United Kingdom Flat Growth and The Lending Scheme

Looking at the quarterly inflation report of the Bank of England(BoE) gives indication how dip the euro crisis and lack of willingness of banks to lend money is affecting the economy at large. The BoE in its report reduced the expected growth rate from 0.8% to 0% compared to what it was in the same period a year ago of 2%.

The reasons for this forecast of the growth forecast are obvious to all and sundry which are; the euro crisis , the weather which , the bank holidays as well as government cut in spending.

The Lending Scheme

The new £80bn lending scheme which officially started on 1st of August for drawings is to allow banks and building societies borrow money at a reduced cost from BoE and eventually lend to households and the businesses with the hope that it will stimulate the economy activities in the UK. Banks and building societies will have access to it for a period 18 months and there is no limit on what individual banks can borrow from the scheme but will be able to borrow up to 5% of  their previous lending to the real sector as at the end of June 2012.

The banks are to lend to the real sector of the economy but the concern here is that banks  might take the loan to boost their profit and balance sheet position rather than lending to the businesses that are struggling with funding. On the building societies perspective, instead of allowing the building societies to decide who to give these funds to, I think BoE should have attached some conditions to it by designating some aspect of the loan to first time home buyers who might not have large initial deposits to finance their mortgages.

Is Islamic Finance The Panacea?

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The principle of Islamic finance (Non-Interest Finance) focuses more on transparency of dealings, social responsibility through proper equitable distribution of wealth. The crisis in the Euro for the past couple of years with the conventional banks struggling to weather the storm looks promising for the Non- interest financing.

'Musharaka' which I largely believe is the major significant argument for Islamic finance is a financial activity where the bank or investor provides the fund for an enterprise but also participate in the managing of the firm. Profits earned on the venture will be shared between the parties based on the agreed ratio and the losses will be shared based on their capital contribution.

For instance, If conventional banks were required to share the profits and losses of their clients like the 'Musharaka', whether on business investments or mortgages which led to sub-prime crisis in 2008 they would be much more careful. This is because their financial returns would depend more on the performance of the projects that they finance. Interest-based lending substantially divorces financial institution from their customers risks and focuses only on the interest to be earned on the loan deal. In many cases, the banker who brings in the loan deal has already collected his or her bonus and sometimes retired by the time the deal goes bad and eventually causes problem for the entrepreneur and the bank.  

Budding entrepreneur with great business idea without collateral often fail to attract finance under the conventional system because of the interest based finance but Islamic finance has bridged this gap through profits and loss sharing.

Despite the prospect of Islamic finance, challenges abound as well. Some school of thought argued that Islamic finance instruments are only an hybrid version of the conventional instrument and that there is no significant difference. There is also shortage of qualified professional who specializes in Islamic instruments and also diversity in the laws and procedure in different countries where it's been practice. I believe if these challenges are eliminated, non interest finance can be the panacea for the financial crisis.