Shari’ah-compliant benchmark and Shari’ah-based “raf’ al-haraj” benchmark on prohibition of riba

What is it about?

Interest is prohibited in Islam because interest is usurious and imposes extra burden on borrowers. Thus, Islamic financial institutions are instructed to invest in client’s firm based on profit and loss sharing principles or namely mudaraba and musharaka mode of financing. However, the portfolio Islamic financial institutions are overwhelmingly dominated by murabaha (cost-plus) financing. Currently, there is no clear benchmark as to how the maximum limit of profit can be capped. If interest is prohibited because it is usurious and burdensome, an unbounded level of profit imposed on scheme can turn to be usurious and burdensome and should be prohibited as per the same guiding principles. This paper proposes to set up two benchmarks to judge whether a particular financial transaction is acceptable or not in the context of Islamic finance; ‘Shari’ah-compliant’ benchmark and ‘Shari’ah-based’ 'raf' al-haraj' (the removal of hardship) benchmark. The former benchmark can be applied to ensure that a transaction brings ‘profits on sales’, not ‘profits on loans’. The latter benchmark should be addressed to ensuring that a transaction does not exploit the customers of Islamic banks. This theoretical framework suggests two type ‘gray-zones’; the ‘Shari’ah-compliant but less contributing to the removal of hardship’ type gray-zone and the ‘controversial on compliance but contributing to the removal of hardship in borrowers’ type gray-zone. The width of gray-zones for Islamic banks in each country may vary.

Featured Image