Islamic Banking V/S Conventional Banking: What is the difference?

  • - by   Mindcypress
  • Sep 13, 2021
Islamic Banking V/S Conventional Banking: What is the difference?

Staying true to your values is what makes a Muslim individual close to their ethnicity. Sharia/Islamic Banking is one way to connect your beliefs and innovation together. Such a banking network has gained popularity in parts of Asia, Africa, and the Middle East, eliminating the need for traditional banking. There are a lot of Islamic Banking Certifications that can help you understand the core of Sharia Laws and regulations. Further, this blog explains the basics involved with Islamic Finance.

What is Islamic Banking?

Islamic finance is a way to perform financial activities that are compatible with the principles of Sharia. Sharia law forbids you from unethical, immoral, speculative activities as well as interest, gambling, and indecision.

Islamic finance motivates entrepreneurship, mutual cooperation, generosity, and a spirit of partnership that connects the capital owner with the real economic activities that may actually contribute to the welfare of society through commerce, manufacturing, construction, and related areas.

This is not only limited to the modes of financing but, also comprises all business and financial transactions or rulings.

All of us must seek lawful wealth for our needs, attain self-sufficiency, and provide shelter, and so on. There is a high demand from the Muslim community for Sharia-compliant alternatives to conventional finance.

The main challenge revolves around what is allowed and what is not, according to the Sharia Laws.

Sharia lays down rules that promote fair dealing and business ethics based on universal principles.

These principles consider the community needs that commit to a healthy society. Let us dive into the principles!

Principles and Types of Islamic Banking

Islamic banking has to strictly follow the norms of Sharia Law. For a lot of Muslims, traditional banking institutions are a big No! The Islamic beliefs avert them from getting involved with usury or interest (Riba). The main focus being, how you generate capital in compliance with Sharia. This makes it very important for you to understand the basic principles involved with Sharia Banking.

                                              Islamic Banking

  • Sharing Profit & Loss- A profit is shared amongst the partners, depending on a prefixed ratio and the investment made. It is based on who provides the capital and the one who manages the entire process.
  • Paying Interest (Riba) - According to Islam, usury (Riba) is strictly prohibited as it exploits the borrowers and favors the lender.
  • Unpredictability & Risk (Gharar) - Islamic culture forbids you from investing in contracts that are high at risk or unpredictable. The word Gharar itself means uncertainty, hazard, or risk.
  • Investing in Prohibited Industries- The industries that hamper social responsibilities or are considered as a thread, are forbidden by Islam. These include industries like alcohol, pornography, pork, etc.

Now that we know the basic principles, let’s dive straight into the types of Islamic Banking investments.

  1. Musharaka (Joint Venture) - This type of financial model involves sharing of profit and loss with the partners. The profit ratio is decided by observing the level of participation and effort.
  2. Mudaraba (Investment Partnership) - The arrangement between partners, where one makes the investment and the other manages is known as Mudaraba.
  3. Ijarah (Leasing) – The philosophy of Islamic Law talks about a lease or Ijarah and is based on employing somebody on wages. It is also related to the trade of a property, in exchange for
  4. Murabaha (Cost-plus Sales) – Debt-based financing is known as Murabaha, a sale in Sharia Banking is defined as the exchange of commodities that hold a mutual value.

What is Conventional Banking?

Conventional banking focuses on generating profits, through the interest charged. It is an unethical banking system that runs on manmade laws and regulations. This system allows the public to deposit money at low-interest rates and gives a loan to the borrowers at a higher rate.

Difference between Islamic Banking & Conventional Banking

                                                     Financial Modeling

Down below we have listed the major differences between Islamic Banking and Conventional Banking:

  1. Transactions- In conventional banking money is treated as a product, whereas in Sharia banking your assets are the product and money is only a medium of exchange.
  2. Time Value- Conventional banks earn their profits based on the time taken to repay the loan. Islamic Banks earn profits by exchanging goods and services.
  3. Interest- Conventional banks ensure to charge interest, even if the organization is at a downfall. But, when it comes to Islamic Banks profit or loss is always shared depending on the prefixed ratio.
  4. Exchange- During payout conventional banks do not allow an exchange of goods and services as a medium. For Islamic banks, it is mandatory to trade goods or services under Salaam and Istisna contracts.
  5. Failure- If at any time a project fails to complete its purpose, a conventional bank will write off your loan as a non-performing loan. Whereas, Islamic banks will transfer the management of an organization and change it to a better one.

Islamic/Sharia banking has extensively increased the demand of professionals who have completed an Islamic Banking Certification. Specifically, when it comes to Muslim-dominated areas around the world. Sharia Finance requires a lot of time and attention, as it involves legal laws and regulations. It might sound difficult but once you get a hang of it, it’s going to be a piece of cake!

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