a deferred payment structure. Examples include trading 1 kg of dates today for 1 kg of dates at a later date, or buying 1 kg of gold on credit which would be exchanged at a later date.
Adherence to anti-commodity riba regulations would mean placing restrictions on transactions involving these ribawi commodities, which heavily constrain the activities of Shariah-compliant traders and Islamic financial institutions. These entities would need to ensure:
- That gold, silver and currencies be exchanged at equal amounts, and must be bartered and traded at market prices.
- Commodity traders must exchange their goods without deferred payment structures or lock-in prices for future delivery.
- This makes it very hard to engage in the global trade of these commodities, bringing about a number of challenges that these traders must tackle. These include avoiding common practices such as:
i- Arbitrage in currency trading: A number of global and digital currency exchanges and markets allow and sometimes encourage traders to engage in arbitrage opportunities, which while not outright forbidden, can, at times, violate commodity riba regulations.
Read more about: Currency Carry Trade vs. Currency Exchange: Which is Shariah-Compliant?
ii- Using futures contracts and other derivatives: Many financial instruments such as derivatives, which are widely used and a mainstay in global trade and commerce, cannot be used as they violate commodity riba restrictions and could encourage gharar.
iii- Short-selling: Another common feature of global financial markets, short-selling involves the borrowing of a commodity or financial instrument, selling it at the current price, then repurchasing it when the price drops and returning it. This makes them incompatible with anti-riba restrictions.
With that in mind, there are alternative structures in commodity trading Shariah-compliant traders and institutions may use in order to ensure compliance. These include:
- Equitable bartering: This is the direct exchange of these ribawi commodities at the same amount.
- Spot transactions: This is the trade of goods for immediate delivery.
- Murabaha financing: Islamic financial contracts such as commodity Murabaha and others are designed to avoid riba in all its forms as well gharar.
Islamic banks can use the cost-plus financing model where the sale price is agreed upon in advance and without the use of interest.
Read more about: Your Basic Guide to Commodity Murabaha
- Salam contracts: Salam contracts are used in trading where the commodity is paid for in advance
Read more about: Salam Contracts vs. Futures Contracts, A Comparative Analysis
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.
