Does modern day interest still qualify as Riba? Part I

A common question today is asked about Riba:

Does modern day interest still qualify as Riba? Because Riba is seen as a privilege that is not oppressive to the individual

In this two-part series, we will shed some light on this dilemma across several discussion points. By understanding Riba-based economies, we can appreciate the value of exploring alternative financial models that promote equitable and just economic systems.

1. What is Riba (Interest)?

In the modern financial landscape, interest is commonly defined as the monetary charge for the privilege of borrowing money. Interest is often expressed as a fiat unit amount, while the interest rate used to calculate interest is typically expressed as an annual percentage rate (APR). Interestingly, the idea of 'privilege' is attached to these interest-based transactions, an idea that starkly contrasts with Islam's worldview on the subject.

According to Islamic principles, wealth is considered the property of Allah Almighty, entrusted upon those holding it. As such, Islamic Law sets the boundaries that clearly differentiate fair transaction practices from oppressive ones.

Riba is an Arabic term which linguistically refers to "excess" or "growth". In English, it has been translated as both "usury" and "interest" by different authors. Riba refers to a system that necessitates an undeserved gain and creates overwhelming harm to individuals, society, and the economy. In this context, Riba is strictly prohibited in Islamic finance.

The 21st century has provided unfortunate opportunities for us to experience first-hand the oppressive reality of Riba-based economies and their harms. We will delve deeper into the adverse consequences and examine their implications in greater detail later in this discussion.

We come across the term "interest" quite often in our daily lives, whether it's through loans, mortgages, or our savings accounts. But what exactly is interest? Let's break down this financial concept.

2. What are the types of Interest?

There are two main types of interest: simple interest and compound interest.

Simple Interest: This is the most basic form of interest. It's calculated as a percentage of the initial amount borrowed or invested. Simple interest doesn't consider any interest earned over time. For example, if a person borrows £1,000 at a 10% annual simple interest rate for two years, they'd pay £100 in interest each year (£1,000 x 10% = £100), for a total of £200 in interest over the two years.

Compound Interest: This is a more complex form of interest because it considers not only the original amount borrowed or invested but also any interest that has been added to that amount. With compound interest, an individual earns or pays interest on both the principal and the accumulated interest. This can lead to faster growth of an investment or, in the case of a loan, a higher total amount to repay. Expanding on the above example, if a person borrows £1,000 at a 10% annual compound interest rate for two years, they'd pay £100 in interest the first year (£1,000 x 10% = £100), and £110 in the second year (£1,100 x 10% = £110), totaling £210 over the two years.

Why Interest Matters: Interest plays a significant role in our financial lives. When individuals take out loans or mortgages, the interest rate determines how much they will ultimately pay back to the lender. When we invest in savings accounts, bonds, or other investment vehicles, the interest rate helps us gauge how much our investments will grow over time.

It's essential to understand interest rates and how they affect the world around us, whether directly or indirectly. By grasping the concept of interest, we can make more informed choices and better manage our personal finances to avoid the pitfalls of interest.

A Note on Islamic Finance: While interest is a common feature of conventional finance systems, it is considered forbidden (haram) in Islamic finance. Islamic finance principles prohibit interest-based transactions, as they can lead to wealth inequality and economic exploitation. Instead, Islamic finance offers alternative financial instruments that promote fairness, risk-sharing, and social justice, such as profit-and-loss sharing, partnerships, and leasing arrangements.

The idea of renting money is unnatural to the laws of nature. Imagine an individual who has his surplus wealth in the form of a physical asset, say a horse, for example. He would incur the physical storage cost of the asset, and the horse's value would wane over time as it aged. Depending on the nature of the asset, the one holding it would encounter some sort of cost in doing so.

If the individual lent his physical wealth, the horse, usually one of two repayment terms may be asked for:

1. The borrower pays a charge to account for the loss of value or usage of the wealth.
2. The borrower returns a horse of the same age and in the same physical condition to the one that initially left the owner.

When we think about a rent for using money, we are essentially asking for both at the same time. A return for the horse as it left the owner and a charge for being able to use the wealth. An owner hoping for new wealth in addition to their non-depreciating asset which in turn would be converted to a non-depreciating asset sounds wonderful and an investors dream. However, in the physical world perpetual wealth creation from a single stock of non-depreciating asset will remain impossible.

Although Riba is commonly translated to interest, there are cases where that which we conventionally would call interest would not fall under Riba and cases where we would say a transaction contains Riba but would not include any interest as we know it. So, let’s have a deeper dive into the types of Riba.

3. What are the types of Riba?

In Islamic Law, the topic of Usury is listed to occur in two forms.

1. Debt-Based Transactions (Riba al-duyūn)

Debt-based usury entails interest charged due to a loan, either at the beginning of the transaction, as we find with home-based mortgages as an example, or at the end of the time period of the loan in the event of the borrower requiring extra time to pay off the loan, as we find with credit card-based transactions.

Debt-based Riba occurs in two types:

A. Interest for extension (zidnī unẓirka)

Interest charged in exchange for an increase for time to repay what is owed. This debt could be a result of borrowing interest-free or on a credit-based sale and was a common practice before Islam amongst the Arabs. We find this type of Riba prevalent in Credit cards, Buy Now Pay Later schemes & Overdrafts.

B. Pre-defined interest (Riba al-qurūḍ)

Interest charged from the outset of borrowing. We find this type of Riba prevalent in personal loans, mortgages & car finance agreements.

2. Sales-Based Transaction (Riba al-buyū)

The most defining elements of Sales-based Riba are Riba al-faḍl (usury of surplus) and Riba al-nasī’ah (usury of waiting). Riba al-faḍl involves the exchange of Ribawī items with different weights, amounts, or qualities at the same time. The transaction is taken on the spot and an exchange is done instantly with the only factors being the quantities or qualities of the commodities.

Riba al-nasī’ah on the other hand is an asynchronous transaction with regards to delivery and the quantities and qualities of the commodities remain the same.

The teachings of the Messenger (May Allah’s praise and blessings be upon him) list Riba-based wealth as two categories, as follows:

1. Gold, Silver, and any wealth considered similar. In today’s age, this would include fiat money, like dollars and pounds etc.
2. Dates, Wheat, Barley, Salt, and similar storable staples, such as rice in today’s age.

In Islamic jurisprudence these items are known as Ribawi items. According to Islamic law, trading Ribawī items must follow specific rules to avoid Riba (usury or interest), which is forbidden in Islam.

If a person gives someone one ounce of gold now and receives two ounces of gold a month later, that's a Ribawī transaction.

A Ribawī transaction is a type of trade that has one or both of the following features:

1. A surplus in the quantity of specific commodities traded with the same commodity. There's more of one thing traded than the other, like if you gave someone two dates and they only gave you one in return.
   This rule does not apply on commodities traded with a non-similar commodity in either category. For example, trading Gold with Silver or Gold with Dates would not necessitate similar quantities. A failure to comply with this condition would result in Riba al-faḍl and would be prohibited.
2. There's a delay in one or both parties receiving what they're owed, like if you gave someone 1kg of Gold but they gave you 500g Silver in return in one week's time or gave someone 2kg of dates for 1kg of Barley in a week’s time.
   This rule always applies between any Ribawī items traded with another in the same category, whether identical or dissimilar. A failure to comply with this condition would result in Riba al-nasī’ah and would be prohibited.

If wealth from one category is exchanged for wealth from another category; there are no rules that apply. This means it would be permissible to have a deferred exchange of 100g of silver for 4 kg of dates or 1g of gold for 10 kg of rice.

Having examined Riba from an Islamic lens, let's now turn our attention to understanding interest as it is commonly known in the conventional financial system.

4. The history of interest

Interest has a long and complex history, particularly in its relationship with religious beliefs and cultures through the ages. In Christianity, the practice of charging interest was initially viewed as morally wrong and prohibited. However, over time, this stance evolved, eventually leading to the acceptance of interest in modern financial systems and by the Church itself. Here is a brief overview of this transformation:

1. Early Christianity: In the early days of Christianity, the practice of usury, or charging interest on loans, was considered sinful and forbidden. This prohibition was rooted in various biblical passages, such as Exodus 22:25, Leviticus 25:36-37, and Deuteronomy 23:19-20, which discouraged the taking of interest from fellow believers in need.

2. Middle Ages: During the Middle Ages, the Catholic Church maintained its opposition to usury. Theologians like St. Thomas Aquinas argued that charging interest was morally wrong, as it constituted a form of double-charging for the same good. [1] Money, in their view, was a medium of exchange and should not be used to generate further wealth.

3. Rise of Trade and Commerce: As trade and commerce expanded throughout Europe, the demand for credit increased. This growth led to the emergence of alternative financial arrangements, such as partnerships and profit-sharing agreements, which circumvented the church's prohibition on usury.[2] Some financial institutions, like the Medici Bank in Italy, thrived during this period, with their operations often involving interest-bearing transactions.[3]

4. Reformation and Changing Attitudes: The Protestant Reformation in the 16th century brought significant changes to the religious landscape, including a shift in attitudes toward usury.

The rise of trade in Europe led to an increased demand for credit, which created pressure to find ways around the Church's prohibition of usury.

As a result, alternative financial arrangements emerged, such as partnerships, profit-sharing agreements, and the use of "hidden" interest rates.

Reformers like Martin Luther and John Calvin acknowledged the practical necessity of interest in a growing economy. While they did not wholly endorse the practice, they believed that moderate interest rates could be morally acceptable under certain circumstances.

5. Gradual Acceptance: Over time, the practical needs of burgeoning economies and the influence of new religious perspectives led to a more widespread acceptance of interest. Governments began to regulate interest rates, setting limits on the amounts that could be charged. This change legitimised the practice of lending and borrowing at interest within the view of the christians.  

6. Modern Financial Systems: Today, interest is a fundamental component of modern financial systems, playing a vital role in loans, mortgages, investments, and more. While some religious organisations and individuals still express concern over the moral implications of interest, it is generally accepted by both Church and Christians in today’s financial landscape.

In summary, the evolution of interest in Christianity has been marked by significant changes over time. The initial prohibition of usury, rooted in religious teachings, eventually gave way to the acceptance of interest as a fundamental aspect of modern financial systems. Understanding this Historical context offers valuable insights into the development of contemporary financial practices and the role of eroding religious beliefs in shaping economic systems.

This concludes the first of our two part series on Riba. Click here to read part 2,where we dive deep to discuss the ruling of Riba in Islam and its wisdom, the economic pitfalls of Riba and begin to gain a clear picture of how entrenched our society is in Riba today.

Sheikh Dr. Sajid Ahmed Umar holds a 3-year University Diploma in Arabic language and Islamic Studies, a Bachelors degree in Comparative Islamic Law and Jurisprudence Methodology. He also holds a Masters degree in Judiciary, and is a qualified Judge. Sheikh Dr. Sajid has also completed a PhD in Comparative Islamic Law with his postgraduate research focusing on the area of Liquidity Management and Financial Risk Management through an Islamic lens.