38 AN INTRODUCTION TO ISLAMIC FINANCE
various circumstances; the rule of non-interference with market supplies;
the rule against hoarding; and the rule against collusion among market par-
ticipants (Mirakhor 2007).
Risk Sharing
Another core principle of Islamic economics is the notion of risk sharing.
This is based on the principle of liability, which states that profi t is justifi ed
on the basis of taking responsibility, possibly even becoming responsible for the
loss and the consequences. This legal maxim, said to be derived from a saying
of the Prophet (pbuh) that “profi t comes with liability,” implies that Shari’ah
distinguishes lawful profi t from all other forms of gain and that entitlement
to profi t exists only when there is also the liability, or risk, of loss.
The central proposition of Islamic fi nance is risk sharing and the prohibi-
tion of interest-based transactions in which a rent is collected as a percentage
of an amount of the principle loaned for a specifi c time period without the full
transfer of the property rights over the money loaned to the borrower. One
result of this type of transaction is that the risk is borne by the borrower.
Rather, Islam proposes a mutual exchange (al-bay’) in which one bundle of
property rights is exchanged for another, thus allowing both parties to share
the risks of the transaction—something which is sanctioned. The emphasis on
risk sharing is evident from one of the most important verses in the Qur’an
with respect to economic relations (2:275). The verse states that: “... they
say that indeed an exchange transaction (bay’) is like a riba (interest-based)
transaction. But Allah has permitted exchange transactions and forbidden
interest-based transactions.” The nature of property rights inherent in these
two transactions hints at one of their crucial differences. al-Bay’ is a contract
of exchange of one commodity for another where the property rights over
one commodity are exchanged for those over the other. In the case of a riba
transaction, a sum of money is loaned today for a larger sum in the future
without the transfer of the property rights over the principle from the lender
to the borrower. Not only does the lender retain rights over the sum lent but
property rights over the additional sum to be paid as interest is transferred
from the borrower to the lender at the time the contract of riba is entered
into. Arguably, the above verse renders exchange and trade of commodities
or/and assets the foundation of economic activity in the Islamic Paradigm.
From this, important implications follow. Exchange requires freedom for
parties to contract. This in turn implies freedom to produce, which calls
for clear and well-protected property rights to permit production to proceed.
To be able to exchange freely and conveniently, the parties need markets. To
operate successfully, markets need rules of behavior and enforcement mech-
anisms to reduce uncertainty in transactions and ensure the free fl ow of
information. They also need trust to be established among participants;
competition among sellers, on the one hand, and buyers, on the other; trans-
action costs to be reduced; and the risk to third parties in having to bear
externalized costs of two-party transactions to be mitigated.