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.
GOOD LUCK EVERYONE!
