How do islamic banks make money

In the past few years, it has made great advances. The commodity that is to be delivered to the Bank will be purchased by customer through a commodity broker and the Bank in turn, will assign another commodity broker to sell the commodity. Islamic mortgages, or house purchase plans HPPs can involve ijara, where you are technically leasing the property from the bank, or diminishing Musharaka, where you buy in partnership with the bank and your monthly repayments gradually buy it out. Historically, Islamic finance and its practicing institutions have been sheltered in the Middle East and a few other Muslim countries for hundreds of years. This means that earning interest riba is not allowed. Next Article. The prohibition on paying or receiving fixed interest is based on the Islamic tenet that money is only a medium of exchange; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or by lending to someone else.

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Muslim banks aka Islamic banks are financial institutions that operate under Sharia law and regulations. On the surface, there is little difference between Muslim banks and other more conventional financial institutions. In fact, most people completely oblivious as to how these institutions work. However, following Sharia law has major implications for how these banks omney money and keep profits flowing i. This how do islamic banks make money will hopefully add to your knowledge and help you to understand the quirks of this narrow but growing sector of the financial industry. Even though this is oversimplifying things quite a bit, Muslim banks and related financial institutions follow three broadly specific conditions constraints that are based in Sharia Law.

Strings attached

Like any business, banks sell something—a product, a service, or both. Banks work by selling money as a storage service. Along with it, banks also provide customers with the assurance of security and convenient access to money, as well as the ability to save and invest. Your bank loans your money out to others at a cost to the lendee, in the form of an interest rate think: mortgages, student loans, car loans, credit cards, etc. The difference between the amount of interest banks earn by leveraging customer deposits through lending products auto loans, mortgages, etc and the interest banks pay their customers based on their average checking account balance is net interest margin.

Biggest Difference Between Muslim and Conventional Banks

Muslim banks aka Islamic banks are financial institutions that operate under Sharia law and regulations. On the surface, there is little difference between Muslim banks and other more conventional financial institutions.

In fact, most people completely oblivious as to how these institutions work. However, following Sharia law has major implications for how these banks make money and keep profits flowing i.

This hub will hopefully add to your knowledge and help you to understand the quirks of this narrow but growing sector of the financial industry.

Even though this is oversimplifying things quite a bit, Muslim banks and related financial institutions follow three broadly specific conditions constraints that are based in Sharia Law. Muslim banks and related banking institutions are not allowed to charge. This is probably the biggest constraint and the one big characteristic that most Muslim banks are known.

It is such a distinguishing characteristic that in some non-Muslim countries where Muslim banks operate, they operate under the broad term of «no-interest banking» instead of Muslim banking for marketing reasons. The reason for charging no interest stems from an interpretation of Sharia Law that states how «one must work for profits,» and that the act of simply lending money to someone in need does not count as work.

In short, «Money cannot be used to create more money. Islamic finance does not allow for high levels of uncertainty, also known as «argharar», in business transactions. In order to comply with this constraint, Muslim banks are required to disclose all information to prospective investors and to request all information from potential business interests. An important caveat that follows from this rule is that an Islamic financial institution cannot sell something that it does not.

Selling something that you do not own outright is considered the highest degree of risk because the risk of unavailability is extremely high. Therefore, the selling of financial products such as derivatives or CDO’s collateralized debt obligationsproducts that brought the global economy to its knees a few years ago, are prohibited or considered «haram.

Islamic finance requires that you invest only in morally upright and ethical causes. Therefore, Muslim banks are prohibited from investing in certain vices and morally-gray business prices such as gambling, prostitution, slavery, or drug-trafficking. Since it is such a large part of Islamic finance, I wish to provide two examples of how no-interest banking affects business operations in Islamic banking situations.

First, let’s take the simple case of setting up an account at a bank. In many conventional banks, interest-bearing savings accounts are offered to customers. The interest rates are promoted and marketed as a way to get customers to invest and keep their money with the bank.

Profits from the Muslim bank’s successful transactions are redistributed to individual savings accounts. However, losses from the bank’s unsuccessful transactions can affect savings account as. Another example comes from how Muslim banks handle mortgages. If you were to purchase this house via mortgage from a conventional banking institution. This is in stark contrast to an Muslim banking institution which doesn’t believe in interest rates. In the end, you actually end of saving a ton of money.

The road to success has not been easy. The aforementioned rules that constrain Islamic finance have prevented sharia-compliant firms from engaging in many profitable activities that conventional banks salivate. Historically, Islamic finance and its practicing institutions have been sheltered in the Middle East and a few other Muslim countries for hundreds of years. Furthermore, many of them have been largely subsidized by wealthy nation-states or empires that were devoted to the cause of Islamic finance and Sharia Law.

Moreover, global growth and expansion have been particularly difficult because most places in the world lack the regulatory framework to govern much less understand Muslim banking transactions.

Brief example, in the mortgage case that we examined earlier; the transaction would most likely be taxed twice in a non-Muslim country once, when the bank purchases the house, and another time when the bank sells the house back to you.

Of particular concern are the worries that Muslim banking institutions won’t be able to compete on the global stage efficiently. Having operated in heavily subsidized cultural environments for so long. Of course only time will tell if this is true of not. Despite many worries and misgivings, Muslim banks have had some great successes. The UK, for example, is quickly trying to establish itself as the premier western center for Islamic Finance and sharia-compliant financial transactions.

Moreover, London has recently become the first non-Muslim location that issues Sukuk, the Islamic financing equivalent of a bond. Meanwhile, in the world of microfinance, Muslim banking is fast becoming a popular option for both short term and long term loans. In developing nations like Ethiopia, where over one-third of the population identifies as Muslim, Muslim banking products are seen as safer and more in sync with local traditions.

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HubPages Inc, a part of Maven Inc. As a user in the EEA, your approval is needed on a few things. To provide a better website experience, toughnickel. Please choose which areas of our service you consent to our doing so. Updated on February 2, Justin Muirhead. Biggest Difference Between Muslim and Conventional Banks Even though this is oversimplifying things quite a bit, Muslim banks and related financial how do islamic banks make money follow three broadly specific conditions constraints that are based in Sharia Law.

Making Money On The No Interest Model Since it is such a large part of Islamic finance, I wish to provide two examples of how no-interest banking affects business operations in Islamic banking situations.

Global COmpetition: Of particular concern are the worries that Muslim banking institutions won’t be able to compete on the global stage efficiently. Have you ever dealt with an Muslim banking institution? How was the experience? It was excellent, beyond my wildest expectations They are good for some transactions, terrible for.

I prefer conventional banks. Bring on the interest rates!!! See results. Successes on the Global Stage Despite many worries and misgivings, Muslim banks have had some great successes.

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How is Islamic finance different?

Making Money On The No Interest Model

This profit is deemed to be a reward for the risk that is assumed by the bank. The customer pays back the value in deferred payments. This profit is deemed to be a reward for the risk that is assumed by the bow. The commodity that is to be delivered to the Bank will be purchased by customer through a commodity broker and the Bank in turn, will assign another commodity broker to how do islamic banks make money the commodity. The principal means of Islamic finance are based on trading, hence, banks can profit from the buying and selling of Shari’ah Compliant goods and services.