Islamic Banking Practices

Islamic banking practices are structured so that money can be distributed from central depositories to individuals who need the money in order to buy an item or proceed in trade or manufacturing without the payment or receiving of interest being involved.

In Islam the paying or collecting of interest is forbidden. The Muslim term for usury is riba. The prohibition is based on several passages from the Quran:

Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say: "Trade is like usury but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord desist shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (for ever). Quran 2: 275

O ye who believe! fear Allah and give up what remains of your demand for usury if ye are indeed believers. Quran 2: 278

O ye who believe! devour not usury doubled and multiplied; but fear Allah; that ye may prosper. Quran 3: 130

For the iniquity of the Jews We made unlawful for them certain (foods) good and wholesome which had been lawful for them; in that they hindered many from Allah's way. That they took usury though they were forbidden; and that they devoured men's substance wrongfully; We have prepared for those among them who reject faith a grievous punishment. Quran 4: 160 - 161

These strictures are quite plain. A way to avoid direct violation of these pronouncements from the Quran is to structure transactions and contracts so that interest is not involved. This is often done by the bank buying the item, holding the deed to it, and selling it on installments for a higher price to the individual who is using it. This is called bai' al 'inah. There are variations of this that include a "deferred payment sale" and a "credit sale".

A method more commonly used in business loads in called Musharakah. This is structured as a joint venture in a project or a business. Both parties contribute to the investment (the borrower's portion would be like a down-payment). The bank provided funds would allow the bank to receive a percentage of the profits. The entreprenuer actually running the business might be required to buy out the bank's interest in the venture over a certain period of time. When the borrower provides none of the capital the transaction is called mudarabah.

In murabahah the price is fixed so that the seller gets an increased profit designed to compensate for delayed payment. Musawamah is the same idea without the buyer knowing the markup.

Hibah is the practice of banks giving depositors a "gift" out of a portion of their own profits based on the size of the size of the deposit. This is done in order to encourage people to place their money with the bank.

With Ijarah the use of an item is leased. It can be used in conjunction with a contract to purchase (bai) that comes into play at the end of the lease period.

A loan in which a bank charges no interest, but which the receiver may give a gift to the bank is called a qard hassan.

It should be noted that by Islamic law none of these transactions are allowed if something forbidden is involved such as pork, alcohol, or gambling. Also common ideas such as the benefits of compound interest are disregarded.

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