THE PRINCIPLE OF ISLAMIC BANKING

There are almost 2 billion Muslims worldwide, a statistic that cannot be overlooked even in the banking industry. However, Muslims have very strict laws governing financial transactions. Islamic banking must adhere to the laws of Sharia to be true Islamic banking centers.

The Sharia Law of Islamic Banking

Sharia law is the law of Islam. The rules concerning financial transactions are known as Fiqh al-Muamalat. The most prominent of these laws are the laws concerning the charging of interest or fees on loans or usury fees. This is known as Riba. Islamic banking laws also forbid investing in financial unknowns, such as trading in futures, and in businesses that participate in ventures that are against Islamic principles.

Islamic Banking Principles for Interest

To comply with the laws concerning interest, Islamic banks often require a large down payment on property or goods being purchased. They may also require collateral equal to the value of the transaction. Instead of granting “loans” in the conventional way, a bank will purchase the goods or property from the seller and enter into an agreement with the buyer to sell it to them at a higher price. Since this is an exchange of goods, not money, the banks are allowed to enter into this transaction and make a profit. This is known as Murabaha (cost plus) and is how all property is purchased through a Sharia compliant bank. Islamic banks do not issue mortgages.


These transactions can fall under specific categories and practices. Safe Keeping (Wadiah) is where the customer transfers funds to the bank to hold (Keep) until their debt is repaid. During that time the bank is allowed to invest those funds to generate a profit for the bank. The bank may also charge a service fee for keeping the account safe during this period. The bank is allowed to give a gift (Hibah) on the account in the form of a monetary payment at the end of the term if it wishes. The bank, however, must have all deposited monies readily available should the debt be repaid and the deposit claimed.

Banking Partnerships for Business

Mudharabah (profit sharing) is a partnership that is formed between an entrepreneur and a bank to start a business. The Bank will supply all the money necessary to start the business and as the business operates it will receive a set amount of the profit until the initial debt is repaid. The bank will also receive as a bonus, an additional percentage of the profits until the loan is paid. Musharakah (joint venture) runs on the same principal except there are more than one business partner when the business is created.

Governing Boards of Islamic Banks

Each banking institution employs a special governing board that makes sure that all Sharia laws are complied with within the institution. This board will review all practices and investments prior to a transaction being finalized. They are also responsible for reviewing any potential investments the bank may make to ensure they comply with investment rules.

While many of these practices may seem strange to western bankers, Islamic banking has taken its hold in the Middle East. Deposits into Islamic banking institutions have been growing between 25 and 40% a year since 1975. Currently it is estimated that almost 200 billion dollars a day transacts in Islamic banks world-wide.