Is interest earned on a business loan RIBA? Quran vs. economics
hope you all are good so this video is the continuation of my discussion on the subject of revival it is enunciated and the glorious quran and today's question is is interest earned on a business clone river as i have been emphasizing earlier.
That there is a lot of confusion amongst the mind of many muslims that interest and rebar are the same concept and this is due to the fact that majority of the muslims are victims of the theory of lead or blind following and they do not apply a.
Reason as it is commanded by the glorious quran to distinguish between what is riba and why it is different from interest now with reference to riba we need to understand that the etymological meaning of the term rebar as it is used in the glorious quran is.
As a verb to grow or swell or as a noun this would imply excessive growth or abnormality so essentially it is an attributive term riba is an attributive term if we critically study the glorious quran on the contrary when we talk about.
Interest interest is the price of a factor of production and this factor of production is called capital whether it is physical capital or financial capital as we all know that there are four factors of production land labor capital and enterprise and all these factors of production.
Command a price or a cost for their use because they are limited in supply and price of factor land on natural resources is called rent for labor it is wages for capital it is interest and for enterprise this is called profit so this is the fundamental difference that we need to keep in mind.
That tribal is an attributive term as it is explained in the glorious quran on the contrary interest is an economic concept it is the price of factor capital okay with reference to today's question i would like to explain some terms related to the concept of interest you must have heard the term normal.
Interest now what is normal interest usually normal interest would imply the equilibrium rate of interest that is prevalent in any economy at any given point in time so this concept is called normal interest so it means uh.
We assume or the theory assumes that there is competition uh in the market and as a result of this competition the interest rate is also competitive and this competitive interest rate that is determined through the interaction of demand for and supply of.
Loan money is called the normal interest now what is abnormal or excessive interest this is another related concept so logically we can understand this is the interest that is above the normal rate of interest and this may rise in a situation where there are fewer creditors in the market a monopoly dioplay or oligopoly like situation and.
Whereby they're in a position to charge a higher interest rate to the borrowers then what should be child or what is child under a competitive business environment and this is called abnormal interest or excessive interest then there is a concept of nominal interest or normal interest rate so.
Nominal interest rate is the interest rate that includes an element of inflation in it for example when we say that the nominal interest rate for one year is ten percent per annum this would imply that this 10 percent is expressed inclusive of inflation rate so whatever is the inflation rate during this one year time.
This 10 percent includes that element of inflation and another concept is the real interest rate and of course what is real interested this is the interest rate that does not include the element of inflation for example if we say the nominal interest rate is ten.
Percent and the inflation rate during that tenure is three percent then we'll say that real interest rate is seven percent that is ten percent nominal rate minus three percent inflation rate and this is the real interest rate and this real interest.
Rate basically demand i mean confirms the purchasing power of money so if somebody offers you ten percent nominal rate and the rate of inflation is three percent what you are getting in terms of purchasing power is seven percent return on your loan money or your investment and finally there's a related concept with a reference to a business loan.
Transaction and this is called debenture what is a debenture dementia is a financial instrument through which businesses raise loan or large corporations raise loan money so this is basically an acknowledgement of a debt and of course in this case the creditors are called debenture holders just to distinguish them from the equity.
Holder who are the owners of our business who have invested their personal money into the business so when they invest the borrowed money the creditors are called the debenture holders and the very instrument through which that the loan money is raised for a business that.
Is called a debenture now we look at the concept of rebar as it is explained in the glorious quran verse 130 of chapter 3 reads you who believe do not consume rebar doubled and readable be mindful of god so that you may prosper so if we look at the contents of this.
Verse we need to understand that rebar is explained as an attribute that is doubling and redoubling one's wealth so and you also need to keep this fact in mind that this is the only verse in the glorious quran that explains what is.
Rebar and the very words doubled and readable would imply that this is basically an attribute of term and god is commanding through this verse to the believers that they should not indulge themselves into any exploitative monetary or financial activity that may result into doubling and redoubling.
Their wealth at the expense of somebody else this is forbidden in the sight of god if we just examine this verse in the historical context we will appreciate and understand that in the past especially in the medieval and primitive societies what used to be the case that if there.
Was a borrower who was in need of money to meet his day-to-day obligations probably a poor chap a poor person and when he would approach any rich person for the advancement of that loan the very terms of the loan agreement were drafted in a manner whereby the poor person will keep on paying the interest rate that used to be exorbitant.
And ultimately the loan amount will stay there and the poor person will become more poor and whatever little wealth he or she may have everything will be lost uh in the payment of that interest so this was strictly prohibited.
Uh even in the medieval societies also based on the principles of morality and this was hit by the glorious quran also that if a needy person seeks loan to meet his day-to-day obligations then you should not charge rebar on it and it is better that you may.
I mean wave of that amount as a charity but it has no application to a business loan transaction for the simple reason that in the modern world the business loans uh are burned within the framework of elaborate rules and regulations economic principles and more importantly they are based on the monetary policy of.
The central bank of uh country a point that i'm going to explain later now when we have to seek guidance from the glorious quran in the context of a business loan transaction there are two important verses.
When these verses are read in conjunction we can understand the implications of a business clone transaction in the site of god the first verse uh is given in chapter two this is verse 275 and it reads god has permitted trading and forbidden.
Usually so this simply implies that trading based on principles of morality or what we call the fair trading is permissible in the sight of god but if this trading includes an element of rebar that is exploitative monetary or financial gain by the trader or by the merchant then this is not acceptable.
And the second verse is verse 29 of chapter four that reads that you believe do not wrongfully consume each other's wealth but trade by mutual consent so it means when there is an element of rebar this would ultimately result in wrongful consumption of each other's wealth for example if a merchant is charging very high price for the merchandise so it.
Means that he is asking uh for additional money from the buyer and it means the buyer has to forego that additional money and this may result in reduction of first value similarly if there is a business loan transaction and the creditors are charging very exorbitant interest rate.
Again this would result in reduction in the wealth of the borrower so the glorious quran put emphasis on mutual consent and the legal terms we call it at arms length principle so what is mutual consent or at arm's length principle is a situation whereby the debtor and the creditor or the borrower and the lender they.
Decide the term of the loan the rate of interest on that loan money and all other related matters with mutual consent and no single party is in a position to dominate or influence the consent of the other party uh as i explained earlier and in the past i mean for personal loan transactions.
There could be an element of exploitation and that would ultimately give birth to the concept of that was strictly prohibited and that is still still strictly prohibited in the sight of god but when we talk about business loan in the modern.
World we need to appreciate the fact that in the modern world the business loans are going by very elaborate framework of rules and regulations there are strict economic principles and concepts as well as we need to keep in mind the fact that the interest rate that is chart on a.
Business loan is dependent upon several factors one such factor is the interest rate or the central interest rate determined by the central bank of a uh country or an economy because all other interest rates revolve around that uh central interested within acceptable.
Banks or limits as we call it then of course uh there may be another factor related to for example uh the need of the specific business the type of competition for loan money in the business so there are there are several factors that would influence the interest rate for a business known transaction and it is not possible for.
An individual lender to practice riba in the modern business world in the context of a business loan and one related factor may be that the interest rates in modern economies are basically determined or they they are at the mercy.
Of the central bank of a country and the central bank through its monetary policy sets the interest rates and of course then regulates them from time to time that are in the best interest of largest segment of the society or the economy so it is ensured that there is no element of exploitation or abnormality in the interest structure that is prevalent in.
Any modern economy okay another related question may be that why do businesses seek loan why do they need loan of course common sense would say that if a business is in need of money and there is a shortfall i mean it can't provide that money through its personal resources and of course they.
Would try to borrow that money this is one one reason but there are other i mean technical and uh financial reasons for which large corporations and businesses prefer loan money over equity or the money that they can invest from their personal wealth.
For one such reason is that the loan money or the borrowed money uh is always considered as a cheaper source of finance there is empirical evidence to sport it and the one obvious reason is that the interest provides a tax shield.
So this would imply that the interest expense that a business has to pay on its loan business loan it is a tax deductible expense so this means it's going to lower the profits or taxable profits of a business so they have to pay lower taxes and second factor is that.
Most businesses know that the interest that they're going to pay on a business loan or a debenture the profits that they can generate through that loan money are much higher because they pay only a fraction of the profit in the form of interest to the creditors so because of these reasons businesses prefer.
To borrow money so that they can utilize that money to generate wealth for their business and pay only a fraction of it to the creditor so this truth uh will make it clear that there is no or there could be no element of rebar in a business loan transaction in the modern world because.
Everything is highly regulated and what the creditors get in the form of interest it is always a fraction of the profit that is generated through that loan money and we also need to keep this fact in mind that why rebar may not be present in.
The modern business world in relation to business loan transaction we know that the financial institutions like bank insurance funds or pension funds they play a very dominant role and basically they they serve the role of or they become the interface between the borrowers and the lenders so what.
Happens is that the lenders would open a deposit account uh in any financial institution and the borrowers would seek loan from that financial institution and of course the bank is going to charge different interest rate uh.
To the borrower and to the lender so what i'm trying to explain is that on the deposit accounts interest rate offered is much lower for example when when we discuss in the context of western world it is not even a half percent on the contrary that the interest that they charge on uh.
The loan money this may range from six percent to uh i mean if we talk about credit cards even up to 20 22 percent so this interest rate differential is the income of the bank but in any way the interest rate that the creditor even in the context of financial bank that the charge on loan money would never result in doubling and redoubling the banks of.
The financial institutions wealth in any case this point we need to keep in mind because this is the strict interpretation and definition of the concept of riba as i have explained earlier with reference to verse 130 of chapter 3 of the glorious quran.
Now i'm going to conclude what we have discussed so far so uh first fact that we need to keep in mind is that interest is not rebar rather interest is the price or cost for the utilization of factor capital it's a factor of production and this capital may be physical capital or.
This may be financial capital physical capital in the context of the state may include i mean lie dams road networks buildings and so on and so on and this would apply to uh businesses also for example plant and machinery their buildings infrastructure and financial capital is of course the money and the.
Second conclusion that we can draw from all this discussion is that the economic uh activity gets a boost when businesses seek loan from the financial institutions and generate economic activity and this would ultimately.
Result in generation of more capital and if we just look at the first world countries we know that there is there is excessive capital available in these countries because of this enhanced economic activity and as a consequence because there is excess supply of capital the interest rate that is being.
Charged is much lower when you compare with the uh interested that is child in a developing country in the developing countries judy the interest rate is in double digit figure whereas in the developed countries usually it isn't the single digit figures we need to keep this fact uh also in our minds and of course as i explained earlier.
That businesses basically generate well they are not needy person once they borrow money they are not going to fulfill their some essential needs like marrying a child or for the education of a child or for a shelter what they are doing is they are generating wealth and of course morality and equity will demand that they should share part of.
That wealth or profits with the creditor and of course uh this is uh done through instruments like debenture or other loan instruments uh therefore uh i mean we can say with the confidence that the glorious quran.
Categorically distinguishes between a personal loan transaction and a business loan transaction in the context of a personal loan transaction the glorious quran commands that uh even if it is waived off as charity this would be the most commendable act in the site of god on the contrary when it comes to a business loan transaction the glorious.
Quran would emphasize that all such affairs must be carried out with mutual consent and if there is mutual consent and there is no exploitation on the part of one party then of course this is an acceptable practice in the sight of god i hope you enjoyed this video please keep watching for my future.
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