A thread on Islamic banking

Banks in the Muslim dominated countries (Islamic banks) function very differently from conventional banks in 2 ways:

a) They cannot collect interest (Riba) on loans disbursed
b) They cannot invest in businesses involving alcohol, weapons, etc

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So how do they make money ?

Instead of charging interest to the clients, banks enter a partnership known as mudaraba. They become a partner in the client's business depending on the money loaned. The client pays back the principal with a share of the profit.

2/

In case the client's business makes a loss, the banks make a loss as well.

So in essence Islamic Banks are more like a VC rather than a conventional bank.

There are close to 300 banks in the world which comply to islamic principles with 3 trillion $ in assets (in 2016)

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Compared to a traditional bank, Islamic banks are very cautious when it comes to approving loans.

One of the first islamic banks in the modern world, Mit Ghamr in Egypt, approved only 40% of business loans in its 1st year of operation. And default rates were close to zero.

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This low risk appetite works both ways. On the + side, it can save the banks from high NPAs. On the - side, they can slow down the economic growth a lot.

These banks also offer products like islamic mutual funds where customers can invest only in islamic compliant companies

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Also for muslims to participate in global economies, Dow Jones Islamic Market (DJIM) index was launched in 1999.

This index applies certain filters on the Dow Jones companies. 1st filter it removes all the alcohol, tobacco, banking, casinos and defence companies

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The second filter is to remove companies basis interest income levels.There are around 2700 companies which pass both these filters & have been included in DJIM.

Given that many companies in DJIM are tech & CPG cos, the index tends to outperform Dow Jones regularly.

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