Halal loans are loans provided by banks that operate according to the Islamic rules of Shariah. These rules, called as Fiqh al-Muamalat, are based the Islamic rules of transactions and promote principles of Islamic economics. Quite a few Islamic banks began to provide alternative financial and banking products in the late 20th century. For customers and commercial Halal companies that want to operate within Islamic percepts, halal loans provide a way around conventional, interest-bearing loans.
Fundamental Islamic banking principles prohibit collecting and paying interest, which is known as riba. The word itself translates as increase, addition, or excess. Under Sharia principles, interest is considered to be compensating in excess without due consideration. Riba can be defined in classic Islamic discourses as surplus value without counterpart. It may also be roughly translated as numerical value was immaterial and ensure equivalency in real value.
The Sharia does not permit accepting or paying interest for loans of money, so halal loans were created as an alternative. They operate in different ways — for instance, when a buyer approaches the bank for a money loan to buy a particular item, the bank may buy it directly from the seller. The bank resells the item to the buyer under strict conditions, which include established collateral. While the bank does sell it to the buyer for a profit, this is not explicit, and no penalties are imposed for late payments. From the very start, the item is registered under the buyer's name, and it may be property or goods.
This type of purchase and deferred payment resale transaction is called Murabaha under Islamic principles. The bank sells the property to the buyer for a fixed, openly stated price in customer-friendly installments. The price factors in both profit and administrative costs. Halal loans thus allow customers to acquire assets without having to opt for traditional interest-based loans.
Ijarah is another approach that is basically a rent-to-own type of transaction. The bank first acquires the property or goods, and the customer leases it until he or she can pay back the full amount over a period of time. Halal loans that work on the Ijarah format can use a contract that allows the buyer to acquire the property after a fixed period of time. Alternatively, they may take the form of basic lease agreements.
There is also a joint venture approach called Musharakah, which translates as sharing. The basic principle involves lending money to businesses, and both entities are responsible for the value of the investment. The profit is made by the sale of stakes at a later date, and both parties agree beforehand to lose or share whatever profit may come. Banks may also issue floating rate interest loans that are based on a rate of return for that company. The bank may suffer a loss under this practice, in accordance to Islamic law, which declares it unjust that the lender profits hugely, leaving only a small portion to the debtor.
A Mudaraba contract is another version of halal loan in which a venture capitalist or financial expert provides the investment. The entrepreneur provides the labor, and any profit or loss are shared by both parties. If the investment is unsuccessful, the bank does not charge a handling fee. It only charges a fee if a profit is made.