Riba in Islamic Banking and Finance

What is Riba in Islamic Banking?

Riba can be roughly translated as "Usury" or unjust, exploitive gains made in trade or business. The word "Riba", in Arabic language, literally means an "increment' or addition". In Islamic Fiqh the term riba has a special meaning. Riba in Islamic Banking is an unjustified increment in borrowing or lending money, paid in kind or in money above the amount of loan, as a condition imposed by the lender or voluntarily by the borrower. This definition of Riba Islamic Finance is derived from the Quran and is unanimously accepted by all Islamic scholar there are two types of Riba, identified to date by these scholars namely 'Riba An Nasiyah' and Riba Al Fadl'.

  • 'Riba An Nasiyah' is defined as excess, which results from predetermined interest (sood) which a lender receives over and above the principle (Ras ul Maal)
  • 'Riba Al Fadl' is defined as excess compensation without any consideration resulting from a sale of goods. `Riba Al Fadl' will be covered in greater detail later.

Prohibition of Riba:

During the dark ages, only the first form (Riba An Nasiyah) was considered to be Riba. However the Holy Prophet also classified the second form (Riba Al Fadl) as Riba. The meaning of riba Islamic finance has been clarified in the following verses of Quran:

  • "O those who believe fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your capital; neither will you do wrong nor will you be wronged." Al Baqarah 2:278-9

These verses clearly indicate that the term Riba Islamic finance means any excess compensation over and above the principal which is without due consideration. However, the Quran has not altogether forbidden all types of excess; as it is present in trade as well, which is permissible. The excess that has been rendered haram in Quran is a special type termed as Riba. In the dark ages, the Arabs used to accept Riba as a type of sale, which unfortunately is also being understood at the present times. Islam has categorically made a clear distinction between the excess in capital resulting from sale and excess resulting from interest. The first type of excess is permissible but the second type is forbidden and rendered haram.

  • "Seized in this state they say: 'Buying and selling is but a kind of interest', even though Allah has made buying and selling lawful, and interest unlawful." Al Baqarah 2:275

riba in Islamic banking


Riba in Quran

The Qur'an states the following on Riba:

That they took riba, though they were forbidden and that they devoured men’s substance wrongfully – We have prepared for those among men who reject faith a grievous punishment”
(Qur'an 4:161)
“Those who charge riba are in the same position as those controlled by the devil's influence. This is because they claim that riba is the same as commerce. However, God permits commerce, and prohibits riba. Thus, whoever heeds this commandment from his Lord, and refrains from riba, he may keep his past earnings, and his judgment rests with God. As for those who persist in riba, they incur Hell, wherein they abide forever”
(Qur'an 2:275)
It is because trade and usury are absolutely different. In trade one earns profit as a result of initiative, enterprise, efficiency and hard work. But the interest is not earned through hard work or any value creating process. It is not the reward of labour but is in fact unearned income. Moreover interest is fixed whereas profit fluctuates. In case of trade there is risk of loss also, but in case of interest the lender gets his fixed amount irrespective of the fact whether the debtor earns any profit or sustains loss. God has forbidden interest but has permitted trade.
“God condemns riba, and blesses charities. God dislikes every disbeliever, guilty. Lo! those who believe and do good works and establish worship and pay the poor-due, their reward is with their Lord and there shall no fear come upon them neither shall they grieve. O you who believe, you shall observe God and refrain from all kinds of riba, if you are believers. If you do not, then expect a war from God and His messenger. But if you repent, you may keep your capitals, without inflicting injustice, or incurring injustice. If the debtor is unable to pay, wait for a better time. If you give up the loan as a charity, it would be better for you, if you only knew."
(Qur'an 2:276-280)
“O you who believe, you shall not take riba, compounded over and over. Observe God, that you may succeed.
(Qur'an 3:130)
“And for practicing riba, which was forbidden, and for consuming the people's money illicitly. We have prepared for the disbelievers among them painful retribution.”
Qur'an 4:161)
“The riba that is practiced to increase some people's wealth, does not gain anything at God. But if people give to charity, seeking God's pleasure, these are the ones who receive their reward many fold.
(Qur'an 30:39)
 

Riba in Hadith of Prophet Muhammad (Peace Be Upon Him)

Riba is also mentioned in Ahadith and is considered one of the seven major sins:

“Jabir said that Allah's Messenger (may peace be upon him) cursed the accepter of usury and its payer, and one who records it, and the two witnesses, and he said: They are all equal”
(Sahih Muslim)
“It is reported on the authority of Abu Huraira that the Messenger of Allah (may peace be upon him) observed: Avoid the seven noxious things. It was said (by the hearers): What are they, Messenger of Allah? He (the Holy Prophet) replied: Associating anything with Allah, magic, killing of one whom God has declared inviolate without a just cause, consuming the property of an orphan, and consuming of usury, turning back when the army advances, and slandering chaste women who are believers, but unwary.
(Sahih Muslim)
Abdullah-bin-Hanjalah reported that the Messenger of Allah said: A Dirham of usury a man devours with knowledge is greater than thirty-six fornications.
(Ahmad, Darqutni)

Types of Riba:

  • The first and primary type is called Riba Au Nasiyah or Riba Al Jahiliya.
  • The second type is called Riba Al Fadl, Riba An Naqd or Riba Al Bai.

The first type was specified in the Quranic verses before the sayings of the Holy Prophet this type was termed as Riba al Quran. However the second type was not understood by the Quranic verses alone but also had to be explained by the Holy Prophet it is also called Riba al Hadees.

Riba An Nasiyah

This is the real and primary form of Riba Islamic Finance. Since the verses of Quran have directly rendered this type of Riba as Karam, it is called Riba Al Quran. Similarly since only this type was considered Riba in the dark ages, it has earned the name of Riba Al Jahiliya. Imam Abu Bakr Hassan Razi has outlined a complete and prohibiting legal definition of Riba An Nasiyah in the following words:

  • "That kind of loan where specified repayment period and an amount in excess of capital is pre determined.".
  • One of the hadith quoted by Ali Ibn Talib (RAA) has defined Riba An Nasiyah in similar words. The Holy Prophet said:"Every loan that draws excess is Riba.".
  • The famous Sahabi Fazala Bin Obaid has also defined Riba in similar words: "Every loan that draws profit is one of the forms of Riba.".
  • The famous Arab scholar Abu lshaq az Zajjaj also defines Riba in the following words: "Every loan that draws more than its actual amount.".
  • One of the hadith quoted by Ali Ibn Talib (RAA) has defined Riba An Nasiyah in similar words. The Holy Prophet said:"Every loan that draws excess is Riba.".
  • The famous Sahabi Fazala Bin Obaid has also defined Riba in similar words: "Every loan that draws profit is one of the forms of Riba.".
  • The famous Arab scholar Abu lshaq az Zajjaj also defines Riba in the following words: "Every loan that draws more than its actual amount.".

Riba An Nasiyah refers to the addition of the premium which is paid to the lender in return for his waiting as a condition for the loan and is technically the same as interest. The prohibition of Riba An Nasiyah is one of those issues which have been confirmed in the revealed laws of all Prophets (AS). Some of the old testaments has rendered Riba as haram (See Exodus 22:25, Leviticds 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 23:8, Nehemiah 5:7, and Ezakhiel 18:8,13,17 & 22:12). The Quran has also stated the prohibition of Riba in various verses has warned those who persist in practicing it of a war which is certain to be declared on them by Allah Himself and His messenger and has seriously threatened those engaged as writer, witness and dealer in Riba transactions.

According to the above definition of Riba An Nasiyah, the giving and taking of any excess amount in exchange of a loan at an agreed rate is included in interest irrespective whether at a high or low rate. It has been proven through ahadith that the Holy Prophet paid excess at the loan repayment time but since this excess was not paid through an agreed rate, it cannot be called interest. This clarifies that the word "Draws" in the hadith definition "The loan that draws interest is Riba” has been used to highlight the giving and taking of excess amount through an agreed rate in the loan contract. Due to this, Imam Abu Bakr Hasas has added the word "condition" to the definition.

The fact that Riba An Nasiyah is categorically haram has never been disputed in the Muslim-community. In short, the Riba Islamic Finance of today which is supposed to be the pivot of human economy and features in discussions on the problem of interest is nothing but this Riba, the unlawfulness of which stands proved on the authority of the seven verses of the Quran, of more than forty ahadith and of the consensus of the Muslim community.

Wisdom behind the prohibition of Riba An Nasiyah First of all, we should realize that there is nothing in the entire creation of the world, which has no goodness or utility at all. But it is commonly recognized in every religion and community that things which have more benefits and less harms are called beneficial and useful. Conversely, things that cause more harm and less benefit are taken to be harmful and useless. Even the noble Quran, while declaring liquor and gambling to be haram, proclaimed that they do hold some benefits for people but the curse of sins they generate is far greater than the benefits they yield. Therefore, these cannot be called good or useful on the contrary, taking these to be acutely harmful and destructive, it is necessary that they be avoided.

The case of Riba An Nasiyah is not different. Here the consumer of Riba in Islamic Banking does have some casual and transitory profits apparently coming to him, but its curse in this world and in the Hereafter is much too severe as compared to this benefit. The consumer of Riba in Islamic Banking suffers such a spiritual and moral loss that it-virtually takes away the great quality of being 'human' from him. An intelligent person who compares things in terms of their profit and loss, harm and benefit can hardly include things of casual benefit with an everlasting loss in the list of useful things. Similarly no sane and just person will say that personal and individual gain which causes loss to the whole community or group is useful. In theft and robbery for example, the gain of the gangster and the take of the thief is all too obvious but it is certainly harmful for the entire community since it ruins its peace and sense of security.

Hadith on Riba An Nasiyah:

  • From Usamah ibn Zayd: The Prophet said: "There is no riba except in Nasiyah [waiting]." (Bukhari, Kitab al Buyu, Bab Bay al- Dinari bi al-dinar nasa'an; also Muslim and Musnad Ahmad) "There is no riba in hand-to-hand [spot] transactions."(Muslim, Kitab al-Musaqat, Bah bay’i al-ta'ami mithlan bi niithlii also in Nas’an).
  • From Ibn Mas’ud: The Prophet said: "Even when interest is much, it is bound to end up into paltriness." (Ibn Majah, Kitab al-Tijarat, Bab al-taglilizi fi al-riba; also in Musnad Ahmad).
  • From Anas ibn Malik: The Prophet, said: "When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, lie should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually."(Sunan al-Bayluqi, Kitab al-Buyu', Bab kulli qardin jarra manfa'atan fa huwe riban).
  • From Anas Ibn Malik: The Prophet said: "If a man extends a loan to someone lie should not accept a gift." (Mislikat, on the authority of Bukhara's Tarikh and Ibn Taymiyyah’s al-Muntaqa).
  • From Abu Burdah Ibn Abi Musa:I came to Madinah and met 'Abdullah Ibn Salam who said, you live in a country where riba is rampant; hence if anyone owes you something and presents you with a load of hay, or a load of barley, or a rope of straw, do not accept it for it is riba. (Mislikat, reported on the authority of Bukhari).
  • Fadalah Ibn 'Ubayd said: "The benefit derived from any loan is one of the different aspects of riba." (Sunan al-Bayhaqi).

 

Riba Al Fadl

The second classification of Riba is Riba Al Fad. Since the prohibition of this Riba has been established on Sunnah, it is also called Riba Al Hadees.

Riba Al Fadl actually means that excess which is taken in exchange of specific homogenous commodities and encountered in their hand-to-hand purchase & sale as explained in the famous hadith: The Prophet said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat- in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot).".

This hadith enumerates 6 different commodities namely:

  1. Gold.
  2. Silver.
  3. Dates.
  4. Wheat.
  5. Salt.
  6. Barley.

Six commodities can only be bought and sold in equal quantities and on spot. An unequal sale or a deferred sale of these commodities will constitute Riba Islamic Finance. These six commodities in fiqh terminology are called "Amwal-e-Ribawiya". Does this hadith apply only to the items mentioned in it? Does it concern sales of barley or wheat but not rice? Of dates but not raisins? A complete legal definition differs in every fiqh. Scholars such as Taoos and Qatada hold that Riba Al Fadl includes these specified types only, however a majority of Islamic scholars believe that some other commodities should also be included. In order to answer the question, which other commodities should be included, some fiqhs hold that the characteristics which are common amongst these items can be used as basis (illat) for Riba Al Fadl. An illat is the attribute of an event that entails a particular divine ruling in all cases possessing that attribute; it is the basis for applying analogy. Ribawi goods are therefore goods that exhibit one of the efficient causes occasioning application of rules of Riba in Islamic Banking.

Various schools define these causes differently:

IMAM ABU HANIFA: Imam Abu Hanifa sees only two common characteristics namely:

  1. Weight.
  2. Volume.

Meaning all these six goods are sold by either weight or volume. Therefore all those commodities, which have weight or volume and are being exchanged, with the same commodity will fall under the rules of Riba Al Fadl.

IMAM SHAFI: The two characteristics observed by Imam Shafi are:

  1. Medium of Exchange or
  2. Eat-able.

Therefore this law will apply on everything edible or having the natural ability of becoming a medium of exchange (currency).

Imam Maalik: Imam Maalik identified the following two characteristics:

  1. Eatables and

  2. Preservable

Imam Ahmad Bin Hanbal: Three citations have been related to him:

  1. First citation conforms to the opinion of Imam Abu Hanifa.

  2. Second citation conforms to the opinion of Imam Shafi.

  3. Third citation includes three characteristics at the same time namely edible, weight and volume.

After a detailed study of the above schools of thought, it has been declared by Islamic scholars that if a commodity bears both of the two characteristics namely; it has weight and can be used as a medium of exchange, then the following two kinds of transactions are not allowed when the same goods are being exchanged:

  1. A deferred sale of goods (A deferred sale is when the goods are returned/or paid for after some undetermined period)

  2. A sale of unequal quantities of the same goods

However, when only one of the two characteristics is present to term the sale as Riba Al Fadl, then exchange of unequal goods are allowed but deferred sale is not allowed. The prohibition of Riba Al Fadl is intended to ensure justice and remove all forms of exploitation through 'unfair' exchanges and to close all back-doors to Riba An Nasiyah because in the Islamic Shariah, anything that serves as a means to the unlawful is also unlawful.

Hadith on Riba Al-Fadl:

  • From Umar Ibn al-Khattab: The last verse to be revealed was on riba and the Prophet was taken without explaining it to us; so give up not only riba but also raihah [whatever raises doubts in the mind about its rightful-ness]. (Ibn Majah)
  • The Prophet said: "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of Equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a (riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sells barley for date anyway you please on the condition it is hand-to-hand.
  • From Abu Said al-Khudri: The Prophet said: "Do not sell gold for gold except when it is like for like, and do not increase one over the other; do not sell silver for silver except when it is like for like, and do not increase one over the other; and do not sell what is away [from among these] for what is ready." (Bukhari, Kitab al-Buyu', Bab bay’i al-fiddati hi al-fiddah; also Muslim, Tirmidhi, Nasai and Musnad Ahmad)
  • From 'Ubada Ibn al-Samit: The Prophet said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand-to-hand."(Muslim, Kitab al-Musaqat, Bah a-sarfi wa bay’i al-dhaiiahi hi al-,raragi nagdan; also in Tirmidhi)
  • From Abu Said al-Khudri: The Prophet said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, and hand-to-hand. Whoever pays more or takes more has indulged in riba. The taker and the giver are alike [in guilt]." (Muslim, ibid; and Musnad Ahmad)
  • From Abu Said and Abu Hurayrah: A man employed by the Prophet in Khaybar brought for him janibs [dates of very fine quality]. Upon the Prophet's asking him whether all the dates of Khaybar were such, the man replied that this was not the case and added that "they exchanged a sa' [a measure] of this kind for two or three [of the other kind]". The Prophet replied, "Do not do so. Sell [the lower quality dates] for dirhams and then use the dirhams to buy janibs. [When dates are exchanged against dates] they should be equal in weight." (Bukhari, Kitab al-Buyu', Bah idles arada bay'a tamrin bi tamrin khayrun minhu also Muslim and Nasa’i)
  • From Abu Said: Bilal brought to the Prophet some harm [good quality] dates whereupon the Prophet asked him where these were from. Bilal a replied, "I had some inferior dates which I exchanged for these - two sa's for a sa'." The Prophet said, "Oh no, this is exactly riba. Do not do so, but when you wish to buy, sell the interior dates against something [cash] and then buy the better dates with the price you receive.' (Muslim, Kilab al Musaqat, Bab al-ta'amr mithlan hi nritlrlin; also Musnad Ahmad)
  • From Fadalah Ibn 'Ubayd al-Ansari': On the day of Khaybar he bought a necklace of gold and pearls for twelve dinars. On separating the two, he found that the gold itself was equal to more than twelve dinars. So he mentioned this to the Prophet who replied, It [jewellery] must not be sold until the contents have been valued separately."(Muslim, Kitab al-Musaqat, Bab hay'i al qda .ah filia kliara-zun wa dhahab; also in Tirmidhi and Nasa'i)
  • From Abu Umamah: The Prophet said: "Whoever makes a recommendation for his brother and accepts a gift offered by him has entered riba through one of its large gates."
    (Buluglr al-Maranr, Kitab al-Buyu', Bab al-riba, reported on the authority of Ahmad and Abu Dawud)
  • From 'Abdullah Ibn Abi Awfa: The Prophet said: "A najish [one who serves as an agent to bid up the price in an auction] is a cursed taker of riba."(Cited by Ibn Hajar al-'Asqalani in his commentary on al-Bukhari called Fath at-Bari Kitab al-Buyu, Bab al-najish; also in Suyut, al Jan, al-Saghir, under the word al-najish and Kanz al 'Ummal, op. cit., both on the authority of Tabarani's alKahir)

 

Interest and Trade

The Holy Quran says: “Those who swallow usury cannot rise up save as he ariseth whom the devil hath prostrated by (his) touch. That is because they say: Trade is just like usury; whereas Allah permitteth trading and forbiddeth usury…….”(2:275) Why does God permit trade and forbid usury?

It is because trade and usury are absolutely different. In trade one earns profit as a result of initiative, enterprise, efficiency and hard work. But the interest is not earned through hard work or any value creating process. It is not the reward of labour but is in fact unearned income. Moreover interest is fixed whereas profit fluctuates. In case of trade there is risk of loss also, but in case of interest the lender gets his fixed amount irrespective of the fact whether the debtor earns any profit or sustains loss. God has forbidden interest but has permitted trade.

 

Why Is Interest Prohibited?

As we have already discussed, interest has not only been prohibited and declared unlawful by Islam but has also been strongly condemned as a criminal offence in this world and a major sin liable to punishment in the Hereafter. According to al-Qur’an, charging of interest amounts to declaration of war against God and God’s Messenger; while according to the Sunnah it is a criminal and sinful act worse than adultery. But no reason for its prohibition has been provided either in the Qur’an or by the Sunnah of the Prophet. This has left the scholars and jurists to find out reasons and explain as to why interest has been prohibited. Regarding reasons of prohibition of interest views differ widely. However, they are unanimous on one single point at least that the prohibition is due to moral, social and economic harms of interest.

Let us briefly underline some of the very harmful effects of interest and decide for ourselves why it has been prohibited.

  • Riba in Islamic Banking or usury inculcates miserliness, selfishness, callousness, indifference, inhumanity, greed and worship of wealth. It destroys the spirit of sympathy, mutual help and cooperation, and thus effects adversely the feelings of love, brotherhood and unity among the community. We find around us that the usurers are generally miser, selfish and hard-hearted Shylocks, devoid of milk of human kindness, who exploit the misery of the poor and charge their pound of flesh without feeling any moral compunction for the sufferings of the borrowers.
  • Interest breeds idleness and promotes unearned income. Instead of undertaking business ventures and using their business acumen, skill, knowledge and entrepreneurship, people having money start lending it on interest and thus living like parasites. Such easily gained money is generally wasted on vices like gambling, horse-racing, betting, drinking and adultery, and in expenditure on luxurious living, marriage ceremonies and festivities.
  • Interest causes many economic evils as well. It leads to hoarding of money adversely effecting its circulation among larger sections of society. It also causes establishment of monopolies, cartels and concentration of wealth in few hands. Thus distribution of wealth in the community becomes uneven and gulf between the rich and the poor widens. The community is divided sharply into two camps - have and have-nots - whose conflicting interests badly effect peace and harmony in the society. Moreover, due to interest economic distortions like recession, depression, inflation, unemployment, etc. are also caused.
  • Capital investment is withheld from those enterprises which cannot yield profit equal to the prevailing rate of interest, even though such projects may be very vital for the country and nation. The flow of all financial resources in the country turns in the direction of those enterprises which carry the prospect of a profit margin equal to or more than the current rate of interest, even though such enterprises may have little or no social value.
  • Interest charged on international loans has aggravated debt-servicing problem of the debtor countries. It has not only impeded the economic development of the poor nations, but has also resulted into transfer of resources from the poor to the rich nations. Moreover, it is adversely effecting the relations between the rich and the poor states and thus harming the cause of international security and peace.

NOTE:
Understanding the concept of Riba in Islamic Banking, is a fundamental part of Islamic banking training. Riba in Islamic Banking is explained in more details, in diploma in Islamic finance and master in Islamic finance programs, which are offered by AIMS.

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