Differences between Islamic Banking and Traditional banking
Thursday, June 26, 2008

v     The Essential Differences between Islamic Banking and Traditional banking from another perspective would be as follows:

v     (i) Focuses on the human contribution as a source of income (profits) and limits income from just capital. The Islamic Bank emphasizes that it is an institution entrusted with the management of capital for the purpose of economic growth through the creation of new job opportunities. It derives its income for such a service as a Mudarib, (money manager for economic growth). The Islamic bank stresses the definition of a commission or a management creditd as remuneration for the work it does. The Islamic Bank objective is to expand its profits through serving the economic growth targets of the community. [2]


v     (ii) Since the activity of commercial banks is based primarily on the use of public funds, it is essential that public interest rather than individual or group interest be served by Islamic commercial banks. This point should the second difference between Islamic and conventional commercial banks. The sIslamic banks should use all deposits which come from the public for serving the public interest and realising the relevant socio-economic goals of Islam. They should play a goal-oriented rather than merely a profit-maximising role and should adjust themselves to the different needs of the Islamci economy. [3]


v     (iii) A third substantial difference is that the Islamic banks will be universal or multi-purpose banks and not purely commercial banks.[4] They would be a cross-breed of commercial and investment banks, investment trusts and investment-management institutions, and would offer a wide range of services to their customers with whom they will have to have a long-term bank-clinet relationship. A preponderant part of their financing would be for specific projects or ventures and most of their very short-term financing would also be withing the framework of such agreements, as indicated earlier. Their equity-oriented investments could not permit them to borrow short and lend long. This should tend to make them [5]less crisis‑prone compared to their capitalist counterparts. Since the overnight, call loan or very short‑term inter‑bank market may be available to them only to a limited extent within the framework discussed later, they may have to make a greater effort to match the maturities of their liabilities with the maturities of their assets. [6]


v     (iv) A fourth difference is that they would have to make a more careful evaluation of applications for equity‑oriented financing. Although the conventional banks also have to evaluate applications, the crutches of collateral and of non‑participation in risk are nevertheless available to them and their main concern does not go beyond ensuring the security of their principal and interest receipts. Since the Islamic bank would share in the risk of the consignment, venture, business or industry, it would need to be more careful. This should introduce a healthy dimension in the whole lending business and eliminate a whole range of undesirable lending practices. [7]


v     (v) A fifth difference would be that profit-and-loss sharing would tend to foster closer relations between banks and enterprenures which is the hallmark of multi-purpose banks.[8] This should help intoroduce financial expertise in no-financial  firms and also enable the banks to assume the role of technical consultants and marketing advisers and act as catalysts in the process  of industrilisation and development. The banks would take care of all the reasonable and agreed financial needs of their mudharabah clinets thbus relieveing themof the need to run around for funds tto overcome their normal liquidity shortages. Like the conventional banks they may have to have an ‘alternative care’ unti to nurse companies in varying stages of poor helath bak to life. Neverthelss, the careful evalutation of projects reaquired by profit-and-loss sharing, foloowed by continuing close relationship may tend to minimise cases needing such treatment. [9]


v     (vi) A sixth difference would be in the framework designed to help banks overcome their liquidity shortages. In the interest-based-system, it is possible for banks to resort to the money market or the central bank. Access to the money market may not be possible for extremely short periods [10]because of the difficulty of profit‑sharing in isolated loan transactions. Interest‑free access to the central bank may lead to a misuse of this facility while muddrabah lending by the central bank may be only within an agreed framework, determined by the extent of the economy’s need for high‑powered money for attaining a given monetary expansion and not necessarily available whenever an individual commercial bank runs short of cash. [11]


v     Three alternative arrangements may be made to solve this dilemma.

v     First, banks could have an understanding with other banks for mutual credit facilities, as is the usual practice of conventional banks, but within the profit‑and‑loss‑sharing framework.

v     Second, there could be an inter‑bank cooperative arrangement to extend reciprocal accommodation to each other on condition that the net use of this facility is zero (mutual borrowings cancel out mutual lendings) over a given period.

v     Third, the banks could create a common fund at the central bank as a part of the statutory reserve requirement to provide mutual accommodation. http://www.freewebs.com/eastvision/blog.htm?blogentryid=3622510



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