Disconnect Between Riba Theory & Practice, Concerns About Separation of Church & State in US | IRR Part XVI

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 DISCONNECT BETWEEN RIBA IN THEORY UNDER THE SHA’ARIAH AND IN PRACTICE

As Dr. Mahmoud A. El-Gamal[1] pointed out in his most insightful article “Incoherence of Contract-Based Islamic Financial Jurisprudence in the Age of Financial Engineering”[2] (May 2007), there is a disconnect between the goals of Islam and the methodology chosen to avoid the strictures against Riba.

I would suggest, as noted above, there is also a disconnect between the artificial contract forms and structures used and how they might be interpreted under US law as compared to what they were intended to accomplish.

Furthermore, Dr. El Gamal notes that even when the capital markets have dealt with Sha’ariah compliant financial products (embodying equity like legal structures, so different from the loan products they are intended to mimic), they cost more than the equivalent loan product.  It is submitted that if these religious oriented financial products were actually fully tested in the US courts and the courts properly interpreted the text of these legal documents, it is likely that there would even be a greater pricing disparity.  Indeed, for good reason; because the legal structures are based on re-characterizing a loan as equity, with all of the attendant risks, including, intervening creditors, claims of lack of priority and difficulty of enforcement associated with such products.  These deficiencies usually result in pricing disparities.  Moreover, it is unclear whether there even is a summary enforcement remedy of foreclosure, which is also fundamental to the pricing of a loan product.  Frankly, it is likely that the very nature of the documents is open to question.  After all, it is not supposed to be a loan; or is it?

The response of the English courts is cogent.  They found that it’s not their business.  They chose instead to deal with the note itself and not the overlay of Sha’ariah compliant legal structures and the documents; and, as noted herein, well they should.  This is because the enforcement of these structures is fraught with all manner of legal difficulty for all the reasons noted herein and likely others as well.

This kind of analysis echoes the views of Rabbi Epstein in his work the Tosefot Bracha[3] noted above.  He noted the success of the banking function in promoting commerce and prosperity and yet it appeared to be prohibited Biblically.  There was a disconnect.  How could something so good, be so wrong?  His answer was cogent.  He found that the new world of commerce and finance was to be embraced and that this was indeed what the Talmud was suggesting, thousands of years before.  Whether it is the original Iska (part loan and part investment trust) structure or its further development in the Heter Iska, the Halacha  is not fixed; it is vibrant.  It developed mechanisms to meet the needs of the real world and market place.  Similarly the Sha’ariah and the mechanisms described above that are Sha’ariah compliant.

Nevertheless, to be fair, it requires some further practical changes, because nefarious debtors have sought to misuse the US courts to defeat their obligations.  However, if properly employed in the religious setting, only, as intended, then it serves a vital function.

In the case of a Heter Iska, ordinary loan documents can be signed and, as noted below, a separate instrument (whether on the wall and unsigned or signed only by witnesses and not the parties), resolves any religious concerns about Ribit.  This while not upsetting the requirements of the capital markets and US law.  Hence, religious matters are dealt with in a way amenable to religious authorities and the wonderful benefits offered by the capital markets are embraced.  As noted below, this kind of approach, in practice, may provide a useful solution as to how to deal with similar Sha’ariah law concerns.

Dr. El-Gamal also notes that the higher cost of the Sh’ariah compliant version of a financing, as compared to an ordinary loan, is also of concern.[4] Ideally, this should be a focus of Islamic jurists and mitigate against a wholesale rejection of the benefits of the capital markets approach under US law.  Why not find a way to accept these lower cost formats on some expedient basis? Thus, Dr. El-Gamal points out the focus on “contract forms” as a means of purporting to provide financial products and services in accordance with Islamic law or Sha’ariah may in fact be misguided.  In essence, instead of extending a mortgage loan on most favorable terms and rates, the Sha’ariah banks are purporting to buy the property first and then re-sell it to the customer in a credit priced transaction where the borrower still pays on the basis of a benchmarked implicit rate of return on capital comparable to (but higher than) prevailing mortgage rates.  He points out that this, therefore, should be viewed as fundamentally adverse to the interests of the Sha’ariah in protecting borrowers.  Why engage in this kind of exercise if the result is to hurt and not benefit borrowers? As noted above, the structures become very complicated and with each level of complication there are added concerns about enforceability and additional costs and pricing.  Moreover, ultimately, the whole structure appears to be a ruse.  There are other structures not discussed in this article that add even more additional layers of structure but the common theme is that ultimately it is all just a mechanism.  At its heart, it is just an analogue; a means by which a loan with interest is derived.  The form takes precedence over the substance.  Is this what religion has come to stand for? Do it one way, as a matter of form, and it’s OK and, yet do the very same thing in substance, using another form and it’s not.

The incoherence that Dr. El-Gamal speaks of has many different layers of application.  Frankly, as noted at the beginning of this article, the objects of each system may be the same, to facilitate the movement of capital from those with a surplus to those in need.  The methodology chosen may not always perform as intended, especially when the structure is subjected to the laws of another system.  Hence, there is further incoherence, as it were.

The solution may lie in the concepts expressed below.  Instead of forcing one religion’s internal solutions on another conflicting legal system, it may be more effective to minimize the intrusion.  Why not adopt the best each system has to offer and do so in a manner that limits interference or entanglement.  Set forth below is a possible solution.

 

BLOWBACK BECAUSE OF REAL LIFE CONCERNS ABOUT SEPARATION BETWEEN CHURCH AND STATE IN THE US

There are reportedly initiatives underway in at least 7 States and reportedly as many as 22,[5] to ban the use of Sha’ariah in their State courts.

Bill Mears of CNN in discussing the matter,[6] reports that this is in reaction to a most disturbing case in New Jersey.  It would appear that  a lower court judge refused to grant a restraining order against a Muslim husband who was accused by his wife of forcing her to have sex with him.  The husband defended himself against the charge of rape by asserting he was just exercising his right as a husband under Islamic law to have marital relations when he so desired.  Thus, he was acting in accordance with his religious beliefs, albeit wholly inconsistent with US law that viewed his actions as nothing more than rape.  Fortunately, the New Jersey Appeals Court[7] intervened and overturned the lower court’s decision to deny the wife the protection of a restraining order.  The New Jersey Appeals Court found that the case “presents a conflict between the criminal law and religious precepts.”[8]  The Appeals Court went on to say “In resolving this conflict, the judge determined to exempt (the husband) from the operation of the State’s statutes as the result of his religious beliefs.  In doing so, the judge was mistaken.”[9]

Earlier this year, a Florida Senate panel approved an anti-Sha’ariah bill.  Scott Keys[10] reported that the panel deliberated for 3 minutes.  The bill had already been passed by the Senate Judiciary Committee.  A concurrent bill was also to be voted on in the Florida House.  The proposed legislation would ban the use of foreign laws like the Sha’ariah in Florida courts.

A similar ban was on the ballot in Oklahoma to amend the State Constitution.  The initiative was preliminarily enjoined by the Federal Court of Appeals in the 10^th Circuit.[11] Under the Oklahoma version, the State Constitution was to have been amended to mandate its State courts to apply only US law and not International law like the Sha’ariah.[12]  Legislators in Louisiana, South Carolina, Utah, Tennessee, Texas and many other States are undertaking similar legislative initiatives.

There are in fact conflicts between Western law and traditions and other systems of law like the Sha’ariah.  They cannot be readily integrated.  The differences are striking and irreconcilable.  My own view is there is no reason to meld these conflicting systems of law and ethics.  Rather, they can and should continue to exist side by side, as discussed in this article.

---

[1] A noted Islamic scholar who is the Chair of the Islamic Economics, Finance and Management and Professor of Economics at Rice University.

[2] Supra footnote 176. See also supra footnote 179.

[3] Supra footnote 42

[4] See also Handbook of Islamic Banking, page 94, which notes that Islamic banks in England are more expensive more than conventional banks for the same types of credits. The Handbook is edited by M. Kabir Hassan and Mervyn K. Lewis.  It is published by Edward Elgar Publishing, Inc. of the UK and Northampton, Mass. in the US. It may be referenced on the Internet as well.  See also “Interest and the Paradox of contemporary Islamic Law and Finance” by Mahmoud A. El-Gamal of Rice University; Losing Interest:  Financial Alchemy in Islamic, Talmudic and Western Law by Michael H. Lubetsky; Islamic and Jewish Perspectives on Interest by Joel S. Newman (89 Tax Notes 1311-12/4/2000); Contemporary Practices of Islamic Financing Techniques by Dr. Ansaf Ahmad (1993); and Issues in Islamic Banking by Mahammad Ne Jatillah Siddiquim; The Islamic Foundation, Leicester, London UK (1983/140314 at page 152).

[5] See Report by Scott Keys in ThinkProgress.org on February 29, 2012; Report by Donna Leinwand of USA Today on 12/9/2010; and Report by Bill Mears of CNN on 11/29/2010.

[6] Ibid

[7] S.D. v. M.J.R., 415 N.J. Super 417, 2 A.3d 412 (2010).

[8] Ibid

[9] Ibid

[10] Supra footnote 190

[11] Awad v. Ziriax  (Federal Court of Appeals-10^th Circuit Index # 10-6273-Jan. 10, 2012).

[12] See Op Ed by Michael A. Helfand “A Law We Don’t Need” – LA Times (November 10, 2010).

Sha’ariah Compliant Structures | IRR Part XII

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

 

SHA’ARIAH COMPLIANT STRUCTURES

Under the Sha’ariah, various transactional structures have been developed that mimic a loan structure, with an interest-like payment, but, which are intended not to fall astray of the prohibitions against Riba.[1]  The term “Sha’ariah compliant” has been used to describe these various formats. In essence, like Rav Chama’s dictum in the Talmud,[2] a derivative-like structure may be formulated that creates a stream of interest-like income, but does not fall astray of the prohibition against Riba.

It would appear that words do matter. In essence, calling interest rent or a deferred purchase premium price is deemed to be Sha’ariah compliant, as noted below. As more fully discussed below, the Sha’ariah compliant formats outlined below can be said to be a loan analogue, which at its very essence is a loan repayable with interest. However, the form of the transaction is something else, it would appear that in this context, form does govern over the substance.

All this is fine and good when tested wholly within the religious jurisprudential system that gave birth to the concepts.  However, when the particular mechanisms are analyzed and tested under another system of law, then unpredictable and unexpected results can occur.  To better understand the issues, set forth below is a description of some of the more prevalent Sha’ariah compliant structures.

When dealing with real estate financings, one of the following Sha’ariah compliant  structures is generally employed:

1.         Murabaha;

2.         Musharaka; or

3.         Ijara.

The “Murabaha” financing structure is based on a credit price that has a premium built in to account for the time value of money.  Thus, the credit price is higher than the all-cash price that would otherwise pertain.  It generally takes the form of an installment sales agreement.  When real estate is being financed, it conforms to a deed of trust like legal structure, as more fully described below.

In the Murabaha structure:

1. The borrower agrees to pay for the property over a period of time in agreed upon installments.  These obligations are set forth in a deed of trust like document that secures the payment obligations.
2. In the event of a default, the borrower is liable for the full contract price.[3]  The contract price is equal to the full amount of the principal amount advanced by the lender  plus interest, costs and other fees.  These are all rolled up into the deferred purchase price.  These amounts can’t be charged separately.
3. The conveyance of actual title to the property from the middleman (i.e., the lender’s designee as the holder of the deed of trust) generally awaits the time when payment in full is made.  This is the recommended procedure.  Some do make the conveyance immediately after the documentary closing.  This would tend to make the transaction appear more like a conventional mortgage financing structure.

The need for the lender or its nominee to hold title to the real estate during the term of the financing until payment in full is made is a serious structural problem for the typical bank lender in the US.  The ownership of real estate brings with it all of the burdens of real estate with none of the benefits (which remain with the borrower).  Thus, unlike the typical mortgage where the lender has no real responsibility for operating or other liabilities of the real estate, in the Murabaha structure, technically, the lender bears these responsibilities.  Indeed, a clever Plaintiff’s attorney might successfully argue that this is in fact the case.  Once the jump is made from religious documents enforceable only under religious law to actual US legally enforceable documents, there are a number of unexpected consequences that may ensue.  This goes beyond just issues of priority in a legal and/or bankruptcy context.  It also includes such matters as environmental issues, slip and fall cases or landlord and tenant claims.  Indeed, it is possible in a bankruptcy scenario that the lender’s claims may be equitably subordinated to other creditors claims because the lender is, in effect, the owner of the real estate.

The “Musharaka” financing structure is similar to a Heter Iska format.  The term “Musharaka” literally means partnership.  It combines a partnership-like relationship with a put/call as to the lender’s ownership interest in the investment vehicle.  The put price is unrelated to the value of the property.  It is based on a deferred purchase price arrangement,[4] as more fully described below.

In the Musharaka structure used by some banks:

1. The lender contributes (loans) the funds needed by the borrower to acquire the property.  The lender does so under an agreement whereby it ostensibly will participate in the profits generated in accordance with a pre-agreed formula.
2. The borrower participates by managing the joint venture and putting in so-called sweat equity.[5]
3. The borrower buys out the lender over time by making periodic payments (of what amounts to principal plus interest) until full ownership of the property is acquired at the end of the term.

The Musharaka structure compounds the issues noted above relating to the Murabaha.  This is because in the Musharaka, the lender and borrower are actually described as partners.  The fact that it may be a disguised loan under US law might enable the borrower to thwart the lender if there is any equity value over and above the loan amount.  On the other hand, in a loss situation, the buy out concept actually subordinates the lender’s right to payment to the creditors of the joint venture, which would likely take precedence under US (and especially bankruptcy) law.

The “Ijara” financing structure is based on a lease to own structure, as more fully described below.

In the Ijara structure, the lender buys the real estate and leases it to the borrower.  At the end of the lease, the lender sells the property to the borrower for the original acquisition price.  The rent is equal to the interest that would otherwise be charged for the loan.

The lease payments are said to be for the use of the real estate.  However, the rent is not a market rent.  Instead the amount fixed is nothing more than interest on the principal amount advanced by the lender.  It bears no relationship to the fair market rental value of the property.  Indeed, if the lease were tested in a US court, it might be viewed as a sham.  In reality it is a nothing more than a disguised loan (or, in the context of real estate, sometimes referred to as an equitable mortgage[6]).

The loan documents for the Ijara are based on a lease structure, as follows:

1. The term of the lease begins on the date that the asset (i.e., real estate) is delivered by the borrower/tenant  to the lender/landlord.
2. The tenant cannot be forced to buy the real estate at the end of the term of the lease.  The tenant however, has the option to purchase the property on or before the expiration of the term of the lease.
3. To be Sha’ariah compliant, the lease should not be the kind of triple net financing lease, noted above, where the tenant assumes all of the obligations as to the property leased and the lender bears no risk of loss.  The lender, as the landlord, must retain some risk of ownership.  This might include paying the real estate taxes, bearing the risk of loss on a fire or other casualty and paying for property insurance and/or structural repairs.  However, under the Sha’ariah (as opposed to the Halacha) the tenant may agree to reimburse the landlord for these expenditures, which would be rolled up into the lease payments.  Under the Halacha, this risk of loss must be borne by the landlord and can’t be reimbursed by the tenant, or it’s not a genuine lease.

There has been some effort made to adapt this kind of Ijara structure to the capital markets.  Thus, Fannie Mae reportedly committed to invest $10 million in home financings originated by the American Finance House Lariba Bank.  Using this kind of structure.  However, it is of limited applicability because it varies so much from the typical capital markets financial products that are based on a loan payable with interest.  It also fails because of all of the other concerns noted above.

Other lenders like the Bank of Kuwait (through the Al-Manzil Islamic Financial Services in New York), reportedly use the Murabaha structure noted above for home mortgages in New York, Connecticut and California.  Guidance Financial Group, in Washington DC, reportedly uses the Musharaka based structure for its real estate loans.

Besides the capital markets concerns noted above, there are also other concerns; they range from regulatory and accounting concerns (i.e., having real estate instead of loans on the books and because a bank lender cannot generally be in the real estate business[7]) to tax issues (like who is the real owner for depreciation and other purposes or is the transaction treated as nothing more than a disguised loan).  There are also significant title concerns (i.e., who is the real owner), as outlined below.

The matter of title insurance can be very challenging.[8] This is because the typical mortgage lender requires a lenders policy be issued as a condition to closing.  Under the typical lender’s title policy, the lender is ensured that:

(i)             it has a priority first mortgage lien on real estate;

(ii)           it is also ensured that its borrower is the sole owner of  the real estate; and

(iii)          that title to the real estate is not otherwise encumbered, except in a manner expressly agreed to by the lender.

This is antithetical to this Sha’ariah compliant structure.  While attempts have been made to create a lenders policy based on the Murabaha, as the equivalent of a deed of trust (in lieu of a mortgage), as noted above, this may not  necessarily be the functional equivalent.  This is because, there is a difference between insuring a first mortgage lien securing a loan and insuring the payment obligations under an installment purchase agreement (which may not be insurable at all).  The Murabaha is even more complicated because it’s a partnership and a buyout of a joint venture interest in the entity that owns the property.  In the case of the classic Ijara, there is no lender’s policy.  It is submitted that a leasehold title insurance policy is possible.  However, in the classic Ijara, it’s not a mortgage or loan at all; or is it?

Interestingly, the conceptual arrangements embodied in the three Sha’ariah compliant structures, outlined above, were not followed in practice by the Talmud, for a variety of reasons.[9]  Nevertheless, the Sha’ariah embraced them and hence the differences between these bodies of law that derive from the same Biblical sources of prohibition.  They however evolved in their own unique fashion over time.

Thus, for example, the Talmud prohibits a credit price that is higher than the all-cash price.  The Sha’ariah, on the other hand, does not accept this Talmudic prohibition.  It is not Biblically proscribed[10] and like the lease of real estate structure noted above, the Sha’ariah developed in a different direction from that of the Halacha.

The Talmud also did not accept the concept of a lease being exempt from Ribit, where, as a practical matter, the landlord bears no actual risk of loss, as noted above.  A true lease requires the landlord to bear the risk of loss for fire or other casualty.  Thus, in the case of a fire, the tenant is not liable to replace the property.  The Sha’ariah overcomes this issue by asserting (although technically speaking, the landlord must bear some risk of loss), that doesn’t mean, contractually, the borrower can’t agree to reimburse the landlord for the loss.  The Halacha doesn’t make this fine distinction and views this as a disguised loan arrangement and not as a true lease.

Connect with Leonard Grunstein on Facebook

---

[1] As discussed above, the definition of Riba is in dispute. Some Sha’ariah authorities maintain that it is only interest on interest (i.e., compound interest) or a usurious rate of interest that is Riba and Haram (prohibited as a sin). Ordinary interest would not therefore be Riba according to these authorities. This seems to mirror Western traditions that prohibit excessive interest (i.e., usury) but not ordinary interest.

[2] Supra footnote 118

[3] The contract price has no relationship to the actual value of the property. It is as noted above just a loan with interest by another name.

[4] i.e. just like the contract price, the put price is the principal amount of the loan plus interest and other costs, all rolled up into one fixed amount.

[5] I note in passing, that under the Heter Iska arrangement, the recipient manager must be paid separately for this work. It can be a somewhat higher percentage of profits to recognize this contribution or even a nominal sum paid for the services.

[6] Consider the analogous concept of a car lease. It is just financing paper if the monthly rent is not a market one. An artificial rent amount that is nothing more than a monthly installment of principal and interest is likely a financing device; not a genuine lease. Similarly the purchase option; a fair market value option price is indicative of a real lease. On the other hand, a fixed purchase option price that is the equivalent of what the principal outstanding balance would be for a loan product with the same payment terms is likely a financing device and not a real lease. There are differences in the tax treatment of a real lease and a financing device. A business may deduct rent under a genuine lease of property used in the business. However, only interest is deductible in a loan not the payments of principal. Furthermore, if really a financing device and the true beneficial owner is the borrower (with all of the benefits and burdens of ownership and otherwise satisfying the applicable requirements of the IRS), and then the borrower may be entitled to a depreciation deduction.

[7] There are limited exceptions upon a foreclosure or deed in lieu and then only for a limited period of time.

[8]  See Insuring Title and Islamic Restricted Financing by Junie E. Caspi (2004).

[9] There is a third line of reasoning reported in the Talmud (Talmud Tractate Bava Metzia page 69b) which differs from the Iska structures noted above and which has not been followed in practice.  In Tractate Bava Mezia (Talmud Tractate Bava Metzia page 69b), Rav Chama (an Amora in the Talmud) considers the concept of one individual renting money to another.  It would appear that this might be a possible construct whereby the individual providing the money could charge a rent for the money.  The Rivash (Rav Isaac ben Sheshet, a 14^th century Halachic authority) explains that the basis for Rav Chama’s view is that in fact words (i.e., form) do matter (over substance). Thus, by referring to the transaction as a rental and providing for the payment of an annual rent and not interest, the proscription against Ribit might be avoided, according to Rav Chama.  Tosafot (supra footnote 118, alongside the text cited above) in commenting on this text notes that there is a difference between a lease of an article of personal property and a lease of money.  In the case of personal property, the article is returned intact at the conclusion of the lease.  Moreover, as a matter of law, it is the lesser who bears the risk of loss on a casualty (as opposed to the lessee).  Thus, a lease of property is not really comparable to a lease of money.  Money, after all, is fungible.  Thus, once the money is used by the lessee it is unlikely that the same money would be returned. Also, if the money is stolen, what then?  Does the lessor/lender bear the risk of loss or does the lessee/borrower? Although Rav Chama’s concept was not followed in Halachic practice, interestingly, though, this approach found greater acceptance under the Sha’ariah, as more fully described below.

[10] See the Mishna on page 60b of Talmud tractate Bava Metzia. See also the Tosafot (as well as the Ritva) on the text describing how this is a Rabbinical enactment and not Biblically proscribed,

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].

---

[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.