Analysis of Prohibition Against Riba in Practice & Rules | IRR Part XI

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

 

AN ANALYSIS OF THE NATURE OF THE PROHIBITION AGAINST RIBA AND ITS APPLICATION IN PRACTICE, INCLUDING WHETHER ENTITIES ARE SUBJECT TO THE SAME RULES AS INDIVIDUALS

It is respectfully suggested that not all interest is prohibited Riba and not all Riba is interest[1].

Consider for example the 16^th century Ottoman Cash Waqfs[2]. They were permitted to charge interest. A Waqf[3] was viewed as a separate legal entity (as distinguished from the individuals who invested or operated the same). There is also a Fatwa[4] issued by Ebusud Effendi, the 16^th century Mufti of Istambul that expressly determined that a Waqf and Charitable Trust could charge borrowers interest and pay interest to the providers of capital to the entities. Many a 16^th century effendi made profit this way. The use of an entity as an intermediary shielded both the debtor paying interest to the entity and those providing capital to the entity and thereby earning interest from the prohibition against Riba. The interest had to be fair in theory. Indeed Cash Waqfs were said to be formed to help borrowers, who were otherwise paying excessive rates of interest.

Yahia Abdul-Raman[5], relying on the Fatwa of Baraka[6]reports that the term interest can be used in documents to satisfy local legal requirements, so long as Riba was not practiced in the transaction. The Fatwa itself states that there is no objection to using the term interest as an alternative to profit or rate of return. Hence it is possible to have a parallel set of documents with the term interest being used as appropriate to satisfy capital markets requirements, so long as Riba is not practiced. However, just what is or is not Riba was not defined.

Al Baraka Bank in London devised a structure for interest bearing loan documents to be imbedded in the transactional documents that are otherwise Sha’ariah compliant. This was done in an attempt to thereby achieve satisfaction of the requirements of the capital markets, without falling astray of the Sha’ariah. Thus, it employs a Mushraka[7] framework, where under the Bank and borrower initially buy the home to be financed as a joint venture; but the Bank retains title to the property, as described below. The Bank then sells its interest to the borrower at a mark up that reflects the interest factor it charges. Ownership of the property however remains with the Bank until the purchase price is paid in full (i.e.: the principal and interest factor that comprises the mark up). However, consistent with UK law, the Bank also takes a mortgage lien against the property. The borrower enters into a lease with the Bank of the property, where under the borrower rents the property from the Bank at a rental rate equivalent to the monthly interest and amortization payments that would ordinarily be charged (albeit at a higher rate of interest that the prevailing rates for a traditional mortgage loan). In essence it is viewed as an installment sales contract under the Sha’ariah and a mortgage loan that is interest bearing under UK law.

The concept of having a separate set of traditional interest bearing loan documents could be very useful, if properly structured. A good example of how this can be successfully accomplished is noted above in the discussion of the use of a Heter Iska. Just embedding a set of traditional loan documents in a Shariah complaint structure may not be the appropriate solution. On the other hand, if properly structured, then conceptually it can be adapted to meet the requirements of the capital markets, as well as, US legal requirements. Indeed, courts in the UK dealing with a Murabaha[8] structured product with parallel interest bearing note and mortgage held that under English law the interest earning note prevailed[9].

However, as more fully discussed below, just embedding a set of more traditional loan documents in a structure that is inconsistent with capital markets and likely Sha’ariah requirements may not be advisable, for the reasons set forth below. Consider the inconsistent expectations. The bank hopes the documents will be interpreted in favor of the traditional loan documents embedded in the structure so as to have an ordinary interest bearing loan obligation that is secured by a priority first mortgage on the property. On the other hand, the borrower desires that the transaction be Sha’ariah compliant and not be viewed as an interest bearing obligation that is likely prohibited Riba according to many Sha’ariah scholars and others. The courts or other juridical authorities in the US and in the Islamic world may have conflicting views as to how to interpret and enforce the various documents encompassing the transaction between the bank and borrower. There is a need for clarity and predictability and yet it is conspicuously absent, as described in this article. As noted below in the discussion of modern Sukuk structures, these issues have been put into focus with unintended and less than desirable results.

Sukuk bond structures are very interesting. Instead of being asset based (i.e.: with a security interest in the assets or mortgage on real estate) they are said to be asset backed (i.e.: the lender actually owns the assets). However, as discussed below this is not always so clear. Typically, an Ijara[10] rental structure is then employed, if the underlying collateral is real estate. It provides for a rental arrangement with the borrower under a lease of the property, with the rental being tied to the yield agreed to with the lender. As noted below there is no thought given to providing for a genuine market rent, it is just a derivative interest based financial arrangement.

However, as more fully discussed below, many such Sukuk structures also provide for a set of loan documents to be embedded in the transactional structure. These are not exactly typical mortgage loan documents that are compliant with capital markets requirements. They may in fact be a vain effort to mimic those kind of loan documents; but, as noted below, the path taken is anything but traditional from a capital markets’ prospective. For example, instead of providing for a first priority mortgage securing an interest bearing note, it provides for a putative mortgage lien securing a buy-sell arrangement between the borrower and lender. This is more like a preferred equity structures that mimics equity. Indeed, depending on the vagaries of the forum dealing with the matter, it might be interpreted as an equitable loan between the lender and borrower or it might be viewed as just plain equity. The buy-sell arrangement is another way of saying the preferred equity must be repaid. It purports to convert what looks like equity into a loan. However, even if that is the case, it is on a subordinated basis; rather than on a priority basis of the sort represented by a first mortgage against the property. There are real risks associated with this kind of arrangement, both structural and from a bankruptcy point of view, as discussed below[11].

Abu Hanifa[12] was one of the greatest known Imams in history.  He issued a Fatwa[13] (commonly known as the Hanifa Fatwa) ruling that there was no prohibition against charging Riba in a foreign land (i.e.: a country not under Islamic sovereignty and control and where Islamic law is not the law of the land). The Fatwa of Sha Abdul Aziz of India goes even further and just flat out permits Muslims to lend non-Muslims on interest[14].

It would appear that some Sha’ariah scholars have adopted the position that whether a Waqf, government treasury or bank, a legal person (i.e.: entity, as opposed to an individual) is not subject to the prohibition against Riba (when it pays or charges interest). This includes the scholarly work done by the Mufti of and various Sha’ariah legal authorities at the Al-Azhar University in Egypt. For example, Dr. Muhammad Shanqri al-Fanjar of Al-Azhar asserts that bank interest is not Riba. He views the blanket equation of Riba and interest as something to be avoided.[15]

Similarly, as noted above, Sheikh Dr. Muhammad Sayyid Tantawi, the Grand Mufti of Egypt and a leader of Al-Azhar, held that government bond interest is not Riba[16]. Dr. Tantawi viewed government bond interest as, in essence, a sharing arrangement in the government’s profits.

Dr. Tantawi also issued a Fatwa on December 2, 2002, in which he held, in effect, that bank interest is permitted, as more fully discussed below. In his Fatwa, Dr. Tantawi noted that it is well known banks fix the pre-specified return to depositors (i.e.: interest rate on deposits) after a detailed study of the international and domestic market conditions and the economic circumstances in society. This, as well as, the special conditions and nature of each transaction and the average profitability thereof are also considered by the bank in setting the pre-specified return (i.e.: interest rates) payable to depositors. He summarizes his position in the Fatwa as follows:

“In summary, pre-specification of profits for those who invest their funds through an investment agency with banks or other institutions is legally permissible, and above legal suspicion (la shubhat fiha). This transaction belongs to the domain of benefits that were neither explicitly permitted nor explicitly forbidden (min qabil al-masalih al-mursalah), and does not belong to the domain of creeds or formal acts of worship, wherein change and alteration is not allowed.

Based on what has been stated [we rule that] investing funds with banks that pre-specify profits or returns is legally permissible and there is no harm therein, and Allah [only] knows best.”

Shaykh Mahmud Shaltut Grand Imam of Al-Azhar ruled that post office savings interest and state bond interest was not prohibited Riba[17]. He reasoned that a pre-fixed share of the profits (which is equivalent to an interest rate) is not prohibited Riba, if offered by the State or an affiliate thereof. He goes on to say that there is no exploitation of either party in this kind of arrangement[18]. This concept is a dramatic breakthrough in thinking by Sha’ariah scholars. It laid the groundwork for the  even more dramatic Fatwa by Dr. Tantawi[19] noted above.

These eminent Sha’ariah authorities ruled that banks can, in effect, pay interest to depositors, in the form of pre-specifying the profits or return as a percentage of the amount deposited by the customer (i.e. interest in common parlance). It is not a percentage of the actual profits of the bank, In essence, just don’t use the term interest expressly and it’s permitted. Whether it’s a prefixed share of profits as a percentage of the principal amount invested or some other analogous formulation for interest, form appears to govern over substance.  Thus, the concept of “interest based” products being permitted as opposed to “interest bearing” products. Dr. Tantawi goes on to explain that the pre-fixing of profits benefits the depositor in this age of corruption, dishonesty and greed. He goes on to say that just as profits may be shared by two parties, so too can the parties agree that one would receive a pre-specified share of profits.[20] Tantawi rules that this concept does not contradict the Koran or the Sunnah. It benefits both parties and forbidding it would result in harm[21].

Others have found that the use of the term interest does not in and of itself violate the prohibition against Riba. Thus, Sheikh Dr. Yusuf Al-Quaradawi and others issued a Fatwa in October 1990, ruling that it is possible to use the term interest, instead of the term profit or rate of return, in order to benefit from the financial advantages granted by the relevant authorities in the West with regard to deposits and financings. This would include using the term interest in tax declarations or the documents used by the bank in various financings. It is respectfully suggested that this Fatwa recognizes the need for a parallel set of loan documents so as to better access the capital markets. At the same time, there would also be a Sha’ariah compliant structure and set of documents, so as not to fall astray of the requirements of the Sha’ariah. This concept is more fully discussed below. It is also helps support the proposed solution set forth in Section XVIII below.

Notwithstanding these well reasoned, expedient and useful Fatwas and scholarly approaches described above, that are sensitive to the realities of the marketplace and the human condition and provide a nuanced and practical approach to dealing with the issues, there are conflicting views. Some have scholarly pretensions but many are pronouncements made by the more nationalistic side of Islam. They do not seek to live side by side with non-Moslems or integrate. Rather, it would appear they want to conquer and impose their own brand of Islam on others. One such harsh critic of Islamic banking (including the Sha’ariah compliant forms they have adopted) was Osama Bin Laden. He was the notorious head of the terrorist organization Al-Qaeda until his demise. Among other dastardly acts, he was responsible for the 9/11 bombing of the World Trade Center and the thousands of deaths of innocent souls in New York City. In a rambling so called Fatwa he published[22], declaring war against the US, he included a statement to the effect that the banks in Saudi Arabia violated the prohibition against Riba. There was no discussion of the Sha’ariah or analysis of just how this was so, in theory or in practice.  It was just one of many baseless pronouncements he made in his so called Fatwa. Interestingly, notwithstanding his pronouncements, even Osama bin Laden reportedly had a bank account.

However, even as these extremist views are being forcefully expressed, interest or its equivalent is being charged and paid by Moslems in Islamic and non-Islamic jurisdictions. Described below are some of the so-called Sha’ariah compliant structures.

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[1] See An Economic Explication of the Prohibition of Riba in Classical Islamic Jurisprudence by Dr. Mahmoud A. El-Gamal (2001) in the Proceedings of the Third Harvard University Forum of Islamic Finance.

[2] Supra footnote 183 at page 6. Of Article by Dr. Farooq, noted therein. See also An Analytical Review of Different Concepts of Riba (Interest) in the Sub-Continent by Farooz Azizi, Muhammed Mahmud and Emad u Karin in Kasbit Business Journal 1 (1): 36-43  (Fall 2008)., that asserts that Riba is compound interest (i.e.: usury) and that it is extreme exploitation that is restricted by the Koran. It goes on to state that borrowing for trading purposes on interest and Bank interest is not prohibited Riba.

[3] a religious or other foundation.

[4] Supra Footnote 183, at page 10 of Article by Dr. Farooq, which cites the Fatwa of Ebusud Efendi, a 16^th century Mufti of Istambul, permitting a Waqf to charge interest. See also discussion by Timur Kuran,  supra footnote 162, at pages 7-8. See further discussion by Dr. El-Gamal,, supra footnote 176, at page 109. Finally, see The Concept of Artificial Legal Entity and Limited Liability Company by Mahmoud M. Sanusi in Critical Issues on Islamic Banking and Finance and Takaaful, beginning at page 192, et seq.

[5] A founder of the American Finance House-LARIBA.  Parenthetically, the term LARIBA can be loosely defined as no Riba.

[6] Reported in The Art of Islamic Banking and Finance at Page 213.

[7] See discussion below regarding this type of Sha’ariah compliant financing structure.

[8] As defined below.

[9] See, for example, the Beximco  UK case described in Section XII below.

[10] As defined below.

[11] See The Logic of Financial Westernization in the Middle East by Timur Kuran in the Journal of Economic Behavior and Organization, Vol, 56 (2005) beginning at page 553.

[12] A 7^th century Islamic religious legal authority and Imam.

[13] See Masri and Keller (1997)- Reliance of the Traveler: The Classic Manual of Islamic Sacred Law Umdat Al- Salik at page 944. See also Dr. Salah al Sawi, A Polite Reconsideration of the Fatwa Permitting Interest-Based Mortgages for Buying Homes in Western Society-2001 (www. Islamic-Finance.com), which argues that the Hanafi Fatwa should be limited to circumstances of necessity, only, where there is no other possible alternative.

[14] Supra Footnote 187, at page 38.

[15]Supra footnote 183, at page 25 of Dr. Farooq’s article.

[16] Ibid at page 17 of Dr. Farooq’s article.

[17] Ibid at page 16 of Dr, Farooq’s article.

[18] Ibid

[19] Chibli Mallat, Tantawi on Banking Operations in Egypt in Islamic Legal Interpretation: Mufti and their Fatwas at page 286 (1996). See also Fatwa of Ibn Baz ( Abdul Aziz ibn Abdullah ibn Baz),Grand Mufti of Saudi Arabia,  Ruling 137 in Volume 19 beginning at page 240, in opposition to Tantawi’s  view.

[20] Ibid at page 118.

[21] Ibid at page 119.

[22]  Dated August 23, 1996 and reproduced by PBS Newshour Online (at www.pbs.org/newshour terrorism/bin laden fatwa 1996…html).

The Sha’ariah, Prohibition Against & Analysis of Riba | IRR Part X

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

 

THE SHA’ARIAH- SOURCES OF THE PROHIBITION AGAINST RIBA

The Sha’ariah[1] is not a monolithic legal code. The Koran[2] and the Sunnah[3] (upon which the Sha’ariah is said to be derived,) are also not a legal code. Instead of containing precise answers to questions of religious law, they set forth broad guidelines.

In the period since the Koran, Islam did not experience a phase of codification in the development of the Sha’ariah of the sort experienced by the Halacha. There is no Sha’ariah equivalent to the encyclopedic work represented by the Talmud. There are also no codes of law like that compiled by Maimonides or represented by the TUR or Shulchan Aruch.

There is also no comparable body of legislated laws or common law to that in effect in the US. The US has federal, state and local laws that have been legislated and are binding on its citizens. The US also has a body of common law, with established legal precedents, that can be relied upon in courts or other proceedings. Neither of these hallmarks of the US legal system exist in Islam. While, some Sha’ariah scholars have sought to establish some sort of consensus (known as “Ijma”), this has not necessarily been successful in practice. It does not appear that such scholarly positions have actually been accepted as binding by most who profess to be members of the Islamic faith.

There is also no supreme authority that can determine questions of law like the Supreme Court of the US. In this regard, both the Sha’ariah and Halacha suffer from this same disability in modern times. Hence, the many conflicting views of greater or lesser authority or acceptance, that remain unresolved.

The Sha’ariah might fairly be described as a collection of views over the years, from a variety of sources. As noted above, many of them are in conflict. The sources of the views expressed include those of recognized legal authorities such as the Mufti of a particular Islamic state, as well as, those reputable scholars. It also includes the views of self-professed authorities and spokesmen of differing backgrounds, education and authority. All claim to derive their views from the Koran or the Sunnah. However, sometimes the Koranic text quoted in support of a particular position may not be so clear. As noted below, these claims may or may not survive genuine scholarly scrutiny. Indeed, as noted below, self-appointed spokesmen for Islam, such as Osama Bin Laden, apparently can successfully challenge the views of such leading legal authorities as the Mufti of Egypt’s Al Azhar Institute[4]. This is often done in the name of advancing a particular brand of Islam. There is often not even the veneer of a legal or scholarly approach to these pronouncements. As discussed below, just because someone says that the Koran says so doesn’t make it so. Fortunately, extremists, no matter how strident, cannot actually legislate and control how most members of Islam act in practice. Nevertheless, the extremists have caused a great deal of conflict, discussion and debate by established legal authorities.

In this regard it should be noted, that there is a dispute among recognized Sha’ariah authorities as to the very meaning of the term Riba and its application. Yet, there is no supreme authority, recognized by most of Islam that is capable of deciding the matter.

What is a Moslem in a non-Islamic state to do? How is a determination to be made given the lack of a supreme authority? Is everyone to make his or her own personal decision as to which Sha’ariah authority to follow? Are there mitigating circumstances applicable when living in a non-Islamic state? What about those who reside in an Islamic state that purports to apply Sha’ariah law; but, nevertheless permits foreign banks to make loans on interest and its own banks to do so, directly or indirectly, as discussed below? Moreover, which of the conflicting views is right? Absent a supreme Islamic authority recognized by most Moslems, does any Islamic state have the right to decide on its own?

Notwithstanding all the clamor about prohibited Riba and the pedantic distinctions between “interest bearing” instruments vs. “interest based” interments, the reality is that interest or its equivalent is being charged by all manner of banks or other lenders. This includes loans or its equivalent by Moslems to other Moslems. Indeed this has been the case both before Islam, after the inception of Islam and to date.

Is everyone just wrong or is there another interpretation of the Koran? Are there views espoused by religious authorities and scholars that can help explain these practices?

This article suggests that not everyone who charges or pays interest or its equivalent is wrong. But, the fact is many disagree with this proposition. Furthermore, as a practical matter, many Moslems can and do vote with their feet on the issue. Thus, as noted below, many Moslems have bank accounts. Many also borrow from banks using traditional interest bearing loan documents (and not Sha’ariah compliant forms,) because it costs less. In line with the foregoing, HSBC has reportedly closed its Sha’ariah compliant mortgage lending department in London. Consider, why should HSBC or any other bank offer something more expensive and complicated than a traditional mortgage loan when there is no genuine demand for the product. It would appear that Moslem borrowers rightly prefer the simplicity and lower cost of a traditional bank mortgage loan product. They also apparently want to earn interest on their insured bank deposits.

Is right to prohibit these beneficial financial products to Moslems? Is it better to offer Moslems only non-competitive financial products, that are at rates and costs less favorable than prevailing market terms? Is it fair to require Moslems to do so, all in the name of an interpretation of the Koran that may not be justified or appropriate? What about the relevant scholarly views and Fatwas issued by noted Islamic authorities that purport to permit the same, as discussed below; are they just to be ignored?

The answer is not clear. Thus, as discussed below, there appears to be no accepted definition of the word Riba, or of the rules governing the application of the prohibition against Riba, in practice. Instead there are conflicting views of the sort described below and practices accepted by some, but not all, of Islam.

 

ANALYSIS OF THE DEFINITION OF THE TERM RIBA

The Koran itself does not define the word Riba. Thus, although the Koran and the Sunnah use the term Riba, there is no explanation provided as to the meaning of the term. This includes the actual proscription set forth in the Koran itself[5]. While there is an example set forth in the Koran of prohibited Riba[6], there is nevertheless no actual definition provided in that text as well. This is similarly the case in the other verses[7] in the text of the Koran where the term Riba is used. in the Koran. Sha’ariah scholars and authorities over the years have grappled with the meaning of the term Riba and the rules applicable to the prohibition against Riba.

The text of the Koranic prohibition, noted above, set forth in Chapter 2, verse 275 of the Koran, is enlightening. It states that “Bay[8] is permitted and “Riba” is prohibited. What is Riba and what is the difference between Bay (trade) and Riba is not described. Thus, for example, (much like under the Halacha[9],) selling a note at a discount to achieve a given interest like yield is likely considered trade not Riba. On the other hand, accomplishing the same result directly by fixing a rate of interest in the note (to achieve the same yield) is generally reported to be prohibited, as Riba.

The example of prohibited Riba described in Chapter 3, verse 130 of the Koran can fairly be used to elucidate at least one meaning of the term Riba. The example given is of a lender who initially purports to make an interest free loan to a borrower. The borrower is unable to pay off the loan upon maturity. In order to obtain an extension, the lender charges the borrower double or quadruple the loan principal amount, as an extension fee. This is prohibited Riba according to the express provisions of the Koran. This is certainly an excessive and usurious rate of return. As discussed below, some suggest that hence, the term Riba, as opposed to the term “fa’eda” which means “interest” in Arabic, as noted below.

Timur Kuran derived the term Riba from the root “Rib”[10]. He goes on the state that the meaning of the term Rib is precisely the construct set forth in Verse 130 of the Koran noted above.

The Sunnah[11]also set forth an example of wrongful Riba[12]. Indeed, some scholars[13] link the term Riba only to the specific example given in the Sunnah of six particular commodity for commodity type transactions[14] and not any others. Thus, gold for gold, silver for silver, wheat for wheat, dates for dates, salt for salt and barley for barley transactions are expressly provided for in the Haddith. These items represent stored value in ancient times. Gold and silver both have intrinsic value. The other listed commodities can be dried and stored over time. In effect, they can be used (like gold and silver) to store value over time.

Under, this view, a loan of paper money (or trading in fiat currencies, as opposed to specie,) may not be covered by the prohibition against Riba. It is not one of the commodities expressly listed in the Haddith. Moreover, since paper currency is subject to depreciation against other currencies and inflation, it would appear that under this view, it is permitted to provide for inflation protection as well as depreciation against other currencies[15].  It is suggested that this view of paper money may be restated as, in effect, permitting the sale of credit (i.e.: a loan of paper money on interest), as a function of trade. There may be support for this proposition in the Malaysian Islamic Banking Law, which permits trade in debt (bay al-dayn)[16]

Sir Sayid Ahmad Kahn[17] suggests that the typical bank loan to a business (or even to an individual) does not exhibit the exploitive possibilities of a rich man lending to a poor man for consumption purposes[18], as contemplated by the Koran. Thus, the  Koranic prohibition is not applicable to the typical bank mortgage loan context, for the purpose of purchasing a house or investment property. Consider, the lender is typically not an individual, but rather a legal person. The borrower is not typically a poor person borrowing to eat; but rather someone looking to make an investment in a home, rather than renting, or in an income producing property, as a trade or business. Consider also the economic context where these mortgage loans generally occur. It is in a modern commercial economy, where money is the source of wealth. In addition, the rates of interest charged for use of the money are not excessive. Indeed, they are likely among the lowest rates charged to consumers in history.

Mahmoud Abu–Said[19], an eminent Sha’ariah authority, ruled that a market rate of interest is not Riba (or excessive interest).

In the 1930’s a Syrian Sha’ariah Scholar, Maroufal-Danalibi, asserted that the Koran only prohibited Riba with respect to consumption loans and not investment loans[20].

The Mufti of Egypt, Shaykh Muhammed Sayid Tantawi[21], asserted that interest may be charged with respect to government bonds.  He also noted that the Koran does not define the term Riba beyond contrasting it with Zakat[22] and Bay (trade). The only genuine example of Riba provided in the Koran, is that doubling or quadrupling of the principal amount of a loan, as an extension fee[23].

Some of the Sha’ariah authorities suggest that the lack of specificity in the Koran with respect to the meaning of the term Riba and it application was intentional[24]. In this regard, Dr. El-Gamal quotes Mohammad Taqui Usami[25] as follows:

“It must be understood that when we claim that Islam has a satisfactory solution for every problem emerging in any situation in all times to come, we do not mean the Holy Qur’an or the Sunnah…or rulings of Islamic scholars provide a specific answer to each and every minute detail of our socio-economic life. What we mean is that the Holy Qur’an and the Holy Sunnah…have laid down broad principles in the light of which the scholars of every time have deduced specific answers to the new situation arising in their age…”

The key according to some is to analyze the actual means by which Riba was charged at the time and understand that this is what Mohammed sought to prohibit. They go on to say that logic[26] can then be used to discern other analogous circumstances where the prohibition should be applied. This is a slippery slope for a number of reasons. First and foremost, there is no assurance, absent divine inspiration, that the positions asserted based on human logic alone are correct. Indeed many positions can be rationalized in the abstract. Hence the existence of many conflicting positions. Secondly, as Dr. El-Gamal suggests, can something good, like the lower cost of an “interest bearing” financial product, be prohibited in favor of a higher effective rate of interest attributable to an analogous “interest based” product?  Human logic can lead to the contrivance of devices that may be inherently flawed. After all, as Dr. El-Gamal[27] suggests, this incoherence is at once apparent and should be viewed as something wrong.

This can be analyzed on a number of levels. Thus, how could the Sha’ariah dictate that debtors be prejudiced with higher costs than would otherwise be the case (i.e.: when using an “interest based” Sha’ariah compliant financial product as compared to an ordinary “interest bearing” product compliant with capital markets standards). The Sha’ariah, Dr. El-Gamal notes, was intended to benefit debtors not prejudice them. How, therefore, can “interest based” products, employing complex synthetic or derivative financing structures and techniques (that are interest by another name) be permitted and lower cost “interest bearing” products be prohibited?

It would appear that, according to some, if the term “interest” is used, then it is generally prohibited. On the other hand, if an algorithmic or derivative formulaic structure is used that is wholly based on interest (which yields, in effect, a rate of interest), then that structure is permitted. Consider the structures and documents described below which are viewed by many as Sha’ariah compliant. Is it any wonder that some view these structures as mere artifice; nothing more than interest by another name.

Before discussing the details of these Sha’ariah compliant structures, it is important to understand the historical and legal context, including in terms of prior views on just what is Riba and how the prohibition against Riba is applied in practice.

As noted above, many Sha’ariah scholars use Fiqh (jurisprudence or logic) to decide a particular issue that is not expressly provided for in the Koran and Sunnah. These views are sometimes expressed in Fatwas.

Consider how the term Riba was defined by Abdullah Yosuf Ali[28], in his authoritative English translation of the Koran. He defines the term Riba as usury (i.e.: excessive interest) not ordinary interest[29]. He explains that only undue profit in the specific commodities listed in the Koran is prohibited[30]. He excludes economic credit and modern banking and finance from the purview of the term Riba.

M. Siddieg Noorzay[31] asks if Riba means interest per se, then therefore, it must be $0. On the other hand, he posits that a positive rate of return should be permissible, as long as it is not usurious. He goes on to cite Yusuf Ali as noted above, for the proposition that Riba means usurious interest; not ordinary interest.

Some, as noted above, have defined Riba as compound interest[32], as opposed to ordinary interest. Indeed, as noted above, the term in Arabic for interest is “fa’eda”, not Riba.

Notwithstanding all the authorities cited above, some Sha’ariah scholars still equate the term Riba with interest and prohibit it.  I can’t help but wonder if they personally have bank accounts and credit cards. Be that as it may, as discussed herein, actual practice by many good Moslems can vary from these pronouncements[33].

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[1] Loosely defined as the way or the path. It appears to be similar in meaning to the term Halacha, which may also be loosely defined as the path or the way.

[2] A book attributed to Mohamed that is said to be authored with prophetic inspiration.

[3] The Sunnah are a collection of reports by others of the (i) sayings of Mohamed (“Hadith”) and (ii) actions of Mohamed.

[4] A scholarly institution of authority and position within the Egyptian governmental and religious establishment of Egypt

[5] Chapter 2, verse 275. “Trade is just like usury; whereas Allah permits trading and forbids usury.”

[6] Chapter 3, verse 130, which provides that should not consume Riba  in the context of charging double or quadruple the loan amount upon maturity of the loan as a fee for an extension..

[7]  Chapter 2, verse 76; Chapter 2, verses 278-9; Chapter 30, verse 39.

[8] trade

[9] See discussion of T-bill vs. T-Bond in Section I above.

[10] In his article, The Logic of Financial Westernization in the Middle East (2004) at pages 2-3.

[11] In this case in a Haddith.

[12] ie: double or quadruple the principal amount as the cost for an extension beyond the original maturity date. (See Koran Section 3:130. Which speaks about Riba  in terms of doubling or quadrupling the amount loaned.

[13] Infra footnotes 167 and 196.

[14] Sahih Bukhar Volume 3, Book 34, #344.

[15] The Hanafi and Hanbali Schools of thought regarded fiat currency (as opposed to specie) as something not expressly covered by the 6 commodities listed in the Hadith described above..

[16] Infra footnote 176 at page 114.

[17]  A Sha’ariah authority in 19^th century India

[18].  Kahn discussed the concept of Riba (usury) vs. ordinary interest and asserted that the Koranic prohibition against Riba applied to the poor borrowing for necessities and not commercial ventures. (cited at page 10 in article by Dr Farooq noted in footnote 171 below.)

[19] Author of Contemporary Economic Issues: Usury and Interest (1986). See also Abdul Aziz, Islamic Corporate Finance: A Tool for Economic Development of Moslem Countries and Dr Mohammed Omar Farooq, The Riba-Interest Equation and Islam: Reexamination of the Traditional Arguments (2005).

[20] Islamic Laws of Riba (Interest) and Their Economic Implications in the International by M. Siddieg Noorzay in the Journal of Middle Eastern Studies 14, No.1 (1982) at page 3.

[21] In a Fatwa in1989.

[22] Charity

[23] Islamic Law and Finance: Religion, Risk and Return (Kluwer Law International, the Hague-1998) by Frank E. Vogel and Samuel L. Hayes III, at page 72.

[24] See  “Interest” and the Paradox of Contemporary Islamic Law and Finance, by Dr. Mahmoud A. El-Gamal, in the Fordham International Law Journal, Volume 27, Issue 1(2003), at pages 116-117.

[25] Ibid ,as quoted by Dr. El-Gamal from Usami’s  An Introduction to Islamic Finance (1988) at page 237.

[26] “Fiqh “, sometimes defined as jurisprudence

[27] Supra footnote 176. See also the Incoherence of Contract-Based Islamic Financial Jurisprudence in the Age of Financial Engineering, by Mahmoud El-Gamal, Rice University (May-2007).

[28] A 20^th century translator of the Koran into English

[29] As noted above, the term for interest in Arabic is “fa’eda”.

[30] Infra,  footnote 167.

[31] Islamic Laws of Riba (Interest) and Their Economic Implications in the International by M.  Siddieg Noorzay in the Journal of Middle Eastern Studies 14, No.1 (1982) at page 3.  Similarly, Egyptian legal jurist Al-Sanhuri in the 1940’s who asserted Riba is interest on interest, as noted in The Riba-Interest Equation and Islam: Reexamination of the Traditional Arguments by Dr Mohammed Omar Farooq (2005).

[32] Vogel and Hayes at page 46

[33] Supra footnote 179.

Definition of “Ribit”, Discussion of Prohibition | IRR Part II

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

 

THE DEFINITION OF THE TERM “RIBIT” AND A DISCUSSION OF THE ORIGIN AND NATURE OF THE PROHIBITION

The Bible,[1] in Deuteronomy[2] prohibits an individual from charging or paying “Neshech”[3] to another individual.  This includes Neshech as to money, food or other things for which Neshech is [typically] taken.

Another similar prohibition is set forth in Exodus.[4]  It provides that when an individual loans money to another then Neshech should not be imposed.

In Leviticus,[5] another term is introduced besides Neshech.  Thus, when helping someone who has suffered diminished circumstances, there is a prohibition against charging Neshech or “Tarbit”.[6]  The Bible[7] then goes on to say that you shall not provide money on the basis of earning Neshech or provide food on the basis of earning “Marbit.[8]

What is “Neshech” and what is “Marbit” is the subject of a discussion in the Talmud[9] in the Tractate of Bava Metzia,[10] aptly entitled “Eizehu Neshech V’Eizehu Marbit” (What is Neshech and What is Marbit).  It would appear that the term Neshech is usually used in the context of earning interest income on money that is loaned.  Marbit is a synonymous concept that is usually employed when dealing with a commodities futures contract for the provision of food as opposed to money.  Nevertheless the conclusion of the Talmudic discussion is that they both have the same meaning and can be used interchangeably.[11]  The more modern term “Ribit” is derived from the root of the Biblical term “Marbit” noted above.

What is and is not prohibited interest (i.e., “Ribit”) is discussed at length in the Talmud and among later Halachic authorities.  In this regard, I note in passing a Tosefta[12] that demonstrates just how abstruse the meaning of the term can be in practice.  Thus, the Tosefta states that there are things, which are Ribit; but are nevertheless held not to be Ribit.  Examples of the principle cited are then provided in the text.  One example given is concerning a loan that is sold at a discount.  Another is about an “Shtar”[13] (likely a commodities future document but possibly a bond) sold at a discount.  Both of these transactions yield what would otherwise be “Ribit” and yet the Tosefta holds they are not Ribit.

Consider, it is prohibited to charge or pay interest; however, it would appear to be permitted to sell, at a discount, the obligation to make payment by a certain date of a fixed sum.  In effect the typical sale of T-Bills at a discount to yield an equivalent rate of return to prevailing market interest rates is permitted.  However, entering into a T-Bond with the same rate of return (albeit, stated as an interest rate instead of a synonymous yield to maturity) is prohibited.[14]

Consider also a variety of items that are Halachically held to be prohibited Ribit; but which in common usage would generally not be considered to be interest, as follows:

1.         A thank-you note or gift;

2.         A service of some kind performed by the borrower for the lender that is not separately remunerated;

3.         A favor done by the borrower for the lender in response to the kindness of making an interest free loan; or

4.         An installment purchase agreement where the deferred purchase price is higher than the all-cash price.

5.         A bond or finance lease, where the Landlord (Lender) bears no risk of loss.[15]

On the other hand, selling one’s own check at a discount[16] is not considered to be Ribit.  Furthermore, while having two different sales prices, one for an all cash purchase and one for a deferred purchase is held to be Ribit; nevertheless, under certain circumstances, a price fixed on the basis of a deferred payment arrangement can be discounted for cash.[17]  Moreover, the Talmud held that a trust for the benefit of orphans could make loans and charge interest, which is exempt from the prohibition against Ribit, under certain circumstances.[18]

Is this all mere sophistry?  For example, is there a genuine difference between the T-Bill discount and the T-Bond stated interest rate noted above?  Under US Law the answer is that, in practice, there is no real distinction between the two concepts; they are in effect the same thing.  Why then prohibit one and permit the other under the Halacha and the Sha’ariah?  Is this really a matter of form over substance? It is suggested that the answer is not that simple.  It requires further analysis to develop an approach that may help answer this fundamental question.

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[1] Tanach an acronym (”TN’K”)- meaning Torah (the Five Books of Moses), Neviim (the Prophets) and the Ketuvim (the Holy Writings) also known as the Septuagint, the original Greek translation of the Bible that the Talmud views as authoritative

[2] Chapter 23-Verse 20

[3] The term “Neshech” is often loosely translated to mean interest but the word literally means a “bite” or “biting”.

[4] Chapter 22-Verse 24

[5] Chapter 25-Verse 36

[6] The term “Tarbit” is also loosely translated to mean interest but the word literally means an “addition”.

[7] Supra 26 . See Verse 37

[8] See definition of the term “Tarbit” above. The term “Marbit” also is loosely translated to mean interest but the word literally means an “increase” or “addition” and is derived  from the same root as Tarbit. See also definition of “Ribit” below, which is derived from the same root.

[9]The Talmud referred to herein is the Bavli. It is an encyclopedic work compiled and edited in about the beginning of the 6^th century in Babylonian by Ravina and Rav Ashi, who were the leading Amoras (Halachic spokesmen) of their generation. It is organized along the lines of a prior compilation of laws known as the Mishna, which was edited by Rav Yehuda, HaNasi (literally the leader) in the beginning of the 3^rd century in the land of Israel. Both works were intended to summarize the body of oral laws and traditions that explain and codify the law and lore sourced in the Bible in detail. Subsequent enactments are also detailed. The Bavli, which was edited in Babylonia, is to be distinguished from a prior version of the Talmud, known as the Yerushalmi (or Jerusalem version), which was edited in the Land of Israel. The printed text of the Talmud Bavli used is known as the Vilna Shas.

[10] Chapter 5

[11] Ibid.

[12] The Tosefta is a body of Tannaic writings that was collected but which was not included by Rabbi Yehuda, Hanasi in the Mishna, and the authoritative work of Tannaic literature he codified at the beginning of the 3^rd century.  It is thus helpful in terms of helping to understand the Mishna (as a contemporary expression of thoughts on the same subject matter as the Mishna, but is not itself authoritative. The concepts cited are found in  Chapter 4 of the Tosefta on Bava Metzia, in Paragraph 2.

[13] A written document that is witnessed by at least two qualified and competent witnesses. It is not an agreement in the sense understood under US law. Rather, it is what amounts to presumptive evidence as noted below.

[14] See an analogous example of selling one’s own check at a discount that is also not prohibited Ribit, as reported herein.

[15] A form of lease that is based on the so-called triple net form, but, one where the Landlord, in effect,  bears no risk of loss, at all. This concept of a lease being a prohibited Ribit or Riba transaction is more fully discussed below.

[16] As described in Brit Yehuda 15-17 by Rav Blau, provided don’t violate certain conditions.

[17] After the transaction is symbolically consummated by way of a kinyan.

[18] In the Talmud, Tractate  Bava Metzia at page 70a, there is a discussion about how a trust for the benefit of orphans may be permitted to charge what is considered rabbinically proscribed interest. Similarly, a charity may also be permitted to charge such Ribit. See also Tosafot (which posits that since the lender is exempt from the prohibition against  Ribit under these circumstances then so is the borrower) and Ritva on the text cited above.