Interest paid by Banks is Not Riba
Abdul Hakeem Murad
Several verses in the Quran and some hadith speak against charging Riba on loans. What does the Arabic word Riba mean?
Let us first consider the definitions of the English words Usury and Interest. The following definitions are from the Random House Webster’s Dictionary (1990)
Interest: the sum paid or charged for the use of money or for borrowing money.
Usury: the practice of lending money at an exorbitant interest rate
Which English word does Riba correspond to: interest, usury or both?
The Quran speaks of what Riba is in the following verse:
003.130: O you who believe! Devour not Riba, doubled and multiplied; but fear God; that you may prosper.
It is clear that the above Quranic injunction prohibits lending money at excessive rates of interest that would double or triple the lender’s sum in a short period of time. It is evident that the reference is towards usury.
It should be recalled that in pre-industrial times, lending was practiced commonly in the form of usury. When an individual experienced financial difficulty and needed to borrow money, he had recourse only to usurious moneylenders who would exploit his predicament. The borrower usually accepted terms for the loan that he knew could lead to his financial ruin.
This form of lending obviously caused a great deal of harm by ruining many people’s lives, was immoral, and we can understand why a just and compassionate system like Islam would ban it. This is indicated by the following verse in the Quran
004.161: That they took Riba, though they were forbidden; and that they devoured men’s substance wrongfully; we have prepared for those among them who reject faith a grievous punishment.
It is common knowledge that modern banks pay interest on deposits as well charge interest to borrowers but do not practice usury. The great advance of social and economic well being experienced around the world over the past two hundred years has been fueled by pooling of capital by banks. Individuals willingly lend their savings to a bank if some interest is paid to them for the use of their money. The resulting pooling of resources can generate large sums that can be used by others to carry out large projects. During the industrial revolution people realized that establishment of large industries required large investments, which were, in general, beyond the reach of one or a few individuals. If, instead, many investors could be motivated to contribute then large investments could be possible. Banks provided the institutional framework for this process. The bank of-course charges a higher rate of interest than it pays in order to generate income for its stockholders and for its own expenses. Through this process of capital pooling, the bank is able to lend to individuals who need large sums of money, such as when buying a house or a business. The bank’s rate of interest is kept low by competition with other lenders and also by government regulation. It is very clear that banking practice is not usury and cannot be equated to the Quranic term Riba.
However, Muslim scholars have traditionally concluded that any rate of interest is Riba and is therefore prohibited. They base this on the verse:
002.278,279: O you who believe! Fear God, and give up what remains of your demand for Riba, if you are indeed believers. If you do it not, take notice of war from God and His Apostle: But if you turn back, you shall have your capital sums. Deal not unjustly, and you shall not be dealt with unjustly
This verse seems to require a lender to get back only the “capital sum” he has advanced. Thus it may be interpreted to forbid loans with any rate of interest; whether nominal or exorbitant. However, if we recall that the verse was revealed at a time when usury was the standard model for borrowing we can see that, consistent with the verses quoted above, its injunction is to refrain from usury. The modern banking practice in which one can borrow and lend at small rates of interest was not known at that time.
The practice of borrowing and lending money has gone through revolutionary changes as mankind has achieved economic progress. In the modern economic structure lending of money is most often to generate resources to enable the borrower to carry out his plan of expanding his personal or business conditions, thus both the lender and the borrower expect to gain from the transaction.
Traditionally Muslim scholars have maintained that it is good to give loans to help people but it should be “Qard-e-hasana”, that is, a loan in which the lender gets back exactly what he loaned. This, in idealistic terms, is an excellent suggestion but in reality very few people are willing to follow it. It is human nature that most people are motivated by self-interest and not by exhortations of doing good. The modern banking system helps accomplish public good by rewarding people for lending money.
The traditional interpretation of the term Riba as any kind of interest whether small or large has greatly damaged the Muslim umma worldwide. It has blocked Muslims from developing financial institutions that could finance industrial and social progress. This is one of the factors that kept the Muslim part of the world economically stagnant while Europe and America expanded their economies steadily in the 18th, and 19th centuries.
In all Islamic rulings there is a moral intent; a clear purpose to protect or to benefit people. The moral purpose of banning usury is to stop exploitation of people and to save them from financial ruin.
If we interpret the verses above to imply that loans with even small rates of interest are forbidden by Islam, then we reach the absurd conclusion that a bank is doing something immoral when it loans money to a store owner to expand his business, or to a student to help pay his college tuition. These two examples are among a wide variety of situations for which people borrow money, but they illustrate that modern banks do not aim to exploit people in dire circumstances. Their business is to provide opportunities for growth to individuals. This is commendable and moral, and it does not make any sense to say that it is prohibited in a just system like Islam.