In this article, we will briefly discuss the 5 main differences between conventional banking and Islamic banking.
Conventional banks earn their profit by charging interest for their services without sharing any risk with debtors. Meanwhile, Islamic banks share the risk with businesses and use equity participation systems to earn their profit. Equity participation means that if a bank loans money to a business, the business will not pay interest on the loan, but instead gives the bank a share in its profits.
From an Islamic perspective, you should not accept any income that comes from interest. So, an increasing number of Muslims are looking for Islamic banks to avoid interest-based services. Therefore, Islamic banks would be a solution for Muslims seeking financing.
5 Major Differences between Conventional Banking and Islamic Banking
| Conventional banking | Islamic Banking |
| Lending | Financing |
| Conventional banks deal with business activities of lending and borrowing money based on interest. Indeed, interest is the backbone of conventional banks. | Compared to Conventional Banks, Islamic Banks are trading institutes and not money lending houses. Islamic Banks avoid interest-based activities and prohibit all impermissible transactions such as the sale of debts. |
| Conventional banks finance all businesses unless they engage in illegal activities. Generally, conventional banks do not participate in trade, production processes, but only act as money lenders. | Islamic banks forbid financing to businesses that harm society in some way and engage in impermissible activities, such as marijuana, alcohol etc. Islamic banks actively participate in trade, business activities and its processes. |
| Generally, in conventional banks, any financing and deposit are mainly loan based. | Islamic banks have a solid Shariah administering structure which is based on Shariah rulings. These types of Banks consider loans as non-commercial and they exclude the loans from the domain of commercial transactions. Certainly, Islamic banks provide interest-free loans by structuring the financing features using Islamic contracts such as ijara, murabaha, etc. |
| Conventional banks utilize money as a commodity. Money is lent for interest. That is, the relationship of the customer and the bank can be described as Creditor-Debtor. | Islamic banking products are usually backed by assets and involve trading and renting of assets and participation on a profit & loss basis. Hence, the relationship between the customer and the bank can be described as a partnership. |
| Evidently, compensation is always based on interest | However, compensation is always based on Price (Thaman) |
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