Lets bank the Islamic way?

[livingdead]

In simple words... lets say i am the Islamic Bank and John is the borrower. When John borrows $100 from me and makes a 20% profit on his business, I get back $120. And if in case John makes a 20% loss, i get back $80. This is what we mean by profit or loss sharing. In some ways it is similar to buying the share of a company.

To repeat why has already been pointed out:
An enterprenure does not like his equity diluted. That is why he would rather borrow money with interest than give share to somebody. If and when he wants to dilute his stake, he would like to do it in such a way, that he still retains control.

A bank does not have information/knowledge about profitability of all the business that take money from. Why would a bank want to take additional risk to invest in a company? I am talking about ordinary high street banks here.

The depositor in a normal high street bank thinks his money is safe, and he will earn a modest return from his account. He does not have the risk apatite to invest in stocks, which is why he is okey with very low returns.

As you can see, none of them want what you want them to do.

That is not to say a financial institution cannot invest in equity. In addition to VCs and other funds,there are investment bankers. Call them islamic banker if you wish. Here in UK they are called Casino bankers( not a nice term)
Till recently the regulators in UK allowed high street bankers have investment banking arm.
That created risk for ordinary depositor. Hence, current govt is going to ringfence the high street banking.

Please note, I am not against investment banking. I am opposed to it being the only form of banking(or preferred form).

 

[InFn-0]

To repeat why has already been pointed out:
An enterprenure does not like his equity diluted. That is why he would rather borrow money with interest than give share to somebody. If and when he wants to dilute his stake, he would like to do it in such a way, that he still retains control.

A bank does not have information/knowledge about profitability of all the business that take money from. Why would a bank want to take additional risk to invest in a company? I am talking about ordinary high street banks here.

The depositor in a normal high street bank thinks his money is safe, and he will earn a modest return from his account. He does not have the risk apatite to invest in stocks, which is why he is okey with very low returns.

As you can see, none of them want what you want them to do.

That is not to say a financial institution cannot invest in equity. In addition to VCs and other funds,there are investment bankers. Call them islamic banker if you wish. Here in UK they are called Casino bankers( not a nice term)
Till recently the regulators in UK allowed high street bankers have investment banking arm.
That created risk for ordinary depositor. Hence, current govt is going to ringfence the high street banking.

Please note, I am not against investment banking. I am opposed to it being the only form of banking(or preferred form).

Well, maybe the way i wrote up my previous posts led you to think im some pro-Islamic banking sorta guy but it is not that way, infact given the choice i'd probably prefer to borrow from a conventional bank due to my confidence in business. Anyway, i respect that there are certain drawbacks to the Islamic banking system and some folks might prefer conventional banking rather than what i understand to be Islamic banking.

Speaking of the debt problems that have arisen in europe and usa, imo these are not because of conventional banking problems, these are rather because of outlandish gambling practices in the name of "investment" in bubble stocks, bubble real estate and what not derivatives... in other words things that are not part of the core business.

 

[LEGENDARY WARRIOR]

okay..what does the bank gain from this?
Say,you are the bank.Why are you doing all this?How do you and your employee benefit?

Banks can profit from the buying and selling of approved goods and services. The principal means of Islamic finance are based on trading, and it is essential that risk be involved in any trading activity, so banks and financial institutions will trade in sharia-compliant investments with the money deposited by customers, sharing the risks, and the profits between them.

Islamic banks are structured so that they retain a clearly differentiated status between shareholders' capital and clients' deposits in order to make sure profits are shared correctly.

Although they cannot charge interest, the banks can profit from helping customers to purchase a property using a ijara or murabaha scheme. With an ijara scheme the bank makes money by charging the customer rent; with a murabaha scheme, a price is agreed at the outset which is more than the market value. This profit is deemed to be a reward for the risk that is assumed by the bank.

There are firm laws governing the types of business the banks can trade with. There should be absolutely no investment in unsuitable businesses, including those involved with armaments, pork, tobacco, drugs, alcohol or pornography.

 

[S.M.R]

Well I must say,this thread is getting more and more interesting,and its of course a certain degree of pleasure talking to you

Lets go back to the roots.How paper currency was started? There have been many attempts in the middle ages,some of the earliest forms of paper currency was found to be used in China around 900 AD,as noticed byb the esteemed traveller,Marco Polne failed attempt was made by one of the emperors of this sub continent,Muhammad -bin-Tughlaq.It took more of the present shape in the hands of Stockholm Banco,Sweden,which would hand over cheques in exchange for silver coins as it was inconvenient and risky to carry them around.Then came the dollar.In US,it was decided to replace the gold coin dollar with an equivalent cheque that certifies the bearer to have a sum of money equivalent to what the bank note says.say,if you have 100 coins,yo can exchange them for a bill of 100 dollar.So,it holds the same value what 100 gold coins could have.So,the value remains the same and your buying power is as good as what could have been with those gold coins.

Thats how the evolution happened.It made transactions easier.See,we should not have any problem,as long as that currency is acceptable across everywhere.It really doesnt matter what you call it,gold coin or a dollar,whats in a name?

Regarding the withdrawal of banknote part.Yes,yo are right,it has happened before in the past,where one country changes its currency.Not too distant past,many European countries changed their currency to Euro.Say Germany,they used Deutsch mark.But then those Deutsch marks were exchanged by the bank for Euro.So again,the bank has the liability,so,no problem there.

At the end of the day,what does it matter,by what name you call your currency?You should not bother as long as it has buying power.

Thanks for the history of paper money. You are right, there is no problem as long as 100 dollar bill is actually equal to gold worth 100 $. But that is only possible when the govt. has ensured the printing of such $ when it has same value of gold in backing of those $ being printed. The problem arises when govts. keep printing $ without sufficient backing of commodity having real intrinsic value (normally gold). So the 100 $ bill will not equate to the same quantity of gold as the time passes, bcaz of inflation. Had it been gold in place of 100$ bill, we have at least minimized or almost eliminated the effect of inflation. Bit offtopic but this is what I was trying to imply.

The bank is liable to pay back your money as per terms and conditions.

Yes, but as long as it has 'ability' to pay back. People realizing this fact prefer to invest in property / gold etc instead of taking interest from banks. Just consider the recent huge increase in gold prices, what do you see the reason behind that? This is now an open secret that most of the third world countries (even developed countries) who had reserves in US$ have started converting their reserves into gold. As they know, the dollar is valuable as long as it is acceptable, but gold having no boundaries, will be widely accepted and will fetch the 'real intrinsic value' for their reserves.

 

[S.M.R]

I am not the most educated guy when it comes to Islamic banking, but from what i understand, microsoft surely wont be taking 100% investment from banks. If they take $100 million and total investment was $1 billion(10% loan to investment ratio), and they end up making a $10 billion profit, then they would have to pay the bank $1 billion (10% loan to investment ratio). In my understanding, Islamic banking can be extremely profitable when economy is on a boom, and extremely "loss-able" during recession times. This way banks dont get to hoard up the wealth of the nation and they share the gain or pain of the other businesses.

Islamic banking is not based on giving money for the sake of getting returns and has nothing to do with the original business of its client.

It just enters into a business transaction with its clients and for sure it earns some profit on it. The client has to pay the agreed amounts irrespective of its business prosperity.

 

[nForce]

Thanks for the history of paper money. You are right, there is no problem as long as 100 dollar bill is actually equal to gold worth 100 $. But that is only possible when the govt. has ensured the printing of such $ when it has same value of gold in backing of those $ being printed. The problem arises when govts. keep printing $ without sufficient backing of commodity having real intrinsic value (normally gold). So the 100 $ bill will not equate to the same quantity of gold as the time passes, bcaz of inflation. Had it been gold in place of 100$ bill, we have at least minimized or almost eliminated the effect of inflation. Bit offtopic but this is what I was trying to imply.

Sir,
Lets face it.What magical property does gold have to control inflation?Inflation is a phenomenon that happens irrespective of the currency.Even if it is gold,it may still happen,and will definitely happen.If a commodity is scarce,then its price will increase,does not matter we buy it in terms of gold or paper currency.People will demand more gold coins for the same commodity if it is more scarce than before.
I can understand your inclination towards gold,its bright,shiny,malleable,ductile,and quite rare in this planet.Apart from that,does it have any other property that makes it a better form of currency than paper currency?At least paper currency is easier to carry than gold,which is heavier than iron.

Yes, but as long as it has 'ability' to pay back. People realizing this fact prefer to invest in property / gold etc instead of taking interest from banks. Just consider the recent huge increase in gold prices, what do you see the reason behind that? This is now an open secret that most of the third world countries (even developed countries) who had reserves in US$ have started converting their reserves into gold. As they know, the dollar is valuable as long as it is acceptable, but gold having no boundaries, will be widely accepted and will fetch the 'real intrinsic value' for their reserves.

Now you come to my area.The market has been serving as my bread and butter for quite some time.
Well,thats the way the market behave.Everything is dependent upon demand and supply.If the demand is more and supply is less then price of commodity will increase.Someone may apply hoarding tactics to that,nothing uncommon.
While the price of gold has increased,price of silver has increased in a higher rate,,and price of property has increased even in much much higher rate in my region.Now shall we replace gold by silver or property as the prime candidate for currency?Its just that the price of commodities are varying at different rate and gold is no exception to that.

One thing that I would like to see is an Universal Currency,a bigger set of Euro,a currency which can be used for International transactions.But one thing for sure,we will never be able to describe it in terms of absolute value,for there will always be a variation in demand and supply,and there will always be a variation in price.

 

[InFn-0]

The problem with gold backed currency is that you cannot increase its amount in the market as gold is limited. That way number of goods will increase and currency will remain stable. Which means in day 1 you will get 10 apples for $1 and in day 2 you will get 12 apples for $1, instead of inflation we will have deflation. That way people would be making percieved gains just by saving their money and not investing it anywhere, therefore willingness to invest will go down the drain.

 

[S.M.R]

Sir,
Lets face it.What magical property does gold have to control inflation?Inflation is a phenomenon that happens irrespective of the currency.Even if it is gold,it may still happen,and will definitely happen.If a commodity is scarce,then its price will increase,does not matter we buy it in terms of gold or paper currency.People will demand more gold coins for the same commodity if it is more scarce than before.
I can understand your inclination towards gold,its bright,shiny,malleable,ductile,and quite rare in this planet.Apart from that,does it have any other property that makes it a better form of currency than paper currency?At least paper currency is easier to carry than gold,which is heavier than iron.

Again, I am not saying that we should start using gold as currency in place of paper. What I am trying to say about is the intrinsic value of the currency. By which I mean whether we use gold / full bodied coins / or any other thing which has full intrinsic value OR we should keep gold / other valuables in reserves and paper money should be equal to those reserves. Now, how use of paper money cause inflation, that is simple, when govt. just keeps printing money without any backing, it causes inflation. There are no doubts about ease / advantages of use of paper money but its disadvantages are more damaging.

Now you come to my area.The market has been serving as my bread and butter for quite some time.
Well,thats the way the market behave.Everything is dependent upon demand and supply.If the demand is more and supply is less then price of commodity will increase.Someone may apply hoarding tactics to that,nothing uncommon.
While the price of gold has increased,price of silver has increased in a higher rate,,and price of property has increased even in much much higher rate in my region.Now shall we replace gold by silver or property as the prime candidate for currency?Its just that the price of commodities are varying at different rate and gold is no exception to that.

One thing that I would like to see is an Universal Currency,a bigger set of Euro,a currency which can be used for International transactions.But one thing for sure,we will never be able to describe it in terms of absolute value,for there will always be a variation in demand and supply,and there will always be a variation in price.

You are right. However, as I have said earlier that I am not saying the use of Gold as substitute of currency, however i ll strongly recommend to have your savings converted into gold / other precious commodities.

 

[nForce]

Again, I am not saying that we should start using gold as currency in place of paper. What I am trying to say about is the intrinsic value of the currency. By which I mean whether we use gold / full bodied coins / or any other thing which has full intrinsic value OR we should keep gold / other valuables in reserves and paper money should be equal to those reserves. Now, how use of paper money cause inflation, that is simple, when govt. just keeps printing money without any backing, it causes inflation. There are no doubts about ease / advantages of use of paper money but its disadvantages are more damaging.

I think we are nearing conclusion in this thread.
Yes,there is no limit for printing notes although it is conducted by the central bank of the country,and depends upon demand-supply curve.But it will be wrong just to say printing notes causes inflation,or more of a half truth.Actually it is both ways around.Printing a lot of notes causes a huge supply and less demand,hence resulting in inflation.Again a high inflation creates a huge demand and hence higher levels of supply becomes necessary.The later is called Quantitative easing.
There has been many past cases where the balance has been disturbed,say in case of Germany,right after First World War.Inflation was so high that Reichsbank could not simply keep up printing notes,and people used to get their salary daily,sometimes even twice a day,for the rates would change drastically,every hour.It has happened in Bolivia,where at one point of time,people had to carry a suitcase-full of money to buy a TV set,the good old wallet,just wont do.
but these are all examples of gross mismanagement and collateral failure of the economy of a country.

To avoid these the Central banks do NOT print indiscriminate amounts of bank notes barring those rare and desperate circumstances like that of the Reichsbank ,in the example I mentioned above.

Yes,material things like gold and property do come handy in turbulent times,as these are among some of those things which are always in demand.But then you will also have to keep two facts in mind,first liquidity,second market demand.
no matter how much gold/property you hold,it is of no use unless you liquify your assets,meaning you convert them into some form of currency so that you can exchange it for other commodities.People don't tend to buy gold or exchange it for anything when the time is rough.They just want to ride it out,they reduce their spending.That means,when it is recession time,there is a pretty good chance that your gold will lie idle in your safe.Everybody will try to sell it,and hence its value will decrease.

But then again when the times are good,you can always exchange those assets of yours for a good some of money.

You are right. However, as I have said earlier that I am not saying the use of Gold as substitute of currency, however i ll strongly recommend to have your savings converted into gold / other precious commodities.

Investing in commodities is always a good idea.Here in India,we even have Hindu festivals related to that,where people buy gold/silver.The festival is meant for investment only in a subtle manner.It is called Dhanteras,celebrated on the first day of the five-day Diwali Festival.

Quantitative Easing

Dhanteras

 

[TechMan]

No techman, your example doesn't fit here. Interest in Islamic Banking system is just like if take alcohol by saying that doctor has advised me to take some in order to keep myself active.

No mate your analogy regarding alcohol is incorrect for this case. I am not an expert in Islamic banking or commerce/economy but I know that the basic principle is you cannot earn money from using money. There has to be a product or service behind it.

Here is a much better reply by someone from another forum since I am not that knowledgeable.

The way it is supposed to work is for instance: If I take a loan out for a house. The bank owns the home to begin with, lets say its $200,000. They increase the price of the house and sell it to me, let's say $300,000. I pay back over 180 months (15 years), for 1666.67 per month. After the first year of payment I will own 6.66% of the house and the bank loses that much ownership.
If for some reason I default and can't pay anymore the bank can repossess the house and sell it or rent it out - whatever, its up to them. However any profit gets split based on ownership .. so if I own 6.66% of the house along with the bank. Now lets say someone else bought the house, he pays the bank and I get the 6.66% of the pay. Once he pays off the house he retains ownership and all other owners are now out of the picture - my original 6.66% may as well have been paid off first or slowly throughout.
I'm not explaining it the best, my knowledge within it is limited - but the whole point is that the Bank shares the risk with the person it loans out to.
There are a few aspects which seem similar to interest and it gets confusing.

 

[yahya07]

Man this whole "Islamic banking" is all nonsense. All I know is one thing, if you want to buy a house and take a loan from an "Islamic bank", you would end up paying a lot more than just going to a commercial bank. You can change all the terminology in between and twist and turn the words to avoid the term "interest", but at the end of the day its all a sham. This is whats wrong with Muslims, a sheikh gives a fatwa that this bank is "Halal" and Muslim will flock to it.

Now I'm not advocating interest, but modern financial system is very different to 7th century caravan trading. Many of the financial instruments and ideas weren't even invented then, so Islam really doesn't say much about it. Every Muslim country takes loans from World bank and IMF, so whether you like it or not every Muslim indirectly benefits from interest.

 

[TechMan]

Man this whole "Islamic banking" is all nonsense. All I know is one thing, if you want to buy a house and take a loan from an "Islamic bank", you would end up paying a lot more than just going to a commercial bank.

How can you say that in Islamic Banking you will be paying more? And even if it is true, what has it to do with the legality of system. Whether you pay more or less doesn't make it illegal or un-Islamic.