TOPIC: RIBA

Preview
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 Riba: Definition, Evidence, Types

 Issues on Riba: Misconceptions &
Rationales
 Financial contracts in Islam
 RIBA:
DEFINITION,
EVIDENCE & TYPES
 Riba - Definition
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• Literally
- excess, increase, expansion, growth

• Technically
– every excess in return of which no reward or equivalent
counter-value is paid
– a predetermined excess or surplus over and above the loan
received by the creditor conditionally in relation to a specified
time period
– A forced increase in value in the amount being loaned out
– “Premium” that must be paid by borrower to lender along
with the principal amount as a condition for the loan or for an
extension in its maturity
 Riba - Definition
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• During pre-Islamic days (jahiliyyah):

• Lending out money for a specified time and received from him a
fixed amount of money every month as interest

• ‘Modern’ jahiliyyah:
• Lending out money to another on a condition that after a certain
time it would charge a fixed amount in addition to the principal
• Addition with no additional labor but due to time for which the
principal has been borrowed

• 3 elements of riba’:
• Excess/surplus over and above the loaned capital
• Determination of the surplus according to time
• Surplus portion is pre-determined even with the willingness from
borrower to pay that portion
 Prohibition of Riba: Evidence
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• Besides Quran, other earlier scriptures had also prohibited usury

• Bible: “Lend, hoping for nothing again” in Luke
• Aristotle: “ A piece of money cannot beget another piece”
• Thomas Aquinas: “To take usury for money lent is unjust in itself, because
this is to sell what does not exist”
• Practice of the Jews: prohibition is applied only among Jews

• Al-Quran on prohibiting riba: al-Rum verse 39, al-Nisa: 161, al-Imran: 130,
al-Baqarah: 275-281. For example:
– (2:275) “… they say, trade is like riba, but Allah has permitted trade and
prohibited riba… beware of the war on the part of Allah and His Apostle…”

• Various sunnah on prohibition of riba, severity of its sin and its form. An
example:
- “The Prophet of Allah s.a.w. cursed the receiver and the payer of riba, the
one who records it and the two witnesses to the transaction and said: they
are alike (in guilt)”
 Prohibition of Riba: Evidence
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• All jurists agree that riba is prohibited (haram)

• Prohibition of riba comes in 4 stages:
• Stage 1: Surah 30. Ar-Rum: 39
‫َّللا ۖ َو َما آت َ ْيت ُ ْم ِم ْن‬ ِ َّ‫َو َما آت َ ْيت ُ ْم ِم ْن ِربًا ِليَ ْربُ َو فِي أ َ ْم َوا ِل الن‬
ِ َّ ‫اس فَ ََل يَ ْربُو ِع ْن َد‬
- ‫ون‬َ ُ‫ض ِعف‬ْ ‫َّللا فَأُو َٰلَ ِئ َك ُه ُم ْال ُم‬ َ ‫زَ َكا ٍة ت ُ ِريد‬
ِ َّ َ‫ُون َو ْجه‬
Stress the fact that riba does not increase individual/national wealth, but on
the other hand it decreases wealth unlike the act of charity (al-Quran,
30:39)
• Stage 2: Surah 4. An-Nisaa: 161
َ ‫اط ِل ۚ َوأَ ْعتَ ْدنَا ِل ْل َكا ِف ِرينَ ِم ْن ُه ْم‬
- ‫ع َذابًا أَ ِلي ًما‬ ِ ‫اس ِب ْال َب‬
ِ َّ‫ع ْنهُ َوأَ ْك ِل ِه ْم أَ ْم َوا َل الن‬ ِ ‫َوأَ ْخ ِذ ِه ُم‬
َ ‫الر َبا َوقَ ْد نُ ُهوا‬
Strong warning of punishment if not obeying the injunction (al-Quran, 4:161)
 Prohibition of Riba: Evidence
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• Stage 3: Surah 3. Al-i'Imran:130

- َ‫َّللا لَعَلَّ ُك ْم ت ُ ْف ِل ُُون‬
َ َّ ‫عفَةً ۖ َواتَّقُوا‬ َ ‫ضعَافًا ُم‬
َ ‫ضا‬ ِ ‫يَا أَيُّ َها الَّذِينَ آ َمنُوا ََل تَأ ْ ُكلُوا‬
ْ َ‫الربَا أ‬
O Believers! Don't indulge in Usury by doubling and redoubling. And
fear Allah so that you may be successful. (al-Quran, 3:130)
• Stage 4: Surah 2. Al-Baqara
• Distinguish between trade and riba. Believers should refrain
from interest or they will suffer both in this world and in the
hereafter (al-Quran: 2;275-276)
ِ ‫َّللاُ ْالبَ ْي َع َو َُ َّر َم‬
– ۚ ‫الر َبا‬ ِ ‫( قَالُوا ِإنَّ َما ْال َب ْي ُع ِمثْ ُل‬275)
َّ ‫الر َبا ۗ َوأَ َُ َّل‬
• Clear prohibition of interest and Allah declared war against
those who are still involved (al-Quran, 2:278-281)
‫س أ َ ْم َوا ِل ُك ْم‬
ُ ‫ُسو ِل ِه ۖ َو ِإ ْن ت ُ ْبت ُ ْم فَلَ ُك ْم ُر ُُو‬ ٍ ‫فَإِ ْن لَ ْم ت َ ْفعَلُوا فَأ ْ َذنُوا ِب َُ ْر‬
ِ َّ َ‫ب ِمن‬
ُ ‫َّللا َو َر‬
(279)- َ‫ظلَ ُمون‬ ْ ُ ‫ظ ِل ُمونَ َو ََل ت‬ ْ َ ‫ََل ت‬
 Types of Riba
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1. Riba al-Qard (debt) – riba an-nasi’ah

• As being highlighted in Quran, thus also known as riba al-Qur’an
• Root word nasa’a means postponement meaning to defer, to wait
• Time that is allowed for the borrower to repay the loan in return for
the premium
• Fixing in advance of a positive return; any amount over & above
principal
• Common in conventional banking products e.g. credit cards

2. Riba al-Bay’ (sale) – riba al-fadl

• Also known as riba al-Sunnah
• Applies to sale transactions in commodities: exchanging one
commodity for the same commodity but unequal in amount
 Riba al-Qard
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Various incidences of riba al-Qard (i.e. riba that arises from loan):

1. Loan with interest or other benefits

-when there is a predetermined excess/surplus over the loan received by
the creditor conditionally in relation to a specified time period

2. Excess amount imposed due to delinquency in debt

repayment or default
-Jahillians increased the amount of debt outstanding if payment is overdue
= riba al-jahiliyyiah
 Riba al-Bay’ (sale)
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• The Arabs used certain commodities like wheat, barley,

dates and salt (termed as ribawi items) as medium of
exchange to purchase other things, and as such they were
like money
• The basis for prohibition of riba in exchange of
commodities is based on hadith of the Prophet on six
commodities (i.e. ribawi items):
“Gold for gold, silver for silver, wheat for wheat, barley
for barley, dates for dates, salt for salt – like for like,
equal for equal, and hand-to-hand (spot); if the
commodities differ, then you may sell as you wish,
provided that the exchange is hand-to-hand or a spot
transaction.” [Muslim]
 Riba al-Bay’
• Summary of rules under the hadith
13
Exchange Condition
(Amount & Time)
Money1 + Money1  Equality
 Hand-to-hand (spot)
Food1 + Food1  Equality
 Hand-to-hand (spot)
Money1 + Money2  Hand-to-hand

Food1 + Food2  Hand-to-hand

Money + Food  No conditions – free trading

Money + Others  No conditions – free trading
Food + Others  No conditions – free trading
Others + Others  No conditions – free trading
14
Riba al-Bay’
• Interpretation/Implication
• TYPE A: In trading commodities of same group (eg. gold for
gold), both commodities must be exactly equivalent and
prompt delivery – relate with the strong reminder from the
Prophet when Bilal exchanged dates of lower quality with
better ones.
• TYPE B: In trading commodities of same group but different
kind (gold for silver), promptness of delivery is a condition.

• TYPE C: In trading commodities of different groups and kind

(eg. gold for fish), no condition imposed, free trading can
exist.
Islam encourages earning of profits from
trade but forbids charging of interest
 Riba al-Bay’
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• Implications
– Certain restrictions imposed upon trading of ribawi commodities
– One presumable rationale for the injunction is to curb price speculation or
exploitation on essential items
– Some jurists have relied on this Hadith to render modern-day currency
derivatives impermissible

• Issue: What commodities do this Hadith apply to?

– Strictly these 6 commodities only- [Jurists Qatadah & Tawoos]
– Any commodity which is sold by weighing or measuring- [Hanafi & Hanbali]
– Either eatables or used as universal legal tender- [Shafi’i]
– Either food items (i.e. non-durable@istihlaki) or they can be stored (i.e.
durable@isti’mali)- [Maliki]
 Staple food such as rice?
 Non-food commodities such as oil?
 ISSUES ON RIBA:
MISCONCEPTIONS
&
RATIONALES
 Selected Issues on Riba
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• What constitutes riba?

• Al-Quran does not specify what riba is and the context that it is used
refers to the particular practice at the time
• Prophet mentioned “Beware, riba of jahiliyyah has been
abolished”
• Al-Quran al-Baqarah: 275-280 “al-bay and riba are different”
• Several misconceptions about riba and its prohibition,
resulting in confusion in its applications
• Interest-based commercial transactions were invented by modern
day business; thus, not covered by the riba referred to in the Qur’an
• Bank interest is not riba because it is not excessive (usurious)
• Riba should be allowed under dharurah
• Riba is only relevant to consumption loans, not commercial loans
 “Modern day interest is not riba”
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• Argument
– Prohibition of riba was revealed in the last days of the Prophet’s life
• Did not elaborate on the interpretation and definition of riba
• Ambiguity in the meaning of riba (area of Mutashabihaat): its
prohibition cannot be extended to modern day banking

• Addressing Misconception
– Fact that Prophet included prohibition of riba in his last sermon does
not mean that the prohibition was only introduced at that time
• Emphasizing importance, given the last sermon was attended by
most of his followers, reiterate prohibition of riba
– Other prohibitions were also not given elaborate definitions
• E.g. prohibition of pork, liquor, gambling, adultery, etc.
• These were well known to its immediate audience
 “Modern day interest is not riba”
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• Addressing this Misconception

– Mutashabihaat refers to verses of the Qur’an whose exact meaning
is not known with absolute certainty. Ignorance of correct meaning
does not affect lives of Muslims because no precept of Shari’ah is
revealed through them
• E.g. “Alif Lam Mim”
• References made to the “hand of Allah” in the Qur’an, in An-Nisaa 3:73

– However, riba has substantial affects on wellbeing - relates to

prevalent economic and social practice

– It is not imaginable that Allah the All-Merciful would wage war

against a practice, which correct nature is not known to anybody
 “If it is not excessive, it is not riba”
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• Argument
– Al-’Imran (3:130) - “O those who believe do not eat up riba doubled and
redoubled”
– If rate of interest is not excessive (e.g. doubled) then it does not constitute riba
and therefore not prohibited

• Addressing this Misconception

– Other verses on the same subject matter must be studied in relation to each
other
• Al-Baqarah (2:278) – “O those who believe fear Allah and give up whatever
remains of riba, if you are believers”
• Every amount, regardless of magnitude, over and above principal is riba
– Qur’an is a book of guidance, not a book of statutes and legal text
• Embodies many expressions having persuasive value
• Al-Baqarah (2:41) – “Do not sell My verses for a little price” – does not imply
that one can sell Verses for a high price
– Expression “doubled” meant to emphasize added severity
 “Riba is allowed under dharurah”
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• Argument
– Doctrine of Necessity (dharurah):
“the situation where the person find himself in danger or
extreme hardship, such that he fears the occurrence of harm to
his life, bodily organs, honor or wealth. The specific implications
of this are that he is allowed, in such a case, to commit that
which is normally forbidden, abandon that which is normally
obligatory, or delay an obligation from its proper time of
performance…”
– Wahbah az-Zuhayli

– E.g. It is permissible to consume pork to save one’s life from

dying of hunger
 “Riba is allowed under dharurah”
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• Addressing this Misconception: Qs

– Is the “necessity” real or exaggerated by imaginary
apprehensions?
– Can the necessity be met with by any other permissible
means?
– Have all other permissible alternatives been
exhausted?
– Can the project be delayed until available halal option
exists?
– Islam provides means of financial intermediation in the
form of profit and loss sharing
 “Riba allowed for commercial loans”
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• Argument
-The common practice of riba during the time of its prohibition was the charging of interest
on consumption loans taken by poor people to finance their basic needs
-This form of exploitation is not present in production loans whereby in many cases, the
debtor is economically well-off
• Loans taken by rich businessmen are used to generate profit
• Basic cause of prohibition of riba, zulm (injustice), is absent

• Addressing this Misconception

To say that commercial or productive loans were not in existence then is not accurate
• There are evidences to substantiate that the practice of interest-based production loans
dated back to much earlier times
– As early as 2000 B.C. in Babylon, 500 B.C. in Greece, in time of Byzantine emperor
Justinian (527-565 A.D.)
– A number of al-hadith reporting on the practice of riba-based commercial loans
• Nature of Qur’anic prohibition - includes all forms of riba regardless of whether or not
prevalent at time of its revelation
 Economic Rationale for Prohibition of
Riba
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1. Element of injustice in financing productive

activities
• Riba-based loan constitutes contract with–
• Interest obligation (certain) vs. Business outcome
(uncertain) : unequal counter-values
• Riba-based loan is Injustice to debtor as well as creditor
• Injustice to debtor – obligated to pay interest even if business
venture results in no profit or loss
• Injustice to creditor – in the event of substantial profits, creditor
receives a return disproportionate to amount of generated profits
• Unlawful appropriation of other people’s property.
• Breeds sense of distrust that do not promote cooperation; hence,
hampers productivity and efficiency.
 Economic Rationale for Prohibition of
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Riba
2. Element of biasness in financing projects
• The rich is able to generate more wealth without
exerting much effort since riba assumes money as a
commodity. Since they have more access to financial
markets, they are better positioned to gain the rewards
from those markets.
• Thus, this worsens social, political and economic issues
related to income inequality.
• Plus, financing is geared towards security-oriented (that
depends on collateral provision) and not growth-
oriented (that depends on feasibility of value-added
projects normally led by SMEs).
• Thus, inhibits growth, innovation and entrepreneurship.
 Economic Rationale for Prohibition of
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Riba
3. Negative effects of a “credit society”
• Easy availability of credit cultivates a materialistic society
• People live under great stress to repay bank debt. Banks exercise “control” over
economic agents = People become “enslaved” to banks
• Quest for economic development clouds good moral judgment among
firms
• Greed leads to unethical business practices e.g. Greed in pay packages
• Degradation of natural environment (to reduce cost) (i.e. negative externalities
= another form of market failure)
• Little concern on work-life balance which might lead to family breakdown and
social ills
• Less responsible government spending
• Governments put less care about their spending with the knowledge that
future generations are responsible to pay back the national debt.
• Sovereign debt crisis becomes a serious threat on economic stability which is
one of the goals of an economic system.
 The Impact of Interest on the Economy (1)
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The classical economists:

There is a reward for the amount of saving in the shape of interest.
The higher is the rate of interest the larger the premium for savings and vice
versa.
Link between saving and investment: An increase in savings means an
increase in the volume of investment in a country

Response:
An increase in the rate of interest means an increase in the cost of investment
which will adversely affect the total investment in the country.
Rather, there is direct relationship between saving and income (Y) of the people
because savings (S) and consumption (C) as well as induced investment (I)
depends on income.
If income increases savings increases.
J M Keynes: an increase in the rate of interest will decrease investment and as a
result the whole economy will be badly affected.
 The Impact of Interest on the Economy (2)
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Scenario 1 : there is no interest

The amount of savings will be available for investment with zero cost
and the rate of investment will increase and the economy will take off
based on Musharakah and Mudarabah modes of finance both.

It is basically the rate of investment [rate of return] that influences

positively the total income of the people which ultimately enhances the
ability of the people to save more.

This is how one can explain the enormous increase in savings during
the present century in-spite of a steep fall in the rate of interest.
 The Impact of Interest on the Economy (3)

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Scenario 2:

Increase in debt and debt servicing in the country concerned.

Foreign loans play a crucial role in the economic development of the

recipient country.

However, a loan taken by the poor country on a high price

(high rate of interest) will rather increase the total amount of loan and
will make difficult the repayment of installments of the debt.

The debt service ratio is steadily increasing in terms of export earnings,

percentage of GDP ratio and percentage of current total expenditure of
the country like Pakistan, Bangladesh etc.
 FINANCIAL
CONTRACTS-i
 Contract in Islamic Financing
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1. Trading-based arrangements
• Murabahah
• Bai-bithaman ajil

2. Leasing-based arrangements
• Operating lease
• Financial lease

3. Equity-based arrangements
• Mudharabah
• Musyarakah
 CONCLUSION
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 To be safe: Follow mainstream view on riba

and interest
 IBF is not only about interest-free banking

 Trading or Debt-based is never totally

impermissible even though equity-based
instruments have more economic merits.
 Ingredients of a successful project is still
applicable in IBF