• Ribā: (lit.

increase, Hebrew: Ribit)

– Superficial translations: “interest”, “usury” (exorbitant
interest).
– In fact: there is Ribā without interest (or time), as well as
interest without Ribā (embedded in most Islamic banking
instruments).
– Islamic Law recognizes the time value of money.
– Correct definition: The unbundled sale of credit, e.g. an
interest-bearing loan, interest being the price of credit.
• Bay`u l-Gharar:
– The unbundled sale of risk, e.g. gambling, insurance,
derivatives, payment or premium being the price of
unbundled risk.
History of Usury and Ribā
prohibitions
• Non-Abrahamic prohibitions of “usury”:
– Code of Hammurabi (ca 2100 BC): interest ceilings of
33% and 20% on loans-in-kind.
– Hindu law: total interest may not exceed principal.
– Plato,…: Capital not viewed as a valid “factor of
production”.
• Judeo-Christian-Islamic prohibition of “Ribā”:
– Exodus [22:25], Leviticus [25:35-7], Deuteronomy
[23:19-20], Bava Metzia, Chapter 5, Mishna 2.
– Luke [6:27-36], Benedict XIV (De Synodo Diocesana,
X.iv, n.6), First Council of Carthage (345)-until-Fourth
Council of the Lateran (1215).
– Qur’an [30:39], [3:130], [2:275-279], various Prophetic
traditions.
Universality of prohibitions of
Ribit
• Interpretations of Exodus [22:25], later Canonical
Texts
– Rare: “Ami” (my people) interpreted to mean poor debtors.
– Commonly (Ami = children of Israel) interpreted to apply
prohibition of Ribit only to inter-faith loans; c.f. Talmud (Bava
Metzia 70b – 71a).
– Maimonides (Laws of Loans, Ch. 5, Law 2) restricted permission
of charging moderate interest to cases of necessity.
 – Fourth Council of the Lateran (1215) allows Jews to charge
interest at non-usurious (non-exorbitant) rates.
– Distinguish consumption loans (to the needy) from productive
loans.
• Sixteenth Century – modern day:
– Heter ‘Iska: replaced loan-financing with silent partnership
investment.
– Moral hazard problems led to refinements of HI to allow for fixed
interest.
– Calvin permitted moderate interest on loans.
– Modern debates on interest rate ceilings (as in the code of
Hammurabi).

Islamic Sharīca: Prohibition of

Ribā
• Al-Sharīca:
– Lit.: “The Way” … to a water hole … in the desert! (comp.
Halakhah).
– Revealed Law in Canonical Texts: The Qur’an and Prophetic
traditions.
• Islamic Law: A mixture of canon and common law
– Fiqh (jurisprudence): (lit.) understanding of the Sharīca
– Canon Law: All rulings must be referred back to the Canonical
Texts.
• Unanimous interpretations are raised to the same
authoritative level.
– Common Law: Jurists rely on precedents in opinion,
interpretation, etc.
• Universal Prohibition of Ribā (interest on
loans):
– Explicit in Canonical Texts. Virtually no dissent on interpretation.
– Islamic finance avoids loans as finance contracts: loans are for
charity.
Neither a borrower nor a lender be …
• Finance without interest-bearing loans:
– Equity finance:
• Obvious “profit/loss-sharing” rules in partnerships, silent
partnerships, and (contemporary) ownership of common
shares.
• Recent trend: Islamic mutual funds, VC, private equity
funds, etc.
• Silent partnerships used to generate Islamic banks’
“liabilities-side”.
– Debt finance (Islamic banking “assets-side”):
 • Form: initiate debt (including implied interest) through
cost-plus sales (Murabaha), leasing (’Ijara), etc.
– OCC #867 (1999) & OCC #806 (1997) recognized
respective contracts as “secured lending within the
business of banking”.
• Substance: Enforcement of closer ties to “real”
transactions, marking collateral value and implied rate of
return to market.

“Sharīca Compliant Finance”

• Islamic financial institutions appoint religious scholars to serve
on “Sharīca boards”, approve contracts and monitor
operations.
• Efforts are underway to “harmonize Sharīca and accounting
standards” (e.g. AAOIFI, etc.).
• What do Sharīca boards consider to check for Sharīca
compliance?
– Real and legitimate transactions underlying financial
contracts.
– Absence of Ribā (interest on a “loan-like” contract) and
Gharar.
– A contract form that ensures the above.
– A contract wording that ties the contract form to
historical forms known in classical jurisprudence (hence
the Arabic names).
– In the tradition of Canon Law, the names imply
permissibility.
– In the tradition of Common Law, the names and contract
specifics ensure derivation from precedents and valid
analogies.
Example 1: Home financing
– Object to the “mortgage loan” language, since interest-
bearing loans (secured or otherwise) clearly constitute
Ribā.
– First step: The Islamic financing firm “acquires” the
property.
– Second step: The firm typically finances the customer’s
purchase of the property in one of three ways:
• Cost-plus credit sale (Murābaha): Customer buys the
property from firm on credit, amortization schedule
calculated in similar manner to conventional mortgage
(often LIBOR+ used as benchmark).
• Lease-to-own (‘Ijāra wa qtinā’): Customer pays rent for
portion owned by firm + buys back part of firm’s equity.
Rent determined by market rental rate of comparable
properties, or LIBOR+.
 • Rolling partnership (mushāraka mutanāqisa): similar to
lease, different treatment of taxes, insurance, capital
gains sharing, etc..
Example 2: Investing in stocks (Islamic mutual funds)
– Eliminate companies with primary or substantial businesses that
are illicit in Islam (e.g. liquor, tobacco, gambling, pornography,
etc.).
– Eliminate companies with excessive debt-to-assets (highly
leveraged).
– Eliminate companies with excessive interest income (idle
capital).
– Within the resulting universe of securities, apply standard
portfolio management techniques to provide a variety of risk-
return profiles under different business conditions (e.g. sectoral
bias, growth, value, …).
– Some have argued for regional, developmental, and ethical
biases being incorporated in the portfolio selection
methodologies (ethical investing), but such considerations seem
currently to be secondary at best.

Growing pains of Islamic Finance

• Contemporary Islamic finance is a only a few decades-old.
• Its emergence and growth coincided with (and resulted from)
increased degrees of adherence to explicit Islamic forms (from
ritual worship, to dress-codes, to social processes, to
economic life).
• This explains the focus on contract forms and names.
• There is an ongoing effort to bridge a centuries-wide gap of
jurisprudence development to meet today’s Muslims’ needs
within various national legal/regulatory frameworks.
• This often puts form above substance, and results in higher
(legal and other) short-term transactions costs (in this
instance, including your time… Thank you!).