Types of Islamic finance: the contracts behind the products

A conventional bank makes most of its money one way: it lends, and charges interest. Islamic finance rules that out, so it uses a handful of older contracts instead. Each one is a different way of sharing risk and reward, and the contract matters more than the label on the product.

Here are the ones you’ll meet in the UK, grouped by what they do.

Partnerships

Mudaraba (profit sharing). One side brings the money, the other brings the work. Profit is split in a ratio agreed at the start. If the venture makes a loss, the person who put in the money bears it, unless the manager was negligent or broke the terms. In a savings account, you’re the one with the money and the bank is the manager. Al Rayan Bank says it runs its instant access account this way.

Musharaka (joint venture). Both sides put in money. Profit is shared as agreed, and losses in line with what each put in. It’s used for business and project finance.

Diminishing musharaka (co-ownership). A partnership in an asset where one partner buys out the other in stages. This is the backbone of most UK home purchase plans: you and the provider buy the home together, you buy its share bit by bit, and your ownership grows until the home is yours. Gatehouse Bank and StrideUp both describe their plans this way.

Agency

Wakala (agency). You appoint the bank as your agent to invest your money for you, aiming at an expected profit rate. The agent is paid a fee, and many contracts let it keep anything earned above the expected rate as an incentive. Al Rayan Bank uses wakala for its notice, fixed term and cash ISA accounts, and QIB (UK) for the accounts it offers through Raisin. Gatehouse Bank’s terms appoint the bank as your agent without using the word.

Mudaraba and wakala both pay an expected rate, not a guaranteed one. In practice, UK banks have aimed to pay what they quote, but the contract doesn’t promise it. That difference is the point. Read more on expected profit rates.

Sales

Murabaha (cost-plus sale). The bank buys something you want and sells it to you at a price that includes a profit it tells you upfront. You usually pay in instalments. The price is fixed once agreed, so it can’t creep up the way interest can. It’s used for some car finance and business finance.

Tawarruq, or commodity murabaha. A chain of two sales used to raise cash. You buy a commodity, often a metal, on deferred payment, then sell it straight away for cash. Banks use it widely for personal finance and to manage their own money. It’s also the most criticised contract on this list: the International Islamic Fiqh Academy ruled in 2009 that organised tawarruq, as banks typically arrange it, isn’t permissible. Other scholars allow it with conditions.

Salam (pay now, deliver later). The full price is paid upfront for goods delivered on a set future date. It was used for crops, and still turns up in commodity finance.

Istisna (made to order). A contract to build or manufacture something, with the price agreed in advance and payment often in stages. It’s used for construction and big projects.

Leasing

Ijara (lease). The provider owns an asset and rents it to you. In principle, because it owns the asset, it carries the main risks of ownership, such as the asset being destroyed. In a home purchase plan, the rent you pay on the provider’s share is usually an ijara. Al Rayan Bank describes its plans as a partnership in which you lease its share.

Ijara wa iqtina, or ijara muntahia bittamleek (lease to own). A lease that ends with the asset passing to you. Car and equipment finance sometimes uses it.

Safekeeping and loans

Qard (interest-free loan). A loan repaid in the same amount, with nothing extra agreed. Islamic current accounts are often a qard from you to the bank. The bank must repay your money in full and doesn’t pay profit. Al Rayan Bank runs its current account this way.

Wadiah (safekeeping). Money held in trust for safekeeping. Some banks abroad use it for current accounts.

Investment and insurance

Sukuk. Certificates that give holders a share in an asset or project, paid from what it earns, rather than a loan. The UK government issued sukuk in 2014 and again in 2021. Read our sukuk explainer.

Takaful. Cover based on members helping each other. Members put contributions into a shared fund that pays claims, and an operator runs it for a fee or a share of profit. Compare takaful.

Why it matters when you compare

Two accounts can show the same rate and work very differently underneath. The contract decides:

• who carries the loss if investments go wrong
• whether the rate is expected or fixed
• what happens if you want your money early
• whether your money is invested at all, as with a qard current account

The provider’s own terms are the place to check, and many say which contract they use in a section on the Sharia principles. When we compare savings and home purchase plans, we show the contract each provider states, with a link to its document. Where a provider doesn’t state one publicly, we say so rather than guess.

Your money is protected the same way whichever contract a UK bank uses: eligible deposits are covered by the FSCS up to £120,000 per person, per banking licence.

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