What Is Trading Framework?
Framework is a comprehensive arrangement of rules and regulations that administers and controls agreements, acts, decision making, etc. Trading is generally explained as the commercial exchange of goods and services. So, basically trading framework can be defined as a comprehensive arrangement of rules and regulations that administers and controls agreements, acts, decision making related to commercial exchange of goods and services. In this chapter, our focus would be on describing the process of trading governed by Islamic principles (Shariah) as compared to as it has been governed under conventional legal system (common law).
Islamic trading framework is governed by Shariah law (Islamic law of contract), which has been discussed in detail in Chapter 2. Here, we will discuss differences and similarities between both the trading frameworks.
Differences and Similarities Between Conventional and Islamic Trading Frameworks
We will start introducing trade in Islam from a verse of Holy Quran, in which Allah SWT has compared between trade and interest and declares the permissibility of former and prohibition of latter.
Those who devour usury will not stand except as stands one whom the Evil One by his touch Hath driven to madness. That is because they say: “Trade is like usury,” but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (The offence) are Companions of the Fire; They will abide therein (for ever). (al-Baqarah 2:275)
One of the most relevant words in this verse is Bai’ which can be translated as an exchange of one object for another; one of the objects usually is the subject matter and the other being is considered as price. The Mejelle is considered as an authority on hanafi commercial law, describes a sale as “the exchange of property for property” with mutual consent. So in the broader context, Bai’ can be used for any bilateral contract. So, we can simply translate it to exchange involving all sorts of trading activities. There are few exclusions from the set of exchanges; for instance, riba-based exchanges are universally prohibited. Likewise, exchanges that lead to complete uncertainties are not valid. As mentioned earlier, a trading activity in Islam must be free from all prohibited practices.
Different types of transactions (exchange) carry different bearings with respect to the liabilities and benefits for the involved parties. For instance, in a normal trading activity, one party passes on the property rights coupled with usufruct to the other party. In the case of Ijarah (as discussed in Chapters 2 and 3), which can also be called as the sale of usufruct, one party transfers usufruct for rental but holds the ownership, which eventually means that the later party would carry the ownership-related liabilities. Then, in contracts like loans, complete ownership along with usufruct of the underlying asset is transferred to the borrower for temporary time period. Borrower can use the asset and even generate income as he can do with his other belongings, but in this case after a stipulated time period the asset must go back to the lender. Another type of exchange is Musharakah, in which partners share the ownership, its benefits, and related liabilities as per the agreed terms and conditions.
In general trade transaction, ownership of the underlying asset is transferred as the sale agreement is agreed upon and signed by the parties. It is regardless of the payment terms which can be on cash or on credit basis. The most important thing in this regard is the consent of the parties. Unlike a loan transaction where the borrower after getting the temporary control on the underlying asset is supposed to return the same after agreed time, in deferred payment case, the buyer is responsible to pay the agreed price and not return the asset.
Now let us discuss how conventional trading framework or common law deals with these exchanges. Interest is one of the key factors in the loan and loan-related transactions. Contrary to Bai’, which yields return on the basis of underlying risk, interest-based loan transactions contain the certain right of return. In Islam, “risk and reward” are vital elements of trade. Transactions/exchanges become usurious if they lack the elements of risk and reward.
Loan and trade (Bai’/exchange) are different and that constitutes the main difference between Islamic and conventional trading frameworks. A trade is said to be occurred when the underlying asset is completely in terms of ownership and once it is confirmed it becomes irreversible, which automatically means that the asset gets excluded from the ownership of the seller. As far as loans are concerned, ownership of the underlying asset is only passed on for a definite time period and same or similar asset is required to be paid back (Al-Jaziri, 1973). If the kinds of the goods to be traded are different from each other, one of items can be delivered on deferred basis. Example of this could be a credit sale or advance payment for ordering to manufacture a table through Istisna. In other words, if a currency is exchanged for edibles such as wheat, then it would not be considered as riba, but on the other hand if rice is exchanged for wheat on deferred basis, riba is found as they belong to same genus (Muslim, 1981, with annotation by Nawavi). Now let us talk about loan transactions, which are required to be fulfilled on equivalent basis for repayment purposes. Almost all the modern-day banking transactions fall under this imperative. The unequal exchanges in banking transaction show the presence of riba. That is why, since conventional banks buy and sell money, their trading cannot be called as Bai’.
Sarakhsi a renowned Hanafi jurist says: “Trade is of two kinds: permitted (Halal), which is called Bai’ in the law; and prohibited (Haram), which is called Riba. Both are types of trade. Allah Almighty informs us, through the denial of the disbelievers, about the rational difference between exchange (Bai’) and Riba, and says: ‘That is because they said Bai’ is like Riba’. Almighty, then, distinguishes between prohibition and permission by saying: ‘And Allah has permitted sale and prohibited Riba’.”
As in Al-Baqarah 2:275 (mentioned above), trade is considered as one of the commendable professions among countless legal ways of earnings. Islam as a way of life has recognized trade as a tremendous way of acquiring wealth.
Trading framework in Islam is based on divine knowledge source of which are Quran, Sunnah, Ijma, Qiyas, and Ijtihad. In the words of Addas (2008), “the Islamic trading framework is not a product of human thought resulting from any scientific inquiry: it is a divine direction leading to a unique way of earning legitimate profit.” Trading framework in Islam is governed by Islamic law of commercial contracts.
Besides riba, there are a few supplementary issues which are diverging when it comes to Islamic law and conventional law (common or civil law). These issues are also important to be deliberated. These issues basically arise due to the differences in worldview. For instance, under Islamic law, the understanding is that all the properties are created and provided by God. This is clearly in contradiction with the modern secular mind-set as per which property is a secular item. This item may be redefined if needed. Another common way is to look for how legal system decides to value property claims. As far as Islamic law is concerned, property cannot be reduced, inviolable, and virtually supreme. Islam is minutely concerned with the way properties are acquired; that’s why its lawfulness is discussed in detail in both the Quran and the Sunnah, which are considered above reason in Islamic jurisprudence. Islamic economic system promotes earning through fair and effective means. The primary things need to be considered are that other’s rights should not have exploited. This way, economic activities would generate and whole society would get benefit. Islam emphasizes collective welfare over individual rights. Society at large takes preference in many instances. This concept is in line with modern thinking prevalent in the West, which tends to have started criticizing economic management through open-market approaches. The reason is that these approaches stress on economic growth without considering the impact on quality of life and increasing the income inequality in society. There is no doubt that Islamic religious principles are primarily in contrast to the principles of uncontrolled and ungoverned capitalism as they are viewed as posing threats to civilization by rejecting Shariah values.
Trading framework
Basis of difference | Conventional trading framework | Islamic trading framework |
|---|---|---|
Religious belief | Secular and separates religion from other parts human life | Belief in unity of God and relates this belief to economic life of a man |
Freedom of economic activity | In socialism, government enjoys economic freedom but in capitalism individuals enjoy freedom | Restrictive freedom is allowed in light of Shariah both by the government and/or individuals |
Ownership of means | Socialism-state ownership Capitalism-individual ownership | Allah is the exclusive owner. Man is the caretaker of the property |
Basis of economic system | Riba or interest | Interest free; PLS, zakat and compensation based |
Competition | Socialism-no competition Capitalism-logical and unethical competition | Logical competition and financial cooperation |
Wealth distribution | Socialism-equal Capitalism-unequal | Equitable |
The Philosophy of Risk-Sharing
Any discussion on profitability would not be considered complete without discussing the respective risks. Which brings us to another significant aspect of Islamic finance theory is that of risk-sharing. The conventional finance can be conceived as a game of spectators, where a big crowd watches a few skillful players playing in the ground. On the other hand, Islamic finance can be considered as a participatory sport, where everyone is involved and there is no spectator. Furthermore, there is perception of default moral blanket on all Islamic financial transactions. One of the most important aspects which are considered while making an investment is risk.
In ideal form of Islamic finance, the component of risk-sharing is supposed to be ingrained in the transactions. For instance, in the case of Mudarabah, those who provided finances for investment share risk of any loss in capital with the other part which carries out actual activities. The second party also bears the risk of losing their effort and time. On the other hand, in conventional finance, risk is left to be borne by specialists and is also traded among them. The risk is sometimes shifted and the other times transferred to other parties. Mostly, the risk borne by parties is quite disproportionate as compared to the profits they make. For instance, banks provide investors with loans backed by collateral. That is how these financial institutions keep themselves covered from different kinds of risks like risks linked to marketing, production, and distribution, and their exposure is limited to the collateral related risk only. Islamic finance permits depositors who invest their monies with financial institutions to share the risks related to selecting the right type of investment and its respective success. On the other side, these financial institutions and banks advancing funds tend to share risks with the receivers of funds like manufacturers, farmers, traders, etc. Islamic finance lacks corporate governance which can allow depositors to have their say in investment decisions. There have been a number of alternatives proposed for this. And on the advances side, financial institutions can also be part of the decision-making process by becoming part of the board of directors of parties receiving the funds. The point to be noted here is that risk and respective responsibility for making decisions are (at least ideally supposed to be) spread across a greater number of concerned people. Returns come with risk and for taking risk one needs to be responsible. So, if one party is sharing the risk, it is given right to have say in decision making. This helps for participation of a much greater segment of investors and entrepreneurs in economic activities, which makes them feel that they are one of the participants of the game rather than just spectators. And the benefits of involving wider range of participants are more than enhancing the feeling. It improves the bank stability. Indirectly, the surplus units (investment depositors) share risk with deficit units (firms) through the process of banking intermediation. By including deposits and investors under the umbrella of voters, Islamic banks can impact the profitability of the firms by influencing their corporate governance. To conclude, the banking sector’s stability gets strengthened by the stability of the real sector. It results in the overall increase in integrity of the overall economic system.
Conclusion
This chapter discusses both the practical and philosophical similarities and differences between Islamic and conventional trading framework. A general rule of fiqh is worth mentioning here which is not only relevant to the trading but to all types of dealings; that is, the primary regulation governing all things in Islam is their permissibility. This means that everything is permissible except it is explicitly forbidden by Shariah law. Same is the case with trading frameworks; Islamic trading framework includes whatever a conventional trading framework has except the forbidden parts. We discuss these forbidden parts in detail which include gharar, riba, risk shifting, etc. We also discuss the philosophical differences including property ownership, risk-sharing, and the impacts on economy. Islam seems to present a more comprehensive yet compatible trading framework to be practiced, which not only suits Islamic world view but is also promoted to have positive impact on the economies at large.