An Introduction to Islamic Finance: Theory and Practice

99

CHAPTER

5

Risk Sharing as an Alternative to Debt

Alternative to Debt

I

slam has long endorsed risk sharing as the preferred organizational struc-
ture for all economic activities, prohibiting interest - based contracts of any
kind. Indeed, as we have seen, it requires mandatory risk sharing with the
poor, the deprived and the handicapped based on its principles of property
rights.
The notion of risk has many dimensions. In general terms, it entails the
possible occurrence of an event — accident, fi re, sickness, perhaps — that leads
to a loss. Economic agents who face such common risks try to transfer and
reduce their risk exposure through insurance. Automobile drivers can trans-
fer their accident risk by buying car insurance. Industrial plants are exposed to
various risks such as fi re and theft; industrialists transfer these risks through
insurance. Labor faces the risk of unemployment; labor transfers this risk
through unemployment insurance. Retirees face the risk of losing their
income; they transfer the risk through social security or pension plans.
Much has been written about risk and the sources of risk but the empha-
sis has, for the most part, been on risk transfer rather than risk sharing. This
chapter discusses the Islamic perspective on risk and how it can be mitigated
by sharing. Further, it addresses the broader implications and stability of a
fi nancial system based on the sharing of risk.

UNCERTAINTY AND RISK

Uncertainty is a fact of human existence and stems from the fact that the
future is unknown and therefore unpredictable. Uncertainty, if severe enough,
can lead to anxiety and inaction. For each of us, a lack of certainty about
the future is exacerbated by ignorance of how others behave in response to
uncertainty. Yet individuals have to make decisions and take actions that
affect their own lives as well as those of others. Decision - making is one
of the most fundamental of human capabilities and is inexorably bound

An Introduction to Islamic Finance: Theory and Practice, Second Edition

by Zamir Iqbal and Abbas Mirakhor

Copyright © 2011 John Wiley & Sons (Asia) Pte. Ltd.