Differences Between
Islamic Bank and Conventional
By :
Ust Hj Zaharuddin Hj Abd Rahman
One must refrain from making a direct comparison between Islamic banking
and conventional banking (apple to apple comparison). This is because they are
extremely different in many ways. The key difference is that Islamic Banking is
based on Shariah foundation. Thus, all dealing, transaction, business approach,
product feature, investment focus, responsibility are derived from the Shariah
law, which lead to the significant difference in many part of the operations
with as of the conventional
The foundation of Islamic bank is based on the Islamic faith and must stay
within the limits of Islamic Law or the Shariah in all of its actions and deeds.
The original meaning of the Arabic word Shariah is 'the way to the source of
life' and is now used to refer to legal system in keeping with the code of
behaviour called for by the Holly Qur'an (Koran). Amongst the governing
principles of an Islamic bank are :
* The absence of interest-based (riba) transactions;
* The avoidance of economic activities involving oppression (zulm)
* The avoidance of economic activities involving speculation (gharar);
* The introduction of an Islamic tax, zakat;
* The discouragement of the production of goods and services which contradict
the Islamic value (haram)
On the other hand, conventional banking is essentially based on the debtor-
creditor relationship between the depositors and the bank on one hand, and
between the borrowers and the bank on the other. Interest is considered to be
the price of credit, reflecting the opportunity cost of money.
Islamic law considers a loan to be given or taken, free of charge, to meet any
contingency. Thus in Islamic Banking, the creditor should not take advantage
of the borrower. When money is lent out on the basis of interest, more often
that it leads to some kind of injustice. The first Islamic principle underlying for
such kind of transactions is "deal not unjustly, and ye shall not be dealt with
unjustly" [2:279] which explain why commercial banking in an Islamic
framework is not based on the debtor-creditor relationship.
The other principle pertaining to financial transactions in Islam is that there
should not be any reward without taking a risk. This principle is applicable to
both labor and capital. As no payment is allowed for labor, unless it is applied
to work, there is no reward for capital unless it is exposed to business risk.
Thus, financial intermediation in an Islamic framework has been developed on
the basis of the above-mentioned principles. Consequently financial
relationships in Islam have been participatory in nature.
Lastly, for the interest of the readers, the unique features of the conventional
banking and Islamic banking are shown in terms of a box diagram as shown
below:-
Conventional Banks Islamic Banks
1. The functions and operating modes 1. The functions and operating modes of
of conventional banks are based on Islamic banks are based on the principles
fully manmade principles. of Islamic Shariah.
2. The investor is assured of a 2. In contrast, it promotes risk sharing
predetermined rate of interest. between provider of capital (investor)
and the user of funds (entrepreneur).
3. It aims at maximizing profit without 3. It also aims at maximizing profit but
any restriction. subject to Shariah restrictions.
4. It does not deal with Zakat. 4. In the modern Islamic banking system,
it has become one of the service-
oriented functions of the Islamic banks
to be a Zakat Collection Centre and they
also pay out their Zakat.
5. Lending money and getting it back 5. Participation in partnership business
with compounding interest is the is the fundamental function of the
fundamental function of the Islamic banks. So we have to understand
conventional banks. our customer's business very well.
6. It can charge additional money 6. The Islamic banks have no provision to
(penalty and compounded interest) in charge any extra money from the
case of defaulters. defaulters. Only small amount of
compensation and these proceeds is
given to charity. Rebates are give for
early settlement at the Bank's
discretion.
7. Very often it results in the bank's 7. It gives due importance to the public
own interest becoming prominent. It interest. Its ultimate aim is to ensure
makes no effort to ensure growth with growth with equity.
equity.
8. For interest-based commercial 8. For the Islamic banks, it must be
banks, borrowing from the money based on a Shariah approved underlying
market is relatively easier. transaction.
9. Since income from the advances is 9. Since it shares profit and loss, the
fixed, it gives little importance to Islamic banks pay greater attention to
developing expertise in project developing project appraisal and
appraisal and evaluations. evaluations.
10. The conventional banks give greater 10. The Islamic banks, on the other
emphasis on credit-worthiness of the hand, give greater emphasis on the
clients. viability of the projects.
11. The status of a conventional bank, 11. The status of Islamic bank in relation
in relation to its clients, is that of to its clients is that of partners,
creditor and debtors. investors and trader, buyer and seller.
12. A conventional bank has to 12. Islamic bank can only guarantee
guarantee all its deposits. deposits for deposit account, which is
based on the principle of al-wadiah,
thus the depositors are guaranteed
repayment of their funds, however if the
account is based on the mudarabah
concept, client have to share in a loss
position..
Last update: 22-02-2007 10:02
