TUTORIAL 10

1. The basic principle of Islamic banking is the prohibition of Riba.

Discuss the evidence, rationale of prohibitions and types of Riba in Islamic banking
and finance.

SUGGESTED ANSWER:

Definition of riba:

Every excess in return of which no reward or equivalent counter value is paid / a

Evidence/Proof:

All jurists agree that riba is prohibited (haram) due to clear prohibitions

Various verses in Quran prohibit riba: al-Rum verse 39, al-Nisa: 161, al-Imran: 130, al-Baqarah:
275-281. For example:

(2:275) they say, trade is like riba, but Allah has permitted trade and prohibited riba
beware of the war on the part of Allah and His Apostle

Various sunnah on prohibition of riba, severity of its sin and its form. An example:

The Prophet of Allah s.a.w. cursed the receiver and the payer of riba, the one who records it
and the two witnesses to the transaction and said: they are alike (in guilt)

Rationale/reasons for prohibition of riba:

i.Element of injustice in financing productive activities:

Contract with unequal countervalues

Injustice to debtor obligated to pay interest even if business venture results in no

Injustice to creditor in event of substantial profits, creditor receives a return

The rich is able to generate more wealth without exerting much effort or contributing to
productive activity

Riba assumes money as a commodity, one which the rich has in abundance

iii.Inconsistent with Islams perspective on debt:

Incurring debt is discouraged

-Prophet s.a.w. refused to offer salat-ul janazah of a person who died indebted

-Borrowing money should be limited to cases of dire needs

-To practice moderation in consumption

However, permitting riba enables lending to become a viable business

-Banks motivated to lend as much as possible

-Banks exploit mans inherent greed to spend beyond their means

-Result in negative repercussions

iv.Negative effects of a credit society:

Easy availability of credit cultivates a materialistic society

-People work harder to repay bank debt

-Banks exercise control over people: become enslaved to banks

Quest for economic development clouds good moral judgment and Islamic value system

-Greed leads to unethical business practices: degradation of natural environment (to reduce
cost)

-Less emphasis on institution of family leads to social ills

Essentially, Muslims forget their roles as abd and khilafah

-Members of society should help each other in times of need

-Riba entails taking advantage of another people

-Breeds hatred, jealousy, ill-will towards the rich

v.Negative effects on production:

Impediment to healthy economic growth

-Riba-based lending is security-oriented rather than growth oriented

-Lending directed to established businesses:

=Creditworthiness and adequate security (collateral)

=Potential entrepreneurs without security to pledge are denied credit

Inefficient allocation of resources

-Bank interest return does not vary with actual profits, no incentive to give priority to ventures
with highest profit potential

-Lending based on creditworthiness, not profitability

Discourages innovation

-Interest obligations act as disincentive for experimenting with new, unproven methods of
production, especially for small-scale enterprises and agriculture.

Leveraged financing favors large-scale businesses

-Domination of big businesses over smaller entrepreneurs will curtail competition and in turn
will affect product variety and innovation

Anti-productive

-Inflexibility: in a loss situation leads to bankruptcies loss of productive potential and

Funding not channeled to deserving economic agents

-Utility of certain projects is with reference to criteria other than profitability

-E.g. projects that benefit the public, poverty alleviation

vi.Negative effects on distribution:

Disproportionate supply of credit to the already affluent segments of population since

Wealth inequality (in terms of purchasing power) is widened

Rich become richer and poor become poorer

Domination of large enterprises leads to demise of smaller economic units

Lacking collateral and established economic standing, poorer segments of economy at

Wealth and income disparities worsen

Transfer of real assets to the lenders

Debt-financing requires collateral in the form of real assets

In event of default, there will be transfer of real assets from borrower to lender

Long run, wealth inequality (in real terms) becomes prevalent.

Types of riba:

Riba al- Fadhl:

Riba of surplus/riba of excess; a type of riba that exists in, or results from, a sale transaction
whose underlying is a ribawi item. Riba of surplus or riba al-fadhl comes into existence in a sale
transaction that involves the exchange of one ribawi commodity/ribawi item (such as dates,
wheat, etc) for the same type of commodity but different amount or weight. For example, the
exchange of 10 kg of excellent-quality dates for 20 kg of poor quality dates. In simple terms,
riba al-fadhl arises from the exchange between two items of the same type, but in unequal
amounts, whether in terms of quality or in terms of delivery time.

The addition on one side of the transaction is in physical quantity rather than in value, and
whether that extra addition is initially stipulated in the contract or not.
Riba An-nasia:

A type of riba that exists in, or results from, a sale transaction which unduly benefits one the
counterparties in the form of a surplus or extra amount due to delay of delivery of his side of
the transaction. More specifically, riba al-nasi'ah arises in loan transactions (on the basis of
future repayment of more than the principal) as well as sale transactions (on the basis of
deferred price). An example of loan-based riba al-nasi'ah would be a loan with $1,000 principal
on which $1,200 is to be paid next year. An example of sale-based riba al-nasi'ah is a sale of 100
kg of dates to be paid back with 120 kg six month later.

This type or riba is clearly forbidden in Qur'an. It existed in the pre-Islamic era in the Arabian
peninsula, and thus was known as riba al-jahiliyah (riba of the era of ignorance).

2. Explain briefly how Riba al- Fadhl and Riba An-nasia arise in transactions by example.

SUGGESTED ANSWER:

(refer notes/ above explaination)