First Principle of Islamic finance:Riba

 

What is Riba and what are the top reasons it is prohibited in Islamic banking and Finance?

After the 2008 financial crisis, conventional banks and financial institutions were criticized due to their interest-based models. And, it was the time when western and non-Muslim countries like The USA and the UK began to realize the importance and benefits of Islamic banking. 

Islamic finance is proud to give an interest-free returns on short-term and long-term investments. It is providing multiple financial instruments or products that not only cater the financial needs of the borrower but also contribute towards social development and values.

Prominently, there are two main factors that make Islamic different from conventional financing; one is trading in only halal trade activities and secondly which is the most important one: the “Interest-Free” profit.

Islamic banks with the help of Sharia guidelines avoid this most forbidden act of interest. There are multiple benefits of doing this which we will discuss in the latter part of this blog.

 

This blog is all about interest, everything we should know and what are the reasons Islam has strictly prohibited it?

What do Islam and Christianity say about it?

We are familiar with words like Usury and Riba which have the same meaning as interest; it means excess or increasing the growth of money through unfair means.

 Quran is the holiest book of Muslims and it says, even one penny of interest is not allowed and who is involved in that kind of action will be declared an enemy of Allah (SWT). In the holy book, Riba has been discussed plenty of times with rationality, and every time God has forbidden Muslims; not to come close to this action.

Not only in Islam jurisprudence; where rules are set by the Quran and other schools of thought like Maliki Shafi, Hanafi and Hanbali , but other religions like Christianity and Judaism are not in the favor of excessive and aggressive creation of money.

Even in the Bible, it has been stated clearly not to charge extra money from the poor and innocent.

What are the reasons, Why Interest is not allowed?

From the above discussion, it definite to state that usury should not involve in any kind of business. Because there are both economic and social side effects or we may call negative outcomes. Here, we will discuss the rationales behind the strictness of Riba.

Increases poverty

When borrowers don’t have security, the banks charge with a high interest rate to take advantage of their poor financial condition. A prominent example is the pay-day or shark loans where interest is charged up to 300%-400% of the principal amount.

In most cases, it becomes impossible to pay it back and poor people become prey and suffer immensely.

 No productivity

The commercial banks once lend the loan or take deposit; the money is circulated among the debtor and creditor. Once the mortgagor will pay the installment with interest the same amount will be credited to the deposit holder account.

Due to this oddity, the ethical values and norms are completely ignored and more focus on the individual benefits and company goals. Therefore, we can well imagine there is only the circulation of money with no beneficial or productive activity.

It contributes towards inflation

To explain this we will take the example of the interbank rate. The Interbank rate is an increase of interest rates by the central bank. Due to this impact, the cost of financing will also increase. This burden will be shifted to the recipient: one who accepts a loan. Simultaneously, to pay the debt obligation and avoid default, the debtor will transfer the load of the debt toward the customer.

This circle will ultimately result in price hikes and have a negative effect on the purchasing capacity of the people. 

 No sharing of profit and loss

Islamic investment products like Mudarbha where both the fund managers and account holders are exposed to the risks. We all know, every kind of business whether it is a manufacturing concern or services can face loss due to any unfortunate event. Islamic banks will share this drain and the profit will vary depending upon the net outcome of the investments.

 But it is quite the opposite in the other world where a fixed return is credited to the savings or term deposit accounts. The customer is not involved in any hazard or loss; despite receives a guaranteed profit every month that leads to interest.

 Lead to selfishness in society

As we mentioned above, riba not only cause economic downturns but lead to social difficulties as well. The rich will become richer and poor will suffer more. The customer is entitled to defuse the liability, no matter if he is facing financial difficulties. Moreover, the condition becomes more saviors when a penalty is imposed, in case of delay or on non-payment.

 Islamic values promote brotherhood and charity among society; to help those who are in need. In   Murabha contract, the cost of the borrowing is already disclosed at the start. In case when Islamic banks have to charge plenty these charges are donated to charitable institutions for social welfare.

It is nothing but a dumb money

Nobody knows in the chain what they will do with the money; are they going to put these funds in some investment venture or public projects? There is no benefit associated except the creation of money on money.

 

The Difference between Riba and Halal Profit

To conclude, this conversation has more to tell about the difference between Interest and interest-free profit.

 

	RIBA	PROFIT
CUSTOMER LIABILITY	It’s premium which has to be paid as a condition of the agreement	Its predetermined amount calculated by estimating value of production minus cost of production
RATE DETERMINATION	Rate is prefixed and becomes the liability of the borrower as soon as the contract starts	Profit is predetermined and liability will not be charged unless business activity has not began
Rate of Return	Rate is always positive, it cant be negative as customer is not exposed to risk factors.	Customers will be part of the risk factor, as a result, rate can be zero or negative in some cases.