Where do Islamic banks invest?

The investment system of Islamic banks is fundamentally different from that of conventional banks. The culture of loan defaults that has taken root in the country can be significantly reduced through the proper application of Islamic banking principles—particularly by addressing issues such as fund diversion and money laundering.

Islamic banking is built on a moral and ethical framework based on the Qur'an and Sunnah. In conventional banking, money is treated as a commodity, whereas in Islamic banking, it is viewed as a medium of exchange. Islamic banking also places strong emphasis on societal welfare, avoiding investment in sectors that are harmful to society.

To ensure proper governance, Islamic banks operate under the guidance of a Shariah Board, composed of Islamic scholars, economists, and experts in Fiqh al-Muamalat. This board plays a crucial role in maintaining transparency and building customer trust.

At its core, Islamic banking promotes a system of profit-and-loss sharing between banks and customers. This ensures fairness in financial dealings. As a result, the appeal of Islamic banking is not limited to the Muslim population—non-Muslims are also increasingly drawn to its ethical framework.

In conventional banking, deposits earn a fixed rate of interest. However, there is no guarantee of receiving interest in every case. In contrast, Islamic banking strictly prohibits interest (riba) and operates on the principle of Shariah compliance.

A key distinction in Islamic banking lies in the relationship between the bank and the customer. If the bank generates a profit, the customer shares in that profit based on a pre-agreed ratio. If the bank incurs a loss, the customer may not receive any return, and in certain cases, capital loss may also be shared. This risk-sharing approach is one of the defining features that sets Islamic banking apart from conventional systems.

In Bangladesh, Islamic banks invest through various modes such as Mudaraba, Murabaha, Musharaka, Hire Purchase, Ijarah, and Salam. Internationally, many other Shariah-compliant investment methods are also practiced.

Under the Mudaraba system, one party provides the capital while the other manages the business using their skills and effort. The capital provider is known as Sahib al-Mal, while the manager is called the Mudarib. If the business earns a profit, it is shared between both parties according to a pre-agreed contract. If there is a loss, the capital provider bears it. However, if the loss occurs due to negligence, violation of rules, or breach of contract by the Mudarib, then the Mudarib is responsible for the loss.

Murabaha refers to a cost-plus financing method, where a product is sold by adding a fixed profit to its purchase price. Once a Murabaha transaction is completed with a declared profit, the same product cannot be resold under identical terms. Similarly, after the investment period ends, no additional profit can be charged. Upon maturity, if repayment is delayed, compensation or penalty may be applied for the extra period. While provisions exist for such expenses, the misuse of this system—particularly in sectors like construction—has been observed in Bangladesh.

Farid Ahmed Fakir, Former Head of Islamic Banking and Senior Vice President, AB Bank PLC