Principles of Islamic banking and finance/PIBF201/Rationale for Islamic finance/Rationale Behind Prohibition of ''Riba''

The Rationale Behind the Prohibition of Riba

Although the Shari`ah did not clearly mention any rationale for banning the Riba, the following three main reasons were stated for strict condemnation of Riba in Islam from economic point of view:

1. Riba reinforces the tendency for wealth to accumulate in the hands of a few, and thereby diminishes human beings concern their fellow men.

2. Islam does not allow gain from financial activity unless the beneficiary is also subject to the risk of potential loss; the legal guarantee of at least nominal interest would be viewed as guaranteed gain.

3. Islam regards the accumulation of wealth through interest or usury as selfish compared with accumulation through hard work and personal activity.

It is evident from the above mentioned reasons that interest mechanism prevents the fair distribution of positive or negative outcomes of economic activities among the lender and borrower and worsens the income distribution. This occurs either by providing the capital owner a certain and fixed percentage of earning in any case regardless of the negative outcome of the business, or by limiting his earning with only a predetermined amount of return in case the borrower entrepreneur earns considerably high income out of his/her financial capital.

The main reason advocated by Siddiqi and Ganameh as to the rationale of prohibition is that it is oppression involving exploitation. In matters of consumption loans, it is necessary that those who have wealth should assist those without, and in productive loans, a guaranteed return on capital is unjust given the uncertainty surrounding entrepreneurial profits, whereas a return to both parties as a rate of profit would be more equitable.

Taji al-Din argues the reason appears to be the restriction in circulation of wealth amongst those who already have it. Lenders would not provide loans to those they believe are unable to repay, thus such wealth would be restricted to those able to service the debt. This is something forbidden categorically by the Quran and the effects on society result in the accumulation of wealth amongst those who have it and increase the divide between the rich and poor.

Mawdudi believes the cause relates to the undesirable resulting effect of an imbalance between production and consumption. This is caused by the transfer of purchasing power from those with a high propensity to consume to those with a low propensity to consume. The latter group reinvests its income in production, increasing production and decreasing consumption demand. Cost of capital results in increased prices of consumption goods, accentuating this process.

Mawdudi believes this is the source of evils in the economy such as stagnation, depression, monopoly and ultimately imperialism. Interest free loans and prohibition of return on capital along with zakat, wages, profit and profit-share recreates this balance. The focus shifts to the entrepreneur whose activity becomes the only source of income along with wages, giving him the upper hand in society. Siddiqi and Ganameh cite the hadith of “income devolved on liability” in this context. Some argue that interest allows the creation of a group of people who contribute nothing to society, simply generating income from capital. This starves society of their contribution and the rationale of prohibition is to reverse this.

Hameedullah believes the reason is the unilateral nature of the risk born in these agreements. The Islamic principle is for a reward, there must be some liability incurred – without this a return is prohibited.

Qazi Irfan argues that riba was prohibited just to prevent the creation of "extra liability/demand" because that is fake and "does not exist" physically, this artificial "extra liability/demand" creates scarcity of the produce in the society and unjustly accumulation of the produce in few hands. Riba is a mechanism and dangerous weapon that has a power to get hold of assets/properties of individuals, enterprises, and nations deceitfully. This is unfair and against the nature, so Allah banned riba very strictly to stop this criminal action.

Nature is the Limit in Islam; anything not natural is prohibited, stopped, and declared illegal. The above economic reasons are the only base for the prohibition of riba, Allah has allowed everything that is natural but given its strict judgment to stop any behavior, agreement, and practice that is not natural.