Conventional and Islamic Finance Differences You Need To Know

In the previous post, we have talked about riba, gharar, and maysir. There are more differences between Islamic finance and conventional finance besides having a difference between interest and interest-free systems. Here we explain to you what are other differences between Conventional and Islamic Finance.

Risk distribution and how to treat it

Islamic finance applies the principle of a profit-loss-sharing (PLS) scheme. There are two kinds of PLS schemes, they are mudarabah and musharakah.

Firstly, mudarabah is a partnership in which one partner provides capital (rabbul mal) and invests money in the other partner’s commercial enterprise (mudarib). The capital supplier gives 100% of the capital, while the working partner manages the project. The profit distributes among the parties with the predetermined ratio. The capital provider will lose their money if the project fails and the working partner will lose time and effort.

Secondly, musharakah shares the profits and losses with all members who put their money. Unlike mudarabah, where a single party provides entire capital, musharakah happens when the profit and loss are distributed between two (or more) partners who contribute money to the firm.

Handling the cash

There is no agreement on the exchange of goods and services in conventional finance when paying for cash financing, running financing, or working capital funding. Conventional finance only relies on interest-based loans. Islamic However, Islamic finance requires the execution of agreements for the exchange of goods and services while disbursing funds under Islamic financial contracts (Murabaha, Salam, Istisna, etc.).

Distribution of the wealth

Islamic finance does not merely focus on profit. For example, zakat is an act of obligation. The social reason is to help people who reserve the right to receive zakat. It is different from the conventional when it comes to other Islamic financial instruments. Conventional finances will leave the money in a few hands. On the other hand, the multiplier effect on Islamic finance truly increases the wealth of the public of society. Thus, a huge number of individuals receive actual riches.

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