Shariah Guidelines for Trading and Investment in Stocks
Islam prohibits all forms of interest in a financial transaction. There isn’t a doubt about the prohibition of interest in Islam whether taking or giving it.
Then how come companies have been deemed Shariah compliant, when they are involved in raising debt which is interest bearing?
Let us examine what the Shariah scholars have said in this regard. Also, what are the safeguards in place to monitor such interest bearing debt in Shariah compliant companies.
As mentioned in AAOIFI Shariah Standard 21 – Financial Papers and Bonds:
“Participation or trading (for investment and trading) in the shares of corporations whose primary activity is permissible, but they make deposits or borrow on the basis of interest
The fundamental rule is that of prohibition of acquiring shares of and transactions (investment and trading) in the shares of corporations that sometimes undertake transactions in Riba and other prohibited things even when their primary activity is permissible, but from this rule subscription and transactions (investment or trading) are exempted with the following conditions:
3/4/1 That the corporation does not state in its memorandum of association that one of its objectives is to deal in interest, or in prohibited goods or materials like pork (swine) and the like.
3/4/2 That the collective amount raised as loan on interest – whether long-term or short-term debt – does not exceed 30% of the market capitalization of the corporation, knowingly that raising loans on interest is prohibited whatsoever the amount is.”
Hence, it can be understood that the learned Shariah scholars at AAOIFI have taken cognizance of the market situation of companies taking interest bearing debt. Given that, AAOIFI has spelt out certain conditions which needs to be met for allowing investment in such companies.
Firstly, the company’s primary business activity should not be of conducting business transactions involving interest.
Secondly, in the case of interest bearing debt, it should be capped at a certain ratio to the company’s market capitalization.
Let us further examine what the Shariah scholars board of the first and oldest Shariah indices have said i.e. The Shariah scholars board of Dow Jones Islamic Market Indices:
“The second level of screening involves scrutiny of the financial situation of companies passing level one screening. At level two screening, the primary or basic business of the company has already been determined to be in compliance with Shari’ah precepts. The concern of the second level of screening, however, is with haram (unlawful) elements in the capital structure of the company.
There are many situations in which corporations will generate, through an activity or activities unrelated to the primary business of the company, revenue that is haram. In such instances, when clearly unlawful revenue is combined with the lawful, the relevance and significance of such revenues must be subjected to examination.
Many companies that promote development through the provision of beneficial and humane services are based in countries where there are no laws that prohibit the giving and taking of Interest. Nearly all companies in such countries routinely place excess corporate funds in interest bearing deposits, certificates of deposit (CDs), bonds, bills, notes and other interest bearing instruments. Many companies also invest in the debt of other companies. In these ways, income from interest will also form a part of the total earnings of companies that otherwise conform to Shari’ah precepts”
It further states:
“In what is now approaching a consensus opinion, contemporary Shari’ah scholars have allowed the acquisition of shares in companies in which the primary business activity is deemed lawful if leverage does not exceed 33%.
This ruling is based on two principles.
Firstly, despite the serious sin committed by a borrower by borrowing on the basis of interest, the loan so acquired becomes his property.
Secondly, a proportion less than one third is understood to be minor. That a third or more is representative of a preponderancy may be derived from a hadith, related by al-Bukhari, in which the Prophet of Allah, upon him be peace, said,”… Then a third. And a third is a great deal,” when he was asked how much of one’s estate may be bequeathed to other than the prescribed heirs.”
Through the above pronouncements, it must be amply clear that although the Shariah scholars condone companies which are involved in using interest bearing debt, they have allowed investment in these companies conditionally.
Condition 1: The company’s main business activity should be Shariah compliant.
Condition 2: The levels of debt to its market value should be less than a third.
(Screen shot from Islamicly Desktop portal as on 20th June 2020)
Hence, it can be concluded that investment in such Companies having interest bearing debt is permissible conditionally.
Islamicly screens companies to be in compliance with Shariah threshold on a daily basis. On Islamicly, you can check if a company passes the various financial ratio screens as well.
