Islamic Finance Blog & Articles
In terms of how an Islamic savings account looks and works for the individual using it, it's not all that different from traditional savings accounts. The major difference is in how the bank uses the money in their possession, because Islamic bank accounts are guided by Shariah law. Want to learn more about Islamic savings accounts? Then read on for everything you need to know, including what they are, how they work, and things to look out for as a potential future account holder with an Islamic bank.
What Is An Islamic Savings Account?
An Islamic bank account works exactly the same as any other bank account, except they are bound by Shariah law, as well as your usual financial laws to prevent fraud, etc.
Interestingly, these bank accounts are open to both Muslims and non-Muslims alike. Why, you might ask? Well, because Islamic bank accounts are often seen as one of the more ethical ways to keep your money safe. The bank follows typical Shariah law expectations, so you won't be able to ask for money to invest in an alcohol based business, for example. To many non-Muslims, this is an ethically sound lending system compared to mainstream banks.
Away from this though, Islamic bank accounts don't allow interest to be paid or charged, because of the view that money in and of itself is intrinsically worthless. In Shariah law, money is more a means to an end, something which you can use in exchange for a commodity that is useful but that holds no value in its own right. By this view, Islamic bank accounts focus on investing in properties, commodities, and businesses that are useful in some way, and they don't allow transactions to take place purely for speculation's sake.
How does Islamic Savings Account work?
So, how does a Shariah compliant savings account work? It's simple enough. Money that is saved in an Islamic savings account is eligible to be used by the bank to lend to customers for investment purposes etc, except their investments won't be given out to businesses or individuals that are involved in the following sectors:
- Pork production and consumption
So as you can see, a bank that refuses to invest in these areas because of Shariah law doesn't just appeal to Muslims, but also to morally conscious individuals from other religions or points of view.
Another key element of how Shariah compliant savings accounts work is the bank's belief in risk-sharing, as opposed to risk transference. Essentially, this boils down to when investments go bad. Say an Islamic bank were to invest in a business, but that business did not make profits. Rather than making their money back through interest rates as other banks would do, an Islamic bank would simply get their money back through payments and then call it even. If the business were to go bust and no repayments could be made, then the bank takes the hit, spread equally across everybody in the savings scheme.
This is a good thing from the point of view of many, because in Shariah law, you aren't allowed to make money through inactivity. Essentially, you can't make money just because you've lent somebody money (i.e. by making them pay back more through interest than you originally lent). You must instead get a cut of the profits from a useful business or commodity making money, which will then be shared equally with all who invested through their savings accounts.
An Islamic bank works by sharing everything with everybody, both the profits and the losses.
How does Islamic Account compare to mainstream banking?
When you look at an Islamic savings account compared to mainstream banking, the major differences are these:
- No interest is paid or earned
- Only sound financial investments can be made (Islamic banks avoid risky transactions at all costs to protect their members' savings)
- All investments are in ethical, Shariah compliant businesses
But in terms of the day to day running of the bank from your end as the customer, you won't notice much difference compared to your usual savings accounts in mainstream banking, except you will no longer receive interest payments for banking with them. Instead, you may receive a payment as Hibah (Gift) which are those payments that are earned when an Islamic bank has made a profit with a business that it has invested in. Besides this, you won't notice much difference other than the reassurance that your money is being invested in ethical businesses that follow Shariah law, and that your bank is only investing in financially sound businesses.
How do Islamic banks make money?
You might now be scratching your head a little, wondering how you can receive the Hibah payments when your Islamic bank doesn't charge interest on loans, so isn't making any money. Because they don't make money, do they?
Well, actually yes they do. It's like we explained earlier. An Islamic bank will not ask for interest on loans given, but once the loan has been repaid and the business is running successfully and earning profits, then the bank will ask to receive a cut of this. The bank will then distribute those collective profits from businesses it has invested in, and spread them equally amongst customers who bank with them. Simple enough to understand, right?
And this method of earning money is perfectly ethical under Shariah law, because they do not make the money through idle means. Instead, a business that has been invested in and proven itself to be useful by earning extra profits is helping make the bank money, and thus everybody who banks with them too.
Things to watch out for
If you're thinking of opening an Islamic savings account, then that makes sense, but here are the four areas you need to look into before agreeing to open an account with any Islamic bank:
- When can you take your money out again? Is it after one, two, or three years, etc?
- What is the Hibah and when is this typically paid? (by law a Hibah doesn't HAVE to be paid, it always has been in the past, but it doesn't have to be, so make sure it's clear what you will receive and when before joining an Islamic bank)
- The minimum and maximum deposit amount to ensure the particular savings account is right for you.
A Shariah compliant savings account is a morally sound, ethical, and smart investment decision for your finances, whether you're a Muslim or not. Why? Because these banks are bound by Shariah law, so they only invest ethically and never risk money knowingly as other banks might do. To put it simple, when you put your money in an Islamic savings account, everybody is in it together. All the risks and rewards are shared equally, hoping the investments and loans that are made will prove useful, thus making both society and the business/financial world a better place.