The word “riba” in Arabic literally means an “increment” or “addition.” In Islamic Fiqh the term riba has a special meaning as an unjustified increment in borrowing or lending money, paid in kind or in money above the amount of the loan, as a condition imposed by the lender or voluntarily by the borrower.
Usury and interest
Until a few hundred years ago any extra amount demanded by a lender in addition to his capital was called usury. Early European philosophers such as Plato (427–347 BC) and Aristotle (384–322 BC) condemned the practice of taking usury. Aristotle compared money to a barren hen which laid no eggs – a piece of money cannot beget another piece of money, he held. The Roman Empire, in its early stages, prohibited the charging of usury. The Christian Church prohibited all usurious transactions. The famous incident in Jerusalem where Jesus Christ chased away the moneylenders from the Temple was kept alive in Church preaching. Although usury was practised all over Christendom and elsewhere, the Church was consistent and vehement in its condemnation of usury.
However, by the end of the thirteenth century several factors appeared which considerably undermined the influence of the orthodox Church. Eventually, the reformist group led by Luther (1483–1546) and Zwingli (1484–1531), agreed to the charging of interest on the plea of human weakness. According to Encyclopaedia Britannica:
“In old English law, the taking of any compensation whatsoever was termed usury. With the expansion of trade in the 13th century, however, the demand for credit increased, necessitating a modification in the definition of the term. Usury then was applied to exorbitant or unconscionable interest rates. In 1545 England fixed a legal maximum interest; any amount in excess of the maximum was usury. The practice of setting a legal maximum on interest rates was later followed by most states of the United States and most other western nations.”
Thus, beginning in the mid-sixteenth century, the prohibition on usury (in the old sense) was legally removed in all western countries. The environment in which it took place, as evidenced by the above quotation, is noteworthy – expansion of trade and demand for credit. Borrowers were mainly rich merchants, and they used the short-term credit for buying and selling goods. The moneylenders were lending their own money and/or that of their wealthy clients. The borrowers knew how much they could make using a given amount of credit, and they paid the lenders a portion of this profit. This supplied the justification for demanding the extra amount.
But this justification for “limited interest” under a particular circumstance was, in the course of time, stretched out and applied in general. Support was forthcoming on other grounds too. For example, Sir Francis Bacon (1561–1626) advocated: “Since of necessity men must give and take money on loan and since they are so hard of heart that they will not lend it, otherwise there is nothing for it, but that interest should be permitted.”
The new “moderate” form of usury – interest – was legal and “moral;” economic theories were developed with this limit and justification as the base. Theories found their way into textbooks, more theories were developed, and interest became an integral part of economic theory. In practice, the theory was applied universally, whether the original conditions which justified the extra payment existed or not.
Theories of interest
Shaikh Mahmud Ahmed, in his book Towards Interest-free Banking, presents and disputes many of the theories of interest:
“leaving out some notable exceptions, like Bohm Bawerk’s Capital and Interest, significant parts of Keynes’ General Theory and parts of Harrod, Hawtey and Kurihara, questioning the validity of interest, bulk of the effort of economics has been to justify it, yet not a single argument advanced in favour of this institution has a leg to stand on. All theories of interest evolved till the time of Bohm Bawerk, including those resting on productivity, abstinence and demand and supply concepts, were unanswerably repudiated by him. Yet economics continues whipping these dead horses, without evolving any persuasive answers to his criticism.”
He also takes other theories, including time preference, liquidity preference, deposit mobilization, scarcity of capital, and rationing capability of interest, and proves them untenable.
The Islamic position on interest
The Holy Book of Islam, the Quran, prohibits the demanding and receiving of interest in the following terms:
“O ye who believe! Devour not usury, doubling and quadrupling [the sum lent]. Observe your duty to Allah that you may be successful.” (Quran, 3:130)
“O ye who believe! Observe your duty to Allah, and give up what remaineth [due to you] from usury, if ye are [in truth] believers.
And, if you do not, then be warned of war [against you] from Allah and His Messenger. And, if ye repent, then ye have your principal [without interest]. Wrong not, and you shall not be wronged.” (Quran, 2:278–279)
“Jabir (ra) said that Allah’s Messenger cursed the acceptor of interest, its payer, and the one who records it; and the two witnesses; and he said: They are all equal.” (Sahih Muslim, hadith no. 3881)
In banking and finance, our concern is with money and money loans. Therefore what is relevant to our discussion here is only riba al Nasiah, and there has never been any doubt or differences of opinion as to what this meant. The Quran has prohibited the taking of this kind of riba in the strongest possible terms. Its authorised interpreter – the Prophet – has said that accepting, paying, recording and witnessing it are all equally prohibited. On the other hand, the Quran also says, “then ye have your principal [without interest],” thus entitling the lender to the full return of his capital. Therefore, in order to comply with the prohibition fully and without a shade of doubt, and in order not to infringe the right of the lender, a simple but comprehensive definition is popularly adopted – in money matters, any addition to the principal sum is riba. This also accords with the definition of usury in other faiths.
Today, a fixed deposit in a bank is considered an investment because it earns a return, and a loan is considered an asset by the bank for the same reason. But they are both interest-earning loans. Whatever the purpose, money is available only as a loan at interest. The lenders (both the depositors and the bank) are not really concerned about whether the money was invested in any productive activity or consumed; neither is their return related to the result of any productive activity in which their capital was used. Even when the loan was intended for consumption or the investment resulted in loss, the pre-determined interest must be paid. In contrast to this position, in the Islamic tradition, the distinction between investment and lending had been clearly recognized and provided for. However, unfortunately in modern times, its importance does not seem to have been fully appreciated and acted upon.
The Quran recognizes two different sets of purposes for which money is needed, and notes the two techniques used by capital-owners to cater to these needs. But the techniques must match the purposes. The need of entrepreneurs for capital is recognized, and in order to cater to this need, investment of capital in productive employment is encouraged, but it must be done on a profit and loss sharing basis. Borrowing and lending (for productive or non-productive purposes) are also recognized as legitimate needs and techniques, but they should be done on the basis of mutual help – without loss or profit to either party.
The author is from Corporate Banking at Emirates Islamic Bank.