We are all familiar today with lending and interest. I recall when I first discovered that Islam actually had a strong position on this matter – Riba is expressly, and in the strongest terms, forbidden. At first, I did not process the reasoning behind it, nor did I particularly much care – I filed it away as something that sounded somewhat interesting but of limited use to me – in my defence, I must have been young at the time!
The term Riba in itself warrants a lengthy discussion, however for the purposes of this paper I will restrict this definition to that of interest on a loan. The actual definition (or what we can refer to as a definition, because it is not actually defined in precise terms in Islamic source material, but rather several instances or examples are put forward to us of what results in Riba) is much wider than interest on a loan, but that is a matter for another discussion.
In classic works, Riba is often translated as Usury. I recalled that I had come across mention of Usury in Christianity, but was sure it meant a high and oppressive level of interest, not just all interest. I was speaking with an Italian lawyer some years ago, who wanted to learn more about Islamic finance, and she informed me that the Ministry of Finance in Italy publishes, monthly, a usury rate. If anybody, retail or corporate, had a credit facility and was paying an interest rate higher than this published Usury rate, then that contract is deemed void and unenforceable.
Now, that is fascinating. The echoes of a distance, divine voice manifesting today via monthly publications by a Ministry of Finance. For Muslims, Riba is not a distant voice – it is a loudspeaker that bellows in our faces every single day of our lives. We see it, many of us are drawn into it, some of willingly accept it for business reasons, and a lot of us are trying our very best to simply avoid it.
And it is impossible to avoid. The only decision we can make is to what extent we are involved in Riba. This draws back to the nature of modern fiat money, and the process of credit creation by private banks – but, again, a discussion for another day.
Today, I want to focus on the journey Riba, or Usury, has taken in the context of the major Abrahamic faiths – Christianity, Judaism and Islam. Each have treated Usury differently, both historically and in modern times.
I will limit my analysis to matters relevant to this article, and not delve into rabbit hole of theological positions of these faiths.
Interest in Christianity
All lending at interest was deemed impermissible in early Christian times. Early Christian scholars such as St. Jerome and St. Thomas Aquinas argued against charging interest. Their arguments, rooted in scriptural interpretation, were incorporated into Canon Law and reinforced by church councils that prohibited interest as a sin.
St. Thomas Aquinas provided, in the 13th century, a comprehensive theological and philosophical argument against Usury, stating it was unjust to charge interest on a loan because money is a medium of exchange and not a thing that can be sold for its use. The Council of Lateran III (1179) excommunicated open usurers. The Council of Vienne (1311) allowed excommunication of rulers who protected usurers.
We can see Usury is quite a serious thing.
However, it wasn’t that long before we saw attempts to circumnavigate this prohibition.
In fact, some attempts at finding loopholes for lending resulted in significant developments in the history of banking. For example, the Medici family developed Bills of Exchange for this reason.
They would issue a bill of exchange in one currency and agree to a repayment in a second currency at a future date, often weeks or months later. Interestingly, this future date was often set to match the time it would take to travel to a distant and relevant city (even if nobody was going there), thus lending support for the position that this time delay was necessary to allow for the physical movement of the parties. The profit came from manipulating the exchange rates between these currencies, where the cost to repay this bill of exchange (not a loan of course) in the new currency was greater than the original amount. This enabled the bill to operate as effectively as a loan with interest, but disguised as a practical and useful financial product.
Another significant development was the use of Contractum Trinius (three contracts) in the 13th century. It goes like this:
- A lender provides an “investment” into an “enterprise” for a period of one year
- This lender then took out “insurance” on the investment with the borrower, to protect the capital repayment
- The lender then sold the rights to any profits made over that period in return for a fixed percentage (the required interest rate)
This combination of contracts, each of which, in isolation, appears to be reasonable and commercial, reproduces the effect of a loan.
Now, this structure was universally condemned by Catholic jurists and theologians until the 16th century, because it certainly resulted in a loan with interest. Pope Sixtus V condemned such practices in 1586.
But there were many who defended this structure, for its practical application to commerce. By the end of the 17th century, the continued prohibition of this structure was deemed to be un-manageable, and most Catholic theologians validated this practice of the triple contract.
In a similar vein, the definition of Usury evolved from any interest on a loan, to only a higher level of interest that was deemed to be unfair.
Usury in Judaism
There is a prohibition derived from the Torah that charging interest to fellow Jews is prohibited. This is clearly differentiated to lending to non-Jews, to whom charging interest is permitted. In medieval Europe, where many professions were closed to Jews, this contributed to the development (or the perception of such development) of Jews playing the role of money lenders.
The role of money lenders in general was still, at the time, seen as a role for people with lower morals and standing, and the money lenders were deemed to be in a lower station in society. In commercial cities, it would be common to see the money lenders be based in the seedy parts of the cities, alongside brothels, disreputable drinking establishments and so on.
So do Jews not lend money to other Jews? Well, they do.
A Heter Iska is a Jewish religious document used to achieve compliance with the prohibition on charging interest on loans between members of the Jewish faith. There is not a lot of public (and detailed) information on this, but the basics of it are well understood.
Rather than structuring a transaction as a loan with interest, the following occurs:
- A Partnership Structure – the relationship is reframed, and instead of a lender, we have an Investing Partner, and the borrower becomes a Managing Partner
- Capital Division – Typically 50% of the funds are treated as an interest-free loan, while the other 50% is considered an investment by the lender in the business of the borrower
- Profit Sharing – What would otherwise be considered interest payments, are now recharacterized as the lender’s share of profits from his investment
This structure, the argument goes, creates a genuine risk-sharing arrangement that differs fundamentally from a pure interest-bearing loan, thereby satisfying religious requirements while maintaining the economic substance of the transaction.
Islam and Riba
One thing I do like about Riba in Islam is that no (serious) attempts have been made to whitewash and weaken the definition of Riba. We all know any interest on a loan is Riba. There are exceptions but, again, another story.
What we do see, however, in modern Islamic banking and finance is a weakening in the application of this prohibition and the enabling of structures to replicate Riba via (what looks like) investment structures or combinations of sales contracts.
We see that Bai al Inah is prohibited by all four major schools of law (when these are pre-organised trades). A typical Bai al Inah is a sequence of two sales between two parties, such that the outcome is a loan with interest.
This is deemed to be a clear trick for Riba by AAOIFI thus impermissible.
So what did Islamic banks do? They used three parties instead of two, but, of course, with the same level of organisation and prearrangement of all the sales. Three parties is not two, right?
RIGHT?
So it cannot be Bai al Inah. When it was deemed that even three parties were not enough, and this was being criticised, we moved to four parties. Four is not three is not two, right?
RIGHT?
So it cannot be Bai al Inah
This is called Tawarruq now.
What is not shown are one or two other parties, apart from the four that are presented, that manage the risks of the underlying asset and actually own them. The reason they are not shown is because everything would collapse if this was disclosed. I think even the scholars do not know about them.
Oh, and in case I forget, instead of seeing this as some apologetic, Hiyal type approach (which it certainly is), the industry doubled down. It created whole exchanges to conduct such Tawarruq transactions, to make it easier.
For example, in Malaysia, we have the Bursa Suq al Sila, which does nothing but organised Tawarruq (which even the Fiqh Council of the OIC deemed Riba and impermissible). It conducts quite a few of these Tawarruq transactions.
The total annual volume is around $2.5 trillion.
Trillion.
Let that sink in.
The whole GDP of Malaysia is $421bn.
And what is the volume of the underlying commodity base that supports this? It is largely Crude Palm Oil, and Malaysia, (the whole country) maintains around $2bn volume of this commodity.
Even if all of this was made available to this BSAS exchange, (in reality, only a fraction is available) then that means the actual volume of commodity that exists is only 0.1% of the Tawarruq transactions that occur on this exchange annually.
And it is an absolute requirement of Tawarruq structures, and a clear Shariah requirement for the BSAS, that every single Tawarruq deal must be able to deliver the commodity to the buyer if requested.
That is so absurd here, I must pause while I write to let that sink in …
Have you ever come across statements that the benefits of Islamic finance being it is based on real trade, the real economy and real assets, and how this is a clear differentiator between Islamic finance and the flow of capital for lending and credit?
Let’s read again, the justification provided for Heter Eska:
“This structure, the argument goes, creates a genuine risk-sharing arrangement that differs fundamentally from a pure interest-bearing loan, thereby satisfying religious requirements while maintaining the economic substance of the transaction.”
Instead of investments, we are using sales transactions. But, word for word, this justification is precisely what Islamic finance uses to justify the above structures.
This is only one example of the journey we have taken to justify Riba. The same journey is reproduced in every single activity of an Islamic bank, and in the global Sukuk (Islamic bond) markets. Stories for another day.
Summary
We have seen that Christianity tried to uphold the prohibition and even developed clever workarounds using combinations of contracts to create the outcomes of loans. Eventually, they even did away with that workaround and simply changed the definition of Usury from interest to high levels of interest.
The Jewish faith uses Heter Eska to replicate loans using what looks like investment agreements, and they don’t even bother to pretend it’s a clever workaround. They just do it.
In Islam, we have strictly upheld the definition (well, one of them) of Riba being interest on a loan. Then we decided we actually cannot do without debt and lending, so we created more and more complex structures to replicate debt. And to try to hide the Riba.
Then we doubled down moving from two parties, to three, then four.
Then we created exchanges where trillions of dollars change hands with virtually no commodity existing.
And this is seen as the epitome of innovation.
There is no sign of being apologetic, wringing our hands and saying, “well, we are trying our best”. It is outright accepted as a fait accompli and more and more resources are being applied to it, and we are progressing relentlessly forward like a juggernaut of Riba.
My Own Contribution to This Catastrophe
As Global Head of Structuring at JP Morgan, the essence of my job was to deliver products that ticked all the required boxes and thus were technically seen to be Shariah compliant, yet delivered what the parties and the industry wanted. Once I did that, then I had to go and make money from them.
I did both of these things very well. I say that not to brag, but just to highlight that is the way it is. In order to do this, I had to have superior levels of understanding of the following:
- What the underlying product we are trying to replicate looks like, how it works legally, regulatory, operationally, compliance etc.
- Which aspects of the above were problematic (or, more often, outright Haram)
- How to replicate these aspects in a Shariah compliant way, such that it would gather the approval of my Shariah board and that of every Islamic bank I worked with (which was dozens of them)
- How then to deal with the complexities of the above step, as they invariably make all aspects of documentation, legal, compliance, risk, and operations more problematic and difficult
The final step required deep understanding of how contracts work, recourse, risk management and many other areas.
As a structurer, I quietly admire the work put in by medieval Christians to find a loophole around Usury. The Heter Iska is a little disappointing, because, really, very little effort is made to hide what is happening.
As a structurer, the greatest validation for me was that I could explain the final structure in detail to a Shariah board of the most famous scholars in the world, and the product was approved. Now, I see this is a matter of pain and regret. But in a professional sense, I never once took a product to any Shariah board that was not then approved.
(Except once, when the Shariah board at Al Rajhi bank outright refused my proposal (presented in Arabic, as they didn’t speak English and I liked them for that straight away) on Profit Rate Swaps, and they sent me packing, and I left that meeting with admiration for those noble scholars).
And the products I delivered to the market were, overwhelmingly, debt and credit products, priced at interest. But hidden and structured so well that it would take someone with a better financial structuring mind than mine to find fault with them. That did not happen.
Modern Islamic finance products do not try half as hard as I did to hide their intent to hide Riba. It is very superficial structuring, and very easy to unpack and spot their clumsy structuring attempts.
But it works for them, so what can I say?
I should remind the reader that I walked away from modern Islamic finance for the very reasons I was taking pride in it, as I outline above, but, slowly, as I matured, I realised I was not only part of the problem, but a central and driving force of the problem.
For that, I ask for forgiveness daily from my Creator, and work to spread knowledge to warn Muslims of the path we have been taking for the last 50 years.
How to navigate Riba in our lives – LINK
People’s Charter for Reform – LINK
How to build a truly Islamic home financing product and system – LINK