Islamic banking follows Islamic laws and principles, primarily the tenet that interest must not be paid or collected and that profits and losses are shared. There are two other rules that come to play in Islamic banking. First, banks cannot be involved with businesses that take part in industries that are considered sinful, like gambling and alcohol. Neither can entrepreneurs take part in ventures that deal with sinful activities. Second, excessive risk cannot be taken in ventures.
On loans, borrowers only repay the amount that was originally borrowed. As a gratuity, the borrower can pay choose to pay the lender a small amount of extra money. Such a token should not be promised to the original lender, but paid on a voluntary basis to show appreciation for the loan. Neither should the lender expect such a gift in exchange for loaning money.
Islamic banks should not assess penalty fees for activities such as late payments.
There are some Islamic banks that have investment accounts. All profits made on these accounts – none of which are guaranteed – must be shared with the bank.
A common concept that Islamic banking uses to offset earning or paying interest, is leasing. For example, to allow an individual to purchase a piece of property, an Islamic bank might first purchase the property and then allow the borrower to instead lease that property rather than earn interest from loaning a mortgage. The bank can then resell the property to the borrower at a higher price and the borrower to earn equity through monthly rent/lease payments. Vehicle purchases occur in a similar manner. In both cases, there is no penalty assessed for late payments because these are considered usury, which is also forbidden by Islamic principles.
When the property is resold at a higher price, a “profit” is earned, though it is not thought of as profit. Both parties involved with the transaction must agree to any profit margin.
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