When determining the interest rate to charge borrowers, one of the factors to consider is the cost of funds, i.e. the price the bank has to pay to the owners of the funds, who are either depositors or lenders for using the funds.
On the other hand, a partnership or trade based (Islamic) financial transaction should not have a cost of funds simply because the owners of the funds are not lending or selling the funds and therefore should not expect any consideration for the transaction. Funds are monetary capital and Shariah stipulates that money cannot be traded because it is not a commodity, it is merely a medium of exchange.
So, technically, under Shariah terms, capital has no cost. Surely this is a concept which traditional conventional bankers may find difficult to grasp.
Why is money devoid of any cost?
This is because the owners of money cannot expect to earn more money without undertaking some form of economic activity. Shariah stioulates that owners of money cannot trade the money for profit. Any exchange of money which is not equal in amount constitutes riba.
When determining the profits to be charged to customers (‘profits charged’, oxymoron?) for a Murabahah or Istisna transaction, banks cannot base it on the cost of funds simply because there is no cost to start of with. The cost of funds arises when Shariah based banks operate in an identical manner to a conventional banks, i.e. as an intermediary between lenders and borrowers.
On the other hand, a partnership or trade based (Islamic) financial transaction should not have a cost of funds simply because the owners of the funds are not lending or selling the funds and therefore should not expect any consideration for the transaction. Funds are monetary capital and Shariah stipulates that money cannot be traded because it is not a commodity, it is merely a medium of exchange.
So, technically, under Shariah terms, capital has no cost. Surely this is a concept which traditional conventional bankers may find difficult to grasp.
Why is money devoid of any cost?
This is because the owners of money cannot expect to earn more money without undertaking some form of economic activity. Shariah stioulates that owners of money cannot trade the money for profit. Any exchange of money which is not equal in amount constitutes riba.
When determining the profits to be charged to customers (‘profits charged’, oxymoron?) for a Murabahah or Istisna transaction, banks cannot base it on the cost of funds simply because there is no cost to start of with. The cost of funds arises when Shariah based banks operate in an identical manner to a conventional banks, i.e. as an intermediary between lenders and borrowers.
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