Islam & Riba/Interest

November 2008 Islam & Riba/Interest

Presentation Outline • The WIIFM factor (What’s In It For Me?) • Definition of Interest • Interest in Quran • Interest in Hadith • Types of Riba/Interest • Why Interest is such a Sin? • Some common myths • Some common questions ... and their answers

The WIIFM factor • Quran declares war on those who deal in Interest, and Hadith regards it as a sin 70 times more than committing adultery with one’s own mother • No other sin except Shirk has received such a wrath from Allah and the Prophet (SAW) • Yet we are all affected by Interest one way or the other because today’s global financial system is based on Interest • As a recipient: Interest on bank deposits/savings schemes/bonds • As a giver: Commercial loans from banks • As an employee of a bank, receiving interest income and being part of an interest-based financial system • As a country created in the name of Islam it is a matter of Pakistan’s survival to create an Islamic economic & financial system

Definition of Interest • No explicit definition given in the Quran, but it can be derived from a verse as any sum received above the capital [‘if you repent yours is your principal’ – 2:279] • Definition in Hadith: Any conditional excess in a loan over and above the principal • Definition in Encyclopedia Britannica: The price paid for the use of credit or money • Definition in Wikipedia: Interest is the fee paid on borrowed money. The lender receives a compensation for foregoing other uses of their funds, including (for example) deferring their own consumption • Working definition: Any predetermined/conditional additional amount in a loan over and above the principal

Interest in Quran • “And whatever Riba you give so that it may increase in the wealth of people, it does not increase with Allah” [Rum – 39] • Makkan Surah • Not of prohibitive nature • Some scholars believe Riba here refers to gift in anticipation of a greater gift in return Stage 1: Clarifying that Riba carries no reward with Allah

Interest in Quran • “O those who believe, do not eat up Riba doubled and redoubled” [Al e Imran – 130] • Madni Surah • Revealed in 2nd Hijri • After the battle of Uhud • First prohibitive order against Riba • The context of Uhud is on the account that Makkans had obtained war loans on Interest; Muslims are being forbidden to seek Interest-bearing loans Stage 2: Outright ban on Interest but not retrospectively

Interest in Quran • “And because of their charging Riba while they were prohibited from it” [Nisa – 161] • About Jews • Revealed before 4thHijri (because most Jews left Medina after 4thHijri) • Indicates sinfulness of taking Riba but not prohibitive for Muslims

Interest in Quran • “Those who take Riba will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said, ‘trading is but like Riba’. And Allah has permitted trading and prohibited Riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is upto Allah. And the ones who revert back, those are the people of fire. There they shall remain forever. Allah destroys Riba and nourishes charities. Stage 3: Reiterating the ban on Interest and imposing it retrospectively on all loans

Interest in 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, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you do wrong, nor be wronged. And if there be one in misery, then defer till ease. And if you leave it as alms it is far better for you, if you really know.” [Baqara – 275 to 281] • Revealed after the conquest of Makkah • Prophet Muhammad (SAW) declared void all Riba dues • Historical context: Treaty with BanuSaqeef of Taif who demanded that they be allowed Interest; after these verses they withdrew their demand

Interest in Hadith • “All such loans that bring excess / return with them are Riba” [Narrated by Hazrat Ali] • The Prophet (SAW) cursed the receiver and the payer of Interest, and the one who records it, and the witnesses to the transaction, and said ‘they are all alike’ (in guilt) [Muslim, Tirmizi, Musnad Ahmad]

Interest in Hadith • “Riba has 70 parts; the smallest of which is equivalent to a man committing adultery with his own mother” [Ibne Majah] • “There will certainly come a time for mankind when everyone will take Riba, and if he does not do so, its dust will reach him” [Abu Dawood, Ibne Majah]

Interest prohibited in all religions • Judaism disallows Interest as mentioned in the Old Testament – Exodus 22:25, Leviticus 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 • Christianity also prohibited Interest; Catholics don’t allow Interest even today but Protestants approved it when they rebelled against Catholics and ‘reformed’ Christianity

Types of Riba • There are two types of Riba, and both are prohibited • Riba al Quran – also called Riba al Nasiyah or Riba al Jahiliyyah (any predetermined/conditional increase over principal amount) • Riba al Hadith – also called Riba al Fazl or Riba al Bai (currency exchange in the form of commodities, especially in barter trading) • As the names suggest, Quran mentions the first type of Riba while Hadith also prohibits the second type

Riba al Quran • Real and primary form of Riba • Had several forms in Arabia • Loan given on predetermined Interest rate for a defined period; the principal along with Interest to be repaid at the end of the term • The creditor would charge a monthly Interest from the debtor while the principal would remain intact upto the day of maturity • If the borrower could not pay at the end of the term, the lender would allow more time against additional Interest Islam considers lending as a charitable, not commercial transaction

Riba al Hadith • “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts, and any increase is Riba” [Abu Saeed Khudri in Muslim] • When Bilal (RA) told the Prophet (SAW) that he traded two volumes of lower quality dates with one volume of high quality dates he said that it was precisely the forbidden Riba [Abu Saeed Khudri in Muslim]

Why Interest is such a Sin? • Against the core objective of Shariah – to establish justice (Adl) in the world • Economic slavery perpetrated by an Interest-based economic system deprives human beings from basic human dignity and relegates them to the status of mere economic animals • Unique nature of money • Overall effects of Interest on economy and society

Nature of Money/Capital • Fundamental difference between Islam and Capitalism – Is Money a God to be worshipped or is it a tool to serve humanity? • Capitalism holds Money capital much superior to other sources of production (eg land, labour) • Capitalism treats money as a commodity which can be sold, leased, etc while Islam believes money is distinct from other commodities in several ways (eg differences in intrinsic value/utility, quality, identifiability) Modern-day capitalism has mastered the art of stealing a man’s rights, and then selling them back to him as a privilege

Overall effects of Interest – on Allocation of Resources • Loans are typically advanced to those who can offer collateral; serving only the big and already rich, thus reinforcing unequal distribution of capital • As of Dec 2007, 25,780 or 0.5% out of a total 4.9m borrowers having a loan amount of >PRs10m were recipients of 68% or PRs1.8 trillion of total loans/advances[Source: State Bank of Pakistan Monthly Bulletin Dec 2007] Depositors of PRs10,000 to PRs100,000 make up 60% of total depositor base, but their share of total deposit amount is only 17%

Overall effects of Interest – on Allocation of Resources Source: State Bank of Pakistan Monthly Bulletin; data as at 31 December 2007 The distribution of deposits and advances reveals that the elite few are the main beneficiaries of our banking system while all others are systematically excluded from access to capital and opportunity

Overall effects of Interest – on Production • Since collateral based lending does not care about the actual purpose the loan is put to use, it encourages conspicuous consumption – by individuals, businesses and governments • Conspicuous consumption at macro level results in high government debts

Most debtor nations External debt (public + private) as a % of GDP Source: CIA Factbook Of the US$54 trillion global external debt, top 20 countries account for 90%; including 14 European countries

Government debt – US Source: Wikipedia The biggest economy in the world is also the world’s most debtor nation ever, vulnerable to a major financial crisis

Overall effects of Interest – on Distribution • Interest based system either inflicts injustice to the borrower (if the business fails but he still has to repay the debt with Interest) or lender (if the borrower makes a huge profit from lender’s money but only pays a small amount in Interest) • 20-30% of an industrial project is typically financed by equity contribution while 70-80% through bank loan, which is really depositors’ money. Profit earned on such projects is largely kept by the business groups while a small portion comes to depositors via the bank as Interest • This means that 25,780 borrowers are also the major beneficiaries of other people’s money in great disproportion of their contribution to wealth generation process. This is a systematic transfer of wealth from poor people to rich people

Overall effects of Interest – on Distribution Effect of low/high interest rate over short/long periods The power of compounding plays havoc with borrowers at high interest rates over long periods of time

Overall effects of Interest – expansion of artificial money and Inflation • Since Interest-bearing loans have no obvious/direct connection with actual production, there is a serious mismatch between the loans advanced by the banking system and the goods & services produced in the economy. This is a basic reason for Inflation • This phenomenon is aggravated by the “money creation’’ characteristic of modern banking, through which banks are able to create “money out of nothing’’ by way of fractional reserve banking system • This artificial money is the bubble that bursts in a financial crisis “The collapse of the global marketplace would be a traumatic event with unimaginable consequences. Yet I find this easier to imagine than the continuation of the present regime” George Soros

Overall effects of Interest – The Liquidity Pyramid Source: Independent Strategy Interest-based system has created a mega liquidity bubble which can burst any time

Evolution of the Liquidity Pyramid Source: Independent Strategy Derivatives market has skyrocketed since 1990s due to globalization of capital and technological advancements

The busting of the Liquidity Pyramid – wealth destruction Bear Stearns 1-year share price performance US$ From US$20bn to US$230m in 14 months; Bear Stearns experienced a 99% free fall in share price

The busting of the Liquidity Pyramid – wealth destruction • The crisis has been called a sub-prime crisis, which led to a liquidity crunch. But it is really a debt crisis involving the entire mortgage industry, bond re-insurers, credit card debt, corporate debt, etc. • The prosperity created in recent years was simply not real or sustainable, it was financial engineering run amok. Real work was shipped to China and India while investment bankers in the West created wealth out of thin air, using leverage like a magician uses sleight of hand during magic tricks to dazzle the audience. Well, the party is over and the effects of de-leveraging will be very painful. [Acamar Economic Journal, March 2008]

Overall effects of Interest – expansion of artificial money and Inflation Hyperinflation in 20th century Inflation 1923-24: A German woman feeding a stove with currency notes, which burned longer than the amount of firewood they could buy Source: Wikipedia

Some common myths

1. It is Usury (and not Interest) that is prohibited • “O those who believe, do not eat up Riba doubled and redoubled” [Ale Imran – 130] • “And if you repent, yours is your principal” [Baqara – 275 to 281] • The words doubled and redoubled are not restrictive and only used to reflect the worst practice • Also, Hadith clarifies/explains the Quran and we see no evidence that it differentiates between excessive and low rates of Interest • Logically, who will decide what rate of Interest is excessive? Also, excessive is a relative term

2. Consumption vs Commercial / Production loans • The basic premise here is that the poor take consumption loans while the rich take commercial loans; charging Interest to the poor is wrong while it is ok to the rich • Some also argue that commercial loans were not there during the time of the Prophet, so the Quran’s references are only for consumption loans • Validity of a transaction is not based on the financial status of a party • Neither the Quran nor the Hadith differentiates between consumption and commercial loans • It is factually incorrect to say that commercial loans were not common at the time of the Prophet (SAW) • Banking transactions go back to 2000 BC • Trade related commercial loans were common in Arabia

3. Zulm – the basic cause of prohibition • The argument here is that the basic cause (illat) of prohibition of Riba is Zulm (“neither you do wrong nor be wronged” – Baqara 279); if Zulm is not there then the prohibition should not apply • There are two assumptions in the above argument: • Basic illat of the prohibition is Zulm • There is no Zulm in the modern Interest-based transactions • Zulm is not the illat but the hikmat of prohibition

3. Zulm – the basic cause of prohibition • Illat is the basic feature of a transaction on which the application of the law depends • Hikmat is the wisdom behind the law • Example: When the red light is on, every car has to stop regardless of whether there is traffic or not. Here the illat is the red light while the hikmat is the prevention of accidents • In a loan transaction the basic illat is the predetermined excess over principal, not the Zulm

4. Interest should be allowed under the Doctrine of Necessity • Some argue that Interest has become such an integral part of modern day economy that it is impossible to avoid; it should therefore be permitted using the law of necessity • Shariah acknowledges the doctrine of necessity but only in life-threatening or extreme emergency situations where no other alternative exists, and it is also time-bound • For most of the Muslims today there is no extreme need to take or give interest or participate in such transactions • To a limited extent in foreign transactions only, the law of necessity may be applied by a government transiting to an Islamic economic system

5. Riba is among Mutashabihat, hence unclear • Mutashabihat refer to two types of things • Initial wordings of some of the Surahs which were not explained by the Prophet (SAW) • Qualities / features of Allah which are beyond human understanding (eg the hand of Allah) • Shariah has not made people responsible to know the Mutashabihat or act based on them • Then how can Quran declare a war on those who take Riba without first ensuring its proper understanding?

6. Was Riba prohibited in the last year of the Prophet (SAW)? • No. Quranic verse prohibiting Riba (Ale Imran 130) was revealed as early as in 2nd Hijri • It was only reconfirmed by the Prophet (SAW) in his last sermon • Hazrat Umar’s (RA) statement: The Prophet passed away without adequately explaining Riba, so avoid Riba and everything Riba-like • Here he is referring to Riba al Fazl (which is more complex and dynamic), not Riba al Quran

Some common questions… and their answers

1. Which side of the fence do we wish to be on? • It is not necessary to have a ready-made Fatwa on everything we do • Hand on our heart, we should ask ourselves what is right and what is wrong (Hadith: Istafti Qalbak) • Some things are clear-cut black or white, and Interest is one of these • Now we have to decide which side of the fence we want to be on – with Allah and His Messenger or fighting Allah and His Messenger?

2. Is it permitted to invest in Govt Bonds / Defence or National Saving Certificates? • No • Government bonds and other saving schemes promise a guaranteed fixed return (Interest) along with safety of principal • Islamic alternative Sukuk has recently been introduced and may become available to individual investors in Pakistan in a few years

2. Is it permitted to invest in Prize Bonds / other types of Lottery? • Lottery: A chance for a prize for a price (essential ingredient is to put one’s money at stake in expectation of a reward – not to fulfil a genuine need) • Lotteries of all types are Haram due to the element of Qimar (gambling) which is prohibited in Shariah • Some scholars allow buying prize bonds as long as the intention is to use them as a way to save money (not to benefit from the possible reward); however, if other avenues of saving are available this should not be practised • Some recent lottery schemes are more complex and demand extra care (eg some Internet marketing schemes, TV/radio shows rewarding callers with big prizes on dialling high-priced numbers)

3. Is it permitted to invest in Shares? • Yes, with some restrictions and avoiding certain market practices • Shares/stocks are essentially undivided stakes in the assets of a business; their sale/purchase is allowed in the secondary market • However, (1) the business itself must be Halal, (2) the company should have a mix of liquid and illiquid assets (3) it should not have a large amount of Interest-bearing debt • Some market practices like day-trading (very short term sale/purchase of shares), short selling (selling without owning), borrowing shares on rent, etc are not allowed • In short, simple buying and holding shares (except the negative list as mentioned above) in expectation of dividend and/or capital gains is allowed For unsophisticated investors Islamic mutual funds are an excellent way to earn decent returns at a manageable level of risk

4. What private wealth management options are available to a Muslim today? Low risk, Liquid High risk, Illiquid Muslims today should be ready to forego some return in order to comply with Shariah

5. How Islamic is Islamic Banking? • Today’s Islamic banking is just a start, a small step to create an alternative to mainstream conventional banking • Islamic banking is an attempt to help people come out of absolute haram, but it is far away from the true and ideal Islamic financial system • Generally Islamic banking products are designed to comply with the form of Shariah but not necessarily its spirit • A second generation of Islamic banking products is needed – based on real sharing of risk and return – to move from Shariah compliance to Shariah-based or Shariah-driven products Today’s Islamic banking does not fulfill the objectives of Shariah; it is a start but not the end

6. How does car Ijarah or Islamic car financing scheme work? • Islamic car financing scheme or car Ijarah is essentially a rental arrangement, almost similar to rent-a-car schemes • Here the bank is like the owner of rent-a-car business that allows the client to use the car against a monthly rental. Bank assumes all ownership risks • Since current market rental of rent-a-car model is the same as what the bank charges, the scheme is Islamic in nature. However, sale of the car to client at the end of lease period at a deep discount to its market price or as a gift is questionable Leasing a car for personal or company use from a conventional bank under conventional finance lease arrangement is prohibited

7. How does Islamic housing finance scheme work? • Islamic housing finance is typically done on a Diminishing Musharakah basis, in which both the bank and the client become partners in a property • The client being the resident in the property pays market rental on the bank’s share while under a separate independent arrangement it also buys back periodically the bank’s share at a pre-agreed price • As the client buys the property his rental is reduced and after the mortgage period he becomes 100% owner of the property Obtaining a mortgage for house / commercial property from a conventional bank under conventional mortgage schemes is not permissible

8. How to obtain working capital finance in an Islamic way? • Islamic financing is always asset-based or asset-backed • Murabaha is the most popular product (>80% of all transactions) for Islamic working capital finance, which is a (deferred) sale on declared profit • The bank buys the required raw material or inventory for the client from a supplier, adds its profit and sells it to the client who pays over 3-12 months period Murabaha is not an ideal mode of Islamic financing, but it is a good first step to get out of absolute haram

9. Are credit cards permissible? • If credit cards are used to obtain ‘credit’ (spend now, pay later in instalments on interest) it is not permissible at all • If there is no other option (eg for a frequent traveller) and payment is made to the issuing bank at the end of each month promptly then one is allowed to have a credit card • However, it is not preferable since agreement to pay interest on the outstanding amount is one of the stipulated conditions • The spirit of credit cards (consumerism on borrowed money) is against the spirit of Shariah as well as common sense and financial prudence • It is best to have a debit card, which is totally permissible US is drowned under US$915bn credit card debt; Pakistan has started with US$1bn and will follow the same path if people do not resist

Conclusion...and what we can do? • Bank Interest is haram as explicitly mentioned in the Quran & Hadith, and formally endorsed by the Supreme Court’s detailed verdict in 1999 • Present financial system is based on Interest and therefore at war with Allah and His Messenger • We are obligated not to be a part of this system • We should try to change the system by: • Switching our bank deposits to current account or accounts in Islamic banks • Switching to permissible financing alternatives for business expansion and personal financing needs • Switching one’s job from conventional banks or insurance companies The essence of Islam is Halal & Haram; the one who does not follow the essence is likely to lose out even if he is particular about the details

Islam & Riba/Interest