CHAPTER 2 THE ISLAMIC MICROFINANCE APPROACH TOWARD POVERTY
2.3.1. Definition of Riba and Prohibition of Interest
The underlying prohibition of Riba is stated in the Holy Quran. The term and its nature are revealed in several verses, including reasons why it is strictly banned (Saeed 1999).
As discussed in the previous section, the technical meaning of Riba is ‘an increase’ that
12 The terms Shariah or Syariah are interchangeable. It originates from the rules that were dictated in the Holy Quran and Sunnah – the teachingss, practices and explanations rendered by The Prophet Muhammad.
is generally associated with the economic, banking and financial systems. In a specific description, Riba occurs when, on the top of principal capital or loan, there is an additional amount of profit.13
In the Holy Quran, Riba is mentioned in different contexts during the prophetic period, hence it results in several interpretations (Al-Harran 1993). First, Riba is associated with the moneylender tradition in the pre-Islamic period. The practice of usury is categorized as Riba al-Nasiah, which refers to lending money with excessive interest payments; usually this ‘loan shark’ practice is directed toward the poor (Saeed 1999).
This type of Riba also refers to ‘incentive for waiting’; in the modern financial system it is called the time value of money. The second type of Riba, Riba al-Fadl, is a return that is related to trade and commerce (e.g. commodity exchange) and a loan in kind (Lewis and Algaoud 2001). A detailed description of Riba is presented in Table 2.1.
Table 2.1. Classifications of Riba in Economic Transactions
Source: El-Diwany (2010)
In the context of Islamic economics, usury, in particular the interest concept, and other illicit trade and commerce transactions, are prohibited because:
13 The general concept in Islam in gaining profit is through trade, commercial transactions and productive investment. In this context, ‘commerce’ should be understood in the broader economic sense, since there are many business activities involved, for example, production of commodities and goods, logistics and transportation, sales and marketing, employment, financial transactions and other related contracts. However, commerce becomes unlawful (Haram) when there is any element of unjust, exploitative, speculative, deceitful or corrupt practices revealed. In addition, trade involving pigs, alcohol, drugs and narcotics is regarded as Haram.
Type of Riba Translation Application
Al Nasiah, Al Jahiliah or Al Qurud
Usury of waiting or time value of money
Involves a delay in an exchange of counter values, i.e. deferral of payment with additional profit; lending money with interest.
Al Fadl or Al Buya
Usury of incremental (surplus)
Increment of an exchange of counter values, i.e. one piece of gold to be given now in return for two pieces of gold to be received later; involves a non-monetary transaction
(commodities) exchange of unequal amounts of the same type, i.e. an amount of good-quality dates is traded for a larger amount of poor-quality dates.
Interest has an exploitative element that allows wealth accumulation in the hands of a limited number of individuals and/or economic institutions. Evidence shows that since early civilization, interest was a means for rich people to gain advantage from the poor. In other words, the interest-based system would create a huge socioeconomic disparity between the rich and the poor (Ayub 2008). This thinking is also evident in Judaism and early Christian teachings (Homer and Sylla 1991).
Interest related to the time value of money discourages an innovative spirit and hard work since a financial return can be generated from unproductive activities like hoarding and speculative business rather than investing in the genuine economic ventures that promote growth, job opportunities and prosperity.
Pre-determined interest allows one party (i.e. the investor) to earn bigger profits without sharing risk and equal effort, thus eventually it would create unjust and unethical behaviour (Al-Harran 1993).
Despite the prohibition of Riba, many Muslim clerics express different opinions in understanding the nature of Riba when it applies in the context of the modern banking and financial system. The mainstream dispute about Riba is represented in traditionalist and modernist views (Lewis and Algaoud 2001; Saeed 1999; Vogel and Hayes 1998).
The first view claims that Riba should be in understood as stated in the Holy Quran and the Prophet’s teachings, therefore all forms of interest must be eliminated from the economic and financial system (Ayub 2008). The proponents of this traditionalist approach argue that Muslim society should build its own model rather than operating as a subdivision of the conventional banking and financial system.
However, the modernists assert that Riba should be also viewed as a moral-spiritual principle especially in responding to the dynamic change occurring in Islamic economies and societies (Saeed 1999). The supporter of the moderate interpretation of Riba argues that the interest-based financial approach is acceptable if it is not excessive in nature and if the objectives focus on poverty alleviation and financial inclusion, and if the approach contributes to development in the society. In particular cases where only the conventional system is available, it would be permissible under emergency or certain conditions (Darurah). This view also demonstrates a compromise approach by adopting a dual model that enables the Islamic banking and financial operations to exist in conjunction with the conventional approach.
In Indonesia, for many years, the Riba interpretation has been a controversial issue among traditionalist and modernist scholars (Antonio 2004; Effendy 2003). According to Antonio (2004) the discourse of riba among the mainstream Islamic organisations such as Muhammadiyah, NU dan MUI dated from the colonial period, but the issue did not gain momentum since the organisations were more focused on education, economic and social activities. After the establishment of Bank Muamalat Indonesia (BMI) in 1991, the discourse of riba emerged however, due to political concerns, Muhammadiyah, NU and MUI were inclined to compromise that interest rate is riba but the practice of conventional banking was categorised permissible as long as the bank does not charge an excessive interest rate. In this case, Muhammadiyah and NU supported the establishment of conventional banks in order to provide financial services to their members. A similar view also demonstrated by MUI that interest rate of conventional bank could be accepted under a specific condition, i.e. emergency situation (Darurah) in which no Islamic banks were accessible. Accordingly, after the collapse of the New Order government, the majority of Islamic organizations reached a consensus that payment of interest is Riba and not permissible for Muslims to engage in the interest-based transactions. Officially, the Islamic National Council (Majelis Ulama Indonesia or MUI) declares interest is Riba through a nonbinding edict (Fatwa) No. 1/2004. Broadly speaking, many Muslims accepted the edict, but continued to borrow money from conventional banks because this was a long-established practice and there were limited practical alternatives (Antonio, 2004). Some Muslims use both conventional and Islamic banks, while a smaller number permanently switched to use the Islamic banking system. In this debate, the government has sought to accommodate the call of Muslims by adopting a dual banking system. In 2008, the Islamic Banking Law was introduced in order to provide a legal framework and equal playing field for the faith-based banking and financial sector to grow (see discussion in Chapter 6).