Another charge brought against the interest-free economic theory is that it is most likely to corrode the centuries-old motivation of savings which leads to massive capital formation which in turn is utilized for lending on interest for developmental purposes. Under this established system, the savers are paid interest out of the interest payment received from the borrowers.
The basis of such an argument is that the non-payment of interest on savings in an interest-free economy will reduce the value of the original capital over a period of time due to the inflationary effects.
Believers of the interest rate doctrine also state that on one hand, interest functions as an inducement to save and on the other it serves as a shield against the decline in the value of the original capital and that the abolition of interest in an economy shall severely impede the very incentive to save, thereby plunging the economy into a severe monetary crisis where the fresh capital shall not be made available. This will lead to large-scale economic deterioration in a society.
Analysis
Is it true that people save only because they get paid the interest on their savings? For a moment, let’s assume that the banks in a given economy stopped paying interest on savings and term deposit accounts. Well, why assume? With interest on saving accounts at around 1% or below and on term deposits at less than 2% per annum in most jurisdictions for the last several years, the non-payment of interest is almost a reality in the current scenario. Have the people stopped saving due to utterly unattractive interest rates on their savings?
By nature, man is inclined to save because God has not bestowed upon him the ability to envision the future. The urge to save in man not only revolves around his present income and expenditure but also on the expected but uncertain future income and his growing financial needs. Since man cannot predict his futuristic financial circumstances, there is an in-born tendency in him to save for the ‘rainy days’.
In the primitive age too, man used to set aside part of his farm produce for unforeseen circumstances, such as drought or damage to crop due to flooding, etc. Here I would like to refer to the valuable advice Prophet Joseph or Yusuf (peace be upon him) gave to the representative of the king at the time to save the grains in the ears for use during the severe drought the kingdom may face in future. He said: “For seven consecutive years, you shall sow as usual and that (the harvest) which you reap you should save in ears, except a little of it which you may eat. (Chapter 12, Verse 47)”.
In fact, this natural tendency gets a boost by adopting values of all divine religions which strongly support self-thrift and oppose extravagance in one’s lifestyle. As such, observance of such values promotes a higher degree of correlation between an individual’s income and his savings, irrespective of the ‘rate-of-return’ phenomenon.
Imagine, if the Islamic values of self-thrift and prudence are applied in the true spirit in a society, they can generate formidable capital which is unimaginable in a capitalist society where the extravagance is generally encouraged through various means including borrowing on interest – a modern-day means of which is the misuse of credit cards.
It is but natural that the individuals in an Islamic economy, having collected ample savings, will look for profitable avenues to invest in order to benefit from the savings and also to guard from inflationary effects; of course this will be after they have met with their respective Zakat obligations. By default, all such savings will flow into equity investments (or risk capital as discussed earlier) in the absence of the interest rate apparatus in such an economy.
It is not necessary that every person holding reasonable financial resources in an Islamic economy will anyhow venture into trading activities. Such passive investors may have a wide universe to diversify his savings and spread the risk. They can buy shares of Shariah compliant joint-stock listed companies such as Islamic banks and financial institutions, industries, service sector organizations, exchange-traded funds, REITs, venture capitalist organizations, cooperative societies, etc, or venture into private equity opportunities.
Various investments may have a different degree of risk and maturity, depending on the investor’s appetite for return and his sustaining power. Some may be less risky than others, with the apparent high risk being offset by the expected high return besides regular appreciation in the value of the investment.
Hence, an Islamic economy is not only quite capable of generating massive capital by virtue of practicing Shariah values, it is also more profit-oriented than the conventional environment since it provides investors the right and the eligibility to share the entity’s profit, unlike the conventional interest-based economy where the interest rate is fixed at the outset.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: We shall wrap up this interesting debate in order to move on to the differences between Islamic and conventional banks.