‫بسم هللا الرحمن الرحيم‬
The Economic Rationale of
Riba (Interest) Prohibition in
Islam
Prof. Dr. Abdel-Rahman Yousri Ahmad
Department of Economics
Faculty of Commerce, Alexandria University
“Riba: Definition”
• The word “Riba”, in Arabic language, literally
means an “increment” or “addition". In Islamic
Fiqh the term riba has a special meaning.
• Riba 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.
• Riba defined in this way is called in Fiqh riba alduyon ‫( ربا الديون‬debt usury). Riba also is an
unjustified increment gained by the seller or the
buyer if they exchanged goods of the same kind in
different quantities. This is called “riba al-fadle” or
“riba-al-buyu” ‫( ربا البيوع‬trade usury).
Practice of Riba
• The Arabs before Islam practiced riba in
several forms but most familiar of these was
the one associated with postponement of
loans repayment after a certain grace
period. This is called in Fiqh “riba alnasi‘ah” ‫ربا النسيئة‬. If postponement of debt
repayment is accepted one period after
another riba will accumulate at a compound
rate.
• Another popular form of “riba al-duyun”, in
the pre-Islamic era, was practiced through
trade finance.
• Imam Al-Razi ‫ الرازى‬, jurist Al- Jassas‫الجصاص‬
and others reported that merchants in
Arabia used to accept loans for financing
their trade on condition that riba will be
given periodically every three or six months
to the lender while promising to pay him the
principal back after one year or more as
agreed.
• If, for any reason, the debtor failed to pay
the principal in due time riba will
accumulate, exactly as the previous form, at
a compound rate. ‫يتضاعف الربا بمعدل مركب‬
“Riba al-Buyu”.
• The Prophet ‫ النبي صلى هللا عليه وسلم‬exposed to
his companions, also, this form of riba
known as “riba al-buyu” ‫ربا البيوع‬. He warned
them that barter exchange of commodities of
the same kind, unless quantities exhanged
are equal, will involve riba. He (PBUH)
advised all traders to use money for the
exchange of such goods to avoid riba.
• In Islamic literature this kind of riba is also
described as “riba al-khafi” ‫ الربا الخفي‬, i.e.
disguised or implicit riba, in contrast to “riba
al-duyon” (riba al-nasi‘ah) which is
considered “Jali”‫ الربا الجلي‬i.e., explicit or
clear.
Riba Practice in Modern Time
• The “riba” system was formally introduced in
Islamic countries during the 19th and 20th
Centuries through two channels;
• (i) secular legislations which have endorsed
the Western definition of usury,
• (ii) the modern banking system whose
activities are interest based.
• These two channels were opened during the
era of Western colonial rule to the Islamic
world. Besides, the riba system has
increasingly gained strength in the Islamic
world because of the serious economic
dependence on the Western world on one
hand and secular education which neglected
the teachings of Islam.
Justification of Interest!
• Affected by the changes some Muslim scholars
and jurists from the Islamic world volunteered to
defend the interest system, by distinguishing
interest from riba. The same controversy of
ancient times and mid centuries has been
repeated in the modern Islamic world.
• A. Jawish ‫(عبد العزيز جاويش‬1908) insisted that
prohibited riba is only that which is accumulating
at a compound rate. Thus simple interest is not
riba.
• M. Dwaleeby ‫(معروف الدواليبي‬1950) thought that
interest charged on consumption loans is
definitely “usury”, but that on loans taken to
finance trade or production is not.
• A. Sanhory ‫(عبد الرزاق السنهورى‬1956) an eminent
Professor of Law and Fiqh emphasized the
prohibition of all kinds of interest, whether
simple
or
compound,
charged
on
consumption loans or on production loans.
• Yet he recognized that the economic system
prevailing
in
contemporary
Islamic
countries is not confirming with Shari’ah
rules and Islamic ethics. Thus business
finance on loss and profit sharing basis, as
Islam requires, has become rare.
• Under such conditions it has become “most
urgent” for business people to seek finance
on interest basis.
• Sanhory emphasized that debt finance involving
interest has become a matter of great urgency that
it justifies a Resort to Necessity Rule “Darura” ‫حكم‬
‫ الضرورة‬in Shari’ah.
• Sanhory emphatically asserted that “Darura to
riba” (necessity of interest) is not similar to
“Darura” which permits eating pork or dead
animals’ flesh. Yet the capitalist system adopted
by Islamic countries, or imposed upon them from
outside,
and
its
interest-based
financial
institutions has created emergency conditions
calling for relaxation of riba prohibition rule.
• Hence, he concluded that simple, but not
compound, interest may be allowed till the
economic system can be changed and become
Islamic.
• S. Tantawy ‫سيد طنطاوى‬, Egypt’s grand “mufti”, (1991)
who never denied that riba is strictly prohibited
thought that interest may be allowed in some
cases because, he claimed, is equal to profit
which is ‘Halal”. Bank loans, he argued, are
usually directed to investment activities and if
profit on investment can be rightly estimated, at a
reasonable degree of certainty, why not take it in
form of interest?
• In fact it has been a gross mistake to treat
“estimated” profit as realized, from Shari’ah point
of view. In Fiqh, as in economics, profit is the
difference between revenues received from the
sale of goods and the value of inputs and this can
never be mixed with interest which is the payment
for the use of borrowed money.
• Another attempt to separate interest from riba has been
made by some economists in the Islamic countries who
believed that interest rates are frequently less than or
equal to the inflation rate.
• Therefore, under such conditions, interest payments may
be considered as a compensation to the loss in real value
of money, and not riba.
• This argument to the disappointment of its exponents
could not defend interest if the general price level
decreased, remained constant, or increased at a rate lower
than the interest rate.
• In all these cases, which are quite possible in practice,
interest will be riba according to the inflation/interest
argument.
• This attempt failed to justify interest, as claimed by its
exponents, upon Ta’weed ‫(مبدأ التعويض‬compensation)
principle set in Fiqh by Abu Yusuf ‫ ابو يوسف‬in the 8th
Century
Rules For Riba Prohibitioon
• To emphasize interest or riba prohibition reference
should be made to three Fiqh rules;
• (i) A benefit gained from a loan is riba ( ‫كل قرض‬
‫)جر نفعاً فهو ربا‬. This is a fiqh rule which is based
on the ethics of Qard Al-Hassan (Benevolent or
good loan) in Quran and Hadith of the Prophet
(PBUH). In Hadith “the only reward to the
lender is thanksgiving and repayment of his
loan”
• (ii) (‫ )الخراج بالضمان‬which means that the capital
owner has to choose either to get a “return” on
his capital through profit/loss sharing, or a
“guarantee” for repayment of his capital intact.
A “return” and “guarantee” on capital can not be
combined together in one deal,
• (iii) (‫ )الغرم بالغنم‬which means that the capital
owner will be entitled to “Profit” only if he is
ready to accept “loss” if this is realized.
• These 3 rules are the basis of all profit and
loss sharing financing methods in Islam,
and they leave no doubt that interest paid to
bank depositors above their money, or
interest paid by borrowers from banks for
the use of banks’ money is riba.
Four Arguments In Favour Of
Interest-Free or participatory
Finance*
• 1st Argument
•
The interest system is inherently incapable of
allocating available liquid funds among firms
and activities in the society according to
considerations of efficiency, productivity and
growth. A just participatory system based on
profit/loss sharing financing methods would
offer, in principle, an efficient substitute.
*These arguments sums up with modifications are part of a paper entitled “the rationale of Riba Prohibition
in Islam” delivered by the author In an International Seminar held by the Islamic Foundation, Leicester, U.K,
2000. Published later by the author (A.R.Yousri) as well as by the Institute of Islamic Banking in London
• First: Criticism of Secular economic theory which
claims that the interest mechanism guarantees an
efficient allocation of available funds.
• According to the Keynesian theory every
businessman would estimate the marginal
efficiency of investment (r) while the interest rate
(i) is determined by money demand and supply. If
(r) is equal or greater than (i) it will be rewarding to
borrow and finance the investment project.
• Otherwise the project will not be undertaken.
• Accordingly, available money for lending will be
allocated efficiently among firms and economic
activities.
• The above argument is unacceptable:
• Let us assume for sake of simplicity and
discussion that (i) measures accurately the
opportunity cost of money available for
lending in the credit market, and that a
uniform interest rate (i) is applied by banks
(lenders) in all cases of borrowing. [These
simple assumptions will be dropped later on]
• Under such assumptions, the 1st question
is; Would all investment projects fulfilling
the condition of (r≥ i) find access to
finance? The 2nd question is; Would banks
(lenders) give preference to projects with
relatively higher (r)? A matter that will help
in achieving best allocation of resources?
• In Practice, not all investors with projects
satisfying the ( r ≥ i) condition and seeking
interest-based finance are treated equally by
banks (lenders) as we have simply
assumed.
• Young and small entrepreneurs with high r
for their investment projects are willing to
borrow, but they may only obtain a minor
share of banking loans. On the other hand,
Large corporations ( with high net-asset
worth) are given priority and better
borrowing terms, irrespective of how funds
will be used by them.
• Banks (lenders) are concerned, above
anything else, with borrowers solvency. In
fact, banks set preferential treatments and
financing priorities on credit-worthiness
basis. Banks which maximize their profits in
micro operations, based on the interest
mechanism, are blind or not concerned with
best allocation of their financial resources at
the macro level. Their main concern is
identical, namely to make profits while
taking utmost precaution for loan repayment
plus interest.
• The answers of two questions which have
been posed are now clear.
• For the 1st Question. We find that not all
firms with (r) greater than (i) are able to
borrow. They are willing to borrow but they
are not neglected or given least attention
by banks. This is because of their lack of
sufficient credit-worthiness or because of
their small size.
• Answer to 2nd is associated with the typical
nature of banks. These are private
institutions looking for their private
interest. The secular theory assumes that
banks would achieve best allocation of
financial resources at the macro level by
following the rule of financing investment
projects that have (r) greater than (i). But
they, for their micro interests do not stick
to such rule. Besides, their financing
system at the micro level does not
necessarily give any preference to those
firms whose (r) are higher than others.
• Therefore, we cannot claim that loanable funds
would be optimally or best allocated through an
interest-based financing system.
• Theoretically speaking an Islamic freeinterest financial system would offer a much
better substitute for allocating available
funds among firms and activities.
• Assuming that an interest-free financial
institutions would aim at maximizing their
‘halal” (i.e. permissible by shari’ah)
revenues, a preference will be given to
projects with higher (r ) over other projects
with relatively lower (r).
• Under such circumstances, an optimum (or
the best) pattern of funds allocation in the
economy will be realized. Deviation from
this pattern may occur, however, because
of; 1st failure to estimate accurately (r) on
the part of enterprises and/or
• 2nd inability of the financiers to estimate
rightly the expected profitability of the
investment projects which are applying for
finance. This may well happen because of
the Asymmetric information problem or lack
of experience on the part of the financiers.
• Notice that such factors that cause inefficiencies
are likely to exist also in an interest-based system.
The Structure of the Financial Market
( Conventional Market Interest Based
Surplus
Units
(Savers))
Receiving
Interest
MONEY
Payment
of
Interest
Financial Intermediaries
( Banks and Companies etc.)
Deficit
Units
(Investors)
MONEY
Market Efficiency is measured by ability of the Financial Intermediaries to Transfer
Financial Resources Efficiently from Surplus Units to the Deficit Units, Giving Preference to
investors or investment projects which are most productive. This will enable Financial
intermediaries to offer best returns to Surplus Units (Savers) under perfect competition
ALLOCATION OF FINANCIAL RESOURCES
And
ECONOMIC EFFICIENCY
FINANCIAL INTERMEDIARIES
A 5%
B 20%
C 12%
D 30%
E 10%
F 7%
A,B,C,D,E, and F are investment projects . For simplicity and for purpose of Explanation we
assume that these are the investment projects which need finance in the Economy’s Real
Production Sector. Rates of Profits which associate projects measure their productivities. We
assume that each of these projects need finance of 100 million dollar a year and that risk is
equal in all projects. Financial and Economic Efficiency in Allocating Financial Resources
necessitates giving priority in financing : D > B > C > E > F > A
In An Interest-Based Financial System, the theory says that all Investment projects will be able
to demand finance from Intermediaries, except A and F if the rate of interest is 10%. This
means that the interest system cannot distinguish between projects on bases of their relative
productivities. It only excludes those which cannot pay the current rate of interest. In practice
Conventional Banks may even give preference to low productivity projects on bases of their
creditworthiness or ability to present collaterals. On the other hand finance based on
profit/loss sharing would give priority to projects according to their productivities which are
reflected in their expected profit rates. THUS FINANCE BASED ON PROFIT/LOSS SHARING IS
MORE CAPABLE OF ACHIEVING FINANCIAL AND ECONOMIC EFFICIENCY
• INVESTIGATING THE SIMPLE ASSUMPTIONS
THAT HAVE BEEN MADE ABOUT THE INTEREST
AND ITS MECHANISM.
• Firstly, current or market rate of interest cannot
simply be taken to measure the opportunity cost
of available units of money capital.
• The rate is not determined in practice as the
theories claim by loanable funds or by money
supply and demand. It is rather determined by
monetary
authorities,
which
take
into
consideration, besides loanable funds or money
supply and demand, several macroeconomic
policy requirements such as income and price
stability, unemployment rate, public debt, and
balance of payments situation.
• Determined in this way the interest mechanism
will not necessarily help in allocating loanable
funds efficiently among firms or between different
economic activities.
• Research studies, years ago, showed that (r)
tends to increase considerably at boom and
fall sharply at depression, whereas the rate
of interest, due to macroeconomic policy
requirements, would not be changed at all in
the same manner.
• Hence allocation of loanable funds
according to the interest mechanism would
further be driven away from the optimum
resource allocation pattern.
On the contrary in an Islamic financial system
• On the contrary in an Islamic financial system,
under the same circumstances, available funds
will be distributed efficiently among investors
since financiers share with them expected profit,
high or low.
• Assuming that financiers would raise their risk
margin proportionally with expected future returns
at boom and that they would be reluctant to
extend their finance at depression because they
would share in loss, which would be quite
expected, profit and loss sharing mechanism
would also help in bringing about stability at the
macro level.
The problem of small enterprises with the
interest-based financial institutions
• The problem of small enterprises with the
interest-based financial institutions is quite
serious in the developing world, though it
may be relatively of minor importance in
developed countries. “Surveys indicate that
less than 1% of small firms in developing
countries obtain credit at controlled rates
from financial institutions; the remainder
rely on the informal sector. The combined
net effect is to raise their capital costs and
reduce their ability to compete against large
firms” according to W.B (1987).
•
• In fact failure of small businesses to obtain
finance from banks have forced them quite
frequently, in the absence of equity finance,
to borrower from money lenders in the
informal market at very high rates of
interest.
• So they have jumped from the frying pan to
the fire. A study concerning the informal
credit market in Peru mentioned that
interest rate in that market was as high as
800% - 1000% per annum sometimes in the
mid 1980s.
• Todaro, M., states that “commercial banking
system of many LDCs restricts its activities
almost exclusively to rationing scarce
loanable funds to “credit-worthy” mediumand large-scale enterprises in the modern
manufacturing sector.
• Small farmers and indigenous small scale
entrepreneurs and traders in both the formal
and informal manufacturing and service
sectors must normally seek finance
elsewhere sometimes from family members
and relatives, but more typically from local
moneylenders and loan sharks who charge
exorbitant
rates
of
interest.”
• INTEREST RATE CONTROLLING POLICIES,
HOW FAR DO THEY HELP?
• It may be claimed, that such policies have
exerted favorable economic effects, which is
not true. In the developing world, to which
Islamic
countries
belong,
experience
showed that interest rate and selective
credit policies have reduced the efficiency
of investment on the whole. “This is
particularly true when controls on interest
rates make them negative in real terms. As
well as promoting investment in low return
projects, interest rate controls encourage
firms to build up their inventories.
• Furthermore, faced with the need to ration
credit, banks lend to the borrowers they
know well - large-scale enterprises and
public enterprises- or even to the industrial
groups that own them.
• In Colombia, interest rate controls reduced
the funds available for smaller-scale
industrial enterprises; the efficiency of
investment fell as a result.
• Interest rate controls also keep credit cheap
in relation to labor for those firms with
unrestricted access to loans from the formal
financial sector and thus encourage capitalintensive investments in some parts of
industry.
• These distortions ultimately affect growth.”
• All the facts mentioned above are quite
relevant to Islamic countries, which are
classified without exceptions, within the
LDC category.
• The interest system now in application in all
Islamic countries (with minor exceptions)
against Shari’ah is not helping in allocating
their scarce funds efficiently among firms or
between different economic activities.
• The
system
is
also
discriminating
unfavorably against small-scale firms,
farmers and traders irrespective of
efficiency or productivity considerations.
• The riba system is full of contradictions and
attempts to regulate it through interest rate
controls have either failed or accentuated its
imperfections.
• On the whole, therefore, the system, which
is prohibited by Shari’ah, is adversely
affecting economic development in the
Islamic countries.
• On the contrary a financial system based on
profit and loss sharing offers a much better
alternative to Islamic countries since it is
expected to be free of all the imperfections
of the riba system.
2nd Argument
•
The interest system brings about and
effectively maintains a pattern of income
distribution, which is biased towards wealthy
people and large businesses, irrespective of
rational economic considerations. A just
interest-free financial system supports a just
income distribution pattern fairly correlated
to economic efficiency, productivity and
actual factors contributions to the total value
added.
• This argument is directly dependent on
preferential treatment given by interestbased financial institutions, mainly
commercial banks, to wealthy persons and
large enterprises because they are creditworthy.
• Medium-scale enterprises are not deprived
of finance from banks but they may not
obtain all their requirements always while
they are usually charged with relatively
higher interest rates. Small-scale firms in all
economic sectors are discriminated against,
as mentioned previously.
• In quite a few number of developing countries,
however, governments provide for special
arrangements to cover a higher portion of small
activities financial requirements through banks.
• Yet even then, credit ceilings are usually imposed
strictly upon the small share of finance allotted to
small activities, whereas cumbersome formalities
and heavy guarantees are demanded from their
owners.
• Thus the interest system will effectively help large
enterprises to grow larger and rich entrepreneurs
to grow richer irrespective of their economic
efficiency or productivity.
• On the other hand small entrepreneurs even
with bright new ideas, carefully studied
projects with prospects of high returns and
possible positive contribution to GDP will be
deprived of finance or may obtain much less
than their requirements.
• Hence they have much less chance to grow
their activities and their incomes. It should
be noticed that this problem is particularly
serious in most developing countries, where
small-scale activities employ the largest
portion of the total labor force, while its
share in GDP is much less than medium and
large-scale businesses.
• An Islamic interest-free financial system
would not cause the same disturbances.
• “Mudaraba”, first and foremost in Islamic
finance, is based on personal confidence of
the capital owner in his partner, the agent
manager; in his efficiency, dedication to
work and honest character.
• Thus economic and managerial
considerations are taken into consideration
where trust-worthiness replaces creditworthiness.
• Profit, when realized, will be divided
between the capital owner and his partner,
the agent manager according to a mutually
agreed proportions while all loss, if
happened, is borne by the capital owner.
• It should be noticed that the agent manager
also suffers, in the last case, from the loss
of all his efforts, as these will be rewarded
nothing.
• Musharaka, another principal financing method,
flexibly allows for large and small capital
• owners to come together in various forms of
companies. Partners will divide realized profits
among them according to agreed proportions,
fixed in advance in the company’s contract. Fiqh
rules allow small partners to obtain the same
percentage share in realized profits as large
partners, or even more, according to efficiency,
experience or managerial efforts considerations.
On the other hand loss, if happened, will be borne
by all partners according to their shares in the
company’s total capital.
• Economic justice is carefully protected and
maintained between partners in Musharaka.
All other Islamic financing methods are of
the same nature, i.e., based on partnership
and profit/loss sharing principles.
• Some of these methods namely Istisnaa
(‫)استصناع‬, Muazr’ah (‫ )مزارعة‬and Murabaha
(‫ )مرابحة‬can be used effectively to solve the
financial problems faced by small-scale
entrepreneurs, farmers and traders in
particular.
To conclude
• the Islamic financing methods would undoubtedly
help in supporting a just income distribution
pattern. These profit/loss sharing methods neither
discriminate against persons who share only with
their managerial efforts or business experience,
nor against small partners, and facilitate finance to
small-scale firms on the basis of confidence in
their efficiency and expected returns.
• However, it should be expected that the
application of the Islamic financing methods will
be faced with many problems at the beginning, as
actually has happened in practice.
3rd Argument
•
The interest system encourages
passive behaviour to develop among
people having liquid funds by helping
them to relinquish responsibilities and
risks in investment activities. In
contrast, sharing in responsibilities and
risks is inherent in the profit/loss
sharing methods of finance
• No doubt that the interest system relieves money
capital owners from holding any responsibilities
and risks related to the execution or outcome of
the investment activities financed by their funds. It
is claimed by the interest system’s exponents that
this is one of its merits since easy and risk-less
income is guaranteed to the capital owners
periodically.
• It is also claimed that entrepreneurs within this
system are willingly accepting its terms and
satisfied that the financiers do not intervene in
their business. Interest paid by the entrepreneurs
is included in costs and thus transferred to
purchasers through sales, while net profit once
realized is totally their own.
• Yet, such system is viewed quite differently
on ethical and social grounds, as well as on
macro-economic basis.
• Money capital owners are encouraged to
develop a passive behaviour in the
production sector. On the other hand
entrepreneurs financed by loans and paying
interest are not really doing this with
comfort whether at boom when interest
rates are relatively high and the
uncalculated risk is greater than normal or
at recession when interest rates are
relatively low but loss expectations are
greater than normal.
• If profits are not actualized they, alone, will
face the consequences and may be subject
to bankruptcy. Ethically, this is a kind of
gambling rather than risk-taking based on
rational calculations.
• Therefore, within the interest system,
options of self- finance, equity or a mixture
of equity and debt finance may be preferred
by enterprises than purely debt finance.
• The growth of the interest-based finance in any
society whether through the banking system or by
selling bonds in capital markets will directly be
reflected in growth of passive behaviour among
society members.
• Individuals who receive guaranteed interest paid
to them periodically without bearing any
responsibilities or risk cannot be considered but
inactive society members. As well as, their
passive behavior is emphasized by full option
given by the banking system to restore their funds
at any time.
• Those inactive individuals are considered sleeping
partners in secular literature and it is estimated
that the growth of their members in any society
would endanger economic growth.
• It goes without saying that partnership
based on profit/loss sharing mechanism
would help in getting rid of passive
individualistic behavior.
• The Islamic modes of finance help directly
in promoting responsibility and risk-taking
morals and motivations, which are quite
essential for economic growth. The
economic rational of the interest-free
finance is quite clear here, i.e. providers and
users of finance will be sharing together in
all the responsibilities and risks involved in
the investment activities from A to Z. All
partners are actually active in the Islamic
system.
• Islamic ethics motivate people to
exchange opinions, advices, share
positively in production. All these
ethics are basic for rational behaviour
and good deeds. At the same time the
sharing ethics will always provide a
support for brotherhood and
cooperation among members of the
Islamic society.
4th Argument
•
Prohibition of interest would not
affect savings, as well as it would not
affect their mobilization provided that
anti- interest ethics are prevailing, and
the application of various interest-free
financing methods is conducted
successfully by specialized
participatory finance institutions .
• Classical and Neo-classical economists held
that national saving is positively related to
the rate of interest: S=f(r). The Keynesian
theory refuted this proposition and showed
that saving is function of income. Practical
evidences confirm the Keynesian
proposition to a great extent. High-income
groups, in comparison to low or middle
income, are more capable of saving in any
society.
• High-income economies, in comparison
to low and middle income at the world
level, save higher proportions of their
incomes. However attempts to defend
“interest” as a prime mover of saving
continued but on new basis.
• “Real” rather than “nominal” interest is
given much attention by secular
economists in this respect.
• Literature concerning these attempts for
developed and developing countries can not
be surveyed here. Yet since Islamic
countries belong to the developing world
our attention will be given to empirical
studies testing the responsiveness of
savings to real interest within this scope. G.
Arrieta (1988) reviewing several empirical
research studies showed that saving
responsiveness to real interest could not be
confirmed in five out of nine studies and still
requires further enquiries. (See Annex for a
summary of empirical tests, results and
policy implications).
• Islamic economists should treat the results
of secular empirical researchers with care.
Conclusions, which are unfavourable to the
interest system, would strengthen the
economic argument against it but they
should not intervene with “belief”
concerning riba prohibition in Islam.
• Also there are cases in developing
countries where empirical studies indicate
that real interest rates played a positive role
in mobilizing saving resources.
• These studies would strengthen the secular
view, which is supporting the interest
system, but they are irrelevant to the Islamic
economic rationale concerning riba
prohibition. In fact the interest mechanism
may play a significant role in mobilizing
saving resources if the prerequisites of this
system are well satisfied. These
prerequisites are mainly; favourable secular
laws, suitable ethical values to interest,
active interest-based financial institutions,
and prevailing habits in terms of savers’
willingness to obtain guaranteed and
regular returns on their funds.
•
Concerning the Islamic countries we have to
be careful, therefore, before drawing any
conclusion with respect to the responsiveness of
savings to interest rates (nominal or real). Secular
laws prevailing at present in these countries are
favourable to the interest system, with exceptions
in quite a few cases. Commercial banks were
established in most of the Islamic countries during
the Western colonial rule and succeeded in
developing their financial activities gradually. A
portion of the Muslim population has become
accustomed to deposit savings in commercial
banks in return for guaranteed regular interest
(income).
• Most of those who developed this antiIslamic behaviour have been affected by the
western life-style and secular values. Some
of them would assert that they deposit their
savings in commercial banks only because
they have no other alternative to “protect”
their funds or to “invest” them profitably on
their own.
• Besides, governments, large and medium
scale businesses in the modern
manufacturing, trade and services sectors
deposit their savings in commercial banks.
• On the other hand a large section of
population in the Islamic countries is still
against interest transactions. It is important
to note that this section has not been
affected by modern attempts to justify
interest. And that it is consisting mainly of
low and middle-income households, smallscale farmers, traders and manufacturers.
Yet, the petite savings of all those are not
given any, or proper, attention by
commercial banks.
•
• Under all these circumstances it will not be
unexpected that interest-based financial
policies would be in some cases, successful
in savings mobilization.
• However many of the above mentioned
factors are bound to change once “efficient”
Islamic interest-free financial institutions are
established. Not only petite savings will be
mobilized by these Islamic institutions but
also the savings of all those who say that
they have no alternative to commercial
banks at present.
• In fact, a revival of Islamic Shari’ah and
ethics would settle the matter decisively
against the interest-based system and its
ability to mobilize Muslims’ savings. But
before realizing this precious target, it is
very important that the ability of any new
Islamic financial institution to effectively
mobilize saving resources would mainly
depend on an efficient practice of interestfree financing methods, success in
achieving highest possible “halal” returns
and thus gaining the confidence of the
savers to invest their funds through them.
Summary
•
Riba, in all forms, is strictly prohibited in Islam.
Interest was, and still is, the most popular form of
riba all over the world.
• Contemporary attempts in some Islamic countries
to justify interest by claiming that it is not identical
with riba are unacceptable on Shari’ah as well as
on economic grounds.
• Four main arguments are made in this paper to
expose the economic rationale of riba prohibition
and its implications. These arguments are
important to strengthen the case against the
interest system, which was introduced in most of
the Islamic countries during the period of their
colonial rule
• . The arguments, it should be emphasized,
are not meant to explain the “reason” of riba
prohibition in Islam.
• Firstly, it is argued that the interest system
is inherently incapable of allocating
available liquid funds among firms and
activities in the society according to
considerations of efficiency, productivity
and growth.
• An Islamic system based on profit/loss
sharing financing methods would offer an
efficient substitute.
• Secondly, the interest system brings about,
and effectively maintains a pattern of
income distribution which is biased towards
wealthy people and large businesses,
irrespective of rational economic
considerations.
• An Islamic interest-free financial system
supports a just income distribution pattern
fairly correlated to economic efficiency,
productivity and actual factors contributions
to the total value added.
• Thirdly, the interest system encourages
passive behavior to develop among people
having liquid funds by helping them to
relinquish responsibilities and risks in
investment activities. In contrast, sharing in
responsibilities and risks is inherent in the
profit/loss sharing methods of finance.
• Fourthly, prohibition of interest would not
affect savings, as well as it would not affect
their mobilization, provided that Islamic
ethics are prevailing, and the application of
various interest free financing methods is
conducted successfully by specialized
Islamic institutions.
Thanks if you have
Carefully Listened
and thought !
• A.R.Yousri