The term Islamic bank refers to financial institutions that abide by the statutes of Islamic law, or Sharia. Islamic banks do not pay interest on checking or savings accounts and they are also prohibited from collecting interest.
Islamic banks follow the principals of Islamic law, or Sharia, which is a framework that guides people in both the public and private aspects of their lives. Sharia prohibits the paying of interest or the charging of fees when lending money, which is referred to as riba.
Islamic banks can provide capital to its customers, and remain profitable at the same time, through the use of an equity-participation process. For example, the bank may loan money to a business but is prohibited from collecting interest on the loan. Instead, the business will offer the bank a share of its profits. This arrangement allows the bank to share in the risk of trade, rather than a transfer of risk.
Islamic banks can also provide potential homeowners with a mortgage-like transaction and still follow the principals of Sharia. One approach is for the bank to purchase the property and resell it to the buyer at a profit through an installment plan; much like the payments a homeowner would make on a more conventional mortgage.
Some commercial banks may offer their customers what is referred to as an Islamic window. In doing so, these banks can provide the same services and follow the same principals as an Islamic bank.