In essence, Rahn is collateral which is any property or asset used to secure a debt. For example, a home purchase is typically secured by pledging the home as collateral. If the borrower defaults, the financier can seize the property. But why did the Shariah allow for Rahn? What are the Shariah wisdoms tied to Rahn? The following four seem to be the key wisdoms:
1. Rahn facilitates transactions and mitigates credit risk. Many deals would fall through if the debt remain unsecured. Collaterals broaden the scope of trade, financing and lending products available. For businesses who are asset rich and cash poor, it allows them to make use of their high asset inventory to secure further financing, avoiding the need for a deposit. Therefore, one wisdom behind Rahn is that is facilitates transactions, and transactions facilitate the needs of people.
2. Rahn allows the impact of debt and the corresponding liability to be absorbed by the asset and not fall onto an individual. Unmanageable and unrepayable debt brings numerous issues to individuals economically, mentally, spiritually, emotionally and of course, the reputational risk as a result. Thus, another wisdom behind Rahn is that it safeguards humans from being disorientated in their life which ultimately impacts their purpose of life.
3. Classically, Rahn was most used in trade contracts. Financing was not frequent in the medieval period as it is today. Whilst we have credit checks and data to give a sense of assurance to the creditors and financiers, classically, there was nothing but one’s reputation as a reference. There was only one’s appearance or market rumour as a reference for credit history. There was no data to refer to for vendors. More effort would be expended to extract information on the potential buyer, which meant that data would have to be disclosed to third parties to secure information on the buyer. Hence, Rahn played a huge role in mitigating the information asymmetry and providing an incentive to the seller and vendor to trade. Rahn gave assurance to the creditor and vendor that their interests are secured by the collateral.
4. In today’s markets, Rahn is usually furnished to secure financing deals. With so short cash buffers and constant cash flows, secured financing is key to ensure timely trades and the flow of supply chains, making sure the downstream is not impacted by a single point of bottleneck. Therefore, Rahn helps to ensure that the supply chain keeps flowing and transactions to keep occurring.