How does Islamic banking work?

The basis for all Islamic finance lies in the principles of the Sharia, or Islamic Law, which is taken from the Qur’an and from the example of Prophet Muhammad (peace be upon him).

Islamic banking operates without interest which is not permitted in Islam, as money in itself is not considered to have intrinsic value. As interest is income generated from money, it is seen as effortless return. Instead money must be used in a productive way and wealth can only be generated through legitimate trade and investment, which involves an element of risk.

Islamic banking therefore uses various principles recognised as Sharia compliant such as Ijara (leasing), Musharaka (partnership) and Wakala (agency agreement). Islamic banks use these principles to develop Sharia compliant financial products, such as savings accounts and home finance, which allow Muslims to conduct their finances in an Islamic way.

How does IBB ensure its activities are Sharia compliant?

By following Islamic finance principles laid down in Sharia, Islamic law. To ensure the rules are followed as closely as possible, IBB has a Sharia Compliance Officer (SCO) and a separate independent body called the Sharia Supervisory Committee (SSC).

The SSC is comprised of Islamic scholars and experts in the interpretation of Islamic law and its application within modern day Islamic financial institutions. The SCO is also trained to the highest standards, set down by The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). It is recognised as the highest Sharia compliance standard in the Islamic finance industry. The combined works of the SCO and the SSC ensure that both the IBB’s products and its activities comply with Islamic rules at all times.

If I buy a home with a HPP, I will be charged rental and not interest. Can you explain how an IBB HPP works?

IBB has developed the Home Purchase Plan as a Sharia compliant alternative to a mortgage. The principle difference between a HPP and a conventional mortgage is that the lending/borrowing relationship does not exist. For this reason interest does not form part of the arrangement.

As a Sharia compliant product, IBB’s HPPs are based on joint ownership and lease agreements arranged using two separate principles of Islamic finance:

With a HPP, of say 20 years, IBB and the customer buy the property jointly. The customer then has 20 years to buy the Bank’s share for the same initial purchase price. This is based on the Diminishing Musharaka (diminishing partnership) principle of Islamic finance.
At the time of completing the joint purchase, the customer will live in the property even though a large share of it is owned by the Bank. Therefore, until the customer becomes the full owner, they will lease the portion of the property still owned by IBB and pay a monthly rental to the Bank. This is based on the Islamic financing principles of Ijara (leasing).
When all acquisition payments have been made and the finance has been settled, ownership of the property transfers fully to the customer and they now own their home outright, without having paid any interest.

It is also important to note that the money IBB uses to buy homes jointly with its customers is from Sharia compliant sources. The Bank does not use any interest-bearing products to finance customer’s homes. Instead it uses its own funds, or the savings deposits from its customers, creating a virtuous circle for everyone involved.

Under the principles of Sharia, the presence of interest creates an inequitable relationship between two parties favouring one over the other; this imbalance can ultimately lead to wider negative social and economic implications, as has been seen in recent years with several major global banks failing. This is why it is forbidden in the Qur’an as generating money from money is effortless and useless approach of making money, it instead encourages trade and investment.

As the UK’s only wholly Sharia compliant retail bank, IBB offers consumers a different approach to banking. Over the last decade, IBB has helped thousands of UK Muslims undertake their day-to-day banking requirements without compromising the principles of their faith.