Concept of Riba and Interest

 The word used by the holy Quran

concerning ‘interest’ is riba. The literal
meanings of riba are money increase,
increase of anything or increment of
anything from its original amount.
 Islam prohibits only those increases
that are charged on loan with a prefixed
rate.
 It covers both Usury and Interest
Prohibition of Riba in The
Holy Quran
The First phase
 "That which ye lay out for increase

through the property of other people,

will have no increase with Allah. But
increase which ye lay out for charity,
seeking The Countenance of Allah, (will
increase); it is these who will get A
recompense multiplied." -- Sura Ar Rum: 39
Prohibition of Riba in The
Holy Quran
 "For the iniquity of the Jews we made
unlawful for them certain (foods) good and
wholesome which had been lawful for them -
in that they hindered many from Allah's way.
That they took usury, though they were
forbidden; and that they devoured Men's
substance wrongfully- We have prepared for
those among them who reject Faith a
grievous punishment.“ -Sura Nisa : Verse 161-162
Prohibition of Riba in The
Holy Quran
 The 2nd Phase
 "Ye who believe! Devour not Usury,
doubled and multiplied; But fear Allah;
that Ye may (really) prosper" Al-Imran :130
 Usury is the opposite extreme of
charity, unselfishness, striving and
giving of ourselves in the service of
Allah and of our fellow-men.
Prohibition of Riba in The
Holy Quran
 "Those who devour Usury will not stand
except as stands one whom The Evil One
bu his touch Harth driven to madness.
That is because they say, "Trade is like
Usury," But Allah hath permitted trade And
forbidden usury. Those who after receiving
Direction from their Lord, Desist, shall be
pardoned for their past; their case is for
Allah (to judge); But those who repeat
(the offence) are the companions of the
Fire; they will abide therein (forever)
Prohibition of Riba in The
Holy Quran
 Allah will deprive Usury of all blessing,
But will give increase for deeds of
charity; For He loveth not creatures
ungreatful anf wicked.“-- Baqarah: 275-76
 The 3rd Phase
 " Ye who believe! Fear Allah, and give
up what remains of your demand For
Usury if ye are indeed believers.
Prohibition of Riba in The
Holy Quran
 The 3rd Phase (contd.)
 " If ye do it not, Take notice of war from
Allah and His Messenger; But if ye turn back,
Ye shall have your capital summs; Deal not
unjustly and ye shall not dealt with unjustly."
 If the debtor is in a difficulty, grant him time
till it is easy for him to repay; But if ey remit
it By way of charity, that is best for you if ye
only knew.“-Baqarah : 278-80
Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Definition Riba is a Profit is the net
predetermined positive outcome of
return arising out a business
of the loan operation
operation
determini Time is the Favorable business
ng factor determining transaction, cost
factor of Riba effectiveness and
market
Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Base Loan is the base Trade or
of Riba. No loan investment is the
no interest. base of profit.
Fund- Risk of loss is not Risk of loss is
owner’s applicable to Riba associated to Profit
Risk
 Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Fund- The more the firm PLS system does
user’s Risk is levered the increase the risk of
more it is risky the firm
Beneficiary Lender is the lone profit is shared by
beneficiary of both the owner of
Riba. the fund and the
entrepreneur
 Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Certainty The rate of Riba, No rate is prefixed
and period etc. in connection with
are prefixed. Profit.
Frequency A lender may An investor or a
of receive Riba for seller can earn profit
outcome for once out of one
many times out of
one single single contract or
contract of loan. transaction.
 Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Calculation Calculation of Riba Calculation of Profit
p(1+r)t , where, Sales rev– Tot. Cost
p=pricipal, t = time (variablecost +
r = rate of interest Fixed cost)

Effect on Riba as buit-in Profit as system

price level increases the price does not increases
level and welcome the price level
inflation
 Distinction Between Riba and
Profit
Points of Riba Profit
diffences
Islamic Riba is totally Profit is permitted
view prohibited in in Islam
Islam
Status of Capital is Capital is not
Capital protected. That is protected. That is
in no way the there is possibility of
lender will lose of losing the capital
the capital lend. invested.
KINDS OF RIBA
 Riba Al-Nasia: The term nasi’ah comes from
the root nasa’a which means to postpone, to
defer, or wait, and refers to the time that is
allowed for the borrower to repay the loan in
return for the ‘addition’. Therefore, riba al-
nasi’ah means interest on loans.
 Example of Riba Al-Nasia: X give Tk. 1000 as
loan to Y for one year @ 10% interest. After one
year X gets tk 1000+100 as principal and interest
respectively.
KINDS OF RIBA
 Riba Al-Fadl Riba al-fadl is the excess
charged against spot transaction. It covers all
spot transactions involving cash payment on
the one hand and immediate delivery of the
commodity on the other.
 Example of Fadl: X exchange one kg of
superior quality rice to two kgs of inferior
quality rice with Y.
Differences between Riba Al-
Fadl and Riba Al-Nasia:
Riba Al-Fdal Riba Al-Nasia
Riba Al=Fadl relates to Riba Al-Nasia relates
excess charged to sale to the excess charged
transactions in loan transactions

1Riba-Fadl is forbidden Riba Al-Nasia is

by the Hadith of the forbidden by the clear
Holy Prophet. text of the Quran,
Differences between Riba Al-
Fadl and Riba Al-Nasia:
Riba Al-Fdal Riba Al-Nasia
Riba-Fadl is prohibited Nasia was in vogue in
by the prophet as a the Jahiliyya and is
precautionary and forbidden by Islam
preventive measure. because of its evil and
Because the practice cruel nature
of Riba Al-Fadl may
lead to Riba Al-Nasia
Arguments For and Against Riba

Arguments For Arguments against

Interest is a reward for Reward for savings
saving could be rationalized if
savings were used for
investment to create
additional capital and
wealth.
 Arguments For and Against Riba
Points Arguments for Arguments against
Productivity interest is justified as Interest is paid on
productivity of money-not on capital,
capital . and is paid irrespective
of capital productivity
Time An inevitable Its seems reasonable
difference consequence of the to allow next year’s
value difference between economic conditions to
the value of capital determine the extent
goods today and of the reward.
their value after a  
year
Impact of Riba
 1. Social Impact of Riba
a. Interest makes a man selfish and
miser;
b. It creates hostile relation between the
rich and the poor;
c. Moral decay spreads out in the society
Interest hindrances the flow of
savings and formation of capital
It is assumed that if the rate of interest goes
up the amount of savings also goes up
Now, if rate of interest is up > savings goes
up>consumption exp. goes down> demand
for goods also goes down>sales goes down>
revenue/profit decreases> savings /inv.
decreases.
Again, Int. up> price of goods goes up>
consumption exp. goes up> Inv./ savings fall
down.
Interest discourages the
amount of Investment
According to Keyns, if the rate of int.
goes up then the entrepreneurs feel
discouraged to borrow > amount of
investment goes down.
If the rate of int. goes down then people
feel encouraged to borrow more >
amount of investment goes up.
Impact of Riba

a. Interest hindrances the flow of savings

and formation of capital
Keyns advocates for '0' interest rate to
increase savings and investment.
According to Keyns,
Total income=Total consumption exp. +
Total investment expenditure
Interest reduces the marginal
efficiency of capital

Interest reduces the marginal efficiency

of capital and it rapidly goes down to
the point where marginal efficiency of
capital equals to the rate of interest. At
this point investment is stopped.
Interest creates deficit of
capital
 Entrepreneurs can not invest in project where
rate of return is less than the rate of interest.
So, no fund become available to invest in
such projects.
 According to Umar Chapra,
Interest+Profit =Total Income
 Now, as the rate of interest goes higher and
higher the profit of the entrepreneur goes
lower and lower and sometimes he makes
loss. As a result capital is reduced.
Interest diverts investment
into speculative sector
 Investors prefers
a. more profitable
b. less risky and
c. quickly recoverable sectors of
investment like buying govt. security,
discounting bills, and other speculative
sectors. As a result crisis mounts in
productive sectors.
Interest encourages artificial
crisis in financial sector
 The bankers and other lenders of
money hoards money to increase the
rate of interest by creating artificial
crisis in the money market
Interest reduces long term, risky
but most desirable investments
 gestation period of long term investment
which further aggravates the burden of
interest
 makes it difficult to service debt and
 sometimes make the entrepreneurs bankrupt.
So, Investors often feel discouraged to invest
in such projects by procuring fund from
interest based sources.
Interest creates idleness
among the savers:
 Interest creates idleness among the
savers:
 As the lender is to an extra certain
income, he feels discouraged to go for
any laborers or risky venture.
Interest reduces overall
production
 In an interest based economy
investment stops where marginal
efficiency of capital equals the rate of
interest.
 If, for example, the rate of interest
would have been zero, the amount of
invested could be extended until the
marginal efficiency of capital was zero.
So, interest hindrances production to
reach its maximum point.
Int/
profit

10%

ARR

0
Amount of investment
Interest increases the price level
Interest as a fixed cost is added to the
cost of production. As the cost of
production goes up the price of the
product also goes up.
 Interest decreases the demand for
goods
By increasing the price level interest
reduces the purchasing power of the
people. Asa result demand for goods
and services also decreases.
Impact of Interest on
Distribution
 Interest increases unemployment:
As interest reduces the amount of investment
so the number of unemployed people also
increases
 Interest increases exploitation of labor
As unemployment increases the demand for
labor decreases but supply of laborers
increases. Hence the laborers got least
bargaining power. So they are to be exploited
by selling their lobor at a price less than
normal.
Interest creates monopolistic
opportunity for the capitalist
 Capital never share losses. The income
of the lender bank or individual is
always certain. So their income goes up
day by day inspite of a debacle in the
economy. So, wealth concentrate within
few hands.
Interest impose unnecessary
burden on organization
 If the rate of return from the project is
less than the rate of interest then the
entrepreneur is in danger.
 The entrepreneur is getting nothing for
his time and labor. Again he/she has to
pay the lender the due amount of
interest from his own pocket.
Interest deprives land from its
due share
 Due to reduction in the investment the
demand for land also decreases. So
they do not get standard rent. Again
the small land owners often compelled
to sell their land to repay the interest
overdue because of crop failure or
some other reason.
Interest reduces income of the
depositors
The depositors often dry up their
interest received in the form of buying
with higher price.
 Interest Concentrates wealth in the few
hand through public finance
Govt. often borrow from banks or
capitalists for i) welfare exp ii) to meet
the exp. of war etc. Ultimately the govt
imposes tax on general member of the
public to repay the loan with interest.