Islamic banking is accelerating rapidly worldwide. The number of Islamic financial institutions has increased significantly in the Middle East and Southeast Asia. There are also International Financial Institutions in Europe and the United States adopting some Islamic instruments to attract investors who prefer the use of Islamic credit instruments, such as Murabaha, Mudaraba, Musharaka and Ijara.
Islamic commercial banks have products similar to those offered by conventional banks. Conventional banks earn their money by charging interest and fees for services. Islamic banks earn their money by profit and loss sharing, trading, leasing, charging fees for services rendered, and using other Shariah contracts of exchange. In a commercial banking, the Shariah board is involved in supervising bank operations to make sure they comply with Shariah principles.
Islamic finance is based on four core principles: prohibiting usury, avoiding speculation and avoiding gambling. The Shariah board is the backbone of an Islamic bank; it plays a vital role in establishing and operating the bank.
The fundamental purpose for establishing an Islamic bank is to promote and encourage Islamic principles. Conventional banks are profit-making organizations that generally aren’t based on religious principles. Islamic banks operate based on Islamic business law (called fiqh-u–muamalat) for their basic transactions. They also follow the financial laws and regulations of the countries in which they operate.
Conventional banks likewise operate based on a country’s financial laws and regulations. They don’t have contact with any religious body. The relationship between a customer and an Islamic bank is completely different. The debtor and creditor relationship does exist at times in Islamic banking.
Investments in conventional commercial banks are based on guaranteed principal and earning a fixed amount of income. Even if the bank lost the money in an investment, the bank is still liable to pay back all the money due.
In Islamic banking, the concept of investment is different. Although the customer deposits the money in order to earn extra income for her savings, her principal and returns aren’t guaranteed.
The failure of an investment is not very common in Islamic banks because the banks are very concerned about their customers and make their investment choices very wisely.
In principle, Islamic banking provides a risk sharing model, primarily because Shari’a requires one to bear the risk of one’s invested capital, in order to be entitled to its returns.
On the other hand, the conventional bank shares no loss with the customer if the asset is destroyed, which is mainly because a conventional bank takes no such risk on its investment when lending. A conventional bank charges late payment fees and take the same to its income. In comparison, Islamic banks do not charge any late payment fees since financial penalties are impermissible in Islam.
Islamic banks don’t charge the customer unless the asset is delivered to him/her in usable condition. Islamic banks, being market players like their conventional counterparts, have to price their products as per the prevailing market rates. The assertion that Islamic banking products are more expensive than conventional ones is simply not true.
The prices of Islamic and conventional banking products can only be fairly compared once Islamic banks have their own bench mark and an independent market. The difference between conventional, which called western banking and Islamic banking are following:
– The functions and working modes of conventional banks are based fully manmade principles.
– The functions and operating modes of Islamic banks are based on the rule of Islamic Shariah.
– The investor is assured of a fixed rate of interest. It promotes risk sharing among provider of capital (investor) and the user of funds (entrepreneur). It target at maximizing profit without any restriction. It also aims at maximizing returns but subject to Shariah restrictions.
– 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.
– Lending money and having it back with compounding interest is the essential function of the conventional bank.
– Participants in partnership business are the fundamental functions of Islamic banks. So we have to recognize our customer’s business very fine.
– The Islamic banks have no prerequisite to charge any additional money from the defaulters. Only little amount of compensation and these proceeds is given to donations.
– Conventional bank very frequently it results in the bank’s own interest becoming prominent. It makes no effort to ensure growth with equity. It gives due importance to the community interest. Its ultimate aim is to ensure expansion with equity. For interest-based commercial banks, borrowing from the money market is moderately easier.
– For the Islamic banks, it must be based on a Shariah approved underlying business. Since income from the advances is fixed, it gives less importance to developing expertise in project assessment and evaluations.
– Since it shares profit and loss, the Islamic banks pay better attention to developing project appraisal and evaluations.
– The conventional bank offer greater emphasis on credit-worthiness of the customers.
– The Islamic bank, gives greater emphasis on the viability of the projects.
– The status of a conventional bank, in relation to its clients, is that of creditor and debtors. In relation to its clients is that of partners, investors and buyer and seller.
– A conventional bank has to guarantee all its deposits.
– Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed compensation of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position.
– Islamic banks are less risky. They are more adaptable than their counter parts in terms of bank capital requirement and mobilization of deposits.
– The global financial crisis presented a big opportunity to the Islamic banking and finance industry.
– In 2008-2009, the Islamic banking industry was estimated to have experienced asset growth of 31.8 percent compared to 12.6 percent in the conventional banking.
– The Islamic bank total assets range between US$1.88 trillion to US$2.1 trillion in 2016 and are expected to reach US$3.4 trillion by 2018 globally. It provides an alternative financial services option to all consumers and investors.