The Islamic community has different views regarding the interest and income generated from lending and investment. While the world is working towards profit, Islamic law forbids any income generated from loans or investments. Riba is the term used for the pursuit of such gains.
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Riba Definition:
What is Riba in Islam?
Riba, or “sin of interest in Islam,” refers to lending and depositing money to earn interest. Literally, Riba’s name means excess or growth. In translation, Riba represents the concept of exceeding or increasing and, more often, “usury” or unjust, and points to exploitative gains made in trade or business. Islamic religion prohibits such gains, and hence, Riba is forbidden in the community, even if the interest rates are low.
Here’s a detailed explanation of Riba in the context of Islamic finance:
- Definition and Types:
- Riba is traditionally understood as any excess compensation without due consideration (i.e., without providing equivalent counter-value or service).
- It is categorized into two types: Riba al-Masih (riba of delay) and Riba al-fadl (excess).
- Riba al-nasi’ah refers to the interest on loans or debts, where the borrower must pay back more than the amount borrowed.
- Riba al-fadl refers to the excess or surplus in trade transactions made without exchange or consideration, such as trading goods of the same type but in unequal quantities.
- Prohibition and Rationale:
- The prohibition of Riba is explicitly mentioned in the Quran and Hadith, aiming to prevent exploitation and injustice in financial dealings.
- Riba fosters inequality, allowing wealth to accumulate in the hands of a few, leading to societal harm and economic disparities.
- The prohibition encourages risk-sharing, cooperation, and entrepreneurship, as it promotes trading and investment based on profit and loss sharing rather than guaranteed interest on loans.
- Implications for Islamic Finance:
- Islamic finance operates on principles that avoid Riba, leading to the development of alternative financial products and services that comply with Sharia law.
- Products such as Murabaha (cost-plus finance), Musharaka (joint venture), and Ijara (leasing) are designed to provide economic activities and financial growth without engaging in interest-based transactions.
- The focus is on asset-backed or asset-based transactions, where money must be used productively and profit earned through legitimate trade and asset investment.
- Impact and Challenges:
- The prohibition of Riba has led to the growth of the Islamic finance industry, catering to Muslims and non-Muslims seeking ethical and socially responsible investment opportunities.
- However, applying Riba-free principles in a globalized financial system presents challenges, including standardizing Islamic financial products and regulatory acceptance across different jurisdictions.
Although Riba is the notion of Islamic Banking, its scope is not limited to charging high interest. It also includes the barter of goods that are not equal in value and quality. In broader terms, Riba is an unequal exchange of money or goods, where one has to pay or give more than what they get. This concept is easier to understand through interest.
Many religious concepts in the Islamic traditions are based on Sharia Law. All the beliefs are derived from the Islamic scriptures, Hadith, and Quran, and Riba is one of those beliefs. There are two main reasons behind the prohibition of Riba:
- To ensure that any type of exchange is free from illegal and unequal means.
- They have made unfair and one-sided exchanges illegal so that there is no misuse of wealth.
The Islamic religion believes in encouraging people to be more helpful and charitable. This will help in creating a community that is not self-centered. Instead, they are kind towards others. If people only think about their profit, it will create a society full of resentment and doubt. Islam aims to remove such hostile feelings from society. To work towards this objective, the Shari’ah Law forbids Riba so that people do not lend money to earn interest but rather be charitable and lend money without charging interest.
If no interest or income is allowed, how do people generate income?
The answer is Murabaha. It is a financing system widely used in Islam. It is a cost-plus financing structure where parties at both ends of the transaction agree upon a selling price that includes the asset’s cost and the markup. Instead of the interest, the markup (Murabaha) becomes the income. This is referred to as a credit sale and is legally allowed by Islamic law. When an asset is sold or purchased, the owner is not fully transferred until the buyer has paid the full payment.
Why riba is prohibited in Islam?
Riba is prohibited in Islam because it keeps poor people poor and rich people rich. Riba is considered socially destructive by religious scholars, sociologists, economists, and the whole of Islamic society due to the social inequities that riba promotes and enables.
Riba has been a topic of discussion amongst the Islamic community. There is confusion regarding whether it is entirely prohibited by Shari’ah law and is considered punishable or if the idea of interest is despised. Many may interpret the law as the prohibition of the entire concept of interest gains, while some believe it is just the higher interest rates that are considered usury. In any way, it is believed to be exploitative under Islamic law.
There is a broad scope for interpreting Riba. The rationale behind Riba’s exploitative nature can be interpreted in many ways. One such justification is given by a contemporary scholar who believes that lenders should at least get the time value of the money they lend. If not excessive interest, they must be paid enough interest to cover up the inflation.
There is a history of struggle revolving around Riba amongst Muslims. Many have struggled economically as they are morally bound to follow the laws laid down by their religion. At one point, were some moderations were made to lessen the strictness of this law and let people become economically independent. However, the moderation lasted only for a shorter period.
Giles Kepel’s book Jihad: The Trail of Political Islam explains how some Islamic jurists tried to interpret this law in a way that does not oppose the rules of the Quran and, at the same time, moves towards the modern economy, where effective investment is defined by generative interest. This was necessary as, in the 1960s, many Muslim countries became part of the world economy.
However, the fallback from the law was only short-lived. In the 1970s, the ban on Riba was reinforced, prohibiting all lending aimed at interest generation.
In Islam, Riba fundamentally challenges the conventional financial system’s reliance on interest, promoting a financial ecosystem that values equity, transparency, and social welfare.
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