Islam Poverty and Microfinance

Microfinance has been talk of the town since last decade or so. Islamic microfinance is recently entered in market and since then been in experiment mode with varied degrees of success. Islamic Microfinance is based on concept of prohibition of interest and profit and loss sharing. Interest based microfinance has been a success in societies with largely Muslim populations. Our scope of work is to analyze grounds for Islamic Microfinance specially

Why Islamic Microfinance is needed?

What will be the Instruments used by Islamic Microfinance Program?

What can be challenges and opportunities for Islamic Microfinance?

Current section will focus on how Islam sees poverty? What measures are provided in Islam to combat poverty? What is common denominator in Islam, Islamic Finance and Microfinance.

Introduction

Islam is not only a religion but a complete way of life that was revealed to humanity by our creator who is most knowledgeable, wise and just. Islam was revealed as a practical religion to be implemented in our daily life since it covers all aspects of human life. As such, when implemented honestly and correctly, Islam provides solutions to all problems that are faced by humanity. One of the most widespread and dangerous problems faced by humanity is that of poverty, hunger and starvation. Millions of human souls on this planet are living under extreme poverty and very inhuman conditions.

Poverty is as old as the human existence itself. This has been a cause of concern in every society and throughout the history. During current era poverty came under limelight recently and has been a focus of international community. Everybody is talking about poverty reduction and different measures are being suggested for the purpose. Different instruments are being tried with different levels of success. However situation has not improved to such a level where it can be claimed that this Anti poverty drive has paid its dividends.

As we have stated that Islam provides solution to every problem of human life. Here we will theoretically examine that

1. How Islam sees Poverty? Is it a blessing or a curse
2. What are the instruments to reduce poverty in Islam?
3. How effective are these Instruments?
4. How Islamic approach to poverty reduction is different from a conventional approach?

What is Poverty in Islam?

In Islam poverty is a multidimensional concept. Term used in Islamic literature for a poor person is "Faqeer". A person is considered to be a Faqeer or Poor who do not have sufficient material wealth in hand to satisfy his/her basic needs which are defined in fiver broad categories.

1. Protect his/her religion
2. Protect his/her Physical Self
3. Seek Knowledge or Education
4. Protect his/her Family
5. Accumulate some Wealth

These are necessary to lead a good social, individual and economic life ensured by Islam. People who are not able to meet these necessities are poor.

Islam is not against property and wealth rather it wishes its followers not make the wealth accumulation their sole purpose of existence. Islam considers richness a blessing from their creator as long as it is acquired by halal means and the person fulfills all his responsibilities towards Allah and society.

Islam does not see poverty as a virtue rather it is seen as a social anomaly that is to be removed and alleviated. In many Ahadith Prophet P.B.U.H sought refuge from poverty. To eradicate poverty Allah S.W.T has included built in features in his revealed religion to protect humankind from poverty.

Islamic Instruments to Reduce Poverty

The built-in instruments of Islam to reduce poverty includes

1. Zakat
2. Sadaqat
3. Qarz-e-Hasan

The Obligatory Zakat:

Zakat means 'purification' and 'growth'. It is mandatory for every Muslim who possesses over a prescribed limit of wealth for at least one year to pay a certain amount to poor. This is called Zakat. The Zakat proceeds are to be distributed among poor and needy. To protect the self respect of poor Allah S.W.T has declared that Zakat is the "right" of poor in wealth of rich. Payers of Zakat do not oblige poor by giving Zakat rather they just give them their due "right". Islam has attached so much importance to Zakat that it is one of the five pillars of Islam. Anyone who does not believe on any of these five pillars of Islam cannot be categorized as Muslim.

Zakat is due on accumulated wealth that has been in the possession of a person for at least one year. The dynamics of Zakat are completely defined in Islamic Jurisprudence. Zakat is payable on accumulated assets i.e. Money, Crops, Inventory, Gold, Silver, Animals, Shares and so. Rates of Zakat differ in certain cases. As this is on accumulated assets people who does not save do not have to pay Zakat. Zakat recipients are also defined in Quran and cannot be paid out of defined categories. Following verse of Quran mention the people who can be Zakat recipients.

"As a matter of fact, Zakat collections are only for the needy and the indigent, and for those who are employed to collect them and for whose hearts are to be won over and for the ransoming of slaves and for helping the debtors and for the way of Allah and for the hospitality of the way-farers. This is an obligatory duty from Allah: and Allah is All-knowing, All-Wise: (9: 60)

1. The Needy

A Person is needy if he depends on others for his sustenance. This will include all such helpless people who stand in need of monetary help and co-operation of others, temporarily or permanently. Thus Zakat can be spent to help the invalids, orphans, widows, the aged and the jobless people and those who have been afflicted by unforeseen calamities. They may be given temporary help or granted pensions permanently The Poor: People who have means of livelihood but insufficient to meet their basic needs.

2. The Indigent

They are the people who are self-respected. They would neither beg nor ask others for help. They are struggling for their livelihood but due to insufficient resources they cannot make ends meet. According to Hadith, an indigent person is one

"Who does not get enough to satisfy his needs ; who is neither recognized to be poor so that people may render him necessary help, nor he stands up to beg."
(Bukhari, Muslim)

3. The In-Debtors

These are the people who are heavily under debt and cannot generate enough to pay off their debts. They can be jobless or earning a little, or those who may be left with nothing if they pay off all their debts, or those who have been reduced to poverty due to unforeseen calamities like paying heavy penalties and fines, failure of business etc.

4. Stranded Traveller or Wayfarer:

The wayfarer, whether he is well off and rich at home, can be helped with Zakat money if he stands in need of such help while on a journey.

5. To Free Slaves:

Zakat money is to be used to purchase slaves and free them.

6. To Win over Hearts

People whose hearts are to be reconciled to Islam and in the interest of the Islamic State. They can be non-Muslims, or even the newly converted Muslims whose faith in Islam is not yet firm and strong enough to motivate them to serve the interests of Islam and the Islamic State.

7. In the Way of Allah:

Zakat money can also be spent in the path of Allah. This can include many things, basically any project that helps Muslims or Islamic causes.

8. Amileen-i-Zakat or Zakat Workers:

Those whose job it is to collect and re-distribute Zakat money get their salary from the Zakat money.

There are more regulations in disbursement of Zakat and who is eligible to receive Zakat but that is beyond scope of this topic.

Sadaqat:

Zakat levied by Islam can easily be enough to solve the problems of poverty and starvation in the islamic society in particular and in. However Islam has adopted a multidimensional poverty reduction startegy by encouraging Muslims to give charity in addition to the compulsory Zakat. Islam has given so much importance to social safety and care for others. For example, the Prophet Mohammad (pbuh) once said that the person who sleeps full while his neighbour sleeps hungry is not a true believer. Islam has promoted charity and giving in may ways like if one Muslim is not able to fulfill his islamic dutiies he is required to feed certian number of poor people. For example, for the persons who are not able to fast in Ramadan, they are required to feed some poor people for each day they do not fast. And there are many such examples.

Charity in the holy Qur'an and the Sunnah:

Like Zakat we can mention of sadaqat on many occassions in Quran and Hadith. We can quote few of these as reference

"O ye who believe! Cancel not your charity by reminders of your generosity or by injury, like those who spend their substance to be seen of men, but believe neither in Allah nor in the Last Day. They are in Parable like a hard barren rock, on which is a little soil; on it falls heavy rain, which leaves it (just) a bare stone. They will be able to do nothing with aught they have earned. And Allah guideth not those who reject Faith." (Holy Qur'an, Chapter 2, verse 264).

"And be steadfast in prayer and regular in charity" (Holy Qur'an, Chapter 2, verse 110).

"By no means shall you attain righteousness unless ye give (freely) of that which you love; and whatever you give, Allah knows it well." (Holy Qur'an, Chapter 3, verse 92).

Allah (swt) said addressing the messenger of Allah, Mohammad (pbuh): "Of their goods take alms (charity), so that you might purify and sanctify them, and pray on their behalf" (Holy Qur'an, Chapter 9, verse 103).

Allah (swt) said: "So he who gives (in charity) and fears (Allah), and (in all sincerity) testifies to the Best, We will indeed make smooth for him the path to Bliss. But he who is a greedy miser and thinks himself self-sufficient, And gives the lie to the Best, We will indeed make smooth for him the Path to Misery; Nor will his wealth profit him when he falls headlong (into the hell fire)." (Holy Qur'an, Chapter 92, verses 5-11).

When the messenger of Allah, Mohammad (pbuh), sent one of his companions to call the people of Yemen to Islam, he asked him to tell them the basics of Islam, among which was: "... and tell them that Allah has made obligatory on them a charity that is taken from their rich and given to their poor..." (Reported by Bukhari and Muslim).

How Can Zakat Eradicate Poverty?

Zakat is an Integral part of Islamic belief. It is one of the five concept necessary to believe to become a muslim. Besides religious Zakat is an economic concept and has socio economic implications.

If Islam was implemented in the world today, starvation would be eliminated from the planet within the first year. The Zakat due on agricultural products ranges from 5% to 10% of the produce. There is also Zakat due on various types of animals such as sheep, cows and camels. Imagine if 5%-10% of all agricultural production in the world, plus the required amounts on animals are distributed among the hungry and starving people of this world. The problem would be solved immedeatly. In the system we have today, some nations intentionally spoil a part of their agricultural production in order to maintain high prices for their produce. Can you see the difference between the system driven by human greed and the Islam which was imposed by Allah (swt), the most gracious and most merciful?

In addition, Islam can solve the problem of poverty. Consider the Zakat due on money. Zakat is due at 2.5% on money that has been in one's possession for over a year. Now consider this simple fact: Forbes Magazine reported that in 2004 there were 587 billionaires worldwide, with a combined net worth of $1.9 trillion dollars. If in 2004 these 587 richest people in the world paid zakat, we would have had $47.5 billion dollars distributed among the poor.

This calculation has just considered less than 600 individuals on this earth. What about if everyone contributed to a global Zakat fund in the same way? The total world GDP (summation of gross domestic product of all countries in the world) was estimated in 1999 to be $27,357.9 billion dollars. The 2.5% Zakat on this would amount to $683.95 billion dollars annually. These are just ball park figures to give the reader an idea of how much money Zakat can generate.

This Zakat money should not only be distributed for immedeate relief to the poor. It can also be given in the form of small business loans. For example, poor farmers can be given loans or even grants from this Zakat money to enable them to purchase the equipment and materials they need to lift them out of poverty. The same can be done for small business owners, or for the poor to set up small workshops or factories to lift them out of poverty once and for all. Within a few years, poverty would be eliminated or at least greatly reduced.

Islam and Microfinance: Common Denominators

Islam and Microfinance are by no means Comparable. Islam is a complete code of life and a divine revelation while Microfinance is just a tiny part of human life and in current form is a human invention. We are by no means comparing both as a system rather just trying to find out the commom objectives. The underlying assumption is that Microfinance objectives tried to be achieved in islamic way will be huge success.

Core Objective of Microfinance is to eradicate poverty. i.e to raise income levels and to broaden financial markets by providing financial and no-financial services to the financially excluded people. Microfinance targets the poor and the economically active poor in the society to assist them create wealth, accumulate assets and raise income to smooth consumption

Islam also wants its followers to be prosperous, self sufficient, self respecting and enterprising. Islam dislikes people to be dependent on others. Islam has developed such a social safety mechanism that people should become self reliant. Islam does not want people to become beggars. Islam has declared begging to be a curse and declared a person who earns his livelihood by hand i.e by working as friend of Allah (s.w.t)

By this we can say that there is a common goal in islam and microfinance i.e to eradicate poverty, to make people self reliant, enterprising and self respecting. There will be only one ultimate soultion to achieve the target of poverty eradication i.e practice microfinance in an Islamic way and added social safety advantages associated with Islam will help achieve this goal. This is not merely an imagination rather it happened in history when in state of Madina people could not find poor people to pay zakat. Every one was prosperous and zakat payer. This was achieved with zakat mechanism only and without microfinance.

Author: Azhar Nadeem

[Read More...] - Islam Poverty and Microfinance

Demystification of Islamic Banking

Is Islamic banking a viable alternative to interest-based conventional banking? Is it really any different from conventional finance? Does it offer a better way forward?

These and other questions face the next generation of Islamic bankers as they inherit an industry that, in just the last decade, grew from a niche market serving a largely Muslim population to a global phenomenon offered side-by-side its conventional counterpart. In the aftermath of the global financial crisis, it is now seen in a completely new light as not only an ethical form of finance, but also as a potentially superior one. First, however, we must understand what Islamic finance is and what it is not.

This article places special emphasis on equity-based Islamic finance because, while "good-enough" Shariah-compliant trade and lease based instruments currently predominate the market and manage to satisfy the letter of the law, stakeholders increasingly demand Shariah-based products that fulfill the original spirit of the law.

All banking is debt, equity, trade, or lease based. And all Islamic finance does is simply dispense with the debt. The same proven risk-oriented principles that benefited past generations of equity-based conventional bankers (more profitably than their interest-based counterparts) also ensures the success of future generations of Islamic financiers. The positive impact that Islamic-style equity has on both the profitability of a business and the well being of society contrasts sharply with the negative effects of interest-based instruments.

The demystification of Islamic banking requires an understanding of four basic points: 1) What is an Islamic bank? 2) How is an Islamic bank different from a conventional bank? 3) How is an Islamic bank similar to a conventional bank? and 4) How do the two compare in practice?

An Islamic bank is a financial intermediary that brings together the providers of capital with the users of capital in accordance with the principles of the Shariah (Islamic Sacred Law). Like conventional banks, a combination of products, services and customers loosely determines the type of banking the institution engages in: at a very basic level, investment bankers execute complex, investment-oriented transactions for large institutions; commercial bankers borrow, lease and lend; and retail bankers service consumer-oriented needs. Though increasingly there is considerable overlap across these industry specialties, with commercial banks offering investment banking expertise, investment banks providing retail operations, and retail banks evolving into full-service commercial banks, the burgeoning demand for Shariah compliant instruments at all levels of the banking value chain has Islamic banks repositioning themselves as one-stop financial shops rather than as specialist boutiques.

Islamic banks are unique in that their activities are regulated by rules derived from the Quran, sunna (Prophetic practice), and the traditional schools of scholarship. Certainly, there are banks that offer cosmetically-enhanced products that are Islamic in name only, but the increasing regulation of the industry, the improving sophistication of the customer base, and the genuine demand for authentic Shariah committees, limits the proliferation of these expedient, non-compliant banks.

An Islamic bank is distinguishable from its conventional counterpart by some basic principles, each of which is derived from the Quran, sunna, or both. While thousands of fiqh (Islamic jurisprudence) rulings operationalize specific injunctions from the primary texts, four basic principles govern at least 80% of all Islamic transactions:

* Riba-Free Transactions: The Arabic word riba refers to "increase" or "addition", and in the commercial context refers to any incremental increase, however great or small, above the original lent or exchanged amount. While riba is of many types, the most common kind is ordinary

commercial interest, where the borrower compensates the lender with an interest payment for the right to use a sum of capital over a period of time.

Often riba is translated as usury, and because in modern times usury normally refers to exorbitant rates of interest, Muslims often mistakenly regard seemingly benign commercial rates of interest as something other than riba. In reality, however, riba refers to any increment above the principal amount, whether it is a soft, development loan charged at 1% annually or a usurious consumption loan charged at 10% monthly. So riba includes both usury and commercial interest.

* Risk Sharing: The concept of risk sharing is common to all Islamic finance transactions, whether equity, trade, or lease based. A few additional conditions make Islamic finance transactions even more equitable in many cases; such as the ruling that silent partners receive profit no more than is proportionate to their investment, while they may receive less; and that working partners may enjoy more pre-agreed profit than is proportionate to their investment, reflecting an emphasis on reward for work rather than reward for merely possessing capital.

The popularity of debt-style, interest-free instruments like Murabaha (mark-up financing) reflects the infancy of the Islamic banking industry and the tendency to gravitate towards something that mimics interest. But even in Murabaha transactions, where the bank intermediates a purchase by buying the good and charging a mark-up in advance, the condition imposed by the Shariah, and absent in a conventional loan agreement, is that the Islamic bank assumes some of the risk as well by holding the good for a period of time. Few conventional banks will choose to own anything, even if only for a short period.

This distribution of risk is itself an equity-based principle. Such seemingly insignificant conditions are often lost in contractual minutiae, and often confuse the layman into thinking that there is no difference between a given Islamic product and its conventional counterpart, but when things go wrong, the details in an Islamic contract place particular emphasis on the equitable distribution of risk.

* Asset and Service Backing: Because Islam restricts the treatment of money as a commodity by declaring unlawful any profit earned from the exchange of like currencies, regardless of the time value of money, transactions are backed by an asset or a service. Asset and service backing ensures that real assets and inventories are created, rather than pyramidic money-lending schemes where money simply creates money and market volatility increases unchecked. Even monetary losses due to inflation are overcome by denominating the exchange of money into an asset with intrinsic utility, such as gold.

Because Islamic banking relies on asset and service backing rather than interest payments, conventional bankers often point to Islamic banking's inability to service demand for short-term loans. This is less true now than ever before. Islamic banks have now gained the expertise and scale necessary to conduct a broader set of activities. Across the world, Islamic bankers now provide car and home loans, fund short-term working capital requirements, and offer a range of shelf-like instruments.

* Contractual Certainty: Contracts play a central role in Islam. The uncertainty of whether a contractual condition will be fulfilled or not is unacceptable in the Shariah and creates gharar (ambiguity or uncertainty leading to dispute). Conventional insurance, interest, futures and options all contain an element of contractual uncertainty. This is distinct from commercial uncertainty, such as whether a business will be profitable or not, which is acceptable because there is an asset (such as property, plant and equipment) or a service (such as labor) underpinning the risk.

Some of the above mentioned differences between Islamic and conventional banking seem inconsequential, even trivial to some, but these ostensibly insignificant conditions spell the difference between financial dynamism and financial disaster, as will be shown later.

The similarities between Islamic banking and conventional banking far outnumber the dissimilarities, because the basic principles of finance remain the same. Companies still only raise cash in one of two ways, with the first method conforming to Islamic principles: 1) by issuing equity, or stocks, done by selling shares in a company, where the rise and fall of the share's value reflects the holder's share in profits and losses; and 2) by raising debt, or large IOUs called bonds, which obligate the company to repay the holder some fixed-income at some given maturity. Like conventional banking, Islamic banking enables the profit-motive, fosters a spirit of transparency and corporate responsibility, and ultimately seeks to promote shareholder value, all within the guidelines of the Shariah. Capitalism, if you will, without the after-taste.

So how do equity-based Islamic banking and interest-based commercial banking compare in practice? The question should be answered on three levels: 1) the profit impact; 2) the economic impact; and 3) the social impact. It is worth emphasizing that in the longer term these levels are inter-related. No company profits unfairly, or suffers adversely, without having a negative residual impact on the economy. And no economy suffers without some concomitant social cost:

* Profit Impact: Comparing the profitability of equity and debt, history is quite telling. Between 1926 and 1999 in the United States:

$1 invested in small stocks would now be worth $5,117;

$1 in large stocks, $2,351;

$1 in corporate bonds, $61;

$1 in government bonds, $44; and,

$1 invested in an extremely safe Treasury bill would now be worth $15.

Out of 54 possible 20-year periods between 1926 and 1999, stocks outperformed bonds all 54 times. For the risk averse among us (i.e. bondholders), in bad times the highest returning bonds still managed worse than the lowest returning stocks. In the worst 20-year period for large stocks, $1 grew to $3.11, and for intermediate government bonds, $1 grew to $1.58 (Ibbotson Associates, 1999). We have to rethink our concept of risk. The perceived long-term safety of bond investing is as illusory as its profitability is real. Equity is not only historically more profitable but, as these numbers convincingly show, the safer long-term choice. Even risk-adjusted returns are higher for equity than they are for debt.

* Economic Impact: The primary objective of most commercial banks is to increase profit by extending loans to creditworthy individuals at the highest possible rate while undertaking the least amount of risk. But this objective focuses both borrower and lender on repayment, not profit. Typically, the lender has little active interest in the borrower's business; only an interest in the borrower's ability to repay, often at all costs, including the well being of the business and the borrower. Equity focuses on profit (and loss). If the principal (lender) has an equity share in the business, he will have an almost exclusive focus on the profitability of the business. Knowing that a loss is possible, the principal will make every effort that the agent (borrower) succeeds.
In a debt transaction the borrower loses everything if the business fails, and is still left to repay. While in an equity transaction, the agent loses nothing if the business fails, besides time and effort, and has nothing to repay. Further, debt inhibits innovation by putting undue focus on repayment schedules while equity promotes innovation by focusing on the business itself. Small, growing businesses need to invest time and money to innovate before becoming profitable, a task made difficult by even the most lenient repayment schedules. Early repayment by the borrower precludes reinvestment into innovating the business, while delayed repayment increases subsequent payment sizes.
Too, the confrontational nature of interest-based lending debilitates business. In a debt transaction, the lender and borrower work in conflict, having to negotiate and renegotiate repayment schedules and lending rates. In an equity transaction, the principal and the agent work in concord to make more money.

From a distributive justice perspective, debt tends to centralize capital into larger corporations that are more able to match stable cash flows with repayment schedules. Equity, on the other hand, is more distributive in that it favors smaller companies that provide a greater profit potential. Speculative debt-based borrowing, including borrowing to finance equity purchases, triggered almost every major financial disaster in the modern capital market era. The negative effects are not merely money-deep; debt affects the collective consciousness of the business community, creating a demeaning and disempowered "borrower culture" rather than a vibrant and productive "investment culture."
* Social Impact: As the Quran mentions in relation to wine and gambling, "In them is great sin, and some profit for men; but the sin is greater than the profit." (2:219) So too, interest has its share of convenient, short-term advantages, but like other evils, comes at the price of a broader social impact.
Real world examples are illustrative. The IMF and the World Bank aggressively disbursed loans for decades in the name of economic rehabilitation and poverty alleviation. Now recipients of their soft loans and structural adjustment programs are deeper in debt than ever before. Their non-usurious, low-interest loans compounded over time to create a situation where interest payments now exceed original principal amounts often by several orders of magnitude. The world's poor now pay several times more in interest payments than they do in all social services combined, leaving us with damning evidence that the debt-based sincerity of the IMF and the World Bank only served to spread world poverty.

At a commercial level, interest-based lending centralizes capital into fewer hands. The common man puts a higher proportion of his wealth into interest-based instruments than the wealthy man because he lacks the capital to make long-term investments and requires a ready source of liquidity, like a bank deposit, which returns a low rate. At the same time, the common man's lower disposable income requires him to continuously borrow capital for consumption purposes, like financing a car, a home or an education. For this, the same man earns a low interest rate and is charged a high borrowing rate.

The owners of capital, on the other hand, include high-worth, decision-making stakeholders of society, like banks, corporations, the government, institutional investors and wealthy individuals. By charging interest, they access the borrowers' and depositors' capital at relatively low rates and allocate them with other owners of capital (often in the form of equity-based investments) for significantly higher profits, which serve only to centralize capital among owners. This is neither conspiracy nor collusion. This is the nature of interest. The lines between borrower, depositor and owner are rarely well defined, but one fact remains: the nature of interest-based lending is such that the lower one's income, the higher one's borrowing rate and the lower one's return on deposits. Equity, on the other hand, levels the playing field, so that large and small investors share identical returns.
With global trends headed in the direction of equity (evidenced by the dramatic emergence in recent decades of the individual investor; the success of the mutual fund; the proliferation of new stock exchanges and equity indices; and an increase in global privatizations) there seems to be a collective acknowledgement that equity is the investment of choice. Debt continues to be a corporate mainstay as the cheaper source of financing, particularly among large, stable borrowers able to reduce their cost of capital by matching expected cash flows with future debt repayments. But to choose debt over equity has severe implications, not just for the business itself but also for society as a whole. Leaving Islamic banking as not only a viable and profitable choice, but also a responsible one.

Author: Cathyearnshaw

[Read More...] - Demystification of Islamic Banking

Prohibition of interest in Islamic Finance

Islamic economics is referred to as the application of Islamic Shari'a law in economic activity. This form of economics has attracted banks and financial institutions in more than 56 countries including Europe and the United States; they cater to customers who want to invest in a halal instrument, or according to Islamic teachings.

Muslim authors state that Islam offers solutions to solve problems of human civilization. They view the financial problems facing developed countries in Africa and Asia are caused by interest-based financial instruments which create "unrepayable debt" says Muhammad Ayub, author of Understanding Islamic Finance. Mr. Ayub goes on to say that interest-based system makes "a class of people richer and leaving others poorer and oppressed."

Suppose you deposit in a conventional bank $1000, at 4 percent interest for a period of one year. At the end of the year, your return is predetermined at $1000+40. The bank will invest your money. If it fell short of $1040, the bank will incur a loss. So an interest-based loan places the risk entirely on the borrower, in this case, the bank. Under Islamic economics, this type of investment is prohibited and is considered "un-Islamic" and "unfair."

The source of prohibition of interest is based on the Qur'an. Verse 2:275 reads: ". . .Allah permits commerce and prohibits riba. . ." The etymology of the term riba comes from Aramaic raba meaning ‘increase'. Muslim interpreters define this term as ‘interest'. In pre-Islamic Arabia, a borrower saw his debt double following a default and redouble if he defaulted again. If the borrower was unable to pay off his debt, he would be pushed into enslavement until the debt is paid. Such a situation was creating a social disharmony in Arabia, to which the Qur'an was responding. The ban on riba was therefore an instrument used to avoid mistreatment of fellow citizens, when their financial situation was in distress.

Among the Muslim community in the Middle East and elsewhere, financial transactions involving interest on borrowed money are accomplished, but without mentioning the word ‘interest'. For example, Y wants to borrow from X $500 at 5 percent interest without violating the prohibition. X buys a TV system from Y for $500 but then promptly returns it for $525, payable in one year installments. The additional $25 represents interest but was not mentioned; it was circumvented instead by the purchase of the TV and selling it, immediately, to the borrower at a higher price, which is equivalent to the amount of interest.

The most popular instrument in Islamic banking is Murabaha, a contract of sale in which a commodity is sold for a profit. The contract involves the purchase of real property by the financial institution which then sells them to the client at an agreed mark-up. A repayment is usually in installments. Accordingly, X wants to buy a car from the dealer and finance the transaction through a bank. Under Islamic economics, the bank does not charge interest. So the bank will buy the car on behalf of the buyer, and immediately sells it to X at the dealer's price plus an extra amount of money for the time spent and the paperwork involved to finalize the deal, the extra amount represents interest on the borrowed money, but the contract does not use the word ‘interest'.

All Muslim authors and practitioners of Islamic finance agree that charging interest is a violation to Islamic Shari'a, but there is no agreement on the definition of ‘interest-free' loan. There is no account for the rate of inflation in this Islamic instrument. In order to protect the purchasing power of money, loans are indexed to the rate of inflation, which is absent from Islamic banking and was proclaimed un-Islamic in two international conferences on indexation, one held in Islamabad in 1986 and the other in Jeddah in 1987.

Critics of interest-free banking claim that those who call for prohibition on interest are guilty of misinterpreting the Qur'an and misreading Islamic history. The Qur'an bans, not interest rate, but usury, or exorbitant interest.

Suleyman Uldag, a prominent Turkish author suggests that "even if interest were unlawful, it would be a lesser sin to deal in interest openly than to cloak it in practices aimed at deception." He writes that "Islamic banking is its own worst enemy."

Another attack on the prohibition of interest came in 1989 through a fatwa (Islamic legal opinion) from Muhammad Sayyid Tantawi, the grand mufti of Egypt and head of the top Islamic university, al-Azhar, who said that simple bank interest is permissible in Islam, while excessive interest rates constitute riba (usury) and thus forbidden. Tantawi added that legitimate instruments, including high-yield government bonds and interest-bearing saving accounts are compatible with Islamic Shari'a. Tantawi's fatwa represented the minority view, and provoked considerable discussion among the Muslim community in Egypt and around the world.

Author: Gabriel Sawma, Esq

[Read More...] - Prohibition of interest in Islamic Finance

Islamic Banking

ISLAMIC BANKING industry is a very different industry compared to the banking sector we see these days. This type of Banking is totally based upon the principles of Islamic law which is also known as Sharee'ah in Arabic. This style of banking industry follows the Islamic economics and it forbids the involvement of interest. The Interest in the Islamic principle is strictly prohibited and is considered as Haraam (forbidden). Many banks in Muslim and non-Muslim countries follow Islamic banking, the Islamic banking sector has experienced a boom in the late years of 20th century.

Islam terms interest as "Riba" (vigorish), and all the products introduced by Islamic Banks are Riba-Free that means that it does not involve interest neither in payments nor on loans. The main concept of this type of banking is that a particular amount of service charged should be charged from the person who is experiencing the banking service, but interest is something should not be applied at any stage in any Islamic Banking Product.

Several financing activity concepts were developed during the early stages of Islamic Banking; these include different forms of partnerships "mufawada" which is the first form of partnership, "mudaraba" limited form of partnership and "al-mal" capital investments. Many of these financial concepts that were developed in the Islamic banking stages are still in practice in popular non-Islamic banks.

Many Muslims are reluctant to invest their money because of the concept of Interest is prohibited in Islam and therefore this type of banking is important in catering the needs of this important segment of the market in both Islamic countries as well as non-Islamic countries. As this style of banking offers a lot more to all its customers therefore it has been gaining popularity not only in the Islamic region but in the non Islamic regions as well.

Author: Ahsan Ayub

[Read More...] - Islamic Banking