[ABSTRACT: The overwhelming majority of scholars have historically held that all interest falls under the rubric of ribâ, banned by the Qur'an. We argue that neither ribâ nor interest have been well defined in the Islamic literature. If we define ribâ as it is used in the Qur'an and sunnah and define pure interest as the term is used by Böhm-Bawerk, we discover that the terms are not synonymous. We demonstrate that some of the criteria traditionally used to identify ribâ, such as time-element, contradict the sunnah. We conclude that ribâ includes all forms of overcharging, including overcharging on interest (usury). We show that some practices held as harâm by the traditionalists are in fact mandatory in order to avoid ribâ. On the other hand the now common practice of issuing unbacked paper currency, scrupulously avoided by Muslims in the first 400 years of the Hijrah era, constitutes a form of ribâ which puts economies at great risk.]

Most of the scholars who have investigated the issue of ribâ have simply assumed that ribâ and interest are synonymous, and then pointed to the unambiguous denunciation of ribâ in the Qur'an to justify their opposition to all forms of interest. This is a very poor methodology. It trivializes an issue so complex that Umar listed as one of the three matters on which he wished the Prophet (peace upon him) had provided more guidance. My approach shall be to take for granted the prohibition of ribâ as being glaringly evident from the Qur'anic texts (3:130;2:275-279) and seek to establish what the word means. We shall then compare this concept against the concepts of interest, usury, and overcharging, and argue that the latter two are, depending on the context, better translations of the term ribâ than interest.

Semantically ribâ means an excess or an addition. The context of the discussion of ribâ in the Qur'an makes four things (besides its prohibition) abundantly clear: (1) that it involves amounts which are in some sense large; (2) that its distinction from legitimate trade is so obvious that only a madman could confuse the two; (3) that it may be contrasted to charity; (4) that it is unjust. It is critical to notice that the principle exposition on the subject of ribâ occurs in the middle of a passage on charity (in Surat-al-baqara):

(267) O ye who believe! Give of the good things which ye have (honourably) earned, and of the fruits of the earth which We have produced for you, and do not even aim at getting anything which is bad, in order that out of it ye may give away something, when ye yourselves would not receive it except with closed eyes. And know that God is free of all wants, and worthy of all praise.

(268) The Evil One threatens you with poverty and bids you to conduct unseemly. God promiseth you His forgiveness and bounties. And God careth for all and He knoweth all things.

(269) He granteth wisdom to whom He pleaseth; and he to whom wisdom is granted receiveth Indeed a benefit overflowing; but none will grasp the Message but men of understanding.

(270) And whatever ye spend in charity or devotion, be sure God knows it all. But the wrong-doers have no helpers.

(271) If ye disclose (acts of) charity, even so it is well, but if ye conceal them, and make them reach those (really) in need, that is best for you: It will remove from you some of your (stains of) evil. And God Is well acquainted with what ye do.

(272) It is not required of thee (O Apostle), to set them on the right path, but God sets on the right path whom He pleaseth. Whatever of good ye give benefits your own souls, and ye shall only do so seeking the "face" of God. Whatever good ye give, shall be rendered back to you, and ye shall not be dealt with unjustly.

(273) (Charity is) for those in need, who, in God's cause are restricted (from travel), and cannot move about in the land, seeking (for trade or work): the ignorant man thinks, because of their modesty, that they are free from want. Thou shalt know them by their (unfailing) mark: they beg not importunately from all and sundry. and whatever of good ye give, be assured God knoweth it well.

(274) Those who (in charity) spend of their goods by night and by day, in secret and in public, have their reward with their lord: on them shall be no fear, nor shall they grieve.

(275) Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say: "trade is like usury," but God hath permitted trade and forbidden usury. Those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (for ever).

(276) God will deprive usury of all blessing, but will give increase for deeds of charity: for he loveth not creatures ungrateful and wicked.

(277) Those who believe, and do deeds of righteousness, and establish regular prayers and regular charity, will have their reward with their lord: on them shall be no fear, nor shall they grieve.

(278) O ye who believe! Fear God, and give up what remains of your demand for usury, if ye are indeed believers.

(279) If ye do it not, take notice of war from God and his apostle: but if ye turn back, ye shall have your capital sums: deal not unjustly, and ye shall not be dealt with unjustly.

(280) If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew. Interest is a predetermined fixed rate of return. Usury means an excessive interest. Overcharging means an excessive price of any sort.

In the Prophet's day few loans were for the purpose of raising venture capital. The usual purpose of a loan was to allow persons in deep financial need to make it to next week. Due to the state of extreme need of such borrowers, the rate of interest on these loans tended to be exorbitant ("doubled and multiplied," 3:130), resulting in additional debt to the borrower as the interest charges made him worse off. The context of the quotes above, immediately followed by a fiery denunciation of ribâ and an entreatment to charity makes this circumstance clear (2:275-281). It is thus unsurprising that the early Islamic scholars perceived all commercial interest as usury.

At root of the attacks on interest is the assumption that by one standard or another it is unearned. There is certainly a distinction between the function of the entrepreneur and of the capitalist. The entrepreneur makes decisions, studies markets, takes risks in that his profit is not predetermined, etc. The capitalist does nothing. He is the owner of the money which the entrepreneur uses. (Note that the entrepreneur may also be a capitalist to the degree that he uses his own money, and the capitalist is an entrepreneur to the degree that he makes investment decisions and assumes risks). It is not risk that makes up "pure" interest, for to the extent that risk is involved that may also be considered entrepreneurial profit. The "capitalist" is then actually an "investor" who is then part entrepreneur and part capitalist. But the risk in a long term government bond does not explain the 6% interest rates current as this paper is being written.

Böhm-Bawerk (1959) has shown that the market rate of interest is not an addition to (or excess over) capital value. This is due to the fact that the source of value is the subjective desire of the participants in the market, and it is a fact that, subjectively, people tend to prefer access to their money now rather than in the future. The key here is access to money. It is true that there are numerous circumstances under which I would want to store my money for future use: a child's education, retirement, a nest egg against emergencies, etc. But even in these cases, I would prefer to have the right to get my principle on demand in case I change my mind. Thus there is a difference between demand deposits and time deposits. In the former case I have given up nothing, and it will indeed be an excess (ribâ) to collect interest. In the latter case, the present value of money inaccessible until a set future time is less than the present value of the same money with no such constraint. This time-preference means that a person considering a time-deposit is being offered a diminution of the subjective value of capital unless a compensatory interest is also offered. Those for whom the market rate of interest exceeds this value difference would be making a profit, but those for whom it is less will be taking a loss. Forcing someone to accept less than the market rate would thus constitute a diminution of the capital sum, a violation of the Qur'anic explication of the terms of the Qur'anic prohibition of ribâ: "but if ye turn back [i.e., abandon ribâ] ye shall have your capital sums; deal not unjustly and ye shall not be dealt with unjustly" (2:279). Thus we see the reason that discounts for cash and surcharges for credit, agreed to between vendor and buyer, have always been permitted by Islamic law.

How does interest on a loan issued by a third party differ from the discount for cash or surcharge for credit? From an economic point of view it does not, except that it adds greater flexibility to the market. Consider the case in which a buyer is willing to pay $2100 next year for a used car but the seller wants $2000 right now. A deal is impossible. But if a third party agrees to lend $2000 to the buyer in exchange for $2100 a year from now, the buyer is happy, the seller is happy, and the lender is happy. Prohibiting such a transaction serves no purpose. Islamic scholars who maintain that all interest is usurious are in the position of claiming that although it would be permissible for the buyer to pay $2000 now, or for the seller to accept $2100 next year, it prohibited for the lender to make both of these possible at the same time.

Abu-Saud (1986) agrees that such a transaction is not harâm, but distinguishes between it and loans for more general purposes. In the example I have cited the loan is for a specific purchase, with the lender as a clear substitute for the buyer in a clearly halâl transaction. Abu-Saud does not believe that the analogy can be further extended to what he calls "charitable debt." Should we consider all "clear cash loans" to be examples of charitable debt? Following the overwhelming majority of scholars, Abu-Saud (1986) argues:

The prohibition of paying an extra amount to the lender of cash is originally based on the fact that money is a "quasi commodity" and has no intrinsic utility, though it serves the purpose of obtaining the utilities of other commodities and goods. Unless its holder uses it, i.e. spends it, it would not give him any economic satisfaction. Thus, Islamicly speaking, if there is a surplus of money in the hands of its owner, it would not, and indeed should not, earn any yield as long as does not exert any effort or undertake any risk. The Islamic principle we should always remember is there is no reward without work and no work without reward.

This argument is erroneous, however, on a number of grounds. In the first place, money commodities like gold do have an "intrinsic" value (one should say use value). Natural monetary commodities, unlike paper currency, evolve a monetary value after being prized initially for their utility. The fact that their monetary utility comes to outweigh their other uses (say in industry or as ornamentation) does not change this fact. Indeed their monetary use only adds to their value. Further, the argument suggests a reliance on the theory of labor value that dominated the thinking of Adam Smith, David Ricardo, and Karl Marx, but which has been demonstrated to be false. Value is not determined by labor, but is subjective. The subjective nature of value leads to numerous consequences in economics, such as marginal utility and time preference. Following the discussion above, it is time preference that brings about a positive rate of interest. Thus the payment of interest is a means of compensating the lender for agreeing to defer payback, which constitutes a loss of value to the lender whom the Qur'an has guaranteed shall suffer no such loss.

The traditional Muslim position has been defended against this type of criticism on the grounds that it is merely the institution of interest that is opposed and not the de facto interest involved in all time-dependent transactions. Given the fungibility of money it seems that a prohibition on the institution of interest is easily circumvented, and there are numerous examples of such circumvention in Islamic history. I propose that there is one very important case where a prohibition on interest is difficult to circumvent, and I suggest that this may be the explanation for the peculiar fact that Islamic world in the classical era never achieved an industrial revolution.

In most cases any proposed fixed interest transaction can be converted into an equivalent (for purposes of marketability) profit-sharing transaction. This is the theory behind the so-called "Islamic banking." There are a few exceptions. Treasury bills, which pay an interest that is not derived from business profits, are a problem, but that problem is gotten around in an Islamic economy by avoiding deficit spending. A more serious problem is reflected in the fact that extremely high risk investments are difficult to finance in the absence of fixed interest. This has been demonstrated by Abdul Aziz (1993) in the case of Islamic economies, but the general principle is obvious in the following hypothetical case. Consider an entrepreneur with an idea so revolutionary that he cannot persuade anyone of its profitability. His offers to various capitalists to permit them a share in profits that they are certain shall be non-existent is fruitless. No profit/loss sharing ratio can be advantageous enough to entice them. Even if he offers them 100% of the profits and none of the losses, they would decline because they would not sacrifice the opportunity costs for what they perceive to be non-existent chance of profit. This would explain why it was the West and not the Muslim world that produced commercial products like electricity and the automobile which were considered laughable ideas by all but the visionaries who brought them to the market.

Let us now return to the definitions of the terms of interest. Most authorities claim that ribâ involves a fixed non zero rate of return for one commodity against a like commodity over time. An examination of the hadith which Abu-Saud (1986) deemed authentic on this subject demonstrates that this interpretation is incorrect on the following grounds. The Prophet (peace be upon him) included in this prohibition certain spot transactions such as the exchange of dates of differing quality unless the exchange was mediated by a market price evaluation of the commodities being exchange. This is traditionally known as ribâ al-Fadhl. Thus we have a kind of ribâ in which no time element exists. Conversely, one can have transactions in which deferred payment with a surcharge for credit is permitted, as we have seen above. Then time element is clearly not the defining element of ribâ.

Then what is the defining element of ribâ? I propose that it is overcharging. This is the element in common in every example given in Qur'an and hadith. The insistence on a market evaluation of the dates in the barter exchange of unlike materials is clearly representative of a concern over overcharging. The same applies to the Prophet's prohibition of brokers' taking unfair advantage of caravans unaware of changes in market prices. A fraudulent misrepresentation of the market price constitutes ribâ:

A man displayed some goods in the market and took a false oath that he had been offered so much for them, though he was not offered that amount. Then the following Divine Verse was revealed: "Verily those who purchase a little gain at the cost of Allah's covenant and their oaths ... will get a painful punishment." (3:77) Ibn Abâ Aufâ added, "Such a person as described above is a treacherous Ribâ-eater (i.e. eater of usury).

When overcharging is applied to fixed rates of interest, it is called usury.

It follows that interest may or may not be usurious, depending upon whether or not the rate charged exceeds the market clearing rate of interest. But when would an agreed-to interest rate exceed the market rate? The answer is clear when we return to the context in which the Qur'an denounces ribâ: namely, when a charitable loan is at issue. It is only the poor and needy, etc. who agree to pay usurious interest rates because of their disadvantaged position in the market place. The Muslim is prohibited not only from charging such rates but from paying them. That is, because such a rates is illegal, lenders who would charge higher rates than they themselves are willing to accept are forced to take market rates. But the context makes clear that in these cases we should give charity instead. This may be in the form of an interest-free loan, or outright sadaqa.

To understand this consider the following case of overcharging to which the principle enunciated in the Qur'anic passages would clearly apply even though there is no time element:

A boatman takes people across the river for one dinar. One day, as he is crossing the river he sees a drowning man calling for help. He tells the drowning man, I will give you a ride, but you must pay me. The drowning man, of course, agrees. The boatman says: the cost will be everything you own plus everything you ever earn from now on. The man is no position to argue, he agrees. The boatman takes him aboard and delivers him to the other side, and demands his payment. The man refuses and offers instead to give him the one dinar standard payment. The boatman drags him before a qâdî and demands payment in full. One would hope that the qâdî would apply the Qur'anic principles and say that the EXCESS (ribâ) charge is harâm, and that while the boatman is entitled to the market value (i.e. one dinar) that in this case charity would be better for him. Such overcharging constitutes ribâ (al-Fadhl) despite the absence of a time element.

Ribâ, as the term is used in the Qur'an, clearly refers to usury. In the hadith it appears to be extended to all forms of overcharging as "having an element of ribâ in them." Such overcharging was made possible by the disadvantaged position of the borrower in the former case and by the withholding of information about market price in the latter case. Discount for cash and surcharge for credit, which are Islamicly permitted are examples of interest and clearly demonstrate that interest and ribâ are not synonymous. Further, there is no distinction between rental for money and rental for non-depreciating land, so that a prohibition of one without a prohibition of the other is a contradiction. Finally, the misidentification of ribâ with interest combined with the common use of unsound currencies permits borrowers to engage in ribâ with impunity. To wit, consider of I wish to borrow a certain quantity from someone which is equal to 100 units of some currency. If interest is prohibited, then I will pay him back in 100 units of this currency one year later. If the currency is sound, he has his principle returned to him (ignoring the fact that I've cheated him of his time preference). But if the currency is unsound, like an Israeli shekel, it may only be worth half of what he loaned me as measured in a sound currency. Now I have robbed him of half the principle, which is undeniably a violation of the Qur'anic injunction.

Of course, if Islamic countries would issue sound currency, then at least this component of ribâ could be removed from time-dependent transactions. The main component of the nominal (as opposed to real) rate of interest in modern economies is the anticipated rate of inflation and that, in economies using paper currency, this rate is dominated by government's tendency to debase the money supply. Neither the Prophet, nor the khulufah rashidûn, nor any other Muslim rulers of the first 400 years of Islam engaged in the fraudulent practice of debasing the money supply, which was a principle reason for the society's dynamism and success [see main paper]. Return to the practice of relying in sound currency would eliminate most nominal interest. Then debates over the legality of interest could center around the small residual which is attributable to time preference.

REFERENCES

Abu-Saud, Mahmoud 1986, Contemporary Economic Issues: Usury and Interest (Cincinnati: Zakat & Research Foundation).

Aziz, Abdul 1993, "Islamic Corporate Finance: A Tool for Economic Development of Muslim Countries," Procedings of the AMSS Fifth International Islamic Economics Seminar (9-10 Oct. 1993) Washington DC), in press.

Böhm-Bawerk, E. V. 1959, Capital and Interest, vol. II, trans. by W. Smart (New York: Kelley & Millmanm, Inc.).