Interest Free Financial System/النظام المالي بدون فوائد
Interest free loans limit and reduce social inequality. By interest-based loans the lender will accumulate increasing amount of wealth despite the borrowers profit or loss.
In Islam if you are seeking to earn through loan then it is seen as an investment. Profit is shared between both the parties according to a pre-determined profit sharing ratio. The profit sharing ratio has to be mutually consented upon and explicitly stated at the time of contracting and has to be a proportion of the profits. And the payment of profit to the financier cannot be in the form of a fixed amount or any percentage of the capital employed. Two examples are given below.
Normal loans with interest
100 dirham investment in ice cream stand with 5% simple interest per annum. If it takes 3 years to repay the accumulated amount is 115. If revenue was 150 dirham borrower will earn profit of 35. The profit decreases with increasing time of loan repayment as interest increases. If you fail to pay bank will sell your ice-cream stand and take the money.
Islamic loan with profit
An example is lender lends 100 dirham for ice cream stand. Profit sharing ratio is 5% to lender. Borrower revenue 150 in 3 years. Made a profit of 50. So lender gets 102.5 and borrower gets 47.5. If there is loss the loss is distributed too. Say your revenue is 90. You need to pay back 10 dirham more to bank. So bank will sell your icea cream stand then keep 10 dirham and return the rest to you. You are not bankrupt!
So you see for same rate and time the borrower earns more in Islamic scheme. If rate was constant with increasing time then interest based bank would earn more and more while borrower earns less and less.
Another example in mortgage
let's say you want to buy a house, that house costs $90 but you have only $5, so you Go to XY Islamic Bank, you tell them that you identified a house that costs $90 dollars and you only have $5.
The XY Islamic Bank proposes something like this: The Bank will appoint an intermediary who will buy the house, but it will sale it to you for $100, and you have 10 years to pay back.
let’s analyze the situation: The Bank just added the value of The house and made it $100, the extra $10 Dollar is a fixed commission that will never increase at any circumstance, (there is no room for interest in Islamic Banking). Now, 8 years of paying back your loans has passed and now you can't pay anymore, however The bank can't charge you interest for being late on your payment.
Either of two things happen: you convince the bank that you will be back on track on your payments or the bank puts the house on the market. let’s say you fail to convince the bank and they put the house on the market but guess what, that isn't so bad either because you own 80% of the house (you have been paying $10 for 8 years =$80). So whatever amount the bank sales on that house, you get 80% of it. The Penalty is you get kicked out of your house, but you are not going to be homeless, maybe you can buy another smaller house then the Mansion you were living in.
The risk of lender is secured by Islamic taxation system as debtors are recipients of Islamic tax whether individual or organisations such as banks.