QUOTE
What we have done with Mr X is effectively take a share of his "profit" in the form of wages. And that is just the same as if we combine your money and mine, and lend it to a start up business. We charge interest and look for capital repayment, and that is a share of the profit too. The alternative is to invest directly in the business by buying shares, for example: that is, by buying part of that business. Either way the business gets money at the cost of some of its future profit. If it takes a loan, then in principle the foregone profit is time limited: if it shares ownership, then it is not. But there is no problem so long as the new business increases production: this is economic growth and it is new wealth out of which the repayments can be made.
I wanted to just add a comment on this earlier statement because it is relevant to how islamic banks operate and I think there is something to learn from them. As noted above, islam still prohibits the charging of interest. Yet there are islamic banks and financial institutions.So I had a wee dig about to see how that can work: because in my mindset it is quite hard to see. Apparently the way they do it founds on the notion of "partnership" or perhaps we could call it "joint enterprise"
For businesses it is reasonably simple: the bank buys part of the business and that is not much different from buying shares. As I said, it means that payment to the bank is not time limited any more that the dividend to shareholders is. But what might not be immediately obvious is that it completely avoids the adverse consequences of a loan: because the payment to the bank, like the payment to shareholders, is not fixed. In other words, if the business is in trouble the payment falls: that is not true for loans. One can immediately see why the banks and financial institutions prefer loans. Usury is at its worst when it results in the transfer of the borrowers property to the lender, due to the lender's financial distress. Default on a loan has just that result, and it is one of the mechanisms which leads to concentration of wealth in the hands of the few: the lender imposes a tax on profit, and therefore taxes all those who buy goods or services from the business: but his tax is unrelated to the ability to pay. So long as the asset is not overvalued he can't lose: and when it is overvalued, the taxpayer bails the lender out.
In the case of house purchase the islamic practice is still a form of partnership. The way they do it is also done in this country, though not very commonly, and it is usually called a "shared-ownership" agreement. What happens is that the buyer buys part of the house and the bank (or in the case of the government scheme something like a housing association) buys part of it too. The UK government is pushing this kind of arrangement for first time buyers because they are now very often unable to buy a house, and that is the aim of all right thinkiing people.
I looked at the arrangement offered by the Islamic Bank of Britain. The repayment is different in England and in Scotland (presumably reflecting the different legal systems) but effectively in both cases the buyer pays for the bank's share in installments. The payments are part purchase payments, and part rent for the use of the property until the whole price is repaid.
In the standard product the rent element is variable and it is, rather curiously, tied to the bank base rate with a margin added. The margin can be varied but any increase is capped at 2% above the margin at the start of the arrangement. The bank states that the relation to the bank base rate is to ensure the product is in line with ordinary mortgages in terms of cost: but insists it is not of itself an interest payment. In support of that it is noted that the occupancy element falls as the acquisition payments are made, with the consequence that the quarterly reviews of that element may result in a reduction; no change; or an increase if the base rate rises more than the reduction for purchasing some part of the bank's share of the property every month. The maximum the bank will buy is 80% of the purchase price so the buyer must find 20% of the purchase price in order to buy a house. The buyer can make enhanced purchase payments if he wishes, and can sell the house at any time without penalty, but with an admin charge. The bank also notes that because it is a part owner it is is responsible for part of the maintenance of the property and it shares the "risks of ownership", whatever that might mean.
To some extent this looks very much like an interest arrangement by any other name, and it is likely to be more expensive because rent does tend to go up, in my experience. But what does seem to be significant is the higher deposit demanded, and the tighter rules on income multiple, which seem to be applied. Those are both important because high multiples and low (or even negative) deposits contribute to asset bubbles. Islamic and shared ownership arrangements are not currently big enough parts of the mortgage market to prevent that: but if they were widespread that might change, assuming the same limits were adhered to
