Levying Penalties for Late Payment in Islamic Banking: A Review of the Perspectives of Islamic Scholars

Abstract

The expansion of the banking industry in the Muslim world, representing both an opportunity and a challenge, has presented a multitude of complex issues for Islamic banking. Among these, the matter of delayed repayment of financing and the imposition of late payment penalties is considered one of the most formidable challenges, primarily due to its perceived resemblance to “Riba” (usury). When a client defaults on their repayment obligations at the scheduled maturity date, the creditor (the bank) incurs financial losses. This loss is compounded by the continuous erosion of the real value of money, a phenomenon exacerbated by macro-economic factors such as geopolitical conflicts and economic instability—as witnessed in nations like Afghanistan—which in turn fuels inflation. In conventional banking systems, repayment delays are managed through the imposition of default interest to compensate the lender. However, in Islamic banking, the utilization of such mechanisms is impermissible due to “Shari'ah” prohibitions against “Riba”. Consequently, the management of bank receivables, addressing payment defaults, and determining permissible forms of compensation for such delays remain critical and persistent issues within the Islamic banking framework. This study, therefore, seeks to address several fundamental questions by examining the diverse perspectives of Islamic jurists (*Fuqaha*) and scholars: Can a creditor legally claim compensation from a defaulting debtor for damages arising from currency devaluation and opportunity cost? Is the practice of stipulating and levying late payment penalties in contracts permissible from a “Shari'ah” perspective? Does such a penalty constitute a form of “Riba”? Finally, are the current penalty mechanisms employed by Islamic banks fundamentally sound and effective? This study employs a qualitative methodology, descriptive-analytical in nature, and is based on desk research. Data were collected, analyzed, and synthesized from secondary sources through a systematic review of the relevant literature. The findings reveal that three distinct jurisprudential viewpoints exist among Islamic scholars regarding the permissibility of late payment penalties, stemming from the aforementioned concerns about “Riba”. The analysis indicates that the current application of penalties—wherein their compensatory aspect often overshadows their deterrent function—has not proven optimally effective in preventing payment delays. This inefficacy is compounded by persistent “Shari'ah” complexities and the issue of debtor insolvency (“I'sar”). Consequently, there is a compelling need for the development and implementation of supplementary mechanisms to address this challenge effectively.