Islamic finance, a unique set of financial instruments and transactions, is guided by Sharia (Islamic law). The laws, rooted in the Qur’an, Sunnah, Hadith and Fiqh, are interpreted by scholars with expert understanding. Islamic principles, such as profit and loss sharing, minimal financial leverage, and avoidance of prohibited activities, set it apart. Notably, Sharia prohibits riba, the charging or receiving of interest, a key distinction from conventional finance.
Islamic banks, in contrast to conventional ones, do not generate income through interest payments. Instead, they adopt a more ethical approach, making money through other means. They typically buy the underlying asset – such as a home, car or business – and then lease it to their customers at an upfront price plus an agreed-upon profit rate. This arrangement, known as Murabaha or Ijara financing, aligns with the ethical principles of Islamic finance.
Islamic finance, beyond avoiding interest payments, is rooted in a community-oriented approach. Islamic bankers seek to limit the risk of losses in their transactions through Musharaka and Wakala, which involve a partnership between two parties who each contribute an equal share of capital. This shared responsibility and profit-sharing model foster a sense of community and mutual support, a key aspect of Islamic finance.
Other Sharia-compliant financing structures include Salam, Bai al Ajel, and Murabaha. Salam is a form of deposit where the bank acts as a trustee and deposits funds in its custody on behalf of the depositor. The deposited assets are guaranteed to be returned on demand by the bank, and the bank can gift or sell part of its benefits from a transaction back to the depositor if required. Bai al Ajel is an alternative to a contract of sale, where the depositor pays a progressively increasing amount of cash to a builder on a construction project. In this way, the purchaser takes on the risk of delay and can purchase the finished product without paying a lump sum at the beginning.
Several companies have developed and marketed Islamic finance products in the United States, including LARIBA Finance House, Guidance Financial Group, and Devon Bank. In addition, many community banks with multicultural solid populations have introduced Sharia-compliant mortgages. These institutions understand the needs of their customer base and have the flexibility to offer tailored products.