Studies in Islamic Finance, Accounting and Governance series
Edited by M. Fahim Khan and Mario Porzio
Chapter 6: Islamic Banking versus Conventional Banking
Claudio Porzio INTRODUCTION Conventional and Islamic banking activity had different evolutions, although they have common origins and foundations in interest prohibition: historically, these have been essentially connected to the extreme poverty of some borrowers; in non-mercantile societies it was necessary and ethically right to protect ‘the weak counterpart’. In the banking activity which has shaped itself in the western context, characteristics of the traditional banking transactions have been influenced by requirements directly connected to the limits in applying the usury prohibition and banks have progressively been ‘separated’ from risks inherent to customers’ activities. On the contrary, in the Islamic context the interest-based system is replaced by a system based on creditor participation in the profits and risks of the activity (a corporate model?). The impossibility of applying predetermined interest rates has not prevented the Islamic credit institutions from offering financial instruments able to satisfy the economic needs and preferences of customers. The main alternative method is risk sharing used in relationships between bank and depositors on one side and borrowers on the other, while profit and loss sharing represents the alternative to calculating interest rates (Piccinelli 2002). The fact that Islamic laws prohibit paying and receiving interest does not imply that they frown on making money or encourage reverting to an all-cash or barter economy: all parties in a financial transaction have to share risk and the profit or loss of the project. Adopting such a model, the proceeds of both deposits and investments are not predetermined but calculated ex-post,...
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