Q&A: Islamic finance

Traditional UK bank accounts and mortgages do not comply with Islam's sharia law, so in the past Muslims faced a big decision - compromise their beliefs or look for alternative ways to manage their finances. Now, however, some organisations offer financial services tailored to suit the two million muslims living in the UK.

What are the main rules for Islamic finance?
The rules lie in the principles of Islam's shariah law, taken from the Qur'an and the Sunnah, (the way) referring to the way in which the prophet Muhammad lived his life.

Central to Islamic finance is the fact that money itself has no intrinsic value, it is simply a medium of exchange. Each unit is 100% equal in value to another unit of the same denomination and you are not allowed to make a profit by exchanging cash with another person. A Muslim is not allowed to benefit from lending money or receiving money from someone.

This means that earning interest (riba) is not allowed. To comply with these rules, interest is not paid on Islamic savings or current accounts or applied to Islamic mortgages.

How do the banking arrangements work for customers?
There are several Islamic financial instruments:

· Ijara works as a leasing arrangement: the bank buys something for a customer and then leases it back to them. Different forms of leasing are permissible, including those where a portion of the instalment payment goes toward the final purchase.

· Murabaha works by the bank supplying specific goods for resale to the customer. This method incorporates a mutually agreed contract and a mutually negotiated margin.

· Musharaka is a joint venture in which the customer and bank contribute to the capital of the operation and agree to share the returns (as well as the risks) in proportions agreed to in advance.

How do the banks make money?
Banks can profit from the buying and selling of approved goods and services. The principal means of Islamic finance are based on trading, and it is essential that risk be involved in any trading activity, so banks and financial institutions will trade in sharia-compliant investments with the money deposited by customers, sharing the risks, and the profits between them.

Islamic banks are structured so that they retain a clearly differentiated status between shareholders' capital and clients' deposits in order to make sure profits are shared correctly.

Although they cannot charge interest, the banks can profit from helping customers to purchase a property using a ijara or murabaha scheme. With an ijara scheme the bank makes money by charging the customer rent; with a murabaha scheme, a price is agreed at the outset which is more than the market value. This profit is deemed to be a reward for the risk that is assumed by the bank.

There are firm laws governing the types of business the banks can trade with. There should be absolutely no investment in unsuitable businesses, including those involved with armaments, pork, tobacco, drugs, alcohol or pornography.

Similar to ethical banking, then?
There is some common ground. Some of the tenets of Islamic banking will appeal to anyone, Muslim or otherwise, who agrees with the underlying principles of equitable distribution for everyone, the ideals of fair trading, spending of wealth judiciously, and well-being of the community as a whole. These principles result in an exacting ethical stance relating to investment.

What choices do people have?
The 1.8 million plus Muslims living in the UK can now manage their money on a day-to-day basis without compromising their deeply held convictions. Lloyds TSB offers a current account, as does HSBC through its Amanah Finance division, together with a home-financing scheme. However, although money is held separately to that managed by the rest of the organisation, these are large institutions that are not wholly compliant with sharia principles.

The Islamic Bank of Britain, which opened in 2004, operates entirely in accordance with sharia law. It has branches in London, Leicester, Birmingham and Manchester and offers a range of savings accounts, a current account and financing deals.

Homebuying products, credit or charge cards and other services will be available later this year. The managing director, Michael Hanlon, says its products are competitively priced and "equivalent to those available in a conventional bank".

The Ahli United Bank specialises in home-financing schemes. As well as helping Muslims buy a property to live in, it now offers sharia-compliant funding for buy-to-let property investments.

Useful contacts
· The Institute of Islamic Banking and Insurance
· Islamic Bank of Britain
· HSBC Amanah Finance
· Ahli United Bank