The Difference Between Islamic Banking Financing and Conventional Banking Loans

I know the title of this post is a mouthful, but I am insisting on the title. Simply because today I came across another round of bashing by individuals on Islamic Banking. Again, the contention is that Islamic Banking is no different from conventional banking; worse still it is claimed that Islamic Banking is more detrimental than conventional banking. How can this be? I watched the video and aghast by the level of ignorance to the nature of Islamic Banking. And gauging from the response by the rest of the audience, it seems that the audience themselves knows no better.

It seems that a lot of individuals are still unconvinced about Islamic Banking. Furthermore, the impression that it is worst-off than conventional banking needs to be addressed. Islamic Banking, while on the surface is still banking, but it is built on a totally different foundation. There are significant difference which is brought about by a single requirement; Shariah-compliance.

Difference 1

The basic difference between Islamic Banking and conventional banking is the contractual relationship. This fundamental difference posed a totally different outlook on what happens after that. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon. But look at an Islamic contract. It is much more complex, but once determined, it really makes total sense. The contract defines the relationship, the relationship defines the responsibilities and subject matter, the subject matter defines the sequencing and ownership requirements for the use in an economic transaction, the transaction defines the rewards and returns on the completion of the contractual obligation. Cause and effect, risks and compensating return, action and rewards.

Difference 2

There is a huge layer of governance surrounding an Islamic Banking proposition. Whatever features that it offers, it goes through strict scrutiny by the regulators as well as the independent Shariah Committee, whom are not under the jurisdiction of the Bank but reports directly to the Board of Directors. The decisions (or “fatwa”) given by the committee will be held solely by the committee themselves, therefore there is a huge responsibility to ensure their decisions have take into account all requirements of justice, customer protection, compliance to Sharia, interpretation to customary civil practices as well as practicality of implementation. In short, decisions my be clear and without any doubt to its validity.

Difference 3

The deployment of Islamic Banking funds is not for charity. It is still a business that needs to be sustained by investing in economic activities, therefore it is misleading to assume Islamic Banking is a holistic endeavor that “should not charge interest” or merely to “provide assistance to the ummah”. There are costs for running an Islamic Banking business, and as far as possible it should be at par to the costs of running a conventional banking business. Returns on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah. The key word is sustainable banking. You cannot grow or even survive if you are not competitive.

Difference 4

For me, the main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk, and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant to ensure conventional banking toe the line to protect customer’s interests.

Islamic Banking, in its DNA is intended more than just being profitable. It is meant to be providing service to support the activities of the ummah (Muamalat) defined within Shariah-compliant transactions. There are specific rules that must be followed; breach of these rules means the penalties are non-negotiable i.e. whatever returns gained from these breaches must be given to charity. Care and consideration is a must. Justice and fairplay is always important in a decision by Shariah Committee. Release of customers burden is a priority.

Many customers still lack knowledge of what Islamic Banking is all about. They collate biased and misleading information from truncated and unverified sources on the internet, facebook postings that intends to be malicious rather than presenting the true picture, and comments by individuals who make generalized comments on their experience which may well be isolated cases due to misinformation, misunderstanding or just plain ignorance to the fact. And yet these comments are sensationalized, made viral and deemed to be the absolute truth without further exploration or verification.

Cut and paste seems to be the easy way forward. Yet people forget the discipline that is practiced by the companions of the Prophet; you must verify the information by determining it all the way to the source of the information, up to naming the individuals who made the first comments, and deciding whether the individuals are trustworthy and of good standing. This discipline is lost in this world of over-abundance of unverified information, where it has become increasingly difficult to separate truth from fact.

Hopefully those doubtful questions on Islamic Banking should be directed to Islamic scholars, Islamic banking practitioners or relevant academicians with stature, knowledge and qualifications before the ummah believes and spread untruth that will, in the end, become a disservice to the religion of Islam by spreading “fitnah”.

There really is a difference between Islamic Banking and conventional banking, and there are some of us trying very hard to make a difference in the compulsion towards riba’.

My earlier posting on roughly the same conversation:

  1. Consequence for Choosing Islamic Banking
  2. Shariah Banking in Malaysia
  3. Conversations on Islamic Banking in Malaysia
  4. Choosing the Right Options