Conventional Bank as Loan House vs Islamic Bank as Finance House
Conventional Bank as Loan House:
It is a loan house; It has deposits as its inputs and loans made to customers as outputs; It has bank depositors and customers on the basis of loans given to or received from the bank; 64 Accumulation of deposits makes it a powerful ‘monetary’ institution with monies available for lending, leaving the legal aspect of loans intact;
It will only be concerned with gathering more deposits and lending out more money, part of which will go for speculative activities (for which the bank has no responsibility) and the rest for debt-capital. The ‘money whirlpool’ this produces brings about inequality between saving and investment, whose immediate result is unemployment; It does not play an active role in the economy in that, as long as the borrower has sufficient collateral, the purpose to which the loan is put does not matter. In other words, money goes where the ‘return’ is highest, not where it is needed most; Interest charges from both sides are considered as a cost. Interest paid to depositors is part of the cost of the bank; similarly, interest paid on borrowed money is part of the cost of the borrower;
The rate of interest is basically determined as the result of speculation of money;
Any changes in the rate of interest come from the money market. Quite often, these changes are dictated by the monetary authority, the Central Bank, and are due to interference in the market mechanism, despite the misleading idea that the market mechanism brings about efficient allocation of resources. Even if this assertion happens to be true, it should be noticed that it does not guarantee justice (equity). Risk is inherently interwoven with investment. Our bank does not involve itself in any investment project; rather, by lending money, it keeps itself away and safe from any risk. Thus, the conventional bank plays a completely passive and neutral role in the economy from which it flourishes.
As we have seen, the individualism implicit in capitalism makes it a zero-sum game. Given that people necessarily interact with others with different and quite often opposing goals, such a game produces conflicts of interest. In addition, as long as there are other ways to earn ‘income,’ the borrower need not engage in any ‘productive’ activity. Speculation, the first immediate derivative of interest, is often an attractive alternative that the speculator need not engage in the difficulties associated with such things as labor – management relations, pricing policy, the most effective use of existing technology, and so on. The huge amounts of money circulating in speculative activities offering a rate of return far above those offered in ‘productive’ activities can only have adverse effects on the economy.
The balance sheet of our bank is such that the value of either side of it varies inversely with general economic activity. Although this might be thought to keep our bank on a safe margin, it also emphasizes the point that it is not integrated into one whole system, all elements of which tend to go up or down simultaneously. Such a bank is alien to the 65 general economic activity. An economy is based on such paradigms is quite vulnerable, as the recent history of capitalism has shown. Profit here is the difference between interest-income received from money loaned out and interest expenses paid to depositors. This difference might be called ‘net interest (RIBA) income,’ to distinguish it from profits earned by economic activities in producing goods (and when we reach the discussion of operational costs of such banking, especially when those costs are passed on to the consumers as if they were independent economic agents. The carelessness of the conventional banks about the economic performance of the system means that it has become separately and independently studied from the real sector as a result of the conflicting interests of the two sectors.
As long as money remains potential capital and is pumped into an economy in the hope of stimulating the system, not only will it fail to become an incentive for increased production, but it will also have adverse effects on the economy by raising general price levels. Furthermore, it is almost impossible to anticipate with any certainty the extent to which the GDP will go up in line with change in the money supply.
Source: Prof. Iraj Toutounchian, Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Narrated by Camille Paldi. Republished with permission.