ISLAMIC AND CONVENTIONAL BANKING

Islamic banks, like conventional banks, are profit-making organisations. Their

aim is to gain profit. However, they are prohibited to trade in riba or to
engage in any business activity that is not in compliance with Syariah
principles. In contrast, there are no such restrictions on conventional banks.
Islamic banking activities are based on the principle of buying and selling of
assets. For example, in financing a home loan, the selling price (including
the bank's profit margin) is fixed from the very beginning.

T h e differences between Islamic banking and conventional banking systems

are listed in the following table:

Characteristics
Business Framework
Islamic Banking System
Functions and operating
modes are based on Syariah
law.
Banks have to ensure that all
business activities are in
compliance with Syariah
requirements.
Conventional Banking
System (Interest-Based)
Functions and operating
modes are based on
secular principles and not
based on any religious
laws or guidelines.

Financing is interest-
Prohibition of Riba' in Financing Financing is not interest-
oriented and is based on the oriented and a fixed/
principle of buying and selling floating interest is charged
of assets, whereby the selling for the use of money.
price includes a profit margin
and is fixed from the
beginning.

Prohibition of Riba in Deposits are not interest Deposits are interest

Deposits oriented but profit and loss- oriented and the investor
sharing oriented whereby is assured of a
investors share a fixed predetermined rate of
percentage of profit when it interest with a guarantee
occurs. of principal repayment.
Banks get back only a share of
profit from the business to
which it is a party and in case of
loss, the investor loses none in
terms of money but foregoes
the reward for its activities
during that period.

Characteristics islamic Banking System
Equity Financing with Bank offers equity financing for
Risk-sharing a project or venture.
Losses are shared based on the
equity participation while
profit is shared based on the
pre-agreed ratio.
Conventional Banking
System (Interest-Based)
Not generally offered but
available through Venture
Capital Companies and
Investment Banks.
Normally they participate
in management as well.

Restrictions Islamic banks are restricted to There are no such

participate in economic restrictions.
activities, which are not
Syariah-compliant.

Zakat (Religious Tax) E.g. Banks cannot finance Do not deal in zakat.
businesses involving pork,
alcohol, etc.
In the modern Islamic banking
system, it has become one of
the functions to collect and
distribute zakat.

Penalty on Default Have no provision to charge Normally charge

any extra money from the additional money
defaulters. (compound rate of
interest) in case of
.Note: Some Muslim countries
defaulters.
allow collecting of penalty and
the justification is the cost
incurred on collecting the
penalty is normally 1 per cent
of the instalment amount due.

Prohibition of Gharar Transactions with element of Trading and dealing in any

gambling and speculation are kind of derivative/futures
strictly forbidden. involving speculation is
allowed.
E.g. Derivative trading is
prohibited due to its
speculative nature.

Customer Relations The status of the bank in The status of a bank, in

relation to its clients is that of relation to its clients, is
partner/investor and that of creditor and
entrepreneur. debtors.

Syariah Supervisory Board Each bank should have a There is no such

Syariah Supervisory Board to requirement necessary.
ensure that all business
activities are in line with
Syariah requirements.

Statutory Requirement Banks have to be In compliance Has to be in compliance

with statutory requirement of with the statutory
Bank Negara Malaysia and also requirements of the Bank
Syariah Guidelines. Neqara Malaysia only.