DEFINITION of Gharar
Gharar is an Arabic word that is associated with uncertainty, deception and risk. It is a significant concept in Islamic finance and is used to measure the legitimacy of a hazardous sale or risky investment pertaining to either short selling, the selling of goods or assets of uncertain quality or delivery, gambling or contracts that are not drawn out in clear terms. Gharar is generally prohibited under Islam; there are strict rules in Islamic finance against transactions that are highly uncertain or that may cause any injustice or deceit against any of the parties.
In finance, gharar is observed within derivative transactions such as forwards, futures and options, as well as in short selling and in speculation. In Islamic finance, most derivative contracts are forbidden and considered invalid because of the uncertainty involved in the future delivery of the underlying asset. Islamic finance also strictly prohibits extending loans with interest, which it considers usury.
BREAKING DOWN Gharar
The word "gharar" is somewhat of a general term in the modern lexicon. Sales or financial transactions considered as gharar are judged relative to the level of misunderstanding that exists between parties and the level of uncertainty that the goods or payment can be delivered. Scholars differentiate between minor and substantial gharar, and while most derivative products are prohibited due to excessive uncertainty, other practices considered as gharar, such as commercial insurance, are vital parts of economic life. It is also permissible for a seller to short-sell fungible items, such as wheat and other commodities, to be delivered at a later date to a buyer.
A sale without physical possession is not necessarily condemned, but the promise of delivery by either party without credibility creates the violation. Transactions and contracts are considered as gharar when excessive risk or uncertainty is combined with one party taking advantage of the property of the other, or one party only benefiting by the other party's loss.
Origins of Gharar
The justification and guidance for forbidding contracts or transactions considered as gharar comes from the hadith, a revered book in Islam. It contains the sayings of the Prophet Muhammad, who spoke against the selling of the birds in the sky, the fish in the water, or the unborn calf in the mother's womb, saying, "Sell not what is not with you." Therefore, questions of gharar arise when a claim of ownership is unclear or suspicious. Clarity of the intended meaning of gharar also comes in the Quran, where it states, "And do not eat up your property among yourselves for vanities," which is interpreted as the prohibition of predatory business practices.