Islamic banking

By most modern interpretations, Islamic law forbids charging interest. So some modern banks have found ways to profitably lend money without it.

Meezan Bank headquarters
Nomi887, CC BY-SA 4.0, via Wikimedia Commons

The Quran has the following to say about the practice of charging interest:

Those who consume interest will stand on Judgment Day like those driven to madness by Satan’s touch. That is because they say, “Trade is no different than interest.” But Allah has permitted trading and forbidden interest. Whoever refrains – after having received warning from their Lord – may keep their previous gains, and their case is left to Allah. As for those who persist, it is they who will be the residents of the Fire. They will be there forever.

Al-Baqara, 2: 275

Now, there’s some scholarly debate about whether the term used in the Quran – “Riba” – really applies to all forms of interest. However, for most Muslims the verse above is a pretty clear ban. For modern banks, this opens an interesting challenge. How do you lend money without charging interest, and yet still remain financially viable?

Today, more than three hundred banks worldwide are compliant with Islamic law. They do this through a range of complicated financial instruments based on principles from the Quran. One (simplified) example is mudarabah, used to fund a business. The bank and the entrepreneur are not “lender” and “owner,” but instead partners in a shared enterprise. The bank provides the money; the entrepreneur provides the expertise and manages the business. If it makes money, both the bank and the businessperson get a share of the profits. If it loses money, the bank loses its investment and the entrepreneur loses the time and effort they had sunk into the business.

Alas, this particular type of partnership is not actually that common any more – for the banks the risk was too great. Instead, the most popular instrument is called murabaḥah. Say you want to buy a house, but you don’t have the money. The bank will buy the house first and then sell it to you. But they’ll sell it to you at a profit to themselves – which is perfectly allowable under Islamic law. And they’ll allow you to pay it off over time – also acceptable. The bank pockets the profit and the buyer keeps the house.

Some Islamic scholars consider murabaḥah to be a dodge, a way of charging interest without saying that you’re charging interest. Even for its supporters, it was supposed to be a kind of transitional instrument on the path to the profit-sharing structures like mudarabah. Debate about these methods of finance continue today, but the Islamic banking sector continues to grow regardless.

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