Murābaḥah Penalty Clause is Ribā in Disguise! The Penalty Clause Questions the Deep-rooted Preference for Literal Interpretation over Substantial Interpretation of Ribā

Abstract

<jats:title>Abstract</jats:title> <jats:p>Following the literal interpretation of <jats:italic>ribā</jats:italic>, jurists have agreed that <jats:italic>muḍārabah</jats:italic> and <jats:italic>mušārakah</jats:italic> are legitimate modes of financing. As both arrangements are highly risky to manage in practice, <jats:italic>murābaḥah</jats:italic> has been introduced as an alternate mode of financing. Despite its extraordinary success, <jats:italic>murābaḥah</jats:italic> has led to moral hazard in the form of frequent delays in payments and defaults for which Islamic scholars have introduced a penalty clause as discouragement. Examination of the <jats:italic>murābaḥah</jats:italic> penalty clause instrument suggests that it is <jats:italic>ribā</jats:italic>, prohibited when interpreted literally. Moreover, the penalty clause has never been enforced in Pakistani courts. This article suggests that the literal interpretation based on the objectives of Sharīʿah (substantial interpretation) will prevent loopholes such as the abuse of the <jats:italic>murābaḥah</jats:italic> instrument and consequently the penalty clause as well and will lead to substantial compliance with the principles of Islamic finance.</jats:p>