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why Islamic finance what the former President Obasanjo of Nigeria Nick the UK home buyer and face all the American college student all have in common they're all trying to pay off loans that seem to increase every single day what started off with a seemingly small interest rate ballooned into something completely unattainable we'll look at each of their examples a little later first let's answer the big question on everyone's mind how is Islamic finance different from conventional finance it looks the same the result is often the same what's the difference well the best way to find out is with a simple real-world comparison let's take $10,000 for instance and let's compare what a conventional bank can do with this $10,000 and what an Islamic bank can do first the conventional bank the conventional bank finds a credit worthy customer and lends at 5% interest the bank is not particularly concerned about what happens to this money other than that it gets repaid the customer on the other hand has already found a borrower willing to pay 7% this borrower runs a small credit co-op for students and lends at 10% one of these students is enterprising enough to lend to his unemployed brother at 15% who has just discovered the power of compounding interest and now lends to street vendors a 25 percent we could go on but you get the idea as we speak there are poor people paying upwards of 40 percent per month now obviously we can't blame conventional banks for everything that happens after they've made the initial loan but we can blame the power of compounded interest interests and the fact that you don't need actual cash to lend money means that the original $10,000 could keep passing hands until we pump out over $100,000 of artificial wealth artificial is Right how much actual cash is there only $10,000 with interest we managed to turn $10,000 into much more now what happens if the street vendors go out of business or the unemployed brother doesn't find his job or the credit co-op goes bankrupt that's right loans don't get repaid and if enough people can't repay their loans lenders get into all sorts of trouble this vicious cycle sets off a domino effect of defaults and imagine that instead of a $10,000 personal loan it's a million dollar business loan or a billion dollar world bank loan compounding interest grows so fast that borrowers are often unable to repay people economies and the environment pay the price as we grow more desperate to meet rising debts so are we surprised when billions of dollars vanish into thin air let's take the example of the Islamic bank with this $10,000 the Islamic bank only invests in actual assets and services in might buy machinery lease out a car or invest in a small business but throughout the transaction is always tied to a real asset or service and this is the central point we can't simply compound assets and services like we can compound interest based loans an asset or service can only have one buyer and one seller at any given time interest on the other hand allows cash to circulate and grow into enormous sums that's the difference between Islamic finance and conventional finance the difference between buying and selling something real and borrowing and lending something fleeting in recent years we've witnessed the most dramatic global financial downturn seen in decades what began as a housing bubble soon became a subprime credit crisis and what many thought would remain a credit crisis soon spread into a global financial meltdown it devastated every corner of the world and while these events affected most of us negatively there was one silver lining people finally gave a serious look at alternative forms of finance and many people stopped believing that interest could solve all problems understanding what caused these events serves as our starting point for understanding Islamic finance and how it differs from conventional finance what conventional finance enables is the ability to sell money when there is no money to sell assets before there are any underlying assets and to allow debts to grow unchecked while borrowers become more desperate interest creates an artificial money supply that isn't backed by real assets the result increased inflation heightened volatility richer rich and poor are poor let's look at three practical examples that show just how Islamic finance is different from and better than conventional finance and while Islamic finance parts ways with conventional finance on more than just being interest free will focus on interest in this module we'll look at three people in three very different real-world situations the first is the former leader of a developing country President Obasanjo of Nigeria the second is Nick a home buyer in the UK and the third is faisal an american college student we begin by quoting former President Obasanjo who said these words after the g8 summit in Okinawa in 2000 all that we had borrowed up to 1985 or 1986 was around five billion dollars and we have paid about sixteen billion dollars yet we are still being told that we owe about twenty eight billion dollars that twenty eight billion dollars came about because of the injustice in the foreign creditors interest rates if you ask me what is the worst thing in the world I will say it is compound interest it seems unbelievable but sadly its typical developing countries start off with relatively small loans and remain saddled with huge amounts of growing debt for generations and remember this could be Nigeria or any other poor country to give just one other example during the years leading up to the 1997 Asian collapse Indonesia's foreign debt as a percentage of GDP was over 60% so Nigeria is certainly not an isolated example there are countless more how did borrowing just five billion dollars end up in having to pay forty four billion dollars in total let's open up a spreadsheet and find out for the sake of simplicity we'll just grow five billion dollars into forty four billion dollars between 1985 and 2000 and see what interest rate we get it must have been a very high interest rate to get to forty four billion dollars in such a short period of time you you so let's start off with 40% per annum no that's not right let's try 30% that still gives us a very high number it turns out that to grow five billion dollars into forty four billion dollars takes an interest rate of only fifteen point six percent now on the face of it around 15% doesn't sound exorbitant he doesn't seem unfair and technically it isn't even illegal according to international law in fact we personally know of banks that charge high risk credits upwards of 30% interest rates but every day numerous countries find themselves in the same predicament as Nigeria UNICEF estimates that over half a million children under the age of five die each year around the world as a result of the debt crisis but as we've seen it's not the debt that's the problem