Islamic Finance Explained Page 1 | Page 2 | Page 3

How does Islamic finance work?

The overarching principle of Islamic finance is that all forms of interest are forbidden. The Islamic financial model works on the basis of risk sharing. In any investment the customer and the bank share in any risk on agreed terms, and divide any profits between them.

The main categories that Halal Financial Services deal with in Islamic finance are: Ijara and Diminishing Musharaka.
-Ijara is a leasing agreement whereby the bank buys an item for a customer and then leases it back over a specific period.
- Diminishing Musharaka is an investment partnership in which profit sharing terms are agreed in advance, and losses are pegged to the amount invested.

The rationale behind the prohibition of interest is clear. Under Islam financial and economic transactions should be transparent and fair to all parties involved. Trade, the buying and selling of goods and services, should be related to items with an intrinsic value, and any element of risk and reward should be equally shared. Interest, which allows an increase to accrue with nothing more than the passing of time, is deemed by its very nature to be unfair. In the case of borrowing, interest places all the burden of risk on the borrower, and the debt remains unfixed with the potential of increasing to large proportions.

Such interest can be seen in the case of mortgages, credit cards etc. For many years a lack of Islamic financing options has meant many Muslims in the UK and other countries have been isolated from many of the financial services that others enjoy. Now with the growth of the Islamic financial marketplace worldwide there are an abundance of Halal products and services for Muslims and the ethically inclined.