The prohibition of payment and receipt of interest ( Riba )

The Islamic law prohibits payment and receipt of interest (riba), which means not only usury, but all forms of “unearned” income or income that does not involve the expending one’s resources or effort. Siddiqi (2004) clarified that riba means any increase or growth in a loan that must be paid by the borrower to the lender, regardless of whether the increase is large or small.

Metwally (1997) links the concept of riba more closely to usury, by defining usury to mean an excess or addition above the principal lent, based on the following verse from the

Qur’an:

Those who eat riba (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say: ‘Trading is only like riba (usury)’, whereas Allah has permitted trading and forbidden usury. (Qur’an, 2: 275)

Any interest or pre-determined payment over and above the actual principal amount is strongly prohibited by the Qur’an and the Sunna. The relevant verses of the Qur’an are clear and unambiguous. For example, one verse declares:

O you who believe! Be afraid of Allah and give up what remains (due to you) from riba (usury) (from now onward), if you are (really) believers. And if you do not do it, then take a notice of war from Allah and His Messenger but if you repent, you shall have your capital sums. Deal not unjustly (by asking more than your capital sums), and you shall not be dealt with unjustly (by receiving less than your capital sums). (Qur’an, 2: 278–279)

Even though, the Qur’an did not specify any particular kind of riba, Muslim scholars have categorised it in two types: riba al-nasi’ah and riba al-fadl. Riba al-nasi’ah refers to the interest on loans and its prohibition essentially implies that the fixing in advance of a positive return on a loan as a reward for waiting is not permitted in Islam. Riba al-fadl is the excess over and above the loan paid in kind. It lies in the payment of an addition by the debtor to the creditor in exchange of commodities of the same kind. The sharia wishes to eliminate not merely the exploitation that is intrinsic in the institution of interest, but also that which is inherent in all forms of unjust exchange in business transactions.

El-Gamal (2000) provides a translation of the Prophet Muhammad’s hadith that explained riba al-nasi’ah as ‘Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts; and any increase is Ribā’ (p. 3).

Regarding, riba al-fadl, narrated on the authority of Abou Said Al-Khudriy: Bilal visited the Messenger of Allah with some high quality dates, and the prophet inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah said: ‘this is precisely riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other’. (El-Gamal, 2000, p.3)

Verse 279 in chapter 2 of the Qur’an above characterises riba as unfair, as implied by the Arabic word Zulm as translated unjust (oppression, exploitation, the opposite of adl, i.e. justice). In Islamic law, a healthy economic environment at any given time does not guarantee positive return or a productive use of money capital as value productivities lie in a future surrounded by uncertainty and risk. Some risk is involved in the productive use of money capital, which, in fairness, the supplier of money capital must share if he or she wants a share in the profit of productive enterprise. Somebody seeking a loan with a positive return must share the risk involved in its use, otherwise it is to be returned without increase. As argued by Islamic economists this unfairness, which is central to the conventional financial system, is bound to impair its efficiency (Maududi, 1984).

This is especially true given that capital is generally allocated on the basis of the creditworthiness of borrowers and not in relation to the expected productivity of the projects being financed. Muslim economists have also demonstrated how interest contributes to the instability of the capitalist system, particularly with regard to loans for business enterprises. For business interest on loans violates the human principles of fairness and care for others (Phillip, 1997; Pryor, 1985; Segrado, 2005). Also, this means that both the supplier of the funds and the borrower share the risks; both prosper when returns are favourable and suffer together when returns are poor. This is in comparison to the conventional system where the risk lies entirely on the borrower, the lender facing default risk, which in most instances is covered by collateral.

Despite the fact that interest occupies a central position in modern economic system and that it became the very life blood of the existing financial institutions, Islam considers that the principle of charging interest is quite opposite of that of business in the spirit of sharing and cooperation and that lending on interest is not as a business in the real sense. It is

interesting to note that some of these prohibitions have also been obeyed in non-Muslim nations (Iqbal & Mirakhor, 2011). Some writers such as Glaeser andScheinkman (1998) and Renneboog et al. (2008) documented that the Catholic Church imposed a universal prohibition on usury in 1139, which was not relaxed until the nineteenth century. In England, a law called The Act against Usury, which prohibited excessive interests on loans, was in effect from 1571 to 1624. The founder of Methodism, John Wesley (1703–1791) stated in his sermon number 50 ‘The Use of Money’ (Wesley, n.d.) that people should not engage in sinful trade or profit from exploiting others. In the seventeenth century, the Quakers refused to profit from the weapons and slave trade when they settled in North America. Moreover, in the 1920s, the Methodist Church in the United Kingdom (UK) avoided investing in ‘sinful’ companies, such as those involved in gambling and the production of alcohol, tobacco and weapons (Iqbal & Mirakhor, 2011).

In legalising trade and condemning interest, Islam considers that there are fundamental differences between the nature of profit resulting from interest charges and that earned by trade. In interest-based transactions, there may be no equitable division of profit between the buyer who makes a profit on the sale of goods purchased, and the seller who derives a profit in consideration of the labour and time spent in procuring the goods. Moreover, there could be no end for an interest-based transaction, since there could always be interests on unpaid interests as long as the principle amount loaned is not fully returned. This could, in extreme cases, create un-repayable debt for generations.

Siddiqi (2004) provides explanations for the prohibition of riba. First, it is a form of social corruption referred to by Arabic scholars as fasad. Second, riba implies the wrongful appropriation of other people’s property without justification. Third, riba decreases the resources of states through a negative effect on the growth of economies. Fourth, riba

demeans and diminishes the humanity of individuals. Fifth, people should be productive and useful, but only by investing their money in useful trade and economic enterprise, because money is an exchange instrument that has no value in itself (Siddiqi, 2004).

In this regard, Gait and Worthington (2009) agree with Siddiqi (2004) in his explanations of social corruption that negative effect on the growth of economies and demeans and diminishes the humanity of individuals lie with the idea of the unrestricted power of the creditor to make profit from interest has no regard to the financial ability of the debtor to repay indebtedness, middle-class consumers, as well as the developing countries, could be caught up in a never-ending debt-trap. They further assert that the wrongful appropriation and decreases the resources of states, because the riba system encourages living

beyond one’s means for both individuals and governments, it results in an accentuation of macroeconomics, inflation and external imbalances in addition of squeezing the resources available for development. This leads some poorer countries to the over-exploitation of their earth’s resources and thus to the destruction of the ecological system. Furthermore, the high degree of interest rate volatility in the modern economies injects great uncertainty into the investment markets and makes it difficult for entrepreneurs to have a long-term investment vision and to make their decisions with confidence. This turbulence in the financial markets and the rise to fictitious assets tend to aggravate economic instability.

The Prophet Muhammad (PBUH) hadith that mentioned previously that Islam considers even interest-based loans taken for investment in a productive activity as not equitable because the profits that may accrue from it is not required to be known forehand and if there is a loss, the entrepreneur has to bear the entire loss in spite of all the risk and engagement he took, whereas the money lender, who did less sacrifice than the entrepreneur, gets an effortless profit determined by a positive rate. In Islam both risks and rewards should be shared by the different parties to the contract (Siddiqi, 2004).

Iqbal and Molyneux (2005) discussing the reasons of prohibiting riba from an economic view, as it is regarded as being unjust to the lender as implied in the Qur’an (2: 279). This is because the real rate of interest may become negative if, say, the rate of inflation is higher than rate of interest. Therefore, lenders who wish to earn a profit from lending money could make a loss. Once again, the loss incurred would be unrelated to the actual use of the funds.

Based on these explanations the rationale for the prohibition of interest, the Islamic economic framework highlights how the risk-reward sharing would be more conducive to the realisation of equity and the promotion of entrepreneurship. In fact, the interest-based financial system relies heavily on collateral and gives inadequate consideration to the strength of the project or the ultimate use of the financing. While collateral and cash flow are indispensable for ensuring repayment of loans, giving them undue weight results in an inaccurate estimation of the purpose for which borrowing takes place. Hence, that system tends to enforce the unequal distribution of capital by allocating financial resources mainly to the wealthy, which has the collateral and cash flow.