Riba in Islam & The Islamic Banking Alternatives

by Muhammad Iftikhar Baig

O believers, devour not Riba, doubling its rate many times. Fear Allah, and you will prosper. Al-e -Imran 130 (Third Revelation)

Ale-e-Imran 130
The words doubled and redoubled interest are used to highlight the shameful aspect of compound interest and not to limit the scope of riba only to compound interest.
Similar to Allahs command Do not bargain on my orders for paltry gains in this world. If one gains the entire world at the cost of hereafter, it is an immeasurable loss - a paltry gain. It does not mean that it is prohibited to obtain paltry gains but permissible to obtain a hefty price.

Those who devour Riba shall rise up before Allah like men whom Shaitan has demented by his touch; for they claim that trading is like usury. But Allah has permitted trading and forbidden usury. He that receives an admonition from his Rabb and mends his ways may keep what he has already earned; his faith is in the hand of Allah. But he that pays no heed shall be among the people of fire and shall remain in it forever. Al Baqarah 275 (Fourth Revelation)

Al Baqarah 275
Similarity between a Riba consumer and a mad person: Both are insensitive to others sufferings. What does Riba do? Create monopolies & open doors to selfishness, greed, injustice and oppression Islam on the other hand encourage highest moral ethics, universal brotherhood, collective welfare and prosperity, social fairness and justice. The above verse carries three strong expressions: a) Haram b) People of Fire c) Forever dwellers

Allah has laid His curse on Riba and blessed charity with increase. He bears no love for the ungrateful sinners.

Al Baqarah 276 (Fourth Revelation)

O you who believe, Fear Allah and give up what remains

of your demand for Interest, if you are indeed a believer. If you do not, then you are warned of the declaration of war from Allah and His Messenger; But if you turn back you shall have your principal: Deal not unjustly and you shall not be dealt with unjustly. Al Baqarah 278 - 279 (Fourth Revelation)

What is Riba?

Riba means any excess compensation over and above the principal which is without due consideration. Its a premium paid to the lender in return for his waiting as a condition for the loan. In the words of Prophet (SAW) Every loan that draws interest is riba.

Wisdom behind prohibition of Riba

To prevent individual gains that cause loss to the whole community. Bank caters loans only to rich sector. Entire capital is utilized for the benefit of few. Community gets poorer. Validity of a Transaction is not based on the Financial Status of the party. It rather depends on the intrinsic nature of the transaction itself. If a transaction is valid by its nature it is Valid irrespective of weather the parties are rich or poor.

Riba: Selected Ahadith

From Hazrat Amr bin Al Aas (RA): When interest based dealing becomes common among people, they will start facing draught and shortage of food. And when bribery becomes norm among people they will live under constant fear of their enemy. From Hazrat Abu Hurayrah (RA) : The Prophet, peace be on him, said: "There will certainly come a time for mankind when everyone will take Riba and if he does not do so, its dust will reach him." (Abu Dawud, Ibn Majah)

The prohibition of Interest is not limited to Islam, but it is shared by Judaism and Christianity.
Some of the old testaments have rendered riba as haram (See Exodus 22:25, Leviticus 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezakhiel 18:8,13,17 & 22:12). Agibi Bank was established circa 700 B.C. in Babylonian and functioned exclusively on equity basis.

CLASSIFICATION OF RIBA

Riba-un-Nasiyah or Riba-al-Jahiliya
Riba-al-Fadl or Riba-al-Bai

CLASSIFICATION OF RIBA

Riba-un-Nasiyah or Riba-al-Jahiliya
that kind of loan where specified repayment period and an amount in excess of capital is predetermined( Imam Abu Bakr Hassas Razi)

CLASSIFICATION OF RIBA
Riba-un-Nasiyah or Riba-al-Jahiliya all loans that draw interest is riba(Hadith quoted by Ali ibn Talib) the loan that draws profit is one of the forms of riba(definition from Sahabi Fazala Bin Obaid)

CLASSIFICATION OF RIBA
Riba-un-Nasiyah or Riba-al-Jahiliya real and primary form of riba premium paid to the lender in return for his waiting giving or taking of every excess amount in exchange of a loan at an agreed rate irrespective of whether it is low or high

CLASSIFICATION OF RIBA
Riba-al-Fadl
excess taken in exchange of specific commodities which are homogeneous legal definition defers in every fiqh

CLASSIFICATION OF RIBA
Hadith prohibiting Riba-al-Fadl sell gold in exchange of equivalent gold sell silver in exchange of equivalent silver sell dates in exchange of equivalent dates sell wheat in exchange of equivalent wheat sell salt in exchange of equivalent salt sell barley in exchange of equivalent barley

CLASSIFICATION OF RIBA
Hadith prohibiting Riba-al-Fadl sell barley in exchange of equivalent barley but if a person transacts in excess, it will be riba.

However sell gold for silver anyway you please on

the condition it is hand-to-hand(spot sales) and sell barley for date anyway you please on the condition it is hand-to-hand(spot sales)

CLASSIFICATION OF RIBA

Imam Abu Hanifa on Riba-al-Fadl commodities must have two common characteristics Weight Volume includes all commodities having weight or volume and are being exchanged

CLASSIFICATION OF RIBA
Imam Shafi on Riba-al-Fadl commodities must have two common characteristics be a medium of exchange be edible includes all commodities that are edible or can be used as a medium of exchange(currency)

CLASSIFICATION OF RIBA
Imam Maalik on Riba-al-Fadl commodities must have two common characteristics can be preserved be edible includes all commodities that are edible and can be preserved

CLASSIFICATION OF RIBA
Imam Ahmad Bin Hanbal on Riba-al-Fadl First citation conforms to the opinion of Imam Abu Hanifa Second citation conforms to the opinion of Imam Shafi Third citation includes three characteristics at the same time i.e. edible, weight and volume

CLASSIFICATION OF RIBA
Present day Islamic scholars on Riba-al-Fadl if two characteristics i.e. weight and use as medium of exchange is present then the following transactions are not allowed

a deferred sale of goods having weight and

homogeneous nature a sale of unequal goods having weight and

homogeneous nature

THE LAWS OF RIBA AL FADL

THE LAWS OF RIBA AL FADL First law Exchange of any of the six commodities with itself

but differing in quality, is allowed only under certain

conditions

THE LAWS OF RIBA AL FADL

First Law CONDITIONS OF EXCHANGE Any difference in value/quality should be ignored The commodities should be exchanged in equal amounts (equal weight and volume). No of direct exchange of commodities of the same kind A person should sell his commodity against cash at the market value and buy someone elses commodity in exchange of cash proceeds at the market value

THE LAWS OF RIBA AL FADL

Second law

Exchange of a product with its raw material is

allowed under certain conditions

THE LAWS OF RIBA AL FADL

Second Law CONDITIONS OF EXCHANGE If the characteristics of the product has been totally changed by the industry, then different amounts can be exchanged. If little difference has been made :either the exchange should be in equal weights or one of the commodities should be sold in the

market and the cash proceeds used to buy the

then one.

THE LAWS OF RIBA AL FADL

Third Law Exchange of any of the six commodities with one another is allowed in unequal amounts but the payment should not be deferred:-

Provided that the general conditions of a sale

contract are fulfilled

TYPES OF RIBA
Riba al Nasiah is classified in two types:-

Sood-e-Mufrad( Simple Interest)

interest calculated only on the initial investment Sood-e-Murakkab(Compound Interest) reinvestment of each interest payment on money invested to earn more interest

TYPES OF RIBA

Quranic verses on absolute prohibition of Riba:

O believers fear God and give up the interest that remains outstanding (i.e. whether it is simple interest or multiplied interest) if you are believers (Surah Al-Baqrah, verse 278)

TYPES OF RIBA

Quranic verses on absolute prohibition of Riba: If you do not do so then be sure of being at war with God and His Messenger. But if you repent, you

can have your principal( only not any kind of

interest or premium). Neither should you commit injustice nor should you be subjected to it

(Surah Al-Baqrah, verse 278)

TYPES OF RIBA

Tijarti Sood(Commercial interest) interest paid on loan taken for productive and profitable purpose

Sarfi Sood (Usury)

interest paid on loan taken for personal need and expenses

TYPES OF RIBA

Tijarti Sood(Commercial interest) interest paid on loan taken for productive and profitable purpose Sarfi Sood (Usury) interest paid on loan taken for personal need and

expenses

Riba: Present day arguments Commercial interest and Usury

In the 17th Century, two new technical terms of interest emerged after the establishment of Banking system namely:

1.

Tijarti Sood (Commercial Interest): Interest paid on loan taking for productive and profitable purposes.
Sarfi Sood (Usury): Interest paid on loan taken for personnel need and expense.

2.

Riba: Present day arguments Commercial interest and Usury

There are two schools of thought on this issue.
First School: This school present two arguments: 1. Riba as practiced during the days of Prophet (SWS) was Usury.

2.

Commercial interest does not exist during the days of Prophet (SWS)

Riba: Present day arguments Commercial interest and Usury

1) Riba as practiced during the days of the Prophet (SAW) was only Usury. Islam when prohibiting something does not only prohibit the prevalent form, but all forms that might erupt in future. The changed state does not change the ruling. E.g. Liquor, Pork, Corruption/Immorality: Todays modern and sophisticated forms does not change their rulings. The same applies to interest and gambling.

Riba: Present day arguments Commercial interest and Usury

2) Commercial interest did not exist in the days of Prophet (SAW).
This claim is wrong as both forms of interest existed in Islamic and pre Islamic history. Some examples: The tribe of Umr bin Aamir used to take interest from the tribe of Mughairah. The tribe of Thaqeef advanced cash as well as commodities on interest to the natives of Taif, the tribe of Mughairah and the business community of Makkah. H.Abbas and H. Khalid bin Waleed (RA) formed a company with joint capital whose prime business was cash advancement on interest. Hazrat Usman (RA) lent money on interest.

Riba: Present day arguments Commercial interest and Usury

Second School of Thoughts:
This school present two arguments:

1) In the present day banking since no-one is exploited or faces injustice, therefore it cannot be called Riba.
Counter Argument: Islam has not only prohibited that one party faces a loss and the other gets profit but also prohibits one party getting confirmed profit and the other party unconfirmed profit from the same investment.

Riba: Present day arguments Commercial interest and Usury

2) There is a Quranic verse O believers do not devour one anothers possession wrongfully; rather than that, let there be trading by mutual consent (Al Nisa verse 29). Wrongful devouring only arise if the consent of one of the parties is absent but in commercial interest the mutual consent is present of both parties, so its not Riba.

Riba: Present day arguments Commercial interest and Usury

Counter Argument: Mutual consent is not the criteria to render anything halal which is haram. Would the act of adultery be allowed if the condition of mutual consent is fulfilled? Similarly there are many transactions in business which are rendered illegal even with mutual concern. Similarly mutual consent is present in commercial interest and gambling too but inspite of that it has been prohibited.

Nature of Money in Islam

One of the wrong presumptions on which all theories of interest are based is that money has been treated as a Commodity. It is therefore argued that just as a merchant can sell his commodity for a higher price then is cost, he can also sell his money for a higher price than its face value, or just as he can lease his property and can charge a rent against it, he can also land his money and claim interest there upon.

Nature of Money in Islam

Islamic principles, how ever, do not subscribe to this presumptions. Money and commodity have different characteristics and there fore they are treated differently.

Difference between Money

and Commodity
Money has no intrinsic utility. It cannot be utilized in direct fulfillment of human needs. It can only be used for acquiring some goods or services. The money has no quality except that it is a measure of value or a medium of exchange. All the units of money of the same denomination, are hundred percent equal to each other. An old and dirt note of Rs.1000/- has the same value as a brand new note of Rs.1000/-. Acommodity, has intrinsic utility and can be utilized directly with out exchanging it for some other things. The commodities can be of different qualities. Every commodity is different from other like an old car and new car have a different value. In commodities, the transactions of sale and purchase are effected on an identified particular commodity. If A has purchased a particular car by pinpointing it, and seller has agreed, he deserves to receive the same car.

Difference between Money and Commodity

Money cannot be pinpointing in a transaction of exchange. If A has purchased a commodity from B by showing him a particular note of Rs.1000/- he can still pay him another note of same denomination.
Conclusion: Money (of the same denomination) is not held to be the subject matter of trade like other commodities, it can only be used as a medium of exchange. If for exceptional reasons, money has to be exchanged for money or it is borrowed, the payment on both side must be equal.

Nature of Money according to Imam Al-Ghazali (R.A)

Imam Al-Ghazali (R.A) the renowned jurist and philosopher of the Islamic history has discussed the nature of money in an early period when the western theories of money were not existent, at all. He says: The creation of Dharhams and Deenars (Money) is one of the blessing of Allah. They are stones having no intrinsic use of usufruct or utility but all human beings need them, every body have a different necessities and they have to fulfill there necessity, there fore the transaction of exchange are inevitable. But there must be a measure on the basis of which price can be determined.

Nature of Money according to Imam Al-Ghazali (R.A)

There fore all these commodities need a mediator to judge their exact value.. Allah Almighty has, created Dharhams and Deenars as judges and Mediators between all Commodities so that all objects of wealth are measure through them. That is why Allah has created them, so that they may be circulated betweens hands and act as a a fair judge between different Commodities. So the one who is using money in an manner contrary to its basic purpose is, in fact, disregarding the blessing of Allah.

Money is neither a Consumption Goods nor a Production Goods

Ludwing Von Mises, the well-known economist of the present century has dealt with the subject in detail. He says: it is true that the majority of economists reckon money among production goods. Nevertheless, arguments from authority are invalid: the proof of a theory is n its reasoning, not in its sponsorship; and with all due respect for the masters, it must be said that they have not justify their position very thoroughly in the matter. He then concludes: Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, dead stock, which produces nothing.

Islamic vs. Conventional Banks

CONVENTIONAL Borrows funds from the depositors paying interest on the liability side of its balance-sheet.
ISLAMIC Partnership (Mudarabah) or profit and loss sharing arrangement between the bank and the depositors.

Islamic vs. Conventional Banks

CONVENTIONAL Lends the funds to the borrowers, charging higher interest on the asset or investment side. ISLAMIC Profit and loss sharing (Musharaka) or trade based financing arrangement (Mubadalah) between the bank and its investment clients.

Islamic vs. Conventional Banks

CONVENTIONAL Between the depositors and the bank, there is an iron wall. ISLAMIC Islamic bank entitles the depositors -- to be informed of what the bank does with their money. -- to have a say in where their money would be invested (Mudarabah).

Islamic vs. Conventional Banks

CONVENTIONAL The interest or the return is predetermined or fixed in advance.
ISLAMIC The profit or the return is based on the actual investment outcome.

Islamic vs. Conventional Banks

CONVENTIONAL Transactions are financial asset based ISLAMIC Transactions are real asset based

Jazak Allah Khair