Five fundamental ways Islamic banking is different from conventional banking

The rapid growth of Islamic banking has attracted much attention lately across the world.\

The two-trillion dollar global Islamic finance industry has grown as a mechanism for financing development, including in non-Muslim countries.

In east Africa, Kenya has positioned itself as the region’s biggest hub for Islamic finance.

The government sees Islamic financing as part of the effort to stimulate economic growth, and to help set the sector up as a source of development funding.

Islamic finance is a about profit-sharing, and prohibits the collection and payment of interest, or riba.

Here are five ways Islamic banking is different from conventional banking:

1. Unlike in conventional where money is a commodity besides being a medium of exchange, Islamic banking does not treat money as a commodity. Therefore, it cannot be sold at a price higher than its face value or rented out.

2. Under Islamic banking, profit on trade of goods or charging on providing service is the basis for earning profit. This is unlike conventional banking where time value is the basis for charging interest on capital.

3. Islamic banking tends to create link with the real sectors of the economic system by using trade related activities unlike conventional banks which use money as a commodity which leads to inflation.     

4. Islamic bank operates on the basis of profit and loss sharing. In case, the businessman has suffered losses, the bank will share these losses based on the mode of finance used (Mudarabah, Musharakah).

Mudarabah is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise.

Musharakah or Musharaka is a word of Arabic origin which literally means sharing. In the context of business and trade it means a joint enterprise in which all the partners share the profit or loss of the joint venture.

This is unlike conventional banks which charge interest in case the business suffers losses by using the bank’s funds. Therefore, conventional banking is not based on profit and loss sharing.

5. Under Islamic banking, the execution of agreements for the exchange of goods and services is a must, while disbursing funds under Murabaha, Salam & Istisna contracts. Under conventional banking, while disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made.