By M. Bakri Musa

Chapter 9: Islam in Malay Life

Reform in Islam

Islamic Economics

The success and vitality of the modern economy is based on the availability of credit. It is credit that makes the economic world spin smoothly. “Credit is the vital air of the system of modern commerce,” observed Daniel Webster. “It has done more, a thousand times, to enrich nations, than all the mines of all the world.” A plaque on Wall Street, the heart of American capitalism, declares, “Credit: Man’s Faith in Man.” Credit is predicated on the promise that it will be repaid.

Shakespeare’s words in Hamlet, “Neither a borrower, nor a lender be: For loan oft loses both itself and friend….” is only true if we do not repay our loans and the gratitude that goes with them. Indeed not repaying our debts can give rise to even worse consequences, as victims of the mafia and triads will testify. Even threats of defaulting can be devastating, as Argentina is now discovering.

Ancient Muslim traders must have had a system of credit and promissory notes; they could not be hauling their gold and silver bullions on their caravans, risking robbery. The hang-up today’s Muslims (and also others) have on the issue of credit rests on the related question of interest (riba) and usury.

The usual argument that interest is sinful arises because of the connotation of extortion. If a father needs money to buy food or medicine for his children, yes it is indeed sinful to charge him any interest at all for the money. If the recipient is truly needy, then simply donate the money. That is the basis of zakat or tithe, one of Islam’s five pillars. If I charge the poor soul an exorbitant interest rate (usury) and if he fails to repay me (as he surely would), do I then break his leg, mafia style? That would not only be sinful but also criminal. You need not wait till Judgment Day to be punished; you go to jail right here on earth, and deservedly so. Nor can I make him my slave to pay off his debt. Slavery and indentured labor have long been banned.

On the other hand, if I have some spare funds that I do not need right away (for example, savings for my children’s education) and an entrepreneur could use that capital to start his business, I see no reason why I cannot be rewarded for letting him use my idle money. After all my money is like any other property I own. If he uses my car, for example, I can charge him a rental fee, so why cannot I charge him a similar “rent” (which is what interest is) for the use of my money?

Another way of looking at it, my lending him money is comparable to my providing him a service. Therefore I should be suitably compensated for that, just as surely as had I repaired his hernia. Besides, my lending serves the greater society, not just the two of us. His company would employ workers and produce useful goods. Had I kept my money under my mattress, nobody would benefit.

There is no question that riba is prohibited in Islam. It says so clearly in the Qur’an as well as in the various ahadith. The crux of the issue is to the actual meaning and intent of that ancient Arabic word. Words have a way of acquiring different meanings with time. Earlier I alluded to the term “poet,” which was highly pejorative during the prophet’s time. Likewise, what riba meant to the ancient Bedouins cannot be simplistically and literally be transferred to all forms of costs of capital in modern economics. One simple reason is that many of these modern financial instruments were non-existent in the prophet’s time. There was no such thing as venture capital or corporate bonds in ancient times.

Another reason for the prohibition of riba is that Islam prohibits “making money on money,” which interests and other forms of the costs of capital imply. One can, however, make money by trading on goods and services, and Islam encourages this. The distinction between money and tangible goods is that the former has no “intrinsic value,” thus trading on it is equivalent to gambling. The value of money is what society puts on it. While this is true for paper money, it is not necessarily so for gold and silver, Islam’s ancient currencies. Those precious commodities do have intrinsic industrial values quite apart from their aesthetic (thus acquired) ones. Silver for example is an important ingredient in film imaging. And gold is useful in certain precision engineering as well as in pharmaceuticals.

For modern Islamic scholars to simply equate riba to all forms of interests is unwarranted. As I will show shortly, there are conceptual differences in the various forms of costs of capital (interest) and that, stripped of its mystery, trading on capital (money) is no different from trading in other goods and services.

Going to my earlier example, how I charge that entrepreneur for the cost of renting my property (capital) is a separate issue. I could for example, share in the risk, that is, seek part control of his company. This is the basis of modern venture capital. When his company is successful, I would sell my shares and recoup my principle plus the “rent” or profit of my money, thus rewarding me for my earlier savings. If I do not want to take the risk of losing my principle, I could pre-sell my shares for a preset price to another willing individual. In this way if the company becomes very successful he gets a bigger reward, if it fails then he takes the risk. This after all is the basis of share options. These are all manifestations of the costs of my money, that is, interest. Or to use my preferred term, reward on savings and investments.

Alternatively I could claim a percentage of the final product. This is common in rural Malaysia where farmers would “rent” their idle rice fields in return for a portion of the harvest. The landowner may decide not to get the harvest and would prefer to sell his share back to the farmer and merely collect the cash. Whatever it is, there is a cost for the use of capital, in this case, his land. You may label this cost in whichever way: interest, stock options, dividends, part ownership, share of harvest, or whatever.

Muslim theologians have no difficulty grasping and agreeing to this concept of borrowing as the lender shares the risks with the borrower. This in contrast, in their view, of putting money is a simple savings account where the depositor bears no risks of losing his money (capital). That is only a matter of degree. There is a small risk, but thanks to modern safeguards banks today are very safe. But back in the early 20th Century in the West and in many Third World countries today, you risk losing your precious money should the bank goes belly up. Indeed many Third World citizens today (including many Malaysians) see an unacceptable risk in their local banks and thus put their money in foreign banks. Similarly, many an investor had lost their capital investing in Third World Railroad bonds.

Thus when an investor seems to invest his funds “passively,” in reality it is far from that. He has to be prudent and investigate the risks and balance the rewards. Even in choosing a bank, not only has he to be careful to choose one that gives the best returns (interests) but also one that is safe, convenient, an offers superior services. All these require diligent evaluations. There is no such being as a passive investor. Thus we could look upon interest as rewards for the diligence of the investor.

Viewed another way, interest or costs of capital may be considered as profits on the trading of that capital which happens in this case to be money, instead of land or rice.

In the ordinary trading of goods and services, there is a fair and right price, determined by the free market of willing buyers and sellers. But if one party monopolizes a commodity and starts hoarding it in order to exact an exorbitant price to rake in the maximum profit, than that is rightly considered illegal (and sinful). America has elaborate antitrust and other laws to prevent business collusion and other anti-competitive behaviors.

Similarly in the trading of capital (money), there is a legitimate cost beyond which it becomes not only exorbitant but creates other serious consequences. Usurious (excessively high) interest rates are bad not only for individuals but also for society. They will extinguish all economic and business activities. There is no redeeming social or economic value in that. The economy would simply collapse.

Malaysia was smart enough not to heed the advice of the IMF during its recent [1997] economic crisis to jack up interest rates to levels that would cripple an already ailing economy, just to support the currency and satisfy the IMF bureaucrats. The bane of many Latin American countries is that their interest rates are so high that they choke off all economic activities.

It is interesting that in the current economic crisis in America triggered by the bust in the housing market, its central bank has purposely kept the interest rate very low.

The voluminous Islamic literature on interests and credits can be divided into two categories: one, usually written by religious scholars who are well versed in Islamic literature but woefully ignorant of modern economics; two, works of competent economists but whose knowledge of Islam consists of selective quotations of the Qur’an and hadith to support their positions. Rare indeed is an exposition that compares and contrasts accepted and well-tested concepts and principles of modern economics and banking with traditional Islamic understanding of the subject. The reason for this is that few economists are well grounded in Islamic learning, and fewer still are religious scholars who also understand modern economics. The ulama’s versions are long on erudite recitations of the Qur’an, hadith, and traditions. They strain to create qualitative differences between various terms which, stripped of their semantic gymnastics, are nothing more than a continuum on the risk-versus-returns spectrum.

The few notable exceptions to this sorry state of affairs are the contributions of Rice University’s economist Mahmoud El-Gamal. He readily admits to not being an Islamic scholar but he has the advantage of at least being a native-born Arabic speaker and thus can read the original Islamic texts and relate those terms and practices into their modern counterparts.

Next: Dealing With the Concept of Interest