P L d 2000 s c 225 (Riba prohibition stayed)

 

 

 

As trade and industry developed after the 11th Century, the more rigorous application of the doctrine of prohibition of usury started being replaced by this differentiation between usury and interest. The Latin noun Usura means the use of any thing, in this case the use of borrowed capital, hence usury was the price paid for the use of money. On the other hand the Latin verb Intereo means “to be lost”; a substantive form Interesse developed into the modern term interest. Interest was not profit but loss. To claim usury was to demand a return for the use of money, which remained illicit, to claim interest was to demand compensation for loss which the lender suffered by depriving himself in various ways which became licit. This compensation for loss is now called opportunity cost of capital, which became a compulsive reason for the acceptance of interest. It is the development of institutionalized credit which rendered the differentiation of schoolmen obsolete, otherwise it is not possible to change them with sophistry at least in this context. The concept of opportunity cost of capital now seems to have become irrelevant in this age of institutionalized credit. It has become irrelevant because the need to differentiate between usury and interest is not so pressing outside the modernized Muslim elite as it was a few centuries ago. Now, the present interest is exactly what usury was claimed to be: i.e. payment of compensation or rent for the use of money. Towards the beginning of this century, a new justification was sought to give legitimacy to the differentiation between usury and interest, It was claimed that the reason for the opposition of the church to interest was because it was charged on consumption loans taken by the poor in their difficult days and the lender took unfair advantage of their need and charged them a rate of interest which was higher than what was ‘fair’. This `unfair’ rate was now termed as usury But what was fair and what was unfair and what was the logical or rational basis to determine the level of fairness, nobody bothered to answer Thus, interest was now confined to the ‘profit’ charged on loans advanced for productive purposes. It was claimed that since the borrower makes profit out of that loan he must share it with the lender. But this logic conveniently ignored that the lender should also share the loss to keep the balance equal.

 

 

 

The propositions that. borrower must, in every case, share his profit, and NOT the loss, with the lender who is not concerned with the fate of the enterprise, has been accepted without any effort to substantiate i;. The net result of all such propositions, the reprehensible character of usury and the fair character of interest, is passed from hand to hand as an accepted, authenticated and established truth. No one appears to have concerned himself with examining the propositions whose joining together produces this distinction. No one appears to have raised any of the queries which should have normally occurred to every one: Were loans granted for consumptional purposes only or mostly in earlier societies? Do modern societies mostly avail of loans for productive purposes? Is there any empirical evidence, any historical proof showing a remarkable excess of productive loans in modern communities as contrasted with a significant excess of consumption loans in olden societies? Is there any statistical verification that the rate of interest charged in modern times is significantly lower than the one that was charged in earlier societies? What is a fair rate of interest, by exceeding which its nature and nomenclature is charged from interest to usury? Do the really needy ever enter the money market? Did they ever do so at any time past? Is there any guarantee that a loan secured for a productive purpose will necessarily result in a reward to the entrepreneur in excess of the rate of interest which he pays for the loan? How does the exploitative element existing in consumptional loans form a different genus or specie compared to the exploitative element in a productive loan when interest is charged during gestation period of an enterprise, or even after it when the production of value made possible by the loan is lower than the rate of interest?

 

 

 

After raising these important questions, Professor Shaikh Mahmud Ahmad says that the distinction between usury and interest was made without any scientific study or empirical enquiry. No one appears to have deemed it essential to provide any kind of evidence in support of this assertion based on the half dozen contentions. The learned economist takes upon himself the onus of examining the questions raised by him and brings home the shaky foundations on which this hypothesis has been developed. Here is the summery of the findings of late Professor Shaikh Mahmud Ahmad about the illogical and arbitrary distinctions between usury and interest. At the outset of his discussion on the subject he says that some economists have tried to shift the responsibility of differentiation between usury and interest to the so-called sophistry of the schoolmen. However, the fact is that they were forced into it by the pressures of trade and industry. It was the existence of “extrinsic titles” which the church recognized worthy of acceptance which necessitated the employment of the word interest, signifying payment for the loss incurred in advancing a loan, as contrasted with usury which was payment for the use of money, and which remained unacceptable to church. The extrinsic titles are now called by a blanket name of the opportunity cost of capital. While there could be some justification for this differentiation by schoolmen, at the time when it was made, in view of the fact of individual lending and borrower being no less significant than institutional credit, the present day development of financial intermediaries as practically exclusive source of capital, has rendered “extrinsic titles” as completely irrelevant. The concept of opportunity cost which could have sanctioned the use of the word interest in place of usury is already an obsolete concept. The effort of economists to provide moral underpinning to the institution of interest with the help of an extinct notion is a variety of sophistry of which it is grossly unfair to charge the schoolmen.

 

 

 

While keeping the concept of opportunity cost at its back and call, economics has chiselled a whole set of reasons for differentiation between usury and interest. It advances the view that in earlier ages loans were advanced for consumptional purposes, to persons in straitened circumstances, and lenders took unfair advantage of their need and charged an unduly high rate of interest. This was usury and was rightly considered reprehensible. Interest `on the other hand’ is charge on productive loans. Since these enable the borrowers to earn substantial profits, there is no harm in the claim of the lender to demand  a part of these profits. This is interest and is entirely fair. This makes a list of half a dozen propositions whose joining together was ensured to seek support for this differentiation. Whether or not it is valid would hinge on how correct the various propositions adduced in its support happen to be. Professor Mahmud expresses his surprise when he notices that economics tends to shirk from examining in depth any of these propositions, and assertion and its repetition are regarded as adequate substitutes for inductive evidence. Economics knows and observes rules of the game which devolve on it as a social science, except when it has to deal with any issue relating to interest, and insistence on the distinction between usury and interest, without advancing a single sustainable evidence for its various contentions, illustrates how indifferent to reality economics can at times become. Since economics declines to advance proof for its contentions on the basis of which it differentiates interest from usury, Professor Mahmud Ahmad undertook to examine their postulates beginning with the claim that in earlier societies most loans were advanced for consumptional purposes.

 

 

 

Looking up the history of ancient societies and their economic picture it appears highly unlikely that consumptional loans could command the bulk of the credit market. For instance, Sumerian society was a busy commercial society. Seals unearthed from the ruins relating to the period indicate international commerce and many clay containing are business documents with ample evidence of credit transactions on interest, but there is no mention of consumptional loans. Similar is the situation of Babylonians who were essentially a commercial society. Most documents that have reached us relate to sales, loans, contracts, partnerships etc. These also indicate a highly developed system of finance. History attests to credit of both these societies being primarily related to commerce and industry, but there is hardly any evidence of consumptional loans. The prosperity of ancient Egypt was nurtured by import of raw materials and export of finished goods. Credit was so developed that written transfers, prepared by  scribes, available in markets, took the place of exchange of commodities or payment, something which is enough to indicate that credit was largely commercial. Similar situation prevails in the case of the other ancient societies including the Assyrians, the Phoenicians, the Arabians, the Indians and the Chinese. which fact confirms the chain that consumptional loans constituted the bulk of credit in ancient societies is not borne out by history. However, instead of reaching an indirect conclusion from the nature of economies of most ancient societies. if the specific history of the nature of loans prevalent in these ancient societies is checked up, one can directly find a confirmation of these results.

 

 

 

History gives ample evidence that earliest loans were those of seeds and animals. Although there is evidence of the existence of all varieties of loans, the first mention of extensive borrowing is made in connection with ship loans in Greece in 7th Century B.C. Productive loans appear to have become even more prevalent after 400 B. C. in Greece. We have some evidence of consumptional loans as well but these were seldom given to people in distress, but were given to the wealthy or average farmers to meet personal emergencies. Loans are stated to have been on the security of either cargoes, or pawns or real estate. Though loan sharks are mentioned in Greek literature but these are not characteristic of any ancient society as no modern society is free of this scourge. There were mitigating circumstances like free loans from temples which are no longer available. Records ofloans in Roman Africa indicate setting up of endowment funds by wealthy persons which advanced loans at 5-6 per cent. In 13th Century Europe consumptional loans were associated with nobility who often incurred debt and ruined. History, thus, appears to contradict both the assertions of economics that early loans were primarily for consumptional purposes and were given mostly to people in distress.

 

 

 

Misrepresentation by economics regarding the nature of loans is not confined to ancient societies but extends to modern age where, contrary to unimpeachable statistical evidence, it is claimed that most of the lending is for productive purposes. The factual position regarding present times is that in most countries belonging to the so-called free world, budgetary deficit of Governments alone exceeds more than one-half of the loanable resources of these countries. Checking the situation in this regard of just two countries, viz., U.S.A. and Pakistan, relating to the decade from 1974-83, Professor Mahmud reaches the conclusion that the above statement is more likely to be an under-estimate than an over-estimate. Unweighted annual average of budgetary deficit for 10 years in U.S.A. comes to 107.17 per cent. of the annual increase of demand and time deposits in the country during these very years. In the case of Pakistan unweighted annual average of budgetary deficit for the period 1975-82 works up to 64.98 per cent. of the annual accretion of total deposits in the banking system. A noteworthy feature of these figures is that the trend of deficit in both countries is virtually consistently in the upward direction This is not the only variety of consumptional loans which pervades the scene. Installment purchases, which involves 13.3 per cent. of disposable income in U.S.A. and is a significant entity in Pakistan as well, have to be added along with other consumptional loans like those covered by credit cards.

 

 

 

So far three of the basic ingredients of the argument of economics for differentiating usury from interest have been formed to have no objective reality. Neither the loans in earlier ages were for consumptional purposes, nor are loans in the present day for productive purposes, nor the implication that exploitation characterized earlier loans and creativity inheres in modern ones conforms to facts; nor was this the reason why Christian Church was opposed to interest and why it relented in its acceptance subsequently. The claim of economics that “almost all loans” in earlier societies were given to “people in distress” is a variety of gross mis-statement of which no discipline can feel proud. The mere fact that security of loan and its assurance of return along with interest has been the permanent consideration of every lender in all ages, immediately excludes the needy and the destitute from the money market. Even pawnbroking is not available to people below the level of moderate poverty. The nearest we come to distress is the case of emancipated peasants who mortgaged their lands to be able to work over them.

 

 

 

A cardinal postulate on which economics leans for its differentiation between interest and usury is the claim that in earlier societies loans were advanced at high rates of interest and were usurious, while a reasonable rate of interest is charged in the modern times. Though no one has defined the word “reasonable”, a study of interest rates in various ages becomes necessary for evaluation of the claim made by economics. Starting with ancient times and confining to the rates more often mentioned in particular contexts we find 20% the customary rate of interest for silver loans during Sumerian period in Babylonia, i.e. 3000 to 1900 B.C. Laws of Manu in India, in 24th Century B.C. set 24% as permissible level of interest. Code of Hammurabi fixed a limit of 20% for loans of silver, a legal maximum which lasted from 1900 to 732 B.C. and beyond during the Neo-Babylonian Empire. In Greece, the rate at the time of Solon (638-558 B.C) was about 16 per cent. and ranged between 12 and 18 per cent. during the time of Orators in Athens. Twelve Tables about 443 B.C. fixed the maximum rate at 8-1/3 per cent. The Greek temple of Delos charged 10% on all loans. In Egypt after 300 B.C. one finds repeated mention of “normal” interest rate of 12 per cent., which was regarded legal and maximum by Roman Emperors. The Code of Justinian (6th Century A. D.) declared 12 % as exorbitant and reduced it to the range of 4-8 per cent. It is for us now to compare the maxima and the minima of ancient times with those of the present days and decide whether there is any difference of the magnitude which can justify the coining of two different names for payment for the use of money.

 

 

 

Early middle ages are marked by controversy about usury and by diverse methods of avoiding it, including partnerships, annuities and triple contracts these last were also called “5 per cent. contracts”. The information about interest rates during this period is relatively scarce, partly because of usury laws and partly because of disturbed conditions in Europe. These factors also operated in some measure in the case of the Islamic World. Though, in the early middle ages, Byzantine commerce could raise money at the moderate rate of 8 to 12 per cent., which was lower still in 10th Century, it was not usual for the rest of Europe. During the 12th Century the rate varied from 8 to 20 per cent. at various periods and places, except for 43.1/3 per cent. charged by Jews in’ England. /During the 13th Century even more fanciful rates were charged by Jews which sometime went up to 300 per cent. Because of widespread dissatisfaction with such high rates, various States fixed maximum limits beyond which would be deemed usury. These varied from 15% in Milan to 10% in Verona. In the fourteenth Century except for loans to princes which commanded 30 per cent. interest, loans could be secured around 15 % . Long term Government loans paid only 5 % . In the 15th Century Montes Piatatis were established which helped lower pawnshop rates to 6 per cent., 5 per cent. became the standard on triple contracts. By the 16th Century Monies had developed into saving banks, and charged 8-10% from borrowers. Annuities were floated by Governments with return varying form 5 to 6 per cent. The trend towards low rate continued in the 17th Century and the discount rate of Bank of England reached 4% in 1968. Colbert, Finance Minister of Louis XIV reduced the return of annuities to 5 % and rates in Amsterdam varied between 3 and 4 per cent. Early middle ages indicate interest rates much higher than ancient rates, whereas the fall in rates during later middle ages lowers the level compared to what obtains today. None of these realities justifies the thesis of economics regarding high rates in ancient times and low rate in modern times. In the Eighteenth Century. England, the Government emerged as the chief borrower, mainly for war purposes. The yield on bonds, which were mostly of the form of perpetual annuities, varied from 3.50 to 6.57 per cent. Usury limit applied on all other loans, which was 6% at first and 5 % later. In France, 5 % is the commonly mentioned rate, particularly in connection with perpetual annuities, but when opportunity presented itself 8-1/2  per cent. became the ruling rate. There were no usury laws in Holland and yet the rate seldom exceeded 3 per cent. In Italy and Germany 5 % was considered normal for census annuities, though some times it fell to 4%. In U.S.A. 5% was regarded a suitable rate and 8% an exorbitant one. England witnessed in nineteenth century rapid economic growth and declining interest rates. Throughout the century yield on British consols kept falling till it was below 2 per cent. in the last decade of the century. Dutch long rates were generally higher than British long rates, reversing the position of earlier two centuries, which was reflected in the change in economic position of the two centuries. Situation was not dissimilar in Belgium, Germany and Switzerland, but in U.S.A., in spite of the declining trend of interest rates, these were almost always higher than the British rates and witnessed wide fluctuations.

 

 

 

The history of interest rates in the present century is remarkable for its wide gyrations. Between 1900 and 1975 we find the lowest and the highest interest rates of marketable credit instruments. For instance, in U.S.A. in 1964 best long municipal bonds sold to yield less than 1 per cent., whereas at the peak in 1974 commercial paper yields reached 12%. The change in interest rates in England, France and Holland is in identical directions. On this basis of this valuable fund of information, Professor Shaikh Mahmud Ahmad reaches the unmistakable conclusion that the  rise and fall of interest rates has an inverse co-relation with the rise and fall of nations. Sidney Homer illustrates this point with reference to several civilizations including those of Babylonia, Greece and Rome. In modern Western civilization, there has been identical fall till the middle of 20th Century and the consistent rise since then can only lead to eventual disintegration. However, that may be, the gyration of rates in this or earlier centuries does not support the thesis of overriding declining trend in rates to justify differentiating interest from usury. The only difference appears to be the widening of the band of fluctuations. We have had the lowest interest rates in this century, provided we exclude availability of free loans, at least partially, in some earlier societies. Simultaneously peak yields of 20th Century are well above identical yields of 17th, 18th and 19th Centuries. The statutory limit for small loan companies in U.S.A. exceeds the limits prescribed by Hammurabi, and even Manu. If we confine ourselves to exceptionally fanciful rates charged by Jews in the middle ages, loan sharks in U.S.A., according to a study made in 1933, charge anything between 240 to 1500 per cent. per annum. Whatever rate of interest we look into from the prime to the Government long one, or the consumptional to the statutory one, 20th Century appears ahead of all earlier ages and epochs. Therefore, the entire basis of differentiation between usury and interest, so far as the level of rates is concerned has no legs to stand upon.

 

 

 

The differentiation of interest from usury as already noted is predicated by economists upon six main postulates. These are, firstly, that loans in earlier societies were mainly advanced for consumptional purposes and to people in distress; secondly, modern loans are largely advanced for productive purposes; thirdly, that the former category of loans is exploitative and the latter creative; fourthly, that this was the reason why Christian church was opposed to usury and eventually relented in favour of interest; fifthly, that interest in earlier ages was high; and, sixthly, that it is comparatively low now. Except the third postulate we have examined each one at some length and found them factually devoid of any basis. There is much to be said about the third postulate as well, but if we concede this postulate to economists, it will involve, in case it adheres to its logic, calling the present basis of banking as usury, as the loans are largely consumptional and advanced at rates which are among the highest in the entire history of interest rates. Applying the criteria of economists, if all loans are usurious today, then it is the responsibility of economics to point out the exact location of that interest which it is trying persistently to differentiate itself from usury.

 

 

 

There are two more fundamental questions, overreaching the flimsy and false postulates of economics, relating to differentiation between interest and usury, to which no attention appears to have been paid. Firstly, what is the principle which governs the differentiation between the two, and secondly, what exactly is the level at which one ends and the other begins? The late economist only amplifies these questions and leaves it to those who regard this differentiation as legitimate to answer these. He finds variations in the level of usury both during the middle ages and at present between various States of U.S.A. How exactly malevolence of usury shifts to benevolence of interest when one crosses a specific limit by even a fraction of 1 per cent., or even while sticking to the same limit by merely crossing over a specific boundary, or while sticking to the same limit and the same location by merely crossing a particular date in a particular year; or finally how does the same rate at the same time and at the same pace becomes benign in one case and malignant in the other?

 

 

 

This so-called differentiation between usury and interest is not comparable to the one between profit and profiteering and rent and rack-rent because there  are principles which govern these differentiations. The absence of a comparable principle in the case of usury and interest is very much like the absence of any categorization among various degrees of blackmail, or adulteration or murder. If this categorization is to be retained evolution of a fundamental principle would be necessary. It is possible to argue that though the basis of differentiation between interest and usury projected by economics may be unsustainable the differentiation may yet be valid for other reasons. In this, context erosion of the value of money during the period of a loan is sometime advanced as a cogent argument. Although the question of inflation has been separately dealt with at length in this judgment, we may see at this stage what Prof. Mahmud has to say on this problem. According to him, if inflation were historically an inseparable appendage of our economy the argument would be an unanswerable one. As it is we who have inflicted it upon ourselves through expansionary fiscal and monetary policies in order to restrict unemployment, instead of eradicating it by adopting the remedies suggested by the economists, particularly by Keynes. If inflation has emerged on account of our mishandling of the economy dictated by our desire to retain the institution of interest, we cannot now turn round and project this as an argument for perpetuation of the same exploitative institution. If interest is the cause of inflation, it cannot now be used as its cure.