Islamic Finance

Read this interesting article: Al-Suwailem, S. (2000) Towards an objective measure of Gharar in Exchange. Islamic Economic Studies. Vol 7, No. 1&2, pp. 61-102.


His paper is very interesting as he defined Gharar, not as uncertainty and risk as in the traditional sense, but a zero-sum game (that is, in order for one to win, the other must lose). He argued quite well using Islamic and non-Islamic sources that one important Islamic principle, the eating of others' money for nothing, is reflected strongly by the zero-sum exchange.

He then suggests a measure of Gharar based on the Shariah: Y(d) = sum_w(p_iy_i) - sum_w'(p_iy_i) where Y(d) represents the net cooperation value for a given player from exchange d. The probability of state i = p_i , y_i = payoff of state i. w = set of states for win-win while w' = set of states for win-lose or lose-lose. So a negative value indicates a zero-sum exchange which is undesirable.

What I find interesting is really his arguments which gives me some insights into Islamic finance. With the argument of zero-sum exchange, I see why gambling is illegal, not so much as the uncertainty and game of chance, but that it is an extreme form of a zero-sum exchange where there is definitely no possibility of a win-win situation. In order for one to win, others have to lose.

That is in contrast with the lucky draws that we always organize in Singapore. I've always wondered why lucky draws are deemed to be legal Islamically. Now I understand. In gambling, the players have to set their bets - which means there will be negative payoffs (a set of winners and losers)...in the lucky draw, the players do not contribute anything, so there is no losers, only winners (payoffs are always positive). Using the Gharar measure, w' will be an empty set and the net cooperation value should not be negative.

That helps set the tone for the financial organizations for more cooperative contracts rather than competing ones. Will write more on this later.