The Islamic financial system's ancient, interesting idea: Banning interest

As the Islamic finance sector booms, sharia-compliant systems present opportunities for growth as well as reflection on western economic models.

The second annual Middle East Islamic Finance and Investment Conference opened this week in Dubai, brightening the international spotlight on Islamic economics and financial systems. The trillion-dollar industry already has many clamoring to get in on sharia-based investments.

What makes it so different? Islamic tradition prohibits charging interest (called "riba") and borrowers and lenders are held to high moral standards. (Are you listening, Goldman Sachs?)

Profit, however, is not forbidden. Instead of the accrued interest debt that most European cultures use, Islamic financiers combine finance and enterprise to construct a profit/risk-sharing system based on equity finance - the investment and sale of stock.

However, the sharia-based financial system has the side effect of discouraging traditional, interest-based microfinance.

Recent data shows that despite the wealth of oil and mineral-rich countries, many are living below the poverty line – 23 percent in Iraq, 18 percent in Iran, 35 percent in Yemen, 28 percent in Lebanon, and 13 percent in Jordan. In these countries, 96 percent of the population is Muslim and thus avoid traditional microfinance systems.

If Western microfinance models were adapted to the Islamic sharia-based finance system, locally-based microfinance could give cash-strapped citizens an avenue out of poverty.

But this is more than just another growth sector for Islamic finance. It raises questions about the fundamentals of economics.

Do Islamic banking regulations present a viable solution to our global economic woes? In short, is this a better way?

As Islamic finance becomes a formidable force in the world’s financial sector, the rest of us would do well to take note.