Muslim scholars generally equate riba with interest. They fail to see a vital distinction that needs to be drawn between riba declared forbidden in the Quran and interest that has come to play a necessary and very useful role in modern finance and economic policymaking. As some modernist scholars, notably Fazlur Rahman, have shown, interest used in modern finance is substantively different from ribaand works like any other economic price. I also argue that riba forbidden in the Quran applies only for those who deserve humanitarian treatment – who need concessional or interest-free loans (qard-hasana) or outright grants (sadaqa). Thus though there is no epistemological ground to think that receiving and paying interest in modern financial transactions is a forbidden thing, Islamic finance institutions are based on the very notion that interest is taboo. However, these institutions are found to have largely failed to get rid of interest, in part, because the interest-free principle is hard to realistically apply except in equity (as in mudarabaand musharaka) financing, which is only marginally used by these institutions due to difficulties and risks involved in such financing and, also in part, because just equity financing does not work for a stable banking industry.
The label “Islamic” used with Islamic finance and banking institutions is inapt, not simply because interest used in modern finance cannot really be condemned as unIslamic, but also because the very principle which justifies their existence in the first place, namely that they should do away with interest, is found, on scrutiny, to be largely violated in practice. The purpose of this paper is thus two-fold: first, to highlight the point that interest used in modern finance is a legitimate economic price and second, to suggest that Islamic banks have not been able to avoid interest except only marginally. We cover the first point in the next section. This is followed, in Section III, by a discussion of the major investment products that the Islamic finance institutions offer and of how they fail for the most part to go without interest. Some conclusions are offered at the end.
II. IS INTEREST USED IN MODERN FINANCE
REALLY BANNED IN ISLAM?
Muslim jurists have widely differed on the specific meanings attached to riba, “which is often, although inaccurately, translated as interest.” “Riba” literally means “an increase,” but all increases are not riba. Despite numerous differences of opinions among pre-modern jurists about the rules of riba restrictions, modern Muslim scholars generally equate riba with interest. This explains the existence of so-called Islamic finance, which seeks to do away with paying and receiving interest. However, as we will see, this view of interest is grossly mistaken. Interest, as distinguished from riba, has come to play a vitally important role in the modern economy.
It is appropriate to concentrate on the meaning of ribathat the Quran appears to convey. We need to closely examine the Quranic hermeneutics and epistemological reason for the ban on riba. The position generally taken by Muslim scholars does not appear to be really tenable on epistemological grounds. On close scrutiny, we can see that the apparent reason for the Quranic injunction on riba stems out of a social concern for establishing justice and fairness to the borrowers who were burdened with unbearable debt because of the extortionate nature of the riba that used to double and redouble on non-repayments, as mentioned in 3:130. This was a pre-Islamic Arab practice, which obviously needed to be condemned on equity or humanitarian grounds. Because of the extortionate (usurious) way Arabian lenders used to lend money, the Quran warns the lenders, in 2:278-280, to give up the remainder of any riba payments due from the borrowers, to be content with just capital repayments, and to postpone repayments or, better still, to write off the loan by way of sadaqa, if the borrower is found to be in a financially straitened condition. This riba prohibition then is clearly based on equity, justice, or humanitarian considerations. This riba should not be equated with interest that has come to be used in modern finance and which represents the opportunity cost of capital. A number of Muslim scholars distinguish between ribaforbidden in the Quran and interest used in modern finance, contending that while the former is clearly unethical and unacceptable, the latter is a legitimate economic charge.
The Dissenting Views of Earlier Scholars
Some earlier Muslim scholars who expressed the dissenting view that riba was not interest and rejected the ban on interest include the thirteenth century Muslim scholar Izz al-Din Ibn ‘Abd al-Salam al-Sulami (mentioned by Fazlur Rahman) and early twentieth century reformist thinker Rashid Rida. Al-Sulami “rejected the ban on interest that had been almost unanimously pronounced by Muslim lawyers, as he rejected stoning to death as punishment for adultery and roundly declared the entire traditional material on the issue to be utterly unreliable.” Rashid Rida rejected the claim that an interest-bearing loan from its inception was forbidden. “Responding to a series of questions presented to him regarding riba in 1907, Rida concluded that the rules of the riba of excess are entirely prophylactic, and the only kind of riba that is morally condemned by the Qur’an is the riba of the pre-Islamic era.” He argued, “The only reason people trade is to obtain ‘an increase, either in quantity or quality, and neither is prohibited for its own sake, since obtaining a gain is the very . . . goal of commerce.’ Since that is the case, the prohibitions of the riba of excess can be overridden whenever there is a legitimate need to do so.”
Fazlur Rahman’s Contribution
It is the noted Pakistani-American scholar late Fazlur Rahman who has provided a fuller articulation of the modern dissenting view on interest. In a groundbreaking article written in Urdu in 1963 and translated in 1964, he cites some sources and observes that, in the pre-Islamic Arabian practice, the initial payment of interest itself for a certain period of time “was not usurious and was, therefore, not considered riba. What made it riba was the increase in capital that raised the principal several-fold by continued redoubling. […] [I]n case the debtor was unable to pay, the term of payment was extended with an enormous increase in the principal amount.” He further argues, “When the entire system was banned, the milder cases within that system were also naturally abolished since the system itself was tyrannical. It cannot, therefore, be argued that since the Qur’an abolished even the milder cases, it must be concluded that the bank-interest of today also stands condemned; this is because the bank-interest of today is a separate kind of system.” He aptly argues that in the modern economic system, “interest occupies the same place as price and performs the all-important function that any price-mechanism performs, viz., of regulating the supply and demand of credit and rationing it among the customers. If the rate of interest, i.e., the price of loaning money, is reduced to zero, then we are faced with a limited supply and an infinite demand. It would become impossible to control the rationing of credit available, so to say, and to assign priorities.” According to him, riba is forbidden in the Quran precisely because, in that historical context, it was indeed exploitative, doubling and redoubling at times of non-repayment. He criticizes Abu Ala Mawdudi’s contention that interest is simply a matter of haggling and speculation on the part of the lender and the borrower. According to him, Mawdudi’s position betrays his lack of knowledge about how modern finance works. He rightly points out, as modern economists do, that interest used in modern finance depends on “many complex economic factors.” But he did not analyze these factors.
He also speaks of a co-operative welfare or sadaqasystem, which can rule out the use of interest. He maintains that until that welfare state can be achieved, going without interest will be suicidal for a modern economy. Fazlur Rahman’s idea of a welfare system is somewhat parallel, but not exactly similar, to the idea of a stationary state that economists sometimes talk about. In the stationary state, which is characterized by no net investment (any new or gross investment that takes place just replaces existing depreciated capital), there is no need for interest to arise. But our real world is far from reaching that state.
Position of Other Modern Scholars
Several other modern scholars associate themselves with the distinction between riba and interest. Imad-ad-Dean Ahmad of the Minaret of Freedom Institute cites people’s time preference – the fact that goods and money are valued by people more at present time than at a future date – as the cause for interest to arise and argues that any unconscionable overcharging, whether on an interest rate or on a spot price, is riba, but market interest is not riba. Yusuf Ali, in a commentary in his most popular Quran translation, says, “My definition [of riba] would include profiteering of all kinds, but exclude economic credit, the creature of modern banking and finance.” Muhammad Asad, Muhammad Pickthall, M. H. Shakir, and Edip Yuksel and his colleagues also translate “riba” as “usury” in an excessive sense, meaning that interest used in business transactions in the structure of modern credit and banking does not qualify as riba. Other scholars who also align themselves with this modern view of interest include author Imam Feisal Abdul Rauf and the Turkish author and columnist Mustafa Akyol. Rauf rightly points out that the invention and use of interest was one of the pillars of capitalism, which, together with the development of limited liability corporate businesses and the growth of liberalism, was instrumental in dramatically changing the economic fortunes of the Western world, while the Muslim world lagged far behind. “The strict prohibition on charging interest still prevails in the Muslim world and has largely prevented it from robustly developing the financial market’s institutions of banking, capital markets, and stock exchanges, the foundations of capitalism. Neither could the Muslim nations effectively control their own monetary policies, since raising and lowering interest rates is the chief way a nation’s central bank controls inflation and the amount of money in circulation.” Mustafa Akyol thinks that, among all Muslim countries, only Turkey most developed and modernized its economy by shunning the orthodox Muslim thought that Sayyid Qutb and Abul Ala Mawdudi promoted