Islamic banking follows Islamic laws and principles, primarily the tenet that interest must not be paid or collected and that profits and losses are shared. There are two other rules that come to play in Islamic banking. First, banks cannot be involved with businesses that take part in industries that are considered sinful, like gambling and alcohol. Neither can entrepreneurs take part in ventures that deal with sinful activities. Second, excessive risk cannot be taken in ventures.
On loans, borrowers only repay the amount that was originally borrowed. As a gratuity, the borrower can pay choose to pay the lender a small amount of extra money. Such a token should not be promised to the original lender, but paid on a voluntary basis to show appreciation for the loan. Neither should the lender expect such a gift in exchange for loaning money.
Islamic banks should not assess penalty fees for activities such as late payments.
There are some Islamic banks that have investment accounts. All profits made on these accounts – none of which are guaranteed – must be shared with the bank.
A common concept that Islamic banking uses to offset earning or paying interest, is leasing. For example, to allow an individual to purchase a piece of property, an Islamic bank might first purchase the property and then allow the borrower to instead lease that property rather than earn interest from loaning a mortgage. The bank can then resell the property to the borrower at a higher price and the borrower to earn equity through monthly rent/lease payments. Vehicle purchases occur in a similar manner. In both cases, there is no penalty assessed for late payments because these are considered usury, which is also forbidden by Islamic principles.
When the property is resold at a higher price, a “profit” is earned, though it is not thought of as profit. Both parties involved with the transaction must agree to any profit margin.
Individuals and businesses can provide capital to entrepreneurs to engage in a permissible business activity (those activities that are not sinful). Any profits made by the entrepreneur should be shared with the person providing capital. However, only the capital provider bears the cost of any losses that occur.
Under Islamic banking there are many ways of trading and selling that circumvent interest-sharing. In nearly all cases, this is done in a manner that provides benefit to all parties involved in the transaction.
Many Muslims world-wide are interested in banking solutions that abide by the laws of their faith. It’s no surprise that wherever there is a large population of Muslim individuals, Islamic banks are becoming mainstream, especially in the Middle East and many European countries.
Even if a Muslim lives in a society whose economy engages in interest-sharing, that person cannot take part in interest-sharing himself. In places where there are no Islamic banks, Muslims are nearly forced to use banks that offer only interest-paying accounts which directly conflict with Islamic principles. When this is the case, Muslims are required to give away any interest received. This must be done without the expectation of getting anything in return. However, even the mere handling of interest goes against Islamic faith.