Key Takeaways
- Gharar refers to uncertainty or risk and is prohibited in Islamic finance to ensure fairness and transparency.
- The concept is often linked to the sale of goods not yet in possession, like unharvested crops.
- Derivative contracts, such as futures and options, are typically considered gharar and are forbidden in Islamic finance.
- Islamic teachings emphasize that contracts must be clear and devoid of excessive uncertainty to prevent exploitation.
- Minor gharar may be acceptable, like short-selling commodities, but substantial risk is not permitted.
What is Gharar?
Gharar is an Arabic term for excessive uncertainty, deception, or risk in a transaction, sometimes described as selling what isn’t yet present or clearly defined. Islamic finance prohibits Gharar on ethical and religious grounds reflected in the Quran and Hadith, and the concept is used when evaluating transactions like certain derivatives and short selling.
The Role of Gharar in Islamic Finance
The word gharar has become somewhat of a general term in the modern lexicon. Gharar sales or transactions are evaluated based on the potential misunderstanding between parties and the uncertainty of goods or payments being delivered. Gharar is generally prohibited under Islam because there are a set of strict rules in Islamic finance against transactions that are highly uncertain or that may cause any injustice or deceit against any of the parties.
The justification and guidance for forbidding contracts or transactions considered as gharar comes from the hadith, a revered book in Islam. It contains the sayings of the Prophet Muhammad, who spoke against the selling of the birds in the sky, the fish in the water, or the unborn calf in the mother’s womb, saying, “Sell not what is not with you.” Therefore, questions of gharar arise when a claim of ownership is unclear or suspicious.
Clarity of the intended meaning of gharar also comes in the Quran, where it states, “And do not eat up your property among yourselves for vanities,” which is interpreted as the prohibition of predatory business practices because such practices do not benefit the whole of society.
Common Examples of Gharar in Finance
In finance, gharar is observed within derivative transactions, such as forwards, futures and options, as well as in short selling and other forms of speculation. In Islamic finance, most derivative contracts are forbidden and considered invalid because of the uncertainty involved in the future delivery of the underlying asset.
Scholars differentiate between minor and substantial gharar, and while most derivative products are prohibited due to excessive uncertainty, other practices considered as gharar, such as commercial insurance, are vital parts of economic life. It is also permissible for a seller to short-sell fungible items, such as wheat and other commodities, to be delivered at a later date to a buyer.
Meanwhile, the sale without physical possession is not necessarily condemned, but the promise of delivery by either party without credibility is a violation. Also, transactions and contracts are considered as gharar when excessive risks or uncertainty are combined with one party taking advantage of the property of the other, or one party only benefiting by the other party’s loss. For that reason, Islamic finance also strictly prohibits extending loans with interest, which it considers usury.
The Bottom Line
Gharar is substantial uncertainty or deception in a transaction, and Islamic finance generally prohibits it for undermining transparency and fairness, based on guidance from the Quran and hadith. Scholars distinguish minor from substantial gharar, often limiting many derivatives, though narrow cases like short-selling fungible commodities may be permitted when delivery is credible.