The Koran prohibits interest, so how do Muslims borrow and lend
Listener: 11 September 2004.

Keywords: Macroeconomics & Money;

Launching his Christianity Without God, Lloyd Geering asked me when I would write a book about the economy without money. I said that anthropologist Raymond Firth had already done so (The Economics of the New Zealand Maori), but I would one day write a column about an economy without interest. Lloyd’s eyes twinkled. “Islam?” The Koran states, “Have fear of Allah and give up what remains of what is due to you of usury.”

The thousand-plus year older Jewish Torah has a more limited prohibition. Deuteronomy states, “To a stranger you may lend upon usury: but to your brother you may not lend on usury.” Because medieval Jews were prevented from entering most professions, they became expert moneylenders to Christians and were hated for it (recall Shylock). Ironically, their expertise was vital to the development of the modern economy, the reason that Cromwell permitted Jews to return to England from 1655.

The parable of the talents in the Christian gospels indicates that interest is permitted. (St Paul’s “the love of money is the root of all evil” is often misquoted by omitting the first three words.) The protestant theologian John Calvin interpreted “usury” as “unjustly exorbitant interest”. Today that meaning usually appears in an English dictionary. It allows reasonable interest payments as a recompense for forgoing the opportunity to spend immediately. (For “waiting”, as the great economist Alfred Marshall, son of the vicarage, described it.)

However, Muslims interpret the Koranic prohibition to mean all interest payments. One banker remarked, “There is no sin in the Koran … which could be as abhorrent and serious as dealing in riba [interest].”

An Islamic banker? The Koran does not prohibit private property, business, borrowing and lending, or banking. Its logic is that money may be advanced, providing the risk is shared between borrower and lender. Banks can exist: there are over 200 Islamic financial institutions in the world. But the return to the lender has to be a share in the profits and losses of the business. Easier said than done, and Islamic financial regimes and institutions have still to work out comprehensive details.

Individuals deposit their savings in an Islamic bank in a mudarabah account. It does not earn interest, but gets a share of the profits from the enterprises that the bank invests in. Borrowing is a little trickier. Instead of credit cards, there are debit cards. It is, however, difficult to borrow to build a new house. One Islamic banker explains that he is still completing his new house, because mortgages are not possible. He pays for developments out of his income. An existing house is easier. The bank purchases the house, adds a margin, and resells it to the putative owner, who pays the price off in equal monthly amounts, which sum to the price of the house.

“Aha,” you say, “the margin is effectively an interest rate.” Arithmetically, that is correct, but the bank takes all the risk if market interest rates change (and on-shares it with its depositors). More-over, Islamic bankers insist that there are moral principles as well. Any late fees have to be donated to charity. Donating a share of one’s income to charity, zakat, is a fundamental requirement of being a Muslim, more important – some say – than the pilgrimage to Mecca. And the bank is not to penalise a borrower who is genuinely broke.

In my reading of Islamic economics (it is not complete: I don’t know how they run monetary policy without interest rates), I am continually struck by the emphasis that it places on moral behaviour. One summary is that although conventional economics was “built to harness human nature, Islamic economics want to reform it”. And they are concerned with the spirit of the law, not its letter: “Playing semantics with God is very dangerous.”

Of course, Geering was not writing about a godless Christianity, but one with a different kind of god. Similarly interest-less Islamic borrowing and lending still have a return for the waiting. It is worth studying each to obtain a better understanding of one’s own system – and to respect the opinions of others.