What Is Riba?
Ribais an Arabic word that means “to increase" or “to exceed" and is commonly used to refer to excessive charges for borrowing money. Charging interest for loans is deemed riba, or an unjust, exploitative gain, and is forbidden under Islamic law.
Key Takeaways
- In Islamic finance, riba refers to interest charged on loans.
- Religious practice forbids riba, even at low interest rates, and it is considered both illegal and unethical or usurious.
- Islamic banking has provided workarounds to riba, including a profit-sharing system in which borrowers agree to return a portion of profits as payment for the loan.
Understanding Riba
Riba is a concept in Islamic banking that refers to charged interest. It has also been referred to as usury, or the charging of unreasonably high interest rates.
Riba is prohibited under Sharia law to ensureequity in commerce.
(Another form of riba prohibits the simultaneous exchange of goods of unequal quantity or quality.)
Islam aims to encourage charity and helping others through kindness. It discourages acting upon motives of selfishness and self-centeredness, which can create social antipathy, distrust, and resentment.
By making riba illegal, Sharia lawcreates opportunities and contexts in which people are encouraged to act charitably by loaning money without interest.
Riba vs. Murabaha
Murabaha, also referred to ascost-plusfinancing, is an Islamic financing structure in which the seller and buyer agree to the cost and markup of an asset. The markup takes the place of interest.
As such, Murabaha is not an interest-bearing loan (qardh ribawi) but an acceptable form of credit sale under Islamic law.
As with arent-to-ownarrangement, the purchaser does not become the true owner until the loan is fully paid.
Riba, or interest, is banned in Islamic finance, although it is acceptable to sell goods or loan money at a profit markup.
Interpretations of Riba
Riba is forbidden under Sharia law (Islamic religious law)because it is thought to be exploitative. Though Muslims agree that ribais prohibited, there is much debate over what constitutes riba, whether it is against Sharia law or only discouraged, and whether or not it should be punished.
Depending on the interpretation, riba may refer only to excessive interest. To some, the entire concept of interest is riba and thus unlawful.
Some modern Islamic scholars believe that interest should be permitted up to the value of inflation to compensate lenders for the time value of their money without creating excessive profit.Nevertheless, ribais largely taken as law and formedthe basis of the Islamic banking industry.
The Muslim world has struggled with ribafor quite some time, religiously, morally, and legally, and economic pressures eventually allowed for a loosening of religious and legal regulation, at least for a period.
In his book, "Jihad: The Trail of Political Islam," Gilles Kepel, a French scholar of Islam, wrote that "since modern economies function on the basis of interest rates and insurance as preconditions for productive investment, many Islamic jurists racked their brains to find ways of resorting to them without appearing to bend the rules laid down by the Koran," adding that "the problem loomed ever larger as more and more Muslim states entered the world economy in the 1960s."
This loosening of economic policy lasted until the 1970s when a "total ban on lending with interest was reactivated."
How Islamic Lenders Make Money
Banks that are Shariah compliant evolved as profit-sharing institutions. A borrower might give back a share of the profits in return for a loan.
This avoidance of riba does not seem to have overly hampered their operations. There are some 560 banks worldwide that adhere to Islamic principles.
In the years leading up to the 1970s, the ban on lending with interest was relaxed slightly, according to Gilles Kepel, one of Europe's leading experts on Islamism.
What Does Riba Mean?
There are many different interpretations of what riba means. It is an Arabic word that in English roughly translates to “exceeding” or “increasing.” Scholars differ on whether charging interest is outright banned by religious law or must always be limited to a reasonable amount.
Why Is Riba Forbidden?
In the Koran, receiving or paying interest is considered a sin because it promotes inequality. Interest is said to increase the gap between the rich and poor and anyone who receives it is expected to donate the money to a charitable cause.
What Are the Types of Riba?
Muslim scholars reference two forms of Riba:
- Ribain a loan contract (Riba al-Nasiyah)
- Ribain a sale or exchange contract (Riba al-Fadl)
In both types, the transaction must be a fair exchange, with neither party exploiting the other.
The Bottom Line
Riba is a core component of Islamic finance, a guide to managing money that is consistent with the moral principles of Islam.
The Koran makes it fairly clear that interest is an exploitative practice. This doctrine is largely respected by about a quarter of the global population as well as other non-Muslim people.
