Sunday 28th August, 2005


Insurance, banking within Islamic system

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German state, Saxony-Anhalt, last year issued the first ever Islamic bond in European history. It is a $121 million, five-year floating-rate note, which pays a “rent” instead of the typical “interest,” in a “shariah” compliant contractual agreement. (BusinessWeek, Euro Edition, August issue)

I have been asked by a small sector of readers to discuss the relevance of insurances, and banking, in the Islamic economic system.

While I am neither an authority on Islamic economics, nor an authority on Islamic jurisprudence, there is a simple rule of guidance which everyone should use, in order to determine whether something is good or not, if they are not privy to in-depth education on the subject.

The one fundamental question is: Does this activity lead to evil, either for the individual or for the community? Some questions to establish an element of evil may be: Does it exploit distress, does it employ fraud or cheating, does the fulfilment of the contract result in disputes, or redound to the detriment of others? Does it cause others to suffer? And importantly, is it difficult to determine the exact value of what is being offered in the contract?

Any answer in the affirmative would render the activity illegal according to shariah or Islamic law.

Islam supports the conduct of business and the issue of contracts, with witnesses. Islam forbids gambling or games of chance and forbids riba which may be regarded as the payment of interest on loans. How then is it possible to issue a shariah compliant bond?

The premise of the bond instrument is that the issuer offers a contract to repay a sum of money, which is representative of a debt. The issuer thus owes, the purchaser of the bond. The issuer promises to return the sum of money, in addition to periodic payments, called interest, in exchange for use of money which he does not have himself. It is as though the purchaser of the bond, lends money to the issuer. Interest therefore that derives from the bond is riba.

German state, Saxony-Anhalt, offered a contract to pay a rental income for the use of the money, based on tangible property.

With respect to insurances, these are all governed by written contracts which clearly state that a certain investment sum, made periodically, will be expected in return for an indemnity of loss of a specified sum. There is thus, no uncertainty, of what is expected, in terms of value.

With respect to uncertainly of loss, that is a pure risk. Pure Risk is inherent in every endeavour.

All human economic activity occurs in an environment of uncertainty, and all human activity presumes a future reward. A businessman who manufactures soft drinks has no certainty about his plant operating, or his product fetching a good price. A homeowner who plants a mango tree does so with the expectation that mangoes will be reaped.

Both individuals take action to reduce the risk of loss. The business may hire expert engineers, an accountant, and labour, to ensure his plant is up and running. His accountant will estimate the cost of down time, equipment failures, transport, etc, as well as inputs into the manufacturing, before a selling price is determined. The homeowner will water his seedling, invest in fertilisers, etc.

The insurance contract is a response to the economics of modern-day risk management. It is based the discovery of a social-scientific principle, involving actual studies of accidents and loss, peculiar to business, property, and individuals.

Without it industry will come to a near halt!

To be continued next week.

* Raziah Ahmed is a registered financial consultant

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