due_logo
Search
Close this search box.

Table of Contents

Gharar

Definition

Gharar is an Arabic term that refers to uncertainty, ambiguity, and deceit within business or financial dealings in Islamic finance. In essence, it states that uncertainty or the lack of information about a financial transaction is unacceptable and haram (prohibited). This is because it could lead to unfair advantage, exploitation, or undue risk for one party.

Phonetic

The phonetics of the keyword “Gharar” would be: /ɡəˈrɑr/

Key Takeaways

  • Gharar is a concept in Islamic Banking: Gharar essentially refers to a contractual term that is uncertain or ambiguous in the Islamic financial system. It is a prohibited concept in Islamic finance as it can pave the way for deceit and unjust practices, thus it is prohibited in Islamic law (Shariah Law).
  • Includes Ambiguity and Uncertainty: The term Gharar is associated with uncertainty, ambiguity, and deceit that is often present in contracts. Any deal where the outcome is obscured or the probability of occurrence is not known can be considered as Gharar. This includes transactions with high unpredictability, speculation, and risk, or those where the details of the contractual obligations are uncertain or unknown.
  • No Speculation or Gambling: Since Islamic finance is based on a system of risk-sharing and avoiding exploitation, elements such as speculation, gambling, and unnecessary risk are seen as Gharar and are therefore prohibited. This further extends to contracts that are incomplete or lacking in essential detail, all of which contribute to the uncertainty and ambiguity that constitute Gharar.

Importance

Gharar is a critical term in the business/finance world, particularly in Islamic finance, where it describes a risky or hazardous sale, or uncertainty in a business transaction which is prohibited in Islamic banking. It is significant because prohibiting Gharar ensures full transparency and discipline in financial transactions, which contributes to maintaining fairness and minimizing exploitation. It encourages clarity about the terms of the contract, the product or service involved, and reduces the chance for deceit or dishonesty. Hence, understanding and avoiding Gharar fosters trust and confidence in financial transactions and relationships and promotes financial stability and societal justice, key goals for economies globally.

Explanation

Gharar, an Arabic word, holds significant importance in the Islamic financial system, as it fosters ethical business practices and transaction transparency. Its main purpose is to eliminate any form of deceit, ambiguity or uncertainty in business transactions, which might lead to the exploitation or unfair treatment of any involved party. Gharar ensures a balance and fairness in Islamic financing, and fosters business models based on trust, clarity and mutual consent. From setting clear terms and conditions for business dealings to providing comprehensive information on product or service specifications, Gharar aims to promote ethical dealing and informed decision making.

In practical use, Gharar restricts the sale or purchase of assets, items, or securities that are uncertain or not yet in existence. This includes speculative transactions, derivatives trading, short selling, and other similar financial activities often associated with the conventional financial market. By banning transactions that are risky or based on probable outcomes, Gharar aims to prevent excessive risk and market volatility, thereby promoting a stable, predictable, and ethical financial environment. The principle emphasizes the importance of ensuring all parties involved in a transaction have a clear, substantial understanding of the terms and are confident in the outcome, which is critical in maintaining an equitable and just financial environment.

Examples

Gharar refers to a term in Islamic finance that stands for uncertainty, ambiguity, or risk. It is a forbidden activity in Islamic economic jurisprudence because it involves dealing with uncertainty, which could lead to unfair advantage or disadvantage to one of the parties involved in a transaction. Here are three real-world examples involving Gharar.

1. Sales of Undefined Goods: In this case, a business might not have clearly defined the detail of the goods being sold. For example, a car dealer selling a car without specifying its characteristics, such as make, model, year, or condition. This transaction is considered Gharar due to it being uncertain or ambiguous for the purchaser.

2. Uncertain Sale Agreement: An example of Gharar in this context would be a contract for a sale of goods on a future date without a fixed price. For instance, a homebuilder and a client may agree to a contract for a new construction property, but the final price is subject to change based on fluctuating costs of labor and materials. This deal is Gharar as it involves excessive uncertainty for the buyer.

3. Derivatives and Speculative Trading: In many traditional finance systems, instruments such as futures, options, and short selling are common. However, these involve high degrees of uncertainty and risk, thus these types of contracts would be considered Gharar in Islamic finance. For example, an investment bank sells complex financial derivatives to its customers, but it can be difficult to determine their actual value or potential payoff, hence the transaction involves elements of Gharar.

Frequently Asked Questions(FAQ)

What does the term Gharar signify in finance and business?

Gharar is an Arabic term that denotes uncertainty, ambiguity, and risk in a financial agreement. This concept is crucial in Islamic financial jurisprudence and prohibits numerous kinds of transaction that are common in conventional finance.

Why is Gharar important in Islamic finance?

In Islamic finance, transactions involving Gharar are usually considered unjust or exploitative as they might lead to problematic consequences. So, Gharar is strictly prohibited as per Islamic Law (Shariah) to protect the parties involved from unfair exploitation due to unequal distribution of risk.

Can you provide an example of Gharar?

For sure, a common example would be selling goods that a party does not possess or have control over at the time of the contract. For instance, selling a fish in the sea before catching it is considered Gharar because there’s a risk and uncertainty of the fish being caught.

Is Gharar comparable to the Western concept of risk?

While Gharar does incorporate an element of risk, it’s not wholly identical to Western concept of risk. Gharar refers to the uncertainty or ambiguity tied to the fundamental aspects of a financial transaction rather than the fluctuation in returns or prices.

What happens if a transaction involves Gharar?

In Islamic finance, any transaction involving Gharar is void and should not be carried out. Any profit derived from such a transaction is considered unlawful and should be returned or donated to charity to cleanse oneself from the financial disobedience.

How does avoiding Gharar impact the financial market?

Avoiding Gharar can lead to a more ethical and equitable financial system. It discourages speculative behaviour, reduces exploitation, and promotes risk-sharing and fairness in financial dealings. Therefore, it could potentially stabilize the market and increase trust among market participants.

Related Finance Terms

  • Islamic Finance
  • Risk Uncertainty
  • Islamic Contract Law
  • Prohibition in Shariah Law
  • Speculative Transactions

Sources for More Information

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More