COVID-19 has amplified calls for Islamic finance

The prohibition of interest on lending and borrowing is a unique characteristic of Islamic finance that promotes ‘sharing’ principle and views interest as burdensome. This unique prescription distinguishes Islamic finance from conventional financial system that has prospered with credit securities and ruled by interest rates.

Interest rates exist in various forms. For example, to calculate the interest rates for risky financial instruments (loans, bonds, mortgages, and many other contracts including Sukuk), the London Inter-bank Offered Rate (LIBOR) was a common interest rate benchmark used, which will soon be replaced by SONIA (Sterling Overnight Index Average).

Interest rates are somewhat ruled by a base rate. In the United Kingdom, control over the level and structure of interest rates was achieved by an interest rate set by the Bank of England, namely Bank Rate. It had a direct influence on interest rates in the domestic banking system. It was also a conventional reference point for the base rates which banks paid on deposits and charged on advances.

Of great interest is the falling trend of the BOE base rate over time. The rate that was peaked at 17% on 15 November 1979 has gradually fallen to almost zero since 19 March 2020. The latest downward revision to 0.1% was intended to limit the economic fallout from Covid-19 – as if the natural law of gravity is showing the world a prescription against the root of all evil.

The trend so far shows an exciting and intellectually stimulating progress in finance. Is there a chance for a zero interest rate policy as an exit strategy to the present unprecedented period of economic calamity? With a proper monetary policy in place, the answer is then up to investors and lenders - are they willing to share their prosperity? Are they willing to fully discount credit risk premiums as a new normal?

In the United Kingdom, government has to step in – it seems to assume the credit risk of small and medium-sized businesses through the coronavirus Bounce Back Loan scheme. In this scheme that will be launched on 4 May 2020, the government will guarantee 100% of the loan and there won’t be any fees or interest to pay for the first 12 months for borrowing between £2,000 and £50,000.

As announced by Department for Business, Energy & Industrial Strategy on 27 April 2020, the loan terms will be up to 6 years. No repayments will be due during the first 12 months. The government will work with a network of accredited lenders to agree a low rate of interest for the remaining period of the loans.

This development suggests that interest on borrowing is burdensome and easing this burden seems feasible. The falling trend of the base rate is a hope that is consistent with the Islamic finance prescription. The fact that this is implemented in a non-Muslim jurisdiction suggesting the universality of such a prescription.