Monday, March 16, 2009
Wednesday, March 11, 2009
The basic principles which govern the rights and obligations of participants in the stock markets are established from the relevant verses of the holy Quran and from the Sunnah. Here is some important norms of Islamic ethics as are applicable to stock markets. All these norms may form the basis of regulation and legislation relating to stock markets.
1. Freedom to Contract
Islam provides a basic freedom to enter into transactions. The holy Quran says: Allah has made trade lawful.(2:275). Further, no contract is valid if it involves an element of coercion for either of the parties. The holy Quran also says: let there be among you traffic and trade by mutual goodwill (4:29). However, this basic norm does not imply unbridled freedom to contract and may be sacrificed when there is a trade-off with other norms requiring specific injunctions as in the case of the framework for conventional finance highlighted above.
2. Freedom from Al Riba
All forms of contracts and transactions must be free from riba. This implies that there is no reward for time preference and under conditions of zero risk. The question of riba has been addressed in a large body of literature and there is a general consensus about the meaning and implications of riba.
3. Freedom from Al Gharar (Excessive Uncertainty)
All forms of contracts and transactions must be free from excessive gharar. This implies that contracting under conditions of excessive uncertainty is not permissible. Islamic scholars have identified the conditions and highlighted situations that involve excessive uncertainty and consequently, disallow a contract.
4. Freedom from Al-Qimar (gambling) and Al-Maysir (Unearned Income)
As highlighted so well in the study under review, contracting under excessive uncertainty or gharar is akin to gambling (al-qimar). And uninformed speculation in its worst form, is also akin to gambling (al-qimar). The holy Quran and the traditions of the holy prophet explicitly prohibit gains made from games of chance which involve unearned income (al-maysir). Here it may be noted that the term speculation has different connotations. It always involves an attempt to predict the future outcome of an event. But the process may or may not be backed by collection, analysis and interpretation of relevant information. The former case is very much in conformity with Islamic rationality. An Islamic economic unit is required to assume risk after making a proper assessment of risk with the help of information. All business decisions involve speculation in this sense. It is only the gross absence of value-relevant information or conditions of excessive uncertainty that makes speculation akin to a game of chance and hence, forbidden.
5 Freedom from Price Control and Manipulation
Islam envisages a free market where prices are determined by forces of demand and supply. There should be no interference in the price formation process even by the regulators. It may be noted here that while price control and fixation is generally accepted as unIslamic, some scholars, such as, Imam Ibn Taimiya admit of its permissibility. Such permissibility is subject to the condition that price fixation is intended to combat cases of market anomalies caused by impairing the conditions of free competition. It is a requirement that the forces of demand and supply should be genuine and free from any artificial element. Islam therefore, condemns any attempts to influence prices through creating artificial shortage of supply (ihtikar). Similarly, any attempt to bid up the prices by creating artificial demand is considered unethical. Such an action of bidding up the price without an intention to take delivery is termed as najas and is not permissible.
6 Entitlement to Transact at Fair Prices
Prices that are an outcome of free play of forces of demand and supply without any intervention or manipulation are believed to be fair. However, in some instances, pricing is based on a valuation exercise. In such cases the difference between the price at which a transaction is executed and the fair price (as per the opinion of valuation experts) is termed as ghubn. The presence of ghubn makes a transaction unethical.
7 Entitlement to Equal, Adequate and Accurate Information
Islam attaches great importance to the role of information in the market. Release of inaccurate information is forbidden. The concealment of vital information (ghish) also violates the norms of Islamic ethics and according to the traditions of the holy prophet, the informational disadvantaged party at the time of the entering into the contract has the option to annul the contract. The traditions refer to price information in the market as well as other information relevant for valuation of the commodity.
8. Freedom from Darar (Detriment)
This refers to the possibility of a third party being adversely affected by a contract between two parties. If a contract between two parties executed with their mutual consent is detrimental to the interests of a third party, then it may enjoy certain rights and options. A case in point is the pre-emptive right (al-shufa) of a partner in joint ownership. This pre-emptive right may be extended by analogy, to a situation where existing minority shareholders are being adversely affected by any decision of the controlling shareholders, such as, to sell additional stocks to the public, to effect a change in management, asset sale, mergers and acquisitions etc. The list of norms of Islamic ethics stated above is by no means exhaustive. It differs from the norms of mainstream financial ethics significantly - in imposing injunctions against al-riba, al-qimar, and al-maysir.
9. Maslahah Mursalah (Unrestricted Public Interest)
Problems such as above may be resolved in the framework of maslahah mursala or “unrestricted” public interest, which is a valid framework of Islamic legislation. The framework is called “unrestricted” public interest on account of its being undefined by the established rules of Shariah. Maslahah consists of “considerations which secure a benefit or prevent a harm but are, in the mean time, harmonious with the objectives (maqasid) of Shariah. These objectives consist of protecting five essential values, namely, religion, life, intellect, lineage and property, which have a much wider scope and meaning. For instance, protecting the right to live includes protecting the means, which facilitate an honorable life, such as, freedom to work and travel. Protection of property requires defending the right of ownership. It also means facilitating fair trade and lawful exchange of goods and services in the community. Any measure which secures these values falls within the scope of maslahah and anything which violates them is mafsadah (evil), and preventing the latter is also maslahah”.
This article is a part of “Ethics And Efficiency In Islamic Stock Markets” By Mohammed Obaidullah
Sunday, March 8, 2009
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Thursday, March 5, 2009
The immediate cause of the current financial crisis appears to be the excessive and imprudent lending by banks (2). This in turn is attributed to the unbridled power of private bankers to create money out of nothing, and then to loan this bank-created money on interest (described as fractional reserve banking). In this present monetary framework, money is traded as a commodity, instead of performing its true function of operating as a medium of exchange. This system favours the rich against the industrious poor. Despite the fact that deposits are sourced from a broad cross- section of the society, their benefit goes mainly to the rich. James Robertson in “Transforming Economic Life”(3) states that:
“Today’s money and finance system is unfair, ecologically destructive and economically inefficient. The money – must – grow imperative … skews economic effort towards money out of money, and against providing real services and goods”.
A substantial proportion of this privately created bank-money is invested in speculative wagering instruments, such as derivatives based on futures, swaps, and options. Such betting instruments are not connected with transactions in the real economy. According to Prof John Gray of Oxford University, (4) derivatives have created a “virtual financial economy” which “has a terrible potential for disrupting the underlying real economy as seen in the collapse in 1995 of Barings, Britain’s oldest bank”. It is therefore no surprise that George Soros has described derivatives as “hydrogen bombs”. Warren Buffet described them as “financial weapons of mass destruction”. The Bank for International Settlements (BIS) currently estimates the notional amount of all outstanding derivatives (including credit default swaps) to be a staggering 600 trillion dollars, more than 10 times the size of the world economy. (BIS, September 2008, pg 20).
Although debt-financing cannot be ruled out, the solution lies in a shift to equity-based financing, posited on profit and loss sharing, which is the primary characteristic of Islamic Finance. In this equitable manner, economic effort would be directed at providing useful goods and services, instead of simply making money out of money. At the same time, the wide gap between the supply of money and the supply of real goods and services would be decisively narrowed. The distinguishing features and benefits of Islamic Banking were aptly summarized by the Islamic Development Bank, based in Jeddah, (established 1975) in the following words:
“Islamic banking is distinctive in two respects: concentrating on the real sector of the economy, it imparts tremendous stability to the economic system by achieving an identity between monetary flows and goods and services, and by operating on a system of profit and loss sharing in its evolved state, it insulates the society from the debt-mountain on the analogy that if the economies enter into recessionary or deflationary phases, the principles of profit and loss sharing protects the states and economic operators from the evils of accumulation of interest and minimizes defaults and bankruptcies.” (5)
1. See generally the article entitled “The End of Prosperity” by Prof. Ferguson of Harvard, published in Time, October 13, 2008, at pages 18 to 21.
2. Dr M Umer Chapra, economics advisor to the Islamic Development Bank of Jeddah in a paper entitled “The Global Financial Crisis”. (Can Islamic Finance Help? (5/11/2008) (shorter version).
3. James Robertson, Transforming Economic Life : A Millennial Challenge, Green Books, Devon, 1998.
4. John Gray, False Dawn : The Delusions of Capitalism, Grunte Books, London, 1998, p62.
This article By Mahomed Shoaib Omar (Specialist Corporate & Islamic Finance Attorney)