Under Islamic Law, any type of interest is considered usury and therefore illegal (in the religious context). How did lenders make money under this restriction? I am asking in the time frame from Rashidun Caliphate to about the Fatimad Caliphate and in the middle east.
Partly through semantics, by replacing use of "interest" either as a term or calculation by a complete system of "reciprocal gifts". In a sense, there is a bit of willful blindness occurring.
As I understand it, a mortgage amortization table would be a wholly acceptable system of reciprocal gifts once all internal use of the terms interest and principal have been removed, and all payments are simply termed gifts under the contract.
From a comment by myself below:
Yes, of course [all the gifts are enforceable].
All the reciprocal gifts are fully outlined in the contract, and are contractual obligations. The semantic trick is to never describe them, or calculate them, explicitly as interest.
There is evidence to suggest that, despite the scriptural prohibition of riba’a (as also by the prior Abrahamic traditions), the practice prevailed in subsequent times. It was quite customary for the creditor to calculate his interest and include it in the sum owed without stating it separately in the agreement
“Every person proceeding to the court of the King of India, Sultan Muhammad Shah, must needs have a gift ready to present to him, in order to gain his favours. The sultan requites him for it by a gift many times its value. When his subjects grew accustomed to this practice, the merchants in Sind and India began to furnish each newcomer with thousands of dinars as a loan, and to supply him with whatever he might desire to offer as a gift or to use on his own behalf, such as riding animals, camels, and goods. They place both their money and their persons at his service, and stand before him like attendants. When he reaches the Sultan, he receives a magnificent gift from him and pays off his debt to them. This trade of theirs is a flourishing one and brings in vast profits.”
However, some scholars of Islamic history have discussed the evolution of a financial institution in the Islamic world, called maona. This institution was a kind of private bank which loaned out state money. The word maona (in Arabic ma’una) means support or help or, as the case might be, reciprocal, mutual help.
One can find precursors of the modern stock-exchange/money market in Islam: ... i.e., the futures-trading in commodities–commodities not yet available in the market but to be delivered in the future. Dates were legally sold at auction before they were harvested. ....
Given that riba is prohibited, as I understand, OP is asking about consumer loans and banks making a profit.
The full-explanation requires detailed consideration of politics and philosophy of Islam. So, a simpler answer (if I may) is to just focus on the instruments used in consumer banking (transactions & savings).
- On payments, there is a spot pricing system for installment plan (paid over a year, two, etc.). It is called Nesiah.
- As for straight out loans, see Qard-Hasan loans - a benevolent type of loan.
These are the main instruments in consumer banking. There are others.
Most banks/financial instituions/merchant houses started off in commercial banking - making money from financing commodity trading. There if of course lots more to the political economy of early Islam.
Firstly, if the loan is intended to finance the purchase of a specific asset, then the seller is allowed to accept being paid later or in installments, and is allowed to charge a mark-up on the 'spot price' to compensate for the value of time (this would not be considered usury under Islamic law). There could also be a middle man (i.e. a financier) who buys from the seller at the spot price and then sells it on to the real buyer for a deferred price (e.g. you want to buy a car, I buy it myself from the dealer then sell it to you but you can pay me in a year instead of today, and I charge you a little extra).
More commonly people want a cash loan rather than an installment sale, and for that there were professional money lenders who would have shops full of stacks of hay or grain or other commodities. If you want a loan, you go to the shop and buy some hay for X dinars on a deferred payment basis then sell to another money lender for immediate payment at X minus %. Now you have X-% in cash and you owe the first money lender a payment of X next year. Change in ownership of the hay would be indicated by people putting their hands over the stack and saying something like "bought!". Older folks in my city say there was a money lenders' quarter at the edge of town that did this very thing until a few decades ago. Modern Islamic banking uses basically this exact same approach today.
Of course Islamic merchants also used other financing schemes that were based on equity (i.e. partnership) rather than debt. So the financier can split the financing into a debt portion (no interest) and an equity portion (with an X% share in profits).
If you want a more academic treatment, try this highly acclaimed recent book (I haven't read it but I'm sure it will give much better coverage of these topics than I ever could): https://www.amazon.com/dp/B072HJJPYK/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1