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Islamic Banking– Interest-Free Banking PDF Print E-mail
Written by Saidat Adeola Otiti   


This is the 1st of 4 series on the topic. Read 2nd, 3rd and 4th


The distinguishing feature of an Islamic bank, indeed an Islamic financial system is the exclusion of Riba (interest) from its operation. This is because Riba is prohibited in Islam in very strong terms.

Islam forbids interest in all its forms, suffice it to say, it is not only Islam that prohibits interest, all major religious and ethical systems have prohibited interest; so whether you look at Christianity, Judaism, Buddhism or Hinduism, interest was originally forbidden. Similarly all medieval thinkers and theologians – Confucuis, Socrates, Plato, Aristotle – stood against interest and regarded it as a form of exploitation. It was only during the last 200 years, in the wake of moral relativism, that the legitimization of interest has taken place.

Prohibition of Interest in the Bible

Luke 6: 35

Lend hoping for nothing in return.

Exodus: 2:25

If you lend money to any of my people with you who is poor, you shall not be to him as a creditor, and you shall not exact interest from him.

Prohibition of Interest (Riba) in the Quran

Surah 30:39

That which you give as interest to increase the people’s wealth increases not with Allah; but that which you give in charity, seeking the goodwill of Allah multiplies manifold

Surah 4 : 160-161

 And their (the Jews) taking of Riba though they were forbidden from taking it…

Surah 3:130:

O you who believe! Eat not Riba doubled and multiplied, but fear Allah that you may be successful.

Surah 2: 275 –279

Those who benefit from Riba shall be raised (on the day of resurrection)

Like those who have been driven to madness by the touch of the devil;

This is because they say: ‘Trade is like Riba’ whereas Allah has permitted trading and forbidden Riba.

Hence those who have received the admonition from their Lord and desist shall not be punished for the past: their case being entrusted to Allah;

But those who revert, shall be the inhabitants of the fire – they will abide therein. 

Allah will destroy Riba and will give increase for sadaqat (deeds of charity)…

O you who believe! Fear Allah and give up the Riba that remains outstanding,

If you do not do so, then take notice of war from Allah and His Messenger! But if you repent, you shall have your capital sums.

Deal not unjustly and you shall not be dealt with unjustly…

In this last revelation, Riba in all forms was utterly condemned, and those who care not for its prohibition are warned of war to be waged against them by Allah and His Messenger (S.A.W). Again, the argument of those who find no difference between Riba and trade, (i.e. no difference between taking a return on money as an asset and taking a return on commodities through trade) was refuted. It was made clear that Riba is different from trade and that Allah prohibits Riba irrespective of any reasons which may be given for its support.

A number of authentic hadiths goes further to reiterate Riba’s prohibition and its inherent danger and implications. One such hadith warned that the least form of Riba is akin to a man commiting incest with his mother. In yet another hadith, riba was listed amongst the major sins to be avoided, alongside commiting murder and associating partners with Allah!. The Prophet (S.A.W) is reported to have cursed the one who devours usury, the one who pays it, the one who writes down its contract, and the witnesses. They all share in the sin equally. 

In essence, the dealing on Riba (interest) is described as akin to madness, something of destruction, the antithetis of faith, deserving of war from Allah and His Messenger, and something which, if persisted in, deserves a parmanent abode in Hell.

The nature of prohibition in Islam, leaves no room for doubts; it is strict, absolute, decisive and unambiguous. 

So, what exactly is Riba (interest)?

Definition of Interest: Mainstream Theories

The theory of interest has for a long time been a weak spot in the science of economics and the explanation and determination of the interest rate still gives rise to more disagreement amongst economists than any other branch of general theory. The main theories are:

Time preference theory: The Austrian economist Bohm-Bawerk tried to explain the rationale of interest and the rate of interest in terms of time preference:- that an average person prefers present over future and if he is required to forgo the present comfort or use of his funds, he is entitled to some ‘remuneration’ known as interest.

Abstinence theory: Similarly, the concept of abstinence has the belief that interest is the ‘reward’ for abstaining from consumption or acts as the ‘price of waiting’.

Liquidity preference theory: The Keynesian concept of ‘liquidity preference assumes a saver is tying up his or her money thus sacrificing liquidity. It is reasoned that this loss of liquidity and transaction inconvenience should be recognized and the saver compensated accordingly through interest.

Of course, Islamic economist and indeed a number of mainstream economists have identified flaws in these various theories of interest.

Definition of Interest (Riba)– Islamic Perspective

In the Shariah, Riba technically refers to anything pecuniary or non-pecuniary, in excess of the principal amount in a loan that must be paid by the borrower to the lender along with the principal as a condition for the loan or for an extension in its maturity. In this sense, Riba has the same meaning and import as interest in accordance with the concensus of all the fuqaha (jurists) without exception.

The term Riba is however used in the Sharia in two senses. The first is Riba al-nasi’ah and the second is Riba al-fadl.

Riba Al-Nasi’ah

The term nasi’ah comes from the root nasa’a  which means to postpone, wait or defer and refers to the time that is allowed for the borrower to repay the loan in return for the ‘addition’ or the ‘premium’. Hence, riba al-nasiah refers to the interest on loans.

The prohibition of riba al-nasiah essentially implies that the fixing in advance of a positive return on a loan as a reward for waiting is not permitted by the Shariah. It makes no difference whether the return is a fixed or variable percentage of the principal, or an absolute amount to be paid in advance or on maturity, or a gift or service to be received as a condition for the loan. The point in question is the predetermined positiveness of the reward.

Riba Al-Fadl

Anything that is unjustifiably received as ‘extra’ by one of the counter parties to a trade transaction is riba al-fadl. There are at least three different ways of indulging in riba-al-fadl.

-          the exploitation that may take place in trade through the use of unfair means even though trade is by itself allowed.

-          Through barter transactions – Because of the difficulty of measuring the counter values precisely in such transactions. The Prophet (S.AW) therefore discouraged barter in a monetized economy and required that the commodity to be exchanged on the basis of barter, be sold for cash and the proceedings used to buy the needed commodity.

-          This leads to a third way of indulging in riba-al-fadl which has received the maximum attention of the fuqaha (Jurists). A number of authentic hadith stipulate that if the same genus of commodities is exchanged against each other, then the same quantity and weight of the commodities should be exchanged spot and be equal and alike.

One of the implication of this hadith is the prohibiton of futures transactions in foreign exchange.

With the aforementioned, it is imperative that any financial system set up to abide by the tenets of Islam, must necessarily operate interest free, hence Islamic banking is non-interest banking.


Saidat.A.Otiti has an MSc in Islamic Economics, Banking and Finance from Loughborough University, UK. She had worked in Chartered Bank  (now StanbicIBTC) and left at a Senior Management Level in 1999. She is currently the MD/CEO of Baytuzzeenah Ltd.