Gharar

Gharar is excessive uncertainty, ambiguity or hazard in the essential elements of a contract under Islamic law. A contract affected by serious gharar is one in which a party does not know with reasonable certainty what is being sold, what it will cost, or whether it will be delivered at all, so that one side's gain may come from the other side's ignorance. Together with riba (interest) and maysir (gambling), it is one of the three main prohibitions that shape Islamic finance.

The Arabic root carries the sense of risk, peril and deception. Classical jurists did not treat all uncertainty as forbidden; they distinguished between uncertainty that goes to the heart of the bargain and the ordinary, unavoidable uncertainty present in any trade.

The prohibition rests mainly on hadith reports, the best known of which, recorded in Sahih Muslim, states that the Prophet forbade the "sale of gharar". Other reports prohibit specific sales that jurists treated as illustrations of the rule: selling fish still in the water, a bird in the air, the unborn young of an animal, or fruit on the tree before it has begun to ripen. Scholars of fiqh al-mu'amalat, the jurisprudence of commercial dealings, derived a general principle from these cases: a sale must identify its object, its price and its delivery clearly enough that neither party is gambling on the unknown.

Jurists divide gharar by degree. Excessive gharar (gharar fahish) invalidates a contract. Minor gharar (gharar yasir) is tolerated, because eliminating it would make ordinary commerce impossible. Buying a house without inspecting its foundations, or paying a fixed entry fee to a public bath without knowing how much water will be used, are classical examples of acceptable minor uncertainty. The tests that later scholars developed ask whether the uncertainty:

• affects an essential element of the contract (the object, the price or the term) rather than an incidental one;
• is substantial rather than trivial;
• arises in a commutative exchange, such as a sale, rather than a gratuitous one such as a gift;
• could be avoided without undue hardship.

Gratuitous contracts receive more latitude because a recipient of a gift cannot be exploited by uncertainty about it. That distinction is the basis of tabarru', the donation mechanism used in Islamic insurance.

Gharar is the main reason many scholars consider conventional insurance impermissible: the policyholder pays a premium for a payout that may or may not occur and whose amount is unknown at the outset. The industry's answer is takaful, in which participants donate to a common pool on a mutual basis rather than buying a promise from an insurer.

Derivatives raise similar questions. Many scholars regard conventional options and futures as containing excessive gharar, since neither the delivery of the asset nor the final settlement amount is certain and most contracts are closed out before delivery. Standard-setters such as AAOIFI have issued standards addressing which hedging structures may be acceptable, and practice varies between jurisdictions.

Islamic law permits certain contracts in which the asset does not yet exist, provided its specification is precise. In salam, the buyer pays the full price in advance for goods of a defined quantity, quality and delivery date. In istisna', a buyer commissions an item, such as a building or a ship, to be manufactured to a specification. These are treated as exceptions justified by need, and their strict conditions are designed to keep the remaining uncertainty minor.

Suppose a trader agrees to buy "whatever a fishing boat catches tomorrow" for US$5,000. Neither the quantity nor the type of fish is known, and the trader may receive fish worth US$500 or US$20,000. Most jurists would regard that as excessive gharar. If instead the trader agrees to buy 1,000 kilograms of a named species of a stated grade, delivered on a fixed date, for US$5,000 paid now, the structure fits the rules of salam and the uncertainty is reduced to an acceptable level.

In an Islamic bank, reviewing products for gharar falls to the Sharia supervisory board. A product later found to contain excessive gharar can be declared non-compliant, with income from it diverted to charity; this is one of the main sources of Sharia non-compliance risk. Because the line between major and minor gharar involves judgment, scholars and boards in different countries do not always agree on where a given product falls.