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How exactly does Islamic banking work?

In the past, lending money with interest, also known as "usura", was considered wrong and was even made illegal by several English kings. The term "usura" used to refer to any kind of financial interest, but now it usually refers to an interest rate that is too high and benefits the lender excessively. However, the way mainstream banks approach ethical or responsible banking has changed over time. Nowadays, banks offer good rates of interest on savings accounts, credit cards, and mortgages, although these financial products often conflict with the principles of Islamic finance, also known as Shariah-compliant finance.

Islamic finance is based on the belief that money is simply a means of exchanging goods and has no value on its own. Therefore, it cannot be used to make more money through lending or earning interest. Instead, Islamic banks make money through trading activities that align with Shariah principles. For example, a bank may engage in ijara, in which it buys an asset such as a car and then leases it to a customer, or murabaha, in which it buys an asset and sells it to a customer with a profit. There are also other practices such as wakala, in which the bank acts as an agent for a customer for a fee, and salam, in which the bank pays for an asset in advance and the seller agrees to deliver it at a later time.

Ethical banking practices, including those based on Islamic principles, are common in many countries. Some traditional banks also offer current accounts that align with Shariah principles, and these accounts are protected by the Financial Services Compensation Scheme. In addition to following Islamic principles, many ethical financial institutions also prioritize transparency, sustainability, and reinvesting profits back into society. Islamic banks are a significant part of the banking industry, but in recent years, other ethical banks have also seen increased popularity and higher profits per employee.

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