Islamic Finance: How It Operates Without Interest

Islamic finance operates on principles that are quite different from conventional banking. While interest and speculation are forbidden, the core concept is risk sharing among all parties involved. Islamic financial products may resemble their Western counterparts, but they adhere to Sharia principles.

Key Sharia-Compliant Products

Murabaha (Cost-Plus Selling): This popular product involves the bank buying an item and selling it to the customer at a higher price, with the profit determined upfront. The customer repays in installments, and late payments might incur fees donated to charity instead of the bank’s revenue.

Ijara (Leasing): Here, the bank purchases an item, like a car, and leases it to the customer. At the end of the lease, the customer owns the item.

Mudarabah (Profit Sharing): In this investment, the bank provides all the capital for a business venture, while the customer manages it. Profits are shared based on a pre-agreed ratio, typically around 50/50. The bank absorbs financial losses unless the customer is at fault.

Musharakah (Joint Venture): This model involves two or more partners who contribute capital and management expertise in exchange for a share of the profits.

Takaful (Insurance): Takaful operates like a mutual fund. Participants pool their money and agree to support each other in times of need. The fund manager oversees the pool and may operate under different models:

• Wakala: The manager receives a fee, and surplus funds belong to participants.
• Mudarabah: Profits and losses are shared between the manager and participants.
• Hybrid: A combination of both Wakala and Mudarabah.

Sukuk (Islamic Bonds): Sukuk are Sharia-compliant bonds that began gaining popularity in the 2000s. They are issued by various countries, with Malaysia being a major player. Despite challenges like the COVID-19 pandemic, sukuk issuance remains a vital tool for raising funds for development projects.

The Growth of Islamic Finance

The Islamic finance sector has evolved significantly. Sukuk issuance hit a high of $162 billion in 2019 before the pandemic affected the market. Predictions for growth vary, with some experts anticipating a decline due to economic conditions, while others see continued expansion.

Islamic finance also includes investment funds, which follow the same ethical principles and offer an alternative to conventional investment options.