Alternatives of Interest and Usury - Essay Example

? Alternatives of Interest and Usury Ayesha Khalid Research-Academia Alternatives of Interest and Usury The concept of interest based banking or transactions is so common in capitalism that financial analysts tend to think that the world's financial system would become more of a catastrophe without interest, but the fact is that now financial analysts have been trying to find alternatives of usury and speculations. Although the work done on discovering interest free ways of banking is relatively premature but in recent years various organs of global financial system have begun to realize the pros and cons of it. Muslim countries cannot be solely associated with this growing phenomenon in fact many European countries e.g. Sweden has given a thought to implement a variant of an interest free system. As mentioned in Islam (2008), 35000 members of JAK Bank have saved 97 million Euros, of which 86 million were given as loans. JAK does not charge or pay interest on its loans. Administrative and developmental costs are paid by membership and loan fees. JAK has a variety of banking products all of which come into action by balancing the individual's saving point system. Carrie (2004) researched the work of JAK and concludes that the bank provides affordable and responsible finance and enables its members to have a say in where and how their money is invested. This shows that the outcome of interest free banking does not always relates to a dominantly Muslim country and can exist viably in a western capitalist state. Interest is generally thought as an extra amount charged over and above the principal amount which is accepted as unethical or unfair in Muslim world. A borrower is a person who is needy and a lender exploits them by charging them with interest so a simple question of justifying the ethical basis of interest arises? This question may be answered by another question, is it alright that an already needy person is being oppressed? Our banking systems ultimately covert into an ugly vicious cycle consisting of a borrower and lender thus there exists a genuine need to find alternatives where interest speculation and gambling can be avoided with debt-like financing, futures and option like contracts and insurance/assurance-like products. Now coming over to debt financing, it is a kind of transaction that is solely dependent on interest! for example a person A needs to raise working capital for their company so they only way they have is to issue notes or bonds of, say $1000 to everyone now that investor will receive an interest of 10% of 10000 after four months. In simpler terms you can say that debt is borrowing money from an outside source with the promise to return the principal, in addition to a agreed upon level of interest. Debt financing is one of the most used methods of financing. The reason why debt financing is so commonly used is that it helps maintain ownership because when you borrow from banks then you have to return the agreed amount on time however here you can choose the time of repayment for yourself without anybody else's interference. Moreover the most attractive factor is that you can decide the amount of interest rate yourself, it is an open option for you according to your budget, but we do need to find ways of excluding interest on it. Here the question is that is this possible? The best alternative is interest free equity financing. Equity financing is an act of raising money for company activities by selling common or preferred stock to individual or institutional investors. In return for the money paid, shareholders receive ownership rights in the corporation. In most cases equity financing is preferred over debt financing especially where the company wants to move on an interest free basis. Here there is no interest cost, the company does not has to pay any interest to the amount provided by the owners ( the stockholders) in fact the cost of production remains low as there is no burden of interest, as there is no burden of interest so the company can cope smoothly over recession periods and other emergencies. It can also use that amount (that was previously paid as interest) to improve the quality and standard of its products thus improving profits which means an increase in the shareholder's return. Given the emphasis on equity rather than debt, Iqbal and Mirakhor (2006) have argued that an interest-free banking (IFB) model would lead to: more varied and numerous investment projects for which financing is sought; more cautious, selective and perhaps more efficient project selection by the suppliers of funds; and greater involvement of the public in investment and entrepreneurial activities, particularly as private equity markets develop, than in the traditional fixed-interest-based system. Moreover equity finance carries less personal risk to your own assets. Equity investments are risk capital with no guarantees that the investor will be getting their money back, let alone make positive returns. This type of investment is not secured to any, particular assets such as property or director guarantees. The risk is solely placed with the investor who is looking for a lucrative exit to make a profitable return on their investment. Now coming over to insurance products first of all we need to define what are they and how do these work. Insurance is a promise of compensation for a specific potential future loss in exchange for a periodic payment. It is designed to protect the financial well being of an individual, company or other entity in the case of unexpected loss. Insurance in some instances is required by law and in others is optional depending upon the type, country and circumstances. Agreeing to the insurance policy, it creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy   holder a sum of money upon the occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the deductible), and the insurer pays the rest. Examples include car insurance, health insurance, disability insurance, life insurance, and business insurance. but insurance as we know are interest oriented dealings because you take a specific sum of money and take a larger or smaller amount should a risk occur. All types of insurance includes ambiguity since the insurer says to you'' pay this much amount of premium and in case a risk occurs to you we will pay you such a sum of money, no doubt this is the very same as gambling. All insurance companies and all those who offer insurance coverage prohibit absolutely insurance against any thing that is not liable to risks. This means that liability to hazards is a pre-condition to insurance coverage, so this is pure gambling. Now gambling factor in insurance can be avoided by making certain changes in conventional concept of insurance. Following the spirit of insurance, a welfare fund can be setup by a group of people. This welfare fund can contain pooled money from everyone in group on annual basis. In order for this welfare fund to work, an understanding must be reached among group members. These understanding states that in case any of the group members suffers a loss, their loss will be recovered through the funds available in the welfare fund on first come first serve basis. The gambling factor is ruled out in case of welfare fund since for some members the chance of "winning" drops down to zero i.e. in such case the welfare funds have already been exhausted by other members when the particular member faces a loss. As an alternative to health insurance Hartman (2008) suggests Takaful: "…the concept of social solidarity, cooperation and mutual indemnification of losses of members. It is a promise among a group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them, out of the fund they donate collectively."  Thirdly let us turn our discussion towards "Future Contracts". This genre of contracts is based on speculation which is very risky because this is just like a bet where you can either lose or win. Futures contract is a contract where a person agrees o buy or sell a specified commodity of standardized quality at a certain date in the future but at market price that exists today, for example person A agrees to buy gold from person B in the future but according to the price of gold that rules today in the market. Now what if in the future price of gold drops/rise? So person A may suffer a loss or enjoy profit. In beginning future markets were for perishable commodities like wheat corn etc but now items such as Treasury bond futures, foreign exchange futures, and stock index futures trade far higher volumes than do agricultural futures. However the plus point of future market is that no premium charge is associated with it. Just to avoid speculation and to make future contracts more reliable, the basis of the contract should be changed; the pre-determined price should be based according to the value that particular good will have at the time of transaction .e.g. if a gold exchange has to be made after 3 months then the decided price should be the same that 1 ton of gold might have after 3 months, the price can be judged according to the ongoing market trends. So market analysts should be made active in this respect so that they can analyze the price of a certain commodity after a specific time. Same is the case with option contracts, but here it is not obligatory for the buyer to buy that thing that he has made a contract for thus the name option, for example country A has made a contract that it will buy a specific amount of wheat from country B, at any time in the following one year (at the ongoing market price of that product). Now the country A has gotten the leverage on country B as the latter knows that it cannot give the specific amount of wheat mentioned in contract to any other country until and unless the contract expires, The remedy for the element of unjustified leverage and speculation in options contract is the same as that for future contracts. Usury, interest and gambling are all synonymous and not only are they detested in Islam but also other religions like Hinduism, Buddhism and Judaism. It turns out that Interest and gambling are more concerned with ethics rather with religion. Shareef (2009) writes in his article that financial crisis of the world's largest financial firms (Fannie Mae & Freddie Mac and Meryll Lynch) have forced relevant financial experts to think the root of the problem and to their surprise the root was attributed to interest or usury itself! He writes: Undoubtedly, capitalists will rise up and denounce this as a step back for the progress of humanity and of civilization. To which we must ask: are we really more civilized now than before when we exercised restraint in our appetite to consume and take advantage of others? As the recent financial meltdown indicated, an interest-based economy results in the economy being built on thin air. The reason why interest is abhorred is that it further crushes the already needy person. It may seem a long shot but consequential evidence suggests that for each dollar accepted by anyone out of interest; it is inevitable there is someone who is struggling hand to mouth to pay that dollar in interest. References Aminuddin, I.,(2009). Historical View on Usury ("Riba"). Islamic Banking Way, Retrieved from http://www.islamicbankingway.com/2009/11/6-historical-view-on-usury-riba.html Carrie, A. (2004). How interest-free banking works – The case of JAK. FEASTA Review. (2), 149-154. Hartman, D., (2008). Islamic Scholars are Correct: Insurance is Usurious Gambling with Uncertainty. Retrieved from http://blogcritics.org/culture/article/islamic-scholars-are-correct-insurance-is/ Islam, Y. M., (2010). Is there a way out from interest-based banking? The News Today, Bangladesh, 14 May, 2010. Iqbal, Z., Mirakhor, A., (2006). An Introduction to Islamic Finance - Theory and Practice. Wiley Finance Editions, (1), 55-59. Shareef, A., (2009). Consider Alternative to Interest. Bangor Daily News, Retrieved from http://www.bangordailynews.com/story/News/Consider-alternative-to-interest,98949 Read More