Islamic Perspectives on Loans & Interests in Contrast With Commercial Banks

Borrowing and lending loans are among the oldest activities in the world. Regulated and documented lending in banks originated from private moneylenders, who offered loans at both organizational and personal levels. In studying and appreciating the form of borrowing and lending in the current world, it is essential to consider the religious and ethical setting in which bank lending occurs. One such setting involves borrowing and receiving loans from Islamic banks. Unlike other typical commercial banks, Islamic banks have unique practices when it comes to the issuing of loans and interests.

Since the founding of Islamic banking in the thirteenth centuries, the Muslim society did not allow interests on loans. The society performed global and domestic businesses without charging any interests. However, Muslims started charging interests on loans later, when imperial powers dominated them.

The topic of banking that is free of interest recaptured the concern of Muslim scholars between 1940’s and 1950’s (Fuad & Mohammed, 1996). At that time, many foreigners had introduced banks that sought to make interests in Muslim countries. Muslim governments, particularly those that were politically sovereign, had begun engaging in global monetary transactions. They had realized value of commercial banking. The problem was how to end the idea of interest from this new banking system. This led to the beginning of the concept of sharing losses and profits called Mudarabah (Lewis & Algaoud, 2001).

Up to date, most Islamic banking systems use this concept in their banking transactions. However, several Islamic banks are working hard to remove the unsuitable terms in the Mudarabah while others are trying to convert the strategies for pricing, as technology advances. These strategies make sure that the benefits achieved balance with the level of the provided service. Besides, these technologies can weigh the total amount that gets used in service provision against interest rates. This shows that, as the level of competitiveness increases, Mudarabah is experiencing changes to stay relevant in the banking industry.

Muslims discourage the issue of interests on loans because they consider it as a way of lengthening the gap between the rich and the deprived (Lewis & Algaoud, 2001). Interests concentrate wealth in only a few people who end up forming monopolies. The Sharia law, which guides Islamic finance practices, disallows this and supports distribution of wealth in a financial system. Under Islamic banking, charging interest on loans gets regarded as extortion.

Islamic banks differ from commercial banks as they have various ways of earning profits without linking the sources directly to loan interests. For instance, these banks earn profits from foreign exchange margins. Also, there is a transformation in the Mudarabah, the most beneficial tool in Islamic banking. The transformation involves an agreement where a customer wanting to buy products or equipment requests the bank to buy the products and vend them to him or her at a higher price, hence making profit. The bank receives a fixed profit in line with the agreement. The bank and the buyer agree to postpone the date of receiving products even though they could be instantly delivered.

Islamic banks do not prohibit lending since Muslims acknowledge that people in the society do not have equal endowments in terms of resources. They lend as a matter of goodwill and generosity and not to get interests. Islamic banks not only lend resources in cash, but they also sell items on credit without charging any extra payment above the market prices.

On the other hand, commercial banks focus on loan interests as a key way of creating revenue. These financial institutions get cash from depositors and lend it at increased interest rates (Kapoor, 2004). Potential customers of commercial banks include entrepreneurs and businessmen. These customers get loans against assets like stock, gold and personal security. Commercial banks charge interest rates depending on the nature and purpose of the loan. However, the amount of interest that the borrower pays is usually higher than that paid to the depositor. The banks relate this difference to the costs involved in offering services, profits, compensation for inflation, and a risk premium when defaults occur (Kapoor, 2004). They also offer loans for short phases, particularly, to other banks and share brokers at a specified interest rate.

This research seeks to investigate the difference between the Islamic banks and ordinary commercial banks. The topic is stimulating because the common expectation is that few people would be interested to invest in Islamic banks, with no interests as the main purpose of any business investment is to earn returns. However, people still invest in these banks, and they compete successfully with commercial banks. Hence, this paper seeks to find out ways in which Islamic banks run differently from the commercial banks, and how they compete with commercial banks successfully, despite their lack of interests. The study will thus show whether Islamic banks are better in providing service than the interest charging banks, by investigating the customer satisfaction index between the two banks.

References

Fuad, A., & Mohammed, A. (1996). Islamic banking: Theory, practice and challenges. London, England: Zed Books.

Kapoor, G. (2004). Commercial banking. New Delhi, India: APH Publishing Corporation.

Lewis, M., & Algaoud, L. (2001). Islamic banking. University of California, Santa Barbara: Edward Elgar Publishing.