One of the integral parts of an Islamic financial system is the prohibition of interest from the economy. The injunctions regarding the prohibition of interest are contained in the Holy Quran, the basic source of Islamic ideology. It is the opinion of a number of Islamic jurists that the Quranic verses that instruct Muslims are clear and reflect the severity of the admonition to those who do not abide by them.
In all these verses the word ‘riba’ is used, which in Arabic generally signifies increase, excess, growth, rise and the like. In the pre-Islamic period the word ‘riba’ was used conventionally to identify a class of business transactions. The common feature of these transactions was that a fixed amount was required over the principal due.
One form of transaction was that a person sold a product to someone on the agreement that a specified price was payable at some future date. If at the end of the stipulated time the price was not paid by the buyer, then the seller would increase the price and extend the payment period.
Another form was that Arabs used to lend money to each other on the agreement that after a specified period of time the borrower would repay an excess amount over the principal sum due. Yet another form was that Arabs would make a loan to someone on the basis of a monthly fixed return over the principal sum and if at the end of the loan period the borrower was unable to repay, they would increase the monthly fixed return.
As far as financial transactions are concerned, there is no dispute among Islamic jurists that the word referred to in the Quranic verses means an excess of money demanded over the principal sum loaned for a specified period of time. However, there is another class of non-financial transactions that is also classified as riba, on the basis of an explicit injunction from the Prophet. This type of riba is known in Islamic jurisprudence as riba al-fadl. This refers to the barter trade of identical commodities.
It is important to note that the chastisement proposed for the sinners of riba is quite severe. Thus, one is led to ask what is so evil in interest that justifies such an admonition.
Islamic jurists have given several justifications for the prohibition of interest and admonition to those who do not abide by this prohibition. One class of reasoning is primarily concerned with the social and individual evils that result in a society which allows interest.
It is argued that at the individual level, interest creates selfishness, miserliness, greed and malevolence. The very act of lending money on the basis of interest reflects the fact that the lender only cares for the principal and interest on it that has to be paid by the borrower under all circumstances. These arguments get more heated when the borrowing party is a person who needed the loan to meet an unforeseen accident or emergency.
The same argument carried to the social level implies that in such a society, there will be a class of people that accumulates most of the society’s wealth and is hostile towards the rest of the people. Therefore, the institution of interest leads to a highly unstable society.
Although the Quranic verses are clear about the prohibition of interest, and as far as financial transactions are concerned there has never been disagreement among jurists, in the recent past there was a controversy over the type of financial transactions that come under this injunction.
Jaffer Shah and Yaqoob Shah argued that another common feature of the financial transactions prohibited on the account of interest was that these transactions were mainly for consumption purposes, and were demanded by poor people. As such, it was claimed that the production loans prevalent in the present financial system cannot be treated as involving interest.
Two arguments supporting this claim were presented: (i) there is no evidence in history that during the time of the introduction of this injunction loans for production were in existence, and (ii) present production loans are in fact collaboration between the lender and the borrower to increase the wealth of both parties. Furthermore, unlike consumption loans, the lender in the case of a production loan (saver) is economically weak and the borrower (investor) is economically the stronger party. As such, there is no possibility of exploitation. This group claims that debt financing for business capital is the outgrowth of industrialisation and as such it was non-existent at that time. Accordingly, production loans should be excluded from the application of this injunction.
In reply to the arguments raised by this group, Justice Maududi and Justice Usmani have argued that in the first place it is not logical to argue that only those forms of interest are prohibited which existed at that time. For this would have the implication of granting legitimacy to several unanimously agreed prohibitions in Islam.
Orthodox jurists have produced evidence both from historical facts and sayings of the Prophet that supports their view that the injunction also applies to production loans. These types of loans were known even in Babylon and ancient Egypt. There is evidence that the loans were made for trade, agriculture and the purpose of running government machinery. Arabs were in close contact with these neighbouring countries and it is difficult to believe that they were unaware of these financial arrangements. In fact, Makka was the centre of world trade in those days.