Continuing with our discussion on the crucial divide between conventional and Islamic finance, we shall from now on drop the term usury and discuss interest alone.
This is because the proponents of interest also agree that the charging of usury is unfair. They however, define usury as excessive interest, not based on the level of rate but if it was outside the agreed rate – which could well be any high rate.
Our aim shall now be to analyze whether an economy in the modern day and age can survive the lack of interest. We will evaluate some of their main arguments to find out if they hold water and in the process learn the wisdom behind the prohibition of interest (or usury) by God Almighty.
Technical definition of interest
Interest is technically defined as monetary gain on a certain amount of funds given as a loan by a person (or entity) called the lender to another person (or entity) termed as the borrower, calculated at a predetermined rate which is applied on the amount of funds borrowed for the agreed lending period.
In other words, the monetary gain is received by the lender from the borrower for allowing the borrower to use the lender’s money for a specified time period, irrespective of the outcome of the application of those funds by the borrower. For the time being, we shall limit our discussion to the financial interest and later on learn that the interest could also be earned in kind and what the Shariah position on it is.
To be able to examine the expediency or detriment of the application of interest in financial matters, it will be useful to study the modes of generating more wealth by applying the original capital. There are only two universally established ways of generating more wealth by applying capital:
a) Loan capital
The loan capital dictates its price of participation in a transaction in the shape of a pre-determined rate, and irrespective of the eventual outcome of the application of the loan capital by the borrower, whether positive or negative.
b) Risk capital
To the contrary, the risk capital is rewarded for its participation in a productive process to the extent of the value that its participation creates (positive or negative) and which was unknown at the time of the application of the risk capital.
As you may have noted from the aforementioned definitions, the loan capital holds a characteristic rigidity when it comes to the economic consideration on its application whereas the risk capital is flexible to the outcome when it is applied for a commercial purpose.
Furthermore, when used in a productive process, the loan capital increases the cost of the goods produced whereas the risk capital helps to curtail it. As such, a factory accountant doing per unit costing will include interest as a direct expense if the borrowed funds have been applied to the production.
Going forward, if the wholesaler has also borrowed funds on interest to purchase these goods, he will include the interest expense in his cost too and by the time the end user purchases the same unit from the retailer, the price will have a laden strata of interest in it. Imagine what the level of inflation in an economy shall be where the entire participants are repeating this cycle.
Moreover, at times the interest rate is unilaterally enhanced without prior notice by the lender institution, introducing the element of uncertainty for the borrower. Also, slight delays in repayment trigger the penalty interest, accumulating to the already existing normal and compounding effects of interest. Therefore, a typical borrower may have to deal with three layers of interest at a time which are not absorbed by any of them and passed on to the end consumer, hence escalating the inflationary effects in a given economy.
If the whole chain uses the risk capital, such an expense will not appear in the per unit cost of goods produced and sold due to the absence of an upfront rate on this type of capital.
Thus, a point to ponder is: will adopting the phenomenon of the risk capital in an economy on a full-scale basis not break the back of inflation?
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
|In next week’s issue: Analysis of the arguments put up by the advocates of interest.