Interest Free Banking a Reality?

The Ugandan government has embraced Islamic banking as evidenced by Cabinet’s recent approval of the same with the proposed Islamic Banking Bill 2014 currently before the Uganda Law Reform Commission undergoing a few changes, and likely to be tabled on the floor of Parliament soon.

Islamic banking is Sharia-compliant banking based on the principles of trade, partnerships, Profit and Loss Sharing (PLS) and the prohibition of reckless risk. Specifically, it prohibits interest-based banking, speculation and financing of haram transactions such as gambling and alcohol. It has the same purpose as conventional banking: to make money for the bank by lending out capital. However, the Islamic economic system revolves around the prohibition of interest. Two of the several Islamic banking products that avoid the concept of interest are Musharaka and Murabaha.

Under a Musharaka contract, the bank provides the money while the client provides the business expertise, and profits are shared at a predetermined ratio while losses are borne exclusively by the bank, having provided all the capital initially. This is essentially a partnership loan between the bank and customer. The bank obtains ownership interests in the assets it finances, or earns a profit-share. Because of the bank’s involvement in the implementation of the project, it has a higher likelihood of success, which should see more successful investments.

On the other hand, Murabaha is cost-plus financing. Because Islamic banks are prohibited from making returns on money lending, these contracts provide for the bank to buy an investment good or commodity on behalf of the client and resell it to the client at a fee which enables the bank to make a profit. So, for example, an Islamic bank will not offer an interest loan to clients to buy a house, but will buy the house instead and sell it to the client for a profit.

Between 2010-2012, interest rates of some commercial banks in Uganda were as high as 30-32 percent. Islamic banking, being interest-free, should increase access to investment finance and see a rise in entrepreneurship projects, as well as boost competition in Uganda’s banking sector inevitably leading to provision of more efficient and better banking services.

Kenya and Tanzania have already embraced Islamic banking with banks such as Standard Chartered offering Islamic banking windows. Kenya’s central bank introduced Sharia-compliant bonds, also known as Sukuk which are bonds backed by an asset, with the bank sharing in the profits derived from the assets. Islamic finance currently accounts for about 2 per cent of the total banking business in Kenya, with corporations making up a considerable portion of the clientele. In Tanzania, Islamic banking gained such popularity upon its introduction more than seven years ago that demand for it eventually far exceeded supply. This was due not only to the large number of Muslims in the country, but also to the lucrative services and partnerships that Islamic banks have offered.

In Uganda, only 8.3 percent of the Ugandan population use banking products, and the Muslim population is only about six million of the total population. Islamic banking products would likely be particularly appealing to Muslims, but would also be available to all Ugandans and should be a viable option for the majority of youthful entrepreneurs and low-income earners, regardless of religious affiliation.

It is noteworthy that the Financial Institutions Act of Uganda (2004) neither envisages nor provides for Islamic banking. The proposed Islamic Banking Bill (2014), therefore, would provide a much needed regulatory framework to realise the benefits of this alternative banking model.

Source: http://www.independent.co.ug/column/comment/9392-interest-free-banking-a-reality-

Islamic Banking VS Conventional Banking

Islamic banking has developed  recently.  Put forward  to be having high ethical criterions, the banking system upraises questions from many.  First of all, we should answer some questions like that in this field.   Are these standards just a sham —a smart  way to hide  that Islamic banks are basically like any other?  Are they a real attempt to reunite religious principles with finance in a capitalist world?

To answer if Islamic banking is totally different from the conventional banking system, we  should know the history of  this  interest-free  banking system.

Origin of Islamic banking

The most important property  of Islamic banking is its banning  of  interest. Doing business  without the use of interest-bearing loans, in the form of Mudaraba rules, advances the coming  of Islam.

Before Islamic period, Arabs  in Mecca, close to the crossroad  of old commerce  routes, coordinated  caravans to carry  goods between Syria and Yemen.  The Meccan merchants  sometimes  used agents to deliver the goods, buy, sell and report back with the numbers for profit or loss.  Later on, it  was  shared according to the traditional  principles  of Mudaraba.

When a merchant  united with others in a shared trading initiative, the profits or losses were shared, under an another principle called Musharaka, suitable  for an agreement between participating sharers in a trade.  Therefore,  the trading caravans were capitalized with  the principle of  sharing profits or losses, not by interest-bearing loans.

Smaller communities

Before modern banking system becomes popular, Mecca was a quite small town, and the forming  a trade caravan was a principal  occasion.  The travelers and their patrons were acquainted  with one another’s general fame  and status, and possibly knew each other as a  person.  That continued true of societies in the early Muslim period.

But, society is more disunited in today’s world.  Rich people  to invest do not need to know anybody  with an  initiative  that requires capitalizing, and people who have trade thoughts may have no contact  with possible investors.

The conventional banking system has grown up to intercede  between the groups of people, enterprisers and investors.  To exist, the banks obviously  have  to make a profit.

Prohibition on interest

The prohibition of  interest (riba) on loans in Islamic banking system is well known.  Riba is considered as haram, or forbidden in Islam.  But to operate  a bank needs  to charge some fees for its services.  For conventional banks, a principal  of profit is from revenue that is obtained from charging interest.

In contrast, Islamic banks make their profits in other ways such as ‘profit-sharing’.  Is it possible for Islamic principles of profit-sharing rather than interest taking to transfer from the  trading caravans to the anonymous banking system that we experience now?

The old systems of Musharaka and Mudaraba survive in the modern Islamic banking system.  They both refer to ways of sharing risk and reward in place of remuneration at a fixed interest rate.

Mudaraba is used for a more passive kind of investment or participating, in which  one side supplies capital or goods, and  the other side  carries out the work necessary  to gain  a profit.

Musharaka presents  a more active investment style by a person  who is either a partner in the business or  a supplier of money.

A very distinct  difference of the Islamic banking system over conventional banks is on the sharing of risk, that is equally spread to either the lender or borrower.