How does Islamic finance work?

How does Islamic finance work? image

If you’re looking for a cash injection for your business, you can consider Islamic business finance. This finance is available to both Muslim and non-Muslim business owners; keep reading to learn more.

This is a guide. Currently, we do not have any lenders on our panel that offer Islamic finance.

What is Islamic business finance?

Islamic business finance is finance you can apply for through Islamic banks. These loans are governed by Sharia law (known as Shari’ah), which states that money should not be made from money; instead, it should be used to exchange products and services. This is why Islamic finance loans do not charge interest.

There are some restrictions on what you can use Islamic business finance for, i.e. activities Sharia law deems harmful or unethical, including alcohol, tobacco and gambling.

How does Islamic business finance work?

As Islamic banks do not charge interest, their financial agreements work a little differently from traditional business loans. Risk-sharing is at the heart of Sharia-compliant finance, which can take the form of a Musharakah (partnership) contract. In this instance, the lender and borrower both contribute working capital and share in profits and losses.

Borrowers can also opt for Mudarabah, also a profit-sharing arrangement. The lender contributes the required capital in this arrangement, and the borrower provides knowledge and expertise. Profits are still shared, but the lender shoulders losses.

How is Islamic finance different from conventional finance?

There are three main differences between Islamic business finance and other loan types. These differences stem from the principles of Sharia, a religious law taken from the scriptures of Islam, which underpins the ethical code of the Islamic faith.

Charging and paying interest

While conventional debt financing typically charges interest, this is prohibited by Sharia law, which means there is no interest to pay. Instead, borrowers might incur admin fees or processing fees, so it’s worth checking with the lender.

Promotion of risk-sharing

Islamic business finance promotes risk-sharing practices (Musharakah) so both the borrower and the bank contribute half the capital required each and share in the profit and losses. With conventional finance, the borrower typically takes on most of the risk, committing to paying back the loan and the interest regardless of the project's outcome.

Restrictions on financing certain projects

Certain activities are deemed sinful or unethical in the eyes of the Muslim faith of Islam, leading to various investments being strictly prohibited when it comes to the use of Islamic Business Finance. Things including, but not limited to, alcohol, gambling and tobacco.

Islamic business finance must also be invested in projects with real, tangible economic and social benefits and can’t be solely tied to financial profit-making decisions.

Business owner applying for Islamic finance

What are the advantages of Islamic business finance?

  • Muslims can apply for finance within Sharia law. Muslims following Sharia law can find themselves restricted when applying for business finance. Islamic finance gives them an opportunity to grow and succeed in business.
  • Risk-sharing splits the risk between borrower and lender. The borrower is exposed to less risk due to the promotion of risk-sharing with the lender. Both parties can take equal responsibility for the profit or loss of a project.
  • A more stable investment that reduces financial risk. Islamic banks are more cautious and considered when analysing finance applications. They carry out thorough audits and company checks to ensure the business they’re investing in is low-risk and will make money.

What are the disadvantages of Islamic business finance?

  • If your business conflicts with Sharia, you will not get an investment. If you sell alcohol, for example, you cannot apply for Islamic business finance. But don’t worry, there are plenty of alternatives to Islamic finance you can consider.
  • It can take longer to see funds. If you want to access funds quickly to grow your business, Islamic finance might not be for you. The application process includes extensive research into your industry and your business by the bank, so some lenders can take a few weeks to process your application in full.

Where can I get a Sharia-compliant loan?

Only Islamic financial institutions offer Islamic business finance. Here are a few providers you can check out offering Sharia-compliant finance and commercial mortgages:

Alternatives to UK Islamic business finance

If your business is in an industry that isn’t sharia-compliant, e.g. alcohol, or you need fast finance, we have plenty of alternative business loan ideas for you to consider. From unsecured business loans (with fund access in just 48 hours) to crowdfunding.

If you need help choosing the right business loan for your needs, our loan comparison tool can help you find suitable loan options. Please note we do not offer Islamic business finance. Get your free quote today.

About the author

Helen Jackson Author
Written by Helen Jackson | May 01, 2024

Money Writer

Helen has over nine years of experience in content writing and writes financial content for us here at Capalona.

Updated: May 01, 2024
Published: April 29, 2024

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