ECONOMICS OF RIBA AL-FADHLTowards a uniform treatment of Riba

Sami Al-Suwailem Islamic Development Bank

IRTI Seminar17 March 2015

TYPES OF RIBA

Loan Riba (riba al-qhard, or riba al-nasi’ah)

Sale Riba (riba al-fadhl, or riba al-boyou’)

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Exchange

Identical

Quadhassan

Differentitems

Similar

Equalquantities

Unequalquantities

LoanRiba

Not of the 6items

Of the 6items

SaleRiba

Trade Trade

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Gold Silver Wheat Barley Dates Salt

Gold ! = ! ✓ ✓ ✓ ✓

Silver ! ! = ✓ ✓ ✓ ✓

Wheat ✓ ✓ ! = ! ! !

Barley ✓ ✓ ! ! = ! !

Dates ✓ ✓ ! ! ! = !

Salt ✓ ✓ ! ! ! ! =

WHY RIBA AL-FADHL?

The six items are essential to the economy and the society

Necessary & fungible commodities are usually used for lending and borrowing—loan riba

A preventative measure against Loan Riba

Is there any thing more?

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ISRAF

Ghazali:

Food is necessary, and different kinds of the same food are equivalent in terms of usefulness, but are different in terms of indulgence or luxuriousness. Shari’ah therefore ignored these luxury aspects in necessary commodities

Ibn Rushed, Jr.

It becomes a form of Israf

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ANALYSIS OF RIBA AL-FADHL

An essential good (e.g. dates) consists of two sets of properties:

necessary properties that are common across different types or flavors of the same material

luxurious properties that differ from type or flavor to another

When we buy or trade, we trade the whole good

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TRADE

What happens when an essential good is exchanged with a with the same good but of a different type?

In words, common properties cancel each other out, and it becomes only a trade of luxury properties

But luxury properties have a higher price than the general price

It follows that the good will be traded at a higher price

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MARKET DYNAMICS

Because the price of the luxury component is higher, the good will be channeled to the riba al-fadh market to gain from the higher price

Riba al-Fadh simply transforms an essential good to a luxury good

The luxury market suites the able and well-off at the expense of the general public

This leads to concentration of wealth10

MODELING RIBA AL-FADHL

The good consists of two components:

Each component has an implicit price:

In general, the price of a luxury good is higher than of necessary one:

The “general” price is intermediate:

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pixi = pxx + pzzi

px < pz

px < pi < pz

xi = x + zi

TRADE

Trade implies changes in quantities

Total differentiation of

Total differentiation of with constant prices:

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dxdxi+dzidxi=1, λi =

dxdxi

, (1−λi)=dzidxi

, 0≤λi ≤1

pixi = pxx + pzzi

xi = x + zi

pi =λipx+ (1−λi)pzi

RIBA AL-FADHL MARKET

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p1dx1 = p2dx2

λi = 0⇒ pi = pzi

pi =λipx+ (1−λi)pzi

pz1dz1 = pz2dz2

EQUILIBRIUM

pz0

pi0

p∗p∗

Qx0Qx

∗Qz0 Qz

∗

General marketRiba al-Fadhl market

SUMMARY

Riba al-Fadhl transforms a necessary good to a luxury good

Israf

This results in higher prices and concentration of wealth

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LOAN RIBA

Can we extend the model to loan riba?

Define the good to have two components:

Time-independent properties

Time-dependent properties

Is there an incentive to trade separately?

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xt = x + zt

ptxt = pxx + pzt zt

zt

TIME-DEPENDENT PROPERTIES

What matters is not the level of

Rather it is the price elasticity of demand

Inelastic demand means price can rise without reducing demand

This creates a profit opportunity to have a loan market

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pzt

PRICE ELASTICITY

Price of time-dependent properties is less elastic than price of time-independent properties

Time-dependent properties reflect urgency and timely need; if need is not met at a specific moment, it cannot be compensated at another moment

Borrowers tend to have a high discount rate that gives lenders good returns

Time-independent properties are stable and robust across time; the need can be satisfied at any point in time

Availability of substitutes makes demand more responsive to price, i.e. more elastic18

IMPACT OF LOAN RIBA

Since price of time-dependent properties is less elastic, owners of capital have and incentive to switch to lending rather trading

Interest itself creates a gap between loan market and general market

We can carry over the analysis of riba al-fadhl to loan riba

Concentration of wealth and higher general market price

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POSITIVE FEEDBACK

Interest pushes the price of time-dependent properties higher

This reflects back on the general market price

Higher general market price leads to higher price of time-dependent properties

Positive feedback loop that ends in a crash

Instability of interest-based systems

Loan riba is worse than riba al-fadhl20

COMPARISON

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RIBA AL FADHL LOAN RIBA

Property Luxurious properties Time-dependent properties

Demand By the rich By the needy

Elasticity High elasticity Low elasticity

Price gap Exogenous Endogenous

Instability Low instability High instability

CONCLUSION

Riba al-Fadhl and Riba al-Nasee’ah (loan riba) have essential common features

Riba impacts the behavior of agents and markets

Promising area of research

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والحمد هلل رب العالمين

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