Why Is Interest Prohibited And How Does it Compound Financial Problems?

In the 21^st century the writing should be on the wall as to why Islam prohibits interest called riba in Arabic and katapira in Chichewa.

The source of this prohibition is the Qur’an. Several verses in the Qur’an such as 2:275, 2: 278, 3:140 etc, have made it explicit that taking or giving of interest in any form is not allowed.

There was a time when some people tried to justify the rationale of interest on business finance and claimed interest is prohibited on consumption loans only, so far there is a general consensus that interest based transactions should not be carried out by a Muslim even if the interest rate is 0.000001 percent.

Apart from being a religious tenet, interest has proved an evil in almost all societies on earth not to mention our beloved mother Malawi. It will sound extreme and two strong to say a great deal of the suffering of Malawians is emanating from interest based financial transactions. But unfortunately, even if no one says it, what the Qur’an has said implicitly or explicitly has a great bearing in the practical life.

Why Islam prohibits interest in the strongest terms should not be a puzzle – the reason is that in our daily life, interest is an exploitation of the weak, in this case the poor who need loans to start businesses and make a living out of it. Within our societies, we can do an eye ball analysis of how interest rate base loans have exploited many poor people that ended up burying hopes to ever do well again.

The recent development in our country has proved that interest is not a good practice, since the dawn of multiparty we have seen a proliferation of so called micro-finance intuitions, these are the institutions that claim to have the human heart and give start up loans to small and medium enterprises. Everyone with a relative or a friend who tried to get a loan from these financial intuitions can bear witness that the results have not been good, if not even worse. The interest component of the small loans has often times made the borrowers poorer than they were before getting the loans.

The simple synopsis is that, the lenders give the poor individual K 20, 000 and is expected to pay back 25% interest in a space of three months and this translates to 100% interest rate if multiplied by four. This is holding because we have four periods of three months a year and this has been the common practice by the micro-finance companies. On the onset of this agreement the money borrowed is been given a cost, (25% of K 20, 000 is K 5  000). So the borrower is expected to pay back K 25, 000 in three month time. This interest amount is predetermined but business outcome cannot be predicted. The borrower can make a loss or a profit assuming the money is invested in a business as intended.

In the course of servicing this loan amidst uncertainties of business, these loans leave the borrower under pressure, to first make a living out of this money, then make more money to pay the principal, K 20, 000 and an additional K5,000 as an interest. The end result is making sure what ever this borrower will buy for sale is highly priced so as to cover the all the said payments.

At a national level we better believe that this is what is fueling the high prices we are seeing everywhere not to mention the common bonya. In the borrowed money there is a certain amount that is just put in without a corresponding real activity named interest.

As everyone is aware that business is uncertain and that often, business activity does not fetch the planned returns, the borrowers are put in a fix to repay the loan with interest or get their belongings ceased. This later occurrence now leaves the borrowers poorer than they were before taking the loan. This and many other examples are just few of the reasons among many that can tell us in simple terms that interest as most people call it, is very evil in our societies. At a macro level interest rate based transaction are anti-development as they constitute making money out of money and it ends there no addition to the development of a country.

At the global level people are coming to realize that we will continue to have episodes of crises like 2007-09, if interest is not checked. The world has kept a lid on the role interest rates played to trigger the crisis. Interest rates mimicked the hacking of asset prices that is commonly known as the asset price bubble that later bust and cause the financial crisis. Some quarters in the economic field still believe the gravity of the crisis let alone the occurrence would have been minimized had the interest been passive.

If and only if the repayment of the loan and any addition to the borrowed money is left to the outcome of business, there would not be so many loan default and casualties. The outcome of the business can make both the borrower and the lender happier than what interest does.

Assume the business carried out by the borrower brings another twenty thousand on top of the borrowed money and the agreement was to share the profits/returns of the business equally (50:50) this would mean the lender would get ten thousand instead of the five thousand, in the other way and the borrower is not left on the cold in the process. This is what Islam advocates, making everyone better off and not making someone else worse off.

After accepting that interest is bad, most people find it hard to imagine how the monetary authorities can regulate a bank that operates without interest, how can the commercial banks operate and make their huge profits in the tune of billions without interest? The wheel was invented already! There is a regulatory framework for interest free financing that regulators use, and it should not be news to know that some of the banks that we have in Malawi do offer interest free financial services in other countries and are regulated without any problems.

As to how the commercial banks can make money without interest, there are so many interest free financial products that are in use, they bring even greater returns than their counterpart products that are interest based. Some of these lucrative products are:

• Profit and loss haring (Partnership)
•  Passive Partnership
•  Diminishing Partnership
•  Sales Contract at a Profit Mark-up
•  Leasing
•  A Lease Ending in the Purchase of the Leased Asset
•  Sales contract with the price paid in advance
•  Contract of Manufacture and Financing
• Real estate services and agency contracts
• Pooled securitization products
•  Islamic insurance

The Islamic financial products are many and include some sophisticated products and derivatives. These are alternatives to what commercial banks offer like the current, savings, fixed, mortgage, credit default swaps (CDS), collateralized debt securities (CDS) just to say a few. The key element is that in all these products, interest is declared a no go zone.

This article has been written by Boyd Abdalla Hamella, a Malawian Student at the University of Birmingham in the United Kingdom, studying Master of Science – Economics majoring in International Money and Banking (MSc Economics-International Money and Banking).