evolution of interest
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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.
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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.
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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
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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
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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.
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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
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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
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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
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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
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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) .
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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
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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.