Introduction to Islamic Economics & Finance

Islamic vs Conventional Finance

Islamic instruments are clearly distinguishable from the interest-based financing on the following grounds.

1. Islamic finance operates differently from conventional financing where the financier gives money to his clients as an interest-bearing loan, after which he has no concern as to how the money is used by the client. In the case of Murabahah attitude, on the contrary, no money is advanced by the financier that he wishes to purchase a commodity, therefore, Murabahah is not possible at all unless the financier creates inventory. In this manner, financing is always backed by assets.

2. In the conventional financing system, loans may be advanced for unethical purposes. A gambling casino can borrow money from a bank to develop its gambling business. A pornographic magazine or a company making nude films is as good customers of a conventional bank as a house-builder. Thus, conventional financing is not bound by any divine or religious restrictions. But the Islamic banks and financial institutions cannot remain indifferent about the nature of the activity for which the facility is required. They cannot effect Murabahah financing system for any purpose which is either prohibited in Shari`ah or is harmful to the moral health or the society;

3. It is one of the basic requirements for the validity of Murabahah that the commodity is purchased by the commodity before selling it to the customer. The profit claimed by the financier is the reward of the risk he assumes. No such risk is assumed in an interest-based loan.

4. In an interest bearing loan, the amount to be repaid by the borrower keeps on increasing with the passage of time. In Murabahah, on the other hand, a selling price once agreed becomes and remains fixed. As a result, even if the purchaser (client of the Bank) does not pay on time, the seller (Bank) cannot ask for a higher price, due to delay in settlement of dues. This is because in Shari`ah attitude there is no concept of time due of money.

5. Leasing is ethical too because the financing is offered through providing an asset having usufruct. The risk of the leased property is assumed by the lessor / financier throughout the lease period in the sense that if the leased asset is totally destroyed without any misuse or negligence on the part of the lessee, it is the financier / lessor who will suffer the loss.

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