Riba & Contemporary Transactions

What is the true scope of the transactions to which the bar of riba is applicable? Can the term riba be also applied to the commercial or productive loans advanced by the banking and financial institutions and to the interest charged thereon?

All transactions, commercial or non-commercial, individual or corporate, private or public, which involve a predetermined rate of return on loan, in money or kind, fall within the scope of riba and as such are forbidden. Advances, loans and interest-based financial instruments used by banking and financial institutions are forbidden in Islam and as such Islamic banking must evolve alternate instruments of financing. Muslims have evolved dozens of such instruments in their business transactions during the last 14 centuries. The State Bank of Pakistan circular 13 dated June 20, 1984, entitled “Elimination of Riba from the Banking System” contains some of these modes. A revised version of the same is included as appendix to the Report of the Prime Minister’s Committee on Self-Reliance. Pakistan Economic Survey 1984-85 devotes a full chapter to this subject. I hope the government and the State Bank remain committed to that position as no new “revelation” is expected to have come from high heavens ever since!

It is very significant that the Qur’an prohibits riba and permits trade in one and the same verse (al-Qur’an, 2:275). This provides internal evidence on relevance of riba for commercial and production loans. There is incontrovertable evidence that commercial transactions were part of the economic life of Arabia during the life of the Prophet (pbuh) and he enforced ban in case of riba on both types of transactions. The riba on loans given by the Prophet’s uncle was abrogated by the Prophet (pbuh) in his farewell address. These loans were commercial loans given to Bani Saqcef (see: Mufti Muhammad Shaft, Masala-e Sood and article on riba in the Urdu Encyclopaedia of Islam; Sayyid Mawdudi, Sood; pp. 239-300). Article on riba in the Shorter Encyclopaedia of Islam (Leiden, Brill, 1953) begins with the following:

“Riba - lit increase, as a technical term, usury and interest, and in general any unjustified increase in capital for which no compensation is given. Derivatives from the same root are used in other Semitic languages to describe interest.

“Transactions with a fixed time and payment of interest as well as speculation of all kinds formed an essential element in the highly developed trading system of Mecca.” (p. 471)

Any effort to exclude fixed increase on commercial or productive loans as outside the pale of riba is conceptually unacceptable, historically untenable and morally outrageous and rebellious.

It is to be realised that modem capitalistic system is based on the institution of debt. Both consumer economy and productive economy are debt-ridden. Islam on the other hand allows loan-giving and loan-taking under certain circumstances on ethical and philanthropic grounds. Islam does not visualise an economy that is debt-based. For the consumer, Islam wants every individual to live within his means and desires the society to ensure that everyone is given a just wage, which is enough to fulfil genuine needs of a family.

The whole concept of a debt-based economy is alien to Islamic approach and as such the model of economy which is to be evolved under an Islamic aegis would be equity-based. Self-financing, cooperative financing, indirect financing and financial intermediation have a role to play in an Islamic economy yet all of them have to be on the basis of risk-sharing and not on the basis of a predetermined fixed return. What is forbidden in Islam is this fixed and predetermined return for one factor. Variable return on the basis of actual productivity and profitability of a venture is perfectly legitimate. As such it deserves to be emphasised that the view that the price of capital in an Islamic economy is zero is erroneous. Capital has a price and this is to be determined in the light of the real productivity and profitability of capital. However, there cannot be a predetermined fixed price of capital. As such all modes of financing have to be risk-sharing and consequently profit-and-loss sharing.

Recently, an Egyptian scholar has tried to differentiate between consumption loans and bank loans. But the fallacy of this approach has been thoroughly exposed by over a hundred ulema of Al-Azhar, and the most profound rebuttal has come from Shaikh Yusuf al-Qardawi, in his book: Fawaid-al-Bunuk Heya al-Riba al-Haram, Cairo, Dar al-Sahwa lil Nashr wa al- Tawzih, and Dar ul Wafa, 1992.

Pakistani banks and some financial institutions finance their clients on the basis of “buy-back on mark-up” agreements. According to this method, the client of the bank purports to sell a particular commodity to the bank and simultaneously buys it back on a higher price on deferred payment basis. A certain rate of mark-up (percent per annum) is applied to the second sale. Does this arrangement fall within the ambit of riba?

Murabaha (cost-plus financing) and bai’ mu’ajjal (sale with deferred payment) are permitted in the Shari‘ah under certain conditions. Technically, it is not a form of financial mediation but a kind of business participation. The Shari‘ah assumes that the financier actually buys the goods and then sells them to the client. Unfortunately, the current practice of “buy-back on mark-up” is not in keeping with the conditions on which murabaha or bai’ mu’ajjal are permitted. What is being done is a fictitious deal which ensures a predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against the letter and spirit of Shari‘ah injunctioris.

While I would not venture a fatwa, as I do not qualify for that function, yet as a student of economics and Shari‘ah 1 regard this practice of “buy-back on mark-up” very similar to riba and would suggest its discontinuation. I understand that the Council of Islamic Ideology has also expressed a similar opinion.

Professor Khurshid Ahmad

Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.