Islamic banking is an ingenious a banking system that is based on two basic principles. One is sharing of profit and loss and two the prohibition of the collection and payment of interest by lenders and investors. Collecting interest is not permitted according to the Quran.
Basically if you invest you money in my company, you get half of the profit and I get half but if the company goes bankrupt and losses all it’s assets you get nothing back for your investment. You do not get interest.
For example, in 1963, Egyptians formed an Islamic bank in Mit Ghmar. When the bank loaned money to businesses, it did so on a profit-sharing model. To reduce risk, the bank only approved about 40% of its business loan applications, but the default ratio was zero.
REAKING DOWN ‘Islamic Banking’
Since this system of banking is grounded in Islamic principles, all the undertakings of the banks follow Islamic morals. Therefore, it could be said that financial transactions within Islamic banking are a culturally distinct form of ethical investing. For example, investments involving alcohol, gambling, pork, etc. are prohibited.
How Do Islamic Banks Earn Money Without Using Interest?
In order to earn money without charging interest, Islamic banks use equity-participation systems. This means that if a bank loans money to a business, the business pays back the loan without interest, but it gives the bank a share in its profits. If the business defaults on the loan or does not earn any profits, the bank does not receive any profit either.
What’s more is the fact the bank cannot take on high risk investment such as selling short or buying long. For example the can only offer rent-to-own model. Banks buy the house or what ever investment under their name and the then the tenant pays rent till the full price of the house is pain in set period of time. Obviously bank can price the house higher than cost of the house to make profit.
I think, the short coming of such system is in the area of credit loans and time-value-of-money. I think, banks should not be allowed to play with other people’s money and move it out of the bank to invest somewhere or give out loans. Banks can give loans using it’s own money however. But not those customer who have opened a bank account with them.
Banks should create an app or platform where customer can meet entrepreneurs directly and consent to any investment.
By time-value-of-money I mean in a sense that inflation cause rise in prices and lower purchasing power of a currency. That’s why we need to introduce sound money backed by gold and silver. Then it does not matter how long you keep you money, it value will remain constant or go up as the demand for gold and silver rises and prices goes down as result efficiency industry and production processes.
I have blocked a domain name for my business idea Vesta International Bank which will be savings and investment that uses Islamic banking system and solve the shortcoming mentioned above!
Very interesting topic, money doesn’t need to be backed by anything to be ‘sound’. The only reason there is any value in the first place is because it is universally accepted that way. It is a medium of exchange, and very complicated. I think its a good idea to follow this Islamic banking stuff though. The only obstacle is the fact that starting your own bank even international bank will cost a lot of money. Whats crazy is that most people actually buy newly established banks off of others instead of starting from scratch. Apparently starting a bank costs relatively the same amount as buying a pre-existing one. There are actually people who set up banks and sell them for a profit.
Yes, very interesting topic indeed. I am surprised at this idea and have never really heard of anything like this before. I wonder how successful this will be as the idea grows or is established. I would be interested in keeping an eye on this. Very Unique!! Great post!