CONVENTIONAL BANKING VS ISLAMIC BANKING

Pakistan is one of those few countries where 2 forms of baking exist, Conventional banking and Islamic banking and both are two distinct systems with different principles and practices. Conventional Bank treats money as a commodity and lends it against interest as its compensation. Islamic banking products are usually asset-backed and involve trading of assets, renting of assets, and participation on a profit & loss basis. Relation between the customer & bank is of Creditor-Debtor. Conventional banking follows conventional financial practices, while Islamic banking operates based on Islamic principles.

Here, let me explain this further, Conventional banking is the widely practiced form of banking around the world. Some key features include: - Interest-based system: Conventional banks charge interest on loans and provide interest on deposits. - Investment in any sector: Conventional banks can invest in any legal business or industry. - Risk and profit sharing: Conventional banks do not involve risk and profit sharing with their customers.

While Islamic Banking operates under the principles of Islamic law (Shariah). Some of its key features are an Interest-free system: Islamic banks strictly avoid charging or paying interest. Instead, they utilize alternative methods to ensure equitable transactions. - Ethical investments: Islamic banks are prohibited from investing in certain sectors such as alcohol, gambling, and pork-related businesses. - Risk and profit sharing: Islamic banks emphasize risk and profit sharing with their customers, promoting a more equitable distribution of wealth.

There are differences as well, both conventional and Islamic banks provide similar services, including checking accounts, savings accounts, and various forms of financing. The core difference lies in the underlying principles and mechanisms used. Major differences between both forms of banking are: 1. Interest: Conventional banks rely on interest as a primary source of revenue, whereas Islamic banks strictly avoid interest-based transactions. 2. Investment: Islamic banks follow ethical investment guidelines, avoiding sectors that conflict with Islamic principles. Conventional banks have no such restrictions. 3. Risk and Profit Sharing: Islamic banks emphasize sharing both risks and profits with their customers, fostering a more cooperative relationship, while conventional banks do not emphasize this principle. It's important to note that these are just general descriptions, and the actual practices may vary between different banks and countries

Core similarities between conventional banking and Islamic banking share are in terms of services offered but differ in their underlying principles. Core areas of operation for each form are:

Under Conventional Banking Umbrella we include:

1. Retail Banking: This includes services such as personal checking and savings accounts, loans (such as mortgages, auto loans, and personal loans), credit cards, and other traditional banking services tailored for individuals and small businesses.

2. Corporate Banking: Conventional banks provide a range of financial services to larger businesses, including lending for capital investments, working capital financing, trade finance, cash management, and treasury services.

3. Investment Banking: This area involves activities like underwriting, mergers and acquisitions, advisory services, securities trading, and capital market activities for corporate clients.

4. Wealth Management: Conventional banks offer services to manage and grow the wealth of high-net-worth individuals, including investment advisory, portfolio management, estate planning, and private banking services.

While in the case of Islamic Banking:

1. Islamic Retail Banking: Islamic banks offer similar retail banking services, but with Shariah-compliant products. This includes Islamic current accounts, savings accounts, home financing (based on the concept of Murabaha or Ijarah), Islamic credit cards, and other ethical financial services.

2. Islamic Corporate Banking: Islamic banks provide financing solutions that comply with Shariah principles, such as trade finance, project financing (based on Musharakah or Ijarah), working capital finance, and other services tailored for businesses.

3. Islamic Investment Banking: Islamic investment banks engage in Shariah-compliant investment activities, including Sukuk issuance (Islamic bonds), Islamic equity investments (based on Mudarabah or Musharakah), and other investment banking services that adhere to Islamic principles.

4. Islamic Wealth Management: Islamic banks offer wealth management services that align with Shariah guidelines. This includes Islamic portfolio management, Islamic mutual funds, Islamic trusts, and other wealth management solutions for individuals and institutions seeking ethical investment options. These core areas reflect the common services provided by both conventional and Islamic banks but with Islamic banking tailored to adhere to the principles of Shariah.

Both forms of banking have their pros and cons.

Islamic Banking Pros: 1. Ethical Principles: Islamic banking follows Shariah principles, which prohibit interest and promotes ethical and socially responsible investments. 2. Risk Sharing: Islamic banks promote a risk-sharing model, where both the bank and the customer share profits and losses. This can foster a sense of partnership and fairness. 3. Asset-backed Financing: Islamic banking emphasizes asset-backed financing, ensuring transactions are based on tangible assets or real economic activities. 4. Financial Inclusion: Islamic banking offers products and services that cater to the needs of a diverse customer base, including microfinance and Islamic social finance solutions.

Islamic Banking Cons: 1. Limited Product Offerings: Islamic banks might have a more limited range of products compared to conventional banks, as they need to comply with Shariah principles. 2. Higher Costs: Islamic banking products may sometimes have higher costs due to the complexities involved in developing Sharia-compliant structures. 3. Lack of Standardization: There can be variations in Shariah interpretations across different Islamic banks, leading to a lack of standardization in products and practices.

Conventional Banking Pros: 1. Wide Range of Products: Conventional banks offer a wide range of products and services tailored to various customer needs, providing more flexibility and choice. 2. Established Infrastructure: Conventional banks generally have well-established and extensive networks, making banking services easily accessible. 3. Global Acceptance: Conventional banking is widely accepted and practiced globally, making it easier for international transactions and interactions.

Conventional Banking Cons: 1. Interest-based System: Conventional banking relies on interest, which may be seen as unethical or exploitative by some individuals or communities. 2. Risk Transfer: In conventional banking, the burden of risk often falls solely on the borrower, as the bank charges interest regardless of the outcome of the borrower's venture. 3. Financing Restrictions: Conventional banks may have fewer restrictions on the sectors they finance, which can lead to financing activities that are ethically or environmentally questionable.

A million-dollar question that is there in everybody’s mind is: Which is better for the people of Pakistan?

The choice between Islamic and conventional banking depends on individual preferences, beliefs, and financial needs. Pakistan has a significant Muslim population, and Islamic banking has gained popularity over the years due to its alignment with Islamic principles. Islamic banking can be a preferred choice for individuals seeking Shariah-compliant financial services and those who prioritize ethical investments. However, conventional banking still offers a wide range of products, greater market presence, and flexibility. Ultimately, individuals in Pakistan need to evaluate their personal values, financial goals, and the offerings of different banks to make an informed decision that best suits their needs. Consulting with financial advisors and considering individual circumstances is recommended to make a well-informed choice.

      

The future prospects of both Islamic and conventional banking are influenced by various factors, including global economic trends, regulatory frameworks, customer preferences, and technological advancements. While it is challenging to predict with certainty which one will thrive, here are some insights:

Islamic Banking: 1. Growing Demand: Islamic banking has witnessed significant growth globally, driven by the increasing demand for Sharia-compliant financial products and services. This trend is expected to continue, particularly in Muslim-majority countries and regions with a high Muslim population. 2. Financial Inclusion: Islamic banking has the potential to promote financial inclusion, as it caters to the needs of diverse customer segments, including those who prefer ethical and interest-free banking options. 3. Innovation and Product Development: Islamic banks are actively working on developing innovative Shariah-compliant products to meet the evolving needs of customers. This includes digital banking solutions, fintech collaborations, and new investment avenues.

 Conventional Banking: 1. Established Infrastructure: Conventional banking has a well-established global presence and an extensive network, providing a strong foundation for growth and adaptability. 2. Technological Advancements: Conventional banks are investing heavily in technology to enhance customer experiences, streamline operations, and provide innovative services such as mobile banking, digital payments, and personalized financial solutions. 3. Market Adaptation: Conventional banks have the flexibility to adapt to changing market dynamics and regulatory requirements, allowing them to navigate evolving financial landscapes effectively.

Something worth noting here is that both Islamic and conventional banking can coexist and cater to different customer preferences and market segments. The future of banking will likely see a convergence of practices, with conventional banks incorporating ethical and sustainable principles, and Islamic banks adopting digital innovations. In summary, while Islamic banking is projected to continue expanding, especially in Muslim-majority regions, conventional banking's established infrastructure, technological advancements, and adaptability may contribute to its continued growth as well. Ultimately, the success of each banking system will depend on its ability to meet customer needs, embrace innovation, and adhere to sound financial practices.

BY: OVAIS ASAD KHAN