Riba and the Rationale for its Prohibition

The Quranic term “riba” means usury or more commonly used term, interest, in modern economics. Riba is a gain in monetary or physical assets without providing a service or sharing the risk in an economic activity. It is consensus of an overwhelming majority of Islamic scholars that all forms of interest in modern financial system constitute riba. Though usury is commonly defined as excessive interest charged in medieval times or in some dubious transactions in the modern world, Islam makes no such distinction. Any gain of value in money over time is considered riba and is forbidden. The famous verse in the Quran “Allah has permitted trade and forbidden interest” (2:274) lays out the rule. In trade, all participants take part in the economic activity and hence share in the profit or loss. Whereas, in interest based contract, the lender is guaranteed a return regardless of the outcome of the economic activity.

Interest based transactions favor the rich since they have access to monetary resources to lend money on interest. They get richer by collecting interest without sharing the risk of economic activity. Individuals or nations borrow money to satisfy their consumer or developmental needs respectively. Easy credit creates a vicious cycle of debt which is impossible to surmount. People and nations live beyond their means and get addicted to live on borrowed money. Interest based economy has also impacted developed countries as well. More recently, Europe and United States are dealing with huge debt problems. For example, United States national debt has just passed $21 trillion mark, which represents over 100{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} of GDP of the nation. High debt results in high interest payments for both individuals and nations. The money what was to be paid for basic needs of population is used up in interest payments. Also, since debt is created by financial institutions out of a vacuum, it increases the money supply, diluting the currency and increasing inflation.

Types of Interest

Riba Al-Fadl refers to sale or exchange of same kind of goods where one trader receives more than the other based on quality or other aspects. In commercial banking, when two currencies are exchanged, the transaction should be at spot (current) rates and not at future rates. A future transaction might benefit one of the parties for the time elapse, thus involving riba-al-fadl.

Riba Al-Nasiah (Riba Al-Qur’an) is the increase in the principal amount of money borrowed. This is the most common form of interest in almost all modern debt contracts which Islamic banks must avoid. Riba involves in setting an agreed upon addition to the principle amount to compensate for time.