Islamic financial institutions offer services similar to traditional banks, but operate without interest due to the prohibition of riba. They use techniques such as co-ownership and sukuk to provide loans and mortgages, and issue debt-based products. These institutions emerged in the 1970s and face various restrictions in their operation.
There is a wide range of Islamic financial institutions that provide services similar to those of traditional financial groups. Such groups can operate commercially and make a profit although technically, neither interest changes hands. Banks and investment companies offer services such as personal loans and mortgages. There are even facilities and markets for Islamic companies to borrow money through a bond equivalent.
Islamic financial institutions face a variety of restrictions in their operation. Most of these relate to the idea that riba, as a literal term, equivalent to the English words to increase or exceed, is prohibited. As a concept, riba means money without something of equivalent value. This applies specifically to finances due to the Islamic interpretation that a lender not having the money from him during the period he is with a borrower does not count as something requiring compensation. Therefore, this means that, in principle, Islamic finance cannot use interest.
It was not until the 1970s that Islamic financial institutions began to emerge. Until this time, most financial arrangements between followers of Islam were informal. Since the 1970s, institutions arose that aimed to follow the concepts of traditional interest-based banking and follow Islamic principles.
There are numerous Islamic consumer banks, which use a variety of techniques to grant loans and mortgages without violating the principle of no interest. These typically require a loan to be tied to the purchase of a specific asset. One technique is for the bank to purchase the asset and turn it over to the customer, but retain legal ownership. The customer who buys the bank’s asset, paying in installments. The total price will be more than the original purchase price paid by the bank, but this additional money is legally considered the bank making a profit on the resale, rather than the difference being an interest charge.
Similarly, Islamic banks may offer mortgages. This is technically accomplished by the bank and the client buying the property as co-owners, although the bank supplies 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 interest in the property, until the client finally takes full ownership. of the property.
Another area involving Islamic financial institutions is the market for companies to issue debt-based products and for investors to trade these products. This is done through sukuk, an equivalent to bonds but without interest payments. The back and forth flow of money works the same way, but from a legal perspective, the issuing company sells the sukuk certificate to the investor; the investor then rents the certificate to the bank, thus creating an income stream equal to the interest payments on the bonds; and eventually the issuing company buys back the certificate at face value.
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