It is important to highlight the role of circumvention in Islamic banking and finance, and differences with genuine innovation to provide alternative solutions in situations where choices are restricted due to explicit prohibitions. For example, the prohibition of interest implies disallowing party A to receive a smaller sum of money from party B in return for a greater sum to be paid by A to pay B on a later date.
A solution to this case of restricted choice is tawarruq, whereby party B sells something of lesser value (say £90) for a deferred price of £100 to party A who then sells it in the market (to a third party C) for £90. This obviously does not attract any Shari’a objections at all, and may in fact be a preferred Shari’a option in some circumstances. It is important to emphasise that tawarruq in this simple form is not an example of innovation, as Shari’a allows its use and in fact recommends it to avoid riba (or the prohibited interest).
The solution comprises the following elements:
For tawarruq to be considered as a Shari’a acceptable arrangement involving true sale, requirements 1-4 must be observed; otherwise, it may be seen as circumventing the Islamic prohibition of riba.
Condition 1 is necessarily about possession. In order to ensure that tawarruq is not abused to circumvent riba, possession by the seller of the commodity and its transfer to the purchasing party must be made a strict Shari’a requirement; otherwise, a series of trades will result in movement of cash-only without any requirement of mobility of the commodity.
Condition 2 does not imply that the credit seller (party B) is prevented from buying the commodity from someone to whom party A later sells the commodity in cash. Rather what it requires is that the credit seller must not supply cash directly or indirectly to the party seeking liquidity around the time of the credit sale. If he does so (whether it is with or without the sale of a commodity), the transaction would involve riba if the price in the credit sale is higher than the spot price.
Here, the concept of a “spurious party” must be employed. In an organised three-party transaction, a party would be considered “spurious” if its involvement in the transaction makes an otherwise prohibited transaction seemingly valid. If in a transaction, a spurious third party is brought in to allow two transacting parties to exchange unequal amounts of money, the transaction would be considered to involve riba, even if the whole transaction is structured around (a series of ) commodity trades.
Hence, although from a Shari’a viewpoint, it is acceptable for a party B to buy a commodity from a party C on a spot basis, to sell it on credit for a profit (higher price) to party A who then sells it on a spot to party C for a lower price, condition 2 above renders the whole transaction Shari’a repugnant.
Although Shari’a allows for a commodity seller to serve as an agent for the buyer, in the context of tawarruq transactions the agency role for the seller must be ruled out because it will allow the buyer of the commodity to receive a smaller amount of cash from the seller (through the third party) today to return to him a higher amount of cash after some time – something akin to riba. Condition 3, therefore, is required to ensure that condition 2 is observed. It is not strictly required if non-observance of condition 3 avoids violation of condition 2.
Condition 4 is a weaker requirement, especially if conditions 1-3 are already met. However, if some of the Shari’a scholars are reluctant to accept conditions 2 and 3, then condition 4 must be binding, and in this case, it becomes the strongest requirement to prevent the incidence of riba in a transaction.
From the above discussion, one may draw a principle, which for ease of reference one may call HD’s Impossibility Principle, which states the following:
“It is impossible for a trade-based transaction to involve riba if at least one of the above four conditions is fulfilled.”
The above-mentioned four conditions may be considered prudential guidelines for using tawarruq in the contemporary practice of Islamic banking and finance. The HD’s Impossibility Principle ensures that these prudential guidelines rule out circumventing Islamic prohibitions in banking and finance transactions.
