Beyond Riba: Reconstruction of Just Financial Orde…
Pakistan has debated the elimination of riba—a Quranic term subjected to judicial interpretation and theological discourse but still lacking a precise statutory definition—for decades. Judicial decisions have been delivered, commissions constituted, reports prepared, appeals filed and withdrawn, deadlines announced and Islamic banking expanded. The central intellectual and legislative task, however, remains incomplete. We have not developed a precise, comprehensive and operational definition of the economic practices that must be prohibited.
This omission is not merely academic. No financial system can be reconstructed around a prohibition that is expressed only as a moral declaration. A law [Who will draft Riba Prohibition Law? Minute Mirror, April 7, 2026] must identify the transaction, the prohibited increment, the parties affected, the substance to be examined and the consequences of violation. It must also distinguish an unlawful return on money from lawful earnings arising from trade, labour, services, ownership and commercial risk.
The first requirement of a serious programme for the elimination of riba is clarity. Riba is commonly translated as interest/usury. This translation is useful but incomplete. Modern interest is one of its most important manifestations, particularly where a lender advances money and contractually claims an additional amount merely because the borrower is allowed time to repay. The prohibition, however, cannot be confined to instruments carrying the label “interest”. Nor can every commercial gain, deferred price or fixed payment be declared riba.
The distinction lies in the legal and economic substance of the transaction. Where money is advanced as a loan and the lender is guaranteed an increase over the principal, the return does not arise from ownership of a productive asset, provision of a service, participation in business or exposure to commercial loss. It arises from the loan itself and the passage of time. The borrower must pay the increase whether the borrowed funds generate profit, produce loss, meet a medical emergency or finance bare survival.
This asymmetry lies at the heart of the problem. Capital is protected; return is predetermined; risk is shifted to the borrower. Trade operates differently. A trader purchases or produces an asset, assumes the risks of ownership, incurs costs, faces the possibility of loss and sells the asset at a profit. The profit is not earned merely because money has been unavailable to another person for a period. It is connected with property, exchange, enterprise and market risk.
Lease income also rests upon a different foundation. An owner permits another person to use an asset while retaining the liabilities associated with ownership. Rent represents consideration for the use of the asset. The arrangement becomes questionable when the supposed owner bears no meaningful ownership risk and the entire structure is merely a cash loan disguised through documents.
Partnership profit has another character. Partners combine capital, work, expertise or enterprise. Profit is divided according to an agreed formula permitted by the applicable juristic principles, while financial loss follows the capital placed at risk. A partner cannot lawfully guarantee himself a fixed return upon capital and compel the other partner to bear every commercial loss.
These distinctions are recognised, with variations, across the major Muslim schools. They differ on matters such as the permissible relationship between capital contribution and profit-sharing ratios, conditions attached to contracts, possession, agency and the allocation of particular risks. They do not treat every profit as riba. Nor do they permit a partner to convert genuine risk participation into a guaranteed return on money. A modern Prohibition of Riba law must preserve these distinctions.
The difficulty is that contemporary finance has developed techniques through which a loan can be divided into several formally separate contracts. An institution may purchase an asset for a few moments, sell it to the customer at a marked-up price, obtain comprehensive security, transfer every economic risk to the customer and calculate its return by reference to the prevailing interest rate.
The transaction may satisfy documentary requirements while reproducing the economic substance of conventional lending. The institution receives a predetermined return; the customer bears the commercial risk; and the institution’s temporary ownership exists mainly to legitimise the financing charge.
This does not mean that murabaha, ijarah or diminishing musharakah are inherently invalid. Each can serve a legitimate commercial purpose. Murabaha can facilitate an actual purchase where the financier genuinely acquires and assumes responsibility for the asset before selling it. Ijarah can finance the use of an asset where the lessor retains real ownership obligations. Diminishing musharakah can support home ownership where the parties genuinely share ownership and the customer gradually acquires the financier’s units.
The problem arises when these contracts are treated as legal devices for guaranteeing the same return that would have been received under an interest-bearing loan. A workable definition must therefore contain both a formal and a substantive test. The formal test will examine the legal category of the contract.
The substantive test will determine whether the financier has provided an asset, service or productive participation and whether it has assumed a genuine risk corresponding to its return. This test should not be misunderstood as hostility towards fixed prices. A lawful sale price may be fixed. Rent may be determined in advance. A service fee may be agreed. The existence of a fixed amount does not by itself establish riba.
The decisive question is what the payment represents. A fee charged for maintaining an account, transferring funds, valuing property, arranging documentation or providing an identifiable professional service may be legitimate. A “service fee” calculated as a percentage of a loan, increasing with time and unrelated to the actual cost or nature of the service may be interest under another name.
The same care is required in relation to delayed payment. A seller, who supplies goods on deferred payment, may charge a price higher than the immediate cash price, provided one price is finally agreed when the contract is concluded. Once the debt has been created, however, an additional amount cannot ordinarily be imposed merely because the debtor requires more time.
This is where many modern systems institutionalise exploitation. A person who is already unable to pay is burdened with compounding additions. Debt grows without any corresponding asset, service or productive activity. The creditor’s claim expands while the debtor’s capacity to escape diminishes.
Inflation presents a more difficult question. A prolonged decline in the purchasing power of money can cause real injustice to a lender who receives the same nominal sum many years later. Muslim jurists and contemporary scholars have taken different approaches to indexation, currency depreciation and compensation for actual loss.
A modern law should not conceal this complexity. It must distinguish a predetermined real return from a narrowly designed mechanism intended to preserve value in exceptional circumstances. Any indexation rule would require strict statutory safeguards. It should not become an indirect method of guaranteeing profit on every loan.
Public debt must also fall within the definition. The State cannot prohibit riba in private transactions while financing its deficits through instruments that promise banks and investors a predetermined return funded by taxation. Sovereign status does not transform the nature of the transaction. Government borrowing must therefore be included in the reform programme rather than treated as a permanent exception.
The statutory definition should also cover disguised arrangements, including sale-and-buyback structures, artificial commodity transactions, guaranteed investment certificates, compulsory repurchase undertakings and partnerships in which one party is insulated from every commercial loss.
Courts and regulators should be authorised to examine connected contracts as a single transaction. Fragmenting one financing arrangement into multiple documents must not prevent scrutiny of its real economic effect.
At the same time, the law must avoid an overbroad definition that paralyses trade and investment. Profit is not riba. Rent is not riba. Salary is not riba.
A genuine service charge is not riba. Compensation for actual damage is not automatically riba. Equity investment is not riba merely because an investor expects profit.
A financial system cannot function without returns. The Quranic objection is not to earning. It is to unjustified entitlement: a claim to increase that is detached from productive participation, service, ownership responsibility and genuine exposure to commercial consequences.
The proposed law should define riba as any stipulated, guaranteed or contractually enforceable addition over a loan or debt that becomes payable by reason of time, without an independent lawful countervalue in the form of an asset, service or genuine participation in commercial risk.
This formulation would require refinement by jurists, economists, accountants, bankers and legislative drafters. It nevertheless provides a clearer starting point than the simple substitution of Islamic terminology for conventional contracts.
The elimination of riba cannot begin with the closure of banks or cancellation of contracts. It must begin with intellectual honesty.
We must decide what is prohibited, why it is prohibited and how it differs from legitimate economic return. Once this foundation is settled, the next question becomes unavoidable: who should possess the power to create money—society through a sovereign monetary authority, or commercial banks through the expansion of credit? This question will determine whether the proposed transformation redesign of the financial system or remains confined to the language of its contracts.
[To be continued]
_______________________________________________________________________
Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds an LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.
