Q. If banking is based on interest-free transactions, what would be its basic practical shape in conformity with the injunctions of Islam?
A. Practically, the interest-free banking system can be structured on tripartite arrangement, between depositors, banks and borrowers. The nature of arrangement will very in different cases as summarised below :
Depositors can be two kinds, Current Account and Saving Account holders. In the Current Account, the depositors want the bank to protect their savings for a short-time. The bank can accept such deposit (money) on Qarz basis. The bank will be bound to repay these funds when demanded by the depositors. In the saving Account, the people want to invest their saving through banks. The bank can accept such deposits on the basis of Mushaarakah or Mudaarabah. For this purpose, the bank draws up contracts specifying the conditions regarding the mode of investment, distribution of profit/loss of investment, etc.
Such contracts become enforceable when both parties agree to it.
Three situations can arise here :
i) Consumption loans: Bank will extend interest-free loans for genuine consumption purposes.
ii & iii) Borrowing for Investment : The banks will enter into Mudaarabah and Mushaarakah agreements with the borrowers of the fund for Investment purposes. The agreement will specify the proportions according to which profits/loss will be shared between the investor and the bank. After charging the Administrative expenses, the bank will distribute the profits among the share holders and depositors according to the terms of agreement.