One of the most obvious reasons why modern banking is condemned conflicting with the Islamic teachings is “the unequivocal prohibition of riba by Quran, which the consensus of Muslim jurists has interpreted as covering all kinds of interest… “(Siddiqi 1983,9). The income of most of the banks comes predominantly from the difference between the interest they charge on loans to their borrowers and what they pay to their depositors.
The Quran prohibits interest primarily because it is unfair. In this article we will take up some of the more important questions concerning the nature of interest to show that the interest charged by the banks is very much within the scope of riba which has been prohibited in Islam.
As regards the definition of riba, Ahmad (S.M.) has rightly pointed out that if while reading Quran “lakum ru’us amwalikum [sic] (2:279) is read with zaroo ma baqiya min al-riba [sic] (2:278) we easily reach the definition of riba [sic]. Any excess above the borrowed sum [charged by the lender] is interest” (Ahmad, S.M 1989, 43). Abu Bakar Al-Jassas has defined riba-based arrangement thus: it is loan given for a certain duration with the condition of an increased obligation on the borrower [compared to the principal borrowed] (Al-Jassas n.d. Vol. 1,469).
The clarification offered by Pakistan’s Federal Shariah Court’s Judgement on Riba is quite unequivocal It also states that it makes no difference whether the loan is for consumption purposes or for commercial purposes. Similarly, it does not matter if the rate of interest is low or high, simple or compound, for short or’ long term, between two Muslims or between a Muslim and a non-Muslim or between a citizen and a state or between two states. Any excess which is pre-determined over the principal sum in a loan transaction will constitute riba all circumstances.
The above verdict is not the first of its kind to be presented by a group of Muslim legal experts on the subject in recent times. More than a quarter of a century ago in the Second Annual Conference of the College of’ Islamic Research in Cairo it was declared that “interest charged on the various kinds of loans constitutes unlawful usury, regardless of whether the loan is for what is called consumption or production [purposes]. ”It also affirmed that “much and little usury is unlawful”. Although ii has not been explicitly clarified in the above statement, the definition does seem to imply that in Islam riba does not recognize any distinction between interest agreed by the pasties and interest charged for de1ay in payment as penalty, as the laws of present-day states likes, for instance, Egypt and France do.
Interest and Rent
Many modern writers tend to confuse interest with rent because of the apparent similarity in the two arrangements of carrying a fixed charge. The distinction between the two, though, is quite clear. Whereas interest, in the context of the Islamic teachings. is the fixed return demanded from another party on borrowing something which by nature is such that It is exhausted when it is put to use, rent is associated with those assets which remain, by and large, intact while they are in the process of being used. Interest has been prohibited because, once exhausted, the remaking of the borrowed article itself is not guaranteed. The only fair way to lend such articles, therefore, is to do so on a sharing agreement for business purposes and an interest-free basis on loans for personal needs)’ In the case of rental agreements, since nothing normally happens to the asset borrowed, the borrower is not likely to be in serious trouble like his counterpart hi the interest-based arrangements and should, therefore, have no difficulty in paying the fixed charge. In a cue where something happens to the asset that destroy it completely or partially, it is the sole responsibility of the owner, unless it is proved flit the user damaged the asset deliberately or was guilty of willful neglect in protecting It. Indeed, the lender of Interest-based loans also undertakes the default risk, yet that risk is only in the event that the borrower disappears or somehow proves that he is unable to pay back the loan even from his personal wealth. Under normal circumstances the lender is able to recover his fixed charge from the borrower. Moreover, what is more important is the fact that the lender does not intend to forego his interest even in the case where the borrower loses the principal amount as well. The fact that the latter sometimes gets Say without paying interest or even the principal amount is not because of a kind-heisted disposition on the part of the lender, but rather in spite Of his firm resolve. In short, the only reason why Qur’an has prohibited interest is that the chargers of interest disregard the plight of the borrowers and not necessarily because they do not undertake any risk at all It is therefore, not quite correct to state that in Islam the “general principle which is beyond dispute as being the criterion for determining the permissibility or otherwise of any method of financing a that the financier cannot avert the taking of some risk if he wishes to derive an income” (Chapra 1985, 166).
Keynes made a distinction between interest charged on capital and the rent on land by suggesting that while there could be intrinsic reasons for scarcity of land, there west none in the case of capital, at teat in the long run. (Keynes 1973, 376) Indeed, there are reasons for criticism on charging interest from a purely economic point of view as well; however, the basic reason. Why it has been condemned by Islam is moral, i.e. interest exploits the need of individuals and stems from greedy and selfish motives of the owners of capital in complete disregard of benevolence, justice, and fairy play. Rent, under normal circumstances, if it is not unfairly exorbitant, cannot be subjected to the same criticism.
Interest on Consumption Loans
There are writers who believe that only that type of interest which is charged by rich money-lender on consumption loans to the poor is prohibited by Qurãn. The Advisory Council of Islamic Ideology of Pakistan too in its meeting on January 33, 1964 at Karachi decided “that ‘Riba’ is forbidden but [the Council] is in disagreement as to whether ‘Interest in the form in which it appears in public transactions’ which in the opinion of Council includes ‘institutional credit’ as well would also be covered by ‘Riba’ specified in the Holy Quran...” There are others who believe that there, was no direct evidence in the original teachings of Islam refuting that claim (Khan, W.M. 1985. 27).
There have been attempts to refute such claims and misgivings on the basis of Qur’an which, after declaring all interest-based borrowing and lending unlawful says “if a debtor is in want, give him time until his circumstances improve (Qur’an 2:280). It has been argued that Qur’an has, in this verse, directly refuted all such claims by mentioning that during the time of its revelation not all the borrowers were needy, otherwise the conditional statement “if a debtor is in want” would have appeared meaningless. Thus it is concluded that in those times too interest-based loans were taken out for commercial purposes as well and that interest is prohibited by Qur’an, whatever the purpose (lslahi, Amin A. 1976, 594-5) Islahi goes on to argue further from the wordings of Quran that in those days too most of the loans were needed for commercial purposes (ibid.). He has also quoted Hamiduddin Farahi’s (1863-1930) opinion about this verse. He quotes him thus:
It is quits evident from the wording of this verse [i.e. Qur’an 2:280] that the Arabs used to charge interest from the well-to-do as well. The people of Quraish, moreover, were traders and commercial interest was common amongst them. I, therefore, find not much of a difference between their conditions sad ours concerning interest and God knows, the truth (Ibid., 595).
The argument (mm Quran alone, however, does not appear to be as irrefutable as it has been made to look. In the absence of supportive historical evidence the verse cannot b claimed to be offering conclusive evidence to the effect that the borrowers at the time of revelation of Qur’an ware mostly well-to-do people who, ipso facto, ought to have borrowed for commercial purposes. What has been ignored in the argument is that the text is testifying to the fact that few borrowers were “in want” at the time of revelation of the relevant verses prohibiting and not necessarily at the time of borrowing. After all, is it not possible that the people who sit deprived at the time of borrowing remain no more deprived when the loans mature? Although It is not very likely that such a change of fortune can take place on a mass scale under normal circumstances, to assume that all borrowers were definitely well-to-do traders at that time is no more than a theoretical possibility, which makes the argument less than thoroughly convincing. However, there is enough historical evidence to show that the Arabs used to borrow funds purely for commercial purposes in the pro-Islamic period. Mecca, Taif, and Najran were well known commercial centres. In the absence of agriculture and industry, trading was the only source of earning and capitalists used to give loans on interest to merchants and entrepreneurs. Udovitch has firmly stated that “Any assertion that medieval credit was for consumption only and not for production is just untenable with reference to the medieval Near East“ (Udovitch 1970, 86). In the above mentioned quotation, Farahi has also supported his argument from Quran by presenting historical reference as well.
Simple Interest and Anatocism
There are again other writers -- like, for instance, Fazlur Rahman -- who think that only excessive compound interest is prohibited by Quran, and not the moderate, simple one.
Presumably ‘based on a similar opinion, interest exceeding 8 percent was prohibits in Egypt, prior to the introduction of the Civil Code of 1949. On the introduction of the code which was drafted under the supervision of ‘Abdar-Razzaq as-Sanhuri, some changes were introduced to the earlier law. One of the changes stipulated that interest on Interest was prohibited, Another stipulation of the act was that the totality of interest due should not be superior to the principal (Mallat 1988, 75-6). This latter stipulation seems to have had at least the qualified backing of Abu Zahrah (1898-1974), a prominent jurist from. the famous Islamic university of Azhar, Although he pleads that the bank; should operate on the principle of participation in the profits and losses (Abu Zahrah n.d., 57), he also offered his opinion about the stipulation referred to above thus: “The modern Civil Code of Egypt has established this Qur’anic principle (which prohibits charging of exploitative interest rates] and decided that [the totality] of interests cannot exceed the principal” (ibid., 56).
The opinion of most of the writers who are in agreement, with the above views stems to be based on a verse of Qur’an which says: “O you who believe, do not take riba charging [it] doubled and redoubled” (Qur’an, 3:1 30). They conclude that since Qur’an has condemned charging of compound interest in this verse, all other vents too should be understood in the tight of this clarification.
This conclusion, however, is as unacceptable as if one were to conclude from the Qur’anic verse “Do not kill your children out of fear of poverty’ (Qur’an, 17:3)) that killing one’s children for reasons other than fear of poverty is legitimate according to Qur’ân. The two verses, far from bearing the meaning given by the two above-mentioned interpretations, are suggesting that whereas charging interest and killing one’s children are criminal acts in any case, they are even more detestable if they are committed “doubled and redoubled” and “out of fear of poverty” respectively. These additional phrases in the text are meant to expose the extremely callous nature of the crimes rather than to provide essential qualifying expressions to define the crimes themselves.
Is Indexation Allowed:
It has been explained above that Sunnah of the prophet has emphasized that in case of transactions involving credit, whether in the case of sale or financial debt, it is highly important that the returned article be absolutely identical to the one borrowed otherwise there is a danger of interest being involved in the exchange. This principle leads U5 to the question of return of financial loans in the inflationary or deflationary periods when the value of. the amount returned undergoes either depreciation or appreciation compared to what it was when borrowed. Obviously, if at the time of return of loan, for instance, the real value of the amount returned has eroded, then clearly the intent of the teaching of sunnsh is being violated. After all, money today has no intrinsic value of its own other than what it can buy (Ranlett. op. cit., 5). If the hundred pounds lent in 1991 by a person to another could buy x grams of gold and in 1992 when the amount was returned, it could buy y grams of gold (and x end y are unequal), clearly it would be a violation of the condition laid down in the hadith that “If you lend gold then receive back the same gold: the same weight and the same quality ...“ (Muslim. op. cit., Vol 4, 211). It also shows that giving interest to a lender in a period of high inflation at a rate less than the inflation rate, which is called negative rate of interest, is also unfair for the lender and, therefore, should be avoided. In other words, the prohibition of riba applies to real interest, not nominal interest, as with inflation a ban on the latter may result in negative real interest (Baldwin and Wilson 1988, 73). Moreover, in the case of deflation there is a possibility of positive real interest as well, even in the case a borrower is returning only the principal amount of’ the loan. Even though falling prices are practically seldom experienced, their occurrence is not impossible, as was experienced in the great depression of the 1930s.
The solution to the problem lies in indexing the loans with the price level of a basket of commodities, so that as the loan is returned it is the value of the amount borrowed which is paid back and not the face value of the currency which has nothing similar to what was lent except the meaningless figure of the loan expressed in a certain currency. The solution of indexation, however, is not acceptable to many present-day Muslim economists.
One reason presented against indexation is that such an arrangement would be ‘similar to interest [such] that it would be impossible to tell one from the other”.” I have already submitted that, contrary to the above claim, it is the very spirit of avoiding interest which compels one to suggest the solution of indexation. A somewhat similar stand was. earlier taken by the Council of Islamic Ideology (CII) or Pakistan against indexation whereby it was argued that it is a requirement of the shariah that the borrower should return to the lender the same quantity as borrowed, even though the price of the commodity may have changed.7~ That is, however, precisely the principle I am invoking, although to bring home just the opposite conclusion. Indeed, if money is to be accepted as a commodity with its own intrinsic value then the council’s view would have been correct. But if that is not the case -- and indeed modern-day money is not desired for its own sake but for the sake of the commodities it can fetch” •- then it can be safely concluded that the council has incorrectly concluded from a correct principle just the opposite of what it requires.
The second argument against the idea presented is that since inflation is the result of circumstances beyond the control of the borrower hence he cannot be held responsible for loss of purchasing power to the lender (Siddiqi 1992, 407). In response to that it could be argued that the erosion in value of the loans has not been caused by the either, so why should he suffer? In fact, the spirit of justice of the economic teachings of Nan demands that neither of the panics should suffer unreasonably. Interestingly, only a few lines later the author shows a complete reversal of opinion thus: “The extreme case in which very high rate of inflation renders a currency almost worthless is however, a case apart. In such cases it can be considered that now the worthless currency is a money different from the one in ‘which the loan was contracted. A formula establishing the ‘rate of exchange’ between the ‘new’ and old currency can be devised and all earlier loans converted to the ‘new currency accordingly” (ibid., 408). it is difficult to appreciate how a principle which under normal circumstances is rejected because it is seems to be unfair to the borrowers can be argued to be acceptable in extreme cases? Either the principle is fair or unfair. How can it be fair under one Set of circumstances and unfair under others? Moreover, who is going to decide if the inflation rate has gone high enough to be declared extreme?
A thin criticism on the idea of indention is that it “gives a privileged position to capital as compared to other factors of production which are also affected by inflation in one way or the other.” It certainly seems to be a valid criticism if the proposal confines the application of indexation to loans alone. We have seen in this chapter that (he economic teachings of Islam emphasize, more than anything else; implementation of justice in all areas of economic dealings. It is in that very spirit that the case of indexation of loans: is being pleaded. How is it possible that the proposal can overlook the equally unfair treatment of wages, salaries, and other contracts which arc confronted with similar difficulties due to inflation? Instead of arguing against the idea of indexation of loans, it should be urged that all other areas of payment affected by inflation should be covered by the proposal as well. One way of going about it in the case of wages and salaries is to ensure that alt public and private sector organizations should increase wages and salaries of, their employees every year at least by the percentage of inflation of that particular year.
A fourth criticism raised against indexation is that when the risk-taking investors are not assured of a stable real value of their investments, there appears no reason for savers and cash holders to be assured when they do not even take any risk (Chapra, op. cit., 40). The logic behind this criticism is that since risk-taken are not immune from losses, why should those who choose to avoid risk be saved against erosion in the value of their money? The obvious answer lies within the statement of this question: Since risk shirkers choose not to participate in the profits of business ventures, they have a right to get back exactly what they have lent and the risk-taking investors should face losses in difficult periods because in good periods they also take profits and, moreover, that is the principle they have chosen their capital to be dealt with in the real world the profit margins do normally take into consideration the risk element attributable to inflation involved in the investment. The same author admits a couple of pages earlier that Inflation undoubtedly does injustice to the interest-free lender by eroding the real value of his loan (ibid., 38). When it comes to the solution of the problem, however, he chooses to oppose the only workable remedy.
A fifth objection to the idea of indexation is that sometimes borrowers are unable to earn enough to return the real value of the principal to their lenders. In that case, it would be unfair to require the indexed-value of the loans to be returned (Khan, A.J., op. cit.). However, this objection can also be raised against the condition of returning the nominal value of a loan if the borrower has been unable to earn enough to do so. In fact, as mentioned elsewhere, Quraan urges the believer to forego the condition o demanding the principal amount as well if the borrower is in difficulty. Doing so, however, would be an optional act of benevolence on the part of the lender in exceptional cases. Under normal circumstances, a borrower is bound to return to his lender the principal amount. What’ is being argued here is that the principal amount which the borrower is obliged to return is the real value of the loan taken and not its nominal value.
The justification of indexation can also be viewed from the point of view of’ credit sales. Whereas pre-determined higher prices for; credit sates is undoubtedly riba if the deferred prices of commodities are forced to remain equal to spot prices in inflationary periods, it would be unfair to sellers and they would understandably stop making credit sales. After all, why should they sell at a lower real price on credit, when they can get a higher one on cash? If the answer is that the sellers should be allowed to charge the prevailing price rather than. the one which stood at the lime the possession of the commodity was transferred to the buyer, then it will be a solution based on the same broad principle which is applied in the case of indexation Why should that principle be allowed in one area of the economy (i.e. credit sales) and disregarded in others (financial credit)?
The rationale for indention can also be viewed from another angle. It has been pointed out in defence of the Islamic proscription of interest that money represents the monetized claim of its possessor to the property rights created by assets that were obtained through work or transfer. Lending money is virtually a transfer of this right, and all that can be claimed in return is its equivalent and no more. Interest on money represents unjustified creation of property rights because it represents a right claimed outside the legitimate framework of recognized property rights (Khan and Mirakhor 1987, 4). In case borrowed money is returned on the basis of the principle of indention, it represents neither the creation of any extra property rights for the lender nor the expropriation of some of those rights for him, as happens when some one lends interest-free Loan in an inflationary period, in fact, it would be an effort to enable the lender to receive back the equivalent of what he had lent. Thus the proposal of extending index-based loans appears to be the most acceptable to the spirit of the Islamic teachings of economic justice.
On the question of how to implement the principle of indention1 the suggestion of Khan (M.A) is worth looking into. He has proposed the floating of a new currency which can be used for all contracts involving deferred payment by one party to another. The value of that currency should be equal to a basket of commodities and it should be readjusted daily on the basis of the prevailing market price of (he commodities. Thus all borrowers should borrow and likewise return in that currency whatever may be its value in relation to the other currency. Likewise, all agreements of salaries, wages, and contracts involving payments over a period of time could also be agreed upon in that currency. He also proposes that the currency should have a single buying and selling rate to avoid speculation (Khan, M.A., op. cit., 6).
Despite the fact that the proposal seems quite promising, it appears to have at least one potential flaw which might wreck the whole idea: There appears to be no way suggested in the proposal to prevent the proposed second currency - which would assume the role of the store of value and, perhaps, legal tender as well -- from driving the official market currency from the economy. When two currencies are simultaneously allowed to operate, the more stable one will be preferred by all in every transaction and this would lead it to be virtually the commonly used currency at the expense of the official one. Thus a reversal of Gresham’s Law is likely to be experienced: ‘good money’ will drive out ‘bad money’. If any limitations on the supply of that currency were to be imposed, such a move would restrict its effectiveness in discharging the function for which it was proposed. If it is suggested that such currency notes would only be supplied to those who genuinely need them, then an unnecessarily large task of distinguishing the genuine demands from the non-genuine ones would have to be undertaken.
The proposal has, however, paved the way for further discussions and proposal for introducing proper indexation to protect asymmetry in the exchange of values in credit arrangements at different points of time. It is surprising that the writer who has presented the above proposal formally to introduce indexation is himself a supporter of the “arguments against indexation, both from the shariah and economic point of view.“ (ibid.). His subsequent attempt to introduce indexation is enough to undermine that statement.
There are other proposals as well to index loans. The proposal of Javed to give “Purchase Value Loans” in place of money loans by linking the purchase value with certain basic commodities, is one of them,” Indeed, if the principle of fair treatment for both panics is accepted, there should not be a dearth of proposals, It should, however, be pointed out that even if the best of indexation instruments are applied meticulously, there ‘will stilt be some variation in the actual value of the amounts borrowed and returned. Complete and total parity in the values borrowed and returned is neither possible nor should it be expected. What needs to be done is to secure as much fairness for both panics as is possible Allah does not expect from believers a behavior that is beyond their ability. Qur’an says: “And give in full measure, and weigh justly on the balance; no burden do We place on a soul beyond capacity” (Qur’än, 6:152),
ft also needs to be clarified that indexation should be employed only when money is borrowed either for business or consumption purposes, It cannot be used in. case money is given in trust for the purpose of safe-keeping alone, The reason is that while in the former case the borrower has made use of the current value of the money he obtained and should, therefore, be obliged to return the same value, in the latter the funds have remained unused, accruing no benefit to the possessor and, for that reason, should not oblige him to return anything to the owner except the face value of the funds entrusted to him.
The decision of Sindh High Court in Pakistan in the early 1990s to allow repayment of a loan on the basis of indexation rather than interest is a judicial recognition of the validity of indention at the judicial level as an acceptable principle for repayments of loans.
Receiving Favours from Debtors
Another important clarification made by sunnah with regard to interest is that the creditors are required to refrain not just from accepting back any value more than the principal extended to the debtor, but should avoid all other favours ‘n the form of gifts or services which cannot be attributable to any other reason but the fact that they are creditors.
For instance, Anas Ibn Malik reports that the prophet, peace be upon him, said: “When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower often a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually” (Al-Bayhaqi n.d., Vol. 5, 350). Likewise, the same narrator reports that the prophet said this: “If a man extends a loan to someone he should not accept a gift.”3 It has been rightly pointed out that this prohibition is not restricted to the few examples of favours mentioned in the above narrations but extend to any kind of favours which a tender receives from his borrower, even if it is apparently as insignificant as taking advantage of the shade of his walls (Saleh, op. cit. ,414).