The concept of sharing risk in Islamic finance has been a common standard for centuries. As globalism rises, the benefits of risk sharing are now being implemented worldwide by conventional financial institutions, including those in the United States. Although risk sharing as an alternative to interest is one of the main foundational principles of Islamic finance, its adaptation by a heavily regulated financial industry seeking to provide consumers with viable alternatives to traditional financing is on the rise.
Concerns regarding interest-based financial transactions are rooted in both historical and religious foundations. Many historical figures, including America’s Founding Fathers, were worried by the effects of interest on society. Both Christian and Islamic scholars have referenced verses in both the Bible and Quran that judge the charging of interest to be unjust. This concept was created as an alternative to “balance the playing field”.
Risk sharing is generally defined as “a method by which the possible cost of a failure or a catastrophic event is distributed amongst the participating individuals in any given initiative” – it attempts to restore the original function of financing to its primary beneficiaries. It is the risks which generate profits and losses. Thus, when risks are shared, profits and losses are also shared, leading to a more just economy overall. Everyone in society benefits when even those who have less wealth are equally and ethically included in society’s prosperity.
Risk sharing can be applied in many different forms – from simple to complex. A modern and hugely popular example of risk sharing is “crowdfunding”, which is the practice of funding a project or venture by raising contributions from a large number of interested people. It’s essential for consumers from all economic backgrounds to understand risk sharing’s varying applications across society. The sharing of risk, no matter what the application may be, is becoming a valued feature in the finance industry in the United States and around the world.
Within the Islamic home finance industry, products and services have been developed that assist consumers of all faiths in purchasing or refinancing a home. The advantage to Muslims is a focus on complying with their laws; that there is a preferred method of finance that allows their participation in home financing while following the principles of their faith – a faith that strictly prohibits interest, or “riba”. The advantages to everyone range from contracts that protect the rights of all parties and prohibit exploitation, to terms such as limits on late fees or penalties, as well as the appeal of opting out of conventional institutions’ perceived appetite for risk and inequitable behavior.
Interest-based debt contracts can be easily replaced by risk sharing contracts; understanding this is essential to consumers looking for alternative methods to traditional financial products. Islamic financing products that employ the principle of risk sharing are a stable and increasingly more popular route to financial security in both the United States and abroad.