Introduction
The introduction of banks replaced the traditional method of storing money. During the Stone Age period, human beings stored their possessions in caves and caverns. An ancient Chinese legend talked of a dragon which was the kept by villagers to guard their treasure. The banking industry replaced the need for hiring animals and soldiers to guard their possessions. The advent of banking replaced the barter trade and signaled the demise of the traditional method of keeping money. The conventional banking system was first developed in England. Banks kept equal an equivalent amount of gold or platinum with the amount of currency in circulation.
Islamic Banking
Islamic banking system is a non-conventional banking system that is ethically motivated and Carries out banking operations in conformity with the Sharia law. The Banking system is predominantly Islamic but allows customers from all religious faiths. It has attracted much attention as a result of its no- interest policy. Contrasted with the Western Banking system, which operates solely on charging interest, Islamic Baking gained prominence when it survived the 2008 economic meltdown. The majority of the Conventional Banks collapsed during the recession. Abstinence from risky business ventures and conformity to other moral and ethical maxims saved the banks from navigating towards financial obscurity. The banking system replaced the traditional method of lending and deposits. Banking systems are closely regulated by the national government. The Islamic banking system is not an exception to the Control by the government. The majority of the Banking institutions in the Islam World operate in conformity in with the International Capital Standard of Basel Accords and the national or regional fractional reserve regulations.
The 2007 to 2010 financial meltdown cast aspersions to the traditional banking system. The conventional banks were at the verge of collapse. The majority of them liquidated. The Islamic Banks did not receive bailouts through the troubled asset program. The financial phenomenon sparked an intellectual debate on the financial system. Academicians and economists debated over long term solution for the cyclical financial downturn. The Interest based banking cast the Islamic into the limelight of the Subprime Mortgage Crisis debate. The Sharia law Muslim economist and scholars saw related products offered by the Islamic banks. Some of them argued that the depository and investment banks should be separated. Islamic banks have an operating policy of avoiding risky business investments that might result to the liquidation of the banks. They refrain from investing in businesses that are shrouded by ethical controversy such as pornography and alcohol. The investments projects that are not consistent with sharia law are have been shunned by Islamic Banks since their establishment in Egypt.
The proliferation of the Islamic banks has been influenced by the broad macroeconomic and structural reforms that have taken place in western countries such as Britain. The liberation of capital movements has facilitated the mushrooming of the Profit Loss Sharing Banking systems. Initially, the banks were tailored exclusively for Muslims. They offered services that were compliant with the sharia law. Muslim economists have rationalized the idea of interest free banking. The ideologists suggested by some of the economists have appeared in the banking interest theory. In response to the justification for interest as a reward for saving, Muslim economists have argued that interest paid regardless as to whether productivity results from the investments, is increases inflation in the economy. Similarly, arguments have been proposed to evaluate the banking systems and come up with long lasting solution to the periodical bailouts that are granted to banks from the taxpayer’s money by the government. Low interest rates bulwark the economy form bankruptcy and liquidation. Low banking rates allows financial institutions to survive in the harsh economic global climate. The Creations of money that does not arise from a business venture creates high cost for the society in case the business ventures are not successful in nature. At low interest rates, banks can borrow from depositors and lend at high interest rates to creditworthy mortgages and credit card companies. Arguments against this proposition are that the low interest rates weaken the economy. They contribute to a weak economy via reduction of the strength of the currency.
JP Morgan Chase
JP Morgan Chase is the largest banking institution in the United States of America. It has a capital base of trillions of dollars and operates as a multinational banking corporation. It is a typical conventional banking corporation with assets worth $ 2.4 Trillion. The bank provides financial services to investment organizations and other financial institutions in the United States of America. It operates the largest hedge fund programs in the Union. The bank follows the conventional banking principles that are common with the western banking systems.
The bank’s operations for some time are skewed towards principles of banking that are not only considered unethical in the, in the Islamic Banking system but also illegal under the secular banking system. The bank was charged $ 80 million in 2012 for carrying out biased research. The penalty was shared between the state of California and the Federal government. JP Morgan Chase was also charged over $ 1.2 billion for the role it played in aiding and abetting the security's fraud that led to the collapse of Enron. Being a large banking corporation, it became the bank of choice for white collar criminals who carry out illegal financial transactions. The Bank was at the core of the Bernard Madoff’s Ponzi scheme that has caused injurious financial consequences to thousands of American families. JP Morgan Chase became aware of the possibility of making mega profit in the credit bidding in the securities exchange. It took part in risky financial venture that saw the company lose over $ 9 billion. In addition, the securities exchange commission, both in the United States of America and UK charged JP Morgan $ 920 million for faulting the securities rules and regulations.
Risky financial transactions only punctuate the operation of the conventional banking systems. The Islamic economics has condemned such transactions and investments for being immoral and against the rules of fair economic play outlines in the Holy Quran. Islamic banking corporations do not make the astronomical losses that were made by the JP Morgan Chase. Nevertheless, If the PLS principles of banking that are synonymous with the Islamic banking were to be applied, the customers and the bank incur the loss proportionally. This principle is usually applied to ensure that justice and equity are promoted in the society.
Islamic Bank of Britain
The bank was established in 2004 to provide sharia law oriented financial services to British Muslims. The bank has branches in the four major cities of Britain and has over 50 thousand customers. It offers services to both the Muslims and non-Muslims. The Islamic economic principles heavily govern the bank. The bank does not charge interest on the loans offered. It does not take part in the risky business ventures that are witnessed in the western Banking systems such as JP Morgan Chase. The bank bases its operations on the principles of faith, value, trust and convenience. The bank does not invest in unethical financial investments such ads selling alcohol, pork and pornography. The financial meltdown witnessed in 2008 affected the banking unit like the other banks. Although the economic condition created weak macroeconomic environment, the bank has continued to register a profit contrary to the expected financial trend.
The United States of America government promised to handle the risky investment schemes carries out by fiscal institutions by the force of law. Fiscal institutions that violate the rules of trading are penalized. This is a scenario is conspicuously missing in the Islamic banking system. The Western Banking system can solve the cyclical fiscal downturn by separating deposit banks from investment banks. The huge capital controlled by the banks is likely to be abused through risky financial trading. Poor reasoning of the managerial team can lead to bankruptcy of the organizations. The organization will make losses from the investment fiasco but cannot transfer the losses to the customers under the principle of capital certainty.
Economists have argued out those banks that approaching insolvency should be nationalized. The insolvent banks take risky loans that lead to the cyclical collapse of the banks and the financial institution. The systemic operations operate under the belief that the banks will government bails them out in case they are at the verge of collapsing. Economists have argued that nationalizations of the financial institutions. The nationalization of the banks that are at the verge of insolvency will save the customers from the ups and downs of failed investment fiascos.
Islamic banks similarly have been rejected western economist for being unpractical in the western banking industry. The banks operate on the Islamic economic principles that are outlined in the Quran. The banks face a legal hurdle in the western governments because religious extremism considers them. Islamic fundamentalism that was considered as anathema in Egypt at the time of launching the first fiat Islamic bank led to the collapse of the institutions. The legal framework of the western countries has to be altered to conform to the principles of sharia law.
Islamic banking would be a cataclysmic failure in a capitalistic oriented country. The market competition witnessed in the Wall Street would drive the Islamic Banking system from religious affiliation to adopt economic practices that were considered as anathema under the Islamic banking system. Businesses are motivated by the profit they make. Success in the Western banking system is measured by the amount of profit the organization makes. Banks are also capitalistically oriented; the desire to make a profit and appear successful before the media and the entire nation forms the background for the risky investment schemes. Prophet Mohamed NIL principles have contributed to the success in the Islamic banking. The banks also carry out, economic practices that are considered unhealthy by their Islamic western counterparts. They don not seek to ascertain the credit worthiness of the customer. They instead look at the market feasibility of the development project. They will invest in the project if the project appears successful to them. They form a partnership with the loaning agreeing on a predetermined ratio of sharing profit from the investment. They would not charge interest for the loan taken from the bank. In the event, the business does not succeed the bank takes the liability of the failed investment project. The investor does not pay back anything for the loan. He or she is protected by the limited liability clause of the partnership. Such financial practice would be considered as an insult to the orthodox western banking practices. The Islamic banking has been around for centuries, but the western conventional banking has remained least influenced by the practice. Instead, Islamic banking has lost its authenticity by adopting the majority of the banking products associated with the conventional banking system.
Conventional banking and the Interest theory debate
It is evident that the conventional banking is ailing and needs drastic reforms to save the global economic depressions that have plagued the world in the 20 century. In 2009, Treasure secretary Timothy Geithner proposed the financial reform principles that would cure the nation of the ailing economic health. He proposed the expansion of the Federal Deposit Insurance Corporation to accommodate the non-financial institutions. Geithner proposed the elimination of the corporate social welfare by allowing firms to fail decently and not to rescue them. To save the tax payers the monetary burden of incurring the losses of failed firms. To ensure that is achieved the large corporations should form a common pool for the funding any firm that is at the verge of collapse. Lastly, Geithner argued that the Federal Deposit Insurance Reserve should be granted the supervisory roles of the financial institutions. The regulations that saved the US from economic recession heavily borrowed from
Earning of interest or creation of wealth from money is forbidden under the Islamic law. When a client is opening a bank account with an Islamic Bank, the client is informed of the Islamic principle that savings in the bank account do not earn interests. The core tenet of all Islamic Financial institutions is shared risk in the growth of money. The principle of capital certainty dictates that saving in a bank account cannot earn a loss. To ensure compliance with the Islamic economic principles, the bank allows the customers to get their capital at a loss. The customer can choose the portion of the loss and receive less the money the customer had invested. The bank will call customers to inform them of the possibility of earning profit. The profit is shared at a predetermined rate. Any profit earned is taxed the same way as the interest earned on conventional banking accounts. The money that is deposited is invested and not lent out.
When a customer takes a loan from an Islamic Bank, the bank enters into a contract with the borrower. The terms of the fiduciary contract dictate the ratio of sharing profit if the investment succeeds. In the case of loss, the bank incurs a loss. The borrower is safeguarded under the limited liability clause. Islamic banking has numerous advantages for any interested customer. The aforementioned advantages are some of the benefits that accrue from a savings account in an Islamic development bank. The greatest risk of opening an account with an Islamic bank is the possibility of losing capital in the event of a loss. In compliance with sharia law, the customers are forced to accept the loss from the unprofitable investment. The risk increases in the event of liquidity. The customer will be forced to incur all the losses the business might have generated.
The same customer will be covered with the principle of capital certainty if the customer opens a bank account in a western Bank. There is a fixed interest rate which the customer will earn in a savings account. The customer can acquire a loan without the strict principles of money lending that are prevalent in the Islamic banking system. Provided that the customer meets the expected criteria for a loan and has several guarantors in the case of default, the customer will be granted a loan. The disadvantages of opening a bank account with a bank that is employing the western banking system is that the customer is subject to exorbitant interest rates. If the customer is unable to raise the expected amount, the bank can auction his property to raise enough money to cover the loan the client had requested from the bank.
There is infinitesimal difference in the operation of Islamic banks and traditional western banks. The risk of saving in Islamic banks corresponds to the harshness of the interests and the penalties imposed on the customer in case of default payment. Both of them are financial institutions regardless of the religious inclination of the bank. They are all aimed at making profit. Sharia law oriented businesses make their profit through ethical investments. Similarly, the conventional banks make their profit through investment and charging interests.
Islamic Banking has been accused of borrowing from the conventional form of banking. The majority of the sharia tailored products and services have been lifted from the traditional banking system. Islamic Banking practices conform to the Keynesian theory of banking. As Keynes argued, Bank failures were responsible for the Great Depression. As Queresh pointed out in the Islam and the Theory of interest, Islamic banks are just like public utilities such as education and health care. They don not charge interest in accordance with the principle of mudaraba. Banks that offer sharia law related products encounter ethical and moral issues in a bid to generate profit from loan consumption and overdraft facilities.
The conventional western banking has been accused of economic exploitation and usury, as referred to, by the Islamic customers. The banks generate profit based on the interest charged on loans. The traditional banking system should adopt some of the banking practices that characterize the Islamic banking system. Both forms of banking need reform. The conventional banking system should adopt the cautiousness associated with the Islamic banking. To ensure that financial institutions do not fall victims of the cyclical financial downturn, conventional banking has to adopt the non-risky financial investment practices of the Islamic banking. However, the success of the Islamic banking cannot be gauged. Islamic banking is at is early stages of financial evolution, hence an economist would not conclusively determine the economic viability of the financial system in the contemporary world.
Conclusion
Both the conventional banking and the Islamic banking have distinct precepts that can easily be adopted by both banking systems to ensure the stability of the financial systems. The rationalization of Islamic banking by the Islamic economist has made it easier for its adoption in the conventional banking system. Although the majority of the western countries are adamant to adopt a legal framework that will enable traditional banks to operate, Islamic banking has gained prominence for surviving the global financial crisis.
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