Shared risk: the alternative of interest
The concept of risk sharing in Islamic finance has been a common standard for centuries. As globalism rises, conventional financial institutions, including those in the United States, are implementing the benefits of risk sharing around the world. While risk sharing as an alternative to interest is one of the main fundamental principles of Islamic finance, its adaptation by a heavily regulated financial industry seeking to provide consumers with viable alternatives to traditional financing is on the rise.
Concerns regarding interest-based financial transactions are rooted in both historical and religious foundations. Many historical figures, including the founding fathers of the United States, were concerned about the effects of interest on society. Both Christian and Islamic scholars have referenced verses in both the Bible and the Koran that judge the charging of interest to be unfair. This concept was created as an alternative to “level the playing field”.
Risk sharing is generally defined as “a method by which the potential cost of a failure or catastrophic event is distributed among the individuals participating in any given initiative”: it attempts to restore the original financing function to its main beneficiaries. It is the risks that generate profits and losses. Therefore, when risks are shared, profits and losses are also shared, leading to a fairer economy overall. Everyone in society benefits when even those with less wealth are equitably and ethically included in society’s prosperity.
Risk sharing can be applied in many different ways, from simple to complex. A modern and very popular example of joint venture is “crowdfunding”, which is the practice of financing a project or company by collecting contributions from a large number of interested people. It is essential that consumers of all economic levels understand the various applications of risk sharing in society. Risk sharing, no matter what the application, is becoming a valuable feature in the financial industry in the United States and around the world.
Within the Islamic home financing industry, products and services have been developed to help consumers of all faiths buy or refinance a home. The advantage for Muslims is to focus on complying with their laws; that there is a preferred financing method that allows them to participate in home financing following the principles of their faith, a faith that strictly prohibits interest or “riba”. The benefits for all range from contracts that protect the rights of all parties and prohibit exploitation, to terms such as limits on late fees or penalties, as well as the appeal of opting out of risk appetite and perceived inequitable behavior of conventional institutions.
Interest-based debt contracts can easily be replaced by risk-sharing contracts; Understanding this is essential for consumers looking for alternative methods to traditional financial products. Islamic financial products that employ the principle of risk sharing are a stable and increasingly popular route to financial security both in the United States and abroad.