Islamic banking is not "interest-free"

But it does present some challenges

One of Pauline Hanson’s (I know, *groan*) latest crusades is against Islamic Banking – something that she refers to as providing “interest-free” loans to Muslims while Australian families struggle to pay their mortgages. Sorry to burst your bubble Pauline, but that’s not how it works. Even though charging interest is technically forbidden under Islamic law (interestingly, the Christian Bible forbids it too, but this is conveniently overlooked in most ‘Christian’ countries), borrowers still have to pay an equivalent premium/ mark-up. It is simply that Islam does not consider money to be a commodity and therefore should not have additional charges on top of it, but the ASSET that the money is financing CAN have a premium/ mark-up attached to it. Consequently, in the case of a mortgage, whereas a conventional Western bank will lend someone money to buy a house and the money is paid back over time plus interest, an Islamic bank would buy the house FOR the person, then sell the house to the person for a mark-up/ premium, to be paid back in instalments over time – a semantic difference that allows compliance with Islamic law. It is NOT interest-free in the way Pauline Hanson is trying to suggest.

Furthermore, Islamic CORPORATE banking actually focuses more on a borrower’s investment intentions from an economic, social and environmental perspective before lending to them, rather than focusing on the borrower’s credit rating as is done in conventional Western banking. This is arguably a more efficient means of allocating financial resources to their most valued uses.

The government has already started adjusting the tax system so that Islamic banking is treated consistently with other banking and not given any unfair tax advantages. Nor do I see any reason why non-Muslims wouldn’t be able to use Islamic banking services too, if it suits their circumstances better than conventional Western banking. After a quick Google search, I couldn’t find any example of non-Muslims being refused access to such financial services. But even if there were such examples, I’m sure Australia could arrange it so that everyone is allowed access. And surely a bit more competition in Australia’s financial industry would be a good thing.

Islamic Banking is also a relatively ‘small’ ($1.4 trillion – yes, trillion – in global assets) but rapidly growing market internationally. Australia would be foolish not to accommodate such a market – think of the foreign investment we’d be able to attract, the major infrastructure that could be financed. I know, I know, I can already hear the people saying “what if it finances terrorism? … what about how Australia is selling off too much of itself to foreign powers … etc. etc. etc.”

First, money laundering and terrorist financing is actually a legitimate concern with Islamic banking (even the IMF recognises this) – not because Islam is associated with terrorism so often, but because so much of the international anti-money laundering and counter-terrorist financing standards are tailored to the structure of conventional Western banking systems, not Islamic banking systems. Consequently, there may be loopholes in Islamic Banking that can be exploited by money launderers and terrorists – Muslim and non-Muslim alike. Again, not because of any association between Islam and terrorism, but because Islamic banking is an emerging, less well-understood and less well-regulated (or rather, regulations haven’t been tailored to their unique features and arrangements) industry. There remains no evidence that money laundering and terrorist financing risks in Islamic banking are any higher than in conventional Western banking. Even so, for the above reasons, this is something that regulators in Australia and internationally would need to investigate further, and I have confidence that any loopholes in Islamic banking for money launderers and terrorists could be identified and mitigated.

Second, we have government institutions responsible for assessing foreign investment bids on the basis of security, competition, etc. Therefore, if you’re worried about Australia selling its soul to foreigners, your anger should be directed at these bodies, not Islamic Banking specifically. And if, like most people I believe, you are not opposed to any and all foreign investment in Australia, then you can’t treat Islamic investment any differently. And if you’re entirely opposed to foreign investment, full stop, then that’s a conversation for another time.

One possible interesting challenge I do foresee is for the RBA to accommodate Islamic Banking. At the moment, the RBA manages economic activity by (among other things) trading short term assets so as to adjust interest rates. The benefit of interest rates is that they, directly and indirectly, affect such a wide range of economic activity that they can be quite effective at managing economic activity. The challenge with Islamic Banking, especially if they become a significant component of the economy, is that they may not respond to interest rates if they don’t use interest explicitly.

However, it may be a simple matter of the RBA just trading in Islamic securities in the exact same way, which will affect the size of the premium/ mark-up on Islamic debt in the same way as with interest rates on conventional debt. And Islamic financial institutions could arguably be subject to the same regulatory oversight and capital reserves requirements as other financial institutions. Again, potentially just semantic differences, but something the RBA would have to account for, lest a significant section of the economy grow beyond their influence and oversight, and risk endangering the whole country if it crashes (remember the US sub-prime mortgage market?).

Islamic banking holds great promise, but also presents challenges that must be addressed. But it should not be hindered by the misunderstandings of Pauline Hanson.