07 Mar 2018
Islamic Accounts: What makes them different
Shariah law lays out the way in which Muslims should manage their money. The law taken from the Qur'an and the Sunnah (the way) rests on the belief that money in itself has no intrinsic value and instead is simply a medium of exchange. As per the law, each unit of money is 100% equal in value to another unit of the same denomination and Muslims cannot make a profit by exchanging cash with another person. What this means is that a Muslim cannot benefit from lending or receiving money from someone and there is no concept of earning interest or riga. It is to comply with these rules that no interest is paid or charged on Islamic accounts or applied to Islamic mortgages. So how do they work?
How do Islamic Banks Earn Money?Shariah law does not allow charging or earning of interest by banks. So, how do they survive? This is resolved by using an equity participation system, wherein if a bank lends money to a business, it does not earn interest but a share in the profits of that business. But, if the business does not earn any profits or defaults on the loan repayment, the bank does not earn anything. The three ways in which Islamic banks work and provide services are:
- Ijara: This is a leasing arrangement, wherein the bank buys something for a customer and then leases it back to them. So, it earns rent.
- Murabaha: This is a contract of sale, wherein the bank buys a specific item from a client for a predetermined profit over the cost of the item, then sells the item back to the client in installments. Since a specific fee is charged rather than the interest, this transaction is legal under Islamic law.
- Musharaka: Here, the customer and the bank contribute to the capital of the operation and agree to share the risks and returns in a pre-decided proportion.