Thursday, July 28, 2005

On mortgage, riba, usury and interest

Commenting on a previous posting, "heraish" wrote:

In the case of a conventional mortgage loan. In case of default. Late payment charges (interest) is added and then the totals are compounded until the foreclosure process is finished which could take up to 6 months. The "Sharia" contract in vogue today places a fixed late payment fee for every month missed without compunding as the situation drags. This is a small value added to the traditional mortgage loan.

So even if we consider the mortgage loan to be permissable in concept without the need for "sharia" equivalents, there are still certain details that are against the spirit of sharia. Which is the taking advantage of a person in distress.

wallahu alem

I have seen similar arguments regarding the impermissibility of conventional credit cards: Even if you pay the entire balance monthly, the argument goes, your contract says that if you are late making a payment you would have to pay interest (and penalties if you do not make the minimum payment). I am of the opinion that credit cards, if abused, indeed become usurious. Like usurers, they entice people to consume beyond their means (or exploit their need to make certain purchases), and only pile-up the heavy interest after you're too deep to get out. The biggest profits are made off of those who can never repay their balances, while those who pay their balances regularly are relatively dispensable.

That being said, I think the argument about the nature of the contract, and the specification of late payment charges (which could be legitimate interest in the classical sense) cannot directly lead to charges of riba or usury. After all, an apartment rent agreement also specifies late payment charges, as does the contract with the utility company. Without looking at the actual dollar amounts, it is difficult to determine whether the charges are usurious riba al-jahiliyyah (increase justified by the mere extension of credit) vs. legitimate interest (to compensate the creditor for actual costs, lost opportunities, etc.).

That distinction between legitimate interest and usury (even if parading under the name of interest, as Luther denounced much usurious behavior of his time) is fundamental; c.f. Eric Kerridge, Usury, Interest and the Reformation, Ashgate, 2002. I have not yet found classical Muslim jurists making that distinction (except, of course, when "interest" takes the form of variable profit share). They obviously recognized the time value, since scholars of all schools "allowed a share for time in the price", thus allowing the credit price in a sale to exceed the cash price. However, I have not been able to find classical jurists who tried to tie the increase in price due to deferment to its fair market value (legitimate interest).

In "Islamic banking", the objective is clearly neither to buy nor to sell the financed commodity, but only to extend credit. In that regard, one can decompose the mark-up -- designated as "profit" -- into three components: (1) transactions costs associated with spurious buying and selling, etc. + (2) legitimate interest reflecting the time value of money + (3) usurious profit collected in the name of Islam. Item (3) constitutes super-normal profits or rents that can be charged to pious Muslims for the mere extension of credit in a manner approved by a "Sharia board". In other words, (3) should be classified as usury.

[Painful thought: depending on how you designate fees paid to the Sharia board, they would either be classified under (1), or under (3). So, while bankers may have few scruples about devouring usury, I wonder how Shari`a-board scholars can sleep at night. In fact, since their fees are only necessary for the extension of credit to a captive market, it is much more reasonable to argue that they simply share in the Shari`a-arbitrage rent-component (3) -- which, according to this taxonomy, is usury.]

The closest to this argument that I have seen has been by Dr. Rafik Yunus Al-Misri, who suggested that one problem with calling the mark-up profit, rather than interest, is that the former is unbounded, whereas the latter is constrained by usury laws that specify interest rate ceilings. I would appreciate any references to classical Islamic jurists going through the decomposition I proposed above.


Blogger Muhammad Saeed Babar said...

You have mentioned that jurists of all schools of thought allow increase in price of a commodity if sold on credit thereby recognizing time value of money. Can we see this transaction from another point of view, which is that one goes to buy certain qty of a commodity and told a spot price but when the buyer is unable to pay on spot, the seller increases the price and allows deferment of payment. Does this constitute riba?

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