The core principles that underpin Islamic finance and conventional banking systems are starkly different. Conventional banking operates on the basis of interest-based transactions, where the lender charges interest on loans, and depositors earn interest on their savings. In contrast, Islamic finance strictly prohibits the collection and payment of interest, known as riba, which is considered unlawful under Sharia law.
Risk-Sharing Approach
Islamic finance emphasizes the concept of risk-sharing, where both the financial institution and the customer share the risks and rewards associated with the investment or financing. This is achieved through profit-and-loss sharing arrangements, such as mudarabah (profit-sharing) and musharakah (joint venture). Conversely, in conventional banking, the lender bears minimal risk, and the borrower assumes the bulk of the risk.
Asset-Backing Requirement
Financial transactions in Islamic home finance must be backed by tangible, real assets, such as property or commodities. This ensures that money is not generated from thin air but is linked to productive economic activities. Conventional banking, on the other hand, often deals with abstract financial instruments and derivatives, which may not have a direct connection to real assets.
Ethical and Social Responsibility
Islamic finance places a strong emphasis on ethical and socially responsible investment. Financial activities must comply with Sharia principles, which prohibit investments in industries deemed unethical, such as gambling, alcohol, or weapons. Conventional banking, while increasingly emphasizing ethical practices, does not have a comprehensive ethical screening process.
Wealth Distribution and Economic Development
Islamic finance promotes the concept of profit-sharing and participatory modes of financing, which foster a more equitable distribution of wealth and encourage entrepreneurship and economic development. Conventional banking primarily focuses on maximizing profits for shareholders and stakeholders.
Objectives and Goals
While conventional banking primarily focuses on maximizing profits, Islamic finance aims to strike a balance between generating returns and promoting social welfare. It emphasizes the principles of brotherhood, solidarity, and mutual cooperation, which are deeply rooted in Islamic teachings.
Despite these fundamental differences, both Islamic finance and conventional banking systems operate within the broader financial landscape and share some similarities in terms of operational practices and regulatory frameworks. However, the underlying principles and objectives remain distinct, reflecting the unique values and beliefs of each system.
