Yves here. This post has more political significance than many readers might appreciate. Even though the issues that Öncü discusses may seem unduly doctrinal and therefore abstract to non-Muslims, they are extremely important to believers. Riba is the second worst sin in Islam. Shirk is the worst. If you commit that sin, you are not Muslim anymore.
In addition, the post also contains important historical information on the development of “Islamic finance” and shows how it was closely linked to the rise of neolibearlism.
By T. Sabri Öncü (firstname.lastname@example.org), an economist based in New York
To elaborate on the question, let me quote five ayats from the Quran that ban “riba” (Arabic: ربا) first and explain “riba” later. These ayats are from the surah Al-Baqarah:
Ayat 275: Those who consume riba cannot stand except as one stands who is being beaten by Satan into insanity. That is because they say, “Trade is just like riba.” But Allah has permitted trade and has forbidden riba. So whoever has received an admonition from his Lord and desists may have what is past, and his affair rests with Allah. But whoever returns – those are the companions of the Fire; they will abide eternally therein.
Ayat 276: Allah destroys riba and gives increase for charities. And Allah does not like every sinning disbeliever.
Ayat 278: O you who have believed, fear Allah and give up what remains of riba, if you should be believers.
Ayat 279: And if you do not, then be informed of a war from Allah and His Messenger. But if you repent, you may have your capital – you do no wrong, nor are you wronged.
Ayat 280: And if the debtor is in difficulty, give him respite till the time of ease; and your foregoing the entire debt from him is still better for you, if only you realise.
The above are not the only translations and debates on whether the Quran can correctly be translated to other languages or not have been going on for centuries. I selected these translations among many candidates and modified them slightly.
Is Riba Usury or Interest or More?
The word “riba” is translated into English at times as “usury”, at other times as “interest” and yet at other times as “usury/interest”.
If you view “riba” as interest, however, then it is clear that these ayats are nothing other than a broadly defined debt restructuring programme. And, Ayat 275 bans interest forever after the restructuring.
And, since the word “usury” does not fit well in this debt restructuring programme, the word “usury” cannot be an appropriate translation of “riba”.
One of the key words in this programme is the word “capital” which appears in Ayat 279. It is the translation of the Arabic word “ruus-u amwal” (Arabic: أَمْوَال رُءُوسُ) which is the plural of “ras-ul mal” (Arabic: المال رأس). However, since capital is uncountable in English, both the singular and plural forms have to be translated as “capital”.
Those translators who view “riba” as interest only also translate this word as “principal” to mean the principal amount of some debt. However, the word “principal” refers only to capital in money form whereas capital can take many forms.
For example, Piketty (2014) defines capital as the stock of all assets held by private individuals, corporations and governments that can be traded in the market no matter whether these assets are being used or not. Of course, Marxian economists strongly disagree with this definition and point out the Marxian definition of capital as a process, not a thing (Marx 1992). These are not the only definitions of capital and I should mention that at the time of Prophet Muhammed another important form of capital −which has existed since antiquity− was merchant capital.
In any event, since the Arabic word “ras-ul mal” does not refer to capital in money form − that is, interest-bearing or usurers’ capital− only, “riba” cannot be viewed as interest only.
No doubt, interest is a form of “riba”, but “riba” is more than just interest.
Riba as Unjustified Gain
“Riba” is a noun in Arabic that means “increment” or “addition” and in the context of the Quran translates to “unjustified excess” or, equivalently, “unjustified gain”. Here is how one Islamic scholar describes “riba”:
However, the concept of riba is a lot wider than is commonly understood. The term riba need not be restricted to any amount charged on cash, but can also mean any kind of excess given over and above any commodity. So any excess paid by a borrower of, say, wheat, to a creditor also implies riba.
Prior to further progress, let me mention that debates among Islamic scholars on what exactly “riba” means in the context of the Quran has never ended and it seems unlikely that these debates will end anytime soon. This means that while many Islamic scholars will disagree with me strongly, there will be many others who will agree with me wholeheartedly.
Classical economists starting with Adam Smith and his contemporaries defined “unearned income” as “economic rent”, and there is no doubt that “unearned income” is a form of “unjustified gain”. Therefore, if one agrees with that “riba” is “unjustified gain” and accepts classical economists’ definition of “unearned income”, then “riba” goes beyond interest and incorporates economic rent also.
The rent you collect from your land or your real estate is a form of economic rent and interest is nothing other than rent on money, but, as Hudson (2016) describes below, economic rent is more than these:
[E]veryone deserves to receive the fruits of their own labour, but not that of others. Classical value and price theory provided the analytic tool to define and measure unearned income as overhead charge for access to land, minerals or other natural resources, bank credit or other basic needs that are monopolized. It aimed to distinguish the necessary costs of production – value – from the unnecessary (and hence, parasitic) excess of price over and above these costs. This monopoly rent, along with land rent or credit over intrinsic worth came to be called economic rent, the source of rentier income.
Hudson (2016) continues:
Land rent is what landlords charge in payment for the ground that someone’s forbears conquered. Monopoly rent is price gouging by businesses with special privileges or market power. These privileges were called patents: rights to charge whatever the market would bear, without regard for the actual cost of doing business. Bankers, for instance, charge more than what really is needed to provide their services.
Before concluding this section let me mention that since it is extracted through the ownership of capital, it is unquestionable that what Marx (1990) called surplus value (a part of the product of their labour workers must abandon when they work for an alien entrepreneur) is also a form of “unjustified gain”. Therefore, although surplus value is not exactly a form of economic rent because it may or may not be decomposed into a rent component (Marx 2000), it should be considered as “riba” as well.
Let me now conclude this section with that Islam and capitalism cannot be compatible for the simple reason that “riba” is banned in Islam, not to mention other reasons.
Ban “riba”, there cannot be any capital accumulation and hence no capitalism.
“Sharia” and “Islamic Finance”
As is well-known, “sharia” is the Islamic law. And according to Islamic scholars, “sharia” compliant “Islamic finance” contracts (which they claim can be traced back to the time of Prophet Muhammad) must be based on risk sharing between contracting parties. Furthermore, they claim also that “Islamic finance” contracts must avoid “gharar” (Arabic: غرر ) which literally means uncertainty in English. They claim this because “gharar” is banned in the Quran (the word is not specifically mentioned in the Quran, but two ayats, namely, Al-Baqarah 188 and An-Nisa 29, are believed to refer to it).
But this is a contradiction in terms.
As is well-known, there are two types of uncertainty: 1) we know the potential outcomes and their probabilities; 2) we do not even know the potential outcomes, let alone their probabilities. Risk is about the first type of uncertainty, but if there is no uncertainty, then there is no risk to share.
Furthermore, especially in the case of finance and economics, the first type of uncertainty hardly ever exists because although on occasions potential outcomes can be known, objective probabilities that can be associated with the outcomes hardly ever exist. Most probabilities that can be associated with known potential outcomes in the case of finance and economics are subjective without question.
Origins of “Islamic Banking”
As Kuran (2004) noted, prior to the 19th century there were no durable financial institutions recognizable as banks in the Muslim world. Although many banks (mostly non-Islamic or traditional) in several Muslim countries had appeared in the 19th and early to mid-20th centuries, the first “modern” commercial “Islamic” bank, Dubai Islamic Bank, was established in 1979.
Coincidentally, 1979 is the year of Iranian revolution which brought Islamists to power in a “modern” state for the first time and some have argued Iranian revolution gave rise to a wider resurgence of Islam across Asia, Africa and elsewhere in the world (Hefner 2010).
But this is not the only interesting coincidence.
The year 1979 coincides also with the beginning of the Deng–Volcker–Thatcher–Reagan revolution (also known as the neoliberal restoration programme) of 1978–80. With this revolution, the economies started to polarise between creditors and debtors, and the debt burden started to shift from the public sector to the private sector (see, for example, Öncü 2016).
If you cannot convince Muslims to participate in the financial system (don’t they call this convincing “financial inclusion” these days?), how can you shift the debt burden from public to private in Islamic countries?
Enter Muslim World League and Organisation of Islamic Cooperation
Both the Muslim World League (MWL) and the Organisation of Islamic Cooperation (OIC) are organisations that came to existence relatively early in the era that started when the United States (US) took over the world leadership from the United Kingdom (UK) at the Bretton Woods Conference in 1944. Both of these organisations had the blessing of the US and have been supported by the petrodollars of Saudi Arabia and the Gulf Region. Together with the now world renown Muslim Brotherhood, they have been among the major instruments of the well-known US green belt project to construct a barrier against the Union of Soviet Socialist Republics (USSR) along the USSR’s southern border.
The MWL (known in the Muslim world as Rabitat al-Aalam al-Islami or Rabitat) is a “non-governmental” organisation based in Makkah, Saudi Arabia. It was established by the government of Saudi Arabia in 1962 and has been funded by it till now. Many of Rabitat’s Jurisprudence Committee members are prominent figures in the world of “Islamic Finance” advising governments as well as “Islamic Banks” on the subject.
The OIC came to being in 1969 upon a decision of a summit held in Rabat, Morocco by Muslim countries following the arson of Al-Aqsa Mosque in Jerusalem. Its first conference of foreign ministers was held in Jeddah, Saudi Arabia in 1970 and it was decided to establish a permanent secretariat in Jeddah headed by the OIC’s secretary general. Together with the International Monetary Fund and the World Bank–not to mention Wall Street− the OIC has been one of the main promoters of “Islamic finance” for decades. Indeed, among the OIC’s current priorities is investment and finance, and hence “Islamic finance”.
From Wall Street to Halal Street
Let me allow a scholar who knows Malaysia way better than I to speak (Rudnyckyj 2013):
Islam has played a pivotal role in the state’s development strategy, as the state has sought to develop industries and services deemed suitable for an increasingly educated and skilled labouring population. Scholars have noted how the state has strategically deployed Islam to discipline the population and create an environment conducive to economic growth…
With the active encouragement of the developmentalist state, Japanese, American, and European firms set up shop in extensive industrial zones and hired a vast number of new workers to provide the labour for export-oriented growth. Islam was deployed by corporations and the state as a means of disciplining especially the young, female labouring population involved in high-tech assembly…
Thus, ‘government policies seek to bring Islam in line with capitalism’ by promoting a form of Islam that is fully compatible with the state’s development objectives…
The promotion of Malaysia as a global hub for Islamic finance is part of state strategies to sustain the nation’s impressive record of economic development since the early 1970s. In part, efforts to foster the growth of Islamic finance are an outcome of how religion and ethnicity have been integrated into …”postdevelopmentalism” in Malaysia.
Let me finish this section with one last quotation from Rudnyckyj (2013):
Islamic finance experts had long bemoaned the dearth of potential employees with training in Islamic finance and the lack of educational programs to train such professionals … For example, the former deputy governor of the Central Bank, Dato’ Muhammad Razif, who was responsible for the Central Bank’s Islamic finance portfolio, stated, ‘If you critically review, even in Malaysia, [Islamic finance] has been based on imitation rather than innovation … Our starting point is compliance, it’s not sharia-based. The bankers right now are converts; conventional bankers transformed into Islamic bankers. Of course [their] mind sets are conventional … My suggestion [is] that banks would employ sharia scholars as bankers’ …
Innovation or Imitation?
Most “Islamic finance” products are some form of special purpose vehicles (SPVs). And SPVs were invented in Wall Street in the 1970s when the Government National Mortgage Association wanted to sell securities backed by a portfolio of mortgage loans.
Let me now allow Gorton and Souleles (2007) speak:
An SPV, or a special purpose entity (SPE), is a legal entity created by a firm (known as the sponsor or originator) by transferring assets to the SPV, to carry out some specific purpose or circumscribed activity, or a series of such transactions. SPVs have no purpose other than the transaction(s) for which they were created, and they can make no substantive decisions; the rules governing them are set down in advance and carefully circumscribe their activities. Indeed, no one works at an SPV and it has no physical location.
They also say:
In short, SPVs are essentially robot firms that have no employees, make no substantive economic decisions, have no physical location, and cannot go bankrupt.
Given what I have said about “riba” so far, I have doubts that Allah would accept any of these.
Let me mention one last thing about “Islamic banking”. In any country where there is “Islamic banking”, “Islamic” banks and conventional banks coexist. And “Islamic” or not, all banks are subject to reserve requirements.
Do you think any bank can obtain reserves without paying interest on them?
Let me now conclude with what I started.
Is “Islamic finance” Islamic?
Gorton, G B and Souleles, N S (2007): “Special Purpose Vehicles and Securitization,” in “The Risks of Financial Institutions”, Editors: Carey, M and Slutz R M, National Bureau of Economic Research, pp 549-602.
Hefner, R (2010): “Religious Resurgence in Contemporary Asia: Southeast Asian Perspectives on Capitalism, the State, and the New Piety.” Journal of Asian Studies, Vol 69, No 4, pp 1031-1047.
Marx, K (1990): “Capital Volume I”, Penguin Books
Marx, K (1992): “Capital Volume II”, Penguin Books
Marx, K (2000): “Theories of Surplus Value”, Prometheus Books and Humanity Books.
Piketty, T (2014): “Capital in the Twenty-first Century,” Belknap Press.
Rudnyckyj, D (2013): “From Wall Street to Halal Street: Malaysia and the Globalization of Islamic Finance,” Journal of Asian Studies, Vol 72, No 4, pp 831-848
Öncü, T S (2016): “TINA, India and Economic Liberalisation,” Economic & Political Weekly, Vol 51, No 29, pp 67–71.