The Adverse Effects of Interest on Society
By Justice Muhammad Taqi Usmani
Justice of the Supreme Court of
The Nature of money and the effects of interest charged by banks and whether it comes within the purview of injustice, are some of the issues discussed by Justice Taqi Usmani, in the course of his judgement on the Historic Judgment on Interest in the Supreme Court of Pakistan, which was considering the Islamisation of the Country's financial system.
The Holy Qur'an has itself decided what is injustice in a transaction of loan, and it is not necessary that everybody finds out all the elements of injustice in a riba transaction, yet the evil consequences of interest were never so evident in the past than they are today. Injustice in a personal consumption loan was restricted to a debtor only, while the injustice brought by the modern interest affects the economy as a whole. A detailed account of the rationale of the prohibition of riba would, in fact, require a seperative volume, but for the purpose brevity we would concentrate on three aspects of the issue:
The logic of the prohibition on theoretical ground
ii. The evil effects of interest on production
iii. The evil effects of interest on distribution.
On a purely theoretical ground, two basic issues will be focused on; firstly on the nature of money and secondly on the nature of a loan transaction.
Nature of Money:
One of the wrong presumptions on which all theories of interest are based is that money has been treated as a commodity. It is, therefore, argued that just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value, or just as he can lease his property and can charge a rent against it, he can also lend his money and can claim interest thereupon.
Islamic principles, however, do not subscribe to this presumption. Money and commodity have different characteristics and therefore they are treated differently. The basic points of difference between money and commodity are as follows:
(a) Money has no intrinsic utility. It cannot be utilized in direct fulfilment of human needs. It can only be used for acquiring some goods or services. A commodity, on the other hand, has intrinsic utility and can be utilized directly without exchanging it for some other thing.
(b) The commodities can be of different qualities while money has no quality except that it is a measure of value or a medium of exchange. Therefore, all the units of money of the same denomination, are hundred per cent equal to each other. An old and dirty note of RS1000/= has the same value as a brand new note of Rs.I000/=.
(c) In commodities, the transactions of sale and purchase are effected on an identified particular commodity .If A has purchased a particular car by pinpointing it, and seller has agreed, he deserves to receive the same car. The seller cannot compel him to take the delivery of another car, though of the same type or quality. Money, on the contrary, cannot be pin-pointed in a transaction of exchange. If A has purchased a commodity from B by showing him a particular note of Rs.l000/- he can still pay him another note of the same denomination.
Based on these basic differences, Islamic Shariah has treated money differently from commodities, especially on two scores:
Firstly, money (of the same denomination) is not held to be the subject matter of trade, like other commodities. Its use has been restricted to its basic purpose i.e. to act as a medium of exchange and a measure of value.
Secondly, if for exceptional reasons, money has to be exchanged for money or it is borrowed, the payment on both sides must be equal, so that it is not used for the purpose it is not meant for i.e. trade in money itself.
Imam Al-Ghazzali view on the Nature of Money
Imam Al-Ghazzali (d.505 A.H.) the renowned jurist and philosopher of Islamic history discussed the nature of money in an early period when the Western theories of money were not existent, at all. He stated:
"The creation of dirhams and dinars (money) is one of the blessings of Allah. They are stones having no intrinsic usufruct or utility, but all human beings need them, because every body needs a large number of commodities for his eating, wearing etc, and often he does not have what he needs and does have what he needs not... therefore, the transactions of exchange are inevitable. But there must be a measure on the basis of which price can be determined, because the exchanged commodities are neither of the same type, nor of the same measure which can determine how much quantity of one commodity is a just price for another.
Therefore, all these commodities need a mediator to judge their exact value Allah Almighty has, therefore, created dirhams and dinars (money) as judges and mediators between all commodities so that all objects of wealth are measured through them... and their being the measure of the value of all commodities is based on the fact that they are not an objective in themselves. Had they been an objective in themselves, one could have a specific purpose for keeping them, which might have given them more importance according to his intention while the one who had no such purpose would have not given them such importance and thus the whole system would have been disturbed. That is why Allah has created them, so that they may be circulated between hands and act as a fair judge between different commodities and work as a medium to acquire other things. So, the one who owns them is as he owns every thing, unlike the one who owns a cloth, because he owns only a cloth, therefore, if he needs food, the owner of the food may not be interested in exchanging his food for cloth, because he may need an animal for example. Therefore, there was needed a thing which in its appearance is nothing, but in its essence is everything. The thing which has no particular form may have different forms in relation to other things like a mirror, which has no colour, but it reflects every colour. The same is the case of money. It is not an objective in itself, but it is an instrument to lead to all objectives.
Hence the one who is
using money in a manner contrary to its basic purpose is, in fact, disregarding
the blessings of Allah. Consequently, whoever hoards money is doing injustice
to it and is defeating their actual purpose. He is like the one who detains a
ruler in a prison. And whoever effects the transactions of interest on money
is, in fact, discarding the blessing of Allah and is committing injustice,
because money is created for some other things, not for itself. So, the one who
has started trading in money itself has made it an objective contrary to the
original wisdom behind its creation, because it is injustice to use money for a
purpose other than it was created for ... If it is allowed for him to trade in
money itself, money will become his ultimate goal and will remain detained with
him like hoarded money. And imprisoning a ruler or restricting a postman from
conveying messages is nothing but injustice."
This brief, yet comprehensive, analysis of the nature of money, undertaken by Imam Al-Ghazzali about nine hundred years ago, is admitted to be true by the economists who came centuries after him. That money is only a medium of exchange and a measure of value is universally accepted by almost all the economists of the world, but unfortunately a large number of these economists failed to recognize the logical outcome of this concept, so clearly elaborated by Imam Al-Ghazzali: that money should not be treated as a commodity meant for being traded in. After holding that money is a commodity, the modern economists have plunged into a dilemma that was never resolved satisfactorily.
The commodities are classified into the commodities of first order which are normally termed as 'consumption goods' and the commodities of the higher order which are called 'productive goods'. Since money, having no intrinsic utility, could not be included in 'consumption goods' most of the economists had no option but to put it under the category of 'Production goods', but it was hardly proved by sound logical arguments that money is a 'production good'. Ludwig Yon Mises, the well-known economist of the present century has dealt with the subject in detail. He says:
"of course, if we regard the twofold division of economic goods as exhaustive, we shall have to rest content with putting money in one group or the other. This has been the position of most economists; and since it has seemed altogether impossible to call money a consumption good, there has been no alternative but to call it a production good... It is true that the majority of economists reckon money among production goods. Nevertheless, arguments from authority are invalid; the proof of a theory is in its reasoning, not in its sponsorship; and with all due respect for the masters, it must be said that they have not justified their position very thoroughly in the matter."
He then concludes: "Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, "dead stock, which... produces nothing."
The author has then expressed his inclination to the Kien's theory that money is neither consumption good nor a production good; it is a media of exchange.
The logical result of this finding would have been that money should not be taken as an instrument that gives birth to more money on a daily basis, nor should it have been taken as a tradable commodity, when it is exchanged for another money of the same denomination, because once it is accepted that money is neither consumption good nor production good, and that it is merely a medium of exchange, then there remains no room for making itself an object of profitable trade, for it will be like a mediator himself has been made a party. But, perhaps due to the overwhelming domination of interest-based monetarily system, many economists did not proceed any further to this direction.
Imam Al-Ghazzali, on the other hand, has taken the concept of 'medium of exchange' to its logical end. He has concluded that when money is exchanged for money of the same denomination, it should never be made an instrument generating profit by such exchange.
This approach of Imam Al-Ghazzali, fully backed, the clear directives of the holy Qur'an and Sunnah, has never been admitted to be true by some realistic scholars, even in societies dominated by interest. Many of them after facing the severe consequences of their financial system based on trade in money have admitted that their economic plight was caused, inter alia, by the fact that money was not restricted to be used for its primary function as a medium of exchange.
During the horrible depression of 1930s, an "Economic Crisis Committee" was formed by Southampton Chamber of Commerce in January 1933. The Committee consisted of ten members headed by Mr. Dennis Mundy. In its report the committee had discussed the root causes of the calamitous depression in national and international trade and had suggested different measures to overcome the problem. After discussing the pitfalls of the existing financial system, one of the committee's recommendations was that "In order to ensure that money performs its true function of operating as a means of exchange and distribution, it is desirable that it should be traded as a commodity."
This real nature of money
which should have been appreciated as a fundamental principle of the financial
system remained neglected for centuries, but it is now increasingly recognized
by the modern economists. Prof. John Gray, of
significantly, perhaps transactions on foreign exchange markets have now
reached the astonishing sum of around $1.2 trillion a day, over fifty times the
level of the world trade. Around 95 percent of these transactions are
speculative in nature, many using complex new derivative's financial
instruments based on futures and options. According to Michael Albert, the
daily volume of transactions on the foreign exchange markets of the world holds
some $900 billions -equal to
The size of derivatives mentioned by John Gray was, by the way, of their daily transactions. The size of their total worth, however, is much greater. It is mentioned by Richard Thomson in his "Apocalypse Roulette" in the following words: "Financial derivatives have grown, more or less from standing starting in the early 1970s, to a $64 trillion industry by 1996. How do you imagine a number that big? You could say that if you laid all those dollar bills end to end, they would stretch from here to the sun sixty-six times, or to the moon 25 900 times"'
James Robertson observes in his latest work, 'Transforming Economic Life' in the following words:
"Today's money and finance system is unfair, ecologically destructive and economically inefficient, the money-must-grow imperative derives production (and thus consumption) to higher than necessary levels. It skews economic effort towards money out of money, and against providing real services and goods. It also results in a massive world-wide diversion of effort away from providing useful goods and services, into making money out of money. At least 95% of the billions of dollars transferred daily around the world are for purely financial transactions, unlinked to transactions in the real economy."
This is exactly what Imam Al-Ghazzali had pointed out nine hundred years ago. The evil results of such an unnatural trade have been further explained by him as follows:
"Riba (interest), is prohibited because it prevents people from undertaking real economic activities. This is because when a person having money is allowed to earn more money on the basis of interest, either in spot or in deferred transactions, it becomes easy for him to earn without bothering himself to take pains in real economic activities. This leads to hampering the real interests of the humanity, because the interests of the humanity cannot be safeguarded without real trade skills, industry, and construction."
It seems that Imam- Al-Ghazzali has, in that early age, pointed out to the phenomenon of monetary factors prevailing on production, creating a wide gap between the supply of money and the supply of real goods which has emerged in the later days as the major cause of inflation, almost the same 'terrible potential' of trading in money as explained by John Gray and James Robertson in their above extracts. We will examine this aspect a little later, but what is important at this point is the fact that money, being a medium of exchange and a measure of value cannot be taken as a "production good" which yields profit on daily basis, as is presumed by the theories of interest. This is a mediator and it should be left to play this exclusive role. To make it an object of profitable trade disturbs the whole monetary system and brings a plethora of economic and moral hazards to the whole society.
The Nature of Loan
Another major difference between the secular capitalist system and the Islamic principles is that under the former system, loans are purely commercial transactions meant to yield a fixed income to the lenders. Islam, on the other hand, does not recognize loans as income-generating transactions. They are meant only for those lenders who do not intend to earn a worldly return through them. They, instead, lend their money either on humanitarian grounds to achieve a reward in the Hereafter, or merely to save their money through a safer hand. So far as investment is concerned, there are several other modes of investment like partnership etc which may be used for that purpose. The transactions of loan are not meant for earning income.
The basic philosophy underlying this scheme is that one who offers his money to another person has to decide whether:
(a) he is lending money to him as a sympathetic act; or
(b) he is lending money to the borrower, so that his principal may be saved; or
(c) he is advancing his money to share the profits of the borrower.
In the former two cases (a) and (b) he is not entitled to claim any additional amount over and above the principal, because in the case (a) he has offered financial assistance to the borrower on humanitarian grounds or any other sympathetic considerations, and in the case (b) his sole purpose is to save his money and not to earn any extra income.
However, if his intention is to share the profits of the borrower, as in the case (c), he shall have to share his loss also, if he suffers a loss. In this case, his objective cannot be served by a transaction of loan. He will have to undertake a joint venture with the opposite party, whereby both of them will have a joint stake in the business and will share: its outcome on fair basis. Conversely, if the intent of sharing the profit of the borrower is designed on the basis of an interest-based loan, it will mean that the financier wants to ensure his own profit, while he leaves the profit of the borrower at the mercy of the actual outcome of the business. There may be a situation where the business of the borrower totally fails. In this situation he will not only bear the whole loss of the business, but he will have also to pay interest to the lender, meaning thereby that the profit or interest of the financier is guaranteed at the price of the destructive loss of the borrower, which is obviously a glaring injustice.
On the other hand, if the business of the borrower earns huge profits, the financier should have shared him in the profit in reasonable proportion, but in an interest-based system, the profit of the financier is restricted to a fixed rate of return which is governed by the forces of supply and demand of money and not on the actual profits produced on the ground. This rate of interest may be much less than the reasonable proportion a financier might have deserved, had it been a joint venture. In this case the major part of the profit is secured by the borrower, while the financier gets much less than deserved by his input in the business, which is another form of injustice.
Thus, financing a business on the basis of interest creates an unbalanced atmosphere, which has the potential of bringing injustice to either of the two parties in different situations. That is the wisdom for which the Shariah does not approve an interest-based loan as a form of financing.
Once interest is banned, the role of 'loans' in commercial activities becomes very limited, and the whole financing structure turns out to be equity-based and backed by real assets. In order to limit the use of loans, the Shariah has permitted to borrow money only in cases of dire need, and has discouraged the practice of incurring debts for living beyond one's means or to grow one's wealth. The well-known event that the Holy Prophet refused to offer the funeral prayer (salat-ul janazah) of a person who died indebted was, in fact, to establish the principle that incurring debt should not be taken as a natural or ordinary phenomenon of life. It should be the last thing to be resorted to in the course of economic activities. This is one of the reasons for which interest has been prohibited, because, given the prohibition of interest, no one will be agreeable to advance a loan without a return for unnecessary expenses of the borrower or for his profitable projects. It will leave no room for unnecessary expenses incurred through loans. The profitable ventures, on the other hand, will be designed on the basis of equitable participation and thus the scope of loans will remain restricted to a narrow circle.
interest is allowed, and advancing loans, in itself,
becomes a form of profitable trade, the whole economy turns into a debt-oriented
economy which not only dominates over the real economic activities and disturbs
its natural functions by creating frequent shocks; but also puts mankind under
the slavery of debt. It is no secret that all the nations of the world,
including the developed countries, are drowned in national and foreign debts to
the extent that the amount of payable debts in a large number of countries
exceeds their total income. Just to take one example of
Peter Warburton, one
"The credit and capital markets have grown too rapidly, with too little transparency and accountability. Prepare for an explosion that will rock the western financial system to its foundation."
Overall Effects of Interest
Interest-based loans have a persistent tendency in favor of the rich and against the interests of the common people. It carries adverse effects on production and allocation of resources as well as on distribution of wealth. Some of these effects are the following:
(a) Evil effects on allocation of Resources
Loans in the present banking system are advanced mainly to those who, on the strength of their wealth, can offer satisfactory collateral. Dr. M. Umar Chapra (Senior Economic Advisor to Saudi Arabian Monetary Agency) who appeared in this case as a juris-consult has summarized the effects of this practice in the following words:
"Credit, therefore, tends to go to those who, according to Lester Thurow, are 'lucky rather than smart or meritocratic. The banking system thus tends to reinforce the unequal distribution of capital. Even Morgan Guarantee Trust Company, sixth largest bank in the U.S has admitted that the banking system has failed to 'finance either maturing smaller companies or venture capitalist' and 'though awash with funds, is not encouraged to deliver competitively priced funding to any but the largest, most cash-rich companies. Hence, while deposits come from a broader cross-section of the population, their benefit goes mainly to the rich."
The veracity of this statement can be confirmed by the fact that according to the statistics issued by the State Bank of Pakistan in September 1999, 9269 account holders out of 2,184,417 (only 0.4243% of total account holders) have utilized Rs.438.67 billion which is 64.5% of total advances as of end December 1998.
(b) Evil effects on production
Since in an interest-based system funds are provided on the basis of strong collateral and the end-use of the funds does not constitute the main criterion for financing, it encourages people to live beyond their means. The rich people do not borrow for productive projects only, but also for conspicuous consumption.
Similarly, governments borrow money not only for genuine development programs, but also for their lavish expenditure and for projects motivated by their political ambitions rather than being based on sound economic assessment. Non-project-related borrowings, which were possible only in an interest-based system have thus helped in nothing but increasing the size of our debts to a horrible extent. According to the budget of 1998/99 in our country 46 percent of the total government spending is devoted to debt-servicing, while only 18% is allocated for development which includes education, health and infrastructure.
(c) Evil effects on distribution
We have already pointed out that when business is financed on the basis of interest, it may bring injustice either to the borrower if he suffers a loss, or to the financier if the debtor earns huge profits. Although both situations are equally possible in an interest-based system, and there are many examples where the payment of interest has brought total ruin to the small traders, yet in our present banking system, the injustice brought to the financier is more pronounced and much more disturbing to the equitable distribution of wealth.
In the context of modern capitalist system, it is the banks that advance depositors' money to the industrialists and traders. Almost all the giant business ventures are mostly financed by the banks and financial institutions. In numerous cases the funds deployed by the big entrepreneurs from their own pocket are much less than the funds borrowed by them from the common people through banks and financial institutions. If the entrepreneurs having only ten million of their own, acquire 90 million from the banks and embark on a huge profitable enterprise, it means that 90% of the projects is created by the money of the depositors while only 10% was generated by their own capital.
If these huge projects bring enormous profits, only a small proportion (of interest which normally ranges between 2% to 10% in different countries) will go to the depositors whose input in the projects was 90% while all the rest will be secured by the big entrepreneurs whose real contribution to the projects was not more than 10%. Even this small proportion given to the depositors is taken back by these big entrepreneurs, because all the interest paid by them is included in the cost of their production and comes back to them through the increased prices. The net result in this case is that all the profits of the big enterprises is earned by the persons whose own financial input does not exceed 10% of the total investment, while the people whose financial contribution was as high as 90% get nothing in real terms, because the amount of interest given to them is often repaid by them through the increased prices of the products, and therefore, in a number of cases the return received by them becomes negative in real terms.
While this phenomenon is coupled with the fact, already mentioned, that 64.5% of total advances went only to 0.4243% of total account holders, it means that the profits generated mostly by the money of millions of people went almost exclusively to 9,269 borrowers. One can imagine how far the interest-based borrowings have contributed to the horrible inequalities found in our system of distribution, and how great is the injustice brought by the modern commercial interest to the whole society as compared to the interest charged on the old consumption loans that affected only some individuals.
How the present interest-based system works to favour the rich and kill the poor is succinctly explained by James Robertson in the following words:
role of interest in the economic system results in the systematic transfer of
money from those who have less to those who have more. Again, this transfer of
resources from poor to rich has been made shockingly clear by the
The same author in another book comments as follows:
"The transfer of revenue from poor people to rich people, from poor places to rich places, and from poor countries to rich countries by the money and finance system is systematic One cause of the transfer of wealth from poor to rich is the way interest payments and receipts work through the economy.
(d) Expansion of artificial money and inflation
Since interest-bearing loans have no specific relation with actual production, and the financier, after securing a strong collateral, normally has no concern how the funds are used by the borrower, the money supply effected through banks and financial institutions has no nexus with the goods and services actually produced on the ground. It creates a serious mismatch between the supply of money and the production of goods and services. This is obviously one of the basic factors that create or fuel inflation.
This phenomenon is aggravated to a horrible extent by the well-known characteristic of the modern banks normally termed as 'money creation'. Even the primary books of economics usually explain, often with complacence, how the banks create money. This apparently miraculous function of the banks is sometimes taken to be one of the factors that boost production and bring prosperity. But the illusion underlying this concept is seldom unveiled by the champions of modern banking.
The history of money
creation' refers back to the famous story of the goldsmiths in medieval
Initially, it was abuse of trust and a sheer fraud on the part of the goldsmiths not warranted by any norm of equity, justice and honesty. It was a form of forgery and usurpation of the power of the sovereign authority to issue money. But overtime, this fraudulent practice turned into the fashionable standard practice of the modern banks under the 'fractional reserve' system.
How the money changers and bankers have succeeded in legalizing the creation of money by the private banks, in spite of the strong opposition from several rulers in England and USA, and how the Rothchilds acquired financial mastery over the whole of Europe and the Rockfeller over the whole of America is a long story, now lost in the mist of numerous theories developed to support the concept of money-creation by the private banks. But the net result is that the modern banks are creating money out of nothing. They are allowed to advance loans in the amounts ten times more than their deposits. The coins and notes issued by the government as a genuine and debt-free money have now a very insignificant proportion in the total money in circulation, most of which is artificial money created by advances made by the banks.
The proportion of real
money issued by the governments has been constantly declining in most of the
countries, while the proportion of the artificial money created by the banks
out of nothing is ever-increasing. The spiral of loans built upon loans is now
the major part of the money supply. Taking the example of
This table shows that money created by the banks has been growing with speed throughout the last two decades until it reached 680 billion pounds in 1997. The last column of the table shows the yearly declining percentage of the real money to the total money supply, which fell from 12% in 1977 to 3.6% in 1997. This phenomenon unveils two realities. Firstly, it shows that 96.4% of the total money supply is debt-ridden money and only 3.6% is debt free. Secondly, it means that 96.4% of the aggregate money circulated in the country is nothing but numbers created by computers having no real thing behind them.
The position in the
"Why are we over our heads in debt? Because we are labouring under a debt money system, in which all our money is created in parallel with an equivalent quantity of debt, that is designed and controlled by private bankers for their benefit. They create and loan money at interest and we get the debt.
So although the banks do not create currency, they do create cheque-book money, or deposits, by making new loans. They even invest some of this created money. In fact, over one trillion dollars of this privately created money has been used to purchase US bonds on the open market, which provides the banks with roughly 50 depositors. In this was though fractional reserve lending, banks create far in excess of 90% of the money and therefore cause over 90% of our inflation."
All this appalling situation faced by the whole world today is the logical outcome of giving the interest based financial system an unbridled power to reign the economy. Can one still insist that the universal horrors brought about by the commercial interest are byt far greater than the individual usurious loans that used to affect only some individuals