How Islamic banks are helping entrepreneurs in this pandemic?

Economics Contributor
Islamic banks
Photo : Dreamstime

There is a clear difference between Islamic banks and conventional banks on how they managed the financial crises in this pandemic. As the second wave of Covid-19 hits the world, many countries have started considering lockdown again. Due to this pandemic, it is totally uncertain how long it will take to get back business as usual. Even we don’t know when our life will be normal again.

At present, businesses and startups are struggling with the closure of the financial market, lack of production and sales. Moreover, e-commerce has also taken a hit due to restrictions in transportation.

As per economics, there are four factors of production. They are… land, labour, capital and entrepreneurship. As a businessman, one has to accept the risk. After the payment of all factor payments from the sales, the return could turn out to be positive or negative.

During last year’s lockdown, many entrepreneurs were forced to absorb losses after paying these factor payments. Thus the global laying off started. Thus, people suffered by losing employment or remained in employment without salaries.

Practically, the capital provider does not undertake such risks. The lender supplies capital at some discussed interest rate. The interest has to pay on time and it does not care how much the capital earns from the investment in the business. Compound interest in the financial system is just like coronavirus. Unpaid interests increase in the future at an exponential rate.

Here is how Islamic banks are different in this pandemic…

Honestly, Islamic banking has some clear economic differences over interest-dependent financial intermediation. This banking offers potential reinforcement between and finance and the real economy.

Islamic banks can only earn from the trade of properties or assets. Or simply by providing the usufruct of real properties. This is to ensure that the profits are linked with real assets in the economy. They cannot use the vice called compound interest.

Therefore, we can say that there are some differences that become more apparent in the crises period. For example, assume a corporate client purchased a real asset on Murabaha at $10,000. The spot payment is $8,000. Islamic bank buys the asset in the spot market and pays the price. Moreover, it takes ownership and constructive possession. Until it is sold the client, the bank bears the risks related to it. To bring efficiency, transparency and cost competitiveness, Islamic bank engages customer as an agent to purchase the real asset on bank’s behalf and take constructive possession of the asset. To reduce risk, insurance cover is assigned.

A basic price is charged which enables the bank to earn profits after deducting all direct and indirect costs. Like, the insurance, installation, transportation and taxes.

Suppose, that all the costs sum up to $1,000. Thus, total investment by the bank is $,9000. If the transaction is all good, the Islamic banks will earn a profit of $1,000. This is also a 10% return on its invested funds. If the client delays payments, the bank can only charge the price of the asset, which is $10,000 in this case.

Policy-wise difference between Islamic and Conventional bank in this pandemic:

In the above written scenario, the conventional bank would earn compounded interest on this delayed payment at the current interest rate. Islamic banks will receive the Murabaha price of $10,000 no matter if it is paid after 1 to 5 years.

The conventional bank would charge interest on its outstanding loan amount as long if the payment is not made. Well, one can say that Islamic banks also charge penalties for late payment. But that is too low and also to maintain a financial discipline. Also, it is considered as a charity amount on late payment. It is only to ensure the moral upliftment of the client.

Thus it is very clear that the Islamic banking system is more distinct and egalitarian than conventional banking. The quicker we accept it, the better we will thrive in this pandemic.

Enjoy Ali Huda! Exclusive for your kids.