Islamic Finance

By Saulat Pervez

Muslims often try to explain that Islam is more than a religion. They contend that Islam is actually a ‘way of life,’ with the Quran and the life traditions of the Prophet Muhammad (pbuh) providing a blueprint for daily life. From marriage and family life to lawful food and drink, from modesty in dress and excellence in social manners to ethics in trade and finance, Islam encompasses all aspects of our existence. One of these, Islamic finance, is gathering more and more interest from Muslims and non-Muslims lately.

A recent article on CNN.com highlights the importance of Islamic finance in today’s economic-crunch world. It reports that according to ratings agency Moody’s, the global Islamic finance sector is worth $700 billion and has the potential to be worth $4 trillion.

Professor Habib Ahmed, Sharjah chair in the school of government and international affairs at Durham University, England, told CNN, “Islamic finance has been growing by 15 to 20 percent per year for some time and there is a lot of interest at the moment. People are looking for alternatives after the economic crisis.” In fact, Durham University will be offering a Masters degree in Islamic Finance from October of this year, in line with a number of other European institutions.

A fundamental difference between conventional banking and Islamic banking is that the latter does not charge interest. The Quran expressly forbids trading in interest in several places.

At one point, God says, “And God has permitted trading and prohibited interest. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to God (to judge). And the ones who revert back, those are the people of Fire. There they remain (for ever).” [2:275]

Interestingly, Judaism and Christianity also prohibit usury. For instance, the Bible states, “Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deut. 23:19) Yet, Islam is the only faith which maintains this prohibition originally observed by Christians and Jews.

“People think the Islamic [financial] system is based on faith, but it’s based on justice. The system is based on justice for the two parties and how you get to the justice is extracted from Islamic faith,” Aly Khorshid, an Islamic finance scholar who writes for Islamic Banking and Finance magazine, told CNN.

Comparison of Islamic and Conventional Finance

Islamic Finance

Conventional Finance

Interest-free

Interest-based

Equity partnership (profit and loss sharing)

Profit is the chief motivation

Inherently micro-financing-friendly

Not inherently micro-financing-friendly

Checks and balances to maintain ethics and justice

Not enough checks and balances which can lead to excess, causing economic meltdowns

Indeed, while Islam prohibits dealing in interest, this does not mean that the system is not based on profit. In his book, An Introduction to Islamic Finance, Muhammad Taqi Usmani explains that commercial banking under Islam is based on the concept of profit and loss sharing. It is an equity partnership in which both parties not only benefit from the profit, but also share in the losses. Other features have been added to Islamic banking in view of contemporary needs, such as leasing, cost plus financing, delayed payment sale, etc. Yet, these are not substitutes for interest. “They have their own set of principles, philosophy and conditions without which it is not allowed in Islamic law to use them as modes of financing,” adds Usmani.

“Islam does not deny the market forces and the market economy. Even the profit motive is acceptable to a reasonable extent. Private ownership is not totally negated,” writes Usmani. “Yet, the basic difference between capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions. Their liberty is not controlled by any divine injunctions. … This attitude has allowed a number of practices which cause imbalances in the society.”

In fact, today’s severe economic downturn was triggered by banks excessively dealing in mortgage-backed securities and credit-default swaps, two of the practices which Islamic banks on principle do not transact.

“The global financial crisis and the credit crunch were inter alia the result of greed and avarice – since financial institutions advanced loans to people who did not have repayment capacity. If the aforesaid financial institutions were practicing Islamic finance, the problem might probably not have arisen,” stated Aftab Ahmad, an economic writer from Islamabad, Pakistan.

“The present interest-based system is of an exploitative nature as capital earns profit under this system without taking any responsibility and running any risk,” he commented. “Besides, smaller sectors of the economy such as the small enterprises and small farmers can not often avail themselves of credit facilities under this system because they are unable to pay interest at the higher rate.”

However, under a profit and loss sharing system, not only is micro-financing easier, the finance system forces the financiers to ensure that their businesses remain profitable. In this way, there would be more “employment generation and national income would increase manifold. Thus, the society, at large, would be the gainer in this system,” Ahmad observed.

At the same time, he believes that current Islamic banking in Pakistan is not entirely based on the profit and loss sharing system. “While the traditional banks pay interest on deposits and charge interest on loans advanced by them, the Islamic banks pay profit to the depositors and collect service charges on credit facilities provided by them. The profit disbursed to the depositors and service charges collected from the borrowers by an Islamic bank have been certified by Islamic scholars as perfectly Islamic in character,” he said.

Ahmad recommends that Islamic banks adopt innovative products to capture a greater market. “The traditional banks, in spite of their gigantic size, are profit-oriented rather than welfare-oriented. By bringing welfare-based products in the market, the Islamic banks may acquire an edge over the traditional banks,” he opined.

With justice and ethics as its chief means, Islamic finance has the potential to not only streamline today’s erratic banking trends but also to eradicate poverty across the globe. As a matter of fact, it is these characteristics which are drawing the attention of traditional financial institutions which are eager to learn their lessons after the recent banking meltdown. Let’s hope that the world at large will adopt this honest and moral system of banking in the near future, affirming divine foresight and wisdom!

1 Comment

  1. Abdu Emano says:

    Al salamu Alaikum. This is an interesting subject especially for those who live in the West. I was wondering about a ligament Islamic Banks that finance according to Sharea way in the US.

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