Difference between Interest and Trade

By Muhammad Ayub

In his one and half page note Difference between Interest and Trade: Weakening Justifications Mr. Salman Ahmed Shaikh has raised an issue with regard to an academic aspect of Islamic banking business: Secondly, how strange it would be to assume that Allah would punish taker of Riba so severely, while from the economic standpoint, the one who undertakes a credit sale transaction which resembles Riba would have earned the same level of profit or in fact more with higher banking spreads. Before discussing the subject, I would like to make a few clarifications: i) There should be no doubt that interest is prohibited because of its economic evils. The related command of Allah SWT is based on the logic that Riba breads distributive injustice leading to destruction of human society. Mr. Salman should have indicated the names of those scholars who argue that Riba is prohibited solely because it is Gods order and there is no rationale behind that; ii) No scholar defends such trade practices of Islamic banks in which essentials of Bai are ignored (like Tawarruq and bail al Inah); all advise that Islamic banks should involve in real sector trading, taking business risk, adding value and thus earn profit; iii) There is not a little difference between interest and trading activity as he mentions; it were the Makkans who, as per the Holy Quran, considered that trade and Riba were alike, while it is crystal clear that both are different: former valid and Halal and the latter invalid and Haram. By saying that why would someone indulge in Riba if the same level of profit can be achieved through a credit sale which only resembles Riba, Mr. Shaikh has proved that he has not been able to understand and appreciate this difference. The Quran has not only referred to the rationale and logic for prohibiting Riba, but also indicated a sound principle on the basis of which all exchanges and transactions can be adjudged as Haram or

Halal (Verses 275, 278 and 279 of Surah Al Baqarah: trade allowed, Riba prohibited; and that whatever is over and above the principal of a loan or debt has to be given up) iv) Islamic banks have to take the price risk and the market / commodity risk for valid profit; otherwise their income / profit margin has to go out of their P/L account. The purpose of this article is to reiterate that while Islamic Shariah accepts profit margin or mark-up in both spot payment and credit trade, it rejects interest due to its being Riba. There is clear difference between the two. The difference between the spot and credit prices of a commodity that gives fixed profit margin to the seller and shows that time may have value when taken as a part of pricing mechanism is the main factor that creates doubts about Shariah position of Murabaha or cost-plus sale of goods by Islamic banks. As such, the main thrust of this article is to explain Shariah position of the difference between cash and credit prices of a commodity and the possible modus operandi of time valuation according to the precepts of the Shariah. There is a consensus among the jurists and the Shariah scholars that credit price of a commodity can genuinely be more than its cash price provided one price is settled before separation of the parties. Accordingly, the Islamic Fiqh Academy of the OIC (that has representation of Shariah scholars from all over the world) and Shariah Boards of all Islamic banks approve legality of this difference. This is tantamount to acceptance of time value in pricing of goods. What is prohibited is any addition to the price once mutually agreed due to any delay in its payment, as commodity once sold, even on credit, becomes property of the purchaser on permanent basis and the seller has no right to re-price a commodity that he has sold and which does not belong to him anymore. The above stance is discernable from the Nass (clear text of the Shariah). The Holy Quran has reported non-believers saying, Verily, the Bai is similar to Riba. Their objection was that they increase the price of commodity in the original transaction of sale because of its being based on deferred payment and it is treated as a valid sale; But if they add to the due amount after the maturity date and the debtor is not able to pay, it is termed as Riba, while the increase in both cases is similar. This argument has been specifically mentioned by the famous exegetist Ibn-Abi-Hatim (d. 327 AH) (Tafseer al Quran, 1999, Vol. 2, p. 545) and also by some others.

The Holy Qurans explanation to the above thinking of non-believers is that if they say that
interest in loans / debts is same as the profit earned in a trade deal, then Allah has permitted trade and prohibited interest implying that whatever one earns in the market over his investment is not interest and hence is permissible. Jalaluddin Sayyuti and Ibne Jarir Tabari have reported the similar

situation of Riba involvement in which a person sold any commodity on credit; when the payment was due and the purchaser could not repay that, the price was enhanced and time for payment extended (Sayyuti, Lubaab al Nuqool: 1423 and Tabari, Jami al Bayan, Vol. 6, p. 8). The great Muhaddith Tirmidhi has reported that the Holy Prophet (pbuh) forbade two sales in one contract. Jurists have explained it to mean that if a person offers to someone to sell a piece of cloth on cash for ten and on credit for 20 (Dirhams) and at separation, one price is not settled then it is a case of two sales in one contract and so prohibited. If one of the two prices is settled, it is not prohibited (Tirmidhi, 1988, No. 1254). Tohfatul Ahwazi, Sharah Jami al Tirmidhi, explains that if a seller says that he sells the cloth for 10 on cash and 20 on credit and the buyer accepts any of the two prices; or if a buyer says that he purchases for 20 on credit or the parties separate on any of the prices, the sale will be valid (vol. 2, p. 236). Shukani explains the above Hadith of the Holy Prophet (pbuh) by concluding that if purchaser in such situation says, I accepted for 1000 on cash, or for 2000 on credit, it would be alright. He adds that Illah (effective cause) for prohibition of two sales in one is non-fixity of the price (Nail al Awtar, Vol. 5, p. 12). Shah Waliullah (RA) in Musawwa, Sharah Al Muwatta, writes that if

parties separate after settlement on one price, the contract is valid and there is no difference of opinion in this regard (Vol. 2, Pp. 28, 29). Among scholars of the present age, the late Shaikh Abdul Aziz ibn Baz, the grand Mufti of Saudi Arabia, in line with the Hambali Fiqh permitted the installments sale wherein the credit price could be higher than the cash price (Abdul Aziz ibn Baz, Fatawa, Urdu translation, KSA, 1995, P.142). Jurists allow the difference between cash and credit prices of a commodity considering it a genuine market phenomenon and practice. It is quite logical and natural that in the market credit price of a commodity be more than its cash price at a point of time while in contracts of Salam (purchase of goods to be delivered in future against spot cash payment allowed by the Holy Prophet) the price paid upfront would be normally less than the anticipated price at the time of

delivery of the goods by the seller to allow a margin of profit for the buyer. In the words of eminent Hanafi jurist Sarakhsi, Selling on credit is an absolute feature of trade.We hold that selling for credit is part of the practice of merchants, and that it is the most conducive means for the achievement of the investors goal, which is profit. And in most cases, profit can only be achieved by selling for credit and not selling for cash. He further observes, A thing is sold on credit for a larger sum than it would be sold for cash (Al Mabsut, Vol.22, P. 45). The comments of Abraham L. Udovitch on the views expressed by Sarakhsi are worth mentioning, This statement makes clear as to why there was a greater profit to be derived from credit transactions....... The difference in price between a credit and cash sale also helps explain why the prohibition against usury, to the extent that it was observed, did not exercise any crippling restriction on the conduct of commerce......... (Udovitch, 1970, p. 80). Islamic economics has the genuine provision of converting money into assets on the basis of which one can measure its utility. Earning even a single penny on a loan of Rupees one million is Haram while building a house with one million rupees and then leasing it on rent is permitted. While Islamic economics concedes the concept of time value of money when taken as a component of pricing mechanism in credit sale, it does not uphold generating rent to the capital as interest does in credits and advances leading to a rentier class in the society. As per the principles of the Shariah, the aspect which matters is the conversion of $ 1000, for example, into an asset in which case that 1000 $ asset may be worth more or less in future leading to profit or loss. This conversion into assets is subject to well articulated rules governing

profit/loss sharing, trading and leasing. The concept of time value of money in the context of Shariah is also established from the fact that Shariah prohibits mutual exchange of gold, silver or monetary values except simultaneously. This is the consensus view of the jurists and Shariah scholars based on an explicit Hadith of the Prophet (pbuh). No difference of opinion among the traditional and the contemporary jurists has been reported in this regard. The rationale behind this principle of Bai al Sarf is that while a person can take benefit by use of a currency / purchasing power which he has received, he / she must give its counter value forthwith and without any delay so that the other party could also take the benefit. If time had no value in Muaamlat, the Holy Prophet and

the Companions might not have stressed so forcefully for instant exchange of the counter values in Bai al Sarf. It further transpires that time valuation is possible only in business and trade of

goods and not in exchange of monetary values and loans or debts. Loaning is considered in Shariah as a virtuous act from which one cannot take any benefit. Therefore, no time value can be added to the principal of a loan, or a debt after it is created or the liability of the purchaser stipulated. Hence, while margin in credit or forward trade is permissible being profit, any addition on the amount of a loan, or a debt emerging from any credit transaction, is prohibited being Riba. It is imperative to observe that trade credit in the form of credit or forward sale may perform an important function of facilitating intermediation between the resource surplus and the resource deficit units with the consideration of the business provided Islamic financial institutions take into account the ownership related risk & reward structure of Islamic finance. It may provide employment to the resource-less and working capital to the producers in commodities sectors and generate economic activity, and remaining within the Shariah imposed limits, could boost the real sector business. It may be reiterated, however, that the regulators must not allow using trade based modes merely as a stratagem or subterfuge without fulfilling the trade conditions. There should be no confusion in this regard about interest vis--vis the concept of rent in Ijarah (leasing). It might be argued, for example, that as per approved Shariah principles, predetermined rent includes a time-value of money, therefore, a predetermined time value of money in loans/debts should also be permitted by analogy. This argument does not have any substantive basis. The rent in leasing is calculated on the basis of capacity of the asset to give usufruct, which is in principle uncertain. Hence, how much time-value of money is actually realized remains uncertain until the asset has completed its economic life. Lessor, as owner of the leased assets, is also the owner of risk and reward of that asset. Further, all jurists agree that anything which cannot be used without consuming its corpus or changing its form altogether cannot be leased out like money, eatables, fuel, etc. The above discussion leads to an important conclusion that while time value of money is acceptable in respect of pricing of assets and their usufruct, it is not acceptable with regard to

any addition to the principal of loans or debts. Valuation of credit period based on value of the goods or their usufruct is different from the conventional concepts of Opportunity Cost or the Time Value of Money. As such, profit and rent are permissible provided Shariah rules relating to trade and leasing are adhered to, but interest is prohibited due to being increase over loan or debt. Towards conclusion of the article, it is reiterated that while Shirkah based modes are preferable to debt creating modes based on trade and Ijarah, the permissibility of the latter category of modes is beyond doubt. The permission of charging mark up in Murabaha is subject to fulfillment of trading rules and conditions set out by the Shariah for such transactions. It goes without saying that the mark-up technique, or for that matter any Islamic modes, should not be used as a back door for allowing interest.

The writer is author of Understanding Islamic Finance John Wiley & Sons, and the Director Research and Training at Riphah Center of Islamic Business of the Riphah international University, Islamabad. He can be contacted at: [email protected]; [email protected]