A Shariah Perspective on Profit Sharing vs. Guaranteed Interest

In today’s world, many employees seek to save their money for future challenges. In this context, some employees choose to invest in fixed-return instruments, earning a fixed and guaranteed interest on their principal amount.

However, others are cautious about such guaranteed returns due to the Shariah impermissibility of fixed and guaranteed interest. Instead of investing in these instruments, they prefer partnership contracts, which provide Shariah-compliant returns on their capital.

The main challenge with profit-sharing contracts is that investors not only have the potential to earn profits on their investment but are also exposed to the risk of loss according to their share in the partnership.

In contrast, those investing in guaranteed interest-based instruments face no such risk, as these are Riba (usury) contracts where the concept of loss does not exist.

From an Islamic perspective, it is strictly prohibited to enter into or invest in Riba-based contracts. Therefore, to avoid engaging in Riba, it is essential for every Muslim to understand the mechanism of profit-sharing and its importance in ensuring Shariah compliance.

Read more about: Riba Explained: Why It’s Forbidden and How It Differs from Trade?

What Is Profit-Sharing?

Profit-sharing, in the context of Fiqh, generally refers to the variable and actual return derived from a legitimate commercial activity.

It is particularly observed in partnership contracts such as Musharakah and Mudarabah, where each participant earns profit according to a pre-determined ratio or in proportion to their share in the partnership.  So, in case the business earn the profit it will be shared among the participants.

What is meant by “profit through trade” (bay’) vs “profit through lending”?

- Profit through trade (Bay‘):  refers to earning money through a permissible mode of finance. It is Halal and permissible from a Shariah perspective. In this type of transaction, the participant is exposed to risk and, in the event of loss, bears it in proportion to their share.

- Profit through lending: refers to depositing money in fixed-income instruments. This is Haram and non-permissible under Shariah. In such transactions, the participant earns a predetermined profit regardless of whether the business generates a profit or suffers a loss.

 
Profit vs returns, what is the difference? 

- Profit: refers to the financial term used when the revenue exceeds the cost or expenses of a business.

In the context of Islamic finance, it refers to the variable and actual income generated from legitimate commercial activities. It commonly occurs in partnership agreements such as Mudarabah or Musharakah.

- Return: is a broader term that also includes the loss of a business. After making an investment, there is a chance of either profit or loss.

In both cases, we can conclude that the return of the business is either profit or loss. However, in conventional finance, it refers to a fixed income from investment, which is not permissible under Shariah law.

Read more about: The Basics of Shariah Compliant Profit & Loss Sharing Models

What Is Guaranteed Interest?

Guaranteed interest in simple terms means the usurious return on the principal amount, regardless of the business outcome.

The lender or depositor receives it in a guaranteed form. It is a predetermined fixed rate of return on the principal amount advanced as a loan. Islam strictly prohibits this practice because it exploits the rights of others and creates an unjust environment in society.

Shariah ruling Profit-Sharing & Interest 

As mentioned in the above paragraphs, Islam permits transactions based on the profit-sharing mechanism. There are various Shariah bases for the permissibility of profit-sharing transactions found in the Holy Qur’an, Hadith, and Ijma‘ (consensus).

The most common among them are as follows:

The permissibility of Sharikah is supported by the Saying of Allah, the Almighty: {“…And, verily, many partners oppress one another, except those who believe and do righteous good deeds, and they are few…”}. [Sad: 24]

Among the Sunnah provisions that support the permissibility of part-nership is the case of Al-Sa`ib Ibn Abu Al-Sa`ib Al-Makhzumi who was a partner of the Prophet (peace be upon him) in business at the beginning of Islam.

On the day when the Prophet (peace be upon him) conquered Mecca, he met Al-Sa`ib, then he (peace be upon him) said: “Welcome my brother and my partner. He jokes not (i.e. he is serious in business) and do not argue (unnecessarily).” 

The Hadith had been related by Al-Hakim who deemed it authentic [2: 61]. Al-Dhahabi agreed with Al-Hakim.

Moreover, the partnership is one of the main transaction since the advent of Islam. This proves the practical consensus and permissibility of the partnership.

The Shariah basis for the impermissibility of the interest are as follows:

In Surah Al Baqarah Aayah number 275:

Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said:"Sale is but like riba",

while Allah has permitted sale, and prohibited riba. So, whoever receives an advice from his Lord and desists (from indulging in riba), then what has passed is allowed for him, and his matter is up to Allah. As for the ones who revert back, those are the people of Fire. There they will remain forever.

In Surah Al Baqarah aayah number 278:

But if you do not (give it up), then listen to the declaration of war from Allah and His Messenger. However, if you repent, yours is your principal. Neither wrong, nor be wronged."

Narrated by Jabir ”: The Prophet cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: "They are all alike [in guilt]."

The consensus of the Jurist as mentioned in the Guide to Islamic Banking: “The fact that Riba An Nasiyah is categorically haram has never been disputed in the Muslim community.”

What does “al-ghunm bil-ghurm” mean and why is it central to halal profit?

It means that no gain can be taken with out taking risk. It acts as a central to the halal profit because number of Sale and partnership transactions are based on this principle.

Read  more about: Is Commission Halal & Permissible in Islam?