Are the Principles of Islamic Banking the Way Forward?
by Ritchie Mehta (02 November 2008)
Over the past couple of years Islamic Banking i.e. banking that is complaint with Sharia law, has been making significant in roads to the banking industry in the UK. Many high street banks, such as HSBC, have launched propositions to attract the lucrative Muslim segments of society both in Britain and around the world.
Interestingly, the very principles that these accounts are based on have in many ways sheltered the account holders from the impact of the global credit crisis. So maybe it's time for the financial professionals to re-think the values upon which the current system is based and look to this niche area of banking for guidance.
For example, the very fact that a Sharia compliant bank account is forbidden to receive and charge interest means that it is largely immune to fluctuating borrowing rates. The account functions on the basis of financing transactions and then sharing the profit between the customer and bank. This is a far more transparent, fair and proportional way for banks to make a profit. Rather then charging extortionate charges and fees which in many cases may well turn out to be disproportionate to the costs incurred.
One of the fastest growing areas of Islamic finance is in the area of home purchase. As home loans are forbidden, home finance is based on the principles of Ijara (leasing) and Musharaka (reducing partnership). Essentially, the bank and customer buy the house together. The bank typically puts down 80% of the funds with the customer providing the other 20%. Ownership at this stage is proportional to the amount each stakeholder has invested. Over the term period (say 30 years) the customer makes repayments to the bank and in return gets an increasing share of the home, until they completely own the property.
Finally, Islamic teachings (on which Islamic banking is based) suggests that money itself has no intrinsic value and that all transactions must be backed by assets. In reality this would mean that a bank would have no exposure and not have to make up risk based financial instruments which have caused many financial institutions to collapse.