Banks from the Shariah Perspective

A bank is essentially an intermediary between those with excess funds (depositors) and those in needing funds (borrowers). Banks take in deposits from those with surplus funds and lends them to those in need of financing. The difference between the interest charged to depositors and the interest charged to borrowers represent the bank’s income. A very simple model indeed!

Everyone wants to own a bank because banks print money (refer to Fractional Reserve Banking Causing Complete Banking Disaster). Fiat money allows banks to make so much money out of thin air.

Let me illustrate, a 1% reserve requirement (imposed by BNM recently) allows banks to lend out RM100,000 from a deposit base of only RM1000. Let’s assume the deposit rate is 2% per annum and the base lending rate (BLR) is 5.5% per annum – banks will make RM5,500 (5.5% x 100,000) but only pays out RM20 (2% x 1,000) to the depositors. Now you see how the banks make money and why so many want to own banks. Even when banks are losing money the government will bail them out (using taxpayers’ money despite most of the taxpayers not benefiting from the banks’ existence!). Granted, the banks face lots of risks, especially risk of non payment but given the cushion, the banks can afford to have an NPL (non performing loan) ratio of 50% and still make money!

I hate to be a party pooper but I don’t think Shariah will agree with the model.

Firstly, money must be backed by real assets; creating money out of thin air is a no no.

Second, money is not a commodity hence cannot be traded.

Thirdly, interest bearing loans are not allowed under Shariah laws, it has to be given out under a partnership or trading arrangement.

Fourthly, money (deposits) cannot grow unless it is put into productive purpose.

Fifth, risk sharing is absent in the conventional banking model whereby the risk is borne wholly by the borrower, they have to repay regardless of their financial state.

Banks, from the Shariah perspective are in actual fact trading houses/venture capitalist/trading partners. They still play the role of intermediary between the two groups, but the modus operandi is different. For starters, fractional reserve banking should not practised. Money is not to be traded but instead be put into real economic activity, profits and risks are shared. The basic principle of Shariah based financing is doing business in a transparent, just and equitable manner. But if one party (the one without the capital) makes 5,500 while the capital owner makes only 20, where is the equity in that?