Riba refers to interest or usury—any guaranteed, predetermined return on a loan or investment regardless of the outcome. It is one of the most fundamental prohibitions in Islamic finance.
Beginner
What It Means
Riba literally translates to “increase” or “excess” in Arabic. In Islamic finance, it refers to any guaranteed return on money lent, which is prohibited because money should not generate more money without productive economic activity or risk-sharing.
Practical Example
A conventional bank account paying 4% annual interest is considered riba. The return is guaranteed regardless of what the bank does with your money. In contrast, profit-sharing arrangements where returns depend on actual business performance are permissible.
Why It Matters
Riba is prohibited because it:
- Creates unearned income without productive activity
- Shifts all risk to the borrower while the lender is guaranteed returns
- Can lead to exploitation, particularly of those in financial distress
- Encourages speculation over productive investment
For investors, this means avoiding companies with excessive interest-bearing debt or those whose primary business involves conventional lending.
Advanced
Types of Riba
Islamic jurisprudence distinguishes two main categories:
| Type | Description | Example |
|---|
| Riba al-Nasiah | Interest on loans—excess payment for deferment of repayment | Bank charging 10% annual interest on a loan |
| Riba al-Fadl | Excess in exchange of similar commodities | Trading 1kg of gold for 1.1kg of gold |
Shariah Screening Thresholds
For equity investments, companies are typically screened for riba exposure:
Interest-bearing debt / Total assets < 30%
Interest income / Total revenue < 5%
Alternatives to Interest-Based Financing
Islamic finance has developed several riba-free alternatives:
- Murabaha: Cost-plus financing where the financier purchases an asset and sells it at a disclosed markup
- Ijara: Lease-to-own arrangements
- Musharakah: Equity partnership with profit/loss sharing
- Sukuk: Islamic bonds structured around tangible assets
Historical Context
The prohibition of riba appears in the Quran and was elaborated in hadith literature. Similar prohibitions existed in medieval Christian and Jewish law. The modern Islamic finance industry, beginning in the 1970s, has developed practical frameworks for riba-free banking and investment.
Interest income received inadvertently (e.g., from cash holdings at a broker) must be purified through charitable donation. This doesn’t make the activity permissible but addresses unavoidable exposure.
