RATIONALE FOR PERMITTING BAI' AND PROHIBITION OF RIBA

Riba in simple terms means increase or growth. It is the income earned by the borrowed financial capital regardless of whether it is in the production process or not. Interest is the allocation, to the capital owner, of an unearned, undeserved, unborn, unavailable and imaginary income that might be attained without producing anything and without contributing any value to the revenue of the society. It imposes all the risks on the debtor directly and on the society indirectly but not on the lender although it is directly related to him/her

As an exchangeable term with riba, interest is defined by Ismail Ozsoy, professor of economics in Fatih University, Istanbul, as "an unearned or unequally distributed income.

Surah Al-baqarah verse no.275

"Those who devour usury will not stand except as stands one whom the Satan by his touch has driven to madness. That is because they say, "trade is like usury", but Allah has permitted trade and has forbidden usury",

verse 276 in the same place he says,

"Allah will deprive usury of all blessing, and will give increase for deeds of charity, for he does not love any ungrateful sinner."

Reason for banning Riba

The main reason advocated by Siddiqi and Ganameh as to the rationale of prohibition is that it is oppression involving exploitation. In matters of consumption loans, it is necessary that those who have wealth should assist those without, and in productive loans, a guaranteed return on capital is unjust given the uncertainty surrounding entrepreneurial profits, whereas a return to both parties as a rate of profit would be more equitable.

Interest mechanism prevents the fair distribution of positive or negative outcomes of economic activities among the lender and borrower and worsens the income distribution. This occurs either by providing the capital owner a certain and fixed percentage of earning in any case regardless of the negative outcome of the business, or by limiting his earning with only a predetermined amount of return in case the borrower entrepreneur earns considerably high income out of his/her financial capital.

Interest allows the creation of a group of people who contribute nothing to society, simply generating income from capital. This starves society of their contribution and the rationale of prohibition is to reverse this.

It is oppression involving exploitation. In matters of consumption loans, it is necessary that those who have wealth should assist those without, and in productive loans, a guaranteed return on capital is unjust given the uncertainty surrounding entrepreneurial profits, whereas a return to both parties as a rate of profit would be more equitable.

It results in restriction in circulation of wealth among those who already have it. Lenders would not provide loans to those they believe are unable to repay so such wealth would be restricted to those able to service the debt. This is something forbidden categorically by the Quran and the effects on society result in the accumulation of wealth amongst those who have it and increase the divide between the rich and poor.

It is clear that in riba-based transaction, the object of sale is time and its price is riba.  Riba essentially applies to money lending as this is the predominant source of debt/liability creation. Under riba-based transaction, postponement of liability justifies return on the capital given.

The time value of money serves as the foundation for all other notions in finance. It impacts business finance, consumer finance, and government finance. Time value of money results from the concept of interest.

Riba ignores the possibility and occurrence of loss that exist in trade and the uncertainty faced by the trader. It guarantees retrieval of principal and a positive yield

Just as Maududi rightly said:

…Which rational principle, which logic, which cannon of justice and which sound economic principle can justify that those who spend their time, energy, capacity and resources, and whose efforts and skills make a business thrive, are not guaranteed a profit at any fixed rate, whereas those who merely lend out their funds are fully secured against all risk of loss and are guaranteed a profit at a fixed rate?

BAI’

Trade has been an ethically acceptable activity in all civilizations since the earliest times and all religions permitted it. In Islam, a great deal of importance has been placed on trade (or Bai’) as a commendable source for the acquisition of wealth. Trade in Islam covers sales on credit as well as sale for cash price. It also includes sale of an item to be supplied in future against price to be paid in cash, on the spot.

There is a significant difference between the trade’s profit and Riba, the former is the result of real investment and economic activity that creates value and in which the business risk is allocated more evenly among all involved parties. Whereas, in Riba-based operations reward is guaranteed to only one party and the business risk is not evenly shared.

Trade is subject to profits as well as losses. That implies that even the recovery of the capital invested in trade is not assured. Profits in trade are not predetermined as regards to their size, even in the case of a credit sale, unlike interest whose size is part of the contract. This is contradictory to the Shari’ah principle that stipulates that a definite return for example would be considered unfair and unlawful.

The main contract of exchange in Islamic commercial law is the contract of Bai’. Bai’ encompasses an exchange of one thing with other; one thing being the subject matter and the other being the price. Transactions in Bai’ require the transfer of complete and instant ownership of the commodity at the time of sale/purchase and the transfer is irreversible once executed.

Not all types of exchange’ contracts are necessarily permissible, as those which give rise to Riba are unanimously prohibited by Islamic law. Islamic banks carry out a number of transactions for conducting real sector business, by serving as intermediaries and getting a return in the form of trade profit, lease rentals or profit from partnership based operations. In Islamic loan transactions, instead of loaning the buyer money to purchase the good, banks might buy the good itself from the seller, and resell it to the buyer at a profit, while allowing him to pay the bank in installments. Banks also provide financing facility on the basis of Mudarabah, Musharakah partnerships and create debt by way of trading and leasing operations to earn a profit; these financial transactions should be associated with productive economic activity.

Qurán 2:275

“Allah has permitted trade and prohibited Riba”