How Islamic banks manage in business without charging interest ?


In a previous article I presented the argument that Islamic banking institutio ns were weathering the present financial crisis comparatively well as they were, or certainly should be, insulated from the disasters in the interbank market and the mess in the derivatives markets as we have seen recently on the complete collapsed of financial Market and that is mainly greed, charging interest and lack of accountability and transparency. A number of readers raised the logical question of how Islamic banks manage to stay in business without charging interest.

To recap, one of the basic principles of Islamic banking is the prohibition of usury or interest. Up until the 1980s interest was generally interpreted to only apply to usury but it is now accepted practice to refer to all interest. Other principles are based on simple morality and common sense, which are by no means unique to Islam. For example, usury was also prohibited by the Old as well as the New Testament. Even literary heavyweights such as Shakespeare weighed in against the practice.

Islamic banking is also by no means a recent phenomenon. The basic practices can be traced back to the early parts of the seventh century. Some experts even claim that many of the concepts and techniques so familiar to us today were later adopted by European bankers. Its fairly recent reemergence coincided with rising oil prices in the mid 1970s thus providing parts of the Muslim world with significant financial resources. The other crucial element was the accompanying search for ethical values in managing their financial affairs, something many of the traditionally western financial organizations could not provide. As this is a trend not only applicable to the Muslim world, the emerging Islamic banks are increasingly being accepted by non-Muslims who do not wish to invest in, or even deposit their savings with companies engaged in unethical and socially harmful activities, such as dealing in alcohol, gambling, pornography and tobacco.

The Islamic economic system is concerned with social justice to ensure that none of the parties involved in a transaction is being exploited without at the same time inhibiting individual enterprise. Extended to the Islamic financial system, this means that the funds individuals and/or companies put at risk share the profits or losses resulting from the enterprise. This concept of sharing the delights or pain of the outcome of business is a progressive one. It is not the strongest financial system that survives, nor the most intelligent. It is the one that is most adaptable to change. Islamic banking encourages better resources management, in particular as outright speculation is not permitted by Islamic law. The participants are keeping pace with sophisticated techniques and have developed products that are not only ethically motivated but also profitable.The basic principle of Islamic banking follows the Islamic rules on transaction. The term "Islamic banking" is synonymous with "full-reserve banking" and "Islamic Law-compliant banking." The most prominent feature of these laws is usury – the prohibition of paying or collecting interest on funds. The Islamic Law also forbids engagement in investments that include financial unknowns such as buying and selling futures, as well as businesses that are forbidden – dealing in products that are contrary to Islamic law and values such as alcohol, pork, gossip or pornography. These principles apply to all individuals, companies and governments.

Banks that comply with Islamic law are forbidden to charge interest or late payment fees, which is also considered a type of interest. To minimize risk, banks will often require a large down payment on goods and property, or insist upon large collateral.

Banks that comply with Islamic law are forbidden to charge interest or late payment fees, which is also considered a type of interest. To minimize risk, banks will often require a large down payment on goods and property, or insist upon large collateral. It is lawful for the Bank to charge a higher price for a good if payments are deferred or collected at a later date since it is considered a trade for goods rather than collecting interest. Islamic Law-compliant banking products include(profit sharing),(safekeeping),(joint venture),(cost plus) and(leasing). Another way that banks work within Islamic laws while trying to turn a profit is by buying an item that the customer wants, and then selling the item to the customer at a higher price.

The profit sharing is a partnership between an entrepreneur and the bank. The bank is known as the asset owner and the entrepreneur as the profit-sharing. The bank provides all of the necessary capital to start a business and the entrepreneur does the work of managing the business. Profits are split at an agreed ratio until the initial funds of the asset-owner are paid off. The asset-owner is also compensated with additional funds based on the profits of the business in terms previously agreed on. In the event that the business folds, the asset-owner shoulders the cost and the profit-sharing is not compensated.

Joint venture is similar to profit sharing, in which an entrepreneur seeks funds for a business venture and pays the bank back with a ratio of profits. However, there are often more than two parties who contribute funds and become partners who can influence the business depending on the amount of money invested. The entrepreneur also contributes funds and shares in the risk. Any loss is proportional to the amount of capital invested in the business.

Safe-keeping is a system in which a person deposits money into a bank and receives a "gift" from the bank. The bank is the keeper of the funds and will refund the entire amount at the demand of the depositor. The bank rewards the amount of time the depositor keeps the money in the bank with a gift, which is not guaranteed. The gift is similar to interest, but lawful according the Islamic law.

Cost-plus governs the issuing of home loans or any other type of goods needed by a borrower. An Islamic bank does not lend money to a borrower to buy properties; rather, the bank will purchase the property at the borrower’s request at a freely disclosed price, and mark up the price for the borrower to pay back, therefore making a profit from the investment. The borrower is named on the title and allowed to utilize the property immediately and pays the bank back in installments.

Another type of loan is the leasing, in which the bank buys the home or item and leases the property to the borrower while retaining ownership of the property. The borrower can either use the property for a pre-determined period of time, or pay off the purchase price and buy out the Bank to attain full ownership of the property.

There are occasionally controversies surrounding the interpretation of the interest, which certain scholars argue was meant to prevent petty money-lenders from abusing borrowers, rather than a modern bank charging a reasonable, agreed upon interest. The general consensus, however, is that any interest is a direct violation of the law of Sharia and therefore unethical.
In conclusion, Islamic financial solutions generally have Arabic names thus intimidating many potential buyers into saying it is all too complicated. At their core, most of these products are essentially the same as their conventional equivalents. The main differences are the absence of interest and often complicated procedures to ensure compliance with Islamic law. Also,should the borrower default on a rental or principal repayment, the bank may advance the borrower an interest-free loan to enable him to continue their payments in anticipation that he will pay in full when he is able to. The good news is that during this period of distress, the borrower retains his home rather than face eviction. Having said this, Islamic banks still appraise credit risk, and indeed are more cautious about who they finance than conventional banks.
The Western countries are now looking into how the Islamic banking System will be introduced in their countries, such as Britain who already implemented an Islamic banks and others. This will help many Muslim immigrants who up to this moment doesn't have any banking alternatives other than using Interest ccommercial banks which is against their Islamic religion principles of not using usury or interest.


Dr. Shacabi

California, USA