Evolution of Interest

8/2/2019 Evolution of Interest

1/12

EVOLUTION OF INTEREST

The concept of "usury" has a long historical life, throughout most of which it has been

understood to refer to the practice of charging financial interest in excess of the principle amount

of a loan, although in some instances and more especially in more recent times, it has been

interpreted as interest above the legal or socially acceptable rate. The practice of usury i.e,

lending money and accumulating interest on the loan- can be traced back 4,000 years (Jain, L.C.

(1929) Indigenous Banking in India, London: MacMillian & Co.),. With the expansion of trade

in the 13th century, the demand for credit increased, necessitating a modification in the definition

of the term. In 1545, England fixed a legal maximum interest, a practice later followed by other

Western nations. Economically, the interest rate is the cost of capital and is subject to the laws of

supply and demand of the money supply. But it has always been despised, condemned, restricted

or banned by moral, ethical, legal or religious entities. and during its subsequent history it has

been repeatedly condemned, prohibited, scorned and restricted, mainly on moral, ethical,

religious and legal grounds. The first attempt to control interest rates through manipulation of the

money supply was made by the French Central Bank until 1847.

THE MEANING OF RIBA

The word riba has been used in the Holy Quran on several occasions. So it is necessary to know

What it means or what it really stands for. Riba has been extracted from Raba. It means addition

,increase. So, riba literally means to increase, to grow to rise, to add, to swell. It is, however, not

every increase or growth which has been prohibited by Islam. In the Shariah, riba technically

refers to the premium that must be paid by the borrower to the lender along with the principal

amount as a condition for the loan or for an extension in its maturity. In this sense riba has the

same meaning as interest in accordance with the consensus of all jurists without any exception.

So the Holy Quran and theHadith do not make any such difference between usury and interest.

Interest and usury both are taken as synonymous for the Arabic word riba.


2/12

TYPES OF RIBA

Althought the Quran did not specify any particular kind of riba, it is generally held that the word

al-riba in the Quran is that kind of dealing which had been in vogue during the pre-Islamic days.

Muslim jurists have classified riba in two types:

1. RIBA AL-NASIAH

2. RIBA AL-FADL.

y Riba Al- Nasiah

The term nasiah means to postpone or to wait and it refers to the time period that is allowed for

the borrower to repay the loan in return for the addition of the premium. Hence it refers to the

interest on loans. The prohibition of riba al nasiah essentially implies that the fixing in advance

of a positive return on a loan as a reward for waiting is not permitted by the Shariah.

y Riba Al-Fadl

Islam, however, wishes to eliminate not merely the exploitation that is intrinsic in the institutionof interest, but also that which is inherent in all forms of unjust exchange in business

transactions. Riba al-fadl is the excess over and above the loan paid in kind. It lies in the

payment of an addition by the debtor to the creditor in exchange of commodities of the same

kind. The following tradition of the Prophet Muhammad (saw) is citedas evidence. It is related

thatAbu Said al-Khurdi said: the Prophet Muhammad (saw) has said that gold in return for gold,

silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, can be traded

if and only if they are in the same quantity and that is should be hand to hand. If someone gives

more or takes, then he is engaged in riba and accordingly has committed a sin.To sum up, riba

al-nasiah and riba al-fadl are both covered by the verse, Allah has allowed trade and

prohibited riba (2:275), while riba-al nasiah relates to loans and riba al-fadl relates to trade.

Although trade is allowed in principle it does not mean that everything in trade is allowed.


3/12

PROHIBITION OF INTEREST IN ISLAM

Islam is the only religion that categorically forbids any transaction based on interest. The

criticism of usury in Islam was well established during the Prophet Mohammed's life and

reinforced by various of his teachings in the Holy Quran dating back to around 600 AD. The

original word used for usury in this text was riba which literally means "excess or addition". The

Islamic ban on interest does not mean that capital is costless in an Islamic system. Islam

recognizes capital as a factor of production but it does not allow the factor to make a prior or pre-

determined claim on the productive surplus in the form of interest.

RATIONALE FOR THE PROHIBITION OF INTEREST

1. Effect on Monetary System

It has been argued, for instance, that interest, being a pre- determined cost of production, tends to

prevent full employment. It has also been contended that international monetary crises are

largely due to the institution of interest (Khan, n.d),

2. Improper Allocation of Funds

Since the returns that the bank gets on the capital sum lent by them is fixed and not linked in any

way to the actual profits, there are no incentives for the banks to give priority to the ventures

with the highest profit potential. In the interest based system, the banks are only interested in

recovering their capital along with interest. The interest system is inherently incapable of

allocating available liquid funds among firms and activities in the society according to

considerations of efficiency, productivity and growth. Theoretically speaking an interest-free

financial system would offer a much better substitute for allocating available funds among firms

and activities.

3. Promotes Inequity

Transactions based on interest violate the equity aspect of economic organization. The interest

system encourages passive behaviour to develop among people having liquid funds by helping

them to relinquish responsibilities and risks in investment activities. In contrast sharing in


4/12

responsibilities and risks is inherent in the profit/loss sharing methods of finance. The interest

system brings about and effectively maintains a pattern of income distribution which is biased

towards wealthy people and large businesses, irrespective of rational economic considerations.

This way, resources tend to remain in a few hands. This perpetuates inequity in the distribution

of resources. So interest gives rise to both inefficiency and inequity, the two major concerns of

the discipline of economics.

4. Exploitation of Needs

Interest, which is the kingpin of the modern banking and financial system, serves as a powerful

tool of exploitation of one sector of the society by another. The taking of interest implies

appropriating another person's property without giving him anything in exchange, because one

who lends one dirham for two dirhams gets the extra dirham for nothing.

5. Hinders Productivity

Dependence on interest prevents people from working to earn money, since the person with

dirhams can earn an extra dirham through interest, either in advance or at a later date, without

working for it. The value of work will consequently be reduced in his estimation, and he will not

bother to take the trouble of running a business or risking his money in trade or industry. This

will lead to depriving people of benefits, and the business of the world cannot go on without

industries, trade and commerce, building and construction, all of which need capital at risk.

6. Moral Aspect of the Interest

Permitting the taking of interest discourages people from doing good to one another (moral

aspect of the prohibition of interest). In a society in which interest is lawful, the strong benefit

from the suffering of the weak. As a result, the rich becomes richer and the poor poorer, creating

socio-economic classes in the society separated by wide gulfs. To pay interest on money lent is

to pay for something that no longer exists, and so the practice is nothing short of theft--which is,

of course, a sin.

7. Inflation

When a businessman who wants to set up a factory borrows money from the bank or from capital

markets, he has to pay interest on the borrowed money even if the business is under a stressful


5/12

condition and needs to retain funds, rather than paying them out as interest. When the lender

pressurizes the businessman/business entity to pay interest even in tough times, the businessman

then recovers that amount of interest from the consumers by charging a higher price for his

product or service. This rise in prices further aggravates inflation. Therefore, interest plays a part

in aggravating inflation.

8. Deterrent to productive economy

Interest is a deterrent to productive economic activity. This is evident from the commonly

observable fact that when rate of interest is low, economic activity increases and people are more

willing to start and expand businesses, which adds positively to the economy. In contrast, when

interest rates are high, people tend to be discouraged from making real investments and are more

interested in saving that money and earning interest on it. This is not good for the economy

because, when a small entrepreneur gets discouraged from borrowing money and starting or

expanding his business due to high interest rates, the country loses out on small scale and

medium sized businesses. These small and medium sized businesses are vital to a healthy

economy because they provide employment to many people. They also add to productive

efficiency of the economy because due to meager resources, they cannot afford wastage and

inefficiency, like the large businesses can.

9. Interest is based on expectation and not reality

Interest rates have a component of risk premium. This risk premium is, to a large extent, based

on perceptions of the investors regarding how a company will perform in the future. Since

interest rates might be fixed well in advance of the actual performance of the company, a well-

performing company may end up paying a higher rate of interest than a poor-performing

company because the expectations with the latter were higher initially, before the actual

performance showed up. So a lot is dependent on prior expectations rather than actual facts that

come along later on but can have only a minimal effect. This is not the case in profit and loss

sharing, where equity holders can share in the profit only after the company has performed well

and has actually made a profit. This way, the profit and loss sharing system rewards the owners

of the business when a business performs well, while in an interest based system, actual good

performance of the business has little effect on a pre-determined interest rate.


6/12

10. Oligopolistic situation

Going by a purely economic argument, productive economic resources concentrated in a few

hands would lead to an oligopolistic situation and competition would be reduced, while we all

agree that competition is very important for efficiency. In a capitalistic system, too much

emphasis and dependence is on people who already possess capital and productive resources

(one need not go into details that capitalistic system propagates unethical practices when the only

concern of people is to get the possession of capital by hook or by crook). But in awarding

unnecessarily high importance to the capitalists, contemporary economists forget that beyond a

certain level, incentive ceases to be an incentive. It becomes a cover for inefficiency. This

inefficiency today can be seen in both the production by the rich capital owners and their

consumption. This is because they can afford to waste. These large corporations can afford to

pay high interest rates. They can also get the interest rates negotiated due to their monopolistic

bargaining power. This increases economic dependence of a country on a few large corporations

and stifles growth of small and medium sized businesses, which are essential for a country's

economic health and also for competition. Often these large corporations are the giant

multinational companies (MNCs) with huge resources at their disposal. If these MNCs come into

a monopolistic position, by crushing the small industrial base of the country, it can have very bad

repercussions for the sovereignty, culture and tradition of that country.

ANALYTICAL JUSTIFICATION OF PROHIBITION OF INTEREST

Today many Muslim and non-Muslim economists, social scientists, socialists and even a number of

capitalist economists have questioned about the so-called positive impact of interest from both

theoretical and technical points. They often stress an important point that money capital cannot be treated as

capital goods on the same basis as productive factors. Lending of money for interest was disliked

and, in most cases, prohibited by all the monotheistic religions. An eminent Western economist, Harrods

(1973) recommended the abolition of interest in order to collapse of capitalism. Not only this, he

speaks with great admiration for an interest-less society in his work Towards a Dynamic Economics. Harrod

also clarified that, It is not the profit itself, earned by services, by assiduity, by imagination, or

by courage, but the continued interest accruing from the accumulation that makes that profit

take event ually appear parasit ical. H e fu r t he r st a t es t ha t a n interest-free society which


7/12

will be a totally new kind of society would be the correct and f ina l a ns w er t o a l l t ha t is ju s t l y

ad va nc ed b y t he c r it ic s o f c ap it a l is m . The interest based society and economy are

abusive. How terrible the interest is it can only be understood from one of the

Prophets Hadith where he says, The interest has seventy levels of sins and the

lowest level is equal to committing adultery with ones own mother (Baihaki and Miskat). It is

really a matter of thinking that why Islam has strictly forbidden interest and its related

activ it ies. In fact , the int erest has a great negative impact on the society, economy and morality

as well. If we look at the matter deeply, the f i r s t h a r m w e n o t i c e b e h i n d i n t e r e s t i s

i t s e c o n o m i c h a r m . I t s t y p e s m a y b e a s f o l l o w s : .

People earn money by interest without any effort. A person is getting $120in place of $100 after a fixed period by interest means that he is actually selling $100 for

$120. In this case, the person gets extra $20 without exchanging anything and

maki ng any e f f o r t . So t h i s i s undoub t ed l y an econo mi c exp l o i t a t i on .

Earning money by interest makes a person re luctant to labor and people losetheir motivation to earn money through labor. As a result, people lose their interest

in agriculture, industry, trading and construction, etc. which influence and hamper

the total welfare of a society. A person will be interested to run his business with his own capital

if he does not have the wide scope to take loan from interest based bank. This will force him to

increase his capital and hence the extent of gross business will also increase. By this way, the

unemployment problem may be reduced to some extent through expanding work

facilities and finally, there will be a positive impact on the total economy of the country. Most

often the whole nation fall into ruin because of the interest based banking system.Suppose, a

person has $10,000 as his capital and he takes $90,000 more as loan from a public bank and runs

a business based on that $100,000. For any inevit ab le reason, if the perso n becomes

bankrupt by losing cent percent of his business capital, then only 10 percent of his

loss will go for him and the rest 90percent will go for the total nation, because the bank is a

public property. In the society, the wide scope to take loan can be exploited by a

se lf ish c lass of peo ple who t ake mi l l ion s of mone y in t he n ame o f runn ing

bu s i ne s s , bu t i n reality they use that money for their self-interest. They do not feel to refund

the original money to the bank. As a result, billions of money of the country is kept in the


8/12

hands of a few dishonest people for unlimited time. As a result, the total economy of

the country is captured by some loan defaulters and hence the whole nation is being highly

affected financially. These are the main reasons of interest being prohibited from economic point

of view. The second harm behind the interest is the social harm. Normally, we see that in case

of loan, the po or and need y borrow from the rich. In th is situation, t he rich get

scope to have extra money in the name of interest because of the existence of interest system.

Inconsequence, the rich become richer and the poor become poorer. The class distinction

therefore grows and takes the shape of class conflict in course of time. From

societal point of view, this is one of the main reasons of interest being prohibited. The third

harm associated with interest is a moral harm. If the interest system exists in the society, the interest-

free loan giving and taking is being collapsed. Nobody wants to lend money to anybody without interest. If

the question of lending money comes, the question of the possible interest comes even

before than that. As a consequence, the kindness, affection, love, fellow-feeling, amity, sense of

brotherhood and the mentality of helping others gradually disappear from the society. This is the moral reason of

interest being forbidden.See for a more detailed discussion Al-Qardawi (1984).There

are some other solid reasons that also prove that interest is an evil system for

the human being and society as whole for all times.

They are given below

It takes away the sense of feeling of human pain. Instead of helping theneedy and poo r, people want to make a fortune out of it.The outlook of interest

hampers spending money and inspired to put that money in a bank or lend to someone. Such

attitude severely impedes the basic economic fo rmu la wh ich is spending inc reases

demand, dema nd increase s product io n, production increases employment and employment

increases overall income of the country.The attitude of interest also hampers the nations economy

as people do not want to invest their money, and they prefer it to multiply in banks.

This takes away the entrepreneurs spirit of investment and taking risks with the

investments.

In todays world credits have become a very significant part of our life. Butin reality, it is an evil system that makes a person its slave. If someone tends to


9/12

outstretch his capabilities and spends on borrowings, thus end up living in a cycle

of earning and paying debts for everything that he owns..The western economies that

are inflated due to consumer borrowings are a farce. It can fall down anytime because

nobody has the r ea l money. According to a r e c e nt r e p o r t t h e p e r

c a p i t a c r e d i t i n U S A i s $ 1 7 , 0 0 0 . T h e r e c e n t f a l l o f internat ional

sto ck mark et was due to such increased cre dit s.. Interest is one of the main causes why

societies are currently deprived from basic needs. Sayyed Maudoodi (1987) commented about

the bad impact of interest as Interest cuts the root s of human lo ve, bro therhood

and fellow-feeling, and undermines the welfare and happiness of human society, and

that his enrichment is at the expense of the well-being of many other human beings.

From the above discussion, it is clear that interest is one kind of illegal earning which affects peoples

personality, humanity, honor, sense of cultural value, belief, faith and character. Apart from

these, the illegal earners will also be deprived from Baraka and the blessings of

Allah. None of his good deeds will be accepted and rewarded. Even, the wealth

earned illegally will not be accepted to Allah if it is spent in the charity work . Be ca u se , t he

Prophet sa id , Al lah i s sacred and He accept s only the sacreds .Apar t

from the above reasons, there may have many other reasons of interest being prohibited

which only Allah knows. Above all, Allah prohibits only those things for

humankind which creates more harm than welfare. So it is our responsibility to

keep ourselves far away from earning money by interest. At the same time, we should lead all

our economic activities following the Islamic Shariah and leaving dealings o f any

kind including borrowing or keeping deposits from any interest based bank.

ISLAMIC SOLUTION TO THE ISSUE OF INTEREST

The Islamic scholars prescribed solutions to the issue of interest that can be based

upon the following two basic principles, see for example Zarabozo (2007):

(1) If an individual/country wishes to lend money to a person/another country for

helping purpose, this act must be based on brotherly principles and it is

absolutely unacceptable to charge any interest in such a case. This principle helps


10/12

to improve relations among different individuals and nations. If this important

principle is applied today, countries will truly give aid and assistance to other countries,

rather than s ucking them into a pat tern o f depend ency a nd debt burden.

(2) If an individual wishes to use his money to make more money, then he must be

willing to put his money at risk. If he puts his money at risk, he can deserve some

share of the profits. This implies that he must accept losses if losses occur. This is a system that

is based on justice. It also has numerous benefits. The one who invests money would be

concerned about the results of his investment and cannot demand his dollar off lesh

regardless of what may occur to the debtor. These solutions can work for

individuals as well as for society as a whole. Banks are essentially financial

intermediaries. They take money from those who have excess money (savings) and

turn it over to those who need money for investment purposes. Interest is not necessary

at all for such a system to work. The bank and its depositors (shareholders) invest, rather than

simply provide loan to their holdings. The money is put at risk and the return to the depositors

will be based on the amount of profits made in the respective investments. Under normal

circumstances of a growing economy, if the bank is big enough and it diversifies its portfolio, the

bank is virtually guaranteed a positive return on its total investments. Thus, those who invest

their money with the bank will also receive a positive return on their money without it being

guaranteed or fixed ahead of time. Numerous Islamic financial institutions such as Islami

Bank Bangladesh Limited,Bank Islam Malaysia Berhad, Dobai Islamic Bank, Jordan Islamic

Bank, Al-Baraka Investment Bank of Bahrain, Bahrain Islamic Bank, Faysal Islamic Bank of

Bahrain,Emirates Islamic Bank, Kuwait Finance House, Qatar Islamic Bank, Faysal Islamic Bank o f E g y p t

, I s l a m i c B a n k o f B r i t a i n a n d s o o n , h a v e b e e n s e t u p t h r o u g h o u t

t h e w o r l d t o d a y . They have been established based on the Islamic Shariah the principle

of avoiding inte re s t a nd ha ve b ee n ve ry suc ce ssfu l an d f lour ishe d to day

( Fr ankandSamue l ,1998) .


11/12

PROHIBITION OF USURY IN VARIOUS RELIGIONS

Hinduism

The earliest such record derives from the Vedic texts of Ancient India (2,000-1,400 BC) in

which the "usurer" (kusidin) is mentioned several times and interpreted as any lender at interest.

More frequent and detailed references to interest payment are to be found in the later Sutra texts

(700-100 BC), as well as the Buddhist Jatakas (600-400 BC). It is during this latter period that

the first sentiments of contempt for usury are expressed. For example, Vasishtha, a well known

Hindu law-maker of that time, made a special law which forbade the higher castes of Brahmanas

(priests) and Kshatriyas (warriors) from being usurers or lenders at interest. Also, in the Jatakas,

usury is referred to in a demeaning manner: "hypocritical ascetics are accused of practising it".

Christianity

Usury has always been viewed negatively by the Roman Catholic Church. The Second Lateran

Council condemned any repayment of a debt with more money than was originally loaned, the

Council of Vienna explicitly prohibited usury and declared any legislation tolerant of usury to be

heretical, and the first scholastics reproved the charging of interest. In the medieval economy,

loans were entirely a consequence of necessity (bad harvests, fire in a workplace) and, under

those conditions, it was considered morally reproachable to charge interest.Therefore, to charge

interest was considered to commerce withGod's property. Also, St. Thomas Aquinas, the leading

theologian of the Catholic Church, argued that the charging of interest is wrong because it

amounts to "double charging", charging for both the thing and the use of the thing.

Judaism

Criticism of usury in Judaism has its roots in several Biblical passages in which the taking of

interest is either forbidden, discouraged or scorned. The Hebrew word for interest is neshekh,literally meaning "a bite" and is believed to refer to the exaction of interest from the point of

view of the debtor. In the associated Exodus and Leviticus texts, the word almost certainly

applies only to lending to the poor and destitute, while in Deuteronomy, the prohibition is

extended to include all money lending, excluding only business dealings with foreigners. In the


12/12

levitical text, the words tarbit or marbit are also used to refer to the recovery of interest by the

creditor.

Conclusion

A very simple consequence of the prohibition of interest is that it produces a balance and

uniformity in the distribution of wealth, a more equitable distribution of income and wealth, and

increased equity participation in the economy. It has been argued that profit-sharing can help

allocate resources efficiently, as the profit-sharing ratio can be influenced by market forces so

that capital will flow into those sectors in early history which offer the highest profit- sharing

ratio to the investor, other things being equal. Interest has been condemned across the religions

and there are numerous evidences to support the claim that an interest-free economy would lead

to widespread prosperity and productivity.

Evolution of Interest

Documents

Transcript of Evolution of Interest