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The Problem with Interest (2nd edition) - by Tarek El Diwany
The literal translation of the Arabic word riba is increase, addition or growth, though it is usually translated as 'usury'. As the following discussion shows, usury is not to be regarded solely as the practice of taking interest on a loan.
Several methodologies exist for describing riba. Here, two defining elements of riba are identified (riba al-fadl and riba al-nasia), and two kinds of transaction into which these elements may be incorporated are described (riba al-qarud and riba al-buyu).
Riba al-fadl involves an exchange of unequal qualities or quantities of the same commodity simultaneously, and could therefore be described as the usury of surplus. Riba al-nasia, the usury of waiting, involves the non-simultaneous exchange of equal qualities and quantities of the same commodity and does not therefore involve a surplus but only a difference in the timing of exchange. Some writers employ the term riba al-nasa to define such an exchange.
Hence, an exchange in which I part with 100 grammes of gold now in return for 100 grammes of gold to be received from you tomorrow can be described as riba al-nasia. An exchange in which I part with 100 grammes of gold now in return for 110 grammes of gold to be received from you now can be described as riba al-fadl.
It is occasionally argued that usurious loans, riba al-qarud, combine both riba al-nasia and riba al-fadl since there is both a delay and a surplus involved in such transactions. This is the modern interest bearing loan, wherein a charge is levied by one party on a debtor in respect of an amount owed. It is one of the major forms in which riba may be practised. The original debt may arise from a loan of money or from the purchase of an item on credit. In either case, the debtor enters into a contract to repay the lender a pre-agreed amount of wealth in addition to the original debt in return for a delay in the timing of repayment. Somewhat confusingly, the term riba al-nasia is occasionally used synonymously with riba al-qarud, but in this text the terms are used as defined above.
Some scholars have in the past asserted that the prohibition on riba al-qarud relates only to high interest charges and not to all forms of interest. Others such as Dr. Tantawi, while Sheikh of al-Azhar in Cairo, have argued that bank interest is a sharing of the bank's profit and may therefore be permissible. In recent times it seems that the Sheikh has either changed his opinion on this matter, or corrected an earlier misunderstanding of his opinion by others. In any case, the view in question has now been widely rejected.
Rejected too have been those arguments that proposed fixed interest rates to be haram and variable interest rates halal. It is occasionally argued that if the rate of interest is allowed to vary then this is permissible since the rate of return is not fixed in advance. This of course is a complete misunderstanding of the mechanics of interest. It is simply the manner of calculating interest that varies here, not the fact of its payment. Under variable rates of interest, interest is indeed charged but the rate at which it is charged is determined at the beginning of each sub-period into which the loan is divided.
Riba al-buyu, the usury of trade, is a second major form in which the elements of riba al-fadl and riba al-nasia may appear. In order to avoid riba al-buyu, both the quality and quantity of the exchanged items must match and the exchange must be simultaneous. Hence, if dates are to be exchanged for dates, the quality and quantity of the dates must be the same and the exchange must be made on the spot. (Quite why anyone would enter into such an exchange is another matter, but Mahmoud El-Gamal at Rice University in Houston has pointed out that the requirement may simply exist in order to encourage the sale of goods for cash in order to achieve fair market values for buyers and sellers, "marking-to-market" as he describes it).
A question now arises as to which kinds of item the prohibition on riba relates to, in other words which are the ribawi items?
'Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt - like for like, equal for equal, payment being made on the spot. If the species differ, sell as you wish provided that payment is made on the spot'.
Hadith: MuslimHadith: Muslim
It therefore seems that riba al-buyu cannot occur under a money-for-goods transaction. Neither can riba al-qarud occur in a money-for-goods transaction since loans are repayable in kind. If correct, this is an important conclusion since it means that where Person A buys a good from Peron B with money, there can be no riba. This in turn means that even if Person A is asked to pay a higher price for deferred payment than for immediate payment, following the purchase of a good, riba does not occur.
Some writers have stated that riba al-jahiliyya, the usury of the days of ignorance, was the only kind of riba known at the time of the Prophet s.a.w. (This kind of riba appeared where a buyer of a good on credit reached the end of the credit period, whereupon the seller offered to extend the credit period for an extra charge). However, the majority view seems to be that both riba al-qarud and riba al-buyu were well established by the pagan Arabs before the time of the Prophet Muhammad s.a.w. and that he warned his companions that riba could be practised in many different ways.
If forced to generalise about the two major forms of riba, one might say that they occur where both counterparties in a contract do not enter, or cannot be assured of entering at a later date, into a fair exchange of countervalues. For example, in riba al-qarud, the borrower is held to pay an amount of value (interest) to the lender for which there is no valid countervalue. And in riba al-buyu, by exchanging two measures of corn for one measure, one party clearly receives more value than the other.
It has also been brought to my attention that Jesus (peace be upon him) evicted the money changers from the Temple in Jerusalem for practising a kind of usury that seems in all respects equivalent to riba al-fadl. Jewish pilgrims arriving in Jerusalem to pay the Temple tax would wish to do so using the half shekel, this being the only silver coin that did not portray the head of a pagan Roman emperor. The usurers of the Temple made a business of receiving the despised silver coins and giving in return the half shekel. The exchange of coin for coin was simultaneous, but the usurers took more weight of silver from the pilgrims than they gave. Thus, they practised an exchange of unequal weight of silver hand to hand, riba al-fadl. The similarity between this mechanism and the practices of those Kings who debased their currency is obvious.
It is often suggested that the use of money sooner rather than later is a valid countervalue to the payment of interest, although the benefit of this earliness of use has itself been questioned by various writers. However, a little consideration does yield some examples of unfairness in the riba al-nasia transaction. For example, if A gives B corn today under an agreement for B to give A the same amount of corn next year, then B is effectively storing and maintaining corn on behalf of A free of charge throughout the period. The exchange may also result in one party having to provide the other with a commodity that is of more value at one time of year than another. If it is easy for A to provide B with corn at harvest time, it may not be so easy for B to provide A with corn at the outset of the growing season.
Riba is mentioned in a number of Qur'anic verses (2:275-279, 3:130, 4:161 and 30:39) and contrasted with acts of charity. It is seen in juristic writings as one of the means of 'devouring' others wealth. This accords with what is known of fixed interest financing mechanisms, relying heavily upon wealth transfer in many cases, for instance where collateral is seized by a lender in a loan default. One might equally argue that the process of money creation also results in the devouring of others' wealth, devaluing their savings through the mechanism of inflation.
Often by reference to less widely known ahadith, some writers regard riba as including a variety of commercial activities such as the artificial bidding up of prices at auction, the payment of commission to a middleman and rent on land. The majority seem to stick with the narrower definitions of riba and classify activities such as money manufacture and auction rigging as fraud or deception.
Whatever the precise scope of riba, in the ahadith the Prophet Muhammad s.a.w. condemns the one who takes it, the one who pays it, the one who writes the agreement for it and the witnesses to the agreement. It is also clear that Allah in due course required the new Muslims of Arabia to give up riba in its entirety.
O you who believe, give up what remains of your demand for usury if you are indeed believers. If you do it not, take notice of a war from God and his Messenger.
Qur'an 2 : 274 to 275
Perhaps those who oppose BBA and murabahah are the 'they' that the Qur'an is referring to. Could it be that the practice described above is in fact permissible in Islam? One might think that Islamic scholars could guide the layman in understanding what really is the difference between trade and usury. Yet even the scholars are divided on some of the crucial issues. For example, regarding the instalment sale of an asset by a financier in the manner described above, Imam Shafi'i is regarded as being favourably inclined by many commentators. However, Imam Malik would seem to be against:
(1353) It reached Malik that the apostle of Allah (may peace be upon him) prohibited two sales within a sale. [Professor Rahimuddin comments: It means that the seller tells the buyer 'I shall sell this cloth to you for Rs. 10 for cash or for Rs. 15 on credit'].
(1354) It reached Malik that a person told another to buy a camel for him for cash and that he would buy it from him at an appointed time on credit. Abd Allah b. Umar considered it a bad kind of transaction and prohibited it.
(1355) Qasim b. Muhammad was asked about the case of a man who purchased a thing for ten dinars on cash or for fifteen dinars at an appointed date on credit, and he considered it bad business and prohibited it.
Imam Malik : Muwatta', (Rahimuddin translation)
When Islamic banks attempt to guarantee receipt of a pre-agreed mark-up by forcing promises to buy and other such contractual obligations upon the purchaser, the very least one can say is that the Islamic banker enters into the realm of what is doubtful. Some argue that if BBA is indeed a form of interest then a huge number of Muslim shopkeepers should be condemned for charging interest of 50% when selling their stock to customers at a mark-up of 50%. But, in a modern murabahah or BBA contract, the banker agrees to sell goods to his customer before purchasing them from a supplier (this of course being the purpose of the promise to buy). In contrast, a corner shop trader agrees to sell goods to a customer after buying those goods from a supplier. The corner shop trader takes the risk that no one will buy his stock. Islamic bankers don't take this risk if they can possibly help it.
The above is a simple 'argument of arbitrage' that explains how the very existence of interest can affect prices where payment is deferred. It is easy to see that if interest rates were 10% in that example then, given the same assumptions, the arbitrage free one year forward price of gold would be $440 per ounce. Most of the Islamic banking industry still depends on the existence of this difference between cash prices and forward prices. It is a difference that arises because of interest and in this sense some Islamic banking techniques rely just as much upon interest as their conventional counterparts. Hence, if Islamic bankers aren't actually practising usury their talk can sound suspiciously like it: "the cost of finance that we can offer on a ten year Islamic mortgage is 10.5% per year" (Malaysia 1997). These are the words of the money lender, the language of usury, of modern banks, leasing and finance companies.
The debate over deferred payment at a mark-up arises because the bulk of the money that society is forced to use is manufactured by banks at interest. It will be difficult to resolve this debate unless it is first realised that the problem arises in the monetary system itself. How can Islamic finance be practised with money that bears interest as a condition for its existence? (see Fractional Reserve Banking on this website).
The appearance of debt trading in the Islamic financial market is a further worrying example of the kind of innovation that erodes the difference between the Islamic and the interest-based paradigms. From the earliest days of large-scale financing, some borrowers would issue bonds to their lenders. The bond would stand in evidence of an amount of money loaned. The amount to be repaid by the borrower at the end of the loan period would be stated on the face of the bond (which is why it became known as the 'face value'). Part of the bond document would be divided by perforations into separate sections, each section known as a 'coupon'. When an interest payment became due, the holder of the bond was required to tear off the appropriate coupon and return it to the issuer in order to claim his payment. Eventually, the term 'coupon' became widely used to describe the level of interest instalments on a bond.
A bond is said to be a 'zero coupon bond' if no coupons (i.e. interest instalments) are due to the bondholder during the life of that bond. Investors therefore only buy zero-coupon bonds at a price that is below face value so that, when the bond matures, the difference between the purchase price and the face value is realised as a gain of waiting. The issuer of the bond guarantees to pay the face value to the bondholder at maturity, and in the event of default the bondholder often has the right to seize collateral.
In the early years of Islamic banking some simple minded commentators argued that zero-coupon bonds are 'Islamic' because no interest is paid during their lifetime. But of course interest is paid, it is just that it is paid all in one go at the maturity date instead of in instalments over the life of the bond.
Reference: www.islamic-finance.com/item5_f.htm
Abridged from: The Problem With Interest (2nd edition 2003) - www.theproblemwithinterest.com
Tarek El Diwany was born in London in 1963. He graduated in Accounting and Finance from Lancaster University in the United Kingdom in 1985. He has worked as an interest rate derivatives dealer in the government bond market, and as Head of Islamic finance for a major financial institution based in London. In 1997, Tarek completed the first edition of The Problem With Interest, and in the same year launched www.islamic-finance.com, where he is now the Editor. In addition to his work as a writer, he runs his own consultancy in business analysis and software development and is an occasional speaker on the topic of Islamic finance and monetary history at conferences throughout the world. He can be contacted by e-mail on tarek@kreatoc.com.
