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Is Interest Really Banned in Islam?

This modern view is well articulated by noted Pakistani-American scholar late Fazlur Rahman. He aptly argues that in the modern economic system, “interest occupies the same place as price and performs the all-important function that any price-mechanism performs, viz., of regulating the supply and demand of credit and rationing it among the customers. If the rate of interest, i.e., the price of loaning money, is reduced to zero, then we are faced with a limited supply and an infinite demand. It would become impossible to control the rationing of credit available, so to say, and to assign priorities.” According to him, riba is forbidden in the Quran precisely because, in that historical context, it was indeed exploitative, doubling and redoubling at times of non-repayment, as mentioned in the Quran (3:130).

Several other scholars associate themselves with this distinction between riba and interest. Imad-ad-Dean Ahmad cites people’s time preference – the fact that goods and money are valued more at present time than at a future date – as the cause for interest to arise and argues that any unconscionable overcharging, whether on an interest rate or on a spot price, is riba, but market interest is not riba. Yusuf Ali, in a commentary in his most popular Quran translation, says, “My definition [of riba] would include profiteering of all kinds, but exclude economic credit, the creature of modern banking and finance” (Cited in Ahmad and Hasan). Muhammad Asad, Muammad Pickthall, M.H. Shakir, and Edip Yuksel and his colleagues also translate “riba” as “usury” in an excessive sense, meaning that interest used in business transactions in the structure of modern credit and banking does not qualify as riba. Other scholars who also align themselves with this modern view of interest include author Imam Feisal Abdul Rauf and author and columnist Mustafa Akyol. Akyol thinks that Turkey’s fast development, among all Muslim countries, is, in part, due to its rejection of the orthodox view of interest promoted by Sayyid Qutb and Maulana Mawdudi.

I also argue in my book in a similar vein: the Quran does not condemn interest per se, but it condemns interest on loans that are extended to persons or entities that deserve humanitarian treatment. A careful reading of the Quranic verses (2:275-276; 3:130; and 2:278-280) suggest that the practice of interest charged during the time of revelation was indeed extortionate, not comparable to business profits, which the Quran permits. To judge whether or not a lender should charge interest to anyone, he should consider his circumstances, and if he is found in financially straitened conditions, the lender should remit interest altogether, postpone the loan repayment (both of which can be labeled as qarza-hasana in Quranic terminology) or, better still, write off the loan as sadaqa. For normal business purposes, however, interest has become an unavoidable, integral part of the modern economy. Furthermore, interest plays a very powerful role as an economic development and monetary policy instrument, and as an essential device for efficient allocation of productive resources. As demonstrated by this author elsewhere, for the most part of their businesses, even so-called Islamic banks have not been able to get rid of interest. But the overt non-embracing of interest deprives the Muslim economies of a powerful monetary policy tool and one that strengthens banking, capital markets, and stock exchanges.

Whether any economic charge – price or interest – is unconscionable should be judged in the light of the overriding fundamental principle enunciated in the Quran about social justice or good we need to observe. The Quran urges us to strictly maintain justice or equity (adl) in all of our affairs (16:90; 4:58; etc.). It directs us to do business in particular to our mutual benefit (4:29). And it strongly urges us to respect the norms of social justice and compassion, wherever appropriate. It is striking that the Quran contrasts interest with zakat or sadaqa, condemning interest and extolling sadaqa (30:39).

From this Quranic position and from Fazlur Rahman’s analysis of the system of sadaqa as a broader co-operative welfare system, we get another insight that where a system of sadaqa deserves to be applied, interest has no role to play. But as long as we are unable to attain that welfare system, the abolition of interest would be suicidal for the welfare of a society and its financial system.

Interest in the modern economy arises due to, and mirrors, three sets of data: profit, time preference, and price level change (inflation or deflation). Take, for example, the case of inflation. Someone borrows from you $100 today and returns it after, say, one year. If during this one year there is a 10-percent inflation, the $100 you’ll receive after one year will be worth 10 percent less than what you lent. So if you’re compensated by a 10 percent interest on the loan, both you and the borrower will be on a just footing, neither losing nor gaining unjustly.

Inflation or deflation is merged in nominal profits. So if the bank makes a profit by investing your money, it is only just that this profit is shared between you and the bank. A producer would like to borrow money to use in his enterprise so long as he earns a return at the margin higher than, or at least equal to, the rate of interest he pays on borrowed capital. The higher is the return on capital, the higher will have to be the interest rate to be in equilibrium with the rate of return situation.

Also, interest plays an essential vital role in helping individuals allocate his income into present consumption and future consumption (i.e., saving) by bringing individuals’ time preference at the margin into equilibrium with the interest rate. The higher is individuals’ time preference, the higher will be the interest rate that will be in equilibrium with time preference, which means that the interest incentive will need to be higher for one to save for the future. So, as modern economic theory tells us, in an equilibrium situation, the market interest rate is equal to both the marginal rate of return on investment and the marginal rate of time preference on saving.

This interest thus plays a vitally necessary and beneficial role in the modern economy. This interest is not banned in Islam.

In the non-bank informal credit market, however, interest rates charged by microfinance institutions and NGOs and individual merchants and landlords to their clientele are often found to be extra-ordinarily high. Even the reputed Nobel Prize winning Grameen Bank is not immune from this accusation. It is the duty of the state to take appropriate measures (e.g., subsidization in some cases) to stem such practices.

By Abdur Rab, a retired economist and author of Exploring Islam in a New Light: A View from the Quranic Perspective, 2010.

*Photo Credit: Tim Peters