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Economic Rationale Of Riba Prohibition And Implications

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The establishment of a practicable system of economy: -

Islam encourages the economy to work in natural way and roots of which are very practical without any exterior forces to do so. That put forth the very reason of being a human to perform at its natural capacity level without exploitation of oneself.

Enabling every one to get what is rightfully due to him:-

Islam being a religion beyond boundaries allow people to earn wealth by actually participating in the work process thus earn the wealth by putting ones efforts directly and practically.

Eradicating the concentration of wealth:

It is of utmost importance in Islamic jurisdiction that the wealth should not be shaking in the hands of few people rather it is encouragingevery one to earn halal income.It is done to reduce the gap between Rich and poor that is result of natural process of economic system.

Economic Rationale of Riba Prohibition and Implications

If we analyze the interest based economic system, we can depict is inefficiency from its incapability of allocation of resources and growth as evident from past track record of the same.

Conventional economists claim that their mechanism of interest based economy assures and guarantees the efficient utilization of available funds. As per Keynesian theory of efficiency that every investor looks for marginal efficiency of investment as their focal point but it is also believed that discount rate(interest rate) is determined by demand and supply. The decision making point is always that MEI must be greater that determined Discount rate or else the project can not be undertaken. he point of discussion here is that what will happen to those projects which do not comply with the MEI/DR? Here comes the utilization of those funds which will remain unutilized, Islamic economic system believes in the risk and profit sharing mechanism thus labor productively will be improved in comparison to conventional based system how ever it should be noted that the same problem still persists in both economic systems that is of prediction of discount rate.

It is also being noted that interest based economic system which is regulated infact controlled by Interest rate factor is affecting the global economy severly.Shariha has strictly prohibited the use of Riba at minute level where as Riba free system offers profit and loss sharing system which is expected to be free from all these contradictions as a whole.

An example of economic exploitation Riba: A person who lends Rs. 100,000/= at a fixed rate of 10% annually hence he will get 10,000/= extra for the waiting of his one year hence he is selling 100,000 for 120,000 without doing any labor work which is doubtlessly an economic exploitation.

Not only Islam but also other religions have rigorously prohibited the Riba. The economic reasons are as follows:

Riba stimulate the wealth to accumulate in few hands chasing major portion of wealth in the hands of few that is going to be problematic for rest of others.

Islamic economic system allow to earn profit only if subject is exposed to risk of loss.In conventional banking system most of the projects are lent by banks are not of their own but of the deposit holders so they just simply relend the existing liability at higher cost they don’t do any thing else and doest not constitute own funds mobilization.

As grounding principle of Islamic finance that promotes distribution of wealth with natural process unlike conventional ones that promotes to earn if you have capital only.

Refraction of Money from its nature of being MONEY:

Having gone through and studied economics in my academia everyone has studies the functions of Money as Medium of exchange, measure of value or store. To understand how riba or Interest changes the function of Money, please refer following example:

A person who has Rs.500,000 in his pocket, He lends Rs. 500,000 to B person on grounds that he will pay 10% interest rate on the amount person A lends to B. At the year end B returns the same with 500,000+50,000 as Interest income to A now he has 550,000 at year end that becomes his income.In this scenario function of money changes to Trading of money from medium of exchange. Money is not a good itself that is sold in market and earn money on it because it has no utility in it.

Interest exploits the system:

DrEjaad, PhD in Islamic Finance explained the exploitation of economy through interest back system. He narrated that cost of money doubles and redoubles after every specific period of time and thus this calculation and system of multiplication continues. Suppose there is a economy named A in which Rs100mn is injected through a business by a Only bank in that country at the rate of 10% thus at the year end economy must be having available funds of Rs110mn with no roll over option available. What if a person who has borrowed from bank goes default? The bank who has funds of general public will also be near to bankruptcy. It is to be noted that it also creates money over money in the economy now at the year end Bank A has 10mn extra to lend to another person for another interest income. Hence Bank earns interest on interest which is exploitation of system.

Positive correlation with Inflation

It is crystal clear fact that interest rate is co determinant of inflation and that affects and is being affected by inflation on real basis. Increase in rate of the inflation results in deflation of real interest rate causing decrease in demand for money, On the other hand supplier of money raises nominal interest rates so that real interest rate does not fall which ultimately results in increase in inflation rate which shows direct correlation of inflation with interest rates hence raise in inflation will result in rise in interest rates and lower demand for money.

It is also supported by the exclusive study of Steven Doldfield (1973), he concluded that for the period from 1952 to 1973 10% increase in interest rate cause three percent reduction in real demand for money M1 and thereafter reduction in demand of money results in declining GDP, keep in mind that interest rates affects Money demand, supply and GDP however no extra output was produced at large.

Debt slaves- Global economy.

As reported by HDR 1992 that rich are becoming riches and the poor are becomingg poorer. In 1960, the worth of one billion population out of 5bn was better off than the worth of thirty billion population of the global economy. It was also putforth that the net transfer from rich countries to poor countries is getting lower by lower i.e for every one dollar poor nations get as loan by rich countries they pay off 11.1 dollar in return to the same, a true example of debt slavery.

Catastrophic effects on Society:

Apart from real monetary effect of Riba, it has severe effects on moral and humanity of the society at large and it is done by accumulation of wealth in the hands of few. Which triggers risk free holding of capital, there by business failure, inequality of income, unemployement and inequal distribution of wealth.Islam as a religion of peace, supports the fair dealing in every work where as such process sucks the blood of human at large thus sticking the same to the holder of risk free capital.

Unjustified pre-determined rate of return:

Money given for investment and business purpose can not predict the rate of return on the investment and it is impossible to know ahead that what will be the rate of return on the same and there is also chance of loss in this game. Therefore, it is unjustified to charge predetermined rate of interest on the investment on which rate of profit is unknown which is morally not justified itself. Capital provider should share the risk in loss and profit if he wants to earn the profit.

Function of interest in endorsing saving:

It is generally believed that interest rate becomes the source of income for those who has saving and thus promote investment and economic development globally.But the fact is other round of the coin, Financial crisis 2008 and Asia crisis are few of the examples of Interest rate miracles that caused huge setback to global economy with special reference to Asia. Financial crisis of 2008 is basically mortgage back crisis and Riba was the major factor behind this.

Above picture depict that Interest basically sucked the economic system into vain and resulting in huge setback to global economies and leaving behind millions of people unemployed. For saving purpose interest rate is not ONLY important factor to ponder on, there are others too like income level, need of consumption, inflation, economic and fiscal measurements and ability to save.

Rent on capital- yes interest is not.

It is putforth before the people by conventional economist that interest is the rate of return of the person who takes risk for lending the money to a person he doest not know and does not trust, it is compensation of the inflation, risk of lending and opportunity cost. Islam does not consider anything halal unless person takes the risk of loss as well and participates in the work and share profit and loss. But how come he earns a fix rate of return on the loan he makes to a person who himself does not know what will be the future return on the same investment in a given period of time.If he does not know the rate of return himself how come he can offer the fixed rate of return to the person who even does not participate in the labor.

Against the wish of Allah:

Allah creates this world and implements His own rulings over His people. It is we who changes the divine guidance. Look at today’s injustice with those who need the money for their routine maintenance where as rich takes the benefit of it and corroborate it as his income. Analyze the virtue of it that Riches charge more than he owes to him and its contrarary to the Divine rulings to help the person who is needy without any ulterior benefit because it is between you and ALLAH and it was never between you and person seeking help.

Unemployment and inflation

It is specifically has been proved by the famous economists including Weitzman concerning inflation and unemployment with respect to effect of Interest rates. Interest rate has direct and positive effect on cost of production, thus higher the interest rates higher the cost of production thus complication the investment and declining in the same. Hence workers are at the verge of unemployment so that cost of labor can be controlled. On the other side, due to increasing interest rates, investors increase the price of their product so that marginal cost can be recovered thus cost push inflation occurs.

Contrary to this when there are lower interest rates then investors opt for capital intensive techniques in which labors are replaced with heavy machinery items.It is now proved that stagflation do exists as earlier it was not entrusted.Todayunemployement and inflation can coexist and economists have suggested that profit sharing mechanism is the only mechanism that can solve the mystery of stagflation

Economic resources are not utilized properly due to selective projects:

In interest based systems and banking with the same, work under fixed rate of return on both sides of liability. One on the deposit holders where they are promised the fixed rate of return and same on loan side where borrower has promised to pay fixed rate of return regardless of the position of business. In this regard, banks take very selective venues for investment and grants loans to big giants only those who have ability to repay even in case of default. When they find lack in party , the proposal is rejected on the grounds of security. Hence all the sources of economy are not utilized properly which could have been used to produce and increase the GNP of country. In conventional economic system only security and probability of return is considered not the economic well being.

Interest and entrepreneurship

In this fast growing economy, enterprenuears play a key role in the development of economy.They are key piilars of economic structure of coutry because they are sole determinents of the progress.The very fact is that they lack in security they just have idea and ability to produce. Due to lack in mortage and security interest backed banking does now allow and grant loans to them on the other hand big land lords and big firms do the same by using their ideas and capitalized the ideas of young entrpreneuers thus they are not paid which is due to them and discourages the new rising starts and this is also one of the key hindrends of economic development in developing economies.

Interest and stability in the economy:

A well proven fact in today’s field of economics is that interest rate plays a key role in the very reason of stability of the capitalist economy.An independent study by Milton Friedman concluded that the only factor behind erratic behavior of US economy is due to Interest rate. This does not only affect the predictability of economy but also cost of doing business, fluctuations in sectorial development, unpredicted movements in loan based investments, stock prices and commodity prices. It also creates gap between long term and short term investment plans due to volatitle cost of funds, investment also becomes volatitle due uncertanility of interest rates thus affecting rate of savings in economy because due to uncertainityin cost of funds, banks are left with excesss funds with them thus banks offer lower rates of return to deposit holders.

Profitability and productivity

From the research it is evident that interest rate plays intermediary role between productivity and profitability. Opponents of Islamic economy argue that profit sharing system reduces the profitability of giant firms and banks but the fact is that it spreads the profit to larger masses than shaking in few hands. Due to sharing of profit, partners put their maximum possible efforts to work hard hence productivity increases in comparison to conventional counter parts loan based investments.Thus Interest based economic system reduces the productivity and profitability at large.

Specifically speaking why each type of Riba is unacceptable :

Riba Al Nasiha: Riba Al Nasiha is redirected at pricing the money in a lay man language. Riba Al Nasihasimply means charging above or over the principal without any due consideration.

The economic reasons why Usury is prohibited in Islam is as follows:

Usury as Unearned Income

It is very simple to understand that money is not commodity or has not any utility in it that can be priced for. Any gain earned on the same is considered as unearned income because it is earned without putting any efforts in it

Double Billing

Universally accepted truth is that through riba fake money is created by charging interest from one and lending the same accumulated interest to an other one and charging the interest from them too.

Usury as Exploitation of the Needy

It is possible in case person has borrowed money for their urgent and routine needs. Person who is borrowing money for meeting his or her routine needs mean he is unable to meet the same in given resoucrs available to him how come he will pay the price of that loan too?

Usury as Discounting the Future

Interest rate is used for discounting the money that is payable in future with what worth it today. A person who does not know the future how come he predicts it when it comes for paying the cost?

Riba Al

Riba al-Fadl results in case of sale process, which occurs when person ask for any compensation without any due consideration resulting from case of sale.It is only accepted when six stated commodities are exchanged without consideraing the quality but must be equal and on spot or else transaction will come under the umbrella of Riba Al Fadal.

Due to imposition of Riba Al Fadl, Islam closed the doors of barter trade unless it is on spot and of similar goods.Riba Al Fadl rises on account of debasing of coins whilst exchanging the same with genuine ones. The very reason Riba Al Fadl was prohibited and was condemned on same grounds. As per Hadith if same item is exchanged for same item then factor of quality has to ignored and quantity and weight be the same that must be on spot transaction. Why that is so? This is because why a person would exchange the same commodities with another ones because he wants to exchange the inferior goods with superior ones which is obviously an unfair deal.

This injuction is aimed at discouraging the people from accumulation of goods, the crystal clear understanding given by Imam Ghazali in his narration about the same topic that On that time Gold and silver were considered as medium of exchange and exchanging the same commodities for same item in different quantities loses the purpose of their existence. An other reason explained by Ibn Qayoom that Riba Al Fadl was prohibited because it could have been possible that person may indulge in Riba Al Nasiha.


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