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A Balanced Banking System

Dec 22, 2007
Banking is a business like all others but customers these days seem at the mercy of whatever the lenders want to charge.

Yes, we can shop around but at the end of the day, they're all in it for profit, gained by ever fluctuating interest rates. They also take risks investing our money without our knowledge and we are susceptible to those investments failing.

However, with the diverse mix of cultures in every country these days it is not that unusual to see a different banking system coming into play.

The Shariah, or Sharia, system of finance has been set up by the Islamic community to comply with their strict laws on banking in accordance with the Qur'an. Sharia law covers all aspects of everyday living for the Muslim community.

Banking and finance are issues that are covered in depth, from personal finances to business banking. Working on a shared profit and loss system makes this system quite different to Western banking. This prevents the bank from monopolising the economy and is less risky to the borrower.

This way, the borrower is more secure, more businesses succeed, more money is borrowed, thus keeping the whole system afloat and everybody from borrower to lender benefits.

Sharia law prevents the collection and payment of interest. So, how do the banks make money?

If a Muslim wishes to utilise a loan to purchase items, the bank actually make the purchase and re-sell to the buyer for a profit that is agreed between the two parties. That profit is set without alteration and it is essential that it is very clear upon the agreement.

No extra charges can be enforced on this loan, even if payments are late. However, rights to the items purchased remain with the bank until the loan is paid in full.

The same principles apply to mortgages. The house is purchased by the bank and resold at an agreed profit to the buyer. Repayments are made in instalments but without the worry for late payment charges. However, a Muslim is expected to meet his repayments without taking advantage.

The land and property will be in the name of the buyer from the outset of the agreement for the security of the borrower but for protection the bank will ask for strict collateral.

As far as business banking is concerned, an individual can borrow interest free money to set up his own business. As with all loans an agreed profit is decided upon from the outset and repaid in instalments.

The borrower provides the labour while the bank provides the finance thus reflecting Islamic law of profit and loss sharing with no one party carrying all the burden of risk/cost of failure.

Money can be lent to businesses, whether existing or new. It is specified that the business must not contradict Muslim beliefs, such as the selling of alcohol or pork, or be involved in any media business which deals in gossip columns or pornography.

Business banking is not free and neither is there any interest imposed. Money is lent on a floating rate interest loan. This means the floating rate is dependent on the company's individual rate of return.

The banks profit on the loan is equal to a certain percentage of the company's profits - the profit sharing side of Sharia law. Once the original agreed amount has been repaid, the profit sharing arrangement ends.

So, money can be lent to businesses and it will be dependent on the individual business as to what the repayments will be. Therefore, any business can afford a loan.

Interest is not paid or collected on current accounts so overdrafts are not permitted. However, there is always the option of Hibah (Gift). This is a voluntary payment by a creditor or debtor in return for a loan. This is usually practiced in Islamic banking but is discretionary.
About the Author
Expert financier Shaun Parker looks into the new business banking culture. To find out more please visit http://www.lloydstsbbusiness.com/accounts/index.asp/
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