Ever since the earliest times of human existence (i.e. dating back to the progeny of Noah) specialisations like carpentry, black-smithy, tailoring, and cultivation existed, leading subsequently to creation of shops and of markets. Initially all trading in goods and services was done by barter, which required the cumbersome job of movement of goods from one place to another. So, to solve this problem, gold and silver currency came in as an alternative exchange material, replacing barter. Trade and commerce needed labour and with high hopes of gains, there is always a risk of losses. Man in his transgression from the Divine guidance began to think of earning wealth, eliminating labour and risk of loss. And instead of investing money in production and developmental projects, he thought out a plan to make his money bring in more and more of it directly. Interest on money lent and usury thus came into existence.
Usury is one of the worst crimes in the sight of Allah, because it eats into the vitals of man’s economy, the rich becoming richer without any risk, quietly but rapidly draining the already meagre resources of the poor and workers. The economic system with interest and usury as its backbone created countless other evils. This is why Islam strictly put total ban on it and simultaneously closed all doors leading to it.
Islamic economics refers to management of resources within the prime values of Shari’ah namely justice (adal), equity (ihsan), freedom (hurriyat), brotherhood (akhuwat), and equality (musawat). Islamic banking is on the other hand a system or group of techniques of management of wealth and money for attaining the above objectives, as below:
I) Mudaraba, which may be defined as an arrangement in which an investor or capital owner (Rab-ul-Mal) entrusts the capital to an agent, manager, bank, or labour partner (mudarib), who is to trade with it and then return to the investor the principal amount together with the agreed share of profit. The agent retains the remaining share of profit as reward for his labour. In case of loss, the` agent is involved only by way of expended time and effort.
II) Musharka is based on the principle of partnership among two or more parties and profits are shared according to a pre-determined ratio; in case of loss it has to be borne in exact proportion to the ratio of capital invested.
III) Ijara is a contract that permits the ownership of an article hired on a certain return for a certain period of time. Leasing or renting in the modern sense is a technique that can be compared with Ijara. Ijara is based on the same principle to own an asset in order to enjoy its benefits.
IV) Bai Mowajjal may be defined as a system, where the purchase of goods is made, but payments are made later, e.g. buying a T.V. or car on instalments. As it is permissible to make purchases on payment of price in cash, it is also permissible to defer payments of the agreed price to a future agreed date with mutual consent of the seller and the buyer. Thus Bai Mowajjal is a sale in which margin of profit is mutually agreed upon between the buyer and the seller. Payment of sale, inclusive of an agreed profit margin, may be immediate, lump-sum, instalment or deferred.
V) Bai Salam is the opposite of Bai Mowajjal. In this case, contract is made to purchase a commodity to be delivered at a future date but payment of price is made in advance. The prevailing system of making advance payments for obtaining machinery, etc. from abroad are examples.
VI) Murabaha/Markup may be defined as cost plus contract. When a person has acquired the ownership of an article and offers the same for sale to another person after disclosing his actual cost, demanding a definite amount of profit over his costs to which the prospective purchaser agrees relying on the word of the seller, then this is called Murabaha . Thus it is agreed percentage or cost price plus some profit.
VII) Indexation of Bank Deposits and Advantages is a system, where the liability of the borrower to the banking system is adjusted, in money terms, to reflect the change in the value of money as measured by a price index during the period the borrowing remained outstanding.
VIII) Investment Auctioning is a system where commercial banks may form a consortium with long term financing institutions and formulate industrial projects with complete details. The consortium may, then, announce the project with the offer of the needed long or medium finance and call for bids from prospective contractors. The project may be awarded to the highest bidder if the party is considered to be a sound one. Otherwise, the project may be awarded to the next highest bidder considered capable of efficient implementation and running of the project.
The most significant advantage of this system, from economics view, is that the price paid by the investors adequately reflects the scarcity value of capital, which is essential for its efficient allocation.
IX) Financing on the basis of normal rate of return is a system, where a specialised public agency may determine the normal rate of return in each industry, business, etc., and the banks may provide funds for the entrepreneurs with assurance that a certain minimum rate of profit would be payable to the bank on the amount provided by it.
Interest-free banking is based on the rationale that interest is not in the interest of humanity. Interest makes the money a commodity and an end in itself. When money in itself becomes the end of economic activities, production, distribution and values get distorted. Market starts serving only the rich. The poor become poorer. This is precisely what is causing suicides of so many farmers in various parts of our country.
In the interest-based economies unproductive income bearing economic transactions flourish. Speculative transactions gain currency. Social values deteriorate. Not only individuals or communities, even nations get trapped into debt traps. The jungle rule like survival of the fittest becomes order of the day. This is what we are witnessing in a number of western nations today.
Conventional banks ignore the backwards for not having credit worthiness and do not allow the new entrepreneurs to come up.