Compound & Simple Interest – Are they Riba?

Wahed Editors 

 

“In an interest-based financial system, at any given point of time, there is not enough money in the system to pay off all the liabilities that arise from borrowings, which makes the concept of charging interest fundamentally flawed”

Islamic investments and finance as a whole have been stirring up debate in every aspect since its conception. What does and doesn’t count, what basics of investment are exempted from the rules, and more questions like these end up creating a few confusing narratives around the fairly simple concept of riba. In a short answer, as it should be, yes simple and compound interests are both considered riba if the lender and borrower follow the Sharia law. This is mainly because all forms of interest – any amount above the principle – are considered debt usury and are haram in the eyes of the Qur’an. To understand why simple and compound interests are considered riba, and hence unlawful, let’s break down a few basic concepts.

 

Simple interest is basically the added sum earned over and above the principal amount lent. So if a lender or institution loans a USD 100 on an interest of 10% per annum, the loanee must return the principal amount of USD 100 with the added sum of USD 10. In the case of compound interest, the interest isn’t levied on the principal sum, but on the entire loan amount inclusive of timely interests. In both of the above situations, it is clear that the lending institution/investor will earn an over and above sum on what they initially lent or invested. Corporate investments promote and practice this as it turns out to be profitable to all, and for many reasons including something as basic as savings.

 The debate usually arises basis one argument — if riba has been prohibited to ensure the distribution of wealth among all, rich and poor, and to eliminate accumulation among lending institutions, then why are interests that are profitable to investors considered haram? As neverending as certain arguments are, due to the various schools of thought, the answer to this one is simple and clear. Simple and compound interests are riba because they defy one primary rule of Islamic investment — earning an income through the exchange of money. Seen from a moral perspective, as it is by most interpreters of the laws, whether the profit is being earned by an individual, a group or an institution, in majority of the cases, the borrower is burdened with that extra sum, and more often than not,with the punishment of increment if the interest is not paid in time. A less known fact is that many religions other than Islam also criticized making profits through interests, but since the spiritual and secular law of Islam is one, this is the one religion that is practising the exchange of money solely for building assets and charitable reasons.

 

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