By Raja Chinnakotla | Spring 2026 – Volume 16

Why is Islamic Finance Different?

In conventional understandings of economics, the idea
of interest and the cost of borrowing money are a
foundation for the field. In the field of economics,
interest is a nonnegotiable fact. Among international
groups, including the World Bank and the IMF, it is
widely frowned upon to deviate from existing
economic norms. However, economic policy is not
bound solely by the theories of a microeconomics
textbook. Outside of the West, cultural and religious
norms shape the rules of an economy. Consider a
question: What would happen if we could function
economically without interest? Beyond that, a more
outlandish concept is abolishing interest as a whole.
For most economists, both of these proposals seem like
a heretical concept. However, interest, or lack thereof,
is the key demarcator of modern Islamic finance, along
with the unique roles of women and requirement of
charity.

In Islam, the concept of interest is seen through Riba
الربا) ). Scholars directly translate Riba to interest. In
the Quran, Riba is seen from the revelations of the
Prophet Muhammad (SAW) from Allah (SWT) in
Surah 3: Ali ‘Imran (or Family of Imran).

يَا أَيُّهَا الَّذِينَ آمَنُوا لَا تَأْكُلُوا الرِّبَا أَضْعَافًا مُّضَاعَفَةً وَاتَّقُوا للهََّ
لَعَلَّكُمْ تُفْلِحُونَ
“O you who believe! (Do) not eat Riba doubled, redoubled.
And consciously revere Allah so that you may
(be) successful” (Quran 3:130).

This revelation shows a direct connection between Riba
and sin. This creates a framework for institutions to
become Sharia ( شَرِيعَة ) compliant, which is guidance of
morals and laws that come from the Quran. Another word
that scholars translate from this section is “usury.”
“Usury” is lending money and charging unreasonably high
rates of interest. Riba is fundamentally excess, which in
the creation of Allah (SWT), is sinful. Economically,
interest imposes a loss on the borrower since they have to
give more money than initially stated by the lender. By
eliminating interest, there is welfare gained from saving
interest on the lender. Thus, for many practicing Muslims,
participating in the conventional economy is a direct
contradiction to their belief system. There is even debate
among religious scholars if the modern economy is
Sharia-compliant, since most currencies in the banking
system have some relation to interest. While only the most
devout Muslim could oppose using interest-bearing
currency, Islamic finance minimizes the culpability of
individuals participating in a system that is contrary to
Islamic beliefs. Muslim kingdoms and nations in the
modern age have developed creative solutions to comply
with Islamic scripture and create Sharia-compliant
financial institutions.

Unconventional Loans

Most Islamic finance operates through means of trade.
Throughout history, the Islamic world has used trade to
expand its economic relevance. In Arabic, Bai’ ( بيع ) is
directly translated to sale, but is used colloquially as a term
of trade. Whether through the Sahara, the Indian Ocean,
or the Silk Road, exchanging goods through trade is the
lifeblood of the Islamic world’s success. Many different
forms of Bai are used for Islamic Finance today. Therefore,
I will focus on three important Bai principles that are most
commonly used as an alternative to interest (State Bank of
Pakistan).

بيع مؤجل). 1 )Bai Muajjal

Bai Muajjal is the most common way Islamic banks
finance items. Essentially, the bank buys a good, like a
house or car, and owns it for a period of time, then sells it
to the buyer once the full amount has been paid. For
example, let’s say Manal was buying a brand new car for
$30,000; however, she doesn’t want to pay in full right
away. First, Manal will contact her Islamic banks and
explain the transaction that will soon happen (this is quite
normal for Islamic banks in America). Then, the bank will
purchase the car Manal wants and increase the car’s value
arbitrarily by 10%. Once the bank has the car, it will allow
co-ownership of the asset until the transaction has been
fully paid for in monthly installments for the
corresponding “interest” involved. Manal will pay (10%
interest) $33,000 over the period the bank allows, then the
car will be fully transferred to Manal. Because both parties
own the car, there is technically no loan involved, since it’s
considered a payment for trade to a different owner.
Therefore, this transaction is Halal, and Manal gets to
whip it in her new car!

بيع سَلَم). 2 )Bai Salam

Translated, Bai Salam means contract. Bai Salam is also
widely used in financing. In this case, there is a contract
with advanced payment for a good delivered at a later date
– think of an online delivery, but the item has to be paid in
full by the end of the contract. Bai Salam is commonly
used for owners who deliver goods at a later date, including
farmers and builders. For example, there is a farmer named
Abdi who needs money to plant corn, but cannot earn
money until the harvest time, 6 months later.

Abdi goes to the Islamic bank, and the bank asks that he
get $10,000, under the conditions he brings 100 bushels to
the bank by harvest time. Abdi gets cash upfront to use
for his harvest. Then the buyer, in this case the bank, gets
the wheat later. There is technically no interest involved,
since it is fully a sale.

3.Bai Al-Wafaa (بيع الوفاء)

Bai Al-Wafaa is often used during emergencies, when
people need money for a short period. It is less common,
but it still has practical uses. Bai Al-Wafaa is when a sale is
conducted for an item, and the seller has to buy the item
back at full price. Wafaa translated into English means
loyalty which is the foundation for these loan transfers.
Let’s say there is a man, Ayub, who owns a $500,000
house but is in desperate need of cash. Ayub sells his
house to his friend Madina for $500,000. Madina has
ownership of the house and can use it in any way possible,
including renting it out to other people. The condition is
that when Ayub returns with $500,000, then Madina must
sell it to him for the selling price of $500,000. This avoids
interest since the repurchase is a separate contract, and
both owners can make money off the asset without having
a loan involved. However, there is no guarantee of profit
from the asset, since the new owners decide what to do
with it.

Islamic Central Banking

In conventional central banking, bonds are IOUs in
which the government lends money for a set period, and
upon maturity, the lender receives a specified interest
payment. The issuance of bonds has been the standard
for central banks, particularly when moving with the
business cycle. However, for Islamic central governments,
this poses a significant problem since issuing Riba is
Haram. Rather than allot bonds to lenders, Islamic
central banks use Sukuk (صكوك).

With its origin from the root word of Sakk, meaning
deed, Sukuk is a certificate of proportionate undivided
ownership of a Sharia-compliant asset. This means that
the entire asset is co-owned, with each party holding a
proportionate share (Brunei Darussalam Central Bank).
This is different from a bond because of the differentiator
between debt and ownership. In a bond, the government
is a debtor to the lender, but in Sukuk, the “lender” is a
partner in the asset, so they gain the profit from what the
government uses the bond for. If the government of
Brunei were to raise funds for a new infrastructure
project, the government would issue sukuks that allow coownership
of the project, and then all profits from the
project would be given proportionally to the lender’s
amount. This is similar to stocks in the US where
individuals purchase parts of a company and receive
dividends proportional to their ownership. Sukuks are
different since these are government projects rather than
corporations on the private market.

Compared to other central banks, Islamic financial
regimes have much less liquidity, but continue lending
regardless of their liquidity positions (Zaheer et al). This
means that Islamic central banks have a less effective
transmission of monetary policy compared to other
monetary regimes. Yet, Islamic banks have a more reliable
alternative asset portfolio since liquid assets are less
reliant. This means that Islamic central banks prioritize
physical projects over holding large sums of cash. During
the 2008 financial crisis, this meant that central banks did
not completely deplete their reserve currencies. Though
not technically a bond, a Sukuk certificate allows raised
revenues with Islamic morals.

Group Savings and Collective Banking

Other ways Islamic finance avoids interest are through
rotating and savings credit accounts (ROSCAs). For
ROSCAs, I will focus on the country of Somalia, since
these types of accounts are more common there than in
other Muslim nations. In Somalia and in communities
with high diaspora populations, Ayuutos (Somali
ROSCAs) are used as an informal way to bank
(Githigaro). In these situations, there is a certain amount
of money given by a group of people to a pool every
month. Then, once a person has their turn, they are
obligated to pay back what they took. For example, in a
group of 12 people, they could each put in 100 dollars a
month. Then there is an order decided on who can take
the money; however, someone in line could switch places
or not take the full amount of money (Pambekti et al).
Then, by the end of the month, $1200 should be returned
to the pool. Interest is accrued when participants don’t
use the entire pool amount, and from the increased
money over time.

The positives of Ayuutos are that they avoid Riba and
are flexible for each person. A tight-knit community with
shared interests benefit from Ayuutos since they offer an
opportunity to finance projects without significant
regulation directly. Moreover, they are often advised by
older women who hold power in a community, so
someone is always in charge of the transactions. Some
drawbacks of Ayuutos are that pools are often only cash
and owned in accounts not tied to traditional banking.
This leads to problems where tracking money can become
a challenge. Taxing accounts also becomes a problem
since Ayuutos in America happen under the table or
without IRS notice. When speaking to a friend whose
relatives regularly use Ayuutos, she mentions how
someone could theoretically take all the money and flee
abroad to Somalia. However, she says that this problem is
mitigated since groups in an Ayuuto know each other,
and the head advisor can control the flow of future
payments. Another factor mitigating misuse of Ayuutos
is being ostracized from a community since committing
such acts is considered sinful and will cause tension. With
tight communities, it is hard to take all the money
without consequence. In her experience, she’s seen people
who have committed fraud with an Ayuuto be dealt with
in ways outside of the traditional legal-framework.

Women’s Role in Islamic Finance

There is a perception in the West that Islam is completely
incompatible with women’s autonomy. However, Islamic
finance allows women’s rights in untraditional and unique
ways. The relationship between finances and women in
Islam might be surprising to non-Muslims. Women play a
role in the transmission of economic policy, like in the
West, but often have privileges of being on boards of
banks that dictate whether an investment is Shariacompliant.

Women are often in charge of ROSCA’s accounts and hold
positions in high central bank offices. For example, in
central banking, Maysaa Sabreen ( ميساء صابرين ) is the first
woman to hold the position of First Deputy to the
Governor of the Central Bank of Syria. In the world of
banking, Eman Al-Binghadeer ( إيمان البنغدير ) is the Head
of Internal Sharia-Audit for the Bahrain Islamic Bank.
Women are gaining positions in Sharia Boards and other
sectors of finance at a rapid pace. Women’s participation in
Islamic finance is growing as the years pass (Zahoor).
Though there is progress to be made, there have been
improvements in integrating women into Islamic finance.

In the Quran, from the Surah 4: An-Nisa (or “The
Women”), women are allowed financial independence.

وَلَا تَتَمَنَّوْا۟ مَا فَضَّلَ ٱللَّهُ بِهۦِ بَعْضَكُمْ عَلَىٰ بَعْضٍۢ لِّلرِّجَالِ نَصِيبٌۭ مِّمَّا
لُوا۟ ٱللَّهَ مِن فَضْلِهٓۦِ إِنَّ 􀘅 ٱكْتَسَبُوا۟ وَلِلنِّسَآءِ نَصِيبٌۭ مِّمَّا ٱكْتَسَبْنَ وَسْ
ٱللَّهَ كَانَ بِكُلِّ شَىْءٍ عَلِيمًۭا ٣

“And do not crave what Allah has given some of you over
others. Men will be rewarded according to their deeds and
women ˹equally˺ according to theirs. Rather, ask Allah for
His bounties. Surely Allah has ˹perfect˺ knowledge of all
things.” (Quran 4:32).

There is a clear distinction that women are allowed to have
money equally. Essentially, this verse highlights that there
is a divine right for Muslim women to have authority over
her financing. Women are allowed separate accounts and
can pursue purchases of large assets without a male
companion. The concept of a “joint-bank account” is not
seen in many Islamic banks. However, cultural trends have
led women to have men control their accounts, as they may
be unemployed or lack financial education.

Before marriage, women ask for a Mahr, a gift to the
wife, which is required before a Nikah (marriage
contract). Like a Dowry, it allows women autonomy to
quantify their worth in a marriage. In the past, Mahr
usually involved the trading of animals or goods. In the
modern day, however, there is a monetary price
associated with the privilege of getting married. For
marriage financing, the money of the wife is hers and
money of the husband is shared between the couple.

Zakat and Charity

Along with a prohibition of interest, one of the central
tenets of Islamic finance is Zakat (Arabic), better known
as charity. One of the consistent parts of contemporary
Islamic finance that remains is moral spending of one’s
money. From the 5 pillars of Islam, Zakat is the
compulsory act of giving 2.5% of one’s total income to
charity. Zakat is given yearly during the holy month of
Ramadan since it is a time of sacrifice of oneself for
others. The origin of 2.5% comes from how monetary
exchanges were conducted in the past. During the time
of the Prophet Muhammad (SAW), gold and silver
would be physically weighed, and 2.5% of the weight
would be given to charity (Al Mustafa Welfare Trust).

Along with giving up income for charity, Zakat also
shows up in modern investing. Halal investing is
achieved through investing in companies that are
compatible with Islamic principles. For different
scholars, their definition of compatible can vary,
although they generally follow similar principles. For
example, a Muslim investment bank would not invest in
unethical companies like those in the tobacco or
gambling industries. There are successful ETFs (pooled
investment securities) that are Sharia-compliant, with
many international financial firms like Dow Jones and
iShares having Halal ETFs. Some of the most successful
Halal ETFs SP Fund S&P 500 Shariah Industry
Exclusions ETF (SPUS) and the Whed FTSE USA
Sharia ETF (HLAL) (Amal Invest).

Sometimes, these ETFs perform better than non-Halal
ETFs. This allows Muslims a Halal way to be included in
the stock market without going against Islamic morals.

Conclusion

When entering an economics lecture, there is a feeling
that there is only one right way to run an economy. This
is an impetus to impose the same economic framework
and institutions across the world. Islamic finance
highlights how economic systems can stray away from
fundamental principles and continue to see success. There
are opportunities to conduct monetary and financial
policies contextually for a country that contribute to
positive economic growth. Rather than forcing a mold
that won’t work on everyone, there should be thought
given to the implementation of economic policies that
take into consideration different factors of a country.
Perhaps the next time you are thinking about interest,
consider the alternatives that Islamic finance creates and
how an economy still runs, even without any interest.

Acknowledgements

Thank you to the EQ E-board for helping me with
editing, members of EQ with peer editing, Dr. Louphou
Coulibaly as my faculty reviewer, Sereen AlHabsi as a
peer reviewer, and my friends back in The Islamic
Caliphate of Minnesota who inspired me to write about
this topic!

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