Types of banking system:

Banking systems differ based on economic structure, regulations, and technology. Common
types include centralized and decentralized systems. Unit banking operates independently
without branches, while branch banking networks expand a single bank's reach. Universal banks
offer diverse financial services, and Islamic banking adheres to Sharia principles. Online and
mobile banking leverage technology for convenience and accessibility.

Traditional banking system:

Centralized Banking System:
In this system, a single central bank regulates and controls the entire banking system of the
country. Commercial banks operate under the supervision and directives of the central bank.
Decentralized Banking System:
Also known as a fragmented or dual banking system, this setup involves multiple regulatory
authorities overseeing banks within their respective jurisdictions. Different regions or states may
have their own banking regulations.
Unit Banking System:
In this system, banks operate autonomously without branches, functioning as standalone entities.
Each bank serves a distinct community or region, catering to the local financial needs
independently.
Branch Banking System:
Branch banking, unlike unit banking, establishes a network of branches under a single bank's operation.
This structure facilitates an extensive reach, enabling banks to provide services across diverse locations
efficiently. It enhances accessibility for customers and promotes convenience in banking transactions.
Such expansion fosters a broader customer base and strengthens the bank's presence in multiple regions.

Universal Banking System:

Universal banks offer a broad spectrum of financial services, encompassing commercial banking,
investment banking, and insurance. Their offerings cater to the diverse needs of individuals,
businesses, and institutions, providing comprehensive financial solutions. Additionally, they act
as one-stop destinations for all banking, investment, and insurance requirements, streamlining
financial management for their clients.
Development Banking System:
Development banks focus on providing financial assistance and support for long-term economic
development projects. They often target sectors such as agriculture, infrastructure, and small-
scale industries to stimulate growth and address developmental challenges.
Islamic banking system:
Islamic banking is a financial system rooted in Islamic principles and Sharia law, which prohibits
the payment or acceptance of interest (riba) and prohibits investment in businesses considered
haram (forbidden). Instead, Islamic banks operate on profit-sharing and asset-backed financing
principles, emphasizing ethical and socially responsible banking practices. This system aims to
promote financial inclusion, fairness, and risk-sharing while aligning with Islamic values. It has
gained global prominence, offering alternative banking solutions that adhere to religious beliefs
and ethical standards.

Islamic Banking Mechanics in Pakistan:

In Pakistan, Islamic banking operates alongside conventional banking under the supervision of
the State Bank of Pakistan (SBP), the country's central bank. The Islamic banking system
functions in accordance with Sharia principles, catering to the financial needs of individuals,
businesses, and institutions while adhering to Islamic laws.
Key features:
Sharia Compliance:
Islamic banks in Pakistan offer financial products and services that comply with Sharia
principles, prohibiting interest (riba) and engaging in transactions that are deemed halal
(permissible) according to Islamic law. Profit-and-Loss Sharing: Instead of fixed interest-based
transactions, Islamic banks in Pakistan engage in profit-and-loss sharing arrangements, such as
Mudarabah (profit-sharing partnership) and Musharakah (joint venture).
Asset-Backed Financing:
Islamic banks provide financing based on tangible assets, ensuring transactions are backed by
real economic activities. This includes Murabaha (cost-plus financing), Ijarah (leasing), and
Istisna (manufacturing contracts).
Sharia Supervisory Boards:
Each Islamic bank in Pakistan has a Sharia Supervisory Board comprising Islamic scholars and
experts who ensure compliance with Sharia principles and provide guidance on Islamic financial
products and transactions.
Takaful Insurance:
Islamic banks offer Takaful insurance, which operates on the principles of mutual assistance and
shared responsibility, providing insurance coverage in compliance with Sharia laws.
Regulatory Framework:
The SBP regulates and supervises Islamic banking operations in Pakistan, ensuring compliance
with Sharia principles while maintaining stability and integrity within the financial system.
Digital banking system:
Digital banking, or electronic banking, allows customers to access banking services and conduct
transactions online or through mobile devices. It offers a variety of services like balance
inquiries, fund transfers, bill payments, and loan applications, all without visiting physical
branches. Leveraging technology, digital banking enhances convenience, accessibility, and
efficiency in banking operations, improving the customer experience significantly.
Mobile banking system:
 Mobile banking system enables customers to perform financial transactions and access
banking services through their mobile devices.
 Users can check account balances, transfer funds, pay bills, deposit checks, and receive
alerts remotely.
 It involves the use of dedicated mobile applications provided by banks or access to
banking services through mobile-friendly websites.
 Mobile banking provides convenience, accessibility, and flexibility for users to manage
their finances anytime and anywhere with an internet connection.
Online banking system:
 Online banking system allows customers to conduct banking transactions and access
financial services over the internet.
 Users can perform various activities such as checking account balances, transferring
funds between accounts, paying bills, and managing their accounts online.
 It typically involves accessing banking services through secure websites provided by
banks or financial institutions.
 Online banking offers convenience, accessibility, and flexibility for users to manage their
finances from anywhere with an internet connection.
 Security measures such as encryption and authentication protocols are implemented to
safeguard users' financial information and transactions.

How Islamic and western banking works:

Islamic banking operates on Sharia principles, prohibiting interest and focusing on profit-sharing
and ethical practices. Products like Mudarabah and Musharakah are common, supervised by
Sharia boards for compliance.
Western banking, in contrast, operates within secular regulations, allowing interest-based
transactions and focusing on profit through interest income and fees. It offers a wide range of
services and is subject to regulatory oversight for risk management and shareholder value.
 Islamic banking adheres to Sharia principles, prohibiting interest (riba) and focusing on
profit-sharing and ethical practices.
 Common Islamic banking products include Mudarabah and Musharakah, which
emphasize partnership and risk-sharing.
  Sharia boards comprising Islamic scholars supervise Islamic banks to ensure compliance
with Islamic principles and ethical standards.
 In contrast, Western banking operates within secular regulations, allowing interest-based
transactions and prioritizing profit through interest income and fees.

Comparison between Islamic and western banking system:

Aspect Islamic Banking Western Banking

Legal Framework Operates under Sharia principles and Operates within secular legal
Islamic law, prohibiting interest (riba)
frameworks, allowing interest-based
and haram investments transactions and diverse investments.
Profit Mechanism Relies on profit-sharing, asset-backedPrimarily generates profit through
financing, and risk-sharing
interest income, fees, and
partnerships. commissions
Supervision Supervised by Sharia boards
Subject to regulatory oversight by
comprising Islamic scholars to ensure government authorities and central
compliance with Islamic principles. banks to ensure compliance with
banking regulations.
Product Offerings Offers products such as Mudarabah, Offers a wide range of financial
Musharakah, Ijarah, and Murabaha, products and services including
emphasizing ethical and socially loans, savings accounts, credit cards,
responsible banking practices and investment opportunities.
Financial Philosophy Focuses on ethical banking practices, Emphasizes financial innovation,
fairness, and risk-sharing, promoting risk management, and shareholder
economic development while aligning value maximization within the
with Islamic values. framework of regulatory compliance.
Risk Management Emphasizes risk-sharing partnerships Utilizes diverse risk management
and asset-backed financing, with a strategies including diversification,
focus on minimizing speculative hedging, and regulatory compliance
risks. to mitigate financial risks.
Regulatory Ensures compliance with Sharia Adheres to regulatory frameworks
Compliance principles and guidelines set by established by government
Islamic scholars and regulatory authorities and central banks to
authorities. ensure stability and integrity within
the financial system.
Stakeholder Prioritizes stakeholder interests Focuses on shareholder value
Engagement and societal well-being, seeking to maximization while addressing
balance financial returns with the interests of stakeholders such
ethical considerations. as customers, employees, and
communities.
Impact:
Economic Growth:
The banking system fuels economic growth by providing capital for businesses, investments, and
infrastructure development.
Financial Stability:
Banks play a crucial role in maintaining financial stability by managing risks, facilitating
transactions, and providing liquidity to the economy.
Job Creation:
The banking sector creates employment opportunities through various roles such as banking
operations, financial advisory services, and risk management.
Wealth Management:
Banks offer a range of financial products and services for wealth management, including savings
accounts, investments, and retirement planning, contributing to individual and collective
prosperity.
Access to Credit:
Banks provide access to credit, enabling individuals and businesses to finance purchases, expand
operations, and pursue entrepreneurial ventures.
Innovation and Technology:
The banking sector drives innovation and technological advancements, leading to the
development of online banking, mobile payment solutions, and fintech services, enhancing
convenience and efficiency for customers.
Government Financing:
Banks facilitate government financing through the issuance of bonds, treasury bills, and loans,
supporting public projects and initiatives.
Financial Inclusion:
Banking systems promote financial inclusion by offering services to underserved populations,
empowering them with access to banking facilities, loans, and savings opportunities.
Consumer and Business Confidence:
Confidence in the banking system is critical for overall economic confidence. Stable and well-
regulated banks inspire trust among depositors and investors, encouraging savings, investment,
and consumption. Conversely, banking crises or failures can erode confidence, leading to panic
withdrawals, reduced investment, and economic downturns.