Principles of Islamic Banking

It is important to understand the key principles that underpin Islamic banking.

Any predetermined payment over and above the actual amount of principal is prohibited.

Islam allows only one kind of loan and that is qard-el-hassan (literally good loan) whereby the lender does not charge any interest or additional amount over the money lent.

The Bank must share in the profits or losses arising out of the enterprise for which the money was financed.

Unlike the interest-based commercial banking system where all the pressure is on the borrower, Islamic finance is based on the belief that the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures.

Making money from money is not acceptable under Islamic Banking.

In Islam, money represents purchasing power, which is considered to be the only proper use of money. This purchasing power (money) cannot be used to make more purchasing power (money) without undergoing the intermediate step of it being used for the purchase of goods and services.

Gharar (Uncertainty, Risk or Speculation) is also prohibited.

Contracting parties should have perfect knowledge of the counter values intended to be exchanged as a result of their transactions and should be free from uncertainty, risk and speculation. Also, parties cannot predetermine a guaranteed profit based on the principle of 'uncertain gains' which does not even allow an undertaking from the customer to repay the borrowed principal plus an amount to take into account inflation.

Investments should only support practices or products that are not forbidden or even discouraged - by Islam. Trade in alcohol, for example would not be financed by an Islamic bank; real-estate finance should not be done for the construction of a casino; and the bank could not lend money to other banks on interest.