Islamic finance is a way to manage money that keeps within the moral principles of . It covers things like saving, investing, and borrowing to buy a home.
The moral principles many Muslims live their lives by are sometimes known as the ‘Shari’ah’. So you may hear Islamic financial services described as ‘Islamic finance’ or ‘Shari’ah-compliant’.
How is Islamic finance different to other types of finance?
Islamic finance is based on a belief that money shouldn’t have any value in itself. It’s just a way to exchange products and services that do have a value.
Linked to this way of thinking about money, is the idea that you shouldn’t make money from money. This means that wherever possible, getting involved in interest by either paying or receiving it should be avoided.
Another important idea that underpins Islamic finance is that it shouldn’t cause harm. For that reason, Islamic financial services should not invest in things like alcohol, tobacco, and gambling.
Islamic finance also encourages partnership. This means that, where possible, both profit and risks should be shared. This can be between two individuals, an individual and a business, or a business and a business.
Anyone can use Islamic finance products and services – you don’t have to be Muslim.
How does Islamic finance work?
There are a number of Islamic finance products and services available in the UK.
A Shari’ah-compliant current account doesn’t pay interest. Instead, in return for having ready access to your money, the deposit you give the bank is used as an interest free loan. This loan is known as a ‘qard’.
If you open a savings account, the bank will invest the money you deposit. But they won’t invest it in anything the Shari’ah says is harmful.
The bank will pay you part of any profit they earn. Depending on what is invested in and how the profit is worked out, this might be called a ‘wakalah’ (where the bank acts as your agent) or a ‘murabahah’ (where a bank buys and trades in commodities to earn a profit).
When it comes to buying a home, there are a couple of alternatives to a traditional mortgage.
In one type of agreement, the bank can directly buy the property you want. Then they sell it to you at a profit and let you pay it back in instalments. This is also called a ‘murabaha’ contract (because they are buying the property and selling it to you at a profit).
Or you can buy the property jointly with a bank, in what is called a ‘musharakah’ (partnership) contract. Then over time you gradually pay the bank for its share of the property.
In both cases, the bank charges you extra to cover their costs and to reflect the fact you’re living in a property they partly own.
What is the Bank of England doing on Islamic finance?
Our job is to keep the UK’s financial system stable. One way we do this is by allowing banks to hold deposits with us. This helps keep them stable so they can keep providing banking services to everyone else.
We noticed Islamic banks were unable to use these accounts because we paid interest on them. So we are creating a new type of account for such banks that doesn’t pay interest. That means Islamic banks in the UK will be able to use some of the same support we give to other banks.