Editor, PlanetArabia Magazine
Interest, an essential tool for central banks, is forbidden in Islam and branded as usury (riba), but embraced Islamic governments as a necessity.
Countries such as Saudi Arabia, Iran and Malaysia who pride themselves as regimes based on Islamic Shari’ah (Islamic law), continue to borrow money in local and international markets and pay interest. They also have their reserves deposited in local and international banks which pay interest.
Although the Quran does not contain any verses which prohibit interest, Islamic scholars rely on a few of Prophet Mohammad’s (pbuh) examples (Hadeeth). The Prophet (pbuh) is quoted as saying “gold for gold, silver for silver”. Shari’ah scholars have since the early days of Islam interpreted this as a prohibition of interest. Loans taken are returned in the same amounts, with nothing added.
Today, with Islamic countries having to cope with integration in the global economy, a new interpretation of the Hadeeth slowly gaining momentum. A line is starting to be drawn between interest and usury, especially at the present time, with low oil prices and states having to borrow to cover their budget deficits.
Interest, as an economic concept, is a necessity for central banks around the world to control investment and market activity. It has taken center stage since the economic crisis of 2008, with the United States dropping interest rates to zero. Last week, the European Central Bank decreased interest rate to negative, or below zero. This in effect means that when you deposit your money in a European bank, you have to pay the bank a fee instead of receiving interest.
When interest rates are low, investors are encouraged to borrow money to develop real estate, build factories, produce and expand the gross national product, and in the process create jobs. Individuals also are encouraged to borrow at lower rates to buy homes. This helps the economy grow.
On the other hand, if interest rates are high, investors avoid borrowing and production is curbed. Individuals prefer to rent homes instead of borrowing at high cost to finance a mortgage.
Interest is comprised of three components: inflation, or the general rise in prices, opportunity cost, or the next best alternative, and risk, or the possibility that the borrower may not be able to repay the loan.
The three elements can be easily calculated based market data. The inflation rate is continuously published by the central bank, opportunity cost can be easily found based on average profits of businesses, and risk can be assessed on average loan defaults.
When Prophet Mohammed (pbuh) said “Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and salt by salt – like for like, equal for equal, payment being made on the spot. If the species differ, sell as you wish provided that payment is made on the spot” (Sahih Moslem).
He referred to commodities, not money. Money itself is not a commodity, but a medium of exchange. This means that if I borrow a bushel of wheat from my neighbor today, I must return it as a bushel of wheat after a given period of time. However, as everyone knows, the value of the bushel of wheat today may be less or more today than what it would be one year from now.
The purchasing power of money, as a medium of exchange, decreases or increases over time. This means that money, unlike commodities, cannot be expressed in the unit of measure. One bushel of wheat will remain one bushel of wheat fifty or one hundred years from now.
On the other hand, one dollar will have a lower value, or a higher value, over time. Its actual value, or purchasing power, may drop to zero after one hundred years, or even tomorrow. This means that if someone borrows $ 1,000, and returns the same amount one year later, the actual value drops, or increases, and in effect, the same amount is not being returned. As such, the rule contained in the Hadeeth, is broken.
Assuming an inflation rate of 3%, an average business profit of 4% and an average rate of default on loans of 1%, a total of 8% is viewed as a rate that gives the lender back the same amount of money which the borrower received. By the same token, if we have a -3% deflation, or general decline in prices, an average business loss of 4% and a zero default rate, interest would be -7%.
Under the positive interest scenario, if someone borrows $ 1,000, an equal amount returned to the lender one year later should be $ 1,080. Under the negative scenario, it should be $ 930. Any deviation from those limits would then be considered as usury (riba), under a new interpretation of riba as “excessive interest”, not just “interest”.