Ethical Banking: What It Is and Why It’s Important
Buying a home is more than just a practical financial move. For the new homeowner, it’s a means of stability that looks ahead toward future generations. It’s a way of putting down roots in a community. It is usually the biggest investment of a person’s life. It’s the place that becomes the setting and backdrop for every major life event to come. It’s a big deal.
Thus, financing that home should align with the homeowner’s values.
Often, financing through a bank is seen as a kind of necessary evil, a hurdle that must be overcome. However, there is another path. This article illuminates that path by explaining ethical banking and its importance.
What Is Ethical Banking?
Ethical banking refers to financial practices that prioritize transparency, fairness, and social responsibility. Rather than focusing solely on profit, ethical banks and financial institutions consider the broader impact of their decisions on people, communities, and the planet. This approach supports lending and investment strategies that avoid industries or activities deemed harmful, such as those contributing to environmental degradation, exploitation, or excessive debt.
Ethical banking means aligning financial choices with personal values; seeking returns that don’t come at the expense of others; and managing money without compromising your integrity. This may include avoiding interest-based lending, supporting sustainable housing, or partnering with institutions that uphold ethical and faith-based principles.
Ethics in Banking and Finance: A Brief History
The first ethical bank, Triodos Bank, was founded in the early 1970s, setting out to loan the money entrusted to it in a responsible manner.
Interest in ethical banking grew after the financial crisis of the early 2000s, as onlookers observed that the situation was created not only due to economic causes but ethical failures as well. Those ethical failures included inappropriate and at times criminal behavior, such as concealing information, false advertising, inadequately assessing risk, and incompetent leadership.
The resulting crisis jeopardized the stability of financial markets worldwide, making it clear that ethics are far more than something nice to have in theory. More people came to the conclusion that ethical financial conduct can translate to greater stability and prosperity for societies and for individuals within them.
Governments have since tightened regulations, but major banks predictably continue to operate to maximize profits, leaving an opening for the creation of more ethical financial institutions. These ethical financial companies attract customers who want to bank or invest according to their values.
Why Is Ethical Banking Important?
Ethical banking offers a meaningful shift toward trust, transparency, and community empowerment. In a world where traditional banks have sometimes contributed to economic instability through opaque practices, ethical banks provide an alternative for financing that is grounded in integrity and accountability. Communities benefit from transparent operations, fair financing structures, and responsible investing.
One thing that sets an ethical bank apart is how it uses customer deposits. Instead of funneling funds into industries that may harm the environment or exploit communities, ethical banks often invest in the following:
- Local businesses and socially responsible startups
- Affordable housing and sustainable development
- Charitable programs and environmental initiatives
- Religious communities and underserved minorities
Islamic Finance: Ethics in Action
Islamic finance is a fast-growing market segment that operates according to ethical values, including transparency, restraint, and a refusal to participate in any activities that take advantage of the weak or harm society. These ethics may be recognized as universal ones, aligning with Judeo-Christian values as well. Because of that, Islamic finance appeals to people of all faiths, as well as a growing number of socially conscious young adults who are looking to leave a positive impact on the world around them.
In a global market that predominantly operates through the conventional financial system, Islamic finance in the West began its journey several decades ago. Initially, Islamic finance was limited to the Middle East. But over the years, it has grown progressively and spread across several continents, with assets growing into the trillions of dollars.
Let’s take a look at the ethical advantages offered by Islamic finance, which align with the values of Muslims as well as Christians and the United States’ Founding Fathers.
Imagine you were sitting in a room with Thomas Jefferson, James Madison, John Adams, and Benjamin Franklin. The topic of discussion? Banking and finance. If you’ve read their statements, you’d know they all voiced concern about private banks and corporations controlling money and its issuance, and the effect it would have on the people. In fact, if you heard John Adams say, “There are two ways to conquer and enslave a country. One is by the sword, the other is by debt,” you would rightly conclude that our Founding Fathers had strong convictions and were concerned about interest, credit, and the spending and buying power of consumers.
Now imagine you were sitting in a room with the most notable Christian and Islamic financial scholars of the world, discussing the same issue — only they were quoting passages from the Bible and the Quran. For instance, Deuteronomy 23:19, “Do not charge your brother interest,” or “God has made commerce lawful and has forbidden interest,” Quran 2:275. Different room, same principles.
These two examples illustrate the alignment of values between interfaith communities — as well as help set the scene for U.S. Islamic finance today.
Ethical Advantages of Islamic Finance
What’s different about the Islamic banking system is the ethical and moral values it is based upon. It seeks to enable people to earn and grow money, benefiting individuals and society as a whole while restraining the richest and most powerful from taking advantage of the weak and vulnerable.
Shariah principles, or Islamic religious laws, forbid any investment that would support industries or activities that are considered harmful to the people and society in general. This includes usury (otherwise known as interest or riba), but they also prohibit speculation and gambling. To understand the wisdom of this, we need to look no further than the 2008 housing market crash, fueled in large part by widespread speculation and other irresponsible practices, irrespective of whether these are legal or not in a given territory.
Related Read: Do You Have to Be a Muslim to Get a Riba-Free Mortgage?
Shared Prosperity of Ethical Banks
One way Islamic financial principles prevent a housing-market-crash-kind of catastrophe is by requiring transactions to be backed by assets, such as actually buying a home together as partners. By contrast, a mortgage loan is not an asset-backed transaction — it is essentially the buying of money now for the promise of more money later, and money has no intrinsic value.
Asset-backed transactions inhibit the kind of speculation that contributes to economic turmoil. Practices like these foster a healthy and vibrant economy where prosperity is shared.
Community-Centric Financial Justice
Financial justice is a basic requirement for the functioning of Islamic finance products. Western or conventional financing looks forward to profiting through interest payments and makes the beneficiary completely liable for any risk. Contrary to this, Islamic financing paves way for the sharing of net profit/loss and the risk involved in a proportional manner between the financier and the consumer.
Therefore, if a financier is expecting a claim on the profits of a project, it is necessary that he/she should also carry a proportional share of the loss of that project.
Driving Economic Growth and Stability
Increases in global debt lead to lower economic growth in the future. This is why more industries are utilizing Islamic finance principles as a way to contribute to the greater good. For example, Silicon Valley (the center of innovation with high economic growth rates) is almost completely financed with equity, which is in line with an Islamic finance structure.
Start-ups for high-tech innovation, scientific development companies, and global technology companies understand that Islamic finance principles serve to insulate them from excessive leverage and uncertainty. This shift promotes financial stability and leads to a healthier economy.
Islamic finance companies themselves have profit creation and growth as their objectives. Outside of home finance, Islamic banks earn money through investing in businesses they think are likely to grow and succeed. In the Islamic banking industry, each bank will naturally try to outperform its competitors through wise investments. This can result in a high rate of return, which benefits both the bank and those who deposit money with it. That’s because when those individuals help fund the investments, they gain a share of the profits. This profit can be higher than in a conventional bank, where people who deposit money earn only a predetermined interest rate while the bank earns the rest of the profits from using their money.
Because of this, Islamic banks choose to invest in businesses based on their potential for growth and success. Each bank invests in promising business ventures and attempts to out-perform competitors to attract more funds from its depositors. This will eventually result in a high return on investments both for the bank and the depositors. This is unlikely in a conventional bank, where depositors redeem returns on their deposits based on a predetermined interest rate.
In some ways, in Islamic finance, investments are approached with a more deliberate decision-making process, compared to conventional finance. Companies with risky financial practices and operations are usually avoided by Islamic financing companies. By performing intensive audits and analyses, Islamic finance promotes the reduction of risk and creates the space for greater investment stability.
Shared Risk
Islamic finance uses the concept of shared risk versus debt to promote sustained, inclusive, and sustainable economic growth. Sharing risk is a method in which the cost of the consequences of a risk is distributed among several participants in an enterprise.
This “sharing” and distribution allows for a more just outcome if something goes wrong — there is no unfair burden on the consumer such as that faced by the borrower of a loan. Interest is a means by which wealth is concentrated in the hands of a few, and the debt that can be realized as a consequence of interest puts many individuals, families, and even corporations in a more precarious financial position. In part because of the dissatisfaction with traditional financing, Islamic finance (which is founded on equitable principles such as shared risk) has gained traction in the U.S. and grown tremendously.
Environmental Sustainability
How can the Islamic finance industry have an impact on the sustainability of our planet? As responsible consumption is a principle in Islam, waste is wrong, and Islamic principles encourage the reuse of goods, waste products, and recycling of materials as much as possible.
Islam also teaches the importance of not wasting water. Searching for ways to conserve water are of the utmost importance to our planet. Water and other natural resources are a sacred trust, and protecting them for future generations is a primary responsibility.
Islamic finance can also support sustainability initiatives by urging our youth, as well as our community, to use responsible consumption and create dwellings that reuse materials in an efficient manner.
Aligning Finance With One’s Faith
Before Islamic finance products were readily available in the U.S., Muslim Americans who wanted to uphold Shariah law could not participate in the American Dream of owning a home because the pathway to owning a home involved interest, or riba, which is not permitted.
Homeownership is part of the American dream and leads to stronger, healthier, and safer communities. In the spirit of this dream, Guidance Residential set out to create an ethical bank model with a modern Islamic home financing solution.
In 2002, after a three-year, multi-million dollar research and development project involving 18 law firms and six of the world’s leading Islamic finance scholars, Guidance Residential’s Declining Balance Co-Ownership Program was created. The premise of the program is that the client and the company are co-owners of a property, and the client purchases shares over time from the company until becoming the sole owner.
Other advantages of the program are the following:
- No prepayment penalties
- Shared risk without the need to share the profit in the case of a sale (the financier does not claim a share of the equity, or the increase of the home’s value that would happen over time)
- The company — unlike a conventional bank loan — has no recourse to come after personal assets in the case of default
Related Read: Learn the Difference Between an Islamic and Conventional Mortgage
What a beautiful thing that this conflict between the American Dream and personal faith is gone now that a competitively priced Islamic financing option is widely available through Guidance Residential, coast to coast to people of all faiths.
Even better is that when looking beneath the surface, it becomes clear why this type of ethical financing is advised. It promotes justice, helps to grow a healthy society, and protects the vulnerable. Purchasing a home through Islamic financing is a beautiful way to align life’s biggest investment with the home buyer’s deepest values.
Getting Started With Islamic Home Financing
Guidance Residential’s co-ownership model of Islamic home financing remains the #1 U.S. Islamic home financing provider, with more than 40,000 families assisted over more than 20 years.
Learn more about Islamic finance, or get started on your homeownership journey today!
Your Guidance Residential Account Executive is here to help with any questions. Looking to refinance or purchase? Have a friend or family member who is looking for a home? Call 1.866.Guidance, or start an application today.
Originally published in July 2015, last updated in October 2025.
