Loan Interest in the Modern World

Introduction

The Torah's prohibition on taking interest is well known. Seen by Chazal as a stealthy form of robbery,[1] one may question whether seeking ways to circumvent the issue is similar to finding ways to give a hechsher to pork.

Nevertheless, not only are leniencies found and implemented widely, but there is very little opposition to them. I have yet to see any recognised poskim who have rejected 'Heter Iska' (the mechanism used to evade the prohibition of interest) outright, although some impose certain limitations.

The reason for this is clear. World business revolves around interest. New discoveries and technology often need substantial funds, which could not be raised by generosity alone. The same is true on a smaller scale for private businesses.

Perhaps more critically in some eyes, most individuals in Eretz Yisrael also need to make use of heter iska when they take a mortgage on a home (if the loan is from a 'Jewish' bank). Even for those who don't, avoiding heter iska entirely is almost impossible. Almost every contract signed with a bank or other service provider contains clauses that involve the possibility of paying interest, halachically problematic even if it never ends up being paid.

The most fundamental question that needs to be addressed is whether ideally we would like to change all of this, and abolish interest payments entirely. Secondary issues are the validity of heter iska itself, and whether better alternatives could be found for those interested in the world as it is today.

Iska

Before we attempt to answer these questions, we need to describe the way that Chazal proposed to invest money for profit. If one person has a business idea but is short of capital for it, he can enter a partnership with an acquaintance who has the money. Both will take a share in any profits, but both will also have to absorb a share of any losses. As the 'borrower' is the one doing the actual work, he must be paid for this. Subsequently, his share in the losses must be lower than his share in potential gains.[2]

The halachic mechanism that this is based on is known as an iska. Part of the money is taken as a loan, and this part must always be paid back in full with no interest. The other part is a deposit and not a loan.[3] It remains the property of the investor, and profits or deficits made on it are his.

For example, the agreement could be that half will be a loan and half will be a deposit, and the payment the borrower receives for his time could be 10% of the profits. The net result is that the investor receives 40% of the profits, but must absorb 50% of any losses. If he doesn't want to take such a big risk, he could agree to take just 5% of the profits, or 10% of the losses (90% loan and 10% deposit, with 5% of the profits as the fee for the borrower's time).

The major difference between this system and loans with fixed interest is the risk factor for the lender. With a pure loan, the only risk involved is the potential inability of the borrower to pay back. The debt itself will always remain fixed, and can only be completely lost if the borrower dies or is bankrupted.[4] Even this risk can be decreased dramatically in the case of a mortgage.

With an iska, the 'lender' is really an investor. He enters into a business partnership with the 'borrower,' and if he has any sense he will only do this if he has great confidence in his partner. He may lose a large percentage of his investment, although he also has the potential to profit without limit.

In a world that only had iska arrangements and no loans with interest, one great advantage would be the care that people would have to take before investing. Worldwide financial crashes would probably not exist. Large companies would also have no incentive to exploit the more vulnerable by persuading them to take loans that they can't afford.

The possible disadvantage is that the hugely increased risk factor would mean that investors would not be nearly as free with their money. A person who does not have the funds to buy a house outright would not be able to take a mortgage as we know it. Payments of any money 'lent' for the house would be dependent on the property price, and such risk would make it impossible for banks to offer 50% mortgages.

I say that this is only a possible disadvantage, as lack of availability of mortgages would also drive house prices down. I invite the economists out there to describe more fully and clearly what all the results would be.[5] At the moment, I am unconvinced that the world with loan interest is better than it would be without.[6]

Heter Iska

However, this doesn't mean that we can ignore the situation around us. Whether we like it or not, the financial world of today revolves around interest. If only religious Jews stopped using heter iska, they would not get most of the benefits described above. We need to explain how heter iska works, and try to clarify when it can be used.

Heter Iska is an extension of the Iska principle described above. Let's say that someone needs a loan of twelve thousand shekel to start a business, to be paid back over a year. The lender wants total interest of 5%, so the twelve monthly repayments will be 1,050 shekels each. A similar result could be achieved by an iska, if for example the agreement is that the lender/investor takes a third of the profits, and the actual profit made by the business is 15%.

Obviously, the problem is that no business can guarantee to make a profit of 15%. Furthermore, the business could also lose money, in which case the investor would have to agree to absorb more than a third of the losses (let's say 50%). How can we come to arrangement when the lender does not want this risk (the normal situation)?

Heter Iska takes advantage of the fact that the amount of profit (or loss) made by the receiver of the money is often not provable. The two sides agree to an Iska with an additional agreement, that if the receiver cannot prove the contrary, the assumption will be that he made a certain profit (in our example, this would be 15%). Furthermore, any proof brought will only be valid if the receiver is willing to take an oath to ascertain the truth of his claim.[7][8]

The assumption is that given such conditions, the chances of the 'borrower' being able to prove a loss or a low profit are minimal. Thus under normal circumstances, the 'iska' will yield the same result as a loan with interest. Nevertheless, as I mentioned before, it is hard to find any condemnation of this as halachic trickery.[9]

I believe that heter iska is generally accepted because a situation where the investor loses out shouldn't really be that far-fetched. In some cases the 'borrower' is a company whose income and expenditure are meticulously recorded, and verified by auditors. It is true that even in these cases, the investor may be able to claim that a small element of doubt exists, and insist on the receiver taking an oath. But what if the receiver is willing to take an oath? And what if the investor believes the receiver?[10]

Theoretically, these cases are the ones that save heter iska from a halachic perspective. However, practically they could destroy its effectiveness. An honest investor who understands how heter iska works will be concerned at the fact that his profit is by no means guaranteed. As with other investments, he may well lose.

What actually happens?

The reality is that even when heter iska is used, the investor losing is unheard of. Whether cases have been brought before batei din or secular courts, the rulings have been similar. Although usually the validity of the heter iska itself has not been questioned, the courts have always found technical ways to reject the claims of the 'borrower' who suffered a loss. Such borrowers have even been criticised for trying to find excuses to get out of paying interest, and causing chilul Hashem!![11]

The reason that this happens is clear. If the borrower could avoid paying interest in these circumstances, the banks would soon stop using heter iska. 'Kosher' banks would not be financially viable, a situation that nobody wants.

It is hard to say whether this means that heter iska nowadays is null and void. Not enough has been written, either by batei din or by secular courts, to clarify exactly how it is viewed. Therefore my position is that although using heter iska is far from ideal, we cannot forbid it outright. Alternatives should always be pursued, but if there are none, those who need to use heter iska (i.e. almost everyone in Eretz Yisrael) are not transgressors.

To be continued

I still need to discuss possible alternatives to heter iska, and how we might be able to work to improve the situation. However, doing this now this would make this post too long, so it will have to wait for next time.

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[1] See Bava Metsia 61a (the question of Rava there is difficult and not necessarily agreed upon, but at least after the Torah forbade taking interest it is considered equivalent to robbery).

[2] Bava Metsia 68b (see Rashi there).

[3] Bava Metsia 104b

[4] Under secular law. In Torah law, bankruptcy never absolves the borrower from paying (although it can delay payment until he is able to survive paying).

[5] I publicised this question here, but as yet the answers I have received are not sufficient.

[6] See also this article (in Hebrew), which concludes that is impossible to calculate which system would be better economically.

[7] Historically, many people were scared to take oaths even when they knew that they were telling the truth, and even when money was at stake. See the Ramban's critiques to Sefer Hamitzvos, Mitzvas Asei 7.

[8] See Terumas HaDeshen siman 302, the earliest source of such an arrangement (fifteenth century).

[9] See Shu"t Minchas Shlomo 1:26-8 where R' Shlomo Zalman Auerbach raises various problems he has with heter iska, but nevertheless states that he does not doubt the legitimacy of it at all.

[10] Another potential problem is that many loans are taken out to cover costs of non-profitable items. A mortgage on a home can definitely be considered an investment, whereas a loan needed to buy a car certainly cannot. This problem is circumvented by writing in the contract that the loan is also for the purposes of maintenance of all existing property of the 'borrower.' So even if the real reason for the loan is the purchase of a new car, we view it as covering the costs of the 'borrower' not selling his house to pay for the car. See also Shu"t Sho'el u'Meshiv, volume 1, part 3, siman 160.

[11] See this article (in Hebrew)