Islamic Accounts: What makes them different

Considered to be the key for worship in the United Arab Emirates

Shariah law lays out the way in which Muslims should manage their money. The law taken from the Qur’an and the Sunnah (the way) rests on the belief that money in itself has no intrinsic value and instead is simply a medium of exchange. As per the law, each unit of money is 100% equal in value to another unit of the same denomination and Muslims cannot make a profit by exchanging cash with another person.

What this means is that a Muslim cannot benefit from lending or receiving money from someone and there is no concept of earning interest or riga. It is to comply with these rules that no interest is paid or charged on Islamic accounts or applied to Islamic mortgages. So how do they work?

How do Islamic Banks Earn Money?

Shariah law does not allow charging or earning of interest by banks. So, how do they survive?  This is resolved by using an equity participation system, wherein if a bank lends money to a business, it does not earn interest but a share in the profits of that business. But, if the business does not earn any profits or defaults on the loan repayment, the bank does not earn anything.

The three ways in which Islamic banks work and provide services are:

  1. Ijara: This is a leasing arrangement, wherein the bank buys something for a customer and then leases it back to them. So, it earns rent.
  2. Murabaha: This is a contract of sale, wherein the bank buys a specific item from a client for a predetermined profit over the cost of the item, then sells the item back to the client in installments. Since a specific fee is charged rather than the interest, this transaction is legal under Islamic law.
  3. Musharaka: Here, the customer and the bank contribute to the capital of the operation and agree to share the risks and returns in a pre-decided proportion.

Islamic banks can trade in only those businesses that are considered suitable by Islam and thus no investments in armaments, pork, tobacco, drugs, alcohol or pornography is allowed. These banks also need to keep a clear distinction between shareholder’s capital and client’s deposits to ensure correct sharing of profits. While Islamic banking is common in Islamic countries, several non-Islamic countries, including the UK, the US, Germany and China, have allowed the opening of Islamic windows in conventional banks. These refer to departments within banks that offer Shariah compliant products to customers.

Islamic Forex Accounts

Available to Muslims, Islamic forex accounts are also known as swap free accounts, since they do not entail a swap or a rollover interest on overnight positions held by a trader. Account holders are instead charged an administration fee for their positions on forex trading products.  These accounts are the same as all other forex accounts, except for the fact that there are no interest or swap charges on overnight positions, no spread widening and no up-front commissions. The trading conditions are the same as in other types of accounts, with similar access to trading platforms.

So, the basic difference between Islamic accounts and traditional accounts is the interest portion. Since Shariah law does not allow payment or receipt of interest, these accounts are structured in such a way that either an administration fee is charged or the profits and risks are shared between the involved parties.

Disclaimer

If you liked this educational article please consult our Risk Disclosure Notice before starting to trade. Trading leveraged products involves a high level of risk. You may lose more than your invested capital.

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