Islamic Finance Blog & Articles
Wherever Muslims go, they often face questions regarding how they can integrate their faith with their daily activities. It's also most especially true since their beliefs are often constantly challenged by non-Muslim expectations and protocols. Because of this, it might be hard to break tradition. However, a lot can actually be learned from them.
The most usually known concepts for Muslims are halal, haram, and riba. Each of these concepts comprises a large part in influencing their everyday activities.
In this article, we will discuss all about what riba is, what forms are allowable for Muslims, and why it is haram.
What is Riba? (Interest)
Riba refers to financial interest payments, which quite literally means "growth," "excess," or "increase." In other terms, these are interests paid on loans or those that are gained on bank deposits.
However, riba can also mean the pursuit of exploitative or illegal trade gains by gaining unreasonably high interest rates. With this, the term itself can be complex in itself.
When it comes to the law of Islam, Riba usually includes two important types: riba al fadl or riba al nasiah.
Types of Riba
Riba al Fadl
Riba Al Fadl is a type of riba that pertains to the trading of differing amounts of similar commodities. This kind of riba is applied to certain commodities only like rice, sugar, oil, or wheat. The extra amount would be riba if the exchange involves the same product, but in unequal amounts.
An example of this is exchanging 1 kilo of dates to 2 kilos of dates. Nonetheless, this kind of riba is quite insignificant in modern economies since we have already greatly advanced from barter systems today.
Riba al Nasiah
On the other hand, Riba al nasiah occurs when there is a clause in a certain contract where the lender will be paid additional just for accepting a delay in debt repayment.
One example of this is when a lender lets someone borrow $1000 for one year with the agreement that it will be paid back with an extra $50.
Since riba is a relatively technical and complex concept, it can be easily interchanged with other concepts like purchase order financing, debentures, admin fees, and more. While some or most of these involve riba, these can be used in situations where riba isn't included too.
The Roots of Riba
The origins of riba trace back to ancient times, even predation the writing of Qu'ran. Basically, dealing with finances involving interest is an affair that has long existed since then.
In ancient Greece, the interest rate was considered a fair profit with 12% on loans. Even in Rome, years later, the yearly rate is 12% per annum which the Decemvirs established.
Regardless, charging interests in especially exorbitant amounts is something that has been long deemed immoral. In fact, in early England, there were already existing penal laws that were put in place against usury. However, the gravity of those laws was increased, whereas William the Conqueror added punishments like perpetual banishment, whipping, and more.
Despite this, the perspective began to shift in recent centuries. Since the 17th century, interest-based loans and banking have become more accepted and considered a norm.
Difference between riba and profit
Seeing as how confusing the term riba is, these two concepts can be bound to get interchanged. Despite the initial perspective, this isn't the same as profit.
You might think that there isn't any economic difference between lending $10 and receiving $12, same as buying something wholesale in the same scenario. However, there is a stark difference. In both situations, there is a similar gain of $2. What makes it different, however, is that Islam prohibits the former and accepts the latter.
Applied in our modern context, riba and profit can be differentiated in terms of contracts like conventional mortgages that often charge interests for accepting repayment delays. In this case, this is an example of riba al nasia.
On the other hand, an Islamic bank is different since it isn't allowed to charge interest. So instead, what it does is it obtains its profit by having an equity stake in a specific property and renting out a part of it.
The most distinct difference between these two is that the Islamic bank is forced to take part in buying and selling a real asset, thereby exposing itself to the risk of loss. Conventional lenders, however, are legally entitled to their own money regardless of what may happen with the asset.
Why is riba haram?
Despite riba being a huge concept in Islam that influences their daily lives, most people often wonder: why is riba haram?
A big part of Islam religion is to live well within your means. Nowadays, however, since there's now the capacity to open several credit lines and be involved in contracts, people often look for more, increasing further debt. Moreover, it also poses social and economic negative effects.
Because of these, so many religions have already started to prohibit and despise Riba. This is because riba-based loans tend to only increase poverty as it usually exploits those who are poor. An example of this is personal loans which often charge up to 40% annualized rate. This very act in itself compels the poor to be trapped in a never-ending cycle of riba and debt. This is because lenders would only care that the loan is repaid, not where the money comes from nor the economic hardship that the borrower has to go through.
The riba-based finance is usually directed to borrowers who can repay their loans while not considering whether the activity is indeed beneficial or advantageous in any way.