Islamic banking is characterized, among other things, by the fact that there is a ban on interest, which applies to all financial transactions. One reason for this dates back to the 11th century:
"The classical Islamic jurist al-Kasani (d. 1191), for example, defines riba as "any pecuniary advantage in a mutual contract which is not offset by any compensation". According to a view widespread in Islam, this also includes interest-bearing loans, because here the lender grants the borrower a certain sum as a loan and - even if at a later date - receives a higher sum back".
http://www.gair.de/pdf/publikationen/IslamicBanking_Zenith20051115.pdf
As one can easily imagine, such a rule leads to a variety of business constructions, all of which aim to circumvent this limitation by some arbitrary feature. Similarly, the treatment of the prohibition of interest in the occidental world is characterized by the invention of ways of circumvention, namely by the construction of the bill of exchange, with the sole aim of overriding ecclesiastical restrictions.
Now, such a situation is not really in line with the actual social objective, namely to guarantee debtor protection, because the opacity of the business constructions resulting from the ban can sometimes result in the opposite of what was actually intended. It is therefore worth considering whether the prohibition of interest can actually provide debtor protection.
The key to a changed understanding of the credit agreement is not to focus on the individual relationship between bank and customer, but to see banks as social institutions. Now, if a bank demands interest from a borrower, the result (if everything goes according to plan) is certainly such that the lender has received more money from the borrower than he had given the borrower for use according to the contract. The catch is that in a world which is not characterised by perfect foresight, it is quite possible that the borrower - for whatever reason - may not be able to pay the agreed debt service. If, in addition, a possible collateral object cannot redeem the outstanding amount through its realisation, this leads to the lender incurring a loss which he must "pay out of his own pocket". Since the money is already gone, the money made available turns out to be a gift, which must be posted as a loss through the write-off of the credit claim and leads to a decrease in the net assets of the lender.
Now a bank has hundreds or thousands of borrowers, and it cannot know which of these borrowers will cause a default. But the bank knows from experience that the risk of a loan default is, let's say, 7% and that about 4% of the default can be compensated for by the collateral of these loans. This means that the bank has to write off 3% of the credit volume per year without receiving any compensation. The fact is that the medieval sanctions for suspension of payments are no longer applied, which means that a debtor no longer has to fear being sold into slavery or thrown into the debtors' tower. This is certainly welcome in terms of debtor protection, but it does not solve the problem of how the lender should deal with the loss he has to assume.
This problem can now be tackled in the following way: since it is known that approx. 3% of the debt volume becomes non-performing and has to be written off, but the possibility of taking out a loan is to be maintained, it now makes sense that all borrowers pay an insurance premium which on the one hand protects the lender from suffering a loss of assets, but on the other hand protects the borrower from losing his livelihood. As with normal risk insurance, this insurance premium is calculated on the basis of the expected loss, i.e. here the loss from write-offs of credit claims to be shown in the annual balance sheet. The effect of this rule is that the bank which charges the borrowers an insurance premium corresponding to the amount of the loss does not obtain any income from the collection of this insurance premium, thus ensuring that the bank cannot obtain a pecuniary advantage, even though all borrowers contribute to a "loan loss insurance".
If you like, the collection of an insurance premium aims to spread the losses that are to be expected from a large number of loans over all borrowers, even if only some of them actually have to declare a suspension of payments. By this contribution, however, each individual receives an insurance against having to pay the outstanding amount for the rest of his life in case of a suspension of payments. For the bank, this means that, even if no income can be generated from the credit business itself, the losses from write-offs of credit claims, which are certain to occur, do not lead to the cessation of credit. This means that both the lender and the borrower are protected, which can also be structured in such a way that insurance premiums are repaid if the volume of losses is below average, while above-average losses are compensated in small steps over the next few years.
Conclusion:
1. in any case, the criterion is met that the bank is not enriched in any way by these insurance premiums.
2. the borrower pays and receives an insurance benefit which enables the Bank to handle a suspension of payments without existential consequences for the borrower. It is therefore not the case that this insurance premium would mean payment without compensation.
3. the bank, which is faced with a large number of borrowers, sees itself in a position to maintain a credit offer without having to bear the losses incurred. (Neither can they, so that the compensation for the losses that are certain to occur must somehow be hidden).
4. with regard to the fact that losses from write-offs of receivables must be compensated, such a construction is also a contribution to transparency, which will lead to a higher level of confidence in the relationship between bank and client.
*** Translated with www.DeepL.com/Translator (free version) ***
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