Question

Explain the concept, principles and operations of Conventional and Islamic Banking

Answer 1

To understand the concept of Conventional banking and Islamic banking, We need to first identify what are the main deference between these two. Then we can know the principles and operations of Islamic banking and how it defers from Conventional banking system.

Difference Between Islamic Banking and Conventional Banking

Let us first understand the major difference between Islamic banking and conventional banking system. “Islamic banking is an Ethical Banking System, and its practices are based on Islamic (Shariah) laws. Interest in completely prohibited in Islamic banking. It is asset based financing, in which trade of elements prohibited by Islam are not allowed. For example, you cannot take a loan for a Wine Shop. On the other hand, Conventional Banking is an Un-Ethical Banking system based on Man-Made Laws. It is profit-oriented and its purpose is to make money through interest”.

  

Below are the main Principles of Islamic banking.

7 Major Principles of Islamic Banking and Finance

Islam has set values and goals that meet all the economic and social requirements of the human life. Islam is a religion that not only focuses on the success of the afterlife but also organza the life of a person perfectly. The Islamic laws are known as Sharia that means clear path. In the present is banking system is against the principles of Islamic banking. Due to the reason, here we discuss the seven major principles of Islamic Banking and finance:

1. Profit and Loss Sharing:

It is one of the best principles of Islamic finance where the partners will share their profit and loss according to the part they played in the business. There will be no guarantee on the rate of the returns that the Muslims will play the part of a partner and not a creditor.

2. Shared Risk:

In the economic transactions, the risk sharing is promoted by the Islamic banking. When two or more parties will share the risk following the principles of Islamic banking the burden of the risk will be divided and reduced in the parties. So it will improve the economic activity of the state.

3. Riba:

It can be regarded as the prohibition of interest:

The wealth will get the return without any risk or effort.

Regardless of the outcome of economic activity the person who gets the loan has to return the money and Riba to the lender.

In principles of Islamic banking, taking advantages of the issues that other are facing is unjust

4. Gharar:

According to the Islamic finance principles, Muslims are not allowed to participate in the ambiguous and uncertain transactions. According to Islamic rules, both parties should have a proper control over the business. As well as the complete information should be shared with both parties so that the profit and loss will be equally shared.

5. Gambling:

In Islam, the acquisition of wealth through evil means or participation in gambling is prohibited. It will protect the Muslims from the conventional insurance products because that is a type of gambling. On the other hand, Islamic banking works in Takaful that involves mutual responsibility and shared risks.

6. No Investment in Prohibited Industries:

The industries that are harmful to society or have a threat to the social responsibilities are prohibited in Islam. They include:

Pornography.

Prostitution.

Alcohol.

Pork.

Drug.

According to the Islamic finance principles, you are not allowed to invest in such industries. You cannot even participate in the mutual funds that will help the industry to flourish.

7. Zakat:

There is a property tax included in the rules of Islam that it known as Zakat, which allows the balanced distribution of wealth. According to the Islamic banking principles the fair amount of Zakat is deducted from the accounts of Muslim in the holy month of Ramadan. Islamic banks promote this social responsibility and distribute the amount among the needy.

Conclusion

So we can say that the principles of Islamic finance guide us to invest in an industry that will help us to achieve the financial and social objectives that have been determined by Islam. The Islamic finance principles have been designed to make an economy successful. So it is a way of saving our money from being invested in a wrong path. Principles of Islamic finance are discussed in more details during diploma in Islamic banking programs, offered by institute of Islamic banking and finance at AIMS.