Different people take different approaches when trying to define Islamic Finance. In the simplest terms, it is a form of modern banking that applies Islamic legal concepts. We use the word Sharia when referring to Islamic Law. This, therefore, means that Islamic banking offers financial products that are Sharia compliant. Islamic Finance has some underlying principles that guide financial institutions and customers as well. These principles can be a powerful tool for poverty alleviation in Africa due to the following reasons.
Prohibition of Interest or Usury
A quick survey of the African market shows that most financial institutions charge more than 13% as interest on the loans they advance to customers. The loans also come with punitive terms in case the borrower fails to repay the loan on time. Many Africans fear to approach the banks because some financial institutions do not give enough grace period to start repaying the loans. Some have even lost their property through auctions when they were unable to repay the loans on time.
The Islamic finance principles prohibit charging of interest or usury. Money should just be a form of exchange and not a store of value as many people tend to believe. In a typical setting, the bank can profit from an undertaking that involves some risk. Let us take for example where a customer wants to buy a car. The bank will buy the car and then lend it to the customer at a price higher than the market value. The financial institutions thus share the risk and are thus entitled to earn some profit from the transaction.
Liability and Business Risk
Many banks require those seeking loans from them to have some of form of collateral. These banks can always liquidate the collateral in case the borrower defaults on repayment of the loan. Some of the most common forms of security that banks accept include logbooks, title deeds and other forms of assets. However, a big number of Africans, especially the youths and women, do not own anything that can be taken as security. Most of them just have business ideas but getting someone who can finance them is an uphill task.