Different between Islamic Banking and non-Islamic banking

By Yusuf Habiib Hussien (Seer)

Banking is one of the most important parts of our day-to-day activities and also plays a major role in the economy. Banking comes in two forms or systems: Islamic banking and non-Islamic banking. However, though Islamic banking exists due to the demand for Islamic banking by Muslims, especially due to the Sharia law, the non-Islamic banking highly relies on transactions based on interest. While both systems align in some ways, there are fundamental differences between Islamic and non-Islamic banking. This article shall look at Islamic banking and its difference with non-Islamic banking. A comparison of Islamic banking shall be made covering principles and practice, products and services, contract and legal frameworks, risk management, social responsibility and ethical principles, and growth and the future.

Islamic Banking vs. Non-Islamic Banking

Now, there are two types of banking systems existing in this modern world. First is the Islamic banking and the second is the non-Islamic banking. Non-Islamic banking is that conventional system of banking with which we all are familiar and associated in our daily routine life. On the other hand, Islamic banking works on principles and practices that have a relation with Shariah law. This article will explore the differences between Islamic and non-Islamic banking systems.

Islamic banking is one of the banking systems that functions in conformation with the principles stipulated by Shariah Law, being the moral and ethical code of conduct which regulates the Islamic way of life. Sharia law does not allow any payment or receipt of interest. Instead, it promotes profit and loss sharing. Islamic banking encompasses concerns of social justice, ethical investment, and economic empowerment for all people irrespective of socio-economic positioning.

Non-Islamic banking refers to the more 'conventional' form of banking that most of us know, based on interest and not bound by any religious/ethical code. Non-Islamic banking offers many products to its customers, including loans, savings accounts, and credit cards.

The Principles and Practices of Islamic Banking

Shariah Law and Banking. One of the important principles in Islamic Banking is that of the operation of Shariah law. Therefore, any transaction performed in that bank must be performed following the moral and ethical codes provided in Shariah law. Overall, Shariah law emphasizes fairness and justice in any financial transactions and transparency.

Riba or Interest. Interest is the concept treated differently in Islamic banking since interest is forbidden. Instead, the concept that is applied by Islamic banks is profit and loss sharing. In this respect, if there is some profit derived by the bank, the bank together with the depositor shares the profits. In cases of a loss, the bank and depositor share the loss together.

The Principle of Profit and Loss Sharing

This would include a major component of profit and loss sharing in Islamic banking. One of the key principles in Islamic banking is the depositor involves sharing the profit and loss of the bank. This would imply that the bank is allowed to invest the depositor's funds in halal businesses, or permissible, and the bank will share the profits of those investments with the depositor but the depositor will also share in the losses.

Product and Service Differences

Account Types. By having various forms of accounts, Islamic banks are able to do so. Just like any bank, Islamic banks also provide savings accounts, investment accounts, and current account. Non-Islamic banking is similar in terms of account varieties; however, the terms and conditions could vary.

Loans and Financing. Islamic banking provides loans and other modes of finance to their respective customers, which needs to be exactly within the perimeters set by Shariah. Loans in this system are given on the basis of profit and loss sharing. It means that the risk or reward from the investment must be shared by the bank as well as the borrower. This is in direct contrast with loans provided through non-Islamic banking, which is interest-based. Investment Opportunities

Islamic banking provides investment avenues that are considered halal, or permissible, by the Shariah law. Hence, investment avenues include real estate, agriculture, and businesses that are deemed ethical and socially responsible. A number of investment avenues are provided by various forms of non-Islamic banking systems, none of which are directed by any religious or ethical codes.

Contractual and Legal Frameworks of Islamic and Non-Islamic Banking

Contracts and Agreements in Islamic Banking. All contracts and agreements in Islamic banking have to adhere to the commitment of Shariah law and hence are equitable, just, and transparent in all financial dealings. All contracts and agreements will be reviewed by Shariah scholars to verify that they meet the commitment.

Contracts and Agreements in Non-Islamic Banking. These contracts and agreements also adhere to the legal expectations, terms, and regulations of the country in which the non-Islamic banking provides its services. Applicably, non-Islamic banking contracts may contain interest-based terms, which Islamic banking does not allow. Non-Islamic banking adheres to a different legal and ethical basis compared to Islamic Banking.

Risk Management and Regulations of Islamic and Non-Islamic Banking

Risk Management in Islamic Banking. Risk management will include the principles of Shariah laws that, as we mentioned, compose of profit-sharing, risk-sharing, and asset-based financing. Islamic banks follow principles of risk management in order to make sure that the risks will be shared among the parties. In cases of Islamic banking, both the bank and the customer will share risks and rewards in potential risk situations, therefore Islamic banking is a stronger framework when compared to traditional banking.

Risk Management in Non-Islamic Banking. In addressing risk management, Non-Islamic banks basically practice typical risk management associated with conventional banking. As an example, credit scoring models are based on quantitative techniques to assess customer creditworthiness. Financial derivatives such as futures, options, and swaps are utilized to effectively hedge risk.

Regulatory Frameworks in Islamic and Non-Islamic Banking. Islamic banks and non-Islamic banks operate within the legal regimes laid down by their national central banking authorities or agencies. In addition and as an exception, Islamic banks are subject to other various regulations issued by their Shariah supervisory boards governing Islamic banking operations that are often aimed at ensuring that Islamic banking operations are conducted in conformity with Islamic principles that govern Islamic banking operations.

CSR and Ethical Practices in Islamic Banking

Corporate Social Responsibility in Islamic Banking. CSR is a cardinal principle in Islamic banking. Islamic banks are supposed to provide finance to projects which contribute directly towards the social welfare and well-being, and to refrain and stay away from providing finances to activities that only contribute negatively to societal welfare and quality of life. In this respect, Islamic banking becomes isolated from the usual functions offered by traditional banking as a socially responsible banking system.

Ethical Values in Islamic Banking. Islamic banking involves systems that are founded on Islamic beliefs and, thus, operate on ethical values including honesty, transparency, and fairness. Islamic banks promote and acknowledge the commitment to Shariah law and rules that define Islamic banking operations.

Growth and Future of Islamic Banking

Globalization and Growth of Islamic Banking. Islamic banking, in particular, has recorded phenomenal growth in the last three decades. By various estimates, there are over 300 Islamic banks in over 60 countries, and the global Islamic finance industry is believed to be over two trillion dollars, and their prospect is expected to get brighter and more rewarding as demand increases in the coming years.

Challenges and Opportunities for Islamic Banking. The improvement of awareness about the principles and practices of Islamic banking is one of the important issues on this way. Islamic banks are more commonly faced with competition from non-Islamic banks, featuring higher customer bases. At the same time, interest in Islamic banking and finance opens opportunities for Islamic banks to be introduced and expand their audience, as well as bringing more opportunities for varieties of products available to clients.

It all depends upon the individual's mind and soul whether it's Islamic banking or non-Islamic banking. If social responsibility and ethical values stand foremost, then it would be pretty well suited to your needs. If one prefers a more conventional and traditionally rooted banking system, then definitely, non-Islamic banking would be more appropriate. It's all about understanding your options and doing your research. This means that Islamic and non-Islamic banking systems were designed with different market needs in mind, yet they also share specific characteristics. The understanding of the way both systems differ explains the decision-making process relating to banking. Either way, a decision on the kind of banking system chosen depends on an individual's belief, values, and the management objectives of their assets. However, whichever model of the banking system is followed, the need and importance of sticking to ethical values and social responsibility in finance has always been prudent.