Negative interest rates, which were once unbelievable by most economists, now do not seem abnormal. Zero interest rates do sound familiar as most of us would have studied it as part of economics; however, interest rates are now getting pushed into the negative territory (Lokesh Gupta And Nafis Alam). Â
The turmoil in financial markets has been observed globally due to tumbling oil prices, uncertainty due to China's slowdown and US rate hikes. The fallouts due to the global downward spiral are surfacing and policymakers such as the central banks in Europe, Japan, Denmark, and Switzerland  have  already adopted the path of lowering interest rates to below zero and now it has gone negative.
In layman's terms, the plunge in interest rates signifies an increase in fiscal deficit, deflation (fall in prices) and weak economic conditions. Central banks opt to cut interest rates as a measure to make saving less attractive by charging commercial banks and depositors for keeping their money with banks. This means depositors will have to pay to keep their money with banks. This is intended to incentivize banks to lend money more freely to individuals and corporates to invest, inject into businesses, and spend money rather than paying a fee to the central bank. The increase in flow of money into the economy will boost industrial production and recovery.
The effects of negative interest rates can be summarized as Retail/corporate depositors will be charged for holding their money with banks, The central bank will charge commercial banks for reserves, A reduction in borrowing costs to stimulate lending and boost inflation Increase in spending and investment elsewhere due to negative returns from deposits, and Lower or negative yields on bonds. If we compare the present market situation with the principles of Islamic finance, we can observe that this has been thought through and is well taken care of under the fundamentals of the Islamic financial system.
The Islamic financial system, which is  also known as interest-free banking, provides pro-active measures to ensure that the economy does not reach the point of a spurting economy. The surprising fact is that the 'pro-active' measures followed under the Islamic financial system are 'reactive' measures followed by the conventional economy for recovery. Interest is strictly prohibited under Islamic finance and it emphasizes the ethical, moral, social, and religious dimensions. The most fundamental pillar of Islamic finance is the profit-sharing feature and permissible (Halal) financial products and services, which must be in compliance with Shariah. The principles of Islamic finance focus primarily toward uplifting society through the concept of justice, equitable distribution of wealth, risk-sharing, no gambling and the sanctity of contracts and offering  Riba  (usury)-free products and services.
The objective behind such a policy is to deliberately boost aggregate demand and output by encouraging business and trade activities. The underlying principle behind the policy is that cash is not subject to a negative interest rate once it is withdrawn from the bank. This will create liquidity surplus in the market and will open channels for other sources of investment driven by equity and partnership models. This will uplift society, create social equity and narrow the wealth and income distribution between the rich and the poor. This is precisely what is preached and practiced under Islamic finance, ie there is an emphasis on fairness, transparency, equitable income and wealth distribution.
The negative real interest rate ideology is a closer example of what Islamic finance intends to achieve.
Islamic finance has already proven its stability during the subprime crisis, that the crisis would have been averted if Islamic financing principles were followed, ie financing the purchase of physical assets and not permissible to finance a debt. A negative interest rate does have its limitations. It does not wave a magic wand to do away with inherent business risks such as the flocking of non-performing loans due to easy loans and the economy sinking into recession.
The success of a negative interest rate implementation in stimulating the economy is something that the future is going to decide. However, the current negative interest rate policy could also be an opportunity for Islamic financial institutions, where the expected outcome has already been taken care of under the principles of Islamic finance. The Islamic financial system is driven by profit-sharing, equity-sharing and asset-based financing and shares the same intended outcome as negative interest rates. This brings an opportunity for Islamic financial institutions to illustrate to the world that the fundamental operating principles of risk-sharing strengthen financial stability. This does not mean that Islamic financial institutions are risk-immune and not vulnerable to financial shocks; however, there are inbuilt checks in place as guided by the principles of Islamic finance to mitigate adverse financial risk and volatility.
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