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The effects of interest

The Verdict
The effects of interest

It carries adverse effects on production and allocation of resources as well as on distribution of wealth

By Syed M. Aslam
Jan 03 - 16, 2000

To rephrase a popular saying— interest by any other name is still interest. December 23, 1999 will be remembered as a day when the Supreme Court of Pakistan ruled that interest, irrespective of its name or form, is un-Islamic and thus unpermissible in a country which prides itself as an ‘Islamic Republic.’

The historic ruling by the apex court of Pakistan has sent ripples not only in Pakistan but through the entire Muslim world. It has much deeper implications for the economy of Pakistan as the Court also ordered that measures should be taken to ensure the implementation of a completely interest-free economy by June 2001.

The judgement was delivered by a Shariat (Islamic jurisprudence) Appellate Bench of the Supreme Court comprising Justices Khalilur Rehman Khan, Munir A. Sheikh, Wajiuddin Ahmed and Maulana Mufti Muhammad Taqi Usmani. Justice Ahmed expressed his reservations in a separate 98-page note about some of the findings of the 716-page majority judgement written by Justice Khan and concurred with by Justice Sheikh and Justice Usmani. The court order is 106 pages long.

Justice Taqi Usmani has also written a 223 note. PAGE’s attempt to interview him was politely turned down saying that he was one of the Justices who gave the judgement. PAGE, however, was welcomed to use the excerpts from Justice Usmani’s elaborate note to create a better understanding about the decision and what it implies.

The foremost question is what is Riba? Justice Usmani writes that Holy Quran did not give any definition to the term Riba for the simple reason that it was well known to his addressees . . . like pork, gambling, adultery, etc. It was not a term foreign to Arabs who used the term in their mutual transactions. Moreover, the literature of Hadith, the sayings of the Holy Prophet (Peace Be Upon Him), has mentioned in detail the transactions of Riba used by pre-Islam Arabs: Loan given for stipulated period with a stipulated increase on the principal payable by the loanee.

Some appellants advanced argument that Holy Quran had prohibited to claim may increase over and above the principal in the case of consumption loans only, where the borrowers used to be poor persons borrowing money to meet their day-to-day needs. Since no productive loans were in vogue in the days of the Holy Prophet (Peace Be Upon Him) it was not contemplated by the verse of Riba to prohibit a charge on the commercial and productive loans. Otherwise, they argued, it is injustice to claim any additional amount on the principal from a poor person, but it is not so in the case of a rich man who borrows money to develop his own commercial enterprise and earn huge profits through it. Therefore, it is only the loans of the first kind that is consumption loans on which any excess is termed as Riba and not an increased amount charged on the commercial loans.

Justice Usmani rejected these arguments as the validity of a financial or commercial transaction does never depend on the financial position of the parties. It rather demands on the intrinsic nature of the transaction itself. If a transaction is valid by its nature, it is valid irrespective of whether the parties are rich or poor. Sale, for example, is a valid transaction whereby a lawful profit is generated. It is allowed regardless of whether the purchaser is rich or poor. Lease is a valid transaction and it is permissible even though the lessee is a poor person. The most one can say is that a poor purchaser or a poor lessee deserves concession on humanitarian grounds, but one cannot say that charging any amount of profit from him is totally haram or prohibited.

Evil Effects

Citing the overall effects of interest, Justice Usmani noted that the ‘interest based loans have a persistent tendency in favour 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.

Effects on allocation of resources

"For instance, 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 summarised the effects of this practice in the following words: ‘Credit, therefore, tends to go to those who, according to Lester Thurow in his book the Sero-Sum Society are lucky rather than smart or meritocratic. The banking system thus tends to reinforce the unequal distribution of capital. Even Morgan Guarantee Trust Company, the sixth largest bank in the US, has admitted that the banking system has failed to finance either maturing smaller companies or venture capitalist and though awash with funds, it is not encouraged to deliver competitively priced funding to any but the largest, most 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 [the central bank] in September 1999, 9,269 account holders out of 2,184,417 or just 0.4243 per cent of the total account holders have utilised Rs 438.67 billion which is 64.5 per cent total advances as of end December 1998."

Effects on production

Similarly, the evil effects of the interest on production was highlighted by Justice Usmani. He noted that "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 the productive projects only, but also for conspicuous consumption.

"Similarly, governments borrow money not ony for genuine development programmes, but also for their lavish expenditure and for projects motivated by the political ambitions rather than being based on sound economic assessment.Non-project-related borrwoings, 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 fourty-six per cent of the total government spending is devoted to debt-servicing, while only 18 per cent is allocated for development which includes education, health and infrastructure."

Effects on distribution

Justise Usmani said 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 which 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 per cent of the projects is created by the money of the depositors. If these huge projects bring enormous profits, only a small portion (on interest which normally ranges between 2-10 per cent in different countries) will go to the depositors whose input in the projects was 90 per cent as against just 10 per cent the entrepreneurs. Even this small portion given to the depositors is taken back by these big entrepreneurs because all the interest paid by them is included in the cost of 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 per cent of the total investment while the people whose financial contribution was as high as 90 per cent get nothing in real terms because the amount of interest given to them is often repaid by them through the increased prices of products. In a number of cases the return received by these small by numerous depositors becomes in real terms.

"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.

Expansion of artificial money and inflation

Justice Usmani noted that "Since interest-bearing loans have no specific relation with actual production, and the financier, . . . the money supply effected through banks and financial institutions has no nexus with the goods and services actually produced. 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.’ 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 goldsmiths of medieval England who used to accept deposit from the people in gold coins in trust against a receipt to the depositors. The goldsmiths realised that only a fraction of the depositors or bearers ever came to demand actual gold and they began lending out some of the deposited gold secretly to earn interest.

"Initially, it was an 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.

"The spiral of loans built upon loans is now a major part of the money supply. For instance, according to the statistics of 1997 the total money stock in the UK was 680 billion pounds, out of which only 25 billion pounds were issued by the government in the form of coin and notes— the rest of 655 billion were created by the banks. It means that the original debt-free money remained only 3.6 per cent of the whole money supply while 96.4 per cent is nothing but a hubble created by the banks.

"The position in the USA is almost the same as that in the UK. Patrick S.J Carmack and Bill Stilli observes the situation as follows: ‘Why are we over our head 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, we get the debt . . . So, although the banks do not create currency, they do create checkbook money, or deposits, by making new loans.


Justice Usmani concluded that any additional amount over the principal in a contract of loan or debt is the Riba prohibited by the Holy Qur’an . The Holy Prophet, (Peace Be Upon Him), "A transaction of money of the same denomination where the quantity on both sides is not equal, either in a spot transaction or in transaction based on deferred payment."