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In the Islamic banking system, banks use deposits to participate in investment schemes.
Islamic banking refers to a system of banking or banking activity which is consistent with the principles of Islamic law (Sharia) and guided by Islamic economics.
In particular, Islamic law prohibits usury and the collection and payment of interest, also commonly called riba in Islamic discourse. Generally, Islamic law also prohibits taking financial risks (such as betting and gambling). In addition, Islamic law prohibits investing in businesses that are considered haram (such as businesses that sell alcohol or pork, or businesses that produce un-Islamic media).
In the late 20th century, a number of Islamic banks were created, to cater to this particular banking market.
Capitalism has been defined in various ways by different economic theorists, but is commonly understood to mean an economic or socioeconomic system in which the means of production are predominantly private and operated for profit, mostly through the employment of labor.
In such a system, money dictates the distribution and exchange of goods, services, and labor in largely free markets. Decisions regarding investment are made privately, and production and distribution is primarily controlled by companies or businesses each competing and acting in its own interests.
According to Persian daily Hamshahri, although most developed countries are regarded as capitalist, some of them have been called “mixed economies“, due to government-owned means of production and economic intervention.
The difference, however, between Islamic banking and capitalism is in their perspective of money.
In capitalism, money is the market asset and evaluated just like other assets in relation to its scarcity or impact on the production sector. The value of money in the capitalist economy is determined through interest rate. For the same reason and no other, the rate of interest is added to the final amount of total costs. From such a point of view, a fixed interest rate will always result in inflation.
In the Islamic banking system, banks use deposits to participate in investment schemes. Based on such a principle, and as per the banking law without usury, “profit share“ is allocated for the bank, and not necessarily a fixed rate of profit. Therefore, bank becomes a partner in profit-making or loss-making economic activities. Perhaps that is why bank profit rates in such a system are not considered to be inflationary.