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Riba, Bank Interest and the Rationale of Its Prohibition

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Riba, Bank Interest and the Rationale of Its Prohibition ISLAMIC DEVELOPMENT BANK ISLAMIC RESEARCH AND TRAINING INSTITUTE RIBA, BANK INTEREST AND THE RATIONALE OF ITS PROHIBITION Visiting Scholars’ Research Series No.___ 1 ISLAMIC DEVELOPMENT BANK ISLAMIC RESEARCH AND TRAINING INSTITUTE RIBA, BANK INTEREST AND THE RATIONALE OF ITS PROHIBITION Mohammad Nejatullah Siddiqi Visiting Scholars’ Research Series No.___ JEDDAH - SAUDI ARABIA 1425H (2004) 2 © Islamic Research and Training Institute, 2004 Islamic Development Bank King Fahd National Library Cataloging-in-Publication Data Siddiqi, M. Nejatullah Riba, Bank Interest and the Rational of its Prohibition Jeddah 150 P; 12½ x 19 cm ISBN:__________ Legal Deposit No._________ ISBN:__________ The views expressed in this book are not necessarily those of the Islamic Research and Training Institute or of the Islamic Development Bank. References and citations are allowed but must be properly acknowledged. First Edition 1425H (2004) 3 ﺑﺴﻢ اﷲ اﻟﺮﺣﻤﻦ اﻟﺮﺣﻴﻢ 4 CONTENTS Page # FOREWORD 9 PREFACE 11 INTRODUCTION 13 Chapter 1: ISLAM AND ITS LAWS 15 • Tawheed 15 • Shariah and its Objectives 17 • Maqasid al-shariah 18 • Justice and Equity 22 • The Individual 25 • Role of the State 27 • History 28 • Justice in Finance 30 • Islamic Rules for Exchange 31 • Conclusions 34 Chapter 2: PROHIBITION OF RIBA 35 • Quran on Riba 35 • Meaning and Incidence of Riba 37 • The Riba Owed to Abbas 38 • Reason of Prohibition 41 • Profits Versus Interest 45 • Quran’s Emphasis on Charitable Giving 48 • Prophet’s Implementation of The Prohibition of Riba 48 • Understanding of Law of Riba by Companions of the 51 Prophet and those who Followed • Understanding of the Law of Riba Down the Ages 53 • The Issue of Bank Interest 55 • Arguments for Bank Interest 57 • Conclusions 63 Chapter 3: ECONOMY WITHOUT INTEREST 65 • Liability Side of an Islamic Bank 65 5 • Capital Protection 67 • Assets of an Islamic Bank 69 • Sharing Based Modes of Finance 69 • Trade Based Modes of Financing 72 • Murabahah 72 • Murabahah Versus Interest 73 • The Problem of Default 74 • Other Asset Based Instruments 76 • Islamic Banking in the Private Sector 78 • Non Bank Islamic Financial Institutions 78 • Islamic Investment Companies 78 • Islamic Mutual Funds 79 • Islamic Insurance/Takaful Companies 80 • Stocks, Options, Derivatives and Risk Management 81 • Islamic Finance Under State Sponsorship 82 • Islamic Banking and Finance in South East Asia 82 • Islamic Finance in Bahrain. 84 • Islamic Finance in Sudan 84 • Iran, Turkey 85 • Pakistan, Bangladesh 86 • The Islamic Development Bank 87 • Islamic Finance and International Finance 88 • Conclusions 89 Chapter 4: ECONOMICS OF ISLAMIC FINANCE 91 • Relative Stability of Islamic Financial System 92 • Absorption of Real Shocks 94 • Stability in the Monetary Sector 96 • Exogenous Sources of Instability 96 • Relative Stability with Fixed Liabilities 97 • Limited Scope of Speculation in an Islamic Financial System 100 • Relative Efficiency of an Islamic Financial System 102 • Uncertainty and Efficiency 105 • Meeting Uncertainty 107 6 • Comparative Advantage 109 • Fairness of the Islamic Financial System 109 • Sharing Enhances Equity 111 • Growth with Islamic Finance 112 • Conclusions 113 Chapter 5: MEETING SPECIAL NEEDS 115 • Government Finance, Financing the Consumer, 115 Microfinance and Finance for Muslim Minorities • Consumer Finance 115 • Islamic Modes of House Finance 116 • Credit Cards 119 • Financing Agriculture 119 • Government Finance 119 • Deficit Financing 123 • Muslim Minorities and Islamic Finance 123 • Conclusions 125 Chapter 6: MONETARY MANAGEMENT, INFLATION AND INDEXATION 127 • Regulation and Governance 128 • Inflation 129 • Indexation 131 • Conclusions 136 Chapter 7: CONCLUSIONS AND PROSPECTS 137 • Future of Islamic Finance 139 BIBLIOGRAPHY 141 INDEX 157 7 8 FOREWORD The Visiting Scholars Program was introduced during 1413H as part of IRTI’s multi-pronged efforts to develop Islamic economics and finance. The program aims at enabling external scholars to visit IRTI on short-term basis in order to carry out certain well-defined research task or project. We were fortunate to have Prof. Nejatullah Siddiqui last year who kindly accepted the invitation to come to IRTI under this program. A tangible benefit of his visit to IRTI is this book. IRTI felt that there was a need to explain riba, bank interest and the rationale of its prohibition in modern terms to the general public and scholars who are unfamiliar with the developing field of Islamic banking and finance. Prof.Nejatullah Siddiqui also shared this feeling. He has therefore written this book with this perspective. Starting from shariah and economic reasons for prohibition of riba the book shows that this prohibition aims at preventing injustice and promoting fairness, equity and efficiency. It then covers the entire financial system, its various components as well as macro-monetary management, and highlights the impact of prohibition of riba along with alternative arrangements under Islamic system showing how the above objectives are achieved. The clear and succinct writing style of the author will help the reader gain understanding of the subject and the issues involved. Acting Director Islamic Research and Training Institute 9 10 PREFACE What is riba? Why does Islam prohibit it? Is bank interest riba? How can we live without interest? This book tries to answer these and similar questions. I am aware of several learned authors doing the same in the past. I have tried not to repeat them as far as possible. Since some of the best works, like those of Abu Zahra and Maudoodi, were written before the spread of Islamic financial institutions, there was a need to enrich the discussion with lessons from the recent practice of Islamic banking and finance. I hope this book fulfills that need. In doing this work, I had the benefit of discussions with Adam Biraima, Ausaf Ahmad, Habib Ahmed, Mabid Ali al-Jarhi, M. Fahim Khan, Mohamed Ali Elgari, Mohammad Anas Zarqa, Mohammad Obaidullah, Mohammad Umer Chapra, Munawar Iqbal, Naseerudin Khan, Omar Zuhair Hafiz, Osman Babikir, Salman Syed Ali and Tariqullah Khan. While I owe many a good points to them, none of them is responsible for any deficiencies that might remain in this work. I have also had the fullest cooperation from the staff of the IDB library and from everybody in the Islamic Research and Training Institute, which hosted me as a visiting scholar to do this job. Thanks are due to the scholars whose comments on the outline were of great benefit to me. Thanks are also due to the two referees who looked at the completed manuscript and helped me in making important additions. Last but not the least, I owe special thanks to the President of the Islamic Development Bank, Dr. Ahmad Mohammad Ali, for facilitating my involvement with this project. Like all human endeavors, this one too must have left many things to be desired. I will appreciate any feedback from the readers. I pray to Allah to accept the services of all those involved, including myself. Mohammad Nejatullah Siddiqi E-mail<[email protected]> 1272 Gingerwood Drive Milpitas, CA 95035, USA 8 Zul-Qa‘dah, 1424H, 1 January 2004 11 12 RIBA, BANK INTEREST AND THE RATIONALE OF ITS PROHIBITION INTRODUCTION WHY THIS BOOK? Muslims have always agreed that riba is prohibited. What constitutes riba has, however, been a subject evoking deliberation and debate over the centuries that followed the age of divine revelation. Not surprisingly, the practice has reflected the differences in interpretation. Yet the core idea, the prohibition relating to the additional payment demanded by giver of a money loan, has sustained itself in the imagination of Muslim peoples in all ages. Its avoidance in practice has, however, had a chequered career. It has ranged from strict adherence to conformity with some exceptions, made on the ground of necessity or because of living outside the lands ruled by Islam, to widespread violations under some stratagem or other. During the modern times with the system of money and banking based on interest, controversy surrounds bank interest, is it the riba prohibited in the Quran or is it not? The overwhelming majority of religious scholars and most of the laymen consider bank interest to be riba while a few scholars and a section of Muslim laymen think it is not. The issue has acquired political significance in recent times because of some Muslim countries’ constitutional commitment to adhere to Islamic Law (shariah). This book is a modest effort to clarify the issues involved. In the first chapter we put our subject of study in perspective by describing Islam’s worldview and the purpose of laws in Islam. How the quest of fairness in the ‘ordinary business of life’ leads to a bunch of rules constraining individual freedom and guiding the state in its supervisory role is explained. The second chapter focuses on the meaning of riba in the light of the relevant texts. Muslims’ understanding of the concept and coverage of riba is traced through the ages till our own day. The effort by some to declare modern bank interest outside the scope of prohibited riba is put in historical perspective. After examining their arguments it is concluded that bank interest is riba. 13 The third chapter examines what the prohibition of bank interest would do to a modern economy. It explores the alternatives to interest based institutions in the light of the developments of interest-free Islamic banking theory and practice since the middle of the last century. It demonstrates that the economy can function smoothly without the institution of interest on the basis of Islamic finance. The fourth chapter focuses on some distinguishing features of interest- free Islamic finance at the macro-economic level. It is argued that Islamic finance is conducive to greater stability and more efficiency than conventional finance. It is a fairer arrangement capable of leading human society to greater equity and higher growth. The fifth chapter shows how Islamic finance meets certain special needs like government finances, finance for the consumers, microfinance, especially for the rural sector, and interest-free financial arrangements for Muslim minorities.
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