How Do Islamic Banks Make Money?

Updated on April 24, 2020
Justin Muir profile image

I have an interest in international banking and will share my research findings here!

How do banks in the middle east make money?
How do banks in the middle east make money? | Source

Muslim banks (aka Islamic banks) are financial institutions that operate under Sharia law and regulations. On the surface, there is little difference between Muslim banks and other (more conventional) financial institutions. In fact, most people completely oblivious as to how these institutions work. However, following Sharia law has major implications for how these banks make money and keep profits flowing (i.e. many Muslim banks do not charge interest). This hub will hopefully add to your knowledge and help you to understand the quirks of this narrow but growing sector of the financial industry.

Bank of Islam
Bank of Islam

Biggest Difference Between Muslim and Conventional Banks

Even though this is oversimplifying things quite a bit, Muslim banks and related financial institutions follow three broadly specific conditions (constraints) that are based in Sharia Law.

1. Muslim banks and related banking institutions are not allowed to charge interest

This is probably the biggest constraint and the one big characteristic that most Muslim banks are known for. It is such a distinguishing characteristic that in some non-Muslim countries where Muslim banks operate, they operate under the broad term of "no-interest banking" instead of Muslim banking for marketing reasons.

The reason for charging no interest stems from an interpretation of Sharia Law that states how "one must work for profits," and that the act of simply lending money to someone in need does not count as work. In short, "Money cannot be used to create more money." Therefore, for a bank to be considered Islamic, it must always provide some kind of service in order to earn its money/profits.

2. Islamic finance does not allow for high levels of uncertainty, also known as "argharar", in business transactions

In order to comply with this constraint, Muslim banks are required to disclose all information to prospective investors and to request all information from potential business interests. An important caveat that follows from this rule is that an Islamic financial institution cannot sell something that it does not own. Selling something that you do not own outright is considered the highest degree of risk because the risk of unavailability is extremely high. Therefore, the selling of financial products such as derivatives or CDO's (collateralized debt obligations), products that brought the global economy to its knees a few years ago, are prohibited or considered "haram."

3. Islamic finance requires that you invest only in morally upright and ethical causes

Therefore, Muslim banks are prohibited from investing in certain vices and morally-gray business prices such as gambling, prostitution, slavery, or drug-trafficking.

Coins | Source

Making Money On The No Interest Model

Since it is such a large part of Islamic finance, I wish to provide two examples of how no-interest banking affects business operations in Islamic banking situations. First, let's take the simple case of setting up an account at a bank. In many conventional banks, interest-bearing savings accounts are offered to customers. The interest rates are promoted and marketed as a way to get customers to invest and keep their money with the bank.

However, in Islamic finance, savings accounts are typically advertised or marketed according to some record or profit/loss. Profits from the Muslim bank's successful transactions are redistributed to individual savings accounts. However, losses from the bank's unsuccessful transactions can affect savings account as well.

Another example is how Muslim banks handle mortgages. Let's say you want to buy a house that currently goes for $350,000. If you were to purchase this house via a mortgage from a conventional banking institution. The bank would provide you with a loan of $300,000 (and you would put down the rest of the money). That $300,000 is lent to you at a specific interest rate (let's say 6%). By the time that you pay off that loan (let's be generous and say 30 years from now), you will have paid the bank a total of $647,514.00.

This is in stark contrast to a Muslim banking institution that doesn't believe in interest rates. In this case, a Muslim bank would get directly involved in the transaction by doing something like buying the house that you are interested in outright, marking up the selling price by an extra $60,000 or $70,000, and selling back to you. You would then pay this new price $360,000 in installments. In the end, you actually end up saving a ton of money.

Banks profit in very different ways overseas!
Banks profit in very different ways overseas!

Difficulties in Following Sharia Compliant Finance

Even though today, Islamic Finance as an industry has ballooned into a $2 trillion dollar mega-marketplace. The road to success has not been easy. The aforementioned rules that constrain Islamic finance have prevented sharia-compliant firms from engaging in many profitable activities that conventional banks salivate over.

Historically, Islamic finance and its practicing institutions have been sheltered in the Middle East and a few other Muslim countries for hundreds of years. Furthermore, many of them have been largely subsidized by wealthy nation-states or empires that were devoted to the cause of Islamic finance and Sharia Law.

Moreover, global growth and expansion have been particularly difficult because most places in the world lack the regulatory framework to govern (much less understand) Muslim banking transactions. Brief example, in the mortgage case that we examined earlier; the transaction would most likely be taxed twice in a non-Muslim country (once, when the bank purchases the house, and another time when the bank sells the house back to you).

Global Competition

Of particular concern are the worries that Muslim banking institutions won't be able to compete on the global stage efficiently. Having operated in heavily subsidized cultural environments for so long. there are legitimate worries that Muslim banks lack the tenacity and efficiency of their conventional counterparts. Of course, only time will tell if this is true or not.

Have you ever dealt with an Muslim banking institution? How was the experience?

See results
Islamic Bank of Britain
Islamic Bank of Britain | Source

Successes on the Global Stage

Despite many worries and misgivings, Muslim banks have had some great successes. The UK, for example, is quickly trying to establish itself as the premier western center for Islamic Finance and sharia-compliant financial transactions. As of 2014, Britain has six major Muslim banks; including The Islamic Bank of Britain (see picture above). Moreover, London has recently become the first non-Muslim location that issues Sukuk, the Islamic financing equivalent of a bond.

Meanwhile, in the world of microfinance, Muslim banking is fast becoming a popular option for both short term and long term loans. In developing nations like Ethiopia, where over one-third of the population identifies as Muslim, Muslim banking products are seen as safer and more in sync with local traditions.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.


    0 of 8192 characters used
    Post Comment

    No comments yet.


    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
    ClickscoThis is a data management platform studying reader behavior (Privacy Policy)