Ethics in Islamic Finance: Defining Ethics (Part 2/2)

By Habib Ahmed

Part 1

Islamic Law and Ethics

islamic financeThe basic principle for commercial transactions is ‘permissibility’ which signifies that all acts/contracts are permissible unless there is a clear injunction of prohibition.

The two broad categories of prohibitions related to economic transactions recognized in Shari`ah are riba (usury) and gharar (risky sales).

At the contract level, these prohibitions are intended to bring about fairness and good measure and, as such, these get more consideration over complete freedom of contracts.

The legal maxim ‘in contracts, attention is given to the objects and meaning, and not to the words and form’ provides the guiding principle of devising contracts in financial transactions. While the form is the contractual construct of the transaction, the substance relates to the outcome. For example, the outcome of a sale contract is the transfer of ownership of an asset in exchange of price. Fulfilling the form, but not the substance will not be harmonious with the spirit of Islamic law.

Reinhart maintains that Islamic law is not just a law, but inheres ethics as both constitute “a call to righteous action in conformity with the guidance of Revelation”. Thus, while the ethics related to contracts will include virtues such as honesty, trust, transparency, etc, they also will incorporate fulfilling the legal obligations and stipulations. As a result, ethics can be evaluated by examining whether the legal conditions and stipulations of a contract are fulfilled or not. (Intention, 200-23)

For a transaction to be ethical, the overall goals of Shari`ah should also be fulfilled at the contract level. Other than avoiding riba and gharar, Monzer Kahf indicates that fulfilling maqasid (objectives) at the transaction level would involve satisfying the objectives, principles and values underscored in the Islamic laws of transactions. This would include, among others, linking returns to risks and bearing the risks of ownership by the owner of the asset. An important related principle includes fulfilling the conditions of a sale which is realized by transferring the asset to a new owner.

Similarly, conditions of trust and guarantee relationships in terms of liability of loss has to be implemented. Given the divine nature of these conditions, a contract would be considered unethical if some of these stipulations are fulfilled.

Another aspect related to ethics at the contract level relates to intention (niyah) and outcomes. While intention is an integral component in worshiping rituals, in economic affairs there is difference in opinions about its status among different schools of thought.

Note that all schools agree that illegitimate motive will make a contract illegal even when the all the legal components of a contract is fulfilled. The disagreements arise in relation to the status of intentions when they are not explicit in contracts. (215)

Thus, an intention of coming up with an illicit act using a valid contract would not only be void, but also immoral. The legality of a transaction will not only depend on the validity of a contract but also on the end use of the contract which can be deduced ex-ante by the niyah and ex-post by examining the outcome or consequences.

Islamic Morals and Ethics

All Islamic banks will be expected to be ethical in ways similar to their conventional counterparts. As mentioned above, these ethics include among others conducting operations with integrity and with due skill, care and diligence, avoid conflict of interest, etc. As ethics relates to the notions of what is right and wrong in the organizational context, for Islamic banks it will also be influenced by the Islamic notions of legality and morality. As such, Islamic banks will have additional ethical dimensions arising from their adherence to the laws and morals of Shari`ah.

Although Islamic scholarship has discussed issues related to the application of laws to ethical practice, the relationship between morality and ethics has not been addressed.

If the ethical and legal norms are presumed to coexist in a transaction, some may argue, as some Shari`ah scholars do, that as long as the requirements and stipulations of the contract are fulfilled, the contract will be both legal and ethical.

However, this argument may lack credence as the outcome of the transactions can lead to adverse effects on morality and societal welfare. One way to link morals to ethics is to examine the impact of activities of firms on the society.

As pointed out by Schwartz and Carroll: “a business activity will be ethical if it promotes good in the society. We use the same logic to determine the ethicality of transactions and activities of Islamic banks. Specifically, activity of an Islamic bank would be ethical when it enhances welfare (maslahah) and morality of individuals in the society. On the contrary, any banking practice that produces adverse effects on either welfare or Islamic morals would be considered unethical. A specific example showing the moral implications of debt and its relation with ethics is discussed next.

Morality and Ethics: The Case of Debt

In an Islamic economy, debt can be either created by interest-free loans or sale-based debt-instruments. Debt can create transactions involving murabahah (cost-plus or mark-up sale), bai-muajjal (price-deferred sale), istisna/salaam (object deferred sale or pre-paid sale) and ijarah (leasing).

Islamic banks do the bulk of their financing by using the fixed-income debt based products. While debt is permissible in Islam, some moral issues related to its size and magnitude can arise. To study the ethicality of extensive use of debt, the morals and welfare implications related to indebtedness are discussed below.

Morals Related to Debt

While Islam does not prohibit debt, several sayings of the Prophet discourage Muslims to engage in excessive indebtedness. The following sayings (hadiths) provide the moral implications related to debt:

Narrated Aisha: Allah’s Apostle used to invoke Allah in the prayer saying, “O Allah, I seek refuge with you from all sins, and from being in debt.” Someone said, O Allah’s Apostle! (I see you) very often you seek refuge with Allah from being in debt. He replied:

“If a person is in debt, he tells lies when he speaks, and breaks his promises when he promises.” (Al-Bukhari)

Narrated Salama ibn Al-Akwa: Once, while we were sitting in the company of Prophet, a dead man was brought. The Prophet was requested to lead the funeral prayer for the deceased. He said, “Is he in debt?”

The people replied in the negative.

He said, “Has he left any wealth?”

They said, “No.”

So, he led his funeral prayer.

Another dead man was brought and the people said, “O Allah’s Apostle! Lead his funeral prayer.”

The Prophet said, “Is he in debt?”

They said, “Yes.”

He said, “Has he left any wealth?”

They said, ”Three Dinars.”

So, he led the prayer.

Then a third dead man was brought and the people said (to the Prophet), Please lead his funeral prayer.” He said, “Has he left any wealth?”

They said, “No.”

He asked, “Is he in debt?”

They said, “Yes! He has to pay) three Dinars”

He (refused to pray and) said, “Then pray for your (dead) companion.”

Abu Qatada said, “O Allah’s Apostle! Lead his funeral prayer, and I will pay his debt.” So, he led the prayer. (Al-Bukahri)

The above two sayings of the Prophet clearly indicate that a Muslim should try to stay away from debt. In the first hadith, the Prophet is seeking refuge from sins and debt, thereby implying the negative attributes of both. In the second hadith, the Prophet refused to lead the funeral prayer of someone who died indebted and did not have the means to repay it.

The incident shows even though the deceased was a Muslim, the consequence of not repaying the debt was a serious enough factor that led him not to lead his funeral prayer. The implications that one can draw from these sayings of the Prophet are the following: people should take on debt only if it necessary, the debt should be of amounts that is within a person’s capacity to repay, and once indebted people should strive to repay it back.

Welfare Implications of Debt on Individuals and Society

The recent financial crisis exposed the damaging features of excessive debt in the economy. It revealed that too much debt was one of the key causes of the predicament and harmed many indebted individuals and economies at large. The aftermath of the crisis led to a renewed scrutiny on the harmful consequences of debt. The weekly Economist published a special report on debt in its 24 June 2010 issue in which it examined various aspects of indebtedness.

The morals related to debt changed from being something negative in the past to acceptable in the present. Over the past century taking on debt became fashionable and was promoted in the society, both at the individual and national levels.

The result of the change in attitude results in the increase in levels of debt for individuals, corporations and nations. This is reflected in rise in the amount of household debt from about GBP 14,000 per head to GBP 24,000 per head between 2001 and 2010 in the UK, and from USD 27,000 to USD 44,000 in the US during the same period (Economist). The corresponding figures for public debt were GBP 5,000 and GBP 18,000 and USD 16,000 and USD 34,000 for UK and US respectively. For ten industrialized countries, the average total debt (private and public) increased from 200% of GDP to 300% between 1995 and 2008, with Iceland having a debt 1200% of its GDP. (Economist)

High levels of debt have various detrimental effects on both individuals and national economies. A study revealed that higher debt levels were associated with lower levels of growth. (Economist). In a study, Campbell and Hercowitz find the higher growth in the level of debt reduces the welfare of households. Economist likened debt to alcohol and nicotine stating ‘a debt boom tends to induce euphoria.’ (Economist). Analyzing the problems related to the crisis, Taleb and Spitzagel identifies too much debt as the ‘real evil’.

Data shows that Muslim countries are not immune to the culture of debt. Consumer debt in the GCC peaked in 2008 at $151 billion and then fell to $139 billion in August 2010 in the aftermath of the crisis. The growth rate of the level of outstanding debt was 80 per cent between 2002 and 2010 (Consumer). A survey shows that 52 per cent of the youth are indebted in Saudi Arabia, of which two-thirds is due to credit cards (Consumer). A study on UAE revealed that 85 percent of UAE residents are in debt, many having difficulty in paying their dues. (Survey)

Another survey reveals that over 25 percent of UAE residents have a debt of Dh 250,000 each and 40 percent have personal loans between Dh 100,000 and Dh 200,000. Interestingly, 20 percent did not have any idea of the amount of debt they owed (Emirates 24/7 2011). A report by Lafferty Group in 2010 indicates that there were 199.4 credit cards for every 100 people in the UAE, which is one of the highest in the world. After the crisis, the amount of bounced checks increased to 25 percent in UAE. (Sambidge)

Part of the problem of high indebtedness is the easy access of credit and the willingness of banks to provide facilities with relatively lax standards. Some specific cases in the UAE indicate banks were permissive with lack of proper scrutiny of clients before providing credit. Walter reports that a person with a salary of Dh 15,000 ran up debts of Dh 250,000 and people with salaries of as low as Dh 6000 managed to get eight credit cards. While it is difficult to ascertain the extent to which the debt was fueled by Islamic banks, given the significant share of the Islamic banking sector in the country it is safe to conclude it has played an important role in the buildup in indebtedness.

Ethics of Debt for Islamic Finance

The above discussion indicates that there may not be any ethical issues arising in using debt from a legal perspective as appropriate Shari`ah compliant instruments can be used to create it. However, the morals derived from the Prophetic traditions indicate the Muslims should strive to keep the levels of debt to a minimum. If the objective on Islamic banks is to expand business by financing goods and services that results in higher indebtedness among individuals, then they contribute to the immorality of being highly indebted as perceived from an Islamic perspective.

Consequently, if the banking practices affect moral values negatively, the practice of Islamic banks would be considered unethical.

Beyond the moral proposition from a religious point of view, limiting the level of debt also can be rationalized from the perspective of welfare (maslahah) implications at the individual and societal levels. As discussed above, higher levels of debt can affect the welfare of individuals in the economy adversely. The evidence of the adverse impact of debt on individuals and national economies indicates that the levels of debt must be kept reasonable and manageable. If Islamic banks ignore the harmful effects of debt on individuals and help to fuel its increase to levels that start to affect the welfare of the people negatively, then these activities could be considered immoral from an Islamic perspective. The implication is that if Islamic banks focus narrowly on the legal technicalities and ignore the impact of debt on the moral teachings and maslahah, they fail to operate ethically.

Conclusion and the Way Forward

The paper discussed the role of laws and morals in defining ethical practices of Islamic banks. While Islamic law and ethics appears to be closely linked, cases may arise when the practice of Islamic banks can produce unethical results even when the contracts are legitimate.

To judge if banking practices are ethical or not, it is important to examine the consequence of transactions on morality and welfare. Situations can arise when the transactions may not have legal/ethical issues at the contract level, but can be unethical as it has adverse impact on welfare or morality. The paper examined the morality of excessive debt and concluded that the practice of Islamic banks could be unethical if they fuel the increase in indebtedness of individuals beyond certain levels.

The ethicality of Islamic banking practice arising from the effects on moral values cannot be grasped by focusing at the legal aspects of contracts only. A question then arises whether morality and ethical norms can be realized by Islamic banks that are engaged in expanding their businesses in competitive markets. While there are certain aspects of ethical self-regulation at the organizational level that can be useful, it has limitations. Davies points out that self-regulation may not be appropriate for “raising standards in the market as a whole, or dealing with a problem where there was a need for the whole industry to change.” (Ethics, 281)

Furthermore, when the conduct of banks has implications that go beyond its realm and affects other members of the society, regulatory oversight may be necessary to govern these activities.

If Islamic banks narrowly focus on legality of transactions that can lead unethical outcomes, there is a need to have a mechanism to ensure that the Islamic banking practices are ethical by not contradicting the moral teachings of Islam. Kamali asserts that if public interest (maslahah) necessitates it, a lawful government is authorized to change the reprehensible into forbidden and the recommended into obligatory.

In the past, Islamic societies had institutions that oversaw the moral issues related to economic affairs. Kamali maintains that while the courts dealt with the legal issues, the market controller (muhtasib) was authorized to intervene and stop immoral practices. During contemporary times, this role can be taken up by the regulators whereby ensuring ethics at the organizational level is moved to the public domain.

The paper suggests that there is an additional role of regulators overseeing Islamic financial industry—it is to promote morality-enhancing ethical behavior in Islamic banking practices.

Works Cited

  • Arabi, Oussama (1997), “Intention and Method in Sanhuri’s Fiqh: Cause as Ulterior Motive”, Islamic Law and Society, 4 (2)
  • Economist, 2010, last access, Thursday, August 6, 2012
  • Kamali, Mohammad Hashim. Shari`ah Law: An Introduction. Oxford: Oneworld Publications, 2008.
  • Sambidge, Andy. “UAE bounced cheques rise in Q1 but value falls 25%”, Arabian Business, August 5, 2010.
  • Walter, Micole. “Survey claims 85% of UAE expats in deep debt”, Gulf News, August 14, 2010.
  • White, Andrew. “Consumer Debt in GCC hits $139bn”, Arabian Business, 8 August 2010.


Taken with slight editorial modifications from

This paper was presented at the 8th. International Conference on Islamic Economics and Finance, held in Doha, Qatar, 19 to 21 December 2011. It is republished here with kind permission of the author and the organizers.

Habib Ahmed is the Sharjah Chair at Durham University. He was Manager, Research and Development, Islamic Banking Development Group, The National Commercial Bank (NCB), Kingdom of Saudi Arabia. He also worked at Islamic Research & Training Institute of the Islamic Development Bank Group, Saudi Arabia and taught at the University of Connecticut, USA, National University of Singapore, and University of Bahrain. He has been a member of the Capital Adequacy Working Group of Islamic Financial Services Board (IFSB) which is responsible for, among others, setting standards and guidelines for Islamic banks and financial institutions.



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