Investors lend money to a corporation when they buy debt such as corporate bonds intending to profit from interest payments - which are prohibited in Islamic finance. The recent credit crisis has greatly increased the cost of short-term lending between banks worldwide, putting more presure on constrained credit markets.
Lending money under the condition that interest will be paid on the principal is also known as usury and is forbidden under the Islamic faith, where it is called 'riba'. To avoid this prohibition, financiers in Islamic countries have developed bond-like lending instruments known collectively as sukuk, which are not considered interest-paying but still profit the lender.
Global banks' unwillingness to lend to each other since the credit crisis began has caused a rise in the spread between the interbank lending-rate benchmark LIBOR and three-month Treasury bills. The situation in the U.S. become so dire that some commentators have called for U.S. Federal Reserve intervention to guarantee short-term interbank lending similar to that in other credit markets.
The Bank of England has reacted to a similar crisis in UK interbank lending by creating a new discount lending facility for emergency overnight loans. The BoE has lowered emergency bank lending rates by 50 basis points to 4.5% and will likely also allow banks to exchange moribund mortgage-backed securities and other impaired debt for higher-quality government bills.
- Prohibition of Interest (Riba) in Islam – The Social, Moral and Economic Rationale. Shodalap.com.
- How to Unfreeze Bank Lending. Wall Street Journal.
- Bank to unveil money market reforms next week. Reuters.