The most famous principle of Islamic Finance is the prohibition of usury or
interest ("riba" in Arabic). There is a consensus among the scholars that
even the interest paid by and to conventional banks is riba. Islam does not recognize
loans as income-generating transactions. They are meant only for those lenders who do
not intend to earn a worldly return through them. They, instead, lend their money either
on humanitarian grounds to achieve a reward in the Hereafter, or merely to save their
money through a safer hand. So far as investment is concerned, there are several other
modes of investment like partnership etc. that may be used for that purpose. The
transactions of loan are not meant for earning income.
The basic philosophy underlying this scheme is that the one who is offering
his money to another person has to decide whether:
 | (a) He is lending money to him as a sympathetic act or |
| (b) He is lending money to the borrower, so that his principal may be saved or |
| (c) He is advancing his money to share the profits of the borrower. |
In the former two cases (a) and (b)
he is not entitled to claim any additional amount over and above the principal,
because in case (a) he has offered financial assistance to the borrower on
humanitarian grounds or any other sympathetic considerations, and in case (b)
his sole purpose is to save his money and not to earn any extra income.
However, if his intention is to share the profits of the borrower, as in case
(c), he shall have to share his loss also, if he suffers a loss. In this case,
his objective cannot be served by a transaction of loan. He will have to
undertake a joint venture with the opposite party, whereby both of them will
have a joint stake in the business and will share its outcome on fair basis.
Conversely, if the intent of
sharing the profit of the borrower is designed on the basis of an interest-based
loan, it will mean that the financier wants to ensure his own profit, while he
leaves the profit of the borrower at the mercy of the actual outcome of the
business. There may be a situation where the business of the borrower totally
fails. In this situation he will not only bear the whole loss of the business,
but he also will have to pay interest to the lender, meaning thereby that the
profit or interest of the financier is guaranteed at the price of the
destructive loss of the borrower, which is obviously a glaring injustice.
On the other hand, if the business of the borrower earns huge profits,
the financier should have shared in the profit in reasonable proportion, but in
an interest-based system, the profit of the financier is restricted to a fixed
rate of return which is governed by the forces of supply and demand of money and
not on the actual profits produced on the ground. This rate of interest may
be much less than the reasonable proportion a financier might have deserved, had
it been a joint venture.
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In this case the borrower secures the major part of the
profit, while the financier gets much less than deserved by his input in the
business, which is another form of injustice.
Thus, financing a business on the basis of interest creates an unbalanced
atmosphere, which has the potential of bringing injustice to either of the two
parties in different situations. That is the wisdom for which the Shar'iah did
not approve an interest-based loan as a form of financing.
Once interest is banned, the role of
"loans" in commercial activities becomes very limited, and the whole financing
structure turns out to be equity-based and backed by real assets. In order to
limit the use of loans, the Shar'iah has permitted to borrow money only in cases
of dire need, and has discouraged the practice of incurring debts for living
beyond one's means or to grow one's wealth.
It should be the last thing to be
resorted to in the course of economic activities. This is one of the reasons for
which interest has been prohibited, because, given the prohibition of interest,
no one will be agreeable to advance a loan without a return for unnecessary
expenses of the borrower or for his profitable projects. It will leave no room
for unnecessary expenses incurred through loans. The profitable ventures, on the
other hand, will be designed on the basis of equitable participation and thus
the scope of loans will remain restricted to a narrow circle.
Conversely, once interest is
allowed, and advancing loans, in itself, becomes a form of profitable trade, the
whole economy turns into a debt-oriented economy which not only dominates over
the real economic activities and disturbs its natural functions by creating
frequent shocks, but also puts the whole mankind under the slavery of debt. It
is no secret that all the nations of the world, including the developed
countries, are drowned in national and foreign debts to the extent that the
amount of payable debts in a large number of countries exceeds their total
income. Just to take one example of UK, the household debt in 1963 was less than
30% of total annual income. In 1997, however, the percentage of household debt
rose up to more than 100% of the total income. It means that the household debt
throughout the country, embracing rich and poor alike, represents more than the
entire gross annual incomes of the country. Consumers have borrowed, and made
purchases against their future earnings, equivalent to more than the entirety of
their annual incomes. Peter Warburton, one of the UK's most respected financial
commentators and a past winner of economic forecasting award, has commented on
this situation as follows: "The credit and capital markets have grown too
rapidly, with too little transparency and accountability. Prepare for an
explosion that will rock the western financial system to its foundation."
*From a magazine article written by Colin Willis, Treasurer, Al Rajhi Banking &
Investment Corporation.
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