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FACTBOX-How Islamic banking works

Mon Jan 21, 2008 9:07pm EST

(Reuters) – For Islamic finance to comply with sharia, or Islamic law, financiers charge no interest and do not invest in prohibited businesses such as trading in alcohol, pork, arms, pornography or gambling.

Following are some widely used methods of Islamic finance:

* Islamic bonds, or sukuk — typically backed by physical assets that pay a dividend or rent to bondholders rather than interest.

* Murabaha — a financier, such as a bank, buys a commodity and sells it to the purchaser at a higher price.

* Mudaraba — the bank provides funding to entrepreneurs, who share the profits of any venture. The entrepreneurs do not put up any capital.

* Musharaka — the bank provides funding to entrepreneurs, who also contribute capital. Profits from the venture are shared.

* Ijarah — Arabic for leasing. An agreement in which banks lease an asset to a client for a specific time at a specific price. At the end of the leasing period, the client may or may not own the asset.

* Istisna — The purchaser asks the seller to create a product, which is then sold to the purchaser at a given price. Istisna allows parties to contract the sale of a something that does not exist at the time of the agreement.

(Compiled by Mohammed Abbas)

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