aMuslima’s guide to Islamic Finance | Conventional Banks versus Sharia Banks
As part of aMuslima’s guide to Islamic Finance series, we want to start with the basic day to day transactions that happen in our lives. Some of us live in Muslim countries where Islamic financing is common. And some of us live in non-Muslim countries where we are bound by the finance system of that country. We encourage you to join us on our quest to unravel the seemingly confusing understanding of Islamic Finance. We welcome feedback and suggestions on these topics feel free to email us here or email us at: firstname.lastname@example.org
What is the basic functions of a Conventional Bank?
A conventional bank is a bank that serves to manage funds from depositors and lend funds to other parties. Conventional bank customers deposits funds to the bank with an agreement to obtain interest income at no risk whether the bank could distribute the funds or not, get a large income or not, the banks still have to pay the interest. In conventional banks, the funds are distributed in the form of credit, where the amount of credit interest could be calculated by the accumulation of its cost of funds, a risk premium, overhead costs and the expected benefits.
Examples of conventional banks are: Citibank, HSBCbank, Bank of China, Mandiri Bank, Bank of America, Bank of England and many more.
How do Islamic Banks differ?
Islamic banks are financial institutions that provide financing and other services in the transfer of payments and circulation of money in which the operation is tailored to the principles of Islamic sharia. Sharia bank also manages the investments of the fund owner (shahibul maal) and distribute funds to other parties. At first glance sharia bank functions are similar to conventional banks. However, in sharia bank, the size of the income received by the fund owners depends on the income received by the bank (as mudharib) in managing the funds mudharabah. So this is very dependent on the skill, prudence, and professionalism of the bank management.
Why are the management skills of an Islamic Bank so important?
When funds are disbursed by the bank and are not paid back or is a default loan, then the cash inflow will be reduced so that the revenues between the bank and the depositor or fund owners mimic the revenues. So the correlation between bank manager skill sets, in being able to manage the funds and also be involved in managing the business they have invested in, and the revenue a bank earns and divides between the depositors is highly related. Conversely, if the funds are credited in a small amount and the payments from debtors are good, then the cash income becomes greater and therefore positive impact on revenues received by the fund owners. So what is done by sharia banks in particular the distribution of funds, will have an impact or risk to the fund owners.
What is the difference between Conventional Bank and Sharia Bank?
- Conventional banks deal with halal and haram transaction, whilst sharia bank only conducts halal investments.
- Conventional bank use interest as the reward to its customers; sharia bank applies profit sharing, buying-selling, and leasing principles.
- Conventional bank is profit oriented; sharia bank is profit and falah oriented. Falah means for the prosperity of the earth and the day after.
- In conventional bank, relationship to its customers is as debtor-creditor. On the other hand, in sharia bank, relationship between bank and customers is a partner affiliation.
- In sharia bank any fund collection and distribution should comply with sharia finance watch, while conventional bank does not.
Why conventional bank is not allowed in Islam?
Conventional bank gives reward to the fund owners in the form of interest in the fixed amount and has been determined in advance. It is not affected by the risks or problems faced by the bank. On the other hand, sharia banks are not allowed to give compensation in the amount specified in advance. Functions of conventional banks in other words are to collect funds from the fund owners with a certain amount of interest, then the funds are disbursed to the provisions of interest rates would be higher than that given to the fund owners. In this case, the bank would receive a profits interest margin. This is the largest and forbidden usury in Islam.
Usury (riba) literally means ziyadah (extra). As for the technical terms, riba means of making extra from the asset or capital with contrary to the principles of Islam. Allah said (QS An-Nisa29),
“O you who believe!, Eat not up your property among yourselves unjustly except it be a trade amongst you by mutual consent….”
According to Imam an-Nawawi of the Shafi’i school, that one form of usury is banned based on Al-Quran and Sunnah is the addition of the subject property because the element of time. In the banking world, it is known as mortgage interest according to the length of time of the loan.
Ibnu al-Arabi al-Maliki from his book Ahkam Al-Quran, stated that riba means addition, but according to Quran, riba means each addition is taken in the absence of a replacement or a counterweight transaction that are justified according to sharia.
A replacement or a counterweight transaction is business or commercial transactions which legitimates the fair addition, such as sale and purchase transactions, liens, leases, or profit sharing of the project.
a) the concept of sale (al-bai’u bithaman ajil), murabahah, bai’ al salam,
b) the concept of lease (ijarah),
c) the concept of profit sharing (mudharabah and musharakah), and
d) the concept of virtue (al-hasan qardhul).
According to mudharabah, bank in its capacity as a mudharib i.e. a person who invests the funds of others, only will get profit if the company that financed has a profit. But if there is a loss, the bank is not entitled to get compensation for his efforts, and losses are shared between two parties: capital losses borne by the funds owners, personnel and time losses borne by the bank.
What if there is no sharia banks in your city?
Recently there are a lot of sharia banks around the world. If you want to know sharia bank in your country one of the links that the author encountered is,
But if you do not find a sharia bank in your town, one possible way you can do is to use existing bank services to keep your savings without taking interest. Interest arising from these deposits can be donated for public purposes such as road repair, construction of drains, public toilets, etc.
May God open the way out and forgive our sins.
Source: Fund-raising and distribution of results of Islamic banks operations (an Indonesian version), by Wiroso, SE, MBA
Construction Mudharabah in Sharia Business, Mudharabah in the Fiqh discourse and Modern Economics practices (An Indonesian version), by Muhammad
Sharia Bank, from theories to practices (An Indonesian version) by Muhammad Syafi’i Antonio