Comparison of Islamic and Conventional Banking System – Term Paper

Comparison of Islamic and Conventional Banking System

Banking is an integral part of every economy in the current world as it controls the finances and financial statuses of almost every citizen in any country. The banking system has undergone various changes throughout its development, with mobile banking being of the latest stages.

The history of banking can be traced back to the prophetic times. One of the examples is the story of Judas, who was Muhammad’s treasurer and kept all his financial records, but later betrayed Muhammad since he was the only one exposed to finances and valued money the most among all the disciples. Banking during the prophetic period was in conformity with Sharia law that drove the economics of Islamic world (Hewetson, 2016). There are also stories about Ananias and his wife Saphira who stole from the treasury of the templ,e and Zacchaeus the tax collector who was a corrupt official but later changed his ways for the better. It is believed that the types of currencies used during the prophetic times were gold, silver, and dinars, with any financial transactions performed in terms of these currencies (Nandy, 2010).

Muhammads grandfather, Abd al-Muttalib, was given visions to find the treasure that could solve all the economic problems of the Jews. He found the treasure and was later crowned as the hero of Mecca. He formed a strong economic base for the Jews and laid a strong foundation of banking services that relates to the banking system in the modern society. He started lending services that did not require interest payment;(Young, 2013).

The omission of interest charges was in line with the requirement of Sharia law and served to reduce the exploitation of the poor since with freedom to charge interest on the borrowed money, other lenders were also at liberty to charge interests at unspecified interest rates. Elimination of interest on the amount of the borrowed money also served to uphold the teachings of the prophet, promote love between the individuals in the society and the spirit of helping one another in the community;(Doraiswamy, 2009). Finally, Abd al-Muttalib taught the nation that the main aim of lending was to encourage growth and development among the members of the communities, and that it was not meant to be a form of business. In the modern society, however, lending institutions charge the interest, which serves to increase their capital and facilitate their financial growth. The charging of interest by modern banking institutions also leads to the consolidation of funds to enable them to renumerate their employees and pay taxes required by corresponding legislation..

The practices implemented by Abd al-Muttalib were passed from one generation to the other. It formed the traditional mode of banking for the Muslim community. The formation of Islamic banks, which is dated to 1970s, marked the beginning of Islamic banking systems. This system followed the traditional modes of financial support practiced at that time. Thus, the banks were not allowed to collect interest on the borrowed money as the main reason of lending was to improve the economic status of the people.

The emergence of conventional banks, popularly known as western, is traced back to the 14^th century. History states that the banking principles emerged from the traders of the Medieval Italy during those times. Later, the lenders accepted deposits from the people and hence acted like banks. This trend continued to spread across Europe. Ancient Greece had a lot of activities and businesses and adopted the trends. In the Roman Empire, the lenders were based in temples. They also accepted deposits from their clients. The lenders in Europe developed the system to multiply their money: to charge interests for the borrowed amounts. Italian lenders developed and grew rapidly in terms of economic net worth. There was a lender by the name Geovanni Medici who accumulated his capital until he opened the first bank, Medici Bank, in 1397 (Capie, 1993). The growth of banking industry in Italy sparked development of more small banks across Europe. As time went by, the banks grew and spread to the American continent, but they concentrated more on their growth and therefore charged enormous interest on the capital loaned to individuals.

Although in the western banking system, lending on an interest basis is to help improve the economic status of the people, just like in the Sharia compliant banking system, western banks are allowed to charge interest in order to grow as well. Financial institutions that adhere to the western banking system are said to be conducting conventional banking practices. These banks are spread all over the world unlike the Islamic banks, which are only concentrated in the Middle East and the Sub-Saharan regions of Africa. Conventional banks are more business oriented, while the Islamic banking systems main motive is to help people. Although some nations have provided restrictions on the interest rates that the conventional banks charge, the exact percentage is not specified in these restrictions (Capie, 1993).

Global migration led to coexistence of the people of different religions and cultures in the same society. Wherever the people go, they will always try to operate within their usual financial system (Esam, 2013). This has caused the emergence of new banking systems within the countries. For instance, in the US, there has been a growth of Islamic banking institutions, which has further led to the growing number of Sharia compliant banks across the world.

According to the report by International Financial Service London (IFSL), the assets of Islamic banks have been on the steady increase since 1990 and recorded $463bn in 2006 (Young, 2013). According to Young (2013), the assets owned by these banks exceeded the assets of conventional banks in the US which had a total of $1.8bn. These numbers show that the banks have a very big impact on the global financial situation.

There is an emerging trend among the banking systems that the financial institutions have adopted. The trend includes incorporation of Sharia policies in the conventional banks, and it has been implemented by the banks in Africa and in the Middle East. Some conventional banks in these regions have introduced Sharia compliant policies to their practices either by forming a department within the same institution or opening a separate branch that practices the principles of the Islamic banking system. This trend has been so widespread since conventional banks want to provide services to representatives of all cultures and religions.

In summary, since the inception of financial institutions, the banking systems across the globe have been working on assisting individuals and legal entities in their private and business financial activities. Based on the comparison of Islamic and western banking systems, it can be concluded that the main difference lies in the purpose of lending – while institutions abiding by Sharia law do not charge interest on the borrowed money, conventional banks objective to grow conditions the requirement to include interest on every loan. However, the recent trend shows that western banks have been implementing Islamic practices to their activities in order to provide multicultural services.

Bibliography

Capie, F. (1993).;History of banking. London: W. Pickering.

Doraiswamy, A. (2009). Security Testing Handbook for Banking Applications. IT Governance Ltd.

Esam F. (2013), Comparative Performance Study of Conventional and Islamic Banking in Egypt, Journal of Applied Finance ; Banking, vol. 3, no. 2, 2013, 1-14 ISSN: 1792-6580 (print version), 1792-6599 (online) Scienpress Ltd, 2013

Hewetson, C. (2016).;Banking litigation. 4th ed. [Place of publication not identified]: Sweet ; Maxwell.

Nandy, D. (2010). Banking Sector Reforms in India and Performance Evaluation of Commercial Banks. Universal-Publishers.

Young, M. (2013). Banking Secrecy and Offshore Financial Centers: Money Laundering and Offshore Banking. Routledge.