Interest-Free Banking
Description
Ivan Tsikota:
"The idea of not charging interest in business activity comes from various religious and scientific sources. Christianity, Judaism and Islam all had a ban on usury. For instance, the New Testament says: “But love ye your enemies, and do good, and lend, hoping for nothing again; and your reward shall be great, and ye shall be the children of the Highest” (Luke 6:35). In Biblical times, Hebrew law clearly prohibited usury (Kabir & Mervyn, 2007), and in Judaism issues of compound interest were resolved every seven years (Kennedy, 2008). Ban on usury now only pertains in the Muslim world, and with few exceptions, e.g. Triodos Bank in Netherlands or JAK Bank in Sweden, most interest-free financial institutions exist within an Islamic paradigm."
History
Ivan Tsikota:
"It appears that the theoretical foundations of interest-free money were first outlined by the German economist Silvio Gesell in his book “Natural Economic Order”4, where he suggested stimulating money circulation by introducing a demurrage fee for holding banknotes (Gesell, 1958), (Kennedy & Kennedy, 1995). Later, his ideas were praised by Irving Fisher and John Maynard Keynes5 (Blanc, 1998). The existence of a fee on money circulation explains the use of quote marks in the title; per se one can speak of a negative interest rate applied on cash assets. Gesell’s ideas can be illustrated by the example of an experiment conducted in a small Austrian town Wörgl6 in 1932-1933. A local bank issued 5,490 ‘Free Schillings’ and backed them with the equivalent amount in the official currency. At the end of each month, the holder of the note had to pay 1% circulation fee from the face value, and was stamped accordingly. Such a small ‘fine’ for holding money caused people to try investing ‘free schillings’ at the earliest possibility.
As a result, within 13,5 months the free schillings circulated 463 times, generating a turnover of 2.283.840 Schillings. On top of that, unemployment dropped by 25%, income from local taxes grew by 35%, and investment in public works rose by 220%. The ‘circulation fee’ comprised 658 Schillings, all of which were spent on public works. However, when approximately 170 towns in Austria (including Innsbruck) expressed their interest in replicating the experiment, the National Bank of Austria prohibited printing of any local currency. (Kennedy & Kennedy, 1995)
According to (Blanc, 1998), the experiment was replicated in the United States, where around 15 towns issued interest-free money. However, due to a lack of clarity with the procedures, the experiment worked out badly, fraudulence and barter flourished. Similar projects were also tried out in Canada and France." (thesis: Increasing Local Economic Sustainability)
Example
Islamic Banking
Ivan Tsikota:
"The history of modern Islamic banking dates back to 1975, with the establishment of Bank Faisal in Egypt (Al-Salem, 2008). Worldwide, the number of Islamic Financial Institutions (IFIs) grew from 37 in 1997 to approximately 300 in 2009. In parallel with this development the size of Islamic financial funds on the global arena is increasing. In first quarter of 2010, they managed approximately $52 billion, and unlike traditional mutual funds, whose net assets decreased by $4.1 billion from 2007 to 2009, IFIs demonstrated growth even against the background of international economic crisis (Ernst & Young, 2010).
In Iran, Pakistan and Sudan only IFIs are allowed (Aggarwal & Yousef 2000), and in some other countries, e.g. Bangladesh, Egypt, Indonesia, Jordan and Malaysia, two systems co-exist (Chong & Liu, 2009). The first non-Muslim country in which an Islamic Bank was established was the United Kingdom; it opened in 2004.
Western and Islamic banking are different not only in the financial instruments used, but also in the philosophy2. First of all, according to (Aggarwal & Tarik, 2000) it is clearly stated in the Quran that: “Allah forbids interest and permits trade”. Gharar – uncertainty and risk – is not allowed (Chong & Liu, 2009) and neither is riba3 – interest. According to Kabir & Mervyn (2007), however, ‘the objection is not to the payment of the profits, but to a predetermined payment that is not a function of the profits and losses incurred by the firm or entrepreneur’. IFIs operate basing on two concepts: profit-and-loss sharing (PLS) and the mark-up principle (MUP) (Aggarwal & Tarik, 2000).
According to the PLS concept, the person providing credit has a right to share profits from the enterprise provided s/he is ready to also share risks and losses, in case it fails. Instead of an interest rate, contractors negotiate distribution of profits (or losses). Generally, two types of contracts are used in this category: musharaka (partnership) and mudarabah (‘finance by way of trust’ (Kabir & Mervyn, 2007)). In case of musharaka, both sides provide resources for the project and share risks of losses or gains. At that, profits are distributed in a pre-agreed proportion, and losses depend on the share invested. In mudarabah contracts, one party submits funding, and another performs management thereof. Profits are distributed on a pre-agreed basis, the assets are possessed by the providing party, and managing side has the right to buy them out.
MUP applies to agreements where the creditor buys goods on behalf of the borrower, and resells or rents it out. Most common forms of financing are murabaha and ijara. In the former case the creditor acquires the asset and then resells it at the original price plus a pre-agreed margin, whereas in the latter the goods are provided for use based on a repayments scheme with the option of the ownership transfer (analogue of leasing today). It is important to state the difference between conventional interest-based lending and murabaha financing; the fee is only charged for the creditors services in acquiring goods and is not dependent on time, i.e. the delay in the repayment of debt does not incur an increase in fee." (thesis: Increasing Local Economic Sustainability)