What is Islamic banking and how does it work?
Religion may not be the first thing that comes to mind when you think about finance, but the two are completely intertwined when it comes to Islamic banking, or Sharia finance. 2015 statistics show that over 24% of the world’s population, or 1.8 billion people, are Muslim, and this market is quickly growing.
But what’s so special about Islamic banking? How is it different from conventional banking? And can non-Muslims participate? Let’s go over the basics now.
To put it simply, Islamic finance is based on Islamic law, which prohibits giving and receiving interest (riba) when you lend money. Islamic financial activities also can’t be used for activities forbidden by Islam, such as gambling or alcohol.
According to the Institute of Islamic Banking, this kind of banking has been around since ancient times, but only in the late 20th century has a number of Islamic banks formed to service Muslims and non-Muslims alike.
Conventional banks earn money by charging interest, but because this is forbidden in Shariah law, Islamic banks use an asset-based risk-sharing system to earn a profit. Members pool together their funds, and profits made from the investment of these funds are shared among the depositors.
When a business takes out a loan from an Islamic bank, it doesn’t give the bank interest, but instead, a share of its profits. If the business doesn’t make any profit, or if it defaults, then the bank gets nothing.
Let’s say you want to buy a house. You could purchase property with either an ijara wa iktina or murabaha scheme:
Yes. In fact, because of its strict lending policies, non-Muslim investors see Islamic finance as a less risky alternative to Western finance.“Islamic banking is getting a firmer foothold in the market right now and it has attracted not just Muslims but also non Muslims not just in Malaysia but in the other parts of the world as well,” OCBC Al-Amin Bank’s chief executive Syed Abdull Aziz Syed Kechik told Reuters in 2008.