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Saturday, March 10, 2007

Usury


If we buy a cup of coffee and get charged for the coffee and also for (the act of) drinking the coffee, then we are being charged twice! We won't accept that and no sane cafe owner would dare charge you that way!

However, when we borrow money, we accept being charged twice. Once, for the payment of principle sum and second time for the privilege of using the money (interest).
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The Wikipedia defines usury as "charging a fee for the use of money". However, as it is now common practice in modern commerce to charge interests, usury is more commonly referred to as "excessive interests charged".

I used to think that only Islam forbids the charging of interests, but this is not so.
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"Usury (in the original sense of any interest) was denounced by a number of spiritual leaders and philosophers of ancient times, including Plato, Aristotle, Cato, Cicero, Seneca, Plutarch, Aquinas, Muhammad, Moses, Philo and Gautama Buddha." [Wikipedia].

In the Sermon on the Mount, Jesus emphasizes lending without concern for a return - or even repayment:
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If ye lend to them of whom ye hope to receive, what thank have ye? for sinners also lend to sinners, to receive as much again. But love ye your enemies, and do good, and lend, hoping for nothing again; and your reward shall be great, and ye shall be the children of the Highest, for he is kind to the unthankful, and to the evil. (Luke 6:35)

The Quran says the same thing:
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The usury that is practiced to increase some people's wealth, does not gain anything at God. But if people give to charity, seeking God's pleasure, these are the ones who receive their reward many fold. (Ar-Rum 30:39)

Aristotle wrote:

"Usury is detested above all and for the best of reasons. It makes profit out of money itself, not for money's natural object... Money was intended as a means of exchange, not for increase of interest."

Buddhist teachings on the Eightfold Path taught by the Buddha over 2500 years ago, includes “the right livelihood,” which says that one ought to avoid treachery, deceit, usury, exploitation, or other harm to humans or animals.

Even Jews were forbidden to practise usury to other Jews, but are allowed to do so beyond their community, ie. to non-Jews.

So it is surprising that the mainstream financial systems that are practised today are mainly interest-based. This is easy profits, and compound interest is accelerated easy profits that grow exponentially! :) To exacerbate the matter, in modern banking, monies are represented as mere electronic digits. Which means that it takes the same effort to count one billion dollars as it is to count ten dollars. So, for the same effort, banks make more money transacting a billion dollars, since computers don't wear off very much (if at all) counting bigger numbers. Hence, it is safe to opine that profits are good in modern banking! Besides, it is the borrower who bears most of the risks, not the lender, as loans are almost always collateralised.

Islamic banking is an attempt to level this playing field. In Islamic banking, both the borrower and the lender share the risks and profits, without the involvement of interests. They are also to fund projects which are for the greater good of both investor and investee, the community and the environment and not for profit maximisation. Islamic banking will not fund haraam activities, ie. activities that are considered detrimental to society, like gambling. In recent years, Islamic banking has gained popularity rapidly, and more surprisingly, among non-Muslims and countries without Muslim majority.

Let's hope this growth happens for noble reasons, since it would be tempting to disguise conventional banking beneath a thin layer of Islamic banking for profit maximisation.

Islamic banking also forbids the trading of financial risks, as it is considered as 'gambling', and gambling is a 'haraam' activity.

That said, big financial institutions and hedge funds have made financial risk management into a fine art. With big capital flows, clever algorithms, market research and computerisation, these institutions are capable of giving huge returns with great certainty in their trades.

Actually, it is faster for institutions to make money in the financial markets than in direct investments. This is not healthy as it means that good startup technologies and businesses will not get the investments needed to create tangible wealth. Sometimes businesses with noble objectives to bring society to a higher good are unable to take off without investments.
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With attractive returns from the financial markets, investors will be more motivated and tempted to multiply their money in there. Also, financial markets are zero-sum games. That means, when one wins, some others have to lose. And when big institutions win big, many small investors will have to lose. This does not help with wealth distribution.
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Communist countries have attempted state planning to distribute wealth which had failed miserably. I think communism was a noble ideology that could not overcome human greed and selfishness. What we need badly is a new way of distributing wealth, without destroying the fabric of society, freedom and the dignity of people.
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This gives rise to a new breed of entrepreneurs who call themselves 'social entrepreneurs'. Social entrepreneurs set out with noble objectives to improve the community sustained through profits. Some examples of such enterprises deal with providing clean drinking water, converting domestic garbage to energy, providing micro-loans to rural villagers, promoting eco-tourism, ecologically sustainable housing,... etc.
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Social enterprises focus on what value they bring to the society in the long term. So, typically, it won't be interested in businesses whose sole aims are to encourage more people to send sms messages on their mobile phones; or for the distribution of more chemically preserved fast food to the masses. Social enterprises will definitely not charge you twice for your cup of coffee. Instead, it might set up cooperatives among coffee growers so that they can sell their crops at a better bargain and have their proceeds used to set up village schools or better access roads to their plantations, benefiting everyone in the long term.
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There is a social enterpreneur who told me that in social enterprises, there are no exit strategies. He cited an example in a project in a village in Nepal where they succeeded in piping water to the hilltops and learned that the 3 hours up and down from the hill to the rivers made by the womenfolk each day was the only time they had away from their mother-in-laws. So, you see, there is still no exit strategy! When old problems are solved, new ones emerge! :)
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Whichever method that will become vogue, be it is Islamic banking, social enterprises, or otherwise, there is a need to balance the globalisation and the cut-and-thrust of the market economy. I am glad that there are many kind souls out there doing their part in this balancing act. Many of them unsung heros and silent achievers, without which many communities would have collapsed into more sufferings.
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With this balance, we would be living in a "capitalism with a human face". Though sounding stark in contrast to Gorberchev's "Socialism with a human face", they both seek to achieve the same - that is, to love people and to move money to where love is.




9 comments:

Christiana Kuo-Chen said...

Indeed, last year was the year of CSR and social entrepreneurs (i.e. Gates, Buffet, Yunus); surely it's inspired lots of people to follow their example. Hopefully this won't be just a short-term phenomena!

Student said...

OMG do u even know the basics of finances?

interest is payment for the use of capital.

if i don't expect a payment, why should i lend out the money? I may as well use it for my own reasons.

And it is not easy profits. There are certain risks involved, and administrative costs involved. Generally if it is easy profit, a lot of institutions would lend out money rather than borrow money.

You write like you understand. I am sad.

jupilier said...

Dear Student

Thank you for reading the article, but there is no need to be sad. Different people have different opinions on subjects like these, and you can find yourself very sad in the Internet, if you allow yourself to be. :) We can agree, agree to disagree, or not agree at all, but still learn something. Belittling remarks are neither here nor there.

In all businesses there are risks and admin costs, but it is quite minimal in the present commercial form of lending as they are well collateralised, if the lenders follow the rules. Also, in many other businesses, when you buy more, there will be discounts and it is also more effort to deliver the purchased goods. However, in money, counting $10 is the same as $1 Billion. In that sense, it is easy.

As I wrote in the article, by definition, Islamic Banking does not charge interests. How do they do it? You can find out more in Wikipedia or other more learned sources.

Anonymous said...

"However, when we borrow money, we accept being charged twice. Once, for the payment of principle sum and second time for the privilege of using the money (interest)."

Dude, I don't think the above makes any sense. If I borrow $10, I would be expected to return $10 (principle) and say $1 (10% interest). I dun see where you're being charged twice leh.

Secondly, its interesting that you quoted Md Yunus of Grameenbank fame. Do you know that Grameen charges an interest rate of around 12% to its lenders?

Last but not least, if I am not wrong, Islamic banking takes a profit out of the businesses they fund. In some cases, they also get a stake in the company as well. If they fund the right companies, the rewards could be many times the interest that the borrower will pay if he chooses to borrow from a traditional bank instead.

jupilier said...

Dear Anonymous (7.53)

Thanks for commenting on the article.

We are so used to paying interests that we think we are not paying twice in a loan. The analogy about paying for the coffee and also paying again for the act of drinking the coffee is an attempt to illustrate that we are paying twice. I know this will not go well with conventional banking, but we are not discussing about conventional banking.

The article discusses about the various financing methods and enterprises, and wonder which ones will serve us better, namely those:
- with interest,
- without interest but with profit/equity (Islamic Banking);
- with interest, aimed at micro-loans that big banks are not interested in
- an investment/enterprise with social noble objectives and allowed to profit

Islamic banking takes equity or profits, but that means that they also take the risks together with the borrower, or more accurately, the investee. If the business fails, they have no profits or interest. In other words, Islamic banking lending is like venture capitalist investments.

As mentioned in the article, there are some banks that put a thin veneer of Islamic banking, as a guise to profit more. This will not help entreprises or pro-actively create life-supporting wealth. In which case, the borrower or investee will be better off with other alternatives.

jupilier said...

Dear Anonymous (7.53)

I would also like to add that if the Islamic Bank fund a business, take a stake and make a big profit, they deserve it because they took the risks together with the investee. The investee benefit by splitting his risks and not having to pay interests.

It is easy in hindsight to cry over giving too much of the company away. However, business is about foresight, not hindsight.

jupilier said...

Dear Anonymous

You may like to read http://jupilier.blogspot.com/2008/01/social-enterprise-2.html
for an example of a social enterprise.

Let me know what you think. (Thanks)

Anon 7.53 said...

hi jupilier,

this is Anonymous (7.53). My earlier comment was just to highlight the downside of islamic banking and micro-financing.

Personally, these are all just just different business models that's all, but the end goal is still heavily leaning towards financial returns and commercial sustainability.

Which is the best model for the borrower? Frankly, they all have their pros and cons and are equally relevant to the target segments they serve. Borrowers will benefit with more options to choose from

I am currently based in Bangladesh and have seen first hand how micro-financing and some of the other CSR activities run by Grameen affiliates works. Hence, I'm just speaking from my personal experience.

I've also commented in lady melissa's article "Ignoble Nobles" that I believe social enterprise and CSR activities are more effective than outright charity.

I think your friend's business model might need a little of tweaking as Lady M pointed out but I am more concern about this sentence:

"Clearly, it will be more efficient to acquire the villagers' land and centralise them for industrialised cattle farming and he can do this forcefully in his country, as it is not a democracy."

If he acquires the land from the villagers, where will the villagers rear their 2 or 3 cows to be purchase from him?

Why not just offer jobs to the villagers to run his cattle farming industry? This will help the locals upgrade their skills (OJT) while earning an income. The society would also move from a subsistence/ agri economy to a knowledge-based economy (hi-tech/ industrial farming)

jupilier said...

Dear Anon 7.53 (What a name!:) )

Firstly, I feel honored to have a learned and experience person like you participating here. You are right about the downsides of both micro-finances and Islamic Banking. They both can be abused.

Any system would have to be sincere in helping the customers. That means, love people and use money, rather than love money use people.

There are some so called Islamic Banks that are making lots of money, by taking advantage of no-interests for their depositors, but lots of profits for themselves. So you see, any system can be exploited for selfish gains if there is no love for the other persons.

As for the cows, your suggestion is somewhat what my friend will be doing. The impressive part is that he could have acquired land and force everyone to work for him for cheap, but he chose to sell the cows to them for cheap, teach them how to rear the cows in their own premises, and send vets around for regular health checks, etc. The villagers will stay put where they are, keep all the profits and are not in his payroll.

Economically, it is less efficient, but if we account for the social stability, sustainability and dignity of the people, it is more effective. It will also keep the rural folks from crowding in urban ghettos.