Islamic Banking and its

comparison with
Conventional Banking
By

Abdullah Al Masud
Lecturer
Southeast Business School
Southeast University
Why Islamic Banking is Needed
□ Assisting Financial Inclusion: The conventional
banking system is based on interest payments (Riba) at
a rate pre-set on the deposits of money. Payment and
receipt of interest is prohibited under Shariah Law, so
Muslims abstain from banking. However, through Islamic
banking, financial inclusion can be promoted and bring a
larger pool of savings in the local and global economy.
□ Reducing the impact of harmful products and
practices: Shariah principles forbid any transactions
that support industries or activities which are forbidden
in Islam. For example, usury, speculation, and gambling
- whether these are legal or not in the place of
transaction.
Riba
□ Definition of Riba from Hadith
It is reported from Hazrat Ali (RA) that the Holy Prophet
““Every loan that derives a benefit (to the creditor) is Riba”
Riba is an Arabic noun derived from the verb Raba, meaning ‘to
increase’, ‘to grow’, and ‘to exceed’. It includes interest which is paid
by banks or on loans such as car loans, home loans or credit card debt.
□ There are many proofs showing that riba is haram and one of the most
serious sins in Islam!
For those with Islamic beliefs, this clear verse prohibiting riba is
sufficient:
“…Allah has permitted trade and has forbidden riba.”Qur’an
2:275
□ In the Qur’an, Allah does not declare war on anyone except those who
deal in riba:
“O you who believe, fear Allah and give up what remains of
your demand for riba, if you are indeed believers. If you do it
not, take notice of war from Allah and His Messenger.”Qur’an
2:278-279
Riba (Interest or Usury) in
Other Religions
Usury in Hinduism and Buddhism
□ The oldest references to usury are found in religious manuscripts of
India, dating back to 2000-1400 BC where the 'usurer' is associated
with any interest lender.
□ In the Hindu Sutra (700-100 BC) as well as in the Buddhist
Jatakas(600-400 BC) there are many references to the payment of
interest, along with expressions of disdain or disrespect for the
practice.
□ Special law was made which forbade the higher class of Brahmans
(Priests) and Kshatriyas (warriors) from lending at interest.
Usury in Christianity
Both old testament and new testament prohibit interest or usury
Classification of Riba
□ Riba is mainly of two types:
1. Riba Al Quran ( Loan Riba)
2. Riba Al Hadith (Trade Riba) it is
also called Riba al Buyu.
Classification of Riba

•Types of Riba
•Riba al Quran (Riba al Nasiah)
•Riba al Dayin
•(Sale based Riba)

•Riba al Qard
•(Loan based Riba)

•Riba Al Hadith (Riba al Buyu)

•Riba al Nasa (Riba due to Deferment)

•Riba al Fadl (Riba due to Excess)

Riba Al Qard
□ This riba is associated with lending and
borrowing (i.e., received in lending or paid in
borrowing).
□ It is a type of riba that constitutes an excess
amount, pecuniary or non-pecuniary, over and
above the principal (asl al-qard) in a loan
(qard) that a borrower pays to the lender along
with principal based on a precondition in the
contract (aqd) or customary practices (urf).
Riba al Dayn or Riba al Jahilliya
□ The surplus or excess payment above
the original debt as a penalty to the
debtor due to his inability to service
the loan repayment within the
stipulated time.
□ E.g.: Interest in credit card due to the
delay in the repayment
Riba al Fadl
□ Any additional quantity or inequality in the exchange of
the (weightable) goods from the similar type of the
ribawi items (Quantity Factor)

□ Such goods may also include other storable food items

or medium of exchange.
□ Example: Exchange of 10 gram 22 caret gold with 12
gram 21 caret gold or exchange of 1 kg azwa dates with
1.2 kg mariam dates will result in Riba-al fadl
Riba al Nasa
□ Any delay in the exchange of the
ribawi items different types and
quantity (Time Factor)
□ E.g. exchange of 1 Kg Rice with 1.5
kg potato can be done, but must be
done in one sitting. Delay will result
in riba al nasa.
Defining a Conventional Bank
1. “ A commercial bank is dealer in
capital or more properly a dealer in
money. He is intermediate party
between the borrower and the
lender. He borrows from one party
and lends to another and the
difference between the terms at
which he borrows and those at which
he lends form the source of his
profit.” ----Prof. Gilbert
Defining an Islamic Bank
□ “Islamic Bank is a financial institution
whose statutes, rules and procedures
expressly state its commitment to the
principles of Islamic Shariah and to the
banning of the receipt and payment of
interest on any of its operations.” – (OIC.
April of 1978 Dakar the capital of Senegal.)
□ Islamic banking is essentially a normative
concept and could be defined as conduct of
banking in consonance with the ethics of
the value system of Islam.
Goals of Islamic Bank
□ To eliminate riba from all sectors of economy
□ To establish Baiya (Trade, Com. & Industry)
□ To mobilize savings for productive purposes.
□ To earn reasonable profit through Halal
transaction.
□ To create more employment opportunities by
increasing economic activities.
□ To ensure equitable distribution of resources
□ To safeguard the excess money lying idle in the
hands of customers.
Features of Musharakah
Contract
□ The capital should be specific, existent and
under disposal.
□ partners shares in capital may be equal or
unequal based on agreement.
□ Nature of capital may be either money,
valuables. or merchandise.
□ Partners have right to participate in the
activities of the firm.
□ No Security provision as a guarantee for Profit.
□ Ratio of distribution of Profit Prefixed, no be
lump sum profit is allowed.
□ Profit is distributed according to the agreed
ratio and loss according to the share in capital
Features of Mudarabah Contract
□ One party supply capital
(Sahib-e-Mal),Other party provide
entrepreneurship (Mudarib)
□ The capital should be specific, existent and
under disposal.
□ Nature of capital may be either money,
valuables. or merchandise.
□ No Security provision as a guarantee for
Profit.
□ Ratio of distribution of Profit Prefixed, no
lump sum profit is allowed.
Features of Mudarabah Contract
□ Profit is distributed according to the agreed
ratio and actual loss is borne by the owner
of capital
□ Delivery of Capital to Mudarib is according
to the need of the business
□ No Security or Guarantee Except Negligence
□ Restriction on Mudarib is permissible on
broad issues
□ Hiring Helping Hands By Mudarib
permissible
□ Mixing of Private Capital Permissible
□ Capital Not a Liability Debt on Mudarib
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
The functions and The functions and
operating modes of operating modes of
Islamic banks are conventional banks
based on Islamic are based on
Shariah manmade principles
IB promotes risk The investor is
sharing between assured of a
provider of capital and predetermined rate of
the entrepreneur interest
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
Maximizing profit It aims at maximizing
should not be profit without any
objective of an IB restriction
Islamic banks collect It does not deal with
and distribute Zakat. Zakat.
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
Participation in Lending money and
partnership business isgetting it back with
the fundamental interest is the
function of the Islamicfundamental function
banks. of the conventional
banks
Wider scope of Narrower scope of
activities compared to activities when
a conventional bank. A compared with an
multi-purpose bank Islamic bank.
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
The Islamic banks It can charge
have no provision to additional money
charge any extra (compound rate of
money from the interest) in case of
defaulters defaulters.
It gives importance to Bank’s own interest
the public interest. Its becomes prominent. It
ultimate aim is to makes no effort to
ensure growth with ensure growth with
equity. equity.
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
For Islamic banks, it is Borrowing from the
comparatively difficult money market is
to borrow money from relatively easier
the money market.
Since it shares profit Since return from loan
and loss, the Islamic is fixed, it gives little
banks pay greater importance to project
attention to developing appraisal and
project appraisal and evaluations.
evaluations.
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
Islamic banks give Conventional banks
greater emphasis on give greater emphasis
the viability of the on credit-worthiness
projects of the clients .
The status of Islamic The status of a
bank in relation to its conventional bank, in
clients is that of relation to its clients,
partners, investors is that of creditor and
and trader. debtors
Islamic vs. Conventional
Banking Compared
Islamic Bank Conventional Bank
Strictly speaking A conventional bank
there is no guarantee has to guarantee all its
for deposit money deposits.

An Islamic bank can A conventional bank

never be a bankrupt has every possibility to
be a bankrupt
Promotes mass Promotes class banking
banking
 Functional Differences
Between Islamic Banking and
Conventional Banking
Functional Differences between
Conventional and Islamic Banks
Islamic Bank Conventional Bank
Collection of deposit Collection of deposit
on the basis of profit on the basis of
sharing interest

Investment following Extending credit on

Buy mode/investment the basis of interest
mode/ lease mode
Issues letter of Issues letter of credit
guarantee
Functional Differences between
Conventional and Islamic Banks
Islamic Bank Conventional Bank
Acting against Creating medium of
Creation of medium exchange and credit
of exchange and credit
Investment in shares Investment in shares
and Mudarabah bond and securities having
coupon rate of interest
No discounting of bill Discounting of bill
 Differences between
Lending policy of CB and
investment policy of IB
Lending/investment of Islamic &
Conventional bank compared
Point of Conv. Bank Islamic Bank
difference.
Mode of Lending Investment
Investment (bui+lease+D.
inv)
Safety of the Prime No guarantee
loan consideration for investment

Collateral Base of the loan Not required/

Security Less important
Lending/investment of Islamic &
Conventional bank compared
Point of Conv. Bank Islamic Bank
difference.
Character of Important to be Very important
the loan considered to be considered
applicant
Purpose of Less important Important
the loan consideration
Liquidity Highly important Less important
consideration as it prefer short as it goes for
term investment term investment
Lending/investment of Islamic &
Conventional bank compared
Point of diff. Conv. Bank Islamic Bank
Financial Important Should be less
strength of consideration impotant
the client
project Less important Very much
Profitability important
Diversification Not a prime An important
of investment consideration consideration
Lending/investment of Islamic &
Conventional bank compared
Point of diff. Conv. Bank Islamic Bank
National Secondary Primary
interest consideration consideration
Close Not a routine Must be a
supervision work routine work
Observation Not followed Strictly
of Shariah followed

You may also look at the following link:

https://www.ubldigital.com/Banking/UBL-Ameen/Knowledge-Center
/Differences-between-Conventional-Bank-and-Islamic-Bank
Issue of Service Charge
□ Service charge is permissible on an
actual basis
□ Advance service charge can be taken
subject to adjustment once the actual
charge is calculated
□ Service charge for any service
provided other than financing may be
taken separately.
Violation of Shariah in
different Mode of Investment
□ Bai is not established in its truest sense
□ Seller do not bui the goods himself
□ Buyer is appointed to buy goods on behalf of
the seller
□ Risk of the merchandize is not borne by the
seller
□ Most often paper transaction is completed
□ Rate of profit changes directly and
proportionately with the change in the credit
period allowed to the client
□ Rebate allowed for early payment of the dues
□ Penalty imposed for the delay in payment
Violation of Shariah in
different Mode of Investment
□ In case of lease rent is not fixed on
actual basis.
□ Period of vacancy is not taken into
consideration
□ Increase of rent unilaterally
□ Penalty is charged on defaulters