Islamic Banking VS Conventional Banking:
Banking is now an essential part of daily life, and it has forms: Islamic banking and conventional banking. These two systems differ substantially and are evident in their operating procedures and policies. Let us first understand the major difference between Islamic banking and conventional banking system. “Islamic banking is an Ethical Banking System, and its practices are based on Islamic (Shariah) laws. Interest is completely prohibited in Islamic banking. It is asset-based financing, in which the trade of elements prohibited by Islam is not allowed. For example, one cannot take a loan for Wine Shop. On the other hand, Conventional Banking is an unethical banking system based on Man-Made Laws. It is profit-oriented and aims to make money through interest”.
1. What is Conventional Banking
A. Understanding the Conventional Account
Understanding conventional banking accounts, we may realize the difference between Islamic and conventional banking. Conventional banking makes deposits in an individual or business account and provides loans to individuals needing financial assistance. Depositing money into a conventional account allows the individual to receive interest on money not being used and they have the opportunity to qualify for a loan such as purchasing a car.
B. Types of Conventional Banking Accounts
Here are some types of conventional banking accounts:
- Checking Accounts: This account allows people to place their money into the account and earn interest (Riba).
- Savings Account: Savings accounts allow you to save your money, collect interest, and use it when you need it.
- Time Deposits: This is similar to a checking account but offers higher interest rates.
All these types of conventional banking accounts are available in Islamic banking but minus Riba (Interest in Islam) and other prohibited elements.
2. Islamic Banking:
Look Into Shariah Compliant Financial Services
Islamic banking is a kind of financial service allowing the use of profit-sharing such as Interest-free Islamic loans, and other financial services based on the guidelines provided by Islamic Sharia Law. Let us go over Islamic banking VS conventional banking in greater detail and point out the significant differences.
Difference between Islamic Banking and Conventional Banking:
Now, let us review some major differences between Islamic banking and conventional banking systems:
Conventional Banking System | Islamic Banking System |
INTEREST RATES | |
| This system operates on traditional financial transactions, including interest rates. | Islamic banking is based on Islamic or Muslim Law principles, which prohibit lending money with interest but promote risk sharing. |
PROFIT AND LOSS SHARING | |
| The bank makes money on loans and pays interest on deposits. | Profit and Loss are shared by the bank and the customer. |
RISK SHARING | |
| The customer bears the risk. | The risk is shared by the Islamic bank and the customer. |
RESTRICTIONS ON INVESTMENTS | |
| No restrictions are imposed | Investments in industries considered Haram are forbidden. Items include alcohol, gambling, pork, maysir, etc. |
CREDIT | |
| Facilitates the generation of credit. | Allows asset-backed financing and encourages real Islamic economic actions. |
PRICING FOR FINANCING | |
| Pricing is based on current interest rates. | The cost of the Islamic financial product is linked to an asset or commodity. |
IMPORTANCE OF MONEY | |
| Money is a product besides a medium of exchange and a store of value. Real Asset is a product. | Money is just a medium of exchange. |
TIME VALUE OF MONEY | |
| Time value is the basis for charging interest on capital. | Profit on the exchange of goods & services is the basis for earning profit |
DEFICIT FINANCING | |
| The expanded money in the money market, without backing the real assets, results in deficit financing. | A balanced budget is the outcome of not expanding money. |
BUSINESS LOANS | |
| Interest is charged even if the organization suffers losses. Thus, there is no concept of sharing loss. | Loss is shared when the organization suffers loss. |
EXCHANGE OF GOODS | |
| No agreement for the exchange of goods and services is made while disbursing cash finance, running finance, or working capital finance. | Executing agreements for the exchange of goods and services is a must when disbursing funds under Murabaha, Salam, and Istisna contracts. |
INFLATION | |
| Due to the nonexistence of goods and services behind the money, while disbursing funds, money expands, which creates inflation. Due to inflation, the entrepreneur increases the prices of his goods and services, incorporating the inflationary effect into the cost of the product. | Due to the existence of goods and services, money does not expand, and thus, no inflation is created. Due to control over inflation, the entrepreneur charges no extra price. |
PROJECT FINANCING | |
| Bridge financing and long-term loan lending are not made based on the existence of capital goods. | Musharakah and diminishing Musharakah agreements are made after ensuring the existence of capital goods before disbursing funds for a capital project. |
GOVERNMENT LOANS | |
| The government can obtain loans from the Central Bank very easily through money market operations without initiating capital development expenditure. | The government can not obtain loans from the Monetary Agency without ensuring the delivery of goods to the National Investment Fund. |
ECONOMY GROWTH | |
| Real growth of wealth does not take place, as the money remains in few hands. | Due to the multiplier effect, real wealth grows among the people of the society and becomes the property of many hands. |
PROJECT LOANS | |
| Due to the failure of the projects, the loan is written off as it becomes a nonperforming loan. | Due to the project’s failure, the organization’s management can be taken over and handed over to better management. |
DEBT FINANCING | |
| Debt financing provides an enterprise with leverage, as interest expense is a deductible item from taxable profits. This causes a huge burden of taxes on salaried persons, which negatively affects their savings and disposable income. This results in a decrease in the real gross domestic product. | Sharing profits in the case of Mudarabah and sharing in the organization of business ventures in the case of Musharakah provides extra tax to the Federal Government. This minimizes the tax burden on salaried persons. This increases people’s savings and disposable income, which results in an increase in the real gross domestic product. |
EFFECT ON GDP | |
| Due to a decrease in the real GDP, the net export amount becomes negative. This invites further foreign debts, and the local currency becomes weaker. | Due to the increase in the real GDP, net exports become positive. This reduces the burden of foreign debt, and local currency becomes stronger. |
Difference between Islamic Banking and Conventional Banking
In many cases, Islamic banking is very similar to conventional banking. For example, a conventional bank allows the account holder to save money and get loans for large purchases such as a home or vehicle. That said, there are significant differences in how Islamic banking operates. How Islamic banks operate is referred to as “ethical” or “people-friendly” banking. Islamic banking is considered more convenient than conventional banking because it encourages people to take smaller loans. In the context of sustainability, the difference between Islamic banking and conventional banking are quite apparent. Islamic institutions offer a more enduring approach due to their unique Islamic finance principles and practices.
Key Note!
Differences in Education for Islamic Banking VS Conventional Banking
There is a big difference between Islamic banking and conventional banking when it comes to education and certification offered to aspiring professionals and others looking for knowledge in the field.
- To succeed in Islamic banking, you must have exacting knowledge and skills from Islamic banking education programs.
- These programs include online Islamic finance certification, comprehensive Islamic banking courses, and an online diploma in Islamic banking and finance.
- These educational avenues offer precise insight into the principles, methods, and legalities of Islamic finance, setting it apart from conventional banking.
- Learning from these programs gives professionals an understanding of the complexities of this financial system.
Islamic Finance VS Conventional Finance: An Analysis
The differences between Islamic banking and conventional banking are quite significant. Conventional banking is a traditional interest-based system, while Islamic banking operates on fairness, social responsibility, and risk-sharing principles of Islamic finance. Not only are there several benefits, but Islamic banking also promotes a more sustainable economy. Islamic banking offers an alternative for customers who want their money used ethically.