How Large is Riba in Islamic Banking?

Direct Answer: In its theoretical and legal (Shariah) form, Riba is precisely zero. The entire purpose of Islamic banking is to eliminate Riba. However, in its economic substance and practical operation, the industry faces ongoing criticism and challenges regarding its closeness to conventional finance, leading some to argue that the *effect* of Riba is not zero.

1. The Theoretical Foundation: Riba is Prohibited

Riba, often translated as "usury" or "interest," is strictly prohibited (Haram) in Islam. The Quran explicitly forbids it. Islamic banking was created as an alternative to the conventional interest-based system.

Instead of lending money for interest, Islamic finance is built on the following principles:

Profit-and-Loss Sharing (PLS): Models like Mudarabah (profit-sharing) and Musharakah (joint venture) where the bank and customer share the business risk and rewards.

Asset-Backed Financing: Models like Murabaha (cost-plus sale), Ijarah (leasing), and Salam (advance payment for goods) where the transaction is tied to a real, tangible asset.

Prohibition of Gharar (Excessive Uncertainty): Contracts must be clear and transparent, avoiding speculative risk.

2. The Practical Reality: The "Benchmarking" Controversy

This is where the core of the debate lies. While the *contracts* are structured to be Shariah-compliant, the *pricing* often mirrors the conventional interest-based system.

The Dominance of Murabaha and the Use of Benchmark Rates

A large portion (often estimated at 70-80%) of Islamic banking assets are in debt-like instruments, primarily Murabaha. Here's how it works and where the controversy arises:

A customer needs financing to buy a car. Instead of giving a loan, the bank buys the car and sells it to the customer at a higher price, payable in installments. This is a trade-based transaction, not a loan, so it is Islamically permissible.

However, how does the bank determine that higher price? In practice, it is almost universally calculated by using a conventional benchmark interest rate, such as the LIBOR or its successor (SOFR, etc.), plus a profit margin.

The Criticisms:

Economic Substance Over Legal Form: Critics argue that if the final cost to the customer is "LIBOR + 2%," the transaction is economically identical to an interest-based loan, making it a form of "legal trickery" (hiyal).

Lack of True Risk-Sharing: The profit rate in Murabaha is fixed and not tied to the actual performance of an underlying business venture, which contradicts the ideal PLS spirit of Islamic finance.

3. Quantifying the "Size" of Riba

We can look at this in two ways:

Perspective	Assessment of Riba's "Size"	Explanation
Shariah-Compliant Perspective	0%	Every product and contract is vetted and approved by an internal Shariah Supervisory Board. Since the legal structure avoids a loan-for-interest and involves an asset, it is considered free of Riba by definition.
Critical / Economic Substance Perspective	Significant (e.g., 70-80% of assets are "Riba-like")	From this view, the widespread use of benchmark rates and the dominance of fixed-return, debt-like products (Murabaha, Ijarah) mean that a vast majority of the industry merely replicates the conventional system in form, not in economic spirit.

4. The Industry's Response and Trajectory

The Islamic finance industry is aware of these criticisms and is actively working on them.

Development of Islamic Benchmarks: Some countries (like Malaysia and Bahrain) are developing their own Islamic interbank benchmark rates based on actual returns from Islamic banking transactions, to replace LIBOR.

Push for More Profit-and-Loss Sharing: There is a strong scholarly and intellectual push to develop more PLS-based products to move the industry closer to its ideal form. However, these are riskier for banks and require more sophisticated risk management.

Emphasis on Ethical Screening: Even with the benchmarking issue, Islamic banks still differ from conventional banks by ethically screening their investments (avoiding alcohol, gambling, pornography, etc.), which holds value for many clients.

Conclusion

The "size" of Riba in Islamic banking depends entirely on the lens through which you view it.

Legally and Formally: It is non-existent. The entire system is structured to avoid it, and for the vast majority of its customers and scholars, this compliance is what matters most.

Economically and in Substance: A strong critique argues that Riba's influence is very large, as the industry's pricing mechanism is deeply entangled with the conventional interest-based system it was meant to replace.

Therefore, while the legal form of Riba is 0%, the practical and economic effect of interest-rate benchmarking is pervasive, creating a significant gap between the industry's ideals and its current reality.