There is a common misconception among Muslims regarding interest being prohibited.
First of all, Islam prohibits usury, not interest. Secondly, one needs to differentiate between usury and interest.
- S: (n) interest (a fixed charge for borrowing money; usually a percentage of the amount borrowed) “how much interest do you pay on your mortgage?”
- S: (n) usury (the act of lending money at an exorbitant rate of interest)
Interest is normally charged on lending of capital (or other goods) which have become overdue and directly cause expenses to be incurred by the lender. The interest usually also takes inflation in to account. An example of this is a movie-store charging you late penalties (interest) at a fixed-rate for overdue movies: if you do not return the movie(s) on time, the store is at a loss because that inventory-asset(s) could’ve been rented to others to generate revenue. The interest covers up the loss incurred by the lender for your failure to repay on time (or failing to fulfill your contractual obligations). Usury, however, occurs when an entity intentionally sets up an environment where it can profit from lending to others. An example of this are the credit card companies (at least in N.America): they will lend you money to acquire goods & services, after you’ve agreed to their terms that if you do not pay your due amounts on time, you are willing to pay an (exorbitant; very high) interest accrued to your principal (borrowed) sum. The current interest rate on credit cards is 18.5%. The unreasonable interest rate covers not only the loss incurred by the lender (simple interest), but also produces a profit (usury). This is the vital difference between usury and interest. Interest is an essential constituent of economics, and must be used to retain proportionate homology when taking measures such as inflation in to consideration. For example: your friend lends you $1, in 2005 (an amount which could purchase 1 can of coke at that time), with mutual consent between both parties that you will return the sum in one year. However, you fail to return the due amount on time (in 2006), and decide to do so 25 years later, in 2030. Due to inflation, a can of coke now costs $5, meaning that the value of $1 of 2005 is now (in 2030) equivalent to $5. Will you pay your friend back $1 or $5? Interest is used to maintain the value of currency, taking in to consideration economic measures such as inflation; the amount may increase, however, the real value remains the same. Usury alters the value.
The reason why usury is forbidden in Islam is because the unscrupulousness of this practice causes the lender to become powerful and the lendee, a slave. A colossal example of this is the Federal Reserve system in the United States of America: a private bank based in United Kingdom owns the US dollar, and loans it to the American government at an exorbitant interest rate (usury); as a result, the US government is always in a perpetual system of ever-increasing indebtedness, and the power of the government is influenced (and in many cases actually) aggregated in to the hands of a few private individuals.
Earlier in the 2000’s, Musharraf’s government had expelled organizations such as the IMF from Pakistan by repaying loans on time and deciding not to borrow any more, due to the exorbitant interest rates on IMF loans. When PPP government took power recently, the first thing that Zardari and Gilani did was to go around the world and beg everyone for loans. The IMF is back in Pakistan, and now that we have once again borrowed from them, they dictate our economic policies. In this scenario, some of our sovereign powers have been aggregated in to the hands of IMF, and GoP (and the people of Pakistan) have become the slaves. This is why usury is forbidden in Islam. The same thing happens in Africa today, which explains their pathetic state of affairs. The lender becomes wealthier, and the lendee, poorer.