Islamic Banking

One of my dear friends abroad received a grant to study at university. She is a very intelligent woman - she spoke at least three languages fluently, already had a degree, worked for an international nonprofit, and raised a beautiful daughter all on her own. When we heard her good news we congratulated her and asked what she intended to study. She smiled and told us, “Islamic Banking.”

Which begat a frantic Google search to determine exactly what the heck that was.

The principles of Islam forbid two things which make Western models of banking problematic: usury and speculation. Usury refers to the charging of interest - this is considered sinful and greedy in Islam. Thus banks which follow Islamic principles can’t charge interest rates for their loans; instead, most follow a proft/loss sharing model whereby the borrower shares a percentage of their profits with the bank. Should the borrower default, or the business fail, the bank loses its money as well. Hence Islamic banks tend to be very cautious when giving out loans; the Mit-Ghamr Savings Bank established in Egypt in 1963 lent to only 40% of business applicants on average. Yet their default ratio was extremely low and said to have been zero during good economic times.

Islamic banks also may not invest in businesses which do not keep in line with traditional Islamic faith - this includes gambling/casinos, the pork industry, or alcohol production. They apply the same moral codes of their faith to their business practices as well. For smaller, personal loans like homes or large appliances the bank will simply buy the product outright - meaning they own it - and then turn around and essentially sell the product back at a slightly higher price with installment payments.

Modern Islamic banking resurfaced mainly during the 1960′s, and today there are over 300 Islamic banks and over 250 mutual funds which comply with Islamic principles. Islamic banks serve customers of all faiths and many Western style banks have also adopted “Islamic windows” which cater to traditional Islamic banking standards for their Islamic customers now.

Besides religious reasons many communities embrace Islamic banking due to its focus on sustainable investments over “boom/bust” style economics, and the belief in investment for the good of all not just for profit. During the economic crash of 2008, for example, Islamic banks were largely insulated from the fallout of bad loan practices that sank other institutions. Unlike Western banks, which often make news for predatory interest rates, Islamic banks are seen more as partners to the communities they serve. Thanks to their profit-sharing model when local businesses succeed, so do they; they don’t profit off the loss or failure of others.

My friend, who had a background in finance and wanted to branch out after working for non-profits towards something with a more progressive bent, decided that was exactly the change she was interested in studying.

So there you go - a brief, Google-powered intro to a concept I’d never heard of until my accomplished friend made it her career.