Is today's prevalent “Islamic banking” really halal? In the home finance (diminishing musharakah) of Meezan Bank etc., when the profit rate is linked to KIBOR and the monthly instalment comes to just as much as a conventional interest-based loan, where then does the real difference remain? Is it permissible to deal with these institutions?

The prohibition of riba is definitive and consensual: ﴿وَأَحَلَّ اللَّهُ الْبَيْعَ وَحَرَّمَ الرِّبَا﴾ (Surah al-Baqarah: 275). A transaction does not become halal merely by a board of “Islamic” being put upon it, nor does every transaction become haram merely by resemblance; the decision will be on what Shariah contract the agreement is in reality established upon and whether its conditions are actually fulfilled or not. So the position of this Dar al-Ifta is neither to declare everything halal without qualification, nor to call everything another name for riba; the ruling will be according to the real structure of each product.

The real structure of this product is that the bank and the customer hold joint ownership (shirkat al-milk) in the house; the bank's share is divided into units; the customer pays rent on the bank's share and keeps buying some units every month, until the whole house becomes his; as the bank's share decreases, the rent also keeps decreasing. The International Islamic Fiqh Academy (Al-Majma' Al-Fiqhi Al-Islami Ad-Duwali), in Resolution No. 136 (2/15) of its fifteenth session (Muscat, 2004), declared this contract permissible with these conditions: the bank should not be bound to buy back the units at the original price — the unit's price should be the market price of the day of sale or an agreed price, so that a guarantee of capital does not become necessary; the expenses of insurance and repair should be in proportion to ownership; profit should not be fixed in the form of a percentage of capital or a determined amount; and the contracts of partnership, rent and sale should be kept independent of one another. Where these conditions are actually fulfilled, the contract possesses a Shariah-valid structure; and where a guarantee of capital and determined profit is introduced, it no longer remains a partnership — it becomes a loan.

In the financing of cars and other purchases, the real test is that the bank first itself buy that thing and obtain its ownership and possession, then sell it to the customer with profit. The Prophet ﷺ said to Hakim ibn Hizam, may Allah be pleased with him: “Do not sell that which is not in your possession” (Musnad Ahmad: 15399; Sunan an-Nasa'i: 4613; sahih according to Al-Albani, Sahih al-Jami': 342). And in the narration of Zayd ibn Thabit, may Allah be pleased with him, reselling a purchased thing at the same place is forbidden until the traders transfer it to their own places (Sunan Abi Dawud: 3499). Therefore, if the bank, without real purchase and possession, merely issues a cheque and takes instalments from the customer with a fixed addition, then this is not murabahah; except for its name, it is an interest-based loan. On this very principle, the International Fiqh Academy, in Resolution No. 179 (19/5) of its nineteenth session (Sharjah, 2009), declared organized tawarruq impermissible, because it is in reality a riba-based loan behind the veil of apparent buying and selling.

This objection carries weight, that linking the determination of price to an interest rate is a weakness of the system. However, the preponderant explicit position is that if the contract is a real sale or partnership, the mere use of an interest rate as a calculative measure (benchmark) does not by itself make it haram; nevertheless, this is a disliked resemblance which Islamic banks should abandon as soon as possible and devise their own independent Shariah measure — this is the explicit statement of Mufti Muhammad Taqi Usmani Sahib (An Introduction to Islamic Finance). So the linkage with KIBOR is an issue of the reform of the system, not of the validity of the contract; the real question will always remain the correctness of the structure and the conditions.

Personal attacks on institutions are not the subject of this fatwa; the principle is that a Muslim read the agreement before transacting. Where a product is actually established upon the above-mentioned conditions — real ownership, real risk, absence of a guarantee of capital — there, dealing is permissible according to the standard of the fiqh academies. And where it is known that this is merely a paper form and the reality is a loan with a fixed addition, avoidance there is obligatory, whatever name may be pasted upon it. In case of doubt, take a copy of the agreement and refer to an authentic scholar or Shariah board.

A Maqasid-based caution: The purpose of Islamic finance is not merely to change the name of riba, but to establish the circulation of wealth upon real trade, ownership and the sharing of risk. It is the customer's right to ask the bank about the Shariah structure of his agreement; and it is obligatory upon the banks that along with the form they also set the reality right.

Translated from the original Urdu fatwa.