Islamic Banking and Finance Definition: History and Example

What Is Islamic Banking?

Islamic banking is a financial system that adheres to financial principles under Sharia law. Islamic banking prohibits the use of interest, speculation, and excessive risk, along with investing in businesses that promote things contrary to Islamic law. It emphasizes profit and loss sharing, fairness, honesty, and transparency.

Islamic banking, or Islamic finance, doesn’t treat money like a commodity and strives to remove harm from financial transactions. Both Muslims and non-Muslims can participate in Islamic banking and benefit from its principles.

Islamic Banking Around the World

The global Islamic banking and finance market is worth $8.94 billion as of 2025 and is expected to grow by 11.6% to $13.89 billion by 2029. The Middle East and Africa region is the largest market, while the Asia-Pacific region is poised to show the most growth. Increasing demand for Sharia-compliant financial services from a younger and growing Muslim population is driving growth in the industry. 

The countries with the highest growth in this area of finance include:

1. Qatar
2. Indonesia
3. Saudi Arabia
4. Malaysia
5. United Arab Emirates

According to a 2024 report by Global Finance Magazine, Iraq had the most Islamic banks, with 15, followed by Bahrain (7) and Qatar (5). Sudan and Saudi Arabia’s Islamic financial institutions held the most assets at $484.0 billion and $322.2 billion, respectively.

Islamic Banking Principles

Islamic banking aims to make finance more equitable by keeping fairness and transparency at the forefront of all transactions. It works on several key principles, including:

• Prohibiting interest: Islamic banking prohibits banks from collecting or paying interest or riba. It is considered exploitative and seen as deepening the divide between rich and poor.
• Risk sharing: Unlike conventional banks, Islamic banks share the risk with their customers.
• Sharing of profit and losses: Islamic banks share profits and losses with their clients.
• Ethical investing: People who follow Islamic finance principles invest in halal or accepted sectors. Examples of those that are haram or prohibited include gambling, weaponry, and alcohol.
• Avoiding speculation: Islamic finance excludes speculation or gharar because it is seen as causing volatility and instability.

Lending takes on a different form under Islamic banking principles. Rather than providing interest-based loans, these institutions use equity participation in their lending practices. For instance, rather than finance the purchase of a home, an Islamic bank buys the property and either leases or sells it to the client in exchange for a fixed installment payment.

History of Islamic Banking

According to the Quran, financial transactions should reflect good governance that specifically includes transparency and accountability. It suggests that wealth should be “supportive” to all community members and that people should avoid indulging in excesses. The use of money should lift others rather than cause harm to others.

Evidence exists of applying religious principles to business and financial transactions—called fiqh al-muamalat. Financial activities that fall under Islamic banking principles include buying and selling, investing, contracts, and saving.

All transactions should adhere to Sharia and be transparent and fair to all parties involved. Another key component is that any financial transaction should have mutual consent, which means it must involve the free will of all participants.

Example of Islamic Banking

Here’s an example to show how Islamic banking works. Since interest is prohibited, banks do not lend interest-based loans. So, if someone wants to make a major purchase, the bank may use the murabaha method, a cost-financing system. Here’s how it works:

• You want to buy a car that’s selling for $40,000.
• You go to an Islamic bank to finance the purchase.
• The bank purchases the vehicle for $40,000 and sells it to you for $45,000.
• You repay the bank in installments until you have repaid the purchase price.

Savings accounts under Islamic banking principles don’t pay you interest, unlike most savings accounts in the U.S. However, the bank can invest your deposits in investments compliant with Sharia law, sharing the profits with you.

How Is Islamic Banking Different from Conventional Banking?

Islamic banking aims to ensure a fair, transparent, and harmless financial process for all involved. Conventional banking often shares the same values, especially among more modern banks, but in some cases it also allows financial institutions to profit while their clients assume a good deal of risk.