Chapter – 02: Fundamental Prohibitions in Islamic Finance

Basic Prohibited Elements:

• Interest (Al-Riba) :
• Gambling(Al-Maisir) :
• Uncertainty (Al-Gharar)
1)Interest (Al-Riba) :
• The word used by the Quran concerning ‘interest’ is Riba. The literal meaning of Riba
are money increase, increase of anything or increment of anything from its original
amount.
• 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 other words, Riba is the predetermined return on
the use of money.
Al-Riba /Interest Basic Characteristics are:
• It must be related to loan;
• A prefixed amount of money to be paid when due;
• A time is fixed for the repayment; and
All these elements for repayment are taken as conditions for loan;
There are two types of Riba.
1. Riba al Nasiah 2. Riba al Fadl
1. Riba al Nasiah: The term nasi'ah means to postpone, defer, or wait and refers to the
time that is allowed for the borrower to repay the loan in return for the addition or the
premium. Hence Riba al-Nasi'ah refers to the interest on the loan. Here the increase or
growth is due to postponement. It can be specified in the beginning of transaction or on
maturity of debt. If the debtor is not able to pay back the debt on maturity and the creditor
gives him some more time in return for an additional amount it is termed Riba al Nasiah.
Characteristics of Riba al Nasiah
There are three types of Riba al Nasiah :
i. Deferred payment: Article is sold on deferred payment basis. Time of payment is fixed.
Inability to pay on the stipulated time attracts extra amount and the payment date is
extended.
ii. Pre determined: A sum is lent and it is determined at the beginning that the borrower
would return an extra amount in addition to the amount loaned within a stipulated time.
iii. Fixed as well as variable rate of interest: A sum is lent at a fixed rate of interest for a
stipulated time period. If the borrower fails to pay within the time, the rate of interest
would increase.
2. Riba al Fadl : The increase is independent of postponement or maturity of debt. It
happens when two same things are exchanged unequally. For example a kilo of wheat
being exchanged for 1.5 kilos of wheat. This transaction was termed as Riba by the Holy
Prophet (PBUH). Therefore, it was called as 'Riba al-fadl’ or Riba-al-sunnah’.
Characteristics of Riba al Fadl
• The increase is independent of postponement or maturity of debt;
• Two same things are exchanged unequally;
• It was called as 'Riba al-fadl’ or Riba-al-sunnah’;
Prohibition of Riba in Qur’an:
The prohibition of Riba appears in the Quran in four different revelations.
The first of these in Makkah, emphasized that while interest deprived wealth of Allah’s
blessings, charity raised it manifold (30:39).
The second revelation in Madina threatening of severe punishment to those who took Riba
in juxtaposition with those who wrongfully appropriated other people’s property (4:160-
161).
The third revelation, around the second and third year after Hijra, enjoined Muslims to
keep away from Riba if they desired their own welfare (3:130).
The fourth revelation near the completion of the Prophet’s mission, severely censured
those who take Riba, established a clear distinction between trade and Riba, and required
Muslims to all outstanding Riba, instructing them to take only the principal amount, and
forgo even this in case of the borrowers’ hardship (2:275-280).
Prohibition of Riba in Hadith
Jabir b. Abdullah reports that the Prophet (PBUH) cursed the receiver of interest and the
payer thereof, the one who records it and the two witnesses thereof. He said:"They are all
alike in guilt."
It is reported from Abu Sa‘eed al-Khudari, he said: the Messenger of Allah said: “Exchange
gold with gold, silver with silver, wheat with wheat, barley with barley, dates with dates,
salt with salt in equal quantities and spot. Anyone who increases the quantity or asks for
increase indulges in riba. The receiver and payer are equal in this.”
Impact of interest:
A. Economic Impact
B. Social and moral impact
C. Political Impact
D. International Impact
A. Economic Impact
1. Impact on capital formation and investment
2. Impact on production
3. Impact on Distribution
4. Impact on Economic Stability
1. Impact on capital formation and investment
i. Interest not only retards capital formation but also reduces the rate of capital
growth. It is the rate of interest, which sets limits to the rate of growth of real capital.
ii. Interest encourages keeping capital idle. On the other, the capitalists will be bound to
invest their funds for earning profit in absence of interest.
iii. Interest reduces the rate of investment especially in risky capital intensive projects.
iv. Interest leads investment to unproductive speculative sector.
v. Interest retards the efficient sanction of bank funds. Banks and financial institutions
emphasize on credit worthiness of the loanees while granting loan. They do not
consider the productivity of the loanees projects and this is because of fixed and
predetermined interest income they desire to drive.
vi. Interest reduces the rate of investment in social welfare projects.
vii. Interest encourages creating idleness amongst the depositors; since it is obtained
without any risk and labor on the part of the depositors.
viii. Interest tends to lead the capitalists towards exploitative behavior and attitude.
2. Impact on production
i. Interest tends to reduce the rate of production since it retards capital formation.
ii. Interest tends to increase the price of commodities and services.
iii. Interest tends to reduce the purchasing power of the people.
iv. Interest tends to reduce the demand of the commodities because of low purchasing
power of the people.
v. Interest compels to destroy the manufactured commodities because of prevalence of
depression in the economy.
3. Impact on Distribution
i. Interest tends to increase the rate of unemployment in a country.
ii. Interest helps reducing the rate of wages.
iii. Interest helps creating economic disparity in the society.
iv. Interest tends to impose tax burden on the general mass of a country.
4. Impact on Economic Stability
i. Interest helps creating inflation in an economy.
ii. Interest helps creating depressions in the economy.
iii. Interest tends to create instability in the economy.
iv. Interest gives rise to speculative business in the stock market.
v. Interest encourages speculative business in commodity market.
vi. The rate of interest tends to make the monetary policy of a country ineffective .
vii. Interest tends to make the exchange rate unstable.
viii. Interest retards the economic growth of a country.
B. Social and moral impact
i. Interest creates greediness and misery amongst the individuals. It includes
the habit of miseries, selfishness, cruelty, love of money, greediness for
accumulation of wealth etc. amongst the individuals.
ii. Interest creates hatred and jealousy in the society.
iii. Interest helps destroying the morality of the people.
iv. Interest helps making the borrowers heavily indebted.
v. Interest tends to reduce the working capacity of the indebted poor.
C. Political Impact
i. Interest helps creating political unrest in the country.
ii. Interest creates obstruction for the Government in performing social
welfare activities.
iii. Interest compels the Government to take resort to loans at the time of
emergency like wars, floods, cyclones etc, because interest-free loans are
not available at the time of emergency of a country.
D. International Impact
i. Interest creates problems in payment of foreign loans.
ii. Interest helps increasing foreign dependence.
iii. Interest serves the interest of the donor countries and not that of
borrowing countries.
iv. Interest tends to create economic disparity between the donor and
borrowing countries
v. Interest helps worsening peace in the world.
2. Uncertainty (Al-Gharar):
The Arabic word Gharar is a fairly broad concept that literally means deceit, risk, fraud,
uncertainty or hazard that might lead to destruction or loss. Gharar in Islam refers to any
transaction of probable objects whose existence or description are not certain, due to lack
of information and knowledge of the ultimate outcome of the contract or the nature and
quality of the subject matter of it.
Types of Uncertainty /Al-Gharar
There are two types of Gharar:
1.Minor Gharar: In Islam dealing with minor Gharar is permissible. e.g demand
variability, sales price variability, input cost variability, all are different types of
minor Gharar or uncertainty.
2.Major/Substantial Gharar: In Islam dealing with major Gharar is prohibited.
e.g trading of an object which is not in possession can not be traded.
Difference among Interest,Profit and Rent
3. Gambling (Al-Maisir)
Gambling is a way of obtaining undeserved money which makes man forget his Creator,
prevents him from performing prayers, leads him to laziness, eliminates his strength to
work and causes grudge and enmity among people. All kinds of gambling, which causes
irreparable wounds in individual and social life, are haram in the religion of Islam.
Prohibition of Gambling in Qur’an
• They/People ask thee/you concerning wine and gambling. Say: "In them is great sin,
and some profit, for men; but the sin is greater than the profit." They ask thee how
much they are to spend; Say: "What is beyond your needs." Thus doth Allah Make
clear to you His Signs: In order that ye may consider”-( 2:219).
• you who believe! Intoxicants (all kinds of alcoholic drinks), and gambling, and Al-
Ansab , and Al-Azlam (arrows for seeking luck or decision) are an abomination of
Shaitan’s (Satan) handiwork. So avoid (strictly all) that (abomination) in order that
you may be successful. Shaitan (Satan) wants only to excite enmity and hatred
between you with intoxicants (alcoholic drinks) and gambling, and hinder you from
the remembrance of Allah and from As-Salat (the prayer). So, will you not then
abstain?- (5:90-91)
Criticism of Conventional Financial System from Islamic View point
• It is based on interest
• It aims at maximization of profit disregarding individual or social welfare
• It leads to social injustice and inequitable distribution of income
• It is unethical, exploitative, unfair and non-transparent
• It leads to wastage of resources and wealth
• It leads to violate and conflict
• It leads to socio-political instability, corruption and mismanagement
• It promotes selfishness
• It ignores religious values