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October 23, 2011 / 74

Lybia and Sharia Financing

In a story today, Al Jazera online says that,

The National Transitional Council (NTC) has declared the liberation of Libya …

And Mustafa Abdel Jalil, head of the NTC said,

We as a Muslim nation have taken Islamic sharia as the source of legislation, therefore any law that contradicts the principles of Islam is legally nullified,” Jalil told the crowd.

So… knowing that “interest” on loans is Haraam (forbidden), and being interested in economics and finance, I wondered about how a bank would operate under such rules. After all – banks make their money by lending out money and charging interest for it (interest representing the “fee” that the owner of the money charges for letting someone else use it instead of spending it immediately themselves.)

Now – if I get it wrong, if I misunderstand how it works, I’d like someone who knows better to please correct me.

It seems that first of all transactions involving fiat currency, since it isn’t REAL money and has no REAL value, can be loaned at interest without being Haraam (forbidden).  So a Muslim could happily charge you interest without violating sharia law if you’re using US dollars for the transaction. How does it work if you’re using something with REAL value for the transaction? Well, since the REAL value must be considered, interest could not be charged.

What an Islamic bank would do is this. Let’s say you want to buy a house. You go to the bank, and if they think you have the ability to pay for the house, the bank will buy the house, then flip it and sell it to YOU at a profit to them, and you will pay for the house in equal installments and you know the total cost of the house from the beginning. No interest is charged – but the bank makes money on the deal. Same story if you wanted to buy a car.

But say you want to go into business. In such a case, the bank “invests” bank capital in your business, you do the work in the business, and you and the bank share in the profits until the bank’s capital is paid back.

There are some other wrinkles in the system, but the base principle is that in such an arrangement, the idea is that the bank (capital) and the business owner (labor) share both risk and reward.

And of course, the bank or the financing individual cannot invest in ventures that would involve Haraam things like alcohol, pork, etc. (So you couldn’t get an Islamic loan to open a barbequed pork restaurant. ;-D)

Also putatively banned are contingent transactions (transactions involving uncertain events in the future), and speculative transactions. So the whole derivatives and credit default swaps rip-off could not have happened under Islamic Banking.

There are other nuances in Islamic finance and banking, including that a true Islamic finance system would theoretically be a “full reserve” system – with the banks achieving (theoretically) 100% reserve ratio…So what sharia law really does in this case is to provide a regulatory framework for the banking system – you know – like US law did before the repeal of the Glass-Steagall act?

If you find the subject interesting, I’d encourage you to do some researching. (I especially like the implicit understanding that fiat currency has no value. Poke THAT in your Federal Reserve/Central Bank/fractional reserve banking system!)


(Portions of this article and the main source of information was, yes, the Wiki referenced below. Wiki’s are good when you’re not after a degree in something, but would like to get a general idea of it.)


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