By Robert Shepard*
Introduction
The prohibition of ribā (ربا(, or usury, is one of the most critical principles shaping financial transactions in Muslim-majority countries. Rooted in Qurʾānic injunctions and classical jurisprudence, this principle forbids any guaranteed monetary gain in lending transactions, viewing it as exploitative and inequitable. Modern Islamic finance has sought to navigate this prohibition by developing financial instruments that align with sharīʿa principles while addressing the demands of contemporary economies. The structuring of loans represents a particularly important area where these efforts are evident. Islamic banks have devised alternatives to interest-based models, relying on mechanisms such as murābaḥa, ijāra, and mushāraka.
This essay explores the central research question: how effective are modern Islamic financial structures in reconciling the prohibition of ribā with the practical needs of contemporary lending? Drawing on examples from jurisdictions such as Malaysia, Saudi Arabia, and the United States, the analysis evaluates these mechanisms in light of their adherence to sharīʿa principles and their operational challenges. Additionally, the essay incorporates an assessment of AI’s role in synthesizing information, testing its ability to inform and refine this analysis.
Analysis: Ribā in Islamic Finance
The prohibition of ribā has deep roots in Qurʾānic injunctions, most notably in verses such as Sūra al-Baqara (2:275–79), which unequivocally condemn usury as unjust and harmful.[1] Classical jurists elaborated on this prohibition, defining ribā as any increase in exchange that is not accompanied by proper compensation.[2] Mahmoud El-Gamal describes ribā as “trading in credit” in a manner that creates inequity, emphasizing that this prohibition aims to prevent financial exploitation while preserving equity in transactions.[3]
Importantly, ribā is not synonymous with interest. El-Gamal highlights that, while some forms of interest are prohibited under sharīʿa, others are not automatically considered ribā.[4] For example, implicit interest rates are common in Islamic credit sales and leasing arrangements, such as murābaḥa and ijāra.[5] These structures are permissible because they frame the financial transaction as a trade or lease agreement rather than a loan. Conversely, certain forms of ribā, such as ribā al-faḍl (inequitable exchanges of the same commodity), do not involve interest but are still forbidden due to their inherent inequity.[6] This distinction underscores the nuanced approach of Islamic jurisprudence, which focuses on the ethical and economic fairness of transactions rather than a blanket prohibition on interest.
In classical jurisprudence, ribā is further divided into two main types: ribā al-nasīʾa, involving deferred payments with interest, and ribā al-faḍl, involving inequitable exchanges of commodities of the same type.[7] Both forms are prohibited to safeguard against predatory lending practices and inequitable trade. El-Gamal argues that, while these rules were historically justified as protections against economic harm, modern Islamic finance often replicates conventional financial structures, leading to criticisms of form-over-substance approaches.[8] This tension is central to contemporary debates about the authenticity of Islamic finance.
Key Mechanisms in Islamic Banking
Among the most prevalent mechanisms is murābaḥa, or cost-plus financing, which accounts for 80–90% of Islamic banking transactions globally.[9] Under a murābaḥa arrangement, a bank purchases an asset and resells it to a customer at a marked-up price, with repayment typically made in installments. This model avoids direct interest by framing the transaction as a sale rather than a loan. However, El-Gamal critiques murābaḥa as a “sale-based ruse” that mimics conventional lending while bypassing the strict prohibition of ribā.[10] Critics argue that this structure prioritizes formal compliance over substantive adherence to sharīʿa principles, undermining the ethical goals of Islamic finance.¹³
Another widely used model is ijāra, a leasing arrangement where the bank retains ownership of an asset and leases it to the customer.[11] At the end of the lease term, the customer has the option to purchase the asset outright. This structure emphasizes asset-backed transactions and avoids speculative practices, aligning with sharīʿa principles. El-Gamal notes that ijāra provides a more transparent alternative to interest-based loans, particularly in real estate and vehicle financing.[12]
Mushāraka, or partnership financing, represents a collaborative approach where the bank and customer jointly own an asset.[13] Over time, the customer gradually buys out the bank’s share. This model embodies the Islamic ideal of shared risk and reward. However, its complexity and administrative costs can limit its accessibility, particularly for smaller clients.[14]
Global Growth and Regional Practices
Islamic finance has grown substantially in recent decades, with global financial assets reaching $4 trillion by 2021 and projected to grow to $5.9 trillion by 2026.[15] Malaysia, a global leader in Islamic finance, has established robust regulatory frameworks to ensure sharīʿa compliance. Institutions like Maybank Islamic employ murābaḥa-based home financing and ijāra-based leasing to meet consumer demand.[16] However, these products often carry higher costs, raising concerns about accessibility for lower-income borrowers.
In Saudi Arabia, banks such as Al Rajhi have implemented mushāraka models for large-scale infrastructure projects, reflecting the country’s emphasis on shared risk and reward.[17] Yet, the widespread use of tawarruq, a mechanism involving cash generation through commodity sales, has sparked debate. Critics argue that it resembles conventional loans too closely, prioritizing form over substance.[18] In the United States, Islamic finance has gained a niche market through institutions like Guidance Residential, which employ murābaḥa and ijāra to offer sharīʿa-compliant home financing.[19] Regulatory support, such as approvals from the Office of the Comptroller of the Currency (OCC), has enabled these products to operate within a conventional financial framework while meeting the needs of Muslim consumers.[20]
AI’s Role in Addressing the Research Question
The integration of AI into the research process for this paper provided a valuable starting point for exploring the complexities of ribā and modern Islamic finance. AI, particularly through ChatGPT, demonstrated significant utility in synthesizing broad concepts and identifying key scholarly resources. For example, ChatGPT suggested Mahmoud El-Gamal’s Islamic Finance: Law, Economics, and Practice and Wael Hallaq’s Sharīʿa: Theory, Practice, Transformations as foundational texts, while also referencing regulatory documents such as the Office of the Comptroller of the Currency’s Interpretive Letters Nos. 806 and 867. These sources proved central to the analysis, with AI offering helpful summaries of key arguments, including El-Gamal’s critique of ribā-compliant mechanisms as overly focused on form rather than substance.
However, while AI provided an excellent starting point, the research process highlighted its limitations, especially in the context of nuanced legal and economic debates. The AI’s summaries were accurate at a surface level but lacked the depth needed to engage critically with contentious issues, such as the ethical tension between murābaḥa’s compliance with sharīʿa and its resemblance to conventional loans.[21] To address this, I had to consult the suggested sources directly, researching El-Gamal’s detailed analysis of ribā and its economic implications. This deeper engagement revealed the foundational economic substance of ribā prohibitions and how these principles are often diluted in modern Islamic finance practices.
In addition, AI’s handling of jurisdictional comparisons required further refinement. For instance, while it effectively identified Malaysia as a leader in Islamic finance and highlighted its regulatory innovations, AI’s treatment of Saudi Arabia’s use of tawarruq and the United States’ regulatory adaptations lacked contextual depth. To rectify this, I analyzed primary sources and secondary literature, including the ICD-Refinitiv report on global Islamic finance growth, to substantiate these claims. For example, AI’s reference to Malaysia’s murābaḥa-based home financing initiatives and the regulatory support for Islamic finance in the United States required validation and additional context, such as the specific regulatory frameworks employed.
Moreover, the research process underscored the need for critical engagement with AI-generated insights. AI’s tendency to prioritize widely accepted narratives sometimes overlooked contentious aspects of Islamic finance, such as criticisms of tawarruq as a circumvention of sharīʿa. By supplementing AI-generated summaries with independent research, I was able to present a more balanced view that accounted for both the ethical aspirations and the practical challenges of Islamic finance.
Conclusion
The central research question posed in this essay—how effective are modern Islamic financial structures in reconciling the prohibition of ribā with the practical needs of contemporary lending?—can be affirmatively answered with cautious optimism. Modern Islamic finance has succeeded in creating financial mechanisms such as murābaḥa, ijāra, and mushāraka that adhere to sharīʿa principles while addressing the practical demands of modern economies. These mechanisms provide tangible alternatives to conventional interest-based loans, promoting ethical finance that aligns with Islamic values.
However, the effectiveness of these models is not without limitations. While the structures technically comply with the prohibition of ribā, critiques regarding their tendency to replicate conventional lending practices highlight ongoing tensions between formal compliance and substantive adherence to ethical ideals. For instance, the widespread use of murābaḥa underscores its practicality, yet it has been criticized as prioritizing form over the spirit of sharīʿa. Similarly, mechanisms like tawarruq further complicate the picture, as they are seen by some as a circumvention of Islamic principles.
Regional practices illustrate both the promise and challenges of Islamic finance. Malaysia’s regulatory leadership and Saudi Arabia’s large-scale mushāraka initiatives demonstrate innovation and adaptability. Meanwhile, the United States showcases how sharīʿa-compliant finance can operate within non-Muslim jurisdictions, albeit on a smaller scale. Despite these successes, accessibility and standardization remain persistent issues, particularly for lower-income populations and global consistency in interpretation.
Ultimately, modern Islamic finance is effective in addressing the prohibition of ribā, providing ethical alternatives to interest-based lending. Its ability to reconcile these principles with practical economic needs, while not perfect, demonstrates its adaptability and growth potential. As the industry evolves, its success will depend on continuing efforts to balance ethical ideals with practical realities, ensuring that Islamic finance remains both viable and authentically aligned with sharīʿa.
Notes:
* Robert (Robbie) Shepard is a 3L J.D. Candidate at Harvard Law School, where he serves as a Notes Editor for the Harvard Law Review. He holds an M.A. in Law and Diplomacy (MALD) from The Fletcher School at Tufts University, where he focused on international law and finance, and a B.A. in International Relations from the University of Georgia, with minors in Arabic and Religion. Through UGA’s study abroad program, Robbie studied Arabic and Islamic religion in Morocco with the American Language Center in Marrakesh. His academic and professional interests include Islamic finance, international law, and the interplay between Islamic and Western legal systems.
[1] Qurʾān 2:275–79.
[2] See Wael Hallaq, Sharīʿa: Theory, Practice, Transformations 525–27 (2009).
[3] Mahmoud El-Gamal, Islamic Finance: Law, Economics, and Practice 47–48 (2006).
[4] Id. at 51.
[5] Id.
[6] Id. at 52.
[7] Id. at 50–51.
[8] Id. at 58.
[9] Islamic Corporation for the Development of the Private Sector & Refinitiv, Islamic Finance Development Report 2022 (2022).
[10] El-Gamal, supra note 3, at 54.
[11] Id. at 14.
[12] See id. at 37.
[13] Id. at 40.
[14] Islamic Corporation for the Development of the Private Sector & Refinitiv, supra note 9.
[15] Id.
[16] See Maybank Islamic, Commodity Murabahah Home Financing-i, Maybank2u (last visited Dec. 23, 2024), https://www.maybank2u.com.my/Islamic/en/personal/financing/property/commodity-murabahah-home-financing-i.page; Maybank Islamic, Ijarah Term Financing-i, Maybank2u (last visited Dec. 23, 2024), https://www.maybank2u.com.my/Islamic/en/business/financing/ijarah-term-financing-i.page.
[17] See Al Rajhi Bank Allocation & Impact Report 2024, Al Rajhi Bank (Apr. 2, 2024), https://www.alrajhibank.com.sa/-/media/Project/AlrajhiPWS/Shared/PDFS/Alrajhi-Group/AlRajhi-Bank-Allocation–Impact-Report-2024.pdf; Musharaka REIT Inks SAR 400 Mln Facility with Al Rajhi Bank, Argaam (May 28, 2018), https://www.argaam.com/en/article/articledetail/id/551843.
[18] See, e.g., Salah Al-Shalhoob, Organised Tawarruq in Islamic Law: A Study of Organised Tawarruq as Practised in the Financial Institutions in Saudi Arabia, King Fahd Univ. of Petroleum and Minerals, Thesis Repository (Apr. 23, 2007), https://eprints.kfupm.edu.sa/id/eprint/14894/1/organised_tawarruq_in_Islamic_law_(Conf_23_Apr_2007).pdf (arguing that organized tawarruq, while presented as an Islamic alternative to conventional financing, closely resembles prohibited forms of interest-based transactions due to issues of ownership, agency, and profit structures that undermine its sharīʿa compliance).
[19] See The Three Islamic Home Finance Models: Musharaka, Murabaha, Ijara, Guidance Residential (last visited Dec. 23, 2024), https://www.guidanceresidential.com/resources/faith-based-financing/the-three-islamic-home-finance-models-musharaka-murabaha-ijara.
[20] Office of the Comptroller of the Currency, Interpretive Letters Nos. 806 & 867 (1997 & 1999).
[21] See El-Gamal, supra note 3, at 56.
(Suggested Bluebook citation: Robert Shepard, Navigating the Prohibition of Ribā in the Modern Islamic World, Islamic Law Blog (Jan. 14, 2025), https://islamiclaw.blog/2025/01/14/navigating-the-prohibition-of-riba-in-the-modern-islamic-world/)
(Suggested Chicago citation: Robert Shepard, “Navigating the Prohibition of Ribā in the Modern Islamic World,” Islamic Law Blog, January 14, 2025, https://islamiclaw.blog/2025/01/14/navigating-the-prohibition-of-riba-in-the-modern-islamic-world/)