A lot of people still lack knowledge of what Islamic banking is really all about and how it differs from the standard banking systems most economies are using right now. There are countless misconceptions, misinformation and fallacies about the dissimilarities of these two banking systems.
The primary difference between these two banking methods is that the Islamic banking system is based on the Islamic Sharia law while the orthodox banking system is based on man-made ideology and principles. Sharia literally translates to ‘the way to the source of life’- it encompasses all the laws governing Muslims in all aspects of life.
Another distinction is that Islamic banks operate on the basis of profit and loss sharing. This means that if an entrepreneur experienced losses, the Islamic bank will share the losses instead of based on the method of finance adopted either Mudarabah or Musharakah as opposed to conventional banks that will still charge interest even if the businessman suffers losses with bank loans.
Conventional banks use money as a commodity as well as a mode of exchange and a store of value whilst Islamic banks only use money as a medium of exchange and a store of value, not a commodity. This denotes that conventional banks trade money at higher prices and rent it out as well whilst Islamic banks don’t.
With regards to profit-making, the Islamic banking system uses time value as a source for charging interest on capital whereas conventional banks use profit on the exchange of merchandises & services as a source of profit charging.
As a result of its profit and loss sharing principle, Islamic banks focus more on debtor investment projects, assessments and valuations compared to conventional banks where income from loan is predetermined.
Repayments of sums for deposit accounts are only guaranteed in Islamic banks if the account was based on the principle of al-wadiah. If not, the depositor will share the losses of the banks investment in accordance with the Mudharabah concept.
Islamic banks cater for the public interest first, its primary objective is to ensure halal (lawful) economic growth whereas the conventional banks focus solely on making profit and the interest of the bank comes first.
There is ample proof that the Islamic banking system is better capitalized, has a higher inter mediation ratio and better asset quality than that of the conventional banking system. Fundamentally the difference between Islamic banking and conventional banking is that the idea fairness to the clients is theoretically focused on the idea of Islamic Banking itself. Conventional banks aim to maximize returns and minimize risk. The bank’s interest comes before the client’s as opposed to the Islamic banking system.