Islamic Banking was founded on higher objectives based on social justice: namely to develop financial intermediation based on risk-sharing for socially responsible economic activities. From an Islamic worldview money is a sterile asset. Its sole economic purpose is to serve as a medium of exchange. Whilst one can lease a land out on rent, one can’t lease out money on interest. From Aristotle to St. Thomas Aquinas the narrative on interest was unequivocal. “Money lending with interest, like sodomy, is against the law of nature.” The pioneering Islamic banks were therefore formed as investment houses. The savers place their funds with the Islamic Bank on a profit-and-loss sharing investment like mudaraba. The Islamic Bank will then invest the funds with their individual and corporate customers on a profit-and-loss sharing basis. Risk-sharing ventures result in a fairer distribution of wealth. Investors assume risk and receive a commensurate return. They receive a return when entrepreneurs make a profit. The higher the profit earned, the higher the share for the investors. If there is no profit made, then there is no return on investment. In contrast to interest-based lending, the lender receives a fixed return even if the borrower has suffered a loss.
On the other hand, if savers are risk averse, they can deposit their funds with Islamic Banks, who will hold them on trust. The funds will not be invested or lent out and the depositors will pay a fee to the Islamic banks for safekeeping. In contrast, the conventional banks will pay interest to the depositors for safekeeping their money. In reality the savers are not depositors. They are lenders and the bank is the borrower. One then wonders, why do we still call this a deposit? Will the savers’ confidence be impacted if this is not called a deposit? Can we still provide deposit protection, if we don’t call it a deposit?
The other objective of Islamic Banking is to only invest the funds in socially responsible economic activities. From an Islamic viewpoint everything on this earth and beyond belongs to God Almighty. And whatever human beings own on this earth is held on trust for God. God gives some an abundance of wealth and to others a pittance. The wealth is but a test on the rich. If the rich consume the wealth wisely, invest the wealth in socially responsible activities and give charity to the poor, they as God’s trustee will pass the test and be rewarded with a place in heaven. But, if the rich spend the wealth wastefully, engage in usurious lending, and ignore the poor, they will fail the test.
