The following question and answer by Sheikh Yusuf Talal DeLorenzo attendees of the Dow Jones University Courses on Islamic Investement.
Question:: My understanding was that only in extreme cases should a Muslim tolerate riba.For example, scholars have allowed Muslims to hold bank accounts even if they incur intereston the pretext that they cleanse their money from the interest accumulated.
In the case of bank accounts it could be accounted as a need since it would almost beimpracticle for one to keep his money at home in paper form. Thus the need for a bank accountto hold the money.
However, is it a need to invest in common stock ?
Answer: There are fundamental differences between the two situations you ask about. In one situation,the primary business of the institution is clearly prohibited owing to its transacting in riba. Inthe other, the primary business may be either lawful or unlawful. Moreover, while the lawfulness ofone situation is indeed based on necessity, the lawfulness of the other is not.
Let me explain this in a little more detail. When it became apparent that there was a real needfor people to place their money in banks, in order to protect it, to transfer it, to have easy accessto it, and to allow others to have access to it, they brought their problems to the scholars of fiqh.When it became apparent that their problem represented a real need, legal license was extended, onthe basis of necessity, to those in need of placing their money in bank accounts at conventional(riba-based) banks. This was because no practical or reliable alternative existed. Later, with theestablishment of Islamic banks, this license was revoked; but only in regard to those with accessto such banks. For example, someone living in Topeka, Kansas might continue banking at a conventionalbank; whereas people in the Gulf, where Islamic banks have proliferated, have an alternative toconventional banks, and must therefore avoid the conventional banks.
So, to summarize, permission (to bank at conventional banks) was given on the basis of necessity.Permission to invest in stocks, however, is not based on any sort of necessity. Buying and sellingare voluntary activities. No one (under normal circumstances) needs to buy or sell in order tosurvive. So the lawfulness of buying and selling stocks is not based on legal license. Rather,buying equity shares of businesses on the stock market is lawful when the primary business ofthe security is lawful, and when a specific set of financial ratios are found to be within certainlimits. All of this has been explained in detail in Lesson One. See the third section, entitled:The Stock Market, and the sections which follow it.