Why Is Interest Haram? 10 Eye-Opening Reasons

Interest on debt (Riba) is prohibited in Islam. In fact, any lending for profit is prohibited. Lending should never be a business and should only be done as charity. The Bible prohibits interest-bearing debt but unfortunately, over time, Christians decided to ignore its prohibition. The Torah also prohibits interest-bearing debt between Jews but they also decided to ignore this prohibition.

In this article, we'll delve into the question, "Why is interest haram?" and why it's crucially important for Muslims to steadfastly uphold the prohibition of interest-bearing debt (Riba). Here are 10 compelling reasons to help you understand why:

Reason #1: It’s An Unfair Agreement

Interest-bearing debt agreements place all the risk on the shoulders of the financed and none of it on the shoulders of the financier.

The lender is contractually entitled to their money back, with interest, regardless of borrower outcomes. This means the lender isn’t really investing, they’re exploiting.

The one-sidedness of this agreement makes it unconscionable in Islam and therefore illegal.

Reason #2: Economic Inequality

Due to the one-sidedness of lending terms, it is possible for the lender to do well while the borrower is doing poorly.

Even in the case of a borrower defaulting on their loan, the lender may end up with collateral that is worth more than what the loan was originally worth.

At scale and over time, the proliferation of these one-sided agreements leads to income inequality where the rich get richer and the poor get poorer.

Reason #3: Social Harmony

Interest-bearing debt pits the contracting parties against one another. This is because the interests of the financier are often at odds with the interests of the financed, like in the case of valuable collateral. Consequently, the two parties work against each other motivated by their self-interests.

Instead, Islam encourages profit-and-loss sharing. In these arrangements, the only way the financier does well is if the financed does well and visa-versa. Aligning the well-being of the financier and financed helps maintain social cohesion and mutual trust.

Reason #4: Money is Directed to the Most Promising Projects First

With interest-bearing debt, regardless of the quality of the idea, if the financier thinks they’ll get their money back, they don’t really care how irrational the financed person’s use of funds is.

They’ll finance pretty much anything if they think they can benefit. This leads to inefficient allocation of capital.

On the other hand, since profit and loss sharing rewards financiers proportionally to outcomes, they care more about these outcomes. As a result, the most promising ideas get funded first, with lousy ideas not getting funding at all.

Reason #5: Emancipating the Slaves

Interest can trap individuals in debt, leading to a cycle of poverty and one could argue, servitude.

Yes, slavery is still alive and well today. It’s the slavery of those trapped in indebtedness to their lenders.

In fact, in some aspects, indebtedness is worse than slavery. At least with slavery, the owner had to provide the slaves with shelter, food, and healthcare.

Lenders don’t have to worry about any of these things and yet they are entitled to the fruits of the debtor's labor nonetheless.

The prohibition of interest-bearing debt protects vulnerable members of society, particularly in desperate or uneducated situations.

Reason #6: Moral and Ethical Development

When acting morally conflicts with personal interests it becomes less likely.

Defaulting on a house that has become worth less than what is owed on it is advantageous financially but at odds with the moral imperative to pay off one’s debt.

Immoral behavior begets more immorality.

The prohibition of interest-bearing debt which has incentive systems that encourage immorality helps people act morally.

Aligning the interests of the financier and the financed teaches individuals to act with empathy, fairness, and consideration for the well-being of others.

Moral behavior begets more morality.

Reason #7: Discourages Speculative Bubbles

As mentioned earlier, lenders don’t care what the borrowers use the money for if they think they’ll get their money back.

When hype is high, people will often take out loans to buy crap which creates crap bubbles... Think the vast majority of crypto and Web 3 projects.

You’ll have a harder time convincing an investor to split the profits from a scam coin investment than you will buying the scam coin with your credit card.

The prohibition of Riba helps keep assets grounded in real economic values.

Reason #8: Encourages Savings and Investments

If lending for profit is allowed, people will make a business of it.

With dedicated businesses, borrowing becomes easier. Worse, borrowing is encouraged.

The lending businesses depend on it. Lenders need people who want to buy things with money they don’t have so they encourage it.

The prohibition of lending for profit (interest on debt), eliminates the lenders’ incentive to get other people into debt and forces people to save before they buy.

Reason #9: Promotes Transparency and Honesty

When well-being isn’t aligned, as is the case with interest-bearing debt, deception becomes encouraged.

Lenders who may be eyeing a borrower’s collateral may obscure just how expensive their loans are.

Remember the variable-rate mortgages that contributed to the 2008–2009 economic crisis? Lenders made it seem like borrowers could afford their loans because they wanted to seize the collateralized homes when the borrower inevitably defaulted.

Interest-bearing loans often involve complex structures that are meant to obscure the true cost of borrowing.

Its prohibition promotes clear and transparent dealings.

Reason #10: Economic Stability

Debt makes people financially fragile.

If someone has a lot of debt and loses their job, their failure to make payments for a period of time can make them susceptible to further economic losses that deepen the financial hole they have to climb out of. Ultimately, this may lead them to even more debt on more unfavorable terms.

Without this indebtedness, they may have been able to cut back on spending and dip into their savings, which they have a habit of accumulating and getting back on their feet.

At scale, financially brittle individuals make financially brittle families which make financially brittle economies. Eliminating debt from personal, family and corporate balance sheets reduces economic volatility and increases financial resilience.

Conclusion: Understanding "Why is Interest Haram?" and its Far-reaching Implications

Numerous compelling reasons explain why interest on debt, or Riba, is prohibited in Islam. It falls upon Muslims to maintain this ban not just for their own benefit, but for the greater good of humanity as a whole.

Towards this end, we must subject any product that claims to be interest-free to aggressive critical interrogation before accepting their claims as fact.

The post Why Is Interest Haram? 10 Eye-Opening Reasons appeared first on Practical Islamic Finance.