What is Islamic Banking and how do the Islamic banks earn profits?



What is Islamic Banking and how do the Islamic banks earn profits?

 Under the Islamic law or Sharia, interest is named as "riba". The law states that no financial institution operating under the Islamic banking law is allowed to collect or pay interest to lenders and investors.

Islamic Banking refers to a system of banking or banking activity which follows the principles and ethics of Shariah Law. Islamic banks emerged in the 1970s and have grown at a very high CAGR of 10-12%. Clearly, it is growing at a much faster pace than conventional finance systems. The Islamic Banks particularly have a high number of Muslim customers but the banks are open to all. In just above 4 decades the Islamic Banking Industry has grown to be a massive $2.2 trillion industry. The significance of Islamic Banks can also be clearly understood by the fact that the IMF is planning to include Islamic Finance to its financial sector assessments.

Key Features of Islamic Banking:

  1. Interest-Free Lending: When a loan is granted by any Islamic Bank, there is no interest charged from the customer i.e. if a firm grants a loan as high as 2 million, still no interest will be charged by the bank and the borrower ends up paying only 2 million dollars towards the loan.
  2. No Interest Payoffs: Similarly when an investor makes deposits with the bank, say 2 million, the investor when chooses to withdraw after 10 years will receive the same amount of money. Therefore, the investor actually ends up with a lower purchasing power due to the concept of Time Value of Money.
Click on the link to learn more about Time Value of Money:


The question arises if there is no interest collection and payoff, how are the banks operating so efficiently, where is the money for salaries, admin expenses, advertising, etc. coming from. Following is how Islamic Banks earn profits.

How do Islamic Banks earn a profit?

Shariah states that making money from money is not ethical and also the Islamic banks have proven to be safer than conventional banks in times of financial crisis. Islamic banks instead of collecting interest from the borrowers, they take a share in the profits of the business.

For example: When a loan is given to a company and an agreement is made that whatever profits the business makes, 10% will be shared by the bank. Therefore, when a profit of $2,00,000 is made, the company gives the bank $20,000. However, in the case of loss being occurred the bank does not benefit from lending the company. Therefore, strict principles, ethics, and rules are followed before giving a loan to any company.

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Thanks for reading!
Please comment on any financial query you had like me to address. I will try to post something worthwhile. 

Coming up Next: What is the difference between organic and inorganic growth?

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