In the beginning of March at the World Islamic Economic Forum in Jakarta political and business leaders accentuated the strength of Islamic principles of banking and investing. Islamic banks are generally doing better in today’s uncertain economic times than their Western colleagues. So our financial institutions have a lot to adopt from Islamic economic system. The Koran states detailed regulations and prohibitions concerning the economic system. First of all, Muslims don’t deal with "riba" – a word interpreted as interest on loans, credit cards or savings accounts.
This prohibition concerns all interest-bearing transactions, whether you are giving a loan or applying for it. The Prophet Muhammad cursed people who pay interest, those who collect it, those who write an agreement based on it, and those who witness such an agreement.
Muslims believe that interest-based transactions are not fair because they give a guaranteed return to the creditor without any guarantees for the borrower. One of the main principles of Islamic banking is the sharing of financial risk and sharing responsibility for profit and loss.
Following this prohibition, Islam banks don’t deal with interest-bearing mortgages. As a result, the U.S. sub-prime mortgage crisis and the following recession haven’t hit Islamic banks as badly as their Western colleagues.
If you want to buy a house and you don’t have enough money, Islamic banks offer two types of financing: • Murabahah: In this type of financing, the bank agrees to buy the property and then re-sell it to the buyer for a higher price. All costs are fixed at the time of the agreement, so there are no late payment fees. The balance is paid through installments within a set period of time.
The buyer gains 100% ownership of the property from the beginning. However, transactions must be backed by real assets (gold, land, equipment) or a high down payment in order to protect lender against default.
• Ijarah: This type of financing is similar to rent-to-own contracts or real estate leasing. The bank buys the property for you, but it remains the owner as long as the buyer makes installment payments. Once the balance is paid off in full, the property is registered in the buyer's name.
There is other aspect of Islamic economic system that has helped Islamic financial institutions to avoid serious financial difficulties. The Koran prohibits investing in businesses that involve gambling, selling alcohol or pork.
Many Muslims have made a conclusion that investing in stock markets or stock trading (buying shares with the intention to sell them and earn profit) is a form of gambling, so it is prohibited by the Koran. When the stock market crushed, they were immune to its ripple effect.
Financial experts also state that Islamic banks tend to rely on deposit accounts because taking credit from international financial organizations is prohibited (it will make them pay interest). That means that Islamic banks have to ensure their clients that their deposits will not be invested in companies that run "un-Islamic" business.
However, in spite of these facts, following Islamic principles is not enough for banks to get the total protection from the financial crisis. Islamic finance is so intertwined with the global financial system that they also can’t avoid problems.
Many Islamic banks have invested their funds in equity. When the prices for real estate go down, their portfolios also go down. Countries involved in computer and electronics manufacturing (such as Malaysia) have been hit by competitive devaluation and reduce of export.
So even though Islamic countries have not suffered from the credit crunch, they have suffered from asset valuations and its financial effect.