Comparative Analysis Between Islamic Banking and Conventional Banking in Malaysia

PAPER ISLAMIC FINANCIAL MANAGEMENT

In conventional banking, the banker - customer relationship is a debtor - creditor relationship where the bank earns a profit by making a spread between interest charged on the borrower of funds and interest paid to the depositors. On the other hand, Islamic finance is governed by Shariah rules that prohibit interest-based transactions. One must refrain from making a direct comparison between Islamic banking and conventional banking.

               Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.

              Islamic law considers a loan to be given or taken, free of charge, to meet any contingency.  Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle underlying for such kind of transactions is “deal not unjustly, and ye shall not be dealt with unjustly” [2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-creditor relationship.

             

             The other principle pertaining to financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labour and capital. As no payment is allowed for labour, unless it is applied to work, there is no reward for capital unless it is exposed to business risk.

Comparison of the conventional banking and Islamic banking are shown in box diagram as below:-

Conventional Banks	Islamic Banks
1. The investor is assured of a predetermined rate of interest.  Lending money and getting it back with compounding interest is the fundamental function of the conventional banks. It can charge additional money (penalty and compounded interest) in case of defaulters.	1. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer’s business very well. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are given for early settlement at the Bank’s discretion.
2. It aims at maximizing profit without any restriction. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations. It does not deal with Zakat.	2. It also aims at maximizing profit but subject to Shariah restrictions. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations. In the modern Islamic banking system, it has become one of the service-oriented. functions of the Islamic banks to be a Zakat Collection Centre and them also pay out their Zakat.
3. The conventional banks give greater emphasis on credit-worthiness of the clients. . The status of a conventional bank, in relation to its clients, is that of creditor and debtors.	3. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.
4. A conventional bank has to guarantee all its deposits from risk.	4. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share risk in a loss position.

            Moreover, Conventional banks encourage people to keep their money idle in banks in return for profit on a fixed proportion after a calendar year which brings us back to the concept of interest or usury. As expected, such liberties have not been allowed in Islam so Islamic banks encourage people to invest their money instead of storing it for a long period of time.

 In addition, Conventional banks, since they run on the concept of creditor-debtor, they may dolly out loans to even those aiming to start a business of alcohol or any unlawful good for that matter. After all, maximum gains and profits would be the main target of the bank at the end of the day and a dealer in alcohol would assure them that. On the contrary, Islamic banks would place certain checks and balances to ensure that money lent is used in an appropriate manner so that the borrower does not make unlawful gains. 

            The fourth and foremost difference that underlies these two banking systems is the concept of interest or Riba (Usury). While interest might play a leading role in the Conventional baking system all over the world, Islamic Shariah has allowed absolutely no room for such concepts; in fact, they prohibit dealings in interest at all costs. As opposed to the concept of Riba, profit and loss sharing between banks and clients has been allowed in Islam and that really forms the basis of Islamic banks. Also, Islamic banks offer service-oriented functions such as Zakat collection to ensure that money in the bank is ‘purified’ and also spent to help those in distress. Since Conventional banks are driven by maximum profit motive, such services remain absent from their system. In essence, social consideration remains a major target in Islamic banking whereas social injustices are common in Conventional Banking.

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