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The reasons why Interest is prohibited in Islam

Updated on November 29, 2013

The Rational For Prohibition of Interest (Riba)

The rationale behind the prohibition of interest-based transaction is not beyond the common wisdom. If the funds are borrowed for consumption purposes, then charging of interest is clearly a sign of moral bankruptcy and inhuman behavior. In case the funds are provided for investment purposes, even then the prohibition is rational. It is obvious that such transactions involve a one-sided traffic. The entire burden of risk and uncertainty, being the norm of trade and business, has to be born by the debtor/investor. On the other hand, the creditor/saver is guarantied for a sure return. Thus the institution of interest is nothing but a source of social injustice and medium of economic exploitation. The Islamic Shariah condemns the institution of interest in all forms and manifestation with utmost caution and severity.

The advocates of the institution of interest in the past (and even today) saw no difference between usury and the ordinary sale-purchase transactions. The very basis of resemblance between the two, according to their reasoning, was the profit motive. If a person could be allowed to earn profit by investing his saving in trade and business, he could equally do so by lending out the same amount to another party and share in the profits. Apparently, this kind of argument makes a sense. However, the two transactions differ a lot. For instance, the following points are noteworthy:

  • In trade (buying-selling) contract, both the parties benefit from the transaction. The buyer (consumer) gets the commodity required with convenience and the seller (producer or supplier) gets the reward of his services furnished, which is implicit in the market value of the commodity concerned. Thus the sharing of benefits between the two parties takes place on the equity basis. In case of lending-borrowing contract, there is certain and guarantied benefit for the creditor and a merely expected but variable share for the debtor.
  • The trading profit, even if assumed to be positive, accrues to the seller once as the transaction is finalized, and its rate is not constant. In contrast, the creditor, in case of usury transaction, goes on receiving the profit at a fixed rate so far as the debt remains outstanding; rather the total return goes on increasing overtime due to compounding.
  • The account is closed in the sale-purchase contract once the transaction is finalized and the price paid. But in the usury contract, the debtor consumes the borrowed money and earns it afresh so as to refund the principal amount along with interest.
  • Finally in all form of business, an individual earns revenues bit by bit after selling his goods or services with the aid of considerable human efforts. The profits are determined as residue, which is not surely positive even if he puts in all the capital, effort and wisdom. In case of usury contract, the creditor offers only financial capital and bears no more pains. Neither he faces risk nor uncertainty and still claims for a sure profit in lump-sum. In fact, he is a sleeping partner in the business but a dominant partner in the reward.

There is another line of reasoning offered in favor of interest-based dealing and which can also be turned down on logical grounds. Interest is regarded as the price for the use of capital in the same fashion as other factor services bear prices. Capital theory is the most controversial branch of economics. The theory confuses various forms of capital and declares 'Interest' as the hiring price for all units. Capital is defined as the man made durable goods like machinery and equipment. When combined with other factors, it improves the quality and enhances the quantity of output. However, it undergoes the normal wear and tear during the process of production. In other words, it depreciates in value overtime but retains its original shape. This is the physical capital and it should earn a predetermined return like other factors. The financial or working capital is the cash money in the hands of the entrepreneur. It prefers certain important functions, however, distinct from the physical capital. Several payment are made out of this 'cash in hand' before the completion of production process or accrual of revenues. These include, for instance, the purchase of raw material, hiring of factor services and payment of remuneration, meeting of the running costs of energy, marketing, exhibition and transportation etc. Put differently, money is barren if held as idle balances. It becomes productive provided two conditions are satisfied. First, it has to be invested in trade and business and transformed into physical capital, machinery and equipment, inventories and raw material etc. Second, it must be combined with other factor particularly the labor or human effort. Money or financial capital is consumed during the process of production and it is regenerated after the process is completed. In other words, it loses its original shape but retains the value when reproduced. Therefore, it is not a factor of production in its own capacity; rather it is a part and parcel of the very person of the entrepreneur. It cannot be hired out like other real factors. The payment of interest as the pre-determined reward against the use of liquid money over some time is therefore illogical. The owner can either invest the capital by himself or he can share his capital with others in the business. In all cases, he has to face the risk of loss and uncertainty of future happenings; which are the essential components of business: in the absence of these characteristics, Islam does not consider money as a separate factor of production and cannot allow a pre-determined reward to an individual merely on the claim that he is the financier of business.

Apart from the major differences in sale and usury contracts, and in the nature and functions of physical and financial capital, Islam prohibited the transactions involving interest on moral and social grounds. This is because it develops miserliness, greed and a selfish attitude in the individuals, and destroys the high virtues of kindness, sympathy, help and mutual regard in the society. It create a tendency among the people to earn wealth by hooks or by crooks. It blocks the circulation of wealth due to hoarding and speculation. It diverts the flow of investment to the projects offering a high rate of interest irrespective of whether or not these are socially desirable. If the capitalists feels that the rate of return on investment is lower than the market rate of interest, he would prefer to withdraw his money from the business. The process of investment will slow down due to non availability of the requisite funds. The impact of this behavior are clear, the economy suffers deficiency in aggregate demand leading to loss of efficiency, unemployment and depression. Thus a few capitalist become the master of the fortune of the economy or they become the parasites or blood suckers of millions of hard workers. Their greed of gathering wealth rises to the climax or a level of madness such that they loss any concern with the national interest. Even at the time of acute emergency, when whole of the nation has to struggle hard for its very existence, the capitalist would like to extend a hand of help only if he expects financial return. This selfish behavior on part of the money holder capitalist creates an air of hatred and aggression against them in the society that leads into class conflicts and ultimate destruction. An Islamic society cannot tolerate this state of affairs to prevail since it is deadly poisonous to the cause of humanity.


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