Islamic Banking as a Paradigm?

Recently I read the book by the nef authors David Boyle and Andrew Simms, The New Economics. The key idea of this book (and of the nef generally) is opposition to the growth ideology, by which our modern economic thinking is dominated. While analyzing the flaws of the current economic system and presenting alternatives, the authors mentioned the possibility “to learn from Islamic banking” (p. 146).

The most common argument against the idea of a “steady state economy” (a term coined by Herman Daly) is that we need growth because the foundation of our banking system is interest payments. For that reason the Islamic banking indeed is an example we can learn from.

The central rule of banking in accordance with Sharia is the prohibition of usury. Therefore, Islamic banks (it shall perhaps be noted here that even in Islamic countries only a small friction of the banking system is really “Islamic” in this narrow sense) are not allowed to charge interest. Nevertheless, they found ways to function without it.

The most interesting practice used in Islamic banking is called “Mudaraba” – according to Wikipedia

Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

Another pattern is called “Musharaka” – here there is a kind of interest payed by the borrower, but the rate of it depends of the rate of return of the investment considered. Furthermore, Islamic banks tend to have a very high leverage ratio (indeed, in theory it shall be 100%, though in practice it is less than this), thus contributing to the stability of the financial system.

For sure, we cannot build up a steady state economy while maintaining the existing financial system, whose foundation is interest payments. But the consequence of this is not, as is often claimed by the defenders of the status quo, that we should abandon the idea of a growthless economy. Instead, we should reform our financial system from the ground up, and thus provide the foundation for a steady state economy. And here the Islamic banking tradition teaches us a lot.

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One thought on “Islamic Banking as a Paradigm?

  1. I really liked the last paragraph:
    “For sure, we cannot build up a steady state economy while maintaining the existing financial system, whose foundation is interest payments. But the consequence of this is not, as is often claimed by the defenders of the status quo, that we should abandon the idea of a growthless economy. Instead, we should reform our financial system from the ground up, and thus provide the foundation for a steady state economy. And here the Islamic banking tradition teaches us a lot.”

    I think a lot of critics towards islamic banking like to find thinks, that they can argue against, for example the standard argument: “Islamic Banks just call interest differently”. We live in a times, where most people just can´t imagine an economic system without interest, so every try to build alternatives are labeled false and fraudulent…

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