Topic 4: Theory of Riba

An Ongoing Debate

Ribaterm with different applications

Prohibition of interest is the most important feature of Islamic economics Yet its meaning are debated upon, especially of lately Broadly three modern trends among Muslims Liberal: Riba = usury alone Mainstream: Riba = usury + interest Socialist: Riba = usury + interest + profiteering Each school has its arguments to defend its position problem with modernist views: their definitions of riba do not conform to all verses and ahadith on subject Interpret riba in relative terms problem with mainstream view: their definitions entails some contradictions in theory and practice
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Ribaterm with different applications

Difference of opinion regarding reason for prohibition of riba lies behind this debate Liberals: the reason is elimination of unfair charge over loan charging interest over consumption loan is unfair, but not on productive loans Mainstream: making both financiers and users of funds apriori return to lender is unfair as he does not share business risk Socialist: elimination of exploitation of poor classes even subsistence wage is riba

Riba in Quran and Hadith

Difference of opinion regarding reason for prohibition of riba lies behind this debate Word 'riba' means to increase, grow, multiply and to climb in economic context, generally considered as a contractual increase on loaned money or commodity (mainstream view) The word, with its variants, used in numerous versus of Quran only in the following verses it is used in economic sense

Riba in Quran and Hadith

People who indulge in riba shall be raised like those who have been driven to madness by the touch of Devil. That is because they say that the riba-based transaction is just like trading, while God has permitted trade and prohibited the riba. Hence those who have received the admonition from their Lord and have desisted accordingly, may have what has already passed, their case being entrusted to God; but those who revert to riba-based dealings, shall be the inhabitants of the hell-fire and abide therein for ever. (You must know that) God deprives riba from all blessings and blesses charity; He loves not any ungrateful sinners (al-Baqarah 2: 275-6)

Riba in Quran and Hadith

O you (who claim to be) believers! Fear God and give up riba that remains outstanding if you are true believers. Behold! If you do not obey this commandment, then God declares war against you from Himself and from His Prophet. But, if you give up your outstanding riba, then you can claim only your principals. Neither should you inflict harm (due to riba) to others, nor others should do harm to you (al-Baqarah 2 :27879)

These verses reveal that: Riba is categorically prohibited it is different from trade it is zulm (unjust) and destined to destruction (muhq) creates evil effects on human personality (mas-oshaitan) Riba is contrasted with spending (Infaq)

Riba in Quran and Hadith

And what you advance as riba-based giving (investment) in the properties of others to increase, it does not increase in the sight of Allah. On the other hand, what you give in charity to please Allah, these are those who multiply (their wealth in the sight of Allah) [al-Room 30: 39] And for their (Jews) devouring of riba even though it was forbidden for them, and for their (Jews) wrongful appropriation of other peoples' property (al-Nisaa 4: 161) O Believers! Do not devour riba doubled and multiplied (i.e. charge not riba on top of riba) and fear God so that you may prosper (Al-e-Imran 3: 130)

Riba in Quran and Hadith

Riba is used in several Ahadith, here some commonly quoted ones are given

1. Ahadith that reinforce Quranic concept of riba

1.1: The Prophet said: "There is no riba except in loaning (Nasaee 4504) 1.2: The Prophet said: "Verily riba is in loaning" (Muslim 2991) 1.3: The Prophet said: "There is no riba in hand to hand (spot) transactions." (Muslim) 1.4: At the last Pilgrimage, the Prophet said: "All of the riba of Jahilliya is annulled. The first riba I annul is that

the owed to my uncle Abbas; it is cancelled completely (Muslim)

Riba in Quran and Hadith

2. Ahadith that refer to riba in barter trade
2.1: Abu Saeed Khudri said that once companion Bilal brought to the Prophet some good quality dates. The Prophet inquired as to where he got those dates. Bilal replied that he had some low quality dates. which he had exchanged in 2:1 ratio for high quality ones in order to present the latter to the Prophet. Upon hearing this, the Prophet said: "Oh no! Oh no! That is riba. That is exactly riba. Do not do it again. If you want to do such an exchange, first sell your dates (for money or another commodity) and then buy other ones." (Bakhari 2145)

Riba in Quran and Hadith

2.2: The Prophet said: "While exchanging gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, exchange like for like (in equal measure) and exchange at spot. Whosoever paid more than what he received or demanded more than what he gave, verily he dealt in riba. Both the payee and the receiver are equal in violating the Law of God" (Muslim: 2971) 2.3: The Prophet said: "While exchanging gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, exchange like for like (in equal measure). Whosoever gave more or took more, verily he made a riba deal. However, you are permitted to exchange gold for silver, wheat for dates, or barley for dates as you wish (in equal or unequal measures) provided that, such an exchange is at spot" (Tirmizee: 1161)
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Riba in Quran and Hadith

2.4: The Prophet said: "Do not exchange gold for gold except it is like for like (in equal measure) and do not increase one over the other; do not exchange silver for silver except when it is like for like (in equal measure) and do not increase one over the other. Furthermore, do not exchange a commodity in hand with the one not in hand (Muslim and Bakhari) 2.5: The Prophet prohibited trading of animals for animals on credit (Tirmizi 1158) 2.6: The Prophet said to companion Jabir b. Abdullah: "In a credit transaction, it is not permissible to take two animals for one. However, if it is a hand to hand (spot) transaction, such an exchange is acceptable (Tirmizi)

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Riba in Quran and Hadith

2.7: Abdullah Ibne Amr states that the Prophet directed him to arrange a good number of camels for an expeditionary force. Abdullah did but could not get the desired number (with the cash at hand). Then the Prophet directed him to acquire more camels in exchange of those young she-camels they were expecting to receive later in alms (zakat proceeds). So, Abdullah acquired additional camels at the rate of one camel at hand for two camels to be paid later (Abu Daud: 2913)

3. Ahadith that refer to implicit riba

3.1: The Prophet said: "If one of you extends loan to another fellow, the former should not accept any gift from the latter." (Mishkat)

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Riba in Quran and Hadith

3.2: The Prophet said: "When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers him a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favors mutually" (Ibn-eMajah: 2423) 4.1: The Prophet cursed all those who take riba, who give riba, who write a riba contract and the two witnesses to a riba contract. He further said: "They are all alike (in guilt)." (Muslim 2995) 4.2: The Prophet said: "As soon as a society deeply indulges in riba and adultery, wrath of God becomes due for it."
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4. Ahadith that refer to general concept of riba

Riba in Quran and Hadith

4.3: The Prophet said: "In any society, when riba becomes common, it causes hunger and poverty in it. And in any society, when bribery becomes common, it makes it depressed (as compared to other nations) 4.4: The prophet counted the most heinous seven sins and riba was one of them 4.5: The Prophet said: "On the night of my ascendance to the Heavens, I came upon people whose tummies were as big as houses that were filled with snakes visible from outside. He asked Angle Gabriel as to who they were. Gabriel replied that they were the people who used to receive riba (in their lives)." (Ibne Majah)

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RibaA general categorization

Traditionally, riba is divided into two classes: riba in loans (riba al-nasia) and riba of surplus (riba alfadl) Word 'nasia' means to postpone, defer or wait Riba in loans is contractual increase, be it normal or excessive, on loaned capital either in money form or in kind All Quranic verses imply this kind of interest Other terms commonly used for riba in loans are riba of Quran riba of old times (riba al-jahiliyya) riba of credit explicit riba and price for time 15

RibaA general categorization

Word 'fadl' means to increase, add or exceed it is forbidden in Hadith and has two forms a) Riba in Barter Exchange: arises when same variety or two different varieties of same commodity are exchanged in unequal measures at spot or with time lag b) Implicit Riba: arises when a money is lent without any explicit contractual increase over the principal but lender draws some casual or regular favors from the borrower favors may be of any form (e.g. negligible money value like a ride on an animal/car, a meal or a gift from the borrower) Other terms used for riba of surplus are riba of hadith and riba in trade 16

RibaA general categorization

Majority of jurists (including liberals) go for another categorization they call riba in loans as real riba and riba in excess as trivial riba different reasons offered to justify real-trivial categorization i. Riba in loans prohibited in Quran, whereas riba in trade prohibited in Hadith only. So, the former should be treated as real and the latter as trivial [Rehman F. (1963)] ii. Practically, gradual obsolescence of barter system has reduced relevance of riba in hadith a great deal, even if considered to be of equal status on theoretical grounds [Ahmed (1995)]
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RibaA general categorization

iii. Riba in loans have more treacherous effects on borrowers when lending is for a long time accrued interest may become several-folds of the principal with the passage of time whereas riba in trade being a one-time charge generally does not exceed the principal even if it is too high Hence, both should not be treated alike [Ahmed (1978)] iv. Hadith 1.1 to 1.3, 2.5 and 2.6 say that riba is only in loans and not in spot transactions, ahadith 2.1 to 2.4 define riba in barter trade apparent contradiction is resoled by the above categorization
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RibaA general categorization

According to Muslim socialists: riba in loans encompasses unearned income of moneylenders, while riba in trade refers to unearned income of merchants and landlords To them, Riba in trade has been as exploitative as riba in loans in history Therefore, if real riba is confined to riba in loans only, then a major part of any economy will remain open to exploitation and oppression [Haque (1993)]

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Riba = UsuryLiberal conception

Primary arguments run as follows:

1. Contradiction in faith and practice of Muslim masses

Muslim majority considers bank interest riba, yet it deals with bank interest so because bank interest is inevitable for the functioning of modern financial system Therefore, to relieve Muslim masses from the guilt of conscience, bank interest should be treated leniently So Pragmatism runs behind their ideology: create possibility for small saver of safely keeping his savings as well as earning a modest return on it involve Muslims in business which was increasingly relying on banks for funding
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Riba = UsuryLiberal conception

2. Use of al (the) before riba in Quran
pre-fix 'al' comes before word 'riba' in Quran which implies its terminological meanings only to their research, only consumption loans prevailed at the time of revelation economy was more or less a subsistence economy large scale lending and borrowing for nonhumanitarian purposes not widely practiced debt existed as means of meeting pressing needs on part of the economically disadvantaged in case of non-payment on due date, interest used to be doubled and tripled to penalize defaulters this growth (increase imposed on debtor at maturity of debt in case he fails to pay it) is known as riba of old times, called usury in current terminology

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Riba = UsuryLiberal conception

Liberals derive further support from (Aale-Imran 3: 30) in which riba on top of riba or compound riba has been prohibited categorically therefore, they conclude that riba refers to usury to them, bank interest is different as it is charged on productive loans determined by market forces that is why it remains the same for everyone argue that interest-based financial intermediation has been instrumental for economic growth since its inception Therefore, Muslim scholars should legitimize bank interest even if it comes under the purview of real riba in strict legal sense
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Riba = UsuryLiberal conception

Observations: Business loans were quite known in early times as well therefore, bank interest cant be permitted under the pretext of being a new phenomenon Serious side effects of interest have been pointed out: like short termism, income inequality, possibility of debt deflation and financial fragility Al is not used to specify common noun, but to classify (in the sense of all) so all kinds of riba are declared Haram Finally, Quran says that you can claim only your original capital sum (ras-ul-mal) this holds for all types of loans
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Riba = UsuryLiberal conception

Other arguments for bank interest 1. Interest is the price of capital If removed, nothing can establish equilibrium between demand and supply of capital Two meanings of capital: money and physical interest is relevant to business liquidity through borrowing that is only one of the sources of capital, along with self-financing and the stock market rate of interest charged by banks is governed by rate announced by the central bank, not by market forces in a modern economy, two markets for money capital: the bond market and equity market
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Riba = UsuryLiberal conception

role of interest in maintaining equilibrium is confined to bond market only rate of interest free of intervention by policy makers is determined by rate of return in the real economy this rate of return is reflected by the prospective rate of profit in the equity market this rate, rather than policy driven rate of interest in the bond market, is crucial for equilibrating capital market This all assumes that economic theory (behind interest is demand and supply) is OK but in fact it is not Capital Controversy and Sraffas criticism exposed the fallacies of neoclassical capital theory back in 1960s
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Riba = UsuryLiberal conception

2. Interest is rental cost of money, just like rent of land But, the rent is paid for certain usufruct of an asset without using it up but this cant be the case with money as: it becomes beneficial only after using it (i.e. changing it into another form), and that benefit too is uncertain 3. Borrower makes profit out of borrowed money so lender should be given his share; i.e. interest But why should the share of lender be priced on ex-ante investment, instead of its ex-post returnwhich seems more fair? further, at least consumption loans should be free of interest on the basis of this argument 26

Riba = UsuryLiberal conception

4. Giving loans implies forgoing present consumption for future Since people have positive rate of time preference (value present consumption higher than future) So lender should be compensated for this sacrifice, else no savings This is a typical of opportunity cost based argument but this calculation presumes that all resources are basically meant for profit-maximization the argument cant work without this assumption Not everyone values present more than future why did and do then most people save?
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Riba = UsuryLiberal conception

If future consumption is by definition uncertain, then why should the reward of transferred present consumption to future (saving) be certain? Moreover, the present banking system involves no sacrifice on the part of saver he can withdraw his savings anytime The conceptual problem with interest is that it attempts to represent a random variable (expected flow of future earnings) with a fixed parameter

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Riba = Usury + interest + profiteeringMSC

The Muslims Socialist Concept (MSC) propels from third kind of ahadith that talk about implicit riba The argument goes that: Since God has forbidden lender (mostly a rich person before the dawn of modern banking) from taking whatever meager value from a borrower (mostly poor person), therefore rich industrialists and landlords should be debarred from appropriating big margins of profit and residual income (surplus value) Argue that riba in loans is domain of money lenders who charge against time whereas, riba of excess is domain of landlords, merchants and speculators who give less in exchange
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Riba = Usury + interest + profiteeringMSC

Observations: Does not correspond to history of Islamic knowledge Goes against many Ahadith; e.g. Once the prophet refused to fix prices of non-food items, while responding to a complaint of people of Medina lodged against profiteering of city-traders A companion who returned with two animals in exchange of one from market exchange was praised Riba as an unjustified advantage becomes a somewhat subjective and relative phenomenon

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Riba = Usury + interestMainstream view

Largely held positions among Jurists Most of their emphasis in recent experimentation of riba-free system has been on abolition of bank interest Within mainstream we have two attitudes towards Islamic finance Orthodox / Conservative (e.g. Pakistani model) emphasize resurgence of business contracts approved by the early Islamic jurists propose profit-and-loss sharing (PLS) as ideal alternative to riba optimistically hope that it would resolve inherent inefficiencies (e.g. increasing income inequalities, emergence of monopolies etc.) of riba based system
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Riba = Usury + interestMainstream view

Pragmatic (e.g. Malaysian model) believes in looking beyond earlier approved business contracts of jurists have more liberal approach; i.e. one oriented towards financial engineering so as to accommodate growing needs of modern financial system under the umbrella of Islam emphasizes that mainstream model of Islamic finance practically problematic

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Mainstream view as Islamic finance

The mainstream view has been applied especially to several areas of modern finance, including 1. Commercial Banking 2. Central Banking 3. Insurance 4. Equity markets (e.g. stocks and mutual funds) Most developments have been in banking industry it consists of about 74% of total industry assets

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Mainstream view as Islamic finance

Twelve alternative modes of bank financing in practice Musharkah (Operating partnership) Mudarbah (Trustee / passive partnership) Diminishing Musharkah (Hire-Purchase agreement) Ijarah (Operating lease) Murabaha (Mark-up sale on deferred payment) Salam (Deferred delivery sale on advance payment) Istisna (Manufacture sale on advance payment) Bai-ul-Einah (Repurchase) Tawarruq (Reverse Murabaha + Liquidation)* Bai-ul-Dayn (Purchase of debt) Fee based modes Qard-i-Hasanah (Benevolent loan)

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