How do Islamic banks make money if interest is prohibited?

The prohibition of interest (riba) in Islam leads Islamic banks to adopt alternative financial models that comply with Shariah law. According to the Qur'an, Allah explicitly forbids usury and emphasizes the importance of trade and charitable giving. For instance, in Surah Al-Baqarah, it states, Allah hath blighted usury and made almsgiving fruitful. Allah loveth not the impious and guilty 2:276. This sets the foundation for Islamic banking principles, which focus on profit-sharing, risk-sharing, and ethical investments.

Islamic banks typically operate on several key principles, such as profit-sharing arrangements (Mudarabah) and joint ventures (Musharakah). In a Mudarabah contract, one party provides the capital while the other provides expertise and management; profits are shared according to a pre-agreed ratio. In Musharakah, all partners contribute capital and share profits and losses in proportion to their investment. This approach fosters a partnership between the bank and its clients, aligning their interests.

Tafsir Ibn Kathir explains that these practices are designed to avoid the exploitative nature of interest-based transactions and to encourage investment in productive ventures, thereby stimulating economic growth. Additionally, Islamic banks engage in leasing (Ijarah), where they purchase assets and lease them to clients, earning profit through rental payments instead of interest.

According to Shia scholarship, as reflected in Al-Mizan, the emphasis remains on maintaining ethical standards in business and ensuring that transactions contribute positively to society. This includes investments in permissible (halal) sectors and avoiding those that involve harm or exploitation.

Overall, Islamic banks create profit through various Shariah-compliant financial instruments that emphasize cooperation and shared risk, distinguishing themselves from traditional banking systems that rely on interest as a primary revenue source.