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Although Islamic commercial banks have many products similar to those offered by conventional banks, the two entities differ conceptually. One key difference is that conventional banks earn their money by charging interest and fees for services, whereas Islamic banks earn their money by profit and loss sharing, trading, leasing, charging fees for services rendered, and using other sharia contracts of exchange. Following are four key ways that conventional and Islamic commercial banks differ.
Interpreting each principle is more difficult than you may think. &cholars spend their lifetimes learning all they can about the intent and past interpretation of sharia law, and they still often have differing opinions about it. 'aking sure that Islamic banks comply with sharia isn!t easy ( hence the necessity of the sharia supervisory board. )his board is the backbone of an Islamic bank* it plays a vital role in establishing and operating the bank.
)he basic purpose for establishing an Islamic bank is to promote and encourage Islamic principles. +onventional banks are profit,making organi-ations that generally aren!t based on religious principles. )hat said, earning money is also a primary function of an Islamic commercial bank. Although the bank has a specific religious purpose, it can!t serve that purpose unless it also meets the ob"ective of earning money. A bank serves no purpose at all if it can!t stay in business. Islamic banks operate based on Islamic business law /called fiqh-u-muamalat0 for their basic transactions, and they also follow the financial laws and regulations of the countries in which they operate. +onventional banks likewise operate based on a country!s financial laws and regulations, but they don!t have contact with any religious body. Islamic scholars recogni-e that money has value, but with limitations. For example, money can!t become more valuable simply because time is passing. 1owever, the value of money can increase if it!s invested in a pro"ect that itself is increasing /in si-e, in success, and so on0.
/Note: )he failure of an investment isn!t very common in Islamic banks because the banks are very concerned about their customers and make their investment choices very wisely. If they didn!t, they soon would have no customers at all.0
1. The functions and operating modes of conventional banks are based on fully manmade principles. 2. The investor is assured of a predetermined rate of interest. . It aims at ma!imi"ing profit without any restriction. $. It does not deal with Zakat.
1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. 2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). . It also aims at ma!imi"ing profit but sub#ect to Shariah restrictions. $. In the modern Islamic banking system, it has become one of the service%oriented functions of the Islamic banks to be a Zakat &ollection &entre and they also pay out their Zakat. '. )articipation in partnership business is the fundamental function of the Islamic banks. *o we have to understand our customer+s business very well. ,. The Islamic banks have no provision to charge any e!tra money from the defaulters. -nly small amount of compensation and these proceeds is given to charity. .ebates are give for early settlement at the /ank+s discretion. 0. It gives due importance to the public interest. Its ultimate aim is to ensure growth with e2uity. 3. 4or the Islamic banks, it must be based on a *hariah approved underlying transaction. 5. *ince it shares profit and loss, the Islamic banks pay greater attention to
'. (ending money and getting it back with compounding interest is the fundamental function of the conventional banks. ,. It can charge additional money (penalty and compounded interest) in case of defaulters.
0. 1ery often it results in the bank+s own interest becoming prominent. It makes no effort to ensure growth with e2uity. 3. 4or interest%based commercial banks, borrowing from the money market is relatively easier. 5. *ince income from the advances is fi!ed, it gives little importance to
developing e!pertise in pro#ect appraisal and evaluations. 16. The conventional banks give greater emphasis on credit%worthiness of the clients. 11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors. 12. 7 conventional bank has to guarantee all its deposits.
developing pro#ect appraisal and evaluations. 16. The Islamic banks, on the other hand, give greater emphasis on the viability of the pro#ects. 11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller. 12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position..