Comparing the Conceptual and Operation Performance of Islamic and Conventional Banks

1553 words (6 pages) Essay in Banking

23/09/19 Banking Reference this

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   ‘Comparing the Conceptual and Operation   Performance of Islamic and Conventional Banks’

 Islamic banking is an Ethical banking system, and its principals, function and operation modes are fully based on Islamic law (Shariah). While on the other hand, conventional banking is a banking system and its principals, function and operating modes are fully based on man-made laws. Shari’ah defines Man-to- God (ibadah) and man-to-man (muamalat) relationship. The primary sources of the Shari’ah are the Qur’an and Sunnah. Shari’ah is the Divine prescriptions in the form of faith and belief, laws and moral norms broadly classified into two standards: Ibadah (worship and devotional practices) and Muamalat (civil transaction). While conventional banking system is established under the principles of capitalism and by charging interest. In capitalism, capital is a factor of production and so demands a risk free fixed reward in the form of interest. And so the only concept behind conventional banking is to make profit while in Islamic banking and finance system the concept behind the operation is profit and loss sharing. Therefore, apart from making profits, social benefits and stability is also desired.

As conventional banks are dealers of money, and in capitalism reward for using money is interest, so the prime source of revenue and cost of funds to conventional banks is charging interest through lending and accepting deposits for interest respectively. That is why, interest is the major driver of operation of conventional banks apart from other services such as guarantees, funds transfer, safety of wealth etc. While on the other hand, Islamic banking system is more concerned about profit and loss sharing and risk-reward sharing and equal wealth sharing. In Islamic banking system operations are broadly divided into shariah compliant and shariah based. Shariah compliant are services and products that comply or adhere to the requirements of the shariah itself. While, shariah based products and services refers to those services and products which are directly derived from the primary source of Islamic laws such as the Qard’ al- hassan (benevolent loan).

Shariah based products and services are said to be originated during Prophet’s period. These products and services have undergone the process of cleansing where any prohibited elements were removed by Prophet Muhammad (PBUH). They include: albay’ (trade), mudarabah (profit sharing), musyarakah (joint venture, profit and loss sharing), murabahah (cost plus), and Ijarah (leasing).

Islamic banking emerged with concepts, techniques and instruments a very long time ago but the history of Islamic finance is divided into two general phases; the early day’s transactions and the modern day experiments, the modern day experiments started in 1960s through initial reforms in differents Islamic countries although the full-fledged system came into existing recently in 1980s. Islamic banking is a system of interest free banking governed by the shariah law in coherence with “Quran”. The shariah has developed specific forms of financial transactions as means of earning without resorting to income generation through interest (Riba), uncertainty (Gharar) and gambling (maysir and qimar). AS conventional banking systems around the world operates with these instruments resulting in periodic recessions and depressions in the financial markets, shari’ah prohibits these in Islamic banking and financial system.

Riba, is the Arabic word for interest, which means “to increase, grow or multiply into more than what would be due”. Riba is prohibited in Islam because it’s create social injustice. In a riba based transaction, the owner of the wealth gets return without making any efforts and the borrower carries all the risk. According to (Quran 2:275) “Those who consume interest cannot stand [on the day of resurrection] except as one stands who is being beaten by satan into insanity. That is because they says “Trade is [just] like interest”, But Allah has permitted trade and has forbidden interest”. In another place in (Quran 2:278-9) “O you who have believed, fear Allah and give up what’s remains [due to you] of interest, If you should be believer. And if you do not, then be informed of a war [against you] from Allah and his Messenger. But if you repent, you may have your principal – [thus] you do not wrong, nor you are wronged.”

Also in a hadith narrated by the prophet’s companion jaabir: “ Allah’s messenger cursed the one who accepts riba, the one who gives it, the one who records it and the two witnesses to it, saying, “They are all the same” (Al-muslim). So clearly Islam and the shari’ah prohibits riba.

The rationale for the prohibition of interest in Islam is its deep concern for moral as well as economic welfare of mankind. The charging of interest implies assumption of another person’s property without giving him anything in exchange, because one who lends one dollar for two dollar gets the extra dollar for nothing. Relying on interest prevents people from working to earn money, since the lender can get extra money without working for it. The value of work will consequently be reduced in the society, and people will not bother to take the trouble of running a business or risking their money in trade or industry. This will lead to depriving people of benefits, and the business of the world cannot go on without industries, trade and commerce. Allowing the charging of interest discourages people from doing good to one another, if interest is prohibited in a society, people will lend to each other on goodwill, and the concept of brotherhood will take root in society. In interest based system the lender is very likely to become richer and richer while the borrower is more likely to become poorer, as the rich will exploit the poor. Thus a social injustice is created in the society. Naturally, this generates envy and hatred among the poor, and contempt and callousness among the rich towards the poor. As a result the peace and stability of nation in which interest based system is implemented is more likely to be disturbed

Apart from Riba (interest), Gharar(uncertainty) is also prohibited in islamic financial system.

Gharar Literally means risk, uncertainty, fraud or deceit. However, in broader terms it refers to the buying or selling of those items or objects, the value or description of which is not certain or capable of being made certain. In Islamic financial system any transaction based on uncertain facts comes under the heading of Gharar. Examples of Gharar where The Prophet (PBUH) has forbidden the transaction include sale of unborn animal inside the mother’s womb, advance buying of the catch of a diver where the exact amount of fish caught is uncertain or the selling of milk in the udder the quantity of which is unknown. In all these cases, it is evident that the sale or purchase of something the value of which is not certain is not allowed in Islamic Financial system as it may lead to the unbearable loss and exploitation of one party. There is no place for speculation and unnecessary risk taking in Islamic financial system because of the inherent risk of loss for one party. Without full disclosure of information and revelation of all the facts of the matter, a valid contract cannot be made. In absence of full transparency, any contract may result in later disagreements and exploitation of one party at the hands of another, leading to an unfavourable business environment.

Another instrument that Islam prohibits categorically is gambling referred in Islam as Maysir or Qimar. Maysir is that type of gambling in which easy acquisition of wealth by chance occurs, whether or not it deprives the other’s right. Qimar, on the other hand, means the game of chance in which one gains at the cost of others. In both cases, wealth is acquired not by hard work or skill but by chance and by exploiting another person. That is why these instruments are prohibited in Islamic Financial System.

In conclusion, the Islamic Financial System is based on the concept of equity of resources and opportunities and provides a level playing field to all no matter how rich or poor they are. Islam prohibits instruments like Gharar, maysir or qamar which are based on exploitation, uncertainty and risk. Instead, it promotes the principle of profit-loss sharing as a means of acquiring capital to encourage the spirit of brotherhood and cooperation in business relationships.

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