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.