NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

This is my second posting about Islamic banking. I hope to share some information about practices that few people hear about, but are pertinent to doing business in the Muslim world–especially regarding microcredit.

For a loan to conform to Islamic law, it must be riba-free; “riba” is usually translated simply as “usury,” and literally means “an increase, addition, expansion or growth which is non-trade related e.g. a loan, advances.” . The purpose of such a law is to prevent the burden of charging interest rates on loans. In order to extend credit fairly, but remain profitable institutions, Islamic banks use 3 different methods for risk-sharing and profit-sharing. :

(1) murabaha, which is tradefinancing and cost-plus mark-up on traded good

??? ??? ??? (2)profit-sharing(mudarabah) and equity participation (musharakah) in which cost-sharingamong partners is also included

??? ??? ??? (3)rentson purchased equipment (ijara)

Finance is not something I understand well, but I think the following example is valid: whereas a “conventional” bank would extend a loan and be repaid in full plus interest payments, an Islamic Bank would be repaid for a loan in full plus a portion of the beneficiary’s profits. So, if the recipient does not make any profit, the burden to repay the loan is alleviated. And if I am totally wrong, by all means, correct me!

All 3 methods are commonly accepted and widely-used by a number of Islamic Banks–but not only in the Muslim world. In fact, some Banks that conform to these practices have succeeded in Europe and the United States, a testament to the profitability (and appeal?) of the alternative methods practiced by Islamic banks.

Also interesting: although Islamic Banks are only about 30 years old–every site I perused for information reminded me of this–the Institute of Islamic Banking reports that Islamic lending has been practiced since the 7th century .