Islamic financial institutions offer services similar to traditional banks, but operate without interest due to the prohibition of riba. They use techniques such as asset purchase and co-ownership to provide loans and mortgages. Sukuk, an equivalent of bonds without interest payments, are used for debt-based products.
There are a wide range of Islamic financial institutions that provide services similar to those of traditional financial groups. Such groups are able to operate commercially and make profits even if technically no interest changes hands. Banks and investment firms offer services such as personal loans and mortgages. There are also facilities and markets for Islamic companies to borrow money through the equivalent of bonds.
Islamic financial institutions face a number of restrictions in how they operate. Most of these refer to the idea that riba – as a literal term, equivalent to the English words to increase or excess – is forbidden. As a concept, riba means money without anything of equivalent value. This is particularly true in finance due to the Islamic interpretation that a lender who is out of his money for the time he is with a borrower does not count as something requiring compensation. This therefore means that, in principle, Islamic finance cannot use interest.
It was not until the 1970s that Islamic financial institutions began to emerge. Until that time, most of the financial dealings between followers of Islam were informal. Since the 1970s, institutions have emerged that aimed to follow the concepts of traditional interest-based banking, while still following Islamic principles.
There are a number of Islamic consumer banks, which use a variety of techniques to provide loans and mortgages without violating the non-interest principle. Usually these require a loan to be linked to the purchase of a specific asset. One technique has the bank purchase the asset itself and deliver it to the customer, but retain legal ownership. The customer then buys the asset from the bank, paying in installments. The total price will be more than the original purchase price paid by the bank, but this additional money is legally treated as the bank making a profit on resale, rather than the difference as an interest charge.
Similarly, Islamic banks can offer mortgages. This is technically accomplished by the bank and the client purchasing the property as co-owners, although the bank provides most of the money and therefore has a majority stake. As with a traditional mortgage, the customer makes regular payments over time. These payments are not classified as interest or repayments, but rather as a combination of rent to cover the exclusive right to live in the property and installments to purchase the bank’s share of the property, until the customer assumes full ownership of the property. property.
Another area involving Islamic financial institutions is the market for firms issuing debt-based products and for investors trading these products. This is done through sukuk, an equivalent of bonds but without interest payments. The flow of money back and forth works the same way, but legally, the issuing company sells the sukuk certificate to the investor; the investor then leases the certificate back to the bank, thus creating an income stream equivalent to the bond interest payment; and eventually the issuing company buys back the certificate at its face value.
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