Islamic finance is a banking system that affects many Islamic countries around the world and has key differences from conventional banking.
Ibrahim Khan, Interest-free loans are possible under Islamic banking – Ibrahim Khanstated that Islamic finance holds several unique attributes regarding debt, ownership, and types of assets or business vehicles permitted or prohibited.
“The key thing about Islamic finance is that there are some big no-no’s,” Khan said. “Interest is not allowed. You are not allowed to have excessive uncertainty in transactions. So, for example, gambling or spread betting would be problematic.
He added that, given the prohibitions against interest, gambling and immoral activities, “Muslims need to think carefully and structure [a loan] in a way that makes it work.
Khan spoke with David Lin, presenter and producer at Kitco News.
ZERO INTEREST LOANS?
In Islamic finance, lending with interest is considered haram, or forbidden. Rather, Islamic loans are structured like equity contracts.
Khan gave the example of a borrower who only has $5, but needs to buy a pencil for $10. An Islamic bank would lend the borrower the additional $5, in exchange for a 50% stake in the pencil.
There would then be rent payments instead of interest payments.
“In fact, I would rent [the bank’s] proportion of the pencil,” Khan explained. “Let’s say it’s $5 in rent over the next year for [the bank’s] proportion, and I will buy it [the bank].”
Over time, the borrower would pay “rent” on the 50% of the pencil the bank owns, while buying back the entire equity of the pencil.
Khan admitted that rent, in this case, is similar to interest payments. However, he said that “from a risk perspective… [the bank] was actually taking a risk of ownership in the pencil. If anything happened to the pencil, [the bank] would end up losing.
Central banks generally conduct monetary policy by buying or selling interest-bearing bonds and setting interest rates. They, in turn, interact with retail banks, which create money through fractional-reserve lending. Such activities would be considered problematic in Islamic finance.
“We’ve never had a purely Islamic economy, certainly since the decoupling of gold from currency,” Khan said. “I think what would happen is you would have a public investment bank… This public investment bank would create new money and put it into infrastructure projects and other needed projects. This would be how new money enters the economy.
Khan said that although the question is “theoretical”, an Islamic central bank could be modeled on this public investment banking framework.
“The base rate or the prime rate would be tied to the money creation rate of this public investment fund,” he said. “That’s how you would control or curb the emission of money through the ecosystem.”
To find out what types of assets are allowed in Islamic finance, watch the video above
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