Introduction
Muslim community numbers about 1.3-1.5 billion people, roughly one-fifth of the world population. This community is spread across many different nations. There are 52 Muslim countries in the world, holding most of the natural resources of the world. Unfortunately, Muslims are still following the western banking system which is based on Riba (interest). The banks occupy an important position in a modern day economy. Through the process of financial intermediation banks help in economic advancement and social welfare. They are manufactories of credit, which serves the community and keeps the wheels of commerce and industry revolving. All of these services involve Riba, as interest is considered to be the price in conventional banking system. But Riba is categorically prohibited in Islam. We need a financial system free of interest to resolve this issue.
The Islamic banking has been defined by the International Association of Islamic Banks (IAIB) as The Islamic Bank basically implements a banking concept in that it adheres strictly to the rules of Islamic Shariah in the fields of finance and other dealings.
In this report I will describe the negative impacts of Riba on current economic system, and possible solutions given in Islam to mitigate those impacts and solve the problems in Conventional banking that is defined as accepting for the purpose of lending or investing, deposits of money from the public, repayable on demand, and withdrawable by cheque, draft, order or otherwise"
Definition of Riba
The word riba was linguistically used by the Arabs prior to Islam to refer to an increase. In commercial practice, it referred to the increase on loans, namely, interest. The definition of riba in classical Islamic jurisprudence was "surplus value without counterpart."
My definition of Riba
"The definition I would accept would be: undue profit made, not in the way of legitimate trade, out of loans of gold and silver, and necessary articles of food, such as wheat, barley, dates, and salt etc.
Prohibition of Riba
Quran explicitly prohibits Riba, and since Quran is an undisputed source of guidance, all Muslims unanimously agree on prohibition of Riba. There is no difference of opinion among any school of thought on prohibition of Riba in Islamic Shariah.
The Quran deals with Riba in 12 verses, the word appearing 8 times in total, 3 times in 2:275, and once in 2:276, 2:278, 3:130, 4:161 and 30:39
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2:275 Allah has permitted trade and has forbidden interest.
Mohammad said in his farewell sermon: "Allah has forbidden you to take Riba, therefore all Riba obligation shall henceforth be waived. Your capital, however, is yours to keep. You will neither inflict nor suffer inequity. God has judged that there shall be no Riba and that all the Riba due to `Abbas ibn `Abd al Muttalib shall henceforth be waived.".
Culminating with the verses in Surah Baqarah: Those who benefit from interest shall be raised like those who have been driven to madness by the touch of the Devil; this is because they say: "Trade is like interest" while Allah has permitted trade and forbidden interest. Allah deprives interest of all blessings but blesses charity…O believers, fear Allah, and give up the interest that remains outstanding if you are believers. If you do not do so, then be sure of being at war with Allah and His messenger. But, if you repent, you can have your principal (Quran 2:275-280).
The crimes of dealing in Riba are so serious that God has declared war against those who deal in Riba. Mohammad has cursed anyone who deals with Riba, the one who takes it, one who pays it and one who records it, they are all equal.
[edit]Rationale of the Prohibition
The main reason advocated by Siddiqi as to the rationale of prohibition is that it is oppression involving exploitation. In case of 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
Mawdudi believes the cause relates to the undesirable resulting effect of an imbalance between production and consumption. Chapra 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.
EFFECTS OF RIBA ON ECONOMY
After consulting literature and internet I concluded following impacts of Riba,
Accumulation of wealth through interest or usury increases the selfishness and greed.
The main problem of Riba is the injustice, as the financiers being assured of a positive return without putting any effort or sharing in the risk, while the entrepreneurs, in spite of their management and hard work, is not assured of such a positive return.
Wages of workers are not commensurate with the share of profit owed to employer i.e. not according to what they deserve but according to what their owners' desire.
Interest-based economies badly affect small businesses, as doing business on interest loans compounds the risk since it binds the businessman to pay interest at a fixed rate whether or not the business has made profit.
Riba is that extra liability created in excess of the produce available and that does not exist. This causes Instability in Market Demand and Supply. Creating an extra liability means creating an extra demand without increasing equal supply
Riba has negative impact on Savings-Investment. Uncertainty about future inflation may discourage investment and saving, or may lead to reductions in investment of productive capital and increase savings in non-producing assets, as Riba results in inflation, this can reduce overall economic productivity rates, as the capital required to retool companies becomes more expensive.
Riba based economic system has the power to concentrate resources in few hands; Riba has played a pivotal role in this concentration. It is very alarming to note that less than 4 hundred individuals own more than 50 percent of the total world's wealth, the situation is worsening day by day.
Riba results in Excessive Profit-Making, as taking the risks of loss and the schedule of payments into account the businessmen borrowing on interest keep a higher margin of profit than they would without interest.
In estimating the cost price of a commodity the businessman includes interest as an expense, which pushes up the prices of the item.
SOLUTIONS TO DEAL WITH RIBA FROM ISLAMIC PROSPECTIVE
The profit-sharing banking system (Islamic Banking), would make the financial system more stable than using Riba. The sharing arrangements between suppliers and users of resources for producing wealth, improves business cycles and stability in the economy.
PRINCIPLES OF ISLAMIC BANKING
The principles of Islamic banking and finance enshrined from al-Quran and Sunnah are quite simple and can be summed up as follows,
1. Any predetermined payment over and above the actual amount is prohibited. Lender should not charge any interest over the money lent. The principle derived from the quotation emphasises that associated or indirect benefits are prohibited.
2. The lender must share in the profits or losses arising out of the enterprise for which the money was lent. Islamic finance is based on the premise that the provider of capital and the user of capital should equally share the risk of business ventures. This is in sharp contrast to the interest based banking system, where all the pressure is on the borrower.
3. Making money from money (via fixed interest payments) is not allowed in Islam. The human effort and risk involved in a business are more important than the money used to finance it.
4. Muslims are encouraged to purchase and are discouraged from keeping money idle as hoarding money is regarded unacceptable in Islam.
5. Gharar (deception) and Maisir (gambling) are also prohibited in Islam. One cannot sell what one does not own, because this is regarded as a form of deception. Also, one cannot sell an item of uncertain quality, an unborn calf for example. The act of gambling means betting on the occurrence of a future event is also prohibited. Under this prohibition, any contract entered into, should be free from uncertainty, risk and speculation.
6. Investments should only support practices or products that are not forbidden or even discouraged in Islam.
7. Ensure that element of exploitation and excessive speculations are avoided.
ISLAMIC ECONOMICS
On the basis of the above mentioned principles, we get a clear picture of an economic system that is referred as Islamic Finance, Islamic Economics or Islamic Banking.
Objectives of Islamic Economics
Broad based economic well being with full employment and maximum rate of economic growth.
Stability in the value of money
A just return is ensured on investment and development projects.
Effective rendering of services.
Socio-economic justice and equitable distribution of income and wealth.
Harmony and cooperation between the members of community, because Islam is absolutely against creating classes in a society.
ISLAMIC DEPOSIT ACCOUNTS
All the Islamic banks have three kinds of deposit accounts, current account, savings and investment account.
a) Current accounts
Current or demand deposit accounts are virtually the same as in all conventional banks. Deposit is guaranteed.
b) Savings accounts
Savings deposit accounts operate in different ways. In some banks, the depositors allow the banks to use their money but they obtain a guarantee of getting the full amount back from the bank, but no profit is promised. In others, savings accounts are treated as investment accounts, capital is not guaranteed but the banks take care to invest money from such accounts in relatively risk-free short-term projects. As such lower profit rates are expected.
Investment account
Investment deposits are accepted for a fixed or unlimited period of time and the investors agree in advance to share the profit or loss in a given proportion with the banks. Capital is not guaranteed.
MODES OF FINANCING
Banks adopt several modes of financing the projects. But they can be broadly categorised into three areas, like investment, trade and lending as discussed below,
1) Investment Financing. This is done in the following ways,
a) Musharaka (joint venture) where a bank joins another individual or business to set up a joint venture, parties participating in the project share profit and loss in a pre arranged fashion. The venture is a legal entity and the bank may with draw gradually after an initial period.
b) Mudarabah (edEntrepreneurship) (Interest free system of Partnership) is a system that relays on profit sharing. Mudarabah is the kind of system where the lender and the borrower both are equally exposed to risk because of the fact that the lender shares profits or losses with the borrower equally. The profit in this case is the substitute for the interest.
2) Trade Financing
This is done in following methods,
a) Murabahah a cost plus contract in which a client, requests the Islamic bank to purchase equipment or goods and sell them to him at a cost plus declared profit. By this technique a party in need of finance to purchase certain goods gets the necessary finance on a deferred payment. The finance provider does the purchasing of the required goods and sells them on the basis of a fixed markup. The need for finance of the one in need is thus met.
b) Ijarah (Leasing), it means selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipments such as plant, machinery, Property, Computers and information technology equipment, Motor vehicles and heavy machinery, and other fixed assets for a fixed period and price. Ijarah gives the Lessee the right to access the equipment on payment of the first installment.
c) Ijara wal Iqtina, where the bank will buy an item for the client and hire it to him for an agreed rent & period, and at the end of that period the client automatically becomes the owner of the item.
d) Letters of credit where the bank guarantees the import of an item using its own funds for any client, on the basis of sharing the profit from the sale of that item or on a markup basis.
e) Istisna, it is often used for longer-term financings (e.g. infrastructure, electricity projects & transport etc). The buyer, or investor, approach the bank, providing all relevant information, including details of the security offered, if the bank agrees, buyer and seller have to deposit security bonds.
f) Bai' Al-Inah (Sale and Buy-Back Agreement)
The financier sells an asset to the customer on a deferred-payment basis, and then the assets are immediately repurchased by the financier for cash at a discount. This agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency. Some scholars believe that this is not compliant with Shariah principles.
g) Salam is a financing technique where a buyer pays in advance for a commodity with specified quantity and quality which will be delivered on a specific date, at a price agreed by both. It is mostly applicable to seasonal agricultural purchases, but it can also be used to buy goods in cases where the seller needs working capital before he can deliver.
3) Lending
Main forms of Lending are following,
a) Qard Hassan, a loan on a goodwill basis where the debtor is required to repay the borrowed amount only. However, the debtor may willingly pay an extra amount beyond the principal amount of the loan (without any promise) as a gift to the creditor.
b) Overdrafts also are to be provided, free of charge.
[edit] Besides this range of financing and lending operations, Islamic banks also offer a full spectrum of retail services that do not involve interest payments. This include checking accounts, spot foreign exchange transactions, funds transfers, travellers' cheques, safe deposit boxes and advice, and other services of modern banking.
Conclusion
Riba is central to the current economy and for Muslims this is unacceptable. The main problems of the conventional economy are interest rates and income inequality. Replacement of interest based system with interest free system is the need of the time. The prohibition of Riba is a way to establish justice between the lenders and borrowers. This would increase accountability and efficiency. Shariah promotes Charity. Banking system given in Islam is the best in the world and solutions given in Quran and Hadith are right and should be followed.
