The Hadith’s ban on forward contractsApril 25, 2012
Agreeing upon a price now for merchandize to be produced or delivered later, which is a pretty common, uncontroversial, and healthy tradition in free market economics, is banned by the Hadith, the collection of sayings and actions of Muhammad.
The following comes from one of the most important and widely accepted Hadith among Muslims, the Sahih Al-Bukhari, Book 34 (The Book of Sales [Bargains]):
Chap. 33. Al-Gharar (the sale of what is not present) and Habal-il-Habala (i.e. the sale of what is in the womb of an animal.)
1022. Narrated ‘Abdullah bin’Umar: Allah’s Messenger forbade the sale called ‘Habal-il-Habala which was a kind of sale practiced in the Pre-Islamic Period of Ignorance. One would pay the price of a she-camel which was not born yet and would be born by the immediate offspring of an extant she-camel.
Similar language appears in Book 10 (The Book of Transactions), Chap. 8, of the Sahih Muslim, another widely agreed upon Hadith, which states that “it is invalid to sell the commodity before taking possession of it” in reference to grain.
It is unfortunate for the world’s Muslims and their economic development that Muhammad made this choice that forever limited the types of transactions available to willing buyers and sellers operating in a free market.
One Western source describes the benefits of production contracts which Muhammad seemed unable to understand:
There are several potential advantages for producers who may consider a production contract. Such contracts may provide for a more stable income for the producer by reducing traditional marketing risks. Such contracts may allow a producer to benefit from technical advice, managerial expertise and access to technological advances provided by the contractor. An agricultural production contract may provide the producer with a guaranteed market, provided that the commodities are produced in accordance with the contract. Finally, such contracts may allow a producer to increase the volume of his business with limited capital since the contractor may often supply the necessary production inputs…
From the contractor’s perspective, production contracts may provide an orderly flow of uniform commodities so as to allow the contractor to control production costs. And such contracts may allow contractors to better respond to changing market conditions. The use of such contracts may allow a contractor to protect its investment in genetics and other intellectual property associated with a particular commodity.
Contemporary sharia financiers have tried to distinguish a forward contract from a futures contract, saying that a forward contract is clear enough to satisfy the requirements of sharia law. However, that interpretation still seems at odds with the plain language of the text above. More on the contract loopholes of sharia finance (salam and istisna’a) later…