13082347 Riba vs Profit

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Transcript of 13082347 Riba vs Profit

QUESTIONS Unlike riba, profit is recognized in Islam because of its characteristic as a justified form of reward for capital and enterprise.(a) Discuss the above statement (b) List in a table the differences between profit and riba

INTRODUCTION Allah forbids riba and permit trades. Surah 2:275 Although riba is forbidden in Islam, profit generated from trade is a justifiable source of income in Islam. This article discusses the differences between riba and profit and from there deduces the rationale of the above injunction. For some people, the religious commitment will be good enough to guide them to reject the practice of riba and deem profit as the only justifiable source of income. However, for the other group, they deserve a more convincing explanation and clarification from economical and social point of view. Since the author is not a Muslim herself, it will not be persuasive to advocate that riba is unjustifiable on religious ground alone. Therefore, with fair amount of religious elements, this article examines riba and profit largely from economical aspect.

DEFINITIONS The Prohibited Riba In a gradual process, little by little Al-Quran prepares the ground and social environment for final prohibition. Riba in Islamic terminology is increase or excess over principal or more precisely, it is called a stipulated/forced/obligatory surplus on a debt.1 Or it can be defined as an increase or excess value (fadf) which in an exchange or sale of a commodity, accrues to the owner (lender) without giving in return any equivalent counter value or iwad. 1 In 1992, the Pakistan Federal Shariah Court ruled that: Any excess which is pre-determined over the

principal sum in a loan transaction will constitute Riba in all circumstances.2 By and large, as a general principal, riba exist as long as the exchange/transaction involves ribawi items and gives rise to inequality of counter values (al-fadl) and determent in time of exchange (alnasiah).3 Terminologically the equivalence of riba in economic tradition is usury, something that was prohibited in Jewish and Christianity also. But modern banking gets around the prohibition of usury little by little and eventually replaces the word usury with interest.4 Usury was also prohibited in ancient China. 5 Since it is not only Islam that prohibits riba, it is reasonable to infer that the practice of riba is somewhat harmful to the society. The Permitted Profit Profit is the return on trade, which is the result of difference between revenue and cost, encompassing the effort and risk undertaken by the entrepreneur. Existence of risks either before-sale or after-sale inadvertently results in uncertainty in profit (or loss). This is based on the legal maxim (Qawaid Fiqiah) that states al-ghunm bil al-ghurm which can be translated as gain is the result of risk-taking.6 Thus Muhammad Ayub (2007) described profit as ex-post, which is only known after the business venture. He also insists that profit generated from trade should be associated with real asset.7

Islam places a great importance

in trade and encourages it because it is the major vehicle of increasing real income. Muslims believe that God wants his people to be prosperous and to avail themselves of the bounties of his creation.

RIBA VS PROFIT Riba vs Profit on Counter-value According to Fiqh scholars profit is a justified increase which is usually generated by exchange of two goods while riba occurs in unjust inequitable exchange of one commodity against another.1 Hanafi, Shafii and Maliki schools all agree on the term unequal countervalue when it comes to defining riba albeit the differences in the exact definitions. Therefore, this remaining of this section dedicates to explain graphically the differences of riba and profit in term of counter-value.

YaM

Q

MBe

MB MBI

O

QAeE 45o

QBee E I

B

YaE

QAE

QBE

O

YbE

N

Yb

OA

MA

MA MAI

M

Figure 1(a) Equal Exchange1 Riba1

Figure 2 (b) Exchange involved

Figure 2 (a) shows the equal exchange between A and B for Y product, in which ya + yb = Y. MN is the opportunity space or the maximum available endowment of Y. At point E (intersection between MN and 45o straight line from the origin), A and B is in equal proportions - A is getting OYaE while B is getting OYbE. The 45o straight line is the equal counter value line, in which Y=X. Figure 1(a) shows that, it is a zero sum game activity where the gain of one party is directly the loss of the other one.1 Any point fall out of point E will not result in equal counter value. Additional value that accrues to either party in this kind of transaction amounts to excess without counter value or prohibited riba in Islam. In the case of Figure 2(b), A has endowment of good OQAe and certain amount of money OMAe and B has endowment of good OQBe and money amount of OMBe. A requires to have more money and sell some of his plenty of good. While B would like to purchase some of good Q from A in exchange for money, in which the exchange normally takes place at a prevailing market price. However, in this transaction, A sells (Q Ae-QAE) of the good for (MBe MBI) which B will pay by instalment. The extra price paid than that of the market value (MBe MBE) is a result of interest imposed on B. This additional amount money that accrues to A is absolutely the loss to individual B, where the stock of individual B decreases from MBE to MBI . Since MA = MB is in absolute terms, so in exchange rationale, this is one side flow which has no any corresponding value in repayment, resulting in riba which is shaded in yellow in Figure 2(b). In Islam, an alternative to prevent riba in deferred payment mode is Murabaha-Muajjal.

Conclusively, riba results from an exchange without equal counter value whereas profit results from an exchange with equal counter value. Therefore, the former is forbidden but the latter is permitted in Islam.

Riba vs Profit on Wealth Creation Islamic commercial law aims at promoting the actual wealth creation instead of artificial and bubble creation of wealth.1 Profit generated in the process of trade is a result of:i.

Additional value of goods - due to physical transformation of an object from one form to another; usually quantifiable in monetary term (price difference final products between raw materials as well as other operational costs) and

ii.

Exchange of goods with others - exchanging goods with lower marginal utility with the higher ones results in higher utilities for both trading parties. This concept will be illustrated below.

Exchange of goods take place because differences in endowments and abilities of producing goods and services and differences in preferences or tastes.4 Most importantly, exchange is needed to maximize utility because of diminishing marginal utility and different marginal rate of substitution. Intuitively, well-balanced, diversified bundles of commodities are preferred to bundles that are heavily weighted toward one commodity, leading to the convex nature of most of the indifferent utility curves.8 It is noteworthy to refer this principle to the context of the story of Bani Israel when they tired of eating the heavenly food manna and salwa and they said that they could not keep satisfied with one type of food only.1 It implies that even the heavenly food is less of a choice to the Israelites than variety of foods. Figure below shows how trade can increase the real wealth between two trading parties and thus justify the return on trade profit.

Y

Y

OCa

XBe

Y

E A

UAo

E

YBE UA1

E

OCb

UBoX OB

UB1

OA

XE

XAe

XE

X

A Figure 2 (a) &(b) Individual Utility Functions before and afterBTrade

Figure 1 (a) & (b): Suppose A has X endowment and nothing of commodity Y while B has only Y. In the initial situation no one is engaged in trade, so the utility level is at the X and Y intercept, resulting in low level of utility UAo and UBo due to diminishing marginal utility. If they agree on trading according to their expected budget lines, they will both be better off, achieving higher utility level, UA1 and UB1. A now will have different relative prices of good X, with an offer curve labelled OCa. The offer curve intersects with the budget line at point E, resulting in higher utility function which is the tangent to the intersection point, E. The similar will be the case of B.

Y X

XB UA1

OB

N OCE

Y

E A

UB1

UBo

OC M UAo

YBE

YBo OA XA XA

Figure 2 (c) Superimposed Utility Functions of Two Parties of Exchange 1

Figure 1 (c): Imposing the two diagrams (a) & (b), we can find the efficiency of exchange process by raising the welfare of both individuals. Before the exchange A and B would ends

up at M and N respectively.

However through exchange they will arrive at anywhere

between M and N with the highest point, E. In contrast with trade, Riba activities do not create new stock of wealth. It is a zero sum phenomenon arises from exchange of two identical goods, which there is no way to increase the utility of one party without reducing the other. For an example, in many countries government raise fund from the public by issuing interest-based notes and bonds with a fixed return.9 If the fund raised does not result in return higher than the promised interest rate, these interests will have to be paid by the next generation in the form of tax as suggested by Ramsey-Cass-Coopman infinite horizon model (which is indifferent between tax and bond). In this case wealth is merely transferred f