Difference between Islamic and Conventional Banking

Group MembersName Roll No

Muhammad Umar Baig (E11MBA078)

Salman Younas (E11MBA097)

Jawad Ahmad (E11MBA109)

Muhammad Ali Yasin (E11MBA122)

Muhammad Sohail (E11MBA139)

contents

Introduction of the project

Importance of trade in Islam

Why Islamic banking

Governing principles of Islamic banking

Difference between Islamic and conventional

banking

Comments on Balance sheet of both system

Holy Quran :

We have created the night as covering and we have created the day for Economic activities

Hazrat Umar Said

“Every system can prevail in this world but not the one which is unjust.”

Introduction

In this project our main focus on the following topics

What is Islamic banking and why we need such system

Difference b/w Islamic banking and conventional banking

Importance of Trade in Islam

Islam has given an immense importance to trade

The nobility of this profession is obvious from the fact that it was the chosen profession of prophet Muhammad (PBUH)

WHY ISLAMIC BANKING

Before explaining the concept “what is Islamic Banking” the elaboration of concept “why Islamic Banking” is very important

Islam is a complete code of life that provides guidance regarding each aspect of life.

WHY ISLAMIC BANKING

The primary objectives of Islamic Economic System are as under.

Equal Distribution of wealth

Social justice

These objectives can never be achieved in Interest/Riba based economic systems.

WHY ISLAMIC BANKING

Now we come to our core question

Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Sharia’h

Governing principles of Islamic Banking

The prohibition of interest or riba based transactions

Avoidance of speculations (gharar)

Avoidance of oppression (zulm)

Introduction of Islamic tax (zakat)

Financing of Shariah Approved activities and discouraging the production of goods and services which are not allowed in Islam

Definition of Conventional Bank

A financial institution that provides services, such as accepting

deposits, giving business loans and auto loans, mortgage lending, and basic

investment products like savings accounts and certificates of deposit.

The traditional commercial bank is a brick and mortar institution with

tellers, safe deposit boxes, vaults and ATMs. However, some commercial

banks do not have any physical branches and require consumers to complete

all transactions by phone or Internet. In exchange, they generally pay higher

interest rates on investments and deposits, and charge lower fees.

Difference Between Islamic And Conventional Banking

Functions and operations are based on Sharia’h principles In Islamic banking whereas

Functions and operations are based on fully man made principles in conventional banking

Promote risk-sharing between provider of capital (investor) and user of funds (entrepreneurs) in islamic banking whereas

Investor is assured of pre-determined rate of interest in conventional banking

Cont………….

Aim at maximising profit but subject to Sharia'h in islamic banking

Aim at maximising profit without any restrictions in conventional banking

Partners, investor and traders, buyer or seller relationship in islamic banking whereas

Creditor-Debtor relationship in conventional banking

Cont……….. Encourage asset-based financing and based on commodity

trading in islamic banking whereas

Conventional banking Based on money trading. Money is a medium of exchange and not a commodity, its sale and purchase is prohibited in Islam

in islamic banking No right of profit if there is no risk involved. The profit and loss sharing depositor may lose money in case of loss whereas

In conventional banking It is almost risk free banking and depositor has no risk of losing its money because interest is guaranteed

Cont……….

Islamic banks have no provision to charge any extra money from the defaulters except for compensation and is used for charitable purposes whereas

C.Banks can charge additional money (penalty and compounded interest) in case of defaults

In islamic banking Importance is given to the public interest or maslahah. Its ultimate aim is to ensure growth with fairness whereas

In C.banks Banks interest is the main objective. It makes no effort to ensure growth with equity.

DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING

For the Islamic banks, it must be based on a Shariah approved underlying transaction but

Interest-based commercial banks don’t care about the activities being performed with their financing.

Greater emphasis on the viability of the projects in Islamic banks

The conventional banks give greater emphasis on creditworthiness of the clients

DIFFERENCE BETWEEN ISLAMIC AND CONVENTIOANL BANKING

Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al- wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the Mudarabah concept, client have to share in a loss position.

A conventional bank has to guarantee all its deposits

Two Basic Sides of Banking Transactions

The Asset side

The liability side

The Asset Side

This side of a bank's transactions refers to the financing

facilities that the banks provide to their clients.

For instance, a conventional bank provides financing to its

clients by giving them interest based loans where as an Islamic

bank provides financing to its client based on profit based

financing such as Murabaha, Ijarah, Salam, etc.

The Liability Side

This side of a bank's transactions refers to the deposit and

investment facilities that the bank provides to its clients.

A conventional bank accepts deposits from its client and forwards

them on interest to other clients who require financing.

The interest that accrues on such a transaction is distributed

amongst the depositors and the bank. On the other hand, an

Islamic bank receives deposits on the basis of Musharakah or

Mudharabah and invests this fund in a Shariah compliant manner .

Other Difference

Deposits

Deposits are collected from savers under both type of institutions for

reward irrespective a bank is operating under conventional system or

Islamic system. The difference lies in agreement of reward. Under

conventional system reward is fixed and predetermined while under

Islamic deposits are accepted through Musharaka and Mudaraba where

reward is variable.

The second phase in savings mobilization process is extension of credit facility to business and industry for return. Both types of institutions (Islamic and Conventional) are providing financing to productive channels for reward.

The difference lies in financing agreement. Conventional banks are offering loan for a fixed reward while IFIs cannot do that because they cannot charge interest. IFIs can charge profit on investments but not interest on loans.

Financing and Investments

Overdrafts/Credit Cards etc.

Conventional banks offer the facility of overdrawing from account of the customer on interest. One of its form is use of credit card whereby limit of overdrawing for customer is set by the bank. Credit card provides dual facility to customer including financing as well as facility of plastic money whereby customer can meet his requirement without carrying cash. As for facility of financing is concerned that is not offered by Islamic banks except in the form of Murabaha (which means IFI shall deliver the desired commodity and not the cash) however facility to shop/meet requirement is provided through debit card whereby a customer can use his card if his account carries credit balance

Short term loans are provided to customer to meet working capital

requirements of firm by conventional banks. Working capital is required

by firms to invest in inventories and accounts receivables and meet the

expenses

Short term loans

Medium to long term loans

Medium to long-term loans are provided for purchase or building of

fixed assets by firms to expand or replace the existing assets. Under

Islamic financial system requirement of firms and individuals are fulfilled

through Murabaha, Bai Muajjal and Istasna. Although financing under

Murabaha, Bai Muajjal and Istasna is very much look like conventional

loans with the only difference of provision of asset and not cash to client

however differences exist in the contracts which alter the nature of risks

and returns

Leasing or Ijarah

Ijarah in the terminology of Shariah is called to hire a specific thing or a

person for a permissible purpose against specific remuneration.

Types of Ijarah1. Ijarah of an Asset

2. Ijarah of a Person

Ijarah of an Asset

To rent out something this is called leasing in English and in

the terminology of Fiqh it is called ijarah of an asset

Ijarah of a Person

To hire ones services for a specific remuneration, it is usually

Referred in English as employment, while in the terminology

of Fiqh it is called as Ijarah of a person or lease :

Types of Ijarah of a Asset

I. Financial lease

II. Operating lease

Agricultural Loans

Agricultural loans include both types of loans short-term as well as

long-term.short term for seeds and fertilizers and long term for

purchase of additional land and equipments. Conventional banks

are providing credit facility by charging interest. Same facility is

provided by IFIs to the farmers under Bai Slam, Bai Murabaha

Musharaka and Mudaraba. Under Bai Salam cash is provided to

farmers for purchase of seeds and fertilizers however this is not

loan rather purchase of finished crops to be delivered by farmers.

ANY QUESTION?