Credit Unions Come Closest Among Western Financial Institutions to Meeting Islamic Shari'a Compliance

MADISON, Wis.Interest paid to depositors on savings by western banks is considered a loan with interest and is not allowed under Islamic financial principles. However, the mutual ownership and equal distribution of profits typical among financial cooperatives may mitigate some restrictions under that law and make credit unions attractive for Islamic savers and borrowers, not only in developing countries, but also in the United States, according to a new technical report issued by World Council of Credit Unions (WOCCU).

The report, "Supporting Credit Union Development in Afghanistan: An Overview of Issues Important to the Development of Shari'a-Compliant Cooperative Finance," outlines the challenges WOCCU confronts in establishing credit unions in the war-torn Islamic country. Robert Wieland, the report's author and a researcher with Main Street Economics, also takes a comprehensive look at ways financial services are evaluated under Islamic jurisprudence, arriving at the conclusion that credit unions may have the best chance to meet the needs of Muslim borrowers with the terms of their religion.

Under Islamic law, lenders may not charge riba, often translated as "interest" or "usury," on money lent, nor pay interest on deposits held without truly sharing in gharar, translated as "risk" or "uncertainty," writes Wieland. The two requirements are part of Shari'a compliance, a term used to describe financial transactions allowed by the Koran. Credit unions' mutuality, which distributes profits in the form of dividends, aligns more closely with Islamic law, according to the researcher, making the cooperative model well-suited for Muslim countries and communities.

"A truly mutualist institution would minimize the costs of achieving Shari'a compliance for its beneficiaries and, to the extent that profits were generated, these would accrue fully to the member-participants," says Wieland. "This reading of Islamic jurisprudence should interest supporters of credit unions."

The report goes on to discuss types of financial products and the way they may be developed for Shari'a compliance, including savings, investments and different types of loans. Under the teachings of the Koran, there are strategies by which financial business may be conducted without violating its laws, which includes a characteristic of generosity and forgiveness without penalty for loans and investments that go bad. However, western financial practices run afoul of those laws in most cases, causing most for-profit financial institutions to operate at odds to those teachings, Wieland says.

"The interest benefit paid to depositors in western banks -- and which motivates a large portion of the liability side of banks -- is off the table in Islamic finance," the researcher writes. "A known and expected increase in one's deposit over time is considered a loan with interest and is not allowed."

Complementary copies of the 21-page report, funded by WOCCU's United States Agency for International Development (USAID) Cooperative Development Program, are available at http://www.woccu.org. Click on "Publications," then "Research Monographs." Hard copies may be requested by sending an e-mail to research@woccu.org.

Information provided by World Council of Credit Unions, Inc. World Council is the apex trade association and development organization of the international credit union system. It promotes the sustainable growth of credit unions and financial cooperatives across the globe. As instruments of economic and social development, World Council, its regional confederations, and national member organizations in 97 countries with 46,377 member credit unions serve more than 172 million people worldwide. Visit us on-line at http://www.woccu.org.