FA readers sceptical of Islamic finance

Two-thirds of our readers question whether Islamic finance offers a real alternative to conventional finance.
Saudi Arabians check out the latest stock market movements.
Saudi Arabians check out the latest stock market movements.

Islamic financial products have grown in popularity during the past few years, but respondents to our web poll last week are not convinced that they are a real alternative to conventional financial products.

The basic idea of Islamic finance is to create a fundamentally different relationship between moneylenders and borrowers, in accordance with Islam’s prohibition on usury. The main concept is that Islamic lenders share risk in a much fairer way than straightforward moneylenders, who simply charge interest based on their perception of the risk involved.

If that were true, one would expect to find that Islamic banks are more risky than conventional banks -- their very existence dictating that they offer a fairer deal than moneylenders. But there is little to suggest that the relationship between borrowers and lenders is any less usurious in Kuala Lumpur than it is in London.

History offers an interesting perspective on the Islamic banking industry. In the Middle Ages, Christians believed that both testaments clearly prohibited the charging of interest on loans, while the Torah prohibited the charging of interest to other Jews, but not to non-Jews. This created an uneasy relationship of convenience that allowed both groups to take advantage of interest-based lending, with Jewish moneylenders bankrolling European Christians, to the satisfaction of both churches.

This relationship started to break down in the 13th century when bankers such as the Lombards created a model of Christian banking that skirted canon law with the invention of legal fictions that replaced interest with various contractual terms that created the same effect -- the so-called contractum trinius.

The dodge was so effective that church leaders could do nothing to stop the practice and, with that, European finance flourished and, as canon law relaxed its view on moneylending, gave rise to modern financial markets.

To some critics, including many strict Muslims and two-thirds of respondents to our web poll, Islamic banking depends on a similar fiction. But, to others, such as the remaining third of our voters, the unique risk-sharing characteristics of Islamic finance offer a genuine alternative to conventional finance.

Perhaps a study comparing the return on capital at Islamic and conventional banks would prove which camp is right.

Photo provided by AFP.

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