The Concept of Riba and 3 Main Consequences of Riba From Islamic Perspective

Islam forbids the adoption of interest (riba) due to the negative consequences that come with it. There is a strong bond between interest and conventional finance. Interest is the most important component of traditional finance. However, Islamic banking and finance must follow Shariah principles guided by Islamic law, which prohibit the use of interest (riba) in any financial transactions.

 

The Concept of Riba

Riba is an Arabic word, meaning usury or interest in English. In Islamic banking, riba refers to charged interest. It has also been referred to as usury, or the charging of unreasonably high-interest rates. Muslims are not allowed to earn income from lending money or borrowing money from someone. This means that earning interest (riba) is not allowed – whether you are an individual or a bank.

There is also another form of riba, according to most Islamic jurists, which refers to the simultaneous exchange of goods of unequal quantities or qualities. It is an arrangement that exploits the poor by continuously tapping them into the growing debt while the rich increase their wealth without creating any value. It expands the gap between the rich and the poor.

There are several verses in the Holy Quran and a number of Hadiths that strongly convey the strict prohibition of it. In the Quran, Allah says: “Those who eat Riba (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaytan (Satan) leading him to insanity” (Baqarah: 275).

Must Read: Know The Difference between Riba and Ribh (Profit)

Different Types of Riba

Islamic scholars classify riba into two main types: Riba al-Nasi’ah and Riba al-Fadl.

Riba al-Nasi’ah

This is the most common form of riba, which involves charging interest on loans. It is the delay in payment or deferment of a debt, where the lender benefits from the time given to the borrower. This type of riba is explicitly forbidden in the Quran and Hadiths. It is often seen in conventional banking systems where interest is charged on loans and mortgages.

Riba al-Fadl

This type of riba occurs in barter transactions where goods of unequal quality or quantity are exchanged. It involves the exchange of similar items but with a disparity in quality or quantity, leading to exploitation. For example, exchanging a higher quantity of lower-quality dates for a smaller quantity of higher-quality dates is considered riba al-Fadl. This prohibition aims to prevent unfair trade practices and ensure fairness in transactions.

Also Read: What Are the 4 Different Types of Riba (Interest)?

Historical Context of Riba

The prohibition of riba dates back to the early days of Islam. In pre-Islamic Arabia, riba was a common practice where moneylenders exploited the poor by charging exorbitant interest rates. This led to severe economic disparity and social injustice. The Quran and Hadiths addressed this issue by prohibiting riba to promote justice, fairness, and social welfare. The prohibition was a significant reform that aimed to protect the vulnerable and ensure equitable distribution of wealth.

In Islamic history, scholars like Imam Abu Hanifa, Imam Malik, Imam Shafi’i, and Imam Ahmad ibn Hanbal have all unanimously agreed on the prohibition of riba. This consensus highlights the importance of maintaining justice and equity in financial transactions.

Modern Implications of Riba

In today’s global financial system, riba is prevalent in many forms, from personal loans to mortgages and credit cards. Islamic finance seeks to provide alternatives that comply with Shariah principles, offering interest-free loans and profit-sharing investment opportunities. By avoiding riba, Islamic finance aims to create a more ethical and sustainable economic system that benefits all participants.

Islamic banks operate on principles such as profit and loss sharing (Mudarabah), joint venture (Musharakah), leasing (Ijara), and cost-plus financing (Murabaha). These models ensure that both the bank and the customer share risks and rewards, promoting a balanced and fair financial relationship.

Consequences of Riba

There are a few reasons for the prohibition of riba. Here we briefly explain the three consequences of riba for you:

1. Riba is Foundation of Injuctice

When a person borrows money, it indicates that the person is in the need of the fund. By charging interest, the lender places an additional burden on the borrower, which is unfair. Interest is a mechanism used by wealthy individuals to generate more money at the expense of the poor, and it promotes inequitable wealth redistribution.

2. Riba Damages Society

Islam emphasizes the significance of public interest, while riba is only beneficial to the lender. Riba exploits the poor and needy people. The wealthy creditors deferred their current earnings in order to profit from the interest on the loans given to needy debtors in the future. As a result, it raises the creditor’s future wealth while decreasing the debtor’s future profits. It is a complete act of exploitation that will increase poverty among the poor.

3. Riba Creates Negative Economic Growth

Riba does not indicate that the money is being used productively. The need to pay the additional charge, interest, causes the borrower to cut back on consumption, lowering demand for goods and services. As a result, there will be a negative outcome. Furthermore, riba destabilizes the economy to some extent. An increase or decrease in an interest rate corresponds to the ups and downs of the economy.

These are the three consequences of riba. Shariah prohibits riba to encourage Muslims to make financial decisions correctly and lawfully. Also, it aims to safeguard Muslims’ wealth from being taken unfairly and to eliminate hatred, evils, and promote justice.

How to Avoid Riba?

– Live within your means and do not take or give loans that have interest

– Make sure you open a Riba-free bank account

– Avoid signing contracts that have interest in certain clauses

– When you are in need of money, instead of taking loans from banks with interest, turn to your family and friends.

– Manage a “goodly loan” (al-qard al hasanah); a loan through which one can incur a kindness towards another human being (being interest-free)

We as Muslims should constantly strive against interest every day and make a conscious effort to avoid it. Those who abstain from such dealings are positioned to be graced with God’s mercy and blessings.

Alternatives to Riba in Islamic Finance

Profit and Loss Sharing (Mudarabah): In a Mudarabah arrangement, the lender provides capital, and the borrower manages the investment. Profits are shared according to a pre-agreed ratio, while losses are borne by the capital provider unless they result from the borrower’s negligence or misconduct.

Joint Ventures (Musharakah): In Musharakah, both parties contribute capital and share profits and losses based on their equity participation. This partnership model aligns the interests of both parties and promotes mutual cooperation.

Leasing (Ijara): Ijara is a leasing arrangement where the bank buys an asset and leases it to the customer. The customer makes lease payments, and at the end of the lease term, they may have the option to purchase the asset.

Cost-Plus Financing (Murabaha): In Murabaha, the bank purchases an asset and sells it to the customer at a profit margin. The profit margin is agreed upon upfront, ensuring transparency and avoiding interest.

Bottom Line

Riba, or interest, is deeply ingrained in conventional finance but poses significant ethical, social, and economic challenges. Islamic finance offers a viable alternative by promoting risk-sharing, fairness, and social justice. By understanding the role of riba in conventional finance and exploring Shariah-compliant alternatives, individuals and institutions can make more informed and ethical financial decisions.

FAQs

What is riba in Islam? Riba refers to any form of guaranteed interest on loaned money, prohibited in Islam due to its exploitative nature.

Why is riba prohibited in Islam? Riba is prohibited because it is seen as unjust, exploitative, and harmful to society, creating economic disparity and social injustice. It undermines the principles of fairness and equity that are central to Islamic teachings.

What are the types of riba? The two main types are Riba al-Nasi’ah (interest on loans) and Riba al-Fadl (unequal exchange of goods).

How can I avoid riba in modern banking? Opt for Islamic banking products, avoid interest-bearing loans and contracts, and seek interest-free loans from family and friends. Educate yourself on Shariah-compliant financial options and seek advice from knowledgeable sources.

What are the consequences of engaging in riba? Engaging in riba leads to social and economic injustice, exploitation of the poor, and negative economic growth. It can also result in divine punishment, as warned in Islamic teachings.

Can non-Muslims benefit from Islamic banking principles? Yes, non-Muslims can also benefit from the ethical and interest-free principles of Islamic banking, which promote fairness and social welfare. Islamic banking offers transparent and equitable financial solutions that can appeal to anyone seeking ethical financial practices.