Difference Between Islamic Banks and Conventional Banks

Topics: Bank, Islamic banking, Finance Pages: 7 (2157 words) Published: August 26, 2013
Difference between Islamic Banks and Conventional Banks
The conventional financial system focuses primarily on the economic and financial aspects of transactions, the Islamic system places equal emphasis on the ethical, moral, social, and religious dimensions, to enhance equality and fairness for the good of society as a whole. The system can be fully appreciated only in the context of Islam's teachings on the work ethic, wealth distribution, social and economic justice, and the role of the state.

Some of the differences between the Islamic Banks and the Conventional Banks
The following is a brief discussion in which we list the fundamental differences in the nature of work between the Islamic and conventional or commercial banks:
First, traditional or commercial banks are intermediate financial institutions which stand between the savers and the investors12 . On the other hand, Islamic banks are a mixture of internationally known traditional financial institutions for they not only operate like saving banks but are also similar to finance companies in so far as they can offer financial support to high risk projects. Furthermore, they can operate as open or closed investment funds [or banks]. Second, the form of the Islamic bank and the form of the conventional bank: The Islamic bank is more than the conventional bank for it works like any other specialized bank, (such as industrial banks, agricultural banks or building societies). It finances projects in all the above mentioned fields in addition to the fact that it can work like any investment bank because it is interested in the establishment of long-term projects.

Third, conventional banks do not get involved in the buying and selling or even the keeping of commodities, only within certain conditions. Also these banks, in accordance with their charters, can not buy capital assets or fixed assets unless they are used by the bank itself13. As for Islamic banks, they can trade with all types of commodities and can keep capital assets and establish limited companies or other types of companies.

Fourth, the conventional bank promises to pay fixed rates on its deposits, regardless of whether it makes profits or losses. The Islamic bank however, does not promise profits; if it made any profits during the financial year it would give the depositors the agreed rates; conversely, if the bank made losses, the depositors would share the burden together with the bank.

12 (Al-Hawari, 1996).
13 (Al-Hawari, 1996) 24
Fifth, any conventional or commercial bank can issue excellence share, which has fixed rate from the profits, but the Islamic bank can not do that because they are of limited interests14
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Sixth, all reserves in the commercial or conventional banks are deducted from the net profit, but in the Islamic bank they are deducted only from the net profit ear-marked for the share-holders15

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Seventh, a considerable part of the conventional or commercial bank’s funds are directed towards commercial (business) loans , but the majority of the funds in the Islamic bank are directed toward Al-Musharaka finance (shared finance or partnership companies), Mudarabah finance (speculative finance) or resale with specification of gain or other .

Eighth, regardless of their rate of profits, the Islamic banks prohibit the production of trading with certain prohibited goods and services in Islam 16such as:
- The finance of breweries or meat processing companies dealing with pigs. - The finance of gambling casinos.
Ninth, one of the characteristic features of the Islamic banks is the existence of what is called `Al-zakat fund'. This seeks to establish social equality. Such funds are found in the Kuwaiti Finance House (KFH), the Islamic Bank of Jordan (IBJ) and various other Islamic banks. This fund is financed by taking 2.5% of the bank's capital every year, with the bank's customers are given the option of paying their...
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