What is Islamic Banking?

BY busadmin  November 26, 2008 at 12:47 PM EDT

Question/Comment: I was reading an article about Islamic banking in Malaysia, and I was surprised to find out that these Islamic banks were affected little if any with this bad lending that is going on in U.S. and in the rest of the world. Do you know what Islamic banking is?

Paul Solman: I feel a longish answer coming on so if you’re not interested in the history of usury, then even you loyal readers may wish to skip today’s entry, or re-read a post from the past.

For a very long time, taking interest on loans was controversial. In the second book of Moses, Exodus, 22:25 (King James Version): “If thou lend money to any of my people that is poor by thee, thou shalt not be to him as an usurer, neither shalt thou lay upon him usury.”

The New American Standard translation: “If you lend money to My people, to the poor among you, you are not to act as a creditor to him; you shall not charge him interest.”

This was interpreted many ways over the centuries, but a dominant one, among Jews, was that the proscription applied only to fellow Jews (“My people”) and thus charging interest to gentiles was permissible.

As Christianity preached a brotherhood of all men, usury in any form was for a millennium or more strictly forbidden. As Jesus says in Luke (6:34):

“If ye lend to them of whom ye hope to receive, what thank have ye? For sinners also lend to sinners, to receive as much again. But love ye your enemies, and do good, and lend, hoping for nothing again; and your reward shall be great.”

And as in Christian scripture, so in the Koran, in somewhat sterner terms:

“Those that live in usury shall rise up before God like men whom Satan has demented by his touch; for they claim that trading is no different from usury.” [The Cow 2:275]1e

“If your debtor be in straits, grant him a delay until he can discharge his debt; but if you waive the sum as alms it will be better for you, if you but knew it.” [The Cow 2:280]1f

The history of the Jews in the West is intimately connected to usury prohibitions. The moneylenders many of us grew up with – from Shakespeare’s Shylock to Isaac in Ivanhoe – were plying a trade restricted to their kind; restricted, that is, until Christianity began making its peace with lending-at-interest during the Middle Ages.

Islam handled the problem differently, by fashioning commercial loans as profit-sharing contracts so that interest would legally be a form of return on capital at risk.

The upshot of what’s long been known as “Islamic banking” is that it’s pretty heavily regulated by religious supervisory boards as well as governments. There are, in short, a lot more roadblocks to fancy financial engineering and opaque lending.

Agence France-Presse wrote this recently: “The rules of Islamic banking and finance — which incorporate principles of sharia or Islamic law — read like a how-to guide on avoiding the kind of disaster that is currently gripping world markets.”

On the other hand, the same dispatch had this:

“And Jennifer Chang, a partner at Pricewaterhouse Coopers in the Malaysian capital Kuala Lumpur, said that given the extent of the global crisis, Islamic banks may suffer damage despite their strong position.

‘Islamic banks, especially in the Middle East, got heavily into private equity and real estate investments, and a lot of loans may be backed by properties. So if the property market goes down, there will be an impact,’ she said.”