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Islamic banks working with “Profit” not with “Interest”
Some Islamic banks do just that.andnbsp; And here is the easiest way to find out the truth: ask them if the profit amount (not the percentage amount) is fixed, or if the customer profit is declared before the bankandrsquo;s actual profit is announced. If either of these is the case, their andldquo;profitandrdquo; is just another kind of riba (usury or interest).
Interest, theandnbsp; additional charge overandnbsp; theandnbsp; loan principal, isandnbsp; theandnbsp; andldquo;costandrdquo;andnbsp; of usingandnbsp; money, and is strictlyandnbsp; forbidden inandnbsp; Islam,andnbsp; whether givenandnbsp;andnbsp; or taken, at a low rate or a high one,andnbsp; to or fromandnbsp; a Muslim orandnbsp; aandnbsp; non-Muslim, whether inandnbsp; Muslim lands or not. The problem with exchanging one amount of money for a larger amount of money at a later date is that there is no underlying asset or service transacted.
Profit, rent and mark-up, on the other hand, are asset and service backed, and permissible in Islam. Profit is earned on the sale of goods and the provision of services. Rent is charged on the usufruct of property. Mark-ups are added to the cost of an asset. The most common financing products that an Islamic bank will use in order to earn profit are musharakas (partnership finance) and mudarabas (investment finance).
Inandnbsp; a musharaka, two or more partners (even thousands of shareholders) commit riskandnbsp; capital and share profitandnbsp; based on an agreed upon percentage, enduring loss in proportion to their in- vested capital. Modern corporations, like those listed on the New York Stock Exchange, are a kind of musharaka.
In a mudaraba, an investing partner brings capital and a working partner brings time and effort to share in profits and losses agreed upon beforehand.andnbsp; Venture capital firms, such as the onesandnbsp;andnbsp; that financed much of Silicon Valleyandrsquo;s growth, are a kind of mudaraba.
Unlike with interest, whichandnbsp; isandnbsp; chargedandnbsp; on aandnbsp; borrower whether theandnbsp; businessandnbsp; succeeds or fails,andnbsp; inandnbsp; a musharaka and aandnbsp; mudaraba theandnbsp; investor profits onlyandnbsp; when theandnbsp; businessandnbsp; profits and therefore theandnbsp; investor fullyandnbsp; shares inandnbsp; the business risk. Some might argue that an interest- based lender also shares risk: the risk of whether his money will be returned or not. But this is not a business risk, it is a credit risk.andnbsp; The difference is substantial: a business risk only risks the business; a credit risk will risk both business and borrower (by forcing repayment, in extreme cases through personal bankruptcy).
Frequently asked questions:
andnbsp;Why does Islam forbid interest when money is just another commodity that comes at a price?
Unlike an actual commodity (like gold, which has traditionally been the standard of measure for currencies), money has no intrinsic value. It derives its value from something other than itself, namely, market demand. So interest actually creates nothing. By creating money from nothing, we bloatandnbsp;andnbsp; economies with asset-less, service-less pieces of paper. And we all know what happens when the supply of anything, even money, exceeds its demand. Its price drops. And when the andldquo;priceandrdquo; of money drops, we get inflation: theandnbsp;andnbsp; money in ourandnbsp;andnbsp; pocket becomes worth less today than it was yesterday. However simplified and stylized this description, it accurately illustrates the macroeconomic debilitation of interest. Because interest serves the interest (coincidence?) of capital owners like banks, governments, andldquo;developmentandrdquo; agencies, corporations and wealthy individuals, it is unlikely to go away.
Theandnbsp; treatment of money asandnbsp; aandnbsp; commodity is partly responsible for burgeoning world poverty (by forcing poor countries to allocate increasing amounts ofandnbsp; capital away fromandnbsp; social services, like healthcare and education, toward debtandnbsp; servicing) and increased market volatility (by widening theandnbsp; gapandnbsp; between theandnbsp; supply of money and the creation of real assets). It is often asked how we would live in a world without interest. We might instead begin asking how we should be expected to live in a world with interest.
Islamic banking doesnandrsquo;t adequately address the inflation problem and you say interest banking is forbidden. If todayandrsquo;s $1is going to be worth 90 cents next year because of inflation, why canandrsquo;t I charge interest to compensate for the loss?
Theandnbsp;andnbsp; short answer:andnbsp; because interest isandnbsp;andnbsp; still wrong.andnbsp; Chargingandnbsp; interestandnbsp; toandnbsp; compensateandnbsp; for inflation is analogous to terrorizing civilians to compensateandnbsp; forandnbsp;andnbsp; globalandnbsp; injustice:andnbsp; twoandnbsp;andnbsp; wrong doandnbsp; notandnbsp; makeandnbsp; aandnbsp; right. Far too many Muslims, sincere practicing ones no less, have somehow reconciled the taking of interest with their personal definition of what the Qurandrsquo;an and Sunna say about the matter. But compensating for inflation is still no excuse for taking interest, no matter how noble one might feel at taking money from a conventional bank. In order to compensateandnbsp; for inflation, Islamic banks provide plenty of instruments that mimic theandnbsp; security and liquidity ofandnbsp; anandnbsp; ordinaryandnbsp; savings accountandnbsp; while also providing a reasonable interest-free return (Meezanandnbsp; Bankandrsquo;sandnbsp;andnbsp; Monthly Musharakaandnbsp; Certificate is just one example, but all the major banks, including non-Muslim banksandnbsp; thatandnbsp; sellandnbsp; permissible Islamic products,andnbsp; offerandnbsp; basic consumer accounts).
If making aandnbsp;andnbsp; long-term personal loan,andnbsp;andnbsp; for instance, one might consider denominating the amount in gold (e.g.andnbsp; An individual lends $100 cash today and tells the borrower that he would like the gold equivalent amount back in 3 years;$100 buysandnbsp; x grams of goldandnbsp; today;andnbsp; at the time of repayment 3 years later, x gramsandnbsp; of goldandnbsp; buys $120; the borrower returns the lender $120 cash).
If Islam forbids fixed-income interest, whatandrsquo;s wrong with floating-rate interest? Doesnandrsquo;t it also rise and fall like profit?
Islam does not forbid fixation. It is permissible to fix profits (in percentage, not absolute, terms), prices, rents and installment plans, to name a few measures. But it is forbidden to exchange money for a larger amount of money (unless the currency is different, in which case it is permissible atandnbsp;andnbsp; spot).andnbsp;andnbsp; Theandnbsp;andnbsp; unlike exchange of like moneys creates riba.andnbsp; But exchanging assets or services for money and money for assets or services is entirely permissible. So the problem does not relate to whether an interest rate is fixed or floating, but to the interest itself.
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I donandrsquo;t have enough money to buy factory equipment (a car, or a home or pay for an education)? How do I avoid interest and still fulfill my short-term financing requirements?
Murabaha (mark-up financing) is an example of an Islamic instrument that funds short-term capital requirements.andnbsp; Because it is theandnbsp;andnbsp; most easily confused with interest-based financing, it is worthwhile going through the basic steps in a murabaha execution:
A customer approaches an Islamic bank with a request to purchase an item, promising to pay at some later date.andnbsp; The bank assesses the product and the customerandrsquo;s collateral (collateral is an Islamically acceptable method of securing a financial obligation) and agrees by making the customer its agent. The customer goes to the market and selects the product. The bank pays the vendor, charges the customer a mark-up, and the customer takes the product agreeing to pay later.
Thisandnbsp; isandnbsp; analogous toandnbsp; aandnbsp; friend buyingandnbsp; some- thing on your behalf, charging a littleandnbsp; extra for the time and effort, and selling it to you with an expectation thatandnbsp; youandnbsp; willandnbsp; repay him atandnbsp; some later date. This is instead of giving you cash to buy it now, and asking for the cash at some later date,andnbsp;andnbsp; charging you interest in addition to the loan amount.
Inandnbsp; aandnbsp; murabaha, theandnbsp; bank providesandnbsp; financial intermediation entirely freeandnbsp; of interest, and be- cause the bank buys and sellsandnbsp; an asset, even if at aandnbsp; profit,andnbsp; theandnbsp; transaction isandnbsp; Islamically permissible. Theandnbsp; difficulty people haveandnbsp; inandnbsp; differentia- ting a murabaha fromandnbsp; a simple short-term loan isandnbsp; byandnbsp; notandnbsp; appreciating theandnbsp; importance ofandnbsp; the seemingly insignificant intermediate stepandnbsp; of the bank owning theandnbsp; item byandnbsp; paying theandnbsp;andnbsp; vendor directly. What this does is satisfy the very basic Islamic requirement of backing the transaction with an asset. The mark-up is no different from the profit any business makes for having provided a legitimate service.
Forandnbsp;andnbsp; home purchases, diminishing partner- shipandnbsp;andnbsp; schemes (or andldquo;diminishing musharakasandrdquo;) also provide the buyer with a financing alternative. In a diminishing partnership arrangement the buyer approaches the bank with a down payment. The bank pays for the rest of the property and theandnbsp;andnbsp; buyer begins living in theandnbsp;andnbsp; property while paying the bank rent. Over time, the buyer buys back the bankandrsquo;s equity in the house and reduces his monthly rent in proportion to his increased ownership of the house.andnbsp; Eventually, the buyer becomes the sole owner. The import- ant point is that the Islamic bank participates in the customerandrsquo;s ownership risk.
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by: jonathangreat
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Date: Thu, 7 Oct 2010 -
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