Charitable contracts in Islamic finance

Qardh contract is widely used by Islamic banks in the Middle East and Europe to provide depositors with guaranteed safe custody of the amounts deposited and at the same time allow banks to use the deposited money in their businesses. COURTESY PHOTO

What you need to know:

  • The contracts are effected on the basis of benevolence (ihsan) and do not involve exchange of counter values. This is because any form of contractual increment on the principle violates the purpose of charity and its principles, that is tabarru’ (donation).
  • These contracts include; qard (benevolent loan), hibah (gift), tabarru’ (donation), i’arah/ariyah (asset lending), waqf (endowment), and ibra’ (rebate).

Charitable contracts (tabarru’) are unilateral contracts aimed at giving wealth to another party without getting advantage from the recipient.
The contracts are effected on the basis of benevolence (ihsan) and do not involve exchange of counter values. This is because any form of contractual increment on the principle violates the purpose of charity and its principles, that is tabarru’ (donation).
These contracts include; qard (benevolent loan), hibah (gift), tabarru’ (donation), i’arah/ariyah (asset lending), waqf (endowment), and ibra’ (rebate).

Qardh Contract
The Accounting and Auditing Organisation of Islamic Financial Institutions, a Bahrain-based Islamic Financial Institutions’ Standard setting body defines qardh (loan), in its Shari’ah standard number 19, as a contract through which a lender transfers ownership of a fungible property to the borrower upon whom it is binding to return a property similar to it on demand.
The Shari’ah logic of qardh contarct is to provide wealth on loan basis to one who will gain from it.
The borrower will employ and consume it in pursuit of his needs and then return back its equivalent value.
Shari’ah prescribes that the creditor does not have to benefit from the loan, otherwise, it tantamount to riba (interest). This is due to the principle that every loan which brings benefit to the creditor is considered riba (interest).

Application
Qardh contract is widely used by Islamic banks in the Middle East and Europe to provide depositors with guaranteed safe custody of the amounts deposited and at the same time allow banks to use the deposited money in their businesses.
The nature of qardh applied is qardh al-hasan (benevolent loan), that is; debt which is free from any type of predetermined condition or promise to repay back more than the original amount borrowed. However, banks are allowed to give a special token of appreciation (hibah), at their discretion, to the creditor at the time of settlement.
Under this structure, the depositor is considered as a lender to the bank, and the bank is a borrower. The bank guarantees return of the deposited money even in case of loss of this money in the ordinary course of business.
In cases where an Islamic bank is the lender, a wide range of Islamic financing facilities would be applied such as; personal financing, hybrid Islamic credit card. Government would also borrow Shari’ah compliant funds through government investment certificates which are structured basing on qardh contract.

Article is sponsored by Tropical Bank to help understand Islamic Banking.