What distinguishes Islamic banking from conventional banking

Islamic banking is now a widely used term and has emerged as one of the most important trends in the financial world. Demand for financial products and services that follow the shariah or Islamic law had always been there. With growth of opportunities, Islamic Banking is now one of the fastest growing sectors in the global financial services industry. Driven by strong demand from both the individual and corporate sectors, Islamic banking assets with commercial banks globally are now close to US$1.7 trillion with an annual growth of 17.6 per cent over the last four years comprising 38 million customers globally with Islamic banks. In addition, the number of institutions offering Islamic financial services is multiplying.
Islam has a unique theory on wealth, its ownership, distribution and social relationship. The theme of Islamic dispensation of wealth is treated as a deeply moral study of self and society. Islam gives precise moral injunctions as to what are and are not acceptable kinds of wealth. They point out how individual preferences on wealth formation ought to be utilised within the social meaning. Under Islamic purview, obviously, profits are important as ends, but the means by which those profits are earned are even more important. Indeed, the reason for the emphasis on proper transaction is that Islam accords great importance to the economic welfare of society.
Islam not only prohibits interest and investment in unlawful activities that are deemed to be harmful to society, but also transactions involving excessive uncertainty (gharar) and all forms of gambling (maysir). Islam makes a clear distinction between what is halal (lawful) and what is haram (forbidden or unlawful) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious. While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it. While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular, the destitute and deprived sections of the society by participation in the process of Zakat (a tax on wealth that is distributed to the needy).
Islamic finance is a form of ethical investment and ethical lending. Under this system, loans and investments are made without interest. Among the ethical restrictions, it has prohibited alcohol and gambling and pork. Islamic funds would never knowingly invest in companies involved in gambling, alcoholic beverages, or porcine food products.
In essence, Islamic finance aims to eliminate exploitation and establish a just society on the basis of the Shariah or Islamic law for the operations of banks and other financial institutions. To ensure compliance to the Shariah, Islamic banks use the services of religious boards comprised of Shariah scholars. Its practitioners and clients need not be Muslim, but they must accept the ethical restrictions underscored by Islamic values.
In Quran, it has been mentioned about Ribaa in different ayats. As per Quran, Ribaa (interest, usury) denotes the amount that a lender receives from a borrower at a fixed rate in excess of the principal. Dealing with ribaa is a practice that Islam considers a major sin. Allah commands Muslims to give it up: "O you who believe! Observe your duty to Allah, and give up what remains from ribaa if you are true believers. And if you do not, then be warned of war from Allah and His Messenger." (Sura Al-Baqarah, 2:278-279).


Islamic banking operates with the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). Islamic banking activities must be practised consistent with the Shariah, which also contributes to Islamic economy. Many of these principles upon which Islamic banking is based are commonly accepted all over the world, for centuries rather than decades.
It is evident that Islamic finance and banking were practised predominantly in the Muslim world throughout the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen.
Profit and loss sharing is the main concept of Islamic banking under Musharakah & Mudarabah mode of financing. While Islam employs various practices that do not involve charging or paying interest, the Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilising the funds at risk on a profit-and- loss-sharing basis. Such participatory modes used by Islamic banks are known as Musharakah and Mudarabah. The concept of profit-and-loss sharing in an enterprise, as a basis of financial transactions is a progressive one as it distinguishes good performance from the bad and the mediocre. This concept therefore encourages better resource management.
The investment must be ethical under Islamic banking financing method. The important principles for Islamic financial instruments for participation and investments that require strict adherence, while providing good returns i.e. Investments must be free of interest, speculation and gambling, all are considered as forms of exploitation and investments are made in permissible activities
Islamic banks, like conventional banks, are profit-making organisations. Their aim is to earn profit. However, they are prohibited to trade in Ribaa or engage in any business activity that is not in compliance with shariah principles. In contrast, there are no such restrictions on conventional banks. Islamic banking activities are based on the principle of buying and selling of assets. For example, in financing a home loan, the selling price (including the bank's profit margin) is fixed from the very beginning.
The differences between conventional banking system and Islamic banking system can be described as under:
Islamic banking has evolved into a global phenomenon with double-digit growth rates throughout the Muslim world. The Organisation of the Islamic Cooperation (OIC) defined the Islamic Bank " ….. An Islamic bank is a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of shariah and to the banning of the receipt and payment of interest of any of its operations….". As per Islamic Banking Act 1883, Malaysia, an Islamic bank is defined as "….a company which carries Islamic banking business. Islamic banking business means banking business whose aims and operations do not involve any element which is not approved by the religion of Islam….".
From the above definitions and discussions, we can summarise that Islamic financial institutions are institutions that are based on shariah principles. And in brief, Islamic banking operations are based on Islamic principles for financial transactions, i.e., risk sharing and prohibition of products and services having Ribaa and profit and loss sharing are major features, ensuring justice and equity in the economy.
The writer is the Deputy Managing Director & Chief Business Officer of Prime Bank Limited. He is an Associate Member of the Institute of Cost & Management Accountants of Bangladesh (ICMAB) and has a postgraduate diploma in Islamic Banking from Institute of Islamic Banking & Insurance, UK. The first shariah-based syndication deal in Bangladesh was concluded through his leadership under lead arrangement of Prime Bank Limited.
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