Title: Difference between Islamic Banking & Conversing Banking

Supervised by:
MR.YASIN ZIA
Submitted by:
HAZRAT NOSH
2014-ag-169
M.Com
4th Semester

Institute of Business Management Science

UNIVERSITY OF AGRICULTURE FAISALABAD

DEDICATION
I dedicated this research project to Almighty Allah.
This research project is dedicated my Parents and Teacher because whatever I am its due to my
Parents and my Teachers make me able to face different challenges and achieve those challenges
& all those who have a soft corner for me in their hearts.
I am also very thankful to my younger sister Aqsa Raziq , she support me in very field of life
(specially in educational life).

Thank you
Hazrat Nosh

ACKNOWLEDGMENT
With the name of Allah most Merciful and Beneficent
I am very thankful to Almighty Allah who gave us the opportunities, courage and insight to
explore more knowledge to complete this research project. I am also thankful to my parents
whose prayers always supported me in very task.
The research project is the check the impact of capital structure on firms performance of the
Automobile firms of Pakistan.
I am glad to express my gratitude to my supervisor Mr.Yasin Zia the Assistant professor
of IBMS Department and also a big thank to the University of Agriculture Faisalabad, which
provides me the opportunities to improve my skills.

LIST OF CONTENTS
Chapter 1

Executive summary

Chapter 2

Literature review

What is bank?

History of banking

Islamic banking

Introduction

History of Islamic banking

Islamic banking global scenario

Modes of Islamic finance

Islamic banking issues

10

Interest based banking

11

The role of interest based banks

12

Products of interest based banking

12

Islamic banking VS interest based banking

13

Similarities and differences

15

Islamic banking playing role in the economic development of Pakistan

17

Motivating factors for Islamic banking

18

Chapter 3

19

Conclusion

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CHAPTER 1
EXECUTIVE SUMMARY

This study is undertaken to understand the concept of Islamic banking and interest
based banking, the difference between the two systems and their economic implications
for an economy. In general terminologies, a financial institution or a financial
intermediary that accepts deposits and channels those deposits into lending activities,
either directly or through capital markets is given the name of bank.The prime source of
revenue and cost of funds to conventional banks (interest based banks) is charging
interest through lending and accepting deposits for interest respectively. Interest is the
major driver of operations of conventional banks although other valuable services
including guarantees, funds transfers, safety of wealth, facilitation in international trade
etc. also form a substantial part of income of banks. Islamic banking, on the other hand,
is a banking system which is in consonance with the spirit, ethos and value system of
Islam and governed by the principles laid down by Islamic Shariah. Interest free
banking is a narrow concept denoting a number of banking instruments or operations
which avoid interest. Islamic banking, the more general term, is based not only to avoid
interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and
un-social practices. In practical sense, Islamic Banking is the transformation of
conventional money lending into transactions based on tangible assets and real services.
The model of Islamic banking system leads towards the achievement of a system which
helps achieve economic prosperity.

CHAPTER 2
LITERATURE REVIEW
What is bank?
A bank is a financial institution and a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly or through capital markets.
A bank connects customers that have capital deficits to customers with capital surpluses.
History of banking
The History of Banking begins with the first prototype banks of merchants of the ancient
world that made grain loans to farmers and traders carrying goods between cities;
recorded as having occurred at about 2000 BC within the areas of Assyria and Babylonia.
Later on, in ancient Greece and during the Roman Empire, lenders based in temples made
loans and added two important innovations: the accepting of deposits and the changing of
money. Archaeology from this period in ancient China and India shows the existence also
of money lending activity.
Islamic banking
Islamic banking is based on the principles of Islamic economics an economic
framework in accordance with Islamic law (Sharia'h).
There are two types of Islamic economics:

Caliphate , the Islamic form of government representing the political unity and
leadership of the Muslim world (Islamic political framework)

Assuming the political framework is non-Islamic, therefore, seeking to integrate

some prominent Islamic tenets into a secular economic framework

Caliphate is the absolute Islamic rule, thus the economy focuses on distribution of
resources in order to meet the basic and luxurious needs of individuals in society, and the
state has a clear role in policing, taxation, managing public assets, and ensuring the
circulation of wealth. Such a political framework in its true form does not exist in today's
world.
Introduction
Islamic banking refers to a system of banking or banking activity that is consistent with

Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamic
law prohibits usury, the collection and payment of interest, also commonly called riba.
Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of
gambling). In addition, Islamic law prohibits investing in businesses that are considered
unlawful, or haraam.
Islamic finance has been gaining momentum on a global scale for the last 30 years.
Many Islamic Banks have sprung up over the last few years. These changes are occurring
both in Muslim and in western countries, and are driven by a global trend amongst
Muslims to become more observant of their faith. It might have been the reason why
Islamic Banking emerged, however, today Islamic Banking is sought by Muslims and
non-Muslims due to the benefits it offers.
HISTORY OF ISLAMIC BANKING
ISLAMIC BANKING: ORIGIN, SCOPE, AND GROWTH
The first modern experiment with Islamic banking was undertaken in Egypt under cover,
for fear of being labeled as a manifestation of Islamic fundamentalism, which was
anathema to the government in power. It took the form of a saving bank based on profitsharing in the town of Mit Ghamr, lasted until 1967, by which time there were nine such
banks in the country. These banks neither charged nor paid interest, invested mostly in
trade and industry, directly or in partnership with others, and shared profits with
depositors. The 1970s heralded the arrival of a new age in Islamic finance witnessing the
establishment of the Nasr Social Bank in 1971 (Egypt), Philippine Amanah Bank in
1973, the Dubai Islamic Bank in 1975, the Kuwait Finance House, the Faisal Islamic
Bank of Sudan, and the Faisal Islamic Bank of Egypt, all in 1977, the Bahrain Islamic
Bank in 1979, and the Qatar Islamic Bank in 1981, to mention a few. By the end of 1996
the number of Islamic banks, IBs, rose to 166 with a total paid-up tier-one capital of $7.3
billion, and total assets of $137 billion. Moreover, if one excludes the Iranian and
Pakistani IBs, the countries that operate under the Islamic system of banking (along with
Sudan), only 40 percent of the paid-up capital and 30 percent of total assets are
commanded by those from other countries. These percentages do not tell the whole
picture. The 19 Gulf Cooperative Council, GCC, states command 18 percent of the total
paid-up capital, and 13 percent of total assets of all IBs. In other words, 10 Iranian, 46
Pakistani, and 19 GCC IBs totaling 75 out of 166, command 78 percent of total paid-up
capital and 83 percent of total assets for the IBs. These numbers appear impressive if one
ignores the size of a single large commercial bank in many developed economies of the

West. Thus, it is quite obvious that IBs are relatively very small and a few of them are
not even profitable
Islamic banking global scenario
Over the last three decades Islamic banking and finance has developed into a full-fledged
system and discipline reportedly growing at the rate of 15percent per annum. Today,
Islamic financial institutions, in one form or the other, are working in about 75 countries
of the world. Besides individual financial institutions operating in many countries, efforts
have been underway to implement Islamic banking on a country wide and comprehensive
basis in a number of countries. The instruments used by them, both on assets and
liabilities sides, have developed significantly and therefore, they are also participating in
the money and capital market transactions. In Malaysia, Bahrain and a few other
countries of the Gulf, Islamic banks and financial institutions are working parallel with
the interest based system.
Bahrain with the largest concentration of Islamic financial institutions in the Middle East
region, is hosting 26 Islamic financial institutions dealing in diversified activities
including commercial banking, investment banking, offshore banking and funds
management. It pursues a dual banking system, where Islamic banks operate in the
environment in which Bahrain Monetary Agency (BMA) affords equal opportunities and
treatment for Islamic banks as for interest based banks. Bahrain also hosts the newly
created Liquidity Management Centre (LMC) and the International Islamic Financial
Market (IIFM) to coordinate the operations of Islamic banks in the world. To provide
appropriate regulatory set up, the BMA has introduced a comprehensive prudential and
reporting framework that is industry-specific to the concept of Islamic banking and
finance. Further, the BMA has pioneered a range of innovations designed to broaden the
depth of Islamic financial markets and to provide Islamic institutions with wider
opportunities to manage their liquidity.

MODES OF ISLAMIC FINANCE

Murabaha
Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in
which the seller declares his cost and profit. Islamic banks have adopted this as a mode of
financing. As a financing technique, it involves a request by the client to the bank to
purchase certain goods for him. The bank does that for a definite profit over the cost,
which is stipulated in advance.
Ijarah

Ijarah is a contract of a known and proposed usufruct against a specified and lawful
return or consideration for the service or return for the benefit proposed to be taken, or
for the effort or work proposed to be expended. In other words, Ijarah or leasing is the
transfer of usufruct for a consideration which is rent in case of hiring of assets or things
and wage in case of hiring of persons.
Ijarah-Wal-Iqtina
A contract under which an Islamic bank provides equipment, building or other assets to
the client against an agreed rental together with a unilateral undertaking by the bank or
the client that at the end of the lease period, the ownership in the asset would be
transferred to the lessee. The undertaking or the promise does not become an integral part
of the lease contract to make it conditional. The rentals as well as the purchase price are
fixed in such manner that the bank gets back its principal sum along with profit over the
period of lease.
Musharakah
Musharakah means a relationship established under a contract by the mutual consent of
the parties for sharing of profits and losses in the joint business. It is an agreement under
which the Islamic bank provides funds, which are mixed with the funds of the business
enterprise and others. All providers of capital are entitled to participate in management,
but not necessarily required to do so. The profit is distributed among the partners in preagreed ratios, while the loss is borne by each partner strictly in proportion to respective
capital contributions.
Mudaraba
A form of partnership where one party provides the funds while the other provides
expertise and management. The latter is referred to as the Mudarib. Any profits accrued
are shared between the two parties on a pre-agreed basis, while loss is borne only by the
provider of the capital.

ISLAMIC BANKING ISSUES

Human Resource for Sharia'h Compliance
Users of Islamic financial services assign primary importance to Sharia'h compliance of
the services they use. It is understandable that Sharia'h noncompliance entails a serious
operational risk and can result in withdrawal of funds from and instability of an Islamic
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bank, irrespective of its initial financial soundness. Sharia'h compliance is hence a serious
matter for an Islamic bank, in addition to its compliance with other regulatory
requirements.
Unresolved Fiqh Issues
Lack of standard financial contracts and products can be a cause of ambiguity and a
source of dispute and cost. In addition, without a common understanding of certain basic
foundations, further development of banking products is hindered.
Legal framework
An appropriate legal, institutional and tax framework is a basic requirement for
establishing sound financial institutions and markets. Islamic jurisprudence offers its own
framework for the implementation of commercial and financial contracts and
transactions.

Interest based banking

Interest based banking is based on the principle that the more you have, the more you can
get. In other words, if you have little or nothing, you get nothing. As a result, more than
half the population of the world is deprived of the financial services of the interest based
banks.Interest based banking is based on collateral.Interest based banks look at what has
already been acquired by a personInterest based banks go into punishment mode when a
borrower is taking more time in repaying the loan than it was agreed upon. They call
these borrowers defaulters. When a client gets into difficulty, interest based banks get
worried about their money, and makes all efforts to recover the money, including taking
over the collateral. In interest based banks charging interest does not stop unless specific
exception is made to a particular defaulted loan. Interest charged on a loan can be
multiple of the principal, depending on the length of the loan period.

THE ROLE OF INTEREST BASED BANKS

Interest based banks engage in the following activities:

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 Processing of payments by way of telegraphic transfer, internet banking, or other

means
Issuing bank drafts and bank cheques
Accepting money on term deposit
Lending money by overdraft, installment loan, or other means
Providing documentary and standby letter of credit, guarantees, performance
bonds, securities underwriting commitments and other forms of off balance sheet
exposures
Safekeeping of documents and other items in safe deposit boxes
Sales, distribution or brokerage, with or without advice, of: insurance, unit trusts
and similar financial products as a financial supermarket
Cash management and treasury
Products of interest based banking
Products offered by mostly interest based banking usually called interest based banking
are given below

Transactional account
Savings account
Certificate of deposit
Credit card

Transactional account

A transactional account is a deposit account held at a bank or other financial institution,

for the purpose of securely and quickly providing frequent access to funds on demand,
through a variety of different channels.
Transactional accounts are meant neither for the purpose of earning interest nor for the
purpose of savings, but for convenience of the business or personal client; hence do they
tend not to bear interest. Instead, a customer can deposit or withdraw any amount of
money any number of times, subject to availability of funds.

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Savings account
savings accounts are accounts maintained by retail financial institutions that
pay interest but cannot be used directly as money in the narrow sense of a medium of
exchange (for example, by writing a check). These accounts let customers set aside a
portion of their liquid assets while earning a monetary return. For the bank, money in a
savings account may not be callable immediately and therefore often does not incur
a reserve requirement freeing up cash from the bank's vault to be lent out with interest.
Certificate of deposit
A certificate of deposit (CD) is a time deposit, a financial product commonly offered to
consumers in the United States by banks, thrift institutions, and credit unions.
CDs are similar to savings accounts in that they are insured and thus virtually risk free;
they are "money in the bank". CDs are insured by the Federal Deposit Insurance
Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA)
for credit unions.
Credit card
Credit card is a small plastic card issued to users as a system of payment. It allows its
holder to buy goods and services based on the holder's promise to pay for these goods
and services. The issuer of the card creates a revolving account and grants a line of
credit to the consumer (or the user) from which the user can borrow money for payment
to a merchant or as a cash advance to the user.
Debit card
A debit card (also known as a bank card or check card) is a plastic card that provides the
cardholder electronic access to his or her bank account(s) at a financial institution. Some
cards have a value with which a payment is made, while most relay a message to the
cardholder's bank to withdraw funds from a designated account in favor of the payee's
designated bank account. The card can be used as an alternative payment method
to cash when making purchases. In some cases, the primary account number is assigned
exclusively for use on the Internet and there is no physical card.

ISLAMIC BANKING VS INTEREST BASED BANKING

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The main difference between Islamic and interest based banking is that Islamic teaching
says that money itself has no intrinsic value, and forbids people from profiting by lending
it, without accepting a level of risk in other words, interest (known as "riba") cannot be
charged.
To make money from money is prohibited wealth can only be generated through
legitimate trade and investment. Any gain relating to this trading is shared between the
person providing the capital and the person providing the expertise.
At Islamic Bank of Britain, we generate all our profit through Shariah compliant trading
and investment activities. We then share the profits with our customers at a pre-agreed
ratio. In order to share profits you must hold one of our savings or investment account
Conventional bank

Islamic bank

1. The functions and operating modes of

conventional banks are based on fully
manmade principles.

1. The functions and operating modes of

Islamic banks are based on the principles
of IslamicShariah.

2. The investor is assured of a

predetermined rate of interest.

2. In contrast, it promotes risk sharing

between provider of capital (investor) and
the user of funds (entrepreneur).

3. It aims at maximizing profit without any 3. It also aims at maximizing profit but
restriction.
subject to Shariah restrictions.
4. It does not deal with Zakat.

4. In the modern Islamic banking system, it

has become one of the service-oriented
functions of the Islamic banks to be
a Zakat Collection Centre and they also
pay out their Zakat.

5. Lending money and getting it back with 5. Participation in partnership business is

compounding interest is the fundamental
the fundamental function of the Islamic
function of the conventional banks.
banks. So we have to understand our
customer's business very well.
6. It can charge additional money (penalty
and compounded interest) in case of
defaulters.

6. The Islamic banks have no provision to

charge any extra money from the
defaulters. Only small amount of
compensation and these proceeds is given
to charity. Rebates are give for early
settlement at the Bank's discretion.

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7. Very often it results in the bank's own

interest becoming prominent. It makes no
effort to ensure growth with equity.

7. It gives due importance to the public

interest. Its ultimate aim is to ensure
growth with equity.

8. For interest-based commercial banks,

borrowing from the money market is
relatively easier.

8. For the Islamic banks, it must be based

on a Shariah approved underlying
transaction.

9. Since income from the advances is

fixed, it gives little importance to
developing expertise in project appraisal
and evaluations.

9. Since it shares profit and loss, the

Islamic banks pay greater attention to
developing project appraisal and
evaluations.

10. The conventional banks give greater

emphasis on credit-worthiness of the
clients.

10. The Islamic banks, on the other hand,

give greater emphasis on the viability of
the projects.

11. The status of a conventional bank, in

11. The status of Islamic bank in relation to
relation to its clients, is that of creditor and its clients is that of partners, investors and
debtors.
trader, buyer and seller.
SIMILARITIES AND DIFFERENCES
Islamic Financial Institutions (IFIs) are operating in the same society where interest based
banks are operating and perform all those functionswhich are expected from afinancial
institution. IFIs are assisting business world by
providing all the services required to run the economy smoothly, however, the
philosophy and operations are different. In this section I will analyze the
operations and products of IFIs in comparison with traditional
Interest based banks. Any financial system is expected to assist in running the economy
by providing the following
Services grouped in two headings.
First; Savings mobilization from savers to entrepreneurs and
Second; Provision of general utility services including transfer of funds, facilitation
in international trades, consultancy services,
Safekeeping of valuables, and any other service for a fee. There is no restriction
onprovision of such services byIFIs as for the service is not against the Sharia.
However there exists difference in mechanism of fundsmobilization from savers to
entrepreneurs as described following. Savings mobilization consists of two phases i.e.
Accepting deposits and extending financing and investments.

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Deposits
Deposits are collected from savers under both types of institutions for reward irrespective
a bank is operating underinterest based system or Islamic system. The differencelies in
agreement of reward. Under interest based systemreward is fixed and predetermined
while under Islamic deposits are accepted through Musharaka and Mudaraba where
reward is variable. Under interest based banking return is higher on long-term
deposits and lower for short-term deposits. Same is the practice in Islamic banking
to share profit with depositors. Higherweight for profit sharing is assigned to
long-term deposits being available to bank for investing in longer termprojects
yielding superior returns and lower weight for short-term deposits which cannot be
invested in long termprojects. The only difference in interest based and Islamic
system lies in sharing of risk and reward.
Financing and Investments
The second phase in savings mobilization process is extension of credit facility to
business and industry forreturn. Both types of institutions (Islamic and Interest
based) are providing financing to productive channels forreward. The difference lies
in financing agreement. Interest based banks are offering loan for a fixed reward
whileIFIs cannot do that because they cannot charge interest. IFIs can charge profiton
investments but not interest onloans. In interest based banking three types of loans are
issued to clients including short term loans, overdrafts andlong-term loans. Islamic
banks cannot issue loans except interest free loans (Qarz e Hasna) for any
requirementhowever they can do business by providing the required asset to client.
Overdrafts / Credit Cards
Interest based banks offer the facility of overdrawing from account of the customer on
interest. One of its form isuse of credit card whereby limit of overdrawing for customer is
set by the bank. Credit card provides dual facility
Tocustomer including financing aswell as facility of plastic money whereby customer can
meet his requirementwithout carrying cash. As for facility of financing is concerned that
is not offered by Islamic banks exceptin the
form of Murabaha (which means IFI shall deliver the desired commodity and not
the cash) however facility toshop/meet requirement is provided through debit card
whereby a customer can use his card if his account carries
Credit balance. Under interest based banking a customer is charged with interest once
the facility availed howeverunder Murabaha only profit is due when the commodity
is delivered to the customer.

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Investments
In order to maintain liquidity interest based banks have many avenues including
government securities, shorterterm loans and money at call and short notices, leasing
companies bonds, investment in shares
etc.
Interestinglymandatory reserve
maintenance by interest based banks with central banks is also rewarded in the form of
interest.Interest based banks can also create liquidity by issuing the bonds against their
receivables. Commercial banks arealso protected by central bank by providing
liquidity in rainy days for interest. Interbank deposits are alsorewarded in the form
of interest by commercial banks.
ISLAMIC BANKING PLAYING ROLE IN THE ECONOMIC DEVELOPMENT
OF PAKISTAN
Islamic banking is unique, but by no means anomalous. It is neither at odds with nor
incomparable to interest based banking. Is it possible to contrast the two models?
I-They are both financial intermediations. A financial intermediary is the institution
that acts as a middleman between cash surplus units (savers) and deficit spending units
(users of fund). It is quite obvious that the main function of interest based banks is
financial intermediation. However, there are those who would like to think that there
is no such thing in the Islamic economic system as financial intermediation and that an
Islamic bank can only be sufficiently Islamic if it can operate like a trader, one who
buys and sells goods and commodities.
II-A case in mind is Murabaha. There are those who say if an Islamic bank does
Murabaha any other form but the traders way of doing things it will not be permissible
from Shari'ah point of view, and an Islamic bank would be in their view a dubious
interest based bank. They say: since it is never the intention of the bank, to own there
assets and hold on to them then, such bank is not sufficiently Islamic.

III-The way interest based banks render financial intermediation is very simple. They
borrow money and lend money. Both assets and liabilities are one form of lending.
Islamic banking function in a rather elaborate (not perplexing) way. They have to
continuously innovate to satisfy the needs of their clients. It is because of this we see
Murabaha, Musharakah, Mudarabah, Istisnaa, Salam to name just a few Islamic
modes of finance. This makes the job of an Islamic banker not all roses, but
certainly a more interesting one.

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IV-A interest based banker is a risk manger. He is concerned with all kind of credit,
market, interest rate, legal and other risk factors. An Islamic banker should be just as
concerned. However, there is one added risk for the Islamic banker, this is what we
may call Shari'ah disobservance risk. Risk analysis refer to the forces that may
cause the outcome of investment to be sub optimal.

MOTIVATING FACTORS FOR ISLAMIC BANKING

Motivation and renewed interest in Islamic finance industry stems from its strong
economic, financial and social considerations, backed by its unique features.
Most significant is its appeal to add to financial diversity and innovation being skewed
towards:
(i)

Asset backed and equity based transactions, which promote entrepreneur

friendliness and consideration of project viability

(ii)

Equitable distribution of risks and rewards among the stakeholders;

(iii)

Inculcating market discipline and higher ethical standards given its

emphasis on non-exploitation and social welfare.

In the wake of high Asian domestic savings rates and build up of the regions foreign
exchange reserves as well as oil surpluses of Middle East in the last few years, Islamic
finance is now also emerging as a way to wealth management, both of richer nations and
highnet worth individuals.

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CHAPTER 3
CONCLUSION

Hence we conclude that the interest based banking is totally dependent upon the interest
in every aspect of banking while the Islamic banking is totally against the interest in
every aspect of banking so due to the interest the Islamic banking and the interest based
banking have very differences which are mainly in product that they are offeringjust like
the interest banks offers credit cards, debit cards, loans on interest ,leasing on interest etc
but the Islamic banking offer different products which are totally on the Islamic halal
rules Murabaha ,Ijarah ,Ijarah-Wal-Iqtina ,Musharakah ,Musawamah ,Istisna'a ,Bai
Muajjal etc.so these products are totally different from that of interest based banking

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