Dow Jones University Questions and Answers

Investing in the Financial Sector

Q: (South America) I was particularly interested to know what kinds of sectors islamic investors should avoid, like the financial sector. I assume that some smaller banks generate more revenue from profits arising investment returns on deposits received. Does it make sense to say that in a scenario where 80% of the bank's revenue is generated from investment returns (from financing development projects), then from whatever returns I might make as a Muslim investor in this bank, I would have to cleanse 20%? I know that I am oversimplifying the scenario for most banks am not taking into account the fact that halaal investment projects in the bank might constitute only a small part of the bank's overall profit. But assuming a direct relationship (each % of halaal investment by the bank contributes 1% of profit to the banks bottom line), is my reasoning correct. I am also wondering to what extent my assumptions about the ratio of halaal to haram (investment vs loan financing) business dealings in a typical bank are sound.

A. The financial sector in general, and banks and insurance companies in particular, represent dangerous ground for Muslim investors owing to their involvement, in a very fundamental way, with riba. As a result, the entire sector has been declared "off limits" by most Shari`ah boards. The Dow Jones Islamic Market Indexes, for example, include no banking or insurance securities. If, however, you are considering an investment in a bank that transacts with a minimum of riba, your answer is at least theoretically correct. However, the real problem is determining the amount of the income the bank actually earns from riba and this, in practical terms, is nearly impossible. Therefore, my advice would be to stay away from such an investment. In addition, several of our most respected Shariah scholars have given the opinion that it is unlawful to deposit in riba-based banks (if an Islamic alternative is available) because to do so encourages and supports the riba-based system of finance. Then, when this is their opinion on deposits, their opinion in regard to investing in such banks is that to do so is clearly unlawful. And Allah knows best.

Financing Alternatives

Q: (USA) Are there any alternatives that can be used today by compaines, when they need to borrow money to fund project other than from (interest bearing means) i.e. the banks and the capital markets?

A: Alternatives certainly exist. When companies need influxes of liquidity, they generally resort to one of two options: they seek loans, or they issue bonds or more stock. Obviously, the option that is free of riba is the issuing of stock. Even so, many corporations are hesitant to do this because it dilutes, or lessens, the value of stock already owned by its shareholders. With proper planning, however, a company can stockpile reserves for reinvestment, and thus address the problem in that manner. If you are shareholder in a company that is borrowing on interest (either from banks or through the issue of bonds), you should communicate your concern to management. If the borrowing exceeds one third of the company's assets, you should liquidate your position. And Allah knows best.

Rationale for the Prohibition of Riba

Q: (South America) While I understand that the shariah is strongly opposed to riba in all its forms, I was condering what the rationale for this is. The Quranic text and prophetic tradition are clear in prohibiting it but I haven't yet seen a clear explanation of why it is problematic. I also fail to see WHY asset-backed ownership is the only permissible type in Islam and exactly what the problem is with other purely financial instruments. Are there any other readings you could recommend to help answer these questions?

A: Please keep in mind that the prohibition is very much a moral issue, and that it is closely related to the concept of khilafah or stewardship. The Islamic concept of monotheism views the Almighty as the Fashioner and Possessor of all creation.

His is all that is in the heavens and on earth. Everything submits to Him (2:116).

When the earth and everything in it belong to the Almighty, the role of humankind is no more than that of caretakers. Even so, humankind has been granted an awesome responsibility, one which, in the poetic language of the Qur'an, even the mountains dared not accept. The terms of this stewardship are that the Almighty allows humankind the use of the physical universe, hopefully for good (though possibly for evil… because humans have the ability to choose), and in return humankind agrees to be accountable for how the physical universe is used. This agreement is the foundation of all worldly justice, and this leads to the Shariah or religious law which includes guidelines for using the Almighty's property for profit and acceptable gain. Unjust enrichment, according to the Shariah, may take many forms; but the most iniquitous of all is enrichment at the expense of others, and this includes lending for profit. Money lending and financing belong to two entirely different spheres; one is charity, pure and simple, and the other is business. The repercussions of this bifurcation range far and wide, and shape much of what is unique about Islamic notions concerning economy and society. Equity investing offers Muslims the opportunity to profit, not by lending at a guaranteed rate of return, but by sharing in ownership, and thus commiting to share in the risks associated with ownership. Such a commitment is clearly in consonance with the concept of stewardship, and this, more than anything else, explains how the Islamic prohibition against interest is as much a moral matter as it is a legal one.

Ijab and Qabul

Q: I had a question about investing in the stock market I have heard that it was questionable because of a condition that is necessary in an islamic contract - that of ijaab and qabool (offer and acceptance). I have heard that when people are in a contract with one another (in any form, including as shares of a company), that a necessary element in the islamic contract is that the parties involved have the right to make decisions regarding the contract. However, some say this does not happen in the shareholder case because it would be impractical in some cases to take the decision of ALL shareholders - thus nullifying the contract islamically and making investing in the stock market questionable. Could you please help me?

I am confused - could you also list the necessary elements in a contract according to the different madhabs in Islam.

JazakAllah

A: Thank you for your question about the fundamentals of a contract in Islamic law. In fact, part of the answer to your question comes from first hand experience. Allow me to explain (but I'll begin at the beginning, the story will come later!) The classical jurists explain that every legal contract is composed of a pillar and four fundamental elements. Thereafter, a contract may have other elements, like conditions, rights, responsibilities, effects, etc. While these may appear to be very basic and therefore very simple matters, they are at the core of all transacting and are therefore very significant for their practical and legal ramifications. The pillar (or rukn in Arabic) is what you asked about in your question, ijab and qabul. As pillars, the obvious inference to be drawn is that if you don't have ijab and qabul, you don't have a contract. Without a pillar, you have no leg to stand on, so to speak! Without an offer and its acceptance, you don't have a sale. (See Lesson Three: Principles of the Islamic Law of Contract where ijab and qabul are referred to as intention and consent.) When you buy stock, you actually enter into a contract with an agent, or a broker for the purchase because it is a part of the regulatory system that only licensed brokers are allowed to actually buy and sell stocks. So, you, the buyer, contract with a broker. This may be done on the phone or in person, by means of a verbal agreement, or in writing, by letter, fax, or the internet. Whatever the means, if you have understood that the broker has agreed to what has been proposed, and if the broker understands that you have agreed, then ijab and qabul will have come about, and you will have a deal, a contract. Generally, what happens next is that your stock broker will send a floor broker to go to a specialist firm (brokers to the brokers who maintain a booth on the floor of the stock exchange) with you order. With your order in hand, the floor broker will go the appropriate place on the floor of the exchange and see what is bid and what is asked for the stock you have requested. This bidding and asking is not only the essence of trading on the stock market, it corresponds exactly to the fundamental pillar of an Islamic contract, or ijab and qabul. Sometimes the floor broker will buy the stock for you from the specialist firm in the booth, and sometimes the floor broker will encounter another floor broker at the booth and conclude a trade right then and there, again by means of a contract based on bidding and asking. Now, to the first hand story. One of your other instructors, Dr. Mohamed Elgari, and I had the pleasure of visiting the New Stock Exchange earlier this year in the company of some other of our colleagues. There we were shown around the floor by a representative of a brokerage company and, as we stood in front of one the booths, two brokers in their special green jackets arrived at just about the same time, each from a different direction. Then, right in front of us, as other brokers were standing and buying from the specialist broker inside the booth, the two brokers looked at each other and, in a matter of seconds, communicated to each other that one was there to sell and the other to buy, and that the stock they were interested in was the same, and that the asking price was so much, that the other broker was willing to bid so much... etc. all in the space of seconds. And then the deal was done! The stock had been traded. Dr. Elgari and I looked at each other, and our colleague, also a Shari`ah scholar, said what we had been thinking... "There's your ijab and qabul!"

Covered Options

Q: Is covered option Islamic? Why or why not?

A: An option, whether covered or naked, differs fundamentally from a stock. A stock represents a share in ownership, equity, of a real company producing goods or services and generally contributing to the economy in a substantial manner. When you buy stock, you help to raise capital for business, and the company and the economy benefit. Options, on the other hand (like futures), are intangibles, and a part of what are known as zero sum markets in which gains can only take place if there are corresponding losses. In other words, if you make a hundred dollars (before commissions), someone else has to lose a hundred dollars. This is the sort of circular economic activity that is clearly forbidden by the Shari`ah. From a purely Shari`ah perspective, however, the form of option to which you allude in your question, also known as writing covered stock calls, is prohibited for the reason that it involves the sale to another party of nothing more than a right to buy the stocks that you own. Most jurists hold the sale of rights to be prohibited. Proponents of futures and options markets will argue that these activities perform the function of stabilizing prices, regulating risk, and so on. They also argue that there is a value to opportunity. But, the bottom line as far as the Shari`ah is concerned is that these markets (and transactions) produce nothing of value, and that, as if that were not bad enough, they operate on the principle that for every winner there must be a loser. Options and futures amount to bets on the direction the market is moving in. Obviously, the ethics of this market are unacceptable. And that cannot fail to have negative effects on the bigger picture, or the economy.

Common and Preferred Stock

Q: My question has to do with preferred stock and whether or not they are halal. In the lesson it mentioned that those that pay dividends are guaranteed, so it is not allowed. This is true of cumulative preferreds, but regularly "non-cumulative preferreds" only pay dividends when the company has earnings. My question is, the security haram if it is guaranteed, or is it haram if it pays a fixed dividend?

A: From Lesson One: Types of Stocks and Businesses:

Ownership shares issued by corporations and traded by investors include both common stock and preferred stock. While there are several ways in which the two types of stock differ, the most significant way, from an Islamic legal point of view, is that preferred stocks guarantee the amount of the dividend.

Such a predetermined and guaranteed rate of return is prohibited for the reason that it may be classified as riba. Thus, while an investor may share the risks of ownership with other investors, the preferred status of the preferred stock means that there is extra compensation for the owner for which the owner has not had to pay. This, in simplified terms, amounts to riba al fadl. In Lesson Two of this course, we will take a detailed look at riba and the forms it may take. For similar riba-based reasons, fixed-income securities, convertible notes, and the like are also prohibited.

As a general rule, then, Muslim investors may trade only in common stock.

In some cases, however, preferred stock may be offered without a fixed dividend or without a dividend at all. Even so, it is the right of the shareholders to change those terms through a vote at their shareholders’ meetings. Thus, while a Muslim investor may purchase such stock, s/he may hold it only for as long as it carries no fixed dividend. If the status of the stock changes as a result of a vote, the Muslim investor will have to liquidate his/her interest in the company immediately. And if a fixed-amount dividend is received before the stock can be sold, the entire amount of the dividend will have to be given away as charity.

Purifying Investment Income

Q: How exactly is investment income 'purified' and how is the amount that comes from interest calculated?

A: Please review Lesson Six: Zakah and Purification, particularly the section entitled: Purification as a Fiscal Responsibility. You may also want to try the exercise that is given there. (We supply the calculator!)

Leasing Haram or Halal?

Q: In this chap. it states that leasing is haram. Because the contract is kept suspense for a certain amount of years. I've always thought that islamic banks do conduct their business this way. For example, say that you are leasing a car from a financial institution. Doesnt the islamic bank buy ther car and then they lease it to you for a set amount of years, and when the duration of years have concluded you can buy the car. Wouldnt that be haram. Please explain more about the leasing factor.

A: Leasing is certainly not haram. The manuals of Islamic law are filled with text on the subject of leasing, and almost all of our modern Islamic banks engage in leasing of one sort or another. Please turn to the Lesson once again and look at the section entitled: Principles of the Islamic Law of Contract. If you scroll down you'll come to some blue text which is a hyper link to an explanation of the different sorts of contracts. Here you'll find that under the heading:

Binding (or obligatory) and facultative (or permissible)

Some contracts are binding, Lazim, once concluded they cannot be revoked except by mutual consent of the two parties.

Some are facultative, Jaiez, which can be revoked by either party, and in some cases by a given party.

Examples of the binding contracts are the contracts of sale, hire and lease, etc.

Purification of Impure Income

Q: In lesson 1 we learnt how a Muslim investor may trade in common stock so long as the preconditions apply. In the section "The debate over Riba" it was clearly mentioned that when a company derives benefit from interest, the Muslim investor will be responsible for cleansing his holdings.

My question is :

1) How can one work out what percentage of riba is involved in their money ? It would seem very difficult ?

A: Yes, this is a very difficult task. But please refer to Lesson Six: Zakah and Purification, and then turn to the section entitled: Purification as a Fiscal Responsibility. There is a detailed explanation there, and several examples with which to practice. Even so, the best way to accomplish this sort of purification is by investing in a reputable Islamic mutual fund with a Shari`ah Supervisory Board that will work with the fund management and their accountants to ensure that everything is done in complete compliance with the Shari`ah. If your fund cannot provide this service for its investor/ clients, it's time to look for another fund! Unfortunately, the number of funds that offer such a service is limited. But when the funds that do not offer this service begin to lose clients and assets to funds that do, then we will see, Allah willing, more and more funds offering the service. This is the nature of competition, and it is a healthy thing because ultimately it is the consumer who benefits.

The Difference Between Bank Deposits and Stocks

Q: 2) My understanding was that only in extreme cases should a Muslim tolerate riba. For example, scholars have allowed Muslims to hold bank accounts even if they incur interest on the pretext that they cleanse their money from the interest accumulated.

In the case of bank accounts it could be accounted as a need since it would almost be impracticle for one to keep his money at home in paper form. Thus the need for a bank account to hold the money.

However, is it a need to invest in common stock ?

A: There are fundamental differences between the two situations you ask about. In one situation, the primary business of the institution is clearly prohibited owing to its transacting in riba. In the other, the primary business may be either lawful or unlawful. Moreover, while the lawfulness of one situation is indeed based on necessity, the lawfulness of the other is not.

Let me explain this in a little more detail. When it became apparent that there was a real need for people to place their money in banks, in order to protect it, to transfer it, to have easy access to it, and to allow others to have access to it, they brought their problems to the scholars of fiqh. When it became apparent that their problem represented a real need, legal license was extended, on the basis of necessity, to those in need of placing their money in bank accounts at conventional (riba-based) banks. This was because no practical or reliable alternative existed. Later, with the establishment of Islamic banks, this license was revoked; but only in regard to those with access to such banks. For example, someone living in Topeka, Kansas might continue banking at a conventional bank; whereas people in the Gulf, where Islamic banks have proliferated, have an alternative to conventional banks, and must therefore avoid the conventional banks.

So, to summarize, permission (to bank at conventional banks) was given on the basis of necessity. Permission to invest in stocks, however, is not based on any sort of necessity. Buying and selling are voluntary activities. No one (under normal circumstances) needs to buy or sell in order to survive. So the lawfulness of buying and selling stocks is not based on legal license. Rather, buying equity shares of businesses on the stock market is lawful when the primary business of the security is lawful, and when a specific set of financial ratios are found to be within certain limits. All of this has been explained in detail in Lesson One. See the third section, entitled: The Stock Market, and the sections which follow it.

Difference Between Murabahah and Interest

Q: I am having trouble understanding the difference between murabahah and interest. What is the difference between buying a car with a fixed rate of profit in installments and paying a car note that involves riba? Aren't loans that include riba at a fixed rate also? Can the middle person charge a higher price because the payment is in installments?

A: There is in fact a world of difference between the two. Unfortunately, though, because the end result is the same, people tend to think that the differences are insignificant, and that the changes required to bring about the same result are merely cosmetic in nature. This is just not so! On the one hand we have Muslims who want to avail themselves of the opportunities afforded by interest-free financing, and on the other we have Muslims who complain that the interest-free financing is "just like" the financing with interest! I have explained in my answer to another question that the prohibition is very much a moral issue, and that it is closely related to the concept of khilafah or stewardship. I further explained that money lending and financing belong to two entirely different spheres; one is charity, pure and simple, and the other is business. The repercussions of this bifurcation range far and wide, and shape much of what is unique about Islamic notions concerning economy and society. Equity investing offers Muslims the opportunity to profit, not by lending at a guaranteed rate of return, but by sharing in ownership, and thus committing to share in the risks associated with ownership. Such a commitment is clearly in consonance with the concept of stewardship, and this, more than anything else, explains how the Islamic prohibition against interest is as much a moral matter as it is a legal one. So, when your Islamic bank arranges for you to have a new car, or a new home, it will do so as your partner. And that means that it will be concerned about you and the business it will be doing with you. This factor, alone, when multiplied by the number of times the Islamic bank does business with someone, whether an individual or a business or an institution, will make a great difference in the way the economy operates. In recent decades, Muslim economists have modelled interest-free institutions and economies. You may want to read the work of Dr. Umar Chapra on the subject.

Short Term Speculation (Day Trading)

Q: Is there an area where buying and selling stock, even if it is acceptable stock, when it becomes like gambling? Especially when it is short-term speculation. If it is, then where is the dividing line? And is day trading allowed by the Shari'ah in the qualifying stocks?

A: There is a well known hadith of the Prophet, upon him be peace, which is also an important legal maxim. It goes like this: "Verily, actions are but by intentions." Now, for reasons related to the concept of khilafah, or stewardship, Islamic law views investments made on the stock market as informed commitments to responsible ownership. Day-trading, however, entails no such commitment. Rather, the purpose is to move in quickly and then to move out just as quickly, taking along whatever profits may accrue. Most day-trading is accomplished in the space of a few hours, as day-traders speculate on rising prices, hoping to sell before prices drop. And certainly, the intention of day traders is not to commit to responsible ownership. On the contrary, their intention from the outset is to sell. They monitor the price fluctuations and they sell as soon as they have made whatever they consider to be acceptable profits. When this is the intention, then whether they take a few hours to liquidate their positions, or a few days, or even a few weeks, they are clearly not committing to responsible ownership; and their actions are clearly contrary to Shari`ah teachings. On the other hand, someone who buys stock with the intention of committing to responsible ownership, but then for whatever reason is forced to reconsider his/her position, will not be the same as a day trader even if s/he holds the stock for only a short time. So, in this matter, as in so many legal matters, it is the intention that is the dividing line.

Understanding Different Rulings

Q: How does one goes about understanding the ruling of the different schools of thought (madhaahib) when so few people (in my world) know about the subject of finance?

A: This is a very good question. In fact, there are very few people qualified to help out in these matters at the present time. This is why Islamic financial institutions, if they are serious about Shari`ah compliance, will be sure to appoint Shari`ah Supervisory Boards. My advice to individual Muslim investors is that they invest with Islamic mutual funds having reputable Shari`ah Supervisory Boards. That way, every aspect of their investing will be sure to comply with Shari`ah teachings. If you are unsure as to whether or not such Islamic mutual funds are available to you in your country, I will suggest that you contact failaka.com, or search the internet for Islamic financial news. As the demand for Shari`ah compliant investment products among Muslim consumers grows, it will only be a matter of time before supply catches up.

Shariah Board Scholars

Q: Who are the scholars of the shari'ah board. What are their orientations, especially when it comes to interpreting the different schools of thought?

A: The scholars of the Dow Jones Islamic Market Index Shari`ah Board are featured, with their bios, at the DJIMI website. Obviously, they are a group of very accomplished scholars. With regard to their legal orientation, the members of the Shari`ah Board represent nearly all of the major schools of Islamic jurisprudence; and they are certainly at home with the teachings of all the different classical and modern schools of Islamic legal thought. More importantly, however, they base their scholarship on the teachings of the Qur'an and the Sunnah; and all of them have published important studies on these subjects. Of particular relevance to the DJIMI, however, is their membership on the Shari`ah Supervisory Boards of major Islamic mutual funds. Finally, you may also note that they come from all over the world.

Contract Components

Q: I asked previously and received no reply what are the essential components to a contract according to the different madhhabs? Also, some say that the offer and acceptance element of the contract is not present if you are a shareholder because you have a very limited say. is this accurate?

A: The classical jurists are in agreement that every legal contract is composed of a pillar and four fundamental elements. The pillar of every contract is an offer and its acceptance. Thereafter, the contract is composed of four fundamental elements; 1. The expression of the intention to transact, the parties to the transaction, the subject of the transaction, and the purpose of the transaction. All the legal schools are in agreement on this; though they may differ on some of the details.

The answer to the second part of the question is that it is not accurate to say that because a shareholder has very little say, the element of offer and acceptance is not present. These are two separate matters, and the one has no bearing on the other. I hope that this will have become clear from my answer to the question about ijab and qabul.

Chance and the Almighty

Q: First, Praise be to Allah for this course, the designers and instructors of it. I pray Allah continue to bless each of you. My question pertains to the interpretation of verses 3:130 and 3:132, not to be argumentative or dogmatic, but because the verses were used in the lessons.

Since Allah leaves nothing to "chance," and with Him there is no such thing as "chance," wouldn't a better phrase used in those verses be "...But heed Allah so that you might really become successful," and "Obey Allah and the Prophet so that you will be shown mercy."? Is "in the chance that" implied in some way in the Arabic? I read Qur'anic Arabic a little, but I am still learning. The question may be off the point of the lesson, but I do wish you would answer.

A: The problem with interpreting the words of the Eternal is that we are limited by our temporal perceptions. This is more a matter of theology than of finance, but I'll attempt to clarify what I mean. The word used here in the Qur'an is "la`alla" which is used in expectation of a thing hoped for or feared. It means either hope or caution, and may be translated as "maybe" or "perhaps" or "in the chance that." In relation to the Almighty such concepts are meaningless... because, yes, Allah leaves nothing to chance. But Allah has left free will and choice to humankind. Thus, the element of chance comes from the doer, the human element, not from the Almighty. So, the meaning of these verses in the Qur'an is that if you, humankind, are heedful of Allah's commandments, you have a chance to become successful.

Supermarkets and Leasing

Q: You have detailed the screening process for investing in the equity market. What about Supermarkets Companies.... they do sell haram meat including pork and sell wine. Therefore would these be excluded or the profits be regarded as a small percentage of their income and therefore acceptable.

Secondly, a slightly varied form of investment. Suppose I own a property, can I rent it out to a conventional Bank or a Supermarket?

A: The primary business of supermarkets is the sale of groceries. Even so, the sale of wine and beer, and of pork and pork products, accounts for a significant part of their income. It is for this reason that supermarkets will not make an acceptable Islamic investment. On the other hand, a gas station with a small market attached to it, one in which beer and wine are sold, may become an acceptable investment because the primary business is the sale of gasoline, and the revenues from beer and wine are minimal in comparison. Nonetheless, every effort must be made to purify your profits from the beer and wine business. If you own the gas station as a franchise, then you may have the right to exclude the sale of beer and wine, and sell only soft drinks. This will be the best situation. If not, then you will be responsible for purifying the impure income by deducting it and distributing it to the poor and needy, as we explained in Lesson Six. The same will be true if you buy stock in such a business.

The answer to your other question is that it is not lawful from a Shari`ah perspective to lease property to a conventional bank or a supermarket or to any other concern whose primary business is prohibited. If, however, you lease the property to a concern (like a gas station) whose primary business is acceptable, but which derives additional income from the sale of prohibited items, like beer, then such a lease will be acceptable; and the sin will be the responsibility of the one who commits it.

Funds for Retirement

Q: is it okay to put money away for retirement? if so, do you recommend any specific type of funds? sister ayesha

A: Yes, it is OK to put money away for retirement. In today's world, where the extended family system is the exception rather than the rule, it is important that people provide for their retirement years. It's fine to trust in Allah. But the Qur'an tells us that once we have decided on a course of action, then we should trust in Allah. The best sort of funds for retirement investments are Islamic funds based on the DJIMI. These are good for the reason that they include only Shari`ah compliant stocks, and are broad based and diversified, and therefore likely to remain stable and profitable. Be sure, however, that the fund you invest in has a Shari`ah Supervisory Board to monitor its holdings, ensure that its cash balances remain minimal, watch over the deduction of impure income from dividends and other sources, represent your concerns to corporate management, and see to the distribution of impure earnings among the poor and needy.

Is This Murabahah?

Q: Is the following transaction classified as Murabahah? If not, is it permissible? I invest a certain sum of money in a company to procure certain raw materials for a fixed rate of return and for a turnaround time of one month. The capital gets re-invested every month and I receive the income monthly as well.

A: While murabahah is a form of inventory financing, the form you suggest in your question is not murabahah. Please turn to Lesson Five: Islamic Financing and Partnerships, and read the section there entitled: Asset-backed Financing. Without knowing the details of the arrangement you outline in your question, it appears to me, from your statement that the rate of return on your investment is fixed, that the arrangement is essentially a loan. From your readings in Lessons One and Two of the course, it should be clear to you that to profit from a loan is riba and clearly prohibited by the Shari`ah.

Publishing Investment Criteria

Q: In the quiz for the lesson called What is Islamic Investment I have answered question number 8 as True, (a. true), and my answer was wrong (only one wrong in ten questions; I have answered the rest correctly.) Then I have reviewed my wrong answer, the explanation was that "Currently, funds claiming to be Islamic are not required to prove that they are Shari'ah compliant. Many do not employ the stringent criteria of Shari'ah compliancy screens." But this answer is based on the current practice in Islamic Funds. But the question was not about what currently Funds are doing, I thought the question was about what Shari`ah requires them to do. My question is that: Although currently Islamic Funds are not required to report the criteria they use for selecting investments, aren't they wrong from Shari`ah point of view? I mean, does the Shari`ah not require them to report their criteria to be checked for Shari`ah-Compliance?

A: Yes, from a Shari`ah point of view, if Islamic mutual funds do not report the criteria they use for selecting investments, they are wrong. This does not necessarily mean that it is unlawful to invest in such funds, but it would be a mistake to do so because you can not be sure that their holdings (investments in stocks) are halal. Generally speaking, if a mutual fund has a Shari`ah Supervisory Board, then the investor may rest assured that the fund’s management is committed to ensuring Shari`ah compliance. Even so, it will be best if the Islamic mutual fund publishes its criteria. Even better is if the fund also regularly publishes the reports of its Shari`ah Supervisory Board. With the facilities available through the internet, Islamic funds have the capability of providing their investors with immediate access to their accounts, and to every pertinent piece of information about the fund, its goals, its objectives, its management, its policies, its Shari`ah guidelines, and so on. Funds that provide such services to their investors will definitely hold a competitive edge over funds that do not. In the near future I expect that several Islamic funds will be providing these services to their investors.

Shari`ah Screens

Q (1): If you can, can you please explain to me how did the board of Shari`ah derive the debt/asset ratio, which is 30%, as a criteria to determine whether the company is an Islamic investment?

Q (2): As we know, there are three additional shariah compliance screens imposed by DJIM on any company meeting the primary business requirement, such as its total debt and account receivables do not exceed 33% and 45% respectively of its total assets and its interest income doesn't exceed 5% of its revenues. my question are how these criteria are determined, what are the rationales behind such barometers?. Don't you think 33% or 45% is too much or too less? How are you sure that those percentages are optimal barometers?

Q (3): What is the rational for excluding businesses from the DJIM which have more than 33% debt or accounts receivable of less than 45%?

A: As these three questions concern the same subject, I will attempt to answer all of them together. To begin with, however, four important points need to be kept in mind. Firstly, that the screens developed by our scholars are interim tolerance parameters, or preliminary attempts to deal with issues of interest as these effect corporations and should in no way be considered the final word on any of these matters. Secondly, that these apply only to non-Muslim owned/operated companies. Thirdly, that this is not to be understood as an endorsement of these corporate practices. And, fourthly, that all impermissible income must be calculated and cleansed. Then, with these points in mind, students are directed to Lesson Four: Shari`ah Aspects of Islamic Finance, and then to the section entitled: Investment Guidelines for Private Equity.

So, then, in answer to the question above at Q (2)… "How are you sure that those percentages are optimal barometers?" I must refer the questioner to the first preliminary point above, i.e., that these should in no way be understood as the final word on the matter. This is because these ratios are the results of ijtihad or effort expended by qualified scholars of fiqh in disciplined academic research. As you know, recourse may be had to ijtihad when there are no texts of direct relevance from the Qur’an or the Sunnah to indicate a Shari`ah ruling on a particular issue. Under such circumstances, it was the instruction of the Prophet, upon him be peace, to "exercise your learned opinion," or use ijtihad to arrive at a ruling. The rules governing the practice of ijtihad, the qualifications for practicing it, and the methodologies to be applied were developed by the jurists of the classical period. Then, within the limits of those rules, contemporary Islamic jurists have practiced ijtihad and arrived at the guidelines or screens for Shari`ah compliance of equities.

It was explained in Lesson One that nearly all modern corporations are involved to one degree or another in interest. Now, remember from the four preliminary points listed above that such interest would not be tolerated in a Muslim owned/operated company, and that all income from interest must be calculated and cleansed (See Lesson Six for how this may be calculated.) In order to place a limit on the amount of interest that may be tolerated in an Islamically-acceptable investment, scholars turned to ijtihad because there are no clear guidelines on the subject in the Qur’an or the Sunnah. Rather, they combed the texts of these revelational sources for something that might be considered of relevance, even if that something was mentioned in a different context. This is for the reason that evidence derived from the Qur’an or the Sunnah is stronger than the evidence of reason alone. This is a well-established legal principle; and this is why certain jurists, Abu Hanifah for example, held evidence from even a weak hadith to be more valid than the evidence of reason (qiyas) alone.

So, it is a clear legal principle that an insignificant amount of impurity will not cause, for example, an entire garment to be considered impure, or an entire water well. The same is true in regard to most transactions. If the basic elements of the transaction are valid from a Shari`ah standpoint, then a slight degree of impurity will not cancel the deal. But measures will have to be taken to rid the deal of the "impure" or incorrect element. Now, there is a hadith in which the Prophet of Allah, upon him be peace, speaks in terms of one third of something as "plenty" or, to use the American vernacular, "a lot." Anything less than that amount, less than one third, is spoken of as "trifling," or insignificant. So, even though this particular hadith was narrated in regard to an unrelated matter, it is nonetheless relevant; and it is evidence from a revelational source, and thus stronger evidence than reason alone. So the connection made by our contemporary scholars is that a company’s interest-based loans may be considered insignificant if they total less than one third of that company’s total assets. This, then, is the basis for one of the screens used by Islamic funds (and by the Dow Jones Islamic Market Indexes).

Another of the screens prescribed by our scholars is that interest-based, non-operating income must be less than five percent of revenues. Now, it should be understood that the income of which we speak here is incidental income, or income separate of the income derived from the primary business of the company. The way this income comes about is that when companies receive payments for goods and services, they may not always be able to spend all of the money, and a cash reserve will begin to accumulate. Then, whether these reserves sit in bank accounts, or whether they are invested, short term, in interest-earning instruments like CDs, they will earn interest. It is this interest that we are concerned with. If it amounts to less than 5% of the company’s revenues, this too may be considered negligible. But, it must be calculated and cleansed. Fortunately, this sort of income is easily traced on the balance sheets of corporations, and the matter of cleansing is relatively simple. (Again, see Lesson Six for instructions on how this may be accomplished.)

Finally, in regard to the screen on accounts receivable, the Shari`ah allows investing in shares of companies in which the primary business activity is deemed lawful if the accounts receivable do not represent the majority (more than 50%) of the total assets. Thus, if the primary business of the company is halal, and the sale methodology for obtaining corporate revenue is through installment payments, which may be deemed incidental or subordinate if the accounts receivable do not exceed 45% percent of the total assets, then investment in such a company will be permissible. It should be noted in this regard that if the receivables total more than fifty percent, the majority of the company’s dealings will actually be in money, and not in goods, services, and assets.

This position is consistent with the established and recognized Islamic juristic rule stating that what is not permitted independently may be permitted subordinately, cited in many contemporary fatwas. Therefore, if the accounts receivable do not exceed 45% of the total assets, consistent with the rule of majority determining ultimate judgment, an Islamic investor will not be prohibited from purchasing shares in such a company. .

Voicing Muslim Concerns to Management

Q: It has been stressed a number of times the that "the Muslim investor will be morally bound to inform management that s/he cannot approve of such transactions." Q : How should a Muslim investor structure a letter to satisfy such a criteria and what kind of items and "arguments" should he put forward to the management/investor relations of a company so that the letter satisfies the Islamic requirement and is also effective?

A: You may want to begin such a letter by addressing it to the company’s CEO (Chief Executive Officer) and then introducing yourself as a shareholder and practicing Muslim whose religious principles dictate that you invest your in accordance with Shari`ah guidelines. Then you may want to mention that the Islamic investment sector, while a relatively new phenomenon, represents an important and growing market. In order to back up your claim, you might then mention how Muslim investment capital is estimated to total between $80 and $150 billion, how Islamic mutual funds are beginning to proliferate, and how Dow Jones and Company launched an index to track the performance of stocks found acceptable to Islamic teachings. This should suffice as an introduction, but you may want to add more, or to these points or others in greater detail. Thereafter, you may want to say something about Islam’s prohibition of riba, and how this equates to interest on loans. It would then be appropriate to explain something about the financial screens developed by Muslim scholars. Then, if the company’s debt/asset ratio is nearing the limits, or if its non-operating interest income percentage is high, you may want to tell the CEO that 1. these practices (i.e., of borrowing on interest, and deriving income from interest-bearing instruments) are repugnant to Islam, and 2. that the company is coming close to the limits of disqualification, and 3. that the company should find other means of financing and investing cash reserves. Then you might want to close the letter by thanking the CEO for giving his/her attention to this issue. Please remember that a polite letter is an effective letter, and that in writing this letter you are acting as an ambassador for all Muslim investors.

A final note: If you know that the company you have invested in has a poor record with regard to labor, or the third world, or the environment, or on any other issue of moral, ethical, or religious concern, then you may want to voice your opinions on these matters as well.

The Riba of Excess and Deferment

Q: "Owing to this prohibition, then, one may not sell high quality wheat for a larger quantity of low quality wheat". What if the money value of the high quality wheat and the larger quantity of lower quality wheat is similar or the same? Re: riba of deferment. "Owing to this prohibition, then, one may not sell low quality wheat now for high quality wheat later". Am I to understand that the person who is bartering the high quality wheat is engaging in riba of deferment? What modern business transactions will come under the actions of riba of excess and deferment?

A: In regard to your first question, what if the money value of the high quality wheat and the larger quantity of lower quality is similar? The answer here is that the money value can be the same, or less, or greater; the transaction is still riba and, as such, is strictly prohibited. Why? The answer to that is because wheat is one of the six commodities expressly mentioned in the hadith we studied in Lesson Two: "Exchange gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt, [as long as you do so by exchanging] like for like, equal for equal, and hand to hand." Thus, the only way wheat may lawfully be exchanged for wheat is like for like, i.e., the quality must be similar; and equal for equal, i.e., in similar quantities. Please return to the third section (Riba in the Sunnah) of that lesson for an analysis of the hadith.

Let’s look at your second question: "Am I to understand that the person who is bartering (for) the high quality wheat is engaging in riba of deferment?" Yes, when someone attempts to sell low quality wheat now for high quality wheat later, that person is dealing in riba. The example here is given to show how (and why) such a deferment might take place.

Let me explain in a little more detail. A farmer has low quality wheat, and is desirous of making a profit from it. The lawful way for the farmer to profit is by means of a sale. But the farmer knows that he can increase his profits if the wheat he sells is of better quality. So he goes to another farmer, one who he knows is presently in need, but who has nothing at the moment to sell. What the needy farmer does have, however, is a field of high quality wheat that is still not ready for harvesting. So, the first farmer, knowing the other farmer’s need, offers him his low quality wheat right then and there. And, in return, the deal he makes with the needy farmer is that when the high quality wheat is ready for harvest, "later", he will take it. In this manner, the first farmer obtains better quality wheat that can be sold at a higher price. And the needy farmer receives something with which to see to his immediate needs (i.e., he can make money now from the sale of the low quality wheat). But, while this may seem reasonable, it is actually an unacceptable situation; firstly because the exchange described is expressly prohibited in the Sunnah, and secondly because the deal is a morally dubious one. You will notice that I added, in parentheses, the word "for" to your question. This is to clarify that the first farmer, the one who is dealing "for" the high quality wheat, is engaging in riba. I hope it is clear to you that the deal offered by the first farmer to the needy farmer is in fact a form of financial exploitation. In the first part of this lesson, Sections One and Two, it was made clear that riba is viewed by the Qur'an as an injustice, an economic evil, an impediment to spiritual growth, and a threat to the welfare of society. The same is true of the Sunnah. For, in the deal I have described, the first farmer has clearly taken advantage of the needy farmer, giving him something of less value now in exchange for something of greater value later.

Now, to the last part of your question: what is the relevance of the riba of deferment and the riba of excess to modern transactions? In Section Three of Lesson Two I wrote that all of the major schools of jurisprudence were agreed on the point that the prohibition of riba applied to loans, to barter, to sales, and to every transaction involving an exchange of countervalues. In Section Four of that lesson, Riba by Definition and its Significance for Us, this matter is explained in greater detail.

Understanding Riba and Gharar

Q: In the topic of Gharar, could it be safe to say that investing in the stock market is Gharar? There is a certain amount of risk involved in investing in the stock market without any assured returns so does this qualify as Gharar?

A: In section five of Lesson Two I wrote:

"Obviously, if we equate gharar to uncertainty and risk, then these are things which occur in the normal course of doing business. When we look to the examples from the Sunnah, and to the definitions and examples given by the jurists, a more coherent picture emerges. Clearly, the prohibition is related to the Shari`ah's insistence on fair and ethical dealings, and on its lack of tolerance for unjustified enrichment."

Now, investing in the stock market, through the purchase of stocks, is not gharar. When you buy stocks, you buy them at a certain price, and in return you receive a share of ownership in a company. Each of the elements in this transaction is clear and unambiguous. So there is no gharar. But when people think of the stock market, they always think of prices rising and falling, and of people making, or losing, fortunes! Unfortunately, when they think in these terms, they lose sight of what is really going on. The stock market is no different from any other market; at least not in its essentials. But, yes, it is more sensational. So, if you buy a car today, and sell it three or four years from now, there will be a difference in the "market value" of your car. Likewise, when you buy a home, and then sell it twenty years later. Or when you buy a corner grocery store. Or a franchise. The market will dictate the price. But the important thing is that the contract of sale will be straightforward and without ambiguity. If it is, the element of gharar will be absent and the deal will be lawful.

Leasing from a Conventional Financial Institution

Q: as salaamu alaikum: i would like to know if it is halal to lease from a kufar financial institution?

A: If a lease can be structured in a way that conforms with Shari`ah principles (as in an ijarah contract), it will be lawful, regardless of whether the lease originates from a conventional financial institution or otherwise. Many Islamic banks, investors, and financial institutions participate in leasing operations that comply with Shari`ah principles and yet involve conventional financial institutions.

Dividing Profits from Mudarabah

Q: Assalamu alaykum, Is there any right for a mudarib to share the incremental value of the rabbul maal's assets at the time of liquidation? Wassalam, Salim M Basalamah

A: The division of profits in a mudarabah is proportional rather than fixed. This being the case, it is possible to specify that the investor's share will be a certain percentage of the returns, if these materialize, or anything above 12% of the returns, etc. Since the investor bears the risk of loss, s/he cannot therefore stipulate the return of invested capital. But if assets have appreciated in value, then at the time of liquidation this increase may be calculated as a part of the gross returns from the mudarabah operations. Moreover, the original contract may contain a clause concerning the distribution of the value of the expected appreciation, specifying that a proportional share may go to the mudarib.

Losses in Mudarabah

Q: Assalamu Alaykoom, If in mudarabah partnership, mudarib has had some losses and in another transaction he reaps profit. This means that profit should be taken to offset the losses first and the remaining profit, if any, can be distributed to all the parties according to the pre agreed proportion. My question is which losses should be offset? Losses in capital owned by robbul maal or loss in mudarib's effort?

A: There appear to be a number of points in this question which require clarification. To begin with, a mudarabah differs substantially from a partnership, which is termed in Islamic law a musharakah and may take a number of different forms. Nonetheless, a mudarabah might be termed a form of what is commonly known as a silent partnership. Secondly, the question speaks of "another transaction" without specifying what sort of transaction, and whether or not it was a part of the mudarabah contract. The content of the second sentence, i.e., that "profit should be taken to offset the losses first and the remaining profit, if any, can be distributed to all the parties according to the pre agreed proportion" is unclear. Is the proposed distribution of profits from one transaction meant to offset losses from the other transaction? Or is the intent that the revenues from the profitable mudarabah transaction should be used first to offset expenses incurred in the mudarabah operation, and that whatever revenue remains will be accounted profits? The final part of the question, however, regardless of what preceded it, may be answered as follows: In a classical mudarabah, the capital investment comes from the rabb ul mal, or investor, while the work comes from the mudarib or agent-manager. Under the terms of the mudarabah contract, the investor is liable for all losses, to the extent of his/her capital share. The agent-manager, however, will bear no loss other than the loss of time and effort.

Employee Stock Options

Q: What is the Islamic view on employee stock options?

A: This is one which many Muslims puzzle over, and with good reason. To begin with, the term "options" often leads to confusion because most Muslims recognize it as perhaps having to do with the options market; and the buying and selling of options is clearly prohibited owing to the element of uncertainty, or gharar, at the time of contracting. (For a detailed discussion of gharar, see: "Lesson Two, Riba and Gharar").

Secondly, people may have questions about the way a typical corporate stock option actually works. I'll outline the general idea below:

In order to reward performance, or to motivate employees to work harder, the company will offer an employee the option of 100 shares at a set price (strike price) which is usually not the same as the market price. Generally, the offer will be valid for a certain period of time (exercise period), a number of years or a number of days from the time an employee leaves the company.

The employee can:

1. Do nothing - the employee pays nothing and receives nothing.

2. Exercise the option by buying the shares and selling them at market value, gaining the difference, less commissions, in cash.

3. Buy all shares at the strike price, and keep them for the future.

4. Sell enough of the shares at market price to and keep the rest of the shares for the future.

Under these circumstances, the "option" is actually an offer, because the price is fixed. The word "option" refers to the fact that the company has given its employee a choice, or choices, either to buy the stock and hold it, or to sell it, or a combination of the two. Under these circumstances there is nothing wrong with an employee opting to buy the stock... but only on condition that the company is Shari`ah compliant or, in other words, satisfies certain financial criteria. Chief among these criteria is that the company must be engaged in a primary business that is halal... companies engaged in riba as their primary business, like most companies in the financial sector, are definitely out of bounds for Muslim investors. The same is true of companies that produce or sell alcohol, tobacco, pork products, so-called "adult entertainment", and so on. So a Muslim investor must be careful about where his/her investment funds are placed. There are also secondary considerations, some of which are concerned with the extent to which a company is involved in riba, through corporate borrowing, or non-operating interest income, and some of which are concerned with accounts recievable. These are refered to as secondary Shari`ah screens; and the Shari`ah Supervisory Boards (SSB) of most Islamic funds have given opinions regarding these screens. Many Islamic funds have adopted the criteria set by the SSB of the Dow Jones Islamic Market Index; because those screens are the most stringent and also the most closely and accurately monitored.

Then, the short answer to the question of whether or not Muslims may exercise stock options when these are offered to them by the companies they work for is yes. And the reason that this is lawful is that the "option" is actually an offer; when the essential elements of any sale are an offer (ijab) and its acceptance (qabul).

Regulating Profits

Question: Is there any restriction in the extent of profits we can take from our customers in halal business transactions in order not to violate Islamic law? I heard it must be less than 30%, is it true? what is the reason? Y 5/15

Answer: Generally speaking, profits may be taken to the extent that the market will allow. Nonetheless, if prices are inflated by artificial means, through exploitation of advantages, or through monopolies, then Islamic law allows for the intervention of the market authorities. Likewise, if profit margins are so high as to be detrimental to the welfare of society, the market authorities will have the right to intervene. The classical jurists of Islam have discussed these subjects, and their opinions have guided modern Islamic financial institutions in setting rates and margins of profit. Earlier this year, a thorough study of the subject by Dr. Shamsiah Mohamad was published by the Dar al Nafais in Jordan (in Arabic).

401K Plans for Muslims

Question: What is the best way to invest in a 401(k) plan. Are we allowed to invest if Islamic Mutual Funds are not listed on the Mutual Funds list. How should we convince the Employer to have Islamic Mutuals Funds. R Anwaar

ANSWER: We are not in the best position to answer the first part of your question as we lack the proper financial advisory credentials. If enough company employees request Shari'ah compliant investment vehicles (resulting in respectable amount of assets for Shari'ah permissible management), then the employer will at least take notice of the demands. The key issue is for Muslim employees to begin making these demands, and then to point to the direction of, say, the Dow Jones Islamic Market Index as a universe of Shari'ah compliant companies from which halal investment vehicles (such as Islamic Mutual Funds) may be created. And Allah knows best.

401K Plan

Q: My question is about taking a loan against my vested account balance. I've been told that any money borrowed must be repaid with interest. Essentially, I must repay myself with interest. I've made the argument with the plan administrators that since the account does not accumulate at some pre-determined fixed rate of interest (there is both chance of gain and loss) why should I be compelled to repay my loan with interest. They think that I should be glad to repay myself with interest and thereby protect myself from adverse market conditions, etc. I've explained my position with regards to Islam and they have still refused to honor my request for an interest free loan. What advice can you offer me? I could really use the loan to repair a house that I purchased interest-free.

A: The situation you describe is an interesting one as it gives rises to a number of important issues. My first reaction to your question was to direct you to seek the advice of a financial planner. But, in fact, your case is one which may be significant for many Muslims in similar situations. 401K funds are structured rigidly and the rules which regulate them are strict. The rules in regard to what you suggest demand that you pay yourself a market-based interest rate on whatever you borrow. The reason that your company officials appear unwilling to work with you on the matter is that they are unwilling to break those rules; and they can hardly be faulted for that. Even so, the issue at stake here is one that impacts a growing segment of the working population here in the US and, ideally, Muslims should be allowed to loan themselves money from their own 401k accounts without interest. Obviously, before that can happen the laws regulating the 401k funds will have to be changed. One way that this can happen is by means of what is known as a Private Letter Ruling. This would have to come from the Internal Revenue Service; and if it were issued, it could be cited by other Muslims as a legal precedent. What I will suggest is that you put your request in writing to your company's plan administrators. Then, when they make their reply to you in writing, you may take the two letters (your request and their reply) and include these in a letter to the Department of Labor (which is in charge of 401k plans). In your letter to the Dept. of Labor, you will need to explain what you want, why you want it, and why you think that it is important for the Dept. of Labor to take action on the matter. Don't expect the issue to be resolved anytime soon, though. These things take time. You may even have to seek legal counsel. But the case is such that you may be able to find a Muslim civil rights group willing to support your effort, or to find you pro bono legal representation. Ultimately, the case will have to go the IRS. I have discussed this with a professional, and he believes the case has merit. And it is Allah who prospers and assists.

Using Interest Income to Pay Interest on Loans

Q: Can riba money be used to pay off a riba loan? If so, would this be considered purification of wealth?

A: It was explained in the section on Purification (Lesson Six, Section Six) that income from interest must be given away, and that… "as a general principle, since the money being distributed represents impure income, it must not be used in a way that will benefit the one distributing it." Then, in accordance with this principle, it should be clear that spending such money to pay one’s bills, regardless of whether these involve interest or not, is simply not acceptable. This is because if you pay your bills with this money, you will benefit from doing so because you will not need to spend of your halal earnings to pay those bills.

For the same reason, if you gift the money is to a charity, it may not be written off for tax purposes because that would benefit you. For the same reason, you should not expect to earn the pleasure of the Almighty by spending such money for charitable purposes. This should explain why money from impure income may not be used to discharge one's Zakah responsibility. Finally, the most that one can hope for in this regard is that by separating the money from one's lawful earnings, and then spending it in charity, one may gain the forgiveness of the Almighty for having earned the money in the manner that it was earned.

Zakah on Employee Stock Options

Q: As a follow-up to Sarah's question on company granted stock options, I'd like to ask about the Zakat that is due on gains received via these options. In certain cases (as with some of the recent IPO's in the tech sector), the compensation achieved from stock options can be huge -dwarfing the other benefits an employee receives (i.e. salary). According to at least one booklet I've read about Zakat calculation, the rate of Zakat is not a uniform 2.5% for every type of asset. In particular, the rate for a windfall is given to be 20%. Given this, would the gains from stock option sales be considered a windfall and therefore be Zakatable at something other than 2.5% ? BTW, I realize that this is not strictly an Islamic investment question. However, it is one whose answer would benefit many people here in the Silicon Valley.

A: At the end of Section Three in Lesson Six, I spoke of the differences of opinion among contemporary scholars in regard to the calculation of Zakah on types of wealth that were unknown in the times of the classical jurists. While the debates of contemporary scholars on these issues may be disconcerting to modern investors, it must be remembered that these issues are new and have yet to receive the attention from jurists that they deserve. As the demand for solutions increases, so will the attention these issues receive from scholars.

Now, with particular reference to the Zakah on gains realized through employee stock options, your observations are astute. It is true that the rate is not uniform for every class of asset. And, yes, it might be possible to identify the returns from such options as windfalls. Some modern scholars have characterized employee stock options as a form of ji`alah or reward for the completion of a specified task or services. As such, they would not fall under the category of a windfall. Another group of contemporary scholars, however, insists that the rate on this type of wealth should equate to the rate on agricultural produce, where the land is exempted. Instead, their position is that Zakah must be paid on the profits earned from one's holdings at the rate of 10% on the net profits earned in a lunar year (or 10.3% per calendar year). Other scholars refine this position somewhat and draw a legal analogy from agricultural produce that has benefited from irrigation, and for which the rate of Zakah is lower, or 5%. I said, in the lesson, that I would not indicate my own preference in these matters, partially at least for the reason that the debates have only just begun. But my advice to you is that you consult with someone you trust who also has knowledge of the subject of Zakah, or with several people, and then decide for yourself what is best. Ultimately, Allah will judge you on the sincerity of your intentions.

Hedging

Q: Why is hedging haram?(Y) 4/29--

A: As a method for protecting a profit position from risk, it is easy to understand why hedging is popular. In conventional finance, risk-hedging takes the form of derivatives, swaps, futures, options, and other risk-shifting devices. The common perception of hedging in Islamic law is that it interferes with one of the law's basic principles, which is that gain accompanies liability for loss, or the link between risk to gain. Moreover, derivatives often contain elements of gharar (discussed in Lesson Two) which clearly render them unacceptable in an Islamic legal framework for the reason that they lead to undue speculation, which is the practical equivalent of gambling. Even so, hedging, in the sense of risk management, is not prohibited outright because the management of risk may take many forms, from portfolio diversification to leveraging equity capital through Islamically-acceptable leases.

The Second Edition of Unlawful Gain

Q: In the second lesson, there is a reference to Nabil A. Saleh's Unlawful Gain and Legitimate Profit in Islam, London 1992. This is the second edition. Can you tell me whether it is substantially improved from or better than the first edition? I ask because I own a copy of the first edition. Thank you. Y

A: The only copy I have is of the second edition and so I am unable to compare. Likewise, there is nothing in the Introduction to indicate any major changes or revisions. In any case, the book is an extremely informative one and deals with material in ways that easily illustrate difficult and complex concepts. For serious students of Islamic finance, it is an essential work.

People of the Book in the DJIMI

Q: What is the consensus about investing in Israeli companies, or companies that invest in Israel? Should those not be excluded by the Shari`ah screens like companies that deal with Alcohol, pork, banks, etc...? Salam R Tarek

A: To our knowledge there is no Shari'ah dialogue involving investment prohibition against Israeli companies or companies that invest in Israel. The Shari'ah screens do not take political background/identity or religious affiliation into account. The Prophet himself, upon him be peace, is known to have transacted with people of other faiths. Following his example, Muslims from that time onwards have transacted with non-Muslim individuals, institutions, companies, and governments. In the Qur’an Muslims are taught to abide by their contractual agreements:

O you who believe! Fulfill all contracts (5:1).

The command in this verse has been characterized by the classical scholars of law as unrestricted and comprehensive, such that it applies to all valid contracts, treaties, and covenants. Moreover, this verse is followed by a further teaching on the subject:

Do not allow your dislike of people who would prevent you from [visiting] the Sacred Mosque to lead you to transgress. Rather help one another in promoting virtue and heedfulness. Do not help one another to sin and enmity. And heed Allah… (5:2)

The Jews and the Christians are accorded special status in the Qur’an which refers to them as People of the Book in recognition of their monotheism and respect for revelation. See Sura Baqarah, (2: 62).

Finally, the Dow Jones Islamic Market Index is based on criteria from the Shari`ah of Islam for the purpose of providing Muslim investors with a measure of the Shari`ah-compliant market. Considerations related to politics, culture, history, and the like are not relevant to the Index.

Having said all of this, though, it is important to note the difference between an index and a fund. The purpose of an index is to measure the market and provide a performance benchmark. A fund, however, is a different matter because it invests the money of Muslims and puts it to use. Funds have the ability to embargo companies, by screening them out of their portfolios, or to engage them, by investing in those companies and then using corporate democracy to leverage their points of view. By means of engagement strategies, a great deal can be accomplished. This is a lengthy subject, but one that deserves further study.

Investing in non-compliant companies

Q: My question is, even though certain companies, ie CitiBank, GE, AOL become un-investable in due to the Shariah screen, dont you think that if Muslims are going to change the way these companies do business, then they should become shareholders and help steer the direction of companies that do conduct Haraam activities. Also, don't you think that by investing in companies like GE, and Disney etc etc, Muslims can help the Ummah because we all know what kind of clout these large multi-nationals have over US Foreign policy?

A: I understand your concern, and I agree with your point that participation is required for change. But there are conditions to participation, and these are represented by our Shari`ah screens. The way that non-compliant companies will get the idea is through our investing in the competion, i.e., in companies that are Shari`ah-compliant. As Islamic funds grow in numbers and size, the market is certain to take note. Thus, to begin with, the important thing is to build our foundations, so to speak, in Shari`ah-compliant funds. Thereafter, normal market factors will take over and, Allah willing, corporations will take note and begin to make the necessary adjustments. This is something which will not take place overnight. But the good news is that a beginning is being made, and the future is in your hands!

Pursuing Careers in the Conventional Finance Industry

Question: 5/12-- I am employed in an insurance company (my whole career of 28 years) in the capacity of an M&A analyst and management professional. Is there guidance around the acceptability of this employment --- in context of the exclusion of insurance industry from Shariah acceptable companies? Does my salary have to be purified? If so, how --- your lessons are focused on shareholders, not employees? What if, after so many years and having reached an older age, I am not easily employable at even 30% of my income if I shift industries? SM

Answer: Much the same question was asked of Shaykh Muhammad al Ghazali, may Allah bless his soul, in my presence over twenty years ago. The answer he gave was the answer given by his teacher, Shaykh Hasan al Banna, to someone who had asked the same question.

Allow me to attempt to answer your question by reproducing a summary of that answer. The Shaykh began by explaining that the message of Islam is one that was sent to liberate humanity at the level of both the individual and society, and on the material as well as the spiritual plane. This is clear to anyone who reads the Qur'an and ponders its meanings.

Now, banking and finance (including insurance) are key elements in modern economic life; and economics are at the heart of social justice. Every Muslim understands the importance of justice, and certainly social justice and the equitable distribution of weath are very much a part of the liberating message of Islam. The actual situation of the Muslim Ummah today, however, is far removed from the ideal envisioned for society by Islam.

Obviously, the improvement of the economic situation of Muslims will go a long way toward bettering conditions in general, and toward bringing about the social justice that is emphasized in the Qur'an. Then, it is crucial that Muslims that make every effort to improve their economic situations, in every Muslim country, and in every Muslim minority community as well.

The only way that this can be accomplished is through education, and then through specialized training, and then through years of hard work and dedication; all of that in the name of Allah. Obviously, when the sector in need of improvement is the economy, then Muslims will have to learn everything about it before they can become effective in it. The same is true of every sector in which the Ummah is lagging.

Now, in regard to the economic sector, the Ummah requires people to understand it at the theoretical level and the philosophical, and others to understand and work with it at the practical level. If the economic system is malfunctioning, then we need people to tell us why. And then we need people to help in correcting it, and bringing it into compliance with our religious ideals and principles.

That being the case or, in other words, in view of the Ummah's need for expertise in the fields of finance, economics, accounting, insurance, and banking, no Muslim should hesitate to pursue studies in those fields, or a career, for the reason that the system is presently flawed, or sullied by the element of riba. On the contrary, if a Muslim is concerned, then s/he should undertake to lend a helping hand in bringing about the necessary improvements.

Under the circumstances at present, it would appear to be a fard kifayah, or the sort of obligation that must be borne by the Ummah as a collectivity; such that if some of its members engage in it, then the others will be freed of the responsibility. Therefore, you may certainly follow a career in insurance. In doing so, however, there are several important things for you to remember.

Firstly, you must remember to keep your intentions pure, i.e., you must work for the sake of Allah, and for the improvement of conditions in the Ummah.

Secondly, you must work with the intention of learning as much as you possibly can about your profession.

Thirdly, you must work with the intention of becoming an expert in your field, so that you may share your knowledge and ideas with other Muslims.

And finally, you must continue to study and learn about the Shari`ah perspective on the operations that you are involved in at your place of work. This is so that one day you will be able to contribute to bringing about Shari`ah-based solutions to the financial problems of the Ummah.

Now that, briefly, was what the Shaykh told the questioner.

Over the past twenty years we have been fortunate to have many Muslims excel in the fields of economics and finance, and increasingly, Muslim economists and bankers have been able to outline and then implement Shari`ah compliant models and institutions. Islamic finance has proliferated and prospered, and continues to do so. And now we are witnessing the rise of an Islamic investment sector.

But, obviously, there is still much to be accomplished. The situation in nearly every Muslim country is that the conventional banks and financial institutions are the most important ones. Islamic banking and insurance are still in their infancy, and need the support of a new generation of educated and motivated workers at every level. Therefore, it is all the more important that you learn everything that you can about the field you have chosen for yourself, and that you excel in it, so that through your knowledge and experience you may help to build a new future.

Finally, you are entitled to every cent of the income you derive from your profession; except, of course, what is due in Zakah. But, otherwise, there is no need to "purify" your wages. You have obviously worked long and hard to be qualify for those earnings, and they are your right because your intentions in doing so have been pure.

Companies Dealing in Gold and Silver

Question: The discussion about which kinds of companies Islamic Equity Funds should avoid includes those companies dealing in gold and silver. What is the basis for this? Surely trade in gold and other precious metals/minerals is permissible in Islam?

Answer: Trading in gold and other precious metals/minerals is indeed permissible in Islamic law. Mining and exploration operations are often financed by Islamic banks and financial institutions by means of perfectly acceptable Islamic contracts. Moreover, the DJIMI universe includes several companies involved in the mining of precious metals like gold and silver.

Quick Liquidation of a Position

Q: One of my friend bought 500 stocks for Vrio company for 35 dollars each stock share and the next day some Japanese company bought this Vrio company and the stock price shot up to 65 dollars and he decided to sell it. Is this allowed or not allowed according to Sharia'h? Please email the answer.

A: The decision to sell was certainly warranted from a business standpoint and there is nothing wrong with it from a religious perspective either. I have described a Muslim investor's purchase of stock as a responsible commitment to ownership; and I have explained that this is why the practice of day-trading is inconsistent with Shari`ah principles. (Please see my answer to an earlier on day-trading above) In the situation you describe here, however, there is no evidence of day-trading, or a day-trading mentality. Rather, something occurred, and the investor took advantage of the situation. Yes, the investor might have held on to the stock of the new company. But s/he originally purchased the stock because s/he saw value in the first company. The high point of that value may have been, in the estimation of the investor, its buyout by another company and the resulting rise in the price of its stock. This may or may not have been a correct assessment of the situation; but it was purely a business decision. The important thing is that nothing in the situation you describe even resembles an intention on the part of the investor to gamble on the direction of the market. Instead, all I can see is that a good investment was made, and the investor decided that it was a good time to profit from it. And Allah knows best

Small Investors can Make a Difference

Q: It seems to me that the best way a Muslim can object to the way the company might be dealing with Riba is not to hold any of its shares. Furthermore acquiring shares of a company with the intention of objecting to its practice does not seem logical because as a very small shareholder any protest will just be ignored and would not cause the company to alter the way it does business.

Any comments will be appreciated.

A: Of course, you are right in supposing that the voice of a small shareholder is not going to make much difference to management. And you are also right in thinking that a good way to object to a company's financial practices is not to hold any of its shares. But if a company is found to be Shari`ah-compliant, i.e., its primary business is halal, and it passes our financial screens, then if you invest in an Islamic mutual fund which holds shares in the company, and the company derives a small percentage of its non-operating interest from riba-based products, you are in an excellent position to object and to making your objections heard. This is because your investment, modest or otherwise, will be added to the investments of many others; and there is strength in numbers. Then, with your Islamic fund holding a sizeable block of shares, the chances that management will listen to your grievances or observations are much greater.

The Residual Value of Leased Assets

Q: I read that Islamic Banks usually make transfer of ownership just an option to sell at the end of a lease. Does this mean that during the commencement of the contract, Islamic Banks retain the owmnership indefinitely and include an option to sell only if they feel it is rewarding?

What if during the commencement of the contract the Islamic bank is certain that it is investing in equipement for a period of 5 years and will definitely sell it at the end of this term, in which case it takes on the shape of a Contract in Suspense. But it merely calls it an OPTION TO SELL instead of DEFFERED SALE although the latter is certainly the only intention by the bank at the time of entering into the contract. Is this not in contravention with the Shariah conditions of contracts?

A: Evidently, you are asking about the ultimate disposition (the residual value) of assets that are leased out in an ijarah contract. The operative principle in the matter is that Islamic law prohibits the conmingling of two separate transactions under a single contract. Likewise, the Shari`ah specifies that the asset will be the property of the lessor when the lease period comes to an end. Thus, when Islamic banks enter into ijarah contracts with their clients, they will not include a clause to the effect that the assets will be sold or gifted to the lessee. Instead, they will unilaterally promise to enter into a contract with the lessee at a later date. Such a promise, according to the classical jurists, is binding only on the party that makes it. Thus, the option in the matter is left to the lessee; if the lessee so chooses, he may enter into a contract with the bank for the sale or gift of the asset. If, on the other hand, he chooses not to, then that is his prerogative.

Termination of a Mudarabah Contract

Q: I am a bit confused about the Termination of a Mudarabah contract. On one hand, the lesson indicates that, according to general usuli principles, no minimum limit can be placed on the cancellation of such a contract. However, later on the in the lesson, there is an indication that, based on the complexity of today's financing arrangements, the rabb-ul-mal and mudarib can agree that the contract cannot be cancelled during a specified period.

I am having difficulty distinguishing between the two situations above, one of which is indicated to be haram (establishing a minimum time limit for the mudarabah contract) and one which is indicated to be halal (establishing a specified period during which the contract cannot be terminated). Could the difference between these two situations be elaborated upon?

A: In fact, the classical jurists differed on the question of termination. The Hanafi and Hanbali schools were of the opinion that the parties to a mudarabah contract could specify its duration, after which time it would automatically come to an end. The Shafii and Maliki schools, however, taught that a mudarabah contract may not be structured in this manner.

In the modern context, it is important that contracting parties have a clear idea of the time element in their enterprises. Then, for this reason, and in light of the opinion of the Hanafi and Hanbali schools, modern Muslim jurists have taken the position that it will be lawful for the two parties to a mudarabah contract to agree to a specific period of time during which neither party shall have the right to terminate the mudarabah.