Interest Free Banking – MBA FINANCE

People have needs — food, clothes, houses, machinery, services; the list is endless. Entrepreneurs perceive these needs and develop ways and means of catering them. They advertise their products and services, peoples expectations are raised and people become customers of the entrepreneur. If the customers’ needs are fulfilled according to their expectations they continue to patronise the entrepreneur and his enterprise flourishes. Otherwise his enterprise fails and people take to other entrepreneurs.

Banks too are enterprises; they cater to peoples’ needs connected with money — safe-keeping, acquiring capital, transferring funds etc. The fact that they existed for centuries and continue to exist and prosper is proof that their methods are good and they fulfill the customers’ needs and expectations. Conventional commercial banking system as it operates today is accepted in all countries except the Islamic world where it is received with some reservation. The reservation is on account of the fact that the banking operations involve dealing in interest which is prohibited in Islam. Conventional banks have ignored this concern on the part of their Muslim clientele. Muslims patronised the conventional banks out of necessity and, when another entrepreneur — the Islamic banker — offered to address their concern many Muslims turned to him. The question is: has the new entrepreneur successfully met their concerns, needs and expectations? If not he may have to put up his shutters!

Broadly speaking, banks have three types of different customers: depositors, borrowers and seekers of bank’s other services such as money transfer. Since services do not generally involve dealing in interest Muslims have no problem transacting such businesses with conventional banks; neither do Islamic banks experience any problems in providing these services. Among the depositors there are current account holders who too, similarly, have no problems. It is the savings account holders and the borrowers who have reservations in dealing with the conventional banks. In the following paragraphs we will see how well the Islamic banks have succeeded in addressing their customers’ special concern.

Islamic banking, characterised by interest-free loans and deposits, has become an increasingly popular area of innovation in international financial markets. This dissertation provides a brief background to the reasons for prohibition of a predetermined rate of interest and introduces the reader to the Islamic alternative to the interest mechanism–the profit and loss sharing system. In conventional banking, the bank charges the borrowers interest on their loans and pays the depositors interest on their deposits. Both are called interest, though the former is always larger than the latter. Interest is also called usury. The Arabic word riba is often translated as both usury and interest. This begs an interesting question: are they all the same? If they are different, what does each mean? Muslims claim that charging interest on loans is prohibited. If so, how does a bank meet its operational costs? The answer will come in my next article.

Read Next