Islamic Banks and Conventional Banks

The conventional financial system focuses primarily on the economic and financial aspects of transactions, the Islamic system places equal emphasis on the ethical, moral, social, and religious dimensions, to enhance equality and fairness for the good of society as a whole. The system can be fully appreciated only in the context of Islam’s teachings on the work ethic, wealth distribution, social and economic justice, and the role of the state. Some of the differences between the Islamic Banks and the Conventional Banks

The following is a brief discussion in which we list the fundamental differences in the nature of work between the Islamic and conventional or commercial banks: First, traditional or commercial banks are intermediate financial institutions which stand between the savers and the investors12 . On the other hand, Islamic banks are a mixture of internationally known traditional financial institutions for they not only operate like saving banks but are also similar to finance companies in so far as they can offer financial support to high risk projects.

Furthermore, they can operate as open or closed investment funds [or banks]. Second, the form of the Islamic bank and the form of the conventional bank: The Islamic bank is more than the conventional bank for it works like any other specialized bank, (such as industrial banks, agricultural banks or building societies). It finances projects in all the above mentioned fields in addition to the fact that it can work like any investment bank because it is interested in the establishment of long-term projects.

Third, conventional banks do not get involved in the buying and selling or even the keeping of commodities, only within certain conditions. Also these banks, in accordance with their charters, can not buy capital assets or fixed assets unless they are used by the bank itself13. As for Islamic banks, they can trade with all types of commodities and can keep capital assets and establish limited companies or other types of companies. Fourth, the conventional bank promises to pay fixed rates on its deposits,

regardless of whether it makes profits or losses. The Islamic bank however, does not promise profits; if it made any profits during the financial year it would give the depositors the agreed rates; conversely, if the bank made losses, the depositors would share the burden together with the bank. 12 (Al-Hawari, 1996). 13 (Al-Hawari, 1996) 24 Fifth, any conventional or commercial bank can issue excellence share, which has fixed rate from the profits, but the Islamic bank can not do that because they are of limited interests14 .

Sixth, all reserves in the commercial or conventional banks are deducted from the net profit, but in the Islamic bank they are deducted only from the net profit ear-marked for the share-holders15 . Seventh, a considerable part of the conventional or commercial bank’s funds are directed towards commercial (business) loans , but the majority of the funds in the Islamic bank are directed toward Al-Musharaka finance (shared finance or partnership companies), Mudarabah finance (speculative finance) or resale with specification of gain or other .

Eighth, regardless of their rate of profits, the Islamic banks prohibit the production of trading with certain prohibited goods and services in Islam 16such as: – The finance of breweries or meat processing companies dealing with pigs. – The finance of gambling casinos. Ninth, one of the characteristic features of the Islamic banks is the existence of what is called `Al-zakat fund’. This seeks to establish social equality. Such funds are found in the Kuwaiti Finance House (KFH), the Islamic Bank of Jordan (IBJ) and various other Islamic banks. This fund is financed by taking 2.

5% of the bank’s capital every year, with the bank’s customers are given the option of paying their Zakat to the bank. Finally, the importance of the 5Cs (capital, capacity, collateral, character, and condition): The Islamic banks attach varying degrees of importance to the elements of the 5Cs from that of the conventional or commercial banks. The commercial bank may give priory to the collateral, whereas the Islamic bank gives priority to character of customer. The commercial bank is perhaps more interested in the capital and capacity, but the Islamic bank is found to be more interested in capacity than in capital.

On the other hand, there may be some similarity between the commercial bank and the Islamic bank on the issue of priority attached to the security and soundness of any project submitted to the bank for the purpose of financing Obstacles There are several crucial factors which are absent from Islamic finance or are present only in part and spread diversely. Current problems of Islamic banks may be summarized as follows’: 1. Shortage of experts in Islamic banking: The supply of trained or experienced bankers has lagged behind expansion of Islamic banking.

The training needs affect not only Arab, both Islamic and non-Islamic are domestic banks. But also foreign banks. Academic institutions. international organizations, and transnational firms must respond to the need by organizing training materials, lectures. and workshops, 2. Absence of accounting (and auditing) standards affectsto Islamic banks: Uncertainty in accounting principles involves revenue realization, disclosures of accounting information, accounting bases. valuation, revenue and expense matching, etc. Thus.

the results of Islamic banking schemes may not be adequately defined. particularly profit and loss shares attributed to depositors. 34 3. Lack of uniform standard of credit analysis, especially for PLS schemes. Similarly, there is a widespread training involving related aspects such as financial feasibility studies, monitoring of ventures, and portfolio evaluation. 4. Potential conflicts with central banks: Islamic banks have been established as separate legal entities; therefore, their relationships with central banks and other commercial banks are uncertain.

Problems may be complicated, Islamic bank is established in a non-Muslim nation, and is subject to that nation’s rules and requirements. 5. Potential conflict between domestic banks. foreign banks, and Islamic banks : It appears that domestic banks and Foreign banks will experience continuing difficulty in adopting Islamic banking practices, including the PLS scheme, until they can become more confident of the results of investing ventures. 6. Lack of a deposit insurance system: The lack of such a system becomes more grave, because Islamic banks generally don’t have standard measures of reserve requirements or liquidity ratios