Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy. Law Baghdad , Dip. Air Law, Postgrad Dip. Law London , M. In this article we shall attempt to outline the definition of interest, so called Riba under the Sharia or Islamic law, followed by a short survey of the laws of some Arab countries which have prohibited or permitted charging interest.
This article is supplementary to a previous article by the authors, entitled: Application of Islamic Law in the Middle East, and would be better understood if read together.
Regulation and prohibition of charging interests are as old as making laws in the human history. Babylon Code of law in B. Christianity and Judaism have also restricted or prohibited charging interest. That the practice has been different is another question. Under Islamic Law, charging interest or Riba is forbidden by verses of the holy Koran, and the "Hadith".
But the uncertainty and the difficulty lie in the lack of a precise definition of Riba and the types of Riba. This difficulty is further deepened because of the many different opinions between the various schools of Islam.
The prohibition of Riba or interest in the Koran came gradual and in stages, starting with discouragement and condemnation of Riba by the Koran to the final prohibition as laid down in the following verse of the Quran:. The benefit which renders the transaction prohibited may be a sum of money, or any goods of a value. Thus, the prohibition has a far wider meaning and application than prohibition of charging interest on loans.
It is a prohibition of usury and any unearned accretion on the capital or the principal, whether it is in the form of interest or any benefit. Riba may be defined as: "monetary advantage without counter value, an advantage which is stipulated in favour of one of the parties in exchange of two monetary values".
The basic concept of Islam is that wealth should not be hoarded or wasted, it should be put to productive use so that the owner, the society and the less privileged may share the benefits. It follows that it is not permissible to leave money idle and charge interest or profit from the mere use of the money by another party without regard to risks, or profits, that may generate.
Usurers only seek profit, or interest without risks. This is contrary to the foundation of Islamic economy which is based on equity and equilibrium. From the aforesaid concept stems the principle of profit and risk sharing between the owner of the capital and the other party, i.
Thus, in contrast to the conventional banking, the capital owner cannot claim both a fixed interest as well as the guarantee of the return of his capital.
Also, Sharia does not consider money as such a commodity, but as a means of payment and as a neutral measure of valuation rather than a commodity by itself. Nevertheless, the owner of the capital may receive compensation on the basis of sharing profits and risks. The prohibition of trading with money plus interest aims at ensuring that money remains a stable value. The aforementioned concepts also signify the basis of economic philosophy and Islamic banking.
This underlines the difference between Western and Islamic Banking Systems, as we shall see later. In Islamic economy and banking, both profit taking and risks sharing goes together. Based on the above, Sharia prohibited usury, as well as transactions having unusual uncertainty and unknown perils called "Gharar", such as gambling, because such transactions run contrary to the principle of balanced relationship or equivalence.
Though, Sharia recognises the sanctity of the contract, the prohibition of usury and contracts of "Gharar" together with some other principles of Sharia such as unjustified enrichment have created restrictions on the freedom of contracting, which Islamic banking must observe in any banking transaction.
Usury in debts or in loans, also called "Riba al-nasia", is the most relevant type of usury practised today. It is a loan or exchange of goods with a condition that the borrower repays the goods or the loan later in addition to an increase in value.
Thus, there are two main elements at least:. Prior to Islam, usury in debt was a common practice whereby the creditor provided the borrower money or goods and received from the debtor interest or increase periodically, and the principal or the loan was to be returned in full at a future date, a practice called "Ribal al Jahiliya.
In short, usury in debt, i. This includes interest charging on loans in today banking transactions. Every loan containing a provision for an increase above the capital is forbidden under Sharia.
It is worthwhile to note that though it is forbidden to agree on an increase in price or value because of delay in repayment, Sharia allows an agreement to sell goods on deferred payment for a price which is higher than the price of the same sale in cash. In this case, and contrary to the ordinary loan agreement, both parties are exposed to certain risks: the seller agrees on a fixed price to be received at a future date, thus accepting the risk if the market price increases at the date of payment.
At thesame time, the buyer accepts the immediate transfer of the property of the goods sold, thus assuming all the risks attached to such a transfer of property. Also, in a contract of sale, deferred delivery of goods or forward purchase, the so called "Sale of Salam", is permitted for a lower price if the goods are specified, as an exception to the prohibition of the rules of Gharar.
As to the effect of interest provision on the contract, there exist different views. For instance, Hanafi School considers the provision concerning interest null and void, but the remaining contract as valid.
Hanbali School considers a loan agreement with interest ipso facto as null and void. Below is a short survey of the provisions of some of the civil and commercial Arab Codes dealing with interest followed by certain court decisions. The question as to whether charging interest is permissible or illegal has been dealt with by the Arab Civil Codes and Commercial Codes in different manners.
It has also been subject to many court decisions in most of the Arab countries. But the outcome has been nearly always in favour of allowing the Western system of interest taking to continue. This is in spite of the constitutional provisions in many Arab countries which declare Islamic law or Sharia as the main source as in Egyptian constitution or a source of legislation as in Kuwaiti and UAE Constitutions , which we have dealt with in a previous article on the Application of Islamic Law in Middle East.
In general the Civil and Commercial Codes of the Arab countries may be divided in two categories as to the manner of dealing with the question of interest:. Firstly: Egyptian Civil Code and those Arab Codes which followed closely the Egyptian Civil Code, whereby charging interest is declared as legal by the relevant Civil Code whether in civil or in commercial matters.
The authors of the Arab Civil Codes, which provided for interest appear to justify that on the ground that: in cases of delay of payment, interest amounts to compensation, because the creditor suffers loss due to lending his capital or as a result of the delay of payment by the debtor, especially when the debtor fails intentionally to pay in time. Some writers have argued that interest in certain cases amount to indemnification or compensation for losses suffered by the creditor.
To reach to such conclusion, they have relied on the Islamic principle of "There shall be no unfair loss nor the causing of such loss", among other arguments. Secondly: Kuwaiti and UAE Civil and Commercial Codes distinguishes between civil matters, whereby charging interest is not allowed in the Civil Codes, and commercial matters, whereby interest is permitted under the Commercial Codes.
Notwithstanding the said provisions, Article of the Commercial Code stipulates that "1. The creditor shall be entitled to an interest in a commercial loan unless otherwise is agreed upon. If a rate agreed upon is stipulated in the contract, and the debtor delays settlement, the interest for the delay shall be calculated on the basis of the agreed rate".
Here, it is noted that Article provides an assumption in favour of the creditor to receive interest, even when the agreement is silent. According to Article 3 of the Kuwaiti Commercial Code, the Code applies to all commercial matters, including loan agreement, and prevails over the provisions of the Civil Code.
Thus, we see here a straight forward prohibition of interest under the Civil Code in compliance with the Sharia, while the Commercial Code — as a special law — allows interest charging contrary to the principles of Sharia. It is worthwhile to recall that Article 1 of the Kuwaiti Civil Code provides that Sharia applies as a source of law in case of the absence of an express legislative provision, but only in the absence of a rule of custom. Also Article 2 of the Kuwaiti Constitution declares that Sharia is a principal source of legislation, among other sources.
Contrary to the above mentioned provisions, Article 76 of the UAE Commercial Code of states that a creditor may stipulate interest in a commercial loan agreement. Here again, there is a presumption in favour of the creditor to claim interest, even if he fails to stipulate that in the agreement. In Jordan the Civil Code did not deal with interest, but interest is charged in accordance with the provisions of an old Ottoman law as well as the Code of Civil Procedures.
Having reviewed briefly the provisions of the laws in some Arab countries dealing with interest, it is worthwhile to see how the court in some Arab countries have dealt with the matter. And the principles of the Sharia are THE main sources of legislation".
The Rector of the Al Azhar University filed a case against the President and others claiming that the provisions of Article of the Egyptian Civil Code which allow interest for delay in payment is unconstitutional and contrary to the Article 2 of the Constitution referred to before. The Court held that: Charging interest is prohibited by Sharia, but Article 2 of the Constitution has no retrospective effect, and therefore Article remained in force and was not effected by the amendment.
Article 2 of the Constitution has not made Sharia directly the common law of the land and that it does not directly apply. But, it has imposed an obligation on the legislator to observe and apply Sharia principle in any future legislation.
Thus, Article 2 of the Constitution is a limitation on the legislator to apply Sharia in respect of any future enactment, and the laws enacted prior to the date of the amended Article 2 of the Constitution, such as the Civil Code, are not effected.
Therefore, Article of the Civil Code remains enforceable, though contrary to Sharia. This decision of the Constitutional Court is widely criticized as poor and not convincing. It is argued that the provisions of Article 2 of the Constitution and the prohibition of interest have become part of the public order and morals and should be applied at least from the date of the enactment in And the Constitutional Court has the duty and function to control and ensure that the application of the laws are not in contradiction with the Constitution.
It has further been argued that the court might have done better if it had based its decision on the principles of necessities and common interest of the society to justify charging interest under the present economic regime.
It has also been submitted that imposition of interest under Article of the Egyptian Civil Code and similar provisions is a compensation for loss suffered by the creditor due to the failure of the debtor to pay.
The creditor does not stipulate interest under Article , but the obligation to pay interest arises after the failure of the debtor to pay. This is in conformity with the Sharia principles of "Theman" that a person causing damage must compensate.
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Rent this content from DeepDyve. Rent from DeepDyve. This approach also provides for social cohesion between different classes, the motivations of which are often conflicting and opposed in the conventional system.
On the subject of stability, the argument is put forward that an interest-based economy has a built-in tendency toward inflation, because the creation of money is not related to productive investments, either at the level of the central banks or at the level of commercial banks. The primary objective of establishing Islamic banks all over the world is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the objectives of Islamic banking when viewed in the context of its role in the economy are listed as following:.
To offer contemporary financial services in conformity with Islamic Shariah ;. To contribute towards economic development and prosperity within the principles of Islamic justice;. Optimum allocation of scarce financial resources; and. To help ensure equitable distribution of income. Offer Financial Services : Interest-based banking, which is considered a practice of Riba in financial transactions, is unanimously identified as anti-Islamic.
That means all transactions made under conventional banking are unlawful according to Islamic Shariah. Thus, the emergence of Islamic banking is clearly intended to provide for Shariah approved financial transactions. Islamic Banking for Development : Islamic banking is claimed to be more development- oriented than its conventional counterpart. The concept of profit sharing is a built-in development promoter since it establishes a direct relationship between the bank's return on investment and the successful operation of the business by the entrepreneurs.
Optimum Allocation of Resources : Another important objective of Islamic banking is the optimum allocation of scarce resources. The foundation of the Islamic banking system is that it promotes the investment of financial resources into those projects that are considered to be the most profitable and beneficial to the economy. Islamic Banking for Equitable Distribution of Resources : Perhaps the must important objective of Islamic banking is to ensure equitable distribution of income and resources among the participating parties: the bank, the depositors and the entrepreneurs.
An Islamic bank has several distinctive features as compared to its conventional counterpart. Chapra , PP. Abolition of interest Riba : Since Riba is prohibited in the Quran and interest in all its forms is akin to Riba , as confirmed by Fuqaha and Muslim economists with rare exceptions, the first distinguishing feature of an Islamic bank must be that it is interest-free. Adherence to public interest : Activity of commercial banks being primarily based on the use of public funds, public interest rather than individual or group interest will be served by Islamic commercial banks.
The Islamic banks should use all deposits, which come from the public for serving public interest and realizing the relevant socio-economic goals of Islam. They should play a goal-oriented rather than merely a profit-maximizing role and should adjust themselves to the different needs of the Islamic economy. Multi-purpose bank : Another substantial distinguishing feature is that Islamic banks will be universal or multi-purpose banks and not purely commercial banks.
These banks are conceived to be a crossbreed of commercial and investment banks, investment trusts and investment -management institutions, and would offer a variety of services to their customers. A substantial part of their financing would be for specific projects or ventures.
Their equity-oriented investments would not permit them to borrow short-term funds and lend to long-term investments. This should make them less crisis-prone compared to their capitalist counterparts, since they would have to make a greater effort to match the maturity of their liabilities with the maturity of their assets.
More careful evaluation of investment demand : Another very important feature of an Islamic bank is its very careful attitude towards evaluation of applications for equity oriented financing.
It is customary that conventional banks evaluate applications, consider collateral and avoid risk as much as possible. Their main concern does not go beyond ensuring the security of their principal and interest receipts.
Since the Islamic bank has a built in mechanism of risk sharing, it would need to be more careful in how it evaluates financing requests. It adds a healthy dimension in the whole lending business and eliminates a whole range of undesirable lending practices. Work as catalyst of development : Profit-loss sharing being a distinctive characteristic of an Islamic bank fosters closer relations between banks and entrepreneurs.
It helps develop financial expertise in non-financial firms and also enables the bank to assume the role of technical consultant and financial adviser, which acts as catalyst in the process of industrialization and development. Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on the one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.
Islam, on the other hand, considers a loan to be given or taken, free of charge, to meet any contingency. Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often it happens that it leads to some kind of injustice. The first Islamic principle underlying such kinds of transactions is that "deal not unjustly, and ye shall not be dealt with unjustly" [].
Hence, commercial banking in an Islamic framework is not based on the debtor-creditor relationship. The second principle regarding financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk Ausaf Ahmed , P.
Thus, financial intermediation in an Islamic framework has been developed on the basis of the above two principles. Consequently financial relationships in Islam have been participatory in nature.
Several theorists suggest that commercial banking in an interest-free system should be organized on the principle of profit and loss sharing. The institution of interest is thus replaced by a principle of participation in profit and loss. The distinct characteristics which provide Islamic banking with its main points of departure from the traditional interest-based commercial banking system are: a the Islamic banking system is essentially a profit and loss sharing system and not merely an interest Riba banking system; and b investment loans and advances in the Conventional sense under this system of banking must serve simultaneously both the benefit to the investor and the benefit of the local community as well.
The financial relationship as pointed out above is referred to in Islamic jurisprudence as Mudaraba. For the interest of the readers, the distinguishing features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown below:. Ahmed, Ausaf Ali, M and Sarkar, A. Thoughts on Economics, Vol.
July-December Dhaka: Islamic Economics Research Bureau. Chapra, M. Towards a Just Monetary System. Leicester: The Islamic Foundation. Hamid, M. Rahman Khan, W. Mangla, I. Research in Financial Service , Vol. Maududi, Syed Abul Ala Sud and Adhunic Banking. Adhunik Prokashani, Dhaka. Mirakhor, A. Concept and Ideology. Shawki Ismail Shehta viewing the concept from the perspective of an Islamic economy and the prospective role to be played by an Islamic bank therein opines: "It is, therefore, natural and, indeed, imperative for an Islamic bank to incorporate in its functions and practices commercial investment and social activities, as an institution designed to promote the civilized mission of an Islamic economy" Ibid.
Ziauddin Ahmed says, "Islamic banking is essentially a normative concept and could be defined as conduct of banking in consonance with the ethos of the value system of Islam" Ibid. It appears from the above definitions that Islamic banking is a system of financial intermediation that avoids receipt and payment of interest in its transactions and conducts its operations in a way that it helps achieve the objectives of an Islamic economy.
Alternatively, this is a banking system whose operation is based on Islamic principles of transactions of which profit and loss sharing PLS is a major feature, ensuring justice and equity in the economy. That is why Islamic banks are often known as PLS-banks. The word used by the Quran concerning 'interest' is Riba. The literal meanings of Riba are money increase, increase of anything or increment of anything from its original amount Maududi , p.
However, all increases are not considered as Riba in Islam. Money may increase in business activities as well. This increase is not at all considered as Riba. The increase, instead of being prohibited Haram , is approved Halal in Islam.
Islam prohibits only those increases that are charged on the loan with a prefixed rate. Muslim scholars equate interest with Riba. 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 Chapra , p.
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