Simply put, Islamic banking is banking that conforms to
Shariah law. Islamic law prohibits charging interest as well as any usury
(i.e., lending money at exorbitant or unlawful rates of
interest). Therefore, interest cannot be
charged on loans, nor can it be paid on savings. Typically Westerners who work in the
Middle East deposit their salary into a local bank, but transfer any money they want to save
(and earn interest on) to an offshore account.
To Western understanding, the idea of a bank that doesn't
charge interest is rather shocking — though a bank that
doesn't pay interest probably shocks few people these days!
But Islamic banks are still banks, which means they also
seek to make profits for their investors. It's just done
As explained by the Institute of Islamic Banking and
Insurance, "The Islamic financial
system employs the concept of participation in the
enterprise, utilizing the funds at risk on a profit-and-loss-sharing basis."
For example, suppose a person wants to
buy a vehicle and needs a loan. Rather than a Western-style
loan where a person gets money which is paid back with
interest, an option in Islamic banking is for the bank to
buy the vehicle, sell it to the individual at a price higher
than market value, and retain ownership on the vehicle until
the money is paid. Or a corporate loan could be extended in
which, in addition to repayment of the loan, the bank earns
a share of whatever profit the company makes.
Finally, Islamic banking prohibits investing in companies that
work in or with items that are unlawful in Islam, e.g.,
alcohol production, gambling establishments.