‘Islamic pawning’ might be the answer to personal debt

A recent editorial in The National argued that pawnshops could provide the answer to the UAE's loan sharking problem.

Certainly, pawnshops might represent a lesser evil than a loan shark, but they also bring with them several complications.

Not the least of these issues are that they are alien to the UAE and involve lending money at high rates of interest.

However, exploring solutions to personal indebtedness is both useful and essential, especially in the light of the growing concern over Emiratis succumbing to the pitfalls of borrowing.

Pawnshops offer secured loans to individuals where the borrower’s personal property is used as collateral for the loan. The property is returned if the borrower repays the loan (with interest) within a certain time period.

If the borrower defaults – and it is inevitable that some will – the pawnshop sells the collateral and keeps the entirety of the proceeds. Since the loan is appraised below the expected sale price of the collateral, the pawnshop profits whether the borrower repays or defaults.

The business model used by pawnshops clashes with local Islamic norms and values related to financial transactions.

Firstly, the loan is a type of ribã or usury, which is expressly forbidden in the Quran and it is considered unlawful in Islamic law.

Secondly, collateral exists to secure the right of the lender to be reimbursed the lent amount at the agreed upon time. Being reimbursed more than the amount lent is not only unjust, it is also usury.

According to Islamic law, when collateral is sold to cover a debt, whatever money is left over after reimbursing the loan must be returned to the owner of the collateral.

But removing usury – and the opportunity to profit by consuming the collateral – leaves pawnbrokers without a financial incentive to offer secured personal loans to individuals.

The UAE needs an alternative solution that agrees with local Islamic norms and values without incurring usury or misappropriating the collateral.

This alternative solution also needs to preserve the general spirit of Islam that personal loans should be given for the sake of reward from Allah, rather than for the sake of financial profit.

One solution is already available through Ar Rahn, or “Islamic pawning”.

Ar Rahn is a relatively new microcredit instrument that is based on three concepts from Islamic finance.

These concepts are that borrowers are required to pay back only the amount owed (al qard al hasan). Borrowers must also place collateral with the lender to ensure payment of the loan (al rahn wa-l-wadi’ah). The lender, meanwhile, can charge a fee for safekeeping the collateral (al ujra).

In Malaysia, Ar Rahn loans typically have a term from one to six months, with the possibility to extend.

Collateral is provided in the form of gold or gold jewellery, with the loan appraised at up to 80 per cent of the value of the gold. Borrowers have the option of paying their loan in instalments or in one lump sum. The collateral is auctioned if the borrower defaults on the loan and the proceeds are used to pay the balance of the loan and the charges for safekeeping, with the remainder returned to the borrower.

The Ar Rahn model removes usury from the picture by placing pawnbrokers in the business of safekeeping and auctioning deposits.

Loan sharks and pawnbrokers are in the business of making money by offering loans to individuals who are desperate and financially vulnerable.

The Ar Rahn model provides a solution to the UAE’s personal microcredit needs that is in line with local values and morals. It also demonstrates the mercy and social justice possible through Islamic loans – in stark contrast to the debt-related depression and suicide so often resulting from its alternatives.

Musa Furber is a research fellow at the Tabah Foundation in Abu Dhabi and an associate at Straightway Ethical Advisory

On Twitter: @musafurber