You are here

Islamic Banking

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.

Comments

You say: "Generally, Islamic law also prohibits taking financial risks ..."

The problem is that no project in the world is free of risk. There is a need for a mechanism to allow people who cannot handle the risk to transfer it to someone else, in exchange for a fixed (but lower) rate of return. This fixed but lower rate is the interest rate. Those who can take risk are welcome to buy shares in enterprises.

I believe in a Libertarian policy: if lenders and borrowers are willing to engage in a transaction involving interest, the government has no business to interfere.

Also, it is NOT true that interest always leads to inflation. Inflation is a result of money supply growing faster than the rate of growth of real economic activity.

I have my doubts about whether Islamic financial theories are well-founded ... but I guess I wont make friends for saying that here :-) !

cannot afford the risk to loose it.
Then he should not use it for investment at all, just spend it or save it.
If there is no inflation, he does not need interest. His money will keep the same value.

The reason why so many informed people are opposed to the interest taking on money-economy is, because in the long run it destroys the real economy.
Working with money becomes more profitable than the producing trading of goods.
Capital will no longer be used to invest in production and agriculture, but to invest and gamble on the financial markets.
This gambling scheme has historically always led to a bubble and bust circle.

You said: "If a person has so little money ... he or she should not use it for investment at all, just spend it or save it ... If there is no inflation, he does not need interest"

So what if the amount is small? Many drops together make an ocean. There is some value in a person delaying gratification and consumption, and making the fruits of his labour available to someone else. He deserves a return for that. If he does not want to undertake any risk, then his return will be lower, but he should still get something. That is the role played by interest.

But ultimately, its best to have a Libertarian viewpoint ... the Government need not interfere in a deal between two citizens, even if it involves interest.

it´s not just a deal between 2 citizens, but a deal between a banking corporation and a private individual.
And normally, for the little people it means a loan deal, where in the end the private burrower looses his whole property and the banker has no risk at all.

And besides, the most important part is, the interest which the private share-holders of central banks put on money, which this very same share-holders have created themselves out of thin air.

The libertarian mantra of no government interference is always the best, does not work when the game is already rigged to start with.

The money game is not about free enterprise, but about a monopoly game, in the end only one player owns everything and everybody else is out of the game.

You said: "it´s not just a deal between 2 citizens, but a deal between a banking corporation and a private individual."

Well, the answer to that is that there should be more banks competing with each other. People should keep their savings with, and borrow from, the bank which gives them the best deal.

You also said: "And besides, the most important part is, the interest which the private share-holders of central banks put on money, which this very same share-holders have created themselves out of thin air."

There is some validity to this. The Central bank should be owned by the people, and not by private interests. Now, to avoid deflation or inflation, the money supply needs to grow at the same rate as the rate of growth of real economic activity. This leads to the question of how best to introduce that new money into the economy. A very reasonable answer is that it should be lent out at the prevailing market rate of interest. Eventually the money will be repaid to the Central Bank with interest. But all that can be lent out again. And so the process continues. The important thing is to keep the money supply growing at the correct rate, with nobody deriving any unfair advantage from the newly created money.

You said: "The libertarian mantra of no government interference is always the best, does not work when the game is already rigged to start with."

This also I agree with. Libertarianism will work if there is vigorous free-market competition.

last comment for now . . .

"Islamic law also prohibits taking financial risks (such as betting and gambling)."

Islamic does not prohibit risk taking - as long as it is carefully calculated and based on a reasoned analysis - NOT pot luck.

On the contrary - Islam (the Quran) reveres businessmen (risk-takers by definition) as some of the greatest benefactors of mankind (not in so many words, but that's the gist of it).

Anyway - risk CANNOT BE AVOIDED ON EARTH. Risk is inherent in the human condition. The best policy for human beings - in order to live in harmony - is to SHARE risk equally in their endeavors.

Communities should insure against loss those who cannot afford to risk their money - (hence, FDIC insured bank accounts). But, that does not entitle them to collect interest on their money. It is enough that they are insured against its loss.

The honest defense against inflation should be a careful introduction of the right amount of capital into the economy and the withdrawal of un-needed capital through harmless means - NOT by "soaking it up" through USURY and redistributing wealth to moneylenders.

Frankly, I am surprised that Kula, as a muslim sees any merit in the practice of "interest" which I cannot in good conscience label as anything other than USURY.

Interest is an abomination, predicated on one person's exploitation of another person's need. And it is absolutely, without question, responsible for inflation insofar as it devalues the money that is borrowed by the interest that is paid.

Also, because interest is NEVER issued, in order for it to continue to be paid to moneylenders, without resulting in the concentration of ALL capital into their hands, money must continually be PUMPED into the economy. This of course, results in inflation.

I agree, however, with Kula's libertarian approach - provided Erlenda's concerns about a level playing field is carefully addressed.

However, my libertarian inclinations extend only as far the principle of brotherhood can be maintained.

I will never accept the dog-eat-dog world of vulture capitalism.

---------------------------------------
"Money" has no value - people do.

___________________________

"Money" has no value - people do.

1) I agree with QRS.

kula.kundalini wrote,

”It is NOT true that interest always leads to inflation. Inflation is a result of money supply growing faster than the rate of growth of real economic activity.”

My view is the exact opposite. I say that interest ALWAYS leads to inflation. Banks make loans. People put some of that loan money into other banks. The banks lend and collect in a cycle, with interest compounding as money goes round and round through the system. Inflation quickly becomes inevitable.

This happens, in part, because we have a debt-based currency. Our money IS debt. The central banks do not issue currency. They issue debt notes. Every dollar is a loan from the central banks. When we give someone ten dollars for a gallon of gasoline, we have exchanged ten dollars worth of debt. Thus, we increase overall debt when we use money for ANYTHING. And since debt IS currency in our system, this causes inflation. Only about 3% of the U.S. money supply is actual currency. The other 97% is debt, owned by the banks. That’s trillions of dollars in “currency,” which is far greater than the combined GDP of the entire planet. I call that MASS INFLATION. We do not have enough money to pay off these compounding debts. Indeed, when we use money to pay off debt, we increase the debt all the more, since we have a debt-based currency. Therefore we pay the debts by sacrificing our standard of living. We become slaves. If we do not have enough money to pay back a debt, we will pay it off in sweat and blood.

I believe all interest is evil, and always causes a nation to eventually collapse. Unfortunately this evil is now so widespread that people cannot imagine a world without it, even though it is destroying the world. They say, “There’s nothing wrong with interest.” I disagree. Interest leads to debt. And when debt is currency (as ours is) we have mass inflation. Debt is the devil’s weapon.

It’s quite possible to have a real currency, not a debt-based currency. And as you said, this currency must NOT be privately controlled.

2) kula.kundalini wrote,

”I believe in a Libertarian policy: if lenders and borrowers are willing to engage in a transaction involving interest, the government has no business to interfere.”

Then you contradict yourself by saying…

”The Central bank should be owned by the people, and not by private interests.”

The “people” means the people’s government. You seem to favor both government intervention and no government intervention.

”Libertarianism will work if there is vigorous free-market competition.”

That’s what we have now, with the U.S. Constitution being ignored, and most regulations being swept aside. Do you favor that? I don’t.

Competition is fine up to a point, but in our "free market" there is a natural human tendency to seek a monopoly in order to eliminate competition. The only thing that can offset monopolies is government regulation.

Libertarianism with its mantra of “free markets” sounds good in theory, but there can be no “free market” in real life without government regulation. Laws against murder, for example, allow people to go about their affairs in relative freedom. Similarly, when you write, ” if lenders and borrowers are willing to engage in a transaction involving interest, the government has no business to interfere,” do you favor allowing two adults to engage in child pornography, for instance?

The British philosopher John Stewart Mill started out believing in “free markets,” but eventually believed there must be some regulation. In his book On Liberty (1859) he espoused his famous “harm principle,” in which a person’s actions should only be regulated if those actions involve harm or the threat of harm to someone else. Mill did not favor laws that supposedly prevented an individual from harming himself. Nor did he favor any notion of “harm” based on sheer religious doctrine, or on social taste. “Harm” must be real and actual. Also, the principle should not be applied to children, or to people who are otherwise incompetent. Mills' views seem reasonable to me, and are the essence of libertarianism.

Unfortunately libertarians become confused by their “free market” mantra. They interpret any objection to their views as a call for the opposite extreme, in which government has a monopoly on everything. That’s Communism, which is just as bad as rampant capitalism. Both involve monopolies. Libertarian opposition to government involvement is so extreme that they would do away with regulations that protect the people.

What we need is a BALANCE between freedom and regulation. This balanced can never be perfectly achieved. Nonetheless, it is a worthy star that can be used to guide the ship of state.

3) Erlenda’s article says, ” Islamic law also prohibits taking financial risks (such as betting and gambling).”

Obviously risk is unavoidable. Indeed, as QRS notes, the sharing of risk encourages a sense of community. I interpret Islamic law to mean that the human impulse to get something for nothing must be discouraged. This impulse always leads to ruin, first for the victim, and then for everyone else. I may "get over" on you today, but tomorrow someone will "get over" on me. Gambling is an example. It is an attempt to “beat the house.” Casinos love this, since it allows them to get all the money in the end. This occurs even in card games like “21,” since there are many players at a table, but only one dealer. Some players may win, but the dealer always ends up with the lion’s share of the loot. Likewise, there are many players in an economy, but only a handful of banks. They always get the loot in the end. Why? INTEREST.

4) For me the most important part of Erlenda’s post is its discussion of the difference between the Islamic view of money and the capitalist view. The Islamic view regards money as a medium of exchange. The capitalist view regards money (and everything else) as a commodity or an asset. It would control ALL exchanges.

Money, like words, is a form of communication. I may not speak Farsi, but I can do business with an Iranian citizen. I can economically “communicate” with him or her. If the capitalist system could, it would commodify language and all forms of communication. This is the secret of oppressive banking. It takes control of a medium of communication, and charges interest on it. It wins no matter who buys and sells. It wins no matter who “gets over” on someone else. The “free market” is rigged. It is not free at all.

For a nation to survive, it must do away with private control of banking, but this is not enough. It must also do away with debt-based currency.

Thanks for the responses. Got to go now, but hopefully I'll be able reply with a separate blog post in the near future. But let me state just one fact for now: The prices of various goods and services depend upon the money supply. What is inflation? Nothing but the rise in prices. So inflation is directly related to the money supply. So, in any discussion of inflation, the money supply has to be the central concept. The issue becomes: How can we properly regulate the money supply, without allowing anybody to take unfair advantage of the system?

My claim is that this is indeed possible with a publicly owned Central Bank. The interest rate is not something that can be directly controlled - it is the result of a market equilibrium between many players who are saving, borrowing, investing etc. A system involving interest is not inherently unfair - though it can be abused if the people are not aware and vigilant. More later, hopefully. Cheers!

”A system involving interest is not inherently unfair - though it can be abused if the people are not aware and vigilant.”

I disagree. I say interest is ALWAYS abused. That’s why it’s so dangerous. I believe that interest IS inherently unfair, since it does not involve a sharing of risk. Even if we disregard moral considerations about “fairness,” interest is inherently dysfunctional. It always gets out of hand.

Money is not inherently unfair. Interest is. People today are so enslaved that they refuse to imagine a world without interest, without tyrannical monopolies, without the copyright system, and so on. All these systems are dysfunctional. All are out of control.

The first step in creating a better world is to imagine a better world.

Islam is mostly about moral fiber. Now the whole point of Islamic rules is to create society based on mutual care and sharing of material and spiritual resources.

In Islamic law there is no tax on income (salary) but only on savings that person does not need for everyday living expenses. Rich are encouraged to share their wealth with poor and endow some of their not needed wealth for public benefits like building roads, shelters and educational institutions. If they borrow money to someone who is poor and he is unable to repay them on agreed time rich person is encouraged to extend that time and even forgive debt.

This concept is based on Divine revelation that it is God who gives wealth to people and if they are not greedy and selfish by giving and sharing with others they will only be given even more. As you can see it is lack of moral that creates selfish accumulation of wealth thus inciting social disorder and this is why compulsory tax (Zakat) has been proscribed.

If rich people would understand the weight (responsibility) of the wealth they have been given they would never allow themselves to accumulate extensive amounts of wealth but procure it further into underprivileged class of people to sustain constant circulation of wealth. If we have societies built on this kind of moral perceptions there would be no need for banks and interests etc. National treasury that collects Zakat would be sufficient to give away or loan wealth to people who are left with no money or basic necessities for life.

What actually happened to mankind is that it has been covertly diverted from the true purpose of this worldly life making it target of "success" while no matter how rich you become you will die and be forced to leave all the wealth to someone else. We are not here to compete who will have better home, car or job but to compete who will have finer moral traits and compassion toward fellow man and other creatures.

What we are witnessing today is direct consequence of distorted picture of our purpose in this world. Everything is intricately connected with the understanding the purpose of life. If we don't get that right nothing down the stream will be right. Its very simple but human beings always tend to complicate everything and then when they are overwhelmed by that complexity they resort to further injustice and immoral behavior resulting in envy, hatred, wars and ultimate doom of mankind.

Sufferings that we experience here in material world are but a reflections of sufferings that await us in eternal world filed with spiritual consequences of our misdoings. The very purpose of our worldly life has been hijacked by evil in its various manifestations and usury is just one branch of that evil.

"Let there be Light!"

"Let there be Light!"



Assume a 10% yearly loan which some poor family needed to invest in there children. Even if they payed 10%/Year for 10years (100% in total) the debt would not have decrease by a nickel, however they would have given back as much money as they have taken.

Of course you don't just loan your money without wanting something back.
Without interest you would be forced to invest in something other then debt and thus would be forced to invest wisely or risk losing money.

Usury is a method for taking from the poor and giving to the rich. The only ones who can truly profit from usury are the ones with (a lot of) money. The poor just slave to make the rich even richer.
Futhermore the really rich just evade taxes by placing their welth outside of the grasp of the taxman, while the poor and middle class pay most of the tax.

Theme by Danetsoft and Danang Probo Sayekti inspired by Maksimer