Bank Treatment Under the Halacha | IRR Part VII

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

IS A BANK OR OTHER ENTITY TREATED DIFFERENTLY UNDER THE HALACHA AS IT APPLIES TO RIBIT?

The Halacha applicable to a bank as a lender would appear to be somewhat different than that of an individual lender.  The entire prohibition against Ribit may not be applicable.  Similarly, if the borrower is an entity as opposed to an individual, there are those who hold that the prohibition against Ribit is inapplicable.  Consider the Biblical construct referred to above of one individual who lends something of value to another individual.  If both are not individuals, or if what is loaned is not a thing of value, then the literal Biblical proscription may not applicable.

A bank is an entity, not an individual.  Indeed, a bank may be considered a “Vaad”,[1] which is separately treated for purposes of determining the applicability of the prohibition against Ribit, as more fully discussed below.  For example, a trust (Vaad) for the benefit of an orphan is permitted to loan money on interest under certain circumstances.[2]  Similarly, a charitable trust may also be permitted to loan money on interest under certain circumstances.[3]

Some have suggested that the prohibition against the payment or receipt of interest does not apply to a payment made by a personal check.[4]  This is because a personal check does not itself have any real intrinsic value.  It is a direction to a third party to pay over funds to the account of the payee.  Even the drawee bank itself is usually not the party that delivers the funds.  Rather, it is typically a clearinghouse or the Federal Reserve itself , which ultimately delivers the thing of value (i.e., the funds).  A bank check or a certified check, unlike a personal check, may itself have value like a commercial instrument.  Of course, legal tender, like US cash, is treated as a thing of value (even though the paper it is printed on does not have sufficient intrinsic value[5]).

In considering the nature of a bank (in contradistinction to an individual), some Halachic authorities have analyzed how the bank is organized and functions in practice.  In a typical bank, there are shareholders, a board and management.  The shareholders in a bank and even the board have no real influence on the day-to-day business activities at the bank.  Thus, under the Halacha, the shareholders in or board of the bank may not be deemed to be the actual lender because they lack the status of so called “Ballut.”[6]  Thus, unless the shareholders have sufficient control over the actions of the bank, so that the bank is deemed to be the alter ego of the shareholders, then the prohibition against making loans on interest may not, as a practical matter, apply to them.  Remember, in a bank, the shareholders don’t determine which loans to make, who to lend to or not or the terms and conditions thereof.  In point of fact, a bank is a highly regulated business in which the shareholders are expressly prohibited from participating in the day-to-day business of the bank, as a matter of law.  This is similarly the case with the board of the bank.  Hence, the shareholders are not deemed to be the lender; rather, it is the bank, as an entity, that is the actual lender.  Therefore, the acts of the bank are not imputed to the shareholders, because there is no so called Ballut by the shareholders under these circumstances.  Whether this would still be the case in a closely held corporation that is not a bank is a separate question discussed below.  However, it would appear that a bank is not the alter ego of the shareholders from a Halachic point of view.[7] As a result, the shareholders in the bank would not be burdened with responsibility for the sin of charging Ribit for loans on interest made by the bank.  In this regard, it should be noted that, as a general matter, the sins committed by one person are not imputed to another person.  A person only bears responsibility for the sins that person commits personally.  The guiding principle is “Ayn Shaliach L’Dvar Aveira” (there is no agent for sin); meaning one individual is not responsible for the sins of another.[8]

The definition of Ballut revolves around a number of attributes as follows:

(a)       authority – the right to deal with the assets of the bank;

(b)       profit – the right to make money;

(c)       responsibility – who is liable for losses.

Consider the typical bank.  The right to deal with the assets of the bank is reserved to management.  Although the board may enact policies in compliance with law, these are general statements of authority within which management has the power to act.  The board, however, cannot itself make a loan.  It is up to management to transact the business of the bank.  Only management (and by extension the staff) at the bank can make a loan.  The shareholders themselves are even further removed as more fully described below.  Indeed, in the US, banking is not only a highly regulated business, but beyond that, the government (through the FDIC[9]), in effect, is almost like a shareholder in a public company for certain purposes.  In addition, the FDIC (and, in effect, other governmental regulators) has many rights that transcend those of the regular shareholders.

It is the bank as an entity, which earns the profits derived from the business transacted, by the bank.  The bank may pay dividends but even that is subject to government regulation.

Any losses incurred in the business transacted by the bank are borne by the bank, as an entity; not the shareholders.  Indeed, as a corporation, the shareholders are not personally liable for any business losses of the bank.  In effect, it is only the capital they invested in the bank that is at risk.

Therefore, shareholders in a bank do not satisfy the standards described above so as to be deemed to have sufficient control and therefore, so-called Ballut over the bank.  The result is not to pierce through the corporate veil, as it were Halachically, so as to deem the shareholders as the lender.  Rather, it is the bank, as an entity, that is the lender).

The Rogachover Rav,[10] in his seminal work the Zaphnat Paneach[11] analyzes the nature of a bank and reaches a similar conclusion.  He notes that the bank is a corporation with limited liability (i.e., limited to the capital invested).  The Rogachover Rav finds that the bank is not considered to be an individual for purposes of the Biblical proscription against taking ribit and neither are its shareholders.

The Maharam Shick[12] and Rav Moshe Feinstein[13] considered the borrower’s side of the equation.  They found that a corporate borrower and its shareholders are not individuals for purposes of the Biblical rule against paying Ribit.[14]  They also held that shareholders in a corporate borrower are not deemed to be the “Balim”[15] or in control, so that the corporation would be deemed to be the alter ego of the shareholders for purposes of violating the Biblical proscription against Ribit.[16]

Rav Asher Weiss[17] recently published a number of written opinions[18] that focus on the nature of entities under the Halacha. In one of those opinions[19] he addressed the question of whether a Jew was permitted to own a majority of the shares in a US bank (eventhough the bank makes loans on interest). In his analysis, he noted the modern corporation is a legal and economic person, as distinguished from the individuals that might own it. Rav Weiss observed that the ownership and control of the corporate entity was divided into three parts, to wit: the shareholders, directors and management, as noted above. Each has its own roles and authority. The directors and managers are not mere nominees of the shareholders and the shareholders have no direct control over the day to day business of the bank. Even the directors can’t directly intervene. It is the management that actually runs the business of the bank. Furthermore, generally, the shareholders are not individually responsible for the liabilities of the bank.

Rav Weiss went on to report that the issue of whether there could be a separate legal entity, as distinct from the individuals owning the same was treated over 150 years ago by the Maharam Schick[20]. He described how the Maharam Schick dealt with what appears to be a credit union like entity. The Maharam Schick held that the indiviual members of the credit union did not have Balut over the entity. While Rav Weiss reported that the Maharshag[21] held otherwise, he went on to discuss the opinion of the Mahari HaLevi[22], who nevertheless held the shareholders don’t have Balut and the entity is a separate legal person. Rav Weiss concluded that the bank is a legal and Halachic person, separate and apart from the shareholders,

In our oral discussion of the matter, Rav Weiss went on to consider the unique qualities of a bank as a separate legal and Halachic person. He reported he felt the bank was responsible for the commandments of the Torah dealing with relations between one person and another (“Ben Adam L’Chavero[23]”). At the same time, he felt that a bank was not responsible for the commandments dealing with relations between a person and G-d (“Ben Adam L’Mekom[24]”). This is nothing short of a stunning analysis and insight. When I inquired about whether the prohibition against Ribit was Ben Adam L’Makom or Ben Adam L’Chavero, he responded that he felt it was more like Ben Adam L’Mekom and therefore, a bank was not bound by the prohibition against Ribit.[25] Rav Weiss reported that he based his thesis in part on the ruling of the Rashba[26], who holds that a charity is permitted to make loans on interest. This is because the Rashba considered a charitable organization to be a separate legal entity and not an individual (and therefore not “your brother” within the meaning of the express biblical prohibition against charging Ribit.[27]) Hence, the prohibition against Ribit[28] did not apply[29].

Interestingly, Rabbi Zvi Hersh Frank[30], held that an Israeli Government owned bank was exempt from the prohibition against Ribit[31]. His view was based on his analysis that no individual has a particular specified ownership interest in a state owned bank and its assets. Therefore it is not a partnership of the people of the State according to Rav Weiss. Rather as noted above it is a separate legal and Halachic entity. Thus, Rabbi Zvi Hersh Frank found that the prohibition against charging iRibit did not apply to a State owned bank.

One of the most striking statements made by Rabbi Aaron Solevetchik, in his discourse on the subject of banks, was that, in effect, without a banking system there existed a circumstance known as “Shaat Hadchak.”[32]  This term literally means overriding times and it expresses a circumstance where ordinary rules may no longer apply.  Thus, Rabbi Aaron Soleveichik considered whether a bank could make a loan and charge interest not just as a matter of Bedeved[33] (i.e., permitted after the fact but not something that should be done in the first instance) but rather even Lechatchilah[34] (in the first instance).

Rabbi Aaron Soleveichick did, however, offer that consideration should be given to having payments to the bank of interest made with a personal check, not a bank check or certified check.  As noted above, a personal check is merely a direction to a third party intermediary to make payment.  The check itself is not legal tender or payment.  It has no real intrinsic value.  Thus, if there is any issue of prohibited Ribit, the maxim of “there is no agent when it comes to performing a sin” (ayn shaliach ledvar aveirah[35]) is applicable.  On the other hand, if a bank check or certified check is used, then a thing of value is delivered, which can be said to be a direct payment (as opposed to a direction to make payment through an intermediary).  He went on to suggest that, since under these circumstances there was no prohibition against Ribit applicable to a bank, there was arguably no need for a bank to have a Heter Iska.

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[1] A separate entity with a legal identity under the Halacha , separate and apart from the individuals involved. Thus, the overseers of a minor orphan are referred to as a Vaad.

[2] Talmud Tractate Bava Metzia page 70a.

[3] Ibid. See also Maharam Shick Section 158.

[4] Rabbi Aaron Soleveichik in oral communication with the author (see discussion summarized below).

[5] Historically, though certain denominations were once also a direction to pay (e.g.:  so-called gold certificates and silver certificates also included a right to redeem in specie).  However, these are no longer in circulation.

[6] The concept of Ballut can have many far-reaching consequences. Thus, if an entity is deemed the alter ego of an individual then sinful actions of the entity are attributed to the individual. Consider the case of a restaurant that serves non-kosher food. Is this the responsibility of the restaurant corporation or the owner? In this regard it is  important to clarify that, while the Iska relationship creates a venture that has certain attributes of a partnership, it is by no means a genuine partnership.  It is, as noted above, an Iska. Thus, if funds advanced by the lender were used by the borrower for. something forbidden under the Halacha, then these actions would not be ascribed to the lender. Interestingly, not all Sha’ariah scholars would agree with this conclusion.

[7] According to Rabbi Aaron Soleveichik (in oral communication with the author), as more fully discussed below.

[8] This principle has sometimes been misused in the context of loans intentionally made by a Jew through a non-Jew, as an intermediary, who then re-loan the funds to a Jewish borrower. There are a number of problems with this construct.  It would appear that the Mishna in Talmud tractate Bava Metzia on page 70 condones this type of practice. However, the referenced case involves an idol-worshipper as either the intermediary or the source of funding (it permits a Jew to act as an agent on behalf of an idol worshipper to loan money to a fellow Jew, as well.) The key to understanding the exception is the nature of the individuals involved. As Rabbi Judah Lowe, the renowned Maharal of Prague, noted in the 16th century, taking of interest is not forbidden because of commercial corruption; it is rather a matter of Scriptural decree (Chiddushei Aggadot on Bava Batra 75b, Part I, at page 134; See also Philosophy of Halacha by Rav Chaim Navon). Thus form does matter. Since the express prohibition is of a Jew lending to a fellow Jew, the Biblical prohibition is not triggered when an idol-worshipper is involved.  Moreover, the concept of a loan on interest to any non-Jew (as opposed to a genuine idol-worshipper) being permitted is likely wrong as well.  (See for example Rashi on pages 70b-71a of the Talmud text cited, where Rashi notes it’s inappropriate to loan on interest to an idol-worshipper as well.)This was the subject of public Disputations in the Middle Ages and whether it was the Rabbi Joseph Albo, a 15^th century Halachic scholar and philosopher or Rabbi Issac Abravenel, another major 15^th century Halachic authority and commentator on the Bible, it appears they asserted that the prohibition of Ribit applied to Christians as well as Jews. The only exception appeared to be loans to idol worshippers. See also Rabbi Abraham ben Mordecai Farissol who participated in the Disputation at Ferrara.  Interestingly, it is reported that David de Pomis, a Jewish physician and 15^th century scholar and author of De Medico Hebraeo Enarratio Apologetica, argued that a Jew could lend money to a Christian just like to another Jew, according to then recent Halachic literature, using a Heter Iska. See discussion thereof in Money lending, The Religious Context, as reported in Jewish Virtual Library.org.

[9] Because of the system of FDIC insurance of accounts

[10] Rabbi Yoseph Rosen

[11] Volume 1, Section 194.

[12] Rabbi Moshe Shick, a 19^th century Halachic authority.

[13] In his seminal Halachic work, the Igrot Moshe (Y.D. 2:63)

[14] Rabbi Moshe Feinstein’s focus on the matter of personal liability of the borrower provided a backdrop to a very interesting discussion between Rabbi Aaron Solevetchik and the author.  As noted above, if the borrower is a corporation and individual shareholders are not personally liable for repayment of the loan, then this mitigates against any issue of Ribit.  I queried Rabbi Aaron Solevetchik concerning how far this concept could be stretched.  Logically, under US law, there is in effect always some form of limited liability.  This is because under the bankruptcy code and various provisions of state debtor/creditor laws, there are generally protections built in for the benefit of debtors, which limit liability.  There is also no concept of debtors’ prison under US law or of selling an individual into slavery in order to pay back debts.  Therefore, at the very least, the debtor’s own person is not subject to enforcement of debts.  Furthermore, there are provisions under State law that protects at least a minimum of property.  For example, there are homestead exemptions under many State laws. (Both Florida and Texas exclude the debtor’s residence from claims by creditors.  NY has a limited homestead exemption.)  There are also exclusions from garnishment for 90% of a debtor’s wages under most circumstances.  (NY law does however provide for the possibility of an installment payment order if the wages are not spent on living costs and are instead just put into savings, subject, however, to overriding federal bankruptcy protection.)  Moreover, under the federal bankruptcy code, future wages are generally protected from creditors of the bankrupt’s estate so that the debtor can begin life anew.  Does this not constitute some form of limited liability, analogous to the corporate borrower, albeit by operation of law.  Rabbi Aaron Solevetchik, however, did not accept this line of reasoning. He felt that the prohibition against Ribit nevertheless continued to apply to loans between individuals, despite these limitations on liability implicit under US law.

[15] See definition of “Ballut” above. The term “Ballim” refers to the kind of owners of an entity who satisfy the tests of Ballut  outlined above.

[16]  Rabbi Zvi Pesach Frank (in his Halachic work, Har Zvi Y.D. at page 126) , however, disagrees with Rabbi Feinstein’s analysis and conclusions.

[17] A leading contemporary Halachic authority and author of the Mincaht Asher.

[18] Sheilot U’Teshuvot Minchat Asher-Volume I.

[19] Ibid, Section 105 at page 357.

[20] Rabbi Joseph Schick, a 19^th century Halachic authority, in YD: Section 158.

[21] Rabbi Shimon Grunfeld, a 17^th century Halachic authority in YD: Section 3.

[22] Rabbi Ya’akov LeBeit HaLevi (Manzanti), a 17^th century Halachic authority in Volume 2: Section 54

[23] The term is loosely defined as matters between one person and another and is intended to incorporate by reference the body of Halacha dealing with such interpersonal relationships (such as monetary matters).

[24] The term is loosely defined as matters between mankind and G-d and is intended incorporate by reference the body of Halacha dealing with observances, services and other commandments included in this category such a observing the Sabbath and the prohibition against Chometz on Passover.

[25] I noted to Rav Weiss that the prohibition against charging Ribit is set forth in the Section of the Schulchan Aruch legal code (promulgated by Rav Yoseph Karo) known as Yoreh Deah (dealing with matters Ben Adam L’Makom) and not Choshen Mishpat (dealing with monetary matters) and didn’t this have some significance. He responded that this was not authoritative, because the TUR (a legal code authored by Rabbi Yakov Ben Asher, a 13^th century Halachic authority, who first set up this categorization (in his predecessor legal code to the Schuchan Aruch, known as the Arba Turim or TUR) apologized for not following the format of the Rambam, who included the laws against charging Ribit in the Section dealing with the laws of lending and borrowing (ie: Ben Adam L’Chavero) in his predecessor legal code. The TUR noted that he did this because in his editing process he sought to juxtapose the laws of Ribit right after a similar exposition of the laws of lending to idol-worshipers and hence the placement in Yoreh Deah. He therefore implicitly did not mean to determine the matter by mere placement.

[26] (Rabbi Solomon Aderet ) Volume 1:669.

[27] Rav Weiss in discussions with the author also based his view on Talmudic sources including one in the Tractate of Pesachim (at page 46a) in which the Rav Yehoshua holds that the prohibition of owning Chometz on Passover does not apply to the portion of the dough separated for the Cohanim as Challah. This is because once separated it belongs to the Cohanim and not the householder baking maztot with the dough. Hence if the dough set aside unbaked rises and, as a result, becomes Chometz, the householder is not the owner of that dough and therefore is not liable for the prohibition. Rav Weiss pointed out that Rashi (on Page 46b) notes that neither the householder nor any individual Cohen is responsible for the prohibition. This is because while title to the separated piece of dough passed to the Shevet of Cohanim but no particular Cohen. As Rav Well notes there is a concept of Shevet Cohanim, which  is a legal and Halachic entity that is capable of acquiring title to the item. However, as an entity it is not responsible for the commandment prohibiting Chometz on Passover. Until an individual Cohen takes possession of the item neither is an individual Cohen responsible. It belongs to the entity Shevet Cohanim. (See also Tractate Nedarim at page 47b dealing with the concept of “Oleh Bavel” which can be defined as the equivalent of we the people represented by the body corporate and Rambam Laws of Trumot, Chapter 9, section 9, which echoes the concept of Shevet Cohanim noted above. On the other hand, see Tractate Yoma at page 11b, which seems to take a different view dealing with Mezzuah. However, Rav Weiss distinguished this source in a discussion beyond the scope of this article.

[28] See also Talmud Bava Metzia at page 57b describing how the Temple treasury is not in the category of “your brother” as discussed above. See also Bava Metzia at page 70 dealing with the funds of an orphan, as noted above. Rav Yosef Karo and Rav Moshe Isserles (in Schulcahn Aruch YD 160:18) permit funds for orphans, the poor, schools and synagogues to charge only rabbinically proscribed Ribit. They reject the practice in some places of charging even Biblically proscribed Ribit.

[29] Rav Weiss also noted in a discussion with the author that interest charges were in essence “schirot” (rental). This is, based on a Rasba  ( Teshuvot Meyuchedet L’Ramban- Section 223), who  analyzed  the nature of Ribit , conceptually, without reference to the Biblical prohibition  against the same. Thus, in the examples given of an entity not responsible for this Biblical prohibition, there is no conceptual basis for prohibiting a rental rate for the money. On the other hand,, where the Biblical prohibition applies, the device of renting the money cannot be used to circumvent the biblical prohibition (see Talmud Bava Kama at page 69b).

[30] A 20^th century Halachic authority, who was the Chief Rabbi of Jerusalem.

[31] Sheilot U’Teshuvot Har Zvi, Orach Chaim-Section 146, as cited by Rav Asher Weiss in a written Teshuva on whether the assets of the State of Israel or its army were subject to the Torah and commandments, which he graciously shared with the author.

[32] Under extreme circumstances, where actions ordinarily prohibited in the first instance are permitted.

[33] Not in the first instance; i.e. with the reservation that should not do so in the first instance, however, if did any way, then not liable for wrongdoing. Nevertheless, an individual should refrain from doing so in the first instance.

[34] In the first instance; i.e.: without qualification.

[35] Talmud Tractate Bava Metzia at page 10a.

Theory vs Practice | IRR Part III

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

THEORY VERSUS PRACTICE – IS THERE A GENUINE PROHIBITION IN OUR TIMES?

It would appear that the extremely onerous prohibitions against interest have seemingly been circumvented in practice over the last few thousand years; virtually from the very inception of the prohibition in the Bible, by all three major Religions (Christian, Moslem and Jewish).  They all proclaim to live by the terms and conditions of the Bible.  They all derive their ethical, religious and legal systems from the very same Bible.  Yet all three have found a way to charge interest in practice, despite what appears to be an express prohibition against charging or paying interest.

Rabbi Baruch Halevi Epstein[1] (author of the seminal work on the Bible known as the Torah Temimah[2]) took up the issue in another of his commentaries on the Bible known as, the Tosafot Bracha.[3]  In commenting on the prohibition of Ribit, he noted the world of the exile was very different from that of ancient Biblical Israel.  When the Jewish people lived in the Land of Israel, they functioned within the context of an agrarian economy.  Rabbi Epstein went on to say that in his time, the only occupation available to observant Jews, as a practical matter, was in trade or money lending.  They were not landed gentry, as in days of yore.

Rabbi Epstein analyzed the economy of his day and found that a money lending or banking system[4] was a structural requirement for business and trade to function properly.  Much like the comment made by Rabbi Aaron Solevetchik[5] noted below, the modern economy couldn’t function without banks being available and loaning money.  As we all witnessed recently, a breakdown in the banking system can paralyze the economy generally.  Rabbi Epstein points out, that absent these opportunities to do business, the Jewish people would be without the means to support themselves in the exile.

This is unlike the Biblical economy.  As Rabbi Epstein pointed out, Biblical Israel was a society where owning land, devoted to growing wheat and other foodstuffs, was critical to subsistence.  In that kind of an agrarian economy, there was no real need for money.  As a nation of landowners, inheritance of land and keeping it in the family was a pre-requisite to success.  The wealth was in the land.  Rabbi Epstein points out that those with a surplus might as well loan it without interest to their brethren as a good deed.  This is because there was little else that could be done with surplus money in a subsistence economy.  Indeed, if anyone needed money it was because they were destitute.  They could hardly be expected to pay interest; they might not even be able to repay the principal.  The charging of interest in that kind of a situation is therefore “Neshech” (biting).

In our times, it is often the borrower who prefers to pay a fixed charge for money, instead of making the lender a partner.  The unlimited return potential is reserved to the borrower/entrepreneur.  The lender may want to be a partner, but the borrower is just as likely, or more likely, to insist that only interest be paid for the money, not a profit share.

Today’s world economy is about business and trade.  Money is the lifeblood of the economy.  Land may still have some value for agricultural use, but its highest and best use is usually non-agricultural.  Often, real estate is best used as part of a trade or business.  Commerce (and hence money) is the source of prosperity and in substance the only real source of income (and therefore sustenance) for the Jewish people.

Rabbi Epstein finds that the Heter Iska was the mechanism that the Rabbis enacted to permit businesses to borrow needed capital so as to enable the businesses to function.  He goes on to posit that the Bible itself implicitly provides the basis for the Heter Iska exception.  The Rabbis did not want to undermine the authority of the Bible, generally, by just excising this express prohibition.  Therefore, according to Rabbi Epstein, the Rabbis enacted a mechanism for avoiding the prohibition, as a matter of form, consistent with the philosophy underlying the religious principle of providing money to those in need.[6]

There are similar philosophical underpinnings to the Sha’ariah compliant financing mechanisms noted below.  They similarly provide a mechanism to avoid the prohibition against Riba, as a matter of form, consistent with the philosophy underlying religious principle of providing money to those in need on the most favorable terms.

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[1] A Halachic authority of the early 20^th century.

[2] A commentary on the Bible that cites to texts in the Talmud, which discuss the particular verse in the Bible.

[3] Leviticus: Chapter 25-Verse 36

[4] Rav Epstein uses the term “Ezrat Kessafim” to describe the banking or money lending function that is an integral and vital element of commerce and trade. Otherwise, as he notes, business cannot “take hold”.

[5] A 20^th century Halachic authority. He is the brother of another eminent Halachic authority, Rav Yoshe Baer Solevetchik. Both were also leading professors of Talmud at Yeshiva University.

[6] Lo Tinayl Delet,..(literally, don’t close the door on borrowers) as quoted in the Talmud Tractate Bava Metzia at page 68b. (See also Talmud Tractate Sanhedrin at page 3a.) This concept is also used as the basis for other enactments like Prosbul (a mechanism whereby the biblical requirement that debts be forgiven every 7 years is avoided) that appear, at first blush, to prejudice the borrower; but, in reality enable the borrower to obtain funding. (See Talmud Tractate Gittin at page 36b.)

Abstract & Introduction | IRR Part I

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

ABSTRACT

The Article provides a timely analysis of the recent defaults, bankruptcies and attempts at restructuring of Sha’ariah compliant financial products, including. the spectacular bankruptcy by a Sha’ariah compliant institutional lender, which threatens to undermine the very basis for these products. It discusses the structural issues exposed by these events as well as the inherent incompatibility between existing Sha’ariah products and the requirements of the capital markets.

The success of the capital markets in the US in delivering low cost financing of homes and income producing properties is incomparable.  Among the requirements for accessing the capital markets is the need for a pristine interest payment stream that is fully secured, with a priority lien on the collateral, and which is readily enforceable. Predictability is the key. Financial products, developed under other systems of law and practice that don’t yield the expected results achievable using the model satisfying the requirements of the capital markets are problematical. They may be denied ready access to the capital markets or be priced at a premium to traditional financial products satisfying the requirements of the capital markets.

The Article traces the origin and development of the Sha’ariah prohibition against Riba, and explores relevant sources, including a number of Fatwas. It also discusses the earlier and parallel development of the Halacha prohibiting Ribit . This includes its successful adaptation over time to deal with changing economic conditions, such as permitting borrowers a means of ready access to the capital markets and the benefits of lower cost financing.  There is also a discussion of the unique role banks or other entities play under the Halacha and the Sha’ariah when compared to an individual. It would appear that banks are not necessarily subject to the prohibition against Ribit or Riba, respectively.

A survey of relevant cases under NY law (as well as certain cases in the UK and elsewhere) is also presented. Certain constitutional aspects of applying religious oriented laws are also explored.

The Article suggests that a more nuanced approach is required that both recognizes and respects the traditions of each system of law and practice and yet permits ready access to the US capital markets. The article concludes with a proposed solution that is based on precedent within the Sha’ariah and Halacha. The solution is consistent with the author’s own experience in practice, in structuring such financial products, in a manner that is capital markets’ compliant.

KEY WORDS: Interest, Riba, Ribit, Sha’ariah Compliant, Capital Markets, Heter Iska, Sukuk, Ijara, Murabaha, Fatwa.

 

INTRODUCTION

In a global economy, with lenders and borrowers[1] from different cultures and disparate systems of law and ethics, conflicts can arise.

This article deals with the apparent conflict of laws and ethical traditions between US law,[2] on the one hand and the Halacha[3] and Sha’ariah,[4] on the other hand, as it pertains to loans and the charging of interest.

There are already a number of cases in the US[5] that have dealt with the nature and enforceability of a Heter Iska.[6]  This body of common law has developed over the years and provides us with guidance as to how a US court might view religiously oriented documents and structures under the Sha’ariah.  As noted below, the results are not always predictable and unexpected consequences may occur.  Indeed, it appears the existing religious oriented formats and structures currently used in practice may not always work as intended, as more fully discussed below.  This raises a number of issues, including legally and philosophically.

Furthermore, as a practical matter, it would appear that the capital markets cannot readily accommodate these Sha’ariah and Halachic compliant formats (designed to deal with the apparent prohibition against charging interest[7] in the form of Ribit[8] and Riba,[9] respectively).  This is because they fall astray of the existing legal and other requirements for accessing the capital markets.

Among other things, the following issues are presented:

1.         Do the existing Halachic and Sha’ariah compliant legal structures and documents work as intended under US law? This includes both the concepts of a parallel set of religious oriented documents and the more integrated versions in uses in Sha’ariah compliant banks, as summarized below.  Implicit in this analysis is the question of what documents govern (when dealing with a parallel set of religiously oriented documents) and how to interpret the religiously oriented provisions in the documents.

2.         Are the US courts best suited to decide matters of interpretation of religiously orientated documents? After all, as noted below, the courts, perforce, must rely on religious experts.  Moreover, as noted below, these religious experts may themselves be in conflict because of disputes as to the meaning or applicability of the religious doctrine at issue before the particular court. Furthermore, as discussed below, a US court[10] might decide an issue differently than a religious court would,[11] yielding a contrary result to what was actually intended by the parties.

3.         Can a US court even decide these kinds of issues under the Establishment Clause?[12]

4.         Beyond the legal issues noted above, do the existing religious oriented financial mechanisms work, in terms of enabling access to the capital markets or is there a problem? Moreover, if the current religious oriented structures and documents in use don’t permit a favorable execution within the existing capital markets, and then is there another possible solution?

5.         Is there really a conflict in principle or in practice? Stated another way, is this more a matter of form over substance or are the Western laws and traditions in fatal and irreconcilable conflict with the near Eastern traditions of the Halacha and Sha’ariah.  Furthermore, is there more philosophical coherence conceptually than might superficially appear to be the case? Moreover, is a more nuanced approach in practice a possible solution to the problem?

It is suggested that a resolution of these issues would be helpful in order to permit the free flow of capital through the capital markets, from sources of capital that adhere to the Halacha or Sha’ariah, to those in need, on the favorable terms and conditions that are the hallmark of the capital markets.

To better understand the problem; consider the basic real estate financing structure so prevalent in the US, Europe and throughout Western culture.  It is based on a loan, evidenced by a note and secured by a mortgage that is repayable with interest.  This is a recognized and accepted financing format under the law and traditions of the West.  It has enabled individuals to buy a home with the help of a local bank or other source of funding within the capital markets on very favorable terms and conditions.  It also underlies the financing of office, industrial, multi-family, hospitals and other types of real estate, whether existing or in development.  Indeed, it is one of the essential structural components of the capital markets and the sine quo none of CMBS.[13]  It has been tested in the US courts (including Bankruptcy courts) and through numerous economic cycles of downturn and growth.  It has been refined over time so as to yield consistent and predictable results.  In short, it is a battle-tested format that accounts in no small measure for the success of the capital markets.

As noted above, the essence of the capital markets’ compliant loan structure is predictability.  After all, the lender loaned the money to the borrower and is entitled to receive it back with interest as agreed to by the parties.  There can be no ambiguity when it comes to this basic and essential agreement between the parties.

The underlying problem is that this simple, elegant, efficient and successful financing structure appears to be expressly prohibited under the Halacha and Sha’ariah.  Indeed, the concept of repaying a loan with interest would appear to be an anathema under the Halacha and Sha’ariah.  This is not a matter of style or perception.  It appears to be a genuine conflict between Western culture and law and public expressions of the near Eastern traditions and legal codes of the Halacha and Sha’ariah.  Western legal systems[14] permit the payment and receipt of interest.  The Halacha and Sha’ariah prohibit Ribit and Riba, respectively and thus, would appear to prohibit the payment or receipt of interest.[15]  Any such prohibited acts are deemed sins[16] under the Halacha and Haram[17] under the Sha’ariah.

Nevertheless, for thousands of years under the Halacha and for well over a thousand years under the Sha’ariah, there have been various practices permitted that, at the very least, mimic interest, but are not considered “Ribit”[18] or “Riba”.[19]  What these structures are and how they originated, both conceptually and in practice and developed over time, are subjects of this article.

The broader question though is, in light of the legal and ethical traditions embodied in the Halacha and Sha’ariah, on the one hand and Western law and practices, on the other hand, can East meet West; do these religiously oriented structures and documents work in practice or do they cause unintended consequences?  Is there a gulf so wide that it can’t be bridged or otherwise resolved?

At first blush, it appears well neigh impossible to meld these opposing systems of law and tradition, because of fundamental and irreconcilable theoretical conflicts.  Indeed, as more fully discussed below, a New York court[20] in considering the effect of a Heter Iska found that there was a triable issue as to what the parties intended.  The court was concerned that the transaction at issue might not be an ordinary, simple loan; but rather some kind of an equity or partnership arrangement.  The difference between the two is striking, as more fully discussed below.  Moreover, as shown below, a Bet Din[21] applying the Halacha would likely have determined that the transaction should be enforced as a loan repayable with interest.  This kind of improbable result points to the need to better understand the various religiously oriented formats summarized below.  This so as to avoid these kinds of results that are contrary to the intent of the parties and the very systems of law that created them in the first place.

It is suggested that a nuanced approach, which permits the systems to exist side by side at some level, might be possible.  Developing an approach to enable the free flow of capital worldwide is certainly a worthy object.  Indeed, the Talmud recognizes this as a most worthy goal, citing the legal maxim of “don’t shut the door on borrowers”.[22]  Nevertheless, accomplishing this in practice is no mean achievement.

Over the years, I have worked on developing solutions reconciling religious sensibilities with US lending practices, acceptable to a variety of banks, institutional and other lenders, borrowers, religious authorities and governmental regulators.  One example comes to mind because of the diverse composition of the parties involved.  An Egyptian banker acting on behalf of a Saudi-managed fund introduced the matter to me.  They were interested in providing financing to a Pakistani real estate developer.  The security was a development parcel in New Jersey.  It was encumbered by a building loan mortgage provided by a major bank from China, with a branch office in New York City.  I was approached because of my reputation as a real estate finance expert, who also had experience in crafting financing structures that did not violate the law against Ribit under the Halacha.  They hoped I could also craft a financing structure that provided for a secure rate of return that was not prohibited Riba and, hence, was Sha’ariah compliant.  At the same time, the financing structure had to conform to the requirements of the Chinese Bank (and by extension, the capital markets).  This is because the real estate (including the buildings and other improvements to be constructed thereon) was encumbered by the Bank’s Building Loan Agreement and Mortgage.  This very same real estate was also intended to secure the new Sha’ariah compliant financing structure I was charged with creating.

How therefore to craft a Sha’ariah compliant financing vehicle that could be rationalized with the typical US loan structure.  To succeed, it had to be satisfactory to the new financing source (requiring compliance with the Sha’ariah and their financial, legal and religious advisors), as well as, the US bankers (including underwriting, credit, legal and compliance), regulators, rating agencies, traders and investors, who are an integral part of the capital markets.

To better appreciate the relevant issues requires some background.  Therefore, set forth below is a discussion of the meaning of terms such as “Ribit” and “Riba”.  Although the words are loosely translated to mean interest, this would appear to be a misnomer.  The terms Ribit and Riba might be better translated as meaning any addition or increase[23] not strictly speaking just interest.  But a true definition of the terms can only be derived from a rigorous legal analysis of the applicable religious principles that coined the terms in the first place.  Indeed, as shown below, these terms embody all sorts of things that would not ordinarily be defined as interest.  Moreover, there are times when what is commonly understood to be interest is religiously defined not to be Ribit or Riba.  This is particularly relevant when viewed in the context of an analysis of the evolution of the Halacha and Sha’ariah in response to the needs of lenders and borrowers and changing conditions over the years.  A matrix of guiding principles is also outlined below and is used as a tool to show the interplay of these systems of law and practice with the requirements of the capital markets and US law.

I begin with a discussion of Ribit because, among other things, it is first in time historically.  It is also because there is already a well-developed body of case law and business practice dealing with the Halachic prohibition against Ribit and the Heter Iska solution.  As such, we are provided with a source of guidance as to how religious oriented forms and structures have been developed and treated legally by the US courts and in practice by the capital markets.  Having participated personally in developing some of the solutions under the Halacha and in respect of US law and the capital markets, I was privy to discussions about various approaches and considerations that resulted in establishing viable solutions that proved to be acceptable to the capital markets.

Section I of this Article contains a discussion of the definition of the term “Ribit” and the origin and nature of the prohibition.

The article then goes on to deal with a number of Halachic solutions to the problem, beginning in Section II with the original Talmudic Iska format.  Theory versus practice is then analyzed in Section III.  The article then discusses the later development of the Heter Iska structure in Section IV and its evolution over time in Section V.  Section VI continues with a discussion of whether a bank is treated differently from an individual lender under the Halacha.

Section VII deals with the response of the US courts to the Heter Iska.

Section VIII discusses why, in light of applicable US case law, the Heter Iska should not be signed by the parties.

Section! IX discusses the sources of the prohibition against Riba.

Section X analyzes the definition of the term Riba.

Section XI discusses the nature of the prohibition and the rules that developed over time dealing with the practical application of the prohibition. This includes an analysis of whether entities are subject to the same rules as individuals when it comes to the prohibition against Riba. A number of Fatwa and other scholarly positions are discussed dealing with when and under what circumstances the prohibition against Riba does or does not apply.

Section XII outlines a number of Sha’ariah compliant structures in current use.

Section XIII discusses the requirements of the capital markets and analyzes how the existing religious oriented documents and structures outlined in this article are inconsistent with those requirements.  In this regard, it should be noted that the Heter Iska format has been adjusted to conform to the needs of

of the capital markets, as described in this article.  However, the Sha’ariah compliant formats have not made such an accommodation; and, hence, the emergence of some of the problems described in this article.

Section XIV outlines a modern Sukuk structure and analyzes whether it successfully achieves the goal or remaining Sha’ariah compliant while, at the same time, satisfying the requirements of the capital markets.

The integration of religious oriented structures and forms in our society in the US also has a constitutional dimension.  This is discussed in Section XV.

Section XVI discusses the disconnect between the concept of Riba in theory and in practice.

It would appear that efforts being made by proponents of the use of Sha’ariah in the US have encountered a negative reaction.  This blowback is discussed in Section XVII.

A proposed solution is outlined in Section XVIII.  The solution offered is then critically analyzed against the criteria outlined in this article.  The conclusions reached are not just theoretical.  They are often based on insights derived from my own real life experiences in the field.

It is important to recognize that the development of a useful proposal must, first and foremost, be based on a genuine respect for each of the legal systems.  Value judgments about which system may or may not be more appropriate or ethical are exceedingly contra-productive.  Indeed, such pronouncements are often the product of ignorance, not just about one of the systems of law being discussed; but, often all of them.  Each of the systems has withstood the test of time and reflects the majesty of their traditions.  They deserve our respect.

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[1] The terms lender and capital provider, landlord, vendor or investor are used interchangeably. The terms borrower and capital recipient, tenant, vendee, operating member or manager are also used interchangeably. Religiously oriented documents or structure sometimes employ one of these other terms in order to distinguish the transaction in form from a loan; similarly the use of the term borrower.  Interestingly, the Talmud, in Tractate Bava Batra, uses the term “Malveh” (literally, lender) to mean obligee and “Loveh” (literally, borrower) to mean obligor (see Elon: Ha-Mishpat Ha-Ivri – 1:483).

[2] The term US law is used generically to distinguish between Western legal traditions, on the one hand and the Halacha and Sha’ariah, on the other hand. This article is based primarily on New York law (unless otherwise specified) and Federal law where applicable. These are used as representative examples of US law and Western legal and ethical traditions.

[3]  The body of Jewish law derived from the Bible as elucidated in the Talmud and by early codifiers and commentators and later religious authorities, as more fully outlined below.

[4] The body of Islamic law derived from the Koran and as elucidated by later religious authorities and scholars.

[5] See the discussion of Heter Iska cases below and in particular the IDB case.

[6] A document and structure in use under the Halacha that is designed to avoid the prohibition against Ribit, as more fully discussed below.

[7] Plato in the Republic prohibited lending on interest. Aristotle in his Politics (at page 1258) thought it an unnatural mode of producing income (i.e., selling money instead of goods).  According to Aristotle, it was the most hated sort of wealth which makes gain out of money itself. Money according to Aristotle was intended just to be a medium of exchange. Thomas Aquinas in his Summa Theological II (at page 78) thought “it is by very nature unlawful to take payment for the use of money but, which payment is known as interest.” However, this all changed with the advent of a mercantile instead of an agrarian economy.  Thus Calvin beginning in 1547 spoke of reasonable interest charges for money being acceptable. Only excessive interest was wrong. After Henry the VIII broke with Rome, England in 1545 passed a law permitting interest to be charged up to a maximum of 10% per annum. In the 19^th Century, the Roman Catholic Church acknowledged that moderate rates of interest were not to be disturbed.

[8] The terms Ribit and Riba, literally, mean increase.  As more fully discussed below, this is a wholly religious based formulation.  It has no counterpart under US law.

[9]  Ibid.

[10]  See the discussion of the IDB case below.

[11] See the discussion of Heter Iska below and how the pre-conditions to bringing a claim thereunder are virtually impossible to satisfy.

[12]See the discussion of cases under the Establishment Clause of the First Amendment to the US Constitution below.

[13] An acronym, meaning Commercial Mortgage Backed Securities. In a typical CMBS offering, an investment bank pools a portfolio of individual loans secured by first mortgages against real estate (usually rental properties and hence the term “commercial”) and sells certificated interests in the pool to institutional investors, like banks, insurance companies or funds. Often the interests are tranched so that the portion of the aggregate loan amount that represents a lower loan to value ratio (i.e. the most senior interests) are sold to investors for a correspondingly lower yield and the portions that are at the higher end of loan to value within the offering are sold for a higher yield. Often the investment bank making a CMBS offering earns not only fees for the underwriting, banking and placing the CMBS; but, also premiums, if the actual yield at which it is sold is less than the underlying stated contract interest rate of the loans in the pool of mortgages that are being securitized.

[14] New York or Federal law is the primary source of law under discussion in this article, unless otherwise stated.

[15] The Halacha even goes so far as to prohibit scribes from drafting the offensive loan documents and witnesses from affixing their signatures. Under the Halacha, an offending lender or borrower is disqualified as a witness generally because of the odiousness of the sinful practice of paying or receiving prohibited interest. (See Talmud Tractate Bava Metzia Chapter 5, at page 11.) There is also a discussion in Talmud Tractate Sanhedrin (at page 25) concerning how those who collect Ribit are not qualified to be a witness. See also Rambam-Mishna Torah: Hilchot Edut 9:1.

[16]See discussion below as to the fact that viewed as sinful conduct but not necessarily civilly actionable.

[17] Literally, forbidden (i.e. sinful).

[18] Exodus 22:24; Leviticus 25:36-37; Deuteronomy 23:20;  Ezekiel 18:13: Psalms 15,5 ; Nehemiah 5:1-13; and Proverbs 25:8.

[19] Koran 3:130; and 2:275-6

[20] See the discussion of the IDB case and other cases dealing with Heter Iska below.

[21] See the discussion below  of how a Bet Din (or Religious Tribunal) would typically, as a threshold matter, reject a borrower’s claim of defense to payment under a Heter Iska.

[22] Talmud Tractate Bava Metzia at page 68a.

[23] or in the case of Riba, an excess, as more fully discussed below.