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Conventional and Islamic Banking
Written by: Dr. Fikret Hadžić
The greatest expansion of Islamic banking and other Islamic financial institutions has been realized in rich Arabic- oil exporting countries. Three Moslem countries (Iran, Pakistan and Sudan) have officially converted own conventional banks into Islamic financial systems. Malaysia and Bangladesh have implemented parallel banking system. In those systems, besides conventional banks there are Islamic banks which are operating based on special law. Islamic Development Bank has become respectable institution, which is supporting development of both Moslem member countries, Moslem communities in non-member countries, as well as numerous Islamic financial institutions.
There are currently 325 Islamic banks operating across the globe. Even though most of them are based in Islamic countries, there is a trend of new Islamic banks increasingly emerging in other parts of the world as well. For instance, there are 2 Islamic banks in Australia, 6 in Bahamas and 38 in the United States of America. Denmark, France and Ireland have one each, while Germany and Switzerland boast five Islamic banks in each country respectively. Great Britain has 23 Islamic banks and Luxemburg has 4. Bosnia and Herzegovina has one bank which operates under the Islamic banking principles.
According to the opinion Dr. Rodney Wilson, Professor of Economics at Durham University, Scotland, the growth of Islamic banks in the last two decades is "extreme impressive and there is no doubt that it will be continued in the future. Their large client base and the volume of work they have been performing, as well as constant personnel education upgrading is a reason for believing that it is not a simple and short-term phenomenon".
Large credit for development of contemporary Islamic financial system is due to theoreticians of Islamic Economy. They developed a special theoretical approach that helped practical implementation of the whole concept. The first Islamic Economics course was introduced in 1967 at Umm Durman Islamic University in Sudan. Today, Islamic economics is studied at many universities in the world - both in the East and the West. It basically is trying to build into the economic theory the ethical and moral principles of Islam as religion. It maintains the view that economic behavior is not motivated only by personal benefit or loss. Human beings are motivated also by ethical principles where moral views are often before material and realization of higher goals above profit of an individual. It is trying to reconcile those two "interests" and to exclude competitive relation between them.
One of the fundamental principles of Islamic finances and which indeed represents the largest difference of the Islamic in regard to traditional finances is contained in the Islamic attitude towards usury and interest. Interest represents payment of a debtor to creditor over a period in exchange for using capital.
In the explanation of strict prohibition of interest in Islam, theoreticians of Islamic economy point out that reasons lie in moral, social and economic spheres of that issue. Lending money against an interest implies that rich people (those that have capital) earn a value without giving anything in exchange for income (interest) they are receiving. If one lends one KM to someone, after a certain period he receives two KM, that means that the additional KM is his extra profit not "earned" by work, without any effort and adequate equivalent value.
Islamic approach to interest is similar to the approach of classical philosophers and classical economists, even Kejny as eminent representative of modern economy. Islamic teachings point that interest discourages people to deal with production and mutual trade of produced goods. When interest is prohibited, people will lend each other with pleasure and will do good deeds not only towards others but themselves as well, because they will be rewarded for their good deeds by the One who is the only one who can give the right reward. Interest slows down the investment process, thereby economic and total social development. Because of expected and promised interest, many people decide for saving capital, withdrawing it from investment process, which may present socially negative activity. On the other side, in the traditional banking, banks are protecting themselves maximum through interest and different security instruments against loans repayment risk. By doing that they transfer the whole loan risk to the beneficiary of loan and become insufficiently interested in the success of his work. In the Islamic banking the risk is attempted to be divided between the bank and the beneficiary of capital. The Bank is directly interested in client's success and participates actively in the management of the future firm. With such placement of funds the Bank may realize also greater income from undertaking against interest but then it would be exposed to greater risk.
(The author is Professor of the School of Economics in Sarajevo)