Islamic Finance vs Conventional Finance

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  • Topic: Islamic banking, Sharia, Riba
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  • Published : October 4, 2012
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International Journal of Business and Social Science

Vol. 2 No. 2; February 2011

Differences and Similarities in Islamic and Conventional Banking Muhammad Hanif
Assistant Professor, National University of Computer & Emerging Sciences, Islamabad PhD-Finance Scholar at International Islamic University, Islamabad, Pakistan E-mail: muhammad.hanif@nu.edu.pk
Abstract
Islamic Banking is growing at a rapid speed and has showed unprecedented growth and expansion in last two decades in spite of mismatching of existing financial framework and business practices. By the end of 2008 volume of Islamic banking has reached to US $ 951 Billion with operation in more than 50 countries. Middle East is the centre of Islamic banking with contribution of approximately 80% while 20% share is contributed by rest of the world. In Pakistan Islamic banking is at infant stage although last 6 years growth is marvelous. Islamic banking has grown at an average annual rate of 76% in the last six and half years (12/03 - 06/10) in Pakistan. Although Islamic banking faces multi challenges however three of them are very vital for its existence. First is Sharia compliance in its operations in an environment which is dominated by interest based practices even in Muslim societies. Second is perception of financial industry practitioners about its performance whether the system is able to serve the total needs of trade and industry. Third is the perception of a large majority of Muslims whether existing practice of Islamic banking is Sharia compliant or mere copy of conventional practices under the banner of Sharia.This study is an attempt to address the perceptional issues by identifying the similarities and differences in Islamic and conventional banking. Evidences suggest Islamic banking is very much practiced like modern conventional banking with certain restrictions imposed by Sharia and addresses the large number of business requirements successfully hence perceiving Islamic banking as totally foreign to business world is not correct. It is further found in the study that Islamic banking is not a mere copy of conventional practices rather major differences exist in the operations of Islamic Financial Institutions (IFIs) in comparison with conventional banking. IFIs have succeeded in creating trust in the eyes of depositors and receive deposits on profit and loss sharing basis however investment and financing options available to Islamic banks are limited in comparison of conventional banks.

Keywords: Islamic banking, Pakistan, Islamic finance, Islamic modes of financing, Sharia compliant JEL Classifications: G 21, G 24

1. Introduction
In the second half of 20th century liberation of Muslim world from colonial powers almost completed and widespread renaissance of Islamic ideology took its path in Muslim societies whereby the masses started looking at the existing social systems through Islamic lenses and proposed modifications and developments. The Muslim thinkers and philosophers challenged the world’s ruling economic and social systems and uncovered their weaknesses. Capitalism was examined and criticized in detail due to its magnitude and general acceptability in majority of leading societies of the world.i Out of the four factors of production (as described in Capitalism) reward of three is fixed and all risk is born by the entrepreneur alone. In capitalism, capital is a factor of production and hence deserves the fixed reward in the form of interest --- a risk free reward. As the bank is dealer of money; and reward for using money is interest according to capitalist system; so the prime source of revenue and cost of funds to conventional banks is charging interest through lending and accepting deposits for interest respectively. Interest is the major driver of operations of conventional banks although other valuable services including guarantees, funds transfers, safety of wealth, facilitation in international trade etc. are also provided...
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