Malaysia in the Era of Globalization #79

M. Bakri Musa

Defining whether one has actually repaid in full what one has borrowed can be problematic. There is a difference between nominal and real values. Most of the time the difference is small or very subtle, but there are times when it can be very dramatic. When the Koran says you must repay in full, it means to my common sense thinking to repay the real original value.

Chapter 9: Islam in Malay Life



Reform in Islam



Islamic Economics
Dealing With the Concept of Interest



As alluded to earlier, the biggest stumbling block to Islamic economics is the concept of interest. Stripped of its complexities, the issue can be simply reduced thus. When B borrows money ($X) from A, there is a cost involved. Regardless of the terminology, someone has to bear that cost. If at the end of the year B returns to A the same amount of money he borrowed the year earlier, that is $X, he claims to have satisfied the Koranic admonition that he repays his loan at its original amount, nothing more and nothing less. But has B done that?

Consider two facts. First is what economists refer to as the opportunity cost for A; he could use that money for something else that would give him profit or pleasure, instead of lending it to B. Assume the monetary value of that opportunity cost incurred by A to be $Y. The second factor is inflation. Inflation can be simply defined as the diminishing purchasing power of a given nominal sum of money. That is to say, an $X today does not buy quite the same amount of goods and services as a year earlier, or stated in another way, an $X today is not the same (“real”) value as the $X of a few years ago. It is only nominally the same. In actuality X is valued less now than in the past because of inflation. If B were to repay A fully a year later, B should also include the amount lost due to inflation. Had inflation rate been 10 percent, then B should return to A $X plus that 10 percent more. If B only repaid the original $X, then he has only nominally paid the whole sum. In actual practical value, B has only partially repaid in the amount of only $(X minus 10 percent).


Then there is the opportunity costs incurred by A in lending the money to B; that is the $Y discussed above. Thus to fully repay A, B would not only have to repay the 10 percent inflation rate but also the additional $Y opportunity cost incurred. Thus to really fulfill the Koranic requirement of equivalency, the $X of a year ago is now in reality $X plus Y plus 10 percent for inflation. Note that there is no interest at all involved here; these are all real, tangible costs.


My essential point is this: when things are nominally (seen to be) the same, it may not be so in reality. Money was invented in part to put a quantitative value on a transaction so as to make it easier to compare the various costs. If economic transactions were accounted in terms of commodities, for example the number of durians, there will be the added issue of the quality of the fruit, size, and whether it is ripe, unripe or rotten and good only for making tompoyak and not for eating.


Ancient Arabs chose precious metals like gold and silver. Those can be standardized by weight and their quality cannot be adulterated.


Today money is merely paper or beeps of “on” or “off” signs on the digital highway. It is backed not by precious metals but by the people’s faith in the underlying supporting economy. Inflation apart, money may lose its value through formal devaluation or changes in the foreign exchange market. To take an extreme example, a ringgit immediately before September 1, 1998 (the date Malaysia imposed capital control and devalued the ringit) was not the same value immediately afterward; it had lost 40 percent of its value with respect to the dollar. Thus if you borrowed one ringgit the day before the devaluation and then returned that same ringgit the next day, you have not returned the original loan even though nominally you have returned exactly what you borrowed.


I can further simplify my argument, this time by not using money but a concrete example. Suppose last year my friend “borrowed” a she-camel from me. A year later he returned the same camel to me. Many would consider such a transaction halal (not sinful) as no riba (interest) was incurred; he returned what he borrowed, nothing more and nothing less. But is that true? Imagine my camel was in heat at the time he borrowed it and was later “serviced” in the pasture by some loose bull. After a year (and a few weeks before he was to return my camel), she delivered a baby. Of course that baby camel would belong to my friend, but two questions would immediately arise. One, is the camel he returned a year later the same one (in monetary value as well with common sense assessment) he borrowed? Obviously not; not only is my camel now “worn out” (depreciated, to use a business term) but also I cannot immediately breed her as she had just delivered a baby. That baby camel may be my friend’s gain but it is definitely my “opportunity cost” loss. Had I not lent him the beast I would have a baby camel.


Another is a real life example. During the Japanese occupation a neighbor back in my old village borrowed some money for a short term to buy land. The working currency then was the Japanese “banana” notes. A few months later, as promised, he repaid the loan in full. But by this time there were rumors of the Japanese defeat, and although the currency was still accepted officially, in the marketplace it was rapidly becoming worthless. The crux of the issue: Has the man repaid his creditor in full? Nominally and technically he had; in practical and real terms he had not. This is a very dramatic example, much more than the ringgit depreciation case noted earlier.


In both examples there was no interest calculation to complicate the issue. Yet even without interest involved, defining whether one has actually repaid in full what one has borrowed can be problematic. There is a difference between nominal and real values. Most of the time the difference is small or very subtle, but there are times when it can be very dramatic. When the Koran says you must repay in full, it means to my common sense thinking to repay the real original value. Modern economists differentiate between real and nominal interest rates. If a bank charges an (nominal) interest rate of 15 percent per year but during that time the inflation rate is 10 percent, then the real interest is only 5 percent (15-10). Had the bank charged a rate of 10 percent, then the real interest rate would have been zero, that is, no interest, technically as well as in reality. Looked at another way, the interest rates charged by banks are not interests at all, rather the anticipated inflation rates.


Again this concept can be readily adapted to the tangible items of life. Suppose last year there was a drought and the rice fields were damaged. The price of rice jumped because of the shortage. I borrowed ten pounds of rice from my neighbor. Two years later, the rains came and the harvest was bountiful and the price of rice dropped. At this time I repaid my neighbor with exactly ten pounds of rice. Have I returned exactly what I borrowed? Common sense says no. Two years ago during the drought, ten pounds of rice was worth $20, but with the glut it dropped to $5. To fully repay my neighbor, I should have given him 40 pounds ($20 worth), not 10. And that extra 30 pounds would not be riba.


A comparable episode occurred during the prophet’s time. One of his companions had borrowed a sac of dates. They were the premium first pick of the season: thick, sweet, and luscious. A few months later he repaid with an equal sac of dates, but this was at the end of the harvest season and the nuts were dried up, less sweet, and plentiful. The lender rightly asked for more. The companion asked the prophet whether the added amount demanded was not riba. The prophet emphatically replied that it was not, and indeed asked the companion to go back to the marketplace to ascertain the price differential between the premium first-pick dates versus the season’s leftovers, and make up the difference.


Two important points arise here. One is the concept of nominal versus real. The two sacs of dates may be nominally the same, but in reality they are worth quite a bit different. Two, the prophet (pbuh) trusted the marketplace to determine the true value of the two sets of dates. I will return to this second point later in Chapter 11 when I discuss free enterprise as an Islamic tradition.


Modern Islamic bankers have learned well from their predecessors in trying to circumvent the prohibition on riba by resorting to service charges, commissions, and other charges. Those ancient Muslims also published their bag of “tricks” in a book they blatantly titled The Book of Escapes and Ruses! It was these novel interpretations of traditional teachings that enabled the Muslim economic empire to expand. At least those ancient Arabs traders were honest enough to admit that they were circumventing the system. And being honest is the first precept in any religion.


My central thesis is this: money, deprived of its mystique, is like any other commodity and property. I can rent my house and rightly claim rental income. I could similarly “rent” out my capital (money) to someone and collect rental income (return on investment). This rental on my capital can be collected in a variety of forms: interests as in simple lending; dividends with bond investments; company shares with stock market (equity) investment; or co-ownership as with venture capital investments. The differences are only matters of degree and not in kind, quantitative not qualitative. They reflect gradations in magnitude of the risk/benefit ratio. The simple interest with bank deposits represents the lowest risk and also correspondingly the lowest returns. Venture capital investments represent the biggest potential for profits but also the greatest risks. It is an investment axiom that high rewards come only with high risks.


Enthusiasts of Islamic banking go through contorted reasoning in trying to differentiate between riba and other forms of returns on investments that are deemed religiously acceptable—halal. Techniques like cost-plus sales (Murabaha), deferred payment sales (Bay Mu’ajjal), deferred delivery sales (Bay’ Salam), and credit sales (Bay Bi-Thaman ‘Ajil) all carry hidden costs that, as El-Gamal rightly observes, any high school student could easily calculate their imputed interest rates. All these Islamic bankers have achieved is simply to complicate an ordinary and simple traditional credit transaction in an effort to camouflage the cost of the funds (interest) by calling it some other fancy name. In the process it makes “comparison shopping” difficult for the consumers.


The beauty of modern credit sales is that they reduced the costs of the credit to a simplified figure that can be used for easy comparison. Credit, which is a manifestation of lending, is a modern fact of life. If everything had to be done on a cash basis, the economy would be crawling. We use credit to build hospitals, schools, and hosts of other activities that benefit society.


Grameen Bank’s Muhammad Yunus asserts that credit is a basic human right. Everyone is entitled to it, especially the poor. Grameen Bank has improved immensely the livelihood of many Bangladesh peasants with its micro credit lending programs. In any religion, that would be considered a praiseworthy deed.


Credit is a matter of faith, and not repaying a loan would be a breach of faith. And breach of faith is not only a sin, it is also a crime, and rightly so. Today we have some Muslim zealots who rationalize that they can borrow money but need not repay it, claiming that interest is haram, and therefore the loan itself is haram. They suddenly discover religion when it comes time to repay the loan. How convenient!


If they feel that way, then they should not have borrowed the money in the first place. To me the greater sin is to borrow with no intention of repaying.


The greatest obstacle to the economic growth of Malays and Muslims generally is that we have denigrated the rewards of savings by labeling them as interest and thus haram. Thus I purposely choose the neutral term “rewards on investments.” We can encourage Malays to save even more if we can dispense with the theologically loaded term “interest” and substitute my “rewards on savings” instead. This is more than just a semantic change or an attempt at “spinning,” rather it represents a qualitative change in concept. It recognizes that lending is a legitimate human activity – a valid service – and therefore profits on it are as valid as in with other economic activities. I will elaborate on this point in the following section on Islamic banks.




Next:   Islamic Financial Intermediaries