The most famous and unique principle of the Islamic financial system is the prohibition of riba. The word riba is most commonly understood as charging or promising a fixed rate of return.
For example: credit cards and conventional bank loans include riba in the a form of periodic compounding interest charged on the outstanding debt amount.Riba is widespread and common in the modern conventional financial system. The entire conventional global financial system is based on it. But just because it’s common, does that make it the best way of doing things?
Hated by Religions
Some of the oldest warnings against riba are found in the Vedic texts of India dating back to between 1,400 and 2,000 BC. The narrative poem “Divine Comedy” by Dante imagines an afterlife where those who charged riba are imprisoned in a sandy desert full of burning fire in the seventh circle of hell.In fact classical Judaism, Christianity, and Islam alike have all unanimously agreed on the prohibition of charging interest.
Riba in Christianity and Judaism
The Old Testament of the Bible mentions three types of verses that deal with usury. One forbids usury in general, without reference to Jews or non-Jews
“Do not ill-treat an alien or oppress him, for you were aliens in Egypt. Do not take advantage of a widow or an orphan... If you lend money to one of my people among you who is needy, do not be like a money lender, charge him no interest.” [Exodus 22:21-25]
Another forbids Jews taking usury from poor non-Jews living with them:
“If one of your countrymen becomes poor and is unable to support himself among you, do not take interest of any kind from him but fear your God that your countryman may continue to live among you. You must not lend him money at interest or sell him food at a profit.” [Leviticus, 25:35-37]
Third set of verses forbids the Jews to take usury from other Jews, but allow them to take usury from others such as Deuteronomy 23:19-20.
The New Testament of the Bible shows that Prophet Jesus (peace be upon him) not only prohibited interest, but asked his followers not to take back even the principal of the loan, and to lend not only to friends but even to enemies.
"Give to the one who asks you, and do not turn away from the one who wants to borrow from you." [Matthew 5:42]
"And if you lend to those from whom you expect repayment, what credit is that to you? Even sinners lend to sinners, expecting to be repaid in full. But love your enemies, do good to them, and lend to them without expecting to get anything back. Then your reward will be great, and you will be children of the Most High, because he is kind to the ungrateful and wicked." [Luke 6:34-35]
What does Islam say about riba?
There are four sets of verses of Quran revealed in different occasions. In order of revelation, they are:
- “Whatever riba (increased amount) you give, so that it may increase in the wealth of the people, it does not increase with Allah” [Ar-Rum: 39]
- “And for their charging ribā (usury or interest) while they were forbidden from it, and for their devouring of the properties of the people by false means. We have prepared, for the disbelievers among them, a painful punishment.” [Al-Nisa: 161]
- “O you who believe, do not eat up the amounts acquired through ribā (interest), doubled and multiplied. Fear Allah, so that you may be successful.” [Al-Imran: 130]
- “Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said: ‘Sale is but like riba.’, while Allah has permitted sale, and prohibited riba. So, whoever receives an advice from his Lord and desists (from indulging in riba), then what has passed is allowed for him, and his matter is up to Allah. As for the ones who revert back, those are the people of fire. There they will remain forever. (275) Allah destroys riba and nourishes charities, and Allah does not like any sinful disbeliever. (276) Surely those who believe and do good deeds, and establish salah (prayer) and pay zakah (charity) will have their reward with their Lord, and there is no fear for them, nor shall they grieve, (277) O you who believe, fear Allah and give up what still remains of riba, if you are believers (278). But if you do not (give it up), then listen to the declaration of war from Allah and His Messenger. However, If you repent, yours is your principal. Neither wrong, nor be wronged. (279)” [Al-Baqarah]
The Prophet Muhammad ﷺ explained these verses of the Quran and clearly prohibited riba (interest) in a number of his sayings. Some of them are presented here.
- The Prophet Muhammad ﷺ cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: "They are all alike [in guilt]." [Sahih Muslim]
- The Prophet Muhammad ﷺ prohibited riba explicitly in his last hajj (pilgrimage to Mecca) which was the most attended gathering of his companions. Jabir ibn 'Abdallah, giving a report on the Prophet Muhammad ﷺ's last hajj, said: The Prophet Muhammad ﷺ addressed the people and said "All of the riba of Jahiliyyah (the days predating Islam) is annulled. The first riba that I annul is our riba, that accruing to 'Abbas ibn 'Abd al-Muttalib [the Prophet Muhammad ﷺ's uncle]; it is being cancelled completely." [Sahih Muslim]
- From 'Abdallah ibn Hanzalah: The Prophet Muhammad ﷺ said: "A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times." [Mishkat al-Masabih]
- From Abu Hurayrah: The Prophet Muhammad ﷺ said: "On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest." [Ibn Majah]
- From Abu Hurayrah: The Prophet Muhammad ﷺ said: "Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother." [Ibn Majah]
It can be understood from the above verses of the Quran and the sayings of the Prophet Muhammad ﷺ that riba is very severe sin and prohibited strictly. The committing of riba or involving interest-based transactions is considered as equivalent to being at war with God and His Prophet Muhammad ﷺ.
Why riba is prohibited
What is the rationale behind the prohibition of riba? Riba has both negative effects socially and negative effects economically. Here’s a few notable negative effects of riba:
Riba-based loans exploit the poor and tend increase poverty. Payday loans are an example of predatory lending to the poor which often charge as high as a 400% annualized rate. Many poor people end up refinancing these loans over and over in a never-ending cycle of debt and riba. Riba-based lender’s only care that the loan is repaid and not where the money to repay comes from or the economic hardship endured by the borrower.
Riba-based finance tends to be directed towards borrowers who are likely to repay without any consideration towards whether he underlying activity is beneficial or productive.
Misallocation of Capital
Unlike riba-based lenders, investors into a business need to believe in the underlying businesses outlook to generate profits by creating economic value. Since riba-based lenders only care about the likelyhood to repay the loan with interest, money flows mainly into the hands of borrowers who are likely to repay, rather than towards the best and most productive economic activities.
Riba leads to excessive leverage in business which can lead to systemic risks and business failures. In finance, leverage means using debt to buy assets. After the 2008 financial crisis, many businesses failed because they had high levels of debt (leverage) and they could no longer sustain the payments of riba. Economists call this process “de-leveraging”.
Exploitation Not Partnership
Riba conflicts with the spirit of brotherhood and sympathy, and is based on greed, selfishness and hard heartedness. Rather than sharing in the risks of a business or investment, riba sets up a lender/borrower relationship. The lender has a financial incentive to squeeze the borrower as much as possible to get the loan back with interest, regardless of the borrower’s situation.
An example of this can be seen when mortgage-holders default on their home loan. Banks often repossess a family’s home and put them out on the street, even if the family has already paid the full price of the house.
Short-Sighted "Dumb Money"
Riba-based investments encourage directionless and short-sighted investments rather than channeling investments towards visionary and meaningful advancements.
In his book Zero to One, Peter Thiel, founder of PayPal and notable Venture Capitalist, explains how the riba-based economic system can be “bizarre”, nothing: “At no point does anyone in the chain know what to do with money in the real economy. ...people actually prefer unlimited optionality. Money is more valuable than anything you could do with it.”
In our next article, we’ll dive deeper into the various forms of riba.