Interest-free loans do not work even on a community let alone economic scale – there is a reason why the Jews have historically flourished as money-lenders in both medieval Europe and the Islamic world – because they furnished a highly demanded and in fact economically useful service.
Islamic banking in the cases where it has become merely feasible is a convoluted process of interest-loaning without calling it interest, and cleric bribery (which is why real deal orthodox clerics disapprove of virtually all of it):
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“The Islamic finance industry has often battled with the question: How Islamic is Islamic banking?
The question’s pertinence was raised in March last year, when Sheikh Muhammad Taqi Usmani, of the Accounting and Auditing Organization for Islamic Finance Institutions (AAOIFI), a Bahrain-based regulatory institution that sets standards for the global industry, said that 85% of Sukuk, or Islamic bonds, were un-Islamic.
Usmani is the granddaddy of modern-day Islamic finance, so having him make this statement is synonymous with Adam Smith saying that free-markets are inefficient.
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As in many Islamic products, the bank enters a partnership with its depositors and invests his money in a Sharia compliant business.
The profit from this investment is then shared between the depositor and the bank after a set time.
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Alternatively, an Islamic banker might enter into a lease agreement for a car or a house with an individual.
The bank would buy a vehicle outright and then lease it back to the person who wanted it, over a time period that would ensure that the capital was repaid and the bank made a profit.
Alternatively the bank would enter into a partnership with a person wanting to buy a house. The bank would buy 70% of the house, the individual 30%.
The bank then rents its share of the house back to the individual until the house is fully paid for.
The bank makes a profit on the rent, which would be higher than equivalent rents in the area, but on an annualised percentage basis, would look very much like a conventional mortgage interest rate.
To the casual observer, a spade is a spade.
Whether the product is dressed up in Arabic terminology, such as Mudarabah, or Ijarah, if it looks and feels like a mortgage, it is a mortgage and to say anything else is semantics.
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However, these bankers had a way of dealing with this, as one investment banker based in Dubai, working for a major Western financial organisation explains:
“We create the same type of products that we do for the conventional markets. We then phone up a Sharia scholar for a Fatwa [seal of approval, confirming the product is Shari’ah compliant].
“If he doesn’t give it to us, we phone up another scholar, offer him a sum of money for his services and ask him for a Fatwa. We do this until we get Sharia compliance. Then we are free to distribute the product as Islamic.”
This “Fatwa shopping”, which was carried out by some institutions, brings us back to the Sharia scholars.
Even these scholars do not agree all the time, which means that in some cases a product is deemed Sharia compliant in one market and not in another.
This is especially the case with Malaysian products, which are often deemed not Sharia complaint in the more austere Gulf.
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But banking is banking.
It is the taking of a deposit and then using it to finance a purchase or business.”
For those who didn’t bother with that article, here is the tl;dr edition: the fundamental problem is that something as simple as storing money, the basic function of a bank, much less lending money, not only has direct costs (think about all the maintenance costs of a bank), it also has a load of what economics calls ‘opportunity costs’ – instead of lending you money for free, your lender could do all sorts of things with that money to make more money, why wouldnt’t he?
This means that in the real world the only way bona fide interest-free loans can exist in an economy is if there was an inwards flow of capital. But, since money doesn’t grow on trees in this universe – oil can be found on the ground but the only reason that Arab oil isn’t worthless is because most countries don’t have oil, this is the problem of scarcity – the only way you can have interest-free loans is if by playing zero-sum games with someone else. That is essentially what the early Muslims did – they made their profit by looting the pagans. In fact, despite looting the infidels, Muslims still couldn’t get a banking and finance economic sector going – see, the other problem with the whole enterprise of loans is one of trust, and Islamic societies tend to be very low trust societies in general.
