For Muslims, the questions around Riba are focused at the level of the individual because we want to know what we can and cannot do. This post looks at the broader societal issue. The conclusion is that riba and the business of lending can increase economic inequality between different segments in society.
Assuming an Islamic state has an overriding need to address economic inequality - it cannot accede to the provision of credit in a manner that we are used to in the West.
What is interest?
This may seem obvious. but it's worth exploring since the result can generate new insights.
Interest is a price charged by a lender to compensate them for not having the use of the money that they are lending.
Interest can also be compensation for the fact that the money they have lent will be worth less in the future than today because of inflation
Interest can also reflect a premium charged by the lender in order to account for the fact that some borrowers will not pay them back. The interest charged to the individual borrowers can vary because they vary in terms of their risk to the lender. Less risky borrowers are charged less and riskier ones are charged more.
The last point is not immediately obvious to everyone it is important however and we shall come back to it.
Access to credit
In a free market, there are all sorts of lenders (e.g. seeking different levels of return and willing to take different levels of risk) and all sorts of borrowers (e.g. those with good 'credit scores vs. those with poor ones). Those with a good credit record can borrow more and more cheaply than those with a poor record. This may be because those with a good record have a history of making repayments on time and so on. And this is where we have our first macroeconomic effect.
People who are poor and find it difficult to buy food and pay rent will invariably find it hard to keep up with their debt payments and if they don't pay their creditors on time, they will have a bad credit record. As a result, either they will not have access to credit at all or if they do, they will have to pay a higher price for it (a higher level of interest). This sounds crazy, but it is true. Credit is one product where the poor will generally pay more than the rich and it is certainly a product where those who need it to survive (rather than buying luxury goods) may not have access to it at all.
Therefore in a society where there is credit, there are two mechanisms by which social inequality is increased, lack of credit to the poor and expensive credit where it is available. There is a third mechanism by which inequality is increased. If rich people have access to credit and the poor do not, the rich may bid up the prices of assets so that they become even more unaffordable to the poor. A real-life example of this is the UK property market, at the time of writing this post. Many young people are 'priced out' of the UK housing market because people with access to credit (e.g. investors) have bid up the prices of property.
Materialism and credit
A further reason why inequality is increased is that people are encouraged (as consumers) to buy things today and pay for them tomorrow. Over the period they borrow money, they pay interest. The assumption here is that the 'joy' they get for the chance to consume something earlier than they otherwise would have done compensates for the reduced consumption that they will have in the future. They will have reduced consumption because in the future their income will be paying interest for their previous consumption.
There is an important principle here. Such an approach to materialism has the following implications. This is a single-period gain. Because the only way you can keep doing it is to keep building up your debts! And at some point in the future, either you go bankrupt or the lender loses their capital or taxpayers' money is used to bail out both you and the lender. A materialist culture, therefore, combined with a system that makes credit easily available, rewards those people who have capital for pandering to the materialistic needs of the consumers but not much else.
No easy solutions
It would, however be naive to believe that the solution should be that lenders make credit available to all and at e.g. similar rates of interest. As we saw above interest performs a number of functions and one of these is to compensate lenders for risk. If lenders are forced to lend to the poor and at interest rates lower than they would normally offer, this may lead to losses for them.
There is another reason why there are no easy solutions. If someone has poor financial circumstances, then offering them more credit and associated interest payments could add to their problems rather than improve them. Credit unions, which do not seek to make a profit and are run for the benefit of their members offer a partial but not a complete solution.
Involvement of the State
If the market is unable to lend without increasing inequality then we must consider the role of the State, the criteria it uses to make loans and how it manages demand if interest is not a pricing mechanism that it wishes to use. This may seem radical and an intervention that is far too statist and dirigiste some might even describe it as socialist or even communist.
To put the above into context it's worth considering the role of the State when it comes to regulation of finance. It is notable that Martin Wolff a columnist writing in the Financial Times (the UK financial industry's newspaper) says:
He arrives at this conclusion via an analysis of financial crises and not via the lens of inequality that I have used.
It's worth examining some of the points that Wolff makes, they are widely considered to be true:
This is a perennial issue, high levels of regulation stymie the returns that the financial sector can make and there is subsequently a call from economic liberals to remove the 'shackles', a new problem then arises, bailouts are needed and accompanied by new regulation.
the latter being justification for a bailout.
So state intervention in the financial markets is not an anomaly in a wholly capitalistic system. At the moment such intervention is justified given the damage that a bank run would cause for the whole economy.
It's not outrageous therefore that if the welfare of the poor is considered to be important, the availability of credit for them and the terms of such finance should be of concern to policy-makers.
Practicalities of intervention
One way of arriving at a solution is to consider why people need loans in the first place.
It is clear that sometimes people need to borrow money to increase their earning power. Loans for such purposes are obviously a 'good thing'. This is one end of a spectrum and the State should intervene to provide such loans at 0% interest, thus making them completely halal. However, an effect of such intervention could be to encourage training providers to raise prices, so where government is effectively subsidising a sector it may also need to intervene in terms of the prices it is willing to pay. The same applies to goods such as medical services.
Buying a car. Now we are moving along the spectrum, is the car for enjoyment or for work? And if it is for work, how blingy or spartan is it? The latter could attract state funding, but the former is less likely to do so. For enjoyment, people should be educated to understand that there is no alternative to saving up.
And what about those who have capital?
My understanding is that having capital is not a problem in Islam. Lending it for interest is a problem. But that is not the only productive use that capitalists have for their capital. They can own shares in enterprises and receive dividends for their risk capital i.e. the profit or dividends they make depends on the risk that they take. Such risk-taking can be inherently more productive than lending capital for interest. It can be applied to the development of new technologies and industries - rather than pandering to the materialist interests of consumers or indeed increasing such materialistic interests.