Irish Mortgage Brokers Blog

In the field of Islamic Finance there are two unlawful or ‘haram’ activities, both are in the area of ‘Riba‘ - which is often translated as ‘interest’ but is better thought of as ‘excess’.

These two are Riba al fadl, and Riba al naseeyah.

Riba al fadl is the easy one to remember, it is the charging of interest, in Christendom we call it ‘usury’, something that was once forbidden under Christian doctrine (hence the pushing of Jews into becoming the earliest bankers - they could engage in this forbidden activity for Christians who wanted to borrow - borrowing was OK, but lending was not).

Riba al naseeyah is the second tenet, and perhaps the most important, because it is an early adaptation of understanding that economic rent is a problem. This isn’t an argument for socialism or anything else, but it is an acknowledgement that Riba al naseeyah [which means 'excess compensation] can be both a financial, societal and economic problem.

Price gouging is one aspect of riba al naseeyah, another would be deriving income far in excess of the actual value supplied. Islamic finance struggles with modern construct at times but it is quite grounded in some respects because the Qur’an has passages that talk about ’silver for silver, wheat for wheat and from hand to hand’.

If western economies were to learn something from Islam it may be best to start that education process with their take on finance. It may mean a massive restructuring of western banks - the idea of investing in equity rather than debt is a very interesting fundamental - but the more important idea of Riba Al Naseeyah is huge and would undermine the very fabric of most of our investment banks who use a rentier position to price gouge regularly.

Often we hear that under Islamic finance ‘interest’ is illegal (it is technically ‘Haram’ or unlawful), the term in Arabic is ‘Riba’ and it doesn’t just cover interest. The basis of the anti-interest ruling is from the Surat Al Baqara Verse 275 ‘God has permitted trade & prohibited riba’ and it restricts wealth building by making money from money, rather it can only be done via investment and commerce.

However, riba is not confined to interest on loans (although that is the primary type), the full name of interest riba is ‘riba al naseeya’ (also known as riba al-Quran or riba al-jahiliyyah). There is a secondary type called riba al-fadl and this is best described as ‘excess compensation’, this can occur where one party makes too much from an exchange. A foundation in Sharia’a compliant finance is that transactions should be fixed in nature (to avoid ‘Gharar’ or uncertainty) and associated with a specific risk, so any compensation beyond what is considered the fair value is also a brand of riba. For instance, if two people exchanged 1kg of metal with each other and one was copper the other silver, the person trading copper for silver would be guilty of Riba al Fadl.

The Mudaraba contract is essentially a contract partnership in Islamic Finance, the Prophet (PBUH) forbid riba or interest, and for that reason the provision of capital for borrowers is generally not performed as a function of debt, but rather as a function of an equity investment.

In this way a Mudaraba relationship can exist with a depositor, but instead of getting interest the Islamic finance institution will invest it on their behalf. However, unlike western banking accounts, a Mudaraba account does not have capital protection as it would be in breach of the profit and loss sharing rule of sharia’a compliant finance. That is a big downside when you compare it to conventional banking.

This brand of deposit account is interesting because it has no guarantee, and yet people willingly sign up to it because it is handled in a responsible manner, shareholder funds are combined with depositor funds to make investments, and these are not securitized or sold on which encourage the probity and diligent underwriting of the investment. Conventional banking could learn a great deal from this.