Differences Between Islamic Bank and Conventional - Essay Example

Differences between Islamic Bank and Conventional Islamic baking is different from conventional banking in a number of ways. The key difference between the two forms of banking emanates from the fact that Shariah foundation forms the basis of Islamic banking. Unlike in conventional banking, all dealings, business approaches, focus of investments, and transactions take place on the basis of Shariah law. Islamic banking is based on the foundation of Islamic faith; thus, it operates within the limits of Islamic faith.

Islamic banking sets forth a number of principles. These principles include the lack of interest (riba) in the transactions, avoiding economic transactions that involve oppression (zulm), and the introduction of an Islamic tax known as zakat (Fahim & Mario 2010, p. 92).Under conventional banking, the danger of insolvency is lower as compared to Islamic banking. Fluctuations in the income of a conventional bank are passed on to depositors as fluctuating payments. On the contrary, losses incurred in Islamic banking do not affect the account holders.

As such, Islamic banks may suffer the losses rather than passing on the losses to the customers. In conventional banks, the major aim to protect against possible risks and losses that may emanate from investments. Therefore, depositors choose to invest their funds in banks that have high returns. On the other hand, depositors in Islamic banks do not look for banks that have high rates of return since the sole aim is not to make high profits (Visser 2009, p. 140).In conventional banking, transactions are shaped by the limits in applying usury prohibition.

This ensures separation of the banks from the risks associated with the activities of the customers. On the other hand, in Islamic banking, a system based on the participation of the creditors in the risks and profit replaces the interest-based system (Fahim & Mario 2010, p. 91). The interest earned in conventional banking is based on the fact that the lender ought to get a fixed return on the investment, regardless whether the venture of the borrower succeeded or did not succeed. On the other hand, Islamic banking prohibits the presence of predetermined return, although it recognizes the legitimacy of profit sharing.

Conventional banking operates for the own interests of the bank; thus, the bank does not make efforts to make sure that there is growth with equity. On the contrary, Islamic banking gives a lot of importance to the interest of the public. Thus, it aims at ensuring that there is growth with equity. In conventional banking, commercial banks based on interest can easily borrow from the money market. Borrowing from the money market in Islamic banking must be based on the approval of the transactions under the Shariah law.

Conventional banks place a lot of emphasis on the clients’ credit worthiness while Islamic banks focus on how viable the projects are (Visser 2009, p. 138).Conventional banks employ the strategy of profit and loss sharing mechanism as a way of reducing the impact of financial risks, which may result from the transactions that the bank carries out. In Islamic banking, there is channeling of funds from depositors with low risk to funding that favors high risk borrowers. This makes Islamic banks be market liability intermediaries.

Conventional banks call for an integrated approach in the management of assets and liabilities. However, such an approach is not a prerequisite in Islamic banks since it is not required to make borrowers and lenders’ preferences compatible and coherent (Fahim & Mario 2010, p. 92). References ListFahim, M. K & Mario, P. (2010). Islamic Banking and Finance in the European Union: A Challenge, London, Edward Elgar Publishing. pp. 91-110. Visser, H. (2009). Islamic Finance: Principles and Practice, Massachusetts, Edward Elgar Publishing. pp. 134-140.