DIFFERENCE BETWEEN RIBA (INTEREST) CHARGED IN CONVENTIONAL BANKS AND PROFIT CHARGED BY ISLAMIC BANKS

The word “riba”, often translated as “usury” or “interest”, comes from the Arabic root meaning “to increase” or “to gain”, and is specifically prohibited in the Qur’an on several occasions.

It’s an extra earning in a lender borrower relationship whereby money is treated as a commodity of trade, either being paid by a client to the financial institution or the institution paying the client. It’s that effortless gain.

Although the term riba and interest is used interchangeably, riba is much wider than interest. All forms of interest is Riba but not all forms of riba is interest. For example, the prophet ﷺ in a narration said that every loan from which we draw benefit is riba. Not all benefits are financial in nature. Thus, riba can be both financial and non-financial while interest is only financial.

Simply put, Riba is return that a Bank gets when it lends money (loan) to a client in a borrower lender agreement. This action is prohibited in the scriptures (Bible, Torah and Quran) to avoid this transaction Islamic banking engages in the buying and selling of assets/commodities so as to generate profits .

For example if the bank lends kes. 1m and charges an additional kes. 200,000 then that is riba.

Profit on the other hand, is a return on risk; based on the Shari’ah basis of No risk no Return principle. When capital is invested, some effort must be applied in order to generate a return called profit. This comes about when you engage in financing activities e.g. buying and selling of products/commodities.

Difference between Interest & Profit
Difference between Interest & Profit – tijara.co.ke

Finally to make it easy to understand we may use an example of an investor who wants to purchase a piece of land; In conventional riba based banking, the customer will come to the bank and apply for loan. The loan once approved is disbursed to the customer who repays the principal with some interest on top. In most instances, the land is taken as collateral.

In Islamic Banking however, land purchase can for instance among other contracts be done through Murabaha (cost plus sale) whereby the Bank will purchase from the vendor and sell to the client at a profit.

The bank can directly purchase the land own it and then sell it to the client at profit. The client then pays for the land (principal and profit) over the agreed period of time.

Interest therefore is when you sell money and charge an additional amount without an underlying economic activity while profit is return earned from engaging in business activity.

The profit rate can be set by the bank without reference to any individual or instrument.

The common practise however is that Pricing is normally benchmarked with the Interest rates given by the regulatory authority. e.g. in London; it is based on the Libor- London Interbank Offer Rate.

In Kenya, it is based on the Central Bank Rate (CBR which is determined by the Monetary Policy Committee of the Central Bank of Kenya. This kind of system uses an interest rate as a bench mark for the profit rates charged to customers.

A customer can for example approach an Islamic bank for the purchase of a plot, and the bank will purchase a plot and sell to the customer at the prevailing CBR plus a margin of 4%.

This often confuses customers because a similar rate of interest is charged by conventional banks. They tend to argue that there is no difference between profit and interest.

The similarity in rates does not make it interest as it is only being used as a measure or benchmark, the difference is usually in the concept. How the 14% is charged.

If a conventional bank is lending kes. 1million at interest rate of 14% it becomes haram. But if Islamic Bank purchases land at kes. 1m and sells to a third party at profit of 14% or even a higher rate is perfectly in order despite the fact that the profit rate is the same as the interest rate or even higher.

19 thoughts on “DIFFERENCE BETWEEN RIBA (INTEREST) CHARGED IN CONVENTIONAL BANKS AND PROFIT CHARGED BY ISLAMIC BANKS”

    1. Wa aleykum salaaam warahmatullahi wabarakatuh…. Generally speaking, if the company is dealing in halal business and the reason for purchasing the shares are free from speculation an uncertainty (Gharar) then it’s ok….otherwise there are other finer details on the Sharia screening of stocks, kindly send us an email on tijarainstitute@outlook.com for more information..

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  1. Salaamu alaikum, thanks for the wonderful enlightenment. I want to know if making an investment with an unislamic bank to reap interest in a stipulated period also falls under the category of riba.

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  2. I live in Ghana and run a private business. I have orders and facing expansion challenges. The banks are willing to lend based on our turnover. Is it haram for me to take such loans in the absence of approved Islamic banks?
    Can we insure our machinery and equipment with the regular insurance companies since they are the only ones we have in Ghana.
    May Allah grant you goodness.

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    1. In Qur’an 278 to 279 Allah says; “O you who believe! Fear Allaah and give up what remains (due to you) from Ribaa (from now onward) if you are (really) believers. And if you do not do it, then take a notice of war from Allaah and His Messenger…”

      RASULULLAH ﷺ cursed the one who consumes riba and the one who pays it, the one who writes it down and the two who witness it, and he said: they are all the same (in sin). [SAHEEH MUSLIM 1598]

      Riba is among the seven most destructive sins ( sab3al muubiqaat) but it has today been trivialized by many.

      Some argue that in places where there are no Islamic Banks it’s allowed to take loan based on Riba out of Dharura/necessity.

      Whilst this could be true in cases where we are forced to open a bank account only for keeping money out of necessity such as insecurity, the same doesn’t apply to taking Riba based loans.

      Dharura or necessity has often been used out of context.

      Al-Zarkashi رحمه الله had this to say with regards to necessity: NECESSITY means when he reaches a state where if he does not consume what is forbidden he will DIE, or almost die, such as one who is in desperate need of food or clothing, in a case where if he remained hungry or naked he would perish, or lose a limb or physical faculty. In that case it becomes permissible to consume what is haraam. [Al-Manthoor fi’l-Qawaa’id 2/319]

      In addition to the aforementioned, being forced by the government or the rules of the land also comes under necessity. If like in most countries taking insurance is a legal requirements then the same is allowed under necessity.

      And ALLAH عز وجل knows best.

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  3. Masha Allah. May Allah increase you in wisdome and knowledge of the deen.
    In a country like Ghana, were we have no islamic banking or other economic sharia organizations that helps to regulate our economic activities as muslims, especially our petty trading mothers who have little or no knowledge about these islamic principles and our Coporate brothers and sisters whose knowledge about the deen is limited as a result of so many factors, who recieve their salaries through these conventional banks and also saves and transact with them. What are the options available to us? Is there any islamic bank outside the country Ghana whose business is beyond land marks (ie assessible to us)?

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    1. Ameen.

      May Allah place Baraka in their businesses.

      We are not aware of any Islamic banks which offer financial services to those outside the country.
      We will notify you as soon as we find one.

      In the meantime however, we highly recommend that you join hands to come up with an Islamic Microfinance/SACCOs.

      We at Tijara are ready, willing and able to help you with technical guidance on setting up the same.

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  4. It will depend on the underlying contract and how it will be executed both on paper and in the system.

    For an Islamic window to be sharia compliant some of the conditions which they ought to fulfill includes separation of funds on Islamic side from those on the conventional side. The funds should then be lent within the shariah principles.

    Generally speaking the banks are shariah compliant. We can only make specific comments upon examining the contract document and how the facility behaves in the system.

    Kindly email us on tijarainstitute@outlook.com for further guidance.

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  5. I have quirry. I wanted to get a car through Islamic finance but from conventional bank which offers Islamic finance like Kenya Commercial Bank Kenya. Kindly advise if its acceptable. Thank you.

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  6. 1-Does that mean that islamic banking only deals with trading of goods and services? 2- how do you factor someone who only needs money for the payment of his/her ward’s school fees but that person does not engage in any trading activities.? 3- In an event that the purchaser of the land is unable to settle the entire amount, how do you retrieve your money? 4- Is islam not against abnormal profit? Why then the 4% plus the CBI rate? 5- what of a petty trader who wants a loan for expansion of her business? How is her loan treated? Among others.

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    1. 1. All forms of financing in Islamic Banks must be backed by purchase/sale of good/services. Even when the money is needed by the customer for personal use the financing must be backed by good or service.
      2. For those who want to pay fees and not use the money for any trade, the can get the funds through: Service Murabaha (the education service can be bought and sold or service Ijara. The same can also be done through Tawaruq (this involves the bank purchasing a fast moving commodity and selling at profit to the customer who sells the same to realize quick cash for his personal use).
      3. Incase the purchaser is not able to repay the facility in full, if the reason for his failure is something outside his control he is given time to repay. But if he still isn’t able to pay then the collateral is sold to recover the exposure. This can be different based on the underlying contract.
      4. Price control is not part of Islamic economics. Even the Prophet during his life declined to control prices. Its however disliked to charge punitive price but not haram. The forces of demand and supply determine the price.
      5. Petty traders can still get financing from Islamic banks. However, our advice is that petty traders come together to form Islamic Saccos to help one another through Qardh Hasan basis or join existing ones who advance loan at no cost. Whilst Islamic Banks strive to operate within the framework of being halal, they are still far from realizing the one of the goal of Shariah; that of enhancing wealth distribution to uplift welfare of the poor.

      Do not get tired to make further clarifications.

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      1. 1-Is child education policy from an insurance company halal to engage in? 2- what does islam say about insurance? Be it vehicle, housing or general property, business, farm, ect.

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      2. Both questions are about Insurance. The conventional insurance as they are does not meet the shariah requirement because they entail gambling and other form ills that contravene Shariah.

        In line with principles of Shariah is the Takaful Insurance. This entails policy holders who are in this case called contributors coming together and making contribution to cover one another in case of a risk through the principle of Taawun.

        If the child’s education policy and the other insurance that you mentioned are from a trusted Insurance company with properly constituted independent Shariah board then it should be okay unless there is a specific issue.

        We can link with with an Insurance expert for further guidance.

        Email us on tijarainstitute@outlook.com.

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