6. IN THE ABSENCE OF LENDING AT A RATE OF INTEREST, WHAT MODES OF FINANCING CAN BE USED FOR: A) TRADE AND INDUSTRY FINANCE, B) FINANCING THE BUDGET DEFICIT, C) ACQUIRING FOREIGN LOANS?
Although Islam objects to the concept of interest, it offers several other legitimate instruments of finance, through which commercial activity could be conducted. For financing trade and industry Murabahah (installment sale), leasing and salam are permissible options. Also the concept of istisna could be employed for transactions. Participation in equity markets of companies is made possible; so also is “timed and diminishing musharakah with clients”. Since trade and industry financing is required for purchasing raw materials, goods and fixed assets, these modes of financing come handy. They can also help alleviate working capital requirements (which are predominantly monthly recurrent expenses) for a business organization. Similarly, Islamic scholars have devised legally valid instruments of finance for solving budget deficits. They have also conceived alternative funding arrangements to foreign loans.
7. WHAT IS AN ISLAMIC BANK? HOW DIFFERENT IS IT FROM A CONVENTIONAL BANK?
The first major difference between conventional banking and Islamic banking is that the former is a system of heterogeneous models, whereas the latter is standardized and homogeneous where ever it is implemented. There are also two broad categories of conventional banks – commercial banking and universal banking. Commercial banks face risks such as moral hazard and information asymmetries between the borrower and the lender. It also bears certain inefficiencies in its operations. Universal banking is relatively less risky as well as more efficient. An Islamic bank, on the other hand is a “deposit-taking banking institution” which offers a wide-range of financial services to customers, excepting borrowing and lending for interest. It uses mudarabah or wakalah contracts to mobilize funds; it can also accept demand deposits. The underlying operating principle of Islamic banks is adherence to laws set out in the Shariah.
8. IF BANKING WERE TO BE BASED ON INTEREST-FREE TRANSACTIONS, HOW WOULD IT WORK IN PRACTICE?
Since the services offered by Islamic banks are comparable to those offered by conventional banks, it is interesting to learn how they accomplish this despite limitations imposed by Islamic scriptures. To begin with, Islamic banks are structured as joint stock companies where shareholders are represented in the Board of Directors. The contracts of mudarabah or wakalah are employed during the resource mobilization process. In the absence of interest payments, a profit/loss sharing mechanism is worked out with investors based upon proportionate capital contributions. Investors could choose a generic deposit or a specific investment opportunity. Islamic banks also use interest-free current accounts to manage cash-flow and other investment needs.
9. DO WE REALLY NEED ISLAMIC BANKS?
As with conventional banks, Islamic banks perform the most crucial social function of financial intermediation, whereby they serve to bring together savers, investors and entrepreneurs. Financial intermediation streamlines an economic system and facilitates transfer of funds from lender to borrower, where the latter can utilize these funds for infrastructure development, industry expansion and other projects. By allocating resources on a production basis, Islamic banks provide incentive to development projects as opposed to dubious/risk-prone investment opportunities. Hence, Islamic banks offer a safer and more productive deposit schemes for its customers.
10. IS ISLAMIC BANKING VIABLE?
Organized Islamic banking is relatively new compared to conventional banking systems. As Islamic banking procedures, deposit schemes and other services keeps evolving, they will eventually be able to compete on par with Western banking institutions. Even as it is, Islamic banking is gaining a positive reputation for delivering superior returns. Islamic banking is even adopted in some non-Muslim countries, which serves as a testament to its viability and principles of operation.