Conventional banking is based on financial principles to earn more profit. Conventional banking would mean activities that earn profits such as lending, safeguarding and exchanging money. Conventional banks earn a profit by charging fees and interest for their products and services.
Islamic banking is based on Shariah principles which include governing laws in all aspects of life. These principles are guided by Islamic economics. Islamic banks work on the basis of sharing profits and losses. They earn a profit by trading, sharing, leasing and charging fees for their products and services.
Basics of Conventional and Islamic Banking
Money is considered a mode of exchange and a commodity in conventional banking. Banks trade money at high prices and rent out money as well due to its value. Islamic banking considers money as a mode of exchange and a store of value. So, Islamic banks do not trade money as a commodity.
Conventional banks operate on the basis of making a profit. It means that only the profit is shared with you. If it is a loss, then it has to be borne by you solely. Islamic banks work on basis of profit and loss sharing. If there is a loss, then the bank would share the loss where it would not be an absolute financial burden on you.
Conventional banking aims to maximise returns on the products and services whereas Islamic banking endeavours to help the public.
Key Differences between Conventional and Islamic Banking
The major differences are:
1. Risk Sharing
In conventional financing, you have to bear all risks to pay back any loan. For example, if you took a loan to start your business, you need to pay back the principal amount along with total interest even if your business failed and you lost your money.
In Islamic financing, if you borrowed a loan based on Mutanaqisah principle to start a business and suffered a loss, the bank will bear some of your loss.
Conventional banking operates on the concept of interest, especially conventional financing. If you take a loan, the bank would charge interest on it. You are expected to pay back the principal amount along with the total interest amount.
Shariah principles forbid charging of any interest, hence Islamic banks do not charge interest. Islamic banking operates more on buying and selling of commodities, leasing and capital sharing rather than charging interest.
Under conventional banking, you can buy products and services to use them for any purpose. There are no restrictions. Under Islamic banking, all products, services and transactions must be “halal” in nature. It means you cannot purchase products such as alcohol or engage in any gambling transactions.
To be eligible for various products such as hire purchase loan, credit card or housing loan, even your income must be deemed “halal” by Shariah principles. Any illicit businesses or businesses that deal with “non-halal” products will not be considered for any product under Islamic banking.
Comparison between Conventional Banking and Islamic Banking
|Conventional Banking||Islamic Banking|
|Governed by Bank Negara Malaysia.||Governed by Bank Negara Malaysia and Shariah Committee.|
|The operating mode and functions are based on capitalistic principles.||The operating mode and functions are based on Shariah principles.|
|The main function is to lend money and get it back along with compound interest.||The main function is to participate in partnership business by understanding the customer’s business and working along with the customer.|
|A predetermined rate of interest is imposed on the user.||Risk sharing is promoted between the investor and user of funds.|
|The main aim is to earn a maximum profit without any restrictions.||The main aim is to earn a profit, but it is subject to restrictions under Shariah principles.|
|Additional money is charged as penalty fees and compounded interest if someone defaults on payment.||No extra money is charged from defaulters. The compensation required by banks is quite small and all proceeds are given to charity.|
|More prominence is given to the growth and popularity of the bank with no effort to ensure equity.||Importance is given to public interest and the main aim is to ensure equity along with growth.|
|Borrowing from banks is easy and can be used for any purpose.||Borrowing from banks must be based on a Shariah-compliant purpose.|
|Income from advances is fixed.||Income from advances is not fixed due to profit and loss sharing principle.|
|Greater emphasis is given to the eligibility and creditworthiness of the customers.||Greater emphasis is given to the viability of projects and public interest.|
|The relationship is that of a creditor and debtor.||The relationship is that of a buyer and seller and/or partners.|
|All deposits are guaranteed.||Deposits based on Al-Wadiah principle are guaranteed whereas deposits based on Mudarabah principle are not guaranteed.|
Conventional Banks in Malaysia
- Affin Bank Berhad
- AmBank (M) Berhad
- BNP Paribas Malaysia Berhad
- CIMB Bank Berhad
- Citibank Berhad
- HSBC Bank Malaysia Berhad
- Hong Leong Bank Berhad
- OCBC Bank (Malaysia) Berhad
- Public Bank Berhad
- RHB Bank Berhad
Islamic Banks in Malaysia
- Al Rajhi Banking & Investment Corporation (Malaysia) Berhad
- Alliance Islamic Bank Berhad
- Bank Islam Malaysia Berhad
- Bank Muamalat Malaysia Berhad
- HSBC Amanah Malaysia Berhad
- Kuwait Finance House (Malaysia) Berhad
- Maybank Islamic Berhad
- OCBC Al-Amin Bank Berhad
- RHB Islamic Bank Berhad
- Standard Chartered Saadiq Berhad
Although the products offered under both banking formats are similar, the underlying concept they work on differ. The key difference among the two are that Conventional banks earn money by charging interest on products or fees for services rendered whereas Islamic banking earns their money through profit and loss sharing and other Shariah-compliant contracts of exchange.