Difference Between Islamic Banking and Conventional Banking

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 in completely prohibited in Islamic banking. It is asset based financing, in which trade of elements prohibited by Islam are not allowed. For example, you cannot take a loan for a Wine Shop. On the other hand, Conventional Banking is an Un-Ethical Banking system based on Man-Made Laws. It is profit-oriented and its purpose is to make money through interest".

difference between Islamic banking and conventional banking

Islamic Banking and Conventional Banking - Major Differences

Now, let us review some major differences between Islamic banking and conventional banking systems:

Conventional Banking System
Islamic Banking System
Money is a product besides medium of exchange and store of value Real Asset is a product. Money is just a medium of exchange
Time value is the basis for charging interest on capital Profit on exchange of goods & services is the basis for earning profit
The expanded money in the money market without backing the real assets, results deficit financing Balance budget is the outcome of no expansion of money
Interest is charged even in case, the organization suffers losses. Thus no concept of sharing loss Loss is shared when the organization suffers loss
While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made The execution of agreements for the exchange of goods & services is must, while disbursing funds under Murabaha, Salam & Istisna contracts
Due to non existence of goods & services behind the money while disbursing funds, the expansion of money takes place, which creates inflation Due to existence of goods & services no expansion of money takes place and thus no inflation is created
Due to inflation the entrepreneur increases prices of his goods & services, due to incorporating inflationary effect into cost of product Due to control over inflation, no extra price is charged by the entrepreneur
Bridge financing and long term loans lending is not made on the basis of existence of capital goods Musharakah & Diminishing Musharakah agreements are made after making sure the existence of capital good before disbursing funds for a capital project
Government very easily obtains loans from Central Bank through Money Market Operations without initiating capital development expenditure Government can not obtain loans from the Monetary Agency without making sure the delivery of goods to National Investment fund
Real growth of wealth does not take place, as the money remains in few hands Real growth in the wealth of the people of the society takes place, due to multiplier effect and real wealth goes into the ownership of lot of hands
Due to failure of the projects the loan is written off as it becomes non performing loan Due to failure of the project, the management of the organization can be taken over to hand over to a better management
Debts financing gets the advantage of leverage for an enterprise, due to interest expense as deductible item form taxable profits. This causes huge burden of taxes on salaried persons. Thus the saving and disposable income of the people is effected badly. This results decrease in the real gross domestic product Sharing profits in case of Mudarabah and sharing in the organization of business venture in case of Musharakah, provides extra tax to Federal Government. This leads to minimize the tax burden over salaried persons. Due to which savings & disposable income of the people is increased, which results the increase in the real gross domestic product
Due to decrease in the real GDP, the net exports amount becomes negative. This invites further foreign debts and the local-currency becomes weaker Due to increase in the real GDP, the net exports amount becomes positive, this reduces foreign debts burden and local-currency becomes stronger

These study contents are taken from Islamic banking and finance courses. These courses are delivered through interactive learning and they are designed by AIMS for masters degree in Islamic banking and finance, which leads to phd Islamic finance.

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