Islamic banking was created as a separate path of financing in order to comply with prohibitions stipulated by Islamic law. Also referred to as Sharia law, Islamic law can be considered God’s law as interpreted by Muslims.
Islamic scholars called Muftis in the Sunni tradition and Mullahs in the Shia tradition are charged with interpreting this law. The central texts of Sharia law are the holy book of the Qur’an, and the examples set forth by Muhammad and his early followers are documented in a collection of texts called the Hadith. To render a legal opinion, scholars weigh an action or principle against these texts and determine if it is in accordance with the spirit of the law.
Sharia law is very clear about charging interest on loans. The Qur’an forbids usury, or riba, in four different revelations based on the belief that money is only a medium of exchange and has no value in itself. Islam has not relented to pressures from the marketplace and has maintained its stance that charging interest on loans is usurious and a violation of Islamic law.
However, by differentiating trade from usury, the Qur’an reaffirms the practice of trading as a respectable profession. The importance of trading partnerships has motivated financial intermediaries to find creative ways to help Muslims access loans without violating Islamic law.
Some of Kiva’s Field Partners that serve Muslim borrowers have created loan products based on Islamic principles to better serve their clients. These products have 0% interest and vary in design and delivery mechanisms. While some charge a service fee to cover the costs of administering loans, others share risk between lenders and borrowers or lease assets to borrowers (see next section for more details).
To certify that these products are compatible with Islamic principles, it is important for a microfinance institution to receive a fatwa, a legal pronouncement made by an Islamic scholar or religious leader, that officially condones its work.
Kiva Field Partners post the following loan products to serve Muslim clients (adapted from traditional Islamic financial principles):
1) Oard Hassan: Interest free loans, usually to students or the very poor.
2) Murabaha: Purchasing goods for borrowers and charging a fee* or mark-up.
3) Musawama: The seller and buyer arrive at an agreed price for a commodity.
4) Mudaraba: A limited liability partnership (not allowing for direct investor involvement).
5) Musharaka: A joint venture with profit and loss sharing.
6) Salam: An advance purchase of goods delivered on a future date set by the buyer and seller.
7) Ijarah: Leasing of goods with a second contract to purchase them at the end of a lease period.
8) Joala: Payment of upfront fees.*
*How much are the fees associated with Islamic loans?