The common practices of an Islamic bank and a Conventional bank came into existence along with the foundation of Islam. However, the establishment of formal Islamic finance occurred only in the 20th century. Nowadays, the Islamic finance sector grows at 15%-25% per year, while Islamic financial institutions oversee over $2 trillion.
Presently, Islamic banking has been one of the fastest expanding industries in the global banking industry since its inception. Industry projections suggest that Islamic banking assets owned by commercial banks around the world will continue to rise as new geographies open up to the practice.
As of 2020, there are approximately 47 financial institutions worldwide with more than $10 billion in Shari’a-compliant assets, with 27 institutions reporting a pre-tax profit of more than $500 million in 2019.
Many Muslims, irrespective of the country they live in can choose what kind of bank they want to deposit their hard-earned money in and deal with on a daily basis.
The main difference
Transactions in Islamic banks are governed by Islamic Shari’a. The biggest difference between how an Islamic bank operates and a conventional bank operates is that within Islam:
- Firstly, charging interest is prohibited.
- Secondly, investment in activities that are against the tenants of Islam is also prohibited.
- Lastly, a trader should own and possess the items to be sold.
Conventional banks only have one mode of financing for their customers and that is a loan. Be it an individual customer, a business partnership, or a corporate client. They can avail an array of products with an underlying mode of debt only from a conventional bank.
Islamic banks primarily work on three modes of finance, namely: rental arrangement (Ijarah), trade/sale basis, and partnerships.
Islamic banks are not only located in Islamic nations. They now have a global presence.
Here are some clear ways the two forms of banking differ:
| Conventional banks | Islamic banks | |
|---|---|---|
| Late payments | Late payment charges are how many of these banks make their profits. | Islamic banks only charge charity to discipline the clients for late payments. |
| Debt | Offer services on debt to depositors and borrowers. | Islamic banks share risk with customers. |
| Saving accounts | Interest-based. | Mudarabah-based (a partnership between 2 parties). |
| Long-term financing | Conventional banks provide loans to their customers and charge compound interest. | Islamic banks form joint ownership in a new asset and rent out their share of assets to the customer & also sell its’ ownership share in that very asset to the customer on a periodic basis. |
| Risk Sharing | Conventional banks’ only risk is if customers default and do not pay back the loan & interest. | Islamic banks’ risk changes with the mode of financing, each mode has a different risk profile. |
| Lending & borrowing mechanism | Borrow funds from depositors on debt/loans and further advance money to customers on loans. Keeping a spread between the rate of deposit & rate of lending, which is their profit margin. | Islamic banks collect deposits on debt/loans in current accounts. Islamic banks offer financing under 3 Shari’a modes: rental, partnership, and trade. |
| Gambling | Conventional banks do not have any issues with allowing gambling transactions (often on credit cards). | Shari’a strictly prohibits any form of gambling (called maisir). Islamic financial institutions cannot be involved in contracts where the ownership of goods depends on an uncertain event in the future. |