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The 10th

International Conference on Islamic Economics and Finance (ICIEF)

Institutional Aspects of Economic, Monetary and Financial Reforms

23-25 March 2015, Doha, Qatar

Freedom of contract, actual justice and Islamic finance regulation:

how to balance legal efficiency and moral legitimacy in market economy

Dr. Valentino Cattelan

University of Rome Tor Vergata

Cover page (title of paper, name of authors, and author affiliations)

10th International Conference on Islamic Economics and Finance

The 10th

International Conference on Islamic Economics and Finance (ICIEF)

Institutional Aspects of Economic, Monetary and Financial Reforms

23-25 March 2015, Doha, Qatar

Freedom of contract, actual justice and Islamic finance regulation:

how to balance legal efficiency and moral legitimacy in market economy

Abstract

This paper aims at investigating the role of contractual freedom in Islamic fiqh, drawing from

this understanding consequent policy-making inputs for an improved regulation of Islamic

financial institutions.

To this objective, taking a comparative perspective with the abstract and general conception of

the freedom of contract in Western law, the paper will highlight how, in reverse, the logic of

fiqh, mirroring God’s actual justice, connects the “real” of economic conditions to the “rights”

of the parties in order to reconcile the legal and moral dimensions of human life.

From this actualisation of justice in real economy the paper will derive some inputs to advance

the regulation of Islamic financial institutions. In particular, a double-level regulatory

framework will be proposed to balance the efficiency of legal standardization with the moral

legitimacy of the Islamic market, through a paradigm of “near financing” able to connect the

“right” of legal rules to the “real” of economic development.

To conclude, the paper will underline how, within this double-level regulatory framework, the

institution of waqf could play a primary role as an instrument to connect the global capital

market with local responsible investments, thus further contributing to justice in market

economy.

Keywords

Freedom of contract; Islamic justice; fiqh; regulation of Islamic financial institutions.

Conference paper (excluding author names and affliations)


2

(Part I)

Does Islamic law recognize the freedom of contract (‘aqd)?

Easy answers and more challenging questions

(1) Does Islamic law recognize the freedom of contract? (2) What do we mean by speaking of

contractual freedom? (3) And how much is the contemporary we implicitly assuming Western

legal postulates in dealing with this issue in the context of Islamic law and finance?

(1) The primary objective of this paper is not to investigate the extent to which Islamic law

recognizes the “freedom of contract” (in Arabic, ‘aqd), or, more correctly, a “freedom of

contracts” (‘uqud), since a unique and general theory of the contract, as it is well-known, does

not exist in fiqh classical treatises.

Notwithstanding, an answer can be easily given to this question.

Looking at the Islamic legal tradition, the conclusion that a doctrine of contractual

freedom does exist in classical fiqh can be inferred from a list of elements: e.g. the normative

pluralism characterizing the interpretation of shari‘ah by the madhahib; the variance of legal

opinions even within the same madhhab; the variations that certain types of contracts have

experienced both in time and in space in the light of local ‘urf, customs; the acceptance by the

Hanafis and the Shafi‘is of “legal stratagems” – hiyal – to reconcile the legitimacy of the

contract and the practical needs of the parties, as a proof of adaptability of the contract to social

life; and so on.

(2) But much more difficult is to establish what we mean by speaking of “freedom of contract”.

Within the Western legal tradition,1 this doctrine derives from a libertarian conceptualization of

the marketplace as a locus of human interactions, holding the single individual able

(i) to assess his interest to enter or not a contract, as well as whether to contract or not with a

certain counterparty;

(ii) to define the best regulation of his economic interests in dealing with this counterparty

(thus creating, modifying or removing certain legal relations);

(iii) to choose, among existing contractual types, the best “form” to rule these relations, or

even to structure new contractual types (by creating new forms, or combining existing

contracts), be this solution the most efficient to undertake.

Generally speaking, the freedom (i) to enter a contract, (ii) to bargain for terms within a

contract and (iii) to choose among different contractual types (existing or defined anew)

1 That is to say, the legal culture within which this concept has been developed in the last two centuries, and from

which its meaning is usually (as well as implicitly) derived.


3

(Dagan & Heller, 2013) has been recognized in the history of Western legal philosophy

according to different levels of libertarianism. Thus, the doctrine of contractual freedom has

been fostered or tamed at different degrees,

(i) by limiting more or less extensively the access to the contract by “weak” subjects (e.g.

the minor of age; the mad person; the inexperienced or vulnerable subject; the consumer; the

investor in the financial market…);

(ii) by exalting the freedom of contract as a slogan for laissez-faire capitalism or, reversely,

by opting for the protection of the weak party in the interaction with the strong one;2

(iii) promoting parties’ self-regulation, either through their choice of the best contract or the

invention of new contracts,3 as expression of an assumed “invisible hand” ruling the market.

A corresponding investigation of the freedom of contract can be drawn by moving from its

underlying philosophy (the “natural law” of each party to exercise his free will in the contract)

to Western scholarship and legislation (the “positive law” of State jurisdiction and policy-

making). In this light, the doctrine of the freedom of contract was originally elaborated in the

19th

century French literature, embodying the Enlightenment myth of a self-regulating

rationality (Ranouil, 1980) that presupposed the autonomie de la volonté (that is to say, the

“autonomy, self-determination” of the human will: see also Gutmann, 2013) as cornerstone of

contractual theory. As highlighted by Atiyah (1979), this enthusiastic devotion to the free will

has later moved in Western law towards a progressive dismantling of the freedom of contract

in the 20th

century, in the light of a more in-depth social approach to the market.4

(3) After this clarification on the “strong” and “weak” notions of contractual freedom, a more

challenging question can be advanced: how much is the contemporary we implicitly assuming

Western legal postulates in dealing with this issue in the context of Islamic law and finance?

As previously remarked, one can certainly deduce from fiqh sources that Islamic law

recognizes the freedom of contract, as conceptualized in the West. But, may it appear

contradictory, this paper does not really deal with this freedom of contract. On the contrary, it

assumes that the less “contractual freedom” as a Western concept is considered in Islamic law

and finance, the better it is.

2 The laissez-faire being the main approach to the regulation of the market in the past, while the latter emerging in

later contract theory of 20th

century. In this frame, Atiyah (1979) has significantly opposed the “rise” and “fall” of

freedom of contract to summarize the evolution of the concept in Western legal theory. 3 E.g. hire-and-purchase in the leasing; multi-ownership structures; synthetic securities; derivatives financial

instruments… 4 Of course, this “fall” has not been extended to any commercial field: for instance, the financial market has

experienced till recently a public policy of de-regulation, by assuming contractual freedom as the core of

competition and efficiency.


4

Here, the risk is to contaminate the search for an Islamic understanding of the freedom of

contract in the marketplace, founded on the specific logic of fiqh, with Western concepts that

were neither originally at stake nor even considered in classical Islamic law. In other terms,

strong hermeneutical concern is required to avoid some easy misunderstandings that can derive

from the replication in Islamic law and finance of concepts that have been formulated and

developed, vice-versa, in a foreign culture, that is to say the Western legal tradition.

Indeed, if something comparable to Western law can be found in Islamic fiqh, as

previously admitted, one should primarily distinguish the “strong” concept of autonomie de la

volonté from the “broad” meaning of the freedom of contract.5 Subsequently, it should be

underlined how the two notions relate to different faculties: the former to the production or

change of the legal order (an exclusive prerogative of God in Islamic law); the latter to the

freedom to regulate economic interests. In this sense, one may conclude that while Islamic fiqh

does not recognise the autonomie de la volonté (being God the only Ruler), yet it does uphold

freedom of contract.6

Within this background, all the classical madhahib show a general favour towards the

enforceability of a variety of commercial transactions, apparently restricted to a closed list of

contractual types, but whose structures, in reality, have been permanently adapted by fiqh

casuistic method in the light of a flexible contextualization of justice to the real economic

conditions of the parties.7 In this sense it has been correctly remarked how the casuistic method

of Islamic law evades any general theory of contract; rather, the treatises propose a list of

contracts, whose prototype is the sale (bay‘), as the model of any exchange of values, and

provide a system of nominate contracts rather than a theory of the contract.8 Thus, fiqh upholds

what can be described as a “plural system of nominate contracts”, fostered by a normative

variance that has established, in different time and space, and according to the interpretative

5 While the French autonomie de la volonté can be seen, in fact, as a juristic principle rooted in Western legal

philosophy stating that the free will of the individuals produces changes in rights, freedom of contract is more a

matter of legal policy, stating that individuals are free to change their rights as they please: a certain shift from a

myth of “natural” self-empowerment to “state” policy-making is therefore implied. 6 My conclusion here is opposite to that by Rayner (1991, p. 97, note 59).

7 A concept on which the paper will widely focus later on.

8 “The system used by the jurists to categorize the nominate contracts was to determine whether, in any given

contract, right passed in ownership or possession, and whether consideration passed or otherwise. The basic

nominate contracts number four:

i. Bay‘ (sale): where right of ownership passes for consideration (tamlik al-‘ayn bi-‘iwad);

ii. Hiba (gift): where right of ownership passes without consideration (tamlik al-‘ayn bila ‘iwad);

iii. Ijara (hire): where transfer of possession occurs for consideration;

iv. ‘Ariya (loan): where transfer of possession occurs without consideration.

Other nominate contracts include those of salam (a contract for delivery with prepayment), mudaraba ([sleeping]

partnership agreement; equity sharing between bank and client), sharika (partnership), mortgage (rahn), ju‘ala,

wadi‘a (deposit), al-muzara‘a (an agricultural contract where the landlord provides the land, seed and plants, and

the worker provides the labour) and ‘umra” (Rayner, 1991, pp. 100-101).


5

work of the madhahib, “how far, if at all, may the parties vary this rigid scheme (i.e., the strict

defining of each contract in terms of its purpose and effect) by introducing agreed special terms

as appendages to the particular nominate contracts they are purporting to conclude” (Coulson,

1984, p. 51).

Although something comparable to the Western freedom of contract was not discussed by

the jurists as an abstract concept per se, further considerations on the matter can be derived

from their attitude towards the admissibility of new contracts, as well the acceptance of

variations/additions to nominate contracts.9 Generally speaking, classical scholars maintained a

narrow view on the admissibility of new contracts, except for the Hanbalis.

The early jurists were concerned that all contracts were free from suspicion of usury and uncertainty,

characteristics which served to nullify any transaction. As a result of this, they decided that individuals

should contract according to the rules of nominate contracts, and thus, not generally free to establish or

create any new and possibly illegal stipulations. Nevertheless, the Hanbali jurists constituted an exception,

for they permitted freedom of contract under the doctrine of ibaha: non-restriction was, for the Hanbalis,

the general rule (El-Hassan, 1985, p. 54).

In fact, despite the Qur’an emphatically advocates the moral obligation to fulfil contracts and

undertakings: “O ye who believe! Fulfil (all) obligations [‘uqud]”10

(Q. V:1) and the sunna

remarks how “Muslim are bound by their stipulations”,11

the enforceability of any kind of

agreement was debated in classical fiqh. More precisely, only the Hanbalis, as shown by Ibn

Taymiyya (d. 728/1328), interpreted the sanctity of contract in Islam as a presumption of

legality of any stipulation not expressly forbidden (doctrine of ibaha):

The underlying principle in contracts and stipulations is permissibility [ibaha] and validity. Any [contract

or stipulation] is prohibited and void only if there is an explicit text [from the Qur’an, the sunna or the

consensus] or a qiyas [analogy] (for those who accept qiyas) proving its prohibition and voiding.12

For the advocates of the freedom of contract in Islamic law, this standpoint found further

support in the Qur’an (“O ye who believe! Eat not up your property among yourselves in

vanities: but let there be amongst you traffic and trade by mutual good-will… [tidjaratan ‘an

9 For a concise investigation of the topic with reference to the legislation of Arab countries, and its divergence

from classical Islamic law, see Saleh (2001). 10

See also Q. VI:153; XVII:34. 11

“Abu Dawud; Tirmidhi; Nasa’i; Ibn Hanbal; Hakim. In other chains additional phrases appear, such as “[but

only] those [stipulations] that agree with the truth”, or “except a condition that makes illicit the licit, or makes licit

the illicit” (Vogel, 2006, p. 15, note 61). 12

Ibn Taymiyya, Fatawa III 474 (quoted in Vogel, 2006, p. 29).


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taradin minkum]”13

(Q. IV:29)). Thus, the Hanbalis claimed that the “only condition

required… for the validity of any contract is the mutual consent of the contracting parties”,

(Rayner, 1991, p. 94) and supported the “reasonable presumption that all contracts are valid

subject to their being expressly forbidden by rule of law, or they contain voidable stipulations,

or contravene Islamic prohibitions (especially those of riba, maysir and gharar), or public

policy or morals” (ibidem, p. 95). As a result, the Hanbalis recognized any innominate contract

provided that it conformed with two fundamental principles of Islamic law, that is to say, the

principle of liberty to contract within the limits of divine law and the principle of sanctity of

contracts (pacta sunt servanda).

This interpretation was opposed by the other Sunni schools (Hanafi, Maliki and Shafi‘i),14

that ascribed to the previous lines of the Qur’an and the sunna the simple value of moral

imperatives. Opposing to the doctrine of ibaha, they argued that the governing text on the

matter was “But do not transgress limits; for Allah loveth not transgressors” (Q. II:190),

supplemented by the sunna of the Prophet: “How can men stipulate conditions which are not in

the book of Allah? All stipulations which are not in the book of Allah are invalid, be they a

hundred in number. Allah’s judgment alone is true and His stipulations alone are binding” (El-

Hassan, 1985, p. 57; see also Coulson, 1984, pp. 100-102). For this reason, they refused any

combination of contracts or the attachment of conditions as invalid.15

However, the apparent

rejection of contractual freedom by the Hanafis, Malikis and Shafi‘is was balanced in their

theoretical approach by different techniques, such as the acceptance, at various levels, of legal

stratagems (hiyal) to reconcile the principles of law with the need of social life.16

At the same time, if something comparable to the Western freedom of contract can be

recognized in Sunni fiqh (as implicitly suggested in these pages), it did not originate per se

from a supposed “free will” of the individual (the French autonomie de la volonté) but was

intended by the classical jurists as the outcome of what revealed by God in the shari‘ah, as the

unique source of justice in Islam. It is indeed this conceptual rectification that should lead to a

radical change in the way in which we look for the freedom of contract in Islamic law…

13

“Mutual good-will” is probably the best translation of taradi, since it reflects the original meaning in Arabic

language, avoiding Western equivalents such as “consent” or “mutual consent” (“mutual good-will” is the

interpretation also proposed by Yusul Ali, 1975). 14

According to Zahraa, anyway, the position of the Malikis should be judged more similar to that of the Hanbali

school (1998, p. 274). 15

“… le principe de la liberté contractuelle ne saurait être admis dans un tel système” (Chehata, 1970, p. 136). 16

In this specific regard, see Horii, 2002. For an investigation of the admissibility in classical madhahib of

different conditions/stipulations (shurut) attached to a nominate contract (shurut al-muqtarina bi-l-‘aqd) see also

Arabi, 1998.


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(Part II)

A radical change of normative paradigm:

from the abstract freedom to God’s actual justice

… in fact, the content of the previous paragraph – inasmuch as it proves the existence of

something comparable to the Western freedom of contract in classical fiqh – actually deprive

Islamic law of its own logic in the understanding of shari‘ah as the revelation of God’s Will.

In this sense, Calder has remarked how

Western scholarship (even when written by Muslims) has rarely presented Islamic law in such a way as to

demonstrate its values rather than the values of the observer. It is the legal practice in the Western sense

(which admittedly corresponds to the special concerns of some Muslim jurists) that dominates the standard

introductions to the subject […]. Certain features of Muslim juristic discourse, those perhaps which are

most revealing of its nature and its intentions, are in such works disregarded in favour of a search for

practical rules (Calder, 1996, p. 979).

Significantly for our topic of discussion, aimed at locating the freedom of contract in the

intersection between the logic of fiqh and the law of Islamic finance, Calder refers to the book

by Saleh on Unlawful gain and legitimate profit in Islamic law to exemplify the tendency to re-

formulate Islamic fiqh in the light of Western law by “reasserting Shari‘ah as a valid and

sensible corpus of commercial and civil laws” (Saleh, 1986, p. 4).

What he wants to achieve is a “financial system based on Islamic ethics”, the subject matter of his final

chapter. What stands in his way, and it does stand in his way, is the tradition of Muslim juristic writing. He

goes through it honourably; but its variation, its complexity, its extravagant exploration of detail, its

constant citation of different authorities, its apparent irrelevance, sometimes, to practice, its cunning and

witty accommodation, sometimes, to practice: all these things make his task difficult, and will alert his

readers to the fact that “a valid and sensible corpus of laws” is not quite what these jurists had in mind

(Calder, 1996, p. 979).

So, what classical Muslim jurists had in mind, if not “a valid and sensible corpus of laws”?

This question deeply affects the attempt to define which freedom of contract (if not that

something comparable to Western law that we have already identified) the logic of fiqh

upholds.

In my view, an appropriate reply to the issue requires to adhere as much as possible to

Islamic anthropology and to its conceptualization of justice (‘adl) as outcome of God’s Will, in

establishing what is “right” (haqq) through the Truth (again, haqq) of the revealed “Path”


8

(shari‘ah). As summarized by Netton (1989), Islamic justice embraces a Qur’anic Creator

paradigm, conceiving “a God who (1) creates ex nihilo [and of whom the human being is

agent]; (2) acts definitely in historical times; (3) guides His people in such time [shari‘ah as

revelation of God’s Will]; and (4) can in some way be known indirectly by His creation

[science of fiqh]” (p. 22).

In the constant actualisation of God’s creation in historical times, it is God’s “decree”

(hukm), as communicated through shari‘ah, to rule. In fact, the notion of hukm relates to the

meaning of “judging”, “ordering”, “ruling” (Wehr, 1994) and implies an established divine

judgement on the ontological status of the action. In view of that, al-Ghazali, as one of the most

celebrated medieval Muslim theologians (A.H. 450-504/C.E. 1058-1111), explains in his al-

Mustasfa (Quintessence) that “a rule (hukm)… denotes the dictum of the revelation when it is

linked to the acts of those made responsible” (Moosa, 1998, p. 9).

In this understanding of human ethics, the hukm determines a pre-defined deontological

status of the action that the reality created by God ontologically actualizes in the “right”

(haqq). In other terms, while the hukm defines the ethical status of the action, the personal

rights (huquq, pl. of haqq) are the means through which the Creator realizes (in the proper

sense of “making real”) that status. The outcome is

a vision of the reality as being in its essence imperative, a structure not of objects but of wills. The moral

and the ontological change places, at least from out point of view. It is the moral, where we see the

‘ought’, which is a thing of descriptions, the ontological, for us the home of the ‘is’, which is one of

demands. […] The ‘real’ here is deeply moralized, active, demanding real, not a neutral, metaphysical

‘being’, merely sitting there awaiting observation and reflection; a real of prophets not of philosophers

(Geertz, 1983, pp. 177-178).

Hence, as significantly remarked, “in Islamic legal sensibility, to determine the empirical

situation is to determine the jural principle. Facts, in other words, are normative, there is no

fact/law dichotomy” (Merry 1988).

In the Qur’anic Creator paradigm, not only is the “real” (haqq) deeply moralized as

materialization of the Truth by the Legislator (al-Hakim), but also the “right” (haqq, again)

reflects in its conceptual structure the unity (tawhid) of the creation, to the extent that an

opposition between the “right” (as the active side of a bilateral juridical relation) and the

“obligation” (its passive counterparty), as in the Western legal thought, does not exist anymore.

In this perspective, Kamali has underlined that


9

the Shari‘ah does not seek to eliminate the distinction between rights and obligations or to emphasize their

duality and division […]. In the Qur’an, right and duty merge into justice so much so that they become, in

principle, an extension of one another. [… The] hukm (ruling) subsumes both rights and obligations. The

relationship between ruling and justice is also of means and ends: a ruling is the means towards justice,

while the fulfilment and realization of haqq in its dual capacities of right and obligation is predicated upon

justice. Islam thus seeks to establish justice by enforcing Shari‘ah rulings which, in turn, is expected

simultaneously to mean the proper fulfilment of rights and duties (Kamali, 1993, p. 357).

Considering all this, in which sense “a valid and sensible corpus of laws” cannot explain to its

deepest meaning the logic of fiqh within regard to contractual freedom?

This occurs to the extent to which while a Western legal approach to the world “describes

and prescribes human conduct in terms of rules, categories [i.e. the idea of freedom of contract]

and generalizations… [and thus] separates fact and law, or what is presented as the ‘is’ and the

‘ought’, promising answers in cases of dispute and leading itself to a distinctive form of

judicial decision-making, one that appeals to rules and generalities beyond the facts of the

particular case” (Pirie, 2013, p. 131), the logic of fiqh, in reverse, proceeds rather from quite a

divergent stance by assessing human acts in the light of the actualisation of God’s Will.

On the one side, Western legal thought, assuming a dichotomy between the “real” and the

“rule” of the legal principle (such as that of contractual freedom), leads to a systematization of

its normative discourse into a “valid and sensible corpus of laws” which has necessarily to

isolate its abstract and general concepts from the “real” of human conditions to sustain the

myth of its self-founding rationality. Accordingly, the principle of contractual freedom is

equally applied to all, being individuals seen as indistinguishable members of a generic

species, “standing in perfect parity before a blind lady of justice” (Hallaq, 2009, p. 166).

Within this dichotomy between law and reality, the balance between the “rule” (i.e. the

authority of state “positive law”) and the “good” (i.e. the inherent justice belonging to “natural

law”) identifies the “right” as the outcome of a persistent tension between the general principle

and the life of the human being.

On the other side, the logic of fiqh, mirroring the actualisation of God’s supremacy in

man’s agency (where the right, haqq, realizes, in the proper sense of “making actual”, God’s

decree, hukm, in the creation), proceeds, on the contrary, by deeming each individual and

circumstance as unique and ijtihad necessarily occurrence-specific, since specifically actual is

God’s creation in each instant. In this sense, inasmuch as the West separates the general rule of

contractual freedom from the real economic conditions of the parties, fiqh has necessarily to

connect the “real” to the specific “right” (haqq) of the parties, as established by God’ decree

(hukm) in the creation as actual justice.


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Accordingly, an Western “abstractisation” of contractual freedom, as well as the

elaboration of a general theory of the contract, the standardisation and proceduralization of

practices become of scarce (if any) importance in the logic of fiqh, focused on the “reality” of

God’s justice, rather than on the “abstract” search for rational principles, since only the

meeting between revelation and reason leads to mirror God’s justice in the actual creation.

In summary, when looking at the logic of classical fiqh according to its own values and

not to the “values of the observer”, the Western abstract and general conceptualization of

contractual freedom (detached from real economic conditions) appears deprived of any

consistency. Within its own normative paradigm, in fact, Islam has never accepted the Western

notion of “blind justice”, for it allowed the rich and the powerful to stand on a par with the

poor and the weak. On the contrary,

[i]n the Shari‘a, the latter had to be protected, and their disadvantage was turned into an advantage in the

Shari‘a courts of law. This in part explains why there was no point in stating the law in the way that it is

recorded in today’s legal codes. Rather, the law was an ijtihadic process, a continuously renewed exercise

of interpretation. It was an effort at mustering principles as located in specific life-situations, requiring the

legists to do what was right at a particular moment of human existence. Even in its most detailed and

comprehensive accounts, the law was mostly a guide that directed the judge and all legal personnel on the

ground to resolve a situation in due consideration of the unique facts involved therein. As a fully realizable

and realized worldly experience, Islamic law was not fully revealed unto society until the principles

meshed with social reality and until the interaction of countless social, moral, material and other types of

human relations involved in a particular case was made to come full circle. In other words, Islamic law is

not that found in the books of the jurists, but rather the outcome of a malleable and sensitive application of

rules in a complex social setting. To know what Islamic law was, therefore, is to know how actual Muslim

societies of the past lived it; but most certainly it is not merely the law as abstracted in the books of jurists

(Hallaq, 2009, pp. 166-167; italics in the original text).

In the end, if a principle of contractual freedom is to be found in the logic of Islamic fiqh,

within the Qur’anic Creator paradigm of Ash‘ari orthodoxy (Netton, 1989), this principle

cannot be identified in the light of Western legal thought, but within a proactive actualisation

of justice, by mustering principles as located in contextualized life-situations, closing a full

circle comprising legal reasoning as well as a countless social, moral and material human

relations involved in the particular case. In other terms, it is by bending the rigidity of the

(abstract) rule to the diversity of (real) human life that Islamic jurisprudence has reconciled

God’s perpetual creativeness and His justice for the mankind, as actualised in the reality of

human history.


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To conclude, it is this actualisation of justice connecting the economic “real” to the legal

“right” that has to be taken into consideration to balance the legal efficiency and the moral

legitimacy of the Islamic market, thus guaranteeing the (full) contractual freedom of the

parties.

In the light of this reflection, the next section will advance some policy-making inputs to

strengthen the regulation of Islamic financial institutions, by balancing the private performance

of God’s Will (as cornerstone of the legitimacy of human action in Islamic thought) with the

public efficiency of the marketplace. In this sense, the paper will argue that the development of

national legislations, legal collections and standards in the Islamic financial market, to the

extent to which has certainly contributed to its efficiency, has indirectly deprived Islamic

finance of its inherent legitimacy as actualised justice. To make up for this disequilibrium (that

can be deemed responsible for narrowing the distinction between conventional and Islamic

finance), the paper will propose some hints to reconcile the criteria of efficiency and legitimacy

in the Islamic market, in accordance with the logic of fiqh.

(Part III)

Islamic contractual freedom and financial regulation:

actualising justice in the efficiency/legitimacy equilibrium

Moving from Western legal thought to the reality of God’s justice in the logic of fiqh, this

section will try to draw from the Islamic conception of contractual freedom, as contextualized

in the real economy, valuable policy-making inputs to improve Islamic finance regulation.

As well-known, an appropriate enabling environment is fundamental for the efficiency of

any market. At the same time the legitimacy of Islamic finance, emphasizing the ethical, social

and moral dimensions of wealth creation as direct result of God’s decree (hukm), cannot be

undermined by moving from the “real” (haqq) to an “abstract” contractual freedom, as in the

Western legal thought (thus locating the rich and the poor at a par, without looking for an

ethical distribution of wealth).

In this precise sense, the pursuit of an enabling environment for Islamic finance not only

requires the efficiency of the market to be fostered, but also the legitimacy of an actualised

justice, as the core of the logic of fiqh, to be nourished.17

17

On the current trade-off between legitimacy and efficiency in the Islamic financial market, see El-Gamal, 2006.


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But, unfortunately, in the debate about Islamic finance regulation, much attention is

usually given only to the first term, by calling for a standardisation of legal rules as a necessary

must to ensure the global efficiency of the market.

Just to give an example of this tendency, it has been said that

[d]isagreement and different interpretations over what is Shariah-compliant and what is not continue to

make it difficult to establish the necessary regulations for the industry to develop globally accepted

products. Some people argue that standardisation is an unrealistic goal, given the fragmented nature of

Islamic finance. I do not agree. There is a need for balanced, globally accepted regulation that does not

impede growth or allow for abuse. […] We need to create an enabling environment for cross-border

connectivity through Islamic finance. This will require measures to develop domestic capital markets and

should go hand-in-hand with national market reforms, based on common international standards.18

To a certain extent this concern for a common legal frame for Islamic finance, able to reduce

the uncertainty of shari‘ah practice in the market, is certainly agreeable, and it has been

already much satisfied by a variety of regulatory bodies and instruments: state legislations at

the national level (e.g. the well-known case of Malaysia; the specific legal and fiscal

interventions by the UK government); the constitution of independent regulatory institutions,

aimed at setting standards for the Islamic market (e.g. AAOIFI; IFSB; ISRA); as well as

important publications of legal collections and maxims, which have to be undoubtedly

welcome as a valuable support for the market actors.

This trend has been understandably supported also by eminent Shari‘ah scholars, as it

certainly represents one side of the strengthening of Islamic financial market regulation.

Thus, in the words of the Malaysian scholar Dr. Mohammed Daud Bakar,19

…the aim of having a standard is to bring the market into harmonious practice, bring costs down, and to

make it clearer for investors. […] I am for one to have Sharia standardization – but is still one of the

issues that is being debated.20

At any rate, while this position is completely sharable in the light of the certainty of law, the

practicability and the efficiency of legal standards, it appears at the same time unable to fully

promote the legitimacy of an actualised justice in compliance with the logic of fiqh.

18

Hussain Al-Qemzi, CEO of Noor Investment Group and CEO of Noor Islamic Bank, as reported online at Saudi

Gazette website (2013). 19

Member of AAOIFI, Chairman of the Central Shari‘ah Advisory Council of the Central Bank of Malaysia and a

member of the Shari‘ah Advisory Council of the Malaysian Securities Commission. 20

Position held at the International Islamic Finance Forum (IIFF), Dubai, as reported in Arabian Business (2008).


13

The efficiency and legitimacy of the Islamic market has necessarily to complement one

another in a balanced equilibrium, as “they will stand or fall together”, simul stabunt vel simul

cadent, in defining the future of the industry.

In other terms, if the inherent ethics of Islamic finance can be fully appreciated only in the

fundamental balance between legal rules with moral, social, material conditions, as created by

God’s Will, to the extent to which the development of national legislations/codifications, legal

collections, maxims or standards harmonizing Islamic finance at a national/global level are

certainly helpful and desirable for market actors, these normative devices cannot replace the

necessity to actualize justice in the empirical situation, for the “right” (haqq) to become “real”

(haqq) in economic development.

Hence, besides legal standards, which certainly represent the fundamental device to foster

market efficiency, the legitimacy of Islamic finance requires a regulatory framework also

aimed at an actualisation of justice as ethical materialization of God’s Will, through an

authentic implementation of contractual freedom according to the logic of fiqh.

Holding this primary criterion for an efficiency/legitimacy equilibrium in Islamic finance,

some policy-making inputs can be advanced for the strengthening of the market in the light of

what the conclusions of this paper will summarize as a double-level regulatory framework.

(A) Hence, as a corollary of the interconnection efficiency-legitimacy in Islamic finance, a

more general move towards a paradigm of near financing should be further implemented in the

market in order to merge the legal “right” (haqq) with the economic “real’ (haqq).

The demand for a paradigmatic shift for the Islamic financial industry, in order to

undertake a more committed effort towards the alleviation of poverty, has already been

advanced, both by practitioners, market participants (Muslim believers or not) and scholars.

Recently, for instance, the attention has been focused on the implementation of models of

micro-credit and micro-finance (mainly by replicating the well-known “bank for the poor”,

Grameen Bank, by Nobel Laureate Prof. Muhammad Yunus), adapted to Islamic finance

through the elimination of interest (riba). Furthermore, the request for a more ethical

perspective in the light of social banking has emerged in Islamic finance literature (especially

in the frame of Islamic moral economy and maqasid al-shari‘ah), according to a trend

comparable to the moralization of the market underpinning Western economic scholarship in

the aftermath of the financial crisis.

But, while both the model of micro-finance and social banking are certainly compatible

with Islamic finance, its own peculiarity should be found in a paradigm of near financing to be

drawn directly from the actualized justice nurturing the logic of fiqh. In this sense, shaping


14

bank activities “as close as possible” to the recipient communities should be seen not only as

the theoretical background for Islamic finance, but should also orient the practice of the

industry towards a linkage between the (global) capital market to the development of (local)

responsible investments, thus contextualizing justice in the “real” economy.21

(B) As a direct corollary of this paradigm, to fully “realize” contractual freedom in Islamic

finance, major attention should be directed towards the role of shari‘ah scholars operating in

the market. In fact, being in charge for an ijtihadic process, as a continuously renewed exercise

of implementing shari‘ah (the “reality” of the revelation as it is) in human life through fiqh

interpretation (the “reality” as it is understood: Faruki, 1962, p. 252), in an “effort at mustering

principles as located in specific life-situations” (Hallaq, 2009, p. 166), shari‘ah scholars should

be deemed accountable for connecting general rules (as shaped by state legislations and legal

standards) to real economy, thus filling the (otherwise persistent) gap between the “abstract”

freedom and the “empirical” life of economic actors.

A gap that, if bearable in the light of a legal regulation and a conceptualization of

contractual freedom from a Western perspective, becomes intolerable in the logic of fiqh, for

the inherent ethics of Islam to be realized.

This contextualization of justice should consequently affect the criteria currently applied

for shari‘ah scholars selection and monitoring.

On the one side, shari‘ah scholars should not been selected anymore only within a

“golden” circle of intellectuals with strong reputation in the market. Inasmuch as these

authoritative figures fully satisfy the search for legal/general rules, in reverse their factual

impossibility to contextualize justice in the light of the needs of (intrinsically) different social

recipients is self-evident. In other terms, their valuable role in the market should been

accompanied by the choice of local shari‘ah scholars acting as medium between Islamic

finance general rules and the real market, whose position would become comparable to the

traditional role of the faqih, the expert of fiqh, or the qadi in medieval Muslim societies,

implementing general standards into the particularistic dimension of social communities.

Further efforts are certainly needed towards this aim, both in terms of educational

programs for professional shari‘ah scholars (combining in their curriculum elements of Islamic

law, micro-economic and social welfare management); as well as in the definition of a

regulatory framework able to allow Islamic finance standards to be flexibly implemented in

local social realities, thus smoothening the rigidity of the general norms into the elasticity of

real life, as the logic of fiqh requires. In this sense, examples of harmonization and

21

On this point, see also the conclusions of the paper.


15

standardization of norms, reconciled with local practices, are well-known in the history of fiqh

(e.g. the role of customs, ‘urf, as source of regulation in classical treatises), and should be re-

appreciated.

On the other side, the selection of shari‘ah scholars in the light of the parameter of

actualized justice should naturally lead to the monitoring of their consultancy role through a

criterion of accountability referred to their role to connect general rules to real economy, acting

as professionals specialized in “bridging” the executive management of Islamic financial

institutions to the local needs of the social communities where those credit institutions operate.

Hence, corresponding mechanisms and procedures addressed to involve locally based shari‘ah

scholars in the shaping of business plans, social investment strategies and wealth creation

should be fostered; at the same time, the responsibility of shari‘ah scholars should be framed

in the light of their satisfactory (or unsatisfactory) capability to contribute to actualize

economic justice in the local community.

(Conclusions)

“Unity in diversity” through a double-level regulatory framework:

the potential of waqf to connect the global market to local responsible investments

The regulatory framework proposed in this paper, advancing a model of legal norms balanced

by moral standards through the practice of fiqh as actualized justice, has been anticipated, in

some aspects, by Dato’ Muhammad Bin Ibrahim, Deputy Governor of the Bank of Malaysia. In

his keynote address at the Asia Islamic Banking Conference in 2010, he has remarked how

[i]n offering Islamic financial services, institutions are bound by a common thread in Islamic finance,

where all transactions must be in congruence with Shariah. However, differences in opinion on the

application of Shariah in financial products across market have often been pointed out to be a major issue

which could hinder a more robust expansion of Islamic finance internationally. Notwithstanding the desire

for more standardisation, we should be mindful not to suppress the generation of alternative point of views

which could be the seeds of innovation and breakthroughs in the marketplace. We need to transform the

differences of Shariah views into competitive strengths for the industry. History has shown that diversity in

opinion had led to the great Islamic civilisation. We should take recognition of this lesson in history. I

therefore would like to suggest that the international Islamic financial community to subscribe to the

fundamental principle of unity in diversity. […]


16

We can agree that complete convergence is neither practicable nor achievable, as Shariah also recognises

differences in customs and cultural practices between various societies. Also, the use of ‘urf, the

methodology through which customary practices are recognized, enables different societies to function

smoothly and efficiently, provided they are not antithetical to the principles of Islamic law of transactions.

‘Urf in Islamic law refers to the general opinion or customs of a community, and forms the basis for rulings

issued by a mujtahid or a group of mujtahids, who has attained the right to exercise ijtihad, which is an

important part of the process of making a Shariah ruling (Bin Ibrahim, 2010).

The reference to a principle of “unity in diversity” and to the exercise of ijtihad defined in the

light of local customs are related to an actualized justice which should orient the practice of

fiqh and Islamic finance towards a double-level regulatory framework, where general legal

rules are combined with the particular moral understanding of real economic conditions, as

described in the pages of this paper.

Within a strengthened paradigm of near financing, through the implementation of a

double-level regulatory framework, a new flourishing for waqf institutions and their intrinsic

philanthropic objectives can be foreseen.

Of course, if on the one side the governance of waqf charities can certainly adopt the

general standards shaped for the Islamic market as guidelines, on the other side, their

fundamental function of eradicating poverty and promoting local economic development calls

for a contextualization of global investments into local justice, by channeling the Islamic

capital market into those philanthropic aims that can be properly assessed only at a local level.

In this sense, the governance of waqf, while inspired by parameters of economic stability

and efficiency, should also incorporate principles of mutuality already applied in the

international non-profit industry, looking at the development of the social community rather

than the free competition among market actors.

Once again, a change in the paradigm of contractual freedom according to the logic of fiqh

can be revealing of the most inner nature of waqf institutions, which can factually materialize

the “reality” of Islamic economic justice, in the light of God’s Will, through the fairness of

distribution of local wealth, where the disadvantage of the poor and the weak are turned into an

advantage by the waqf administration. This could occur also through the appointment of a

representative of the local community as member of the charity governance, mirroring what

has been suggested for the appointment of shari‘ah scholars in Islamic financial institutions in

the management of the waqf through the interaction between executives and civil society.

In this sense, the rediscovery of the institute of waqf in the Islamic financial industry must

be certainly welcome for its inherent philanthropic connotation and possible contribution to a

fairer distribution of wealth in the market. At the same time, may be this rediscovery simply


17

perpetuate an unsatisfactory performance of the Islamic financial market, where human

freedom remains at an “abstract” level (as in the Western legal and economic thought),

accepting the “unequal freedom” existing in the market, then the promise of Islamic finance,

and its inner potential of philanthropic financing, will be unfortunately disregarded.

On the contrary, to the extent to which the institute of waqf will be inserted within a

double-level regulation framework, filling the gap between global finance and local instances

of social development, its implementation will certainly represent a step forward into the future

of Islamic finance as actual alternative to the conventional market.

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