Understand Riba in Islam - Interest Guide
What is Riba in Islam? Riba refers to exploitative gains and unequal exchanges, this includes interest payments (made or received) that are strictly prohibited under Islamic finance rules. The concept of riba is seen a wholly unjust in Islam as it places a financial burden on the recipient of funds.
Riba is prohibited on the grounds that it goes against the Islamic principles of fairness, societal wellbeing, and justice.
WHY IS INTEREST (RIBA) FORBIDDEN IN ISLAM?
In any transaction involving riba, an imbalance is created between the borrower and the lender.
The lender receives a guaranteed profit which is the interest payment paid over and above the actual loan amount.The lender does not assume any of the risks in this transaction, and Islamic finance places emphasis on risk and profit sharing.
Interest is considered one of the major sins in Islam. That alone means that many Muslims will shun interest-based products and services.
WHAT DOES THE QURAN SAY ABOUT INTEREST?
The Quran has multiple verses that explicitly prohibit riba. These include the following:
- Quran 3:130 - this verse states 'O, you who believe, do not consume riba, doubled and multiplied, but fear Allah'.
- Quran 2:275: this verse states 'Allah has permitted trade and forbidden riba'.
WHY IS RIBA CONSIDERED SO HARMFUL?
The absolute prohibition on riba goes beyond the concept of exploitation and usury. It encompasses the concept of ensuring that social, economic, and ethical considerations are part of financial transactions.
Islam emphasises the greater societal good and social wellbeing. Management of funds and income should not be used in practices that cause harm to others. When a borrower is obliged to repay a loan with interest, this is seen as an unfair in Islam. Not only does the borrower have to pay back more than they borrowed, but they face the burden of an increased repayment and potentially a debt trap. Riba is also seen as enabling the concentration of wealth amongst the rich, whilst the poor get poorer.
Another important element of riba that is deemed to be harmful to society is that interest itself generates an income but that income is not linked to productivity of economic activity. Riba is a risk-free gain that does not benefit society.
In terms of moral and societal degradation, riba is fundamentally exploitative and undermines Islamic principles of fairness and compassion. Interest-based systems are dependent on the markets remaining stable, so having a riba free option leads to greater financial stability.
Whether you work in industry, or are planning a large project, there are Islamic finance services that are Sharia compliant that can meet your needs.
At the core of the ban on interest lies the Islamic teaching that wealth should be earned honestly and not through exploitation. If someone comes to you in need and asking for a loan, and you are able to lend them the money but charge interest, you are exploiting their need and benefiting financially.
In very simple terms, the ban on interest relates to promoting fairness and encouraging productive investments and activity. This will ultimately lead to a more compassionate and equal society.
WILL ALLAH FORGIVE RIBA?
For those who partake in riba, whether that is charging or paying interest, the question of whether Allah will forgive them is connected to the wider Islamic concept of tawbah (repentance).
Muslims view Allah as the most forgiving and the most merciful and repentance is encouraged.
However, any repentance must be sincere and when it comes to riba it means that the person must have sincere regret partaking in riba and must immediately stop. There is also an obligation not to return to riba at any stage of life and to try and rectify any harm caused.
HOW TO AVOID RIBA IN MODERN BANKING SYSTEMS AND ECONOMIES?
Whilst it can be challenging to completely avoid riba in the modern and Western banking system, there are interest-free alternatives available in the modern financial markets. The growth of Islamic finance means that more and more services and products are available for those wanting to comply with Sharia rules relating to financial transactions.
The Islamic finance infrastructure and architecture are continually in development and construction.
Products including halal mortgages, halal funding options, halal student loans, and halal index funds mean Muslims can partake in the banking systems without breaching Islamic rules. If you want to explore halal investment options, there are many alternatives to interest-based financial instruments available today.
WHAT ABOUT STUDENT LOANS, CREDIT CARDS, AND MORTGAGES?
All types of financial products are available on the financial markets these days. You should always undertake due diligence to assess the Sharia compliancy of financial products.
Halal and interest-free loans have revolutionised professional industries that focus on societal wellbeing and social responsibility.
There are even interest-free cryptocurrency and bitcoin options available within the United Kingdom and beyond.
ARE THERE ANY PERMISSIBLE FORMS OF INTEREST?
The short answer to this question is no. Riba is strictly prohibited in Islam. However, this does not mean that you cannot find alternative financial products that can provide you with the funding or returns you need.
Whilst there is no form of interest that is allowed, there are Sharia-compliant financial contracts that are sustainable alternatives. These include murabaha and musharaka contracts that enable risk and profit sharing.
HOW CAN I HANDLE UNAVOIDABLE INTEREST FROM SAVINGS ACCOUNTS?
For Muslims, it can be challenging to deal with unavoidable interest from savings accounts, particularly if you live in the West. However, if you have an account that, by design or structure, is based on interest then there are some actions you can take to make sure you adhere to Islamic rules about finance.
- Monitor your account
- Switch to an Islamic bank as soon as possible
- Check with your bank to make sure you are not receiving interest on savings and if you are then ask to waive the interest
- Search for interest-free accounts
- If you do accumulate interest then donate that interest to charity. Muslim scholars and experts have confirmed that you can donate the money received.
- When donating interest do not expect to receive any reward.
- Remember, whilst you can personally benefit from riba, it can be donated to those in need via a registered charity.
HOW CAN I NAVIGATE MODERN BANKING AS A MUSLIM?
Whether you are a student looking to finance your education, or a business hoping to fund new processes and equipment, it can be difficult to operate within interest based banking systems. Here are some key things you can be doing:
- Educate yourself on Islamic finance rules
- Seek out Islamic finance loans, experiences, and markets.
- Support Islamic finance initiatives
- Choose Islamic banks and companies who facilitate riba-free products
- Look for and ask for halal alternatives
- Consult with experts and scholars
- Make ethical investments and avoid any industry, job, product or sector that is rooted in haram activities.
- Encourage financial innovation, policy, and ideas
- Build networks with other Muslims
WHAT ARE THE SPIRITUAL CONSEQUENCES OF ENGAGING IN INTEREST-BASED TRANSACTIONS?
Every Muslim should understand that involving themselves in interest can have spiritual consequences. This can include a spiritual disconnection from the teachings of Islam and Allah's commands. It can also mean there is greater accountability and punishment on the day of judgement.
Not only is interest seen as a bad practice, spiritually it can lead to a loss of blessings and barakah in earnings and family life. There is a whole ethical decline associated with riba that can lead to a mindset that prioritises money and wealth over wellbeing. For Muslims, this is frowned upon.
For those engaging in riba, the spiritual consequences go beyond financial implications. They include a deep sense of moral and ethical responsibility, understanding and complying with Allah's commands, and the pursuit of divine approval.
HOW DO ISLAMIC BANKS OPERATE WITHOUT INTEREST?
Islamic banks operate without interest by adhering to Islamic finance rules relating to operation. Islamic finance products focus on profit and loss sharing and alternative contractual arrangements.
They are able to offer alternative halal products by offering joint venture arrangements, partnerships and Islamically compliant services. Islamic banks also partake in ijarah which is effectively a form of leasing.
Many people wonder how Islamic banks make money and the answer lies in understanding the different forms of products and services they offer.
For example, in a murabaha contract the bank could purchase a house and instead of charging interest on the sale, they sell it to the purchaser for the purchase price plus a mark up. The bank earns a profit via the mark up and not by charging interest.
WHAT ARE HALAL ALTERNATIVES TO COMMON FINANCIAL PRODUCTS?
There are many products and services on the market that offer great alternatives to conventional interest-based services. Here are some listed below:
- Cost-plus financing loans (murahaba)
- Partnerships or joint ventures (musharaka)
- Leasing (ijarah)
- Benevolent loans (qard hasanat)
- Safe custody accounts (wadiah)
- Islamic bonds (sukuk)
Receive insights on ethical financing and Islamic finance directly to your inbox.
Explore more news
WHAT IS ISLAMIC FINANCE?
Islamic finance at its very core is a way of managing money and financial transactions in a way that is compliant with Islamic rules and guidance. There is a significant interplay of sustainability and ethics in Islamic finance.
One of the foundational principles of Islamic finance is that money itself does not have any value. Instead, money is a means through which we can exchange products and services.
Islamic finance rules state that you should not use money to make money. This is why one of the most important Islamic finance principles is the one which prohibits interest in any form.
Paying or receiving interest is not seen as a permissible or equitable way of managing finances in Islam. You cannot make money by charging interest, this is seen as unethical and exploitative but also non-sustainable in the long-term.
Another important element of Islamic finance is that our transactions should not cause any harm to other individuals or wider society.
The focus should be on economic activities that are grounded in tangible assets and services, and partnership arrangements where each party shares in the profits and losses.
Ethics And Islam
Islam provides ethical guidelines within which to operate. These guidelines are based on the teaching within the Quran and from the experiences of the Prophet Muhammad (PBUH).
Underlying Islamic finance is a foundation based on integrity and fairness. The underpinning of Islamic finance with ethical considerations can be seen as contradictory to conventional business models, but ethical finance is a fast-growing industry.
Investors, individuals, and businesses are more socially conscious and want to operate in a more sustainable way.
It seems that everyone wants a more inclusive financial system where there is a real interplay between ethics and finance. Having witnessed the financial collapse of 2008 and the current global pandemic, existing Western finance models have proved to be volatile, unstable, and temperamental.
Islamic finance offers a sustainable, unique and viable ethical alternative. Applying normative ethics to financial and economic transactions brings more equality and sustainability to the table. This is mainly because operating from an ethical perspective is about duties and responsibilities rather than consequences.
Considering the consequences and impact of financial decisions means negative impacts can be identified and eliminated early. This leads to a more robust, fair, and resilient financial system.
Islamic finance recognises that finance has a useful role to play in economics. It requires overarching ethical considerations to be in place to ensure that there is intrinsic value in financial dealings, and these are supported by ethical and moral conduct.
Islam places a great deal of emphasis on ethical conduct. This is because Sharia rules derived from Islamic teachings are based on an ethical framework.
Islam requires us to align our values with the teachings of Islam in all areas of our lives. What this means for parties involved in any kind of financial deal is that the transactions are just, fair and equitable.
Islam And Wealth Distribution
Another important thing to note is that Islamic finance places emphasis on the concept of wealth distribution and social justice.
Practices including the payment of zakat every year, and regular charitable donations in the form of sadaqa aim to distribute wealth fairly. Sharing wealth is a key component of Islam, whether this is through donations or promoting those economic activities, projects, and practices that contribute positively to society.
Justice and fairness are fundamental concepts in Islam.
What Does Islamic Finance Say About Sustainability
When it comes to Islamic finance and sustainability, there is a unique interplay. Islamic finance principles are derived from Sharia law which places great emphasis on ethics and being socially responsible.
This social responsibility covers everything from wealth generation, wealth distribution, climate change, business, capital receipts, financial services, education, personal and business objectives, and education.
Sustainability in Islam must be viewed through the lens of being Sharia compliant in all dealings throughout life.
Adopting sustainable practices means you are promoting fairness and equality in every aspect of your life.
It has long been known that Islamic finance helps to divert capital into those environmental and social projects that benefit society.
There is growing recognition and support for the moral concepts of Islam and their link to global sustainability and development goals as set out by the United Nations.
Sustainable Development Goals
In 2015, the UN established sustainable development goals with the aim of achieving them by 2030.
These goals have common ground with Islamic finance as they both aim to promote social, economic, and environmental sustainability. In fact, there are several aspects of Islam and Islamic finance that align perfectly with the objectives within the UN's sustainable development goals:
- Zero hunger:
- Alleviation of poverty:
- Improving health and wellbeing
- Education
- Clean and affordable energy
- Industry, innovation and infrastructure
- Gender equality
- Clean water and climate action
- Reducing inequality
- Partnership arrangements
Role Of Islamic Finance In Sustainable Development Goals
Islamic finance is already playing a large role in contributing to the achievement of the UN's sustainable development goals. The foundations of Islam already align with these goals seeking to empower vulnerable communities.
Islamic finance initiatives such as zakat and sadaqa focus on poverty alleviation and working towards zero hunger. Islam promotes good health and wellbeing which is another UN sustainable goal.
Whether it comes to climate action, peace and justice, responsible consumption and sustainable cities, Islam is already ahead of the game.
With its emphasis on sustainable and ethical principles, Islam has been focusing on these kinds of goals for over 1400 years.
WHAT ROLE DOES SUSTAINABILITY PLAY IN ISLAMIC FINANCE?
Sustainability is a key concept in Islam, it therefore follows through that Islamic finance will also include elements of sustainability.
The Islamic finance and industry is well placed to support sustainability and sustainable development goals, whether that is individually or via collaboration.
Islam promotes social inclusion and socially responsible finance decision making. In today's global market where there is a wage labour crisis and worries about economic growth, sustainable Islamic finance is becoming more and more popular.
Research indicates that Islamic finance is one of the most sustainable and leading finance and funding models. Not only does Islamic finance base itself on ethics, it works with human beings to problem solve societal issues.
In the United Kingdom, the Bank of England recognises the significance of Islamic finance and the diversity it offers. Islam encourages inclusion and places great value in equality.
What this means for those using Islamic finance is that greater opportunities are available, and many argue that finance models based on Sharia principles will create ethical and socially responsible foundations.
Sustainability And Ethical Investments
Sustainable Islamic ethical investments are those investments that align with socially responsible and sustainable goals.
This interplay of finance and sustainability leads to positive benefits on an environmental, social and governance practices. Let's have a look at some sustainable and ethical Islamic finance investments:
- Green sukuk: green sukuks are Islamic bonds that invest in environmentally friendly projects. These projects can relate to renewable energy initiatives, climate action and other green policies.
- Islamic microfinance: Islamic microfinance provides financial services to people who may find themselves excluded from mainstream funding options.
Community development initiatives: these initiatives finance projects in agriculture, address the vulnerability in communities, and alleviate poverty.
Leveraging Islamic Finance To Build Sustainability
It is clear that Islamic finance has the potential to play an even greater transformative role in sustainability.
What is needed is for all stakeholders from individuals, governments, countries, and organisations to work together to maximise the impact of Islamic finance.
Some strategies that could achieve the synergy between Islamic finance and sustainable development goals include:
- Partnering with sustainability initiatives
- green sukuks
- sustainable investment vehicles
- support for socially responsible enterprises
- Increase in Islamic microfinance services
- Innovative finance models
- Using zakat for sustainable development
- International collaboration
WHAT IS A VENTURE CAPITAL TRUST?
A venture capital trust (VCT) is essentially an investment company. In the UK the government introduced VCTs in 1995 as a way of ensuring that investors could invest in start-up companies. The government was keen to encourage investment in entrepreneurial businesses by offering tax relief to investors. Recently there has been discussion and debate about whether VCTs are halal or haram.
For new businesses, VCTs are a great way of raising investment, and for investors they are an opportunity to invest in upcoming businesses.
For anyone looking for Sharia compliant investing, VCTs can be a good opportunity to invest in a halal way. Investing in VCTs can be halal, but you have to ensure that the VCT you invest in complies with Sharia rules about investment and financial transactions.
In recent years, as the Islamic finance market has expanded so too has the desire for Sharia compliant VCTs. The Islamic VCT market is innovative and presents a viable alternative to conventional investment models which are not always acceptable to Muslims who want to invest in line with Sharia rules.
Whilst it is always a personal choice as to where investors want to invest, for Muslims there are additional considerations that require them to be mindful of Islamic laws.
Let's have a look at how VCTs work and how they can operate in a halal way.
HOW DO VENTURE CAPITAL TRUSTS WORK?
VCTs work by raising money and then using the funds to invest in new and innovative companies. Usually these companies are innovative and privately owned. The idea is that the investment raised is then used to generate a profit and solid return for the investment.
The company can be dealing in products and services, offering employment opportunities, and/or meeting a need in the economy. The number of companies seeking investment is never-ending.
As an investor in a VCT, the investor becomes a shareholder of the trust. It is important to note that the investor does not become a shareholder of each individual company, rather the investor becomes a shareholder of the trust in its entirety.
Most VCTs will invest in different companies. This enables the VCT to keep its investment portfolio options diverse and spreads the risk. It is always important to ensure you have all the information you need about the VCT before investing.
When the companies within the trust return a profit, this is paid over to the shareholders.
WHAT DO VENTURE CAPITAL TRUSTS INVEST IN?
Most VCTs will invest in new, small, and entrepreneurial companies across a wide variety of sectors. These can include tech companies, retail, clothing brands, food outlets and many more.
Many of these companies will be privately owned, and some of them are quoted on the Alternative Investment Market or the London Stock Exchange.
Different Types Of Venture Capital Trusts
There are some different types of VCTs. What differentiates them from each other is the investment focus and area:
- specialist VCTs : these are VCTs that remain focused on a specific interest and sector. For example, there are VCTs that only invest in healthcare, or retail. Due to the lack of choice and sector diversification, this often means that they can carry more risk.
- Generalist VCTs : these types of VCT are wide-ranging when it comes to investment. They invest in companies across different sectors. The value to the investor is that there is diversification and less risk.
- AIM VCTs : the Alternative Index Market (AIM) VCTs invest in shares issued by AIM quoted companies. The AIM was set up by the London Stock Exchange in 1995 to ensure that there was a market for companies who can't (or won't) meet the demanding requirements for listing on the London Stock Exchange.
Venture Capital Trusts And Tax Advantages
One of the main reasons VCTs are popular is that they offer tax incentives. Investors can take advantage of:
- tax free dividends
- up to 30% income tax relief
- tax free growth
- capital gains tax exemptions and deferrals
WHAT IS VENTURE CAPITAL TRUST TAX RELIEF?
VCT tax relief can be claimed when an income tax return is filed with HMRC.
What this means for investors is that they can end up with a lower income tax bill, or even a refund if they have already paid their tax.
Islamic Finance And Venture Capital Trusts
Remember, one of the most critical elements of ensuring compliance with Sharia law when investing in venture capital trusts is that you need to work with a Sharia aware, and Sharia compliant, financial advisor.
This will ensure that the investment contract AND investment models are both compliant with Islamic finance rules.
Islamic Venture Capital Trusts Vs Conventional Capital Trusts
The main difference between conventional VCTs and Islamic VCTs is that Islamic VCTs must comply with Islamic finance rules relating to finance and financial transactions.
Islamic VCTs need to stay away from any form of investment in non-permissible, or haram, industries.
A very simple example of this would be as follows: a conventional VCT could invest in brewery shares. However, an Islamic VCT should stay away from any alcohol related industry.
Going further, anyone looking to invest in Sharia compliant VCTs should do additional due diligence and ask questions about the company they invest in. Does it operate ethically? Does it have conventional debts on its book that is interest-based? If so, then the VCT is not considered to be halal.
Advantages Of Investing In Venture Capital Trusts For Muslims
As long as the VCT is Sharia compliant, Muslim investors offer a diverse range of investment options. Muslim investors can take advantage of investing in other Muslim businesses and industries.
There are numerous ethical investment opportunities with halal VCTs that are attractive to Muslims. Socially responsible investing is a core principle of Islamic finance and there are VCTs out there that are ethical and socially responsible.
Halal VCTs also offer the potential for job creation with early stage companies. Supporting these businesses mean Muslims can indirectly be helping struggling economies and economic development. This aligns with the Islamic finance principles that relate to promoting economic wellbeing and financial inclusion.
WHAT IS WAKALA?
Wakala is a popular model Islamic VCTs when it comes to raising capital.
Wakala permits the asset manager of the trust (on behalf of the investor) to act on their behalf based on agreed conditions and terms.
Both parties then share the profits generated, and take on the risk of any losses together. This kind of profit and loss sharing arrangement aligns with Islamic finance principles.
Mudaraba And Venture Capital Trusts
When it comes to investing in start up companies, mudaraba is a common model that is used. The mudaraba contract is a contract that enables one party to the contract to bring assets in and for the other party to bring in effort and experience.
This means that investor provides the financing, and the entrepreneur takes responsibility for the day to day management of the trust. The contract outlines the respective responsibilities of each party and the profit sharing arrangement.
As already mentioned, despite the many advantages of halal VCTs, investors need to work with Sharia compliant advisors who can direct them to halal VCTs.
Consulting with knowledgeable advisors means you have specific guidance and adherence to Sharia rules.
WHAT IS QARD AL-HASSAN?
Qard al-hassan, also known as qard al-hasan, is an Islamic finance term that essentially refers to a loan that is interest free. Typically in a transaction that includes qard al-hassan, the borrower will repay the amount owing under the principal amount without any other mark up or interest payment being charged. Qard al-hassan financial products are compliant with Sharia rules that dictate that interest (riba) payments are not permissible, whether the interest is being paid or being charged.
These types of loans offer financial solutions for Muslims looking to borrow funds that do not include any interest payments.
Qard al-hassan loans are loans that are provided to help others. The word hassan itself means acceptable or good (of good faith). Islamic banking services are now offering qard al-hassan loans for both Muslims and non-Muslims.
Qard Al-Hassan Loans
In Islam and Islamic banking, Qard al-hasan loans do not have an interest rate element, and this means that businesses and consumers are able to borrow money on a goodwill basis. Generally speaking, qard al-hasan loans tend to be used for welfare purposes. The Quran stipulates that Muslims should endeavour to provide these types of benevolent loans where possible and to those who need these kinds of services.
"Establish regular prayer and give regular charity and give Allah Qard Hassan" (Quran 73:20)
The principle of qard al-hassan in Islam enables Muslims to further the social justice ethos that underpins Islamic finance. Islamic finance facilitates loans from those with the funds to those who need financial assistance without breaching Sharia rules. Qard al-hassan can be viewed as a loan agreement that is akin to giving charity. The borrower and lender sign an agreement confirming the terms of the qard.
HOW DOES QARD AL-HASSAN WORK?
In Islam, qard al-hassan works in the following way. A lender will lend a business or service an amount of money that they need (usually for social justice purposes). The principal amount borrowed will be interest-free. The borrower will then repay the amount of money borrowed without any interest or surplus payments owing. Borrowers are permitted to pay an additional amount back to the lender as a gesture of goodwill, but this cannot be done based on any promise or commitment.
Qard al-hassan loans do not increase over time or accumulate any interest charges like traditional loans do. This means they offer problem solving solutions for Muslims.
The most important element of Islamic qard al-hasan loans is that they are untouched by any form of riba. There should not be any reference or link to the economic market conditions and fluctuations, and the lender cannot ask for the return of the loan before the contractual repayment period ends.
Qard Al-Hassan - The Redistribution Of Wealth
Islamic finance systems focus on socio-economic justice and the enhanced wellbeing of society, especially the alleviation of poverty. Alongside sadaqa and zakat, qard al-hassan is an essential Islamic finance instrument of redistribution of wealth.
Qard al-hassan minimises the cost of borrowing and remains compliant with Islamic Sharia law. It's one of several halal investing principles that guide how Muslims manage and grow wealth ethically.
Social Justice, Qard And The Islamic Finance Economic System
The Islamic finance economic system has always centred on principles of social justice (as mirrored throughout the practices and teachings of Islam). The focus of the finance system is to ensure and improve the overall wellbeing of society and using money to enhance social conditions.
Qard al-hassan is a key concept that acts as a crucial redistributive instrument. The distribution of funds from the rich to the poor aims to reinforce social unity and cooperation. As the global experience of, and appetite for, ethical finance options and factor analysis continues to grow, qard al-hassan is fast emerging as an important tool in the fight against poverty and the drive to ensure there is more financial freedom and equity for poorer communities.
As more and more Islamic finance companies and banks are offering innovative qard al-hassan products and financial services, project management for those customers and business operations working within the social justice sector will become easier and more accessible. Qard al-hassan services will start to become more readily available in banking and private sector financial industries.
The opinion of scholars is that qard al-hassan loans are problem solving as they facilitate the redistribution of funds that are compliant with ethical and Islamic finance principles. Islamic finance is facilitating financial freedom and investment options for those who have historically been excluded from traditional financial markets and industries that did not cater to their religious requirements.
According to Sharia law, qard al-hassan loans are deemed to be acts of good faith, and loans that help those in need. Advancement of news relating to qard products and websites, and information technology means that qard al-hassan financial services are more readily available and searched for online, especially in Middle Eastern territories. This has enhanced the supply and demand of qard services. Historically, qard al-hassan loans have proved to be effective for economic growth, enhancing employment, and alleviating poverty.
Stay informed on finance
