es in Islamic and conventional banking

1.0 Introduction

This study seeks to address the similarities and differences in Islamic and conventional banking while attempting to prove that Islamic banking offers greater promise as a tool for economic upliftment and prevention of financial crises.

A report by KPMG (2011) Islamic banking is a discipline which has its roots in the holy Quran, the sacred scripture of the religion of Islam as well as the Hadith which represents the teachings of the holy Prophet Mohammed (PBBUH). The discipline is also sometimes referred to as Sharia compliant finance.

1.1 Background of Islamic Banking

Islamic Banking is not very different from conventional banking subject to certain restrictions imposed by Islamic law (Sharia) and addresses the needs of a large number of business requirements. Islamic banking is not a mere replication of conventional practices. There are significant differences in what Islamic Financial Institutions (IFIs) do compared to 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 with conventional banks due to the restrictions against unethical investments such as speculation, gambling, alcohol, arms industry, pornography and all interest-based transactions. The difference between the systems are fundamental and at the very root of the operation of Islamic banking activities.

This difference nevertheless has immense implications for the future of banking. As the Vatican’s official organ, L’Osservatore Romano (2009), stated matter of fact a few years ago: “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service”.

1.2 Current Situation

Today Islamic banks are operating in nearly all Muslim countries and many non-Muslim countries. This has been so ever since the 1970s when Islamic banks first emerged in the Middle East. Unlike conventional banking industry, the Islamic banking industry provides only the Islamically compatible financial services for their customers. Therefore, governance according to Islamic requirements is essential to the system. A well-known saying in the industry goes “An Islamic Bank is as good as its Sharia Board”. The Sharia board determines what products such a bank may or may not offer. This is a key feature of Islamic banking industry which distinguishes it from the conventional financial system.

Conventional banks on the other hand have been established on unbridled capitalistic principles based on interest which is unacceptable in Islam (Quran 2:275). Thus Muslims have had little choice but to establish their own financial institutions under Islamic principles and not because of any desire to be exclusive in any sense. In fact Islamic banks promote their products and services to all, irrespective of their religious affiliation w