Islamic banking has the same purpose as conventional banking, except that it operates in accordance with the rules of Sharia’h. While both aim to provide financial services, the approach, principles, and methods are very different. Understanding these differences is crucial for anyone studying finance, investing, or using banking services.
Purpose and Principles
Overview:
Conventional banking primarily operates for profit using interest-based lending. Islamic banking, on the other hand, follows Sharia’h principles, ensuring that profits and losses are shared fairly.
| Conventional Banking |
Islamic Banking |
| Operates for profit using interest-based lending. |
Operates in accordance with Sharia’h principles; profit and loss are shared. |
Inflation and Pricing
Explanation:
Inflation affects pricing and profit. Conventional banking allows entrepreneurs to raise prices to cover inflation, while Islamic banking aims to prevent unnecessary price hikes.
| Conventional Banking |
Islamic Banking |
| Entrepreneurs increase prices due to inflation and incorporate it into product costs. |
Controlled inflation means no extra price is charged solely due to inflation. |
Financing and Capital Projects
Explanation:
Conventional banks may provide loans without checking the existence of actual capital goods. Islamic banks use structured agreements ensuring real capital is in place.
| Conventional Banking |
Islamic Banking |
| Bridge financing and long-term loans made without verifying existence of capital goods. |
Musharakah & Diminishing Musharakah agreements made after ensuring capital goods exist before disbursing funds. |
Wealth Distribution
| Conventional Banking |
Islamic Banking |
| Real growth of wealth does not take place, as money remains in few hands. |
Real growth occurs across society due to multiplier effect; wealth reaches many hands. |
Project Failure Management
| Conventional Banking |
Islamic Banking |
| Loans are written off as non-performing when projects fail. |
Management can be transferred to a better team to protect the investment. |
Profit Sharing vs Interest
| Conventional Banking |
Islamic Banking |
| Debt financing gives leverage; interest expense deductible from taxable profit. |
Profit-sharing (Mudarabah) and participation (Musharakah) contribute to taxes fairly, reducing burden on salaried individuals. |
Leasing and Ownership
| Conventional Banking |
Islamic Banking |
| Ownership transferred to client; risk and reward borne by client. |
Ownership remains with bank; risk and reward borne by bank as asset owner. |
Depositor Returns
| Conventional Banking |
Islamic Banking |
| Fixed interest given to depositors. |
Profits distributed according to bank earnings monthly, based on decided weightages. |
Money vs Real Assets
| Conventional Banking |
Islamic Banking |
| Money is a product and medium of exchange/store of value. |
Real assets are the product; money is only a medium of exchange. |
Basis of Earning
| Conventional Banking |
Islamic Banking |
| Time value of money used to charge interest on capital. |
Profit earned from exchange of goods and services. |
Money Market and Budgeting
| Conventional Banking |
Islamic Banking |
| Expanded money in money market without backing by real assets causes deficit financing. |
Balanced budget ensured by no unbacked money expansion. |
Risk and Loss Sharing
| Conventional Banking |
Islamic Banking |
| Interest charged even if borrower suffers loss; no loss sharing. |
Loss is shared when the organization suffers loss. |
Conclusion:
Islamic banking and conventional banking share the goal of providing financial services, but they differ fundamentally. Islamic banking emphasizes ethical finance, real asset backing, risk and loss sharing, and wealth distribution, while conventional banking relies on interest-based lending and leverage. Understanding these differences helps individuals and businesses make informed financial decisions aligned with their values.
