Money cannot be loaned to another human being for a profit (i.e. interest) regardless of whether it is a loan, mortgage, credit card, bonds or any other financial service. Money should only be a medium of exchange; a tool to enable buyers and sellers to settle transactions. It is not meant to be an industry unto itself.
Something has to be done about banking; not just the banks. The 2008 Financial Crisis, the ensuing ~$14.4 trillion bailout (see graphic below) and rise of Occupy Wall Street movement, has made it easier to discuss the problems of interest and banking as a whole. In the wake of these events, most agree that something needs to be done about the banks. Some politicians, such as Bernie Sanders, have called for break up the banks, while others feel they just need more regulation. Interestingly, even the financial institutions themselves realize there is a problem. They are paying billions to comply with the post crisis Dodd-Frank legislation because they feel it will make the "banks stronger". Although there's muted protest against complying with the legislation, they realize they have to do something to win the hearts and minds of the public who in fact hate them.
Why doesn't regulation work? Regulation has failed to work in the past and it will likely fail in the future. Banks ultimately work to dismantle crisis era legislation when times are good and the crisis has long passed. For example, the current crisis owes its existence in part to the 1999 repealing of the Glass-Steagall (GS) Act which was passed in the wake of the Great Depression to regulate the banks. Consequently, we can expect any current legislation to be repealed in the future. The following illustrates the cycle that predictably will lead to the next economic crisis:
Banks resist regulation because regulation inhibits their freedom. The then senator Phil Gramm justified the repealing of Glass-Steagall in the name of freedom:
"...we have learned that government is not the answer. We have learned that freedom and competition are the answers".
As long as the bankers believe in freedom, they can be expected to repeat the cycle between regulation-deregulation-crisis.
Why does the system go into crisis? It's the "magic" of compound interest. Interest grows exponentially and inevitably outstrips the productive capacity of the economy. The late economist Magrit Kennedy points out that "one penny invested at the birth of Jesus Christ [peace be upon him] at 4% interest would have bought in 1750 one ball of gold equal to the weight of the earth". Similarly, Prof. Michael Hudon nicely summarizes the problem of interest versus the real economy:
"The political fight in nearly every economy for thousands of years has been over whose interests must be sacrificed in the face of the incompatibility between financial and economic expansion paths. Something has to give, and until quite recently creditors have lost. This is the point that modern economists and futurists fail to appreciate. Financial claims run ahead of the economy’s ability to produce and pay...When indebted economies and their governments cannot pay, bankers and investors call in their loans and foreclose."
Where can we find this to be happening today?
In India, where the 300,000+ farmer have killed themselves. These farmers pay "interest at rates anywhere between 36 and 60 per cent" and are unable to keep up with the mounting debt, thanks to compound interest. So they opt to kill themselves instead rather than face the shame of excessive indebtedness.
Re-instituting colonialism. The other area where we can clearly see the dangers of interest are the loans made to the third world. These loans quickly mushroom thereby enabling the wealthy to siphon more and more money away from these poor countries. According to the New York Times: "Nigeria...borrowed $5 billion, has paid back $16 billion and still owes $32 billion on the same debt". So a $5 billion debt results in ~$50 billion of wealth being transferred from a "former" colony to "former" colonizer(s).
Historically, interest has not worked out. Previous civilizations realized the unsustainable nature of interest. Such civilizations actually used to cancel debt to prevent the complete subjugation of the poorer classes. For example, when the Babylonian King Hammurabi died in 1749 BC his successor "Samsuiluna, cancelled all debts to the State, and decreed that all tablets should be destroyed except those concerning traders’ debts". These debt cancellations were routine until 1400 BC after which there was increased inequality and social upheaval illustrating that historically interest has not worked out so well.
Islamic perspective on interest: One of the most famous Islamic Economic policies is the prohibition of interest as evidenced by demand from Muslims for alternatives to mortgages and other interest bearing loans. There are many verses and hadith that indicates its prohibition. This verse indicates how severe it is to deal in interest as it invites a war from Allah (swt) and His Messenger (saw):
“O you who believe! Observe your duty to Allah, and give up what remains of your demands for riba (interest), if you are (in truth) believers. And if you do not, then take notice of war (against you) from Allah and His Messenger. [TMQ 2:278-279].
Given that you can't make money of loans what can you do with them?
In a sense, Islam re-categorized loaning from a commercial activity into act of charity. For example, if you extend a loan twice to a person it counts as a charity:
“No Muslim would give another Muslim a loan twice, except that one would be written for him as charity.” [Ibn Hibban]
Quite a contrast to payday loans! Payday loans effectively penalize serial borrowers with interest rates "typically... between 300% - 900% and, not infrequently, more than 1,000%".
Consequently, loans is more about helping a friend or family member out. As for expanding a business, entrepreneurs can achieve this by partnering with individuals/groups who have capital.
In terms of people getting into debt, this largely happens due to unfortunate circumstance. In Islam, debt is not a way to prop up a consumer economy, but is something that each individual tries to get out of as fast as they can. In fact, Prophet Muhammad (saw) used to pray to be free of debt:
"O Allah, suffice me with what You have allowed instead of what You have forbidden , and make me independent of all others besides You." [Tirmidhi]
Of course there are situations where the real hard done by will fall behind in their debts. So what happens to them? They are actually eligible for a "bailout" if you will. To be more specific they are one of the few categories who are eligible for zakat (2.5% asset tax) that is collected from those who have wealth saved for a year or more above a certain threshold (i.e. the nisab).
Both the zakat and partnerships will be explored in future posts, in sha Allah.