6/23/22, 4:00 PM Islamic Banking Definition
PERSONAL FINANCE BANKING
GUIDE TO US BANKING LAWS
Islamic Banking
By EVAN TARVER Updated March 15, 2022
Reviewed by MARGARET JAMES
Fact checked by SUZANNE KVILHAUG
What Is Islamic Banking?
Islamic banking, also referred to as Islamic finance or Shariah-compliant
finance, refers to financial activities that adhere to Shariah (Islamic law). Two
fundamental principles of Islamic banking are the sharing of profit and loss and
the prohibition of the collection and payment of interest by lenders and
investors.
KEY TAKEAWAYS
Islamic banking, also referred to as Islamic finance or Shariah-
compliant finance, refers to finance or banking activities that adhere to
https://www.investopedia.com/terms/i/islamicbanking.asp 1/11
6/23/22, 4:00 PM Islamic Banking Definition
Shariah (Islamic law).
Two fundamental principles of Islamic banking are the sharing of profit
and loss and the prohibition of the collection and payment of interest
by lenders and investors.
Islamic banks make a profit through equity participation, which
requires a borrower to give the bank a share in their profits rather than
paying interest.
Some conventional banks have windows or sections that provide
designated Islamic banking services to their customers.
Understanding Islamic Banking Practices
There are approximately 520 banks and 1,700 mutual funds around the world
that comply with Islamic principles. [1] Between 2012 and 2019, Islamic
financial assets grew from $1.7 trillion to $2.8 trillion and are projected to grow
to nearly $3.7 trillion by 2024, according to a 2020 report by the Islamic
Corporation for the Development of Private Sector (ICD) and Refinitiv. [2] This
growth is largely due to the rising economies of Muslim countries (especially
those that have benefited from oil price increases).
10%
The anticipated growth of the global Islamic finance industry over
2021 to 2022 due to increased bond issuance and a continuing
economic recovery in the financial markets, according to S&P
https://www.investopedia.com/terms/i/islamicbanking.asp 2/11
6/23/22, 4:00 PM Islamic Banking Definition
Global Ratings. Islamic assets did manage to expand over 10% in
2020, despite the COVID-19 pandemic. [3]
Islamic banking is grounded in the tenets of the Islamic faith as they relate to
commercial transactions. The principles of Islamic banking are derived from the
Quran–the central religious text of Islam. In Islamic banking, all transactions
must comply with Shariah, the legal code of Islam (based on the teachings of
the Quran). The rules that govern commercial transactions in Islamic banking
are referred to as fiqh al-muamalat.
Employees of institutions that abide by Islamic banking are trusted to not
deviate from the fundamental principles of the Quran while they are conducting
business. When more information or guidance is necessary, Islamic bankers
turn to learned scholars or use independent reasoning based on scholarship
and customary practices.
One of the primary differences between conventional banking systems and
Islamic banking is that Islamic banking prohibits usury and speculation.
Shariah strictly prohibits any form of speculation or gambling, which is referred
to as maisir. Shariah also prohibits taking interest on loans. In addition, any
investments involving items or substances that are prohibited in the Quran—
including alcohol, gambling, and pork—are also prohibited. In this way, Islamic
banking can be considered a culturally distinct form of ethical investing.
To earn money without the typical practice of charging interest, Islamic banks
use equity participation systems. Equity participation means if a bank loans
money to a business, the business will pay back the loan without interest and
https://www.investopedia.com/terms/i/islamicbanking.asp 3/11
6/23/22, 4:00 PM Islamic Banking Definition
instead give the bank a share in its profits. If the business defaults or does not
earn a profit, then the bank also does not benefit. In general, Islamic banking
institutions tend to be more risk-averse in their investment practices. As a
result, they typically avoid business that could be associated with economic
bubbles.
FAST FACT
An Islamic bank is entirely operated using Islamic principles, while
an Islamic window refers to services that are based on Islamic
principles that are provided by a conventional bank. Some
commercial banks offer Islamic banking services through dedicated
windows or sections.
History of Islamic Banking
The practices of Islamic banking are usually traced back to businesspeople in
the Middle East who started engaging in financial transactions with their
European counterparts during the Medieval era. At first, they used the same
financial principles as the Europeans. However, over time, as trading systems
developed and European countries started establishing local branches of their
banks in the Middle East, some of these banks adopted the local customs of the
region where they were newly established, primarily no-interest financial
systems that worked on a profit-and-loss sharing method. By adopting these
practices, these European banks could also serve the needs of local
businesspeople who were Muslim.
https://www.investopedia.com/terms/i/islamicbanking.asp 4/11
6/23/22, 4:00 PM Islamic Banking Definition
Beginning in the 1960s, Islamic banking resurfaced in the modern world, and
since 1975, many new interest-free banks have opened. Though the majority of
these institutions were founded in Muslim countries, Islamic banks also opened
in Western Europe during the early 1980s. In addition, national interest-free
banking systems have been developed by the governments of Iran, Sudan, and
(to a lesser extent) Pakistan.
Example of Islamic Banking
The Mit-Ghamr Savings Bank, established in 1963 in Egypt, is commonly
referred to as the first example of Islamic banking in the modern world. When
Mit-Ghamr loaned money to businesses, it did so based on a profit-sharing
model. The Mit-Ghamr project was closed in 1967 due to political factors, but
during its year of operations, the bank exercised a great deal of caution, only
approving about 40% of its business loan applications. However, in
economically good times, the bank's default ratio was said to be zero.
What Is the Basis of Islamic Banking?
Islamic banking is grounded in the tenets of the Islamic faith as they relate to
commercial transactions. The principles of Islamic banking are derived from the
Quran, the central religious text of Islam. In Islamic banking, all transactions
must comply with Shariah, the legal code of Islam based on the teachings of the
Quran. The rules that govern commercial transactions in Islamic banking are
referred to as fiqh al-muamalat.
How Are Conventional and Islamic Banking Different?
https://www.investopedia.com/terms/i/islamicbanking.asp 5/11
6/23/22, 4:00 PM Islamic Banking Definition
One of the primary differences between conventional banking systems and
Islamic banking is that Islamic banking prohibits usury and speculation.
Shariah strictly prohibits any form of speculation or gambling, which is referred
to as maisir. Shariah also prohibits taking interest on loans. Also, any
investments involving items or substances that are forbidden in the Quran—
including alcohol, gambling, and pork—are also prohibited. In this way, Islamic
banking can be considered a culturally distinct form of ethical investing.
How Do Islamic Banks Make Money?
To earn money without the typical practice of charging interest, Islamic banks
use equity participation systems, which is similar to profit sharing. Equity
participation means if a bank loans money to a business, the business will pay
back the loan without interest and instead give the bank a share in its profits. If
the business defaults or does not earn a profit, then the bank also does not
benefit.
The Bottom Line
Islamic banking is also referred to as Islamic finance or Shariah-compliant
finance. It refers to finance or banking activities that comply with Islamic law.
There are many differences between Islamic and mainstream finance, but two
of the most important are the sharing of profit and loss, and the prohibition of
the collection and payment of interest by lenders and investors. Shariah also
prohibits taking interest on loans. Also, any investments involving items or
substances that are prohibited in the Quran—including alcohol, gambling, and
https://www.investopedia.com/terms/i/islamicbanking.asp 6/11
6/23/22, 4:00 PM Islamic Banking Definition
pork—are also prohibited. In this way, Islamic banking can be considered a
culturally distinct form of ethical investing.
Islamic banks make a profit through equity participation, which requires a
borrower to give the bank a share in their profits rather than paying interest.
ARTICLE SOURCES
PART OF
Guide to US Banking Laws Guide
CURRENTLY READING UP NEXT
What Is Islamic Banking? Regulation E Definition Regulation CC
24 of 29 25 of 29 26 of 29
Related Terms
What Is Sharia?
https://www.investopedia.com/terms/i/islamicbanking.asp 7/11
6/23/22, 4:00 PM Islamic Banking Definition
Sharia is an Islamic religious law that governs religious rituals and aspects of day-to-day
life, including finance and banking. more
Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) Definition
The AAOIFI is a non-profit organization established to maintain and promote Shari'ah
standards for Islamic financial institutions. more
Ethical Investing
Ethical investing refers to the practice of using one’s own ethical principles as the main
filter for securities selection. more
Sukuk Definition
A sukuk is a bond-like financial product that complies with Islamic finance (sharia) rules.
more
Shariah-Compliant Funds Definition
Shariah-compliant funds are investment funds governed by the requirements of Shariah
law and the principles of the Islamic religion. more
What Is a Chartered Bank?
A chartered bank is a financial institution in the business of providing monetary
transactions, such as safeguarding deposits and making loans. more
https://www.investopedia.com/terms/i/islamicbanking.asp 8/11
6/23/22, 4:00 PM Islamic Banking Definition
Partner Links
Related Articles
Islamic Financial INTERNATIONAL MARKETS
Contract Working With Islamic Finance
SOCIALLY RESPONSIBLE INVESTING
A Guide to Faith-Based Investing
https://www.investopedia.com/terms/i/islamicbanking.asp 9/11
6/23/22, 4:00 PM Islamic Banking Definition
SOCIALLY RESPONSIBLE INVESTING
A Brief History of Impact Investing
Top 10 Cities for a CAREERS
Career in Finance Top 10 Cities for a Career in Finance
Business SOCIALLY RESPONSIBLE INVESTING
colleagues working What Is an Islamic Investment Policy?
in office using a
tablet.
Older couple REVERSE MORTGAGE
working together Reverse Mortgage Rules by State (and D.C.)
on laptop at home
https://www.investopedia.com/terms/i/islamicbanking.asp 10/11
6/23/22, 4:00 PM Islamic Banking Definition
TRUSTe
About Us Terms of Use
Dictionary Editorial Policy
Advertise News
Privacy Policy Contact Us
Careers California Privacy Notice
Investopedia is part of the Dotdash Meredith publishing family.
https://www.investopedia.com/terms/i/islamicbanking.asp 11/11
