Banking; An overview of the system

Q57 :Are 'riba' and interest synonymous? There exists a general impression that transactions involving all forms of interest are forbidden in Islam. Perhaps an international debate amongst Muslim scholars and religious leaders on this important issue is necessary. What is submitted here are thoughts of a layman who, like most others, is beset with many doubts concerning this rather complex matter. Almost every one agrees that Islam desires the development of a fair economic and commercial system that will prevent wealth from being inactive or concentrated in the hands of a few. Instead it encourages its continuous circulation and utilization so that the whole society becomes prosperous. Circulation and utilization of wealth presupposes an arrangement that will permit the pooling of our individual resources in some shape or form, especially in an industrialized society. Not everyone that possesses capital can become an entrepreneur, nor does everyone with commercial acumen possess enough wealth to finance all the projects he may be able to manage efficiently. Thus a way has to be found which will enable the entrepreneur to borrow funds from those who cannot put them to good use, and, most importantly, make him share the profit of this venture with the lender on an equitable basis. Now, it is obvious that not everyone with money to spare can find an entrepreneur whom he can trust and who needs exactly the amount that is available for investment. This is particularly [true] of small savers (e.g. widows, peasants, small income earners, etc.) not well versed in business matters. Also if the entrepreneur needs to locate and enter into partnership with a large number of small investors, he may find the task wearisome and would not have much time left to attend to the business. Therefore, it seems that a pooling center or a clearing house would need to be set up to bring together the investor and the entrepreneur, ensuring that the legitimate interests of both parties are adequately safeguarded. Without such an arrangement, it would not be possible to collect funds from small savers and make them available to those who need them, especially if this is to be done after due scrutiny and securing reasonable guarantees. This process requires financial and business expertise which can only be provided by a group of properly qualified professionals and not by individual investors themselves. In the system that prevails in almost all countries today, this function is provided by the banks, that secure deposits from individuals and then give loans to businessmen after due scrutiny. The bank charges interest on the money loaned and after deducting its own expenses and profit, passes it on to those whose money it had so utilized. Current practices also allow for the rate of interest charged and paid out to vary according to the market conditions, and the rate does not necessarily remain fixed at a predetermined figure. Thus, both the saver and the entrepreneur gain or lose as a result of the market conditions and this, perhaps, satisfies the requirement of a partnership between the borrower and the lender where the profit or loss is shared equitably. Needless to say, the interaction of a bank makes all lending and borrowing deals impersonal and virtually eliminates the chances of disagreements and disputes between individuals. Also the banking institution is able to cater to the changing demands of the lender and borrower, both with regard to the amount and period involved, which simply will not be possible if the borrower has to deal directly with the lender. All this makes for more efficient utilization of available resources. But not even banks can really become full partners in all business ventures they finance for two reasons. First it is not their line of business and secondly the overheads would become too much of a burden. Now the objection against the current banking system is that it is based on interest which is forbidden in Islam. Perhaps here we need to consider the matter carefully and dispassionately and determine what is the real substance of what is forbidden. The word used in the Qur'an is 'riba' which has not been defined but, perhaps, an insight into its meaning can be gained by examining its context. Many scholars are of the view that an essential component of 'riba' is an exploitation of the needy borrower by a lender. If, for instance, a widow or an orphan or an unemployed person is loaned money by an individual on the condition that the amount returned would be greater than the amount borrowed, then it would be an attempt to benefit from someone's misfortune and this would certainly fall within the ambit of 'riba', but if a businessman obtains a loan to expand his business and increase his profits, surely there is no element of exploitation in requiring him to pay a charge for use of money given to him. After due deductions, this amount is passed on to the individual depositor. Thus, there is no suggestion of any exploitation of a borrower or a lender in such a deal. Indeed, this is a simple business or commercial deal where both the borrower and the lender are subject to the vagaries of the market-place. This becomes even more so when one considers the modern phenomenon of inflation which causes the purchasing power of currency to vary as a result of market forces and even fixed rates of interest do not really remain fixed. The saving schemes floated by various governments also fall under business loans as the money collected is spent on development schemes and infrastructure which, in turn, spur greater commercial activity and create more employment. Again, there is no question of the saver taking undue advantage of the borrower. Another element that needs to be considered is that hardly anyone objects to letting out a house or shop on rent although the rent is a fixed amount. Now, it may be argued that basically a building or money are various forms of the same commodity capital. Thus, if rental of a building is permissible and does not contain an element of exploitation of the poor and the needy, why should borrowing money be otherwise. We Muslims have generally started equating all forms of interest with 'riba'. What may have been understood by learned and pious men hundreds of years ago, however valid in the conditions prevailing at that time, may not necessarily be rigidly applicable to situations and forms of transactions that have evolved only recently. Many discerning people are of the view that perhaps the nearest equivalent of 'riba' in current parlance is usury where money is loaned at exorbitant rates to those in a tight corner in an effort to profit from their misfortune. They do not think that the term 'riba' can really be applied to the current form of commercial interest charged or paid out by a financial institution. Surely what we need to do is to understand the spirit and the essence of the original Qur'anic message, and not put ourselves into a straight jacket of semantics. Occasionally a term used in one language does not have an exact equivalent in another. Therefore, we should not, I think, attempt at translating an essentially untranslatable term, 'riba', into a multifaceted term in another language, 'interest'.

A57 : It is very interesting to receive a letter like this one in which a reader argues a case in an orderly relaxed manner, defending his point of view and airing thoughts that are inevitably shared by numerous other readers. My reader argues that the role of the bank these days is that of a medium, facilitating the all beneficial need of introducing savers to businessmen. Thus the money of the first is made available to the second who are thus able to utilize their expertise and business acumen in order to ensure the growth of the investment. He argues that there is a strong need for this service which is provided by banks which actually act in this respect as clearing houses. That there is such a need cannot be doubted. But whether the system operated by the bank satisfies Islamic requirements is a totally different matter. My reader tries to show that it does meet its requirements, particularly the changes required in the rate of returns on investment. When the objection is raised to the interest system on the basis that the returns are fixed in advance, some people think that if the rate of interest changes then that objection is met. We find this argument clearly exposed by our reader, who goes to the extent of saying that if the rate of interest drops, then both the depositor and the borrower lose. If the rate of interest goes up, both of them are bound to benefit. To start with, this is not correct. Fluctuations in the rate of interest affect depositors and borrowers in opposite ways. If the rate of interest drops, the borrower is pleased because the charge he has to pay to the bank on his loan becomes less, and he benefits as a result, while the saver or depositor receives less on his money, which is something definitely unwelcome to him. The same is true when the rate of interest goes up. The depositor is pleased because he receives more, but the borrower is displeased because he has to pay more. In business, partners either profit together or lose together. If you are a sleeping partner in a business, your share increases at the same time as that of the active partner, because the income comes from a better performance in the business. When the business does not do all that well, both your shares drop. Moreover, changes in the rate of interest do not reflect the performance of the particular business project in which your money has been placed, they only reflect the situation in the money market which is affected by considerations totally different from how individual businesses are performing. Changes in interest rates are determined by central banks which have a totally different role from that of ordinary banks and in isolation of individual business performance. Moreover, the depositor will never share in the loss of the business in which his money is invested. Suppose you have deposited a certain amount in a bank and the bank gives this total amount to a borrower who runs a particular business. It so happens that the project in which money has been invested fails and makes considerable loss. What is your position at the end of the year? You will still receive the interest agreed upon between you and the bank, allowing for any changes in between, and you will not even bother to know to whom your money was lent and what sort of performance it made. We cannot in any way associate this banking transaction with the partnership approved by Islam in which both investor and borrower are actual partners and they share in any profits or losses. The fact is that there is no partnership whatsoever in the arrangements made between the bank and its depositors on the one hand, or between the bank and its borrowers on the other. There are two separate transactions which the bank is happy to run, because at the end of the day, it stands to make much profit. You need to look at the announced performance of leading banks in most countries to discover that they actually make huge profits which come mostly from their running this facility. Besides, one of the basic functions of a bank is to make money available to those who need it. This raises questions on the whole operation because it facilitates for its depositors taking the position of lender. Muslims generally would rather not have the dubious privilege of becoming lenders either to business projects or indeed for any other purpose. It is far easier for us to consider an "investment" role for banks. But this relates to a different aspect of banking operation. Leading banks nowadays operate systems for investing the money of their depositors, putting it in shares and stocks. Such systems are much easier to sort out so that they become acceptable from the Islamic point of view. But when the bank is lending out our money at a profit, then it places us in a position of a lender who gets back more than the principal he lent. The fact is that when you lend someone else an amount of money and you agree with him either explicitly or implicitly that the amount he will return to you at the end of the period of the loan will be more than what you paid him, then this transaction is 'riba', or, to use the proper English term for it, "usurious". The Prophet says: "Every loan that brings in a gain is usurious." It is perfectly permissible that a person who has borrowed money from another pays it back and gives the lender something extra, a gift perhaps or an increase in the amount, but this must not be the result of any prior agreement between them, either explicit or implicit. Indeed, there should be no hint that the lender will be getting anything other than the amount he had advanced. My reader makes much of the differences between what a bank does and the money lender does, to the extent that he prefers to use the Arabic term, 'riba' and makes it clear that he is against usury. At the end of his letter he claims that 'riba' is "an essentially untranslatable term." In this he is totally mistaken because riba is a simple Arabic term which means, from the linguistic point of view, "excess." In a financial transaction, 'riba' refers to the payment of something over and above what has been given in the first place. Early Muslim scholars have told us what is exactly meant by 'riba', when they said that the person would borrow some money for a specified period. At the end of that period he would go to the lender and tell him that he is unable to repay the loan and requires an extension of it. The extension is granted on condition that the amount he repays will be higher. Is this not practiced by banks today? Does the bank charge you the same amount if you repay your loan over three months or six months or a year? Do you not pay much more interest when you make your repayment over an extended period? Besides, who says that banking arrangements do not exploit the weakness of those who need the money? My reader gives the case only of people who have business acumen, but what about borrowing from a bank for a specific purpose which is not expected to generate income, such as buying a car, or indeed a diamond ring for your wife? What does a bank do after the collapse of a business project to which it had made some advances? Is it not true that there is no consideration of the weakness or the status of the borrower? Instead, receivers and liquidators are called in without any regard to the terrible position in which the borrower finds himself. Nevertheless, I have said in the past that the interest system is not exactly synonymous with the usury as it was practiced in the pre-Islamic days. Nevertheless, there are aspects of similarity between the two which are, in the view of most Muslim scholars, sufficient to make the interest system forbidden from the Islamic point of view. If banking facilities are to be made lawful, the first thing that is required is a thorough discussion of the various aspects of the banking system, to be conducted between bankers, economists and Islamic scholars. Who will bring about such a discussion, and when, is far from clear. We can only hope that someone will start the ball rolling.

Our Dialogue ( Source : Arab News - Jeddah )