Chapter 3

Impact of Riba
1. Social Impact of Riba
a. Interest makes a man selfish and
miser;
b. It creates hostile relation between the
rich and the poor;
c. Moral decay spreads out in the society
2. Economic Impact of Riba

Impact on Savings, Investment and

Production
Interest hindrances the flow of
savings and formation of capital
It is assumed that if the rate of interest goes
up the amount of savings also goes up
Now, if rate of interest is up > savings goes
up>consumption exp. goes down> demand
for goods also goes down>sales goes down>
revenue/profit decreases> savings /inv.
decreases.
Again, Int. up> price of goods goes up>
consumption exp. goes up> Inv./ savings fall
down.
Interest discourages the
amount of Investment
According to Keyns, if the rate of int. goes
up then the entrepreneurs feel
discouraged to borrow > amount of
investment goes down.
If the rate of int. goes down then people
feel encouraged to borrow more >
amount of investment goes up.
Interest hindrances the flow of
savings and formation of capital

Keyns advocates for '0' interest rate to

increase savings and investment.
According to Keyns,
Total income=Total consumption exp. +
Total investment expenditure
Interest reduces the marginal
efficiency of capital

Interest reduces the marginal efficiency

of capital and it rapidly goes down to
the point where marginal efficiency of
capital equals to the rate of interest. At
this point investment is stopped.
Interest creates deficit of capital
 Entrepreneurs can not invest in project where
rate of return is less than the rate of interest.
So, no fund become available to invest in
such projects.
 According to Umar Chapra,
Interest+Profit =Total Income
 Now, as the rate of interest goes higher and
higher the profit of the entrepreneur goes
lower and lower and sometimes he makes
loss. As a result capital is reduced.
Interest diverts investment into
speculative sector

 Investors prefers
a. more profitable
b. less risky and
c. quickly recoverable sectors of
investment like buying govt. security,
discounting bills, and other speculative
sectors. As a result crisis mounts in
productive sectors.
Interest encourages artificial
crisis in financial sector

 The bankers and other lenders of

money hoards money to increase the
rate of interest by creating artificial
crisis in the money market
Interest reduces long term, risky but
most desirable investments

 gestation period of long term investment

which further aggravates the burden of
interest
 makes it difficult to service debt and
 sometimes make the entrepreneurs bankrupt.
So, Investors often feel discouraged to invest
in such projects by procuring fund from
interest based sources.
Interest creates idleness among the
savers:

 Interest creates idleness among the

savers:
 As the lender is to an extra certain
income, he feels discouraged to go for
any laborers or risky venture.
Interest reduces overall production

 In an interest based economy

investment stops where marginal
efficiency of capital equals the rate of
interest.
 If, for example, the rate of interest
would have been zero, the amount of
invested could be extended until the
marginal efficiency of capital was zero.
So, interest hindrances production to
reach its maximum point.
Int/
profit

10%

ARR

0
Amount of investment
2. Economic Impact of Riba

Impact of Riba Factors of

Production Distribution and Price
level
Interest increases unemployment
 As interest reduces the amount of
investment so the number of
unemployed people also increases
Interest increases exploitation
of labor
 As unemployment increases the
demand for labor decreases but supply
of laborers increases. Hence the
laborers got least bargaining power. So
they are to be exploited by selling their
lobor at a price less than normal.
Interest creates monopolistic
opportunity for the capitalist

 Capital never share losses. The income

of the lender bank or individual is
always certain. So their income goes up
day by day inspite of a debacle in the
economy. So, wealth concentrate within
few hands.
Interest impose unnecessary
burden on organization

 If the rate of return from the project is

less than the rate of interest then the
entrepreneur is in danger.
 The entrepreneur is getting nothing for
his time and labor. Again he/she has to
pay the lender the due amount of
interest from his own pocket.
Interest deprives land from its
due share

 Due to reduction in the investment the

demand for land also decreases. So
they do not get standard rent. Again
the small land owners often compelled
to sell their land to repay the interest
overdue because of crop failure or some
other reason.
Interest reduces income of the
depositors
The depositors often dry up their
interest received in the form of buying
with higher price.
 Interest Concentrates wealth in the few
hand through public finance
Govt. often borrow from banks or
capitalists for i) welfare exp ii) to meet
the exp. of war etc. Ultimately the govt
imposes tax on general member of the
public to repay the loan with interest.
Interest increases the price level
Interest as a fixed cost is added to the
cost of production. As the cost of
production goes up the price of the
product also goes up.
 Interest decreases the demand for
goods
By increasing the price level interest
reduces the purchasing power of the
people. Asa result demand for goods
and services also decreases.