Category Archives: Basics and Definitions

Interest, its meaning, definition and context of use

Following is a comprehensive understanding of interest, from an email message posted by Mark Robbani of the Institute of Islamic Finance, on the IBF-NET YahooGroup. 


Regarding the meaning of the word ‘interest’: It would be better to define the context of its use first, before discussing its meaning. Putting aside the true linguistic origins of the word, since ‘interest’ is currently an English word, then for our purposes – we should really use the English meaning of it only in financial & economic contexts. Thus:  

[from: http://en.wikipedia.org/wiki/Interest%5D

In finance, interest has three general definitions.

Interest is a surcharge on the repayment of debt (borrowed money).

Interest is the return derived from an investment.

Interest is the right to one’s claim in a corporation, such as that of an owner or creditor.

In economics, interest is the return to capital achieved over time or as the result of an event. In population dynamics the rate of population growth (the interest rate) is sometimes referred to as the Malthusian parameter. This article covers the “financial” use of the term.

[from: www.investorwords.com/2531/interest.html]

Definition 1

The fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate. Here, interest per year divided by principal amount, expressed as a percentage. also called interest rate.

Definition 2

The return earned on an investment.

Definition 3

Partial or total ownership in an asset.

[from: http://en.wikipedia.org/wiki/Interest%5D

In common use the term “interest” is seen as rent paid for the use of money. As with any rental, the market price (or rate) is subject to change to reflect market conditions. The fraction by which the balances grow is called the interest rate. The original balance is called the principal. Interest rates are very closely watched indicators of a financial market, and have a dramatic effect on finance and economics.

The fact that lenders demand interest for loans can be attributed to the following reasons:

Time value of money or time preference

(TVM: Having money now is more valuable than having it at some future time because interest is earned)

(TP: Interest is the value borrowers place on having money now)

Opportunity cost

(OC: The cost in terms of options no longer available once one particular option is chosen)

We should narrow down the use of the generic term ‘interest’ to the more specific ‘interest rate’ and also accept the practical application of ‘interest rates’ as the Central banks of the English speaking and western European countries apply it. Thus:

[from: http://en.wikipedia.org/wiki/Interest_rate%5D

An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. Interest rates are normally expressed as a percentage over the period of one year. Interest rates are also a vital tool of monetary policy and are used to control variables like investment, inflation, and unemployment.

For instance:[from: http://www.bankofengland.co.uk/monetarypolicy/how.htm]

[from: ]The Bank of England sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks, building societies and other institutions for their own savers and borrowers. It also tends to affect the price of financial assets, such as bonds and shares, and the exchange rate, which affect consumer and business demand in a variety of ways. Lowering or raising interest rates affects spending in the economy.

Thus, the meaning & definition of interest appropriate for our purposes is the one ‘in common use’ – which happens to be a “surcharge on the repayment of debt (borrowed money)”, “rent paid for the use of money”, “The fee charged by a lender to a borrower for the use of borrowed money”, etc. All of these definitions are actually for the more relevant and specific term, ‘interest rate’ – and are similar to my own definition, which is a monetary charge applied for the use of money).

Here, the surcharge, rent or fee is actually money, which is exchanged for more money (i.e with a contractual difference in the corresponding/counter values). Since any contractual difference in the value of 2 or more items of the same type, quality and value when they are exchanged (irrespective of the time-period involved or the type, magnitude or form of the difference) is Riba, it therefore follows that the surcharge, rent or fee (in this context) is also riba [as any such surcharge, rent or fee (i.e monetary charge) is an ‘increase’ or an ‘excess’ in a like-for-like (money-for-money exchange) – thus haraam].

Regarding the variations in the application and meaning of the word ‘interest’ in different countries & languages: This is really more to do with sociology rather then the financial sciences. This is really more to do with sociology rather then the financial sciences.

For instance:

Although in the German language “…jurists categorise rent as being interest (while rent is not riba, and in Dutch interest is event called rent) and accountants sometimes go as far as talking about interest on equity (which will finally confuse everybody to mix up profit with interest)…” – when the German and Dutch (and most other) central banks set the base interest rate, they set it as their monetary charge for lending to financial institutions, and not as the base property/asset rental amount, or equity dividend, etc. This alone should make clear the true meaning of interest (and the context of its use) for our purposes. All other meanings are culturally subjective and thus not suitable for our universal & legalistic use.

Although in the German language – when the German and Dutch (and most other) central banks set the base interest rate, they set it as their for lending to financial institutions, and not as the base property/asset rental amount, or equity dividend, etc. This alone should make clear the true meaning of interest (and the context of its use) for our purposes. All other meanings are culturally subjective and thus not suitable for our use.

In conclusion:

My own personal opinion still remains that ‘interest’ (the form in common English and use) and more specifically, ‘interest rates’ riba (as defined by the authentic sources), but riba (again, as defined by the authentic sources) is not restricted to ‘interest’.

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Partnership – Definition and Types

The Arabic word sharekah means partnership or company and denotes mixing of two shares in a way as to make them indistinguishable.

In Islamic jurisprudence, there are several definitions of partnership

Hanafi scholars define partnership as “a contract between partners on both capital and profit.”

Shafe’i scholars define partnership as “a contract giving the right in something to two or more people, making it common.”

Hanbali scholars define partnership as “the coming together of two or more people in disposal or acting.”

Two main kinds of partnerships

Partnerships are primarily of two kinds: partnerships of ownership and partnerships of contracts.

Partnerships of Ownership (Amlaak)

A partnership of ownership means that two or more people share the ownership of a single property, either by their own choice (i.e., by agreeing to buy the property) or without their own choice (i.e., inherting the property, for example). Each of the parties is a partner and none of the parties can dispose of the object on his or her own, without the permission of all other partners.

Partnership of Contracts (Uqood)

A partnership of contacts is between two or more people to have partnership in capital and profit. Such partnerships are subdvided into four kinds:

  1. Amwal – financial company, where two partners contribute finances to start the company. This type further includes Al-‘Inan or unequal share partnership and Al-Mufawadah or equal share partnership;
  2. Wojuh – eminence, where a partner only contributes his or her eminence to the partnership (e.g., Al-Azhar University giving accreditation to an institute in Canada is a partnership where Al-Azhar is exhanging its eminence for a consideration);
  3. Sana’i – workmanship, where the partners contribute labour to the partnership;
  4. Mudarabah – capital-labour partnership, where one partner contributes labour and the other partner contributes capital.

It is the Mudarabah partnership that has become the focus of Islamic economics and finance in the modern era. We will generally not go into more details on all the various kinds of partnerships.

Source: Kharofa, 166-171.

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Definition of Gharar

The Arabic word gharar means risk, uncertainty, and hazard. Unlike ribaa, gharar is not precisely defined. Gharar is also considered to be of lesser significance than ribaa. While the prohibition of ribaa is absolute, some degree of gharar or uncertainty is acceptable in the Islamic framework. Only conditions of excessive gharar need be avoided.

The concept of gharar has been broadly defined by the scholars in two ways.

  • First, gharar implies uncertainty.
  • Second, it implies deceit.

The Qur’an has clearly forbidden all business transactions, which cause injustice in any form to any of the parties. It may be in the form of hazard or peril leading to uncertainty in any business, or deceit or fraud or undue advantage. Apart from the above simplistic definition of gharar, some definitions of gharar seem to have a parallel in the concept of uncertainty in conventional finance. Gharar is defined by the Hanafi jurist al-Sarakhsi as any bargain in which the result of it is hidden.

Source: Obaidullah, 29.

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Norms of Ethics in an Islamic Economic System

In light of the Qur’an and the Sunnah, the scholars have defined some norms of ethics in an Islamic economics system. For brevity, we will list them here for now. Each of these will be discussed in further detail later. An Islamic economic system is based on the following norms of ethics:

  1. Freedom to contract
  2. Freedom from coercion
  3. Freedom from misrepresentation
  4. Freedom from Ar-Ribaa (interest)
  5. Freedom from Al-Gharar (excessive uncertainty)
  6. Freedom from Al-Qimaar (gambling)
  7. Freedom from Al-Maysir (unearned income)
  8. Freedom from price control and manipulation
  9. Freedom from impulse
  10. Right to trade at efficient prices
  11. Entitlement to transact at fair prices
  12. Right to equal bargaining power
  13. Entitlement to equal, adequate and accurate information
  14. Freedome from Darar (detriment)
  15. Mutual cooperation and solidatrity
  16. Maslahah Mursalah (unrestricted public interest)

Source: Obaidullah, 9-15.

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Pre-Islamic Ribaa

An argument often presented by many Muslims is that ribaa mentioned in the Qur’an is actually different from what we call ‘interest’ nowadays. It is important, therefore, to look at what qualified as ribaa in the pre-Islamic times (Ribaa al-Jahiliyyah).

We find various kinds of of situations where ribaa comes into play. A brief look at these reveals that there is no difference between the pre-Islamic ribaa and the present-day notion of interest.

“Qatadah narrates that the ribaa of pre-Islamic times was that where one person bought property from another with a promise to pay at a later time. If the buyer could not pay the agreed upon amount on the settlement date, the seller would extend the payment period and the amount owed.”

According to this example by Qatadah, the Arabs of the pre-Islamic times considered as ribaa the increase in the amount owed from the original settlement date to the revised settlement date.

“Mujahid held the opinion that the ribaa of the pre-Islamic times was that where the borrower would agree to pay more than the borrowed sum if given a specific time horizon to pay.” 

This is increase in amount owed due to failure to pay or additional time is precisely what we call interest in the present-day economic system. In both cases, we see the debt being swapped for a larger amount based on the passage of time.

“According to Imam Razi the norm of the pre-Islamic days was that the borrower of monies would agree to pay an agreed upon amount on a monthly basis for an agreed upon period of time. At the expiration of that period, the borrower would return the original sum. However, if he could not pay, he would be given more time in return for higher monthly payments.”

These monthly payments were also called ribaa by the pre-Islamic Arabs.

Sources: Mawdudi, Abul Ala. Muashiat-e-Islam. 11th ed. Karachi: Ma’araf Islami, 1986. 232.
Obaidullah, Mohammed.
Islamic Financial Services. Jeddah: Islamic Economics Research Center, 2005. 24.

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Prohibition of Ribaa

The evidence on the Qur’an and Sunnah relating to the prohibition of ribaa is reproduced below:

“O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper.” (Qur’an 3: 130)

“Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: “Trade is like usury,” but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (The offence) are companions of the Fire: They will abide therein (for ever).” (Qur’an 2: 275)

“Allah will deprive usury of all blessing, but will give increase for deeds of charity: For He loveth not creatures ungrateful and wicked.” (Qur’an 2: 276)

“O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers.” (Qur’an 2: 278)

Most important here is the distinction Qur’an makes between interest and sale. We will explore this distintion in much more detail late but let us analyse the explanation provided by the Sunnah.

Zaid B. Aslam reported that interest in pagan times was of this nature: When a person owed money to another man for a certain period and the period expired, the creditor would say: You pay me the amount or pay the interest. If he paid the amount, it was well and good, otherwise the creditor increased the loan amount and extended the period for payment again.” (Al-Muwatta, Imam Malik)

The Prophet (pbuh), during his last sermon addressed his revered companions, “Every form of riba (interest) is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting riba. I start with the amount of interest, which people owe to Abbas and declare it all cancelled. He then, on behalf of his uncle, Abbas, cancelled the total amount of interest due on his loan capital from his debtor” (Tafsir Al-Khazin, vol.1, p.301)

The Prophet (pbuh) is reported to have said “Sell gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, in same quantities on the spot; and when the commodities are different, sell as it suits you, but on the spot” (Muslim)

Bilal visited the Messenger of Allah (pbuh) with some high quality dates, and the Prophet (pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah (pbuh) said: “this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other.” (Muslim)

One may note here that the first two ahadith relate to the prohibition of interest in a loan contract where as the last two relate to the prohibition in an exchange contract.

Source: Obaidullah, Mohammed. Islamic Financial Services. Jeddah: Islamic Economics Research Center, 2005. 23-24.

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Literal Meaning of Ribaa

The most well-known and the most central concept in Islamic economics is the prohibition of ribaa, defined as interest. All transactions in Islam must be free of ribaa. In its literal meaning, the word ribaa (raa-baa-vow) means increase or rise. For example, the root word of it is used in the Qur’an as follows:

فَإِذَا أَنزَلْنَا عَلَيْهَا الْمَاء اهْتَزَّتْ وَرَبَتْ
But when We pour down rain on it, it is stirred (to life), it swells. (Qur’an 22: 5)

In the above verse, the word rabat is used to indicate the swelling of barren and lifeless earth. Similarly Allah (SWT) says:

أَن تَكُونَ أُمَّةٌ هِيَ أَرْبَى مِنْ أُمَّةٍ
Lest one party should be more numerous than another. (Qur’an 16: 92)

In the above verse the word arbaa has also been translated as overcoming or increasing. The word can also be translated as being higher in relation to something else. In the following verse Allah (SWT) describes how Mary and her son too refuge on a higher ground by using the word rabwa:

وَجَعَلْنَا ابْنَ مَرْيَمَ وَأُمَّهُ آيَةً وَآوَيْنَاهُمَا إِلَى رَبْوَةٍ
And We made the son of Mary and his mother as a Sign: We gave them both shelter on a high ground. (Qur’an 23: 50)

The above verses make it clear that the word riba refers to an increase from the original status. This is how the term is then used in Islam with reference to interest.

Source: Mawdudi, Abul Ala. Muashiat-e-Islam. 11th ed. Karachi: Ma’araf Islami, 1986. 229-230.

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