Islamic Finance

What is Riba (interest)? A Detailed Definition & Guide

Introduction

“Riba” is a complicated Arabic term loosely defined as interest. It can often be hard to pin down as it can morph and change depending on the situation. 

However, with a basic grounding in Islamic financial law and some helpful rules of thumb, it is possible to be able to effectively navigate this definition and common applications such as loans, mortgages, and business finance.

In this article we aim to do just that. We cover:

  1. What is riba (definition)
  2. What is not riba (but might seem like it is)
  3. Historical examples of riba
  4. The difference between riba and profit
  5. The key Qur’an and Hadith texts on riba (and what that means for us today)
  6. Why riba is prohibited in islam?
  7. What is the difference between riba and usury?

 

What is Riba (interest)?

Literally, riba means  “increase” or “growth”. But when it comes to Islamic law, the word is usually referring to two key concepts: riba al fadl or riba al nasiah

Riba al Fadl

Riba Al Fadl refers to the exchange of two different amounts of the same commodity. For example, exchanging 1 kilo of dates for 2 kilos of dates.

In practice, this type of riba is much less relevant in modern economies as we have largely moved away from barter economies.

Riba al Nasiah

Riba Al Nasia is when there is a condition in a contract that the lender will be repaid an extra amount for accepting a delay in the repayment of the debt. 

For example, Zayd lends £1000 to Bakr for a period of one year with the condition that it will be repaid with an extra £50.

What is not riba (but might be confused for it)

As riba is quite a technical concept, it is easily confused with other related but very different financial concepts.

Some of these include:

  1. Buy now pay later schemes
  2. Admin fees
  3. Debentures and securities
  4. Asset financing
  5. Purchase order financing

The caveat here is that some or all of these concepts also can involve riba – but they can often be used in situations where there is no riba as well.

We will dig into all these concepts in further articles inshAllah.

Examples of Riba in past societies

Dealing in interest is a rather old affair. In Aristotle’s ancient Greece, interest rate was at 12% on loans and was considered a fair profit. Later, in Rome too, 12% per annum was the rate established by the Decemvirs.

But regardless of time and place, charging interest – particularly excessive amounts – has been seen as something immoral. 

In England as early as the reign of Alfred, penal laws were enacted against usury. Edward the Confessor increased the severity of those laws. William the Conqueror afterwards added punishments, such as whipping, exposure on the pillory, and perpetual banishment. 

However, unfortunately, in recent centuries that mood has turned. From the beginning of the 17th century, banking and interest-based loans have become more and more a part of ordinary life and morally accepted. 

The difference between riba and profit

Riba is not the same as profit despite first appearances. 

One might wonder what exactly is the economic difference between lending £10 and getting back £12, and buying something wholesale for £10 and selling it for £12.  

In both instances the gain is £2. However Islam forbids the former and allows the latter.

So what exactly is going on?

Let’s illustrate with an example: In today’s context, we can differentiate between riba and profit in contracts such as conventional mortgages which charge interest for accepting the delay in the repayment of the mortgage (riba al nasia).

In contrast, since an Islamic bank cannot charge interest, it will obtain its return (profit) by actually taking an equity stake in the property and renting out its portion.

The crucial difference is that the Islamic bank has been forced to engage in buying and selling a real asset and expose itself to the risk of genuine loss. While the conventional lender on the other hand, is legally entitled to his money. This is regardless of what may happen with the house.

Similarly, in the crypto world, cryptocurrency miners can mine or validate block transactions based on the amount of coins a miner holds (Proof of Stake). The reward received would not be considered as “interest” (riba) as it is a profit in lieu of the mining effort. 

However, should the platform use the funds for their benefit, then the reward paid to the stakers would be classed as riba which is in compensation for not just the mining process but also for lending their cryptos.

The key Qur’an and Hadith texts on riba

The basics of riba

The Quran and Sunnah have mentioned various warnings against Riba. God says in the Quran:

“0h, believers, fear Allah, and give up what is still due to you from the interest (usury), if you are true believers.” (2:278)

“If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.” (2:279)

Whilst in the hadiths the Prophet PBUH said: “may 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].” [Muslim]

The Prophet also said: “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.” [Ahmad]

The detailed rulings around riba

Although the Quran does not mention details of what Riba looks like, the Sunnah provides us some teachings.

One of the main hadith on this subject is where the Prophet  said: “Gold is to be paid for by gold, silver for silver, wheat by wheat, barley by barley, dates by dates and salt by salt, like for like and equal for equal, payment made hand to hand. He who makes an addition to it or asks for an addition, deals in riba. The receiver and the giver are equally guilty”. [Nasai]

The six commodities mentioned above include monetary items (gold and silver) and non-monetary fungible items (the remainder).

From these six items, the scholars of Islam differed as to whether the prohibition of riba can be extended to other items or not. The literalist school are of the opinion that the prohibition does not extend to outside of these six commodities. 

However, others believe that the hadith is less about the specific items and more about the fact that they are measurable by weight or capacity. 

Yet others argue that the key thing uniting the items named is that they are currency (foodstuffs were a historical form of currency). 

Why is riba haram?

The “there is no reason” school

Indeed, riba is one of the worse sin in Islam,. However, there is no clear indication on why it is prohibited. 

In fact, some scholars have argued that we must accept its prohibition even though the wisdom and reasons are vague. In this regard, Izz Ibn Abdi Salam explains that there are two types of commands; one  is to protect or to bring a benefit to people, while other commands may not satisfy logic and where no clear reason is presented. We must still follow them as adherence to these rules are still considered to be ‘acts of worship’.

This is the opinion of Izz ibn Abdi Salam, Al Juwaini, Imam Ghazali in one of his  opinions, and Imam Shatibi.

The “there is a reason” school

Other scholars have attempted to find wisdoms and meanings to explain the prohibition of riba. 

Some argued that interest can lead to price instability. Ibn Taymiya explained that dirham and dinar are prices for commodities and that we not trade them as if they are commodities themselves, otherwise they will lose their feature of being ‘money’. 

Other Muslim economists too believe that selling ‘money’ as a commodity will eventually have an impact on inflation rate. Tohirovich argues that inflation arises from the unreasonable increase in the mass money on credit due to the interest.

Another opinion is that riba is prohibited because of the negative impact it has on the economy of a society.  Rafiq Yunus al Misri argues that riba may bring some benefits,  even to the orphans and the weak etc. However, the overall negative impact it has, outweighs the positive. 

For example, it creates a gap between different classes of people; where the rich tend to benefit more from charging interest and not having to do much work. Whilst hard working people such as farmers and business owners, have greater chances of making huge losses.

For more arguments on why interest is haram, we have written a two-part essay starting here.

Interest vs Usury, and does Islam definitely ban interest?

Usury is where one charges an excessive amount of interest, e.g. payday lenders. In Islam, there is no distinction in the treatment of “usury” and “interest” – both are haram.

Regarding the prohibition of riba, some contemporary Muslims believe that we should make a distinction between “interest” and “usury”. They argue that the rate of interest is usually so minimal, that the question of exploitation doesn’t really arise.

However, firstly, this approach is not true to the prohibition in the Qur’an. The Qur’an makes a blanket prohibition – it does not distinguish  between those who can afford to repay and those who cannot afford to. 

Secondly, if you glance through the Islamic and pre-Islamic history of Arabia, you’ll realise that the interest type  was not restricted to usury. And loans were granted for commercial and profitable purposes.

Thirdly, as we have previously argued here, the interest banks charge is actually deeply exploitative – it just isn’t as visible and visceral as a pay-day lender.

Fourthly, as Imam Qarafi  explains, a ruling made to protect people, will always remain valid even if people do not feel the need to be protected anymore. For example, the prohibition of adultery is to protect the progeny; and the prohibition of consuming alcohol is to protect the sanity. 

Someone might have no issues with intoxication, yet, this will not make alcohol lawful (halal). Similarly he might be happy to commit zina (unlawful sexual intercourse)yet, acts such as adultery and fornication will still remain haram.

The same logic applies here; if people do not feel oppressed by paying riba, their feelings will still not make riba halal.

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