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Interest

By:
Timur Kuran
Source:
The Oxford Encyclopedia of the Islamic World What is This? Provides comprehensive scholarly coverage of the full geographical and historical extent of Islam

Interest

The question of whether interest is a legitimate financial instrument has long been a source of controversy throughout the Islamic world. The origins of the controversy lie in Qurʿānic verses that prohibit ribā, the ancient Arabian practice whereby borrowers saw their debts rise precipitously if they defaulted, and rise further if they defaulted again. Over the centuries, many Muslims have inferred from these verses that any loan contract specifying a fixed return to the lender is immoral, regardless of the loan's purpose, its amount, or the prevailing institutional framework. They have also condemned an array of common business practices as un-Islamic.

However, anti-interest sentiment has seldom trans-lated into effective political action. At the start of the modern era the anti-interest movement was fragmented, disorganized, and lacking in forceful intellectual leadership. Under the circumstances, Muslim governments, firms, and individuals were openly charging and borrowing interest without encountering opposition. The modern era's first powerful movement to abolish interest-laden business practices developed in India in the waning years of British rule. The movement's preeminent spokesman was Sayyid Abū al-Aʿlā Mawdūdī (1903–1979), a prolific writer who depicted interest as a tool of Western dominance and a source of Muslim decadence.

Since the mid-1960s, Mawdūdī's Pakistani and Indian followers have figured prominently among the contributors to a vast, and still growing, anti-interest literature within the field of Islamic economics. This literature offers numerous justifications for banning interest. The most prominent is that interest provides an “unearned gain” to the lender (who earns a return without exerting effort), while imposing an “unfair obligation” on the borrower (who must repay the loan plus a finance charge even in the event of misfortune). Other justifications are that interest transfers wealth from poor to rich, that it weakens communal bonds by promoting selfishness, and that it fosters idleness.

Muslims opposed to the anti-interest campaign argue that the purpose of banning ribā was simply to eliminate a specific source of exploitation and communal tension. Ribā had to be prohibited, they say, because it pushed multitudes into enslavement. The ban was never intended to apply to all forms of interest, which is why prominent early Muslims distinguished between ribā and other, non-exploitative forms of interest. Another common rationale for rejecting a total ban is that in a modern economy interest-based financing seldom creates grave risks. Competitive pressures generally keep rates within bounds. Moreover, bankruptcy laws and social security programs protect borrowers against unanticipated contingencies.

This case against a prohibition was put forth boldly by Fazlur Rahman, a Pakistani professor of Islamic thought, in 1964. Rahman endured intense criticism for his position, which came to be dubbed “modernist.” Over the years, a few other prominent Islamic thinkers and officials have embraced the modernist position. Most significantly, in 1989 Muḥammad Sayyid Ṭanṭāwī, muftī of Egypt, issued a fatwā (legal opinion) to the effect that “harmless” forms of interest, such as those paid by government bonds and personal bank accounts, do not violate the spirit of Islam. There have also appeared scholarly critiques of the anti-interest drive, including some by Muslims.

Within Islamist circles, however, mainstream intellectual opinion continues to hold that interest impedes social justice. All the research institutes and economics departments that have been established to promote “Islamic economics” treat the abolition of interest as the sine qua non of credible Islamic economic reform. Moreover, at least officially, Islamist political parties are committed to eradicating interest.

The rise of the modern anti-interest movement was not accompanied, at first, by any practical successes. Interest-based contracting remained common, with few opportunities—outside of informal local networks—for saving, investing, borrowing, or lending in an interest-free manner. The 1930s saw a few abortive attempts to establish interest-free banks in India. The first successful bank operating on an interest-free manner was opened in 1963 in the Egyptian town of Mit Ghamr. Although modeled after local savings institutions in what was then West Germany, this bank eventually claimed an Islamic identity on the grounds that it paid no interest on deposits and charged no interest on loans, transacting strictly on the basis of profit-and-loss sharing. The first bank to assert an Islamic identity from the start opened in Dubai in 1975. The subsequent decades saw the spread of Islamic banking to more than sixty countries, including numerous predominantly non-Muslim countries. By 2006 the total assets of the Islamic banking network had grown to more than $300 billion.

These banks make a point of avoiding investments in businesses considered unlawful, such as those that profit from alcohol, pork, gambling, or pornography. But they do not operate in an interest-free manner. They pay and charge interest as a matter of course, albeit in the form of a “service charge,” “markup,” or “profit share.” The most commonly used instrument of lending is murābaḥah, through which a bank buys goods for a client, marks up the price as compensation for its intermediation, and then transfers ownership to the client. What makes the transaction legitimate from a traditional Islamic standpoint is that the bank exposes itself to risk during the short period, often mere seconds, in which it owns the goods. Formally Islamic savings accounts earn profit shares rather than interest. As a practical matter, however, their returns are indistinguishable from interest, for they correlate closely with fluctuations in the interest rates on conventional, interest-earning savings accounts.

The greatest political victories of the anti-interest movement have come in Pakistan, where on many occasions one or more official agencies have declared interest illegal. In 1979 the Pakistani government moved to require banks to abandon interest within five years, though the order's practical impact was deliberately muted by placing certain common financial practices outside the Federal Shariat Court's jurisdiction. In 1992 Pakistani courts removed critical exemptions. However, under pressure from the business community, they have repeatedly granted banks transition periods during which Pakistanis could continue dealing in interest with impunity. Moreover, in the face of imminent deadlines, time and again they have revoked earlier decisions to allow time for reflection and consensus building. Another common pattern has been for one government agency to block another's anti-interest campaign. In 2002, for instance, the Supreme Court rescinded a 1999 judgment of the Federal Shariat Court, under which interest-based banking was to be strictly illegal as of mid-2002.

Four years after the Islamic Revolution of 1979 in neighboring Iran, the government ordered the country's banks to purge interest from all their operations. But the ruling was not enforced, and most clerics have treated returns on bank deposits and government bonds, and often also those on personal and commercial loans, as free from ribā. Although controversy over the legitimacy of interest has not died down, groups characterized as “modernist” or “pragmatist” have so far managed to shield financial markets from Islamist-inspired restrictions.

Outside of Iran and Pakistan, interest continues to be paid and charged relatively openly. Where Islamic banks exist, their operations rely almost exclusively on service charges. Alternatives to interest-based financing are emerging under the aegis not of Islamic banks, think-tanks, or regimes, but of stock markets established outside the purview of Islamic economics. In the belief that dividends and capital gains constitute variable earnings rather than fixed interest, pious Muslims who are reluctant to deposit money in banks have no qualms about holding stocks. Most of the trading in the Islamic world's rapidly growing stock markets lacks religious significance. However, many of these markets now feature Islamic equity funds, which invest only in firms considered legitimate according to Islamic standards. By 2007 the market value of these funds had reached $5 billion.

See also BANKS AND BANKING; ECONOMICS, subentry onECONOMIC INSTITUTIONS.

Bibliography

  • Ahmed, Ziauddin, Munawar Iqbal, and M. Fahim Khan, eds.Money and Banking in Islam. Jeddah, Saudi Arabia, 1983. Essays on the mechanics of eliminating interest, including an influential 1980 report by Pakistan's Council of Islamic Ideology.
  • Chapra, Mohammad Umer. Towards a Just Monetary System. Leicester, U.K., 1985. The most forceful philosophical argument against interest.
  • El-Gamal, Mahmoud A.Islamic Finance: Law, Economics, and Practice. Cambridge, U.K., 2006. Develops a vision of Islamic banking that adheres to the substance of classical Islamic jurisprudence while allowing changes in form.
  • Kuran, Timur. Islam and Mammon: The Economic Predicaments of Islamism. Princeton, N.J., 2004. Contains an account of practical attempts to eliminate interest and a critique of the anti-interest drive.
  • Mannan, Muhammad Abdul. Islamic Economics: Theory and Practice. Lahore, Pakistan, 1970. Widely available textbook that focuses on the urgency and feasibility of eradicating interest.
  • Nomani, Farhad. “The Dilemma of Ribā-Free Banking in Islamic Public Policy.” In Islam and the Everyday World: Public Policy Dilemmas, edited by Sohrab Behdad and Farhad Nomani, pp. 193–223. New York, 2006. Account of modern attempts to eradicate interest, with a focus on Iran and Pakistan.
  • Qureshi, Anwar Iqbal. Islam and the Theory of Interest. 2d ed.Lahore, Pakistan, 1967. One of the first comprehensive arguments against interest.
  • Rahman, Fazlur. “Ribā and Interest.”Islamic Studies3 (March 1964): 1–43.
  • Rodinson, Maxime. Islam and Capitalism (1966). New York, 1973. Best source on the history of the controversy over interest.
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