Islamic Banking

This is not the case. Islamic banks accept deposits from customers on profit and loss sharing or on the basis of “Qard”. These funds are used in Shariah compliant modes of finance, trade or investment. The income generated by these Shariah compliant modes are then distributed among the depositors as profit.

CONVENTIONAL BANKING

1. Money is a commodity as well as a medium of exchange. Therefore, it can be sold at a price higher than its face value and it can also be rented out.
2. Profit is earned by charging interest on capital. ‘Time value’ is the basis for charging interest on money/capital.
3. Interest is charged even in case the organisation suffers losses by using the bank’s funds. Therefore, it is not based on profit and loss sharing.
4. While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods and services is made.
5. Conventional banks use money as  a commodity which leads to inflation.

ISLAMIC BANKING

1. Money is not a commodity. It is only used as a medium of exchange. Therefore, it cannot be sold at a price higher than its face value or rented out.
2. Profit is earned through trade of goods or charging for providing services.
3. Islamic banks may operate on the basis of profit and loss sharing. If the business has suffered losses, the bank will share these losses based on the mode of finance used (e.g. Mudarabah and Musharakah).
4. The execution of agreements for the exchange of services is a must while disbursing funds under  Murabaha, Salam and Istisna contracts
5. Islamic banking tends to create link with the real sectors of the economic system by using trade  related activities. Since money is linked with real assets, it contributes directly to economic development.

Mudarabah is an arrangement in which a person (called Rab-ul-Mal) participates with his money and another person (called Mudarib) participates with his efforts. The parties agree, at the beginning, on a profit sharing ratio between them.

Musharakah is a partnership contract. The profits are shared as per agreed ratios between partners and losses are borne in proportion to their respective capital contributions.

Diminishing Musharakah (DM) is a form of co-ownership in which two or more persons share the joint ownership of a tangible asset (e.g. house) in an agreed proportion. It is agreed that one of the co-owners will purchase, in periodic instalments, the share of the other co-owner until the ownership of that tangible asset is completely transferred to the purchasing co-owner. Furthermore, along with the purchase of share, the (purchasing) co-owner will also make periodic payments for the usage of other co-owner’s share in the asset.

Musawamah is the general sale of goods whereby the seller is not obliged to disclose to the buyer the cost of goods sold.

Salam is a sale transaction in which the seller agrees to supply specific goods to the buyer at a future date against an advance payment which is fully paid at spot. The basic purpose of Salam is to meet he needs of the small farmers for the production of agricultural products.

Istisna is a sale transaction where a commodity is transacted before it comes into existence. In Istisna, the buyer is given an order to manufacture a specific commodity. Following are necessary conditions for Istisna:

– Price is fixed with the consent of parties.

– The specification of the commodity to be manufactured must be agreed between parties.

Ijarah is a type of rental contract whereby the owner of an asset (e.g. house), transfers the right to use to another person for an agreed period and price.

Wakalah is an agency contract in which one person appoints another person as his agent to perform a certain task on his behalf on agreed terms and conditions, usually against a certain fee. A contract of Wakalah can take place only in respect of such acts which the principal is competent to perform himself, provided such act can be performed by the agent.

Kafalah is a contract in which a third party becomes surety i.e. provides guarantee for the payment of debt on behalf of the debtor. It is a pledge given by a third party to a creditor to the effect that if the debtor defaults in payment of the debt, it will be paid by said third party as Kafeel or guarantor.

Qard is a loan contract between two parties where borrower is required to repay only the sum borrowed. It is not allowed for lender to charge any compensation under a qard/loan contract.