Riba: The main cause of all recessions and depressions

Riba: The main cause of all recessions and depressions

General monetary economics (rate of interest is the reward for saving) Vs Islamic monetary economics (interest less banking)

According to classical and Neo-classical economists rate of interest is the reward for savings. Where in Islam interest is prohibited. The reasons are Interest rate made people manipulate poor people and interest made the rich richer and the poor poorer. On expectation of guaranteed return at the maturity period interest rate made people work less.

                As the world economy made the transition to a market economy after the industrial revolution, it is not hard to see when Riba applies and when it does not?

What is Riba?

                Riba is seen as an unjustified earning where a person could receive a monetary advantage in a business transaction without giving just a counter value. Technically it’s a premium that must be paid by borrower to the lender along with the principle amount as a condition for the loan or for an extension of maturity.

Riba (Rate of Interest) is a sin under Islamic law even those hired to write the contract or who witness (and then confirm) contract are a party to the sin. Here prohibition of Riba means that money can be lent lawfully only for either charitable purposes (without any expectation of return above the amount of the principle), or for the purpose of doing lawful business i.e.; investment on the basis of profit and risk sharing. i.e. an investment of the kind that seeks profit while sharing the risk is encouraged in Islam, indeed it is commended.

                Islam doesn’t consider money as a commodity such that there should be price for its use. Money is medium of exchange in asset oriented economy and a store of value. It has made clear distinction between trade and Riba ; where trading is welcomed and riba is prohibited. Trade is that the business risk in trading is allocated more evenly among all the parties involved, where as in Riba operations the business risk lies heavily, if not solely on the borrower.

Flaws in the Theory of Interest-The root cause of the crisis

The present global economic crisis as a result of interest rates; from the American recession in 2008-09 to the crisis in south East Asia and Euro debt crisis at present.

Huge budgetary imbalances, excessive monetary expansion, large balance of payment deficits, insufficient foreign aid and in adequate international cooperation can all be related to the flaws in the mechanism of theories of rate of interest and its working, which also the root cause of the crisis.

                The demand for Economic growth as parallel to inflated interest rates and global economic crisis. Most countries which make the transition to a market economy had developed some kind of crisis in the early stages .Inflation often occurs as  a result of a fast growing economy, hence contracting monetary policy is must to offset inflation. Increase in interest rates would only add to the unemployment level. Keynesian school has emphasized the problem of high interest as contribution to unemployment. Therefore, stressing the need of reducing interest rates to the lowest possible. But now the question is what the optimal rate of interest is? Or should exit?

Islamic economics an alternative to the current system:-

                Islam suggests an interest free system that heavily relays on profit sharing i.e. Mudarabeh.  Here profits are the substitutes for the interest. But one might ask, how banks would have the capital i.e. necessary to lend, when banks do not pay interest for savings A/c’s or capital providers.

                There is a triangle or three way systems where all participants are mutually beneficial.

Those are 1. Bank

                    2. The supplier of savings or funds

                   3. The actual user of capital of the Entrepreneur

Now it is clear that not only banks and entrepreneurs are exposed to risk but also the supplier of funds.

                The lender would be a venture capitalist who is interested in profit sharing, where as banks can study applications of borrowers and hence extend credit, offer portfolio investment for lenders and undertake forgone services.

Conclusion:-Finally a interest free system would  work and provide unlimited prosperity but certainly does not work under the current system, the whole economic system should be altered  and changed in order for the Islamic frame work to success. This system can survive only in Christian, Jewish or Islamic economy that abolishes interest.