Issue 159 Sharia Compliant loans September 9, 2013

We keep hearing about Sharia compliant banks? Mainly because the Middle East is an opportunity to expand businesses and that includes banking. But because many of those countries follow Sharia law, they must follow a new set of rules on how to collect money and do business. One of those ways is Sharia compliant loans.

Based in faith: A sharia compliant loan cannot have any interest attached. Interest on a loan is strictly forbidden. Also, as part of the pillars of Islam, a certain portion must go to charity. Imams have set down these conditions based on what has been written in the Koran itself, and the Sharia laws which it contains. It is essentially a type of loan based on faith itself.

The loan: Basically a person applies for a loan in the standard way anyone normally would in this system. But the catch is that you must pay a percentage of that loan back on top of that original amount. In other words you can get a $100 loan (simplified example) but you will have to pay the business a 10% fee for the loan itself amounting to $10 in this example. This surcharge is the replacement to the traditional interest in western countries systems. But it does not end there. To be Sharia compliant, the loan must also have a certain amount go to charity (charity is compulsory in Islam). Therefore, (using my aforementioned simplified example) an additional 10% ($10) may be charged specifically to go to charity. So you borrowed $100 but had to pay back $120. Like I said, this is a simplified example and the amounts borrowed, along with how much going toward the bank and charity will vary.

Can it work here?: Yes, of course it can. But this is only if an enforcement mechanism exists to ensure a person will pay back the loan. I do not know what enforcement mechanisms are used in other countries with this type of loan, but I imagine a type of repo-man taking property if the person fails to keep up with their payments. This system can be used by banks to their advantage as it is almost guaranteed that they will make a profit off the loan (though they may not do the charity part, and leave that to their public relations divisions). How a bank uses this and if they will beyond the Muslim community is an interesting topic of discussion.

Conclusion: I make no illusion that there may be much more to a Sharia compliant loan. I am just reiterating what I have been told. As I found it interesting, I thought I would share this alternative method of loans that can potentially be used to help certain people who normally would not be able to pay back a loan that uses simple interest. As to whether this is a good idea in general is a topic for another time however. Till next time.