Islamic Banking vs. Conventional Banking
Islamic Banking vs. Conventional Banking (Foreign Exchange Mode)
From the view point of Islamic “Shariah’ (law), in order to be justified as an Islamic way of dealing with financial transactions the banking systems has to avoid interest. Consequently, financial intermediation in Islamic banking between the bank and the client takes place as a partner rather than a debtor-creditor. The financial activities of modern conventional banks are based on a creditor –debtor relationship between depositor and bank on one hand and between borrower and the bank on the other .Conventional banks regard interest as the price of credit reflecting the opportunity cost of money. As interest is prohibited in Islam, Commercial banking in an Islamic framework could not be based on the creditor-debtor relationship. The other aspect of the theoretical basis of Islamic banking is that the interest free bank is not risk free. This principle is applicable to two main factors of production, i.e. labour and capital. According to this principle, as no payment is allowed to labour, unless it is applied to work, no reward for capital should be allowed, unless it is exposed to business risk. From these two principles of the theoretical basis of Islamic banking, it may be said that Islamic financial relationships are of a participatory nature (Ahmed, 1994). Based on the interest-free financing principle, business practices of Islamic banks, especially sources and uses of bank’s funds, are characterized by the following modes or techniques.
| Mode | Islamic Banking | Conventional Banking | Differences |
| Import | Murabaha Bill of Exchange(MBE) | Payment Against Documents(PAD) | Not so differences in practice. |
| Murabaha Post Import(MPI) | Loan Against Imported Merchandise(LIM) | Not so differences in practice. | |
| Force Murabaha Post Import(FMPI) | Force Loan Against Imported Merchandise(FLIM) | Not so differences in practice. | |
| Bai-Muazzal Trust Receipt (Baim-TR) |
Loan against Trust Receipt(LTR) | Not so differences in practice. | |
| Inward Foreign Bills for Collection (IFBC) | Inward Foreign Bills for Collection (IFBC) | ||
| Baim Wes Bills | Force/ Demand Loan Against Imported Merchandise(F/D LIM) | Not so differences in practice. | |
| Export | Foreign Bill for Purchase (FBP) | Foreign Documentary Bill Purchase(FDBP) | Not so differences in practice. |
| Foreign Bill for Collection (FBC) | Foreign Documentary Bill for Collection (FDBC) | Not so differences in practice. | |
| Musharaka Pre-shipment Finance(MPSF) | Packing Credit(P.C) | Not so differences in practice. | |
| F.C. Held | FBP Awaiting Remmitances(FBPAR) | Not so differences in practice. |
Islamic Banking vs. Conventional Banking
100 Short Questions, Answers & Explanations — Islamic Banking vs. Conventional Banking
Basic Concepts
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Q: What is Islamic banking?
A: Banking based on Shariah principles.
Explanation: Avoids interest (riba) and promotes profit/loss sharing. -
Q: What is conventional banking?
A: Banking based on interest-based lending and borrowing.
Explanation: Operates under secular laws. -
Q: Which banking type prohibits interest?
A: Islamic banking.
Explanation: Riba is forbidden in Islam. -
Q: Which banking type allows interest?
A: Conventional banking.
Explanation: Interest is a core income source. -
Q: What is riba?
A: Unjustified increase in capital without service or trade.
Explanation: Commonly means interest on loans.
Objectives
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Q: Main goal of Islamic banking?
A: Promote ethical, Shariah-compliant finance.
Explanation: Based on fairness and social justice. -
Q: Main goal of conventional banking?
A: Maximize profit through interest and service charges.
Explanation: Driven by shareholders’ returns. -
Q: Which banking type focuses on community welfare?
A: Islamic banking.
Explanation: Encourages social development. -
Q: Which banking type focuses primarily on capital growth?
A: Conventional banking.
Explanation: Focuses on profitability. -
Q: Which system considers moral values in transactions?
A: Islamic banking.
Explanation: Guided by Shariah ethics.
Sources of Funds
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Q: Islamic banks’ funds come from?
A: Profit-sharing deposits, investment accounts.
Explanation: Mudarabah and Wakala contracts. -
Q: Conventional banks’ funds come from?
A: Interest-bearing deposits and borrowings.
Explanation: Includes savings and term deposits. -
Q: Are current accounts interest-free in Islamic banks?
A: Yes
Explanation: Treated as Qard Hasan (loan without interest). -
Q: Are savings accounts interest-based in conventional banks?
A: Yes
Explanation: Interest is paid to depositors. -
Q: Does Islamic banking accept term deposits?
A: Yes, but on a profit-sharing basis.
Explanation: Returns depend on actual profits.
Uses of Funds
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Q: Islamic banks invest in?
A: Shariah-compliant trade and assets.
Explanation: No haram businesses. -
Q: Conventional banks invest in?
A: Any profitable business.
Explanation: Including prohibited industries. -
Q: Can Islamic banks fund alcohol industry?
A: No
Explanation: Alcohol is haram in Islam. -
Q: Can conventional banks fund gambling?
A: Yes
Explanation: No religious restriction. -
Q: Islamic banks use asset-backed financing?
A: Yes
Explanation: Transactions must involve real assets.
Contracts & Instruments
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Q: What is Mudarabah?
A: Profit-sharing between capital provider and entrepreneur.
Explanation: Loss borne by capital provider only. -
Q: What is Musharakah?
A: Joint venture with shared profit/loss.
Explanation: Partners contribute capital. -
Q: What is Murabaha?
A: Cost-plus sale financing.
Explanation: Bank sells asset with disclosed profit margin. -
Q: What is Ijarah?
A: Leasing of assets.
Explanation: Similar to rental agreement. -
Q: What is Qard Hasan?
A: Interest-free loan for welfare.
Explanation: Borrower repays principal only. -
Q: Do conventional banks use Mudarabah?
A: No
Explanation: They use fixed interest contracts. -
Q: Do Islamic banks use interest-based loans?
A: No
Explanation: All financing is Shariah-compliant. -
Q: What is Istisna’a?
A: Contract for manufacturing goods.
Explanation: Payment can be made in stages. -
Q: What is Salam?
A: Advance payment for goods delivered later.
Explanation: Common in agriculture. -
Q: Does conventional banking have Ijarah?
A: No equivalent in Shariah sense.
Explanation: Uses lease but interest may be embedded.
Risk & Profit
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Q: Who bears investment risk in Islamic banking?
A: Both bank and client share risk.
Explanation: Based on contract. -
Q: Who bears investment risk in conventional banking?
A: Borrower mostly.
Explanation: Bank secures fixed interest. -
Q: Are Islamic banking profits fixed?
A: No
Explanation: Based on actual returns. -
Q: Are conventional banking returns fixed?
A: Yes
Explanation: Interest rate predetermined. -
Q: Can Islamic bank lose money?
A: Yes
Explanation: Losses are shared in equity-based contracts.
Shariah Compliance
-
Q: Who supervises Islamic banks’ Shariah compliance?
A: Shariah Supervisory Board.
Explanation: Group of Islamic scholars. -
Q: Do conventional banks have Shariah boards?
A: No
Explanation: Governed by secular law. -
Q: Can Islamic banks invest in conventional bonds?
A: No
Explanation: Bonds involve interest. -
Q: Can conventional banks invest in sukuk?
A: Yes
Explanation: Sukuk are Shariah-compliant bonds. -
Q: Do Islamic banks follow AAOIFI standards?
A: Yes, in many countries.
Explanation: Accounting & Auditing Organization for Islamic Financial Institutions.
Products
-
Q: Islamic equivalent of savings account?
A: Mudarabah savings account.
Explanation: Profit-sharing basis. -
Q: Conventional savings account returns?
A: Fixed interest rate.
Explanation: Independent of bank’s profit. -
Q: Islamic equivalent of fixed deposit?
A: Term Mudarabah investment.
Explanation: Profit ratio agreed in advance. -
Q: Islamic credit card principle?
A: Based on Ujrah (fee) or Tawarruq.
Explanation: Avoids interest charges. -
Q: Conventional credit card income?
A: Interest on outstanding balance.
Explanation: Plus annual fees.
Social Impact
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Q: Does Islamic banking promote Zakat?
A: Yes
Explanation: Encourages social responsibility. -
Q: Does conventional banking promote Zakat?
A: No obligation.
Explanation: Secular system. -
Q: Does Islamic banking avoid speculation?
A: Yes
Explanation: Prohibits gharar (excessive uncertainty). -
Q: Does conventional banking allow speculation?
A: Yes
Explanation: No religious restriction. -
Q: Which banking type focuses on halal business?
A: Islamic banking.
Explanation: Must meet Shariah rules.
International Practice
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Q: Is Islamic banking practiced globally?
A: Yes
Explanation: In Muslim and non-Muslim countries. -
Q: Is conventional banking practiced globally?
A: Yes
Explanation: Dominant system worldwide. -
Q: Is Malaysia a hub for Islamic finance?
A: Yes
Explanation: Major Islamic banking center. -
Q: Is New York a hub for Islamic banking?
A: No
Explanation: Dominated by conventional finance. -
Q: Are Islamic banks regulated by central banks?
A: Yes
Explanation: Subject to national banking laws.
Accounting & Reporting
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Q: Do Islamic banks follow IFRS?
A: Sometimes, alongside AAOIFI.
Explanation: Depends on jurisdiction. -
Q: Do conventional banks follow AAOIFI?
A: No
Explanation: Follow IFRS or local GAAP. -
Q: Do Islamic banks disclose profit-sharing ratios?
A: Yes
Explanation: Must be transparent. -
Q: Do conventional banks disclose interest rates?
A: Yes
Explanation: As per regulations. -
Q: Is charity (Sadaqah) part of Islamic banks’ CSR?
A: Yes
Explanation: In line with Shariah values.
Risk Management
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Q: Does Islamic banking face Shariah risk?
A: Yes
Explanation: Risk of non-compliance. -
Q: Does conventional banking face Shariah risk?
A: No
Explanation: Not applicable. -
Q: Which banking system uses asset-backed financing?
A: Islamic banking.
Explanation: Must link to real assets. -
Q: Which banking system often uses unsecured loans?
A: Conventional banking.
Explanation: Based on creditworthiness. -
Q: Which system prohibits short selling?
A: Islamic banking.
Explanation: Seen as speculation.
Legal Framework
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Q: Are Islamic banks governed by Shariah law?
A: Yes, along with local laws.
Explanation: Dual compliance. -
Q: Are conventional banks governed by Shariah law?
A: No
Explanation: Only by secular laws. -
Q: Can Islamic banks operate in non-Muslim countries?
A: Yes
Explanation: Many do so successfully. -
Q: Can conventional banks offer Islamic windows?
A: Yes
Explanation: Many have Islamic divisions. -
Q: Do Islamic banks require fatwas?
A: Yes
Explanation: Shariah approval for products.
Profit Distribution
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Q: How do Islamic banks pay depositors?
A: Share of actual profits.
Explanation: Not guaranteed. -
Q: How do conventional banks pay depositors?
A: Fixed interest rate.
Explanation: Regardless of actual profits. -
Q: Are Islamic bank returns variable?
A: Yes
Explanation: Depend on performance. -
Q: Are conventional bank returns variable?
A: No
Explanation: Fixed by contract. -
Q: Which system shares loss with depositors?
A: Islamic banking.
Explanation: In investment accounts.
Ethics
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Q: Does Islamic banking forbid unethical businesses?
A: Yes
Explanation: E.g., alcohol, gambling. -
Q: Does conventional banking forbid unethical businesses?
A: No universal ban.
Explanation: Depends on local law. -
Q: Which banking system prioritizes social justice?
A: Islamic banking.
Explanation: One of its objectives. -
Q: Which system is purely profit-driven?
A: Conventional banking.
Explanation: Focus on returns. -
Q: Which system avoids exploitative contracts?
A: Islamic banking.
Explanation: No unfair terms allowed.
Customer Relationship
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Q: In Islamic banking, bank is often a partner?
A: Yes
Explanation: In Musharakah or Mudarabah. -
Q: In conventional banking, bank is a lender?
A: Yes
Explanation: Interest-based lending. -
Q: Does Islamic banking require asset purchase before financing?
A: Yes
Explanation: Must own before sale. -
Q: Does conventional banking require asset purchase before lending?
A: No
Explanation: Provides cash directly. -
Q: Which system uses mark-up pricing?
A: Islamic banking.
Explanation: In Murabaha contracts.
Growth & Trends
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Q: Is Islamic banking growing fast?
A: Yes
Explanation: Especially in Middle East & Asia. -
Q: Is conventional banking shrinking?
A: No
Explanation: Still dominant globally. -
Q: Which banking system introduced Sukuk?
A: Islamic banking.
Explanation: Asset-backed certificates. -
Q: Can conventional banks invest in Sukuk?
A: Yes
Explanation: If allowed by policy. -
Q: Which system offers halal investment funds?
A: Islamic banking.
Explanation: Shariah-compliant portfolios.
Final Comparisons
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Q: Interest allowed in Islamic banking?
A: No
Explanation: Riba is haram. -
Q: Interest allowed in conventional banking?
A: Yes
Explanation: Core business model. -
Q: Profit-loss sharing in Islamic banking?
A: Yes
Explanation: Key principle. -
Q: Profit-loss sharing in conventional banking?
A: No
Explanation: Lender gets fixed return. -
Q: Ethical screening in Islamic banking?
A: Yes
Explanation: Avoids haram industries. -
Q: Ethical screening in conventional banking?
A: No
Explanation: Profitability main criteria. -
Q: Does Islamic banking require tangible assets?
A: Yes
Explanation: To back transactions. -
Q: Does conventional banking require tangible assets?
A: No
Explanation: May lend without asset backing. -
Q: Which system aligns with Shariah law?
A: Islamic banking.
Explanation: Built on Islamic principles. -
Q: Which system is universally secular?
A: Conventional banking.
Explanation: Not tied to any religion.