Interest vs Risk-Sharing in Business Partnerships
(This is an excerpt from a discussion at one of the message boards that has been modified from it's original form to better suit the question/answer style on this website.)
Question
I have come to understand that modaraba is not actually a mode of Islamic banking. The principles pertaining to it are as follows (as I understand):
1. There can only be one lender and one borrower, and
2. The borrower cannot pool in his/her money with the lender (bank).
This automatically leads to a conclusion that only the lender can suffer any financial loss while the borrower will only loose his efforts and time in trying to start the business..
This is definitely not equal risk-sharing as Islam ordains. Does anybody has any idea how it works in real world scenario?
Response
I am not addressing the particular case of Modaraba, but the underlying concept of profit sharing because I think it is important to understand that before understanding issues, if any, with Modaraba.
I do not think Islam has ordained that there necessarily be equal risk sharing. In fact, in an ordinary interest-free loan, the lender should get back the original unless he voluntarily chooses not to. There is no risk sharing in such a case either.
The way interest has appeared as opposed to charity and trading leads one to think that there are following issues:
1. Interest based loans are unfair for the borrower. Given that Islam promotes brotherhood, if a person borrows some money and is unable to return it because he has run into a financial loss, let us say the entire money, then the lender still wants to not only get the original, but a 'profit' over and above it even though his brother bore a loss. In other words, the lender is saying, "I do not care what happened with you, I just want to get some profit over your loss too!"
Even in modern times, we see many people who get loans, buy property and then property loses all its value. The borrower has to pay back the original plus the profit even though he is in loss. How hard would it be for a person who borrowed the money in the first place to produce enough to not only return the original but also some profit over it!
2. In such cases where the borrower is in dire need of money, it would be more near to God if the lender gives it as a charity instead to help his brother, assuming that the borrower can do charity. That would earn immense reward from God Almighty. Of course, if the borrower cannot give it as charity, then he should be fair to his brother by giving an interest free loan. He would retain the right to get back the principal if he so wishes.
3. Other than charity, business deals can be made so long as they are not unfair. One example would be interest-based loans. This particular type of financial relationship has been condemned because of the inherent problems for the borrower. However, there are many other ways a business partnership may be formed, which can be fair to both the lender and the borrower. Renting, leasing (not financing), stock sharing, venture capital are some such examples. All of these can be acceptable to Islam. Of course, in application we will have to ensure that no other Islamic limits are being violated.
This write up is just to elucidate the problems understood to be with interest-based loans. These problems are not because of non-profit-sharing, but because of unfairness in the financial relationship. Profit-sharing is of course one solution but not the only solution. I think it has become famous because it is one of the ways economists have tried to solve the problem, and that gained so much popularity that most people have been under the impression that as long as this condition is not satisfied, no other form is valid. That is not the case. It is indeed the unfair practice of giving money that is unacceptable.