Sunday, April 16, 2006

Discussion on Mutuality and Riba with Dr. M. Nejatullah Siddiqi

I have received Dr. Nejatullah Siddiqi's approval to post my email discussion with him regarding my call to mutuality. His comments and questions are indented and in red and prefaced by MNS:. I am hoping to learn a lot from this exchange. (For those who do not know the field, Dr. Nejatullah is arguably the best living Islamic economist, and the most prolific writer on the subject. I am grateful that he took the time to have this e-discussion with me. As I told him, I see this as receiving instruction from him through the Socratic method). The discussion below is extracted from two rounds of email (separated by lines, see below). The second round addresses important methodological issues, as well as substantive ones.

MNS: I am making a partial response to you mutuality centered Harvard presentation. What is the basis of your claim that riba is an extreme form of gharar?

ME-G: My claim is based on the two economic analyses I had done, which resulted in defining riba as trading in credit, and gharar as trading in risk. Based on those arguments, it is clear that trading in credit is the same as trading in credit risk, thus making riba a type of gharar. Just as one who is involved in a trade with major gharar doesn't know if the trade is good or bad (due to randomness, incompleteness of contract, etc.), the one who trades credit risk for a particular amount of interest does not know whether or not he can even recover the principal (credit risk), and whether the interest he will collect will be enough to compensate him (interest rate risk).

That is the sense in which I depart from the conventional juristic and Islamic economic view of interest as a reward without taking risk. On the contrary, I argue, it is a peculiar kind of risk that is being taken, and one which -- if the credit extension is made commutative -- can be quite hazardous to individual lenders and borrowers, as well as to the entire system.

MNS: As regards Qarafi quote, it is his /jurist's rationalization.

ME-G: Yes, of course, and during his time, there would be no distinction between the human juristic rationalization and an economist's. What I am trying to do is to engage his logic and update it based on my contemporary human economist's perspective.

MNS: Allah allows qard, fa lakum ru'usu amalikum. That's it.

ME-G: Indeed, that is all we know with certainty, and the rest is human speculation.
Do you feel that I am not going after the maqsid behind this prohibition in the right way?
I figure that the economist's approach must be like this:

  1. Allah only forbids harmful things
  2. The types of credit extension available now are different from the ones on which the Qur'an commented directly (e.g. as explained in Ibn Al-Arabi's Ahkam Al-Qur'an)
  3. Everything we permit or forbid today based on that verse is based on a form of qiyas
  4. Here comes the difficult step: like Ibn Rushd, I prefer the economist's demonstrative proof over the jurist's rhetorical proof
  5. My economic analysis (which is human, almost certainly wrong, and subject to change) is the best I have for now, and it tells me that what is being forbidden is profiting off of the act of credit extension itself.

Note: as described in AHkam Al-Qur'an, the debt could have resulted from a credit sale. The merchant could have made a profit on the genuine trade part, but he is not being allowed to make a profit off of the credit-extension component, which must thus be non-commutative.

As proof that this line of reasoning is not totally divorced from classical juristic scholarship, I use Qarafi's analysis as further corroboration.

Which step do you find lacking or mistaken?

MNS: Third point, profit motive is a sronger force than urge to cooperate/mutuality. Why must I replace a sronger motor with a weaker one?

ME-G: The profit motive can stay, and the multinational banks can play an important profit-motivated role in taking the mutual financial products to market.

However, allowing the profit motive in the act of credit extension itself invites the types of Shari`a arbitrage that have naturally led to tawarruq (I see very little difference between tawarruq and murabaha in this regard, please see my reply to the last point).

MNS: Shariah does not insist I do so. If your recommendation is basedon masalih, you have yet to prove it. You enumerate advantages, what about disadvantages of mutuality model applied to the financial industry as a whole?

ME-G: Perhaps first and foremost, I am basing the argument on the rule of sadd al-dhara'i`. Do you disagree that Islamic finance as practiced today has found many dhara'i` for the practice of riba, only charging the customer more? (more again in my reply to the last point).

Of course, mutuality has its disadvantages relative to other corporate forms. The primary disadvantage is the inability of mutual financial institutions to capitalize on economies of scale quickly by drawing funds from profit-oriented shareholders.

This is a tradeoff between low-risk low-return at the individual and macro level using mutuality models, and higher risk and return based on profit-motivated financial intermediation.

Your previous emails bemoaned the speculative and risky business of credit proliferation: that is what happens with profit-oriented and fast growing financial conglomerates, that's how they grow: by increasing their capital and increasing the amount of credit they extend.

MNS: Fourth, what you call fiction does bring in real assets into the act of credit extension. Why do you ignore it?

ME-G: Sometimes it does, but other times, as in tawarruq or murabaha with aluminum that never leaves a warehouse, the asset is just a mirage.

What I call fiction is not the asset, but the story being told: We pretend that the bank is making a profit trading in homes, when in fact it never does -- it is a financial intermediary in the business of selling credit. If it profits off the extension of credit, my economic analysis (which is not definitive, of course, and subject to error: I am mainly trying to stimulate debate)
says that profiting of that extension of credit is riba (net interest income being profitably large, whether the interest income is called interest, rent, price mark-up or anything else).

MNS: Why not make this involvement real, making Islamic finance really asset-based?

ME-G: I am all for doing that, but I am arguing that making the contract asset-based in form is insufficient, as long as the profit motive is there to encourage rent-seeking legal arbitrage. Indeed, I envision that a network of Islamic credit unions would in fact insist that credit extension is asset-based in a meaningful way.

I am merely saying that the restricted focus on contracts is insufficient. To regulate financial intermediation Islamically, we also need to say something about corporate form, if only saddan lil-dhara'i`.

Second email round

MNS [referring to the numbered bullets above]: 1.Riba is what Quran means by it in al-Baqarah:275-80 and other verses and, in that light,what Sunnah's application tell us.I do not accept "trading in credit" characterization.

ME-G: What other economic definition would you choose? As I have argued in my paper on riba (which you read a few years ago), "usury" is not a correct term, since it means to us excessive interest, whereas jurists -- based on Qur'an and Sunna -- tell us that even zero interest in selling one ounce of gold today for one ounce tomorrow is riba. Next, "interest" is also unacceptable, since Sunna clearly shows types of riba that do not contain interest.

I have looked for economic definitions, or even an English word that provides an appropriate definition of riba (jami` mani`; containing all types of riba and excluding all types of non-riba), but have not found any. I cannot make or understand any economic analysis unless the term has a clear economic definition.

MNS: The gharar line of argument is Sunnah based. How can I subject a Quranic category/a Quranic prohibition, to a Sunnah category/ a Sunnah prohibition? Neither should you.

ME-G: This depends on whether we agree on definitions, which you have said we don't, so I need to work more on that dimension. Your use of the Qur'an/Sunna dichotomy does not apply, however, in my case for two reasons:

  • This is not the case of using Sunna to overrule the Qur'an, only a case to explain it
  • All writers, as far as I know, agreed on the following: the Qur'an speaks about maysir (gambling), and that is an extreme form of the forbidden gharar. It can be avoided by making the deal non-commutative: a random prize is not forbidden, as long as the beneficiary never pays a price for it!

That is the same as what I am doing if you accept my definitions of gharar and riba. So, the issue is not methodological, only an issue of whether my economic analysis is correct, and what analysis we can put in its place.

MNS: 2.In the part beginning Allah allows qard...I do not accept#2 and therefore,#3 of your response. Please quote Ibn al Araby for me or give a link so I fish it out at riba bearing debt can arise from a sale on deferred payment deal.

ME-G: I am not sure if it is available online. I believe that the same explanation of riba al-jahiliya is also in Tabari, so I will try to get that online first.

[Under separate cover, I sent the following quote from Ibn Al-Arabi's Ahkam Al-Qur'an:

المسألة الثالثة : قال علماؤنا : الربا في اللغة هو الزيادة , ولا بد في الزيادة من مزيد عليه تظهر الزيادة به ; فلأجل ذلك اختلفوا هل هي عامة في تحريم كل ربا , أو مجملة لا بيان لها إلا من غيرها ؟ والصحيح أنها عامة ; لأنهم كانوا يتبايعون ويربون , وكان الربا عندهم معروفا , يبايع الرجل الرجل إلى أجل , فإذا حل الأجل قال : أتقضي أم تربي ؟ يعني أم تزيدني على مالي عليك وأصبر أجلا آخر . فحرم الله تعالى الربا , وهو الزيادة ; ولكن لما كان كما قلنا لا تظهر الزيادة إلا على مزيد عليه , ومتى قابل الشيء غير جنسه في المعاملة لم تظهر الزيادة , وإذا قابل جنسه لم تظهر الزيادة أيضا إلا بإظهار الشرع , ولأجل هذا صارت الآية مشكلة على الأكثر , معلومة لمن أيده الله تعالى بالنور الأظهر

[My translation] Third Point: Our scholars said that riba linguistically means "increase", which requires something over which increase is manifest. Thus, they differed over whether the verse universally forbids all types of riba, or abstract, requiring other texts to explain it. The correct view is that it is universal, since [the Arabs] used to trade and increase [the price for further deferment]. Thus, riba was known for them: a man would trade with another on credit, then when the debt matures, he would tell him: will you pay, or will you increase the debt? Meaning: will you give me more money so that I will give you more deferment? Thus, Allah forbade riba, which is increase. However, since -- as we said -- increase can only be computed relative to a baseline level, and since anything traded for a different genus would not make the increase manifest, and when traded for the same genus, increase is also not manifest except through the Law, this verse became problematic for most, understood only to the ones that Allah has given the most manifest light.
[ME-G] Is that the light of reason?

I found the book online at, which is also a reliable site.
Here is the link to this particular verse:

It makes it very clear that this was a debt based on a credit sale, where the credit component was originally either priced or unpriced, but the murabi wanted to tag a price on further credit extension. Most importantly, this was not -- at least not necessarily -- debt from a loan... See also my blog entries on the Hayderabad fatwa and Rachid Reda's discussion thereof.]

MNS: But we start from the primary case of a cash loan/money loan given for a period of time. Based on this, lakum ru'usu amwalikum is simple, clear, categoric, no rationale attached.Rationales will go on changing with time and place( and intelligence of the scholar!). Your rejection of Islamic economists' rationale does in no way oblige me to accept your rationale, or that of Qarafi, Ibn Rushd or Ibn Araby.

ME-G: Of course not. We all should only accept the rationales offered if they make sense to us. None of us speak with divine authority, so we should toss our ideas in the market for ideas, and hope that debate (like this) can bring us all to better understanding.

MNS: is too much,excluding profit motive from financial business on the ground of sadd al-dharai'.We may lose more than we gain.We have not exhusted possible remedies for the wrong discovered in contemporary practice of islamic finance based on old contracts, have we?

ME-G: You are almost certainly right, and we should look for all possible solutions.

Notice that my argument was not about excluding profit motives from all financial business, only from the retail-level credit and risk intermediation parts, and only after observing that over more than a century not-for-profit intermediaries here in the U.S. (both in insurance and in credit) have been resilient to economic cycles, and have continued to offer excellent
service to their customers. So, that seemed like a good off-the-shelf solution that was motivated by similar concerns, and which achieved very good results.

That's it for now. I have learned a lot from Dr. Nejatullah's writings, and look forward to learning more from future writings and similar discussions.


Blogger Hood said...

Excellent post, this one and the previous, I would appreciate references to ibn Arabi and Qarafi, as well as ibn rushd.
Good luck on your presentation at the Harvard forum, I hope it has a positive effect.

10:28 PM  
Blogger Mahmoud El-Gamal said...

* Ibn Al-`Arabi Ahkam Al-Qur'an, see the posting

* Al-Qarafi Al-Furuq, see the linked presentation and paper in previous blog posting

* Ibn Rushd on riba Bidayat Al-Mujtahid, see linked paper in previous blog posting

* Ibn Rushd on demonstrative vs. rhetorical proofs, see Fasl Al-Maqal, I also like Charles Butterworth's translation of this short text.

7:27 AM  
Blogger Salahuddin Ayyub said...

The one who trades credit risk for a particular amount of interest does not know whether or not he can even recover the principal (credit risk), and whether the interest he will collect will be enough to compensate him (interest rate risk).
If we use the above formulae, Profit will also become a sort of Gharar, where the businessmen does not know whether or not he can even recover the principal, and whether the profit he will collect will be enough to compensate him.

2:24 PM  

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